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HNI Corporation (NYSE:HNI)

Q2 2014 Earnings Conference Call

July 17, 2014 11:00 AM ET

Executives

Matthew McGough - VP, Corporate Finance

Stan Askren - Chairman, CEO, and President

Kurt Tjaden - VP and CFO

Analysts

Todd Schwartzman - Sidoti & Company

Josh Borstein - Longbow Research

Budd Bugatch - Raymond James & Associates

Operator

Good morning. My name is Sally, and I will be your conference operator today. I would like to welcome everyone to the HNI Corporation’s Second Quarter Fiscal 2014 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions) As a reminder, today's conference call is being recorded. Thank you. Mr. McGough you may begin your conference.

Matthew McGough

Good morning, my name is Matthew McGough, Vice President, Corporate Finance. Thank you for joining us for the HNI Corporation conference call to discuss the second quarter fiscal 2014 results announced yesterday after market close. Copies of our financial new release and earnings presentation including non-GAAP reconciliations have been posted to our Web site, www.hnicorp.com. Joining me today from HNI Corporation are Stan Askren, Chairman, President and CEO; and Kurt Tjaden, Vice President and CFO.

Statements made during this call that are not strictly historical facts are forward-looking statements. Forward-looking statements are subject to known and unknown risks. Actual results could differ materially from expected results. The earnings presentation posted on the HNI Corporation Web site includes additional factors that could affect actual results. 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.

Stan Askren

Good morning. In summary, it was another strong quarter. We executed well and delivered good results. I’m pleased with our operational execution and investment returns, which drove second quarter profit improvement. Core office furniture profitability improved over 30% on a relatively flat sales. Sales on our supplies channel driven business improved 2% in a soft demand environment. As expected, organic sales in our other office furniture businesses were down 5% due to strong year-over-year comparisons and timing of large projects.

Our hearth business continues to deliver excellent performance. Operating profits increased 49% on 15% sales growth, sales in the new construction channel remained strong with 13% growth, remodeled retrofit sales improved 18% led by a significant increase in biofuel product sales. Finally, as part of ongoing efforts to reduce structural costs, we decided to consolidate two office furniture facilities into existing facilities. These decisions have an attractive financial return with payback in less than two years. Overall, I feel good about our second quarter results and momentum heading into the second half of 2014.

I’m going to turn the call over to Kurt, and he’s going to cover the financial data for second quarter, third quarter, and the remainder of the year, Kurt?

Kurt Tjaden

Thank you Stan, so for the second quarter 2014, consolidated net sales decreased 0.3% to $509 million or increased 1.3% on an organic basis. Sales for the office furniture segment decreased 3% to $423 million or 1.1% on an organic basis. Net sales for the hearth product segment increased 15% to $86 million. Consolidated gross margins including restructuring and transition charges improved to 35.6% compared to 34.2% in the prior year quarter. Increased price realization, strong operational performance, and higher hearth volume were partially offset by lower volume and increased restructuring and transition charges in the office furniture segment.

As a percent of net sales, total selling and administrative expenses increased 2.9 percentage points, due mainly to restructuring and impairment charges and increased incentive based compensation. In connection with the office furniture consolidations, $4.8 million of restructuring and transition costs were recorded in the second quarter. We expect to save approximately $8 million annually beginning in 2015 from these consolidations. In addition, we recorded a pre-tax goodwill impairment charge of $8.9 million. We ended the quarter with $29 million of cash. Operating activities used $7 million of cash in the first six months of 2014, compared to $18 million of cash in the same period last year.

So let me shift now to the financial outlook for the third quarter and the full year 2014. So for the third quarter 2014, we anticipate overall sales to be up 2% to 6%. Office furniture sales are expected to be up 2% to 6% organically or up 1% to 5% including the impact of divestitures. Organic sales in the supplies driven channel are expected to be flat to up 4%. Organic sales in the rest of our office furniture businesses are expected to be up 4% to 8%, and our hearth sales are expected to be up 9% to 13%.

Non-GAAP gross profit margin, excluding restructuring and transition charges is expected to be modestly higher than third quarter 2013 when it was 35.3%. Non-GAAP SG&A as a percentage of sales, excluding restructuring and transition charges is expected to be slightly higher versus third quarter 2013 due to timing of expenses and higher incentive-based compensation. Last year, it was 27.3%.

