Kimball International, Inc.
Q2 2009 Earnings Call Transcript

Published: 6 Feb 2009

[Operator:]

Good morning, ladies and gentlemen. My name is (Tania), and I’ll be your conference call facilitator today. At this time, I would like to welcome everyone to the Kimball International Second Quarter Fiscal 2009 Financial Results Conference Call. All lines have been placed on listen-only mode to prevent any background noise. After the Kimball speaker’s opening remarks there will be a question-and-answer period where Kimball will respond to questions from analysts. (Operator instructions) As with prior conference calls, today’s call February 6 2009 will be recorded and may contain forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Risk factors that may influence the outcome of forward-looking statements can be seen in the Kimball Form 10-K and today’s release. The panel for today’s call, is Jim Thyen, President and Chief Executive Officer of Kimball International; and Bob Schneider, Chief Financial Officer. I will now like to turn today’s call over to Jim Thyen. Mr. Thyen, you may begin.

[James C. Thyen:]

Thank you, (Tania), and welcome everyone to our second quarter conference call. We hope you had an opportunity to review our earnings release issued this morning, on the results of our second fiscal quarter ended December 31st, 2008. As in our last conference call, our format today will start with my overview comments on the quarter, followed by Bob’s financial review. We will then open the call to your questions. As we know and feel everyday, we are in unprecedented times in the world economy. Financial and housing markets froze during the second fiscal quarter, consumer spending declined dramatically as the U.S. economy along with the other major economies around the world, began an abrupt slowdown in November and December. This trend is continuing today. As the furniture, automotive, and industrial market verticals, in which Kimball competes, were not immune to these forces at work. We began to see noticeable reductions in order trends during the latter weeks of the second fiscal quarter. We took immediate action during the second quarter to conserve cash, improve liquidity and keep our cost structures competitive. We sort and still do to minimize the impact to our customers and sustain our top line sales. The challenges of the credit markets are severe. Burden is broad and deep materially increasing financial and operating risk. Contingency plans have been implemented and are constantly being updated. As it is yet to be determined, how long this economic decline will last, and how deep it will extend given the uncertainty of government intervention. Capital expenditures are being deferred, working capital, particularly trade receivables and inventory is being closely monitored. The expanded processes and procedures for risk assessment of our supply chain to avoid or minimize supply interruptions. Cost structure is a topic that we have discussed in past webcasts. Recall that in the first quarter, we discussed our low selling and administrative expense as a percent to sales. This trend continued in the second fiscal quarter. Actions taken to simplify our business, reduced process complexity, and to eliminate bureaucracy, continue to be a high importance. As the economy continues to decline, all of our markets seek agility, flexibility and responsive service. Much of this is being accomplished with continued leverage of our past information system investments. Our administrative staff is nearly 10% smaller than a year ago, due to these efforts. As a result, our selling and administrative expense in the second quarter declined 19% or $11.2 million, compared to one year ago. And Bob will discuss the reasons for that decline shortly. These cost reductions though are not enough to offset the declining market trends. We had many successes in our just ended second fiscal quarter. New office furniture products introduced at June, at NEOCON, achieved commercial success as planned. National’s Aurora seating had a very successful launch. Our Kimball office product hum minds at work furniture system, has achieved recognition with several important design awards, since introduction and it is having a market impact. Additionally, we continue to have excellent success in the hospitality market during the second fiscal quarter. A record level of sales was achieved with numerous new custom products designed, delivered, and installed in this period. Our