Earnings Call Transcript - MLKN Q1 2023

Ken Diptee, Vice President of Investor Relations

Good evening. And welcome to MillerKnoll's first quarter conference call. I'm joined by Andi Owen, Chief Executive Officer; and Jeff Stutz, Chief Financial Officer. Also available for during Q&A are Debbie Propst, President, Global Retail; and John Michael, President, Americas Contract. 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, 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 assumes no obligation to update or supplement these statements. You may also refer to certain non-GAAP financial metrics, which are reconciled and described in our press release posted on our Investor Relations website.

Andrea Owen, CEO

Thanks, Ken. Good evening, everyone, and thank you for joining our call. MillerKnoll was created to lead our industry and deliver results by offering customers modern design solutions for their workspaces and homes through a unique collective of brands and channels. We continue to leverage and build on the competitive advantages we established during our first year as MillerKnoll. This quarter, we successfully launched our MillerKnoll sales organization and dealer network, introduced new products at the company's first Design Days and continue to capture synergies through our integration work. First quarter results are a testament to our diversified global business. Our multi-channel, multi-brand collective is designed to sustain shifting economic conditions and drive growth. During the first quarter, we experienced the impact of economic softening in various parts of the world, and our results reflect how we can drive strong performance in different segments and regions to balance the performance in others. Around the globe, we hear from customers that the workplace matters. Companies see the benefits of a hybrid model and want to bring teams together for culture, collaboration and productivity. However, the pace at which companies are placing orders and enhancing their workspace varies based on location and sector. In the Americas segment, we posted healthy growth in revenue compared to last year but saw a slowdown in order activity. We are feeling the impact that the economic uncertainty is having on our customers, particularly in the U.S. They have concerns about inflation, piloting smaller orders and requiring more revisions to projects as they learn to operate in a mostly hybrid environment. Given this macroeconomic backdrop, we are proactively taking actions, including continued pricing increases and careful management of discretionary spending. Our International Contract & Specialty segment sales and orders continue to grow after a strong fourth quarter. Our global presence and the ability to take brands into new markets is an important advantage that we will continue to leverage. The international dealer cross-sell pilot now includes 41 dealers from 17 countries on three continents. We plan to expand it to India, the Middle East and Africa later this year. Holly Hunt, which appeals to a premium residential customer that is more resilient to inflationary pressures and Spinneybeck|FilzFelt, whose customized solutions help our customers enhance the acoustics and walls of their spaces, both delivered record sales levels for the quarter. In addition, Geiger and DatesWeiser generated sales growth from their elevated designs for executive offices and conference rooms. Turning to product, we introduced more than 15 new products this year, including new task chairs from both Herman Miller and Knoll, an innovative inlet screen from Knoll, new textiles from Maharam and Knoll, new outdoor and ancillary collections from Muuto, and naughtone café tables and stools. In addition, we've launched new takes on iconic pieces, including a Sun and Vibrant collaboration with Rolf and Mette Hay on select Eames pieces, and the reimagination of the Eames shell chair, which is now available in 100% recycled plastic. These new products reflect innovation and design and functionality and have a commitment to delivering on our 2030 sustainability goals. Whether it's incorporating more planet-healthy materials, using advanced manufacturing practices or reducing our packaging, we are seeing momentum across all areas of our business to lower our carbon footprint and design outlays. We also launched the MillerKnoll Foundation. This philanthropic platform unites the strength of our legacy foundations with programs dedicated to engaging underrepresented youth in art and design, advancing equity in MillerKnoll communities worldwide, and protecting our planet through sustainable design. In addition, we continue to deliver on our commitment to diversity, equity, and inclusion through ongoing education across our company, buying conscious bias and inclusive spaces, the sponsorship of new CEO Action fellows and new Diversity in Design programs. I have confidence in the programs and innovation we are pioneering across our collective. We are actively managing all facets of our business with close attention to market drivers, economic conditions and local market interests. We are prepared for the road ahead. With that, I'll turn it over to Jeff, who will discuss the financial results in greater detail before we open it up for questions.

