Registrant’s telephone number, including area code
Not Applicable
Former name, former address and former fiscal year, if changed since last report
Securities registered pursuant to Section 12(b) of the Act:
Title
of each Class
Trading Symbol(s)
Name of each exchange on which registered
Class B Common Stock, par value $0.05 per share
KBAL
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes
x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer x
Non-accelerated filer o Smaller
reporting company o
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Adjustments
to reconcile net income to net cash provided by operating activities:
Depreciation
3,610
3,632
Amortization
521
475
Loss
(Gain) on sales of assets
41
(1,128
)
Restructuring and asset impairment charges
2,675
—
Deferred income tax and other deferred charges
(639
)
(1,456
)
Stock-based
compensation
1,661
1,945
Other, net
2,295
(867
)
Change in operating assets and liabilities:
Receivables
2,521
2,414
Inventories
(458
)
(2,616
)
Prepaid
expenses and other current assets
1,712
4,341
Accounts payable
(192
)
(556
)
Customer deposits
(631
)
4,283
Accrued
expenses
(13,444
)
(14,222
)
Net cash provided by operating activities
11,056
7,121
Cash Flows From Investing Activities:
Capital
expenditures
(6,873
)
(4,531
)
Proceeds from sales of assets
101
1,196
Purchases of capitalized software
(481
)
(193
)
Purchases
of available-for-sale securities
(5,971
)
(16,842
)
Maturities of available-for-sale securities
12,667
9,963
Other, net
47
26
Net
cash used for investing activities
(510
)
(10,381
)
Cash Flows From Financing Activities:
Change in long-term debt
(25
)
(23
)
Dividends
paid to shareholders
(2,939
)
(2,595
)
Repurchases of Common Stock
—
(3,300
)
Repurchase of employee shares for tax withholding
(842
)
(840
)
Net
cash used for financing activities
(3,806
)
(6,758
)
Net Increase (Decrease) in Cash, Cash Equivalents, and Restricted Cash (1)
6,740
(10,018
)
Cash,
Cash Equivalents, and Restricted Cash at Beginning of Period (1)
73,837
53,321
Cash, Cash Equivalents, and Restricted Cash at End of Period (1)
$
80,577
$
43,303
Supplemental
Disclosure of Cash Flow Information
Cash paid during the period for:
Income taxes
$
34
$
24
Interest
expense
$
15
$
40
(1) The following table reconciles cash and cash equivalents in the balance sheets to cash, cash equivalents, and restricted cash per the statements of cash flows. The restricted cash included in other assets on the balance sheet represents amounts pledged as collateral for a long-term financing arrangement as contractually required by a lender. The restriction will lapse when
the related long-term debt is paid off. Restricted cash also included customer deposits held due to a foreign entity being classified as a restricted entity by a government agency subsequent to our receipt of the deposit.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements of Kimball International, Inc. (the “Company,”“Kimball International,”“we,”“us,” or “our”) have been prepared in accordance with the instructions to Form 10-Q. As such, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted, although we believe that the disclosures are adequate to make the information presented not misleading. Intercompany transactions and balances have been eliminated. Management believes the financial statements include all adjustments (consisting only of normal recurring adjustments) considered necessary to present fairly the financial statements for the interim periods. The results of operations for the interim periods shown in this report are not necessarily indicative of results for any future interim period or for the entire fiscal year. It is suggested that these financial statements be read in conjunction with
the financial statements and the notes thereto included in our latest annual report on Form 10-K.
Note 2. Recent Accounting Pronouncements and Supplemental Information
Recently Adopted Accounting Pronouncements:
In March 2017, the Financial Accounting Standards Board (“FASB)” issued guidance that will shorten the amortization period for certain callable debt securities held at a premium to the earliest call date. This guidance does not require an accounting change for securities held at a discount. The guidance was effective for our first quarter of fiscal year 2020. The adoption did not have a material effect on our condensed consolidated financial statements.
In February 2016, the FASB issued guidance that revises
the accounting for leases. The guidance is intended to improve financial reporting of leasing transactions by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet. Leases will continue to be classified as either operating or finance leases, with the classification affecting the pattern of expense recognition in the statement of income. The guidance also requires additional disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. In January 2018, the FASB issued additional guidance for land easements which permits entities to forgo the evaluation of existing land easement arrangements to determine if they contain a lease. New land easement arrangements, or modifications to existing arrangements, after the adoption of the lease standard will be evaluated to determine if they meet the definition of a lease. In July 2018, the
FASB amended the new standard to clarify certain aspects of the guidance, and they also issued another new standard in July 2018 that allows the option to apply the transition provisions at the adoption date instead of at the earliest comparative period in the condensed consolidated financial statements. In March 2019, the FASB issued clarifying guidance regarding interim transition disclosures. We adopted this lease guidance as of the beginning of our fiscal year 2020. We have assessed our portfolio of leases and compiled a central repository of leases, recording a right-of-use asset and a lease liability for all leases with a lease term of greater than twelve months. All changes required by the new standard, including accounting policies, controls, and disclosures, have been identified and implemented. See Note 6 - Leases in the
Notes to Condensed Consolidated Financial Statements for additional information.
Recently Issued Accounting Pronouncements Not Yet Adopted:
In August 2018, the FASB issued guidance on a customer’s accounting for implementation, set-up, and other upfront costs incurred in a cloud computing arrangement that is hosted by the vendor. Under the new guidance, customers will apply the same criteria for capitalizing implementation costs as they would for an arrangement that has a software license. The guidance is effective for our first quarter of fiscal year 2021 with early adoption permitted. Entities can choose to adopt the guidance prospectively to eligible costs incurred on or after the date this guidance is first applied or retrospectively. We have not yet determined the effect of this guidance on our condensed consolidated financial statements.
In
August 2018, the FASB issued guidance which changes the fair value measurement disclosure requirements. The guidance modifies and removes certain disclosures related to the fair value hierarchy, and adds new disclosure requirements such as disclosing the changes in unrealized gains and losses included in other comprehensive income for recurring Level 3 fair value measurements and disclosing the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The guidance is effective for our first quarter of fiscal year 2021 with early adoption permitted and should
8
be applied retrospectively except for certain disclosures. We have not yet determined the effect of this guidance on our condensed consolidated financial
statements.
In June 2016, the FASB issued guidance on the measurement of credit losses on financial instruments. Under the guidance, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. The guidance is also intended to reduce the complexity by decreasing the number of credit impairment models that entities use to account for debt instruments. In May 2019, the FASB amended the new standard to allow entities to elect the fair value option on certain financial instruments that were previously recorded at amortized cost. The guidance is effective for our first quarter of fiscal year 2021 with early adoption in our fiscal year 2020 permitted. We have not yet determined the effect of this guidance on our condensed consolidated financial statements.
Goodwill and Other Intangible Assets:
Goodwill
represents the difference between the purchase price and the related underlying tangible and intangible net asset fair values resulting from business acquisitions. Goodwill is assigned to and the fair value is tested at the reporting unit level. Annually, or if conditions indicate an earlier review is necessary, we may assess qualitative factors to determine if it is more likely than not that the fair value is less than its carrying amount. We also have the option to bypass the qualitative assessment and proceed directly to performing the quantitative goodwill impairment test which compares the carrying value of the reporting unit to the reporting unit’s fair value to identify impairment. Under the quantitative assessment, if the fair value of the reporting unit is less than the carrying value, goodwill is written down to its fair value. The fair value is established primarily using a discounted cash flow analysis and secondarily a market approach utilizing current industry
information. The calculation of the fair value of the reporting unit considers current market conditions existing at the assessment date. As of September 30, 2019 and June 30, 2019 our goodwill totaled $11.2 million. During the quarter ended September 30, 2019, no goodwill impairment was recognized.
Other Intangible Assets reported on the Condensed Consolidated Balance Sheets consist of capitalized software, product rights, customer relationships, trade names, and non-compete agreements. Intangible assets are reviewed for impairment when events or circumstances indicate that
the carrying value may not be recoverable over the remaining lives of the assets. A summary of intangible assets subject to amortization is as follows:
Amortization
expense related to intangible assets was, in thousands, $521 during the quarter ended September 30, 2019, and $475 during the quarter ended September 30, 2018. Amortization expense in future periods is expected to be, in thousands, $1,560 for the remainder of fiscal year 2020, and $1,923, $1,583, $1,340, and $1,168 in the four years ending June 30, 2024, and $4,495 thereafter.
The estimated useful life of capitalized software ranges from 3 to 10 years. The amortization period for customer relationship intangible assets is 20 years. The estimated useful life of trade names is 10 years. The estimated useful life of non-compete agreements is 5 years.
