MillerKnoll Inc (MLKN) 2003 Q3 法說會逐字稿

Everyone please stand by. We're about to begin.

Good morning everyone and welcome to this Herman Miller Incorporated third quarter for year-end 2003 earnings release conference call.

Just a reminder, this call is being recorded.

This conference call will include forward-looking statements that involved uncertainties and risks. There can be no assurance that actual results will not differ from the company's expectations. Factors that could cause such differences include the company's ability to improve operations and realize cost savings, competitive and general economic conditions, the future profitability of acquired companies and other risks described in the company's annual reports on Form 10-K, it's quarterly reports from Form 10-Q and its other filings with the Securities and Exchange Commission.

Today's presentation will be hosted by Ms. Beth Nickels, Chief Financial Officer and Mr. Michael Volkema, Chairman and Chief Executive Officer. Ms. Nickels and Mr. Volkema are joining by Mr. Joe Nowicki, Treasurer. Ms. Nickels and Mr. Volkema will open the call with a brief presentation, which will be followed by your questions.

We will limit today's calls to 60 minutes. At this time, I would like to begin the presentation by turning the call over to Mr. Michael Volkema. Please go ahead sir.

Good morning everyone, and welcome to our third quarter conference call. Obviously, there's a lot going on in the world today and we'll try to be sensitive to your time and the other things that you need to get done.

I'll open the call with a brief introductory comment, and then I'll turn the conference call over to Beth Nickels for a more detailed review or our financials. And then we'll use the remaining time for your questions.

It's no secret that we continue to suffer from difficult market conditions. As anticipated, we felt the industry softness during the holiday season, and the conflict with Iraq continues to have a chilling effect on new projects. The total number of projects currently in our sales cycle is fairly constant, and our closing ratio remains about the same. Yet several project decisions continue to be deferred awaiting a resolution to the geopolitical uncertainty. Of course, we believe the removal of that uncertainty will set the stage for an industry-wide recovery. I always hate to admit that we're one of those cyclical companies that will benefit from the other side, but it's true.

Again, the leadership team is not waiting for the market conditions to improve. We will continue to identify ways that will lower our costs and improve our performance. Beth, in her overview, will review some of our recent activities.

In addition, we will continue to focus on cash flow from operations, improving our financial flexibility and insuring that we will have the resources to invest in the products that will enlarge our future market opportunity. And with that brief introduction, I'll turn the conference call over to Beth.

Thanks Mike. We'd like to remind everyone this quarter's call is also being web cast and includes a slide presentation, which can be viewed on our web site at hermanmiller.com.

And if you haven't received a press release, it's also available on the web site. This quarter marks the third quarter of a return to profitability. Sales were 310 million and EPS was four cents per share. Our performance, again, reinforced the appropriateness of actions taken last year to redesign our business model.

Our gross margin and operating expenses continue to show great year over year improvement. Our cash flow from operations was extremely strong. Now lets get into the details of consolidated sales, orders and backlogs. On a consolidated basis, net sales for the quarter totaled 310 million, which is at the low end of the guidance we provided.

This represents roughly an 8.9 percent decline on a year over year basis. Our average weekly sales for the quarter were 23.9 million, compared to 27.5 million in the second quarter and 26.7 million in the first quarter. The decline is a reflection of our normal seasonality combined with an industry wide softening and customer demand that Mike already mentioned.

Consolidated new orders for the quarter totaled 282 million, which is also down 8.9 percent compared to last year. Orders booked during the third quarter equate to an average of 21.7 million per week. The level of business activity during the quarter as measured by client visits continue to improve over the prior year, up eight percent for the quarter.

Obviously we haven't yet seen this increased activity translate into orders, but we believe it's a promising sign of pent up demand that will be released once the economy recovers. Project opportunity flow has remained steady over the quarter, but there hasn't been any significant up tic that would suggest a near term dramatic recovery.

Now lets talk about backlog. For the quarter our ending backlog of 166 million was down 14 percent from the second quarter. On a year over year basis, it's relatively consistent with last year's third quarter levels of 165.5 million. Historically, revenues and orders in the third quarter reflect a seasonal slow down and this year was consistent with that trend.