For the year, we are expecting capital expenditures to be $90 million to $95 million, and free cash flow defined as operating cash flow minus capital expenditures and capitalized software is projected to be $65 million to $70 million for the full year. Our estimated range of non-GAAP earnings per diluted share excluding restructuring and transition costs for the third quarter is $0.68 to $0.73. For the full year, we are narrowing our estimated range of non-GAAP earnings per diluted share to $1.75 to $1.85, which excludes restructuring and impairment charges, transition costs, and the gain loss on sales of assets. Stan?

Stan Askren

Okay. Thank you, Kurt. We will wrap this up here. We remain confident in our strategies to drive profit improvement, while simultaneously investing for long-term profit growth. We entered the third quarter with good momentum across the businesses and remain on-track to grow sales and significantly increase profits in 2014. So, with those comments complete, we will now open the session up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Todd Schwartzman with Sidoti & Company. Your line is open.

Todd Schwartzman - Sidoti & Company

Hi, good morning guys.

Stan Askren

Good morning, Todd.

Todd Schwartzman - Sidoti & Company

Could you speak to the order trends in furniture for the quarter by project, contract business as well as continuing business?

Stan Askren

So, let me make sure I understand the question, Todd. Do you want us to talk about projects in contract versus non-projects or contract versus non-contract?

Todd Schwartzman - Sidoti & Company

Well, contract and non-contract individually. Within each of those, what was the pacing like as the quarter progressed?

Stan Askren

Okay, I think I understand. Yes, so as kind of we indicated when we talked to you last, sales in the supplies driven business improved 2% in a soft demand environment. That business basically tracks the overall economy more tightly tied to small business confidence. And so, what you are seeing is, I recall, modest slow improvement in small business confidence that then translates to the supply driven. Then in the other office furniture businesses, which contract is the large percentage of that, we saw at the beginning of the quarter slower type, some delay, and now we see that picking up and it’s basically tracking as we thought the business is improving modestly.

If you look at last quarter, we were down 5%, but it’s primarily driven by really strong year-over-year comparisons, timing of overall business, and large projects. Now what we are saying for the third quarter is that we are going to see modest single-digit improvement there, again I think consistent with what we are seeing in the overall economy is slow, modest growth in employment, new construction, corporate profitability, architectural billing index, those sorts of factors. I don’t know if that helps you or not Todd.

Todd Schwartzman - Sidoti & Company

Yes, yes it does. Thanks and maybe I did miss at the beginning of some of the opening remarks, but did you speak to verticals yet as far as the contract business, I am curious about the GSA and just even on the commercial side, if you called out any relative winners and losers?

Stan Askren

We did not break that out, Todd.

Todd Schwartzman - Sidoti & Company

Was there anything of note?

Stan Askren

No, it’s really kind of the same as we indicated. Central Government is down a little bit, becoming a small percentage. K-12 is kind of tracking the rest, modest, sort of flattish type of business, and the rest is kind of tracking the overall trends that I just talked about.

Todd Schwartzman - Sidoti & Company

And the gross margin guidance for Q3, I believe you said a little higher than last year’s 35.3. What are the factors that lead you to guide down sequentially from the June quarter?

Stan Askren

From quarter-to-quarter, Todd, you are talking Q2 to Q3?

Todd Schwartzman - Sidoti & Company

Right, so Q2, is it 36.3.

Stan Askren

Yes.

Todd Schwartzman - Sidoti & Company

Right, so…

Stan Askren

So, I think sequentially you would expect to see a similar number, and you are going to have puts and takes on a sequential basis on expenses and timing of things, but continued good progress I would say overall as we look out on gross margin on the investments that we have laid in, in operations over the last 18 to 24 months.

Todd Schwartzman - Sidoti & Company

So, you are suggesting that a good portion of that guidance for that margin contraction is seasonal?

Stan Askren

Yes, that would be a piece of it. But you’re talking sequentially we’d expect it to be about the same.

Todd Schwartzman - Sidoti & Company

So, your reference point for the guidance, was that Q2 of ’14 or was that Q3 of ’13 from your perspective?

Stan Askren

Q3 of ’13, our guidance is always versus prior year quarter, which we said we expected it to be modestly higher than the last year same period.

Todd Schwartzman - Sidoti & Company

And last year, Q3 was some 70 basis points higher than Q2, I am just trying to see if there was some noise going on a year ago or there is some change that’s in progress?

