Image source: The Motley Fool.
Kimball International Inc (KBAL)
Q1Â 2021 Earnings Call
Nov 4, 2020, 5:00 p.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning, ladies and gentlemen, my name is Valerie and I'll be your conference call facilitator today. At this time, I would like to welcome everyone to Kimball International First Quarter Fiscal Year 2021 Earnings Conference Call. As with prior conference calls, today's call, November 4, 2020 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 the forward-looking statements can be seen in the Kimball International Form 10-K. 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; T.J. Wolfe, Executive Vice President and Chief Financial Officer of Kimball International; and Michelle Schroeder, Senior Director of Investor Relations.
I will now turn the call over to Kristie Juster. Ms. Juster, you may begin.
Kristine L. Juster -- Chief Executive Officer
Thank you, Valerie, and good afternoon, everyone. We appreciate your participation in today's call to review our first quarter fiscal 2021 results, discuss our business outlook and do a deep dive into the Poppin acquisition, which we announced in the separate release simultaneous with our earnings. We will first review the operating and financial highlights and then direct most of our prepared remarks to the strategic fit that Poppin represents for Kimball International.
Before I begin, I would like to remind you that this will be the last call for Michelle Schroeder as CFO. Michelle informed us of her decision to step back from her role as CFO due to personal reasons. The good news is that Michelle will continue as a senior leader at Kimball International and will continue to direct all our investor relations efforts. Those of you who know Michelle, know she has tremendous knowledge of Kimball International and I personally want to thank her for her meaningful work as CFO and we are thrilled to have her remain at the Company.
At the same time, we've been fortunate in attracting T.J. Wolfe, who became our new CFO, effective October 19th. T.J. has deep experience in global consumer branded organizations and brings more than two decades of experience, including expertise enacting large scale organizational transformation, as well as managing M&A integration and strategic planning activities. Most recently, T.J. served as Chief Financial Officer of the Great Britain Unit of Coca-Cola European Partners. T.J. is with us on today's call and we look forward to getting to know him in our upcoming investor calls and meetings.
On Slide 3, we start our discussion on the quarter. Our company continued to execute effectively within a challenging environment for our industry. We entered the quarter with order rates down 42% year-over-year and as expected, revenues declined 5% sequentially from fourth quarter levels. Despite a year-over-year revenue decline of 27%, we were able to drive a 50 basis point increase in gross margin, reflecting the success of our transformation plan and early benefits from the restructuring program we announced last quarter.
I am pleased to report that we are on target to achieve our expected cost savings of $20 million this fiscal year on the heels of the $26 million in cost savings that we reported in fiscal 2020. These savings provided the resources to reinvest in our business to drive growth and continue to generate operating efficiency. I am also pleased to report that first quarter order rates were 15% higher than they were in fourth quarter and while it is too early to call a bottom, we believe this is a good sign.
Our activity levels are up in both workplace and health, and our hospitality business is doing an excellent job of winning and engaging in longer-term projects. Other key takeaways, we introduced our new health brand, reinstated our share repurchases and we'll share with you shortly information on our Poppin acquisition.
Slide 4 reviews our Connect 2.0 Strategy, which we announced in August as a step change to accelerate our growth. The plan is designed to enable us to effectively manage through the current economic downturn by driving market share gains for Kimball International as well as yielding cost savings and most notably, sets us up for sustaining success in the new forming marketplace. A key element of Connect 2.0 has been a reorganization into four new market-centric business units, workplace, health, hospitality and eBusiness, enabling us to effectively integrate vertical, product and brand expertise into a compelling go-to-market strategy.
It also allows us to get dedicated, focused resources in eBusiness across our brands and end markets. Since our launch of Connect 2.0, we have made significant progress within each of our four business units. Specifically, we launched our new health brand, Interwoven. The Interwoven brand allows us to leverage a group of 23 health experts across 28 top health systems, government agencies and associations. This team will represent the full multi-brand portfolio from Kimball International and at the same time develop innovative, new health specialty products under the Interwoven brand.
We are seeing immediate results in both our ability to more quickly penetrate the market and to access new health environments such as retail health clinics. The health industry is undergoing a tremendous transformation in the utilization of space to improve the safety and delivery of care and the Interwoven team is dedicated to just that.
Additionally, we expanded and introduced a second phase of our Etc. brand within our workplace business unit defined as work style and lifestyle with simplicity. Etc. features affordable ancillary seating and desk configuration that target work from home, satellite offices, co-working environment as well as student housing. Etc. is an important brand to accelerate our offering to address the new hybrid home and office workplace.
Q1 demonstrated our ability to navigate the COVID market softness and our ability to focus on the opportunities that we believe are so important to our future.
