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HNI Corp (NYSE:HNI)

Q1 2012 Earnings Call

April 19, 2012 11:00 AM ET

Executives

Derek Schmidt - VP, Corporate Finance

Stan Askren - President and CEO

Kurt Tjaden - VP and CFO

Analysts

Budd Bugatch - Raymond James

Matt McCall - BB&T Capital Markets

Peter Lisnic - Robert W Baird

Todd Schwartzman - Sidoti & Company

Operator

Good morning. My name is Sarah and I will be your conference operator today. At this time, I would like to welcome everyone to the HNI Corporation First Quarter Fiscal 2012 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). And as a reminder, today’s conference call is being recorded. Thank you.

Mr. Schmidt, you may begin your conference.

Derek Schmidt

Good morning, and thank you for joining us today for the HNI Corporation conference call to discuss first quarter 2012 results, which were announced yesterday after the market closed. My name is Derek Schmidt, Treasurer and Vice President of 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 to our website under the Investor Information section. We encourage you to review this presentation as it does contain details of our financial performance, including the non-GAAP to GAAP reconciliations.

Joining me today on the line 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 up the call for questions.

Before we begin, 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 subject to known and unknown risks. Actual results could differ materially from expected results. Additional information concerning factors that could affect actual 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 the call.

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

Stan Askren

Thank you Derek. Good morning everyone. We will share our sentiment of the first quarter of 2012 and then provide some thoughts on our outlook for second quarter and full year 2012. We'll then open the call up for questions.

We're pleased with our improved performance over the prior year. All segments delivered solid sales growth and our operating results reflect strong execution of our split and focused business model. Performance in our Office Furniture supply driven business was particularly strong as organic growth at 10% exceeded expectations. We're executing well and encouraged by the improving trend in this market. Likewise demand in our contract and international businesses remain robust with 9% top line growth. So we're excited with the fact that both of these segments of office furniture performing well at this point.

Our Hearth business continues to deliver strong performance. Sales and new construction increased 16% as housing starts improved. Remodel and retrofit sales decreased 6% as unseasonably warm weather adversely impacted short term demand for our alternative fuel products.

I'll now turn the call over to Kurt to review specific financial data for the first quarter. Kurt?

Kurt Tjaden

Thank you Stan. So as a reminder, the first quarter 2012 includes results related to Sagus which we acquired in November of last year. So for the first quarter 2012 consolidated net sales increased 12.4% to $445 million or 8.5% on an organic basis. Sales for the office furniture segment increased 14.3% to $379 million or 9.7% on an organic basis and net sales for the Hearth product segment increased 2.4% to $67 million. Consolidated gross margins decreased to 33% compared to 34% in the prior year quarter due to higher material cost, unfavorable mix and the impact of the Sagus acquisition which was partially offset by higher volume and improved price realization. Importantly excluding Sagus consolidated gross margins were in line with the prior year quarter results.

As a percent of net sales, total selling and administrative expenses including restructuring and impairment charges improved 1.3 percentage points due to higher volume and lower restructuring and impairment charges, partially offset by increased fuel costs, investments in growth initiatives, higher incentive based compensation and acquisition related cost. We ended the quarter with $57 million of cash on the balance sheet. We used $28 million of cash in the quarter compared to $22 million in the prior year quarter. I will remind you the first quarter is typically our lowest quarter for operated cash flow due to business seasonality and funding requirements.

Stan Askren

Looking forward we entered the second quarter with strong momentum and are well positioned to deliver solid sales and profit growth for the year in both segments. I'm encouraged by the recent stabilization in the economy, improving conditions in our core markets and strong performance of our businesses. We continued to identify and aggressively pursue attractive investment opportunities for long term profitable growth.

Strong growth in our supply driven business is expected to continue to accelerate, driven by investments in selling, product development and branding. Our Office Furniture contract brands continue to compete well in the markets. Year-over-year growth rates within the contact channel are expected to flatten against strong prior year comparisons in the second quarter.

Last year we benefited from several large government projects during the second quarter. We continue to expect solid growth in the contract business for the full year. We expect continued strong performance in our international business, particularly in China.

Our Hearth segment remains well positioned to continue strong profitable growth, positive momentum in new construction channels expected to continue as single family housing starts improved. Top line growth in the remodel retrofit business is expected to remain modest in comparison to the exceptionally strong performance of our alternative fuel products last year.

