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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 Fourth Quarter and Year-End Fiscal 2017 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 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 fourth 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.
Good morning, everyone. I will share a brief assessment of the fourth quarter then turn the call over to Marshall Bridges, who will review some of the specific financial details, and then I’ll come back on and share some thoughts on our outlook, and then Marshall and I will open it up for questions.
So to start, our fourth quarter played out as expected. We stabilized our supplies-driven business and made strong progress working through our operational transformations. We delivered solid organic sales growth and are excited about our market momentum. I’d like to take a moment to reflect on the year.
2017 was a year of transition. We confronted multiple challenges, some planned, some not. We dealt with rapid and significant changes in our markets. We took our large scale transformations involving our operational network, fulfillment models, business portfolio, and our enterprise system. In short, we responded to our challenges, made investments, and adjust our business to better deliver long-term profitable growth.
I feel good about where we are heading. We are nearing the end of our transitions. The investments we made put us in a position to drive new levels of productivity and take advantage of improving market demand. Our most significant investment has been our business systems transformation initiative, we call it BST.
I am pleased to report we have successfully switched over to our new ERP platform earlier this month. This new platform is a key enabler for long-term value creation. And I'd specifically like to take a moment to thank the numerous members who have been involved in this project for their significant effort, dedication and success, and helping us achieve this key milestone.
Our supplies-driven business is still in transition, but stabilizing. We have a clear vision for how this business move forward and we are building out strategic capabilities. This includes a focused effort around dramatically lowering the effort required to buy out office furniture and making the whole process more convenient and easier for sellers and customers.
During the quarter, we made the difficult decision to close our Paoli business. This decision was part of our continued efforts to drive portfolio efficiency and simplification. We will continue to serve these market requirements through product offerings from the broader family of HNI brands. I am excited about our office furniture business. This had momentum in the market and delivered 8% organic sales growth in the second half of the year. Our Hearth business continues to perform very well with solid growth and record profitability.
I’ll now turn the call over to Marshall Bridges, our Chief Financial Officer to review some financial details for the fourth quarter and then I’ll return to discuss reviews on 2018. Marshall?
Thanks, Stan. For the fourth quarter, consolidated organic net sales grew 3.7% versus the prior year. When including the impact of acquisitions and divestitures, sales increased 0.5%. In the Office Furniture segment, sales increased 3.2% organically or minus 1% in total. Within the Office Furniture segment, organic sales in our supplies-driven business were flat or minus 4% including the impacts of divestitures.
Sales in our contract and international businesses increased 7% organically or plus 2% in total. In the Hearth segment, sales increased 5.1%. New construction sales increased 6%, sales of retail products including wood, gas, and pellet products increased 4%.
Non-GAAP net income per diluted share was $0.47 compared to $0.82 in the fourth quarter at 2016. As expected, the earnings decline was primarily due to lower profitability in our supplies-driven business, which mainly resulted from increased strategic investments, higher input costs, and unfavorable business and product mix.
Okay, I would like to take a moment to provide some color around some several non-recurring items we recorded in the fourth quarter. You can follow this in our GAAP to non-GAAP reconciliation contained in our press release and also in the earnings presentation posted on our website.
The biggest of these items was the impact on the recent tax legislation, which drove a positive $44.8 million revaluation of our deferred tax liabilities. We had $20.9 million of impairment charges and a $4.8 million loss on disposal of assets, both of which were primarily driven by our decision to close the Paoli brand.
We incurred restructuring and transaction costs of $9.8 million related to the final stages of our structural cost reduction initiatives, and we recorded a $10.3 million valuation allowance on a long-term note receivable. The net impact of these items was a $0.30 benefit to earnings per share, which we exclude from our fourth quarter and full-year non-GAAP results. Stan?
So 2018 will be a return to profitable growth. We will conclude our operational transitions and deliver record benefits from core productivity improvements and structural cost reductions. Our probability will improve over the course of the year. The supplies-driven market will continue to be dynamic. We are seeing stabilization in the wholesale channel.
