MillerKnoll Inc (MLKN) 2005 Q4 法說會逐字稿

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

This call contains forward-looking statements within the meaning of Section 27(a) of the Securities Act of 1993 as amended, and section 21(e) of the Securities Exchange Act as amended. Those 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 “anticipate,” “believe,” “confident,” “estimates,” “expects,” “forecasts,” “likely,” “planned,” “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, expense, likelihood and degree of occurrence.

These risks include, without limitation, employment and general economic conditions, the pace of the 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, competitive pricing pressures, the availability and pricing of raw materials, our reliance on a limited number of suppliers, currency fluctuation and 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 our transitions to our new executive management team, our ability to attract and retain key executives and other qualified employees, our ability to continue to make product innovations, the success of newly introduced products, our ability to serve all of our markets, possible acquisitions, divestitures or alliances, to 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 differ 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, EVP and CFO, and Mr. Brian Walker, President and CEO. Ms. Nickels and Mr. Walker are joined by Mr. Joe Nowicki, Treasurer and VP of Investor Relations.

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 and ask that callers limit your questions to allow time for all to participate. At this time, I'd like to begin the presentation by turning the call over to Mr. Walker. Please go ahead, sir.

Good morning, everyone. Well, the safe harbor stuff continues to get longer and longer and more difficult to read. As normal, I'll open this morning's presentation with a few introductory remarks, and then turn the call over to Beth and Joe for a more detailed review of our financials. We'll use any remaining time for your questions.

As a leader of Herman Miller, one of my most significant responsibilities and greatest pleasures is to say thank you to all of our employee owners and the people whose personal commitment and outstanding effort this past year have made the difference and to our investors who trust us with this responsibility of profitably growing Herman Miller.

I'm even more pleased to be able to say that while knowing we have even greater potential going forward. Our core North American office furniture business is enjoying strong growth, and we're coming off the successful launch of the Cella Chair at NeoCon, completing the lineup of what we believe is the strongest seating offering in the industry.

Better yet, in the next 12 months, we will deliver important designs that will add new strength to our other major office furniture categories. Our initiatives in high-growth vertical markets such as health care, learning and home, are also gaining momentum.

Our new technologies and businesses emerging from the Herman Miller Creative Office are also showing great promise. Sonare Technology's first product, which we code-named Babble, has captured amazing market and media attention worldwide. At last calculation, we received 1/3 of the first year's order goal in the first few weeks after introduction.

Now I need to point out that our goal for the first year is quite small, but we are enthused by the initial response. Interest by international media and technology folks confirms that we are in a new space and directing a profound, unmet need for voice privacy.

Later this year, we plan to unveil another business and product from the Herman Miller Creative Office. The product's code name is Motus. Motus is an infrastructure product that will address an unmet need for radical flexibility and programmability in the built environment. We believe this infrastructure will deliver new value to organizations trying to create spaces which are more experiential, such as retailers, museums and learning institutions.

And finally, our international team has done a great set of work worldwide. We've grown share in major markets and are creating a meaningful presence in markets that holds future potential.

The opportunities are out there. We are after them with a measured investment plan and a plan to grow without sacrificing profitability. This past year, we laid the foundation of our strategy. Fiscal '06 will be about deployment. The new products and businesses introduced in the past few weeks are the first steps in that deployment.

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

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

First the highlights. As you saw on our press release, we made great strides in our financial results again this quarter. Sales, orders, backlog, margins, net earnings and EPS all improved over the prior year. Plus, our estimates for the first quarter are evidence we will build on the momentum we started over a year and a half ago.

Our sales for the quarter were almost $408 million, an increase of over 15% from the same period last year. And earnings per share were $0.31, an increase of almost 15% over the prior year. Our orders and ending backlog also showed significant growth over the prior year levels, with orders up over 16% and ending backlog up over 9%.

We saw outstanding leverage in our growth margin, as it increased to 33.1% of sales from 31.8% in the same period of the prior year. Despite over $41 million in share repurchases during the quarter, we ended the year with a cash balance of $154 million due to a strong $36 million of fourth quarter operating cash flow.

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 $380 million to $400 million.

Our domestic business really came on strong during the quarter and helped us to beat our estimates. On a year-over-year basis, sales for the quarter were up 15%. In addition we were up almost 7% from the third quarter, which continues the string of sequential growth that started four quarters ago.

It's important to note that the current quarter's net sales includes $2.1 million from 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, but we didn't recognize any FIN 46-related sales in last year's fourth quarter results.

Consolidated new orders for the quarter total $421 million, up over 16% compared to last year. This equates to an average of $32.4 million per week, which is up almost 24% from the third quarter.

As we mentioned in last quarter's conference call, we started out the fourth quarter with strong order entry and that trend continued as we went through the quarter. It was a very consistent quarter of order entry, with strong orders in every month. We know there was some concern mentioned in the press about the furniture industry slowing down during the quarter, but we didn't see it and we're still not seeing it, as you can tell by our first quarter forecast.

We continue to be encouraged by the high level of business activity, as measured by client visits, which were up 16% from the same quarter last year and up 40% sequentially from our third quarter.

And the attendance last week, at our showroom in Chicago for NeoCon's annual trade show was incredible. Organizers estimated that overall attendance was up 12% and hotel room bookings were up 20%, a great sign of things yet to come.

Regarding backlog -- for the quarter, our ending backlog was about $229 million, which is up approximately 9% from last year's fourth quarter level and also represents an increase of 6% from our third quarter level. It's also the highest year-end backlog in 5 years, since May of 2000.

