HNI Corporation (HNI) Q4 2018 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. My name is Kim, and I will be your conference call facilitator today. At this time, I would like to welcome everyone to the Kimball International Fourth Quarter 2018 Fiscal Results Conference Call. [Operator Instructions]. As with prior conference calls, today's call, August 2, 2018, 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 Bob Schneider, Chairman and CEO of Kimball International; and Michelle Schroeder, Vice President and Chief Financial Officer of Kimball International. I would now like to turn today's call over to Bob Schneider. Mr. Schneider, you may begin.

Thank you, Kim, and welcome, everyone, to our fourth quarter fiscal year 2018 conference call. We announced yesterday our financial results for the fourth quarter and fiscal year ended June 30, 2018. As in prior calls, we have an investor presentation slide deck that has been posted to the Investor Relations section of our website to accompany this conference call. As in the past, I suggest you pull up that slide deck as it includes important information on the quarter along with trending of our financial results. I will start with a few brief comments on the fourth quarter and fiscal year 2018 highlights before I turn the call over to Michelle, who will provide us with the key financial highlights for the fourth quarter. We will then open the call to questions from analysts and investors. I was very pleased with our revenue performance in the fourth quarter, with growth of 7% or 4% on an organic basis, after a couple of quarters of slower growth. The growth was broad based with 5 of our 6 vertical markets increasing compared to the fourth quarter of last year. This was the highest sales quarter in over 15 years. Orders were strong as well coming in at $208 million for the quarter, which was 19% higher or 10% higher than last year on an organic basis. Orders increased in 5 of our 6 vertical markets with the strongest growth coming from the hospitality vertical at a 33% increase on an organic basis. The hospitality market is normally choppy from one quarter to the next because of the project nature of the business so we tend to see big fluctuations from quarter to quarter. Even so, I'm very encouraged by the significant volume of orders received during the quarter in all of our vertical markets. Our order backlog ended the fiscal year, 13% higher than last year or 7% higher, excluding D'style, positioning us very well going into fiscal 2019. Higher transportation, steel and other commodity costs continued to put pressure on our margins in the fourth quarter. We started feeling the impact of these higher costs on our margins a couple of quarters ago. I was pleased to see that even though our operating income margin declined this quarter compared to the fourth quarter of last year, we did see improvement from the second and third quarters of this year, some nice sequential improvement. Michelle will discuss the results in more detail in a few minutes. Despite the strong finish to the year, fiscal year 2018 was challenging from both a growth perspective and a margin perspective. We experienced a pause in the industry mid-year. While we were seeing a lot of activity around design and coding, it was taking longer to get that final order approved and moving forward. I believe part of the reason was the uncertainty surrounding whether the tax reform bill was really going to get passed and in what form. Just as that became reality in December of last year and companies could begin to understand the impact of tax reform on their business, global trade discussions heated up. The recently enacted tariffs and the uncertainty of what is coming next is creating additional caution among businesses. We saw some pent-up demand let loose in the fourth quarter, resulting in our strong sales in the fourth quarter and the backlog I mentioned earlier. We are encouraged by the recent activity as we move into fiscal year 2019. The D'style acquisition that was completed in November of 2017, added $13 million in revenue in fiscal year 2018. This acquisition expanded our metal capabilities and our hospitality vertical market and accelerated our strategy of increasing sales in -- of hospitality furniture into public space areas within the hotel. The integration of D'style into the Kimball International family is coming along nicely. Our margins in fiscal year 2018 were pressured by increasing costs. We started seeing the increase in transportation costs in the -- in our second quarter. It seems a lot of things came together within that industry to cause prices to spike significantly and quickly. The shortage of the over-the-road drivers, increase in demand of transportation services and the impact of the electronic log requirements all are reasons for the increase. In each of our last three quarters, we've seen an increase of approximately $1.5 million each quarter, or approximately $4.5 million for fiscal year 2018. Steel price increases started impacting us in the third quarter. We were not directly impacted by the original steel tariffs because we purchase most of our steel from U.S. suppliers, but we started to see some general inflation increases in steel in the third and fourth quarters. All of this put pressure on our margins in fiscal year 2018. Looking forward to fiscal year 2019, we will have a strong focus on growth with continued focus on design-savvy new products. That has been the key to our success, and acquisitions will also play a key role in that growth. We are actively pursuing tuck-in acquisitions that would complement and expand our current product portfolio. In addition, we are always searching for strategic partnerships as a way to execute on our strategies, and we will continue investing in design-driven innovative products to help fuel growth. On the cost side. It appears that transportation costs have stabilized somewhat recently. In fiscal year 2019, we will still see a year-over-year increase in these costs in the first quarter, since we didn't see the initial increase in fiscal year '18 until the second quarter. But we anticipate these costs will remain stable in the near term. We are monitoring the cost of steel and are buying spot rates where it makes sense to hedge future pricing. We're keeping a close watch on the tariff discussions. The Section 301 tariffs proposed in early July would add a 10% tariff on furniture and furniture parts and components, as originally proposed in early July. Yesterday, President Trump asked the U.S. trade officials to consider increasing that to a 25% tariff. We are analyzing the cost impact of these proposed tariffs and are proactively working with our supply chain partners in China on ways to mitigate the impact. Our suppliers have been very open to our request for pricing concessions to help reduce the overall impact. We are also in close contact with our customers regarding these tariffs. We plan to file comments with the International Trade Commission to request that certain categories be excluded from the list. As we discussed on our last call, we are working on several cost reduction initiatives that we're estimating will save approximately $7 million in fiscal year 2019. We are on track with these initiatives. Also, our National brand had a price increase effective in April, and our Kimball brand had a price increase effective July 2. It normally takes several months for the price increases to fully take effect so will we -- so we will see some benefit in the first quarter especially with the National price increase. But more of that benefit will be beyond Q1. We expect the cost reductions along with the price increases will mitigate the impact of the higher transportation and other commodity costs beginning in the second quarter of fiscal 2019 when the price increase impacts are fully realized and the lean initiatives that I mentioned continuous improvement initiatives are taking hold. I will caution though that if the proposed tariffs I just mentioned are enacted at 25% instead of 10%, this would drive much more work with our supply chain and will put additional pressure on our margins that we will work to mitigate. We're optimistic going into fiscal year 2019, macroeconomic indicators including service-sector employment, construction activity and architectural billings index and RevPAR all support continued growth. Before I turn the call over to Michelle, I wanted to provide an update on my pending retirement. Since my announcement in May, the Board Search Committee has been working with an executive recruiting firm to identify external candidates and the board is now in the process of evaluating both external candidates and an internal candidate. The board expects to announce the new CEO in September. My plan, as previously announced, is to retire on October 31. Now, I will turn it over to Michelle for a brief overview of the financial results before we open the call to your questions. Michelle?

