Q3 2022 HNI Corp Earnings Call
Yeah.
Good morning, My name is Chris and I'll be your conference operator today at this time I'd like to welcome everyone to the agent I Corporation third quarter fiscal 'twenty two results conference call.
All lines have been placed on mute to prevent any background noise.
After the Speakers' remarks, there'll be a question and answer session.
If you'd like to ask a question. During this time simply press star followed by the number one on your telephone keypad.
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Mr. Mcfall, you may begin your conference.
Yeah.
Good morning, My name is Matt Mccall, I'm, Vice President Investor Relations and corporate development for <unk> Corporation.
Thank you for joining us to discuss our third quarter fiscal 'twenty to 'twenty to 'twenty. Two results with me today are Jeff larger chairman, President and CEO , and Marshall Bridges, Senior Vice President and CFO .
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 risk.
Actual risks could differ materially the financial news release posted on our website includes additional factors that could affect actual results.
<unk> assumes no obligation to update any forward looking statements made during the call I'm now pleased to turn the call over to Jeff Lawrence you, Yes. Thanks, Matt.
Good morning, and thank you for joining US are members delivered strong earnings growth in the third quarter, despite softer demand tied to the weaker macro environment.
On the call today I will cover three key points first despite the softer volume environment, we delivered strong earnings growth in the quarter.
Second our residential building products business posted double digit organic revenue and earnings growth in the quarter and third we are prepared for a difficult near term environment and remain committed to our core strategies.
Following those comments Marshall will go through our updated 2022 outlook I will then conclude with some general closing commentary.
Finally, we will open the call to your questions.
Moving to our first key point, we delivered strong earnings growth in the quarter, driven by positive price costs and improving product mix.
Despite the softening demand environment, we generated solid year over year margin expansion and 65% year over year non-GAAP earnings growth in the third quarter.
Consolidated gross and operating margins improved sequentially and on a year over year basis supported by favorable price costs.
We continue to make significant improvement with price cost and by the end of this year expect to fully recover last year's shortfall that was driven by rapidly rising inflationary pressures.
In workplace furnishings, we made progress on our strategic objective of expanding operating margins.
Segment operating margins expanded 150 basis points compared to the prior year driven by favorable price cost and benefits tied to actions made over the last year to improve product mix.
Organic revenue growth was flat in the quarter. However, when excluding the impacts of the recent restructuring and one of our ecommerce businesses segment shipments grew 7% driven by price realization.
Although that restructuring negatively impacted our topline growth it contributed to our margin expansion, reflecting our commitment to improving profitability and workplace furnishings.
I will now move on to my second key point, our residential building products business delivered double digit organic revenue and earnings growth.
Segment revenue grew 10% organically versus the same period last year.
We generated revenue growth in both new construction and remodel retrofit with both channels growing at similar rates during that quarter.
While third quarter orders were down modestly on a year over year basis, and while we expect and prepared and are prepared for a near term challenges in the housing market.
Our category, leading positions and favorable housing demographics continue to reinforce our long term bullishness for this high margin high return business.
Segment profitability was robust in the quarter operating profit increased 19% year over year and operating margin expanded 50 basis points to 17, 7%.
Positive price cost accounted for the majority of the profit improvement.
Our long term strategic focus in this business is unchanged, we will grow revenue by expanding the category.
And taking advantage of our strong competitive positioning in attractive long term market dynamics, while at the same time, maintaining our margins.
Our competitive position is unique and we have a track record of outperforming the market, including during periods of weakening housing demand.
There are several factors that differentiate us first our vertical integration provides the benefits of a stack margin and better control of our marketing message and service levels.
<unk> vertical integration through pursuit of organic and inorganic opportunities will remain an important part of our long term growth strategy.
Second our regional distribution footprint provides unmatched customer service and limits the need for working capital investments by our channel partners.
Third our price point breadth.
<unk> depth and channel reach are unique in the industry and allow us to address the needs of customers of all sizes in all markets.
Finally, our lean manufacturing and product development capabilities are unparalleled in the industry and allow us to continue to expand our competitive differentiation.
