Kimball International F1Q08 (Qtr End 30/9/2007) Earnings Call Transcript

Kimball International, Inc. (KBALB)

F1Q08 Earnings Call

November 5, 2007 2:00 pm ET

Executives

Jim Thyen - President and Chief Executive Officer

Bob Schneider - Chief Financial Officer

Doug Habig - Chairman of the Board

Don Charron - President of Kimball Electronics Group

Analysts

Matt McCall - BB&T Capital Markets

Peter Wahlstrom - Goldman Sachs

Presentation

Operator

Good afternoon, ladies and gentlemen. My name is Shiquana, and I will be your conference call facilitator today. At this time, I would like to welcome everyone to the Kimball International First Quarter Fiscal 2008 Financial Results Conference Call.

All lines have been placed on listen-only mode to prevent any background noise. As a reminder, today's call, November 5th, 2007, will be recorded.

After the Kimball speakers opening remarks, there will be a question-and-answer period when Kimball will respond to questions from analysts, followed by responses to e-mail questions submitted during this call (Operator Instructions).

For all participants listening to today's call on the Internet, you may submit e-mail questions at any time during the call by clicking the e-mail hyperlink conveniently located on the webcast stream.

As with prior conference calls, please be aware that today's call may contain forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Risk factors that may influence the outlook 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 CEO of Kimball International, Bob Schneider, Chief Financial Officer of Kimball International, Doug Habig, Chairman of the Board of Kimball International, and Don Charron, President, Kimball Electronics Group.

I would now like to turn today's call over to Jim Thyen. Mr. Thyen, you may be begin.

Jim Thyen

Thank you, Shiquana, and welcome, everyone, to our first quarter conference call. We hope you had an opportunity to review our October 16th fiscal year 2007 annual shareholders meeting presentation.

It has been posted to the investor relations section of our website at www.kimball.com. We also hope you had an opportunity to review our earnings release issued this morning on the results of the first quarter ended September 30th 2007.

Before we begin, I want to remind everyone that we welcome Internet listeners to submit questions at any time during this call.

As in our last conference call, our format today will start with my overview comments on the quarter, followed by Bob's financial review. We will then open the call to your questions.

As we did in prior calls, I've asked Don Charron, President of our Electronics Group, to join us in support of disclosure, understanding of our results and providing you with appropriate information. Dan Miller, President of our Furniture Group, is traveling, and could not participate in today's call.

If you have been following Kimball for a while, you know that we have had many changes to our business over the last two years, which makes comparability a bit of a challenge.

In today's release, we noted how our net sales for the quarter ended September 30th, were 7.8% higher than a year ago, while income from continuing operations was 4.4%. Internally, we focus more on recent trends, which have been better comparability.

We are very pleased to see the continued improvement in our furniture segment, which has improved each quarter since the third quarter of last year. Specifically, net sales of our office furniture product line in the fourth quarter of fiscal 2007 was 10% higher than the third quarter, and now our first quarter of fiscal 2008, net sales topped the fourth quarter by another 6%.

This is a tremendous successive quarter-over-quarter sales improvement, reflecting the strong market acceptance of our new product introductions made in the third quarter of fiscal 2007.

Over the last few quarters, we have had many choices to make, choices as to whether we would invest in the future for long-term shareholder value or choices to reduce our investments to support a short-term earning horizon.

We did not waver over this period of time. We introduced a record number of new products over the past year, which brings with it large development and marketing collateral costs.

We are continuing to make large investments in new product introductions and sales and marketing initiatives that will drive future growth. Our hospitality product line continues to perform very well with a significant increase in sales over the prior year.

Open orders for our branded furniture product line, which includes both office and hospitality furniture stood at $111.7 million at September 30th, 2007, which is 8% higher than a year ago, and perhaps more importantly, is 17% higher than the beginning of the quarter. So obviously, we are quite pleased with how the furniture segment is beginning to perform.

Now I'd like to make a few comments with respect to our electronics operations. As a reminder, our package of value centers around high durability electronics that typically are designed to endure rigorous testing and must work flawlessly for very long periods of time.