Capitalized software is stated at cost less accumulated amortization and is amortized using the straight-line method. During the software application development stage, capitalized costs include external consulting costs, cost of software licenses, and internal payroll and payroll-related costs for employees who are directly associated with a software project. Upgrades and enhancements are capitalized if they result in added functionality
which enable the software to perform tasks it was previously incapable of performing. Software maintenance, training, data conversion, and business process re-engineering costs are expensed in the period in which they are incurred.
Trade names and non-compete agreements are amortized on a straight-line basis over their estimated useful lives. Capitalized customer relationships are amortized based on estimated attrition rates of customers. We have no intangible assets with indefinite useful lives which are not subject to amortization.
9
Notes Receivable and Trade Accounts Receivable:
Notes receivable and trade accounts receivable
are recorded per the terms of the agreement or sale, and accrued interest is recognized when earned. We determine on a case-by-case basis the cessation of accruing interest, the resumption of accruing interest, the method of recording payments received on nonaccrual receivables, and the delinquency status for our limited number of notes receivable.
Our policy for estimating the allowance for credit losses on trade accounts receivable and notes receivable includes analysis of such items as aging, credit worthiness, payment history, and historical bad debt experience. Management uses these specific analyses in conjunction with an evaluation of the general economic and market conditions to determine the final allowance for credit losses on the trade accounts receivable and notes receivable. Trade accounts receivable and notes receivable are written off after exhaustive collection efforts occur and the receivable is deemed uncollectible.
Our limited amount of notes receivable allows management to monitor the risks, credit quality indicators, collectability, and probability of impairment on an individual basis. Adjustments to the allowance for credit losses are recorded in selling and administrative expenses. Customary terms require payment within 30 days, with terms beyond 30 days being considered extended.
Non-operating Income (Expense), net:
The non-operating income (expense), net line item includes the impact of such items as fair value adjustments on Supplemental Employee Retirement Plan (“SERP”) investments, amortization of actuarial income, bank charges, and other miscellaneous non-operating income and expense items that are not directly related to operations. The gain or loss on SERP
investments is offset by a change in the SERP liability that is recognized in selling and administrative expenses.
Components of the Non-operating income (expense), net line, were:
Three Months Ended
September 30
(Amounts in Thousands)
2019
2018
Gain
on Supplemental Employee Retirement Plan Investments
$
58
$
371
Other
(57
)
(44
)
Non-operating
income, net
$
1
$
327
Note 3. Restructuring
Transformation Restructuring Plan:
In June 2019, we announced a transformation restructuring plan that is expected to optimize resources for future growth, improve efficiency, and build capabilities across our organization. We believe the
transformation restructuring plan will establish a more cost-efficient structure to better align our operations with our long-term strategic goals. The transformation restructuring plan includes the following:
•
Our overall manufacturing facility footprint is being reviewed to reduce excess capacity and gain efficiencies. We plan to exit a leased seating manufacturing facility in Martinsville, Virginia in the second half of fiscal year 2020 and are evaluating our production capabilities and capacity across our organization to identify additional opportunities.
•
The
creation of center-led functions for finance, human resources, information technology and legal functions is expected to result in the standardization of processes and the elimination of duplication. In addition, we are centralizing our supply chain efforts to maximize supplier value and plan to drive more efficient practices and operations within our logistics function.
•
Kimball brand selling resources are being reallocated to higher-growth markets. We also ceased use of four leased furniture showrooms across our brands during the first quarter of fiscal year 2020 and recognized impairment of the leases and associated leasehold improvements.
The efforts are expected to generate annualized
pre-tax savings of approximately $10.0 million when the transformation restructuring plan is fully implemented. We estimate that pre-tax restructuring charges incurred through the end of fiscal year 2020 will be approximately $8.0 million to $9.0 million. The restructuring charges are expected to consist of approximately $3.0 million to $3.3 million for severance and other employee-related costs, $2.0 million to $2.5 million for facility exit and other
10
costs,
and $3.0 million to $3.2 million for asset impairment. Approximately 65% of the total cost estimate is expected to be cash expense.
A summary of the charges recorded in connection with the Transformation Restructuring Plan is as follows:
To date, we have recognized $5.3 million of restructuring
costs related to the Transformation Restructuring Plan. We expect this restructuring plan to be complete by June 30, 2020. It is currently estimated that this plan will incur an additional $2.7 million to $3.7 million of future restructuring charges.
We utilized available market prices and management estimates to determine the fair value of impaired assets. Restructuring is included in the Restructuring Expense line item on our Condensed Consolidated Statements of Income.
Note 4. Acquisition
On October 26, 2018, we acquired substantially all the assets and assumed certain
specified limited liabilities of David Edward headquartered in Baltimore, Maryland. David Edward is a premier designer and manufacturer of contract furniture, sold in the healthcare, corporate, education, and premium hospitality markets. The David Edward product portfolio consists of classic and contemporary designs, focused primarily in the seating, tables, and ancillary furniture categories. In conjunction with the asset acquisition, we leased two existing David Edward production facilities in Baltimore, Maryland and Red Lion, Pennsylvania. The purchase price allocation did not change from the amounts disclosed in our Annual Report on Form 10-K for 2019 and is final as of September 30, 2019.
11
Note
5. Revenue
Disaggregation of Revenue
The following table provides information about revenue by vertical market:
Three Months Ended
September 30
(Amounts
in Millions)
2019
2018
Commercial
$
55.3
$
56.6
Education
34.7
34.6
Finance
17.2
18.2
Government
18.6
17.1
Healthcare
28.9
24.4
Hospitality
46.8
43.2
Total
Net Sales
$
201.5
$
194.1
We report revenue under a single aggregated reportable segment consisting of three operating segments which have similar products and services in nature, utilize similar production and distribution processes, and share similar long-term economic characteristics.
Receivables in the Condensed Consolidated Balance Sheets represent the amount of consideration to which we are entitled in exchange for the goods or services sold to our customers, net of allowances for doubtful accounts. Receivables are recorded when the right to consideration from the customer becomes unconditional, which is generally upon billing or upon satisfaction of a performance obligation, whichever is earlier.
We also receive deposits from certain customers before revenue is recognized, resulting in the recognition of a contract liability reported as Customer Deposits in the Condensed Consolidated Balance Sheets. Customer deposits are typically utilized within a year of the receipt of the deposit. The amount of revenue recognized during the three months
ended September 30, 2019 that was included in the June 30, 2019 customer deposit balance was $20.9 million.
Note 6. Leases
At the beginning of our fiscal year 2020, we adopted new accounting guidance (“ASC 842”) regarding leases on a prospective basis. This guidance requires lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet. The effects of the initial application did not result in a cumulative adjustment to retained earnings. We recognize lease liabilities at the lease commencement date based upon the present value of the
remaining lease payments. Right-of-use assets are based on the lease liability adjusted for prepaid rent, deferred rent, and tenant allowances received. Lease liabilities are amortized based upon the effective interest method, while right-of-use assets are amortized based upon the straight line expense less interest on the lease liability. Lease expense for lease payments is recognized on a straight-line basis over the lease term, except for impaired leases for which the lease expense is recognized on a declining basis over the remaining lease term. Variable lease expense associated with our leases is recognized when the event, activity, or circumstance in the lease agreement on which those payments are assessed occurs. Variable lease expense is presented as operating expense in our Condensed Consolidated Statements of Income and Comprehensive Income in the same line item as expense arising from fixed lease payments for operating leases.
We
have operating leases for showrooms, manufacturing facilities, warehouses, certain offices, and other facilities to support our operations in addition to select equipment that expire at various dates through 2028. We have no financing leases. Certain operating lease agreements include rental payments adjusted periodically for inflationary indexes. Additionally, some leases include options to renew or terminate the leases which can be exercised at our discretion. Lease terms include the noncancellable portion of the underlying leases along with any reasonably certain lease periods associated with available renewal periods. Our leases do not contain residual value guarantees or material restrictive covenants. As our lease contracts do not contain an implicit discount rate, we use an estimated incremental borrowing rate based on the information
available at the lease commencement date in determining the present value of the lease payments. The estimated incremental borrowing rate represents the estimated rate of
12
interest we would have to pay to borrow an amount equal to the lease payments for a similar period of time on a collateralized basis.
The components of our lease expenses are as follows:
Right-of-use
assets for operating leases are tested for impairment in the same manner as long-lived assets used in operations. We recorded $2.2 million of right-of-use asset and associated leasehold improvement impairment resulting from ceasing use of four furniture showrooms after the implementation of ASC 842 as part of our transformation restructuring plan. The impairment is included in the Restructuring Expense line item on our Condensed Consolidated Statements of Income.
