HNI Corp

NYSE:HNI

Earnings Call Transcript 2022-Q2

[Operator]

Good morning. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the HNI Corporation Second Quarter Fiscal 2022 Results Conference Call. [Operator Instructions]. Thank you.

Mr. McCall, you may begin your conference.

[Matthew 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 second quarter fiscal 2022 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 Lorenger, Chairman, President and CEO]

Thanks, Matt. Good morning, and thank you for joining us. Our members delivered strong top and bottom line performance in the second quarter while we continue to invest in strengthening our operational network and go-to-market capabilities. Today, I will cover three key points and discuss why we remain on the right track for 2022 and beyond.

First, we delivered 30% earnings growth in the quarter, driven by solid organic volume growth and positive price cost; second, we continue to invest and deploy capital, maintaining our focus on our long-term strategies and on increasing shareholder returns; and third, last week, we divested Lamex, a move consistent with our previously announced portfolio simplification efforts that will allow us to better focus on our core strategies going forward.

I will cover these points and discuss some thoughts on the recent demand environment. Marsh will then go through our updated 2022 outlook. I will then conclude with some general closing comments. Finally, we will open up the call to your questions.

Moving to our first key point. We delivered 30% earnings growth in the quarter, driven by organic volume growth and positive price cost. Both Workplace Furnishings and Residential Building Products generated double-digit year-over-year revenue growth in the quarter. In Workplace Furnishings, price realization and increased volume drove strong top line growth. When excluding the impacts of the recent restructuring in one of our e-commerce businesses, segment shipments grew nearly 30% in the quarter.

In Residential Building Products, pricing volume and lead time improvements drove 21% organic revenue growth in the quarter. Segment backlog levels remain elevated, which helps improve our second half visibility. Sequentially, our consolidated gross and operating margins improved in the second quarter as we benefited from higher volume and continued to make progress recovering the inflationary pressure we faced last year.

During the second quarter, price exceeded cost by nearly $8 million. We continue to expect price/cost to deliver significant profit improvement in 2022. In fact, our price/cost expectation has improved from what we shared with you last quarter.

I will now move on to my second key point. We continue to invest and deploy capital, maintaining our focus on our long-term strategies. The post-COVID environment, labor and supply chain dynamics continue to be challenging. In response, we opened a new seating facility in Mexico, relocated production lines to take advantage of locations with better labor dynamics and implemented multiple other operational changes.

These investments, which totaled over $5 million in the second quarter, are positioning us for the long term by making our operations more productive and more resilient. We also continue to make investments in our go-to-market capabilities, including advancing our digital efforts, enhancing our connection with end users and developing new products.

During the quarter, we acquired a hearth products installing distributor located in Raleigh, North Carolina. It will add to our already strong competitive position in this fast-growing region. This is the sixth installing distributor we have acquired in the past three years. We now own 27 installing distributors, providing us with unmatched service capability and an improved connection with homebuyers, homeowners and homebuilders. And in total, more than 25% of segment revenue now flows through our unique vertically integrated Residential Building Products model.

Inorganic growth will remain an important part of our long-term strategy in our Residential Building Products segment. Finally, we returned more than $50 million to shareholders in the quarter. We now have returned more than $170 million over the past four quarters through dividends and repurchases, demonstrating our strong cash flow generation capabilities of our business model. And as Marshall will discuss in more detail in a moment, our balance sheet remains in great shape.

I'll finish with my third key point. We continue to make progress, simplifying our business. Last week, we announced the sale of Lamex, a China and Hong Kong-based office furniture business for $75 million, subject to standard post-closing adjustments. This divestiture, along with the elimination of a small brand and the restructuring of one of our e-commerce businesses, all of which occurred this year, are examples of our broader focus on simplifying our Workplace Furnishings business. These initiatives will allow us to better focus on our core strategies going forward with each of these moves ultimately aimed at expanding margins in this segment.

