HNI Corp (HNI) 2006 Q3 法說會逐字稿

Welcome to the HNI Corporation Third Quarter 2006 results Conference Call.

[OPERATOR INSTRUCTIONS].

I would now like to turn the conference over to your host, Melinda Ellsworth.

Please go ahead.

Good morning and thank you for joining us today for the HNI Corporation Conference Call.

To discuss Third Quarter 2006 results we announced earlier today.

My name is Melinda Ellsworth, Vice President, Treasurer and Investor Relations For HNI Corporation.

If you have not received a copy of the financial news release, please call 563-272-7927 and we will send one out to you.

The release is also available at our website at www.hnicorp.com.

Joining me on the line today from HNI Corporation is Jerry Dittmer, Vice President and Chief Financial Officer, and Stan Askren, Chairman, President and CEO.

Stan and Jerry will review the results and then open the call for questions.

Before we begin, please be advised that statements made by the Corporation during this call that are not historical facts are forward-looking statements.

These statements may include but are not limited to statements of business plans and objectives, capital structure and other financial items.

Actual results could differ materially from those projected in any forward-looking statements and relying on forward-looking statements is subject to risk.

Factors that could cause actual results to differ materially from those projected and any forward-looking statements are discussed in the corporation's financial news release announcing Third Quarter 2006 results and its most recent 10-K and other periodic filings with the Securities and Exchange Commission.

The Corporation assumes no obligation to update any forward-looking statements made during this call.

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

Stan?

Thank you, Melinda and good morning, everyone.

We'll follow our usual format in these calls.

I'll share a brief assessment of the business for the third quarter 2006.

Then turn the call over to Jerry Dittmer, our Chief Financial Officer, to review some of the specific financial details.

I'll then come back and share some thoughts on our outlook for the remainder of 2006 and then finally, we'll open it up for questions.

So starting overall, the office furniture business continued to experience solid sales growth.

The contract business segment or business remains strong.

Top line growth in our commercial segment is solid and consistent with overall industry trends.

We experienced solid growth from our strategic investments and market initiatives and as we shared with you during our second quarter conference call, we have been negatively impacted by significant higher material costs throughout most of the year and as a reminder, we have had a lag between material cost increases and price realization in the office furniture segment or business, in particular in the supply driven channels, the cataloguers, typically what we call them.

We will begin to close that gap as the October 1st price increase becomes fully realized during the Fourth Quarter and then ongoing.

In the third quarter, we began to see the anticipated impact of a declining housing market.

As we said during our previous Conference Call, the outlook was uncertain and during the quarter, we in fact did experience a pronounced decline in the new construction business part of our Hearth business.

As a partial offset to that decline, we continued to gain share and we experienced some strong growth in our remodel retrofit business.

Our Hearth drew paths and continues to implement broad based cost reduction initiatives to resize the cost structure for lower demand.

I'll provide more comments in our outlook but for now I'll turn the call over to Jerry Dittmer, our Chief Financial Officer to review some of the specific numbers for the third quarter.

Jerry?

Good morning.

Thanks, Stan.

I will review the numbers beginning with the third quarter results.

We experienced solid sales growth in the quarter up $55 million or 8.8%.

Organic growth across our brands contributed $23 million or 3.6 percentage points and acquisitions accounted for approximately $33 million to increase or 5.2 percentage points.

Gross margins decreased to 34.5% from 37.4% due primarily to higher material and other input costs.

SG&A increased $4.2 million and decreased as a percentage of sales to 25.7% of sales from 27.3% of sales in the prior year quarter.

Factors having a negative impact on SG&A included acquisitions, increased transportation-related costs, and expense of stock compensation.

These factors were partially offset by a $3.4 million gain on the sale of a vacated facility and cost reduction initiatives to adjust to a higher material cost environment in a declining housing market.

Interest expense increased to $4.5 million from $700,000 during the quarter as debt levels increased to fund acquisitions and share repurchases.

We maintain our annualized effective tax rate of 36.5% in third quarter '06 compared to 35.5% in third quarter '05 primarily as a result of higher state tax liabilities and the expiration of the research tax credit.

Net income decreased $4.8 million or 11.8% to $35.8 million driven by increased input in transportation costs, declining in our Hearth new construction business as well as increased interest expense due to higher borrowing levels.

Diluted earnings per share decreased $0.01 to $0.72 in the quarter.

Earnings per share were favorably impacted $0.08 due to the Company's share repurchase program.

