Earnings Call Transcript - MLKN Q1 2024

Operator, Operator

Good evening and welcome to MillerKnoll's Quarterly 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

Good evening and welcome to MillerKnoll's first quarter fiscal 2024 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 Contract; 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 from 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 we 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 at millerknoll.com. With that, I will turn the call over to Andi. Andi?

Andi Owen, CEO

Thanks, Carola. Good evening, everyone, and thank you for joining our call. I'm very excited to share that our team delivered a strong first quarter, as evidenced by our top-line results and margin expansion. Across our enterprise, we have set ourselves up to seize opportunity as market conditions improve, and we believe we are at an inflection point. Now regarding our continuing strategy, I'd like to highlight some of the efforts we're making to become more resilient and future-proof our business, including diversifying our business both in North America and globally, streamlining our global operations, moving production and capacity efficiently, and investing in e-commerce. We believe that the work we're doing is paying off with much to look forward to on the horizon. At the same time, we remain pragmatic about the next few months. We're still in the early period of recovery, and our business segments reflect a varied economic conditions around the globe. Right now, we have cause for both enthusiasm and vigilance. We've seen companies begin to take the leap back into physical space and announce return to office policies. Office leasing in the US began to rebound in the second quarter of 2023, and we're seeing this among our clients as companies continue to announce return to office policies. Moreover, the American Institute of Architects' Billing Index, or ABI, has been flat for the last six months, suggesting a slow, but stable construction outlook. Having said that, we're still seeing mortgage rates at 20-year highs, and uncertainty remains about future rate hikes, which dampens the housing market and impacts the near term in our retail segment. Overall, we remain focused on economic and industry activity worldwide so that we can continue to deliver what our customers and clients value most. Our research and insights team is best-in-class, bringing the latest data and learning to our customers. This fall, we'll be sharing our latest point of view on the workplace, defining ideal spaces based on quality and actionable data. This fresh, thoughtful perspective emphasizes what we believe are the key factors to designing the best basis to support thriving and engaged teams. Internationally, we're seeing some pockets of softness, mainly centered in Europe and China. Similar to North America, we are further pursuing resilient sectors and global accounts. We've seen that our scalability and ability to deliver a wider range of products is a unique market advantage, and we'll continue to seek out these wins. In addition, over the next 12 months, we plan to transition 60 more international Herman Miller dealers into MillerKnoll dealers, expanding our offering to clients and our share of wallet with our dealers. Regarding retail, the deceleration in the North American housing market and the upswing in interest rates across Europe have continued to influence demand in this segment compared to the previous year. Nevertheless, during the quarter, the order trajectory in the North American market surpassed that of other regions, primarily attributed to enhancements in our direct-to-consumer channel. We're strategically allocating resources to improve our digital platforms and technological infrastructure, aiming to enhance the overall customer experience and satisfaction levels, all while intensifying our efforts to fortify brand awareness. Furthermore, in the first quarter, we opened a new design within REIT store in Ardmore, Pennsylvania, which has delivered very promising early results, including robust foot traffic and order placement. Now I'd like to talk a little bit about our gross margins. It expanded year-over-year sequentially and across all of our business segments. In the past, I've talked about focusing on what we can control, and this performance is proof of that. We're seeing efficiency improvements derived from our synergy capture. We have pricing power. We're laser focused on inventory management and product mix, and we continue to seek cost reductions. All of these key elements are enabling us to improve the profitability of our core operations. I'm extremely proud of all the work our teams have done and continue to do every day to seek and seize opportunities. Finally, this quarter was not short on activity, so I'll walk you through a few of the highlights. We started out strong with a successful phase, the largest North American presentation of our MillerKnoll collective of contract products and services. Throughout the quarter, we debuted new products and textiles across our collective, including NaughtOne's Morse Table System, which was awarded Gold by Best of NeoCon; Herman Miller's first collaboration with Gabriel Tan launching the Luva Modular Sofa and Cyclade Tables, as well as the beautiful array of textiles from our textiles group, many with sustainable fabrics at the forefront. The HAY team launched a collection of lamps and other ancillary items. Holly Hunt celebrated their 40th anniversary with a collection of beautiful pieces. At Knoll, we celebrated the 75th anniversary of the Iconic Womb Chair while also introducing the Saarinen Table at a modern lounge height. We relaunched Herman Miller archival classics, all with fresh interpretation, and we made significant progress towards our sustainability goals, bringing solar power to our UK operations facility. All in all, I'm pleased with the strong quarter we delivered. Our team is connecting and moving the business forward in exciting creative ways and we're capturing market share and growth opportunities as they arrive. While I believe the rest of fiscal year 2024 will remain a transitional year with economic indicators trending more positively and pockets of weakness remaining, I'm confident in our ability to deliver shareholder value as we are operating efficiently and making decisions to further improve our margins and profitability. I'm looking forward to progressing towards our goals, positively impacting our industry and advancing our strategy to remain resilient and ready for the future. With that, I want to thank you for your continued partnership with us. I'll now turn the call over to Jeff for a deeper look at our financials.