Before I turn the call over to Marshall, I wanted to provide some thoughts on recent business dynamics given the broader economic landscape and risk of recession. Starting in Workplace Furnishings, orders in the second quarter increased 4% compared to the second quarter of 2021 when orders grew 41% year-over-year. Second quarter order growth was lower than expected and softened later in the quarter, and order growth from small- to medium-sized customers lag growth from contract customers.

Our strategic accounts business, which targets our largest customers was very strong in the quarter, growing over 60% year-on-year. This is a pattern we have experienced before as slowdowns emerge. The smaller customers react more quickly to changes in the economy. It appears this group of customers is pulling back in response to recessionary concerns and declining confidence metrics.

Despite the negative trends, we continue to expect a strong full year revenue growth in Workplace Furnishings. In our Residential Building Products segment, orders in the second quarter increased 14% compared to the second quarter of 2021 when orders grew 40% year-over-year. New construction order rates outperformed remodel retrofit activity. For 2022, we are still expecting strong revenue growth driven by pricing benefits, inorganic revenue and our growth initiatives aimed at expanding the category. Recent order rates have moderated, consistent with well-documented negative trends in single-family housing, primarily driven by deteriorating affordability.

However, elevated builder backlogs and a longer construction cycle in single-family housing will help soften the impact on the second half of 2022. We are preparing for a slowdown, but we remain optimistic about the long-term dynamics in this segment. We continue to believe the opportunities associated with demographic trends and an undersupplied single-family market will benefit our business over the intermediate to long term. Our unique vertically integrated business model has unmatched product and channel reach with the regional distribution infrastructure that offers unparalleled customer service.

Now I'll turn the call over to Marshall to discuss our outlook.

[Marshall Bridges, SVP and CFO]

Okay. As Jeff indicated, we are seeing signs that macroeconomic and recession concerns will negatively impact our second half demand. As a result, we are lowering our 2022 outlook.

Compared to the prior outlook, we now expect slower second half profit growth due to lower volume and the divestiture of Lamex. These factors will be partially offset by improved price cost and reduced expenses. Even with these reductions, we are still expecting strong revenue and profit growth for 2022 compared to the prior year.

In Workplace Furnishings, we now expect a revenue growth rate in the low teens for 2022, and that expectation is approximately 7 to 9 percentage points lower than our previous view. Slower second half volume growth is driving a little more than half of the reduction, a little less than half is due to the sale of Lamex. I would also like to note that our segment growth rate would be in the low 20s when excluding our actions to streamline our portfolio. The sale of Lamex in the previously announced restructuring of e-commerce business are expected to lower reported segment growth rates by about 10 percentage points in 2022.

In Residential Building Products, pricing benefits, revenue from acquisitions and continued benefits from multiple growth initiatives are expected to fuel growth rates in the high teens for 2022. Compared to the prior outlook, segment growth is now expected to be softer in the second half.

A few comments on the third quarter and expected seasonality for 2022. We expect third quarter non-GAAP EPS to be -- to sequentially improve from second quarter 2022 levels and the above prior year results, primarily driven by favorable price cost. Pricing benefits are expected to drive third quarter revenue growth rates in the high single digits to low teens.

Regarding earnings seasonality. As a reminder, we historically generate approximately 70% of our total profit in the second half. In 2022, we are now expecting profit to be slightly less weighted to the back half than in recent years. This differs from our prior outlook due to our strong first half performance and moderating second half outlook.

From a balance sheet perspective, we expect to maintain a strong financial position. Debt to EBITDA was 1.7 at the end of the second quarter, and we expect to lower debt levels in the second half. Our low leverage and continued free cash flow generation will provide flexibility and ample capacity for continued capital deployment.

Finally, some additional detail on the Lamex divestiture. First, the transaction will strengthen our balance sheet. We plan to use the proceeds to repay debt. Second, the sale will be margin accretive on a full year basis -- more importantly, we believe there will be additional benefit from the resulting increase in focus. However, given Lamex's revenue and earnings seasonality with the majority of revenue and almost all profit coming in the second half, the transaction will negatively impact second half 2022 earnings.

