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,” “can,” “potentially,” and similar expressions. These forward-looking statements are subject to risks and uncertainties including, but not limited to, global economic conditions, geopolitical environment and conflicts such as the war in Ukraine, global health emergencies, 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, 2024. Business Overview We are a global, multifaceted manufacturing solutions provider. We provide electronics manufacturing services (“EMS”), including engineering and supply chain support, to customers in the automotive, medical, and industrial end markets. Our core competency is producing durable electronics, and we further offer contract manufacturing services for non-electronic components, medical disposables, drug delivery solutions, and precision molded plastics. 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. CIRCUITS ASSEMBLY, a leading brand and technical publication for electronics manufacturers worldwide, has previously recognized us four times for achieving the Highest Overall Customer Rating in their Service Excellence Awards, and most recently, we received Highest Overall Customer Ratings in four of their seven categories in 2023. 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. Pricing is competitive 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 - 2024 Edition , a comprehensive study on the worldwide EMS market published by New Venture Research (“NVR”), provided worldwide forecast trends through 2028. NVR projects the worldwide assembly market for electronics products to grow at a compound annual growth rate (“CAGR”) of 4.6% over the next five years, with the EMS industry projected to grow at a CAGR of 4.6%. 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 EMS industry is experiencing the impacts of softening demand from global macroeconomic headwinds, especially in the current fiscal year. The financial impact on our future results cannot be reasonably estimated but could be material. Such headwinds include pressure from elevated levels of inflation, higher interest rates, and geopolitical uncertainty. Net sales in the first quarter of the current fiscal year decreased 15% compared to the prior fiscal year first quarter, with decreases in each of our end market verticals. The decrease in sales to customers in the automotive and medical markets were largely driven by decreased demand. The decrease in sales to customers in the industrial market were related to the sale of GES and continued softness specific to smart metering and climate control production. We expect consolidated net sales to continue to lag when compared to fiscal year 2024 with the continued softness in demand and the loss of a major automotive program (impacts beginning in the third quarter) by our customer that was unrelated to any issues with our workmanship, quality, or ability to produce the product, in addition to the expected consolidated net sales decrease from the divestiture of our GES business. We have a strong focus on cost control balanced with managing the future growth prospects of our business. 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 completed 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 its link to our financial performance, which results in varying amounts of compensation expense as profits change. 21 To support our renewed strategic focus, we completed the divestiture of our GES business on July 31, 2024 and undertook restructuring efforts beginning in fiscal year 2024 to align our cost structure with reduced end-market demand levels. In addition, on November 4, 2024, the Company announced that its Board of Directors has approved a plan to cease operations at our Tampa facility, expected to be completed by the end of the fiscal year. The decision was another important step towards sharpening our strategic focus, while leveraging our global footprint and streamlining the operating structure. Production activities on existing customer programs will be transferred out of Tampa, with the majority of the work going to our plants in North America, primarily our newly expanded facility in Mexico and Jasper. We continue to maintain a strong balance sheet, which included a current ratio of 2.3, a debt-to-equity ratio of 0.4, and Share Owners’ equity of $548 million at September 30, 2024. Recently, we have invested to support our expansions and growth in Mexico, Thailand, and Poland. Refer to the Future Liquidity section of Liquidity and Capital Resources below for further discussion of our liquidity. 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. Three Months Ended September 30 Customer Service Years 2024 2023 More than 10 Years % of Net Sales 78 % 74 % # of Customers 36 33 5 to 10 Years % of Net Sales 15 % 20 % # of Customers 12 20 Less than 5 Years % of Net Sales 7 % 6 % # of Customers 12 11 Total % of Net Sales 100 % 100 % # of Customers 60 64 A detailed discussion of risk factors and uncertainties 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, 2024. 