Now I'll give you the breakdown between our domestic and international results. In prior quarters we talked a lot about the tremendous growth in our international business. This quarter it was our domestic business that really hit a home run. Domestic sales for the quarter increased over 16% year-over-year and new orders improved almost 17% on a year-over-year basis.

One concrete example of our continued success with the federal government is a recent notice of award on an approximately $28 million Department of Transportation project, one that won't even begin to hit our orders until the fourth quarter of this year. So there's more good news coming in order entry.

We're also having a lot of success breaking into some long-term competitively held accounts. We just recently won a $4 to $5 million project with a city on the West Coast, an account that had been standardized on one of our competitors for 18 years.

Last quarter we began giving you a little more detail around the portion of our business that is project-related, as compared to base business. This quarter, the project business in our U.S. markets increased again and ran at about 43% of the total, which is the highest rate we've seen since the first quarter of fiscal '02, which would have been August of 2001.

It was six quarters ago that our international business began its great run of year-over-year sales improvement. We saw gains of 15%, 19%, 40%, 40% and 25%. Well, we're very proud to announce that growth in our international operations did continue again this quarter. We slowed down a little, as we expected, due to the tougher comps, but we continued to win some big projects and posted a 10% year-over-year sales gain and a 14% orders gain. We had a little help from favorable foreign exchange rates, which added about $3.6 million to our international sales this quarter, but even when you adjust for that, our international sales still increased from the prior year.

We continue to have great success with the UK government. In addition, the fast track program in the UK has helped them win a lot of quick turnaround-based business from medium-sized customers. Our seating platform is also doing great internationally, and we're making great progress in our targeted markets of India and China.

By country, we saw growth in almost all areas, with significant improvements in Canada, Mexico and our Asia export regions. It continues to be a great story, but as we already mentioned international comparables are now more difficult. As a result, our forecast for the first quarter again includes a slightly lighter mix of international revenue and a lower profit contribution from our international entities.

Relative to our targeted new market segments, our health care focus is also gaining ground. We just won a $5 to $6 million project with a large health care organization that we ship over the next 3 years.

Now let's talk about gross margins. We continued to see strong improvements in our gross margins this quarter. Gross margin was up 1.3 percentage points from the prior year fourth quarter and up a full point from just last quarter. We're still seeing significant year-over-year cost increases in many raw materials, but the good news is that some of them are starting to level off and even decrease.

We also got great leverage from the additional volume and we saw significant benefit from the list price increase that we put into effect last August. We estimate our net sales increased approximately $7 million as a result of the price change. This is the largest impact we've seen yet this year. Unfortunately, price competition drove some additional discounting, which partially diluted this good news. All told, we believe that the net benefit to our domestic net sales, after increased discounting, was approximately $3 million.

And, as we announced last month, there will be another list price increase of, on average, 3.8% effective September 6th of 2005. As with the last price increase, it will take a quarter or two before we see the impact, but it should again help to offset some of the raw material cost increases we're still-- we're still experiencing.

Material costs for the quarter totaled 40.2% of sales, up from the prior year's 39.6%. The biggest driver again this quarter was direct material cost increases. Steel continues to be the biggest factor and amounted to a $3.5 million increase in year-over-year cost. As you may recall, it was last year in this quarter that we saw the first impact of steel prices, approximately a $1.5 million negative impact to us at that time.

The good news is that, as we expected, we did begin to see relief from-- in the steel market during the current quarter as prices came down slightly from the prior quarter. We're cautiously optimistic that after a tough year of cost increases this is a sign of stabilization in the overall steel market.

The bad news is that we did see some increased costs in plastics this quarter, so we're not out of the woods yet on raw materials costs.

Our direct labor costs were 4.6% of sales this quarter compared to 4.9% in the prior year same quarter. The year-over-year reduction is primarily the result of the efficiencies from the Canton, Georgia, plant consolidation. And, again, the continuing efforts of our Herman Miller Production System initiatives across all of Herman Miller are having a favorable impact on both our labor metrics and our material costs.

We did see the direct labor percentage increase slightly from last quarter, mostly due to a higher percentage of temporary workers at some of our plants, combined with some mix shifts during the quarter to products with a higher labor content.

Overhead spending for the quarter, as a percentage of sales, is down substantially from 18.7% last year to 16.8% 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 $2.3 million over the prior year, mostly due to increased volume-related production supply costs and incentive accruals, which I'll talk about more in just a minute when I go through the operating expense details.

Our freight out and product distribution costs totaled 5.3% of net sales in the quarter. That's compared to 5% last year and 5.4% in the third quarter. The increase from the prior year was due primarily to higher fuel costs, something we're all painfully aware of. These were offset, to some extent, by better cube density on outbound loads and also the continued implementation of the Herman Miller Production System into our physical distribution operations. We do believe that, going forward, our combined freight out and product distribution costs will remain relatively flat.

Moving on now to operating expenses, for the quarter, operating expenses totaled $89.7 million or 22% of sales compared to $92.9 million or 26.3% of sales last year. But that's only the beginning of the story. There are several unusual items that I want to talk about further.

The most significant was a non-cash $13 million favorable adjustment to reserves related to open contract years with the federal government General Services Administration or GSA. We talked about this in an 8-K issued in April.