Overall, we are expecting growth from our supplies-driven business both in topline and profit. We continue to hold a unique competitive advantage, which no other manufacturer can match. Our brands, products, fulfillment capabilities, provide unparallel value to our resellers and to our customers. Our contract-driven businesses have strong momentum, which we expect to carry through 2018. We are winning across multiple fronts, strengthening distribution, expanding our product offering, and deepening our relationships with key influencers.
The Hearth business continues to deliver record results. We remain optimistic about growth in our Hearth business and single-family new home construction remains strong, and the remodel retrofit market expands. We remain a strong company with leading market positions and the financial capacity to aggressively pursue profitable growth for our shareholders. I anticipate 2018 to be a good year for HNI.
With that, I’ll let Marshall to provide some details on our outlook.
Okay. Let's start with the first quarter. We feel good about 2018, but the first quarter profit will be a low point for the year. We are projecting a strong organic growth of 5% to 8%, but this will be more than offset by several factors.
First, we will have $9 million of incremental costs related to our BST project in the form of amortization, support, and switchover costs. Second, we are seeing a continuation of unfavorable business mix, we experienced over the second half of 2017. When combined with inflation, we expect a negative $10 million to $12 million price cost gap. Third, we expect to see higher SG&A expenses of $6 million to $8 million primarily driven by investments, including our direct fulfillment initiative.
Additionally, the benefits from our transformations will not yet be fully realized. We expect these trends to reverse as we move through the year. We expect consolidated first quarter organic sales to be up 5% to 8% or up 2% to 5% when including the effects of the divestitures and the closure of the Paoli brand.
Office furniture sales are expected to be up 6% to 9% organically or up 2% to 6% in total. Sales in our supplies-driven business are projected to be up 7% to 10%. We are forecasting sales in our contract office furniture businesses to be up 7% to 10% organically or down to – to up 1% in total. We expect Hearth sales to be up 1% to 4%. Within the Hearth segment, new construction sales are forecasted to be up 2% to 5%. We are projecting retail Hearth sales to be flat to up 3%.
Non-GAAP gross profit margin is expected to be similar to our fourth quarter result of 36.1% of net sales. Non-GAAP SG&A, which includes freight and distribution expense, is expected to be just below our fourth quarter level and be approximately $174 million.
The impacts of the recently enacted tax legislation are included in our estimate. We expect our tax rate will be approximately 19% to 20% in the first quarter and 23.5% for the full-year. Our estimate of non-GAAP earnings per diluted share for the first quarter is in the range of $0.01 to $0.06.
So now let’s shift gears and talk about the full-year. We expect to see improved earnings. We estimate non-GAAP earnings per diluted share will be in the range of $2.40 to $2.80. This is based on 5% to 8% consolidated organic sales growth or 1% to 4% in total. We are expecting our office furniture businesses to deliver organic growth of 4% to 8% with our Hearth business up 3% to 6%.
The impacts from the recently enacted tax legislation are included in our estimate. For the full-year, the impact of the tax legislation or reduce our estimated effective tax rate to 23.5%. We expect full-year free cash flow to be in the range of $100 million to $120 million, which includes estimated capital expenditures of $75 million to $85 million. Stan?
Okay. Thank you, Marshall. With those comments complete, we’ll now open it up to questions.
[Operator Instructions] Our first question comes from Matt McCall from Seaport Global Securities. Please go ahead. Your line is open.
Thanks. Good morning, everybody.
Hello.
So the full-year outlook Q2 to Q4 look really strong. You give a little detail there about the topline, can you talk about the margins you anticipate and as well as some detail from a segment perspective if you could. Just what kind of margin assumptions are in that that full-year guide?
Yes. Matt for the full-year 2018, we are expecting to reach record level gross profit margins in the 39% kind of range. And that’s really driven by two major factors. The growth that we are expecting, the leverage from that as well as structural cost and net productivity improvements.
