HNI Corp (HNI) 2006 Q4 法說會逐字稿

Welcome to the HNI Corporation fourth-quarter and year-end fiscal 2006 conference call. (Operator Instructions).

As a reminder, this conference is being recorded.

I would now like to turn the conference over to our first presenter, Ms. Melinda Ellsworth.

Please go ahead.

Good morning, and thank you for joining us today for the HNI Corporation conference call to discuss our fourth-quarter and year-end 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, 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 in any forward-looking statements are discussed in the corporation's financial news release, announcing the fourth quarter and year-end 2006 results, and its most recent Form 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 the call.

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

Stan?

Good morning, everyone.

As usual, I'm going to share a brief assessment of the business and then turn the call over to Jerry Dittmer, our Vice President and Chief Financial Officer, who will review some of the specific financial details for you.

I will then come back and share some thoughts on outlook.

And then finally, as Melinda said, we will open it up for questions.

So, summary, 2006 was a challenge.

During the year, we saw unprecedented broad-based increases in material input costs.

As we've talked about, this was particularly tough because close to half of our furniture business is in the supplies channel, or the catalog channel as we refer to it sometimes.

And it takes longer to put price increases into effect simply because those customers are not able to process those through the catalog channel without significant notice and significant administrative effort.

The result then was a significant lag in the time between our input cost increases and our ability to realize price.

Despite the challenges, we reported record sales and record operating profit in our office furniture business for the full year.

So we're very pleased with that.

As far as the other segment though, our Hearth business was negatively impacted by the largest annual decline in the housing market since the recession in 1991.

After a decade of industry growth, the market for new construction housing starts has declined more rapidly and severely than I think anyone anticipated.

We took aggressive action in the business -- in the Hearth business to reduce structural and operating costs to adjust to the changing market conditions.

As we've managed through the cost of economic challenges for the full year, we have delivered encouraging top-line growth and market performance and remain focused on creating shareholder value.

Now, shifting to the fourth quarter, the office furniture business ended the year strong with record sales and record profits for the quarter.

Top-line growth was solid.

And we experienced a positive profit momentum as we began to close the material cost and price gap as price increases became effective.

The investments we made in Core Plus initiatives performed at or above our expectations.

We entered the large and fast-growing China office furniture market with the acquisition of Lamex, a leading market player in the Hong Kong and Mainland China market.

We continued our strategy to selectively acquire contract office furniture distribution businesses to accelerate Allsteel's growth in the contract segment.

We launched our On for Learning initiative into the kindergarten through 12th grade market and continued our focus on new product development companywide.

We also recently announced our newest environmental initiative, Nature Core fiberboard, that improves indoor air quality and substantially reduces the negative environmental impact of fiberglass in the workplace.

And then finally, we also continued to streamline our manufacturing operations to take out structural costs and strengthen our lean model as we announced our decision to close a facility in Monterrey, Mexico and consolidate those operations into other locations.

Shifted over to Hearth -- as it relates to our Hearth business, we begin the year strong with 15% growth in the first half of the year and followed by dramatically-declining market conditions and a 10% decline in the second half of 2006.

So, a real dramatic change in the market conditions.

Fourth-quarter sales were down 16%.

And during the fourth quarter, we experienced larger-than-anticipated declines in new construction channel along with moderating fuel cost and unseasonably warm weather, which negatively impacted our remodel retrofit channel sales.

The alternative fuel business -- so, alternative fuel is fuel other than petroleum-based -- was not as strong in the fourth quarter 2006 as it was in the fourth quarter 2005.

I will remind you that in the fourth quarter 2005 through the first half of 2006, alternative fuel stoves were exceptionally strong as energy prices peaked in the fall of 2005.

As you recall, the concerns about heating costs and talk of $70 upwards to $100 barrel oil drove an extraordinary level of consumer demand for alternative fuel Hearth stoves as consumers sought ways to reduce their energy costs.

