MillerKnoll Inc (MLKN) 2005 Q1 法說會逐字稿

Good morning everyone and welcome to this Herman Miller Inc. first quarter fiscal 2005 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 approve 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 report described on form 10-K, 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 Chief Financial Officer and Mr. Brian Walker, President and Chief Executive Officer. Mr. Walker and Ms. Nickels are joined by Joe Nowicki, Treasurer and Vice President of Investor Relations. Mr. Walker and Ms. Nickels 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. Walker. Please go ahead, sir.

Good morning, everyone. I will open our presentation with a few introductory remarks and then turn the call over to Beth and Joe for a more detailed review of our financials. We'll use the remaining time for your questions.

As you saw in the press release, we demonstrated solid progress again this quarter. We built on the sales and order momentum over the past year, both internationally and domestically. We also continued to drive operational improvements through earlier restructuring activities and ongoing implementation of the Herman Miller production system. Overall, our net sales increased 10 percent and our net earnings increased over 130 percent. We were able to accomplish those results, even with a macroeconomic picture that is not improving as fast as anticipated by most. Job growth, nonresidential construction starts and even corporate profitability, while entering some growth, just have not accelerated as quickly as some had anticipated. Having said that, as an industry, we're still making progress over the declines of prior years and we are well positioned to continue to grow into the future.

My priority for the first 90 days as CEO of Herman Miller has been to ensure that we stay on the course with a strategy that Mike, I and the rest of the leadership team put in place. Our intent is to outperform the industry through our continued focus on innovation and the aggressive pursuit of profitable growth in select targeted markets.

Our results within the international side of our business demonstrate the benefit of that strategy, combining market focus and operational excellence with innovative products, like our Mirra chair line and our European system Avak (ph) has been a winning formula. This quarter, I took further steps to align my team to put an organizational construct in place that will help us to further advance our strategic implementation. Our new structure will dedicate sales, marketing and product management resources to specific market opportunities to gain the benefits of focus and a holistic view of specific customer needs. These market growths will in turn be supported by capability groups which will deliver efficient and cost-effective services, ensuring maximum leverage of our core capabilities while meeting common needs across all market groups.

In addition, we have continued our focus on operational excellence. We ran into some pretty big obstacles this quarter from raw material pricing. Fortunately, we were able to offset a good deal of them through the efficiencies we have gained as a result of many changes we have put in place through our business model. Continuous improvement is without a question a fundamental reality of how we operate. At the same time, we recognized in quarter four of last year that our continuous improvement efforts would not be enough to offset the rapidly increasing cost of raw materials, so we quickly announced and implemented a price increase. The long selling cycle in our business results in a gradual benefit from pricing action. This quarter, these actions had no impact on margins. We will see a little benefit in Q2, but this benefit will not be realized in a significant way until quarter's three and four. As we go forward, it won't all be smooth sailing, but we have the right strategy and great people in place to win in the marketplace and to deliver superior value to our customers and shareholders.

With that, I will turn the call over to Beth and Joe for more discussion of our first quarter.

Thanks, Brian. We would like to remind everyone that this quarter's call is also being webcast and includes a slide presentation which can be viewed on our website at hermanmiller.com. And if you have not received the press release, it is also available there.

First, the highlights. Once again, we had another strong quarter. Joe and I will be talking to you this morning about our continued gains and sales, orders, backlog and earnings. In fact, this is the third quarter in a row that we're reporting year-over-year growth in all of these measures. And while we were at the lower end of our sales guidance, the benefits of our reduced cost structure enabled us to close the quarter at the upper end of our earnings guidance.

Our sales for the quarter were 357 million, an increase of over 10 percent from the same period last year and earnings-per-share were 20 cents, an increase of 150 percent over the prior year's same period. Our orders and ending backlog also showed significant growth over the prior year level, with orders up 18 percent and ending backlog up almost 25 percent. Our current quarter results do include minor restructuring costs of $0.5 million before tax from previously announced actions. Our ending cash balance was still a strong $156 million.

Let's start with the specifics of consolidated sales and orders. On a consolidated basis, net sales for the quarter were within the range we've provided of 355 to 375 million. On a year-over-year basis, sales for the quarter were up over 10 percent. Our sequential sales from the fourth quarter to the first quarter also showed slight improvement of 1 percent. Consolidated new orders for the quarter totaled 382 million, up 18 percent compared to last year. This equates to an average of 29.4 million per week, the highest order entry rate we have seen in the past 12 quarters. This is also the first time since the economic expansion began that we've seen double-digit growth rates in both orders and sales. We did experience a slight softening of orders during the middle of the quarter similar to the BISMA report for July, which drove our sales to the lower end of the range. However, right before the implementation of our price increase as you would expect, we saw orders spike up. The good news is that orders have been strong even after the price increase went into effect on August 1st.

