Kalm: Sephiroth's at Nibelheim
When you reach Kalm, go to the Inn and meet up with the rest of your team on the second floor. Cloud then takes the opportunity to relate his experiences with the infamous Sephiroth.
As the story unfolds, Cloud describes how he and Sephiroth were on their way to investigate the malfunctioning Mako Reactor at Nibelheim, Cloud's hometown. As they approached the reactor, they engaged in combat with a monster created by the Mako Reactor. Cloud was too weak to help in the battle, but Sephiroth easily dispatched of the beast.
When they arrive at Nibelheim, Sephiroth talks about his mother, Jenova (a name that should sound familiar to you). Cloud then gets a chance to wander around and visit everyone.
First, go to Tifa's house and visit her room. You can retrieve a pair of Orthopedic Underwear from her dresser, or you can play a tune on her piano. Pay close attention to the totes, you want to play the tune again some day:
Do-Re-Mi-Ti-La
Do-Re-Mi-So-Fa-Do-Re-Do
Next, visit Cloud's house and he'll talk about his mother up until her death. After that, you can visit the rest of the town. For some reason, there seem to be holes in Cloud's memory of his trip to Nibelheim.
In the morning, the team meets up with Tifa, who serves as their guide to the Mako Reactor despite some resistance on Cloud's part. Before you leave, a townsman takes a group photo of Sephiroth, Cloud, and Tifa.
On their way to Mt. Nibel, the team has a close call while crossing a bridge to the Mako Reactor. Cloud must guide the team through the caves and back to the reactor. Along the way, you'll learn more about Materia and the Ancients.
As Sephiroth wonders into the heart of the Mako Reactor, follow him in. Inside, Sephiroth uncovers Hojo's bizarre experiments and begins to realize that he too may have been the result of an experiment. After this strange scenario, Sephiroth vanishes but then later reappears in Shinra Mansion.
Cloud searches the mansion, but cannot find Sephiroth anywhere. In the bedroom, Cloud uncovers a secret door that leads into a dark cavern. At the end of the cavern, Cloud finds Sephiroth in what looks like an old library in which Sephiroth appears to be trying to learn more about Hojo's research.
In the end, what Sephiroth learned drove him mad. He destroyed Nibelheim and slaughtered the villagers, including Cloud's and Tifa's parents. He then turned to the Mako Reactor to free Jenova from its bowels. Tifa was nearly killed as both she and Cloud tried to stop Sephiroth. However, Cloud can't remember what happened when he faced Sephiroth inside Jenova's chamber.
With the story told, the team prepares to rejoin the fight against Shinra. Go back downstairs and you'll receive the PHS. With the PHS in your possession, you can rearrange your party while walking on the World Map - a handy device to say the least. Now go and explore Kalm.