Kimball Electronics, Inc. (NASDAQ:KE) Q4 2023 Earnings Call Transcript

Kimball Electronics, Inc. (NASDAQ:KE) Q4 2023 Earnings Call Transcript August 17, 2023

Operator: Good morning, ladies and gentlemen, welcome to the Kimball Electronics Fourth Quarter Fiscal 2023 Earnings Conference Call. My name is Carla and I’ll 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 August 17, 2023, 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.

Andrew Regrut: Thank you, and good morning, everyone. Welcome to our Fourth 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 fourth quarter and full fiscal year ended June 30, 2023. 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 uncertainties 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.

All commentary today is 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.

Richard Phillips: Thank you, and good morning, everyone. As previously communicated in a press release earlier this week, Don Charron, the longtime Chairman and CEO of Kimball Electronics, recently passed away. As you might imagine, all of us in the Kimball family are deeply saddened by this news and mourning his loss. In the short time that I knew Don, it was clear to me that he was a strong believer in doing the right thing and inspiring others to be a better version of themselves. Don’s contributions to the company and the EMS industry in general are countless. His achievements are impressive and his humility and generosity unparallel. Don’s legacy after 24 years of dedicated service is a corporate culture unlike any other, and I believe I speak for the entire Kimball Electronics team in saying that we are grateful for the opportunity to have known and worked with Don.

Our thoughts and prayers are with the entire Charron family. As difficult as it may be, we do need to focus on the task at hand, which is discussing our results from the quarter, the fiscal year, and the outlook for the business. I am confident it is what Don would have wanted us to do. So with that, I am very pleased with the results we reported for the fourth quarter and fiscal year 2023. Q4 was our sixth consecutive quarter with record sales and operating income and EPS were at all-time highs for the company. The strong finish to the fiscal year drove net sales above the guidance we provided in May and contributed to better-than-expected cash flow generation in the quarter. This performance was achieved with the highest levels of teamwork from our global organization and many others in the value chain.

I would like to thank our employees, our customers, and our vendor partners for their passion, commitment, and support. In total, fiscal 2023 was an excellent year for Kimball Electronics, highlighted by record sales, margin expansion, a 79% increase in net income, and improved return on invested capital. Each of our three vertical end markets reported strong results and we believe the momentum will continue, fueled in part by industry mega trends even if consumer demand softens during a global economic slowdown. Approximately, 48% of our customers reached an all-time high in sales volume with us for the year. And similar to prior years, 77% of the revenue was with customers we’ve worked with for a decade or more. The team supported new product introductions at a rate four times above the historic norm and we continued to leverage our facility expansions in Thailand and Mexico, all while navigating a challenging macro environment.

During the year, we received multiple customer service awards, four in China alone, and for the ninth consecutive year, we were recognized by CIRCUITS ASSEMBLY in multiple categories for service excellence. Our ESG disclosures once again received high marks with the most recent coming from ISS with a Prime rating, which places us among the top 10% in our industry. I am very proud of these accomplishments and all of our achievements in fiscal 2023. We continue to see a strong pipeline for future growth and we are excited by the prospects of our longer-term funnel of new business opportunities. Turning back to the fourth quarter, net sales totaled $496 million, a 33% increase compared to the same period last year. Conditions in the global supply chain continue to improve gradually with component parts needed for our production requirements slowly increasing in availability.

In fact, for the first time in a couple of years, part shortages did not materially impact sales. Starting with automotive, our largest business, net sales totaled $220 million in the fourth quarter an all-time best. This represents a 44% increase compared to Q4 of fiscal 2022 and 44% of total company sales. It also completes a record year with total annual revenue topping $820 million, a 41% increase over the prior year. Approximately 70% of our automotive business supports electronic power steering with the balance in other applications such as regenerative braking. In Q4, and for that matter the full fiscal year, braking systems manufactured in our facility in Reynosa, Mexico, were a major contributor to the overall increase in automotive.

We expect growth in this vertical market to continue, fueled by the industry megatrend of adding electronic content to vehicles. Our experience in chassis control aligns very well with this trend, especially as features that assist drivers in vehicle movements, such as lane departure and self-parking, increase in popularity and adoption. These features leverage advanced technologies and expanded operating systems and as more of them are added to the ECU or electronic control unit in the steering column, the complexity of the manufacturing process and value-added contribution increases, which is good for us. As we have said many times, the steering architecture for electric motors, internal combustion engines or a hybrid of the two is roughly the same, so our support is agnostic to the type of vehicles produced.

