HNI Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 31, 2023

There are 8 speakers on the call.

Operator

Good day, everyone, and welcome to the HNI Corporation's Third Quarter Fiscal 2023 Results Conference Call. Today's call is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. I will now turn the conference over to Matt McCall.

Operator

Please go ahead.

Speaker 1

Good morning. My name is Matt McCall. I'm Vice President, Investor Relations and Corporate Development for H and I Corporation. Thank you for joining us to discuss our Q3 fiscal 2023 results. With me today are Jeff Lowinger, Chairman, President and CEO and Marshall Bridges, Senior Vice President and CFO.

Speaker 1

Copies of our financial news release 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 financial news release 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.

Speaker 1

I'm now pleased to turn the call over to Jeff Lorentz. Jeff?

Speaker 2

Thanks, Matt. Good morning. Thank you for joining us. During the Q3, our profit transformation actions continued to accelerate, reflecting the focus and dedication of our members. We delivered 31% year over year growth in non GAAP earnings per share, despite facing top line headwinds from ongoing macroeconomic pressures.

Speaker 2

On the call today, I will highlight 3 key topics. First, we continue to deliver strong margin expansion in Workplace Furnishings. However, we are not finished and see more opportunity ahead. 2nd, the divestiture of Poppin will drive immediate financial benefits and the integration of Kimball International is progressing nicely. KII accretion exceeded our expectations in the quarter and we expect the rate of accretion to increase over time.

Speaker 2

3rd, we demonstrated the resiliency of our residential building products business model in the face of housing market weakness. Cost reduction actions enacted last quarter helped operating margin in the segment remain unchanged compared to the same period of 2022. This was despite a year over year revenue decline of 22%. Following those highlights, Marshall will review our outlook. I will then conclude with some general closing comments before we open the call to your questions.

Speaker 2

Moving to the first topic, We continue to deliver strong margin expansion in Workplace Furnishings. When excluding KII and Poppin, non GAAP operating margin in the segment expanded 8 20 basis points year over year to 10.7 percent as our profit transformation plan continues to deliver results. This was the 6th straight quarter of year over year operating margin improvement. Both operating profit margin and operating profit dollars Reached the highest level since the Q3 of 2019 despite lower industry volume. We made strong progress with our profit transformation initiatives.

Speaker 2

However, there is still work to be done and we have line of sight to additional improvement opportunities. As we have discussed on previous calls, Our profit transformation plan in our legacy Workplace Furnishings business consists of 4 primary actions. First, we are driving increased productivity. Our focus on lean, cost reduction and better efficiencies continues to deliver improvement. And we expect our recent investments in Mexico to provide outsized benefits as they mature over the next couple of years.

Speaker 2

2nd, we have streamlined our cost structure. On last year's Q3 call, we announced a $30,000,000 corporate wide cost savings program. 12 months later, not only have we achieved that goal, we have added to it. Our cost savings run rate now totals approximately $50,000,000 across the corporation. More specifically, in workplace furnishings, dollars 25,000,000 of that total is contributing to our margin expansion in 2023.

Speaker 2

3rd, we continue to simplify our business as we focus our efforts on the most attractive markets. Examples of portfolio simplification actions taken over the past year include, executing Poppin', Divesting our China business and rationalizing our e commerce offering, all of which are contributing to our improved margins. And 4th, price cost improvement continues to benefit our profitability. These actions and our recent results demonstrate our profit transformation plan does not require volume growth. However, despite a mixed near term picture, We continue to see encouraging trends related to future workplace furnishings demand, particularly given our market position.

Speaker 2

We continue to see growth in the small to medium sized customer segment, where we have an unmatched competitive position. SMB orders grew 6% year over year in the 3rd quarter and are up 9% year to date. In general, this segment has benefited from healthy dynamics. Small and midsize firms have accounted for nearly 100% of net post pandemic hiring. This segment has also benefited from population shifts to smaller secondary metros where office visits are nearly back to pre pandemic levels.

