HNI's (HNI) CEO Stan Askren on Q3 2016 Results - Earnings Call Transcript

| About: HNI Corporation (HNI)

HNI Corporation (NYSE:HNI)

Q3 2016 Results Earnings Conference Call

October 20, 2016, 11:00 AM ET

Executives

Jack Herring - Manager of IR

Stan Askren - Chairman, President and CEO

Kurt Tjaden - SVP and CFO

Analysts

Budd Bugatch - Raymond James

Kathryn Thompson - Thompson Research Group

Operator

Good morning. My name is Christi and I will be your conference operator today. I would like to welcome everyone to the HNI Corporation Third Quarter 2016 Fiscal Results Conference Call. [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 third 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 website.

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 website 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 third quarter 2016, provide some thoughts on our outlook for fourth quarter 2016, and then given you a brief look at 2017 and then open we’ll open the call up for questions.

First of all let me step back provide some perspective on our performance year-to-date. Profit performance through the first half of 2016 was strong. We delivered a 35% increase in non-GAAP earnings per share on 5% lower sales. Then in July we provided earnings guidance for the third quarter of full year 2016 and we expected a slightly improving economy based on the trends and activity level seen at that time.

This included modestly strengthening financial markets, continued growth in single-family housing starts and a bottom of the hearth retail pellet market. What developed during the third quarter particularly in the latter half of the quarter was different than we anticipated. We saw board-based step down across our markets, businesses, channels and product categories which then did not bounce back in the quarter. This led to significant lower quarterly results than we originally projected.

Despite the recently choppiness however we remain focused on the long term. I feel good about what we’re doing and believe we continue to complete well. And let me add additional color here. We then focused on streamline our business and taking up our portfolio really sharpening our focus on the business.

This includes simplifying business, product lines and business processes. In fact in some cases we’ve been willing forego top line growth to drive bottom line improvement. Our results include office furniture operating margins increasing more than 350 basis points over the past three years in a relatively slow economic environment. We’ve also achieved margins in hearth business exceeding previous peak levels by 350 basis points.

At the same time we’re doing all this we also improved our competitive position within our core markets while also continue to significantly invest for the long term. We’ve built a strong foundation for future profit growth and long term shareholder value creation. Our operation performance remains strong while we continue to significantly transform cost structures and capabilities, we continue to make progress of our business system transformation initiative, we achieved a significant milestone this quarter, we successfully brought up two additional office furniture companies on the new enterprise system.

[BLC] [ph] is one of the largest initiatives the company has ever undertaken as a critical enabler to our long-term profitable. We remain on track with our previously announced plan to deliver 35 to $40 million of structural cost savings by 2018. Related to this we recently announced the consolidation of an Indiana office furniture manufacturing facility into other HNI manufacturing operating.

This move is expected to deliver more than $7 million of annual savings to bring our total announced annual structural savings to $16 million. We continue to work with several other significant transformation initiatives. I am confident; we remain focused on the right opportunities to drive long-term profitable growth.

So with those comments I’ll now turn the call over to Kurt Tjaden. Kurt?

Kurt Tjaden

Thank you, Stan. For the third quarter non-GAAP net income per diluted share was $0.80 compared to the third quarter of 2015 when it was $0.93. Consolidated net sales decreased net sales decreased 5.1%, to $585 million or down 6.6% on an organic basis. Sales for the office furniture segment decreased 4.4% or down 6.4% organically.

In our supply driven business sales increased approximately 2% or decreased by 2% on an organic basis. Sales in our North American contract office furniture businesses decreased 10% while sales in our international office furniture businesses decreased 17%. In our hearth business sales decreased 7.3%, new construction sales decreased 30% and sales of retail wood and gas products increase 3% while sales of pellet appliances fell 38%.

Non-GAAP consolidated gross margin increased by 30 basis point to 38.3%, favorable price cost benefits were mostly offset by lower volume. Non-GAAP selling and administrative expenses increased 100 basis points as result of lower volume and the impact of acquisitions partially offset by lower freight cost and expense timing. Stan?

