Earnings Call Transcript - MLKN Q1 2021

Kevin Veltman, Vice President of Investor Relations and Treasurer

Good morning, everyone. Joining me today on our first-quarter earnings call are Andi Owen, our President and Chief Executive Officer; Jeff Stutz, our Chief Financial Officer; John Michael, President of North America Contract; and Debbie Propst, President of Herman Miller Retail. As you may have noticed in our press release that was posted yesterday, we have changed our approach to the quarterly press release to adopt a shareholder letter format that replaces our prepared remarks on the conference call. We believe this approach both provides more timely information for investors and allows more time for questions and dialogue on the call. We have posted today's press release on our Investor Relations website at hermanmiller.com. Wherever any figures are presented on a non-GAAP basis, we have reconciled the GAAP and non-GAAP amounts within the press release as well. Before we begin today's Q&A session, I would like to remind everyone that this call will include forward-looking statements. For information on factors that could cause actual results to differ materially from these forward-looking statements, please refer to the earnings press release, as well as our Annual and Quarterly SEC filings. Any forward-looking statements that we make today are based on assumptions as of this date, and we undertake no obligation to update these statements as a result of new information or future events. Today's call is scheduled for 60 minutes. With that, I'll turn the call back over to the operator and we'll begin to take your questions.

Operator, Operator

Our first question comes from Greg Burns with Sidoti & Company.

Greg Burns, Analyst

Good morning, thanks for taking the questions. I just wanted to start off on the strong margins to get a sense of how sustainable they are across the different segments of the business. I know you've taken some temporary cost actions at the beginning of the pandemic. So I was just wondering, if some of that starts to unwind or come back into the P&L. Can you just give a sense of, relative to where we were this quarter, maybe how we should think about margins and some of the temporary items that you were avoiding going forward? Thanks.

Jeff Stutz, Chief Financial Officer

Yeah, Greg, this is Jeff. I'll begin here. You are correct that our results for the current and previous quarters reflect some significant measures we've taken to reduce costs. Some of these changes are more permanent, while others are designed to be temporary. Earlier this quarter, we announced a return of some cost-cutting measures, specifically temporary wage reductions. Overall, if we look at the significant cost reduction efforts, we enacted workforce reductions that equate to about $35 million to $39 million annually. Additionally, we temporarily reduced certain employee benefit programs, which amount to approximately $24 million to $25 million annually, excluding the wage rollbacks. We have also cut back on travel and expenses due to the constraints we are experiencing from COVID-19. In total, we are looking at annual expense reductions of $85 million to $90 million. As we move forward, we need to determine the right timing to restore some of those benefit programs, and we are currently assessing that. While we had strong results in the first quarter, we are experiencing some order pressures, so we anticipate continuous challenges. These cost reductions are being evaluated. Alongside those, we also have some variable and discretionary expenses that naturally fluctuate with lower revenue. Looking ahead, we plan to make incremental investments in digital programs, as highlighted in our shareholder letter. We see great progress in that area and do not intend to scale back our efforts. Therefore, we expect an increase in digital spending. Debbie, representing the retail business, is on the call and will discuss our marketing initiatives and related expenditures. To summarize, we have implemented structural cost reductions. Regarding margin performance by segment, the retail business stood out this quarter, benefiting from a range of favorable mix factors. We expect some of these benefits to last as we head into the next quarter, although they might be slightly countered by new spending initiatives. The margin performance in that segment has been strong, and we anticipate elevated margins going forward, though not quite at the same level. In the contract side of our business, especially in North America, we are facing some significant order pressures. However, our teams have effectively managed spending in discretionary areas, leading to solid operating performance in that segment as well as internationally. Overall, we are pleased with our Q1 results, and our expectations for the near term indicate we can maintain some of those benefits, even if our top-line performance may dip slightly.

Andi Owen, President and Chief Executive Officer

I think, Greg, what I would add to that, this is Andi, by the way, is I think the last six months have been a testament to the strength of this team to adapt to changing circumstances and keep an eye on the bottom line. And like every other company in the world, we've learned a lot about ways we can operate differently in places where we can do things virtually. So I think we expect to see a good portion of this carry through, to Jeff's point, with the investments that we have been making in digital and we have been making in infrastructure continuing along the way.

Jeff Stutz, Chief Financial Officer

And Greg, this is Jeff again. I might just add, I think if you think about the business in the more medium term, we still are believers that deleverage. If we feel pressure on the top line, deleverage is probably in the range of 25% to 30%. I would say that based on recent performance, it's probably at the lower end of that range, but that's kind of how to maybe think about it at a high level.

