HNI Corporation
Q2 2015 Earnings Call Transcript

Published: 23 Jul 2015

[Operator:]

Good morning, ladies and gentlemen. My name is Ryan, and I will be your conference operator today. I would like to welcome everyone to the HNI Corporation second quarter fiscal 2015 results conference call. [Operator Instructions] Mr. McGough, you may begin your conference call.

[Matthew McGough:]

Good morning. Thank you for joining us for the HNI Corporation conference call to discuss second quarter fiscal 2015 results, announced yesterday after market close. Copies of our financial news release, earnings presentation and 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, Senior Vice President and CFO. Statements made during this call that are not strictly historical facts are forward-looking statements, which are subject to known and unknown risk. Actual results could differ materially from expected results. The earnings presentation posted on the HNI Corporation 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, everyone. We'll share our thoughts regarding second quarter 2015, provide additional thoughts on our outlook for third quarter and for the full year 2015. We'll then open up the call for questions. In summary, it was another strong quarter, we delivered 36% non-GAAP earnings improvement on 12% topline growth, while continuing to invest for the long-term. Our office furniture businesses performed well, 6% sales growth and significant profit improvement. Sales in our supplies-driven business were up 2%. Sales in the remaining office furniture businesses increased 11%, led by 13% growth in our North American contract business. Our hearth business sales increased 8% on an organic basis or 37%, when we include the Vermont Castings acquisition. Momentum continued in our new construction business with organic sales up 9%. Our remodel/retrofit business performed well with organic sales growth of 6%. Within that business, retail gas sales were up 15%, while biofuel product sales were down 8%, due to lower oil prices. Overall, I'm very pleased with our strong results in the second quarter. I'll now turn it over to Kurt.

[Kurt Tjaden:]

Thank you, Stan. Additional financial highlights for the second quarter include, non-GAAP consolidated gross margin, excluding restructuring and transition cost, improved to 36.5% compared to 36.3% in the prior-year quarter. Higher volume, increased price realization and strong operational performance were partially offset by unfavorable product mix. Non-GAAP SG&A as a percent of sales, excluding restructuring, impairments and gain on sale of assets, decreased 110 basis points. The benefit of higher sales volume was partially offset by strategic investments, higher incentive-based compensation and the impact of the Vermont Castings acquisition. We recognized $800,000 of restructuring and transition cost in the quarter, in connection with previously announced closures, acquisition integration and structural alignment. Stan?

[Stanley Askren:]

Thank you, Kurt. Let me recap the first half of 2015 and our outlook for the remainder of the year. I feel very good about our first half performance. Non-GAAP earnings improved 45% on 14% sales growth. Our outlook for the balance of the year remains positive. We expect our earnings performance to be very strong, as we see the benefit of our long-term strategic investments. Our businesses are performing well and we expect to continue to outperform the markets. In the second half of 2015, we expect strong growth in our office furniture businesses, but at a lower rate than experienced in the first half of the year. In our hearth business, we anticipate second half growth comparable to first half growth rates. In summary, we are well-positioned across our markets to continue to deliver strong results for the remainder of 2015. Kurt?

[Kurt Tjaden:]

So financial outlook for the third quarter and the full year 2015. For the third quarter 2015, we anticipate overall sales growth to be 5% to 9% or 1% to 5% on an organic basis. Office furniture sales are expected to increase 1% to 5%. Sales in the supplies-driven channel are forecasted to be flat to up 4%. And sales in the rest of our office furniture businesses are projected to increase 4% to 8%. Hearth sales are expected to be up 20% to 24% or flat to up 4% on an organic basis. Sales in the new construction channel are forecasted to be up 22% to 26%. And within the remodel/retrofit channel, retail gas sales are projected to be up 8% to 12%, while biomass sales are expected to be down 28% to 32%. Gross profit margin, excluding restructuring and transition cost, is forecasted to modestly improve versus third quarter 2014 when it was 36.4%. Non-GAAP SG&A as a percent of sales, excluding restructuring charges, is expected to slightly increase from the third quarter 2014, when it was 27%. The effective tax rate is projected to be approximately 35% for the full year. Capital expenditures for the full year are forecasted to be $110 million to $115 million. Our estimated range for non-GAAP earnings per diluted share for the third quarter is $0.84 to $0.89. And for the full year we're raising the low-end of our guidance by $0.05. Our new estimated range for non-GAAP earnings per diluted share is $2.55 to $2.65. So therefore, as you look at the fourth quarter, we're forecasting overall sales growth to be flat to up 4% and an estimated range for non-GAAP earnings per diluted share to be $0.97 to $1.02. You'll note this is a shift versus our historical trend between third and fourth quarter profitability. The change primarily is driven by the timing of strategic investments and returns, favorable business mix and improved operational performance. Stan?

