MillerKnoll, Inc. (MLKN) Earnings Call Transcript & Summary

The executive team from MillerKnoll. I'm Rex Anderson of Water Tower Research. We're excited to have with us today Jeff Stutz, CFO of MillerKnoll; John Michael, MillerKnoll's Americas President; and Ryan Anderson, the Vice President of Global Research for MillerKnoll. On this call, we also have Carola Mengolini, who heads MillerKnoll's Investor Relations; and Budd Bugatch whose partners with me in Water Tower and content creation on office furniture industry and our work with MillerKnoll. One housekeeping item before we get started, everyone, except John, Jeff, Ryan, Budd and I are muted. All of our live audience is muted. If you have a question for MillerKnoll, please type it into the appropriate field on your screen. We'll forward the question to MillerKnoll afterwards, and they'll respond to you directly. MillerKnoll is known for having conducted extensive research over many decades about how people work. The research has informed many of its furniture designs over those decades, Miller Knoll Research continued over the -- through the pandemic and into the post pandemic and the return to office period. And so that's what we're going to be talking about today. So begin -- let's begin with Ryan, Jeff and John, I'll turn it to you to discuss and share what you've learned from that research and what you're continuing to learn. Ryan, can you start us off with 1 or 2 minutes of the insights you have from your research and the conversations you have with customers?

Sure. Thanks, Rex. And hey, everyone. So good to spend some time with you. Yes, as Rex just indicated, we are fortunate to have a global research team. We conduct a variety of types of research, and we also spend a tremendous amount of time with our customers. In fact, I think I took 24 or 25 market visits myself outside of our research last year. I think if you were to walk in our shoes, what you'd notice right off the bat is that the state of workplace and the state of return to office is much more highly varied, and in some ways, more highly complex than what you might normally read about in business publications. Certainly, some of the large U.S. cities have struggled with some of their office occupancies, New York, probably more so San Francisco and Minneapolis. But at the same time, there's other markets. There's places like Miami and Austin that are vibrant. This is true outside of the U.S. by the way. There's cities like Paris and Stockholm that are doing great. And maybe London is a little bit slower. So there's a lot of things going on. Most of our large organizations that we serve have embraced some degree of flexible working, some sort of hybrid strategy, and they're at various points in the process. Some are at the point where they've decided to allow a little more flexibility in working location, but the people aren't necessarily working that differently. They're still spending lots of time on video calls in front of their laptops, which hinders their ability to go do other work. Others are farther along the journey. And what's kind of nice about our being able to interact with all of them is that we get a chance to see where things are going. And in some ways, it's confirmed probably where our vision of where the future workplace was before the pandemic. Now those organizations that are really actively trying to support flexible working in new ways, sometimes, they'll shrink their overall corporate real estate portfolio a bit to account for hybrid working. But they're also making their spaces better, which surprises some, but they're focused on creating highly desirable spaces that their employees understand, supporting a broader array of activities, having those spaces feel less institutional and more inviting and focusing on long-term flexibility. I mean, for many of these organizations, they've decided that they're not going to wait for some new normal. Office occupancy level still continue to increase almost everywhere monthly. It's going slower than some people may have expected, but it is changing. So instead of waiting for that new equilibrium, organizations are beginning to realize that their workplace can be a vehicle for supporting new ways of working. But I will just say that there's a lot of other organizations, and it probably is the majority that are still in a period of ambiguity. They're trying to understand where things are going. They don't want to make any significant real estate decisions until it's clear. And so our role in that is to be able to share with them what we've learned, including from before the pandemic, but also more recently about how organizations can be successful to mitigate their risk and help them take a longer view of what means -- what a successful workplace means for their organization.

