Asian Metal: Hello Mark and Effie. First off, would you two mind providing me with a brief description of Knowles and the products and services that you provide.

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EFFIE: Knowles has three business units, the first being Knowles Electronics. Knowles Electronics produces microphones and receivers for the hearing health industry. The second business unit is Knowles Acoustics, which produces our trademarked SiSonic microphones. We have started providing microphones to the consumer electronics industry and now have several major clients from the cell phone industry. In addition, this year we acquired a Vienna based company called Sound Solutions (now Knowles Sound Solutions). Knowles Sound Solutions produces receivers and speakers that are also primarily sold to the consumer electronics industry.

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Asian Metal: Would you mind elaborating upon the role of rare earth metals/magnets in your acoustic components?

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EFFIE: Rare earth magnets, specifically NdFeB magnets, are critical to many of our receivers and speakers used in consumer electronics. These neo-magnets are very small, very powerful, and enable us to miniaturize our products, a characteristic that is very important to many of our clients, especially those involved in the cell phone industry.

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MARK: Effie mentioned that the Knowles Electronics portion of our business is the hearing health industry. We make speakers and microphones for hearing aids. We are the largest supplier in the world to companies that manufacture hearing aids. These companies typically use the aluminum-nickel-cobalt magnets in their motors and we consequently purchase large quantities of this material. These magnets work great for this particular application, but in the consumer electronics industry, rare earth magnets are essential. There simply is no substitute for this type of material. We have looked at the price performance of other materials and it just does not work out. Our competition is using the same type of rare earth magnets, and from a performance standpoint, the NdFeB magnets are easily the industry standard. Our concern right now is pricing.

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Asian Metal: Which downstream products utilize this type of receiver/speaker technology?

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EFFIE: Downstream products include but are not limited to cell phones, laptops, and digital cameras. Certain products from the gaming industry also use this type of technology.

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Asian Metal: Where are the manufacturing facilities for these receiver/speakers located?

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EFFIE: Our manufacturing facilities are located in China. Our neo-magnets are also sourced from Chinese suppliers.

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Asian Metal: How has China’s 2010 export quota cut and the following surge in neo-magnet prices impacted your purchasing strategy?

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MARK: An important part of our current purchasing strategy is trying to acquire accurate forecast information. We are going through a variety of channels to acquire this type of information and we are hoping we will be able to get a clearer picture of the 2012 supply and demand situation for both the global and domestic Chinese markets. We basically want to get a better idea of what the curve is going to look like for 2012. We are also making sure we have large sums of cash available so that we can try and make purchases on the downside of pricing trends. Our primary concern, however, is securing supply so that we avoid harming our customers. All of our customers purchasing these speakers and receivers are also dependent upon these magnets, and as a result, it is very important that we secure a reliable source. I say this with great pain but at this point pricing is secondary. So when it comes to the purchasing strategy, our primary concern is securing supply.

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Asian Metal: Have neo-magnet price increases translated into higher retail prices for your acoustic component systems and products?

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MARK: We typically have contracts with our customers that are based upon a firm fixed price. In terms of negotiating price levels and adjusting for increases in material costs, you always have to ask and show supporting information, but most of these folks are not willing to concede to that because they will just go to some other competing manufacturer with their business. There is a lot of competition out there interested in gaining higher market share. Some companies are anticipating that the current high rare earth prices may be a short term situation and are willing to eat the higher material costs.

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Asian Metal: I understand that there is much turbulence in today’s markets, but what type of growth in demand for these speaker/receiver systems do you expect in H1 2012; 2012 in general?

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EFFIE: Our Knowles Acoustics and Knowles Sound business will increase by 10 percent largely because our microphone business will be number one in the world. While most of our microphones do not use rare earth magnets, they are often times used in conjunction with our speakers and receivers that are reliant upon neo-magnets. Typically there’s a 2:2 ratio; that is, one microphone for every speaker/receiver. The noise cancellation technology found in some of the smart phones on the market today requires two microphones. This noise cancellation will become more prominent in the future and as demand for many of these smart phones increases, demand for both the microphones and speakers/receivers will also increase. In addition, our recent acquisition of Sound Solutions has expanded our clientele base and provided both companies with a lot of upside potential.