Thanks, Bob. So Bob covered the fiscal year 2018 highlights. My comments are going to focus on just the fourth quarter. I'm pleased with our results for the fourth quarter and in fiscal year 2018 on a strong note. We reported sales of $184.5 million, which was a 7% increase over the fourth quarter of last year. Now, this does include the D'style acquisition that we completed in November. So an organic basis, our sales increased 4%. It was encouraging that the growth was broad based among our vertical markets. Five out of our six vertical markets experienced growth in the quarter. The largest contributor to the increase came from our hospitality vertical with 26% growth. The D'style acquisition is included in this vertical and so that's part of the reason for the increase. But on an organic basis, sales in this vertical still increased a strong 12%. The increase came from our program business and was spread among various hotel brands. We also saw a solid 14% increase in our healthcare sales in the quarter. We've been talking the last couple of quarters about investments we've made in the healthcare space, including some new product introductions and the new leadership team within our Kimball brand. This vertical has a longer selling cycle than the other office verticals so it has taken a little longer to see the benefits of all the work the team has done in this space. We believe there are a lot of opportunities within this vertical as we move into fiscal '19. Our finance, education and commercial verticals all increased as well during the quarter, and the only vertical that declined was government. State and local government sales were flat, while federal government declined primarily due to a large project that shifted last year. Consolidated orders increased 19% in the fourth quarter. We had a couple of things that impacted the order comparison for the last year but even excluding those items, orders still increased a very strong 10%. At a high level, the 10% was adjusted to remove orders from the D'style acquisition and also was adjusted for the estimated impact of price increases that were effective early in the quarter and pulled orders forward. As a reminder, our National brand had a price increase effective at the beginning of the fourth quarter last year in 2017, which pulled orders into Q3 and out of Q4 last year and thus had the effect the of lowering orders in Q4 of last year by approximately $6 million to $8 million. So it made for an easier comparison this year. National price increase this year was later in April so it did not shift orders from quarter to quarter. Our Kimball brands had a price increase on July 2 of this year and so again we had orders pulled into the fourth quarter of this year to beat the price increase. And thus, it inflated our orders in the fourth quarter of this year by approximately $2 million. Again, even when excluding these items, consolidated orders increased 10%. So we're very pleased with the orders activity in the fourth quarter, but growth was broad based with increases in all of our vertical markets except for government. The significant increase in orders during the quarter resulted in an order backlog at the end of June of $148.9 million, which, as Bob said, is 13% higher than June 30 of last year or 7% higher on an organic basis. Sales of new products were 25% of our total sales during the fourth quarter. This metric does fluctuate depending on the timing of when products hit the three-year mark and fall out of the new product category and when new products ramp up fully. So in the first quarter of this year, we had some products, that are still selling extremely well, hit that three-year mark and they fell out of the new product category. So we saw a dip in new product sales to below 20% in the first two quarters of this fiscal year. So we are now seeing recently introduced products starting to ramp up in volume, and we saw an uptick in this metric to 22% last quarter and 25% this quarter. 25% is very good and in line with our target. As a reminder, we do exclude sales from the hospitality vertical in this metric, as hospitality products are primarily hotel-brand specific. Our consolidated gross profit ended at 32.6% in the fourth quarter compared to 33.6% in the prior year. The higher transportation, steel and other commodity costs reduced our current year margins by approximately 120 basis points. These cost increases had a significant impact on our margins this quarter. And, as Bob mentioned, we believe transportation costs have begun to stabilize at these elevated levels, but the tariffs that are being proposed would have an impact on us and so we're still analyzing that impact and working with our supply chain to mitigate the cost. Sales mix also had an unfavorable impact on our gross margin by approximately 130 basis points. And partially offsetting this realization of price increases during the quarter favorably impacted gross profit by approximately 