1

Off Wall Street Consulting Group, Inc.

P.O. Box 382107

Cambridge, MA 02238

tel: 617.868.7880 fax: 617.868.4933

internet: research@offwallstreet.com www.offwallstreet.com

All information contained herein is obtained by Off Wall Street Consulting Group, Inc. from sources believed by it to be accurate and reliable. However, such information is presented "as is," without warranty of any kind, and Off Wall Street Consulting Group, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. Off Wall Street has strict policies prohibiting the use of inside information. We have also implemented policies restricting the use of experts. Among other things, Off Wall Street: (1) does not hire expert networking firms; (2) does not hire as experts employees of those companies we research; and (3) specifically instructs consultants whom we hire to not provide us with inside information. All expressions of opinion are subject to change without notice, and Off Wall Street Consulting Group, Inc. does not undertake to update or supplement this report or any of the information contained herein. You should assume that Off Wall Street Consulting Group, Inc. and its employees enter into securities transactions which may include hedging strategies and buying and selling short the securities discussed in its reports before and after the time that Off Wall Street Consulting Group, Inc. determines to issue a report. Off Wall Street Consulting Group, Inc. hereby discloses that its clients and we the company, or our officers and directors, employees and relatives, may now have and from time to time have, directly or indirectly, a long or short position in the securities discussed and may sell or buy such securities at any time.

Copyright 2017 by Off Wall Street Consulting Group, Inc. N.B: Federal copyright law (Title 17 of the U.S. Code) makes it illegal to reproduce this report by any means and for any purpose, unless you have our written permission. Copyright infringement carries a statutory fine of up to $100,000 per violation. We offer a reward of $2,000 for information that leads to the successful prosecution of copyright violators.

New Rec: HNI Corp (HNI: $50.50) February 5, 2017 Position: Sell Target: $35 $MM Dec-16e Mar-17e Jun-17e Sep-17e F2016e F2017e F2018e Revs 579 493 527 575 2,201 2,166 2,124 Adj. EPS 0.85 0.31 0.60 0.72 2.64 2.43 2.17 Y/Y Gr -7% 0% -11% -10% 2% -8% -11% PE na na na na 19.1x 20.8x 23.3x Cnsns Rev 582 507 539 595 2.20B 2.24B 2.32B Cnsns EPS 0.85 0.39 0.72 0.92 2.64 3.00 3.41

Shares Out: 45.8M Market Cap: $2.3B FYE Dec Concept: 1. Office furniture demand appears to be in secular decline, and also appears to be nearing a cyclical peak. Expectations that HNI’s office furniture revenues will re-accelerate over multiple years seem unlikely to be met.

2

2. HNI management’s suggestion that margins will expand to new highs may be unrealistic. Gross margins are driven by raw material prices, which are now increasing. SG&A has de-levered over multiple economic cycles. 3. Earnings quality appears poor. Over the TTM period, FCF has represented only 55% of non-GAAP earnings. HNI’s accounting may be too aggressive and seems open to question. Summary: HNI Corp (HNI) is one of the largest US manufacturers of office furniture, which it sells primarily under the HON and AllSteel brands. The company sells to furniture dealers, wholesalers, and office retailers like Staples and Office Depot. Roughly half of its office furniture sales are through the “contract” channel, where furniture dealers bid on a specific project, while the other half is sold into the “supplies driven” channel, where visibility is lower. Office furniture accounted for 77% of HNI’s TTM sales and 65% of pre-corporate EBIT. Hearth products (i.e. fireplaces and stoves) accounts for the remainder. Our investment thesis focuses on the Office segment. HNI bulls view the stock as a “play” on corporate capital investment, thinking that rising business confidence will soon translate into increased demand for office furniture. This would represent a change from the current trend. In September 2016, HNI pre-announced weak 3Q16 results: 3Q16 sales fell -5% Y/Y (versus guidance of 0%-3% growth) and non-GAAP EPS of $0.80 (-14% Y/Y) missed guidance of $0.93. The company blamed this on “overall softer than anticipated demand.” HNI’s share price subsequently fell from $52 to $37. However, since the US election, HNI shares have regained all their lost ground, and trade above $50. HNI management has suggested that revenue growth in the Office Furniture segment will re-accelerate and compound at 4%-5% p.a. through 2020, with 25% incremental operating margins. Buoyed by high expectations for corporate investment post-election, investors appear to give credence to these bullish claims: on a price-to-sales basis, HNI trades near a 10-year high. These bullish expectations seem unlikely to be met. First, US office furniture demand appears to be in secular decline. This has been driven primarily by a shift from cubicle-style personal workspaces to more “open format” space with communal seating, which reduces square-footage-per-employee by as much as 75%. At the same time, furniture spend per square foot is declining, as businesses reduce storage requirements and introduce open tables without drawers and dividers. All told, based on our analysis of CoStar data, we estimate that furniture spending per employee declined roughly -13% from 2007 to 2016 and is still falling, as we will discuss further. Second, US office furniture demand appears to be nearing a cyclical peak. Growth in “professional and business services” payrolls (i.e. the white collar jobs

3

that drive office furniture spending) is decelerating as the US approaches full employment. Recent JOLTS data suggests that growth in white-collar job openings, a leading indicator for employment growth, has also slowed. In recent months, net absorption of office space has slowed, as new deliveries have come on line in an environment of slowing demand growth. Jones Lang LaSalle projects that new office completions will peak in 2017. Within the existing office stock, total leasing activity (which drives furniture demand, since companies usually buy new furniture when they move) also appears to be slowing. JLL estimates that US gross leasing volumes dropped by -6.7% Y/Y in 2016 and are projected to be flat this year, despite the higher Y/Y deliveries of new office inventory. As we discuss, below, our fieldwork also supports the notion that leasing activity and demand for office furniture is slowing. Consensus projections imply that HNI can achieve non-GAAP operating margins of ~10% by 2018 (up from 8.5% in the TTM period), which would be higher than the previous cyclical peak OPM of 9% achieved in the 2003-05 period (a time when HNI was benefiting from a housing boom in its higher-margin hearth segment).

We think such margin expansion is unlikely to materialize. First, raw materials, primarily steel, account for two-thirds of COGS, and prices are now rising sharply (e.g. at $630 per short ton, US hot rolled steel prices are up +58% Y/Y). By comparison, between 2005-07 (a period of similar Y/Y increases in raw material pricing) HNI’s GPM declined by -110bps despite +5% top line growth. Second, as we discuss below, SG&A expense has de-levered during multiple economic cycles. Barring acceleration in top-line growth, margin expansion on the SG&A line through cost cutting and productivity improvements should be difficult to achieve.

In addition, HNI’s reported income statement margins and earnings appear

to bear little relation to actual cash profit generation. HNI generated only $1.48/share of sustainable FCF over the TTM period, compared to $2.70 in reported non-GAAP EPS. Quality of earnings appears poor, and HNI’s accounting seems aggressive. CapEx has far exceeded D&A for the past three years (e.g. $87MM for the TTM period vs. $64MM D&A), despite the fact that the company has been reducing capacity and closing down manufacturing facilities.

