Kimball International, Inc.
Q1 2009 Earnings Call Transcript

Published: 21 Nov 2008

[Operator:]

Good morning, ladies and gentlemen. My name is Nora, and I’ll be your conference call facilitator today. At this time, I’d like to welcome everyone to the Kimball International first quarter fiscal 2009 financial results conference call. All lines have been placed on a listen-only mode to prevent any background noise. As a reminder, today’s call, November 5th, 2008, will be recorded. After the Kimball speaker’s opening remarks, there’ll be a question-and-answer period, where Kimball responds to questions from analysts. (Operator instructions) As with prior conference calls, please be aware that today’s call may contain forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Risk factors that may influence the outcome of the forward-looking statements can be seen in the Kimball Form 10-K and today’s release. The panel for today’s is Jim Thyen, President and Chief Executive Officer of Kimball International; Bob Schneider, Chief Financial Officer of Kimball International; Dan Miller, President-Furniture; and, Don Charron, President-Kimball Electronics Group. I would now like to turn today’s call over to Jim Thyen. Mr. Thyen, you may begin.

[Jim Thyen:]

Thank you, Nora, and welcome everyone to our first quarter conference call. We hope you had an opportunity to review our earnings release issued this morning, on the results of our first quarter ending September 30th, 2008. As in our last conference call, our format today will start with my overview and comments on the quarter, followed by Bob’s financial review. We will then open the call to your questions. As in prior calls, I’ve asked Don Charron, President of our Electronics Group, and Dan Miller, President of our furniture companies, to join us in support of disclosure, understanding our results, and providing you with appropriate information. The earnings we reported today are down from the same quarter last year due to mix changes to lower margin products, more competitive markets, and increases in fuel and commodity costs. We also have underutilized capacity, costs that we are working through our restructuring actions, particularly related to our European consolidation. We are far from pleased with our performance. With that said, I am encouraged that our first quarter net sales, gross profit, and earnings improved over the previous two quarters. While our results are moving in the right direction, I must caution that we are in a very turbulent time due to the credit and financial crisis throughout the world. The volatility and velocity in the market will likely continue into the calendar year. We have several challenges to overcome. Given the economic volatility and the geopolitical uncertainty, we know the US election alone is and will continue to drive a rapidly changing landscape well beyond the November 4 voting results. We know the past few weeks have had dramatic – have dramatically impacted consumer demand, causing uncertainty and anxiety. We know we have little visibility for business beyond the immediate quarter. And we know the automotive industry is in a steep decline. With that said, we continue to see the electronic manufacturing services market as benefiting from outsourcing. And so we believe we are positioned well as a contract manufacturer. As always, quality, reliability, and strong engineering capabilities are valued by our customers and strengthen our relationship. The financial crisis and the economic slowdown will clearly these companies – or those companies, which are larger than we are to push down and to try to serve in our space. It will bring more margin pressure in our markets. It will also cause us to push down and try to serve in a space that is more characterized by high mix, low volume production, especially in our North American plants. Inflation is changing the cost relationship of venues around the world. And clearly, Asia is moving more to serve Asia as the cost and the risk of transportation and logistics becomes a significant component, reducing the gap between our two countries. However, the United States will continue to be challenged by Asia and other lower cost manus, such as India, Northern Africa, Brazil, and Russia. Among our markets, the automotive vertical is the most uncertain for us right now. We clearly know that demand has gone down sharply. We just don’t know how much or for how long. The industrial market has stability in it presently. We are uncertain whether the financial crisis and credit freeze damaged this market for a longer period of time than a couple of months. The medical market and electronics continue to send signals of strength as does the public safety vertical market. Despite the current turmoil, our diversification efforts have enabled net sales growth within our EMS segment for the first quarter of fiscal year 2009 compared to last year. Moving to the furniture segment, we see our markets continuing to tighten and decline. Furniture is more discretionary than some other products in the world. The current overall office furniture market outlook in August was down 4% for the calendar year 2008. That is not a realistically – realistic industry forecast given where we are in the calendar year. Our contract office focused brand is under the greatest pressure. Our mid market brand should continue to benefit from that – from the pressure that is being exerted in the contract office furniture market as the mid market is a lower cost product. Our outlook for the hospitality industry right now is neutral to a decline. The hospitality industry indicators, like RevPAR, clearly, are showing a decline of about 3% for 2009. What remains to be seen is whether our excellence in service and quality will enable us to obtain a larger share of the hospitality market, even though the overall market is smaller. Our financial strength is at a unique position during this time of world economic turmoil. We continue to use our strong balance sheet to look for both – for growth, both organically and through acquisitions, in both electronics and furniture. And to wrap it up, as you are probably aware, the auctions to sell our 27,000 plus acres of timber and farmland will be held over the next three days, Thursday, Friday, and Saturday of this week. As we exited the hardwood raw material market a few years ago and tightened our focus within the furniture segment, having a hardwood timberland operation was examined very closely. Therefore, we felt this investment could benefit the company more by liquidating and using the funds for other future growth opportunities. With that, I would like to turn it over to Bob to discuss our first quarter results in more detail. Bob?

