HNI Corp (HNI) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the HNI Corporation second quarter results conference call.

(Operator Instructions) As a reminder, this conference is being recorded.

I would like to turn the conference over to our host, Vice President and Treasurer, Marshall Bridges.

Please go ahead, sir.

Good morning and thank you for joining us today for the HNI Corporation conference call to discuss second quarter 2008 results, which were announced yesterday after the market closed.

My name is Marshall Bridges, Treasurer and Vice President for HNI Corporation.

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

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

We have also posted a presentation intended to accompany this call to our website.

It can be found under the Investor Information Presentations link.

We encourage you to review the presentation with us during today's call.

Joining me on the line today from HNI Corporation are Bob Driessnack, Vice President and Controller, and Stan Askren, Chairman, President, and Chief Executive Officer.

Stan and Bob 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 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.

Thank you, Marshall, and good morning, everyone.

I'll share a brief assessment of the business and then turn the call over to Bob Driessnack, our Vice President and Controller, to review some of the specific financial details.

I'll then come back and share some thoughts on our outlook and then, finally, we will open the call up for questions.

Overall, we managed well during the quarter, confronting the challenging economic conditions and adapting our business accordingly.

Demand continued to be weak in two of our major channels -- organic quarter sales declined 27% driven by the continued and severe weakness in the new construction channel.

Builders continue to be stressed by low levels of new home construction, which were down 31% in the quarter.

In our office furniture business, sales in the supply-driven channel fell approximately 6% in line with our expectations.

Small office/home office customers who buy through this channel continue to be impacted by the weaker economy, inflationary pressures, and reduced credit availability.

The lower demand levels along with dramatically higher freight cost pressured profitability.

Diesel fuel costs were up more than 60% over the prior year, driving the significant increase in freight costs.

We are also seeing other inflationary pressures, particularly steel costs.

These impacts will be felt more in the upcoming quarters.

We effectively responded to demand and inflationary pressures with broad-based cost management and, as a result, exceeded our expectations for the quarter.

Simultaneously, to our cost-management efforts, we continue to increase our investment in new products and sale initiatives.

We are improving our competitive position and laying the foundation for long-term value creation.

There were other bright spots in the quarter as well.

Our office furniture sales grew due to the continued organic growth of our primary contract brands, which continue to gain market share combined with our acquisition of HBF.

The integration of HBF is progressing nicely, the market reaction to our acquisition is positive, HBF's new product launches are going well, and they won three Neocon awards at the recent Neocon show.

In our hearth business, there is extremely strong demand for alternative fuel biomass products.

High energy costs are driving demand in this category to record levels due, in part, to these demand levels, our acquisition of Harman Stove Company is exceeding expectations.

Harman sales were significantly higher than we anticipated, our hearth team has done a very fine job integrating the business, and we reduced their business working capital by more than 75%.

I'll provide more comments in our outlook.

I will now turn the call over to Bob Driessnack to review some of the specific numbers for the first quarter.

Bob?

Thank you, Stan.

If you would like to follow along, I'll occasionally make reference to the presentation Marshall mentioned, which is posted on our website.

Please note the presentation just summarizes our comments, and you do not need to view it to understand these comments.

For the second quarter 2008, slide six shows consolidated net sales decreased 0.8% to $613 million.

Organic sales were down 6.7%, or $41.5 million due to weakness in the supplies-driven channel of our office furniture business and the continuing decline in the hearth business.

Acquisitions added $36.5 million, or 5.9 percentage points.

Slide seven shows net sales for the office furniture segment increased 2.2% to $515 million.

We experienced a 6% decline in the supplies-driven channel.

The remainder of our business was up approximately 3% with our primary contract brands up more.

Acquisitions added $21.5 million, or 4.3 percentage points.

Slide 8 shows net sales for the hearth product segment decreased 13.9% to $99 million.

Organic sales declined 27% driven by a 36.5% decrease in new construction channel revenues.

Acquisitions added $15 million, or 13.1 percentage points.

Gross margins were 34.2% compared to 34.9% in the prior-year quarter.

A reduction in gross margin was due to decreased volume, increased material costs, as well as accelerated depreciation and transition costs related to the consolidation of several office furniture facilities.

SG&A as a percentage of sales was 30.1% compared to 27.5% in the prior-year quarter.

The increase was driven by higher freight costs, increased investment in product development and selling initiatives, and increased restructuring costs associated with the plant consolidation.

Included in SG&A were freight and distribution costs, which, as a percentage of sales, were 10.5% during the second quarter.

