Good morning. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the HNI Corporation Third Quarter Fiscal '22 Results Conference Call. [Operator Instructions] 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 HNI Corporation. Thank you for joining us to discuss our third 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?

Thanks, Matt. Good morning, and thank you for joining us. Our members delivered strong earnings growth in the third quarter, despite softer demand tied to the weaker macro environment. On the call today I will cover three key points. First, despite the softer volume environment, we delivered strong earnings growth in the quarter. Second, residential building products business posted double-digit organic revenue and earnings growth in the quarter. And third, we are prepared for a difficult near-term environment and remain committed to our core strategies. Following those comments, Marshall will go through our updated 2022 outlook. I will then conclude with some general closing commentary. Finally, we will open the call to your questions. Moving to our first key point, we delivered strong earnings growth in the quarter driven by positive price costs and improving product mix. Despite the softening demand environment, we generated solid year-over-year margin expansion and 65% year-over-year non-GAAP earnings growth in the third quarter. Consolidated gross and operating margins improved sequentially and on a year-over-year basis, supported by favorable price costs. We continue to make significant improvement with price costs, and by the end of this year expect to fully recover last year shortfall that was driven by rapidly rising inflationary pressures. In workplace furnishings, we made progress on our strategic objective of expanding operating margins. Segment operating margins expanded 150 basis points compared to the prior year, driven by favorable price cost and benefits tied to actions made over the last year to improve product mix. Organic revenue growth was flat in the quarter. However, when excluding the impacts of the recent restructuring, in one of our e-commerce businesses segment shipments grew 7% driven by price realization. Although that restructuring negatively impacted our top line growth, it contributed to our margin expansion, reflecting our commitment…

Thanks, Jeff. Demand in most of our markets continues to be negatively impacted by concerns around the economy. As a result, we're lowering our outlook for the rest of the year. In workplace furnishings, we expect fourth quarter revenue to decline at a low teens year-over-year rate, that equates to a full year revenue growth rate in the low to mid single digits. That's lower than our prior expectation of low teens full year growth. The reduced outlook is driven by slower demand activity. As a reminder, the sale of Lamex and the previously announced restructuring of an e-commerce business, will reduce reported segment growth in 2022. Without these actions, which helped drive our margin expansion efforts, full year growth would be approximately 12 percentage points higher and the fourth quarter revenue growth rate would be in the positive low single digits. In residential building products, pricing benefits and revenue from acquisitions are expected to drive year-over-year growth rates in the low to mid single digits in the fourth quarter. This implies a full year growth rate in the mid to high teens residential building products we had previously projected a full year growth rate in the high teens. Again, a lower volume outlook is driving the reduction. I'd like to point out that our revenue growth rates in residential building products are currently being supported by elevated backlogs. We expect the backlogs to normalize by early next year, after which we expect our growth rates will track more in line with the overall new construction and remodel retrofit markets. Fourth quarter non-GAAP earnings are expected to decrease sequentially from third quarter 2022 levels, but be modestly above prior year results primarily due to favorable price cost. From a balance sheet perspective, we expect to maintain a strong financial position in 2022 and beyond. Debt to EBITDA as calculated per our debt covenants was 0.8 at the end of the third quarter, and we expect it will improve in the fourth quarter as debt levels further decline. Our strong balance sheet and capacity to generate free cash flow positions us well for the slowing economy. We have a history of generating strong free cash flow during both periods of economic expansion and recession. Our low leverage and continued free cash flow generation will provide flexibility for the dynamic environment and ample capacity for continued capital deployment. I'll now turn the call back over to Jeff.

Thanks, Marshall. 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. As we move forward, we do so with an experienced team that is prepared to confront an increasingly difficult economic environment, while remaining committed to our long-term core strategic initiatives. We'll now open up the call to your questions.

[Operator Instructions] Our first question is from Reuben Garner with The Benchmark Company. Your line is open.

Thank you. Good morning, everybody.

Good morning.

If we could start on the cost saving initiative. First, Marshall, any color on the timing of the realization would be helpful. And then secondly, I guess if you could discuss kind of you seem to be still pretty optimistic on the long-term story within building products, how you balance or think about your growth investments that you've been making over the last few years in the wake -- in the current environment? Thanks.

Sure, I'll take that cost savings question first, Ruben. The $30 million we expect to be basically fully realized in 2023. The first quarter may be a little bit below that run rate as it becomes mature, but it'd become mature during that quarter.

