Kimball International, Inc.
Q4 2014 Earnings Call Transcript

Published: 1 Aug 2014

[Operator:]

Good morning, ladies and gentlemen. My name is Whitley, and I will be your conference call facilitator today. At this time, I would like to welcome everyone to the Kimball International Fourth Quarter Fiscal 2014 Financial Results Conference Call. All lines have been placed on listen-only mode to prevent any background noise. After the Kimball's speakers' 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, August, 1, 2014, 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's Form 10-K and today's release. The panel for today's call is Jim Thyen, President and Chief Executive Officer of Kimball International; Bob Schneider, Executive Vice President and Chief Financial Officer, and Don Charron, Executive Vice President and President of Kimball Electronics Group. I would now like to turn today's call over to Jim Thyen. Mr. Thyen, you may begin.

[James Thyen:]

Thank you, Whitley. And welcome everyone to our fourth quarter conference call. Our earnings release was issued this morning on the results of our fourth quarter ended June 30, 2014. We have posted a financial summary presentation on our website to accompany this conference call. It can be found on our Investor Relations website along the Webcast link. My overview comments will be followed by Bob's financial review. We will then open the call for questions. Don Charron, Executive Vice President and President of the Electronics Group, is joining us on the call today and will participate in the question-and-answer segment of the call. Approximately 13 months ago we began our fiscal year 2014 operations. In our Electronics segment, we were carrying positive momentum from a successful fiscal year 2013. In our Furniture segment, we were challenged from a marginal fiscal year 2013. I will overview both segments starting with Furniture. We finished fiscal year 2013 in Furniture with declining revenue and net income, vary above breakeven. At the end of fiscal year 2013, we were deep in the implementing corrective actions to address the performance problems. These corrective actions were very important to our turnaround and our Furniture team delivered quite well with very successful execution. We have positive net income in each quarter during fiscal year 2014, and each quarter's earnings shortened improvement over the prior year. The positive improvement in the Furniture segment generated over $10 million of net income for fiscal year 2014. Several factors are contributing to the Furniture segment. First, we made several key management changes and fill these key furniture positions with outstanding talent. We are very pleased with the progress made and the positive impact these management changes have had in our organization. Additionally, we increase investments in product development and marketing. The new product offerings showcase that the offers in hospitality furniture trade shows have been very well received in this market. Our increased scope of new product offerings, along with our qualitative improvement in marketing and product development, positions us well as we enter fiscal year 2015. The increase focus on growth combined, with greater process discipline to ensure an outstanding customer experience was also a key one in the improved performance in the Furniture segment in fiscal year 2014. All of these factors along with sales growth of 10% in the fourth quarter and 9% for the fiscal year when compared to prior year, contributed to the improved profitability of the Furniture segment in our fiscal year 2014. As mentioned earlier, our Electronics segment had positive momentum coming into fiscal year 2014 after a strong finish to fiscal year 2013. Our EMS team capitalized on that momentum and continue its aggressive focus on growth and diversification of our customer and product base throughout fiscal year 2014. As you recall mid-year we announced the future ramp down of business from our largest customer Johnson Controls or JCI, which is one of our automotive customers in the Electronics segment. As an update to this announcement, we did begin to see the reduction in sales to JCI in the fourth quarter as originally anticipated and as report. The phase out of this product will continue in the first and the second quarters of fiscal year 2015. While this is a change in our both business, we have invested appropriately in our business development effort over the years and that investment is being successful. As we monitor our new business connectivity pipeline, we are pleased with the potential that we see developing. It is likely that it will take a couple of quarters after the JCI business transition is completed for that sales reduction to be filled completely and for us to again see year-over-year organic growth overall for the business. We feel confident that we have the right activity in place to continue to drive the organic growth and take advantage of the opportunities in this market. Despite this phase-out of the JCI business, our experienced management team, our track record for quality and reliability combined with our highly integrated global footprint, and our process discipline, all come together and are contributing to another successful year in the EMS segment for crystal year 2014, with sales growth and net income improvement. Finally, activities related to the spin-off of our EMS segment are progressing well. As I mentioned last quarter, there is an extensive amount of work that is being done in order to successfully create, two separate public companies, Kimball International as a Furniture company and Kimball Electronics as an EMS company. Despite the spin-off activity, our EMS and Furniture segments continue with business as usual with no disruption in service to our customers, and no diversion of priorities for continued success. We are on plan to where we thought we would be at this time with the spin-off direction. We are still targeting the completion date to be within 8 to 12 months from the original announcement date, which puts the effective date sometime in the fourth quarter of this calendar year. We are very pleased with the performance of both the Furniture segment and the EMS segment throughout fiscal year 2014. Our consolidated balance sheet remains very strong. Our solid financial conditions allows us the opportunity to continue to invest in initiatives that will drive growth with improved profitability and leave both companies sufficiently capitalized after spin-off is completed. Now I will turn it over to Bob, to discuss our fourth quarter results in more detail. Bob? Thanks Jim.

