HNI Corporation
Q2 2010 Earnings Call Transcript

Published: 22 Jul 2010

[Operator:]

Welcome to the HNI Corporation second quarter results call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions) As a reminder, today's conference is being recorded. I would now like to turn the conference over to our host, Kelly McGriff. Please go ahead.

[Kelly McGriff:]

Good morning and thank you for joining us today for the HNI Corporation conference call to discuss second quarter 2010 results, which were announced yesterday after the market closed. My name is Kelly McGriff, Treasurer and Vice President for HNI Corporation. If you have not received a copy of the financial new release, please call 563-272-7927 and we will send it to you. The release is also available on our website www.hnicorp.com. We posted a presentation intended to accompany this call to our website. The presentation contains details of our financial performance including the non-GAAP to GAAP reconciliation. It can be found by accessing the webcast link under the investor information section of our website. We encourage you to review this presentation. Joining me on the line today from HNI Corporation are Kurt Tjaden, Vice President and Chief Financial Officer and Stan Askren, Chairman, President and CEO. Stan and Kurt 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 strictly historical facts are forward-looking statements. Forward looking statements are subject to known and unknown risks. Actual results could differ materially from expected results. Additional information concerning factors that could affect actual results can be found in the conference call presentation posted on the HNI Corporation website. 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 everyone. I'll share a brief assessment of the second quarter and provide some thoughts on the outlook. And then Kurt Tjaden, our Vice President and Chief Financial Officer will share the comments with me, he will discuss some of the specific financial details. And then as is our usual practice, we will the end call with questions. Strengthening demand in office furniture combined with outstanding execution across the businesses drove strong second quarter results. We continue to leverage our cost structure, and network distribution models. We also invested in growth initiatives to drive long-term shareholder value. We delivered significantly improved results over prior year and exceeded second quarter expectations. Our businesses gained momentum throughout the quarter as the economy and market improved. Office furniture demand improved across the board, the supply driven channel recovered with a 4.7% growth over prior year and we saw a significant turnaround in the contract international businesses, which was up a combined 11.5%. Our second quarter results reflect the success of our investments in new products. We launched a record number of new products in the recent period and they have been well received by the market. For instances, HNI through Allsteel and HBF won a combined five gold and silver product awards at this year's NeoCon office furniture industry show, which was more than any other office furniture manufacturer and our intent is to continue this momentum. Other core growth initiatives included investments in new selling capabilities, dealer development programs, sales training programs, ebusiness solutions and many other items there. We anticipate a 12 to 24 month payback on these incremental investments. Overall, the hearth segment was down 2.3% versus prior year. The hearth new construction channel was up 24% in the second quarter positively impacted by the homebuyer tax credit. The hearth remodel retrofit channel continued to be negatively impacted by challenging retail environment, low fuel prices, fuel oil price, excuse me and the dealership towards our just in time delivery program and a way from early buy dating (ph) programs. As a result, retail sales in the second quarter were down 22%. However, I continue to be upbeat about the future of our hearth business. We are investing in new products and growth initiatives, the strengthening in our already industry leading market position, our recently announced value oriented product initiatives in entering and there is a form of type channel is an example of how we are expanding hearth's breadth and depth in the marketplace even during these challenging times. Hearth continues to be on track for a significant turnaround from 2009 and will be profitable for year. So overall, second quarter results are a product of strong execution across all the businesses. Our performance is a reflection of the power of our slick and focused business model. As I said, we continue to reduce cost, improve operations and invest in growth initiatives that we believe will drive long-term shareholder value. And I want to thank our members for their dedication and hardwork during the last quarter and now I will turn it over to Kurt to review the specific numbers for the second quarter and financial outlook for the third quarter.

[Kurt Tjaden:]