As you know, we do a pretty significant amount of business with the GSA each year. Our contract allows them to audit our pricing and as a result we have always established a reserve against any possible claims they might have. During the quarter we reached a settlement with the GSA on a prior contract audit. This settlement prompted us to evaluate all of our GSA reserves in light of our current pricing systems and it resulted in the favorable adjustment.

Additionally, our fourth quarter operating expenses included approximately $2 million associated with dealer financial statement consolidations that weren't included in the prior year.

I also want to spend just a minute on our incentive accruals. As you all know, we have an EVA-based variable incentive system and last year we paid out at a rate of approximately 50% of target. We've been tracking all year to a payout of around 100% of our target incentives. Based on our over performance in the fourth quarter, we actually ended the year at approximately 120% of our target incentives. As a result, we had to ramp up our incentive accruals in the fourth quarter.

Combined in operating expense and cost of goods sold in the fourth quarter, we had a year-over-year increase in incentive accruals of $5.7 million, $2.4 million more in cost of goods sold and $3.3 million more in operating expense. This was also approximately $2.9 million more than we expensed in the third quarter, $1.1 million of which was in cost of goods and $1.8 million more in operating expense.

In the fourth quarter we also had employee-severance-related costs of $1.6 million, of which $1.3 million was in operating expenses. These were the results of small changes we continue to make to our cost structure to better align ourselves with our strategic initiatives.

The remainder of the increase in OpEx was primarily due to increases in variable selling costs associated with the higher volume.

Restructuring charges for the quarter were only about $100,000 versus $900,000 in the prior year and were associated with the relocation of the Canton operation.

Moving on down the income statement, other expenses for the quarter, net of interest income, totaled $2.7 million compared to $1.2 million last year. Interest expense was up approximately $600,000 due to increased increase rates and lower savings from our prior year interest rate swap transaction.

Last year's fourth quarter also included a gain of $700,000 from fluctuations in foreign exchange rates on our non-functional currency balances and this year that impact was 0.

We also had several unusual adjustments in our taxes this year. Our effective tax rate was 49.1% for the quarter and 39.7% year to date. Last year, the effective tax rate was actually a negative 12.9% for the fourth quarter and only a positive 17% for the full year. That's a pretty big swing in the effective rate, so let me tell you a little more about the details.

The most significant impact in the current quarter's taxes was an unfavorable impact of $4.4 million associated with the repatriation of cash under the American Jobs Creation Act. Last year the President signed into law the AJCA that created a temporary incentive for U.S. corporations to repatriate undistributed income earned abroad by providing an 85% dividend-received deduction. At the time we reported last quarter's results, the tax law, as it was written, did not provide any benefit to us to repatriate our foreign cash and, as such, we did not accrue for this opportunity. Since then, the Treasury and the IRS have issued additional guidance, which now creates the opportunity for Herman Miller to bring back and put to a more productive use some of our foreign cash.

In previous quarters, we've always assumed the undistributed earnings were permanently invested outside of the United States. As a result, we weren't required to report any U.S. tax on these funds. Now that we plan to repatriate that cash, we recorded deferred taxes of $4.4 million in the current quarter in anticipation of repatriating approximately $45 million.

On top of that, in the fourth quarter of the current year we also had approximately $1.2 million of unfavorable adjustments due to tax true-ups caused by recent changes in certain tax laws, as well as other federal, state and international deferred tax adjustments. It's important to note that last year in the fourth quarter there was a favorable $6.9 million benefit from the closing of prior year's tax audits.

With all that said, the important note is that going forward we anticipate our effective tax rate in fiscal 2006 to be in the range of 35% to 36%.

When you roll this all up, net income for the quarter was $21.6 million or $0.31 per share. That compares to earnings per share of $0.27 for the same period last year.

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. Operating cash flow was a great story again this quarter. It amounted to $36.6 million compared to the $36.5 million we reported for the same period last year.

For the full year, we've generated over $109 million in operating cash flow and that's even after making a $23 million voluntary pension contribution. Going through the components, depreciation and amortization for the quarter was $11.9 million. Our net change in working capital for the quarter amounted to a source of funds of approximately $9 million due primarily to increases in accounts payable and accruals.

Our collections of AR continue to remain strong and the AR balances over 90 days improved from the prior quarter due to collection in the state, local and federal government receivables. Our DSO and net inventory in receivables decreased by 0.3 days from the same quarter in the prior year to 49.8 days.

Capital expenditures for the quarter were $13.8 million. This is up from the prior year's $7.3 million due to investments in our sales offices, new product tooling and also the startup process associated with our new UK facility.

For the year, our total capital expenditures were $35 million. We anticipate capital expenditures in fiscal '06 to be approximately $50 to $55 million. The increase from the prior year is partially due to the new UK facility, which is really resulting from the consolidation of our UK facilities and will drive incremental operating improvements. In addition, the higher CapEx represents incremental investments for several new product introductions.

Moving on to our liquidity and cash position, we continue to have great financial flexibility due to our profitability and positive cash flow, combined with $137.2 million available on our revolver and $154.4 million cash balance.

We continued this quarter with an increased level of share repurchase activity. During the quarter we bought approximately 1.4 million shares for $41.1 million at an average price of $29.72 per share. We now have about $58 million in share repurchase authorization available.

We did see an increased level of stock option activity this past quarter. As the stock price rose to some of its highest levels in a couple of years we had several folks exercise their options and, as a result, we issued approximately $28.4 million worth of new stock for the quarter under our benefit plan.

