Q2 2022 Kimball International Inc Earnings Call

February 3, 2022

Yeah.

Good afternoon, ladies and gentlemen, my name is Michelle and I will be your conference call facilitator today at this time I would like to welcome everybody to the Kimball.

Second quarter fiscal 2022 earnings conference call.

As with prior conference call today's call February 3rd 2022 will be recorded and may contain forward looking statements as defined under the private security 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 on 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, Chief Executive Officer of Kimball International and T. J Wolfe Executive Vice President and Chief Financial Officer, I would now like to turn today's call over to Kristy gesture Ms. Juster you may begin.

Good afternoon, everyone and thank you for taking the time to join US on today's call. Our second quarter results were in line with our expectations, reflecting strong demand for our diversified portfolio of Kimball International products. We are pleased with the double digit revenue growth we achieved in the quarter.

Importantly, we have continued to see momentum in orders and pipeline activity throughout the quarter.

The evolution of the hybrid workplace is on track. Despite some delays in return to offices caused by the omnicare on variance.

The return to learning is proceeding as expected and capital projects at major health systems remain on the upswing.

These business trends are consistent with our views on how the markets would evolve post pandemic and support the choices. We have made over the last two years to position Kimball international for accelerated growth.

Workplace and help orders combined have increased at double digit rates in each of the past three quarters, indicating the strength and consistency of demand in these two markets, which account for 89% of our second quarter net sales.

The magnitude and extent of the prevailing commodity inflation and supply chain issues continued to impact our business in a variety of ways.

<unk> us on the top line as well as margin levels.

Despite these pressures we were able to deliver adjusted gross margin improvement of 40 basis points versus last quarter.

Kimball International's year to date performance together with the robust growth in orders, we experienced in the second quarter continue to support our expectations for fiscal 2022 to be a year of 15% to 20% sales growth indicating.

Indicating a substantial pick up in the second half of this fiscal year.

T J will provide additional detail on the elements that affected gross margin in the second quarter and the assumptions underlining our expectations for pronounced margin expansion in this year's fourth quarter.

Taking a closer look at our key end markets.

Replace revenue and orders increased 21% and 42% respectively in the second quarter.

Led by the commercial and education sectors and supported by growth in the finance sector.

These figures include popping where delays in inventory availability presented a challenge to pop ins in stock business model. This caused a pause in the positive sequential momentum and pop in sales, which we expect to resume in this year's second half as evidenced by province bookings up 106%.

Versus last year's quarter.

As the return to office continues companies are investing and re imagining their spaces to accommodate three consistent themes.

Our hybrid workplace that caters to both physically and digitally present workforces of flexible workspace that allows for configuration based on short term needs and the evolving long term trends.

In an amenity rich workspace that attracts and retains the best talent and fosters the culture safety productivity and well being of its workforce.

With ancillary products, representing 85% of our portfolio Kimball International is benefiting from these themes as our products are well suited to address these demands.

Equally our long time, president presence and momentum and secondary metropolitan areas from which we derive approximately 80% of our revenues has been a significant advantage as companies migrate to more affordable geographies or establish satellite offices in these areas.

We have also seen a steady increase in demand in the education vertical driven by the return to in person learning and we are very optimistic for the upcoming educational buying season.

Institutions are looking to create flexible environments that support the many ways of learning, while driving connection and collaboration for students and staff.

Research shows that hybrid learning will become the norm technology will play a critical role in ensuring equitable learning opportunities.

And safety of students and teachers will remain a priority.

Kimball International a responsive design and our ancillary products that support adaptive and flexible environments allow students to learn comfortably and safely and enable staff to gather and collaborate in a variety of ways.

As shared are popping business has been more affected by the supply chain disruption due to the in stock value proposition. In spite of this we continue to see the proof of how carbon will support and elevate our go to market strategy.

Our acquisition was grounded in three assumptions our ability to ramp the direct digi.

Digital <unk> model, our belief and expansion in secondary markets and our ability to expand the <unk> brand and portfolio into the Kimball International dealer channel.

Our progress has been significant in all three areas.

<unk> orders were up 106% our showroom expansion into secondary markets is in full execution with Miami fully operational in both Austin and Atlanta showrooms opening this quarter.

And our new <unk> Pro dealer cross sell opportunity will represent a new channel that is over 10% of our total mix at popping in year one.

We continue to hold much confidence in our ability to scale and expand this business.

Moving to our health market second quarter revenue increased 6% and orders were up 13%. Despite a slight slowdown due to the COVID-19 variance and diverted focus from noncritical care.

Orders have picked up in the second quarter, and we expect demand build further in the coming quarters as focus will return to elective surgeries and preventative care.

We are actively addressing the expanding healthcare concentrations and investing in customized products in areas, such as behavioral health and outpatient clinics, where we see substantial long term growth opportunities.

Staffing shortages and burnout amongst hospital workers have been well documented and health systems are looking for innovative ways ways to attract and retain staff.

We continue to leverage our research and product development efforts to focus on these issues and are designed for the small market incorporate features that facilitate and support offer amenities and operating many of these in the workplace flexible environments and hybrid approaches to patient care.

Our continued focus on innovation with award winning products such as the Emperor and <unk> lines is resonating in the market with new product sales, representing 23% of our health market sales in the second quarter.

And we will continue to provide opportunities for us to expand further into the retail health space.

While our hospitality market is awaiting the full scale return of business in international travel the industry continues to be pressured by the effects of the pandemic.

Within this environment, we are proactively shifting our sales mix to higher margin customized products.

In the first half of fiscal 2020 to customize products account for 64% of hospitality market revenues.

Up from 42% in the first half of fiscal 2021.

We will we will be well positioned to benefit from a recovery in this market.

We expect to materialize during fiscal 2023.

In summary, we are pleased with the strength and the consistency of the demand trends we have seen in the first half of this fiscal year, which is a clear indication that Kimball international is well positioned in the end markets that stand to benefit the most from the pandemic recovery with that I'd like to turn over.

The call to our CFO T J will to provide a financial review that will include our update on operational progress.

