MillerKnoll Inc (MLKN) 2005 Q3 法說會逐字稿

Good morning, everyone, and welcome to this Herman Miller Inc. third-quarter fiscal 2005 earnings results conference call. This call is being recorded.

This presentation contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act as amended that are based on management's beliefs, assumptions, current expectations, estimates, and projections about the office furniture industry, the economy, and the Company itself. Words like anticipates, believes, confident, estimates, expects, forecasts, likely, plans, projects, should, variations of such words, and similar expressions identify such forward-looking statements. These statements do not guarantee future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence. These risks include without limitation, employment and general economic conditions, the pace of economic recovery in the U.S. and in our international markets, the increase in white-collar employment, the willingness of customers to undertake capital expenditures, the types of products purchased by customers, competitive pricing pressures, the availability and pricing of raw materials, our reliance on a limited number of suppliers, currency fluctuations, the ability to increase prices to absorb the additional cost of raw materials, the financial strength of our dealers, the financial strength of our customers, the mix of our products purchased by customers, the success of the transition to our new executive management team, our ability to continue to make product innovation, the success of newly introduced products, our ability to serve all of our markets, possible acquisitions, divestitures or alliances, the outcome of pending litigation or governmental audits or investigations, and other risks identified in our filings with the Securities and Exchange Commission.

Therefore, actual results and outcomes may materially different from what we express or forecast.

Furthermore, Herman Miller Inc. undertakes no obligation to update, amend or clarify forward-looking statements.

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. Nickels and Mr. Walker joined by Joe Nowicki, Treasurer. Ms. Nickels and Mr. Walker 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.

Good morning, everyone. As normal, 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 will use any remaining time for your questions.

As you read in our press release, we had a great quarter. We exceeded the top end of the range we gave for both sales and earnings per share. We saw a 16 percent increase in sales, which is the highest rate of growth we have seen in 17 quarters -- that is a long time. We also saw a double-digit growth rate in orders, and our backlog increased almost 10 percent over the same period in the prior year.

In addition, we were able to turn that volume into bottom-line performance and actually the performance that we had promised. In fact, better than we had promised.

Our earnings per share more than doubled from where it was a year ago. We're doing what we said we would do. The macroeconomic picture also got a little brighter this quarter. We saw continued growth in gross domestic product; a healthy level of corporate profitability; rising employment statistics, especially in the service sector; solid growth in the office construction sector, and improving office vacancy rates. All of these factors are lining up to provide us with a much improved business environment for contract office furniture. And we're ready for it.

We are very excited about our annual industry tradeshow, NeoCon, which will take place in June in Chicago. We've continued making some investments this quarter in our showroom and on our product vocabulary. We have a great addition to our industry-leading seating offering, as well as extensions to our current award-winning products in several categories.

As in the past, we will have an analyst and investor event as part of the show, which you will all receive invitations to shortly. I hope you can make it. It will give you the opportunity to personally experience the heightened excitement that we at Herman Miller have and the excitement within the industry. It should be a great event.

We have talked to you for a while now around the investments we have been making in the Herman Miller Creative Office. This is our initiative to focus on creating innovative new product opportunities. Well, the first one is about to be officially launched.

Sonare Technologies will introduce new sound management technology, providing unique user confidentiality and open plan offices and public spaces. We have already started some early marketing efforts, and national visibility is expected this summer. There is also a second new business from the Creative Office that will formally launch by early 2006. While we're taking a measured and deliberate approach to profitable growth with these ventures, we're very excited about their future potential.

We believe it's our continuous dream of new office furniture like you will see at NeoCon, as well as innovative initiatives like these from the Creative Office that continue to place us on Fortune Magazine's most admired companies list. Again this year we were ranked at the top of our industry, in the top 20 companies overall in its combined score for eight measures of reputation.

With those introductory remarks, I will turn the call over to Beth and Joe for more discussion of our third-quarter results.

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 a press release, it's also available there. Also, the financial amounts and references to internal measures today are unaudited.

First, the highlights. As Brian mentioned, we had another great quarter. I will be talking to you this morning about our continued gains in sales, orders, backlog and earnings. In fact, this is the fifth quarter in a row that we are reporting year-over-year growth in all those measures.

Our sales for the quarter were 382 million, an increase of 16 percent from the same period last year, and EPS was 24 cents, an increase of 118 percent over the prior year's same period. Our orders and ending backlog also showed significant growth over the prior year levels with orders up over 10 percent and ending backlog up almost 10 percent.

We saw outstanding leverage in our gross margin as it increased to 32.1 percent of sales from 30.1 percent in the same period of the prior year. Our ending cash balance grew this quarter to 164 million, which includes a very strong cash flow from operations of over 40 million and almost 23 million in share repurchases during the quarter.

Let's start now with the specifics of consolidated sales and orders. On a consolidated basis, net sales for the quarter exceeded the range we provided of 355 to 375 million. On a year-over-year basis, sales for the quarter were up 16 percent. As Brian said, that is the highest growth rate we've seen in 17 quarters, since November of 2000.

It also continues our string of sequentially increasing growth rates that started a year ago. It is important to note that the current quarter's net sales include 5.7 million due to the consolidation of an independent contract furniture dealership as required under the provisions of FIN 46.

As you may recall, we adopted this provision at the end of last year, so it was not included in last year's Q3 results. This was a higher rate of sales than we expected from the dealership and more than we had seen in prior quarters where we were averaging closer to 2 to 3 million.

Our sequential sales from the second quarter to the third quarter also improved by almost 4 percent, which is very unusual for us. The third quarter is traditionally a much slower quarter due to the Christmas and New Year's holidays.

But as we mentioned in last quarter's conference call, we headed into the quarter with a large backlog of government and commercial business. We also did not have a full week's plant shutdown between the holidays like we had in the past couple of years. That helped us to start the quarter with a great month of December, and we just continued on from there.

Consolidated new orders for the quarter totaled 341 million, up over 10 percent compared to last year. This equates to an average of 26.2 million per week, which is down from the prior quarter but reflects the traditional seasonal trend. Our order entry patterns began to slowdown in December as they usually do around the holidays and averaged about 26 million per week. They were a little lower in January due to how the holidays fell and then started picking back up in February where we averaged 27 million per week. We have seen that pickup continue into the first couple of weeks in March where the orders have averaged over 32 million a week. We continue to be encouraged by the high level of business activity as measured by client visits, which were up over 30 percent from the same quarter last year. And the calendars are full as we head into the spring, and not just because the weather is expected to be better.

