HNI Corporation
Q1 2008 Earnings Call Transcript

Published: 17 Apr 2008

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the HNI Corporation first quarter results. At this time all participants are in listen-only mode, later we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Treasurer and Vice President Mr. Marshall Bridges. Please go ahead.

[Marshall Bridges:]

Good morning and thank you for joining us today for the HNI Corporation conference call to discuss first quarter 2008 results which were announced earlier today. My name is Marshall Bridges, Treasurer and Vice President for HNI Corporation. If you have not received a copy of the financial news release, please call 563-272-7927, and we will send it to you. The release is also available at our website, www.hnicorp.com. Joining me on the line today from HNI Corporation are Bob Driessnack, Vice President and Controller, and Stan Askren, Chairman, President and Chief Executive Officer. Stan and Bob will review the results and then open the call for questions. Before we begin, please be advised that statements made by the Corporation during this call that are not historical facts are forward-looking statements. These statements may include, but are not limited to, statements of business plans and objectives, capital structure and other financial items. Actual results could differ materially from those projected in any forward-looking statements, and relying on forward-looking statements is subject to risks. Factors that could cause actual results to differ materially from those projected in any forward-looking statements are discussed in the Corporation's financial news release announcing the first quarter 2008 results and its most recent Form 10-K and other periodic filings with the Securities and Exchange Commission. The Corporation assumes no obligation to update any forward-looking statements made during the call. I now have the pleasure of turning the call over to Stan Askren. Stan?

[Stan Askren:]

Good morning, everybody. Thank you Marshall. I will share a brief assessment of the business and then turn the call over to Bob Driessnack, our Vice President and Controller to review some of the specific financial details. I will then come back and share some thoughts on our outlook, and then finally, we'll open it up for questions. We faced very challenging economic conditions during the quarter. Demand in our supply-driven channel of the office furniture business experienced substantial weakness and our hearth business continue to be pressured by the unprecedented decline in new home construction. The supply-driven channel, which represented 53% of our office furniture sales in the quarter, and partially consists of small office and home office customers, was much weaker than our contract businesses. Let me provide some context on our selling channels. As you know, we serve most channels in the industry with our multiple companies and brands. The short selling cycle business is such that the supply-driven channel has softened more and faster than the longer selling cycle businesses, such as the larger project contract business or put another way, the closer to the individual consumer making a transaction, the more significant the slowdown. For example, retail, which is approximately 5% of our business, was the weakest of all the channels. The more complex the selling process, the longer the selling cycle, and the more order activity remains solid. The broad economic factors driving the supply-driven the channel replace our consumer confidence, which is at a 16 year low, small business confidence which is at 22 year low, deteriorating employment, slowing corporate profits, and the liquidity crisis. The weakness appears to be impacting in the entire supply-driven channel marketplace, and we continue to effectively compete in the difficult conditions and believe we are generally holding our market position. Our hearth business posted loss for the first quarter, but we continue to expect it will be profitable for the year. Again, let me provide some context. Single-family housing starts are down over 60% since the peak. We dealt with the dramatic decrease in our revenue by limiting $75 million of cost. We will continue to tightly manage the business, but it's becoming more difficult to reduce costs at the same rate without negatively impacting our competitor capability in the long-term value of the business. We have a very strong market share position in the industry with the strongest brand names. This has been an important growth agent up until the housing declines, and we continue to believe that our hearth business will return to being a substantial profit contributor in the future as this housing cycle turns. We were also negatively impacted by increase freight costs and higher than anticipated transition costs related to the simultaneous shutdown of an office furniture facility, the ramp-up of an office furniture facility, the closure of two distribution centers, and the start-up of a new distribution center. This consolidate was a very complex project, which we executed in a very short timeframe. During the consolidation, we experienced a short-term disruption during the complexity of the product and flow that runs through these facilities. The result in restructuring and transition costs totaled $8.5 million in the quarter, versus the $4 million to $5 million we had expected. The decision to consolidate was saving excess of $10 million annually once fully implemented in 2009. It is a good long-term decision and indicative of our efforts to reduce structural cost and we are pleased to have the major effort -- this move behind us. At the end of the quarter, we completed the purchase of HBF, a leading provider of premium upholstered seating, textiles, wood tables, and wood case goods. HBF is an excellent company, which provides distinctive model in terms of selling, brand design, and products that will compliment our existing contract businesses. It will continue to operate as a focused standalone entity with unique brand position and strategy. I'll provide more comments in the outlook, but now I'll turn the call over Bob Driessnack, our Vice President and Controller to review some of the specific numbers for the first quarter. Bob?

