HNI's (HNI) CEO Stan Askren on Q2 2016 Results - Earnings Call Transcript

| About: HNI Corporation (HNI)

HNI Corporation (NYSE:HNI)

Q2 2016 Results Earnings Conference Call

July 22, 2016 11:00 a.m. ET

Executives

Jack Herring - Manager of IR

Stan Askren - Chairman, President, and Chief Executive Officer

Kurt Tjaden - SVP and Chief Financial Officer

Analysts

Matt McCall - BB&T Capital Markets

Operator

Good morning. My name is Chris and I will be your conference operator today. At this time I would like to welcome everyone to the HNI Corporation Second Quarter 2016 Fiscal 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. Herring, you may begin your conference.

Jack Herring

Thank you. Good morning. I am Jack Herring, Manager of Investor Relations. Thank you for joining us to discuss our second quarter fiscal 2016 results. Here with me are Stan Askren, Chairman, President and CEO; and Kurt Tjaden, Senior Vice President and CFO. Copies of our financial news release, earnings presentation and non-GAAP reconciliations are posted on our Web site.

Statements made during this call that are not strictly historical facts are forward-looking statements which are subject to known and unknown risk. Actual results could differ materially. The earnings presentation posted on our Web site includes additional factors that could affect actual results. The corporation assumes no obligation to update any forward looking statements made during the call.

I'm pleased to turn the call over to Mr. Stan Askren.

Stan Askren

Good morning, everyone. We will share our assessment of the second quarter 2016, provide some thoughts on our outlook for third quarter and full year 2016, and then open it up for questions.

I am very pleased with our year-to-date profit performance. We delivered a 34% increase in non-GAAP earnings per share on 5% lower sales. Gross profit has improved significantly driven by strong operational and material productivity. We are clearly realizing the significant financial returns for our investments, including our business system transformation initiative.

Our businesses are strong and we expect to deliver record non-GAAP earnings per share in 2016 while still continuing to aggressively invest and position our businesses for continued long-term profitable growth. We are on track with our goal to double earnings every three or five years and feeling great about that. So for the second quarter, non-GAAP earnings per share increased 28% on 6% lower sales. Sales results for the quarter were as we expected.

Office furniture sales were down 5%, down 7% on organic basis. Sales in the supplies-driven channel were up 1%, or down 2% on an organic basis. Sales in our other office furniture businesses which include North American contract and international, were down 11%. Our North American contract business was down 90%.

Our hearth sale decreased 8%. Strong continued growth in the new channel, the new construction channel, continued with sales increasing 8%. Sales in our hearth retail channel were down 23%. During the quarter dealers with our Majestic, Monessen and Vermont Castings brands adjusted their buying patterns and inventory levels, as a result sales of our retail non-pellet products were down 18%. So let me explain a little bit.

Our industry-leading operational capabilities provide a more efficient delivery model with better cash flow for dealers. These dealers are reducing their inventory levels and realizing the timing of their seasonal orders to the back half of the year. Our retail pellet products, which represented 4% of our sales in the second quarter, were down 52% due to the impact of warm weather and lower energy cost. So, overall, I am very pleased with our strong performance in the second quarter and first half of the year.

I will turn it over to Kurt Tjaden.

Kurt Tjaden

Thank you, Stan. Additional financial highlights for the second quarter include non-GAAP consolidated gross margin of 39.9%, was an improvement of 340 basis points versus the prior year. These results were driven by strong operational material productivity and price realization which was partially offset by lower volume.

Non-GAAP selling and administrative expenses were down versus the prior year due to cost reductions at both the operating segments and corporate, partially offset by the impact of incentive based compensation and acquisitions.

As we look to the third quarter of 2016, we anticipate consolidated sales to be up 3% to flat. On an organic basis consolidated sales are forecasted up 1% to down 2%. Officer furniture sales are expected to be up 4% to flat and organic office furniture sales will be up 2% to down 2%. Supplies-driven office furniture sales are projected to be up 6% to 9% or up 3% to 6% organically. Sales in our remaining office furniture businesses are forecast to be down 3% to 6% and sales in our North American contract business are expected to be flat to down 3%.

Hearth sales are expected to be up 3% to down 1%. New construction channel sales are forecasted to be up 6% to 9%, and sales in our remaining hearth businesses are expected to be down 3% to 6%. Within those remaining hearth businesses we are projecting retail non-pellet sales to be up 3% to flat and retail pellet sales to be down 16% to 19%.

