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) economic, political, or regulatory changes 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) subject to 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. Estimates and assumptions are 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.

26 -------------------------------------------------------------------------------- Table of Contents Business Overview We are a leading global manufacturer of a wide variety of capacitors. Our product offerings include tantalum, multilayer ceramic, solid and electrolytic aluminum and film and paper 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 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. 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 six month period ended September 30, 2012, we shipped approximately 17 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 10,000 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 six month period ended September 30, 2012 and for fiscal year 2012, our consolidated net sales were $439.6 million and $984.8 million, respectively.

We are organized into three business groups: Tantalum, Ceramic, and Film and Electrolytic. The Film and Electrolytic business group operates 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. In addition, all corporate costs 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 persistent 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 six month period ended September 30, 2012. Our largest customer is a distributor, and no single end use customer accounted for more than 7% of our net sales in the six month period ended September 30, 2012. We believe that well-balanced product, geographic and customer diversification helps 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 and have a 27 -------------------------------------------------------------------------------- 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 six month periods ended September 30, 2012 and 2011, respectively, specialty products accounted for 40.5% and 37.4% 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 and 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 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 system which is now in place and growing.

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 to 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.

28 -------------------------------------------------------------------------------- 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 second quarter of fiscal year 2013, we introduced 31,126 new products of which 19,166 were first to market, and specialty products accounted for 40.5% 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.

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 Net sales for the quarter ended September 30, 2012 were $216.0 million, which is an 18.7% decrease over the same quarter last fiscal year. Net sales for the six month period ended September 30, 2012 were $439.6 million, which is a 20.8% decrease over the same period last fiscal year.

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 Our annual goodwill impairment test is assessed as of May 31st of each fiscal year. Testing was not completed prior to the deadline for filing our Form 10-Q for the first quarter ended June 30, 2012. Due to reduced earnings and cash flows caused by macro-economic factors and excess capacity issues in our industry, we revised our earnings forecast; and as a result, 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.

29 -------------------------------------------------------------------------------- Table of Contents Write Down of Long-Lived Assets During the second quarter of fiscal year 2013, the Company incurred impairment charges totaling $4.2 million related to Film and Electrolytic Business Group ("Film and Electrolytic"). In connection with the consolidation of two manufacturing facilities within Italy, the Company obtained appraisals for these facilities. These appraisals indicated that there was a decrease in the market price of the manufacturing facilities; and therefore, the carrying amounts for 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) exceeds 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 the previously announced intent to acquire a 34% economic interest in NEC Tokin by KEMET Electronics Corporation, our wholly owned subsidiary. On October 29, 2012 we were informed by the Chinese Ministry of Commerce ("MOFCOM") that its regulatory review of this proposed transaction would be extended by a period of no more than 60 days, expiring December 31, 2012. Such an extended review period is not uncommon, and MOFCOM can grant regulatory clearance at any time during such review period.

MOFCOM has not informed us of any substantive concerns regarding the proposed transaction. While a definitive closing date cannot yet be determined, we now expect that the transaction will close either near the end of our third fiscal quarter ending December 31, 2012, or during our fourth fiscal quarter ending March 31, 2013.

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 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-two months after the date of the Advance Payment, the 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. 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, which are expected to result in additional termination charges of approximately $4.0 to $4.5 million during the second half of fiscal year 2013. In addition, we are beginning the restructuring of our Evora, Portugal manufacturing facility which is expected to be completed during our fourth quarter ending March 31, 2013. As a part our ongoing commitment to expand our polymer capacity we will be moving certain Tantalum manufacturing equipment from the Evora, Portugal facility to our manufacturing facility in Mexico and the remainder of the equipment will be disposed. We will write-off approximately $5.0 to $7.0 million in equipment and incur termination benefits in the range of $4.0 to $4.5 million. We will also have the manufacturing facility appraised to determine if there is an indicator of impairment. In addition to facilitating our polymer expansion in Mexico this action will reduce Tantalum's operating costs as well as reduce our inventories and in turn, improve cash flow as we complete this fiscal year. The expected future total cash expenditures are estimated to be $8.0 to $9.5 million for the termination benefits described above.

30 -------------------------------------------------------------------------------- Table of Contents Outlook For the third quarter of fiscal year 2013, we expect net sales to decrease 4 to 9% compared to the quarter ended September 30, 2012.

