HNI Corp (HNI) 2017 Q2 法說會逐字稿

Good morning.

My name is Crystal, and I will be your conference operator today.

I would like to welcome everyone to the HNI Corporation Second Quarter 2017 Fiscal Results Conference Call.

(Operator Instructions) And as a reminder, today's conference call is being recorded.

Thank you.

Mr. Herring, you may begin your conference.

Thank you.

Good morning.

I am Jack Herring, Treasurer and Director of Investor Relations for HNI Corporation.

Thank you for joining us to discuss our second quarter fiscal 2017 results.

Here with me are Stan Askren, Chairman, President and CEO; and Marshall Bridges, Vice President and Chief Financial Officer.

Copies of our financial news release, earnings presentation and non-GAAP reconciliations are posted on our website.

Statements made during this call that are not strictly historical facts are forward-looking statements, which are subject to known and unknown risks.

Actual results could differ materially.

The earnings presentation posted on our website includes additional factors that could affect actual results.

The corporation assumes no obligation to update any forward-looking statements made during the call.

I am pleased to turn the call over to Mr. Stan Askren.

Thank you, Jack.

Good morning, everyone.

We'll share our assessment of the second quarter 2017 and then provide some thoughts on our outlook for the third quarter and full year, and then as usual open the call up for questions.

So I'll start off by saying we continue to see dynamic markets conditions with both a wide range of opportunities and challenges.

On the positive side, we're driving strong growth in our contract office furniture businesses, our North American contract business grew 9% in the second quarter and we are expecting stronger growth in the second half.

Our hearth business continues to enhance its leading market position.

We increased profit on flat sales in the second quarter and expect solid growth through the remainder of the year.

We are pursuing new opportunities and confronting several challenges.

As previously communicated, our supplies-driven office furniture business experienced a significant decline in the wholesale channel.

The decline was a step-down in a long-term trend we've been managing actively over the last several years.

In response, we are investing capabilities and advancing initiatives around quick ship, direct fulfillment.

Our response to these [shifts] will make us stronger in the long term as we become closer to our customers, delivering unmatched value.

Separate from the wholesale challenge, orders in our supplies-driven business came in later in the quarter than we expected.

Started slow and recovered late in the quarter.

As a result, more of our second quarter orders will ship in the third quarter than we previously expected.

Order rates have continued to recover, and we're projecting growth for the supplies-driven business in the second half.

Our focus on cost remains.

We are experiencing delayed cost savings as we shift resources to handle the rapid escalation of order rates.

As a result, we estimate $5 million to $6 million of net cost savings will be delayed from the second half into next year.

Despite these short-term challenges, our long-term view remains unchanged.

We see opportunities for both top line growth and ongoing profit improvement.

We will continue to drive our transformations, position our businesses for the future and continue to create long-term shareholder value.

With those comments, I'll now turn the call over to Marshall Bridges for some specifics on the second quarter.

Marshall?

Thank you, Stan.

For the second quarter, consolidated organic net sales were flat versus the prior year.

Including the impacts of acquisitions and divestitures, sales decreased 4.1%.

In the office furniture segment, sales increased 0.2% organically and declined 5.1% in total.

Within the office furniture segment, sales in our supplies-driven business decreased 7% organically or minus 11% when including the impact of divestitures.

Sales in our North American contract business increased 9% organically, or up 2% in total.

Sales in the international business increased 2%.

In the hearth segment, sales increased 0.4%.

New construction sales increased 2%.

Growth was softer than anticipated due to variability in timing within the single-family home construction cycle.

Sale of the retail wood and gas products decreased 4%.

This decline was due to the impacts of dealer/distributors moving to our more efficient just-in-time delivery model.

Sale of the pellet appliances increased $1 million or approximately 24%.

Non-GAAP net income per diluted share was $0.42 compared to $0.68 in the second quarter of 2016.

The change was driven by input cost inflation, deeper discounting, strategic growth investments, non-repeating corporate adjustments and unfavorable product mix.

Stan?

