Kimball Electronics, Inc. — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2019, ended December 31, 2018. Unaudited results; dollar amounts below are in millions unless stated otherwise.
Business context and reporting period
Kimball Electronics is a global electronics manufacturing services company serving automotive, medical, industrial, and public safety markets. On October 1, 2018, it acquired GES, a provider of automation, test and inspection equipment and related services, supporting the company’s strategy to diversify into broader manufacturing solutions.
Financial performance and liquidity
| Metric | Three months ended Dec. 31, 2018 | Six months ended Dec. 31, 2018 |
|---|---|---|
| Net sales | $284.1; up 10% year over year | $549.8; up 8% |
| Gross profit / margin | $20.4 / 7.2%; prior year 8.1% | $38.6 / 7.0%; prior year 7.9% |
| Operating income / margin | $10.2 / 3.6%; prior year $10.1 / 3.9% | $17.2 / 3.1%; down 12% from $19.6 |
| Net income (loss) | $7.1; prior year loss of $8.3 | $12.2; prior year $0.1 |
| Diluted EPS | $0.27; prior year loss of $0.31 | $0.46; prior year approximately $0.00 |
| Operating cash flow | Not separately reported for the quarter | $(4.4); prior year $11.4 |
- Six-month investing cash outflow was $52.5, including $43.9 for GES and $8.5 in capital expenditures. Financing provided $47.3, principally from net borrowing; cash declined $10.6 to $35.9.
- At December 31, cash was $35.9 and current borrowings under credit facilities were $89.1. Management reported no long-term debt. Working capital was $179.3, versus $208.4 at June 30; the current ratio was 1.6, versus 1.9.
- Available short-term liquidity, defined by the company as cash plus unused credit facilities, was $136.8. The amended primary facility permits up to $150 of borrowings, with a potential increase to $225 subject to lender consent. The company reported compliance with its financial covenants.
- Six-month effective tax rate was 19.3%, versus 99.4% a year earlier. The prior period included significant Tax Reform charges, including deemed repatriation and deferred-tax remeasurement. The current period also included favorable tax adjustments.
Material changes versus the prior comparable period
- Sales growth reflected program ramps, new product introductions and stronger demand. GES and adoption of the new revenue standard each added approximately 2% to second-quarter sales; foreign exchange reduced sales by 1%.
- Medical, industrial and public safety sales rose 18%, 20% and 29%, respectively, in the quarter. Automotive sales fell 3%, with strength in North America offsetting declines in China and, to a lesser extent, Europe.
- Gross margin weakened because of unfavorable product mix, higher material costs associated partly with component shortages, GES’s low seasonality, and, year to date, higher domestic healthcare costs.
- New revenue guidance, adopted July 1, 2018, shifted most manufacturing revenue recognition to over time. It increased reported six-month sales by $6.4 and net income by $0.3 compared with the amounts excluding the accounting change. It also resulted in $49.6 of contract assets at December 31 and reduced reported inventory by $45.2 versus the accounting basis without adoption.
- GES contributed $4.7 of goodwill and $19.3 of acquired intangible assets. Its purchase-price allocation remains preliminary; the company recorded a net adjusted purchase price of $40.1 and paid $43.9 net of cash acquired, with a $3.8 net receivable from the seller recognized.
- Cash used by operations contrasted with prior-year cash generation, mainly because working-capital changes used $31.0, including $36.6 for inventory, partly offset by increased accounts payable.
Outlook, management commentary, risks and contingencies
- Management’s stated goal is 8% annual organic growth. It characterizes the EMS outlook as moderate growth with mixed demand and expects Romania facility capacity to continue ramping during the rest of fiscal 2019. Management believes available liquidity will meet operating needs for at least the next 12 months.
- Open orders were $321.5, up 33% year over year; substantially all were expected to be filled within 12 months. The company cautions that orders may be canceled and may not predict future sales.
- Key risks include component shortages and allocations, higher input costs, tariffs and U.S.-China trade tensions, customer demand and program fluctuations, competitive pricing and margin pressure, foreign exchange, and successful integration of acquisitions. The company noted that customer agreements can generally be canceled with little or no notice.
- GES-related estimated pre-closing Vietnam tax, indirect-tax and unrecognized-tax-benefit liabilities totaled $4.2, with a matching indemnification asset recorded; ultimate resolution could differ materially from the estimate. The purchase-price allocation and working-capital adjustment are not final.
- The company recorded $12.1 of deemed repatriation tax, including $11.1 in long-term income taxes payable; approximately $1.0 was expected to be paid in the next 12 months, with the remainder scheduled through fiscal 2026.
- The company repurchased $18.7 of shares in the first half at an average $18.23 per share and had repurchased $63.2 cumulatively under an authorization increased to $80.0. Capital expenditure commitments were approximately $4.3.
Important facts for investors to verify
- Whether sales growth and the 8% organic-growth goal are sustained excluding GES and the revenue-recognition timing effect.
- Whether gross margins recover despite product-mix pressure, component shortages, tariffs and GES seasonality.
- How contract assets, inventory and cash conversion develop, given negative operating cash flow and higher working-capital use.
- GES integration results, final purchase-price allocation, seller receivable collection, and resolution of the estimated $4.2 pre-closing tax liabilities and indemnity.
- Borrowing levels, covenant headroom, liquidity, and the planned repayment of the remaining GES Vietnam facility balance by March 31, 2019.
- Customer concentration and order quality: Philips, ZF and Nexteer together represented substantial sales, and open orders are cancelable subject to contractual terms.