HNI Corporation
Q2 2012 Earnings Call Transcript

Published: 19 Jul 2012

[Operator:]

At this time, I would like to welcome everyone to the HNI Corporation second quarter fiscal 2012 results conference call. (Operator Instructions) Mr. Schmidt, you may begin your conference.

[Derek Schmidt:]

Good morning, and thank you for joining us today for the HNI Corporation conference call to discuss second quarter 2012 results, which were announced yesterday after the market closed. My name is Derek Schmidt, Treasurer and Vice President, Corporate Finance for HNI Corporation. If you have not received a copy of the financial news release, it is available on our website, www.hnicorp.com. A presentation intended to accompany this call has also been posted to our website under the Investor Information section. We encourage you to review this presentation as it contains details of our financial performance, including the non-GAAP to GAAP reconciliations. Joining me on the line today from HNI Corporation are Kurt Tjaden, Vice President and CFO; 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?

[Stan Askren:]

Good morning. We executed well and delivered solid results in the second quarter. Our growth investments and market initiative drove solid sales improvement across both segments. Strong operational performance and market execution contributed to improved margins. Performance in our Office Furniture supply driven business remained robust with organic growth at 12%. Our market leadership position is strong and growing in a continued leverage, the power of our brand to drive outstanding results. As expected sales in our other office furniture businesses were flat against strong prior-year comparison in the second quarter. Last year we benefited from several large government projects. Demand in our international and non-government businesses remained strong in the quarter. Our Hearth business continues to deliver excellent performance. Sales in new construction channel remained especially strong with 20% growth, as housing starts and builder sentiment improved. Remodel and retrofit sales decreased 11%, a decline in fuel prices and warm weather adversely impacted demand for alternative fuel products. I'll turn the call over to Kurt, let him review some specific financial data for the second quarter. Kurt?

[Kurt Tjaden:]

Thanks, Stan. So for the second quarter 2012, consolidated net sales increased 11% to $480 million or 5.2% on an organic basis. Sales for the Office Furniture segment increased 12.3% to $419 million or 5.6% on an organic basis. Net sales for our Hearth product segment increased 2.8% to $62 million. Consolidated gross margin increased to 34.4%, which compares to 33.9% in the prior-year quarter due to higher volume, better price realization and lower material cost. These were partially offset by unfavorable mix and the impact of the acquisition of Sagus and higher restructuring and transition cost. As a percent of sales, selling and administrative expenses, including restructuring and impairment charges were 31.6%, which were consistent with the prior year. Benefits from borrowing leverage were partially offset by investments in growth initiatives, higher incentive based compensation and the impact of the acquisition of Sagus. We ended the quarter with $55 million of cash. Operating activities generated $6 million of cash in the first six months of 2012 compared to $8 million use of cash in the same period last year. Stan?

[Stan Askren:]

We enter the third quarter with strong momentum and are well positioned to deliver solid sales and profit growth for the year in both segments. I'm encouraged by the strong performance of our businesses, particularly in the Office Furniture supply driven business and hearth new construction channel, which both delivered double-digit growth in the first half of 2012. Demand in our office supply driven business is expected to remain strong. Growth rates in the second half of the year will moderate relative to first half, given stronger prior year comparisons. Our momentum is strong and we continued to invest in product development, branding and fulfillment models to deliver continued profitable growth in the future. Our Office Furniture contract brands continue to compete well in their markets. Year-over-year growth rates within the contract channel are expected to modestly increase in comparison to exceptionally strong double-digit growth in the prior year. We expect continued strong performance in our international business, particularly in China, where we are well positioned to outperform the market. Despite challenging market conditions for government sales, we remain on target to deliver solid overall growth in both of our Office Furniture channel for the full year. Our Hearth segment remains well positioned for continued strong profitable growth. Positive momentum in the new construction channel is expected to continue as single-family housing starts to improve. Topline growth in the remodel retrofit channels is expected to remain relatively flat in comparison to the exceptionally strong performance of our alternative fuel products last year. Our core plus strategy remains unchanged. We're investing in our core North American businesses to capture new growth opportunities. Likewise, we're aggressively pursuing attractive prospects in key vertical and fast growing international markets. I remain excited about our new product initiative this year. The needs of the marketplace are constantly changing and our businesses continually innovate to provide highly relevant solutions for our customers. HNI had another strong show at NeoCon this year, as our business has won three Best of NeoCon Products awards. Allsteel also introduced our entry into the Architectural Walls segment at NeoCon. The response in the marketplace has been very positive and we're encouraged about the long-term profitable growth potential of this new business. We are making good progress in our business system transformation initiative, which we communicated earlier in the year. We're leveraging our RCI culture, discipline and processes to champion, old process improvement throughout the company is part of this effort. Overall, I feel confident about our investments and the capabilities we are building to strengthen our market position and to continue to deliver long-term profitable growth. The near term economic outlook remains uncertain, but we're well positioned to expand profits under multiple scenarios. Kurt will provide financial outlook for the third quarter and full year 2012.