Now regarding the impact of the price increase on our orders -- as you may recall, we also had a price increase last year during this quarter that drove orders up then as well. Our best estimate is that this year's price increase accelerated orders in the weeks surrounding the price increase by approximately $13 to $15 million year-over-year. Although when you look at our ending backlog, the difference as a result of the price increase is minimal. Last year, we had about $8 million in orders that were scheduled to ship at the end of the second quarter and this year, that amount is about $10 million.

We also continue to be encouraged by the level of business activity as measured by client visits, which were up almost 48 percent over the same quarter last year and up 25 percent from last quarter.

Now onto backlog. For the quarter, our ending backlog was 234.5 million, which is up a very strong almost 25 percent from last year's first quarter level of 188 million. It's also up about 12 percent from fourth quarter's level of 210 million.

Now I will give you a breakdown of our domestic and international results. Domestic sales for the quarter increased 5 percent year-over-year, while new orders improved 12.4 percent on a year-over-year basis. This represents the fourth quarter in a row that our domestic orders have experienced a year-over-year increase. Our Florida, Portland and Southern California markets continued to experience strong growth. In addition, our Geiger and Herman Miller for the Home businesses also had great growth this quarter.

Our international business environment was without question one of the highlights of the quarter. On a year-over-year basis, sales increased almost 41 percent and new orders for the quarter grew almost 54 percent. International did have a lower first quarter of last year, so the comparisons were easier, but their results were still outstanding. As we have mentioned, one of the key elements of our strategy is to strengthen our position in select international markets. Our performance in international this quarter demonstrates the progress we're making. Specifically, we continue to see revenue growth in the UK, the Middle East, Mexico, Asia export and South America. In the UK, which is our largest international market, we have seen the total value of visible projects up 60 percent over last year and approximately 47 percent of our orders in the quarter were to new clients.

In addition, showroom visits and sales activity calls are also substantially up. It has been another great quarter for our international team.

Now, let's talk about growth margins. Although it was definitely a challenging quarter for gross margins, we still were within the range of 31 to 32 percent we had given you as an expectation. We did experience the cost increases in many raw materials that we discussed last quarter and pricing pressure continues. In the end, the additional volume leverage, combined with the operational improvements we continue to put in place, allowed us to report consolidated margins of 31.4 percent versus the prior year’s 31.3 percent. Our margins did decline from the prior quarter's 31.8 percent rate, mostly driven by the raw material cost increases that I will get to in a minute.

Pricing pressure continued this quarter, although at a lower rate of growth than last year. Higher discounting in the first quarter as compared to a year ago reduced our domestic margin by approximately 1.4 million, or approximately 0.4 percent of net sales. The August price increase varies by product line, but averages approximately 4 percent of list. As Brian mentioned, we didn't see the impact of this on our sales or margins in the first quarter, but for a portion of the second quarter, we should start to see the benefits. By the third quarter, it should really help to lessen the year-to-year impact of pricing pressure, as well as the impact of increased material cost that I will discuss now.

Material cost for the quarter totaled 39.8 percent of sales, which is the highest percentage we have seen for awhile. Certainly, the pricing pressure I mentioned earlier has had an impact on this, but the bigger driver is raw material cost increases. We, along with most other manufacturers, began talking with you a few quarters ago about the impact of rising steel prices on our business. We started to see the some impact last quarter, about 1.5 million of year-over-year increases, but we still had favorable contracts in place and some inventory of low-cost steel. This quarter, those contracts expired and the inventory was depleted and as a result, we experienced a 3.9 million year-over-year increase of steel prices. That's in line with what we mentioned to you last quarter and our outlook right now is for this impact to continue through the year.

In addition, we're beginning to see some increases in plastics and wood cost; not nearly a significant as the steel impact, but they will also affect our margins. The price increase on our own products will help to offset this. Plus, our operations team is continuing to work on ways to offset these increases through the ongoing implementation of our Herman Miller production lean manufacturing system. So we are confident we will be able to offset a good portion of the raw material cost increases as we get further into the year.

Our direct labor costs were great again this quarter at 4.9 percent of sales, which is consistent with what we saw in the fourth quarter, but down substantially from the 5.3 percent we saw in the prior year same quarter. The year-over-year reduction is primarily the result of the efficiencies from the Canton, Georgia facility consolidation that we started last year about this time. Overhead spending for the quarter as a percentage of sales is also down substantially from 20 percent last year to 18.6 percent this year, reflecting the leverage from the incremental volume and also the cost reductions from the Canton consolidation. Dollars of overhead spending for the quarter increased by 1.3 million over the prior year, primarily as a result of incentive accruals. As you may recall, last year in the first quarter, we accrued an EVA-based incentive at approximately 65 percent of our full rate. And this year, we're currently on track to pay a full bonus.