Now on to backlog. For the quarter, our ending backlog was 215 million, which is up almost 10 percent from last year's third-quarter level of 196 million and reflects the continued improvement in our industry. But backlog did decline from last quarter's very high level of 256 million. A good portion of this was due to the revenue we recognized on several U.S. government projects this quarter. These are the ones we mentioned last quarter that were sitting in the backlog and could not be recognized due to accounting revenue recognition guidelines.

In addition, we had several large commercial projects that shipped out of backlog this quarter.

Now I will give you a breakdown of our domestic and international results. In prior quarters, we have talked a lot about the tremendous growth we've seen in our international business. While that continued again this quarter, we saw noticeable improvement in our domestic markets as well. Domestic sales for the quarter increased 14.2 percent year-over-year, and new orders improved 7.5 percent on a year-over-year basis. This represents the fifth quarter in a row that both domestic orders and sales have achieved a year-over-year increase.

We saw strong order growth in Texas where our teams have been having a lot of success in the oil and gas sector and also in the New York and Denver markets. Our Herman Miller for the Home business had another great quarter of growth both in sales and orders also.

Last quarter one of you asked for little more detail around the portion of our business which is project- related versus base business. We did some research, and our project business in our U.S. markets ran about 39 percent for the quarter, which is up from both the prior year and last quarter. In addition, the average project size included in our tracking database is 20 percent larger this quarter than the average project size for the last 12 months.

Now I cannot say enough good things about our international business. They just kept rolling along and had another great quarter. While they did slowdown a little this quarter as we expected, they continued to win some big projects. And they are beginning to have success with more quick turnaround base business from medium-sized customers with a program in the UK they call FASTRAK.

On a year-over-year basis, international sales increased over 25 percent, and new orders for the quarter grew almost 22 percent. They did have a little help again from favorable exchange rates, but even when you adjust for that, our international sales for the quarter still increased almost 20 percent from the prior year.

By country we saw growth just about across the board with significant improvements in Canada, Mexico, and our Asia export regions. It continues to be a great story, but as we said last quarter, their comparables start to get a lot more difficult now. As a result, our forecast for the fourth quarter again includes a slightly lighter mix of international revenue and a lower profit contribution from our international entities.

Now let's talk about gross margin. Its another area where we continue to demonstrate great year-over-year improvement. In fact, 2 full points of improvement. The bad news is that we are still seeing the significant year-over-year cost increases in many raw materials as we expected. That caused some pretty big unfavorable variances year-to-year. But we got incredible leverage from the additional volume, and we also saw significant benefit from the list price increase that we put into effect in August. And in the end, we were able to improve our gross margins to 32.1 percent versus 30.1 percent in the prior year. This is down from the 32.6 percent we achieved last quarter, primarily due to slightly deeper discounts, higher commodity prices in plastics and steel and a mix shift to a higher proportion of systems products.

On a positive note, this quarter we saw a larger than expected favorable impact from the price increase that we implemented in August. As I talked about on our last call, we saw a small impact in the Q2 results of approximately $1 to $2 million. But this quarter the impact was closer to 4 to 5 million and played a bigger role in offsetting the material cost increases we have been battling. It is still not offsetting all the material cost increases, but it is definitely a big help.

However, increased discounting reduced the positive impact of the price increase. Higher domestic discounting in the third quarter as compared to a year ago reduced our margin by approximately $2 million or .4 percent of net sales. As compared to the prior quarter, discounting also had an unfavorable impact and reduced our domestic margin by approximately $400,000.

Material costs for the quarter totaled 39.9 percent of sales, the same percentage as last quarter, but significantly more than the prior year's 38.8 percent. Certainly the discounting I mentioned earlier had an unfavorable impact on the material percentage, but again this quarter the biggest driver was raw material cost increases.

It still continues to be the biggest factor and amounted to a 5.3 million increase in year-over-year cost. This also up from last quarter by about 300,000, although we do believe it will level off in the fourth quarter.

We continue to see increases in plastic cost this quarter, also. Not merely as significant as the steel impacts, but they are definitely having an unfavorable effect on margins and are expected to increase next quarter.

Our direct labor costs were another highlight this quarter at 4.4 percent of sales compared to 5.2 percent in the prior year's same quarter. The year-over-year reduction is primarily the result of the efficiencies from the Canton, Georgia facility consolidation, and again the continuing efforts of the HMPS initiatives across all of Herman Miller are having a favorable impact on both our labor metrics and our material costs.

Overhead spending for the quarter as a percentage of sales is down substantially from 20 percent last year to 18.2 percent this year, reflecting the leverage from the incremental volume and also cost reductions from the Canton consolidation. Dollars of overhead spending for the quarter increased by 3.5 million over the prior year, primarily as a result of increased incentive accruals and volume-related production supply costs.

Last year in the third quarter we accrued an EVA-based incentive at approximately 50 percent of our full rate, and this year we are still on track to pay a full bonus.

On a sequential basis, overhead spending for the quarter as a percentage of sales was up slightly from the 17.7 percent recorded last quarter, due primarily to a shift in product mix to a higher proportion of systems products as compared to seating products in the prior quarter. In addition, we had a slightly higher rate of incentive accruals recorded in this quarter as compared to the second quarter.

Our freight out and product distribution costs are another bright spot again this quarter. Even in the face of increasing oil costs, we were able to reduce our cost as a percentage of sales. Combined freight and distribution amounted to 5.4 percent of sales for the quarter as compared to 5.8 percent of sales for the same period last year. They even decreased slightly from the 5.5 percent we saw last quarter.

The reductions are primarily due to the continued efficiencies resulting from the implementation of the Herman Miller Production System and our physical distribution operations. Our efforts here have had a significant impact in offsetting increased fuel costs as diesel prices have spiked up over the last few quarters.

Moving on now to operating expenses. For the quarter, operating expenses totaled 93.7 million or 24.5 percent of sales as compared to 84.8 million or 25.7 percent of sales last year. The current year includes approximately 1.6 million associated with dealer financial statement consolidations that were not included in the prior year.