[Kurt Tjaden:]

So for the third quarter 2012, we anticipate overall sales to be up 11% to 14%. Office Furniture sales are expected to be up 13% to 16%, including sales from Sagus were up 3% to 6% organically. Organic sales in each of our Office Furniture channels are expected to be up 3% to 6%. Hearth sales are expected to be up 3% to 7%. Non-GAAP gross profit margin is expected to increase modestly versus the third quarter 2011, when it was 35.6% excluding restructuring and transition charges. Non-GAAP SG&A as a percentage of sales excluding restructuring and transition charges is expected to be similar to third quarter 2011, when it was 27.5%. Net interest expense is projected to be $2.6 million and the effective tax rate is projected to be approximately 36% for the third quarter. For the year we're expecting capital expenditures to be in the range of $50 million to $55 million and we project full year 2012 depreciation and amortization to be approximately in line with 2011. Our estimated non-GAAP earnings per diluted share for the third quarter is $0.65 to $0.70. And for the full year 2012, we are narrowing our estimate of non-GAAP earnings per diluted share to $1.35 to $1.45, which excludes restructuring charges and transition costs. This summarizes our outlook for the quarter and the full year 2012. I'll now turn it back to Stan for closing comments.

[Stan Askren:]

Thank you, Kurt. I remain positive about our markets and our ability to grow sales and increased profits in 2012. We continue to aggressively invest in long-term profit growth, and I remain confident, our investments are delivering long-term shareholder value. Our businesses are strong, competitive and well positioned in the markets. So with those comments, I will now open it up for questions.

[Operator:]

(Operator Instructions) Your first question comes from Chad Bolen, Raymond James.

[Chad Bolen:]

I guess, Stan, in the continued strength and the supply driven channel, I think it's been a pleasant surprise for us, given a lot of the macro data points seem to be softening, and small business confidence hasn't been setting the world on fire. Could you just give us a little bit of color as far as what you're seeing there in terms of drivers? Is it finally some actual recovery and demand from small businesses, as market share execution and you're playing a role, just whatever color you can give us?

[Stan Askren:]

I think certainly small businesses confidence level has not popped up or showing any great movement, either down or up, I guess. We've seen in the short term, it looks like it's moving down a bit. I'm not sure if that's significant enough to kind of change the overall macroeconomic. That's a good question. We're looking at it hard. I do think that we are performing well, executing well in that segment. I think you're seeing clearly the benefit, the pay off of investments that we've made in prior years around brand, products, selling models and pro-forma models. It's broad-based, recovery multiple, sort of different industry segments within the small business and also different geographies as well. So we are pleased with those results as well. And I think it's an indicator of the return of the investments we've made in the past.

[Chad Bolen:]

And if we look at the contract side of the business, it looks like you're guiding for a little bit of a reacceleration in 3Q versus what you saw this quarter. Can you quantify or share with us any of the leading indicators for project activity in terms of visits and things like that? What are you seeing there? Have you seen any change in customer behavior, attitudes with movement in the economy?

[Kurt Tjaden:]

The pipeline looks good. The activity levels, which we don't really look at visits and that sort of things, we look at sort of the bid activity and just sort of the overall settlement with our share of partners, and our different companies and their sales force, et cetera. The activity level is good. We have not seen any significant decline or change in activity levels. I'd be lying to, if I didn't tell you, we're looking hard at sort of this uncertainty in the economy and making sure that we're not missing anything, but it feels good to us going forward. Especially, when you sort of net out the federal government, sort of downdraft, overall if feels very, very solid. And activity level with all the players, all the companies is very good.

