Earnings Call Transcript
MILLERKNOLL, INC. (MLKN)
Earnings Call Transcript - MLKN Q3 2023
Operator, Operator
Good evening and welcome to MillerKnoll’s Third Quarter Earnings Conference Call. As a reminder, this call is being recorded. I would now like to introduce your host for today’s conference, Vice President of Investor Relations, Carola Mengolini.
Carola Mengolini, Vice President of Investor Relations
Thank you, Lisa. Good evening and welcome to MillerKnoll’s third quarter fiscal 2023 conference call. I am joined by Andi Owen, Chief Executive Officer; and Jeff Stutz, Chief Financial Officer. Also available during the Q&A session are John Michael, President of Americas Contracts and Debbie Propst, President of Global Retail. Before I turn the call over to Andi, please remember our Safe Harbor regarding forward-looking information. During the call, management may discuss information that is forward-looking and involves known and unknown risks, uncertainties and other factors, which may cause the actual results to be different than those expressed or implied. Please evaluate the forward-looking information in the context of these factors, which are detailed in today’s press release. The forward-looking statements are as of today and assume no obligation to update or supplement these statements. We may also refer to certain non-GAAP financial metrics, which are reconciled and described in our press release posted on our Investor Relations website. With that, I will turn the call over to Andi.
Andi Owen, CEO
Thanks, Carola. Good evening, everyone and thank you so much for joining our call. Throughout this quarter, our team delivered strong earnings and margin improvement despite challenging economic conditions. We have many competitive advantages. We have a collection of strong design brands, which are sold across multiple business channels and that cater to different customer segments around the globe, and we are nimble. We are capturing synergies, reducing our cost structure, and optimizing our capabilities so that we are positioned to capture opportunities as and when the macroeconomic picture improves. To be sure, this is a disruptive period. Traditional office usage and layouts are not as relevant as they once were, and new opportunities exist to help our customers design more hybrid, collaborative work environments. Our contract clients continue to engage us in conversations about reimagining their workspaces, both to enhance employee experience and to create multi-use spaces. Because of this, the volume of customer discussions remains very high, and the funnel of potential project opportunities is robust, albeit somewhat uncertain in terms of timing. These customer interactions continue to emphasize the importance of non-traditional product categories to home and office settings. We believe that this pivot to premium ancillary product solutions gives MillerKnoll and our distribution partners a distinct competitive advantage given our best-in-class collective brand. To this end, I will highlight the great performance of some of our smaller luxury brands, such as Holly Hunt, Muuto, and Spinneybeck Filzfelt, which support our strategy towards a diversified global business model that includes luxury ancillary products catering to both the residential and commercial client base. As we continue to build our presence as one collective MillerKnoll brand, we are also seeing a new pattern emerge with our dealers and the way we are winning business. Now with more offerings across our portfolio, we are better suited to win whole floor plan solutions than ever before. We are also using the transitional period across our industry as a strategic opportunity on many fronts, introducing innovative products, pursuing new sector expansion and investing in our digital capabilities, all of which permits us to further our reach and remove friction claims for our dealers and our customers. As it pertains to our retail segment, we believe that higher interest rates have temporarily slowed new and second home buying, and in some cases, also delayed decisions to upgrade and renovate current spaces. Additionally, we are seeing customers temporarily shift more of their discretionary spend towards travel and leisure. Although we believe this is a short-term trend due to pent-up demand after an extended period of pandemic-related isolation, we are preparing for a near-term slowdown in our demand environment. This won’t jeopardize our long-term growth strategies, but we know that it is happening. To that end, we are analyzing and reviewing our retail footprint. We will continue to expand our reach through targeted channel development and digital experiences. During the quarter, we finished converting HAY stores in the U.S. into DWR spaces in several key marketplaces. Based on the success of HAY’s wholesale business in Europe, we opened our first HAY shop-in-shop with Nordstrom here in the U.S. Moreover, through a wholesale partner, we also opened our first Herman Miller and Knoll