MillerKnoll Inc (MLKN) 2004 Q3 法說會逐字稿

Good morning, everyone, and welcome to this Herman Miller Incorporated third-quarter fiscal 2004 earnings results conference call. This call is being recorded. This conference call will include forward-looking statements that involve 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, the competitive general and economic conditions, the future possibility of acquiring companies, and other risks described in the Company's annual report on Form 10k, its quarterly reports on Form 10-Q and its other filings with the Securities and Exchange Commission.

Today's presentation will be hosted by Ms. Beth Nickels, Executive Vice President and Chief Financial Officer, and Mr. Michael Volkema, Chairman and Chief Executive Officer. Ms. Nickels and Mr. Volkema are joined by Mr. Joe Nowicki, Vice President of Investor Relations and Treasurer. Mr. Nickels and Mr. Volkema will open the call with a brief presentation, which will be followed by your questions. We will limit today's call to 60 minutes.

At this time, I would like to begin the presentation by turning the call over to Mr. Volkema.

Good morning, everyone. Thanks for attending our third-quarter conference call. I'm going to open the conference call with a few introductory remarks, and then I will turn the call over to Beth Nickels and Joe Nowicki for a more detailed review of the financials. In the course, we will use the remaining time for your questions.

You're going to hear Beth use the word 'growth' several times this morning as she describes our results for the quarter -- growth in sales, growth in orders, growth in backlog, growth in net earnings. As you all know, growth isn't a word that our industry has been using over the past three years and as you know, the effects of the economic downturn on our industry have been significant. As a result, you've heard us repeatedly talk about our focus on making difficult choices to realign our cost structure, create a variable distribution model, implement HMPS, ROE manufacturing strategy and establish a capital structure which provides financial flexibility while reducing our cost of capital.

As you know, the last few quarters, we've been hinting at growth and talking about a brighter outlook based on a strengthening of some of the major economic industries that drive the underlying dynamics of our industry. That's some of what we are beginning to see and what Beth will be talking about today.

We still remain cautiously optimistic on our short-term results. Not all of those indicators are positive and none of them would indicate a dramatic comeback in volume during the near-term. But our confidence in the long-term capability of the Company have never been greater (sic). I've always said that the key to our long-term, sustained success is in redefining the marketplace through innovation. That's what has driven our past success and what I believe will define our future success.

Even during the downturn, we continued to make significant investments in new products for our marketplace. (indiscernible) for instance that was launched last fall has been a great success so far. Volumes are way ahead of our initial business plan and the acceptance has been positive across the globe. In fact, over 20 percent of our sales are from our international markets. Our largest order this last quarter is for 3500 chairs to a branch of the UK government. We will continue to invest heavily in new product programs that we believe will grow our share of the contract office furniture market.

We will also continue to aim our innovation capabilities at new markets. I mentioned last quarter our efforts to investigate growth opportunities in selected vertical markets within North America; that work is underway and remains promising. In addition, our creative office team is also developing innovations that go way beyond our traditional marketplace. As I've said before, I believe that this is some of the best work we've done since the introduction of Action Office.

We are continuing to invest heavily in innovation. It won't all happen overnight but they are establishing a framework for our long-term, continued success.

Fortune magazine recently recognized us as one of the most innovative companies in any industry. Obviously, we consider this recognition a great honor and a strong affirmation of the work we had done and will continue to do.

With those brief introductory comments, I will turn the conference call over to Beth and Joe.

Thanks, Mike. We'd like to remind everyone that this quarter's call is also being webcast and includes a slide presentation, which can be viewed on our Web site at HermanMiller.com. If you haven't received a press release, it's also available there.

First, the highlights -- our sales for the quarter were 329.6 million, up 6.2 percent from the year-ago period. EPS was 11 cents, an increase of 175 percent over the prior year's same period. The results include the negative impact of a restructuring charge of 1 cent.

Our orders and ending backlog were also significantly improved over the prior-years levels with orders up almost 10 percent and ending backlog up 18 percent.