This compares to 9% during the same period last year.

The increase is primarily due to higher fuel costs.

Slide nine illustrates the change in freight and distribution costs.

The second quarter of 2008 included $3.6 million of restructuring charges and transition costs in connection with a facility shutdown, a facility rampup, closure of two distribution centers, and a consolidation and startup of a new distribution center.

The $3.6 million included $1.6 million of accelerated depreciation and other transition costs, which were recorded in cost of sales, and $2 million of costs recorded as restructuring costs.

The effective tax rate for second quarter 2008 was 34.5% compared to 35.3% in the second quarter of '07, primarily due to a reduction in state taxes.

We anticipate the annualized tax rate for 2008 will be approximately 35.7%.

Net income was favorably impacted, $0.01 per share, as a result of our share repurchase program.

During the first six months of 2008, we repurchased 1,004,700 shares at a cost of $28.6 million.

There is approximately $164 million remaining under the current authorization.

On Slide 10 you'll see cash flow from operations in the second quarter were $58 million compared to $55 million in the prior-year quarter.

The slight increase in the quarter was primarily due to lower inventories offsetting lower net income.

This brings year-to-date cash flow to $60 million compared to $96 million for the comparable 2007 period.

That wraps up the financial comments for the second quarter, and I'll turn the call back over to Stan.

Thank you, Bob.

As we look forward, we expect another challenging period in the third quarter primarily due to inflationary cost pressures and continued declines in new home construction.

We are implementing price increases, eliminating waste and attacking structural costs to offset inflationary cost pressures primarily from steel and freight.

Rising costs will be the single biggest challenge during the quarter.

We will begin to see the benefit of our combined actions in the third and fourth quarter and anticipate they will fully offset the current inflationary pressures by the beginning of next year.

Demand will remain mixed in the third quarter.

Sales of our alternative fuel appliances driven by high energy costs will continue to be strong, however, the category is not large enough to fully offset the new construction impact on our hearth business.

We also expect office furniture sales to grow modestly due to relative strength in our international and contract-oriented businesses and the HBF acquisition.

We expect our supplies-driven channel to be down less in the third quarter driven by the seasonal rampup and strength of government and education sales.

Our position in these vertical markets continues to improve; however, the underlying fundamentals of the small office/home office customer have not significantly changed consistent with the overall economy.

We expect the supplies-driven channel to remain soft in the near term.

Consistent with our actions in the second quarter, we will continue to tightly manage our costs and maintain our increased investment in the new products and selling initiatives.

We remain excited about our strong business platforms and our position once the business cycle turns.

I'll have Bob provide the financial outlook for the third quarter 2008.

Bob?

Thank you, Stan.

For the third quarter of '08, we anticipate overall sales will be approximately flat.

Office furniture is anticipated to be flat to up 5% for the quarter driven by a modest decline in the supplies-driven channel, solid organic growth in the rest of the segment, and the favorable impact of acquisitions.

Hearth is anticipated to be down approximately 10% to 15% including the impact of acquisitions.

Gross profit margin for the third quarter is expected to be approximately 2.3 to 2.5 percentage points lower than the third quarter of 2007.

The gross margin decline is primarily due to inflationary cost pressures and lower volumes in the hearth business.

As Stan indicated, we are implementing price increases, eliminating waste, and attacking structural costs to offset these inflationary pressures.

We have implemented price increases averaging from 3.5% to 4.5% across most of our businesses since April with the majority becoming effective July 1.

Most of our companies have also announced additional price increases averaging 3% to 10% depending on the market end product effective between August and October.

As a result of these increases, we expect to realize approximately 2% or over $10 million in price during the third quarter and approximately 3%, or approximately $20 million in the fourth quarter.

However, we anticipate input costs will increase over $30 million in each of the third and fourth quarters leaving us with a price cost gap.

We expect to completely offset the current inflationary pressures when the price increases become fully effective near the end of this year.

SG&A excluding restructuring and transition charges as a percentage of sales for the third quarter is expected to increase 2.3 to 2.7 percentage points compared to the prior-year period when it was 26.2%.

Approximately half of the SG&A increase is from the impact of rising fuel costs.

In the third quarter of 2007, freight and distribution was 9.3% of sales.

We project this to increase approximately 1.25 to 1.5 percentage points in the third quarter 2008.

The remainder of the increase primarily relates to not repeating $5 million of non-operating gains that we had in the prior-year period and additional investments related to product development and selling initiatives.

We anticipate SG&A-related restructuring and transition costs to be approximately $700,000 to $800,000 in the third quarter.

