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Good morning. My name is Kelly and I will be your conference operator today. I would like to welcome everyone to the HNI Corporation Third Quarter Fiscal 2018 Conference Call. All lines have been placed on mute to prevent any background noise. 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.
Good morning. I am Jack Herring, Treasurer and Director of Investor Relations for HNI Corporation. Thank you for joining us to discuss our third quarter fiscal 2018 results. Here with me are Jeff Lorenger, President and CEO; and Marshall Bridges, Senior Vice President and CFO.
Copies of our financial news release, earnings presentation, and non-GAAP reconciliations are posted on our Web site. 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'm pleased to turn the call over to Jeff Lorenger.
Thanks, Jack. Good morning, everyone. We'll share our assessment of the third quarter and provide some thoughts on our outlook for the fourth quarter. We'll then open up the call for questions.
We are pleased with our overall results. The third quarter was an important time for us. We continued our market momentum, turned the corner on our BST transition, and drove $10 million of net productivity and cost savings benefit. Our team is focused on delivering consistent flawless execution to our customers, while reducing costs through rapid continuous improvement. We remain confident our investments will continue providing strong returns for our shareholders.
In our supplies-driven business, we delivered strong results, growing 12% in the quarter, while generating strong profit improvement. This business is focused on selling the small and medium-sized companies, and over the last several years, we have invested significantly to enhance our market-leading position.
In the last 12 months, this market has become more active, and we have seen strong returns from our investments. During a very dynamic period, we have strengthened our relationships with our channel partners, and accelerated our market momentum, while adapting our business models to evolving customer needs.
Our hearth business grew sales and delivered profit results as expected. We continue to be excited about our market position and growth potential as that business remains on track for another year of record profits.
In our contract business, we did see softer sales, primarily due to timing. Contract was down 3% compared to the 22% increase, we delivered in the third quarter of last year. We are still seeing solid overall activity in the contract business and a growing sales funnel. The projects are being delayed and generally taking longer to move through the sales cycle. We have confidence in our competitive position and maintain a positive market outlook.
Looking at our operating expenses, we were able to smartly manage them below our expectations, helping improve our profit for the quarter. We did this while continuing to invest in growth and fulfillment initiatives. Overall, I feel good about our momentum and our path forward to drive long-term shareholder value.
I'll now turn the call over to 00:03:52 Marshall to review some financial details on the third quarter. Marshall?
Thanks, Jeff. Third quarter consolidated organic net sales grew 4.6% versus the prior year, including the impacts from closing and divesting small office furniture companies sales increased 1.9%. In the Office Furniture segment, sales increased 4.7% organically or 1.4% in total. Within the Office Furniture segment, sales in our supplies-driven business increased 12%, sales in our contract business were down 3% organically or down 9% in total.
In our Hearth segment, sales increased 3.9%, new construction sales increased 6%, sales of retail products increased 2%, non-GAAP net income per diluted share was $0.90 compared to $0.82 in the third quarter of 2017. The benefit of productivity gains improved price realization and the impacts and the tax change more than offset higher input costs in the quarter.
Jeff?
Thanks, Marshall. Let's shift to our fourth quarter outlook. Overall, we expect strong profit growth, primarily driven by cost savings and productivity gains. We're also expecting solid organic sales growth of 5% to 8% on a consolidated basis.
Looking at our outlook for each business, we expect our supplies-driven business to be up 5% to 8%. We continue to have strong momentum and see positive market conditions in supplies. Sales in our contract business will grow 3% to 6% organically as we have discussed in the past our contract business is inherently volatile due to our high mix of projects. Over the short-term, we can see significant fluctuations in our growth rates that are not necessarily indicative of the overall market or our competitive strength. I continue to feel good about how we are competing in our long-term prospects for growth. We expect the hearth business will be up 8% to 11%. We're seeing solid growth in both new construction and retail products. We have attractive opportunities in front of us and I'm excited about what we can achieve.
I will now have Marshall to provide some details on our outlook. Marshall?
Looking to the fourth quarter, we expect consolidated organic sales to be up 5% to 8%, we're up 2% to 5% when including the effects of closures and divestitures. Office furniture sales are expected to be up 4% to 7% organically or flat up 3% in total. Sales in our supplies-driven business are projected to be up 5% to 8%. We're forecasting sales in our contract office furniture business to be up 3% to 6% organically or down 2% to 5% in total. We expect hearth sales to be up 8% to 11% with new construction sales up 5% to 8% in sales of retail hearth products at 10% to 13%.