On August eighth, the Board of Directors authorized an additional $200 million for share repurchase.

During the quarter, we repurchased 1.5 million shares for approximately $62.5 million for an average of $41.18 per share.

At the end of the Third Quarter, $173.2 million was remaining under the repurchase authorizations.

Now a few comments on our year-to-date results.

During the first nine months of 2006, sales increased $219 million or 12.2%.

Solid organic growth across our brands contributed $130 million or 7.3 percentage points and acquisitions accounted for approximately $89 million increase or five percentage points.

Gross margin increased $55 million while margins decreased to 34.9% from 36.1% due to higher material and other input costs.

SG&A increased $58.3 million but remained virtually flat as a percent of sales to the prior year.

Factors impacting SG&A were increased transportation related costs, acquisitions and expense of stock compensation.

Year-to-date, interest expense increased to $9.5 million from $1.5 million on moderate debt levels consistent with our capital structure strategy.

Net income decreased 8.8% or -- I'm sorry, $8.8 million or 8.6% from the prior year period driven by increased input and transportation costs as well as increased interest expense due to higher borrowing levels.

Diluted earnings per share decreased to $1.82 versus $1.83 in the prior year.

Earnings per share were positively impacted $0.15 due to the Company's share repurchase program.

During the year, we have repurchased 3.6 million shares for approximately approximately $170.3 million on an average of $47.64 per share.

Now let's move to our segment results starting with office furniture.

Sales for the third quarter increased $62 million or 13%.

As previously mentioned, we experienced solid organic growth, representing $35 million or 7.3 percentage points of the increase.

Strategic acquisitions represented a $27 million or 5.7 percentage points in incremental sales.

Operating profit increased $1.3 million or 2.6%.

Operating profit margin decreased to 9.3% from 10.2% as a result of increased material costs, freight and distribution costs, and investment in Lamex and other strategic distribution acquisitions.

Operating profit was positively impacted by a $3.4 million gain on the sale of vacated plant facilities as we mentioned earlier.

Moving to our Hearth segment, sales for the third quarter decreased $7 million or 4.3%.

Organic sales decreased $13 million or 8.1 percentage points.

Acquisitions contributed $6 million of the new sale.

Operating profit decreased $4 million or 17.2% in the quarter.

Operating profit margin decreased to 12.5% from 14.4% in the prior year quarter as a result of lower volume, increased freight and distribution costs, and higher volumes of lower margin products.

Now let's look at some of the other financial metrics for HNI in total.

Cash flow from operations decreased to $71.1 million compared to $102.6 million last year.

The decline is primarily due to lower profit, increased inventory levels to achieve best total cost and seasonal build in our Hearth stove business and lower accruals for incentive cost and compensation.

During the year, we funded $78 million in acquisitions and $170 million of share repurchases with cash from operations, private placement debt, and borrowings under our revolving credit facility.

As we look forward, interest expense in the fourth quarter is expected to be comparable to third quarter.

We anticipate total debt at fiscal year end 2006 will be in the range of 300 to $325 million.

Capital expenditures are anticipated to be approximately 55 to $60 million for the full year 2006.

Depreciation and amortization expense will increase to approximately $70 million for the full year due to intangibles associated with acquisitions.

Corporate expenses for the full year will be approximately $45 million reflecting higher interest cost and stock based compensation expense, and finally, cash flow from operations in 2006 is anticipated to be comparable to 2005.

That wraps up our financial comments.

I'll return it back over to Stan.

Thank you, Jerry.

So as we look to the fourth quarter, order trends will remain solid in the office furniture business.

As it relates to the Hearth business, the new construction channel will continue to be under stress which will likely drive sales and operating profitability lower as we adjust to the declining housing market.

We anticipate overall sales growth to be in the mid single digits.

Office furniture is expected to have solid top line growth in the high single to low double digits and Hearth is anticipated to decline in the low double digits.

Sales from acquisitions of approximately $23 million will continue to have a minimal or slightly negative impact on the operating profit during the quarter.

Gross margin is expected to improve but will still be approximately 1.5 percentage points lower than the prior year, as higher material costs are partially offset by moderate price realization and then SG&A as a percentage of sales, which I'll remind you includes freight and distribution is expected to be one percentage point lower than the prior year, and overall for the outlook, the outlook for the office furniture business remains positive.

Core fundamentals are solid.

Our businesses are well positioned in the markets.

We're competing well in our strategic growth initiatives are on track.

