News Column

HNI CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

April 29, 2014

Overview

The Corporation has two reportable segments: office furniture and hearth products. The Corporation is a leading global office furniture manufacturer and the nation's leading manufacturer and marketer of gas- and wood-burning fireplaces. The Corporation utilizes its split and focus, decentralized business model to deliver value to its customers with its various brands and selling models. The Corporation is focused on growing its existing businesses while seeking out and developing new opportunities for growth.

Net sales for the first quarter of fiscal 2014 increased 2.2 percent to $452.2 million when compared to the first quarter of fiscal 2013. The change was driven by an increase in hearth product sales across both the new construction and remodel-retrofit channels as well as an increase in office furniture sales in the contract channel, partially offset by the effect of divestitures and a decline in sales in the supplies-driven channel of the office furniture segment. Gross margin for the quarter increased from prior year levels due to higher volume in the hearth products segment and increased price realization partially offset by lower volume and unfavorable mix in the office furniture segment. Total selling and administrative expenses increased due to investment in strategic initiatives and higher incentive based compensation partially offset by freight efficiencies and lower restructuring charges. The Corporation realized a pre-tax gain of $8.4 million on the sale of a vacated facility.

Results of Operations

The following table presents certain key highlights from the results of operations for the periods indicated:

Three Months Ended Percent (In thousands) March 29, 2014 March 30, 2013 Change Net sales $ 452,201$ 442,297 2.2 % Cost of sales 297,029 294,515 0.9 % Gross profit 155,172 147,782 5.0 % Selling and administrative expenses 145,210 144,556 0.5 % (Gain) on sale of assets (8,400 ) - NM Restructuring and impairment charges (28 ) 156 (117.9 )% Operating income 18,390 3,070 499.0 % Interest expense, net 2,132 2,516 (15.3 )% Income before income taxes 16,258 554 2,834.7 % Income taxes 5,242 (625 ) 938.7 % Net income $ 11,016$ 1,179 834.4 %



Consolidated net sales for the first quarter of 2014 increased 2.2 percent or $9.9 million compared to the same quarter last year. The change was driven by an increase in hearth product sales across both the new construction and remodel-retrofit channels as well as an increase in office furniture sales in the contract channel, partially offset by the effect of divestitures and a decline in office furniture sales in the supplies-driven channel. Compared to prior year quarter, divestitures of several small businesses, including office furniture dealers, resulted in a $6.8 million sales decline.

Gross margin for the first quarter of 2014 increased to 34.3 percent compared to 33.4 percent for the same quarter last year. The increase in gross margin was driven by higher hearth products sales volume and increased price realization partially offset by lower volume and unfavorable mix in the office furniture segment.

Total selling and administrative expenses, including restructuring charges, as a percentage of net sales decreased to 32.1 percent compared to 32.7 percent for the same quarter last year due to volume and freight efficiencies partially offset by investment in strategic initiatives and higher incentive based compensation. First quarter 2013 included $0.2 million of restructuring and transition charges associated with plant consolidations.

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The Corporation realized an $8.4 million gain on the sale of a vacated office furniture manufacturing facility which had been held for sale since 2009.

The provision for income taxes for continuing operations for the three months ended March 29, 2014 reflects an effective tax rate of 32.2 percent compared to (113.0) percent for the same period last year. First quarter 2013 reflects the effect of a retroactive extension of the 2012 research tax credit of $0.9 million. The 2014 estimated annual effective tax rate is expected to be 35.0 percent.

Net income attributable to HNI Corporation was $11.1 million or $0.24 per diluted share in the first quarter of 2014 compared to $1.4 million or $0.03 per diluted share in the first quarter of 2013.

Office Furniture

First quarter 2014 sales for the office furniture segment decreased 2.0 percent or $7.5 million to $358.4 million from $365.8 million for the same quarter last year. Compared to the prior year quarter, divestitures resulted in a $6.8 million sales decline. Net sales in the supplies-driven channel were negatively impacted by harsh weather. This decrease was offset partially by an increase in the contract channel due to strength in core commercial markets and increased sales to the federal government driven by a few large projects. First quarter 2014 operating profit prior to unallocated corporate expenses increased 89.6 percent or $7.8 million to $16.5 million as a result of increased price realization, freight efficiencies and a $8.4 million gain on the sale of a vacated facility. These were partially offset by lower volume and unfavorable mix. First quarter 2013 included $0.2 million of restructuring and transition costs.

