HNI Corporation

Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the HNI Corporation fourth quarter fiscal 2022 results conference call. 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. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. Mr. McCall, you may begin your conference.

Good morning. My name is Matt McCall. I'm Vice President, Investor Relations and Corporate Development for H&I Corporation. Thank you for joining us to discuss our fourth quarter fiscal 2022 results. With me today are Jeff Loringer, 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 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'm now pleased to turn the call over to Jeff Loringer.

Jeff? Thanks, Matt. Good morning, and thank you for joining us. On the call today, I will highlight four key topics. First, we delivered strong earnings growth in the quarter despite a soft macro environment. Second, our workplace furnishings margin expansion initiatives are delivering results. Third, we are prepared for 2023. And fourth, we are positioned for strong growth beyond 2023. Following those comments, Marshall will review our outlook. I will then conclude with some general closing commentary. We will then open the call to your questions. Moving to the first topic, we delivered strong earnings growth in the quarter, even though we experienced a softer demand environment. We generated solid year-over-year margin expansion and 47% year-over-year non-GAAP earnings growth in the fourth quarter. This was despite volume pressures associated with macroeconomic concerns. Consolidated gross and operating margins expanded on a year-over-year basis, led by favorable price costs, which continued to improve in the quarter. And for the full year, we fully recovered the price-cost shortfall driven by the rapidly rising inflationary pressures we experienced in 2021. Fourth quarter profits improved in both segments. Residential building products operating margin expanded 170 basis points year over year, reaching nearly 20%. Our fourth quarter results demonstrate the strength of our differentiated business model in residential building products. workplace furnishings fourth quarter non-gap operating profit more than doubled despite lower sales the year over year top line decline was driven by divestitures and restructuring activities implemented earlier in 2022 excluding these actions fourth quarter year-over-year segment revenue growth was just over four percent although these streamlining efforts negatively impacted our top line They contributed to our margin expansion, reflecting our commitment to improving profitability in workplace furnishings. That leads to the second topic. Our initiatives to expand workplace furnishings margins are delivering results. Non-GAAP operating margin expanded 150 basis points year-over-year in the fourth quarter and in the second half of 2022. Favorable price cost and benefits from our cost reduction and simplification efforts drove the improvement. As we have discussed on prior calls, we are driving multiple initiatives to expand margins in workplace furnishings. These efforts are in three broad categories. First, we are simplifying our business to focus on our most attractive markets. Actions taken in 2022, including the sale of Lamex, the e-commerce business restructuring, and the discontinuation of a small workplace brand, reflect our efforts to drive profit improvement through simplification and focus. Second, we are lowering our cost structure. We announced the $30 million cost reduction plan last quarter. That plan is well underway and we are now on track to reduce costs $30 to $35 million in 2023. Approximately $25 million of that total will impact workplace furnishings this year. Third, we are driving productivity and we'll see future benefit from ongoing operational investments. Our fourth quarter productivity improved versus the prior year as we continue to benefit from our lean actions in improving supply chain health. We expect our productivity momentum to continue and positively impact 2023. Regarding investments, our largest operational investment is our new facility in Mexico. In 2021, we started up a new seating plant in Saltillo, Mexico. We plan to expand that operation and shift to a larger building during 2023. Although these actions have negatively impacted our short-term results, they will drive margin expansion as they mature. The third topic is we are prepared for some headwinds in 2023. In workplace furnishings, we expect to drive profit improvement notwithstanding anticipated top-line pressures. Our margin expansion initiatives focused on simplification, cost, and productivity will continue to gain traction this year. We expect those efforts when combined with favorable price costs, will more than offset lower volume driven by macroeconomic concerns and inconsistent office reentry patterns. In residential building products, we are prepared for a slowing near-term demand environment. Cost actions and favorable price costs will partially offset buying pressures while we continue to position for growth beyond 2023. Overall, our cost structure is improved, our balance sheet is strong, and we expect a strong free cash flow year despite an overall weaker demand environment in 2023. That brings me to my fourth topic for today. We anticipate in our position for strong growth beyond 2023. In workplace furnishings, our research indicates the market will recover and demand patterns will change in a way that aligns with our market positions. Specifically, population migration patterns towards secondary and tertiary geographies positive employment and demand trends with small to mid-sized offices, and feedback from large corporate customers regarding return to office plans and adoption of hybrid work models all align with our strong market coverage and product and price point breadth and depth and point to the return of sustained volume growth post-2023. In residential building products, we are continuing to invest in our growth initiatives in the areas of category awareness, new product innovation, online capabilities, and the expansion of our wholly owned installing distributor footprint. Overall, the housing market has strong fundamentals. It is undersupplied, and demographic trends support future demand growth. Additionally, an aging housing stock will drive remodeling activity. The average home is now 40 years old, supporting robust renovation growth. Given the market's strong fundamentals, our unique growth opportunities, and our category-leading positions, We are bullish about our growth in this high margin, high return business beyond 2023. I will now turn the call over to Marshall to discuss our initial outlook for 2023. Marshall.

