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HNI Corp (NYSE:HNI)
Q4 2019 Earnings Call
Feb 20, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, my name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the HNI Corporation Fourth Quarter and Year End Fiscal 2019 Results. [Operator Instructions].

Thank you. Mr. McCall, you may begin your conference.

Matt McCall -- Vice President, Investor Relations and Corporate Development

Thank you, Tiffany. Good morning. My name is Matt McCall, I am Vice President, Investor Relations and Corporate Development for HNI Corporation. Thank you for joining us to discuss our fourth quarter fiscal 2019 results. Here with me are Jeff Lorenger, Chairman, 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 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'm now pleased to turn the call over to Jeff Lorenger. Jeff?

Jeffrey Lorenger -- President and Chief Executive Officer

Thanks Matt. Good morning everyone. We will share our assessment of the fourth quarter, giving you detail around what met or exceeded our expectations, and what did not play out as we had anticipated. We will then provide some thoughts on our outlook for 2020. Finally, we will open up the call for your questions.

Our teams delivered a strong fourth quarter. We generated our best top-line growth rate of the year and expanded operating margins, despite choppy demand and tariff challenges. Our annual productivity and cost savings initiatives continue to gain momentum, and drive improved profitability. Overall, our results show the performance our organization can drive, and I am optimistic about what we can accomplish in the future.

We grew fourth quarter non-GAAP earnings per share by 16% year-over-year and we came in at the high end of our guidance range. I would like to highlight the following three items that came in as or better than expected. First; we delivered strong cost and expense control. Gross margin and SG&A as a percent of sales were both better than we had expected. Our fourth quarter EBITDA margin was the best in over 15 years. Our teams delivered strong margin improvement, and we expect solid gross margin expansion in 2020.

Second, contract Furniture revenue grew in line with our outlook. The broader commercial Furnishings environment remained solid. We are investing heavily in areas that will drive future growth and improved margins, and we are forecasting continued Furniture segment growth in 2020, but also expect conditions will remain choppy.

Third, free cash flow was strong and better than expected. In 2019, we generated $153 million of free cash flow compared to our initial plan of $130 million to $140 million. We returned $136 million to investors through share buyback and dividends, and we reduced our debt levels by $75 million, representing a 30% improvement. Our balance sheet is in excellent shape, and along with our free cash flow expectations, it provides capacity to support our strategic growth initiatives in 2020 and beyond.

There were two items in the quarter that did not play out as we had anticipated, neither of which derail our longer-term view. First, revenue in the Hearth segment fell short of projections. Our new residential construction business ramped up more slowly than expected. However, we are encouraged by the improvement in single-family home construction, and have multiple initiatives under way to drive growth in 2020.

Second, growth in our supplies driven Office Furniture business was below expectations. That said, supplies did grow 9% year-over-year in the quarter, which was a significant improvement compared to the first three quarters of 2019. We had forecasted more growth. Our shortfall was driven by lower than expected e-commerce holiday sales. It is important to know that e-commerce was up 50% compared to the prior year quarter, and we continue to see -- we continue to see strong growth in 2020.

As we look to 2020, we expect solid profit growth, we will achieve this while significantly increasing our investments in strategic growth initiatives, which will drive sustained revenue growth, margin expansion and free cash flow generation over the next three to five years.

I'll now turn the call over to Marshall to provide more details about our 2019 year end results, and our guidance for 2020. Marshall?