Supplemental cash flow and other information related to leases are as follows:
Leased assets obtained in exchange for operating lease liabilities
$
0.1
Other
information:
Weighted-average remaining term (in years)
6.1
Weighted-average discount rate
4.6
%
The following table summarizes the future minimum lease payments as of September 30, 2019:
Fiscal
Year Ended
(Amounts in Millions)
June 30 (1)
2020
$
3.5
2021
4.6
2022
4.4
2023
3.9
2024
3.1
Thereafter
6.2
Total
lease payments
$
25.7
Less interest
$
3.4
Present value of lease liabilities
$
22.3
(1) Lease payments include options to extend lease terms that are reasonably certain of
being exercised. The payments exclude legally binding minimum lease payments for leases signed but not yet commenced. At September 30, 2019, we have an additional operating lease that has not yet commenced for which we will record a right-of-use asset and lease liability of $1.6 million. The lease will commence in our second quarter of fiscal year 2020 with a lease term of approximately 7 years.
13
The following table summarizes the future minimum lease payments as of June 30, 2019 before adoption of ASC 842:
Fiscal
Year Ended
(Amounts in Millions)
June 30
2020
$
4.6
2021
4.2
2022
4.1
2023
3.6
2024
2.5
Thereafter
3.8
Total
lease payments
$
22.8
Practical Expedients Elected
We elected the following practical expedients as a result of adopting ASC 842:
•
We elected not to separate non-lease components of a contract from the lease components to which they relate for all classes of lease assets.
•
We
elected the package of practical expedients available for transition which allowed us not to reassess (1) whether any expired or existing contracts contain leases, (2) the classification of the leases as operating or finance and (3) the amount of initial direct costs associated with the leases.
•
We elected that our date of initial application be the beginning of our period of adoption which was July 1, 2019.
•
We
elected not to recognize a right-of-use asset or lease liability for short-term leases that have a lease term of twelve months or less.
•
We elected not to assess whether land easements that were not previously accounted for as leases are or contain a lease.
•
We did not elect to use hindsight in determining the lease term and in assessing the likelihood that a lessee purchase option will be exercised.
Note
7. Earnings Per Share
Basic earnings per share are based on the weighted average number of shares outstanding during the period. Diluted earnings per share are based on the weighted average number of shares outstanding plus the assumed issuance of common shares for all potentially dilutive securities.
Three Months Ended
September 30
(Amounts
in Thousands, Except for Per Share Data)
2019
2018
Net Income
$
11,384
$
10,876
Average
Shares Outstanding for Basic EPS Calculation
36,937
37,109
Dilutive Effect of Average Outstanding Compensation Awards
310
283
Average Shares
Outstanding for Diluted EPS Calculation
37,247
37,392
Basic Earnings Per Share
$
0.31
$
0.29
Diluted
Earnings Per Share
$
0.31
$
0.29
14
Note 8. Income Taxes
In determining the quarterly provision for income taxes, we use an estimated annual effective tax rate
which is based on expected annual income, statutory tax rates, and available tax planning opportunities in the various jurisdictions in which we operate. Unusual or infrequently occurring items are separately recognized in the quarter in which they occur. Our effective tax rate for the three months ended September 30, 2019 of 27.4% was higher than the effective tax rate of 24.4% for the three months ended September 30, 2018 primarily due to prior year state tax provision adjustments.
For interim reporting, LIFO inventories are computed based on quantities as of the end of the quarter and interim changes in price levels. Changes in quantities and price levels are reflected in the interim financial statements in the period in which they occur, except in cases where LIFO inventory liquidations are expected to be reinstated by fiscal year end. The earnings impact of LIFO inventory liquidations during
the three month periods ended September 30, 2019 and 2018 was immaterial.
Note 10. Accumulated Other Comprehensive Income
During the three months ended September 30, 2019 and 2018, the changes in the balances of each component of Accumulated Other Comprehensive Income, net of tax, were as follows:
The
following reclassifications were made from Accumulated Other Comprehensive Income to the Condensed Consolidated Statements of Income:
Reclassifications from Accumulated Other Comprehensive Income
Three Months Ended
Affected Line Item in the Condensed Consolidated Statements of Income
September 30,
(Amounts
in Thousands)
2019
2018
Postemployment Benefits Amortization of Actuarial Gain (1)
$
88
$
99
Non-operating
income (expense), net
(23
)
(25
)
Benefit (Provision) for Income Taxes
$
65
$
74
Net
Income
Derivative Gain (Loss)
$
—
$
(16
)
Non-operating
income (expense), net
—
4
Benefit (Provision) for Income Taxes
$
—
$
(12
)
Net
Income
Total Reclassifications for the Period
$
65
$
62
Net
Income
Amounts in parentheses indicate reductions to income.
(1) See Note 15 - Postemployment Benefits in the Notes to Condensed Consolidated Financial Statements for further information on postemployment benefit plans.
Note 11. Commitments and Contingent Liabilities
Guarantees:
Standby letters of credit were issued to lessors and insurance institutions and can only be drawn upon in the event of our failure to pay our obligations to a beneficiary. As of September 30,
2019, we had a maximum financial exposure from unused standby letters of credit totaling $1.5 million.
We are periodically required to provide performance bonds in order to conduct business with certain customers. The bonds are required to provide assurances to customers that the products and services they have purchased will be installed and/or provided properly and without damage to their facilities. We are ultimately liable for claims that may occur against the performance bonds. We had a maximum financial exposure from one performance bond totaling $5.1 million as of September 30, 2019.
We are not aware of circumstances that would require us to perform under these
arrangements and believe that the resolution of any claims that might arise in the future, either individually or in the aggregate, would not materially affect our condensed consolidated financial statements. Accordingly, no liability has been recorded as of September 30, 2019 with respect to the standby letters of credit. We also enter into commercial letters of credit to facilitate payments to vendors and from customers.
Product Warranties:
We provide an assurance-type warranty that guarantees our product complies with agreed-upon specifications. This warranty is not sold separately and does not convey any additional services to the customer. We estimate product warranty liability at the time of sale based on historical repair or replacement
cost trends in conjunction with the length of the warranty offered. Management refines the warranty liability periodically based on changes in historical cost trends and in certain cases where specific warranty issues become known.
16
Changes in the product warranty accrual for the three months ended September 30, 2019 and 2018 were as follows:
Three
Months Ended
September 30
(Amounts in Thousands)
2019
2018
Product Warranty Liability at the beginning of the period
$
2,238
$
2,294
Additions
to warranty accrual (including changes in estimates)
278
343
Settlements made (in cash or in kind)
(370
)
(318
)
Product Warranty Liability at the
end of the period
$
2,146
$
2,319
Note 12. Fair Value
We categorize assets and liabilities measured at fair value into three levels based upon the assumptions (inputs) used to price the assets or liabilities. Level 1 provides the most reliable measure of fair value, whereas Level
3 generally requires significant management judgment. The three levels are defined as follows:
•
Level 1: Unadjusted quoted prices in active markets for identical assets and liabilities.
•
Level 2: Observable inputs other than those included in Level 1. For example, quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets.
•
Level
3: Unobservable inputs reflecting management’s own assumptions about the inputs used in pricing the asset or liability.
Our policy is to recognize transfers between these levels as of the end of each quarterly reporting period. There were no transfers between these levels during the three months ended September 30, 2019. There were also no changes in the inputs or valuation techniques used to measure fair values compared to those disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019.
We hold a total investment of $2.0 million
in a privately-held company, consisting of $0.5 million in equity securities without readily determinable fair value and $1.5 million in stock warrants. The investment in equity securities without readily determinable fair value is classified as a Level 3 financial asset, as explained in the Financial Instruments Not Carried At Fair Value section below. The investment in stock warrants is also classified as a Level 3 financial asset and is accounted for as a derivative instrument valued on a recurring basis, as explained in the Financial Instruments Recognized at Fair Value section below. See Note 13 - Investments in the Notes to Condensed Consolidated Financial Statements for further information regarding the investment in equity securities
without readily determinable fair value, and Note 14 - Derivative Instruments in the Notes to Condensed Consolidated Financial Statements for further information regarding the investment in stock warrants. No purchases or sales of Level 3 assets occurred during the three months ended September 30, 2019.
17
Financial Instruments Recognized at Fair Value:
The following methods and assumptions were used to measure fair value:
Financial
Instrument
Level
Valuation Technique/Inputs Used
Cash Equivalents: Money market funds
1
Market - Quoted market prices
Cash Equivalents: Commercial paper
2
Market
- Based on market data which use evaluated pricing models and incorporate available trade, bid, and other market information.
Available-for-sale securities: Secondary market certificates of deposit
2
Market - Based on market data which use evaluated pricing models and incorporate available trade, bid, and other market information.
Available-for-sale securities: Municipal bonds
2
Market
- Based on market data which use evaluated pricing models and incorporate available trade, bid, and other market information.
Available-for-sale securities: U.S. Treasury and federal agencies
2
Market - Based on market data which use evaluated pricing models and incorporate available trade, bid, and other market information.
