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Kimball International Inc  (KBAL)
Q2 2019 Earnings Conference Call
Feb. 05, 2019, 11:00 a.m. ET


Prepared Remarks:


Good morning, ladies and gentlemen. My name is Ashley, and I'll be your conference call facilitator today. At this time, I would like to welcome everyone to the Kimball International Second Quarter 2019 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 and investors. (Operator Instructions)

As with prior conference calls, today's call, February 5, 2019, will be recorded and may contain forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from the forward-looking statements. Risk factors that may influence the 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 Kristie Juster, CEO of Kimball International and Michelle Schroeder, Vice President and Chief Financial Officer of Kimball International.

I would now like to turn today's call over to Kristie Juster. Ms. Juster, you may begin.

Kristine L. Juster -- Chief Executive Officer

Thank you, Ashley. Good morning, and welcome to the Kimball International's second quarter 2019 call. We announced our results yesterday for second quarter ending December 31, 2018. As with prior calls, there's an investor presentation slide deck on our website that includes important information on the quarter along with trending.

I want to start by thanking our employees, our business partners and our investors for their valuable conversations over the last 90 days. Our time together has been valuable over the last 90 days. Our time together has only given me more confidence in our exciting future. We have three objectives of this call. One, to start talk about our progress. Two, to further share our path ahead and three, to dive into our Q2 results.

It's important to begin with the statement, our job is clear. We must deliver on our commitments of today while we're building our future growth chapter. I'm pleased with our progress on the transition at Kimball International. We have labeled this transition NXT. NXT is not our growth strategy. It is the preparatory phase for real growth. It establishes the key learning work streams and it is the spark that ignites the business, the strategy and the organization.

NXT will be completed by the end of our fiscal year in June, and will launch us into fiscal 2020 with a clear new vision. Today, we have completed our charter and we are well in to a preparation phase. We have clearly established our 2019 priorities, which drives our focus and is our first full-on investment. These initiatives are well into flight.

Healthcare acceleration, this is our commitment to both specialty product development and additional manpower in this vertical. National brand ease of doing business, our intense focus around using technology to drive efficiency, inspecting and ordering of our products. Our companywide continuous improvement plans that we will talk about later in the call. And of course, our integration of David Edward acquisition that is well under way.

I wanted to name a few to provide tangible evidence of our progress. In the preparation phase, I personally met with many of our dealers, our end-users and our influencers to understand first hand, our obstacles and our opportunities.

We are just in the final stages of articulating our purpose as a company and as a family of brands. Our purpose is both foundational in our history and aspirational in our future. Our purpose is what unifies us, inspires us and differentiates us. It's the lens through which we view all aspects of our business. It's a Y (ph) .

There is no more powerful gift to give an organization than the authentic, clear and unique articulation of purpose. Alongside purpose, we have launched our high-potential development program called Elevate. It is 12 of our top talent engaged in a year-long program focused on executive development, action learning and a direct engagement with the executive team to actualize our strategy.

And finally, we have constituted a new operating rhythm, allowing efficiency of work, focus on priority initiative and a top level allocation of funding. So, what's next in our path ahead? I'm excited that we'll be rolling out the first view of our growth strategy to the Board this week. It's full, it's real and it's thoughtful. Our objective is to be ready to communicate our full strategy before fiscal year-end, along with the creative expression of our purpose. Then starts the fun to take the work on the road to all our employees and stakeholders.

In summary, I could not have asked for a better first quarter, deepen learning in interaction, as we bring NXT to life.

Now, let's turn to our Q2 results. We had a strong revenue growth of 13% or 11% organically. We were especially encouraged by growth in healthcare, hospitality and our commercial verticals. Sales in the government vertical remained soft, and this is the only vertical we experienced decline.

Orders finished up 5%. Digging deeper into a few of our verticals and products, as we stated, we have expanded our commitment to healthcare. We see this as a high-growth vertical, driven by fundamental economic and demographic factors.

National health expenditures are expected to outpace GDP through 2026. We plan to continue fueling healthcare growth through aggressive new product development in both patient room and public spaces, expansion of our talent and a focus on training, both internally and with our dealer partners.

Education is a focus vertical for our National brand. The shift in education to a more collaborative work environment leverages our expertise in the lounge category. And our products were recognized this quarter receiving two awards. The KORE Work Cart received the 2018 Nightingale Award for product innovation and excellence and the Delgado Contract Seating was named Best of Year Honoree by Interior Design Magazine.

Now, turning to profitability. Operating profit finished at 7%, after adjusting out CEO transition costs. While we were not satisfied, I'm encouraged by the continuing improvement we're making in our cost structure. We offset year-over-year inflation with our continuous improvement initiatives in the quarter.