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Thanks Jeff. Fourth quarter consolidated organic sales increased 3.9% versus the prior year, to $616 million. Including the impacts of closures and divestitures, sales were up 3%. In the Office Furniture segment, organic fourth quarter sales increased 5.9% year-over-year. Within the Office Furniture segment, supplies driven revenue increased 9%, contract sales were up 3% organically, and we generated strong profit growth in Office Furniture, with fourth quarter non-GAAP operating income, up 39% versus the prior year. Hearth Products segment sales decreased 1% year-over-year. Within the Hearth segment, new residential construction revenue was down 1% and sales and remodel retrofit products also declined 1% year-over-year. We also showed strong profit improvement in the Hearth segment. Hearth non-GAAP operating profit increased 9% versus the prior year quarter. Overall, fourth quarter gross profit margin expanded 50 basis points year-over-year to 38%. Non-GAAP operating profit grew 12% versus the prior year quarter and non-GAAP operating margin in the fourth quarter, expanded 80 basis points to 10.5% of net sales. Non-GAAP net income per diluted share was $1.12, representing a 16% increase versus the $0.97 reported in the fourth quarter of 2018.

Below the line, we benefited from reduced debt levels and continued share buyback activity as expected. This drove approximately $0.03 of our total $0.15 of non-GAAP EPS growth versus the prior year.

Okay, let's shift to our 2020 outlook. For 2020, we are forecasting the following; revenue of $2.30 billion to $2.35 billion, that represents total year-over-year growth of 2.5% to 4.5%. We are also forecasting diluted earnings per share to be in the range of $2.60 to $2.90. From a segment perspective, in 2020, we expect revenue in Office Furniture to be up 2% and Hearth products to be up in the 4% to 6% range. We expect gross margin to expand 70 to 90 basis points, versus the 37.1% we generated in 2019. Operating margin expansion is expected to be up less, as we ramp up our growth investments.

One comment on seasonality as you are modeling the year; we expect our quarterly earnings progression in 2020 to follow the pattern we've seen over the last two years. So that means we'll generate most of our profit in the second half, and have minimal first quarter earnings.

Finally a quick note on the coronavirus; we are expecting the coronavirus to negatively impact us. The situation is obviously dynamic, but based on what we currently know, we estimate the coronavirus will reduce sales in the PRC and Hong Kong and lower consolidated 2020 sales growth by approximately one percentage point. That impact is included in our guidance and we'll update you as the situation develops and evolves.

We also have exposure to China on the cost of goods lines through our global supply chain. At this point, we're not expecting a significant impact there.

Jeff?

Jeffrey Lorenger -- President and Chief Executive Officer

Thanks Marshall. To summarize, we had a strong finish to 2019, demonstrating the results our organization can drive. We expect solid profit growth in 2020, while significantly increasing our investments to drive sustained revenue growth, margin expansion and free cash flow generation over the next three to five years. Our teams continue to manage well. I would like to thank all of our HNI member-owners for their continued commitment and dedication.

With those comments complete, I'll open it up for questions.

Questions and Answers:

Operator

[Operator Instructions]. Our first question comes from the line of Greg Burns with Sidoti. Your line is open.

Gregory Burns -- Sidoti -- Analyst

So we're seeing a bit of mixed results among the peer group, obviously, out of a pretty solid quarter, both sides of the Office Furniture business. But maybe, could you just give us your view on on the macro? Any changes in the demand environment, particularly in the contract side of the business, and maybe if you could give us maybe a little bit of color on order growth rates or order patterns and how they're shaping up in the early part of this year?

Jeffrey Lorenger -- President and Chief Executive Officer

Yeah. Sure Greg. You know on the macro kind of demand environment, you know in the Office side, the cyclical drivers are mixed. They are -- I'd say they are better than they were six months ago. We kind of had that slow patch. It started out pretty good January through May. We had kind of a negative slow patch in late summer, and then we saw it kind of firm up as we exited the year. I mean, you look at the major drivers. We tend to look at, CEO confidence. It was down, but it's recovering. Office work and employment is growing, it supports kind of our outlook for 2020. Interestingly enough, small business, where we have disproportionate exposure was, was kind of flattish in 2019. And then the Office continues to grow. Office construction, you know, there is still activity there. Small business confidence is still at historically high levels. So overall kind of it at a macro level, it has kind of firmed up for us a bit. I would expect the demand patterns to be solid, and I still think there's going to be some choppiness out there, just given all the different currents kind of pulling back and forth.