Before I share our announcement on the Poppin acquisition, I'd like to turn it over to Michelle to summarize our financials for the quarter.
Michelle R. Schroeder -- Executive Vice President
Thanks, Kristie, and good afternoon, everyone. I will now provide an overview of our first quarter fiscal 2021 financial performance. Let's turn to Slide 5. Net sales decreased 27% to $147.9 million, reflecting the ongoing impact of the COVID-19 health crisis. One area we did see growth in the quarter was in the government vertical within the workplace end market. Sequentially, net sales declined only 5% in line with our expectations. Despite the revenue decline, we were pleased with the eighth consecutive quarter of year-over-year gross margin improvement.
In the first quarter, gross margin expanded by 50 basis points to 35.4% reflecting cost savings from our ongoing transformation plan. Our transformation plan savings in the first quarter totaled $4.8 million split between cost of goods sold and selling and administrative cost. The savings from our transformation plan together with disciplined cost management resulted in a $9.2 million reduction in selling and administrative costs to $41.7 million.
On an adjusted basis, excluding CEO transition costs and the impact of our Supplemental Employee Retirement Plan, selling and administrative expenses amounted to $40.8 million or 27.6% of sales. Our effective tax rate in the first quarter of fiscal 2021 was 25.7% compared to 27.4% in the prior year. We estimate our effective tax rate will average approximately 25% to 27% in fiscal year 2021. Net income was $5.4 million or $0.14 per diluted share compared to $0.31 per diluted share in the first quarter of fiscal 2020.
Excluding restructuring charges and CEO transition costs, adjusted EPS was $0.23 compared to $0.40 in the year ago quarter. Our adjusted EBITDA was $15.8 million compared to $23.8 million in first quarter of fiscal year 2020. Adjusted EBITDA margin declined 110 basis points year-over-year to 10.7% due to the leverage lost on fixed costs with the lower volumes.
We generated $27 million in cash from operations, capital expenditures were $4 million, most of which were related to technology investments in product specification tools to simplify the ordering process and manufacturing upgrades to increase automation compared to $7.4 million in the year ago quarter. This quarter, we returned $3.3 million of capital to shareholders in the form of dividends. Although, we reported a year-over-year revenue decline, we are pleased that we saw some sequential leveling in a couple of our key markets as shown on Slide 6.
Within workplace, sales to the education and government verticals increased sequentially, while sales to the finance vertical showed only a slight decline in the first quarter resulting in a 5% increase when compared to the June quarter-end. Workplace accounted for approximately 64% of our total revenue in the first quarter of fiscal 2021, health revenues declined 5% sequentially and represented 14% of our total sales, and hospitality saw a 26% sequential revenue decline and represented the remaining 22% of sales.
Slide 7 shows that similar to the positive momentum seen in our sequential revenue trend, we are also seeing positive sequential momentum in new orders, which increased 15% from fourth quarter levels. By end market, health orders grew 23%, while workplace orders declined 10% sequentially primarily due to seasonality within the education vertical. We were pleased with the substantial sequential growth in hospitality orders of 149% but note that was primarily driven by a single large order during the quarter. Our backlog at the end of September was down 7% versus September of last year, which is similar to the 7% year-over-year decline in backlog we had at the end of the fourth quarter.
Now a quick look beyond Q1. First quarter orders were down in both health and workplace compared to the prior year and with October just wrapping up, we were encouraged to see the year-over-year rate of decline in orders subside a bit in October in both health and workplace compared to the year-over-year first quarter decline. Orders were still down versus last year but at a lower rate. Orders in health started to stabilize at a lower rate of decline in August and have held at the lower rate since then. While the rate of decline in workplace orders was lower in October and project quoting activity remained high, we are still seeing fluctuations from week-to-week in order rates.
We remain cautious in the near-term outlook anticipating a period of continued softened activity before returning to growth. We are starting to see pressure on our freight and distribution costs caused by the significant increase in demand for shipping services created by the COVID pandemic and port congestion. We are working to mitigate the impact of these cost increases.
I'll close by saying, our first quarter financial performance demonstrated the resilience of our business and the efficiency of our operations. I'm excited about the opportunities that the acquisition of Poppin will bring to Kimball International.
I will now turn the call back to Kristie to provide further insight on the Poppin acquisition. Kristie?
Kristine L. Juster -- Chief Executive Officer
Thanks, Michelle. Now the big news, which is our definitive agreement to acquire Poppin, a tech-enabled, market leading B2B commercial furniture design company that has been on our radar for some time, particularly for its ability to help us jump-start our eBusiness.