Stan Askren

Okay, so as we look at the fourth quarter of 2016 we continue to expect an uncertain economic environment. Our markets remain dynamic and we product demand will continue to be choppy.

In office furniture we expect our contract business to improve modestly based on slightly increased activity levels. Our supply driven businesses projected lower as small business confidence remain subdued. In hearth we expect continued growth in the new construction business driven by single-family housing starts and we project modest improvement in our retail wood and gas business while retail pallet appliance sales stabilize near the bottom.

Let me turn the call back to Kurt for specifics on the numbers.

Kurt Tjaden

So for the fourth quarter office furniture sales are expected to be down 1 to 4%. Organic office furniture sales are expected to be down 3 to 6%. Supplies driven office furniture sales are projected to be down 2 to 5% or down 5 to 8% organically. Sales in our remaining office furniture businesses are forecasted to be flat to down 3% and within that organic sales in our North American contract businesses are expected to be flat to up 3%.

Hearth sales are expected to be up 1% to down 2%, new construction sales are forecasted to be up 2 to 5% and we’re projecting retail wood and gas sales to be flat to up 3%. Finally retail pellet sales are projected to be down 10 to 15%.

Non-GAAP gross profit margin for the quarter is expected to be approximately 40% and non-GAAP SG&A which includes freight distribution expenses is expected to be approximately 29% for the quarter.

We’re now projecting the full year 2016 tax rate to be approximately 43.5% and free cash flow for the year is expected to be in the range of 80 to $90 million.

Our estimate of non-GAAP earnings per diluted share for the fourth quarter is in the range of $0.81 to $0.91 resulting in projected full year 2016 earnings per share of $2.60 to $2.70.

I’ll remind you that the fourth quarter of 2016 results included approximately $0.05 of nonrecurring tax benefits. Excluding these one-time tax items we expect EBIT for the fourth quarter of 2016 to be at or better than the fourth quarter 2015.

And finally to reiterate our outlook for 2017. We continue to remain committed to providing you shareholders our best current view of the business. The guidance range provided in our press release is broad however given the uncertainty in the economy. We expect again to reiterate full year consolidated sales to be in the range of up 2% to down 2% resulting in an initial estimate of non-GAAP earnings per diluted share for the full year 2017 in the range of $2.75 to $3.15. Stan?

Stan Askren

So let me wrap it up here. Our businesses are strong and well positioned for the future, our brands are competing well in their markets, we continue to identify investment opportunities that will deliver strong financial returns, and I remain confident in our ability to drive long-term shareholder value creation.

So with those comments complete, Kurt and I stand by for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from Budd Bugatch with Raymond James. Your line is open.

Budd Bugatch

Good morning. The first question I guess is has anything changed since you gave your business update, what are you seeing in the marketplace that’s different than what you did when you gave your assessment of the third quarter?

Stan Askren

I think Budd what the best comment would be is the markets have firmed up. As I indicated in my opening comments we projected third quarter based on the trends we saw big step down, we’ve seen lots of volatility in certainly this year and recent years and so you see a step down and then you see a step back up, step down. It’s stepped down and it’s said there and then as we’ve finished out the quarter we saw it firm back up and I think that’s the significant change since we announced last.

Budd Bugatch

I am not sure I understand that. It firmed back up at the lower level or you actually saw some from where it stepped down to?

Stan Askren

It firmed back up where it was which is at lower level historically but better than the step down.

Budd Bugatch

Can you quantify that at all Stan.

Stan Askren

I think it’s in the guidance we provided to you but go ahead Kurt.

Kurt Tjaden

I think that’s the best way to think about it Budd, if you think back to what we’ve given for full year guidance originally back in July and look at what we’ve given now for the full year and you take out what happened in the third quarter we’re trying to back what we, you’d recall implied in that fourth quarter guidance. So overall I’d say it’s flat to minus a couple of percentages.

