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KIMBALL INTERNATIONAL INC - Quarter Report: 2018 December (Form 10-Q)



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2018
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number    0-3279
kimballlogonobrand.jpg
KIMBALL INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Indiana
 
35-0514506
(State or other jurisdiction of
 
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 
1600 Royal Street, Jasper, Indiana
 
47549-1001
(Address of principal executive offices)
 
(Zip Code)
(812) 482-1600
Registrant’s telephone number, including area code
Not Applicable
Former name, former address and former fiscal year, if changed since last report

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). 
Yes  o    No  x

The number of shares outstanding of the Registrant’s common stock as of January 23, 2019 was:
Class A Common Stock - 257,079 shares
Class B Common Stock - 36,454,633 shares



KIMBALL INTERNATIONAL, INC.
FORM 10-Q
INDEX
 
Page No.
 
 
 
 
PART I    FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II    OTHER INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

KIMBALL INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands, Except for Share and Per Share Data)
 
(Unaudited)
 
 

 
December 31,
2018
 
June 30,
2018
ASSETS
 

 
 

Current Assets:
 

 
 

Cash and cash equivalents
$
38,993

 
$
52,663

Short-term investments
42,076

 
34,607

Receivables, net of allowances of $1,362 and $1,317, respectively
64,085

 
62,276

Inventories
48,994

 
39,509

Prepaid expenses and other current assets
15,331

 
18,523

Assets held for sale
281

 
281

Total current assets
209,760

 
207,859

Property and Equipment, net of accumulated depreciation of $181,743 and $180,059, respectively
88,433

 
84,487

Goodwill
11,161

 
8,824

Other Intangible Assets, net of accumulated amortization of $37,688 and $36,757, respectively
12,022

 
12,607

Deferred Tax Assets
6,828

 
4,916

Other Assets
12,090

 
12,767

Total Assets
$
340,294

 
$
331,460

 
 
 
 
LIABILITIES AND SHAREOWNERS’ EQUITY
 
 
 
Current Liabilities:
 
 
 
Current maturities of long-term debt
$
25

 
$
23

Accounts payable
52,236

 
48,214

Customer deposits
26,849

 
21,253

Dividends payable
3,044

 
2,662

Accrued expenses
42,491

 
50,586

Total current liabilities
124,645

 
122,738

Other Liabilities:
 
 
 
Long-term debt, less current maturities
136

 
161

Other
14,642

 
15,537

Total other liabilities
14,778

 
15,698

Shareowners’ Equity:
 
 
 
Common stock-par value $0.05 per share:
 
 
 
Class A - Shares authorized: 50,000,000
               Shares issued: 257,000 and 264,000, respectively
13

 
13

Class B - Shares authorized: 100,000,000
               Shares issued: 42,768,000 and 42,761,000, respectively
2,138

 
2,138

Additional paid-in capital
2,607

 
1,881

Retained earnings
264,267

 
249,945

Accumulated other comprehensive income
1,861

 
1,816

Less: Treasury stock, at cost, 6,324,000 shares and 5,901,000 shares, respectively
(70,015
)
 
(62,769
)
Total Shareowners’ Equity
200,871

 
193,024

Total Liabilities and Shareowners’ Equity
$
340,294

 
$
331,460

See Notes to Condensed Consolidated Financial Statements

3


KIMBALL INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Amounts in Thousands, Except for Per Share Data)
 
(Unaudited)
 
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
December 31
 
December 31
 
2018
 
2017
 
2018
 
2017
Net Sales
$
201,008

 
$
178,614

 
$
395,131

 
$
353,974

Cost of Sales
136,019

 
121,194

 
264,269

 
232,547

Gross Profit
64,989

 
57,420

 
130,862

 
121,427

Selling and Administrative Expenses
51,491

 
45,415

 
103,670

 
93,465

Operating Income
13,498

 
12,005

 
27,192

 
27,962

Other Income (Expense):
 
 
 
 
 
 
 
Interest income
428

 
234

 
847

 
468

Interest expense
(56
)
 
(74
)
 
(106
)
 
(105
)
Non-operating income (expense), net
(1,226
)
 
263

 
(899
)
 
549

Other income (expense), net
(854
)
 
423

 
(158
)
 
912

Income Before Taxes on Income
12,644

 
12,428

 
27,034

 
28,874

Provision for Income Taxes
3,239

 
5,050

 
6,753

 
10,539

Net Income
$
9,405

 
$
7,378

 
$
20,281

 
$
18,335

 
 
 
 
 
 
 
 
Earnings Per Share of Common Stock:
 

 
 

 
 
 
 
Basic Earnings Per Share
$
0.26

 
$
0.20

 
$
0.55

 
$
0.49

Diluted Earnings Per Share
$
0.25

 
$
0.20

 
$
0.54

 
$
0.49

 
 
 
 
 
 
 
 
Dividends Per Share of Common Stock
$
0.08

 
$
0.07

 
$
0.16

 
$
0.14

 
 
 
 
 
 
 
 
Class A and B Common Stock:
 
 
 
 
 
 
 
Average Number of Shares Outstanding - Basic
36,793

 
37,476

 
36,951

 
37,452

Average Number of Shares Outstanding - Diluted
37,088

 
37,736

 
37,347

 
37,775

See Notes to Condensed Consolidated Financial Statements


4


KIMBALL INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in Thousands)
 
(Unaudited)
 
(Unaudited)
 
Three Months Ended
 
Three Months Ended
 
December 31, 2018
 
December 31, 2017
(Unaudited)
Pre-tax
 
Tax
 
Net of Tax
 
Pre-tax
 
Tax
 
Net of Tax
Net income
 
 
 
 
$
9,405

 
 
 
 
 
$
7,378

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale securities
$
41

 
$
(11
)
 
$
30

 
$
(44
)
 
$
17

 
$
(27
)
Postemployment severance actuarial change
158

 
(41
)
 
117

 
239

 
(84
)
 
155

Derivative gain (loss)
(2
)
 
—

 
(2
)
 
—

 
—

 
—

Reclassification to (earnings) loss:
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale securities
—

 
—

 
—

 
3

 
(1
)
 
2

Amortization of actuarial change
(103
)
 
27

 
(76
)
 
(66
)
 
17

 
(49
)
Derivatives
5

 
(1
)
 
4

 
—

 
—

 
—

Other comprehensive income (loss)
$
99

 
$
(26
)
 
$
73

 
$
132

 
$
(51
)
 
$
81

Total comprehensive income
 
 
 
 
$
9,478

 
 
 
 
 
$
7,459

 
(Unaudited)
 
(Unaudited)
 
Six Months Ended
 
Six Months Ended
 
December 31, 2018
 
December 31, 2017
(Unaudited)
Pre-tax
 
Tax
 
Net of Tax
 
Pre-tax
 
Tax
 
Net of Tax
Net income
 
 
 
 
$
20,281

 
 
 
 
 
$
18,335

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale securities
$
15

 
$
(4
)
 
$
11

 
$
(30
)
 
$
12

 
$
(18
)
Postemployment severance actuarial change
238

 
(61
)
 
177

 
506

 
(188
)
 
318

Derivative gain (loss)
(11
)
 
2

 
(9
)
 
—

 
—

 
—

Reclassification to (earnings) loss:
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale securities
—

 
—

 
—

 
3

 
(1
)
 
2

Amortization of actuarial change
(202
)
 
52

 
(150
)
 
(133
)
 
43

 
(90
)
Derivatives
21

 
(5
)
 
16

 
—

 
—

 
—

Other comprehensive income (loss)
$
61

 
$
(16
)
 
$
45

 
$
346

 
$
(134
)
 
$
212

Total comprehensive income
 
 
 
 
$
20,326

 
 
 
 
 
$
18,547

See Notes to Condensed Consolidated Financial Statements


5


KIMBALL INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Thousands)
 
(Unaudited)
 
Six Months Ended
 
December 31
 
2018
 
2017
Cash Flows From Operating Activities:
 
 
 
Net income
$
20,281

 
$
18,335

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization
8,320

 
7,542

Gain on sales of assets
(1,164
)
 
(2,153
)
Deferred income tax and other deferred charges
(1,907
)
 
5,369

Stock-based compensation
3,628

 
2,511

Other, net
(1,166
)
 
729

Change in operating assets and liabilities:
 
 
 
Receivables
(1,486
)
 
2,203

Inventories
(6,745
)
 
656

Prepaid expenses and other current assets
2,795

 
(8,892
)
Accounts payable
3,292

 
(1,938
)
Customer deposits
5,596

 
4,529

Accrued expenses
(7,536
)
 
(13,509
)
Net cash provided by operating activities
23,908

 
15,382

Cash Flows From Investing Activities:
 
 
 
Capital expenditures
(10,346
)
 
(11,722
)
Proceeds from sales of assets
1,269

 
5,630

Cash paid for acquisitions
(4,850
)
 
(17,800
)
Purchases of capitalized software
(374
)
 
(423
)
Purchases of available-for-sale securities
(26,196
)
 
(18,902
)
Maturities of available-for-sale securities
18,618

 
16,477

Other, net
30

 
(133
)
Net cash used for investing activities
(21,849
)
 
(26,873
)
Cash Flows From Financing Activities:
 
 
 
Net change in capital leases and long-term debt
(23
)
 
(26
)
Dividends paid to shareowners
(5,562
)
 
(4,857
)
Repurchases of Common Stock
(9,130
)
 
(1,781
)
Repurchase of employee shares for tax withholding
(1,035
)
 
(2,426
)
Net cash used for financing activities
(15,750
)
 
(9,090
)
Net Decrease in Cash, Cash Equivalents, and Restricted Cash (1)
(13,691
)
 
(20,581
)
Cash, Cash Equivalents, and Restricted Cash at Beginning of Period (1)
53,321

 
63,088

Cash, Cash Equivalents, and Restricted Cash at End of Period (1)
$
39,630

 
$
42,507

Supplemental Disclosure of Cash Flow Information
 
 
 
Cash paid during the period for:
 
 
 
Income taxes
$
2,641

 
$
13,139

Interest expense
$
69

 
$
105


(1) The following table reconciles cash, cash equivalents, and restricted cash per the statements of cash flows to the balance sheets. 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. Beginning in the second quarter of fiscal year 2018, 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.
(Amounts in Thousands)
December 31,
2018
 
