Prepared remarks
Good morning, ladies and gentlemen, and welcome to the Kimball Electronics Second Quarter Fiscal 2026 Earnings Conference Call. My name is Alicia, and I'll be your facilitator for today's call. Today's call, February 5, 2026, 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'd like to turn the call over to Andy Regrut, Vice President, Investor Relations, Strategic Development and Treasurer. Mr. Regrut, you may begin.
Thank you, and good morning, everyone. Welcome to our second quarter conference call. With me here today is Ric Phillips, our Chief Executive Officer; and Jana Croom, Chief Financial Officer. We issued a press release yesterday afternoon with our results for the second quarter of fiscal 2026 ended December 31, 2025. 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. Actual results can differ materially from the forward-looking statements. Our commentary today will be focused on adjusted non-GAAP results. Reconciliations of GAAP to non-GAAP amounts are available in our press release. 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 2026 and Ric will complete our prepared remarks before taking your questions. I will now turn the call over to Ric.
Thank you, Andy, and good morning, everyone. I'm pleased with the results for the second quarter and our updated guidance for fiscal 2026. Sales in Q2 were in line with expectations, highlighted by another quarter of strong double-digit year-over-year growth in the Medical vertical. Margins improved compared to the same period last year and cash from operations was positive for the eighth consecutive quarter. Our focus as a Medical CMO continues to gain momentum as we leverage our unique capabilities in the industry. We expect top line growth in Medical to outpace our other two verticals as we balance our portfolio across the markets we serve. Our recent announcement to rebrand as Kimball Solutions and the grand opening of the new medical manufacturing facility in Indianapolis reflects this strategy and our expanded offering of capabilities and services. Turning to the second quarter. Net sales for the company were $341 million, a 5% decline compared to Q2 last year. From an end market perspective, strong results in Medical were offset by declines in North American automotive and industrial and continued softness in China. Starting with Medical. Sales in the second quarter were $96 million, up 15% compared to the same period last year and 28% of total company sales. This represents our fourth consecutive quarter of year-over-year revenue growth in this vertical. Approximately half of our medical business is in North America, while the other half is roughly split between Asia and Europe. The increase in Q2 was driven by growth in Poland and Thailand. North America was flat in the quarter. We continue to view the Medical vertical as a compelling opportunity to diversify our top line and leverage our core strengths as a trusted partner in a complex and highly regulated industry. Megatrends such as an aging population, increasing access and affordability to health care, and the trend toward smaller medical devices requiring higher levels of precision and accuracy are expected to fuel future growth. Our strategy is to align with new and existing blue-chip customers in need of manufacturing capacity for products with long life cycles and high degrees of visibility. A great example of this strategy coming to life is our new facility in Indianapolis. Tomorrow, we will be celebrating the grand opening with a ribbon-cutting ceremony and plant tour showcasing our state-of-the-art facility that adds capacity to our U.S. footprint for manufacturing medical products, including single-use surgical instruments and drug delivery devices such as auto-injectors. Indy, however, is not the only example. Thailand, Poland, Mexico, and Jasper also serve the medical market with HLAs and finished medical products. To complement our organic growth, we're actively pursuing our discipline in acquisitions that could bring new customers, increase exposure to faster-growing end markets, expand our geographic reach, and add manufacturing capabilities, including opportunities for vertical integration. Together, these strategies strengthen our global platform and position the company for a sustainable return to profitable growth. Next is Automotive, with sales of $162 million, down 13% compared to the second quarter of last year and 48% of the total company. The decline in Q2 was driven by lower sales in North America, related to the electronic braking program transferring out of Reynosa in mid fiscal '25 and recent pressures in the U.S. related to tariffs. The combined impact represented the majority of the decrease in the quarter, although Automotive sales were also down in China. This was partially offset by strong growth in both Poland and Romania with programs in steering and braking, respectively. Our company has supported the automotive market since the mid-'80s, and it has become a good business for us, generating strong cash flow when production volumes are at or above planned levels. Electronic steering and braking applications continue to be our sweet spot, with advances such as steer-by-wire and brake-by-wire or electronic mechanical braking, increasing the electronic content on vehicles. We are also seeing early stages of growth from the full assembly of an EPP or Electronic Power Pack, a steering system HLA that integrates the motor and ECU. In addition, OEMs are starting to design in a second steering system in vehicles, particularly in certain higher-end cars and trucks. Finally, sales in Industrial totaled $83 million, a 5% decrease compared to Q2 last year and 24% of total company sales. Our Industrial business is heavily concentrated in North America, where the majority of the decline occurred due to lower demand for HVAC systems. This was partially offset by higher sales in Europe, resulting from a rebound of the smart meter business for us in that region. I'll now turn the call over to Jana for more detail on Q2 and our updated outlook with raised guidance for fiscal 2026. Jana?