[Robert Schneider:]

Our fourth quarter consolidated net sales were $336.8 million, which was an increase of 6% from the fourth quarter of last year. Sales increased in both the EMS segment and the Furniture segment in the fourth quarter. Net sales in our EMS segment increased 3% compared to the fourth quarter of last year, and in at just shy of our previous quarterly sales record. We saw growth in three of the four vertical markets we focus on, including medical, automotive and industrial. Sales to customers in the automotive market increased in the fourth quarter despite a $10 million reduction in sales to JCI compared to last year. As Jim mentioned, sales to JCI started to ramp down in the fourth quarter of this fiscal year. Sales to customers in our smallest market which is public safety declined compared to last year. Sales in the Furniture segment increased 10% in the fourth quarter compared to last year, on increases of both hospitality and office furniture. The increase in hospitality sales was partially the result of a large project that shipped during the fourth quarter and accounted for $6.2 million in sales during the quarter. And we were encouraged to see a 30% growth in our office furniture sales to the federal government in the fourth quarter compared to last year which is a nice change. We also saw sales growth of office furniture to the State Government in education verticals during the quarter. Orders received in the Furniture segment during the fourth quarter increased 4% compared to last year due to an increase in orders of hospitality furniture. Our open order backlog as of June 30th was 2% higher than June 30th of last year and 14% higher than where we ended last quarter. Or consolidated gross margin improved 1.4 percentage points in the fourth quarter compared to last year. While margins improved in both of our segments, the primary contributor to the increase was the Furniture segment. We also had a favorable shift in our sales mix towards the Furniture segment which carries a higher margin than the EMS segment. Gross profit as a percent of net sales in the EMS segment increased 0.2 of a percentage point in the fourth quarter when compared to last year. Competitive pricing pressures continue in this segment so we feel good when we're able to increase margins even by a small amount. Gross margins in the Furniture segment increased 2.3 percentage points in the fourth quarter compared to last year. Jim discussed the factors contributing to our much improved furniture profitability earlier. Consolidated selling and administrative expenses increased 9% in the fourth quarter compared to the prior year. One of the largest contributors to the increased expense was higher employee compensation costs including both increased salary and incentive compensation costs in both segments. In addition, we recognized $2 million of incremental expenses related to the spin-off of our EMS segment. Most of these costs are unfortunately not deductible for tax purposes. We will continue to incur incremental expenses in the first-half of fiscal 2015 as we move towards the completion of the spin-off. Our spin expenses are expected to total around $6 million when completed. Also included in the selling and administrative line in the fourth quarter was a $1.7 million pre-tax gain recognized on the sale of an idle facility that we had for sale. The effective tax for the fourth quarter was 25.2%. The effective tax rate was favorably impacted as in prior quarters by a higher mix of earnings from our foreign business units, which are located in lower tax rate countries compared to the U.S. We also had $1.1 million of favorable state tax accrual adjustments during the fourth quarter. The effect of these state tax accrual adjustments was offset by the negative effect of the non-deductible nature, most of the spin-off related costs. Consolidated net income in the fourth quarter of fiscal 2014 was $7.8 million, compared to $7.1 million in the fourth quarter of last year. Earnings per share was $0.20 in the fourth quarter of this fiscal year. We had two unusual items in the fourth quarter, one was the gain on the sale of the building and the other was the spin-off costs. The after tax impact of the gain on the facility we sold this quarter was more than offset by the net effect of the spin-off cost we recognized. The net impact of these two items on the quarter reduced net income by $1.2 million and reduced earnings per share by $0.03. So our $0.20 EPS would have been higher without these two items. On a segment basis, our EMS segment recorded net income of $7.1 million in the fourth quarter compared to net income of $7.4 last year. Fourth quarter net income in the Furniture segment was $2.3 million compared to a net loss of $642,000 last year. We were very pleased with the performance in both of our segments this quarter. Our cash and cash equivalents at June 30, 2014 was $136.6 million compared to $103.6 million at June 30 of last year. Our operating cash flow in the fourth quarter was $5 million compared to $22.5 million in the fourth quarter of last year. We continue to focus on managing our working capital metrics. Day sales outstanding, or DSO, increased slightly from 43.7 days during the fourth quarter of last year to 45.3 days for the fourth quarter of this year, related to an increase in the EMS segment primarily due to the mix of sales by customers during the quarter. Given the contract nature of the EMS segment, payment terms by customer and by market vary and as the mix of sales by customer changes, it impacts this measure. Our production day supply on hand, or PDSOH, inventory measure increased slightly from 52.4 days for the fourth quarter of last year to 53 days for the fourth quarter of this year. Capital investments for the fourth quarter totalled $8.3 million, mostly for new machinery and equipment in the EMS segment. We continue to have almost no long term debt, which stood at $293,000 at June 30, 2014, and our total availability to borrow under our credit facilities was $84.9 million at June 30. Our balance sheet remains very strong. With that, I'd like to open up today's call to questions from analysts. Whitley, do we have any analysts with questions in the queue?