In the second half of 2006, especially in the fourth quarter, those conditions changed as energy prices came down and we had warmer temperatures, reducing consumer demand for alternative fuel appliances.

Profitability was severely impacted due to the rapid sales declines and higher material input costs.

As the market leader in that industry, we continued even with these challenging conditions to gain share in the new construction channel and to continue to grow our remodel retrofit business.

And for that, we are pleased.

We took action to aggressively resize the Hearth business, all without negatively impacting our long-term growth potential.

We made some difficult decisions and took some difficult actions, reducing employment levels by more than 20% and consolidated divesting several of our retail and distribution locations.

That is in addition to several other significant cost-reduction initiatives across the board.

Total annualized cost savings for that business to date are approximately $50 million.

And then finally, we continued to return capital to our shareholders during the year.

We increased our quarterly dividend 16.1% and returned $240 million in cash to shareholders through dividends and share repurchase.

During the past three years, in fact, we have returned over $600 million in cash to our shareholders with the repurchase of approximately 20% of shares outstanding.

I will come back later and provide comments and our outlook.

But now, we will turn the call over to Jerry Dittmer, our CFO, to review some of the specific numbers for the fourth quarter and the full year 2006.

Jerry?

For the fourth quarter 2006, consolidated net sales were 682 million, an increase of 3.8% from the prior year.

Acquisitions accounted for 24 million or 3.6 percentage points.

Gross margins were 33.4%, down 3.2 percentage points due to decreased volume in our Hearth segment and higher material input costs in both segments that more than offset price realization.

SG&A as a percentage of sales decreased to 25.9% compared to 27.7% as 7 million of costs associated with new acquisitions, 2 million of increased freight and distribution costs and 1.6 million related to the resizing of our Hearth business were more than offset by lower incentive-based compensation expense and other cost-reduction initiatives.

As Stan mentioned, we made the decision to close a small office furniture facility in Monterrey, Mexico and will move production to other HNI locations.

During the quarter, we recorded a 900,000 charge in connection with the shutdown of Monterrey and final costs for two facility shutdowns completed earlier in the year.

As a reminder, fourth quarter 2005 included 2.4 million of restructuring costs.

The annualized tax rate was reduced during the fourth quarter compared to earlier in the year, primarily due to the reinstatement of the Research Tax Credit and a 4.1 million adjustment of deferred tax charges.

Net income was favorably impacted $0.06 per share as a result of our share repurchase program.

During the year, we repurchased 4.3 million shares at a cost of 203.6 million.

There is approximately 139.8 million remaining under the current authorization.

During the fourth quarter, we also made the decision to sell a small, non-core component of the office furniture segment and recorded a pretax charge of approximately 7.1 million to reduce assets held for sale to fair market value.

For the full year of 2006, consolidated net sales increased 10.1% to 2.7 billion.

Acquisitions accounted for approximately 113 million or 4.6 percentage points.

Income from continuing operations was 129.7 million.

Net income per diluted share from continuing operations for the full year was $2.57 including the $0.08 per share effect of the positive tax adjustment.

Cash flow from operations declined due primarily to lower earnings and increases in working capital, driven by increases in accounts receivable and lower incentive compensation accrual.

That wraps up the financial comments.

I will turn it back over to you, Stan.

So as we look to 2007 overall for the year, we anticipate more modest top-line growth.

We expect the top-line growth in the office furniture business will be consistent with the industry and anticipate improved profitability for the year as we fully realize the benefit of price increases and core cost-reduction initiatives.

For the Hearth business, market conditions remain uncertain and we anticipate 2007 will continue to be challenging.

First-half sales and profit comparisons will be especially difficult as declining market conditions are compared to a strong first half of 2006.

The timing of the housing recovery is unknown.

Based on prevailing industry perspectives, we believe a recovery is more likely to occur in 2008.

