Good day and thank you for standing by and welcome to the HNI Corporation Second Quarter Fiscal 2021 Conference Call. At this time, all participants are in a listen only mode. After the speaker presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Matt McCall. Please go ahead.
Good morning. My name is Matt McCall. I'm Vice President, Investor Relations and Corporate Development for HNI Corporation. Thank you for joining us to discuss our Q2 fiscal 2021 results. With me today are Jeff Lorenger, Chairman, President and CEO and Marshall Bridges, Senior Vice President and CFO.
Copies of our financial news release, Earnings presentation and non GAAP reconciliations are posted on our website. Statements made during this call that are not strictly historical facts are forward looking statements, which are subject to known and unknown risks. Actual results could differ materially. The earnings presentation posted on our website includes additional factors that could affect actual results. The corporation assumes no obligation to I'm now pleased to turn the call over to Jeff Lorentz.
Jeff?
Thanks, Matt. Good morning, and thank you for joining us. In the Q2, our members executed at a high level, delivering substantial year over year profit improvement. The post pandemic recovery continues to provide reasons to be encouraged about both the general environment and our opportunities at HNI. However, the macro backdrop, along with our strong growth, also presented new challenges in the quarter related to labor availability, And the recovery of the cycle, multiple secular trends and numerous H and I specific growth initiatives.
We have a track record of effectively deploying capital, Driving annual productivity and cost savings and managing through macro and operational challenges. On today's call, I will cover 3 key highlights The Q2, 1st, non GAAP EPS doubled year over year despite increasing pressure from inflation and returning costs. 2nd, Our Residential Building Products segment delivered exceptional performance. 3rd, demand in workplace furnishings is recovering. I will start by providing some detail on those highlights.
Marshall will then cover our 3rd quarter outlook. I I will conclude with some general comments. Finally, we will open up the call to your questions. Our first highlight for the quarter, we doubled non GAAP EPS versus the prior year despite increasing pressures in returning costs. Non GAAP earnings per share of $0.40 was up 100% And the $0.20 reported in Q2 2020.
In the quarter, we overcame greater than expected pressures related to material inflation, Labor availability and supply chain capacity. We generated 22% sales growth and our network ramped up to meet that demand. In addition, as we discussed last quarter, some of the costs related to temporary measures taken in the Q2 of 2020 returned. Despite these pressures, we drove strong margin expansion and profit growth. Overall, the second quarter shows the power of our diversified revenue streams, Our ability to react quickly to changing market dynamics and our overall operational capability associated with our member owner culture.
Our second highlight for the quarter, we delivered exceptional revenue and profit growth in our residential building products segment. On a year over year basis, total revenue growth exceeded 50% in the quarter and operating profit more than doubled, with operating margins expanding more than 500 From Q2 2020 levels. From a channel perspective, new construction revenue was up more than 30% from year ago levels and remodel retrofit sales increased nearly 90% versus the prior year quarter. Orders were equally strong in the quarter, growing 53% year over year. As the quarter progressed, the comps became more difficult, Order growth moderated but remained at high levels.
Our value propositions, growth initiatives and supply chain strength continue to resonate with homeowners, As we look forward, we remain optimistic about the prospects for both remodel retrofit and new construction. Long term demographic trends and a persisting housing supply demand imbalance will continue to support a prolonged housing cycle and elevated remodeling activity. Nesting and de urbanization trends also provide secular support, and we have an outstanding opportunity to grow the category in both new construction and remodel retrofit. As a reminder, in new construction, 2 thirds of homebuyers see having a fireplace as a must have feature of the home, The less than 40% buy 1. And on the remodel retrofit side, we estimate that only about 3% of all remodeling projects involve fireplace.
To take advantage of these opportunities, we are driving a better connection with the homebuyer and homeowner, is our model home virtual tour capability where we content where our content and messaging seamlessly plugs into the builder's virtual experience. This allows us to reach the home buyer early in the decision process with consistent and effective content. We have strong competitive positions in both new construction and R and R. Our vertically integrated business model, unmatched product depth Pricing breadth, strong builder relationships and regional distribution infrastructure all provide differentiation for this business. As a result, we have significant opportunities ahead of us to grow revenue in the building products business.
The 3rd highlight for the quarter, our workplace furnishing segment is recovering. On an organic basis, net sales in the segment increased 9 And orders grew 32% versus the prior year period. 2nd quarter non GAAP operating income grew 21% year over year despite the pressures With orders in our businesses focused on these markets increasing 55% year over year in the second quarter, putting us back to pre pandemic levels. In addition, the North American contract market continues to recover with orders in our contract businesses Up more than 23% in the Q2 year over year. And in the past 5 weeks, contract orders were up approximately 30% versus the prior year period.
