Hni Corp Q3 FY2025 Earnings Call

Hello, everyone, and welcome to HNI Corporation's third quarter results conference call. This call is being recorded. I would now like to turn it over to Mr. Matt McCall. Please proceed, sir.

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 2025 results. With me today are Jeff Lorenger, Chairman, President and CEO; and VP Berger, Executive 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. I'm going to divide my commentary today into three sections. First, I will provide some comments about our third quarter results. Non-GAAP earnings per share increased 7% year-over-year, driven by a record third quarter non-GAAP operating margin. Next, I will discuss our expectations for the fourth quarter of 2025. Our full year earnings outlook is unchanged from what we provided on last quarter's call. We continue to anticipate a fourth consecutive year of double-digit non-GAAP earnings improvement. And finally, I will provide additional detail about recent demand activity and how we see our markets playing out in the fourth quarter and as we move into 2026. Following those highlights, VP will provide additional color around our fourth quarter outlook. He will also comment on the strength of our balance sheet, both currently and what we anticipate after the completion of the pending acquisition of Steelcase. I will conclude with some closing comments, including some additional thoughts on our Steelcase transaction before we open the call to your questions. I'll begin with the third quarter. Our members delivered another strong quarter despite ongoing tariff-driven volatility and continuing macro uncertainty. The positive momentum of our strategies, the benefits of our diversified revenue streams, our focus on items within our control and the merits of our customer-first business model continue to deliver strong shareholder value. For the quarter, we delivered non-GAAP diluted earnings per share of $1.10. EPS grew 7% versus last year, which was modestly ahead of our internal expectations. Total net sales in the third quarter increased 3% organically over the same period a year ago and profit margins in the third quarter were strong. Our non-GAAP operating margin expanded 10 basis points year-over-year to 10.8%. This non-GAAP EBIT margin was the highest on record for the third quarter. In the Workplace Furnishings segment, organic net sales increased 3% year-over-year, fueled by growth across all major brands. We delivered similar organic growth rates in our brands focused on small- and medium-sized businesses and on contract customers. From a profitability perspective, Workplace Furnishings' non-GAAP segment operating profit margin expanded 40 basis points year-over-year and exceeded 12%. Third quarter profitability benefited from our profit transformation efforts, recognition of KII synergies and modest volume growth. In Residential Building Products, third quarter revenue was roughly unchanged versus the prior year period. New construction revenue was down slightly, while remodel retrofit sales grew modestly, both on a year-over-year basis. We delivered this top line performance despite continued challenging housing market dynamics as we continue to compete well and our internal growth investments are bearing fruit. Consistent with expectations discussed on last quarter's call, third quarter segment operating profit margin contracted year-over-year driven by continued investment. However, segment operating margin still came in at a strong 18%. Despite expectations of ongoing uncertainty, we remain encouraged about the opportunities tied to the broader housing market, and we continue to invest to grow our operating model and revenue streams, and the consistently strong profit margins in this segment are evidence of the business' unmatched price point breadth and channel reach, along with the benefits of its vertically integrated business model and overall operational agility. To summarize, our third quarter performance demonstrates the strength of our strategies and our ability to manage through varying macroeconomic conditions while remaining focused on investing for the future. We expect strong results to continue, driven by our margin expansion efforts and continued volume growth. That leads to my comments about our outlook for the fourth quarter. Overall, we expect our margin expansion efforts and continued revenue growth will support ongoing year-over-year EPS improvement, all while we continue to invest to drive future growth. In Workplace Furnishings, segment orders increased 2% after excluding the estimated impact of prior quarter pull-forward activity and hospitality orders. We are again excluding hospitality from our adjusted order growth and backlog metrics as the business has experienced meaningful tariff-related volatility over the past two quarters, which has temporarily skewed results. Adjusted orders from contract customers performed better than those from small- to medium-sized businesses. Our adjusted segment backlog at the end of third quarter was up 7% from the third quarter of 2024. I will discuss our outlook for our workplace markets, including hospitality more in a moment. Moving to Residential Building Products, orders in the third quarter increased 2% year-over-year. Remodel retrofit orders outperformed and were up mid-single digits from third quarter 2024 levels, while new construction orders were down low single digits. Overall, year-over-year segment order growth accelerated towards the end of the quarter. Builder sentiment has weakened in recent months and continues to reflect the impacts