Q3 2023 HNI Corp Earnings Call

Participants:
Jeffrey D. Lorenger; Chairman of the Board, President & CEO; HNI Corporation
Marshall H. Bridges; Senior VP & CFO; HNI Corporation
Matthew Scott McCall; VP of IR & Corporate Development; HNI Corporation
Beryl Bugatch; Head of Consumer Hardlines; Water Tower Research LLC
Gregory John Burns; Senior Equity Research Analyst; Sidoti & Company, LLC
Reuben Garner; Senior Equity Research Analyst; The Benchmark Company, LLC, Research Division
Steven Ramsey; Senior Equity Research Analyst; Thompson Research Group, LLC

Presentation
Operator:
Good day, everyone, and welcome to the HNI Corporation Third Quarter Fiscal 2023 Results Conference Call. Today’s call is being recorded. (Operator Instructions). I will now turn the conference over to Matt McCall. Please go ahead.

Matthew Scott McCall:
Good morning. My name is Matt McCall. I’m Vice President, Investor Relations and Corporate Development for HNI Corporation. Thank you for joining us to discuss our third quarter fiscal 2023 results.

With me today are Jeff Lorenger, 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 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.

I’m now pleased to turn the call over to Jeff Lorenger. Jeff?

Jeffrey D. Lorenger:
Thanks, Matt. Good morning. Thank you for joining us. During the third quarter, 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.

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. Second, 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. Third, 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.

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 820 basis points year-over-year to 10.7% as our profit transformation plan continues to deliver results. This was the sixth straight quarter of year-over-year operating margin improvement. Both operating profit margin and operating profit dollars reached the highest level since the third quarter of 2019 despite lower industry volume. We made strong progress with our profit transformation initiatives. 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. Second, we have streamlined our cost structure. In last year’s third quarter call, we announced a $30 million 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 million across the corporation.

More specifically, in Workplace Furnishings, $25 million of that total is contributing to our margin expansion in 2023. Third, 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 exiting Poppin, divesting our China business and rationalizing our e-commerce offering, all of which are contributing to our improved margins.

And fourth, 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. 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 third quarter and are up 9% year-to-date. In general, this segment has benefited from healthy dynamics. Small- and mid-sized 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. 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 third quarter 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.

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 predictive 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. 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 Poppin and the integration of Kimball International is progressing nicely. Excluding Poppin, KII added approximately $0.06 of non-GAAP EPS in the quarter. These results exceeded our expectations. Moreover, KII generated a strong operating margin of 10.6%, this was despite incurring $5 million of incremental purchase accounting costs during the quarter. 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 previously announced annual run rate synergy amount associated with the KII acquisition of $25 million as a floor with a strong potential for upside. The sale of Poppin, which we completed in early September, provides immediate financial benefits, recall Poppin had an annual operating loss of nearly $20 million prior to the sale. While KII’s operating margin is already in double digits, cost synergies, elimination of Poppin losses and ongoing productivity efforts point to additional margin expansion opportunity in the months and years ahead.

My third topic is we demonstrated the resiliency of our Residential Building Products business model in the face of housing market weakness. Third-quarter operating margin in the segment remained unchanged versus the prior year and was up sequentially. 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 million to $20 million of our targeted cost savings benefiting Residential Building Products this year with another $5 million to $10 million of benefit next year. These cost reduction efforts along with normal seasonal patterns will result in further improvements to segment profitability in the fourth quarter of this year.

Importantly, demand trends in this segment continue to stabilize. Third-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. Both new…

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