So we will start with the second quarter 2010 where consolidated net sales from continuing operations increased 6.3% to $398 million. Sales for the office furniture segment increased 7.8% to $343 million while net sales for the hearth product segment decreased 2.3% to $56 million. Consolidated gross margin including restructuring and transition charges improved to 35.5% compared to 34% in the prior year quarter. Total selling and administrative expenses as a percent of sales including restructuring and impairment charges improved 1.3 percentage points. Second quarter 2010 included $2.4 million of restructuring and transition costs which were associated with the shutdown and consolidation of office furniture facilities, of which, $1.1 million were included in cost of sales. Importantly we ended the quarter with $44 million of cash. We generated $2 million of cash during the first six months, which was compared to $49 million generated in the prior year. So as we move on to our outlook for the third quarter, we anticipate overall sales from continuing operations to be up 7% to 9%. Third quarter 2009 included $8 million of sales from discontinued operations with $6 million in the office furniture segment and $2 million in the hearth segment. Office furniture sales are expected to be up 7% to 10% with growth in both the suppliers drive and contract channels. Hearth sales are expected to be up 5% to 7% driven by the remodeled retrofit business shift in delivery timing. Excluding restructuring and transition charges, gross profit margin is expected to decrease approximately 1.2 to 1.3 percentage points versus third quarter 2009 when it was 37.3%. Third quarter 2010 is expected to include $1.2 million of restructuring and transition cost compared to $1.6 million in the prior year quarter. Excluding restructuring and transition charges, SG&A as a percentage of sale is expected to range from 28% to 28.6% compared to 28.3% in the third quarter 2009. We anticipate SG&A related restructuring and transition cost to be approximately $600,000 in the third quarter and again, these charges relate to the shutdown of previously announced office furniture facilities. Important to note third quarter profitability will be negatively impacted by higher material costs and accelerated investments in growth initiatives. We are projecting input costs to exceed the benefits of price increases and cost reduction initiatives in the third quarter by approximately $6.5 million; however, our previously announced pricing actions along with cost reduction initiatives will only offset increased material cost by the end of 2010. In addition, we are reinvesting a portion of our cost recess savings to focus growth initiatives across our core businesses. The projected impact on the third quarter from these investments is approximately $5 million. Net interest expense is projected to be $3.2 million and the effective tax rate is projected to be approximately 38% during the third quarter. So for the year we continue to expect to generate free cash flow in excess of $80 million and capital expenditures will be approximately $25 million to $30 million again primarily focused on new products. That summarizes the second quarter results and outlook for the third quarter 2010, I'll now turn the call back to Stan.

[Stan Askren:]

I'm encouraged by the strengthened demand in office furniture and hearth business despite the ongoing economic uncertainty. As we said, we're accelerating investments in core selling marketing and product initiatives to strengthen our multiple platforms for growth and drive long term shareholder value. We remain focused on improving operations and reducing cost and in conclusion we are excited that our business is financially strong and well positioned for growth. So with those comments we'll now open it up to questions.

[Operator:]

(Operator Instructions) Your first question is from the line of Mark Rupe with Longbow Research.

[Mark Rupe:]

Hey guys good quarter. Hey, Stan, on your comments on demand obviously it's pretty clear that you're happy with your strengthening demand. On the office furniture side in particular the supply channel seems to have put up its first quarter of growth I believe in a long time. Just curious to see how as you're looking at third quarter, the difference between kind of the supply channel and all the other office furniture how you think about that 7% to 10% growth.

[Stan Askren:]

Yes, I think the supply side is lagging a little bit. So it will tend to be more on the 5% to 7% sort of side it is, and then the contract side will be higher than that.

[Mark Rupe:]

Okay and as far as some of your larger distributors, are they restocking at all?

[Stan Askren:]

We're seeing just a little bit. Some of that has to do with buy ahead, price buy ahead so it's really hard to tell but not significant I would say restock activity.

[Mark Rupe:]

Okay and then on the hearth commentary for the third quarter you cited driven by remodeled retrofit, I know there is a seasonal bump but is there any kind of incremental impact above that you're expecting from that piece of the hearth channel?

[Stan Askren:]

The remodel retrofit worked – the answer I think – let me try this, Mark, and see if this answers what you're asking. We don't see any sort of core demand in improvement other than the seasonal improvement and also you'll see a sales bump there because we have shifted, helped our dealers with cash and so they're shifting from kind of the early buy to more of taking deliveries more in line with sort of seasonal demand. So no real improvement on kind of the core but seasonal uptick and then there's change in ordering ship pattern.

[Mark Rupe:]

Okay and then just secondly on the pricing and the raw material, kind of headwind in the back half, since the late April call and some of the pricing that's been put through has there been any kind of change in what the overall back half headwind could be as far as your estimation or any change on the philosophy or taking price on maybe some of the inputs may have. I don't know if they have rolled over enough for you.

[Stan Askren:]

I'll take a whack at this and maybe Kurt can back me up here. Overall, no real change; we anticipated there'd be material cost sort of bump up and then a bit of a moderation and that's what we've seen. We put price increases in that by the beginning of the next year should fully cover that gap and that's about what we thought that was going to be. So we're on a track with what we anticipated.