Speaker 2

We believe this segment will continue to outperform. Switching to contract, recent demand has been down modestly. However, we are seeing encouraging signs for the future. Orders from contract customers were down 4% year over year in the Q3 and have declined 3% on a year to date basis. Those rates are consistent with lower return to office rates in the larger markets and lagging hiring activity by large companies.

Speaker 2

Looking forward, we see dynamics which support an increase in furniture buying events. I'll remind you that Furniture events are the primary driver of demand in our industry. Replacing office furniture is an episodic event, generally driven By an office move or need to refresh an environment for employee recruitment and retention. Going forward, the predicted acceleration of lease expirations and the need for companies to adapt their spaces for hybrid work support an increase in these events. Hybrid work has become the new normal.

Speaker 2

According to a recent Gallup survey, more than half of all remote capable employees are now working in hybrid environments, with that number expected to move to 60% in coming quarters. And office lease rollover activity is expected to more than double next year and remain elevated through 2028. These factors taken together support an increase in furniture buying events. Moving to my second topic, We completed the divestiture of POPN and the integration of Kimball International is progressing nicely. Excluding POPN, KII added approximately $0.06 of non GAAP EPS in the quarter.

Speaker 2

These results exceeded our expectations. Moreover, KII generated a strong operating margin of 10.6%. This was despite incurring $5,000,000 of incremental purchase Our confidence in the strategic and financial benefits of the combination with Kimball International continues to build. KII better positions us to lead in the evolving workplace environment and provides new opportunities for profit growth. And importantly, we continue to see the previous announced annual run rate synergy amount associated with the KII acquisition of $25,000,000 as a floor with a strong potential for upside.

Speaker 2

The sale of Poppin, which we completed in early September, provides immediate financial benefits. Recall Poppin had an annual operating loss of nearly $20,000,000 prior to the sale. While KII's operating margin is already in double digits, Cost synergies, elimination of pop and losses and ongoing productivity efforts point to additional margin expansion opportunity in the months years ahead. My third topic is we demonstrated the resiliency of our residential building products business model in the face of housing market weakness. 3rd quarter operating margin in the segment remained unchanged versus the prior year and was up sequentially.

Speaker 2

This was despite a year over year revenue decline of more than 20% as this segment continues to face volume pressure in line with the overall weakness in the broader housing market. We continue to see $15,000,000 to $20,000,000 of our targeted cost savings benefiting residential building products this year, with another $5,000,000 to $10,000,000 of benefit next year. These cost reduction efforts along with normal seasonal patterns and will result in further improvements to segment profitability in the Q4 of this year. Importantly, demand trends in this segment continue to stabilize. 3rd quarter orders were 18% below year ago levels, which represents an improvement compared to rates seen in the first half when segment orders declined 29% year over year.

Speaker 2

Both new construction and remodel retrofit activity have shown similar sequential improvement. Additionally, the improvement has continued in the early part of the 4th quarter. Although mortgage rates and affordability continue to weigh on housing, Single family new construction has been a bright spot. Year over year growth in new single family permits averaged 5% in the 3rd quarter, which supports further new construction improvement in 2024. Despite the near term headwinds, we are bullish on the intermediate to long term dynamics for The demand fundamentals remain strong.

Speaker 2

U. S. Housing is undersupplied. Demographic trends point to robust future construction growth. Renovation activity will benefit from an aging housing stock and there are indications that renovation activity will accelerate as existing homeowners are less likely to relocate given the current mortgage environment with many having attractive lower interest rates.

Speaker 2

In addition to the strong long term market fundamentals, we have unique growth opportunities. We continue to invest in our initiatives aimed at expanding the market, including in the areas of category awareness, new product innovation, online capabilities and the expansion of our wholly owned installing distributor footprint. The market's fundamentals, our unique growth opportunities and our category leading positions point to the return of growth. I will now turn the call over to Marshall to discuss our outlook. Marshall?

Speaker 3

Thanks, Jeff. Let's start with our expectations for demand in the 4th quarter. In workplace furnishings, we expect organic revenue to be approximately flat with Q4 2022 levels. That outlook is consistent with recent order patterns. It excludes Kimball International and it assumes continued SMB outperformance.

