Kimball's (KBALB) CEO James Thyen on Q3 2014 Results - Earnings Call Transcript

May. 5.14 | About: Kimball International, (KBAL)

Kimball (KBALB) Q3 2014 Results Earnings Conference Call May 5, 2014 11:00 AM ET

Executives

James Thyen – President and Chief Executive Officer

Donald Charron – President, Kimball Electronics Group

Robert Schneider –Chief Financial Officer

Analysts

Todd Schwartzman - Sidoti & Company

Operator

At this time, I would like to welcome everyone to the Kimball International third quarter fiscal 2014 financial results conference call. [Operator instructions.]

As with prior conference calls, today's call, May 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. And Mr. Thyen, you may begin.

James Thyen

Thank you, operator. Welcome everyone to our third quarter conference call. Our earnings release was issued this morning, reporting the results of our fiscal third quarter ended March 31, 2014. We have posted a financial summary presentation to our website to accompany this conference call. The presentation can be found on our investor relations website, alongside the webcast link.

I will start with my overview comments, followed by Bob’s financial review. We will then open the call to your questions. Don Charron, executive vice president and president of our electronics group, is joining us on the call today and will participate on the question and answer segment of this call.

We completed another quarter with increased sales and very nice improvement in our earnings over the prior year. Our overall third quarter sales were 3% ahead of last year, and our consolidated net income was almost double that of the prior year third quarter, with most of that net income improvement coming from the furniture segment.

Third quarter sales are normally a seasonally low quarter for the furniture segment, so it was encouraging to see that kind of profitability improvement in a quarter where we usually lose some of the fixed cost leverage due to that seasonality.

As we look at the current state of the furniture industry, we are seeing mixed demand in various furniture vertical markets. In the third quarter, we saw some strength in our order activity within the financial services and the state government vertical markets.

On the other hand, both shipments and orders for the federal government continue to fall below prior year levels. The federal government has become a much smaller part of our business, and so the impact of continued reductions is not as great as it has been in the past.

Our day-to-day office furniture business has been stable. Some customers, driven by the fiscal uncertainty that remains, are continuing to defer the purchases of new furniture for large projects. Forecasted order activities remain strong, which is encouraging.

The hospitality market is in a stable recovery, with continued strength in the higher end of the market. We’ve intensified the focus of our sales team and leaders on converting quoting activities into actual orders.

Looking at the industry forecast, BIFMA is currently forecasting an increase in office furniture sales of 4% for calendar year 2014, with most of the growth coming in the second half of the calendar year.

There are two key measures of the hospitality industry health and profitability: occupancy rates and RevPAR, or revenue per available room. Both are indications of hotel ownership’s propensity to renovate existing hotels and to construct new facilities. Both measures are at or near pre-2008 recession levels, indicating a strong market for in-room cased goods and seating orders.

New hotel construction in calendar year 2014 is projected to increase from the very low level by 37% according to the January 2014 report from PricewaterhouseCoopers. We are preparing hard for two key furniture trade shows in May and June: the Hospitality Design Show in Las Vegas, and the NeoCon Office Furniture Show in Chicago.

The workspace environment continues to change at a rapid pace. The change is creating opportunities in the marketplace. We have accelerated our new product development activities to capitalize on these workspace opportunities. We are looking forward to showcasing our new products and business solutions at the upcoming furniture shows.

In our EMS segment, most of the markets in which we compete remain stable. Our third quarter sales grew a little over 2% compared to last year. We were pleased with the operating income performance in this segment for the third quarter. Excluding proceeds received from the antitrust lawsuit, our operating income margin was 4.5% for the quarter.

The team remains focused on executing our strategic plan. January, the trade publication Manufacturing Market Insider, or MMI, released its annual list of the 50 largest EMS providers worldwide. Kimball Electronics was ranked 20th on the top 50 list, showing that we continue to be a strong player in the EMS market.