Stan Askren

I don’t think anything is substantive from a change, Todd, so I would call it noise and timing of expenses, if anything.

Todd Schwartzman - Sidoti & Company

Got you. And lastly the gross margin performance for Q2 is better than I expected, did you rank or allocate its contribution of each of the factors that you called out that contributed to that margin?

Stan Askren

No, I mean it really goes back to when we said it’s a result of price realization, really strong operational performance, and then higher hearth volume, and then we had some detracts from there around some lower volume in the office furniture, and then increased restructuring transition charges in the office furniture segment, so lots of things contributing to that.

Todd Schwartzman - Sidoti & Company

And one more there if I could, non-res construction, what are you seeing at this point across the country?

Stan Askren

Well, I think we see it continuing to grow nicely. Now I think everybody who tracks it is forecasting it will be down a bit, but it’s still strong double-digits, and we’re in a great spot in the hearth well aligned with large builders, and so we should benefit well from that. We don’t see a big departure from what we have been thinking and saying up to this point.

Todd Schwartzman - Sidoti & Company

Great, thank you.

Operator

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

Josh Borstein - Longbow Research

Hi gentlemen, thanks for taking my questions here. Just to touch on a question, Todd asked just to make sure I understand, the progression of the quarter as it played out in office furniture you saw, it grew as the quarter progressed, so as you exited you saw the strongest strength in terms of orders. Is that right?

Stan Askren

Yes, I would say that it is correct, but not -- I don’t want to over state that, not in a huge way. Just coming out of the winter, that cold spell still had a little bit of lag and then it began to accelerate, and then I think we have reached a normalized plain, and we have given you as I think the guidance of where we think that’s going to go.

Josh Borstein - Longbow Research

And staying on office furniture, I know the comparisons were difficult in North American contract last year, but if you look at the growth rate in office from say 2Q ’12 to 2Q ’14, it’s about 1% to 2%. So even with the difficult comparison, did office furniture sales come in lower than your internal expectations?

Stan Askren

No. They haven’t, and if you break it down, there is lots of ups and downs and timing of things moving around, but we’re performing as we thought. We think we’re performing well, vis-à-vis the markets on an organic basis. If you focus on North America, I think we’re competing very well.

Josh Borstein - Longbow Research

Okay, great. And just to touch on a question I asked last quarter, I asked you about whether you thought there was an inflection point in office furniture. Do you feel any differently, three months later than you did last quarter and specially considering how you can see through some these weather related impacts?

Stan Askren

No, it’s playing out Todd, like we thought it was going to play out. First quarter, we had some noise, second quarter a little bit. But, I do not see any major tab lift or point of inflection that’s going to change our view of office furniture. I think we’re in for slow, relatively steady, consistent growth, and until the economy decides to kick it in gear here, I think that’s the mode we’re going to be in.

Josh Borstein - Longbow Research

Okay. And then just one final one from me, can you talk a little bit about what you’re seeing internationally in your key markets, for example any other reforms in the PRC have had an impact or with selections in India?

Stan Askren

Yes I think those are great questions. Certainly as we look in China and India are two of our primary focuses international. Hong Kong is relatively slow the real-estate market there is relatively flat. That’s a major sort of catalyst for change. PRC, the reforms there around sort of spending with a lot of the government related businesses has put a bit of a damper, like we see that business picking up the second half as well. But that market is slower than it has historically been still we believe a great market to be in and we will be a major growth area for us as we go forward. India is interesting, the run up to the election put a slowdown and damper on that overall economies. I have been there recently, there is tremendous confidence in the election of Modi and tremendous believe that the business reform, the government reform is going to be a major catalyst for that market but I would say that is yet to play out and is most likely going to take longer than most people believe. So, to net all that out it’s like it’s relatively muted or not a high growth, one of those environments now when we think as we go forward, we are going to see continued acceleration in growth in those businesses. Not counting on a lot here for the remainder of the year, some modest improvement in the second half but not factoring in big time growth in either one of those markets.

Josh Borstein - Longbow Research

I appreciate it. Thanks for the color and good luck on the rest of the year.

Operator

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

Budd Bugatch - Raymond James & Associates

Thank you for taking my questions. I have a little bit of a longer-range question, just make sure that we are looking at the model right because we have now the growth in -- is the phone okay? Because it sounds like we are getting a little bit of feedback?