Thank you Christy and good afternoon, everyone. We're very pleased to report double digit revenue growth this quarter, especially given the continued economy wide labor and logistic challenges.

Our second quarter net sales were up 11% to $151 4 million compared to the prior year's quarter, if not for the labor and supply chain issues that constrained our production shipment capabilities in the first half of this year, our revenue for the quarter would've been approximately $18 million higher than reported.

Top line growth continues to be led by strength in our workplace and health end markets offsetting continued expected weakness in the hospitality market and a slightly lower than anticipated contribution from <unk> of $13 5 million.

As Christie already mentioned, despite strong demand trends the ongoing supply chain issues, particularly impacted sales at pop in which experienced a challenge to its in stock business model as a result of inventory availability issues. We expect corporate revenue growth to resume next quarter. However, because of the impact COVID-19 related labor and logistic issue.

You said had on top of the near term results. We have recognized a onetime $34 1 million noncash goodwill impairment charge associated with the <unk> acquisition.

Charges, partially offset by a corresponding decrease in our earn out liability.

These actions do not change our view of <unk> long term prospects at all and simply reflect the current COVID-19 related operating environment. We continue to see profit is a key driver of our long term growth model and are excited to underline this commitment through investments such as the three new pop in showrooms opening this fiscal year.

Gross margin adjusted for onetime pandemic related expense of $1 6 million was 31, 8% and increased 40 basis points sequentially. Despite the widespread inflation and supply chain pressures.

Raw material inflation and higher freight and labor costs continue to pressure our margins, partially offset by price increases that went into effect earlier in 2021 and ongoing cost savings programs.

While we expect the pace of inflation to subside over the coming months, we think that prices will maintain their elevated levels, thus, creating a new normal and our input cost environment, which we've attempted to offset through our various pricing actions as.

As we mentioned to you before we announced the price increase that went into effect on October one and.

And introduced a price surcharge effective as of November 15th that will become a permanent price increase next month Approx.

Approximately one third of our backlog reflects the November surcharge and the remaining two thirds, including includes the previously announced price increases, giving us good visibility to improving gross margins, especially starting in the fiscal fourth quarter.

Adjusted selling and administrative expenses amounted to $48 5 million compared to $40 7 million in the year ago quarter, primarily related to a full quarter of costs associated with the <unk> acquisition compared to just three weeks in the year ago quarter and incremental investments such as the Miami pop and showroom to support our sales growth and new product introductions.

Yes.

Excluding the goodwill impairment the earn out adjustment as well as the acquisition related non-GAAP charges and restructuring the second quarter. Adjusted net loss was $5 7 million or <unk> 16 per diluted share compared to adjusted net income of $3 3 million or <unk> <unk> per diluted share in the prior year quarter adjusted EBITDA was 4 million.

Compared to $9 1 million a year ago.

Diving into our end markets net sales in workplace health increased 21% and 6% year over year, respectively.

Order activity in the workplace and market was 42% higher compared to the year ago quarter include the full contribution from pop and whose orders were up 106% year over year and double digit order growth rates in commercial finance and education verticals within workplace health orders were up 13% year over year.

Does this activity in the hospitality market remains at depressed levels, which is reflected in the 23% revenue decline in order activity, 12% below the year ago quarter.

Our second quarter and total backlog was a record $196 9 million compared to $178 million in the prior quarter and $144 9 million in the second quarter of fiscal 2021, and we expect $134 million of this backlog to ship out in the third quarter.

From a balance sheet and cash flow perspective, we ended the quarter with $99 6 million in short term liquidity, which includes cash and cash equivalents plus the unused amount of our credit facility. Our capital expenditures were $8 million and we returned 4 billion of capital to shareowners in the form of dividends and share repurchases.

Despite the near term challenges, we are reaffirming our guidance for fiscal year, 2022, and still expect year over year revenue to increase approximately 15% 20%.

Gross margins in the third quarter should be comparable to the first half and should see a sequential increase in the fourth quarter capital expenditures net of disposals are on track to total approximately $25 million unchanged from prior guidance with spending primarily allocated to the construction of our new warehouse in Jasper and a new automated manual metal manufacturer.

<unk> capability in our Salem facility.

We continue to anticipate operational excellence projects to yield cost savings of approximately $10 million in fiscal 2022. These savings will partially fund our ongoing growth investments, namely the opening of new pop in showrooms as Kristie mentioned earlier as well as our marketing and promotional spend building out of our sales force.

As a result, we project higher overall SG&A spend in fiscal 2022 compared to the prior year.

For our third quarter guidance, we forecast year over year revenue growth of 23% to 25% with gross margins at approximately 31% and SG&A expenses totaling $50 to $52 million.

With that I will turn the call back to Christy for closing remarks.

Thank you T. J, we are pleased with our strong year to date demand, we have experienced across our broad product portfolio selected geographies in key vertical markets, which reinforces the relevance of Kimball International's innovative designs to today's dynamic workplace and healthcare environments.

In addition to our record backlog heading into the second half of the fiscal year, which incorporates the price increases in the surcharge. We implemented in recent months our sales team have line of sight to sustained high activity levels that are contributing to our broader pipeline we.

We are focused on accelerating market share gains and continued investment in growth by opening and scaling our new showrooms investing in new product development and introductions.

And the expansion of our selling organization.

I'd like to close by acknowledging and thanking all our Kimball international employees for their commitment and contributions everyday as a company, we remain dedicated to providing a safe and inclusive workplace being responsible for a more sustainable future and making a difference in our communities.

We have confidence in our progress and much conviction as our business continues to ramp and our end markets return.

Now I'd like to turn the call back over to the operator.

Thank you and again, ladies and gentlemen, if you would like to ask a question at this time. Please press star one on your Touchtone telephone. If your question has been answered or you wish to remove yourself from the queue. Please press the pound key.

And our first question comes from the line of Greg Burns with Sidoti <unk> Company. Your line is open. Please go ahead.

Good afternoon.

When you look at the.