Since many of our stock options had been underwater for a while, there just hasn't been much activity the past couple of years. We knew it would catch up. In addition, a few years back we also issued some options in lieu of a cash bonus. These had a shorter life and are now coming into the money.

This is probably also a good time to mention that under the last timing for implementation of FAS-123R, we will not be required to begin expensing stock options until Q1 of fiscal year 2007, so not for another year from now.

Although Black-Scholes still appears to be the most widely accepted valuation methodology, we plan to use the next year to evaluate alternative valuation methodologies and establish the appropriate assumption to use. We feel there'll be a significant amount of learning that we'll go through over the next 12 months as other companies implement ahead of us, so we plan to watch closely.

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

Thanks, Joe. Let's turn to the outlook now for the first quarter of fiscal '06.

As I mentioned earlier, our backlog is very strong and, in fact, it's the highest year-end backlog we've seen in a long time and our order entry rates continue to be strong. The first few weeks of this quarter have averaged almost $31 million per week. As a result, we're fairly optimistic about the first quarter.

As most of you know, the first quarter is traditionally a pretty slow period for us, normally slower than the fourth quarter, but that doesn't appear to be the case this year. We expect our first quarter sales to be in a range of $420 to $440 million, which represents growth of 17% to 23% over the prior year.

But it's important to note that this quarter will contain an extra week of sales. We are traditionally on a 52-week accounting calendar, but every few years we need to pick up an extra week to get back in alignment with the traditional calendar year. This is that year. As a result, we will have 53 weeks in this year and that extra week will be in Q1.

Now let me explain the revenue guidance in a little more detail. We start this quarter with a beginning backlog of $228 million. Included in that amount are large orders of approximately $5 million that will not ship until sometime after the first quarter. This brings the backlog available to ship to about $223 million. We normally ship 80% to 90% of that amount in the following quarter.

We then add in an amount-- an amount for the 6 to 8 weeks available to order and ship within the quarter. In this quarter we will make that 7 to 9 weeks to take into consideration the extra week.

We assumed a rate of $29 to $31 million per week. This leads to our guidance of $420 to $440 million.

Now let me talk a little more about our earnings guidance. We expect earnings per share of between $0.30 and $0.34. 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. While steel should now level off on a year-over-year basis, plastics and fuel costs will still be a problem. So we anticipate gross margins to still be approximately 33%.

In total, we're expecting a great quarter to start the new year off.

In summary, once again, we met and exceeded the commitments we made last quarter. 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 in quite some time, over $400 million for the quarter, and the best news is we see it continuing. Our first quarter forecast is even stronger. As our press release stated, our business is definitely accelerating.

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

Thank you. [OPERATOR INSTRUCTIONS] Matt McCall, BB&T Capital Markets.

Let's see, where to start. The comment you made about the discounting environment, and I know you quantified it, is that a result of still-aggressive pricing from unused capacity or is it more related to an increase in the project business, which I understand is normally more heavily discounted? Or I'm sure it's both, but maybe if you can say which way it's heading?

Matt, this is Beth. I'd say it's probably related more to the projects-- the increased projects business. As you know, those have-- tend to have higher discounts because of the higher volumes. And we haven't-- we actually haven't seen tremendous discounting pressure on the other business.

Yes, Matt, this is Brian. I would add to that. What I would say to you is I think while our industry is always a fairly tough pricing structure because it's a-- you bid on each project, so we're kind of like in the construction industry that you often bid on the next major installation. So that pressure's always there.

I would say it's not as difficult as it was a couple years ago when we were in the height of the downturn. So that certainly has improved, but the you get that offset by additional major projects out there and that increases the impact in terms of the percentage of the total business.

OK. OK. So the year-over-year-- the year-over-year impact is more from improving business trends, which is the offset. So it's not that pricing's getting any more aggressive on that day-to-day business?

I don't believe so.

OK. And I want to talk about costs a little bit. I missed the materials number. First, could I get that and then I'll-- as a percent of cost of goods or sales?

It was 40.2% of sales.

40.2%? And could you quantify what the plastics impact was? I know you talked about steel being $3.5 million. What plastics was?

It was approximately $700,000.

OK. And you talked a lot about or you gave your outlook for freight. Can you talk about your outlook for some of the other main areas of costs or materials related to your overhead? And then maybe, if it's not quantifiable, maybe the net impact of those items versus your-- versus your price increases and what the-- what the net impact might be, going forward.

I think direct labor, probably sort of relatively flat as we cycle in the efficiencies from the Canton consolidation. We-- some of it's dependent on product mix and which products have higher direct labor content, but not significant shifts in direct labor.

Overhead is quite dependent on volume. We don't see any huge, significant changes in the dollar spending, except for the annual increases in input costs like wages and benefits and pensions. But that will get leveraged as we have higher volume increases.

Freight out and distribution we expect to stay relatively flat and we're hoping to offset the higher fuel costs by our efforts in-- through the Herman Miller Production System.

OK. And the incentive accruals, are they going to be as big of an impact, year-over-year? I assuming you pay 120% and for the most part this year it was 100%, so could we see some more levels over that 100% mark?

The actual dollars, Matt, should be, if we hit our plan, if we hit plan, we're at 100% of the target. So, in some sense, it should lessen with our results in terms of improvement, because remember, we measure improvement, not getting to an absolute dollar amount.

Right.

So we saw a fairly large improvement in the EVA this year. We'd have to have a similar improvement to get to the same dollar level next year. Follow what I mean?

Right. Right.