Gregory Burns -- Sidoti -- Analyst

Okay, thanks. And then looking into 2020, obviously, you are still projecting some operating leverage, but maybe a little bit less so than we saw in '19. You mentioned putting some money to work beyond various growth initiatives. Could you give us a little bit more color on what exactly those are, where you're putting your money to work, and are there any larger ones in particular that we should be focusing on?

Jeffrey Lorenger -- President and Chief Executive Officer

Yeah, that's, we are -- if you go back a couple of years, Greg, we went through this ERP implementation. And you know, despite the fact that they then went well, and we came through that, it was still disruptive and so we're now through that and we're starting to see the benefits, number one, and then we're going to start to add to those. So we're looking at three areas primarily, if I keep it at a high level; one is Office Furniture in general. We're ramping up across the board in the Furniture business. The new product pipe is strong. We're accelerating that with dealer engagement activities, branding, sales coverage, e-comm, we continue to invest in, so that -- there is a lot going on kind of soup to nuts on the Office Furniture side.

And then on the Hearth business, we've got growth initiatives we're investing in pretty heavily as well. Homebuyer education, connecting to homebuyers during their homebuying process. Insert awareness, existing homebuyers, we're doing direct outreach programs to existing homeowners for replacements. And in regional builders, we are targeting, there's a lot of regional builders out there as well, and we've got some growth initiatives that are targeted right at them as well.

And then finally the third bucket is basically our digital assets and capabilities, and that's really focusing on customer experiences, improving the process, in the sales process and those will be leveraged across both businesses.

Gregory Burns -- Sidoti -- Analyst

Okay. And then I guess maybe from a continuous improvements -- cost improvement perspective. I guess you targeting -- I think it was $10 million to $15 million maybe in the back half of -- looks like you got most of that, but as we look into 2020, do you have any explicit kind of cost saving goals that you might be able to share with us, or is this just kind of just general blocking and tackling, taking cost out of the business?

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Yeah, Greg, it is general activity -- sort of what drove our benefit in 2019 and will continue on to 2020. But it is significant, when you add it all up, we're expecting $20 million to $25 million of benefit from our annual productivity and cost savings efforts in the year.

Gregory Burns -- Sidoti -- Analyst

Thanks. And then the -- your outlook for the Office segment next year I guess definitely, the industry is looking for about 2% growth. So it looks like you're looking for a little bit of growth on top of that. So I felt like you had some easier comps from the earlier part of this year. So maybe you could just kind of give us your view on your Office Furniture segment this year? Maybe, China is a little bit of a detractor on why that's a strong outlook for -- why are we looking for about 3% at the midpoint versus the industry versus what I thought, were maybe some easier comps for you from the earlier part of this year?

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Yeah Greg, we're expecting better growth in 2020 in Office Furniture than we saw in 2019. So I think that's the first point. Secondly, you know, the market has firmed up, but it's not as strong as it was sort of the middle of the year, when we saw some really high growth rates, particularly in contract. So we do expect to start slowly. Our funnel and our pre-order activity supports growth, but it's not going to start off super strong. We're feeling pretty good about that 2% to 4% growth rate guidance we gave for the year for Office Furniture. That includes some good e-commerce growth, and I'm not sure the market -- I think that's at or above market. I'm not sure the market's stronger on that right now from our perspective.

Gregory Burns -- Sidoti -- Analyst

Okay, thanks. And just lastly, in terms of the seasonality in the fourth quarter. Can you maybe help us quantify what minimal profitability means? Are you looking for about the same level that you were at last year? Maybe a little bit better? I don't know, is there any way you can help us kind of quantify what minimal means?

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Yeah, I think minimal, if you look at the last two years in the first quarter we were -- we had minimal profit. We were $0.02 last year, we're certainly going to try to exceed that. But it's not going to be a sea change from what we saw last couple of years.

Gregory Burns -- Sidoti -- Analyst

Thank you.

