HNI Corporation

Thank you for standing by. My name is Christina, and I will be your conference operator today. At this time, I would like to welcome everyone to the H&I Corporation second quarter 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 again, please press star one. Thank you. 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 second quarter fiscal 2024 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. 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 Loringer. Jeff?

Good morning, and thank you for joining us. Our members once again demonstrated the organization's ability to deliver strong profit growth in the second quarter. Non-GAAP EPS of 79 cents exceeded our internal expectations and was 44% higher than the prior year period. It was also a record result for the second quarter. In workplace furnishings, the combination of our profit transformation initiatives and the benefits from the Kimball International acquisition continue to deliver strong earnings growth with segment non-GAAP operating profit growing 67% year over year. In residential building products, we drove profit growth and margin expansion despite ongoing housing market challenges. Non-GAAP operating profit increased 17% year over year, demonstrating the strength of our business model. Overall, our strategies, our dedicated member owners, our customer-first mindset, and our proven ability to manage through all parts of the economic cycle helped us drive excellent results in the first half of 2024. Looking forward, we are increasingly optimistic about the future and the opportunities that we see in both segments of the business. On the call today, I will highlight five key points that underscore our positive outlook. First, workplace furnishings operating margin reached a multi-decade high for the second quarter. reflecting our continued commitment to improving the profitability in this segment. Second, our combination with Kimball International is generating strong results. Third, our residential building product segment posted profit growth and margin expansion despite ongoing housing-related softness. Fourth, we expect revenue growth in both segments in the second half of the year. And fifth, beyond 2024, we have elevated earnings growth visibility. Following those highlights, Marshall will review our outlook. I will conclude with some general closing comments before we open the call to your questions. Moving to the first point, workplace furnishings operating margin reached a multi-decade high for the second quarter. Workplace furnishings non-GAAP operating margin expanded 370 basis points year over year to 11.9%, a second quarter level last seen in the late 1990s. This was also the ninth straight quarter of year-over-year operating margin improvement in the segment. The 370 basis points of margin expansion was on top of last year's strong result. Over the last two years, operating profit margin in workplace is up nearly nine percentage points. This year's second quarter margin improvement was primarily driven by strong productivity gains. Driving productivity is a key part of our workplace furnishings profit transformation plan. Our operations continue to become more efficient across the board, including significant gains in labor and material efficiency. And there's more to come as we have line of sight to additional margin expansion in the back half of 2024 and beyond. Recall, our profit transformation plan does not require demand improvement, and our recent margin expansion has been achieved without cyclical top line support. However, as I will discuss later, We believe the market is slowly improving and will add to our future profit growth. Moving to my second point, our combination with Kimball International is generating strong results. KII continues to be highly accretive and was a major contributor to our record second quarter profit. KII added an estimated $0.15 to our non-GAAP EPS in the second quarter, while generating an operating margin of 13.3%. And revenue and accretion surpassed the expectations we shared with you last quarter. Kimball International is providing us with new growth opportunities and strengthening our market positions. We remain very encouraged by the complimentary nature and attractive post-pandemic positioning of KII's workplace offering. Additionally, KII's healthcare and hospitality businesses are well positioned within attractive, expanding segments and both generating growth. As we announced in May, we now have line of sight to $50 million of cost synergies from the combination. I will talk more about this later, but those synergies will continue to fuel profit growth and margin expansion over the next couple of years and, again, do not require demand growth. Our confidence in the combination's strategic and financial benefits continues to prove out and accelerate. Moving to my third point, residential building products posted profit growth and margin expansion despite ongoing housing-related weakness. Our actions to drive productivity and lower cost expanded operating margin to 13.8%. This was up 260 basis points year over year, despite overall housing market pressures. Looking forward, we remain bullish about the intermediate to long-term dynamics for this business, and we expect revenue growth to return