[Bob Schneider:]

Thanks, Jim. We reported today net sales in the first quarter of $339 million – $339.5 million, which is an increase of 2% over the same quarter of the prior year. Importantly, our gross profit declined $9.3 million or 13.7%. During the first quarter, we began our European consolidation efforts announced in April by moving a significant portion of the Ireland production into our Poland facility. In addition to the items Jim mentioned that hurt our first quarter results, this also caused some inefficiencies that we had anticipated. While our first quarter gross profit is a significant decline from a year ago, I want to remind everyone, and this is important, that the drop occurred mostly between the second and third quarters of last year. It was at that time that we saw significant increases in commodity costs, and also a mix shift to lower margin products. Since that time, our gross profit percentage has been stable, and in fact, up slightly. I point this out because the immediate trend is important, and we had discussed the drop in gross profit several quarters ago. However, as Jim said, while improving, we are still not satisfied with our performance. Another important measure is our selling, general, and administrative expenses. In the call in March, we announced a restructuring involving 150 of our management and administrative staff across the company, including corporate. I had mentioned that we were planning for most of this reduction to be completed by June 30th. And therefore, we would begin to see the benefit in the first quarter of fiscal 2009, the quarter that we just ended. That is what occurred, and our SG&A percent of net sales in the first quarter was the lowest in over a decade at 15.7%. Our SG&A spend in the first quarter was $4.9 million lower than last year when we exclude the favorable impact of the SERP liability adjustment mentioned in our press release. But it was not enough to offset the $9.3 million reduction in gross profit that I mentioned earlier. Also benefiting SG&A during the first quarter was lower incentive compensation costs due to lower earnings. Our effective income tax rate for the quarter was 37%, which approximated the prior year first quarter, along with the immediately preceding quarter. As mentioned in our press release, we acquired an EMS company during the quarter, Genesis Electronics Manufacturing in Tampa, Florida. This acquisition supports our growth and diversification strategy, bringing new customers in a key – in key target markets. We will transition the operations and workforce out of the existing Genesis facility and into the current Kimball electronics Tampa facility located less than one mile away. The acquisition did not have a material impact on our financial results in the first quarter. Moving to our balance sheet, cash, cash equivalents, and short term investments less short term borrowings on our revolving credit facility totaled $22 million as of September 30th. This compares to $30 million at the start of the fiscal year, with the decline resulting from our acquisition of Genesis during the quarter and higher than expected inventory levels, in part driven by order push outs by customers. Cash flow from operations during the first quarter totaled a positive $14 million. Our DSO, that’s Day Sales Outstanding, was 45 days, which was no change from the first quarter of last year. While our PDSOH, that’s Production Days Supply on Hand, was 65 days, compared to 57 days in the prior year quarter. We are closely monitoring our inventory, which is still higher than planned. Our AP days, however, have increased to 62 days in the first quarter this year, compared to 56 days last year, which helped to offset the negative cash effects and increased accounts receivable of increased accounts receivable and inventory. With that, I’d like to open up today’s call to questions from analysts. Nora, do we have any analysts with questions in the queue?

