Kimball International, Inc.
Q4 2017 Earnings Call Transcript

Published: 5 Aug 2017

[Operator:]

Good morning, ladies and gentlemen. My name is Ben and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Kimball International Fourth Quarter and Fiscal Year 2017 Financial Results Conference Call. All lines have been placed on listen-only mode to prevent any background noise. After the Kimball speakers' opening remarks, there will be a question-and-answer period where Kimball will respond to questions from analysts and investors. [Operator Instructions]. As with prior conference calls, today's call, August 3rd, 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 of 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:]

Thanks Ben, and welcome, everyone, to our fourth quarter and fiscal year 2017 conference call. The financial results for our fourth quarter ended June 30, 2017, were released yesterday afternoon after the market closed. As in prior calls, we have an investor presentation slide deck that has been posted to our Investor Relations section of our website to accompany this conference call. The slide deck includes some very important trending, particularly page eight, which we're very proud of, which shows our sales growth and op income improvement. The slide deck makes it much, much easier to see the picture of how Kimball International is performing. So, I hope you're able to see that. I will start today with a few brief comments reflecting back on fiscal year 2017 before I turn the call over to Michelle, who will provide us with the key financial highlights for the fourth quarter. It's key to note that my comments reflect the entire fiscal year, while Michelle will focus on the fourth quarter. We will then open the call to questions from analysts and investors. For our fiscal year 2017, it was an excellent year marked by many achievements. Our 3,000 employees worked tirelessly on developing new and innovative products, strengthening relationships with our design partners, providing exceptional service to our dealers and customers and implementing many, many productivity improvement initiatives. All aimed at serving our customers better, faster and at a lower cost. That effort paid off as our sales for fiscal year 2017 increased 5%, while operating income increased 69% on a GAAP basis or 34% when you exclude restructuring in both years. Our margin improvement during the year was significant. It certainly is very nice leverage to increase profits 34% on a 5% sales increase. I want to now touch on a few of the milestones that I think were significant in 2017. First, we continued our aggressive launch of new products. The workspace is in a constant state of evolution, and today more than ever, the design process is critical in every step of creating today's modern flexible environment. Our team continues to create furniture and workplace solutions that provide designers with the inspiration they need to create innovative workspaces while giving customers a unique platform to portray their brand story. Sales of our new products in fiscal year 2017 increased a very strong 23% over the prior year. This is a key measure and reflects our commitment to continued investment in the development of products that create a more effective working environment for our customers. Both Kimball Office and National Office Furniture showcased several additional new products at the Office Furniture Show in Chicago in June, and that will benefit us in this coming year. Another area of focus in fiscal 2017 was growth with our goal of outpacing the Office Furniture industry order growth rate. I'm pleased to report that our Office Furniture orders increased at a faster pace than the industry, as reported by BIFMA, for the first three quarters of fiscal 2017. We are still awaiting BIFMA's estimate for June to get a read on the fourth quarter. Continuing with our milestones, in fiscal 2017, we completed the sale of our Post Falls, Idaho facility culminating the restructuring of our manufacturing footprint we've been discussing for the last roughly three years. This single effort is resulting in $5 million per year in cost savings and is a significant contributor to our improved earnings. You may recall a couple of years ago, we announced a goal to get to 8% operating income and then we reached it. Then in the first quarter of fiscal -- this fiscal year, we announced an increased mid-term outlook, which looked out 12 to 18 months of mid-single-digit sales growth and consistent operating income margins ranging from 8% to 9%. We exceeded 8% operating income in two of the four quarters during fiscal 2017 and ended the full fiscal year at 8.5% on a GAAP basis. Note, this included a restructuring gain related to the sale of the Post Falls facility. When excluding this gain, our fiscal year operating income ended at 8.2% as a percent of sales, reaching our increased goal of 8% to 9%. Our adjusted return on capital for fiscal year 2017 was 21.5% and exceeded my expectation. Our improved margins, continued keen focus on managing working capital and investing in capital projects expecting a return greater than our cost to capital, were all major contributors. As a reminder, when we calculate this metric, we include cash and capital, so this is the return on all capital available to management. Of course, excluding cash, our return on capital is off the charts. We benchmark very favorably with our competitors and are the best in the industry where public data is available. As I look back on fiscal year 2017, I'm very proud of the team work from all of our employees to achieve the results we did. As I look forward to fiscal year 2018, we believe our strategic initiatives around further developing our distribution network continuing to diversify beyond workspace environments by growing our healthcare, education, and hospitality sales, building upon our delivery of high design and innovative products to the market and focusing on continuous improvement will provide the catalyst for continued sales growth and margin improvement. As a result, we are providing an update on our financial targets. We believe our sales will continue organic growth on average in the mid-single-digits over the next two years. With this sales -- level of sales growth, we believe we will achieve operating income margins of 9.5% to 10.5% in fiscal year 2019 with return on capital exceeding 20%. I've mentioned in past calls that we are working on potential acquisitions and given the fluid nature of such, these sales and earnings targets do not include any acquisitions for ease and clarity. Also to put our new targets into perspective, our operating income margin for fiscal years, 2014, 2015, 2016, and 2017 were respectively 1.6% of sales, 4.8%, 6.4%, and 8.2%, excluding restructuring. Our new 9.5% to 10.5% target continues a very nice trend. There is still choppiness in our markets, but many of the macroeconomic indicators are positive and point to the opportunity for growth. As long as the economy remains stable, we believe the 9.5% to 10.5% op income margin in fiscal 2019 is attainable. Now, I will turn it over to Michelle, for a brief overview of the financial results before we open the call to your questions. Michelle?

