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HNI Corp. (NYSE:HNI)

Q3 2009 Earnings Call

October 22, 2009 11:00 AM ET

Executives

Marshall H. Bridges - Treasurer and Vice President, Corporate Finance

Stan A. Askren - Chairman, President and Chief Executive Officer

Kurt A. Tjaden - Vice President and Chief Financial Officer

Stan A. Askern - Chairman, President and Chief Executive Officer

Analysts

Leah Villalobos - Longbow Research

Todd Schwartzman - Sidoti & Company, LLC

Budd Bugatch - Raymond James

Matthew McCall - BB&T Capital Markets

Peter Lisnic - Robert W. Baird

Operator

Ladies and gentlemen, we'd like to thank you for standing by and welcome to the HNI Corporation Third Quarter Results Teleconference. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. (Operator Instructions). And as a reminder, today's call will be recorded.

I would now like to turn the conference over to your host Mr. Marshall Bridges. Please go ahead sir.

Marshall H. Bridges

Good morning and thank you for joining us today for the HNI Corporation conference call to discuss third quarter 2009 results, which we announced yesterday after the market closed. My name is Marshall Bridges, Treasurer and Vice President 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.

We posted a presentation intended to accompany this call to our website. It can be found by accessing the webcast link under the Investor Information. We encourage you to review the slides with us today during the call.

Joining me on the line today from HNI Corporation are Kurt Tjaden, Vice President and Chief Financial Officer; and Stan Askren, Chairman, President and Chief Executive Officer. Stan and Kurt will review the results and then open the call for questions.

Before we begin, please be advised that statements made by the Corporation during this call that are not strictly historical facts are forward-looking statements. Forward-looking statements are subject to known and unknown risks. Actual results could differ materially from expected results. Additional information concerning factors that could affect actual results can be found in the conference call presentation posted 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 A. Askren

Thank you, Marshall. Good morning everyone. As is our usual custom, I'll share a brief assessment of the third quarter, and then I'll turn the call over to Kurt Tjaden, our CFO who will review some of the specific financial details. I'll then come back and will share some thoughts on outlook and then finally, we'll open it up for questions.

So, overall we had a strong quarter, particularly considering the highly challenging market conditions. We dramatically increased profitability in the face of a 32% revenue decline, achieving an 8.4% operating income margin on a non-GAAP basis.

For the first time since 2007, we drove non-GAAP operating profit margins in our Office Furniture segment to over 11%. We returned our Hearth business to profitability and improved the operating profit margins over the prior year period on a non-GAAP basis.

We accelerated our already strong cash flow generation. Operating cash flow during the quarter was almost double the same period last year. We've already generated more free cash flow in the first three quarters of this year than we did in all of 2008.

We increased our financial flexibility and strengthened our balance sheet, repaying $52 million of debt and increasing our cash balance by $26 million. Our debt-to-EBITDA ratio is now approximately 1.6, down from last quarter and well within our bank debt covenant.

As expected, we did see a seasonal uptick in volume. Revenue was up $71 million versus the second quarter, primarily driven by government and education office furniture sales and Hearth's remodel-retrofit channel.

We benefited from our ongoing efforts to increase share in these markets. Our major channel benefited from seasonal demand but conditions remain challenged across our businesses.

Sales in the supplies driven channel of our office furniture business were down 30% versus prior year. The remainder of office furniture businesses declined 35%.

Apart from seasonality, not a lot has changed in the office furniture market. The day-to-day business remains weak and projects are as competitive as ever.

In our Hearth business, remodel-retrofit sales, including alternative fuel products, were down 29% versus the prior year. Lower energy prices and the negative retail environment continue to pressure this channel.

The new home construction channel in our Hearth business performed better than expected. Third quarter sales were down 26% versus the prior year as a result of less negative new home construction and our aggressive efforts in the market.

Our third quarter results reflect the power of our reset cost structure, particularly when combined with higher volume. Our members have done an outstanding job of attacking costs and increasing efficiency throughout the Corporation, and I want to expressly thank them for their hard work and their commitment to the business.

I'll now turn the call over to Kurt Tjaden. Kurt?

Kurt A. Tjaden

Thank you, Stan. If you'd like to follow along, I'll occasionally make reference to the presentation, Marshall mentioned as posted on our website. I'm going to cover the third quarter 2009 results.

As you can see on slide eight, consolidated net sales decreased 31.5% to $454 million. Sale for the Office Furniture segment decreased 32.2% to $380 million driven by a substantial weakness in both the supplies driven and contract channels.

