Earnings Transcript for KBAL - Q3 Fiscal Year 2021

Operator: Good morning, ladies and gentlemen. At this time, I would like to welcome everyone to Kimball International Third Quarter Fiscal Year 2021 Conference Call. As with prior conference calls, today's call, May 4, 2021 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 forward-looking statements. Risk factors that may influence the outcome of forward-looking statements can be seen in the Kimball International's 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's website. On today's call are Kristie Juster, CEO of Kimball International; and T.J. Wolfe, Executive Vice President and Chief Financial Officer. I would now like to turn the call over to Kristie Juster. Ms. Juster, you may begin.

Kristine Juster: Thank you, everyone, for joining us to review our third quarter results and discuss our business outlook. The third quarter was our most challenging period since the pandemic began due to several key factors that I will review in our outline on Slide 3. First, this is our seasonally lowest quarter. The contract furniture industry normally experiences a drop-off in orders and revenue in our fiscal third quarter. Second, revenues came in below our forecast, due to slower than anticipated order rates early in the quarter. And third, as expected, inflationary pressures on our raw materials, and continued high logistics costs were most pronounced in the third quarter, ahead of our price increases. That said, there were several data points in the third quarter supporting our view that the industry is showing signs of recovery, and that Kimball International is well-positioned to capture market share gains as business conditions progress. Most significantly is the cadence of order rates in our Workplace and Health business units, which account for close to 80% of Kimball International's year-to-date revenues. Although order rates in these two end markets declined in the third quarter, they improved progressively throughout the period and into April, indicating a pickup in the conversion of bidding activity into hard orders. At the same time, bidding activity in both workplace and health increased at a strong double-digit rates compared to Q2 levels, another indication of better market conditions ahead. We also expect considerable sequential recovery in our gross margin in the fourth quarter. As our March price increases begin to take hold and will contribute to a substantial rebound in gross margin, compared to the third quarter. Importantly, we continue to execute well on our Connect 2.0 strategy, in terms of gaining traction in our targeted end markets, achieving our cost saving targets, and making meaningful progress on the stage one priorities that we have identified to drive revenue growth and synergies within our Poppin acquisition. Now let's review Kimball International's end markets and a relative positioning with respect to a business recovery. Beginning with Health on Slide 4, we continue to see this market ramping out of the pandemic more quickly than our other end markets, reflecting a faster return of the health administrative workers, increased public funding, and expansion of areas such as behavioral health, academic medical centers, and specialty hospitals. The previously announced official launch of our new health brand, Interwoven, has brought together a dedicated team of professionals with extensive industry knowledge and experience, which is enabling us to engage in key strategies within targeted health organizations, including the expansion of projects, services, and geographies. Order rates in health increased progressively throughout the third quarter. And we saw a meaningful pickup in the number of orders, and of bidding opportunities compared to Q2. Also in the third quarter, we had significant sales to the Veterans Administration, where the government has announced an $18 billion program to modernize VA hospitals across the country. We have over 600 products qualified for purchase by the VA, and consider public health to be an important growth driver for the business. The recently passed stimulus bill allocates substantial funding to support mental health services, behavioral education, and training as well as tele-health, and improved veterans care. New product introductions accounted for approximately 21% of our total health sales in the third quarter. The Interwoven Health Specialty Products provide solutions for caregiver stations, exam rooms, treatment areas, and patient rooms, all designed around the improvement of the delivery of care. We recently launched Embra, a thoughtfully designed family of lounge seating that make people feel more at home and at ease in health care spaces. The modular design allows for flexibility and space, all customized with elements of storage, lighting, and power, and provide the warmth of a residential aesthetic. Our progress in health is driven by both an expansion of new product solutions, and targeting of the new markets such as the Veterans Administration. Slide 5 provides an update on the Hospitality market. Third quarter sales in this end market were up sequentially, as we work off our backlog. But orders were down considerably, reflecting the continued impact of the pandemic on travel and leisure activities. Custom products, which