Kimball International, Inc. (NASDAQ:KBAL)
Q2 2016 Earnings Conference Call
August 3, 2016, 11:00 AM ET
Robert Schneider - Chairman & Chief Executive Officer
Michelle Schroeder - Vice President and Chief Financial Officer
Steven Ramsey - Thomson Research
Good morning, ladies and gentlemen. My name is Candice 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 Year 2016 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 and investors [Operator Instructions]
As with prior conference calls; today's call August 3, 2016, will be recorded and may contain forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from the forward-looking statements. Risk factors that may influence the outcome of forward-looking statements can be seen in the Kimball International Form 10-K and today's release.
The panel for today's call is Bob Schneider, Chairman and CEO of Kimball International; and Michelle Schroeder, Vice President and Chief Financial Officer of Kimball International.
I would now like to turn the call over to Bob Schneider. Mr. Schneider, you may begin.
Thank you Candice, and welcome everyone to our fourth quarter conference call. The financial results for our fourth quarter and fiscal year ended June 30, 2016 were released yesterday afternoon. As in prior calls, an investor presentation slide deck is posted to the investor relations section of our website to accompany this conference call.
The slide deck includes trending of key metrics that makes it much easier to see the progress we are making towards achieving our operating income goal of 8% to 9%. I will have a few brief comments before I turn the call over to Michelle, who will provide us with the key financial highlights for the quarter. We will then open up the call to questions from analysts.
Our fourth quarter capped off a years in which we made significant progress in the journey towards our turnaround goal of achieving operating income of 8% to 9% and earnings per share of $0.23 to $0.27 on quarterly sales of $170 million to $180 million. For the year, our sales increased 6% while our GAAP operating income increased a very strong 93%, excluding restructuring and spin off cost in the prior year to get a better apples-to-apples comparison.
Our non-GAAP operating income increased 58% still pretty strong. The graph on slide number 21 in the investor presentation slide deck, shows the progress we are making in that journey with significantly improved operating margins for last couple of years finishing fiscal 2016 at 6.4% excluding restructuring. That was our best performance in the last 15-years.
Now I realize that 6.4% is not up to what our competitors are doing, but it's great progress and I'm proud of our team and the work so for in our turnaround journey. The investments we have made in our people and our innovative product design and development and in marketing efforts to elevate the recognition of our brands are driving our improvement.
Now to turn the focus on to the fourth quarter. Overall, I'm pleased with our fourth quarter results despite a few challenges that impacted earnings for the quarter. Let me summarize, the key highlights for the fourth quarter. Our focus on innovative design of products continued with the premier of 18 new products at the Contract Furniture Industry show in Chicago in June. We believe our nimble size and our culture helps with speed and new production introduction, which is necessary to compete in a rapidly changing marketplace.
We continue to see growth in office furniture as sales increased 3% and our orders increased 6% over the fourth quarter of the prior year primarily on the strength of the healthcare, government and education vertical markets. The hospitality vertical sales increased 6%, which is fantastic given last year's tough comparison. In the fourth quarter last year, we shipped a $9.5 million order related to a record order for a single property.
Shipments of this size for a single property order are very unusual excluding that larger order, our sales would have increased 38%. This was a very strong quarter for our hospitality vertical. And with our improved results and focus on working capital management, we generated $9.2 million of operating cash flow during the fourth quarter. Lastly, our fourth quarter earnings were hindered by higher employee healthcare cost that Michelle will talk about shortly. Despite the higher cost though, our earnings improved over the prior year quarter.
Regarding the consolidation of our Idaho facility into our Indiana facilities, we made a lot of progress in the fourth quarter. The transfer was completed in stages with the final production transferred to an Indiana facility at the end of March. Our fourth quarter was then snapped ramping up production and training. This project by the way was roughly 18 month effort by many, many employees. As I discussed in last quarter's call, this was one of the complex restructuring initiatives we completed, so let me give you a little bit more background. Basically, it was selling up a new metal production facility from the ground up in an existing wood facility in Indiana. If you recall when we first announced the restructuring, we estimated it would take until the end of September 2016 to complete it.