stores in Shanghai. In addition, we are strategically expanding our international business. Around the world, different regions are in varying phases of return to office. Due to our global footprint, we continue to capture business in areas with more favorable economic conditions such as the Middle East, Asia, and India, to name a few. Our global reach, unmatched product portfolio, and expertise in areas such as healthcare, education, and hospitality are a meaningful advantage. We are making strategic choices to prioritize projects and opportunities that drive sales and margin expansion across all channels. I will show a few examples. Through our integration work, we continue to capture cost synergies with $123 million of implemented savings to date as we work our way towards our goal of $140 million. We are creating systems to deliver improved quality, reliability, and production lead times. Our Geiger facility in Hildebrand, North Carolina, does incredible work, and we are restructuring more MillerKnoll production there, creating a center of excellence for premium upholstery and craft wood products. We are also looking across our global operations network to identify where we have available capacity and unharnessed capabilities. We will move production to the places that are best suited to manufacture items versus having solely brand-dedicated facilities. For example, during the quarter, we shared our decision to shift some metal fabrication work from Toronto to East Greenville, Pennsylvania. We are fine-tuning our brand portfolio. With multiple brands and channels, we can select where and how we sell items. This quarter, we began the work to wind down Fully as a standalone branded sales channel. Going forward, select Fully products will be sold through our existing designer reach and Herman Miller channels. Before I hand the call over to Jeff, I would like to highlight that we continue to lead through innovative design. During the third quarter, we launched a variety of exciting new products across our collective brands. In addition, we continue to deliver against our sustainability goals, reducing our carbon footprint and using sustainable materials. For example, Herman Miller was recently recognized with a chemical footprint project for our commitment to minimizing chemical footprints and integrating criteria for better alternatives into our design practices. In the months ahead, we continue to manage our business, taking into consideration the macroeconomic pressures we are all experiencing. We are vigorously controlling the factors that we can, leaning into our strategy and adapting our business priorities to anchor on our best assets and to develop areas where we see future success. As we navigate various market conditions around the world, we are prioritizing our work around innovation and what drives our business, where there is margin to gain, opportunities to build for future success, and ensuring that our customers turn to us first. With that, I will turn the call over to Jeff for his prepared remarks.
Jeff Stutz, CFO
Thanks, Andi and good evening, everyone. We appreciate you joining us. During this quarter, we delivered adjusted earnings of $0.54 per share, beating our guidance and significantly outperforming the same period last year. While net sales came in lower than the same time last year, we experienced another quarter of strong margin expansion that contributed to our improved performance. At the consolidated level, net sales in the third quarter of $984.7 million decreased 4.4% on a reported basis and 2.7% organically compared with the same quarter last year. Consolidated orders for the quarter were $885.4 million, reflecting a decline of 17.6% from the same quarter last year. Softer demand tied to global macroeconomic uncertainty and elevated comparables in the third quarter of last year resulted in year-over-year pressure for orders in each of our business segments. Within our Americas Contract segment, net sales totaled $484.6 million, a year-over-year decrease of 4.9% on a reported basis and an organic decrease of 4.5%. New orders for this segment came to $461.6 million, reflecting a decrease of 12.6% from the same quarter last year on a reported basis and down 11.8% organically. During the past few months, general economic uncertainty and the impact of rising interest rates have weighed on business and consumer sentiment levels. The result has been slowing demand patterns and further delays in customer return to office timelines. That said, gross and operating margins in the Americas segment have continued to improve as expected, driven by net pricing benefit and cost synergy integration. Operating margins for this segment improved 980 basis points on an adjusted basis versus the same period last fiscal year. Within our Global Retail segment, net sales in the quarter were $257.6 million, a decrease of 7.7% compared to the same period last year on a reported basis and down 5.5% organically. New orders totaled $213.7 million in the third