Actually getting to a certain number, it's actually how much did we improve over the past year. Our guess is that will probably ease a bit next year in terms of-- in terms of the actual dollars paid out on the bonus.

To put in perspective, the cost of the incentive accruals a year ago at-- when we were paying about 50% of target was $15.5 million. The cost this year for the 120% was $33.5 million. So next year, at 1X, it's probably around that $30 to $33 million range.

OK. So no year-over-year impact?

Not much. From this year, from '05 to '06, not much. It does-- because it's a percentage of base, as bases go up it increases a little bit, but only relative to the salary-- underlying salary increases.

OK. OK. And the next question and the final question, I guess, the-- you talk about seasonal patterns would normally have Q1 slower than Q4 kind of thrown out the window because of the strength right now and then you made the comment about the $28 million of orders that are going to hit in Q4. I guess two parts. How should we look at seasonality this year? I know it's difficult to forecast, but how should we look at seasonality, I guess, in relation to the past? And those $28 million of orders-- orders that will start hitting in Q4, I assume that means most of the shipments will occur next year?

The $28 million is a long-term project. It's probably a 3 or 5-year contract, so it's scheduled to start entering in the fourth quarter of this year, but it will be over a several year period.

OK.

So that was meant to be an indication of some-- an example of some of the inroads we're making.

OK. And then the seasonality? How should we-- how should we view this year from a seasonality perspective? Is there any way to tell?

Hey, Matt, this is Joe. That's a tough kind of question to answer. Traditionally, we have a seasonal pattern where the summer's a little slower and also the holiday season for us, around the business holidays, is a little slower, as well, too, traditionally. But, again, we're bucking that trend this year. We expect the first quarter here to be actually above where the fourth quarter numbers were. So it's really a tough question to answer for you.

And last year, as we saw the recovery, our third quarter actually, sequentially, I believe, was up slightly from the second quarter. So that was one of the first times that had ever happened.

Yes.

It's usually down in the 5% to 10% range.

Right. Right. Well, I guess the-- I know you have some visibility in your pipeline and I'm not trying to get guidance going out, but I mean, the visibility, would it-- is it-- can we just throw the normal trends out the window and kind of one quarter a time? I mean, I know it's difficult to--

Matt, we don't-- the truth is, we don't have any visibility that far out. Our educated guess would be that now that we're through with the first year of the recovery that some of that seasonality between second and third will probably come back, that it would be-- We've never seen a pattern, that I'm aware of ever in the company's history, to have two years in a row where we saw increases from second to third. So it's likely-- now, will it be as pronounced as some other years? Maybe not.

Part of the reason you typically see a little bit slower level in the first quarter is because international, when you see what happens, especially in Europe, the European market kind of slows down in August. But we're really seeing the outlook this year as being a, the market's still in a bit of the early stages or at least the mid stages of the recovery, as well as having that extra week. So that kind of offsets that pattern.

Budd Bugatch, Raymond James.

Brian, take a little bit of a longer view for me now. We've come through the recovery, at least the beginning of the snapback period. Are we through that? And what is now the sustainable rate of growth of a, the industry, Herman Miller? What's-- what's the margin outlook? What's the direction from here? What's your goals? And where are we on a return on capital goal and did you-- Beth, did you give us what the EVA was this year?

I did not, because it's not a GAAP number and when we announce that we then have to go through a reconciliation.

Can we-- what's the R, what's the C-star and what's the capital? We'll do the math.

I can get back to you with those specific numbers, Budd, if you want. I can get the details under that.

OK, Brian, would you take the longer question, then?

Sure. Well, first of all, I think we're still in the recovery phase from everything I can tell from talking to our sales force and looking at what the BITMA (ph) numbers are.

So I actually think we'll finish fiscal-- or calendar 2005 still sort of above trend-level on that long-term trend growth rate. My guess is, if you believe BITMA's (ph) numbers, even for 2006 they're probably a little higher than what you think the long-term is.

We've talked about that in the long run we think the growth rate of the industry will probably get closer to what GDP is and I think next year BITMA's (ph) estimate right now is between 6% and 7% and I think if you look at GDP for calendar 2006, you're probably looking at, what, 3.5%, 3%, I think, probably a consensus. That's probably higher than I think it'll run in the long term.

Over the long run, you've seen-- you've seen the industry grow somewhere around 120%, I believe, as a long-run average of multiple of GDP. I think that's probably reasonable if we're looking at the next 4 to 5 years and then after that, you're probably talking about a slide back just to GDP.

So I guess if you net that all out, we think we've got another year from here, probably, of reasonably above-average growth. That means I'm pretty confident in that.

We think that we can continue to grow at a faster rate than BITMA (ph) for a couple of reasons. As you know, our goal is that we're going to try to-- our goal is to grow at least 10% per year and we think we can do that in a couple ways. First, we think we can grow faster than BITMA (ph), than the overall industry. We also think the work that we're doing around the vertical market is going to enable us to get to some places that are growing and will continue to grow fast, in particular health care, our home business, our retail business is growing quite nicely, as well as, we see some real opportunity in some of the emerging markets and international.

Now probably later in our long horizon is what happens from the work of the Herman Miller Creative Office and we're very enthusiastic about what we're seeing right now from what we're calling the Sonare Technology business and its first product, Babble, but it's pretty small in terms of the total business. We really won't see the size of those until we get to-- out to that four or five year horizon is what our guess is.

