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Article by DailyStocks_admin    (03-16-08 01:22 PM)

KEMET Corp. CEO OLOF LOOF PER bought 62,500 shares on 3-12-2008 at 4.29

BUSINESS OVERVIEW

General

KEMET Corporation, which together with its subsidiaries is referred to herein as “KEMET” or the “Company”, is a leading manufacturer of tantalum capacitors, multilayer ceramic capacitors (“MLCC”), and solid aluminum capacitors. For the year ended March 31, 2007 (“fiscal year 2007”), KEMET generated net sales of $658.7 million, up 34.4% from $490.1 million in fiscal year 2006. In fiscal year 2007, total net sales were broken down geographically as follows: North America and South America (“Americas”) sales were approximately 32.7%, Asia and Pacific Rim (“APAC”) sales were approximately 42.3%, and Europe, Middle East and Africa (“EMEA”) sales were approximately 25.0%. During fiscal year 2007, the Company shipped approximately 40.3 billion capacitors compared to 40.1 billion in fiscal year 2006.

Capacitors are electronic components that store, filter, and regulate electrical energy and current flow and are one of the essential passive components used on circuit boards. Virtually all electronic applications and products contain capacitors, including communication systems, data processing equipment, personal computers, cellular phones, automotive electronic systems, military and aerospace systems, and consumer electronics.

Since its divestiture from Union Carbide Corporation (“UCC”) in December 1990, KEMET’s business strategy is to be the preferred capacitor supplier to the world’s most successful electronics original equipment manufacturers (“OEM”), Electronics Manufacturing Services providers (“EMS”), and electronics distributors. The Company’s customers include Alcatel, Arrow Electronics, Avnet, BAE Systems, Boeing, Bosch, Bose, Celestica, Cisco Systems, Dell, Delphi, Elcoteq Network, Ericsson, Flextronics, Hewlett-Packard, Hon Hai, Huawei Technologies, IBM, Intel, J.C. Tally, Jabil, Jaco, Motorola, Nokia, Northrop Grumman, Raytheon, Rockwell Collins, Sanmina-SCI, Siemens, Solectron, TRW, TTI, and Visteon. KEMET reaches these customers primarily through a direct, salaried sales force that calls on customers located around the world.

Background of Company

KEMET’s operations began in 1919 as a business of UCC to manufacture component parts for vacuum tubes. In the 1950s, Bell Laboratories invented solid-state transistors along with tantalum capacitors and other passive components necessary for their operation. As vacuum tubes were gradually replaced by transistors, the Company changed its manufacturing focus from vacuum tube parts to tantalum capacitors. The Company entered the market for tantalum capacitors in 1958 as one of approximately 25 United States manufacturers. By 1966, the Company was the United States’ market leader in tantalum capacitors. In 1969, the Company began production of ceramic capacitors as one of approximately 35 United States manufacturers.

The Company was formed in 1990 by certain members of the Company’s management at the time, Citicorp Venture Capital, Ltd., and other investors that acquired the outstanding common stock of KEMET Electronics Corporation from UCC.

Public Offerings, Recapitalization, and Stock Purchases

In October 1992, the Company completed an initial public offering of its common stock and a related recapitalization to simplify its capital structure. In June 1993, the Company completed an additional public offering of common stock and used the net proceeds to reduce outstanding indebtedness.

In January 2000, the Company sold 6,500,000 shares of its common stock in a public offering for $142.6 million in net cash proceeds after deducting underwriting fees and offering expenses. The net proceeds were used to repay outstanding debt under the Company’s short-term credit facility and to fund capital expenditures.

The Board of Directors has previously authorized programs to purchase up to 11.3 million shares of its common stock on the open market. Through March 31, 2007, the Company had made purchases of 5.4 million shares for $63.6 million, some of which occurred during fiscal year 2007. The Company does not anticipate any further stock purchases under these authorizations. Approximately 615,000 treasury stock shares were subsequently reissued in connection with the exercise of employee stock options. At March 31, 2007, the Company held approximately 4.4 million treasury shares at a cost of approximately $44.7 million.

Stock Splits

In September 1995, the Company’s Board of Directors declared a two-for-one stock split whereby one additional common share, par value $.01, was issued for each common share outstanding to shareholders of record on September 13, 1995.

In May 2000, the Board of Directors declared an additional two-for-one stock split. The record date for this stock split was May 24, 2000, with distribution of the additional shares on June 1, 2000.

Outstanding Debt

In May 1998, the Company sold $100.0 million of its 6.66% Senior Notes pursuant to the terms of a Note Purchase Agreement dated as of May 1, 1998. These Senior Notes have a final maturity date of May 4, 2010, with required annual principal payments of $20.0 million which began on May 4, 2006. The outstanding balance at March 31, 2007 was $80.0 million.

In November 2006, the Company sold $175.0 million of its 2.25% Convertible Senior Notes pursuant to the terms of an Indenture dated as of November 1, 2006. These Convertible Senior Notes have a final maturity date of November 15, 2026 unless earlier redeemed, repurchased or converted. These Convertible Senior Notes have semi-annual interest payments of approximately $2.0 million which began on May 15, 2007.

The Capacitor Industry

Because of a capacitor’s fundamental nature and widespread application, demand for capacitors tends to reflect the general demand for electronic products, which, though cyclical, has been growing over the past several decades. Growth in the electronics market and the corresponding growth in the capacitor market were fueled by:

• The development of new products and applications, such as cellular phones, personal computers, and electronic controls for engines and machinery;

• The increase in the electronic content of existing products, such as home appliances, medical equipment, and automobiles; and

• The growth in the number of capacitors required in certain complex electronic products that use state-of-the-art microprocessors.

Capacitors

Capacitors are electronic components consisting of conducting materials separated by a dielectric, or insulating material, which allows a capacitor to interrupt the flow of electrical current. Capacitors can be either surface-mount or leaded. Surface mounting is an assembly technique used by customers in production of high volumes of circuit boards for electronic products.

KEMET manufactures a full line of capacitors, including tantalum, multilayer ceramic and solid aluminum. Most customers buy both tantalum and ceramic capacitors from the Company. KEMET manufactures these types of capacitors in many different sizes and configurations. The Company produces surface-mount capacitors, which are attached directly to the circuit board without lead wires, and leaded capacitors, which are attached to the circuit board using lead wires.

The choice of capacitor dielectric is driven by the engineering specifications and the application of the component product into which the capacitor is incorporated. Product design engineers in the electronics industry typically select capacitors on the basis of capacitance levels, size, and cost. Tantalum and ceramic capacitors are commonly used in conjunction with integrated circuits, and the same circuit may, and frequently does, contain both ceramic and tantalum capacitors. Generally, ceramic capacitors are more cost-effective at lower capacitance values, tantalum capacitors are more cost-effective at higher capacitance values, and solid aluminum capacitors can be more effective in special applications.

Management believes that sales of surface-mount capacitors, including multilayer ceramic, tantalum, and solid aluminum capacitors will continue to grow more rapidly than other types of capacitors in both the United States and worldwide markets, because technological breakthroughs in electronics are regularly expanding the number and type of applications for these products.

Our Strategy

KEMET has used its position as a leading, high-quality manufacturer of capacitors to capitalize on the increasingly demanding requirements of its customers. Key elements of the Company’s strategy are centered around five themes (the “Themes”). These Themes are the foundation and focus areas of KEMET’s strategy.

1. The math must work. KEMET believes that in order to effectively serve its customers, which in-turn will result in serving its shareholders, partners, and employees, it must be a profitable organization. Accordingly, KEMET’s strategies and business decisions must be grounded with focus on the financial impact of a particular decision or strategy. The financial impact must consider both long-term results as well as short-term results. Investment of KEMET’s resources (both capital and human) will be influenced by the Theme, The math must work .