quarter, down 23.5% compared to the same quarter last year on a reported basis and down 21% organically. Here again, macroeconomic pressures and increased stock market volatility have eroded consumer sentiment and buying activity. Overall margin performance in this segment did improve sequentially from the second quarter, but remained lower on a year-over-year comparison due to elevated freight expenses and higher inventory costs that we outlined last quarter. As Andi mentioned, this quarter, we decided to cease operating Fully as a standalone brand. By integrating Fully into our global retail organization, we will reduce operating costs and further optimize our retail structure. As part of our commitment and focus to drive profitable growth and streamline our organization, we are constantly reviewing our channels to market, products and processes to identify ways to leverage our strengths. This decision is an example of that. Turning to our International Contract and Specialty segment, net sales for the quarter were $242.5 million, reflecting an increase of 0.6% on a reported basis and an increase of 4.3% organically. New orders in this segment were $210.1 million, down 27.2% year-over-year on a reported basis and down 24.5% organically. From an adjusted operating margin perspective, this segment delivered strong year-over-year improvement with an increase of 270 basis points, mostly driven by pricing actions taken earlier in the year and favorable product mix. Shifting back to the enterprise level results, we were pleased this quarter to report a meaningful improvement in margin performance. Our consolidated adjusted gross margin in the period was 35.7% and the adjusted operating margin was 7.5%. These results are 260 and 340 basis points higher than the same period last year respectively. Higher pricing, benefits from cost synergies, and a reduction in variable compensation more than offset higher commodity costs and other inflationary pressures to drive these positive increases. Turning to cash flows in the balance sheet, during this quarter, we generated $75.7 million of cash flow from operations and paid down $18.1 million of debt. As part of our focus on maintaining a strong balance sheet, this quarter, we executed an interest rate hedge, which provides an immediate reduction in current interest expense. Together with our previous three hedge instruments, this has provided a fixed interest on 65% of our total bank debt. We ended the period with a net debt-to-EBITDA ratio as defined in our credit agreement of 2.6x. Regarding our guidance for next quarter, the outlook reflects a revenue guide informed by recent order trends. We expect net sales to range between $930 million and $970 million and adjusted earnings to be between $0.37 and $0.43 per share. Before we open the call for your questions, I want to highlight that our focus on actions toward diversifying our business, driving profitable growth, and capturing cost synergies are helping us navigate short-term macroeconomic challenges. More importantly, they are strategically positioning us to capture further top-line and margin expansion when the macroeconomic trends improve. With those prepared remarks, I will now turn the call back over to the operator to take your questions.
Operator, Operator
Thank you. We’ll take our first question from Greg Burns with Sidoti & Company.
Greg Burns, Analyst
Good afternoon. Can you just talk about the order trends in the early part of this quarter? Have you seen any improvement or has it stayed about the same?
Jeff Stutz, CFO
Hi, Greg, this is Jeff. I will take that. The good news is we did see improved trends as we made our way through the quarter, really across each of our three business segments. While we ended the quarter in the organic numbers that I gave you in my prepared remarks, order entry levels in the month of February, for example, were actually better than the full quarter trend in each of the three segments. So, we did see some improvement. In the first couple of weeks of Q4, I would say generally, that’s continued.
Greg Burns, Analyst
Okay. And then just specifically, the decline you saw internationally, the international segment has kind of been an outperformer relative to North America, but it seems like it’s catching down. Is there anything in particular going on there?
Andi Owen, CEO
I think just a couple of things, Greg, and then I’ll turn it back to Jeff. I think the international business is a little lumpier as far as timing and placing orders. If you think about last year, they had an amazing quarter with the price increase that we instituted, and so they are up against really significant comps. There is a little bit of timing in quarter-over-quarter, and there is some comparison to last year in international. We are seeing more weakness in the European business than across the globe. We are also seeing China come back a little more slowly than we had thought. But on the whole, long-term, we feel very optimistic. Jeff, I’ll let you add.