90 basis points. And leverage on the higher volumes favorably impacted gross margin by approximately 80 basis points. Selling and administrative expense increased 7% in the fourth quarter compared to last year, primarily due to a $1.2 million gain on the sale of some idle land in the prior year and then the additional expenses from D'style that we didn't have last year. We also increased our sales and marketing expenses to fuel growth. Partially offsetting these increases was lower incentive compensation costs during the quarter. Our operating income margin ended at 7.9% compared to 9% in the prior year and that's on a GAAP basis. The gain on the sale of the land of $1.2 million in last year increased our operating margins by 70 basis points last year. Excluding the gain from last year, our operating income in dollars would have been approximately $400,000 higher this year than last year. As Bob mentioned, to address the cost challenges, we have several productivity and lean initiatives that we're working on, which we estimate will save approximately $7 million in fiscal year '19. And just as a reminder, these initiatives, including making investments in equipment and automation at our production facilities to improve production inflow and increase efficiency, we're also working on lean initiatives around our transportation and warehousing processes where there is opportunities to reduce costs. And we have other -- many other small lean initiatives continually occurring throughout the company. We anticipate these initiatives along with the price increases that were recently implemented in both our Kimball and National brands will offset the transportation and commodity cost increases in the second quarter. The effect of tax rate for the fourth quarter was 31.4% and that's compared to 33.4% in the prior year. The lower rate is primarily due to the benefit from tax reform. Because we're a fiscal year reporting company, we had blended federal statutory rate for fiscal 2018 of 28.1%. So the full reduction to the 21% rate will be in effect for fiscal '19. Net income in the fourth quarter ended at $10.3 million compared to $10.6 million in the prior year and earnings per share for the fourth quarter equaled $0.28, which is equal to last year. Now moving to the balance sheet, our cash, cash equivalents and short-term investments balance was $87.3 million at the end of June. Our operating cash flow in the fourth quarter was $20.5 million compared to $15.1 million in the fourth quarter of last year. So a nice increase from last year. We paid $2.6 million in dividends and repurchased 32,000 shares totaling approximately $516,000 during the fourth quarter, and we have about 1.2 million shares remaining under our current share repurchase program. So we'll continue to monitor the market and repurchase shares opportunistically. Our capital expenditures totaled $6.5 million for the quarter, primarily related to investments in manufacturing equipment and automation, renovation for our corporate and Kimball brand headquarters to better reflect the office of today and our showroom renovations. Our capital expenditures for the entire fiscal year 2018 totaled $22.3 million, and we do expect to continue to have elevated levels of capital expenditures for fiscal year '19 as we continue these investments and automation and the corporate and Kimball brand headquarters' renovation. We're currently estimating capital spending of around $30 million to $35 million for next year. Our balance sheet remains strong with very little debt as of June 30. We do have a 30 million credit facility for Kimball International and we are in compliance with all covenants. But before we open the call for questions, I do want to mention that the new accounting rules for revenue recognition will be effective for Kimball International beginning in fiscal 2019. The most significant change related to this accounting rule will be the reclassification of certain items on our statement of income. For direct bill customers, currently, any fees paid to dealer agents for facilitating the sale and performing certain services are netted against revenue. Under the new standard, these will be recognized as revenue with an offset either in cost of sales of selling expense. In addition, any commissions or fees that we paid to third-party purchasing organizations will be recognized as a selling expense rather than being netted against revenue. So the results of these changes will be an increase in net sales and an offset in increase in cost of sales or selling expenses, so there will be no impact on operating income dollars, but there will be a reduction in operating margins because of the higher sales numbers. So we will be restating prior year numbers so that you'll have a comparable year-over-year data and we'll start that with our first quarter reporting for fiscal '19. So with that, I'd like to open the call today. Kim, are there any one in the queue with questions?

