Q2 2023 Kimball International Inc Earnings Call
Good afternoon, ladies and gentlemen, my name is Sarah and I will be your conference call facilitator today.
At this time I would like to welcome everyone to the football International second quarter fiscal 2023 earnings Conference call.
As with prior conference call today's call February 2nd 2023 will be recorded and may contain forward looking statements as defined under the private Securities Litigation Reform Act of 1995.
Actual results could differ materially from the forward looking statements.
Risk factors that may influence the outcome of forward looking statements can be seen in the symbol 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 Cymbalta International's website.
On today's call are Kristie, Juster, Chief Executive officer of stable international and teaching false teeth.
Vice President and Chief Financial Officer.
I'd like to turn today's call over to Kristie Juster, That's juster you may begin.
Good afternoon, everyone and thank you for joining today's call I'm pleased to share in the second quarter of fiscal 2023, we drove significant year over year revenue growth in all our end markets workplace health and hospitality and this marks the fourth consecutive quarter.
Strong gross margin expansion, delivering 550 basis points improvement year over year.
We are especially pleased by Kimball International's continued ability to outperform the industry, despite a challenging macroeconomic environment and heightened recessionary risks.
After our last earnings call from early November through mid December we saw a softening of demand in our workplace and health end markets. While we absorb this across many of our geographic regions. The slowdown was more pronounced in the major metropolitan markets, such as New York and San Francisco.
It's also important to note this quarter faced a strong bookings comps from the previous year as we experienced a pull forward from pricing actions taken in December 2022.
Through our conversations with our customers and dealer partners, we can attribute the slowdown in our order conversion to macroeconomic headwinds combined with the continued forming view of the hybrid workplace.
Our upstream activity and sales for health continues to be strong. However for many projects that average time to close a transaction has increased by several weeks and in some cases with our larger health system even by months.
Demand in secondary markets, which makes up 79% of our trailing 12 month sales was down as well, but to a lesser degree.
And we believe this strategic focus has proven to provide resiliency throughout the market downturn and will accelerate our return to demand grows.
Order patterns during the second half of December and into January have seen a material improvement with workplace and health orders in January up approximately 10% year over year.
Turning to our end markets in the second quarter, our largest end market workplace saw sales increased 15% year over year and our view on return to offices highly consistent.
Office matters more than ever in a hybrid format. It is beyond the workspace, but a place to create belonging community in connection.
We believe hybrid is here to stay and it will influence location size and format of offices setting up secondary markets and ancillary categories as the highest growth areas.
This hybrid change will require flexibility and an employee centric environment, turning all of this from a space to a personalized place filled with a wide variety of formats servicing individual word collaboration and community.
With return to office as new record highs.
These are settling in too and becoming more comfortable with defining their own unique hybrid work strategies.
One of the largest manufacturers of ancillary products, which comprised 88% of our trailing 12 months sales our comprehensive product portfolio is structured to benefit from this trend.
Happens Q2 performance has been softer due it due to a heavy reliance on the top five major metro markets for its core b to B business model.
We continue to offset this with focus and delivery around our new incremental growth initiatives.
I've been so revenue continues to comprise more than 50% of overall pop in sales for fourth quarter in a row and our new pod category grew more than 35% sequentially and more than 75% year over year. We are also excited to launch the second generation of our pods this quarter.
<unk>, which provides a full array of functional upgrades, including enhanced privacy mobility durability and accessibility to our new 80, a compliant model.
These new generation two pods are now are now available through both our top and direct selling organization and our Kimball international dealer sales team.
We continue to expand the incremental opportunities, but the pop in brand in categories and the role they play at Kimball International in the diversification of our channels and synergies within our workplace and health business.
Sales to our health end market increased 17% year over year in the second quarter as the adaptability and flexibility of our product portfolio continues to effectively address the needs of health care facilities to maximize efficiency and quality of care.
In December we became a key supplier to health Trust one of the largest group purchasing organizations in the United States States, which serves over 1800 hospitals, we are already seeing significant adoption and traction with this key customer should we anticipate will result in further market share gains.
