Kimball Electronics, Inc. (NASDAQ:KE) Q3 2024 Earnings Call Transcript May 8, 2024
Kimball Electronics, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning, ladies and gentlemen. Welcome to the Kimball Electronics Third Quarter Fiscal 2024 Earnings Conference Call. My name is Carla, and I will be the facilitator for today’s call. All lines have been placed in a listen-only mode to prevent any background noise. After the completion of the prepared remarks from the Kimball Electronics leadership team there will be a question-and-answer period. [Operator Instructions] Today’s call, May 08, 2024 is being recorded. A replay of the call will be available on the Investor Relations page of the Kimball Electronics website. At this time, I would like to turn the call over to Andy Regrut, Vice President, Investor Relations. Mr. Regrut, you may begin.
Andy Regrut: Thank you, operator, and good morning, everyone. Welcome to our third quarter conference call. With me here today is Ric Phillips, our Chief Executive Officer; and Jana Croom, Chief Financial Officer. We issued a press release yesterday afternoon with our results for the third quarter of fiscal 2024. To accompany today’s call, a presentation has been posted to the Investor Relations page on our company website. Before we get started, I’d like to remind you that we will be making forward-looking statements that involve risks and uncertainty and are subject to our safe harbor provisions as stated in our press release and SEC filings and that actual results can differ materially from the forward-looking statements.
Our commentary today will be focused on adjusted non-GAAP results. Reconciliations of GAAP to non-GAAP amounts are available in our press release. This morning, Ric will start the call with a few opening comments. Jana will review the financial results for the quarter and guidance for fiscal 2024, and Ric will complete our prepared remarks before taking your questions. I’ll now turn the call over to Ric.
Ric Phillips: Thanks, Andy, and good morning, everyone. As you know, I recently completed my first year at Kimball Electronics. It’s been a good journey already, and I am excited about the future for the company. Before I get into our Q3 results, I want to share some observations on the business and provide an update on our strategic direction and structure moving forward. Firstly, I mentioned early on that I was drawn to the Kimball opportunity for a number of reasons, but at the top of my list were the outstanding company culture and the opportunity to build on a strong foundation to achieve significant value creation. My experiences so far have confirmed those perspectives. We spent a great deal of time visiting our locations, meeting with customers, and working with our leadership team to complete an in-depth review of our strategic focus, vertical market structure, and organization design.
Based on that review, we are announcing steps today to sharpen our strategic focus and to further position the company for profitable growth and stronger performance moving forward. Those steps, which we have taken recently, or are taking now, include the following. First, divesting our automation, test and measurement business. While this business has a bright future ahead, it is not a good strategic fit for Kimball and our goals for future growth. The business models are not synergistic and it is imperative that we focus on the growth opportunities in our core EMS business. We are still an active customer of the AT&M business. Next, increasing the focus and support for our core EMS business, including realigning our medical solutions business unit in Indianapolis into our EMS medical vertical for further differentiation.
Consistent with these structural moves, we have elevated two key executives to enterprise-wide operations and commercial responsibility, Steve Korn as Chief Operating Officer and Kathy Thomson as Chief Commercial Officer. In addition, we are responding to this period of end-market softness by controlling what we can control, including resizing our team, taking specific cost actions, and continuing to focus on significant working capital improvements. We recorded impairment and restructuring charge in the third quarter to support some of these actions. Jana will provide additional detail in a few moments. As we anticipated, the operating environment remained challenged for the EMS industry and our sales in the third quarter declined. We expect the macro headwinds to persist in fiscal 2025.
During this period of end-market softness, we are taking action by proactively aligning our cost structure with short-term demand trends, remaining competitive with stable operating margins, and focusing on working capital improvements. Notably, inventory levels are now down over $90 million from the peak. We continue to make investments in longer-term growth opportunities that are supported by a robust funnel of new business in the next 18 to 24 months, while deploying a capital allocation strategy that balances organic growth, lasting customer relationships, and returning cash to shareowners with opportunistic share repurchases. Net sales in the third quarter totaled $425 million, a 12% decrease from the prior year. The decline was shared across the three vertical markets we support with softness in each region of our global footprint.