I'm pleased to share that our previously announced $7 million fiscal year 2019 cost reduction plan has progressed to a $10 million savings, due to the hard work and dedication of our employees. Through the first half, we realized $4.1 million of that plan. As it relates to tariff, we began, experienced 10% of furniture imports since September of '18 and net of our mitigation efforts have experienced a 40 bps margin impact in the quarter.

Since our last call, the pending 25% has been delayed and we are encouraged by the continued discussions between US and China. We have taken a conservative planning stance, estimating a March increase. The performance in the quarter has allowed us to make some very important investments in our future strategic plans.

As shared through the NXT discussions, we've embarked upon the rigor of purpose work, we've invested in our talent, we've accelerated our NPD, we placed further investment on our digital ease of doing business and we are very much on track in our exciting new David Edward acquisition.

In closing, I remain encouraged by the favorable momentum in the industry, as BIFMA continues to project a 3.3% growth for calendar year in 2019. We have confidence in our focus on driving growth. We're pleased with our progress in fighting inflation and we're committed to investing in the future.

And now, I'll turn it over to Michelle for a more detailed financial results before we open the call for questions.

Michelle R. Schroeder -- Vice President and Chief Financial Officer

Thank you, Kristie. We continued our strong top line performance, building on the momentum from last quarter. Our second quarter sales were $201 million, which was a 13% increase over the second quarter of last year.

On an organic basis, excluding our David Edward acquisition, our sales increased a strong 11%. And as Kristie mentioned, the growth in revenue was led by strong performances in our healthcare, hospitality and commercial verticals. Our healthcare sales increased 20%, and this is the third quarter in a row where we have experienced very strong double-digit growth in this vertical.

We attribute this growth to our investments and strategic focus as Kristie previously mentioned. We're also seeing larger healthcare project ship as we solidify our relationships with strategic accounts. The acquisition of David Edward will further fuel growth within this vertical, as we increase sales of not only the David Edward branded healthcare product, but also as we leverage their capabilities to expand the Kimball health portfolio.

Sales in our hospitality vertical increased 16%, and while both custom and program increased, our custom business showed the strongest growth and that's been a focus of ours over the last several quarters. And this is the fourth quarter in a row where we have experienced very strong double-digit growth in the hospitality vertical, as we take advantage of opportunities in that market.

Commercial revenue was up 29%, with growth being assisted by the continued development of strategic relationships with our end customers and the traction from new product sales. This quarter, we had several more mid-sized projects that shipped, contributing to the growth. The only vertical that declined was government, which was down 21%. Government vertical includes federal, state and local agencies, and the decline this quarter was primarily due to decreased federal sales.

Additionally, the prior year quarter, we had several large projects that shipped, that did not occur in the current year. The government vertical is about 9% of our total sales this quarter and vertical of the smaller size are more dramatically impacted by timing of project business.

Our consolidated orders increased 5% or 4% organically, and orders were led higher by a 22% increase in healthcare, 5% increase in commercial, and a 10% increase in the education vertical market. Our backlog finished at $144 million and that was a 9% increase over last year.

Our new product sales again were strong during the quarter, the sales being up 60%, representing an impressive 27% of our total sales during the quarter. We do remain committed to aggressively investing in new product development to fuel our future growth.

And just as a reminder, we do exclude sales from the hospitality vertical in this metric because hospitality products are primarily hotel-brand specific. Our consolidated gross profit increased 13% in the second quarter, with gross margins ending at 32.3% compared to 32.1% last year, so up 20 basis points.

The price increases leveraged from higher sales volumes, savings we realized from cost reduction initiatives and lower healthcare costs, all benefited the quarter while higher tariffs, steel and transportation costs negatively impact our results by approximately 110 basis points.

We were able to offset those increases with the price increases and our cost reductions. So still a headwind, but at a lower level than we have been experiencing. As expected, the David Edward acquisition also reduced our consolidated gross margin by 40 basis points.

The progress made to improve the productivity on the shop floor has already been significant, given the short time since we've acquired them in late October and our work continues there. We have a well-thought-out plan that's being effectively executed to drive productivity and thus, improving profitability.

Selling and administrative expenses in the second quarter increased 20 basis points as a percent of net sales, and increased 13% in absolute dollars compared to the prior year. The increase in selling and administrative expense was driven by higher compensation costs, including incentive and commission costs related to the higher sales and improved operating profits, costs related to strategic growth investments and CEO transition costs.