During Q2, we also made significant progress on our three key initiatives of our perfect Harmony go to market strategy, we activated our new customer excellence operating model designed to deliver industry, leading personalized customer service experiences launched.
Well, it's a multi branded specification ordering capability for a full workplace health portfolio and are going live in a few days with our brand new Kimball International website.
Our newly unified infrastructure delivers a seamless experience for all our brands and shares market insights and trends across our distribution partners and our end users.
These key enablers truly unleash the power of perfect harmony and our unified multi branded go to market strategy.
We're also incredibly proud that in addition to many of our showrooms our corporate headquarters in Jasper, Indiana advanced our well certification to platinum status in December .
With one of our guiding principles being our people our company. It is incredibly important to us Kevin environment that puts the health for health and safety of our employees first and aligns this focus with the products and solutions, we create for our customers.
Turning to hospitality revenue was up 64% year over year and increases in both leisure and business travel pro property improvement and decision making.
We have been very consistent over the previous quarters and our belief in the return to growth in this end market due to pent up demand and continued renewed interest in travel.
We took a measured approach to this rebound by focusing on driving customer mix streamlining our logistics network and partnering with our customers.
Our Q2 bookings increase of 20% year over year shows further proof of this demand ramp and we now anticipate an even stronger performance in the back half of fiscal 2023 and into fiscal 2024, making hospitality a clear differentiator for Kimball International.
With our operational improvements and our focused approach. We believe we will drive further pop profit contribution and margin expansion in the coming quarters, and we'll continue to build on the exciting leadership position of Kimball hospitality.
Over the past four years, we have taken critical actions to improve and optimize our business business in all our end markets in the second quarter, we returned to pre pandemic levels of operational reliability, reinforcing our long standing commitment to quality assurance customer service.
And lead times, our efficient operating model and our omni channel multi brand and go to market strategy combined with our expertise in ancillary products and secondary markets.
Proven our continued ability to adapt quickly to changes in the environment Kimball International is well positioned to continue to grow profitably as we move into the second half of fiscal 2023.
Now I will turn over the call our CFO T. J will for a review of our second quarter financials, and a discussion of our outlook for the remainder of fiscal 2023 P. J.
Thanks, Christy good afternoon, everyone. Our second quarter results reflect solid execution from the Kimball International team strong growth in both the topline and profitability.
Net sales growth of 21% was driven by strong performance in all three end markets as pricing actions taken over the previous year offset inflationary pressures.
It workplace, we saw particular strength in the commercial education and government verticals, leading to 15% overall sales growth.
Sales growth benefited from our previously announced price increases and was partially offset by a volume decline of approximately 8%.
Workplace quarters were down 17% due to volume declines partially offset by price.
Oh, if revenues grew 17% overall with.
Previously announced pricing actions more than offsetting volume declines of 5% while orders were down 31% we.
We attribute this large drop in health order volumes to the fact that health projects are generally more complex and have longer conversion times, and therefore subject to delays more than our workplace business.
The return of property improvement demand drove strong performance in the hospitality market with revenue up 64% and orders up 20% year over year.
As Christie already noted our order trends in all three end market strictly December and into January and make us cautiously optimistic that the patterns observed in Q2 revpar temporary in nature.
We achieved exceptional gross profit expansion of 550 basis points year over year to 36, 2% as a result of our focus on eliminating running hot cost such as overtime and expedited freight.
The optimization of our operational excellence programs combined with further realization of our previously announced price increases.
Throughout the quarter, we've reached pre pandemic levels of performance and operational reliability.
<unk> seen an easing of the supply chain disruptions and associated costs, while experiencing moderate inflation in certain commodities.
Our manufacturing operations are running efficiently and virtually all of our products are back to standard lead times.
Driven by continued operational excellence improvements, we successfully lowered our SG&A spend by 330 basis points and adjusted SG&A by <unk>.
210 basis points.
As Christie mentioned due to lower demand in major metropolitan areas, which are pop into primary markets. We've recognized a one time $36 7 billion non cash goodwill impairment charge associated with the pop in acquisition, bringing the carrying value to zero.
