Good morning, ladies and gentlemen. Welcome to the Kimball Electronics Third Quarter Fiscal 2021 Earnings Conference Call. My name is Cindy and I will be your facilitator for today's call. All lines have been placed in a listen-only mode to prevent any background noise. After the completion of the prepared remarks from the Kimball Electronics leadership team, there will be a question-and-answer period. Today's call, May the 6th, 2021, is being recorded. A replay of the call will be available on the investor relations page of the Kimball Electronics website. At this time, I would like to turn the call over to Andy Regrut, Head of Investor Relations. Mr. Regrut, you may begin.

Thank you, Cindy, and good morning everyone. My name is Andy Regrut and I recently joined Kimball Electronics as the Head of Investor Relations. I'd like to welcome you to our third quarter conference call. With me here today is Don Charron, our Chairman and CEO; Mike Sergesketter, Vice President and Chief Financial Officer; and Jana Croom, Vice President of Finance. We issued a press release yesterday afternoon with the results of our third quarter ended March 31st, 2021. To accompany today's call, a presentation summarizing the financial results has been posted to the investor relations page on our company website within the Events and Presentations tab. Or, if you're listening via the webcast, you can follow along by advancing the slides or download them from the Downloads tab on the webcast portal. Before we get started, I would like to remind you that on today's call, we will be making forward-looking statements that involve risks and uncertainty and are subject to our safe harbor provisions as stated in our press release and SEC filings, and that actual results can differ materially from forward-looking statements. All commentary today is focused on non-GAAP results. For the third quarter of fiscal 2021, this excludes one-time after-tax benefits amounting to $0.5 million or $0.02 per diluted share associated with non-operating items. Reconciliations of GAAP to non-GAAP amounts are available in our press release. This morning, Don will start the call with a few opening comments. Mike will review the financial results for the quarter, and Don will complete our prepared remarks before taking your questions. Now I’ll turn the call over to Don.

Thanks, Andy, and good morning, everyone. I’m very pleased with our results for the third quarter. Our team remains resilient in the face of many ongoing challenges around the world, including the COVID-19 pandemic and the global shortage of semiconductors. Despite these headwinds, we delivered solid top line growth with very good results across multiple end market verticals and our adjusted EPS in the quarter was up 56% compared to Q3 last year. In addition, the operating margin rate once again exceeded our goal of 4.5% and we generated strong cash flow from operations for the fourth consecutive quarter. On a year-to-date basis, our cash flow from operations has more than doubled from the prior year. Due to the global shortage of semiconductors, a significant amount of our shippable backlog shifted out of Q3 and Q4 of fiscal year 2021 and into the first half of fiscal year 2022. Many industry experts are forecasting that this semiconductor shortage will remain with us for most of this calendar year. Our materials teams around the world have been working day and night to find solutions to overcome this shortage. Based on the semiconductor delivery commitments that we currently have from our suppliers, we are still expecting a very strong fourth quarter of fiscal year 2021, both sequentially and year-over-year. Beyond these excellent results, we have never lost sight of the fact that the health and safety of our employees remains our number one priority, and we continue to make every effort to keep our facilities safe. A number of employees testing positive for COVID-19 has remained at a low level, minimizing disruptions and allowing us to continue to deliver on our promises to our customers, which was evident in our top line results for the third quarter and year-to-date fiscal year 2021. Net sales increased 6% compared to the same period last year and while foreign currency did have a favorable impact, the growth was solid even after adjusting for FX. Strong sales increases were posted in our automotive, industrial and public safety verticals. Automotive sales were up 12% in Q3 from a year ago with the strength resulting from the ramp-up of certain programs, including fully electric vehicles, lower volumes in the third quarter of last year, which began to see the impact of COVID-19 and favorable foreign exchange rates. An example of the programs with electric vehicles includes electronic power steering systems. It’s an application and architecture that is largely the same for both electric vehicles and vehicles driven by internal combustion engines or hybrids. This is an area where we continue to invest to keep pace with expected future growth as the popularity of electric vehicles rises. There are other applications that are similar in terms of approach and focus and we have been successful in winning additional programs. We have strong relationships with several customers that support many of the most popular brands in the world and we expect these relationships to fuel growth in this vertical market in the years to come. On a sequential basis, sales in automotive were down 8% from last quarter, an outcome from the global semiconductor shortage. And while dependent on our ability to overcome the component shortages, we expect sales to continue to be strong into fiscal year 2022. The medical end market vertical was down 2% in Q3 as a result of strong prior year sales related to the COVID-19 global pandemic and reduced elective procedures also due to the ongoing global pandemic. We expect this decline to be short-lived as more of the population is vaccinated and physicians, offices, and hospitals resume elective procedures and activities. Shifting now to the industrial vertical, sales increased 5% in the third quarter compared to the same period last year with the strength resulting from automation tests and inspection sales, higher end market demand for climate control products, for instance, HVAC applications in the U.S. and favorable FX, partially offset by decreased demand for smart metering products. We expect a strong fourth quarter in the industrial vertical driven by orders from machines scheduled to be shipped by GES. And finally, sales in public safety were $13.5 million, an increase of 9% driven by the ramp-up of new programs. As I alluded to in our second quarter call, we have received Board approval for another critical expansion of our global footprint. We plan to invest approximately $25 million to $30 million on the expansion, which will double the size of our footprint in Mexico. We expect to break ground over the summer with completion within approximately 12 months. This combined with our Thailand expansion is a continued demonstration of our strong market positioning and growth opportunity for the future. And finally, I’m so proud of our team and the effort to deal with the challenges caused by the pandemic and the global semiconductor shortage. In April, we were honored by achieving the highest overall customer rating in Circuits Assembly’s 2021 Service Excellence Awards. Consistency in anonymous surveys, such as this speaks volumes about our customer service culture. So I’d like to point out that this is the third time in four years that we have been recognized for this award. Circuits Assembly is a leading industry publication covering the mixed technology electronics assembly marketplace, and recognizes companies that received the highest customer service rating as judged by their own customers. The awards were presented to outstanding electronics manufacturing services providers in the categories of quality, dependability, timely delivery, responsiveness, value for price, and technology. And we were recognized for achieving the highest overall customer rating in all five service categories for EMS companies with annual sales over $500 million. This is a great example of how our strong company culture and core values are helping us get through this together. Now, I’ll turn it over to Mike to discuss our third quarter results in more detail.