[Mark Rupe:]

So, yes, I think it was $15 million or 20 million headwind was the expectation.

[Kurt Tjaden:]

Yes, a little less. I'd say probably $12 million to $15 million. Certainly we've seen steel moderated to look out to the back half of the year but it's in the ballpark.

[Mark Rupe:]

Okay and I'm not sure if you mentioned, as it relates to second core specifically on kind of the gross margin kind of components, I think you had an expectation for a price discounting it's like a $6 million to $7 million impact and raw material $1 million to $2 million, did I miss that on the prepared comments?

[Kurt Tjaden:]

No, you got that and that was part of the (inaudible) and a piece of that is, Stan to talk, was the return as well as our improved day to day and transactional business. So we actually had better price realization in the second quarter than we have anticipated.

[Operator:]

You have a question from Budd Bugatch with Raymond James.

[Budd Bugatch:]

Yes congratulation on the quarter Stan, Kurt good for your team. First question I guess is on the contract side of the office furniture business, it was up I think 11.5% in the second quarter.

[Stan Askren:]

Correct.

[Budd Bugatch:]

How are you looking at the two components in the third quarter with revenues upwards of 7% to 10% total?

[Stan Askren:]

Yes what we said is the supply side to be on kind of the lower side of that let's say 5% to 7% and contract will be up 10% to 14%. Contract also includes our international business, which is primarily China, not huge, but it's very, very strong as well.

[Budd Bugatch:]

Are you seeing that in terms of orders? I know you don't typically get into the order discussion but can you kind of give us a feeling of what the backlog looks like or how that plays into the quarter?

[Stan Askren:]

Yes let me comment on momentum here around order activity, it's probably the best way for me. We are seeing sort of still solid order momentum consistent with what we saw in second quarter. Now we are monitoring that closely given all the press and some of these indicators which would indicate that the economy is moderating some but right now we're seeing sort of the same momentum but as I say we look at orders daily and certainly look at them weekly and we're prepared for multiple scenarios as always but right now it's continuing.

[Budd Bugatch:]

When you are looking at some hearth, I was pleased to see the construction channel up as much but you're just saying that's seasonal, did I get that right?

[Stan Askren:]

Well, the construction is really an impact of this first time home buyers tax credit is what believe was a big part of that and there was a huge push by builders and all that to get homes built and get completed. We believed for the second half the new construction is going to be basically flat to maybe slightly down.

[Budd Bugatch:]

You had told me in the past I think that – I had always thought that the hearth business in construction was a latter part of the cycle, but kind of disabused me of that notion, is that still correct?

[Stan Askren:]

Well, of the cycle –

[Budd Bugatch:]

To build a house but there's a lot of work that goes in and when you're doing new construction in the hearth, there's a lot of work and a lot of the revenue recognition actually happens earlier.

[Stan Askren:]

Yes, there's a lag between when they start a house, build a house and when they get the fireplace installed and then we bill it. That was compressed in the first half because everybody was scrambling. So there was a lot of I think compressed activity to get homes started and completed and so that may be the new norm. I don't think so. I think it's more around kind of the 60-day lag from the time our house has started to the time we actually see the revenue.

[Budd Bugatch:]

Mark went over the pricing issue. Let me talk about the sales initiatives and the growth initiatives. Can you go into a little bit more flavor as to what's included there any what may be causing that and how you recoup that?

[Stan Askren:]

Yes, I'll give you the philosophy. The philosophy is we've done a tremendous job, we meaning the management team and the members of this corporation, so not we Stan here, but the members and the management team have done a tremendous job on cost reset. And then as we see this economy sort of turning we're back on the gas regarding sort of growth, market initiatives. Now if I remind you, but we go to market through multiple selling models, multiple companies, multiple brands to cover, you know, the broadest segment of this office furniture than anybody. So these growth initiatives are coming in multiple flavors, multiple places in the organization but they include the general areas around accelerated product development, helping our channel partners and our dealers do a better job of transacting business with our dealer partners. New selling models, some of that is around government, some of that is around education, some of that is right in our core business sort of client as well. Helping our dealers develop, so helping them with new systems and processes and those sort of things. So there is many, many different flavors of this. We have a process in which we are acting as a strategic investment fund as a corporation for each of the operating companies. They come to us and propose what they want to invest in. We have a very detailed tracking process and so we're tracking that as if – as a strategic investment type of company at the corporate office. We're – we wanted to make everybody aware that we're on kind of on the gas investing and we anticipate a relatively quick feedback, somewhere around the 12 to 24-month time period. And we think this is the right time to get on that.