Stan Askren

Yes, you are fine, Budd. We hear you fine.

Budd Bugatch - Raymond James & Associates

Okay. We have seen the growth now in hearth and the recovery. The way our model looks at it and the way it is historically, hearth peaks in the fourth quarter and office peaks in the third quarter. Is that still the way you think about it in terms of revenues?

Stan Askren

Yes, I think if you look at historic norms that is in fact still the case as we look at going forward. As you know Budd, sometimes we get quarterly the events, seasonality or something taking place within that but I think for your model purposes that’s still a good assumption.

Budd Bugatch - Raymond James & Associates

And consolidated revenue still higher in the third than in the fourth?

Stan Askren

Yes.

Budd Bugatch - Raymond James & Associates

Okay. And now as we think about hearth going forward, we are not going to have the same kind of consistent high growth rates, I mean that’s got to moderate as we look into 2015 and beyond, does it not, what is your thinking about that?

Stan Askren

Well, I never accept that with the management team in organization but I think because of what your view is single family starts along with weather and fuel prices, so if you believe that starts are going to continue to go at a healthy rate then we are in a very good position to benefit fully, to participate fully in those improvements. If you don’t believe that then those numbers should be moderated down but we still believe that there is a lot of runway here for hearth top-line and hearth bottom-line improvement.

Budd Bugatch - Raymond James & Associates

So, if we pause at a 15% growth rate in hearth for next year that doesn’t seem out a range to you?

Stan Askren

It depends on what your assumptions are around how fuel and weather but I am trying to evade the exact precision of questions but if economy improves and housing improves that’s probable.

Budd Bugatch - Raymond James & Associates

That’s my working assumption I would hope that’s yours as well but I am going to ask the question.

Stan Askren

Yes, you are very harmful at this. The answer is yes, we continue to be optimistic about single family housing starts which are the primary driver and we continue to be optimistic about our market position and our performance for our customers and we continue to believe that leverage of 30% to 35% on that cost structure is achievable there. So, if you buy all that then your conclusion fits mine.

Budd Bugatch - Raymond James & Associates

Okay, I mean it’s hard to asking a lean company this question but what’s the kind of capacity constraint in hearth now, is there one or where do we, we are not back to anywhere near the peak volume but we have changed the structure of the business.

Stan Askren

Yes, there is not any capacity constraints that’s going to require significant structural cost at, is the answer to your question. And that’s why this 30% to 35% leverage we think is there, so I believe I was asked this question last round and I answered somewhere around, we are probably at 60% to 65% capacity. But you know this, Budd, we are not a steel mill or a chemical processor, you can add capacity pretty economically and you can buy it in manageable chunks and so we can keep that going.

As far as bricks and mortar, I think we are in good shape for some time to come and you said it our lean thinking and a lean process, we are constantly finding ways to better platform product to better flow product, to find better uses of floor space to design equipment that will operate and function in smaller footprint and on and on and on, faster I guess. So, we feel like we are in a good shape on capacity for the foreseeable future at hearth.

Budd Bugatch - Raymond James & Associates

Okay. And in office, again we think with non-res construction, the project business space fairly good in the next year. What about the supplies business? What are the factors underlying that other than the economy? Is that really the key driver for supplies in 2015?

Stan Askren

It really is Budd I mean it has to with small business components and people that run that actually that, I believe when you look at the numbers are predominant employers in this country, it’s their level of confidence in their business and their future prospects and therefore their desire and their ability to invest in the future which to a large extent has to do with people and then that drives back to where we meet the market. So that’s the primary driver, is just the overall sort of prospects of small business in this country.

Budd Bugatch - Raymond James & Associates

So Stan, last question for me, are there any red flags out there that are worrying you in either of the segments into 2015?

Stan Askren

The answer is but we feel the same as we have in the past, the answer is no, I don’t today see any red flags other than the normal risk that we deal within running the business and the overall challenges. There’s no big event that I can see out there that’s going to alter our course and our thinking about where this business is going.

Budd Bugatch - Raymond James & Associates

Okay, terrific, well thank you very much.

Operator

There are no further questions at this time, Mr. McGough I’ll turn the call back over to you.

Stan Askren

Okay well this is Stan Askren and we appreciate your interest in HNI, thanks so much for joining us and we look forward to talking to you in the future, good day.

Operator

This concludes today’s conference call, you may now disconnect.

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