We will finish with my third key point, we are planning and prepared for a difficult near term environment and notwithstanding we remain committed to our core strategies.
Bravo broader macro indicators point to increasingly challenging operating conditions as we move into 2023.
In workplace furnishings, the outlook for corporate profits is softening and executive sentiment is at recessionary levels. As a result, we are seeing companies being more cautious with spending.
Residential building products, we are expecting top line declines in 2023.
Higher mortgage rates are negatively impacting affordability, which is pressuring new home construction and remodel retrofit activity.
During the quarter in response to the softer demand trends in anticipation of weaker macro conditions in 2023, and as part of ongoing efforts to improve long term profitability, we initiated a corporate wide cost reduction plan.
While these actions will strengthen our earnings and cash flow during what is expected to be a weaker economic period in 2023.
They also will provide another source of support as we work toward our core long term strategy of expanding margins and workplace furnishings and for the Corporation.
When fully implemented the permanent savings associated with these actions are estimated to be $30 million on an annual basis.
Our team is experienced and we will stay focused on our long term core objectives, despite macroeconomic headwinds.
Before I turn the call over to Marshall I want to comment on recent market dynamics and workplace furnishings.
Specifically, what we are experiencing and what our research tells us and why both provide encouragement about future demand trends.
During the third quarter, we faced a wide range of demand patterns and workplace furnishings.
Orders from larger contract customers in major markets remain subdued as business leaders appeared increasingly hesitant to spend given the weakening economic conditions.
In addition, many of these customers continue to struggle with how to effectively execute their office reentry objectives and.
In general larger customers are active and engaged with us to understand what working model and furniture applications best fit their objectives.
This has resulted in a more complicated sales process and as these customers iterate and evaluate multiple possibilities. They are also taking longer to reach decisions and in many cases deferring decisions at.
At the other end smaller transactional activity sold through national supply dealers and wholesalers was also weak throughout the third quarter.
Historically this part of the market tends to react quickly to macro uncertainty consistent with what we are currently experiencing and what we shared with you on our last earnings call.
Unlike those two areas of softness demand from the mid market, where we hold a leading position showed strength in the quarter.
When compared to contract customers in larger markets. We are finding mid market customers are more likely to be back in the office utilizing either traditional in person or hybrid working models in which employees split time at home and in the office.
Positive mid market activity is indicative of underlying demand tied to return to office and adoption of hybrid work.
That demand is driving growth in the mid market, even in the face of increasing economic doubt.
We are encouraged by this trend as it illustrates the underlying strength and demand that will emerge more broadly once the economy stabilizes and as more customers implement office reentry plants.
To that point, our research indicates several trends have developed over the last two to three quarters.
First full time remote work is becoming less favored by both employers and employees with both increasingly realizing the long term shortcomings of zero face to face interaction.
Second hybrid working models continued to grow in popularity.
Again, both employers and employees increasingly see the benefits of this balanced approach.
And importantly, our research and our recent experiences both indicate the shift to hybrid comes with the need and willingness to spend more on furniture.
While activity with some customers may be paused given current conditions. We believe we are well positioned from a market product and price point perspective to benefit from the eventual market recovery.
I will now turn the call over to Marshall to discuss our outlook for the remainder of the year Marshall.
Thanks, Jeff demand in most of our markets continues to be negatively impacted by concerns around the economy.
As a result, we're lowering our outlook for the rest of the year.
Workplace furnishings, we expect fourth quarter revenue to decline at a low teens year over year rate.
That equates to a full year revenue growth rate in the low to mid single digits, that's lower than our prior expectation of low teens full year growth the reduced outlook is driven by slower demand activity.
As a reminder, the sale of land next and the previously announced restructuring of an e-commerce business.
We will reduce reported segment growth in 2022 without these actions, which helped drive our margin expansion efforts full year growth would be approximately 12 percentage points higher in the fourth quarter revenue growth rate would be in the positive low single digits.
And residential building products pricing benefits and revenue from the acquisitions are expected to drive year over year growth rates.