Operating expenses continued their year-over-year improvement. Our ending cash balance was a strong 197.2 million.

Now, let's get into the details of consolidated sales, orders and backlog. On a consolidated basis, net sales for the quarter were at the upper end of the guidance we provided of 320 to 335 million. On a year-over-year basis, the sales for the quarter were up just over 6 percent. Now, this is the first time in three years that we have been able to talk to you about year-over-year sales increases.

Also encouraging that our industry trade organization is reporting increased volume trends as well (sic). Our sequential sales from second quarter to third quarter were consistent but even that is good news, as the third quarter is traditionally much lower than the second quarter due to the holidays.

Consolidated new orders for the quarter are also a great story. They totaled 309.9 million, up almost 10 percent compared to last year. This equates to an average of only 23.8 million per week, but this includes two holiday weeks, one of which was the Christmas week when we were completely shut down.

Our order patterns did slow down over the holidays, as we traditionally see, but then they picked back up again once everyone was back to work. In the two weeks since the quarter end, we continue to see the higher levels. The average weekly order rate for our last four weeks was 27.3 million.

We also continue to be encouraged by the level of business activity as measured by client business, which was up 10 percent from last year's third quarter.

Now, onto backlog. For the quarter, our ending backlog was 196 million, which is up a very strong 18 percent from last year's third-quarter level of 166.1 million. It's down about 9 percent from second quarter's level of 216 million but again, that's normal due to the holiday season.

Last quarter, we talked about the unusually high amount of our backlog that was for product shipped to our own dealers and governmental agencies during the second quarter but not recognized as sales because it didn't meet our revenue-recognition guidelines. Those sales were recognized in the third quarter, which decreased our backlog and also explains the majority of our $7 million decrease in the finished goods inventory that Joe will talk about later.

Now, I'll give you a breakdown of our domestic and our international results. Domestic sales increased 4.6 percent year-over-year while new orders improved 9.6 percent on a year-over-year basis. This represents the second quarter in a row that our domestic orders have experienced a year-over-year increase. Our southern California and Texas markets continue to experience strong growth again this quarter.

Our international business environment was another one of the highlights for the quarter. On a year-over-year basis, new orders for the quarter grew at a strong 10.9 percent and sales increased by an even stronger 15.2 percent.

Our international revenues were impacted by positive exchange rates but even excluding the currency impact, we are seen both year-over-year and sequential growth. Specifically, we continue to see growth in Canada and Japan again this quarter. They've been strong all year long. But even more promising was a large pickup in our business in the UK this quarter. We won some large jobs with Resolve for the Metropolitan Police and the BBC, plus the large government contract for the Mirror Chair, which is now being manufactured in the UK.

We've also seen a reawakening of demand from the financial sector. It's been a great quarter for our international team.

Now, let's talk about gross margin. We knew this would be a challenging quarter in gross margins due to the holidays and the inefficiencies of the Canton move, and it was. We were able to keep our gross margin percentage constant from last year to this year at 30.1 percent but it did decline from the 30.9 percent that we saw in the prior quarter. The primary cause of the decline from last quarter was the reduced ability to leverage fixed overhead costs as a result of the lower manufacturing volumes during the quarter. Even though sales were reasonably constant from last quarter, our manufacturing volumes were down almost 10 percent. All of our facilities were actually closed for one full week around Christmas, and we only worked a partial week around New Year's.

As I mentioned earlier, the finished goods inventory at the end of last quarter was higher as a result of products that were shipped but not recognized. That inventory was sold this quarter, so we really had overhead from both the current quarter and the overhead that was included in the inventory value we sold.

Pricing pressure continued this quarter. Higher discounting in the third quarter, as compared to a year ago, reduced our domestic margins by approximately $4.5 million. Now, the good news is that the level of discounting did improve slightly from the level we saw in the second quarter of this year.