Thanks, Don, and good morning, everyone. During my comments, I will be referring to the slide deck Andy mentioned during his opening comments. As Don mentioned and depicted on Slide 3, third quarter net sales were $310.3 million, a 6% increase compared to net sales of $293.9 million in Q3 last year. Foreign exchange rates favorably impacted sales by 3% in the third quarter. A breakdown of sales by vertical market as described by Don is summarized on Slide 4. Our gross margin rate in the third quarter reflected on Slide 5 was 8.4%, a 150 basis point increase from the third quarter of last year. The gross margin improvement was driven by improved operating execution, favorable product mix within our automotive vertical market, a result of a shift to more mature and larger programs and favorable foreign currency rates, partially offset by higher profit-sharing bonus expense. Adjusted selling and administrative expenses were $11.6 million in the third quarter, up $1 million or 10 basis points when measured as a percent of sales compared to the third quarter last year. This increase was primarily driven by higher profit-sharing bonuses, higher salary and payroll-related costs. As a reminder, adjusted selling and administrative expenses exclude changes in the fair value of our SERP liability, which is directly offset in other income and expense from changes in the fair value of the SERP investments. Adjusted operating income for the third quarter was $14.4 million or 4.6% of net sales as shown on Slide 7 in the deck. This represents an improvement from $9.7 million or 3.3% of net sales in the same period a year ago, primarily driven by the increase in gross profits that I just mentioned. Other income and expense was an expense of $600,000 in the third quarter, which compares to an expense of $1.9 million in the third quarter of fiscal year 2020. The expense in Q3 of this year includes $600,000 in net foreign currency losses and $300,000 of net interest expense, partially offset by $200,000 in gains from the SERP investments. The expense in the third quarter last year includes $1.1 million of net interest expense, $900,000 in losses on the SERP investments, and $200,000 in net foreign currency gains. The effective tax rate for the current year third quarter was approximately 25%; in the prior year third quarter the effective tax rate was approximately 28%. Slide 8 reflects our adjusted net income trend. In the third quarter of fiscal year 2021, adjusted net income was $9.9 million compared to net income of $6.3 million in the third quarter of fiscal year 2020. Adjusted diluted earnings per share were $0.39 in the third quarter, this compares to diluted earnings per share of $0.25 reported for the same quarter last year. Now turning to the balance sheet, cash and cash equivalents at March 31, 2021 were $89.7 million. Operating cash flow trends are shown on Slide 11. Our cash flow provided by operating activities during the fiscal third quarter was $31.5 million driven by net income plus non-cash depreciation and amortization and changes in working capital. In the prior year third quarter operating activities provided $12 million of cash. Our cash conversion days for the quarter ended March 31, 2021 were 66 days, down from 81 days in the quarter ended March 31, 2020 and down from 75 days in the second quarter of fiscal year 2021. Compared to the second quarter of fiscal year 2021, we saw improvement in each of our day sales outstanding, contract asset days, production days, supply on hand and accounts payable days. Slide 12 reflects our capital and depreciation trends. The capital investments in the third quarter of $8.7 million were largely to support launch and ramp-up of new programs and to replace older machinery and equipment. We continued to study our capacity needs to support growth plans. The Board approved plan to expand our Thailand operations was officially kicked off last quarter and a plan to expand our Mexico operation was approved this quarter. Both expansions add much-needed capacity to support the forecasted growth from both existing and future customers and demonstrate our strong organic growth opportunities. Borrowings on our credit facilities at March 31, 2021 were $60.5 million, which is down $25.6 million from December 31, 2020 and $57.6 million from June 30, 2020. Our short-term liquidity available representative cash and cash equivalents plus the unused amount of our credit facilities totaled $226 million at March 31, 2021. There were no shares repurchased in the third quarter of fiscal year 2021; since October 2015, under our Board authorized share purchase program, a total of $79.7 million was returned to our shareholders by purchasing 5.3 million shares of our stock. In conclusion, our financial condition continues to be strong and we’re in an excellent position to take advantage of growth opportunities and improve operating margins and return on invested capital, while being able to confront the continued uncertainties caused by the COVID-19 pandemic and the global semiconductor shortage. I’ll now turn the call back over to Don.