We expect net interest expense to be $4.1 million to $4.3 million, a slight decrease from the same period last year.

We anticipate the effective tax rate during the third quarter will be 35%.

I'll turn it back to Stan.

Thank you, Bob.

So, overall, we'll continue to confront the economic challenges facing us and adapt our business to them.

You should expect more strong cost management, aggressive pursuit of improvement, structural cost reduction, and continued investment for growth.

We are improving our competitive position, sharpening our cost structure, and laying the foundation for long-term value creation.

We, I, continue to be excited about our position once the business cycle turns.

With those comments complete, we'll now open it up to questions.

Thank you.

(Operator Instructions) Matt McCall, BB&T.

Just to clarify the guidance first -- you gave your SG&A guidance, and you said that there is another $700,000 to $800,000 in charges.

Is the $700,000 to $800,000 included in the guidance range that you provided for the SG&A line?

No, Matt, that would be on top of that.

And, obviously, a great job managing costs in the quarter.

The first part of the question is can you provide a little bit more detail as to what you did and then maybe what's left that you can do?

So, Matt, I mean, what we did is a lot of some big things and a lot more small things.

So if you remind these kind of our split and focus business models, we have these multiple businesses.

Each have focused management teams and a very disciplined process around managing to their particular market, their particular cost structure.

So it's kind of the stuff that we do well, have done well, over the years.

So first we look at what are the big structural costs, and so we talked about plant consolidations and change in our logistics distribution network.

The second thing, then, is just good old-fashioned cost management of both in the operations as well as in SG&A.

What's left, I guess, was the second part of that question -- it's more of the same, is what I would say.

There's still more structural costs that we're after.

We don't really lay that out on a prospective sort of basis, so as that develops, we'll share that with you, and then just grinding it out, day-to-day, in each of the operations, each of the businesses.

And help me I understand -- I guess you beat both my -- or our expectations and also the implied guidance ranges that you gave last quarter.

Where did the surprise come, and can we expect similar surprises to come in future quarters?

I can't tell you on the last one, I guess.

The surprise really came, as I say, there's no one big area.

It's just kind of the culmination of these eight to 10 business units just kind of grassroots, plant-by-plant, business-by-business, just managing well, and the culmination of that, really, is what the surprise ends up being.

Okay, and then -- thanks for the detail on the expected price recognition and also your inflationary pressures.

Can you tell us what that was?

What the net effect of maybe price versus inflation was in Q2?

The net effect, Matt, was probably about $5 million unfavorable to the year-over-year results.

Todd Schwartzman, Sidoti & Company.

With respect to commodity costs, could you talk a little bit about what you've seen in foam?

Yeah, I think, Todd, foam is a petrochemical base, so we are seeing some modest increase there.

And maybe, if you could, some comment on the pace of contract furniture orders throughout 2Q?

The pace was good.

I think we said that our business was solid there.

So I'm not sure what else -- ask another question here, Todd, to make sure I'm covering what you want to know.

Well, fairly steady month-to-month throughout 2Q?

Yes, I would say it's fairly steady month-to-month.

Okay, and, again, in office furniture, what were the strongest and weakest geographical markets?

We don't break that out.

I mean, certainly, in the past, the New York financial markets are not great.

The Southern markets are not great right now, just due to -- a lot of it is associated with housing as well, so if you go to markets that are not great in housing, the small office/home office guys are not doing great as well.

And in terms of housing in those weakest residential real estate markets around the country, are hearth sales down commensurately with housing or is are they performing a little better, a little worse?

I think, you know, overall, our business is so dependent on new construction that our sales are going to be down commensurate with starts.

Budd Bugatch, Raymond James.

Congratulations on the quarter.

And it's hard to say congratulations in this economy with what you're having to face, but you've done a terrific job of managing through this, or you're doing a terrific job of managing through it -- so congratulations to all your associates, too.

Appreciate it.

Just a couple of issues on segment margins -- pleased to see -- I think your original guidance was for hearth to be breakeven or so abouts, and you did a little bit better than that.

As you look down the road here in third and fourth quarter, what do you see as the segment margin track?

Bud, for the third quarter it will be comparable to the second quarter, a little bit better because it's a seasonal quarter for us but still, certainly, under pressure.

For the fourth quarter, I think it's still kind of far out.

We're still waiting for that visibility and seeing where the seasonal business goes.

Housing -- don't see it improving at all, obviously, in the near term.

I think, for you, that's going to be even a late cycle when it does improve.

So at least for that side of the business.

The biomass, then, seeing good demand and any change in that?