CONDENSED CONSOLIDATED RESULTS OF OPERATIONS Comparison of the Second Quarter of Fiscal Year 2013 with the Second Quarter of Fiscal Year 2012 The following table sets forth the operating income (loss) for each of our business segments for the quarters ended September 30, 2012 and September 30, 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): 31 -------------------------------------------------------------------------------- Table of Contents Quarters Ended September 30, 2012 September 30, 2011 Amount % to Total sales Amount % to Total sales Net sales Tantalum $ 109,308 50.6 % $ 112,290 42.3 % Ceramic 53,116 24.6 % 56,112 21.1 % Film and Electrolytic 53,567 24.8 % 97,112 36.6 % $ 215,991 100.0 % $ 265,514 100.0 % Gross margin Tantalum $ 17,168 $ 26,747 Ceramic 15,984 18,387 Film and Electrolytic (214 ) 17,061 32,938 15.2 % 62,195 23.4 % SG&A expenses Tantalum 12,278 11,659 Ceramic 6,293 6,083 Film and Electrolytic 9,412 10,613 27,983 13.0 % 28,355 10.7 % R&D expenses Tantalum 3,488 3,623 Ceramic 1,726 1,702 Film and Electrolytic 1,619 2,037 6,833 3.2 % 7,362 2.8 % Restructuring charges Tantalum 1,987 864 Ceramic 1,081 49 Film and Electrolytic 5,454 692 8,522 3.9 % 1,605 0.6 % Other operating expenses Tantalum (6 ) - Ceramic 2 - Film and Electrolytic 3,624 (40 ) 3,620 1.7 % (40 ) 0.0 % Operating income (loss) Tantalum (579 ) 10,601 Ceramic 6,882 10,553 Film and Electrolytic (20,323 ) 3,759 (14,020 ) -6.5 % 24,913 9.4 % Other (income) expense, net 9,114 4.2 % 8,548 3.2 % Income (loss) before income taxes (23,134 ) -10.7 % 16,365 6.2 % Income tax expense 1,787 0.8 % 2,047 0.8 % Net income (loss) $ (24,921 ) -11.5 % $ 14,318 5.4 % 32 -------------------------------------------------------------------------------- Table of Contents Consolidated Comparison of the Second Quarter of Fiscal Year 2013 with the Second Quarter of Fiscal Year 2012 Net Sales Net sales for the quarter ended September 30, 2012 were $216.0 million compared to $265.5 million in the second quarter of fiscal year 2012, an 18.6% decrease primarily due to a 6.1% decrease in unit sales volume. The decrease in Ceramic and Film and Electrolytic unit sales volumes are due to a general softening of the market. The decrease in unit sales volume for Ceramic and Film and Electrolytic was partially offset by an increase in average selling prices due to favorable product mix shifts. Tantalum incurred a unit sales volume increase due to a shift from EMEA to Asia, however, this was offset by a 14.8% decrease in average selling prices due to the regional shift to sales in Asia. The other driver for the decrease in net sales related to Film and Electrolytic's machinery division net sales which had a decrease of $11.5 million in the second quarter of fiscal year 2013 compared to the second quarter of fiscal year 2012 due to a decrease in unit sales volume.

The following table reflects the percentage of net sales by region for the quarters ended September 30, 2012 and 2011: Quarters Ended September 30, 2012 2011 Americas 29 % 31 % EMEA 33 % 40 % APAC 38 % 29 % 100 % 100 % The following table reflects the percentage of net sales by channel for the quarters ended September 30, 2012 and 2011: Quarters Ended September 30, 2012 2011 Distributors 42 % 43 % EMS 18 % 12 % OEM 40 % 45 % 100 % 100 % Gross Margin Gross margin as a percentage of net sales decreased from 23.4% in the second quarter of fiscal year 2012 to 15.2% in the second quarter of fiscal year 2013.

The primary contributors to the decline in gross margin were lower unit sales volume and our inability to reduce 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, but have not been able to offset the significant unfavorable shift in regional sales mix. In addition, we incurred $1.9 million of plant start-up costs in the second quarter of fiscal year 2013 compared to $0.7 million in the second quarter of fiscal year 2012.

Selling, General and Administrative Expenses Selling, general and administrative ("SG&A") expenses were $28.0 million, or 13.0% of net sales for the second quarter of fiscal year 2013 compared to $28.4 million or 10.7% of net sales for second quarter of fiscal year 2012. The $0.4 million decrease in SG&A expenses primarily consist of a $1.7 million decrease in selling and incentive expense consistent with the decrease in net sales and a $0.4 million decrease in professional fees. Partially offsetting these decreases was a $0.9 million increase in costs related to our anticipated equity investment in NEC Tokin, we incurred a $0.6 million expense related to contributions to charitable organizations involved in the establishment and improvement of health and educational facilities in the Democratic Republic of the Congo and a $0.2 million increase in 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.

Research and Development Research and development ("R&D") expenses were $6.8 million or 3.2% of net sales for the second quarter of fiscal year 2013, compared to $7.4 million, or 2.8% of net sales for the second quarter of fiscal year 2012. The 7.2% decrease resulted from a headcount reduction taken in the second quarter of fiscal year 2013 to align the R&D expenses with an acceptable percentage of Net sales.

33 -------------------------------------------------------------------------------- Table of Contents Restructuring Charges We incurred $8.5 million in restructuring charges in the second quarter of fiscal year 2013 compared to $1.6 million in restructuring charges in the second quarter of fiscal year 2012. Restructuring charges in the second quarter of fiscal year 2013 included $3.9 million for reductions in workforce across the Company as a whole in response to lower volumes and demand, and reducing overhead within the Company as a whole. In addition, we incurred $2.8 million in termination benefits associated with the initial phase of converting the Landsberg, Germany manufacturing facility into a technology center, and $0.8 million in termination benefits associated with converting the Weymouth, United Kingdom manufacturing facility into a technology center. The total termination benefits expected for the conversion of the Weymouth manufacturing facility are $2.6 million of which $1.7 million have been recognized, the expected completion is the third quarter of fiscal year 2014. In addition to these personnel reduction costs, the Company incurred manufacturing relocation costs of $1.0 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 second quarter of fiscal year 2012 included $1.0 million for headcount reductions in Tantalum's Mexico operations and $0.6 million for the relocation of equipment to Mexico and China.

Operating Income (Loss) Operating loss for the quarter ended September 30, 2012 was $14.0 million compared to operating income of $24.9 million for the quarter ended September 30, 2011 primarily due to a $29.3 million decrease in gross margin for the second quarter of fiscal year 2013 as compared to the second quarter of fiscal year 2012. During the second quarter of fiscal year 2013, a $4.2 million loss was realized on the impairment of two manufacturing facilities in Italy.