carry higher margins, accounted for 50% of our year to date hospitality sales, up from 30% one year ago. We expect to build on this trend, as we navigate what is likely to be an uneven recovery in hospitality, with leisure, business, and international travel each ramping at a different pace. We are closely managing our costs in this business, where our fixed costs tend to be much lower, given that we source approximately 75% of our hospitality products. Higher ocean freight costs, however, had a significant impact on Q2 and Q3 results. We expect the margin in Q4 to show improvement from Q3, as we are able to partially offset higher costs with pricing. As we had stated previously, we continue to see increased activity in leisure travel, but anticipate a later ramp for the broader business and international travel. Now let's move to Slide 6, where we begin our discussion of the Workplace market, which represents the largest portion of our business. Although the pandemic impact on workplace furniture spending continues to be felt across the industry, we see early indications that a market recovery is in sight. Our order rates progressively increased through the third quarter, and that trend continued into April. Additionally, the number of new opportunities that we are bidding on increased at a double-digit rate from Q2 levels, as did the dollar value per opportunity. These data points signal that employers are engaged in the development of a new forming work environment, which our research indicates will be comprised of a combination of the office, satellite locations, and work from home. Kimball International's new omni-channel capabilities put us in a strong position to gain share of the new hybrid workplace. On Slide 7, we share our outlook on the future of work, which is the product of our proprietary research. At the center of a new forming hybrid model is the concept that, by providing flexibility in where you work, employers will be able to attract, retain, and develop the most qualified and diverse workforce. It is clear the office plays a crucial role as a centralized hub for collaboration, learning, and teamwork, complimented by both work from home, and in some areas, satellite locations. The pandemic has taught us that, while work can happen anywhere, offices play an important role in corporate culture, creating community and driving innovation. Moving to Slide 8, you can see how well Kimball International is positioned to take advantage of the transitioning workplace market. Approximately 85% of our workplace products are in the ancillary category, which, in contrast to systems, are ideally suited for the collaborative atmosphere of the new office environment. And approximately 80% of our workplace business is derived from secondary markets, where office re-entry is taking place at a faster rate than in larger metropolitan areas. Additionally, these secondary markets like Austin, Nashville and Miami are gaining in appeal due to their favorable business climate and the attractiveness of a less dense, more comfortable living situation. The Poppin acquisition, which we completed in mid December of 2020, is a key driver of our ability to accelerate future market share gains. On Slide 9 is a summary of the Stage 1 priorities we outlined when we announced the acquisition and have been focused on over the last several months. First, we have identified 10 markets for Poppin showroom expansion, and plan to open 5 in fiscal 2022. These locations will be in secondary markets where Kimball International has long standing relationships. Second, we are expanding our work from home portfolio with new product introductions scheduled for late summer and alongside scaling our corporate sponsorship program. Third, the PoppinPro dealer program will officially launch later this month to over 1,000 existing Kimball International dealers, providing them full access to Poppin's suite of products, new categories and services. Slide 10 provides a closer look at PoppinPro, which will provide our Kimball International network with an assortment of innovative products that are tailored to meet the needs of the post-pandemic workplace. This program includes two new categories of PoppinPods and PoppinSpaces. Each provides flexibility and adaptability in an open space environment for individual, private and group use, all enabling productive teleconferencing, pop-up offices and meeting spaces. The just-launched PoppinSpaces is a simple, flexible system of freestanding rooms that gives our customers the ability to add collaboration, meetings and private workspaces for their employees without the cost of construction. Dealers in the A and D community are excited about the launch of PoppinPro because they will gain access to the new product categories, benefit from the simplicity and speed in the transactions, and gain quality products at an affordable price, and all with the unique design, colors and fun offered by the Poppin brand. To sum up, on Slide 11 Kimball International supports work and life wherever it happens with a portfolio of high quality products and solutions that are well-suited to today's dynamic marketplace. Now I will turn the call over to T.J. Wolfe, our Chief Financial Officer, for a financial review of the third quarter and our guidance for the June quarter. T.J?

