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HNI Corp (NYSE:HNI)

Q1 2014 Results Conference Call

April 17, 2014 / 11 A.M E.T.

Executives

Matthew McGough – VP, Corporate Finance

Stan Askren – Chairman, CEO and President

Kurt Tjaden – VP and CFO

Analysts

Matt McCall – BB&T Capital Markets

Josh Borstein – Longbow Research

Todd Schwartzman – Sidoti & Company

Operator

Good morning. My name is Jay, and I will be your conference operator today. I would like to welcome everyone to the HNI Corporation first-quarter fiscal 2014 results conference call. (Operator Instructions). As a reminder, today's conference call is being recorded.

Thank you. Mr. McGough, you may begin.

Matthew McGough

Good morning, and thank you for joining us today for the HNI Corporation conference call to discuss the first-quarter fiscal 2014 results, which were announced yesterday after the market closed. My name is Matthew McGough, 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 on 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 reconciliation.

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 the call for questions.

Before we begin, please be advised 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 can differ materially from expected results. Additional information concerning factors that could affect actual results can be found on the conference call presentation posted on 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 Askren

Good morning. We'll share our assessment of the first quarter of 2014, and provide some thoughts on our outlook for second-quarter and full-year 2014. I will then open the call up for questions.

In summary, it was a good quarter. We're off to a strong start for the year, with improved sale performance and significant profit growth over prior-year. We continue to deliver strong operating results while investing for long-term, profitable growth. Our hearth business exceeded expectations and delivered outstanding sales and profit growth.

Operating profits improved 226%, on 23% sales growth. Remodel/retrofit sales increased 32%, as cold weather drove demand for our products, led by a significant increase in biofuel product sales. Sales in the new construction channel increase 12% on the strength of our market position and the continued housing market recovery.

Our supplies-driven business sales declined 6% organically. We expected that decline due to a softer demand environment, which was further negatively impacted by the harsh weather. Sales momentum is improving, and as we enter the second quarter, we are well positioned to deliver solid growth. Sales on the remaining office furniture businesses grew 6% organically, led by 9% organic growth in our North America contract business. Overall, I'm very pleased with our strong first-quarter results.

Kurt?

Kurt Tjaden

Thank you, Stan. For the first-quarter 2014, consolidated net sales increased 2.2% to $452 million, or 3.8% on an organic basis. Sales for the office furniture segment decreased 2% to $358 million, or decreased 0.2% on an organic basis. Net sales for the hearth product segment increased 22.7% to $94 million.

Consolidated gross margins increased to 34.3% compared to 33.4% in the prior-year quarter due to higher volume in the hearth products segment and increased price realization, which was partially offset by lower volume and unfavorable mix in the office furniture segment.

As a percent of net sales, total selling and administrative expenses, including restructuring and impairment charges, decreased 0.6 percentage points due to volume and freight efficiencies, partially offset by investments in strategic initiatives and higher incentive-based compensation.

We recognized an $8.4 million gain on the sale of a vacated facility of the quarter, and we ended the quarter with $46 million of cash, and we used $36 million of cash in the quarter compared to $31 million in the prior-year quarter. The first quarter is typically our lowest quarter for operating cash flow due to business seasonality and funding requirements.

Stan?

Stan Askren

Okay, so looking forward, our strategies are on track, and we are off to a strong start for the year. We are well positioned to deliver double-digit profit improvement for the year. We expect our supplies-driven business to be up mid-single-digits, organically, in second quarter. The severe winter weather is behind us, and the demand environment is improving.

Our remaining contract office furniture businesses will be down low- to mid-single-digits in the second quarter due to a strong year-over-year comparison, and timing of large projects. I will say our market momentum is strong, and we expect continued strong growth in the business for the year.

In our hearth segment, we anticipate growth to be up mid- to high-teens for the second quarter. New construction channel growth is expected to continue, as the housing market recovery continues. Growth in our remodel/retrofit business is projected to be up mid-teens.

