Kimball International Inc (NASDAQ:KBAL)
Q1 2020 Earnings Call
Nov 5, 2019, 11:00 a.m. ET
- Prepared Remarks
- Questions and Answers
- Call Participants
Good morning, ladies and gentlemen, my name is Katherine and I'll be your conference call facilitator today. At this time, I would like to welcome everyone to the Kimball International First Quarter Earnings Conference Call. Currently all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As with prior conference calls, today's call November 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 press release.
During today's call, the presenters will be making references to an earnings slide deck presentation that is available on the Investor Relations section of Kimball International website. On today's call are Kristie Juster, CEO of Kimball International; and Michelle Schroeder, Vice President and Chief Financial Officer of Kimball International.
I would now like to turn the today's call over to Kristie Juster. Ms. Juster, you may begin.
Kristine L. Juster -- Chief Executive Officer
Thanks, Katherine, and good morning everyone. Welcome to Kimball International's first quarter earnings conference call. One year ago, we announced a new chapter at Kimball International and our commitment to accelerated value creation.
In May, we shared the details of our new Kimball International Connect strategy, casting our long-term three year objectives beginning fiscal year 2020 of 4% to 7% revenue CAGR, a 150 basis points to 250 basis points of adjusted EBITDA improvement, and 10% to 15% adjusted EPS growth. In July, we provided the details of our transformation plan. Delivering $16 million of cost savings initiatives in fiscal 2020. And today, we are very pleased to communicate the details of our first big proof point that our efforts are well under way, all while [Phonetic] settling the stage for a long-term sustainable performance. In the call, I will walk through the highlights of our Q1 performance, comment on market leading indicators and provide specifics around progress on our Kimball International Connect strategy. Michelle will then provide details of our financial performance and I'll wrap up with color on our path ahead and open for Q&A.
For our Q1 highlights on Slide four, we ended the quarter with revenues of $201 million, a 4% increase year-over-year, which included organic growth of 2%. Our National and Hospitality brands continue to show solid performance, offset by the planned Kimball brand realignment. Michelle, will provide commentary on vertical market performance. We continue to gain significant traction in ancillary product overall and specifically the healthcare and hospitality verticals. Orders were down 4% against strong comps of 18% prior year growth again mainly impacted by the Kimball brand sticks that is well under way and lower hospitality orders, which are comping strong 48% growth in the prior year.
Operating income of 7.5% or 9.8% on an adjusted basis increased 200 basis points. Gross profit of 34.9% increased a 100 basis points, and at the same time, selling and administrative costs decreased 160 basis points, while beginning our strategic investments in Kimball International Connect. We are very pleased with the adjusted EBITDA performance of $23.8 million or 11.8%, up 190 basis points.
And finally, adjusted EPS increased 29% to $0.40 compared to $0.31 a year ago. Our Q1 performance gives us confidence that we are gaining traction in both our sustaining gross margin improvement and our ability to transform to a more cost-efficient operating model. We do expect our revenues to ramp in the back half of the year as our investments start to take hold against specific strategic initiatives.
Turning to Slide five for a view of macroeconomic indicators we track for the industry, most notably since last quarter. This may increase their forecast for 2019 U.S. office furniture to 7.4%, but there are 2020 outlook is forecasted to be lower at 2.2% due to the anticipated slowing in the U.S. economy. The report cited interest rate cuts slowing GDP and capital spending in a tougher trade environment. As factors for the lower level of growth in 2020. Macro trends working in our favor include the tight labor market and a shift to more collaborative, resimercial working environment.
The Architecture Billings Index by AIA, which serves as a leading indicator of non-residential construction activity was 49.7 in September, up from 47.2 in August. So we're still below the 50 mark, it is much improved. It was also encouraging to see the design contracts index rebounding to 54.4 from 47.9 in August as firms saw an increasing number of clients signed contracts for new projects. RevPAR or Revenue Per Available Room is a leading indicator for our Hospitality business.
Forecast for calendar 2020 estimate growth of 1%, which is in line with 1.1% forecasted growth in 2019. We continue to see strong activity, especially as it relates to the second half of fiscal year driven by the strength in the Vegas market. We believe our brand positioning, and our growth strategy will help to mitigate risks of a slowing market as we are strategically shifting our focus to higher growth markets. We are putting ourselves in a better position to react as we continue to execute against our transformation plan, while leveraging new ways of working to include our program management office capability and diligent operating rhythm. We will continue to remain focused on understanding changes in demand patterns and we will respond accordingly.