We focus on four market verticals that require high durability type electronics, those being automotive, medical, industrial controls and public safety. The Reptron Electronics acquisition in the third quarter of last year was focused primarily on the medical and industrial market verticals, and it is coming along quite nicely.

We still have much work to do in integrating the operations and gaining plan synergies. We are pleased with the progress to date and are also pleased to report that for the 7.5 months since the acquisition, we are net income positive.

We noted in the last conference call that we have a significant number of TOWs occurring, meaning transfers of work, between our production facilities. The majority of these TOWs relate to Reptron customers taking advantage of Kimball's worldwide geographic footprint.

We have announced to employees at two Reptron facilities, those being Gaylord, Michigan and Hibbing, Minnesota, that we will be exiting those locations over the next six to nine months due to lack of customer interest in those regions.

It is not surprising that the Reptron customers want to take advantage of Kimball's broader worldwide manufacturing footprint. We expected that they would. Based on our advanced discussion with customers, we expect substantially all of the related sales of these two operations to transfer to other Kimball electronic facilities.

Another point of emphasis I would like to share with you is regarding our Nanjing, China, electronics facility. We had our first full quarter of production during the quarter ending December 30th. This operation is still in the start-up phase, and had an operating loss of approximately $0.02 per share in our first quarter, which is a $0.01 improvement over the fourth quarter of last year.

We are adding customers and production lines to this facility and expect continued improvement in earnings as the facility ramps up.

Also within the electronics segment, we have seen some change in our sales mix among our four market verticals. As we have mentioned in previous calls, our strategy is to diversify our book of business within this segment.

As a result, sales to customers in our medical market vertical have become a bigger portion of this segment's sales than it was in the past. However, it is important to note that we continue to add customers in the automotive market, and this market is still an important part of our overall electronics business.

Lastly, we announced in October that during the first quarter, we completed buying back the 2 million shares of class-B common stock, previously authorized for a repurchase by the Board of Directors.

The stock was repurchased from June through September of 2007, at an average price of $12.96 per share and a total investment of $25.9 million. Since 1997, the company has repurchased $101 million of its common stock.

Additionally, we announced that our Board voted to expand the authorization by another 2 million shares. Clearly, we would not be taking these actions without confidence in our cash generating ability and the future growth of Kimball.

With this stock buyback and the acquisitions we made over the last two years, you've seen the change in our asset mix. We have been actively analyzing what our optimal capital structure should be. The changes we have made thus far have been deliberate in our strategy to drive shareholder value. With that, I would like to turn it over to Bob to discuss our fourth quarter results in greater detail. Bob?

Bob Schneider

Thanks, Jim. You likely have noticed that we changed the format of our press release to include tables and bullet point explanations of key events. As Jim noted, it becomes challenging to compare to the prior year due to all of the changes in our businesses during this time. We hope the format of this release helps in your understanding of the various changes.

Overall, we had a very good first quarter. Typically, in our furniture markets, the quarter ended September 30th tends to be a bit slower than the fourth quarter. But we were very happy to see our overall consolidated sales approximate the fourth quarter and increased 7.8% over the first quarter of the prior year.

When looking at our furniture segment net sales, recall that in the prior year first quarter, we were still in the contracts private label business and accordingly, one must remove those sales to get an apples-to-apples comparison.

In doing that, our remaining sales, which are made up of office and hospitality furniture, were up 7.4% over the prior year. Electronic sales were up 12.4% over the prior year first quarter, made up of $36.6 million in additional sales from the Reptron acquisition, partially offset by $33 million pricing change described in today's earnings release.

Our automotive electronic sales were down compared to the prior year, in part due to the UAW strike with GM, although the effect was not significant to the quarter, which is a tribute to our diversification efforts.

Over the years we have added a significant number of new, European and Asian automotive customers, and have expanded our medical, industrial and public safety market verticals, all of which lessened our reliance on the domestic automotive market.

Earnings per share from continuing operations for the first quarter totaled $0.17, which included $0.01 for restructuring. Without restructuring, EPS was $0.18. An important point to note is the $0.02 per share of income recorded related to the Polish offset credit program for investments made in our Poznan, Poland operation.

