HNI Corporation (NYSE:HNI) Q3 2023 Earnings Call Transcript
HNI Corporation (NYSE:HNI) Q3 2023 Earnings Call Transcript October 31, 2023
HNI Corporation beats earnings expectations. Reported EPS is $0.93, expectations were $0.63.
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 speaker's remarks, there will be a question-and-answer session. [Operator Instruction] I will now turn the conference over to Matt McCall. Please go ahead.
Matt 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 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 am now pleased to turn the call over to Jeff Lorenger. Jeff?
Jeff 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 three key topics first, we continue to deliver strong margin expansion in Workplace Furnishings. However, we are not finished and see more opportunities 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 the operating margin in this 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 this 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 a 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 four 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 and 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 previous 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 construction and remodel retrofit activity have shown similar sequential improvement. Additionally, the improvement has continued in the early part of the fourth 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 third 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 segment. The demand fundamentals remain strong. 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. 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?
Marshall Bridges: Thanks, Jeff. Let's start with our expectations for demand in the fourth quarter. In Workplace Furnishings, we expect organic revenue to be approximately flat with fourth quarter 2022 levels. That outlook is consistent with recent order patterns, it excludes Kimball International, and it assumes continued SMB outperformance. In Residential Building Products, we expect revenue declines to further moderate in the fourth quarter with revenue declining at year-over-year rates 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 fourth quarter, we expect KII to add $140 million to $150 million of revenue.
We also project KII accretion will be consistent with third quarter results. An additional note on KII, earlier, Jeff mentioned $5 million of incremental purchase accounting costs in the third quarter of that $5 million, approximately $3 million is associated with inventory step-up and should be considered one-time in nature. That points to an adjusted operating margin for KII of approximately 12.5% in the third quarter. Fourth quarter non-GAAP EPS is expected to solidly increase year-over-year to be modestly below our just reported third quarter 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 third quarter to the fourth. Shifting to the balance sheet.
We ended the third quarter with total debt of $509 million, which was down significantly from the $598 million outstanding a quarter ago, our working capital dynamics continue to improve and return to historical levels that drove free cash flow per share of more than $2 in the third quarter. 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.
Jeff Lorenger: Thanks, Marshall. Our strategies are delivering results. Operating margin in Workplace Furnishings continues to expand, reaching 10% in the third quarter. Our profit transformation initiatives have momentum, and we expect continued year-over-year profit improvement in the segment. The integration of Kimball International is doing well. KII is already strengthening our business and delivering earnings accretion, which will only increase as our synergies mature. KII better positions us to lead in the evolving workplace environment and provides new opportunities for profit growth. 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 of Workplace Furnishings and drive long-term high-margin revenue growth in Residential Building Products. I want to thank all HNI members including our new members from KII. Our results reflect their collective effort and dedication. We will now open the call to your questions.
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