June 30,
2018
 
December 31,
2017
 
June 30,
2017
Cash and Cash Equivalents
$
38,993

 
$
52,663

 
$
41,852

 
$
62,882

Restricted cash included in Other Assets
637

 
658

 
655

 
206

Total Cash, Cash Equivalents, and Restricted Cash at end of period
$
39,630

 
$
53,321

 
$
42,507

 
$
63,088

See Notes to Condensed Consolidated Financial Statements

6


KIMBALL INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREOWNERS’ EQUITY
(Amounts in Thousands, Except for Share and Per Share Data)
 
Common Stock
 
Additional Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Treasury Stock
 
Total Shareowners’ Equity
Three months ended December 31, 2018 (Unaudited)
Class A
 
Class B
 
Amounts at September 30, 2018
$
13

 
$
2,138

 
$
1,431

 
$
257,825

 
$
1,788

 
$
(64,511
)
 
$
198,684

Net income
 
 
 
 
 
 
9,405

 
 
 
 
 
9,405

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
73

 
 
 
73

Issuance of non-restricted stock (9,000 shares)
 
 
 
 
(125
)
 
 
 
 
 
125

 
—

Conversion of Class A to Class B common stock (7,000 shares)
—

 
—

 
 
 
 
 
 
 
 
 
—

Compensation expense related to stock incentive plans
 
 
 
 
1,683

 
 
 
 
 
 
 
1,683

Restricted share units issuance (15,000 shares)
 
 
 
 
(382
)
 
 
 
 
 
201

 
(181
)
Repurchase of Common Stock (371,000 shares)
 
 
 
 
 
 
 
 
 
 
(5,830
)
 
(5,830
)
Dividends declared ($0.08 per share)
 
 
 
 
 
 
(2,963
)
 
 
 
 
 
(2,963
)
Amounts at December 31, 2018
$
13

 
$
2,138

 
$
2,607

 
$
264,267

 
$
1,861

 
$
(70,015
)
 
$
200,871

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended December 31, 2017 (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
Amounts at September 30, 2017
$
14

 
$
2,137

 
$
712

 
$
234,616

 
$
1,246

 
$
(56,710
)
 
$
182,015

Net income
 
 
 
 
 
 
7,378

 
 
 
 
 
7,378

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
81

 
 
 
81

Issuance of non-restricted stock (9,000 shares)
 
 
 
 
(121
)
 
 
 
 
 
120

 
(1
)
Conversion of Class A to Class B common stock (1,000 shares)
—

 
—

 
 
 
 
 
 
 
 
 
—

Compensation expense related to stock incentive plans
 
 
 
 
975

 
 
 
 
 
 
 
975

Performance share issuance
 
 
 
 
 
 
1

 
 
 
 
 
1

Repurchase of Common Stock (2,000 shares)
 
 
 
 
 
 
 
 
 
 
(35
)
 
(35
)
Dividends declared ($0.07 per share)
 
 
 
 
 
 
(2,641
)
 
 
 
 
 
(2,641
)
Amounts at December 31, 2017
$
14

 
$
2,137

 
$
1,566

 
$
239,354

 
$
1,327

 
$
(56,625
)
 
$
187,773

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended December 31, 2018 (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
Amounts at June 30, 2018
$
13

 
$
2,138

 
$
1,881

 
$
249,945

 
$
1,816

 
$
(62,769
)
 
$
193,024

Net income
 
 
 
 
 
 
20,281

 
 
 
 
 
20,281

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
45

 
 
 
45

Issuance of non-restricted stock (21,000 shares)
 
 
 
 
(288
)
 
 
 
 
 
276

 
(12
)
Conversion of Class A to Class B common stock (7,000 shares)
—

 
—

 
 
 
 
 
 
 
 
 
—

Compensation expense related to stock incentive plans
 
 
 
 
3,628

 
 
 
 
 
 
 
3,628

Performance share issuance (81,000 shares)
 
 
 
 
(1,709
)
 
 
 
 
 
1,057

 
(652
)
Restricted share units issuance (15,000 shares)
 
 
 
 
(382
)
 
 
 
 
 
201

 
(181
)
Relative total shareholder return performance units issuance (27,000 shares)
 
 
 
 
(523
)
 
 
 
 
 
350

 
(173
)
Repurchase of Common Stock (567,000 shares)
 
 
 
 
 
 
 
 
 
 
(9,130
)
 
(9,130
)
Dividends declared ($0.16 per share)
 
 
 
 
 
 
(5,959
)
 
 
 
 
 
(5,959
)
Amounts at December 31, 2018
$
13

 
$
2,138

 
$
2,607

 
$
264,267

 
$
1,861

 
$
(70,015
)
 
$
200,871

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended December 31, 2017 (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
Amounts at June 30, 2017
$
14

 
$
2,137

 
$
2,971

 
$
230,763

 
$
1,115

 
$
(60,796
)
 
$
176,204

Net income
 
 
 
 
 
 
18,335

 
 
 
 
 
18,335

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
212

 
 
 
212

Issuance of non-restricted stock (19,000 shares)
 
 
 
 
(372
)
 
 
 
 
 
373

 
1

Conversion of Class A to Class B common stock (1,000 shares)
—

 
—

 
 
 
 
 
 
 
 
 
—

Compensation expense related to stock incentive plans
 
 
 
 
2,511

 
 
 
 
 
 
 
2,511

Performance share issuance (226,000 shares)
 
 
 
 
(2,261
)
 
(4,462
)
 
 
 
4,622

 
(2,101
)
Relative total shareholder return performance units issuance (38,000 shares)
 
 
 
 
(1,283
)
 
 
 
 
 
957

 
(326
)
Repurchase of Common Stock (107,000 shares)
 
 
 
 
 
 
 
 
 
 
(1,781
)
 
(1,781
)
Dividends declared ($0.14 per share)
 
 
 
 
 
 
(5,282
)
 
 
 
 
 
(5,282
)
Amounts at December 31, 2017
$
14

 
$
2,137

 
$
1,566

 
$
239,354

 
$
1,327

 
$
(56,625
)
 
$
187,773

See Notes to Condensed Consolidated Financial Statements

7


KIMBALL INTERNATIONAL, INC.
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.
Prior Period Reclassifications
Our prior period financial statements were recast for the full retrospective adoption of guidance on the recognition of revenue from contracts with customers. Certain prior period amounts on the Condensed Consolidated Statements of Cash Flows have also been recast to incorporate restricted cash flows and restricted cash balances, as a result of the retrospective adoption of new accounting guidance.
Note 2. Recent Accounting Pronouncements and Supplemental Information
Recently Adopted Accounting Pronouncements:
In August 2018, the Securities and Exchange Commission adopted disclosure and simplification amendments which update certain disclosure requirements that were redundant, duplicative, overlapping, outdated, or superseded. The amendments require a shareowners’ equity statement provided in interim financial statements or in a note. The adoption resulted in the addition of an interim Condensed Consolidated Statements of Shareowners’ Equity.
In June 2018, the Financial Accounting Standards Board (“FASB”) issued guidance to improve the accounting for and to reduce the cost and complexity of share-based payments to nonemployees for goods and services. The guidance is effective for our first quarter of fiscal year 2020 with early adoption permitted, but it may not be adopted earlier than our adoption of the new revenue standard. We early adopted the guidance in our first quarter of fiscal year 2019 in advance of the October 2018 retirement of our Chief Executive Officer and Chairman of the Board of Directors, who will have stock compensation awards vesting after his retirement. The adoption did not have a material effect on our condensed consolidated financial statements.
In May 2017, the FASB issued guidance that clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. The guidance was adopted during our first quarter of fiscal year 2019 and was applied prospectively to awards modified on or after the adoption date. The adoption of the guidance did not have a material effect on our condensed consolidated financial statements.
In March 2017, the FASB issued guidance that requires employers that present a measure of operating income in their statement of income to include only the service cost component of net periodic benefit cost in operating expenses, which will impact the presentation of our postemployment benefit plan. Employers are required to present all other components of Net periodic benefit cost separate from the service costs and disclose the line item in which the components of Net periodic benefit cost other than the service cost are included. Due to the immaterial amounts in prior periods we did not apply the rule retrospectively. The guidance was adopted during our first quarter of fiscal year 2019 and did not have a material effect on our condensed consolidated financial statements.
In February 2017, the FASB issued guidance that clarifies the scope of guidance on nonfinancial asset derecognition as well as the accounting for partial sales of nonfinancial assets. This new guidance is meant to clarify the scope of the original guidance that was issued in connection with the guidance relating to the recognition of revenue from contracts with customers, as defined below, which addresses recognizing gains and losses from the transfer of nonfinancial assets in contracts with noncustomers. The guidance was adopted during our first quarter of fiscal year 2019 concurrently with the adoption of the guidance on recognition of revenue from contracts with customers. The adoption of this guidance did not have a material impact on our condensed consolidated financial statements.

8


In November 2016, the FASB issued guidance which requires an entity to include in their cash and cash equivalent balances in the statement of cash flows those amounts that are deemed to be restricted cash and restricted cash equivalents. The guidance was adopted during our first quarter of fiscal year 2019 and was applied retrospectively to each prior reporting period. The guidance resulted in certain prior period amounts being reclassified to conform with the current period presentation, including the addition of restricted cash to cash and cash equivalents on the Condensed Consolidated Statements of Cash Flows.
In January 2016, the FASB issued guidance which is intended to improve the recognition and measurement of financial instruments. The guidance revises an entity’s accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. The guidance also amends certain disclosure requirements associated with the fair value of financial instruments. The guidance was adopted during our first quarter of fiscal year 2019 and did not have a material effect on our condensed consolidated financial statements.
In May 2014, the FASB issued guidance on the recognition of revenue from contracts with customers. The core principle of the guidance is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration which the company expects to receive in exchange for those goods or services. To achieve this core principle, the guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. The guidance addresses several areas including transfer of control, contracts with multiple performance obligations, and costs to obtain and fulfill contracts. The guidance also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In July 2015, the FASB decided to defer the effective date for this new revenue standard by one year, which made the guidance effective for our first quarter of fiscal year 2019 financial statements using either of two acceptable adoption methods: (i) full retrospective adoption to each prior reporting period presented with the option to elect certain practical expedients; or (ii) adoption with the cumulative effect of initially applying the guidance recognized at the date of initial application and providing certain additional disclosures. In March 2016, the FASB issued additional guidance which further clarified assessing whether an entity is a principal or an agent in a revenue transaction, and impacted whether an entity reports revenue on a gross or net basis; in April 2016, the FASB issued additional guidance that addressed identifying performance obligations and implementing licensing guidance; and in May 2016, the FASB issued additional guidance that clarified collectability, noncash consideration, and other transition issues. The amendments had the same effective date and transition requirements as the new revenue standard. We adopted the standard at the beginning of fiscal year 2019 using the full retrospective approach which required that we recast prior year comparative periods to provide comparable financial reporting for all reported fiscal years. All changes required by the new standard, including accounting policies, controls, and disclosures, have been identified and implemented as of the beginning of fiscal 2019. We applied the transition practical expedient related to remaining performance obligations for reporting periods presented before the date of initial application. See Note 4 - Revenue in the Notes to Condensed Consolidated Financial Statements for more information on revenue recognition.
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 to add, remove, and clarify disclosure requirements related to defined pension benefit and other postretirement plans. The guidance is effective for our first quarter of fiscal year 2021 with early adoption permitted and should be applied 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 be applied retrospectively except for certain disclosures. We have not yet determined the effect of this guidance on our condensed consolidated financial statements.