We estimate the sale will reduce second half EPS by approximately $0.08 when including the benefit of reduced interest costs.

Third, the transaction will positively impact our second and third quarter results on a GAAP basis. Those impacts have been and will be excluded from our non-GAAP results. We expect the sale to generate a pretax gain of approximately $50 million in the third quarter. The expectation of that gain created tax benefits in the second quarter that increased our second quarter GAAP EPS by approximately $0.21.

I'll now turn the call back over to Jeff.

[Jeffrey Lorenger, Chairman, President and CEO]

Thanks, Marshall. We remain focused on our two primary objectives: improving the long-term profitability of our Workplace Furnishings segment by driving margin expansion; and delivering strong top line growth in Residential Building Products by leveraging our differentiated business model. Although the environment is becoming more challenging, we remain focused on improving our long-term competitive positions.

We expect strong earnings growth in 2022, while maintaining a strong balance sheet. And we have an experienced team that is prepared to confront an increasingly difficult economic environment while maintaining our long-term strategic objectives.

We'll now open the call to your questions.

[Operator]

[Operator Instructions] Your first question today comes from the line of Reuben Garner with Benchmark Company.

[Reuben Garner, Benchmark Company]

Could we start with the differences you're seeing in the contract in the small- to medium-sized businesses? Specifically, I guess, I'm wondering, you said you've seen this in the past. Do you see any differences here? Is this kind of a canary in the coal mine and we're going to see softness in contract? Or is there two economies, two stories to tell in that regard?

[Jeffrey Lorenger, Chairman, President and CEO]

Reuben, that's a great question. I mean when we refer to the past, I mean historically, we have seen when the SMB business goes into a slowdown before the contract just based on the selling cycle. This time, I don't -- I can't predict whether that's going to happen or not. I think we're still assessing what that looks like. We're going to prepare for a slowdown.

But it may be a pause as customers just continue to work through -- the larger customers continue to work through their plans like they've been doing.

It may take a little longer to sort out than in the past. And the economic uncertainty is not really helping us. But Again, I'm not prepared to say it's canary in the coal mine. I'm just saying that we clearly see it in our SMB business, it's a shorter-cycle business, the recession economy is -- that is operating like it typically has in the past. But I'm not here to claim that the contracts won't necessarily operate that way.

But we're looking at multiple scenarios there, just kind of given the whole post-pandemic world we're in right now.

[Reuben Garner, Benchmark Company]

Right. And so that the -- you mentioned your largest accounts doing well. Are you seeing regional differences? Is this kind of strength of recovery in some of the major markets that might be a little different than some of the small business customers in smaller markets?

[Jeffrey Lorenger, Chairman, President and CEO]

Yes. No, I wouldn't say it's regionally based, Reuben. I think it's just -- some of the larger customers have been studying this -- their post-pandemic plans, hybrid model emerging, and they've got those plans underway. And I think they've been moving out on some of that. And again, it's a longer cycle. And so those things have been holding up very well for us, but it's not really regionally based at this point. It's kind of across the board.

[Reuben Garner, Benchmark Company]

Okay. And then switching gears to the residential business. So any color you can give us on the breakdown between the growth you're seeing in new construction versus repair and remodel? Is repair and remodel still growing? And then can you break down price versus volume for us?

[Marshall Bridges, SVP and CFO]

Yes. Sure, Reuben. So what we saw in the quarter is that remodel retrofit sales grew faster than new construction. On an order basis, it was the opposite. There's some noise in there from some of our programs to encourage people to order earlier in the year for their fall demand.

But what we're seeing right now is the remodel retrofit is stronger than new construction, no surprise given what's happened in the market. So what we're expecting for the full year in Residential Building Products is growth in the high teens. That includes about 7 percentage points from acquisitions. So organic growth would be in the low teens, which includes about 10% price realization. So non-price organic growth for the year would be in the low single digits.