[Operator:]

(Operator Instructions) You have a question from the line of Todd Schwartzman with Sidoti & Company. Please proceed.

[Todd Schwartzman:]

Hi, good morning guys.

[Robert Schneider:]

Hi, Todd.

[Todd Schwartzman:]

Bob, regarding the spin related expenses of $6 million total, I think you said, has there been anything incurred thus far other than Q4s $2 million, just want to get a sense of what remains?

[Robert Schneider:]

We had some in Q3 and, let's see Todd if I can track that down for you that quickly. Let's see, we had pre-tax in Q3, $856,000 and in Q4 we had [$1.978 million] (ph) and that brings us to $3 million in fiscal 2014 and roughly another $3 million will happen in fiscal 2015.

[Todd Schwartzman:]

Great, thanks. Now, just looking at consolidated SG&A cost going forward, where are the – couple of puts and takes in Q4 pertaining to the sale of the facility as well as the cost of the spin-off. But looking ahead in fiscal 2015, is that $57 million number pretty good quarterly run rate to use for modelling purposes?

[Robert Schneider:]

Todd, really, really good question and very depended on a lot of things. Depending on profitability for incentive compensation cost and also Todd, very important as we get past the spin in terms of what the effects will be on each of the separate business units, which we are continuing to work on and we will go public with that in October. Not totally sure on your question whether the $57 million would be recurring, we do have seasonality in our business which impacts it quarter-to-quarter also.

[Todd Schwartzman:]

Right. And I should preface it by saying that, I realize that you're on track, it's like if anything it looks the spin, maybe expected to occur slightly sooner than you thought. You can chime in on that if I'm wrong. But I'm just assuming status growth that the spin just does not occur until I see it happening. So, maybe not a fair way to look at it but it's just kind of assuming the business remains as is, as factoring at seasonality as well just wanted to get a sense of whether there is any deceleration in some of those compensation related cost going forward?

[Robert Schneider:]

If we assume there is not a spin and for the annual total cost on SG&A very, very depended on profitability and the incentive compensation cost which is really the wildcard I think to that point. Todd, outside of that, there are not any very large adjustments, and again, that's all preface as you had indicated in your question, assuming that we did not have the spin.

[Todd Schwartzman:]

Okay.

[Robert Schneider:]

And Todd let me add to that, the quarter we just ended, the $57 million in SG&A you referred to, that does have a fair amount of investment that we made in new product introductions that is a little higher than we had in the past, which is something we'd like to see because that's very important for growth of the company into the future.

[Todd Schwartzman:]

So, you do or do not take your foot of the pedal as far as fiscal 2015?

[Robert Schneider:]

We keep that foot on the pedal for growth and new product introductions and marketing programs. And so the cost that you see in the quarter we just ended, were not going to let up in terms of reducing investments in new product introductions and marketing.

[Todd Schwartzman:]

And I just wanted to, for my clarification, ask you to speak a little bit more Jim about the – what you're seeing in EMS in terms of backfill, the JCI business? I think I heard you say that it will take a couple of quarters beyond Q2 to see year-over-year organic growth in EMS segment revenue, is that correct? And also, what was the JCI top line contribution in the fourth quarter?

[James Thyen:]

That is correct. We do see taking a couple of quarters out. We have very heavy activity in our business development. Our pipeline is robust and healthy and so we're confident about filling that hole. Donald, actually will elaborate a little bit.

[Donald Charron:]

Yeah, I think, as Jim said, we're confident that we've got the right activities in place to backfill for JCI, like timing of those new programs really the question mark here. When they'll start to ramp up and how much revenue we'll have in place to backfill the JCI business. The good news is that, as we predicted the JCI business is winding down as we previously predicted. So, we've got good visibility of the wind down part of shift, how fast the new programs will ramp up actually.

[Robert Schneider:]

And Todd, as a reminder, in the 8-K we put forth back in December, we had estimated about $19 million in sales with JCI with respect to the business that's going end of life and exiting. We're pretty close to that. And we also had estimated getting the point to the ramp down, dropping down to roughly $5 million in sales for the second quarter of 2015. And our latest view is that, that's still is pretty much on target. So, the ramp down is phased, and it gives us some time to backfill appropriately.