Our year-over-year gross margins were also negatively impacted by the Canton move. As we discussed last quarter, we are relocating a significant portion of our manufacturing from Georgia to West Michigan. This caused approximately $1 million in additional costs due to inefficiencies. We did anticipate these costs and they were within our forecasted amounts. The move is now complete. All of the equipment has been moved and is up and running in our existing West Michigan facility. There's no further production occurring in Canton, Georgia. We still have some learning curves to work through in order to increase our productivity, but we should start to see the improvements in the fourth quarter.

Material costs for the quarter totaled 38.8 percent of sales, which is up slightly from the 38.3 percent last year. Most of the increase was caused by the higher discounting discussed earlier. In addition, our product mix for the quarter was weighed more towards seating (ph), which has a higher material content than our other products.

There was also a favorable LIFO inventory adjustment in the prior year of $800,000 that reduced material costs last year. This was offset to some extent by the continued efforts of our procurement and supply chain management team (indiscernible) of suppliers. We did, however, begin to see a year-over-year increase in steel costs based on the dramatic increases in market pricing that we've all heard a lot about over the last 60 days.

To put this in context, our steel purchases are about 75 million per year. Based on our contracts and long-term relationships, we've been able to lock in lower-than-market prices through June, although we are subject to surcharges. As a result, we are seeing average price increases of about 6 percent.

Our steel costs were up approximately 200,000 in the third quarter, as compared to last year. We do anticipate this impact next quarter to be closer to 1.5 to 2 million. We are watching this issue closely to determine if it will be a long-term cost change that we need to adjust customer pricing for, or if it is just a short-term issue. Our operations team is continuing to work on ways to offset these increases due to ongoing implementation of our Herman Miller production lean manufacturing philosophy.

Our direct labor costs increased from 4.9 percent of sales in the prior year to 5.2 percent this year. The increase was driven primarily by the inefficiencies from the Canton move, combined with annual wage increases and also the higher discounting mentioned earlier.

On a pure dollar basis, overhead spending increased by 1.5 million compared to the same quarter last year. During the current third quarter, overhead spending was increased by 900,000 as result of incentive accruals but in the prior-year third quarter, overhead spending was decreased by 2.5 million due to the reversal of similar incentive accruals.

Moving on now to operating expenses, we continue to demonstrate year-over-year improvement in this area. For the quarter, operating expenses totaled 84.8 million, or 25.7 percent of sales, as compared to 85.5 million, or 27.5 percent of sales last year.

Operating expenses were also impacted by changes in incentive accruals. During the current third quarter, operating expenses were increased by 2.2 million as a result of incentive accruals, but in the prior-year third quarter, operating expenses were decreased by 1.4 million due to the reversal of similar incentive accruals. In total, the most significant decreases in operating expenses were in compensation, depreciation and bad debt reserves. Reductions to our bad debt reserve decreased our third-quarter operating expenses by 2.1 million.

We do anticipate operating expenses to be higher in the fourth quarter due to traditional increases in marketing and promotional spending in anticipation of new product launches at the annual NEOCON trade show. We normally see a 3 to $5 million increase in our fourth-quarter operating expenses when compared to the third quarter.

Restructuring charges for the quarter totaled 1.1 million and were primarily associated with the relocation of the Canton operation, as previously announced. This amount was less than initially anticipated due to the timing of the employee pension settlement. There will continue to be a small amount of restructuring charges in the future as the final costs are incurred.

Moving on down the income statement, other expenses for the quarter, net of interest income, totaled 3.3 million compared to 3.2 million last year. The main component of the expense was a foreign currency loss that totaled $1 million for the quarter versus a gain of 700,000 in the prior year's same quarter. The loss was primarily due to the impact of currency movement in our non-functional currency cash reserves in the UK and Mexico. Now, this was partially offset by $700,000 in savings from our interest rate swaps that were executed in prior periods.

Our effective tax rate was reduced this quarter to a full-year estimate of 32.5 percent, versus the prior quarter's 36.5 percent estimate. The decline in the effective tax rate was due to increased tax credits for 2003 and 2004 and a reconciliation of book-to-tax differences from the filing of our tax return in February. We believe this will only impact the current year and our forecast for future years is still around 36.5 percent.

