Q3 2020 HNI Corp Earnings Call

Good morning.

Good morning, My name is Lisa they'll be your conference operator today I would like to welcome everyone to the H. and I Corporation third quarter fiscal 2020 results conference call. All lines have been placed on mute to prevent any back.

Background noise. After the speakers remarks, there will be a question and answer session. If you would like to ask a question. During this time simply press Star then the number one on your telephone keypad. If you would like to withdraw your question press the pound key as a reminder, today's conference call is being recorded. Thank you Mr. Mccullough you may begin your conference.

[noise]. Good morning, My name is Lisa and I'll be your conference operator today.

We'd like to welcome everyone to the H. and I Corporation third quarter fiscal 2020 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session. If you would like to ask a question. During this time simply press Star then the number one on your telephone keypad, if you would like to withdraw your core.

Justin Press the pound key as a reminder, today's conference call is being recorded. Thank you Mr. Mccullough you may begin your conference.

Thank you Lisa Good morning, My name is Matt Mccall, and Vice President Investor Relations and corporate development, reaching <unk> Corporation.

Thank you for joining us to discuss our third quarter fiscal 2020 results with me today are Jeff launcher, Chairman, President and CEO, and Marshall Bridges, Senior Vice President and CFO.

Copies of our financial news release earnings presentation, and non-GAAP reconciliations are posted on our website state.

Statements made during this call.

Strictly historical facts are forward looking statements, which are subject to known and unknown risks actual results could differ materially.

The earnings presentation posted on our website includes additional factors that could affect actual results.

Ration assumes no obligation to update any forward looking statements made during the call.

Now I'm pleased to turn the call over to Jeff launches Jeff.

Good morning, and thank you for joining us.

Our members delivered another solid quarter in an environment that remains challenging and it.

And again our results demonstrate much of what is unique about each night.

As we look ahead, we are prepared to confront the near term macro challenges and we also see opportunity in signs that our strategies are gaining momentum.

You noticed some changes to our normal quarterly earnings report and called for me specifically, we have included more detail around our third quarter results and fourth quarter expectations in the release.

This allows us to focus our coal commentary on the key highlights of the quarter.

A key issues and opportunities going forward and our strategic efforts aimed at pursuing long term revenue growth margin expansion and free cash flow generation.

Now I will start with four key highlights from the third quarter.

First our residential building products segment delivered strong year over year growth.

Generated 9% year over year revenue growth in the third quarter were 8%, excluding the impact of acquisitions.

This is a substantial improvement from the second quarter.

6% year over year revenue decline.

Our third quarter order patterns indicate these positive volume trends should continue.

Orders increased 13% year over year, and consistent with most new home construction or remodeling indicators order growth remained strong throughout the quarter.

Our unique model in this business continues to provide a competitive advantage our focus on operational excellence, our vertically integrated structure and our investment in regional distribution centers and allowed us to take advantage of accelerating demand.

We're competing better than ever in this space and we continue to drive strong financial returns with third quarter operating margins, expanding 270 basis points year over year to a third quarter record of 19.6%.

Second highlight of the third quarter was our workplace furnishing segment delivered solid profitability. Despite continued recessionary pressure.

In general customers remain in a holding pattern and.

Third quarter revenue was down 27% year over year.

However, the segment still was able to generate a profit of nearly $17 million in the quarter.

We're seeing some signs that demand activity is becoming less bad in the segment orders.

Orders in workplace furnishings, excluding E commerce declined 25% year over year in the third quarter. This was.

This was an improvement from the 35% order decline in the second quarter.

Furthermore, order declines moderated as the quarter progressed this.

This trend is encouraging, but we're not expecting a dramatic improvement over the next couple of quarters.

Orders in our workplace furnishing ecommerce business increased 35% year over year in the third quarter.

That is strong growth, but it is lower than the triple digit order increase we generated last quarter.

Much of the moderation in order rates was expected as was the result, and and was a result of tougher comps in supply constraints.

We did see September orders Reaccelerate and this improvement as a result of the continued strong demand environment combined with our improving inventory positions.

Our third highlight for the quarter was we continue to smartly manage your cost and expenses, we reported a decremental margin of 19% in the third quarter. This is better than our previously communicated target of 25% off.

Also recall, we were up against a strong prior year comp in the third quarter as our productivity efforts and cost management drove a 50% incremental margin in the third quarter of 2018.

We continue to manage through the near term recessionary environment in the workplace furnishing segment, while remaining focused on our long term strategies.

Finally, our fourth quarter.

Works Hot end of the quarter was continued strong free cash flow generation, our balance sheet strength and cash flow outlook provide ample flexibility to navigate through the period of softness in work were placed furnishings, while maintaining our key growth investments in both segments I will now turn the call call EBITDA margin will provide some additional details around our fourth quarter outlook.