Net sales for the Hearth Products segment decreased 27.7% to $74 million driven by similar declines in both the new construction and remodel-retrofit channels.

Consolidated gross margins, including restructuring and transition charges, were 36.7% which compares to 33.9% in prior year quarter. This 2.8 percentage point improvement was due to cost reduction initiatives, price realization and lower material costs.

SG&A, including restructuring and transition charges as a percentage of sales, was 29.6% versus 28.8% in the prior year quarter. While the percentage of sales increase is due primarily to volume de-leverage, actual SG&A dollars declined 57 million due to cost control initiatives which were partially offset by increased restructuring costs.

Freight and distribution expense, which is included in SG&A, totaled 9.3% of sales during the third quarter. This compares to 10.8% during the same period last year. This decrease is primarily due to reduced fuel costs and network improvements.

Slide nine summarizes our restructuring and transition charges and reconciles our non-GAAP to GAAP results. As shown, third quarter 2009 included $6 million of restructuring and transition costs, of which $1.6 million were included in cost of sales. These costs included $4.1 million associated with the shutdown and consolidation of the three office furniture manufacturing facilities and $1.8 million related to the restructuring of hearth operations which was net of a non-operating gain related to the sale of a building.

For comparison, we recorded $1.5 million of restructuring and transition costs in the third quarter of 2008.

Year-to-date cash flow from operations was $136 million which compares to $105 million in the prior year. This increase was driven by strong working capital management which was partially offset by lower earnings.

We reduced total debt by $119 million during the first nine months of 2009, using cash flow from operations and proceeds from the sale of long-term investments.

That wraps up the financial comments. Now I'll turn the call back over to Stan.

Stan A. Askern

Thank you, Kurt. As we look forward the market environment continues to be dynamic and volatile providing limited visibility. Nonetheless we would share with you our best current view of the fourth quarter.

As I said earlier in the call, our third quarter results benefited from relatively strong seasonal office furniture demand. We expect seasonal demand to dissipate in the fourth quarter resulting in revenue and profitability below our third quarter levels.

Apart from the seasonal downturn, we expect office furniture demand to remain generally at existing levels with continued volatility where we see no clear indication of significant improvement or decline in the near-term.

Our Hearth business continues to be in challenging conditions, particularly in the remodel-retrofit channel due to relatively low energy prices and the negative retail environment.

We believe hearth demand, including demand in the new construction channel, will continue to stabilize and expect slightly higher sequential revenues due to seasonality.

Overall, despite the challenging and relatively unchanged base demand conditions, we remain excited about the future given our ongoing cost reset actions, focused on cash flow generation and our aggressive efforts to improve our competitive position.

I'll let Kurt provide some specific financial outlook for the fourth quarter.

Kurt A. Tjaden

Thank you, Stan. I would like to point out two factors which influence the year-over-year comps for the fourth quarter. First, last year's fourth quarter was a 14-week period compared to 13 weeks in 2009. Second, we implemented price increases across many of our businesses in October 2008. Customers ordered ahead of these price increases before the full impact of the economic downturn, positively impacting last year's fourth quarter results.

Taking these factors into account, we anticipate overall sales to be down 33 to 39% for the fourth quarter 2009.

We expect the Office Furniture segment to be down 33 to 39%. Within office furniture, we expect the supplies-driven channel to decline closer to 33% and the rest of the segment to be down near to 39%.

Hearth sales are anticipated to decline 31 to 37% driven by declines in both the new construction and remodel-retrofit channels.

Gross profit margin, excluding restructuring and transition charges, is expected to increase approximately 1.9 to 2.5 percentage points from the prior year quarter results of 33%. This increase will be driven by continued cost reset actions and favorable material costs.

Included in cost of sales will be approximately $2.4 million of restructuring and transition charges related to previously announced consolidations.

SG&A, as a percentage of sales excluding restructuring and transition charges, is expected to increase 3.3 to 3.9 percentage points from the fourth quarter 2008 non-GAAP results when it was 28%. While the percentage of sales increase is primarily due to volume deleverage, actual SG&A dollars are projected to significantly decrease.

We do anticipate SG&A related restructuring and transition costs to be approximately $1.8 million in the fourth quarter. Net interest expense is projected to be $2.5 million and finally, the effective tax rate is anticipated to be 38% during the fourth quarter.

This summarizes our outlook for the fourth quarter of 2009. I'll now turn the call back to Stan for closing comments.

Stan A. Askren

So, I'll conclude here.