At the same time, since 2012, HNI has been capitalizing expenses related to

an ERP implementation and various (and vaguely defined) “business systems transformation” initiatives, but has repeatedly held off from amortizing these capitalized expenses, which totaled $29MM in the TTM period (or $0.44/share after tax), and now amount to $144MM (or $2.19 per share) on the balance sheet.

4

The company originally said it would begin amortizing these in 2014 or 2015, but now appears to be telling investors that amortization will begin sometime in 2017 (and will be done over an abnormally long 10-year depreciable life). Interestingly, we note that HNI sacked its auditor in 2015, and, at the same time, shuffled its audit committee, which now appears to include only one member (a 19-year board veteran) with accounting experience.

Overall, HNI’s approach to cost capitalization seems very aggressive, and,

given that aggressiveness, it is notable that the company has increased its total FY16 CapEx guidance substantially throughout the course of 2016 (from $105MM-$110MM a year ago, to $130MM-$135MM today), which it had not done in prior years. This accounting has the potential to increase reported earnings, but it is also open to question. We will discuss HNI’s accounting, below.

As noted, following HNI’s pre-announcement of weak 3Q16 results, shares

fell to $37. We think that, if investors begin to question the bull case regarding HNI’s top line growth, and, importantly, if investors begin to seriously question the quality of reported earnings, HNI’s share price is likely to return to much lower levels. Our $35 price target represents a 0.75x price-to-sales multiple against our projected 2018 revenues of $2.1B, which is the middle of the range in which HNI has traded over the past 10 years. Our $35 price target also represents a 16.2x multiple of our 2018 earnings projection of $2.17. HNI currently sells at a 14.8x multiple of consensus 2018 EPS of $3.41, so there might be additional downside to our price target. Borrow information: HNI Supply quantity Quantity on loan Available to borrow Date 10.9M 0.4M 10.5M Feb-2 Source: Markit/Data Explorers While reasonable efforts have been made to ensure the accuracy and completeness of this data, no warranty of accuracy, completeness, appropriateness or any other kind is given by Off Wall Street, Markit/Data Explorers or their respective licensees or affiliates in relation to this data. Copyright in securities lending data: Markit/Data Explorers. All rights reserved. Background: HNI Corp. (HNI), headquartered in Muscatine, Iowa, is one of the largest US manufacturers of office furniture, and is also the largest US manufacturer of hearth and fireplace products. Over the TTM period ending Sep-30, the Office Furniture segment accounted for 77% of total HNI revenues and 65% of pre-corporate EBIT, while the Hearth segment accounted for the remainder. Figure 1, below, shows HNI’s annual revenues by segment since 1998. Note that the company has spent $667MM on acquisitions over this time period.

5

Figure 1. HNI revenue by segment ($MM)

Source: Company filings, OWS

Figure 2, below, shows the progression of HNI’s total organic revenues since 1998, based on the Y/Y% organic growth figures disclosed in the company’s 10-K filings. It appears that organic revenues are currently almost -8% below their 1998 level (in nominal $ terms), suggesting that organic revenues have compounded at a slightly negative rate over the past two decades. This supports the notion (which we discuss below) that the office furniture market is in secular decline. Figure 2. HNI organic revenues (1998 = 1.00)

Source: Company filings, OWS

6

HNI says that revenues from its Office Furniture segment are split roughly 50/50 between the “contract” and “supplies driven” channels. “Contract” sales are typically made to larger customers, who put out an RFP to furniture dealers. “Supplies driven” sales have a shorter lead time and typically don’t involve a bidding process.

Market share in the higher-end “contract” furniture business is split across the “big 5” players: the publicly traded furniture companies (MLHR, KNOL, SCS, and HON), plus Teknion. These “contract” sales are typically made through furniture dealers who strike an exclusive distribution relationship with a single primary vendor. Each major metro area tends to have a single dealer that represents each of the main manufacturers, and these dealers bid against one another for contract jobs.

By contrast, the “supplies driven” channel caters to smaller businesses that

typically would not put out an RFP for furniture. In this channel, HNI sells to large wholesalers (e.g. Essendant and SP Richards), plus national retailers with a network of B2B sales offices, such as Staples and Office Depot.

The lower-end “supplies driven” channel is much more fragmented than the

“contract” business. HNI claims to have 20%-30% market share, with the #2 player, Global Furniture Group, holding roughly ~15% share. Haworth is another large player in the “supplies driven” market, but the remainder is split across a multitude of niche players. In the “contract” business, HNI sells primarily under the AllSteel brand. Based on our discussions with industry participants, among the “big 5,” it appears that AllSteel (i.e. HNI) and Teknion are generally considered “second-tier” brands, while Herman Miller, Steelcase, and Knoll are viewed as “premium” brands. In the “supplies driven” channel, HNI sells primarily under the HON brand. “Systems and storage” (i.e. desks, cubicles, file cabinets) accounted for 64% of HNI’s 2015 Office Furniture sales. “Seating” accounted for 32%, and “Other” products accounted for the remaining 4%. We note that, since 2010 (when HNI first started disclosing this information), the mix of “systems and storage” revenues has dropped from 71% to 64%, due to secular shifts in the consumption of office furniture (which we discuss below). Turnaround time in HNI’s office furniture business is short: product is typically manufactured and shipped within “a few weeks” of order receipt. As such, visibility appears to be relatively limited.

7

HNI and its competitors manufacture domestically. Except at the very low end, office furniture must be manufactured in the US (or at least assembled in the US) because it is not economic to ship pre-assembled furniture from overseas, and business customers (unlike IKEA shoppers) typically will not assemble their own furniture. As of Dec-31-2015, HNI had 10.7MM square feet of total manufacturing space (the majority of which was dedicated to office furniture), of which it owned 9.1MM square feet. Roughly ~8% of Office Furniture sales are from non-US sources, and these are manufactured abroad.

Raw materials account for roughly two-thirds of furniture COGS. The key

raw materials are steel, aluminum, and wood products. 78% of HNI’s inventories are recorded under the LIFO method and it does not appear that the company has historically hedged its raw material pricing. According to HNI, roughly ~50% of sales in the Hearth segment is driven by new home construction. Roughly 40% is driven by retrofit of existing homes (i.e. addition / replacement of fireplaces), while pellet stoves account for ~10% of Hearth segment sales. Operating margins (before corporate level expenses) have averaged roughly ~7% in the furniture business and ~9% in the hearth business over the long term, with relatively large cyclical swings. Figures 3 and 4, below, show historical (GAAP) OPM by segment, through FY 2015. We discuss HNI’s margins in more detail, below. Figure 3. Office Furniture segment – GAAP OPM

Source: Company filings, OWS

8

Figure 4. Hearth segment – GAAP OPM

Source: Company filings, OWS Discussion: 1. The US office furniture market appears to be in secular decline. According to BIFMA, the industry body, total US consumption of office furniture remains below its late 90’s peak. Even in nominal dollar terms, adjusting for cyclical swings, it appears the overall market hasn’t grown in 20 years. See Figure 5, below. Figure 5. US office furniture consumption ($B)

Source: BIFMA, OWS In real, inflation-adjusted terms, US office furniture consumption is down roughly 33% since peaking in 2000. Figure 6, below, adjusts the BIFMA numbers for inflation (using the US GDP deflator). The secular decline is rather clear.