We had another 2.5 million year-to-year increase in operating expenses due to incentive accruals. As I mentioned earlier, last year we were accruing at 50 percent incentive and this year at 100 percent. The prior year operating expenses also benefited from an incremental 1.4 million reduction in bad debt reserves. The remainder of the increase was due to increases in variable selling costs associated with the higher volume.

Restructuring charges for the quarter totaled about 300,000 versus 1.1 million in the prior year and were associated with the relocation of the Canton operation. There will continue to be a modest amount of restructuring charges in the next quarter as some of the final Canton costs are incurred.

Operating income at 7.6 percent is the highest we have seen in 15 quarters when we were generating significantly more volume.

Moving on down the income statement, other expenses for the quarter, net of interest income, totaled 2.7 million compared to 3.3 million last year. Interest expense was up approximately 200,000 due to increased interest rates. Fluctuations in foreign exchange rates on our nonfunctional currency balances caused a foreign currency loss of approximately 200,000 for the quarter as compared to a loss of 1 million in the prior year.

Our effective tax rate was 35.4 percent for the quarter and 34 percent year-to-date. This is higher than last year's same quarter rate of 22.9 percent and last year's 32.5 percent year-to-date. The prior year third-quarter tax rate included favorable adjustments for increased tax credits for 2003 and 2004 and a reconciliation of booked to tax differences resulting from the filing of the federal tax return last February. We anticipate our effective tax rate for the full year to be approximately 34 to 35 percent. When you roll this all up, net income for the quarter was 16.8 million or 24 cents per share. That is more than double the amount of last year's 11 cents of EPS, and it is above the top of the range we provided at the beginning of the quarter.

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

Thanks, Beth. Operating cash flow is another great story and amounted to over $40 million this quarter. It's a significant improvement over last year for this period when we generated approximately 7 million, although last year's cash flow from operations did include a $26 million voluntary contribution the Company's employee pension fund.

Going through the components, depreciation and amortization for the quarter was 11.6 million. In addition, our net change in working capital for the quarter amounted to a source of funds of approximately 13 million due primarily to decreases in inventory and increases in accruals. Our collections of A/R continue to remain strong, and the A/R balances over 90 days have improved from the prior quarter due to collections in state, local and federal government receivables.

Our DSO and net inventory and receivables decreased by 1.5 days from the same quarter in the prior year to the 52.1 days. Capital expenditures for the quarter were $10 million. This is up from the prior year's 4.6 million due to investments in our West Michigan Experience Center, our Washington D.C. National Design Center, tooling for our new products that are to be released this summer, and some IT investments. We anticipate capital expenditures for the full year to remain low and approximate 30 to 35 million.

Moving on to liquidity and cash position, our profitability and positive cash flow combined with 137.2 million available on our revolver and our 164.2 million cash balance continue to provide us with a tremendous level of financial flexibility.

We continue this quarter with an increased level of share repurchase activity. During the quarter, we bought approximately 859,000 shares for $23 million at an average price of $26.40 per share.

As you may recall, we started the quarter with only 22 million remaining on our existing border authorization. We did receive an additional board authorization for another $100 million at the end of the quarter at the scheduled January board meeting. We now have about 99 million in share repurchase authorization available.

As discussed in prior calls, we currently have listed for sale our Canton, Georgia building that we exited last year. We do have an interested buyer, but do not have a formal agreement at this time.

As a final note, many of you are probably aware of the recent SEC clarification related to leasee accounting for operating leases. Issues included within this clarification include the treatment of tenant improvements, landlord incentives and rent abatement terms. This clarification has prompted some companies to reevaluate their accounting for operating leases and has resulted in some restatements. In the case of Herman Miller, based on our analysis, the impact of this clarification was not material.

Thanks, Joe. Let's turn to the outlook for the fourth quarter of fiscal '05. As I mentioned earlier, our backlog is down from last quarter, and the traditional seasonal slowdown in orders has driven our order rates a little lower on a sequential basis. But we're still very optimistic based on the order rates in the last several weeks. We definitely expect to continue to see growth over the prior year, but just not at the percentage level we saw last quarter.

As a result, we expect our fourth-quarter sales to be in a range of 380 million to 400 million, which represents growth of 7 to 13 percent over the prior year.

Now let me explain that guidance in a little more detail. We started this quarter with a beginning backlog of 215 million. Included in that amount are large orders of approximately $9 million that will not ship until sometime after the fourth quarter. This brings the backlog available to ship to about $206 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 29 to 32 million per week. This leads to our guidance of 380 to 400 million.

Now let me talk a little more about our earnings guidance. We expect earnings per share between 23 and 28 cents. 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 continued benefits of the implementation of the Herman Miller Production System. We will again be favorably impacted by the price increase.

On the other hand, we expect to see the continued impact of raw material cost increases both in steel and now plastics. So we anticipate gross margins to still be in the range of 32 to 33 percent. We also anticipate seeing a higher level of operating expenses than in the prior quarters as is traditional in our fourth quarter.

We have several new product launches that are planned for this year, in addition to the annual trade show in Chicago called NeoCon, all of which increases our spending this time of year. We also will not have the benefit of the $7 million favorable tax adjustment that helped us last year. So our year-to-year comparables will be more difficult. But in total it will be another solid quarter with continued growth.

In summary, we again met and actually exceeded 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, our highest level of sales growth in quite sometime. Our gross margins have again demonstrated the benefits of both our cost reduction activities and the price increase. Our cash balance continues to be strong even with a significant year-over-year increase in our share repurchase activity.

Lastly, as Brian mentioned, the macroeconomic drivers of our industry are clearly indicating reasons for increased optimism and continued growth.

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

(OPERATOR INSTRUCTIONS). Susan McClary (ph), UBS.

Can you talk a little bit about the contribution margin during the quarter, where that stood relative to your guidance?

Do you mean from a gross margin perspective or the operating expense portion of it?

From both actually.

I think she is talking, Joe, about the building to leverage sales into the operating income line. Is that it?

Exactly.

I think the guidance we have given in the past is that for every increased dollar of sales, we expect to drop 15 to 20 cents to the bottom line. In this quarter, we were in that range. I think we are at about 16 percent.