[Michelle Schroeder:]

Thanks Bob. While Bob looked back at the entire year and highlighted the accomplishments we achieved, I'm going to drag my comments to the fourth quarter. So, we ended the year with great momentum in the fourth quarter with sales growth of 4%, operating income margin hitting 9%, including a gain on the sale of some excess land that had a 70 basis point favorable impact, we have return on capital of 23% for the quarter and operating cash flow of $15.1 million. The results for the quarter ended at the high end of our expectation. We now have 16 consecutive quarters of year-over-year sales growth, given the choppiness of the furniture markets over the last couple of years, we're very proud to say we had year-over-year sales growth every quarter for the last four years. Looking at our sales by vertical, fourth quarter sales in the government, finance, education, and commercial verticals increased over the prior year. We've seen some nice projects with both federal and state government contracts, resulting in a 29% increase in sales to the government vertical market. In the education market, the late spring and summer are the peak buying periods for educational facilities, and we seized on that opportunity and saw sales growth of 18% in the education market. We also saw a double-digit sales increase in the finance vertical market with sales up 37%. Sales declined in both the healthcare and hospitality vertical markets. We are continuing to see delays in healthcare spending due to the political debates that continue around the Affordable Care Act. And I mentioned last quarter also that we had recently made a leadership change in the Kimball Office healthcare organization. And so we're excited about the future growth opportunities in this vertical market under our new healthcare leadership. Hospitality sales declined in the quarter, partially the result of a very strong prior year comparison. In fact, we had record sales in the hospitality vertical market last year in the fourth quarter. Now taking a different slice at our sales to get a good comparison to the Office Furniture industry. If you look at our Office Furniture industry sales, which includes all verticals except hospitality. Our sales increased a very healthy 11% in the fourth quarter when compared to the prior year. As Bob noted, sales from new Office Furniture products introduced in the last three years were very strong for the entire fiscal year. For the fourth quarter, sales of new products increased 14% and approximately 29% of our total fourth quarter Office Furniture sales. Now, moving to orders, our consolidated orders were flat in the fourth quarter compared to last year. Orders increased in the education, government, finance and hospitality vertical markets, while orders declined in healthcare and commercial markets. If you recall in last quarter's conference call, we highlighted that our National Office Furniture brand implemented a price increase effective April 1st, and we estimated this had the effect of pulling approximately $6 million to $8 million of orders forward into the third quarter that would have otherwise been received in the fourth quarter. So, this was a boost to our orders last quarter as we disclosed. This quarter, of course, has the opposite effect. So, adjusting for this impact, consolidated orders in the fourth quarter would have increased by approximately 4%. Now looking at, again, Office Furniture orders, which excludes hospitality, they declined 1% in the fourth quarter and adjusting for the impact of the price increase Office Furniture orders would have increased 4%. As Bob mentioned, we don't have June industry data from BIFMA yet to determine if we outpaced the industry again this quarter. If you look just at April and May, the industry was down 6% in April, but rebounded in May with a 3% increase in order, which averages to a decline of 2% for those two months. Again, for the entire quarter, we were up 4%, excluding the impact of the price increase. The consolidated open order backlog at June 30th increased to $131.6 million, which is a 1% increase compared to June of last year. Our order backlog is the highest it has been in several years, which is very encouraging as we begin fiscal year 2018. As I move to operating income results, my comments reflect operating income, excluding restructuring costs and this non-GAAP disclosure is reconciled in our investor slide deck. So, non-GAAP operating income in the fourth quarter increased 42% compared to last year. Operating income margin was 9% compared to 6.6% in the same quarter last year, excluding restructuring. The current year fourth quarter includes a $1.2 million pretax gain on the sale of excess land we sold, which positively impacted our operating margins by 70 basis points. So, excluding this gain, our operating income was 8.3%. In addition to the leverage gained on the higher sales volumes, we are also realizing the full $1.3 million of benefits from the Idaho facility exit, which contributed to the improved results compared to last year. We were also successful in collecting on an outstanding note that we had partially reserved. So, we recognized income of approximately $490,000 as we brought that reserve back to income. Increased incentive compensation costs, resulting from the improved earnings partially offset these improvements. The effective tax rate for the fourth quarter was 33.4% compared to 34.5% in the prior year. Our effective rate is a little lower this year because our domestic manufacturing deduction credit was higher with the increased earnings. Net income for the fourth quarter improved to $10.6 million compared to $7.1 million in the prior year, excluding restructuring. Moving to the balance sheet as of June 30, our cash, cash equivalents, and short-term investments balance was at $98.6 million. Operating cash flow in the fourth quarter was $15.1 million compared to $9.2 million in the fourth quarter of last year. We paid $2.2 million in dividends during the fourth quarter. Our capital expenditures totaled $4.4 million in the fourth quarter. Capital expenditures ended a little lower than we originally estimated for this fiscal year as we did push some expenditures into fiscal year 2018 and we estimate our total capital spend for fiscal year 2018 will be approximately $25 million to $30 million, which is higher than normal. The higher capital spend in 2018 includes investments in manufacturing automation and cost to renovate our corporate and Kimball Office headquarters, to better reflect the new layout and design of offices today. Our balance sheet remains strong with very little debt as of June 30. We have a $30 million credit facility for Kimball International and are in compliance with all covenants. In closing, we were very pleased with the progress made in fiscal 2017 and we're excited about the momentum we have going into fiscal year 2018. With that, I would like to open the call today for questions. Ben, do we have anyone with questions?