9

Figure 6. Inflation-adjusted US office furniture consumption (in 2009 dollars)

Source: BIFMA, OWS The secular decline has been driven by a number of factors. First, since the early 2000s, there has been a broad trend away from cubicle-style personal workspaces and toward more “open format” space with communal seating. The new style office space looks like Figure 7, below. In many cases, we are told that companies are forgoing assigned seating entirely. Since a portion of the employee base tends to be traveling or working from home at any given time, this further increases utilization of seats (i.e. there are fewer empty chairs and work spaces).

10

Figure 7. “Open format” seating (source: Herman Miller catalog)

Source: Herman Miller, OWS

The attraction for employers is that personal space-per-employee can be reduced by as much as 75%, as employees are shifted from a 6’ x 6’ cubicle to a 2’ x 4’ bench space. According to interior architects with whom we spoke, 250 square feet per employee (including common areas, etc.) used to be the rule of thumb. Now, spaces in the low 100 square foot range are common, and some of the most aggressive designs specify as little as 85 square feet per employee.

The impact of this shift can be seen in the numbers. Figure 8, below, shows

the change in white-collar employees, occupied square footage, and furniture spend, from 2007-2016. Since 2007 (the last peak in the employment cycle), the number of white-collar employees in the US has increased by +14%. However, based on our analysis of CoStar data, it appears that occupied office square footage has increased by only +6% over the same time period.

11

Figure 8. Change in employees, space, furniture consumption (2007=1.00)

Employees = “Professional and business service employees” from monthly OES survey (source: BLS). Occupied square feet is sourced from OWS analysis of CoStar data. Furniture spend is based on BIFMA data.

Note that this occupied square footage number is likely overstated, since industry participants tell us that the amount of so-called “shadow space” (i.e. square footage that is leased but actually sits unoccupied) has increased substantially since 2007.

Looking at the numbers in a different way, Figure 9, below, shows the trend

in occupied square footage per employee since 1999. This analysis is based on data from Reis. Note the decline in square footage per worker appears to have accelerated since the last recession. This accords with our discussions with industry participants, who suggest that the “open format” trend started accelerating around 2009. According to these contacts, we are now well into the “mainstream adoption” phase of the open format trend.

12

Figure 9. Occupied square feet per office worker (source: Reis)

Source: OWS analysis of Reis data At the same time that square footage per employee has been dropping, furniture spend per square foot has also declined. This is caused by two major factors. First, the reduction of employees’ personal space and the move toward the “paperless office” has markedly reduced storage requirements. Instead of a desk with drawers and/or a file cabinet, the typical office worker is now often provided with just a single 2’ by 2’ pavilion that can double as a seat. See Figure 10, below. Figure 10. Storage pavilions

Source: Knoll

13

In addition to reduced storage requirements, the general aesthetic trend has been toward less “stuff” per square foot. Even in private offices (which have been shrinking in number), there has been a move toward open work tables and less furniture overall, and away from the old style heavy desks with lots of shelving and bookcases. Figure 11, below, shows an example of this trend from Knoll’s “Antenna” line of private offices. According to industry participants, the overall trend toward less “stuff” per square foot has been reducing the average ticket for office furniture. Figure 11. Private office design

Source: Knoll Ultimately, based on our discussions with industry participants, it appears that the changes causing a secular decline in office furniture demand aren’t driven by a design fad so much as by a fundamental change in the way people work. The emergence of smartphones, ubiquitous Wi-Fi, and cloud-based storage and file access, appear to have created a truly “mobile” white-collar workforce, and this mobility means a shift away from the concept of “personal space” in the office, since workers are no longer tethered to a single physical spot. As a result, square footage in the office is transforming from “dedicated” to “undedicated” space.

Businesses are still spending on amenities to attract high quality employees, we are told, but this spending is shifting away from furniture and toward perks like espresso machines, food, nicer laptops, etc. Of course, this represents a shift in spending away from HNI and other furniture manufacturers.

14

According to furniture industry contacts, even those businesses that transitioned entirely to open, communal benches, and later discovered that it provided insufficient private space for workers, are responding not by reverting to older designs, but by adding phone call “cubbies” and shared quiet rooms where employees can retreat to engage in deep work. This supports the notion that declining personal space per worker likely represents a cultural shift rather than a design fad. It does not appear likely that the secular downtrend in furniture spend per worker or per square foot will reverse any time soon. We can see this cultural change embodied in two additional trends. First, the number of employees working from home is growing rapidly. Precise data is hard to come by, but, according to Global Workplace Analytics, a consultancy, 3.7MM US workers (2.8% of the labor force) now works from home at least 50% of the time. This number has doubled since 2005 and in recent years has grown at 2x the pace of total payrolls growth. See here: http://globalworkplaceanalytics.com/telecommuting-statistics. Note this data is only updated through 2014, so it is unclear whether this trend is accelerating now that smartphones have been in widespread use for several years. The other, more visible trend is the growth of co-working spaces. According to CoStar data, WeWork alone took down 2.1MM square feet of space in New York between it’s founding in 2010 and 2015. To put that number in context, total net absorption of office space in NY totaled 13.7MM square feet over the same time period, according to Reis. In 4Q16 alone, according to CBRE, WeWork leased an additional 200K square feet in midtown Manhattan (which would have made it the #3 largest lessor in that market during the quarter). It is difficult to quantify how much space is being taken up by the mushrooming number of WeWork copycats and competitors. The important thing to note is that co-working spaces generally do not purchase traditional office furniture. Instead, most co-working spaces, including WeWork, furnish their spaces with cheaper product from retailers like IKEA and West Elm. Therefore, to the extent that office space utilization shifts to a co-working format, it should reduce the total available market for office furniture vendors like HNI. 2. US office furniture demand appears to be nearing a cyclical peak.

Office furniture consumption is driven by two factors. The first factor is net absorption of office space to accommodate more workers. The second factor is the total volume of leasing activity and associated move-ins / move-outs, since businesses typically buy new furniture when they move to a new space. Our

15

research suggests that both of these factors are near a cyclical peak and may now be slowing.

First, growth in “professional and business services” payrolls (i.e. the white

collar jobs that drive office furniture spending) is decelerating as the US approaches full employment. See Figure 12, below.