Outlook for the gross margin.

What's been the I guess the biggest change is the biggest factor impacting that it looks like you're expecting a little step back in the third quarter, but.

Some improvement into the fourth quarter.

Whereas previously I think the idea was we would see kind of sequential.

Improvement throughout the year so.

And the biggest factor that's changed there and what gives you confidence that you're starting to see that.

Trend to improve into the fourth quarter.

Yes, sure Greg So I think a few things there I think one certainly in the first half.

Relation outstripped, our initial estimates and so I think the realization of that in the near term and I think the other factor is that the supply chain strengths have really delayed our ability to convert backlog into revenue and so I mentioned.

The record backlog gives us a lot of visibility, but most of our most recent pricing actions are still held up there. So as I've mentioned, one third of the backlog has our most recent price.

Two thirds prior to that and so as that starts to convert in the fourth quarter. We will see margin expansion. There I would also note that in Q3, we would have in it.

Slightly adverse mix element, so hospitality would play a bigger mix rolling in Q3 versus Q2, which would offset any of the kind of improvement we could see a workplace and health. So I think those are the broad factors, but in general why do we feel confidence in Q4, I would say is what we see in the backlog with pricing there.

Okay.

Okay, Great and then.

In terms of.

Labor constraints does that is that your biggest.

<unk>.

Bottleneck right now in terms of production or is there other <unk>.

Imply chain issues that are impacting your ability to meet demand.

Sure.

Spanned all three areas, we've talked about before labor materials, and logistics and I would say in each case labor, we see an improving landscape. So we've been able to hire.

We've added about 10%.

Our manufacturing workforce by about 10% since the beginning of the year, we're going to look to try to do a similar amount over the next six months on the material side I would say, it's probably settled out it's not getting any worse, but not any better at this point I think what we're learning now is how to work in this environment. So how can we expedite materials how can we.

Our trans load to get things to our factories faster. So we're learning to adapt in this constrained logistics environment. So I think.

Labor outlook, improving materials and logistics similar but we're learning to live with the new normal.

Okay.

In regards to pop and how what percent of their business.

Sure.

Is that kind of that on demand that's been impacted by the inventory constraints.

And going forward can you just touch on.

The pop in pro program.

How long has that been live in kind of what's your outlook there for.

For driving growth at <unk>.

Sure. Let me just kind of break out the channels again, I'll hand, it to Chris to talk about pro but as a reminder, there's really four channels within pop and we've got are the primarily the b to B. There is also a wholesale channel.

Much smaller direct to consumer and then popping pro which I'll, let kristy mentioned, but by far the <unk> and again. This is on demand and stocks short lead time is the vast majority of their business and so as we referenced with the pullback in the previous quarter that was the big driver was that that business wasn't able to deliver because of inventory levels.

I haven't been replenished to where they were prior to the pandemic, but I'll, let Christine talk about pro for a minute sure. So happens so we started at.

The program the concept of the program at the beginning of the acquisition.

And.

We commented in his script that we believe the pro volume will be about 10% of the next by the end of the year, which is obviously the first year that we've been doing it if you think about launching top intro into the commercial channel as you know it takes a little while to get the traditional trade and dealers.

Comfortable in selling the <unk> portfolio and Acclimating to the lead times and the value proposition that is a part of that model and we've been very pleased with the progress.

We have we do see lots of opportunity in the future.

The things that we've seen forming is that the pod business.

Is.

A very attractive business that goes into that channel and that is obviously a brand new category for us. So we made good traction we're getting great feedback from our dealers.

A lot of.

Alignment between the Kimball international selling organization.

The pop and expertise and we really think that is a significant opportunity going forward.

Okay and then just lastly, you did mentioned <unk> orders were up 106%, but how much.

As the backlog up like is this is this on demand kind of order flow lost business or is it something that falls into backlog that you could fill at a later date.

Yes, Great question, Greg and I would say for the most part the backlog and pop and does not work like our traditional business. So that's as evidenced by the results in the quarter. So in our in our existing workforce and help business outside of the top if we get an order and there's a long lead time, we put it in the backlog and produce at what we can with pop and they do have.

A small backlog, but it's things that would be delivered with them will say four to six weeks is very short. So in some cases as you say if you can't deliver on demand. It is a loss sale. They are able to put some projects in the backlog, but most of it would be on demand.

Okay, great. Thank you.

Thank you and our next question comes from the line of Rudy Yang with Bahrenburg. Your line is open. Please go ahead.

Hey, guys. Thanks for taking my question.

I guess, firstly could you guys just provide although round, how maybe order trends have evolved.

So I guess, specifically orders last year.

Earlier last year really coming from secondary markets, where a majority of their workplace and health segments are forecast.

So I guess are there any numbers you could kind of put a rod where secondary primary market order growth currently stands and maybe talk to how much more potential you think secondary markets have to ramp up in terms of orders.

Sure Let me let me start.

And then I'll hand over to Christie for her thoughts I think a few things when we look at it we look at orders in a few different ways I would say number one the order pattern and we said this last quarter has been.

Very consistent over really the past nine months and this goes through the different variants that have come out to put challenges of the market. The price increases we've taken the supply constraints, we've seen very resilient and consistent demand throughout that period.

I think when you look at the day to day and project business day to day again as the larger part of our business that is that is two thirds of it I do think in the project space, particularly in health you see some delay.

Variant put challenges of health systems over the past two months project.

One element and then as we've talked about the secondary markets that is our strength those came out of the pandemic.

Earlier in the calendar year, very well metropolitan markets were catching up people say the fall, but those again were impacted more by the <unk> over the past few months. So I would say metropolitan markets, a large mature markets have pulled back in the short term.

But again not quite the same impact in secondary so thats just a few of the points that I'd highlight.

I would just add that we are seeing.

Full of secondary markets, certainly getting back to work with a significant growth trend.

And then some of the networks six metropolitan markets that we followed two of them New York and San Francisco are definitely lagging there is no doubt about it.