Yes, Ruben, it's Jeff. We still like, as I said, the long-term opportunities in residential building products and our efforts continue to expand the category both in the new construction and remodel retrofit. We've got a new product pipe, that's pretty -- that is strong. We're getting into the electric category in a big way. We've done some inorganic growth moves through our distribution footprint. And -- so 2023, clearly the economy is in -- we're going to face headwinds, particularly in the housing market. But we like our chances to offset some of that anyway with these growth initiatives, and we're seeing that right now even currently.

Okay, great. And then on the building products side, you mentioned new construction held up better than R&R in the quarter, I think, at least from an orders perspective. Can you talk about on the R&R side, is that a product that’s inventoried? Was there a destocking that took place in the channel at all that impacted things? And then I assume as kind of the backlog in new housing unwinds that part of the market, you would expect to kind of see more pressure than R&R moving forward. Is that the right way to think about it?

Yes, Ruben, maybe just to take these in order, we did see the R&R orders in the quarter to be down more than the segment average. And that reflected maybe two things. One is timing in that we had a lot of orders placed earlier in the year for fourth quarter deliveries. So even though orders were down in the third quarter, we expect shipments in the fourth quarter and [indiscernible] retrofitted to grow pretty decently. It also probably reflects a little bit of impact from the decline in the consumer spending trends around the house, but there's definitely some timing impact there. And then I think as we look forward, historically remodel retrofit is just less volatile than new construction. So yes, we do expect new construction to decline more than remodel retrofit when all this housing impact hits.

Okay. And as a follow-up to that, as you think about where the business is today versus maybe 3, 4 or 5 years ago, is there any way for us to gauge how much either increased penetration there is in the use of fireplaces, on the new construction side or during incremental share gains in the segment just trying to see maybe what revenue. And I guess [indiscernible] pricing in there to what revenue might look like? [Indiscernible] it starts with a return to what we kind of saw back in '17, '18, '19?

There's a lot of moving parts to that equation. We're definitely [indiscernible] affordability and lots of other pressures. We got a lot of good strategic initiatives that Jeff mentioned around every [indiscernible] the category on our new products. But I think in general, Reuben, the way to think about it is that we should track single family construction, plus or minus a few percent at least over the near-term.

I think that's right, Marshall. Reuben, the other thing I would say is, the business is much more in tune to the customer journey and to creating poll for our bit -- our products. We've -- there's a lot of online selling now. We've deployed a lot of digital assets early in the customer buying process. And despite the fact that we're kind of in a near-term pinch, I think that's a change in the business longer term that's going to pay dividends. So like I said, we're even seeing it now relative to being in touch with customers, being in touch with design aesthetics, and influencing those purchase decisions earlier in the process with much more specificity and, particularly, with our owned footprint. And that where we can control that content and work closely with the builders. And so that we've got a lot underway there, which I think if you ask about change from '18, to say, let's project to '24 or '23 even, that's, I think, going to pay dividends. They will be muted, given the overall macro, but those will, I think, accelerate once we get through some of the affordability issues.

Okay, great. Thanks, guys. Good luck going forward.

Thank you.

The next question is from Rex Henderson with Water Tower Research. Your line is open.

Good morning, and thanks for taking my question and congratulations on the work you've done on margins in bringing them back. That's really quite encouraging and impressive. Let me get to the workplace segment. We've just recently began to see a little bit of uptick in back to office according to this capital systems index on [indiscernible]. And I'm wondering if you're seeing any correlation between a market where there's a positive result with that index and positive results in back to office [indiscernible] customer activity and orders?

Well, Rex, that's a good question. I think when I comment on the midmarket, I think that is exactly what we're seeing. I mean, even in the light of the economic outlook, we're seeing -- we generated solid growth in the mid market. And some of those, those mid tier cities, they have adopted either the traditional or the hybrid model and they are back to work, and that's why I think: one, we hold a strong position there. And two, I think that's indicative as this continues to work through and swiping starts to get increase in other markets. That's a solid indicator for demand coming out of this.

Okay. Interesting. And on the residential side, I'm interested in new construction. And you said that you think you're tracking new construction starts more or less in orders there? And can you give me a little bit color on what orders -- the trend in orders there? And kind of where you see it, say it, at the end of the year?

Yes, Rex, you're asking about residential building products orders?

Yes.

Yes, so as we stated in the press release, orders were down about 6% in the third quarter versus the prior year. New construction is stronger with our retrofit as I said earlier. In that new construction, strength really reflects that builder backlogs, the backlogs at our installing distributors, so there's still orders coming in. We do expect that to fall off and interact more in line with housing permits, and just general housing activity. Remodel retrofit orders have declined more. As I said earlier, there's some timing to that. There's some -- also some probably consumer impacts there. But we have a big backlog to work through there. Our backlog and remodel retrofit is elevated due to the orders that were placed earlier in the year. And that's going to buffer and soften any kind of decline we have probably takes the rest of the year maybe into 2023, early 2023 to normalize that backlog.