[Budd Bugatch:]

And the strategic investment fund, what is that quarterly? What do you – what typically do you put forth to the various business units?

[Stan Askren:]

What we're going to see Budd is probably here for the foreseeable future like $5 million a quarter.

[Budd Bugatch:]

And, lastly from me, I noticed that inventory grew a little faster than sales this quarter. I'm just curious as to what may be behind that, and is that going to come back down or how should we think about that?

[Kurt Tjaden:]

Yes, Budd, that absolutely will come down. You should expect to see inventory roll-off by about $10 million during the third quarter. We – Stan talked that timing impact on the Hearth business, so we had some inventory we're holding for remodel, retrofit that will shift in the third quarter. We did some steel buy ahead at the end of the quarter to take advantage of lower prices. And then also on our transactional business as we're sourcing foreign product and we're ramping up that as one of our growth initiatives, there is a slight inventory lift there. But as the overall terms continue to improve, quality of inventory continues to get better and we would expect to see that continue to track in the right direction.

[Stan Askren:]

That was not a surprise and as Kurt said, we feel good about our core processes around managing working capital and specifically managing inventory Budd.

[Budd Bugatch:]

So just to be clear, you say that the third quarter, end of quarter inventory will be $10 million below the second quarter end of inventory?

[Kurt Tjaden:]

Correct.

[Budd Bugatch:]

Okay. Thank you very much. Congratulations and good luck.

[Kurt Tjaden:]

Thanks Budd.

[Operator:]

Next question is from Peter Lisnic with Robert W. Baird.

[Josh Chan:]

Good morning. This is Josh Chan filling in for Pete. I was just wondering with the $5 million investments into the foreseeable future what kind of incremental operating margin should we expect to see as we look out one to two year with volume growth?

[Stan Askren:]

Well, we'll give you the leverage that we've been giving, Josh, which is a 30% sort of bottom line leverage as we drive incremental top line.

[Josh Chan:]

So there's really essentially no impact you'd say from the $5 million or?

[Stan Askren:]

I'm not sure. Explain your question a little bit better.

[Josh Chan:]

Yes, I was just wondering if the $5 million investments continuing on would kind of eat into that leverage essentially?

[Stan Askren:]

No, as we said, we should get a full payback in 12 months to 24 months Josh. And so, it's really to drive top line growth which then will convert to profit dollars at a greater than 30% sort of bottom-line leverage.

[Kurt Tjaden:]

Now, let me just add to it. I think short term, clearly as we've talked, third quarter you're seeing that. But as Stan said, if you look 12 months to 24 months out, as those start to roll through, that 30% leverage is what we're expecting to drop to the bottom line.

[Josh Chan:]

Okay, great. And then could you talk about the pricing environment a little bit, how receptive was the market to your price increase? And did your competitors do similar price increases?

[Stan Askren:]

Well, the market is always – it's always a tough market to get through price increases. But I would say that we have the price increase has been set, it will stick we believe. And the competitive climate, I'm not exactly sure specifically, but in general, we believe that the competitive climate is not changed around pricing, and that this industry in the past is especially when it's big material cost tends to get price increases to cover that type of cost.

[Josh Chan:]

Okay. And then a last question, you talked a little bit about mix of lower margined products at office, could you elaborate on that a little bit?

[Stan Askren:]

Well, it's – it's mix of A, big project versus day-to-day is really what we're talking about. So when you do big project bids, you tend to have lower margins more competitive than when you have day-to-day type of business.

[Josh Chan:]

Okay, I understand. Thanks for your time.

[Stan Askren:]

Okay, thank you, Josh.

[Operator:]

Our next question is from Todd Schwartzman with Sidoti & Company. Please go ahead.

[Todd Schwartzman:]

Hi, good morning, all. What did you see in the quarter in terms of number of large projects, say $1 million dollars and up versus a year ago?

[Kurt Tjaden:]

We don't track and never disclose that Todd.

[Todd Schwartzman:]

Okay. And did you mention what the Q2 furniture orders were?

[Kurt Tjaden:]

No, we did not. We do not disclose orders.

[Todd Schwartzman:]

Got it. Also, staying on office furniture, what would you say was the sweet spot in the segment in terms of customer size, number of employees, vertical market, industry, so on and so forth? Geography I guess you could throw in there, as well.

