Kimball Electronics, Inc.

Good morning, ladies and gentlemen. My name is Angel, and I will be your operator for today's conference call. At this time, I would like to welcome everyone to the Campbell Electronics Third Quarter Fiscal 2020 Financial Results Conference Call. All lines have been placed on listen-only mode to prevent any background noise. After Kimball's speaker's opening remarks, there will be a question and answer period where Kimball will respond to questions from analysts. Analysts can ask questions during the question and answer segment by simply pressing star and the number one on your telephone keypad and questions will be taken in the order they are received. Today's call, May 5, 2020, will be recorded and may contain forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Risk factors that may influence the outcome of the forward-looking statements can be seen in Kimball's annual report on Form 10-K for the year ending June 30, 2019, and other filings with the Security and Exchange Commission, the SEC, and in today's release. The panel for today's call is Don Sherwin, Chairman of the Board and Chief Executive Officer, and Mike Sergisgetter, Vice President and Chief Financial Officer of Kimball Electronics. I would now like to turn today's call over to Don Cheron. Mr. Cheron, you may begin.

Thank you, Angel. Welcome, everyone, to our third quarter conference call. Our earnings release was issued yesterday afternoon on the results of our third quarter, ended March 31, 2020. We have posted a financial summary presentation to accompany this conference call. The presentation can be found on our Investor Relations website within the Events and Presentations tab, or if you are listening via the webcast, you can follow along by advancing the slides or download them from the Downloads tab on the webcast portal. I will begin by making a few remarks on the overall quarter, and then I will turn it over to Mike for the financial overview. After that, we will answer any questions that you may have. We are pleased with the results we delivered in the third quarter of fiscal year 2020, despite the interruptions and challenges caused by the COVID-19 pandemic. The safety and health of our employees, customers, suppliers, and communities are paramount. We are making every effort to keep our facilities safe, following current guidelines suggested by applicable country authorities. Because of the variety of critical medical device assemblies we manufacture around the world, our facilities are classified as essential businesses, and so all are currently operational but have been affected to varying degrees by COVID-19. We serve a diversified portfolio of markets, geographies, and customers. In our third quarter, We experienced a double-digit decline in sales to customers in our medical vertical, which was primarily unrelated to COVID-19. However, we are seeing a significant increase in demand for medical assemblies for the near future, specifically those related to respiratory care and patient monitoring products. We have customers whose products are essential to the health and safety of people around the globe. We are proud of what we do for the world and we are proud of our people and their extraordinary efforts and contributions during this challenging time. I feel honored and privileged that our company can play such an important role to help in this pandemic. In our automotive vertical, we started to see the impact of COVID-19 in our third quarter results, although the severity of the impact from the extensive automotive plant shutdowns in North America and Europe will not be reflected in our results until our fiscal fourth quarter. We are, however, encouraged by the recent announcements of several of our domestic automotive customers and their plans to restart production on May 18th. We also are pleased with the return of our production output in China to near pre-COVID-19 run rates. We continue the ramp up of several new programs including a large program for an existing customer who supports a vehicle OEM that specializes in fully electric vehicles. We anticipate our overall run rates for our automotive vertical will return to a new normal and when added to the ramp up of these new programs will return us to middle single digit growth rates in the first half of fiscal year 2021. Within our medical vertical, we have been working hard to respond to the significant increases in demand from our existing customers for their respiratory care and patient monitoring products. These increases are immediate and our customers expect that they will continue over the next several quarters as the world deals with the pandemic and the shortages of the medical equipment in these product categories. These COVID-19 related increases when added to our base medical business will help us generate strong double-digit growth in our medical vertical in the fourth quarter of fiscal year 2020 and the first half of fiscal year 2021. We continue to gain traction in the new business opportunities pipeline for our GES business. The recent new orders for machines I mentioned on our last quarter call are on schedule to be delivered in the