Okay. Any commentary about SG&A for the year, Marshall?
We are expecting SG&A to be up a little bit over prior year including freight and distribution expenses. It should run in the kind of 32% of net sales range.
Got it. Okay. So the outlook you gave for Hearth and you gave detail none of this sub unit I guess, when you talked about retail being flat in Q1. As we look at the cold weather in the country and the rising heating oil prices, I guess the anticipation was that there would be some more positive commentary around the retail side of the Hearth business. Any reason that some of those trends are being offset?
We are performing well there, Matt. So you maybe right, but there's all sorts of – its location by a regional sort of differences. There's dealer inventory et cetera. So our best guess right now is flat, but we like cold weather a lot. We like when it gets cold, warm cold because it takes two events to really rock the consumer of their procrastination to get them moving and buying the Hearth appliance, so you could be right.
Well I mean, I recall the last time we saw this, the growth rates were 50% if I remember correctly. So I mean nothing that’s indicating that type of growth. I know it’s a small part of the business today just because of some of the weakness in the last couple of years, but no indication that you are seeing that type of inflection.
Our best guess at this point is flat.
Okay. That’s fair. You mentioned product line expansion in office furniture, you guys don't go into too much detail on the product side, but can you provide a little bit more detail about what you're doing and I know that because there's so many questions about what's going on from a product perspective and a customer demand perspective, and how those shifts are occurring and the impact that’s having on the industry. Can you just talk about what you're doing and maybe how you're addressing some of those shifts?
Yes. I think, Matt we're really talking about new product introductions and you said it, the office is changing, moving from traditional products to more open collaborative sort of spaces, casual, soft seating is a major initiative for us. We continue to expand our walls business, moving from traditional panel to more desking type solutions, stance solutions, more seating solutions and different value profiles sort of from the entry-level value side and supplies all the way up to the high-end, and so its – as you know Matt, we’re a pretty broad, pretty deep company and so you are seeing this virtually in all of the companies, all of the categories, all of the price points just adopting and shifting to this new office.
Okay. All right. That’s fair. And then I guess, one more, Marshall in your Q1 outlook, you talked about the SG&A increase on year-over-year basis and a lot of that was around the direct fulfillment model. Did I hear you say that the spending is going to kind of moderate post Q1 and the two elements that we’ve talked about in the past are now in spending, but the return of the revenue? I mean do you have any visibility into how long the spending, the elevated spending investments going to occur and when the revenue should return?
Yes. Matt, the first quarter is a period of investment. I think you're referring to the direct fulfillment, and yes there are still investment going on in the first quarter and we expect that to moderate and move through the year as well as see some ramp up in volume, but the volume is not something we have a clear view right now that we are willing to share.
Okay. Thank you, guys.
[Operator Instructions] Our next question comes from Kathryn Thompson from Thompson Research Group. Please go ahead. Your line is open.
Good morning. This is Steven on for Kathryn. I guess to think about the office unit. First, is the supplies mix of office sales still near the 50% level?
Yes, basically.
Okay. And then even thinking beyond 2018 from a philosophical view on the supplies business, do you view this as a growing unit for you or is this once the investments in the shift is made over the next few quarters more of a cash flow run asset for you?
We see this as a growing part of the business. We are – just overall that the market is looking for better value, performance for a price, looking for more convenience, looking for an easier selling process. We're uniquely positioned. We've invested aggressive. We have a long legacy serving that market. And as we delta with the wholesale channel shift, I think we put in place more direct fulfillment models for our dealers and the large national supply dealers, and I think that will serve us well as that market continues to grow, I think we are in a unique competitive advantage, unique position.
All right. And then on the contract side of things, could you discuss the sales trends on your legacy office products and new products and anything you would call out there not only in Q4, but looking back over the last year or too?