In addition, $1.1 million was recognized for goodwill impairment in the second quarter of fiscal year 2013. This was offset by a $1.7 million settlement gain on a defined benefit pension plan recognized in the second quarter of fiscal year 2013. Additionally, restructuring charges increased $6.9 million in the second quarter of fiscal year 2013 as compared to the second quarter of fiscal year 2012. These expense increases were offset by decreases in R&D and SG&A expenses of $0.5 million and $0.4 million, respectively in the second quarter of fiscal year 2013 as compared to the second quarter of fiscal year 2012.

Other (Income) Expense, net Other (income) expense, net was an expense of $9.1 million in the second quarter of fiscal year 2013 compared to an expense of $8.5 million in the second quarter of fiscal year 2012. Interest expense for the second quarter of fiscal year 2013 increased $2.9 million compared to the second quarter of fiscal year 2012 due to an $125 million increase in our 10.5% Senior Notes. In addition, during the second quarter of fiscal year 2013, we recognized a $0.4 million foreign currency exchange gain as compared to a $1.4 million loss on foreign currency exchange in the second 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 second quarter of fiscal year 2013 was $1.8 million compared to a $2.0 million of income tax expense for the second quarter fiscal year 2012. Income tax expense for the second quarter of fiscal year 2013 was comprised of $1.8 million related to income taxes for foreign operations. There is no U.S. federal income tax benefit from the second quarter of fiscal year 2013 loss due to a valuation allowance on deferred tax assets.

Income tax expense for the second quarter of fiscal year 2012 was comprised of $2.2 million of income tax expense from foreign operations and $0.2 million of state income tax benefit. There was no U.S. federal income tax expense related to the second quarter of fiscal year 2012 earnings due to the utilization of net operating loss carryforward deductions.

34 -------------------------------------------------------------------------------- Table of Contents Business Groups Comparison of the Quarter Ended September 30, 2012 with the Quarter Ended September 30, 2011 Tantalum The following table sets forth Net sales, Gross margin, Gross margin as a percentage of Net sales, Operating income (loss) and Operating income (loss) as a percentage of Net sales for our Tantalum business group for the quarters ended September 30, 2012 and 2011 (amounts in thousands, except percentages): Quarters Ended September 30, 2012 September 30, 2011 Amount % to Net sales Amount % to Net sales Net sales $ 109,308 $ 112,290 Gross margin 17,168 15.7 % 26,747 23.8 % Operating income (loss) (579 ) -0.5 % 10,601 9.4 % Net Sales Net sales decreased 2.7% during the second quarter of fiscal year 2013 as compared to the second quarter of fiscal year 2012. Average selling prices decreased 14.8% for the second quarter of fiscal year 2013 as compared to the second quarter of fiscal year 2012. The decrease in average selling prices was primarily due to a regional shift from EMEA to Asia. The decrease in average selling prices was partially offset by a 14.3% increase in unit sales volume during the second quarter of fiscal year 2013 as compared to the second quarter of fiscal year 2012. The current difficult economic environment in EMEA decreased net sales to $23.5 million in the second quarter of fiscal year 2013 as compared to $39.8 million in the second quarter of fiscal year 2012. Net sales in Asia increased to $57.5 million in the second quarter of fiscal year 2013 as compared to $42.8 million in the second quarter of fiscal year 2012.

Gross Margin Gross margin decreased by $9.6 million during the quarter ended September 30, 2012, as compared to the quarter ended September 30, 2011. The decrease in gross margin was significantly impacted by the shift in net sales from higher margin EMEA products to lower margin products sold into Asia. In addition, plant start-up cost related to the vertical integration efforts totaled $0.5 million in the quarter ended September 30, 2012. Efforts to reduce costs through vertical integration and lean/process engineering improvements are ongoing, but have not been able to offset the significant unfavorable shift in regional sales mix.

Operating Income (Loss) Operating loss for the second quarter of fiscal year 2013 was $(0.6) million compared to operating income of $10.6 million in the second quarter of fiscal year 2012. The $11.2 million decrease was attributable to a decrease in gross margin of $9.6 million, a $1.1 million increase in restructuring charges and an increase in SG&A expenses of $0.6 million when comparing the second quarter of fiscal year 2013 to the second quarter of fiscal year 2012. This decrease was partially offset by a $0.1 million decrease in R&D expenses in the second quarter of fiscal year 2013 as compared to the same quarter of fiscal year 2012.

Ceramic The following table sets forth Net sales, Gross margin, Gross margin as a percentage of Net sales, Operating income and Operating income as a percentage of Net sales for our Ceramic business group for the quarters ended September 30, 2012 and 2011 (amounts in thousands, except percentages): Quarters Ended September 30, 2012 September 30, 2011 Amount % to Net sales Amount % to Net sales Net sales $ 53,116 $ 56,112 Gross margin 15,984 30.1 % 18,387 32.8 % Operating income (loss) 6,882 13.0 % 10,553 18.8 % 35 -------------------------------------------------------------------------------- Table of Contents Net Sales Net sales decreased by 5.3% during the second quarter of fiscal year 2013 as compared to the second quarter of fiscal year 2012 primarily due to a decrease in unit sales volume. Unit sales volume decreased 6.4% during the second quarter of fiscal year 2013, as compared to the second quarter of fiscal year 2012 due to excess capacity in the marketplace in the second quarter of fiscal year 2013. In the second quarter of fiscal year 2012, we increased our unit sales volume due to the market's response to the tsunami in Japan.