So the guidance that we had given on the leverage in the past was given even before we knew about the steel increases. So we have been pretty pleased that we are still able to be within that range, despite absorbing the increased steel costs. And in the future, if you start to look at that leverage from an EPS perspective, it is even greater as we start to use some of that cash to more aggressively repurchase the shares.

Okay. So we could see that perhaps come up a bit then go forward?

From an EPS perspective.

Okay. And what about given the success of the price increases that you have already seen, do you expect that that will be an even greater contribution going forward?

This is Brian. I don't know that it will be a greater contribution going forward on the current price increase. We are actually quite pleased with the level we are capturing. If you will listen to all of Beth's analysis of that in her prepared comments, we are capturing around 50 percent this past quarter.

We actually thought going into the price increase, if we could capture between 1/3 and 1/2, that would be actually pretty good. So I don't know if we expect that number to improve as we get into the fourth quarter. Of course, the question that we are ourselves is what do we do from here because while we think raw material prices have stabilized at least in the case of steel, we still are continuing to be faced with other input cost increases like health care and those kind of things that tend to go up on an annual basis as we all know from watching the popular press. Those things are moving up very quickly.

So we are still in the process of asking ourselves when should we consider another price increase. Some of our competitors have already indicated they are going to do another one. I think the fact that we have seen this one stick at least to some degree gives us some belief that as we get into next year, there might be room for considering more price increases.

Okay. So that is something that we could see coming up later in your fiscal '06?

Yes.

Budd Bugatch, Raymond James.

Just a couple of questions. One, can you talk a little bit about the competitive landscape and what you're seeing out there in terms of what you have to do to win the business? And by the way, thank you very much for that delineation between project business and regular business.

You are welcome. On the competitive landscape, I don't think it is any -- this is Brian -- it is no less or no more competitive than I think it has been in the last bit. Certainly I think the good news is that you start to see project activity coming up. And the fact that we are gaining some of the price increase at least to the level that we have gives you some believe that at least the level of demand is out there, that it is not quite as intense as it was. But I would say there is not a project that goes by that you don't see the usual suspects showing up and in there competing hard.

What I think we have seen is not only the level of our kind of base customers coming back to us, new project activity, as Beth mentioned, at a little bit larger size. As well we have seen the systems business come back, which, of course, in our mind is one of the keys to your long-term customer retention because that tends to be where the installed base comes from.

And I think from a discounting perspective, when you look at the number on a year-over-year basis, it is more significant. Actually it was 2 million year-over-year for the quarter, but on a sequential basis, it was only up about 400,000. So even though the price increase had taken much more -- you know affected us a lot more on the top line, sequentially discounting did not go up a whole lot.

Okay. Secondary, I am just questioning -- congratulations on the 7.6 percent operating margin, but it certainly is well below the high watermark of several years ago. When do you foresee, if ever, getting back to those levels? What does it take other than just -- I know volume would be expended -- but at what level of volume do you think that would be?

Well, if you go back to some of the stuff that we have kind of talked about publicly and internally, quite frankly, around our long-term strategic plan, when we look out -- we laid it out as our 2010 goals, which, of course, is around five years from the end of this fiscal year. We have planned for or built into our goal of getting back to an 11 percent operating margin, and I think that is going to take a combination of things.

It is going to take continued improvement in efficiencies both manufacturing and operating expense by the way. It is also going to take, as you can imagine, a sustained level of sales growth.

Now what that means to me, we not only have to be able to grow faster than the industry, because I don't believe the industry will be able to necessarily grow at the same very high-level that we're forecasting through this next calendar year, which is around 8 percent. Next year we can grow at a premium to that and be at double-digits. But then from then on, we have to find new markets or new areas for us to grow and to be able to continue at that kind of double-digit growth rate. If you combine that with our continued focus on efficiencies through the work of the Herman Miller Production System and by the way taking that work beyond manufacturing, not only in terms of our own internal processes around things like physical distribution, in the office, but also how we connect with distribution. And I actually think that is the next big area of significant kind of fruit out there for us to go get is how do we eliminate waste between us and the dealers.

That does not mean that today it is not work that has to be done, but we have to find a way to take the duplicated efforts out the same way we have done it within our own manufacturing. We have begun some of that work, and we can see some real promise there.

And I think in addition to the new markets that Brian mentioned around the top line, one of the keys will be the innovation in both our current markets and in markets that are adjacent to the office furniture. So we won't be limited just by the growth on the traditional industry metrics.

And you gave us an 11 percent goal for 2010. I am thinking that is May of 2010. Do you want to put a number of sales on that other than double-digit? How long for double-digit sales growth?

We picked -- the goal that we have for 2010, Budd, is 2.6 billion.

2.6 billion. Do you want to give us any interim goals?

Well, what we did is really to get to that you got to grow at essentially double-digit every year for the next five years, and this year we are on track to do that it looks like. We're pretty confident with what we see with industry numbers next year that we can continue along that path.

My last area of inquiry is, if I do my math right, it looks to me like at least stretching out this quarter on what you have done is you are returning to shareholders something on the order of $120 million a year through share repurchases and the increased dividend (inaudible) for an annualized basis. This year you will earn somewhere in the $65 million net income range.

What is the game plan going forward? How long do you continue to return that kind of cash to shareholders? You -- essentially it looks like your matching or close to matching a depreciation with CapEx or maybe a little bit less CapEx than depreciation.

What is the game plan, Brian? How do you think about it?

The work that we did around our capital structure last year, the conclusions that we came to with the board was that we have no longer needed to keep the excess cash on our balance sheet. So we are actively repurchasing shares in order to reduce the level of cash, and the board settled on an amount of about $60 million that they said they would be comfortable with us having in terms of cash on the balance sheet.

So our goal is for the next couple of years to aggressively reduce that balance. And then we get to a more normalized level going forward.

Budd, I think the good news about our business model is, as you know from watching us for a long time, we do generate a tremendous amount of cash. And I think we will continue to have free cash flow, even once we have worked through the excess, that is probably at least equal to if not greater than our earnings.