2. Hear the customer and be responsive. KEMET believes the Company’s growth and profitability will be influenced based on its ability to satisfy its customers’ needs. Customer needs are constantly changing. Customer priorities are constantly evolving. KEMET’s focus is to be ever attentive to the customers and quickly adapt to their needs and requirements. Maintaining and expanding KEMET’s existing relationship with customers is considered key to its success. KEMET seeks to continue growing with emerging electronics companies around the globe through its distributor network and its direct sales force. Customers around the globe are demanding increased levels of service to provide ease of ordering, just-in-time delivery to multiple facilities, flexible scheduling, computerized paperless purchasing, specialized packaging, and a full breadth of product offerings. KEMET believes that it has responded to each of these customer needs and positioned the Company to capture a larger portion of OEM and EMS capacitor supply requirements.

3. Light the fire—show you care. KEMET believes that a positive, serving attitude of its employees is a key strategy that will add to its growth. Maintaining and expanding the customer base will be influenced by being responsive to its customers’ needs and requirements. By showing the customers that they are valued and that their satisfaction is the number one priority, customer loyalty will be enhanced.

4. Build what the customer wants—in the meantime sell what we have . Customers’ needs are constantly evolving. Customers’ preferred suppliers will provide products that fill their current and future product needs. KEMET recognizes the importance of providing products that fill the customers’ unique requirements. KEMET manufactures a full line of products with different specifications in order to respond to the needs of its customers. During fiscal year 2007, the Company shipped approximately 40.3 billion capacitors of various types, with types being distinguished by dielectric material, configuration, encapsulation, capacitance level and tolerance, performance characteristics, marking, and packaging.

Become The Capacitance Company . Customers prefer to be able to satisfy their varied capacitor product needs through one supplier. This procurement approach provides the customer with a number of benefits—greater volume of products usually results in buying power and reduced prices, less administrative expenses, more flexibility, and more customer service. In order to capitalize on this desire by the customer, KEMET is focused on being considered The Capacitance Company by its customers—the supplier of choice for all capacitance needs. KEMET currently is a provider of tantalum capacitors, ceramic capacitors, and solid aluminum capacitors. High-frequency electronics are evolving very rapidly. There are significant differences between the functional characteristics and the cost of tantalum, ceramic, and solid aluminum capacitors. Electronics designers choose from among these capacitor technologies based on the functional and cost requirements of specific applications. Most of KEMET’s competitors focus on one of these capacitor technologies. KEMET has the most complete line of capacitor technologies across these primary capacitor types. KEMET has expanded its product line, as well as its capacity, through acquisitions that it considers strategic. In April 2006, KEMET acquired the tantalum business unit of EPCOS AG, and on April 24, 2007, KEMET Corporation announced that it had purchased approximately 92.7% of the shares and votes in Evox Rifa Group Oyj. These acquisitions provide KEMET with access to new markets and new customers, notably in the European industrial, automotive and telecommunications industries.

In addition to the five Themes , KEMET has established eight priorities (the “Priorities”) as primary areas of focus. These Priorities are:

1. Flatten the organization—and continually build an effective and lean organization. KEMET believes that a flat organization (fewer levels of management) is a more effective and more customer responsive organization. KEMET has attempted to establish an organization structure with this in mind. The Company is organized into two distinct business units: Tantalum Business Unit and Ceramics Business Unit. Each of these business units is responsible for its entire operations including sales, manufacturing, and research and development efforts. In addition, the Company implemented regional sales units to provide better customer responsiveness. The regional sales units are broken down by geographic region: the Americas, APAC, and EMEA. KEMET believes that this structure brings decision ownership and accountability to the proper level within the organization—the person closest to the customer that has the knowledge and authority to make the best and quickest decisions for the Company. This structure has been established with shared goals and objectives, and provides incentives and rewards based on shared success.


2. Leverage technology—deliver what the customer wants, focus on speed-to-market, and do it right the first time. The capacitor industry serves the dynamic electronics marketplace. The electronics marketplace is continually under pressure to improve product functionality, decrease size, increase speed, and decrease cost, among other market pressures. KEMET attempts to serves this market with a focus on these needs—provide what the customer wants, do it in a timely manner, and do it right the first time. KEMET attempts to understand the customers’ needs by staying close to the research and development facilities of its customers. KEMET has a Product Line Management and a Technical Sales Consultant organization which have, as part of their primary functions, the charter to understand the customers’ technical needs and plans, and convey that information to KEMET’s technology organization so that KEMET provides what the customers want, in the time period they want it. In fiscal year 2007, KEMET released over 2,700 new products, 336 of which were first to market (which is a product not currently supplied by any competitor).

3. Quality and Reliability must be a given in the minds of our customers. KEMET is a leader in an industry in which customers require high quality standards and exacting product specifications. The Company has built its brand reputation on continuous improvements and a company-wide commitment to quality products and services. Ranked best in class by independent surveys and recognized by numerous customer awards, KEMET strives to exceed customer expectations to achieve preferred supplier status. The Company continues to utilize Lean and Six Sigma methods to drive towards zero defects while increasing process speed and eliminating non-value added activities.

4. Short work-in-process (“WIP”) and one roof strategy. KEMET believes that to be an efficient manufacturer and to build products cost effectively, it must optimize the use of manufacturing space and capital. Minimizing WIP improves both areas by reducing the amount of floor space required to store this inventory, and by reducing the costs of the Company to finance this inventory. KEMET has made it a priority to focus on minimizing WIP in order to obtain the benefits mentioned. Additionally, KEMET believes that building the product, from start to finish, under one roof (in one factory) improves efficiency, reduces material handling, and also minimizes WIP.

5. Build product in low cost locations world wide. KEMET’s customers are under worldwide competitive pressure to reduce their product costs and these pressures are passed along to component manufacturers. The Company believes that it has achieved a strong position as an overall low-cost producer of capacitors. To maintain this position, it is constantly seeking to reduce material and labor costs, develop cost-efficient manufacturing equipment and processes, and design manufacturing plants for efficient production. KEMET believes that manufacturing in low-cost areas is a key component of its manufacturing strategy. KEMET has manufacturing facilities in South Carolina, Mexico, Portugal, and China. In July 2003, the Company announced a reorganization of its operations to relocate production facilities from the United States to low-cost locations in Mexico and China. A production facility opened in Suzhou, China, in October of 2003, and a second facility opened in May of 2005. KEMET also believes that building product close to the customer that will use the product is critical. Customers want to have their supply provider in close proximity to their manufacturing facilities. This closeness gives them a shorter lead-time, from ordering to receipt, and improves their just-in-time planning.

6. The people at the front lines call the shots. KEMET believes that to be responsive to customer demands and needs it is best to have the people that are closest to the customer, the people at the front line, that have the knowledge and ability to make the correct decisions that support the customer, have the authority and responsibility to make those decisions.

7. Brand KEMET globally. KEMET believes its reputation as a high quality, high reliability product supplier, that provides superior customer service, and low cost products, is part of the KEMET brand. KEMET feels that its brand has value which results in repeat business. Accordingly, KEMET has established marketing its brand as a priority.

8. Easy- To - Buy-From (“ETBF”). KEMET believes that it is a market leader in reliable and timely delivery of capacitor products. As most customers have moved to just-in-time inventory management, the timeliness and reliability of shipments by their suppliers have become increasingly important. The Company has designed its manufacturing facilities and ETBF order entry system to respond quickly to customer needs. KEMET’s order entry system provides on-line pricing, scheduled delivery dates, and accurate inventory information; and it provides a direct link between the Company and its major distributors.

Markets and Customers

KEMET’s products are sold to a variety of OEMs in a broad range of industries including the computer, communications, automotive, military, consumer and aerospace industries. KEMET also sells an increasing number of its products to EMS providers, which also serve OEMs in these industries. The Company is not dependent on any one customer or group of related customers; although two customers in fiscal years 2007, 2006, and 2005 accounted for over 10% of the Company’s net sales. The Company’s top 50 customers accounted for approximately 85.1% of the Company’s net sales during fiscal year 2007.

KEMET produces a small percentage of its capacitors under military specification standards sold for both military and commercial uses. The Company does not sell any of its capacitors directly to the United States government. Certain of the Company’s customers purchase capacitors for products in the military and aerospace industries.