We did not have similar income in the first quarter of last year and such is classified as non-operating. It is not likely that we will receive similar amounts in the future, as this Polish program is nearing end of life.

As required by regulation fair disclosure rules, I must inform you that the earnings per share excluding restructuring number I just quoted is a non-GAAP financial number. Refer to our press release for further information on non-GAAP financial numbers.

Another important area I would like to point out is our SG&A percentage of 17.8% in the first quarter. As we have noted in the past, there tends to be a seasonal aspect to our SG&A investments leading up to the NeoCon Office Furniture Show in the fourth quarter, which tends to increase the SG&A in that quarter and it tends to decline in the first quarter.

That is what occurred during the first quarter of fiscal 2008, bringing our SG&A down to 17.8%. We’ve been working on reducing our SG&A spend and expect to see continued improvement in this very important measure.

Now a few comments on our cash flow and balance sheet. Cash flow from operations during the first quarter was a positive $17.4 million, compared to a positive $17.7 million last year. As expected, with the large number of TOWs that Jim referred to, we currently have areas of redundant inventory at multiple locations, which will be significantly reduced after the number of TOWs is reduced to more normal levels.

Our first quarter production day supply on hand stood at 56.7 days, which is a two-day increase from the same period last year. This is an important opportunity for improvement and will have a significant impact on improving cash flow.

Our day's sales outstanding, a key measure of our accounts receivable, stood at 45.2 days for the first quarter and that compares to 42.8 days for the prior year quarter. Our cash and short-term investment balance, less short-term borrowings, under our credit facility was $56.1 million at September 30, 2007.

An important point to note in our 10Q, and may frankly be hard to find due to the size of the document, is that we also have $4 million in cash and investments that are not included in the $56.1 million that I just mentioned.

Instead it is recorded in other current assets and represents restricted cash, since it is used as collateral to support a short-term credit facility at our Wales, U.K. operation. U.S. GAAP requires that we record this cash and investments, the $4 million, separately from what you see as the cash and investment line items on the balance sheet.

Jim mentioned we completed the stock buy-back in the first quarter. This brought our outstanding Class-A and Class-B share total to 36.9 million shares at September 30th, 2007. For your earnings per share modeling purposes for Q2, assuming no changes in stock outstanding our weighted average shares outstanding on a diluted basis is expected to be around 37.8 million shares.

Lastly, in past conference calls, I have referenced the excess burden brought about from SOX 44, which was one section of the Sarbanes-Oxley legislation dealing with internal controls. The SEC and PCAOB have recently issued revised rules that will allow us to simplify our current processes around documenting and assessing internal controls without compromising the integrity of our strong internal control structure.

This will allow us to redirect these efforts to focus on the business, which is a nice development. With that I would like to open up today's call to questions from analysts and e-mail questions from anyone listening on the Internet. Shiquana, do we have any analysts with questions in the queue?

Question-and-Answer Session

Operator

(Operator Instructions) Also at this time, those of you listening on the Internet may submit questions by way of the e-mail hyper link conveniently located on your screen. One moment for the first question, please. The first question comes from Matt McCall with BB&T Capital Marketing. Please proceed Mr. McCall.

Matt McCall - BB&T Capital Markets

Thank you ma'am. Good morning everybody.

Jim Thyen

Hi, Matt.

Matt McCall - BB&T Capital Markets

First, trying to get an idea, you mentioned a few things that can likely help your gross margin going forward. Trying to get an idea of the trajectory of the potential gross margin improvement. Can you talk about in a little bit more detail, your expectations going forward from China?

You've now highlighted two plant closures with Reptron. I think that's up from one last quarter, and really what kind of time frame you're hoping, and really what the potential benefit should be as we move toward the latter half of the year?

Jim Thyen

Sure, Matt. I'll make a few comments, and then I'll ask Don Charron to build on those. It's clearly our growth strategy in electronics. We're focused on a greater utilization of the capacity that we have available.

