MillerKnoll Inc (MLKN) 2005 Q2 法說會逐字稿

Good day, everyone, and welcome to the Herman Miller Inc. second-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 improve operations and realize cost savings; competitive and general economic conditions; the future profitability of acquired companies; and other risks describing the Company's annual report 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 and Chief Financial Officer, and Mr. Brian Walker, President and Chief Executive Officer. Ms. Nickel and Mr. Walker are joined by Mr. Joe Nowicki, Treasurer. 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'll 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 will use the remaining time for your questions.

As you read in the press release, we are building on the momentum that we started to see over a year ago. We saw top-line growth across the board in sales, orders, and backlogs. And we clearly saw the year-over-year leverage in our financials that we had been anticipating. We generated almost 70 percent earnings growth during the quarter. Overall, it was a good, solid quarter.

But we also know that we still have our work cut out for us. Raw materials cost continued to increase this quarter. Some indications show that they have started to level out, but they are definitely having an impact on our margins. The good news is that our gross margins continue to improve despite the negative impact of raw material costs. Much of this improvement is due to the hard work our operations team did during the downturn to improve manufacturing efficiencies. Our price increase also began to have a favorable impact this quarter and should continue into the third and fourth quarter.

We experienced a jump in our operating expenses this quarter. This is particularly true if you compare this quarter to the same quarter of last year. This was not a surprise to us. Some of it is due to a legal settlement we received in the prior year. Some of it is due to dealers we now consolidate that we did not last year. And some is due to our investment levels for new products and marketing. We introduced some great products this past year and we have even more great products in development that will be out in the upcoming year.

We are operating within our plan that was designed to achieve and build on the growth we have experienced in the last few quarters. As always, we will continue to match our spending levels with our revenue to be sure they stay aligned.

At the end of calendar year 2005, we have a much greater sense of optimism than we did a year ago at this time -- optimism not only in our own structure and strategy, but also in the business environment that we operate in. With the presidential elections behind us, the macroeconomic picture is also beginning to show some improvement. The retail environment showed some solid gains in November. Corporate hiring is forecasted to grow. The manpower report released this last week suggests that employers' optimism on business prospects is expected to turn into increased hiring next year.

Our industry also had some positive news this quarter with legislation passed last week by President Bush. Section 637 of the Consolidated Appropriations Bill ends a monopoly for Federal Prison Industries, Inc. in federal contracts. The bill allows government agencies to determine whether FPI or a private company can provide the best price, quality, and time of delivery. It will allow office furniture makers a much greater opportunity to compete for federal government contracts.

Our forecast for the third quarter reflects this optimism and continues the successive strain of positive results we began over a year ago. We know we still have some challenge in front of us, but I am confident 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 second 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. If you have not received the press release, it is also available there.

First, the highlights. As you saw in the press release, we had another great quarter. Joe and I will be talking to you this morning about our continued gains in sales, orders, backlog, and earnings. This is the fourth quarter in a row that we are reporting year-over-year growth in all these measures. Thanks to our improved order entry rates and backlogs, we are forecasting growth to continue right into the third quarter. We traditionally see a seasonal slowdown in the third quarter, but thankfully it doesn't look like that will be the case this year.

Our sales for the quarter were 368 million, an increase of 11.5 percent from the same period last year. And earnings per share were 22 cents, an increase of 83 percent over the prior-year same period. Our orders and ending backlogs also showed significant growth over prior-year levels, with orders up over 9 percent and ending backlog up almost 19 percent. We saw some great leverage in our gross margin, which increased to 32.6 percent of sales from 30.9 percent in the same period of the prior year. Our ending cash balance was still a strong 146 million, which includes cash flow from operations of over 29 million and more than 30 million in share repurchases during the current quarter.

Let's start now with the specifics of consolidated sales and orders. On a consolidated basis, net sales for the quarter were about at the middle of the range we provided of 360 to 380 million. On a year-over-year basis, sales for the quarter were up over 11 percent. That is the highest growth rate we have seen in quite a while and continues our string of increasing growth rates that started a year ago.

Our sequential sales from the first quarter to the second quarter also improved over 3 percent. Traditionally, we see higher sales in the second quarter due to increased government business. Their fiscal year ended in September and this normally drives increases in our orders in sales for the quarter. As I will talk about in a minute, part of our increased backlog is due to this U.S. government business that was shipped but not recognized in the quarter.

Consolidated new orders for the quarter totaled 390 million, up over 9 percent compared to last year. This equates to an average of 30 million per week, the highest order entry rate we have seen in the past 13 quarters. Sequentially, from the first quarter to the second quarter, orders increased over 2 percent.

Our order entry pattern stayed pretty stable over the quarter, increasing slightly every month. We averaged about 27 million a week in September, about 31 million a week in October, and just under 32 million per week in November. It has started to slow down the past couple of weeks, which is typical during the holiday season.

What is also important to note about our order pattern is that we did not see any negative impact from the price increase that was implemented in August. As you may recall, last quarter we talked about the increase in weekly order rates right before the price increase, and then the slight drop-off in order entry rates right after. Well, the order rates picked right back up this quarter and continued to grow throughout the quarter. When I discuss our gross margins a little later, I will talk more about the favorable impact the price increase is having.