T.J. Wolfe: Thanks, Kristie, and good afternoon, everyone. I will provide more details about Kimball International's financial performance in the third quarter of fiscal 2021 and our guidance for the fourth quarter which includes a significant rebound in gross margin. Let's start on Slide 12 with key financial highlights. Net sales increased 2% sequentially to $138.7 million including an $8.9 million contribution from Poppin but declined 22% year-on-year. I will discuss sequential revenue order dynamics by end market in a moment. Our gross margin was 28.7%, 530 basis points below last year's third quarter levels, mainly due to logistics and raw material inflation, higher health care costs, and the loss of leverage on a lower revenue base. Of the total $6 million of transformation plan savings in the third quarter, $4 million related to our operational excellence program helping to mitigate part of these margin pressures. As a reminder, we announced selective price increases in our Workplace and Health product lines that went into effect March 1 to help offset some of the industry-wide inflationary cost pressures. Given the timing of the price increase, we did not see a material benefit in the third quarter, but expect to see a more meaningful contribution during the fourth quarter which will benefit gross margin, with a full realization of pricing in the first quarter of fiscal 2022. Selling and administrative expense declined by $0.7 million to $44.9 million benefiting from cost management and savings from our transformation program of $2 million. Excluding SERP adjustments, acquisition-related charges, and $1.7 million of amortization from the Poppin acquisition, adjusted selling and administrative costs were $42.6 million or 30.8% of sales compared to $47.2 million or 26.5% in the prior year. Our total transformation savings in the third quarter were $6 million, bringing our year-to-date cost savings to $16.8 million, which puts us firmly on track to achieve $20 million in transformational program savings by fiscal year-end. We plan to reinvest a portion of these savings in the fourth quarter as we increase our SG&A spend in anticipation of a business recovery in fiscal 2022, and the continued expansion of Poppin. Our GAAP net loss was $4.5 million or negative $0.12 per diluted share, including $3.5 million or $0.09 in after-tax special restructuring charges as well as amortization related to the Poppin acquisition. This compares to net income of $9.5 million and earnings of $0.25 per diluted share in the third quarter of fiscal 2020. Adjusted diluted EPS was negative $0.03 compared to earnings per share of $0.27 in the year ago quarter. Adjusted EBITDA was $1.9 million. Now let's take a closer look at our sequential revenue performance by end market on Slide 13, keeping in mind that the third quarter is our seasonally lowest quarter. Hospitality sales increased 61% sequentially as we worked through our backlog and accounted for 25% of total revenue this quarter. Health sales decreased 9% sequentially and accounted for just under 18% of our total revenue this quarter. Workplace revenues, which represented 57% of our total sales, declined 10% sequentially. And new product introductions for Workplace accounted for approximately 27% of total Workplace sales in the third quarter. As Kristie mentioned earlier, the contract furniture industry normally experiences a seasonal decline in revenue during this reporting quarter. Historically for us, that has been around a 10% decline in revenue from Q2 to Q3 for Workplace and Health, which is the rate of decline we saw this year. Slide 14 shows positive sequential momentum in new orders in Workplace, which increased by 2%, including a sequential improvement in Poppin orders as Poppin was part of our results for a full quarter in Q3 versus only a few weeks in Q2. Within Workplace, we see a particular ramp of order rates in the education vertical. Orders in Health declined 4% and Hospitality orders decreased 40% sequentially. And it's worth noting that order rates in both the Health and Workplace end markets improved progressively throughout the quarter and this positive trend continued into April as well. We saw a 6% increase in total orders for Health and Workplace in April compared to March. Thus, while order trends in the third quarter were quite soft, there were definite signs of improvement throughout the period and into the first month of the fourth quarter. While it is too early to call this a trend, we are cautiously optimistic that it signals the beginning of an industry recovery. Now let me switch to the balance sheet and cash flows on Slide 15. We ended the quarter with $34 million in cash and cash equivalents. In the third quarter, we generated $2.8 million of operating cash flow compared to $4 million in a comparable period of fiscal 2020. Capital expenditures were $5 million compared to $5.6 million in the year ago third quarter. The majority of our CapEx was machinery and equipment in our manufacturing facilities and investments in technology. Year-to-date capital expenditures were $13.9 million and we expect full year CapEx to be approximately $20 million. This quarter, we returned $4.8 million of capital to shareowners in the form of dividends and share purchases, bringing the year-to-date figure to $12 million. Based on our backlog of $129.6 million at the end of the third quarter, and the tenor of our order rates, we expect a sequential increase in Workplace and Health revenue to be offset by a decline in Hospitality revenue due to the lower Hospitality backlog entering the quarter, resulting in fourth quarter revenue to be in line with third quarter levels. We are projecting gross margin to rebound significantly expanding by approximately 300 basis points from Q3 levels as the March price increase takes hold offsetting a portion of the continued commodity and freight pressures in Q4. We are planning to selectively increase selling and administrative investments in the fourth quarter around our growth initiatives, including Poppin, return to work and incremental health resources. We will continue to monitor incoming orders throughout the quarter and adjust planned investments, if needed. I will now turn the call back to Kristie for her closing remarks. Kristie?