in the second half of 2024. That leads me to my fourth topic, We expect revenue growth in both segments in the second half. I will start with some comments on expected back half workplace furnishings demand. Then I will follow those with some detail on second half residential building products revenue. We continue to see signs the workplace furnishings market is slowly improving. Pre-order activities remain elevated, but the translation to orders is continuing to take longer. For the second half of 2024, we expect workplace furnishings revenue to increase at a low single-digit rate year-over-year. That outlook is based on the supportive data points in SMB and KII and with contract. Our SME business continues to generate growth. SMB orders grew 2% year-over-year in the second quarter, on top of a 4% increase in the same period of 2023. This segment of our business continues to benefit from healthy dynamics, including population shifts to secondary and tertiary geographies, and relatively higher office usage in those markets. Kimbell International continues to perform well. KII orders grew over 3% year-over-year in the second quarter. As I mentioned earlier, the combination with KII has strengthened our workplace furnishings business and given us access to new growth opportunities. with strong market fundamentals, including healthcare and hospitality. Additionally, KII's product portfolio is well positioned to support the hybrid work environment. As companies reconfigure their spaces to better support hybrid, KII will benefit. In our contract business, we see growth on the horizon. Our pre-order metrics remained elevated, an indication of future growth. Our year-to-date quoting activity, contract sales funnel, and visits during design days to our Experience Center in Chicago, all are up double digits year over year. Looking out, we believe we are particularly well positioned to benefit as the workplace furnishings market continues to improve. We have unmasked products and pricing breadth and depth. We have products that work for customers, ranging from small businesses to the largest multinationals. Our brands are distributed widely across geographies, from tertiary markets to the top MSAs. and we can address the needs of all workplaces, schools, healthcare facilities, and hotels. We have adapted our product offering in anticipation of the new ways people are working and will work. Today, most knowledge worker tasks are supported by six activities, focus, mentorship, innovation, collaboration, socialization, and learning. And each of these tasks calls for unique furnishing applications. At design days in June, we introduced the intentional office, a philosophical approach to addressing the needs of today's office by designing environments that support each of these six activities. This approach to the market, our coverage of the market, and our unwavering focus on the customer have us well positioned to benefit from an improving demand environment. Let's shift to second half residential building products demand. Overall, demand remains choppy, but the trends are improving. For the second half, we expect residential building products revenue to grow at a mid single digit pace versus prior year period. This outlook is consistent with our improving order trends. When excluding changes we implemented to our early order program, normalized second quarter orders grew 4% year over year. This is the first quarter of order growth since mid 2022 when the housing correction started. Looking forward, we expect demand to improve from here. Supply-demand fundamentals for the housing market remain strong. Although recent housing inventories have ticked up, single-family housing remains massively undersupplied, while demographics support additional demand growth. In addition to the improving market dynamics, we continue to invest in unique growth opportunities. These include new product innovations such as electric fireplaces, efforts to better connect with builders, homeowners, and homebuyers, online capabilities, and the expansion of our wholly owned installing distributor footprint. Summarizing my fourth point, we are expecting top line improvement in the second half in both workplace furnishings and residential building products. That, along with continued margin expansion in both segments, will drive record EPS in 2024. Moving to my fifth and final point, we have elevated profit growth visibility through 2026. We expect KII synergies to total $50 million. This is double the estimate we provided when the acquisition closed. Additionally, the ramp-up of our facility in Mexico is expected to contribute an incremental $20 to $25 million to the bottom line. Both initiatives are currently underway and provide strong visibility to future earnings growth. Of the $70 to $75 million in total benefit, an estimated $45 to $50 million will positively impact the 2025 to 2026 period. This is equal to approximately 70 cents of EPS, or more than 20% growth from the current year consensus estimate. As we have communicated for several quarters, we can continue to grow profit without volume growth due to initiatives like these. Volume growth will only enhance our profitability. I will now turn the call over to Marshall to discuss our outlook for 2024. Thanks, Jeff.