Thanks, Mike. Before we open the lines for questions, I’d like to make a few closing comments. First, I need to reiterate how proud I am of our people around the world. We have made the health and safety of our employees the number one priority all while continuing to deliver on our promises to our customers. The company is in a solid position and we are committed to build success in the future. Finally, as previously announced, it is with mixed emotions we say farewell to Mike, our friend and colleague. Mike has been a trusted partner for decades and his leadership and in-depth knowledge of our business will be sorely missed. On behalf of our Board of Directors and the entire company, I want to extend our sincere gratitude and appreciation to Mike for his dedication and service. Mike, we wish you the very best. You will always be a valued member of the Kimball Electronics family. I also want to congratulate Jana on her new role as CFO. We are fortunate to have a leader of Jana’s caliber ready to assume the reins for this key position. Her experience in financial management strategy and operations make her an ideal fit to move our organization forward. Jana, would you like to say a few words?

Thanks, Don. I’m very excited about the opportunity to take over for Mike. Kimball Electronics has a distinguished history, a talented team and a promising future with a strong company culture and a purpose of creating quality for life. I look forward to working alongside you and the other members of the leadership team to drive growth and enhance shareholder value.

Thanks, Jana. I’m looking forward to it too. With that, I would like to open the lines for questions. Cindy, do we have any analysts with questions in the queue?

Your first question comes from Anja Soderstrom with Sidoti.

Hi, everyone, and congratulations on a quarter amidst a challenging backdrop. My first question will be on the industrial segment and the GES business there. Can you just elaborate a little bit on how that’s been trending? And also, maybe talk a little bit about the competitive landscape for GES?

Sure. Anja, first of all, I want to just remind you that we do have a degree of seasonality in our GES business, and so – and that seasonality, typically the strongest quarter has been Q4. Now we’ve just owned the company just short of three years. So we’re learning more and more each and every quarter as we go. But we do have a degree of seasonality there. And our fourth quarter of our fiscal year is GES’s strongest quarter. Overall, if you – and also, if look at what customers we serve with GES services, they’re primarily in the manufacturing of smart mobile devices and the semiconductor industry. So those are the types of industries that our machines that we develop, design, and manufacture serve those needs, if you will, in the market. And when you look at the spending, the capital spending trending in those areas, it’s quite strong. Now it’s focused in the smart mobile device area, and we’re really happy with where we have content and relationships there because those customers are doing well in the end market, in that, in their respective end market, the semiconductor industry, as you know, is adding capacity at a pretty rapid pace right now, given the shortages. And just the fact that demand has far outpaced supply here during this period, and so capacity is being added and we hope to be able to gain traction and grow there as those capital decisions, capital deployment decisions, are made within the semiconductor space. We are actively pursuing a diversification strategy because the technology that we have and own there at GES, especially in areas like optical inspection of critical dimensions. That technology is used in many different manufacturing environments, supporting many different end market verticals. So we have a diversification strategy. It’s active there and we hope to continue to grow that business. But right now it’s strong and it’s trending upward in those two areas I mentioned, smart mobile device manufacturers and semiconductor.

Okay. Thank you. And then in the auto segment, it seems like you said the backlog is going to spill into fiscal 2022, but you still have visibility for the fourth quarter, and just talk about the dynamics there and what a strong fourth quarter looked like there. You had a pretty easy compare year-over-year, but a little bit tougher sequentially.

Yes. I’ll just preface what I’ll say there, Anja, in the fact that we have commitments from suppliers for deliveries and we’re factoring that into our production plans every day. As we speak, the biggest risk we face is if a supplier de-commits, meaning that they gave us a delivery schedule and they couldn’t meet it themselves for their own reasons. And so that’s the biggest risk we face. But that being said, when you look at the commitments we have, those commitments would support a strong fourth quarter for us. Plus, as we mentioned in the script today, the GES machines and the order for machines from GES will also be a strong contributor to the quarter, but coming specifically back to automotive, yes, we are looking at the commitments we have from suppliers, and we are factoring those into what we think our production and sales will be in the quarter, and that’s why we believe we’re going to have a strong fourth quarter. I also would just say that demand that shifted out, it did not cancel. I just want to emphasize that. It shifted out. And so we can see a strong start to the fiscal year 2022, especially in automotive because that demand is shifting out ahead of us. And there are several areas we can look to that will support that demand staying strong, such as inventory of vehicles in the U.S. being at or below all-time lows, and demand being quite high among buyers in the market. So that should prove to be very favorable for our automotive end market vertical. And especially as this component shortage starts to subside, I am confident in our ability to execute on the manufacturing side once the semiconductor shortage subsides.