Normally we see a slowdown through the holidays. A few weeks after the holidays when we would have expected clients to start thinking about furniture, they instead started thinking about the war and Iraq. Clearly, we would prefer to enter the fourth quarter with a higher backlog and order pacing so that we could continue to demonstrate earnings momentum.

Unfortunately, the uncertainty in the global environment prevented that. When and how this demand will return remains unclear. Now I'll give you some specifics around domestic and international operations. Domestic sales decreased 10 percent, while new orders declined 13 percent on a year over year basis.

On a sequential quarter basis, meaning second quarter to third quarter, North American sales decreased 14 percent while orders declined 23 percent. As you may recall, we had reported sequential quarter gains in sales up through the second quarter. It wasn't until this quarter that we felt the renewed effects of economic uncertainty.

On a positive note, our international business environment showed some encouraging signs this quarter. On a year over year basis sales for the quarter decreased only 1.7 percent, but new orders actually increased 14 percent. We saw year-to-year improvements in orders in Mexico, South America and the U.K.

In addition, we've recently been awarded an $11 million project with the U.K. government. This follows the $9 million U.K. government project that we're completing in the current year and have discussed in prior calls. This new project is the largest furniture project currently going on in the U.K. and potentially across Europe. This has not been included in our order entry figures yet and will ship next fiscal year.

Now let's discuss gross margin. We continue to make gains toward improving gross margin. Once again, this was a bright spot for the quarter. While net sales dollars were down 8.9 percent, gross margin dollars declined only 5.1 percent reflecting the benefits from the implementation of earlier cost reduction initiatives. Our gross margin improved to 30.1 percent from 28.9 percent on a year-over-year basis despite a $30 million decline in sales volume.

Current quarter gross margins were favorably impacted by two-and-a-half million of reductions in incentive compensation accruals based on the full year financial expectations. Sequentially, meaning second quarter to third quarter, gross margin decreased by 1.7 percentage points from the second quarter, but this was due to the lower seasonal volumes that impacted our ability to leverage fixed overhead costs.

The results for the quarter again showed improvement in almost all areas of cost of goods sold when compared to the prior year. Most notable were our continued improvements in overhead spending. On a pure dollar basis, overhead spending declined by $7.9 million compared to last year. This decline of almost 11 percent is greater than the relative decline in sales over the same period. Overhead spending was also down by 5.8 million compared to the second quarter, but as a percentage of sales it increased by 1.1 percentage points due to the lower volume. Material costs for the quarter totaled 38.3 percent of sales, consistent with the prior year but an increase from the second quarter of 0.8 percentage points.

We began to feel the impact this quarter of the steel component price increases that we've discussed in past conference calls, but the great efforts by our procurement and supply chain management team through negotiation and sourcing consolidations have reduced this impact to less than half of our initial estimates. In addition, we're also beginning to experience increases in our plastic components due to the impact of crude oil and natural gas prices. Our procurement and supply chain teams are continuing their pursuit of over 250 initiatives to further improve our material pricing to offset these challenges.

Our freight-out and product distribution costs totaled 5.8 percent for the quarter, down 0.6 percentage points from last year. This is great news in light of the significantly increased fuel costs that are up over 16 percent from last year at this time. Our transportation and distribution teams have been actively pursuing other cost savings in order to offset these increases, and they're working.

Pricing pressure has continued to compress gross margins. Higher discounting in the third quarter as compared to a year ago reduced our domestic margin by approximately $5 million; however, discounting was relatively flat when compared to the second quarter levels. On a year-to-date basis, discounting has reduced domestic gross margin by approximately $16 million as compared to the prior year. We've done a good job so far mitigating the impact of discounting.

We want to assure you that we continue to work at reducing our costs. These efforts should continue to yield positive results and we will not stop pursuing ways to be more effective. As you know, last week we announced a further workforce realignment. We notified approximately 115 manufacturing employees of involuntary layoffs, and eliminated 150 office and indirect production employees. These changes should drive annual savings in the range of eight to nine million, with approximately three-and-a-half million in manufacturing overhead.

Let's move on now to operating expenses. Our performance in this area is also encouraging. For the quarter, operating expenses totaled 85.5 million or 27.5 percent of sales, excluding special charges. This is a 2.4 percentage point improvement or $16.4 million on a year-over-year basis. However, you might remember in fiscal year 2002, the company accelerated depreciation on some of its technology related assets, that added 7.9 million to prior year's third quarter costs. Operating expenses also benefited from the reduction of approximately 1.4 million of incentive compensation accruals.