The initial stages of the consolidation over the last several months went very well and so we pulled up the completion date. The last product transfer was the most complicated and we frankly underestimated the time and resources it would take to achieve this last phase including the amount of training required for our employees. While we completed the physical move ahead of plan, we had inefficiencies during the fourth quarter as our employees in Indiana are still learning the efficacies of metal production.
While we realized plant savings on freight and handling during the fourth quarter as expected from the restructuring actions, those savings were primarily offset by the labor inefficiencies. As we continue to work on training and efficiency initiatives, we will not realize the full $1,250,000 savings related to this restructuring plan in the quarter ending September 30, as we have noted in past.
Instead, we anticipate approximately $600,000 of net savings in the fourth quarter of fiscal 2017, which ends in September. By the end of calendar year, which is our second quarter, we should be passed the learning curve and recognizing the full $1,250,000 per quarter savings.
Lastly, I’m pleased to say that we signed an agreement to sell our Idaho facility that we just existed with the closing of the sale expected to occur in September. Cash proceeds from the deal after factoring in closing cost and estimated taxes on the transaction will be approximately $10 million. Ongoing carrying cost on the facility were north of $500,000 per years, so it will be nice to not have that burden going forward.
Concerning our capital structure. We had $47.6 million of cash and almost no long-term debt as of June 30, 2016. The proceeds of from the sale of the Idaho facility will of course increase our cash balance even further. We understand that we are heavily capitalized today it is our intent to better aligned our capital structure with that of our peers, as we complete our turnaround efforts. Priorities for our capital will consist of reinvestments back into the business for growth, stock buybacks to offset the effect of stock compensation dilution, a dividends at a level comparable to our peers by in acquisitions or partnerships.
And should capital of generation outpace the need for funding from these priorities additional stock buybacks will be evaluated. Our return on capital is already approaching industry leading levels and will remain a key metric as we evaluate our capital structure and performance going forward.
And finally, I would like to mention the couple of governance items. We are honored to have benefitted from the wisdom leadership and friendship of Tina Vujovich, our board member for the past 22 years. Tina retired from our board in April of 2016 and will be greatly missed. After studying our growth strategy and experience voice on our Board, Tina's vacancy will be filled or was filled by the appointment of Dr. Susan Frampton, President of Planetree, Inc. A global leader in advancing patients center to healthcare.
Also appointed to the Board was Kristy Juster, President of the Global Writing Segment of Newell Rubbermaid. Both Susan and Kristy provide our board background and experience in areas that will help to propel Kimball's strategic planning and future growth.
Additionally, our Board of Directors recently created a Chief Compliance Officer role filed by our General Counsel and Board Secretary, Julie Heitz Cassidy. This role furthers the company's long-standing commitment to ethical standards compliance and legal obligations.
Now, I will turn the call over to Michelle for a brief overview of the financial results before we open up the call to your questions. Michelle.
Thanks Bob. Our consolidated sales for the fourth quarter increased 4% to a $164.7 million; we do continue our trend of sales growth over the prior year with this being the 12th consecutive quarter with year-over-year growth. We experienced sales growth in four of our six vertical markets this quarter with the largest [industry] (Ph) is coming from the government. Both federal and state governments contributed to the 17% increase in this vertical.
We had a few larger projects and two recent state contract wins that boosted sales during the quarter. Sales to the healthcare industry increased 17% over the fourth quarter of last year. We continue to see significant opportunity in this vertical and are focusing efforts to expand our products solutions, as well as increase awareness of our brands in the healthcare market.
Fourth quarter sales to the education market increased 11% over the last year, due to a couple of large projects this year. Sales in the hospitality vertical increased 6% over the last year, which is really quite significant given the difficult comparison for last year. As Bob talked about, we have the shipment in last year related to larger order.
The total order was for 14 million and that an unusually large. 9.5 million of that order shipped in fourth quarter and as Bob mentioned, if you exclude that unusual orders, sales would have increase 38%. So once again, this was an example of the variability we see in this market from quarter-to-quarter due to the project nature of the hospitality vertical.
