Kimball Electronics, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements Certain statements contained within this document are considered forward-looking under the Private Securities Litigation Reform Act of 1995. The statements may be identified by the use of words such as “believes,” “anticipates,” “expects,” “intends,” “plans,” “projects,” “estimates,” “forecasts,” “likely,” “future,” “may,” “should,” “would,” “could,” “will,” “potentially,” and similar expressions. These forward-looking statements are subject to risks and uncertainties including, but not limited to, global economic conditions, geopolitical environment, global health emergencies including the COVID-19 pandemic, availability or cost of raw materials and components, foreign exchange fluctuations, and our ability to convert new business opportunities into customers and revenue. Additional cautionary statements regarding other risk factors that could have an effect on the future performance of Kimball Electronics are contained in our Annual Report on Form 10-K for the year ended June 30, 2021. Business Overview We are a global, multifaceted manufacturing solutions provider. We provide contract electronics manufacturing services (“EMS”) and diversified manufacturing services, including engineering and supply chain support, to customers in the automotive, medical, industrial, and public safety end markets. Our core competency is producing durable electronics, and we further offer diversified contract manufacturing services for non-electronic components, medical devices, medical disposables, drug delivery devices and solutions, precision molded plastics, and production automation, test, and inspection equipment. Our manufacturing services, including engineering and supply chain support, utilize common production and support capabilities globally. We are well recognized by our customers and the industry for our excellent quality, reliability, and innovative service. For the third time in four years, we were recognized in 2021 for achieving the Highest Overall Customer Rating in CIRCUITS ASSEMBLY’s 2021 Service Excellence Awards. CIRCUITS ASSEMBLY is a leading brand and technical publication for electronics manufacturers worldwide. The contract manufacturing services industry is very competitive. As a mid-sized player, we can expect to be challenged by the agility and flexibility of the smaller, regional players, and we can expect to be challenged by the scale and price competitiveness of the larger, global players. We enjoy a unique market position between these extremes which allows us to compete with the larger scale players for high-volume projects, but also maintain our competitive position in the generally lower volume durable electronics market space. We expect to continue to effectively operate in this market space; however, one significant challenge will be maintaining our profit margins while we continue our revenue growth. Price increases are uncommon in the market as production efficiencies and material pricing advantages for most projects drive costs and prices down over the life of the projects. This characteristic of the contract electronics marketplace is expected to continue. The Worldwide Manufacturing Services Market - 2021 Edition , a comprehensive study on the worldwide EMS market published by New Venture Research (“NVR”), provided worldwide forecast trends through 2025. NVR projects the worldwide assembly market for electronics products to grow at a compound annual growth rate (“CAGR”) of 3.4% over the next five years, with the EMS industry projected to grow at a CAGR of 7.1%. We continue to monitor the current economic and industry conditions for uncertainties that may pose a threat to our future growth or cause disruption in business strategy, execution, and timing in the markets in which we compete. The COVID-19 pandemic continues to impact the global economy, and we are actively monitoring its impact on all our operations. The well-being and safety of our employees remains our number one priority, and we are following guidelines suggested by applicable authorities, including utilizing protective shields, face masks, body temperature scanning, social distancing, and proper hygiene as appropriate for our operations. Our response to each positive case in our facilities follows our procedures for communication to our employees, contact tracing, self-quarantining, testing, and sanitization of the affected work areas. Because of the variety of critical medical device assemblies we manufacture around the world, our facilities were classified as “essential businesses” or otherwise permitted to operate under shelter in place orders or other similar orders during government-mandated COVID-19 shutdowns, but all have been affected to varying degrees by COVID-19. We continue to maintain close contact and communication with our customers and our supply chain to ensure safety measures follow appropriate guidelines for the health and safety of all parties and to minimize disruption of operations. While the availability of vaccines is encouraging, significant uncertainties and risks still exist related to the effectiveness and uptake of the various vaccines and the severity and duration of the impact of COVID-19 on our end markets, the supply chain, the health and availability of our workforce, and global macroeconomic conditions; therefore, its financial impact on our future results cannot be reasonably estimated but could be material. 