Our strategies remain unchanged. We're investing in our core businesses to capture new growth opportunities, and aggressively pursuing attractive prospects in key verticals and growing international markets.

Kurt?

Kurt Tjaden

So, financial outlook for the second-quarter and full-year 2014. For the second quarter, we anticipate overall sales to be flat to up 4%. Office furniture sales are expected to be down 1% to up 3% organically; or down 2% to up 2%, including the impact of divestitures. Organic sales in the supplies-driven channel are expected to be up 4% to 8%. Organic sales in the rest of our office furniture businesses are expected to be down 1% to 5%, and hearth sales are expected to be up 15% to 19%.

Gross profit margin is expected to improve versus the second-quarter 2013, when it was 34.2%. Non-GAAP SG&A as a percentage of sales, excluding restructuring and transition charges, is expected to be similar to second-quarter 2013, when it was 29.8%. Net interest expense is projected to be $2.3 million, and the effective tax rate is projected to be approximately 35% for the full year.

For the year, we are expecting capital expenditures to be $90 million to $95 million, and we expect full-year 2014 depreciation and amortization to be $50 million to $52 million. Our estimate of non-GAAP earnings per diluted share for the second quarter is $0.32 to $0.37 per share. And for the full year, we are raising our estimate of non-GAAP earnings per diluted share to $1.70 to $1.85, which excludes restructuring charges and the gain on the sale of a vacated facility.

Stan?

Stan Askren

Thank you, Kurt. So, I will conclude. I remain confident in our strategies to drive profit improvement, while simultaneously investing for long-term growth. We entered the second quarter with strong momentum across our businesses, and we remain on track to grow sales, and significantly increase profits in 2014.

With those comments complete, we'll now open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Matt McCall with BB&T Capital Markets. Your line is open.

Matt McCall – BB&T Capital Markets

Thank you. Good morning everybody. So, let's see. Let's start with the trend in contracts. I think you said you expect it to be down – timing, tough comps. If you look at – that was the total business; I think that includes international, if I remember correctly. Can you talk about the trends, maybe in orders, and how much timing is hurting? And what's the expectation for the furniture business, maybe for the full year, if you can talk about it in terms of contracts, in terms of supplies and international?

Stan Askren

Okay, let me see if I can answer that question, Matt. I know Kurt will jump in here with color. So, for contract, we started off with a strong first quarter, as we indicated. I think we said organic North American contract was up 9%, and that coming off really strong momentum. That momentum has continued, even through the first quarter.

Day-to-day – and we have a strong day-to-day business in our contract segment – we're probably shorter cycle on the contract than some of the other players, just due to the nature of how we go to market. The day-to-day did take a dip, consistent with the harsh weather, but the project business pipeline continued to be strong.

You saw that also – I think we mentioned in here that our Federal Government business in that contract was up 30%-some, and so we have the benefit there. So, we have kind of this anomaly in the second quarter, where we anticipate contract sales are going to be down. Don't take that as a loss of momentum for the year. We continue to see strong momentum, and that's going to be up mid-single-digits as we sit here today.

On the international side, we expect international to be up strong for the year, mid-single-digits, starting off slower for the first part of the year. And as you recall, Matt, we are driven by Hong Kong, PRC, and India, along with a pretty good export component. And so Hong Kong is slow right now; not a lot of real estate, not a lot of investment churn. Our market momentum, our market position there, is excellent.

Mainland China has slowed, but there is good momentum, we think, building there. We think that will come on. And India is going to be subdued for a couple of reasons: one is, we are making some restructuring changes there, and exiting some business segments that are not profitable. It is typical of what we do when we acquire a company like that. Second, just that overall economy has slowed, as they go through their national election, which takes 30 days. But for the year, we expect that to be strong.