On a sequential basis, however, sales increased $4 million, or nearly 1%, which is impressive given the 32% growth we experienced in the prior year quarter. We estimate, on a two-year stack basis, that growth in each of our verticals is in the low to mid teens. Although we are anticipating year-over-year declines next quarter, we do expect sequential growth over Q3. Net sales in the automotive vertical, our largest business, were $202 million, down 9% compared to Q3 last year, and 47% of total company sales. The decrease this quarter was driven by continued weak demand in Europe, incremental softness in North America, and a decline in China. When comparing Q3 sales to last quarter, North America and Europe both posted sequential increases. We continue to believe the longer-term opportunity for growth in automotive will be driven by an increase in the rate at which electronic content is being added to vehicles, specifically in steering and braking systems.
This content leverages advanced technologies and expanded operating systems that align very well with our core manufacturing capabilities and proven expertise in safety-critical products, which ideally positions us for further advancements. As we have stated numerous times, the architectures of the steering and braking systems are agnostic to vehicle type, internal combustion engines, EVs, or hybrids, and that the automotive industry is highly regulated with stringent certifications, validation protocols, and change management systems. So this business is sticky and often results in program life cycles that can span 8 to 10 years in length with single-source awards. Net sales in our medical vertical were $113 million, a 17% decrease compared to Q3 last year, and 27% of total company sales.
The decline this quarter was driven by lost sales with the major customer involved in an FDA recall, partially offset by growth with other customers. As a reminder, our annual guidance assumes a net $50 million reduction in medical sales from this dynamic. That is, a $100 million decrease in sales with the customer involved in the recall, partially offset by a $50 million increase in sales in new and existing programs. Similar to automotive, we continue to believe megatrends in the medical industry, including an aging population, increasing access and affordability to healthcare, decreasing medical device sizes combined with the need for higher levels of precision, increasing connected drug delivery systems, and the industry-wide trend of outsourcing higher level assemblies will contribute to our longer-term top-line growth.
We are strategically positioned to support technological advances in this vertical through Kimball Medical Solutions. Net sales in industrial were $110 million, a 14% decrease compared to Q3 last year, and 26% of total company sales. As a reminder, results for the AT&M business are included in this vertical. In the third quarter, approximately half of the decline in sales in industrial resulted from year-over-year weakness in the AT&M business, with the balance driven by lower demand for internal climate control systems and smart meters in Europe, which, as we reported last quarter, have been commoditizing. We frequently refer to industrial as green and clean with products that promote energy efficiency, safety, carbon neutrality, and the better consumption of natural resources, including water, gas, and electricity.
We see the megatrend in legislation and incentives supporting the decarbonization as meaningful growth drivers, and we are strategically positioned to support products that reduce environmental impacts. So a quarter filled with a number of important developments. I’ll now turn the call over to Jana for her insights on the financial results and a review of our guidance. Jana?
Jana Croom: Thank you, Ric, and good morning, everyone. As Ric mentioned a moment ago, our results this quarter included impairment associated with the AT&M business, as well as restructuring expenses in support of sharpening the strategic focus of the company. All-in, the activity totaled $14.5 million after-tax, or $0.58 per share, with goodwill and asset impairment equaling $14 million, or $0.56 per diluted share, restructuring expense of $1.2 million, or $0.05 per diluted share, partially offset by recovery of a legal settlement of $700,000, or $0.03 per diluted share. For clarity, my review of the financial results for the quarter will exclude these items. Net sales in Q3 were $425 million, a 12% decrease compared to the third quarter of fiscal 2023.
For context, the AT&M business contributed over 100 basis points to the decline. There was not an impact from foreign exchange on consolidated sales year-over-year. The gross margin rate in Q3 was 7.9%, a 100 basis point decline compared to 8.9% in the third quarter of fiscal 2023 with the decrease coming from lower absorption in our EMS manufacturing facilities and the AT&M business, both a result of declining sales. Adjusted selling and administrative expenses in the third quarter were $16.6 million, an $800,000 decline compared to the adjusted results in Q3 of last year, primarily the result of lower bonus. We are continuing to take a hard look at our cost structure in the current macroeconomic environment. When measured as a percentage of sales, adjusted selling and administrative expenses were 3.9%, a 30 basis point increase versus Q3 last year due to lower sales.
