Kimball International, Inc.
Q2 2020 Earnings Call Transcript

Published: 5 Feb 2020

[Operator:]

Good morning, ladies and gentlemen. My name is Crystal, and I will be your conference call facilitator today. At this time, I would like to welcome everyone to the Kimball International Second Quarter Earnings Conference Call. Currently all participants are in a listen-only mode. [Operator Instructions] As with prior conference calls, today's call, February 5, 2020, will be recorded and may contain forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from the forward-looking statements. Risk factors that may influence the outcome of forward-looking statements can be seen in the Kimball International Form 10-K.During today's call, the presenters will be making references to an earnings slide deck presentation that is available on the Investor Relations section of Kimball International's website. On today's call are Kristie Juster, CEO of Kimball International; and Michelle Schroeder, Executive Vice President and Chief Financial Officer of Kimball International.I would now like to turn the today's call over to Kristie Juster. Ms. Juster, you may begin.

[Kristie Juster:]

Thanks Crystal, and good morning everyone. Welcome to Kimball International’s second quarter earnings conference call. We are six months into the execution of our transformation plan that is fueling our Kimball International Connect strategy and I am pleased to report our implementation in financial delivery is exceeding our expectations. In today's call, we are increasing our estimated cost savings for fiscal 2020 from $16 million to $21 million. This performance paves the ways for both improved profit and increased investment in growth as we move forward.In our material today, I will walk through the highlights of our Q2 performance, comment on market leading indicators and provide specifics around progress on Kimball International Connect strategy. Michelle will then provide details of our financial performance and I'll wrap up with color on our path ahead before we open the call for Q&A.Please turn to Slide 4 for our Q2 highlights. Our net sales were in line with our expectations for the quarter, but short of our overall long-term growth guidance of 4% to 7% that we've included in our three-year financial objectives. We ended the quarter with revenues of the $192 million, a 4% decrease year-over-year against a difficult comparison to 13% growth in the prior year.Comps for the prior year from our three focus verticals were very strong with commercial up 29%, hospitality up 16%, and healthcare 20%. At the same time, our Kimball brand experienced unexpected reduction in revenues as we continued our planned realignment of the business in the first half of the year.Now turning to orders, orders were strong, up 13% as we experienced broad-based growth across all verticals. We were particularly encouraged by the growth within hospitality, up 31% assisted by strength in Las Vegas market. Healthcare was up 10% against 22% growth in the prior year as our strategic focus in investment into this vertical by the Kimball brand continues.Our backlog finished the quarter at $173 million, up 20% over prior year positioning us well for a strong start to the back half. Our growth will be led by hospitality and healthcare market, coupled with the continued traction of a national brand in the ancillary product category. Michelle will provide more commentary on vertical market performance later in the call.Operating income of 7.4% or 8.6% on an adjusted basis increased 220 basis points. Gross profit of 34% increased 170 basis points giving us confidence in our sustaining improvement in gross margin. At the same time, adjusted selling and administrative costs decreased 50 basis points even while funding our strategic investments in Kimball International Connect. We expect our strategic investments will continue to ramp in the second half of our fiscal year in order to accelerate longer-term growth.We are very pleased with the adjusted EBITDA performance of $20.9 million, up 23%, representing a margin of 10.9%, up 240 basis points. And finally, adjusted EPS increased 27% to $0.33, compared to $0.26 a year ago.Turning to Slide 5 for a view of the macro-economic indicators we track for the industry. This