Jeff Stutz, CFO

Thank you, Andi, and good evening, everyone. As Andi just said, we are proud that our teams delivered a very strong quarter. The results reflect some of the themes that we've been communicating over the past several quarters. First, our focus on diversification, both across geographies, business sectors, and customer segments; and second, our focus on margins, taking action across several fronts. For the first quarter, we generated adjusted earnings of $0.37 per share, which were $0.16 above the midpoint of our guidance. Overall, strong net sales and gross margin expansion across all of our business segments drove the over-performance. Net sales in the first quarter were $918 million, above the midpoint of our guidance, driven by strong performance in the Americas Contract segment. Our consolidated gross margin was 39%, which was 450 basis points higher than the same quarter a year ago and also improved on a sequential period basis. Moreover, this marks the third consecutive quarter of consolidated year-over-year adjusted gross margin expansion. As Andi mentioned, several factors contributed to this, including the realization of price increases, ongoing benefits from integration-related synergies, and positive shifts in product and channel mix. Our consolidated adjusted operating margin was 6% for the period. Turning to cash flows in the balance sheet. This quarter, we generated approximately $131 million in cash flow from operations. This represents an increase of nearly $200 million compared to the same quarter last year, mostly driven by working capital improvements. As a result of this, we were able to retire $66 million of debt and took the opportunity to repurchase approximately 1.7 million shares for a total cash outlay of $31.7 million. We finished the first quarter with a net debt-to-EBITDA ratio of 2.5 times, which puts us comfortably under the maximum limit defined in our lender agreements. New orders at the consolidated level totaled $914 million in the first quarter, reflecting an organic decrease of 1.3% from the same quarter last year. While this is lower from last year on an absolute basis, the rate of year-over-year decrease once again improved this quarter. Within our Americas Contract segment, net sales in the period were $490 million, representing an organic decrease of 1.7% from the same quarter last year. New orders in the period totaled $487 million, which was up 2.1% over last year. This is particularly encouraging as it's the first time in four quarters we've reported an increase in order levels in the Americas segment. I'd also like to highlight the fact that our Americas Contract team delivered another quarter of double-digit adjusted operating margin, which totaled 10.6% in the quarter. Turning to our International Contract and Specialty segment, net sales for the quarter totaled $228 million, down 10.9% organically year-over-year, while new orders came in at $228 million, reflecting a year-over-year organic decrease of 3.6%. While we continue to be very optimistic about the medium to long-term growth potential in this segment, near-term macroeconomic headwinds, particularly in China and parts of Europe, are impacting demand. Adjusted operating margin within this segment was 6.5% in the first quarter, down year-over-year, driven by lower sales volume. This was partially offset by improved gross margin performance, which continues to benefit from previous price increases and our cost synergy program. Moving to our Global Retail segment, net sales in the first quarter of $199 million, were down 13.6% organically from the same quarter last year. New orders in this segment of $199 million were 6.4% lower than a year ago on an organic basis. While the slowdown in the North American housing market and the rise in interest rates globally continue to affect the demand for this segment compared to last year, we are optimistic about the progress our team is making in expanding our market share through our direct-to-consumer channels, given the relative order performance of some of our competitors. And as such, we are further positioning our most mature retail brands as preferred choices for authentic design. Adjusted operating margin in the Retail segment was 1.6%, down year-over-year, mainly due to a combination of lower volume and product mix. Now turning to our near-term guidance and outlook. Given the improvements we are seeing in gross margins across each of our business segments and continued signs of demand stabilization in our North American Contract business, we are increasing our adjusted earnings guidance for the full fiscal year, which we now expect to range between $1.85 and $2.15 per share. As it relates to the second quarter of fiscal 2024, we expect net sales to range between $950 million and $990 million and adjusted diluted earnings to be between $0.52 and $0.58 per share. And I'd point out that this guidance takes into consideration the relative seasonal increase in sales that we expect to experience in our Retail segment from the first quarter to the second quarter of our fiscal year. So with that overview of the numbers, I'll now turn the call back over to the operator, and we'll take your questions.