This action does not change our view of long term prospects and simply reflects the current operating environment and near term demand trends.
As a result of this charge, we reported a GAAP net loss of $36 million or 99 cents per diluted share.
Excluding the noncash charge for parking and restructuring expenses, we reported adjusted net income of <unk> 3 million or eight cents per diluted share.
Our ability to execute in the market combined with our industry, leading gross margins our ability to scale SG&A expenses with revenues as well as our operational excellence programs continued to drive strong adjusted EBITDA performance totaling $16 million for the quarter, which was four times higher than last year's comparable quarter.
Adjusted EBITDA margin also expanded significantly to eight 8% compared to two 7% in the year ago quarter.
Our total backlog at quarter end up $144 8 million comprised of roughly two thirds workplace health and one third hospitality is in line with our expectations as we continue to improve our operational reliability and reduce lead times, which are now back to pre pandemic levels.
Turning to the balance sheet and cash flow statement, we ended the second quarter with $14 million in cash and $60 million of debt equating to a net debt to EBITDA ratio of 0.9 times compared to one eight times at the end of fiscal 2022.
Well below our covenant votes.
In the second quarter, we generated $13 million in operating cash flow and <unk>.
To our recently opened warehouse and a better automation for Sony that is slated to go live in April 2023, we're also investing in automated storage and retrieval system to increase efficiency and capacity at our Santa Claus, Indiana facility, which produces the majority of our case goods products. These three projects represent capital investments totaling approximately 17.
Which will drive efficiency enhanced production capabilities and margin improvements in the coming years.
We also returned $5 2 billion of capital to shareowners in the form of dividends and share repurchases.
Working capital needs have flattened and are beginning to ease as a result of our initiatives, which will have a beneficial impact during Q3 and Q4.
Proceeds from an improved cash conversion cycle will be used to reinvest in our business further reduce leverage and return additional cash to shareowners in the form of dividends and share repurchases.
Now looking at our full year 2023 outlook. Despite the current demand environment and considering how order trends through January we are pleased to maintain our adjusted EBITDA guidance of 48 to 52 million, representing approximately 47% year over year growth at the midpoint.
However, due to the uncertain macroeconomic and demand environment, we are lowering our revenue guidance to 720 $740 million, representing approximately 10% growth at the midpoint.
Our industry, leading gross margin improvements along with our ability to scale SG&A with revenue continued clear path to deliver the impressive adjusted EBITDA growth, we guided to at the beginning of the fiscal year.
For Q3, specifically, we expect a sequential decline in revenue as we enter our seasonally slowest quarter.
We also anticipated modest sequential decline in Q3 gross margin as a result of lower.
For closing remarks.
Thank you T J or streamed over the last four quarters and our ability to navigate short term demand dynamics continues to prove the connect to Plano strategy and transformation at Kimball International is well entrenched and activated our focused approach on three connected domestic end markets our expertise.
And secondary and ancillary our growing omnichannel capability and our commitment to operational excellence and optimization all lead to driving industry, leading gross margins and a focused approach to market share gain.
I'm very pleased with our meaningful progress at Kimball International and want to thank all our employees for their commitment and care of what we do every day. Thank you.
You again for joining us today, and now operator, I would like to open the call to questions.
Thank you we will now begin the question and answer questions to ask a question you May Press Star then one on your Touchtone phone.
If youre using a speakerphone please pick up your handset before pressing the keys.
To withdraw from the question queue. Please press Star then two.
At this time, we will pause momentarily to assemble our roster.
Our first question comes from Reuben Garner with Benchmark company. Please go ahead.
Thank you good evening everybody.
Maybe if we could start with the the changes to the guidance I want to make sure I understand that.
So the lower revenue outlook, how much of that is from.
The softness that you already saw in November and December versus an expectation that things will be.
Copier weaker on a go forward basis, because it sounds like for whatever reason that was a fairly short lived.
You know pullback in that things have already kind of recovered I mean does the is the change in the outlook simply explained by what you already experienced.