In summary, we've executed well through this downturn, dramatically resetting our cost structure, improving profitability and cash flow and enhancing our competitive position. We're still facing significant challenges and you should expect continued aggressive actions as we continue to adjust to the prevailing marketplace conditions.

But I have to say I am as excited ever about our organizational capabilities, the investments we are making for our future growth and our ability to adapt our business to these dynamic economic conditions.

So, that completes our comments here. I'll now open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Mark Rupe of Longbow Research. Please go ahead.

Leah Villalobos - Longbow Research

Good morning. This is Leah Villalobos in for Mark. Congratulations on the execution in this quarter. It looks like the gross margin in both the -- and the SG&A came in a lot better than you had discussed on the last quarter call. And I was wondering if you could talk a little bit about what's changed since then?

Kurt Tjaden

Sure. On the gross profit line Leah, that was really driven by cost containment. But we also realized the benefit from higher volume that was at the top end of our range as well as favorable material costs. Non-GAAP SG&A was basically flat on a percent of sales basis, better than we expected by 1.5 to 2%. And that was of two factors. One was again better cost containment and the other one is continued improvement in our freight and distribution efficiencies.

Leah Villalobos - Longbow Research

Can you talk a little bit about what you are doing with the freight and distribution?

Stan Askren

Well Leah, you may recall, last year we initiated some significant changes in kind of our overall network model. We realigned some distribution centers. We engaged in some third-party logistics initiatives and some better planning. And then we just worked very aggressively on laying in cube utilization and just good old fashion and grinded out sort of operational improvement.

Leah Villalobos - Longbow Research

And then, as far as the material costs being lower in the quarter, how much lower were they?

Kurt Tjaden

They were about $10 million lower in the quarter on material costs and we had another $3 million in diesel.

Leah Villalobos - Longbow Research

And then looking at the guidance for the fourth quarter, what is your expectation?

Kurt Tjaden

You should expect material costs, we look to be about 16 to $17 million favorable and another 3 on diesel.

Leah Villalobos - Longbow Research

Great. Thank you very much. Good luck.

Operator

Our next question comes from the line of Todd Schwartzman with Sidoti & Company. Please go ahead.

Todd Schwartzman - Sidoti & Company, LLC

Surprisingly all my questions were just asked and answered. Thank you very much.

Stan Askren

You bet, Todd.

Operator

Our next question will come from the line of Budd Bugatch of Raymond James. Please go ahead.

Budd Bugatch - Raymond James

I was hoping you guys might be able to quantify some of the benefits in gross margin maybe, in particular pricing, see what you had to say there?

Kurt Tjaden

You're talking specifically about the third quarter?

Budd Bugatch - Raymond James

Yeah, I'm sorry, yeah.

Kurt Tjaden

Yeah. We had projected $20 million of price favorability and that's basically what we realized in the third quarter results. So right in line with expectations.

Budd Bugatch - Raymond James

Okay. That's very helpful. And given the excellent cash flow generation guys, any changes to the outlook for, maybe what working capital looks like and what the year-end debt balances are going to be trending towards?

Kurt Tjaden

Yeah on work -- year-end total free cash flow for the year, we see sits somewhere in the 140 to $150 million range. Inventories, we'd expect to see continue to decline in line with revenue in the fourth quarter, another $10 million or so. In debt, we would not anticipate seeing a change in our current debt level. We have some significant prepayment penalties in our remaining debt. So what you should expect to see is us continuing to build cash.

Budd Bugatch - Raymond James

All right. Those are my questions guys. Congratulations on the excellent quarter.

Stan Askren

Thank you.

Operator

Our next question comes from the line of Matt McCall of BB&T Capital Markets. Please go ahead.

Matthew McCall - BB&T Capital Markets

Thank you. Good morning everybody.

Stan Askren

Hey Matt.

Matthew McCall - BB&T Capital Markets

Okay. Kurt, first, you talked about a couple of things that would impact Q4 and one was the impact of the orders that were placed ahead of price increase last year, correct?

Kurt Tjaden

Right.

Matthew McCall - BB&T Capital Markets

Can you quantify what you think that impact was and maybe give us an order of magnitude on how it's impacting the relative performance this year?

Kurt Tjaden

Really, it's difficult to break that out, Matt. There's a lot of factors that impacted that. That's not something we got that level of detail on.

Marshall Bridges

And we're not full of it. Just we would -- you hear us talk about other companies, it was just that -- you got a lot of the problems earlier in the quarter before things really got bad last year.