22 The EMS industry continues to experience component shortages, component allocations, and shipping delays, particularly with semiconductors, which were especially challenging in the current first half of the fiscal year. Component shortages or allocations could continue to increase component costs and potentially interrupt our operations and negatively impact our ability to meet commitments to customers. We have taken various actions to mitigate the risk and minimize the impact to our customers as well as the adverse effect component shortages, component allocations, or shipping delays could have on our results; however, the duration or severity of the component shortages is unknown. COVID-19 interruptions and supply chain restraints have also resulted in an industry-wide inflation of components, labor, freight, and other operating costs. Through contractual pricing arrangements and negotiations with our customers, we have been able to mitigate a majority of these cost increases; however, our profitability has been impacted in the short term, and the financial impact on our future results cannot be reasonably estimated but could continue to be material. Sales to customers in the automotive market for the current fiscal year quarter declined by 8% when compared to the record sales experienced in the second quarter of fiscal year 2021, largely driven by the current shortage of semiconductors and its continuing impact on global automobile production. However, sales to customers in the automotive market experienced a 7% sequential increase compared to the first quarter of fiscal year 2022, largely driven by the ramp-up of certain products. We anticipate demand from customers in the automotive market to remain strong and expect a stronger second half of fiscal year 2022 than the first half as we expect the supply to catch up with the demand and the launch of new programs. In the medical market, sales were slightly higher in the current fiscal year quarter when compared to the second quarter of fiscal year 2021 primarily due to the launch and ramp-up of new products. In the industrial market, we had higher sales in the current fiscal year quarter in large part due to higher end market demand for climate control products and smart metering products. Sales to customers in the public safety market were slightly higher in the current fiscal year quarter compared to the second quarter of fiscal year 2021. We have a strong focus on cost control balanced with managing the future growth prospects of our business and growing backlog of orders due to the global component shortage and logistical challenges. We expect to make investments that will strengthen or add new capabilities to our package of value as a multifaceted manufacturing solutions company, including through our recently announced capacity expansions. Managing working capital in conjunction with fluctuating demand levels is likewise key. In addition, a long-standing component of our profit-sharing incentive bonus plan is that it is linked to our financial performance which results in varying amounts of compensation expense as profits change. We continue to maintain a strong balance sheet, which included a current ratio of 1.7, a debt-to-equity ratio of 0.2, and Share Owners’ equity of $445 million at December 31, 2021. Our short-term liquidity available, represented as cash and cash equivalents plus the unused amount of our credit facilities, some of which are uncommitted, totaled $120 million at December 31, 2021. In addition to the above discussion related to the current market conditions, management currently considers the following events, trends, and uncertainties to be most important to understanding our financial condition and operating performance: • Employees throughout our business operations are an integral part of our ability to compete successfully, and the stability of the management team is critical to long-term Share Owner value. Our talent management and succession planning processes help to maintain stability in management. • Due to the contract and project nature of the contract manufacturing industry, fluctuation in the demand for our products and variation in the gross margin on those programs is inherent to our business. Effective management of manufacturing capacity is, and will continue to be, critical to our success. • The nature of the EMS industry is such that the start-up of new customers and new programs to replace expiring programs occurs frequently. As such, our ability to continue contractual relationships with our customers, including our principal customers, is not certain. While our agreements with customers generally do not have a definitive term and thus could be canceled at any time with little or no notice, we generally realize relatively few cancellations prior to the end of the product’s life cycle. We attribute this to our focus on long-term customer relationships, meeting customer expectations, required capital investment, and product qualification cycle times. New customers and program start-ups generally cause margin dilution early in the life of a program, which is generally recovered as the program becomes established and matures. 