You come back to supplies, as you may recall when we talked in February, we spotted the winter weather was harsh, harsher than historic, and we knew that it was going to negatively impact supplies; very short cycle business. And a lot of our resellers and a lot of our end users simply have lost days.

People weren't going to work. People weren't off selling. And that business tends to go away pretty quick; tends to come on slightly quick. So, as we indicated to you, the supply segment was down 5%, 6%. First quarter, we expect it to be up mid-single-digits. And second quarter and for the year, we expect it to be up low-single-digits as it goes forward.

So, I would say we've got all sorts of noise around timing and volatility, but I think the core message here is we feel good about market momentum in all these segments, and we expect the year to be stronger than the last time we talked to you, quite frankly. That's why we've raised the range of our guidance.

Matt McCall – BB&T Capital Markets

Very helpful, Stan. Thank you. The supplies outlook – can you talk a little bit about the visibility you have there? You talked about short cycle nature of contract. I know supplies is even more day-to-day. So what are the indicators that you're watching, that tell you that the market momentum is improving?

Stan Askren

Yes, well, we watch our large – you characterized it well: it's harder, because it's shorter cycle. But a lot of what we do is stay in close contact with our resellers, and simply talk to them about what kind of activity they are seeing. So a lot of it is, I would say, is qualitative discussion. We do watch small business confidence, although there can be some disconnect on that. But we take a hard look at that.

And then we do watch our – I call it our small project business, and bid activity for small projects, which there is an element in that as well. And then, it's literally watching the orders week by week, Matt, is our best indicator of momentum, up or down.

Matt McCall – BB&T Capital Markets

Okay, okay. Perfect. And then the final question I have is you talked about – I think, Kurt, you may have said CapEx in the low $90 million range this year. I think last year, it was $80 million. You were running $30 million to $40 million in periods before that. I've got it dropping [50 million in 2015] (ph); I'm not sure if that's correct or not.

But my question is, we talked about not only CapEx investment but also OpEx investment, and you invested in the front end of the business. Are you going to see a similar step-down in investment spending as we move out into 2015 that I have forecasted?

Kurt Tjaden

I think we continue to see attractive opportunities to invest in our business, Matt. And that investment level, particularly on the front end, that portfolio continues to turn over. We talked about additional investments in the back end, around operational reconfiguration, new products, plant layouts; as Stan described it, non-restructuring, it is not really restructuring expense, those kinds of opportunities. I think if we see attractive opportunities continue, we'll continue to invest in those.

Stan Askren

Yes, I would jump in there with Kurt here, Matt. We have some tremendous investment opportunities for shareholders right now around capital projects that are driving productivity improvements. In addition, we're also needing to respond to shifting the mix of product. So we've talked about this many times in the past. As archival storage or metal filing shifts down, we're investing in the other categories on the way up. That is somewhat of a shift of production capacity and type of capacity. So, our investment falls in two of those – those two areas, I should say.

Matt McCall – BB&T Capital Markets

Okay, so don't expect a big margin bump as we move forward from the tailing off of some of the OpEx investment.

Stan Askren

Yes, I think that's right. And the second thing, though, is you should know that as we invest CapEx, we see pretty quick paybacks on those investments as well. Typically, we are running – to be 18 to 36 month sort payback on that CapEx investment. We are committed to continue to drive this leverage that we've talked about over the last several years, of – we expect to be leveraging that 30% sort of level as we go forward. And that may range, at different points of time, from 20% to 40%; but, overall, our outlook is below that 30%.

Matt McCall – BB&T Capital Markets

And that's for the Company as a whole?

Stan Askren

Correct.

Matt McCall – BB&T Capital Markets

Okay, all right. Thank you, guys.

Operator

The next question comes from Budd Bugatch with Raymond James. Your line is open.