Non-GAAP gross profit margin is expected to be approximately the same as the second quarter of this year when it was 39.9%. Non-GAAP SG&A is expected to be approximately 20.5%. So our estimate of non-GAAP earnings per diluted share for the third quarter is now in the range of $0.90 to $0.95 a share. So for the full year 2016, our current best estimate of non-GAAP earnings per diluted share is now in the range of $2.80 to $2.95 a share. We expect consolidated sales to be down 1% to 3%, in line with our prior guidance. We are forecasting office furniture sales to be down 1% to 4% and sales in our hearth business for the year is expected to be flat to down 3%.

Stan?

Stan Askren

All right. Well, thank you, Kurt. I will wrap up here. Our businesses are strong and well-positioned for the future. Our brands are competing well in their respective markets. We continue to identify investment opportunities that will deliver strong financial returns in the future. I am confident in our ability to drive long-term shareholder value.

So with those comments complete, Kurt and myself will now open it up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from Matt McCall with BB&T Capital Markets. Your line is open.

Matt McCall

So let's, maybe start with the guidance for next, or for this year and really I want to talk about it relative to what you talked about in mid-June, just before Neocon. What did you see the change there? I know there are some changes to interest expense. What debt load did you assume in the previous guidance? And I am really getting at, did anything really change on the top line or from a margin perspective, or is it mostly just the benefits of the lower interest expense that caused you to take the guidance higher from June?

Stan Askren

Well, first off, Matt, as Kurt indicated to you, our guidance for the remainder of the year and top line is consistent with prior guidance. So we are seeing the overall market kind of behaving as it did the last time we addressed this or talked about it. There is no real change there. The upgrade in the guidance is just continued strong execution, operational performance. And we are believing that it's going to continue as we go forward. I will let Kurt address the interest.

Kurt Tjaden

Yes. I don’t think interest changed, Matt, in our outlook. We refinanced our credit agreement in April and took out some private placement debt with a revolver that has lower financing, but I would say that was all incorporated in our full year, our quarter and full year guidance. So to Stan's point, it's really driven by that strong operational performance which we have seen through the first half of the year and continuing through the back half.

Matt McCall

Okay. All right. So when I think about the contribution margin, just the core contribution margin of the two segments. How should I think about them, really think about as they move out into next year? I don’t want to ask about the top line but if I think about the operating contribution margin for each of the segments and then layer in the savings from the initiatives as you quantified, can you just talk about how we should -- maybe a refresher on the timing of some of the savings might help as well. But operating contribution margin by segment, how to look at it and then how to layer in that savings and the timing of that savings?

Stan Askren

Yes. I wouldn’t think about it too differently than we have talked in the past, Matt. I would think of office furniture 25 percentage points or so that can be plus or minus a few. In hearth, we have set our leverage and hearth operational leverage in the 30% to 35% range on kind of a normalized basis. So, Matt, you are exactly right. The add is those structural cost takeouts on top of it. And I think what we have said last quarter, couple of quarters before, remains similar to today. Our outlook, we said we would start to see a modest amount of benefit here in the back half, really the fourth quarter, of 2016 and kind of 50% to 60% in 2017. About $35 million to $40 million that we had laid out at run rate by 2018. So I think it's pretty consistent with what we have talked in the past but you are thinking about how you layer that up, you are on the right track.

Matt McCall

And that 50% to 60%, will it be front half loaded, back half loaded, pretty evenly weighted?

Stan Askren

I would probably skew it more as it builds through the year, as you think about it. So that would be my direction.

Matt McCall

Okay. So a question about hearth business. That was good color on what's going on in retail. The retail pellet business still down, I am trying to make sure, I think it was the retail non-pellet business you said was facing some inventory adjustments. Is there, I guess the continued weakness overall in hearth, I know there are a lot of things working against you, the inventory now layered in. But when do you anticipate there could be some growth just looking not even changes in the market but more about changes in the comp situation and getting some of these onetime items out of the way.

Stan Askren

Next year. So experiencing strong growth in new construction channel, [like in] [ph] in that a whole lot. Interesting sort of dynamics around this supply chain destocking, whatever term you might want to use of the acquired Vermont Castings dealers, which includes Monessen, Majestic and Vermont Castings brands. So we have, one of our strengths in the hearth business is really an outstanding ability to deliver products through a manufacturing capability and a distribution capability closer to time of order. So that allows the dealers to not -- they don’t have to take early buy inventory and hope and pray it sells through. They are able to take it as they order it and that creates tremendous opportunities for improved cash flow for the dealers and we become sticker with them as well. So that’s all good.