And but we are spending our time really in those secondary markets, where we can see the growth and then I'll just comment on the ancillary category. We continue to see the ancillary category outpaced everything else.

Significantly and we're very pleased with the progress and the new product development that we have in that area and the last.

I would say is the health and new product development number is really gaining momentum. So we're excited about the progress that we're making in our health specialty area.

Okay.

And then secondly, how long does it take.

The benefits of lower materials costs kind of flow into your results.

Any of that recognized this quarter or is it more kind of the price increase is starting to take effect that played a larger role and kind of mitigating impacts to your margin this past quarter.

Sure. So I think on when the price increases that we've realized from our suppliers have come on quite quickly much faster than they have in the past because inflation is coming through the supply chain quicker and then as we've said it takes us three to six months to pass those on.

In our list prices as far as where you would see improvements in metals, So steel aluminum and then in corrugated perhaps.

Those contracts in general will re price as the market reprice, so their structure to lower.

Automatically as market rates decrease.

The broad remainder of our procurement portfolio would require some other actions that would require you revisiting the supply base, so certain commodities reprice, but others will take take more time.

Okay, that's super helpful.

And then turns on your backlog at $134 million that will be move next quarter I guess, how does that firstly compared to the amount of backlog you have been able to move historically and how much of that one third in orders tied to I guess previously the lower negotiated prices will move into next quarter.

Sure. So I would say the majority of the backlog that carries prices prior to the November price increase the majority of that and I would say maybe 80 20, we'll clear this quarter. So both of those orders have been in for some time.

Majority of those will clear this quarter I think when you look historically, how we've turned our backlog I think we are if you look over the last four quarters.

Increased every quarter I think we're getting back now to sort of a normal cycle, where you would expect to turn roughly two thirds of the backlog in any given quarter.

That's kind of what our historical level would be.

Also it depends on the mix of hospitality as we've talked about because that is a longer.

The project lifecycle more like six months, but I think I think we're beginning to get back into where.

The backlog should begin to level out and then we can begin to lower it over time as we ramp up production through again hiring and improved supply chain.

Great and then finally, just on pop in I guess, despite supply chain disruptions. This quarter, you still anticipate sales will kind of pick back up in the second half of the year.

So I guess, firstly, what gives you confidence supply chain issues or pop and specifically will improve going forward and secondly, I know you kind of mentioned earlier that sales are using loss come back to that four to six week period. So do you expect to make up any of those kind of lost sales from this quarter just going forward.

Yes on the first point as far as what gives us confidence. So we have visibility now to inventory replenishment for part of it is on the water. So again as a reminder.

Thats a source product primarily from Asia. So we have.

Good visibility to what's on the water will be arriving in the port.

Two our warehouse and ultimately to the customer so I think that visibility and again those shipping times worse than we had anticipated in the prior core quarter, which is what.

It had drove to the lower revenue numbers. So I think we've got better visibility to inventory levels, and therefore stocking going forward and as far as the sales.

I mentioned.

Those sales are in some ways loss sales. If you don't have the inventory on hand, those customers. We'll look elsewhere. So I think that doesn't that doesn't mean that we are have a loss data for prospects for the back half, but those aren't sales will necessarily be able to recoup a recover.

And maybe I'll just add just a couple of thoughts just one thing that I would add is one of the one of the dynamics that happens with that.

Digital lead Gen model their search marketing is really the main component is when your inventory is so low you actually can't invest in search mechanics, and so this search marketing is significantly down because our inventory position is not available and doesn't allow us to do that we will turn.

Matt back online.

We are tracking the inventory coming in so that will come back on the other dynamic is that the consumer uses the website for information. It's a completely transparent model and you can see right now some of our models are actually out of stock that will be turned back on so those two dynamics will.

Turnaround the moment that the inventory gets back in position.

Great. Thanks, so much guys.

Thanks, Rick.

Thank you and again if you have a question at this time. Please press Star then one.

And our next question comes from the line of Tom <unk> with Hilton Capital. Your line is open. Please go ahead.

Hi, all thanks for the questions.

Just on the to follow up a little bit on gross margin and I had some follow ups, but on the gross margin I am curious in terms of the price. If you calculate it in the second price surcharge, which will become permanent does that sort of fully catch you up or you saw a little bit behind.

Understanding theres a lag.

Yes, Tom So what we've been saying is that the pricing actions, we've taken so up to and including the surcharge will cover what we believe are the are the elements of inflation there'll be sticky. So we think about those as being wages elements of the supply base that won't automatically reset as I mentioned things like steel aluminum corrugated those reset but.

Others don't and then a higher level of logistics cost because while we do think the current let's say ocean freight rates won't stay where they are we don't see them going back to where they were so in our model. We've taken into account. What we believe are those sticky amounts of inflation and thats, how we use.

<unk> set our price increases.

And just out of curiosity, how has the response been I mean, obviously youre still looking at a decent growth in orders, but I'm just curious if youre getting any okay.

Pushback I don't know what the magnitude is on a percentage basis, but.

If that had the impact of demand do you think at all.

We so far we have had levels of price realizations that matched our expectations. So with each subsequent price increase.

<unk> captured the amount reflected capture.

I think this quarter will be something Thats, certainly watch as we've got these pricing actions fully in the market <unk>.

But to date no no significant challenges in Russia.

I would just add Tom that we have a very seasoned selling organization that has long time relationships with our dealer partners. We do a tremendous amount of work to educate our dealer partners.

To support them through this process. So I think it's T. J O. It says our market is very rational in regards to price.

But they are deep conversation to make sure that we are setting up the right partnerships and business in the future.

Our selling organization has done an outstanding job.

Okay, Great and then in a totally different area, you mentioned, the sort of education buying season and I'll admit to.

<unk> of knowledge here, but kind of what's the timing when you're seeing orders.

Going into the summer for delivery in the fall or when would that sort of be and then I was just curious in terms of the.

Types of products they're.

Ordering is there any sort of change relative to what a typical education buying season.

Season might look like.

Sure I'll take the timing and I'll pass the product over to Christy, but for timing that with tenants that would tend to be March April may for delivery and installation in the middle to end of summer prior to the school.