Speaker 3

In residential building products, we expect revenue declines to further moderate in the 4th quarter with revenue declining at Year over year rate in the high single digits to low teens. That outlook assumes new construction will outperform our model retrofit. Let's shift to the expected impact of Kimball International. For the Q4, we expect KII to add $140,000,000 to $150,000,000 of revenue. We also project KII accretion will be consistent with Q3 results.

Speaker 3

An additional note on KII, Earlier, Jeff mentioned $5,000,000 of incremental purchase accounting costs in the Q3. Of that $5,000,000 approximately $3,000,000 is solidly increase year over year to be modestly below our just reported Q3 results. This is consistent With normal seasonal patterns, recall we typically see lower sequential volumes and margins in Workplace Furnishings as we move from the Q3 to the 4th. Shifting to the balance sheet, we ended the 3rd Quarter with total debt of $509,000,000 which was down significantly from the $598,000,000 outstanding a quarter ago. Our working capital dynamics continued to improve and return to historical levels that drove free cash flow per share of more than $2 in the Q3.

Speaker 3

In terms of leverage, our gross debt to EBITDA at the end of the quarter was 2.2 times. Our reasonable leverage and strong cash generation will continue to provide flexibility for the dynamic environment and ongoing investment. I'll now turn the call back over to Jeff. Thanks Marshall.

Speaker 2

Our strategies are delivering results. Operating margin we expect continued year over year profit improvement in the segment. The integration of Kimball International is going well. KII is already strengthening our business and delivering earnings accretion, which will only increase as our synergies mature. KI better positions us to lead in the evolving workplace environment and provides new opportunities for profit growth.

Speaker 2

And we are increasingly confident in the combination of strategic and financial benefits. In Residential Building Products, We have adjusted the cost structure and demonstrated the resiliency of our margins, while continuing to invest in our growth strategies, leading brands and operating platforms. Although the near term remains dynamic, we are uniquely positioned to drive high margin growth as housing recovers. In summary, we remain committed to our core strategies of continuing to expand margins at workplace furnishings and drive long term high margin revenue growth and Residential Building Products. I want to thank all HNI members, including our new members from KII.

Speaker 2

Our results reflect their collective effort and dedication. We will now open the call to your questions.

Operator

Thank you. We'll take our first question from Steven Ramsey with Thompson Research Group.

Speaker 4

Hi, good morning. Maybe to look at SMB up again and outperforming contract, Do you expect this to persist for a few more quarters even though contract is stabilizing? Is there anything in the pipeline that may show directionally how the two Customers drive results for the next few quarters.

Speaker 3

Yes, Stephen. I mean, look, I think we continue to

Speaker 2

I think SMB will outperform. As I laid out in the prepared remarks, I mean, We have a strong position there, that's part of it. The market is healthy, they've been hiring, returned to office, they're still Even though they've returned, they're still looking at furniture events in those spaces. So, our belief at this point is SMB will continue to outperform and contract will stabilize. I think that's a good way to think about it.

Speaker 4

Okay, helpful. And then on the population shift, it's clearly helping the workplace segment as you've discussed for a few quarters now. Can you talk to How this is or could help the resi segment over time? Do you have the distribution In place where the population shift is occurring?

Speaker 2

Yes, that's a good question, Stephen. We do. We've added First of all, we have a strong independent network that is services those markets. We've also added some wholly owned distributor footprint in some of those markets recently and we continue to be active Keeping an eye on all of that. So I do believe that the population shift will also benefit over time The resi business.

Speaker 4

Okay, helpful. And then last one for me again on the resi business. Curious The dynamic you're hearing on the ground for the R and R side of resi, hearing from others that it's sluggish, but Steady out there and not continuing any kind of demand degradation on a sequential basis, but I'm curious if that's How you would describe spending on fireplaces?

