Kimball International, Inc.

Bob Schneider – Chairman and Chief Executive Officer Michelle Schroeder – Vice President, Chief Financial Officer

Thank you, Carmen. And welcome everyone to our second quarter earnings conference call.

The financial results for our second quarter ended December 31, 2015 were released yesterday afternoon after the market closed and Investor Presentation slide deck has also been posted to our website to accompany this conference call. You can find that at www.kimball.com, in our – the IR section.

If you typically do not view the slide deck, I’d really suggest you look at it, it have some very good information that is trended and makes it a lot easier to see the turnaround progress being made at Kimball International. I will have a few brief comments today before I turn the call over to Michelle, who will provide us with the key financial highlights for the quarter.

We will then open up the call for questions. As a reminder, because prior year second quarter results include expenses that were eliminated from our cost structure after the spin-off of the electronic segment.

Our comments this morning will focus on adjusted pro forma operating income which adjust historical results for these expenses. We exclude these expenses from prior year comparisons because if we did not do so, our improvement would look even better than the strong results that we have.

But that would not reflect the real economics. The point is, we look at adjusted pro forma results to give you an apples-to-apples comparison as it gets very complicated to do that with a spin accounting.

A reconciliation of GAAP operating income to non-GAAP adjusted pro forma operating income is included on last page of the investor slide deck, that I mentioned, that’s on our website. It’s been a long journey in our turnaround and I’m thrilled with our overall performance this quarter.

To summarize a few key highlights for the quarter that we are very pleased with. First, our Office Furniture orders well outpaced BIFMA, which is the market indicator.

For the quarter, with 13% increase over the prior year, BIFMA was a negative 0.4%. Our hospitality orders were very strong for the quarter also with orders being up 27% when you exclude an unusually large order that we told you about in the second quarter of last year and more on that shortly.

We’ve mentioned our operating income goal of 7% to 8% in prior calls. And I’m very pleased, we reached at earlier than anticipated, as we recorded 7.5% adjusted pro forma operating income in the second quarter.

This was also, by the way our best earnings in 15 years, that, we are very proud of, but we are not done. Our return on capital approximated 22% for the second quarter, which is among the best in our industry.

We had mentioned in prior calls that when we reach the 7% to 8% op income guidance, we have best-in-class return on capital. And I’m happy to report to you that is what occurred in the second quarter.

The strong results this quarter were achieved in part by our success with our many new products introduced over the last several quarters. We discussed in the past, hitting the gas pedal on new products, really for the past year or so we’ve mentioned at these calls and coupled with our renewed focus on innovative design drove the strong results.

We’re starting to feel the traction, and it shows up in strong year-over-year new product sales. These sales were up 45%.

Now let me expand on these highlights in a little bit more detail. We are very pleased with the 7.5% adjusted pro forma operating income for the second quarter.

Despite the fact, that we have not yet completed the restructuring activity in Idaho and therefore, are not yet benefiting from the estimated sales – savings related to this. And in spite of not yet seeing that benefit, our Q2 earnings were the best in 15 years.

I was confident, a year ago that we would reach our operating income goal. But frankly, I did not expect improvement to come as quickly as it has.

I’m so proud of the engagement and focus of our entire Kimball International team, approximately 3,000 dedicated employees. If you recall, our guidance of hitting 7% to 8% operating income by the quarter ending September of 2016 was primarily faced around two assumptions.

First, gaining traction with our new product introductions, and thereby driving growth in sales. And secondly, realizing the cost savings from completing the exit of the Post Falls, Idaho facility and transferring that production to Indiana facilities.

On the sales side, we are achieving sales growth faster than we’d anticipated in our original guidance estimate, which contributed to the acceleration of our margin improvement. Our Kimball office team has been very successful in elevating the brand as a design leader with so many exciting new products.

And our National Office Furniture brand continues a long tradition of providing new and innovative solutions to the marketplace. These efforts have resulted in several awards and design recognitions that we recently received which we are very excited about.

And I will touch on those in a minute. On the cost side, as I mentioned earlier we’re not yet realizing savings related to the exit of the Idaho facility.

The exit of the Idaho facility continues on schedule, with an expected completion by this coming June 30. After which time, we will begin realizing the estimated savings of $1,250,000 per quarter.

So we’re not seeing any of that savings now. However we are still, we were still able to achieve the operating income goal in part due to the results of our many other continuous improvement and other productivity initiatives to improve our margins.

This coupled with the additional sales growth just mentioned, that drove reaching the 7.5% adjusted pro forma operating income sooner than we had anticipated. Because we have reached our operating income goal earlier than planned, without the benefit of the savings of the restructuring activity, we are adjusting our guidance upwards which Michelle will discuss in more detail shortly.