Operator

Your next question comes from the line of Steven Ramsey with Thompson Research Group. Your line is open.

Steven Ramsey -- Thompson Research Group -- Analyst

Good morning, guys. Thought I would start with Hearth; the just strong outlook there, starts and permits being strong. I guess given where new construction is in the outlook in the mid-single digit range, how much of that is just catching the wave of a strong environment? How much of it is the investments you're making to further penetrate, repair, remodel, replacement demand and new builders -- regional builders?

Jeffrey Lorenger -- President and Chief Executive Officer

Yeah, I'd say it's some of both. I think the new construction is definitely a driver. We tend to lag permits 90 days. So I think we're seeing some of that stretch out a little bit more. That's kind of, I think what we saw in the fourth quarter. Labor shortages, things like that. So we're lagging, maybe a little bit more than normal. But that's a big piece of it. But our growth initiatives do come online. You know, some of them are early days. Some of them are just getting rolling, but they'll provide us some tailwind here in the back half.

Steven Ramsey -- Thompson Research Group -- Analyst

Got you. And on the replacement side of things, is this an offset or a negative contributor and the number you're putting out is basically new constructions growing better than your, guide but repair and replacement isn't. Is it an offset?

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Yeah, for Hearth we're expecting to grow 4% to 6% for the year. I would say that the new construction side would be at the higher end of that and the remodel retrofit side to be at the lower end of that.

Steven Ramsey -- Thompson Research Group -- Analyst

Great. On Office for 2020, can you maybe even broadly talk to supplies or contract driving better growth, and on e-commerce is that, is that a bigger driver for supplies more than contract or vice versa?

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Yeah, I'd say the e-comm business platform is probably a bigger driver on the supply side for sure, and that's just where that business is at.

Steven Ramsey -- Thompson Research Group -- Analyst

And just thinking for 2020 broadly, is supplies or contract a better growth driver?

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Yeah, Steven. I think that our view that splitting the Office Furniture business into these two -- you know two categories, supplies and contracts, is a little bit too simple of a way of describing our business. So we're just going try to move away from describing that way. What I would tell you is that, we do expect to see more growth in what we formerly called supplies, due to e-commerce as Jeff noted, and the contract business is where our international business is. It's going to be impacted by the coronavirus a bit. So we're expecting to be a little bit lower there. But again I think, those general categories are a bit too simplistic to really describe the breadth of what we're doing these days.

Steven Ramsey -- Thompson Research Group -- Analyst

Got you. On S&A expenses, good job holding those well below sales growth. How much of that was just slower e-commerce trends in the quarter, or is that a result of past investments that you're making, bearing fruit and just how that may play out in 2020?

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Yeah. The big driver there, Steven, is our productivity efforts. We had a good, we had a good quarter, good year on driving productivity and freight distribution in our core business.

Steven Ramsey -- Thompson Research Group -- Analyst

Excellent. And on gross margin expansion for 2020, could gross margins still expand, even if you came in below your sales guidance range?

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Certainly, not having volume will make it harder, but we would fully expect to expand gross margins and I think the big driver of that will be this productivity, we mentioned earlier, that we expect to drive in 2020 of $20 million to $25 million.

Steven Ramsey -- Thompson Research Group -- Analyst

Excellent. And then I guess lastly from me, we're hearing from various parts of the field, the channel, the inflation overall is pretty nominal right now? Is that what you're seeing in in either Hearth or Office contract side of things?

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Yeah, I think if you look at material inflation, we are seeing a pretty nominal, maybe even slightly favorable. But we still see pressure on wages and healthcare and benefits and so forth. So we are expecting a little bit input cost pressure in 2020, but it's much less than we saw in 2019.

Steven Ramsey -- Thompson Research Group -- Analyst

Great color. Thank you.

Operator

[Operator Instructions]. Your next question comes from the line of Reuben Garner with Benchmark. Your line is open.