Moving into our progress in deployment of the Kimball International Connect strategy. Looking at Slide six, you'll see a new slide depicting our brand positioning, relative size of the brands today and more importantly the path and differentiation we are driving through our Connect Strategy. The vertical axis is a continuum from standard product type to custom product. And the horizontal axis reflects from Commercial to Hospitality environment. We continue to expand the National and Kimball product portfolios to deeper into the resimercial category types.
In addition, we are focusing on Kimball and Hospitality brands in the custom development. The shift to resimercial is driven by a clear consumer trend of blending elements of commercial and resimercial design in the workplace, while the shifting to more custom products leverages our existing capability into a world of customization and unique workspaces. Our heritage of expertise in both office and hospitality sectors positions us to take advantage of this intersection in the commercial marketplace today. We are excited about the evolution of our brands and our ability to expand our portfolio into higher growth markets in sustaining consumer insights.
Turning to Slide seven, focusing on the tangible efforts we have made in each of our four pillars of the Kimball International Connect strategy. First, is inspire our people, our new purpose has been fully activated across our organization and is providing the energy, the excitement and the foundation that is so important in this next chapter of this company. I'm pleased to announce that we opened our newly renovated Kimball International headquarters this month, this investment provides a fully operational working showroom showcasing our diverse product portfolio in a functioning work environment, while also providing a best-in-class workspace for our employees.
This will be the first time that all three brands are connected through a common area called the hardwood hub. It is a place where our employees can collaborate in an informal environment increasing interaction, creativity and effectiveness. We are excited about our new home and welcome anyone on the call to visit and experience firsthand how we deliver on our purpose, dare to be the makers of possibility.
The second pillar of our strategy is build our capabilities, we have completed the structural transformation of HR, IT legal and supply chain and our deep into standardizing ways of working in each function. Our new operating rhythm is up and running, driving the rigor [Phonetic] needed in the management of the transformation of this magnitude and we have also just began Phase 1 of the evaluation of our indirect spend which will fuel savings in the back half of the year. Helping us to deliver the $16 million cost savings.
The third pillar of our Kimball International Connect strategy is Fuel Our Future. As we shared last quarter, we continue to focus on optimizing our facilities, prioritizing our initiatives across Kimball International and standardizing our processes driven by lean and product engineering excellence. We are highly focused on our plan to close our Martinsville, Virginia facility by absorbing the custom seating capability into our existing footprint and expanding our third-party supply base in low cost countries.
In addition, we have implemented a formal staging gate process to manage our continuous improvement opportunities that will drive our $16 million cost saving initiatives in 2020. As exciting as this is there is a strong pipeline that is already building for fiscal 2021, and I continue to be amazed by the agility and creativity of the organization to drive continuous improvement. All of these actions enable the fourth pillar accelerate our growth. I'd like to add more context to the performance of our Kimball brand.
In our strategic deep dive in early April it was apparent that the Kimball brand had not been responding or performing to our expectations. We undertook three main initiatives to turn the business to sustaining success. A realignment of selling resources to higher growth markets and intense continuous improvement approach to correct our margin issues within the systems category in a commitment to training, development and talent in our healthcare vertical. Our new President Phyllis Goetz has done a tremendous job of leading the team to our new vision and focus.
We anticipate these wholesale changes will cause a distraction to our revenue growth through the first half of 2020 which we plan to recover once the new initiatives are in place. We are pleased to report the sales realignment is complete and we have started to fill our new focused positions. Our Kimball brand showed improvement in systems margins allowing us to reestablish our systems competitiveness in the market, and our healthcare vertical continues to show exciting growth of 18% in Q1, are two year stacked growth of 38%. We have also just starting to see a rebound in orders. We are committed to the Kimball brand and business and are very pleased with the progress.
Our Kimball Hospitality brand is the largest player in the hospitality industry and has made a step change in performance over the last two years. We continue to focus on our custom capabilities to fuel our growth and margin expectations and are excited about our inroads in the Vegas market that will drive our growth in Q4 and into 2021. Our growth in the hospitality vertical is 8% in Q1 and a two-year stacked growth of 51%. As a reminder, the hospitality business is project oriented and shipments are tied directly to installations, which can cause some volatility among the quarters.
And finally, we expect our National brand will continue to be a high performer with a dedicated focus to the ancillary category. National has played a leadership role in the changing consumer landscape to the resimercial design in product offering. In Q1, our new product development was up 48% year-over-year. We continue to believe the introduction of fresh new offerings with the National signature, ease of doing business is the catalyst.
