HNI Corporation
Q2 2011 Earnings Call Transcript

Published: 21 Jul 2011

[Operator:]

Good morning. My name is Sean and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the HNI Corporation Second Quarter Fiscal 2011 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions). As a reminder, today’s conference call is being recorded. Thank you. I’d now like to turn the call over to Mr. Derek Schmidt. Please go ahead, sir.

[Derek Schmidt:]

Good morning, and thank you for joining us today for the HNI Corporation conference call to discuss second quarter 2011 results, which were announced yesterday after the market closed. My name is Derek Schmidt, Treasurer and Vice President of Corporate Finance 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. A presentation intended to accompany this call has been posted to our website. This 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 up 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 to 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?

[Stanley Askren:]

Good morning everyone. I’ll share an assessment of the second quarter of 2011 and provide some outlook thoughts regarding third quarter, while Kurt Tjaden, our CFO will then open the call up for questions. We executed well and delivered solid results in the second quarter. Sales in our office furniture contract and international businesses remained especially strong and exceeded our expectations with 25% top line growth primarily driven by large projects. Overall sales in our supplies business declined 5% year-over-year. Core demand in our supplies-driven business was relatively flat, consistent with uncertainty in small business confidence. The quarter was adversely impacted by a substantial inventory reduction of $12 million by our large wholesale partners, who took advantage of our streamlined fulfillment model and their initiatives to improve their return on invested capital. Our Hearth business significantly exceeded expectations. Remodel-retrofit sales increased 32% as remodeling activity improved and our alternative fuel products were constantly impacted by higher oil prices. The new construction channel was down 11%, due to the difficult housing market and the prior year benefit comparison of the home buyer tax credit. I’ll now turn the call over to Kurt to provide some specific financial data for the second quarter. Kurt?

[Kurt Tjaden:]

Thank you, Stan. For the second quarter 2011, consolidated net sales increased 8.7% to $433 million. Sales for the Office Furniture segment increased 8.7% to $373 million, again, negatively impacted by the $12 million wholesale partner inventory reduction. Net sales for the Hearth Products segment increased 8.4% to $60 million, and consolidated gross margins decreased to 33.9% compared to 35.5% in the prior year quarter due to increased material costs, unfavorable mix of business, and lower price realization. As a percent of net sales, total selling and administrative expenses improved 0.9 percentage points due to higher volume and lower restructuring charges, which were partially offset by increased fuel costs, investments in strategic growth initiatives and higher incentive-based compensation. We ended the quarter with $47 million of cash. Operating activities used $8.4 million of cash during the first six months of 2011 compared to generating $1.5 million of cash during the same period last year. Our inventory increased $18 million from the same period last year. This was due to one, the timing of large contract projects that we expect to ship in the third quarter; two, an inventory investment made to level load to our production, which we expect to ship in the balance of 2011; and three, increased volumes and higher material costs. I’ll now turn back to Stan.

[Stanley Askren:]

Okay. Thank you, Kurt. Looking forward, we entered the third quarter well positioned to deliver solid sales and proper growth over prior year. Our contract brands are performing well. We anticipate continued double-digit growth in our contract business, driven by strong demand. Year-over-year growth rates within our contract channel are expected to moderate in the second half of the year, again, stronger prior year comparison. We continue to see significant international growth, particularly in China. We’re aggressively expanding our geographical sales presence in the region and investing in new products. In our supplies channel, we expect growth to continue to be constrained in our day-to-day transaction business due to challenged small business confidence. We are executing well and continue to aggressively pursue cost reduction opportunities. We are the leaders in supplies channel and remain committed to invest in product development and resources to strengthen our channel partners and grow our business. In our Hearth segment, we anticipate solid double-digit growth as our remodel-retrofit business is expected to remain strong and the year-over-year comparables for new construction become more favorable. We remain on track to grow sales and increase profits for the year 2011. We have and we will continue to adjust pricing in response to material inflation. We continue to advance strategic investments in new products and selling initiatives to support long-term growth. We recently launched a record number of new office furniture products that have been well received by the market. HNI had a strong showing at NeoCon, our industry trade show this year. Allsteel won four Best of NeoCon Products awards, and HBF, HON and Allsteel won multiple people choice product awards. These recognitions are reflection of the focus and quality of our new product development process. Our investment in this area continues to drive success. And then finally, we will remain vigilant in reducing costs and providing outstanding value to our customers. Kurt, will now provide the financial outlook for the third quarter

