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Kimball International, Inc. (NASDAQ:KBALB)

F2Q 2014 Earnings Conference Call

February 5, 2014 1:00 PM ET

Executives

James C. Thyen – President and Chief Executive Officer

Donald D. Charron – Executive Vice President, President-Kimball Electronics Group

Robert F. Schneider – Executive Vice President and Chief Financial Officer

Donald W. Van Winkle - Executive Vice President, President-Office Furniture Group

Analysts

Todd Schwartzman – Sidoti & Company, Inc.

Richard L. Greenberg – Donald Smith & Co., Inc

Operator

Good morning, ladies and gentlemen. My name is Glenn, and I will be your conference call facilitator today. At this time, I would like to welcome everyone to the Kimball International's Second Quarter Fiscal 2014 Financial Results Conference Call. All lines have been placed on listen-only mode to prevent any background noise. After the Kimball 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, February 5, 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 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 C. Thyen

Thank you, Glenn. Welcome everyone to our second quarter conference call. Our earnings release was issued this morning on the results of our quarter ended December 31, 2013. We have posted a financial summary presentation to our website to accompany this conference call. Presentation can be found on our Investor Relations website along the Webcast link. We also issued a press release on January 20, 2014 announcing our plans to spin-off our Electronics Manufacturing Services segment as an independent public company along with a plan conversion to a single-class of stock.

For these reasons, Don Charron, Executive Vice President and President of Electronics Group is joining Bob and myself on the call today.

You are all keenly aware of the dynamics of the ever-changing landscape. These are economic governance on our business markets. Digitalization of our lives brings a constant need for organizational and personal adaptability, flexibility, agility, innovation and a continuous re-examination of business models and roles. Intensity and speed of these changed dynamics is driven by the markets that we choose to serve and compete within.

Those of you, who have followed us for a number of years, know of our ability and conviction to adapt, and our constant re-invention of our company and the service of our shareholders. We are proud of the organization and the business platforms we have developed in the Furniture segment and the Electronics segment. We are also confident in the strategic focus within the two segments and that the investments made or balanced, in appropriate for future growth and profitability in these markets.

The Board believes that recapitalization and separating our company into two public companies is the best strategic alternative to enable investors and shareholders to properly value our different business separately. We expect the spin-off to be completed in the next 8 months to 12 months. I will continue my overview comments on the results of the second quarter. That will be followed by a comment from Don Charron, followed by Bob’s more detailed financial review, then we will open the call to your questions.

Consolidated sales in the second quarter increased 9% while our net income climbed to $9.2 million with both of our segments contributing to the solid performance for the quarter. Furniture segment sales increased 6% in the second quarter. Our furniture markets for the most part are gaining strength with the exception of office furniture sales to the federal government. Furniture projects are often influenced by the balance of confidence and anxiety in the business climate. I know you all know this. Heading into our third quarter, which is the normal seasonal low period for furniture, we are encouraged by the 28% increase in our furniture order backlog as of December 31 compared to December of 2012.

Looking ahead, BIFMA’s currently forecasting an increase in office furniture sales of 4.9% for the calendar 2014, forecasts for one of the leading indicators in the hospitality industry. RevPAR or Revenue per Available Room is a 6.6% growth for calendar year 2014. Other key economic indicators, including GDP growth in the U.S., a recent pickup in the recovery of the U.S. office market, employment growth, strong corporate balance sheets among others are generally encouraging. These positive data points continue to give us an increased sense of optimism albeit with caution for our Furniture segment going through the calendar year of 2014.

With improving markets, we had been and will continue to increase investment in new product introductions along with sales, marketing initiatives, business development initiatives to further stimulate our growth. We saw a significant margin improvement in the Furniture segment during the second quarter. As you know from prior calls, one of our key priorities within the segment has been profitability improvement.

We made very nice progress toward reaching our operating income goal during the second quarter and will continue our focus on project execution and process discipline. One other item I would like to mention with respect to our Furniture segment is that recently we made a noteworthy addition to our furniture team, Mike Wagner has been appointed to the position of Vice President, General Manager for Kimball Office Furniture.

Mike comes to us widely respected and with extensive office furniture industry credentials and experience. We are confident that the Kimball Office team will excel under Mike’s leadership. Market dynamics in the EMS segment are very similar to last quarter with mixed demand within the four verticals that we complete in. Automotive and industrial sales remained strong in the second quarter. We continue to benefit from the strength of the U.S. automotive market and improvement in the Chinese market.