9


In March 2017, the 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. This guidance is to be applied on a modified retrospective basis, with a cumulative-effect adjustment recorded directly to retained earnings as of the beginning of the period of adoption. The guidance is effective for our first quarter of fiscal year 2020 with early adoption permitted. 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. 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.
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 will also require 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. The guidance is effective for our first quarter of fiscal year 2020 with early adoption permitted. We have assessed our portfolio of leases and compiled a central repository of active leases. We are also evaluating key policy elections under the standard which we will use to develop an internal policy to address the new standard requirements. While we continue to assess the impact on our accounting policies, internal control processes, and related disclosures required under the new guidance, we will be required to record a right-of-use asset and a lease liability for all leases with a lease term of greater than twelve months. We do not expect this standard to materially affect our consolidated net income. These conclusions could change as we continue to evaluate the new standard or if our lease portfolio changes. We anticipate electing certain of the available practical expedients, including the transition option, upon adoption on July 1, 2019.
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. During the quarter ended December 31, 2018, we assessed goodwill for impairment, and no goodwill impairment was recognized.
During fiscal year 2019, we recorded $2.1 million in goodwill from the acquisition of David Edward. During fiscal year 2018, we recorded $8.8 million and $10.7 million, respectively, in goodwill and other intangible assets from the acquisition of D’style, Inc. We recorded an additional $0.2 million of goodwill during fiscal year 2019 as a result of a working capital adjustment related to the acquisition of D’style. See Note 3 - Acquisition in the Notes to Condensed Consolidated Financial Statements for more information on this acquisition.

10


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:
 
December 31, 2018
 
June 30, 2018
(Amounts in Thousands)
Cost
 
Accumulated
Amortization
 
Net Value
 
Cost
 
Accumulated
Amortization
 
Net Value
Capitalized Software
$
38,828

 
$
36,360

 
$
2,468

 
$
38,482

 
$
35,922

 
$
2,560

Product Rights
162

 
162

 
—

 
162

 
162

 
—

Customer Relationships
7,050

 
726

 
6,324

 
7,050

 
422

 
6,628

Trade Names
3,570

 
417

 
3,153

 
3,570

 
238

 
3,332

Non-Compete Agreements
100

 
23

 
77

 
100

 
13

 
87

Other Intangible Assets
$
49,710

 
$
37,688

 
$
12,022

 
$
49,364

 
$
36,757

 
$
12,607

Amortization expense related to intangible assets was, in thousands, $484 and $959 during the quarter and year-to-date period ended December 31, 2018, and was, in thousands, $451 and $746 during the quarter and year-to-date period ended December 31, 2017. Amortization expense in future periods is expected to be, in thousands, $981 for the remainder of fiscal year 2019, and $2,047, $1,664, $1,295, and $1,052 in the four years ending June 30, 2023, and $4,983 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.
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, foreign currency rate movements, investment gain or loss, 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.

11


Components of the Non-operating income (expense), net line, were:
 
Three Months Ended
 
Six Months Ended
 
December 31
 
December 31
(Amounts in Thousands)
2018
 
2017
 
2018
 
2017
Gain (Loss) on SERP Investments
$
(1,097
)
 
$
413

 
$
(726
)
 
$
764

Other
(129
)
 
(150
)
 
(173
)
 
(215
)
Non-operating income (expense), net
$
(1,226
)
 
$
263

 
$
(899
)
 
$
549


Note 3. Acquisition
David Edward
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. David Edward sells primarily in the North American and Middle Eastern markets. 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 the two existing David Edward production facilities in Baltimore, Maryland and Red Lion, Pennsylvania. The acquisition purchase price totaled $4.9 million. The purchase price is subject to certain post-closing working capital adjustments.
A summary of the preliminary purchase price allocation is as follows:
Purchase Price Allocation
 
 
(Amounts in Thousands)
 
 
Assets:
 
 
Receivables
 
$
359

Inventories
 
2,740

Prepaid expenses and other current assets
 
284

Net property and equipment
 
796

Goodwill
 
2,111

 
 
$
6,290

Liabilities:
 
 
Accounts payable
 
$
1,321

Accrued expenses
 
119

 
 
$
1,440

 
 
$
4,850

The operating results of this acquisition are included in our condensed consolidated financial statements beginning on October 26, 2018. For both the quarter and year-to-date periods ended December 31, 2018, net sales and net loss related to David Edward were $2.6 million and $0.4 million, respectively. Direct costs of the acquisition during the quarter and year-to-date periods ended December 31, 2018, of approximately $0.3 million and $0.5 million, respectively, were expensed as incurred and were included on the Selling and Administrative Expenses line of our Condensed Consolidated Statements of Income.

12


Goodwill is primarily attributable to the anticipated revenue and supply chain synergies expected from the operations of the combined company. For tax purposes, goodwill is tax deductible over 15 years. See Note 2 - Recent Accounting Pronouncements and Supplemental Information in the Notes to Condensed Consolidated Financial Statements for more information on goodwill. The following summarizes our goodwill activity:
Goodwill related to David Edward Acquisition
 
 
(Amounts in Thousands)
 
 
Goodwill - June 30, 2018
 
$
—

Goodwill - at acquisition date
 
1,960

Adjustments to purchase price allocation
 
151

Goodwill - December 31, 2018
 
$
2,111

The purchase price allocation is provisional pending final valuations and purchase accounting adjustments, which were not final as of December 31, 2018. We utilized management estimates to assist in the valuation process.
D’style
On November 6, 2017, we acquired certain assets of D’style, Inc. (“D’style”) and all of the capital stock of Diseños de Estilo S.A. de C.V. headquartered in Tijuana, Mexico, a member of the D’style group which manufactures exclusively for D’style, strengthening our North American manufacturing footprint. The purchase price allocation was adjusted during the second quarter of fiscal year 2019 and included an increase of $0.2 million in goodwill and a decrease of $0.2 million in receivables and is final as of December 31, 2018. The portion of the earn-out related to fiscal year 2018 performance totaling $0.4 million was paid during our quarter ended September 30, 2018 which reduced the fair value earn-out liability from $1.1 million as of June 30, 2018 to $0.7 million as of September 30, 2018. During the quarter ended December 31, 2018, the fair value of the contingent earn-out liability was adjusted to $0.4 million relating to an adjustment of the contingent earn-out liability that is based upon fiscal year 2019 D’style, Inc. operating income compared to a predetermined target.
Note 4. Revenue
At the beginning of fiscal year 2019, we adopted new accounting guidance on the recognition of revenue from contracts with customers using the full retrospective approach and adjusted fiscal year 2018 to provide comparable financial reporting for all reported fiscal years. The primary impact of the new revenue standard was a reclassification of certain items on the statement of income. For contracts involving products that are sold directly to end customers, fees paid to dealer agents for facilitating the sale and performing certain services are recognized as either cost of sales or selling expense rather than being netted against revenue. In addition, any commissions or fees paid to third-party purchasing organizations are recognized as a selling expense rather than being netted against revenue. The result of these changes was increases in net sales, cost of sales, and selling expenses. On a net basis these changes had no impact to operating income dollars but did reduce operating income as a percent of net sales. The new standard also required several less significant changes including classifying the reserve for returns and allowance as a liability rather than a contra-receivable, recognizing a recovery asset for potential product returns, and capitalizing costs to obtain sales contracts. There was no cumulative effect of adopting the standard at the date of initial application in retained earnings.

13


The following tables present the effects of the adoption of the new standard on prior period financial statements:
Impact to Condensed Consolidated Statements of Income
 
Three Months Ended December 31, 2017
(Amounts in Thousands)
As Originally Reported
 
Adoption of New Revenue Standard
 
As Adjusted
Net Sales
$
173,674

 
$
4,940

 
$
178,614

Cost of Sales
119,738

 
1,456

 
121,194

Gross Profit
53,936

 
3,484

 
57,420

Selling and Administrative Expenses
41,931

 
3,484

 
45,415

Operating Income
12,005

 
—

 
12,005

Operating Income as of Percent of Net Sales
6.9
%
 
 
 
6.7
%
 
 
 
 
 
 
 
Six Months Ended December 31, 2017
(Amounts in Thousands)
As Originally Reported
 
Adoption of New Revenue Standard
 
As Adjusted
Net Sales
$
343,191

 
$
10,783

 
$
353,974

Cost of Sales
229,666

 
2,881

 
232,547

Gross Profit
113,525

 
7,902

 
121,427

Selling and Administrative Expenses
85,563

 
7,902

 
93,465

Operating Income
27,962

 
—

 
27,962

Operating Income as of Percent of Net Sales
8.1
%
 
 
 
7.9
%
Impact to Condensed Consolidated Balance Sheet
 
As of June 30, 2018
(Amounts in Thousands)
As Originally Reported
 
Adoption of New Revenue Standard
 
As Adjusted
Receivables, net of allowances
$
60,984

 
$
1,292

 
$
62,276

Accrued Expenses
49,294

 
1,292

 
50,586

Performance Obligations
Revenue is measured as the amount of consideration we expect to receive in exchange for transferring distinct goods or providing services to customers. Our revenue consists substantially of product sales, and is reported net of sales discounts, rebates, incentives, returns, and other allowances offered to customers. We recognize revenue when performance obligations under the terms of contracts with our customers are satisfied, which occurs when control passes to a customer to enable them to direct the use of and obtain benefit from a product. This typically occurs when a customer obtains legal title, obtains the risks and rewards of ownership, has received the goods according to the contractual shipping terms either at the shipping point or destination, and is obligated to pay for the product. Customary terms require payment within 30 days, and for certain customers, deposits may be required in advance of shipment.
We sell products both to independent dealers and directly to end customers. Sales to independent dealers typically include products only, as the independent dealer provides additional value-added services to end customers. Direct sales to end customers include products and may include related services such as installation and design services. These services are distinct from the delivered products within the context of the contract, and therefore revenue is recognized for products, installation, and design on a discrete basis. The performance of services may be outsourced to independent dealers or other third parties, but we typically retain the primary responsibility for performance of the services when selling directly to end customers. For services, revenue is recognized when the service is performed and we have an enforceable right to payment. Service revenue does not represent a significant portion of our total sales.

