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Good morning. My name is Heidi and I will be your conference operator today. I would like to welcome everyone to the HNI Corporation Second Quarter Fiscal 2018 Conference Call. All lines have been placed on mute to prevent any background noises. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, today’s conference 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 2018 results. Here with me are Jeff Lorenger, Chief Executive Officer and President and Marshall Bridges, Senior 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 Jeff Lorenger.
Good morning, everyone. We will see our assessment in the second quarter and provide some thoughts on our outlook for the rest of the year. We will then open up the call for questions.
Results for the second quarter exceeded our expectations. Stronger top line growth was the main driver of our performance. We delivered organic sales growth of over 8% for the quarter. As we look across our markets, we see strong overall activity in customer engagement, our investments in distribution in new products and fulfillment capabilities are being well received and gaining momentum. We are encouraged by the performance of our supplies driven business, which was up 10% in the quarter. We continued to refine our supplies operating model and are pleased with the results. We are successfully navigating what continues to be a dynamic environment with significant channel shifts. We like what we are seeing and are excited about where we can take the supplies business. In our hearth business, we continue to generate strong results. Hearth grew nearly 11% in the quarter with strong performance in both new construction and retail products. We continue to compete well on hearth with brands, products and fulfillment capabilities that are unmatched.
Shifting to the cost side of our performance, we had higher than expected operational costs. Part of the higher operational costs were inflation driven, part were due to a slower ramp up on cost savings and productivity initiatives. We remain on track to achieve our cost savings and productivity goals, but the timing of some projects will finish later than previously expected.
I will now turn the call over to Marshall to review the financial details of the second quarter. Marshall?
Thanks, Jeff. Second quarter consolidated organic net sales grew 8.4% versus the prior year. Including the impact of closing and divesting small office furniture companies, sales increased 5.7%. In the office furniture segment, sales increased 7.8% organically or 4.3% in total. Within the office furniture segment, sales in our supplies driven business increased 10%, sales in our contract business increased 5% organically or were down 1% in total. In our hearth business, sales increased 10.8%, new construction sales increased 10% and sales of retail products increased 12%. Non-GAAP net income per diluted share was $0.44 compared to $0.42 in the second quarter of 2017. Organic volume growth and lower taxes more than offset incremental costs from our Business Systems Transformation project and strategic investments. Jeff?
Thanks, Marshall. Let’s shift to our outlook. Looking forward, we expect to continue driving strong sales growth. We have momentum in each of our business and expect mid single-digit organic growth for the second half of the year. For the third quarter, we expect our supply-driven business will be up 6% to 9%. Small business demand has remained strong and we are competing well. We are seeing strength across our customer base, which is more than offsetting continued declines in the wholesale channel.
We expect our contracts business to grow 2% to 5% in the quarter, while the growth in contract is slightly lower than we – what we saw earlier this year. We feel good about our forecasted growth on top of the 22% increase we delivered in the third quarter of last year. We expect our hearth business will be up 2% to 5%, our new construction business is forecasted up 4% to 7% with sales of retail products flat to up 3%. As I noted earlier, we are seeing higher operational costs. In the second half we expect the negative impact from additional inflationary pressures and delayed timing related to our cost savings and productivity initiatives. The primary driver of the slower ramp up on cost savings and productivity is the longer adjustment period related to our BST implementation. That said, the issues are short-term, I feel good about our BST implementation and our ability to deliver significant shareholder value. We have line of sight to our future stay and are making daily progress on our journey. I remain confident 2018 will be a year of strong organic top line growth and improved earnings.
Marshall will now provide financial details on our outlook.
Looking into the third quarter, we expect consolidated organic sales to be up 4% to 7% or up 1% to 4% when including the impact of closures and divestitures. Office furniture sales are expected to be up 4% to 7% organically or up 1% to 4% in total. Sales in our supplies driven business are projected to be up 6% to 9%. We are forecasting sales in our contract business to be up 2% to 5% organically or down 2% to 5% in total. We expect hearth sales to be up 2% to 5% and as Jeff referenced we expect new construction sales to be up 4% to 7% and that retail product sales flat to up 3%. Non-GAAP gross profit margin is expected to be between 38% and 38.5%. Non-GAAP SG&A which includes freight and distribution expense is expected to be in the range of $180 million to $185 million. Our estimated non-GAAP earnings per diluted share for the third quarter is in the range of $0.80 to $0.90.
