Kimball International, Inc.
Q1 2010 Earnings Call Transcript

Published: 5 Nov 2009

[Operator:]

Good morning, ladies and gentlemen. My name is Heather and I will be your conference call facilitator today. At this time, I would like to welcome everyone to the Kimball International First Quarter Fiscal 2010 Financial Results Conference Call. All lines have been placed on listen-only mode to prevent any background noise. After the Kimball speaker opening remarks, there would be a question-and-answer period where Kimball will respond to questions from analysts. (Operator instructions) As with prior conference calls today's call November 5, 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, Executive Vice President and Chief Financial Officer. I would now like to turn today’s call over to Mr. Jim Thyen. Mr. Thyen you may begin.

[Jim Thyen:]

Thank you, Heather, and welcome everyone to our first quarter conference call. 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. We hope you had an opportunity to review our earnings release, which was issued this morning on the results of the first quarter, ended September 30, 2009. Sales in the first quarter of fiscal year 2010 decreased 19% when compared to the prior year fiscal ’09. Our Electronic Manufacturing Services segment has seen more positive signs of recovery from this recession than we are in the Furniture segment. The decline was 10% in the EMS segment compared to the prior year. We did see sequential improvement in the last two quarters with the first quarter sales increasing 9% from the fourth quarter, and the fourth-quarter sales improved 8% from the third quarter. The decline in the Furniture segment was 30% versus last year. A decline has also been experienced when compared to the fourth and third quarters of fiscal ’09, as we are now experiencing the full impact of the recession in the furniture markets. I will say more about that as we review the various market sectors. Our consolidated gross profit as a percent of net sales for the first quarter remained constant compared to the prior year. Bob will discuss that in more detail. Our balance sheet remains solid, containing significant strength and flexibility for these economic uncertainties. We continue to exhibit excellent cash control and excellent cost control. Bob will also expand on those facts. As you know, Kimball International provides a variety of products from its two business segments. This diversification does bring some leading and lagging aspects to our results, when experiencing the economic change of the recent past. It is the nature of the various markets that we serve. I am sure you have been reading and hearing on a national level that the latest estimates are that the recession may already be over. We do not believe that to be the case in all of our markets served. The abrupt slowdown in our markets occurred in the second and third quarters of last fiscal year, and since then our quarterly sales have stabilized and slowly improved. It is important to note though that the improvement in the economy remains spotty with some segments improving and some continuing to decline. We are experiencing the same, but it can be hard to see that -- but it can be hard to see that when looking at our consolidated sales slowly increasing since the market low point in the third quarter of last fiscal year. I hope to make that a bit clearer for today with my comments and by answering any questions you may have. I will make some brief comments about each of our vertical markets, starting with the Electronic Manufacturing Services segment. A portion of the economy that abruptly and very significantly declined last year, and is now showing some stability is the automotive market. The “cash for clunkers” program in the US and its equivalent in Europe did remove many automobiles from the retail inventories. Indications are that the improvement was a pulling up of the automotive sales from future quarters and not new demand creation. The US and European automobile markets continue to announce changes addressing the need to reduce capacity. That is very important to the recovery of this vertical. The Asian auto market is accelerating in demand for output. Given this mix of business change, we are cautiously managing our supply chains to obtain the correct balance of service and inventory support. This market remains very important to Kimball even though our concentration of sales is significantly lower than a few short years ago by choice. During the first quarter, automotive represented approximately 18% of our worldwide sales. We continue to add new contract wins announced in this market and are pleased with the margin improvement opportunity that new contracts will bring in the future quarters as it takes several quarters for new programs to be launched and put into full production in this automobile market. The medical EMS market continues to show stability and some strength. Our growth in this vertical market is the result of our diversification strategy that we emphasized several years ago. Our global capability is serving us well as this market adjusts to the reality of the national healthcare debate, and the growing demand for