Unidentified Speaker

Hi, guys. This is Bobby filling in for Budd. Thank you for taking my questions, and congrats on the quarter. My first question centers around a modeling question. For the hearth segment, how should we think about the leverage for the next couple of quarters? I know we've talked about the 30% to 35% range there. But for the last two or three quarters, you've posted plus-40% contribution margin. Should we expect a 40%-plus again in the second quarter, and have margins improved sequentially?

Stan Askren

Yes, good question, Bobby. Certainly, that business has done a really – very fine job of driving topline sales, and driving some really great bottom-line leverage and profit improvement. I think our suggestion to you is, you should choose a number like 35% for your leverage. That team continues to impress and surprise us. But I think the smart money would say, 35% is probably the right number.

Eventually, that leverage is going to have to come down, simply as they consume capacity. But we're really proud of what they've done in that business.

Unidentified Speaker

Now, on capacity, is there any upcoming capacity issues there in that segment that we should note, that maybe suspending would have to be done for manufacturing footprint?

Kurt Tjaden

No.

Unidentified Speaker

Perfect. And that's it for my questions. Thank you for taking my questions, and best of luck going forward.

Operator

The next question comes from Josh Borstein with Longbow Research. Your line is open.

Josh Borstein – Longbow Research

Hi, Stan, Kurt and Matt. Thank you for taking my questions here. You know when you look at what you see in the pipeline for contract office furniture, do you feel as if we reach an inflection point, where things are starting to pick up at a quicker pace than they have been? Or do trends still look similar to what you described before, as just kind of a low-growth environment.

Stan Askren

I would say, Josh, we're at – we're really – you said, point of inflection. I think we're just right – getting a better visibility as what that's going to be, simply because the screwy impact of the harsh weather on this. That said, I am feeling more optimistic, more bullish, about contract momentum than I have for some time; but early, early, Josh.

Josh Borstein – Longbow Research

Okay. That's helpful. So, with BIFMA's forecast, they have, I think, the mid-single-digit growth this year; a much more significant growth next year. Does that more bullish forecast from BIFMA begin to make a little more sense for you, based on what you've been seeing the past few months?

Stan Askren

Yes. Global Insight does that forecasting for BIFMA. And if you go to deconstruct that model, it's based on a bunch of assumptions. And so it's assumptions on assumptions. But certainly – and they are around corporate profitability; it's around employment growth; it's around real estate absorption, capital investment. All of those things, if you look at our economy, look like they're getting better. I'm feeling like there's more optimism. And, certainly, I don't know whether the number they've come up with absolutely is going to be the number. But certainly I feel, today, absent some disruptive event, that next year should be better than this year, based on those factors that I just laid out.

Josh Borstein – Longbow Research

And on the – with the trends – you said you're noticing a little bit of an improvement here. Does that translate at all, as people begin to spend more on office furniture, where you see a trade-up in products from, say, trading up to HON to Allsteel or to more Gunlocke, anything like that?

Stan Askren

There typically, in an economic recovery, is a trade-up; but the whole market trades up. And because we play in all the classes and all the price points, all of the boats rise with that. So you won't really see an overall mix change between those, but we're uniquely positioned, and well positioned, to play in all those segments. So as the trade-up happens, it's the entry guy moving up a notch. It's the mid-guy moving up a notch. And I think we're in a great spot to play, regardless of where it goes.

Josh Borstein – Longbow Research

Great. And then just one more for me on the acquisition pipeline. Any niches that you're currently looking at, that you don't play in, that you would like to get into? Or anything looking particularly attractive right now?

Stan Askren

Yes, it's a good question, Josh. We don't really comment on that. But I would tell you, our model or our process continues the same. We are always open for acquisitions that we think, A, we can understand; B, fit our strategy; and C, that we can create value. But I can't comment on anything specifically.

Josh Borstein – Longbow Research

Fair enough. I appreciate the color, and good luck.

Operator

The next question comes from Todd Schwartzman with Sidoti & Company. Your line is open.