Figure 12. Y/Y% growth in “Professional and business services” payrolls

Source: BLS, OWS

At the same time, recent JOLTS data suggests that growth in white-collar

job openings, a leading indicator for employment growth, has also slowed, and has now gone negative on a Y/Y basis. See Figure 13, below.

16

Figure 13. JOLTS job openings – “Professional and business services” Black line = 6mo moving average

Source: BLS, OWS Unless there is a large stock of potential white collar workers that have not yet re-entered the labor force, which seems unlikely, employment growth should continue to decelerate, reducing the net absorption of office space and associated tailwind to furniture demand. Indeed, in recent months, net absorption of office space has slowed, as new deliveries have come on line in an environment of slowing demand growth. Figure 14, below, shows the rolling 4Q average of net absorption across the total US market, according to Reis data. It appears 1Q16 might have marked peak net absorption for this economic cycle.

17

Figure 14. US office space net absorption – 4Q rolling average (sq. ft. millions)

Source: Reis, OWS The second cyclical factor that drives furniture demand, the volume of leasing and associated move-ins / move-outs within the existing office stock (i.e. gross absorption), also appears to be slowing.

According to Jones Lang LaSalle, US gross leasing volumes (in square footage terms) were down -6.7% Y/Y in 2016, and are projected to be approximately flat Y/Y in 2017. This is despite the fact that new office completions are projected (by both JLL and Reis) to increase Y/Y and peak in 2017, before declining in 2018.

This macro projection is supported by our own extensive fieldwork. Over the past month, we spoke and/or visited with commercial tenant brokers, furniture dealers, and interior architects in the following markets: Boston, New York, Washington DC, Atlanta, Miami, Houston, Austin, Dallas, Chicago, Denver, Los Angeles, San Francisco, and Seattle. Our fieldwork indicates that gross leasing volumes since approximately ~2012 have been driven primarily by large corporations consolidating their operations within a single location and/or building out private campuses. This is often referred to as “build to suit” development. Our discussions with commercial tenant brokers in particular make clear that so-called “whales” (i.e. very large tenants taking down square footage in 100K to 1M range) have accounted for the bulk of their own business in recent years, and that leasing activity among smaller tenants has been declining.

18

Take Dallas for example. According to Reis, the office vacancy rate in the Dallas metro area has remained elevated, hovering in the low 20% range for the past decade (by comparison, the total US vacancy rate is currently 16%). Nevertheless, Dallas has been one of the strongest US markets for commercial office construction throughout the current economic expansion.

This strength appears to have been due mainly to high levels of “build to suit” activity in Dallas over the past 4-5 years. For example, Toyota, State Farm, Liberty Mutual, Schwab, Verizon, Perot Systems, Facebook, and Capital One, have all either recently completed major “build to suit” projects or are set to complete them in 2017.

However, as one contact in Dallas told us, “We’ve enjoyed a 7-year run with

massive build-to-suit” projects, but “this will be hard to maintain . . . a lot of the big deals [in Dallas] have already been done.” This contact noted that activity “started to slow down” in 4Q16.

This was consistent with the discussions we had with brokers and other industry participants across the major metro markets we surveyed. In general, the majority of brokers we spoke with were not enthusiastic about the prospects for leasing velocity over the next 1-2 years. These contacts typically noted the relative lack of “big scores” (as they called them) on the horizon relative to the level of activity maintained over the prior few years.

The two markets we surveyed where brokers generally expected 2017 leasing volumes to be higher than 2016 were San Francisco and Seattle, but this was generally based on expectations that more mega-sized leases would be signed.

In New York, our conversations indicated that, despite a low vacancy rate

(< 10%), leasing activity is expected to remain muted. One broker contact noted that Time Warner, which is set to consolidate its 7 Manhattan locations into a single headquarters at Hudson Yards, only did so because Related Companies (which owns both the Hudson Yards development and TW’s current headquarters) agreed to buy TW out of its current location in Columbus Circle. This contact suggested that the fact Related Companies needed to provide a “carrot” to secure its own “whale” anchor tenant (by poaching them from one of its own properties, to boot) is symptomatic of a general weakness in leasing demand.

All told, it appears that the trend of “whales” building out new headquarters

and/or consolidating their locations into a single space, is now mature and the cycle may be declining. With leasing activity among smaller tenants still in decline (according to industry participants), unless there is a re-acceleration in the pace of

19

“build-to-suit” activity, it seems that gross leasing volumes, and the associated demand for office furniture, should continue to decline over the next 2-3 years. 3. Increased competition may be pressuring office furniture manufacturers like HNI. Several of HNI’s publicly traded competitors have noted increasing competition in the market and aggressiveness on pricing in recent quarters. For example, on its Dec-21 earnings call, Steelcase (SCS) noted, “We’re just facing increased competition in the [day-to-day, shorter lead time] segment of our dealers business.” On Dec-22, Herman Miller noted the “competitive pricing environment.” Increasing competition was also a theme mentioned on multiple occasions throughout the course of our field research. For example, one large office furniture dealer in Los Angeles told us that he was getting “three calls a day” from niche players looking for him to carry their product. He noted that Asian competitors had recently starting building out assembly and distribution infrastructure in California to provide the required level of product availability to gain access to more dealers’ catalogs. Another contact, a sales rep at a “big 5” furniture showroom in Miami, also suggested that his business was under pressure from new entrants, in this case at the higher end of the market. He said that industry prices were declining as a result. Some industry participants speculated that barriers to entry were falling because of the shift to “simpler” designs (e.g. flat work tables), but, although intuitively this seems likely, it’s not clear whether this is a significant issue. We plan to explore this issue further as we continue our fieldwork in the coming months. 4. Expectations for margin expansion seem unlikely to be met.

HNI management has suggested to investors that it can achieve 25% incremental operating margins on 4%-5% p.a. office furniture sales growth through 2020. Consequently, consensus “street” projections imply that HNI can achieve total non-GAAP operating margins of ~10% by 2018 (up from 8.5% in the TTM period), which would be higher than the previous cyclical peak OPM of 9% achieved in the 2003-05 period (a time when HNI was benefiting from a housing boom in its higher-margin hearth segment).

20

Figure 15, below, shows HNI’s non-GAAP operating margins since 1998, along with the non-GAAP OPM projections implied by “street” consensus (in green).

Figure 15. Non-GAAP OPM (w. implied “street” projections in green)

Source: Company filings, OWS

We think such margin expansion seems unlikely to materialize. First, it appears that HNI has enjoyed a major tailwind to gross margins from

the collapse in raw material prices from 2014-16. However, this tailwind should now turn into a headwind, as steel prices have rebounded sharply and are now up +58% Y/Y (clients can track US hot rolled coil steel prices using the Bloomberg ticker: MBST5274 Index). We note that, even since HNI management last spoke on its Oct-20 earnings call, US steel prices are up +34%.