Non-GAAP gross profit margin is expected to be between 38% and 38.5%. Non-GAAP SG&A, which includes freight distribution expense, is expected to be $175 million to $180 million. Our estimate of non-GAAP earnings per diluted share for the fourth quarter is in the range of $0.91 to $1.01. This results in a full-year estimate of non-GAAP earnings per diluted share of $2.35 to $2.45. This compares to our prior guidance of $2.35 to $2.55. The primary driver of that narrowed for your outlook is lower than previously expected sales and our contract furniture business.
Our full-year tax rate is expected to be approximately 22.5%. We now expect full-year free cash flow be in the range of $135 million to $140 million including $65 million to $70 million of capital expenditures.
Jeff?
Thanks, Marshall. We remain positive about our markets and prospects for growth. We have strong brands, strong operating platform, and the financial capacity to drive significant long-term value for our shareholders.
With those comments complete, I'll open it up for questions.
[Operator Instructions] Your first question comes from the line of Matt McCall from Seaport Global Securities. Your line is open.
Thanks. Good morning, everybody.
Good morning, Matt.
Jeff, could you talk a little bit about the comment you made on the contract side, you said you're seeing projects delayed, I think that's some new commentary we have heard at least recently. Can you expand on those comments what you're seeing we think is driving that shift?
Yes, Matt. As you know, the business is inherently lumpy on any quarter basis. We did see in the quarter, project slide out. It's mostly they're taking longer to go through the sales cycle. We're still seeing strong growth. We have seen strong growth over the last several quarters, and our comps are getting a little more difficult as well. Overall, the market still is active. We like our competitive position, and the outlook is still good, but we just saw a little bit about a slowdown in getting products through the pipe.
So these are the - I'm just making sure, I understand that the projects being delayed or these projects where the awards are being delayed or these projects where you've been awarded the business and it's being pushed out in the next quarter. Just make sure I understand the terminology you're using?
Yes, Matt, it's a little bit of both; it's all across the map. Sometimes some things are just taking longer. People are busy and it's taking longer to get to the sales cycle, it's taking longer to get decisions made, decisions are coming later in the cycle. And so, it's a little bit of both.
Okay. Can you talk about the hearth segment margin outlook in your guidance, is a little lower than we expected in the quarter, but what's in the guidance, how long the pressures are expected to persist, and maybe how beyond Q4 is there anything to think about?
Yes. We did see a bit of margin pressure in the third quarter in hearth and as you saw, the vast majority of that was driven by inflationary pressures and excessive net price realizations. We had about $1 million more inflation than price realization in the third quarter. We have pushed through another round of pricing in the hearth business. And as we look into the fourth quarter, we expect to close that gap to basically neutral as we enter the fourth quarter, and we're expecting some good volume growth in hearth in the fourth quarter which will leverage well and create margin expansion versus the prior year.
Okay, so neutral there. What about on the tariff front? Last we spoke I think that you were still evaluating the impact of the 10% going to 25%. Can you give us an update on what the outlook is for your potential pressure, and what you are doing to combat it?
You know, Matt, this is Jeff. We have at time now to review the announced tariffs and they are going to have an impact, you know to different degrees on our various businesses. Near-term we're implementing pricing actions which include list price adjustments and in some cases surcharges. Over the long-term, you know, we expect to maintain, you know remain neutral on a price cost basis, given the tariff specifically.
Can you put any numbers behind that? I think, we had the numbers on our notes from, you know, kind of the assumption around 10%. What was the - what's 50% - what's 25% mean from a dollar perspective?
It's a number kind of moving around a bit, Matt, as we assess what sourcing decisions need to make obviously with that 25% tariff can directly [ph] change, where you want to source your supply chain from. You know that said, you know, it's roughly speaking, you know, 10% to 12% of cost of goods sold is a potential impact, but you know it's a number that can move around, taking those decisions. And as Jeff said we expect to build offset those pressures with pricing actions as we enter into 2019.
Okay. Okay. And then finally from me, the single-family environment is getting very little love out there. Can you talk about what you're seeing from a housing perspective and what you're hearing and kind of the trends and the expected trends just given the way the markets treat some of these housing names?
Yes, Matt. This is Jeff again. You know, the indicators we look at, we still see growth. You know we are seeing slower activity in permits and some of the same data you look at every day. It given some mixed signals, but the builders are still confident and our team is confident in our market position. So we still like our position and we still see growth there albeit maybe a little bit mix.
So, is it basically the macro indicators you mentioned, you know the - or the industry data around permits, is that where you're referencing slowdown or are you hearing your customers actually talk about slower growth expectations?
I think is a bit of both, Matt, I mean, it's more on the macro side, we talked to the builders, they still feel pretty confident. I think everyone recognizes that mortgage rates and affordability are headwinds, but we still have some pretty favorable demographic trends and there's not a lot of inventory out there. So, how it all plays out just to be determined, but it doesn't feel like it's dramatically bad, it may be slightly less good.