Hey, Reuben sure I would say that the majority of it. So if you think about as we mentioned.
Remember in early December was what is the slowest period that we saw during the quarter it improved.
Currently in the back half of December and as we noted January orders were up 10% year over year, So I think <unk>.
Primarily what we experienced a little bit of cautious optimism around what Q4 will hold and also thinking about the fact that education buying season as one of the biggest drivers from Q3 into Q4, and our belief that that would potentially be more resilient than maybe the corporate vertical.
And the reason you're able to maintain the EBIT.
EBITDA guidance range is that it is priced calls coming in better than you anticipated or are there other cost savings initiatives or anything else. How are you going to how are you going to manage to get the same spot.
Yes, Jeremy but I think the gross margin delivery in Q2.
It's above our initial expectations and our belief is that as you mentioned youre, making faster progress on price cost faster realization of our operational excellence initiatives driving.
<unk> and then really into Q4 leverage coming back through our facilities as we ramp to the to the higher volume period in Q4. So I think it's a combination of those three but really we were really pleased with the gross margin performance in Q2 and that gave us confidence to hold the EBITDA guidance for the full year and and Ruben I'll, just add a little bit of cash.
All of that as you know we've made a lot of operational changes over the last couple of years facility optimization, etc, and we're just starting to see that flow through.
The gross margin. So we were very pleased with the gross margin that we were able to deliver and feel confident that some of that favorability is on a sustainable basis.
Perfect. That's very helpful and then.
So the health care side was a little bit surprising what exactly do you think went on there did you see the same kind of recovery kind of late in the quarter and in January across all of your units or I guess, what's the pattern in orders the same ore was health care or.
Excuse me hospitality are any different at all than workplace.
Yeah. So let me start with your question on health the health vertical so theres no doubt that we saw a lag in order conversion in the quarter. So it did it did operate a little differently than we anticipated the activity. We are tracking the activity closely and we still feel very comfortable.
Well that that activity is in the funnel right now, but that's some of that activity is delayed.
To remind you that the health vertical was the first vertical to actually achieve prepaid prepaid debit levels for us and so we are seeing some of that slow down at this point in time, but we have no change to our perspective on how important that vertical is to us and I'll just comment on kind of the two things that are new to us.
One is the fed Gov business continues to be a really important part of business for us and we like the progress that we're seeing there as well as we just opened up the new healthtrust GPO and both of those pieces will be critical to our growth in the future.
And you can maybe you want to comment on the hospitality Dan just on the.
Hospitality point Reuben you know if you look back to Q2, we did see some softness in the same period in hospitality that we did in workplace health and trying to think about what drove that during that period was it.
Hiring xiety around recessionary concerns.
The cumulative effect of all of the fed's rate hikes, but that was certainly a period of slower decision, making an investment commitment by our customers, but I think from a more macro standpoint, we mentioned the hospitality is at a different point in its recovery cycle and we can talk more about this but I think we still believe it.
Room rates and occupancy levels, continuing to improve and thereby allowing for more investment.
Hospitality properties.
Okay, great. Thanks for the color guys I appreciate it.
Yeah.
Our next question comes from Greg Burns with Sidoti and company. Please go ahead.
Hi, good afternoon.
I just wanted to start with.
EPS in the quarter could you just bridge me between EBITDA and EPS. It looks like there was like a kind of a strange.
Tax rate going on but it just seemed like the earnings where we're much lower than what.
What the EBITDA would have implied.
Sure Greg So one of the things you know when we think about the impact of the pop and goodwill impairment that we mentioned.
Impairment of the goodwill roughly similar amount in the same quarter of the previous year and one of the issues. You have is that that is not a deductible item for us.
Tax purposes. So you would affect have a negative tax rate when you when you take out the goodwill we would've had.
Positive earnings net income however that is not reflected for tax purposes. So you actually have any tax expense on a book loss and that will when we look at the full year adjusted numbers and you heard my guidance of 25% to 27%. When you look at the full year number and you strip out.
The goodwill impairment, that's how you get back to that effective tax rate, which is more than what we'd seen a normal case also to rubin.