Jeffrey Stutz, CFO

Thanks, Andi. Good evening, everyone. Our results for the first quarter reflect the steps we've taken to position MillerKnoll for growth. These results also leverage the benefits of our diverse business model, which has helped to mitigate some of the pressures from the current macroeconomic environment. We also saw signs of stabilization in our supply chain, and lead times returned to near normal levels, although some pockets with longer lead times still remain. As we look ahead, we continue to focus on what we can control and providing solutions to our customers. As you saw in our press release issued today and the 8-K filed on September 8, we changed our reporting segments to align with changes in our organizational structure, which was effective at the start of the first quarter. As a quick reminder, our segments now consist of Americas Contract, International Contract & Specialty, and Global Retail. Turning to our results, consolidated net sales in the first quarter were $1.1 billion, an increase of 37% on a reported basis and 12% organically compared to the same quarter last year. Consolidated orders continued to exceed prior year levels on a reported basis with orders of $1 billion reflecting an increase of 11% year-over-year. On an organic basis, orders were down 11% compared to the same period last year, primarily driven by the Americas Contract and Retail segments. In the Americas Contract segment, sales in the first quarter were $537 million, an increase of 41% on a reported basis compared to the same period last year and up 15% organically. Order levels in the first quarter increased 3% to $511 million compared to the same quarter a year ago on a reported basis and declined 17% organically. The decrease was due to several factors. These include a challenging comparison due to pent-up demand caused by the pandemic last year, projects taking longer due to dealers being understaffed, and general uncertainty surrounding the current macroeconomic environment. Now I'll turn to the Global Retail segment. Sales in the quarter for this segment were $269 million, up 11% compared to the year-ago period on a reported basis and down 4% organically. New orders totaled $249 million in the first quarter, up 9% to last year on a reported basis and down 8% organically. The segment's performance was mainly impacted by a shift in consumer spending towards experiences such as post-pandemic travel and continued macroeconomic uncertainty. We're making targeted investments to both scale the retail business and drive new customers to our channels, while at the same time, carefully managing our overall cost structure in this business. During the quarter, we opened six new stores across Los Angeles, New York, Denver, West Palm Beach, Copenhagen, Denmark, and Nagoya, Japan. In the second quarter, we plan to open an additional Herman Miller location in Ginza, Japan. And given the ongoing rationalization of our store fleet, we also closed two locations in the quarter. These stores were in Portland and Costa Mesa. Turning to our International Contract & Specialty segment. Favorable business sentiment and healthy demand across several key international markets continued to drive impressive growth. For the quarter, sales totaled $273 million, reflecting an increase of 63% on a reported basis and up 30% organically. New orders in the first quarter were also robust, totaling $252 million, an increase of 31% year-over-year on a reported basis and up approximately 1% organically. We are very pleased with the strong order growth in India, South Korea, and the Middle East, which was partially offset by softness in China and Central and Eastern Europe. Our consolidated gross margin for the first quarter was 34.5%, which is down 70 basis points compared to the same period a year ago. Adjusted gross margin decreased 150 basis points compared to the comparable quarter last year. And the variance was primarily driven by higher commodity costs and other inflationary pressures, partially offset by recently implemented price increases. Last month, we announced an 8% average list price increase in the Americas Contract segment, which will take effect in October to help further mitigate inflationary headwinds. Looking ahead, if the inflationary environment stabilizes, we believe that additional traction from net price increases and cost reduction initiatives will drive gross margin expansion in the periods ahead. Given the current macroeconomic backdrop, we are proactively taking additional steps to improve our near-term profit and cash flow outlook. These include offering a voluntary retirement window, further optimizing our organizational structure, reductions in program spending, and rationalizing capital expenditures. As a result of these planned actions, we expect to realize annualized expense reductions of between $30 million and $35 million. These savings should begin gaining traction during the third quarter and be more fully realized in the fourth quarter. Our operating margin for the first quarter on a reported basis was 4.7%. On an adjusted basis, the operating margin was down 40 basis points compared to the prior year. The decline in operating margin reflected the near-term inflationary pressures in gross margin, which were partially offset by well-managed operating expenses. We reported diluted earnings per share in the quarter of $0.34 and adjusted diluted earnings per share were $0.44 in the period compared to $0.50 in the year-ago period. Turning to the balance sheet, at the end of the first quarter, our liquidity position reflected cash on hand and availability on our revolving credit facility totaling $402 million. Regarding our guidance for the second quarter, we expect second quarter net sales to range between approximately $1.03 billion and $1.07 billion and adjusted earnings per share to be between $0.39 and $0.45. I might also mention that we've provided other elements of our guidance in our supplemental materials that were included with the earnings release. This guidance considers the near-term inflationary environment as well as the proactive steps that we're taking to offset these pressures. And we'll continue to prudently manage our cost to maintain our financial flexibility during these periods of economic uncertainty. So to close, we have a strong collective of brands that provides MillerKnoll with an unparalleled competitive advantage to meet and exceed the needs of our customers on a global scale. We believe we have a unique and diversified business model that provides resiliency for our business going forward.