excellence in quality, reliability, and service value was rewarded as several key customers across the number of markets we serve chose to reduce their cost structure by changing their sourcing strategy and informing us of their decision to consolidate supply with Kimball. We are extremely pleased with the results achieved in the sale of our Timberlands and related properties. In addition to obtaining maximum value for our shareholders, I am very confident in our excellence in environmental stewardship of these properties will be sustained by the new owners. Our marketing process brought to the auction future owners having similar values in hardwood timber management and land stewardship as those of Kimball. The integration of the acquired company Genesis Electronics, into our electronic segment, continues to be managed very well and is proceeding on plan. It has brought the additional diversified business intended by the acquisition. Among our markets as I look forward, the climate of consumer anxiety and uncertainty, the highly stressed international financial markets, and the depressed U.S. housing market, along with the growing unemployment rate remain upper most in our minds. The automotive market vertical is the most uncertain for us right now. We clearly know that world demand will go down. We just don’t know how much farther and for how long. As we’ve mentioned in our prior webcasts, we have been working diligently in diversifying our markets in electronics. In the second quarter, our sales of automotive electronics that ended up in GM, Ford, and Chrysler vehicles, sold here in North America, represented approximately 11% of our total Electronics segment sales, and only approximately 6% of consolidated Kimball International. This is the lowest mix of sales in over a decade and was well - was managed very well as we diversified with other automotive customers and also other end verticals in electronics. Industrial market is showing weakness due to the slowing commercial activity, along with reduced residential construction, and remodeling, and the general decline in consumption in our nation. The medical market in electronics continues to send signals of strength, as thus the public safety vertical market. We see our order volumes continuing to tighten and decline in the Furniture segment. Furniture is more discretionary and some other products purchased in the world. Vacancy rates on commercial properties are increasing. Occupancy rates and per room revenue rates are declining in the hospitality industry The current office furniture market outlook by BIFMA is forecasted down approximately 10% for 2009, calendar year. Our contract office furniture Focus brand is under the greatest pressure, because of its project nature, and dependency on the availability of commercial credit. Our mid-market office furniture brand is also experiencing reduced order rates, as even smaller businesses are choosing to defer discretionary spending. Our outlook for the hospitality market right now is declining, for the same reasons of lack of credit availability and decline in consumer spending. The hospitality market has longer lead times and therefore we have clarity of sales revenue a bit further in the future than many of our other products. Accordingly, orders won in previous months will be shipping over the coming quarter. But thereafter, we will begin to see the economic downturn impact this portion of our business more significantly. What remains to be seen is whether our excellence in servicing quality will enable us to obtain a larger share of the hospitality market, even though the overall market is significantly smaller. We know the past few months have dramatically impacted consumer demand, causing uncertainty and anxiety. All of this has impacted our recent order trends and as a result, our open orders at December 31 2008, being 11% lower in the Furniture segment and just three months ago at September 30 and 16% lower in the Electronics segment. This will impact our third quarter sales and earnings. Like most companies, we have much less visibility, for order patterns beyond the immediate quarter. Our financial strength gives us an advantage during this time of world economic turmoil. We continue to use our strong balance sheet to try to achieve growth in sales, both organically and through acquisitions in both Electronics and Furniture. With that I would like to turn it over to Bob to discuss our second quarter results in greater detail. Bob?