[Chad Bolen:]

Last question from me, if we think a little bit beyond 2012, and as we get past the addition of Sagus and the ramped up spending on some growth investments that you've done this year. Should we be thinking about 2013 as getting back to something more normative in terms of contribution margin or do you think you'll have continued investments? Whatever color you can give us?

[Kurt Tjaden:]

We plan to update our outlook for '13 next quarter. It's something we did last year. We'll continue to evaluate it, if that makes sense. I think certainly given the uncertainty with the economy and the political environment that is probably more challenging this year than last year. But to your question, if there would be investments we're making, we would expect to continue to see returns and progress on delivering profitable growth going into 2013. But no specific targets at this time.

[Operator:]

Your next question comes from David MacGregor of Longbow Research. Josh Borstein - Longbow Research This is Josh Borstein in for David Macgregor. In K through 12, given the stronger back half seasonality to the business. What did state and local spending look like coming up here compared to this time last year?

[Stan Askren:]

I'm sorry. Repeat that question again. We missed the last part. I guess you broke up on this. Josh Borstein - Longbow Research Just looking at K through 12 and that vertical, and given the stronger back half seasonality in that business. What did state and local spending look like coming up compared to what it was this time last year?

[Kurt Tjaden:]

It's relatively flat. It's been relatively flat and that's our view of it going forward. Also within those state and local budgets, education continues to be a priority for virtually all of the states around sort of state competitiveness and kind of making sure that the populations are giving what they feel like they need from the states. So flat spending and with K through 12 education giving probably more than their share of focus and finances. We feel good. Sagus I feel good about the K through 12 segment in the market. Josh Borstein - Longbow Research And then, you mentioned lower input costs in the quarter. I think you had said last quarter, you talked commodity inflation for 2Q through 4Q, it will be modest to flat. Has your outlook changed at all or can we expect lower than anticipated material inflation in the back half of the year?

[Kurt Tjaden:]

Not significant changes in the outlook. It's moderated, but not materially different than what we said last quarter. Josh Borstein - Longbow Research And then just one last one from me. In the second quarter the Chinese GDP slowed down a little bit, the slowest rate since 2009. Your business there, however, still seems pretty resilient. Is that still the case there? Are you seeing any sings or things maybe slowing down?

[Stan Askren:]

Yes. Certainly we've seen it slow compared to the tore rid pace it's been on the last couple of years, it's still very, very strong. And we're still achieving high double-digit growth percentages there. It's been a last couple of years, but very, very healthy and very solid performance by that group in the part of the world as well.

[Operator:]

Your next question comes from Matt McCall, BB&T Capital Markets.

[Matt McCall:]

Just look at the full year guidance, it looks like you maybe took down the full year by a couple of pennies relative to consensus, at least the Q3 number looks pretty good. So what is it about Q4? I don't hear a lot of doubt in your voices. So what is it that's expected to currently be a little bit slower in Q4 or am I looking at it wrong?

[Kurt Tjaden:]

So let me start now and I'll let Stan take in here. So what we did is narrow our range on the guidance and cut to $1.35 to $1.45.

[Stan Askren:]

The range is $1.35 to $1.45. Previous, the range was $1.50 to $1.35.

[Kurt Tjaden:]

So you are now down, Matt, by a nickel.

[Stan Askren:]

Two reasons, one, we're just another quarter deeper into the year. So the principal upside has gone down. Second, the economic uncertainty, we're just kind of making it sure we're not sort of too optimistic out there based on the economic uncertainty. So no real change in our view of sort of tone and the market, but just further along and saying the upside is less than we sort of factored into that range last quarter and the previous quarter. And we're just kind sort of dialing in a little bit higher.

[Matt McCall:]

So it's seems like you're language is very consistent with the last couple of quarters, when we spoke with you. So it's not really anything that you're seeing, just let's be over more cautious, and you have an extra quarter of data?

[Stan Askren:]

Yes, exactly. Our language is consistent. We have one less quarter. And there's a little bit more uncertainty. We're not feeling it yet, but as we looked on the horizon and saying, wow, may be we should make sure we got just a little bit more caution. Haven't seen, haven't felt it yet, but happen to have $1.50 out there is not probably reasonable at this point, probably to bring out to.

[Matt McCall:]

And then I think there was a question earlier kind of about the incremental margin. But if you talk about some of these items, and I think, Kurt, you talked about incentive comp this quarter, you talked about growth spending for a number of quarters. How should we look at these items that have been affecting your incremental margin in recent quarters as it move forward? And I guess, I'll just end there and then I'll follow-up with another one.