Gross Margin Gross margin as a percentage of Ceramic net sales decreased to 30.1% as compared to 32.8% in the second quarter of fiscal year 2012. The driver of the gross margin percentage decrease was primarily attributable to a decrease in unit sales volume.

Operating Income Operating income for the second quarter of fiscal year 2013 decreased $3.7 million due to a $2.4 million decrease in gross margin when comparing the second quarter of fiscal year 2013 to the second quarter of fiscal year 2012. In addition, restructuring charges increased $1.0 million and SG&A expenses increased $0.2 million when comparing the second quarter of fiscal year 2013 to the second 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, Operating income (loss) and Operating income (loss) as a percentage of Net sales for our Film and Electrolytic business group for the quarters ended September 30, 2012 and 2011 (amounts in thousands, except percentages): Quarters Ended September 30, 2012 September 30, 2011 Amount % to Net sales Amount % to Net sales Net sales $ 53,567 $ 97,112 Gross margin (loss) (214 ) -0.4 % 17,061 17.6 % Operating income (loss) (20,323 ) -37.9 % 3,759 3.9 % Net Sales Net sales decreased 44.8% in the second quarter of fiscal year 2013 compared to the second quarter of fiscal year 2012. Average selling prices for capacitors increased 7.8% in the second quarter of fiscal year 2013 as compared to the same quarter last year. Average selling prices improved due to a favorable shift in product line mix. Capacitor unit sales volume for the second quarter of fiscal year 2013 decreased 36.9% compared to the second 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 $4.3 million related to foreign exchange, primarily the Euro. The Film and Electrolytic machinery division's net sales decreased by $11.5 million in the second quarter of fiscal year 2013 compared to the second 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 $0.8 million unfavorable impact related to foreign exchange.

Gross Margin (Loss) Gross margin (loss) as a percentage of Film and Electrolytic net sales decreased to (0.4)% in the second quarter of fiscal year 2013 as compared to 17.6% in the second 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 $1.4 million of plant start-up costs related to the Skopje, Macedonia and Evora, Portugal facilities in the second quarter of fiscal year 2013 compared to $0.7 million in the second quarter of fiscal year 2012. In addition, the machinery division's gross margin decreased to $(0.1) million in the second quarter of fiscal year 2013 as compared to $5.0 million in the second quarter of fiscal year 2012.

Operating Income (Loss) Operating loss for the second quarter of fiscal year 2013 was $(20.3) million as compared to operating income of $3.8 million in the second quarter of fiscal year 2012. The $24.1 million decrease is primarily attributable to a $17.3 million decrease in gross margin 36 -------------------------------------------------------------------------------- Table of Contents and a $4.8 million increase in restructuring charges. During the second quarter of fiscal year 2013, a $4.2 million loss was realized on the impairment of two manufacturing facilities in Italy. In addition, $1.1 million was recognized for goodwill impairment in the second quarter of fiscal year 2013. These decreases were partially offset by a $1.7 million settlement gain on a defined benefit pension plan recognized in the second quarter of fiscal year 2013, a $1.2 million decrease in SG&A and a $0.4 million decrease in R&D expenses in the second quarter of fiscal year 2013 as compared to the same quarter of fiscal year 2012.

Comparison of the Six Month Period Ended September 30, 2012 with the Six Month Period Ended September 30, 2011 The following table sets forth the operating income (loss) for each of our business segments for the six months ended September 30, 2012 and September 30, 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): 37 -------------------------------------------------------------------------------- Table of Contents Six Months Ended September 30, 2012 September 30, 2011 Amount % to Total sales Amount % to Total sales Net sales Tantalum $ 218,507 49.7 % $ 234,733 42.3 % Ceramic 104,661 23.8 % 115,491 20.8 % Film and Electrolytic 116,455 26.5 % 205,146 36.9 % $ 439,623 100.0 % $ 555,370 100.0 % Gross margin Tantalum $ 35,453 $ 59,547 Ceramic 30,441 37,124 Film and Electrolytic (645 ) 44,876 65,249 14.8 % 141,547 25.5 % SG&A expenses Tantalum 23,868 23,617 Ceramic 12,308 12,269 Film and Electrolytic 19,062 22,745 55,238 12.6 % 58,631 10.6 % R&D expenses Tantalum 7,630 6,966 Ceramic 3,450 3,353 Film and Electrolytic 3,486 4,129 14,566 3.3 % 14,448 2.6 % Restructuring charges Tantalum 2,031 899 Ceramic 1,179 88 Film and Electrolytic 6,576 1,643 9,786 2.2 % 2,630 0.5 % Other operating expenses Tantalum 20 49 Ceramic 25 2 Film and Electrolytic 3,679 32 3,724 0.8 % 83 0.0 % Operating income (loss) Tantalum 1,904 28,016 Ceramic 13,479 21,412 Film and Electrolytic (33,448 ) 16,327 (18,065 ) -4.1 % 65,755 11.8 % Other (income) expense, net 21,051 4.8 % 15,810 2.8 % Income (loss) before income taxes (39,116 ) -8.9 % 49,945 9.0 % Income tax expense 3,558 0.8 % 3,778 0.7 % Net income (loss) $ (42,674 ) -9.7 % $ 46,167 8.3 % 38 -------------------------------------------------------------------------------- Table of Contents Consolidated Comparison of the Six Month Period Ended September 30, 2012 with the Six Month Period Ended September 30, 2011 Net Sales Net sales for the six month period ended September 30, 2012 decreased by $115.7 million, or 20.8% to $439.6 million compared to the same period in fiscal year 2012 primarily due to a decrease in unit sales volumes. The decrease in unit sales volume for Ceramic, and Film and Electrolytic are due to a general softening of the market. 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. Tantalum incurred a unit sales volume increase due to a shift from EMEA to Asia; however, this was offset by a 4.3% decrease in average selling prices due to the regional shift to sales in Asia. The other driver for the decrease in net sales related to Film and Electrolytic's machinery division net sales decrease of $29.4 million in the second quarter of fiscal year 2013 compared to the second quarter of fiscal year 2012.