23 • Risk factors within our business include, but are not limited to, general economic and market conditions, component availability, logistical challenges, customer order delays, globalization, global health emergencies including the COVID-19 pandemic, impact related to tariffs and other trade barriers, foreign currency exchange rate fluctuations, rapid technological changes, supplier and customer financial stability, the contract nature of this industry, the concentration of sales to large customers, and the potential for customers to choose a dual sourcing strategy or to in-source a greater portion of their manufacturing. The continuing success of our business is dependent upon our ability to replace expiring customers/programs with new customers/programs. We monitor our success in this area by tracking the number of customers and the percentage of our net sales generated from them by years of service as depicted in the table below. While variation in the size of program awards makes it difficult to directly correlate this data to our sales trends, we believe it does provide useful information regarding our customer loyalty and new business growth. Additional risk factors that could have an effect on our performance are located within the “Risk Factors” section of our Annual Report on Form 10-K for the year ended June 30, 2021. Six Months Ended December 31 Customer Service Years 2021 2020 More than 10 Years % of Net Sales 78 % 79 % # of Customers 35 30 5 to 10 Years % of Net Sales 17 % 17 % # of Customers 21 22 Less than 5 Years % of Net Sales 5 % 4 % # of Customers 12 18 Total % of Net Sales 100 % 100 % # of Customers 68 70 Financial Overview At or for the Three Months Ended December 31 (Amounts in Millions, Except for Per Share Data) 2021 as a % of Net Sales 2020 as a % of Net Sales % Change Net Sales $ 315.3 $ 320.6 (2) % Gross Profit $ 20.8 6.6 % $ 29.7 9.3 % (30) % Selling and Administrative Expenses 13.9 4.4 % 13.5 4.3 % 3 % Operating Income 6.9 2.2 % 16.2 5.0 % (57) % Other Income (Expense) (0.2) 2.4 Provision for Income Taxes 1.6 3.5 Net Income $ 5.1 $ 15.1 (66) % Diluted Earnings per Share $ 0.20 $ 0.60 (67) % Open Orders $ 770.8 $ 433.8 78 % 24 For the Six Months Ended December 31 (Amounts in Millions, Except for Per Share Data) 2021 as a % of Net Sales 2020 as a % of Net Sales % Change Net Sales $ 608.0 $ 652.4 (7) % Gross Profit $ 36.4 6.0 % $ 60.2 9.2 % (40) % Selling and Administrative Expenses 26.1 4.3 % 26.5 4.1 % (2) % Other General Income 1.4 0.3 Operating Income 11.7 1.9 % 34.0 5.2 % (66) % Other Income (Expense) (1.4) 4.6 Provision for Income Taxes 2.6 6.7 (62) % Net Income $ 7.7 $ 31.9 (76) % Diluted Earnings per Share $ 0.30 $ 1.26 (76) % Net Sales by Vertical Market Three Months Ended Six Months Ended December 31 December 31 (Amounts in Millions) 2021 2020 % Change 2021 2020 % Change Automotive $ 139.0 $ 151.9 (8) % $ 268.4 $ 270.1 (1) % Medical 89.8 87.1 3 % 174.8 214.3 (18) % Industrial 71.8 67.7 6 % 135.7 137.8 (1) % Public Safety 10.8 10.5 3 % 21.9 23.8 (8) % Other 3.9 3.4 17 % 7.2 6.4 12 % Total Net Sales $ 315.3 $ 320.6 (2) % $ 608.0 $ 652.4 (7) % Second quarter and year-to-date fiscal year 2022 consolidated net sales decreased compared to the second quarter and year-to-date period of fiscal year 2021. The impact from foreign currency fluctuations was less than 1% on net sales in the current quarter and current year-to-date periods compared to the second quarter and the year-to-date periods of fiscal year 2021. By end market vertical, our market verticals fluctuated as follows: • Sales to customers in the automotive market during the second quarter of fiscal year 2022 decreased 8% compared to the second quarter of fiscal year 2021. This decrease is largely due to the unfavorable impact of component shortages, partially offset by the ramp-up of certain programs, including programs for fully electric vehicles. • Sales to customers in the medical market increased in the second quarter of fiscal year 2022 when compared to the second quarter of fiscal year 2021 primarily due to the ramp-up of certain products. Sales to customers in the medical market decreased in the year-to-date period of fiscal year 2022 compared to the year-to-date period of fiscal year 2021 as the prior year-to-date period sales benefited from the temporary increase in demand for medical assemblies, specifically those related to respiratory care and patient monitoring products as a direct result of the COVID-19 pandemic and related global shortage of respiratory equipment. Partially offsetting this year-to-date period decrease is the launch and ramp-up of new products. • Sales to customers in the industrial market increased in the second quarter of fiscal year 2022 when compared to the second quarter of fiscal year 2021, primarily due to higher end market demand for climate control products and higher demand for smart metering products, which were partially offset by the phase out of certain products. Sales to customers in the industrial market decreased in the year-to-date period of the current fiscal year when compared to the year-to-date period of the prior fiscal year largely due to the phase out of certain products, which were partially offset by higher end market demand for climate control products and higher demand for smart metering products. • Sales to customers in the public safety market declined in the year-to-date period of fiscal year 2022 compared to the year-to-date period of fiscal year 2021 primarily due to material availability issues and reduced demand driven by the COVID-19 pandemic. 