When you roll this all up, net income for the quarter was 7.8 million, or 11 cents per share. The negative impact of restructuring charges was a 1 cent per share, net of tax, for the quarter.

Now, I'll turn the call over to Joe Nowicki, Treasurer and VP of Investor Relations, to talk about our cash flow and the quality of the balance sheet.

Thanks, Beth. For the quarter, operating cash flow was 7.2 million. Keep in mind this includes the voluntary contribution to the Company's employee pension fund of 26 million and also outflows of $4 million related to previously-announced restructuring charges.

Working capital changes resulted in sources of cash of 15.6 million, driven primarily by a $7 million reduction in inventory and a $12 million increase in accruals.

Our collections of AR continue to remain relatively strong; our DSO in inventory and receivables decreased by 1.7 days from the same quarter in the prior year to 53.6 days. In addition, our over 90 day AR aging has continued to improve year-over-year and is currently running at half the level it was a year ago.

Capital Expenditures for the quarter were 4.6 million; this is down from the 7.4 million we spent in the same quarter last year. Year-to-date, we've spent 19.4 million in Capital Expenditures and our forecast for the full year has been reduced to between 25 and 35 million. We continue to closely scrutinize capital spending to ensure we're making the right investments to sustain the business and preserve our ability to introduce innovative, new products.

As discussed in prior calls, we currently have listed for sale our Canton, Georgia building that we have exited this quarter. The property has been appraised and listed but due to market conditions, we expect it will take awhile before it is sold.

Moving onto liquidity and cash position, we are again, this quarter, in compliance with all debt covenants and don't foresee any problems with compliance in the future. Our profitability and positive cash flow, combined with the 186 million available on our revolving credit facility and 197 million cash balance, continue to provide us with tremendous financial flexibility.

In January, we announced the outcome of our capital structure review that we mentioned last quarter was in process. We reviewed, for the Board, our overall capital structure, including our cash balance, with the goal of ensuring financial flexibility while reducing our cost of capital.

Recognizing the adjustments we've made to our business model, we concluded it was not necessary to retain the significant cash reserves that we had been accumulating over the past couple of years. We continue to believe that share repurchases are an extremely efficient method of both returning cash to shareholders and reducing our long-term cost of capital. As a result, the Board approved an additional share repurchase of $100 million. In addition, they approved a $26 million voluntary contribution to the Company's employee retirement plan and approved our regular quarterly cash dividend.

During the third quarter, we did increase our share repurchase activity in alignment with that January press release. During the quarter, we bought 608,239 shares for $14.9 million at an average price of $24.46 per share. The time from when that press release went public to the beginning of our quarter and blackout period was quite short, so we were limiting how much repurchase we could do but we were still able to get a small start to the repurchase program. We plan to step up this activity during the current quarter. The new authorization, plus the amount remaining on our old authorization, leaves us with about 126 million in total authorization available.

In addition to using share repurchase to meet our other capital structure goals, it's also been our practice to use (indiscernible) tool to actively offset dilution. However, options carry a reload feature that encourages executives to build ownership. Given the current stock price, we do expect seeing a higher participation rate in both the reload program and the exercise of existing options during this quarter.

Thanks, Joe. Now, let's turn to the outlook for the fourth quarter. As Mike and I have both discussed, we are encouraged by our recent order and backlog trends but we remain cautious because of the softness that continues in some of the economic indicators that drive our industry.

We expect our fourth-quarter sales to be in the range of 335 million to 355 million, which represents a growth rate of 4 to 10 percent over the prior year. Now, this will be our second consecutive quarter of year-over-year growth, a trend which we anticipate to continue. We also expect earnings per share to be between 10 and 15 cents, which includes the restructuring charges of approximately 2 cents per share for the previously announced action.

Let me further explain our guidance on revenues. We start with our beginning backlog of 196 million. In that amount, there are 6 million of large orders in international and our own dealer networks that will not ship until sometime next year. This brings the backlog available to ship to about 190 million. We normally ship 80 to 90 percent of that amount in the following quarter. We then add in an amount for the 6 to 8 weeks available to order and ship. We assumed a rate of 25 to 28 million per week, which is what we've been seeing the last few weeks. This gives us our guidance of 335 to 355 million.