Activities related to the spinoff of our EMS segment are progressing very well. There is an extensive amount of work that is being done in order to successfully split Kimball International into two separate public companies. We are on plan as announced in January. We intend to complete our initial filing of the SEC Form 10 registration statement in mid-May.

We are expecting the spinoff completion date to be within 8 to 12 months from our original announcement date of January 20, which puts it around the end of the calendar year. As we head into the last quarter of fiscal year 2014, we are encouraged about the opportunities that exist in the markets we serve in both segments.

Sustaining our operational excellence will continue to be a key priority with the uncertainty that remains in the current economic climate and the execution requirements of spinoff. We will compared to seek opportunities to invest in initiatives that will drive growth with improved profitability.

Our consolidated balance sheet remains strong, our cash balance increased to $138 million as of March 31. Now, I will turn the call over to Bob Schneider to discuss our third quarter results in more detail. We will then open the call to questions. Bob?

Bob Schneider

Thanks, Jim. Our third quarter consolidated net sales increased 3% from the third quarter last year, ending the quarter at $310.8 million. Both of our segments contributed to the growth this quarter.

Net sales in our EMS segment increased 2% compared to the third quarter of last year. Our strongest growth came from sales to the automotive industry, as we continue to see strength in the U.S. and Chinese markets.

The industrial market and medical market both experienced a slight increase in sales in the third quarter. Sales to customers in our smallest market, which is public safety, declined compared to last year. Sales in the furniture segment increased 5% in the third quarter compared to last year, on increases of both hospitality and office furniture.

We experienced growth in all of our office furniture vertical markets, except for the federal government, which was down 27% from last year. Orders received in this segment during the third quarter were down 4% compared to last year, on lower orders of hospitality furniture. Despite the decline in orders, our open order backlog as of March 31 was 13% higher than March 31 of last year, as orders started picking up in March.

Or consolidated gross margin improved 1.6 percentage points for the third quarter compared to last year. While margins improved in both of our segments, the primary contributor to the increase was the furniture segment.

Gross profit as a percentage of net sales in the EMS segment increased 0.2 of a percentage point in the third quarter when compared to last year. We remain committed to our continuous improvement efforts as an opportunity to increase our margins, but overall we are pleased with our results in this segment.

Once again, this quarter our furniture segment margins increased substantially, increasing 3.2 percentage points compared to last year. Similar to our discussion last quarter, our financial results continue to reflect benefits realized from the operational improvements and increased focus on project execution and the process discipline. Recent pricing adjustments also had a favorable impact on margins.

Consolidated selling and administrative expenses increased 4% in the third quarter compared to the prior year. The largest contributor to the increased expense was higher employee compensation costs, including both increased salary and incentive compensation costs in both segments.

In addition, we are incurring incremental costs related to the spinoff of our EMS segment. Those costs totaled $855,000 in the third quarter, primarily related to audit fees and legal fees. The after tax impact of these costs was approximately $500,000 and the earnings per share impact was $0.01. We will continue to incur incremental costs as we move toward the completion of the spinoff.

If you recall, during the first quarter of this fiscal year we received $5 million in proceeds from the settlement of two separate antitrust class action lawsuits. The class action suits allege that various electronics industry suppliers conspired to fix prices of certain electronic components, resulting in inflated prices to the purchasers. This was related to components purchased several years ago by some of our manufacturing facilities in the EMS segment.

There were some disputed items that were not paid out in Q1. Those disputed items have now been settled and so we received an additional $666,000 in the third quarter. The after tax impact of this income was approximately $400,000 and the earnings per share was $0.01. The income was recorded in the EMS segment.

The net of the incremental spend costs just mentioned was also $0.01, so the net of these two items is zero. The effective tax rate for the third quarter was 15.4%. The effective tax rate was favorably impacted by a higher mix of earnings from our foreign business units, which are located in lower tax countries compared to the U.S.

In addition, we recorded approximately $700,000 of favorable tax accrual adjustments including a decrease in the deferred tax asset valuation allowance for one of our foreign units and some state tax accrual adjustments.