We continue to be encouraged by the level of business activity as measured by client visits, which were up a little over 5 percent from the same quarter last year. That may seem like a low number, but it is important to note that during the quarter we were renovating our main customer experience facility in West Michigan. As a result, we were trying to minimize the number of visits, but even in light of that, we were still up year-to-year.

The good news is that our new Front Door Customer Experience Center in West Michigan opened on Monday and it looks wonderful. We have already had several customers through this week who gave very positive feedback. There are a lot of additional customer visits planned for the next quarter to take advantage of this great selling tool.

Now on to backlog. For the quarter, our ending backlog was 256.4 million, which is up almost 19 percent from last year's second-quarter level of 216 million. It is also up over 9 percent from first quarter's level of 235 million, the highest backlog we have had in 14 quarters. In total, we increased our backlog by approximately 22 million during the quarter. Almost 5 million of the increase was U.S. government business that I mentioned earlier. Due to accounting guidelines on revenue recognition, it was shipped but not recognized in the quarter. The good news is that it will help us to have a strong third quarter, which is traditionally a slower time of the year.

Now I will give you a breakdown of our domestic and international results. We continue to see consistent and steady growth in our domestic markets. Sales for the quarter increased 6.7 percent year-over-year and new orders improved 6.9 percent on a year-over-year basis. This represents the fourth quarter in a row that our domestic orders showed a year-over-year increase. We saw strong order growth in our Texas, Florida, and Denver markets. Our Herman Miller for the Home business also had another great quarter of growth.

Our international business environment was again a major highlight for the quarter. On a year-over-year basis, sales increased over 40 percent and new orders for the quarter grew almost 22 percent. This is the second quarter in a row of over 40 percent revenue growth. They are on a phenomenal roll. It is true we have benefited by favorable foreign exchange rates, but even when you adjust for that, our international sales for the quarter still increased almost 34 percent from the prior year.

By country, we saw growth just about across the board, with significant improvements in South America, where we had more than double the prior year's volume, and again this quarter in the UK, where we had over 100 percent increase in revenues. It has been a great story in our international business for the last four quarters, where we have seen revenue growth up 15 percent, 19 percent, 41 percent, and 40 percent respectively. Their year-to-year comparables will now be much more difficult.

As we have discussed before, our international business is very project-driven. Many of the major project that we've won in our international markets have now been completed. As we expected, their orders have now started to drop off. So our forecast for the third and fourth quarter includes a much lighter mix of international revenue and a lower profit contribution from our international entities.

Now let's talk about our gross margins. This is another area where we had great success this quarter. We continued to experience significant cost increases in many raw materials, as we expected, but we got a lot of leverage from the additional volume and we did begin to see the initial impacts of the list price increase that we put into effect in August. In the end, we were able to improve our gross margins to 32.6 percent versus 30.9 percent in the prior year and 31.4 percent from last quarter -- so the highest margins we've produced in a while and really reflects the benefits of all of our HMPS lean manufacturing initiatives.

Pricing pressure did continue this quarter, but at a much slower pace than last year. Higher discounting in the second quarter as compared to a year ago reduced our domestic margin by approximately 2.1 million, or approximately 0.6 percent of net sales. We were pleasantly surprised by the favorable impact we started to see from the price increase implemented in August. As we discussed last quarter, we did not expect to see much this quarter, but really thought it would started to kick in by the third and fourth quarters.

In October and November, we did begin to see the impact, which in total increased net sales by approximately 1 to 2 million in the second quarter. It is not yet offsetting all of our material cost increases, which I will talk about next, but it is definitely helping. The benefits from this should continue in the third and fourth quarters.

Material costs for the quarter totaled 39.9 percent of sales, just slightly above where it was last quarter. Certainly, the discounting I mentioned earlier had an impact on the material percentage, but the biggest driver once again this quarter was raw material cost increases. By far, the largest impact has been steel costs. In the first quarter, there was a 3.9 million year-over-year increase, and this quarter it was a little worse and amounted to a 5 million year-over-year increase. We believe our steel prices will increase a little more in Q3, and then level off by Q4.

We are also beginning to see some increases in plastics and wood costs -- not nearly as significant as the steel impact, but they are having an impact on margins. The price increase in our own products will help to offset this. As I just mentioned, it started to benefit us already this quarter. 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 that going forward, we will be able to continue to offset most of the raw material cost increases.

Our direct labor costs were great again this quarter, at 4.3 percent of sales, compared to 4.9 percent in the first quarter and 5.2 percent in the prior year's same quarter. That is the lowest rate that I think we have ever seen. The year-over-year reduction is primarily the results of the efficiencies from the Canton, Georgia facility consolidation that was in process last year about this time. But the trend also reflects the tremendous efforts by everyone on our operations team who have been part of our HMPS initiatives.

Overhead spending for the quarter as a percentage of sales is also down substantially -- from 19.3 percent last year to 17.7 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 1.4 million over the prior year, primarily as a result of increased incentive accruals. As you may recall, last year in the second quarter, we accrued an EVA-based incentive at approximately 50 percent of our full rate, and this year we are on track to pay a full (ph) bonus.