Sales from new office furniture products introduced in the last three years increased 34% compared to the fourth quarter of last year. We were very pleased to see that new product sales approximated 29% of our total office furniture sales in the fourth quarter. Our focus on fast space launching of new flexible furniture solutions meet today's design trends and collaborative office environment is really paying off.
Overall, our orders were up 2% in the fourth quarter led by a significant increase of 34% in the healthcare vertical. In addition to the healthcare, orders in government, commercial and education verticals also increased in the fourth quarter. Orders in the hospitality verticals declined during the quarter.
A reduction in orders from our custom business which typically are the larger orders more than offset an increase in orders of our program business, and what we call program business is more than midscale and upper midscale and this is where more of the growth in industry is coming from at this time. The hospitality industry is still strong but occupancy levels appear to have stabilized according to a recent PWC report.
The consolidated open order backlog was 129.9 million at the end of the June, which was a significant increase of 16% over June last year. This is a very healthy backlog and positioned us well heading into the first quarter of 2017.
As I move to operating income results my comments reflect operating income excluding restructuring cost in both years, excluding cost related to the spinoff of our electronic segment in the prior year and excluding the impact of adjusting our supplemental employee retirement plan liability to fair value, which is offset in the other income line and thus result in no impact in the income which is why we adjust for it.
So the non-GAAP disclosure is reconciled on the last page of our investor slides deck and this is the best comparison of our ongoing operation. The non-GAAP disclosures simplify the comparison. We continue to see improvement in our year-over-year operating income. Fourth quarter adjusted pro forma operating income increased 5% over prior year and ended at 6.7% of net sales compared to 6.6% in the fourth quarter of last year.
The current year quarter benefited some price increases, lower incentive compensation cost, cost savings initiatives and lower freight cost. Our intensive compensation costs are lower to slight improved earnings, because we did revise our intensive compensation plans at the beginning of the fiscal year making the performance targets harder to reach in 2016.
The fourth quarter also benefited from savings realized related to the restructuring actions; however, most of that benefit was offset by the additional training and start up costs. To go in the other way, we had much higher employee healthcare cost during the quarter.
Last quarter mentioned that we had one large healthcare claim that hit in the third quarter that was followed-up with another larger claim in the fourth quarter. Our healthcare and other benefit costs in total were $1.7 million higher in the fourth quarter of this year compared to last year. So, this impacted our operating margins by a 100 basis points in Q4.
We continue to manage our healthcare cost, but this cost line item has some variability in it due to the size and timing of claims. And as Bob mentioned earlier, in spite of the increase in healthcare cost our earnings still did improve over the last year.
On other matters pre-tax restructuring cost related to the exit of the post form Idaho facility were $1.4 million in the fourth quarter our effective tax rate was 34.5% compare to 45.9% in the prior year and last year's rate was high because of the expenses related to the spinoff of electronics were not deductable for tax purposes.
Our fourth quarter adjusted net income, which excludes restructuring cost was $7.1 million in the fourth quarter of this year compared to prior year adjusted net income of $5.8 million.
Now moving to our forward-looking guidance. As a reminder, our guidance syncs up with the completion of our restructuring activities and realizing the savings from that restructure. Our estimated savings from the restructuring plan is $1, 250,000 per quarter or $5 million annually. As Bob mentioned, we expect to pass normal start up cost by the end of the calendar year at which time we will realize the full saving.
Due to the continued start up costs, we anticipate net savings of approximately $600,000 in the first quarter of fiscal year 2017 instead of the full $1,250,000. As a result of the lower than expected savings in the first quarter, it will be more challenging to hit our guidance next quarter.
We expect to be near the low end of our guidance, which was sales in the range of $170 million to $180 million. Operating income in the range of $13.6 million to $16.2 million, which equates to the 8% to 9% operating margin. EPS in the range of $0.23 to $0.27 and return on capital exceeding 20%.