Trading securities: Mutual funds held in nonqualified SERP
1
Market
- Quoted market prices
Derivative Assets: Stock warrants
3
Market - The privately-held company is in a start-up phase. The pricing of recent purchases or sales of the investment are considered, if any, as well as positive and negative qualitative evidence, in the assessment of fair value.
Contingent earn-out liability
3
Income
- Based on a valuation model that measures the present value of the probable cash payments based upon the forecasted operating performance of the acquisition and a discount rate that captures the risk associated with the liability.
18
Recurring Fair Value Measurements:
As of September 30, 2019 and June 30, 2019, the fair values of financial assets that are measured at fair value on a recurring basis using the market or income approach are categorized
as follows:
Available-for-sale securities: Secondary market certificates of deposit
—
11,230
—
11,230
Available-for-sale
securities: Municipal bonds
—
1,922
—
1,922
Available-for-sale securities: U.S. Treasury and federal agencies
—
19,919
—
19,919
Trading
Securities: Mutual funds in nonqualified SERP
11,774
—
—
11,774
Derivatives: Stock warrants
—
—
1,500
1,500
Total
assets at fair value
$
51,790
$
62,479
$
1,500
$
115,769
Liabilities
Contingent
earn-out liability
—
—
360
360
Total liabilities at fair value
$
—
$
—
$
360
$
360
The
fair value of the contingent earn-out liability as of June 30, 2019 of $0.4 million was paid out during the quarter ended September 30, 2019, relating to fiscal year 2019 performance of D’style, an acquired business.
The nonqualified supplemental employee retirement plan (“SERP”) assets consist primarily of equity funds, balanced funds, target date funds, a bond fund, and a money market fund. The SERP investment assets are offset by a SERP liability which represents our obligation to distribute SERP funds to participants. See Note 13 - Investments in the Notes to Condensed Consolidated Financial Statements for further information regarding
the SERP.
Non-Recurring Fair Value Measurements:
Certain assets are measured at fair value on a non-recurring basis. These assets are not measured at fair value on an ongoing basis, but are subject to fair value adjustments when events or circumstances indicate a significant adverse effect on the fair value of the asset. Assets that are written down to fair value when impaired are not subsequently adjusted to fair value unless further impairment occurs.
19
Non-recurring
Fair Value Adjustment
Level
Valuation Technique/Inputs Used
Impairment of Leases
3
Income - Based on a valuation model that measures the present value of remaining lease payments less estimated sublease income at a discount rate that captures the risk associated with the future cash flows.
During
the first quarter of fiscal year 2020, due to ceasing use of four showrooms related to the Transformation Restructuring Plan, we recognized an impairment loss of $2.2 million to reduce the related asset groups to fair value. The impairment loss is included as a component of the Restructuring Expense line item on our Condensed Consolidated Statements of Income. The asset groups used to calculate impairment included the right-of-use lease assets, leasehold improvements, and lease liabilities.
Financial Instruments Not Carried At Fair Value:
Financial instruments that are not reflected in the Condensed Consolidated Balance Sheets at fair value that have carrying amounts which approximate fair value include the following:
Financial
Instrument
Level
Valuation Technique/Inputs Used
Notes receivable
2
Market - Price approximated based on the assumed collection of receivables in the normal course of business, taking into account the customer’s non-performance risk.
Equity securities without readily determinable fair value
3
Cost
minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Impairment is assessed qualitatively.
On a periodic basis, but no less frequently than quarterly, the investment in equity securities without readily determinable fair value is qualitatively assessed for impairment when there are events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. If a significant adverse effect on the fair value of the investment were to occur and was deemed to be other-than-temporary, the fair value of the investment would be estimated, and the amount by which the carrying value of the investment exceeds its fair value would be recorded as an impairment loss. See Note
13 - Investments in the Notes to Condensed Consolidated Financial Statements for the carrying amount of this investment.
The carrying value of our cash deposit accounts, trade accounts receivable, trade accounts payable, customer deposits, and dividends payable approximates fair value due to the relatively short maturity and immaterial non-performance risk.
Note 13. Investments
Investment Portfolio:
Our investment portfolio consists of municipal bonds, certificates of deposit purchased in the secondary market, and U.S. Treasury and federal agency securities. Municipal bonds include general obligation bonds and revenue bonds, some of which are pre-refunded. U.S. Treasury securities represent
Treasury Bills and Notes of the U.S. government. Federal agency securities represent debt securities of a U.S. government sponsored agency, and certain of these securities are callable. Our investment policy dictates that municipal bonds, U.S. Treasury and federal agency securities must be investment grade quality. Our secondary market certificates of deposit are classified as investment securities, being purchased in the secondary market through a broker and available to be sold in the secondary market. All certificates of deposit are FDIC insured.
20
Our investment portfolio is available for use in current operations, therefore investments are recorded within Current Assets in the Condensed Consolidated Balance Sheets. The contractual maturities of our
investment portfolio were as follows (maturity dates for municipal bonds are based on pre-refunded dates and maturity dates for government agency securities are based on the first available call date, if applicable):
All
investments are classified as available-for-sale securities which are recorded at fair value. See Note 12 - Fair Value in the Notes to Condensed Consolidated Financial Statements for more information on the fair value of available-for-sale securities. The amortized cost basis reflects the original purchase price, with discounts and premiums amortized over the life of the available-for-sale securities. Unrealized losses on available-for-sale securities are recognized in earnings when there is intent to sell or it is likely to be required to sell before recovery of the loss, or when the available-for-sale securities have incurred a credit loss. Otherwise, unrealized gains and losses are recorded net of the tax-related effect as a component of Shareholders’ Equity.
No investments were in a continuous unrealized loss position for greater than twelve months as of September 30,
2019. There were no realized gains or losses as a result of sales in the three months ended September 30, 2019 and September 30, 2018.
Supplemental Employee Retirement Plan Investments:
We maintain a self-directed supplemental employee retirement plan (“SERP”) in which executive employees are eligible to participate. The SERP utilizes a rabbi trust, and therefore assets in the SERP portfolio are subject to creditor claims in the event of bankruptcy. We recognize SERP investment assets on the Condensed Consolidated Balance Sheets at current fair value. A SERP liability
of the same amount is recorded on the Condensed Consolidated Balance Sheets representing an obligation to distribute SERP funds to participants. The SERP investment assets are classified as trading, and accordingly, realized and unrealized gains and losses are recognized in the Other Income (Expense) section of the Condensed Consolidated Statements of Income. Adjustments made to revalue the SERP liability are also recognized in income or expense as selling and administrative expenses and offset valuation adjustments on SERP investment assets. Net unrealized holding gains for the three months ended September 30, 2019 and 2018 were, in thousands, $24 and $344,
respectively.
21
SERP asset and liability balances were as follows:
Equity
securities without readily determinable fair value:
We hold a total investment of $2.0 million in a privately-held company, including $0.5 million in equity securities without readily determinable fair value. The investment in equity securities without readily determinable fair value is included in the Other Assets line of the Condensed Consolidated Balance Sheets. See Note 12 - Fair Value in the Notes to Condensed Consolidated Financial Statements for more information on the valuation of these securities. We do not hold a majority voting interest and are not the variable interest primary beneficiary of the privately-held company, thus consolidation is not required.
Note
14. Derivative Instruments
We hold a total investment of $2.0 million in a privately-held company, including $1.5 million in stock warrants. The investment in stock warrants is accounted for as a derivative instrument and is included in the Other Assets line of the Condensed Consolidated Balance Sheets. The stock warrants are convertible into equity shares of the privately-held company upon achieving certain milestones. The value of the stock warrants will fluctuate primarily in relation to the value of the privately-held company's underlying securities, either providing an appreciation in value or potentially expiring with no value. During the quarter ended September 30, 2019, the change in fair value of the stock warrants was not significant.
See Note 12 - Fair Value in the Notes to Condensed Consolidated Financial Statements for more information on the valuation of these securities.
Note
15. Postemployment Benefits
Our domestic employees participate in severance plans which provide severance benefits to eligible employees meeting the plans’ qualifications, primarily for involuntary termination without cause.
The components of net periodic postemployment benefit cost applicable to our severance plans were as follows:
Three Months Ended
September 30
(Amounts
in Thousands)
2019
2018
Service cost
$
126
$
127
Interest cost
19
23
Amortization
of actuarial income
(88
)
(99
)
Net periodic benefit cost
$
57
$
51
The
benefit cost in the above table includes only normal recurring levels of severance activity, as estimated using an actuarial method. Unusual or non-recurring severance actions, such as restructuring actions, are not estimable using actuarial methods and are expensed in accordance with the applicable U.S. GAAP.
22
Note 16. Stock Compensation
Stock-based compensation expense during the three months ended September 30, 2019 and 2018, was $2.1
million and $1.9 million, respectively. The total income tax benefit for stock compensation arrangements was $0.6 million during the three months ended September 30, 2019, and $0.5 million during the three months ended September 30, 2018.