Greg Burns, Analyst

And then looking at the kind of the relative strength of international. Where is that coming from? Was that on the back of the backlog coming through the quarter? Or are you seeing businesses there start opening up? And as they do bring employees back, they're incentivized to start making buying decisions to adjust their offices. I'm just trying to get a feel for kind of what's driving that relative strength internationally? And maybe is that something we might see in North America as we start to open up here?

Andi Owen, President and Chief Executive Officer

It's a great question, Greg. I think international sort of gives us hope as we look at what's happening in North America right now. But I would say a big portion of what's happening there is the kind of curve that many of the countries and the rest of the world are on related to COVID. So if we think about the APAC region, China is in many ways up and running in a very, very normal way. We look at our businesses there. People are walking around without masks. People are back in the office. So we are really seeing that part of the world kind of coming back up to normal. Even in parts of Europe, particularly around Denmark and places like that, we have seen life return to the new normal. So we are optimistic that as we continue down this curve in COVID, we'll see those things start to happen. And also don't forget, with the acquisition of naughtone and HAY, we're seeing a really nice uptick in both of those businesses. That's supporting the international business as well. So as strong indicator we think of what's coming in the U.S., hopefully, if we get this under control but that business has been very healthy. Jeff, would you add anything?

Jeff Stutz, Chief Financial Officer

No, I think that's good. I think just regionally, Andi, you alluded to China, you alluded to parts of Continental Europe. I would also add Japan and the Middle East were two really strong performers for the business this quarter. So that would I think bear mentioning.

Greg Burns, Analyst

Okay. And then lastly, can you just talk about order trends throughout the quarter? And I think in the press release, you mentioned some pretty good moderation in the declines in the first couple of weeks of the second quarter. Can you just give a little bit more detail, is that specific to maybe retail, or is it across the board? Can you just give us a little bit more color on order trends?

Jeff Stutz, Chief Financial Officer

Yes, Greg, this is Jeff. Maybe just a little bit, and I'd ask John and Debbie, feel free to chime in and add color here. At the headline level, the consolidated level, just to give you an idea. We were down in total. These are organic numbers, by the way. We were down about 35% organically in the month of June by itself. That improved. We were trending closer to down 20% organically by the time we closed the quarter and I would say through kind of the back half of the quarter. And in the first couple of weeks of the second quarter, organically on the order of that down 20% still, so more consistently. And then just to frame that for you, with acquisitions, we're down closer to 10% in the first couple of weeks of the quarter.

Andi Owen, President and Chief Executive Officer

John Michael, do you want to share your thoughts on the North America contracts?

John Michael, President of North America Contract

Sure, Andi. Thanks. Good morning, Greg. I would say, we definitely saw a strengthening in order trends in the back half of Q1 and into Q2. Another relevant data point if we look at the opportunity funnel going forward, it is not down nearly as much as the order trend is. And I think that's indicative of the fact that our clients are still trying to figure out what's next in terms of the future of the office. We're obviously in conversation with them on that. But there is a bit of a pause as people are trying to figure out what the right next moves are relative to the workplace.

Andi Owen, President and Chief Executive Officer

Yes. I think that's a great point, John, because I think what we're seeing, which we've mentioned to all of you guys before, is we're not seeing many cancellations, but we are seeing people kind of push things down the road a little bit. So we think as things start to turn around, we'll start to see some of that funnel become more operational, which we're starting to see in Q2. Debbie, would you add any point of view on retail?

Debbie Propst, President of Herman Miller Retail

Absolutely. So in the retail segment, we saw June orders at plus 17% to LY and then July and August were both within 1 point or 2 of plus 50 to LY. So we've definitely seen order trends pick up. A couple of dynamics there to consider. The first is that in June, our East Coast brick-and-mortar locations were still closed for the majority of that month. And then secondly, in July, we launched our new dwr.com website, which has had significant conversion improvement. And with our mix contribution of e-commerce sitting at double LY, that improvement of conversion has been significant for us. So our conversion rate of that new dwr.com website is a 26% increase versus our previous website experience. And there are some really exciting metrics that indicate advanced performance throughout the whole customer journey online.

Operator, Operator

Our next question comes from Steven Ramsey with Thompson Research.

