Earnings Call Transcript - KE Q1 2024

Operator, Operator

Good morning, ladies and gentlemen. Welcome to the Kimball Electronics First Quarter Fiscal 2024 Earnings Conference Call. My name is Ellen, and I will be the facilitator for today's call. All lines are placed in 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 on November 7, 2023, is being recorded. A replay of the call will be available on the Investor Relations page of the Kimball Electronics website. At this time, I would like to turn the call over to Andy Regrut, Vice President, Investor Relations. Mr. Regrut, you may begin.

Andy Regrut, VP, Investor Relations

Thank you, Ellen, and good morning, everyone. Welcome to our first quarter conference call. With me here today are Ric Phillips, our Chief Executive Officer; and Jana Croom, Chief Financial Officer. We issued a press release yesterday afternoon with our results for the first quarter of fiscal 2024. To accompany today's call, a presentation has been posted to the Investor Relations page on our company website. Before we get started, I'd like to remind you that we will be making forward-looking statements that involve risks and uncertainties and are subject to our Safe Harbor provisions as stated in our press release and SEC filings, and that actual results can differ materially from the forward-looking statements. Reconciliations of GAAP to non-GAAP amounts are available in our press release. One other housekeeping item to mention: starting this quarter, miscellaneous sales, which previously had been reported in the other category in our vertical market breakdown are now included in the respective vertical they pertain to. All prior periods have been recast to reflect this change. This morning, Ric will start the call with a few opening comments. Jana will review the financial results for the quarter and guidance for fiscal 2024, and Ric will complete our prepared remarks before taking your questions. I'll now turn the call over to Ric.

Ric Phillips, CEO

Thanks, Andy, and good morning, everyone. I am very pleased with our results for the first quarter, particularly in light of the current macro environment. Q1 was a strong start to the fiscal year, with record first quarter sales and operating income, year-over-year margin expansion, and 13% growth in net income. While these results were in line with our expectations, we have been evaluating the impact of recent short-term market disruptions, including the UAW strike, global economic conditions, and geopolitical events, and have updated our guidance for the full year of fiscal 2024 to reflect softening demand in the end market verticals we serve. We will provide more detail in just a moment. Net sales in Q1 totaled $438 million, an 8% increase compared to the first quarter last year with two of the three vertical markets posting double-digit growth. Automotive, our largest business, reported net sales of $213 million, a 13% increase compared to the first quarter of fiscal 2023 and 49% of total company sales. To be clear, these results were not materially impacted by the UAW strike. The targeted walkouts began on September 15, and our fiscal quarter ended two weeks later at the end of that month. Based on the locations directly impacted by the strike and the vehicle models produced at those plants, we estimate a relatively small impact to our top line in October. However, this situation is fluid with possible downstream ripples to come as the OEMs and Tier 1 suppliers evaluate the current state. With over 35 years of experience producing safety-critical, high-quality electronic assemblies that meet the stringent regulatory requirements of this industry, we are ideally positioned to grow as our customers grow, particularly with the continued electrification of vehicles. As an example, I recently had the privilege of representing our company at a celebration with the ZF Group when Kimball Electronics was awarded a new multi-year program in electronic power steering, with the work to commence in calendar year 2025 at our facilities in Poland and China. The strategic partnership between the companies dates back to our early beginnings in the automotive industry and has grown to where ZF is currently our second-largest customer. Our unique manufacturing capabilities in electronic steering, electronic motor controls, braking systems, battery management, and redundant safety systems align with advancements in the industry. And our support of applications in internal combustion engines, electric vehicles, or a hybrid of the two positions us for growth as consumer preferences and adoption rates evolve. Net sales in medical were $102 million, a 12% decline compared to the same period last year and 23% of total company sales. This result was in line with our expectations. As a reminder, our annual guidance reflects a $100 million reduction in sales with a major customer in this vertical partially offset by growth in other programs. While there are not any updates that we can speak to with regard to this customer, it is important to emphasize that our relationship with them has never been better and we are positioned to provide support as needed. Longer term, we continue to be encouraged by mega trends in the medical industry and believe they will support future growth, particularly as medical devices get smaller in size and require higher levels of precision and accuracy and as connected drug delivery systems become more prevalent. Our business development efforts focus on medical applications including sleep therapy, patient monitoring, AEDs, and surgical systems, especially with OEMs looking to outsource higher level assemblies or HLAs, which as a category represent an opportunity for more value-added content. Finally, net sales in industrial totaled $123 million, a 21% increase compared to Q1 last year, and 28% of total company sales. The increase this quarter represented the largest for any of the three verticals we support, with climate control, public safety, smart metering, factory automation, and green energy charging and storage driving the growth. We expect the movement toward responsible usage of natural resources and heightened conservation to provide a meaningful tailwind in the years to come. And we're aligned with products that reduce environmental impacts and promote energy efficiency, safety, and carbon neutrality. This opportunity could become even more pronounced for us in EV charging as consumer adoption of electric and hybrid vehicles expands globally. So in summary, a very good quarter and strong start to fiscal 2024. I'll now turn the call over to Jana to provide more detail on the financial results for Q1 and our guidance for the full year. Jana?