According to the company, raw materials, primarily steel, account for two-

thirds of COGS. Our analysis of historical changes in GPM supports the notion that raw material prices are a major driver. Figure 16, below, shows HNI’s annual GPM going back 20 years.

21

Figure 16. HNI gross margins

Source: Company filings, OWS

There are several points to note from this chart. First, it is obvious that HNI

has enjoyed a major tailwind to GPM from the unique 2014-16 combination of collapsing raw material prices and a stable economic environment (previous declines in raw material pricing have coincided with recessions). We note that, by comparison, Herman Miller (MLHR) and Steelcase (SCS) show a similar boom in GPM over the past two years, so this does not appear to be company specific to HNI.

Second, HNI’s own historical trend supports the notion that changes in raw

material prices are sufficient to trump the operating leverage impact from changes in sales. For example, between 2005 and 2007, a period when raw material prices were increasing sharply, HNI’s GPM declined by -110bps despite +5% top line growth. In 2009, despite a massive -33% Y/Y drop in sales, GPM increased by +100bps Y/Y, as HNI enjoyed a favorable raw material comparison against the “blow off top” steel pricing of early 2008. And from 2009-12, a period when revenues increased +23% but raw materials were rebounding from their post-2008 lows, HNI’s GPM actually fell by -30bps.

All told, we think it’s likely that increasing raw material prices could have a

substantially negative impact on HNI’s gross margins in 2017-18. At the same time, HNI’s SG&A expense has de-levered during multiple

economic cycles. Figure 17, below, shows the long-term historical trend. In the last cycle, SG&A bottomed in 2006 at just below 27% of sales. During this cycle, at

22

least so far, SG&A bottomed in 2015 at 29% of sales (and has de-levered so far in 2016 on falling sales).

Figure 17. HNI - SG&A % of sales (GAAP)

Source: Company filings, OWS

HNI’s historical track record suggests that, barring acceleration in top-line

growth, margin expansion on the SG&A line through cost cutting and productivity improvements should be difficult to achieve. 5. Quality of earnings appears poor. HNI’s accounting may be aggressive and seems open to question.

The margin discussion, above, notwithstanding, HNI’s reported income statement margins and earnings appear to bear little relation to actual cash profit generation. This seems to be due mainly to persistent and substantial amounts of cost capitalization. See Table 1, below.

23

Table 1. HNI income statement and FCF metrics compared

2011 2012 2013 2014 2015 2016E*

Non-GAAP net income 48.0 51.7 65.7 93.6 117.3 121.9 Non-GAAP EPS $1.05 $1.13 $1.43 $1.97 $2.58 $2.67

D&A 46.3 43.4 46.6 56.7 57.6 66.4

CapEx 27.8 39.5 61.0 74.3 82.6 92.8 Capitalized software 3.3 20.8 17.9 38.4 32.4 29.7 Total CapEx 31.1 60.3 78.9 112.7 115.0 122.5

Sustainable FCF** 61.2 32.4 33.6 24.2 60.5 59.5 FCF / share $1.34 $0.71 $0.73 $0.53 $1.33 $1.30

* Mgmt FY16 guidance = $130MM-$135MM in total CapEx & cap. software ** FCF = NI + D&A - CapEx

Source: Company filings, OWS

First, HNI’s CapEx has exceeded D&A by wide margins over the past several years. This is despite the fact that the company appears to be reducing and consolidating its manufacturing capacity, and has been closing down manufacturing facilities. We understand that HNI has been telling investors that the high CapEx is driven by investment for “productivity improvements” within the existing capacity base.

HNI management credits the expansion of the company’s GPM in recent

years to such productivity improvements (and points to this expansion to support its claim that 25% incremental operating margins going forward are achievable). Of course, it is difficult to identify how much this CapEx might have contributed to the expansion in HNI’s gross margins. However, as we noted above, the simultaneous GPM expansion at other publicly traded furniture companies suggests that the main driver of GPM has more likely been a macro factor that impacted the whole industry (i.e. raw materials).

More questionable, perhaps, is that since 2012, HNI has been capitalizing

expenses related to an ERP implementation and various (and vaguely defined) “business systems transformation” initiatives (ironically dubbed “BST” by the company-you can’t make these things up).

There are several notable points to highlight on this issue. First, the amounts

capitalized ($165MM over 5 years and counting, or $2.52/share after tax) appear

24

unusually high. By comparison, refer to our PDCO initiation from August 2016. We wondered then if PDCO might have been aggressive in capitalizing expenses related to its own ERP rollout, and those totaled only $89MM (compared to PDCO’s initial budget of $35MM in capitalized expenses), roughly half the amount HNI has capitalized so far.

It also appears, based on public comments by HNI management, that the

“BST” expenses being capitalized extend beyond the simple implementation of an Oracle ERP, and may include a variety of other internal expenses the company deems to be related to “productivity improvement.” For example, here is HNI’s CEO on the 1Q16 earnings call, roughly 4 years after “BST” was launched:

“Business Systems Transformation is a broad-based transformation on how we work. It's a national extension of our rapid, continuous improvement culture with substantial process simplifications already occurred that eliminates waste from our combined total business . . . BST is not just an Oracle implementation. It's really understand, simplify, standardize then flow. And so we have 100 people to 150 people working full-time on that, and we're seeing the benefits in the business even before we roll to the – do an Oracle implementation.” [Source: 1Q16 earnings call; OWS emphasis]

HNI investors should demand that HNI management be more clear with investors how it is accounting for the “100 to 150” full time employees and other various costs of “BST” that may not be directly related to the Oracle implementation. It appears that HNI has repeatedly suggested over the years that this CapEx would scale back, or at least level out, but that has not happened. For example, here is HNI management responding to a question on its 4Q 2012 earnings call (note that 2012 CapEx totaled $60MM, less than half its present run rate):

[Street analyst]: [Y]ou gave some CapEx guidance [for 2013] and it looked like that's a little, maybe a step-up from what we saw this year. Yet it seems like – given what you've said about Q1 . . . it seems like you're implying . . . some reduced spending. . . Answer – Kurt A. Tjaden: . . . I would posit that most of [our projected] earnings enhancement is driven by investments already made . . .