product produced in lower-cost venues. Today this is our largest EMS market, and we remain very active in quoting new business and obtaining new customers in this global market vertical. The industrial EMS market is showing pockets of improvement. We have seen growth in this market due to new customer wins along with the effect of stimulus tax credits provided to consumers, who are replacing heating and air conditioning units with high efficiency units meeting greater SEER ratings. Much of this heating and air conditioning business though tends to be seasonal, even with the stimulus tax credit and so may decline over these winter months, which is normal variation. The public safety EMS market is continuing to show strength and optimism. It remains an important aspect of our growth, diversification and margin improvement goals. Regarding our Furniture segment and the markets that we serve in that segment, furniture purchases tend to be more discretionary in nature and more deferrable than some other products. Typically rebounds in the furniture markets do not manifest into significant order flow improvements within this industry until several quarters into the future. We experienced that in the downside of the economy and would expect that pattern to follow as the economy recovers. We have all heard the phrase, new normal and the reset economy. It is very hard to tell with this recession just how long it will take before there is meaningful economic growth or if the current economic activity level is the new baseline. Falling occupancy rates of commercial properties, both office properties and hotels, declining RevPAR rates in the hotel industry, declining commercial real estate values, and the commercial lending activity are all key factors to keeping the outlook tentative and uncertain for the reminder of this fiscal year. Key metrics we are closely monitoring are the unemployment rate, now at 9.8%, and the underemployment rate estimated to be near 18%. Our sense is that there will have to be a marked improvement in these rates before there is a positive increase in consumption and discretionary consumer spending, and before companies gain the confidence in their businesses that would lead to furniture purchases. As our industry has significant excess capacities, we expect the competitive pressure in the electronics markets and both the hospitality and commercial office furniture markets to remain intense for some time to come. This variation in the outlook as projected by various industry and trade associations of the various markets is as they should be. Much of that outlook is tied to the indicators I have mentioned, along with the greater flow of commercial credit. Our results and our outlook are consistent with and directionally correct with the projections of growth occurring or beginning in calendar year 2010 by the various industry and trade associations. During the first quarter, we continued to make investments supporting our customers and our business development with new products and selective capital investments directly linked to the customer needs. I'm pleased to note that we have finished the construction of the new state-of-the-art electronic facility in Poznan, Poland. At the end of 2008, recall we announced the restructuring and consolidation of our European operations into Poland, and we broke ground on the new facility. We are now at the stage of setting up production lines and qualifying production runs in that new facility. We expect to be fully moved into the new facility and out of the previous Poland site and Wales by the end of 2011, calendar 2011. In the meantime, we will have a period of time of redundant overhead costs with the three sites that will soon become one site. The new construction was completed on time and under budget. In our furniture operations, we are implementing new state-of-the-art ultraviolet light cured finish lines often referred to as UV finish lines, which improves the durability of our finishes and achieve indoor air quality standards, enhancing the environment and our green sustainability strategy. We expect to have four of these state-of-the-art finish lines up and running by the end of this fiscal year. These investments are merely examples of our confidence in the future of our markets. We continued our strong actions into Q1 to conserve cash, improve liquidity, and continue to improve our cost competitiveness, while promoting growth in those vertical markets, which are showing some signs of stabilization and are beginning to be indicators of recovery. While the economy seems to have stopped its steep decline, we are certainly not complacent with where we are in terms of working capital. Until our markets begin to show marked improvement, we will continue to have risk of customer bankruptcy, which can impact our accounts receivable and potentially drive excess or obsolete inventory risk. Additionally, there is financial and operating risk with suppliers that could disrupt our supply chains. These are areas that are being closely managed and monitored to reduce that exposure. With that I'd like to turn the call over to Bob to discuss our first quarter results in a little bit more detail. Bob.