Also, this business is sticky. Automotive is an industry that is highly regulated with stringent certifications and validation protocols, making it expensive and time-consuming to change the supply chain once the production has commenced. And programs are often single-source awards that can span eight to 10 years in length. Next is Medical, with net sales in the fourth quarter of $121 million, a 6% increase compared to Q4 last year and 24% of total company, the results this quarter were adversely impacted by a decline in sales with a major customer who is remediating a FDA recall that is not related to our work with them. For fiscal 2023 in total, sales in the Medical vertical market grew 26% to a record $494 million, with the increase driven by applications supporting sleep therapy and respiratory care, image-guided therapy, in-vitro diagnostics, drug delivery systems, AED, and patient monitoring equipment.

Longer term, the industry mega trends in Medical continue to support future growth, especially as the population ages and accessibility and affordability to healthcare increases. Also, the movement towards smaller medical device sizes with high levels of precision and accuracy and connected drug delivery systems fit very well with our expertise. Our new business development efforts are heavily focused on Medical, as OEMs look to outsource higher-level assemblies or HLAs. HLAs as a category represent an opportunity for us to add more value-added content. For instance, our facility in Mexico is now producing a pediatric flowmeter for React Health. This is an example of how we can bring value and speed to the market with only nine months needed from start to first shipment.

Finally, net sales in the industrial vertical market totaled $142 million, a 38% increase over the fourth quarter last year and 29% of total company sales. This topped our previous best from last quarter by 12%. It also completes a year where sales in this business were nearly $475 million or 33% above fiscal 2023. Our position in Industrial is in excellent setup for future growth, with consumer trends raising awareness on the consumption of natural resources and encouraging the conservation of water, gas, and electricity. This megatrend is supported by legislation and incentives, focused on decarbonization. We are strategically aligned with products that reduce environmental impacts and promote energy, efficiency, safety, and carbon neutrality.

This includes most major brands of residential and commercial heating and cooling systems, smart metering, factory automation, and EV supercharging stations. So in summary, an excellent quarter, a record-setting year, and solid momentum headed into fiscal 2024. I’ll now turn the call over to Jana to review the Q4 financials in more detail and outline our guidance for the coming year. Jana?

Jana Croom: Thank you, Ric, and good morning, everyone. As Ric highlighted, we had an excellent finish to a record year with net sales in the fourth quarter of $496.1 million, a 33% increase over Q4 last year. This was our sixth consecutive quarter with record revenue, eclipsing our previous best by more than $10 million and capping off the sequential step up that was reflected in our guidance. In our fourth quarter, foreign exchange had a negligible impact on consolidated sales year-over-year. The gross margin rate in Q4 was 10%, an all-time high for the company and then 80 basis point improvement compared to the fourth quarter of fiscal 2022, with the increase driven by high levels of operational efficiency, resulting from record sales in our EMS manufacturing facilities and the completion of a high-margin program in our AT&M business produced throughout the fiscal year that shipped in the fourth quarter.

The gross margin rate in fiscal 2023 is an example where excellent results could have been better. Non-manufacture revenue, that is pass-through sales on items such as expedited freight or spot purchases of materials had a dilutive impact on gross margin. These sales are intended to recover unusual costs on a dollar-for-dollar basis, but there is no margin associated with them. Cost recovery for actions taken to mitigate parts shortages have become more common these days and in fiscal 2023, we estimate the impact was approximately 20 basis points on our gross margin versus normal. I’d like to point out that we don’t adjust for this or really any items we consider core cost of doing business in our adjusted OI margin. Adjusted selling and administrative expenses in the first quarter were $18.2 million compared to $14.8 million in Q4 last year, with the increase resulting from added resources to support our top-line growth, wage inflation and higher bonus expense.

When measured as a percentage of sales, however, adjusted selling and administrative expenses were 3.7%, a 30 basis point improvement compared to Q4 last year. Adjusted operating income for the fourth quarter was $31.5 million or 6.3% of net sales, which compares to last year’s adjusted results of $19.4 million or 5.2% of net sales. This was also a record result for the company and reflects a sequential 100 basis point step up compared to the third quarter, driven by the record gross margin I mentioned a moment ago and continued leverage of our facility expansions in Thailand and Mexico. Other income and expense was expense of $4.9 million compared to expense of $5.3 million last year. The effective tax rate was 27.6% in the fourth quarter compared to 35.1% in Q4 last year, with the lower rate resulting from less executive compensation reaching the annual limit for deductibility and the mix of earnings being more heavily weighted towards lower tax jurisdictions.

Adjusted net income in the fourth quarter of fiscal 2023 was $19 million or $0.76 per diluted share compared to net income in Q4 last year of $9.9 million or 40% per diluted share, representing a 90% plus increase in EPS year-over-year. Turning now to the balance sheet. Cash and cash equivalents at June 30, 2023 were $43 million and cash flow generated by operating activities in the quarter was $44.1 million. Cash conversion days were 94 days compared to 86 days in the fourth quarter of last year and 92 days in Q3. As a reminder, we started including customer advances in our CCD calculation. Q4 of last year has been recast to reflect this change. Inventory ended the quarter at $450 million, $55 million higher than Q4 last year, but $38 million lower than Q3.