[Bob Driessnack:]

Thank you, Stan. For the first quarter 2008, consolidated net sales decreased 7.5% to $563 million. Acquisition added $20 million or 3.3 percentage points. Organic sales were down due to substantial weakness in the supplies-driven channel of our office furniture businesses and the continuing decline in the hearth business. Net sales for the office furniture segment decreased 6.4 % to $466 million. This decrease was driven by an approximately 12% decline in the supplies-driven channel. The remainder of our business was up approximately 2% with our primary contract brands up more. Acquisitions added $7 million or 1.4 percentage points. Net sales for the hearth product segment decreased 12.6 % to $97 million. Acquisitions added $13 million or 11.9 percentage points. Excluding acquisitions our product sales declined 24.5% driven by a 34% decrease in new construction channel revenue. Gross margins were 32.7% compared to 33.9% in the prior year quarter. The reduction in gross margins was due to decreased volume as well as the accelerated depreciation and transition costs related to the consolidation of office furniture facilities. SG&A as of percentage of sales was 30.8% compared to 28% in the prior year quarter. The increase was driven by higher freight costs, increased investment in product development and selling initiatives, increased restructuring costs, and transitional cost associated with plant consolidation, as well as costs associated with new acquisitions. Included in the SG&A totals were freight and distribution costs, which as a percentage of sales were 10.9% during the first quarter or 10.3% when excluding transition costs. This compares to 9.3% during the same period last year. This increase is primarily due to higher fuel costs. First quarter 2008 included $8.5 million of restructuring charges and transition costs in connection with the facility shutdown, a facility ramp-up, closure of two distribution centers and a consolidation and start-up of a new distribution center. These cost included $400,000 of accelerated depreciation and $3.9 million of other transition costs recorded in cost of sales. $800,000 of costs recorded as restructuring costs and $3.4 million of other transition costs recorded in selling and administrative expenses. The effective tax rate for the first quarter 2008 was 43.9% compared to 35.5% in the first quarter 2007, due to a deferred tax adjustment. We anticipate the annualized tax rate for 2008 will be approximately 35.6% including this adjustment. Net income was favorably impacted $0.01 per share as a result of our share repurchase program. During the first quarter, we repurchased 704,700 shares at a cost of $22.1 million. There is approximately $170 million remaining under the current authorization. Cash flow from operations was $2 million compared to $41 million in the prior year quarter, due to the lower net income and the timing of working capital requirements in the current year. That wraps up the financial comments for the first quarter, and I'll turn it back over to Stan.

[Stan Askren:]