Sales and Distribution

KEMET’s domestic sales, and most of its international sales, are made primarily through the Company’s direct sales and customer service employees. The Americas sales staff is organized into four regions supported by field offices. A substantial majority of the Company’s international sales are made through regional offices in Europe, Asia, Canada, Mexico, and Brazil. The Company also has independent sales representatives located in South Korea, Puerto Rico, and the United States.

KEMET markets and sells its products in its major markets primarily through a direct sales force. In addition, KEMET uses independent commissioned representatives. The Company believes its direct sales force creates a distinctive competence in the market place and has established strong relationships with its customers. With a global sales organization that is customer-based, KEMET’s direct sales personnel from around the world serve on KEMET Global Account Teams. These teams are committed to serving any customer location in the world with a dedicated KEMET representative. This approach requires a blend of accountability and responsibility for specific customer locations, guided by an overall account strategy for each customer.

Electronics distributors are an important distribution channel in the electronics industry and accounted for approximately 53.8%, 58.0%, and 52.0% of the Company’s net sales in fiscal years 2007, 2006, and 2005, respectively. In fiscal years 2007, 2006 and 2005, two distributors of passive components each accounted for more than 10% of net sales.

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

The Company’s distributor policy also includes a “ship-from-stock and debit” (“SFSD”) program which provides a mechanism for the distributor to meet a competitive price after obtaining authorization from the local Company sales office. This program allows the distributor to ship its higher-priced inventory and debit the Company for the difference between KEMET’s list price and the lower authorized price for that specific transaction. The Company establishes reserves for its SFSD program based primarily on certain distributors’ actual inventory levels comprising 91% to 95% of the total global distributor inventory. The remaining 5% to 9% is estimated based on actual distributor inventory and current sales trends. Management analyzes historical SFSD activity to determine the SFSD exposure on the global distributor inventory at the balance sheet date. Should the distributors increase inventory levels, the estimation of the inventory at the distributors for the remaining 5% to 9% could be estimated at an incorrect amount. However, the Company believes that the difference between the estimate and the ultimate actual amount would be immaterial.

Sales by Geography

In fiscal year 2007, total net sales were broken down geographically as follows: the Americas sales were approximately 32.7%, APAC sales were approximately 42.3%, and EMEA sales were approximately 25.0%. Although management believes that the Company is able to provide a level of delivery and service that is competitive with local suppliers, the Company’s capacitor market shares in Asian and European markets tend to be significantly lower than in the United States because some international electronics manufacturers prefer to purchase components from local producers. As a result, a large percentage of the Company’s international sales are made to foreign operations of United States manufacturers. A portion of the Company’s European sales are denominated in local currencies including the euro; therefore, a significant appreciation of the United States dollar against such foreign currencies or the euro would reduce the gross profit realized by the Company on its European sales as measured in United States dollars. Substantially all of the Company’s European export shipments are made duty-paid, free delivery as required by local market conditions (see Note 9 to consolidated financial statements).

Inventory and Backlog

Although the Company manufactures and inventories standardized products, a portion of its products are produced to meet specific customer requirements. Cancellations by customers of orders already in production could have an impact on inventories; however, cancellations have not historically been significant.

The backlog of outstanding orders for the Company’s products was $84.0 million and $94.6 million at March 31, 2007, and 2006, respectively. The current backlog is expected to be filled during the first quarter of fiscal year 2008. Most of the orders in the Company’s backlog may be cancelled by its customers, in whole or in part, although some may be subject to penalty.

Competition

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

The Company’s major United States competitors include AVX Corporation and Vishay Intertechnology, Inc., in the production of tantalum and ceramic capacitors. The Company’s major foreign competitors include Kyocera/AVX Corporation, Murata Manufacturing Company Ltd., Samsung Electronics Co. Ltd., TDK Corporation, Yageo Corporation, and Taiyo Yuden Co., Ltd. in the production of ceramic capacitors and EPCOS (until April 2006 when the business unit was acquired by KEMET), Kyocera/AVX Corporation and Samsung Electronics Co. Ltd. in the production of tantalum capacitors.

Raw Materials

The most expensive raw materials used in the manufacture of the Company’s products are tantalum powder, palladium, and silver. These materials are considered commodities and are subject to price volatility. Tantalum powder is primarily purchased under long-term contracts, while palladium and silver are primarily purchased on the spot and forward markets, depending on market conditions. For example, if the Company believes that prices are likely to rise, it may purchase a significant amount of its annual requirements for forward delivery.

Tantalum is used in the manufacture of tantalum capacitors. Management believes the tantalum needed has generally been available in sufficient quantities to meet manufacturing requirements. However, the increase in demand for tantalum capacitors during fiscal year 2001, along with the limited number of tantalum suppliers, led to increases in tantalum prices and impacted availability. Tight supplies of tantalum raw material and some tantalum caused the price to increase from under $50 per pound early in calendar 2000 to over $300 per pound in calendar 2001. The average price of tantalum raw material at March 31, 2007 was over $175 per pound. During the fiscal years ended March 31, 2004 and 2003, the Company recorded $12.4 million and $40.8 million, respectively, of charges related to a tantalum inventory purchase commitment that exceeded market prices (see Critical Accounting Policies and Long-Term Supply Agreement). During fiscal year 2005, the Company was able to renegotiate the pricing arrangement under tantalum inventory purchase commitment, and accordingly, the Company reversed $11.8 million of the original charges.

During fiscal year 2001, the Company entered into a joint venture agreement with Australasian Gold Mines NL, which subsequently changed its name to ABM Resources NL (“ABM”) to establish an independent source of tantalum to meet the increasing demand for tantalum capacitors from key customers. This transaction closed in April 2001, and included KEMET’s acquisition of a ten percent equity interest in ABM. Upon successfully achieving the objective of establishing an independent source of tantalum material, KEMET sold its interest in the joint venture. KEMET sold its equity interest in ABM in January 2007.

Although palladium is presently found primarily in South Africa and Russia, the Company believes that there are a sufficient number of suppliers from which the Company can purchase its palladium requirements. Although palladium required by the Company has generally been available in sufficient quantities, the limited number of suppliers could lead to higher prices, and the inability of the Company to pass any increase on to its customers could have an adverse effect on the margin of those products in which the metal is used. The Company continues to take actions to minimize the impact of future palladium price increases on its profit margins. The Company has significantly reduced the palladium and silver requirements in the production of MLCCs with a major shift in the production process using base metal electrodes, such as nickel.

Silver and aluminum have generally been available in sufficient quantities, and the Company believes there are a sufficient number of suppliers from which the Company can purchase its requirements.

Patents and Trademarks

At March 31, 2007, the Company held 66 United States and 75 foreign patents and 7 United States and 70 foreign trademarks. The Company believes that the success of its business is not materially dependent on the existence or duration of any patent, license, or trademark other than the trademarks “KEMET” and “KEMET Charged”. The Company’s engineering and research and development staffs have developed and continue to develop proprietary manufacturing processes and equipment designed to enhance the Company’s manufacturing facilities and reduce costs.

Research and Development

Research and development expenses were $33.4 million for fiscal year 2007, $26.0 million for fiscal year 2006 and $26.6 million for fiscal year 2005. These amounts include expenditures for product development and the design and development of machinery and equipment for new processes and cost reduction efforts. Most of the Company’s products and manufacturing processes have been designed and developed by Company engineers.The Company continues to invest in new technology to improve product performance and production efficiencies.

Segment Reporting

Effective October 1, 2005, KEMET organized into two distinct business units: the Tantalum Business Unit (“Tantalum”) and the Ceramics Business Unit (“Ceramics”). Each business unit 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 units and are allocated to the business units based on the business units’ respective manufacturing costs. (See Note 9 to consolidated financial statements).