[Kurt Tjaden:]

We again, Matt, remain consistent with our outlook. Leverage is a full year look. It's going to be choppy quarter-to-quarter. The 30% objective remains where we're targeting for. In core leverage if you take out acquisition, the impact of that has been in the 20% range for the year, if you kind of just take the midpoint of guidance. And if you think about, Stan talked about (BFP) and our Walls investment as a couple of examples that are longer term, more strategic payback that we're not seeing return on. That core leverage still is 30% north of it.

[Stan Askren:]

Let me amplify that a little bit, Matt. The way we think about this is, our job is to take the core and make sure we maximize in the efficiency and maximize in our cost, and doing we do very well which is grind it out in the core. That comes out typically around about 30%. As Kurt says, we don't really care whether that comes out right on a quarterly basis. It makes no difference to us. Because it's just not how we run the business. Then we think about what's the last core. And then we think about what are the plus opportunities. One of these opportunities in the market with businesses, with customers, with business models that we should be grabbing and bringing in-house and then doing what we do well, to create long-term value. One of those coincidences is Sagus. So Sagus, K through 12, the industry leader comes for sale, it is not leveraging at 30%. But it's a great brand, great people, great distribution, great product that needs our operational sort of execution. So we grab that, pull that in and then go through our transformation process, which sometimes takes two to three years. In the mean time, that's not going to leverage at that same 30%, and so that's part of that plus. Another example would be sort of internal investment opportunities. The event and what we showed at NeoCon, we showed this Architectural Walls segments. New segments, $0.5 million to $700 million segment, fast growing, looks like it fits our business model well. It's related to kind of how the contract business goes to market. We understand the product. We understand the application. We understand the selling model. And so there we're doing an initial start-up, starting with an alignment with product creator and we're investing to develop that business. Same thing that has no sales when we start-up has multiple millions of dollars of investment, which we believe as we kind of come online two to three years from now that will be a three to five year. That's a significant side of business generating at least the same level of profit as a core. And so we're going to continue to find these, as they come forward and grab them and then pull them in, because when we get greetings to do, you know, is drive long-term profitable growth. Don't become too sort of captive on, are we leveraging at certain percentage. Likewise, you want us, shareholders wants us to be efficient with the resources that are given. And so we got to come back on that core and make sure we're doing it out. So that continues to be kind of just quarter plus sort of mentality and how that impacts leverage I think.

[Matt McCall:]

I don't have perfect data here, so if you exclude Sagus and if you exclude internal investments, you mentioned Walls specifically and some of the gross spending. Is that core, the incremental margins, where you wanted? I guess is the way I look at it.

[Stan Askren:]

Absolutely, correct. We are leveraging in the core. For the year we will leverage at 30% plus.

[Matt McCall:]

And then in response to another question, you said that you seem to benefit for some of your investments in the past paying off. And we've talked about there has been a lot of little things and you talked about branding, you talked about distribution. If you had to pick one that had paid off the most, what do you think that would be or could you pick one?

[Stan Askren:]

I don't think I could pick one. I wish business was that easy, Matt, because if it was I'd be a hero. All of it has to hang together. You got to have the brand, the selling, the distribution, the product development, the internal efficient operation, the fulfillment model. And when you have all of that you get really great growth. If you are missing one piece, it's a little bit like an engine, it just doesn't run right. Now, you still have momentum, but it's not tuned and tailored then it's not hitting on all cylinders. And so for us this is the challenge and the opportunity to come back and make sure we're working all of the different pieces simultaneously. So they come together and then integrate in a way and they create this long term sustainable competitive advantage, to give customers what they want, when they want and how they want it, and do that everyday, more better faster for less, is what we'd say. So I can't point to one thing, it's many things. But one thing I can point to, we got a great team of members, a great team of employees working on this that grind us out every day.

[Operator:]

Your next question comes from Peter Lisnic, Robert W. Baird.

[Peter Lisnic:]

First question, just on the taking the $1.50 down a nickel to $1.45, is that just more caution on volume or is there any incremental expense that you're billing in there as well?

[Stan Askren:]

I think the explanation we just took Matt through, I'll just amplify that again. So, Peter, we haven't really changed our guidance per se, we just narrowed the range, why? Because we're a quarter deeper; b, because I think there is less upside due to the uncertain economy.