I'm going to jump in here real quick, Ryan. Thanks for that. I want to just start by thanking Rex and Budd and the whole water tower team for having us. It's terrific to be with all of you, and I'm super honored to be here with two great colleagues in Ryan and John and Carola, of course, supporting us from an IR perspective. It's great to be able to have a conversation with investors that aren't all about modeling assumptions for the upcoming quarter or even upcoming year and talk more about what's affecting the business. And there's probably no greater topic that we're spending our time on than our own evaluation of return-to-office trends, and our own readiness for that as a business. So it's very timely, and it's great to have this conversation. So maybe a combination of Ryan and John together. Ryan, you talked about you made a comment there that, I think touched on the level of uncertainty in the market right now. And for anyone who's followed us for any length of time as an industry in the contract space -- true in the retail space as well, when measures of sentiment, be it CEO or consumer confidence levels begin to decline, our customers, they pull back. And their nervousness gets translated into cautiousness in how they spend and the timing of that spend. And certainly, we're seeing that. We saw it this past quarter that we just reported our fiscal third quarter, where we saw order pressure, order demand declines year-on-year across each of our three business segments. And I'm here to tell you, that is not unusual in our business. We've been through many downturns over the years, and that tends to happen in recessionary environments, or pre-recessionary environment. But Ryan, I'm curious, when I think back to a year ago, a little more than a year ago. Our business in North America was really starting to feel a ramp-up in activity, in project activity. And we had really fairly positive trends on the order front, particularly in the third quarter of a year ago. And that's in North America. Internationally, the business was really, really coming along quite nicely. And I think our general feeling was that, that was the beginnings of return to office activity and some pent-up demand. And I'm curious, the combination of -- in your research, are you sensing a hesitancy on the part of customers? And how is that coming through in your work? And then, John, you made a comment on our conference call about the funnel of activity increasing year-over-year. Maybe you can just put a little color to that.

Sure. I can kick things off. I think that a lot of organizations believe that a return to office was something that would happen in a matter of weeks or months with the announcement of some sort of policy. And what they've realized is that their employees significantly reorganized their entire lives during the pandemic and are working hard towards actually trying to have a more balanced, more enriching work experience. All the data that we've got, like we've surveyed 10,000 employees -- or excuse me, 10,000 workers globally as part of an initiative that we're in called Future Forum. We also do separate research. The vast majority of people want to spend quality time in offices. Only 15% of the 10,000 we surveyed last quarter wanted to be fully remote. When we asked them what's holding you back in terms of getting into the office more? You would expect #1 answer was commute time and cost. But the #2 thing was over scheduled meetings. There's a lot of people that, in the course of the pandemic, tried to replicate in-office experiences with tons of meetings. And so it forms like this very rigid schedule that lot of employees don't like. And so what we're in the midst of is people actually having to change the way they work as teams and as individuals to do the work that's important to them, including having better social comradery interaction with colleagues having better quality time outside of video, in-person, even coming to the office to do focused concentrated work. There's a lot of reasons why people want to come in, but the change is happening slowly as they evolve their work processes. So we saw some investment in making those spaces better. I think that, that will continue as the momentum occurs. But I do think there was a certain mindset that people got concerned when everyone didn't come back in an instant as to what that new equilibrium might be. And the reality is, it's still playing out. There's a few different data sources that are publicly available, showing office occupancy levels. And as I said, they're going up. They're just going up more like a balanced mutual fund than an IPO. Like it's not like something that happens in a week. It's something that's happening gradually. And in some ways, we're more optimistic that as those spaces get tuned towards supporting the activities employees want that it might be stronger eventually. But right now, they are, they're in a period of uncertainty because I think they expected to see something different by now.