I think the question is going to be, do we find a strategic investment out there that we have to do or they could help us get towards that ultimate goal of 2.6 billion. So barring that, I think we will continue to run for sure, as Beth said, fairly strongly at least the next 12 months in terms of that kind of cash return between share repurchases and dividends given the amount of cash that we had. Then it will moderate a bit, but I think it will continue to be more than just a dividend rate assuming we don't find some major investment to go after.

We have in our capital structure tenants a metric that says we will return a minimum of 20 percent of our EBITDA on a trailing three-year basis to our shareholders. That is a metric we always look at to make sure that we are at least exceeding that number.

Todd Schwartzman, Sidoti & Co.

I think you mentioned that client visits are up more than 30 percent in the quarter. Is that correct?

That is correct.

How long does it take typically for a client visit to translate into a sale both for an existing client, and also if you could talk about for a new account?

It varies tremendously. Most of the client visits are related to large projects. So they would have a longer leadtime than the day to day type business. And oftentimes the people who are coming in are CEOs, facility managers and people who are just starting to think about a new facility. So in those cases it could be a year or two of down the road before you actually would even see an order.

I would guess, Todd, and this is a gut feel. I don't have -- this is nothing we have got an exact science around. I would guess on average, as Beth said, you are taking on big projects, you're probably talking at least six months to a year for most of the visits in that they are people making major capital decisions, and they are generally not only making a decision about a major project, they are probably making a major vendor decision.

So these intend to be people that are making a strategic visit to us as much as they are making just a decision to come in and look at a chair and buy one. That is not the people typically we get when they are coming back to West Michigan, and they are investing a fair amount of time and energy.

And that 30 percent growth, is that the largest increase in two years or longer, or how does that stack up historically?

Let me look a minute. I don't have the percentage, but when I look at the actual numbers, it looks like it is probably about the biggest increase we have seen. Between the third and fourth quarter of last year, we had a pretty significant increase also.

It's sort of stacked up, Todd. The industry generally always lags at the economy turning around, and if you think that we are just really started to see those visits pickup last year you know late in the spring, early in the summer and now you're starting to see that trend continue and turn into real orders, it makes sense with this timelag of six months that we talked about a minute ago as well.

Okay. Regarding potential market share gains, last quarter Q2, Brian, you said that if you are gaining share anywhere, it is in seating, and that on the international side you thought that your share of the desk market was growing. I wonder if you could just update us a little bit on any more recent share gains.

Well, first of all, there is really no reliable data that you can look at on a quarter-to-quarter, month-to-month basis and be able to make predictions about by product line. You've really got to take that as a more overall longer horizon.

I think my comment was related to over the last few years we know we gained share in seating, in international in particular because the business is growing more rapidly than the overall market. We really have not had a very good offer in the past in the area of desking. We believe that is what has given us -- about international problem, I have very little data when you go market to market. The U.S. is way more sophisticated in that regard.

I think in the more recent periods we don't have data to talk about it by product line at all. Our look at the data so far at least from where we were last quarter to today we would say we are holding our own at worst. We have not seen the numbers for February for the industry yet, so we don't know. For the first couple of months of the quarter, we were pretty consistent with the industry so far.

Great. Thanks.

Matt McCall, BB&T Capital Markets.

First, Beth, I think you in your assumptions to get to the guidance you said that you're going to assume shipments of 29 to 32 million. Is that right?

The order entry and shipments for the six to eight week period that we have available to order and ship, so the backlog plus that number, yes.

Okay, okay. Well, I was looking back, and it did not look like shipments have ever reached that level from what I can calculate. Normally I think you said you know we had 26, 27 shipments even though orders may be higher. Is there anything I should take from that, or is it just better volume?

Well, the increased trend that we have seen in the last few weeks, plus coming out of the traditional holiday slowdown, we tend to always see an increase between the orders in the third and fourth quarter.

Okay. Okay. You were talking about international. Can you talk about the sources of strength? You mentioned a couple of countries. Can you break it down where the strength came from? It may be from a geographic basis. Are you getting some big customer wins, and can you break down the growth there a little bit?

Sure. We mentioned Canada, Mexico. We also have the Asia export, which was strong. And then again this quarter we had expected to see a sort of significant decline in the UK simply because we had finished some large customer projects. In fact, the UK surprised us this quarter because they had a significant percentage of the business ended up being this quick turnaround sort of day to day business. And in addition, project business in the UK came back quite strong. We had some significant wins during the quarter that we had not anticipated. So I would say the UK, Asia export, Canada and Mexico will be the key areas.

In fact, if you look at the percentage increase, Canada had a very big year-over-year percentage increase just for the quarter, which a lot of times, remember when we are looking at fairly small numbers at a base, sure it's very very project dependent. So you're going to see (multiple speakers) yes, you can see any particular customer project turn any particular geography in and of itself pretty great from period to period.

That is also the case in Mexico. They should have had a great quarter in percentage growth, as well, too. I think they are up in the 80 percent, and it is several really big project wins that helped them a lot, came together in the quarter for Mexico.

But I think the kind of macro thing that is happening is ARC seating products, which not only play in the U.S., seating is one of the few product categories that plays great across geographic orders. Our seating lineup, particularly with Aeron and Mira, has enabled us to reach out to distribution that I think in pastimes we were not able to get to.

The great thing about seating is it has a much less need in terms of service and sophistication at the dealer level. We are able to get to a lot of those projects in a much easier fashion on an export basis, if you will, to places that we don't have a lot of production capacity. So that is one big factor.

The second thing is, we have a European desking system which has been very successful. And in the past, we did not really have a good offering there. And when you look at that European desking offer, it is not only important in Europe, practically for us in the UK, it is also important in some of the Asian countries where you will see sort of a mix of influence between U.S. and European design. So having those two things combined is what has really giving us more strength from an international perspective.

Okay. All right. Thank you. That was very good. Let's see. Uses of cash, you talked about continuing to buy back shares. It looks like the pace slowed a little bit in Q3. I know the stock price was up. Was there any impact there, or is it just -- (multiple speakers)? Go ahead.

There was a combination of the board authorizations starting to run out and waiting for our board meeting to kick it back up. And then when we put the (inaudible) during our blackout period, I think we are a little conservative in the ranges that we put in there for the program guys.

So not a significant decrease. It simply was a couple of factors combined together.