The following table reflects the percentage of net sales by region for the six months ended September 30, 2012 and 2011: Six Months Ended September 30, 2012 2011 Americas 28 % 28 % EMEA 34 % 38 % APAC 38 % 34 % 100 % 100 % The following table reflects the percentage of net sales by channel for the six months ended September 30, 2012 and 2011: Six Months Ended September 30, 2012 2011 Distributors 44 % 44 % EMS 17 % 14 % OEM 39 % 42 % 100 % 100 % Gross Margin Gross margin was $65.2 million or 14.8% of net sales for the six month period ended September 30, 2012 compared to $141.5 million or 25.5% of net sales for the six month period ended September 30, 2011. The primary contributors to the decline in gross margin were lower unit sales volume and our inability to reduce 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, but have not offset the significant unfavorable shift in regional sales mix. In addition, we incurred $3.3 million of plant start-up costs in the six month period ended September 30, 2012 compared to $0.7 million in the six month period ended September 30, 2011.

Selling, General and Administrative Expenses SG&A expenses for the six month period ended September 30, 2012 were $55.2 million, or 12.6% of net sales, as compared to $58.6 million, or 10.6% of net sales for the same period in fiscal year 2012. The $3.4 million decrease in SG&A expenses included a decrease of $3.1 million in selling and incentive expenses consistent with the decrease in sales and a $2.1 million decrease in incentive compensation. Partially offsetting these decreases was a $0.8 million increase in costs related to our anticipated equity investment in NEC Tokin, an increase of $0.7 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 and we incurred a $0.6 million expense related to contributions to charitable organizations involved in the establishment and improvement of health and educational facilities in the Democratic Republic of the Congo.

Research and Development Expenses R&D expenses for the six month period ended September 30, 2012 were $14.6 million, or 3.3% of net sales compared to $14.4 million, or 2.6% of net sales for the same period in fiscal year 2012. Our goal is to reduce R&D expenses for fiscal year 2013 39 -------------------------------------------------------------------------------- Table of Contents through headcount reductions taken in the second quarter of fiscal year 2013 to align the R&D expenses with an acceptable percentage of net sales; the increase of only $0.1 million is consistent with this objective.

Restructuring Charges During the six month period ended September 30, 2012, we incurred $9.8 million in restructuring charges compared to $2.6 million in restructuring charges for the six month period ended September 30, 2011. The restructuring charges in the six month period ended September 30, 2012 included $4.1 million for reductions in workforce across the Company as a whole in response to lower volumes and demand, and reducing overhead within the Company as a whole. In addition, we incurred $2.8 million in termination benefits associated with converting the Landsberg, Germany manufacturing facility into a technology center and $1.7 million in termination benefits associated with converting the Weymouth, United Kingdom manufacturing facility into a technology center. The total termination benefits expected for the conversion of the Weymouth manufacturing facility are $2.6 million; the expected completion is the third quarter of fiscal year 2014.

In addition to these personnel reduction costs, the Company incurred manufacturing relocation costs of $1.2 million for relocation of equipment to Bulgaria, China, Macedonia and Mexico and for the consolidation of manufacturing operations within Italy. The restructuring charges in the six month period ended September 30, 2011 included $1.4 million in charges for the relocation of equipment to Mexico and China and $1.2 million for reductions in workforce.

Operating Income (Loss) Operating loss for the six month period ended September 30, 2012 was $18.1 million, compared to operating income of $65.8 million for the six month period ended September 30, 2011. Gross margin decreased $76.3 million and restructuring charges increased to $9.8 million compared to $2.6 million of restructuring charges for the six month period ended September 30, 2011. In addition, during the six month period ended September 30, 2012, a $4.2 million loss was realized on the impairment of two manufacturing facilities in Italy compared to a $0.1 million loss on sales and disposals of assets in the six month period ended September 30, 2011. Also, $1.1 million was recognized for goodwill impairment in the six month period ended September 30, 2012. These expenses were offset by a $1.7 million settlement gain on a defined benefit pension plan recognized in the six month period ended September 30, 2012 and a $3.4 million decrease in SG&A expenses.

Other (Income) Expense, net Other (income) expense, net was an expense of $21.1 million in the first half of fiscal year 2013 compared to an expense of $15.8 million in the first half of fiscal year 2012. Interest expense for the first half of fiscal year 2013 increased $5.9 million compared to the second quarter of fiscal year 2012 due to an $125 million increase in our 10.5% Senior Notes.