Our freight out and private distribution costs are another highlight. Combined, they amounted to 5.5 percent of sales for the quarter, as compared to 6 percent of sales for the same period last year. They increased slightly from the 5.4 percent we saw last quarter, primarily due to the increased fuel costs, as diesel prices spiked up. The good news is we were able to offset a large portion of that due to our efforts to continue to implement the Herman Miller Production System in our physical distribution operations.

In addition, the relocation of our Canton facility continues to have a very positive impact these costs by allowing us to consolidate a higher percentage of shipments and ship more full truckloads of product.

Moving on now to operating expenses. For the quarter, operating expenses totaled 94.8 million, or 25.7 percent of sales, as compared to 80.8 million, or 24.5 percent of sales, last year. As Brian mentioned, it is important to note that in the second quarter of last year, we received a favorable judgment in a lawsuit that allowed us to reverse a $5.2 million legal accrual that had been provided for in previous periods.

The current year also includes approximately 1.9 million associated with dealer consolidations that were not included in the prior year. 1.3 million of this was from the consolidation of the FIN 46 variable interest entity that I will talk about in a minute, 600,000 was from an Oklahoma City dealer that we consolidated into our Dallas-owned dealer operations this quarter. These items alone amount to over half of the year-over-year increase.

We had another 1.9 million year-to-year increase due to incentive accruals. As I mentioned earlier, last year we were accruing at 50 percent incentive and this year at 100 percent. There was a $2.1 million increase due to benefit program increases, such as pension costs and healthcare costs. We also spent almost 900,000 on the International Orgatech Trade Show in Germany. That show only takes place every two years and represents an incremental cost to last year and last quarter's spending. Lastly, we increased our spending levels from the first quarter for planned investments and new product development and marketing.

Restructuring charges for the quarter totaled $100,000 versus 4.4 million in the prior year, and were primarily associated with the relocation of the Canton operation. 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 2 million compared to 2.5 million last year. Interest expense was down approximately 200,000 from last year due to lower debt levels combined with savings from our existing interest rate swap. Currency gains contributed to the improvement with $400,000 this quarter versus 100,000 in the prior year, driven primarily by the impact of the weakening U.S. dollar on our nonfunctional currency balances in Canada and the UK.

As we discussed in the prior conference call, we adopted the provisions of FIN 46 at the end of the fiscal year 2004. 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 one independent contract furniture dealership to which the company is providing ongoing financial support through a loan.

This consolidation increased the current quarter's net sales by 2.9 million, orders by 8.3 million, and backlog by 11.6 million. It also reduced net earnings by about $300,000. The effect on the Company's balance sheet as of November 27, 2004 was an increase to assets of approximately 1.2 million and liabilities of 1.3 million.

Our effective tax rate for the quarter was 33.4 percent. This rate was slightly lower than originally anticipated due primarily to the finalization of prior years' IRS audits. We anticipate our effective tax rate for the rest of the year to be approximately 34 to 35 percent.

When you roll this all up, net income for the quarter was 15.4 million, or 22 cents per share. It is an 83 percent improvement over last year's 12 cents and at the higher end of the range we provided at the beginning of 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 a very strong 29.4 million compared to 3.3 million in the prior year. Depreciation and amortization for the quarter was 11.7 million. In addition, our net change in working capital for the quarter amounted to a source of funds of approximately 1.4 million due primarily to increases in accounts payable and accruals.

Our collections of Accounts Receivable continue to remain strong and our over-90-day A.R. again have continued to improve year-over-year. Our Days Sales Outstanding and net inventory and receivables increased slightly by 0.3 days from the same quarter in the prior year to 51.5 days. That was due primarily to the impact of the FIN 46 VIEs on our balance sheet.

Capital expenditures for the quarter were 7.3 million, which is down from the 9.3 million we spent in the same quarter last year. Going forward, we anticipate capital expenditures for the year to remain low at approximately 30 to $35 million.

Let's move on to our liquidity and cash position. During the quarter, we finalized an agreement on a new $150 million five-year revolving credit facility. Our prior five-year agreement was ending in April of '05. Current credit market conditions allowed us to renew at even more favorable terms than our prior revolver. Our profitability and positive cash flow combined with the 137 million available on our new revolver and 146.3 million cash balance continue to provide us with tremendous financial flexibility.

We continued this quarter with an increased level of share purchase activity. During the quarter, we bought approximately 1.3 million shares for $30 million at an average price of $24.08 per share. We still have about 21.9 million in share repurchase authorization available on our existing Board authorization. We do plan to review our capital structure with the board at their January meeting, and will announce any additional actions at that time.

As discussed in prior calls, we currently have listed for sale our Canton, Georgia building that was exited last year. We do have an interested buyer and we are currently in preliminary discussions.