Thank you, Bob. So as we look forward, the current economic uncertainty makes it difficult to make any meaningful projection. In the short selling cycle, weak times in our supply-driven business do not provide much forward visibility. That said, we expect the economy to continue to be difficult. We anticipate economic factors that specifically impact us, such as consumer and small business confidence, employment, and new home construction will continue to present us near-term challenges. Material costs did not have a large impact in Q1 due to our contracts and price realization. However, fuel costs have recently shown rapid and large increases. We expect material and fuel costs to become more challenging in the upcoming quarters. We are closely reviewing, and will address, these increases with cost containment efforts and price as a competitive environment allows. We expect the weakness in the supply-driven channel of our office furniture business to continue. Our contract focus businesses are currently seeing solid order intake, but new business [quotes] are slowing. We anticipate the project business will soften some with economy as organizations reduce or differ capital project in hiring. Conditions in the hearth industry will continue to be challenging, particularly in the new construction channel. Timing of any housing market recovery continues to remains uncertain. We will continue to tightly manage our costs and improve our competitive position with an eye on a mid-term housing market recovery. Overall, we continue our investments and growth initiatives and position for the market recovery as we enhance our selling capabilities and launch a record number of new products in 2008. We work to offset the market weakness by eliminating waste, attacking structural costs, and streamlining our business consistent with our past practice. Now, I will have Bob provide the financial outlook for the second quarter 2008. Bob?

[Bob Driessnack:]

Thank you, Stan. For the second quarter 2008, we anticipate overall sales for the quarter to be flat to down 5%. Office furniture is anticipated to be flat to up 5% for the quarter driven by a mid-to-high single-digit decline in the supplies-driven channel, moderate organic growth in the rest of the segments and the favorable impact of acquisitions. Hearth is anticipated to be down approximately 20%, including the impact of acquisitions. Gross profit margin for the second quarter is expected to be approximately 1 to 1.2 percentage points lower than the second quarter 2007. A gross margin decline is due to increased input costs, lower volumes in the hearth business and the supplies-driven channel, and $1.5 million to $2 million of transition costs related to the previously mentioned office furniture consolidations. SG&A excluding restructuring and transition charges as a percentage of sales for the second quarter, is expected to be increased 3 to 3.5 percentage points compared to the prior year period when it was 27.4%. A major driver of the increase is the impact of rising fuel costs on freight and distribution expense. In the second quarter of 2007, freight and distribution was 9% of net sales. We project this to increase approximately one percentage point. Additional investments related to product development and selling initiatives will also drive an increase. We anticipate SG&A related restructuring and transition costs to be approximately $1.5 million to $2 million in the second quarter. Combining the restructuring and transition costs in cost of sales and SG&A, we expect total restructuring and transition-related costs to be $3 million to $4 million in the second quarter. We expect interest expense to decrease slightly from the same period of last year due to lower average interest rates, partially offset by increased borrowings. We anticipate the effective tax rate for the second quarter will be 35%.

[Stan Askren:]

Thank you, Bob. So overall, we're faced with some economic challenges. In the phase of these challenges we'll do what we've always done, adapt new conditions and aggressively improve -- improvement across the total costs of corporation. We are attacking structural costs. We're investing for growth of the record number of new price to launch this year. And we're working to improve our selling models and capabilities. I remain excited about the long-term prospects of the HNI Corporation. Our strong fundamentals remain unchanged and we will continue to adapt, innovate and come out of this environment stronger than ever. With those comments complete, I'll now open it up to questions.

[Operator:]

Thank you. (Operator Instructions). And we have question from the line of Chris Agnew of Goldman Sachs. Please go ahead.

[Chris Agnew:]

Hello. Good morning, gentlemen. First question I want to focus on your cash flow. Can you help me think through a couple of issues that I should not be extrapolating for the full year, for example, I am reading your comments on working capital, and it's particularly much higher than in the first quarter? And your capital expenditures how much of the what was impacted there in terms of the transition costs and anything else that's relevant for sort of thinking forward? Thanks.

[Bob Driessnack:]

Hi, Chris. This is Bob. I think you had a couple of questions there. Let me start with cash flow. I think in the first quarter the timing was really more seasonally driven and we had a very strong start in 2007, which contributed to the $40 million in 2007. So for the full year, I think our cash flow will probably be less obvious. It will be a great year 2007 more comparable to 2006 levels. For capital expenditures, the $17 million in the first quarter had a little but several million for the transition investment. I would anticipate CapEx similar level in the second quarter and still in the range may be a little bit less than what we gave you for the full year, $65 to $70 million.