Jana Croom, CFO

Good morning, everyone. Before I start, I just wanted to let you know we heard from some of you that our slide deck is not up. We are actively working to correct that now and it should show here shortly in a moment or two. With that, just to keep us on time, I'm going to continue with our prepared remarks. So as Ric highlighted, we are very proud of our results in Q1. Net sales in Q1 totaled $438.1 million, a first quarter record high for the company and 8% above Q1 of fiscal 2023. Foreign exchange favorably impacted consolidated sales by approximately 1% year-over-year. The gross margin rate in Q1 was 8.1%, a 90 basis point improvement compared to the same period last year. This result was predominantly driven by higher levels of cost absorption in Mexico, as we continue to leverage our expansion there. Adjusted selling and administrative expenses in the first quarter were $16.2 million, relatively flat to the Q1 adjusted results reported last year of $16 million. When measured as a percentage of sales, however, adjusted selling and administrative expenses were 3.7%, a 20 basis point improvement over Q1 last year. Adjusted operating income for the first quarter was $19.3 million or 4.4% of net sales, which compares to last year's adjusted result of $13.3 million or 3.3% of net sales, a 110 basis point improvement. Other income and expense was an expense of $6.3 million compared to an expense of $1.4 million last year. The increase is a result of higher interest expense year-over-year, a product of our elevated debt levels and the current interest rate environment. The effective tax rate was 18.6% in the first quarter compared to 21.9% in Q1 of fiscal 2023, with the lower rate resulting from a mix of earnings more heavily weighted in lower tax jurisdictions. Adjusted net income in the first quarter of fiscal 2024 was $10.8 million or $0.43 per diluted share, a 13% increase compared to adjusted net income in Q1 last year of $9.5 million or $0.38 per diluted share. Now turning to the balance sheet. Cash and cash equivalents at September 30, 2023, were $56.6 million and cash flow generated by operating activities in the quarter was $12.8 million. This represents our third consecutive quarter of positive cash flow generation. Cash conversion days were 103 days compared to 94 days in the first quarter of fiscal 2023 and 94 days last quarter. As a reminder, we started including customer advances in our CCD calculation. The results from fiscal 2023 reflect this change. Inventory ended the quarter at $482.2 million compared to $450 million at the end of Q1 last year and $450 million at the end of fiscal 2023. Capital expenditures in the first quarter were $11.3 million, supporting organic growth, maintenance requirements, and investments in automation and efficiencies. Borrowings on our credit facility at September 30, 2023, were $296.7 million compared to $232.5 million a year ago and $281.5 million at the end of Q4. Our short-term liquidity available represented as cash and cash equivalents, plus the unused amount of our credit facilities totaled $147.1 million at the end of the first quarter. There were no shares repurchased in the first quarter of fiscal 2024. Since October 2015, under our Board-authorized share repurchase program, a total of $88.8 million has been returned to our shareholders by purchasing 5.8 million shares of common stock. We have $11.2 million remaining on the repurchase program. As Ric highlighted, we have updated our guidance for fiscal year 2024, with net sales now expected to be flat with the prior year compared to our previous estimate of a 4% to 7% increase. Operating income margin is also estimated to be in line with fiscal 2023, which is within our previous guidance range of 4.7% to 5.2% of net sales. The outlook for capital expenditures did not change with a range of $70 million to $80 million. From a top line perspective, our current outlook is approximately $100 million lower than the midpoint of our previous guidance range. The decline is spread fairly evenly between two of our verticals. First, for automotive, the EV market in North America is experiencing slower adoption as end customers wait for technology to advance, particularly in the SUV and pickup truck segments of that market. Industrial is experiencing customer pushouts occurring in climate control applications, especially in Europe as economic conditions there continue to be challenging. We expect sales in the second quarter to be roughly in line with Q2 last year and then for sequential top line growth to occur in the back half of the year.