[Kurt Tjaden:]

For the third quarter 2011, we anticipate overall sales to be up 6% to 9%. Office furniture sales are expected to be up 5% to 7%. Sales in the supplies-driven channel are expected to be flat to down 4%. Sales in the rest of our office furniture businesses are expected to increase 15% to 18%. Parts sales are expected to increase 13% to 15%. Gross profit margin is expected to be in line with third-quarter 2010 when it was 35.3% excluding restructuring and transition charges. Operating leverage from the year-over-year volume increase is expected to be partially offset by higher material costs. SG&A as a percentage of sales is expected to be moderately higher than third quarter 2010, when it was 28.4% due to higher freight and distribution costs. Our net interest expense is projected to be $2.5 million. And the effective tax rate for the third quarter is projected to be approximately 36%. Capital expenditures are expected to be approximately $30 million to $35 million, primarily focused on new products. And we project depreciation and amortization will be $46 million to $48 million for the year. So, for the third quarter we anticipate non-GAAP earnings per diluted share in the range of $0.37 to $0.43 excluding restructuring charges and transition costs. For the full-year 2011 we expect non-GAAP earnings per diluted share in the range of $0.90 to $1.00 per share excluding restructuring charges and transition costs. That summarizes our outlook for the third quarter of 2011. I’ll now turn the call back to Stan for closing comments.

[Stanley Askren:]

So, in closing our formal comments, I remain positive about our markets and the prospects for our businesses going forward. Despite economic uncertainty, we remain on track to increase sales and profits in 2011. Our performance is a reflection of the power of our unique split and focused business model. We continue to reduce costs, improve operations and invest in growth initiatives that will drive shareholder value. Our business is financially strong and well positioned for long-term profit growth. With those comments complete, we’ll now open it up to questions.

[Operator:]

(Operator Instructions). Your first question comes from the line of Mark Rupe. Your line is to open.

[Leah Villalobos:]

Good morning. This is Leah Villalobos in for Mark this morning. On the supplies side of the Office Furniture business, I know there is a one-time inventory in the second quarter, but kind of looking at that business going forward, clearly we’ve seen small business confidence coming down. Is there anything else going on there?

[Stanley Askren:]

No, not that we’ve seen, Leah. We believe that we are performing well in that market. And we think it’s simply that the core demand is muted by small business confidence or lack of confidence regarding top line growth and then uncertainly around healthcare credit and all the other things that you read about. We think we’re very well positioned, competing well and we have a leadership position there that we continue to invest to grow that position regardless of what the economy is and regardless of where that small business confidence is at.

[Leah Villalobos:]

Okay, great. And then on the contract side of the office furniture business, clearly, you’re seeing some great strength there. I was wondering if you could talk a little bit more about what you are seeing in terms of where that strength is coming from.

[Stanley Askren:]

Yeah there’s several factors driving that growth. One, corporate profitability has been good in those large corporations. Two, to a large extent what we’re seeing in the industry, I’ll call it a real state strategy play. So there’s lots of corporations that are driving cost reduction. They’re chasing better lease rates. They’re thinking about consolidation, how do they get more out of less tighter work spaces et cetera. So that’s driving a significant amount of churn, a significant amount of furniture (inaudible). The other factor is simply pent-up demand. They’re through the recession. There were a lot of companies, a lot of firms that put off spend and now are to the point where they’re – seem a little bit unlike or they’re finding the place, where they just simply have to refresh. And so they are investing money. And then you have factors around – there’s some growth in there as well, multinational corporations, emerging market plays are seeing significant growth and they are investing in their business. And then the rest is kind of mix up the remainder of that demand.