[Chris Agnew:]

Okay. Great. And in terms of, I guess, the supply-driven business and the contract business, is there any color in terms of vertical markets or geographies that you can provide us? Or were you seeing both markets fairly broad-based?

[Stan Askren:]

No, Chris. Certainly there are some regional differences. And because we're so broad, it's hard to kind of plough through all of them. I think we would say we have situations that are different based on the channel, based on the geographies, based on the vertical markets. I think, obviously, the financial sector and a market like New York is the most significantly impacted. The rest I would say there is nothing notable that I think we can point out that would be helpful to you.

[Chris Agnew:]

Okay. On the hearth business, at what point do you think you need to take much more serious and further cost action in that business?

[Stan Askren:]

It's a good question. It's a real challenge there. I think that team has done us super job of attacking structural cost. The issue we're down to now is really a couple of really excellent manufacturing facilities there. We think are in a great position when this turns around. So the risk would be as if we take additional manufacturing capacity of line, go through that huge cost and complexity only to have this market rebound. And if it re-bounces like we think it should based on history, it's going to be rebound relatively fast and relatively hard. We believe that quality has been cyclical here and then we're closer now to that bottom than we've ever been. And so we continue to sort of drive through the cost management day-to-day, the structural cost that gives harder and we're posed for the return in the market.

[Chris Agnew:]

Okay. Thanks. And final question, I mean that it will be tough for a lot of your smaller competitors as well, do you think and are you prepared to look at opportunities, for say, smaller tuck-in acquisitions and maybe to frame that? How much fire power do you have to consider any potential transactions? Thanks.

[Stan Askren:]

You bet, Chris. Thank you. Yeah. We actually completed two acquisitions here in the last several months. One in the fire play side which was Harman, which is a great company that just got caught at the wrong place at the wrong time on a cash basis and we have them under the family and that's been a super acquisition. We're able to go on and leverage their strong brand and their strong products and their great numbers, and provide some lean sort of expertise, and some market leverage. And it has been good. We are excited about that. The second one is this HBF acquisition. That really resulted sort of in furniture brands, making decision of focused more of their attention on their core business and a company that we think is a very fine company that compliments our other businesses becomes available and we are able to pick it up. I imagine that there are going to be more of those sorts of acquisitions and we have the fire power to use your term. I think the goal is to complete those, where those make sense and where we can create value with them.

[Chris Agnew:]

Okay. Great. Thank you.

[Operator:]

Our next question comes from the line of Matt McCall of BB&T Capital Markets. Please go ahead.

[Matt McCall:]

Thanks. Good morning, everybody.

[Bob Driessnack:]

Good morning, Matt.

[Matt McCall:]

Can you first address the unallocated corporate expense down dramatically year-over-year? Is this just $9 million level? Is that a sustainable number or what, explain. I know you have been very cost conscious but how did you decrease it that much?

[Bob Driessnack:]

Hi, Matt. This is Bob. Good question. In the first quarter, we saw the benefit of adjusting some incentive compensation and other market-driven costs. We did have favorable timing and some of our medical benefits and things. We expect the full year to be in a $50 million to $55 million range, so going forward run rate is probably more about $14 million to $15 million for the quarters.

[Matt McCall:]

Okay. That's helpful. I know it's a small part your business, Stan, but you talked about the retail business and the weakness there, do you think that it's just purely cyclical and purely a result of the consumer weaknesses out there? Do you think there is something else going on, specifically I would talk about imports, talk about just overall secular ships that may be going on to retail channel, anything outside of cyclicality?