Clearly, China is in that space. We're looking at both new business growth that comes organically, as well as we're open to acquisitions and then we have a significant number of activities that are really focused on variable costs productivity to improve those margins. So we're pushing both growth and margin improvement. Don, you want to add some building points?

Don Charron

Yes. I would, Jim. First of all, we were able to get some margin improvement in this past quarter, and Bob mentioned the selling price changes in our bear practice. That has some of the effect on the percentage, but there's real improvement in there as well.

And a lot of that improvement is coming from the lean Six Sigma activities and global supply chain initiatives that we've had going on, on an ongoing basis in the business for the past several quarters.

There are opportunities to take those practices, if you will, and leverage them into the former Reptron business units and we're doing that now and we're getting the fruits of our labor to show up a little bit, but there's more yet to come.

The operating leverage is probably the significant thing that will come from our consolidation plan. As you mentioned, or as you saw, we did announce the consolidation of two Reptron locations, the Gaylord, Michigan, operation and the Hibbing, Minnesota, operation.

There will be some improvements in terms of margin from leveraging our lean Six Sigma activities and global supply chain initiatives, but those consolidations more than anything will help our operating leverage.

Matt McCall - BB&T Capital Markets

And I guess it's the timing that, I think, the Gaylord facility was, I think, expected to be closed by the end of this year. What about the Hibbing? And I guess if we can get any quantification of the expected improvement there it will be helpful.

Don Charron

Well, let me just speak to the timing. As we mentioned six to nine months, and I think first thing that I think is important to note here is that those customers and those facilities and the business that we're relocating is very critical to our long-term business panels.

So, we have been very careful about how we have worked on those transition plans, very open with the customers that are affected and are taking all of the necessary steps to mitigate the risk that they see associated with those moves, namely continuity of supply and quality.

And so what that does in the end in terms of mitigating that risk, which is the both the biggest concern of those customers that are being asked to relocate in our footprint, it can in some cases add to the timing. And if that's what it takes to make sure that we keep the business, make sure that we keep the customer satisfaction at the levels it is today, we'll extend as necessary.

So six to nine months is what we're thinking the timeframe is before that business is fully relocated.

Matt McCall - BB&T Capital Markets

And is that going back to the Gaylord facility, are we still talking about the end of this calendar year and the Hibbing facility will be over the next six to nine? Or is anything changed with Gaylord?

Don Charron

Gaylord is on track; as we previously announced and Hibbing is a little early on, but we think that's six to nine months from now and as we further develop the details of those transition plans with those customers, that we'll be able to more accurately define the time line.

Matt McCall - BB&T Capital Markets

I understand. Okay. And, Jim or Bob, I guess, on the furniture side, as we look at some potential for some improvement on the gross margin line there. Is it simply volume that's going to improve that, or I think you mentioned your lean initiatives and I think you just mentioned the Six Sigma lean initiatives.

Are you seeing capacity open up, and potentially capacity utilization go down, and maybe open up the opportunity for consolidation from a factory standpoint?

Jim Thyen

It's a little bit of all of that, Matt. Clearly we're focused heavily on making the investments to drive the growth, the top line. We do have capacity available and we're focusing on selling into that capacity and having a greater utilization.

But also we have significant activities going on in our supply chain, sourcing strategies that not only deal with qualifying our customers, but things we've talked about in the past, rationalization, consolidation, and moving into heavy collaboration with our customers along that supply chain.

We're continuing to make investments to keep the improvement up on quality and reliability. We're receiving acknowledgement of that from our customers and we think that's transmitting itself into our increased order rate and our growth rate.

And we're continuing to make investments in the selling strategy and the marketing strategy, both in terms of our accounts, our do dealers, our customers, our channel effectiveness, and also in expanding our workforce, as well as strengthening the relationships that we have for our named accounts or our key relationships that drive our growth. So it's a little bit of all of that.

Matt McCall - BB&T Capital Markets

Okay. I agree that good signs, I think, from the growth standpoint. Did the SG&A line I think Bob, you mentioned some of the things that hit Q4. Obviously that was big gyration in Q4 over last year. Other than that, is there anything that could help us understand kind of the sustainability or should we expect SG&A to kind of hover in current at the Q1 levels, or until we get to Q4?