Income Taxes For the six month period ended September 30, 2012, income tax expense of $3.6 million was comprised of a $3.5 million income tax expense related to foreign operations and $0.1 million of state income tax expense. During the six month period ended September 30, 2011, we recognized net income tax expense of $3.8 million comprised of a $4.8 million income tax expense related to foreign operations, $0.1 million of federal and state income tax benefits, and a $0.9 million U.S. federal income tax benefit related to a prior year settlement.

Business Groups Comparison of the Six Month Period Ended September 30, 2012 with the Six Month Period Ended September 30, 2011 Tantalum The table sets forth Net sales, Gross margin, Gross margin as a percentage of net sales, Operating income and Operating income as a percentage of net sales for our Tantalum business group for the quarters ended September 30, 2012 and 2011 (amounts in thousands, except percentages): Six Months Ended September 30, 2012 September 30, 2011 % to Net % to Net Amount sales Amount sales Net sales $ 218,507 $ 234,733 Gross margin 35,453 16.2 % 59,547 25.4 % Operating income 1,904 0.9 % 28,016 11.9 % 40 -------------------------------------------------------------------------------- Table of Contents Net Sales Net sales decreased 6.9% during the six month period ended September 30, 2012, as compared to the same period of fiscal year 2012. Average selling prices decreased 4.3% for the six month period ended September 30, 2012 as compared to the same period ended September 30, 2011. In addition to the decrease in average selling prices, unit sales volumes decreased 2.8% during the six month period ended September 30, 2012 as compared to the six month period ended September 30, 2011. The decrease in average selling prices was primarily related to a regional shift from the Americas and EMEA to Asia. The current economic situation in EMEA caused a decline in net sales to $50.1 million for the six month period ended September 30, 2012 as compared to $68.7 million in the period ended September 30, 2011. The slowdown in the Americas decreased net sales by $5.1 million from $63.7 million to $58.5 million. Asia revenue increased to $109.8 million for the six month period ended September 30, 2012 as compared to $102.4 million in the period ended September 30, 2011.

Gross Margin Gross margin decreased by $24.1 million or 40.5% during the six month period ended September 30, 2012, as compared to the six month period ended September 30, 2011. Gross margin as a percentage of Tantalum net sales decreased to 16.2% in the six month period ended September 30, 2012 as compared to 25.4% in the six month period ended September 30, 2011. The decrease in gross margin was significantly impacted by the shift in revenue from higher margin Americas and EMEA to lower margin products sold into the Asia region. In addition, plant start-up costs related to the vertical integration efforts totaled $0.9 million during the six month period ended September 30, 2012.

Efforts to reduce costs through vertical integration are ongoing as well as lean/process engineering improvements, but have offset the significant shift in regional sales mix.

Operating Income Operating income for the six month period ended September 30, 2012 was $1.9 million, as compared to an operating income of $28.0 million in the first half of fiscal year 2012. The decline is attributable to the decrease in gross margin of $24.1 million as compared to the six month period ended September 30, 2011. This decrease was also attributable to an increase in SG&A and R&D expenses of $0.9 million and an increase in restructuring charges of $1.1 million during the six month period ended September 30, 2012 as compared to the six month period ended September 30, 2011.

Ceramic The table sets forth Net sales, Gross margin, Gross margin as a percentage of net sales, Operating income and Operating income as a percentage of net sales for our Ceramic business group for the six months ended September 30, 2012 and 2011 (amounts in thousands, except percentages): Six Months Ended September 30, 2012 September 30, 2011 % to Net % to Net Amount sales Amount sales Net sales $ 104,661 $ 115,491 Gross margin 30,441 29.1 % 37,124 32.1 % Operating income 13,479 12.9 % 21,412 18.5 % Net Sales Net sales decreased by 9.4% during the six month period ended September 30, 2012 as compared to the same period of fiscal year 2011. The decrease was primarily attributable to the 4.3% decrease in average sales price during the six month period ended September 30, 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. In addition, unit sales volumes decreased 5.3% due primarily to excess capacity in the marketplace in the six month period ended September 30, 2012. In the six month period ended September 30, 2011, we increased our unit sales volume due to the markets response to the tsunami in Japan.

Gross Margin Gross margin decreased by $6.7 million during the six month period ended September 30, 2012, as compared to the six month period ended September 30, 2011. Gross margin as a percentage of Ceramic net sales decreased to 29.1% in the six month period ended September 30, 2012 as compared to 32.1% in the six month period ended September 30, 2011. The decrease in gross 41 -------------------------------------------------------------------------------- Table of Contents margin is primarily attributable to a decrease in average selling prices. In addition, gross margin for the six month period ended September 30, 2012 included a $1.4 million decrease in manufacturing costs net of a $3.5 million decrease related to favorable foreign exchange for the Mexican Peso.

Operating Income Operating income declined from $21.4 million in the first half of fiscal year 2012 to $13.5 million in the first half of fiscal year 2013. The decrease in operating income of $7.9 million was attributable to the $6.7 million decrease in gross margin in the first half of fiscal year 2013 compared the first half of fiscal year 2012. In addition, restructuring expenses in the first half of fiscal year 2013 were $1.1 million higher than the first half of fiscal year 2012.