[Stanley Askren:]

Thank you, Kurt. I'll summarize here, office furniture and hearth businesses are performing well. We remain on track to grow sales and significantly increase profit. With those comments complete, we'll now open it up to questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Josh Borstein from Longbow Research.

[Josh Borstein:]

Just a few questions. Some of your peers over the past quarter, Knoll and Steelcase, in particular, mentioned in their last call a trend towards larger projects with extended shipping dates that they attributed to whole buildings and campus projects versus the smaller renovation projects that they were seeing previously. Is that something you guys have seen in your contract business as well?

[Stanley Askren:]

So Josh, is the question about shipping or the project size?

[Josh Borstein:]

It was the project size and extended shipping dates, and they attributed that just larger whole building projects as opposed to just kind of one floor renovations that they had been seeing previously.

[Stanley Askren:]

Yes. I think our mix of large, medium and small is probably the same. I don't think there is anything really to distinguish the difference. We are seeing a bit of a slowdown just in the ability of the trades, the dealers, architects and designers, the dealers, et cetera, to process this thing, this step through. I would say the channels and the network is plentiful right now. And so people are just really busy working that step through, and that's leading to some delays and some extended push-outs I guess. It's not a big factor, but it is a factor.

[Josh Borstein:]

So the push-out is coming from the A&D community actually having too much work right now?

[Stanley Askren:]

No. I don't want to narrow it down that. No. I think it's a combination. I think it's the A&D firms, I think it's the construction firms and I think it's even the dealers that are having to plan and execute and all that stuff. So it's a combination of kind of from A to Z I think.

[Josh Borstein:]

And then in the contract side of the business, you guys put up a fourth straight quarter of double-digit growth. And looking at the first half of the year, you guys are outpacing this by about nearly double, outpacing your peers. I know one quarter doesn't make a trend, but four quarters seem to. So Stan, I know in the past you said the games have been broad-based, but if you had to put your finger on just one or two things that are really making a difference in the business right now, what do you think they would be?

[Stanley Askren:]

Josh, I'm going to come back to that same sort of line. It's broad-based, it's products, it's selling, it's execution, it's multiple companies within our contract as well. So you can't really nail it down to one thing. It's just positive momentum kind of putting all the factors together to get ahead in the right direction. We're feeling good. We're proud about sort of the, proud isn't the right word, we're pleased with the performance we've seen last year in contract and this year in contract. And I continue to be positive about the outlook.

[Josh Borstein:]

And just one for me, I'll hop back in the queue. Stan, last quarter you mentioned you were more positive on the business than you were the three months prior. Do you still feel that way here after 2Q?

[Stanley Askren:]

Yes, I do Josh. If you look at the fundamentals across is the macroeconomic factors are positive. If you look at non-res construction spending, office spending, I haven't looked at it real recently, but it's not like over 25%. If you look at employment gains, it's up; field confidence and small business confidence are kind of bouncing around, but I don't think there is enough to change the mind there. What is interesting a little bit is this noise that we just talked about. The first question you asked around sort of the ability for the channels to absorb it. The net of all this is it's going to continue to be that term that we are getting tired of around here, choppy, lumpy whatever. But I still feel like the economy is solid, we're well positioned, I think the industry's got an uptick and it should continue.

[Operator:]

Your next question comes from the line of Matthew McCall from BB&T Capital Market.

[Matthew McCall:]

Kurt, back to the seasonality shift that you referenced earlier. Just want to understand, I think you mentioned timing of strategic investments, product mix, and I think I wrote, improved operational performance. Can you give us a little more detail there, is the anticipated margin benefit is going to help Q4 going to come more gross margin, going to come SG&A, where we're going to see the big difference there?

[Kurt Tjaden:]