Our freight out and product distribution costs are another highlight. Combined, they amounted to 5.4 percent of sales for the quarter, as compared to 5.9 percent of sales for the same period last year. Now they increase from the 5 percent we saw last quarter primarily due to the increased fuel costs. Based on our fuel surcharge tables, we paid a little over 3 percent more per mile this year over last year. The good news is that we were able to offset a large portion of that due to our efforts to continue to implement the Herman Miller production system and our physical distribution operations. In addition, the relocation of our Canton facility continues to have a very positive impact on these costs by allowing us to consolidate a higher percentage of shipment.

Moving on now to operating expenses. For the quarter, operating expenses totaled 88.6 million, or 24.8 percent of sales as compared to 85.6 million, or 26.4 percent of sales last year. The low percentage of sales reflects the leverage received from the additional volume. We did anticipate higher overall dollars of spending this quarter, although some of the program dollars spending was delayed and will be incurred in the remainder of the year. The dollar increase in spending is substantially due to variable selling costs associated with the higher volume, as well as the year-over-year increase in incentive bonuses of 1.4 million.

Restructuring charges for the quarter toppled $0.5 million versus 3.8 million in the prior year and were primarily associated with the relocation of the Canton operation, as previously announced. There will continue to be a modest amount of restructuring charges in the future as the final costs are incurred. In total, over the full year, this should amount to approximately $1 to $2 million.

Moving on down the income statement -- other expenses for the quarter net of interest income totaled 1.7 million, compared to 2.5 million last year. Interest expense was down approximately 0.5 million from last year due to lower debt levels, combined with savings from our existing interest rate slots. Also included in other expenses for the quarter are accounting gains related to two separate dealer transactions. One is a 500,000 pretax gain resulting from an ownership transition of one of the two dealerships that we consolidated last quarter under FIN 46. In addition, during the quarter, we acquired certain assets and liabilities of another one of our independent dealers and as a result, we recorded at $400,000 pretax gain due to the reversal of a financial guarantee that was recorded under FIN 45.

As we discussed in the prior conference call, we adopted the provisions of FIN 46 at the end of fiscal '04. This new accounting standard broadens the requirements in determining whether a company must consolidate the financial statements of another entity. As a result, the current quarter's results reflect the consolidation of two independent contract furniture dealerships to which we had provided ongoing financial support through loans and/or financial guarantees. As I just mentioned, one of these dealerships was transitioned during the first quarter and as such, ceased to be consolidated from that point going forward. Excluding the impact of the transition, the consolidation of FIN 46 entities increased the current quarter's net sales by 2.5 million and net earnings by about 100,000.

In addition the effect on the Company's balance sheet as of August 28th was an increase to the assets of approximately 1 million and an increase to liabilities by about 800,000.

Our effective tax or for the quarter was 32.9 percent. This rate was lower than originally anticipated because a portion of the net gain from the transition of the FIN 46 entity wasn't subject to tax. We anticipate our effective tax rate for the rest of the year to be approximately 34 to 36 percent. When you roll this all up, net income for the quarter was 14.3 million, or 20 cents per share. It's a 150 percent improvement over last year's 8 cents of EPS and at the high end of the range we gave you at the beginning of the quarter.

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

Thanks, Beth. For the quarter, operating cash flow was 2.8 million, which is net of our voluntary contribution to our pension fund of 23 million. As we discussed during the year, one of our capital structure goals was to continue to make progress in working down our underfunded pension liability. We ended last year with an underfunded liability of approximately $48 million. Given our strong cash flow, we felt the current quarter was an appropriate time to continue with that plan.

Depreciation and amortization for the quarter were 11.8 million. In addition, our net change in working capital amounted to a use of approximately $400,000 for the quarter. Our collections of AR (ph) continue to remain strong and our over day AR aging has continued to improve year-over-year. Our DSO and inventory in receivables increased by 1.7 days from the same quarter in the prior year to 51.2 days in total, due primarily to the impact of the FIN 46 VIEs on our balance sheet and also an increase in our international accounts receivable.

Capital expenditures for the quarter were 3.8 million. This is down from the 5.5 million we spent in the same quarter last year. Going forward, we anticipate capital expenditures for the year to remain low at approximately $40 million.