14


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; therefore, our warranty is not considered a separate performance obligation. We estimate the costs that may be incurred under warranties and record a liability at the time product revenue is recognized. See Note 8 - Commitments and Contingent Liabilities in the Notes to Condensed Consolidated Financial Statements for additional information on warranty obligations.
Disaggregation of Revenue
The following table provides information about revenue by vertical market:
 
 
Three Months Ended
 
Six Months Ended
 
 
December 31
 
December 31
(Amounts in Millions)
 
2018

2017
 
2018
 
2017
Commercial
 
$
63.6

 
$
49.3

 
$
120.2

 
$
101.6

Education
 
18.1

 
17.4

 
52.7

 
49.1

Finance
 
18.1

 
17.9

 
36.3

 
31.1

Government
 
18.8

 
23.8

 
35.9

 
51.3

Healthcare
 
28.5

 
23.8

 
52.9

 
44.2

Hospitality
 
53.9

 
46.4

 
97.1

 
76.7

Total Net Sales
 
$
201.0

 
$
178.6

 
$
395.1

 
$
354.0

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.
Contract Balances
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. During the three and six months ended December 31, 2018, impairment losses on doubtful accounts receivable were $0.0 million and $0.5 million, respectively. During the three and six months ended December 31, 2017, impairment losses (income) on doubtful accounts receivable were $(0.2) million and $0.0 million, respectively.
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. Changes in the customer deposits during the six months ended December 31, 2018 are as follows:
(Amounts in Millions)
Customer Deposits
Balance as of June 30, 2018
$
21.3

Increases due to deposits received, net of other adjustments
62.5

Revenue recognized
(57.0
)
Balance as of December 31, 2018
$
26.8

Customer deposits are typically utilized within a year of the receipt of the deposit. The amount of revenue recognized during the three and six months ended December 31, 2018 that was included in the June 30, 2018 customer deposit balance was $4.2 million and $20.9 million, respectively. The amount of revenue recognized during the three and six months ended December 31, 2017 that was included in the June 30, 2017 customer deposit balance was $4.2 million and $19.2 million, respectively.
Additionally, funds paid to certain independent dealers in exchange for their multi-year commitment to market and sell our product represent costs of obtaining contracts. These incremental costs of obtaining contracts are capitalized to the extent we expect to recover them, with $0.3 million reported in Prepaid Expenses and Other Current Assets and $0.3 million reported in Other Assets in the Condensed Consolidated Balance Sheets as of both December 31, 2018 and June 30, 2018. The capitalized costs are amortized over the term of the contract. Amortization expense recognized in Selling and Administrative Expenses was

15


$0.0 million and $0.1 million for the three and six months ended December 31, 2018, and $0.1 million and $0.2 million for the three and six months ended December 31, 2017.
Significant Judgments
We use significant judgment in estimating the reduction in net sales driven by customer rebate and incentive programs. Judgments primarily include an estimate of the most likely sales levels to be achieved and the corresponding rebate and incentive amounts expected to be earned by dealers and salespersons. In the three and six months ended December 31, 2018 and 2017, we had an immaterial amount of adjustments to estimates for cumulative growth rebates and incentives that related to the preceding fiscal years. We also use judgment in estimating a reserve for returns and allowances recorded at the time of the sale, resulting in a reduction of revenue, based on estimated product returns and price concessions.
Accounting Policies and Practical Expedients Elected
For shipping and handling activities, we are applying an accounting policy election which allows an entity to account for shipping and handling activities as fulfillment activities rather than a promised good or service when the activities are performed, even if those activities are performed after the control of the good has been transferred to the customer. Therefore, we expense shipping and handling costs at the time revenue is recognized. We classify shipping and handling expenses in Cost of Sales in the Condensed Consolidated Statements of Income.
We are also applying an accounting policy election which allows an entity to exclude from revenue any amounts collected from customers on behalf of third parties, such as sales taxes and other similar taxes we collect concurrent with revenue-producing activities. Therefore, we present revenue net of sales taxes and similar revenue-based taxes.
For incremental costs of obtaining a contract, we elected a practical expedient which permits an entity to recognize incremental costs to obtain a contract as an expense when incurred if the amortization period is less than one year. This election had an immaterial effect on our condensed consolidated financial statements.
For significant financing components, we elected a practical expedient which allows an entity to recognize the promised amount of consideration without adjusting for the time value of money if the contract has a duration of one year or less, or if the reason the contract extended beyond one year is because the timing of delivery of the product is at the customer’s discretion. As our contracts typically are less than one year in length and do not have significant financing components, we have not presented revenue on a present value basis.
Note 5. Income Taxes
On December 22, 2017, the Tax Cuts and Jobs Act (“Tax Act”) was signed into law. The Tax Act reduced federal corporate income tax rates effective January 1, 2018 and changed numerous other provisions. Because Kimball International has a June 30 fiscal year-end, the lower corporate federal income tax rate was phased in, resulting in a blended U.S. federal statutory tax rate of 28.1% for our fiscal year ended June 30, 2018, and 21% for fiscal year 2019. Prior to the effective date of the Tax Act, the U.S. federal statutory tax rate was 35%.
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 was 25.6% and 25.0%, respectively, for the three and six and months ended December 31, 2018, which approximated the combined federal and state statutory tax rate. Our effective tax rate was 40.6% and 36.5%, respectively, for the three and six months ended December 31, 2017, impacted by a one-time discrete $2.0 million unfavorable impact from applying lower federal income tax rates under the Tax Act to net deferred tax assets which was partially offset by a reduction of income tax expense of approximately $1.6 million year-to-date to reflect the new rates under the Tax Act.

16


Note 6. Inventories
Inventory components were as follows:
(Amounts in Thousands)
December 31, 2018
 
June 30,
2018
Finished products
$
28,817

 
$
23,756

Work-in-process
2,663

 
1,378

Raw materials
32,949

 
29,158

Total FIFO inventory
64,429

 
54,292

LIFO reserve, net
(15,435
)
 
(14,783
)
Total inventory
$
48,994

 
$
39,509

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 and six month periods ended December 31, 2018 and 2017 was immaterial. Our FIFO inventory increased from June 30, 2018 to December 31, 2018 in part as a result of the David Edward acquisition and also due to increased inventory in transit.
Note 7. Accumulated Other Comprehensive Income
During the three months ended December 31, 2018 and 2017, the changes in the balances of each component of Accumulated Other Comprehensive Income, net of tax, were as follows:
Accumulated Other Comprehensive Income
 
 
 
 
 
 
(Amounts in Thousands)
 
Unrealized Investment Gain (Loss)
 
Postemployment Benefits Net Actuarial Gain (Loss)
 
Derivative Gain (Loss)
 
Accumulated Other Comprehensive Income
Balance at September 30, 2018
 
$
(50
)
 
$
1,840

 
$
(2
)
 
$
1,788

Other comprehensive income (loss) before reclassifications
 
30

 
117

 
(2
)
 
145

Reclassification to (earnings) loss
 
—

 
(76
)
 
4

 
(72
)
Net current-period other comprehensive income (loss)
 
30

 
41

 
2

 
73

Balance at December 31, 2018
 
$
(20
)
 
$
1,881

 
$
—

 
$
1,861

 
 
 
 
 
 
 
 
 
Balance at September 30, 2017
 
$
(12
)
 
$
1,258

 
$
—

 
$
1,246

Other comprehensive income (loss) before reclassifications
 
(27
)
 
155

 
—

 
128

Reclassification to (earnings) loss
 
2

 
(49
)
 
—

 
(47
)
Net current-period other comprehensive income (loss)
 
(25
)
 
106

 
—

 
81

Balance at December 31, 2017
 
$
(37
)
 
$
1,364

 
$
—

 
$
1,327


17


During the six months ended December 31, 2018 and 2017, the changes in the balances of each component of Accumulated Other Comprehensive Income, net of tax, were as follows:
 
 
 
 
 
 
 
 
 
Accumulated Other Comprehensive Income
 
 
 
 
 
 
(Amounts in Thousands)
 
Unrealized Investment Gain (Loss)
 
Postemployment Benefits Net Actuarial Gain (Loss)
 
Derivative Gain (Loss)
 
Accumulated Other Comprehensive Income
Balance at June 30, 2018
 
$
(31
)
 
$
1,854

 
$
(7
)
 
$
1,816

Other comprehensive income (loss) before reclassifications
 
11

 
177

 
(9
)
 
179

Reclassification to (earnings) loss
 
—

 
(150
)
 
16

 
(134
)
Net current-period other comprehensive income (loss)
 
11

 
27

 
7

 
45

Balance at December 31, 2018
 
$
(20
)
 
$
1,881

 
$
—

 
$
1,861

 
 
 
 
 
 
 
 
 
Balance at June 30, 2017
 
$
(21
)
 
$
1,136

 
$
—

 
$
1,115

Other comprehensive income (loss) before reclassifications
 
(18
)
 
318

 
—

 
300

Reclassification to (earnings) loss
 
2

 
(90
)
 
—

 
(88
)
Net current-period other comprehensive income (loss)
 
(16
)
 
228

 
—

 
212

Balance at December 31, 2017
 
$
(37
)
 
$
1,364

 
$
—

 
$
1,327


18


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
 
Six Months Ended
 
Affected Line Item in the Condensed Consolidated Statements of Income
 
December 31,
 
December 31,
 
(Amounts in Thousands)
 
2018
 
2017
 
2018
 
2017
 
Realized Investment Gain (Loss) on available-for-sale securities (1)
 
$
—

 
$
(3
)
 
$
—

 
$
(3
)
 
Non-operating income (expense), net
 
 
—

 
1

 
—

 
1

 
Benefit (Provision) for Income Taxes
 
 
$
—

 
$
(2
)
 