Sales to customers in the medical industry declined slightly in the second quarter but the market remained stable. On the other hand lower spending by government agencies has had a definite impact on the public safety market, which is the smallest of our four vertical markets. We continue to focus on growth opportunities in all four of these markets.

Want to take a minute to address the announcement in December related to the ramp down of business from our largest customer Johnson Controls or JCI, which is one of our automotive customers in the EMS segment. In our first quarter Form 10-Q, we disclosed that certain programs we currently have with JCI would be reaching an end of life beginning in fiscal year 2015. This is the nature of the Electronics Manufacturing Service industry and these events occur frequently. Subsequently, during the second quarter, JCI made a strategic decision to in-source a majority of the remaining programs that we currently manufacture for them.

As you maybe aware JCI recently announced a strategic change in the sale of the division which buys our automotive electronic components. We have won many supplier awards from JCI in the past and we wish them the best with the sale of this division. The Form 8-K that we filed with the SEC in December includes our best estimate of the impact of this event on our EMS sales going forward.

Now I’ll turn the call over to Don Charron for his comments and then Bob to discuss our second quarter results in more detail. After that we will open the call to your questions. Don.

Donald D. Charron

Thank you Jim. And many of you are aware I have been the President of Kimball Electronics Group since joining Kimball in 1999. Over the past 15 years I have had the pleasure in leading a Kimball Electronics team in becoming a truly global company serving our customers around the world. We make the customer to focus at everything we do which has served us well. Personal relationships are important to us as we strive to build long-term global partnerships with our innovative design services solutions and our expensive manufacturing capabilities we are able to execute to the highest quality and reliability expectation in the EMS industry.

I look forward to continuing to build our new strengths as I take over it the CEO responsibilities of Kimball Electronics and now I’ll turn it Bob for the financial results. Bob.

Robert F. Schneider

Thanks Don. Our second quarter consolidated net sales were $320.3 million, which is an increase of 9% from the second quarter of last year and was the best quarterly sales of any quarter in the last five years. Net sales in our EMS segment increased 10% compared to the second quarter of last year. We saw a strong growth in the industrial market as sales continued to ramp up with one customer in particular. Sales also increased in the automotive industry as that market remains strong. Sales to customers in the public safety and medical industry declined compared to last year. Sales in the Furniture segment increased 6% in the second quarter compared to last year on increases of both hospitality and office furniture.

We experience growth in all of our office furniture vertical markets except for the federal government which was down significantly from last year. Despite this significant decline, government sales were actually up compared to the first quarter which makes for the third quarter in a row, we’ve seen sequential growth in sales to the government. We were very pleased with the margin improvement we realized in the second quarter. On a consolidated basis, gross profit has a percent of net sales improved 2.2 percentage points over the prior year. Gross profit as a percent of net sales in the EMS segment increased four-tenths of a percentage point in the second quarter when compared to last year.

The margin improvement in this segment is because we had a $1.1 million inventory write-down in the second quarter of last year, which is causing a favorable variance to this year, excluding this write-down from last year margins would have been down slightly. We saw a significant improvement in our Furniture segment margins during the second quarter as gross profit as a percent of net sales increased 4.8 percentage points compared to last year. Our financial results reflect benefits realized from operational improvements and increased focus on project execution and process discipline.

In addition, recent pricing adjustments net of discounting have had a favorable impact on margins. Consolidated selling and administrative expenses increased 16% in the second quarter compared to the prior year. The largest contributor to the increased cost was higher employee compensation costs, including both increased salary and incentive compensation costs in both segments. In addition, our investment in sales and marketing activities which Jim alluded to earlier increased for the Furniture segment.

The normal revaluation to fair value of both the asset and liability related to our Supplemental Employee Retirement Plan, also known as SERP impacted both selling and administrative expenses and other income during the quarter. As I have discussed many times in the past, the strong performance of the equity markets during the second quarter resulted in a $1.3 million gain on our SERP asset which is recorded in other income but was offset by a $1.3 million expenses recorded in selling and administrative expenses resulting from the corresponding increase in the SERP liability.