[Operator:]

[Operator Instructions] Our first question comes from the line of Kathryn Thompson of Thompson Research Group. Your line is open. Please proceed.

[Steven Ramsey:]

Good morning guys. This is Steven on for Kathryn.

[Bob Schneider:]

Good morning Steven.

[Michelle Schroeder:]

Good morning Steven.

[Steven Ramsey:]

I have a few questions more regarding your outlook on margin and sales. On margin improvement in the next couple of years, how much of that is from better volumes on fixed costs? And if sales turned slightly negative over that timeframe, would margin improvement still be possible?

[Bob Schneider:]

It's primarily driven by volume, Steven. There are many, many continuous improvement efforts that we're doing on our cost structure. So, that will have some benefit, but the primary driver is increased volume. And along with the new product introductions that generally have a higher margin associated with those will give us some lift also.

[Steven Ramsey:]

Okay. And then are you able to just even thinking broadly, if sales turned slightly negative in low single-digits, is margin -- operating margin improvement still achievable?

[Bob Schneider:]

Yes, as I mentioned, there are some elements that go to continuous improvement and also the new products that we're introducing. But to get to the 10.5% level, we're going to need volume to get us there.

[Steven Ramsey:]

Okay, great. And then I did want to follow up on the new products because it's obviously been a big factor of your success. And you've -- I would say kind of officially come-off with a low base on new products. Does this create a headwind to sales or margin improvement over the next two years because of your success? And to follow-up, how high as a percent of total sales, do you think new products could get to in the next couple of years?

[Bob Schneider:]

Yes, we clearly -- as you look at our turnaround over the last three years and the sales volume increases, we clearly are getting to a point now where we are healthy and therefore, comparables get tougher. The new product introductions this last quarter were up -- sales were up 14% on new products. If you go back, I don't know maybe three quarters ago, it was much, much higher than that. And so it's very, very clear that eventually you're going to get to the point that comparables get tougher, the increases -- percentage increases will get lower. But we clearly are going to be continuing with the efforts we have been doing on new products and we'll be reaping the benefit of that higher margin on those new products as we go forward. But comparison to prior years, it's going to get tougher just by virtue of the math and three years of working to get healthy and then getting healthy, it does make it tougher to have those percentage increases.