[Peter Lisnic:]

If we could switch over to Hearth just for a second, do you mind running through the review and may be the profitability mix there between new and remodel. Just trying to see what the growth trends there being somewhat divergent, how that factors into the profitability mix as we look forward?

[Kurt Tjaden:]

So the profitability between remodel and retrofit in new constructions is about the same, so no difference between the segments. And as Stan talked, the growth story year-to-date as we look for the balance of the year really is new construction. And if you think about the correlation where single-family starts were high teens through the first half of the year, see that moderating a bit in the second half and that is a business we have a very strong position in the market. So we get any lift in single-family starts that's an area we benefit disproportionately.

[Peter Lisnic:]

But generally, you alluded to it a little bit in the last comment. But on Sagus, the profitability maybe not leveraging quite where the core is, can you give us a sense as to where the profitability trends are in that business? How it's progressing in terms of integration?

[Kurt Tjaden:]

Yes. I'll talk profitability. We expect that business to be nominally profitability for the full year. Highly seasonal, heavily backend loaded with the education side. But as we transform that business, expected to be nominally profitable and cash positive for the year, on track with our expectations, as we came into this acquisitions. I'll let Stan talk transformation.

[Stan Askren:]

Still in early stages of transformation, Pete. The only thing I'd say is very strong cash flow on that business as well. So our transformation efforts tend from a cost standpoint take a little bit longer to cash flow though tend to come much faster. And they're right on track. I think doing a great job and we expect them to be at that same level of profitability here as we go forward.

[Peter Lisnic:]

And then, just last question on that one. If I look at the implied sequential revenue ramp in that business from second quarter to third quarter, it's a pretty substantial increase. I'm guessing a lot of that is seasonality. But I'm wondering if there is any sort of competitive gain that you're realizing there and now it's underneath the HNI umbrella?

[Stan Askren:]

We would love to think so. I think it's too early that we claim and beating our chest too early on competitive gains. It is highly seasonal though to your point there. Just how schools buy, and how they build, and how they remodel and then they're all ramping up getting ready for the new school season, so it is up. It is a challenging business from that standpoint.

[Operator:]

Your next question comes from Todd Schwartzman of Sidoti & Company. Todd Schwartzman - Sidoti & Company On the recent May number for small business optimism, do you think that's a blip? Is it a seasonal thing? Ultimately you'll think that will be proven to be the case or just something else more secular going on there?

[Kurt Tjaden:]

I don't think we know, Todd. Todd Schwartzman - Sidoti & Company Most of my questions have pretty much been addressed thus far. But did you give the organic growth rate for supply driven sales for Q2?

[Kurt Tjaden:]

For Q2? Todd Schwartzman - Sidoti & Company Yes.

[Kurt Tjaden:]

I think we had organic at 9% to 12% for Q2. Todd Schwartzman - Sidoti & Company 9% to 12% was your guidance. I just want to see what it came in at?

[Kurt Tjaden:]

We're about right on it or at the high-end of the range. So I think we're just a little north of 12%. Todd Schwartzman - Sidoti & Company And on the Hearth side, your sales came in up pretty closer to the low-end of your guidance of up to 3% to 7%. I'm wondering if you could just walk us through some of the dynamics there. I realized that the tough comp was a big part of that and that in turn was due to the alternative fuel products. But did you kind of underestimate just how great a quarter that piece of the business was a year ago?

[Stan Askren:]

No. I think its hot weather and fuel prices. Dealers or consumers aren't pulling remodel retrofit alternative fuel appliances, Todd. So it's hotter and hell out there and people aren't buying Hearth appliances when it's hot. Todd Schwartzman - Sidoti & Company And what was the mix of new construction remodel for the quarter?

[Kurt Tjaden:]

It's roughly one-third or two-thirds, Todd. In fact a few points, but not significant. Todd Schwartzman - Sidoti & Company So that probably stay the same or it goes north of that skewing towards the builders going forward?

[Kurt Tjaden:]

Yes, a little more, a slight skew.

[Operator:]

There are no further questions queued up at this time. I'll turn the call back over to Mr. Schmidt.

[Derek Schmidt:]

Thank you so much for your interest in HNI. We look forward to talking to you in the future. Have a great day.

[Operator:]

This concludes today's conference call. You may now disconnect.