[Stan Askren:]

Well, I think Matt, the best way to probably determine the answer to your question, did you go sort of cruise through some of those large big box office, furniture office supplies retailers and probably to better handle is sort of what there we did. We certainly think that the consumer, is in kind of a credit crunch and the consumer slowdown has impacted that channel in that sort of selling model. If you look at a kind of the overall segment there, those great customers of ours are really challenged right now as well. And I think if you look at their specific result, they'll indicate you to office furniture in particular and some of their other classes of product are more severely impacted. Do I think there is a larger issue? I think I am not prepared to comment on that. Certainly, the whole import private label has been a challenge for us. The good news, if there is good news and if you're counting the dollar is the cost of imports is going up dramatically. Look, if you think about the dollar R&D appreciation, if you pick China, for instance, that's changed dramatically. If you think about the transportation costs, that's changed dramatically. The costs in China are going up and so the playing field from our global economic basis is probably leveling back to domestic supply. And so I think that's a good longer term factor for us, primarily, US based manufactures.

[Matt McCall:]

Okay. All right. And you commented a little bit about price pursuing price if needed. Can you talk a little bit about the price that was recognized in the quarter? I would assume there would be some price benefit maybe in furniture and maybe a price hit. Maybe there is some deflationary trends and how can you comment on that, maybe quantify the benefits?

[Bob Driessnack:]

Hi, Matt. This is Bob. I think in the office furniture segment, we did have some realization of price, primarily some increases instituted in the prior year. It was just enough or little bit more than not to offset material costs in the quarter but not substantial. The hearth business remains very competitive, but we had a pretty much neutral position on price in the first quarter.

[Matt McCall:]

Okay. That's helpful. Thank you. And finally, looking at the hearth business, talking about profitability for the year, can you remind me, I guess two parts to this question, can you remind me of the breakeven level if there is, if that's a way you want to look at it for the hearth business overall? And then, did the Harmon acquisition help or hurt the profitability this quarter?

[Bob Driessnack:]

Yes, the Harmon acquisition help to top line really was kind of a neutral on the bottom line. The benefits of that are to come as the year goes on and then next year is really when we start to see the benefit. As far as the breakeven, we don't really break that out. Obviously, as you look at our sales level and our deleverage, I mean, we're approaching that. We expect to be profitable for the year, for the quarter as you saw we did go red. So, that I think as far was the best indicator we can give.

[Matt McCall:]

Okay. All right. Thank you, guys.

[Bob Driessnack:]

Thank you.

[Operator:]

Next question comes from the line of Budd Bugatch of Raymond James. Please go ahead.

[Budd Bugatch:]

Good morning, Bob. Suppliers-driven channel is obviously a real challenge and as I recall pricing in that sector requires something that was 90 to 180 day lead time to effect the price with fuel going up and costs going up in such a volatile and strong way, what are your plans and what have you done in that and when would you see additional price realization on that?

[Bob Driessnack:]

Yeah, I mean you've summarized it well about the challenge. It is the challenge for us, especially when big costs go up and hurry to recapture exactly in the period. We planned to kind of take it on as we have in the past, which is kind of work that through, give our customers adequate notice, so they can go work it to their system as well. We do have price increases going on right now. So we anticipate that some of this material costs is going to recover, we anticipate that costs would go up. The question still is how much will some of these costs go up and stay and that's yet to be determined, and so we manage it company-by-company, channel-by-channel. And first thing we try to do is, scratch back all the costs we can through efficiency eliminating the waste, and then we actually work with our channel partner to get it all the way through.

[Budd Bugatch:]

And Stan, if we were to think of how to quantify some of that, how would we best to be able to do that for modeling purposes or even for thought purposes going forward?

[Stan Askren:]

Well, it's pretty darn hard right now, because it's all moving pretty fast. And so I would say, for second quarter there is not a big impact, its how you should model it and we'll have to comeback and provide clarity on third and fourth quarter when we have more visibility there.

[Budd Bugatch:]

Okay. Looking at the up loss in the first quarter in hearth and you talk about being profitable for the year, do you reach profitability in the second quarter and imply it in the guidance?

[Stan Askren:]

More like breakeven, but there is a strong seasonal impact to that business especially as the mix is shifted less, do construction more to, sort of, remodel retrofit alternative fuel stoves. And so the second and third quarter is really when that stove buying season comes on and that's when the most of the profitability is earned in this year.