Is that that a good run rate? And then when we look at Q4, is it more of -- I think you talked about a few million dollar sequential increase as you focused on NeoCon spending. Is that really the only, I guess, seasonal factor we need to keep in mind when we look at our numbers?

Don Charron

Matt, that's probably the biggest. In the near term, as you look forward, historically, the second quarter SG&A rate is pretty close to the first quarter. So, a lot of things obviously impact that, a lot of moving parts. But if you look at our past, you'll see it's somewhat near that. You tend to see a spike up in the fourth quarter.

Matt McCall - BB&T Capital Markets

Okay. And then, just one clarification. You mentioned the 2.1 million shares or 2 million shares. If I do the math at $12.96 that comes up to 2 million, but I think the press release said $1.7 million. I just want to understand what I'm missing there.

Don Charron

It's really just -- it's few days of activity in June. That's the best way to look at it, because we bought shares back in the last week of June, and that was about 300,000 shares, and $1.7 million happening in Q1, and so in totality, then, that's the 2 million shares, and actually, the shares we bought in June were paid for and the cash went out in July. So the cash out flow happened in the first quarter.

Matt McCall - BB&T Capital Markets

Okay. Okay. I got it. That makes sense. Okay. All right. Thank you, guys.

Operator

(Operator Instructions) Your next question comes from Chris Agnew with Goldman Sachs. Mr. Agnew, you may go ahead with your question.

Peter Wahlstrom - Goldman Sachs

Good afternoon. This is Peter Wahlstrom on behalf of Chris.

Jim Thyen

Good afternoon, Peter.

Peter Wahlstrom - Goldman Sachs

How are you doing?

Jim Thyen

Great.

Peter Wahlstrom - Goldman Sachs

Do you provide a breakout of the mix between the hospitality and furniture, office furniture sales as a percentage of revenue?

Don Charron

Peter, we do not. We look at hospitality and the office furniture as our branded furniture product line, and we only report in total.

Peter Wahlstrom - Goldman Sachs

Okay. And could you give us a little bit of a sense, given currently end market trends in terms of commercial construction and what we have seen recently in hospitality? Do you view that as still growing fairly robustly? Or is there some sense of a slowdown in that area?

Jim Thyen

No. We're seeing a lot of positive indicators in that marketplace and our outlook for the future remains positive and strong and it's being demonstrated in our growth in our branded furniture book of business.

Peter Wahlstrom - Goldman Sachs

Okay. And the discounting that you mentioned in that hospitality space, has that been a more recently phenomenon, or has that been something that is part of this business just engrained?

And if it is relatively new, what do you believe is the driver behind this?

Bob Schneider

Peter, the margins in hospitality had been a bit tighter last six months, last three to six months. A key driver behind it, I'm not sure. It's a competitive marketplace, but we have seen a tightening slightly in the last three months to six months.

Peter Wahlstrom - Goldman Sachs

Okay. Have you seen any new end trends in this area?

Bob Schneider

No.

Jim Thyen

No. And one other key thing to keep in mind, Peter, that I should have mentioned earlier, the replacement market in the hospitality industry is larger and more robust than the new construction market.

Peter Wahlstrom - Goldman Sachs

Okay. Then switching to office furniture, and you mentioned some specific discounting during the quarter. On what particular product categories have you seen more discounting, and has this pricing stabilized, or what sort of trends should we expect heading into your fiscal year '08?

Jim Thyen

We've seen the greater pressure in the contract portion of the marketplace as opposed to the mid-market? I don't know that the pressure will abate any or go away any. I think it's the nature of the industry. It's the nature of the economy that we're in right now. I think it will continue in the contract portion.

Peter Wahlstrom - Goldman Sachs

Okay. And you've recently anniversaried your October 2006 furniture price increases. Do you anticipate another price increase in the future?