Moving now to orders, our Office Furniture order rate during the quarter was very strong compared to the industry. Office Furniture orders, as I mentioned, when that includes all verticals except hospitality were up 13% compared to the second quarter of last year, while BIFMA estimates orders in the Office Furniture industry were down 0.4% for the same time period.

Our intense focus on the design community and establishing our sales as a design leader with exciting new products is translating into increased orders and contributed to us outpacing the industry this quarter. Our hospitality orders though declined in the quarter due to $13.8 million order, we received in the second quarter of last year.

As I mentioned to you last year, orders of this size are unusual in the hospitality vertical. As a matter of fact, this was the largest single property order we had ever received and that’s why we call that out to you last year.

Excluding this order, hospitality orders increased 27%, which I was very pleased to see. Overall this was an excellent quarter for both shipments and orders.

I mentioned earlier that we recently won various awards for our new products. We are really, really excited about the attention our new product introductions are drawing in the design community.

Kimball was recognized during interior design magazines, 2015 Best of the Year award ceremony, where they’ve recognized the very best products and projects of design. Kimball office received the Best of Year award for our Canopy product, conceived by 2015 interior design Hall of Fame inductee, Primo Orpilla of Studio O+A and developed with a design team of Kimball office.

Canopy moves beyond conventional, open-plan benching to give each user a versatile work tool that changes according to the needs of the moment. And in the project category for showroom design, Studio O+A was awarded Best of Year Award for our Kimball office, Chicago showroom design.

In our National Office Furniture Mio Collaborative tables were chosen as an Honoree in the Best of Year awards. We were thrilled to be so highly recognized by interior design.

magazine. Additionally National’s Essay Seating and Wedge Cushions were winners in Interiors and Sources magazine Readers’ Choice contest.

And the Essay Seating, which is a new seating product for the education market, also was recognized in the New Product of the Year award by both School Planning & Management magazine and College Planning & Management magazine. We’re excited about the recognition of our products as some of the best in the industry and attraction our new products are having and reaching our operating income goal.

In addition to product awards, we have also recently been recognized in a few of the communities in which we operate, that I thought I’d share with you. Our Fordsville, Kentucky manufacturing facility was named Entrepreneur of the Year by the Ohio County Chamber of Commerce.

The award was in recognition of our growth and development within the community and our continued efforts and dedication to safety, as well as our dedication to be innovative in business. Our Santa Claus, Indiana manufacturing facility, recently received recertification in the Indiana Voluntary Protection Program or VPP as a STAR site.

Indiana VPP sites are recognized as leaders in workplace safety and health. We take pride in the communities, in which we are located and are committed to helping them, be great places for our employees to live and work and importantly we were recognized with a great place to work designation in July of this past year, which demonstrates our commitment to employees to be an employer of choice.

But this is so important, as it is our employees that differentiate Kimball International from our competitors. It is one thing to feel good internally about what we are doing to create value for our company.

But very inspiring and motivating to receive these various external recognitions. All of this is due to the dedication and efforts of our 3,000 employees.

In closing, while we had an excellent quarter with strong orders and are very pleased with our financial progress over the past year, we are keeping a very close eye on the overall economy. With the volatility experienced in the market since the beginning of the year, and more caution in the economic forecast for 2016.

We are closely monitoring key indicators for our markets. Now, I will turn it over to Michelle for a brief overview of the financial results, before we open it up to your questions.

Michelle?

Thanks, Bob. As Bob mentioned our operating income reference today is the adjusted pro forma operating income, and the operating income reconciliation is included on the last page of the investor slide deck that was posted to our website.

Consolidated sales for the second quarter were $163.8 million which was an increase of 8% compared to last year with increases in all of our vertical markets except for the government, this is the 10th consecutive quarter we’ve experienced sales growth over the prior year. We saw some pretty healthy growth in a couple of our vertical markets this quarter.

Sales to the finance vertical increased 35%; as we continue to work with customers to build products solution for the bank of the future thorough both custom products available as well as creating applications with our existing product that meet our customers’ needs. This is a vertical you may recall that was challenge last fiscal year.

Healthcare activity continued at a nice pace, with sales growth of 31% in the second quarter. We focused a lot of efforts in this vertical with many new products, specifically designed for the healthcare space and we increased our marketing efforts directed toward this vertical.

Our new products that address the educational market needs are gaining traction as well, with second quarter sales in the education vertical increasing 21% over last year. Sales in the hospitality verticals increased 8% in the second quarter.

