HNI CORP (HNI) FY 2022 MD&A

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of the Corporation’s historical results of operations and of its liquidity and capital resources should be read in conjunction with the Consolidated Financial Statements of the Corporation and related notes. All dollar amounts presented are in millions, except per share data or where otherwise indicated. Amounts may not sum due to rounding. Statements that are not historical are forward-looking and involve risks and uncertainties. See "Item 1A. Risk Factors" and the Forward-Looking Statements section within "Item 1. Business" for further information.

Overview

The Corporation has two reportable segments: workplace furnishings and residential building products. The Corporation is a leading global designer and provider of commercial furnishings, and a leading manufacturer and marketer of hearth products. The Corporation utilizes a decentralized business model to deliver value to customers via various brands and selling models. The Corporation is focused on growing its existing businesses while seeking out and developing new opportunities for growth.

In 2022, the Corporation achieved solid gross and operating margin improvement and strong earnings growth, despite a weakening macroeconomic environment that drove softer demand, particularly in the second half of the year. Strong price realization in both reportable segments drove higher sales and helped the Corporation recover the unfavorable price-cost impact experienced in the prior year due to the rapid onset of material, freight, and labor cost inflation in 2021. In workplace furnishings, business simplification plans and capacity actions, including restructuring of an eCommerce business, the addition of a new manufacturing facility in Mexico, and the divestiture of Lamex, have favorably impacted margins and are expected to deliver improved segment profitability going forward. In residential building products, higher mortgage rates and macroeconomic concerns in 2022 have started to pressure volumes in this market, coming off several periods of historically strong sales and profit performance driven by COVID-19 pandemic-induced trends. However, the Corporation’s category-leading position and favorable housing demographics support the expectation of solid demand over the long-term in this segment. In spite of elevating economic pressures during the year, the Corporation maintained a solid balance sheet, which supported a strong level of investment in the business to allow for the continued execution of strategic initiatives.

Consolidated net sales for 2022 were $2.362 billion, an increase of 8.1 percent compared to net sales of $2.184 billion in the prior year. The change was driven by a 16.7 percent increase in the residential building products segment, and 3.6 percent year-over-year sales growth in the workplace furnishings segment. The acquisition of residential building products companies added incremental year-over-year sales of $43.7 million, and the divestiture of Lamex reduced year-over-year sales by $48.7 million. See "Note 4. Acquisitions and Divestitures" in the Notes to the Consolidated Financial Statements for additional information.

Net income attributable to the Corporation in 2022 was $123.9 million compared to net income of $59.8 million in 2021. The increase was driven by favorable price-cost and a net gain on the sale of Lamex of $49.4 million, partially offset by reduced net productivity, higher investment spend, and increased expenses related to restructuring, impairment, and cost reduction initiatives.

In preparation for continued pressure from lower volumes heading into 2023, the Corporation initiated corporate-wide cost savings actions in third quarter 2022 that are estimated to save approximately $30 million on an annual basis.

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Results of Operations

The following table presents certain results of operations:

Net Sales

Consolidated net sales for 2022 increased 8.1 percent compared to the prior year. The change was driven by price realization in both the residential building products and workplace furnishings segments, along with higher residential building products volume, partially offset by lower volume in the workplace furnishings segment. The lower workplace volume was primarily driven by restructuring of an eCommerce business, which resulted in unfavorable year-over-year sales impact of approximately 5 percent. Also affecting the year-over-year sales comparison was a $48.7 million unfavorable impact from the sale of Lamex, and a $43.7 million favorable impact from acquiring residential building products businesses.

Gross Profit

Gross profit as a percentage of net sales increased 70 basis points in 2022 compared to 2021, primarily driven by favorable price-cost, which was partially offset by operational investments and reduced net productivity. Favorable price-cost was attributable to the Corporation’s ability to implement price increases in response to recent inflationary pressures which have driven up the cost of labor, materials and transportation.

Selling and Administrative Expenses

Selling and administrative expenses ("SG&A") as a percentage of net sales increased 10 basis points in 2022 compared to 2021, driven by lower workplace furnishings volume, higher freight costs, and increased investment spend, partially offset by price realization.

Selling and administrative expenses include freight expense for shipments to customers, research and development costs, and amortization of intangible assets. Refer to "Note 2. Summary of Significant Accounting Policies" and "Note 6. Goodwill and

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Other Intangible Assets" in the Notes to Consolidated Financial Statements for further information regarding the comparative expense levels for these items.