Speaker 3

Yes. I think overall, Stephen, we're seeing demand Kind of declines moderate. New construction is the relative bright spot there, specifically related to remote retrofit. We're also seeing We still have Pretty low existing home turnover, which drives remodeling events. And of course, consumer sentiment is not helping there.

Speaker 3

But certainly, the trend Is improving, although still down year over year.

Speaker 4

Okay. That's helpful. Thank you.

Operator

We'll take our next question from Reuben Garner with Benchmark Company.

Speaker 5

Thank you. Good morning, everyone. Good morning.

Speaker 3

Congrats on

Speaker 5

the strong quarter, guys. So Maybe on the workplace margins to start, Jeff, I think you said, I think the words where there's room to run or more to go There, can you talk about I see the savings or heard the savings come in better than anticipated. That $50,000,000 was that a recognized to date number or run rate? And when you say there's more to go, I mean, is this 10 plus percent Kind of legacy numbers sustainable without volume acceleration because of your initiatives or was there anything kind of mix

Speaker 3

Yes. Reuben, so several questions in there. The first one is that the $50,000,000 that Jeff mentioned is our cost savings program that was really enacted starting earlier this year and we had another tranche kind of mid year. $40,000,000 to $45,000,000 of that will hit 2023 with another $5,000,000 to $10,000,000 rolling over into 2024. The part that rolls over into 24 is mostly associated with the Residential Billing Products segment.

Speaker 3

As it relates to Workplace Furnishings, we've got about $25,000,000 of that total $50,000,000 that hits that segment, all of which hits this year. In terms of where the margins can go, we see continued opportunity. The reason we were up so much year over year in the Q3 is really three things At favorable price cost, we had better productivity and we had better SG and A efficiency. And we see opportunity in all three of those to continue, maybe not all the same rates. And on top of that, we have this investment in Mexico that we're making that will begin to mature and help out subsequent years.

Speaker 5

Okay. And then on the residential side, you mentioned existing home sales. Just curious How much fireplace activity, retrofit activity is tied to inspections? Is that a big part of What can drive demand and if we do see a rebound in home sales when rates drop that can kind of get the R and R segment turned around?

Speaker 3

Yes. I'm not sure we have precise data on inspections, but we do know that remodeling events are pretty highly correlated with The purchase of new home, usually remodeling events occur within a year or 2 after the purchase. And given that new homes are not selling as much, Existing homes are not selling as much. We're definitely seeing some softness in that segment. But if it did if we do see existing homes ticked up, we would see remodeling tick up eventually.

Speaker 5

Okay. And last one for me, a nice snapback in margins in the residential business. I think if I'm looking at it correctly comparable to the year On much lower base, is there any positive price cost in there as well or is all of that from the initiatives you put in place earlier in the year?

Speaker 3

Yes, we were flat at 17.7 percent operating margin in Residential Building Products in the 3rd quarter. And yes, there's multiple factors there, kind of the same three factors I mentioned. We did have favorable price cost there. We also had better productivity as well as

Operator

We'll take our next question from Greg Burns with Sidoti and Company.

Speaker 6

Good morning. The outlook for flattish workplace growth, I think last quarter you were talking about low single digit growth in the second half, So a little bit of a reduction there. Can you just talk about what changes you're seeing in the demand environment there to lower your outlook?

Speaker 3

Greg, I'm not sure I'd characterize it as a major change. We did talk about low single digits. I think the organic revenue in Workplace excluding KII and POPPIN was 1.7% in the Q3, so right in that range. And then flattish, maybe puts us at the low end of low single digits for the back half, but I wouldn't call it a major change.

Speaker 6

Okay. I don't know Kimball had a good sized healthcare business. Could you just talk about Maybe some of those adjacent markets like healthcare, education, where maybe you could drive incremental growth if the core office Segment isn't recovering to the pre COVID levels? Like what initiatives do you have in place? And I guess Specifically, how was Kimball's Healthcare business this quarter?

