HNI Corporation
Q3 2014 Earnings Call Transcript

Published: 16 Oct 2014

[Operator:]

Good morning. My name is Stephanie, and I will be your conference operator today. I would like to welcome everyone to the HNI Corporation third quarter fiscal 2014 results conference call. (Operator Instructions) Mr. Matt McGough, you may begin your conference.

[Matthew McGough:]

Thank you. Good morning. I'm Matthew McGough, Vice President, Corporate Finance. Thank you for joining us for the HNI Corporation conference call to discuss the third quarter fiscal 2014 results announced yesterday after market close. Copies of our financial new release and earnings presentation including non-GAAP reconciliations have been posted to our website, www.hnicorp.com. Joining me today from HNI Corporation are Stan Askren, Chairman, President and CEO; and Kurt Tjaden, Vice President and CFO. Statements made 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. The earnings presentation posted on the HNI website includes additional factors that could affect actual results. The corporation assumes no obligation to update any forward-looking statements made during the call. I'm pleased to turn the call over to Stan Askren.

[Stanley Askren:]

Good morning. We'll share our assessment of third quarter 2014, provide some thoughts on our outlook for fourth quarter of 2014 and then the full year 2015, and then at the end we'll open the call up for questions. In summary, it was another strong quarter. We delivered topline growth and strong profit improvement in both our office furniture and hearth businesses. We continued to deliver strong operating results, while investing for long-term profitable growth. Our hearth business continues to deliver outstanding performance. Operating profits increased 65% on 27% sales growth. Remodel retrofit sales improved 38% led by a significant increase in biofuel product sales. Sales in the new construction channel remain strong with 13% growth. We delivered solid sales and profit growth in our office furniture businesses. Operating profits increased 17% on 5% sales growth. Sales were up 2% in our supply-driven business, while sales in our remaining office furniture businesses was up 10%. Overall, I'm very pleased with our third quarter results and the momentum that we are achieving, heading into the fourth quarter. With that, I'll turn it over to Kurt Tjaden?

[Kurt Tjaden:]

Thank you, Stan. So for the third quarter 2014, consolidated net sales increased 8.7% to $615 million or 9% on an organic basis. Non-GAAP net income per diluted share improved 33% from the prior-year quarter to $0.81, excluding restructuring and transition cost. Sales for the office furniture segment increased 4.8% to $489 million or 5.2% on an organic basis. Sales for the hearth product segment increased 26.7% to $126 million. Non-GAAP consolidated gross margin improved to 36.4% compared to 35.3% in the prior-year quarter. Higher volume, increased price realization and strong operational performance were partially offset by unfavorable mix in investments and operations. As a percentage of net sales, selling and administrative expenses decreased 0.2 percentage points due to higher volume, which was partially offset by investments and strategic initiatives, higher incentive-based compensation and timing of expenses. In connection with the office furniture consolidations, $4.9 million of restructuring and transition costs were recorded in the third quarter with $3.9 million included in cost of sales. As a reminder, for these actions, we expect to save approximately $8 million annually beginning in 2015. Stan?

[Stanley Askren:]

Thank you, Kurt. Looking forward, I am encouraged by the continued strong performance of our businesses. We expect another strong quarter to finish the year with solid sales growth and double-digit profit improvement. We expect the office furniture sales momentum to continue, led by our contract business. Supply-driven business is improving at a lower rate, due to a muted small business spending environment. In our hearth business, we expect strong growth in the new construction channels. Our brands are well-positioned to continue to outperform the market. We project continued growth in our remodel retrofit business, driven by strong momentum in biofuel product sales. After our third quarter close, we completed the acquisition of Vermont Castings Group. VCG, as we call it, is a great opportunity to create long-term shareholder value as part of our very successful hearth and home business. VCG's unique brands, strong customer relationships and quality products will strengthen our hearth strategy and our brand portfolio. A few of the details regarding the VCG acquisition are as follows. Annual revenue is approximately $100 million. This was an all cash transaction. We paid approximately 7x trailing 12-months EBITDA, and earnings will add nominal profit to the corporation in the fourth quarter 2014, and will positively contribute to 2015. We expect to deliver positive economic profit from this acquisition within two years. Kurt?