Let's move onto liquidity and cash position. We are getting in compliance with all of our debt covenants this quarter to don't foresee any problems with compliance in the future. Our profitability and positive cash flow combined with 186.2 million available on our revolving credit facility and 155.8 million cash balance continue to provide us with tremendous financial flexibility. Again this quarter, we increased our share repurchase activity in alignment with the January press release that was announced and the additional share repurchase authorization. Through the quarter, we bought approximately 1,379,000 shares, put (ph) $37.5 million, an average price of $27.22 per share. We plan to continue this level of activity during the current quarter. We still have about $52 million in share repurchase authorization available.

As discussed in prior calls, we currently have listed for sale our Canton, Georgia building that was exited last quarter. We do have an interested buyer, but have not yet reached a definitive agreement.

Thanks, Joe. Now let's turn to the outlook for the second quarter of fiscal '05. We expect our second quarter sales to be in a range of 360 to 380 million, which represents growth of 9 to 5 percent over the prior year and sequential growth from the first quarter of 1 to 6 percent. This will be our fourth consecutive quarter of year-over-year growth. We also expect earnings-per-share between 19 and 24 cents.

Let me further explain our guidance on revenues. We start this quarter with a beginning backlog of about 235 million. As mentioned earlier, included in that amount is 10.5 million of orders that will not ship until sometime after the second quarter. This brings the backlog available to ship to about 224 million. We normally ship 80 to 90 percent of that amount in the following quarter. We then add in an amount for the six to eight weeks available to order and ship within the quarter. We assumed a rate of 24 to 27 million per week. This leads to our guidance of 360 to 380 million.

Now let me talk a little about our earnings guidance. As we just went over, we had another strong quarterly EPS result and we plan to build on it next quarter. We do expect to see the continued benefits of the Canton consolidation and our Herman Miller production system benefits will also continue. In addition, we'll get some benefit from the higher volume. On the other hand, we do expect to see the continued to impact of raw material cost increases. And as Brian mentioned, we probably won't see much benefit from our price increase in the second quarter. So, we anticipate growth margins will still be in the range of 31 to 32 percent.

Our operating expenses ran a little bit lower than anticipated in the first quarter due to some delays in program spending. We expect that spending to increase and drive higher total operating expenses in the second quarter. That additional information gives more clarity to our second quarter guidance.

In summary, we again met the commitments we made last quarter in both sales and earnings. It was great to be able to report to you another quarter of year-over-year sales growth, and in fact, double-digit growth. Our Canton relocation is now behind us and we again saw the savings we promised. Our cash balance is strong and we're in compliance with all of our loan covenants. We increased our share repurchases and made an additional voluntary contribution to our pension plan as part of the capital structure plan that we communicated in January. We are still cautious because of the near-term economic trends that drive our industry, but very optimistic with our future revenue potential based on our continuing investments in our strategy. Now I'd like to turn the call back to the operator to open it up for your questions.

(Operator Instructions). Budd Bugatch, Raymond James.

This is actually Chris Thornsberry on behalf of Budd Bugatch, who's home observing Rosh Hashanah today. I have a couple of quick questions for you, if I could.

The first question is -- with regard to the North American market -- I know international is very strong for you this quarter. Domestic was 5 percent sales and orders of up (ph) 12 percent. What are you seeing with your order book and visibility going forward in the next couple of quarters? And when do you really expect the commercial market here in the states to really kind of recover in earnest?

I will start it and then Beth or Joe can jump in. I think we believe we are actually seeing the movement in the U.S. market in total. The only thing that has probably left everybody a little concern was the July year-over-year order numbers when we saw it go backwards for the industry. Our belief is that that is a little bit of an anomaly. If you go look at the data, you see a real spike in June then a fall-off in July. Lots of competitors had price increases announced that were effective near the end of May or June. Ours happened to be effective at the end of July. Our belief is that you saw a lot of orders brought into those earlier periods, which made July a bit of an anomaly. Now of course, we don't know that for a fact. Our patterns actually as Beth mentioned were that we saw July to be a little light in the beginning or early -- late June, early July was a little light. And than we saw it tick up right before the price increase and continue to see really good activity in August. So we are pretty confident that in fact the industry's current estimates, at least for this calendar year, look real to us. Now your guess is as good as mine as you get into next calendar year. They have double-digit numbers out there. Do I think we'll have good growth in the industry next year? The answer is yes. I think it's really going to depend on what does the economic data continue to play out as overall. But right now, we continue to be cautiously optimistic that the industry is going to continue to grow and that we can continue to get our fair share or more than our fair share of that.