Speaker 2

Yes, Greg, good question. I think the activity is Pretty been pretty solid throughout the year and it's starting to build in the healthcare segment. And KII had quite a bit of Product Pipe in that piece of the business that will be coming online in 2024 as well. So we like that position and we do believe that's an opportunity for growth Overall, education, they've been strong in education similar to our legacy business. Both have had pretty solid years to date.

Speaker 2

We see the education vertical as an opportunity for growth going forward as well. And then I would mention they have a hospitality business that's competing well at this point. We see some Good second half growth in their hospitality business, kind of pent up demand, catch up from kind of the Post COVID remodel activity, refresh rates for hotels. So all three of those healthcare, education, hospitality, We can rotate into and lean into notwithstanding core commercial.

Speaker 6

Okay, great. Thank you.

Operator

We'll take our next question from Budd Bugatch with Water Tower Research.

Speaker 7

Good morning and thank you for taking my question and congratulations on a very good quarter to your team and to your members, Really impressive. Marshall, I would love to get maybe if you could walk on the workplace, the legacy workplace, Even just on a GAAP basis from a $5,600,000 operating profit in last year to $39,600,000 this year. And I can't remember if the 5.6% included much of Lamex or a drawdown of that. I thought that might have been included all balled into the gain number. So maybe you could give us some more color on that on a walk from Those margins, because that's pretty impressive.

Speaker 3

Yes. But there is a bit of Lamex in the GAAP numbers in the prior year, both Sales and profit as well as the gain. If you look at the non GAAP, it's probably a little cleaner. The segment Excluding KI and Poppins, up $31,000,000 in operating profit year over year. And there's really 2 big items there.

Speaker 3

Got price cost favorable about $21,000,000 and net productivity was up about $11,000,000 So there's some rounding there, but those two things really drove that $31,000,000 profit improvement in the segment.

Speaker 7

So the $11,000,000 continues or is that That continues and then anniversaries in the 2021, how do we think about that going forward? How do we think about that kind of 2:one kind of

Speaker 3

The productivity is going to continue. We certainly see benefits from our ongoing lean initiatives as well as Investment as we look out. Price cost, this is we're anniversarying Some lower price periods and we got pretty stable commodities. So I don't think that's going to continue at the same rate, but it's not going away immediately.

Speaker 7

And commodities, are they stable or are they starting to have they fallen and Are we having to do any are we worrying anything about pricing having to be retraced?

Speaker 3

For the year, commodities are pretty stable. We had some inflation when you include everything early in the year and we had a little bit of deflation here recently. As we look to the 4th quarter, we're starting to see a little bit of We're starting to see a little bit of pressure from diesel and some other commodities, but in general input costs are pretty stable.

Speaker 2

And we think pricing, but we'll kind of hold in there where it's at today, where that's kind of what we're seeing in the marketplace.

Speaker 7

And we typically do a once a year price increase. Do we not usually have that adjustment? Is that usually beginning of the year kind of thing? And I know In this environment, nothing is usual, but I'm trying to I'm showing my age.

Speaker 2

Yes. But yes, it's typically kind of in the Q1. It moves around a bit Depending on the cycle, but it's typically in the Q1.

Speaker 7

Okay. And this has been part of your strategy, Jeff, of getting the workplace furnishings margins Back to this kind of level. So the other side is RBP and having that grow, keeping the kind of great profitability you have there. Are there any new programs that you are anticipating to try to maybe spark a little bit more of the RVP Stuff or is it just too tough?

Speaker 2

No. Look, we're continuing to invest in that. You hit it right on Ed, Budd. This has been our goal is to reset margins and have a line of sight for more and that's what we start. We've been talking About that for a couple of years and that will continue.

Speaker 2

RBP, look, we like our operating model. We're going to continue to invest in that business because it's only a matter of time. And the fact that we've been able to kind of hold our margin profile In that business, notwithstanding the volume decline, we like where that can go. I'd say the 3rd piece of this though is The integration of KII, that's where we're working hard there. I commented on their business in healthcare and hospitality And also integration and synergies.