[Robert F. Schneider:]

Thanks, Jim. We reported today net sales in the second quarter of $327.6 million, which is a decrease of 6% from the same quarter of the prior year. The Electronics segment and the Furniture segment were each down 6%. Importantly, our gross profit declined $10.4 million or 15.5% that is a significant decline from a year ago, but I want to remind everyone that the drop in our gross profit as a percent of sales occurred mostly between the second and the third quarters of last fiscal 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 percent has been stable and in fact up slightly at 17.2%. This was an important point. I point this out because the immediate trend is important and we had discussed the gross profit - the drop in gross profit several quarters ago. As an update on commodity prices, while we have seen several commodities drop significantly in the second quarter, it will take sometime before we see that positively impact our cost of goods sold. It is also important to note that steel, for example, while it is dropped in price per ton significantly in the second quarter, it is still approximately 40% higher than a year ago. Jim mentioned our reduction in selling and administrative expenses of $11.2 million from Q2 of last year, which is a significant reduction. This led to our selling and administrative expenses for the second quarter, being only 15% of sales beating the much-improved Q1 percent of 15.7%. Recall in March of 2008, we announced a restructuring, involving 150 of our management and administrative staff across the company including at corporate. I had mentioned in previous conference calls that we were planning for most of these reductions to be completed by June 30 of 2008, and therefore we would begin to see the cost benefit in Q1 of fiscal 2009. That is what occurred in our selling and administrative expenses as a percent of net sales in Q2 was the lowest in over a decade at 15%. Our actual office staff reduction over the past year ended up beating 175 positions. Also benefiting selling and administrative expense during the second quarter was lower incentive compensation cost, which is linked to earnings and the usual SERP accrual, that is our supplemental employee retirement plan. As I mentioned in the past, we have a non-qualified retirement plan that is funded primarily with employee contributions over the years. This plan is administered by Vanguard with investments in various funds. Since it is non-qualified, the poor performance of these funds, these investments in the second quarter due to the stock market decline is recorded in other income expense net as a loss of $2.2 million. The same amount is recorded as income in selling and administrative expense and therefore there is no effect on overall profitability. That said, to get to the correct economic change in our selling and administrative expense, we have to add the $2.2 million to our expense for the quarter. I mentioned this because even doing this, we still have a selling and administrative percent of sales that is best in the last decade. Also, you may have noticed a new line on our P&L that being other general income. This comprises two specific items that occurred during the second quarter. The first has to do with the planned sale of our Poland facility, and subsequent lease back. As background, we had an agreement on April 11, 2008 with a party in Poland to sell and lease back the facility and real estate that houses our current Poznan Poland operation. We plan to lease back the building until December 2011, at which time we will have completed the consolidation of our European operations into a newly constructed facility in Poland. The closing on the sale of the existing facility was planned to occur in the second quarter, but the buyer was unable to close the transaction due to financing reasons. Pursuant to the agreement, Kimball was entitled to retain approximately 1.4 million euros or approximately $1.9 million of deposit funds which was recorded as income in the new other general income line. Additionally, we will continue to market the current facilities in real estate. The second amount included in the other general income line is the pretax gain on the sale of a portion of our Timberlands that Jim referred to. As previously announced, we held an auction of our 27,200 acres of hardwood Timberlands in early November, this asset was no longer strategic to Kimball International, and we had decided earlier in the year to convert it to cash for use in growing our Furniture and Electronics segments. The total proceeds from the sales were $50.6 million, with over 75 different buyers of the various parcels. Final closing dates on the sales were based on completion of land surveys, $11 million closed in December, and the remainder is planned for closing in Q3. The $11 million amount in December resulted in a pretax gain of $8 million for the second quarter. That amount plus the $1.9 million of income related to the deposit funds for the terminated Poland facility sale, totals to the $9.9 million of other general income you see on our P&L in the second quarter. Restructuring recorded during the quarter totaled $1.1 million and related primarily to the EMS segment’s European consolidation activities that we had perviously disclosed. Exclusive of the other general income and the restructuring expenses, income from continuing operations was $2.5 million for the second quarter, and that compares to $4.6 million in the same quarter of the prior year. The decline of 46% is driven by higher commodity costs and lower volumes, which reduced our opportunity to leverage our fixed costs. Note that the income from continuing operations excluding restructuring and other general income that I just referenced are non-GAAP financial measures. Refer to our press release for a reconciliation to the reported GAAP income from continuing operations measures. Our effective income tax rate for the quarter was 33.6%, which approximated the prior year second quarter. The second quarter was favorably impacted by an $800,000 tax benefit related to our European operations, and also a positive $500,000 adjustment related to a research and development tax credit in United States. You may recall that the R&D credit expired December 31, 2007, it was retroactively reinstated by Congress on October 3 2008, which then allowed us to record a catch-up entry for all of calendar year 2008 and the benefit shows up in our second quarter. Moving to our balance sheet, cash, cash equivalents, and short-term investments less short-term borrowings on our revolving credit facility totaled $7.6 million as of December 31. This compares to $22 million at the start of the second quarter. Operating cash flow for the second quarter was a negative $1.1 million, compared to a positive $12.4 million in the second quarter of the prior year, driven primarily by timing of accounts payable payments along with the lower income from our core operations. We’ve also seen a slowing of accounts receivable collections in the latter part of the second quarter. Total short-term liquidity available, represented as our cash, cash equivalents, and short-term investments, plus the unused amount on our revolving credit facility amounts to $110.6 million as of December 31 2008. We continue to have virtually no long-term debt, which amounts to only $410,000 at December 31 2008 and also total shareowner’s equity balance of $377.7 million at December 31. With that, I would like to open up today’s call to questions from analysts. (Tania) do we have any analyst with questions in the queue?

[Operator:]

(Operator Instructions) One moment please for the first question. And your first question will come from Beth Lilly of Woodland Partners. You may ask your question.

[Elizabeth M. Lilly:]

Good morning everybody, it’s Beth Lilly calling.

[James C. Thyen:]

Hello Beth.