We will continue to implement structural and operating cost-reduction initiatives as required to ensure we are appropriately in line with market conditions and well positioned for a market recovery.

I'm going to turn it back to Jerry, who will provide the financial outlook for the first quarter and full year 2007.

Jerry?

For the full year and first quarter, we anticipate overall sales growth for the year to be in the low-to-mid single digits.

Top line for the first quarter is anticipated to be flat.

Office furniture is expected to have top-line growth in the mid single digits for the full year and for the first quarter.

Hearth sales are expected to continue to trend lower with the first half down approximately 30% and the full year down approximately 20% based on what we know today.

Sales in the first quarter are anticipated to be down 30 to 35% from the prior year, reflecting the housing market conditions and lower comparable sales of alternative fuel stoves.

For the year -- for the full year, incremental sales from acquisitions of approximately 40 million will have minimal impact on operating profit.

In the first quarter, sales from acquisitions will be approximately $20 million.

Gross profit margin for the full year is expected to be flat with fiscal year '06.

Gross profit margin for the first quarter is expected to be approximately 1.5 percentage points lower than the prior-year quarter, negatively impacted by lower Hearth volumes.

SG&A, including freight and distribution as a percentage of sales for the full year and the first quarter, is expected to be flat with prior-year periods.

SG&A will include approximately $3 million of restructuring charges in the first quarter compared to 1.7 million in the prior-year period.

Capital expenditures are anticipated to be 60 to 70 million for the full year as we continue to invest in new product developments and related tooling and other infrastructure efficiencies.

Depreciation and amortization expense is anticipated to be comparable to the prior year.

We anticipate that the annualized effective tax rate for 2007 will be 35.5%.

Unallocated corporate cost, which includes interest expense, is anticipated to be 55 to 60 million for the full year 2007.

Interest expense is anticipated to increase by approximately 5 million, reflecting a full-year impact of current debt level.

Now back to you, Stan.

So in closing, our office furniture businesses are well positioned in their markets.

We have strong brands and solid market performance.

We feel that we're competing well and our strategic growth initiatives are on track.

As it relates to our Hearth business, as I said, ultimately where housing starts end up and the timing of an industry recovery remains uncertain.

However, the Hearth business is an important part of our overall strategy.

We will continue to manage through the cycle and are confident we will emerge stronger and well positioned to benefit when the market recovers.

We remain focused on the long-term, and we will continue to meet short-term challenges head on.

I have a great deal of confidence in our members of the management team and believe we will drive continued success in our markets and continue to create value for our shareholders.

With those comments complete, we will open it up for questions now.

(Operator Instructions).

Budd Bugatch, Raymond James.

Just on Hearth, I guess with the very sober guidance that I think you're giving of running Hearth revenues, first quarter, I think it would be a challenge to say the least to make an operating profit out of that division.

How should we think about incremental operating profit for incremental dollars of revenues in both Hearth and office?

As far as the Hearth, there will be a small profit in the first quarter.

And an example would be as far as the -- if you want to give an example, as far as the op margins, basically it's -- we're saying it would be 2% to 2.5% down.

So, for instance, if you had a (technical difficulty) -- so basically, if sales were down 5%, the operating margin would likely be down about 10 to 15%.

Okay, that's helpful.

When you look at the acquisition revenues, I think you said 20 million in the first quarter.

Is that right, Jerry?

That's correct.

Total for the Company?

Yes.

Yes.

How does that -- is that pretty much all office still?

Is that Lamex?

Yes, it's all office.

It's mostly Lamex and then one dealer acquisition.

And how long will that -- will those revenues continue in terms of the ones you now have in-fold?

It's 20 million in the first quarter, 40 for the year.

And most of that other 20 is spread throughout the rest of the year.

When you look -- and with this challenging period, how are you thinking about repurchases at this point in time?

You made certainly a significant amount in 2006.

This is Stan.

As you know, we don't really share exactly what we're going to do here.