[Leah Villalobos:]

Okay. And in terms of how that trended throughout the quarter, did you see that accelerate? Is it sort of stable? What was the pattern like there?

[Stanley Askren:]

I would call it stable. Certainly, we are coming up more difficult comparables.

[Leah Villalobos:]

Sure.

[Stanley Askren:]

As we come out of the recession, but now I think our view is that pipeline is still stable, is still good and it is a bit lumpy now and then because of – there’s lot of big projects out there, particularly government projects and how they come in and our shift does drive some lumpiness there, but overall demand feels like it’s stable.

[Leah Villalobos:]

Okay, great. And then just lastly, on the lower price realization during the quarter, is that – I know you’ve taken some pricings, so is that really an issue of the discounting on larger projects or is there anything else going on there?

[Stanley Askren:]

It’s a mix issue, Leah, of the larger projects versus the smaller projects. Pricing is, I would say, is stabilized overall.

[Leah Villalobos:]

And then, if I could just throw one more in there, actually, I think on the last call you had talked about the price cost gap closing by the end of the year, is that still kind of you’re thinking at this point?

[Kurt Tjaden:]

Yeah, that’s absolutely about the point as we look for the back half of the year, we’d be negative in the third quarter, but as we see the whole benefit of those price increases roll in by the fourth quarter, we would expect that to be positive.

[Leah Villalobos:]

Thank you, best of luck to you.

[Stanley Askren:]

Thank you.

[Operator:]

Your next question comes from Budd Bugatch. Your line is now open.

[Budd Bugatch:]

Hi, Stan. Hi, Kurt. Hi, Derek.

[Stanley Askren:]

Hi, Budd.

[Budd Bugatch:]

Just to make sure I understand – excluding that $12 million inventory reduction by your customer, then I guess supplies would have been up modestly in the quarter, is that right?

[Stanley Askren:]

Flat, Budd, probably would be a better characterization of that.

[Budd Bugatch:]

Okay. And you’ve got it going flat to down, did you say 4% or 5% in the next quarter. Is there anybody else going to do an inventory reduction or do you have any more of that to come that you’re aware of?

[Stanley Askren:]

Not that we’re aware of, Budd. Now they’re certainly, I mean quite candidly this is one of those mixed stories. We have worked hard to streamline, improve our fulfillment models and give our customers the opportunity to get their product fulfilled in faster timeframe. Likewise, our large customers are all well-managed corporations that are driven by gross margin, return on invested capital, and so they’re – they have their internal processes of sorting through, how do they improve their businesses. So, that’s all is ongoing, so there may be something in there. I don’t think it’s going to be at this level and there’s nothing that we’re aware of at this point.

[Budd Bugatch:]

I understand that’s a longer-term positive, because anything that helps your customers are longer-term positive.

[Stanley Askren:]

You bet

[Budd Bugatch:]

You’ve talked in the past about the growth initiatives, you referred to them, you quantified them in the past. Could you give us kind of a run rate of where we are on growth rate, growth initiative spending and how that looks like for the second, third quarter and the rest of the year?

[Kurt Tjaden:]

Sure, Budd. So, we were starting to come up on anniversarying those strategic investments. So for the second quarter, it was only about an incremental $2 million and for the back half you basically have anniversaried it. So there shouldn’t be incremental spending as you think about it from a year-on-year basis. Still very pleased with the progress. Again, as we’ve talked in the past, most of those run-ups, 12 to 18, 24-month payback and we’re pleased with what we’re seeing, but, again, continue to modify and adjust those as appropriate.

[Budd Bugatch:]

Okay. And you have called out China again and obviously something I’m very much very interested in. Can you quantify anything that’s going on there?

[Stanley Askren:]

It’s still, Budd, performing very, very well. I’d say compared to what we told you in the past, it’s as strong – at least as strong as it has been in the past.

[Budd Bugatch:]

Okay, all right. Good. Terrific. Congratulations. Good luck on the rest of the year.

[Stanley Askren:]

Thanks Budd.

[Operator:]

Your next question comes from Matt McCall. Your line is now open.