Low to mid single digits in the fourth quarter. This implies a full year growth rate in the mid to high teens residential building products. We had previously projected a full year growth rate in the high teens again, a lower volume outlook is driving the reduction.
I'd like to point out that our revenue growth rates in residential building products are currently being supported by elevated backlogs we.
We expect the backlog to normalize by early next year after which we expect our growth rates will track more in line with the overall, new construction and remodel retrofit markets.
Fourth quarter non-GAAP earnings are expected to decrease sequentially from third quarter 2022 levels.
The modestly above prior year results, primarily due to favorable price cost.
From a balance sheet perspective, we expect to maintaining strong financial position in 2022 and beyond debt to EBITDA as calculated per our debt covenants with 0.8 at the end of the third quarter.
And we expect it will improve in the fourth quarter as debt levels further decline or.
Our strong balance sheet and capacity to generate free cash flow positions us well for the slowing economy, we have a history of generating strong free cash flow during both periods of economic expansion and recession, our low leverage and continued free cash flow generation will provide flexibility for the dynamic environment.
And ample capacity for continued capital deployment.
I'll now turn the call back over to Jeff. Thanks Marshall.
We remain focused on our two primary long term objectives, improving the profitability of our workplace furnishing segment by driving margin expansion.
Delivering strong topline growth in residential building products by leveraging our differentiated business model.
As we move forward, we do so with an experienced team that is prepared to confront an increasingly difficult economic environment, while remaining committed to our long term core strategic initiatives. We will now open up the call to your questions.
Thank you and as a reminder, if you'd like to ask a question. Please press Star then one on your telephone keypad.
Our first question is from Reuben Garner with the benchmark company. Your line is open.
Thank you and good morning, everybody.
Good morning.
If we could start on the cost saving.
Initiative.
First Marshall any color on the timing of the realization would be helpful. And then secondly, I guess, if you could discuss kind of.
You seem to be still pretty optimistic on the long term story within building products, how you balance or think about your growth investments that you've been making over the last few years in the way in this current environment.
Sure I'll take the cost savings question first Rubin.
The $30 million, we expect to be.
Basically fully realized in 2023, the first one maybe a little bit below that run rate as it becomes mature, but it would become mature during that quarter.
Yes, Reuben this is Jeff.
We still like as I said, the long term opportunities in residential building products and our efforts continue to expand the category both in the new construction and remodel retrofit.
We've got a new product pipe, that's pretty that is strong we're getting into the electric category in a big way.
We've done some inorganic growth moves through our distribution footprint and so 2023, clearly the economy is and we're going to face headwinds, particularly in the housing market, but we like our chances to offset some of that anyway with these growth initiatives and we're seeing we're seeing.
That right now even currently.
Okay, Great and then on the <unk>.
Building products side, you mentioned, new construction held up better than R&R in the quarter I think at least from an orders perspective.
Can you talk about on.
On the R&R side is that a product thats inventoried was there a destocking that took place in the channel at all of that that impacted things and then I assume as as kind of the backlog in new housing unwind that part of the market you would expect to see more pressure than R&R moving forward is that the right way to think about it.
Yes, maybe just to take these in order, we did see the R&R orders in the quarter to be down more than the segment average.
That reflected mainly two things one is timing and then we had a lot of orders placed earlier in the year for fourth quarter deliveries. So even though orders were down in the third quarter, we expect shipments in the fourth quarter and remodel retrofit to grow pre.
Pre decently.
It also probably reflects a little bit of impact from the <unk>.
Klein and the consumer spending trends around the house, but theres definitely some timing impact there.
And then I think as we look forward historically remodel retrofit is just less volatile than new construction. So yes, we do expect new construction to.
To decline more than remodel retrofit when all of this housing impact hits.
Okay, and then as a follow up to that.
As you think about where the business is today versus maybe three or four or five years ago is there any way for us to gauge.
How much either increased penetration there is in the use of fire places on the new construction side or incremental share gains in the segment just trying to see maybe what what revenue and I guess you could throw pricing in there to what revenue might look like.