Okay. It was a good color. And then in medical, what are you seeing there in terms of the electives returning?

Still a slow pace on that. As you know, we had the favorable impact of building in the COVID-19 year, when the demand was there for COVID-19 patient care. That’s been built out and it’s run its course, but we still see areas of our medical market vertical that are not yet back at pre-COVID-19 run rates. That’s going to require people going to see their doctors again; people feel uncomfortable going to see their doctors. People feel uncomfortable going to the hospital for elective procedures. That business has not recovered. And I think it’s more difficult to predict, but look, I think we should all be encouraged by the vaccinations and the vaccination rates that we’re seeing across the U.S. Obviously, we have the rest of the world, we’d like to see keep pace as well. That should help and that would be a nice increase of opportunity to increase our sales in the medical vertical when that does happen.

Okay. Thank you. And in terms of your facility expansion, you’re talking about expanding Mexico now. Why Mexico, and what are you primarily producing in Mexico?

Yes, Mexico is a large facility for us today. In fact, it's one of the largest facilities we operate and we’ve been there for decades, and it’s a very popular preference of our customers, so. And I guess to answer your question, what do we make there? We support all four verticals there in Mexico. It’s a very complex, large-scale manufacturing facility. And again, it supports all four of our end market verticals and we’re at capacity. We literally had no room left in that plant. So we waited as long as we could, and we have opportunities in our new business opportunities pipeline that are very close to being awarded. So that’s how close. I wanted you to know that’s how close we take it before we make a decision to expand. And the expansion decision is based on the popularity of that footprint to our customers. In other words, that’s their preference. For various reasons, it’s their preference. And that’s where they’d like to see their product manufactured. So we’re following, really following our customers with these expansions, if you will. It’s really following their preferences, where they want us to build their products and what programs they have in the pipeline that they want produced in Mexico. And of course, as we announced last quarter, Thailand, that we’re following their preferences. That’s why those expansions are where they are.

Okay. Thank you. And lastly, about your cash cycle days improvement, you said you target about 65 days since you're off there, and sustainable is to add in, and what’s the puts and takes there? I guess that will support a completely improved cash flow if you can keep it at that level.

Yeah. Structurally, when we do our analysis, structurally, we believe 55 days is where we should be operating on a pretty consistent basis. In this environment with component shortages, anytime you hear us say shippable backlog is pushing out because of a shortage issue, as we talked about today, that usually means some inventory’s coming in, but the one part you need to build the unit is not. And so we would expect to see our PTSOH, which is our inventory metric, grow in this period. It could be short term and we work it back down, but we do think it’s sustainable. And I wanted to explain the global semiconductor shortage so that you’d understand that with this type of a shortage situation, where customers want the product, it’s shippable backlog, but it’s moving out because of the shortage, that some of that inventory’s going to come in and we’ll see a swelling, a temporary swelling. But we are, as a management team, working hard to keep our cash conversion cycle at 65 days. And we haven’t been there, and for various different reasons, we’ve kind of had to battle to get there over the last few quarters. We actually had excess inventory, for example, that we’ve been working down during this period in other areas of our business. So I would want us to think about 65 days as a normal landing pattern for us on the whole cash conversion cycle.

And what’s your ability to take deposits for inventory that you need to hold?

That’s not as prevalent in our customer relationships and commercial agreements, but we have, and we’ll continue in the future, have mechanisms to relieve inventory directly back to them. If it, for some reason, is excess due to their forecast or due to their demand going away. So we do have some relief mechanisms in our commercial agreements, but deposits isn’t one of them.

Okay. I will hand it over. I just want to wish Mike well on his new chapter and congratulate Jana on her new position. I’m looking forward to be working with you.

Thank you very much, Anja.

Thank you.

Thank you, Anja.

Your next question comes from Mike Morales of Walthausen & Company. Mr. Morales, go ahead with your question.

Thank you, operator and good morning, Don, Mike, and Jana. Good to talk. So let me get the important things out of the way first. I’ll echo congratulations on your retirement, Mike, it’s been a real pleasure working with you over the years and best of luck on your future endeavors, wherever that may take you. And likewise, congratulations to Jana on the new role, really excited to see what you can bring to the company. All right, let’s get down to brass tacks now. A lot of good color in the answers there. As I think about the commentary on the fourth quarter and the raw material shortages that everybody seems to be facing right now, I think back to when we saw some production disruptions in the auto OEM space last year, and kind of the headwinds that caused. Certainly, in the news, we’re seeing a lot more of that across OEMs pretty much globally. Is that kind of baked into your expectation for the fourth quarter based on where you’re sitting today, or just in that qualitative commentary that those production or disruptions, even with how severe they may be, there’s still a pathway to sequential growth?