We are just introducing a new product offering that is a simpler specification called contract light. The perfect answer to the end users desire to change out resimercial design, product more frequently or with the same commitment to quality and service known by National. I attended the launch of contract like to our selling organization in October and the response was outstanding. This new category will be one of our critical focus areas of investment and ramping throughout 2020.
And to wrap up, our strategic progress on Slide eight, I'll summarize the $5.6 million cost savings we delivered in Q1 from our transformation plan. Our operational excellence cost savings exceeded our original plan, delivering $3.6 million through product value engineering, manufacturing realignment and in-sourcing of products to leverage capacity.
Our center-led cost savings was on track at 300,000 in the quarter and our new ways of working through already defined showroom closures and reduction of selling in low growth markets delivered a savings as expected at $1.7 million. As you can see we are well on our way to our committed $16 million, 2020 cost savings target.
With that, I'll turn the call over to Michelle, where -- she will do a deeper dive into the quarterly financial results. Michelle?
Michelle R. Schroeder -- Vice President, Chief Financial Officer
Thanks Kristie, and good morning to everyone. I'd like to turn your attention to Slide nine, as I discuss our first quarter financial performance. We ended the quarter with $201.5 million in sales, an increase of 4% or 2% on an organic basis. Our net income increased 5% to $11.4 million. Our adjusted EBITDA of 23.8 million increased 23.9% and resulted in a margin of 11.8% up a 190 basis points versus a year ago. Adjusted EPS increased 29% to $0.40 compared to $0.31 a year ago.
Turning to Slide 10, I'll take you through the details of our financial performance in the quarter. Gross margin improved 100 basis points to 34.9%. The improvement was driven by product pricing and savings from our transformation plan, partially offset by sales mix shift and performance of David Edward as we continue to execute our integration plan.
David Edward impact during the quarter was 50 basis points, the 34.9% margin marks a step change in gross profit, as we've been able to more than offset the cost pressures from raw material inflation and tariffs through price increases, continuous improvement initiatives, shift in our supply chain, value engineering of products and leverage from sales growth.
Selling and administrative expenses improved 160 basis points to 25.2% of sales. On an adjusted basis where we exclude CEO transition costs and serve Selling and administrative expenses improved 90 basis points, adjusted selling and administrative dollars remains flat enabling the 90 basis point improvement resulting from sales growth.
We were able to hold adjusted dollars flat even after investing $1 million in growth initiatives tied to our Kimball International Connect strategy and having 800,000 of costs related to the David Edward acquisition that we didn't have in the prior year. We expect the growth initiatives to increase during the remainder of the fiscal year.
For the quarter, benefits from the transformation plan of $1.3 million and combined reduced retirement and healthcare spend of 700,000 were offset by a prior year gain on sale of assets of $1.1 million and the selling and administrative expenses from the acquisition. We were pleased with the earnings improvement over the prior year, as well as our level of profitability.
We do expect to see some variability in our results over the short term, especially as we execute our strategy and transformation plan and our Kimball brand realignment. But we believe our strong first quarter sets us up well to deliver our expected performance for the fiscal year. Our transformation plan gives us the ability to either accelerate our pull back on growth investments, based upon our top line performance and the delivery of the benefits from the transformation plan.
Moving to Slide 11, you will see the chart indicating the importance of new products to our sales. New product development remains a key aspect of our growth plan. During the quarter, sales of new products were up 19% year-over-year to $44 million and new product [Phonetic] represented 30% of our total office furniture sales excluding hospitality. Our new product introductions are focused on higher growth ancillary and healthcare products.
Let's turn to Slide 12 to discuss sales by vertical. We experienced sales growth in three of our six verticals led by healthcare, which was up 18% and is notable considering we were lapping 20% growth last year. This quarter represents the sixth quarter in a row where we've had double-digit increase in sales within the healthcare vertical. The hospitality and government verticals, were up 8% and 9% respectively. These positive trends were partially offset by a decline in commercial, our largest vertical. This decline was due to softness within the Kimball brand as discussed earlier.
As shown in the graph on the bottom left, we've experienced two year stack growth in the double digits within the larger hospitality and healthcare verticals. Focus within these verticals has been a key part of our overall growth strategy and in the graph, to the right you can see our progress in these two verticals, over the last two years. The mix of both our hospitality and healthcare sales as a percent of our total sales has grown over this time period.
Let's now turn to Slide 13 to discuss order growth by vertical. Overall orders were down 4% on a difficult comparison to 18% growth in the prior year. On a two-year stack basis orders were up 14%, order declines in the hospitality and commercial verticals more than offset growth in the remaining four verticals. The 16% decline in hospitality was due to lapping 48% growth in the prior year, which included four large projects. We expect market strength in the back half of the fiscal year, bolstered by the development in Las Vegas, stemming from the new sports teams and new convention center attracting even more travelers. The 13% decline in commercial was also due to lapping strong growth of 24% in the prior year and also the transformation within the Kimball brand.