Okay. Let’s shift to the full year, so looking at the full year we now expect consolidated organic sales will grow 6% to 8% or be up 3% to 5% in total. We are expecting our office furniture business to deliver organic growth of 6% to 8% with our hearth business up 5% to 8%. We estimate non-GAAP earnings per diluted share will be in the range of $2.35 to $2.55. This compares to our prior guidance of $2.40 to $2.70. The primary driver of the reduced full year outlook is the higher operational costs we mentioned earlier. Jeff?
Thanks Marshall. We remain positive about our markets and prospects for growth both in top line and earnings. We have strong brands in the markets we serve and the operating platform to drive significant long-term shareholder value. With those comments complete, I will now open it up for questions.
Thank you. Your first question comes from the line of Budd Bugatch with Raymond James. Please go ahead.
Good morning, congratulations on the quarter. Jeff and congratulations to you on your first conference call.
Thanks Budd.
And good luck to you on your tenure. Go over if you would again for us or maybe a little bit more slowly what are you saying in input costs and how do they look going forward?
Yes. But for the year we are seeing the total inflation of around $60 million and that’s weighted a bit in the back half which is about $15 million to $20 million each of the third and fourth quarters.
And what about pricing to overcome that?
Yes. For the year, we are expecting price realization to be in the range of $50 million and again that is weighted in the back half and around $15 million to $20 million into the third and fourth quarters.
So basically pricing will offset that in each of those each – the inflation of each of the third and fourth quarter and what you are saying is you have gotten somewhere between $10 million to 20 million on pricing already?
That’s correct, except for – but I am not sure we are going to fully offset the inflationary pressures in the back half. The gap will be pretty small, but we do expect a small negative cap there.
Okay. And basically are you seeing any moderation or stabilization in costs, situation is pretty dynamic. We have seen some inflation over the last 3 months and so as we said right now, this is our best estimate, but it’s a pretty dynamic situation out there.
Sorry, go ahead, Jeff.
No, I think Marshall said we are looking at all input costs and it is – it’s dynamic. This is our best guess at this time and we are monitoring it very closely.
And when you talk about input costs, so would you rank the issues for me, is it steel primarily or was it steel plus, steel plus freight, where is that?
Yes, they are fairly broad-based. Approximately two-thirds of those input costs are material and within the materials bucket, steel is the biggest driver there, but we are also seeing pressures from other metals and a variety of commodities. And then we are also seeing some pressure on the freight side as well as some other buckets as well.
What are some of the other buckets make sure we…
Labor would be the biggest of those, but there are other items as well.
Okay. Also talk to us a little bit about if you would the delay and the productivity in the BST maybe explain a little bit what’s going on there?
Yes, Budd. I think first let me say that we are pleased with the platform overall. It’s going to be a powerful framework for our future. The bottom line is we have changed all the workflows for the organization and suiting us. And it’s taking just a little bit longer as the organization gets comfortable working in a new system in order to go get that productivity. We have line of sight to it. Confidently, we are going to go get it, but it’s probably a quarter delayed in some of the projects and the projects are all over the board as well. So, there is a lot of little projects and we are getting after some of them and they are hitting and other ones are just – are delayed.
And so can you quantify that at all, how do we quantify it, where does it hit in terms of P&L where we do see that and where the difference is to what you thought you were going to see earlier in the year?
Yes, but the delay is probably hitting in the back half approximately $6 million negative impact. That’s disproportionate in the third quarter and is where it hits in the P&L, there is a mix between cost of goods sold and freight costs there, freight distribution, more on the cost of goods sold, but not as wages you might think if and where the costs are.
So, if you say it’s disproportionate, you are saying something like $4 million in the third quarter, $2 million in the fourth?
That’s good estimate.
And this is virtually to your original expectations or is that how do we think about that?
Yes, that’s versus our last set of expectations.
Okay, alright. And I know and congratulations on the fact that supplies driven business is growing faster, maybe you can characterize what you are also seeing in contract – which the debt market look like today?
Yes, Budd. I would say overall, there is solid market momentum out there. It’s still a bit choppy, but overall, we are competing well. The market is pretty active. I think the third quarter story is we still like our growth. It’s going to be like I said earlier a little slower based on the 22% comp of prior year, but the contract market is about what we thought it would be and it continues to be and we are going to grow, we are going to show growth in the back half.
Organically, but again, you have that divestiture right, which you are comparing against?
Correct. The divestiture and a closure of that will be our carving out for the organic growth calculations, but….
Can you quantify those, what’s the lost – given the divestiture in each of the last two quarters?
Yes. The divestiture had the impact in the first half divestiture and the closure of decreasing net sales, approximately $25 million and the increasing operating profit approximately $3.5 million in the first half. Those are both first half numbers.
And in the last half, what are you looking at in terms of the divestiture impact and the closure impact?