Looking to the back half, we believe workplace furnishings has turned a corner and expect to drive revenue growth through the remainder of the year. Recent order patterns are encouraging and are indicative of our agility, our competitive position and improving demand trends. Market demand signals indicate activity will continue to ramp in the back half. As a result, we continue to expect year over year revenue growth in our Workplace Furnishing segment to accelerate as the recovery in our contract business gains momentum. Our workplace furnishings businesses have unmatched price point breadth, channel access and market reach, and we are investing in multiple strategic initiatives aimed at driving continued outperformance.
A few examples of our growth initiatives include the December 2020 acquisition of Design Public Group. We are seeing strong momentum with DPG. Year to date orders are up over 40% with record bookings in May June. BPT is also giving us more access And greater insight into the work from home segment and e commerce possibilities. Another example is our recently launched This is a mobile app we built to drive engagement with dealer sales reps.
It currently provides quick access to marketing content, Product information, visualization and order status updates, all from a single mobile enabled platform. Over 600 dealer sales reps are already using the app. We expect that number to grow as we add more capability. Additionally, we are investing to make our contract dealers more efficient and effective. This includes technology to streamline the design and selling processes and platforms to make their back office more efficient.
These investments along with our existing competitive differentiators position us well to benefit from office reentry, work from home and deurbanization trends. I will now turn the call over to Marshall to provide some detail around our Q3 outlook. Marshall?
Let's start with our outlook for consolidated revenue growth. We expect 3rd quarter revenue to grow in the mid 20% range compared to the prior year quarter. Because of our seasonality, this outlook implies 3rd quarter volume will be substantially above 2nd quarter levels, The sequential growth in the mid-twenty percent range. That level of growth when combined with the general labor and sourcing environment is presenting new challenges. Our staffing levels and overall supply chain capacity are ramping up, but not as fast as demand.
As a result, we expect labor and supply chain constraints This will limit 3rd quarter revenue growth versus the prior year quarter by 4 to 6 percentage points. That headwind is included in our outlook. This is a timing impact. We can solve these constraints over time. We are capturing demand and expect that 4 to 6 percentage points of growth flow to subsequent quarters.
Let's move to our 3rd quarter outlook for the residential building products segment, Recent order trends, new home construction activity, the outlook for remodel retrofit demand and expected benefits tied to our multiple growth initiatives Combined to suggest a revenue growth rate in the mid to high 20% range compared to the prior year quarter. We see continued momentum with both remodel retrofit and new construction. Now let's shift to our outlook for workplace furnishings. Strong second quarter order trends are growing backlog And a low prior year comparable adjusted growth rate including acquisition impacts in the low to mid 20% range on a year over year basis. Let's shift to 3rd quarter profitability.
Compared to the prior year quarter, we expect the impact of strong volume growth to be mostly Cost challenges related to inflationary pressures, increased growth investments and the return of costs associated with temporary actions taken in the prior year. While we expect operating income to modestly higher than the Q3 of 2020, operating margins will likely compress on a year over year basis. We do expect margin expansion to return post the Q3 as our recent price actions take hold and we anniversary the temporary cost actions taken during the pandemic. Finally, some comments on our cash flow and balance sheet expectations. Quarter ending debt levels were approximately 170 The gross leverage ratio at the end of the Q2 of 2021 was approximately 0.9, unchanged from last quarter.
On a sequential basis, While our leverage ratio was unchanged, cash increased by more than $24,000,000 We expect free cash flow to ramp up in the second Half consistent with normal seasonality and our projected cash flow will provide ample capacity for continued growth investment, dividend payments and opportunistic M and A and buyback activity. I'll now turn the call back over to Jeff.
Thanks, Marshall. Let me wrap up by stating that as we look to the rest of 2021 and into 2022, we remain optimistic about our businesses and our markets. We continue to gain momentum in workplace furnishings where our winning customer experiences, the multiple strategic investments discussed earlier and our operational excellence will combine to provide a competitive advantage as the market recovers. Recall our focus in our workplace furnishings segment is a combination of driving revenue growth and expanding margins. We are increasingly confident in the recovery of the workplace furnishings market as order strength is broadening across customer groups, Our improving order growth in the quarter and over the past 5 weeks is encouraging.