And we do continue to see growth in both new construction as well as renovation. We’ve talked a lot about our new product introductions playing an instrumental role and achieving our operating income goal ahead of schedule.

Sales from new office furniture products introduced in the last three years increased 45% compared to the second quarter of last year as Bob mentioned. And as a reminder, last quarter new products sales were up 33%.

So we are seeing a nice trend there. New product sales approximated 22% of our total office furniture sales in the second quarter, compared to only 17% in the second quarter of last year.

This is a good measure of the traction we’re getting with our new products and are focused on the design community. Our consolidated orders in the second quarter were up 6% compared to last year.

And the comparison to last year is a tough comparison because of the $13.8 million hospitality order that Bob talked about. Our office furniture orders increased 13% for the second quarter, while the industry was down slightly and the quarter for us started out a little slower in October, but November and December were pretty strong.

We were excited that we surpassed BIFMA’s estimate for the industry by such a wide margin for the quarter. Hospitality orders declined 13% due to that large record order of last year and if you exclude that order, hospitality orders were up a very strong 27%.

Our order backlog at the end of December was $125.3 million, which was a 5% increase over December of last year. The strong orders during the quarter along with the increased backlog is encouraging heading into our normal seasonal low quarter.

But as a reminder, our fiscal year third quarter is normally our lowest sales quarter of the year. Second quarter non-GAAP adjusted pro forma operating income as shown on the last page of our investor slide deck was 7.5%.

After so much work this past year, was very exciting quarter to be able to achieve our operating income goal before ahead of our original estimate. The improvement compared to last year’s second quarter operating income of 4% is remarkable.

As Bob mentioned, the benefit from the leverage of the higher sales volume contributed to that improved margins. In addition, recent price increases and the impact of margin improvement initiative also contributed to the improved result.

Partially offsetting the improvements, we did experience some higher warehousing and handling costs particularly within the hospitality market as we’re working to reduce our inventory levels. And we did experience some normal start-up expenses related to the relocation of products from our Idaho operation to our Indiana location.

The effective tax rate for the second quarter was 36.6%, the IRS did permanently extend the research and development credit in December making it retroactive for calendar year 2015. As a result, we recorded in R&D credit of about 243,000 in the second quarter.

We expect our combined effective tax rate on average to normally be in the range of 35% to 38%. Our adjusted pro forma income from continuing operations after excluding restructuring costs was $7.7 million in the second quarter of this year.

This is a substantial increase compared to prior year adjusted pro forma income of $4.3 million, which is again, as adjusted for the spin-off costs and the pro forma retirement related adjustments related to the spin-off. Pretax restructuring costs related to the exit of the Post Falls, Idaho facility were $2 million in the second quarter and as we mentioned earlier, we do expect this restructuring to be complete by June 30 of this year.

So looking forward, we are adjusting our earnings guidance as a result of achieving our sales growth faster than we have anticipated in our original estimate. And also reaching our operating income goal before realizing the benefit of the savings from the restructuring activity.

The hard work that team has done to increase sales and improve margins gives us the confidence to increase our operating income guidance to 8% to 9% once we began seeing the savings from the Idaho facility exit which will be fully realized for the first time during the quarter ending September 2016. So this is very clear, we have come a long way in our journey of improving performance of our businesses.

And we just had a great quarter at 7.5% adjusted pro forma operating income. But we will not consistently perform at that level or better until we complete that restructuring plans and complete working through that.

So the first full quarter following the completion will be the quarter ending September 2016. And that’s a very important to note.

One of the new sites actually incorrectly reported the timing of hitting our guidance this morning. So it’s in the quarter ending September 2016 that we estimate our sales will be in the range of $170 million to $180 million.

Our operating income will be in the range of 8% to 9% and our EPS to be in the range of $0.23 to $0.27. So again to summarize, so that’s in the quarter ending September 2016 forward, we feel, we will be able to consistently perform at the 8% to 9% operating income level, subject to the usual seasonality in our industry that we see in the third quarter.

And this guidance does assume that economic conditions do not significantly deteriorate over the next three quarters. We are cautiously optimistic that the U.S.

economy will continue to grow although at a slower pace. And we will continue to monitor activity in our markets very closely.

Moving to the balance sheet. As of December 31, our cash and cash equivalents was $26.1 million.

Our operating cash flow in the second quarter was $8.9 million compared to $8.5 million in the second quarter of last year, which still did include one month of electronics. We paid $2.1 million in quarterly dividends in the second quarter.

Our capital expenditures totaled $3 million for the quarter, which was primarily for machinery and equipment purchases. In the past year, we’ve purchased 20 million of stock.