We will continue to look at repurchases based on sort of our uses of cash.

And so, we are always looking at reinvesting back in the core business.

We look at potential acquisitions.

And then, we sort through other uses of cash.

We are in and out repurchasing sort of based on our overall priorities.

I guess my last question -- you talked about the restructuring charges in Q1.

Is that pretty much affecting SG&A?

Would that be fair to say that that's in Hearth, or would there be additional expenses in office as well?

How would that break out?

Most of it is going to be in office related to the shutdown of our Monterrey facility.

So the full 1.7 million is office essentially?

I think I got the right number there.

That was last year. 3 million is -- approximately 3 million was the number we gave you.

That's right.

And that's all office?

Correct.

And that will be called on on our restructuring line, or will that show up in SG&A?

That will be in a separate line on the financials, and it will say restructuring and impairment charges.

Good luck on this challenging period.

I know that it's going to be interesting.

Craig Kennison, Robert W. Baird.

This is actually Ryan Kelly for Craig.

If you could just talk more about raw materials.

They've obviously fluctuated a lot.

Can you tell us where you think you are in a cycle there?

Are they starting to stabilize and then how do you think you're going to progress through '07 in catching up on those costs?

We think that material costs have moderated somewhat.

But we still anticipate modest inflation in material costs.

A lot of that though is yet to play out, as you know.

I think these things are relatively volatile.

But we believe it's going to be up -- the material costs are going to be up but less than they have been last year.

And we have some that are going up, some that are coming down.

Okay and then just on the acquisition front, what are your thoughts and strategies there?

Given you are shutting down some office furniture capacity, it wouldn't seem like you need capacity.

So, would you be looking at additional breadth of product or distribution?

And then, as it relates to the Hearth business, are you continuing to invest to grow in that business or is it more of a weather the downturn here?

As it relates to manufacturing capacity, I'm not sure we've ever made an acquisition to acquire a manufacturing capacity.

That's rarely our reason for acquisition.

Primarily, our acquisition strategy is around acquisition of selling capacity brands, products you mentioned that clearly is -- would be a reason for us to do acquisition or to enter a geographic market that we're not in.

So, i.e., Lamex in Asia.

So, our strategy would continue to be around those things as we are always looking at the potential for us to grow the business via acquisition, to acquire something in one of those categories I just listed.

Are we continuing to invest in the Hearth business?

Yes, where we think we can get a return.

We are -- it's one of those challenges.

We're significantly resizing our cost structure.

But we are the market leader in that business and we're committed to it.

We believe this is going to cycle through.

We've been through office furniture cycle before.

We fully plan to come out even stronger than when we went in.

So that may mean that in some situations we are investing more in sort of front-end go-to-market initiatives.

And then just a final question, can you talk about where you are comfortable from a leverage standpoint?

You seem to be hovering around the 40% debt to cap.

Is that a fair way to think about your kind of new target?

I think that's comfortable for now.

Chris Agnew, Goldman Sachs.

You know office furniture, I've sort of got you growing about 6% organically, and you are forecasting mid single digit but kind of in line with BIFMA.

But if I was to assume that Allsteel continues to grow very strongly for you, what does that imply for your sort of mid market positioning, your HON product?

Are you losing market share in that area or is the mid market growing much more slowly across the board than say the contract segment?

First off, we do not think we're losing market share.

I think overall as you've seen the recent BIFMA numbers, the industry has stepped down here in recent months.

So we've gone from some higher single digits to mid.

November, BIFMA numbers were -- orders were plus 3, December were plus 2.

So I think you would say that overall, the whole market is slowing down.

Certainly, we are frequently asked which -- what do we see?

Well, the contract market continues to be the strongest.

The mid market has been solid but is growing less than the contract segment.

And with your Allsteel business, have you -- are you continuing to plow ahead with making acquisitions to expand your distribution or have you pared back your expansion strategy given other areas you're facing and addressing with the Hearth business?