And I think we are cautious because we're hearing some of the comments about recent economic data and this additional sort of soft patch in the economy. But when we look at our activity with customer visits up 48 percent, it sounds like there was some employment data today that came in about what was expected -- we are not seeing that softening at this point. So, we are hopeful that our activity will continue on the way it has been.

Okay, thank you. Which customer business you mentioned are up 48 percent year-over-year? Is that overall for Herman Miller as a whole, or as that domestically? And it if it's not for domestic, what are you seeing in domestic versus international?

The 48 percent is overall, and it's up 25 percent from last quarter.

But most of those visits are (MULTIPLE SPEAKERS) domestic, Chris.

Most of it's domestic?

Yes. We do get some international customers that come to visit us in the U.S., but the lion's share would be U.S. customers.

Okay. Final question here on the steel costs. I think you said that the steel costs are expected to be around the same level as you saw in Q1 over the rest of the year. Now, is that the incremental of approximately $4 million in steel costs that you're expecting in Q2 and going forward?

Actually in Q2, it's probably going to be a little bit more than it was in the first quarter, so probably 4 to 5 million in Q2 versus the 4 million we saw in the first quarter.

Do you expect that to decline a little bit going forward as you start to hit some of those anniversaries of steel price increases?

We are hoping when we get into the third and fourth quarter, we'll see some relief. There has also been some recent discussion about China and that they may be -- allow some of their capacity for the rest of the world to use. So our hope is that we will see some relief on the supply side also.

And with the price increase (indiscernible), could you go into a little bit more depth as to how much the price increase was? Do you expect that to cover most of the steel costs? And what has been the customer response so far since you have instituted the price increase? Has there been any pushback or any mix shift to lower price point items because of this price increase, or are you not seeing that?

Chris, first of all, the average price increase at list was 4 percent, if you take it across all of the product lines, this is Brian. Historically, what we have seen is between a 30 to 50 percent capture by the time you get through -- some of it ends up not dropping through because you have customers who have long-standing contracts that have price protection in them. Customers like in government are a little bit more difficult for the timing to push those things through and just general competitive factors. So, the historical number is somewhere between a third and a half.

Right now, we remain fairly confident that we're going to be able to capture at least that third to a half. Our confidence really comes from the fact that, first, everybody in the industry has done some form of a price increase, and in fact, I think the average is slightly higher probably than our 4 percent, which makes you believe that you're seeing a movement by the whole industry. And so everybody is feeling major impact by steel. So far from what we hear from our field sales personnel and the folks in contracts is that while customers obviously don't like the price increase, because you're hearing about this as a general factor in the economy, it seems to be folks are at least more accepting of it and willing to say we understand that you guys have done a lot of good word to hold prices for a number of years. And by the way, our profitability is also being impacted by increasing raw materials. So so far, we are optimistic and confident that we're going to see a piece of this thing stick.

If we can get somewhere around a 1 to 2 percent increase in prices, we can offset a pretty good chunk of that steel number. So again, if the price increase is 4, Chris, we can capture half of it and get 2 percent. If you take 2 percent of our current quarter sales of 350 million odd, you get pretty close to covering that steel price increase, if not maybe a little bit more.

I think another thing we will see is -- if we don't see any release in steel going forward, or if we start to see a greater impact in plastics or any of the other commodities, we will try to capture an even greater percent. We have the benefit of not having to go to another price increase, but instead, working on just capturing a greater percent of the one that was already announced.

The one offset, Chris, probably the thing that we're trying to make sure that everyone understands is that, while the price increase was effective for orders that were placed before July 30th and shipped before the end of the calendar year, so you get just a kind of spike in orders because people are trying to get them in, you still have kind of the lag for folks that have either contractually a period of time before price increase can become effective and/or folks that have some form of price protection based on CPI. Now, that is not a huge chunk, but there is a fair amount of that out there or a project that in fact were reported prior. So we get a little bit of a time lag in here that traditionally, somewhere between three and six months before you start to see a lot of benefit. That's why we don't think we will see a lot in Q2, given the amount of backlog that will actually ship that we already had at the end of Q1. But as we get into Q3 and Q4, we will have a much better read. And as we get to the later part of Q2, about how well we're doing it to get it to stick.

That is very helpful. Thank you very much.

Susan Maklari, UBS.

Good morning. Can you give us a some idea of where your capacity utilization is currently, and where it was this time last year?

I think as we've talked about in terms of our capacity, when we went through the downturn, we were very careful to protect the capacity so that we could participate in the economic expansion. Our goal was to make sure we kept at least 2 billion in capacity without having to add back any additional facilities. That of course assumes a certain product mix. And if you have had significant shift in product mix, you might have some issues with equipment lines. But we're very comfortable tat we have enough manufacturing capacity to handle a $2 billion level. And we continue as we implement the Herman Miller production system to find more and more ways to have additional capacity with the same equipment and facilities.