[Kurt Tjaden:]

So the financial outlook for the fourth quarter 2014 and full year 2015. For the fourth quarter 2014, we anticipate overall sales to be up 13% to 17% or up 8% to 12% on an organic basis. Office furniture sales are expected to be up 5% to 9%. Supply-driven furniture sales are expected to be flat-to-up 4%. Sales in our remaining office furniture businesses are expected to be up 11% to 15%. Hearth sales are expected to be up 38% to 42% or up 18% to 22%, excluding the impact of the Vermont Castings Group. Non-GAAP gross profit margin is expected to be slightly higher versus fourth quarter 2013, when it was 35.7%. Non-GAAP SG&A as a percentage of sales is expected to be slightly lower versus fourth quarter of 2013, when it was 28.7%. The effective tax rate for 2014 is projected to be approximately 35%. And for the year, we're expecting capital expenditures to be $90 million to $95 million. Free cash flow defined as operating cash flow minus CapEx and capitalized software is projected to be $70 million to $75 million for the full year. So for the full year 2014 we are raising our projected non-GAAP earnings per diluted share to be in the range of $1.95 to $2 per share. This includes our estimated fourth quarter non-GAAP earnings per diluted share forecast of $0.63 to $0.68 per share. So looking to 2015, our current best estimate of full year non-GAAP earnings per diluted share is in the range of $2.40 to $2.65. This strong profit improvement across our businesses will be driven by continued topline growth, operational improvements and benefits from strategic investments. For our office furniture segment for 2015, we expect mid single-digit organic sales growth, led by our contract business and an improving North American economy. Including the impact of Vermont Castings Group, our hearth business is expected to grow sales in the mid-teens in 2015, driven by continued strength in the new construction channel. We expect remodel retrofit channel growth will be moderated due to strong comparables on bio product fuel sales. Stan?

[Stanley Askren:]

Well, I'll conclude here. I remain confident in our strategies to drive significant profit improvement, while simultaneously investing for long-term profitable growth. We entered the fourth quarter with strong momentum across our businesses and we remain on-track to grow sales and significantly increase profits in 2014 and 2015. With those comments complete, we'll now open it up for questions. Question-and-Answer Session

[Operator:]

(Operator Instructions) Your first question comes from the line of Josh Borstein with Longbow Research. Josh Borstein - Longbow Research Can you talk a little bit about the order trends in both contract and supplies and just how the quarter played out whether you saw any acceleration or deceleration throughout the quarter?

[Stanley Askren:]

Yes. Josh, I would say, there was increasing, I think it accelerated during the quarter, not in a huge way, but certainly exit with stronger momentum than we entered the quarter in both contract, I would also say, supplies as well. In particular, the project business is very, very strong. The day-to-day is increasing, the supplies business is increasing, but at a lower rate. Josh Borstein - Longbow Research And last quarter you had expressed the opinion that office furniture is in for a slow steady consistent growth, until the economy decides to kick into another gear. Is that still your outlook?

[Stanley Askren:]

Yes, it is. And there is going to be periods where it's going to accelerate more than others, but obviously we've had, we're coming off a strong third quarter and looking at a strong fourth quarter. And so I believe until recent events that that the economy was picking up, and there is new constructions picking up, offices picking up, churn events are picking up in office furniture, and we were starting to see acceleration. This last period in particular was strong, we think the rest of year will be strong, but I think, I am holding to my comments from the last quarter. Josh Borstein - Longbow Research And on the hearth side, you again, just referring to last quarter, you mentioned capacity rates in hearth were running 60% to 65% with no imminent reasons for expansion. Does that imply you can absorb some of the demand from Vermont Castings with your current footprint?