25 A significant amount of sales to Nexteer Automotive and Philips accounted for the following portions of our net sales: Three Months Ended Six Months Ended December 31 December 31 2021 2020 2021 2020 Nexteer Automotive 17% 19% 17% 17% Philips 16% 14% 15% 18% Open orders were up 78% as of December 31, 2021 compared to December 31, 2020, primarily from an increase in the automotive and medical verticals. The increase in open orders in both the automotive market and the medical market is driven by the component shortages, which has limited our ability to fulfill customer orders. Open orders are the aggregate sales price of production pursuant to unfulfilled customer orders, which may be delayed or canceled by the customer subject to contractual termination provisions. Substantially all of the open orders as of December 31, 2021 are expected to be filled within the next twelve months. Open orders at a point in time may not be indicative of future sales trends due to the contract nature of our business and the variability of order lead times among our customers. Additionally, COVID-19 and the component shortages could impact the timing and certainty of fulfillment of open orders. We have experienced lost absorption in the current fiscal year quarter as we are retaining our workforce to be well-positioned for the anticipated growth in the second half of the current fiscal year. We also incurred higher material costs, increased freight costs driven by the component shortages, and wage inflation in the current quarter compared to the prior year second quarter. While we have been able to mitigate a majority of these cost increases, our profitability has been impacted in the short term. As a result, gross profit as a percent of net sales in the second quarter of fiscal year 2022 declined when compared to the second quarter of fiscal year 2021. Also contributing to the quarter-over-quarter decline was the favorable foreign currency fluctuation impacts experienced in the second quarter of fiscal year 2021. These factors were partially offset by lower profit-sharing incentive bonus expense in the current quarter and lower depreciation expense from the change in estimates of useful lives on Surface Mount Technology production equipment in the second quarter of fiscal year 2022. See Note 1 - Business Description and Summary of Significant Accounting Policies of Notes to Condensed Consolidated Financial Statements for more information on the change in estimates of useful lives. Gross profit as a percent of net sales also declined in the first half of fiscal year 2022 when compared to the first half of fiscal year 2021, primarily driven by the same factors above in the quarterly discussion, with a smaller impact from the change in estimates of useful lives as this change was implemented in the second quarter of the current fiscal year. Selling and administrative expenses increased as a percent of net sales and in absolute dollars in the second quarter of fiscal year 2022 when compared to the second quarter of fiscal year 2021. The selling and administrative expenses increased primarily from higher salary and related payroll costs and stock-based compensation, including non-recurring charges related to executive succession planning, which were partially offset by lower profit-sharing incentive bonus expense and lower legal and tax services fees. Selling and administrative expenses increased as a percent of sales but decreased in absolute dollars in the year-to-date period of fiscal year 2022 compared to the year-to-date period of fiscal year 2021. The selling and administrative expenses decreased in absolute dollars primarily from lower profit-sharing incentive bonus expense and the decrease in the fair value of the liability for the supplemental employee retirement plan (“SERP”), partially offset by higher salary and payroll related costs and stock-based compensation. The lower net sales was the primary driver for the increase as a percent of net sales for the current year-to-date period. Other General Income in the six months ended December 31, 2021 and 2020 included $1.4 million and $0.3 million, respectively, of pre-tax income resulting from payments received related to the class action lawsuits in which Kimball Electronics was a class member. These lawsuits alleged that certain suppliers to the EMS industry conspired over a number of years to raise and fix the prices of electronic components, resulting in overcharges to purchasers of those components. 