Thanks, Joe. Let's turn to the outlook for the third quarter of fiscal '05. Given our high backlog, we are expecting an unusually strong third quarter. As you know, traditionally we see a seasonal slowdown during the holiday time. The past two years, we even had a one-week manufacturing shutdown between Christmas and New Years. This year, we will be working through the holiday break. As a result, we expect our third-quarter sales to be in a range of 355 to 375 million, which represents growth of 8 to 14 percent over the prior year and is reasonably consistent with our second-quarter sales. We expect earnings per share between 18 and 23 cents.

Let me further explain our guidance on revenues. We start this quarter with a beginning backlog of 256 million. Included in that amount is approximately 9 million of orders that will not ship until sometime after the third quarter. This brings the backlog available to ship to about 247 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, although given the shortened holiday weeks, we only use six weeks of available orders for our calculation. We assumed a rate of 24 to 27 million per week because average order rates tend to be lower in January. This leads to our guidance of 355 to 375 million.

Now let me talk a little more 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 expect to see the continued benefits of the Canton consolidation and our Herman Miller Production System benefits will also continue. We will get some additional benefit from the price increase that we only started to see this quarter.

On the other hand, we do expect to see the continued impact of raw material cost increases. So we anticipate gross margins to still be in the range of 32 to 33 percent. As we discussed, we also anticipate operating expenses to decrease slightly in the third quarter.

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 for the second quarter in a row. Our gross margins are beginning to demonstrate the benefits of both our cost reduction activities and the price increase we implemented in August. Our cash balance is strong, even with the significant increase in our share repurchase activity, and we have strong backlog and forecast as we head into the third quarter.

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

Thank you. (OPERATOR INSTRUCTIONS) Todd Schwartzman of Sidoti & Co.

Good morning. Question on Section 637. Could you talk a little bit about the opportunities that you're seeing there, how big they are, what share of the pie you think you might capture ultimately?

Todd, this is Brian. Our understanding is that FPI sales of furniture last year were around 140 to $150 million, though that's actually, I think, down a bit from where it was at its peak -- but around 140 to 150 million. We have a larger share of government business that we do overall, so I think you could imagine that if we just got our normal share of the industry, we would be talking around 15 to $20 million kind of opportunity. We tend to be little bit of a premium with the government. Of course, more folks have announced they are going to get into selling to the government as well. But to put it in perspective, it is around that size of an opportunity in total.

On the tax rate guidance, 34 to 35 percent, do you feel comfortable with that as guidance for the full year as well?

As far as we can see at this point, we don't have anything else that is significant that is open with the IRS that would have an impact to that.

Okay, thanks.

Budd Bugatch at Raymond James.

Good morning. That's a new one. Can you talk a little bit about the composition of revenues in terms of systems, seating, storage, and maybe the varying growth rates on that issue?

Sure. This quarter we did see -- over the last few quarters, I guess, we have seen a little bit of a shift in our product mix to a higher percentage of seating versus systems. Our outlook going forward for this next quarter at least is that it will shift a little bit higher to the systems market, which in some respects is a great thing, because that is the business that got hurt the most during the downturn. So to see that come back is great news. From a margin perspective, systems margins tend to be a little bit lower than seating, so in the short-term, it could have a slightly negative impact on our margins.

Is there anything systemically that leads you to more systems? Is it because of projects, is it because -- it's got to be because of projects?

I think that is it. I think you're starting see the project activity pick up. And certainly we have seen it across all of the systems lines for the most part, so it is not a system specific, which would lead you to believe it is. I think it's not only projects but I also think what we are doing is seeing some base business ordering, where folks are adding on to previous installations, which is another reason I think that we've seen discounting be a little better than maybe we anticipated, as well as capturing some of the price increase, because you start to see folks adding on rather than just the big bid projects.

In the projects business, if you think about it from an installation perspective, it makes sense that systems lead projects. The systems go in first and then the chairs come in after that.

I agree with that. Also, I know this is a bit harder to put your fingers on, but the project business versus daily business, just give me a historical perspective of where it was, where you think it is, and where do you think it goes over the next year to 18 months or two years?

As you've said, this is a difficult one to get to. Certainly the international business has largely been driven by major project wins. So that's why Beth in her comments said we don't expect some of the extreme robustness we have seen in the first couple quarters to necessarily continue into the third there, because we have had some big wins in international; so that has been largely driven by project business.

In the U.S., in the domestic business, I would tell you that the average project size that we have been working has still been relatively small compared to (indiscernible) history, which I think would lead one to conclude that so far we are not seeing lots of big project business as much as we are seeing more add-on sort of base business.

(multiple speakers) So more floors than just facilities, if I could look at that way on a physical basis?

I think what you are seeing is folks more adding on to bring in additional people, begin to add on -- you know, a floor that maybe they are redoing. I think that my own -- and this is a gut feel; I (indiscernible) we have any really solid data to suggest this -- that what you would see is folks finally getting to probably some of the replacement cycle, that they are beginning to say, well, even that stuff's been in place for a long time, we need to reconfigure.

In the past, they've probably left, even when they needed a reconfigured team, meaning they shifted their organization structure, they were probably (indiscernible) folks less than optimally. I will say as we are starting to hear more from the field sales organization that they are starting to see more potential projects out there than we were seeing certainly in the first quarter. As we got to the end of the second quarter, we started to hear more about projects coming online, which is good news.

