Kimball International, Inc.

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 Symbol International Second Quarter Fiscal 2023 Earnings Conference Call. As with prior conference calls, today's call, February 2, 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 Symbol International's website. On today's call are Christy Juster, Chief Executive Officer of Bimble International, and T.J. Wolf, Chief Vice President and Chief Financial Officer. I would now like to turn today's call over to Christy Jester. Ms. Jester, 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 of 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 risk. 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 observed this across many of our geographic regions, the slowdown was more pronounced in major metropolitan markets such as New York and San Francisco. It is also important to note This quarter faced a strong bookings comp 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 a continued forming view of the hybrid workplace. Our upstream activity and sales funnel 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 systems, 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, outperforming primary markets by more than 10 points. And we believe this strategic focus has proven to provide resiliency throughout the market downturn and will accelerate our return to demand growth. 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 increase 15% year over year, and our view on return to office is highly consistent. The office matters more than ever in a hybrid format. It is beyond a workspace, but a place to create belonging, community, and 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 the office from a space to a personalized place filled with a wide variety of formats servicing individual work, collaboration, and community. With return to office at new record highs, companies are settling into and becoming more comfortable with defining their own unique hybrid work strategies. As one of the largest manufacturers of ancillary products, which comprise 88% of our trailing 12-month sales, our comprehensive product portfolio is structured to benefit from this trend. Toppin's Q2 performance has been softer due to a heavy reliance on the top five major metro markets for its core B2B business model. We continue to offset this with focus and delivery around our new incremental growth initiatives. Top and pro revenue continued to comprise more than 50% of overall top and 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, which provides a full array of functional upgrades, including enhanced privacy, mobility, durability, and accessibility through our new ADA-compliant model. These new Generation 2 pods 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 with a pop in brand and 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 healthcare 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, which serves over 1,800 hospitals. We are already seeing significant adoption and traction with this key customer, which 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 a multi-branded specification and ordering capability for our full workplace and health portfolio, and are going live in a few days with our brand new Kimball International website. Our new 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 are also incredibly proud that in addition to many of our showrooms, our corporate headquarters in Jasper, Indiana, advanced our wealth certification to platinum status in December. With one of our guiding principles being our people are our company, it is incredibly important to us to have an environment that puts the 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, as increases in both leisure and business travel drove property improvement and decision making. We have been very consistent over the previous quarters in 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 profit contribution and margin expansion in the coming quarters and will continue to build on the exciting leadership position of Kimbell Hospitality. Over the past four years, we have taken critical actions to improve and optimize our business in all our end markets. In the second quarter, we returned to pre-pandemic levels of operational reliability, reinforcing our longstanding commitment to quality assurance, customer service, and lead times. Our efficient operating model and our omni-channel multi-branded go-to-market strategy, combined with our expertise in ancillary products and secondary markets, has 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 to our CFO, TJ Wolf, for a view of our second quarter financials and a discussion of our outlook for the remainder of fiscal 2023. TJ? Thanks, Christy.

Good afternoon, everyone. Our second quarter results reflect solid execution from the Kimball International team with strong growth in both the top line 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. In workplace, we saw particular strength in the commercial, education, and government verticals, leading to 15% overall sales growth. The sales growth benefited from our previously announced price increases and was partially offset by a volume decline of approximately 8%. Workplace orders were down 17% due to volume declines partially offset by price. Health revenues grew 17% overall with previously announced pricing actions more than offsetting volume declines of 5%, while health orders were down 31%. 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 are subject to delays more than our workplace business. The return of property improvement demand drove strong performance in the hospitality end market with revenue up 64% and orders up 20% year over year. As Christy already noted, our order trends in all three end markets during late December and into January make us cautiously optimistic that the patterns observed in Q2 were of a temporary 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 costs, such as overtime and expedited freight, facility optimization, and other operational excellence programs, combined with further realization of our previously announced price increases. Throughout the quarter, we reached pre-pandemic levels of performance and operational reliability. We are seeing 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 210 basis points. As Christy mentioned, due to lower demand in major metropolitan areas, which are Poppin's primary markets, we have recognized a one-time $36.7 million non-cash goodwill impairment charge associated with the Poppin acquisition, bringing the carrying value to zero. This action does not change our view of Poppin's 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 $0.99 per dilute share. Excluding the non-cash charge for popping and restructuring expenses, we reported adjusted net income of $3 million, or $0.08 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, continue to drive strong adjusted EBITDA performance, totaling $16 million for the quarter, which is four times higher than last year's comparable quarter. Adjusted EBITDA margin also expanded significantly to 8.8% compared to 2.7% in the year-ago quarter. Our total backlog at quarter end of $144.8 million, comprised of roughly two-thirds workplace and 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 in debt, equating to a net debt to EBITDA ratio of 0.9 times compared to 1.8 times at the end of fiscal 2022 and remained well below our covenant levels. In the second quarter, we generated $13 million in operating cash flow. In addition to our recently opened warehouse and our metal automation facility that is slated to go live in April 2023, 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 million, which will drive efficiency, enhance production capabilities, and margin improvements in the coming years. We also return $5.2 million of capital to shareholders in the form of dividends and share purchases. 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 shareholders in the form of dividends and share or purchases. Now looking at our full year 2023 outlook, despite the current demand environment and considering our 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 to $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, give us a continued clear path to deliver the impressive adjusted EBITDA growth we guided you 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 operating leverage in workplaces health combined with an adverse impact from end market mix. We do, however, expect a strong recovery of our revenue and adjusted EBITDA contributions in the fourth quarter. We are planning for full-year capital expenditures of approximately $25 million and expect our full-year effective tax rate to be in a range of 25% to 27%. With that, I will now turn the call back to Christy for her closing remarks.