Consolidated net income in the third quarter of fiscal 2014 was $7.2 million, compared to $3.7 million in the third quarter of last year. On a segment basis, our EMS segment recorded net income of $6.9 million in the third quarter, compared to net income of $6.5 million last year.

The third quarter net income in the furniture segment was $760,000, compared to a net loss of $2.5 million last year for an improvement of $3.2 million. We are very pleased with the performance in both of our segments this quarter.

Our cash and cash equivalents at March 31, 2014 was $138.3 million compared to $103.6 million at June 30. We had another strong quarter of operating cash flow in the third quarter, $19.8 million compared to $11.4 million in the third quarter of last year, with the increase primarily due to improved earnings.

We continue to focus on managing our working capital metrics. Days sales outstanding, or DSO, increased from 40.3 days for the third quarter of last year to 46.5 days for the third 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 improved from 56.4 days for the third quarter of last year to 54.9 days for the third quarter of this year. The improved PDSOH resulted from ongoing successful inventory management initiatives in our EMS segment.

Capital investments for the third quarter totaled $9.6 million, mostly for new machinery and equipment in the EMS segment. We continue to have almost no long term debt, which stood at $296,000 at March 31, 2014, and our total availability to borrow under our credit facilities was $82.2 million at March 31.

Our balance sheet remains very strong. With that. I’d like to open up today’s call to questions from analysts. Operator, do we have any analysts with questions in the queue?

Question-and-Answer Session

Operator

[Operator instructions.] And your first question comes from the line of Todd Schwartzman with Sidoti & Company.

Todd Schwartzman - Sidoti & Company

Bob, you had spoken briefly to the inventory. What was the year over year change in inventory attributed to JCI?

Robert Schneider

There’s not much change yet in terms of JCI, and the impact on inventory. The sales level that we had indicated in our March 8-K in terms of what we estimated for JCI ramping down, I think it only ramped down $3 million in sales from what it was pre that announcement. So very minor effect from JCI.

Todd Schwartzman - Sidoti & Company

And just to reflect what’s left in that business in Q4 and early part of fiscal 2015?

Robert Schneider

We had $20 million in sales in the quarter just ended, in March. And as we had announced back in December, we expect that in the quarter ending in June, to go down just $1 million to $19 million. And most of the ramp down happens in the quarter ending in September, which it drops to $11 million, and then the December quarter drops to $4 million.

Todd Schwartzman - Sidoti & Company

With R&D and other investment spending trending higher on the furniture side, what are the considerations for the quarterly SG&A run rate on a consolidated basis?

Robert Schneider

I don’t know the numbers off the top of my head. I know we’re doing a lot on new product introduction. As it relates to R&D that would drive an impact, our R&D tax credit, that has been relatively stable over the last several years. But of course the tax credit has not been renewed at this point. But a lot of the new product introduction doesn’t qualify for R&D as it would be defined in terms of that credit.

Todd Schwartzman - Sidoti & Company

And with I guess now about five weeks of Q4 already in the books, what are you seeing as far as the foreign mix, the country mix, and what does that lead you to approximate the fourth quarter effective tax rate look like?

Robert Schneider

I think the effective rate, we’re generally looking at the mid to high 20s on our effective tax rate. The quarter we just had was an aberration, because of a deferred tax adjustment that I mentioned earlier, and some state tax returns getting finished, and then the accrual being trued up in Q3. Q4 and then going into Q1 and Q2 of next year, generally the mid to high 20s effective tax rate is really where you need to be looking at it.

Todd Schwartzman - Sidoti & Company

Looking at the incentive comp, you had an increase in Q3 year over year. Are you expecting a similar increase in dollars in the fourth quarter on a year over year basis?

Robert Schneider

Yes, we would. Don’t have the exact dollar amount, but with profits being significantly higher than where we were a year ago, we will have higher incentive comp costs in Q4 than we had a year ago.

