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HNI Corp., (NYSE:HNI)

F3Q10 (Qtr End 10/02/10) Earnings Call Transcript

October 21, 2010 11:00 am ET

Executives

Kelly McGriff - Treasurer and VP

Stan Askren - Chairman, President and CEO

Kurt Tjaden - Vice President and CFO

Analysts

Todd Schwartzman - Sidoti & Company

Matt McCall - BB&T Capital Markets

Josh Chan - Robert W. Baird

Mark Rupe - Longbow Research

Budd Bugatch - Raymond James

Operator

Welcome to the HNI Corporation Third Quarter Results Conference Call. At this time, all participants are in a listen-only mode. Later, there will be a question-and-answer session with instructions given at that time. (Operator Instructions) As a reminder, this conference is being recorded.

At this point, I would like to turn the meeting over to our host Mr. Kelly McGriff. Please go ahead.

Kelly McGriff

Thank you for joining us today for the HNI Corporation conference call to discuss third quarter 2010 results which were announced yesterday after the market closed. My name is Kelly McGriff, 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 also posted a presentation intended to accompany this call to our website. The presentation contains details of our financial performance, including the non-GAAP to GAAP reconciliation. It can be found by accessing the webcast link under the Investor Information section of our website. We encourage you to review this presentation.

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

Before we begin, please be; 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 known to – are subject to known and unknown risks. Actual results could differ materially from expected results. Additional information concerning factors that could affect 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 this call.

I now have the pleasure to turning the call over to Stan Askren. Stan?

Stan Askren

Double digit growth in the office furniture contract and international business contributed to our 3% increase in sales over third quarter 2009. Weak small business confidence during the quarter impacted our supply driven channel. We’re the only major office furniture company to participate in the full spectrum of the office furniture market. In the third quarter we saw very different result across the segments. Our contract and international business driven by large projects continue to experience strong results with top line growth of nearly 12%. The supply driven channel was down 2% over prior year impacted by weak small business confidence, we think, a reflection of the pace of the economic recovery and political uncertainty around taxes and healthcare.

Overall sales in the hearth segment were slightly below last year. The hearth new construction channel was down 6% in the third quarter negatively impacted by the continued pressure in the housing market. The hearth remodel-retrofit channel was up 2.5% reflecting cautious consumer demand and moderate energy prices. That said, I remain upbeat about the future of our hearth business. We’re on track for significant improvement from 2009 and it will be profitable for the year.

I’m going to let Kurt review some of the specific numbers for the third quarter. Kurt?

Kurt Tjaden

For the third quarter 2010 consolidated net sales from continuing operations increased 2.8% to $459 million. Sales for the office furniture segment increased 3.5% to $387 million. Net sales for the hearth product segment decreased 0.8% to $71 million. Consolidated gross margins, including restructuring and transition charges decreased to 35.1% which compares to 36.9% in the prior-year quarter.

Total selling and administrative expenses as a percent of sales including restructuring and impairment charges improved 0.9 percentage points. Second quarter 2010 included $700,000 of restructuring and transition costs, which were associated with the shutdown and consolidation of office furniture facilities. This included accelerated depreciation and transition cost of $1 million which was recorded in cost of sales net of $300,000 reduction in restructuring expenses.

The effective tax rate for the third quarter 2010 was 44.6% which compares to 33.7% in the third quarter of 2009. This increase is primary due to expiration of the research tax credit in 2010 and a reduction in the anticipated capital gain from the sale of a closed manufacturing facility which negatively impacted our projected capital loss carry forward utilization. We ended the quarter with $72 million of cash and generated $49 million of cash during the first nine months compared to $136 million in the prior year.

That wraps up the financial comments for the quarter. I’ll turn the call back over to Stan.

Stan Askren

So looking forward, we expect continued strong results in the contract business. Discounting pressures remain yet our contract brands are performing well and represent outstanding value proposition. Our operational excellence combined with strategic investments in new products, programs and distribution are key drivers for continued growth.

We continue to see significant improvement in our international business particularly in China where we realized significant growth. Our investments in new products organization and go to market capabilities have positioned this business for continued strong growth in the future.

We believe our initiatives in the supplies driven channel will drive near term growth despite the challenges with small business confidence. We’re transforming the value price transactional business with new products, marketing the fulfillment programs. We’ve enhanced our selling resources and e-business capabilities to drive business through our dealers and channel partners.

In addition, we remain focused on accelerating growth in the government and education vertical markets. The hearth business will be profitable for 2010. Even with the modest decline in the sales, we’re anticipating significant profit improvement. We continue to strengthen our industry leading market position through investments in new products, marketing programs and distribution models. This business is strategically positioned to generate strong financial results as the market returns.