[Street analyst]:. . . But is there going to be incremental spending next year or are you going to kind of level off at these levels? �

Answer – Kurt A. Tjaden: I think you hit it. It's kind of a level. Nothing significant. We're looking to redeploy existing investment dollars, where we have opportunities. . . But [on] net, not significant from an incremental investment perspective year-on-year. [Source: 4Q12 earnings call]

Notably, HNI still hasn’t begun amortizing most of the capitalized software that has accumulated on its balance sheet from “BST.” As of Sep-30-3016, the

25

company had $144MM in capitalized software on its balance sheet, or $2.19 per share. However, amortization expense on the P&L has been running at only ~$4MM p.a., or $0.06/share. This low amount does not seem to square with management’s claim that it is already benefiting from “simplifications already occurred,” since it should be amortizing any investment from which it is realizing a benefit. See Table 2, below. We note that HNI’s deferred tax liability has ballooned (to $102MM as of the most recent balance sheet date) because it has been amortizing these capitalized expenses for income tax purposes, but not on the P&L it presents to investors. Table 2. Capitalized software (balance sheet item) and associated amortization (on P&L)

2011 2012 2013 2014 2015 2016E

Cap. software (gross) 15.5 36.1 52.8 93.3 122.9 153.5 Accum. amortization 12.0 13.8 14.4 17.7 21.2 25.6 Cap. software (net) 3.5 22.3 38.4 75.6 101.7 127.8

Amortiz. of cap. soft. 1.7 1.9 2.9 3.3 3.5 4.5 Source: Company filings, OWS

Further, it appears that HNI has repeatedly delayed the start of amortization. For example, it seems HNI had told “street” analysts on its 1Q 2013 earnings call (the last time it appears that “street” analysts bothered to ask about this issue) that it expected the D&A impact of these “BST” investments to start running through the P&L in 2014-15:

[Street analyst]: All right. And then with the increase in CapEx and these investments, I guess, that you're making, at what point do we see the D&A piece kick up on the income statement? . . .

Answer – Kurt A. Tjaden: Yeah, I think it's really 2014 and 2015, more towards 2015 when you start to see it . . .

[Street analyst]: Okay. And . . . can you give us a feel for how significant the ramp in D&A might be at that point?

Answer – Kurt A. Tjaden: No. I think we'll decline on that one. [Source: 1Q13 earnings call]

We understand that HNI has recently told investors that it should begin amortizing these capitalized expenses on its balance sheet sometime in 2017, but that it will do so over an unusually long 10-year depreciable life. Table 3, below, shows the depreciable life assumption for capitalized software that is disclosed by a random selection of companies across various industries. Relative to peers, it appears that HNI’s 10 years would be an extreme outlier.

26

Table 3. Capitalized software – Depreciable life Ticker Company Depreciable life of cap. software (from 10-K) PAY Verifone 3-5 years EV Eaton Vance 3 years max DE Deere 3 years HPE HP Enterprise 3 years max DIS Disney 3-10 years CUB Cubic Corp 3-7 years MWA Mueller Water 3 years (revised from 6 years in 2014) APD Air Products 3-10 years FICO Fair Isaac 3 years FFIV F5 Networks 3-5 years AAPL Apple 3-5 years CPRT Copart 3 years

Source: 10-K filings, OWS

Putting the difference into perspective, were HNI to amortize its cap software over a 3-year period, in line with other companies, that would represent roughly a $0.73/share annual hit to reported earnings (over a 10-year life, it would be roughly ~$0.22/share p.a.).

Interestingly, we note that in 2015, HNI sacked its auditor

(http://bit.ly/2kCPFfM). Incidentally, this took place around the time that HNI management had previously claimed (see above) it would have to start amortizing the capitalized expenses on its balance sheet.

At the same time that it sacked its auditor (i.e. prior to the 2016 annual

meeting), HNI also shuffled its audit committee. As of the date of the 2016 proxy, the audit committee consisted of three members: Cheryl Francis, Dennis Martin, and Larry Porcellato. Francis was previously on the audit committee, but was promoted to Chairwoman. Martin and Porcellato were new to the audit committee.

Of the three, it appears that Cheryl Francis is the only audit committee

member with any specific background in accounting or finance. She was formerly CFO of RR Donnelly, but resigned for “personal reasons” in March 2000 (http://www.prnewswire.com/news-releases/chief-financial-officer-cheryl-francis-resigns-at-rr-donnelley-73081002.html), and it does not appear that she has held any corporate management role since that time. She is one of the longest serving members of HNI’s board, having held a board seat since 1999.

Martin was CEO of Federal Signal and has a management consulting

background (his bio notes “he is considered a lean business expert.”) Porcellato ran

27

a series of building products companies as CEO. Interestingly, it appears that Martin, who is only 64, may have resigned from HNI’s board since being appointed to the audit committee in Spring 2016: he is no longer listed as a board member on the company’s website (http://www.hnicorp.com/investors/corporate-governance).

Perhaps oddly, it does not appear that HNI disclosed Martin’s resignation to

investors in an 8-K filing. However, in August 2016, HNI appointed a new board member, John Hartnett (press release here: http://investors.hnicorp.com/file/Index?KeyFile=35434183), who appears to have replaced Martin as the third member of the audit committee. Hartnett, also, has no apparent accounting or finance background: his bio states that he has held “a series of engineering, marketing, and management roles” at Illinois Tool Works.

Lastly, we also note that HNI moved its long-serving CFO to a different role

within the company in January 2017. Kurt Tjaden, who has held the CFO role since 2008, was moved to the role of President, HNI International. For a company with less than 5% of its total sales generated overseas, this doesn’t necessarily seem, at least from our outsider’s perspective, to be a promotion.

Overall, HNI’s approach to cost capitalization seems aggressive, to say the least, and, at the same time, there appears to be an unusual amount of volatility around the board and executive suite. Given these factors, it is notable that the company has increased its total FY16 CapEx guidance substantially throughout the course of 2016 (from $105MM-$110MM a year ago, to $130MM-$135MM today), which it had not done in prior years. Of course, this accounting has the potential to increase reported earnings. Caveat emptor. This may be “BST.” 6. Recent results HNI is due to report 4Q16 results after the market closes on Wednesday, February 8, and will hold a conference call on Thursday morning. HNI’s 3Q16 results, which the company pre-announced in September, fell well short of management’s guidance and “street” expectations. Total 3Q16 sales of $585MM fell -5% Y/Y (versus guidance of 0%-3% growth) and were down -6.6% Y/Y on an organic basis. Non-GAAP EPS of $0.80 (-14% Y/Y) missed guidance of $0.93. The company blamed this on “overall softer than anticipated demand.” In the Office Furniture segment, revenues of $455MM were down -4.4% Y/Y (-6.4% Y/Y organic). Management had previously guided to revenue growth of 0%-4% Y/Y. The company noted that revenues were down -2% Y/Y in the