Environmental

The Company is subject to various Mexican, European, Chinese, Portuguese, and United States federal, state, and local environmental laws and regulations relating to the protection of the environment, including those governing the handling and management of certain chemicals used and generated in manufacturing electronic components. Based on the annual costs incurred by the Company over the past several years, management does not believe that compliance with these laws and regulations will have a material adverse effect on the Company’s capital expenditures, earnings, or competitive position. The Company believes, however, that it is reasonably likely that the trend in environmental litigation, laws, and regulations will continue to be toward stricter standards. Such changes in the law and regulations may require the Company to make additional capital expenditures which, while not currently estimable with certainty, are not presently expected to have a material adverse effect on the Company’s financial condition. See “Legal Proceedings” for a discussion of certain other environmental matters.

Employees

As of March 31, 2007, KEMET had approximately 9,100 employees, of whom approximately 900 were located in the United States, approximately 6,200 were located in Mexico, 1,100 in China, 700 in Portugal and the remainder were located in the Company’s foreign sales offices. The Company believes that its future success will depend in part on its ability to recruit, retain, and motivate qualified personnel at all levels of the Company. While none of its United States employees are unionized, the Company has approximately 5,100 hourly employees in Mexico represented by labor unions as required by Mexican law. The Company also has approximately 600 employees in Portugal represented by labor unions. The Company has not experienced any major work stoppages and considers its relations with its employees to be good. In addition, the Company’s labor costs in certain non-U.S. jurisdictions are denominated in the local currency. Inflation or a significant depreciation of the United States dollar against the local currency would increase the Company’s labor costs.

CEO BACKGROUND

Gurminder S. Bedi, 59, Director, was named such in May 2006. Mr. Bedi served as Vice President of Ford Motor Company from October 1998 through his retirement in December 2001. Mr. Bedi served as Vehicle Line Director at Ford Motor Company from October 1996 through October 1998 and in a variety of other managerial positions at Ford for more than thirty years. He currently serves on the board of directors of Compuware Corporation. He earned a Bachelor of Science degree in Mechanical Engineering from George Washington University and a Masters of Business Administration degree from the University of Detroit.

Frank G. Brandenberg, 60, Chairman of the Board of Directors and Director, was named Chairman in March 2005 and a Director in October 2003. Before his retirement in 2003, Mr. Brandenberg was a Corporate Vice President and Sector President of Northrop Grumman Corporation. Prior to joining Northrop, he previously spent 28 years at Unisys where his last position was Corporate Vice President and President, Client/Server Systems, and then later served as the President and Chief Executive Officer of EA Industries, Inc. He currently serves on the board of directors of American Mold Guard Inc. He received a Bachelor of Science degree in Industrial Engineering and a Masters of Science degree in Operations Research from Wayne State University and completed the Program for Management Development at the Harvard Business School.

Per-Olof Loof, 56, Chief Executive Officer and Director, was named such in April 2005. Mr. Loof was previously the Managing Partner of QuanStar Group LLC, a management consulting firm. Prior thereto, he served as Chief Executive Officer of Sensormatic Electronics Corporation and in various management roles with Andersen Consulting, Digital Equipment Corporation, AT&T and NCR. Mr. Loof serves as a board member of Global Options Inc., and Devcon International Corporation. Mr. Loof was recently elected to the Board of Directors of Evox Rifa Group Oyj, a public company listed on the Helsinki Stock Exchange. KEMET acquired a majority interest in Evox Rifa Group Oyj in April 2007, and has announced its intention to de-list the company. He received a “civilekonom examen” degree in economics and business administration from the Stockholm School of Economics.

E. Erwin Maddrey, II, 66, Director, was named such in May 1992. Mr. Maddrey is President of Maddrey and Associates. Mr. Maddrey was President, Chief Executive Officer, and a Director of Delta Woodside Industries, a textile manufacturer, from 1984 through June 2000. Prior thereto, Mr. Maddrey served as President, Chief Operating Officer, and Director of Riegel Textile Corporation. Mr. Maddrey also serves on the board of directors for Blue Cross/Blue Shield of South Carolina, Delta Woodside Industries, Inc., Delta Apparel Company, and Renfro Corp.

COMPENSATION

Effective as of July 1, 2006, the compensation structure of the Board of Directors was changed as follows. The Chairman of the Board of Directors is paid an annual director’s fee of $60,000. Each director (other than the Chairman and any director that is employed by the Corporation) is paid an annual director’s fee of $35,000. In addition, all directors (other than any director that is employed by the Corporation) receive an annual grant of 2,500 shares of restricted stock of the Corporation. No director who is a full-time employee of the Corporation is paid an annual director’s fee. The Chairman of the Audit Committee of the Board of Directors receives an annual retainer of $7,500, and each member of that Committee receives an annual retainer of $5,000. The Chairmen of the Compensation Committee and the Nominating and Corporate Governance Committee each receive an annual retainer of $5,000, and each member of each of these Committees receives an annual retainer of $3,000. All directors are reimbursed for out-of-pocket expenses incurred in connection with attending meetings. Each director (other than any director that is employed by the Corporation) receives as additional compensation a fee of $1,500 per meeting for attendance at each meeting of the Board and for attendance at each meeting of a Committee of the Board. In conjunction with this modification of the compensation structure of the Board of Directors, the Compensation Committee hired a third party consultant to examine director compensation. The consultant examined nationwide surveys to compare the director compensation of peer companies. The Compensation Committee used this data to determine the adjustments to the Corporation’s directors’ compensation.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

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

The Company’s business strategy is to be the preferred capacitor supplier to the world’s most successful electronics original equipment manufacturers, electronics manufacturing services providers, and electronics distributors. The Company intends to reach this goal through technology leadership, organic and strategic growth initiatives and by continuing to provide state of the art customer service. The Company reaches its customers through a direct, salaried sales force that calls on customer locations around the world. In fiscal year 2007, total net sales were broken down geographically as follows: the Americas sales were approximately 32.7%, APAC sales were approximately 42.3%, and EMEA sales were approximately 25.0%.

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

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

Electronic products are in a long-term growth phase as evidenced by the proliferation of cellular phones, personal computers, and consumer electronics. The growth of the capacitor industry, however, has been cyclical, and lower average selling prices for capacitors have corresponded with the long-term growth in units.

Average Selling Prices (“ASPs”) —Capacitor average selling prices have trended down over the long-term growth period. KEMET estimates the historical average annual decrease in ASPs to be approximately 7% to 8%. This, in turn, requires the Company to effectively manage costs to remain competitive. An example of this is the Company’s decision to move the manufacture of commodity manufacturing to low-cost locations. (See “Enhanced Strategic Plan.”)

Cyclicality —Periods of significant expansion and correction have marked the long-term growth of the capacitor market.

Expansion periods —Expansion periods usually offer the opportunity for the Company to exercise more control over ASPs as industry capacity utilization is high. Customer demand often exceeds the available supply. Firm or higher pricing combined with higher volumes cause this to be the most profitable part of the cycle for the industry, and the industry generally adds capacity during this period.

Correction periods —Correction periods usually offer the opportunity for the customer to exercise more control over ASPs as industry capacity exceeds customer demand. Lower pricing combined with lower volumes during this period cause this to be the least profitable part of the cycle for the industry.

The fiscal year ended March 31, 2001 represented a cyclical peak and the Company reported record revenues and profits of $1.4 billion and $352.3 million, respectively. During such an expansion period, the Company is challenged with meeting demand and not over expanding capacity, which it may not be able to bring on line until after the expansion. The increase in demand requires maintaining higher raw material inventory levels at higher prices, which challenges the Company to increase inventory turnover as well as managing inventory to a reasonable level to reduce issues such as obsolescence, particularly when the expansion ends.

The four fiscal years following fiscal year 2001 (i.e. fiscal year 2002 through fiscal year 2005) represent what the Company considers an unprecedented correction phase of the long-term growth trend. Demand decreased markedly, and the quarterly decline in ASPs was often in excess of the historical average annual decrease. During such a correction phase, the Company is challenged with aligning costs with the reduced stream of revenues. The Company must remain financially sound with sufficient financial liquidity to not only operate effectively during the correction phase but also have the financial wherewithal to react when the next expansion cycle begins. During this correction phase, the Company began a number of initiatives (see Special Charges for Fiscal Year 2007, 2006 and 2005) to meet these challenges.