[Reuben Garner, Benchmark Company]

Perfect. And sorry about that. I guess I misread or misinterpreted the release. I was thinking new construction. I guess I just read the orders comment. So going forward, do you feel that the strength in repair and remodel is going to hold? I mean there's been some clear slowdowns in DIY. I think the fireplace industry is more contractor-driven, and there's probably an element of backlog. How do you guys feel about that portion of the business going forward?

[Marshall Bridges, SVP and CFO]

I think we're expecting both sides of the business to slow down. We have a pretty large backlog, particularly in the remodel retrofit that's going to soften that a bit. So I mean, we're expecting new construction to be softer than remodel retrofit in the back half. That said, Reuben, if you exclude price, we're still expecting low single-digit sort of unit growth for the segment in the back half. So this is not a -- where it's going to fall off rapidly. It's more of a gradual easing.

[Operator]

Your next question comes from the line of Greg Burns with Sidoti.

[Gregory Burns, Sidoti]

Could you just talk about the strategy behind the vertical integration, the acquisition of these installing distributors, how does that benefit you? And what are your plans going forward in terms of growing that part of the business?

[Jeffrey Lorenger, Chairman, President and CEO]

Yes, Greg, it's a great question. I mean we've -- we set out a couple of years ago to really get closer to our customers, first of all. What's important to homeowners, what in -- whether it be R&R, what's important to homebuyers in new construction. And so part of that effort is digital, part of it is go-to-market, part of it is market research. But the other part is service. And so we had this network, and we decided we could -- we can leverage that network even more as we get more insights about the consumers and homeowners and homebuyers and we can control the service model more directly -- we -- it's a great combination. It's a strong business anyway on its face, just in the typical B2B installing distributor model. But that's really what it's about.

It's about leveraging, now the insights we're getting to get closer to the customer and provide better service levels to the customer. And so that's -- it's a profitable business, and now we're going to add that piece to it. Service capability is really what it's about.

[Gregory Burns, Sidoti]

Okay. Is there any potential conflicts with other distributors as you kind of move into markets?

[Jeffrey Lorenger, Chairman, President and CEO]

Typically, no. We've -- we're careful about that, and we're collaborative about that. And in some of these cases, we've become a succession plan to an owner that doesn't have another plan who wants to get out of the business and retire. And so it takes all forms, but we are -- we've got great independent dealers, the strongest network in the marketplace, and we love that model as well. And so it's really complementary, and we're very collaborative when we do this. That's all the last six we've done last few years have been that way.

[Gregory Burns, Sidoti]

Okay. And you mentioned a couple of times you're preparing for a slowdown. What does that mean? Are you just putting plans in place in case you see things get worse, is there an actual -- is there anything being implemented currently? Or is it something that you're just planning for?

[Jeffrey Lorenger, Chairman, President and CEO]

Yes. Look, Greg, I think it's just we're being prudent. We're -- we always have kind of been that way. We will -- we'll have plans on the shelf, and we'll also take some altitude out of the system a bit, just to keep some dry powder. When the pandemic hit, for instance, we took a bunch of cost out. When inflation hit, you can see we took pricing actions. I mean, we couldn't take it fast enough, but now they’ve flipped around, we built the facility in Mexico. So we just -- we have a history of being able to move fairly quickly and being pretty agile on that front. And so that's what I mean when I say preparing.

[Gregory Burns, Sidoti]

Okay. Great. And then just lastly, I mean, it sounds like you don't feel like the Building Products business is going to fall off a cliff here. It sounds like you're expecting more of a moderate slowdown. Do you -- given what you're seeing in the market in terms of housing, is there a potential for contraction? I know the comps are going to get -- you've had a couple of strong quarters behind you and now I assume the -- just so we're seeing macroeconomically, it seems like there's a slowdown in general slowdown in housing. I don't see how -- that doesn't necessarily impact that side of the business more strongly. I just wanted to get a feel for your view on that.