[Budd Bugatch:]

Okay. Just back for a second a question I forgot to ask you. You had just under $7 million of acquisition revenue in the first quarter reported, none of that was HBF because that wasn't completed until the end of the quarter I believe. Where was the other $7 million, was it in the transactional side or the supply side or was it in the contract side?

[Bob Driessnack:]

Budd, this is Bob. That was in the contract side.

[Budd Bugatch:]

So the contract side would have been up year-over-year. Can you give us kind of an order of magnitude of how much that might have been up?

[Bob Driessnack:]

Yeah. If you look at our core contract business, our challenge is always sorting through what supply and what's contract.

[Budd Bugatch:]

I know.

[Bob Driessnack:]

If you look at our core contract businesses, which would be going to lock in all fields, they were up for the first quarter more than that month.

[Budd Bugatch:]

Okay. And did the acquisition come inside those two or would have been HON Company. I feel…

[Bob Driessnack:]

The acquisition would have been part of….

[Budd Bugatch:]

Would have been HON. I feel.

[Bob Driessnack:]

The acquisition would have been separate.

[Budd Bugatch:]

Would have been separate?

[Bob Driessnack:]

Yeah.

[Budd Bugatch:]

Okay. So then, it looks like the transactional side was somewhere down between 13% to 15% year-over-year?

[Bob Driessnack:]

About that slow, Budd.

[Budd Bugatch:]

Okay. All right, just couple of other questions. Refresh us or update us on the restructuring actions beyond the second quarter restructuring transition cost for the third quarter and fourth quarter, is there so much to be done?

[Bob Driessnack:]

Budd, when you get into the third and fourth quarter, there is a little bit but it's not much, it's probably $1 million to $2 million for the balance of the year.

[Budd Bugatch:]

And the benefits of that, when will that start to approve on to the operating statements?

[Bob Driessnack:]

We'll start to see some of the benefits for this in the second half of 2008. And then, I think we've previously talked about the full realization of these being in 2009.

[Budd Bugatch:]

And do you want to give us a quantification of how much in the second half?

[Bob Driessnack:]

Second half is probably in the nature of $5 million to $6 million.

[Budd Bugatch:]

Okay. Thanks Bob. Thank you, Stan. Good luck on it. I know it's a challenge for you.

[Stan Askren:]

Thanks, Budd

[Operator:]

Our next question comes from the line of Todd Schwartzman of Sidoti & Company. Please go ahead.

[Todd Schwartzman:]

Hi. Good morning, gentlemen. Just a quick clarification on the gross margin guidance for Q2, is that versus the, what I think is a non-GAAP number of 34.9 that I'm looking at or is there some other number I should be using?

[Bob Driessnack:]

Todd, this is Bob. I think it's versus the prior year's second quarter guidance, so 1 to 1.2 percentage points down from the prior year's second quarter.

[Todd Schwartzman:]

On the Opt margin side, when do you foresee hitting double digits on a full year basis?

[Stan Askren:]

I think that's too hard for us to forecast right now, Todd, due to this sort of uncertainty of the economy in the market.

[Todd Schwartzman:]

Okay. One last thing, getting back to possible acquisitions within office furniture in North American markets, is there any niche, any tuck-in product category that you would like to be better represented in that you really can't or don't choose to grow organically?

[Stan Askren:]

Nothing that I am prepared to comment on, Todd.

[Todd Schwartzman:]

Okay. Thanks a lot.

[Stan Askren:]

Thank you.

[Operator:]

We have no further questions at this time. Please continue.

[Stan Askren:]

All right. Well, thank you very much for tuning in. We appreciate your interest in the company and we look forward to talk with you in the future. Have a good day.

[Operator:]

Ladies and gentlemen, that does conclude our conference for today. If you like to listen to the replay, this conference will be available after 12