$
—

 
$
(2
)
 
Net Income
 
 
 
 
 
 
 
 
 
 
 
Postemployment Benefits amortization of actuarial gain (2)
 
$
—

 
$
43

 
$
—

 
$
87

 
Cost of Sales
 
 
—

 
23

 
—

 
46

 
Selling and Administrative Expenses
 
 
103

 
—

 
202

 
—

 
Non-operating income (expense), net
 
 
(27
)
 
(17
)
 
(52
)
 
(43
)
 
Benefit (Provision) for Income Taxes
 
 
$
76

 
$
49

 
$
150

 
$
90

 
Net Income
 
 
 
 
 
 
 
 
 
 
 
Derivative Gain (Loss) (3)
 
$
(5
)
 
$
—

 
$
(21
)
 
$
—

 
Non-operating income (expense), net
 
 
1

 
—

 
5

 
—

 
Benefit (Provision) for Income Taxes
 
 
$
(4
)
 
$
—

 
$
(16
)
 
$
—

 
Net Income
 
 
 
 
 
 
 
 
 
 
 
Total Reclassifications for the Period
 
$
72

 
$
47

 
$
134

 
$
88

 
Net Income
Amounts in parentheses indicate reductions to income.
(1) See Note 11 - Investments in the Notes to Condensed Consolidated Financial Statements for further information on available-for-sale securities.
(2) See Note 13 - Postemployment Benefits in the Notes to Condensed Consolidated Financial Statements for further information on postemployment benefit plans.
(3) See Note 12 - Derivative Instruments in the Notes to Condensed Consolidated Financial Statements for further information on derivative instruments.

Note 8. 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 December 31, 2018, we had a maximum financial exposure from unused standby letters of credit totaling $1.4 million. 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 December 31, 2018 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.

19


Changes in the product warranty accrual for the six months ended December 31, 2018 and 2017 were as follows:
 
Six Months Ended
 
December 31
(Amounts in Thousands)
2018
 
2017
Product Warranty Liability at the beginning of the period
$
2,294

 
$
1,992

Additions to warranty accrual (including changes in estimates)
354

 
839

Settlements made (in cash or in kind)
(606
)
 
(478
)
Product Warranty Liability at the end of the period
$
2,042

 
$
2,353


Note 9. 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
 
Six Months Ended
 
December 31
 
December 31
(Amounts in Thousands, Except for Per Share Data)
2018
 
2017
 
2018
 
2017
Net Income
$
9,405

 
$
7,378

 
$
20,281

 
$
18,335

 
 
 
 
 
 
 
 
Average Shares Outstanding for Basic EPS Calculation
36,793

 
37,476

 
36,951

 
37,452

Dilutive Effect of Average Outstanding Compensation Awards
295

 
260

 
396

 
323

Average Shares Outstanding for Diluted EPS Calculation
37,088

 
37,736

 
37,347

 
37,775

 
 
 
 
 
 
 
 
Basic Earnings Per Share
$
0.26

 
$
0.20

 
$
0.55

 
$
0.49

Diluted Earnings Per Share
$
0.25

 
$
0.20

 
$
0.54

 
$
0.49



Note 10. 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 six months ended December 31, 2018. 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, 2018.
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

20


below. See Note 11 - 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 12 - 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 six months ended December 31, 2018.
Related to the prior year acquisition of D'style, we determine the fair value of our long-lived and intangible assets on a non-recurring basis in connection with our periodic evaluations of such assets for potential impairment and record impairment charges when such fair value estimates are lower than the carrying values of the assets. The fair value of the contingent earn-out liability as of June 30, 2018 of $1.1 million was reduced to $0.7 million as of September 30, 2018 due to payment of $0.4 million for the earn-out relating to fiscal year 2018. During the quarter ended December 31, 2018, the fair value of the contingent earn-out liability was adjusted to $0.4 million, and we recognized $0.2 million of income within Selling and Administrative Expense which was partially offset by Interest Expense. The adjustment was attributable to fiscal year 2019 D’style, Inc. operating income compared to a predetermined target for the fiscal year.

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 currently in an early stage of start-up. 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.
Derivative Liability: Foreign exchange contracts
 
2
 
Market - Based on observable market inputs using standard calculations, such as time value, forward interest rate yield curves, and current spot rates adjusted for Kimball International's non-performance risk.
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.


21


Recurring Fair Value Measurements:
As of December 31, 2018 and June 30, 2018, the fair values of financial assets that are measured at fair value on a recurring basis using the market approach are categorized as follows:
(Amounts in Thousands)
December 31, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
Cash equivalents: Money market funds
$
13,249

 
$
—

 
$
—

 
$
13,249

Cash equivalents: Commercial paper
—

 
22,007

 
—

 
22,007

Available-for-sale securities: Secondary market certificates of deposit
—

 
12,637

 
—

 
12,637

Available-for-sale securities: Municipal bonds
—

 
6,003

 
—

 
6,003

Available-for-sale securities: U.S. Treasury and federal agencies
—

 
23,436

 
—

 
23,436

Trading Securities: Mutual funds in nonqualified SERP
11,425

 
—

 
—

 
11,425

Derivatives: Stock warrants
—

 
—

 
1,500

 
1,500

Total assets at fair value
$
24,674

 
$
64,083

 
$
1,500

 
$
90,257

Liabilities
 

 
 

 
 

 
 

Contingent earn-out liability
—

 
—

 
441

 
441

Total liabilities at fair value
$
—

 
$
—

 
$
441

 
$
441

 
 

 
 

 
 

 
 

(Amounts in Thousands)
June 30, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
Cash equivalents: Money market funds
$
24,407

 
$
—

 
$
—

 
$
24,407

Cash equivalents: Commercial paper
—

 
25,918

 
—

 
25,918

Available-for-sale securities: Secondary market certificates of deposit
—

 
11,850

 
—

 
11,850

Available-for-sale securities: Municipal bonds
—

 
16,508

 
—

 
16,508

Available-for-sale securities: U.S. Treasury and federal agencies
—

 
6,249

 
—

 
6,249

Trading Securities: Mutual funds in nonqualified SERP
12,114

 
—

 
—

 
12,114

Derivatives: Stock warrants
—

 
—

 
1,500

 
1,500

Total assets at fair value
$
36,521

 
$
60,525

 
$
1,500

 
$
98,546

Liabilities
 

 
 

 
 

 
 

Derivatives: Foreign exchange contracts
$
—

 
$
10

 
$
—

 
$
10

Contingent earn-out liability
—

 
—

 
1,056

 
1,056

Total liabilities at fair value
$
—

 
$
10

 
$
1,056

 
$
1,066

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 11 - Investments in the Notes to Condensed Consolidated Financial Statements for further information regarding the SERP.


22


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 11 - 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, and dividends payable approximates fair value due to the relatively short maturity and immaterial non-performance risk.

Note 11. 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.
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): 
 
December 31, 2018
(Amounts in Thousands)
Certificates of Deposit
 
Municipal Bonds
 
U.S. Treasury and Federal Agencies
Within one year
$
9,672

 
$
5,099

 
$
15,485

After one year through two years
2,965

 
904

 
7,951

Total Fair Value
$
12,637

 
$
6,003

 
$
23,436

All investments are classified as available-for-sale securities which are recorded at fair value. See Note 10 - 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 Shareowners’ Equity.

23


 
December 31, 2018
(Amounts in Thousands)
Certificates of Deposit
 
Municipal Bonds
 
U.S. Treasury and Federal Agencies
Amortized cost basis
$
12,637

 
$
6,009

 
$
23,456

Unrealized holding gains
—

 
—

 
1

Unrealized holding losses
—

 
(6
)
 
(21
)
Fair Value
$
12,637

 
$
6,003

 
$
23,436

 
 
 
 
 
 
 
June 30, 2018
(Amounts in Thousands)
Certificates of Deposit
 
Municipal Bonds
 
U.S. Treasury and Federal Agencies
Amortized cost basis
$
11,850

 
$
16,532

 
$
6,266

Unrealized holding gains
—

 
—

 
—

Unrealized holding losses
—

 
(24
)
 
(17
)
Fair Value
$
11,850

 
$
16,508

 
$
6,249

An immaterial amount of investments were in a continuous unrealized loss position for greater than twelve months as of December 31, 2018. Realized gains and losses as a result of sales in the three and six months ended December 31, 2018 and December 31, 2017 were also immaterial.
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 income 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 as selling and administrative expenses and offset valuation adjustments on SERP investment assets. Net unrealized holding gains (losses) for the six months ended December 31, 2018 and 2017 were, in thousands, $(1,089) and $486, respectively.
SERP asset and liability balances were as follows:
(Amounts in Thousands)
December 31,
2018
 
June 30,
2018
SERP investments - current asset
$
3,188

 
$
3,868

SERP investments - other long-term asset
8,237

 
8,246

    Total SERP investments
$
11,425

 
$
12,114

 
 
 
 
SERP obligation - current liability
$
3,188

 
$
3,868

SERP obligation - other long-term liability
8,237

 
8,246

    Total SERP obligation
$
11,425

 
$
12,114

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 10 - 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.


24


Note 12. 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 December 31, 2018, the change in fair value of the stock warrants was not significant. See Note 10 - Fair Value in the Notes to Condensed Consolidated Financial Statements for more information on the valuation of these securities. Information on the location and amounts of derivative fair values in the Consolidated Balance Sheets are presented below.  
All foreign exchange contracts were settled as of the quarter ended December 31, 2018.
Fair Values of Derivative Instruments on the Condensed Consolidated Balance Sheets
 
 
 
 
 
 
 
 
Asset Derivatives
 
Liability Derivatives
 
 
 
 
Fair Value As of
 
 
 
Fair Value As of
(Amounts in Thousands)
 
Balance Sheet Location
 
December 31
2018
 
June 30
2018
 
Balance Sheet Location
 
December 31
2018
 
June 30
2018
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
Accrued expenses
 
$
—

 
$
10

 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
Stock warrants
 
Other Assets
 
$
1,500

 
$
1,500

 
 
 
 
 
 
Total derivatives
 
$
1,500

 
$
1,500

 
 
 
$
—

 
$
10

 
 
 
 
 
 
 
Note 13. 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
 
Six Months Ended
 
December 31
 
December 31
(Amounts in Thousands)
2018
 
2017
 
2018
 
2017
Service cost
$
126

 
$
131

 
$
253

 
$
266

Interest cost
24

 
21

 
47

 
42

Amortization of actuarial income
(103
)
 
(66
)
 
(202
)
 
(133
)
Net periodic benefit cost
$
47

 
$
86

 
$
98

 
$
175

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 are not estimable using actuarial methods and are expensed in accordance with the applicable U.S. GAAP.
During fiscal year 2019, we reported service cost in the Cost of Sales and Selling and Administrative Expenses lines of the Condensed Consolidated Statement of Income, interest cost in the Interest Expense line, and amortization of actuarial income in the Non-Operating income (expense), net line. During fiscal year 2018, all costs were recognized in the Cost of Sales and Selling and Administrative Expenses lines and were not segregated between the operating and non-operating sections of the Condensed Consolidated Statement of Income because the impact was immaterial.