[Matt McCall:]

Thank you. Good morning everybody.

[Stanley Askren:]

Hey, Matt.

[Matt McCall:]

Thanks for the detail or the outlook on the full year and you know what I’m going to do, I’m going to jump ahead to Q4. But if I look at the Q4 or the full year guidance back in the kind of that Q4 implied guidance, looks like about $0.45 is the number. And if I look at normal seasonality top line, you’d be down about 2%, that’s assuming normal seasonal patterns. So the question is if we’re going to see what would be about a $5 million decline in revenue and I’m making the assumption that that’s true, help me understand the potential for $3.5 million to $4 million of incremental operating profit. Kurt, you mentioned some of the price coming through and the price cost turning positive. I’m sure that’s part of the explanation, but I don’t know if that could account for all of the $3.5 million to $4 million that I’m calculating.

[Kurt Tjaden:]

I think you calculated, you’re in the right range, Matt. And the number is exactly around that for that price cost turning positive. So that as we look forward would be in the range for explaining that difference.

[Matt McCall:]

Okay. So you’re giving me a price cost benefit of $3.5 million to $4 million, but then the – I’m assuming there will be the normal seasonal pattern of them I’m calculating $5 million. So would you have some offset there or is there anything else I need to take into account?

[Kurt Tjaden:]

No, I think you’ve got key items. As we see it today. I think you’re on the right track.

[Matt McCall:]

Okay. Anything from a segment perspective that you expect? Can you maybe talk about the – is – I’m assuming that’s more price cost improvement in the Furniture segment rather than Hearth, is that a correct assumption?

[Kurt Tjaden:]

Yes.

[Matt McCall:]

Okay. One thing you didn’t do is quantify discounting, inflation and things like that. Kurt, any detail you can provide there, you’ve done that in past?

[Kurt Tjaden:]

Well, I think Leah asked the question earlier. So if you think about for the third quarter, what we’re looking at is about $5 million negative price cost GAAP, and again flipping that in the back-half of the year based on what we see today.

[Matt McCall:]

And then what was the net pressure in Q2?

[Kurt Tjaden:]

Net pressure as about 9 versus we had said 5 to 6 and you got a little bit of higher material cost, but as Stan talked earlier, the difference on the price side was really a mix of business with a greater percentage of larger projects.

[Matt McCall:]

Okay that’s a nice segue. And the final question I have, Stan, you mentioned some of those large projects and the lumpiness especially tied to government. Give us an update on that government outlook. There’s lot of obviously concern about both federal and state and local, but what’s the trend there? And what’s your outlook as you look out into the back half of this year and next year?

[Stanley Askren:]

We’ve had double-digit government growth this year both federal and state and local have grown both. Federal has been stronger. And the pipeline still looks good for us, Matt. It’s certainly we would anticipate some moderation here as the state and local governments sort through their budget issues. And then the big question here is where does this federal government budget, sort of this whole harangue we are watching in Washington D.C. end up. But I think there’s still some legs in that government buy. It should moderate and then big question around Congress and the President and where they end up on this.

[Matt McCall:]

And any thoughts on or can you share the mix of government, what it’s going to look like this year and maybe what that compares – how that compares last year and what your expectations are for next year?

[Stanley Askren:]

It’s similar I would say, Matt. I don’t have those numbers here right in front of me right now, but my feel here is that it’s a similar mix and it should be similar going forward.

[Matt McCall:]

Okay thank you all.

[Stanley Askren:]

All right. Thanks, Matt.

[Operator:]

Your next question comes from the line of Peter Lisnic. Your line is now open.

[Joshua Chan:]

Hi, good morning. This is Josh Chan filling in for Pete. Just on the wholesale inventory de-stocking, was it just one customer? And did it surprise you that they did that this quarter in particular?

[Stanley Askren:]

We have two large primary wholesalers, both of them are participating in the process. And surprise is probably not the right word. It’s always uncertain, Josh, as to when large customers are going to do different things. Part of it has to do with their unique business climate, their plans, their strategy, when do they feel comfortable in making those moves. And so, ongoing discussion we’ve had that notion, it’s one of those things that is always possible when they did this quarter, sort of execute we think very well on that particular item.