I would add to that, Ryan. I think that, Jeff, you're right, there was definitely pent-up demand coming out of the first end of the pandemic, if you will. And when you think about how abruptly the pandemic began, probably not surprising, right? I mean literally projects were stopped mid-project in many cases for more than a year. So not only was there the restart of a lot of projects that were already in-flight, companies that obviously put on hold a lot of other plans in the process. I do think that the conversation has changed over the last 6 to 9 months. Still hesitancy, still a lot of companies trying to figure out what to do next. But I think they've gone from, particularly at the executive level -- and most of the customers that I speak with, have gone from, "Gosh, we're really not sure what to do, and we're going to wait and see," to, "Hey, we need our people back in the office more. We need connection, we need collaboration. We need to be mentoring our younger employees and our new hires and none of that can happen virtually." And so the conversation is more about, "Help us figure out the best way to do that." I just wrapped up a session that we had in New York, where we had 35 design principles from the United States, Mexico and Canada for the last 2 days doing a lot of best practices, thought sharing those types of things. And they confirm not only what Ryan said, but really what we're hearing sort of in real time for customers, and that is, they know they have to get it right because if they don't get it right, it will be harder to get their employees back in the space. So we're seeing things like a flight to premium. Premium spaces are continuing to lease out at a pretty good clip, whereas maybe B or C spaces, if you will, are very dormant. And I think that really speaks well to the portfolio that we have to offer the market, right? We have a level of brands that are premium in nature. And for that company that's trying to upgrade the employee experience, I think that's an area where we can lean in and really be helpful. There is a lot of activity. There is a lot of conversation. The hesitancy and the constant iteration, right, and I heard this a lot from the design firm principles that I was with, like we used to iterate on a floor plan maybe 2 or 3 or 4 times, and now it seems like it's 7 or 8 or 9 times, and there's a lot more people involved in the decision-making process. So the activity is still there, but the deal flow or the order flow, it's definitely being impacted by that. When I talk to our dealers about the environment today versus maybe pre-pandemic, they tell me for a -- anything from a $200,000 project to a $2 million project, it feels like 3x the effort to get that deal closed across the finish line and ordered. So on the one hand, I think we're encouraged by the activity. You mentioned, Jeff, we saw quite a nice jump in our funnel activity from the previous quarter to this most recent one. But we're also just aware of the fact that it's taking a longer amount of time for those projects to sort of make their way through the funnel.

Yes. I'm glad you said that because I do think sometimes there's a perception that there's inactivity. In fact, most organizations are really trying to engage with their employees to get a better sense of what types of spaces are in demand, what types of spaces will be used more it's a good thing. I think it will pay dividends for them and for us long term. But that piloting process, yes, it can take a bit. What's interesting is that those projects that I think we've seen moving forward and those organizations that have shared their plans with us, they are creating better spaces. They might be a little bit smaller in terms of the total square footage or square meters, but, to be honest, that's not always bad for us because the mix of products that's on the floor is less likely to be rows and rows of highly commoditized small desks and much more interesting sort of ancillary furniture and others that are well suited to our portfolio. There's a few secondary sources within the commercial real estate world that try to put a number to this. Generally, we've seen $18, $19, $20 a square foot furniture budgets from 2018, 2019 increasing. It's not uncommon to see $28, $29, $30 a square foot. I was with a nonprofit in the Midwest just last week that told me they were budgeting at $39 a square foot. So if the space is a little bit smaller, but the mix of products is much more favorable, and they want a less institutional sort of feel not as much paint, not as much steel, not as much glass, but warmer, softer, interesting materials that have a higher degree of comfort, that's really well suited to what we've been building for a long time.

Yes. And I would add to that, Ryan. We've always had a close working relationship with commercial real estate professionals. But if you think about it from a landlord perspective right now, how do I make my property more attractive, more appealing, higher on the consideration list for companies that are looking for space? And we're doing a lot more partnering early in the process to help landlords really make sure that their space shows well. And they do that by obviously building out certain areas and that type of thing to show what the space can be. So it's created different types of opportunities, I think, than maybe we've seen before, but definitely opportunity.

It is. In fact, the Real Estate Board of New York put out a report last month. Typically, when you look at occupancy levels, it's measured through badge swipes on security systems. But the Real Estate Board of New York did a different study where they were working with an organization that basically triangulated cell phones coming in and out of buildings. They found by the way, that it was closer to 60% of pre-pandemic levels as opposed to 50%, which is what a lot of the badge swipes indicated. But even more interestingly, the Class A spaces, meaning the higher quality spaces, the more desirable spaces in the vibrant neighborhoods were at about, I think, it was 66% or 67% occupancy compared to before the pandemic. And those Class B less desirable spaces were down to like 53%. So not only are we seeing the demand for nicer spaces and the demand to create nicer interiors. I think the evidence is beginning to bear out that they get better use.