I mention just because it inflates our SG&A expenses, while at the same time inflates our inflates our other income but again has no impact on net income. The SG&A impact of SERP in the prior year was less than $300,000. The effective tax rate for the second quarter was 19.2% compared to 12.3% in the second quarter of last year. Included in the second quarter of this fiscal year is a one-time tax benefit of approximately $700,000 or $0.02 per share related to a tax law change in Mexico that occurred in December. Without this adjustment our effective tax rate would have been 25.2% for the second quarter, our tax rate is higher this year when compared to last year’s 12.3% because of the improvement in earnings from our domestic operations which carry a higher tax rate.

Consolidated net income in the second quarter of fiscal 2014 was $9.2 million compared to $4.2 million in the same quarter of last year, excluding the class action lawsuit proceeds in Q1 of this fiscal year, our net income in the second quarter was the best quarterly net income of any quarter in the last seven years. On a segment basis, our EMS segment recorded net income of $5.2 million in the second quarter compared to net income of $3.9 million last year. Second quarter net income in the Furniture segment was $4.5 million compared to net income of $1.5 million last year. We are very pleased with the performance in both of our segments of this quarter. Our cash and cash equivalents at December 31, 2013 was $129.6 million compared to $103.6 million at June 30.

Operating cash flow in the second quarter was a strong $29 million compared to $20.5 million in the second quarter of last year with the increase primarily due to the improved earnings. We continue to focus on managing our working capital metrics. Day sales outstanding or DSO increased from 43.7 days for the second quarter of last year to 47.3 days for the second quarter of this year related to an increase in EMS segment primarily due to mix of sales by customer 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 improved from 59.1 days for the second quarter of last year to 53.4 days for the second quarter of this year. The improved PDSOH resulted from ongoing successful inventory management initiatives in our EMS segment. Capital investments for the second quarter totaled $9.1 million mostly for new machinery and equipment in both of our segments. We continue to have almost no long-term debt which stood at $298,000 at December 31, 2013 and our total availability to borrow under our credit facilities was $82.2 million at December 31. Our balance sheet remains very strong.

With that I’d like to open up today's call to questions from analysts. Glenn do we have any analysts with questions in the queue.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Todd Schwartzman of Sidoti & Company. Mr. Schwartzman, please go ahead with your question.

Todd A. Schwartzman – Sidoti & Co. LLC

Thank you. Good afternoon gentlemen. I wanted to just start off with regard to the spin-off. Could you remind us, please, what is the number of shares of electronics that each share of international will receive?

James C. Thyen

Todd, we haven't determined that yet, there are 38,400,000 million shares, if my memory is correct, of total Class A and Class B of Kimball International and we need to determine as we work through the capital structure exactly what that conversion will be, whether it will be 1 to 1 or some other proportionate conversion rate.

Todd A. Schwartzman – Sidoti & Co. LLC

Okay. So, Bob, relative to the date of the completion of the spin, how much lead time do you think you will have once the details are available?

Robert F. Schneider

Our expected date for filing the Form 10 with the SEC is in May. I’m not sure exactly how long it will take through the various iterations with the SEC before all of that is public, and then we’ll have an appropriate amount of runway left Todd to talk through what all the information is, capital structure et cetera that’s in the Form 10.

At this point, I don’t know exactly. It’s a moving target depending on what kind of questions we’ll have from the SEC and then responding to them et cetera.

Todd A. Schwartzman – Sidoti & Co. LLC

Okay, sounds good. On to business now for – looking at EMS first. Directionally you spoke to the four sectors. Is there any additional color? Maybe quantify the increases in auto, industrial or the decline in safety and medical as well just to give a sense of whether things improved sequentially with regard to public safety and medical in particular from Q1.

James C. Thyen

Todd, I know you are familiar with the industry forecast there, they are generally forecasting moderate growth. We certainly see the semiconductor industry that's forecasting 3%, 4% growth and while that is not a market we are in, it can be a little bit of a proxy to kind of point to the future. We seek to have our four verticals kind of balanced. We’d like to have an even book of business over EMS segment in all four of them and right now medical is a little bit below the other three and so they are a little bit more elevated, but all four markets are very positive for us and we are optimistic. Don would you like to add something?

Donald D. Charron

All right. Certainly if you look sequentially, the momentum that we have had in automotive for example and industrial, according to the numbers, strength wise year-over-year, but also sequentially we saw some momentum there and as Jim mentioned in his opening comments, the automotive piece especially that this customers we serve here for the U.S. automotive market and the customers we serve in China for the China automotive market have been particular points of strength.

Todd A. Schwartzman – Sidoti & Co. LLC

Outside of – within just – sticking with that automotive piece. Aside from the U.S. and China, what does the rest of the world represent as a percentage of your EMS auto sales?