of elevated interest rates, ongoing affordability issues and weaker consumer confidence. And housing trends have broadly followed builder sentiment with permits moving lower. Despite expectations of ongoing uncertainty and headwinds, we remain encouraged about the opportunities tied to the broader housing market, and we continue to invest to grow our operating model and revenue streams. I will finish by making a few comments about our markets and provide additional detail around our elevated EPS growth visibility. On our last few calls, we highlighted an increased focus on investing to drive growth in both segments. Our 2025 to-date revenue strength and encouraging leading indicators have provided added support for our growth initiatives and investments. As we look at our Workplace Furnishings segment, we are encouraged about the developing fundamentals of this business. The macro and industry backdrops have shown consistent improvement in recent months. Return to office data appears to be indicating an inflection. The castle card swipe data following Labor Day reached post-COVID highs with Class A buildings in the top 10 markets approaching 98% peak day occupancy. Further, in a recent KPMG survey, nearly 80% of CEOs surveyed now expect employees to be full time in office over the next three years. This is up from fewer than 40% in the April 2025 survey. And according to CBRE, nonviable space is being converted at record levels. This positively impacts our business in two ways. First, it results in more forced moves as landlords encourage current tenants of this nonviable space to relocate. And second, it will accelerate the expected Class A square footage shortage, which will either drive the addition of new space or increased investment in upgrading existing Class B space. Each of these dynamics results in more furniture events. Finally, calendar year 2025 is expected to see the highest net absorption of office space since 2019. Historically, absorption has been an important indicator of office furniture demand. JLL estimates more than 6 million square feet was absorbed on a net basis in the third quarter of 2025 alone. This compares to total negative net absorption of more than 100 million - 150 million square feet over the past five years. Office vacancy rates are falling for the first time in seven years as we enter what JLL has deemed a new office growth cycle. In New York City alone, businesses leased 23 million square feet of additional office space during the first nine months of 2025. This is the largest amount of new workspace rented for that period in two decades. And in total, 18 of the largest U.S. markets are exceeding pre-pandemic leasing activity over the past year. The macro and industry backdrops are clearly improving, and we expect our contract business to disproportionately benefit from these trends as much of the industry growth cycle to date has been in secondary and tertiary markets. Finally, I will comment on our hospitality business. As I mentioned earlier, compared to our other businesses, this vertical has seen more tariff-related demand volatility over the past two quarters. Despite this pressure, we expect revenue in this business to be relatively flat in 2025 overall. We have seen recent improvement in preorder activity, and our pipeline continues to build, pointing to a solid growth year in 2026. Looking ahead, we believe we are particularly well positioned to benefit as the workplace furnishings market continues to improve. We have strong market positions and offer compelling value to our targeted customers with a diversified portfolio of brands. Moving to Residential Building Products. We believe in the positive long-term market fundamentals. We continue to perform well despite an ongoing soft new construction environment, and we acknowledge a market-driven revenue recovery will take some time. We are, however, optimistic about our opportunities to increase revenue through our growth initiatives. Specifically, we continue to invest in developing market-leading new products that offer customers more options and features. We are driving new programs to increase homeowner and homebuyer awareness of their fireplace options, ensuring our products are considered in all remodel and new construction projects. And we are strengthening our already strong relationships with builders across the country, helping them deliver the best overall value to the homeowner. Encouragingly, we are outperforming the market in this segment despite still being in the early days of each of these initiatives. And while we invest in growth, we will continue to deliver high-margin results and strong profits in this business. Longer term, single-family housing remains undersupplied and demographics will support additional demand growth. The results of our ongoing investments, which will enhance our connection to customers and build on our leading brands will fortify our position of strength in the industry. Finally, and importantly, we continue to have elevated earnings visibility this year and next. Our outlook for 2025 revenue continues to include full year growth in both segments. Our outlook for 2025 earnings reflects expectations for mid-teens percent EPS growth. In addition to increased profits and volume growth, KII synergies and the ramp of our Mexico facility are expected to continue to drive significant savings. These two initiatives are expected to contribute a total of $0.75 to $0.80 of EPS in the 2025-2026 period. I will now turn the call over to VP to discuss our outlook for the remainder of 2025 and our balance sheet. VP?