Ric Phillips, CEO

Thanks, Jana. In closing, I am very proud of our accomplishments in the first quarter and the strong start to the fiscal year. This includes the financial results, but there were also other noteworthy awards, distinctions, and achievements for the company. As an example, our facility here in Jasper was recently recognized as one of the best places to work in manufacturing in Indiana. I want to congratulate General Manager Jason Davis and the entire team on a job well done. With an outlook for fiscal 2024 that is carefully navigating the current macro environment, we continue to be encouraged by the longer-term growth opportunities in the three vertical end markets we serve, each supported by favorable industry megatrends. With a strong funnel of new business, our capital allocation strategy is focused on organic growth, which will likely include additional global expansions in the future, combined with investments in automation and efficiency. We are winning together the Kimball way and I'm excited about what lies ahead for our company. Ellen, I would now like to open the lines for questions. Do we have any analysts with questions in the queue?

Mike Crawford, Analyst

Thank you. In Mexico, where are you on cost absorption? I know there is some margin expansion opportunity there. So if you could explain the answer in terms of capacity utilization, revenue margin potential that would be very helpful.

Jana Croom, CFO

Hey. Good morning, Mike. A lot of what you're seeing in Q1 in terms of the favorable impact that we've seen, 4.4% OI margin versus the last year's 3.3% is really Mexico coming into its own from a cost absorption and leverage perspective, offset by the fact that we just brought Poland on. So the challenge of the timing of growing the facilities is that you've got one that's sort of hitting where you need it to be from a margin perspective offset by one that you just got off the ground. Mexico is tracking in line with where we expect it to track from both our revenue and an OI margin perspective. Although, as we look at the outcome for FY 2024, it is going to be slightly impacted by what we're seeing come through in terms of our expectation from the North American auto market. But you can expect that we're going to manage the costs, particularly direct labor and indirect labor, appropriately as we navigate through it for the short run.

Mike Crawford, Analyst

Okay. Thanks, Jana. And you kind of segue into the second part of my question was, how is Poland ramping up since the groundbreaking this summer?

Jana Croom, CFO

Yes. Candidly, the industrial market in Europe has been choppier than what we anticipated originally as it relates to the European market in Poland. But the funnel is still strong. And so in the short term, the absorption of Poland is not going to be as strong over the course of this fiscal year as we had hoped. But again, we're going to control costs, we're going to control the labor market, and we're not going to over-index on it, but we do have a strong funnel of continued growth there. And so what is becoming now is a balancing act between what our customers are telling us in the short run, right? So the timing of when we need to ramp up versus all of the NPIs that we know are coming in FY 2025 that we've got to get ready for and so it's conversations with customers to make sure we're not going to push out and then we can balance our labor and material needs against that.

Mike Crawford, Analyst

Okay. Thank you. And just one last one from me. I know you mentioned technology advancement in SUVs and pickups in North America, but how would you frame the impact of the UAW strike in one region of your global automotive vertical end market as affecting your overall automotive business and supply chain, and when that could potentially normalize?