[Marshall Bridges, SVP and CFO]

No, we would agree with you, Greg, I think it's just a question of timing. The backlog and the stuff in motion as we sit right now, we believe, gives us visibility to what we described as low single-digit growth in the third and fourth quarter. I think the fourth quarter remains a little bit unknown to us. But like I said, we do have some big backlogs there. But eventually, that's going to flow through to us.

[Jeffrey Lorenger, Chairman, President and CEO]

Yes, probably we think that would probably hit more in '23, if anything, Greg.

[Operator]

Your next question comes from the line of Rex Henderson with Water Tower Research.

[Rex Henderson, Water Tower Research]

Sorry, I'm filling in for Budd. And I haven't done this for a while. Bud had a conflict and couldn't be here today. I just -- first of all, I wanted to give you some props and some congratulations on doing a really good job in navigating through some really confusing times over the last couple of years. I did have -- wanted to focus on the RBP segment a little bit and the vertical, the 27 locations that you have now. Can you give me a little bit of color on how much of your RBP business now flows through those 27 locations? And what kind of advantages you get in terms of margins or sales growth through those -- relative to the rest of that business?

[Jeffrey Lorenger, Chairman, President and CEO]

Yes, Rex, it's -- as I said in the prepared remarks, it's about 25% of the overall business segment revenue that segment flows through our low owned distributors. As I said earlier, I think one of the big benefits of that, I'll elaborate a little further on the earlier question was, as we also can control the marketing content at a local level, as we get closer to the customers, we kind of use it as an incubator. So we own that group. We test and learn on marketing connectivity to the customer base, run it through that group and then we take it to our independents.

So it really -- it provides a really nice mechanism with which, like I said, to improve service, try things out to resonate with customers, put them in the system and get them implemented quickly and then we prove them out, and then we can give them to the rest of the network on the independent side. That's a big benefit of that as well.

[Rex Henderson, Water Tower Research]

Okay. Do you have any vision for how big that segment can -- that vertical can be? And whether you're going to continue to grow it through either greenfield or continued acquisitions? Do you have any end goal for what that segment can be?

[Jeffrey Lorenger, Chairman, President and CEO]

Well, Rex, not really an end goal. Like I said earlier, it's kind of a case-by-case, market-by-market situation. Sometimes it's -- a distributor calls us. Sometimes we call them. And so basically, what we do know is we know how to run that business and it gives us a lot of built-in advantages with customers and in the service model. And so we're always kind of opportunistically looking for options to build the network out. But I don't really have a point in time or an end game necessarily.

[Rex Henderson, Water Tower Research]

Okay. And in preparation for potential slowdown later this year, early next year, you said you're putting some plans on the shelf. A year or so or late last year, you said you had a lot of open positions. Is that still the case? Are you still holding a lot of positions open? Or is your hiring slowed down? What's happening on the labor force right now and your expectations for that?

[Jeffrey Lorenger, Chairman, President and CEO]

Yes. I think we're pretty stable, Rex, on the labor force right now on direct labor side. We've been able to kind of catch up a bit. And we also -- Mexico has come online, and it continues to ramp, and it will be fully ramped here by the fourth quarter. And so that's taken pressure off as we had planned. So basically, we're kind of where we need to be on a labor front standpoint.

[Rex Henderson, Water Tower Research]

So you really don't have a lot of open positions that you're looking to fill at this point anymore. You feel like you've got all the jobs you need to have filled are filled, pretty much?

[Jeffrey Lorenger, Chairman, President and CEO]

Yes. I mean, look, there's always some stuff here and there, some engineers and some things that we're always in the market for. But we're not -- it's more back to normal times, not craziness.

[Rex Henderson, Water Tower Research]

Okay. Very good. And finally, one of the things -- one of the comments Budd made was that in the RBP segment, a lot of the builder side goes to spec homes, building on spec. Is that still the case? Or are you getting orders from new homebuyers? And what's happening there and the differences between spec and new home buyers?