25


Note 14. Stock Compensation
Stock-based compensation expense during the quarter and year-to-date period ended December 31, 2018, was $1.7 million and $3.6 million, respectively, and during the quarter and year-to-date period ended December 31, 2017, was $1.0 million and $2.5 million, respectively. The total income tax benefit for stock compensation arrangements during the quarter and year-to-date period ended December 31, 2018, was $0.4 million and $0.9 million, respectively, and during the quarter and year-to-date period ended December 31, 2017, was $0.3 million and $1.4 million, respectively. Included in the income tax benefit for the year-to-date period ended December 31, 2017 was a $0.6 million benefit for excess tax benefits from the vesting of stock awards, while the year-to-date period ended December 31, 2018, had an immaterial amount of excess tax benefits for both periods.
During fiscal year 2019, 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, 2018.
Type of Award
 
Quarter Awarded
 
Shares or Units
 
Grant Date Fair Value (5)
Annual Performance Shares (1)
 
1st Quarter
 
34,176

 

$16.12

Annual Performance Shares (1)
 
2nd Quarter
 
23,889

 
$16.15 - $16.17

Relative Total Shareholder Return Awards (2)
 
1st Quarter
 
9,703

 

$21.16

Relative Total Shareholder Return Awards (2)
 
2nd Quarter
 
60,754

 
$21.46 - $21.49

Restricted Stock Units (3)
 
1st Quarter
 
170,686

 
$15.99 - $16.39

Restricted Share Units (3)
 
2nd Quarter
 
138,844

 
$16.46 - $16.48

Unrestricted Shares (4)
 
1st Quarter
 
12,318

 

$16.39

Unrestricted Shares (4)
 
2nd Quarter
 
9,522

 
$16.48 - $16.49

(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 capital during fiscal year 2019, 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 116,130. Annual performance shares vest on June 30, 2019.
(2) Performance units were awarded to key officers under the Company’s Relative Total Shareholder Return program. Vesting occurs at June 30, 2020 and June 30, 2021. 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 140,914.
(3) Restricted stock units were awarded to officers and key employees. Vesting occurs at June 30, 2019, June 30, 2020, and June 30, 2021. Upon vesting, the outstanding number of restricted stock units and the value of dividends accumulated over the vesting period are converted to shares of common stock.
(4) Unrestricted shares were awarded to non-employee members of the Board of Directors and key employees 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 is 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. 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 and unrestricted shares was based on the stock price at the date of the award.
Note 15. 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 December 31, 2018 and June 30, 2018 and were included in the Other Assets line of the Condensed

26


Consolidated Balance Sheets. For more information related to our investment in the privately-held company, see Note 10 - 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, net of a $0.1 million allowance, and $0.6 million, net of a $0.1 million allowance as of December 31, 2018 and June 30, 2018, respectively, and were included on the Receivables and Other Assets lines of our Condensed Consolidated Balance Sheets.
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 December 31, 2018.
Note 16. 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 December 31, 2018 and June 30, 2018, we had no material past due outstanding notes receivable.
 
As of December 31, 2018
 
As of June 30, 2018
(Amounts in Thousands)
Unpaid Balance
 
Related Allowance
 
Receivable Net of Allowance
 
Unpaid Balance
 
Related Allowance
 
Receivable Net of Allowance
Independent Dealership Financing
$
1,098

 
$
88

 
$
1,010

 
$
666

 
$
50

 
$
616

Other Notes Receivable
175

 
175

 
—

 
183

 
183

 
—

Total
$
1,273

 
$
263

 
$
1,010

 
$
849

 
$
233

 
$
616


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Business Overview
Kimball International, Inc. (the “Company,” “Kimball International,” “we,” “us,” or “our”) creates design driven, innovative furnishings sold through our family of brands: Kimball, National, and Kimball Hospitality. Our diverse portfolio offers solutions for the workplace, learning, healing, and hospitality environments. Our values and integrity are demonstrated daily by living our Guiding Principles and creating a culture of caring, that establishes us as an employer of choice. “We Build Success” by establishing long-term relationships with customers, employees, suppliers, shareowners 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 as of January 2019 for the North American commercial furniture market, which they define as including office, education, and healthcare furniture products, projects a year-over-year increase of 3.3% for calendar year 2019. The forecast for two of the leading indicators for the hospitality furniture market (January 2019 PwC Hospitality Directions U.S. report) includes a projected increase in RevPAR (Revenue Per Available Room) of 2.3% for calendar year 2019, while occupancy which has been hovering at peak levels is forecasted to decrease 0.4% in calendar year 2019.

27


Management currently considers the following events, trends, and uncertainties to be most important to understanding our financial condition and operating performance:
•
On October 23, 2018, the Board of Directors (“Board”) appointed Kristine L. Juster as the Chief Executive Officer of the Company effective November 1, 2018 to succeed Robert F. Schneider who retired as Chief Executive Officer and Chairman of the Board on October 31, 2018, as previously announced. Ms. Juster served as an independent member of the Board since April 2016 and was a member of the Audit Committee. Ms. Juster, age 55, served for over 20 years as a Global Executive at Newell Brands, Inc., a leading global consumer goods and commercial products company (“Newell”), until her retirement in April 2018. During her tenure at Newell, Ms. Juster served as President of the Global Writing Segment from May 2014 until her retirement in April 2018, as President of Newell’s Baby and Parent Segment from November 2011 to April 2014, and in other roles of increasing responsibility since joining Newell in 1995, including serving as President of Newell’s Home Décor Segment and President of Newell’s Culinary Lifestyles Segment. Throughout her career, Ms. Juster drove significant growth for the businesses she led through brand innovation, distribution channel expansion including e-commerce, and a global mindset. Ms. Juster has a proven track record of scaling growth strategies, while preserving the core values that are critical to the long-term sustainability of a business.
•
Productivity and lean initiatives are projected to result in $10 million of cost savings in our fiscal year 2019 compared to the prior year. These initiatives include investments in equipment and automation at our production facilities to improve production flow and increase efficiency, improvements in transportation and warehousing processes, and other various lean initiatives across all areas of our Company.
•
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. David Edward sells primarily in the North American and Middle Eastern markets. 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 the two existing David Edward production facilities in Baltimore, Maryland and Red Lion, Pennsylvania. See Note 3 - Acquisition in the Notes to Condensed Consolidated Financial Statements for additional information.
•
On November 6, 2017, we successfully completed the acquisition of certain assets of D’style, Inc. (“D’style”) and all of the capital stock of Diseños de Estilo S.A. de C.V., which have administrative and sales offices and warehousing in Chula Vista, California and a manufacturing location in Tijuana, Mexico. The acquisition expands our hospitality offerings beyond guest rooms to public spaces and provides new mixed material manufacturing capabilities. See Note 3 - Acquisition in the Notes to Condensed Consolidated Financial Statements for additional information.
•
On December 22, 2017, the Tax Cuts and Jobs Act (“Tax Act”) was signed into law. The Tax Act reduced federal corporate income tax rates effective January 1, 2018 and changed numerous other provisions. Because Kimball International has a June 30 fiscal year-end, the lower corporate income tax rate was phased in, resulting in a U.S. statutory federal tax rate of 28.1% for our fiscal year ended June 30, 2018. The statutory federal tax rate is 21% for our fiscal year 2019 and subsequent years. The changes included in the Tax Act are broad and complex.
•
The impact of higher commodity prices is expected to intensify as pricing pressure from our vendors increases, and we are also exposed to fluctuation 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, which is currently planned to increase to a 25% rate effective in March 2019. The U.S. government continues to assess the ongoing need for tariffs, but if there are no further changes or exclusions from tariff regulations 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 monitoring this situation, but because the scope and duration of these trade actions remains uncertain and continues to evolve, at this time we are uncertain of the potential impact that these tariffs may have on our future results of operations. Transportation costs are managed by optimizing logistics and supply chain planning, and increasing prices on our products. Our National brand recently

28


announced a price increase which was effective on November 1, 2018, while our Kimball brand implemented a price increase effective on February 4, 2019.
•
On November 2, 2018, we received notification from the U.S. General Services Administration Office of Inspector General (“GSA OIG”) in response to our self-reporting in 2016 of subcontractor reporting noncompliance and inaccuracies. The GSA OIG Contractor Reporting Program reviewed the information we provided and has stated that, based on current information, it does not anticipate taking any further action on this matter.
•
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. In addition, a long-standing component of our Annual Cash Incentive plan is that it is linked to our Company-wide and business unit performance which is designed to adjust compensation expense as profits change.
•
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 $109.7 million at December 31, 2018.

Financial Overview
Our fiscal year 2018 results have been recast to reflect the impact of the adoption of guidance on the recognition of revenue from contracts with customers using a full retrospective transition method.
 
At or for the
Three Months Ended
 
 
 
For the
Six Months Ended
 
 
 
December 31
 
 
 
December 31
 
 
(Amounts in Millions)
2018
 
2017
 
% Change
 
2018
 
2017
 
% Change
Net Sales
$
201.0

 
$
178.6

 
13
%
 
$
395.1

 
$
354.0

 
12
%
Gross Profit
65.0

 
57.4

 
13
%
 
130.9

 
121.4

 
8
%
Selling and Administrative Expenses
51.5

 
45.4

 
13
%
 
103.7

 
93.5

 
11
%
Operating Income
13.5

 
12.0

 
12
%
 
27.2

 
28.0

 
(3
%)
Operating Income %
6.7
%
 
6.7
%
 


 
6.9
%
 
7.9
%
 


Adjusted Operating Income *
$
14.0

 
$
12.0

 
17
%
 
$
28.7

 
$
28.0

 
3
%
Adjusted Operating Income % **
7.0
%
 
6.7
%
 
 
 
7.3
%
 
7.9
%
 
 
Net Income
$
9.4

 
$
7.4

 
27
%
 
$
20.3

 
$
18.3

 
11
%
Adjusted Net Income *
9.8

 
7.4

 
33
%
 
21.4

 
18.3

 
17
%
Diluted Earnings Per Share
$
0.25

 
$
0.20

 
 
 
$
0.54

 
$
0.49

 
 
Adjusted Diluted Earnings Per Share *
$
0.26

 
$
0.20

 
 
 
$
0.57

 
$
0.49

 
 
Open Orders **
$
144.2

 
$
132.6

 
9
%
 
 
 
 
 
 
* Items indicated represent Non-GAAP (Generally Accepted Accounting Principles) measurements for fiscal year 2019.
** Items indicated represent Key Performance Indicators.
See the “Non-GAAP Financial Measures and Other Key Performance Indicators” section below.