We continue on it.

I will remind you that the distribution strategy for Allsteel is not a huge one.

It is not as if we are a wholesale-acquiring distribution.

That's a very select strategic strategy, and I don't foresee that we're going to be doing just a huge number of acquisition.

Where we find that we're not able to develop distribution as fast as we would like in a market that we don't have the selling capacity and capability we would like, we will continue to make acquisitions.

We think about these things in the long-term, and we don't think about them just in the short term.

So, our strategy has not changed.

Okay and then I guess changing tack on to the Hearth business, I mean if I look at your forecast for sales declines and the decline in the fourth quarter, how can we see or maybe can you give us a bit more color on how you are taking market share?

We are doing it the same way we were before, taking care of customers better than the competition does and can.

We have the two strongest brands in that industry.

We think we have the best service capability in the industry.

We think we have the best products, and we think we have an effective cost structure.

So when you put all those things together, it makes for a pretty effective value proposition that we are fighting day in and day out to win the heart, souls and minds of the customers.

But is it not fair to say though that you are sort of declining in line with -- as fast as the market is declining overall, like if we look at new home sales -- or new homes being built that you are sort of declining, in line or even a little bit faster?

Well I think we don't break those details out.

Our business is a little bit more complex than that as well is what I would say.

We have a remodel retrofit component that has, as I indicated in my comments, had some pretty extraordinary growth last year.

And then, that's I think we have indicated is 30 to 35% of our mix in that business.

And then you have new construction.

So, when we tell you that we think we are taking market share, we're serious about that.

Then, final question, I know you gave some guidance on tax rate going forward.

But can you provide a little more color on the adjustment to defer taxes in the fourth quarter and also the reinstatement of the tax credit?

This is Jerry.

We had basically been accruing all year at 36.5%.

So what you'll see in the fourth quarter is number one, we made the adjustment for the full year because of the reinstatement of the Research Tax Credit.

You also have in there the deferred tax adjustment, the 4.1 million.

The other thing you'll see is because we have the discontinued operations, when you look at the financial statements that are in the news release, the discontinued ops are -- are basically net of tax.

So, that -- the tax is already out of there.

So when you look at your tax line item, the 10 million that already has the tax out for all of these items.

So if you are trying to get back to an effective tax rate for the quarter, it is very difficult to do because of all of the different components.

So, sorry the deferred tax adjustment is mainly because you were accruing up to 36% and then you were realigning it for what it should have been the full year?

No, from the 36.5 to the 36 is because of the reinstatement of the tax credit.

The 4.1 million, that was part of our preparation for FIN 48.

That's a new pronouncement that defines uncertain tax position that will be adopted in the first quarter of '07.

We identified some differences in our deferred tax liability and made those adjustments in the fourth quarter.

And that's what you see is the $0.08 for the quarter, which is a 4.1 million.

(Operator Instructions).

Matt McCall, BB&T Capital Markets.

Wanted to follow up on one of the last questions just to understand.

It sounds like service levels are very important to your market share gains.

Obviously, it's probably a pretty competitive market out there.

Can you maybe break down some of the items that pressured margins?

Obviously, it is volume.

But is there -- are you having to compete on price at all and maybe to what degree higher cost levels impacted your margins year-over-year?

Those are good questions.

The answer is absolutely.

When you see a downturn like this, our customers are asking for help on their profitability as well.

And so they are going back to all of their suppliers, asking for help in improving margins and we're doing that.

It is hand-to-hand combat sort of thing of working with builders, working with large customers to help them improve costs.

And so that comes in many forms.

We help them identify things they can do differently to remove waste.

We help them identify what they can do differently with sort of product selection, service selections, help them identify things that we can do to rebundle products.

Instead of just providing a hearth or a fire place, we're able to provide a mantle surround.

And it really depends on each market, each builder, each situation on what we do there.

And as we've said, there are some material cost drivers there as well.

It's difficult to get price.