Makes total sense. And I would say sort of a bellwether for us is what's going on in the design community. And as I mentioned, the time we just spent with a number of design principles, nobody is not busy, right? There's activity out there. Some of it has shifted, right? Industries like health care, life sciences, pharma, et cetera, are more active than others. But clearly, there's a lot of activity. And with the exception to your earlier point, Ryan, of maybe a couple of large cities that are trailing to come back in terms of back into the Central Business District, a lot of activity really across the board.

I can jump in real quick. One of my comments that I've been saying really since the beginning of the pandemic, and I think we're really starting to see this play out, and frankly, I think this informs some of our logic in the Knoll transaction was that my belief has been that the winners in our business in our industry of the future are going to have three key things that they offer. They're going to have the channels to reach customers, multiple channels to market. And so when I think about MillerKnoll and again, what I think that the Knoll acquisition gave us, it gave us some multiple new e-commerce channels to market. We got very high-performing dealers in North America. We got some incredible manufacturing capability and centers of excellence in Europe, in Canada and in the U.S. And so we have the channels to market. Products and obviously, a lot of the deal had to do with rounding out our product offer, and this whole push to premium that you talked about, Ryan, and companies looking for more choice and a different look and feel is very important. And I think the Knoll transaction really filled some gaps in our offer that give us the broadest offer in the industry. But the third key is knowledge. And, Ryan, this is right up your alley. And, John, yours too from a selling perspective. And I'm just curious as companies are iterating and considering this kind of new normal in the return to office to whatever degree they're planning it, what are they wrestling with? What -- and you've touched on some of this already, but where are we showing up to help them? And in what facets?

You can start, Ryan.

Sure. Well, I can think of a lot of different ways to answer that one. I mean, particularly from where I sit, we do get a lot of inbound requests asking bigger questions about how work is changing and a lot of talent related questions. I just had an inbound request last week from a senior corporate real estate and a large financial services insurance company saying, "Hey, we're thinking about going remote first, hybrid, help us to understand the differences there." I mean one of the nice things about the capabilities you described is that we can essentially support work wherever it happens. So regardless of which direction they go, I know there's a business opportunity for us there. But they're looking for us basically to mitigate risk, help get them in touch with other organizations that have been successful to try to look beyond headlines to know what is or isn't working. And then I think what is a little bit different, and I'm really thankful for the capabilities of our dealer channel when it comes to this is there are a lot of organizations that may not have capital to go redo everything and it may be that they're not identifying three floors of this building, they're looking at their whole portfolio saying, I think there's some improvements that I need to make incrementally across the board. If I look at some of the products that Miller and Knoll and others have released in recent years, they're really good at like being added into an existing environment like OE1, Rockwell Unscripted and adding some more agility, adding some more social spaces, better places to take a video call, whatever might be needed without having to disrupt the entire floor plate. So in some cases, they're wrestling with it because they don't think of it as something that's pertinent to just one location. They need to evolve their entire real estate portfolio forward, but it's great that we can walk alongside them. Sometimes I say we might not have all the answers, but we're here to ride shotgun with you and if we take this kind of show-to-shoder approach like we're going to dig in this together, we give them resources, we connect with customers. We share our podcasts, research paper, whatever. By the time they're ready to make a move like we've been along that journey with them for a while.

I would add to that. In terms of to your question, Jeff, other forms of help, right, that people are looking for or asking for. If you think about how spaces were being outfitted pre-pandemic, we had this phenomenon, I'm going to call it going on in our industry called resimmercial. And spaces were being filled with product that had maybe originally been designed and intended for a residential environment. And that was showing up on projects or other spaces. And that added a level of complexity in terms of project execution that I think, after a few years of that, customers began to grow weary of. And so this notion of, we want the space to be inviting, we might even wanted to have more of a hospitality feel than a corporate feel, but we don't want to add complexity and risk to our project execution process in that regard. So I think bringing Miller and Knoll together and all the group brands, right, from Muuto to HAY to NaughtOne, to CBS, et cetera, Geiger, DatesWeiser, all those brands really allow us to through our dealer network, provide a full solution that can be corporate or feel more hospitable -- hospitality or residential in nature from a single vendor, which mitigates risk, leverages buying power, all those types of things. So as customers are trying to solve these problems, they still always have an eye on their budget, right, and making sure that they're competitive; and #2, really trying to mitigate the risk of the project and make sure that it delivers on time.

