SIMPSONVILLE Feb 18, 2020 (Thomson StreetEvents) -- Edited Transcript of KEMET Corp earnings conference call or presentation Thursday, February 6, 2020 at 2:00:00pm GMT

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

I would now like to hand the conference over to your host, Mr. Richard Vatinelle. Sir, you may begin.

Thank you, Lara, and good morning, everyone. Welcome to KEMET's conference call to discuss the financial results for the third quarter of fiscal year 2020, which concluded on December 31, 2019.

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

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

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

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

Thank you, Richard. And good morning, everyone. As we monitor the coronavirus developments in China, let me start by saying that the health and safety of our employees, their families, customers and suppliers is our top priority. On January 27, as information on the outbreak became more widely publicized, I imposed a travel ban on all of our employees until February 28, to and from the countries of China, including Hong Kong, Japan, Thailand, Vietnam and Indonesia. This included inbound travel from customers and suppliers as well. We're encouraging video conferencing to take the place of face-to-face meetings.

As the number of infected individuals has grown exponentially since the beginning of our travel ban, we plan to reevaluate this travel ban as we approach into this month, and either extend it or discontinue it.

We are monitoring the Wuhan coronavirus outbreak closely and have implemented precautionary measures across all of our locations in the Asia Pacific.

Following the directive from the China's central government, the 2020 holiday period in those areas has been prolonged, February 9, 2020. Many shipping lanes for goods are currently closed and expected to follow the same schedule.

We'll continue to adhere to the guidance from the government as well as global and local health authorities regarding the proper prevention and management of this issue.

We are running our key channel and facility in Suzhou at around 40% capacity by the workforce that has been allowed to stay in place throughout the period. Other workers will be allowed to return to work on February 10.

Because the situation is still very fluid, it remains unclear as to the impact this will have on our business. However, the electronics industry in general remains strong and demand continues for our products. Any impacts would most likely cause delayed revenue and not lost revenue. Of course, many, if not all, of our customers in China are under the same guidelines for a return to workday. The sense in the region is that local service and retail industries in China will be impacted more. Again, we're keeping a close eye on the situation.

Now a few words on the progress of the merger agreement for -- an update. There's a special meeting of stockholders that will be on February 20. There was a proxy that was filed and mailed on January 14, and a supplemental proxy was filed on February 5.

Regarding the processes for antitrust filings, all of the filings have been filed, the U.S., the Hart-Scott-Rodino, Germany and Austria have been approved. China, Mexico and Taiwan are remaining outstanding at the moment as well as the CFIUS approval.

The CFIUS approval was filed on January 3 and the 45-day period began January 23. We're having ongoing dialogue as expected, and we are on course with no unusual events. We're still expecting a closing in the second half of this calendar year.

So I'd ask you to please refer to our proxy and our supplemental proxy for all of the merger details. Before I give you more color around the state of our business and the environment, I'll turn the call over to Greg to recap the numbers for the quarter. Greg?

Thank you, Bill, and good morning, everyone. I'm sure you've had a chance to review our press release this morning, so I will highlight only a few key metrics from it. I will start my review of the numbers on Slide 3 and 4 of the webcast material.

Revenue for this quarter was down 15.8% to $294.7 million compared to Q3 last year of $350.2 million and above the midpoint of our earlier guidance. Revenue is down 10% sequentially from $327.4 million in the trailing quarter ended September 30. The lower revenue level reflects the destocking, which continues in the distribution channel as we work with our distribution partners toward normalized inventory levels.

GAAP net income was $16.6 million or $0.28 per diluted share for this quarter compared to GAAP net income of $40.8 million or $0.69 per diluted share for the quarter ended December 31, 2018.

This decline was due to lower revenues for the most part, SG&A, nonrecurring expenses related to the merger agreement, foreign exchange losses from a weaker U.S. dollar compared to the same quarter last year and a higher income tax rate in fiscal year '20. Our non-GAAP adjusted net income was $27.6 million or $0.46 per diluted share compared to $62.7 million or $1.06 per diluted share in the third quarter last year.

GAAP gross margin was down compared to last year's third quarter by 370 basis points from 35.3% to 31.6% as a result of the lower revenue levels. Non-GAAP gross margin was in line with guidance as it came in at 31.9%.