[Operator:]

(Operator instructions) One moment please for the first question. And your first question comes from the line of Beth Lilly [ph]. Please proceed.

[Beth Lilly:]

Good morning.

[Bob Schneider:]

Good morning, Beth.

[Jim Thyen:]

Good morning.

[Beth Lilly:]

I wanted to ask a couple of questions. Let’s start with the restructuring that’s occurring in the furniture business that you – that you approved in the first quarter. Can you talk about – and I looked through your Q, it looks like the cost for the furniture restructuring – is it $2.4 million? Is that right?

[Jim Thyen:]

The cost that hit the first quarter with respect to restructuring in furniture, I don’t have it right in front of me, Beth, but it was not that large. I believe the total for the whole quarter is $900,000, if I think – correction, $953,000.

[Beth Lilly:]

Yes. No, my question is, is this going to be the total cost for this – to charge in the furniture segment for the consolidation plan. Is that $2.4 million?

[Jim Thyen:]

No. It is not that long – that high. I don’t recall offhand, Beth, how large that is.

[Beth Lilly:]

Okay. All right. And then on the EMS segment, is the total expected costs are $23 million, correct?

[Jim Thyen:]

Let me go back, Beth, to your first question in terms of the furniture side of the business. The total expected consolidation costs are $1 million.

[Beth Lilly:]

Okay.

[Jim Thyen:]

And that is pre-taxed. The European side, the total restructuring cost within that consolidation, which we had in our last 8-K, with respect – or excuse me, the 10-K, was $20.1 million.

[Beth Lilly:]

Okay, $20.1 million.

[Jim Thyen:]

You add the workforce reduction that we announced, I believe is March 7th, and that was $2.5 million of restructuring cost. Some of that impacted furniture, some impacted electronics, and some was corporate.

[Beth Lilly:]

Okay. And are you able to quantify then what kind of savings you think you’re generate from these charges in the restructurings that are occurring–?

[Jim Thyen:]

We have not disclosed the benefits for the office furniture consolidation or the European consolidation. The workforce reduction plan that we announced in March, we said at that time that it would be $12 million to $13 million annually of savings. And that’s what we’re reporting today in the press release in terms of the benefit that we’re now seeing in the first quarter that we had anticipated, and is actually occurring on an annualized basis to get to that $12 million to $13 million.

[Beth Lilly:]

Yes.

[Jim Thyen:]

Okay. For competitive reasons, Beth, the other restructurings that I just mentioned, we have not disclosed the estimated cost savings.

[Beth Lilly:]

Okay, okay. Do you think there’s going to be a point in time that you’re going to be willing to do that?

[Jim Thyen:]

I don’t think we will. Strategically, we felt that, competitively, it just would not be beneficial for us to share that information.

[Beth Lilly:]

Okay. In the past, you’ve talked about getting the margins in your two businesses, the furniture and the contact manufacturing, up to kind of industry levels. And I’m wondering if you’d be willing to talk about where you are with that plan? One, how long do you think it’s going to take you to get there? I guess that’s, yes. I guess that’s just the issue. Yes.

[Jim Thyen:]

We had mentioned, Beth, I believe that was in our May conference call that in two years, which would have put us to the fourth quarter of fiscal 2010, that we would get to 8% on furniture and 4% in the electronics from an operating margin standpoint. We are looking very closely in terms of the timeline to achieve that given what has transpired from that point until today. Obviously, we have anticipated the impacts in the economy, et cetera. And so we’re – we are exploring just how long it’s going to take to get to that – to get to that – those cost measures in a two-year period.

[Beth Lilly:]

Yes. So there’s a chance that you’re going to push that out then?

[Jim Thyen:]

There is a chance. And important to know and I think you would agree, and all the listeners, there have been absolutely huge changes in the world economy that happened since May.