22 Results of Operations At or for the Three Months Ended September 30 (Amounts in Millions, Except for Per Share Data) 2024 as a % of Net Sales 2023 as a % of Net Sales % Change Net Sales $ 374.3 $ 438.1 (15) % Gross Profit $ 23.6 6.3 % $ 35.5 8.1 % (34) % Selling and Administrative Expenses 13.5 3.6 % 16.0 3.7 % (16) % Restructuring Expense 2.3 0.6 % — — % — % Gain on Disposal (1.3) (0.3) % — — % — % Operating Income 9.1 2.4 % 19.5 4.4 % (53) % Other Income (Expense) (6.2) (6.2) Provision (Benefit) for Income Taxes (0.3) 2.5 (111) % Net Income $ 3.2 $ 10.8 (71) % Diluted Earnings per Share $ 0.12 $ 0.43 (72) % Open Orders $ 594 $ 907 (35) % Net Sales by Vertical Market Three Months Ended September 30 (Amounts in Millions) 2024 2023 % Change Automotive $ 188.4 $ 212.5 (11) % Medical 89.8 102.4 (12) % Industrial 96.1 123.2 (22) % Total Net Sales $ 374.3 $ 438.1 (15) % First quarter fiscal year 2025 consolidated net sales decreased 15% compared to the first quarter of fiscal year 2024. The impact from foreign currency fluctuations on net sales was less than 1% in the current quarter compared to the first quarter of fiscal year 2024. By end market vertical, our market verticals fluctuated as follows: • Sales to customers in the automotive market decreased 11% during the first quarter of fiscal year 2025 compared to the first quarter of fiscal year 2024. The decrease in the first quarter is due to customer demand reductions, particularly in North America and Europe. • Sales to customers in the medical market declined in the first quarter of fiscal year 2025 compared to the first quarter of fiscal year 2024. The decrease is primarily due to customer demand reductions. • Sales to customers in the industrial market decreased 22% during the first quarter of fiscal year 2025, when compared to the first quarter of fiscal year 2024. Approximately half of the decline is related to the sale of GES and the remainder is due to continued softness in industrial specific to smart metering and climate control production. Sales to Nexteer Automotive, ZF, and HL Mando accounted for the following portions of our net sales: Three Months Ended September 30 2024 2023 Nexteer Automotive 18% 16% ZF 13% 14% HL Mando * 10% * amount is less than 10% of total 23 Gross profit as a percent of net sales in the first quarter of fiscal year 2025 declined when compared to the first quarter of fiscal year 2024 as we experienced lost absorption on lower revenue. Selling and administrative expenses decreased both as a percent of net sales and in absolute dollars in the first quarter of fiscal year 2025 when compared to the first quarter of fiscal year 2024, driven by cost reduction efforts, decreased profit-sharing bonus expense, and the classification of factoring fees. In the three months ended September 30, 2024, we recorded pre-tax restructuring expense of $2.3 million for employee-related costs as we undertook restructuring efforts to align our cost structure with reduced end market demand levels. We completed the divestiture of GES on July 31, 2024 and recorded a gain on disposal of $1.3 million during the first quarter of fiscal year 2025. See Note 3 - Sale of GES of Notes to Condensed Consolidated Financial Statements for more information. Other Income (Expense) consisted of the following: Three Months Ended September 30 (Amounts in Thousands) 2024 2023 Interest income $ 222 $ 299 Interest expense (4,792) (5,447) Foreign currency/derivative gain (loss) (1,034) (674) Gain (loss) on SERP investments 345 (177) Factoring fees (537) — Credit facilities fees and bank charges (263) (201) Other (172) (79) Other income (expense), net $ (6,231) $ (6,279) Interest expense has decreased in the three months ended September 30, 2024 compared to the three months ended September 30, 2023 due to lower interest rates and lower borrowings on credit facilities. Foreign currency/derivative gains (losses) result 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. Prior to fiscal year 2025, factoring fees were recorded in Selling and Administrative Expenses on our Condensed Consolidated Statements of Income. Our provision (benefit) for income taxes for the three months ended September 30, 2024 and September 30, 2023 was $(0.3) million, or (9.4)% of income before taxes on income, and $2.5 million, or 18.6% of income before taxes on income, respectively. The tax benefit in the three months ended September 30, 2024 was the result of an interest recovery on a prior period tax audit. Open orders were down 35% as of September 30, 2024 compared to September 30, 2023. The decrease in open orders from September 30, 2023 is primarily driven by reduced orders due to cancellation of a major automotive program, other automotive customer demand reductions, and medical customer demand reductions. Open orders at a point in time may not be indicative of future sales trends due to the contract nature of our business. Our open orders depend on the lead times from our customers, which have reduced since September 30, 2023 when parts were more constrained, which also contributed to the decline in open orders. Liquidity and Capital Resources Working capital at September 30, 2024 was $439.0 million compared to working capital of $471.7 million at June 30, 2024. The current ratio was 2.3 at both September 30, 2024 and June 30, 2024. The debt-to-equity ratio was 0.4 at September 30, 2024 and 0.5 at June 30, 2024. 