Our adjusted EBITDA for the quarter was $56.7 million, down from the $82 million in the third quarter last year. On an LTM basis, which you can find on Page 5, adjusted EBITDA margin as of this quarter remained strong at 22.2% compared to 19.3% in the third quarter of last year.

This is further evidence that the structural changes made over the last few years to our business continue to pay off on the bottom line despite the current macroeconomic headwinds.

Non-GAAP income taxes were $11.1 million and an effective tax rate of 28.7% compared to Q3 last year of $2.7 million at an effective tax rate of 4.1%. As explained in our last earnings call, the lower non-GAAP effective tax rate in the prior year was the result of a valuation allowance on the U.S. and certain Japanese deferred tax assets.

As a result of the significant improvements in our profitability, along with our forecast for continued strong profitability going forward, the company made the decision to release the valuation allowance on these deferred tax assets in Q4 of last year.

Accordingly, the non-GAAP effective tax rate has increased to a more normalized rate. We expect this higher effective tax rate to continue in future quarters for both GAAP and non-GAAP results.

Now on Page 6. Non-GAAP SG&A expenses came in below our forecast at $41.2 million compared to last year's third quarter of $43.8 million. The decline was mainly due to lower incentive compensation and benefits accruals as compared to the third quarter last year.

On Page 7, capital expenditures during the quarter were $30.8 million compared to $36.2 million in the prior quarter. This coming quarter, we expect to spend in the range of $50 million to $60 million for capital expenditures as we continue our planned capacity expansion to support future customer demand and improve our IT infrastructure around the globe. We expect capital expenditures, including IT and corporate spending for the full year ending March 2020, to be in the $130 million to $140 million range, excluding approximately $45 million to $50 million of customer-funded capacity expansion related to the customer capacity agreements.

We previously have disclosed these capacity agreements with 3 separate customers, whereby 1/3 of our expanded ceramics capacity, once completed in fiscal year '21, will be in effect pre sold to these 3 customers. Net inventories decreased $5.1 million this quarter to $263.1 million compared to $268.2 million last quarter. This decrease is across all of our business groups as we make adjustments to our production levels in order to stay in line with current demand. We expect our net inventories number to continue -- excuse me, to drop in the fourth quarter.

Cash on hand was $208.4 million as of December 31, 2019, an increase of $15.7 million over last quarter ended September 30, 2019. We had a strong cash flow generation performance this quarter with $31.9 million cash provided by operating activities, which included onetime payments of approximately $11 million related to litigation settlements, $5.3 million of nonrecurring expenses related to the merger agreement, and another $6.1 million payment of token-related antitrust fines. Our accrual for these token-related antitrust fines now stands at $19.7 million.

Our net debt was $103.3 million at quarter end. We continue to have a strong balance sheet that provides us significant financial flexibility. Now I will turn the call back over to Bill to comment on the business groups.

Thank you, Greg. So let's take a look at our business groups, starting with the Solid Capacitor group. Solid Capacitor's revenue was $34.8 million lower or down 14.6% versus the same quarter last year. And if you look at the two solid capacitor product lines, the revenue for the ceramic product line decreased $7.2 million or 7.6% versus the same quarter the previous year. Ceramic revenue decreased in the distribution channel and increased in direct channels, the OEM and EMS while regionally, Europe and America decreased and Asia showed a positive increase compared to the same quarter a year ago. The increases were driven by product mix and a favorable MLCC pricing. Segments showing growth as compared to the same quarter a year ago include defense and aerospace, industrial and medical.

Our focus for future growth in our ceramic products segments continues to be development, design-in and supply of ceramic capacitors requiring high performance, reliability based on more robust designs and materials. Many of these require larger sizes to handle higher current and voltage for power requirements. We said that previously, we are insulated, but not immune from the global market dynamics because of our product focus and business model. We are forecasting reduced ceramic revenue for the upcoming quarter due to the general global market conditions that remain sluggish, and specifically demand that is somewhat stagnant or declining in automotive and industrial markets because of tariffs or other global macroeconomic factors.

We also plan on further reducing ceramic inventory within our distribution network this quarter by shipping in lower volumes and our distributor partners will ship to their customers to help balance out the inventory in the channel. We saw progress in the previous quarter, but anticipate further corrections will be necessary. Given the global market conditions, we believe this is the right thing to do.

Revenue for our tantalum product line decreased $27.6 million or 19.2% versus the same quarter last year.