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Asian Metal: What type of price behavior do you expect for neo-magnets and neo-magnet material during the remainder of 2011?

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EFFIE: We think the market prices for neo-magnets and their respective materials will be flat for the rest of the year largely due to weak European and US economic activity. Particularly in Europe, a lot of customers are unwilling to buy large quantities of inventory because they want to wait and see where the European economy is headed. Chinese demand is also dropping. The market for these materials is very soft and we really don’t expect any increases in demand during the remainder of the year.

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MARK: We also think a lot of speculators have been dumping stockpiled material that they have been hoarding for a while.

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Asian Metal: So you think that Chinese suppliers are going to hold prices steady?

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EFFIE: In my opinion, Chinese suppliers will absolutely hold prices steady. Baotou steel is currently increasing stockpiles and may adopt other policies in the future to keep price levels steady.

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Asian Metal: What about price behavior for 2012?

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EFFIE: We believe 2012 will see marginal price increases for neo-magnet material. In the beginning of the year, we expect a lot of buyers will return to the market to purchase material. Furthermore, we are hopeful that by this time the global economic situation will have stabilized.

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Asian Metal: How do you plan to ensure a steady and reliable supply source for your specified neo-magnets?

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EFFIE: Right now our number one concern is ensuring a stable supply of neo-magnets. We work closely with our suppliers to ensure a long term relationship and to guarantee a steady supply source.

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MARK: We work on a contractual basis, and as Effie mentioned, we have a great relationship with our magnet suppliers. In addition, when there is an opportunity to buy on a cash position, we want to make sure that we are able to pay our suppliers quickly. Working capital is very important to our suppliers; with this year’s enormous increases in rare earth prices, they require a large reserve of working capital so that they can go out and procure material when necessary. Some of our suppliers do not have the working capital to procure enough material to meet our magnet demands. We want to be in a position so that when we contract, and when we execute a contract, we have the money to make sure our suppliers get paid immediately.

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Asian Metal: You mentioned earlier that your manufacturing facilities are located in China. How has this benefited your business?

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MARK: Having our manufacturing facilities located in China has proven to be a strong advantage. Simply put, there are two rare earth markets: there is the Chinese internal market and then there is the Chinese export market. Right now China is working to protect its import market more than its export markets. In terms of sourcing, being located in China has definitely given us a material cost advantage.

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Asian Metal: How would you respond to the closure/loss of one of your major neo-magnet suppliers?

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MARK: Part of Knowles’ purchasing strategy is to always have two sources of supply. It ensures that everyone remains competitive and also guarantees another source of supply should anything unexpected ever happen. Let me give you a brief example; there is a plant in Japan that manufactures some parts for us. This plant is located in southern Japan and supplies certain devices that are critical to our speakers and receivers used in cell phones. Back in March, when northern Japan was devastated by a natural disaster, one of this plant’s wafer suppliers, located in northern Japan, suspended production. This plant, however, also sourced wafers from Finland and was consequently able to secure a steady supply source. It is Knowles’ policy to always dually source materials.

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Asian Metal: With several ROW mines slated to come on-line in the next few years, have you considered sourcing rare earth materials/products from mines outside of China?

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EFFIE: We are very interested in sourcing from mines outside of China. Right now we are looking at some of the mines in the US, specifically in California, but we are not really limiting ourselves to any particular mine. Whoever offers us the best price and can guarantee good quality will get our business.

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MARK: Effie was alluding to Molycorp earlier, and we have been reading a lot of stuff about Mark Smith and all the activity that has taken place at Mountain Pass in the past couple weeks. Right now it seems like there is a lot of great potential not only for Molycorp, but for sources from all over the world. Once competition comes on board, I really think it is going to be a game changer. Again, to our earlier point, you always want to have two sources of supply. While it is still early, we are cautiously optimistic that good things are going to be happening relatively soon. I should note that soon is measured in years, not weeks.

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Asian Metal: I understand that Knowles Electronics is one of the pioneering companies in advanced acoustic components technology. Have you looked into alternative solutions to neo-magnet materials for your products?

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EFFIE: Yes, we have looked into alternatives for neo-magnets but failed to find any suitable substitutes. We considered using samarium magnets but it just did not work out. They offered us a limited price reduction but the performance was not even close to that of the neo-magnets.

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