Kimball International, Inc.
Q3 2015 Earnings Call Transcript

Published: 6 May 2015

[Operator:]

Good morning, ladies and gentlemen. My name is Lucy, and I will be your conference call facilitator today. At this time, I would like to welcome everyone to the Kimball International Third Quarter Fiscal 2015 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 May 6, 2015, 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 back from forward-looking statements can be seen in the Kimball International Form 10-K and today’s release. The panel for today is Bob Schneider, Chairman and Chief Executive Officer 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 now begin.

[Bob Schneider:]

Thank you, Lucy. And welcome everyone to our third quarter earnings call. The financial results for our third quarter ended March 31, 2015 were released yesterday after the market closed. We also posted an Investor Presentation slide deck to our website to accompany this call and I would suggest that you review that also. I will have a few brief comments before I turn the call over to Michelle Schroeder, who will provide us with the key financial highlights for the quarter. We will then open the call to analyst and investors for questions. Our comments this morning will focus on adjusted pro forma operating income which adjusts for the unusual nature of our historical results due to the spit off of our electronic segment in October. It provides better apples-to-apples comparison. A reconciliation of GAAP operating income to non-GAAP adjusted pro forma operating income is included on page 34 in the investor slide deck that was posted to our website yesterday afternoon. We are very pleased with the 17% sales growth in the third quarter and extremely delighted with the improved operating income performance that our team achieved during the quarter. Adjusted pro forma operating income was 4.2% in the quarter compared to last year third quarter of less of 1%. Our third quarter is the normal seasonal low period for office furniture, as you know and the 4.2% operating income was the best operating income percent we’ve had for our third quarter since 2006 or in other words the best in nine years. Our turnaround is gaining traction and we are progressing nicely towards our 8% operating income goal. I’d like to take a minute to remind everyone about what we’ve done thus far with the turnaround and then talk about the future and provide some color around the guidance we included in the press release. Prior to the electronics spinoff last October under the guidance of our former CEO Jim Thyen and former Chairman Dough Hobbick [ph], we made some key leadership changes within the organization which provided us a very strong foundation and positioned us for growth and margin improvement post spend. Building upon that the new executive team also took action immediately after the spinoff by announcing a restructuring plan to consolidate our Post Falls, manufacturing facility into other existing facilities and to sell a corporate aircraft focused on employee business travel. In addition Kimball some key corporate governed strangers in connection in the spin last October and that increasing shareholder value which included the equalization of the class A and class B shares. So, all shares now have equal voting right. And recently, our Board adopted best practice government’s policies including the establishment of a lead independent Director, the implementation of a resignation policy for board members not receiving majority votes in an uncontested election. The implementation of restrictions on hedging, pledging of company share held by Board members and executive and the approval of the use that a relative total shareholder return metric as a measure for the award of performance shares to key senior level executives. With these changes and many - many other efforts we are really gaining traction with adjusted pro forma operating income above 4% in each quarter this fiscal year. And again our third quarter operating of 4.2% was the best in nine years. We are well on our way to 8% and many of you have been asking for guidance or a timeframe on when we will hit the 8% operating income goal. We’ve said that we need both increased volume and cost reductions to hit the 8%. As significant component of the cost reductions is the consolidation of our Post Falls facility into other existing facilities in Indiana. That restructuring effort is progressing according to plan and we are confident that all activities will be completed by September 2016 as previously announced. As a result, we included long ranged guidance in our earnings press release yesterday on where we expect our sales and operating income to be when the restructuring is complete that is the quarter immediately following September of 2016. For that quarter ending December 31, 2016 which is a year and three quarters now we expect our quarterly sales to be in the range of $170 million to $180 million and our operating income to be in the range of 7% to 8% depending on the sales mix which is very important. At this sales and operating income level our return on capital will be approximately 20% which is among the best in the office furniture industry, that’s a very important point. To get to the $170 million to $180 million in the sales for the quarter ending December 2016, we are forecasting office furniture sales growth of approximately 8.5% which is in line with current [indiscernible] estimates for calendar year 2015. For hospitality we are forecasting flat sales for fiscal '16 and a 5% increase beginning in fiscal 17. While the hospitality market is very strong right now, we're forecasting flat sales in fiscal '16 because we are not forecasting another significant hospitality order in fiscal '16 like the one we received in the current fiscal year, which we have announced totaled $13.8 million. So we're not planning for a repeat of that size in fiscal '16. The operating income guidance of 7% to 8% includes the $5 million in annual savings, we expect to gain from the post falls restructuring and the $800,000 annual savings from the sale of the corporate airplane. The components within operating income will vary a year and a half from now depending on sales mix. So we are only providing guidance on the operating income percent, not gross profit and SG&A. As we move forward between now and December 2016 we expect to see continuing improvement in our margins, but will likely have some volatility as we work through the restructuring and other margin improvement initiatives. Sales mix likewise could add some volatility from quarter-to-quarter between now and completion of the turn-around. We also expect the office furniture industry to continue to have the seasonal decline in what is our fiscal third quarter. Therefore sales may not reach the $170 million level as quickly in that third quarter period. We are providing this disclosure in response to your feedback and in an effort to be more transparent in our disclosures. We continue to value your feedback and I hope this additional information is beneficial to you. Now, I will turn the call over to Michelle for a brief overview of the financial results before we open the call to your questions.