Yes. For the second half, it will be in the range of $32 million of sales impact and approximately $3 million of operating profit impact, so an increase in operating profit of $3 million and decreased sales a little over $30 million.
Okay. Thank you. I will let others get on this call. Thank you very much.
Thanks.
Your next question comes from the line of Kathryn Thompson with Thompson Research Group. Please go ahead.
This is Brian [indiscernible] on for Kathryn Thompson. Congratulations on the quarter. First question I guess would be on the hearth business, good double digit growth here, can you just clarify any drivers for that business, why that was kind of the double digit growth you saw for the first time in a while and then how that might contribute to fiscal year ‘18 guidance?
Yes. Hi Brian, this is Jeff. I think the hearth business overall is competing well. They are on their game and on all other segments. That drove growth rate to a little bit higher than we anticipated. So overall for the year we expect to be up high single-digits and so the quarters may move around a little bit, but overall sort of the up high single-digits. And the drivers are really that they are executing well with their platforms and hitting on a lot – most of their cylinders.
Okay. And I wanted to follow-up for transportation costs, have you seen any increase in those and are those impacting margins at all?
We have seen some inflation from freight costs both inbound and outbound freight and that’s in that $60 million total input cost increases that we mentioned earlier when we are answering Budd’s question.
Thanks.
Thank you.
Your next question comes from the line of Matt McCall with Seaport Global. Please go ahead.
Thank you. Good morning everybody. So that maybe go back to the productivity delays and the cost save, the reconciliation of cost save, I am just trying to understand actually the – I know there are some thing that have been progressing quickly, is it doing anything on the service level front, because people set the first concern on folks here that the ERP, are service levels being maintained, are you having to spend more to ensure that they do just help me understand what the customer maybe seeing?
Yes. Matt, this is Jeff. I think the service levels we worked through we may add a couple of issues there right after July, but we worked through the service levels to customers that was job one. And so we have worked through most of that really quickly to maintain service levels. And in fact in some of our efforts in order to do that because we wanted to maintain those levels we had to rely on some of the other things. I think that’s just part of kind of intricacies of how this has gone.
Okay. So is the – is there a financial impact from maintaining those service levels that goes beyond just that the way that the savings what I am getting at is you got the delayed savings that you are expecting – expected, but is there in addition to that some service level expenses that were maybe or service expenses that were maybe elevated?
Yes. No, I don’t really think so Matt. There was – we just focused the core group on those service levels maybe before they went after some of the other stuff and for a few extra months. But now there is not like a permanent service level increase in costs at all.
Okay, alright, that’s helpful. Thanks Jeff. So I think one of the questions was asked around pricing overall, what about contracts specifically, what was the contract pricing benefit in the quarter, what’s baked into the guidance as we progressed through the year, I know you guys have talked about the demand environment, what’s the pricing environment overall look like for contracts specifically?
The pricing environment in contract Matt is pretty similar to what we have seen in the last several quarters.
Yes. I would say Matt it’s pretty stable. We monitor it obviously pretty closely, but right now as we saw in the second quarter, we project that the pricing environment is pretty stable, not too much volatility from our vantage point.
And we are not seeing a meaningful difference in the price utilization between the supplies-driven business and contract business at this point.
Okay. And the price realization and the timing of the price realization is all pretty consistent across those businesses?
Yes, it is.
Okay, alright. So, I just want – I don’t look you said there is – I apologize I am in the lobby right now, so I can’t hear part of it. But you talked about, Marshall, your input cost expectations for the back half and your pricing expectations for the back half how does those compared to what you thought there we are going to be a quarter ago. So, I can give a $60 million in cost in the back half, where did that number look like and in the $50 million in price, what did that number look like last quarter?
Well, there has been a lot of movement there, but if you boil all that, Matt, I think it’s about $5 million to $7 million higher on the input cost side in the back half and the pricing is pretty similar to what we had thought back in May when we did the last call.
Okay, okay. So – and the last question I had I guess related to that as we look out, it looks like in your Q4 guidance and the other outlook you gave, it looks like you are pointing to some margin expansion in Q4, can you give us an idea of the level of comfort you have, but Marshall, could you help me out with kind of a bridge to the future when it comes to some of the buckets. Can you remind me of some of those buckets where they stand today and how they give you confidence that Q4 should start to show some margin improvement on a year-over-year basis?
Yes, Mat, this is Jeff. I would say, from a high level, as we have talked about, I think – our active velocity coming out of BST implementation was a little bit slower on the ramp, but we like what we see as we look out. And I think that in the fourth quarter we are going to start to see the benefits of that albeit maybe a little bit delayed. And so that we have line of sight to that and that gives us confidence in a macro sense that we are going to be able to expand margins in the fourth quarter.