Thanks, Jeff. Let's start with seasonality. This is important because we are expecting 2023 seasonality to be different than what occurred in 2022. And that difference will distort quarterly year-over-year comparisons of sales and profits. Specifically, we expect sales and earnings seasonality in 2023 to be more in line with pre-pandemic trends. That follows three years of abnormal seasonality. 2022 seasonality was particularly unusual in that quarterly revenue peaked in the second quarter and first half revenue exceeded second half revenue. That unusual pattern was primarily driven by backlog dynamics that positively impacted the first half, and deteriorating workplace furnishings demand that negatively impacted the second half of 2022. As a result, our first half comparisons will be more challenging on a year-over-year basis and our second half comps less so. Due to the change in seasonality, we expect more than 85% of our annual profit will be generated in the second half of 2023. That compares to 60% the second half of 2022. all right let's let's move on to our outlook for the first quarter in workplace furnishings we expect first quarter revenue to decline at a year-over-year rate in the low 20s this decline is the result of last year's unusual seasonality the continued negative impact of broader macroeconomic concerns and the sale of lamex With respect to seasonality, first quarter 2022 benefited from the unwind of backlog built up during 2021. That unwind will not repeat in this year's first quarter and accounts for more than 10 percentage points of our expected year-over-year sales decline. In addition, the sale of LAMEX will lower growth in workplace furnishings by five percentage points or $17 million in the first quarter. First quarter residential building products revenue is expected to decline at a year-over-year rate in the mid to high teens. It is important to note that segment backlog is currently approaching normal levels, which means our revenue after the first quarter should trend more closely with pre-pandemic seasonality and be fully impacted by weakening new construction and remodel retrofit activity. In total, consolidated revenue for H&I overall is expected to decline at a high team's rate in the first quarter. We expect consolidated non-GAAP operating income to be approximately break-even in the first quarter of 2023. Let's move to our outlook for 2023 overall. During 2023, we plan to drive $80 to $85 million of year-over-year profit support through improved price cost, better productivity, and reduce structural cost. These items will partially offset the earnings pressure associated with top-line trends. Importantly, our efforts do not come at the expense of future growth. We will continue to invest throughout 2023. Looking at the segments, we expect the $80 to $85 million of profit support to drive profit growth and workplace furnishings. and offset much of the negative impact from lower volume in residential building projects that's being driven by the weakening housing market. Shifting to the balance sheet, we have a strong financial position which provides flexibility for investment and positions us well for a slowing economy. Gross debt to EBITDA as calculated per our debt covenants was 0.7 at the end of the fourth quarter We have a history of generating strong free cash flow through a variety of economic conditions, and we expect free cash flow in 2023 to benefit from a return to more normal working capital levels. Our low leverage and continued free cash flow generation will provide flexibility for the dynamic environment and continued investment. I'll now turn the call back over to Jeff.

Thanks, Marshall. Before we take your questions, I want to take a moment to mention that in December, H&I was again named one of America's most responsible companies, ranking number six in Newsweek's fourth annual list of America's 500 most responsible companies. These rankings are based on public data that analyzes the top performance across environmental, social, and corporate governance categories. Important components in our H&I members' daily efforts include a commitment to reducing our environmental impact, making a positive social impact, and practicing good corporate governance. Our goal of enhancing where people work, live, and gather shines a light on our decades-long commitment to sustainability and good corporate citizenship, and most importantly, on the commitment and efforts of all H&I members who make a positive difference every day. In closing, we remain focused on our two primary long-term objectives, improving the profitability of our workplace furnishing segment by driving margin expansion, and delivering strong top-line growth in residential building products by leveraging our differentiated business model. We'll now open the call to your questions.