[Michelle Schroeder:]

Thanks, Bob. As Bob mentioned our operating income referenced today is adjusted pro forma operating income, which adjust for the impact of the spinoff and also reflects the economics of our post-spin furniture company. An operating income reconciliation is included on page 34 in the investor slide deck. Sales were strong in the quarter at a 145.9 million, which was an increase of 17% over the third quarter of last year. This is the 7th consecutive quarter we've shown an increase in our quarterly sales over the prior year. We normally see a different sales in the third quarter with the seasonal nature of the office furniture industry, however, this year our third quarter sales actually exceeded our first quarter sales due to the strength of the hospitality market. Sales in five of our six vertical markets increased. Sales in the hospitality vertical were up 11.1 million or 36% and that was fueled by strong sales in the program our non custom business. Last quarter we mentioned received a $13.8 million hospitality order, 2.2 million of that order shipped during the third quarter and we expect the majority of the remainder of that order to ship in the fourth quarter, although a portion is scheduled to ship in June. So there is a possibility some may push into the first quarter of next fiscal year. The hospitality market remains very strong. All metrics look positive and feedback from our customers is very encouraging. The other commercial vertical which includes corporate businesses and sales that don’t fall into any of our other five verticals was up 8.8 million or 21%. This vertical represents our largest vertical. The economy and overall business conditions remain strong in both day-to-day and project business fueled in part by our new product and marketing initiative. Education, healthcare and government verticals were each up approximately 1.5 million. During the third quarter we launched new products aimed specifically at the education and healthcare markets with FA seeding from our National Office Furniture brand focused on the education market and Kimball Health from our Kimball office brand focused on the healthcare market. And both of these products have been well received in the market. Sales to customers in the financial services market declined in the quarter. We discussed in prior calls the importance of our new product introductions and we're starting to see traction on some of those new products. During the third quarter sales of 19.1 million were from office products introduced in the last three years, which is how we internally define a new product. This is an increase of 25% from 15.3 million of new office products sales in the third quarter of last year. Orders received during the third quarter were 15% higher than last year lead by increased orders in the other commercial vertical. Our order backlog at the end of March was a 104.5 million or 22% higher than March of last year and positions us well heading into the last quarter of our fiscal year. Third quarter non-GAAP adjusted pro forma operating income as shown on page 34 of our investor slide deck was 4.2%, which is a significant improvement from the six-tenth of a percent in the third quarter of last year. Leverage from the higher sale volume, the benefit from price increases, net of higher discounting and operational improvements all contributed to the improved result. Our effective tax rate for the third quarter was unusually low at 10.5%. During the quarter we had 1.5 million of favorable tax adjustments related to prior year activities. 1.1 million of that is related to the expiration of statutes of limitations on positions taken on previous tax returns and the remainder was primarily adjustments as we finalized our fiscal year 2014 tax returns in March. We do expect our combined effective tax rate on average to be somewhere in the high 30s. Our adjusted pro forma income from continuing operations after excluding all restructuring and spinoff costs and adjusting the prior year for the pro forma retirement related adjustments was 5.3 million in the third quarter of this year or 3.8 million if you exclude the favorable tax adjustments I just mentioned. This compares to adjusted pro forma income of 940,000 in the third quarter of last year. Pre-tax restructuring cost for the quarter was 388,000, which included 616,000 of cost related to the Post Falls facility which was partially offset by income of 228,000 as we finalized the sale of the corporate airplane during the quarter. No savings were recognized in the third quarter related to Post Falls. We did realize a benefit of approximately 200,000 related to the airplane beginning in this quarter. Now, moving to the balance sheet. As of March 31st, our cash and cash equivalents were 50 million. Our operating cash flow in the third quarter was 10.3 million. Capital investments totaled 5.9 million in the third quarter and this is a little higher than normal due to some building renovation cost we had related to move with the spinoff. We did repurchase approximately 316,000 shares under our share repurchase authorization program during the third quarter at a cost of 3.1 million and we paid 1.9 million in quarterly dividends. Approximately 1.7 [indiscernible] of shares remained under our share repurchase authorization program as of the end of March and we continue to review and discuss with our board options around our capital structure including repurchasing additional shares. We continue to have almost no long-term debt which stood at 271,000 at March 31st 2015. We also have a $30 million credit facility. Our balance sheet remains very strong. So with that I would like to open up today's call to questions from analyst and investors. We will see to if we have anyone with questions in the queue.