However we do not repurchase any shares during the second quarter and we continue to review and discuss with our Board of Directors options around our capital structure including repurchasing additional shares. Days sales outstanding, which is our measure of accounts receivable performance was approximately 29 days for both the second quarter of this year and the second quarter of last year.

Our inventory metric, our production day supply on hand for the second quarter of this year increased to approximately 53 days from approximately 42 days from the second quarter of last year. Driven by increased inventory levels to support growth customer lead time requirements and the restructuring activities.

We continue to have almost no long-term debt, which was at $226,000 at December 31. With that I would like to open the call today to questions from analysts.

Carmen do we have anyone with questions?

Hi, good morning, congratulations on really good quarter. So question dealing with margins, this past quarter with this guidance you’ve now raised your EBIT to 8% to 9% for the quarter ending September 30, from low end of 7% to 8%.

So it seems that obviously you are optimistic on the next two quarters, at the end of current fiscal year. So is it fair to say that implies that you expect continued sales gains in finance, healthcare and education that’s not too far off, what you just achieved this quarter and that the EBIT rate for the next two quarters should rise steadily from the adjusted 7.5% on up to that 8% to 9% range.

In short, Mark, no and the reason is we have the usual seasonality that happens in the – primarily in the office side of the business and that always put pressure in our quarter ending in March, relative to the quarter that we just ended. And so we are going to have the usual cyclical seasonality that’s going to put pressure on sales levels, relative to the previous quarter, the sequential previous quarter, ending in December.

Right.

That therefore makes it very difficult in terms of spreading fixed costs to get the margin up to where it was in the quarter we just ended. So you can’t trend so to speak that from the level that we have now trending in over the next two quarters to get to that 8% to 9%.

And the reason is Michelle touched on why we are jumping ahead effectively the three quarters to the quarter ending in September and giving guidance to that quarter is because it is when we get to get to that quarter, we will have the Post Falls, Idaho restructuring totally behind us. And the uncertainty of really the most complex transport work we have ever done in the history of this company, we will have that done.

And between now and then we run the risks of just the duplicate labor issues that happen on learning curve, as you're transitioning so much business. And we need to get that cost out of our cost structure and then be leaping that $1.2 million – $1,250,000 a quarter thereafter.

And at that point, being much more confident we can consistently be at that 8% to 9% level. But between now and then, there's room for some volatility just because of seasonality in the third – what is our third quarter ending in March.

And of course also we're very cautious in terms of what might be going on with the overall economy in general.

Okay. So with the, yes, I forgot about that third quarter seasonality.

With the Post Falls that’s closing, you mentioned possible learning curve. But you've already been transitioning a lot of that work out of Post Falls into current facilities.

Is that correct and if so, how was that learning curve would be going?

Yes. That is very, very correct.

We today, I say today, as about a week ago, we have about half of the number of employees in the Idaho facility that we had on the day we announced our plans. So we've pretty much cut in half in terms of headcount, there's a lot of equipment that has been moved out of that facility and it's in multiple facilities in Indiana.

So it's going very, very well, we're probably in terms of all of the transfer work et cetera, we're probably 18% or so of the way completed. And we've got another 20% or so to get to the finish line on that.

But during the last several quarters and the quarter just ended and in the quarter we're in right now, we're having start-up costs, learning curve, duplicate labor, extra inventory because you've got product being made at two different locations and that will be out of our system until we get this done. The latest of which would be to June 30, 2016.

And then after that, is going to Michelle's point that risk, that extra effort although the cost et cetera will be behind us. And we'll have a lot more confidence in terms of the stability of our profitability going forward at that point.

Okay. And then what percent of the production was in Idaho prior to, starting to wind that down?

That's a very good question. But that one facility is 475,000 square feet.

I don't remember off the top of my head, the total square footage we have in manufacturing. But it was one of about, maybe 12 facilities, gives you a little bit of perspective, very, very important in terms for our medical – our metal product.

Because that was the facility where we did the metal bending and actually made the metal furniture of Kimball, we didn't have any – we don't have any other facility doing that. We will, as we get this completed by June.

So a very, very important facility as it relates to that product. But in terms of total manufacturing, a small percentage of our total square footage and product.

Okay. So then looking at the gains in finance, healthcare and education where sale gains are pretty amazing.

I assume there were no big orders that cause the big lump upwards. And was that spread out across in each vertical, was that spread out amongst mark counts or was it concentrated towards just certain one or two accounts?

Nothing of significance in terms of concentration and I would ask if you look at our slide deck that accompanies this call on our website, we spell out and show graphically how those various verticals were doing. Just to give you a little more perspective on it, but then comparison to the prior year.