Start sort of returned to what we saw back in 17 18 19.
There's a lot of moving parts of that equation.
We are definitely finding affordability and lots of other pressures, we got a lot of good strategic initiatives that Jeff mentioned around average to expand the category and our new products.
In general remain the way to think about it is that we should track single family construction, plus or minus a few percent at least over the near term.
Thats I think Thats, Ryan Morris Aruba, and the other thing I would say is the business is much more in tune to to the customer journey into creating pull for our products. We've you know theres a lot of online selling now we've deployed a lot of digital assets early in the cut.
Some are buying process and despite the fact that we're kind of in a near term <unk> I think that's a change in the business longer term, that's going to pay dividends or like I said, we're even seeing it now relative to.
Being in types with customers being in touch with design aesthetics and influencing those those purchase decisions earlier in the process with much more specificity.
And in particularly with our owned footprint and that where we can control that content and work closely with the builders and so that we've got a lot underway, there, which I think if you ask about changed from 18 to say lets projected 'twenty four or 'twenty three even that's I think going to pay dividends there'll be muted.
Given the overall macro but those will I think accelerate once we get through some of the affordability issues.
Okay, great. Thanks, guys. Good luck going forward.
Thank you.
The next question is from Rex Henderson with water type of research your line is open.
Good morning, and thanks for taking my question and congratulations on the work you've done on margins.
Bringing them back Thats really quite quite quite encouraging impressive let me let me, let me get to the workplace segment.
We've just recently began to see a little bit of uptick in back to office. According to the capital systems Index on bad swipe and Im wondering if youre seeing any correlation between a market where.
There is a positive.
Positive results from that.
And positive result in fact, the office in New York and customer activity and orders.
Well.
That's a good question I think I think.
One of my comment on the mid market I think that is exactly what we're seeing I mean, even in the in the light of the economic outlook, we're seeing where we generated solid growth in the mid market and some of those those mid tier cities.
They have adopted either the traditional or the hybrid model and they are back to work and Thats why I think one where we hold a strong position there and two I think thats indicative as this continues to work through and swiping starts to get.
Increase in other markets.
A solid indicator for demand coming out of this.
Okay.
Interesting.
And on the residential furniture on the residential side.
Im interested in new construction and you said that you think you're tracking new construction starts more or less in orders there.
And can you give me a little color on <unk>.
On what order trend in orders there.
And.
Kind of where you see it.
At the end of the year.
Yes, thanks, Youre asking about residential building products orders.
Yes, so as we stated in our press release orders were down about 6% in the third quarter versus the prior year.
New construction is stronger than remodel retrofit as I said earlier.
And that new construction strength really reflects.
The builder backlogs the backlogs at are installing distributors, who said theyre still orders coming in and we do expect that to.
Falloff in track more in line with with housing permits and just general housing activity remodel retrofit orders have declined more as I said earlier there is some timing to that there is some.
There is some also some probably consumer impacts there, but we have a big backlog to work through there our backlog in remodel retrofit is elevated due to the orders that were placed earlier in the year and thats going to buffer and soften any kind of decline we have probably takes the rest of the year and maybe into 2023 early 2023.
To normalize that backlog.
Okay, and so you think early buy by January February the backlog will be gone.
Yes.
At current trends what do you think orders are.
Where orders going between now and then do you have any feel for that.
So the easier part of that question. The answer is yes, the backlog should be normalized by say January February the.
Harder part is to speculate on what orders are going to do.
Certainly we see weakness in the new construction activity around permits which are running.
Roughly down 20% versus prior year.
Remodel retrofit is a little bit hard to gauge and that there's not as many leading indicators to that bit signs show thats going to be soft as well that we're prepared for it to be down <unk> I don't know that were able to offer a quantitative outlook how.
How much it's going to be down right now.
Yes, I would just.
I would add to that Rex just kind of as you step back from the specific where orders headed.
In the short term.
Look everybody knows the economies in a tough spot as we enter 2003 most of the leading indicators are slowing.
We're seeing some of that as well now we're prepared for softer demand.