[Elizabeth M. Lilly:]

And I have a couple questions. I wanted to just, can you walk me through the cash and then the short-term debt on the balance sheet and so, what is the net cash number? I missed that?

[James C. Thyen:]

The net cash Beth, net of the revolver is $7.6 million.

[Elizabeth M. Lilly:]

Okay, so the revolver is how much then?

[James C. Thyen:]

The revolver is $72.3 million and the cash and short-term investments is $79.9.

[Elizabeth M. Lilly:]

Okay. Okay great. And then just so I can understand in terms of the land sale. So, if my math is correct you’re going to get - you generated $50.6 million in total brokerage right for all 27,200 plus okay.

[James C. Thyen:]

That’s correct.

[Elizabeth M. Lilly:]

And you have received so far $11 million of that 50.6?

[James C. Thyen:]

That is correct. The $39 million to come in Q3.

[Elizabeth M. Lilly:]

Okay so, and what will be the gain on that $39.6 then?

[James C. Thyen:]

The pretax gain in the third quarter will be $23 million, and the net income effect of that is in the neighborhood of $13 million

[James C. Thyen:]

Beth I’ll have to explain that a little bit better. Starting at a higher level, our strategies in each one of our markets have not changed due to this economic climate, but our priorities have. And clearly our first priority goes to what you and Bob are just been talking about liquidity, age preservation, and how we deploy our capital - the utilization of our capital. The second priority is our cost structure and that is the focus of your question and it really goes to maintaining our financial health and being competitive in the marketplace. We have a goal of 8% operating income for Furniture, and 4% operating income for Electronics. We set that goal before this economic decline started and we intend to keep that goal although we’ve recognized this economic crisis causes us to evaluate whether we should extend the timeline from the date that we are originally said it. So, the SG&A and the cost of goods, all has to be reduced continuously, before going to hit those operating income goals.

[Elizabeth M. Lilly:]

And so would you remind me Jim of what’s your target date to hit those goals in those two businesses?

[James C. Thyen:]

Originally, we said the fourth quarter of ‘10 fiscal year ‘10, but that was before this severe economic climate and financial crisis came upon the world, our nation. And we are going to do what we need to do to remain healthy and stay committed to our strategies. Our fourth priority - our third priority is to retain our core. Liquidity, cost structure, retain our core, and that goes to both our capability in our people, as we go through these very severe economic times. So, we are going to remain true to those and I think that’s going to mean that, quarter four of fiscal year ’010, which was a very realistic goal before this economic crisis came on us. It’s probably going to have to be extended a little bit.

[Elizabeth M. Lilly:]

So, maybe 2011?

[James C. Thyen:]

We haven’t decided yet.

[Elizabeth M. Lilly:]

Yeah. Okay, so do you think there is additional costs that can come out your - out of the SG&A line?

[James C. Thyen:]

I think it’s a continuous journey. It’s a daily journey. I think we have to be relentless in eliminating bureaucracy, complexity, and try to keep that cost moving down. On the flip side, and on today’s world we seem to be, we don’t quite know, which way we are tipping between deflation and inflation. And lack of clarity that we have with this uncertainty and anxiety is going to make determination between deflation and inflation, very hard to determine in the short-term. Let me clearly, if you look at just fuel price declines what have you the spending power of the dollar has gone up, but I don’t know that it will sustain and that’s pretty important to our cost ratios.

[Robert Schneider:]

Beth I would just add in terms of the SG&A percent. Part of the challenge is just estimating what sales will be going forward and as we’ve indicated the backorder levels being down going into Q3, bakes it for a difficult sales quarter and consequently goes to the matter of - to what degree might sales be down relative to what we do with our cost structure.

[James C. Thyen:]

It varies with sales, as you know on the administrative we view as discretionary, just having different timelines of discretionary spending, but we believe it’s a controllable expense. We must continuously focus on reducing, continuously collaborate with all our supply partners to get - keep that cost going down.

[Elizabeth M. Lilly:]

Can we have a - let’s shift gears for a second and just talk about the two businesses and, EMS and the Furniture segments. The Furniture segment earns money in the quarter and if you look out, do you think that Furniture, the Furniture business will earn money for the year as well as do you think EMS can earn money for the year? I think that both be profitable?

[James C. Thyen:]

Well everything we do is aimed at try and achieve profitability. The economic climate as you know, and as I tried to articulate in my opening comments, it’s pretty uncertain right now for calendar year 2009.