No.

In fact, Budd, there's tremendous demand there like we have never seen before, and that just gets better, and it's driven by factors like fuel oil costs in the Northeast and also in the rural areas -- liquid propane costs and those both have seen very large escalation in previous months.

And so we think that's going to continue to be strong until those change.

I think you may have told me you were being challenged to keep up with the demand.

Is that still the situation?

That is the situation.

The growth in those are several -- 100%, 200%, 300% sort of numbers, and so we're sorting through what's the right capacity to bring online.

Certainly, when you see that type of growth just being smart about a sustainable profit model as that cycles is what we're looking for.

The second part is just a challenge -- it's just suppliers.

Are you trying to rationalize some of that excess demand by pricing?

Yes, certainly, that's what's going on now.

Now, a lot of that is supporting our dealers and our distribution.

They're out there selling as well, so pricing is clearly one of those things that we are putting through and is being discussed a lot in that channel.

Okay.

And in terms of office segment margins, 6.5% in this -- normalized in this quarter -- next year -- last year, third quarter, if I remember right, seasonally, you were like 11.7, if I remember right, or 11%.

Obviously, don't expect to see those kinds of op margins, but what do you think?

Budd, I think what we will see is a margin that's fairly comparable to the second quarter, the key reason being the material cost increases and the input costs with fuel and things that we talked about.

Some of the competition has imposed fuel surcharges.

Are those realistic in office?

Can you get that?

It depends on which channel, Budd.

Our supplies-driven channel, which goes through wholesale, catalog, et cetera, is more difficult for our channel partners to recover that.

So we're trying not to hang them with it.

Some of the other channels that are more direct through a dealer to an end-user client, then it is easier to get it.

So we have kind of a mixed bag here -- some of our companies have it on; some do not, depending on their go-to-market channel partner situation.

And if I heard the numbers right, it looks like your input costs, as it is now today, are running an incremental $30 million a quarter, and that's what it needs to get to full recovery?

And your pricing looks like it probably averages maybe 4% to 5%.

So -- it's as you will start to get recovery of that, then maybe a little bit of that gap you've faced sometime first and second quarter next year?

Actually, what we're seeing, Budd, is there's a gap that, barring some additional sort of step-up inflation, we think that gap will be closed on a dollar basis by the beginning of next year.

So we begin to close a little bit in third quarter, in the October -- sort of August/October price increases come online.

We then begin to close it some more fourth quarter, and then by the beginning of the year, when it's fully implemented, we should be closed on a dollar basis.

Okay, but is that $30 million of incremental input cost a quarter about right?

That's correct.

Okay, and that's where it is today, knowing what you know today --

Correct.

Barring any future moves in the commodities.

Correct.

Okay.

Last question for me, then, goes to the fundamental question is, as we raise prices and have to cope with all of this, what are you seeing alternative competitive nature that might worry people and investors about elasticity of demand and these kinds of issues?

It's a great question, and I don't think we have a great answer on that.

I think we'll have to wait and see.

Certainly, our kind of diversity of product categories and material sites and segments in the market gives us a better position, I think, than a lot of folks.

But I think, as prices go up, you may see people defer, pull back, or move to a different price point sort of product.

Our advantage is we have all the price points in the industry covered, for the most part.

We'll have to watch how this inflation and price increase impacts demand.

I don't see a big change, but we'll have to watch it.

Okay.

Well, great, and continue good work, gentlemen.

Thank you, Budd.

(Operator Instructions) Christopher Agnew, Goldman Sachs.

Thank you.

Good morning, gentlemen.

Congratulations on a very strong execution in a very tough environment, particularly on the acquisition side.

How would you describe your appetite for acquisitions at the moment, and are sellers out there, or potential sellers, are their expectations in line with yours or is that a barrier to, maybe, you doing potentially some more deals?

Well, I think, Chris, our acquisition strategy continues, which is we are always open and evaluating potential acquisitions that fit our business, that we can, by owning, we can create value.

So that continues.

I think your question around pricing -- certainly, there are some positive signs -- the private equity leverage buyer is out of the market.

That makes things more attractive.

The challenge, though, is in a down cycle many of the companies will wait until their earnings recover before they want to put themselves on the market.

So it's probably a smaller available group with probably not as much competition there.

But go back -- our strategy continues of finding companies that fit our business that we can create value with.

Okay, and on the contract side of the business, obviously, a longer tail, and you won't comment on any particular numbers looking further out, but are there any indications in terms of order activity, markup activity, conversations with customers that you're seeing that you can provide to us?