Reuben Garner -- The Benchmark Company -- Analyst

Thank you, good morning guys.

Jeffrey Lorenger -- President and Chief Executive Officer

Good morning.

Reuben Garner -- The Benchmark Company -- Analyst

So maybe, let's start with the SG&A investments, just a couple of follow-ups. One, can you can you quantify what you're spending or what the incremental investment is this year? And then secondly, are these new investments the way to think about it, that's kind of the new run rate for SG&A? Or are these one-time and you might have a bit of leverage that kicks in, in 2021?

Jeffrey Lorenger -- President and Chief Executive Officer

Yeah. The amount. If you look across the SG&A, is roughly $18 million on an incremental basis, Reuben and I would say they would lever. We don't have exact timing on that, but they would probably start to lever in 2021, depending on the investment.

Reuben Garner -- The Benchmark Company -- Analyst

Okay.

Jeffrey Lorenger -- President and Chief Executive Officer

So it's not necessarily a new run rate. And some of it -- some of it will go into the run rate, but others will lever.

Reuben Garner -- The Benchmark Company -- Analyst

Got it. And then, so you've got $20 million to $25 million in productivity offset by the $18 million in incremental. What's your price cost outlook for this year? Is that expected to be a tailwind or and then I guess, are there any other puts and takes on the margin front, aside from those few factors and volume leverage?

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Yeah. Reuben, on the price cost front, we're expecting it to be favorable in the range of $5 million to $10 million on the year. That's mainly carryover from what we saw in 2019. The price realization is going be a lot less than we saw in the, -- as I said earlier, the input costs are also less. But we still expect to be slightly favorable there. The rest of the rest of the drivers I think are smaller, but we do have some headwinds on the SG&A front that involve variable comp and things like that, which is probably the only missing piece of the puzzle that we haven't already talked about.

Reuben Garner -- The Benchmark Company -- Analyst

Okay, perfect. And then last one for me, a couple of strong years of free cash flow generation. Can you talk to me about -- I guess, the puts and takes on the free cash flow front in 2020, specifically working capital, you had a -- looked like a little tailwind in '19 as neutral, kind of the way to think about 2020, and then now that your balance sheet is -- you're approaching no net debt, what are the plans for uses of cash? Are there acquisition targets on the building product side or in Office that you could take a look at? Just talk to me about, what the uses of cash are? Thanks guys.

Marshall Bridges -- Senior Vice President and Chief Financial Officer

So let's take the first part of that question first. You know, as it relates to working capital, we did a nice job of freeing up some working capital out of the core business in 2019, which helped us generate that $153 million of free cash flow we did in 2019. We're expecting free cash flow to be a little bit less in 2020 in the $130 million to $140 million range, and the difference between the two is really working capital timing. I'm not sure, we expect the same working capital benefit that we saw in '19 versus '20. But it's still healthy cash flow.

Jeffrey Lorenger -- President and Chief Executive Officer

Yeah. And on the M&A question, I mean you're right, we have dry powder. We have a strong position in the balance sheet. And you know candidly, we're always looking for value creation opportunities. You know, both on the Hearth side and the Office Furniture side. We look at capability enhancements, products, and so that's an active process that's ongoing and obviously, when we see something, we will pursue it.

Operator

There are no further questions in queue at this time. I turn the conference back over to our presenters.

Jeffrey Lorenger -- President and Chief Executive Officer

Oh, thank you everybody, and thank you for joining us today on the call, and thank you for your continued interest in HNI Corporation. Have a great day.

Operator

[Operator Closing Remarks].

Duration: 27 minutes

Call participants:

Matt McCall -- Vice President, Investor Relations and Corporate Development

Jeffrey Lorenger -- President and Chief Executive Officer

Marshall Bridges -- Senior Vice President and Chief Financial Officer

Gregory Burns -- Sidoti -- Analyst

Steven Ramsey -- Thompson Research Group -- Analyst

Reuben Garner -- The Benchmark Company -- Analyst

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