Investment in NEC TOKIN

On March 12, 2012, KEC, a wholly owned subsidiary of the Company, entered into a Stock Purchase Agreement (the “Stock Purchase Agreement”) with NEC TOKIN Corporation (“NEC TOKIN”), a manufacturer of tantalum capacitors, electro-magnetic, electro-mechanical and access devices, to acquire 51% of the common stock of NEC TOKIN (which represented a 34% economic interest, as calculated based on the number of common shares held by KEC, directly and indirectly, in proportion to the aggregate number of outstanding common and convertible preferred shares of NEC TOKIN as of such date) (the “Initial Purchase”) from NEC Corporation (“NEC”) of Japan. The transaction closed on February 1, 2013, at which time KEC paid a purchase price of $50.0 million for new shares of common stock of NEC TOKIN (the “Initial Closing”). The Company accounts for its investment in NEC TOKIN using the equity method for a non-consolidated variable interest entity since KEC does not have the power to direct significant activities of NEC TOKIN. The Company believes that the NEC TOKIN convertible preferred stock represents in-substance common stock of NEC TOKIN and, as a result, its method of calculating KEC’s economic basis in NEC TOKIN is the appropriate basis on which to recognize its share of the earnings or loss of NEC TOKIN.

In connection with KEC’s execution of the Stock Purchase Agreement, KEC entered into a Stockholders’ Agreement (the “Stockholders’ Agreement”) with NEC TOKIN and NEC, which provides for restrictions on transfers of NEC TOKIN’s capital stock, certain tag-along and first refusal rights on transfer, restrictions on NEC’s ability to convert the preferred stock of NEC TOKIN held by it, certain management services to be provided to NEC TOKIN by KEC (or an affiliate of KEC) and certain board representation rights. KEC holds four of seven NEC TOKIN director positions. However, NEC has significant board rights.

Concurrent with execution of the Stock Purchase Agreement and the Stockholders’ Agreement, KEC entered into an Option Agreement (the “Option Agreement”) with NEC, which was amended on August 29, 2014, whereby KEC had the right to purchase additional shares of NEC TOKIN common stock from NEC TOKIN for a purchase price of $50.0 million resulting in an economic interest of approximately 49% while maintaining ownership of 51% of NEC TOKIN’s common stock (the “First Call Option”) by providing notice of the First Call Option between the Initial Closing and April 30, 2015. Upon providing such First Call Option notice, but not before April 1, 2015, KEC could also have exercised a second option to purchase all outstanding capital stock of NEC TOKIN from its stockholders, primarily NEC, for a purchase price based on the greater of six times LTM EBITDA (as defined in the Option Agreement) less the previous payments and certain other adjustments, or the outstanding amount of NEC TOKIN’s debt obligation to NEC (the “Second Call Option”) by providing notice of the Second Call Option by May 31, 2018. The First and Second Call Options expired on April 30, 2015 without being exercised.

Through May 31, 2018, NEC may require KEC to purchase all outstanding capital stock of NEC TOKIN from its stockholders, primarily NEC (the “Put Option”), provided that KEC’s payment of the Put Option price is permitted under the 10.5% Senior Notes and Loan and Security Agreement. However, in the event that KEC issues new debt securities principally to refinance its outstanding 10.5% Senior Notes due 2018 and its currently outstanding credit agreement, including amounts to pay related fees and expenses and to use for general corporate purposes (“Refinancing Notes”), prior to NEC’s delivery of its notification of exercise of the Put Option, then the earliest date NEC may exercise the Put Option is automatically extended to the day immediately following the final scheduled maturity date of such Refinancing Notes, or in the event such Refinancing Notes are redeemed in full prior to such final scheduled maturity date, then on the day immediately following the date of such full redemption, but in any event beginning no later than November 1, 2019. If not previously exercised, the Put Option will expire on October 31, 2023.