month's calendar year forecast for U.S. office furniture is 7.4% in 2019 and 2.2% in 2020. This December forecast is unchanged from the prior October forecast I reviewed last call. The deceleration of the 2020 forecast is attributed to the deceleration of the U.S. GDP from 2.3% in 2019 to 2.1% in 2020.The architecture billing indexed by AIA, which serves as a leading indicator of non-residential construction activity rose to 52.5 in December, up from 49.7 in September with improvement in each of the last three months. Improvement is attributed to the business conditions rebounding from a period of softness throughout much of the spring and summer. We are encouraged with the improvement in this 9 to 12 month leading indicator of non-residential construction activity.RevPar or revenue per available room is a leading indicator for our hospitality business. Forecast for calendar 2020 estimate growth of 0.7%, which is in line with 0.9% forecasted growth in 2019. We continue to see strong activity, especially as it relates to the second half of our fiscal year, driven by the strength in the Vegas market.All these forecasted metrics were released prior to the recent coronavirus outbreak in China. We are diligently managing this very fluid situation. The safety and well-being of our employees is our Number 1 priority and we are keeping in close contact with our small employee base in China.We have implemented a travel ban to and from China. With minimal sales outside of North America, the impacted area for us is our supply base. Approximately 15% of our total material spend for office furniture is sourced from China and our hospitality business imports approximately 50% to 60% from our supply partners in China.We have some buffer inventory because of our planning in anticipation of the Chinese New Year. The circumstances are very fluid at this time, and so it is difficult to determine what level of impact this may have on our business. We are keeping in close contact with our employees, suppliers and our customers while actively building contingency plans.Setting aside this unique situation, we are in a very healthy place supported by both our improving margins driven by our transformation work and available capital setting us up to take advantage of the opportunities and at the same time manage the volatility. We believe this landscape gives us a solid foundation for execution of our Kimball International Connect strategy and related transformation plan as we pursue our three-year financial objectives.Moving on to our progress update and the deployment of our Kimball International Connect strategy, we introduced Slide 6 in our last call, which is a depiction of our brand positioning, relative size of the brands today, and more importantly, the path and differentiation we’re driving through our Connect strategy. As a reminder, the vertical access is a continuum from standard to custom product type and the horizontal access reflects from commercial to hospitality environment.You will continue to see how the actions we are taking directly relate to the repositioning of our brands. Our portfolio strategy is grounded in maximizing our expertise across the intersection of hospitality and resimercial with an expansion into higher growth markets and product platforms such as custom. Each of our brands in our business units play an important role in this evolution.Turn to Slide 7 where we will focus on the progress made in each of our four pillars of the Kimball International Connect strategy during the quarter. First is inspire our people. On January 13, we announced the creation of two new executive positions at Kimball International. First, with the newly declared consolidation of our global manufacturing operations, Greg Meunier has been promoted to Executive Vice President, Kimball International Global Operations.Greg’s deep experience gained over the course of his 31-year tenure with the company will be an incredible asset in the transition. Greg's relationship with our people and knowledge of our business will allow him to have an immediate impact on the significant opportunity we see ahead.Second, we are implementing a company-wide approach to all corporate business practices, including legal, compliance, and Environmental, Social and Governance (BATS