Marshall.

Good morning, everyone.

Let's turn to the outlook for workplace furnishings first in the workplace furnishing segment, we expect fourth quarter year over year revenue declines to be in the mid teens.

That's better than what we've seen over the last two quarters and is based on three factors.

First as Jeff mentioned, we have seen year over year order declines trend less bad as you.

As we stated in the press release workplace furnishing orders were down 25% for the third quarter and the declines moderated this quarter progressed sockets.

We expect more growth from our ecommerce business given the continued demand strength, along with our improving supply position.

And third our fiscal calendar has an extra week this year, which we expect will add four to seven percentage points of growth to the quarter.

I should note. It also adds cost so this growth delivers lower incremental margins compare to true organic growth.

Shifting to our fourth quarter outlook for residential building products recent order trends housing construction activity and the extra week support fourth quarter year over year growth rates in the mid to high teens.

Moving on to profitability, we would also like to emphasize what we're expecting for decremental margin for the full year, we expect decrementals to be less than 20%. This implies meaningfully higher decremental margins in the fourth quarter, primarily driven by unfavorable business mix accelerating investment levels and the impact of the extra week.

We continue to target decremental margins of 25% over time.

Finally, I'd like to make some comments on our cash flow and balance sheet.

Since the early days of the pandemic. Our teams are focused on driving free cash flow.

As a result, our free cash flow through the first three quarters is tracking 70% ahead of prior prior year levels, Despite lower profitability.

We ended the quarter with $109 million of cash in the balance sheet.

That balance is more than quadrupled the balance from the end of last quarter.

We've reduced our net debt by 65% or nearly $123 million.

And our gross leverage ratio is 0.9, well below our debt covenant of 3.5.

So we have substantial financial flexibility in a high quality balance sheet and.

And we're not expecting any meaningful capital structure stress.

Ill now turn the call back over to Jeff. Thanks Marshall.

Past six months have demonstrated how much.

But what is accessible by age night and I believe this experience has helped age and I become a stronger company in many respects, which will serve us well as we move forward.

As I looked at 2021 and beyond I would like to call out a few items.

First we remain excited about the prospects for our residential building product segment.

Our unique vertically integrated model with more than 20% of revenue coming from our own installing distributors along with our recent success in managing through the spike in demand surrounding the pandemic puts us in a strong position as we move into 2021.

We have ramped our investments in this business to better market directly to home buyers and consumers in both the new construction and remodel retrofit markets.

Our belief is that increased marketing in what has long been an under marketed industry will provide revenue upside that may not be fully appreciated.

This will add to what is already a strong cyclical backdrop as indicated by low housing inventory and increased household formation.

And we will also benefit from encouraging secular trends such as urban flight larger home sizes and increases in home ownership.

In summary, we believe the revenue growth opportunity in this segment is strong and we will continue to invest aggressively to grow this addressable market and the categories in which we compete.

Second while we remain cautious near term, we expect workplace furnishings revenue to continue to recover as you.

As we move to a more supportive environment.

Looking ahead to 2021, we expected challenging first quarter as we lap pre cobot conditions. However, moving through the year, we expect more companies to return to offices, while those return dynamics likely take many forms each will support improved demand.

Longer term, we see positive trends emerging that lineup nicely with our competitive strengths, specifically, we're particularly well positioned to benefit from increasing work from home demand.

Our unmatched price point, Brett our product depth, and our distribution capabilities put us in a strong position to benefit from elevated work from home activity a re.

A recent example of our efforts in the home office space is a win with a large enterprise clients.

Their employees, which number in the tens of thousands will be able to choose home office furniture from a preset selection of our products. There are many more opportunities like this in the pipeline.

We're also uniquely positioned to benefit from trends tied to de urbanization or urban flight.

This trend should lead to more satellite offices away from city centers and in smaller markets. These markets that these are markets that play to the strength of our go to market models, and where we have strong competitive positions.

Next we believe Densification of office space, which.

Which was a headwind for this segment for years will stabilize if not reverse in a postcode world.

Finally, we believe office space layouts will change while these.

While the exact lay out of the office of Tomorrow remains up for debate. It will not look like the office of yesterday.

Change is good for our workplace furnishings businesses.

Third our cash flow outlook is encouraging in our balance sheet will remain strong.

Marshall discussed our cash flow and balance sheet outlook as we look toward 2021, our targeted uses of cash continue to be ongoing dividends support we have not cut our dividend in over 65 years of paying it.

Investment in growth opportunities in M&A in both workplace furnishings, and residential building products and finally opportunistic share buyback.

In conclusion I'm extremely proud of all of our age nine members ended the company's collective focus and ability to adapt over the last six months.

2020 has presented and continues to present challenges that were unforeseen just a few short months ago. However.