Gain on Sale of Subsidiary

In the current year, the Corporation recorded a pre-tax gain of $50.4 million as a result of the divestiture of Lamex in July 2022.

Restructuring and Impairment Charges

In the current year and prior year, the Corporation recorded restructuring and impairment charges primarily related to efforts to drive business simplification and improve long-term profitability in the workplace furnishings segment, including the restructuring of an eCommerce business. Charges include:

Refer to "Note 6. Goodwill and Other Intangible Assets" and "Note 17. Restructuring and Impairment Charges" in the Notes to Consolidated Financial Statements for further information regarding restructuring and impairment charges.

Operating Income

For 2022, operating income as a percentage of net sales increased 270 basis points compared to 2021. The increase was driven by favorable price-cost and gain on the sale of Lamex, partially offset by reduced net productivity and higher investment spend.

Interest Expense, Net

Interest expense, net was $8.8 million and $7.2 million in 2022 and 2021, respectively. The increase was driven by increased borrowings during 2022 and higher interest rates on the Corporation’s variable-rate revolving credit facility.

Income Taxes

The following table summarizes the Corporation’s income tax provision:

The income tax provision reflects a lower rate in 2022 compared to 2021, primarily due to the sale of the Lamex business in July 2022. This transaction created valuation adjustment tax benefits related to existing deferred tax assets, as well as basis differences, which significantly reduced the Corporation’s full year effective tax rate. See "Note 8. Income Taxes" in the Notes to Consolidated Financial Statements for further information relating to income taxes.

Net Income Attributable to HNI Corporation

Net income attributable to the Corporation was $123.9 million or $2.94 per diluted share in 2022 compared to $59.8 million or $1.36 per diluted share in 2021.

Comparison of Fiscal Year Ended January 1, 2022 with the Fiscal Year Ended January 2, 2021

To review commentary for the consolidated and segment-level results of operations comparison of the fiscal year ended January 1, 2022 with the fiscal year ended January 2, 2021, please refer to Item 7 of the Corporation’s Form 10-K filed March 1, 2022 with the Securities and Exchange Commission.

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Workplace Furnishings

The following table presents certain results of operations in the workplace furnishings segment:

Net sales in 2022 for the workplace furnishings segment increased 3.6 percent compared to 2021. The impact of the sale of Lamex in the third quarter of 2022 decreased net sales by $48.7 million compared to prior year. Aside from this item, segment sales were up 7.3 percent, primarily driven by price realization across most customer segments along with volume growth in the international and small and medium-sized business customer segments, partially offset by lower eCommerce and contract customer volume. The contract customer business was negatively affected by macroeconomic uncertainty which impacted return-to-office plans and investments by large corporate customers. Lower eCommerce volume was due to the previously announced restructuring of an eCommerce business, and had an unfavorable impact of approximately 8 percent on workplace furnishings year-over-year sales.

Operating profit as a percentage of net sales increased 20 basis points in 2022 compared to 2021, driven by favorable price-cost and improved mix, partially offset by increased investments, reduced net productivity, and lower volume.

Residential Building Products

The following table presents certain results of operations in the residential building products segment:

Net sales in 2022 for the residential building products segment increased 16.7 percent compared to 2021, driven by price realization and volume growth in both the new construction and existing home channels. Included in the 2022 sales results was a $43.7 million favorable impact from acquiring residential building products companies.

Operating profit as a percentage of net sales decreased 80 basis points in 2022 compared to 2021. The decrease was driven by the impact of acquisitions, higher SG&A, and reduced net productivity, partially offset by favorable price-cost and higher volume.

Liquidity and Capital Resources

Cash, cash equivalents, and short-term investments totaled $19.5 million at the end of 2022, compared to $53.7 million at the end of 2021. These funds, coupled with cash flow from future operations, borrowing capacity under the Corporation’s existing credit agreement, and the ability to access capital markets, are expected to be adequate to fund operations and satisfy cash flow needs for at least the next twelve months. Based on current earnings before interest, taxes, depreciation and amortization, the Corporation can access the full $400 million of borrowing capacity available under the revolving credit facility, which includes the $89 million currently outstanding, and maintain compliance with applicable covenants. As of the end of 2022, $1.1 million of cash was held overseas and considered permanently reinvested. If such amounts were repatriated, it could result in additional foreign withholding and state tax expense to the Corporation. The Corporation does not believe treating this cash as permanently reinvested will have any impact on the ability of the Corporation to meet its obligations as they come due.