Todd Schwartzman - Sidoti & Company

But that doesn’t really accelerate very much, that year over year change, versus the third quarter change?

Robert Schneider

It could, although we don’t give guidance in terms of how the earnings will be going, and so clearly very high earnings in Q4 would drive it even higher. If earnings are not as high, then it would impact conversely. But we don’t give guidance. But I am confident, even without a significant change in earnings in Q4, the amount of incentive comp costs that we have would be higher than a year ago, just because overall we’re doing much, much better than a year ago, profit-wise.

Todd Schwartzman - Sidoti & Company

And switching to EMS for a SEC, what is the trend with regard to customer outsourcing? I know JCI took some stuff in house, but some folks in the industry have spoken lately to the opposite as kind of a longer term trend. Where are there opportunities for Kimball Electronics going forward in that regard?

Donald Charron

I think that what we see on the customer community is somewhat mixed, but still a strong preference toward embracing outsourcing. There are still selective examples where companies are reversing their strategies and insourcing.

We see that probably more in the automotive space than we do anywhere else, but I think for the most part, what we see is a steady, growing demand for outsourcing projects, especially in Europe.

I think Europe was a little later in embracing the outsourcing model in general, and so our business outlook there continues to be steady and growing, and we’ve seen more opportunities every day coming into our new business pipeline. So we see growing opportunities in all four verticals, but especially in the medical and industrial verticals.

Todd Schwartzman - Sidoti & Company

Just for clarification purposes, Bob, you had said that federal shipments in the quarter were down 27%. Is that correct?

Robert Schneider

That’s correct.

Todd Schwartzman - Sidoti & Company

Then I thought you were about to state that the federal orders were down 4%, but I wasn’t sure. I think you maybe were speaking to the consolidated segment orders.

Robert Schneider

The consolidated segment orders were down 4% for furniture. But yes, in terms of Q3, the actual shipments on federal were down 27% and the orders were down, I don’t recall how much. But recognize, the amount of federal business is now around 6% of the total office furniture sale, so it’s a very small base and minor movements have a pretty decent percentage change.

Todd Schwartzman - Sidoti & Company

Okay, so federal is down 6% of sales?

Robert Schneider

Of the total of office furniture.

Todd Schwartzman - Sidoti & Company

What was the level, on average, of the most recent price increase?

Robert Schneider

They were in the neighborhood of 2% to 4%. That’s with respect to office furniture. One was in June of last year and one was, for one of the other businesses, was in December of last year.

Todd Schwartzman - Sidoti & Company

And in hospitality, wondered if you can give some more color, the forecasts certainly are pretty bright, and just wondering what’s driving the expected construction strength at the high end. And just, if you would, talk about what you’re seeing in hospitality. I know that the RevPAR forecast is pretty good. What are you guys seeing in particular?

Robert Schneider

All the metrics look very bullish on hospitality. Jim referred to the new construction increase relative to a low basis a year ago, up substantially. And we’re getting quote activity that’s very strong, from existing renovation type business and also from new construction.

James Thyen

We’re also seeing external capital come into the industry for constructing new hotels or renovating, rebranding existing hotels.

Todd Schwartzman - Sidoti & Company

And on the office side, how competitive was pricing in Q3?

James Thyen

The discounting did not vary that much from prior quarters or from last year. The market remains very competitive, but it’s opportunistic, and it’s strong, generally strong.

Todd Schwartzman - Sidoti & Company

And I know your longer term objective for the furniture margins is a bit higher, but I guess taking it step by step, when do you see getting the furniture business to, let’s say, mid-single digit op margin on an annual basis?

Robert Schneider

We estimate that around $620 million, that’s $155 million a quarter, is roughly where we think that we get to that 8% operating income goal. You know, a lot of it is dependent on leverage of our cost structure and that incremental volume we think will get us very, very close to that 8% goal.

Operator

And we have no further questions at this time. I will now turn the call back over to Jim Thyen for any closing remarks.

James Thyen

Thank you, operator. 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.

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