Jeff Stutz, CFO
Yes. The only thing I would add, Greg, is that we had an amazingly strong quarter of order entry last year in our International segment. We had 74% order growth in the third quarter of last year. We’ve never seen anything even touching those types of percentages, so remarkable growth. So, these are real tough comps. And even in the Americas segment, we had growth that was up 37% in the year-ago period. I’m always cautious about pointing to comps, but this is one of those moments where it matters because those were remarkably strong numbers a year ago.
Greg Burns, Analyst
Okay. And then in terms of your synergy targets, I know Fully was a Knoll brand. Is this part of that $140 million in savings there, or is this incremental to that? Are there any other brands that might be absorbed into your broader network?
Andi Owen, CEO
Yes. This is part of the synergy savings, Greg. It’s a great question. As part of the integration process, we will continue for the next several months to evaluate what is profitable, what are the right decisions. We will let you know when we make those decisions and announce them publicly. But right now, Fully is the only place that we’ve made that decision, and it is the right thing to do; always hard to do, but the right thing to do.
Greg Burns, Analyst
Okay, thank you.
Operator, Operator
We will take our next question from Reuben Garner with Benchmark Company.
Reuben Garner, Analyst
Thank you. Good evening, everybody.
Andi Owen, CEO
Good evening.
Reuben Garner, Analyst
Jeff, maybe to start, operating expenses in the third quarter came in lower than what you guys were looking for, and it looks like there is a step-up in dollars in the next revenue. Can you kind of walk through maybe what was different for you in the third quarter? Is there any seasonality of spending leading to the step-up in the next quarter?
Jeff Stutz, CFO
Yes. Happy to, Reuben. You’re spot on. Given order trends, we are really taking every measure to manage costs in line with lower demand levels. One of the big factors in the third quarter was the impact of declining volumes around incentive compensation. We saw some of those accruals come down in the third quarter, so you won’t get a repeat of that in Q4. We tend to see some seasonal uptick between Q3 and Q4 in spend rates as we ready ourselves for new product releases. So, I think all of those factors combined caused that. Those programs work as designed. They are variable. When you see volume levels drop, you see those come down, so that isn’t a surprise.
Reuben Garner, Analyst
Okay. And then same line of questioning on the gross margin side. With your guidance for the next quarter, you're still on the path you laid out at the end of last year, despite less volume than you probably would have otherwise thought. Can you kind of walk through what improved sequentially? Is it simply price flowing through, and maybe some deflation or inflationary release?
Jeff Stutz, CFO
Yes, you’re hitting on a couple key points, Reuben, and we feel good about the margin expansion across the business even as demand levels have fallen. Our guide for Q4 will be informed by a couple things. Pricing is one, on the order of 30 basis points. We are starting to see market prices move, particularly with commodities; the market price of steel, for example, has been ticking up. But we still believe overall, as a basket, commodities will be favorable to us sequentially. The mix factor also plays a role, and we expect meaningful improvement in the retail side of our business as we move into Q4.
Andi Owen, CEO
The last thing I would add, Jeff, is just you start to see synergy capture coming through that line as well. As we continue to capture more synergies, we will also see improvement in the margin.
Reuben Garner, Analyst
Alright. I’m going to squeeze one more in; a follow-up on Holly. Is that something you are not able to do because of developments with hermanmiller.com and internal initiatives versus some structural change?
Andi Owen, CEO
It’s a great question, Reuben. When Knoll acquired Fully, it offered them a digital avenue to market that they didn’t have, but we have that and a very well-established retail business. As we look across the organization and find redundancies, we need to address that. We don’t need the duplication we’ve had. Although Fully is a small portion of our business, it has been breakeven at best. This was the right decision and we can still maintain those great products without incurring the extra cost that made it unprofitable.
Reuben Garner, Analyst
Got it. Thanks, guys and good luck going forward.