We are confident in our ability to continue to drive improvements in our gross margins and also operating expenses. Our gross margin assumption for next quarter is 31 to 32 percent. This is improved from the current quarter to reflect higher production volumes with less holidays and increased efficiencies due to the Canton move being complete. It also anticipates some increased costs for steel, as previously discussed.

Typically, our opening expenses increased by 3 to 5 million in the fourth quarter, as the additional new products and marketing program investments ramp up for the launches at NEOCON in June, as I mentioned earlier.

We are continuing our past practice of only giving one quarter's guidance. We still feel there's a lot of uncertainty in the marketplace and as such, it's difficult to provide any longer-term estimates. Current (indiscernible) forecast for the calendar year 2004 are an increase of 5.6 percent in shipments.

As we've said in the past, we believe we can grow faster than the industry in periods of economic growth. We also continue to believe that we have substantial leverage in our business model. However, we are conscious of the fact that, as time goes forward we will be facing continued pricing pressure and standard inflationary increases in our cost structure. Even with that, we're targeting that for every incremental dollar of sales, we can generate between 20 and 30 cents of income after tax and after bonus -- a lot of leverage.

It's also important for us to know here that we will be implementing FASB interpretation Number 46 in the fourth quarter. The intent of this (indiscernible) is to provide the clarity of representation for entities which, under the traditional consolidated accounting rules, may not have been included in the Company's consolidated financial statements. This was initially scheduled to be effective with our second-quarter results but has been delayed twice and now goes into effect May 29, which is the last day of our fourth quarter.

Based on our current analysis, we anticipate consolidating two of the independent dealerships that we have financing arrangements with. The impact of this is not included in the above forecast because we do not feel it will be a significant impact and it's dependent upon their year-end financial statements.

In summary, we once again met the commitments we made last quarter -- 330 million in sales and 11 cents per share in net earnings.

It was great to be able to report to you a quarter of year-over-year sales growth and we're thankful for your patience as investors. Based on the order entry rates we are seeing, the positive economic trends and our continuing investments in innovation that Mike discussed, we are very optimistic about our future revenue potential.

Our Canton relocation is also now behind us and we are on track to begin to recognize the savings we promised.

In addition, our cash balance is strong and we are in compliance with all of our loan covenants. We started to implement the capital structure plan that we communicated in January and work there will continue.

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

Thank you. The question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS). Margaret Whelan with UBS.

Good morning, guys. Congratulations. Great, great progress in last couple of years and it's good to see the growth finally! You know you have these headwinds of (indiscernible), whether it's labor or foreign currency, or steel or whatever, but what can you do in terms of these new product introductions now? Can you actually raise your prices at all?

Margaret, I think that, without question, even on the merit of the Mirror Chair, for example, which was a product that we came out with that clearly was trying to reset the reference point around what we will call performance in a price category -- part of why that chair I think has been so well accepted is that it did just what we wanted it to do, which is it's competing against a lot of older models.

The really good news is the margins on that particular chair really are at or above what we expected them to be and consistent with some of our other iconic products like the Aeron Chair.

So, I think where we in fact do innovation, we can get premium margins and are getting premium margins.

To what degree (indiscernible) premium? Is it a couple of hundred basis points?

We don't disclose our margins specifically by product line and especially for competitive reasons, we would rather stay away from competitive details.

Okay. In terms of the competitive environment, you do a dealer survey every month and a lot of those dealers have been saying that, within your price points at Herman Miller, you (indiscernible) to be the only manufacturer that's actually investing in new products at the moment. Do you feel like you're gaining share, or is that something you'll know right after NEOCON?

I would say it this way -- that probably, in the time that I've been in the position that I'm in, I've never been more excited about the robust nature of our development queue. We are going to have a really good NEOCON in '04, and we're going to have a spectacular offering by '05 -- new systems line, new seating line. So you know, we are really encouraged that we do have a product development queue that is robust and I think will be timely in relationship to the uptick in the market.