Thanks, Jeff. I'll start by discussing our outlook for revenue and profit. Beginning with the top line. Fourth quarter revenue in Workplace Furnishings is expected to increase at a high single-digit rate year-over-year organically. The impact of divestitures is expected to reduce the year-over-year organic revenue growth rate in Workplace Furnishings by a little less than 100 basis points. The benefits of our order and backlog growth, along with an extra week in our fiscal year are expected to drive solid revenue growth in the fourth quarter. For Residential Building Products, fourth quarter net sales are also projected to increase at a high single-digit rate compared to the same period in 2024. Pricing actions are expected to be the primary driver of growth. However, we also expect our borrowing capacity will continue to provide us with significant financial flexibility. Moreover, while we expect our initial post-closing net leverage to approximate 2.1x, we continue to project our debt levels will return to our targeted range of 1 to 1.5x within 18 to 24 months of closing. In the meantime, we remain committed to the payment of our long-standing dividend and continuing to invest in our business to drive future growth. I'll now turn the call back over to Jeff.

Thanks, VP. During the third quarter, we remained financially disciplined, managing the middle of the income statement to drive profit improvement while pursuing revenue growth. As we look forward, several positive secular trends and our HNI-specific initiatives will help offset macro-related risks and continued tariff-driven volatility. We will remain focused, conservative and ready to adjust as required. And as a result, our earnings outlook for the full year is essentially unchanged, and we continue to expect the fourth consecutive year of double-digit non-GAAP EPS growth. This outlook demonstrates the benefits of a stronger-than-expected third quarter, our ongoing visibility story and our proven ability to manage through changing economic conditions. Before we take your questions, I wanted to provide some thoughts on the pending Steelcase acquisition. As we approach the closing, we are excited about the future of bringing together our combined capabilities to create new career growth opportunities for our team members, deliver more value for our customers and dealer networks and further support and invest in the communities in which we operate. The deal is right from a strategic, financial and cyclical perspective, and our two companies are highly complementary on many fronts. We currently expect synergies to reach $120 million and ultimate accretion to total $1.20 per share when fully mature, excluding purchase accounting. And as VP highlighted, our anticipated strong free cash flow will help us quickly deleverage our balance sheet. The addition of Steelcase will further strengthen the tenets of the HNI investment thesis, and we are positioned for continued success. We have elevated earnings growth visibility for several years, broad and diverse product and market coverage in Workplace Furnishings, market-leading positions in Residential Building Products, and we continue to invest to drive growth. All this is supported by our strong balance sheet and the ability to generate continued free cash flow. I want to thank each HNI member for their continued dedication and congratulate them on another excellent quarter. We will now open the call to your questions.

Your first question comes from Greg Burns of Sidoti & Co.

That $1.20 of accretion from Steelcase that you just mentioned, is that considering just the synergies that you've already outlined? Or is that...

Yes, Greg, that's the $120 million that we talked about on the investor call back in August. So that number has not changed. And just the way the share count works, that now converts to about $1.20 in accretion.

Okay. So that's just your initial outlook, maybe there's potential upside to that if you get your hands around the business and drive additional savings.

I think just to add to that, we are very confident in that number. We will follow our disciplined integration process, and once we are involved, if there are additional opportunities, we will pursue them. But that is what we have officially stated for now.

Okay. Great. And then where are you in terms of the $0.75 to $0.80 from KII and Mexico? How much have you gotten so far and what remains?

Yes. We had said that $45 million to $50 million would be recognized between '25 and '26. We had mentioned kind of splitting it half and half. We're seeing a little bit more come forward of '26 in the last quarter here of '25. So I would tell you, maybe a little bit more in '25 and '26. But I think more importantly, to Jeff's point on visibility, we do see the $45 million to $50 million coming through.

Okay. You provided a lot of information about the positive fundamentals in the office space sector. We've observed a gradual improvement in demand over the past few years, showing low single-digit growth. However, when we consider the current state of the industry compared to pre-pandemic levels, I understand you've implemented several price increases. What is the current volume like compared to pre-pandemic levels? I'm trying to assess our position in the cycle and the possible increase in demand if conditions improve going forward.

Yes, Greg. It's a bit challenging to make precise estimates given the current pricing situation. However, I would confidently say we are likely at about 30% to 35% in terms of volume, still down due to pricing actions and tariffs. As we look at the post-COVID recovery and other macroeconomic factors beginning to improve, that's the perspective we have. We remain optimistic about the space.

Yes. Even if it returns half that, Greg, you're looking at mid-single-digit volume growth for a significant number of years. So the backdrop is set up, even if it doesn't get back to the 30% more, there's still a lot of volume growth opportunity.

Your next question comes from the line of Reuben Garner of Benchmark.

Can you provide a comparison of your full year guidance? Specifically, what are the differences in the fourth quarter now compared to a few months ago? It seems like the top line is somewhat higher, but there are also increased costs. Could you detail that for us?