In fiscal year 2006, the Company believes that the unprecedented correction phase concluded as evidenced by lower percentage decreases in ASPs. The Company saw ASPs actually remain flat, adjusted for product mix during the last two fiscal quarters of that year. During fiscal year 2007, the Company experienced basically flat ASPs, adjusted for product mix, and continued to see an increase in demand.

At March 31, 2007, the Company had $258.0 million of cash and short- and long-term investments. KEMET intends to satisfy both its short-term and long-term liquidity requirements primarily with existing cash and cash equivalents and cash provided by operations. During the fiscal year ending March 31, 2007, the Company issued 2.25% Convertible Senior Notes in the amount of $175.0 million. The funds were obtained to strengthen the Company’s liquidity position in the event of another downward cycle. Please refer to the discussion below under the heading “Acquisitions” for a discussion of the recent use of a portion of the Company’s cash and short- and long-term investments.

Business Segments

Effective October 1, 2005, the Company organized into two distinct business units: the Tantalum Business Unit (“Tantalum”) and the Ceramics Business Unit (“Ceramics”). Each business unit 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 units and are allocated to the business units. In addition, all corporate costs are also allocated to the business units.

Tantalum Business Unit

The Tantalum Business Unit operates in six manufacturing sites in the United States, Mexico, Portugal, and China. This business unit produces tantalum and aluminum capacitors. The business unit also maintains a product innovation center in the United States. Sales of Tantalum’s products are made in all regions in the world.

Ceramics Business Unit

The Ceramics Business Unit operates in three manufacturing sites in Mexico and China. This business unit produces ceramic capacitors. In addition, the business unit also has a product innovation center in the United States. Sales of Ceramics’ products are made in all regions in the world.

Acquisitions

Tantalum business unit of EPCOS AG

As previously reported, pursuant to the terms of an Asset and Share Purchase Agreement and an Asset Purchase Agreement between KEMET Corporation and certain of its subsidiaries (the “Company” or “KEMET”) and EPCOS AG, a German corporation (“EPCOS”), the Company completed the purchase of the tantalum business unit of EPCOS on April 13, 2006 for a purchase price of EUR 80.9 million (approximately $98.4 million). The acquisition included all of the issued share capital of EPCOS-Pecas e Componentes Electronicos S.A. and certain other assets of the tantalum business unit of EPCOS, primarily in Germany. Of the EUR 80.9 million, KEMET paid in cash approximately EUR 68.3 million (approximately $82.7 million) and assumed certain liabilities and working capital adjustments of EUR 12.6 million. As previously announced, the acquisition did not include EPCOS’ tantalum capacitor manufacturing facility in Heidenheim, Germany. As a result, KEMET and EPCOS entered into a manufacturing and supply agreement under which EPCOS continued to manufacture product exclusively for KEMET at the Heidenheim facility to ensure a continued supply of product to customers during the transition period. In connection with the acquisition, the Company paid approximately $4.4 million in legal and professional fees which have been included as part of the purchase price. On September 29, 2006, the Company agreed upon the final purchase amount related to the April 13, 2006 closing date and accordingly received a favorable credit of EUR 3.0 million (approximately $3.8 million). This amount reduced the Company’s goodwill recorded in the transaction.

The transition period concluded on September 30, 2006, and consequently, KEMET purchased certain of the Heidenheim, Germany manufacturing assets and the research and development assets at a price of EUR 8.2 million (approximately $10.4 million). The Company also purchased inventories at the Heidenheim plant for EUR 1.2 million (approximately $1.6 million). In addition, the Company assumed a pension liability of EUR 1.1 million (approximately $1.3 million) for the Heidenheim employees. Finally, the Company incurred additional legal and audit fees relating to the acquisition of $0.5 million. The net additional purchase price was EUR 8.8 million (approximately $11.1 million).

Taking into account both the April 13, 2006 closing adjustment and the transition agreement on September 30, 2006, the Company purchased the tantalum business unit of EPCOS for a total purchase price of EUR 86.7 million (approximately $105.8 million). The final cash settlement was made in October 2006.

The purchase price was determined through arms-length negotiations between representatives of the Company and EPCOS.

Evox Rifa Group Oyj

On April 24, 2007, KEMET Corporation announced that its wholly owned subsidiary, KEMET Electronics Corporation (“KEMET”), had purchased approximately 92.7% of the shares in Evox Rifa Group Oyj (“Evox Rifa”) pursuant to a tender offer which commenced on March 12, 2007, and was completed on April 12, 2007. Evox Rifa had 178,156,018 shares outstanding at the time of the commencement of the tender offer. KEMET purchased approximately 165.2 million shares at a price of EUR 0.12 per share or approximately EUR 19.8 million (approximately $27.0 million), representing a 47% premium to the volume-weighted average trading price of the Evox Rifa shares on the Helsinki Stock Exchange during the 12 months prior to February 19, 2007 and approximately a 44% premium to the average trading price during the 3 months prior to February 19, 2007. KEMET has also announced that it intends to acquire the remaining outstanding shares pursuant to a squeeze-out proceeding. Following the settlement of the completion trades relating to the tender offer, Evox Rifa has become a subsidiary of KEMET.

In addition, pursuant to the tender offer, KEMET offered to acquire all of the outstanding loan notes under the convertible capital loan issues by Evox Rifa for a consideration corresponding to the aggregate of the nominal amount per loan note of EUR 100 plus accrued interest up to and including the closing date of the tender offer. The outstanding amount of the loan notes at the time of the commencement of the tender offer totaled approximately EUR 5.6 million (approximately $7.6 million). Holders of approximately 95.7% of the convertible capital loan notes issued by Evox Rifa have tendered their loan notes pursuant to the tender offer, and KEMET has redeemed these notes as of April 24, 2007. KEMET redeemed approximately EUR 5.3 million (approximately $7.3 million) of the total outstanding convertible capital loan notes and paid all accrued interest up until the date of settlement of the tender offer. In addition to the payment made for the shares and loan notes, KEMET assumed approximately EUR 19.2 million (approximately $26.1 million) in outstanding indebtedness of Evox Rifa. The total purchase price for Evox Rifa, assuming the acquisition of all shares and loan notes at the tender offer price, is expected to be approximately $36.7 million.

The Company is in the process of recording the acquisition and will provide the necessary financial information in a later filing with the Securities and Exchange Commission.

The Company anticipates that these acquisitions will further strengthen its global leadership position in the capacitance industry and provide greater access to the European market and customers.

Enhanced Strategic Plan of 2003

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

KEMET’s strategy had three foundations:

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

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

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

To execute the Plan, KEMET substantially reorganized its operations around the world. Several KEMET facilities were relocated based on access to key customers, access to key technical resources and knowledge, and availability of low-cost resources. KEMET recorded special charges of approximately $50.5 million over the period of the reorganization related to movement of manufacturing operations. This has yielded an approximate one-year payback based on unit volumes at the time of the announcement, and a $50 - $60 million savings with volume recovery achieved in fiscal year 2006. In addition, there were special charges reflecting the change in status of the facilities that were vacated through this move. The timing of the special charges was dependent on the timing of operational decisions The Company still has two remaining moves, which are scheduled to be completed in fiscal year 2008. See Fiscal Year 2007 Special Charges, Fiscal Year 2006 Special Charges, and Fiscal Year 2005 Special Charges under Results of Operations.

KEMET in the United States

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

Commodity manufacturing currently in the United States has been substantially relocated to the Company’s lower-cost manufacturing facilities in Mexico and China. There are two remaining moves currently underway which are scheduled to be completed by the end of fiscal year 2008. Production that remains in the United States will focus primarily on early-stage manufacturing of new products and other specialty products for which customers are predominantly located in North America.