Matthew McCall - BB&T Capital Markets

Okay. All right. So, okay. Got it. All right. So, on the obviously things you said Stan, pretty volatile right now. Can you talk about -- and you talked about project activity being aggressive as ever. Can you talk about that project pipeline? Any changes over the past three months or since the quarter closed?

Kurt Tjaden

I think Matt, we're seeing volatile just weekly, daily, sort of segments move around. It all kind of, sort of ends up at about the mean. I don't think we've seen any significant changes up or down in kind of what we've been seeing as a run rate here the last third quarter. As we mentioned there's a seasonal change due to kind of at the end of the year budget cycles and government education and just sort of timing stuff but that base demand level seems to be pretty stable.

Matthew McCall - BB&T Capital Markets

Okay. So, moving on to the guidance, it looks like you did a north of 8% margin in Q3 and looks like the guidance range is somewhere in the 3.6 to 4.8 range, if I'm doing the math right, back -- putting back in the restructuring. So I guess that the question is, historically it looks like the seasonal pattern there, it sounds like what you're saying is there is a normal seasonality that you are experiencing or expecting.

Looks like the seasonal pattern there is not quite extreme, 8 going to 4. Can you help us understand, what's the new normal, I guess or what's the new baseline that we should be looking at as we start to approach fiscal year'10?

Marshall Bridges

Matt, I think we do have a pretty significant seasonal aspect of our business that Stan talked about earlier. And if you look over the last -- last year I think our sequential drop third to fourth quarter is pretty much in line what we're expecting this year. The last two or three years before that, we didn't really see the same seasonality, so you need to factor in those years.

If you go back before those periods, we did see some pretty significant sequential drops in revenue. And the main factor driving this sequential profitability drop is simply volume deleverage, we have less volume and delevering at say $0.35 of a $1, so our profitability lowered.

Matthew McCall - BB&T Capital Markets

Okay.

Marshall Bridges

It's in office furniture as well, the Hearth business has a mix comparable, if you look at sequentially, it's not a fair mix of comparison.

Matthew McCall - BB&T Capital Markets

Okay, okay so -- but Marshall, as we start to look at fiscal year '10, help us understand how to look at that relative to what we've just seen happen in Q4, with the new cost -- Q3 with the new cost model and what the forecast is for Q4?

I know you've got some additional costs that are going to come out. Just help us understand how -- I don't know -- flat top-line next year from current levels and just the normal seasonality. What kind of things, do we need to think about for next year's result?

Kurt Tjaden

That's pre-tax, unless to exact this (ph), so you think of cost reset, we think now this year, we are going to take out about a $110 million in structural cost, which if you annualize that into 2010 would be about 140 to $150 million. And really that's due to as we had cost come out during this year and a number of our announcements will start to see the full benefit of that roll through 2010. And we are not done, you know this well. That's an ongoing effort and an area of continued focus for us.

Stan Askren

I think then Matt, for us to comment on sort of what we see in 2010 is I think it would be probably premature and it will not be very helpful at this point as to what we expect on kind of the market.

That's still so dynamic involved, anything we would give you, would probably not be helpful. I think we just say, we think it's -- the base demand have stabilized and then we'll just have to see how the economy sort of comes back online. When it comes back online and how fast in both Office Furniture and Hearth and sort of what's the lag as to when we can get traction there as well. I wish we could give you more but I think to give you more would just not be wise.

Matthew McCall - BB&T Capital Markets

No and to be clear it was not a top-line question at all. It was basically just making assumption on the top-line flat what -- And Kurt kind of hit on it. It sounds like Kurt that if I remember that 110 number was going to be 100 and then the 140 to 150 seems a little bit higher than I remember as well. Are there new initiatives -- I know you've been out and selling -- but are there new initiatives that we may not know about or is it just more blocking and tackling, getting now taking that number up to an incremental 30 to $40 million next year?

Kurt Tjaden

No I think you hit it Matt. It is slightly higher than what we talked last quarter and other than the recently announced restructuring we just continue to take costs out on a daily weekly monthly basis across our business.

As you recall now, we also kind of have a policy of not sort of calling the shot. We basically said -- we'll let you know when we announce something what the benefit will be in. And so we continue to work these items as we go forward.

Matthew McCall - BB&T Capital Markets

Okay. And then, final two. That's 140 or 150 does include Owensboro and all the costs that you just referenced are permanent in nature. Is that correct, Kurt?

Kurt Tjaden

That's correct.

Matthew McCall - BB&T Capital Markets

Okay. Thank you guys.

Marshall Bridges

Thank you Matt.