Kristine Juster: Thank you, T.J. To wrap up on Slide 16, early indications are that business conditions are on the upswing. The workplace is changing and we believe Kimball International is in the right geographies, the right verticals and the right product categories. With a new digital lead generation machine, we are in a strong position to capture market share at an accelerated pace. And our cost efficiencies will enable us to deliver long-term value as we ramp. I would also like to take a moment to comment on Kimball International's company-wide approach to ESG. We currently are compiling data across our organization that supports our commitment to being responsible stewards of the environment, maintaining a diverse and caring culture that emphasizes employee safety and wellbeing, and having strong corporate governance practices. Our Board Of Directors and executive leadership demonstrate our meaningful commitment to diversity, and we look forward to sharing more information and reporting on our broader ESG focus in the coming months. I would now like to open the call for questions.

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Greg Burns of Sidoti & Company. Your question please.

Greg Burns: In terms of some of the green shoots of the improvements, are there early signs of improvements you are seeing? I mean, can you just talk about how that’s translating in terms of maybe order quoting activity, what you are seeing there? And is it centralized with like smaller business -- are you seeing it with smaller businesses first, and maybe larger projects with longer sales cycles? Any signs there that you might start to see that pick up in the second half of the year?

T.J. Wolfe: Sure, Greg. I think when we talked about this, when you look at the progression throughout the quarter, clearly it was a slow start to January in orders which translated to a slow February in shipments. But what we saw throughout the quarter was this progressive strengthening from January through March, and then into April we noted it was a 6% increase over the previous month in Workplace and Health. And I think when you look down kind of to your question at what we would call day-to-day orders, so those less than $50,000 in value versus project orders which are longer and larger -- longer in duration. We saw a significant increase in the day-to-day orders in April, and actually our strongest performance over the past year. And so I think those were very encouraging signs about the types of activities we were seeing. So again, the size of orders, and this was our kind of hypothesis from the beginning that we would begin to see the day-to-day orders come back first before larger projects, so that is playing out. And I think within the verticals we talked about this, but the education buying season also starts during Q3, and we saw the signs of that picking up as well. So I think those are two specific data points we look to that are the green shoots we feel.

Greg Burns: Okay. When you look at the work from home opportunity and how you see that playing out, is it mostly going to be through -- are you mostly addressing that through company sponsored programs or do have any plans on, like, further digital investments around maybe like a website or B2C type channels?

Kristine Juster: Yes, Greg, this is Kristie. We've focused our efforts on the B2B environment and the corporate sponsorship program. We've talked about our initiative with Poppin to gain corporate sponsorship. We have over a hundred corporations that have signed up for that now and so we do see that it's early stages in that process. Although we do have some B2C business because Poppin is actually able to transact from a B2C basis, that's not the focus of our initiative. And so we feel very good about where we're focusing. We feel good we're in the front end of that market and it will form as this new hybrid model is forming in the workplace.