[Michelle Schroeder:]

Thanks Kristie and good morning everyone. I'd like to turn your attention to Slide 9 as I discussed our second quarter financial performance. We ended the quarter with $192.2 million in sales, which was a decrease of 4.4%. Our net income increased 17% to $11 million. Our adjusted EBITDA of $20.9 million increased 22.9% and resulted in a margin of 10.9%, which was up 240 basis points versus a year ago. Adjusted EPS increased 26.9% to $0.33 compared to $0.26 a year ago.Turning to Slide 10, I'll take you through the details of our financial performance in the quarter. Gross margin improved 170 basis points to 34%. We’ve made progress over the last three quarters in achieving sustaining year-over-year gross margin improvement. Savings from our transformation plan have been a key contributor of that improvement as we realized a $3.8 million of savings this quarter, which resulted in a 200 basis point improvement in margin.Pricing realization also contributed to the improvement to the tune of 200 basis points this quarter. Partially offsetting this improvement was the loss of leverage on the lower revenue and unusually high employee healthcare claims during the second quarter with an increase of $1.5 million over last year on the gross margin line. We feel really good about where the improvement is coming from and that the improvement is real.Selling and administrative expenses increased 30 basis points to 25.9%. On an adjusted basis, where we exclude CEO transition costs and SERP, selling and administrative expenses improved 50 basis points to 25.4%. Adjusted selling and administrative expenses decreased $3.3 million, despite investing $1.8 million in growth initiatives tied to our Kimball international Connect strategy. We expect growth investments to increase during the remainder of the fiscal year.For the quarter, benefits from the transformation plan of $3.3 million and reduced sales commissions of $1 million were partially offset by higher healthcare expense of $700,000, which is in addition to the $1.5 million increase I mentioned earlier that's included in the gross margin line.We were happy with the level of earnings improvement over the prior year considering the expected modest decline in sales. We continue to anticipate some variability in our results as we execute our strategy to realign the Kimball brand and invest for growth. We believe the order growth experienced during the quarter, the actions taken within our Kimball brand and the hospitality opportunity in the Las Vegas market sets us up well to deliver revenue growth in the second half of the fiscal year.Our transformation plan gives us the ability to accelerate our pullback on growth investments based upon top line performance and the delivery of the benefits from our transformation plan. All of this assumes no major disruption due to the coronavirus, which as Kristie mentioned, is very fluid right now.Moving to Slide 11, you will see the chart indicating new product sales performance for our National and Kimball brands. New product sales mix remained at a strong level of 29% of combined National and Kimball brand sales and grew 2% over the prior year. The National brand experienced new product growth of 28% resulting from new ancillary product introductions. New product development remains a key aspect of our growth plan.Let's turn to Slide 12 to discuss sales by vertical. Four of the six product verticals, reported sales declines, led by a 12% decline in commercial and 8% decline in hospitality. Both government and education delivered growth at 15% and 11% respectively. As Kristie mentioned, sales declines were driven by difficult prior-year growth comparison of 29% in commercial, 20% in healthcare and 16% in hospitality. In the prior year quarter, the commercial vertical had a higher than normal concentration of projects contributing to that growth.As we turn next to Slide 13, you will see that all verticals reported order growth in the quarter with hospitality leading with 31% coming from strength within the Las Vegas market. The healthcare vertical grew 10% or 32% on a two-year stacked basis driven by the Kimball brand’s continued investment and strategic shift to this higher growth vertical. The strength in orders along with the 20% growth in backlog positions us well for a solid Q3 and a strong finish to our fiscal year.Turning to our cash flow performance on Slide 14, we generated $2.3 million in cash flow from operations and used $3.8 million in free cash flow. Cash flow was negatively impacted in the quarter by a one-time change in the payout timing of our annual cash incentive plan and the timing of our final accounts payable run at the end of December.We continue to focus on working capital management. CapEx finished at $6.2 million for the quarter, which included completion of the headquarters remodel. We returned $4.6 million of capital to shareholders during the quarter, including $3.3 million in dividends and $1.3 million in share repurchases.Our balance sheet remains strong with minimal debt. Return on invested capital for the quarter finished at 38.4%. Growth in our earnings and discipline in investing our capital over the years have contributed to this impressive performance and we rank among the best relative to our public office furniture peers.On Slide 15 you will see both our acquisition framework and acquisitions we have completed over the last few years. As a reminder, the key takeaway here is that we intend to grow our business, both organically and through acquisitions. We look for acquisition targets that align with our purpose and our Kimball International Connect strategy.These targets would have higher growth products that complement our existing portfolio, new product categories and/or new channels of distribution. An important financial consideration is that the expected return exceeds our weighted average cost of capital within three years post close of a transaction.Turning to Slide 16, we recap our three-year fiscal 2020 through 2022 financial targets, which are unchanged from last quarter. On the top line, we are expecting 4% to 7% organic growth. We’re targeting 150 basis points to 250 basis points of improvement in adjusted EBITDA margin by 2022 and forecasting EPS growth of 10% to 15%. Our outlook is based on assumptions for GDP growth of 1.5% to 2.5%, a flat share count and excludes the impact of any potential acquisitions.I will now turn the call back over to Kristie to provide color on our path forward. Kristie?

[Kristie Juster:]

Thanks, Michelle. Although we do not provide short-term guidance, I think it is important to provide some insight given the patchiness we expect as we execute our transformation plan and invest in our Kimball International Connect strategy.We expect our full fiscal year 2020 growth to outpace this month’s 2020 calendar year growth forecast of 2.2% supported by the strong growth in orders we saw across all verticals in Q2. Our Kimball hospitality growth will be back half loaded due to the installation timing of the Vegas projects. We are now on track to deliver $21 million cost savings for the fiscal 2020, up from the original estimate of $16 million.Our organic growth agenda will start to take shape as we have strong proof in our ability to drive a more cost efficient operating model. Our growth investment year-to-date of $2.8 million will ramp to accelerate future growth. We expect to invest approximately $30 million in CapEx for the full fiscal year 2020. Fiscal 2020 is shaping up to be a strong confirmation in our ability to deliver on our new Kimball International Connect strategy.And with that, I’ll turn the call over to Crystal and we’ll be happy to take your questions.

[Kristie Juster:]

Thank you, Crystal, and thank you for joining us today, and we appreciate your continued interest in Kimball International and we look forward to keeping you informed on our progress. Have a nice day.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a wonderful day.