We expect to close the material cost gap and experience positive profit momentum as we begin to realize the benefit of the price increase going forward.

As we've said here several times, the Hearth business is in transition.

Market conditions remain uncertain in the midterm.

Ultimately where housing starts to end up is unclear at this time.

We're aggressively resizing our cost structure to a adjust to a lower demand level and I'll just remind you that our Hearth business is important part of our overall strategy.

We are the market leader and there we have the strongest brand, the best distribution and we feel like the best value propositions there and we expect our Hearth business to continue to make a positive contribution to our overall profitability.

With those comments complete, we'll be glad to open it up for questions.

[OPERATOR INSTRUCTIONS].

Your first question comes from the line of Craig Kennison from Robert W. Baird.

Please go ahead.

Good morning, everyone.

First question, could you remind us of the mix of your Hearth business relative to new construction and remodeling?

Yeah, Craig.

Historically, it has run somewhere between 65 to 70% new construction and the remainder would be in the remodel retrofit side.

And what kind of new construction market do you anticipate given your guidance for double digit declines in the Hearth segment?

Well, that's a great question.

We think, if you look at the latest data here, that housing starts are down 18 to 20%.

We think that has not yet reached the bottom, so where that ends up is anybody's guess I think at this point.

And in terms of the expense reduction initiatives you're taking in the Hearth business, how far or how much will profitability be effected if indeed your revenues are down as far as double digit?

Well, I think that we're right in the middle of going after those costs in a big way.

I mean, if you look at it, it's likely a multiplier down of 2 to 2.5 times.

Okay, thank you very much.

Thanks, Craig.

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

Please go ahead.

Thanks, good morning.

Good morning, Matt.

Let's see.

First, talk about the acquisitions you made in Q4.

Was it about $14 million?

What were those?

Well, Matt, you talking about last year?

Am I doing the math wrong?

I mean you said 78 million, maybe I have the math wrong so you made no acquisitions.

Are you looking for what our sales will be in the Fourth Quarter perhaps from acquisitions?

No.

Did you make any acquisitions in Q3?

No, we did not.

Okay.

Well I've got a number wrong.

That's fine.

Skip that one.

Talk a little bit about the outlook for SG&a if you could maybe go out past Q4, it looks like you're reducing that line item as a percent of sales pretty substantially in the second half.

Is it delayed?

Is it cancelled?

Will some of that spending that was plain, I think originally we had talked about more of an increase this year.

I know you talked last quarter about maybe some reevaluation of some of the spending.

What should next fiscal year look like on that line?

Yeah.

We just pointed out really looking at any guidance for next year, but the answer is you really can't answer the question there in the end when you said your SG&A, we really have resized it as we have to resize our cost structure.

You take a hard look which we have done at our spending and have lowered that level down and I think the guidance that you heard Stan give is that it's looking to be down about a percentage point.

Last year, we were running about 27.8% in the Fourth Quarter in the 06, we're still saying we're down by another point.

And that's the run rate we'll continue at and we'll continue to look at that based on what happens in the Hearth business going forward.

Okay.

So 27.8 down 100 basis points.

Right. 27.8 was last year.

Right and then down 100 from that.

And then can you maybe quantify the impact that you saw this quarter?

I guess the spread between the raw material inflation and I guess the lack of a full price increase?

What was that spread?

What was the impact of the gross margin line I guess?

It was about two points.

And so in that guidance, are you expecting to recoup all of that in Q4 or will you continue to be rolling some of the price increase through?

Well, we will not recoup at all in the fourth quarter.

We're going to get about half of the quarter we'll get a price increase and then we'll get the full effect then starting in the First Quarter of next year.

Okay.

Matt, in regards, I think the question you have on acquisitions is there was half that was paid out in the third quarter as we settled up some of the working capital and that from the acquisition of Lamex.

So then that's probably not wrong, but it's not anything new, okay.

Well thank you, thanks very much.

Okay.

And your next question comes from the line of Susan Maklari from UBS.

Please go ahead.

Good morning.

Good morning, Susan.

On the Hearth side of things, can you elaborate on some of the kind of cost cutting initiatives and things that you're looking at?

Maybe kind of in reference to how that fits in with your lean manufacturing that you've been very dedicated to over the last few years.

Yeah.

Susan, basically, and this is something unfortunately we have lots of experience in having gone through the office furniture downturn.

So basically, this business is being resized.

It's kind of looking at streamlining, the business enterprise wide, so we're their cost that don't carry -- where do we scale back?