I think I've mentioned before to you, Margaret, as CFO, probably what I most thought of the last couple of years was the fact that we roped off those investments in R&D. Even though we were going through the restructuring and we had to make some really difficult choices around where we cut costs, that was an area that we protected.

That's what we're hearing from your dealers, definitely.

In terms of the uses of cash, going forward, can you comment? I know share repurchasing is going to be a factor, but what about raising the dividend?

Margaret, obviously we released information on some conclusions around the capital structure after the January Board meeting. We do have, on agenda again, a revisit of the dividend question. They charge us to go out and do a little more work around that piece of the discussion, and so it is an agenda item for this next Board meeting in April.

In April, okay. Just finally housekeeping, what's the share count assumed in your guidance -- (technical difficulty)?

For the fourth quarter?

Yes.

Probably similar to what it was in the third quarter because we do expect there to be a little bit of dilution due to the exercise of options -- (multiple speakers).

(Multiple Speakers) -- be a little share creep?

No, the net should be a decrease but not very significant.

Budd Bugatch of Raymond James.

This is actually Chris Thornsberry on behalf of Budd Bugatch. Congratulations on a good quarter! I've got a couple of quick questions with regards to the order rates. I saw that the backlog increased year-over-year by 18 percent and you said that customer visits were up about 10 percent. Could you comment a little bit on the make-up of the orders, whether you're seeing larger orders than you have seen in the past? Could you comment a little bit on that?

On the international part, we're definitely seeing orders that are larger. The project business has seemed to come back a lot, especially in the UK, so those orders are definitely larger in terms of absolute dollar amount.

When we compare backlog to last year and the fact that it's up 18 percent, if you look at backlog last year, it was unusually low due to the geopolitical instability that occurred and then we saw a pickup when it looked like there was going to be a quick resolution in Iraq. We saw a significant sort of impact during the quarter, and that allowed the shipments to not (indiscernible). (indiscernible) difference between the backlog increase versus the sales projected increase for the fourth quarter.

Thanks, just one more quick question relating to margins and overall margins, the operating margins. I know you're factoring in some steel cost increases as well and freight cost was a question of mine. I know that a lot of companies have been experiencing higher freight costs. How does that factor into your margin forecast? Also, does any international sourcing factor into that and the potential for bringing margins up a little bit with lower-cost?

Chris, we haven't experienced increased freight costs, actually. Our freight cost were level with the preceding quarter, so it hasn't been our experience.

What was the second part of your question?

I just want to know if you had any potential margin expansion due to maybe sourcing some of your production and increased sourcing of your production.

clearly, as a part of the HMPS (ph) work, (indiscernible) doing a great job in trying to figure out how to get cost savings to offset anything that we see coming through from a material increase. So he obviously has sources of supply in other parts of the world today, and he's in a mode where he continues to investigate how those might help out in a bigger way in the future.

We will say, though, that, from a scale perspective, it is not our intention to go out and switch suppliers to try to eliminate those increases right away. One of the reasons that we think we've been able to keep that at a manageable level, versus some other companies who might be struggling more, is because of the relationships we have and the fact that we've stuck with them through some of the more difficult times; I think they are protecting us from both the source of supply and the amount of the increases that we are seeing.

John Emrich (ph) with Bricoleur Capital.

Just a question of clarification on FAS 46 -- your guidance didn't include it because you don't think it's significant specific (indiscernible) I guess that means it's not significant to that quarter, because that's the only guidance you provided. Will it become more material, on an annual basis, as it comes into your reporting periods for the full period?

When you look at it on an annual basis, we expect that our sales will show an increase of probably about 10 to $15 million. The two dealers actually have revenue that's higher but a significant part of it is products that we sell to them that gets eliminated.

On an income statement perspective, we don't know at this point. We don't think it's going to be material but the accounting rules are very complex around how you actually record their income and losses.

Thank you.

Chris Hussey with Goldman Sachs.