And just from an anecdotal perspective, we've had several of our salespeople say for the first time in several years, we have had customers calling us up in the last few weeks saying they need to use up their budgets and could they place an order and get shipment still in the month of December? So that is very encouraging.

So you're not working now -- you'll work through the Christmas week, then?

That's right. We'll all go out on the line if we need to help produce the product.

Brian, just give me a number on project versus over-the-transom or daily business. Is it 40/60? My memory is it ranges between 40 percent to 60 percent projects versus regular business. Is that fair or not fair? You have a lot more visibility and experience with it than I do for sure.

Yes, but I don't know if I can give you a number off the top of my head to be honest with you. Let us go away. We will look at that. I don't know if I have a straight answer for you. If you told me it was 60 percent base business, that would not surprise me. I think that sounds reasonable to me. But I don't know if I can give you a number off the top of my head.

Okay, thank you very much.

David Small of Goldman Sachs.

Just a quick question. R&D as a percentage of sales or in total dollars, could you give us what that was for the quarter, maybe, versus where that was last year? And what do you think that R&D spending will be like going forward in terms of -- I know you have talked about new products coming out over the next few years. That would be great.

We're looking for some percentages for you. I can tell you that R&D was one of the areas where we did protect our spending, so it has gone up as a percent of sales over the last few years as our sales decreased. I think during the quarter, we were about 8.3 million in spending for R&D.

Would you expect it stay constant over the next few quarters or you plan to increase that?

That's a great question, David. I would think it will probably increase slightly as we get into the third and the fourth quarter, because we have a lot of stuff that is in the development queue moving towards launch, which when you get towards launch, you tend to see dollars ramp up because you're doing a lot more prototyping and those kind of things. So I think we will see little bit higher level as we get in the third and the fourth quarter in dollar terms.

It was running percentagewise for the quarter 2.2 percent. Our historical number, if you look over a long period of time, it has always run right around 2 percent, between 1.8 and 2.2ish. It was a little higher than that, of course, during the downturn when the sales were a bit lower. I think as a percentage of sales, that's about where it will continue to be, but we might see a little bit higher number in the third and the fourth quarter.

We tend to have higher spending closer to NeoCon, and we have some products that were targeted to come out during NeoCon this year.

And are those products that will impact your results next year?

Yes (multiple speakers). It will depend on how fast we get them out from an order entry standpoint. We certainly will have one product that will be orderable when we get to NeoCon. We have two other products that we're targeting for at least a debut at NeoCon that will be orderable sometime in the fall. So those, you have a ramp-up period -- it tends to be a new product, you don't see a lot the first year. You get in the second year after their introduction.

We usually start with a restricted order entry process and then you open it up for all order entries several months later.

That's great. Thank you very much.

Matt McCall at BB&T Capital Markets.

Two, I guess, big picture questions. I look back and in periods of increasing industry shipments that you've really outperformed the overall industry. But since February, I think industry shipment is up about 5 percent and in the last three quarters, your domestic shipments are only up about 6.5 percent. Do you expect that gap to widen going forward, given what you have said about the project business coming back? And do you think what's holding that back is just -- is there any specific economic indicator that you can point to that you're looking as a signal that that gap might start to widen?

I don't think there is any particular economic indicator that would drive that. I would tell you if you looked at it historically, my own recollection would be that generally in good times we grow at about 1.5 times the industry rate. So if the industry would be at 5, we would be at 7, 7.5, something to that effect.

I don't know if I can say why we have not gotten it quite back up to that level. I think some of it is you're now just starting to see the power of the installed base come in. I think what you see when you get to that premium, it is a combination of three factors -- strong installed base, ability to win projects, and ability to come out with innovative new products that create new opportunities that you didn't have in the past.

And I think we have not really seen the benefits yet of our new products introduced last year at NeoCon because we are just in the process of opening up order entry in the next couple of months. I think that, coupled with the other new stuff that we talk about a second ago, are what will enable us to get back to that premium. So I think as we continue to see the economy pick up, see the installed base come back and we deliver on what we believe we can in terms of getting new products to market, that will drive us back to that kind of premium.

Okay. And if you look out into calendar '05 and even into '06, I think BIFMA has an 80 percent plus industry growth rate out there. That would imply if we got to that 1.5 times, you're talking about 12 percent. Just from an internal planning standpoint, what kind of industry growth are you looking at? Are you in agreement with BIFMA's numbers -- and that is for '05. And then if you could comment on based on what we know now -- and I know it's a while out -- but what do you foresee for 06. Where are we in this cycle?

You know, it's tough for us to predict. One of the reasons we established a cost structure like we have now is so that we will be successful no matter what the general economy and the industry does. Our hope is that the industry is coming back and that the BIFMA number is reasonable and that we will grow at a premium to those.

We tend to look at white-collar employment and business profitability as the leading indicators that help us determine if that is a reasonable percentage or not.