The purchase price for the Put Option will be based on the greater of six times LTM EBITDA less previous payments and certain other adjustments, or the outstanding amount of NEC TOKIN’s debt obligation to NEC as of the date the Put Option is exercised. The purchase price for the Put Option is reduced by the amount of NEC TOKIN’s debt obligation to NEC which KEC will assume. The determination of the purchase price could be modified in the event there is a disagreement between NEC and KEC under the Stockholders’ Agreement.

The Company has marked the option to fair value and in the quarter and six-month periods ended September 30, 2016 recognized a $1.6 million gain and a $10.4 million loss, respectively, which was included on the line item “Change in value of the NEC TOKIN option” in the Condensed Consolidated Statement of Operations. The line item “Other non-current obligations” on the Condensed Consolidated Balance Sheets includes $31.0 million and $20.6 million as of September 30, 2016 and March 31, 2016, respectively, related to the respective fair value of the Put Option.

KEC’s total investment in NEC TOKIN including the net call derivative described above on February 1, 2013, the closing date of the acquisition, was $54.5 million which includes $50.0 million cash consideration plus approximately $4.5 million in transaction expenses (fees for legal, accounting, due diligence, investment banking and various other services necessary to complete the transactions). The Company has made an allocation of the aggregate purchase price, which was based upon estimates that the Company believes are reasonable.

Summarized financial information for NEC TOKIN follows (amounts in thousands):



	September 30, 2016		March 31, 2016
Current assets	$	249,818	$	240,427
Non-current assets	258,333		260,614
Current liabilities	171,193		179,360
Non-current liabilities	368,011		335,500



	Quarters Ended September 30,				Six-Month Periods Ended September 30,
	2016		2015		2016		2015
Sales	$	126,589	$	117,358	$	247,099	$	232,092
Gross profit	27,055		25,055		53,601		49,723
Net income (loss)	2,012		2,007		4,362		7,261

A reconciliation between NEC TOKIN’s net income (loss) and KEC’s equity investment income (loss) follows (amounts in thousands):



	Quarters Ended September 30,						Six-Month Periods Ended September 30,
	2016			2015			2016			2015
NEC TOKIN net income (loss)	$	2,012		$	2,007		4,362			7,261
KEC’s economic interest %	34		%	34		%	34		%	34		%
Equity income (loss) from NEC TOKIN before adjustments	684			682			1,483			2,469

Adjustments:
Amortization and depreciation	(581		)	(488		)	(1,125		)	(624		)
Inventory profit elimination	78			(32		)	46			(98		)
Equity income (loss) from NEC TOKIN	$	181		$	162		$	404		$	1,747

A reconciliation between NEC TOKIN’s net assets and KEC’s investment in NEC TOKIN follows (amounts in thousands):



	September 30, 2016			March 31, 2016
Investment in NEC TOKIN	$	15,174		$	20,334
Purchase price accounting basis adjustments:
Property, plant and equipment (1)	3,565			3,365
Technology (1)	(10,413		)	(10,134		)
Long-term debt (1)	(1,684		)	(1,975		)
Goodwill	(8,377		)	(7,555		)
Indemnity asset for legal investigation	(8,500		)	(8,500		)
Inventory profit elimination (2)	326			371
Other	(650		)	(604		)
KEC’s 34% economic interest in NEC TOKIN’s net assets	$	(10,559	)	$	(4,698	)

(1) Amortized over the estimated lives.

(2) Adjusted each period for any activity.

As of September 30, 2016, KEC’s maximum loss exposure as a result of its investments in NEC TOKIN is limited to the aggregate of the carrying value of the investment, any accounts receivable balance due from NEC TOKIN and obligations in the Put Option.

Summarized transactions between KEC and NEC TOKIN are as follows (amounts in thousands):



	Quarters Ended September 30,				Six-Month Periods Ended September 30,
	2016		2015		2016		2015
KEC’s sales to NEC TOKIN	$	5,135	$	4,474	$	8,282	$	9,330
NEC TOKIN’s sales to KEMET	1,889		2,112		3,761		3,590



	September 30, 2016		March 31, 2016
Accounts receivable	$	3,708	$	5,220
Accounts payable	792		1,019
Management service agreement receivable (1)	649		748

(1) In accordance with the Stockholders’ Agreement, KEC entered into a management services agreement with NEC TOKIN to provide services for which KEC is being reimbursed.