Greg Burns: Okay. And then in terms of the 4Q guidance in terms of SG&A, I guess there's some additional savings to be had on your $20 million, you are talking about some incremental investments back into the business. So relative to the third quarter, do you expect between those two dynamics, SG&A to be up sequentially or flat?

T.J. Wolfe: Yes, Greg, that's right. So if you think about it, we will have additional savings come through from operational excellence. The majority of that will fall in cost of goods as it has, but you're right, we will have a sequential increase in SG&A. And really what we're looking at is we have been gating these investments as we evaluate the market, look for the ramp to occur, and now we feel is the right time to make some of those, and we mentioned those are in health expertise, related to the VA, the launch of PoppinPro, and around the new forming workplace and how we can support that from a research, design and innovation standpoint. So that will all result in a sequential improvement from -- sequential increase from Q3.

Greg Burns: Okay. And lastly, in terms of the first phase priorities for Poppin, can you just talk about where you are in terms of implementing those, when we might see those start to have some impact on Poppin sales growth?

Kristine Juster: Sure. So, we're very pleased with the progress that we've made with Poppin. The PoppinPro launch is actually happening this month. We are starting with a full launch to over a thousand dealers. The team has done just an outstanding job of putting launch plans together. The launch plans are actually for our internal sales force, for our dealer community, and then for the A&D community. It's completely activated through digital tools so Poppin has been very much engaged in creating these launch plans. And then we will have kind of a customized approach with key dealers that are going into what we're calling this Poppin Plus -- PoppinPro Plus program that they'll actually have some support on the ground in the local markets. So that is sooner than we anticipated, so very pleased. The categories that are -- the dealers will have access to the full Poppin portfolio. The categories that we are focused on are the new Pod category and also the brand new Spaces categories that just launched last month under Poppin Direct as well, and that's the flexible walls program that we talked about that's so critical to open office environments, quick ship, setting up short-term leases. So great progress there, great engagement across Kimball International and Poppin to make that happen. I will also say we're very excited about what we're going to do with the Poppin showrooms. We stated that we have 10 kind of secondary markets in our view. 5 of those are going to happen as quickly as we can in '22 and really we are working diligently on making that a reality, and it's been really fun for the team. And then the last piece that I would say is we really think there's some product manufacturing VAVE synergies and opportunities in our future, and the teams are starting to work on that as well. So very pleased with the progress and really excited for you guys to see it in the market and for us to see it in the growth build of Poppin in Kimball International.

Greg Burns: Okay, great. Thank you.

Operator: [Operator Instructions] Our next question comes from the line of Kara Anderson of B. Riley Securities. Your question please.

Kara Anderson: Hi, guys.

T.J. Wolfe: Hi, Kara.

Kara Anderson: So I just want to dig a little on the price increase. So you called out no material benefit in the third quarter, a more meaningful pickup in the fourth quarter, 300 basis points improvement and full realization in 1Q of next year. But if I recall the price increase won't really alleviate all the pressures you're seeing so I'm guessing on kind of what does it look like to take you back to the 35% gross margin level? And is that in sight for Kimball over the course of the next year?

T.J. Wolfe: Yes, Kara, so great question. So let's kind of go back on the facts of the price increase. So this is across the Workplace and Health portfolios broadly. Kind of directionally in the low single-digit range of 3% to 4%, but it wasn't specifically -- it wasn’t that uniformly so there were deviations from it, but that was the broad direction of it. Because of the backlog in the order cycle, again, you don't really see that much at all in this quarter, in Q3. You will begin to see it in Q4, but then as the backlog works through you will see the full realization in Q1. But as you point out, the margin compression created by freight and the commodity cost increases, those exceed the price increase that we took. I think when you begin to look at the path back towards historical margins, the big lever that you'll begin to see is the loss of leverage reversing itself once volumes recover. And if you actually kind of look order of magnitude in this previous quarter, loss of leverage was actually the biggest drag year-over-year because we were cycling really what was a non-COVID quarter in Q3 of '20. So I think that was the biggest drag this quarter. Freight and commodity certainly material to the margin compression, but the path backward -- path back up will certainly include a recovery of leverage in the P&L.