[Steven Ramsey:]

Right. And then on sales and I think some of your commentary points to this, the industry both this month publicly traded peers have reported mixed and choppy sales and order trends in the past 18 to 24 months in an inherently volatile industry. And I guess, two questions on this. Why do you believe you guys have maintained positive sales in order trends through this timeframe? And do you believe this success will result in tough comps for you guys in the next couple of years?

[Bob Schneider:]

I think over the next couple of years, we're going to continue to push and strive to take market share. We've been doing it for many, many quarters. We don't know the results yet for the fourth quarter. But I see that effort absolutely continuing. And in terms of putting a strain on margin, going back to what I said earlier, it clearly gets tougher as we're now to the point -- past the point of turnaround and more to healthy stage and then more normal growth and it makes that a little bit tougher.

[Steven Ramsey:]

Excellent. And then last question on the automation effort. How widespread are you trying to push automation through your operations? And maybe discuss some of the benefits from that?

[Bob Schneider:]

Yes, good question. We've been doing robotics and automation really for maybe three or four years. And we're putting a lot of that increase -- and Michelle talked about in terms of CapEx this coming year in that area. The challenge in most of the locales where we have operations is generally low unemployment. And so we have to think very creatively where we can use automation to be able to grow this business and it's a significant portion of our capital spend as we go forward. That said, in terms of the increase over normal depreciation levels, which is around $16 million a year. The biggest portion of that increase getting up to the $25 million to $30 million is the work that we're going to do on the Kimball Office and the Kimball International headquarters to renovate this facility to better reflect the way designers are looking at buildings today and the furniture in those buildings.

[Steven Ramsey:]

Excellent. That will do it for me. Thanks.

[Bob Schneider:]

Thanks Steven.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Paul Sonkin of Gabelli. Your line is open. Please proceed.

[Paul Sonkin:]

Good morning.

[Bob Schneider:]

Good morning Paul.

[Paul Sonkin:]

I guess following up a little bit on new product introductions. I guess could you talk a little bit about designers that you're working with? And kind of like what the pipeline looks like? I think you'd discussed that in the past?

[Bob Schneider:]

Yes, we have. We haven't been specific on the designers, Paul. And for competitive reasons, I don't want to do it here today. But we've had designers working with us and sometimes interior design firms help in terms of designing product that today is available for sale and getting very, very good reviews and winning a lot of awards. And actually, some of the awards that are in our slide deck came from product that was designed by some international designers, in one case that comes to mind.

[Paul Sonkin:]

And then I guess, do you have any -- like are you rolling out anything big at any trade shows over the next six months?

[Bob Schneider:]

Well, the trade show that just ended in June. We had around -- it was 14 or 15 new products introduced and those products will be ready for order over the coming couple of quarters or so and that is the biggest trade show of the year. There are a few other smaller throughout the year. But we introduced quite a few products, just this past June. And really continuing the trend, Paul, of what we've done for about three years at that level of significant product introductions. And now it's working to get all those products ready for order.

[Paul Sonkin:]

Got you. And then I guess, $98 million of cash. Could you just talk about what -- kind of what you're thinking in terms of different alternatives?

[Bob Schneider:]

Yes. What you've clearly--

[Paul Sonkin:]

You knew that question was coming?

[Bob Schneider:]

Yes, every call. Clearly, we have a lot of cash. We are positioned very, very well for growth as we look at a few things. We're doing things in terms of organic growth, automation of our facilities is one important use for our cash going forward. We will consistently look at the marketplace in terms of our stock to buy back stock, to avoid dilution for new stock issuance to -- for executive incentive compensation. And then we will also look at buybacks where it makes sense at the proper evaluation. And then lastly, looking at acquisitions and that is something that we are continuing to do and literally every week, there are deals that come across our desk and some get more scrutiny than others, and we're going to continue that effort. And I recognize we have not done an acquisition in a couple of decades or so in the furniture side of our company. But I'm very confident that we are going to find an acquisition that would add value to this company, certainly, beat our cost of capital by a wide margin we would hope and help our margins going forward. But that remains to be seen, but just -- I shared that, just so you know, our intention and our efforts is very much to grow this company and fill where we might have product voids et cetera and using a great capital structure to allow us to do that.