26 Other Income (Expense) consisted of the following: Three Months Ended Six Months Ended December 31 December 31 (Amounts in Thousands) 2021 2020 2021 2020 Interest income $ 11 $ 26 $ 35 $ 33 Interest expense (473) (616) (868) (1,439) Foreign currency/derivative gain (loss) (128) 2,545 (700) 4,967 Gain on SERP investments 402 811 315 1,361 Adjustments after measurement period of GES acquisition — (282) — (282) Other (21) (73) (240) (94) Other income (expense), net $ (209) $ 2,411 $ (1,458) $ 4,546 The foreign currency/derivative gain (loss) resulted from net foreign currency exchange rate movements during the periods. The revaluation to fair value of the SERP investments recorded in Other Income (Expense) is offset by the revaluation of the SERP liability recorded in Selling and Administrative Expenses, and thus there is no effect on net income. The adjustments after measurement period of GES acquisition relate to charges recognized from agreements reached after the measurement period on disputed claims with the sellers of GES. Our provision for income taxes for the first six months ended December 31, 2021 and December 31, 2020 was $2.6 million, or 25.0% of income before taxes on income, and $6.7 million, or 17.3% of income before taxes on income, respectively. The increase in the effective tax rate was driven by the lower rate in the prior fiscal year, which was favorably impacted by a mix of earnings in jurisdictions with rates lower than the U.S. federal statutory rate of 21.0%. Comparing the balance sheet as of December 31, 2021 to June 30, 2021, Receivables decreased $17.2 million largely due to lower sales volumes. Contract assets, which reflect the unbilled accounts receivable that occur when we recognize revenue over time, increased $11.3 million. Our inventory balance increased $103.8 million primarily due to the component shortages as we continue to purchase material not impacted by the shortages so we can fulfill our customer orders once the impacted components are received. Property and equipment, net increased $15.8 million primarily from the Mexico and Thailand facility expansions. Accounts payable increased $38.4 million primarily due to the increased inventory purchases. Borrowings on credit facilities increased $36.8 million primarily for working capital purposes. Liquidity and Capital Resources Working capital at December 31, 2021 was $265.3 million compared to working capital of $282.6 million at June 30, 2021. The current ratio was 1.7 at December 31, 2021 and 1.9 at June 30, 2021. The debt-to-equity ratio was 0.2 at December 31, 2021 and 0.1 at June 30, 2021. Our short-term liquidity available, represented as cash and cash equivalents plus the unused amount of our credit facilities, some of which are uncommitted, totaled $119.5 million at December 31, 2021 and $206.7 million at June 30, 2021. Cash Conversion Days (“CCD”) are calculated as the sum of Days Sales Outstanding (“DSO”) plus Contract Asset Days (“CAD”) plus Production Days Supply on Hand (“PDSOH”) less Accounts Payable Days (“APD”). CCD, or a similar metric, is used in our industry and by our management to measure the efficiency of managing working capital. The following table summarizes our CCD for the quarterly periods indicated. Three Months Ended December 31, 2021 June 30, 2021 December 31, 2020 DSO 52 53 58 CAD 14 14 19 PDSOH 91 61 58 APD 76 64 60 CCD 81 64 75 We define DSO as the average of monthly trade accounts and notes receivable divided by an average day’s net sales, CAD as the average monthly contract assets divided by an average day’s net sales, PDSOH as the average of monthly gross inventory divided by an average day’s cost of sales, and APD as the average of monthly accounts payable divided by an average day’s cost of sales. 27 Cash Flows The following table reflects the major categories of cash flows for the first six months of fiscal years 2022 and 2021. Six Months Ended December 31 (Amounts in Millions) 2021 2020 Net cash (used for) provided by operating activities $ (56.5) $ 72.3 Net cash used for investing activities $ (27.8) $ (14.4) Net cash provided by (used for) financing activities $ 35.5 $ (33.4) Cash Flows from Operating Activities Net cash used for operating activities for the first six months of fiscal year 2022 was driven by changes in operating assets and liabilities. Net cash provided by operating activities in the first six months of the prior year was largely driven by both net income adjusted for non-cash items and changes in operating assets and liabilities. Changes in operating assets and liabilities used $83.2 million of cash in the first six months of fiscal year 2022 compared to $23.2 million of cash provided in the first six months of the prior year. The cash used of $83.2 million from changes in operating assets and liabilities in the first six months of fiscal year 2022 is largely due to an increase in inventory, which used cash of $106.9 million primarily due to the component shortages as we continue to purchase material not impacted by the shortages so we can fulfill our customer orders once the impacted components are received, and the decrease in accrued expenses and taxes payable, which used cash of $12.1 million from a significant portion of accrued incentive compensation payments occurring during the first half of the fiscal year. Partially offsetting cash used by inventory and accrued expenses was an increase in accounts payable, which provided cash of $36.3 million largely resulting from increased inventory purchases, and a decrease in accounts receivable, which provided cash of $15.2 million primarily resulting from decreased sales volumes. The cash provided of $23.2 million from changes in operating assets and liabilities in the first six months of fiscal year 2021 was largely due to a decrease in inventory, which provided cash of $46.5 million primarily due to the