Kimball International, Inc.
Q1 2018 Earnings Call Transcript

Published: 4 Nov 2017

[Operator:]

Good morning, ladies and gentlemen. My name is Huey and I will be your operator assisting today. At this time, I would like to welcome everyone to Kimball International’s First Quarter 2018 Financial Results Conference Call. [Operator Instructions] As prior to the conference calls, today’s call November 2, 2017 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 or forward-looking statements can be seen in the Kimball International Form 10-K and today’s release. The panel for today’s call is Bob Schneider, Chairman and CEO of Kimball International and Michelle Schroeder, Vice President and Chief Financial Officer of Kimball International. I would now like to turn today’s call over to Bob Schneider. Mr. Schneider, you may begin.

[Bob Schneider:]

Thank you, Huey. Good morning, everyone and welcome to our first quarter fiscal year 2018 conference call. We announced yesterday a pending acquisition and also the financial results for our first quarter ended September 30, 2017. As in prior calls, we have an investor presentation slide deck that has been posted to the Investor Relations section of our website to accompany this conference call. The website includes important information on the acquisition along with trending of our financial results. I will start with a few comments regarding our announcement yesterday of the acquisition of D’style and first quarter sales and order trends before I turn the call over to Michelle, who will provide us with the key financial highlights for the first quarter. We will then open the call to questions from analysts and investors. On prior calls, I mentioned our strategic focus to diversify beyond workspace environments by growing our healthcare, education and hospitality sales. Much of that strategy revolves around organic growth with new products, but also acquisitions. As part of that strategy, I am very excited about the pending acquisition of D’style along with its subsidiary Allan Copley Designs. D’style, which is headquartered in Chula Vista, California, just south of San Diego, is well known and respected in the hospitality industry for providing public space furnishings such as lobby areas and guest room accent pieces with tremendous custom capabilities with steel, glass and other mixed materials. D’style is a natural fit with our existing hospitality brand. They are focused on the public spaces in a hotel complements nicely our strength of providing quality high design guest room furnishing. We have been interested for sometime in increasing our public space offering and they have been interested in increasing their guest room furnishings, making for a great marriage of D’style and Kimball hospitality. Equally important to the strategic fit, I am very encouraged by the similarities of D’style’s values and culture with ours. D’style has been in business for over 25 years and will continue to market products under its brand name. The previous owners have established strong relationships with interior designers in the hospitality industry and will remain in charge of day-to-day operations in their California headquarters. D’style supply chain model has approximately 25% of their product manufactured in their own facility in Tijuana, Mexico and 75% manufactured and purchased from third-party supply partners in Asia. The purchase price for the acquisition will be $20 million, which is inclusive of a $2.2 million contingent earn out and is subject to certain post-closing purchase price adjustments. The $20 million purchase price equates to approximately a 6 times EBITDA multiple. D’style sells primarily in North America with annual sales of approximately $20 million in calendar year 2016. The acquisition is expected to be accretive to earnings in our fiscal year 2018. I’ve mentioned in prior calls, our focus is on acquisitions that can exceed our cost of capital of roughly 10%, and we expect to do that with this investment in a couple of years and thereafter. The expected closing date is within the next 30 days. We are very excited to welcome the employees of D’style to the Kimball Hospitality brand and the Kimball International family. Moving now to a few observations on our first quarter results, clearly, our markets are experiencing some volatility based on competitor earnings releases and looking at our own sales and orders in the first quarter being down. Our sales were down 3% in the first quarter on a tough comparable to last year, but I was very pleased to see that in spite of this decline in sales, we were able to improve earnings to the highest level in over 15 years. More on that shortly from Michelle. Our orders were also down in Q1 by 7%, which seems odd to me given the strength of the economy. As we entered October though, orders began to improve and encouragingly orders ended incredibly strong during October, up 22%. Needless to say, our markets remain choppy and so I wouldn’t overemphasize the order pattern of a quarter or a single month of October. That said, we continued to rollout new products to drive volume. As a reminder last quarter, we provided long-term financial targets. We believe our organic sales will average mid single-digit growth over the next 2 years. With this level of sales growth, we believe we will achieve operating income margins of 9.5% to 10.5% in fiscal 2019 with return on capital exceeding 20%. You probably noted in our release that we achieved 9.4% operating income in the first quarter ending in September, which was fantastic and continued our trend of improved operating results. Please see Page 13 in our investor packet on our IR site for the trend, because the first quarter ended just under the 9.5% low end of our target, you might be wondering why we are still forecasting to hit the target in fiscal 2019 and not sooner. As a reminder, we have a seasonally lower period in our third quarter, so in order to hit the 9.5% to 10.5% target for a fiscal year, we have to have better margins in our first, second and fourth quarters to offset the seasonally low third quarter. As perspective, our margin for all of fiscal ‘17 was 8.2%. As long as the economy remains stable, we believe the 9.5% to 10.5% operating income margin is attainable. Now, I will turn the call over to Michelle for a brief overview of the financial results, before we open the call to your questions. Michelle?