Commercial MnO2 products were down approximately $15 million, and commercial polymer products were down approximately 14.2% or 15%. Both products were negatively impacted by a combination of excess inventory in the distribution channel and general softness in the telecom segment within EMS. Revenue for our specialty tantalum products increased $1.7 million year-over-year, driven by strength in the military and medical segments. Our focus for future growth in our tantalum product remains on new product development and design-in success for applications requiring higher frequencies, harsh environments, limited board space and enhanced audio quality. These application requirements across many end segments, including the tablet or PC, telecom and cloud computing, automotive and industrial. The solid capacitor business group gross margin decreased to 41.6% or 250 basis points lower than the same quarter last fiscal year. But I have to comment and go off my script for a second to say 41.6% is a fantastic gross margin that continues even while we have revenue that declines.

These market impacts were somewhat offset by continued focus on reoccurring cost-out initiatives that we continue, yield improvement and alignment of our manufacturing cost structure with lower volumes.

Looking forward into Q4, the backlog in tantalum is increasing driven by improving inventory picture for our polymer products and distribution and a corresponding strengthening in order rates. Tantalum book-to-bill was approximately 1.15. Backlog in ceramics is approximately 6 months with more normalized lead times for all products.

Our Film and Electrolytic's business revenue was $42.9 million, which was $7.3 million lower than the same quarter last fiscal year in 2019. Revenue slowed across distribution and OEM channels during the second quarter across all regions driven by softening automotive market. Gross margin was 3% compared to 13.5% in the same quarter in fiscal year 2019. Decreasing volumes in the automotive market and a shift in product mix contributed to the lower margin in the third quarter. On a positive side, we're seeing a growing number of opportunities coming from the electrification of vehicles as well as from the increase of worldwide investments into green energy. But with the strong investments we are putting in R&D, we are very well positioned for future growth in all those key applications. The investments in R&D also include extension of product offerings on solid -- on aluminum solid polymer and significant advances on the axial aluminum hybrid polymer technology.

For the Magnetics, Sensors & Actuators Business Group, revenue for the quarter came in at $48 million, which was $13.4 million lower than the same quarter in fiscal year 2019. The gross margin came in at 14.9%, which was a decrease of 430 basis points year-over-year. The decrease was mainly driven by lower demand for our EMI flex suppression sheets, primarily related to a slowdown in the smartphone market. We're experiencing a continued slowdown in demand for piezo actuator products using semiconductor production equipment, consistent with the overall semiconductor market situation as well as specific customer-related markets. In addition, we are subject to the global year-over-year slowdown in the global server market. On the positive side, we continue to see strength and upward momentum in our metal wire business for the medical catheter guidewire market.

Additionally, we continue to see nice growth to the distribution channel as we develop and place more new products into the channel to position and grow MSA long tail business, particularly new choke coil series name METCOM, which was released to the distribution channel and is expected to make significant inroads into the market for the foreseeable future. I am very pleased with the pipeline of projects that we have in place for the future as we expand MSA's reach well beyond Japan and Asia in general.

For the regions. Europe closed at $61.6 million, which was down 20.8% versus the same quarter last year. In distribution, POS came in at $42.7 million, which is a 10% decrease from the previous quarter and a 19.4% decrease same quarter year-over-year. Our EMS OEM business has been almost flat quarter-over-quarter driven by the OEMs and slightly down year-over-year. The good performance has been driven from a large increase in our green energy customer base and by our industrial business, while our automotive business saw a usual year-end slowdown. Our distribution business has seen a steep decline quarter-over-quarter of 21% and 35% year-over-year. Distribution partners as well as POS customers are ordering less to correct their high inventories. We assume this trend continues on a lower level for the first half of calendar '20.

In the Americas, revenues closed at $64.4 million, which was a 19.3% decrease from last quarter and a 29.6% decrease from the same quarter last year. The distribution business continued to soften last quarter, was down 10.2% and down 32.2% from a year ago. We do expect that channels to be down this quarter as the inventory correction continues.

Our OEM business was down quarter-over-quarter by 25.2%, but up 9% versus a year ago. The EMS channel was down 26.2% quarter-over-quarter and down 33.9% versus a year ago. The decreased numbers were driven by excess inventory and reduced requirements for some of our networking customers. We do expect the OEM EMS business in the Americas to flatten out this current quarter, and our POS business was down slightly quarter-over-quarter. But our expectations are this flattened -- that this will flatten out this quarter as well.

