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Text: I'm Vice President, Investor Relations and Corporate Development for HNI Corporation.
Actual results could differ materially.
Our members delivered another solid quarter in an environment that remains challenging.
And again, our results demonstrate much of what is unique about HNI.
As we look ahead, we are prepared to confront the near-term macro challenges and we also see opportunity and signs that our strategies are gaining momentum.
You will notice some changes to our normal quarterly earnings report and call format.
Specifically, we have included more detail around our third quarter results and fourth quarter expectations in the release.
This allows us to focus our call commentary on the key highlights of the quarter, the key issues and opportunities going forward, and our strategic efforts aimed at pursuing long-term revenue growth, margin expansion, and free cash flow generation.
Now, I will start with four key highlights from the third quarter.
First, our Residential Building Products segment delivered strong year-over-year growth.
We generated 9% year-over-year revenue growth in the third quarter or 8% excluding the impact of acquisitions.
This is a substantial improvement from the second quarter 6% year-over-year revenue decline.
Our third quarter order patterns indicate these positive volume trends should continue.
Orders increased 13% year-over-year and consistent with most new home construction and remodeling indicators, order growth remains strong throughout the quarter.
Our unique model in this business continues to provide a competitive advantage.
Our focus on operational excellence, our vertically integrated structure, and our investment in regional distribution centers have allowed us to take advantage of accelerating demand.
We 're competing better than ever in this space and we continue to drive strong financial returns with third quarter operating margins expanding 270 basis points year-over-year to a third quarter record of 19.6%.
The second highlight of the third quarter was our Workplace Furnishings segment delivered solid profitability despite continued recessionary pressure.
In general, customers remain in a holding pattern and third quarter revenue was down 27% year-over-year.
However, the segment still was able to generate a profit of nearly $17 million in the quarter.
We are seeing some signs that demand activity is becoming less bad in this segment.
Orders in Workplace Furnishings excluding eCommerce declined 25% year-over-year in the third quarter.
This was an improvement from the 35% order decline in the second quarter.
Furthermore, order declines moderated as the quarter progressed.
This trend is encouraging, but we are not expecting a dramatic improvement over the next couple of quarters.
Orders in our Workplace Furnishings eCommerce business increased 35% year-over-year in the third quarter.
That is strong growth, but it is lower than the triple-digit order increase we generated last quarter.
Much of the moderation in order rates was expected as was the result -- and was a result of tougher comps and supply constraints.
We did see September orders reaccelerate and this improvement is a result of a continued strong demand environment combined with our improving inventory positions.
Our third highlight for the quarter was we continued to smartly manage our costs and expenses.
We reported a decremental margin of 19% in the third quarter.
This is better than our previously communicated target of 25%.
Also recall, we were up against a strong prior-year comp in the third quarter as our productivity efforts and cost management drove a 50% incremental margin in the third quarter of 2019.
We continue to manage through the near-term recessionary environment in the Workplace Furnishings segment while remaining focused on our long-term strategies.
Finally, our fourth quarter -- our fourth highlight of the quarter was continued strong free cash flow generation.
Our balance sheet strength and cash flow outlook provide ample flexibility to navigate through the period of softness in Workplace Furnishings while maintaining our key growth investments in both segments.
Let's turn to the outlook for our Workplace Furnishings first.
In the Workplace Furnishings segment, we expect fourth quarter year-over-year revenue declines to be in the mid-teens.
That's better than what we've seen over the last two quarters and is based on three factors.
First as Jeff mentioned, we have seen year-over-year order declines trend less bad.
Second, we are expecting more growth from our eCommerce business given the continued demand strength along with our improving supply position.
And third, our fiscal calendar has an extra week this year, which we expect will add 4 percentage points to 7 percentage points of growth to the quarter.
I should note it also adds cost.
So this growth delivers lower incremental margins compared to true organic growth.
Shifting to our fourth quarter outlook for Residential Building Products.
Recent order trends, housing construction activity, and the extra week support fourth quarter year-over-year growth rates in the mid-to-high-teens.