29


Net Sales by End Vertical Market
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended

 

Six Months Ended

 
 
December 31

 

December 31

 
(Amounts in Millions)
2018
 
2017

% Change

2018
 
2017

% Change
Commercial
$
63.6

 
$
49.3

 
29
%
 
$
120.2

 
$
101.6

 
18
%
Education
18.1


17.4


4
%

52.7


49.1


7
%
Finance
18.1


17.9


1
%

36.3


31.1


17
%
Government
18.8


23.8


(21
%)

35.9


51.3


(30
%)
Healthcare
28.5


23.8


20
%

52.9


44.2


20
%
Hospitality
53.9


46.4


16
%

97.1


76.7


27
%
Total Net Sales
$
201.0


$
178.6


13
%

$
395.1


$
354.0


12
%
Second quarter fiscal year 2019 consolidated net sales were $201.0 million compared to second quarter fiscal year 2018 net sales of $178.6 million, or a 13% increase including $2.6 million of net sales resulting from the David Edward acquisition. The increase in organic sales was primarily driven by volume and to a lesser extent by increased prices. Net sales for the six-month period ended December 31, 2018 of $395.1 million increased 12% compared to net sales of $354.0 million for the six-month period ended December 31, 2017 primarily driven by volume and to lesser extent by increased prices.
Key explanatory comments for our sales by vertical market for the second quarter and year-to-date period of fiscal year 2019 compared to the second quarter and year-to-date period of fiscal year 2018 follow:
•
Sales growth to the healthcare vertical market was driven by our strategic focus in this marketplace which continues to show stability and growth.
•
We continue to see strength in the hospitality industry driving increased sales in both custom and non-custom projects. The D’style acquisition also contributed to the sales increase.
•
New products and continued development of our strategic relationships drove the higher sales in the commercial vertical market.
•
Our sales to the finance vertical market increased for the year-to-date period as large financial institutions continue to update their office environments.
•
Our sales to the education vertical market were positively impacted early in our fiscal year as the timing of the normal education buying season was delayed and deferred sales into our first quarter.
•
Government vertical market sales declined primarily due to decreased federal government sales as we shipped fewer large projects in the current year.
•
Each of our vertical market sales levels can fluctuate depending on the mix of projects in a given period.
Open orders at December 31, 2018 increased 9%, or 7% on an organic basis, when compared to the open order level as of December 31, 2017 due to increases in both the office furniture order backlog and hospitality 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 second quarter of fiscal year 2019 we recorded net income of $9.4 million, or diluted earnings per share of $0.25, inclusive of after-tax CEO transition costs of $0.4 million, or $0.01 diluted earnings per share. In the second quarter of fiscal year 2018 we recorded net income of $7.4 million and diluted earnings per share of $0.20. Excluding the CEO transition costs, adjusted net income for the second quarter of fiscal year 2019 was $9.8 million, or $0.26 per diluted share. In the first six months of fiscal year 2019 we recorded net income of $20.3 million and diluted earnings per share of $0.54, inclusive of $1.2 million, or $0.03 per diluted share, of after-tax CEO transition costs. Excluding the CEO transition costs, our adjusted net income for the first six months of fiscal year 2019 improved to $21.4 million, or $0.57 per diluted share, compared to net income for the first six months of fiscal year 2018 of $18.3 million, or $0.49 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 20 basis points in the second quarter of fiscal year 2019 compared to the second quarter of fiscal year 2018. Increased product pricing, the leverage gained on higher sales volumes, lower healthcare expense, and

30


savings realized from our cost reduction initiatives were partially offset by labor, commodity, tariff, and transportation increases. The David Edward acquisition also negatively impacted our gross profit in the second quarter, as expected, and will continue to in the short-term until productivity improvements and synergies are realized. Gross profit as a percent of net sales decreased 120 basis points in the first six months of fiscal year 2019 compared to the first six months of fiscal year 2018. Increased product pricing, the leverage gained on higher sales volumes, and savings realized from our cost reduction initiatives were more than offset by a shift in sales mix to lower margin products, and increases in labor, transportation, commodity and tariff costs and the negative impact of David Edward on gross margin.
Selling and administrative expenses in the second quarter of fiscal year 2019 compared to the second quarter of fiscal year 2018 as a percent of net sales increased 20 basis points, and increased 13% in absolute dollars. Contributing to the second quarter fiscal year 2019 increased selling and administrative expense was $0.5 million of CEO transition costs. In addition the selling and administrative expense increase was driven by higher commission expense related to the higher sales levels, higher salary and incentive compensation expenses, strategic growth investments, and the incremental selling and administrative expenses of the David Edward operations. The second quarter of fiscal year 2018 included a $1.7 million pre-tax gain on the sale of an administrative building which did not repeat in the second quarter of fiscal year 2019.
For the first six months of fiscal year 2019 compared to the first six months of fiscal year 2018, as a percent of net sales, selling and administrative expenses decreased 20 basis points due to the increased sales volumes. In absolute dollars, selling and administrative expenses in the first six months of fiscal year 2019 compared to the same period of fiscal year 2018 increased 11% primarily due to the CEO transition costs, higher salary expense, higher incentive compensation costs as a result of higher earnings levels, higher commission expense resulting from the higher sales levels, and higher employee benefit expense such as healthcare and retirement. In addition, the prior year included a $1.0 million higher gain on sale of assets than the current year-to-date period.
Partially offsetting the higher selling and administrative expenses were favorable variances within selling and administrative expenses of $1.5 million for both the second quarter and year-to-date period of fiscal year 2019 compared to the second quarter and year-to-date period of fiscal year 2018 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.

Other Income (Expense) consisted of the following:
 
Three Months Ended
 
Six Months Ended
 
December 31
 
December 31
(Amounts in Thousands)
2018
 
2017
 
2018
 
2017
Interest Income
$
428

 
$
234

 
$
847

 
$
468

Interest Expense
(56
)
 
(74
)
 
(106
)
 
(105
)
Gain (Loss) on Supplemental Employee Retirement Plan Investments
(1,097
)
 
413

 
(726
)
 
764

Other
(129
)
 
(150
)
 
(173
)
 
(215
)
Other Income (Expense), net
$
(854
)
 
$
423

 
$
(158
)
 
$
912

Our second quarter and year-to-date period of fiscal year 2019 results of operations included the impact of the enactment of the Tax Act, which was signed into law on December 22, 2017. The Tax Act reduced federal corporate income tax rates effective January 1, 2018 and changed numerous other provisions. Because Kimball International has a June 30 fiscal year-end, the lower corporate income tax rate was phased in, resulting in a U.S. statutory federal tax rate of 28.1% for our fiscal year ended June 30, 2018, and 21% for our fiscal year 2019 and subsequent fiscal years. The quarter and six months ended December 31, 2017 included approximately $1.6 million year-to-date in reduced income tax expense to reflect the new rates under the Tax Act. The benefits of the lower rate were more than offset by a one-time discrete $2.0 million unfavorable impact as a result of applying the new lower federal income tax rates to our net deferred tax assets.
Our effective tax rate of 25.6% and 25.0% for the three and six months ended December 31, 2018 approximated the combined federal and state statutory tax rate. Our effective tax rate was 40.6% and 36.5%, respectively, for the three and six months ended December 31, 2017, impacted by the additional income tax expense due to the Tax Reform.

31


Comparing the balance sheet as of December 31, 2018 to June 30, 2018, our inventory increased in part as a result of the David Edward acquisition and also due to increased inventory in transit in preparation for the manufacturing shutdown period for the Chinese New Year. Our accrued expenses line decreased from June 30, 2018 to December 31, 2018 as our total accrued cash incentive compensation related to our fiscal year 2018 performance was paid out. The change from June 30, 2018 to December 31, 2018 in our treasury stock line was driven by our repurchase of common shares during the first half of fiscal year 2019.
Liquidity and Capital Resources
Our total cash, cash equivalents, and short-term investments, decreased to $81.1 million at December 31, 2018 from $87.3 million at June 30, 2018, primarily due to capital expenditures of $10.7 million, the acquisition of David Edward for $4.9 million, and the return of capital to shareowners in the form of stock repurchases and dividends totaling $14.7 million, which more than offset $23.9 million of cash flows from operations during the first six months of fiscal year 2019.
Working capital at both December 31, 2018 and June 30, 2018 was $85.1 million. The current ratio was 1.7 at both December 31, 2018 and June 30, 2018.
Our short-term liquidity available, represented as cash, cash equivalents, and short-term investments plus the unused amount of our credit facility, totaled $109.7 million at December 31, 2018. At December 31, 2018, we had $1.4 million in letters of credit outstanding, which reduced our borrowing capacity on the credit facility. We had no credit facility borrowings outstanding as of December 31, 2018 or June 30, 2018.
Cash Flows
The following table reflects the major categories of cash flows for the first six months of fiscal years 2019 and 2018.
 
 
Six Months Ended
 
 
December 31
(Amounts in thousands)
 
2018
 
2017
Net cash provided by operating activities
 
$
23,908

 
$
15,382

Net cash used for investing activities
 
$
(21,849
)
 
$
(26,873
)
Net cash used for financing activities
 
$
(15,750
)
 
$
(9,090
)
Cash Flows from Operating Activities
For the first six months of fiscal year 2019 net cash provided by operating activities was $23.9 million fueled by $20.3 million of net income while the first six months of fiscal year 2018 net cash provided by operating activities was $15.4 million inclusive of $18.3 million of net income.
Changes in working capital balances used $4.1 million of cash in the first six months of fiscal year 2019 and 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. In addition, increased inventory levels driven by higher inventory in transit was partially offset by an increase in customer deposits. Changes in working capital balances used $17.0 million of cash in the first six months of fiscal year 2018 and was primarily due to a reduction in our accrued expenses balance as our accrued cash incentive compensation and the retirement profit sharing contribution which are both related to our fiscal year 2017 performance were paid out. Also contributing was a prepayment of estimated income taxes for fiscal year 2018 which are included in the prepaid expenses and other current assets line.
Our measure of accounts receivable performance, also referred to as Days Sales Outstanding (“DSO”), for both the six-month periods ended December 31, 2018 and December 31, 2017 were 28 days. 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 both the six-month periods ended December 31, 2018 and December 31, 2017 were 42 days. We define PDSOH as the average of the monthly net inventory divided by an average day’s cost of sales.