Our strategy is split and focus with leverage drives the broadest and deepest coverage across the industry. We’re uniquely positioned to benefit from our multiple growth platforms going forward.

So, Kurt will share the financial outlook for the fourth quarter.

Kurt Tjaden

For the fourth quarter of 2010, we anticipate overall sales from continuing operations to be up 10 to 12%. Fourth quarter 2009 included $8 million of sales from discontinued operations with $6 million in the office furniture segment and $2 million in the hearth segment.

Office furniture sales are expected to be up 13 to 15% with growth in both the supplies driven and contract channels. Sales in the supplies driven channel are expected to increase 7 to 10% and we see momentum continuing in the rest of our office furniture businesses with sales up 18 to 22%. Hearth sales are expected to be flat to up 2% driven by seasonality and the remodel-retrofit business which is tempered by continued pressure in the housing markets.

Excluding restructuring and transition charges gross profit margin is expected to decrease approximately 2.2 percentage points versus fourth quarter 2009 when it was 37%. Fourth quarter 2010 is expected to include $800,000 of restructuring and transition cost which compares to $2.2 million in the prior year quarter. Excluding restructuring and transition charges, SG&A as a percentage of sales is expected to decrease approximately 2.1 to 2.6 percentage points compared to 32.3% in the fourth quarter 2009. We anticipate SG&A related restructuring and transition cost to be approximately $400,000 in the fourth quarter and these charges relate to the shut down of previously announced office furniture facilities.

Fourth quarter profitability will be negatively impacted by the following factors. Fourth quarter 2009 included one-time inventory adjustments of approximately $5 million which were primarily related to reduction in LIFO reserves which was driven by the significant decrease in inventory levels last year. We are projecting a negative price cost gap of 6 to $7 million in the fourth quarter of 2010 versus the fourth quarter 2009. Price increases we implemented in the third quarter will fully offset input cost increases. However, discounting and customer mix primarily government and large projects will negatively impact the quarter.

We do expect our previously announced pricing actions combined with further input cost reductions to close the price cost gap during the first quarter 2011. We continue to reinvest a portion of our cost reset savings to focus strategic growth initiatives across our businesses. Total investment spending for the fourth quarter is approximately $5 million.

Net interest expense for the quarter is projected to be $3.1 million and the effective tax rate for the fourth quarter is projected to be approximately 39%. Capital expenditures will be approximately $30 million primarily focused on new products. For the year, we continue to expect to generate free cash flow in excess of $80 million and we’ll end the year with approximately $110 million of cash on the balance sheet.

That summarizes our outlook for the fourth quarter. I’ll now turn the call back to Stan for closing comments.

Stan Askren

I remain optimistic about the office furniture and hearth markets. I’m confident our investments in selling, marketing and products initiatives will continue to drive improvements across the businesses. We see sales momentum continuing in the contract and international business and expect near term growth in the hearth and supplies driven channels as well. We remain focused on improving operations reducing costs and generating cash. Our business is financially strong and well positioned for growth.

With those comments complete, I’ll now open it up to questions.

Question-and-Answer Session

Operator

(Operator’s instructions) Our first question will come from the line of Todd Schwartzman with Sidoti & Company.

Todd Schwartzman - Sidoti & Company

On the office furniture side, adjusted for the seasonal bump in Q3, did the contract business meet your internal expectations?

Stan Askren

Yes

Todd Schwartzman - Sidoti & Company

Did it exceed your expectations?

Stan Askren

No, we’re right along.

Todd Schwartzman - Sidoti & Company

Got you and I don’t know if you’ve mentioned this, but discounting for the quarter, how much did that cost you in way of revenue?

Kurt Tjaden

Discounting for the quarter Todd, it was somewhere between discount and mix was about $4.5 million negative.

Todd Schwartzman - Sidoti & Company

Thanks guys.

Operator

We’ll move on to the line of Matt McCall with BB&T Capital Markets.

Matt McCall with BB&T Capital Markets

Let’s see, so first on the guidance Kurt, you gave I think a true comp on the top line, what was that true comp I think we have to adjust for some discontinued ops, what’s the revenue comp you’re using?

Kurt Tjaden

I think it’s already adjusted for that Matt. So the numbers that we gave for guidance that 10 to 12 for overall and 13 to 15 already included all of the discontinued ops.

Matt McCall with BB&T Capital Markets

So what’s the dollar comp, I guess I’m trying to make sure I’m putting that growth on the right revenue number.

Kurt Tjaden

Yeah, well fourth quarter ‘09 you need to back out $8 million out of sales.

Matt McCall with BB&T Capital Markets

For the original.

Kurt Tjaden

Six of that was in office furniture and two of that was in the hearth segment.