But even after adjusting for both of these, operating expenses still declined 8.7 percent, reflecting our continued focus on cost control.

Compared to second quarter levels, operating expenses in absolute dollars declined 7.3 million, but as a percentage of sales was up 1.6 percentage points, due to the decreased volume. Declines could be seen across the board. We did have increased costs associated with the upcoming new product launches, and also some increased note receivable reserves, associated with some of our U.S. dealers.

As reported last quarter, we believe we can continue to maintain close control over our op-ex spending. The additional workforce realignment announced last week will help us to drive an additional four-and-a-half million in annual operating expense savings.

At the same time, we intend to continue investing in those projects and programs that we think are essential to innovation and future sales growth.

Moving down the income statement to operating margin and net income. Our 2.6 percent operating margin for the third quarter improved from the prior year of a negative one percent, due to the improvements mentioned above. The decrease from last quarter's 5.8 percent is due to the lower volume levels.

Other expenses for the quarter net of interest income, totaled 3.2 million compared to five million last year. Included in this reduction is 300,000 of interest savings from our interest rate swap agreement. In addition, we had a $700,000 currency gain due to an unrealized gain on U.S. dollar denominated cash held in the UK.

The effective tax rate was 34 percent for the quarter. As explained in previous quarters, the lower rate's driven primarily by changes in amortization of goodwill, related to the adoption of FAS 142, the effects of changes in international and state tax provision and the size of permanent deductible items relative to our earnings.

Net earnings for the quarter were three million or four cents per share, which is within the range provided in our second quarter press release. This compares to a net loss of 11.6 million or a negative 15 cents per share in the prior year third quarter.

Excluding special charges in the prior year, net earnings were a negative 5.4 million or a negative seven cents per share.

Now lets talk about cash flow and the quality of the balance sheet. For the quarter, operating cash flow continued to be very strong as we generated 36 million of cash from operations.

This compared to 49 million for the same period last year. However, if you exclude the $15 million voluntary contribution to the company's employee pension fund, cash flow from operations was almost 51 million. Year to date cash from operations is 141 million. As you might recall, one of the primary objectives of our restructuring plan last year was to strengthen our cash flow.

We're seeing evidence that the objective is being met. In light of current conditions, we monitor our accounts receivable and credit exposure very closely and believe we're adequately reserved for bad debt expense. Our collections of accounts receivable continue to remain relatively strong. During the third quarter, we reduced our inventory and accounts receivable balances by 34 million from the prior quarter.

And our DSO in inventory and receivables improved by more than four days from the same quarter in the prior year. We continue to monitor the health of our dealer network. They're critical to the success of our long-term strategy and are clearly feeling the pain of the current economic environment. In working with them, we've developed action plans to be sure we have adequate coverage in key markets, and also to limit our risk exposure.

We did, as a result, increase our notes receivables reserves by $2 million during the quarter. Capital expenditures for the quarter were 7.4 million. Year to date, our cap acts has totaled 20 million, which is almost 24 million below last year. We continue to closely scrutinize capital spending to ensure we're making the right investment, to sustain the business and to preserve our ability to introduce innovative new products.

Based on the reduced pace of our capital spending, we now project cap acts for fiscal '03 to be in a range of 25 to 30 million. And we want to reiterate that although we've lowered our spending levels, we continue to make investments to significantly improve our product in terms of quality, durability and price competitiveness.

We've introduced a wide variety of extensions to our eco-space and resolve product platform, a breakthrough technology in ergonomic seating called Posturefit, and we plan to introduce a new, high performance work chair later this fiscal year. We also continue to make investments in research, as we evaluate concepts that will lead to the commercialization of new, innovative products as well as new product platforms.

Now I'd like to give you an update on the status of the facilities that were exited in the restructuring. As we mentioned last quarter, the largest facility located in Rockland, California, is currently under contract. This contract remains in place and we received a non-refundable deposit of $750,000 in January.