During fiscal year 2020, the following stock compensation was awarded to officers and other key employees and to members of the Board of Directors who are not employees. All awards were granted under the 2017 Stock Incentive Plan. For more information on stock compensation awards, refer to our Annual
Report on Form 10-K for the fiscal year ended June 30, 2019.
Type of Award
Quarter Awarded
Targeted Shares or Units
Grant
Date Fair Value (5)
Annual Performance Shares (1)
1st Quarter
34,305
$16.85
-
$16.93
Relative Total Shareholder Return Performance Units (2)
1st
Quarter
28,080
$21.25
Restricted Share Units (3)
1st Quarter
188,588
$16.85
-
$17.24
Unrestricted
Shares (4)
1st Quarter
9,091
$17.19
(1) Annual performance shares were awarded to officers and other key employees. The number of annual performance shares to be issued will be dependent upon the Company’s return on invested capital during fiscal year 2020, with a percentage payout ranging from 0%
to 200% of the target number set forth above. The maximum number of shares that can be issued under these awards is 68,610. Annual performance shares vest on June 30, 2020.
(2) Performance units were awarded to key officers under the Company’s Relative Total Shareholder Return program. Vesting occurs at June 30, 2022. Participants will earn from 0% to 200% of the target award depending upon how the compound annual growth rate of Kimball International common stock ranks within the peer group at the end of the performance period. The maximum number of units that can
be issued under these awards is 56,160.
(3) Restricted share units were awarded to officers and employees. Also, in connection with the redesign of the Company’s annual cash incentive plan certain employees were awarded time-based retention and performance-based transition units. The number of performance-based transition units to be issued will be dependent upon the Company’s EBITDA during fiscal year 2020, with a percentage payout ranging from 0% to 100% of the target. The maximum number of units that can be issued under the performance-based transition awards is 35,598. The
Company also awarded performance-based transformation units that will earn from 0% to 100% of the target award depending upon the Company’s reduction of operating costs and EBITDA during fiscal year 2020. The maximum number of units that can be issued under the performance-based transformation award is 2,165. Vesting occurs at June 30, 2020, June 30, 2021, and June 30, 2022. Dividends accumulate over the vesting period for all awards except the time-based retention and performance-based transition awards.
(4) Unrestricted shares were awarded to non-employee
members of the Board of Directors as consideration for service to Kimball International and do not have vesting periods, holding periods, restrictions on sale, or other restrictions.
(5) The grant date fair value of annual performance shares and restricted share units that do not receive dividends was based on the stock price at the date of the award, reduced by the present value of dividends normally paid over the vesting period which are not payable on outstanding annual performance share awards or certain restricted share unit awards. The grant date fair value of the Relative Total Shareholder Return awards was calculated using a Monte Carlo simulation. This valuation technique includes estimating the movement of stock prices and the effects of volatility, interest rates, and dividends. The grant date fair value of the restricted share units that receive dividends and unrestricted shares was based on the stock price at the
date of the award.
Note 17. Variable Interest Entities
Our involvement with variable interest entities (“VIEs”) is limited to situations in which we are not the primary beneficiary as we lack the power to direct the activities that most significantly impact the VIE’s economic performance. Thus, consolidation is not required. Our involvement with VIEs consists of an investment in a privately-held company consisting of equity securities without readily determinable fair value and stock warrants, and notes receivable related to independent dealership financing.
The equity securities without readily determinable fair value and stock warrants were valued at $0.5 million and $1.5 million,
respectively, at both September 30, 2019 and June 30, 2019 and were included in the Other Assets line of the Condensed Consolidated Balance Sheets. For more information related to our investment in the privately-held company, see Note 12 - Fair Value in the Notes to Condensed Consolidated Financial Statements.
The carrying value of the notes receivable for independent dealership financing were $1.0 million at both September 30, 2019 and June 30,
2019 and was included on the Receivables and Other Assets lines of our Condensed Consolidated Balance Sheets.
23
We have no obligation to provide additional funding to the VIEs, and thus our exposure and risk of loss related to the VIEs is limited to the carrying value of the investment and notes receivable. Financial support provided by Kimball International to the VIEs was limited to the items discussed above during the quarter ended September 30, 2019.
Note 18. Credit
Quality and Allowance for Credit Losses of Notes Receivable
We monitor credit quality and associated risks of notes receivable on an individual basis based on criteria such as financial stability of the party and collection experience in conjunction with general economic and market conditions. As of September 30, 2019 and June 30, 2019, we had no material past due outstanding notes receivable.
On October 24, 2019, we entered into an amended and restated credit agreement (“Credit Agreement”) with JPMorgan Chase Bank, National Association, as administrative agent. The Credit Agreement has a maturity date of October 24, 2024 and allows for up to $75 million in borrowings, with an option to increase the amount available for borrowing to $150 million at our request, subject to participating banks’ consent. We believe our principal sources of liquidity from available funds on hand, cash generated from operations, and the availability of borrowing under this Credit Agreement will be sufficient for the foreseeable future. There are currently no revolving loans
outstanding under the Credit Agreement.
The revolving loans under the Credit Agreement may consist of, at our election, advances in U.S. dollars or advances in any other currency that is agreed to by the lenders. The proceeds of the revolving loans are to be used for general corporate purposes including acquisitions. A portion of the credit facility, not to exceed $10 million of the principal amount, will be available for the issuance of letters of credit. A commitment fee on the unused portion of principal amount of the credit facility is payable at a rate that ranges from 15.0 to 25.0 basis points per annum as determined by our ratio of consolidated total indebtedness to adjusted consolidated EBITDA.
The interest rate is dependent on the type
of borrowings and will be one of the following two options:
•
the adjusted London Interbank Offered Rate (“Adjusted LIBO Rate” as defined in the Credit Agreement) in effect two business days prior to the advance (adjusted upwards to reflect bank reserve costs) for such interest period, plus the Eurocurrency Loans margin which can range from 100.0 to 175.0 basis points based on our ratio of consolidated total indebtedness to adjusted consolidated EBITDA; or
•
the
Alternate Base Rate, which is defined as the highest of the fluctuating rate per annum equal to the higher of
a.
prime rate as last quoted by The Wall Street Journal;
b.
1% per annum above the Adjusted LIBO rate; or
c.
1/2% per annum above the Federal Reserve Bank of
New York;
plus the ABR Loans spread which can range from 0.0 to 75.0 basis points based on our ratio of consolidated total indebtedness to adjusted consolidated EBITDA.
24
Our financial covenants under the Credit Agreement require:
•
an adjusted leverage ratio of (a) consolidated total indebtedness minus unencumbered U.S. cash equivalents on hand in excess of $15,000,000
provided that the maximum subtraction shall not exceed $35,000,000 to (b) adjusted consolidated EBITDA, determined as of the end of each of its fiscal quarters for the then most recently ended four fiscal quarters, to not be greater than 3.0 to 1.0, and
•
a fixed charge coverage ratio of (a) the sum of (i) consolidated EBITDA, minus (ii) 50% of depreciation expense, minus (iii) taxes paid, minus (iv) dividends and distributions paid, minus if the Adjusted Leverage Ratio is greater than 1.00 to 1.00 for the then most-recently ended four fiscal quarter period, repurchase
of Equity Interests to (b) the sum of (i) scheduled principal payments on indebtedness due and/or paid, plus (ii) interest expense, calculated on a consolidated basis in accordance with GAAP, for the trailing four quarters then ending, to not be less than 1.10 to 1.00.
The complete Credit Agreement was filed as Exhibit 10.1 to our Current Report on Form 8-K filed on October 30, 2019.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Business Overview
For
over 65 years, Kimball International, Inc. (the “Company,”“Kimball International,”“we,”“us,” or “our”) has created design- driven, innovative furnishings that have helped our customers shape spaces into places that bring possibility to life by enabling collaboration, discovery, wellness, and relaxation. We go to market through our family of brands: Kimball, National, Kimball Hospitality, David Edward, and D’style by Kimball Hospitality. Our values and integrity are demonstrated daily by embracing our purpose and guiding principles while fostering a culture of caring that establishes us as an employer of choice. We build success by nurturing long-term relationships with customers, employees, suppliers, shareholders and the communities in which we operate.
We closely monitor key indicators for the markets in which we compete. As reported by the Business and Institutional Furniture Manufacturer
Association (“BIFMA”), the forecast by IHS Markit, a global information provider, as of October 2019 for the North American office furniture market, projects a year-over-year increase of 6.1% for calendar year 2019 and 2.2% for calendar year 2020. The forecast for two of the leading indicators for the hospitality furniture market in the August 2019 PwC Hospitality Directions U.S. report includes a projected increase in RevPAR (Revenue Per Available Room) of 1.1% for calendar year 2019 and 1.0% for calendar year 2020, while occupancy levels for calendar years 2019 and 2020 continue to hover at peak levels.