Thank you. At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. And our first question comes from Rex Henderson at Water Tower Research.

Good morning, and congratulations on a really impressive quarter. Terrific margin performance. I did have some questions about, first of all, order trends in the two segments. Coming out of December into January and February, directionally, what are you seeing in those order trends in the two segments?

Okay, Rex. Let me start with workplace. I'll look at it in three buckets. In kind of our mid-market segment, They remain strong. Orders in the Q4 and year-to-date are both up strong double digits. You know, it's consistent with, you know, what's going on in the market, actually. Migration patterns, you know, large cities losing office jobs, smaller cities gaining, employment trends, small, mid-sized businesses adding jobs. So that's what we're seeing in that portion of the market. And then we go to our contract segment. It is stabilizing to improving. Orders are flat year to date. You know, I would say their pre-sale activity is improving as people focus on hybrid environments. I think, you know, we're looking for more of a second half improvement there. And then third, we have our transactional business is still down. Those trends are down double digits. And those are real short cycle, small orders that are really sensitive to macro environment headwinds. Okay.

And Rex, as it relates to residential building products, our orders were down 18% in the fourth quarter. And we saw some pressure in both the new construction as well as remodel retrofit, they were down Similarly, now we do expect new construction to be down more than remodel retrofit during 2023.

Okay, so you've already answered one of my other questions, which is some differentiation between what's happening in new build and retrofit and remodel in the RPP segment. And so new construction is worse than the retrofit business. Is that right?

Yeah, we expect it to be worse. Traditionally, at least historically, the Romano retrofit business is just not as volatile. And we basically track single family construction activity in the new home side. Exactly. So we're seeing some pressure there. Expect it to really be fully impacted in the second quarter and the quarters thereafter.

And then one other question. You know, your gross margin performance here was really quite impressive. I'm wondering if you're beginning to see any competitive pressure or customer pushback on prices as commodity prices come down. Are you seeing anybody pushing back on prices at all?

You know, Rex, that's a good question. We monitor that pretty closely. We haven't seen anything yet, as I think there's some in these spaces, particularly in the workplace side, are still announcing price increases. And, you know, we're kind of in line. We've been in line with what we've seen in the market. So but, you know, we keep an eye out for that. But so far, there hasn't really been I think it was such a shock to the system that I think in general, people were, you know, kind of hitting getting hit with inflation across the board. So it's so far been been been accepted.

Rick, there's still inflationary pressures out there that we have to cover, and we are still recovering our margins. So we're still making progress there, and it seems like the market is behaving pretty similarly.

Okay. Very good.

Thanks. I'll pass on the questions to someone else. Thanks. Thank you.

We'll move next to Bud Bugach at Water Tower Research.

Yeah, good morning, and also thank you for taking my questions. I hope everybody's well there. I just want to follow up on Rex a little bit with, in terms of hearth, are we seeing any change in the product mix? I know you've done a great job on the logistics, but I'm wondering, are we seeing anything in terms of penetration?

in terms of new housing and is product mix like electrical making a change in what are making an impact there yeah hey bud uh good question i mean i think we we are we've been working on that for a bit um and it when it comes to electric for example look we're seeing a lot of um opportunity there we're launching a lot of new products in that category it's expanding the category we've got examples where we've got places in the country where the IR rate was zero, and it jumps to 50% just because of the electric availability on that unit. So it's really an expansion of the category, not a replacement of the category. And then we also are seeing some traction, as we've talked in the past on our insert business, as customers become more aware of their ability to do an insert that's easier than having to blow up a whole remodel and replace maybe an old wood burner with an insert gas that's made for an easy install. We're starting to see a lot more traction there as well. And that's really category expansion because otherwise they weren't going to be looking at a remodel just yet. So it's a way that we can get a unit in there without doing a full remodel.

Jeff, that incident rate jump sounds really fantastic. Is it really moving the needle? Is it of a size yet to make a difference in the overall category, or is it still too small?