Our unique industry leading residential building products platform is positioned for sustained long term revenue growth. Our growth strategies in this segment continue to gain traction, and we see strong demand supported by demographics and low housing inventories. As a reminder, our focus in our building products segment is on maintaining our strong margins while continuing to drive strong revenue growth. As we move through the next stage of the recovery, we do so positioned to grow revenue, expand margins and increase cash flow. I would like to conclude by stating I'm extremely proud of and thankful for the efforts of all H and I members, particularly given how hard everyone is working to overcome the constraints we've described.
We will now open up the call to your questions.
Thank you. Your first question is from Greg Burns of Sidoti and Company. Your line is open.
Good morning. In relation to the 4 to 6 points of growth due to some of the staffing and supply chain challenges. Could you just talk about where that is in the business? Is that mainly in the workplace furnishing And then also how much of a margin impact are those constraints
Yes. For the Q3, Greg, the constraints are mostly in workplace furnishings. And in terms of the margin impact, it's not a material driver right now. Of course, inflation, which is Hand in hand with these factors is a big headwind for us in the 3rd quarter.
Okay. So, it's not really creating efficiencies, it's just limiting your ability to produce more is really The impact here?
Yes.
Okay. All right. And then, I guess, you gave a little color on The order patterns you're seeing in workplace furnishings after the quarter, can you just talk about In the Residential Building Products segment, you did mention that they moderated a little bit. Can you just talk about kind of when in the quarter and How we've trended into the 1st part of
Q3? Yes, I think what we're seeing is a little bit of noise just based on the So if you think about last year, Ramallah retrofit kind of Tail off is in the early stages of the pandemic. And so a lot of the reason our growth rates in the Our retrofit sales rec actually up 90% versus the prior year. If you kind of compare that to 2019 levels, Our growth rate is pretty similar to what we saw in the Q1 and that's continuing. We're still seeing strong activity, Now we're starting to compare against where orders grew in the Q3 of 2020.
So the growth rate is coming down. It's more
And then in terms of some of the growth initiatives you mentioned on the The residential building products side of the business, how are you seeing the benefit of those yet in your numbers? Or is that still Things that are in the early stages that will benefit you in future quarters. Is there any way to quantify or any Qualitative kind of color you can give around the impact those are having? Thank you.
Yes, Greg, this is Jeff. Look, I would tell you, we can quantify. I'll give you a couple of examples. I would also tell you we're also early on, but we're there's That's one of our initial areas of focus to connect with homeowners, existing homeowners. And those are up over 90% year to date.
We're also seeing anecdotally much more website traffic from awareness And another growth initiative is of the electric category And to create awareness and acceptance of electric fireplaces, and we're gaining traction there with sales in that category up over 100%. And so even though it's early, we have real tangible evidence that those growth initiatives are taking hold and starting to drive the business.
Okay, great. Thank you.
Thank you.
Your next question is from Reuben Garner from The Benchmark Company. Your line is open.
Thank you. Good morning, everybody. Apologies if I repeat anything. I got kicked off the call briefly earlier. But maybe just a follow-up on Greg's First question to start, Marshall, can you clarify what if the labor Trains are not causing the year over year margin pressure.
Is it entirely price cost that is leading to the near term margin drag and that will normalize as your price increase comes through as we move into the 4th quarter?
Yes, Ruben, that's certainly a major factor. So in the second quarter, we had a price cost gap of about 11,000,000 We expect that to be $10,000,000 to $15,000,000 in the 3rd quarter of a negative price cost gap. As we move into the 4th We expect our price increases to ramp up and catch up with the inflation and be roughly neutral. So that's about a 200 basis point headwind That's going to abate as we progress into the Q4. And that's the major driver, but we also have the Impact of some of the costs that are coming back from temporary actions we took last year, we're investing in growth, And we've got some impacts from the normalization of the variable comp and insurance programs, all of which impact the second and third quarter more than the 4th.
Your next question is from Steven Ramsey from Thompson Research Group. Your line is open.
Hi, good morning. Maybe to start with on the orders and delayed single family starts, kind of the extending lag time between Starting completion yet seeing strong orders in resi. Is that pushing out resi sales For single family into Q4 and even into early 2022 or is that not a major factor in the segment?
Stephen, this is Jeff. I'll take a shot at that. I don't we don't think it's pushing out. The long term fundamentals remain. The supply demand imbalance we've talked about, You know, just, you know, for instance, new home sales slowed in June.
I mean, that was the headline. However, you know, building permits outpacing starts, Starts are outpacing orders. And builders are trying to manage the inventory right now just to manage their margins. So We're very bullish on that and we don't think it's pushing out. We continue to see strong activity there As far as for quite a while.
