Kimball Electronics, Inc. (NASDAQ:KE) is a global, multifaceted manufacturing solutions provider serving the automotive, medical, and industrial end markets. The company recently announced strategic actions to sharpen its focus and position the business for long-term value creation amidst a challenging macroeconomic environment.

Business Overview

Kimball Electronics provides electronics manufacturing services (EMS), including engineering and supply chain support, to customers across its three key end markets. The company's core competency is producing durable electronics, and it further offers contract manufacturing services for non-electronic components, medical devices, medical disposables, precision molded plastics, and production automation, test, and inspection equipment.

Kimball Electronics' manufacturing services, including engineering and supply chain support, utilize common production and support capabilities globally. The company is well recognized by customers and the industry for its excellent quality, reliability, and innovative service, having been honored multiple times by CIRCUITS ASSEMBLY for achieving the Highest Overall Customer Rating in their Service Excellence Awards.

The contract manufacturing services industry is highly competitive, with Kimball Electronics positioned between the agility and flexibility of smaller, regional players and the scale and price competitiveness of larger, global players. The company's unique market position allows it to compete with larger scale players for high-volume projects while maintaining a competitive position in the generally lower volume durable electronics market space.

Strategic Repositioning

In the third quarter of fiscal 2024, Kimball Electronics made the decision to divest its automation, test and measurement (AT&M) business unit. While the AT&M business has a bright future, it was determined to not be a strategic fit for the company's core EMS focus and growth goals. The business models were not synergistic, and it was imperative for Kimball to sharpen its focus on the significant opportunities in its core EMS operations.

Concurrent with the AT&M divestiture, Kimball is increasing the focus and support for its core EMS business, including realigning its medical solutions business unit in Indianapolis into the EMS medical vertical for further differentiation. To support these structural changes, the company has elevated two key executives to enterprise-wide operations and commercial responsibility - Steve Korn as Chief Operating Officer and Kathy Thomson as Chief Commercial Officer.

Navigating a Challenging Macro Environment

The operating environment remained challenged for the EMS industry in the third quarter, with Kimball Electronics reporting a 12% year-over-year decline in net sales to $425 million. The company expects these macroeconomic headwinds to persist through fiscal 2025, driven by factors such as elevated inflation, higher interest rates, and geopolitical uncertainty.

In response to the softening demand, Kimball is taking proactive actions to align its cost structure, including resizing its workforce and taking specific cost actions. The company recorded $14.5 million in after-tax charges in the third quarter related to goodwill and asset impairment associated with the AT&M divestiture, as well as restructuring expenses.

Despite the near-term challenges, Kimball remains focused on long-term growth opportunities, with a robust funnel of new business awards expected over the next 18-24 months. The company is balancing its capital allocation strategy to support organic growth, maintain lasting customer relationships, and return cash to shareholders through opportunistic share repurchases.

Segmental Performance

Automotive:

Kimball's largest business segment, automotive, reported net sales of $202 million in the third quarter, down 9% year-over-year. The decline was driven by continued weak demand in Europe, incremental softness in North America, and a decrease in China. However, on a sequential basis, North America and Europe both posted increases. The company believes the long-term opportunity for growth in automotive will be driven by the increasing rate of electronic content addition to vehicles, particularly in steering and braking systems.

Medical:

Net sales in the medical segment were $113 million, a 17% decrease compared to the prior year quarter. The decline was primarily due to lost sales with a major customer involved in an FDA recall, partially offset by growth with other customers. Kimball continues to believe megatrends in the medical industry, such as an aging population, increasing access and affordability to healthcare, and the industry-wide trend of outsourcing higher-level assemblies, will contribute to its long-term top-line growth.

Industrial:

Net sales in the industrial segment were $110 million, a 14% decrease compared to the prior year quarter. Approximately half of the decline resulted from year-over-year weakness in the divested AT&M business, with the balance driven by lower demand for internal climate control systems and smart meters in Europe. Kimball sees the megatrend in legislation and incentives supporting decarbonization as a meaningful growth driver, with the company strategically positioned to support products that reduce environmental impacts.

Financials

In the third quarter of fiscal 2024, Kimball Electronics reported net sales of $425 million, a 12% decrease compared to the prior year period. Excluding the impact of the divested AT&M business, the company estimates its year-over-year sales decline was in the low-to-mid single digits. Gross margin in the quarter was 7.9%, a 100 basis point decline from the prior year, primarily due to lower absorption in the EMS manufacturing facilities and the AT&M business.

Adjusted selling and administrative expenses in the third quarter were $16.6 million, an $800,000 decline compared to the prior year, driven by lower bonus expense. Adjusted operating income was $17 million, or 4% of net sales, compared to $25.6 million, or 5.3% of net sales, in the prior year quarter.

Other income and expense was an expense of $6.3 million in the third quarter, compared to an expense of $3.3 million in the prior year, primarily due to higher interest expense on elevated debt levels in the current interest rate environment. The company's adjusted net income in the third quarter was $8.4 million, or $0.34 per diluted share, compared to $16.4 million, or $0.65 per diluted share, in the prior year period.

For the full fiscal year 2024, Kimball is reiterating its guidance for adjusted operating income of 4.2% to 4.6% of net sales, with net sales expected to decline 4% to 6% compared to the prior year. The company has updated its capital expenditure guidance to a range of $55 million to $60 million, down from the previous range of $70 million to $80 million.

Liquidity

Kimball Electronics maintained a strong balance sheet, with cash and cash equivalents of $65.2 million and short-term liquidity, including the unused portion of its credit facilities, totaling $182.6 million as of March 31, 2024. The company's cash conversion days were 110 days in the third quarter, compared to 92 days in the prior year period, with a focus on further improving working capital management.

Kimball has a board-authorized stock repurchase plan, under which it has repurchased $88.8 million of common stock since October 2015. The company has $11.2 million remaining on the repurchase program and expects to continue returning cash to shareholders through opportunistic share repurchases.

Outlook

Kimball Electronics expects the macroeconomic headwinds to persist through fiscal 2025, and the company is taking proactive steps to align its cost structure with the current demand environment. The divestiture of the AT&M business and the realignment of the medical solutions unit will allow the company to sharpen its focus on its core EMS operations and position the business for long-term profitable growth.

Conclusion

Despite the near-term challenges, Kimball remains optimistic about its long-term prospects, with a robust funnel of new business opportunities and a capital allocation strategy that balances organic growth, customer relationships, and shareholder returns. The company's strategic repositioning, coupled with its strong financial position and operational excellence, position Kimball Electronics for continued success in the years ahead.