Beginning in March 2014, NEC TOKIN and certain of its subsidiaries received inquiries, requests for information and other communications from government authorities in China, the United States, the European Commission, Japan, South Korea Taiwan, Singapore and Brazil concerning alleged anti-competitive activities within the capacitor industry.

On September 2, 2015, the United States Department of Justice announced a plea agreement with NEC TOKIN in which NEC TOKIN agreed to plead guilty to a one-count felony charge of unreasonable restraint of interstate and foreign trade and commerce in violation of Section 1 of the Sherman Act, and to pay a criminal fine of $13.8 million. The plea agreement was approved by the United States District Court, Northern District of California, on January 21, 2016. The fine is payable over five years in six installments of $2.3 million each, plus accrued interest. The first payment was made in February 2016 and the next payment is due in February 2017.

On December 9, 2015, the Taiwan Fair Trade Commission (“TFTC”) publicly announced that NEC TOKIN would be fined 1,218.2 million New Taiwan dollars (“NTD”) (approximately U.S. $38.8 million) for violations of the Taiwan Fair Trade Act. Subsequently, the TFTC has reduced the fine to NTD609.1 million (approximately U.S. $19.4 million). In February 2016, NEC TOKIN commenced an administrative suit in Taiwan, challenging the validity of the amount of the fine.

On March 29, 2016, the Japan Fair Trade Commission published an order by which NEC TOKIN was fined ¥127.2 million (approximately U.S. $1.3 million) for violation of the Japanese Antimonopoly Act. Payment of the fine was made on October 31, 2016.

On July 26, 2016, Brazil’s Administrative Council for Economic Defense approved a cease and desist agreement with NEC TOKIN in which NEC TOKIN made a financial contribution of Brazilian real 601 thousand (approximately U.S. $0.2 million) to Brazil’s Fund for Defense of Diffuse Rights.

On May 2, 2016, NEC TOKIN reached a preliminary settlement, followed by definitive settlement agreements on July 15, 2016 which are subject to court approval, in two antitrust suits filed with the United States District Court, Northern District of California as In re: Capacitors Antitrust Litigation, No. 3:14-cv-03264-JD (the “Class Action Suits”). Pursuant to the terms of the settlement agreements, in consideration of the release of NEC TOKIN and its subsidiaries (including NEC TOKIN America, Inc.) from claims asserted in the Class Action Suits, NEC TOKIN will pay an aggregate $37.3 million to a settlement class of direct purchasers of capacitors and a settlement class of indirect purchasers of capacitors. Each of the respective class payments is payable in five installments, the first of which became due on July 29, 2016, the next three of which are due each year thereafter on the anniversary of the initial payment, and the final payment is due by December 31, 2019. NEC TOKIN has paid the initial installment payments into the two plaintiff classes’ respective escrow accounts.

The remaining governmental investigations are continuing at various stages. As of September 30, 2016, NEC TOKIN’s accrual for antitrust and civil litigation claims totaled $72.7 million. This amount includes the best estimate of losses which may result from the ongoing antitrust investigations, civil litigation and claims. However, the actual outcomes could differ from what has been accrued.

Pursuant to the Stock Purchase Agreement, NEC is required to indemnify NEC TOKIN and/or KEC for any breaches by NEC TOKIN or NEC of certain representations, warranties and covenants in the Stock Purchase Agreement. NEC’s aggregate liability for indemnification claims is limited to $25.0 million. Accordingly, KEMET, under equity method accounting, has established an indemnity asset in the amount of $8.5 million (based upon our 34% economic interest in NEC TOKIN). However, pursuant to the Stock Purchase Agreement, claims arising out of fraud or criminal conduct are not limited by the $25.0 million indemnification cap, and for such claims the claimant retains all remedies available in equity or at law.