James C. Thyen

We have that figure, but we generally do not break that down, but Europe automotive market, it remains stable for us also. So we have the three major venues of North America, U.S., China, Asia and Europe they are pretty solid.

Todd A. Schwartzman – Sidoti & Co. LLC

And for the second quarter, what were the total EMS bookings?

James C. Thyen

Bookings, of course it’s a project business. They kind of ebb and flow, it’s rather erratic, I don’t know that we have – do we have that precise number?

Robert F. Schneider

Well, we don’t Todd, but as you look at bookings in electronics, very important to recognize that winning an actual contract and when that results are the sales, sometimes is a year into the future. Bookings in the quarter just ended, don’t have the exact numbers, but they were very strong relative to the – actually the last three years, but that I don’t mean to imply that’s going to immediately turn into sales in the near-term because often there is setting up the production lines, buying the equipment, getting validation before it actually translates into sales, but we had a very good booking quarter this past quarter.

Todd A. Schwartzman – Sidoti & Co. LLC

And prior to Q2, what was the trailing 12 month figure in bookings just as of that point. So that would be as of the end of September.

James C. Thyen

It’s been very stable for the last year, it’s down just a little bit. Of course we have the JCI change, but it’s been very stable, consistent with our quarter forecast. So...

Todd A. Schwartzman – Sidoti & Co. LLC

So in dollars, Jim, that would be how much?

Robert F. Schneider

Todd, we don't have that number readily available and also it’s not a number that we have published in the past.

Todd A. Schwartzman – Sidoti & Co. LLC

Okay. Will that – fast forwarding to the spin, will there be more detail moving forward with electronics as a standalone or is it pretty much – have you set the tone for how that is going to transpire? Or is that still kind of being figured out?

Donald D. Charron

We have not yet Todd and both furniture and electronics, we have a lot to strategize and plan for how we will handle investor relations in both companies.

Todd A. Schwartzman – Sidoti & Co. LLC

Okay. Looking at Furniture, regarding the second-quarter product development cost, the step up in sales and marketing, can you quantify that and also speak to the third-quarter trend, how we should think about modeling the current quarter?

Robert F. Schneider

But I don’t have the exact numbers on the product development, but that in total in terms of marketing spend and new product introduction with our furniture operations, we are increasing and the amount that we will have in this coming quarter will be more than it was a year ago, I don’t have the specific amounts in front of me.

Todd A. Schwartzman – Sidoti & Co. LLC

Okay. And what was the sales delta for the hospitality piece of the Furniture business for Q2?

Robert F. Schneider

Sales delta…

Todd A. Schwartzman – Sidoti & Co. LLC

On a year-over-year basis.

James C. Thyen

Our overall furniture increase was 6% in furniture.

Robert F. Schneider

Todd, we don’t break out the specifics between hospitality and office furniture, both were up, hospitality was up very strong from a year ago, but again we don’t break out the specific percentage increases.

Todd A. Schwartzman – Sidoti & Co. LLC

Okay. And I know that you had broken out for the purposes of showing the sequential improvement the government business, the federal government. If you were to strip out the – well, how much was government down on a year-over-year basis?

Robert F. Schneider

It was down 27%.

Todd A. Schwartzman – Sidoti & Co. LLC

Okay.

Robert F. Schneider

But that's federal government Todd.

Todd A. Schwartzman – Sidoti & Co. LLC

Right.

James C. Thyen

Federal government, that is sales, yes.

Robert F. Schneider

If you strip that out Todd, in terms of office furniture, it was up in the mid-single digits, which is pretty strong relative to what the market has been doing. All the other verticals in office were up, except for federal.

Todd A. Schwartzman – Sidoti & Co. LLC

Got it, okay, that helps. Taking into account seasonality, third-quarter furniture sales are typically less than second quarter. How does that 4.6% operating margin for the Furniture segment trend for the rest of calendar 2014?

Robert F. Schneider

I will say this Todd, it is always challenged in Q3, because the volume levels as you just pointed out tend to be less, don’t have a specific number, but it will be a challenge to maintain that at what we’ve just seen in Q2 relative to the volume levels that historically are down.

James C. Thyen

I think the – an important aspect of that is, we have excellent discipline in our cost control and our process control. So it would pass the third quarter seasonality.