However, as we emerge from this period, we will do so a stronger company well positioned to grow revenue expand margins and generate cash flow.

We'll now open up the call to your questions.

Thank you as a reminder to ask a question. Please press star one on your telephone to withdraw your question press the pound or hash key please standby only come pilots you and thereafter.

And our first question comes from the line of Rueben Garner from the benchmark Company. Your line is open.

Thank you good morning, everybody.

Good morning.

Maybe can we start with the fourth quarter.

Decremental margin outlook.

You mentioned business mix and.

Increased investments I guess can you elaborate on on those two a little bit where are you seeing the mix impact obviously, you're you're going to get a benefit from the building products business getting grow.

Growing and in the office business declining what mix, you're referencing and then on the investment side, just on the detail into which businesses that would be.

Where are those investments would be and then the anticipated benefits of those as we move into next year.

Yeah sure Rubin, so maybe the mix issue first so I think we talked personal last call that we are seeing increased government mix in the workplace furnishings business and that typically comes with a little bit lower profit profile. So thats the business mix, we're referring to there the investments.

Our interesting, we're expecting to invest $5 million to $7 million incrementally in the fourth quarter and about a third of that is in the hearth business around our marketing efforts and category expansion initiatives and the other is the.

The other big item there is investments in digital and data analytics, which include things like E Commerce infrastructure abstract trade partners visualization tools and things like that and the rest is really around operational productivity.

Okay, Thanks, Marshall and the.

The investments that you're making to grow the category in hard and just grow the business in general are you already.

Are you already seeing benefits from this I mean, the third quarter, 8% organic growth of the low double digit kind of implied organic growth for the fourth quarter. I mean, that's definitely seems higher than any other inside the home <unk> building product categories.

You know at least that we've seen that need a contractor in the house can you just talk about kind of the end markets there versus maybe.

Some of the internal initiatives that might be driving faster growth.

Yeah, Ruben I'd say first in Baltimore at first and foremost as I said in my remarks, it's really the the initial growth based on our model I mean, we have you know we have.

Just as the strong vertically integrated model that has been very responsive to the market and broad product.

Product depth and price points, so that Debbie 0.1, but two is the market that the investments in category expansion and basically consumer awareness are really just getting going so they are starting to the I think shows some signs but for.

For the most part those are going to be you know outward looking.

Investments that that probably pay back more middle middle to late next year. So net net the model itself is is strong.

In the short term and the investments are well underway to continue that that growth going forward.

And Jeff you mentioned I think that there was a.

That the that the growth opportunity for the category was maybe underappreciated do you have a target for how you know how much faster you can grow than the market over the next couple of years.

Most of the market I mean.

If I told you the housing was going to grow X percent and aren't always gonna grow well.

Why percent what kind of growth above the categories can you senior in your building products.

Well Rubin, we don't we're not really looking at it that way. It's good question I think what we're talking about is you know 68% of homebuyers say a fireplace is a must have you had only 40% actually by one so that's that's really what we're focused on we're focused on you know growing the addressable market.

Through that effort in that and how that's going to translate I mean, there's a bunch of trajectory is there, but but the bottom line is we're going to move.

You know that 40% up to 68% in a perfect world through those efforts.

And then the other thing we got existing homes in the remodel space, We got 30.

30 million older gas in wood burning units installed in need of an upgrade and so we know where those units are at where many of those units are at and we're increasing our efforts there to ramp replacement activity. So those are the two the two big awareness place.

Great and then switching gears a little bit on the sneak one more in about the home office.

Opportunity for you guys you know I guess can you can you one.

Touch on elaborate on the ecommerce supply constraints I think you mentioned accelerating growth in the fourth quarter. So can you tell us maybe how your.

Getting around those and then you mentioned an enterprise.

When I can tell us how that set up is the is the customer buying furniture for their employees to use at home and it is it the same product that you would normally sell into the office or is that the thing that you are selling through the E Commerce channel like.

Through the end is underway theres other world and thanks, and congrats on the quarter. Good luck navigating through the rest of the year.

Yes.

Let me, let me hit the E Com supply first I mean, you know basically we we were in a really strong position, but the business was so robust we stocked out of some of our top running.

SK use and we're reloading those as we speak I think even if you look in your Theres a lot of supply constraint is port constraints container constraints, there's still a lot of that out there, but we've been able to we got on it early we've been able to get in and into a pretty solid stock position going into the fourth quarter. So we think for the most part those.

Constraints will subside.

And then the question on the enterprise Enterprise client yes.

You know that first of all let me just say, we're seeing all kinds of discussions and those types of opportunities take all different kinds of forms.

You know some clients provide a stipend that's what happens to be the case here and they will be products that aren't so much. These are more core workplace products commercial products.