Jana Croom, CFO

Yes. So the UAW strike itself had very, very minimal impact on our top line, right? In terms of this plant shutdown, there was a disruption that impacted our supply chain, minimal. What we are seeing in conversations with our customers is the strike caused the OEMs and thus the Tier 1s to reevaluate the supply chain, finished goods inventory levels, expectations for sales over the course of the year. And so it's the ripple effect of that that we are still evaluating. It's sort of, hey, don’t let a good tragedy go to waste as everyone's looking at what they've got and evaluating what the needs are for the next three to six months as they work through it and see where it shakes out, which is why it feels like it's a temporal issue. So short-term, next couple of quarters as they work through it and then back to the levels that we had previously anticipated when we gave guidance at Q4.

Ric Phillips, CEO

Mike, it's Ric. Just maybe one thing to emphasize that Jana had mentioned a little bit earlier, we are really committed, not just in Mexico and Poland, but globally, to making sure as we see these demand signals, which we're sharing with you that we are adjusting our direct and indirect labor as quickly as possible in order to protect those margins. So that's a key priority for us right now in the short-term softening.

Derek Soderberg, Analyst

Yeah, good morning. Thanks for taking the questions. On the revenue guidance, what was the biggest change this quarter? I know you guys mentioned macro weakening, some effects of the strike in automotive. But what was the biggest driver of the lower guide? Was it that automotive piece? Can you just help maybe quantify the change in guidance by segment, but particularly automotive? And then I've got a follow-up.

Jana Croom, CFO

Yeah. So I will tell you, it's pretty evenly split between automotive and industrial. In industrial, it's primarily Europe, although we did see softening in North America as well. So if I had to gauge it for you, I'd probably say 65/35 there. The automotive market in North America, it's spread across all of our plants that service the auto market. It really is just as we evaluate the SUV and pickup truck market for EV, and this is something that we've talked about before, the technology related to the battery and the life that you need, the towing capability that you need in that market. It feels like consumers are pressing pause, or that's what we're hearing from our customers in terms of the adoption rate there. We're monitoring it carefully with our customers.

Derek Soderberg, Analyst

Got it. That's helpful. No, go ahead, Jana.

Jana Croom, CFO

As we're saying then it's the finished goods inventory from the UAW strike. What we don't want to do is have to come back to you with lower guidance again. So we try to be very thoughtful about the full year and what it might entail.

Derek Soderberg, Analyst

I understand. Regarding the automotive sector, I recall Ric mentioning that there is a minor impact in October, and it might become more noticeable in the next quarter or two. Is the expectation that things will start to stabilize by the fourth quarter of fiscal 2024? Is that the timeline we should anticipate? Could you clarify the effects of the strike and demand on the automotive business and how we should approach this as we progress through fiscal 2024?

Ric Phillips, CEO

Sure. I think that's probably a pretty good estimate, Derek. Again, we're being cautious. The impact, as you mentioned thus far has been minimal for us. But we really want to watch this environment and see what the next steps are in terms of how the Tier 1s and the OEMs respond and sort of get back to normal. But we definitely view this as short term for sure. And I think the estimate that you gave is probably consistent with what we would expect from a timing standpoint.

Derek Soderberg, Analyst

Got it. And if I could just squeeze one more in. Jana, congratulations on another quarter of positive cash flow with guidance and operating income margin and then sort of unchanged CapEx. I'm curious how you expect cash levels to move throughout the year. Is the expectation that you're going to have to tap the credit facility further? Can you just talk a bit about cash burn and sort of your expectations for fiscal 2024? Thanks.

Jana Croom, CFO

Yes, I was anticipating this question. As you all know, I pay close attention to the balance sheet and cash flow, which plays a significant role in my considerations. This year, we saw a 7% increase in inventory during Q1, aligning with our revenue volumes. My current focus is how the inventory arriving matches the fluctuations in demand. Often, because we are still recovering from supply chain challenges, we placed orders many weeks ago, and demand is shifting more rapidly than the inventory we will receive. In the short term, we need to navigate this with our customers. However, I believe that over the next three to four quarters, we will successfully work down our inventory levels in collaboration with our customers. Looking at our net debt to trailing 12-month EBITDA, it's below 2x, and I aim for it to be around 1.5 to 2 times, which is close to where we are now. Our previous PDSOH at 55 days is behind us; I expect the new normal for Kimball to be approximately 75 days. While this is not our current position, it is an improvement compared to two years ago. From a financing perspective, we have significant resources available, including the sidecar we exercised last February, allowing for additional organic growth and necessary CapEx for automation and facility expansions. We'll also work on reducing inventory levels over time, which will ultimately be reflected in our operational performance. Moving forward, I encourage everyone to pay attention to our results in the upcoming quarters and see if we maintain positive operating cash flow and whether it's trending positively. So, just stay tuned over the next three to four quarters.