Testing the business with cost savings and other efforts I would tell you historically, we have a track record of success managing through downturns, our balance sheets in great shape.
We generate cash flow so it could be challenging short term, but we're encouraged by the opportunities once the economy stabilizes we have unique operating models as we talked about.
Commented earlier, we're going to stay on our long term core objective of the strategic initiatives and then workplace like I said the mid market I think is indicative of strength and when return to office activity comes back in earnest and adoption of hybrid continues to grow there's still a war for talent and our exposure.
Across these markets and particularly in North America, where we primarily operate I think is going to bode well for us.
And as I commented earlier as well, but on the residential side are you just talking about our efforts that we've put in investments.
Pretty significant investments last few years to connect with customers to expand the category to create awareness to understand design patterns.
To leverage our strong distribution model those are all.
0.2.
It really <unk>.
Strong opportunistic.
And.
Outlook once we kind of get through this this near term headwind.
Okay.
Thanks for your time.
Thanks appreciate it.
The next question is from Greg Burns with Sidoti Your line is open.
Good morning.
What percent of your businesses contracts mid market and SMB can you just segment at the sizing of those three segments of your business.
Yes, Greg we like to talk about contract in F&B.
Roughly 50 50 split now it's not.
The precise split.
SMB might be slightly bigger.
I think what you're getting at is SMB actually we were chosen to break out a couple of sub components of SMB here by talking about the mid market in the transactional business.
We don't we don't offer a precise split on that mid market would be larger than the transactional business, but we don't we don't give the precise mix.
Okay.
And then relative to $30 million in cost savings there was a $5.
6 million charge this quarter for some restructuring is that tied to the $30 million is that separate a separate set of cost savings.
How should we think about that.
No thats directly related to the $30 million the corporate wide cost savings program will save $30 million, Switzerland mature next year, and we incurred $5 $6 million of charges related to it in the quarter.
Okay.
And.
Total SG&A was down.
It is lower than we expected down pretty significantly sequentially.
Im assuming some of that is variable.
But.
Once the 'twenty three rolls around and goals reset I'm, assuming maybe some of that variable comp comes back online. So I'm just trying to figure out.
Based on the better the lower than expected operating expenses this quarter.
What's a good run rate to build off of as we go into 'twenty three.
<unk>.
And start factoring in some of those cost savings.
Yes, that's a good observation, Greg we the third quarter, the P&L did benefit from lower variable compensation.
There was an adjustment made there that's sort of onetime in nature. So.
In terms of ongoing run rate none of those numbers have the $30 million in it and we're going to continue to adjust the business as Jeff mentioned earlier for the challenging short term are expecting.
So I don't know that we have.
Estimate on where SG&A is we're always going to continue to invest a bit.
But we are prepared for a more challenging.
2023, what I would offer.
Is that we do have some offsets in actions first the cost actions that we just talked about the $30 million program is one of three things that can offer some benefit next year.
There are two that we would expect price cost to be favorable in 2023.
And then we would also expect net productivity to improve given that supply chains are normalizing and our Mexico operation is maturing collab.
Collectively those are probably offering benefit in the range of $80 million next year, which we expect will help offset partially.
Mitigate the volume pressure, but in terms of SG&A run rate, we don't have an outlook for you. Okay. That's definitely helpful and I guess.
Maybe you kind of answered.
Part of this next question, but.
It sounds like Youre catching up on price cost. So it seems like inflation is.
Becoming less of a concern but.
Any update on supply chain freight.
Labor or any of these other kind of moving parts that have been impacting the margins over the last year or so are you seeing any improvement on that front.
Yes, we are we in the last call we talked about price cost for the corporation mean favorable $60 million to $70 million for the for 2022, we're expecting that to be in the $75 million to $80 million range. The reason for the increase is.
More stabilization in the commodities.
Yeah.
Hey, Greg relative to supply chain it has stabilized as well, although it is not at pre pandemic stability, but it is it is operationally, it's still a bit of a challenge, but it's much more stable than it was a year or two years ago.