So we expect stronger demand in the second half of the year.

Our contract office furniture business has continued to drive strong growth, demand in our supplies-driven business is stabilizing and we're now seeing solid growth in our hearth business.

We're in the midst of multiple transformation, positioning our supplies-driven business for long-term success, driving further business simplification and improving our operational cost structure.

I'm confident our growth together with our demonstrated record of cost efficiency will continue to drive long-term profit improvement for our shareholders.

We will continue to invest for the long term.

One of our major investments is our Business Systems Transformation initiative.

I'll remind you, this initiative, which we call BST, is a broad-based transformation of how we work, a systematic RCI of our information factories and is a key enabler to our long-term success.

We are progressing well towards our next significant milestone, which is bringing a large portion of our North American office furniture businesses up live on this new ERP platform at the beginning of the fourth quarter.

In addition, we're investing in new products, selling and fulfillment capabilities.

This will further grow and solidify our position as the best cost producer in our markets delivering unmatched breadth, quality and services for our customers.

So Marshall, back to you.

For the third quarter, we expect consolidated organic sales to be up 7% to 10%, or down 1% to up 2% when including the impacts of acquisitions and divestitures.

Office furniture sales are expected to be up 8% to 11% organically, or down 2% to up 1% in total.

Organic sales in our supplies-driven business are projected to be up 1% to 4%, or down 6% to 9% when including divestitures.

Sales in our remaining office furniture businesses are forecasted to be up 15% to 18% organically, or up 7% to 10%, including the impacts of acquisitions and divestitures.

We expect hearth sales to be up 3% to 6%.

Within the hearth segment, new construction sales are forecasted to be up 7% to 10%.

We are projecting retail wood and gas sales to be up 2% to 5%.

And retail pellet sales to be flat to up 3% versus the prior year.

Non-GAAP gross profit margin as a percentage of net sales for the third quarter is expected to be approximately 39%, an improvement over prior year.

Non-GAAP SG&A, which includes freight distribution expense, is expected to be approximately 30% of net sales.

Our estimate of non-GAAP earnings per diluted share for the third quarter is in the range of $0.76 to $0.86.

Looking at the full year 2017, we expect consolidated organic sales to be up 2% to 5%.

The net impact of acquisitions and divestitures is expected to reduce sales by approximately $100 million.

As a result, total net sales are forecasted to be in the range of minus 2% to plus 1%.

Office furniture sales are expected to be up 2% to 5% organically for the year.

Sales in our hearth business are expected to be up 2% to 5%.

We now expect full year free cash flow to be in the range of $40 million to $50 million.

This is lower than our prior estimate due to reduced income expectations and working capital timing, driven by lower incentive compensation accruals and investments in inventory.

Our current best estimate of non-GAAP earnings per diluted share for the full year 2017 is in the range of $2.35 to $2.55.

Stan?

So I'll wrap this up then.

Our businesses are strong and performing well in their markets.

Our strategies are working and we remain committed to the investments we're making for long-term growth and profitable success.

We're confident in our ability to deliver profitable growth to create long-term value for our shareholders.

So with those comments complete, we’ll now open it up for questions.

And your first question comes from the line of Matt McCall from Seaport Global Securities.

So maybe start with the contract outlook, up 15% to 18%, I'm looking at the comp, I believe, it was down 10%, 11%.

But it seems like that's an acceleration.

I was curious about what you're seeing and maybe talk about the geographical strength or weakness, vertical strength or weakness.

What's behind that strength, other than -- I mean, the comp is easy, but there's some good growth on top of that easy comp.

Yes, Matt.

I mean, it's coming across the board and it's coming from many, many factors.

And as you know, these things go this direction kind of depending on where you're positioned.

And I think we're in the right position, I think we've got the right value proposition.

I think the teams are doing a nice job of executing.

There's no specific, I think, geography or vertical to call out here.

And we're pleased with the results and like what we're seeing here.

And does the pipeline indicate that this is -- there's anything that's not sustainable, that there's -- are there some big projects in there that would impact it, that would skew it upward?