32


Cash Flows from Investing Activities
During the first six months of fiscal year 2019, we invested $26.2 million in available-for-sale securities, and $18.6 million matured. During the first six months of fiscal year 2018, we invested $18.9 million in available-for-sale securities, and $16.5 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 six months of fiscal year 2019 we had a cash outflow of $4.9 million for the David Edward acquisition and during the first six months of fiscal year 2018 we had cash outflow of $17.8 million for the D’style acquisition. During the first six months of fiscal years 2019 and 2018, we received proceeds from the sale of assets net of selling expenses of $1.3 million and $5.6 million, respectively, the majority of which relates to the sale of Internet protocol addresses in fiscal year 2019 and the majority of which relates to the sale of our fleet of over-the-road tractors and trailers in fiscal year 2018. During the first six months of fiscal years 2019 and 2018, we reinvested $10.7 million and $12.1 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 showrooms, 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 $5.6 million and $4.9 million in the six-month periods ended December 31, 2018 and December 31, 2017, respectively. Consistent with our historical dividend policy, our Board of Directors evaluates the appropriate dividend payment on a quarterly basis. During the first six months of fiscal years 2019 and 2018, we repurchased shares pursuant to a previously announced stock repurchase program which drove cash outflow of $9.1 million and $1.8 million, respectively.
Credit Facility
We maintain a $30 million credit facility with a maturity date of October 2019 that allows for both issuances of letters of credit and cash borrowings. This facility provides an option to increase the amount available for borrowing to $55 million at our request, subject to the consent of the participating banks. At December 31, 2018, we had $1.4 million in letters of credit outstanding, which reduced our borrowing capacity on the credit facility. At both December 31, 2018 and June 30, 2018, we had no borrowings outstanding.
The credit facility requires us to comply with certain debt covenants, the most significant of which are 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 six-month period ended December 31, 2018.
The table below compares the adjusted leverage ratio and the fixed charge coverage ratio with the limits specified in the credit agreement.
 
 
At or For the Period Ended
 
Limit As Specified in
 
 
Covenant
 
December 31, 2018
 
Credit Agreement
 
Excess
Adjusted Leverage Ratio
 
(0.33
)
 
3.00

 
3.33

Fixed Charge Coverage Ratio
 
152.18

 
1.10

 
151.08

Future Liquidity
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 second quarter of fiscal year 2019, our Board of Directors declared a quarterly dividend of $0.08 per share, to be paid during our third quarter of fiscal year 2019. We will continue to evaluate market conditions in determining future share repurchases. At December 31, 2018, 0.7 million shares remained available under the repurchase program. During fiscal year 2019 we expect to continue investments in capital expenditures, particularly for projects such as our headquarters renovation, showroom renovations, machinery and equipment

33


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, a decline in demand for our products, 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.
Non-GAAP Financial Measures and Other Key Performance Measures
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 GAAP in the United States in the statements of income, statements of comprehensive income, balance sheets, or statements of cash flows of the company. The non-GAAP financial measures used within this MD&A include (1) adjusted operating income defined as operating income excluding CEO transition costs; (2) adjusted net income defined as net income excluding CEO transition costs; and (3) adjusted diluted earnings per share defined as diluted earnings per share excluding CEO transition costs. 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 how its core operations performed without expenses incurred for the CEO transition. Excluding these amounts allows investors to meaningfully trend, analyze, and benchmark the performance of our core operations. 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
 
 
 
 
(Amounts in Thousands, Except for Per Share Data)
 
 
 
 
 
 
Three Months Ended
 
Six Months Ended
 
December 31
 
December 31
 
2018
 
2017
 
2018
 
2017
Operating Income
$
13,498

 
$
12,005

 
$
27,192

 
$
27,962

    Pre-tax CEO Transition Costs
502

 
—

 
1,557

 
—

Adjusted Operating Income
$
14,000

 
$
12,005

 
$
28,749

 
$
27,962

Net Sales
$
201,008

 
$
178,614

 
$
395,131

 
$
353,974

Adjusted Operating Income %
7.0
%
 
6.7
%
 
7.3
%
 
7.9
%
 
 
 
 
 
 
 
 
Net Income
$
9,405

 
$
7,378

 
$
20,281

 
$
18,335

Pre-tax CEO Transition Costs
502

 
—

 
1,557

 
—

Tax on CEO Transition Costs
(130
)
 
—

 
(401
)
 
—

After-tax CEO Transition Costs
372

 
—

 
1,156

 
—

Adjusted Net Income
$
9,777

 
$
7,378

 
$
21,437

 
$
18,335

 
 
 
 
 
 
 
 
Diluted Earnings Per Share
$
0.25

 
$
0.20

 
$
0.54

 
$
0.49

    After-tax CEO Transition Costs
0.01

 
—

 
0.03

 
—

Adjusted Diluted Earnings Per Share
$
0.26

 
$
0.20

 
$
0.57

 
$
0.49

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. Adjusted operating income percentage is also a key performance indicator, which is defined as adjusted operating income as a percentage of net sales.

34


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 is 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 10 - 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, 2018.
Off-Balance Sheet Arrangements
Our off-balance sheet arrangements are limited to standby letters of credit and operating leases entered into in the normal course of business. 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 8 - 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, 2018. During the first six months of fiscal year 2019, there were no material changes in the accounting policies and assumptions previously disclosed other than our Revenue Recognition policy which is described below.
Revenue recognition - Effective at the beginning of fiscal year 2019, we adopted guidance on the recognition of revenue from contracts with customers, using a full retrospective method. Under the new guidance, revenue is measured as the amount of consideration we expect to receive in exchange for transferring distinct goods or providing services to customers. Our revenue consists substantially of product sales, and is reported net of sales discounts, rebates, incentives, returns, and other allowances offered to customers. We recognize revenue when performance obligations under the terms of contracts with our customers are satisfied, which occurs when control passes to a customer to enable them to direct the use of and obtain benefit from the product. This typically occurs when a customer obtains legal title, obtains the risks and rewards of ownership, has received the goods according to the contractual shipping terms either at the shipping point or destination, and is obligated to pay for the product. Shipping and handling activities are recognized as fulfillment activities and are expensed at the time revenue is recognized. We recognize sales net of applicable sales taxes and similar revenue-based taxes.
We use judgment in estimating the reduction in net sales driven by customer rebate and incentive programs. Judgments primarily include expected sales levels to be achieved and the corresponding rebate and incentive amounts expected to be earned by dealers and salespersons.

35


We also use judgment in estimating a reserve for returns and allowances which is recorded at the time of the sale, based on estimated product returns and price concessions. The reserve for returns and allowances is recorded in Accrued Expenses on the Condensed Consolidated Balance Sheets, and the expense is recorded as a reduction of Net Sales in the Condensed Consolidated Statements of Income.
We perform ongoing credit evaluations of our customers and impair receivable balances by recording specific allowances for bad debts based on judgment using factors such as current trends, the length of time the receivables are past due, and historical collection experience. The allowance for accounts receivable balances that are determined likely to be uncollectible are a reduction in the Receivables line of the Condensed Consolidated Balance Sheets, and the expense is recorded in Selling and Administrative Expenses in the Condensed Consolidated Statements of Income.
New Accounting Standards
See Note 2 - Recent Accounting Pronouncements and Supplemental Information in the Notes to Condensed Consolidated Financial Statements for information regarding New Accounting Standards.
Forward-Looking Statements
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, adverse changes in the global economic conditions, the impact of changes in tariffs, increased global competition, significant reduction in customer order patterns, loss of key suppliers, loss of or significant volume reductions from key contract customers, financial stability of key customers and suppliers, relationships with strategic customers and product distributors, availability or cost of raw materials and components, changes in the regulatory environment, 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, 2018.
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, which is currently planned to increase to a 25% rate effective March 2019. The U.S. government continues to assess the ongoing need for tariffs, but if there are no further changes or exclusions from tariff regulations 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 monitoring this situation, but because the scope and duration of these trade actions remains uncertain and continues to evolve, at this time we are uncertain of the potential impact that these tariffs may have on our future results of operations. 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, 2018.

36


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 December 31, 2018, 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.
We adopted new accounting guidance on the recognition of revenue from contracts with customers at the beginning of fiscal year 2019. As a result, we implemented changes required by the new standard, including accounting policies, internal controls over financial reporting, and disclosure controls, and we implemented new processes and procedures and Enterprise Resource Planning system changes to provide the information required by the new guidance.

37


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. At December 31, 2018, approximately 0.7 million shares remained available under the repurchase program.
 
 
 
 
 
 
 
 
 
Period
 
Total Number
of Shares
Purchased
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
Month #1 (October 1-October 31, 2018)
 
225,285

 
$
16.21

 
225,285

 
800,526

Month #2 (November 1-November 30, 2018)
 
10,833

 
$
16.51

 
10,833

 
789,693

Month #3 (December 1-December 31, 2018)
 
135,279

 
$
14.78

 
135,279

 
654,414

Total
 
371,397

 
$
15.70

 
371,397

 
 

38


Item 6. Exhibits
Exhibits (numbered in accordance with Item 601 of Regulation S-K)
3(a)
3(b)
10(a)*
10(b)*
10(c)*
10(d)*
10(e)*
10(f)*
31.1
31.2
32.1
32.2
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
*Constitutes management contract or compensatory arrangement


39


SIGNATURES
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.

 
 
KIMBALL INTERNATIONAL, INC.
 
 
 
 
By:
/s/ KRISTINE L. JUSTER
 
 
Kristine L. Juster
Chief Executive Officer
 
 
February 5, 2019
 
 
 
 
 
 
 
By:
/s/ MICHELLE R. SCHROEDER
 
 
Michelle R. Schroeder
Vice President,
Chief Financial Officer
 
 
February 5, 2019

40