We think so. Again, Mike, I just preface that with we’re in this shortage, we’ve got commitments, we’ve baked that into the Q4 outlook commentary and so the risks we face, that we have to manage, is de-commitments. And we’re doing that as I mentioned, our teams around the world are working day and night, but we’re not in total charge of that. As you can imagine, with a supply base of the big names that I know you’re familiar with, and the fact that we’re in there competing for those parts in many cases with a lot of different, let’s say buyers that need that material. But in terms of the demand, it’s very strong. I mean, in terms of customers taking everything we can build, for example, very strong. So, if there is an opportunity to improve a shortage, for example, and instead of the de-commit risk I gave you, actually a supplier did better than they committed and delivered us more material, that certainly could just as easily deliver more upside for us because the demand is very strong. For us, I think the big challenge is really to make sure that we don’t get more de-commits. We have strong demand with existing customers, with existing programs. We got new programs, they’re still ramping up, and we’ve got all three of our geographies really pushing hard. And I say, all three, China, North America, and Europe. And so yes, the demand is there. We’ve got to manage the de-commits and it should result in a very strong fourth quarter for us.

Understood. And I think the auto industry has kind of found itself in the unique position right now of having stepped out of line as it relates to picking up these semiconductor components. And now they’re at the back of the line and they can’t cut to the front and get what they need. And as I think historically that’s a very new thing for the auto industry. So the question is, have discussions with any of your major customers, whether existing or prospective, changed or evolved as they think about consistency of supply?

Well, first of all, Mike, you said that very well. In terms of, let's say automotive, getting out of line and going to the back of the line and realizing they can't fight their way back to the front of the line. They're learning a lesson. I mean, we have the opportunity to talk to our customers, which again, are some of the largest tier one companies in the world. And so they deal with all these vehicle OEMs. There is a lesson being learned here by all, that should not have got out of line in the first place, should've had a more comprehensive supply chain strategy to get through the pandemic. And yes, I think the lessons are being learned, and I do think we'll see changes in how production schedules are fixed and set and fixed out further into the future versus sort of this idea that we somehow have this flexibility that, oh, if we're wrong and we dropped our forecast and we dropped our demand and we're wrong, and we want to quickly change it upward. Laws of physics start to come into play in terms of how fast you can turn back on the supplies, especially in the area of semi-conductors. So there's lessons being learned. I do think what we'll see and what we've already required from our customers proactively, and this goes back several months ago, Mike, we were already asking our customers to place firm orders on us or forecasts that were very firm out for a full year. So that as we got back in line for this component supply, we stayed in line and we stayed in line with the right kind of forecast going out far enough. And so it's going to take a little while to get through this, but I definitely believe there's a lesson being learned here.

Right, right. That's helpful. Maybe switching to the GES business and the positive commentary there. We can't talk about the shortages and the challenges to auto without talking about maybe the benefits that could bring to the GES business. Can you help me understand what the sales cycle looks like for that business? And is there some metric that you guys use to gauge the health of the sales funnel there, whether it's like evaluation tools in the field or some other metric that you'd be willing to share and just help me understand how prospective new business there is developing?

Yes. We're discovering new avenues in our business that are quite exciting. There are numerous opportunities to implement this technology in various aspects of what we currently do, and we utilize the technology in our manufacturing facilities as well. The primary model is based on capital equipment. Currently, we generate revenue from services and software, but the bulk of our revenue comes from capital equipment sales. You might assume that orders for such equipment would typically be placed well in advance due to its nature, but our experience has been different. These are high-value machines, yet the lead time from receiving an order to when the machine is actually built and shipped is surprisingly short. However, the development process begins much earlier, sometimes months or even years in advance, focusing on the technology and the problems it aims to address. We are working on enhancing our funnel metrics to communicate more effectively regarding this business. As a technology-driven company, we often own the intellectual property related to the technology, which amplifies our enthusiasm for the growth possibilities and applications. We are still in the learning phase, and I hope to share more about the funnel metrics soon to provide clearer insights into our outlook. Additionally, we believe our diversification strategy will help mitigate the seasonality effects I mentioned earlier, especially considering our strong Q4s. We have a substantial backlog for Q4 this year, but we also experience lighter quarters, and we are actively addressing this situation as well.

Got it, got it. That's really helpful color. It's good to see the consistency in the financial results too, as it relates to the margin target that you guys have laid out, especially in a challenging environment. So good works folks. As far as those targets that you've put out there, are you guys reevaluating where you're comfortable with the growth margin and the operating margin targets now that we've got three consecutive quarters under the belt and structural improvements in place that seem like they're going to stay in a post-COVID world?