28

“supplies driven” business (well below management’s guidance of positive 6%-9% Y/Y) and -10% Y/Y in the “contract” business (versus guidance of flat to -3% Y/Y). Office Furniture segment operating margins of 9.8% were down -40bps Y/Y. In the Hearth segment, revenues decreased -7.3% Y/Y. Management’s previous guidance was -1% Y/Y to +3% Y/Y. Sales tied to new construction were down -3% Y/Y, sales tied to retrofit increased +3% Y/Y, while sales of pellet appliances (which make up ~10% of the Hearth segment) fell by -38% Y/Y. Hearth segment operating margins of 14.7% were down -210bps Y/Y. Corporate expense of $12.2MM compared to $10.8MM in the prior year quarter, and accounted for -30bps of operating margin de-leverage. Consolidated (GAAP) gross margin of 37.9% was up +30bps Y/Y. Management attributed this on the conference call to “favorable price cost benefits” (i.e. raw material pricing) outweighing the negative impact of declining sales. GAAP SG&A of $168.3MM compared to $170.4MM in the prior year quarter. As a % of sales, SG&A increased to 28.8%, up +110bps Y/Y. Sustainable FCF (NI + D&A – CapEx) totaled $25.2MM in the quarter, or $0.55 / share. This compared to reported, non-GAAP EPS of $0.80. Management guided to a 4Q16 Office Furniture revenue decline of -1%-4% Y/Y (-3%-6% Y/Y organic). Sales in the “supplies driven” channel were projected to be down -2%-5% Y/Y in 4Q (-5%-8% Y/Y organic), while sales in the “contract” channel were projected to be flat to up +3% Y/Y. Hearth segment sales were projected to be up +1% Y/Y to down -2% Y/Y. Management guided to non-GAAP 4Q16 gross margins of 40.0% (which compares to 37.7% in the prior year quarter). Non-GAAP SG&A was projected to represent 29% of sales for the quarter (versus 28% in the prior year quarter). Management guided to non-GAAP EPS of $0.81-$0.91 (down 0%-11% Y/Y). Management also provided initial 2017 guidance on the 3Q16 earnings call. Total sales growth is expected to be -2% Y/Y to +2% Y/Y. Non-GAAP EPS is expected to be between $2.75-$3.15 (+3%-18% Y/Y). We note that HNI management expects to realize $35MM-$40MM in cost savings ($0.53-$0.61/share after tax) from its latest round of consolidating its manufacturing footprint, which it expects to start in 2017. 7. Financial assumptions

29

We project total revenues for HNI of $2.16B in 2017 (-2% Y/Y) and $2.17B in 2018 (-2% Y/Y). This compares to consensus of $2.24B (+2% Y/Y) and $2.32B (+4% Y/Y) in 2017 and 2018, respectively. For the Office Furniture segment, we project revenues of $1.64B (-3.0% Y/Y) in 2017 and $1.59B (-4% Y/Y) in 2018. Underlying this projection, we assume that white-collar employee growth of 1%-2% is offset by the continued decline in per-employee furniture spend and a low single-digit Y/Y decline in gross leasing volumes. For the Hearth segment, which is not the focus of our investment thesis, we project revenues of $520MM in 2017 (+3% Y/Y) and $536MM in 2018 (+3% Y/Y). These growth rates assume a low-to-mid single-digit growth rate in single-family housing starts, and a low single-digit growth rate in retrofits/remodels. We project GAAP GPM of 37.9% in 2017 (-50bps Y/Y) and 38.1% in 2018 (+20bps Y/Y). Our projection assumes that the rebound in raw material prices (especially steel) negatively impacts HNI’s gross margin in 2017 at a similar magnitude to prior periods (as discussed above). This is partially offset in our model by the $35MM-$40MM (~180bps) GPM benefit that management expects from the closing of manufacturing facilities, which should partially benefit 2017 and be fully incorporated into 2018 numbers. If we are under-estimating the raw material impact, or if management is over-estimating the margin benefit from its latest restructuring activities, our GPM projections could prove conservative. We project SG&A represents 30.1% of sales in 2017 (+10bps Y/Y) and 30.1% of sales in 2018. Given HNI’s historical track record of SG&A deleverage, this might be a generous assumption, especially if the top line declines as we project. In addition, we project that amortization expense will increase to $11.2MM ($0.17/share) in 2017 (up from $4.5MM in 2016) and $18.7MM ($0.29/share) in 2018. This assumes that HNI begins amortizing its capitalized software around mid-year 2017, over a 10-year period. Of course, as we discuss above, the timing of this amortization appears to be highly uncertain. It is also not clear whether “street” analysts are including this amortization expense in their own models. In sum, we project non-GAAP EPS of $2.43 in 2017 and $2.17 in 2018. This compares to “street” consensus of $2.98 and $3.39 in 2017 and 2018, respectively. While our EPS projection for 2018 is well below consensus, note that we project the gap between FCF and reported earnings should narrow as non-cash amortization hits the P&L and CapEx drops over the next two years (which, based

30

on HNI’s track record, may not happen). Therefore, our 2018 EPS projection should be closer to actual cash earnings than is presently the case. 8. Valuation Our $35 price target implies a market cap of $1.6B, 0.75x our projected 2018 revenues of $2.1B. According to Bloomberg, over the past 10 years, HNI has traded at a median P/S multiple of 0.75x, so our price target implies that HNI simply returns to a “mid cycle” price to sales multiple. We note that, in past periods when investors have appeared to assume that the cycle was turning down (as in mid-2012 and early 2016), HNI has historically traded closer to a 0.60x P/S multiple.

Looking at the bottom line, our $35 price target also represents a 16.2x multiple of our 2018 earnings projection of $2.17. HNI currently sells at a 14.8x multiple of consensus 2018 EPS of $3.41, so there might be additional downside to our price target.

If our thesis plays out, a 16.2x multiple would be too generous for a cyclical

business lapping peak demand and peak margins. We note that, following HNI’s Sep-2016 pre-announcement of weak earnings, shares traded down to $37. We expect HNI shares to fall below that level. 9. Risks to our target price The key risk to our thesis is if we have misidentified where we are in the office cycle. Since the US is nearing full employment (which should limit future payrolls growth and associated net absorption), the bigger risk would be around gross leasing volumes, which we discuss, above. The other risk is that investors may ignore quality of earnings and cash flow issues, and that the SEC might also continue to ignore these issues. HNI might continue aggressively capitalizing expenses, keeping them off the P&L. 10. Financial projections

31

Annual projections

2014 2015 2016E 2017E 2018E

Revenue 2,222.7 2,304.4 2,201.3 2,165.6 2,123.6 COGS 1,438.5 1,457.0 1,356.4 1,345.1 1,315.1 Gross profit 784.2 847.4 844.9 820.5 808.4 SG&A 645.8 668.6 661.5 651.6 639.0 Amortization 3.3 3.5 4.5 11.2 19.2 1x gain/loss -10.7 -0.2 0.0 0.0 0.0 Restructuring 33.0 11.8 2.1 0.0 0.0 EBIT (GAAP) 112.8 163.7 177.0 157.7 150.2 Int income 0.4 0.4 0.0 0.0 0.0 Int expense 8.3 6.9 5.2 4.4 4.4 EBT 104.9 157.2 172.0 153.3 145.8 Taxes 43.8 51.8 58.9 49.1 46.7 Net income 61.2 105.4 113.1 104.2 99.2 Dil EPS (GAAP) $1.35 $2.32 $2.48 $2.28 $2.17