Operator

And we have a question from the line of Peter Lisnic of Robert W. Baird. Please go ahead.

Peter Lisnic - Robert W. Baird

Good morning gentlemen.

Stan Askren

Hi Peter.

Peter Lisnic - Robert W. Baird

I guess the first question on the pricing, the $20 million you talked about. Is that just a function of basically carrying forward the impact of higher materials cost that you incurred last year or is there a new product/mix element to that number as well?

Stan Askren

Peter, that was -- you hit it in the latter part, it was primarily that closing the gap between material costs, rapid escalation in price.

Peter Lisnic - Robert W. Baird

Okay. And then, can you maybe give us that breakdown by segment? I presume that majority of that's in office but probably some in Hearth?

Kurt Tjaden

It is primarily -- you should assume it's primarily in the office, very little in Hearth.

Peter Lisnic - Robert W. Baird

Okay. And then what -- it sounds like obviously the competitive landscape at times is difficult, what are you seeing from a pricing perspective and has that changed for the better or worse over the past quarter or two?

Kurt Tjaden

Well, not a big huge change in pricing and certainly the bid pricing, the project pricing continues to be competitive. But we are not seeing significant change, it's a challenging world out there. There is lots of supply chasing demand and the competitors are sharp and we remain sharp as well to make sure we're getting more than our fair of share.

Peter Lisnic - Robert W. Baird

And is there anything material in terms of deterioration in the supply channel?

Kurt Tjaden

I'm sorry, ask that again Peter I'm not sure I understand.

Peter Lisnic - Robert W. Baird

Well you talked about the projects out of the business. I was just wondering in the supplies base channel?

Kurt Tjaden

There's some, the answer is no. Not appreciably, there are some things that we're doing around promotions and programs, the new product launches, items like that but not the day to day prices.

Peter Lisnic - Robert W. Baird

Okay. And then separately on the balance sheet/cash flow, clearly made a great progress there and doesn't sound like with the prepayments the debt will be coming down. But can you maybe talk about other potential uses of cash outside of just letting it in this interest rate environment just sort of build up on the balance sheet?

Kurt Tjaden

Our quality really hasn't changed here, except I think we're comfortable with less than a little bit of cash built up on the balance sheet here. It's still at relatively modest level. And so we're comfortable running that build. But our policy has been that a) we reinvest back into the core business; b) we're always looking at acquisitions that we can create value. We also consider dividends and share repurchase and it kind of depends on what we believe the outlook is and what the current opportunities are.

And that's something that our Board of Directors looks at on a quarterly basis. And we have extensive discussion around that but we don't see any real change in that policy here I think in the near term.

Peter Lisnic - Robert W. Baird

Okay and I am just -- I guess I'm wondering whether or not you are seeing anyone or anything on the acquisition front come to the forefront here, given the end market pressures and maybe some competitors under pressure?

Kurt Tjaden

Yeah we don't typically comment on that, Peter.

Peter Lisnic - Robert W. Baird

All right, how about on the valuation multiples that you might be seeing?

Kurt Tjaden

We don't comment on that either.

Peter Lisnic - Robert W. Baird

I got to keep trying.

Kurt Tjaden

I understand. I understand.

Peter Lisnic - Robert W. Baird

All right. Thanks for your help guys. I appreciate it.

Kurt Tjaden

You bet.

Operator

And our next question is a follow up from the line of Mr. Todd Schwartzman.

Todd Schwartzman - Sidoti & Company, LLC

Hi. I just wanted to get some clarification. I ask you to please repeat the guidance that you gave regarding SG&A for the fourth quarter relative to the prior year 28%, both in terms of absolute dollars and on a percent of sales.

Kurt Tjaden

Yeah. What we said, Todd, is SG&A as a percent of sales excluding restructuring and transition charges is expected to increase 3.3 to 3.9 percentage points from the fourth quarter 2008 non-GAAP results when it was 28%. And we didn't provide it dollar -- what we are expecting a significant decrease year-on-year.

Todd Schwartzman - Sidoti & Company, LLC

From that 179 number, we'll call it.

Kurt Tjaden

Correct.

Todd Schwartzman - Sidoti & Company, LLC

Okay. Thanks a lot.

Operator

There are no further questions in queue at this time.

Stan Askren

All right. Well, thank you very much for joining us this morning. We look forward to updating you in the future. Have a great day.

Operator

Ladies and gentlemen, this does conclude our conference call for today. On behalf of today's time, I'd like to thank you for your participation and thank you for using AT&T. Have a wonderful day. You may now disconnect.

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