Matt, if you go back and look -- and BIFMA's current forecast that I have is 8 percent, I think, for next year in terms of shipments in calendar 2005 -- if you looked at then sort of backing that down over time (multiple speakers). So is 8 percent the right number? I would not be surprised to see a number that's a little bit less than that, but of course, it's just depending on what you believe the forecast will be.

We think whatever number ultimately plays out, we can do better than that number as you described earlier, depending on how we execute. But I think there is a good chance that we will at least see a number that is as strong as this past year for BIFMA, and probably a little bit of acceleration, assuming business spending picks up the way it is forecasted to.

One of the keys for us is really innovation and continuing to come out with new products and trying to redesign what that industry is.

Anton Chukumba (ph) at Morningstar.

Congratulations on a great quarter. Two quick questions. First off, I just wanted to see if there were any particular industries -- talk a little bit about the U.S. government -- but any particular industries where sales and orders are particularly strong? And then I just wanted to get a quick update on how the Mirra chair is doing.

From an industry perspective, I will start and Brian can jump in. Oil and gas has been strong, as you probably would expect, so we're seeing existing customers and the attainment of some new customers in that arena. Financial institutions I think are coming back a little bit, especially with some of the recent consolidations in that industry -- that tends to drive business with us.

The hot industries for us have been, as Beth mentioned, for sure oil and gas, finance, and insurance organizations. We have seen some pretty good work in light manufacturing, which is a little bit unusual for us, which I think is a good sign of where we are in the cycle. Electronics and computers have always been one of our really good segments, so as that group starts to get more healthy, that is a good sign for us. And of course healthcare, as the whole economy has seen, we have had some good wins that have not shown up yet in sales on the healthcare side that we are pretty excited about, where we have got some essentially sole source type of agreements with a couple of big healthcare organizations. We can't tell you who yet, but we are pretty excited about those. So those are the industries that we are continuing to see.

Mirra Chair is doing wonderfully. It continues to grow and is ahead of its plan that we started off with. The margins are very good. So we're really happy with what the Mirra Chair is doing. And we also think, by the way, that Mirra Chair is benefiting the Aeron Chair as well as the rest of our program, because we tend to then have a more broad offering of innovative seating displays across different price points. So you not only have to look at the Mirra Chair, but you have to look at it in combination with everything else. It is also helping us in our retail business that we do for Herman Miller for the Home, as the retailers really see that as a new differentiated item for them to sell.

And the Mirra Chair, specifically from an international perspective, is doing very well. It was one of the few products we have been able to introduce that has a truly international acceptance, and a lot of our big wins have come from markets outside of the U.S.

Opaque thanks.

Margaret Whelan at UBS.

It's Susan actually. Can you talk a little bit about -- it seems like your backlog is up more than the industry. Do you have any sense as to whether or not you're gaining some share?

Well, we always are cautious when we talk about share, especially on a short-term perspective, and don't like to look at just the monthly and quarterly numbers to determine that. Anecdotally, we would like to think we're gaining market share. We seem to have a lot of recent wins, and some of them have been competitive wins. So our goal as they said is to definitely grow at a premium to the industry and to gain market share, but I would not just take one number like a backlog number and draw that conclusion.

What about in terms of product, do you think you're gaining more share in a certain area versus others? For example, systems versus seating or something?

I think if there is an area that we're stronger in, Susan -- and we haven't looked at share recently by product category -- but if there is an area that we have tended to be gaining ground in for share, it has been seating. Seating has been a big part of our growth engine, as Beth mentioned earlier, in terms of where we see the mix. Now, again, that is going to rotate around a little bit in the third quarter, so we may see something different from that end. Now if you look internationally, what has really driven a lot of the growth, for the last couple of years it has been seating; but more recently, it has actually been on their desking products, particularly the Abak line, which is not the newer version we just introduced at NeoCon, but kind of the original product line. That has been a very big (indiscernible) on those project wins we have had in the international business.

Okay. And then can you give us a sense of where you're thinking about your incremental margin, given how the raw material costs are coming up and price increases though are helping you a bit?

We have said for the near-term that gross margin would stand at 32 to 33 percent. In terms of leverage overall, we continue to say that we can draft about 15 to 20 cents to the bottom line after taxes and after incentive comp on every incremental dollar of revenue over last year's levels.

How does that compare to this quarter? It seems like it was a little bit lower than that. Is that just because of more pricing pressure?

This quarter it was actually about 17 cents compared to last year's numbers. You have to be careful on a quarterly perspective when you do that leverage; you have to go back to last year's base to do it.

Okay, so once adjusted for the charges and things.

Yes.

Hi, guys. It's Margaret. Can I ask you a bigger picture (ph) question about capital spending? It seems like until the last two or three years you were spending more than 100 percent of D&A on CapEx, and it has come down a lot as you reduced your capacity. But as a percent of your D&A, where do you think spending will be over the next couple of years?

I think because, as you can expect with the spending coming down from those levels, the D&A number is changing. If you think about it more in terms of absolute dollars for the near-term, we will probably be in that 30 to $35 million range this year, and then going forward, growing up to about 50 million over the next few years. But we have made a lot of major investments in technology already that we don't think we need to make again.