Thank you for your question, Mike, and for acknowledging our three consecutive quarters. Our management team has been focused on achieving a consistent operating income margin target, and we are pleased to have met or exceeded it for three quarters in a row. While we are happy with this achievement, we are striving for even more consistency and want to build on this foundation for several more quarters. We do believe there is potential for margin expansion beyond our current target. Although we are not ready to provide specific figures yet, we are dedicated to this goal. The first step in this phase of our journey is to establish greater consistency beyond just three quarters of hitting our target. Our management team is committed to identifying the opportunities for margin expansion.

Fantastic. Lastly from me, I'll ask the question this way, as you look at your facility portfolio right now, are there any other popular facilities with your customers that are near or at capacity?

Yes, I'd like to provide some insight on that topic. Our new business opportunity pipeline is quite strong. Our challenge lies in assessing our footprint to determine where our customers want us to be. As we approach capacity in our operations, it's important for us to make smart capital deployment decisions regarding expansion. Over the next three years, our main focus will be on expanding our existing locations in response to customer demand. This is a crucial message because, as we learned from our experience in Romania, the costs associated with new operations can significantly outpace revenue at first, which impacts our overall results. Now that Romania is operational and profitable, we plan to concentrate on expanding where we already have established leadership and infrastructure. This approach allows us to align expenses more closely with revenue, minimizing the impact of upfront costs. As we evaluate our footprint in places like Thailand and Mexico, plus growth in China and Europe, we can see that we are well-positioned for the next few years. For now, our primary focus will remain on the expansions in Thailand and Mexico, and we have new business development strategies focused on these areas.

And it'd be fair to assume that all of these discussions would be done in a similar way to the way that you're approaching the Mexico expansion, as it relates to prospective new business being on the cost to fill that expansion, right?

That's correct. It's similar to the idea from the movie "Field of Dreams" – if you create it, they will come. However, we prefer to have a commitment from customers before we proceed with these developments. It's a challenge to coordinate this effectively, especially when encouraging customers to invest in a fully occupied site, which can be difficult for larger programs. We need to strike the right balance, and I believe we achieved that in our cases in Thailand and Mexico. Now, our focus is on getting those expansions occupied and securing the necessary contracts from customers who motivated us to undertake this expansion.

Great. I appreciate all the color, folks. It’s great to touch base with you. Well.

Your next question comes from Hendi Susanto with Gabelli Funds. Please go ahead, Mr. Susanto.

And then first of all, thank you, Mike, for all our interaction and you will be missed. All the best for the retirement.

Thank you.

Don, you've shared that you are expecting strength in Q4, both sequentially and year-over-year. You said like very strong. Is it reasonable to expect double digit on both? Can you quantify that?

Hello, Hendi. Thank you for your question. I can't provide that level of detail, but we recognize that the year-over-year comparison is softer because of last year's Q4 results. Let's focus on the quarter we just completed, which was $310 million, and consider how much it was affected by material shortages and our material commitments. In the quarter we finished, a significant amount of backlog shifted, some of which will be recovered in Q4, and a portion has moved into the first half of fiscal year 2022. The $310 million quarter shows strong performance, with a growth rate better than what we achieved in Q3, which we are optimistic about. However, I must emphasize the risk of de-commitments from major suppliers, as unforeseen issues could arise. So, while our demand and material commitments are strong right now, please focus on the sequential performance rather than the year-over-year comparison.

Yes. And then, Don, if we focus on sequential, I think overall we are seeing a strong demand in automotive, and then people are expecting strong demand and then supply shortages for the next several quarters. And then, if you look at your automotive sales in the last quarter, like $140 million, can we think that can be a baseline, while we are still dealing with strong demand in automotive and in shortdates in components?

Yes. I think that's a good approach, Hendi. I think that's a good approach. That's how we look at it. I mean, that's how we look at it.

And then, Don and Mike, gross margin has stayed above historical rates. There are positive and negative variables that other companies are talking about now, such as high raw material costs, higher logistics costs, and then, on the positive side negotiation for higher price, and then strong demand for electronic components. How should we think about gross margin in terms of those variables? I don't know which variables are applicable in the Kimball Electronics' case, I mean which ones may not be the case. Can you give some color on that?

Absolutely. You expressed it well regarding the factors that will influence margin. We're currently in a situation where there is recognition throughout the value chain of rising costs that need to be addressed. Occasionally, there can be a disconnect within the chain, where rising expenses are evident, but there's reluctance to engage in discussions for a commercial agreement that benefits everyone involved. Right now, there's a synchronization occurring, partly due to the pandemic and partly due to the global semiconductor shortage. At least there is recognition that these costs are significant, increasing, and likely to persist. We take all of this into account when setting our operating margin target. Additionally, we consider the SG&A side of the equation, as our business expands we aim to explore operating leverage opportunities in our SG&A. So, if we deviate from our 4.5% operating income target, it could be due to factors in gross margin or leveraging SG&A. We aim to maintain the 4.5% operating income target, as consistently achieving that suggests we're optimizing gross margin and managing SG&A effectively. More updates will follow as we assess the potential for margin expansion in upcoming quarters, but all these elements contribute to our efforts to reach our 4.5% operating income target.