Okay. So have you seen any increase in the amount of capacity that you are using? And has that helped you at all in maybe helping to offset some of the increases that you're seeing, because you're getting better leverage on it?

Actually, if you heard Beth's numbers -- this is Brian, Susan -- if you looked at Beth's numbers earlier where she read what has happened to overhead. As an example, overhead went from if I remember like 20 percent down to 18.6 percent of sales -- that's where you're seeing it come through, as well as in the labor side. Because, while labor -- generally, you think of direct labor being variable with sales, that is true to a point. There is some level of sort of base -- if you get a line, there has to be a number of people on it. We certainly are seeing leverage in that way and will continue to see it. If you use the raw numbers that we're running, roughly $1.50 billion right now, and we believe we can get the 2 billion, we're probably running at 75 percent of our capacity right now. The one thing that does move is, obviously, we will add people as we go up there.

So, where we continue to get the same kind of leverage we had this quarter on people costs, maybe not, but we also believe there's still a fair amount of efficiency left in the labor force. And in particular, that overhead number, we can continue to get a great deal of leverage in it. So in fact if you look this quarter, most of the material increase we saw, which was a big number, about 2.4 percent of sales, material costs went up year-over-year, we were able to offset almost every bit of that through better utilization, either from just using capacity or efficiency gains. But of course, we took all of our good news, in terms of efficiency and leveraging and had to use it to offset material costs, rather than drive it into the bottom line.

Okay. And can you just give us some sense of going out maybe longer-term, where do you see your gross margins heading? I know that they seem to be slowing a bit because of the higher raw material costs. But looking out longer-term as you get the price increases and you get the capacity and all of those variables coming through, where do you see it?

I will give you a general directional statement. My belief is, and this is an interesting topic we often have with the Board of directors. My belief is in the long run, we still have a trend that margins are going to continue to increase, especially if we can count on relatively modest growth by the industry and our ability to take a little bit of share. As we continue up the utilization curve and continue the march to implement the Herman Miller production system, I think we will continue to see margin expansion. If material costs stayed flat, we believe that probably likely over a long period of time, you could add one to two points of margin. Now, the question is going to be -- does material cost continue to trail up with it, or as we hope, we will see some drop-off in things like steel prices, and that will enable us to gain a little bit further traction on margin.

And I think the key for us is, you have to remember when we're talking about margins in that context, we're talking about sort of the core business as it sits today. And we historically have always had an emphasis on innovation and new products, and our new products tend to have much higher margins because of the differentiation. So we will continue to invest in both new markets and new products to help us to take those margins to a different level.

Okay, thank you.

Matt McCall (ph), BB&T Capital Markets.

Good morning. Beth, you just mentioned new markets. And you've spoken a little bit in the past about acquisitions in, say, health care, education. I know those are different markets entirely. Can you talk about the near-term opportunities you see out there from the acquisition of front in specifically health care and education, and there are other areas of need or interest? Just elaborate a little bit on that?

Sure. First, of course you know that it's probably not appropriate for us to discuss any specifics of our acquisition strategy as it relates to targets. But we have been looking at various acquisitions and alliances in both the education and the health care markets to help us fill in either areas where we have product gaps, or where we want to get contact or relationships with new customers and new distribution channels. So we are looking at lots of opportunities within there. I haven't concluded as to whether any of them should be specifically be an acquisition or alliance, but we are focused on growing our market share and expanding in both of those areas.

Those are real easy areas you are focusing on most in the acquisition front?

Yes. Primarily, health care is a big one for us because we have a number of clinical products. We would like to really expand our clinical product offering either through alliance or acquisition. Particularly, we would like to do more of the patient room area. That is something that we think has got a lot of promise and we think fits with our expertise. So we are working on that, as well as we're working on alliances from a different angle, which is hooking up with some other companies that already have entree to other parts of the health care markets than we do. Primarily, our sales today are to acute-care hospitals. We have been doing some work with another company on doctors' practices and the way that they're building out doctors practices. And following that is a way to get to a whole different set of customers, which is a pretty fast expanding area in health care.

On the learning side, probably the most at-hand thing is we're working on some classroom seating ideas that we're pretty excited about. It's kind of a combination of an alliance and some product development that we think has a lot of promise.

We are continuing to look, though, in the office environment area as well. We have a very robust, large, very competent channel that we can add additional products to. And certainly, our focus has always been primarily in systems furniture, meeting and storage. There is a lot of opportunity in areas like soft seating, tables and those kind of things as you see more and more folks putting these kind of collaborative and community spaces into the office environment in a bigger way.