Overall I feel great about our investments and market going into 2012 across all businesses. Our new product and platform initiatives are innovative and highly relevant to the changing needs of our customers. We are fully leveraging our RCI culture and lean discipline in pursuit of transformative initiatives to drive additional structural costs resulting in ongoing process improvement.

We are continuously building and enhancing our selling programs and processes to make HNI the preferred choice, the first time, every time for our partners and customers. We are investing in our core, aggressively pursuing new growth opportunities to extend our core and building strong businesses to deliver long term value to our shareholders.

Kurt will now provide the financial outlook for the second quarter and full year 2012.

Kurt Tjaden

So for the second quarter 2012 we anticipate overall sales to be up 8% to 11%. Office Furniture sales are expected to be up 9% to 12% including sales from acquisition were up 2% to 5% organically. Organic sales in the supplies driven channel are expected to be up 9% to 12% and sales in the rest of our Office Furniture businesses are expected to be flat to slightly down (inaudible) strong prior year comparisons and Hearth sales finally are expected to be up 3% to 7%.

Non-GAAP gross profit margin is expected to increase marginally versus second quarter 2011 when it was 34.5% excluding the restructuring and transition charges. Non-GAAP SG&A as a percentage of sales excluding restructuring and transition charges is expected to be similar to second quarter 2011 when it was 31.5%.

Net interest expenses projected to be $2.7 million in the effective tax rate is projected to be approximately 36% during the second quarter. For the year we are expecting capital expenditures to be $50 million to $55 million and we project full year 2012 depreciation and amortization to be approximately in line with 2011.

So our estimate for non-GAAP earnings per diluted share for the second quarter us $0.13 to $0.18 per share and for the full year 2012 we are narrowing our estimate of non-GAAP earnings per diluted share to $1.35 to $1.50 per share which excludes restructuring charges and transition costs.

This summarizes our outlook for the second quarter and full year 2012. I'll now turn the call back to Stan for closing comments.

Stan Askren

Thank you Kurt. I'm encouraged by the continued improvement in the economy and remain optimistic about our markets and prospects for growth. I'm confident our investments are accelerating product growth and delivering long term shareholder value. Our business is financially strong and very well positioned for the future.

With comments complete we will now open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Budd Bugatch from Raymond James. Your line is open.

Budd Bugatch - Raymond James

I guess I have a few questions. First question is did you give us Kurt, the impact of Sagus on the operating results for the year other than, I know gross margin and sales but the EPS, was it accretive or dilutive in the quarter

Kurt Tjaden

Guidance for the year Budd we said would be…

Budd Bugatch - Raymond James

What was it in the first quarter?

Kurt Tjaden

First quarter it was $0.05 diluted.

Budd Bugatch - Raymond James

It was $0.05 diluted. And for the year what do you expect?

Kurt Tjaden

We would expect it to be nominally accretive for the year.

Budd Bugatch - Raymond James

Nominally accretive and second quarter?

Kurt Tjaden

And second quarter nominally accretive, recall but highly seasonal business with a K-12 and as we transform that particularly in the first part of the year you see a skew of profitability on that business towards the back of the year.

Budd Bugatch - Raymond James

Precisely where I was going because that would have set to me I think in the second quarter, you would have seen kind of a little bit of a bump because of it now and wouldn’t that affect gross margin?

Kurt Tjaden

We would see a slight bump on the bottom line nominally accretive not much on the gross margin line.

Budd Bugatch - Raymond James

Okay and can you help me explain there why?

Kurt Tjaden

More from as we think about production leveling in the first quarter and were transforming that business the impact is more material there than it is on the second quarter from a dollar and a percentage perspective.

Stan Askren

May be a level above but here as well as if you think about K-12 education business and the seasonality, its highly seasonal, number one, number two, it's a tremendous asset brand market position for us but it is not unusual of reach, we do buy businesses that need operational transformation and so what you are seeing the financial impact is us moving business from a large batch sort of inventory position to more of a lean flow produce the order and that creates some really distortions in the short term around margins and absorption but also inventory so what you are seeing is highly seasonable going through significant transformation which is consistent with what HNI does with these acquisition.