[Operator Instructions]. The first question comes from Kathryn Thompson from Thompson Research.

This is Steven Ramsey on for Kathryn. Can you -- I may have missed this on the call. Can you review your pricing again? And then -- and maybe how you think your pricing change relates to competitors in the space?

Our pricing. What we've mentioned earlier is we came out with price increase in April with one brand. We came out with another one and the -- another brand in July. The amount of increase we didn't mention, but I will tell you it's very similar to what our competitors have done. We very much watched what is happening in terms of the market with respect to when to come out with the price increase. Given our market size, we clearly are a follower in terms of that with respect to the market. And -- but very much have been watching what our cost increases have been throughout our cost structure, and then planning for when we could, perhaps, come out with a price increase, which we did on those two dates. As a Michelle mentioned, when do a price increase, if the world was very simple, it would be very easy and the very next day the prices would go up. But due to various contracts, there often is a delay on when we see the impact of those price increases. So the National, the one brand price increase will be benefiting us in the first quarter of fiscal '19. The other price increase we did with Kimball in July, we probably won't see as much effect until you get into the second quarter of fiscal '19, just due to the lagging effect of that process.

Got you. And then, I guess, kind of putting together the $7 million of cost savings and how those filter in, combined with the price increases. I guess two questions there. Kind of what is the pace of the $7 million coming in through the year? And maybe if I heard you right or wrong that you would be -- the price-cost gap would close in the second quarter of fiscal '19?

That's correct, Steven. The $7 million savings, we've got a little bit in the first quarter and then it ramps up more in the second quarter. Each quarter it's a little bit more, but there is a little bit bigger ramp-up between Q1 and Q2. And then we do expect between that and the price increase impact that we would be able to offset the transportation cost and commodity cost increases that we've been seeing.

And, Steven, after that quarter, we would have margin expansion because the continuous improvement processes -- projects we're working on will be finishing up, as we go out through the year. So we would have additional benefit thereafter. But it's Q2, where we are able to offset the various cost increases that we have mentioned earlier.

Great, okay. I would be interested to hear given the increased focus on new products in the last few years and, kind of, the way your more current set of new product introductions are going. Can you talk about maybe what you've learned in launching new products? And if margin trends -- initial margin trends in a product launch are better now than when you would launch them a few years ago? Or maybe even it's not even fair to compare them because of the inflation pressures going on right now versus the past couple of years?