Right. So going forward, should we look more at the Q2 and Q1 levels as a guide?

Somewhere in that range.

Okay. You mentioned the new sound management technology. Can you put any numbers behind the opportunity that you see there?

We won't put numbers behind it. This is basically a start-up venture from scratch, and we don't give information sort of by business unit or product line, and we don't expect it to have a material impact. Because the real benefit is the value that it shows to our customers in terms of innovation and the potential for some great new markets for us.

I think the other thing with this product is it is somewhat difficult to even predict market size because we are creating technology that is in a space that does not exist today. Most people are today in the sound business are either dealing with aesthetics, things like MUSACT, things that help you with enjoying the sound around you, and/or with being disturbed by sound or masking, white noise, pink noise.

This is actually getting at privacy. How do I keep -- or confidentiality? How do I keep my conversation, my interactions from being overheard by someone else? So think of what is going on in terms of the HIPAA law and those kinds of things. So either we believe a very new space that yet know one else has tackled and we have a fair amount of what we think is very encouraging IP in that area, as well as we have been able to recruit a gentlemen who was with Motorola for a number of years, has worked in the RF ID business, who we think has some keen insights how to take what was in technology we had already developed with some other partners, and we have seen some pretty encouraging signs from early use tests.

Now this will continue to be a very, very small part of our business from a revenue standpoint, you know, in kind of the short to mid-term basis. But we think it is a beginning of not only getting that technology out there, but then asking ourselves what other technology, and we have some other IP in these areas or adjacent areas, to enable us to build an actual business around this.

It is a core problem as many people know in open plan systems environment today. It's one of the big complaints you here, for instance, from HR folks or legal people. How do I deal with confidentiality of information? It's also an area that is certainly gaining ground in areas like health care with HIPAA laws, as well as you can imagine it even in your business or in conversations around things like mergers and acquisitions, and all the things where the level of confidentiality is important, and people are trying to figure out how to deal with that.

All right. Just a couple more. You mentioned the year-over-year impact of steel. Can you quantify the year-over-year impact from plastics and some of the other raw materials that are rising?

Plastics, I know sequential was I think about $200,000.

But on a year-to-year basis, it is almost about $600,000 more than what it was in the prior year. Last quarter it was about $400,000 that we talked about, and this quarter it was around a $600,000 increase quarter to quarter. That has been the biggest kind of change in the percentage increase in cost, the plastics piece driven by obviously the oil and natural gas cost.

Right. Right. And then, too, I missed the materials and direct labor as a percent of sales.

Material was 30 --

It was content with last quarter, 39.9 percent. And the labor costs I think was constant as well, too.

I think it was 5.4. Direct labor, direct labor costs were 4.4 percent compared to 5.2 percent last year.

Okay. Great. Well, congratulations on a great quarter. Thanks, guys.

Virginia Genereux, Merrill Lynch.

Maybe first, Brian and Beth and Joe, can you reconcile for me the sequential decline in the backlog with your, with I think, Beth, your comments about I want to say larger orders, larger orders picking up? Your backlog has accelerated sequentially for sort of the past four quarters, and then it was down 40 million. Maybe that is just a point in time.

The explanation really revolves around the seasonality of our business. Historically our third-quarter shipments are usually down anywhere from 3 to 15 percent because of the holidays. This time sequentially they were up, and that was because we started with a high backlog, and we had some positive surprises and we increased business. The order rates during the quarter are always lower.

The fourth quarter is the hardest for us to predict from a revenue standpoint because so much is dependent on the first six weeks of the quarter where we take orders in and ship them out. And it's always a different level of order entry than you have over the holidays, so you don't know how much of the pickup you can anticipate.

So our positive feeling is that the first two weeks of the month since the quarter end, orders were actually 33 million and 31 million, so much higher than the average rate during the second quarter.

Now, can we predict that it is going to stay at that level for the next four weeks? You would be a little nervous predicting that. However, we are comfortable that we can predict that is going to be higher than the average order rate during the second quarter or during the third quarter.

I don't have the data in front of me, but I think it is not an unusual trend for us even in other years of good growth like we have had this year to actually see the backlog decrease a bit from second quarter to third quarter because of the fact that you do get order entry. Order entry tends to be very brisk in November and sometimes in the first week or so of December, then it falls off. And what you do is you see a lot of folks come back from their vacations and product starts to ship in that kind of late January, early February time, and the backlog tends to kind of moderate during that period. Then you rebuild a lot into the fourth quarter.

So I don't know that that is an unusual thing to see from past experience. It is unusual actually to see shipments behave the way they did this year from second to third where you did not see the decrease.

The other thing to keep in mind, which I think Beth mentioned in her prepared comments was, we did have a fair amount of business that actually we had shipped, but we were not able to recognize their revenue in the second quarter. So it was in the backlog still. But the products have actually been to the customer, but because of their revenue recognition, especially with government contracts, does not happen until the product is actually installed and signed off by the users. We call it delayed invoicing. Some of that really impacted coming out of the backlog and into shipments this quarter.

Yet that was 5 million? Beth, what was --?

It was about 6 million I think, the decrease in our deferred billings to the government.

Okay, that is helpful. There was a sequential decrease last year, but it was less? (multiple speakers).

(multiple speakers) -- about 20 (ph) million I think sequentially last year and about 28 million two years ago.

Percentage-wise?

Right.

Okay. Let me ask you on the FIN 46 orders, can you tell us first how much -- that was I think 12 million of your backlog in November. Can you tell us how much of the backlog was sort of FIN 46 consolidation totals to sales?

I think in backlog it's about 5 million. I know year-to-date orders from the FIN 46 are about 10 million.

Okay. Thank you. Let me ask you, as you look into next year, you've gotten probably a point or so of growth of sort of sales growth from FIN 46. What happens next year? Is this just sort of -- because this was the first year of that, you get a percent, and then it's an ongoing thing? Or --?

A couple of things are happening with that one. First of all, we have now recouped all of the losses we had recorded related to that dealer. So going forward we can no longer report any income from the consolidation of this dealer. So that gets back down into the minority interest line. And you'll see that that popped up on our balance sheet I think for the first time.

However, this dealer is profitable and is quite strong, and we're working with them right now to try and get them an outside banking relationship. So our hope is that they will be moved off our balance sheet and our income statement sometime next year, hopefully around the beginning of the year.

