Business context and reporting period
HNI Corporation’s unaudited Form 10-Q covers the quarter and six months ended July 2, 2016, compared with the corresponding 2015 periods. The filing identifies two reportable segments: office furniture and hearth products. Although the request metadata says 2015 Q2, the filing itself is for 2016 Q2.
Financial performance
| Metric | Three months ended July 2, 2016 | Three months ended July 4, 2015 | Six months ended July 2, 2016 | Six months ended July 4, 2015 |
|---|---|---|---|---|
| Net sales | $536.5 million | $568.2 million | $1,037.6 million | $1,091.7 million |
| Gross margin | 38.9% | 36.3% | 38.0% | 35.8% |
| Operating income | $46.0 million | $39.4 million | $65.5 million | $54.8 million |
| Net income attributable to HNI | $29.0 million | $23.9 million | $40.9 million | $32.4 million |
| Diluted EPS | $0.64 | $0.52 | $0.90 | $0.71 |
Second-quarter operating margin was approximately 8.6%, versus 6.9% a year earlier. For the first half, it was approximately 6.3%, versus 5.0%. Despite lower sales, gross profit rose 1.4% in Q2 and 1.0% year to date; improved operations, material productivity and pricing outweighed lower volume.
For the first six months, operating cash flow was $31.8 million, compared with cash used of $31.9 million in 2015. Capital expenditures and capitalized software totaled $55.9 million, versus $49.9 million. Cash and cash equivalents were $24.4 million at July 2, 2016, and short-term investments were $6.8 million. Total debt was $276.2 million, including $83.2 million classified as current and $193.0 million long term. Total equity was $505.9 million.
Changes versus the prior comparable period
- Q2 sales declined 5.6%; first-half sales declined 5.0%. Management attributed the declines to weaker organic sales in both segments, including a softer office furniture market and strong prior-year comparisons.
- Office furniture Q2 sales fell 5.0% to $428.1 million, while segment operating profit rose 9.0% to $43.4 million. Hearth Q2 sales fell 7.8% to $108.4 million, and operating profit declined 10.8% to $10.0 million.
- Q2 selling and administrative expense declined 3.0% in dollars but increased to 30.3% of sales from 29.4%, reflecting lower volume and higher incentive compensation, partly offset by cost reductions.
- The effective tax rate fell to 35.4% for Q2 from 36.4%, and to 34.8% for the first half from 36.7%. HNI cited the timing of the R&D tax credit enactment and foreign earnings mix.
Outlook, management commentary and notable items
- Management expressed optimism about the long-term prospects of both markets but gave no specific earnings or sales forecast. It expected positive operating cash flow for 2016 and projected full-year capital expenditures of approximately $125 million to $130 million.
- HNI acquired a small office furniture company on January 29, 2016, for approximately $34 million net of cash acquired; the business had annual sales of approximately $30 million. The acquisition and divestitures of small office furniture-related businesses increased sales by $6.5 million in Q2 and $11.2 million in the first half versus 2015.
- Q2 included $2.0 million of restructuring costs and $3.5 million of transition costs related primarily to the Paris, Kentucky hearth facility closure and Muscatine, Iowa office furniture realignments. HNI also recorded a $2.0 million nonrecurring litigation-settlement gain. The filing reports restructuring expense net of applicable adjustments in the income statement; these disclosed gross costs and the gain should not be treated as directly comparable line items.
- HNI repaid $150 million of senior notes at maturity in April using its revolving credit facility. The facility commitment was increased to $400 million and extended to January 2021; $276 million was outstanding at quarter-end. A $150 million interest-rate swap fixes the rate at 1.29% against one-month LIBOR through January 2021.
- The company was in compliance with credit covenants at quarter-end and expected to remain compliant over the following 12 months. Management said cash, investments, operating cash flow and borrowing capacity should be adequate for at least 12 months. It cited demand, economic and housing conditions, material costs and availability, competition, distribution relationships, execution of initiatives and credit availability among the risks to results.
- The board increased the quarterly dividend 3.8%, from $0.265 to $0.275 per share. HNI repurchased 208,000 shares for $8.7 million in the first half; $184.0 million remained under the authorization. Ordinary-course litigation, environmental, tax and other claims were not expected by management to have a material adverse effect. No material legal proceedings or material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether the sales decline and segment weakness continued after July 2, 2016, particularly in office furniture and the hearth retail channel.
- How sustainable the margin improvement is given lower volume, incentive compensation, transition and restructuring costs, and the one-time litigation gain.
- Acquisition performance, final purchase-price allocation, and resulting goodwill and intangible-asset estimates.
- Debt maturity classification, available revolver capacity, covenant headroom and exposure to variable interest rates despite the swap.
- Delivery of the stated 2016 capital-spending and cash-flow expectations, and the ongoing cash demands from dividends and share repurchases.