Or is this an indication of the health of that part of the business?

Well, I guess, the way to answer it is, Marshall gave you the outlook, which is continued very strong contract sort of segments sales.

And so the pipeline is good.

It's a broad mix of large projects, small projects.

And so we see this continuing as far as we could see, which is basically through '17.

Beyond that, I'm not going to hesitate to pretend to guess what's out there, but we like a lot the momentum and we like a lot the prospects for the future.

Okay.

Perfect.

The cost savings delay, I think you referenced that you're pursuing stronger growth.

Maybe that's what delaying some of the savings, but can you first quantify the savings impact or the delays in Q2?

Can you maybe provide more details as to what exactly is going on there?

And then does the -- what does the delay, $5 million to $6 million, do to your outlook for FY '18 in terms of cost savings?

So I'm going to let Marshall answer the number questions.

But basically, I'll explain what's happening here, is orders started off slow in the quarter, and so we had a lot of operations folks that were deployed to initiating transformative moves, cost reductions, projects, consolidations, et cetera.

And then we saw a significant rapid acceleration of orders and demand, both in supplies and in contract.

So what happens there is you take people that are previously working on cost reductions and consolidations, and you put them on simply getting production out.

And so when that happens and you slow down moves because you need to get out what you have and you can't afford disruption.

And so that's really what transpired here is the simple sort of whipsaw of slow demand with very rapid demand means we're redeploying resources -- people and resources.

Marshall, any comment on the numbers?

Yes, Matt.

As Stan mentioned in the call earlier, we're expected to shift about $5 million to $6 million of cost savings from the second half of '17 into '18.

And so we're still trying to develop our '18 outlooks, we're not really prepared to talk about total cost savings, but we have talked about that $35 million to $40 million of structural cost reduction that we anticipate achieving.

And about $15 million of that will hit '18 now.

We'd expected that to be more like $10 million and the other $5 million hits '17.

So that's pushed out a little bit.

Okay.

Okay.

So Stan, back to what you were saying, are there -- are you running into any service issues because of this ramp?

Does it cost you any money to service the customer because you weren't able to kind of meet the demand or -- I'm kind of trying to get a handle on the top line impact.

Yes.

I think, Matt, the team is that a nice job of managing through this.

And so I think we're not seeing a degradation of service.

We're seeing some lead times extend a bit, but not in an unusual way, given kind of the seasonality of our business.

And if it costs us money, well, as we said, we're deferring cost savings.

And it's the right thing to do to protect our customers, our dealers, our resellers, et cetera.

Okay, but beyond the deferred cost savings, there's no incremental cost that you've experienced?

Not in a significant way.

No, we're not -- it's not a loss of business.

I mean, certainly as I say, because we're running flat out, we're not getting the productivity that we ordinarily are used to, but that's not unusual for this busy seasonal sort of aspect of our business to experience that.

Okay.

Got it.

I'm going to sneak one more in.

The competitive pricing pressures, is that just typical pressures that you see from your traditional, say, contract competitors?

Or is there something that's new, smaller players, newer players coming in, some of these new product categories?

What's the dynamic from a pricing perspective?

Is this just kind of how you've always experienced it?

Or is it something -- is there anything that's different about these current pressures?

No, I think it's -- I think you characterized it correctly when you say it's similar to what we've seen in the past.

I mean, as you know, in this contract world, it's a project-by-project sort of market-by-market local type of skirmish.

And so there are different periods when you'll see competition -- pricing competition go up or discounting go up.

It's nothing extraordinary from where we sit.

And by the way, you know as the guys that are pretty good at best cost producer status, we're prepared to play whatever game needs to be played there.

But it's nothing -- it's not new entrants that we see or nothing new that's changing the competitive dynamic, just more of the same.

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

I guess to make sure I understand the deeper discounting commentary, that is related to contracts or is it related to supplies?

Related to contract primarily, Budd.

Okay.

And that's deeper than before -- deeper than the first quarter, deeper than -- with the last conference call, Stan, where it's showing -- it's gotten more competitive?