Adjusted operating income for the third quarter was $17 million, or 4% of net sales, which compares to last year’s adjusted results of $25.6 million, or 5.3% of net sales. Other income and expense was expense of $6.3 million in the third quarter versus expense of $3.3 million in Q3 of fiscal 2023, with the change resulting from higher interest expense this year and outcome of elevated debt levels in the current interest environment and foreign currency movements. The actual effective tax rate skewed higher by the impacts of the impairment and restructuring charges was approximately 52% in the third quarter of fiscal 2024. We continue to expect a consolidated tax rate in the mid-20s. Adjusted net income in the third quarter of fiscal 2024 was $8.4 million, or 34% per diluted share, compared to adjusted net income in Q3 last year of $16.4 million, or $0.65 per diluted share.
Turning now to the balance sheet. Cash and cash equivalents at March 31, 2024 were $65.2 million, and cash flow from operating activities in the quarter was $42.6 million. Cash conversion days were 110 days, compared to 92 days in the third quarter of last year, and 117 days in Q2. The decrease in CCD this quarter compared to Q2 was driven by overall better management of working capital with the biggest improvement occurring in production days sales on hand. We are looking to continue to significantly improve our cash conversion days as we actively and aggressively manage its components. Inventory ended the quarter at $396.2 million, compared to $488.2 million at the end of Q3 of fiscal 2023, and $455.7 million last quarter. We are very pleased with the reduction in inventory and expect this number to continue to decline as we work with customers to right-size inventory to match the current demand outlook.
Capital expenditures in the third quarter were $13.4 million, a balance of supporting future growth, maintenance requirements, and investments in automation and efficiency. Borrowings on our credit facility at March 31, 2024 were $319.6 million, compared to $289.4 million a year ago, and $321.8 million at the end of Q2. Our short-term liquidity available represented as cash and cash equivalents, plus the unused portion of our credit facility, totaled $182.6 million at the end of third quarter. There were no share repurchases in the third quarter of fiscal 2024. Since October 2015, under our board-approved authorized share repurchase program, a total of $88.8 million has been returned to our shareholders by purchasing 5.8 million shares of common stock.
We have $11.2 million remaining on the repurchase program, and as Ric highlighted, we expect to return cash to shareholders with opportunistic share repurchases in the quarters to come. We are reiterating guidance for adjusted operating income of 4.2% to 4.6% of net sales, and response to the current environment, net sales are expected to decline 4% to 6% compared to prior year. Our estimate for capital expenditures has been updated with an expected outcome in the range of $55 million to $60 million, compared to our prior guidance of $70 million to $80 million. As Ric previously stated, we anticipate macro headwinds to persist in fiscal 2025 based on early indications from customers. As a result, we expect to continue executing our efforts to streamline the company with additional anticipated pre-tax restructuring charges of $1 million to $2 million.
We will provide a more fulsome update next quarter when we provide FY 2025 guidance. I’ll now turn the call back over to Ric.
Ric Phillips: Thanks, Jana. Before opening the lines for questions, I’d like to share a few thoughts in closing. We recently published our annual ESG disclosures with the release of our 2023 Guiding Principles Report themed, How We Are Winning Together The Kimball Way. The report reflects the deep roots of sustainability in our culture and highlights numerous sustainability related recognitions and accomplishments from calendar 2023. I’d like to thank our team for once again putting together a best-in-class summary that captures the focus, effort, and achievements from the company towards sustainability. I believe the 2023 report is our finest and demonstrates our dedication to the guiding principles of customers, people, citizenship, and profits.
For those of you that have not had the opportunity to review the report, it can be found on our corporate website. I am confident you will be thoroughly impressed. During this time of short-term market choppiness and uncertainty as to when consumer demand will return to normalized cycles, the actions announced today further position the company for long-term value creation. We continue to work to stabilize and improve our operating income margin. The divestiture of the AT&M business will increase our focus on EMS operations, while consolidating the EMS and medical solutions manufacturing organizations solidifies our medical platforms, particularly as we look to extend our reach into higher level assemblies. In addition, we are improving our shared services organization through a lens of centers of excellence with new processes that leverage recent investments in technology.
All of these actions have made the company leaner, more nimble, and with a cost structure that aligns with the current market conditions, but not at the expense of future growth. We won’t cross that line. As the future growth materializes, we intend to hold these savings, enhancing our competitiveness, and improving returns to stakeholders. As I mentioned earlier, I’ve never been more excited about the future of the company. Carla, we would now like to open the lines for questions.
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