Operator, Operator

Thank you. Your first question comes from Budd Bugatch with Water Tower Research. Your line is open.

Budd Bugatch, Analyst

Thank you and good evening, Andi, Jeff, Carola, John and Debbie. Hey, congratulations on the margin performance in the quarter. I would love to start, but just by punching into the order flow during the quarter, if you can make some commentary on how that went particularly in Americas Contract? I think if I caught your drift, you're saying we're seeing some improvement in that. And did that show up late in the quarter? And how has the second quarter started?

Jeff Stutz, CFO

Yeah, Budd. Good evening. This is Jeff. I'll start and then John and Andi, if anyone please add as you see fit. So maybe just on the Americas segment in particular, so order activity in the first half of the quarter was positive, Budd, and showed some signs of slowing in August and the first couple of weeks of September. Now with that being said, the timing of last year's price increase, which, as a reminder, was 8% at the start of October a year ago, would certainly be expected to make September's comparisons much more difficult in the current year. But when we zoom out from that week-to-week data, the general trends over the past three quarters have shown improved demand activity, and that gives us some confidence that more consistent growth is around the corner. So it was a bit choppy in August and early September. I think we're seeing some of that bump up against the tough comps from last year due to the sizable price increase we put in place at the beginning of October, but I'll pause there. And John, anything you have?

John Michael, President of Americas Contract

Thanks, Jeff. I'd just add, if we looked at additions to the funnel for the quarter, we had, I think, the second largest volume of additions to the funnel that we've had in the last 12 quarters. So from a project activity perspective, we're still seeing a fair amount of activity. And we've seen the day-to-day business maintain a steady pace as well. So I think to your point, Jeff, a lot of opportunity. I think we're seeing some regional differences, right, in terms of strength of markets, but overall, very positive.

Budd Bugatch, Analyst

That's interesting because we had heard, and I'm sure you're aware that maybe project activity had lessened in the quarter and day-to-day business had replaced that. Is that not what you're seeing? Is that varying with what you're seeing?

John Michael, President of Americas Contract

We're seeing the day-to-day activity maintain a steady solid pace. And in terms of new project adds to the funnel, it's been very robust for the last 90 days.

Budd Bugatch, Analyst

Got you. Okay. And in Retail, what are you seeing, Debbie? Are you seeing any indication that maybe we're at the bottom and not getting any much worse or bouncing along the bottom?

Debbie Propst, President of Global Retail

So, Budd, just from an order pacing perspective throughout the quarter, we actually saw a very strong August. We attribute softness that we saw in June and July, obviously, to the macroeconomic conditions, but also the heightened travel spend during the summer months. And on an adjusted basis, our August order performance was actually flat to last year. So we feel like we have momentum. Additionally, we believe, as we look at benchmarks externally, we're taking share, given the increased performance of our marketing tactics and all the other investments that we're making to improve our efficiencies and how we engage with the customer.