Cash Flow – Operating Activities

Operating activities were a source of $81.2 million of cash in 2022, compared to a source of $131.6 million cash in 2021. The lower cash generation compared to the prior year was primarily due to changes in working capital. Changes in working capital balances resulted in a $72.7 million use of cash in 2022 compared to a $34.4 million use of cash in the prior year. As demand moderated toward the end of 2022, and a company-wide cost savings initiative was put into place, the Corporation’s accounts payable and accrued expense balances were reduced, resulting in a net use of cash.

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The Corporation places special emphasis on management and control of working capital, including accounts receivable and inventory. Management believes recorded trade receivable valuation allowances at the end of 2022 are adequate to cover the risk of potential bad debts. Allowances for non-collectible trade receivables, as a percent of gross trade receivables, totaled 1.5 percent and 1.2 percent at the end of 2022 and 2021, respectively. The Corporation’s inventory turns were 8.4 and 8.9 for 2022 and 2021, respectively.

Cash Flow – Investing Activities

Capital expenditures, including capitalized software, were $68.4 million in 2022 and $66.5 million in 2021. These expenditures are primarily focused on machinery, equipment, and tooling required to support new products, continuous improvements, and cost savings initiatives in manufacturing processes. Additionally, in support of the Corporation’s long-term strategy to create effortless winning experiences for customers, the Corporation continues to invest in technology. The Corporation anticipates capital expenditures for 2023 in an estimated range of $60 million to $70 million.

Cash Flow – Financing Activities

Debt - The Corporation maintains a revolving credit facility as the primary source of committed funding from which the Corporation finances its planned capital expenditures, strategic initiatives, and seasonal working capital needs. In the second quarter 2022, this facility was amended and the maturity extended until June 2027 with a revised maximum borrowing capacity of $400 million. Cash flows included in financing activities represent periodic borrowings and repayments under the revolving credit facility. See "Note 7. Debt" in the Notes to Consolidated Financial Statements for further information.

Dividend - The Corporation is committed to maintaining or modestly growing the quarterly dividend. Cash dividends declared and paid per share are as follows:

The last quarterly dividend increase was from $0.31 to $0.32 per common share effective with the June 8, 2022 dividend payment for shareholders of record at the close of business on May 27, 2022. The average dividend payout percentage for the most recent three-year period has been 75 percent of prior year earnings or 28 percent of prior year cash flow from operating activities.

Stock Repurchase - The Corporation’s capital strategy related to stock repurchase is focused on offsetting the dilutive impact of issuances for various compensation-related matters. The Corporation may elect to opportunistically purchase additional shares based on excess cash generation and/or share price considerations. The Board most recently authorized $200 million on May 17, 2022, for repurchases of the Corporation’s common stock. See "Note 10. Accumulated Other Comprehensive Income (Loss) and Shareholders’ Equity" in the Notes to Consolidated Financial Statements for further information.

Sales of Stock - The Corporation records cash flows received from the sale of its common stock held in treasury, primarily in connection with stock option exercises and the HNI Corporation Members’ Stock Purchase Plan. See "Note 10. Accumulated Other Comprehensive Income (Loss) and Shareholders’ Equity" and "Note 11. Stock-Based Compensation" in the Notes to Consolidated Financial Statements for further information.

Cash Requirements

As of December 31, 2022, the Corporation has the following obligations and commitments to make future payments:

Purchase Obligations - The Corporation’s purchase obligations include agreements to purchase goods or services that are enforceable, legally binding, and specify all significant terms, including the quantity to be purchased, the price to be paid, and the timing of the purchase. Estimated purchase obligations total $149 million during 2023 and $4 million thereafter.

Debt - Debt principal obligations are approximately $1 million during 2023, and $189 million thereafter. Interest obligations from debt are estimated to be approximately $9 million during 2023 and $31 million thereafter. Refer to "Note 7. Debt" in the Notes to Consolidated Financial Statements for additional information.