As anticipated, inventory is leveling off, contributing to the improved cash flow generation in the quarter, and we expect this trend to continue in fiscal 2024. Capital expenditures in the fourth quarter were $23.9 million supporting our facility expansion in Poland, adding equipment in Mexico, and the capital needed for new product introductions across our global footprint. For fiscal 2023 in total, CapEx equaled $90.7 million, which was near the midpoint of our guidance range. Borrowings on our credit facility at June 30, 2023 were $281.5 million compared to $180.6 million a year ago and $289.4 million at the end of Q3. Our short-term liquidity available represented as cash and cash equivalents plus the unused portion of our credit facility totaled $194.1 million at June 30th, 2023.

There were no shares repurchased in the fourth quarter of 2023. Since October 2015, under our Board authorized share repurchase program a total of $88.8 million has been returned to our shareowners by purchasing 5.8 million shares of common stock. We have $11.2 million remaining on the repurchase program. In total fiscal 2023 was an excellent year for our company with record sales of $1.8 billion, a 35% increase year-over-year, adjusted operating income of 4.8% of net sales, a 110 basis point improvement compared to fiscal 2022, year-over-year EPS growth of nearly 80%, and return on invested capital of 9.4% versus ROIC of 7.2% last year. As Ric highlighted, we are providing guidance for fiscal year 2024 with net sales estimated to be in the range of $1.9 billion to $1.95 billion, a 4% to 7% increase year-over-year.

This outlook reflects a decline in our Medical business of approximately 10%. The decrease is driven by a $100 million reduction in sales with a major customer, partially offset by growth in other Medical program. Despite that short-term decrease, we expect growth with other customers to still allow us to achieve positive growth overall in fiscal 2024. We are very encouraged with future business opportunities, particularly as our major customer is able to resume certain product shipments in the years to come. While we pride ourselves on long-term customer relationships, it is also important to note that we have made meaningful progress in diversifying our customer base by adding 8% new customers in FY’24. Our guidance for operating income in fiscal 2024 is a range of 4.7% to 5.2% of net sales, taking into consideration the ramp-up of the facility expansion in Poland, while staying in line with our longer-term objective of 5% plus OI margin.

Capital expenditures are expected to be in the $70 million to $80 million range. We will continue to deploy a capital allocation strategy focused on organic growth with approximately 30% of our CapEx supporting maintenance requirements and the balance representing investments in growth, automation and efficiency to support a funnel of new business opportunities and our recent facility expansions. In addition, inventory should normalize as global supply chain disruptions continue to ease and the resulting cash flow generated from improved working capital management will be directed towards reducing our leverage ratio. And finally, on behalf of the Kimball family, I would like to thank the investment community for its outpouring of condolences during this difficult time.

For many, myself included, Don played a key role in educating us, not just about Kimball but about the EMS industry. Don loved to show off our facilities and he was exceptionally proud of our employees and the quality of work we did to take care of our customers. We will miss him. I’ll now turn the call back over to Ric.

Richard Phillips: Thanks, Jana. Before we open the lines for questions, I’d like to share a few thoughts in closing. It’s been about six months since I first joined the Kimball family and at someday feels like I started yesterday. When I was first looking at a new professional opportunity I was attracted to Kimball Electronics for three reasons, the culture, the people, and the business opportunity for value creation. Fast forward to today, all of them are better than what I expected. First, we live our culture every day, it’s reflected in our annual guiding principles survey with employee engagement scores well above industry norms and we hear from our customers that our culture differentiates us from our peers. In my career, I’ve seen a lot of companies and I can tell you this one upholds its principles better than any other I’ve seen.

It’s impressive with consistency at each of the locations I’ve visited an incredibly strong foundation. The people, they are outstanding with the level of commitment, passion, and love for the company. When you have that there’s not a lot you can do. And the business opportunity is tremendous, you can see it in our performance and we have great momentum to go even better places than where we are today. So I’m having fun working with a great team. In July, our extended leadership team gathered for a Summit with the theme focused on winning together the Kimball way. It was a great opportunity to reflect on our first role of the company which is to be leaders of the entire business. If we have that mindset and bring it to work every day we’ll be successful.

For me winning together is the fun of business. It’s working on a great team with a great culture and a common set of priorities. It’s understanding that if we’re not getting better tomorrow, someone will pass us up. That continuous improvement mindset is a great trade and a core belief of our company. So what does it mean to win the Kimball Way? It means staying true to our guiding principles. It means being collaborative and team-oriented. It means setting high aspirations not on unrealistic goals but attainable targets that require stretching to reach. Winning the Kimball way is maintaining focus on our strategic priorities, communicating openly and proactively, and being accountable to our company to our customers to each other and to our shareowners.