I think that touches on an important point that I spend a lot of time in investor conversations, and that is, again, a point around some of the deal logic with combining Herman Miller and Knoll, and that is the deal part of the vision was that we felt the combination would be a value add and a way to serve our dealers as customers, meaning giving them a lot more tools to win and be effective in serving their customers in the marketplace. And then backing that up with a lot of the digital tools and capabilities that we've invested in as a company to make that buying process have less friction than it has in the past. And I think your point around trying to become more of a single source to eliminate waste in the process and increase reliability and lead times and so forth along the way, and serve the best products in the industry, that's a big part of why we put the deal together to begin with. And I think it's still -- and maybe you can comment on this, John. This is -- we began the process with what we have internally talked about is cross-selling, which is, in North America, creating a single network of dealers that have the full suite of MillerKnoll products. That was really only last June that, that was kicked off. This is an area that gets -- I get lots of questions on, and it was certainly, and I acknowledge that this was an area that we viewed as a risk coming into the deal. We knew that there was going to be -- it wasn't going to be a straight line up. It was going to be some bumps along the way. And I'm happy to report that we haven't been surprised by anything. I think the planning was very thorough and you and your team have done an amazing job executing. But maybe you can characterize a little bit about what you're hearing from dealers and that journey on getting our dealers trained on this cross-sell and our own sales people for that matter?

Sure. Thanks, Jeff. Yes, to your point, the notion of having a fuller portfolio to offer to our dealer partners was a significant benefit of bringing Herman Miller and Knoll together. And I would say across the board, our dealers are thrilled with the opportunities that those brands present. I mean let's be honest, there's a learning curve, right? And so you start in June and you have a number of dealers that are learning new products, learning new ways to specify. I think across our industry, it's fairly well-known that there's -- design resources are tight in dealerships, right? So you sort of put all that together, and you realize that you got to be a little bit patient and you give the dealers time to get comfortable, ramp up, get the product on their showroom floors, and all the things that allow them to effectively market the products. And we've been very methodically and systemically going about that, to your point, for the last 9 months. And obviously, we track that closely, not only quarter-to-quarter, but month-to-month and actually week-to-week. And we continue to see it ramp up. So I think that when you think about the portfolio that we have for the network, you go back, Jeff, to the deal rationale and there are a lot of elements to that. But one of the key parts of the strategic rationale centered around both Herman Miller and Knoll is sort of foundational belief in the power of problem-solving design to improve the lives of people where they work, where they live, where they teach, where they heal, et cetera. And that sort of manifests itself in that portfolio that we offer to the dealers. And the market responds to that. I mean I have yet to talk to a customer or a design firm that wasn't thrilled with the opportunity that the Miller portfolio now presents. So we're excited about it. And quite frankly, I think we're just getting started in terms of what it will ultimately be.

Rex and Bud, how are we doing on time?

We're getting close to the end. I'm going to ask you, Jeff, to kind of wrap things up here for us and give us kind of a very high-level view of all of these trends that Ryan and John have talked about in terms of the budget that people have per square foot, the combination of Knoll and Herman Miller products and what all that's going to mean? What your vision for that is over the longer term on both the top line and the margin? What's the opportunities for you on a -- over -- without getting too detailed, what's going on over the next couple of years?