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 $263.4 million at September 30, 2024 and $220.1 million at June 30, 2024. 24 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”) and less Advances from Customers Days (“ACD”). 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 September 30, 2024 June 30, 2024 September 30, 2023 Days Sales Outstanding 66 58 58 Contract Asset Days 18 16 17 Production Days Supply on Hand 100 93 108 Accounts Payable Days 56 50 71 Advances from Customers Days 20 17 9 Cash Conversion Days 108 100 103 We define Days Sales Outstanding as the average of monthly trade accounts and notes receivable divided by an average day’s net sales, Contract Asset Days as the average monthly contract assets divided by an average day’s net sales, Production Days Supply on Hand as the average of monthly gross inventory divided by an average day’s cost of sales, Accounts Payable Days as the average of monthly accounts payable divided by an average day’s cost of sales, and Advances from Customers Days as the average of monthly customer deposits divided by an average day’s cost of sales. Over the past several quarters, we have supported our customers through strategic inventory builds to mitigate parts shortages, which adversely impacted our PDSOH and CCD metrics. We have experienced customers push out deliveries and sales declines, which have negatively impacted our cash conversion days and working capital. We expect our CCD metrics to improve as we align our working capital with the lower sales levels. Cash Flows The following table reflects the major categories of cash flows for the first three months of fiscal years 2025 and 2024. Three Months Ended September 30 (Amounts in Millions) 2024 2023 Net cash provided by operating activities $ 45.5 $ 12.8 Net cash provided by (used for) investing activities $ 5.2 $ (11.3) Net cash (used for) provided by financing activities $ (53.0) $ 14.0 Cash Flows from Operating Activities Net cash provided by operating activities for the first three months of fiscal year 2025 was driven by net income adjusted for non-cash items and changes in operating assets and liabilities. Net cash provided by operating activities for the first three months of the prior year was driven by net income adjusted for non-cash items, partially offset by changes in operating assets and liabilities. Net income adjusted for non-cash items provided cash of $16.8 million in the first three months of fiscal year 2025, while changes in operating assets and liabilities provided $28.7 million of cash in the first three months of fiscal year 2025, largely due to a decrease of accounts receivable, which provided cash of $20.1 million primarily resulting from decreased sales volumes compared to the three months ended June 30, 2024, and an increase in advances from customers, which provided cash of $8.7 million. Partially offsetting cash provided by accounts receivable and advances from customers was a decrease in accrued expenses and taxes payable, which used cash of $22.5 million primarily driven by timing of profit-sharing incentive bonus and income tax payments. The cash used of $9.7 million from changes in operating assets and liabilities in the first three months of fiscal year 2024 was largely due to an increase in inventory, which used cash of $34.0 million, driven by investment to support our newly expanded facilities, a decrease in accounts payable, which used cash of $11.6 million, and an increase in contract assets, which used cash of $8.9 million. Partially offsetting cash used by inventory, accounts payable, and contract assets was a decrease in accounts receivable, which provided cash of $45.3 million primarily resulting from decreased sales volumes compared to the three months ended June 30, 2023. 25 Cash Flows from Investing Activities Net cash provided by investing activities of $5.2 million in the first three months of fiscal year 2025 was largely due to the $18.5 million of proceeds from the sale of GES, partially offset by capital investments of $13.5 million primarily to support new business awards and replacement of older machinery and equipment. See Note 3 - Sale of GES of Notes to Consolidated Financial Statements for more information on the divestiture of GES. Net cash used for investing activities in the first three months of fiscal year 2024 included $11.3 million cash used for capital investments. The capital investments were primarily to support new business awards, facility expansions, and replacement of older machinery and equipment. Cash Flows from Financing Activities For the first three months of fiscal year 2025, net cash used for financing activities of $53.0 million resulted largely from net payments on our credit facilities of $49.1 million. For the first three months of fiscal year 2024, net cash provided by financing activities of $14.0 million resulted largely from net borrowings on our credit facilities of $15.4 million primarily for