Thank you, and good morning, everyone. As Ric highlighted, net sales in the second quarter were $341.3 million, a 5% decrease year-over-year. Foreign exchange had a 2% favorable impact on consolidated sales in the quarter. On a sequential basis, sales were down just over 6% compared to Q1, with the decline primarily occurring in the Industrial vertical market driven by reduced sales in the North American climate control submarket. The gross margin rate in the second quarter was 8.2%, a 160 basis point improvement compared to 6.6% in the same period of fiscal 2025, with the increase resulting from favorable mix, the closure of our Tampa facility, favorable FX rates, and our global restructuring efforts. Adjusted selling and administrative expenses in the second quarter were $12.6 million, a $2.5 million increase year-over-year. When measured as a percentage of sales, the rate was 3.7% this year compared to 2.9% last year. As we previously indicated, expenses will be higher in FY '26 as we make strategic investments in business transformation, IT solutions, and business development for the future. Adjusted operating income in Q2 was $15.3 million or 4.5% of net sales, which compares to last year's adjusted results of $13.3 million or 3.7% of net sales. Our improved guidance for adjusted income reflects the impact of higher sales as well as the selling and administrative investments I just spoke about, and the grand opening of our new CMO facility in Indianapolis, where we will incur higher depreciation and other expenses related to the plant opening. We have worked hard to balance the needs of the business against the backdrop of declining sales. We will continue our restructuring efforts in FY '26 and beyond as we align our cost structure to end market demand. Other income and expense was an expense of $3.8 million compared to $4.8 million of expense last year. Once again this quarter, interest expense drove the decrease, down 50% year-over-year. The effective tax rate in Q2 was 47.9% compared to 1.2% last year, with the higher rate driven by the impact of a provision to tax return adjustment and the valuation allowance adjustment associated with the expected sale of the Tampa facility. For the full year of fiscal '26, we continue to expect an effective tax rate in the high 20s to low 30s. Adjusted net income in the first quarter was $6.9 million or $0.28 per diluted share compared to last year's adjusted results of $7.4 million or $0.29 per diluted share. Turning now to the balance sheet. Cash and cash equivalents at December 31, 2025, were $77.9 million. Cash generated by operating activities in the quarter was $6.9 million, our eighth consecutive quarter of positive cash flow. Cash conversion days were 91 days, an 8-day increase compared to last quarter, but a 16-day improvement compared to Q2 of fiscal '25. We continue to focus on improving cash conversion days by actively managing the components, and we are pleased by our progress thus far. Inventory ended the quarter at $281.7 million, marginally higher than Q1, but down $24.5 million or 8% from a year ago. Capital expenditures in Q2 were $18.2 million, with much of the spend once again this quarter on leasehold improvements in the new facility in Indianapolis. Borrowings at December 31, 2025, were $154 million, up $16 million from the first quarter, but down $51 million or roughly 25% from a year ago. Short-term liquidity available, represented as cash and cash equivalents plus the unused portion of our credit facilities, totaled $363 million at the end of the second quarter. We invested $4.3 million in Q2 to repurchase 149,000 shares. Since October 2015, under our Board authorized share repurchase program, a total of $109.5 million has been returned to our shareholders by purchasing 6.8 million shares of common stock. We have $10.5 million remaining on the repurchase program. As Ric mentioned, we are raising our guidance for fiscal '26, with net sales expected to be in the range of $1.4 billion to $1.46 billion, which compares to our previous guidance of $1.35 billion to $1.45 billion. The improvement is driven by strength in the Medical vertical as well as the ramp of Automotive programs at both European facilities. Adjusted operating income is now estimated to be 4.2% to 4.5% of net sales versus our prior estimate of 4.0% to 4.25%, with the improvement driven by higher sales balanced against investments in our Indianapolis CMO facility, business development needs, and business transformation and IT solutions to further innovations and enhance our capabilities. The guidance for capital expenditures did not change, remaining in the range of $50 million to $60 million for the fiscal year. I'll now turn the call back over to Ric.