Todd A. Schwartzman – Sidoti & Co. LLC

Okay. And on the project execution improvement and the process discipline that you cited as responsible for I guess the large lion's share of the gross margin improvement in the Furniture segment. Can you speak with a little more detail on the ways in which did the execution improve specifically? What you were doing? Where are you in the timeline? What inning are we in? How much more benefit or pick up is there yet to come?

James C. Thyen

Well, it certainly is a continuous journey, variable cost productivity as you know just never ends, and that’s going to remain our extreme focus of ours and in all of our businesses, but also in furniture. We are going to continue to partner with our suppliers. We are going to continue to press our lean activities. We are going to continue to look at how digital technology can bring us opportunities to change the front-end as well as all the processes that go to supplying the product and we’ve made a lot of progress, but we have more to go, our 8% operating goal is going to remain as a goal to achieve.

Todd A. Schwartzman – Sidoti & Co. LLC

What can you tell us about the order rates, order entry for Furniture for the quarter just ended?

Robert F. Schneider

The order rates were up, they were up with the office side of the business on furniture. Hospitality was down in the quarter and – we got to put that into context in terms of year-to-date, orders in hospitality actually set a record, we had a very strong Q1 and the orders were a little bit slower in Q2, but office was actually pretty good relative to the market in Q2. And when I say good in that mid-single digits increase in orders.

Todd A. Schwartzman – Sidoti & Co. LLC

Right. On the office side of things, the pickup in the industry and the latest recovery really has been without the benefit of any kind of meaningful pickup in non-res construction. What are you seeing both in terms of office construction and even also on the hospitality side? I know you have spoken in the past as far as expectations for hotel build. But if you could maybe just update us on that as well as on the commercial side of things in terms of cranes in the sky and so on and whether that's flat, up or down from Q1 and what you see going forward?

James C. Thyen

We have seen a little short-term nervousness I mean in U.S. we’ve certainly had weather conditions and that’s added on top of the seasonality, but overall our funnels, our projects and our request for quotations, they are remaining fairly strong. You do see some indicators, the architectural index is hovering right below that 50, but we are optimistic that it’s stable and it’s positive.

Robert F. Schneider

And Todd, I would add with respect to the hospitality industry that market remains very bullish, the average daily rate or RevPAR all those are really bullish measures for the industry which means the hotel operators have better funding for remodeling and sometimes construction and that industry is doing very, very well right now.

Todd A. Schwartzman – Sidoti & Co. LLC.

And that forecast for – the third-party forecast for RevPAR growth of around 6% seems that that’s been kind of status quo for a while now. I think there are some in the industry that as it relates to BIFMA and in the office side of things including government of course, a lot of folks tend to think that BIFMA really is aggressive early in any given calendar year and then their forecast comes in a little bit as the year progresses. What’s been the track record of the - with the – of the predictors of RevPAR growth, how reliable has it been and had there been any change in their forecast. And so what was that for the prior projection prior to up 6%?

James C. Thyen

The last couple of years has been roughly 6% RevPAR growth and more importantly for us at the higher end of the various hotel flags a little bit stronger than the 6%, so there is even more growth in the high end which typically once custom furniture which fits right in our sweet spot, but that’s been pretty consistent for probably maybe a couple of years, I would estimate, and starting roughly a year ago is when that really started translating into more activity quote activity with the four and five star hotel and more growth for us in terms of the wins that we’ve had in that industry. So its been gaining traction for about a year and there is no indication that its losing traction.

Donald D. Charron

I think another element is the occupancy rate which is forecast, so they will continue to increase this next year and the association has been pretty accurate on that.

Todd A. Schwartzman – Sidoti & Co. LLC.

So full year if the numbers have actually been compiled yet for full year calendar 2013 for the industry RevPAR for example was up around 6% would you say?

James C. Thyen

That is – the last I just saw which was a PWC research paper on this, it was around 6%.

Todd A. Schwartzman – Sidoti & Co. LLC

Okay. Why don’t you just talk briefly on the S&A expenses and some of these initiatives and specifically if you could tell us what you are doing in terms of R&D, in terms of sales and marketing activities in particular, if you could quantify as well that would be great what the year-over-year change is and also how the second half plays out again for modeling purposes, just you know what to give us a sense of if you could of what the puts and takes are and the nature of that bump up in S&A that you guys reported for Q2?