We don’t really have anything to call out specific there, Steve, and I think the sales trends are solid for our legacy products. Obviously, we are introducing new categories of products and expanding where we need to, but I don’t think there is anything specific or unique to call out.
All right. Thank you, guys.
Thank you.
Our next question comes from Greg Burns from Sidoti & Company. Please go ahead. Your line is open.
Good morning. Could you please talk a little bit more about the rationales closing the Paoli brand and maybe just a little bit more color, how you look at some of your other brands? Are you reviewing any other brands? Or maybe sale or closure?
Well, the answer Greg as we – like all smart business people, we try to look at the portfolio, and over the years you make choices around brands and channels and portfolios and product categories, and Paoli has been a great company for us. We just felt like due to the changing office, due to sort of where they’re positioned where some of our other brands and products categories is positioned, we’re just about to go ahead and take that business in other direction to exit that business.
We have that coverage through other brands and through other channels. And so we're always looking at our portfolio and thinking about where do we add, where do we delete, similar to you and your investment portfolio. We're always thinking about what’s the future, or is there a future here? Is it generating return or not? And then we move accordingly.
So we’ve gone through a period of clean up our corporate portfolio. I think we’re in really, really good shape right now for the near-term, for the foreseeable future around how we are positioned and what's in the portfolio and what's not to answer you more specifically.
Okay. Can you give us a sense of maybe the accretion from that divestiture?
Yes. Sure. Greg, the closure of the Paoli brand will add approximately $8 million of profit to 2018.
Okay. Thanks. And last quarter you call out some of your structural cost savings initiatives or maybe taking a little bit longer to achieve. Have you gotten your hands around the projects that were causing the problems and do you feel good about getting that $15 million of structural cost savings in 2018 that you talked about last quarter?
Yes. I think Greg, that’s what we meant – including those comments about largely completing those transitions and the business stabilizing. So the answer is yes. We do feel good that we have a handle on those. Now it's going to take a while to get through that. I think the 2018 results reflect that. First quarter is going to be a low point and then we’re indicating that it's going to improve as we go through the year. As Marshall indicated, we should be at or near record gross profit levels and that includes getting a handle on resolving these transition issues.
Okay. Thank you.
[Operator Instructions] Our next question comes from Budd Bugatch from Raymond James. Please go ahead. Your line is open.
Hi. This is Katherine West on the line for Budd Bugatch. I just had a question kind of on that record gross profit number that you're estimating. When do you move the supplies channel business to more to direct-to-consumer model? Can you walk me through kind of what the margin or the incremental margin difference there and kind of what kind of factors into that gross profit, obviously some costs savings, but – and how you deal with inflation there?
Yes. Katherine, our gross profit improvement is really driven by the volume leverage that we’re expecting in organic growth, and in that, significant productivity and structural cost reduction that we’re expecting in 2018. So the business mix shift is not a major story there. As it relates to inflation, we do expect to see some inflation kind of maybe in the 3% range and we expect to offset that with price realization. So we do expect to have a minimal price cost gap.
Also a follow-up question, you have some strong revenue guidance for the office furniture business, just kind of what you're seeing in the pipeline and just general industry demand there? If you don’t mind.
Well, I think as we indicated, we reported some solid numbers in both segments of our office furniture business. So we see supplies stabilizing. We are excited about what we're seeing specifically in the dealer channel and I would say our wholesale sort of business has stabilized, and so we see positive trend there. I think that's underlying sort of an overall economic – more positive economic climate uptick.
And then second, we finished the year, the second half of 2017 very strong in the contract segment. We expect that momentum to continue, both large projects and small projects and day-to-day business. And so it’s just kind of across the board, I would say and I think we had positive momentum rolling into 2018. I think the more positive economic environment helps that. Let’s just hope that keeps happening.
All right. Thank you.
Thank you.
End of Q&A
And there are no further questions at this time. Thank you for joining. This concludes today’s conference call. You may now disconnect.
All right. Thank you so much for joining the call. We’ll talk to you soon.