consumption of the inventory build at the end of the prior fiscal year in addition to the reimbursement from certain customers for the excess raw material inventory we purchased based on their forecasts during the ramp-up due to COVID-19. Partially offsetting cash provided by inventory was an increase in accounts receivable, which used cash of $34.1 million primarily resulting from increased sales volumes and customer sales mix. Cash Flows from Investing Activities For the first six months of fiscal years 2022 and 2021, net cash used for investing activities was $27.8 million and $14.4 million, respectively. During the first six months of fiscal year 2022, we invested $27.9 million into capital expenditures for expansions at our Thailand and Mexico facilities, capacity purposes, and to support new business awards. During the first six months of fiscal year 2021, we invested $14.7 million into capital expenditures for capacity purposes, to support new business awards, and replacement of older machinery and equipment. Cash Flows from Financing Activities For the first six months of fiscal year 2022, net cash provided by financing activities of $35.5 million resulted largely from net borrowings on our credit facilities of $37.0 million primarily for working capital purposes, partially offset by remittance of tax withholdings on share-based payments. For the first six months of fiscal year 2021, net cash used by financing activities of $33.4 million resulted largely from net payments on our credit facilities of $32.6 million and the repurchases of our common stock under an authorized stock repurchase plan, partially offset by the receipt of $3.0 million for the final net working capital adjustment from the GES acquisition. Credit Facilities The Company maintains a U.S. primary credit facility (the “primary credit facility”) among the Company, the lenders party thereto, and JPMorgan Chase Bank, National Association, as Administrative Agent, and Bank of America, N.A., as Documentation Agent, scheduled to mature July 27, 2023. The primary credit facility provides for $150 million in borrowings, with an option to increase the amount available for borrowing to $225 million at the Company’s request, subject to the consent of each lender participating in such increase. 28 The proceeds of the loans on the primary credit facility are to be used for working capital and general corporate purposes of the Company including capital expenditures and potential acquisitions. A portion of the credit facility, not to exceed $15 million of the principal amount, will be available for the issuance of letters of credit. A commitment fee on the unused portion of the principal amount of the credit facility is payable at a rate that ranges from 20.0 to 25.0 basis points per annum as determined by the Company’s ratio of consolidated total indebtedness to adjusted consolidated EBITDA. On November 8, 2021, the primary facility was amended to provide, among other things, (1) the interest rate calculation method will generally transition from the London Interbank Offered Rate (“LIBOR”) to the Secured Overnight Financing Rate (“SOFR”) on the transition date of December 31, 2021 on applicable borrowings; (2) the Eurocurrency borrowings are replaced with Term Benchmark borrowings; (3) if any Term Benchmark borrowing is denominated Euros, the Euro Interbank Offered Rate (“EURIBOR”) shall be utilized; and (4) all ABR borrowings will be denominated in U.S. Dollars. The interest rate on borrowings is dependent on the type and currencies of borrowings and will be one of following two options: • prior to the transition date of December 31, 2021, any Term Benchmark borrowing denominated in U.S. Dollars will utilize LIBOR in effect two business days prior to the advance (adjusted upwards to reflect bank reserve costs) for such interest period as defined in the agreement, plus the Term Benchmark Loans spread which can range from 125.0 to 175.0 basis points based on the Company’s ratio of consolidated total indebtedness to adjusted consolidated EBITDA; • after the transition date of December 31, 2021, any existing or future Term Benchmark borrowing denominated in U.S. Dollars will utilize SOFR which is a rate per annum equal to the secured overnight financing rate for such business day published by the SOFR Administrator, the Federal Reserve Bank of New York, on the immediately succeeding business day, plus the Term Benchmark Loans spread which can range from 125.0 to 175.0 basis points based on the Company’s ratio of consolidated total indebtedness to adjusted consolidated EBITDA; • any Term Benchmark borrowing denominated in Euros will utilize the Euro Interbank Offered Rate (“EURIBOR”) in effect two business days prior to the advance (adjusted upwards to reflect bank reserve costs) for such interest period as defined in the agreement, plus the Term Benchmark Loans spread which can range from 125.0 to 175.0 basis points based on the Company’s ratio of consolidated total indebtedness to adjusted consolidated EBITDA; or • the Alternate Base Rate (“ABR”), which is defined as the highest of the fluctuating rate per annum equal to the higher of a. JPMorgan’s prime rate; b. 1% per annum above the Adjusted LIBO Rate (as defined under the primary credit facility); or c. 1/2 of 1% per annum above the Federal Funds