Hearth Products

First quarter 2014 net sales for the hearth products segment increased 22.7 percent or $17.4 million to $93.8 million from $76.5 million for the same quarter last year. The increase was driven by an increase in both the new construction channel due to housing market recovery and the remodel-retrofit channel due to strong remodeling activity and demand for alternative fuel products. Operating profit prior to unallocated corporate expenses increased $8.1 million to $11.7 million compared to $3.6 million in the prior year quarter due to increased volume and higher price realization offset partially by higher incentive-based compensation.

Liquidity and Capital Resources

Cash Flow - Operating Activities Operating activities used $36.1 million of cash in the first three months of 2014 compared to $31.3 million in the first three months of 2013. Working capital resulted in a $64.4 million use of cash in the first three months of the current fiscal year compared to a $55.6 million use of cash in the same period of the prior year. The Corporation's first quarter is historically the lowest quarter for operating cash flow due to seasonal business patterns and funding requirements. Cash flow from operating activities is expected to be positive for the year.

Cash Flow - Investing Activities Capital expenditures, including capitalized software, for the first three months of fiscal 2014 were $22.7 million compared to $14.8 million in the same period of fiscal 2013 and were primarily for tooling, equipment and capacity for new products, continuous improvements in manufacturing processes and the on-going implementation of new integrated information systems to support business process transformation. For the full year 2014, capital expenditures are expected to be approximately $90 to $95 million, primarily related to new products, operational process improvements and capabilities and the business process transformation project referred to above.

During the first quarter of 2014 the Corporation completed the sale of a facility located in South Gate, California. The proceeds from the sale of $12.0 million are reflected in the Condensed Consolidated Statement of Cash Flows as "Proceeds from property, plant and equipment".

Cash Flow - Financing Activities The net borrowings under the revolving credit agreement at the end of first quarter were $39 million and are classified as short-term as the Corporation expects to repay the borrowings within a year.

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The Credit Agreement governing the Corporation's revolving credit facility contains a number of covenants, including covenants requiring maintenance of the following financial ratios as of the end of any fiscal quarter:

a consolidated interest coverage ratio of not less than 4.0 to 1.0, based upon the ratio of (a) consolidated EBITDA (as defined in the Credit Agreement) for the last four fiscal quarters to (b) the sum of consolidated interest charges; and a consolidated leverage ratio of not greater than 3.0 to 1.0, based upon the ratio of (a) the quarter-end consolidated funded indebtedness (as defined in the Credit Agreement) to (b) consolidated EBITDA for the last four fiscal quarters; or a consolidated leverage ratio of not greater than 3.5 to 1.0, based upon the ratio of (a) the quarter-end consolidated funded indebtedness to (b) consolidated EBITDA for the last four fiscal quarters following any qualifying debt financed acquisition.



The note purchase agreement pertaining to the Corporation's Senior Notes also contains a number of covenants, including a covenant requiring maintenance of consolidated debt to consolidated EBITDA (as defined in the note purchase agreement) of not greater than 3.5 to 1.0, based upon the ratio of (a) the quarter-end consolidated funded indebtedness (as defined in the note purchase agreement) to (b) consolidated EBITDA for the last four fiscal quarters.

Additional borrowing capacity of $211 million is available through the revolving credit facility. The revolving credit facility is the primary source of committed funding from which the Corporation finances its planned capital expenditures and strategic initiatives, such as acquisitions, repurchases of common stock and certain working capital needs. Non-compliance with the various financial covenant ratios in the revolving credit facility or the Senior Notes could prevent the Corporation from being able to access further borrowings under the revolving credit facility, require immediate repayment of all amounts outstanding with respect to the revolving credit facility and Senior Notes and/or increase the cost of borrowing.

The most restrictive of the financial covenants is the consolidated leverage ratio requirement of 3.0 to 1.0 included in the Credit Agreement. Under the Credit Agreement, consolidated EBITDA is defined as consolidated net income before interest expense, income taxes and depreciation and amortization of intangibles, as well as non-cash, nonrecurring charges and all non-cash items increasing net income. At March 29, 2014, the Corporation was well below the maximum allowable ratio and was in compliance with all of the covenants and other restrictions in the Credit Agreement and the note purchase agreement. The Corporation currently expects to remain in compliance over the next twelve months.

The Corporation's Board of Directors (the "Board") declared a regular quarterly cash dividend of $0.24 per share on the Corporation's common stock on February 12, 2014, to shareholders of record at the close of business on February 24, 2014. The dividend was paid on March 3, 2014.