Andi Owen, CEO

I think one of the really important points, hi Budd, it's Andi, about the Retail business is also the relative strength that we're seeing in the North America Retail segment where we are seeing momentum and demand pick up compared to the past few quarters, and that's encouraging since it's one of our largest segments.

Debbie Propst, President of Global Retail

And the segment that we have a direct-to-consumer more mature strategy, our business internationally is largely wholesale where we have limitations with open to buy of the wholesale partners that we sell into.

Budd Bugatch, Analyst

So you're seeing better DTC than you're seeing in-store, is that what I understand?

Debbie Propst, President of Global Retail

We think about our direct-to-consumer business as both our store business and our e-commerce business. We also have a wholesale business, which is the sell-in of our products into third-party retail partners. Our direct-to-consumer business is performing much more resiliently right now, given the more agility we have and the levers we can deploy in that piece of our business versus in our wholesale business.

Budd Bugatch, Analyst

And I think we said this, and that was my understanding that your wholesale business is primarily offshore, not domestic.

Debbie Propst, President of Global Retail

Primarily international.

Andi Owen, CEO

Yes. That's correct, Budd.

Budd Bugatch, Analyst

Okay. A couple of other things. You've raised the earnings guidance for the year. And I think when you were giving that guidance at the end of the fiscal year, you also mentioned a sales expectation modestly below that you're just reported. Any update on that sales expectation for the full year, Jeff?

Jeff Stutz, CFO

Yes. Well, I think, we're largely in the same place. I mean we're several quarters out to end of fiscal. I think what we wanted to make sure we signaled here is that the over-performance that we delivered in Q1, we believe we can take that to the bottom line full year. I don't think there's a meaningful change in the outlook from a revenue perspective. But we were intentionally vague, as you remember, at the end of the year when we talked about the revenue guide. So I think we're basically in the same place.

Budd Bugatch, Analyst

I do remember that.

Andi Owen, CEO

Of course, you feel bad.

Budd Bugatch, Analyst

Sorry, it's a fault that I'm trying to overcome. Regarding restructuring, can you provide some details on what that involves and the current status? Should we expect more restructuring charges in the upcoming quarters, and is it mainly related to salaries and compensation?

Jeff Stutz, CFO

We had total charges this quarter amounting to approximately $15 million, which includes special charges. Some of these costs were related to restructuring expenses tied to workforce reductions that have already been announced and implemented both in the US and internationally. While we do not have imminent plans for further restructuring, we will respond to business conditions as necessary. The restructuring component of these charges was around $5 million, while the rest relates to costs associated with achieving integration linked to our synergy capture program. These integration costs from ongoing projects will continue, and we are approaching the end of this three-year process, which will conclude by the end of the first quarter of the next fiscal year. Most of the remaining projects involve showroom consolidation and planned manufacturing changes. As such, we expect to see additional impacts on operating expenses and cost of goods sold from these initiatives throughout the remainder of this fiscal year as we finalize these projects.

Budd Bugatch, Analyst

We will continue to focus on the integration. The amortization of PI will proceed as planned. The restructuring will take place as we identify relevant projects, which may have an impact. I recognize that this involves sensitive issues regarding compensation and workforce, but those details have not yet been disclosed. Is that the correct understanding?

Jeff Stutz, CFO

That is correct. Nor do we have necessarily plans to announce them so. Again, we'll react to business conditions as we move through the balance of the year.

Budd Bugatch, Analyst

Understood. Okay. Thank you very much. I'll let others proceed. Thank you.

Jeff Stutz, CFO

Thanks, Budd.

Andi Owen, CEO

Thanks, Budd.