Got it. Okay. Thank you all.
Thanks, Matt.
Your next question comes from the line of Beryl Bugatch from Raymond James. Your line is open.
Good morning, Jeff. Good morning, Marshall. Good morning, Jack. Let me just try and put some numbers together, the tariff impact, Marshall, you said 10% to 12% of cost of goods sold is potentially impacted. That means you probably have $140 million to $150 million a potential product you import now that could be subjected to tariff. Is that the way to read that?
Yes. But that's correct.
Okay.
And again as I said with Matt, that's a number that can move around depending on where we decide to source things from after this discuss in the - after this is implemented in the beginning of the year.
So, put some color to that what are you importing that makes up that $140 million to $150 million of imports?
Yes. That's a great question. So, more than two-thirds of that is associated with the supplies-driven business. And the supplies-driven business is you know competes against a lot of Asian importers and a lot of product that is brought in from China. And what we're seeing is some pricing action, pretty consistently across the competitors there. So there's a…
What does that mean, they're raising prices?
Yes, yes.
Okay. I'm sorry.
Yes. If you look at what that is there's a combination of components in finished goods. The supply's business does have some finished goods that come in from China. That's different than our other businesses.
So you're saying about a $100 million of it is close to supplies-driven.
Yes, maybe a bit more than that actually, but that's in the ballpark.
Okay. All right, greater than $100 million. To Matt's question, can you give us maybe an idea of what kind of order growth rate you saw in contract for office?
No, Beryl, we don't we don't generally disclose that. What I would say is our sales following is growing and the activity is still strong.
Well, I understand that Jeff, but if you're going to give us a timing kind of issue, then I think it goes from sales funnel to order to backlog to deliver. And how do we get some comfort that the salesman really got orders at the end of it that goes to backlog and delivery?
Yes, but we feel pretty confident in the 3% to 6% growth rate that we're anticipating from the fourth quarter in the contract business and the order rate support that we have seen a recent uptick in orders here to support as well as Jeff said good funnel activity and preorder activity. As we look into what is going to happen next year because this delay is going to hit 2019 we're still assessing how that that plays out, obviously that's a positive, but there may be other we're still assessing how that plays out. Obviously that's a positive but there may be other things going on there as well.
I mean in contract, you got a pretty quick backlog movement that if it's in the backlog it's delivered within four weeks and typically in most of the contract side. Is that correct still?
It is. Four weeks, it could be a couple weeks more now. But generally you're right.
Yes, I mean most people don't put it in the backlog so really got a bonafide specification of how it's going to be configured?
Correct.
Yes, right on.
Okay. All right, all right. When you're looking at the SG&A and this is the third quarter you had a $4.1 million unfavorable variance in freight and distribution which I take it represents all that we've been hearing about freight. Can we get an idea of what you think fourth quarter will look like on that?
Yes, part of that freight and distribution that you've seen throughout the year and in the third quarter has to do with our investment in the quick ship fulfillment which we talked about last year. There is still some incremental cost there but we have seen inflation as well which I think what you're alluding to. For the for the fourth quarter, we're expecting to be pretty much in line with the prior year levels of freight and distribution and we're starting anniversary where we had a lot of quick shipping we're getting some productivity there as well as some inflation from the carrier rates.
Yes, we were pretty well in place in the fourth quarter last year, right?
Pretty well, there's always a little bit more incremental there but for the most part that's correct.
Okay. And so and then the other side of the SG&A was that $5.9 million you talked about increased incentive expense. I don't think you had any - expense last year. What's causing the incentive? What's the accrual for the fourth quarter requisite?
Yes, so as relates to the third quarter we're anniversarying where we really took those programs down last year given our results, so we're now resetting to more normalized levels. So that's what's causing that increase there. We'll still see some of that in the fourth quarter but not as much.
So the bulk of that $6 million delta is incentive comp accrual?
Yes. There's an incentive comp accruals as well as the mark-to-market and the stock price on deferred compensation programs. That's also in there. And then we've got some investments, there also in a SG&A related to go-to-market growth initiatives and the fulfillment that we talked about earlier.
Okay. One of the other areas that hasn't been talked about much is change in hearth as energy costs rise, we get nearer a breakpoint where the heating side of the business starts to get attractive. And I know it's been reduced to a fraction of where it used to be but can you reflect for us what that looks like as, as unfortunately energy cost rise?
Yes.
From energy analyst, it's fortunately as energy cost rise?