The transaction is expected to close by the end of April. During the quarter the carrying value of the Rockland facility, which amounts to $16 million was reclassified to current assets in anticipation of the fourth quarter sale. We previously entered into a sublease for a good portion of the Zeeland, Michigan facility called the facility. This week we signed a sublease for another portion of the facility with the same tenant, who's expected to take possession by the end of the month.

We've seen an increase in activity related to the Holland, Michigan chair plant. We've received several offers on the facility, but haven't yet agreed on a final price or purchaser. We still believe the property is recorded at an appropriate value.

Let's move on to our liquidity and cash position. Our increased profitability in cash flow has resulted in a significant improvement in our coverage ratios. As a result, we're again this quarter in compliance with the debt covenants without the benefit of amendments negotiated last spring to exclude special charges from the calculations for a period of time. The improving trend in profitability and cash flow, the $200 million available on our revolving credit facility, and our significant cash balance provide us tremendous financial flexibility. Subsequent to quarter end, we made a $10 million scheduled principal payment, bringing our outstanding private placement note balance to $45 million.

During the quarter we also resumed our share repurchase activity, buying 494,000 shares for $8.3 million. This approximates an average price of $16.91 per share. We expect to continue our repurchase activity. Consistent with our past practice, the level of repurchases will be balanced against our cash flow, our desire to reinvest in the business, and our mandate to maintain a high degree of financial flexibility.

Pension plans continue to receive a lot of attention lately, so we thought it'd be helpful to give you a brief update on the status of our defined benefit cash balance plan. At fiscal year end, we were in an underfunded position of approximately $54 million despite making voluntary cash contributions of $37 million last year. Since that time, we estimate that the poor performance in the stock market has further increased the underfunded status. We made an additional $15 million voluntary contribution in the current quarter and are anticipating making a similar contribution in the fourth quarter. We maintained a strong cash position, ending the quarter with a cash balance of $188 million.

Now let's turn to the outlook for the balance of the fiscal year. As I mentioned earlier, the current global environment has contributed to continued weakness in our near-term order demand. With the war in Iraq and its undetermined impact on the economy, we can't reasonably anticipate a recovery in order entry rates for the fourth quarter. As a result, we expect our sales to be in a range of 305 to 325 million with earnings per share between one cent and six cents before special charges. This suggests that full-year revenues should be between 1.32 billion and 1.34 billion with earnings per share in a range of 34 to 39 cents before special charges.

In summary, our financial performance validates the adjustments made to our cost structure. Equally important, we're confident in our positioning for future growth. We were able to maintain profitability this quarter on a much lower volume base. Great effort has gone into the implementation of our restructuring, and the results are evident. While we're disappointed that the economy hasn't yet shown signs of a recovery, we must also be realistic that, given the current world events, we cannot anticipate an improvement in our order rates this quarter. However, we remain confident that we have the right leadership team in place to see us through these difficult times and the right business model to position us for future market opportunity.

Now I'd like to turn the call back to the operator to open it up for questions.

Thank you. If you'd like to ask a question on the phone line today, you may signal by pressing the star key, followed by the digit one on your touch-tone telephone. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that will be star, one to ask a question. And we'll take our first question from Budd Bugatch with Raymond James.

Good morning. This is Brian Gordon sitting in for Budd, who was not able to make it this morning. First question is in regard - market share versus . It looks like through the first two months or so of the quarter industry shipments were down about 4.8 percent. Do you think February deteriorated that much, or do you think perhaps you lost a little market share versus the industry?

Brian, this Mike, I'll start. I think if you go back two previous quarters, you'd not that we picked up market share, when you look at those two quarters. Obviously, the information has lagged as you point out. So we don't know what happened in the comparison between our final quarter. The number we have is a little deeper than what you have, yes, 4.8 percent and we don't know what happened in the last month yet. So and obviously, we've heard enough anecdotal evidence from you know, other competitors that they too experienced a seasonal downturn in that they haven't seen a recovery.

And we always try to be careful that we don't put too much emphasis on the quarterly numbers. We try to look more at the trends over a little bit longer period of time.

OK, thank you very much.

We'll take our next question from with UBS Warburg.

Good morning. Can you talk a little bit about where your current break even level is?

Our current break even level is still probably pretty close to the 1.2 billion or 300 million per quarter. The changes that we just announced will help bring that down a little bit going forward. But we also anticipate that if we don't see any kind of increase in sales, we'll continue looking for other ways to reduce our costs.