Asia closed at $127 million, which was 4.3% decrease from the prior quarter and 4.5% down compared to the same quarter last year. POS came in strong at $60.7 million, increased by 2% from the prior quarter, and up 12% from the same quarter last year. The market is flattish in Asia, however, we do see signs of recovery in some of the segments as China continues to drive 5G, IoT and enterprise storages.

Booking from the SSD and servers remain positive. Book-to-bill ratio at our distribution channels is increasing steadily, while their inventory levels continues to drop. We are hoping that the trade deals signed between U.S. and China will also help consumer confidences in PMI readings in China. Pipeline is solid in Asia, and the team will continue to build a larger customer base with a focus on POS sales and new design-ins.

Our Q3 revenues for Japan and Korea closed at $42.3 million, which is a decrease of 6.6% versus the prior quarter and a decrease of 13.1% year-over-year. The demand for the automotive segment remained low as did demand in our consumer segment related to notebook, PCs and LCD TVs. Alternatively, demand for products used in medical remains strong, and demand for products used in semiconductor-related equipment segment started to improve. In the distribution channel, POS reached $3.4 million, an increase of 36% from the previous quarter and year-over-year.

The regional book-to-bill shows significant improvement coming in at 1.13 for the quarter, helped by an increase in demand from industrial segment customers. For our distribution channel, POA generated $115 million in revenue, down 12% compared to Q2. POS for the quarter came in at 161, down 1% as compared to Q2 and in fiscal '20.

This POS to POA alignment drove our inventory in the channel down 3%. Overall, our book-to-bill, on an overall basis, consolidated not just distribution, has been increasing slightly over the past few weeks and now stands at 1.06 on a consolidated basis.

Before I turn the call back to Greg -- and for the forecast, let me make a comment on the general market with a focus on a couple of segments. While the second half of 2019 had -- which has undoubtedly showed weaker demand for electronics, we remain very confident moving forward. Overall, we expect electronic content to grow in 2020 by 2.4%. Semiconductor sales seem to have hit their lowest level and are slowly yet steadily climbing back up. Passive components sales were strongly correlated to semiconductor sales, although typically lag behind 1 or 2 quarters.

Biggest limitation at the moment remains an overall inventory situation, which we are actively addressing.

So segment-wise, military, defense and aerospace will repeat the gains and strong demand showed last year. Auto sale units are likely to stay depressed, but the electronic content associated is expected to rebound and grow, although slightly.

Perhaps the most exciting trend we see is a more robust 5G rollout, which in turn is helping to lift smartphone sales. I would like to remind you that the content of MLCC in a smartphone is over 1,000 pieces per device. Positive smartphone sales will rapidly consume significant capacity of MLCC capacitors and is not unlikely to witness tightness in the supply chain in the second half of this calendar year.

Lastly, we see significant growth in all server and storage solutions ranging from solid-state drive devices to edge computing hardware units, which is a great fit for our polymer products.

I'd like to just comment on a few of our recent design wins. At the 2020 Las Vegas, CES, a new 8-K led TV was introduced with sound emission achieved by a tweeter frame vibration technology. KEMET piezo electric acoustic module is an integral part of such design, an impressive achievement from our technology group in Japan.

We also continue to strengthen our position in the solar inverter market covering with our ceramic products, the micro inverters and our film one's but with a higher power range. In both cases, we are working closely with customers who need KIMMET timely support in order to fulfill their growth projection.

Revenues resulting from such cooperation are projected to hit $20 million in our fiscal '21, with a customer, in particular, breaking $10 million in sales, up from just $1 million just 3 years ago.

In the automotive space, as I mentioned, we see positive activity. We recently locked in several designs and applications ranging from onboard chargers, electric compressors as well as Level 3 and 4 autonomous driving boards. In this space, KEMET can truly show its full product lineup, including our new MPX inductor series, which will be fully automotive grade next month.

In SSD segment, our solid-state drive, we continue to work with our customers to order -- in order to establish KEMET as a technology market leader.

A recent design win we closed last year is now ramping up and is expected to generate over $10 million in sales starting in 2021. It definitely continues to be an exciting time at KEMET.

Thanks, Bill. So before talking about our outlook, I want to reiterate what Bill said about the coronavirus outbreak and our priority being the safety and well-being of our employees, our customers and our suppliers.