Okay. That's helpful. And then Don, can you give some color on one industrial segment outside of semiconductor equipment? And then secondly, Public Safety revenue seems to indicate a revenue bounce back and insight on those two?

Yes. In our Industrial vertical, the key focus is on climate control products, which have a significant customer base in the U.S. and Europe. This sector is considerably larger than semiconductor equipment, which is more of a developmental space for us rather than a substantial revenue source at the moment. Climate control products currently lead our industrial vertical, while smart metering products, especially in Europe, had been gaining traction before the pandemic but suffered during it. We anticipate that as the pandemic eases, growth in smart metering will recover to pre-pandemic levels. Presently, climate control products are performing well, particularly with our HVAC customers in the U.S., and this is a positive trend we expect to maintain. We are also looking forward to seeing improvements in smart metering as we return to previous performance levels. On the Public Safety front, we did lose a long-time customer, which contributed to a decline in that area. While it was unfortunate, we are transitioning through this phase and have replenished our project pipeline with new and exciting programs. Public Safety may not be a large segment for us, but it holds strategic importance, and we are glad to be moving past the impact of losing that legacy business and filling the gap with new opportunities.

So, Don, how sustainable is the new funnel in the Public Safety segment?

We reported a positive number this quarter, which is encouraging, and we've established a strong foundation for our business with a new pipeline. However, the challenges in Public Safety lie in the fact that the business opportunities are generally smaller and less stable compared to our other sectors, with more fluctuations in that area. I can't provide a definitive answer on how sustainable it is, but we aim for an 8% organic growth target in Public Safety, similar to our other sectors and overall. I want to emphasize that we are striving for at least 8% organic growth consistently.

I see. And then, let me ask this question for Mike. Can you provide some insight on the timing and the amount of CapEx for additional capacity in Thailand and Mexico? I believe you mentioned around $8 million to expand production capacity in Thailand. I'm not sure how much more would be needed to complete that.

That number is what we reported last time for facilities. I believe it might have included the initial expenses; however, it does not cover working capital and other requirements. As that business grows, we expect to see some increase in those areas. The funding for Thailand began in Q3 when we broke ground, so a significant portion of that will be accounted for in Q4 and Q1. We anticipate occupying that location around December or January of next year. Regarding the expansion in Mexico, we received approval for that this quarter and are currently in the design phase for the building. We have secured the land, and we expect to break ground in late June or early July. It will take about 12 months to complete. The amount reported for facilities covers the initial infrastructure needed to get the building operational. We will add capital as necessary to support revenue growth within the building, implementing new lines as needed. We anticipate occupying that capacity about a year from now, likely around next June and July, and we expect to have some business operational immediately upon opening.

And so Hendi, maybe if I could build on Mike's comments a little as well, in past calls, we've talked about sort of a more normalized rate of CapEx would be something at or slightly above depreciation. But when you look at bricks and mortar, you just almost have to stack that right on top of what would be a normal CapEx run rate that would be at or slightly above depreciation. So as you look at your model and how you build your model, I think you'd want to consider the fact that the $8 million number for Thailand, roughly, and the $25 million to $30 million number for Mexico, they sort of sit on top of a CapEx number that would be somewhere close to depreciation and a little above. Does that make sense?

So Don, if I interpret correctly, so the Mexico CapEx will be $25 million to $30 million?

Yes, the cost for the land, building, and infrastructure will be between $25 million and $30 million.

Okay. And then will you spend that whole amount within a year?

We'll take occupancy laid out in installments as we break ground and move towards taking occupancy at the end. But yes, we think Mexico will be taking occupancy sometime around a year from now. So yes, most of the capital would be deployed in fiscal year 2022.

And then last question for me. Don, you indicated that capacity at Mexico is running at full capacity. Can you give insight into other manufacturing locations, whether or not they have run at full capacity or close to full capacity?

Thailand, we did the, that's why we released the expansion there. As I mentioned earlier Hendi, I think as we look at the preferences of our customers, new business pipelines and projected or forecasted needs. Yes, I would say China and Poland, or maybe we could say Europe, but Poland would be areas that we're keeping a close eye on because they are running at high utilization rates today.

I see. How about Romania, Don?

Romania is ramping up too. Also running at a high utilization rate. So, that's one of the things we want to study. It's unlikely we would expand them both at the same time, both being Poland and Romania; we would look at our, again, our customer preferences, where they are expecting us to add capacity in Europe, and then we would decide. We believe that's a little further out, Hendi; it's not next year, it's further out than Thailand and Mexico, but we can see where those operations are running from a utilization standpoint. And we can see it coming, let's say in a three-year horizon for sure, possible.