Stephen, just to add to that, our new construction sales were up 24% in the Q1 and we actually accelerated 31%. So we had thought it might decline a little bit from that strong Q1 growth rate because of the trends you mentioned and we just Haven't seen
it yet. Okay. Yes, that's helpful color. And then Wanted to clarify on the cost the temporary cost reductions coming back in. Can you maybe clarify the impact Q3 and Q4 or another way to think about it maybe, what quarter do you expect that temporary comeback to be over, be completed and operating at normal?
Yes. There's about $18,000,000 of Cost related temporary actions that we took last year, they're coming back in 2021. About $10,018,000,000 hit the 2nd quarter. We expect about $6,000,000 to hit the 3rd and by the 4th, we only have about $2,000,000 left and then that's the end of it.
Okay. Okay, great. And then last thing for me. On the workplace guidance for Q3, What swings that range to low high? Is it broad based demand from here or is it the constraints that you've discussed?
I think it's mostly constraints. We probably will see some variation in demand, but I think given that we've got that 4% to 6% buffer, it really comes down How we manage the constraints?
Yes. This is Jeff. I would agree. I think the demand continues. If we look at 5 week order averages, for instance, in the contract segment, we're for the quarter, order was up 20 We were up 23% in the 5 weeks, up 30%.
So it's really just guessing how we can break constraints, and it's kind of all over the It's kind of all over the map with supply chain and labor throughout the value chain.
Excellent. Thank you.
We have a follow-up question from Reuben Garner from The Benchmark Company. Your line is open.
Thank you. Good morning, guys. Can you hear me?
Yes, we can hear you.
All right. Sorry about that. So I don't know what I missed and what's been asked, but I'm going to do my best. The first question is kind of a follow-up. I heard Greg's First question about the cost impact or the margin impact from the constraints.
And I think you just clarified, Marshall, What that impact is to your margins in the second, third and fourth quarters? Is there does that include the price Toss drag and if not, can you quantify what that looks like and how that you expect to sort of progress as we move into Q4 and then into early next year?
Yes, Ruben, sorry, you keep getting disconnected. So what I answered just previously had to do with the returning costs related to the temporary actions we took last year. So that's one headwind we face. Price cost is significant though, right? So maybe I'll kind of cover that.
So I think I mentioned that we had about $11,000,000 price cost gap in the second quarter, and we expect that to be $10,000,000 to $15,000,000 in the third. By the time we get to the 4th quarter, we expect our pricing actions to catch up with inflation even though it's continued to go up and will basically be price cost neutral by the 4th So that we do expect our incremental margins to be higher In the Q4 than they have been here in the second and third because of that price cost gap.
Will the incremental margins sort of return to normal less that $2,000,000 That you called out before or will the sort of labor constraints and supply chain and other factors, will we need to factor that In Q4 and beyond.
Yes. I wouldn't expect in the return to normal in the Q4. There's a lot of Price that we're pushing to cover that inflation, which isn't creating any incremental profit, right? So that dilution It's going to lower our incremental margins along with the other items
that we've already talked about.
Got it. And then I think I heard you say that the small to midsized business is back to pre pandemic levels. I guess 1, did I hear you right? And 2, it sounds like contract is really starting to accelerate. Do you guys That will get back to pre pandemic levels maybe quicker than we would have thought 3 or 6 months ago?
Well, yes, I think the business that focus on the small to midsize customers is doing really well. Our order activity in the 2nd quarter is basically back to 2019 levels. We're still running below that in contract, but as you said, it is encouraging accelerating. So I think the outlook for contract is positive, but it is moving slower than the small to which is where we have a lot of our exposure. So it's a positive to us.
And I think the other positive thing is that The growth environment is encouraging, but we're also focusing on driving margin expansion in that segment. So We're pleased with the traction we're getting in our productivity and cost savings initiatives and just the improvement we're making across the board there. So That's one of our big near term goals in addition to the recovery in the top line.
Got it. And last one for me. Any comments or color on the home office or I guess your e commerce business? Is that I know we're going to start anniversarying some really difficult comps there. Is that something we need to factor in?
Or is that business remain pretty robust even
Yes. Reuben, this is Jeff. I'd say that both of those aspects of our business remain robust. And we like our positions there and we continue to invest in both those aspects of the business.
Thanks guys. Appreciate it.
Okay. Yes. Take care.
There are no questions over the phone. I will now turn the call back to Jeff Lawndreffer for closing comments.
Great. Thanks. Thank you
for joining us today and have a great day everybody.
This concludes today's conference call. Thank you for participating. You may now disconnect.