Operator, Operator

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

Gregory Burns, Analyst

Good afternoon. In North America now that we're nearing the end of the integration process, how has the consolidation of the dealer networks gone? Are we at the point now where they're fully up to speed and generating the level of productivity that you would expect them to? Or is there still a level of learning curve that they need to move up to sell the full portfolio of products? Thanks.

Andi Owen, CEO

Yes. I mean I would say, overall, Greg, we're very pleased in North America with the pace at which our dealers and our dealer designers have learned all the product lines from the corresponding legacy companies. But I'll let John add some color to that.

John Michael, President of Americas Contract

Yes, I think we are really, really pleased with the way the network has come together. We had just last week 22 of our largest dealers in West Michigan, 11 originally from the Miller side, 11 from the Knoll side. Honestly, you couldn't tell who came from which camp, right? They really have meshed extremely well together. Obviously, there's a learning curve to learn the new products. And I would say if I characterize our FY'23, that learning curve, we probably started up it a bit more slowly than we expected, but we finished much stronger than we expected. We really picked up a lot of momentum throughout the course of the year. And I think we exceeded our expectations in terms of what we would call cross-sell legacy Miller dealers selling new products and vice versa. So we're really pleased with the way the network has come together.

Gregory Burns, Analyst

Okay, great. I understand there are macro issues affecting some international markets. Can you discuss the opportunities for selling the broader portfolio? I know you're adding dealers, but how far along are you in tapping into that opportunity in the long run? Are we still in the early stages, or are we not seeing much progress yet? Also, is there potential for you to counter some of the macro challenges with these organic growth initiatives?

Andi Owen, CEO

Yes, Greg, you're exactly right. We initially focused our efforts on North America because it’s our largest market, and we're just starting to expand internationally. We've successfully converted some dealers, and in terms of product rationalization and understanding product specifications, along with continuing dealer conversions, we see significant potential, especially in selling the Knoll Studio ancillary products globally. There’s still a lot of progress to be made, and we’re genuinely excited about the possibilities for growth in this area.

Gregory Burns, Analyst

Okay. Great. Go ahead.

Andi Owen, CEO

We had very limited contract dealers in the past, focusing mainly on interior design and retail wholesale customers. Expanding that product line to include contract dealers is a new initiative, and we are enthusiastic about it. Jeff, do you have anything to add?

Jeff Stutz, CFO

Yes, Greg, we may have mentioned this at the end of the year. Just to recall, Knoll did not have a broad international dealer network, and we are transitioning to the MillerKnoll dealer format. Currently, around 80 out of 335 international Herman Miller dealers have been transitioned, and we anticipate another 60 to be completed by the end of this year. We are progressing with this effort at a steady pace.

Gregory Burns, Analyst

All right. Great. And then lastly, I appreciate the kind of balanced approach you're taking to capital allocation. Relative to your leverage, is there a target you're trying to get to? Are you comfortable at 2.5 times? Are you trying to reduce that any further going forward?

Jeff Stutz, CFO

Yes, we're comfortable with the 2.5 leverage level we have now. From the start, we have aimed to follow a path that reduces our debt over time, and that plan hasn't changed from our view. In the long term, a leverage ratio of around two times seems reasonable, although that is also greatly affected by demand and the earnings power of the business. We intend to keep paying down debt as we progress, but we are not fixated on the current leverage ratio.

Gregory Burns, Analyst

All right. Great. Thank you.

Operator, Operator

Your next question comes from the line of c Garner with Benchmark. Your line is open.

Reuben Garner, Analyst

Andi, good evening. Good evening, everybody.

Andi Owen, CEO

Hey, Reuben.

Jeff Stutz, CFO

Hey, Reuben.

Reuben Garner, Analyst

So Andi, you mentioned an inflection point. I was curious if you could elaborate on that. Is that an inflection in MillerKnoll specifically? Was that a profitability comment? Was that a macro perspective? Anything that you can kind of give on that comment would be helpful.