[Beth Lilly:]

Yes, yes. Okay. The other question I want to ask you is that you’ve got – if I look at your balance sheet, you have over $2 per share in cash. Okay. And you’re about to sell this acreage. And if you look at the transaction prices, it’s all over the map, but anywhere from $2,000 to $4,000 an acre. And so, I have a couple of questions. First is that what would be the tax? How do we look at the proceeds then from those land sales that are going to occur over the next several days? At what rate do we tax them, is it a capital gains rate? And then secondarily, can you talk about the use in the cash because you’re going to – you’re going to have a lot of cash in your balance sheet come Monday morning. I mean, I know it’ll take a while to collect it, but–

[Jim Thyen:]

Yes. The tax rate, they are capital gains. But effectively, the rate for most of the gain is going to be a 35% federal rate. We’re still exploring the ability on some of the timber, and what tax rate, any gain on the sale of that timber that has been held – I believe, the tax law indicates timber held more than 15 years might be eligible for different rates. And we’re trying to explore that. But the overall rate, we approximate for 35% from a federal standpoint. And Beth, I want to qualify one thing that you had indicated in terms of our current cash position. It is very important to look at the total cash that you had indicated, and you have noted that we always report that net of borrowings under our credit facility. And so really, when you look at September 30th, $22 million is really the more economic view in terms of a net cash position on that liquidity. And it was $30 million at June 30th as I had indicated in terms of some of their older comments.

[Beth Lilly:]

Oh I see. Okay. Yes, okay. So it’s $25 million, which is – all right. It’s less than $1 per share.

[Jim Thyen:]

Yes, yes.

[Beth Lilly:]

Okay. But either way, it’s interesting because if you look on Schrader’s Web site and you look at what things are going – what per acres are going for in the different regions, I mean it’s arguably – you’re going to garner a lot of cash from these sales over the next couple of days.

[Jim Thyen:]

Well Beth, of course, we won’t really know until the auctions are done. That’s the nature of the auction. But it certainly puts that asset in the position so the markets can speak what the value is. And yes, we’re hopeful that we have chosen the right time. And with our strategy, starting a couple of years ago when we exited the raw material hardwood component industry, we’re hoping that this is the best time and in the best interest of shareholders to convert that asset.

[Beth Lilly:]

Can you talk about the possible priorities in the use of that cash?

[Jim Thyen:]

Well the priorities, it’s going to go to keep our balance sheet strong and to support our growth and diversification strategy in both of our – our two main segments, furniture and electronics. And we will use it to support both growth organically as well as by acquisition. That’s not growth for growth’s sake. It’s growth to improve our margins and our profitability.

[Beth Lilly:]

And you have a share repurchase program in effect, right? There’s a two-million share buyback.

[Jim Thyen:]

Yes, we do.

[Beth Lilly:]

Okay. And you’ve bought – let’s see here. As I look at your Q, you’ve bought about 33,000 shares under that program, is that correct?

[Jim Thyen:]

Bob?

[Bob Schneider:]

No. We have not purchased any shares. Now I want to remind, Beth, that we did buy roughly two million shares back in fiscal ’08. And it happened, I believe, some of it was in June and some it was in July of the next – of fiscal ’09. But since then, we had renewed the two million authorization, and we’ve not made any purchases under it.

[Beth Lilly:]

Okay, okay. And is there a reason for that?

[Jim Thyen:]

The reason for?

[Beth Lilly:]

That you haven’t been buying back stock.

[Jim Thyen:]

Of course, we constantly, with the Board, evaluate that alternative, and what’s the best use of our cash. And at this time, the Board of Directors has not decided in the short term to exercise that authority.

[Beth Lilly:]

You think that as the cash comes in from these proceeds, you might look at that issue again?

[Jim Thyen:]

We’ll constantly evaluate our options. That’s normal for our Board, constantly examine current situations and what the options are for going forward.

[Beth Lilly:]

Okay. Great. Those are all my questions. Thank you.

[Jim Thyen:]

Thank you, Beth.

[Operator:]

You have no further questions at this time.

[Jim Thyen:]

Okay. That brings us to the end of today’s call. While the volatility in the financial markets is driving tremendous uncertainty around the world, we are well positioned with strong brands, strong businesses, and a strong balance sheet to seize market opportunities as they arise. We appreciate your interest in Kimball. And we look forward to speaking with you on our next call. Thank you. Have a great day.

[Operator:]

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