It’s what you can expect from me and it’s a priority for our team. We’ve accomplished a great deal in the past six months and during a record-setting fiscal 2023, but I’m even more excited now about what lies ahead for the company. Operator, we would now like to open the lines for questions, please.

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Q&A Session

Operator: [Operator Instructions] The first question comes from Derek Soderberg from Cantor Fitzgerald. Please go ahead with your question.

Jana Croom: Hi, good morning.

Derek Soderberg: Yeah, thanks for taking — yeah, good morning to everyone. I just wanted to start off by sending my condolences to the friends and family of Don. I had the opportunity to meet him in Jasper and got a personal tour of the facility from Don and what joy that was to have that opportunity with him. As it relates to the quarter, I just want to congratulate the Kimball team on the great quarter. And as it relates to sort of the strength in automotive I think that’s certainly stuck out in the quarter, sounds like the braking systems — you’re ramping in Reynosa, a major contributor, but first, how many programs are you ramping and braking today and do you expect to start ramping new program wins in fiscal ’24 in braking? And then, beyond that, when do you expect revenue from braking to really sort of hit that inflection point to become a material portion of company sales?

Jana Croom: Yeah, that’s a great question. So we actually don’t disclose exactly how many NPIs we have relative to braking, but as we’ve talked about repeatedly, it is growing and we expect it to be a significant portion of our automotive book of business into the future, and we expect to be producing braking programs and all of our geographic regions within the next two fiscal years. So I know that’s not exactly accurate to your question, Derek, but.

Derek Soderberg: Yeah, well, maybe can you just speak about some of the customer feedback you’ve gotten on those programs on these things? You can expand braking to some of the customers you’ve been working with for a while in steering, any commentary on some of the feedback you’re getting from customers?

Jana Croom: Yes, absolutely, and so as we have discussed regenerative braking, which is the specific area of braking that we play in is really gaining traction. It started off specifically with electric vehicles and so while steering is engine agnostic, regenerative braking right now is specific to the EV market, and basically what it does is it allows you to store that power back to the battery. What we are finding is the additional benefits of regenerative braking, which is higher safety, less wear and tear on the vehicle, et cetera — is gaining adoption with internal combustion engines as well, and so as a result of that more and more of our customers, the Tier 1 suppliers, are entering into regenerative braking as the next generations of all types of vehicles are coming out.

And so the work that we did launching back in has been very, very well received and we are actively working with multiple partners, so not just — the braking in Reynosa was very specific to one automotive customer. What I am pleased to say is that we are working with multiple customers now on regenerative braking programs across the globe. And as we’ve said before, remember, we don’t hunt those opportunities. Our customers are coming to us saying, hey, we’re launching this and we want you all to be our supplier and partner of choice.

Richard Phillips: And that, Derek, it’s Ric, just adding on, I was recently in Reynosa and I would say the customer feedback has been very strong. The particular line that we began with their in braking was — is extremely highly automated and effective and it’s really exciting to see that ramp up. There’s kind of no people around other than monitoring, which is exciting and lot of great feedback based on that.

Derek Soderberg: Got it. That’s great to hear. And appreciate the detail. If I can squeeze in one more. Jana, it sounds like you can turn the dial a bit on inventory just given some of the easing supply disruptions. Can you talk about inventory levels sort of as we look into fiscal ’24? What sort of the new normal for inventory levels you’d like to work towards? Maybe you can express that as a ratio. How should we think about inventory levels as we sort of move throughout fiscal ’24?

Jana Croom: Yeah, it’s interesting because, I, as well as you all have been paying a lot of attention to a couple of things, inventories, backlog of open orders, et cetera, and really trying to figure out what does this look like into the future. Obviously, right, PDSOH at 92 days, this not where we want it to be, but if I’m being perfectly honest, I think 65 days is probably a metric of bygone days. I think that just-in-time inventory isn’t something — people — it’s primacy and recency, right, and so there is some psychology to the level of inventory that our customers want us. I think 75 days as a target over the next four to five quarters is really what we’re shooting for at minimum, and so we’ll continue to monitor it, but that’s what I’m looking at.

And so as it translates what you saw is exactly what we expected, right, which was the rise in inventory levels and then sort of the roll-off to the steady state where we’re at now and so we should be able to continue to grow revenue but not have meaningful increase in our inventory level in terms of absolute dollars in FY’24.

Derek Soderberg: Awesome. Really appreciate the color.

Operator: Thanks, Derek. The next question comes from Tim Moore from EF Hutton. Tim, you may ask your question.