Budd Bugatch

Okay. Talk to me a little bit about what you’re seeing in cost. You had a tailwind for now a few years in costs and we’re beginning to see I think the early signs of some commodity inflation, first in steel and now more recently with some things that are going on around the world and some of the chemicals that go into foam. Are you seeing the same or can you tell us what you…..

Stan Askren

I think Budd our outlook on commodities is going to be moderately more inflationary, moderately off. I think it’s going to be interesting to see where steel ends up. We as you recall, we index steel and so we lag on the way out, we lag on the way down and I think we’ve got a pretty good picture for first half but I think the second half is a big picture and now I think the commodity picture there is lots of sort of input cost questions and lots of supply changes as well. I don’t – unless the economy picks up significantly I don’t think we’re going to see significant inflation, moderate but I think we’re well prepared to handle whatever comes based on the picture that we have in front of us.

Budd Bugatch

And your last price increase was early 2016, is that right, is what when you normally adjust prices once a year or so.

Stan Askren

Generally yes Budd.

Budd Bugatch

Okay. And in the fourth quarter what are the charges that we look and how should we think about that?

Kurt Tjaden

So you’re talking about the non-GAAP restructuring changes Budd?

Budd Bugatch

Yes, sir, what charges do we have?

Kurt Tjaden

So you would have what was filed in recently in the 8-K I believe that was laid out for New Orleans, Indiana. There would be some with that. There would be a little bit left in Paris which is a hearth operation which was announced earlier this year and then we’ll also have the donation of the building which we referred to in our press release. And then we have some ongoing charges for operation, other operations transformations here in our Muscatine operations.

Budd Bugatch

That’s all third quarter right or is that fourth quarter?

Kurt Tjaden

Those will all continue in the fourth quarter.

Budd Bugatch

So you donated a building and that charge continues into the fourth quarter?

Kurt Tjaden

There are some charges that continue in the fourth quarter with that.

Budd Bugatch

It was 1.6 million in the third right?

Kurt Tjaden

Right, so we’re accelerating, that starting accelerating that depreciations and that donation will actually happen in the fourth quarter so you’ll see charges continue into the fourth quarter.

Budd Bugatch

Can you quantify for us what the charges are likely to be total or….

Kurt Tjaden

Total for that building or in total across all of those Budd?

Budd Bugatch

Well I’ll get it off line, I’ll put it that way.

Kurt Tjaden

Yeah, it’s probably easier to walk you through that but I think at a macro level for the year Butt, lets handle it offline, probably easier to do that.

Budd Bugatch

Yeah, let’s do that and we’ll talk about that then. Okay, thank you very much.

Operator

And time for one last question and our last question comes from the line of Kathryn Thompson from Thompson Research Group. Your line is open.

Kathryn Thompson

Hi, thank you for taking my questions today. I would like to dig a little bit more into your 2017 guidance. If you look at the past few fiscal years you typically give out your guidance in conjunction with Q4 earnings but you’ve decided to give it little bit early this year. One, what’s the thought process for doing, taking that step and strategy and then second in the same spirits you were able to get some granularity for Q4 guidance, if you could at least give the logic for the fundamental demand, gross margin and SG&A type levers that dictated ’17 guidance. Thank you.

Kurt Tjaden

So let me take a shot at it Kathryn. I think if you go back to last couple of years we’ve actually given guidance in on the this call for the full year at a fairly broad range and then updated that and narrowed that range through the year. So this is consistent with our past practice.

In answer to your second one, A, we give a pretty broad range across as we said, given the uncertainty across the business but I think as we’ve talked about you get to between inflation and the structural cost actions that we’ve talked about you can get to a margin assumption. We’ve talked about our operating leverage targets of 25% to 35% across our businesses that will help to those ranges and that would include pricing and inflation on your assumption.

So I think the components are there and as you look at the two segments and your view on housing and then how that trades off with what might happen in office, I think you got the components. Now high level that’s how we account with that sales range and that earnings range but again great degree of uncertainty I think as we look through the end of this quarter on how 2017 develops.