I'll start by quickly summarizing the outlook for demand and profit that Jeff just covered, beginning with demand. Second half revenue in workplace furnishings is expected to increase at a low single digit rate year over year. I'll note that our new outlook represents a reduction from what we provided in our April earnings release. That release implied workplace furnishings would grow at a mid single digit rate in the second half. The change primarily reflects timing in the contract space, As Jeff mentioned, we continue to see elevated pre-order metrics and a healthy sales funnel, both of which point to future growth. However, our contract business has a heavy mix of projects. The timing of when those projects ship and install can cause variation in our growth rates. This type of variation is not new. We've seen timing impact the contract business in the past, and the BIFMA order trends have been volatile this year as well. Moving to residential building products, we expect second half revenue to grow at a mid-single digit pace versus the same period in 2023. I'd also like to note that year-over-year trends in both segments are expected to improve from the third quarter to the fourth, which means that most of the growth that we are expecting in the second half is going to be in the fourth quarter. Shifting to our profit outlook, We expect margin expansion in both workplace furnishings and residential building products to drive continued earnings growth in the second half. Our expectations for 2024 profit have increased compared to the outlook we provided in April. Specifically, we expect that our outperformance in the second quarter will more than offset the impact from lower second half top line growth in workplace furnishings. I'll wrap up with a few comments on our balance sheets. We maintained our strong financial position. Gross leverage at the end of the quarter was 1.5 times as calculated in accordance with our debt agreements. That ratio is down from 1.9 times in the first quarter due to higher profit and modestly lower debt. In addition, during the quarter, we accelerated our share buyback activity with more than $10 million of repurchases. The combination of our strong balance sheet and consistent cash flow generation provides a high degree of financial flexibility and capacity for capital deployment. Our current priorities for cash deployment remain reinvesting in the business, funding dividends, pursuing buybacks, and M&A opportunities. I'll now turn the call back over to Jeff.

Thanks, Marshall. We remain committed to expanding margins in workplace furnishings and driving long-term revenue growth in residential building products. We had an excellent start to 2024, delivering record first-half earnings, and we anticipate record EPS for the full year 2024. Beyond this year, we are positioned for continued success. In summary, we have elevated earnings growth visibility, broad and diverse product and market coverage in workplace furnishings, a market-leading position in residential building products, and a strong balance sheet and the ability to drive continued free cash flow. I want to thank all of our H&I members for their continued hard work and dedication to deliver these results. We will now open the call to your questions.

Thank you. At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. And we'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Bud Bugach. from Water Tower Research. Your line is open.

Jeff, Marshall, Matt, congratulations to you and your team on the strong performance in the quarter and on the guidance as well. I would like, I think, to go right to talk a little bit about revenues. I think that's the major change that you're expecting from what you've been doing. Talk a little bit more in color of what you're seeing in each of the segments, if you will. I say you talked a little bit about a longer cycle in contract and what's driving that and the relationship to the overall economy, which if you look at some of the other reports this morning may be showing a little bit of a kind of a weakness and certainly some of the hard areas like cars and automobiles.

Yeah, but that's – you know, look, we see a lot of activity. You talk about the cycle, and we've been through this before. You've been around. You've seen this. And it does feel like customers are active. I mean, look, we've been kind of – the space itself has been kind of bouncing on the bottom for a bit here. So, you know, I think what we see is people – interested in getting, you know, reconfiguring, looking at their office space, trying to figure out what they're going to do. And what I would say is strategically, a lot of people are starting to figure out that they have a, you know, they have a position, a strategic position on what it needs to look like in the post-pandemic work model. But a lot of companies just haven't yet reconfigured their offices to support for instance, their particular hybrid model. But we do believe we see reality has sunk in, and a lot of companies are saying, yeah, we've now studied this long enough, and we need to move out on this. And so even though it's elongating, there's still a little bit of hand-wringing about exactly how to execute. There's a lot of interest in doing so, and that's what we're That's what we're seeing. That's what we're feeling. That's what our customers are saying.