I suppose this question is for the pellet business which I think is what you're referring to there. Yes. No. We've seen - our pellet is very small, it's roughly 3% of the total HNI business but we are expecting some pretty decent growth there in the fourth quarter from that business. That's embedded in our retail estimate of that we gave of 10% to 13% growth. I'd say roughly half of that growth is coming from the pellet products and so we're pretty excited about that trajectory as we enter the fourth quarter here.
Okay, all right. That's interesting. That's a delta from where we bid, right?
Yes, it's been relatively low dollar growth here for the last year or so but that's right.
Okay. And you have been giving us some new disclosure, I think as part of revenue recognition in supplies and contracts. Can we get those numbers through the fourth, third and fourth quarter for last year to know where, what those baselines are or I can do that with Jack offline if it's okay?
Yes. We can get those. And they'll be in our queues in case as we continue to file.
Okay, all right. Thank you very much. Appreciate it. Good luck on the fourth quarter and on the balance of the year.
Thanks, Beryl.
Your next question comes from the line of Greg Burns from Sidoti & Company. Your line is open.
Good morning. When we look at the 4Q guide, can you just let us know what's embedded in terms of the cost savings realizations that you've been targeting? I know you're, the total I think was $35 million to $40 million maybe and you had about $15 million remaining, so do you expect to get that full number in the fourth quarter?
Yes. So, just take a step back. It relates to the benefit for net productivity gains and cost savings in the fourth quarter. We're expecting between $13 million to $15 billion there. Some of that is driven by, I think what you're referring to, Greg, on the structural cost takeout that we talked about two, three years ago was $35 million to $40 million. Some of that is embedded in that $13 million to $15 million number. And that's sort of the last tranch after we get through the fourth quarter, all of that $35 million to $40 million we mentioned a few years ago it will be in place. But in addition to that structural cost takeout, we are seeing the benefit of just a lot of small projects, we're getting back to what we typically, historically been good at, is grinding out good cost savings on a daily basis.
Okay, great. And then we look I guess beyond the fourth quarter into 2019, it is going to be more about offsetting kind of some of these headwinds you've been discussing or do you feel like you get some incremental margin leverage based on some of these ongoing initiatives that you - that you have in place?
Yes. So if we've got momentum on the cost savings and productivity gain side, but there are a lot of headwinds out there and how - all of that mixes up is yet to be determined. As we said earlier, we do think we've got pricing actions to help offset the inflationary and tariff pressures, we have momentum, but I'm not sure we've got a view on what exactly that does the margins next year yet.
Okay, great. Thank you.
Your next question comes from the line of Kathryn Thompson from Thompson Research Group. Your line is open.
Good morning. This is Steven Ramsey on for Kathryn. The strategic investments that you called out in the press release, can you talk about these, were they more cost takeout focused or growth - top line growth focused, were they different than the kinds of investments you've been making in the past year or two?
Yes. Steven. This is Jeff. Those investments we called out the release are mostly focused on - sale capability and growth in international. There's always ongoing investments on the on the cost side as Marshall referenced where we're getting back on the gas relative to our kind of day-to-day, many small projects, daily improvements, but investment you're referring to where we're really selling capacity and international.
Great. Thinking about cost of goods sold and the 10% to 12% - you called out, is that tariffs only impact? And is not - can you maybe talk about just more intrinsic inflationary pressures that are impacting you aside from the 10% to 12%?
Well the 10% to 12% sort of the amounts of Chinese exposure we have, so that's mean - that could possibly subject to a tariffs, when it's relates to inflation we are seeing pressures, and they're not getting any better, that's for sure. If you look at what we're expecting in the fourth quarter, that's include in our guidance, we're expecting a total inflation including tariff impact from the fourth quarter in the range of $18 million to $22 million. We don't have a great view of how that's going to turn out next year, but we don't expect it to slow down any.
All right. And then - just this like - maybe more of an intangible kind of broader step back question. As if you think about just visibility in your business and having confidence in an outlook has visibility changed at all given there's so much movement in your various end markets both on the demand/top line side of things and the cost side of things?
Yes. Stephen, this is Jeff. That's a good question. I don't think, I mean - it's obviously dynamic out there right now, and it's probably more dynamic than it was when we entered the year. But from a pure visibility standpoint, it's about the same - you know, kind of across the board where we look at parts versus supplies versus contract you know we have seen you know like we talked about, you know we had some projects slide on the contract side, but you know, we've reassessed that and the visibility out looks pretty similar to what it has been in the last 12 months.
Great. Thank you.
And there are no further questions at this time. I turn the call back over to Mr. Lorenger for closing remarks.
Okay, thanks so much, and I'd like to thank everybody for joining us today and have a great day. Thanks.
And this concludes today's conference call. You may now disconnect.