On Slide 8, you will see the financial terms of the transaction, which are $110 million initial cash payout plus contingent payments of up to $70 million based on the achievement of certain milestones over the next three plus years. We will fund the purchase price with a combination of cash on hand in our credit facility, which we have amended to increase our borrowing capacity to $125 million. What we are paying for is a significant growth engine that aligns with our Connect 2.0 Strategy and with our long-term vision to create an omnichannel commercial furnishing design powerhouse supported by a robust manufacturing and sourcing infrastructure.
Slide 9 illustrates how well the Poppin acquisition aligns with Connect 2.0 strategically, it literally checks all the boxes. Poppin brings us new products and new categories that we can offer through our existing channels, immediately expands our direct channel business, establishes a real presence for us in the fast growing corporate-sponsored and direct to consumer work from home categories and provides digital capabilities that can be scaled across our portfolio of brands.
Slide 10 provides a closer look at Poppin. The company was founded in 2009 and over the last five years has become one of the industry's leading disruptors. They design fresh and clever commercial furniture that is in stock and ready to ship with a simplified ordering process, which will be even more important in the new workplace environment. Supporting its digitally native platform is a salesforce in the five showrooms located in major cities. Poppin's strategy includes a mixture of online and offline customer conversion pass with approximately 80% of their B2B business starting with digital qualifications leading to a 60% close rate. Poppin is the easiest way to outfit your office.
After experiencing a 40% compounded annual growth rate from 2014 to 2019, Poppin had to close its urban showrooms to comply with the COVID-related lockdown, which significantly reduced sales. Since the onset of COVID, Poppin has expanded its work from home portfolio, developed corporate partnership programs, reopened showrooms, expanded focus on direct to consumer and started targeted campaigns in secondary markets. With over 71% of their revenue from repeat business and being fully engaged with clients to assist them in navigating the new hybrid workplace, Poppin is uniquely situated to accelerate both return to work at headquarter locations and satellite offices and work from home.
On Slide 11, we have detailed the complementary nature of our two businesses. Today, there is minimal or no overlap in the combination of the two business models. This immediately broadens our markets from large corporations to micro businesses, from secondary to urban markets through both direct and traditional channels with an expansive selection of prices, products and categories. And Poppin's strength are data-driven business development, industrial design, sourcing and brand marketing, whereas at Kimball International, our core competencies are around manufacturing, interior design and industry expertise. Over time, we believe uniting these capabilities will result in a commercial furniture design powerhouse.
Slide 12 summarizes the specific areas that we've identified to create revenue in operating synergies. The bolded actions are ones that we consider Stage 1 priorities. Our near-term priorities are revenue acceleration with four specific actions to note, one, scale Poppin's marketing playbook in the secondary markets where Kimball International is well known with deep marketplace expertise and relationships. Two, leverage Poppin's experience in the work from home category through direct to consumer and developing corporate-sponsored programs for both Poppin and Etc. Three, develop a complementary dealer expansion program called Poppin Pro within the Kimball International traditional dealer network leveraging the selling and dealer-partner expertise in relationships from Kimball International with the Poppin brand and simplified assortments in buying process. And fourth, launch the new category of Poppin Pods across the Kimball International selling and dealer network. These Privacy Pods are small mobile units that enable privacy in an open office environment that are uniquely adaptive for our post-pandemic workplace and allow for immediate set up of satellite offices. We also see Poppin Pods as adaptable for use in our health and hospitality markets. In terms of operating synergies, we see significant medium-term opportunities in design, logistics, sourcing and manufacturing. These are just some of the areas that start to illustrate the ongoing value from the acquisition.
Slide 13 gives you a sense of the financial impact of Poppin based on each company's results for the nine months ended September 30th. On a pro forma basis, the acquisition adds about 10% to our revenue line, but similar to other fast-growing industry disruptors, Poppin has made aggressive investments in channel development resulting in negative EBITDA. Post-acquisition, our net debt to EBITDA ratio will be approximately 0.5. This allows us to retain the same capital allocation priorities that we have spoken about in the past. Slide 14 details those priorities, which include organic growth investments, strategic acquisitions in the context of Connect 2.0, capital expenditures to drive efficiencies, dividend payments and share buybacks and that's stated in our press release, we have reinstated our share repurchase program effective this quarter.
Finally, Slide 15 summarizes the reasons why Poppin is a strategically compelling acquisition for Kimball International. By acquiring Poppin, we believe Kimball International will be uniquely positioned in the evolving commercial furnishings marketplace. We will immediately move to being one of the leading omnichannel players built through a combination of expansion of markets, brands, products, categories and capabilities.