Yes, it's a little bit -- it's deeper than last year, okay, somewhat.

And it's deeper a little bit than last time we talked, last time -- last conference call.

And you said that you think contract will be up 15% to 18% organically in the third quarter, is that right?

That's correct.

So are you the price leader here?

Is that -- because that's certainly faster than the market, right?

Well, I might have phrased [it] -- I don't know.

Budd, you know better than anybody here that nailing it all down is difficult.

There's lots of thing going on.

I mean, we all compete a little differently.

Our value proposition seems to be resonating well.

Our execution on the sales process seems to be going well.

And I think everybody is working the discounting lever a little bit more aggressively than the past.

And just to make sure I understand, is this -- are there verticals that are stronger than others here that you're free to -- that you care to disclose?

Or is it geographical?

Or how should we get the feeling of what's going on in the overall market here?

For us, it's broad-based, Budd.

Okay.

All right.

Broad-based geographically, broad-based vertical.

That's the way to understand that?

Yes, sir.

Okay.

You talked also about more investment.

Make sure I understand, where are those investments?

We needed to do investments in distribution for supplies with the shift in the wholesaler environment, is that correct?

Correct.

Yes.

And how do we think about that?

Can you not only quantify it, but give us some color as to where those investments are?

Are they distribution investments?

New DCs, how many and over what time period are they -- those investments likely to be made?

You've hit it right.

So it relates to the sort of our fulfillment investments, the fulfillment models, we're going to invest approximately kind of $5 million to $10 million this year, Budd, and that's probably going to hit F&D.

And you're right, it's investment in freight fulfillment and DC capacity.

And mostly, third quarter, fourth quarter, Marshall?

Or how do we think about that?

Yes, it will be -- mostly in the third and the fourth quarter, there was a little bit in the second quarter as well.

So pro rata, pretty evenly?

It will ramp.

It will be a little more in the fourth than the third, and the second was the lowest.

Okay.

And investment, when you talk about investment, does that hit the SG&A line or does it hit assets?

It's primarily going to hit -- this particular investment is primarily going to hit F&D, so SG&A in the broad sense.

So freight and distribution within...

Freight and distribution.

So these are period expenses?

Yes.

Got you.

Okay.

That's helpful.

Help me, if you would, Marshall, you went over the guidance and I thought you said net operating income up 30 -- is it 39%?

What was -- how did -- go over that again, if you would, a little more slowly.

This old man can't quite catch up.

Yes, yes, yes.

Okay.

Yes, in the third quarter, I think you're talking about gross margin we anticipated being 39%.

Gross margin?

Okay.

I thought you said operating margin.

That's what got me.

We said non-GAAP gross profit margin.

Appropriately 39%, which is an improvement over last year.

Okay.

Okay.

All right.

Very good.

And the other side of this equation is the guidance, the EPS went down by $0.05 on the bottom end and I think by $0.15 on the top end from your June prerelease.

What's changed?

Yes, the primary driver there, if you think about it, that's like a 10 point -- $0.10 drop on the midpoint, Budd, so the primary driver is those delayed cost savings we just talked about.

So that $5 million to $6 million that shifts into 2018 is a big driver.

And there's a little bit of incremental competitive pricing pressure that rounds out the balance.

And I think, Budd, when we did our release, we had the full visibility into the amount of resources that we needed to redeploy and to focus, to execute our current order demand and to take care of customers.

And so that's what changed.

And has there been any change in the revenue?

The revenue guidance in that June was, I think, organic, what, down 5% to plus -- down 2% to plus 5%, is that right?

Budd, there's really been no change to our outlook for revenue guidance for the year.

Okay.

I thought that the -- when I had the divesture of Artco Bell and some of the dealers, I had it at $80 million of an adjustment and you said $100 million.

So maybe you -- a little -- maybe offline Jack could go over for us how those adjustments look either backwards and forwards to make sure we got the right number, so we can do our model correct.

Okay.