Management currently considers the following events, trends, and uncertainties to be most important to understanding our financial
condition and operating performance:
•
‘Kimball International Connect’ Strategy - In May 2019, Kimball International introduced a comprehensive strategy to connect our purpose, our people, and our brands to drive growth and unlock the Company’s full potential. Kimball International Connect seeks to enable the power of our people and position our organization to engage at higher levels of collaboration and interdependence. We believe this strategy will successfully position us for the future and result in enhanced shareholder value over the long term. Our Kimball International Connect Strategy is comprised of four pillars:
•
Inspire
Our People: Leveraging our legacy of a bold and entrepreneurial spirit, we are working to cultivate a high-performance, caring culture. We unveiled our new purpose to our employees on May 9, 2019 and are investing in our training, technology and systems to remain an employer of choice and a great place to work.
•
Build Our Capabilities: We are creating center-led functions, including finance, human resources, information technology and legal and are centralizing supply chain leadership to reduce duplication, deliver efficiencies, and drive consistency. We are also adopting ways of working to ensure the use of common best practices and approaches.
To achieve our goals, we established a Program Management Office to oversee execution.
•
Fuel Our Future: We are driving lean throughout the organization, removing duplication at the business level, and infusing capital to accelerate efficiencies. Related to this, we are employing a more metrics-based approach and driving toward more formal standardized operating practices.
•
Accelerate Our Growth: We are continuing to advance new product development across our brands,
selectively expanding our verticals and channels, including healthcare and e-commerce, and driving commercial excellence. We
25
believe by being our customers’ first choice for shaping places that bring collaboration, discovery, wellness and relaxation to life, we will capture greater market share.
•
Transformation Restructuring Plan - In June 2019, we announced a transformation restructuring plan that is expected to optimize resources for future growth, improve efficiency, and build capabilities across our
organization. We believe the transformation restructuring plan will establish a more cost-efficient structure to better align our operations with our long-term strategic goals. The efforts are expected to generate annualized pre-tax savings of approximately $10.0 million when the transformation restructuring plan is fully implemented. We estimate pre-tax restructuring charges incurred through the end of fiscal year 2020 will be approximately $8.0 million to $9.0 million. The transformation restructuring plan includes the following:
•
Our overall manufacturing facility footprint is being reviewed to reduce excess capacity and gain efficiencies. We plan to exit a leased seating manufacturing facility in Martinsville, Virginia in the second half
of fiscal year 2020 and are evaluating our production capabilities and capacity across our organization to identify additional opportunities.
•
The creation of center-led functions for finance, human resources, information technology and legal functions is expected to result in the standardization of processes and the elimination of duplication. In addition, we are centralizing our supply chain efforts to maximize supplier value and plan to drive more efficient practices and operations within our logistics function.
•
Kimball
brand selling resources are being reallocated to higher-growth markets. We also ceased use of our four leased furniture showrooms across our brands during the first quarter of fiscal year 2020 and recognized impairment of the lease and associated leasehold improvements.
•
On October 26, 2018, we acquired substantially all of the assets and assumed certain specified limited liabilities of David Edward Furniture, Inc. (“David Edward”), which is headquartered in Baltimore, Maryland. David Edward is a premier designer and manufacturer of contract furniture, sold in the healthcare, corporate, education,
and premium hospitality markets. David Edward products are sold primarily in the North American market. David Edward’s products are generally specified by architects and designers, represented through a network of independent representatives, and sold through authorized furniture dealerships. The David Edward product portfolio consists of classic and contemporary designs, focused primarily in the seating, tables, and ancillary furniture categories. In conjunction with the asset acquisition, we leased two existing David Edward production facilities in Baltimore, Maryland and Red Lion, Pennsylvania. See Note 4 - Acquisition in the Notes to Condensed Consolidated Financial Statements for additional information.
•
We
expect commodity prices to moderate, but we will continue to be exposed to fluctuations in transportation costs, which vary based upon freight carrier capacity and fuel prices. We utilize both steel and aluminum in our products, most of which is sourced domestically. The U.S. originally imposed tariffs of 25% on steel and 10% on aluminum imported from several countries effective June 2018. The government expanded its list of products subject to tariffs to include furniture products, parts, and components at a 10% rate effective September 2018, increasing to a 25% rate effective June 2019. The U.S. government continues to evaluate the ongoing need for tariffs, and if further tariffs are assessed the landed cost of our products could increase materially, which would reduce our net income if we are unable to mitigate the additional cost. We are actively striving to offset increases in the cost of these materials through supplier negotiations, global sourcing initiatives,
product re-engineering and parts standardization, and price increases on our products.
•
Due to the contract and project nature of furniture markets, fluctuation in the demand for our products and variation in the gross margin on those projects is inherent to our business, which in turn impacts our operating results. Effective management of our manufacturing capacity is and will continue to be critical to our success. See below for further details regarding current sales and open order trends.
•
We
expect to continue to invest in capital expenditures prudently, including potential acquisitions, that would enhance our capabilities and diversification while providing an opportunity for growth and improved profitability.
•
We have a strong focus on cost control and closely monitor market changes and our liquidity in order to proactively adjust our operating costs, discretionary capital spending, and dividend levels as needed. Managing working capital in conjunction with fluctuating demand levels is likewise key.
•
We
continue to maintain a strong balance sheet. Our short-term liquidity available, represented as cash, cash equivalents, and short-term investments plus the unused amount of our credit facility, was $134.9 million at September 30, 2019.
See the “Non-GAAP Financial Measures and Other Key Performance Indicators” section below.
Net Sales by End Vertical Market
Three
Months Ended
September 30
(Amounts in Millions)
2019
2018
% Change
Commercial
$
55.3
$
56.6
(2
%)
Education
34.7
34.6
—
%
Finance
17.2
18.2
(5
%)
Government
18.6
17.1
9
%
Healthcare
28.9
24.4
18
%
Hospitality
46.8
43.2
8
%
Total
Net Sales
$
201.5
$
194.1
4
%
First quarter fiscal year 2020 consolidated net sales were $201.5 million compared to first
quarter fiscal year 2019 net sales of $194.1 million, or a 4% increase including $4.0 million of net sales resulting from the David Edward acquisition. Organic net sales increased $3.4 million, or 2% primarily due to price increases and also due to higher volume in our healthcare, hospitality, and government vertical markets. Sales growth benefited from new ancillary products within National, healthcare products within
27
Kimball, and custom business within Kimball Hospitality. Sales growth was partially offset by softness within the Kimball brand as we realign selling resources
to higher growth areas.
Key explanatory comments for our sales by vertical market for the first quarter of fiscal year 2020 compared to the first quarter of fiscal year 2019 follow:
•
Sales growth to the healthcare vertical market was driven by our strategic focus in this marketplace which included aligning resources, building relationships, and introducing new healthcare products. The healthcare market continues to show stability and growth.
•
The
hospitality vertical market growth was driven by increased custom hospitality project sales.
•
Government vertical market sales increased in the first quarter on higher state government sales.
•
Our sales to the education vertical market were similar to the prior year first quarter as we experienced mixed demand among our brands.
•
Our
sales to the finance vertical market decreased compared to strong prior year sales levels.
•
Our sales decline in the commercial vertical market resulted from an intense continuous improvement approach to correct margin issues within the systems category that caused a temporary distraction to our revenue growth in this vertical market.
•
Each of our vertical market sales levels can fluctuate depending on the mix of projects in a given period.
Open orders
at September 30, 2019 decreased 1%, or decreased 3% on an organic basis, when compared to the open order level as of September 30, 2018 due to decreases in the hospitality furniture order backlog which was partially offset by increases in the office furniture order backlog. The office furniture order backlog increase was primarily due to organic increases while the David Edward order backlog contributed to a lesser extent. Open orders at a point in time may not be indicative of future sales trends.
In the first quarter of fiscal year 2020 we recorded net income of $11.4 million,
or diluted earnings per share of $0.31, inclusive of after-tax restructuring costs of $3.2 million, or $0.08 per diluted share and after-tax CEO transition costs of $0.1 million, or $0.01 per diluted share. In the first quarter of fiscal year 2019 we recorded net income of $10.9 million, or $0.29 per diluted share, inclusive of after-tax CEO transition costs of $0.8 million, or $0.02 per diluted share. Excluding the restructuring and CEO transition costs, our adjusted net income for the first three
months of fiscal year 2020 improved to $14.7 million, or $0.40 per diluted share, compared to adjusted net income excluding CEO transition costs for the first three months of fiscal year 2019 of $11.7 million, or $0.31 per diluted share. See the “Non-GAAP Financial Measures and Other Key Performance Indicators” section below.