And when you're faced with sort of this inflationary environment on material costs, we are fighting through that as well.

Then finally, certainly as the sales come down, you do get somewhat of a deleverage.

And so that's, as we talked about, really attacking that to take structural costs out, fixed costs out so that as we roll out of this thing or as it begins to bottom out, we have a very effective cost structure that puts us at or above the margins that we rolled into the downturn with.

So all of those factors are taking place simultaneously.

And then you guys quantify annual cost savings thus far or to date of $50 million.

Was that -- how should we look at that?

Is that -- was that recognized -- I guess two questions -- was that recognized in Q4 or what level was recognized in Q4?

And then, what should we look at -- should the full benefit be included in our assumptions going forward and/or is there more coming?

This is Jerry.

The $40 million of that 50 was completed in '06.

With another 10 million, that will be fully implemented in '07.

If you take a breakdown on fixed and variable, about two-thirds of that was fixed; about one-third of that is variable.

And so as far as going forward, just to keep that in mind, and as far as those costs giving credit for them going forward, that also is getting down to our new run rates also as far as volume -- as far as headcount and (multiple speakers).

Then finally, I think there was a question about raw material, the raw material levels that you're facing.

When you provide the guidance that you're providing, what cost levels are you using?

Are you using the end of Q3 -- the end of Q4 using yesterday's spot levels on some of these items?

I guess I'm trying to get a gauge on what any improvement would do to your margin line.

The numbers we're using basically are the costs that we see at the end of fourth quarter and beginning of '07 plus what we feel are the anticipated increases and decreases will be going forward.

So, you are looking at the prices that you face, but you are also trying to project out what the potential benefit could be?

Or are you just flatlining what the cost level was?

No, it's the first one.

We actually are looking at what benefits we can get during the year.

And what level of -- I guess two questions.

What was the pressure that you faced in '06 and what level of relief, if any, are you anticipating in '07?

Basically, we saw some modest inflation.

Mostly, it was cost pressures were up in the single digits on a lot of those items like steel, wood, etc.

And that is what we see for the year going forward.

On that I guess just pulling a little bit different scenario.

Doesn't seem like the cost levels are quite as high.

Maybe that is the spot market.

And the difference here is you guys don't necessarily recognize pure spot increases.

Is that right?

Well, we buy a very, very broad set of commodities from steel to aluminum to zinc to fabric to plastics to particleboard to veneer to core board to fuel, all the way through.

So, certainly, you could look at different categories and come to different conclusions.

But, when you net out the total market basket for us, we see modest inflation up, working on the gas (multiple speakers) to change that but that is what we factored in.

Okay but a better pricing environment at least in furniture?

Yes.

Budd Bugatch, Raymond James.

Jerry, I think you confused me.

On the $50 million cost savings, that's an annual number.

And you said something like 40 million was implemented in '06.

Was that recognized in '06 or what would be the -- what would you analytically think the impact would be in '07?

Is it 10 million just the delta or--?

No, it is in the total 50 million as we went and implemented them. 40 million of them were completed in '06.

The rest of them, we're completing here early in '07.

And that includes -- as far as additional costs taken out, this includes everything from the severance we've already recorded and anything that has to do with any facilities or other reductions, we're looking at those on a go-forward basis.

Most of them are in place though in January of '07.

No, I understand that they are in place.

I'm just wondering if I look at '07 as a year in total, what would be the incremental impact on the P&L in '07 versus '06.

Is it the total 50 million?

Yes.

It's a total 50 million will impact the difference in '07 versus '06, even though that 40 million has already been done.

You have accomplished the actions but the financial impact will be felt in '07.

That is correct.

And there was no impact in '06 essentially?

Correct.

For the most part, that is correct.

De minimis.

Exactly.

That was our final question.

Please continue.

We appreciate your time and your attention this morning.

And we wish you the best and look forward to speaking with you soon.

Thank you.

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