Yes, I can explain that, Reuben. Starting with revenue, if I look at Workplace and Residential revenue, it aligns mostly with our previous expectations. Both are anticipated to see a high single-digit increase in the fourth quarter due to the additional week. The slight pressure we are experiencing comes from the product mix. The backlog and pipeline show a greater proportion of project-driven business and systems, which is primarily a timing issue. This draws a bit lower margin, but it also leads to other business opportunities involving ancillary products that are likely to appear in Q1. So, it's mainly a timing matter. The second aspect of our Q3 performance relates to the timing of investments, some of which have shifted into the fourth quarter, whereas a part of that was originally budgeted for the third quarter. Those investments will rebound. Importantly, our outlook for the second half remains unchanged. There is just a bit of movement between the two quarters. Additionally, I want to highlight that, as Jeff mentioned, we are experiencing insurance-related pressure year-over-year, impacting our SG&A. We probably need to adjust our tax rates as well; the tax rate for the second half is now at 24.4%, about 80 basis points higher than we previously discussed, which brings our full-year tax rate to 23%. When considering all these factors, the second half of the year is not fundamentally changing; it involves some timing adjustments and certain one-time expenses.

That's really helpful. Regarding the residential building products sector, you have certainly exceeded expectations given the current end markets this year. I understand you have some ongoing investments aimed at fostering growth. How much potential do you have for growth in that area? To rephrase the question, if next year is expected to be somewhat stagnant, do you believe you can still achieve growth that outpaces the market in terms of volume?

Yes, it's a good question. I think we can. It's all relative to the macro environment. Given the investments we're making, like in the new construction business, for example, we're outperforming. In October, our orders were flat while permits 90 days prior were down by high single digits, indicating the lag time we've been observing. This suggests we believe we can outperform this market. However, the question remains as to where the market is ultimately headed, and your guess might be just as good as ours, but we definitely can outperform. Our retail performance is strong, with gas inserts up year-over-year, and we're just starting to introduce stoves into the big box channel. Our wholesale business has also seen year-over-year growth due to a strong operating model supporting smaller independent dealers. Overall, our investments in service quality, vertical integration, and builder relationships are beginning to show results. While we are still in the early stages, these efforts are starting to yield positive outcomes, and we believe we can stay ahead of the demand curve. The central question is where that macro demand curve lies and what additional growth we can achieve beyond that.

Okay. And I'm going to sneak one more in on the contract business. It seems like some good momentum on that side and the timing of you guys adding Steelcase seems nice. Can you talk about any risks out of the gate as you're integrating the company? And if we did see an acceleration in demand, just kind of what gives you confidence that you'd be able to kind of, I guess, participate in that upswing as you're putting the two companies together?

Yes, that's a great point, Reuben. I want to emphasize that there will be no changes on our end. Our dealer partnerships and brand distribution will stay the same. The sales force will remain unchanged for both HNI and Steelcase. I believe our strategy will allow us to capitalize on current trends since everyone is focused on that. Our cultures align well, and we're off to a strong start. We're optimistic about addressing our key objectives, particularly focusing on cost synergies while maintaining the distinctiveness of both businesses and their brand identities. This will enable us to continue building on those strengths, and we expect to engage with evolving trends, especially in some larger markets.

Question comes from the line of Steven Ramsey of Thompson Research Group.

This is Brian Biros on for Steven.

Sure.

On the resi side, I guess, sales were flat. Orders grew 2% and really accelerated at the end of the quarter, it sounds like. So I guess can you just parse out maybe like why orders grew and if there's anything to call out really that drove the acceleration into the quarter end?

Yes. And are you talking about the resi side or Workplace, Brian, just to make sure I'm...

Sorry, the resi side.

Yes, you are correct. For the quarter, orders are up 2% for the segment. The remodel retrofit was up 7% and actually accelerated as we progressed through the quarter. We also increased our backlog to 13%, which gives us confidence in achieving high single digits for the quarter. The backdrop of everything Jeff mentioned supports this, enabling us to outperform the market. We're beginning to see positive signs for the retail season in most parts of the country, excluding the West Coast. All these factors support our high single digits with the extra week. Looking at the full year, it's important to note that we expect to grow in the mid-single digits in a challenging market that has not seen growth. While most of this growth will come from price increases, we will also demonstrate unit volume growth in the fourth quarter and to some extent for the full year.

Got it. Helpful. And secondly, I guess, just on the Workplace segment, the opportunity set there, maybe by sector, is there a way to think of how much that reflects return to office compared to non-office verticals?

It's quite difficult to analyze that accurately. I believe it's a combination of factors. The sectors have remained resilient, particularly in education and healthcare. Currently, the federal government is in an unusual position. However, if I were to assess the return to office trend, I would say it is still in the early stages compared to some other sectors. Nevertheless, we anticipate that certain sectors will continue to perform well in the future. Overall, sectors have shown a bit more strength than the return to office trend, which is just starting to gain momentum.

I'd now like to hand the call back to Mr. Lorenger for final remarks.

Great. Thank you for your interest in HNI, and have a great day. I appreciate your time.

Thank you so much for attending today's call. You may now disconnect. Goodbye.