Speaker 2

So that's what I would say the 2 items we've been talking about We're continuing to lean in the workplace margins and RVP growth investments and then bring KII on and Kind of mind that those that profit and that model, it's got strength, but there's more to do.

Speaker 7

Well, that's and you got right to My third area of questioning was on Kimball. What kind of RCII or RCI programs do you see going for that? They've had they have a number of Had a number of divisions that might not have been performing up to snuff. Anything that you feel comfortable talking about at this point in time?

Speaker 2

Yes, Budd, really all I would say is we got we dispossessed the Poppin thing, that was kind of job 1 as we got in there. And now we're getting our arms around the synergies and the team and they're doing great and there'll be more we'll probably have more Details on that going forward, but right now I'd say, 50,000 feet, it's going great. Love the team and what they bring to the table and we're continuing to invest in that business as well.

Speaker 6

Okay. But I

Speaker 3

would just add to that. And look, healthy margins in that business right now, it's very strong. We do see synergies moving forward. In the run rates we see right now and their profitability is About $10,000,000 of annual improvement related to duplicative corporate costs. So that's $10,000,000 to 25,000,000 Synergies that we expect as a floor and so the other 15 we see coming over the next couple of years and so real clear line of sight to that and as Jeff mentioned it It has strong potential for more that we'll communicate as we get further into it.

Speaker 7

And how does that feather in? I mean, how much have we seen so far and how much feathers in Over the next couple of quarters quarterly rate? Yes.

Speaker 3

We're averaging about $2,500,000 a quarter right now. So we've got About a $10,000,000 run rate as we sit right now, probably add $5,000,000 to $8,000,000 next And then we get the full incremental $15,000,000 in 2025 for a $25,000,000 run rate. And when you take that $25,000,000 Plus the $20,000,000 benefit from exiting POP in, plus the strong profitability that KA had before the acquisition, Again, we're looking at EV, the EBITDA multiple on the acquisition of NEAR-five. It really speaks to the value creation opportunity that we have.

Speaker 7

Wow! Okay. And last for me is corporate overhead looks is this the current run rate of $20 some 1,000,000 or how do we Think about that on a quarterly basis and how much of that was variable comp?

Speaker 6

Yes.

Speaker 3

Corp, if you look at the 4th quarter, we do think it's going to be up $6,000,000 or $7,000,000 being that $21,000,000 to $22,000,000 range, not just up a little bit from the Q3 and yes, the big drivers of the year over year increase are variable comp, it was pretty low last year and it's rebounded this year And we got some variation in insurance programs that also contribute to that variation.

Speaker 7

Okay.

Operator

And there are no further questions at this time. I'd like to turn the call back over to Jeff Lorentz for any additional or closing remarks.

Speaker 2

Great. Thanks everybody for joining us today. Once again, thanks to all HNI members. Have a great day.

Operator

And that concludes today's presentation. Thank you for your participation and you may now disconnect.

Powered by Quartr

Key Takeaways

  • The profit transformation plan drove 31% year-over-year growth in non-GAAP EPS and expanded Workplace Furnishings margin to 10.7% (ex-Kimball/Poppin), marking six straight quarters of improvement.
  • Corporate cost savings have reached a $50 million run rate—$25 million benefiting Workplace Furnishings—through productivity gains, SG&A streamlining, portfolio simplification, and price-cost optimization.
  • Sale of Poppin (removing ~$20 million in losses) and Kimball International integration exceeded expectations, contributing ~$0.06 to EPS, achieving a 10.6% operating margin, and targeting at least $25 million in annual synergies.
  • Residential Building Products sustained a 17.7% operating margin despite a 22% revenue drop, supported by $15–20 million in cost savings, an 18% order decline (improved from 29%), and 5% growth in new single-family permits.
  • Q4 guidance calls for flat Workplace revenue, moderating high-single-digit to low-teens declines in Residential, Kimball to add $140–150 million in revenue, and leverage at 2.2x with free cash flow >$2 per share.
AI Generated. May Contain Errors.
Earnings Conference Call
HNI Q3 2023
00:00 / 00:00