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

KEMET in Mexico

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

KEMET in China

In recent years, low production costs and proximity to large, growing markets have caused many of KEMET’s key customers to relocate production facilities to Asia, particularly China. KEMET has a well-established sales and logistics network in Asia to support its customers’ Asian operations. The Company’s initial China production facility in Suzhou near Shanghai commenced shipments in 2003. The Company began shipping products from its second production facility in Suzhou in 2005. Manufacturing operations in China will continue to grow, and KEMET anticipates that production capacity in China may be equivalent to Mexico in the future. Like KEMET Mexico, the vision for KEMET China is to be a Chinese operation, with Chinese management and workers, to help achieve KEMET’s objective of being a global company. These facilities will be responsible for maintaining KEMET’s traditional excellence in quality, service, and delivery, while accelerating cost-reduction efforts and supporting efforts to grow the Company’s customer base in Asia.

KEMET in Europe

As previously mentioned, the Company completed the acquisition of the tantalum business unit of EPCOS on April 13, 2006. The Company also acquired Evox Rifa Group Oyj on April 24, 2007. These acquisitions have provided the Company with manufacturing operations in Europe. KEMET will maintain and enhance its strong European sales and customer service infrastructure, allowing KEMET to continue to meet the local preferences of European customers who remain an important focus for KEMET going forward.

Global Sales and Logistics

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

Critical Accounting Policies

The Company’s significant accounting policies are summarized in Note 1 to the consolidated financial statements. The following identifies a number of policies which require significant judgments or estimates.

The Company’s estimates and assumptions are based on historical data and other assumptions that KEMET 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.

The 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 consolidated financial statements. It is important that a reader of the financial statements understand that actual future results could differ from these estimates, assumptions, and judgments.

KEMET’s management believes the following critical accounting policies contain the most significant judgments and estimates used in the preparation of the consolidated financial statements:

• INVENTORIES. Inventories are valued at the lower of cost or market, with cost determined under the first-in, first-out method and market based upon net realizable value. The valuation of inventories requires management to make estimates. The Company also must assess the prices at which it believes the finished goods inventory can be sold compared to its cost. A sharp decrease in unit demand could adversely impact earnings as the reserve estimates could increase. Conversely, a sharp increase in unit demand could favorably impact earnings as the reserve estimates could decrease.

During fiscal year 2005, the Company renegotiated the contract with Cabot Corporation associated with the tantalum purchase commitment. Due to the changes made in the contract, a portion of the 2004 and 2003 purchase commitment losses were reversed. In the fiscal year ended March 31, 2005, the Company decreased its purchase commitment liability by recognizing a gain of $11.8 million. As of March 31, 2006, the Company had purchased the inventory that was committed to be purchased under the agreement.


The Company has assumed a supply agreement with Cabot resulting from the acquisition of the EPCOS tantalum business unit on April 13, 2006. This contract extends through September 2007. The Company recorded an unfavorable contract provision on its opening balance sheet related to this agreement.

The net realizable value of current tantalum inventory and the losses with respect to future tantalum commitments were calculated based on current market prices for tantalum. There is no established market on which tantalum raw materials are regularly traded and quoted. The Company based its determination of current market price on quotations from suppliers of these materials. In quantifying the charges that were recorded against future purchase commitments, the Company assumed, for lack of another benchmark, the current market prices would continue through calendar year 2007, when KEMET’s purchase commitments were scheduled to end. Had other assumptions on current and future prices for tantalum been made, the amount of the inventory losses against purchase commitments would have been different.

• ASSET IMPAIRMENT—GOODWILL and LONG-LIVED ASSETS. KEMET adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” on April 1, 2002. Under SFAS No. 142, goodwill, which represents the excess of purchase price over fair value of net assets acquired, and intangible assets with indefinite useful lives are no longer amortized but are to be tested for impairment at least on an annual basis in accordance with the provisions of SFAS No. 142.

Effective October 1, 2005, the Company organized into two distinct Business Units: the Tantalum Business Unit and the Ceramics Business Unit. Accordingly, the Company had to alter the method which it used to test for goodwill impairment. The Company evaluated its goodwill on a reporting unit basis consistent with the provisions of SFAS No. 142. This required the Company to estimate the fair value of the reporting units based on the future net cash flows expected to be generated. At December 31, 2005, the Company determined that no goodwill impairment existed.

The Company’s goodwill is tested for impairment at least on an annual basis. The impairment test involves a comparison of the fair value of its reporting units, as defined under SFAS No. 142, with carrying amounts. If the reporting unit’s aggregated carrying amount exceeds its fair value, then an indication exists that the reporting unit’s goodwill may be impaired. The impairment to be recognized is measured by the amount by which the carrying value of the reporting unit being measured exceeds its fair value, up to the total amount of its assets.

On an ongoing basis, KEMET expects to perform its impairment tests during the first quarter of each fiscal year and when otherwise warranted. In accordance with SFAS No. 142, KEMET completed its annual goodwill impairment test in the first quarter of fiscal years 2007, 2006, and 2005, none of which indicated impairment. During the fiscal fourth quarter 2005, KEMET completed another goodwill impairment test due to the asset impairment the Company recorded in that quarter. See below for a discussion on the fiscal fourth quarter 2005 Asset Impairment. This test yielded no goodwill impairment.

As of March 31, 2007, KEMET had goodwill in the amount of $36.6 million.

For the impairment or disposal of long-lived assets, KEMET follows the guidance as prescribed in SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” In accordance with SFAS No. 144, long-lived assets and intangible assets subject to amortization would be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset or group of assets may not be recoverable. A long-lived asset classified as held for sale is initially measured and reported at the lower of its carrying amount or fair value less cost to sell. Long-lived assets to be disposed of other than by sale are classified as held and used until the long-lived asset is disposed of.

Tests for the recoverability of a long-lived asset to be held and used are measured by comparing the carrying amount of the long-lived asset to the sum of the estimated future undiscounted cash flows expected to be generated by the asset. In estimating the future undiscounted cash flows, the Company uses future projections of cash flows directly associated with, and which are expected to arise as a direct result of, the use and eventual disposition of the assets. These assumptions include, among other estimates, periods of operation, projections of sales, cost of good sold, and capital spending. Changes in any of these estimates could have a material effect on the estimated future undiscounted cash flows expected to be generated by the asset. If it is determined that a long-lived asset is not recoverable, an impairment loss would be calculated equal to the excess of the carrying amount of the long-lived asset over its fair value. The fair value is calculated as the discounted cash flows of the underlying assets on a pre-tax basis.

Using the factors above, a test for recoverability of the Company’s tantalum and ceramic assets was performed as of March 31, 2005. The results of the test for recoverability indicated that the carrying amount of the long-lived assets exceeded the estimated future undiscounted cash flows. As a result, KEMET calculated the excess of the carrying amount of the long-lived assets over its fair value on a pre-tax discounted cash flow basis using the factors above. The discount rate used was an estimation of KEMET’s pre-tax, weighted-average cost of capital. The Company, accordingly, recognized a non-cash impairment charge of $100.2 million ($44.2 million for tantalum products and $56.0 million for ceramic products). The Company believed that it was appropriate to record these impairments due to continued erosion in average selling prices which have been greater than historical reductions. (For further discussion, see Fiscal Year 2005 Special Charges.)

Future changes in assumptions may negatively impact future valuations. In future tests for recoverability, adverse changes in undiscounted cash flow assumptions could result in an impairment of certain long-lived assets that would require a non-cash charge to the Consolidated Statements of Operations and may have a material effect on the Company’s financial condition and operating results.

• REVENUE RECOGNITION. The Company recognizes revenue only when all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the seller’s price to the buyer is fixed or determinable, and (4) collectibility is reasonably assured.

A portion of sales is related to products designed to meet customer specific requirements. These products typically have stricter tolerances making them useful to the specific customer requesting the product and to customers with similar or less stringent requirements. Products with customer specific requirements are tested and approved by the customer before the Company mass produces and ships the product. The Company recognizes revenue at shipment as the sales terms for products produced with customer specific requirements do not contain a final customer acceptance provision or other provisions that are unique and would otherwise allow the customer different acceptance rights.