Budd Bugatch - Raymond James

So nominally accretive in the second quarter you are going to get it nominally accretive for the year which says me that the third and fourth quarter you will see some accretion that’s more than nominal is that correct because to offset a $0.05, delusion in the first quarter.

Kurt Tjaden

That’s correct.

Budd Bugatch - Raymond James

Okay because we are trying to figure out you know obviously it's our error and I think the streets are -- we were looking at the second quarter guidance coming well back below what we were guiding for and I think we were actually lower than the consensus so we are trying to understand what’s causing that differential. In the last quarter call you also said you were going to be spending some more money on SG&A projects I think some systems project and some other things and I wondered if you could quantify what that impact might have been on the second quarter and on the first quarter and maybe again for the year.

Kurt Tjaden

Yes so for the first quarter about a couple million dollars of investment and we would expect that to ramp through the year, somewhere in the $10 million to $15 million incremental spend and I will remind you again that’s across selling, that’s across new product introductions as you referred to that business system transformation.

Budd Bugatch - Raymond James

So on a quarterly basis its 2 million in the first quarter and the run rate at the end of the year is about 4 million a quarter is that right?

Kurt Tjaden

I will say a reasonable assumption.

Budd Bugatch - Raymond James

OK all right I have got a bunch of other questions but I will let others ask their own.

Operator

Your next question comes from the line of Matt McCall from BB&T Capital Markets. Your line is open.

Matt McCall - BB&T Capital Markets

So Kurt you ran through that guidance, I just want to make sure I missed what was Q1 and what was the full year so did I understand you to say that the full year you expect the furniture business outside of supplies to be flat to down or was that for Q2?

Kurt Tjaden

That was Q2.

Matt McCall - BB&T Capital Markets

Alright. And what’s the expectation for the full year?

Kurt Tjaden

I think consistent with as we have said in the past Matt, low to mid-single digits for the full year.

Matt McCall - BB&T Capital Markets

That’s contract international?

Kurt Tjaden

That would be correct.

Matt McCall - BB&T Capital Markets

Okay and maybe Stan this might be for you, is that consistent with your expectation for the industry, I guess I am asking this because it looks like based on the what you just reported that maybe supplies did a little bit better in Q1 than you were guided in the contract in the international where we did a little bit and it is modest but a little bit less than you would expect it so is there anything that’s changing in the environment that would cause those deltas (ph) to show up?

Stan Askren

Those slides are guidance too closely on contract international, I am just kind of reset everybody, we look at the year and there is a lot of moving pieces in a business like ours and including government moving around, large project, corporate, contract international China supplies et cetera, so sometimes I feel like do you all grab some of these individual pieces and over analyze and I understand what you are trying to do so. The answer to your question specifically we are very excited about the strength and supplies, it's been a long time since supplies has been this strong and it is coming on and we are seeing continued strength going forward based on the indicators that we look at which is really kind of broad market momentum.

So, the answer is yes, I think the supplies is stronger than we thought. I don’t feel like contract with international is really changed significantly in my mind anyway exactly how we lay that out for you all have to go look at but no I don’t think I have changed my view of that but I have become more excited about what’s going on in the supply land.

Matt McCall - BB&T Capital Markets

And then one of the you mentioned indicators, one of the indicators we watch obviously I think you did do is a small business opting as a metric and it did take lower last moment for the first time in six months. It sounds like you are referencing more company specific drivers what’s happening in the channel obviously that’s more important but are you seeing any signs that would be consistent and sound like it but any signs that it will be consistent with what the small business in the (inaudible) indicators is telling us?

Stan Askren

The answer is no Matt; you know again we do look at small confidence. It took up minor tick down it's a pre-overtime and I think it's a pretty good indicator we don’t get too excited on a monthly basis at this moment. There is a lot of noise and even look at the sample size of the companies in that small business index. We don’t over process that too much. It's kind of a good early indicator for us and overtime and its good correlation but month and month changes; I don’t get too excited about.

Overall we are seeing very healthy activity in the market for us, we feel like we are the markets improve and we feel like we are performing well in that market.

Matt McCall - BB&T Capital Markets

So in supplies and so jumping back to contract a little bit, the Kurt’s expectation for low to mid-single digit growth, how much, is that your expectation for the market overall, I know you have done a lot of things to try to improve your share but what’s the expectation for the market this year and then what are some of the things that drive that optimism?