[Operator:]

[Operator Instructions] The first question comes from Todd Schwartzman of Sidoti & Company. Please go ahead.

[Todd Schwartzman:]

Why don't you just clarify, I may have heard u incorrectly, but I thought I heard you say that you intent for the operating margin to exceed 4% in each quarter. I thought you said this year, but I'm assuming you mean fiscal '16, is that right?

[Bob Schneider:]

No, what I was referring to is the first three quarters of this fiscal year, each quarter has exceeded 4%, which is huge improvement. Last year for the whole year we had, I believe it was 2% operating income. So three quarters into this year were above 4, nice improvement.

[Todd Schwartzman:]

So where do you show on an adjusted basis for Q2?

[Bob Schneider:]

Do you have that handy Michelle?

[Michelle Schroeder:]

For Q2, I believe --

[Todd Schwartzman:]

I’m sorry 3.5, I’m honestly what I'm missing there.

[Michelle Schroeder:]

We were at 4 for Q2, we were at 4.6 for Q1 and I believe 4 for Q2 and then 4.2 for Q3.

[Todd Schwartzman:]

Okay. I just need to check my reconciliation and thanks for that.

[Michelle Schroeder:]

There is a reconciliation on the last page of the investor slide deck.

[Todd Schwartzman:]

And those nominees that you just gave to show that’s not based on any subsequent restating or further adjustments and what was reported at the time of the quarterly results, is that correct?

[Michelle Schroeder:]

That’s correct, yes.

[Todd Schwartzman:]

Looking at Q3 to Q4, so sequentially the gross margin mix certainly is always going to be a part of it, but maybe including that and in addition to mix, what are the considerations that we should look out for modeling the gross margin sequentially in the fourth quarter?

[Bob Schneider:]

Very important to look at the mix with respect to hospitality and you do have the orders that we took in terms of all the market verticals that can give you a sense of the business that's going to happen in Q4. And recognize real key element in terms of our Q4, we’ve got the vast majority of the very large project in hospitality market that we talked about in the last call. Michelle, I think you said 2.2 million sell in the Q3?

[Michelle Schroeder:]

That’s correct.

[Bob Schneider:]

And most of what is left is going to follow in the Q4. And as we’ve talked before, we are doing a lot of work in both our hospitality business and some parts of our office business in terms of improving margins. The hospitality margin now is not to where the office has, and so consequently when you see a lot more hospitality mix in our Q4 numbers that’s going to push the margin a little bit lower. That’s going to have a negative impact on the margin.

[Todd Schwartzman:]

Got it. Of the 11.6, of the 13.8 hospitality, whatever that's yet to ship, would you say somewhere between 9 and 10 gets delivered in Q4?