Thank you, TJ. Our strength over the last four quarters and our ability to navigate short-term demand dynamics continues to prove the Connect 2.0 strategy and transformation at Kimball International is well entrenched and activated. Our focused approach on three connected domestic end markets, our expertise in secondary and ancillary, our growing omni-channel 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 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 session. To ask a question, you may press star, then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the question queue, please press star, then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Ruben Garner with Benchmark Company. Please go ahead.

Thank you. Good evening, everybody. Maybe if we could start with the changes to the guidance, I want to make sure I understand it correctly. 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 choppier or weaker on a go-forward basis? Because it sounds like, for whatever reason, that was a fairly short-lived pullback and that things have already kind of recovered. I mean, is the change in the outlook simply explained by what you already experienced?

Hey, Ruben. Sure. I would say that the majority of it's so. If you think about it, as we mentioned, you know, November and early December was the slowest period that we saw during the quarter. It improved significantly in the back half of December. And as we noted, January orders were up 10% year over year. So I think 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 is 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 EBITDA guidance range is that is price-cost coming in better than you anticipated? Are there other cost-savings initiatives or anything else? How are you going to manage to get to the same spot?

Yeah, Ruben, I think the gross margin delivery in Q2 was above our initial expectations, and our belief is that, as you mentioned, making faster progress on price cost, faster realization of our operational excellence initiatives, driving synergies, and then really into Q4, leverage coming back to 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 we were really pleased with the gross margin performance in Q2, and that gave us confidence to hold the EBITDA guidance for the fourth year.

And Ruben, I'll just add a little bit of color that, as you know, we've made a lot of operational changes over the last couple 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 healthcare 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 was the pattern in orders the same, or was healthcare or work, excuse me, hospitality any different at all than workplace?

Yes, let me start with your question on the health vertical. So there's no doubt that we saw a lag in order conversion in the quarter. So it did operate a little differently than we anticipated. The activity, we are tracking the activity closely, and we still feel very comfortable that that activity is in the funnel right now, but that some of that activity is delayed. Just to remind you, the health vertical was the first vertical to actually achieve pre-pandemic 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 FedGov 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 health trust GPO. And both of those pieces will be critical to our growth in the future. Do you maybe want to comment on the hospitality?

On your hospitality point, Ruben, you know, if you look back to Q2, we did see some softness in the same period of hospitality that we did in workplace and health. And, you know, trying to think about what drove that during that period, you know, was it, you know, higher anxiety around recessionary concerns and, you know, the cumulative effect of all the Fed's rate hikes. But that was certainly a period of slower decision-making and investment commitment by our customers. But I think, you know, from a more macro standpoint, we mentioned that hospitality is at a different point in its recovery cycle. And we can talk more about this, but I think we still believe in, you know, room rates and occupancy levels continuing to improve and thereby allowing for more investment in these hospitality properties.

Okay, great. Thanks for the call, guys. Appreciate it.

Our next question comes from Greg Burns with Sidoti & Company. Please go ahead.

Hi, good afternoon. I just wanted to start with the EPS in the quarter. Could you just bridge me between EBITDA and EPS? It looks like there was kind of a strange tax rate going on, but it just seemed like the earnings were much lower than what the EBITDA would have implied.

Sure, Greg. So one of the things, you know, when we think about the impact of the pop-in goodwill impairment that we mentioned, we had an 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 for tax purposes. So you, in effect, have a negative tax rate. When you take out the goodwill, we would have had positive earnings in that income. However, that's not reflected for tax purposes. So you actually have a 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 what we'd see in a normal case. Also too, Ruben, if you, 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 Poppin. So there were a couple 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 mention 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?

Yeah, we didn't. On the sales numbers, we disaggregated the sales volume and price. So the volume decline in workplace sales was 8%, health was 5%. We didn't do that for orders. Workplace orders were down 17%, health down 31%. And there was obviously a benefit from price in those numbers. I think when you look at the remainder of the year, 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 more flat year over year into the second half. And one of the things to think about, Greg, is the comps we're addressing, right? 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 price driven, but that will begin to fade over the second half and volume unit levels will stabilize.

Okay, thanks. And then in terms of poppin', How much is that business below the revenue when you bought it? Because it sounds like more than half the revenue is coming from new initiatives since you bought it. So how much is that core business still down?