Sorry, Greg if you look back to the prior year when we had the impairment in the prior year, although that was a similar amount that was partially offset by a reduction in the earn out associated with carbon. So there were a couple of different things happening in the prior year versus the current.
Okay. Thanks.
And then in terms of the volume kind of metrics you were talking about before I was trying to keep up but I don't.
I might have missed it but did you mentioned like how much in terms of the orders like.
How much is volume driven and then when we look at the full year guidance for.
10% revenue growth could you just.
Kind of give a mix of what the assumption is there for volume versus price.
Yes, we didn't.
The sales numbers that we disaggregated the sales.
And price so the volume decline in workplace sales was 8% health was five we didn't do that for orders workplace orders were down 17% health down 31, and there was a obviously a benefit from price and those numbers I think when you look at the when you look at the remainder of the year you know as we mentioned.
We have put all the pricing actions that we believe we need to keep up with inflation those are already in the market. So the benefit of price will.
Mathematically fade over the back half of the year. So what we have thought about is that you get to a place where.
Your volume will look or flat year over year in the second half and one of the things to think about Greg is the comps we're addressing right. If you if you think about.
This quarter now the Q3 versus the prior year you know we were.
Very much in the depths of the Omicron variant wave at this time last year and so when you think about the comps in the second half they are different.
From a volume perspective, a little bit easier in the second half of our fiscal year than in the first half.
So we're taking all that into account, but certainly still.
Still price driven but that will begin to fade over the second half volume unit levels will stabilize.
Okay. Thanks, and then in terms of pop and how.
How much is that.
Below.
So like the revenue when you bought it because it had half the revenues or it sounds like more than half the revenue is coming from.
New initiatives since since you bought it so how how much is that core business is still down.
Yes, I think if you look at the core <unk> business.
I would say you know it's down Directionally, what you would see the entire kind of industry on a unit volume with a major metro markets down. So you can say something in the magnitude of 25%, which is which is what those major metro markets are down but to your point the pods, which is new but that is a pop ing direct sale as well.
Through pop in pro the growth there in the secondary market. So I think certainly popping is feeling the effect that the major Metros, New York, San Francisco, but I think our belief is that that does have a path back to growth. It's just a longer term.
<unk> play and I think it also speaks to our desire to diversify poppins footprint into more secondary markets into the pop in pro channel through additional product expansion.
And Greg I would just add the top end performance and metropolitan markets, It's more reliant on the metropolitan markets, but it's no different than what the overall market is seeing.
I guess can you bifurcate poppins revenue maybe that.
The core legacy <unk> versus the new initiatives like how much growth are you seeing.
From maybe the new areas versus.
Guess, what might be considered legacy pop in revenue in.
Is that equaling like flat or is it still down even with the new growth initiatives.
Yes, I don't I don't have a split of that at hand, Greg I'll have to get back to you offline, but I think I think we're certainly what were trying to appreciate is in the near term.
With if you think about return to office if it is kind of at some level of more stagnation in the major metros, where we believe there's room to grow from there, but I think that has pushed our investment towards these other areas, which is again secondary pro in pods. So I don't have the bifurcated numbers by kind of.
Product category or channel right now, but we can I can take.
Take a look at that.
As we start to grow happened going forward one of the things that you'll see is for.
I'm, a channel agnostic as to where the order goes to so when you think about the end user they're the ones, who will make the decision as to whether they want to buy it through the dealer, which the chaos selling organization or the pop ing direct model and so we are we're doing all of that channel work right now.
But you know that brand and that opportunity will start to become fully integrated throughout Kimball international.
Okay, great. Thank you.
Thanks, Greg.
Again, if you'd like to ask a question. Please press Star then one at this time.
Our next question comes from Rex Henderson with Auto Power Research. Please go ahead.
Okay.
Right.
Good afternoon, and thanks for taking my call.
Chris.
Question first of all congratulations on the really strong gross margin performance.
You gave some some components of that gross margin improvement.
So we can kind of understand where that goes in the future can you kind of breakout how much of those gross margin improvement came from each one of the three components. How do you give us some color on how you how you achieve that where that's going.