[Bob Schneider:]

Probably, I would say it’s a good estimate. Our intent is to deliver all of it, but also near delays.

[Todd Schwartzman:]

But the point is from we said now some of it is scheduled for June, but it could, it’s probably end of month, end of quarter it could go it's way?

[Bob Schneider:]

It could push, yes.

[Todd Schwartzman:]

And what gives you the confidence that if part of it pushes, with just be a small piece of that remaining 11.5?

[Bob Schneider:]

Because we’re shipping it all the time, and we’ve been shipping a lot in the lateral part of the current quarter, excuse me the third quarter and is happening now all the way through the end of the fourth quarter. And it’s just being cautious that on large projects like this, it’s common that there delays and may push into the following quarter.

[Todd Schwartzman:]

On the guidance, a little bit unsure as to why you’ve not talking about the gross margin assumption that’s built into the earnings guidance. Can you speak to maybe that a little bit more than you have thus far?

[Bob Schneider:]

Todd it’s the period that we’re looking at, it’s quite a bit into the future. And there is just so much mix that drives variation in terms of the SG&A and also the gross margin. And that’s why we haven’t, I know in prior calls, we’ve talked about approximately 32% gross margin. And in this guidance, you see that we actually raise the amount of sales. We think it’s going to take to get us to that 8% up income. We’ve done a ton of modeling of this actually starting several months ago. And we put a lot more effort into late to dial this in. And the challenge we saw is that depending what happens with the hospitality relative to office furniture, the mix really swings the gross profit percentage. So the guidance I’ve given already in the last call was somewhere around 32%, it could be higher than that depending on the mix, but we feel very confident that as we look at all parts of our business the 7% to 8% operating income is going to happen in that first quarter after we complete the turnaround.

[Michelle Schroeder:]

And I guess another out there we say the gross profit will vary because of the mix so will SG&A because hospitality also has the lower SG&A percent.

[Todd Schwartzman:]

What is the mix? Let’s say 20% hospitality on the low-end with the high of 30%, just to kind of keep it simple using that same 175 midpoint. What would the margin range, gross margin range look like do you think?

[Bob Schneider:]

Todd, I don’t know, off the top of my head. I will just say that on the low-end that I’d indicated before 32%. On the high-end it might be necessary, I think you’re going to have to do some analysis looking at the variation we’ve seen in the past to try to make an estimate of what the high-end of that gross profit might be. End results being op income of 7% to 8%.

[Todd Schwartzman:]

And because the mix can change from quarter-to-quarter, is it really kind of an exercise with utility to try and factor in seasonality quarter-to-quarter, to any great extent when trying to wrap your raw materials around the gross margin?

[Bob Schneider:]

I think as you look at the seasonality in the third quarter of fiscal ’17, which would be that very first third quarter after we have completed the turnaround. Clearly as we always see in the third quarter, generally see, you’re going to see some pressure and office furniture is going to push the sales level down. We’re not going to the leverage our sales overall fixed costs is much and you’re going to have reduced op income in that quarter. I don’t think its exercise of utility, because it generally happens pretty consistently.

[Todd Schwartzman:]

And what’s the pricing environment like these days in projects?

[Bob Schneider:]

Very highly contested in projects in the office furniture industry, and also in hospitality. We’re not seeing let up at all, and I know as you look at hospitality with the business being so strong. And I know we’ve mentioned before. I think, I used the phraseology that it’s in on fire, in the hospitality industry right now with refurbishments, and now new construction. They’re seems to be a lot of capacity and the industry that’s becomes available to absorb that additional business and that keeps pressure on the pricing.

[Todd Schwartzman:]

I know Michelle had highlighted defining the new products as those launch in the past three years. What can you tell us about some of the more recent launches those that have actually been shipping long enough to really move in needle thus far that’s contributing to your success and maybe also speak about what you’re seeing geographically if there are any pocket of strength or weakness?