Okay, great. Moving on, the growth has been great, you know, three quarters in a row. But I think three of the last five quarters, you have hit the low-end of your revenue guidance. Is there anything we should read into that? Is it any indication of the strength or timing of the recovery versus your original expectations?

I think one of the things we have said is that we have a difficult time like everyone else trying to anticipate what's going to happen with the economy and we're doing our best to predict what that means in the short-term. But that we are going to make sure that whatever the volume level is, that we hit the profitability targets that we set for ourselves so we don't have to wait for that recovery to get a better bottom line. So we're focused more on the leverage side and making sure that we have great profitability, no matter what the top line is.

I think, Matt, your answer, I think everybody has generally anticipated that the economic recovery was going to be more robust than it has turned out to be in the business sector in general. If you can look at anything from the chip industry to all of the recent earnings misses, I don't think anyone has seen nearly the strength that we all hoped would happen, in terms of business spending. Having said that, I think the good news for us as an industry is, we fell far enough that I think there is still room for growth, even if the industry -- or even if the economy isn't quite as strong as folks thought, because we have got to be getting close to people in the replacement cycle. Much like I think you will see in the PC industry, that there is just a natural replacement cycle that does hit.

You anticipated my next question, and that was -- what is the normal replacement cycle? You had strong shipments really from '96 to 2001. Do you look at a five, 10-year replacement cycle, or an upgrade cycle -- what do normally look for there?

I think an average of what we usually see is about seven years. So somewhere in that five to 10 is probably realistic and it's one of those areas where during the steps of the downturn, people could defer their purchases. But it's getting to the point where there's some pretty ugly looking offices out there. So we're hopeful that we will start to see a little -- start to come back.

It's interesting so far, Chris, when you look underneath it, a lot of the increase in order activity in many ways has been smaller orders, which would lead one to believe that what we are beginning to see already is folks doing a lot of replacement, rather than major new projects coming on board, which I think is a good sign.

Okay, great. One quick one. The exchange rate impact of the quarter -- did I miss that, or did you give that? I know you have given it in previous quarters.

This is Joe, Matt. The effect impact for the order was roughly around $3 million on sales, and about $0.5 million on the operating income line. So it wasn't a big deal. The FX rate a year ago were pretty much in line with where they were in the current year. So (indiscernible).

Alright, thanks guys.

Eugene Gardner (ph), Gardner, Russo & Gardner.

Good morning Brian, Beth and Joe. Congratulations on the continued success in the challenging environment. Couple of quick questions for you. First, Beth, you cited the increase in new clients that you've received internationally. I was just wondering if you could maybe flesh that out a little bit and any reasons that you are seeing the inflow of new clients? And then secondly, maybe just quickly touch on any early successes from the repositioning of resolve (ph), and whether that's had any impact? And then lastly on the right-sizing of the facilities that you've talked about, and Brian, you said as we've moved up to maybe this $1.5 million run rate, I'm just wondering where we are in the need to add people, or as you've consolidated the facilities, whether you found additional efficiencies and so want that may be positive surprises there?

I will start with your first question around the increasing, the new clients in the UK and let Brian jump in.

The percent that I gave for orders coming from new clients was UK-specific. And I think the success we're seeing there is sort of twofold. One is really the success we are having with some of our newer products. The Avak product line in the UK is very popular, along with the Mirra chair, has been extremely popular in all of the international markets and a big percentage of our growth in that product line has been international based. Resolve is also a great differentiator for us in the markets, and in the UK specifically, they've had some great wins that have been very visible. The Metropolitan Police, for instance, where people see the furniture on television when there is a big crime. So we are beginning to have higher visibility. I think also, our operations and sales folks there have been focused on growing the markets, whereas some of the others in the market, we have our largest presence in the UK and not all of our competition is as visible as we are there. And so we have been able to focus on growing the sales. We got through our restructuring early so that the teams were focused again on growing the business, while I think some others were still a little preoccupied and not serving the customer as well.

One thing I would add to that -- I think what we see is not only new customers in the UK, and as Beth mentioned, some surprising new customers for Resolve -- I don't think you would normally think of the Police Department, especially in a fairly conservative place like the UK, with Resolve, but in fact, did a great installation with that product, which we think is a further validation that that product has a broader application than some might want to believe, which is really exciting for us.

In addition to that, we've been able to tap into some new large international customers that are U.S.-based that we have not historically served in the U.S., but we have been able to crack their business in different markets, like Brazil as an example, and are now beginning to get an entree to follow them to other countries that we believe will actually open up opportunities back in the U.S. So indirectly, our international business in some ways is leading some new entrees into some U.S. customers at the same time, which is pretty exciting.