[Bob Schneider:]

Thanks, Jim. We reported today net sales in the first quarter of $274.7 million, which is a decrease of 19% from the same quarter of the prior year. As Jim mentioned, the decline was very swift in our second and third quarters of last year, and while at the very low level, it is good to see our first quarter sales. We're actually up slightly from the immediately preceding fourth quarter. Our EMS segment was down 10%, compared to the first quarter last year, but we need to recall, though that all of this decline actually occurred during the second and third quarters of fiscal 2009. A very encouraging sign is the improvement in our EMS segment in the first quarter, where sales increased 8.6% over the immediately preceding quarter on improvement in the automotive, medical, and industrial control markets. The furniture market was down 30% and about half of that decline also occurred in the second and third quarters of last year. And we have had a trend of reduced quarters since then with the quarter just ended being the lowest sales level since the beginning of the economic downturn. Jim spoke of the overall economy and how furniture purchases tend to be deferrable. As companies have focused on conserving cash and liquidity, it is clear that many are still deferring purchases of furniture, along with other capital expenditures. Within our furniture segment, the mid-market office furniture brand has declined at a lesser rate than the contract market brand, and with declining RevPAR rates in the hospitality industry, that's revenue per available room, which is forecasted by the way to be down 16.1% for calendar 2009, hotel operators have been hard-pressed to build or even complete in some situations new hotels, and they are also hard-pressed to refurbish existing hotel venues, which has put significant pressure on our Kimball Hospitality brand. Importantly, our gross profit as a percentage of net sales was 17.2% in the first quarter, which was equal to the prior year. This is quite encouraging because of two things. First, with a 19% consolidated reduction in sales, we have naturally lost some leverage on our fixed manufacturing costs, which would tend to decrease the gross profit percentage but that did not happen. And secondly, our mix of sales changed in the first quarter whereby approximately 60% of our total sales related to electronics compared to 54% in the prior year first quarter. As our Electronics segment has lower margins, this mix change would tend to reduce our consolidated gross profit percentage. But as I noted earlier that did not occur and the consolidated margin remained flat. We've taken decisive action in our units to reduce cost and so in spite of the lower volumes we have been able to increase select margins in the furniture segment. It is important to note that we have removed manufacturing capacity since last year, but not to the extent that sales have declined. Our team members have been very focused on cost innovation over the past year, looking for innovative ways to serve our customers in new and less costly ways. As a result of that is the $9.9 million reduction in selling and administrative expenses, exclusive of the SERP, that's Supplemental Employee Retirement Plan, which I'll talk about in a minute. The $9.9 million reduction represents an 18% cost decline in the quarter compared to the same quarter a year ago. That is a huge decline. Other net in our P&L was income of $2 million in the first quarter compared to expense of $800,000 in the same quarter of the prior year. There are several components that comprise the income, the largest being $1.5 million of income in our SERP retirement account. As we've discussed in the past when the general stock markets increase, it tends to drive SERP expense in our selling and administrative areas. I need to remind you though that we also have exactly offsetting income in other net, in our P&L with no affect on our profits. On a segment basis, our Furniture operations had a profit in the first quarter of $1.8 million, while the EMS segment had a net loss of $219,000. The US automotive “cash for clunkers” program in our Q1 caused enormous strains on our supply chain as we and our suppliers rushed to fill orders for new vehicles, and many of those orders drove expediting expenses that Kimball was not able to re-bill to our customers and therefore hindered our electronics earnings. Our cash position at September 2009 approximated at the beginning of the quarter. Our net cash and investments at September 30th after deducting borrowings on our short-term credit revolver was $87.5 million. Our operating cash flow in the first quarter was a positive $12.5 million. Additionally, we continue to have almost no long-term debt, which stood at roughly $400,000 at September 30, 2009. This is a financial position that is the envy of most companies, but we're not complacent with where we stand. We've worked hard in reducing past due accounts receivable and driving collection on accounts according to terms. Consequently, our DSO, that's day sales outstanding, in the first quarter was 46 days. That is up compared to the 45 last year in the first quarter. However, it is down from the 51 days we experienced at the height of the downturn in the economy during the third quarter of last fiscal year. Likewise, we have performed lean events with dedicated teams to reduce inventory levels and achieved a lower production-day supply on hand of 62 days, which compares to 65 for the same quarter last year. An important part of working capital is payments to our vendors and we have been diligent in ensuring we are not paying quicker than prudent. And so while our lower sales volumes by itself naturally tend to drive some cash flow generation, we were able to see additional generation through the actions just mentioned. We are monitoring these areas closely as we expect that as our sales begin to improve, we will need to support them with additional working capital thereby using cash. That said we do not expect a deterioration in the metrics, which goes to our continued focus on our cash cycle. With that I would like to open up today's call to questions from analysts. Heather, do we have any analyst with questions in the queue?

[Operator:]

(Operator instructions) As there are no further questions in queue at this time, I'd like to turn the call back over to Bob. Thank you.

[Bob Schneider:]

Thank you, Heather. And that brings us to the end of today's call. We're operating in a volatile environment with significant legislative question marks on the horizon regarding healthcare, cap and trade, and unemployment tax increases just to name a few. That coupled with financial markets that appear to be stabilizing, but yet are fragile, continues to drive tremendous uncertainty in this economy. At Kimball, we are well positioned with strong brands, strong businesses and strong balance sheet to seize market opportunities as they arise. We appreciate your interest. We look forward to speaking with you on our next call. Thank you. Have a great day.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.