Jason Smith, Analyst

Hey guys. Thanks for taking my questions. Just curious, when you look at your backlog, have you seen any issues with decommits or cancellations?

Jana Croom, CFO

So, not so much decommits or cancellations, much more push out, right? So, as we look at even the $100 million that we’ve seen this year, it's really about, hey, we're going to push out. Where we may watch that, again, is the auto market in North America that right sizes itself coming out of that finished goods inventory and really an evaluation of the growth in the adoption rate. That always becomes the negotiation with our customers around the next generation of products.

Operator, Operator

Apologies, everyone. It appears we’ve lost connection with our speaker, please stand by while we reconnect them. Hi Jason, your line is now open, you may continue.

Jason Smith, Analyst

Okay. Thanks. And then just to circle back to the auto strike. Just want to confirm that I heard correctly, you have baked in some potential headwinds from this into the new updated guidance?

Jana Croom, CFO

We did. Yes.

Anja Soderstrom, Analyst

Hi. Thank you for taking my questions. Most of them have been addressed already. But I'm curious about the medical end market. What do you see in terms of overall demand? I know you mentioned some of your program wins there, but what is your view on the overall demand from the medical end markets?

Ric Phillips, CEO

Thanks, Anja. It’s Ric. Yes, great question. As you saw, as Jana outlined, the change in guidance from a top-line standpoint, it really was an automotive and industrial story. So Medical, of course, as you know and as we shared in our original full year guidance had baked in a $100 million reduction from one customer who is dealing with an FDA consent decree. Therefore, we guided down 10% for the year. That outlook for medical has not changed. So we're continuing to see wins, good momentum with other customers. We still have high hopes in the long-term for the relationship with that one customer, but overall, we like what we see and our outlook for the year in medical has not changed from what we previously communicated.

Hendi Susanto, Analyst

Good morning, Ric. Good morning, Jana.

Ric Phillips, CEO

Hi, Hendi.

Jana Croom, CFO

Hi, Hendi.

Hendi Susanto, Analyst

Hi, Ric and Jana. Regarding the $50 million reduction in guidance for the automotive sector, could you provide some insight on how that impacts internal combustion and clarify our level of exposure to electric vehicles?

Jana Croom, CFO

Andy, I'm going to restate your question just to make sure we heard it because we're working on some technical difficulties here.

Hendi Susanto, Analyst

Yes.

Jana Croom, CFO

What you said was of the $50 million reduction that we saw in automotive kind of we give you a breakdown between EV and combustion engine? Is that?

Hendi Susanto, Analyst

Yes.

Operator, Operator

Sorry, Jana continue.

Jana Croom, CFO

Okay. So primarily, it was related to the EV market. As I said before, though, the concern was we are still evaluating the UAW strike and what we might hear from the Tier 1 in terms of how they're evaluating the impact of that. We sort of tapped on what we thought was a good placeholder for that impact, and that would be broad, so related to both combustion engine and the EV market. As the year paces out, we'll give you more color to help you understand the actual advances and how they ship out.

Hendi Susanto, Analyst

Yes. And then second question, Jana. So I think with the slowdown in EV, does it affect your charging station business and whether you can share some color on how much the impact may be qualitatively?

Jana Croom, CFO

Yeah, that's a great question. Here's the thing, you already had robust EV adoption across the globe and charging stations, particularly the Supercharger stations that you're going to see in place at gas stations, plants, supermarkets, shopping centers, etc., needed to catch up to the demand. And so while you might see some openings, there was a lot of work to be done in terms of growth there to support the last five years arguably of growth in the EV car market. We still feel really good about EV charging as a growth opportunity for Kimball going forward. We'll continue to give you updates and see how it goes. But the funnel for that opportunity is very robust.