Andi Owen, CEO

Yes. It's really a macro perspective and also the sentiment that we're hearing from our customers from CEOs and from research that we've done around returning to office, around spending time together, I think that we are seeing a lot more of our clients finding ways to bring people back together, finding ways to utilize their space. I think the world has moved through a cycle of remote to hybrid to flexibility. And I think as John talked about new projects and new demand in the funnel that return and I think CEO sentiment around the return has turned to the majority in favor of being together more often, and that works well for us, and we're excited about that. That's what I meant.

Reuben Garner, Analyst

And so that project funnel that John referenced, what about the willingness and maybe this goes into your inflection point comment? Are you seeing a change in the willingness to kind of pull the trigger on those projects? Or is it still kind of that planning and thinking about the new way of work phase?

Andi Owen, CEO

Yes. We're seeing more confidence in decision-making. The less CEOs and decision-makers waiting to see what everyone else is doing and sort of boldly going into what's right for their organization, obviously, with some help and guidance from us. And the decision points, I don't think there is short and John, please add to this, as short as they used to be pre-COVID, but they've certainly shortened substantially from where they were six months to a year ago. What would you add, John?

John Michael, President of Americas Contract

I agree, Andi, that there is still a lot of refining that happens before the plan is finalized. People really want to make sure they get it right. However, I would also note that there is an increasing sense of urgency among CEOs and leaders, perhaps even some frustration regarding this issue. This aligns with Andi's point and serves as a catalyst for action, prompting them to move forward with certain projects and make decisions. This is clearly a positive development for us and our industry.

Reuben Garner, Analyst

Great. And Jeff, sorry if I missed this, but can we give an update on where we are in the price/cost journey? I know you guys had an increase out as recently as this summer, I believe? Are the current kind of double-digit margin run rates that you're seeing in the Americas fully reflecting your price cost? Have you gotten your margin back or is there still kind of room to run there?

Jeff Stutz, CFO

Yes, Reuben, I agree with you. To clarify, we did implement an increase that took effect in early July. It was not the significant 8% to 10% increases we've experienced in previous years, but rather closer to an average of 3%. This aligns more with historical price increase trends, and it will take time to fully integrate. We see potential for further improvement. I want to take this opportunity to emphasize our synergy plan, which we've been diligently working on for over two years. Although market conditions have somewhat obscured our efforts, we've made substantial progress. In our Americas business, we achieved over 800 basis points of gross margin expansion year-on-year this quarter, which is significant. I credit this to pricing and the price-cost factors that have shifted slightly in our favor. I believe there's still more potential for growth here. The synergy plan is coming together, and as I mentioned earlier regarding our ongoing projects, we anticipate more opportunities for margin expansion. However, it's important to note that we need some level of demand support to realize this. Therefore, we will continue to closely monitor the macroeconomic environment. If we see support in that area, we believe we are positioned for additional margin expansion as we progress.

Reuben Garner, Analyst

You stole my thunder. That was my follow-up question. So I think I'll end with stock repurchase. I believe that was the largest repurchase we've seen in some time for the quarter. Maybe just update us on what you're thinking is there? Is that something we'll continue to see if the stock kind of remains at these levels? It seems to speak to your confidence that maybe we're turning a corner here, and the stuff is not reflective of that, but I don't want to put words in your mouth?

Andi Owen, CEO

Yes, I would say we believe we're oversold, but I think we have a very balanced perspective on capital allocation. We'll continue to pay down debt. But if we continue to see opportunistic time to purchase our stock, we'll do that too. We believe that's a great return for our shareholders, and we believe in the future.

Reuben Garner, Analyst

Great. Thanks, guys. Congrats on the strong results and good luck.

Jeff Stutz, CFO

Thanks, Reuben.

Operator, Operator

There are no further questions. We turn the floor back to President and CEO, Andi Owen for any closing remarks.

Andi Owen, CEO

Thank you so much guys for joining us on the call. We really appreciate your continued support of MillerKnoll and we look forward to updating you on our next quarterly call. Have a great night.

Operator, Operator

This concludes today's conference call. You may now disconnect.