Unfortunately, there's a significant sort of workforce adjustment there and the rest is just kind of tightening up across-the-board in looking at where do we take costs out.

So it's continued sort of lean sort of process with kind of a rescaling due to a lower sales level anticipated.

Okay.

Do you forecast having significant excess capacity there that may have to come out?

No.

Okay so that's pretty well balanced then?

Yes.

And then you also said that you experienced some market share gains in that business which is pretty impressive given what a lot of the builders are saying.

Can you give us more details on that?

Well, not a whole lot more except to say we're seeing share gains even in the new construction side that has to do with just aggressively going after new business, focused on the large builders providing pretty effective value proposition.

Secondly, we're gaining share in the remodel retrofit side.

There's a big growth in alternative fuel appliances, appliances that burn wood, burn biomass material such as wood pellets and corn, et cetera, And that's got a significant growth area for us in the last year.

Okay and then just one last question.

Jumping to the office furniture side of things.

Did you see any material pull forward in demand in the quarter as the price increases went into effect and did that have any kind of impact on the sales that we see in the Fourth Quarter?

Yeah.

We did see some, Susan, I think last time I reported that we were anticipating something like 20 million.

It was less than that.

It was about half that, and that's actually good news from the standpoint of the business then that what's ordered later is ordered at a higher price so that's what the we experienced.

Okay, thank you.

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

Please go ahead.

Good morning.

I hope you can hear me.

Yes, Budd, go ahead.

If I heard you right and I apologize because I'm on a cell phone, I think you said for the Fourth Quarter, Jerry, down 150 basis points you expected for gross margin?

That is correct.

Last year, Budd, we were at 36.5 and we're expecting that to be down about 1.5 points.

That includes the effect of 100 basis point improvement due to price increase?

That is correct.

So 250 basis points before that.

Would it be fair to assume that most of that is centered in the impact on Hearth because of the lower production?

No.

It's really both in office furniture and Hearth.

I understand that but I would expect with office furniture perhaps to have some efficiencies and maybe some improved gross margin and with Hearth to have the negative impact.

Would that be unfair?

No, that would be fair.

Okay.

Can you remind us too in office or in the office segment if you talked about this kind of now with the balance between specified and the contract side?

We don't break that out, Budd.

I know, but the gain that you seen, can you kind of maybe qualitatively tell us if it's more one over the other?

Well, I think my opening comments, I indicated that the contract segment or business in particular is very strong.

The rest of our business is solid and tracking well but contract is very strong.

Okay, and going and going forward, and I know that this is is really tough-- well you're in unfortunately chartered waters because you face this with office but now unchartered waters with Hearth.

What should investor look at as success and when should investors expect success in the resizing of the Hearth business and will the ultimate margins be comparable to what you have been able to drive over the last couple of years as you have the boom and when should we be able to see that?

Yeah, let me answer the latter part of the question first , which is our goal is to hold our return on sales percentage as our margin.

The question of when do you get there is a big one, and that's highly dependent on how long this takes for the housing market to reach the bottom, and I'm reading a lot of the stuff that you and your friends, all of the sort of stuff are published in and I'm reading what large builders are saying and my conclusion is it's highly uncertain, I'm seeing any where from 6-24 months before that happens.

We would lag once that hits the bottom, my guess is, Budd, and it's a guess by a quarter to six months before we arrive at sort of steady state.

So you'll be two quarters after we, let's say we bought them in period X. You'll be X plus two quarters before you can think you'll get to your relative margin and be at the proper size.

Is that reasonable?

Are you there?

Did you hear what I said?

Yes, that is reasonable.

Okay, I'm sorry.

I didn't hear your answer and my last question is on the Hearth business, can you kind of tell us the impact between gross margin and our SG&A and cost of goods on this resizing ?

Will most of it be balanced between the two?

Yeah, I would say so.

We're looking at all parts of the business and so I would say it is going to be balanced.

Okay, and I apologize.

I have one more question too.

I think you had this for Susan but we should expect no restructuring charges.

Do you haven't to take out capacity out or plant out?

I wouldn't go that far.

We're going through that assessment right now so I answered Susan's question as we don't see taking factories out but there may be some restructuring charges there.

Again it depends on how far this goes.

Okay.

Good luck on it.

I know it's a challenging period.

Thank you.

[OPERATOR INSTRUCTIONS].

All right well, with that, we appreciate your answers and your attention and look forward to talking to you soon.

Thank you.

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