Jim Thyen

We're going to keep watching the general economies of this whole marketplace, both the contract as well as the mid-market as it relates to office furniture. We know there's pressures there that part come from worldwide demand, there's pressures there that come from regulations not only in this country, but in areas where our supply chain is positioned, and Asia and China, and we know our economies are changing.

Overall, we do see that choppiness in the credit market that you see, but we see a lot of strength in the economy, too. So we're going to keep working with our suppliers to keep trying to bring variable cost productivity and continuous improvement on the materials side.

But we will also work with our customers. And in those cases where we cannot offset some of those worldwide demand pressures, we're going to work with our customers on how we can succeed together in the marketplace.

Peter Wahlstrom - Goldman Sachs

Okay. Very good. On the EMS side, does the volume ramp up in the new China facility require Kimball to win new business or customers, or is a fair amount of that capacity largely accounted for from the shift away from the Gaylord and Hibbing facilities?

Jim Thyen

We started the Greenfield in China with a book of business in mind. I'll let Don elaborate a little further on that.

Don Charron

It really, it's -- Peter, it's both. In our phase-one ramp-up is really business that we already have with customers that have a strong preference to see their business transition flawlessly to the China facility as part of our ramp-up there.

But there's also, if you look, phases two and three of our ramp-up would be more winning new business, and we have in our minds a fairly significant allocation of that facility's overall capacity to automotive, and China as being one of the faster growing automotive markets in the world.

And we have customers that intend to participate in that growth rate in China, and have asked us to be prepared to support them as they develop their plans there. So it does require us to win new business, but in cases to win business with customers we already know.

And of course, phase three is hopefully new customers we've not yet met yet, and when they see our capabilities we've made there, and see the investments we've made there, they too will be a part of our overall growth plans in China.

Peter Wahlstrom - Goldman Sachs

Okay. And if you were to think about one of your EMS market verticals that has either been growing more quickly organically or has better margins, helping to potentially offset some of the drag from domestic automotive, which one would you say that that would be?

Don Charron

I don't know that I could speculate on that, Peter. But I will say this. I think that the market opportunities, if you look at the data that's available on our market, published by companies like technology forecasters, iSuppli, to name a few, they will tell you that the fastest growing available market within the EMS industry is the medical area, and so certainly we hope to gain our share of the rapid growth there.

But, ironically, the second fastest according to their data is the automotive industry. And there we have a lot of experience, more than 20 years, and so maybe our view is slightly different in terms of how much of that available market growth we should truly be interested in. But I think that given that data and that backdrop of that data, I think we would expect to see the same in our overall practice.

Peter Wahlstrom - Goldman Sachs

Okay. And when you look at acquisition opportunities for this business, is that specific to EMS again, or is there some opportunity also in the office furniture or branded segment that you are looking at?

Jim Thyen

It's not specific to EMS, and we are open and analyzing alternates that support our growth and diversification strategy in both segments.

Peter Wahlstrom - Goldman Sachs

Okay. And last question for you is, I realize that you're still analyzing what an ideal capital structure could look like, but is there a certain amount of debt or leverage that you are comfortable with at this stage in the cycle.

Doug Habig

This is Doug Habig, and, yes, we recognize that as we go forward, our capital structure should be adjusted to reduce our cost to capital, and also as Bob mentioned before, with our Board of Directors, we continually analyze our dividend, our capital expenditures, our cash flow and our share repurchases to make sure that as we go forward, we're doing the right things for shareholder value. But there is not a number we have pegged now in terms of debt that we know is optimal.

Peter Wahlstrom - Goldman Sachs

Okay. Thank you very much.

Operator

(Operator Instructions) At this time there are no further questions.

Bob Schneider

Thanks, Shiquana. Jim, we have no e-mail questions either.

Jim Thyen

Okay. That brings us to the end of today's call. In summary, we had a very good quarter. While I would like to see our segments improve more quickly, I am pleased that they are moving in the right direction.

We are committed to our strategy of growth and diversification, and driving long-term shareholder value. We appreciate your interest in Kimball, and we look forward to speaking with you on our next call. Thank you, and have a great day.

Operator

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

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