[Stan Askren:]

We saw broad based, Todd. I guess, we don't track, first of all, we don't track that and disclose it the way you describe it. But, this sort of improvement has been broad based across virtually all of our businesses and we saw as we said good improvement in supply, we saw a strong improvement in the contract side and strong improvement in the international side. So as you know, we have the split and focus business model and I would say everybody participated in the improvement.

[Todd Schwartzman:]

And is there a two to three-year goal or perhaps a longer-term goal for operating margins in office furniture?

[Stan Askren:]

Not that we've disclosed. We do often talk about this leverage at approximately 30% and we see that into the foreseeable future.

[Todd Schwartzman:]

And on the lower end of the furniture business, lower end of the supplies business, has there been any noticeable change in the level of competitive pressure from imports or has that been pretty much status quo?

[Stan Askren:]

I would say it's pretty much status quo, Todd.

[Todd Schwartzman:]

Thanks, guys.

[Stan Askren:]

All right, thank you.

[Operator:]

We've a question from Matt McCall with BB&T. Please go ahead.

[Matt McCall:]

Thanks. Good morning, everybody.

[Stan Askren:]

Hi Matt.

[Matt McCall:]

I'm going to kind of I think continue on one of those – the last questions. If you look at the supplies business, I think if you track some of the small business data that's out there I think small business optimism, I guess they're still not optimistic. You said there's not really any restocking yet the supplies are starting to grow again. Is it – do you think it's share gains or are you actually seeing those customers despite the lack of optimism start to buy again?

[Stan Askren:]

It's a great question. I think maybe there probably was some pent-up demand from the dramatic decline. Second, we've got some vertical markets that are – believe increased our emphasis and I think we're seeing probably some share gains. For example, K through 12 education, certainly government has been a major emphasis and a major growth area for us. And then, I feel good about our momentum and kind of the core office furniture. So I would say it probably is some share gain. But to be fair, it's tough to call on share gains and sort of by a quarterly basis, which we don't do it historically. But I feel good about momentum.

[Matt McCall:]

And then given all the signs from a macro perspective it didn't sound like you're seeing anything that would kind of take you off of this broad based momentum theme that you've been talking about for a couple quarters. Nothing internally saying that anything is happening kind of behind the scenes?

[Stan Askren:]

We are not seeing it yet. I read the newspaper and I get concerned about moderating recovery, but it hasn't worked its way through to our business yet, if it's going to.

[Matt McCall:]

Okay. And then, Kurt, you said that discounting wasn't as bad, pricing maybe was a little better. Can you give us the numbers behind that?

[Kurt Tjaden:]

Yes, it really came back to that day-to-day transactional business as oppose those large projects that have a happier discount emphasis and we thought that both our contracts and our supplies business through the second quarter. So that beat was, I think we said 6% to 7% negative impact and it was closer to 2%.

[Matt McCall:]

Okay and then on that investment side you talked about $5 million going forward. Was that the same number you recognized or invested in Q2?

[Kurt Tjaden:]

The $2 million in Q2 is to kind of get up and run and then Q3 will be more like $5 million.

[Matt McCall:]

Okay and then finally, anything from a comp perspective in any of these groups? Do the comps get easier, better or remind me in the back half of the year, I'm having technical difficulty here. I just want to make sure that as we look at the back half of the year I'm understanding what you're going to face.

[Kurt Tjaden:]

Let me make sure I understand your question Matt.

[Matt McCall:]

Okay.

[Kurt Tjaden:]

If you just play it back again.

[Matt McCall:]

Yes, yes no you just talked about some of the growth trend. You talked about contract up 12% and I think you talked about the expectations for Q3 but as we progressed through the year did the comps and forgive my ignore but I just don't have the model, I just want to make sure I understand what the comp trend is in the back half of last year. Did things get that much better, that much easier; how do you look at the rest of the year relative to what you experienced last year?

[Kurt Tjaden:]

No I think you would see pretty similar trends the last year, no major differences.

[Operator:]

At this time there are no further questions in queue.

[Stan Askren:]

Okay well, with that we want to thank you for your interest in HNI and appreciate your time today and we look forward to talking with you soon, thank you.

[Operator:]

Ladies and gentlemen this conference will be available for replay after noon Central Time today through midnight Central Time on Thursday July 29th. You may access the AT&T executive replay service at anytime by dialing 1800-475-6701 entering access code 164082. The number again is 1800-475-6701, access code 164082. This does conclude your conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect. Copyright policy