Kara Anderson: Okay. So is it fair to say like if we are projecting that volume return three, four quarters out, then we would also expect you to get back to that level, if our timelines are correct?

T.J. Wolfe: Yes. You would find it marry up with the return of volume, absolutely.

Kara Anderson: Okay. And then can you talk about how Poppin is progressing in comparison to the sort of the order rates, bidding activity trends that you've talked about for the whole business?

T.J. Wolfe: Yes. Sure. So when you look at Poppin, and Kristie just commented on the progress we've made with our Stage 1 priorities, when you look at what we will call as kind of the legacy core business that Poppin had prior to our acquisition, it remained at depressed levels as we have seen. So Poppin's markets in major cities remained depressed as ours did. So when that's kind of the performance that you saw this quarter, again $9 million in revenue, significantly below what Poppin's rates were prior to COVID. So that drag and kind of depressed top line still continues. We would look for their ramp to follow Kimball International's kind of Workplace, Health ramp with some deviations given they're in metro markets. And what we've said is secondary markets will begin to recover first, followed by large metro markets. So I think they're experiencing the same macro environment we are. And we will look to see their revenue again begin to grow as we come out of the ramp in the next quarters.

Kara Anderson: Got it. And then I wanted to ask on the PoppinPods and the PoppinSpaces, are those new product categories for Kimball? And how do you compare those to peers offering about there? I guess, I just want to get a handle on the significance of those.

Kristine Juster: Yes. So they are brand new categories for Kimball, for the traditional dealers and they will be serviced through the PoppinPro program. The PoppinPods launched right before COVID. So Poppin really has not experienced the benefit of that category. Although they were very pleased with the initial launch, and then we went into COVID. We do feel that those products have significant application to the post-pandemic work environment that's going to take place. And then Spaces are brand new. And it's really quite an exciting category for us. We actually just rolled out Spaces to our Health team today. And I heard a lot of excitement about it. It's the ability to construct with flexible walls, offices, small meeting rooms. And so you can literally set up an office without any type of construction. And of course, what we keep hearing in our feedback on the new workplace is all about the flexibility that's needed in the interiors of these spaces. And so those two product categories support that research wholeheartedly and we are excited to take them. And then there are new product pipelines that will support those two categories, both in the direct Poppin model and through our traditional network with PoppinPro.

Kara Anderson: Got it. And then do you have any data points around the success you've had in that corporate sponsored work-from-home category that you can share?

Kristine Juster: Yes, we are just learning that category. I think I shared, it's about a little over a 100 corporate sponsorships that we have engaged upon. And those are literally employee's ability to order the product directly. We are seeing the volumes ramp over time, but it's still a new learned behavior for the employee to actually go on their internet and learn how to purchase product. It's also a new behavior for the employer to actually require the employee to purchase the product through their organization. So I think it has significance going forward, and we are kind of building that as we go. So we’ve confidence in what it will be, but it's still early on in the stages.

Kara Anderson: Got it. Thank you. That’s it for me.

Kristine Juster: Thanks, Kara.

Operator: Thank you. At this time, I'd like to turn the call back over to Kristie Juster for closing remarks.

Kristine Juster: Yes. I would like to thank everyone for joining us on the call today. And we certainly look forward to keeping everybody informed on our progress. We continue to share just the beliefs that what we’ve done during the COVID times will set us up for tremendous success going forward, and that we truly are ready to ramp out of COVID with the opportunities that we’ve been working on. I also want to thank all of our employees at Kimball International for what they’ve done to get us through this pandemic. And we’ve invited all of our employees back to our offices and we’ve experienced that over the week, and we can -- frankly, we can feel the excitement and the reconnection that everybody has. So we are really pleased about our path ahead and we thank you all so much for your time this evening.

Operator: This concludes today's conference call. Thank you for participating. You may now disconnect.