Moving on to profitability, we would also like to emphasize what we are expecting for decremental margin.
For the full year, we expect decrementals to be less than 20%.
This implies meaningfully higher decremental margins in the fourth quarter, primarily driven by unfavorable business mix, accelerating investment levels, and the impact of the extra week.
We continue to target decremental margins of 25% over time.
Finally, I'd like to make some comments on our cash flow and balance sheet.
Since the early days of the pandemic, our teams have focused on driving free cash flow.
As a result, our free cash flow through the first three quarters is tracking 70% ahead of prior prior year levels despite lower profitability.
We ended the quarter with $109 million of cash in the balance sheet.
That balance has more than quadrupled the balance from the end of last quarter.
We've reduced our net debt by 65% or nearly $123 million and our gross leverage ratio is 0.9, well below our debt covenant of 3.5.
So we have substantial financial flexibility and a high-quality balance sheet and we're not expecting any meaningful capital structure stress.
The past six months have demonstrated how much of what is exceptional about HNI and I believe this experience has helped HNI become a stronger company in many respects, which will serve us well as we move forward.
As I look to 2021 and beyond, I would like to call out a few items.
First, we remain excited about the prospects for our Residential Building Products segment.
Our unique vertically integrated model with more than 20% of revenue coming from our owned [Phonetic] installing distributors along with our recent success in managing through the spike in demand surrounding the pandemic puts us in a strong position as we move into 2021.
We have ramped our investments in this business to better market directly to homebuyers and consumers in both the new construction and remodel retrofit markets.
Our belief is that increased marketing in what has long been an under-marketed industry will provide revenue upside that may not be fully appreciated.
This will add to what is already a strong cyclical backdrop as indicated by low housing inventory and increased household formation and we will also benefit from encouraging secular trends such as urban flight, larger home sizes, and increases in home ownership.
In summary, we believe the revenue growth opportunity in this segment is strong and we will continue to invest aggressively to grow this addressable market and the categories in which we compete.
Second, while we remain cautious near-term, we expect Workplace Furnishings revenue to continue to recover as we move to a more supportive environment.
Looking ahead to 2021, we expect a challenging first quarter as we lap pre-COVID conditions.
However, moving through the year, we expect more companies to return to offices.
While those return dynamics will likely take many forms, each will support improved demand.
Longer-term, we see positive trends emerging that line up nicely with our competitive strengths.
Specifically, we are particularly well positioned to benefit from increasing work from home demand.
Our unmatched price point breadth, our product depth and our distribution capabilities put us in a strong position to benefit from elevated work from home activity.
A recent example of our efforts in the home office space is a win with a large enterprise client.
Their employees which number in the tens of thousands will be able to choose home office furniture from a preset selection of our products.
There are many more opportunities like this in the pipeline.
We are also uniquely positioned to benefit from trends tied to de-urbanization or urban flight.
This trend should lead to more satellite offices away from city centers and in smaller markets.
These are markets that play to the strength of our go-to-market models and where we have strong competitive positions.
Next, we believe densification of office space, which was a headwind for this segment for years, will stabilize, if not reverse, in a post-COVID world.
Finally, we believe office space layouts will change.
While the exact layout of the office of tomorrow remains up for debate, it will not look like the office of yesterday.
Change is good for our Workplace Furnishings businesses.
Third, our cash flow outlook is encouraging and our balance sheet will remain strong.
Marshall discussed our cash flow and balance sheet outlook.
As we look toward 2021, our targeted uses of cash continue to be ongoing dividend support.
We have not cut our dividend in over 65 years of paying it.
Investment in growth opportunities in M&A in both Workplace Furnishings and Residential Building Products and finally opportunistic share buyback.
In conclusion, I'm extremely proud of all of our HNIs members and of the company's collective focus and ability to adapt over the last six months.
2020 has presented and continues to present challenges that were unforeseen just a few short months ago.
However, as we emerge from this period, we will do so a stronger company well positioned to grow revenue, expand margins, and generate cash flow.

user
recent order trends suggest yoy workplace furnishing revenue declines will moderate slightly in q4.

assistant