[Paul Sonkin:]

Okay. I guess the obnoxious question would be return on invested capital including cash or excluding cash because excluding cash, you're at like 49%, which is insane?

[Bob Schneider:]

Yes. It's going to be very difficult to find a company that has return on capital to that level.

[Paul Sonkin:]

How much you're going into software?

[Bob Schneider:]

Yes, yes. But we certainly, Paul as we talked about in the past, we are going to be very sensitive to how any acquisition impacts both of our metrics, of return on capital from operations and the overall holistic return on capital of the total amount of capital of this company. We will look at both of those and we will also look very closely at our cost to capital, which of course, is lower than either of the other two and be sensitive of what impact any acquisition would have on that also.

[Paul Sonkin:]

Now, -- so how is the environment for acquisitions looking? I mean, are people delusional in terms of what their businesses are worth, like -- what is the environment like?

[Bob Schneider:]

I would say in some cases, the valuations are quite high. And we're very sensitive to the analysis of that and what it would take to buy a company with a high valuation and what kind of goodwill would it put on our books and put us at risk to someday write-down that goodwill, which you so often see. But I would say not everyone is of that opinion of extremely high valuations and we're seeing a mix of both.

[Paul Sonkin:]

Just in terms of scale, and I know I ask this question every time. Like what -- would you do something like $20 million, $100 million, $300 million like--?

[Bob Schneider:]

Very, very good question, Paul. And I assure you given the experience level and history of our company on acquisitions on the furniture side of the company that we will put our foot in the water first, but not dive in, in terms of a hugely significant acquisition. And -- so when you mentioned $100 million, $300 million, those are extremely large for a company that some people have been involved with acquisitions before. But a lot of our folks have not. And so we're going to be deliberate on the size of the company we think we could digest and get experience with out of the gate.

[Paul Sonkin:]

All right. That's a very good answer. Thanks.

[Bob Schneider:]

Thank you, Paul.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Kathryn Thompson of Thompson Research Group. Your line is open. Please go ahead.

[Steven Ramsey:]

Hey guys. I had a quick follow-up on the acquisition topic. A few publicly-traded peers have businesses outside of the Office Furniture industry, some of the dynamics there less volatile sales orders, and therefore, of margins. Is there any interest to expand into a new market?

[Bob Schneider:]

Steve, we will -- we want to definitely keep in mind the market verticals we're in. Some of them just how -- what those growth rates are and the structural challenges in terms of Office Furniture. We will be very, very sensitive to that. I certainly can see the day in the future where we are looking at a market that might be one lane over, a little bit different than perhaps what we're doing today. But we'd certainly build on and leverage our core competencies. We'd certainly relate to the design community that we have such good relationships with and allow us to leverage that. But getting back to the question Paul had asked in terms of getting out of the gate or initially in terms of acquisitions, I think it's more prudent to stay maybe in our own backyard with our first acquisition and not venture too far away, given just our exposure and experience level with deals, given as I said, earlier, we haven't done an acquisition on the furniture side of this company for so long. And I do want to clarify so that all listening understand, there are several folks within the management team of Kimball International that have a lot of experience on deal structure and acquisitions, as they worked on the Electronic side of our company a few years ago before the spinoff. So, I don't mean to imply that there is not experience on valuation, deal structure, and post-acquisition planning. What I mean is the Furniture side of our company has not done an acquisition in a couple of decades, whereas, as you may know, three years ago and prior, we had done many, many acquisitions. They just were all on the Electronic side.

[Steven Ramsey:]

Excellent. Thank you.

[Bob Schneider:]

Thanks Steven.

[Operator:]

Thank you. [Operator Instructions] And I'm showing no additional questions in queue. I would like to turn the conference back over to Mr. Bob Schneider for any closing remarks.

[Bob Schneider:]

All right. Thanks Ben and thanks all of you for joining us today. Fiscal year 2017 was a milestone year in our journey to achieve 8% op income. We could not have accomplished what we did without the efforts and engagement of every one of our 3,000-plus employees. And we're so very much appreciate it -- appreciate that. We are excited about the opportunities that lie ahead in fiscal year 2018 and we appreciate your interest in Kimball International. We look forward to speaking with you on our next call. Thanks. And everyone have a great day.

[Operator:]

At this time, listeners may simply hang up to disconnect from the call. Thank you. And have a nice day.