So that’s going to work through. That should work through between now and the middle of next year, I would say. And then the other is this pellet decline. So it's a dramatic decline. It ran up dramatically. The previous 24 months are now running down dramatically. I would say we are getting down towards the bottom of where I think that’s going to sellout. That’s probably another through this burn season, so the middle of next year it should start to annualize there. And it's becoming a smaller and smaller portion of our business so it has less and less impact. So as to your question, again, is I would say the middle of next year, Matt, is when we start to see all this stuff kind of reaching equilibrium and we feel the full benefit of the new construction growth and less of the downdraft from sort of supply chain, inventory positions and the negative draft from pellet decline.

Matt McCall

Okay, perfect. And then my final question. Similarly on the contract side, you talked about flat to down 3%. We heard some decent commentary at Neocon about the project environment and maybe some strength in the back half of this year into the early parts of next year. Are you seeing anything that's consistent with that, that would lead you to believe that growth could return for that part of your business?

Stan Askren

No. Kurt provided some guidance on this. So really we are seeing and our view hasn’t changed on this. it's going to continue at the current run rates but the comps become easier and we are liking a lot of what's going on with our business there but I don’t think, Matt, we are calling anything additional up or recall anything additional down since we spoke with you last.

Kurt Tjaden

Yes. Matt, just as you think about that guidance for the year, that would imply back half on our North American office furniture businesses would be flat to up very modestly. And that’s in line, as Stan said with what we have talked about before.

Operator

The next question is from Kathryn Thompson with Thompson Research. Your line is open.

Unidentified Analyst

It's Chris calling in for Kathryn today. Just a couple of questions. One, I was hoping you could shed some light on any differentiation in demand trends for supplies versus your contract office business?

Stan Askren

Say more please. I am not sure I understand the question.

Unidentified Analyst

Well, are you seeing different products being sold to the supply segment of your business versus your contract segment of your business, or is it the same type products? Are you seeing a differentiation between the two?

Stan Askren

Nothing that we would call out.

Unidentified Analyst

Okay. And then I know you spoke about expenses earlier. I think first half corporate expenses were lower by about 18%. Is this something that we should expect to continue in the second half and how much of the cost reductions are the result of fixed versus variable expenses?

Kurt Tjaden

So I will take your corporate question first. I would expect, from a full year basis, corporate expenses to be up slightly, we have got some issues on timing. We had some big cost reductions in the back half of last year that will anniversary. Some strategic investments. Some of the things with our self insurance programs around medical and other insurance programs that move between the quarters. And then finally you think about incentive-based comp that rolls through their, predominantly around profit sharing for our members as our business profitability improves. So we would expect to see full year core non-allocated corporate to be up very modestly versus prior year. Your second question was a broader variable, fixed...?

Unidentified Analyst

Well, just if you separate -- when you look at your, the reductions you've had. Is it more fixed cost related or is it more variable cost related?

Stan Askren

Everything in our business is variable. We [haven't] [ph] owned its cost. So we don’t really separate that out in our thinking. We take cost out and we expect cost to come out and it stays out when it comes out.

Kurt Tjaden

And I would add, I will take a slightly different twist on it. If you think about structural cost, a bit to Matt's earlier question, what we have yet to see the real benefit of, is important is the structural, the big structural cost takeouts. We talked about at the beginning of this year, just starting to come in to play in the back half of the year. So there remains significant opportunity as we look out from now through the next three years to further reduce our structural cost. And we called out, back in February, again $35 million to $40 million on a run rate basis.

Stan Askren

And we feel good about that opportunity in front of us. That we haven't backed off that at all. So as Kurt said, that’s still yet to be executed and still yet to be accounted for as we go forward.

Operator

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

Unidentified Analyst

This is Bobby filling in for Budd. Congrats on another strong operational quarter. Most of my questions have already been answered but I was just curious, Kurt, can you maybe talk to us a little bit about what you're seeing from raw materials and maybe what the outlook is for the remainder of the year?

Kurt Tjaden

Yes. So...

Stan Askren

You want me to take on that? So clearly first half of the year there was some modest deflation. And as we look in the second half of the year, we will start to see that flat kind of be flat. So we won't see the same benefit. But remember, Bobby, we buy particularly steel and many of our materials on an index basis, so we tend to lag. So it's more of a 2017 and really as you start to get past the second quarter before we start to see any significant impact from a material cost increase.

Unidentified Analyst

Okay. And then is there any announced -- there's no announced plans now of a price increase but a price increase could be on the table in the typical fashion it usually is as you guys approach it in 2017, if steel does reinflate or continues to reinflate, I guess, is the better way to say it?

Stan Askren

Yes. I think you summarized it well, Bobby.

Operator

I am showing no further questions at this time. We will turn the call back to the presenters.

Stan Askren

Well, thank you so much for tuning in. We appreciate your interest in HNI and we look forward to speaking with you more in the future. Have a great day.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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