So that's-- also, we still are-- still believe that our goal of 10% growth per year over the next 5 years is something we're going to stick with and we're going to figure out how to make happen.

Margins? Where do they go to? How fast do they get there?

I think we talked about this on the last call, that our goal for operating margins is to get to 11%. This year we finished, if you take out all the special stuff, I think around 7.2%. Next year we're looking at numbers somewhere around 8%, give or take, maybe a little north of that, depending on what the growth rate is. So we can see that kind of continued progression.

I think the question for us is going to be how much innovation can we drive to get to higher level margin products. Certainly we see that out of things like Aeron and Mirra. We're hopeful that that's going to be the same case with Cella and we've got 2 new major systems lines coming out this year, as well as 2 new product lines coming out of the Herman Miller Creative Office. Those things give us confidence that that, along with our continued work on HMPS, or the Herman Miller Production System, will continue to drive margins north.

Will they be at the same rate of increase we've seen as the kind of-- you would call it the snapback and recovery. Of course, it will be harder as we get further along in the cycle, but we're still pretty optimistic we've got room for improvement.

Return on capital goal? And I've got one followup.

Return on capital goal.

Our cost of capital that we're using right now, Budd, is 9% and our expected improvement for this year was an $11 million number.

You want to know what the long-term goal is. If I remember right, that number was-- Budd, I'd have to go look at it.

We don't recalculate it back into what it is as a percent.

OK, well, we can do that offline. Just on the balance sheet, how's the board thinking about the balance sheet these days in terms of--? You've been comfortable with very high levels of capital and the cash. The $45 million, I take it now, is no longer restricted or offshore? What's-- is there any restricted cash left on that $154?

Yes. First of all, we have over $70 million in cash in our international entities. We're bringing back $45 million. The remainder were considering permanently invested overseas. Part of it is to fund the building, the new building, in the UK and another portion is to make sure that our international entities have strong balance sheets themselves.

The money that we're bringing back -- according to the tax law, there are several allowable investments for the cash. All are geared toward creating jobs in America and the 2 that apply most to Herman Miller are investments in research and development, which is at the core of our business model, and investments in capital expenditures.

We are still committed to our share repurchase program and, as Joe mentioned, in his comments, we still have about $58 million remaining on our board authorization, but our first priority for the cash is the execution of our strategy and some of the things that Brian mentioned. We have some aggressive plans to grow the business so I think the management team and the board right now is comfortable with the higher levels of cash to make sure that we're able to take advantage of opportunities that come our way that will help us to accelerate our strategy, whether it be in either the vertical markets or in the Herman Miller Creative Office investments.

And your R&D this year was what? And what do you think it will be next?

R&D was about $33 million, just over 2% of sales.

[multiple speakers]

[inaudible] then it will be closer to 3%.

OK. And-- but the capital-- you're not going to put new capital much in the way of bricks and mortar, I wouldn't think.

No, other than the UK building next year, Budd, and a little bit going on related to new sales showrooms or, if you will, what we call national design centers. We do have a couple of those we have to do next year where we have to move.

But if you're going to accelerate something with that cash use, you need to do it-- I would think the best way would R&D or systems?

It'll be R&D. It's be tooling costs. Typically, our business model, even when we come out with a new product line, take Cella as an example, doesn't really generate new capital in terms of the building and, in fact, we're pretty confident that the work that we're doing around HMPS is going to continue to free up some space so that as we bring out new products, it doesn't really generate bricks and mortar as much as it generates need for tooling, as you say, investment in R&D, and then there's, of course, the question about acquisitions and other strategic investments that would move us forward faster in terms of the implementation of our vertical market strategy.

And, Budd, under the tax laws, we don't have to invest that whole amount in the first year. We have a couple years to do that.

Hey, Budd, I should also answer you that next year the CapEx is a little higher than we've been running, not only because of those investments but it's lots of things. As volume levels have picked back up, where we were able to utilize some tooling that was, in a sense, backup tools that we put into production during the downturn because we didn't need as much backup, well, now as we get back up to these higher volume levels, we are starting to add some tooling back that gives us that extra set of, if you will, backup tools in case one breaks. Because at these kind of volume levels, our cushion, in terms of response time is, obviously, lower.

Virginia Genereux, Merrill Lynch.

Let me ask, because you explained this a little bit why the-- gave a lot of detail on why the incremental margin for May wasn't-- wasn't sort of as high as it had been running and it was really the comp accrual. How about for the August quarter? Your guidance implies-- the height of your range implies sort of a 21% to 22% incremental margin. What-- and it seems like maybe that's coming from SG&A. Why wouldn't you have a better incremental margin in August?

That's a good question, Virginia. As we go from year to year, there are several costs that do increase and one example is our pension expense. It's been unusually low the last few years based on how the actual-- actuarial assumptions have played out. That won't be the case this year. Pension expense last year was a little under $1 million and next year we expect it to be over $5 million.

In addition, we're cautious as we think about raw material costs. I mean, we could have oil at $60 a barrel. That could have a significant impact on some of those costs.

So our leverage estimates in the first quarter are a little lower than they've been in the past, but as we go through the quarters, we should have a better handle on what the real cost of raw material inputs will be and also what the benefit is going to be from the price increase that goes into effect in September. So we're optimistic on the future quarters that, hopefully, we can get back to that higher level.

OK. And this $5 million pension expense you mentioned, that's an annualized number, right?

Correct.

Correct.