Good morning, guys. Let me just start off on that last one. Are the two dealerships you guys are going to be consolidating -- do they operate at a loss right now, or do they make money?

One is profitable; one is operating at a loss.

In combination sort of breakeven or -- (multiple speakers) -- profitable bigger than the other one?

They both offset each other. The only qualifier I have there is that the way you treat the income and the way you treat the losses isn't necessarily similar. We can't necessarily (indiscernible) those or we would put them on the book.

But the materiality -- (multiple speakers) -- consequence is and that's why we've indicated that we don't think it's material.

The steel price issue -- you mentioned in your comments you've locked in through June on some of these contracts. I guess the question I have is, why do you think you're going to see, then, the price increases accelerate here in the May quarter?

The second question will be, after the June contracts expire, could we then expect it to have a greater impact, should steel prices remain as high as they are today into fiscal '05?

The reason we're seeing increase is because although the contract price is locked in, they do have an ability to put surcharges on. So, the surcharge is what is driving the increase. The estimate is that if we didn't have contracts in place over the next year, this could have cost us around $20 million in increased costs but because the contracts are in place, our expectation is, in total, it will probably be about a $5 million impact. That's assuming that we see some relief this summer. Expectation is May and June -- April and May are going to be pretty ugly in terms of steel costs but then it will start to get better after that.

So if a put myself in the shoes of your supplier, by selling to you guys, they have an opportunity (indiscernible) lost of about $15 million you think over the next year? Normally, you would (indiscernible) about $20 million more but because you are paying below contracts, it will only be about a $5 million increase?

Assuming they could take that premium price and reallocate it to another buyer.

Fair enough. Again, are they going, in these long-term relationships, are the going to make that up, catch that up over the life of the cycle, do you think, or do you feel pretty confident you'll never see that extra $15 (ph) million?

I would say we're pretty confident in our procurement folks and they did a lot of (indiscernible) in the past around the increased costs that we had the last couple of years when we were protecting them as suppliers when steel prices were dropping.

Terrific. So for fiscal '05, you are thinking an incremental $5 million from steel prices potentially with modest improvement over the summer in steel prices?

I would say that's pretty close.

Assuming there isn't more materially relief -- no pun intended! (LAUGHTER). (multiple speakers) -- because, obviously, the spot market has been driving a fair amount of some of the increases.

All right, terrific. The second line of questing I have is on the variable compensation. Beth, have you adjusted variable compensation at all in terms of what you're thinking for the year? I know, in the second quarter, you had ratcheted down from a .65 to a .5. The third quarter, are you still (indiscernible) .5 times?

Very close to a 0.5; it's actually, I think, a 0.45, so very close to being on plan with where we had expected at the beginning of the year.

So for the full year, we are still looking for about that 12 to $13 million variable compensation accrual?

Correct.

For fiscal '05, in your guidance vision now, the marketplace seeing a pickup here -- is it potentially possible that variable compensation could double?

Yes.

Then lastly, on the bad debt, you mentioned a bad debt reserve. I just want clarify because, I'm sorry, sometimes I don't understand these things quite -- did you have to increase your bad debt reserve by $2.1 million, did you say?

No, decrease.

Okay, so you're seeing better payments coming through and so you were able to lower your bad debt reserve during the quarter?

Right. The aging, I think as Joe mentioned, receivables over 90 days was actually half of what it was a year ago.

Is that because of the general pick-up in the economy or are you starting to see the health of your dealerships improve here? What do you think is sort of driving that?

A combination, I think, of all those factors.

Terrific, so the dealerships no longer a distraction at this point (sic), in your view, going forward?

No. We still have a watchlist of those that we have concerns about that we still continue to closely track. We also want to make sure that as the business does pick up that they are able to participate in it because it requires an increased investment in working capital. So, we're going to make sure that we monitor it and that we give them the support they need to be able to participate in it and to stay healthy.

Last housekeeping question -- can you just quantify the FX for us?

The effect of FX on the income statement or on --?

On the income statement, if you can, from both the revenue and operating profit standpoint?