The school start in the fall that would that would kind of apply universally. So if you think about kind of in the spring time for delivery and installation. This summer is generally the pattern that it flows through.

Okay.

Can you talk border near term right in terms of that.

Yes, Okay alright.

Alright, and from a product portfolio perspective, one of the reasons that education is such an important vertical for us is because of our expertise in ancillary is lounge tables seating.

So as educational environments are going into more open environment. If you think about the role of technology and educational format.

The rooms are looking different theyre needing.

They are working with open floor plans now.

Until our product portfolio fits extremely well in the educational environment, and we're seeing that actually take place and we have.

That pipeline, that's designed specifically fill the needs of education, So and that is an area that we've been in for quite some time.

Got you, Okay, and then just one last one and this is probably to my neutral, but just curious on the.

The goodwill write down I mean, given the fact that what seems to be occurring in the market is.

Temporary if you will although it's less temporary than we all thought I'm just curious about what sort of the mechanism and understanding part of the earn out is an offset but since you would think that the nature of the business hasnt necessarily been impaired on a long term basis, just curious what triggered the write down.

Yes, no that's great.

Good question and I think as we said our long term prospects.

End of <unk>.

Excited to the business haven't changed but when you look at sort of the way the rules around this work at the valuation models. They put a heavy emphasis on the near term periods. So when you. When you then look at a compressed period like we had in the prior quarter. Although you might still have this confidence longer term basically the way the valuation work.

It has that impacted it pulls down kind of the analysis as we said though.

Significantly offset by a $22 $5 million decrease in the earn out and so I think when we when we look at the totality of that.

Still very excited about what <unk> is going to do for us.

In that space.

Yes makes sense and I did see the offset in the release thanks very much.

Thanks, Tom.

Thank you and I'm showing no further questions at this time I would like to turn the conference back over to Kristie Juster for any further remarks.

Great. Thank you Michele Firstly I want to thank everybody for joining us Tonight and their engagement in our business at Kimball International.

We have entered this challenging time with an incredible focus on delivering results for.

For the short term with diligence, but also making sure that we are really building this business for the future and I'm incredibly proud of the progress that we've made on our strategic agenda and we will be excited to tell you about our path forward next quarter. So thank you very much and wishing everyone a nice evening.

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

[music].

Good afternoon, ladies and gentlemen, my name is Michelle and I will be your conference call facilitator today at this time I would like to welcome everybody to the Kimball International second quarter fiscal 2022 earnings Conference call.

As with prior conference calls today's call February three 2022 will be recorded and may contain forward looking statements as defined under the private security 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 on 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.

No website on today's call are Kristie Juster, Chief Executive Officer of Kimball International and T. J Wolfe Executive Vice President and Chief Financial Officer, I would now like to turn today's call over to Kristie Juster Ms. Juster you may begin.

We are pleased with the double digit revenue growth, we achieved in the quarter and importantly, we have continued to see momentum in orders and pipeline activity throughout the quarter.

The evolution of the hybrid workplace is on track. Despite some delays in return to offices caused by the omni Kron variant.

The returned to learning is proceeding as expected and capital projects that major health systems remain on the upswing.

These business trends are consistent with our views on how the market's water ball post pandemic and support the choices. We have made over the last two years to position Kimball international for accelerated growth.

[noise] workplace and help orders combined have increased at double digit rates in each of the past three quarters, indicating the strength and consistency of demand in these two markets, which account for 89% of our second quarter net sales.

The magnitude and extent of the prevailing commodity inflation and supply chain issues continue to impact our business in a variety of ways.

That's on the top line as well as margin levels.

Despite these pressures we were able to deliver adjusted gross margin improvement of 40 basis points versus last quarter.

Indicating a substantial pick up in the second half of this fiscal year.

Taking a closer look at our key end markets workplace revenue and orders increased 21% and 42% respectively in the second quarter.

Led by the commercial and education sectors and supported by growth in the finance sector.

These figures include popping, where delays and inventory availability presented a challenge to pop ins in stock business model. This caused a pause in the positive sequential momentum and pop in sales, which we expect to resume in this year's second half as evidenced by Poppins bookings up 106%.

Versus last year's quarter.

As the return to office continues companies are investing and re imagining their spaces to accommodate three consistent themes.

Our hybrid workplace that caters to both physically and digitally present workforces are flexible workspace that allows for configuration based on short term needs and the evolving long term trends.

And then the amenity rich workspace that attracts and retains the best talent and fosters the culture safety productivity and well being of its workforce.

With ancillary products, representing 85% of our portfolio Kimball International is benefiting from these themes.

As our products are well suited to address these demands.

We have also seen a steady increase in demand in the education vertical driven by the return to in person learning and we are very optimistic for the upcoming educational buying season.

Institutions are looking to create flexible environments that support the many ways of learning, while driving connection and collaboration for students and staff.

Research shows that hybrid learning will become the norm technology will play a critical role in ensuring equitable learning opportunities.

And safety of students and teachers will remain a priority.

Our acquisition was grounded in three assumptions our ability to ramp the direct digi.

Digital <unk> model.

Our belief in expansion in secondary markets and our ability to expand the pop in brand and portfolio into the Kimball International dealer channel.

Our progress has been significant in all three areas.

<unk> orders were up 106% our showroom expansion into secondary markets is in full execution with Miami fully operational in both Austin and Atlanta showrooms opening this quarter.

And our new proppant pro dealer cross sell opportunity will represent a new channel that is over 10% of our total mix at popping in year one.

We continue to hold much confidence in our ability to scale and expand this business.

Moving to our health market second quarter revenue increased 6% and orders were up 13%. Despite a slight slowdown due to the COVID-19 variance and diverted focus from noncritical care.

Orders have picked up in the second quarter and we expect demand built further in the coming quarters as focus will return to elective surgeries and preventative care.

Staffing shortages and burnout amongst hospital workers have been well documented and health systems are looking for innovative ways ways to attract and retain staff.