[Joshua Chan:]

Okay. So is it fair to even to characterize this de-stocking as almost initiated by you rather than them?

[Stanley Askren:]

No, the customer is always the one that places the orders, Josh.

[Joshua Chan:]

Right.

[Stanley Askren:]

So part of that, though, in any sort of customer-supplier relationship is the confidence of the supplier can in fact execute at a different level. And then the customer makes decisions about their service levels and how they might supply their customers differently. And so it’s a classic customer-supplier sort of relationship and how do we take care of the end customer better and how do we improve the process to do that, and that’s what you’re seeing here.

[Joshua Chan:]

All right. And then switching over to the remodel side on Hearth, very strong growth there. Would you characterize that as more a function of the easy comp or is there any other thing going on like share gains over there?

[Stanley Askren:]

Well, I think you’re looking at end demand, it’s really strong. We want to make sure we characterize what remodel-retrofit means the most. It means alternative heat source or fuel. So what’s driving that is high oil prices, which make heating the oil more expensive and then often liquid propane prices drive that as well. And so when oil goes to $95 to $100, consumers that are using heating oil or some other heat source are looking for lower cost, and so they simply are moving to appliances that use pellet fuel or cordwood fuel to heat their home and that drives the demand.

[Joshua Chan:]

Okay. And then finally on cash flow, given probably similar or maybe a little higher income in the back half of the year compared to prior year, would it be reasonable to expect cash flow to be up similar to last year as well in the second half?

[Kurt Tjaden:]

Absolutely, Josh. I mean, I think, we’ve said full year free cash flow we’d expect it in the 70 to 75 range and that remains consistent.

[Joshua Chan:]

Okay. Thank you for your time.

[Stanley Askren:]

You bet, Josh.

[Operator:]

Your next question comes from Todd Schwartzman. Your line is now open.

[Todd Schwartzman:]

Hi, good morning guys. Most of my questions have been answered already, but just a couple of housekeeping things with regard to the guidance. Historically, the non-GAAP EPS tends to be lower sequentially from Q3 to Q4, how should we look at that, I mean viewing more than a six-month model in terms of when we might – if ever see a return to that type of normalcy, if that’s the case?

[Stanley Askren:]

I think it’s a similar question that Matt had, Todd. And really if you look Q3 to Q4 this year, we’ve got price cost going from a negative to a positive. And from a normal seasonality we don’t see anything at this time any difference quarter-to-quarter in our business trends that, I would say, would model out any differently.

[Todd Schwartzman:]

It’s just the pivot point, the transition on the costs occurring in that.

[Stanley Askren:]

Absolutely.

[Todd Schwartzman:]

Yeah. Okay. Also if you could, just to make sure, we’re apples-to-apples here, when you spoke of the sales deltas you expect for Q3, what – were there any adjustments to the as reported number, any divestitures or deconsolidations or whatnot that we should be aware of?

[Kurt Tjaden:]

No, nothing of significance, Todd.

[Todd Schwartzman:]

Okay. And in terms of additional price increases, where are you at that?

[Stanley Askren:]

Well, I think we’re continuing to monitor sort of the input cost, continuing to think about the overall market and where it heads. And that we are – as always we’ll adjust prices if needed and where we’re able to. I should tell you that the supplies channel, supplies business (inaudible) notified the market of a price increase effective September 1, but beyond that there is no additional price increases planned out there that haven’t already been put into effect.

[Todd Schwartzman:]

And what is the level of that September 1?

[Stanley Askren:]

Somewhere between 4% and 4.5%.

[Todd Schwartzman:]

Okay. Very good. Thank you very much.

[Stanley Askren:]

All right, Todd, thank you.

[Operator:]

There are no further questions at this time. I like to turn the call back over to the presenters.

[Stanley Askren:]

Thank you very much for your interest in HNI. We look forward to speaking with you soon and have a great day.

[Operator:]

This concludes today’s conference. You may now disconnect.