Yes, so there's Artco Bell, but we also have some dealer kind of ins and outs, some acquisitions of dealers and some divestitures of dealers.

And so when we talk about the $100 million, we're including all of that.

So it's $100 million impact for the full year reduces net sales.

Okay.

And Stan, the last question for you is we've got a doubling of earnings in 3 to 5 years.

It's kind of a long-term outlook for HNI, which is certainly impressive.

Is -- any change to that at all?

Any change to your thinking?

Or maybe it's next quarter, 5 years?

Or has that spread out at all?

Yes, I think it's a great question.

But, I mean, the answer is no.

It hasn't changed.

And that's why we say 3 to 5. Because these things, these challenges and these opportunities come and go.

And so I would say we're as optimistic -- I am actually more optimistic about the outlook than I've been.

And we get these changes, I think we have a response.

I think we understand how to grow the top line, we know how to get after cost, we know how to manage our assets efficiently and it's a little bit of a [callout], a different play on the line.

But we're in great shape for this.

Does it go out from 3 years, more like 5 years?

Well, today, if you ask me I'd say it's, you said it, more like 4 to 5 years.

But stay tuned.

If we keep rocking and rolling on the contract, that double-digit top line growth, then maybe it's more like 3 years.

And so no, I continually feel great about the prospect of doubling earnings every 3 to 5 years.

Timing comes and goes.

And I'm pretty careful, by the way, about not getting nailed down to is it 3 years?

Is it 4 years?

Is it 5 years?

Because it is so dynamic out there and we're in multiple businesses with lots of good competitors.

And we adjust and I think we feel great about the investments and about our capabilities as an organization to continue to drive long-term profitable growth.

Okay.

And I guess, last for me is trying to understand what are the non-GAAP adjustments looking forward to in the third and fourth quarter?

And we got restructuring, we got transition cost.

Do we know what they are or what you're planning?

It's difficult to estimate those, Budd, given all the ins and outs.

But based on what we know now, I would estimate that we expect $3 million to $4 million of sort of restructuring and transition for the third quarter, and $4 million to $6 million in the fourth quarter.

Okay.

So $3 million to $4 million in the third, and $4 million to $6 million in the fourth.

Okay.

And that's what your guidance is based on?

Or is it -- your non-GAAP has gonna have, I guess, a midpoint of each of those, is that what you're looking at?

Well, the non-GAAP numbers would not include those.

So if they vary, it won't have an impact.

Your next question comes from the line of Kathryn Thompson from Thompson Research Group.

I wanted to circle back up on your North American contract sales, up 9%.

And as you said earlier, you're looking at mid to -- mid-teens or so for contract volumes in Q3.

And this, again, is an environment where you're seeing greater discounting.

There had been some leadership changes, from my understanding, within your organization.

So how have leadership changes or changes in the sales, how you approach sales, impacted this?

And also given that you are clearly outperforming the industry, what are the broad buckets where you're seeing greater traction?

Yes.

Great, Kathryn.

So to the first question here, I mean, the results that we're seeing in the contract business due to the selling cycle are really the result prior to these leadership changes.

The leadership changes are for lots of different reasons.

Sometimes it's succession, sometimes it's development.

So they weren't made due to performance.

And so I would say that the growth that we're seeing is not related.

Now, I'd also say the leadership changes hopefully will continue to accelerate that growth in the future, but not an impact on current state.

Again, where we're seeing this growth is really broad based.

So our contract business competes well in the mid size sort of client.

And we've talk to you about our value proposition, well -- or our value proposition position, I think we're positioned well there.

And so it's just a lot of different factors that are coming together that are leading us to win a lot of great business right now.

Big, small business, different geographies, different sectors, different verticals, whatever term you want to say.

Okay.

Again, once again, the office segment.

If you could break out between supplies and contracts, can you share at least directionally how margins trended between supplies and contracts?

And particularly, we understand that there is a disruption going in supplies.

But when you look at the overall performance in the quarter, getting a better understanding of how the contract versus supply's operating margins are trending.