So let me step back with that here, Matt, in terms of context. So for the full year, as we said in opening comments, we've improved our outlook. And Stan just talked, feels like, we believe we're continuing to outperform in our markets. Our profit margins for the full year is significantly improving, while we're investing. Office furniture margins, we'd expect to be up 150 basis points to 200 basis points for the year. Hearth margins total, including Vermont Castings, up 20 basis points to 40 basis points. So recall, we are bringing that business into it. What we're really talking is a third quarter to fourth quarter timing shift. And the big piece of it, Matt, comes back to strategic investment timing. So timing of when we're making those investments and when we see the returns of those investments. And think about the things that we've talked about on prior calls. So Vermont Castings, we're coming up on a one-year anniversary of significant transformative benefits that we start to see in the fourth quarter. Benefits of two office furniture facilities that we closed last year that we see the benefits of. Stan talked about portfolio and what we are seeing in terms of product. And investments we've made in operations around capability and in different core process. All those things going into the fourth quarter. So that's the big mix part of it. The second part is we've got some business mix that moves around between the quarters. And whilst it's a headwind in the second quarter and the third quarter, it actually is neutral in the fourth quarter, and that can be size of projects year-on-year, that can be day-to-day versus project, that can within product. But that flips between third and fourth quarter. And then the last slide, and if you recall in the fourth quarter of last year, we had some significant challenges from a cost perspective around west coast port disruption and carrier capacity. And you'll recall that we have a significant volume lift in the fourth quarter that we struggled operationally to be able to service efficiently and effectively. We've rolled through those, so that's not a repeat. The big piece is the strategic investment piece of it, that's probably more than half and the other is the other comments that I talked about.

[Matthew McCall:]

So if I think about it maybe and look at from a full year perspective, and I think about the investments that you made this year, I know Stan, those are going to be ongoing. But is there anyway -- as you layered in Vermont Casting that impacted your incremental margin. I mean if some of these things have impacted the results this year, as we start to think about how to model next year in the context of what you just talked about. How much of the Q4 margin picture is going to -- how closely is the '16 margin picture going to look like to Q4 margin picture? Are we going to get back to kind of full year trend, is that the better guide?

[Stanley Askren:]

Yes. I think, Matt, and the answer is I don't know. We haven't planned our next year lap. But there's a part we've said consistently is that we're expecting to deliver this leverage, 25% to 30%. And so that's really what you ought to plan for is, is topline with this 25% to 30% leverage over a year, we will move around by quarter, but I don't think you should jump all over the fourth quarter and just extrapolate that. Because Kurt said, there is a lot of noise in there that moves around. And we have so many different moving pieces that I tend to take a longer-term review on this rather than take one quarter and extrapolate it forward, if I was you.

[Matthew McCall:]

And then maybe just a follow-up on the contract space a little bit. The second half outlook is that that growth is going to slow. I just want to make sure I understood that that was basically just because of some of these delays and the pipeline filling and issues that come with that that you referenced, when Josh asked the question, those are the issues, it's not necessarily a cyclical slowdown.

[Stanley Askren:]

Well, again, I'll go back and say, it's all pretty choppy. Our last year third quarter of '14 we were up 12%, fourth quarter '14 we were up 21%, first quarter we were up 15%, second quarter we were up 13%, and we start to lap those high growth rates. And so there's some of what Josh and I talked about, but some of that is we're just running in that some comparables that just are not sustainable, I don't think, as you start to anniversary those.

[Operator:]

Your next question comes from the line of Budd Bugatch from Raymond James.

[Budd Bugatch:]

I understand, Stan, that lumpy and bumpy cannot make you grumpy. I am trying to understand in office, your expectation when we had the first quarter call was for office to be up 8% to 12% in the second quarter, and I think we were up 6% to 4% overall. So what changed or what surprised you during the quarter? Was it in supplies, or was it in contract, or was it in both?

[Stanley Askren:]

It was more supplies, Budd, I would say.

[Budd Bugatch:]

So supplies were flat you said and that surprised you?

[Stanley Askren:]

Well, supplies were not as strong, which was coming out. Now, supplies we had some forward sort of inventory build and deploying to some customers. Our large customers take inventory and they place in. So it's a little bit more tricky to forecast kind of what sell-through, et cetera, but I would say, small business confidence was down a little bit. Transaction type of day-to-day went down a little bit, and there is always noise there. So it was not as strong that we anticipated.

[Kurt Tjaden:]

But I think it was important for the full year, as you think about supplies. We've said, since the beginning of the year we expect low-single digit growth and that still holds true for the full year.

[Budd Bugatch:]

In supply, even though there is some turmoil in that sector, right, and we do have some changes afoot?

[Kurt Tjaden:]

Right. So even with those changes, we're still expecting supplies channel to be low-single digits for the year.

[Budd Bugatch:]

Well, that particular area should be less lumpy and we should be less grumpy, because of that, right? That's a less bumpy area, less grumpy area? Tell me then if you would, what the mix today between supplies and contract is? It used to be 50-50, where does it run today?

[Stanley Askren:]

I've used that, I continue to use that number, Budd.

[Budd Bugatch:]

If we grow the two segments at different rates, at some point of time that's got to change, Stan, doesn't it?

[Stanley Askren:]

That is a mathematical fact.