Effective Rate (as defined under the primary credit facility); plus the ABR Loans spread which can range from 25.0 to 75.0 basis points based on the Company’s ratio of consolidated total indebtedness to adjusted consolidated EBITDA. At December 31, 2021, we had $98.5 million in borrowings under the primary credit facility and $0.4 million in letters of credit against the primary credit facility, and $40.0 million of the borrowings were classified as long-term as the Company intends, and has the ability, to refinance for a period longer than twelve months. At June 30, 2021, we had $62.7 million in borrowings under the primary facility and $0.4 million in letters of credit against the primary facility, and $40.0 million were classified as long-term. The Company’s financial covenants under the primary credit facility require: • a ratio of consolidated total indebtedness minus unencumbered U.S. cash on hand in the United States in excess of $15 million to adjusted consolidated EBITDA, determined as of the end of each of its fiscal quarters for the then most recently ended four fiscal quarters, to not be greater than 3.0 to 1.0, and • a fixed charge coverage ratio, determined as of the end of each of its fiscal quarters for the then most recently ended four fiscal quarters, to not be less than 1.1 to 1.0. We were in compliance with the financial covenants during the six-month period ended December 31, 2021. 29 Kimball Electronics has foreign credit facilities available to satisfy short-term cash needs at specific foreign locations rather than funding from intercompany sources. These foreign credit facilities can be canceled at any time by either the bank or us. As of December 31, 2021, we maintained the following foreign credit facilities: • A Thailand overdraft credit facility which allows for borrowings up to 2.4 million Thai Baht (approximately $0.1 million at December 31, 2021 exchange rates). We had no borrowings under this foreign credit facility as of December 31, 2021 or June 30, 2021. • An uncommitted revolving credit facility for our Netherlands subsidiary, which allows for borrowings of up to 9.2 million Euro (approximately $10.4 million at December 31, 2021 exchange rates) that can be drawn in Euro, U.S. dollars, or another optional currency. We had $4.5 million in borrowings outstanding under this Netherlands revolving credit facility as of December 31, 2021 and $3.5 million as of June 30, 2021. • An uncommitted revolving credit facility for our Poland operation, which allows for borrowings of up to 5 million Euro (approximately $5.7 million at December 31, 2021 exchange rates) that can be drawn in Euro, U.S. dollars, or Polish Zloty. We had no borrowings under this foreign credit facility as of December 31, 2021 or June 30, 2021. Factoring Arrangements The Company utilizes factoring arrangements for certain of our accounts receivables with third-party financial institutions in order to extend terms for the customer without negatively impacting our cash flow. These arrangements in all cases do not contain recourse provisions which would obligate us in the event of our customers’ failure to pay. Receivables are considered sold when they are transferred beyond the reach of Kimball Electronics and its creditors, the purchaser has the right to pledge or exchange the receivables, and we have surrendered control over the transferred receivables. In the six months ended December 31, 2021 and 2020, we sold, without recourse, $125.3 million and $186.0 million of accounts receivable, respectively. See Note 1 - Business Description and Summary of Significant Accounting Policies of Notes to Condensed Consolidated Financial Statements for more information regarding the factoring arrangements. Future Liquidity We believe our principal sources of liquidity from available funds on hand, cash generated from operations, and the availability of borrowing under our credit facilities, will be sufficient to meet our working capital and other operating needs for at least the next 12 months. The unused borrowings in USD equivalent under all of our credit facilities totaled $62.8 million at December 31, 2021. We expect to continue to prudently invest in capital expenditures, including for capacity expansions and potential acquisitions, that would help us continue our growth and development as a multifaceted manufacturing solutions company. In fiscal year 2021, we approved capacity expansions at our Thailand and Mexico facilities. We anticipate our Thailand facility expansion will be complete in the second half of fiscal year 2022 and the Mexico facility expansion will be complete in the beginning of fiscal year 2023. We have also approved a plan to expand the facility in Poznan, Poland, and the expansion is expected to be completed in early fiscal year 2024. We are in a solid financial position to be able to weather the continuing impact of COVID-19; however, significant uncertainties and risks exist related to the severity and duration of the impact to certain markets, the supply chain, and to global macroeconomic conditions. At December 31, 2021, our capital expenditure commitments were approximately $26 million, consisting primarily of commitments for the expansion of our Mexico and Thailand facilities, capital related to new program wins, and capacity purposes. We anticipate