A portion of sales is made to distributors under agreements allowing certain rights of return and price protection on unsold merchandise held by distributors. The Company’s distributor policy includes inventory price protection and “ship-from-stock and debit” (“SFSD”) programs common in the industry. The price protection policy protects the value of the distributors’ inventory in the event the Company reduces its published selling price to distributors. This program allows the distributor to debit the Company for the difference between KEMET’s list price and the lower authorized price for specific parts. The Company establishes price protection reserves on specific parts residing in distributors’ inventories in the period that the price protection is formally authorized by management.

The SFSD program provides a mechanism for the distributor to meet a competitive price after obtaining authorization from the local Company sales office. This program allows the distributor to ship its higher-priced inventory and debit the Company for the difference between KEMET’s list price and the lower authorized price for that specific transaction. The Company established reserves for its SFSD program based primarily on certain distributors’ actual inventory levels comprising 91% to 95% of the total global distributor inventory related to customers which participate in the SFSD program. The remaining 5% to 9% is estimated based on actual distributor inventory and current sales trends. Management analyzes historical SFSD activity to determine the SFSD exposure on the global distributor inventory at the balance sheet date. From time to time, the Company “builds-up” inventory levels due to factors such as anticipated future demand exceeding capacity and when the Company moves manufacturing from one location to another location. When the distributors “build-up” inventory levels, the estimation of the inventory at the distributors for the remaining 5% to 9% could be estimated at an incorrect amount. However, the Company believes that the difference between the estimate and the ultimate actual amount would be immaterial.

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

• POSTRETIREMENT BENEFITS. KEMET’s management, with the assistance of an actuarial firm, performs an actuarial valuation of the fair values of its postretirement plans’ benefit obligations. Management makes certain assumptions that have a significant effect on the calculated fair value of the obligations such as the:

• weighted-average discount rate—used to arrive at the net present value of the obligation;

• salary increases—used to calculate the impact future pay increases will have on postretirement obligations; and

• medical cost inflation—used to calculate the impact future medical costs will have on postretirement obligations.

Management understands that these assumptions directly impact the actuarial valuation of the obligations recorded on the Consolidated Balance Sheets and the income or expense that flows through the Consolidated Statements of Operations.

Management bases its assumptions on either historical or market data that it considers reasonable. Variations in these assumptions could have a significant effect on the amounts reported through the Consolidated Statements of Operations.

The Company froze accrual of benefits of its domestic non-contributory pension plan on June 30, 2003. Prior to the end of fiscal year 2004, KEMET terminated and liquidated its defined benefit pension plan and, as a result, recognized $50.4 million in pension settlement charges. During fiscal year 2005, KEMET recognized $0.6 million of additional costs relating to the final settlement of its defined benefit pension plan. The termination of the pension plan is anticipated to result in future savings of approximately $6 million per year. KEMET continues to provide other defined contribution retirement plans to its employees.

• INCOME TAXES. Income taxes are accounted for under the asset and liability method, as prescribed by SFAS No. 109, “Accounting for Income Taxes.” Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to be recovered or settled. Valuation allowances are recognized to reduce deferred tax assets to the amount that is more likely than not to be realized.

Management believes that it is more likely than not that a portion of the net deferred tax assets for the United States, Portugal, Switzerland, and Australia will not be realized, based on the scheduled reversal of deferred tax liabilities, the recent history of cumulative losses, and the insufficient evidence of projected future taxable income to overcome the loss history. Management has provided a valuation allowance related to any benefits from income taxes resulting from the application of a statutory tax rate to the deferred tax assets. KEMET continues to have net deferred tax assets (future tax benefits) in several other countries which the Company expects to realize assuming, based on certain estimates and assumptions, sufficient taxable income in certain foreign tax jurisdictions to utilize these deferred tax benefits. If these estimates and related assumptions change in the future, the Company may be required to reduce the value of the deferred tax assets resulting in additional tax expense.

Results of Operations

Historically, revenues and earnings may or may not be representative of future operating results due to various economic and other factors.

Comparison of Fiscal Year 2007 to Fiscal Year 2006

Overview:

Net sales:

Net sales for fiscal year 2007 were $658.7 million, which represented a 34.4% increase from fiscal year 2006 net sales of $490.1 million. The acquisition of the EPCOS tantalum business unit resulted in an increase in net sales of 19.3% in fiscal year 2007. Sales revenue for the core business increased 15.1% due to increased sales volumes. During fiscal year 2007, average selling prices (“ASPs”) remained relatively flat for existing products. The Company also had 2,700 new product introductions during fiscal year 2007, of which 336 were first to market. Each of these factors contributed to the increase in core net sales.

Cost of good sold:

Cost of goods sold for the fiscal year ended March 31, 2007, was $517.4 million as compared to $399.3 million for the fiscal year ended March 31, 2006, a 29.6% increase. The increase in cost of goods sold was impacted 20.9% by the purchase of the EPCOS tantalum business unit. New product offerings increased cost of goods sold by 8.7%. The Company believes many of the actions it initiated or carried out during fiscal years 2007, 2006, and 2005 (see Fiscal Year 2007 Special Charges, Fiscal Year 2006 Special Charges, and Fiscal Year 2005 Special Charges) resulted in lower costs and more efficient operations and accounted for the improved gross profit margin in fiscal year 2007. In addition, manufacturing throughput increased in fiscal year 2007 as higher volumes resulted in the absorption of fixed costs over more units versus fiscal year 2006.

Research and development:

Research and development expenses were $33.4 million for fiscal year 2007, compared to $26.0 million for fiscal year 2006. These costs reflect the Company’s continuing commitment to the development and introduction of new ultralow ESR tantalums, tantalum face-down products and additional case sizes. Ceramics improved its current product offerings by developing flex migration for crack elimination, and also developing a floating electrode design while expanding Hi-CV offerings. These advancements extend the Company’s leading position in certain capacitor technologies. It is the Company’s intent to continue to invest at least 5% of net sales in research and development efforts.

Special charges:

Special charges for the fiscal year ended March 31, 2007, were $35.8 million as compared to $17.3 million for the prior fiscal year.

The charges are explained in detail by quarter for both fiscal year 2007 and 2006 later in this section.

Operating income/(loss):

The operating income for the fiscal year ended March 31, 2007, was $5.9 million compared to a loss of $10.2 million in the prior year. The increase in operating income from the prior year was principally from a combination of the aforementioned higher sales levels and manufacturing efficiencies reflected in Costs of goods sold.

Other (income)/expense:

Other (income)/expense increased in fiscal year 2007 compared to fiscal year 2006 due to greater foreign currency transaction gains and a gain on sale of an equity investment in fiscal year 2007.

Income taxes:

The effective tax rate for fiscal year 2007 was 7.5%, resulting in a tax expense of $0.6 million. This compares to an effective tax rate of 103.1% for fiscal year 2006 that resulted in a tax benefit of $12.5 million. The Company’s tax expense remained lower than the historical average of 30% to 36% due to income sourced in foreign jurisdictions with lower tax rates. The Company also recognized a net tax benefit of $1.2 million from the normal process of evaluating its worldwide tax contingencies. No tax benefit is recognized for the domestic tax loss for fiscal year 2007 due to the establishment of a valuation allowance during fiscal year 2004. Future fluctuations in the valuation allowance are expected to result in a tax rate below the 30% to 36% historical average.

Fiscal Year 2007 Special Charges

The Company reports a measure entitled Special Charges. These charges are considered items outside of normal operations, and it is the intent of KEMET to provide more information to explain the operating results. Since some of the items are not considered restructuring charges as defined by U.S. generally accepted accounting principles, the Company has provided the breakout of U.S. generally accepted accounting principles restructuring and impairment charges and those other charges and adjustments separately. The Company included the costs related to stock options and other share-based payments in fiscal year 2007 to provide a more suitable comparison to fiscal years 2006 and 2005.