And then in addition, the learnings that we had during this downturn, we really accelerated the learnings through HMPS, and we truly believe that we will not need to get back to the kind of levels we had in the past from a facilities and a manufacturing standpoint. So if you look at the 30 to 40 million this year growing to the 50 to 55 million over the next few years, I think that would be a better way to look at it, instead of looking at it in terms of percentage of depreciation.

The percentages sort of converge on one another because the depreciation number is coming down, so they will converge a bit on one another. But we don't foresee in any way, Margaret, it going back to the levels that it was in the past. (multiple speakers) the driver behind it going forward will be much more probably around what is the level of new product introductions we have. And that is primarily related to tooling, not to manufacturing facility. We're pretty confident that we've got the facilities still and are continuing to do enough in the way of improvements and utilization that we have plenty of facilities to grow into from where we are today.

Okay. And Joe, in your prepared comments, what did you say about the $60 million cash from international? I didn't get that.

60 million cash from international? I'm sorry -- I missed that.

I thought you said something about cash coming in from international. Is that wrong?

(indiscernible)

Okay. Because the question I had is just that you have been very prudent and conservative with your balance sheet over the past couple of years, which is smart, because we really didn't know when the freefall would stop. But now that we seem to have turned the corner, the balance sheet is kind of lazy, given the net cash position, given where interest rates are. What do you think the primary use of the cash is going to be going forward? Would you buy in more stock and could you (indiscernible) to market yields, special dividend, acquisitions, how are you thinking about it?

We did a lot of work around our capital structure last spring. And our conclusion at that time was that we would double the dividend. We also increased our acquisition of shares significantly because we had made it through the downturn. We discovered how resilient our business model was and that we could generate cash flow even during the toughest of times. We have a lot more confidence going forward that we will continue to do that.

We wanted to make sure that we kept enough flexibility, at least for the next year, so that we could be opportunistic in terms of acquisitions or new product innovation. So we will continue to aggressively repurchase shares, but we also, at least while we implement our strategy for the near-term, will want to make sure we keep enough flexibility if we want to make a bigger play somewhere else that we can.

Bigger play strategically in terms of new market or new products?

Correct.

Thanks very much.

Justin Morra (ph) of Lord Abbett.

I apologize -- Susan was asking this question about the discussion of the incremental flowthrough on sales. If I look at just six month numbers to make it easy, sales are up year-over-year about $70 million, operating earnings about 20 million, 19 million, which gives you about 27 percent kind of flowthrough. I know you've talked obviously about the 25 to 30 percent, but is that fair to use that as a basis?

That is close. We hadn't (ph) looked over a longer period of time, so when we respond to the kind of leverage questions and how much are we getting, so much varies from quarter-to-quarter; what I tend to do is I look at it over the past year. So the leverage 17 percent number that Beth mentioned, it is really compared to last year for the full year. And look at our earnings after (ph) further restructuring charges, take that out of it, and then compare that to what we did in the quarter. That is where I get to the 17 percent number. But I think the logic you want went through of what you described was similar to what I did on a longer period for a full year.

Brian, relative to the comment about the government business, 140, 150 million, just trying to understand that a little better. Do you get any share of that today or is that all incremental to the industry? I just suspect that obviously that product is being made by somebody.

Yes. Essentially, that 140 million is being made today by Federal Prison Industries. There are players in the industry who sell them components today. Right? Essentially, they bought components, assembled them, made some of their own parts and pieces. We do a lot of business with the federal government today. The total market for the government is way bigger than that 140 million. So the question is, what piece of the 140 million will we get?

And I think the one thing you do have to keep in mind -- Federal Prison Industries is not going away, so as long as they are still competitive -- now they have to be competitive -- what's really different is in the past, they could be competitive in the sense that they could have a good price but not necessarily the best value to the customer. Over time, they may not even meet the customers' exact requirements, but because the government could mandate that they had to buy from FPI, it sort of was a closed market, if you will. So will we go in and get 15 million, get our normal share, or something bigger? That will all depend on which agencies, how good are we at competing for that piece of it. And by the way, how well does FPI do a change in their own abilities, right? But it really adds to the market that is now available for the industry.

And you just know, based on past experience, that when you're bidding against them or at least complementary products, that they are X percent higher than you, so therefore that is where the opportunity may lie?

We do not know necessarily that they are higher than us overall, but when you look at it price to value, if you will, we are pretty competitive with those folks, especially if it is somebody who really does care about what they're doing with the employees. One of the things you find in the federal government, which is interesting if you get underneath it, they are faced with a huge turnover in folks from the baby boomers who are going to be retiring. So some of the agencies are very nervous about their ability to attract and retain the best folks.

And so, while you wouldn't think of it that way, facilities are high on their list of ways to make sure that they can get the best people. Well, when they're left with just Federal Prison Industries, of course, they no longer have to get excited about quality or innovation in the product to make the folks more productive, more comfortable, because they had closed market.

You also might find in cases where some of the agencies have a high need for speed or reconfigurability or those kind of things, that in some ways again it is not a feature necessarily FPI had to offer. Now I'm not saying they don't have some of those features, but we believe when it comes down to the total package, we can compete with them. That's all we ever wanted. All we wanted was an open field to go compete.