From a business standpoint, it is still too early to gauge the full impact as the situation is still evolving. Our outlook that I'm about to cover, takes into consideration the estimated business disruption for the current extended Chinese New Year's holiday. But beyond that, we have little visibility, and therefore, cannot speculate on the impact to the business.

All that said, we expect our fourth quarter sales to be in the range of $275 million to $288 million, down approximately 19% to 23% from last year's third quarter and sequentially down 2.3% to 6.7%. The lower revenue number reflects the continuing distribution channel correction, which Bill discussed. That said, we believe our gross margin will continue to be relatively strong and reflect the positive impact from our structural changes. And we expect non-GAAP gross margin to remain between around 28% and 30%.

SG&A expenses should be $43 million to $45 million and R&D expenses in the range of $12.5 million to $13.5 million. We expect our fourth quarter and full year non-GAAP effective tax rate to be in the range of 29% to 33%.

Thanks, Greg. Clearly, we need to work through the impact of the coronavirus over the next few months and continue to do our part to control its spread, both within China and the world. KEMET will be doing this part within our facilities and also keeping our employees as safe as possible around the globe through our internal policies.

We believe the industry itself has an underlying strength that will show resilience to the current disruption we are now experiencing in China. The uptick that we expect in the coming cycle driven by 5G and the resurgence of new cell phone requirements will provide opportunities and again create a supply/demand squeeze on our large-case ceramics, as small case size producers gobble up their capacity to serve the consumer market demand.

We remain focused to complete our expansion in our ceramics business, and we are not slowing down our efforts to be prepared to capture that growth immediately when it presents itself.

Of course, I also wish to thank all of our employees around the globe who developed these new technologies that produce or support our quality products that make it all possible. And I especially wish to thank our employees that are -- that have provided assistance to our China locations with special thanks to our Japanese employees and our Italian purchasing team that have provided thousands of masks to our China locations just recently.

Bill, congratulations on navigating December's choppy environment and the design wins you talked about emanating out of CES. My first question was really one on the fiscal fourth quarter revenue outlook. I'm hoping you can just give us some of the incremental positives and negatives as we look at trends. One, for the inventory reduction that you hope to achieve in the channel. How much of the first half inventory reduction would be completed, exiting the quarter at the guidance midpoint? And then if there are notable comments regarding either channels or products, that would be helpful as well?

Yes. Let me address it, I guess, in a couple of ways. One, let's -- putting aside the impact, if there is an impact from the China situation and the virus, any disruption there on going back to workdays.

We started the -- we started in the quarter in Q4 at about the same pace, we started Q3. And so encouraged from that perspective that the pace at which we were seeing ordering and potential shipments and what we would say, we have on the rock, in other words, booked to be able to ship this quarter would be in the high end of the range of our forecast. So we see that as a positive the -- and at that -- to your question, then, about the impact on inventories. In that range, we would expect to see distribution inventories potentially decline somewhere between $8 million and $12 million, which is a good drop for us. Which would leave us with maybe just a little bit for adjustments in June, we think, to get to what might be a normalized level. So we're trying to make good decisions about what we're selling in, based upon what's being sold out. And still, if we end up in the mid of the range or in the high mid of the range for the revenue, again, barring an impact of the -- of China, could disrupt things. That's where we'd expect inventories to drop, and that's our goal. So we're -- we think that, that would reflect only a small, as Greg said in his remarks, at the current level, maybe a 2.7% decline at the high end of the range. So maybe it's a 3% to 3.5% decline quarter-over-quarter, which considering all things, I think, is a pretty minor drop quarter-over-quarter.

Absent -- again, absent what goes on with China. We tried to bake in on the lower end of our range the potential impact for China, not knowing whether what -- even if we come back to work on the 10th, if everything actually gets out the door to our customers because they have the same issue. They've got to bring -- they've got to start work. They have to bring back employees who left for the holiday. As we all know, in China, not everyone comes back to work. So there's the rehiring of folks, and that has to happen, not just at KEMET, but it has to happen at our customers as well.

But we're encouraged by what we saw. As we rolled into the weeks -- first week of January, we were encouraged by our booking, by the book-to-bill, and by what we were expect -- where we can ask to ship during the quarter.

That's helpful. And certainly, China is a very dynamic situation right now. I wanted to use my follow-up with a question for Greg.

