HNI Corporation — Form 10-Q Summary
Period clarification: The request identifies 2017 Q3, but the filing is for the quarter ended September 29, 2018. Comparisons below are against the corresponding 2017 periods. Financial statement amounts are in millions of dollars unless otherwise noted.
Business context and reporting period
HNI operates in office furniture and hearth products. The unaudited filing reports the three and nine months ended September 29, 2018. Management describes HNI as focused on growing its businesses, developing new opportunities, and improving efficiency.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $611.1 | $599.5 | $1,659.8 | $1,591.6 |
| Gross profit | $233.3 | $221.2 | $611.1 | $579.7 |
| Operating income | $53.6 | $57.7 | $84.4 | $87.3 |
| Net income attributable to HNI | $39.9 | $37.3 | $61.0 | $56.0 |
| Diluted EPS | $0.89 | $0.84 | $1.38 | $1.24 |
| Gross margin | 38.2% | 36.9% | 36.8% | 36.4% |
| Operating margin | 8.8% | 9.6% | 5.1% | 5.5% |
Q3 sales grew 1.9%; HNI-attributable net income rose 7.1%. Nine-month sales increased 4.3% and net income increased 9.0%. Operating income declined in both comparisons. Lower tax expense helped lift net income: the effective tax rate was 21.9% in Q3 and 20.8% for nine months, versus 33.3% and 33.0%, respectively, in 2017.
- Segments: Q3 office furniture sales were $471.7 million, up 1.4%, and segment operating profit was $46.1 million, up 16.0%. Hearth sales were $139.4 million, up 3.9%, while operating profit fell 24.1% to $21.8 million. The prior-year hearth comparison included nonrecurring gains.
- Cash flow: Operating activities generated $115.0 million in the first nine months, versus $57.3 million in 2017. Management attributed the increase mainly to working-capital timing. Investing activities used $26.1 million; capital expenditures and capitalized software totaled $47.0 million, compared with $103.9 million a year earlier. Financing activities used $68.5 million. Cash rose by $20.4 million to $43.7 million.
- Balance sheet and liquidity: Current assets were $513.9 million and current liabilities $436.0 million at September 29, 2018. Total debt was approximately $250.1 million, including $150 million drawn on a $450 million revolving facility and $100 million of fixed-rate notes. Long-term debt on the balance sheet was $249.3 million. HNI reported compliance with debt covenants and expects adequate liquidity for at least 12 months.
- Capital returns: Nine-month dividends paid were $38.2 million, or $0.875 per share. HNI repurchased 368,822 shares for approximately $14.9 million and had $63.1 million remaining under its repurchase authorization.
Material changes and unusual items
- Q3 gross margin improved 130 basis points, attributed chiefly to productivity, improved pricing, and lower restructuring and transition costs. Input-cost inflation and lower contract office furniture volume partly offset those benefits.
- Q3 selling and administrative expenses rose 5.9%, faster than sales, reflecting incentive compensation, strategic investments, business systems transformation amortization, and deferred compensation effects. Operating margin declined 80 basis points.
- Interest expense increased: net interest expense was $2.5 million in Q3, up 43%, and $7.4 million for nine months, up 96%. HNI cited higher average debt, variable rates, debt issuance cost amortization, and cessation of capitalized interest.
- The 2017 comparison included a $6.0 million gain from sale and license of an intangible asset and a $0.8 million gain on sale of a closed facility. 2018 restructuring and impairment charges were $2.3 million for nine months, versus $3.3 million; 2018 also included $1.7 million of transition costs in cost of sales.
- HNI completed a $16.9 million sale-leaseback of a manufacturing facility in Q1 2018, leasing back part of it for 10 years. The $5.1 million gain is deferred and amortized as a reduction to rent expense.
- On September 21, 2018, HNI acquired a small hearth products company for approximately $3 million; preliminary goodwill from the acquisition was $3.4 million.
Outlook, risks, and contingencies
Management expressed optimism about long-term prospects in both markets and confidence that business investments will generate returns, but provided no specific revenue or earnings guidance. Full-year 2018 capital expenditures were expected to be approximately $65 million to $70 million. HNI said it was committed to maintaining or modestly growing its quarterly dividend.
Key disclosed risks include demand and market conditions, housing starts, raw-material and component costs, customer and dealer concentration, competition, product acceptance and defects, international operations, execution of business systems transformation and restructuring, integration of acquisitions, and financing restrictions. HNI reported no material change to previously disclosed risk factors. A reporting unit in office furniture triggered interim impairment testing due to lower projected operating results; no impairment was identified, but future estimates could change. HNI also reported ordinary-course legal, environmental, tax, and other contingencies that it did not expect to have a material adverse effect.
The Artcobell-related litigation was resolved on October 9, 2018, after quarter-end. HNI said it was not required to make payments and expected an immaterial recovery in Q4 2018. The company expected to adopt the new lease accounting standard in fiscal 2019 and anticipated higher reported assets and liabilities from recognizing lease assets and obligations.
Important facts for investors to verify
- Confirm the reporting-period mismatch: this is a 2018 Q3 filing, not a 2017 Q3 filing.
- Assess whether sales growth can continue amid weakness in contract office furniture and the impact of dealership closures and divestitures.
- Track whether margin improvement persists as input costs, incentive compensation, strategic investment, and systems-transformation costs affect results.
- Evaluate debt, interest expense, covenant headroom, and refinancing or rate exposure; the filing states covenant compliance but does not provide the actual leverage ratio.
- Monitor working-capital cash-flow timing, the 2018 capital-spending plan, and the effect of leases recognized under the forthcoming accounting standard.
- Review the office furniture reporting unit’s projected performance and impairment sensitivity, as well as the final purchase-price allocation for the hearth acquisition.