[Marshall Bridges, SVP and CFO]

Rex, we are very strong with the national builders, and we follow their mix. So I wouldn't necessarily say that we're over indexed on spec homes. We're just going to look a lot like the larger builders. And recall, we're coming off really low inventory levels. So I'm not sure that there's a lot of speculative buildings out there, but that's probably a question to ask them rather than us.

[Operator]

Your next question comes from the line of Steven Ramsey with Thompson Research Group.

[Steven Ramsey, Thompson Research Group]

A couple of questions on price costs. Maybe can you walk through the trajectory of price cost through the first half? How that plays out, you think in the second half? And why you think that's going to be better now than what you had previously thought?

[Marshall Bridges, SVP and CFO]

Yes. Yes. So price cost in the first quarter was about $2 million favorable. In the second quarter, it was about $8 million favorable. In the third quarter and the fourth quarter, we're expecting to be $25 million to $30 million favorable during each quarter. And the reason for that is twofold. One is we are going to get more price realization sequentially, so it's been ramping up. Just as an example, Steven, we recognized about $62 million in incremental price versus the prior year in the first quarter. That went to $70 million in the second quarter, and it's going to go higher in the back half. In inflation, we're going to start anniversarying the period last year where inflation had ramped up.

So the incremental inflation versus last year is not as great. So the combination of more price realization and less incremental inflation gets us a much more favorable price cost. When you look at the year, we're now expecting price cost to be favorable in the $60 million to $70 million range. And that puts us basically at a place where we recover what we've lost last year. So if you look over the last two years, we're roughly neutral on price cost.

[Steven Ramsey, Thompson Research Group]

Okay. Very helpful, very helpful. And then thinking about the residential segment and how you think about maintaining profitability if or when things slow kind of combined with the investments you're making to take advantage of the long-term opportunity? How do you think about keeping the pedal down on investments for long-term gains? And I guess maybe what I'm getting at, would you allow margins in that segment to go to mid-teens for a time on lower volumes to keep the investments down for long-term growth?

[Marshall Bridges, SVP and CFO]

Steven, that business is highly profitable. And certainly, as volumes decline, it's going to put some pressure on it. We are in that business for the long term. We are very interested in growing that category. We're going to keep investing. We may decelerate the investments a bit. And as an example, this year, even though we do see a slowdown coming, we're continuing to invest in that business. In the back half, we're expecting to invest $7 million to $9 million for the corporation, and roughly half of that is going into Residential Building Products.

[Jeffrey Lorenger, Chairman, President and CEO]

Yes, Steven, I think it's a great question. I think, look, we talk about that. But again, as you said, we want to grow that category. We want to grow the revenue there. So we'll be smart about it, but we've been investing through the whole pandemic in that business the last two years quite -- at a quite nice cliff, and we don't -- we will continue to do so. We need to maintain some profitability. But we can take some short term here and there in order to continue to kind of lean into that business.

[Steven Ramsey, Thompson Research Group]

Right. Makes sense. Okay. And then last quick one for me. On the e-commerce restructuring in Workplace. Can you share more on the actions you're taking? And maybe is this something that benefits the second half earnings? Or is this something that is more helpful to 2023?

[Marshall Bridges, SVP and CFO]

Yes, Steven, what we did there is we exited some low-profit product categories in that e-commerce business. So yes, I think there is some benefit to the P&L, but we're kind of in a -- kind of chaotic or a volatile situation right now, so it's not a large benefit. It is putting a pretty big headwind on our sales growth. But again, it's not much of a profit impact. I think it's got more benefit next year.

[Jeffrey Lorenger, Chairman, President and CEO]

I agree. More benefit next year.

[Operator]

There are no further questions at this time. Jeff Lorenger, I turn the call back over to you.

[Jeffrey Lorenger, Chairman, President and CEO]

Thank you. And thanks to everybody today for joining us and your interest in HNI Corporation. Have a great day.

[Operator]

This concludes today's conference call. Thank you for attending. You may now disconnect.