Gross profit as a percent of net sales increased 100 basis points in the first quarter of fiscal year 2020 compared to the first
quarter of fiscal year 2019. Increased product pricing and the savings realized from our productivity and cost reduction initiatives were partially offset by unfavorable sales mix shift. The David Edward acquisition also negatively impacted our gross profit in the first quarter, as expected, and will continue to in the short-term until productivity improvements and synergies are realized.
Selling and administrative expenses in the first quarter of fiscal year 2020 compared to the first quarter of fiscal year 2019 as a percent of net sales decreased 160 basis points, and decreased 2% in absolute dollars. The
improvement was driven by $0.9 million lower CEO transition costs, cost savings initiatives related to our transformation restructuring plan, and lower employee healthcare and retirement expense, which were partially offset by David Edward selling and administrative expenses and a prior year gain on the sale of assets which did not repeat in the current year. Also included in our first quarter fiscal year 2020 selling and administrative expenses are growth investments which are expected to increase throughout fiscal year 2020 which will partially offset the savings we expect to achieve from the transformation plan in future quarters.
Also contributing to the lower selling and administrative expenses were favorable variances within selling and administrative expenses of $0.3 million for the first quarter of fiscal year 2020 compared to the first quarter of fiscal year 2019 related to the normal revaluation to fair value of
our Supplemental Employee Retirement Plan (“SERP”) liability. The impact from the change in the SERP liability that was recognized in selling and administrative expenses was offset with the change in fair value of the SERP investments which was recorded in Other Income (Expense), and thus there was no effect on net income.
In June 2019, we announced a transformation restructuring plan that is expected to optimize resources for future growth, improve efficiency, and build capabilities across our organization. We believe the transformation restructuring plan will establish a more cost-efficient structure to better align our operations with our long-term strategic goals. We recognized pre-tax restructuring
28
expense
of $4.4 million in the first quarter of fiscal year 2020 related to our transformation restructuring plan. See Note 3 - Restructuring in the Notes to Condensed Consolidated Financial Statements for additional information.
Other Income (Expense) consisted of the following:
Three Months Ended
September 30
(Amounts
in Thousands)
2019
2018
Interest Income
$
607
$
419
Interest Expense
(23
)
(50
)
Gain
on Supplemental Employee Retirement Plan Investments
58
371
Other
(57
)
(44
)
Other Income (Expense), net
$
585
$
696
Our
effective tax rate of 27.4% for the three months ended September 30, 2019 was higher than the combined federal and state statutory tax rate due to a tax provision adjustment related to the prior year. Our effective tax rate was 24.4% for the three months ended September 30, 2018 which approximated our statutory rate.
Comparing the balance sheet as of September 30, 2019 to June 30, 2019, our accrued expenses line decreased as our
company retirement contribution and approximately half of our accrued cash incentive compensation related to our fiscal year 2019 performance was paid out. The right-of-use lease assets and current and long-term lease liabilities lines are the result of implementing ASC 842 as of the beginning of our fiscal year 2020. See Note 6 - Leases in the Notes to Condensed Consolidated Financial Statements for additional information.
Liquidity and Capital Resources
Our total cash, cash equivalents, and short-term investments, was $106.4 million at September 30, 2019
and $106.3 million at June 30, 2019. Cash flows from operations of $11.1 million were primarily offset by capital expenditures, including capitalized software, of $7.4 million and the return of capital to shareholders in the form of dividends totaling $2.9 million during the first three months of fiscal year 2020.
Our short-term liquidity available, represented as cash, cash equivalents, and short-term investments plus the unused amount of our credit facility, totaled $134.9 million at September 30, 2019. At September 30, 2019, we had $1.5
million in letters of credit outstanding, which reduced our borrowing capacity on the credit facility. We had no credit facility borrowings outstanding as of September 30, 2019 or June 30, 2019.
Cash Flows
The following table reflects the major categories of cash flows for the first three months of fiscal years 2020 and 2019.
Three
Months Ended
September 30
(Amounts in thousands)
2019
2018
Net cash provided by operating activities
$
11,056
$
7,121
Net
cash used for investing activities
$
(510
)
$
(10,381
)
Net cash used for financing activities
$
(3,806
)
$
(6,758
)
Cash
Flows from Operating Activities
For the first three months of fiscal year 2020 net cash provided by operating activities was $11.1 million fueled by $11.4 million of net income while the first three months of fiscal year 2019 net cash provided by operating activities was $7.1 million inclusive of $10.9 million of net income. Changes in working capital balances used $10.5 million of cash in the first three months of fiscal year 2020 and used $6.4 million of cash in the first
three months of fiscal year 2019.
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The $10.5 million usage of cash from changes in working capital balances in the first three months of fiscal year 2020 was primarily due to a reduction in our accrued expenses balance as the retirement profit sharing contribution and approximately half of our accrued cash incentive compensation which were both related to our fiscal year 2019 performance were paid out during our first quarter of fiscal year 2020.
The $6.4 million usage of cash from changes in working capital balances in the first three months of fiscal year 2019
included a reduction in our accrued expenses balance as our total accrued cash incentive compensation and the retirement profit sharing contribution which were both related to our fiscal year 2018 performance were paid out which was partially offset by an increase in customer deposits.
Our measure of accounts receivable performance, also referred to as Days Sales Outstanding (“DSO”), for the three-month periods ended September 30, 2019 and September 30, 2018 were 29 and 28 days, respectively. We define DSO as the average of monthly accounts and notes receivable divided
by an average day’s net sales. Our Production Days Supply on Hand (“PDSOH”) of inventory measure for the three-month periods ended September 30, 2019 and September 30, 2018 were 44 and 41 days, respectively. The inventory increase was primarily driven by an intentional increase of outsourced high demand products. We define PDSOH as the average of the monthly net inventory divided by an average day’s cost of sales.
Cash Flows from Investing Activities
During the first three
months of fiscal year 2020, we invested $6.0 million in available-for-sale securities, and $12.7 million matured. During the first three months of fiscal year 2019, we invested $16.8 million in available-for-sale securities, and $10.0 million matured. Our short-term investments included municipal bonds, certificates of deposit purchased in the secondary market, and U.S. Treasury and federal agency securities. During the first three months of fiscal years 2020 and 2019, we reinvested $7.4 million
and $4.7 million, respectively, into capital investments for the future. The capital investments in both the current and prior year were primarily for facility improvements such as renovations to our corporate headquarters, and various manufacturing equipment upgrades to increase automation in production facilities which is expected to yield future benefits.
Cash Flows from Financing Activities
We paid dividends of $2.9 million and $2.6 million in the three-month periods ended September 30, 2019 and September 30, 2018,
respectively. Consistent with our historical dividend policy, our Board of Directors evaluates the appropriate dividend payment on a quarterly basis. During the first three months of fiscal year 2019, we repurchased shares pursuant to a previously announced stock repurchase program which drove cash outflow of $3.3 million.
Credit Facility
As of September 30, 2019 we had a $30 million credit facility which matured in October 2019 that allowed for both issuances of letters of credit and cash borrowings. At September 30, 2019, we had $1.5 million in letters of credit outstanding, which reduced our borrowing
capacity on the credit facility. At both September 30, 2019 and June 30, 2019, we had no borrowings outstanding.
The credit facility required us to comply with certain debt covenants, the most significant of which were the adjusted leverage ratio and the fixed charge coverage ratio. The adjusted leverage ratio is defined as (a) consolidated total indebtedness minus unencumbered U.S. cash on hand in the U.S. in excess of $15,000,000 to (b) consolidated EBITDA, determined as of the end of each of our fiscal quarters for the then most recently ended four fiscal quarters, and may not be greater than 3.0 to 1.0. The fixed charge coverage ratio is defined as (a) the sum of (i) consolidated EBITDA, minus (ii) 50% of depreciation expense, minus
(iii) taxes paid, minus (iv) dividends and distributions paid, to (b) the sum of (i) scheduled principal payments on indebtedness due and/or paid, plus (ii) interest expense, calculated on a consolidated basis in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”), determined as of the end of each of our fiscal quarters for the trailing four fiscal quarters then ending, and may not be less than 1.10 to 1.00. We were in compliance with all debt covenants of the credit facility during the three-month period ended September 30, 2019.
The table below compares the adjusted leverage ratio and the fixed charge coverage ratio with the limits specified in the credit agreement.
On October 24, 2019, we entered into an amended and restated credit agreement (“Credit Agreement”) that allows for up to $75 million in borrowings, with an option to increase the amount available for borrowing to $150 million at our request, subject to participating banks’ consent. The Credit Agreement has a maturity date of October 24, 2024. This amended and restated credit agreement replaced the existing credit facility mentioned above. The complete agreement was filed as Exhibit 10.1 to our Current Report on Form 8-K filed on October 30, 2019.