I see. Yes. Thank you Don, and thank you, Mike, and then all the best for the work up for the remainder of the year.

Your next question comes from John Deysher of Pinnacle. Go ahead, Mr. Deysher and ask your question.

Good morning, everyone, and thanks for taking my call. Most of my questions have been answered, but I just wanted to circle back to the capital spending for both Mexico and Thailand. Can you give us your ballpark estimate of what CapEx is going to be for both the year end June 2021 and next year, June 2022? That would be very helpful.

Yes. 2021 might be tougher than 2022, John, just because depending on how some of that spending falls between now and the end of the fiscal year and the start of fiscal year 2022. But if you look at our depreciation and as I said, we would expect a kind of a normal operating condition that we would run at depreciation or slightly above when we're growing, like we're growing. So let's take that number at between $30 million and $35 million today, depreciation. And then you add on top of that, the Thailand and Mexico expansions, you're probably getting close to twice depreciation for fiscal year 2022 or pretty close to it. And again, it depends how much falls into Q4 2021 and then how much sort of slips over to FY 2022. But that's how we want you to think about it at least. That's about as accurate as I can get it to you at this stage.

So just thinking through those numbers, you're thinking $60 million to $70 million in FY 2022?

Ballpark. Yes, ballpark.

Okay. We haven’t seen the quarterly results yet, so I’m not sure what the year-to-date capital expenditures are for fiscal 2021.

We were averaging around eight per quarter until now. I believe Q4 could be larger. Once you review the figures, it’s probably in the range of $22 million to $24 million, but this will depend on how much capital, as I mentioned, could be deferred from Q4 to Q1 next year and actually gets accounted for in Q4. That’s the figure we are considering, but it's expected to be the highest capital expenditure quarter of the fiscal year, specifically Q4.

Okay. All right. Good. And how are you anticipating financing Thailand and Mexico?

From available liquidity.

Okay. All right. Cash flow, that's good. And you mentioned you're following your customer's request. I was just curious, the pipeline for the customers who are pushing you to expand Mexico. What verticals does that fall into for those new customers who are moving the expansion forward?

That's really interesting. Good question. We have some large programs already awarded in automotive, industrial and medical. We have others that we're working on to get awarded. All three of those verticals will be well represented in the expansion.

Represented equally, do you think, or skewed one towards the other?

That's a really good question. They are all competing for capital and must meet our targets for return on invested capital. Looking at the current situation, it could potentially be an equal split among the three areas.

Your next question is from Jason Crawshaw with Polaris Capital Management.

Yes. Good morning. A couple of quick questions, I guess, in the case that you get a de-commit from a supplier, are there sort of penalties that you have to pay to the customer for the de-commit, i.e. that you can't fulfill the order? Or is that just sort of normal course of business, that is the reality of the current state of the situation? I guess that's the first question.

Well, it ends up being in the conversation, Jason, that's for sure. But I think when it's this widespread, what we experienced, it's almost like a force majeure-kind of operating condition. And the value chain realizes that we're all going to have to get through this together and we can't just be firing lawsuits at each other. So I would say it ends up in the conversation and it ends up in some of the frustrating comments, but I think in general, we stick together and get through it as a value chain.

Got it. Okay, that's fine. For my second question, when considering the shortage in semiconductors and the automotive industry, is this affecting the entire chipset or product line, or are there specific components that are significantly more impacted, while others will still receive a reasonable supply of chips in the autumn?

Yes. It's more like across everything, in terms of all component types. If you ran down the list of the big seven semiconductor suppliers in the world, they all have their challenges. I wouldn't necessarily hold one of them out as being better or worse than the other, so. And I would say this though, Jason, some of those component categories will recover faster because the capacity increment and the lead time to actually make the part is different. So they won't all get well at the same time, they didn't all get bad at the same time, get short at the same time. But the recovery will be different by component category.

Got it. Great. And then I guess just the last question. Sort of when you do your forecasting, right, let's say you've got commitments from suppliers that, for a 100, right? But you kind of look around, you see what the economic reality is. If they're telling you a 100, do you kind of handicap and say, you know what, we're only going to bake in 90, or is your forecasting based on exactly what your suppliers are telling you?

Both. It's both. If there is a track record of performance, we'll build our production schedule around that commitment from that supplier. If there's not a track record of performance, maybe if there's a track record of de-commits, yes, then we'll hedge in what we put in our guidance.

Got it. Okay, thanks guys. I appreciate it.

I'm showing no further questions at this time. I would like to turn the conference back to Mr. Don Charron.

Thank you, Cindy. Thank you, everyone. That brings us to the end of today's call. We appreciate your interest and look forward to speaking with you on our next call. Thank you, and have a great day.

At this time, listeners may simply hang up to disconnect from the call. Thank you and have a nice day.