Greg, as we look at the gross margin guidance, certainly, gross margins are hanging in quite well, given the macro backdrop and the inventory reduction the company is trying to achieve in the quarter. As we look at the sequential change from December to March, can you just help us understand how much of that is related to pricing resets that typically take place around this time of year versus just the volume impact of what's happening as you bring inventories down on hand and in the channel and as we work through that situation, and if there are other factors, it would be helpful to quantify those as well?

Yes, the -- Craig, the pricing reset, there would be a small amount in there for the -- for our fiscal fourth quarter. But also, as you would know, as we adjust on the distribution channel side, distribution revenues for us tend to be a little bit higher margin than others. So from a mix perspective, it's not quite as advantageous either. I'd say there are some other mix changes in there as well. And the reason we're able to maintain those margins at that level is, as we adjust our production capacity and take out costs, and we continue to have some really meaningful cost reduction projects that offset some of those negative factors.

On that last point, Greg, is it possible to provide us with some color on any further opportunities that would exist through the year? Or are things that can be done to reduce fixed costs really, front-end loaded in calendar '20?

It's nothing new from what we have been doing over the last several years. So it's continuing the tantalum vertical integration initiatives. We've also given the pullback in ceramics demand, in particular. We've also had to reduce our labor force there a bit. And then I would say, as we add capacity going forward for ceramics as we expect that business to pick up, we have done -- we will do that really with -- really just direct labor and the fixed overhead. And the variable kind of fixed overhead costs will just get spread over more and more volume. And so we would expect that, that would be a positive driver to our margins going forward. So again, nothing new, in particular, if all those initiatives that we continue to execute against, like we've been talking about for a few years now.

And lastly, if I could. Bill, thanks for giving us an update on some of the things that are happening from a regulatory and a process standpoint relative to the Yageo acquisition. My question is for those countries where we're awaiting approval, U.S., Mexico, Taiwan and China, I believe. Can you give us any update on how interaction is going with those entities? Anything that we should be focused on as it relates to closing out those approvals?

No, nothing outside of the ordinary. We're having the dialogue that you would expect us to have where we're answering questions and providing information. So there's nothing unusual that's occurring. They're on pace, which we're encouraged by that the contacts were all made relatively quickly after the filings. And we've been providing the information they've been asking. So nothing unusual, nothing to be concerned about to date, and we're working through the process. And we are -- we believe that the time line is still the time line that we put out originally is that sometime probably early in the -- hopefully, early in the second half of the calendar year, we'll be able to wrap it up. So that -- nothing has changed in the time line at this point.

(Operator Instructions) We have your next question coming from the line of Marco Rodriguez from Stonegate Capital Management.

Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [11]

I apologize, I had some technical difficulties with my phone, so if you covered working capital accounts, let me know and I can circle back around to the transcript. But just wondering if you can talk a little bit more about on the balance sheet, inventory days have been kind of coming up pretty steadily here throughout the fiscal year. Just trying to get a gauge as far as what maybe those drivers are? And what your expectations are as the quarter progressed here?

Sure. So I would say now inventory has started to come down a little bit. And I did mention in my prepared remarks that we expect it to come down further in the fourth quarter. So -- but you're right, it has increased. And I'd say, throughout the year, it's been 3 reasons. Probably, firstly, it's related to the ceramics business and getting us balanced out. As the demand there has softened at least through the distribution channel, and so we think we're -- we've got that at equilibrium now and has started to come down. After that, the other reason that inventories had increased, but again, coming down as we had some really good buys. We thought for tantalum ore at good prices. And so we bought -- short term, we bought more than we actually required, but it was at really good prices. And so we went ahead and did that. And then the other -- to the -- to a lesser extent, driver is in Film and Electrolytic. As you'll recall, we shut down our Granna, Sweden business and moved all of that productive capacity in electrolytics down to our Portugal, Evora facility, and so we had to build inventories up there. And most of that's now worked off. But those things are all -- we're working through that. We would expect some meaningful reductions -- further reductions to the inventory in the fourth quarter, but probably still more to go into fiscal year '20 as well.

Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [13]

Got it. That's helpful. And then in terms of us thinking about the gross margins and the impact of that inventory kind of cycling through as we look into fiscal '21, how should we be thinking about that sort of dynamic?