Enhance Strategic Plan of 2003 (the “Plan”)— During fiscal year 2007, the Company recognized $8.6 million in costs relating to the Plan. The Plan included moving manufacturing operations to lower cost facilities in Mexico and China. As of March 31, 2007, the Company had recorded cumulative charges of $50.5 million in connection with the Plan. The manufacturing moves to lower cost regions are substantially complete. Two manufacturing operation moves still remain to be made which are the anode manufacturing move to Mexico, which is currently in progress, and the tantalum polymer manufacturing move to China, which has not yet started. It is expected that both moves will be completed by the end of fiscal year 2008. During the fiscal year ended March 31, 2007, the Company recognized a charge of $2.8 million for a reduction in force primarily in Europe and Mexico. All costs are expensed as incurred.

Loss on Sale of Property— During the fiscal year ended March 31, 2007, the Company completed the sale of its Shelby, North Carolina facility for which the Company recognized a $0.2 million loss on the sale. In addition, the Company is in the final steps of selling its vacant facility in Matamoros, Mexico. Accordingly, the Company recognized a charge $0.1 million on the potential sale which should be completed in the first fiscal quarter 2008.

EPCOS integration— KEMET completed the acquisition of the tantalum business unit of EPCOS on April 13, 2006. During fiscal year 2007, the Company recorded charges of $16.2 million related to the integration which are included in Selling, general and administrative expenses on the Consolidated Statements of Operations.

Impact of SFAS No. 123(R) “Share-Based Payment”— In fiscal year 2007, the Company implemented SFAS No. 123(R) “Share-Based Payment” and recognized a charge of $6.8 million relating to the cost recognition for awards of share based compensation. In fiscal year 2006, there were no charges for stock option expense.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Comparison of the Three-Month Period Ended December 31, 2007, with the Three-Month Period Ended December 31, 2006



Net Sales



Net sales for the three months ended December 31, 2007, increased 38.2% to $228.7 million as compared to the same period last year, with 31.5% or $72.1 million of net sales being contributed by the Film and Electrolytic Business Group Excluding the Film and Electrolytic Business Group, unit volumes in the three-month period ended December 31, 2007 increased 13.0% as compared to the same period last year. Mix-adjusted average selling prices for the December 2007 quarter decreased approximately 12.0% compared to mix-adjusted average selling prices for the December 2006 quarter.



By region, 25% of net sales for the three months ended December 31, 2007, were to customers in North America and South America (“Americas”), 40% were to customers in Asia and Pacific Rim (“APAC”), and 35% were to customers in Europe, Middle East and Africa (“EMEA”). For the three months ended December 31, 2006, 31% of net sales were to customers in the Americas, 45% were to customers in APAC, and 24% were to customers in EMEA.



By channel, 46% of net sales for the three months ended December 31, 2007, were to distribution customers, 17% were to Electronic Manufacturing Services customers, and 37% were to Original Equipment Manufacturing customers. For the three months ended December 31, 2006, 55% of net sales were to distribution customers, 22% were to Electronic Manufacturing Services customers, and 23% were to Original Equipment Manufacturing customers.



Cost of Sales



Cost of sales for the three months ended December 31, 2007, was $188.6 million, or 82.5% of net sales, as compared to $127.5 million, or 77.1% of net sales, for the same period last year, with $59.3 million being attributed to the Film and Electrolytic Business Group. Excluding the Film and Electrolytic Business Group, the increase in cost of sales as a percentage of sales was due to a less favorable product mix partially offset by the Company’s cost reduction efforts, to a lesser extent. The Company has continued to experience higher costs in two of its raw materials, palladium and silver. Silver is used by both the Tantalum and Ceramic Business Groups while palladium is used primarily in the Ceramic Business Group.



Selling, General and Administrative Expenses



Selling, general and administrative (“SG&A”) expenses for the three months ended December 31, 2007, were $28.1 million, or 12.3% of net sales, as compared to $21.2 million, or 12.8% of net sales for the same period last year. The SG&A expenses for the three months ended December 31, 2007 include $11.9 million or 5.2% of net sales related to the Film and Electrolytic Business Group.

Research and Development Expenses



Research and development (“R&D”) expenses for the three months ended December 31, 2007, were $8.6 million, or 3.8% of net sales, as compared to $8.7 million, or 5.3% of net sales for the same period last year. The R&D expenses for the three months ended December 31, 2007 include $1.0 million related to the newly formed Film and Electrolytic Business Group. The continuing level of R&D expenses reflects the Company’s efforts to be the “The Capacitance Company.” During the quarter, the Company introduced approximately 272 new products of which 142 were first to market.



Special Charges



The Company reports a measure entitled Special Charges. These charges are considered items outside of normal operations, and it is the intent of KEMET to provide an alternative depiction of its operating results. Since some of the items are not considered restructuring charges as defined by U.S. generally accepted accounting principles, the Company has provided the breakout of U.S. generally accepted accounting principles restructuring charges and those other charges and adjustments separately.

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



Reductions in workforce — During the three months ended December 31, 2007, the Company recognized a charge of $1.7 million for a reduction in force in Portugal and Germany. For the three months ended December 31, 2006, the Company recognized a charge of $1.2 million for a reduction in force in Mexico.



Manufacturing relocations — During the three months ended December 31, 2007 and 2006, the Company incurred expenses of $1.2 million and $0.6 million, respectively.



Impact of SFAS No. 123(R) “Share-Based Payment” — In fiscal year 2007, the Company implemented SFAS No. 123(R) “Share-Based Payment.” Charges related to SFAS No. 123(R) following the year of implementation are not included in Special Charges and are therefore omitted from the table. To enhance comparability, however, current period charges related to SFAS No. 123(R) are included in the following narrative. During the three month periods ended December 31, 2007, and December 31, 2006, the Company recognized charges of $0.7 million and $1.2 million, respectively, related to the cost recognition of issued stock options.



Acquisitions integration costs — As part of the Company’s recent acquisitions, the Company has and will continue to incur costs to integrate the new Film and Electrolytic businesses into KEMET. The Company incurred $1.8 million of costs during the third fiscal quarter of 2008. During the third quarter of fiscal year 2007, the Company recorded charges of $4.0 million related to the acquisition of the tantalum business of EPCOS AG (“EPCOS”) which are included in SG&A expenses on the Consolidated Statements of Operations. As of March 31, 2007, all integration costs associated with the tantalum business of EPCOS had been incurred.

Operating Income/(Loss)



Operating loss for the three months ended December 31, 2007, was $(1.6) million, compared to an operating income of $6.2 million for the quarter ended December 31, 2006. The decrease in operating income was primarily due to a decrease in gross margins created by an unfavorable product mix.



Other (Income)/Expense



Interest income decreased in the three months ended December 31, 2007 versus the comparable period in the prior year primarily due to the Company’s acquisitions. The convertible debt offering in November 2006 increased the amount of interest expense recorded during the three month period ended December 31, 2007 as compared to the previous year. Furthermore, additional interest expense was incurred in connection with the Company’s acquisitions. Other (income)/expense increased in the three months ended December 31, 2007 versus the comparable period of the preceding year due primarily to foreign currency transaction gains in the three-month period ended December 31, 2007.



Income Taxes



Income tax expense totaled $5.7 million for the three months ended December 31, 2007, compared to an income tax expense of $0.7 million for the three months ended December 31, 2006. The net income tax expense is comprised of a $0.8 million benefit due to the settlement of foreign tax issues, a $2.2 million expense related to tax law changes in Mexico and Germany, a $3.0 million expense related to fixed asset write offs in Germany, a $1.2 million expense related to foreign operations, and minor federal and state income tax expense.



Management evaluates its tax assets and liabilities on a periodic basis and adjusts these balances on a timely basis as appropriate, based on certain estimates and assumptions and sufficient future taxable income to utilize its deferred tax benefits. If these estimates and related assumptions change in the future, the Company may be required to increase the value of the deferred tax liability, resulting in additional income tax expense.

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