[Elizabeth M. Lilly:]

So you’re not willing to say, I mean, if the present environment continues, do you think Furniture can earn money?

[James C. Thyen:]

As we generally – we do not provide earnings guidance. We try to provide you with appropriate information. Allow you to translate that into what you think future results might be. And I mean, the global economic turmoil is dramatically affected. Order patterns, it’s affected all of our markets. The patterns are little bit more volatile. It’s a lot more challenging to manage. We see the challenging continuing. We don’t see the clarity coming. What - right at this time, in the nation or the world. And so, we’re going to - our priorities is to focus on that liquidity, our cash preservation and number two is our cost structure and all of that is designed to string and return to our shareholder. But we honestly, we don’t give guidance for the future outlook.

[Elizabeth M. Lilly:]

Okay, last question is, as the cash comes in from the land sales and I want to congratulate you on that on selling that the excess lands. Could you talk about the priorities and is share repurchase is an option?

[Robert Schneider:]

Share repurchase, I guess is always an option. We do have the authority given from the board. And certainly, the Board really has the first choice on, I guess how cash is used, firms are deployed in the business. We are going to we intend to stay focused on our four strategies of a barrier a little bit based upon the vertical markets, because we believe strongly and being market-driven and customer-centered and so the demands of customers in the automotive market are little bit different than the medical, little bit different than the mid-market office furniture, and the hospitality. We intend to preserve our balance sheet strength, and then focus on continuing to grow and diversify our business. We want to keep our operational excellence very high. So, we are going continue to invest in tools like Lean and Kaizen and Six Sigma, to keep our quality and reliability and our service to our customers are very high. We believe the scorecards we get from our customers are very important to going through this economic storm and I have indicated that in my opening comments that we have seen some of our customers recognize that value and as they have chosen to lower their cost structure and consolidate, and perhaps choosing a little bit different risk threshold on suppliers. Several of them are consolidating with Kimball as their choice. I think that’s a result of our high quality or high reliability, our high service package. It comes from our people. Finally, we intend to continue invest in our people, in our information systems, and all the tools that enable our people up to succeed for our shareholders. And we are going to try to do that and return to profit. Now the water if you will for everybody in this competitive landscape has gotten a lot lower, there are more rocks sticking up. It takes greater skill to navigate through these. And I believe unless the unemployment rate starts to head the other way, so that consumers can start consuming, so our residential market starts to turn. All that has to be start to move in that direction if this credit crisis is going to enthrone and give all of us maybe a little bit easier competitive landscape to grow and produce profitability. I'm not telling you anything you don’t already know, it's a very precarious time that we’re at, and all of our markets are right there in that economic turmoil.

[James C. Thyen:]

Yeah.

[Elizabeth M. Lilly:]

So it sounds like buying back stock is not a priority right now and more, it's more about just a preservation of the cash and reinvesting into the business. Is that a fair statement. Jim?

[James C. Thyen:]

We’re focused on the long-term health, this company and operating it in the best interest of the shareholders that are long-term holders

[Elizabeth M. Lilly:]

Okay. Thank you.

[Robert Schneider:]

Thank you for your questions. They are excellent questions.

[James C. Thyen:]

Thank you.

[Robert Schneider:]

Have a great day.

[Elizabeth M. Lilly:]

You too.

[Operator:]

(Operator Instructions) There are no further questions at this time. This concludes the question and answer session. I will now like to turn the call over to Mr. James Thyen for closing comments.

[James C. Thyen:]

Okay, Tania. Thank you. That brings us to the end of today’s call. We also have no questions that came in through the Internet on e-mail. Couple closing comments, volatility in the financial markets is driving tremendous uncertainty around the world. It has changed the priorities of all companies including ours. Our strategies for each market remains, as we have reviewed them. The tactics driven by our priorities have changed. Maintaining liquidity is most important followed by cost competitiveness and general financial health of the company, and retaining our core. We are well positioned with strong brands. We have strong business units, a very capable committed organization and a strong balance sheet. To take advantage of market opportunities as they rise, arise in this period of uncertainty. We are required to remain flexible, very agile, and constantly adjust priorities in this climate, and we will do that. We appreciate your interest in Kimball, and we look forward to speaking with you on our next call. Thank you, and 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.