We believe our principal
sources of liquidity from available funds on hand and short-term investments, cash generated from operations, and the availability of borrowing under our credit facility will be sufficient to fund future dividends and meet our working capital and other operating needs for at least the next 12 months. During the first quarter of fiscal year 2020, our Board of Directors declared a quarterly dividend of $0.09 per share, to be paid during our second quarter of fiscal year 2020. We will continue to evaluate market conditions in determining future share repurchases. At September 30, 2019, 2.7 million shares remained available under the repurchase program. During fiscal year 2020 we expect to continue investments in capital expenditures, particularly for projects such as our headquarters renovation,
showroom renovations, machinery and equipment upgrades and automation, and potential acquisitions, that would enhance our capabilities and diversification while providing an opportunity for growth and improved profitability.
Our ability to generate cash from operations to meet our liquidity obligations could be adversely affected in the future by factors such as general economic and market conditions, the impact of changes in tariffs, lack of availability of raw material components in the supply chain, loss of key contract customers, and other unforeseen circumstances. In particular, should demand for our products decrease significantly over the next 12 months, the available cash provided by operations could be adversely impacted.
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Non-GAAP
Financial Measures and Other Key Performance Indicators
This Management’s Discussion and Analysis (“MD&A”) contains non-GAAP financial measures. A non-GAAP financial measure is a numerical measure of a company’s financial performance that excludes or includes amounts so as to be different than the most directly comparable measure calculated and presented in accordance with U.S. GAAP in the statements of income, statements of comprehensive income, balance sheets, statements of cash flows, or statements of shareholders’ equity of the company. The non-GAAP financial measures used within this MD&A include (1) organic net sales, defined as net sales excluding the acquisition-related net sales during the periods for which there were no sales related to such acquisition in the comparable period; (2) adjusted operating income, defined
as operating income excluding restructuring expenses, CEO transition costs, and market value adjustments related to our Supplemental Employee Retirement Plan (“SERP”) liability; (3) adjusted operating income percentage, defined as adjusted operating income as a percentage of net sales; (4) adjusted net income, defined as net income excluding restructuring expenses and CEO transition costs; (5) adjusted diluted earnings per share, defined as diluted earnings per share excluding restructuring expenses and CEO transition costs; (6) adjusted EBITDA, defined as earnings before interest, taxes, depreciation, and amortization and excluding restructuring expenses and CEO transition costs; and (7) adjusted EBITDA percentage, defined as adjusted EBITDA as a percentage of net sales. Reconciliations of the reported GAAP numbers to these non-GAAP financial measures are included in the table below. Management believes it is useful for investors to understand and to be able
to meaningfully trend, analyze and benchmark how our core operations performed without market value adjustments related to our SERP liability or expenses incurred in executing our transformation restructuring plan or our CEO transition. Many of our internal performance measures that management uses to make certain operating decisions exclude these expenses to enable meaningful trending of core operating metrics. These non-GAAP financial measures should not be viewed as an alternative to the GAAP measures and are presented as supplemental information.
Reconciliation of Non-GAAP Financial Measures and Other Key Performance Indicators
(1) Represents David Edward net sales for our fiscal year 2020 first quarter as the acquisition date was October 26, 2018 thus we did not own David Edward during our first
quarter of fiscal year 2019.
The open orders metric is a key performance indicator representing firm orders placed by our customers which have not yet been fulfilled and are expected to be recognized as revenue during future quarters. The timing of shipments can vary, but generally open orders are expected to ship within a twelve-month period.
Return on Invested Capital is a key performance indicator calculated as: [(Earnings Before Interest, Taxes, Amortization, Restructuring Expense, and CEO Transition
Costs) multiplied by (1 minus Effective Tax Rate)] divided by (Total Shareholders’ Equity plus Net Debt). Net Debt is defined as current maturities of long-term debt plus long-term debt less cash, cash equivalents, and short-term investments.
Fair Value
Financial assets classified as level 1 assets were valued using readily available market pricing. For commercial paper and available-for-sale securities classified as level 2 assets, the fair values are determined based on market data which use evaluated pricing models and incorporate available trade, bid, and other market information. We evaluated the inputs used to value the instruments and validated the accuracy of the instrument fair values based on historical evidence. The investment in stock warrants and equity securities without readily determinable
fair value of a privately-held company are classified as level 3 financial assets. The stock warrants are accounted for as a derivative instrument valued on a recurring basis considering the pricing of recent purchases or sales of the investment as well as positive and negative qualitative evidence, while the equity securities without readily determinable fair value are measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The contingent earn-out liability was classified as a Level 3 financial liability and is valued based on a valuation model that measures the present value of the probable cash payments based upon the forecasted operating performance of the acquisition and a discount rate that captures the risk associated with the liability.
See Note
12 - Fair Value in the Notes to Condensed Consolidated Financial Statements for additional information.
Contractual Obligations
There have been no material changes outside the ordinary course of business to our summary of contractual obligations under the caption, “Contractual Obligations” in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended June 30, 2019.
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Off-Balance
Sheet Arrangements
Our off-balance sheet arrangements are limited to standby letters of credit and a performance bond. These arrangements do not have a material current effect and are not reasonably likely to have a material future effect on our financial condition, results of operations, liquidity, capital expenditures, or capital resources. See Note 11 - Commitments and Contingent Liabilities in the Notes to Condensed Consolidated Financial Statements for more information on the standby letters of credit. We do not have material exposures to trading activities of non-exchange traded contracts.
The
preceding statements are forward-looking statements under the Private Securities Litigation Reform Act of 1995. Certain factors could cause actual results to differ materially from forward-looking statements.
Critical Accounting Policies
Our condensed consolidated financial statements have been prepared in accordance with U.S. GAAP. These principles require the use of estimates and assumptions that affect amounts reported and disclosed in the condensed consolidated financial statements and related notes. Actual results could differ from these estimates and assumptions. Management continually reviews the accounting policies and financial information disclosures. A summary of the more significant accounting policies that require the use of estimates and judgments in preparing the financial statements is provided
in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019. During the first three months of fiscal year 2020, there were no material changes in the accounting policies and assumptions previously disclosed.
Certain statements contained within this document are considered forward-looking under the Private Securities Litigation Reform Act of 1995. The statements may be identified by the use of words such as “believes,”“anticipates,”“expects,”“intends,”“plans,”“projects,”“estimates,”“forecasts,”“seeks,”“likely,”“future,”“may,”“might,”“should,”“would,”“will,” and similar expressions. These forward-looking statements are subject to risks and uncertainties including, but not limited to, the impact of changes in tariffs, successful execution of our transformation restructuring plan, adverse changes in global economic conditions, the impact of changes in the regulatory environment, the loss of key suppliers, the loss of or significant volume reductions from key contract
customers, the financial stability of key customers and suppliers, the availability or cost of raw materials, components, or services, or similar unforeseen events. Additional cautionary statements regarding other risk factors that could have an effect on the future performance of Kimball International are contained in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk with respect to commodity price fluctuations for components used in the manufacture of our products, primarily related to wood and wood-related components, steel, aluminum, and plastics. These components are impacted by global pricing
pressures and general economic conditions. The U.S. originally imposed tariffs of 25% on steel and 10% on aluminum imported from several countries effective June 2018. The government expanded its list of products subject to tariffs to include furniture products, parts, and components at a 10% rate effective September 2018, increasing to a 25% rate effective June 2019. The U.S. government continues to evaluate the ongoing need for tariffs, and if further tariffs are assessed the landed cost of our products could increase materially, which would reduce our net income if we are unable to mitigate the additional cost. We are actively striving to offset increases in the cost of these materials through supplier negotiations, global sourcing initiatives, product re-engineering and parts standardization, and price increases on our products. We are also exposed to fluctuation in transportation costs which vary based upon freight carrier capacity and fuel prices. Transportation
costs are managed by optimizing logistics and supply chain planning, and increasing prices on our products.
There have been no material changes to other market risks, including interest rate and foreign exchange rate risks, from the information disclosed in Item 7A “Quantitative and Qualitative Disclosures About Market Risk” of our Annual Report on Form 10-K for the fiscal year ended June 30, 2019.
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Item 4. Controls and Procedures
(a)Evaluation of disclosure controls and procedures.
We
maintain controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon their evaluation of those controls and procedures performed as of September 30, 2019, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.
(b)Changes in internal control over financial reporting.
There
have been no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2019 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
A
share repurchase program authorized by the Board of Directors was announced on August 11, 2015. The program allows for the repurchase of up to two million shares of common stock and will remain in effect until all shares authorized have been repurchased. On February 7, 2019 an additional two million shares of common stock were authorized by the Board of Directors for repurchase. At September 30, 2019, approximately 2.7 million shares remained available under the repurchase program.
37
Item 6. Exhibits
Exhibits (numbered in accordance with Item 601 of Regulation S-K)
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