Okay. And so you think early, by January, February, the backlog will be gone. And at current trends what do you think orders are -- where orders going between now and then? Did you have any feel for that?

The easier part of that question answer is yes. The backlog should be normalized by, say January, February. The harder part is to speculate on what orders are going to do. Certainly, we see weakness in the new construction activity around permits, which are running roughly down 20% versus prior year. Remodel retrofits a little bit hard to gauge and that there's not as many leading indicators to that. But signs show that's going to be soft as well. We're prepared for it to be down, Rex. I don't know that we're able to offer a quantitative outlook, how much it's going to be down right now.

Okay.

Yes, Rex, I would just -- I would add to that, Rex, just kind of heavy step back from the specific where are orders heading in the short-term. Look, everybody knows the economy is in a tough spot as we enter '23. Most of the leading indicators are slowing. We're seeing some of that as well. Now we're prepared for softer demand. We're adjusting the business with cost savings and other efforts. Now, I will tell you historically, we have a track record of success managing through downturns. Our balance sheet is in great shape. We generate cash flow. So it could be challenging short-term, but we're encouraged by the opportunities, once the economy stabilizes. We have unique operating models. As we talked about, as I commented earlier, we're going to stay on our long-term core objective strategic initiatives. And then workplace, like I said, the midmarket I think is indicative of strength and when return to office activity comes back in earnest and adoption of hybrid continues to grow. There's still a war for talent and our exposure across these markets, and particularly in North America, where we primarily operate, I think is going to bode well for us. And as I commented earlier as well, on residential side, we are just talking about our efforts to -- that we've put in investments, pretty significant investments last few years to connect to customers, to expand the category, to create awareness, to understand design patterns, to leverage our strong distribution model, those are all point to a really strong opportunistic and outlook, once we kind of get through this near-term headwind.

Okay. Well, thanks for your time. Good luck.

Thanks. Appreciate it.

The next question is from Greg Burns with Sidoti. Your line is open.

Good morning. What percent of your business is contract midmarket and SMB? Can you just segment out the sizing of those three segments of your business?

Yes, Greg, we like to talk about contract and SMB, roughly being 50-50 split. It's not a precise split. SMB might be slightly bigger. I think what you're getting at is, SMB actually, we've chosen to break out a couple sub components of SMB here by talking about the midmarket and the transactional business. We don't offer a precise split on that. The midmarket would be larger than the transactional business, but we don't give a precise mix.

Okay. And then, relative to $30 million in cost savings, there was a $5.6 million charge this quarter for some restructuring, is that tied to the $30 million? Is that separate set of cost savings? How should we think about that?

No, that's directly related to the $30 million. The corporate wide cost savings program will save $30 million, which fully mature next year, and we incurred $5.6 million of charges related to it in the quarter.

Okay. And total SG&A was down. It was lower than we expected down pretty significantly sequentially. And I'm assuming some of that's variable. But once the '23 rolls around and goals reset, I'm assuming maybe some of that variable comp comes back online. So I'm just trying to figure out based on the better the lower-than-expected operating expenses this quarter, what's a good run rate to build off of as we go into '23 and start factoring in some of those cost savings?

Yes, that's a good observation, Greg. We -- the third quarter, the P&L did benefit from lower variable compensation. There was an adjustment made there, that's sort of one-time in nature. So in terms of ongoing run rate, none of those numbers have the $30 million in it. And we're going to continue to adjust the business as Jeff mentioned earlier, for the challenging short-term we're expecting. I don't know that we have a estimate on what SG&A is. We're always going to continue to invest a bit. But we are prepared for more challenging 2023. What I would offer is that we do have some offsets and actions. Of course, the cost actions that we just talked about the $30 million program is one of three things that can offer some benefit next year. The other two that we would expect price cost to be favorable in 2023, and that we'd also expect net productivity to improve given that supply chains are normalizing and our Mexico operation is maturing. Collectively, those are probably offering benefit in the range of $80 million next year, which we expect will help offset partially mitigate the volume pressure. But in terms of SG&A run rate, we don't have an outlook for you.

Okay. No, that's definitely helpful. I guess, I maybe kind of answered part of this next question. But sounds like you're catching up on price costs. So it seems like inflation is becoming less of a concern. But any update on supply chain freight, any labor, any of these other kind of moving parts that have been impacting the margins over the last year or so? Are you seeing any improvement on that front?