Accurate.
Sure I think if I was to put in and we can talk a little bit about.
The specifics, but it sort of order of magnitude I think it was certainly price realization would be first on the list.
And then I think after you looked at price I think number two would be.
Operational excellence savings and then I think the third bucket would be comprised of really all other bead.
Whether it's leverage.
Product mix, and just kind of overall moderations in things like inflation.
Inflation for example, LIFO.
And actual income item in this quarter versus expense in the prior year, So I would say.
Price certainly leading the way operational excellence and then a combination of all others below though below there and so I think when you think about the sustainability of that we would say that absent a change in the trajectory of inflation. We have closed the price cost gap that we had desired to.
And so now we would see incremental price realization in the back half, but no immediate pricing actions necessary to close the gap further.
Okay, and then looking forward you can expect.
The improvement due to pricing to kind of fade over the next couple of.
Couple of quarters, but the the operational excellent is there more is there more.
More juice and operational excellence to help there.
Yes. There is an example would be we mentioned these capital investments are metal automation and investment in our Seattle facility, almost approximately $6 million to $7 million that isn't even commissioned until April . So we still have two months before that the commission and the automated storage retrieval system.
Santa Claus facility that will be commissioned in the.
Following fiscal year. So we feel that we still have a lot of benefits that can come from operational excellence.
From things like these capital investments, but also a lot of it is just some classic lean manufacturing and.
Kind of more six sigma ways of working.
Okay.
The second topic I wanted to address was the tax rate, which was <unk>.
Very high even even the adjusted tax rate was extremely high excuse my naivete, a little bit about tax accounting.
But can you give me some some a little bit of breakout of why that number was so high given the you know.
I understand that the write off is not tax deductible, but still a $7 million tax expense seemed really high.
Yeah, no absolutely right. So maybe this can be an offline topic as well, but as.
As you mentioned you know our DAC tax rate was a tax expense on a loss, which would be a negative tax rate.
But as you mentioned, even the non-GAAP tax rate after adjustments was higher than the effective rate that I indicated for the full year and a lot of that has to do with the accounting treatment, whether these things like the goodwill impairment are treated as a discrete or non discrete items. So what happens is the impact of the taxes factory that gets <unk>.
In a quarter or spread out over the remainder of the year and what Youll see is that the taxing the tax impact of that is going to be spread.
Over the following six months and so it will normalize into roughly the full year non-GAAP rate that I indicated of 25% to 27%, but happy to talk more offline about that.
That's where I was going to you know how do you get from from that Big tax number two a 25% tax rate over the course of the year.
That helps.
And then we'll talk about that a little more later finally.
I'm very you know from a from the perspective of holders.
Holders of the of the equity.
Your continued return of capital.
It is important and I congratulate John .
You need to do buybacks and dividend in a difficult environment over the last couple of years.
You give me some color on where you think thats going over the remainder of this year and into next.
Sure Brooks.
We've talked before I think that's very important to our.
Our management team as it is an effective and diverse allocation of capital. So we've certainly show that we want to invest back in our business with $25 million in Capex. This year as you mentioned, we've maintained our dividend throughout the entirety of the pandemic.
And now we know we've been able to decrease our leverage to what is that.
It's a much more sustainable level at 0.9 times trailing 12 months.
So if you think about places we're going to allocate the future I think it's certainly continued investment in our business. I think you know I was thinking about the share repurchase, but also M&A and as we look at where our leverages they'll toward launch where we'd like it to be looking at opportunities in the market for us to to.
Continue to expand our capabilities. So I think what we would but we would talk about it as a balanced and consistent allocation of capital generate the best return.
Okay, well alright, thank you very much for taking my call and.
Hope to talk to you a little bit later, thank you again thank.
Thank you.
Yeah.
Yeah.
This concludes our question and answer session I would now like to turn the conference back over to Kristy Juster for any closing remarks.
Thank you Sara well. Thank you everyone for joining our call. This evening have a wonderful evening and we very much look forward to sharing our progress in the future. Thank you.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.