During the three months ended March 29, 2014, the Corporation repurchased 133,000 shares of common stock at a cost of approximately $4.7 million, or an average price of $35.14 per share. As of March 29, 2014, approximately $82.6 million of the Board's current repurchase authorization remained unspent.

Cash, cash equivalents and short-term investments, coupled with cash from future operations, borrowing capacity under the existing facility and the ability to access capital markets, are expected to be adequate to fund operations and satisfy cash flow needs for at least the next twelve months.

Off-Balance Sheet Arrangements

The Corporation does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on the Corporation's financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Contractual Obligations

Contractual obligations associated with ongoing business and financing activities will result in cash payments in future periods. A table summarizing the amounts and estimated timing of these future cash payments was provided in the Corporation's Annual Report on Form 10-K for the year ended December 28, 2013. During the first three months of fiscal 2014, there were no material changes outside the ordinary course of business in the Corporation's contractual obligations or the estimated timing of the future cash payments.

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Commitments and Contingencies

The Corporation is involved in various kinds of disputes and legal proceedings that have arisen in the ordinary course of business, including pending litigation, environmental remediation, taxes and other claims. It is the Corporation's opinion, after consultation with legal counsel, that additional liabilities, if any, resulting from these matters are not expected to have a material adverse effect on the Corporation's financial condition, cash flows or on the Corporation's quarterly or annual operating results when resolved in a future period.

Critical Accounting Policies

The preparation of the financial statements requires the Corporation to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Corporation continually evaluates its accounting policies and estimates. The Corporation bases its estimates on historical experience and on a variety of other assumptions believed by management to be reasonable in order to make judgments about the carrying value of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. A summary of the more significant accounting policies that require the use of estimates and judgments in preparing the financial statements is provided in the Corporation's Annual Report on Form 10-K for the year ended December 28, 2013. During 2014 the Corporation changed its estimate regarding the quarterly accrual of annual incentive plan expense to more accurately match expense with earnings. During the first three months of fiscal 2014, there were no material changes in the accounting policies and assumptions previously disclosed.

New Accounting Standards

For information pertaining to the Corporation's adoption of new accounting standards and any resulting impact to the Corporation's financial statements, please refer to Note N. New Accounting Standards of the Notes to the Condensed Consolidated Financial Statements, in Part 1, Item 1 of this Quarterly Report on Form 10-Q.

Looking Ahead

Management remains optimistic about the office furniture and hearth products markets. Management believes the Corporation is well positioned to drive sales and significantly increase profits in 2014.

The Corporation continues to focus on creating long-term shareholder value by growing its businesses through investment in building brands, product solutions and selling models, enhancing its strong member-owner culture and continuing to execute its long-standing continuous improvement discipline to build best total cost and a lean enterprise.

Forward-Looking Statements

Statements in this report that are not strictly historical, including statements as to plans, outlook, objectives and future financial performance, are "forward-looking" statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Words, such as "anticipate," "believe," "could," "confident," "estimate," "expect," "forecast," "hope," "intend," "likely," "may," "plan," "possible," "potential," "predict," "project," "should," "will," "would" and variations of such words and similar expressions identify forward-looking statements. Forward-looking statements involve known and unknown risks, which may cause the Corporation's actual results in the future to differ materially from expected results. These risks include, without limitation: the Corporation's ability to realize financial benefits from its (a) price increases, (b) cost containment and business simplification initiatives, including its business system transformation (c) investments in strategic acquisitions, production capacity, new products and brand building, (d) investments in distribution and rapid continuous improvement, (e) ability to maintain its effective tax rate, (f) repurchases of common stock and (g) consolidation and logistical realignment initiatives; uncertainty related to the availability of cash and credit, and the terms and interest rates on which credit would be available, to fund operations and future growth; lower than expected demand for the Corporation's products due to uncertain political and economic conditions, slow or negative growth rates in global and domestic economies or in the domestic housing market; lower industry growth than expected; major disruptions at our key facilities or in the supply of any key raw materials, components or finished goods; competitive pricing pressure from foreign and domestic competitors; higher than expected costs and lower than expected supplies of materials; higher costs for energy and fuel; changes in the mix of products sold and of customers purchasing; relationships with distribution channel partners, including the financial viability of distributors and dealers; restrictions imposed by the terms of the Corporation's revolving credit facility and note purchase agreement; currency fluctuations and other factors described in the Corporation's annual and quarterly reports filed with the Securities and Exchange Commission on Forms 10-K and 10-Q. The Corporation undertakes no obligation to update, amend, or clarify forward-looking statements.

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