Okay alright, thank you.
Thanks.
The next question is from Steven Ramsey with Thompson Research Group. Your line is open.
Hey, good morning, I'm, sorry, I got disconnected for a minute. So sorry, if im asking the same question again, maybe to start with on ready.
Where is inventory now and entering this slowing period do you think the channel and <unk> specific inventory is in a good place to adjust for that.
Steven you're asking like channel inventory, that's is that kind of your question.
On the resi side specifically.
Yes, I mean look.
There is there is probably some inventory there that needs to be adjusted but recall, we've got this unique regional distribution center network in which we hold inventory.
And deliver in just a few days to do the majority of our.
Dealer partners. So I don't know that Theres, a big inventory correction, and although theres, probably a little bit there.
I think there's probably a little bit there, but we've kind of been monitoring that and it's it's been flushing through throughout the year.
Distributors clearly some of them loaded up based on lead times and supply chain issues, Stephen but Dave Dave.
They've unwound, a big chunk of that I think we're getting to the end of that here in the backlogs are going to be mostly normalized by the end of the year.
Okay helpful and then on <unk> margins, increasing again.
They're pretty normal high teens levels can you talk to price cost.
Typically there and with the investments.
Can you talk to the impact on investments for growth in the third quarter and how you think about it in the coming quarters with the near term slowly.
And residents in building products, we did.
Generate positive price cost.
$10 million, so that added to operating margins.
We did invest in the quarter in that segment it was around $1 million of investment.
It's spread across that go to market activities, we've discussed grow the category new product et cetera.
Okay helpful. And then looking forward on signals of inflection you talked about how transactional activity in the workplace segment.
Is is moving with the economy.
Are you looking for that internally as your key signal for optimism and activity turning up or are there other internal.
The metrics that Youre looking at.
Steve when we look at we look at all aspects of the business I think transactional historically has been pretty predictive of general economic trends.
But you know we are in this period of the post pandemic kind of office redo and so we're slicing it a lot.
Multiple different ways, that's why we kind of talked about the mid market Youre seeing regional differences youre seeing size of business differences.
And so.
I think.
To continue to look at all of that and.
The mid market as I said in my prepared remarks, I think is.
Going to be indicative of maybe the some of the other segments relative to.
Return to office floor plate application hybrid models and and even in the even in the.
This uncertain time, that's showing some strength so you know I.
I think we we don't have as we're kind of in uncharted waters. There post pandemic. So we're going to look at all of it in the mid market was our attempt to give you a little bit of a new nuance of how we're going to look at it.
And I'll tell you we're going to continue to you ask a question just a minute ago about residential we will continue to invest in our core strategies on expanding workplace furnishing margins and driving top line growth.
Notwithstanding near term.
Headwinds in housing.
Okay helpful. Thank you guys.
Thanks.
The next question is from Reuben Garner with the benchmark company. Your line is open.
Thanks, guys. My follow up question was actually just asking I couldn't figure out how to get out of the queue. So I'm going to ask one more clarification, while I have you there so.
The last quarter I think you talked about the smaller businesses.
Turning.
As the macro conditions worsened that just to clarify this quarter have you seen any rebound from them at all I know you're talking about the middle market mid market showing strength, but is that to say that the small business small businesses have been.
Have improved can you just talk about them.
<unk> versus contract on the order front. Thanks.
Yeah, I think Ruben that was the question Greg was kind of asking too I think is is SMB is inclusive of what we call transactional real day to day business and kind of mid market business and so what I would say is as we've said the mid market customer, which is some small you know a good chunk of small business.
<unk> has been pretty pretty robust the transactional business has continued to be down we commented on that last time and it is.
It is it is not showing signs of.
Turning it's it's very historically driven by macroeconomic trends and that tends to be really small business customers.
Got it thanks that makes sense good luck guys.
Thanks.
We have no further questions at this time I'll turn it over to Mr. Larger for any closing remarks.
Great no. Thanks for your interest in <unk> and thanks for taking the time to join US today to chat about the business have a great day. Thanks.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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