Stan Askren

We all expect to do better than the market, I mean that’s the challenge I gave the operating companies and again we feel good about our progress, you have lots of moving parts so you have a government spend, that’s changing going down. We feel good about the large corporate accounts and we feel good about the small to medium sized projects. You net all that out we think there is very solid, sustainable positive growth going forward in that as Kurt says in that sort of low to mid-single digit level.

The comparable last year are incredible as well especially around these large government projects that are in the works, et cetera, a lot of that is going away and Matt as you know our feel is based sort of marketing activity and it is hard to get really dialed in specifically on as it how much better we are going to do in the overall market going forward.

Matt McCall - BB&T Capital Markets

OK and then finally on the Hearth side you broke out the new construction activity, up 16% I guess you could use multiple metric here but I know you have decided in the past the strength at the large builder I mean is there anything you can point to that says a hey the large builders are growing to X and we are growing and we are taking more share there, again it's kind of that market versus company dynamic that I am trying to get to.

Stan Askren

Yes I don’t have any specific for your math; I will tell you again if you look at the dramatic downturn that how you went through in our corresponding moves to address that the restructured cost, the same time we invested in new products, branding, selling, distribution, closer alignment with larger builders. We think that’s going to pay off nicely, our best look at this thing going forward in Q2 as new constructions are going to be up somewhere between 8% and 11% and I would say we are pretty careful to claim sort of share gains and short term horizons because there is so much noise but I think we are going to compete very, very well in those markets as that recovers.

Operator

And your next question comes from the line of Peter Lisnic from Robert W. Baird. Your line is open.

Peter Lisnic - Robert W. Baird

I guess the first question on the investment cost, Kurt I think you were, you mentioned 2 million in the first quarter, as I kind of look at the model I am just wondering do we see a significant ramp in the second quarter and then that cost tailing off or are we just kind of ramping steadily toward that 10 to 15 through the year.

Kurt Tjaden

You've got it at the latter common; it ramps gradually through the year.

Peter Lisnic - Robert W. Baird

Okay, all right. And then the thing that I am still trying to explore a bit is particularly on the business system optimization process. Just how we think about that spending going forward outside of 2012 and then to what degree or what magnitude do the benefit start to roll in. Is there some cost savings that we see accrue in the back half of the year from that investment or is it really more of a 2013 accretion on that front and then to what degree might we see that both in the back half of '12 and '13 is really what I am after.

Stan Askren

I understand your question. These business system transformation investments sort of return questions are complex. I think to answer your question specifically, you should think about the benefits accruing latter in the sort of a period of '13 and '14. The investments are highly dependent on a lot of work around; it starts as an ERP implementation for us. It is a lot of rethinking our business processes and consistent with our lean sort of understand, simply stabilize and then connect lean processes. So the cost savings club in a lot of different ways all the way from efficiency savings to actually rolls to supply. It's how we project and rolled the forecast, a production, it rolls to our in-house SG&A expense, allowing us to do things more efficiently and there is a huge aspect to your being more effective with our customers. And then finally the impact when we do this is we're driving sort of more faster with less for our customers. We're optimizing our costs and we are also optimizing our working capital.

So to lay those specific benefits out and when they roll through, we're not going to share those. Certainly we work those and sure we are not going to share those and certainly at this point but be assured that we are looking, talking working this thing very aggressively at my level on down to make sure we generate a very healthy return for shareholders.

Peter Lisnic - Robert W. Baird

The one to follow up on that one, I just wanted to ask was on the cash side of the process. I think you alluded to better cash conversion if that's the right way of thinking about it. Is that correct? I mean historically you've been a very strong free cash flow generator. Is there a way that you can maybe give us a guide pulse for the improvement in cash conversion that we might see as a result of this process?

Kurt Tjaden

On the one hand there is absolutely a cash component of this project as Stan talked about, particularly on the working capital piece whether that's inventory, it's back to these business processes around how we collect and how we manage payable so there is a benefit. But again similar difficult to quantify and not at that point yet.

Stan Askren

I'll state this. We are early in a which is going to be a longer term project as well. You asked a very good question. I think we'll be talking about this for a couple of years as we go through. It’s a very comprehensive design implementation and the benefit of the investment will take years to invest and years to generate that benefit. And so as we go, we'll try and share that which we can but I think a lot of this is going to be a general conversation like this in the future.