fourth quarter of fiscal year 2020. We are also excited about the role GEF is playing in our digital and industry 4.0 strategy as we work to roll out EMTAB, a GEF-developed software solution in all our global facilities in 2020. We are working diligently to respond to the volatility in demand and change in the mix of our overall business We continue our relentless pursuit to achieve our operating margin and return on invested capital goals. We are doubling down on execution across all of our units as we continue to drive Lean Six Sigma projects and global supply chain initiatives to improve yield and throughput and drive improvement in our margins. Margin expansion and capital efficiency will continue to be priorities of focus for us. Our cash conversion days for the quarter ended March 31, 2020 were 81 days, up from 75 days in the quarter ended March 31, 2019, and from 76 days in the second quarter of fiscal year 2020. While the volatility in demand has made it difficult for us to achieve our inventory objectives, and thus our cash conversion days objectives, we remain committed to our inventory reduction goals and actions. We invested $5.7 million in capital expenditures in the third quarter of fiscal year 2020. The majority of these capital investments were for capacity expansion and to support the launch and ramp up of new programs. During the third quarter of fiscal year 2020, we also returned $2.7 million to our shareholders by purchasing 214,000 shares of our common stock, which brings our total to $76.7 million and 5.1 million shares purchased since October 2015 under our board-authorized share repurchase program. As a result of the COVID-19 environment, our plan has been temporarily suspended until further determination by our board. And finally, as I stated earlier, I am so proud of our people around the world and our collective response to the COVID-19 pandemic. Our strong company culture and core values have and will continue to help us get through this together. Our number one priority will continue to be keeping our employees healthy and safe. We will continue 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. Now I will turn it over to Mike to discuss our third quarter results in more detail. We will then open the call to your questions.

Mike? Thanks, Don. Before I get into my normal discussion on our financial results, I wanted to stress that our financial condition continues to be strong, and we believe we are in a solid position to be able to support the increased demand in the medical market relative to the COVID-19 pandemic. and to do our part in helping to solve the shortage of critical medical devices necessary to help save lives. Our short-term liquidity available represented as cash and cash equivalents plus the unused amount of our credit facilities totaled $122 million at March 31st, 2020. We have the ability to increase the borrowing capacity on our primary credit facility by an additional $75 million upon request subject to consent of the participating lenders as well as other options to enhance our liquidity. Now regarding our Q3 results, I will be referring to the slide deck Don mentioned, which can be found on our investor relations website within the events and presentations tab. Or if you're listening via the webcast, you can follow along by advancing the slides on the webcast portal. As shown on slide three, our third quarter net sales were $293.9 million, which was a 6% decrease compared to a very strong third quarter of fiscal year 2019 with net sales of 313.5. Ladies and gentlemen, please hold. I'll continue with our sales results. So as shown on slide three, our third quarter net sales were $293.9 million, which was a 6% decrease compared to a very strong third quarter of fiscal year 2019 with net sales of $313.5 million. The decline in net sales was largely the result of overall lower demand compared to the prior year, particularly in the medical vertical. which was primarily unrelated to COVID-19. Foreign exchange rates reduced our consolidated net sales by approximately 1% compared to the third quarter a year ago. Slide 4 represents our net sales mixed by vertical market. Comparing our net sales by vertical to the same quarter in the prior year, our automotive vertical was down 2% compared to the same quarter a year ago Driven largely by lower demand of existing products, including the negative impact to demand from COVID-19 starting in the last part of the quarter, which was partially offset by the ramp-up of certain programs for fully electric vehicles and new product introductions. As Don mentioned, we started to see the impact of COVID-19 on the automotive industry in our third quarter results. although the severity of the impact will not be reflected in our results until our fiscal fourth quarter. Our medical vertical was down 12% in the current quarter compared to the prior year third quarter resulting from lower overall demand that was partially offset by the ramp up of certain products. We anticipate growth of sales to customers in the medical market in the upcoming quarters as we are currently experiencing a significant increase in demand for medical assemblies specifically