[Budd Bugatch:]

Even at my age, I think I got that one right. Can you quantify for us the investment spending in the third quarter then, Kurt? What's the delta in spending either in SG&A or efficiency that you're going to see in that quarter, and maybe we can quantify a little bit what the return comes into fourth quarter? How do we think about that?

[Kurt Tjaden:]

I think in the third quarter, Budd, that investments spending between operations are up in cost of goods and SG&A is probably $5 million to $10 million, right. That is blended between the two. As you look about into the fourth quarter that investment spend continues, but if you kind of try and normalize between fourth quarter, what you might have called and what we're seeing, I'd say, half of that is really the returns that we start to see. So if you want to say, hey, you're at $0.80 and we're at $1 at the midpoint $0.10, or you're talking $7 million to $8 million of type of return, and again recall, we have talked about those big structural cost transformation starting to roll in and to see full run rate. And as Stan has talked on prior calls, great investment opportunities across the business frontend and backend that we start to see the payoff of.

[Budd Bugatch:]

No, you guys do a fabulous job of running that, so I'm trying to figure out that return, how does that factor up between seg? I mean, is it much of it because of the VC lapping and you're getting the benefit of some cost reductions or efficiencies that we've been able to bring to that, or is it in domestic -- ?

[Kurt Tjaden:]

Yes, it's split between the two, Budd. Sorry, go ahead, finish you question, Budd.

[Budd Bugatch:]

Say it again, I've missed it, Kurt.

[Kurt Tjaden:]

No, I'm sorry I interrupted you, midstream there maybe. It's split between the two segments. I mean, clearly Vermont Castings provide the benefit on the hearth side. I would tell you they are also continuing to have strong core operational performance and execution with similar investments. So the way I think about it, come back to it, I talked about full year profit improvement within the segments, that should help you as you model that in for the balance of the year to get to where that benefit flows through.

[Budd Bugatch:]

And those benefits would continue to flow, at least some of them through the first three quarters of next year?

[Stanley Askren:]

So you're absolutely correct. And the other thing, and you and I have had this conversation over the years, we're never done. We are working the next level of what those transformational cost opportunities are and it should be. And I would tell you, there is a nice lift that we're actively working and taking action on now. So that's really what's driving this operational leverage that we talk about of 25% to 30%. And the reason it's not exactly linear by quarters, because these big investments happen, and it take this different time for the returns, et cetera, but as Kurt and I have said, we feel confident that we can drive this leverage not only this year, but we're confident we're going to drive it next year. We should be able to drive it into the future, all else equal, unless the pricing environment goes the heck or raw materials go to heck in the short-term, but we're on it.

[Budd Bugatch:]

And two other areas for me, the biomass or that area, we've expected that to be weaker, because of the price of energy and also because of the time of the year. How are you thinking about that now given the energy cost? And energy prices have had some stickiness down here, and what are you thinking really the longer term?

[Stanley Askren:]

We think longer term it will normalize kind of at a manageable positive sort of mean. Now, last year we saw extraordinary growth. So we saw in third quarter and fourth quarter in that category 40% to 50% growth in that category. This year seeing third quarter and fourth quarter, we see decline somewhere between 25% and 35%. Still positive sort of growth, if you have kind of cut the top off that and smooth that out, we have a significant sort of position in that. There are still other compelling reasons as to why one would want to use the biomass appliance. We continue to invest in that. But it's really very volatile due to energy cost. And the second thing would be just temperature, weather patterns. Severe winter helps, a warm winter doesn't help.

[Budd Bugatch:]

And the final area for me is just corporate overhead. Given the good results, are there any lumpiness coming in the corporate overhead, incentive accruals that might pop up to be heavier than normal? What do we have in that area?

[Stanley Askren:]

I think as you look at the back half of the year, Budd, I'd expect it to be relatively close to what we saw in the second half of 2014.

[Budd Bugatch:]

So you would model that as flat year-over-year, no inflation growth, nothing in that?

[Stanley Askren:]

You've do got pluses and minuses in there, but nothing of significance.

[Operator:]

Your next question comes from the line of Kathryn Thompson from Thompson Research Group.

[Kathryn Thompson:]

First, I want to focus it better on hearth. Just with some of the prior research we do on the more residential products, we're finding that there is a difference in terms of the demand momentum for higher price products versus lower price points. So pulling the string on your hearth business, are you seeing a greater volume increase for different price products within what you're selling and how has that changed over the past 12 months?