Matt McCall with BB&T Capital Markets

Okay, okay, that was the, I just missed that, okay. If my calculations, my quick calculations are correct, the midpoint to top line is not far from what you just reported, yet your SG&A midpoint seems a little bit higher than what you just reported, can you help me connect the dots there as to why it be seems some SG&A de-leveraging?

Kurt Tjaden

You know part of that is the lumpiness that we’ve talked about Matt in those investments in selling and marketing and the other thing you probably got some timing of expenses between quarters, but really nothing else of significance.

Matt McCall with BB&T Capital Markets

So, as I look at it from a dollar basis, how should we treat SG&A, I think it sounds like there is some opportunity on the gross margin lines moving to Q1 relative to the price cost arena, what about the SG&A line, how do we look at that as we approach ‘11 estimate?

Kurt Tjaden

I think one we’re still working through our 2011 estimates. Our objective on SG&A is as we think of those investments is to fund that incremental way. You fund that internally and offset through cost reset actions. So over time we would expect to see that kind of neutral lines, there is going to be some lumpiness in the quarters.

Matt McCall with BB&T Capital Markets

Okay, and just to clarify that $5 million in investment, is that an incremental spend relative to a year ago, I think you broke that out for Q4, I guess two parts, the first part is, is that incremental spend and then was that, was a similar amount spent in the Q3?

Kurt Tjaden

Yes, I’ll start backwards, those are similar amounts to what we spent in the third quarter and we estimate it’s 2 to $3 million of that is incremental in the fourth quarter that, and we were able to offset part of that with cost savings.

Matt McCall with BB&T Capital Markets

Okay, and then Stan, maybe for you on the supply side, you’re forecasting a little bit of growth, it’s kind of the same question I have asked, as last quarter, how, you referenced some of these internal initiatives and maybe that’s what Kurt is referencing with the spending. The small business environment seems to be still pretty weak, is it easy comp story, is it just anticipated success from some of these initiatives, help me understand how supplies can be growing in this environment?

Stan Askren

Good question. You are on a key point here which is, first off, it’s choppy, okay. If you look at kind of where we come from, second quarter was strong, third quarter was not a strong. We saw small business confidence kind of strengthened earlier in the year and kind of take a dip here mid part of the year. We are not really forecasting small business confidence to move in a big way. So, what we are showing, what we are talking about is the traction that we are getting, that we are seeing in conversations in the market around our strategic investments, in things like new products in or strong emphasis on the entry level transaction business and investment in dealers, investment in selling resources, and investment in sort of our e-business, side of the market and then investment in vertical market.

Then finally we do have math, a bit of an anticipated, a bit of a pick up. We’ve announced price increase in that segment of the market effective the beginning of 2011. I’d anticipate that we’ll see some pull ahead in orders which is typically what we see and we’ll get some benefit of that as well.

Matt McCall with BB&T Capital Markets

Final question, the projection for contract up 18 to 22%, can you talk about the opportunity to continue that level of growth, is there a big buckle of build from some, from several large projects, or is this something that you see is just this level of growth or level of top line performance as sustainable as we move into ‘11?

Stan Askren

The last question is a great question about how sustainable is this. We right now feel good about the activity we see. It’s coming from multiple areas. So a) we’re seeing a lot of real estate churn, a lot of cost reset around occupancy cost which drives furniture events. Federal government is very strong large projects, some pent-up demand that is breaking loose and then segments of the market, customer types that we’re seeing some growth. Where that goes in 2011 is tough to forecast at this point. We feel good about what’s in front of us today. One of our guys sort of characterize, we have our people on the tallest map of the ship with binoculars looking for trouble and we have yet to see it, but we are always running multiple scenarios and making sure we’re prepared for up, flat and down.

Matt McCall with BB&T Capital Markets

Okay, thank you guys.

Stan Askren

You do, Matt.

Operator

We do have a question from the line of Peter Lisnic with Robert W. Baird.

Josh Chan - Robert W. Baird

This is Josh Chan filling in for Pete. First question on the supply driven channel, why was it below your forecast, now looking backwards, was it deterioration late in the quarter or was it inventory de-stocking, could you give us some color on that?

Stan Askren

Sure Josh. So, I remind you that is a very short selling sort of cycle business Josh. The second thing is the latter part of the, actually September is our biggest sort of month for sales and for profit. So, what we saw is we had announced a price increase in that business and typically we’ve got a large set of orders and so then you kind of wait and hold your breath to see what fills in when once you kind of work through that long. During that period small business confidence, the economy started to slide sideways and I think that’s where we end up today with numbers that were less than we anticipated.

Josh Chan - Robert W. Baird

So, was it sort of a deferral of order in our delivery intake?

Stan Askren

Small businesses operate at small orders very short selling cycle. So is it deferral or is it, avoid it’s tough to tell Josh.