Ric Phillips, CEO

I think as we shared earlier today, it's a relatively small part of that segment for us. But as Jana said, we are optimistic about the long-term growth for sure.

Hendi Susanto, Analyst

Okay. Got it. Yes. And then Jana, Ric, I think, let's say, despite the slowdown in the automotive market, can we reasonably assume that you are partially offsetting that with the increase in the dollar content?

Jana Croom, CFO

So in some cases, some of our contracts are balanced volume and pricing. In some cases, they are not. It becomes incumbent upon us not to say, hey, we're going to get an increased price, but to say, hey, how do we control the OpEx expense associated with the temporary interruption. It's a partnership with your customers that you have, but a lot of it is uncommon upon you with the company to control your costs.

Ric Phillips, CEO

And Hendi, it's Ric. I just want to clarify your question because I think you mentioned electronic content. Yes. Okay. So I think the, in addition to that, we still see strong electronic content increasing in auto. And so your question is, do we still think that our participation in the electronic content will outpace unit growth of vehicles? Yes.

Hendi Susanto, Analyst

Got it. Jana, you mentioned potential discussions with customers regarding cost management. Some companies implement a win-win strategy for both parties—customers and suppliers. Could you provide more details on the options available when negotiating long-term supply agreements and whether you can negotiate certain incentives when dealing with pushouts?

Jana Croom, CFO

Negotiations with customers are ongoing and constant. We are always engaged in discussions with our customers. It's important to understand that negotiations are not just a momentary event. Additionally, in this environment, similar to the EMS landscape, the focus remains on partnerships with customers regarding aspects such as pricing and volume, capital deployment and the expected returns, as well as automation, innovation, and efficiency. In that sense, the dynamics haven't changed. However, what has changed, especially from my three years in the EMS business, is that, according to our Chief Commercial Officer and Chief Operating Officer, who have over 50 years of combined experience, automotive companies have become better customers. They recognize the necessity of maintaining healthy suppliers, avoiding the previous race to the bottom and commoditization in the industry. Consequently, achieving a win-win scenario is not just common; it has become an expectation.

Mac Furst, Analyst

Yeah. So this is Mac Furst, Singular Research. Good morning, Ric, Jana, and Andy. Correlations on the quarter. I mean revenue is still up despite the loss of that $100 million contract in the medical vertical that we spoke about last quarter. I have two questions about automotive. You spoke about the additional revenue opportunity with ZF. Can you give us some color? Can you attach a revenue estimate on an annual basis for that additional business that you're trying to do with ZF starting in 2025?

Ric Phillips, CEO

I would love to provide that information, but we had a great meeting, as I mentioned earlier, and we have strong customer and partnership support. However, we are unable to disclose specific details at this time. This is significant for us in the long run.

Mac Furst, Analyst

Okay. Okay. Can we, for a second, talk about the ripple effects that you expect in the next couple of quarters about the after FA UAW strike. If I were to throw out a certain number, say, revenue impact of, say, $30 million, $40 million, or $50 million over the next three, four quarters, is that something that is too high? Or is that a number that's too low?

Jana Croom, CFO

The guidance that we provided is based on the information that we have right now, and tended to be holistic for the remainder of the year. So $100 million down roughly versus the midpoint of our guidance range, with fairly even spread between automotive and industrial, automotive focused more heavily in the North American market. That would indicate that over the three remaining quarters at $50 million in total for the full fiscal.

Mac Furst, Analyst

Okay. So maybe revenue down by $50 million over the next three quarters. Okay.

Jana Croom, CFO

Yes.

Operator, Operator

We currently have no questions on the line, sir.

Ric Phillips, CEO

Thanks, Mac.

Operator, Operator

We currently have no further questions on the line. So I'd like to close the call here and thank you all for your participation. If you would like to access the replay, you can do this by dialing +1866-813-9403 and use access code 264925. Replay instructions will also be available on the Kimball Electronics Investor Relations page. Thank you all again for joining today's call. You may now disconnect your lines, and have a great rest of your day.