It's still in its early innings, but I'd say we're in the bottom of the first. But I think... You know, we're seeing, I believe it's going to be a material contributor to our business going forward. But, you know, we're off a low base right now.

Okay. And do you see much more in the way of M&A activity in that segment, in that business unit, in terms of additional dealers?

Yeah, that's a good question. I think, look, we do have a unique model, and our wholly owned installing distributor network is a, is a really nice asset in this business. And we do see lots of, there's a lot of opportunity out there for that aspect of our business. And we aren't, you know, we operate in tandem with our distribution, our independent, and it's always, you know, we, but there's succession events, there's, you know, geographical expansions. So, We absolutely have that in our quiver, and it's a focus of ours, and I do believe that would be something that you'll see more of down the road.

Okay, great. And last for me, I know commodity inflation, particularly in steel, was unwelcome and had to be covered over the last post-COVID period. Are we seeing some retreat in there? And Marshall said we're still seeing inflationary pressures, but I wonder If he can pinpoint where it is or maybe quantify what we're seeing in that.

Yeah, but so, look, we're seeing inflation in two broad categories. The first one is wages. I would say that the wage inflation has moderated, but we're still seeing year-over-year increases like you do in any given year. And then there's a second bucket where there's kind of a broad set of commodities that are still under some pressure. A lot of that's carried over from the prior year. So we're seeing some inflation from those two buckets. That's being partially offset by lower steel costs. But the net of the three is that we're seeing inflation, you know, roughly speaking, we're expecting input cost inflation to be up in the $15 to $20 million range for the year.

Gotcha. But like the return to seasonality, that's not significantly different than we see almost every year, which we cover with a small price increase once a year annually. Is that a fair way to look at it?

Absolutely. That's very fair.

Okay. Great. Thank you very much. And let me add my congratulations to Rex's March of Performance as well. is impressive. Thank you very much and good luck on 2023. Great.

Thanks, bud.

We'll go next to Ruben Garner at the Benchmark Company.

Thanks. Good morning, guys. Maybe to start, you referenced profit improvement in workplace kind of in the face of the volume headwinds. Can you give any detail on exactly how much volume decline you can withstand with some of these changes or a way to think about decremental margins, kind of X the price cost and savings and productivity initiatives that you have?

Yeah, Ruben, we do expect to see volume improvement, I'm sorry, profit improvement despite the lower volumes. I think maybe the way to answer your question is that we're roughly thinking that workplace volume for the year in terms of total top line would be down on organic basis in the low to mid single digits and that would be you know a big decline in the first half followed by some moderation the second half so under those conditions we have enough profit support to drive our operating profit growth that we mentioned in terms of decremental margins or incremental margins in a workplace on average runs around 35%. And, of course, we have offsets to, you know, help mitigate that. So really the decremental margins for workplace would not really be calculable, right? We're expecting lower volume, lower sales, and higher profit.

Okay. And that low to mid single-digit, decline in workplace. Last quarter, you talked about strength you were seeing in mid-market. That low to mid-single digits seems like a relatively modest decline relative to what the industry orders have been in recent months. Can you update us there? Is mid-market still outperforming, and is that kind of what gives you confidence that maybe you'll do something better than what we've seen of late?

Yeah, there's two things there maybe to point out is, first of all, our orders in the fourth quarter, when you exclude the restructuring of the e-commerce business and divestiture dynamics, were up 3%. So we did see fourth quarter activity that's in line with that expectation. Secondly, just to remind everyone that we saw a pretty significant step down in demand in the back half of 2022. So as we anniversary that step down, it's not that we expect a lot of demand growth from where we are right now, but we'll certainly see lower lower comps are going to be, you know, easier to compare against.

Yeah, and I think, Ruben, you know, as I commented earlier, the mid-market, you know, for lack of a better term, year-to-date is running up strong double digits. You know, presale activity points to continued strength there. And so we just believe, you know, the migration patterns and employment trends align with our strengths. And so that's really... maybe offsetting some of the other areas of the business.

Okay, and then on the housing side, new construction I think is a little bit easier for us to get a handle on or at least kind of guess where the market's going. Can you give us any color on the R&R side of your business, how you expect that to hold in any kind of other puts and takes, whether it be share gain opportunities or any other drivers outside of the market specific to your fireplace business.