Yes. The biggest driver of that fourth quarter product expansion, Matt, is the productivity cost savings achievement that Jeff is mentioning there. We also need to continue to see the good volume growth and minimized that price cost gap that we talked about earlier. The one unique thing and it’s not terribly large is the impacts from BST start to reverse in the fourth quarter. It’s been a negative in fact for the first three quarters but we will see benefits from that as we anniversary some cost that we expense last year that we no longer have.
Okay, alright. Thank you, guys.
Thanks Matt.
Your next question comes from the line of Greg Burns with Sidoti & Company. Please go ahead.
Good morning. What percent of your business is here on the supply side is coming from also?
I would say it’s probably in the 5% to 7% range. Is that about right?
Yes, dramatically, it’s the kind of low teens, yes.
Okay. And then…
And then I guess perhaps we should clarify, I think Jeff answered the question as percentage high and I am answering, it’s the supplies business.
Okay, alright. And what’s the profitability of going through the wholesale panel versus direct, is your direct margins comparable to what that were when you were going majority through wholesale?
I think you are good in QR, kind of quick shift fulfillment or maybe you are talking about just in general if we don’t go to the wholesaler. At this point either way, we are working through those new flows and new processes.
Yes, Greg, I think we anticipate, look we got some startup costs on that and then we are early on in this journey, but we anticipate those margins will be comfortable going forward as this model gets built out.
Okay. And could you just talk about maybe some of the programs or initiatives you have in place to better service that dealer channel as you move away from the wholesale, I know at NeoCon we saw a little bit of the EasyQuick product kind of initiative in the HAN showroom, so if you can just talk about any of those? That will be helpful. Thanks.
Yes. We have got multiple, I mean, what we are really doing is we are getting close to the DSRs and the dealer sellers in those markets that rely on that type of service. We are putting in place new selling capabilities, new selling tools in digital tools that make your life easier in order to process their business. And we are really providing support in the sales process that they require in order to make the sale and make it easier and part of that you saw at NeoCon with the EasyQuick project is determining what they need and the make-me order that part of that program as well is we are making – the make your order business easier for them by going to high runners and a group of products that they can sell easily everyday and be comfortable with.
Okay, great. And then lastly could you just talk about your plans in terms of e-commerce, I know you purchased, but what are your plans for that asset maybe leveraging that to accelerate growth of the supplies in HAN?
Yes, it’s a great question. We are investing in that business right now and it’s growing fairly rapidly and where we are driving those capabilities across the business where it makes sense. And also we are running that business separate, but we also are working with HAN and merchandising the appropriate HAN products through that channel, but it is a growth platform for us for sure.
Alright. Thank you.
We have a follow-up from the line of Kathryn Thompson with Thompson Research Group. Please go ahead. Kathryn Thompson, please un-mute your line and go ahead.
So, just following up on that free cash flow guidance that you have given at the beginning of the year, you gave a range for $100 million to $120 million. Is there any change in that projection and how should we think about as we look over the next 18 to 24 months in terms of that free cash run-rate?
Hi, Kathryn. Yes, we are estimating now that our free cash flow be in the $125 million to $135 million range for the year. So that’s an increase over what we had said at the beginning of the year. And I think we are focused on driving that free cash flow and we should expect similar results for the next year or so.
Okay. Also could you give anymore color and then this is really more stepping back and looking at [indiscernible], any color on market momentum or feedback in the office side in terms of what you are seeing in terms of momentum of business and this is kind of more of your day-to-day business is how we think about that’s an indicator of broad economic trends? Thank you.
Yes, sure. As I have stated earlier, Kathryn, I think we are seeing strong momentum on the supply side for sure and it is coming the market we are executing well by making the investments I think to meet the market and the market is fairly strong out there, the small and medium business activity is strong and that translates to really core day-to-day business as we look at it. So I see that momentum continuing. We see some strong momentum on the contract side as well. So overall, the furniture space from our vantage point has got strong momentum and we like what we see.
And so it’s better improving momentum versus last year at the same time?
I am sorry the question is just better momentum than last year at this time.
Correct.
Yes, I think in the supplies business for sure, it’s better momentum. Contract, it’s probably similar, but slightly better.
Okay, great. Thank you so much.
Thanks.
There are no further questions in the queue. I turn the call back over to Mr. Lorenger. Please go ahead.
Okay, thank you everyone for your interest in HNI and I would like to thank you for taking the time today and we will talk to you soon. Thank you.
This concludes today’s conference call. You may now disconnect.