Okay. And then lastly for Joe or Beth, relative to inventory, it looks like -- if I'm looking at the right numbers -- on a dollar basis year-over-year, it is relatively flat, but your backlog is up 19. Is that just kind of a timing of orders, when they entered inventory, or --?

It's mainly due to that government business. That's why year-over-year it is relatively flat, but sequentially, because of the seasonality of the government business with their fiscal year-end, you tend to see it increase right now. And the business with the government is treated like a direct sale. When we ship it, the customer basically has to sign off on the punch list before we can invoice it. Our other sales that go through nonowned dealers get invoiced when it's actually shipped to the dealer.

Sorry, what percentage of the 19 percent was that government business then that is now gone? It is now out of backlog, right?

It's in the (indiscernible) backlog, and it will ship out during this current quarter. From a year-to-year perspective, that number was off about $5 million.

Okay, thanks.

Andrew Gundlach at Artemis Advisers.

Good morning. Congratulations on a good quarter. A couple of quick questions. Going back to the '00/'01 year, what was the peak weekly order rate that you achieved? Roughly off the top of your head if you don't know.

I don't know off the top of my head. (indiscernible)

In total, our revenues were down from the highest to the lowest by about 40 percent, so you probably could look at a number --.

I wouldn't have been surprised if we had some average weeks up in the mid-40s, 40 to 45, kind of in that range.

Okay. And your current capacity can handle that level of weekly orders at this overhead cost? Because I am looking -- going through your percentages, the overhead cost seems to come down about $1 million sequentially a quarter. I don't know how long it can stay that way. But I am just curious what weekly order rate you can put on top of that overhead cost, which I guess is a similar way of asking a couple of the previous questions.

(multiple speakers) more to the leverage question. But there is -- from a manufacturing facility perspective, we are confident we can get back up to that number. We have the square footage to be able to produce the products. Part of it will depend on what product mix we have, and if it is all in newer products where we have to add machinery and equipment, that would have an impact. It also depends on the timing, on how long it takes you to get back to that level, because each year you see increases in things like salaries and wages and benefits that you have to absorb.

So part of the question revolves around how quickly you get the business and part of it revolves around what the mix is when you get it. But we are very confident, at least from a facilities perspective, we would not have to add facilities to produce that capacity.

The biggest driver of capacity for us in the short run is that if it came in -- let's say we had a major, major turn in the industry and in our demand picture -- the biggest driver of capacity for us in the short run will be people and getting the folks in on the production line, which of course goes more to the direct labor side. But there is a complement to direct labor in terms of indirect labor, because now you're talking about maybe expanding from 1.5 shifts to 2 shifts, so you need more folks around to manage a plant, that kind of stuff. So the overhead doesn't stay exactly flat, even excepting the kind of inflationary pressure stuff.

I understand. You mentioned EVA. This is my second question. Are you seeing any pressure on your direct labor costs, given that you are doing a little bit better?

(multiple speakers) Are we seeing pressure on our direct labor cost? As a percentage of sales, direct labor is actually driving down --.

Exactly. But going forward, you see wage increases and stuff like that, real wage increases?

Last year, we saw wage increases I think around 3 percent overall, somewhere in that range. We don't see the picture a lot different than that going forward into the next year. The bigger driver of compensation costs, really quite frankly, are around the benefits area. If there is an area that you look at more, it's around healthcare and those kind of things.

And if you remember, our incentive payment, which is also paid on the manufacturing side to direct labor, is doubled -- at a rate that was double last year's level. And it gets into the wage increases, employees are seeing twice the amount of incentive compensation this year.

I understand. Last question, with respect to steel purchasing, are you locking in prices for next year already or how does that work? How should we think about that?

We historically have locked in for longer periods. Right now, we've got small piece of our purchases locked in, but more in the 30, 60, 90-day range. Because we still believe over time they are going to kind of ease back up, and locking in at this rate does not seem to be very prudent right now.

So if we see spot rates fall, that is going to be good news for you. You'll feel that immediately almost.

Well, you could probably look at it as being probably three to six-months out by the time you get through the whole purchasing cycle and everything. But as they fall, it certainly is helpful to us.

How come -- just an aside -- how come we haven't seen the raw material price increases in your raw material line and inventory? You know what I mean?

It is in there. It is just that we've been also managing the inventory levels.

So turns have improved basically?

We are just (multiple speakers) inventory faster is what is happening.

Especially with the decrease in the number of facilities we have.

I was going to say, is that because last year in these quarters you had excess inventory because you knew you were shutting down a plant and you didn't want to miss sales, stuff like that. Is that --?

That is correct.

Thank you very much.

That does conclude our question-and-answer session. At this time, I would like to turn the call back to the speakers for any closing comments.

In closing, we appreciate you joining us for today's call. We hope that we have answered all of your question and given you further insights into our results and what is driving our business. We wish you all a very happy holiday season and look forward to talking to you in the next quarter.

Thank you. That does conclude our call. We do appreciate your participation. At this time, you may disconnect.