Well, we've heard the phrase top of the funnel in a couple of different calls. And has the top of the funnel translated so far into request for proposals or RFQs? And are we seeing competitive bid situations that are increased?

Yeah, but let me just maybe take a step back. So we're expecting workplace furnishings to be up low single digits in the back half. You know, and that's really led by the SMB business and KII. Those are performing above average, and then the contract business is performing below that number. So your question is sort of aimed at the contract business. I would say that the contract business, as Jeff mentioned in his prepared comments, the pre-order metrics are very healthy. We're seeing double-digit increases in the funnel. We're seeing double-digit increases in quoting. Our design days visits were very strong. So all indications that, you know, as Jeff said, that people are looking to reconfigure their office and make some moves. However, it is being elongated, as you said, and we think that revenue is pushed out subsequent quarters. So I think what we're seeing here is that the shorter cycle businesses continue to do a little better than the longer cycle business, but we're encouraged by all of it.

That's really very helpful, Marshall. Thank you. And in RVP, you're talking about, again, some growth there. And that's been a segment that's been under some pressure with higher mortgage rates and lower housing activity more recently. What are you seeing that's giving you the comfort there? Your business is strong. You've got a large market share in the hearth side. So is it really from the market share perspective or some of the initiatives you've had? I think Jeff mentioned online and and electric furnaces? Are they really what's driving the better expectations?

Yeah. If you look at what happened in the second quarter from the order perspective in residential building products, we showed 4% growth in orders on a normalized basis. And what really drove that was the amount of retrofits side of things. New construction was roughly flat. So the turn of Remodel retrofit is very encouraging to us. That's something that's been soft for well over a year, really going back to 2022. Now, that's a pretty seasonally low order period for remodel retrofit, but we did see growth on a low base. As we look forward, we think we're going to see growth in both new construction and remodel retrofit and be up in that mid-single-digit rate in the back half.

And that's pretty exciting because, as you say, one of the one of the issues and pushbacks that you and I, you and I have discussed over the last number of years is the issue of incidents in in new housing for fireplaces. And and I know that there's a psychographic want of fireplaces, but some of the numbers haven't shown that. Are we seeing any improvement in incidents in in single family housing from a standpoint of fireplaces as part of the new new new homes?

It's hard to measure that, but what I would say is that our new construction business being flat, you know, it's maybe a little bit disconnected from what we've seen in new construction of single-family homes, and I think that reflects the affordability pressures, the mix of housing pressures that we see.

Yeah, I think we've got a combination right now, but it's not, it's kind of, It's flattened out a bit on the incident rate. We've got a combination of affordability, spec homes, and construction lags that are kind of all meeting up at the same time period. We think that'll start to unlock. And as you say, we've got a lot of investments pointed at this space as well relative to educate homebuyers and homebuilders, remodelers. The electric units are taking off a bit. And so... You know, as interest rates, we see some relief there. We believe we'll be able to, you know, peer up the growth again. And like Marshall said, the turn and remodel is very encouraging. That's the first. You know, in both our businesses, Bud, you know, we've kind of been riding a little bit, you know, on the lower side. And so, as you said in the prepared remarks, I mean, you know, we we believe we can continue to expand our margins without growth. And now that we're starting to see some signs of growth, that really – that's just add to, you know, what we've got going.

No doubt. I mean, the performance of the company and the performance of your team has been superb and remarkable, and you're all to be congratulated on that. And I look forward to seeing the results as they come forward for the balance of this year and into the upcoming years. Thank you.

Great. Thanks, bud.

Your next question comes from the line of Greg Burns from Sidoti & Company. Your line is open.

Morning. When we look at the profit visibility and some of the numbers you gave around cost savings, the 45 to 50 that you're projecting for 2025 and 26, is that incremental? Because I think some of the KII synergies I'm assuming have been I just want to understand the buckets and if that's all incremental or have you already realized the piece of that and the total is going to be that over the course of the next two years?