OK, and can you just also talk a little bit about the product mix during the quarter?

Sure. Product mix didn't change significantly from the prior quarters, but systems products as a percentage of revenue didn't change as significantly as some of the other product mix, and I think that's because of the installed base you have in systems. Free standing would have probably the largest decrease in year-over-year sales, and followed by seating and that's because it's easier to change out those products in a project.

OK, thank you.

We'll go next to with ARIA Partners.

Hi how are you guys?

Hi .

Quick question for you. The, given the guidance that you gave, the one to six in the fourth, including special charges, given the recent layoff you announced, did that bring you guys negative again for the fourth quarter, when you include special charges in that?

It could if we hit the bottom end of the range.

OK.

Special charges for the actions we just implemented are probably around four cents a share.

OK. So if you hit the bottom end of the range then it will bring you back into the negative territory then?

It could, yes.

OK, great. Thank you.

And once again that is star-one to ask a question.

We'll go next to Chris Hussey with Goldman Sachs.

Good morning guys.

Morning Chris.

Chris.

Couple of questions. First, sort of mundane one on the pension. You know, in as much as you guys have had to make, you know, pretty substantial contribution to pension the last years, are you considering just raising the expense that you will expense on normalized basis to your pension?

We have increased the expense. I think so far this year, it's been probably close to $1 million, and we changed our asset return assumption from nine-and-a-half to eight-and-a-half percent, which adds almost two-and-a-half million in total annual expense.

And are those, Beth, are those changes you've made subsequently, I mean, just recently that we should sort of be factoring into our model for next year?

We've been making them during the year. We've dropped our estimate sort of mid-year down to nine percent, and then most recently based on what we've been hearing and seeing from both the SEC and our outside consultants we're bringing it down to 8.5.

So we've been adjusting our accruals all along.

OK. And which would have roughly a $2.5 million impact but not necessarily all incremental in fiscal 2004.

Correct. Probably half of that's incremental for next year.

OK. And then the - once you've made this $15 million contribution the fourth quarter, your under funded position is it going to be roughly the same $54 million or so?

We're not exactly sure at this time. We don't get those updates and that actuarial assumptions and things finalized until the year-end. So probably a good guess that it would be somewhere around where it was last year.

Yes, and that's the strategy to sort of keep it at that level. That's where you're coming up with the 15 million that you have to consider?

Right. Correct.

And then the - when, you know, sort of mundane on the bonus accruals. Just want to make sure, on the bonus accruals you would accrue roughly $11 million, I think, of bonuses through the first half of the year.

You've backed out roughly four. If we get to the low end of your range in fourth quarter, will you expect more reversals of bonus accruals?

Yes.

And - but if we're at the high end of the range, kind of keep the bonuses out there?

Correct.

And then when we look out to 2004, do you have a sense in '04, fiscal '04, what you guys are thinking? I know it's a difficult to have a crystal ball, especially today, but any help you can give us on that, Mike?

Well I think, Chris, that the question is is just tell me what the duration of the conflict is?

Two weeks.

Well, if it's two weeks there's some really good things going to start happening to our company and our industry, if it's that quick. Because, again, I think it doesn't - I don't think it has to be all concluded. I think it just has to be - there has to be some known duration that people can start to get their minds around.

And, again, I think we're obviously right at the threshold but we'll know a lot more in a very short period of time. Because we know client by client that there is enormous amount of pent up demand out there. And we're all doing it, right. I mean we're all deferring purchases, waiting to see what the outcome of this uncertainty is.

And when that releases, you know, I think you'll start to see a lot of the decisions that have been deferred taken off deferral and that business will release itself and we'll start to benefit from it.

And to give you some guidance on forecasting, if you think about the tap line and do your estimate of what you think the gross percentage will be, you could, a good rule of thumb will be for that every dollar increase of sales, you could assume that about 45 to 50 cents would drop to the pre-tax line before incentive compensation.

And then if you include incentive compensation at sort of today's estimates, you could say that probably at least 25 to 30 cents would drop to pre-tax. Now that's totally dependent, of course, on how the performance is and at what percentage increase revenue you have. That give you at least some guidance for modeling, I think.