We continue to leverage our research and product development efforts to focus on these issues and our designs for this more market incorporate features that facilitate and support offer amenities and operating many of these in the workplace flexible environments and hybrid approaches to patient care.

Our continued focus on innovation with award winning products such as the Emperor and as re lines is resonating in the market with new product sales, representing 23% of our health market sales in the second quarter.

And we will continue to provide opportunities for us to expand further into the retail health space.

While our hospitality market is awaiting the full scale return of business in international travel the industry continues to be pressured by the effects of the pandemic.

Within this environment, we are proactively shifting our sales mix to higher margin customized products.

In the first half of fiscal 2020 to customize products account for 64% of hospitality market revenues.

Up from 42% in the first half of fiscal 2021.

We will we will be well positioned to benefit from a recovery in this market, which we expect to materialize during fiscal 2023.

Our call to our CFO T J will to provide a financial review that will include our update on operational progress.

Thank you Christy and good afternoon, everyone. We're very pleased to report double digit revenue growth this quarter, especially given the continued economy wide labor and logistic challenges.

Our second quarter net sales were up 11% to $151 4 million compared to the prior year's quarter.

So the labor and supply chain issues that constrained our production shipment capabilities in the first half of this year, our revenue for the quarter would've been approximately $18 million higher than reported.

As Chris already mentioned, despite strong demand trends the ongoing supply chain issues, particularly impacted sales at popping, which experienced the challenge to its in stock business model as a result of inventory availability issues. We expect <unk> revenue growth to resume next quarter. However, because of the impact COVID-19 related labor and logistic issue.

Has that had on top of this near term results. We have recognized a one time $34 1 million noncash goodwill impairment charge associated with the <unk> acquisition.

Charges, partially offset by a corresponding decrease in our earn out liability.

Gross margin adjusted for one time pandemic related expense of $1 6 million was 31, 8% and increased 40 basis points sequentially. Despite the widespread inflation and supply chain pressures.

As we've mentioned to you before we announced the price increase that went into effect on October one and.

<unk> introduced a price surcharge effective as of November 15th that will become a permanent price increase next month.

Approximately one third of our backlog reflects the November surcharge and the remaining two thirds, including include the previously announced price increases, giving us good visibility to improving gross margins, especially starting in the fiscal fourth quarter.

Yes.

Compared to $9 1 million a year ago.

Diving into our end markets net sales of workplace health increased 21% and 6% year over year, respectively.

Order activity in the workplace and market was 42% higher compared to the year ago quarter included the full contribution from pop and whose orders were up 106% year over year and double digit order growth rates in commercial finance and education verticals within workplace health orders were up 13% year over year.

There is this activity in the hospitality market remains at depressed levels, which is reflected in the 23% revenue decline in order activity, 12% below the year ago quarter.

Our second quarter and total backlog was a record $196 9 million compared to $170 8 million in the prior quarter and $144 9 million in the second quarter of fiscal 2021.

We expect $134 million of this backlog to ship out in the third quarter.

From a balance sheet and cash flow perspective, we ended the quarter with $99 6 million and short term liquidity, which includes cash and cash equivalents.

Plus the unused amount of our credit facility, our capital expenditures were $8 million and we returned 4 million of capital to shareowners in the form of dividends and share repurchases.

So despite the near term challenges, we are reaffirming our guidance for fiscal year, 2022, and still expect year over year revenue to increase approximately 15% 20%.

Gross margins in the third quarter should be comparable to the first half and should see a sequential increase in the fourth quarter.

Capital expenditures net of disposals are on track to total approximately $25 million unchanged from prior guidance with spending primarily allocated to the construction of our new warehouse in Jasper and a new automated mineral metal manufacturing capability in our Salem facility.

We continue to anticipate operational excellence projects to yield cost savings of approximately $10 million in fiscal 2022.

These savings will partially fund our ongoing growth investments, namely the opening of new pop in showrooms as Kristie mentioned earlier as well as our marketing and promotional spend and building out of our sales force.

As a result, we project higher overall SG&A spend in fiscal 2022 compared to the prior year.

For our third quarter guidance, we forecast year over year revenue growth of 23% to 25% with gross margins at approximately 31% and SG&A expenses totaling $50 to $52 million.

With that I will turn the call back to Christy for closing remarks.

We are focused on accelerating market share gains and continued investment in growth by opening and scaling our new showrooms investing in new product development and introductions and the expansion of our selling organization.

Responsible for a more sustainable future and making a difference in our communities.

We have confidence in our progress and much conviction as our business continues to ramp and our end markets return.

Now I'd like to turn the call back over to the operator.

Thank you.

Ladies and gentlemen, if you would like to ask a question at this time. Please press star one on your Touchtone telephone. If your question has been answered or you wish to remove yourself from the queue. Please press the pound key.

And our first question comes from the line of Greg Burns with Sidoti <unk> Company. Your line is open. Please go ahead.

Good afternoon.

When you look at the.

Outlook for the gross margin.

What's been the I guess the biggest change is the biggest factor impacting that it looks like you're expecting a little step back in the third quarter, but.

Some improvement into the fourth quarter.

Whereas previously I think the idea was we would see kind of sequential.

Improvement throughout the year so.

And the biggest factor Thats changed there and what gives you confidence that you'll start to see that.

Trend to improve into the fourth quarter.

Yes, sure Greg So I think a few things there I think one certainly in the first half.

<unk> outstripped, our initial estimates and so I think you know the realization of that in the near term and I think the other factor is that the supply chain stress has really delayed our ability to convert backlog into revenue and so as I mentioned.

The record backlog gives us a lot of visibility, but most of our most recent pricing actions are still held up there. So as I mentioned, one third of the backlog has our most recent price.

Two thirds prior to that and so as that starts to convert in the fourth quarter. We will see margin expansion. There I would also note that in Q3, we would have in it.

Slightly adverse mix element, so hospitality would play a bigger mix rolling in Q3 versus Q2, which would offset any of the kind of improvement we would see a workplace and health. So I think those are the broad factors, but in general why do we feel confidence in Q4, I would say is what we see in the backlog with pricing there.