Non-GAAP adj. EBIT (GAAP) 112.8 163.7 177.0 157.7 150.2

Restructuring 38.2 12.6 5.3 4.4 0.0 Other 1x -10.7 0.0 -0.4 0.0 0.0 Transition costs 4.9 4.6 8.4 6.0 0.0 Adj. EBIT 145.2 180.9 190.3 168.1 150.2 Adj. net income 93.6 117.3 121.9 111.3 99.2 Adj. EPS $1.97 $2.58 $2.67 $2.43 $2.17

32

% of sales 2014 2015 2016E 2017E 2018E Revenue 100.0% 100.0% 100.0% 100.0% 100.0% COGS 64.7% 63.2% 61.6% 62.1% 61.9% Gross profit 35.3% 36.8% 38.4% 37.9% 38.1% SG&A 29.1% 29.0% 30.0% 30.1% 30.1% Amortization 0.1% 0.2% 0.2% 0.5% 0.9% EBIT (GAAP) 5.1% 7.1% 8.0% 7.3% 7.1% Int income 0.0% 0.0% 0.0% 0.0% 0.0% Int expense 0.4% 0.3% 0.2% 0.2% 0.2% EBT 4.7% 6.8% 7.8% 7.1% 6.9% Taxes 2.0% 2.2% 2.7% 2.3% 2.2% Net income 2.8% 4.6% 5.1% 4.8% 4.7%

Non-GAAP adj. EBIT (GAAP) 5.1% 7.1% 8.0% 7.3% 7.1%

Restructuring 1.7% 0.5% 0.2% 0.2% 0.0% Other 1x -0.5% 0.0% 0.0% 0.0% 0.0% Transition costs 0.2% 0.2% 0.4% 0.3% 0.0% Adj. EBIT 6.5% 7.8% 8.6% 7.8% 7.1% Adj. net income 4.2% 5.1% 5.5% 5.1% 4.7%

33

Y/Y% 2015 2016E 2017E 2018E Revenue 3.7% -4.5% -1.6% -1.9% COGS 1.3% -6.9% -0.8% -2.2% Gross profit 8.1% -0.3% -2.9% -1.5% SG&A 3.5% -1.1% -1.5% -1.9% Amortization 6.1% 27.2% 151.7% 71.2% EBIT (GAAP) 45.0% 8.1% -10.9% -4.7% EBT 49.8% 9.4% -10.9% -4.9% Taxes 18.2% 13.8% -16.7% -4.9% Net income 72.4% 7.3% -7.8% -4.9% Dil EPS (GAAP) 72.0% 6.7% -8.1% -4.9%

Non-GAAP adj. Adj. EBIT 24.5% 5.2% -11.6% -10.6%

Adj. net income 25.4% 3.9% -8.7% -10.9% Adj. EPS 31.0% 3.4% -8.9% -10.9%

34

Quarterly projections

Jun-16 Sep-16 Dec-16E Mar-17E Jun-17E

Revenue 536.5 584.6 579.1 492.8 526.9 COGS 327.6 363.1 350.4 308.5 326.7 Gross profit 208.9 221.6 228.8 184.3 200.2 SG&A 161.3 168.3 167.8 163.8 159.8 Amortization 1.0 1.2 1.2 1.2 1.2 1x gain/loss 0.0 0.0 0.0 0.0 0.0 Restructuring 0.6 0.4 0.0 0.0 0.0 EBIT (GAAP) 46.0 51.7 59.8 19.3 39.2 Int income 0.1 0.1 0.0 0.0 0.0 Int expense 1.1 1.1 1.1 1.1 1.1 EBT 45.0 50.6 58.7 18.2 38.1 Taxes 15.9 16.8 20.2 5.8 12.2 Net income 29.0 33.8 38.4 12.4 25.9 Dil EPS (GAAP) $0.64 $0.74 $0.84 $0.27 $0.57

Non-GAAP adj. EBIT (GAAP) 46.0 51.7 59.8 19.3 39.2

Restructuring 2.0 1.1 1.1 1.1 1.1 Other 1x -2.0 1.6 0.0 0.0 0.0 Transition costs 3.5 1.6 1.5 1.5 1.5 Adj. EBIT 49.5 56.0 62.4 21.9 41.8 Adj. net income 31.0 36.8 40.1 14.2 27.7 Adj. EPS $0.68 $0.80 $0.88 $0.31 $0.60

35

% of sales Jun-16 Sep-16 Dec-16E Mar-17E Jun-17E Revenue 100.0% 100.0% 100.0% 100.0% 100.0% COGS 61.1% 62.1% 60.5% 62.6% 62.0% Gross profit 38.9% 37.9% 39.5% 37.4% 38.0% SG&A 30.1% 28.8% 29.0% 33.2% 30.3% Amortization 0.2% 0.2% 0.2% 0.2% 0.2% EBIT (GAAP) 8.6% 8.8% 10.3% 3.9% 7.4% Int income 0.0% 0.0% 0.0% 0.0% 0.0% Int expense 0.2% 0.2% 0.2% 0.2% 0.2% EBT 8.4% 8.7% 10.1% 3.7% 7.2% Taxes 3.0% 2.9% 3.5% 1.2% 2.3% Net income 5.4% 5.8% 6.6% 2.5% 4.9%

Non-GAAP adj. EBIT (GAAP) 8.6% 8.8% 10.3% 3.9% 7.4%

Restructuring 0.4% 0.2% 0.2% 0.2% 0.2% Other 1x -0.4% 0.3% 0.0% 0.0% 0.0% Transition costs 0.7% 0.3% 0.3% 0.3% 0.3% Adj. EBIT 9.2% 9.6% 10.8% 4.4% 7.9% Adj. net income 5.8% 6.3% 6.9% 2.9% 5.3%

Y/Y% Jun-16 Sep-16 Dec-16E Mar-17E Jun-17E Revenue -5.6% -5.1% -3.0% -1.6% -1.8% COGS -9.5% -5.5% -5.7% -2.2% -0.3% Gross profit 1.4% -4.4% 1.6% -0.8% -4.2% SG&A -3.6% -1.2% 1.2% -0.2% -0.9% EBIT (GAAP) 16.8% -15.4% 25.1% -1.0% -14.7% EBT 19.7% -14.8% 25.8% 2.8% -15.2% Taxes 16.5% -9.6% 40.5% -0.9% -23.4% Net income 21.6% -17.2% 19.2% 4.6% -10.7% Dil EPS (GAAP) 21.5% -18.0% 17.6% 2.9% -11.0%

36

Financial metrics Price $50.50

Shares 45.8 MV $2,313

Net debt $201 EV $2,514

Book value $524 TBV $86

($MM) FY16E FY17E FY18E Adj. EBIT $190 $168 $150 Adj. EBITDA $257 $246 $247 SCF (NI + D&A - CapEx) $60 $76 $96 CapEx $122 $106 $100

EV/EBITDA 9.8x 10.2x 10.2x EV/EBITDA-CapEx 18.7x 18.0x 17.1x