Kimball International, Inc. today announced the following results for the quarter ended March 31, 2018:

Revenue was $157.9 million, a 3% increase over the prior year, inclusive of the recent D'style acquisition. Excluding D'style, organic net sales were flat compared to the prior year.
Operating income was $8.5 million or 5.4% of net sales, compared to $10.9 million or 7.2% of net sales in the prior year.
Net income was $5.9 million and diluted earnings per share was $0.16, while prior year net income was $7.2 million and diluted earnings per share was $0.19.

Bob Schneider, Chairman and CEO, stated, “I was pleased to see continued strength in the hospitality market in our third quarter; however, increased sales in this vertical market were unfortunately offset by lower sales in other market verticals, resulting in flat organic sales for the third quarter. Encouragingly, we saw a pick up in orders late in the quarter continuing into April. Consolidated organic orders increased approximately 30% in April over the prior year, and specifically in the hospitality vertical, April orders were the strongest of any month we have seen since 2014. As I look to the future, I am very excited about the many new products we've recently introduced to the market that are starting to gain traction, and also the ones we will be introducing at the office industry trade show in June. Our product portfolio is filling out very nicely with creative products resonating with the design community and end-users. While we are pushing hard on new product introductions, other teams are also actively working on continuous improvement and cost reduction projects to offset the increased inflation we are experiencing in transportation, steel and other commodities. Our teams have several productivity and lean initiatives that have been in the works for several months, with anticipated savings of approximately $7 million in fiscal year 2019. In addition, our National brand recently implemented a price increase that was effective on April 6, 2018, while our Kimball brand announced a price increase that will be effective in July 2018, which will help in offsetting the heavier than usual commodity inflation we are experiencing. We estimate that higher transportation and commodity costs reduced our operating income by approximately $1.9 million in our third quarter.”

Mr. Schneider concluded, “Regarding our capital structure, we generated $11 million of operating cash flow during the third quarter, bringing our total cash balance to $77.7 million at the end of March. We are investing in automation and new technologies in our operations, and have been active the last few quarters buying back shares, which we expect to continue. We have approximately 1.3 million shares remaining under our share repurchase program. Lastly, we just recently completed the acquisition of D'style and are continuing to actively pursue other tuck-in acquisitions that will create synergies with our current brands. Our capital structure continues to be very strong and available to support growth.”

* The item indicated represents a Non-GAAP measurement. See “Reconciliation of Non-GAAP Financial Measures” below.

Consolidated net sales increased 3%, driven by increases in the hospitality and commercial vertical markets partially offset by declines in the healthcare, education, and government verticals. The hospitality vertical grew both due to the D’style acquisition and due to organic sales growth. Although sales in the healthcare vertical declined, it has experienced a strong rebound in quoting activity. Sales declined in the education vertical as new construction projects were down compared to the prior year.

Orders received during the third quarter of fiscal year 2018 decreased 6% from the prior year, primarily driven by decreases in the government, commercial, education, and healthcare vertical markets, partially offset by increases in the finance and hospitality verticals. Excluding the D’style acquisition, orders received decreased by 9%. The decline in orders is in large part driven by the timing of a price increase at one of our office furniture brands in the prior year. The price increase went into effect April 1, 2017 which had the effect of accelerating orders prior to the price increase.

Margin pressures continued in the third quarter. Gross profit as a percent of net sales declined 320 basis points from the prior year due to transportation cost increases, higher discounting, and an increase in the LIFO inventory reserve, partially offset by price increases and the additional margin contributed by D’style. In addition, sales mix had an unfavorable impact on the third quarter results. With the seasonally low volume in the third quarter, when larger projects that include lower margin systems product ship during the quarter, the impact on margins is magnified. The Company expects the margin pressure related to sales mix to begin subsiding in the fiscal year fourth quarter ending in June 2018.

Selling and administrative expenses in the third quarter decreased 140 basis points as a percent of net sales and decreased 2% in absolute dollars compared to the prior year. The decrease in selling and administrative expense was driven by lower incentive compensation, partially offset by the additional selling and administrative expenses of the D’style acquisition including amortization of acquired intangibles and acquisition expenses.

The Company benefited from a lower effective tax rate of 31.2% for the third quarter of fiscal year 2018 compared to the prior year effective tax rate of 36.8%. The decline was driven by the new tax act, where the Company's statutory federal tax rate for fiscal year 2018 is a blended rate of 28.1% compared to the previous rate of 35%. The Company expects the lower tax rate to generate significant tax savings in future periods.

Operating cash flow for the third quarter of fiscal year 2018 was $11.0 million compared to operating cash flow of $17.6 million in the prior year, a decrease of $6.6 million. The decrease was primarily driven by changes in working capital balances and lower net income.

The Company's balance in cash, cash equivalents, and short-term investments was $77.7 million at March 31, 2018, compared to $98.6 million at June 30, 2017. The year-to-date fiscal year 2018 decrease was primarily due to a $17.8 million cash outflow for the D’style acquisition, capital expenditures of $15.8 million, and the return of capital to share owners in the form of $8.1 million in stock repurchases and $7.5 million in dividends, which more than offset $26.4 million of cash flows from operations.

Financial Targets

On April 13th, BIFMA (Business and Institutional Furniture Manufacturers’ Association) published its commercial furniture industry outlook for U.S. commercial furniture which includes office, education, and healthcare, lowering their projection for calendar year 2018 market growth to 1.9% from their previous projection of 4.8% growth, and setting their 2019 growth projection at 3.6%. Mr. Schneider commented, “As a result of the new BIFMA outlook for 2018 and 2019 along with increasing discounting, transportation, steel and other commodity costs, we have reassessed our previously disclosed financial targets.” The Company’s previous financial outlook was mid-single digit organic sales growth, operating income as a percent of sales between 9.5% and 10.5% in fiscal year 2019 and return on capital to exceed 20%. The updated outlook, excluding acquisitions, is the following:

Over The Next Three To Five Years:

Sales — mid-single digit organic growth annually
Operating Income Margin — growth of 2X to 2.5X sales growth
Operating Income Long-Term Target — 10%
Effective tax rate — 25% to 27%
EPS — growth of 2X to 2.5X sales growth

“We started our turnaround journey with the spin-off of our Electronics business in 2014. At the spin-off date, we set a goal to get to an 8% operating income margin and did so quickly, improving our adjusted pro forma operating income from continuing operations margin from 1.6% in fiscal year 2014 to 8.2% in fiscal year 2017. Few thought we could achieve the 8% goal as quickly as we did. We now are earnestly pushing to achieve the goal of a consistent 10% operating margin over the next three to five years. While the above outlook is organic, we fully expect to grow beyond the mid-single digit growth level when including future acquisitions,” noted Mr. Schneider.

The Company's financial targets assume that economic conditions do not significantly worsen, negatively affecting the industries which it serves. It also does not include any potential impact to sales and earnings related to future acquisitions or the government’s review of our subcontract reporting process.