Deferred Compensation - Deferred compensation obligations, which include both cash and Corporation stock, are expected to be approximately $0.5 million during 2023 and $6.6 million thereafter. Refer to "Note 11. Stock-Based Compensation" in the Notes to Consolidated Financial Statements for additional information.

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Post-Retirement Benefit Plan - Post-retirement benefit plan payments are expected to be approximately $1 million during 2023 and $11 million in aggregate from 2024 through 2031. Refer to "Note 13. Post-Retirement Health Care" in the Notes to Consolidated Financial Statements for additional information.

Operating and Finance Leases - Operating and finance lease obligations are expected to be approximately $27 million during 2023 and $94 million thereafter. In addition the Corporation has approximately $65 million in commitments related to leases which have been signed but not commenced as of the end of 2022; these commitments primarily relate to a manufacturing facility under construction. Refer to "Note 14. Leases" in the Notes to Consolidated Financial Statements for additional information.

Other Obligations - Other long-term obligations of approximately $10 million are primarily comprised of uncertain tax and put option liabilities. Additionally, in 2022 the Corporation entered into a long-term commitment to purchase solar energy from a local utility to satisfy a portion of the Corporation’s electricity demand in the Muscatine, IA area. The project is currently estimated to commence in 2025 with the Corporation’s future commitment approximating $13 million. For the Corporations’s estimated future obligations related to product warranties and self-insured liabilities, refer to "Note 2. Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements.

Litigation and Uncertainties

See "Note 15. Guarantees, Commitments, and Contingencies" in the Notes to Consolidated Financial Statements for further information.

Looking Ahead

The Corporation continues to navigate near-term uncertainty driven by macroeconomic conditions including the impacts of the pandemic and recent dynamics around labor availability, supply chain capacity, and cost inflation. However, management remains optimistic about the long-term prospects in the workplace furnishings and residential building products markets. Management believes the Corporation continues to compete well and remains confident the investments made in the business will continue to generate strong returns for shareholders.

Critical Accounting Policies and Estimates

General

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon the Consolidated Financial Statements, prepared in accordance with Generally Accepted Accounting Principles ("GAAP"). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Senior management has discussed the development, selection, and disclosure of these estimates with the Audit Committee of the Board. Actual results may differ from these estimates under different assumptions or conditions.

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Management believes the following critical accounting policy reflects its more significant estimates and assumptions used in the preparation of the Consolidated Financial Statements.

Self-Insurance

The Corporation is primarily self-insured or carries high deductibles for general, auto, and product liability, workers’ compensation, and certain employee health benefits. The general, auto, product, and workers’ compensation liabilities are managed via a wholly-owned insurance captive, with estimated liabilities of $23.8 million and $26.3 million as of December 31, 2022 and January 1, 2022, respectively, included in the Consolidated Balance Sheets. Certain risk exposures are mitigated through the use of independent third party stop loss insurance coverages.

The Corporation’s policy is to accrue amounts in accordance with the actuarial determined liabilities. The actuarial valuations are based on historical and current factors such as cost experience, claim frequency, and demographic information, along with certain assumptions about future events including legal actions, medical cost inflation, the number or severity of claims, and the magnitude and change of actual experience development. No changes were made to the methodologies utilized to estimate self-insurance reserves in 2022. While the recorded amounts are sensitive to the assumptions and factors described herein,

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management believes that such assumptions and actuarial methods used to determine self-insurance reserves are reasonable and provide an appropriate basis for estimating the liabilities. However, inherent uncertainty due to variability in the facts and circumstances of individual claims, as well as the length of time from incurrence of claims to final settlement, may result in the Corporation’s ultimate exposure differing significantly from what is currently estimated.

As of December 31, 2022, the Corporation’s self-insurance reserve was accrued within an actuarial determined range, which accounts for the subjective nature of the estimate. The span of the current range is approximately $6 million.

Recently Issued Accounting Standards Not Yet Adopted

In September 2022, the FASB issued ASU No. 2022-04, Liabilities—Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations. ASU 2022-04 enhances transparency of supplier finance programs by requiring disclosure of key terms, amounts outstanding, a rollforward of outstanding amounts, and a description of where in the financial statements outstanding amounts are presented. ASU 2022-04 is effective for the Corporation in the first quarter of fiscal 2023. While this guidance will not impact the financial condition, results of operations, or cash flows of the Corporation, management is currently evaluating the impact on the notes to the consolidated financial statements.