Lastly, a comment on healthcare. We continue to be pleased with our healthcare vertical performance and remain optimistic that growth will continue into the future with our focus on this vertical and favorable demographic trends.
Turning to our cash flow performance on Slide 14, we generated $11.1 million in cash flow from operations and $3.7 million in free cash flow, that's up $1.3 million over the prior year. We continue to manage our working capital well, but did have a $10 million increase during the quarter from June, due to the timing associated with the payment of retirement and incentive compensation accruals.
CapEx of $7.4 million remains higher than normal as we completed our headquarters' renovation in October as Kristie discussed earlier. There is truly a buzz in the air, and excitement among our employees as they settle into their new home and I'm eager to see the reaction and here the feedback from our customers as they tour through our newly renovated headquarters over the coming months.
During the quarter we returned $2.9 million in capital to shareholders in the form of dividends. Our balance sheet remained strong with minimal debt. Return on invested capital for the quarter finished at an impressive 51%. Growth in our earnings and discipline in investing our capital over the years has contributed to this impressive performance where we rank among the best relative to our public office furniture peers.
On Slide 15, you'll see both our acquisition framework and acquisitions we've completed over the last few years. The key takeaway here is that we intend to grow our business both organically and through acquisitions. We look for targets that align with our purpose and our Kimball International Connect strategy. These targets would have higher growth products that complement our existing portfolio, new product categories and our new channels. We've recently replaced our $30 million credit facility with a $75 million credit facility. The expansion of our facility enable greater access to liquidity that we can use to fund potential acquisitions that fit our criteria. We will remain disciplined in our approach.
Turning to Slide 16, we recap our three-year fiscal 2020 through 2022 financial targets which are unchanged from last quarter. On the top line, we are expecting 4% to 7% organic growth. We are targeting a 150 basis points to 250 basis points of improvement in adjusted EBITDA margin by 2022 and forecasting EPS growth of 10% to 15%. Our outlook is based on assumptions through GDP growth of 1.5% to 2.5%, a flat share count and excludes the impact of any potential acquisitions.
I wanted to touch briefly on Slide 17 that was included in the deck last quarter. This slide is also unchanged from the prior call. Purpose of this slide is to help you better understand our forecasted EBITDA improvement included within our financial targets. The slide provides a walk forward from our fiscal '19 EBITDA to forecast the fiscal '20 EBITDA, qualitatively identifying the relative components of growth, cost savings transformation costs and growth initiatives. The key takeaway for fiscal year '20 is that our cost savings will fund our growth investments in our cash transformation efforts, while the EBITDA resulting from top-line growth drops to the bottom line.
I will now turn the call back over to Kristie, to provide color on our path forward.
Kristine L. Juster -- Chief Executive Officer
Thank you, Michelle. As excited as I am that our transformation has quickly taken hold and is clearly reflected in our Q1 margin performance. I'm also aware, that we have significant transformation under way and that we may see volatility throughout the quarters as we set up Kimball International for an accelerated level of value creation in the long term. Although, we do not provide short-term guidance, I would like to provide some insight to what we see in our path ahead.
In the first half of fiscal year 2020 we are comping significant revenue growth of 12%. Our Kimball Hospitality growth will be back-half loaded due to the installation timing of the Vegas projects. We are on track to deliver our $16 million cost savings throughout 2020. Our growth investments will ramp throughout 2020 as we see realities of transformation savings and we have not altered our perspective on the year due to softening of the market because of our work in higher growth markets, our focus to turn around the Kimball brand and our confidence in our cost out target.
Lastly, I'd like to thank our 3,000 employees for embracing our new agenda and making it a reality. I am very proud of our team for what we have accomplished at Kimball International.
And with that, I'll turn the call over to Katherine and we'll happily take your questions.
Questions and Answers:
Thank you. [Operator Instructions] And I'm showing no further questions in the queue at this time, I'd like to turn the call back over to Ms. Kristie Juster, CEO of Kimball International for closing remarks.
Kristine L. Juster -- Chief Executive Officer
Thank you, Katherine. And thank you for joining us today and your continued interest in Kimball International, and we look forward to keeping you updated on our progress. Have a nice day.
[Operator Closing Remarks]
Duration: 29 minutes
Kristine L. Juster -- Chief Executive Officer
Michelle R. Schroeder -- Vice President, Chief Financial Officer