Kimball Electronics : Q3 2021 Transcript

Kimball Electronics Inc. (Q3 2021 Results)

May 6, 2021

Corporate Speakers

• Andrew Regrut; Kimball Electronics, Inc.; Head of IR
• Donald Charron; Kimball Electronics, Inc.; Chairman & CEO
• Michael Sergesketter; Kimball Electronics, Inc.; VP & CFO
• Jana Croom; Kimball Electronics, Inc.; VP, Finance

Participants

• Anja Soderstrom; Sidoti & Company, LLC; Analyst
• Michael Morales; Walthausen & Co., LLC; Analyst
• Hendi Susanto; Gabelli Funds, LLC; Analyst
• John Dasher; Pinnacle; Analyst
• Jason Crawshaw; Polaris Capital Management, LLC; Analyst

PRESENTATION

Operator: Good morning, ladies and gentlemen. Welcome to the Kimball Electronics Third Quarter Fiscal 2021 Earnings conference call. My name is Cindy and I will be your 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 the 6th, 2021, 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, Head of Investor Relations. Mr. Regrut, you may begin.

Andrew Regrut: Thank you, Cindy, and good morning everyone. My name is Andy Regrut and I recently joined Kimball Electronics as the Head of Investor Relations. I'd like to welcome you to our third quarter conference call. With me here today is Don Charron, our Chairman and CEO; Mike Sergesketter, Vice President and Chief Financial Officer; and Jana Croom, Vice President, Finance.

We issued a press release yesterday afternoon, with the results of our third quarter ended March 31st, 2021. To accompany today's call, a presentation summarizing the financial results has been posted to the investor relations page on our company website within the events and presentations tab. Or, if you're listening via the webcast, you can follow along by advancing the slides or download them from the downloads tab on the webcast portal.

Before we get started, I would like to remind you that on today's call, 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 forward-looking statements.

All commentary today is focused on non-GAAP results. For the third quarter of fiscal 2021, this excludes onetime after-tax benefits amounting to $0.5 million or $0.02 per diluted share associated with non-operating items. Reconciliations of GAAP to non- GAAP amounts are available in our press release.

This morning, Don will start the call with a few opening comments. Mike will review the financial results for the quarter, and Don will complete our prepared remarks before taking your questions. Now I'll turn the call over to Don.

Donald Charron: Thanks Andy, and good morning, everyone. I am very pleased with our results for the third quarter. Our team remains resilient in the face of many ongoing challenges around the world, including the COVID-19 pandemic and the global shortage of semiconductors. Despite these headwinds, we delivered solid top line growth with very good results across multiple end market verticals. And our adjusted EPS in the quarter was up 56% compared to Q3 last year.

In addition, the operating margin rate once again exceeded our goal of 4.5%, and we generated strong cash flow from operations for the fourth consecutive quarter. On a year- to-date basis, our cash flow from operations has more than doubled from the prior year. Due to the global shortage of semiconductors, a significant amount of our shippable backlog shifted out of Q3 and Q4 of fiscal year 2021 and into the first half of fiscal year 2022. Many industry experts are forecasting that this semiconductor shortage will remain with us for most of this calendar year. Our materials teams around the world have been working day and night to find solutions to overcome this shortage. Based on the semiconductor delivery commitments that we currently have from our suppliers, we are still expecting a very strong fourth quarter of fiscal year 2021, both sequentially and year- over-year.

Beyond these excellent results, we have never lost sight of the fact that the health and safety of our employees remains our number one priority, and we continue to make every effort to keep our facilities safe. The number of employees testing positive for COVID- 19 has remained at a low level, minimizing disruptions and allowing us to continue to deliver on our promises to our customers, which was evident in our top line results for the third quarter and year-to-date fiscal year 2021.

Net sales increased 6% compared to the same period last year. And while foreign currency did have a favorable impact, the growth was solid even after adjusting for FX. Strong sales increases were posted in our automotive, industrial and Public Safety verticals. Automotive sales were up 12% in Q3 from a year ago, with the strength resulting from ramp up of certain programs, including fully electric vehicles, lower

volumes in the third quarter last year which began to see the impact of COVID-19 and favorable foreign exchange rates.

An example of the programs with electric vehicles includes electronic power steering systems. It's an application and architecture that is largely the same for both electric vehicles and vehicles driven by internal combustion engines, or hybrids. This is an area where we continue to invest to keep pace with expected future growth as the popularity of electric vehicles rises. There are other applications that are similar in terms of approach and focus and we have been successful in winning additional programs. We have strong relationships with several customers that support many of the most popular brands in the world and we expect these relationships to fuel growth in this vertical market in the years to come.

On a sequential basis, sales and automotive were down 8% from last quarter, an outcome from the global semiconductor shortage. And while dependent on our ability to overcome the component shortages, we expect sales to continue to be strong into fiscal year 2022. The medical end market vertical was down 2% in Q3 as a result of strong prior year sales, related to the COVID-19 global pandemic and reduced elective procedures, also due to the ongoing global pandemic. We expect this decline to be short- lived as more of the population is vaccinated and physicians, offices, and hospitals resume elective procedures and activities.

Shifting now to the industrial vertical, sales increased 5% in the third quarter compared to the same period last year, with the strength resulting from automation, test and inspection sales; higher end market demand for climate control products, for instance, HVAC applications in the US; and favorable FX, partially offset by decreased demand for smart metering products. We expect a strong fourth quarter in industrial vertical driven by orders for machines scheduled to be shipped by GES. And finally, sales in Public Safety were $13.5 million, an increase of 9% driven by the ramp up of new programs.