You know, the $45 to $50 million is all incremental compared to – $45 to $50 million is all incremental relative to 2024. So, Greg, you're right in that some of the benefits from those initiatives have been realized. Those two initiatives in total are about $70 to $75 million of benefit. So we've got a little bit of that already realized, about $25 million of it.

Okay. And I guess that doesn't include your just ongoing annual maybe efficiency or cost initiatives. Do you have a number around that, like how much that could be on an annual basis?

You're right. Certainly a lot of organizational resources are focused on delivering that 45 to 50 million incremental, but we will still be driving daily, weekly, you know, annual productivity gains. Just to give you some color, we don't necessarily have a forward-looking guidance on that, but if you look back historically in, you know, a couple of years before the pandemic, we were averaging 10, $11 million of annual productivity gains. So I'd expect that we'd be able to deliver something in that neighborhood.

Okay. And really strong performance on the workplace margins, you know, getting to that double-digit range, I think, is faster than we expected. Do you have a target on, you know, where you think that segment can operate on the recurring basis or, you know, an ongoing normalized basis?

Yeah, it's a good question, Greg, and we have talked about that a lot. I will point out that our operating margin in this segment is now 10%, you know, when you look back the last four quarters. And I would also point out there's nothing abnormal in that time period. So over time, as a reference point, just kind of how it gives you philosophically how we think, you know, In 2009, our operating margin in residence building products was in the low single digits. Now it's consistently in the high teens. So I would tell you I don't know the workplace being in the high teens, you know, is in the mix, but I can confidently say we're not satisfied with 10%. And so we will continue to, you know, work on that and push that, push the margin.

All right, great. Thank you. Yep, thanks.

Your next question comes from the line of Ruben Garner from the Benchmark Company. Your line is open. Thanks.

Good morning, everybody. So just a follow-up on the workplace top line. Marshall, I think you referenced, I believe it was quoting activity and the funnel being up double digits. I think that's the first time I've heard you guys sort of reference those two and put any numbers around it. Is Is that a pretty clear acceleration? In the second quarter, were you seeing growth? I'm just trying to gauge. One, is that directed specifically at the contract piece of workplace? And two, how long has this been going on and how close are we to where those kind of transition to the actual order growth side?

Yeah, those metrics are a mix of contract and other parts of the business as well, although maybe a little more weighted toward contract. What I tell you, Ruben, is they've been elevated for some time. We've seen this cycle where things take longer to continue. I think we're starting to see that slightly improve. I think it's consistent with our outlook that things are slowly turning. So we're not necessarily saying that we've got a big inflection point here, but we are seeing encouraging signs that we're going to see growth looking forward so if you look at where the growth is coming from as i mentioned earlier you know we're expecting to be up in the low single digits in the second half uh that's really driven by the fourth quarter we're expecting the third quarter to be nearly flat and it's really being driven by strength in uh smb and kai and uh you know the contract side of things

is below average right now but we're very excited about the growth we're seeing on the horizon in contract okay and then on the margin side um you've if my math is right you've got you know somewhere in the range of 350 maybe 400 maybe 400 basis points of margin um sort of within your control in the office or workplace segment over the next few years. I guess my question is, Jeff, you mentioned the last four quarters, you're at 10%. Obviously, this quarter in particular, you were at 12%. What's kind of the baseline that we're sort of adding those incremental savings to? In other words, was there anything seasonality-wise or mix-wise or anything else in the second quarter that makes that number not the right one to build off of?

I think Ruben, there's nothing unusual, but we do have seasonality. So I think if you look at the last four quarters, Jeff mentioned that we've been at 10%. That's probably a good number to start from. But we are talking about $45 to $50 million incremental from 2024. So I think that's maybe a good baseline to move from.

Okay. And then last one for me. I don't want to beat a dead horse, but I just want to clarify on the residential building product side. You know, we've heard recent months, the past couple few months, some areas are seeing a little bit of a slowdown from maybe what was expected earlier in the year. And your outlook seems to be largely unchanged. And I recognize that you have maybe easier comps because of some dynamics going on last year. But have you seen any material change in demand or conversations with your customers that gives you any kind of concern about where things are headed in the second half?