our available liquidity will be sufficient to fund these capital expenditures. We have purchase obligations that arise in the normal course of business for items such as raw materials, services, and software acquisitions/license commitments. In certain instances, such as when lead times dictate, we enter into contractual agreements for material in excess of the levels required to fulfill customer orders to help mitigate the potential impact related to component shortages, which require longer lead times. In turn, our material authorization agreements with customers cover a portion of the exposure for material which is purchased prior to having a firm order. At December 31, 2021, our foreign entities held cash totaling $54.2 million. Most of our accumulated unremitted foreign earnings have been invested in active non-U.S. business operations, and we expect we may only repatriate a minor amount of these earnings to the United States in a tax-efficient manner. Our intent is to permanently reinvest the remaining funds outside of the United States, and our current plans do not demonstrate a need to repatriate these funds to our U.S. operations. However, if such funds were repatriated, a portion of the funds remitted may be subject to applicable non-U.S. income and withholding taxes. 30 The Company has a Board-authorized stock repurchase plan (the “Plan”) allowing the repurchase of up to $100 million of our common stock. Purchases may be made under various programs, including in open-market transactions, block transactions on or off an exchange, or in privately negotiated transactions, all in accordance with applicable securities laws and regulations. The Plan has no expiration date but may be suspended or discontinued at any time. The extent to which the Company repurchases its shares, and the timing of such repurchases, will depend upon a variety of factors, including market conditions, regulatory requirements, and other corporate considerations, as determined by the Company’s management team. The Company expects to finance the purchases with existing liquidity. The Company has repurchased $79.7 million of common stock under the Plan through December 31, 2021. Our ability to generate cash from operations to meet our liquidity obligations could be adversely affected in the future by factors such as general economic and market conditions, lack of availability of raw material components in the supply chain, a decline in demand for our services, loss of key contract customers, unsuccessful integration of acquisitions and new operations, global health emergencies such as the COVID-19 pandemic, the duration and severity of the COVID-19 pandemic and the related uncertainties around the financial impact, and other unforeseen circumstances. In particular, should demand for our customers’ products and, in turn, our services decrease significantly over the next 12 months, the available cash provided by operations could be adversely impacted. Additional cautionary statements regarding our risk factors are contained in our Annual Report on Form 10-K for the year ended June 30, 2021. Fair Value During the second quarter of fiscal year 2022, no level 1 or level 2 financial instruments were affected by a lack of market liquidity. For level 1 financial assets, readily available market pricing was used to value the financial instruments. Our foreign currency derivative assets and liabilities, which were classified as level 2, were independently valued using observable market inputs such as forward interest rate yield curves, current spot rates, and time value calculations. To verify the reasonableness of the independently determined fair values, these derivative fair values were compared to fair values calculated by the counterparty banks. Our own credit risk and counterparty credit risk had an immaterial impact on the valuation of the foreign currency derivatives. See Note 7 - Fair Value of Notes to Condensed Consolidated Financial Statements for additional information. Off-Balance Sheet Arrangements As of December 31, 2021, we do not have any material off-balance sheet arrangements. Critical Accounting Policies Kimball Electronics’ Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles require the use of estimates and assumptions that affect amounts reported and disclosed in the Condensed Consolidated Financial Statements and related notes. Actual results could differ from these estimates and assumptions. Management uses its best judgment in the assumptions used to value these estimates, which are based on current facts and circumstances, prior experience, and other assumptions that are believed to be reasonable. There have been no material changes to our critical accounting policies since our Annual Report on Form 10-K for the year ended June 30, 2021. For further information regarding our critical accounting policies, refer to “Note 1 - Business Description and Summary of Significant Accounting Policies” of Notes to Consolidated Financial Statements and “Critical Accounting Policies” in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended June 30, 2021. New Accounting Standards See Note 1 - Business Description and Summary of Significant Accounting Policies of Notes to Condensed Consolidated Financial Statements for information regarding New Accounting Standards. 31