Steven Ramsey, Analyst

Good morning, everyone. On I guess I'll start with continuing on retail. Maybe can you start with the brick-and-mortar side, you said demand was up 4% but traffic levels down. Does that mean sales up 4%? And then maybe can you go deeper into kind of what's driving that figure? I mean, is it bigger purchases, higher ticket items, or is it customers buying more smaller items? Just any color?

Debbie Propst, President of Herman Miller Retail

Absolutely. This is Debbie. I can take that question. So we are seeing traffic rates down about 50% to 55% to last year in our brick-and-mortar locations. But we are obviously seeing the performance of those locations in sales at plus 4% to last year. So what we're seeing is a higher intent customer actually coming to the physical location at a different point in their customer journey versus what we typically see. So usually, the sort of store interaction or studio interaction is during the consideration phase when the customer is still browsing and flexing ideas. And now what we're seeing is the customer coming to the store studio at the end of their journey, ready to transact once they've touched and felt the product. So we're seeing higher intent that's driving higher conversion in the traffic that is coming through the door, and we're also seeing higher order value, as customers are spending more on upgrading their home. Obviously, our homes have more pressure on them than they've ever had before. We have to make spaces work harder within the home. People are looking for multi-use decorating tactics. And so we're really able to help with that and drive a larger value through our store channels as a result.

Steven Ramsey, Analyst

I guess, on the web growth for retail, I guess, with the strong growth and then orders being up so strong as well in the quarter. Two questions, I guess: Are you able to ship and deliver products in a timely manner? And then second, how much of that order reflects a buildup of just demand not being able to ship as timely as maybe normal times? And the strong order patterns up 40% in Q1, does that indicate sales trending at similar levels on a year-over-year basis to Q1?

Debbie Propst, President of Herman Miller Retail

So we're going into Q2 with pretty normal backlog coming out of Q1. A little bit of the June ship sales volumes were obviously orders that we collect data in April and May and didn't ship, but our orders and sales levels are very close to each other throughout the course of Q1 in totality. So I feel really good about the order trends that we're seeing.

Steven Ramsey, Analyst

Great. So there's no reason that Q2 sales, there's no puts and takes that would take Q2 sales much, much lower necessarily than what orders would indicate.

Debbie Propst, President of Herman Miller Retail

We got a slight bump coming into June from orders that we took in April and May, but we’re expecting similar order rates that we're seeing in July and August carry forward into Q2.

Steven Ramsey, Analyst

Great. And then last one for me, kind of switching to North America contract. In discussions with companies and clients, what are they saying about the future of the office compared to some of the theories and ideas that brokers and others have discussed, as well as office furniture companies have discussed on what the office of the future looks like? Do any orders that you have now reflect kind of the new world of offices?

John McPhee, Unknown

Steven, this is...

Andi Owen, President and Chief Executive Officer

Actually, go ahead, John. And I'll add when you're done. Go ahead.

John McPhee, Unknown

I would say we're definitely seeing customers make that transition and the new thinking about the future of the workplace. And I think our point of view and what we see in client conversations is the work model is going to be much more distributed. I mean pre-COVID, 14% of employers said that their employees could work effectively remotely. Similar survey done in June of this year, that number was 42%. So we've seen the migration to a more distributed work model, but I think the pandemic has definitely accelerated that. And I think we're going to be in a mode where the workplace, including the office, is going to be more on-demand, more of an on-demand resource that supports different types of work and adds value. The office really shines in the areas of building culture and community and enhancing individual focus and supporting intensive teamwork and collaboration. And we're starting to see the shift in terms of layout and design that supports those primary functions. What would you add to that, Andi?

Andi Owen, President and Chief Executive Officer

And I would say, Steven, this has represented a real opportunity for us and one we're excited about because the distribution of the workforce has been happening for a very long time prior to COVID. But given the multichannel distribution model we have, given our strength in residential furnishing, and the fact that we are here to help people sort of revamp the spaces they do have that are office oriented, as well as support the workers that are working from home and now schooling from home, we think we're even more set up for a distributed workforce of the future than we ever have been before. So I definitely think that the companies we're talking to, the customers we're working with are on the continuum. Everywhere from we're coming back to normal as soon as we can back to the office, just like we used to. All the way to a larger portion of our folks are going to be working from home. But we're supporting every customer in a different way along that journey. So it's been a really interesting time for the company and it’s full of opportunity for our business model.

Operator, Operator

Our next question comes from Reuben Garner with Benchmark.