James C. Thyen

Fair amount of the bump up in SG&A is the compensation incentive piece, there was a little warranty in there, it was probably less than third of that change. Things that we are doing is we are accelerating our – in furniture we are accelerating our presence in marketing and how we position our products and our business solutions that we offer in the marketplace. We are accelerating our new product development and both in volume as well as in speed introduction to the market.

Todd Schwartzman – Sidoti & Company, Inc.

Had there been any new hires on that front Jim?

James C. Thyen

Yes, we are continuing, the National Office team has not made any significant new hires that organization is stable and moving fine. Kimball office, we continue to develop the organization under Mike Wagner and we’ve had three or four people join us in the marketing in the product area, marketing area and in the sales area.

Todd A. Schwartzman – Sidoti & Co. LLC

And what caused the need to increase warranty reserves for the quarter?

James C. Thyen

Primarily, customer claims on some products that were out there exhibited a little problem.

Robert F. Schneider

Todd, and to build on that a little bit, some of that is driven by the volume increase and as I alluded to earlier in parts of our business we had record orders and that drives a ton of increase in sales and we had product made in Asia with new suppliers to support that growth and there’s always a learning curve. And Kimball International fully stands behind our product and so we accrued whatever is necessary to make the product right. As Jim mentioned, it’s roughly a third of the increase, not a significant point, but wanted to point out and highlight.

Todd A. Schwartzman – Sidoti & Co. LLC

Were there any recalls at all?

Robert F. Schneider

No.

Todd A. Schwartzman – Sidoti & Co. LLC

Okay. Lastly, if you could just maybe either on the whole or break it out by segment if you prefer, your take on the current state of raw materials and where we are headed in the back half of 2014.

Robert F. Schneider

We are seeing some increases Todd, but I mean watching it very, very closely, this past quarter, we didn’t have a real significant cost change as a result of it but we are very much watching commodities to see where it might go into the future and hopefully doesn’t change our modeling as we go forward our forecasting.

Todd A. Schwartzman – Sidoti & Co. LLC

Okay, thank you very much. That's all I’ve got guys.

James C. Thyen

Thank you, Todd.

Operator

(Operator Instructions) And your next question comes from the line of Richard Greenberg with Donald Smith & Company. Please proceed.

Richard L. Greenberg – Donald Smith & Co., Inc.

Hey guys, first on the EMS segment, when you look at your margin of 3%, that compares say to third quarter of 2013, which was admittedly abnormally high at 4.9% on roughly the same sales level. I would have thought that a sales level of $181 million would get you pretty close to your 4% margin. And it certainly should be higher or getting close to the level that you achieved in fourth quarter or third quarter of last year. Why are we still below this 4% level at $181 million of revenues?

Robert F. Schneider

But Rich some of that is driven by the – it's obviously mix of the customers, is driving a portion of it. We're getting a lot of pressure is somewhat constant I guess in terms of the need for cost down from our customers that we’ve managed through. We talked about the higher profitability of our businesses, so incentive costs are a little bit higher. All that come into play and has put pressure on the 3%. Don, if anything you want to add?

Donald D. Charron

Bob, and I would just say that we continue to work on all of the margin improvement activities in our business that we have in the past and we are confident that we continue to work on our Lean Six Sigma projects and there are various supply chain initiatives that we are working on, that we'll be able to restore in those margins in the places where we pull back a little bit and frankly get closer to our goal of 4% operating income.

Richard L. Greenberg – Donald Smith & Co., Inc.

Okay. And then secondly, just on the loss of the JCI business and I guess I would like to hear a little bit, because it is running, whatever, at $20 million or so a quarter. That’s going to be a big hit come – over the next few quarters. Can you give us some sense of what it’s going to take to replace that business and kind of the timeframe and some of the things you are working on there? And is it possible that after you lose that business we can get back to the $700 million or so or so annualized level or in revenues or is it really going to take a few years for you to regain that business?

Donald D. Charron

Well you are right and that it’s a significant change in our business, in our book of business and one that we certainly had anticipated just even a couple of quarters ago, but that being said we have invested over the years I would say appropriately in our business development business efforts and we’ve been successful if you – as we monitor our new business pipeline. In the activity there we are very pleased with what we see and you have seen it in our last four or five quarters where we’ve done a little bit better than market growth as our organic growth rate.