Operator, Operator

Your first question comes from Budd Bugatch with Water Tower Research.

Budd Bugatch, Analyst

Good afternoon, Andi, Jeff, Ken, and Debbie. I guess I just would love to get a little bit more color on the order book maybe versus what you expected in the quarter in terms of orders and what you're seeing in terms of what your customers are telling you and what you can see in terms of visits and sales activity that I know you monitor?

Andrea Owen, CEO

Hey, Budd, nice to hear you. It's Andi. As far as customer visits, I think that's a really encouraging sign. Our customer visits are up 10% from last year and also up in the quarter. I think the order trend for us in the Americas was slightly lower than we were hoping that it would be, but I think it varied throughout the quarter. I would say stronger than we thought it would be internationally, and the demand in retail has been, I think, on par with our competitors from an orders standpoint. John, what would you add from a contract standpoint on orders?

John Michael, President, Americas Contract

I think I would agree, Andi, and add that there's robust activity. If you talk to the dealer network, they're all incredibly busy. I think some of the things that we're seeing is a lot of hesitation on the part of customers in terms of pulling the trigger on a new and more hybrid-focused work environment and also probably some hesitation in terms of the size of projects going forward in terms of what's going to be required. That said, most companies that we talk to realize they have to do something and they're in the process. It's just an iterative process and it takes a little bit longer to get the order to close than in a pre-pandemic kind of environment.

Budd Bugatch, Analyst

For my follow-up question, I would like to know about the inventory and debt, as inventory was significantly higher than I anticipated. Could you provide some insights on inventory and debt, and perhaps share the ratio for the banks and debt holders? Jeff, could you comment on inventory and debt? It appears to me that inventory was around $60 million higher than I expected, and the same goes for debt.

Jeffrey Stutz, CFO

Yes. Budd, great question. Good to talk to you. I hope you're staying clear of the store. I assume you are, given that you're on the call.

Budd Bugatch, Analyst

It's here and it's notable, but we are…

Jeffrey Stutz, CFO

Yes, I can only imagine. Well, so clearly, we did have a build in inventory, and you see that in the cash flow. I think our cash flow from operating activities was negative; I want to say $67 million. It's in that ballpark, Budd. A big chunk of that is working capital tied up related to inventory, a couple of areas where we're seeing it. We do see some inventory buildup in the Contract business related to the continued relative strength in International, so I would make that point. That one will certainly take. I think that if you look at the area that was a bit of a surprise, we did have an inventory build in the Retail business. Debbie can unpack this a bit in a little more color. But I would just simply say that the lead times that that business was contending with back in the spring and even the early part of summer were such that we were ordering in front of it, trying to get in front of it. And with the falloff in demand that we saw in the quarter, as I mentioned in my prepared remarks, orders organically were down 8% for that business. We did see a buildup in demand or in inventory levels, which piled up. In fact, we had to incur some unexpected costs related to warehousing, storage, and transportation of that inventory that weighed on margins in the period. So that's really the primary area. Debbie, I don't know if you had any color.

Debbie Propst, President, Global Retail

Budd, I'd just add, this is Debbie. We in our dedicated retail inventory increased quarter-on-quarter by 7% as a result of the shift in demand trend; and as Jeff alluded to, that 7% increase was largely stored in short-term warehousing locations. We've now secured longer-term locations that are at much lower cost impacts than we've always been storing that buildup that we've had over the last few months. The great news is, is that our inventory is largely not liable inventory. Only 3% of our total inventory for Retail is seasonal, meaning outdoor. We did, however, have a year-outdoor business and about 3% is what we would call discontinued, and we're moving through that in our outlets in our clearance section.