Yes, we are. We, in the last call, we talked about price cost for the corporation mean favorable $60 million to $70 million. For 2022, we're expecting that to be in the $75 million to $80 million range. The reason for the increase is more stabilization in the commodities.

Yes, I would say, Greg, relative to supply chain it is stabilized as well, although it's not at pre-pandemic stability. But it is operationally it's still a bit of a challenge. But it's much more stable than it was a year, two years ago.

Yes. All right. Thank you.

Thanks.

The next question is from Steven Ramsey with Thompson Research Group. Your line is open.

Hey, good morning. I'm sorry, I got disconnected for a minute. So sorry, if I'm asking the same question again. Maybe to start with on resi, where is inventory now? And entering the slowing period, do you think the channel and HNI specific inventory is in a good place to adjust for that?

Steven, you’re asking like channel inventory? That's -- is that kind of your question?

Right, on the resi side specifically.

Yes, I mean, look, there's probably some inventory there that needs to be adjusted. But recall, we've got this unique regional distribution center network in which we hold inventory and deliver in just a few days to majority of our dealer partners. So I don't know that there's a big inventory correction, although there's probably a little bit there.

Yes, I think there's probably a little bit there, but we've kind of been monitoring that. It's been flushing through -- throughout the year. Distributors, clearly -- some of them loaded up based on lead times and supply chain issues, Steven, but they've unwound a big chunk of that. I think we're getting to the end of that here and the backlogs are going to be mostly normalized by the end of the year.

Okay, helpful. And then on resi margins increasing again and at their pretty normal high teens levels, can you talk to price cost, specifically there, and with the investments, can you talk to the impact on investments for growth in the third quarter and how you think about it in the coming quarters with the near-term slowing?

In residential building products, we did generate positive price cost, approximately $10 million that added to operating margins. We did invest in the quarter. In that segment, it was around a $1 million of investment, it spread across the go-to-market activities we discussed, grow the category, new products, et cetera.

Okay, helpful. And then looking forward on signals of inflection, you talked about how transactional activity in the workplace segment is moving with the economy. Are you looking for that internally as your key signal for optimism and activity turning up? Or are there other internal metrics that you're looking at?

Steven, we look at all aspects of the business. I think transactional historically has been pretty predictive of general economic trends. But we're in this period of the post-pandemic kind of office redo, and so we're slicing it a lot, multiple different ways, that's why we kind of talked about the midmarket. You're seeing regional differences, you're seeing signs of business differences. And so I think we're going to continue to look at all that. And the midmarket, as I said in my prepared remarks, I think is going to be indicative of maybe -- some of the other segments relative to return to office, [indiscernible] application, hybrid models. And even in the -- this uncertain time, that's showing some strength. So, I think we don't have as we're kind of in uncharted waters there post-pandemic. So we're going to look at all of it and the midmarket was our attempt to give you a little bit of a new nuance of how we're going to look at it. And I'll tell you, we're going to continue to -- you ask a question just a minute ago about residential, we will continue to invest in our core strategies on expanding workplace furnishing margins and driving top line growth, notwithstanding near-term kind of headwinds and housing.

Okay, helpful. Thank you, guys.

Thanks.

The next question is from Reuben Garner with The Benchmark Company. Your line is open.

Thanks, guys. My follow-up question was actually -- just [indiscernible] couldn't figure out how to get out of the queue. So I'm going to ask one more clarification, while I have you, though. So the last quarter, I think you talked about the smaller businesses, turning as the macro conditions worsened. Just to clarify this quarter, have you seen any rebound from them at all? I know you're talking about the middle market -- midmarket showing strength, but is that to say that the small business, small businesses have improved? Can you just talk about them versus contract on the order front? Thanks.

Yes, I think, Reuben, that was the question Greg was kind of asking too, I think is SMB is inclusive of what we call transactional, real day-to-day business and kind of midmarket business. And so what I would say is, as we've said, the midmarket customer, which is some small -- a good chunk of small business has been pretty, pretty robust. The transactional business has continued to be down. We commented on that last time, and it's not showing signs of turning. It's very historically driven by macroeconomic trends and that tends to be really small business customers.

Got it. Thanks. That makes sense. Good luck, guys.

Thanks.

Thanks.

We have no further questions at this time. We'll turn it over to Mr. Lorenger for any closing remarks.

Great. Thanks for your interest in HNI, and thanks for taking the time to join us today to chat about the business. Have a great day. Thanks.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.