working capital purposes and capital expenditures. Credit Facilities The Company maintains a U.S. primary credit facility (the “primary credit facility”) scheduled to mature May 4, 2027. The primary credit facility provides for $300 million in borrowings, with an option to increase the amount available for borrowing to $450 million at the Company’s request, subject to the consent of each lender participating in such increase. The Company also maintains a 364-day multi-currency revolving credit facility (the “secondary credit facility”), which allows for borrowings up to $100 million and has a maturity date of January 3, 2025. The proceeds of the loans on the primary credit facility and the secondary credit facility are to be used for working capital and general corporate purposes of the Company. We were in compliance with the financial covenants of the primary and secondary credit facilities during the period ended September 30, 2024. We also maintain foreign credit facilities for working capital and general corporate purposes at specific foreign locations rather than utilizing funding from intercompany sources. These foreign credit facilities can be canceled at any time by either the bank or us and generally include renewal clauses. As of September 30, 2024, we maintained foreign credit facilities at our Thailand operation, our China operation, our Netherlands subsidiary, and our Poland operation. See Note 8 - Credit Facilities of Notes to Consolidated Financial Statements for more information on our credit facilities, including the terms of the credit facilities such as interest, commitment fees, and debt covenants. Factoring Arrangements We participate in our customers’ supply chain financing arrangements 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 three months ended September 30, 2024 and 2023, we sold, without recourse, $87.3 million and $103.0 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 $186.8 million at September 30, 2024, including the $100 million secondary credit facility. Our secondary credit facility matures on January 3, 2025. Additionally, accounts receivable factoring arrangements could provide flexible access to cash as needed. While our primary credit facility includes a covenant that limits the amount of sold receivables outstanding at any time, currently and historically, we have been considerably below this limit. We expect to continue to prudently invest in capital expenditures, including for capacity expansions and potential acquisitions, that would help us continue our growth as a multifaceted manufacturing solutions company. At September 30, 2024, our capital expenditure commitments were approximately $13 million, consisting primarily of capital related to new program wins. We anticipate our available liquidity will be sufficient to fund these capital expenditures. 26 We expect to continue our restructuring efforts, including the closure of our Tampa facility. We expect these restructuring efforts to be predominantly cash expenditures to be incurred over approximately the next 12 months and estimate between $10.0 million and $14.0 million of pre-tax restructuring charges, including $8.0 million to $11.0 million for Tampa exit costs. Once Tampa’s operations have ceased, we expect to sell the building and land, with the proceeds from the sale anticipated to exceed the exit costs. 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. In turn, material authorization agreements with customers cover a portion of the exposure for material that we must purchase prior to having a firm order. At September 30, 2024, our foreign operations held cash totaling $75.7 million. Most of our accumulated unremitted foreign earnings have been invested in active non-U.S. business operations, and it is not anticipated such earnings will be remitted to the United States. The Company continually evaluates its global cash needs. If such funds were repatriated or we determined that all or a portion of such foreign earnings are no longer permanently reinvested, we may be subject to applicable non-U.S. income and withholding taxes. Determination of the amount of any potential future unrecognized deferred tax liability on such unremitted earnings is not practicable and is recorded in the period when any foreign earnings are determined to be no longer permanently reinvested. The Company’s Repurchase Plan allows 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 Repurchase 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 $94.7 million of common stock under the Repurchase Plan through September 30, 2024. 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, 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, 2024. Fair Value During the first quarter of fiscal year 2025, 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 9 - Fair Value of Notes to Condensed Consolidated Financial Statements for additional information. Off-Balance Sheet Arrangements As of September 30, 2024, 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, 2024. 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, 2024. 27 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.