But generally speaking, no single large orders drove that, it's really, it's getting traction on the new products that are going into those verticals.

Have you expanded your sales force by much?

Not substantially.

Okay. So then once you hit that 8% to 9%, assuming you hit it in the September quarter.

Aside from the seasonality of the third quarter, looking at Q1, Q2 and Q4. Is there any reason why those quarters, whatever are below 8% to 9%?

Our view is Mark that, once we get Post Falls finished, all things being equal, we're going to be very confident in being at that level of profitability going forward. We will always have the Q3 pressure that could perhaps push it below.

But generally speaking, we’re going to feel very, very good that we can maintain that profitability. I’ve mentioned before in prior calls when discussing at that time, 7% to 8% operating income guidance and goal.

And now what we have just gone public with in terms of 8% to 9%. Our businesses are improving tremendously over this past year.

They're not all, where they need to be and so I'm very, very confident as we continue to grow both – all of our businesses and improve those that are not as healthy as they need to be. We're going to be positioned very well to maintain that 8% to 9% and even to bypass that although at this point, we're not sure what that might be and what’s the timeframe might be.

Okay. And then, I assume at this point your manufacturing facilities are additional just running one shift, so there's still lots and lots of capacity to go?

It depends on how you measure a capacity. Generally speaking, we are operating on one shift.

We often have certain type of production process as it might be on a second shift. But generally speaking, one is the correct answer to that.

But when you look at capacity, and you look at it, a lot of our markets that we're in terms of the employment base. The ability to add a second shift or third shift, the constraint is finding people to do that.

So when I look at our businesses, I think, I think we don't have a whole lot of opportunity to go to full second shifts and certainly, I don't think we could do third shifts from a theoretical standpoint, given the employment base in lot of our locales.

Okay. Then, let’s see.

You spoke of price increases that help gross margin. What quarter do you start to see these gains and price increases?

Or is that something you just continuously level in…

What we do, Mark as we pay very, very close attention to what is happening in our markets with the key players in the market that are much, much bigger than us. Trying to get a sense of what is happening in terms of price increases to the market.

We study that, we study what's happening in terms of our cost structure and then making determination, do we need to have a price increase? We are small player in the office furniture industry.

In the hospitality industry, we're a very big player relative to all of our competitors. But that is more custom and project based and price increases really don't – it doesn't come into play as, because it's so custom.

But as it relates to office furniture, we are a small player, we watch what's happening in the industry and we don't have specific timelines on when we do price increases, it's really when we think it is needed because the cost structure and looking at what's happening in the market.

Okay. And so then the material costs were down.

Is that driven by the lower raw material costs?

Yes. Seeing things like steel prices being down, aluminum pricing being down, we have some things go in the other direction though that are netting negatively.

But generally it netted out positive this past quarter.

Okay. And then just lastly, share buybacks.

The way the press release read it, makes it sound as they bought back $10 million this quarter. But on the call it sounds like you didn’t buy any shares this quarter.

Yes. We did not buy anything this quarter.

The work that we did in this past year, in total, that started – Michelle, in March here?

March. Yes, March.

In March up through when did we stopped – about?

In Q1.

In Q1?

We had about $10 million in the first quarter. So $10 million year-to-date…

Yes. So, in $10 million year-to-date, $20 million in terms of what we’ve done in the calendar year.

I assume it’s a little confusing, but nothing happened in the second quarter.

Yes. That $9.7 million that’s in the press release is a year-to-date number.

That’s comparing our cash at June to our cash at December.

Okay. All right.

And then is there any intention to buy just opportunistically or why not buyback if it’s steady rates every quarter?

What we do Mark, as we discuss with our Board a couple of things, one is the capital structure and the amount of capital we have on our balance sheet, that discussion in the February Board meeting a year ago prompted us to take $20 million of our cash and buyback stock. That’s one aspect.

The other aspect is selectively throughout the year, looking at where it makes sense to buy some shares that fund normal annual incentive comp, so that we don’t dilute the shares year-over-year through executive compensation.

Okay. All right.

That was all I had. I appreciate all the help.

Thank you.

All right. Thank you, Mark.

Thank you.

Okay. Thank you, Carmen.

And thanks everyone. In closing, I just want to reiterate once again how pleased I was, with how quickly we are seeing improvement in our operating results.

When we initially provided the guidance around our operating income goal of 7% to 8%, I was confident we’ll be able to hit that target once we started realizing the savings from the Idaho facility exit as I mentioned. To get there, before realizing those savings is a true testament to the focus and commitment and engagement of the entire team of Kimball International this past year.

We appreciate your interest and look forward to speaking with you on our next call. Thank you, and have a great day.