[Stanley Askren:]

It's a very good question, a complex question to answer. So we are working diligently to help the builders differentiate their product with hearth appliances. Hearth appliance is in the top three for desired amenities. If one is not careful, the builder doesn't really understand and they'll spec a low end and that makes the home owner unhappy. So we're working hard, Kathryn, with the builders to show them how to give there an upscale, up-priced product, but also help them engineer sort of the total install, so they actually have lower cost and more margin. So we're seeing nice unit dollar average growth on a same-for-same type of situation. What makes it hard for us to track, is just as you know, is the mix of housing, because entry-level housing versus custom housing will see different movement there, but we're working hard to move people up, is probably the operative term here.

[Kathryn Thompson:]

Maybe another way to think about that question is how much did price versus volume contribute to overall results at least in the quarter for hearth?

[Stanley Askren:]

We don't break that out.

[Kathryn Thompson:]

On the office side, so understanding that construction cycle right now, we're only starting to see some real volume growth from earlier cycle building materials, for instance, aggregates and steel size you're seeing high-single digit volume growth in the current market. Based on your experience in prior cycles, what has been the timing lag between increase in demands for these earlier type of basic building products versus demand for your office products really be more on the contract side. And what is other than some of the bottlenecks that we're seeing with labor and backlogs here, what is tagging along with that? Is there anything in the current cycle that would change that timing?

[Stanley Askren:]

Again, great questions Kathryn. Certainly, non-res new construction office is a very positive factor for us. It's hard for us to track that timing, because it depends on a lot of factors. Is it sold new construction or is it going to be leased, and then there is a whole domino effect that happens as well. So new construction is built for somebody or somebody is going to occupy it. When they leave their old space, that becomes available, somebody moves there, which then somebody moves there, which somebody moves there. And so if you think about office furniture events, is how we think about it, they come from lots of different things. So the real estate strategies come from facility, management strategies come from business drivers. And most of office furniture is for existing workers, about 10% is for new workers. So there is so many different dynamics, Kathryn, we have not been able to track the timing exactly. There's a good correlation here, but lagging at it and leaving it, we have not been able to sort through. I like a lot when the economy is building new office buildings, and I like it a lot when the economy is adding jobs, because those are the most positive furniture events that the industry can have.

[Kathryn Thompson:]

And my final question was just a cleanup question regarding your guidance and this maybe because I'm a little bit newer with coverage. But I know that you talked about investments that are going to be hitting in Q3, and you touched on them too in the Q&A. But could you maybe just give a little bit more clarity, a little bit more at least confidence for me as newer coverage, in better understanding that. What gives you confidence in those investments made in Q3 will yield? What types of investments in Q3 will yield results once you get into Q4 and beyond?

[Stanley Askren:]

I mean if you go back, we've been talking about these types of moves in these investments for years. So what gives us confidence is past performances results. And because we're a split and focus company, we're a company that plays in many different segments with many different brands. It's a very broad-based picture. We're investing in product, we're investing in distribution, we're investing in sales capacity, we're investing in manufacturing capacity, we're investing in people, we're investing in IT platforms, and so we are focused on volume growth. We're a company that's very tuned into sort of cost efficiencies. And so we invest a lot to drive cost efficiencies as well. And they go all the way from large facility transformations to a couple of more feet on the street to sell education product. It goes from large brands like HON Company to smaller brands like Maxon. And we run it kind of as a portfolio strategy, so big stuff, little stuff. And so as we look at it, we just kind of sort of lay it in and see where it's going to come and as we play with the operating companies. Now, I'll be honest with you, Kathryn, not all of our investments generate a return, but we have a pretty good track record of making good investments that generate nice returns. That goes back to this sort of leverage that Kurt and I talk about. We feel like we're outperforming the market on the topline, that's the volume growth both heart and in office furniture. Second, we said, overtime we should be driving 25% to 30% operating leverage on incremental dollars. And so we're driving volume growth and we're also expanding margins, and then we're driving capital efficiency. And the reason why we think it's going to happen is because that's what we've been doing and that's what we plan to continue to do.

[Operator:]

Your next question comes from the line of Josh Borstein from Longbow Research.

[Josh Borstein:]

Just one more for me, Kurt. It looks like you guys paid down some debt on the quarter. Just wanted to know if you can update us on the balance sheet?

[Kurt Tjaden:]

No pay down on debt in the quarter, Josh. If you see a movement between short-term and long-term, it all has to do with maturity on our long-term private placement, which comes up in early next year and we just have a reclass between the two, between short-term and long-terms of accounting. Yes, it's purely the accounting audit, nothing from a debt perspective.

[Operator:]

We have no further questions in the queue. End of Q&A

[Stanley Askren:]

Well, thank you very much for the excellent questions. Thank you for your interest in HNI. We look forward to speaking with you in the future. Have a great day.

[Operator:]

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