[Stanley Askren:]

Yes. I mean, obviously, that's all part of the consideration now. I would tell you we acquired Vermont Castings, in part they've got some good operations, some good businesses. We'll go in and apply our lean process with them. I mean, we teach them, give them the tools and help consult them through that process. And I think that's going to continue to free-up additional capacity for even more growth as we go forward.

[Josh Borstein:]

And do you have an earnings accretion estimate for Vermont Castings for, I guess, maybe the rest of this year or '15?

[Stanley Askren:]

Yes. It's nominal for the rest of the year. It's going to be a couple of pennies, would be our guess, Josh. Next year it's somewhere around $0.05 to $0.10 and we're still sorting a lot of that out, but it's all positive. There is no drag that we foresee.

[Josh Borstein:]

And then just one more for me. On the commodities side, seen any changes there? Obviously, steel coming down, but do you expect any margin benefit from falling commodities?

[Stanley Askren:]

No. I would say we're seeing some moderate increase in commodities. It's all very manageable. A lot of it has to do with just supply changes, industry consolidations of some of the supply bases around; you see this stuff all the way around from particleboard to linerboard, et cetera. So I think it's going to be similar vein to this year, very manageable, with maybe a slight uptick due to really supply changes more than demand.

[Operator:]

Your next question comes from the line of Matt McCall with BB&T Capital Markets.

[Matt McCall:]

So Kurt, I tried to write all the '15 outlook. Could you briefly or quickly go through those numbers you gave for the outlook for 2015?

[Kurt Tjaden:]

Sure. So earnings per share non-GAAP $2.40 to $2.65; mid-single digit organic sales growth in office furniture, led by contract; and then hearth business expected to grow sales in the mid-teens, driven by new construction; and some muting on growth on remodel/retrofit in the bio product segment.

[Matt McCall:]

I tried to plug that in the model as we were going, so that's implying kind of a high-single digit organic growth rate. You get the benefit of the topline from Vermont Castings, and you also get the accretion Stan just spoke of. But if I just look at the numbers, it looks like the incremental margin that's baked into that is something in the mid-teens, if my math is right. Why would you see such a step down in the incremental margin from the 25% to 30% that you've done over the last two years?

[Kurt Tjaden:]

Well, I think your math is probably -- we should look, because I would say overall we're probably, if you take that combination it's cultured in mid-single digit growth as opposed to high, and if you took that at the midpoint of the guidance, Matt, you'd be right back in that sweet spot of that 25% to 30% target leverage.

[Matt McCall:]

So that's your organic number, plus the $0.05 to $0.10 from Vermont Castings?

[Kurt Tjaden:]

Correct.

[Matt McCall:]

And then so if you are assuming contract leads in your mid-single digit, are you expecting supplies to grow next year?

[Stanley Askren:]

Yes. We have supplies. I think Kurt's guidance here or my guidance was supplies should be up mid-single digits as well.

[Matt McCall:]

Well, I missed that part.

[Stanley Askren:]

Matt, you know what, looking at my notes here, and to be fair, it's probably low-single digits.

[Kurt Tjaden:]

Yes, Matt. I'd say, more higher on contract, low-single digits on supplies. And that's how you kind of end up with that mid-single digit overall. Does that help?

[Matt McCall:]

Yes, it does. And so if you look at the more recent trends and the outlook that you have for Q4, it seems like your contract business is doing a little bit better than the overall industry. I know sometimes, its apples and oranges, but can you talk about if you are and if you do think that you are outperforming, what's driving that outperformance?

[Stanley Askren:]

You know, Matt, where I am at on this is claiming outperformance on anything in this business and the quarter is a fool's errand. So we have good momentum, I'd say that. What's working, we've got some really good big project wins. I think our contract business is performing well. Some of that's timing. You really have to look at this business around these things over the longer term or else you come up with all sorts of bad conclusions I think.