those related to respiratory care and patient monitoring products as a direct result of the COVID-19 pandemic and related global shortage of respiratory equipment. Our industrial vertical was down 3% from a year ago as lower in market demand for climate control products and the phase out of certain programs were partially offset by increased demand for smart metering products. Lastly, sales in our public safety vertical were down 18% from the prior year third quarter as a result of the continued phase-out of certain programs and lower overall demand. The gross margin in the third quarter, reflected on slide 5, was 6.9%, which was a decline of 160 basis points from the 8.5% in the third quarter of last year. However, our gross margin did improve 20 basis points sequentially from the second quarter of fiscal year 2020. Our decrease in gross margin in the current year compared to a year ago was primarily due to lower volumes and unfavorable product mix, which partially were offset by lower profit sharing bonus expense. Selling and administrative expenses, slide six in the deck, were $9.6 million in the third quarter, which was down approximately $2.4 million in absolute dollars and is down 60 basis points as a percent of net sales compared to the prior year third quarter. The decrease in selling and administrative absolute dollars was largely due to changes in the fair value of this supplemental employee retirement plan or SERP liability which accounted for 50 basis points of the decrease compared to the prior year third quarter. The revaluation of the SERP liability is exactly offset by gains or losses recorded in the SERP investments during the quarter, which is recorded in other income and expense net, and as a result has no impact on net income. Operating income for the third quarter on slide 7 in the deck came in at $10.6 million, or 3.6% of net sales. This compares to operating income of $14.5 million, or 4.6% of net sales in the same period a year ago, driven by the decline in our gross profit percent previously mentioned, which was partially offset by the favorable impact of the comparison to the prior year quarter relating to changes in the fair value of the SERP liability. Sequentially, compared to our second quarter, our operating income as a percent of sales improved by 80 basis points, on the revaluation of CERF liability and the improvement in gross profit. Other income and expense net was an expense of $1.9 million in the third quarter, which compares to income of $200,000 in the third quarter of fiscal year 2019. Other expense net in the current year third quarter includes $900,000 in losses on the CERF investments and $1.2 million in interest expense. partially offset by $200,000 from favorable exchange rate fluctuations and other items. Other net income net in the prior year third quarter included $800,000 from favorable exchange rate fluctuations and other items and $600,000 in gains on SERP investments, which were largely offset by $1.2 million of interest expense. The effective tax rate for the current year third quarter was 28%, which compares to 19.3% in the prior year third quarter. The current quarter rate is slightly above our expected effective tax rate of the mid-20% range, primarily due to a change in mix of earnings among our various tax jurisdictions. The prior year third quarter effective tax rate was favorably impacted by discrete tax benefits related to provision to return adjustments. Slide 8 reflects our adjusted net income trend. Our net income in the third quarter of fiscal year 2020 came in at $6.3 million. This compares to our quarterly net income of $11.8 million in the third quarter of fiscal 2019. Diluted earnings per share were 25 cents for the third quarter of this fiscal year, which compares to diluted EPS of 46 cents reported in the same quarter last year. which was also a record quarter for diluted EPS for us. Cash and cash equivalents of March 31, 2020 were $58.3 million. Operating cash flow trends are shown on slide 11. Our cash flow provided by operating activities during the current year third quarter was $12 million, which was driven by net income plus non-cash items. Thank you for joining us. and the Board of Trustees. Slide 12 reflects our capital and depreciation trends. As Don mentioned, our capital investments in the third quarter totaled $5.7 million, largely related to manufacturing equipment to support new production awards and to increase capacity. Borrowings on our credit facilities at March 31st, 2020 were $122 million, which were down $4 million from our borrowings at June 30th, 2019. In conclusion, our financial condition continues to be strong, and we believe we're in a solid position to be able to support the increased demand in medical market related to the COVID-19 pandemic and to do our part in helping to solve the shortage of critical medical devices necessary to help save lives. As Don mentioned, we're very proud of the work our teams are doing to support the efforts to combat this disease on a global scale. With that, I would like to open up today's call to questions from the analysts. Angel, do we have any analysts with questions in the queue?