I want to acknowledge and welcome Randy Nicolau and the Poppin team to the family at Kimball International. Poppin will continue to be run by Randy and the highly qualified leadership team. Our Connect 2.0 Strategy together with the Poppin acquisition gives us great confidence in our ability to create significant value for all Kimball International stakeholders.
Now, I'd like to open up the call for questions.
Questions and Answers:
Operator
Thank you. [Operator Instructions] Our first question comes Greg Burns with Sidoti & Company. Your line is open.
Greg Burns -- Sidoti & Company -- Analyst
Good afternoon. I guess trying to...
Kristine L. Juster -- Chief Executive Officer
Hi, Greg.
Greg Burns -- Sidoti & Company -- Analyst
Hi, just wanted to start off I guess with the Poppin acquisition. What percent of Poppin's current business is contract versus residential consumer?
Michelle R. Schroeder -- Executive Vice President
Yeah. Right now, we -- the B2B business on the Poppin side is just under 75%.
Greg Burns -- Sidoti & Company -- Analyst
Got it. And the revenue decline they experienced this year, I mean is the B2C -- was that growing, just not offsetting the B2B declines? Could you just help us understand the revenue decline there was just because another -- some other digitally native brands with the work from home and...
Michelle R. Schroeder -- Executive Vice President
Right.
Greg Burns -- Sidoti & Company -- Analyst
E-commerce growth, they've been growing pretty well. Could you just discuss the revenue decline at Poppin?
Michelle R. Schroeder -- Executive Vice President
Sure, Greg. I'm going to let T.J. comment and then, I'll add anything at the end.
Greg Burns -- Sidoti & Company -- Analyst
Okay.
Timothy (T.J.) Wolfe -- Chief Financial Officer
Hey, Greg. it's T.J. Good to meet you. So yeah, I think as Kristine mentioned, the majority of Poppin's portfolio at this point is B2B and so as we moved into Q2 and saw the slowdown, saw not only workplaces shut down but Poppin being forced to shut down their showrooms, that was what led to the revenue decline in Q2, which will -- again, their calendar year Q2, which rolled over into Q3 as well. So again, I think it's a function of the market that they're serving and the channels that they're accessing that you saw a differential between there and maybe some of the other e-commerce players you were talking about.
Greg Burns -- Sidoti & Company -- Analyst
And...
Kristine L. Juster -- Chief Executive Officer
I would...
Greg Burns -- Sidoti & Company -- Analyst
Was that...
Kristine L. Juster -- Chief Executive Officer
I would also just -- yeah, Greg, let me just add a little more color. The other thing I would say is Poppin was running at a growth rate of about 80% going into the COVID decline and so they had a really exciting business model that they were running B2B and then with their urban showrooms. And now, they've made some really significant pivots to focus on direct to consumer, secondary markets and so, there is -- we are excited about what the opportunities are ahead with that model.
Greg Burns -- Sidoti & Company -- Analyst
Okay. And when you think about some of the revenue -- potential revenue synergies, how do you see you being able to accelerate -- maybe even accelerate the growth of the brand hereby leveraging -- in particular, leveraging your distribution channels with their products and is there opportunity here for maybe to leverage the Poppin infrastructure to sell like Etc. or other brands, like what are the cross-sell opportunities?
Kristine L. Juster -- Chief Executive Officer
Yeah, that's -- I -- that's exactly what we're excited about. So there is a set of initiatives that will accelerate Kimball International and then there is set of initiatives that will accelerate Poppin. So let me just make some comments around that. One, we believe that there is new categories and new products that we will put through our existing channels. One of those examples is Poppin has recently launched the Pods category that we will put across the dealer channel that we have. Their capabilities will also expand our direct channel, as you know, we do have a direct channel in hospitality but that does not go outside that vertical today.
They also have -- they're building the capability in work from home, they have a whole corporate sponsored program that will expand with both Poppin and Etc. and then when we look at it, their digital capabilities can go across all of Kimball International. When you look at the Poppin side, it's really about scaling them into secondary markets, bringing Poppin Pro into traditional trade and then helping them to access the larger end customers that they don't access today. So there is a really rich set of opportunities that sit on both sides.
Greg Burns -- Sidoti & Company -- Analyst
Okay. And then, when we think about maybe from the profit cost perspective, it sounds like pretty, pretty compelling revenue synergies. So are you going to still run the business at a loss and focus mainly on growth? How should we think about margin synergies going forward and what the margin profile of this business will look like in the near to long-term?