Jeffrey Stutz, CFO

Yes, Budd, and then just to kind of close it out on your question on the leverage ratio, the net debt to adjusted EBITDA for our lending agreements ended the quarter at 2.9 turns.

Operator, Operator

Your next question comes from the line of Greg Burns with Sidoti & Company.

Greg Burns, Analyst

I just wanted to start off with the order trends. When we look at the 17% decline organically in the Americas, how much is that price versus volume?

Jeffrey Stutz, CFO

Greg, this is Jeff. So I don't have those numbers split out precisely. But I mean, your question is a fair one that you've got a fair amount of pricing that's built up over the last 12 months. So in the Americas, it wouldn't surprise me to see unit volume demand declining 20%, 25% in that range, whereas order entry levels in dollar terms were down 17%. I think that's directional.

Greg Burns, Analyst

Okay. And then just the early part of this quarter, has there been any kind of shift in the trajectory or a similar type trajectory in the early part of this quarter?

Jeffrey Stutz, CFO

Yes, yes. The first three weeks of the quarter, Greg, Americas orders were improved a little bit, down 12% organically from last year.

Greg Burns, Analyst

Okay. And then when we look at the overall, I guess, corporate enterprise office business, are you able to size how big the business is now versus pre-pandemic? Like how much has it shrunk? And do you feel like you need to focus on maybe some adjacent areas like health care or education, maybe some other verticals to kind of grow that business?

Jeffrey Stutz, CFO

Greg, this is Jeff. John will likely want to add something here. However, I would say that the main question we're all eager to understand is how much of this situation is due to macroeconomic factors that have caused delays in returning to the office. Unfortunately, we can't currently provide specific estimates about the size of the various industry segments. John, feel free to add your thoughts if you'd like.

John Michael, President, Americas Contract

Well, I think in terms of the question about verticals, we've got an active and healthy healthcare business. We're very active in higher education as well as public sector. So we in times when the office business is softer, we lean into those verticals that are more resilient. Certainly, we've been doing that. But I would say even in sort of the core office business, there are pockets where there is still a lot of strength in activity: professional service firms, investment banking, legal, life sciences, pharma. All those types of firms are still very active and providing a lot of opportunity. Tech companies, obviously, are down as compared to where they were in the last few years. Manufacturing is probably not quite as active as it has been. But there are definitely pockets of activity across verticals and in the office segment as well.

Operator, Operator

Your next question comes from the line of Alex Fuhrman with Craig-Hallum.

Alex Fuhrman, Analyst

You guys have done a very good job of navigating through all of the supply chain crisis and passing on cost increases to your customers. Wondering as you look at maybe the next step of that with everything that's happening, particularly in Europe and just the surge in electricity prices and producer prices in general, do you think you're going to be able to continue to pass on a lot of those cost increases in Europe? Are there perhaps opportunities to increase manufacturing elsewhere in the world and import more product there? Just curious to how you're thinking about the spike in manufacturing costs for your European businesses?

Andrea Owen, CEO

Yes, Alex, it's a great question. I think when you look at how we're manufacturing around the world, we are localized as much as we possibly can be in all the markets where we sell. And I would say from a price increase, it is also market by market. So where we felt the most of the burden of commodities, we've been able to raise prices. So far, we haven't necessarily seen an increase in discounting or anything like that. But we're watching Europe very closely. Like everything else these days, it's changing minute to minute. But we feel we have a very flexible and agile approach because we are localized there. I think that will make a difference in how we look at what's coming forward.

Alex Fuhrman, Analyst

Okay, that's really helpful. And then just if I could ask another about the decline you're seeing in order volumes. I mean, it looks like it's been just the last couple of months that things have slowed since the last quarter. I know you talked about the perhaps the difference between unit and dollars here. But are there any other additional call-outs regionally or anything like that? I mean, it just seems like a pretty meaningful decline in orders from the last quarter. Just wondering if there's any noise, like one or two just massive orders last year that maybe skewed those comparisons that could shed more light on that?