Peter Lisnic - Robert W. Baird

Okay, all right, got it. And then one perhaps painful and granular question Hearth, I understand the new construction side of it. I am wondering if you can give us a feel or a flavor for what you are seeing on the remodel side and if there is a way of stripping out just the fuel cost related demand element of Hearth remodel. In other words are you seeing stronger remodel demand from customers ex the swings in fuel prices?

Stan Askren

If I give this to you, this is more anecdotal rather than detailed analysis. (Inaudible) that we are seeing a strip off the alternative fuels and this unreasonably warm weather than we've seen here that the core remodel retrofit is largely flat, maybe slightly up at this point. And this is not a great season for us right now as the weather gets warm and looking out, the trees are green etcetera. We do see a bit of a downtick and we don't quite see as much activity. Part of this is dealer house and inventory. They may be selling through as well. So a little bit harder for us to tell exactly what the core market's doing.

Peter Lisnic - Robert W. Baird

No that's actually very helpful. I was just after the confidence aspect of it.

Operator

Your next question comes from the line of Leah Villalobos from Longbow Research. Your line is open.

Unidentified Analyst

Hi, this is Josh (ph) for Leah. Thanks for taking my questions. Now you had mentioned that gross margin was impacted by unfavorable mix. Can you discuss the drivers behind that and how you think about that going forward?

Kurt Tjaden

Sure so Josh, mix is a complex issue for us as you think about the breadth of our business. That could be everything mix from a customer, a channel, a product, project versus day-to-day, a combination of those items. So really in that comment it's not one particular item there, Stan talked about government channel versus others and all those things come to impact that. But it's really a combination of those factors as opposed to any individual we call out.

Unidentified Analyst

Okay, thanks. And then we had heard of a 3 to 5% price increase in all field products scheduled for April. Was that the case and so did you see any pull forward in demand ahead of that increase?

Kurt Tjaden

We did announce that price increase and implemented on contract. You typically you see it from an order perspective Josh. You don't see it from a shipment perspective. Because it is built to order. So that no impact on the quarter from a shipment perspective.

Unidentified Analyst

Okay, thanks. And then just lastly, could you give any end-market color regarding the contract business specifically, what you are seeing in government and education?

Kurt Tjaden

Sure Josh. Government is slowing down as we expected central government and state local. This is not really the great education season quite yet. That's yet to come. But our feel is, is the government is hanging in there pretty well. I think we are competing well there. The segments, in particular the K-12 segment is actually doing well than we had hoped plus a little bit. I think we are performing well, that acquisition integration is going well.

Operator

Your next question comes from the line of Todd Schwartzman from Sidoti & Company. Your line is open.

Todd Schwartzman - Sidoti & Company

Could you quantify the ending backlogs furniture?

Kurt Tjaden

We don't break those numbers out Todd.

Todd Schwartzman - Sidoti & Company

On the Sagus deal, it seems that; tell me if this is correct, it seems that Sagus alone was responsible pretty much for the 100 basis point margin degradation. Is that accurate?

Kurt Tjaden

It's accurate.

Todd Schwartzman - Sidoti & Company

So in other words a price and volume is pretty much fully offset the other factors sided the mix and input cost issues.

Kurt Tjaden

Correct.

Todd Schwartzman - Sidoti & Company

Okay, what is the outlook for raw materials? What's the trend we should think about from where you sit now for the remaining three quarters?

Kurt Tjaden

Modest to flat.

Todd Schwartzman - Sidoti & Company

Okay. You had previously for the first quarter guidance you had stated you expected slightly lower than the prior year's 33.4% SG&A to sales. Came in about 110 basis points below that. Just curious, was that 32.3 actual number. Was that about in line with what you were thinking when you guided to slightly below?

Kurt Tjaden

I think Todd we did a little better than we expected and that maybe some timing, it maybe some cost savings, it’s a combination of things. But generally in line with what we expected. Not significant.

Operator

And there are no further questions in queue.

Stan Askren

All right. Well thank you very much for your interest in HNI. We appreciate your time and look forward to talking to you in the future. Have a great day.

Operator

And this concludes today's conference call. You may now disconnect.

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