Thanks, Jana. Before we open the lines for questions, I'd like to share a few thoughts in closing. As Jana detailed, we are pleased to raise the outlook for the fiscal year, driven by strength in the Medical vertical. We continue to monitor the outlook for FY '27, particularly in the North American automotive and industrial verticals as the consumer continues to respond to tariff impacts, changes in U.S. tax subsidies, and economic concerns. We'll provide more color on our outlook as the year progresses. 2026 is a year of milestones for our company, with our facility in Romania celebrating 10 years of operations; China, 20 years; and it's the 65th anniversary for the enterprise. As we previously announced, we are celebrating this anniversary and embracing our future with a new company name, Kimball Solutions. This rebrand is a strategic move that reflects our evolution beyond traditional electronics manufacturing services, with an expanded portfolio of capabilities that includes design and engineering support, supply chain management, precision plastics for medical applications, and high-level and final product assemblies for the verticals we serve. It also embodies our customer-centric approach to long-lasting partnerships, providing end-to-end solutions from design and prototyping to new product introduction, to manufacturing and aftermarket support. The rebrand will occur in a phased rollout at locations across the global footprint beginning in July of 2026 and will be completed when the company officially changes its name a year later, pending shareholders' approval. This change, along with the recent investments in Indianapolis, demonstrates our commitment to innovation and the vision to deliver comprehensive solutions worldwide. While the name of the company is changing, our core values of integrity, quality, and continuous improvement remain steadfast. These steps are a celebration of our heritage and a move toward the future, building tomorrow together. I've never been more excited about the company, and thank you for your support. Operator, we would now like to open the lines for questions.
Questions and answers
Our first question comes from Mike Crawford with B. Riley Securities.
Jana, regarding Automotive, I believe Nexteer is the main driver of your steer-by-wire growth. They continue to be your largest customer, contributing 19% in the September quarter. What percentage was Nexteer in December?
20%.
20%? And then are your other customers also expanding that? Or is it more braking that's driving some of the recovery there?
So we are seeing steering and braking with our largest automotive customers now being Nexteer and ZF. So it's not exclusive to Nexteer, but obviously, globally, Nexteer is our largest customer.
Okay. Yes. Well, it's great to see that flattening out. And then on the growth side, can you remind us what the capacity is and ramp expectations are for this new facility in Indianapolis?
The new facility in Indianapolis is 300,000 square feet, which is significantly larger than our current space. We are not yet able to determine how this will translate into revenue because it depends on the volume of work we handle, but there is a substantial opportunity for growth. We needed to showcase this for the types of business we are quoting for that facility.
And then I mean, I think Philips remains your largest Medical customer to date, but I imagine much of the work that you're doing in Indianapolis would be with some of your emerging growing Medical customers? Or do I have that wrong?
No, you have that correct. And as an example, if you look at the growth in Q2 and the year-to-date growth, it was split fairly evenly amongst North America, Europe, and Asia, and fairly evenly in the subverticals within Medical, meaning it was not driven by respiratory care. And so Medical for Kimball is growing. And you're right, that CMO space would likely not have Philips content just because that's not the makeup of the business that we perform for them. It would be new customers and expanded opportunities there.
Okay. And just a final question. Is it primarily plastic injection molding, or what are some of the value-added CMO applications that contribute to the fastest-growing segments of your business?
Yes, Mike, it's Ric. Great question. Yes. So we expect that facility. And again, as Jana said, we'll be working with customers. We're excited about our funnel and some of the discussions that we're having. But we could imagine, think of single-use surgical instruments, drug delivery devices such as an auto-injector. Certainly, as you said, plastic injection molding, we expect to be very significant, and we'll have significant capacity there. So all of those are expected to be housed at least partially in that CMO facility in Indy.
Our next question comes from the line of Derek Soderberg with Cantor Fitzgerald.
So I wanted to start with automotive. So a little bit of softness in China and North America. Just given that you guys won't be comping against quarters in the past with the braking program in North America. Just going forward, how should we think about sort of growth in the Automotive piece for Q3 and Q4, sort of flattish declines year-on-year, sort of down single-digit percentages. What's sort of the right way to think about Automotive for the rest of the year?
Yes. So great question. We will finally anniversary the end of the EV100 program in Q3. And so what we would expect is Q3 Automotive to be flat to potentially up just a little bit because we finally work that through the system. And we've got the 2 new programs in Europe, and Europe has been rebounding nicely for us. So in terms of Automotive and the sluggishness, the worst of it is past us in Q1 and Q2.
Got it. That's helpful. And then, Ric, just if you could comment on some of the win rates you're seeing across the business. Any sort of change in the size of the wins? What sort of gets you excited for what you're seeing in the portfolio as we sort of kind of look forward here?
We're really excited, Derek, and appreciate the question. We're seeing consistent win rates even though it's quite competitive out there. There are times when we encounter program bidding situations where we choose not to accept margins that don't meet our standards. So, it remains very competitive. However, we believe our strengths in long-term customer relationships, our capabilities, flexibility, and quality of operations continue to benefit us. Looking ahead, especially in Medical and also in Industrial, there are a few points to highlight. We're always looking for lift and shift opportunities, where we collaborate with customers currently manufacturing on their own and are interested in transitioning that work to us, allowing them to focus on R&D or sales. We're noticing an increase in these discussions, and they usually involve significant programs, such as a customer potentially shutting down an entire plant and moving everything to our facilities. These projects are larger if we successfully close them, and we're enthusiastic about these talks. The CMO discussions we're having also involve programs that are considerably larger than our usual average medical program because of the nature, growth, and scale of those customers' businesses. Great question.