Sure. From a revenue standpoint, just looking at the international growth, the 15 percent number that I quoted -- if you take out the effect of FX, the real growth is about 5 percent. The trend is still significant because the previous two quarters were negative.

Then, in terms of expense, it hit us to the tune of about $1 million in the quarter in terms of an FX loss that was included in other income and expense.

Right, and the international, the FX revenue -- all your costs are pretty much international as well, so you weren't getting a benefit there on the margin, or do you have some U.S. dollar costs that allow you to get some benefit?

Can we get back to you on that one?

Of course. Thanks, guys!

(OPERATOR INSTRUCTIONS). Tucker Anderson with Cumberland Associates.

Two questions -- first, you've talked a little bit about freight costs and steel costs extensively. Could you talk about any other raw material changes you're seeing? Are your contracts, either in freight or steel -- as part of the surchargeability (indiscernible) energy prices? And if these petrochemical prices stay at these levels, what it might do to your cost pressures?

We aren't seeing any real changes in any of the other commodity costs. We did have an issue earlier in the year because of the oil prices that affected some of our plastics, but that seems to have leveled off. At this point, we're not anticipating anything other than the steel to have any kind of significant impact on us.

(indiscernible) off a series of contracts, as you referenced.

Second, the incremental margins that Beth mentioned are obviously, you know, very impressive and basically imply that you are expecting very little variable cost increase associated with higher volumes that basically will be able to (indiscernible) through a lot of gross margin right to the bottom line, except for incentive comp. Is there some point at which there might need to be a step function in expenses? If your hope about growth is right, would it just be very marginal increases in variable cost or at some point, might you have to do something more significant?

I think you are absolutely right to recognize that there is a step function that occurs at certain levels of revenue -- increases or decreases -- and we discovered, in the downturn, that at about $250 million worth of revenue drop, we had to take another step function every time that occurred. So there is an anticipation that, at some point, we would have to increase cost more significantly but from a fixed overhead perspective, we've (indiscernible) -- from a manufacturing capacity, we have the ability to get back up to 2 billion in revenue. So we shouldn't have to do it in the way of any additional buildings or factories.

Okay, thanks.

A follow-up from Margaret Whelan with UBS.

Beth, will you give us an idea what percent of the products (indiscernible) right now are new products, you know, that have been launched in the last couple of years?

What percent of our new products -- sales of new products --.

One, we are probably going to have to go back and look up so we don't misstate it.

Okay. Then just in terms of the product innovation, which I know you've always done a great job on, is there anything coming up that we need to know about or that you could share with us?

Well, not to maybe give away the NEOCON surprises, we won't go into detail on that on the conference call but we will say that we do have a system platform that will be launched, at least in North America, and an array of other supporting seating (ph) products that we have enhanced at NEOCON. So, we're looking forward to a good NEOCON. As we said before, we're most excited that I think the sales file that we keep reviewing indicates that there is many more people (sic) back in the market right now interested in trying to rehabilitate their work environment, so much more optimistic.

In terms of the sales contracts, the order backlog that is coming in, do you have a sense for what percent of those (indiscernible) relocations versus your installed base customers, or new business?

I don't think we've moved off of the pattern in recognizing that, as far as existing client base, you still have a 70 to 75 percent recidivism from existing customers. So, whether they are larger products or whether they are day-to-day business, that's really what I think (indiscernible) pulled out of the market over the last three years was really the major project business. But that transcends both new customers and existing customers.

That is starting to come back?

We believe that the activity level is higher there than we've seen it in three years.

Thanks very much.

To get back to you on your last question, when you talk about new products and percent of sales, we calculate it two different ways, actual sort of new products and enhancements, new product enhancements. If you talk about just new products, during the quarter, it represented about 8.5 percent of our sales.

Ms. Nickels, we have no further questions. I will turn the conference back over to you.

Thanks, everyone, for your time and attention today. We look forward to talking with you all next quarter and hopefully seeing you at our NEOCON investor's event in June. Thanks.

Thank you. That does conclude today's conference. We appreciate your participation. You may now disconnect.