Josh Chan - Robert W. Baird

On the pricing environment, I think you talked about pricing being negative on a year-on-year basis. Do you think industry pricing has at least stabilized on a sequential basis or are you still seeing incremental deterioration in pricing?

Stan Askren

We think, first off the pricing deterioration to a large extent have to do with the size of the projects or the mix of the size of the projects. Pricing hasn’t deteriorated on a project-by-project basis; it’s just that the industry is running more large projects and less day-to-today business. To answer your question specifically, we think it’s stabilized and don’t anticipate further deterioration with that framework set.

Operator

We’ll move on to line of Mark Rupe with Longbow Research.

Mark Rupe - Longbow Research

Hi, guys. Just wanted to make sure I’m clear on the supplies channel performance relative to what you initially thought. Did you guys put to a price increase in that July, early July timeframe?

Stan Askren

Yes.

Mark Rupe - Longbow Research

So that, was there could have been pull forward index to 2Q I assume?

Kurt Tjaden

Significantly.

Mark Rupe - Longbow Research

Okay. So that would explain some of it, but there were still probably strong patterns through early July for you guys to think that 5 to 7 was still adequate?

Kurt Tjaden

Correct

Mark Rupe - Longbow Research

Okay. So, I mean, then ending kind in the September period and October period, I have to assume with 7 to 10% even despite the pull forward may be anticipate for first quarter that demand came back?

Stan Askren

The market activities or market buzz or conversations with dealers and our channel partners would indicate that we will see better activity in that channel.

Mark Rupe - Longbow Research

On the contract side, obviously, great growth outlook, just would love any kind of color you could provide on kind of the flow of some of the larger project activity may be since July 1st and where we are today?

Stan Askren

Yeah, it was kind of steady I guess Mark and certainly in the government buying season you see a pretty intense activity around kind of their budgeting cycle. We are well positioned there with our companies and their value proposition and so it’s kind of across the board sort of activity. Our international business, our China business is very, very strong as well and that’s in those numbers and that continues, has been stronger from the beginning and continues to be strong now.

Mark Rupe - Longbow Research

Okay, and China represents again of that business?

Stan Askren

It’s about 5% of our total business.

Operator

Now we’ve a question from the line of Budd Bugatch with Raymond James.

Budd Bugatch - Raymond James

Just a couple of questions, most of them have already been asked. Any chance of getting an idea of the orders for contract in the quarter, I realized the short selling cycle of the supplies driven makes that less relevant, but what about contract orders and backlog?

Stan Askren

We don’t disclose that Budd. The activity has been strong and remains strong.

Budd Bugatch - Raymond James

Government for your last year was at about $70 million total, U.S government, is that about the right number?

Stan Askren

Total state and federal government is more along the lines of 300, 290 I think is probably closer to the number of last year.

Budd Bugatch - Raymond James

I was thinking U.S government is 70, but-

Stan Askren

It’s about half and half, Budd.

Budd Bugatch - Raymond James

Okay, all right. On the idea of on the hearth side, one of the things that I find curious is your hearth business actually gets better in the fourth quarter when building is seasonally weakest which tells me that the mix of that business changes as you get through the year. Can you kind of shed some color on the way that business flows?

Stan Askren

Yeah, it’s a good observation and a good question. Our mix of that business has changed dramatically with the housing, new construction site down and with the new remodel retrofit or the bio-fuel heating business up. Our mix is more along the remodel retrofit these days of 70%, new constructions like 30%, used to before the housing crash it was the inverse of that. What you are seeing is just really heating season. So around here we pray for a really big nationwide cold snap. I mean everybody needing a heading fuel appliance and that’s what we’re counting on here.

Budd Bugatch - Raymond James

So that’s part; that’s in your guidance thinking that we’re going to have a cold winter.

Stan Askren

No, our guidance is-

Budd Bugatch - Raymond James

I don’t want to forecast weather.

Stan Askren

The normal sort of law, no we don’t forecast weather.

Budd Bugatch - Raymond James

It was $5 million about, your results this quarter about $5 million below in hearth than you expected, I mean that’s just really all new construction?

Stan Askren

It’s both, its new construction and just a slower retail market than we anticipated when we put out that projection last time.

Budd Bugatch - Raymond James

That’s because that’s a high average ticket, what’s the average ticket for the consumer in that side of the business?

Stan Askren

Couple of thousand dollars.

Budd Bugatch - Raymond James

Okay. All right, well good luck on the fourth quarter and into 2011.

Operator

(Operator instructions)

Stan Askren

Okay, well thank you very much for your interest in HNI and we look forward to talking with you in the future. Have a great day.

Operator

Ladies and gentlemen, this conference will be made available for replay after 12 noon today through October 28 at midnight. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 173126. Those numbers again are 1-800-475-6701, with the access code 173126. That does conclude your conference for today. We appreciate your participation and you may now disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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