[Michelle Schroeder:]

Thanks Bob. It has been many years since we have done an acquisition and I’m very excited as well about the excellent strategic and cultural fit of the D’style transaction. The product offering and unique capabilities that D’style brings will definitely help to elevate our hospitality brand awareness in the market. Now, moving on to our results, Kimball International’s first quarter sales ended at a $169.5 million, and as Bob noted, this was a decline of 3%. The commercial office furniture market has been challenged the last few quarters, but this was the first time in 17 quarters that our signed compared to the prior year and we knew it was going to be difficult to continue increased sales, because of the multiple year-over-year increases we have had and the very solid first quarter sales growth last year of 12%, that always makes for a tough comparison the following year, which we have experienced this quarter. But even with the sales decline, operating income margin exceeding prior year ending at 9.4% and our return on capital was very strong at 23.2%. Overall, it was a good start to fiscal year 2018 and while we would have liked a sales increase, we are pleased that we were able to improve adjusted operating income margin to 9.4% despite the lower sales. We saw a lot of diversity in our sales among the vertical markets this quarter. Strength in the education and government verticals both with double-digit sales increases was more than offset by softness in the hospitality, healthcare and finance vertical markets. Each of these vertical markets that were down this year had tough comparables with very solid double-digit increases in the first quarter of last year. Overall, quoting activity does remain high and project activity is robust. It seems that final decision-making to move forward on certain projects is taking a little longer and we believe with respect to the healthcare market, softness continues to be impacted by uncertainties surrounding healthcare reform. We are focused on our strategic initiatives around further developing our distribution network and also building upon our delivery of high design and innovative products to gain market share in our market verticals. Now I want to touch a little bit deeper on the hospitality vertical. We have discussed in the past how this vertical is choppy from quarter-to-quarter because of the project nature of the business. And this quarter really provides a good example of that. We expected higher sales of hospitality products this first quarter. However, several hospitality customers requested push out of their delivery dates beyond the first quarter for various reasons. These requests are not uncommon as hotel renovations or new build projects get delayed. However, we had more requests than usual in the first quarter to delay delivery causing low sales volume in the quarter. As a result of these push-outs from Q1, we do expect our second quarter sales in the hospitality vertical market to be at least 25% or so above the $30 million in sales we had this quarter. $30 million was a low quarter. Now that’s going to be a significant ramp up in sales in Q2 compared to the quarter we just ended. Again, this has historically been a choppy sales market and it continues to be so. Overall, growth is continuing in the hospitality industry and quoting activity is high. The latest forecast from PwC expects RevPAR to grow about 2% in calendar year 2018. And as a reminder, RevPAR is revenue per available room and that’s a common metric in the hotel or in the hospitality industry. When looking at sales to all verticals, excluding the hospitality vertical, which does give us a better comparison to BIFMA’s reported industry data, sales excluding hospitality increased 2% in the first quarter as compared to the prior year. BIFMA industry data for September is not yet available. So, we really don’t have a comparison for the quarter, but the industry data showed sales were flat in July and a 2% increase in August. And again, we were up 2% for the quarter. Our new products continued to do well in the market prior to this quarter. Sales of our new products had grown significantly with double-digit growth for 11 quarters in a row with all but one of those quarters exceeding 20% growth over the prior year. As expected, after that level of historical growth, we did see a decline in new product sales this quarter as some products that are still selling extremely well hit that 3-year mark and fell out of the new product category. But of course, we are still selling these products. It’s just one day they were considered the new product and the next day they were not. In fiscal year 2017, we introduced 20 new products between our Kimball International brands that have been very well received in the market and we have some exciting new product introductions and enhancements planned for fiscal year 2018. As Bob mentioned, our Kimball International order volume did slow in the first quarter, with orders ending 7% below the prior year. As a result of the lower orders during the quarter, our consolidated open order backlog at September 30 declined to $122.1 million, which was a 4.5% decrease compared to September of last year, but despite the drop in orders for the quarter, we were encouraged with the strong 22% rebound in orders in October. As I move to operating income results, my comments reflect operating income excluding restructuring gain in the prior year and this non-GAAP disclosure is reconciled in our investor slide deck. So as I mentioned earlier, we were encouraged to see that in spite of the 3% lower sales, we did improve our earnings for the quarter. Our focus on continuous improvement, the benefit of recently implemented price increases and a favorable shift in product mix to higher margin product contributed to the improved operating margins in the first quarter as non-GAAP operating income increased to 9.4% of sales compared to 8.8% in the same quarter last year, again, excluding that restructuring gain. So I am proud to note that this was our highest non-GAAP operating income percent quarter in over 15 years. Our effective tax rate for this first quarter was 33.4% compared to 37.8% in the prior year and the effective rate is lower this year primarily due to a tax benefit that we received for stock compensation that vested during the quarter. Net income for the first quarter improved to $11 million compared to $9.9 million in the prior year, excluding restructuring, which was an 11% increase. Now moving to the balance sheet, our cash, cash equivalents and short-term investment balance was $97.8 million at the end of September. We had operating cash flow in the first quarter of $7 million compared to $13 million in the first quarter of last year. We paid $2.2 million in dividends during the first quarter. In August, our Board approved a 17% dividend increase beginning with the dividend that was just paid in October. We also returned $1.8 million to shareholders in the form of share repurchases during the quarter. Our capital expenditures totaled $6.6 million for the quarter, primarily related to investments in manufacturing, automation, renovation for our corporate headquarters to better reflect the office of today and some showroom renovation. We estimate our total capital spend for fiscal year 2018 will be approximately $25 million, which is higher than normal as we continue these investments. And depreciation and amortization by the way is approximately $15.5 million annually to put the expected CapEx in perspective. Our balance sheet remains strong with very little debt as of September 30. We have a $30 million credit facility and are in compliance with all covenants. With that, I would like to open today’s call to questions. Huey, do we have anyone with questions?

[Bob Schneider:]

Alright. Thank you, Huey and thanks everyone for joining us today. We are very excited about the D’style acquisition and look forward to continued financial progress through the year and our goal to achieve 9.5% to 10.5% operating income in fiscal 2019. We appreciate your interest in Kimball International and look forward to speaking with you on our next call. Thank you and everybody have a great day.

[Operator:]

At this time, listeners, you may now hang up and disconnect from the call. Thank you and have a nice day.