I think Jeff mentioned a couple of the strategic growth initiatives that probably hit a little more on the R&R side than they do on the new construction side. As I mentioned earlier, Ruben, the R&R side is historically less volatile, so we're expecting New construction declined, like I said, in line with single-family housing activity, and the existing home or remodel retrofit side of the business be down less. Expecting a little pressure in both sides, that's for sure, though.

Thanks. Good luck, guys. Thank you.

We'll move next to Stephen Ramsey at Thompson Research Group.

Hi, good morning, and sorry if I'm repeating myself, getting on a little bit late here, but I'm curious how much of your inventory currently is still carrying higher costs from inflation and how that works its way through the P&L early in 2023 to benefit margins, and maybe as a follow-on to that, how do you think about cash generation this year and is networking capital a tailwind there?

Stephen, the quick answer to your inventory question is that, you know, our inventory was essentially flat on a year-over-year basis. So we've normalized a lot of inventory that we brought in during 2022. So it's not going to have a material impact on our margins. The second part of your question about working capital, that's a continued focus for us. We have used working capital for the last two years as we dealt with all the supply chain issues. We brought in some inventory to buffer against that. We are working inventory efficiency as well as overall working capital efficiency. As I touched on in our prepared comments, we expect to have more normalized working capital levels during 2023, and that should be a source of cash for us this year.

Great. And then thinking about cash generation for this year as well as a low leverage level. Can you talk about cash deployment, the willingness to do acquisitions on the resi side of things in an uncertain period if people are willing to deal and how you think about share buybacks in the slower time period? Thanks.

Yes, Stephen. As I said just a bit ago, I think on the resi side, we are always kind of looking at the marketplace and trying to decide what opportunities are out there. And, you know, we've shown an ability and an appetite to do that in the past, and that will continue, you know, as we see, you know, attractive opportunities on the resi side for sure.

In terms of our priorities, Stephen, look, we expect to deploy capital. You know, historically our primary objective is to invest in the business. We also look to maintain and modestly grow our dividend, and then we pursue M&A insurer purchase case-by-case basis depending on conditions and opportunities, and we should continue to do that.

Great. Thanks for the color. And we'll go next to Greg Burns at Sedoti.

Good morning. Marshall, you had mentioned the backlog normalizing on the building product side of the business and that will kind of get the business more back to a a normal cadence could you just talk about what what historically the typical seasonality that that business is and you know i guess maybe what you're what you're um expecting in terms of like the current demand trends there yeah so historically uh residential building products

sort of hits a trough in the second quarter and then builds in the back half, and then starts to decline again, and then again bottoms out in the second quarter. So that did not happen last year. Last year, if you look at our quarterly revenue, we were pretty consistent from quarter to quarter, and that's because the backlog buffered the seasonality. You know, we had more demand than we really had capacity, and so we pretty much had the same revenue, plus or minus a few percent each quarter. So this year, In the first quarter, we're basically normalizing the backlog. So as we enter the second quarter, we're going to start to experience that typical seasonal dip as well as start to begin to feel the impact of the housing market declines. Okay.

And then you did talk about the improved profitability you expect on the workplace furnishing side of the business. But in total, I guess with the 80 to 85 million of savings you're projecting, do you expect to grow earnings next year?

In workplace furnishings, we do expect to expand margin and grow profit dollars in the segment.

I mean, on a consolidated basis. Like, are you going to be able to offset the declines in volume on the building product side of the business and generate consolidated earnings growth next year?

Our expectation right now is that there's a pretty significant decline in residential building products, which is going to, even though we're going to offset a good chunk of it with our actions, that the net impact of that is going to be more than the profit growth and workplace furnishings. So consolidated earnings, we expect to be down, just maybe not nearly as down as you might think, given the amount of volume that's being declining.

Got it. Okay, that's helpful. Thank you.

And that does conclude our question and answer session at this time. I would like to turn the conference back over to Mr. Loringer for closing remarks.

All right. Well, thanks, everybody, for joining us today. Have a great day, and we'll talk to you next time.

And this concludes today's conference call. Thank you for your participation. You may now disconnect.