Reuben Garner, Analyst

I experienced some technical issues and missed most of Greg's questions, but I caught the end of them. Apologies if I repeat anything. I want to start by discussing the backlog; I believe you mentioned it was flat year-over-year in the release. It doesn't seem like that is influenced by retail conditions. So, first, is that correct? Secondly, if it is, does that suggest increased confidence that things might recover more quickly this time around compared to previous recessions, particularly in North America?

Jeff Stutz, Chief Financial Officer

Reuben, this is Jeff. And that was not a repeat question for the record…

Reuben Garner, Analyst

One for one…

Jeff Stutz, Chief Financial Officer

Let me provide some insights on the backlog. Specifically, for the North American contract business, the backlog in that area is down approximately 20%. Retail, as previously mentioned by Debbie, has a fairly normal backlog as we come out of the first quarter, so there are no significant surprises there, and we're actually in good shape. In contrast, the international backlog has increased by about 13%, and this is organic growth. Generally speaking, while there is still a lot of uncertainty, I don't want to create a different impression. We are seeing some order pressure in the MAC business, and with the backlog declining, uncertainty remains. However, given the circumstances leading to this pressure is virus-related, it feels temporary. If we can gain some assistance from scientific advancements, we believe we can recover more quickly. That said, we're not out of trouble yet. On the international front, we're quite pleased with the performance; it has been very strong. As Andi noted, it appears to be ahead in the recovery curve. However, it's important to remember that the international segment generally has a longer lead time in backlog due to the nature of the business, including longer shipping distances and project-driven dynamics. So, I'd advise caution when making assumptions about converting that backlog into shipments, as it typically takes longer compared to what we observe in North America.

Reuben Garner, Analyst

Could you provide a similar breakdown for the order trends you observed in the international business? Additionally, what progression did you see in North America? I recall you mentioning it improved modestly in the second half. Could you elaborate on that for us?

Jeff Stutz, Chief Financial Officer

Yes, happy to. This is Jeff again, Reuben. I'll start with the international business. We began the quarter with organic order rates down about 20% year-over-year. However, we saw significant improvement as the quarter progressed. By the end of the quarter, the reported organic number was down about 10%. In the first couple of weeks of the new quarter, it has improved to a decline of about 5%. So we've observed a positive trend there, and we hope to maintain it. On the North American contract side, June was challenging as we started off with order entry levels down close to 50%. However, this improved significantly by the end of the quarter, with August showing declines closer to just below 40% year-over-year. In the initial weeks of the new quarter, we are down around 30%. While we are still seeing substantial year-over-year declines, we are encouraged by the trend.

Reuben Garner, Analyst

Thank you, Jeff. It seems like I'm on track with my questions. I want to focus on the sustainability of margins, particularly in light of the 25% to 30% decremental margin you mentioned in the release. Given the current progress, I'm curious whether we should consider a decremental margin on a sequential basis based on our position in Q1, rather than comparing it year-over-year. Clearly, the decremental margin didn't factor in when comparing the first quarter to last year. Can you help us understand how we can move from 15.2% at the ink level to the next few quarters?

Jeff Stutz, Chief Financial Officer

Yes, Ruben, you're spot on here. I’d like to follow up on your last question. First, let's take a step back. You know our margin performance in this business is always fluctuating. We often highlight that the changes from one period to the next can be influenced by various factors, such as bonus expenses that increase over time. These are unusual times for us. We're coming out of a first quarter with a very favorable mix. I can elaborate on that if you wish. However, I believe that the lower end of that margin range is reasonable, and looking at it on a sequential basis does not seem unrealistic to me. While I would need to review the calculations myself, it doesn’t sound unreasonable. In Q1, due to significant cost reductions, we exceeded typical expectations and saw lower revenue accompanied by higher operating profit. However, this is not necessarily indicative of future performance. As mentioned earlier, we have reduced costs in several structural areas, some of which are temporary initiatives. We’re currently assessing when to reinstate certain measures, like temporary benefit reductions, but no final decisions have been made. As travel and entertainment gradually resume, we expect related costs to rise. We've already reversed some of the temporary wage reductions we announced earlier this quarter, with more changes ahead. Additionally, Andy has been particularly focused on safeguarding our digital initiatives, opting to invest rather than scale back. We want to ensure we're proactive in certain areas, with plans for increased digital spending in the upcoming quarters. Overall, this suggests that a 25% to 30% decline is reasonable, but I would lean towards the lower end based on our recent performance.

Reuben Garner, Analyst

And is there anybody in the queue behind me, I do have one more but I don't want to be selfish here.