[Todd Schwartzman:]

So, the fourth quarter, sales of JCI did it approximate in the $19 million or is that something less than that?

[Robert Schneider:]

It was a little bit shy of that but very close to it. And also Todd, recognize that, and I think we might have talked about this in the past, JCI will remain a customer. So, not all of the product is going end of life for exiting and some of the business was purchased by another company that has been and will continue to have Kimball make product for them. So, it was a sub-portion of the total JCI business that was going to be exiting. Just as a point of reference.

[Todd Schwartzman:]

Any insight into new wins in the quarter on the EMS?

[James Thyen:]

Just to back that, we continue to have some success on that front Todd. So, I don’t have any specifics to share with you but overall we continue to see positive activity in the pipeline, our win rate has been out of our targeted level, so, we’re pleased with that. And really now it's more about the timing of ramping up those new programs.

[Todd Schwartzman:]

Just trying to, just kind to get my arms around the sales decline or flat to declining sales year-over-year organically in EMS. So, there is no misunderstanding. If there is a new program from an existing customer, do you include or exclude that in organic sales?

[James Thyen:]

Well, if it's a new program with an existing customer, we would consider that to be part of our organic growth rate.

[Todd Schwartzman:]

Okay. And in fiscal 2015, is there anything else, of size or substance to know that's reaching end of life?

[James Thyen:]

No.

[Todd Schwartzman:]

Okay. On furniture, where did the furniture, - where does furniture volume need to be? I know that the – you had previously spoken to, I think it was 8% op margin goal ultimately, is that correct?

[James Thyen:]

So, you're at 3%, 3.1% in the latest quarter. Where does the volume in that business need to be for you, for that segment margin to hit say 5%, alternatively 6%, 7%, so on, up towards your goal. Do you have any stair-step, kind of back of the envelop expectations?

[Robert Schneider:]

To get the 8% Todd, we need about $155 million to $160 million a quarter in sales. I haven't stair stepped it but that's roughly what the contributions margin that we have in our business that we need to get to the 8% goal. With our frame of reference that we just ended at $137 million last quarter.

[Todd Schwartzman:]

Got it. In the office furniture brand, could you quantify maybe or speak to the sales increases or decreases as the case maybe that you're seeing by specific product category. So, again that's exclusive of Kimball hospitality?

[Robert Schneider:]

As an overview, the whole furniture segment sales were up 10%. As, I think we'd indicated, biggest portion of that is hospitality and our big driver of that was a $6.2 million order that shipped in the quarter, which is important to know and understand because that size order doesn't repeat frequently. As you pull that out Todd and you look at what's the office effect, BIFMA in the quarter was up 1.3% and we were up little bit over 2x that roughly. So, our office business actually did quite well relative to the market in Q4. And hospitality did quite well in part due to a very large order that got shipped in the quarter.

[Todd Schwartzman:]

So you are up about 2.5% on the office side and expect $6 million order was hospitality up more than that year-over-year?

[Robert Schneider:]

Yes.

[Todd Schwartzman:]

Okay.

[Robert Schneider:]

I don't have a percent right in front of me but they were up even without that order.

[Todd Schwartzman:]

With respect to this furniture R&D dollars, how much are you dedicating or will you dedicate going forward to the collaborative type products?

[Robert Schneider:]

That's a huge amount of our new product introduction. Development is just on that collaborative open space type product. That said, we also have a lot of investment that's in CD. But the vast majority of our focus and what we did at NeoCon this year with respect to office furniture was really, it was like collaborative, the collaborative type product. We had Todd 12 new product introductions at NeoCon just with Kimball office. And we had about half of that at national. And very strong focus on new product introduction, marketing programs, it goes back to my point earlier that we have hit the gasp pedal in those areas and we feel we have to do that and we’ll continue to do that to significantly grow the furniture business.

[Todd Schwartzman:]

Great. As I recollect going back couple of years ago, I think the hospitality - in terms of gross margins, the hospitality margin was about a third lower than the office furniture. Is that correct? What's the trend in there? Any update on that might be helpful, just to give us a sense of how to think about a consolidated segment margin.

[Robert Schneider:]

We don't disclose the actual gross margin between those product lines Todd. We have had challenges in hospitality in the past as we disclosed in this past year, that go to what our margin ended up being. But in terms of the opportunity for gross margin, there's a lot of similarity between office and hospitality. That doesn't mean we're always getting that type of margin but in many cases we do, that are consistent among the two markets.

[Todd Schwartzman:]

Great. Thank you. That's all I've got. Appreciate it.

[Robert Schneider:]

Thank you.

[Operator:]

(Operator Instructions)

[James Thyen:]

Thank you, Whitley. And that brings us to the end of today's call. We appreciate your interest. We look forward to speaking with you on our next call. Thank you and have a great day.

[Operator:]

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