Kathryn Thompson

So maybe just conceptually if you look at for instance what you discussed on for Q4 for supply sales being down, and office being flat to down. Are you anticipating a continuation of that trend? Really it’s more of a, do you expect more a little bit more the status quo that you’re expecting for the back half of this year continue into next year or is there do you expect any type of change in that trend and I know it’s your first step at it but it just helps us understand.

Stan Askren

Sure, yeah understand Kathryn, so again this is Stan, so Kurt indicated we even talked about not following best practice and not giving any guidance because it’s relatively uncertain. A lot of this depends on what happens with the economy. So we’re anticipating I think a similar economy and I would say our relative growth against the economy is going to firm us some next year 2017 versus 2016. We should be through a lot of our sort of our, I’ve talked about our focus on improving the product foundation and slacking out of some businesses and some things. We should be through that and we should to see some growth relative to the economy.

Now the economy is down significantly we’re not projecting that we’re going to just smoke the whole thing and be up big time. So we’ll start with the fundamental which is the economy has stayed relatively the same, we’re going to roll into the first quarter of the year at a similar trend slightly increasing as we finish the year out on virtually all of our businesses. Then when you roll in as Kurt said our ongoing leverage and then you roll in our structural cost take out and then you add in some other factors you get generally at those numbers that we laid out for you.

Kathryn Thompson

Okay, thank you. Just for the quarter freight and distribution costs were down roughly 7% or so. Was this driven by lower volumes or was this part of your overall structural expense reduction efforts so really just trying to get a sense that this is something more structural or just something that’s a more function of volume.

Stan Askren

Ongoing - so the answer is it’s kind of business as usual for the most part. You’ll always see us driving productivity and some of it is relative to last year we were bringing up some regional distribution centers and maybe there was some additional costs that recurring. It’s no big switch or change in what we’re doing, it’s really more sort of ongoing productivity initiative I believe.

Kathryn Thompson

Okay. That’s helpful. And I know that you mentioned in your prepared comments and release this fall about closing your Indiana facility but as you continue to focus on continued lean efforts and efforts to take out structural cost, what are other types of actions you may consider taking as we look towards of back half of this year and into 2017?

Stan Askren

So we’re always – we think about this a couple of ways. So the answer is Kathryn we always are working prospective of A, structural I call it core productivity and then B, structural cost take out and so we came forward and announced earlier in the year this 35, $40 million of structural cost savings by 2018. We’re mid innings on that I would say. We probably now have official announced half of that. We’ve several other major projects teed up to continue to take that structural cost saving out.

In addition we’re just continue to drive core productivity around our material flows, our information flows and just sort of running our business more efficiently. We’ve got a pretty good track record over the last 30 years I guess of kind of just trying out. So I think there will be more to that. So there is a very intensive activity always at HNI around those sorts of things. Good times and bad times, I would tell you that often we’re attacking structural costs when things are the best, we don’t wait around until things get tough.

Kurt Tjaden

If I could add Kathryn to Stan’s comments, what you should feel good about when we talked about 35 to $40 million of structural cost by ’18 was getting in a roughly two-thirds that in place next year. We are on track to deliver that. So to your earlier question if you think about ’17 that’s well in play and well advanced to meeting that objective.

Kathryn Thompson

Okay. And final clean up just related question - related to that 35 to 40. This is all achievable regardless of how that - of the 30 to 45 structural cost. Is there any lever that's tied to sales trends? This is achievable even if sales were to drop to just theoretically.

Kurt Tjaden

Yes, the answer to that question is yes.

Kathryn Thompson

Okay, great. Thank you very much.

Operator

That was our last question in queue. We’ll turn the call back over to our presenters for any closing remarks.

Kurt Tjaden

All right. Well, thank you so much for tuning into our earnings release conference call. We look forward to talking to you in future and hope you have a great day.

Operator

And ladies and gentlemen, this does conclude today's conference call. Thank you for joining us today. You may now all disconnect your lines.

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