Timothy (T.J.) Wolfe -- Chief Financial Officer
Yeah. And sure, Greg -- so it's T.J. again. So I think, maybe we can start with kind of the EBITDA evolution in this past year what we see going forward. So we already talked about the revenue decline during the middle of this year. I think what we saw was Poppin maintaining their salesforce, their infrastructure and investing to be able to ramp quickly coming out of COVID. So I think that's what we see as driving the EBITDA loss that we talked about earlier. I think when you look at a gross margin level, you see a similarity to what Kimball is demonstrating today. And then, I think as you begin to scale this business, then you begin to see the opportunities in leveraging common infrastructure again across both the digital platforms, Kimball's manufacturing capabilities and we would see that being a key value driver in this transaction.
Greg Burns -- Sidoti & Company -- Analyst
Okay. So is there a kind of model or target in terms of margins, I mean, are you -- is it operating at a loss now just because of COVID, like was this business profitable at some point prior to COVID? And I guess looking forward, is there kind of a target on getting this to profitability?
Timothy (T.J.) Wolfe -- Chief Financial Officer
Yes. So Greg, I think as far as forward-looking, what we see is -- a reasonable estimate would be, this will be EBITDA positive during the second half of our fiscal year '22. So again, this is taking into account the current COVID crisis, what we see is the revenue evolution and the opportunities and then, again EBITDA positive at that point.
Greg Burns -- Sidoti & Company -- Analyst
Okay. Okay, great, thanks. And then, in terms of -- you gave some good color on the order patterns and improvements you're seeing there. I was just wondering if you could maybe dig in on the hospitality side a little bit because it sounds like you had a big project, did that all go into backlog, will that ship next quarter and then, we kind of see a return to the previous quarters' trends or are you seeing any kind of improvement in the hospitality side of the business?
Kristine L. Juster -- Chief Executive Officer
So we did, Greg, get a -- we did get a large order during the quarter for hospitality. As you said, that will not ship in the second quarter, part of that order will ship in the back half of our fiscal year. As you recall, hospitality has a longer lead time. So part of that project will ship the second half of our fiscal '21 and part of it will ship in the fiscal year '22.
Greg Burns -- Sidoti & Company -- Analyst
Okay. And I guess, aside from that large order, are the broader trends in the industry kind of similar to what we saw in the last quarter or have you seen any improvement in that market?
Kristine L. Juster -- Chief Executive Officer
That market continues to be very choppy, there is project work that we're quoting, there is some activity out there, but it just continues to be very choppy in the hospitality. We are seeing pockets of improvement in that industry. The resort and hotel areas, those are not coming back as quickly as like leisure activity. People are traveling more from leisure versus business, so we're seeing that pick up a little bit, but it continues to be very choppy and very competitive.
Greg Burns -- Sidoti & Company -- Analyst
Okay. And then, lastly on the hospitality side, the -- you talked about the freight and shipping costs kind of increasing, is that mainly tied to the hospitality side of the business and what's going to be the impact on margins from those rising costs?
Kristine L. Juster -- Chief Executive Officer
Yeah. So with the freight, the ocean freight is primarily hospitality. We have a little bit on the health and workplace, but the ocean freight is primarily hospitality, but we're also seeing increases in our domestic freight because of all the shipping that's going on in the U.S., we're seeing that demand is very high. So we're starting to see pressure on our domestic freight costs as well which -- that impacts the workplace and the health verticals.
Greg Burns -- Sidoti & Company -- Analyst
Okay, great. Thank you...
Kristine L. Juster -- Chief Executive Officer
So we have in Q -- yeah, so I was just going to say in Q1, the impact of freight was about a negative 40 basis points. So we'll see that going into Q2, but the teams are working really hard to try to mitigate those costs as much as we can.
Greg Burns -- Sidoti & Company -- Analyst
Okay, great. Thanks for taking the questions.
Kristine L. Juster -- Chief Executive Officer
All right. Thanks, Greg.
Operator
[Operator Instructions] I'm showing no further questions at this time. I would like to turn the call back over to Kristine Juster for any closing remarks.
Kristine L. Juster -- Chief Executive Officer
Great, thank you very much. Well, thank you for joining our call today. It is -- this is an incredibly exciting time for Kimball International. We've proven our ability to manage effectively in a challenging time, we're making very significant progress on our long-term organic growth priorities and we're excited about embarking upon our new acquisition in the business that we believe sets us up for such success in the future. So thank you to everybody and have a nice evening.
Operator
[Operator Closing Remarks]
Duration: 34 minutes
Call participants:
Kristine L. Juster -- Chief Executive Officer
Michelle R. Schroeder -- Executive Vice President
Timothy (T.J.) Wolfe -- Chief Financial Officer
Greg Burns -- Sidoti & Company -- Analyst