Todd Schwartzman – Sidoti & Company

Hi. Good morning, guys. Just wanted to follow up on Josh's last question. Maybe you could just remind us, what was the last acquisition that the hearth segment made?

Stan Askren

Harman in 2008 (inaudible) 2008 era.

Todd Schwartzman – Sidoti & Company

Great, thanks. On the furniture side, what did you see in Q1, and subsequent, with respect to government sales and orders?

Kurt Tjaden

So, first quarter, as Stan talked about, we saw strength in the contract side due to some large projects; overall, up slightly for the quarter; but again, that's lumpiness, as we talked about in the channel. So overall for fed gov, remind you, it's only 4% of our office furniture sales, and our outlook remains pretty much unchanged, which is down 10% to 15% for the year. So, still shrinking, albeit at a lower rate than we've seen over the last several years.

Todd Schwartzman – Sidoti & Company

Got it. And looking at BIFMA's forecast for next year, double-digit growth, how credible do you guys find that to be, at this point?

Stan Askren

Well, I commented on that, I think, with Josh, Todd, which is – how credible is any economic forecast? Global Insight does that BIFMA forecast. They are one of the leading firms. BIFMA has had them look at that forecast model a bunch of times. Forecast models are great at predicting straight lines, or either increasing lines or decreasing lines; not so great at forecasting points of inflection.

And the model – and I don't have it here in front of me – but as I recall, is made up of the same things that you look at all day long, which is corporate profitability, capital investment, employment growth, office vacancy absorption, et cetera. And so I think it's like any economic model: it's a good indicator, but I wouldn't take exactly the specific details to the bank. I think what it says, which is what I commented on, is – next year should be better than this year. And I think that makes sense to me, based on what's going on in our global economy and our domestic economy.

Todd Schwartzman – Sidoti & Company

Yes. I thought you had spoken more to this year, but I guess certainly timing is critical. I think if you take a two-year stack approach, if you look at low- to mid-single, combined with 10%, 11%, 12% – if you compound that, is that a fair two-year type of compound growth, if you had to guess this far out?

Stan Askren

Wouldn't it be great if we get that growth? That means the economy is buzzing. And we feel that we are super well-positioned to benefit from that growth if the economy goes.

Todd Schwartzman – Sidoti & Company

Of course, on an average, annual basis, that's not far off from what the industry has posted historically, right? If you took a 12%, 13% type, two-year combined growth number. On R&D, since the beginning of this year, has your expectations for R&D spend on the furniture side changed at all? If so, how?

Stan Askren

No, I don't think, Todd, we – the answer is no, it did not change. We're really continuing to execute the plays that we've called here in the past. We are excited about our new product development pipeline. As you recall, in the past, we put out a tremendous amount of really effective new products. Virtually all of the operating companies have done so, and so we see more of the same going forward.

Todd Schwartzman – Sidoti & Company

And if we fast-forward to two years from now, and it turns out you beat BIFMA growth for both 2014 and 2015, what do you think you would point to as the key factors there?

Stan Askren

Well, that has to do with a bunch of factors. It means that we have served our customers better than their alternative, and we've done it – so we've done it effectively, done it efficiently. And we've met the market in a way that is the most meaningful. And our objective, as you know, is always to do that very efficiently, as well. So we are focused on continuing to not only meet the market, but to do it efficiently, and to drive our cost structure, and drive our profitability up as we do that.

Todd Schwartzman – Sidoti & Company

And on the commodities side, is there anything else you'd care to highlight?

Stan Askren

No real meaningful movement, Todd, in any of the commodities. It's a pretty tame, mild inflation environment, right now.

Todd Schwartzman – Sidoti & Company

Sounds good. Thank you very much.

Operator

There are no additional questions. I'd like to hand the call back to the presenters.

Stan Askren

All right, well, thank you very much for your interest in HNI, and our performance in first quarter. We look forward to talking to you in the future. And I trust you'll have a great day. Thank you.

Operator

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

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