OK and on the raw materials side, let me ask you, if your steel impact was $3.5 million this quarter, steel prices were 85 BPS of pressure by our math, gross margins were a little north of 33, wouldn't that alone, especially given the size of the August quarter-- wouldn't you see some sequential gross margin expansion in August, just on-- even if other stuff goes up? Isn't that what you said, that you thought steel would not be a factor?

I think we're expecting it to be about flat quarter-to-quarter on a sequential basis from the steel impact.

So flat quarter-on-quarter, so it's still negative $3.5? I mean, year-over-year?

Well, year-over-year last year in the first quarter we had almost a $5 million impact. So it was-- steel on a year-over-year basis, hopefully, is baked into the year-over-year counts now.

Hey, Virginia, this is Joe. The first quarter of last year we still didn't see the full impact of all the steel pricing kind of hit us, because of some of the contracts that we had in place. It was really like the second quarter of last year and the third quarter that really started to kick in.

Right. So, Joe, I'm sorry, is steel then-- is steel going to be still a net hurt, year-over-year, in August?

It'll be consistent with where it was last quarter, but year-over-year still could be a slight hit to us, yet.

It'll be flat with fourth quarter but because last year's first quarter was the beginning of the upward swing, Virginia -- this is Brian -- you'll actually see a bit of an increase when you compare year-over-year.

OK. Now I think when we talked about steel prices easing, what we hear from our folks is, due to contacts and all of those things, we don't really start to see any benefit from the easing, also, until after the first quarter. So the first quarter is-- And that's why Beth said, even as we start to look at the leverage factors, it's going to take us really to get through the first quarter to sort out what's going to happen with steel prices from there, as well, as those other input costs. So that's why you hear us being a little cautious about wanting to see what the direction looks like when we get through there.

Right. That makes sense. Thanks, Brian. That was our sort of thought that you'd get some help later in the year.

The other thing to keep in mind, by the way, on the pension item, just to go back to that, it's a little odd going from pension expense cash is-- this year we didn't get nearly as much of a pension contribution, so we've got the odd saying that cash and cash flow will be better based on pension, while-- in a year that expenses actually go the opposite direction. What we're really seeing is a snapback to what is, I think, our long-run cost of pension if you looked at our kind of service costs. It runs about what we're going to see this year.

Right, $5 million a year.

Yes, it's actually a little bit less than $5 is what the long-run average, but we're headed back to that number.

OK. And even that still says you guys should have some room in August, but let me ask you this, Brian, while you're talking. Your commentary on sort of north of 8% margins for fiscal '06, again, if you're-- if we think about the alleviation of the inflationary pressures and what should still be, as you said, a pretty good growth year, again, I'd see you getting-- see you getting much better margin expansion than just 8%.

Well, I think, again, as always, Virginia, that depends on when you-- what you think the end top line is going to be, to some degree. We're pretty confident in that kind of 8, 8.1 range. We're pretty confident in there, given everything we know. Can we do better than that? Certainly we can if everything goes in our favor, if we have a few good surprises like we had this year. That could happen.

Again, you are seeing pretty big run-ups. You can't forget, not only in fuel, but as well as you've got health care costs still being a big driver for a lot of people, including us.

The real question here is going to be what can we capture out of that price increase, the next round that we're going to do in September. If we can get some help from that and continue to stick some of what we did this year, then I think we start to get a little bit more optimistic that you can beat that goal. But that's really kind of a key thing.

OK. And is there any scenario, Brian, on that, lastly, where you would have to give back-- if inflationary pressures moderate, is there any historic precedent or scenario under which you guys would have to roll back some of those price increases?

I've never seen-- I've never seen a rollback situation other than this business is interesting in that we always deal with list less a discount factor. So it tends to be what happens with the discounting over time. We didn't do a surcharge, like some folks did, which are specifically tied to a commodity change. We didn't do that. Ours was a general price increase. So I would say, no, I don't think we're in danger of a rollback.

Certainly, when you start talking to purchasing agents your ability to hang on to price increases are much stronger when you have a good story like we've had this last year that, hey, commodity prices are just up. So as long as we don't see some massive drop in commodity prices, I think we'll keep what we've got out there right now.

Todd Schwartzman, Sidoti.

Did you quantify the fourth quarter contract size versus the prior year?

We did percentage of projects business versus base business. We said that that was about 43% of the total. We didn't do project size. Because the projects come in over a-- sometimes over the course of several quarters, it's difficult to actually give a contract price-- contract size. It has to be-- we'd probably guess it flat to up a little bit.

OK. Could you share with us, maybe, a worst-case scenario of what the highest level of discount you offer in-- in recent-- let's say in the past quarter?

We don't talk about specific discounts. They're basically are governed by our GSA contracts. So we can't offer a customer anything deeper than we would offer the government for the same type of project.

Although there are very large projects that fall outside of that scope that we can. But, as you can imagine, Todd, that's a bit of competitive intelligence we'd just as soon not be talking about, because that moves around project to project, customer to customer, what's the competitive situation. And so it really moves depending on the mix of the product lines, what are we trying to do at that time in terms of the significance of a particular customer or segment that we're trying to break into. So that's not one that we'll share in a public forum.

Got you. Also, adjusted for FX, what was the percentage sales increase internationally for the quarter?

I believe it was about 4%. Let me change that.

It's just about 5%, 4.-- I was looking for the exact number right here. Yes, 4.6%.

OK and the comparisons are getting tough, obviously, going forward.

Right.

Susan McClary (ph), UBS Warburg.