Andi Owen, CEO
Thank you.
Operator, Operator
We will take our next question from Budd Bugatch with Water Tower Research.
Budd Bugatch, Analyst
Good afternoon, Jeff. Good afternoon, Andi and the team. Congratulations.
Andi Owen, CEO
Good afternoon, Budd.
Budd Bugatch, Analyst
Can you hear me, am I coming through?
Andi Owen, CEO
Yes. We can hear you.
Budd Bugatch, Analyst
Okay, thank you. Congratulations on managing the margins. That’s impressive. And the difference is at least to my model, mostly centered in the Americas, which I don’t suspect is a big surprise. In terms of revenue, I know you said the order patterns have started to improve. Can you quantify that or are we looking at a positive orders year-over-year in the last couple of weeks of the quarter and maybe the first couple of weeks of the next?
Jeff Stutz, CFO
Yes, Budd, this is Jeff. We started the quarter lagging down double-digit percentages. We improved in January and February to single digits. The percentage still declined, but there’s an improving trend line. That has moved a little bit in the first couple of weeks of Q4, but nowhere near as low as it was to start back in December. So, it’s still pressure, but it’s moving in the right direction.
Andi Owen, CEO
Operator, are we getting feedback on the line?
Operator, Operator
Yes, madam. I am hearing that.
Andi Owen, CEO
Thank you, Budd, can you hear?
Budd Bugatch, Analyst
I can hear you fine. I’m not getting the feedback. So I don’t think it’s coming from my line.
Jeff Stutz, CFO
Alright. We were getting a little feedback in the room. Yes. I would say that trend is at least moving in the right direction, albeit still year-on-year pressure combined with some of the funnel metrics we’re seeing.
John Michael, President of Americas Contracts
From a funnel perspective, we’ve seen significant growth in the over $1 million size projects, something we really haven’t seen a lot of since pre-pandemic days. Significant activity there, and the overall funnel is up quarter-to-quarter as well. From Q3 to Q4, our net funnel additions were up 38%. The activity seems to be percolating a bit, and that gives us some encouragement to see some change in order trend over time as well.
Budd Bugatch, Analyst
And when you’re talking about the funnel, you’re talking about visits and projects you’re bidding on? Or is there something more concrete to what you define as the funnel?
John Michael, President of Americas Contracts
It’s identified project and account opportunities that our sellers have identified and are pursuing in the market. They are live projects that we’re tracking in pursuit of.
Budd Bugatch, Analyst
And the BIFMA numbers look like we’re getting into a situation where orders are just about flat year-over-year, getting there. The fact that you’re still down single-digit, does that mean that you’re performing a little bit behind BIFMA for the rest of the industry?
Andi Owen, CEO
You have to look at BIFMA with a grain of salt. Depending on how players are reporting their numbers and what’s included in contract, you can’t necessarily make that lead.
Budd Bugatch, Analyst
Okay. I always take those numbers with a grain of salt indeed.
Jeff Stutz, CFO
I’ll keep it at the enterprise level just because we don’t guide at the segment level, but our margin expansion has been strong. Pricing was a big factor for us this quarter, and it really has been favorable with 400-plus basis points improvement in gross margins. We are seeing product mix shifts that have been in our favor, net commodity impacts have leveled off significantly, and we did experience some overhead loss from lower production levels, about 70 basis points down year-on-year. Overall, we’re seeing positive changes occur.
Andi Owen, CEO
Budd, yes, that’s the representation of our margin trends as outlined. We are very pleased about that.
Budd Bugatch, Analyst
Thank you very much. Good luck going forward.
Operator, Operator
We will take our next question from Steven Ramsey with Thompson.
Steven Ramsey, Analyst
Hi. Good evening.
Andi Owen, CEO
Hi Steven.
Steven Ramsey, Analyst
Maybe to start with just bringing the Americas orders and demand into the context of companies laying off workers, but the tug of war against companies wanting workers in the office. How is that shaping conversations for the longer term?