We set this guidance 15 months ago to coincide with the completion of our restructuring activities and our expected turnaround of the company and were very pleased with the progress made so far and are continuing to push for improved earnings.
Moving to the balance sheet as of June 30, our cash and cash equivalent totaled $47.6 million, our operating cash flow in the fourth quarter was $9.2 million compared to $1.8 million in the fourth quarter of last year, and we paid $2.1 million in quarterly dividends in the fourth quarter.
Our capital expenditures totaled $3 million for the quarter, which was primarily for showroom renovations and machinery and equipment. We did not repurchased any shares during the fourth quarter and Bob discussed earlier our plans to utilize our cash and we continue to review and discuss with our Board of Directors options around our capital structure.
Our fourth quarter days sales outstanding, which is a measure of accounts receivable performance, improved to approximately 25 days compared to 29 days for the fourth quarter of last year. And our inventory metric or production day supply on hand for the fourth quarter of this year increased to approximately 48 days from approximately 46 days in the fourth quarter of last year.
We continue to have although still long-term debt which stood at 241,000 at June 30, and we have a $30 million credit facility. Our balance sheet remains very strong.
With that, I would like to open up today's call to questions from analysts. Candis, do we have any one with question?
And our first question comes from the line of Catherine Thomson of Thomson Research. Your line is now open.
Good morning guys. This is Steven Ramsey on for Catherine today. My first question on the outlook for achieving 8% to 9% operating margins, couple of questions regarding that. First, do you expect gross margin expansion along with that or leading that? And secondly, would you expect more of that to benefit on the operating side with SG&A?
Steve, if you look at our gross margin for the quarter just ended was 32.6, so pretty strong. We need some volume increase over the current levels of sales to get to the $170 million to $180 million in terms of our projection. And as Michelle said, we think in terms of our cost structure we'll probably on the low end of the actual Op in guidance, the earnings per share guidance also.
In terms of where that falls, the performance improvement that we were planning in terms of 1,250,000 per quarter of savings, most of that is in the gross profit line and we are not anticipating as Michelle said to get all of that in the quarter ending in September. We think we'll $600,000 of the 1,250,000.
So we will likely have some expansion in gross profit as we get more the benefits of post falls restructuring behind us. And with respect to SG&A, I am very, very hopeful and statistics would tell us that the likelihood of continuing to have very few but large claims hitting our healthcare that shouldn't happen all the time.
And what happened in Q3 and that happened again in Q4 with some unfortunately some very large healthcare issues with some of our employees and their families, we don't expect that to continue. So that would have benefit impart in terms of the gross profit line and some of the benefits of the SG&A line also.
Now, one thing I would say to that is, our healthcare costs normally are higher in the first and second quarters of fiscal year as we get later in the calendar year. So while we hopefully don't have the large claims they normally do trend a little higher in Q1 and Q2.
Excellent and then you alluded to this, I think in this commentary that maybe even thinking pass the Q1 guidance and not looking for further guidance here, but over the longer-term. Do you guys need top-line growth to achieve margin expansion or do you think you can achieve that at expansion if sales were to trend down at some point?
We definitely need the help of top-line growth, we are going to get that expansion as we get the restructuring behind us, get that completed. As we look beyond that, we have done some much in terms of continuous improvement, restructuring efforts to lien out this business. And with every company, there is still opportunity for more, but we have done a lot up to this point and we will continue to focus on that but the primary driver will be higher volume and be able to leverage our fix cost in the future.
Excellent. Thank you guys.
Thank you. [Operator Instructions] And I'm showing no further questions at this time. I would like to turn the conference back over to Mr. Schneider for closing remarks.
Thank you, Candice. In closing, I’m very, very pleased with the progress made in 2016 and our journey to turnaround the financial performance of the company. The journey is not complete, but we are getting much, much closer. We continue to aggressively invest in strategic growth initiatives, while keeping our focus on long-term results. I'm excited to begin the new fiscal year 2017 with great momentum. We appreciate your interest and look forward to speaking with you on our next call. Thank you and everyone have a great day.
Ladies and gentlemen thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Have a great day everyone.