Good question, Steve. We really, really hit the gas pedal on new products starting 4, 4.5 years ago. And in order to do that and not just completely blow our new product introduction budgets, we had to really rethink how we come out with new products and speed the market. And so a lot of process changes were put in place to really speed up the process, to try to take cost out of new product introduction. And so we're a lot faster than we were then. And the products, of course, now compared to 4, 5 years ago, they just looked so different. Much, much more contemporary. With respect to margins, it's difficult comparing to some of the prior type product introductions because those often had a lot more material content that we have today. When you're thinking about case goods and open plan. But generally, the margins are equal to or better. And then as we -- of course, as you would expect, as we introduce a product and we work through all the introduction issues that typically occur, margins tend to get better. We spend a lot of time working with our supply chain. I would say, much more time than we had done in the past to try to remove cost on new product introductions, to try to get the target pricing and the target margin where we want it when we came out with that product.

Great. And then lastly, how would you compare not maybe in the last quarter to last year versus the past large order trends versus small order trends in your end market?

The quarter we just ended, both were up substantially, both were strong. And I am, obviously, very, very pleased to see that, but I know as you go back about nine months ago, maybe six months ago, there were stresses on day-to-day orders, there were stresses on large projects. But for us, both of those were strong this last quarter.

Excellent. And then my final question. Kind of what the flurry of acquisitions and partnerships in the space recently. How does -- does that change your outlook on the market getting pricing or sales trends or does that -- or are you guys looking at the partnership avenue as well to expand your portfolio?

We are investigating acquisitions, we're looking at partnerships where it makes sense. In terms of what impact it has on pricing, I'm not sure if that's substantial of a change in the marketplace, but it certainly helps with some of those collaborative partnerships to be able to bring products to our distribution. But yes, we're looking at both of those, in addition to a lot of focus on organic growth with new products.

[Operator Instructions]. Your next question comes from Samantha Doxie from Walthausen & Company.

First, pre-buying activity out of the price increases correctly. So you said you had about $2 million of orders that was for that?

Samantha, this is Bob. The first part of your question we couldn't hear if you could you repeat it?

Oh, I'm sorry. I just want to make sure I'm understanding the pre-buying activity out of the price increase correctly. So you mentioned on the call that about $2 million of orders were for to beat the price increases?

That's right. For this quarter, the Kimball brand price increase was effective July 2, and so we estimate about $2 million of orders that were pulled forward to beat that price increase.

Okay. Awesome. And then just quickly next. There's been some news out there about management teams regretting the whole open office space move and it actually -- that it decreases employee collaboration and everything like that. So I guess maybe any comments you guys have on that? Or how it may impact you in the future?

Samantha, the key to that is really good design, and -- not only in terms of our products but with the design firm working with them as to how the layout of that facility is going to be set up. And when done properly and the different areas of the building that become available for people to work, it works very, very well. And we actually have lived that with one of our brands here at Kimball International. And so we -- which really positions us, I think, very well to come out with new products that really help in this whole process. Those types of installations where they don't really think through all the different needs of the unique needs of that particular aspect of the company, you do get some negative feedback. And I think the key is just how you do the design. What we really stress with our employees, again, as I said, we have lived through this, how -- it's a real important mindset change that no longer is your physical space of your desk that's no longer really just your office, it's the whole building. And with mobility and the different modes of work that are available within the whole facility, it works very, very well. So I would -- my response would be before anybody should partake of and undertake a renovation and a relay out of their facilities, they really have to think through the design and work with companies that have experience doing it, and -- to be able to avoid some of those issues.

There are no further questions at this time. I now turn the call over to Mr. Schneider.

Thanks, Kim, and thanks, all of you, for joining us today. Our fourth quarter performance and June 30 backlog positions us very well moving into fiscal year 2019. I'm excited about the initiatives our teams are working on to support our long-term growth strategies. My retirement is still a few months away, but I want to thank you for -- all of our investors, for your support over the years. I'm confident our board will appoint a CEO who will continue to focus on and drive shareholder value. Thank you, everybody, and have a great day.

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