Film and Electrolytic The table sets forth Net sales, Gross margin (loss), Gross margin (loss) as a percentage of net sales, Operating income (loss) and Operating income (loss) as a percentage of net sales for our Film and Electrolytic business group for the six months ended September 30, 2012 and 2011 (amounts in thousands, except percentages): Six Months Ended September 30, 2012 September 30, 2011 % to Net % to Net Amount sales Amount sales Net sales $ 116,455 $ 205,146 Gross margin (loss) (645 ) -0.6 % 44,876 21.9 % Operating income (loss) (33,448 ) -28.7 % 16,327 8.0 % Net Sales Net sales decreased by 43.2% from $205.1 million in the first half of fiscal year 2012 to $116.5 million in the first half of fiscal year 2013. Capacitor unit sales volume for the first half of fiscal year 2013 decreased 41.8% 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 $8.2 million related to foreign exchange. The Film and Electrolytic machinery division's net sales decreased net sales by $29.4 million in the six month period ended September 30, 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 $1.8 million related to foreign exchange. These decreases were partially offset by an increase in capacitor average selling prices which increased 16.4% at comparable exchange rates for the six month period ended September 30, 2012 as compared to the same six month period in fiscal year 2012 due to a favorable shift in product line mix.

Gross Margin (Loss) Gross margin decreased $45.5 million in the first half of fiscal year 2013 compared to the first half of fiscal year 2012. 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 $2.4 million of plant start-up costs related to the Skopje, Macedonia and Evora, Portugal manufacturing facilities in the first half of fiscal year 2013 compared to $0.7 million in the first half of fiscal year 2012.

Gross margin as a percentage of Film and Electrolytic net sales decreased to (0.6)% in the six month period ended September 30, 2012 as compared to 21.9% in the same six month period in fiscal year 2012.

Operating Income (Loss) Operating loss was $(33.4) million in the first half of fiscal year 2013 compared to an operating income of $16.3 million in the first half of fiscal year 2012. The decrease in operating income of $49.8 million was attributable primarily to the $45.5 million decrease in gross margin, an increase in restructuring charges of $4.9 million during the six month period ended September 30, 2012 as compared to the six month period ended September 30, 2011, and a loss of $4.2 million in the first half of fiscal year 2013 related to the impairment of manufacturing facilities in Italy as compared to no write downs in the corresponding period during the prior fiscal year. In addition, a $1.1 million charge was recognized for goodwill impairment in the second quarter of fiscal year 2013. These expenses were offset by a $1.7 million settlement gain on benefit plan recognized in the six month period ended September 30, 2012, a $3.7 million decrease in SG&A expenses and a $0.6 million decrease in R&D expenses.

42 -------------------------------------------------------------------------------- Table of Contents 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.

On August 28, 2012, we entered into an Agreement, with an OEM pursuant to which the OEM agreed to an 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-two months after the date of the Advance Payment, the 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. 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 September 30, 2012 or March 31, 2012.

Short Term Liquidity Cash and cash equivalents totaled $160.5 million as of September 30, 2012, a decrease of $50.0 million as compared to $210.5 million as of March 31, 2012.

Our net working capital (current assets less current liabilities) as of September 30, 2012 was $358.2 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 $33.5 million and $24.4 million at September 30, 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.

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 $36.9 million in interest payments, expected capital expenditures in the range of $65.0 million to $70.0 million including $24.0 million related to the Advance Payment discussed above, deferred acquisition payments of $71.0 million, payments related to restructuring liabilities, and $1.5 million in debt principal payments.

Should we require more capital in the U.S. than is generated by our operations domestically, for example to fund significant discretionary activities, such as business acquisitions, we believe we could raise capital in the U.S. through debt issuances. 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 $50.0 million for the six month period ended September 30, 2012 as compared with a decrease of $24.9 million during the six month period ended September 30, 2011.

43 -------------------------------------------------------------------------------- Table of Contents The following table provides a summary of cash flows for the quarters presented (amounts in thousands): Quarters Ended September 30, 2012 2011Net cash provided by (used in) operating activities $ (26,624 ) $ 50,989 Net cash used in investing activities (30,343 ) (31,689 ) Net cash provided by (used in) financing activities 7,399 (43,604 ) Effects of foreign currency fluctuations on cash (458 ) (584 ) Net decrease in cash and cash equivalents $ (50,026 ) $ (24,888 ) Operations Cash used in operating activities in the six month period ended September 30, 2012 totaled $26.6 million compared to cash provided by operating activities of $51.0 million in the six month period ended September 30, 2011. This decrease was primarily a result of a $84.9 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, settlement gain on benefit plan and stock-based compensation) for fiscal year 2013 compared to fiscal year 2012.

The change in operating assets resulted in a $37.1 million decrease in cash generation in the six month period ended September 30, 2012 as compared to the six month period ended September 30, 2011. The decrease is primarily related to a decrease in cash generated through a decrease in accounts receivable, in the six month period ended September 30, 2012, we generated $5.6 million due to a decrease in accounts receivable compared to the six month period ended September 30, 2011 where we generated $30.4 million due to a decrease in accounts receivable. In addition, we used $9.0 million through an increase in prepaid expenses in the six month period ended September 30, 2012, compared to the six month period ended September 30, 2011 where we generated $3.4 million due to a decrease in prepaid expenses.

Offsetting these uses of cash was $2.5 million of cash provided by operating liabilities in the six month period ended September 30, 2012 compared to $42.5 million of cash used in operating liabilities in the six month period ended September 30, 2011. Within operating liabilities, an increase in accounts payable and accrued expenses accounted for $3.9 million of the increase in cash provided in the six month period ended September 30, 2012 compared to $33.5 million cash used related to the decrease in accounts payable and accrued expenses in the six month period ended September 30, 2011. In addition we used $7.8 million in the six month period ended September 30, 2011 related to other long-term obligations compared to a $0.3 million use of cash for long term obligations in the six month period ended September 30, 2012.