[Bob Schneider:]

Let me just remind everybody. The new products that we did last year, we did about, I think it’s 15 to 16 or so new products in office furniture that we announced at NeoCon. We did another 8 to 10 or so in the new healthcare vertical that we’re really effectively doing a start-up company in that vertical. All that happened in this past fiscal year. And we've said, those are going to start getting traction. We also believe that the margins on those will be, in a lot of cases, better than what our existing margins are. When we look at new products, we’re seeing good traction in those new products and I think the metric that we’re using, which we’ve always used looking at sales of new products introduced in the last three years, if you look at what we did a year ago in Q3, relative to what we did this year and that huge increase that 25%, that is primarily driven by the new products that we’ve been introducing. And so the traction is good. That brings us to this coming year in terms of NeoCon and what we’ll be introducing, and likewise roughly 13 to 15 to 16 new products will be introducing again at NeoCon. And so I’ve said it in the past, I’ll say again. We are hitting the gas pedal on new product introductions. And so the traction is nice right now and I expect it continue. The new products that we introduced on in the healthcare vertical, the sales cycle is longer, we’re not seeing as much of increase immediately because frankly, that was announced in November of last year at San Diego at the healthcare design show, so it’s going to take some time for that to get traction but that is really moving along nicely, we’re getting a lot of very good comments on the new healthcare products. In terms of geographically where we’re seeing differences, I really not -- nowhere stands out in particular where we’re seeing significant change, it’s pretty much broad based throughout the country.

[Todd Schwartzman:]

Great. And you talked about the strength in both day-to-day and project business, is one outperforming the other and how, what is the strength throughout the quarter and pass into April and May thus far.

[Bob Schneider:]

The trend for both in the last month of the quarter was greatly improved over the first two months of the quarter, we saw some nice pickup in March. And in terms where -- as we always into our fourth quarter, we see continued uptake relative to what we see in the third quarter. So, general strength in latter part of the quarter and continuing going forward.

[Todd Schwartzman:]

And contrastingly the relative respective strength of day-to-day with project.

[Bob Schneider:]

Yes. I’m not aware Todd, of any significant difference. Both sides are seeing some uptake, obviously strong uptake as you look our percentage increase in volume. With respect to the project business, we are seeing some larger projects and I say larger in the vein of getting up into that million dollar range. So, seeing little bit more excitement in terms of coding activity on those types of projects. But I wouldn’t say it’s necessarily different relative to the day-to-day because both were seeing a lot of activity.

[Todd Schwartzman:]

And that pickup that you’re seeing in the million dollar plus range, is that isolated in to maybe couple of verticals or is it something more widespread.

[Bob Schneider:]

Let me clarify that Todd, I mean getting closer up into the million dollar. So, 752 a million, not so much over a million dollars seeing some improvement.

[Todd Schwartzman:]

Okay. And that improvement is that just in healthcare or is that more widespread.

[Bob Schneider:]

It’s widespread, it’s not so much in the finance vertical, but it’s widespread and we respect healthcare, going back to my comments earlier, we’re early in the selling cycle in terms of the new healthcare products.

[Todd Schwartzman:]

Okay. And finally what’s the outlook look for commodities?

[Bob Schneider:]

We hope fairly stable, we have been seeing some increases but doing a significant amount of work in terms of trying to reduce cost on other commodities to gain it.

[Operator:]

Thank you. You have no further questions at this time. [Operator instruction] I would now like to turn the call back over to Bob Schneider for closing remarks.

[Bob Schneider:]

Thank you, Lucy. And that brings us to the end of today’s call. We had really good quarter, sales are very strong, our new products as I mentioned, they’re getting traction with new products sales up 25%, our operating income percent as I mentioned was best in nine years. The plane sale restructuring is now behind us saving us 800,000 per year going forward, the Post Falls restructuring is underway and our teams are working very hard to execute the plan which will save us $5 million per year ones finished. Our Board is taking action on our capital structure, you saw with the comments with respect to the buyback the share repurchase in Q3 and our Board implemented the best practice government changes we announced in February. And lastly we’ve increased significantly the financial transparency with more disclosers and our just started guidance on when we think to turnaround will be substantially behind us and we will be at the market level of operating income. We appreciate your interest and look forward to speaking with you on our next call. Thank you and have a great day.

[Operator:]

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