Andrea Owen, CEO

I think from a comparison standpoint, if you look at last year, this quarter in the Americas specifically, we had a much bigger flurry of activity around kind of that first, if you remember, sort of post-COVID return to office. So I think comparatively, there is that in the numbers. I also think regionally, when you look at it, North America, United States, in particular, we have a lot more indecision. We have a lot of CEOs that are still kind of iterating on what they want their return to office to look like. In other parts of the world, we have a lot more decisiveness, so we haven't seen this questioning. The projects are taking longer. I think if you were to ask John Michael, what does your funnel look like in the Americas? He would say it's super healthy. It's just taking a lot longer. So I look at this order decline and I say I'm not incredibly worried. I think we're certainly facing uncertainty and I think we will see some decline. But I also think there's a matter of people being indecisive and understanding how to work in a hybrid environment. So I would say activity is strong, projects are taking longer, and there's definitely a regional variant in how we're approaching the return to office post-COVID.

Jeffrey Stutz, CFO

The only other thing I would add is a data point that I find encouraging, despite the significant uncertainty. The encouraging aspect for me is that when we look at the business activity in the Americas segment, it has remained relatively healthy on a day-to-day basis. Historically, this has often served as a leading indicator of major declines, and while things are indeed down, they have held up better than in previous downturns. This is certainly a positive sign and likely reflects the ongoing activity that John mentions when we engage with dealers and customers.

Operator, Operator

Your next question comes from the line of Budd Bugatch with Water Tower Research.

Budd Bugatch, Analyst

Thank you for taking the follow-up. I guess, Jeff, maybe I thought the question would have been asked about price versus cost in the quarter. Do you have any way to characterize that in terms of what's your realized pricing versus the commodity inflation and labor inflation and what you're seeing future on that?

Jeffrey Stutz, CFO

Sure, Budd. Let’s clarify things. I’ll discuss the year-over-year gross margin. We experienced a solid improvement from pricing at the overall level, with a net price realization increase of approximately 330 basis points compared to last year, which is promising. Commodities are still at high levels. There are signs, as you may have noticed, that in certain categories, they're starting to stabilize and may even decrease, but overall they remain elevated compared to the previous year. This situation contributed to roughly 240 basis points of gross margin erosion. Additionally, freight and transportation costs remain high, leading to an estimated 90 basis points of margin pressure. It's important to note that some of the costs related to retail inventory, while significant, are temporary as we work to reduce those balances. Labor and overhead combined added about 70 basis points of pressure. In terms of gross margin, there were also product and channel mix changes that contributed to 60 to 80 basis points of pressure year-over-year. That gives you a comprehensive view of the situation.

Budd Bugatch, Analyst

So we got 330 positive and I'm looking at about 460 to 480 negative. Is that right?

Jeffrey Stutz, CFO

Yes, considering product and channel mix shifts, I would not factor that into the price/cost equation in response to your question. Yes.

Operator, Operator

Your next question comes from the line of Greg Burns with Sidoti & Company.

Greg Burns, Analyst

Thanks for taking one more here. So I just wanted to dig into the price increases and the impact that has had on demand. Is there any element of pull-forward that's happened over the last couple of quarters, where now that's like exacerbating or why we're seeing such a significant decline this quarter maybe instead of maybe a more moderate slowdown? Like how do you think pricing has affected demand in previous quarters? And then going forward, if things are slowing down, do you still feel comfortable being able to pass along as much price as you've been passing along, especially with the new proposed increase?

John Michael, President, Americas Contract

Sure. Hi, Greg. This is John Michael. Yes, I think from a price perspective, conversations with customers, there's never been a better time to have a conversation with a customer about price increase because they all understand it, because inflation is pretty much across the board. As we look at our competitive set and how prices have gone up, we see that we are in line with others. So I don't think we see any significant impact from the price increases. The conversations we've had with customers and the projects we've been pricing of late would indicate that the market is accepting the pricing that we have, and we should be able to continue to realize it going forward.

Operator, Operator

There are no further questions. I'll turn the call back to Andi Owen for closing remarks.

Andrea Owen, CEO

Thank you. Thank you, everybody, for joining us on this evening's call. In closing, we're really proud of the resiliency demonstrated by our collective of brands and the progress we're making through our integration work. The leadership team and I feel strongly about the opportunity that lies ahead for MillerKnoll. And thank you again for your time today, and we look forward to speaking with you next quarter. Thank you.

Operator, Operator

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