From some of our company's not what I'll call core E com.

Amazon type products that are going to going into that program in particular.

So it is but like I said those those are all.

Those are all over the map, but there is a lot of discussion there and we are seeing those those start to land.

Great. Thanks again guys.

Thanks drew.

Our next question comes from the line of Steven Ramsey from Thompson Research. Your line is open.

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Hey, good morning.

I guess to start with a quick follow up on the E. Com inventory issue that inventory cause lost sales or did that push what would have been sales into.

Into orders and Thats benefits Q4.

No Steven itself in that in that World. It's a lost sale they move on they move on to another another skew or they or they maybe lived they back out live to re look later, but it's not it doesn't operate like the core business, where it just it lead times out and pushes and Stephen I would point out.

This was pretty common in that in that segment that the demand is so strong that a lot of players in the space had similar issues to what we've experienced.

Oh, great Okay.

And then I think you know.

E Com.

You know it's.

Do you think about next six to 12 months in moving this business forward and people start going back to the.

To the office to a larger degree.

Does that shift your investment priorities and maybe.

Dozens internally as you start to think about.

This business being a greater profit.

Contributor than what it already is over the next.

One to two years as the corn deneke impact sales.

You know Stephen I think you know what I would say is is it's going to continue to were going to reinvest this business, it's getting to be a big part of our of our kind of go forward model I think at this point you know, it's it's been incremental up to pre pandemic and now you know I think.

Ultimately going to settle out you know in the long run as incremental business I do believe that the vast majority of employees will ultimately settle out working you know some some at the home some at the office and both are going to require furniture in both locations and so so the way we look at that business.

He is it's we're going to continue invest in it it will it will become core.

More core over time and in support kind of where we believe the future work is headed.

Excellent, Okay, and then thinking about.

Which is at the ready.

Ready market regarding Q3 result in the Q4 outlook.

Can you discuss if there is any mix impact or temporary cost reductions driving margin there and then.

Discussing the ability to drive high teens margins in Red the long term.

Offset by.

Some growth investments that were already discussed.

Maybe that's why Q3 was so much better than than expectations, even as we make those investments and how that plays out over the next.

The three quarters.

Sure Stephen as it relates to the margins in residential building products. There wasn't really anything abnormal in the third quarter. We just had really strong volume.

And of course, we have adjusted our cost structure for a much lower volume level and it came in much stronger so thats the big the big issue there.

As we move forward and margin expansion is really not our goal.

We really want to grow this business, Jeff talked about our efforts to create awareness and grow the category three and continue to invest pretty strongly there, but we'd expect to be able to hold margins at levels that we see here recently they are very strong are really getting good ROI C and the recent.

The recent results really reflect the strong operational model, we have there combined with some healthy market.

Great and then last quick one on on.

Already Mark.

Market how is the performance of the recently acquired distributors.

Here to expectations or or acquisitions over the past couple of years and then what is the pipeline for more deals going forward.

Yeah, I think the performance is that that team does a great job with those the performance is in line as we as we model as we expected and and they were in some nice markets for us and we we are continually looking.

Looking across the network to see where it makes sense to continue to add those two are our own network.

Excellent. Thank you.

Thanks. Our next question comes from the line of Greg Burns from Sidoti Your line is open.

Good morning.

In terms of the the order patterns on the the office side of the business can you talk about maybe where where if anywhere specifically.

You saw the improvements was it on the.

The the Han kind of build supplies business or more of the contract wholesale side of the business or or maybe years.

Across broad base.

Broad based but can you just talk about that please.

Yes, let's talk of workplace furnishings, excluding E commerce and when I tell you. There is that we didn't see a lot of difference between the comp.

The contract business in the small to mid size business or the hunt business as you mentioned.

He we were down orders were down like 35% in the second quarter and we we progressively got better as we move through the quarter. So we exited September down in the high teens.

I tell you that you know the last five weeks.

The last five weeks were in the low twentys. So it's consistent with what our outlook that AIDS, it's going to moderate the declines will moderate in the fourth quarter, but b, we're not expecting it to come back really quickly in either side of the business to your original question Greg.

Okay, great. Thanks, and I think you mentioned what that.

What that extra week added into will add in terms of your growth outlook for the fourth quarter. The the workplace, but I don't think you.

Clarify that for.

The residential building products how much of the.

Yes are we getting to the outlook for that part of the business.

Now the.

Extra week is for both businesses it adds 4% to 7% for both businesses. Okay. Okay, great. Thanks.

Okay. Thank you.

Thanks.

And we have no further questions in queue I'd like to turn the call over to Derek Jeff Florange or for closing remarks.

Thank you again for joining our third quarter call. We continue to be excited about what is ahead. We look forward to speaking with you next quarter have a great day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.

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