Even though our outlook's mostly unchanged, there's some moving parts in there. I think the new construction side has been a little bit slower, and remodel retrofit's been a little bit more encouraging. If you look at the second quarter, Ruben, we expect it to be down to low single digits, and we were down a little more than that. And that really reflected some softness in new construction that was partially offset by less decline than expected from our retrofits. I think our outlook, in aggregate, is more or less unchanged, but there's some moving parts there that may be more consistent with what you're hearing. Our lines, our model retrofit for us is pretty noisy year over year, so it's difficult to get a good trend on it. I think we're finally starting to get there.

Okay, I'm going to sneak one more in. How much multifamily exposure do you have within the Hearth business? Because that's been another concern from investors. As we work through this record backlog of units under construction, it kind of leaves like an air bubble at some point, maybe going into 25. Is that a risk for you or is that a relatively small business?

No, it's relatively small, Ruben. It's relatively small. We don't view that as a risk.

Got it. Thanks, guys. Congrats on the strong results and good luck. Yep, thanks.

And your last question comes from the line of Stephen Ramsey from Thompson Research Group. Your line is open.

Hi, good morning. Something I'm curious about on workplace with S&B and KII outperforming currently and kind of looks like through the balance of the year, do those customer groups have better margins than contracts so that looking out a little bit further, when contract does come back, is that a negative mix impact to the margin story there?

Steven, there's not much difference between the margins on an incremental basis. So I don't know that it's a tremendous headwind or a big tailwind, probably not something we spend a lot of time on.

Yeah, plus, Stephen, I would just say as contract, as we talk about as contract comes back, kind of the way the offices are configured, you know, I think plays to our benefit relative to the types of products we can put in there and even the types of products that KI has brought to the table. So, I mean, you know, we don't really view that as a downside. You know, it's really just about the revenue, and we think the margins will kind of, As we've talked about, we want to continue to lean into expanding those margins, even as contract comes back up. Got you.

Okay. And then thinking about workplace margin a little bit more, with the new cost structure coming into place over the next six months to two years, if volumes do grow in 2025 and 2026, in that segment does that change uh does the new cost structure change the incremental margins you would get over that time frame i mean just help us think about what margins could do as or if volumes grow yeah that's that's a good question clearly the change in our efficiency is is going to benefit our incremental margins i mean in workplace those that typically run

kind of the mid-30s, so we're probably turning a little bit above that when we come back right now. Now, there's a lot of variables that can go into that incremental margin, which probably are equally as big as the recent progress we've made. But on average, that mid-30s number was historically a good number, so we'd be a few points above that.

Okay, helpful. And then switching to RESI, the M&A pipeline has been a part of the story over the past

many years can you describe where that resi uh pipeline is now and is there real potential for things getting done second half of this year or early 2025 you know like we said it's great question steven we're always you know kind of taking a look out there and we've also said we're not in any hurry we kind of um kind of let the game come to us but you know suffice to say we're always uh in the market you know, in that space. So I don't have anything, you know, eminent by any means, but we will stay active, at least at a strategic level.

Okay.

And then one other thing on Resi. On the distribution side of things, you clearly have some owned distribution and then, I guess, sell through other third-party distributors. And the building product landscape for distributors is consolidating. I'm curious how you look at that strategically and if it's presenting any upside or challenges as you adapt to this changing building product distribution landscape.

Steven, we primarily sell to specialty dealers and installing distributors. Not saying that that overall trend doesn't impact us, but maybe a little less so than some of the other categories. And of course, you know, we do own about 25% of what we do flows through distribution we own, so that also helps us.

That's great. Thank you. Thanks.

Thank you. And with no further questions, I'll turn the floor back over to Mr. Loringer.

Great. Thanks for joining us today, taking the time, and have a good day.

Thank you. This does conclude today's conference call. You may now disconnect. Have a great day.