Okay.

Okay, Great and then.

In terms of.

Labor constraints does that is that your biggest.

<unk>.

Bottleneck right now in terms of production or is there other <unk>.

Supply chain issues that are impacting your ability to meet demand.

Sure.

Spans all three areas, we've talked about before labor materials, and logistics and I would say in each case labor, we see an improving landscape. So we've been able to hire.

We've added about 10%.

We're learning how to work in this environment. So how can we expedite materials, how can we trans load to get things to our factories faster. So we're limited to adapt in this constrained logistics environment. So I think.

Labor outlook, improving materials and logistics similar but we're learning to live with the new normal.

Okay.

In regards to pop and how what percent of their.

Business.

Does that kind of that on demand that's been impacted by the inventory <unk>.

Strengths and going forward can you just touch on.

The pop in pro program.

How long has that been live in kind of what's your outlook there for.

For driving growth at <unk>.

Sure. Let me just kind of break out the channels again, Chris you could talk about pro but as a reminder, there's really four channels within pop and we've got our primarily for <unk>. There is also a wholesale channel.

Smaller direct to consumer and then popping pro which I'll, let kristy mentioned slipped by far the <unk> and again. This is on demand and stop short lead time is the vast majority of their business and so as we referenced with the pullback in the previous quarter that was the big driver was that that business wasn't able to deliver because of inventory levels.

Haven't been replenished to where they were prior to the pandemic, but I'll, let Christine talk about pro for a minute sure so tough and so we started at.

The program the concept of the program at the beginning of the acquisition.

And I think we commented in his script that we believe the pro volume will be about 10% of the next by the end of the year, which is obviously the first year that we've been doing it if you think about launching harp intro into the commercial channel as you know it takes a little while to get traditional trade and dealers.

Comfortable selling the <unk> portfolio and Acclimating to the lead times and the value proposition that is a part of that model and we've been very pleased with the progress.

We have we do see lots of opportunity in the future one of the things that we've seen forming is that the pod business.

Is.

A very attractive business that goes into that channel and that is obviously a brand new category for us. So we made good traction we're getting great feedback from our dealers.

A lot of.

Alignment between the Kimball international selling organization and the proper pop and expertise and we really think that is a significant opportunity going forward.

Okay and then just lastly, you did mentioned <unk> orders were up 106%, but how much.

As the backlog up like is this is this on demand kind of order flow lost business or is it something that falls into backlog that you could fill at a later date.

Yes, that's a great question, Greg and I would say for the most part the backlog and pop it does not work like our traditional business. So that's as evidenced by the results in the quarter. So in our in our existing workforce and help business outside of pop if we get an order and there's a long lead time, we put it in the backlog and produce it when we can with pop and they do have a small.

<unk> backlog, but it's things that would be delivered with them will say four to six weeks is very short. So in some cases as you say if you can't deliver on demand. It is a loss sale. They are able to put some projects in the backlog, but most of it would be on demand.

Okay, great. Thank you.

Thank you and our next question comes from the line of Rudy Yang with Bahrenburg. Your line is open. Please go ahead.

Hey, guys. Thanks for taking my questions.

I guess, firstly could you guys just provide although round, how maybe order trends have evolved.

Specifically orders last year.

Earlier last year really coming from secondary markets, where a majority of their workplace and health segments are focused.

So I guess are there any numbers you could kind of put a rod where secondary primary market order growth currently stands.

Maybe talk to how much more potential you think secondary markets have to ramp up in terms of orders.

Sure. Let me, let me start and then I'll hand over to Christie for her but I think a few things when we look at it we look at orders in a few different ways I would say number one the order pattern and we said this last quarter has been <unk>.

Consistent over really the past nine months and this goes through the different variants that have come out to put challenges of the market. The price increases we've taken the supply constraints, we've seen very resilient and consistent demand throughout that period.

When you look at the day to day and project business day to day again as the larger part of our business that is that is two thirds of it I do think in the project space, particularly in health you see some delay as global crop variant put challenges of health systems over the past two months project. That's one element and then as we've talked about.

Secondary markets that is our strength those came out of the pandemic earlier in the calendar year very well metropolitan markets were catching up people say the fall, but then those again were impacted more by the <unk> over the past few months. So I would say metropolitan markets are large and the small markets have pulled back in the short term.

But again not quite the same impact in secondary so that's just a few of the points that I'd highlight.

I would just add that we are seeing.

Full of secondary markets, certainly getting back to work with a significant growth trend.

And then some of them as we have six metropolitan markets that we've followed two of them New York and San Francisco are definitely lagging there is no doubt about it.

But we are spending our time really in those secondary markets, where we can see the growth and then I'll just comment on the ancillary category. We continue to see the ancillary category outpaced everything else.

Significantly and we're very pleased with the progress and the new product development that we have in that area and in Alaska.

The thing that I would say is the health and new product development number is really gaining momentum. So we're excited about the progress that we're making in our health specialty area.

Okay.

Then secondly, how long does it take for the benefits of lower materials costs.

<unk> results.

Was any of that recognized this quarter or is it more kind of the price increase is starting to take effect that played a larger role and kind of mitigating impacts to your margin this past quarter.

Sure So I think on.

The price increases that we've realized from our suppliers have come on quite quickly much faster than they have in the past because inflation is coming through the supply chain quicker and then as we've said it takes us three to six months to pass those on.

In our list prices as far as where you would see improvements in metals, So steel aluminum and then in corrugated perhaps.

Those contracts in general will reprice as the market reprice, so their structure to lower somewhat automatically as market rates decrease.

Okay, that's super helpful.

And then turns on your backlog at $134 million that will be move next quarter I guess, how does that firstly compared to the amount of backlog you have been able to move historically.

And how much of that one third in orders tied to I guess previously in the lower negotiated prices.

Moving to the next quarter.

Sure So I would say the <unk>.

Juruti of the backlog that carries prices prior to the November price increase the majority of that and I would say the 80 20 rule clear this quarter. So both of those orders have been in for some time.