So you could -- that --?

We will be giving up both sales.

Okay. And is that likely to be replaced by somebody else? How should we think about that?

No, we tend to have dealer transitions periodically. If someone is either in trouble or if there is a generational transfer or a dealer who has below average market share and we want to go in and try to turn them around, we own a few dealers. We don't anticipate significant changes in that. We are working with a few of the dealers right now to help them buy the businesses from us. So you will see transitions periodically.

Each year you will see usually one or two dealers move in or move out. We are in the process of selling another one right now that hopefully will close in the fourth quarter.

Okay. But if based on your expectations currently, you think that you won't have those sales -- those sales won't be in the numbers next year? They won't be consolidated (multiple speakers)

Yes.

Okay. If you guys could also elaborate a little bit on your price increase commentary, right, the 4 to 5, but also slightly greater discounts, then although moderating certainly, but still sequentially greater year-over-year. On the discount side, is that because -- is that due to more systems business, or could you just talk a little bit more about that?

It is not necessarily related to a particular product line. I think what you see is -- I mean we talked about this as we were preparing for the call. Really you almost can think about this is we had a net $2 million price increase. (technical difficulty)-- meaning we did forward -- some of it gets pulled out from increased discounting. And what happens essentially is we have some customers that you are still in there working on large projects with, that, in fact, you might maintain the prices that we had struck before the price increase for them to actually win the business.

You always get this kind of trade-off in between -- our initial goal was to try to get you know between 50 and 30 percent of the price increase to stick. I think so far we are pretty comfortable that is happening. And, in fact, discounting has been a little bit less this year than we originally thought it might be. (technical difficulty)--

Even -- one thing about our industry is that traditionally our industry every year has increased discounting. Even in good times when business is strong, you tend to see year-over-year increases in discounting. It is just an expectation, I think similar probably to the auto industry.

Okay. That is helpful. So should we expect that to sort of continue to moderate? You all were, if you disclose in your full year which is helpful, sales impacted by discounting, we are sort of running -- ran 18 million the past two fiscal years. I guess --

I think if you look back to the period, you know the last time we had reasonable growth, we actually saw discounting increases really moderate a lot. I think our hope is that if we continue to see that kind of level of activity in the industry, then, in fact, it will at least moderate to its level of increase being more like we saw this past quarter.

Of course, that is really difficult to predict, and it will jump around depending on what is the mix of those large projects, which is where often you see that discounting really get heavier and what your mix of government business.

So you have to really kind of look at it over a longer horizon. But I would say right now we are seeing some of that moderate. It is a bit more moderation than, quite frankly, we had thought would happen. So you know the best way to describe it right now is we are cautiously optimistic.

And there are a lot of variables. Another one is the type of products we have. And if we are able to -- if the product we came out with last year with Mira was a lower-priced product, our goal this year was our new chair offering in another -- is to set a new reference point at even lower price than the Mira chair. Those products if they hit (technical difficulty)-- the customer at a lower-priced point won't be discounted as much either.

Okay. Interesting. That is helpful. Then on the raw materials outlook, how much -- what is your outlook there, and how much visibility do you have? If you're running now 5 and change on steel price impact and, Joe, as you said 600 I think on plastics, you are seeing sort of a 6 million impact on raw materials. It sounds like it will be of that magnitude in May. As you look out, how does that moderate?

Steel -- what we have been seeing and hearing is that it is moderating, and hopefully prices are starting to come down a little bit. I think it is probably anyone's guess what happens on the fuel cost and then how that ultimately impacts plastics.

So we stay as close to it as we can, and we make choices around the length of contracts that we locked into based on our sort of best guess at where those prices are heading. And we chose, when steel prices started to pick up and we had large contracts expiring, we chose to wait it out and to do a lot of shorter term contracts because we did not want to lock in for anything beyond a three to six-month period at that point.

The other piece I would add is that we continue to do a lot of work recently with our suppliers on the whole lean manufacturing initiative, the whole what we define as first mile working with the vendors and our suppliers on some of the Herman Miller Production System concepts that we have done, trying to work with our suppliers on how to improve efficiencies in their process as well, too.

So, Joe, how should I -- if I look out into fiscal '06, can you tell me what you think the negative year-over-year impact will be, or can you at least tell me if I have got steel spot rates, your leadtime was what in terms of months?

I think on a year-over-year basis, if you look at how the steel impacted us (technical difficulty)-- the order last year and then assume that we are now at this sort of $5 to $6 million run-rate and an increase that got sort of feathered in during the year, you have to look at each quarter to see at what point it started to hit us last year. So you have a little bit less in the numbers last year, so you are differential would be higher the first part of the year, and then it would level off and be more level year-over-year during the second half of next year.

Yes. I think the net of it is -- and I think what you are hearing as well -- we need to go back and take a look at that when it is --. Ultimately we expect that the current run-rate on material is not going to vary greatly next year.

So whenever we are running night now -- forget about year-over-year increases -- whatever we are net paying today for steel and with some concern to plastics might rise a little bit, we are not necessarily expecting steel to drop-off. We are simply saying we think it is going to moderate and at least stop this steep decline.

If it is all lost, because we tried to be fairly nimble around our contracts, our ability to access those lower prices should be fairly fast. I say fairly fast. It is probably a six-month horizon because remember we are sort of last to get to spot prices in some ways because we are not that big of an industry in terms of buying steel compared to, say, the automotive guys and some of them.

I don't know that we will see it immediately, but I think the net of it from a sort of planning process for us right now is we are not expecting a major change one way or the other from where we are at today with maybe the exception being what happens with this current issue around fuel prices and their impact on plastics.

Okay. Thanks. That is helpful, Brian. And then lastly (technical difficulty)-- to go on, to take the other side, why would weekly -- if you look at your international business and the things that you discussed there, the growth and sort of the maybe secular drivers of that, and your weekly order rates of sort of 32 million or so -- I know we are only a couple of weeks into the quarter -- why would those drop? Is there a seasonality dynamic, or why would they drop?

Well, there is always weekly volatility. And we can -- our weekly order rates can vary in the $5 to $7 million a week at given points during the quarter. You know if a full large project is injured one week, it could have a $3 million impact versus the next week. And the international business is very project-oriented. So they will have much more volatility in their numbers.