And the areas that we said we wanted to be the market leaders in or were the market leaders in were in the UK and Japan. And those happen to be the locations from an economic perspective that have been stronger than continental Europe.

Let me talk a little bit about Resolve. Resolve actually this past quarter had its largest sales yet in its history, which is great news. In fact, we've had three quarters in a row of increasing sales of Resolve, we've had some very large customer wins that got installed this quarter -- USAA, big insurer as well as Verizon Wireless were two very large installations this quarter. Resolve is doing well. We think the repositioning has worked. Certainly, we are pushing the uniqueness of its ability to increase density and, get more people in a floor plate at a very attractive price.

So, that, we think, is working. I would say we're also right now engaged with how do we expand the capabilities of Resolve so that it can reach out to a broader client base yet than what we have been able to. So that is something that we have sort of in the development queue right now, we're talking our way through.

As far as facilities go, Eugene, yes, we are pretty much through all of the consolidation stuff. As Beth mentioned, everybody's in place. I think we had some surprises. I'd tell you, they are twofold. One, our freight cost year-over-year are relatively flat, if not down as a percentage of sales. And the interesting thing with that is with the fast rising cost of fuel, one would have actually expected freight costs to be up. And so it turns out that the work of consolidating production back from California and Georgia to here, we dropped a lot of wasted routes or trucks running back and forth with parts that weren't on their way to an end customer. That saved us a lot of money to offset what would have been a big cost driver.

The second area is, we have one large distribution center left that is in West Michigan. It is becoming amazingly empty, in some respects. And that is because no longer are we double-handling a lot of products. We're now building them and manufacturing and doing milk runs of the truck ultimately from manufacturing to manufacturing plant, skipping going through the distribution center or simply using distribution as a cross dock without putting it away in racks.

Now, the good news of that is, while we don't have a large cost reduction because we got rid of an asset, what it does do is gives us even further ability that adds sales growth for us to have a facility that we have the potential of converting to other use when we need to. And that is just an example. We continue to find that in all of the manufacturing facilities, a better and better ability to utilize square footage and move things in closer than what they were before.

If there is any offset to all of the great work we've had around facilities is, we continue to learn about what it is like to have more people on a site and what do you do with things like parking and bathrooms and how to keep them cool in the hot summer when you're having a much higher density. But so far, we've been able to figure that out and we're really encouraged by what we're seeing.

That is terrific. Thank you, and best wishes for continued success.

(Operator Instructions). Charles Carr (ph), M. Rich (ph) Capital.

Thank you. I have two questions. I missed the D&A number. Can you repeat that again and tell me what the number was last quarter, please?

Depreciation and amortization for this quarter was $11.8 million. And last quarter -- I'll keep looking for that one, if you have to go to your second question.

Sure. The weekly order rate that you mentioned in the sales walk I think was 24 to million. Is that correct?

Yes.

So that is a good bit slower than in the previous two quarters. Is that a seasonal thing, or is there something else driving that?

There are a couple of reasons why we were conservative in our estimate of the next sort of several weeks rates. First, we know there was some level of price increase that has cited the first quarter of weekly order rates. Probably our best estimate is to the tune of about $1 million a week. Second, we are trying to be cautious based on the recent macroeconomic indicators. And then third, international has some very large projects. And, although they are still very strong, they may not be able to run at exactly the same run rate they were in the first quarter.

I see, so the international was a big driver?

Right.

Charles, back to your first question on our fourth-quarter depreciation and amortization -- that was roughly $14 million.

14 million? Okay. And then, what is the big drop there?

Really, it's a result of our lower fixed asset base that -- our capital spending, as you know, has some down over the past few years, and that is what has really lowered that amount.

So there was a change based on the fiscal year change?

Yes.

Okay, thank you.

Essentially, Charles, you have, especially, I would imagine, the IT thing that we put in five or six years ago when we had a really big run-up in CapEx and we put in our ERP system. A lot of those things begin to roll off now that they are no longer in the depreciation pool, if you will.

Okay, I got it.

They are still being utilized, actually, but we are now beyond them, in terms of depreciation.

Got it. Thank you.

We have no further questions at this time. I would like to turn the conference back over for any additional or closing remarks.

In closing, we would like to say that we appreciate you joining us for today's call. We hope that we've answered all of your questions and given you further insight into our results and what is driving our business. We remain confident in our strategic direction and believe we can continue to improve our operating results. For those of you observing the Jewish holiday, we wish you a reflective and restful day. Thanks and we'll talk to you next quarter.

Thank you. That does include today's conference and you may disconnect at this time.