Andi Owen, President and Chief Executive Officer

Go ahead.

Reuben Garner, Analyst

All right. I'll sneak one more in then. On that note, Jeff, in the retail business, how much does e-commerce boost our performance? It seems like it contributed significantly to our growth this quarter and is expected to continue. How much of the margin improvement you've seen is due to sales through that channel, especially since you're probably selling more home office products online right now? How should we consider long-term retail margins? If the e-commerce shift is more permanent, could it lead to changes in your long-term margin targets?

Debbie Propst, President of Herman Miller Retail

So Reuben, this is Debbie. There are really three dynamics at play that are impacting margin performance in retail right now. One of those is category mix. We did see a big shift into our workspace category, which is predominantly a curation of products that we manufacture vertically. We also saw audience mix shift. So, we saw a shift from our retail contract business and our retail trade businesses into the residential consumer. So for residential consumer to trade penetration this time last year were about 70-30. And this year, we're serving 83% to residential consumers directly versus 17% to trade. And so that's an important note because despite the fact that we were slightly more promotional than last year, our trade channel has a higher discounting rate. So, we were able to save on this comping as we drove the residential channel directly. And then the last element is channel mix. So obviously, without shifting more volume through web, we saw significant improvement in margin and that's really because of the category mix that we're seeing in web but also because we don't have such a high commission structure associated with web sales. We do incent, as of this quarter, our studio staff with the web sales; they help drive, but obviously, the commission structure of sales driven in studios is higher. So some of these things are dynamics that we can actively maintain as we go through the rest of the year, but we do expect to see margins normalize a little bit through the course of the year.

Reuben Garner, Analyst

Got it. Great. Thank you, guys and congrats…

Andi Owen, President and Chief Executive Officer

I would just add to that, that we’ve spent a lot of time building a really strong leadership team in the retail business and building strength. There's been a ton of opportunity. And then we've had calls in the past where retail has not been a strength for us. And I think one of you said in your notes, it's gone from lagger to leader, and I think we all agree with that. So when Debbie said we see margins normalizing, I think we see margins normalizing to what is the new normal in retail because of the opportunity that's ahead of us. So we think that there's going to be a bright spot going forward. Certainly, we've benefited from mix into task seating. But there have been a lot of other categories in the retail business that have performed extremely well. Given the focus on the distributed workforce, so we're very optimistic about this business in the future and the team.

Debbie Propst, President of Herman Miller Retail

We are, and we have some tremendous levers for growth in front of us. We talked a little bit about the investment in digital performance we're seeing of our new dwr.com website, and we have new Herman Miller and the new HAY website underway. But beyond just the digital opportunity, we have a huge assortment opportunity, as this business was previously being run as a, what I’d call, analog business. It was about what we could showcase in a physical studio and/or through a catalog. And as we're moving to more of an omni-channel approach, the assortment curation that gives us tremendous growth potential. Our audience management opportunity is also huge. And we have been using our last touch attribution model and we're moving to our multi-touch attribution model. So, we really understand the role that each marketing channel plays in the customer journey. But we've, in the meantime, been making some shifts in the way that we think about our marketing spend across channels and are seeing record return on ad spend performing. We have opportunities in our planning and inventory in terms of enhancing inventory turns and reducing liquidation, and we're working on the launch of a new retail concept, which we spoke briefly about in our shareholder letter last night. This really focused on our performance and work-from-home retail assortments. And those stores will really offer the customers the opportunity to explore the breadth of our performance category and also really understand how that performance category can improve their personal performance that drive wellness throughout the course of their life. We have opportunities in our fulfillment channels and with our warehousing as we grow the business and then lastly, ongoing cost savings as we continue to strive towards a one Herman Miller approach to how we run this retail segment.

Reuben Garner, Analyst

Great. Thanks again, guys for all the detail. Congrats on an impressive quarter and good luck navigating through the rest of the year. And hopefully, everybody stays safe.

Operator, Operator

And I'm not showing any further questions at this time. I'd like to turn the call back over to Andi.

Andi Owen, President and Chief Executive Officer

Thank you so much. So just to remind you, we're big believers in our strategy. We really think it reinforces our purpose of design for the good of humankind. We believe that we will not only weather the near-term disruption from COVID but will emerge stronger on the other side. So thank you for joining us on the call today, and we appreciate your continued interest in Herman Miller, and we really look forward to updating you again next quarter. Take care and stay safe.

Operator, Operator

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.