And Beth, you hit on it earlier in the call that if revenue were to, you know, sort of not improve from these levels in '04, that you guys would look for other opportunities to make more moves. Implicit I guess in that comment is that you have a plan for what you think '04 can do. You made four percent cut of your workforce, you know, do you want to share sort of what you're idea is that you think you can get growth for next year?

I think the best way to talk about that is we have multiple scenarios. If, obviously, the conflict goes on for a period of time and we know what the delay is to get these projects into the system and actually shipped, then we have to look at, you know potentially a soft first half of next fiscal year and a more robust second half. If it would be very short in duration, that could release itself a little bit earlier. So, we have a number of different scenarios. And at this point, I think we really don't want to give guidance, you know, on full-year FY'04 yet.

That's fair enough. Say, thanks a lot, guys.

Thanks, Chris.

And we'll take our next question from with Solomon Capital.

Hi. I was wondering if you could - got a little distracted - if you could go back over the dynamics in the notes receivable - the reserve just to - just to help me understand what's going on there because didn't you reverse that a couple of quarters ago?

Our notes receivable had actually come down over the year because of payments that were made. Our - we actually increased the reserve against note receivables from two million to four million this quarter ...

OK.

... to take into consideration the health of our dealer network. And then in accounts receivable, our reserves have come down because accounts receivable have come down. But as a percentage of the accounts receivable balance, it's actually gone up. So we've tried to be very conservative and to take into consideration the economic conditions with both our customer base and our dealer base.

OK, great. Thank you.

And we'll take a follow-up question from with Aria Partners.

Hi. How are you guys? In terms of the - in terms of the war ending, obviously you think that that will then, I mean, drive other things such as corporate profitability and service sector employment and so forth which have more of a direct effect on your company. Is that basically your thinking there is that those things will increase once the war ends?

Well, I wish I could tell you that it is actually corporate profitability that drives, you know, our industry forward. It actually is more perceived corporate profitability which creates the activity for our industry. So, corporations could be very profitable and doing well, but if they perceive the future to be uncertain, we're a deferrable expense.

On the other hand, if they think that this might be the time where the market's going to begin to release itself, they begin to prepare for that in a way that allows them to compete effectively in their markets. So, it's really more a perception of corporate profitability ...

What was - ...

... than it is actual .

... what would you say, though - you've - the war, you know - you think the war ending's also going to deal with things like new office construction and service sector employment and all the other things. You know, there are other key drivers for your industry. It kind of sounds like you think once the war gets over, things like new office construction, service sector employment, furniture replacement - those areas are going to pick up. Is that correct?

Well, I think, first of all, when you get into nonresidential construction, may be a slightly different issue, right? I mean obviously that has a longer lead-time. I think when we're talking about increased prosperity for us, it relates to what we think are the pent-up demand around projects that we know our current inside customers that sometimes are as much around rehabilitating their existing environment - changes that they've made to the environment that deferred the expenditure of trying to reorganize, say, their customer service department. That's different from what we think is going to be a longer-term recovery around the nonresidential construction. I don't think we're including that in our calculation about what next year could be.

Great. Thanks, guys.

Once again, that is star, one for questions. We'll take our next question from with AL Capital.

Yes, hi. I wanted to ask you how much of your newly used furniture are you seeing come back to compete against your new sales, as some of your competitors I understand are seeing that throughout the United States and throughout the world?

There isn't currently a good way to track how much used furniture is entering the system, other than a lot of anecdotal evidence and obviously at the beginning of the contraction, especially out in Northern California, it was a huge issue. There are still pockets around the country that still talk about that being a considerable factor for them. We've seen it diminish in some other areas. But it's still part of the reality that we are dealing with, which are people are looking for low cost and/or used solutions to bridge them until they can get to a place where they can think more deliberately about redoing the space in its entirety. So it's still a factor, but it's very difficult to gauge with some precision.

Thank you.

Thanks .

And there are no further questions at this time. I'd like to turn the conference back over to the speakers for any additional or closing remarks.

Thanks everyone for your time and attention today. In the midst of all that is going on in the world, we add our thoughts and prayers to yours and hope for a quick resolution to the conflict. We hope that our next call will be to the backdrop of global peace and reconciliation. Thank you.

Thank you. Once again that does conclude today's teleconference. We appreciate your participation. You may disconnect at this time.