The majority of those will clear this quarter I think when you look historically, how we've turned our backlog I think we are if you look over the last four quarters.

Increased every quarter I think we're getting back now to sort of a normal cycle, where you would expect to return roughly two thirds of the backlog at any given quarter I don't.

Kind of what our historical level would be also it depends on the mix of hospitality as we've talked about because that is a longer.

Project lifecycle more like six months, but I think I think we're beginning to get back into where the.

The backlog should begin to level out and then we can begin to lower it over time as we ramp up production through again hiring and improved supply chain.

Great and then finally, just on Patheon I guess, despite the supply chain disruptions. This quarter you still anticipate sales will kind of pick back up in the second half of the year.

So I guess.

Firstly, what gives you confidence supply chain issues or pop in specifically will improve going forward and secondly, I know you've kind of mentioned earlier that sales are usually last conducted at four to six week period. So do you expect to make up any of those kind of lost sales in this quarter just going forward.

On the first point as far as your what gives us confidence. So we have visibility now to inventory replenishment for part of it is on the water. So again as a reminder.

Thats a source product primarily from Asia. So we have.

Good visibility to what's on the water will be arriving in the port.

Two our warehouse relatively to the customers. So I think that visibility and again those shipping times worse than we had anticipated in the prior core quarter, which is what.

It drove to the lower revenue numbers. So I think we've got better visibility to inventory levels, and therefore stocking going forward and as far as the sales.

I mentioned.

Those sales are in some ways loss sales. If you don't have the inventory on hand, all of those customers will look elsewhere. So I think that doesn't that doesn't mean that we're having less days of our prospects for the back half with those of our sales are necessarily be able to recoup a recover.

And really I'll just add a couple of thoughts just one thing that I would add is one of the one of the dynamics that happens with that.

That back online.

And we are tracking the.

Inventory coming in so that will come back on the other dynamic is that the consumer uses the website for information. It's a completely transparent model and you can see right now some of our models are actually out of stock that will be turned back on so those two dynamics will turnaround the moment that the.

Inventory gets back in position.

Great. Thanks, so much guys.

Thanks, Rick.

Thank you and again if you have a question at this time. Please press Star then one.

And our next question comes from the line of Tom <unk> with Hilton Capital. Your line is open. Please go ahead.

Hi, all thanks for the questions.

On the to follow up a little bit on gross margin and I had some follow ups, but on the gross margin I'm curious in terms of the price if you calculate it in the second price or the surcharge, which will become permanent does that sort of fully catch you up or you saw a little bit behind understanding theres a lag.

Set our price increases.

Okay, and just out of curiosity, how has the response been I mean, obviously youre still looking at a decent growth in orders, but I'm just curious if youre getting pushed.

Pushback I don't know what the magnitude is on a percentage basis, but.

If that had the impact of demand do you think at all.

We so far we have had levels of price realizations that matched our expectations. So with each subsequent price increase.

Again capture the amount reflected capture.

I think this quarter will be something Thats, certainly watch as we've got these pricing actions fully in the market <unk>.

But to date no no significant challenges in Russia and I.

I'd just add Tom that we have a very seasoned selling organization that has long time relationships with our dealer partners. We do a tremendous amount of work to educate our dealer partners.

And support them through this process. So I think it's T. J O. It says our market is very rational in regards to price.

But they are deep conversation to make sure that we are setting up the right partnerships and business in the future and our selling organization has done an outstanding job.

Okay, Great and then totally different Arie you mentioned, the sort of education buying season.

I'll admit to.

Lack of knowledge here, but kind of what's the timing would you be seeing orders.

Going into the summer for delivery in the fall or when would that sort of be and then I was just curious in terms of the.

Types of products they're.

Ordering is there any sort of change relative to what a typical education buying season.

Season might look like.

Sure I'll take the timing and I'll pass the product over to Christy, but for timing that was tenders that would tend to be March April may for delivery and installation in the middle to end of summer prior to the school.

The school start in the fall that would that would kind of apply universally. So if you think about kind of in the spring time for delivery and installation of the summer is generally the pattern that it flows through.

Okay.

Border near term right in terms of that.

Yes, okay. Thanks.

Alright, and from a product portfolio perspective, one of the reasons that education is such an important vertical for us is because of our expertise in ancillary lounge tables seating and so as educational environments are going into more open environment. If you think about the <unk>.

Role of technology in educational format.

The rooms are looking different theyre needing.

They're working with open floor plans now.

Until our product portfolio fits extremely well in the educational environment, and we're seeing that actually take place and we have.

Pipeline, that's designed specifically fill the needs of education, So and that is an area that we've been in for quite some time.

Got you, Okay, and then just one last one and this is probably to my neutral, but just curious on the.

The goodwill write down I mean, given the fact that.

What seems to be occurring in the market is.

Temporary if you will although it's less temporary than we all thought I'm just curious about what's sort of the mechanism and understanding part of the earn out is an offset but since you would think that the nature of the business hasnt necessarily been impaired on a long term basis, just curious what triggered the write down.

Yes, no. That's a great question and I think as we said our long term prospects.

Of.

It has that impacted it pulls down kind of the analysis as we said though.

Difficultly offset by a $22 $5 million decrease in the earn out and so I think when we when we look at the totality of that.

Still very excited level, probably is going to do for us.

In that space.

Yes makes sense and I did see the offset in the release thanks very much.

Thanks, Tom.

Thank you and I'm showing no further questions at this time I would like to turn the conference back over to Kristie Juster for any further remarks.

Great. Thank you Michele will firstly I want to thank everybody for joining us Tonight in their engagement in our business at Kimball International we have entered this challenging time with an incredible focus on delivering results.

For the short term with diligence, but also making sure that we are really building this business for the future and I'm incredibly proud of the progress that we've made on our strategic agenda and we'll be excited to tell you about our path forward next quarter. So thank you very much and wishing everyone a nice evening.

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

Q2 2022 Kimball International Inc Earnings Call

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