That being said, this hole will be a significant hole once it totally reveals itself in our book of business which is a couple of quarters out and for our 8-K you can see the numbers there that we are estimating in terms of the transition of this JCI business. we kind of feel so we’ve got to continue to keep the focus on the new business developments and certainly its likely that the next – it would take at least three or four quarters after the transition is complete to be able to start to see that hole being filled up completely and again see year-over-year organic growth overall for the business, but we feel like we’ve got the right things in place to continue to drive the organic growth and take advantage of the opportunities in the market.

James C. Thyen

Don just building on that too in terms of the sales to JCI in Q1 of this fiscal year Q2 and then what we are expecting for Q3 and Q4 are somewhat flat and so that does allow time Don to do what you just described before start seeing a more significant drop which happens in Q1 of fiscal 2015.

Richard L. Greenberg - Donald Smith & Co., Inc.

Okay. But it doesn't mean, I mean on the other side, to look at it slightly positively, you - I guess it obviates the need for some of the capital spending. Because I believe in certain areas say Poland you were running short of capacity and then you had been talking about possibly expansion in Eastern Europe or China. At this point, does that mean that you can shelve those plans?

Donald D. Charron

No, I don’t believe it means we can shelve those plans its kind of just the timing and we go through a reassessment, but the need to continue to have capability in Europe is going to be there and its going to be important to our future.

James C. Thyen

But certainly we want to do the best we can to focus our business development effort to drive business growth, the best we can in the areas where we are under utilized and certainly as this JCI business transitions in the out quarters, we have a focused effort to replace that business and drive utilization where that business will have move down, so that’s important, and our overall focus in development, but that being said we are serving a base of customers that are large multinationals with business in many cases in all these various regions of the world. So we don’t necessarily back off of taking advantage of the growth opportunities lets say in one region at the expense of another, we try to drive growth the best we can across the group to serve this group of global customers.

James C. Thyen

And Rich this business mostly relates to domestic U.S., some in Mexico and none of this impacts with what we are doing in Europe.

Richard L. Greenberg - Donald Smith & Co., Inc.

Right, okay. And then, Bob, on the Furniture side, I think in the past we've talked about in order to get to that 8% margin goal you needed to get to $600 million or so plus in revenues. I mean is that still the target? And given the stronger backlog and orders you are seeing, is that a possible goal to reach for in fiscal 2015?

Robert F. Schneider

Don't want to give guidance Rich, but I would tell you that your memory is good. It's about $625 million, $155 million a quarter, is our estimate based on contribution margin of our product that would put us at that 8% and that's not that far away frankly it's maybe 10% to 12% increase in volume and so very much obtainable whether happening in fiscal 2014 or 2015, we hate to give guidance on that given the volatility in the market but we feel good that it's not that far of a stretch to get to that goal and as we've talked about in the past, it's primarily a volume play, it's not a margin play to hit that goal. It's to get the volume up.

Richard L. Greenberg - Donald Smith & Co., Inc.

Right, okay. And then just final question, the cash keeps building, we've in the past talked about the buyback and who knows at this price whether it even makes sense. I am not pushing for that, but I guess really my question is, do you put things on hold regarding the cash until the split is done or would you consider any actions prior to completing the reorganization?

James C. Thyen

We are going to continue to operate our business. We got two very viable segments here that are functioning very well, and there is opportunity for growth and that will use some cash just in funding normal growth opportunities. But the cash allocation and any major that involves our stock or dividends whatever it would be discussed by the Board and as it always is. There we are going to look at our strategic direction here to form two public companies and we want to make sure those companies get launched with a solid balance sheet and ample resources and ample cash to keep funding their positive momentum.

Richard L. Greenberg - Donald Smith & Co., Inc.

Right. I just – and I don't recall off the top of my head your incentive plans from your proxy. But if there were some sort of return on invested capital measure where there would be kind of some almost penalty for having this much cash. I’m just wondering if that would incentivize possibly returning some of that cash to shareholders, because now it sits there and it is a penalty on return on invested capital, return on equity, et cetera. So, it really brings up the question of whether the incentives are properly aligned.

James C. Thyen

That's a very good point, the cash, the cash allocation and the cash use is going to be a very important and viable topic for our Board as we go through spin here and form two public companies and your point is well taken.

Richard L. Greenberg - Donald Smith & Co., Inc.

Okay, great. Good results, guys, thanks a lot.

Robert F. Schneider

Okay thanks Rich.

James C. Thyen

Thank you.

Operator

At this time, I would like to now turn the call over to Mr. Jim Thyen for closing remarks.

James C. Thyen

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

Operator

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

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