Well, I wish we had a crystal ball. What I would tell you is the original vision that we had for the deal, it's playing out as we had hoped. And in fact, there have been some events in the world that I think are giving us even more confidence that it was the right move. To be a first mover in industry consolidation in our space and to be able to pick our own partner and know that it makes sense from a product overlap perspective, from a channels to market integration perspective. The synergies on the revenue side, which we haven't talked a lot about here, and we certainly haven't quantified them to the Street, but we've always said that we're big believers, and we're seeing real opportunities across all of our business segments, be it retail, our international business and in our -- in the Americas contract business. We believe it is early days, but we're beginning to see the flywheel speed up, and we feel very good about that. The other thing that I would say is, there have been some incredible pressures from the economy over the last 18 months with inflation and supply chain. The supply chain pressures aren't gone completely, but they're easing. And some of those inflationary pressures are beginning to fade as well. And of course, we've been very aggressive with pricing, as have all of our major competitors. And the beauty of that is, being at this point in time in a cycle, we don't know where the future takes us, but we're seeing margin expansion at a time when there's demand pressure. And I can tell you that, that hasn't always been the case. And so I think we're in a little bit of a unique time, and we think -- we believe and our -- certainly, our guidance for the fourth quarter indicates that belief that we have a lot more margin expansion ahead of us, even if we're in a muted demand environment. But in terms of the deal logic and where we think this takes us, I think it's those three things that I talked about. It's the power of the distribution channels that this combination gives us across multiple businesses contract and retail, it's the wealth of products across all of our collective brands that set us apart. And because of folks like Ryan and John's talented sales team as well as those folks around the world that serve our customers every day. We offer more knowledge and insights than anybody else in this space. And I think it's a powerful combination. And as soon as we start to get some cooperation from the elimination of health care crises and a tough economy, I think we're going to be off to the races.

All right. Thanks for your time today. Thanks for all these insightful comments. Before we wrap up, I want to ask my partner, Budd, to chime in. He's been covering this industry and has been involved in the furniture industry for more years than he wants me to talk about. So Budd, if you got any comments on what you learned today?

Thank you, Rex. And Jeff and Ryan and John and Carola, thank you all for your time and for our listeners. Thank you for your time. I do have several takeaways that I thought were fascinating from the conversation. One, I was interested to find out from Ryan that there are a lot more variation to what's going on in terms of the hybrid take-up by geography than we may have thought than we get from just looking at the average that we see from some of the resources we see. And secondly, I know we've seen a lot of activity. We hear that through the various competitors, and it's very interesting to see that, that funnel of activity is really going on. And I think Ryan said that in every organization that they talk to. Third, for me is a flight to quality. I hadn't thought about that before. But I think that the dollars per square foot of furniture really means that, that mitigates some of the revenue pressures that we may have seen from the economy. And John talked about the actual fact that institutions don't want to see -- don't want to -- organizations don't want to feel institutional. They want to feel very welcoming and very much more residential, very much more like you're going to a place that's going to be very comfortable for. And as Jeff said, the reality that the MillerKnoll combination has a wealth of tools is, I think, very interesting and probably underappreciated by my community, by our community of the investors. So I think that's a competitive advantage that I think gets driven home as we see over time. So I think these are unique. So again, to Ryan, Jeff, John Carola, thank you for your time, Rex. Thank you for your moderation. I'd love to plug the podcast that I know that Ryan and John and the team do, but again, thank you for our participants. Ryan, John, Jeff, can you give us just maybe a final comment or two, and then we'll sign off.

I'll just go real quick and just say thanks again for pulling this together. And as we've -- I've said many times in the past that one of the things that has always helped pay the bills in this business is change. And boy, are we seeing a lot of it in the world right now. And I think that causes customers to rethink their environments, and that tends to result in opportunities for those in the industry who are creative and who can meet the customers where they are. And I think we're as well-positioned to do that as anybody.

Again, again, to our participants, thank you and, especially, to our audience. Thank you for your attention. And we will publish a management series in the not too distant future that just recaps this conversation, talks a little bit -- usual length of a podcast that you can see for yourself and you can see that research happen as it happens real time. Again, thank you very much and so long.

Great. Thank you all very much, and look for our research. Thank you. Bye-bye.