Investing Cash used in investing activities increased $1.3 million in the six month period ended September 30, 2012 compared to the six month period ended September 30, 2011. The variance is comprised of a $10.2 million increase in capital expenditures in the six month period ended September 30, 2012 compared to the six month period ended September 30, 2011. For the six month period ended September 30, 2012, capital expenditures are primarily related to the new manufacturing facilities in Skopje, Macedonia and Pontecchio, Italy and other restructuring related activities as well as efforts to reduce costs and increase capacity. This increase in the use of cash was offset by a $11.6 million decrease in cash used for acquisitions. During the six month period ended September 30, 2011, we paid $11.6 million for the acquisition of Cornell Dubilier Foil, LLC.

Financing Cash provided by financing activities increased $51.0 million in the six month period ended September 30, 2012 as compared to the six month period ended September 30, 2011. In the six month period ended September 30, 2012, the $15.8 million in proceeds from the issuance of debt resulted from the private placement of our 10.5% Senior Notes. In the six month period ended September 30, 2012 we used $6.6 million for deferred acquisition payments related to the KEMET Foil and KEMET Blue Powder acquisitions and $1.6 million for debt payments. In the six month period ended September 30, 2011, the significant use of cash related to a restriction that was placed on a portion of our cash balance on August 15, 2011 arising from our potential $36.5 million principle payment on the Convertible Notes. In addition, in the six month period ended September 30, 2011, we used $7.2 million for payments related to debt.

44 -------------------------------------------------------------------------------- Table of Contents 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 September 30, 2012 as follows (amounts in thousands): Payments Due by Period More than Total Year 1 Years 2-3 Years 4-5 5 years OEM loan $ 24,000 $ 4,000 $ 20,000 $ - $ - 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.

Adjusted operating income is calculated as follows (amounts in thousands): Quarters Ended September 30, Six Months Ended September 30, 2012 2011 2012 2011 Operating income (loss) $ (14,020 ) $ 24,913 $ (18,065 ) $ 65,755 Adjustments: Restructuring charges 8,522 1,605 9,786 2,630 Write down of long-lived assets 4,234 - 4,234 - ERP integration costs 2,099 1,918 3,775 3,123 Plant start-up costs 1,930 718 3,291 718 Stock-based compensation expense 1,242 984 2,506 2,175 Goodwill impairment 1,092 - 1,092 - Acquisition related fees 866 - 1,408 610 Settlement gain on benefit plan (1,675 ) - (1,675 ) - Net loss on sales and disposals of assets (31 ) (40 ) 73 83 Registration related fees - 77 20 281 Adjusted operating income $ 4,259 $ 30,175 $ 6,445 $ 75,375 45 -------------------------------------------------------------------------------- Table of Contents Adjusted net income (loss) is calculated as follows (amounts in thousands): Quarters Ended September 30, Six Months Ended September 30, 2012 2011 2012 2011 Net income (loss) $ (24,921 ) $ 14,318 $ (42,674 ) $ 46,167 Adjustments: Restructuring charges 8,522 1,605 9,786 2,630 Write down of long-lived assets 4,234 - 4,234 - ERP integration costs 2,099 1,918 3,775 3,123 Plant start-up costs 1,930 718 3,291 718 Stock-based compensation expense 1,242 984 2,506 2,175 Goodwill impairment 1,092 - 1,092 - Amortization included in interest expense 954 1,012 1,924 2,056 Acquisition related fees 866 - 1,408 610 Settlement gain on benefit plan (1,675 ) - (1,675 ) - Net foreign exchange (gain) loss (442 ) 1,391 1,347 1,268 Net (gain) loss on sales and disposals of assets (31 ) (40 ) 73 83 Registration related fees - 77 20 281 Income tax impact of adjustments (1) (90 ) 406 (87 ) 390 Adjusted net income (loss) $ (6,220 ) $ 22,389 $ (14,980 ) $ 59,501 -------------------------------------------------------------------------------- (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.

Adjusted EBITDA is calculated as follows (amounts in thousands): Quarters Ended September 30, Six Months Ended September 30, 2012 2011 2012 2011 Net income (loss) $ (24,921 ) $ 14,318 $ (42,674 ) $ 46,167 Adjustments: Interest expense, net 10,110 7,251 20,536 14,608 Income tax expense 1,787 2,047 3,558 3,778 Depreciation and amortization 11,521 11,852 23,177 23,011 Restructuring charges 8,522 1,605 9,786 2,630 Write down of long-lived assets 4,234 - 4,234 - ERP integration costs 2,099 1,918 3,775 3,123 Plant start-up costs 1,930 718 3,291 281 Stock-based compensation expense 1,242 984 2,506 718 Goodwill impairment 1,092 - 1,092 - Acquisition related fees 866 - 1,408 - Settlement gain on benefit plan (1,675 ) - (1,675 ) - Net foreign exchange (gain) loss (442 ) 1,391 1,347 1,268 Net (gain) loss on sales and disposals of assets (31 ) (40 ) 73 83 Registration related fees - 77 20 - Adjusted EBITDA $ 16,334 $ 42,121 $ 30,454 $ 95,667 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.

46 -------------------------------------------------------------------------------- Table of Contents 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, settlement gain on benefit plan, restructuring charges, plant start-up costs, net foreign exchange gain/loss, stock-based compensation expense, 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; † 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.

47 -------------------------------------------------------------------------------- Table of Contents 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.

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