Normally when we look at this, we are going to ask herself what is the eight-week or the 13-week run-rate, and we begin to watch what the longer-term trend is. What I think you hear when we talk about the first two weeks, it is a two-week sample. It is hard to draw a conclusion just from that. Now if you combine those two weeks with the four (technical difficulty)-- week of February, you begin to see a trendline that looks closer to what Beth was using in her a), if I multiply 27 or 29 million a week, whatever it was times this number of weeks, that is how I get to the forecast. So that is why you hear us using a longer horizon for that and not just picking that point estimate of a one-week trend. Because it does bounce around.

I mean there is a lot more volatility in it. We were fortunate, quite frankly. We had two weeks in a row that were actually fairly similar to one another. That is not a normal pattern.

And our history the last few years at least has been that February orders are low. March jumps up quite a bit, and then April tends to go down a little bit from the March levels. We are not sure if that is because of the normal spring vacations that people tend to take in that month, but at a monthly basis, there is sort of a trend that April tends to be lower than March levels.

Thank you. And you said February, Beth, ran what, I'm sorry?

Let me see if I specifically said February. I think I did. 26.

Tucker Anderson, Cumberland Associates.

Let me just follow --

27 in February.

Tucker, your line is open. Please go ahead.

Two questions. One very specific and then a general question. The specific question is, as you approach your fiscal year-end, is there any thought of re-examining your current assumptions with regard to your pension plan as a lot of people are doing, and finding that even though the markets have gotten better, they are lowering their assumed rate of returns, things like that that might cause additional contributions to the pension plan?

We do have an expectation that our pension expense is increasing because we've made some significant contributions the last few years that have kept our expense at a lower-level. Our current return assumption based on our asset allocation mix is an 8.5 percent return. We're looking at that currently and waiting for some information back from our actuaries and other market data to see if that is still seems appropriate.

And if it wasn't, I just want to make sure I understand that would you would do is then change a period expense as opposed to deciding to make another significant onetime contribution?

A lot of it will depend on where our underfunded status ends up at the end of the year. We currently think we are getting closer to that fully funded figure, so the flexibility we have we really don't want to be in an overfunded position.

Okay. Thanks. The general question is simply to a follow-up a little on Brian's discussion with Budd and looking at sort of cash generation capabilities of the Company and the cash needs on a longer-term basis, not focusing on the shorter term.

And I guess the other part of the puzzle is, how you view going forward sort of the cash intensity of your business? As your mix changes, as you continue to make these fiscal improvements and things like that, you have made a lot of progress especially on the working capital line, and that is part of it. It is also, you know, the longer-term investments. And do you continue to see yourself sort of as continuing to be able to increase what we could call, you know, the cash turnover of the business and become less cash intensive over time?

I think in general we feel that we have sort of fundamentally changed our business model. You saw some years of capital spending that were in the $100 million range. We believe we can now operator our business at much lower levels. There will be periods where we will need additional investments for various things. We think we will end this year at about a 30 to 35 million in CapEx. You will see that tick up next year probably, $10 to $20 million more.

But averaging around that $45 to $60 million a year in CapEx at least for the foreseeable future, we think we will be able to fund our strategy at those kinds of doubles.

Yes, Tucker, I should mention a little bit about why Beth is talking about going up. We just have a few -- particularly we have one facility in international we have had 20-some years on a lease basis, that that facility is -- we are at the end of the lease. So we are going to have to do something with the people. We just -- we cannot stay in the current building. That is one of the things you see next year for a tick-up.

We also have a very heavy new product introduction schedule over the next 12 to 18 months, and that, of course, generates capital in the form of tooling.

I think maybe to answer to your broader question in another way, the ability for us to have cash turnover in the business we think will continue to increase. We are continuing to see more and more efficiencies on how we push things through manufacturing and through our physical distribution and through the dealers. So I think the ability for us to get that kind of turnover in the working capital, we still think there is room to go there, although we have made great improvements.

On the other side of that, the other factor that has traditionally been a big capital thing for us as a business has been because we were not spending the product through the facility this fast, it also got into do we need more manufacturing square footage.

Right now we are very confident that our Herman Miller Production System work will enable us to continue to grow the business and do it within the current facilities. We are converting some space that today is utilized for activities like physical distribution.

We think that space often longer-term will probably be used for manufacturing space instead, which will give us more capacity. So I think we believe the mix of that turnover in the cash continued to be not only as intensive as it has been, but in fact we can continue to see some improvement in that.

Yes, I understand there will be the year-to-year fluctuations, and I wouldn't be surprised if you know you could eliminate those (inaudible). But it does seem to me if one sort of abstracts and generalizes that you guys are sort of a leading-edge of what is going on in general in industry, and that is that IP and IT are becoming more important, and for a whole bunch of reasons, that means that we should continue to see (technical difficulty)--.

The one thing that I did not know is as you sort of conceptualize where your business is going to be 10 years from now and how the mix might change and things like that, if that would accelerate some of these trends or if it might offset some of the trends?

I think barring a large significant acquisition of some kind, we think that the other things that we are headed towards actually if anything take us further in that direction of being less asset intensive, if you will.

I think the work we're doing around (inaudible) management is just an example, although very small. It is not going to be an asset intensive business. It is going to be intellectual property intensive as you mentioned.

I think we do see that happening, but I would also say if you just look at our core business, while we have never been very asset intensive anyway, I think there the folks around the Herman Miller Production System are just continuing to find new levels of our ability to push or as they would say pull product through, and the real kind of next chapter to that are, what do we do with our supply base and what do we do with distribution?

Ultimately the way for us to get the market less expensive is to get that total value chain knitted together even tighter than we have today.

Those were all the implications of the point you mentioned where the thing that I was getting out of the call, but I did not want to bias my question by giving you my conclusion. But thanks a lot, guys, and congratulations on the wonderful quarter.

In closing, we appreciate you joining us for today's call. We hope that we have answered all of your questions and given you further insights into our results and what is driving our business. As you can tell, we are very enthusiastic about the progress we have made and our prospects moving forward. We look forward to talking to all of you again next quarter and hope to see some of you at NeoCon.