Andi Owen, CEO
It’s a great question. John alluded earlier to the amount of activity that we are seeing, and I think it’s directly related to returning to work, to leaders of companies wanting to find ways to get people back in the office. We are seeing an uptick in activity looking to find creative ways to change spaces to adapt to the new workforce, so more activity than we’ve had in the past. That is shaping our ability to help people make these decisions about their workspaces.
John Michael, President of Americas Contracts
Literally every C-level conversation we are having in the last 90 days, those executives are looking for ways to get their employees back in the office. They understand the importance of return to office for reasons like culture, connection, and collaboration. They are becoming bolder in their desire to have people back because they understand the business impact of not having their employees back in the workplace. That will change from a headwind to a tailwind as companies come to grips with that.
Steven Ramsey, Analyst
Okay, great. Shifting to international, can you share if this is a new initiative in expanding your dealer network internationally? Is this going to be a major sales benefit in the next couple of quarters?
Andi Owen, CEO
Yes. We have been investing in and developing our international sales team, expanding our dealer network internationally for the last several years. We stand more ready now than we did a couple of years ago to capture opportunities in different markets. This has been a conscious effort and we will start to reap the benefit as we find these opportunities.
Jeff Stutz, CFO
This is where the combination of Herman Miller and Knoll plays to our advantage. We now have new tools and new solutions to offer existing dealer partners, opening doors in markets where we have high expectations.
Steven Ramsey, Analyst
Great. Last quick one for me on the Fully shift. How quickly does that help profitability in the retail channel?
Andi Owen, CEO
We will be unwinding this in the next quarter, and then we will see it in Q1. This is a small portion of the retail business.
Jeff Stutz, CFO
I think that’s fair.
Steven Ramsey, Analyst
Great. Thank you.
Andi Owen, CEO
Thank you.
Operator, Operator
We will take our next question from Alex Fuhrman with Craig-Hallum Capital Group.
Alex Fuhrman, Analyst
Hey guys. Thanks for taking my question. I’m hoping you could square a bit the differences in what we are hearing about for orders versus your revenue trends.
Jeff Stutz, CFO
Yes, Alex. Good question. The orders did get a little better, and in particular, in the international business, we have line of sight to orders that we have confidence in early enough in the quarter to influence revenue in Q4. While our Q4 revenue guide is down from the Q3 number, this is reflective of economic conditions and has some seasonality expected in Q4.
Alex Fuhrman, Analyst
Great. That’s helpful. Can you give us a sense of where the backlog should be? At $400 million before COVID, now around $700 million. Do you expect that to continue to work lower throughout next year?
Jeff Stutz, CFO
We are nearing a point where the backlog is largely stabilized. As we move through Q4 and into Q1 of next year, our expectations would be that we are at that new normal level. We’re not going to give an absolute dollar amount, but we think it’s going to stabilize.
Alex Fuhrman, Analyst
Great. That’s helpful. Thanks.
Andi Owen, CEO
Thank you.
Operator, Operator
We will take our next question from Budd Bugatch with Water Tower Research.
Budd Bugatch, Analyst
Yes. Sorry to prolong it, but I wanted to make sure I understood something. Are there still acquisition and integration charges continuing?
Jeff Stutz, CFO
Yes, there are potential for other charges, but we are not guiding on those because it can move around. The only absolute known would be the amortization cost I mentioned.
Budd Bugatch, Analyst
Got it. Well, thank you very much, and good luck in future periods.
Operator, Operator
And there are no further questions. We turn the floor back to President and CEO, Andi Owen, for any closing remarks.
Andi Owen, CEO
Thanks again everyone for joining us on the call. We appreciate your continued support of MillerKnoll and we look forward to updating you on our progress again next quarter. Thanks again and have a great night.
Operator, Operator
That does conclude today’s presentation. Thank you for your participation, and you may now disconnect.