Yeah, I think if you look at the core B2B business, I would say it's down directionally what you would see the entire kind of industry on a unit volume or the major metro markets down. So you could say something in the magnitude of 25%, which is what those major metro markets are down. But to your point, the pods, which is new, but that is a Poppin direct sale as well, you know, through Poppin Pro, the growth there in the secondary market. So I think certainly Poppin is feeling the effect of 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 trend. play. And I think it also speaks to our desire to diversify Poppin's footprint, you know, into more secondary markets, into the Poppin Pro channel and through additional product expansion.

And Greg, I would just add the Poppin performance in metropolitan markets, it's more reliant on the metropolitan markets, but it's no different than what the overall market is seeing.

Got it. Yeah. Okay. So when you I guess, can you bifurcate Poppin's revenue, maybe that core legacy B2B versus the new initiatives? Like, how much growth are you seeing from maybe the new areas versus, I guess, what might be considered legacy Poppin revenue? And is that equaling like flat or is it still down even with the new growth initiatives?

Yeah, I don't have a split of that at hand, Greg. I have to get back to you offline. But I think we're certainly, what we're trying to appreciate is in the near term, you know, if you think about return to office, if it is kind of at some level of more stagnation, the major metros where, you know, we believe there's room to grow from there. But I think that has pushed our investment toward these other areas, which is, again, secondary, pro, and pod. So I don't have the bifurcated numbers by kind of, product category or channel right now, but I can take a look at that.

Okay. And, Greg, as we start to grow Poppin' going forward, one of the things that you'll see is we're kind of 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 is the KI selling organization, for the PopinDirect model. And so we are doing all that channel work right now, but that brand and that opportunity will start to become fully integrated throughout Kimball International.

Okay, great. Thank you.

That's great.

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 Water Power Research. Please go ahead.

Good afternoon and thanks for taking my call. I had a couple of questions. First of all, congratulations on the really strong gross margin performance. You gave some components of that gross margin improvement. So we can kind of understand where that goes in the future. Can you kind of break out how much of those that gross margin improvement came from each one of the three components? Can you kind of give us some color on how you achieve that and where that's going in the future?

Sure, Rex. I think if I was to put in, and we can talk a little bit about, you know, kind of the specifics, but in sort of order of magnitude, I think it was certainly price realization would be first on the list. And then I think after you look down at price, I think number two would be operational performance excellent savings. And then I think the third bucket would be comprised of really all other being whether it's leverage, product, BU mix, and just kind of overall moderations and things like inflation, for example, LIFO being an actual income item in this quarter versus an expense in the prior year. So I would say price certainly leading the way, operational excellence, and then a combination of all others 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. Then looking forward, we can expect the improvement due to pricing to kind of fade over the next couple of years. couple of quarters, but the operational excellence, is there more juice in operational excellence to help there?

Yeah, Rex, there is. And the example would be, you know, when we mentioned these capital investments, you know, our metal automation investment in our Salem facility, you know, approximately six to seven million, that isn't even commissioned until April. So we still have two months before that's commissioned. And the automated storage and retrieval system in our Santa Claus facility, that will be commissioned in the following fiscal year. So we feel that we still have a lot of benefit that can come from operational excellence from things like these capital investments, but also a lot of it's just some classic lean manufacturing and, you know, kind of more Six Sigma ways of working.

Okay. Okay. The second topic I wanted to address was the tax rate, which was very high. Even the adjusted tax rate was extremely high. Excuse my naivete a little bit about tax accounting, but can you give me a little bit of breakout of why that number was so high? I understand that the write-off is not tax deductible, but still a $7 million tax expense seemed really high.

Yeah, no, absolutely, Rex. So maybe this can be an offline topic as well, but as you mentioned, you know, our gap tax rate was a tax expense on a loss, which would be a negative tax rate. But as you mentioned, even the non-gap 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 nondiscrete item. So what happens is the impact of that tax effect either gets captured in a quarter or spread out over the remainder of the year. And what you'll see is that 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 our treatment.

That's where I was going. How do you get from that big tax number to a 25% tax rate over the course of the year? And that helps. And then we'll talk about that a little more later. Finally, I'm very, from the perspective of holders of the equity, your continued return to capital is important. And I congratulate you on continuing to do buybacks and dividends in a difficult environment over the last couple of years. Can you give me some color on where you think that's going over the remainder of this year and into next?

Sure, Rex. And, you know, we've talked before. I think that's very important to our management team is an effective and diverse allocation of capital. So we've certainly shown that we want to invest back in our business with $25 million in CapEx this year. As you mentioned, you know, we've maintained our dividend throughout the entirety of the pandemic. And now, you know, we've been able to decrease our leverage to what is a much more sustainable level at 0.9 times trailing 12 months at the DVDF. So if you think about places we're going to allocate in the future, I think it's certainly continued investment in our business. I think, you know, thinking about the share of purchase, but also M&A. And as we look at, you know, where our leverage is now, where we'd like it to be, looking at opportunities in the market for us to, you know, continue to expand our capabilities. So I think what we would talk about is a balanced and consistent portfolio. allocation of capital to generate the best return.

Okay. Well, all right. Thank you very much for taking my call, and hope to talk to you a little bit later. Thank you again. Thank you, Alex.

This concludes our question and answer session. I would now like to turn the conference back over to Christy Jester for any closing remarks.

Thank you, Sarah. 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.