As I alluded to in our second quarter call, we have received board approval for another critical expansion of our global footprint. We plan to invest approximately $25 to $30 million on the expansion, which will double the size of our footprint in Mexico. We expect to break ground over the summer with completion within approximately 12 months. This, combined with our Thailand expansion is a continued demonstration of our strong market positioning and growth opportunity for the future.

And finally, I'm so proud of our team in the effort to deal with the challenges caused by the pandemic and the global semiconductor shortage. In April, we were honored by achieving the highest overall customer rating in Circuits Assembly's 2021 Service Excellence Awards. Consistency in anonymous surveys such as this speaks volumes about our customer service culture. So I'd like to point out that this is the third time, in four years, that we have been recognized for this award. Circuits Assembly is a leading industry publication covering the mixed technology electronics assembly marketplace and recognizes companies that receive the highest customer service ratings as judged by their own customers.

The awards were presented to outstanding electronics manufacturing services providers in the categories of quality, dependability, timely delivery, responsiveness, value for price and technology. And we were recognized for achieving the highest overall customer rating in all five service categories for EMS companies with annual sales over $500 million. This is a great example of how our strong company culture and core values are helping us get through this together.

Now let's turn it over to Mike to discuss our third quarter results in more detail. Mike?

Michael Sergesketter: Thanks, Don, and good morning, everyone. During my comments, I will be referring to the slide deck Andy mentioned during his opening comments. As Don mentioned and depicted on Slide 3, third quarter net sales were $310.3 million, a 6% increase compared to net sales of $293.9 million in Q3 last year. Foreign exchange rates favorably impacted sales by 3% in the third quarter. A breakdown of sales by vertical market as described by Don is summarized on Slide 4.

Our gross margin rate in the third quarter reflected on Slide 5 was 8.4%, a 150 basis point increase from the third quarter of last year. The gross margin improvement was driven by improved operating execution; favorable product mix within our automotive vertical market, a result of a shift to more mature and larger programs; and favorable foreign currency rates, partially offset by higher profit sharing bonus expense.

Adjusted selling and administrative expenses were $11.6 million in the third quarter, up $1 million or 10 basis points when measured as a percent of sales compared to the third quarter of last year. This increase was primarily driven by higher profit sharing bonuses, higher salary and payroll related costs. As a reminder, adjusted selling and administrative expenses excludes changes in the fair value of our SERP liability, which is directly offset in other income and expense from changes in the fair value of the SERP investments.

Adjusted operating income for the third quarter was $14.4 million or 4.6% of net sales as shown on Slide 7 in the deck. This represents an improvement from $9.7 million or 3.3% of net sales in the same period a year ago, primarily driven by the increase in gross profits that I just mentioned. Other income and expense was an expense of $600,000 in the third quarter, which compares to expense of $1.9 million in the third quarter of fiscal year 2020. The expense in Q3 of this year includes $600,000 in net foreign currency losses and $300,000 of net interest expense, partially offset by $200,000 in gains on the SERP investments.

The expense in the third quarter last year includes $1.1 million of net interest expense, $900,000 in losses on the SERP investments, and $200,000 in net foreign currency gains. The effective tax rate for the current year third quarter was approximately 25%. in the prior year third quarter, the effective tax rate was approximately 28%.

Slide 8 reflects our adjusted net income trend. In the third quarter of fiscal year 2021, adjusted net income was $9.9 million compared to net income of $6.3 million in the third quarter of fiscal year 2020. Adjusted diluted earnings per share were $0.39 in the third quarter. This compares to diluted earnings per share of $0.25 reported for the same quarter last year.

Now turning to the balance sheet, cash and cash equivalents at March 31, 2021 were $89.7 million. Operating cash flow trends are shown on Slide 11. Our cash flow provided by operating activities during the fiscal third quarter was $31.5 million, driven by net income plus non-cash depreciation and amortization and changes in working capital. In the prior year third quarter, operating activities provided $12 million of cash. Our cash conversion days for the quarter ended March 31st, 2021 were 66 days, down from 81 days in the quarter ended March 31, 2020, and down from 75 days in the second quarter of fiscal year 2021. Compared to the second quarter of fiscal year 2021, we saw improvement in each of our day sales outstanding, contract asset days, production day supply on hand, and accounts payable days.

Slide 12 reflects our capital and depreciation trends. The capital investments in the third quarter of $8.7 million were largely to support launch and ramp up of new programs and to replace older machinery and equipment. We continue to study our capacity needs to support growth plans. The board-approved plan to expand our Thailand operations was officially kicked off last quarter. And the plan to expand our Mexico operation was approved this quarter. Both expansions add much needed capacity to support the forecast in growth from both existing and future customers and demonstrate our strong, organic growth opportunities.

Borrowings on our credit facilities at March 31, 2021, were $60.5 million, which is down $25.6 million from December 31, 2020, and $57.6 million from June 30, 2020. Our short term liquidity available, representative cash and cash equivalents plus the unused amount of our credit facilities totaled $226 million at March 31, 2021. There were no shares repurchased in the third quarter of fiscal year 2021. Since October 2015, under our Board authorized share repurchase program, a total of $79.7 million was returned to our shareowners by purchasing 5.3 million shares of our stock.

In conclusion, our financial condition continues to be strong and we're in excellent position to take advantage of growth opportunities and improve operating margins and return on invested capital while being able to confront the continued uncertainties caused by the COVID-19 pandemic and the global semiconductor shortage. I'll now turn the call back over to Don.

Donald Charron: Thanks Mike. Before we open the lines for questions, I'd like to make a few closing comments. First, I need to reiterate how proud I am of our people around the world. We have made the health and safety of our employees the number one priority, all while continuing to deliver on our promises to our customers. The company is in a solid position and we are committed to build success in the future.