Well, I think what we said is we expect the contract business and our international business to continue to show some modest growth in the third quarter, so we're looking at 2 to 6.

I think we have the same question as you do, and it's still a relatively short cycle -- is as this economy cycles down, what's the impact on some of those longer-selling cycles?

So bid activity is hard to even track right now because it's moving around.

So we're looking at this, saying, when you take our non-supplies-driven business growth of 2% to 6% makes sense to us.

Your supplies-driven business, contract?

They are non-supplies-driven.

Non-supplies, right, right.

And steel -- obviously, it's going to be up year-over-year and sequentially.

But in terms of with the U.S.

economy softening, are you seeing any opportunity for steel prices coming down, as you're looking at the market, as your buyers are talking to the mills, et cetera?

Yes, I think you all watch us closely, and you understand, I think, as well -- what we're seeing is certainly the U.S.

economy and the softening of auto, appliance is a plus, and then it's offset by the dollar and offset by global demand -- China and India, for infrastructure.

I think the steel guys are feeling big input cost pressures as well, and they're going to work very, very hard to hold their price.

So to answer your question, we're not seeing pressure either way right now at this point.

I hope we see pressure for it to go down, but we're not banking on that right now.

And is there -- has there been any change in the way you think about committing or think about how you go about buying steel?

Has there been any change on the supplier side as well?

Yes, I think the challenge always in these situations is we -- who wants to commit and who wants to lock down on contracts?

I think it's fair to say that we had some longer-term contract commitments, and along with lots of companies in the U.S.

economy, and when steel input costs went up, and steel prices went up, the steel suppliers all chose not to honor those contracts.

And so we're -- now the question is, where is steel going?

And so I would say we haven't changed how we think about this.

We have the same set of tools, it's just how well you manage it, and where is it going?

So I think it's a lot of what we've learned in the past in these situations.

Would it be fair to say that future movements in sales are probably going to have a more direct or immediate impact on your earnings?

Yes, I would say so because right now there's not many in the U.S.

economy that are locked into longer-term contracts.

Okay, great, and good luck.

Thank you, Chris.

Craig Kennison, Robert W.

Baird.

Congratulations on your cost-cutting initiatives.

Most of my questions have been addressed, but with respect to your hearth sales guidance, what does that assume in terms of acquisition revenue?

For the third quarter, we've got about $10 million or $11 million in acquisitions included in that guidance.

And could you remind me what it was in the second quarter?

The second quarter was about $15 million.

Is that mostly a seasonal downtick?

It's not really a seasonal downtick.

I think we had a very strong second quarter, probably a little bit better than we had initially expected, and the third quarter is in line with our initial expectations.

Okay.

And then just going back to Bud's question on the biomass market -- how large, potentially, is that market and how significantly, really, could it move the needle in the hearth business?

I guess I'm asking what percentage of your hearth business is currently represented by that biomass market and how large could it be?

I think we're covered.

The biomass side of our business is about 15% of our total, roughly, right now.

And, Craig, we'll get you a better answer here -- about 15% of the total business.

It's growing at a very high rate.

The potential of that, if you go do the studies of what the available market is, potential market, it can grow, we think, over the years, at a significant number.

The key driver to that is the relative cost of the biomass fuel -- pellets and corn and other things relative to the cost of fuel oil and LP.

And so we think there's a lot of legroom there.

We have a significant share of that market.

I would say probably upwards to 40% to 50% of that current market, and we will participate in that, I think, in a nice rate.

And would you just walk through an example of the install process?

Is this something that can be used both as a retrofit and for new construction?

And what's the cost to a consumer looking to retrofit, for example?

Typically, it's used as a retrofit or a supplemental heat, zone heat sort of thing.

So, typically, you're going to always put in a central system.

Some of these biomass appliances can be actually integrated in with your heat pump system or your forced air system.

But, typically, you'll find a room in the house on the main floor and to use it to be a boost to your central system.

The cost of installing those, depending on the system, is in the $3,000 to $8,000 range depending on the type of appliance and the complexity of the install.

And any sense that current market price is for fuel -- what kind of payback period it requires?

Again, it depends on what part of the world you live in and the cold index, and it depends on availability of fuel.

The closer you are to a fuel source, the better the cost.

It depends on what part of the country -- whether you're fuel oil or LP.

But typically we're seeing payback right now -- a couple of years.

And, with that, Mr.

Bridges, we turn the conference back to you.

Okay.

We appreciate everybody's interest in HNI; look forward to talking with you soon.

Have a good day.

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