[Matt McCall:]

Final one. Your corporate expense line was up quite a bit year-over-year, if my model is correct, about 25%. How do you want us to think about that near-term? How do we model that next year? What drove the increase on a year-over-year basis?

[Kurt Tjaden:]

So we are up about $3 million bucks I think for the quarter, Matt; $5 million year-to-date. You had three things going on. One, you've got the expense side of our business system transformation investment that we talked about in prior calls. Second, given the strong performance, we have higher incentive-based compensation, and as you know, for us a big component of that is profit-sharing that we pay out to our members. And third is we've got some group medical that variance it rolls through that timing and things. So I would tell you, as you look into fourth quarter, part of that guidance on corporate unallocated I would expect it to be higher than full year than last year, probably a similar number that what you saw for third quarter, but that should be included in that overall SG&A guidance that we gave you, which as a percent of sales should be slightly lower. Does that help?

[Matt McCall:]

Yes, it does. And just one more back to the incremental margin. So you said, if I strip out Vermont Castings, I'm going to get something in that mid-20% range. Is that before bringing in the projected savings, that $8 million of savings from the restructuring?

[Kurt Tjaden:]

No. I think what I said, and I'll clarify is, all-in for next year, if you take kind of a mid-single digit sales increase and midpoint of guidance, you should get to a 25% to 30% leverage all-in; Vermont Castings in, savings from the restructuring, and all of our investments and other operational improvements.

[Operator:]

Our final question comes from Todd Schwartzman with Sidoti & Company.

[Todd Schwartzman:]

I wanted to ask about the strategic investments some of the growth initiatives that clearly are helping for -- if you could discuss segment by segment, were these investments higher on a year-over-year basis? Are we seeing a little moderation there? And do you take your foot off the pedal maybe a little bit going forward?

[Stanley Askren:]

So we don't break it down segment by segment, Todd. I would say to you, the strategic investments are running about the same as they were. Not any big increase, not any big decrease. So no, we're not taking our foot off the table. That will be ongoing. We still see similarly great opportunities to invest and create shareholder value, both from a capital standpoint and also from a sort of expense standpoint.

[Todd Schwartzman:]

And also if you haven't already, could you talk to the seasonality of Vermont Castings versus the rest of hearth and home technologies?

[Stanley Askren:]

No, we're not prepared to do that. We don't break that out. I would say, you should anticipate, it should be consistent though with the overall hearth business. Whatever minor change or deviation difference that would be is really kind of lost in the overall mean.

[Todd Schwartzman:]

And I know it's still early, but any integration issues to speak of thus far?

[Stanley Askren:]

No, I mean we've only had that business for a month. And Todd, I'll remind you we have a long history at hearth of doing these deals and really driving that. It's a good business. It's not a broken business. The hearth team that we have is very experienced on this. And so no issues yet, and I don't think this is a big high risk sort of integration opportunity.

[Todd Schwartzman:]

And finally, you said that both contract and supplies orders were you had more momentum exiting the quarter than the early part of the quarter. Was there steady progress maybe month-to-month for the full quarter? I know that it's not ideal to take such a short-term view of things, but if you can just kind of give a sense of the pace that would be helpful.

[Stanley Askren:]

No, I don't think there is anything special to call out there, Todd, on month-to-month or anything else. I think it's a general statement that it picked up during the quarter. And I don't think there is anything, any signal, for the market or for you going forward that you should pick up from that.

[Todd Schwartzman:]

And pacing, any different thus far in the first couple of weeks of Q4?

[Stanley Askren:]

No.

[Operator:]

I would like to hand over.

[Stanley Askren:]

Thank you very much. So we appreciate everybody's interest in HNI and appreciate you dialing in, and look forward to reporting our results in the future and look forward to talking you soon. Thank you.

[Operator:]

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