Our next question comes from the line of Anja Soderstrom with Sidoti.
So I'm just curious, first, with this new facility that you're opening, as you ramp up, how should we think about that having an impact on the margin?
We certainly think over time that the CMO space has an opportunity for margins accretive to what you've seen from us historically. That's going to depend program by program and customer by customer and again, in all competitive situations. But we think that that space and our capabilities lend itself for that to be accretive in the long term.
But Anja, I will tell you, in the near term, it's going to drag, right, because we have all the depreciation expense, all the additional expense associated with the opening of that facility. We're currently running both facilities, right, because we've got to move everything over and then we'll have to close the facility. So for the next 6 to 9 months or 2 to 3 quarters, it's going to be a drag. The reason that I want to point that out is the operating income margin that we produced in Q2, considering the fact that we had $16 million less sales and the impact of the grand opening of the Indy facility and other investments that we made, I think is a testament to our commitment as a leadership team to deliver value to the organization and to our shareholders. It was a lot of work, and while we feel very confident in the strategy for the future, we're working hard to offset that drag in other areas of the business.
Okay. And then how do you see the cash cycle days play out in the coming quarters? It was quite elevated for the quarter.
Yes. So for the last 2 years, we've really been focused on cash conversion and cash cycling. We saw it tick up from 85 days to 90 days, primarily driven by North America and the impact of autos and industrial. We saw inventory tick up a little bit. That remains a key focus of the organization. We worked really hard to solidify working capital and reduce inventory, which has a corresponding impact on debt on the balance sheet. You can expect that to continue to be a laser focus for us as a leadership team. To put it plainly, I would expect Q3 to come back down from where it was in Q2. I'd like to provide some additional color on the remainder of the year. If you take the midpoint of our revenue guidance at $1,430 million and strip out what we've done so far at $707 million, that leaves roughly $723 million to go. What that would imply is that Q3 and Q4 are going to be roughly aligned with Q1 in terms of revenue growth. We've already discussed the automotive sector, and the fact that we've anniversaried EV100 is noteworthy. From a Medical perspective, I would remind everyone that we had the consigned inventory sale in Q3 of FY '25 of $24 million. So when we report Q3, we'll provide growth figures in Medical, including and excluding inventory sales. We will make that clear for you. Our focus remains on the North American Industrial segment as well and we will see how that unfolds.
Our next question comes from the line of Max Michaelis with Lake Street Capital Markets.
Thanks for the color on the model, too. So if we look at Automotive, I was just hoping if you could provide some more color on maybe the opportunity with the EPP, the Electronic Power Pack program, and then some of the opportunities surrounding the OEMs with the second steering design. I mean, can these become similarly sized to the old braking program that ended up going away? Or kind of just help me out with where the potential is with these two programs?
So we are really excited about the EPP program because it's our first higher-level assembly in Automotive where you're combining the motor and the printed circuit board assembly, and so that's really exciting. In terms of size of the program, the EPP is not as big as the braking program was. It's probably about 2/3 of that size. But from a future strategic focus in Automotive, it's very exciting. Additionally, as you consider the continuum of opportunity in Automotive, particularly regarding ADAS, you've got steering programs now, and braking programs now, with steer-by-wire and brake-by-wire. This is all very exciting. We are also exploring ADAS, where there will be a central brain functioning in the car controlling all its electronics. That is something that Kimball is also interested in pursuing in the future. We expect that as EPP becomes more common in vehicles and the second steering column becomes more common in vehicles along with ADAS, these are strategic areas we want to participate in.
Awesome. Next one, if we look at the Medical space, you talked about inorganic opportunities last quarter; I don't think you mentioned them in the prepared remarks in this call. When we look at some of the things you guys provide, with the auto-injectors, sleep therapy, drug delivery, what are some of the other spaces or sub-verticals that you guys are looking at where you're seeing some great opportunities?
Max, it's Andy. We have done a fairly deep dive on end market exposures. In vitro diagnostics is really interesting to us. Cardiology is also particularly intriguing. We would certainly consider opportunities or adjacencies to expand into those areas, especially if they provided a chance to either deepen our relationship with an existing customer or add a new customer and the same for manufacturing capabilities.
There are no further questions at this time. A replay of this call will be available beginning later today and will remain available through February 19, 2026. To access the replay, please dial (877) 660-6853 and enter the access ID 13757544. And with that, this concludes today's conference call. Thank you, everyone, for your participation. You may now disconnect.