Yes, Kathryn, there's not a major trend there between the 2 parts of office furniture.

Well, it's more like our supply's margins improving?

Or did they take a step back?

Are contract margins improving?

Or did they take a step back versus last year?

Yes.

Well, our results versus last year are down.

So it's going to be down consistently between those 2 sides.

Okay.

All right.

You may have answered this earlier in the call.

Apologies I came in a little bit later.

But could you give an update on the pace of your direct orders as you shift that supplies business model to more direct orders?

Yes.

We're really just starting that, Kathryn.

So it's just ramping up.

It's not noteworthy at this stage.

It's coming online as we expected.

And we would expect it, as Marshall indicated, to ramp up in the third quarter and fourth quarter.

It's just starting to get rolling now.

Okay.

And I note that you gave, you outlined a few factors that impacted the full year guidance, cost savings shifting into '18 in addition to discounting in the market.

But how much of a factor, if at all, did inflation play into lowered '17 guidance range?

Yes, Kathryn, we are expecting significant inflation around the 5% level for the full year.

But as it relates to our prior expectations, we had most of that in there.

There's $1 million or $2 million more inflation versus our prior expectations.

But the big drivers are the cost savings delay and the competitive pricing.

Okay.

Perfect.

And then, once again, not to beat a dead horse with discounting in the market, but it would be helpful if you could clarify what areas -- or if it's more small orders or if it's being more competitive with larger orders in terms of what is driving -- where you're seeing the greater pockets of discounting in the market?

Yes, I mean, I guess what I could say is it's in the contract segment.

And it would typically be the larger projects are seeing more competitive pricing.

A lot of the smaller projects, by nature, aren't -- don't get the same sort of shootout at the OK Corral than some of the large stuff does.

And your final question comes from the line of Greg Burns from Sidoti & Company.

In terms of the supplies business, what percent of that business is wholesale now?

Greg, approximately 20% of supplies-driven business runs through wholesalers as we sit now.

Okay.

And just I wanted to better understand, what's driving this shift?

Is this being driven by wholesalers moving to other suppliers?

Or is it being more driven by -- proactively by you and your customers?

Well, first off, it's -- the large customers are looking for more efficient ways to fulfill their furniture requirements, and we're responding to that.

Second, the wholesale model is challenged.

As you see, secular decline in supplies and sort of electronic office, you see them searching for a more productive future, a more productive financial picture, and that's leading them to take actions to change how they fulfill furniture, who they fulfill furniture to, et cetera.

We simply are responding to both customers and to our channel.

The wholesalers are important customers to us.

They play a valuable role.

We see them playing a valuable role.

Our best guess is that's shifting due to just sort of industry dynamics and more efficient and effective ways of fulfilling furniture requirements.

Okay.

And then lastly, could you just maybe give a little bit more color on how you expect this shift to benefit HNI once you have it fully implemented in terms of your direct fulfillment capabilities?

I would assume there's a little bit of a margin hit upfront, but maybe what are some of the broader benefits that you'll see from this move?

Well, I think we will be more connected, more closely connected to the -- actually the purchasing customer, the customer who's reselling and fulfilling the end user requirements.

I think it'll allow us to more fully capitalize on our lean capability of linking and leaning supply all the way through from sort of end last-mile delivery to production scheduling, et cetera.

You're correct, in the short term, there's a financial hit.

In the long term, we are always pretty optimistic about our ability to wring cost out and find efficiency in the supply chain to make the economics work.

Okay.

So do you see this connection with the customer is like an opportunity for you to gain market share in the supplies market?

Yes.

I think if we provide a better experience and a more efficient sort of fulfillment model, we're going to get more business.

And we believe we can do that.

And we currently have no more questions in the queue at this time.

Mr. Herring, I call -- I turn the call back over to you.

This is Mr. Askren.

So thank you very much for tuning in.

We appreciate your interest in HNI, and we look forward to speaking to you in the future.

Have a good day.

And this concludes today's conference call.

You may now disconnect.