Well, we haven't put any guidance out and won't until the next quarter for fiscal year '20, but I think you can see the confidence that we have in our general gross margin levels now of sort of the fourth quarter guidance, 28% to 30%. And so we've done -- really, the team, I think, has done a phenomenal job in some soft conditions that we've seen now for the second half of the year to keep those margins up at that kind of level by offsetting some of that softness with meaningful cost reduction projects, the kind of structural changes that we've talked about before. And so we would expect more of the same of that going forward, obviously, subject to how the market and some of the growth starts to kick back in.

Marco Andres Rodriguez, Stonegate Capital Markets, Inc., Research Division - Director of Research & Senior Research Analyst [15]

Got it. Okay. And then just lastly, I know this is a difficult question in a dynamic situation in China with the virus, but maybe if you can just kind of put some additional thoughts on how you guys are thinking about some contingency aspects. If the shutdowns extend further into March, for example, just sort of what steps or what sort of plans you might be able to put in place? And how long they might be able to take the kind of shift capacity? Or how you might think it might impact the electronic supply chain?

Yes. I mean that's a good question. We have the ability, in some cases, of course, to shift capacity. It doesn't -- nothing like that can happen necessarily overnight. And in some cases, we wouldn't be able to shift capacity from one facility to another based on equipment, size of the product that we're making, larger case versus small case, in polymer, for instance.

But at the same time, and I mentioned this in my remarks, of course, our customers there would be -- a very large portion of what we produce in China, of course, stays in China. And our customers will be affected the same way. I think the demand is still there. I think it's not a matter necessarily of lost revenue, it's a matter of deferred revenue. So yes, there could be an impact if it was extended long into March. We're not quantifying what that would be at the moment. I don't think we're expecting that. I mean at the moment, it's February 6. The current comments from the region and the government is that the February 10 date is still holding.

But yes, I mean, if that were to take place, there are some plans we have to address that. But again, most of our customers are going to be facing the same thing. I think it's a matter of deferral. It would cause a disruption in the supply chain. There would be a lot of pent-up demand behind the customers. That -- it's a ripple effect, of course, going from us to our customers, to their customers to the end demand, especially, if it's in the consumer segment or if it's in automotive, for instance, would be a little different. So it's a task that we are looking at to see how we would address it. At the moment, we have our fingers crossed at the February 10 date that they tell us is holding continues to hold.

You mentioned the inventory that you have built up of ore, and I just wanted to ask what this would be a time scale for reducing that inventory and coming back into the market for raw materials? And whether you foresee any increase in prices and how that might impact you later in the year?

It will take several -- the way our inventory accounting works, and I'll let Greg get into the detail of that, but when we buy ore, let's say, in the December quarter or even a September quarter, that adds to our inventory. Of course, it takes a while for that pricing to work through the income statement. So we would expect to see benefit of that lower raw material, if you will, throughout the course of this next fiscal year. And of course, we are also continuing to -- we continue to buy ore, it's a continuous supply chain regarding that. But I don't believe that we're going to see any significant price increases on the raw material side in ore. We're not projecting that. As Greg -- we took advantage of a situation where we get it lower than we have been buying. So we took the opportunity and used some cash that we had to do that. I don't know, Greg, if you want to make a comment about inventory accounting here? But...

Yes, and I would say with that incremental ore that we bought, we would expect that to work off in the fourth quarter. And so there's a lot of tantalum ore that we have that we're able to buy. And so we will constantly look at where we think we can get the best pricing available. And so that will be dependent on the market demand overall, but I wouldn't expect to see a big -- a lot of variability in our raw material costs as we go forward.

And an additional question I wanted to ask you is just on the merger with Yageo proceeding, what is your timescale as we stand now? Do you expect any delay in U.S. approval, particularly security-related checks for your business?

No, we don't -- we're not expecting any delays. We're still sticking to our timetable of the closing in the second half of the calendar year. Regarding at least the Hart-Scott-Rodino filing in the United States, that's already been approved. That time frame has expired and therefore, it's approved as well as Austria and Germany. So we're working through the filings with the other jurisdictions. There is nothing out of the ordinary that's taking place. And we're still believe that our timetable we published earlier, which is at closing in the second half of the calendar year, as I said, is unchanged.

Okay, if we have no further questions, operator, then we'll conclude the call. And we appreciate everyone who has been on the call this morning and asking questions. Thank you very much, and we'll talk to you next quarter. Thank you.

Thank you, everyone, for participating. This concludes today's conference. You may now disconnect. Have a lovely day.

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