The CEO transition costs during the quarter were about a $0.5 million. The strategic investments we are making are helping to set the foundation for our next chapter of growth. Operating income this quarter ended at $13.5 million, which was an increase of 12% compared to operating income of $12 million last year.

And excluding CEO transition costs, adjusted non-GAAP operating income was $14 million or $17 million -- or 17% increase or 7% of sales. Our effective tax rate for the second quarter was 25.6% compared to 40.6% last year. And that lower rate is primarily due to the benefit from the tax reform. Our net income for the second quarter ended at $9.4 million compared to $7.4 million last year, and diluted earnings per share were $0.25 compared to $0.20 last year.

Now moving to the balance sheet. Our cash, cash equivalents and short-term investments balance was $81.1 million at the end of December. We had operating cash flow of $16.8 million in the second quarter compared to $8.4 million in the second quarter of last year and we paid $3 million in dividends and repurchased 371,000 shares, totaling approximately $5.8 million.

At the end of December, we had 654,000 shares remaining under our current share repurchase program. So, we will continue to monitor the market and repurchase shares opportunistically.

Our capital expenditures totaled $6 million for the quarter and $10.7 million through the first six months. These capital expenditures were primarily related to investments in manufacturing equipment, automation, facilities, maintenance and renovation for our corporate and Kimball brand headquarters.

We expect capital expenditures for fiscal year 2019 to be around $30 million as we continue these investments. Our balance sheet remains strong with very little debt as of December 31st. We have a $30 million credit facility and are in compliance with all covenants.

So to wrap it up, we were very pleased with continued strong growth in Q2 and the expansion of our cost reduction plan. While margins are not where we wanted them to be, we do see a pathway to improvement through growth and the rightsizing of our cost structure.

As Kristie mentioned, over the next couple of months, we will be communicating our new growth initiative that will set the foundation for our future growth and success. Along with that, we will communicate our new long-term financial targets. We are excited about the future and really excited to have Kristie onboard. We look forward to sharing more with you soon.

With that, I'd like to open today's call to questions. Ashley, do we have anyone with questions?

Questions and Answers:


Thank you. (Operator Instructions) And our first question comes from the line of Spiro Gianniotis with Alphatec PC. Your line is now open.

Spiro Gianniotis -- Alphatec PC -- Analyst

Hey, Kristie. Congrats on the new position and the current quarter.

Kristine L. Juster -- Chief Executive Officer

Thank you very much.

Spiro Gianniotis -- Alphatec PC -- Analyst

Could you please provide a little bit of color on the integration of the Idaho facility into the Indiana facility and the efficiencies achieved? And just a follow-up on that.

Regarding the depreciated equipment with the initiative of healthcare and product development and development in general, when do you plan on purchasing new equipment for your growth initiatives and what might impact will it have on the current production facilities?

Kristine L. Juster -- Chief Executive Officer

Okay. Let me start by saying, certainly, that move was one of the critical factors in our continuous improvement that we've highlighted in this call that we're increasing the $10 million. So, we're feeling good about the progress. And I'm going to let Michelle kind of take the details of that work and then our future view on equipment.

Michelle R. Schroeder -- Vice President and Chief Financial Officer

Yeah. So, we announced that Idaho facility closure right after completing the spin-off of our electronic segment back in 2014. And it took us probably about 18 months to complete that restructuring plan and moving all of that product to our Indiana facility. So, that is all complete. That's been complete for quite some time, and we are realizing the benefits related to that. A lot of that was related -- the savings were related to moving from Idaho. The costs to do that here and the transportation costs from Indiana were a lot less than they were from Idaho. So, we are definitely realizing the benefits of that.

To answer your question on healthcare and when we might be spending investment on new equipment, the David Edward acquisition was really a key -- one of the key factors for healthcare growth. So, we have the production facility, actually two production facilities that we acquired with David Edward. We're working in those facilities right now, improving the profitability and improving the flow of the product within those facilities. So, that's going to be really a key to our healthcare growth.


Thank you. (Operators Instructions) Okay. I'm not showing any further questions at this time.

Kristine L. Juster -- Chief Executive Officer

Great. Ashley, thank you very much. I just want to close by saying, I'm thrilled to have the opportunity to share our progress and to give a view around our path forward. I want to thank -- give my thanks to our employees, our partners and our shareholders, and the commitment to Kimball International. And we look forward to talking to you next quarter. Thank you.


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

Duration: 22 minutes

Call participants:

Kristine L. Juster -- Chief Executive Officer

Michelle R. Schroeder -- Vice President and Chief Financial Officer

Spiro Gianniotis -- Alphatec PC -- Analyst

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