Can you comment a little bit, coming out of NeoCon, do you see any changes to the competitive landscape as the business starts to come back?

Well-- Susan, this is Brian. Coming out of NeoCon, specifically, NeoCon's always been tough to predict major changes coming out of there. I don't think we saw anything at NeoCon in particular that would tell us that the competitive landscape got shifted because of NeoCon.

Now certainly, at least, we feel like we did as well as anyone at NeoCon. You are continuing to see lots of new systems products from folks. We're pretty confident that stuff that we have in the pipeline is not only competitive but differentiated from what other folks are doing. And we feel pretty good that our position as the leader in terms of innovation was reaffirmed at NeoCon with us doing things that were unique and different that other folks hadn't gotten to yet.

So from that angle, we think no major change. We haven't seen any particular tactical moves since NeoCon, but it's only been a week or two, but I don't know that you'd see any coming out of that that you could point to.

OK. And can you comment on, do you still think that you're gaining some share? Do you have any sense for that's going now that you've kind of closed one fiscal year and headed into another?

Well, again, we always say it's difficult to look at these things in short-- in the short run. We would believe that, based on some of the recent stuff we've seen, that we're trending upward. I think year-over-year for the year it's probably not much, probably flat, but we think in recent months we've started to see that turn, which would be about what we would expect that as the market is picking up we tend to do better.

We also think that, coupled with the stuff that we've got in the pipeline is where our real confidence comes that in the long run we will do well in terms of market share versus the others.

OK. And then one last question. I know that industries like financials and insurance have been fairly strong recently. Are you seeing any industries that are starting to come back that were maybe a bit weaker or any changes there in terms of demand?

I don't know that we've seen any trends different from what we've seen in recent quarters. We did have some data in terms of who-- who we're seeing today buying, Susan, and the folks that you see -- light manufacturing, electronics and computers, communication companies, insurance and financial, as you mentioned, as well as health care. Health care is one that is-- is really strong, continues to be strong, which, of course, is one of the ones that we're targeting. But in overall, I don't think that list of who we see strong from a CIC code has really changed a lot in the last couple of quarters.

OK and did you mention anything about the increase in customer visits this quarter versus last or year-over-year or anything?

Yes. It was up, I think, 40% sequentially and 16% year-over-year.

John Emmerick (ph), Ironworks Capital (ph).

A couple unrelated questions off hacking chat rooms. What were allowance for doubtful accounts and warranty reserves in the quarter?

Pretty immaterial. Accounts receivable [inaudible] on the bad debt.

I guess I'm looking for the-- the balance sheet contra account would be?

Oh, the actual reserve?

Yes.

Did you have another question while we're looking that one up?

Sure. The $2 million in your financial statement consolidation that wasn't in prior years, is that a one-time thing or is that a go forward expense? I didn't understand exactly what that was?

What that is, John, you know there's this Rule FIN 46 that requires you to record these variable interest entities?

Right.

We have, I think, one dealer left that we have to consolidate. So we've been consolidating them for the entire year, I believe, starting in the first quarter of last year.

Right.

So the $2 million was their sales. Was it net sales?

I think it was operating.

Operating expense.

Right.

It was operating expenses that were consolidated in this year or in this quarter.

So that's the go-forward expense hit?

It's a go-forward unless we get to the point that we no longer have to consolidate them and we keep thinking they're going to-- essentially they get to a point that they're quote/unquote deconsolidated in one way or the other, but we haven't gotten to that. It's a little difficult to predict because it has to do partially what they do from their own financing.

Bad debt reserves, as the end of the fourth quarter, the end of the year, we've got $5.6 million, which was down about $200,000 from the end of the quarter before, third quarter. Warranties, $13 million, unchanged from third quarter.

Where do the-- This is-- I don't know whether since the bubble burst, I guess, the kind of allowance for doubtful accounts, if you look at it as a percentage of gross accounts receivable and warranty reserves as a percentage of gross inventory have been having-- going down, which I guess is a function of you're just writing off-- you're expensing more than you're writing off. Where do those-- is that also impacting the kind of lack of improvement in margin going forward that folks were expecting from leverage that you're trying to-- you have to start beefing those back up again? Or how-- where do those go?

No, actually the-- when you think about warranties, specifically, the reason it's going down as a percentage is more because of the systems we've put in place, some of the quality systems, and the fixes that we've done in issues that were identified a year or two ago and the number of new issues has gone down.

So warranties, specifically, in the last few years has gone down just because of the quality of work we're now doing.

Essentially, it's cash going out the door, reducing the reserve.

OK.

The bad debt has been-- our receivables have just been extremely strong and as the economy has recovered, the quality of the receivables has continued to go up. So even though the accounts receivable balance went up, quarter-over-quarter, the quality actually got better and are-- we're over, I think, 99% current.

I think, John, the short answer in some way was during the downturn, we were fairly conservative with AR, nervous about what was going to be the difficult impact on dealers, in particular. Remember that's most of or receivables. They're from our dealers. And being concerned about what would happen to them through a prolonged downturn.

That's logical.

I think the good news is, that, in fact, our dealers survived extremely well and we had very little in terms of issues and they have very strong balance sheets as of today, as well as good availability on their own credit lines. That's just let us-- so the calculation gets driven down over time because the health of their receivables keeps getting better and, in some ways, our conservatism provided to be, maybe, not as warranted as we would have thought through the downturn.

OK. Last question. You said that seasonality of Q3 being down from Q2 historically might return this year. What about Q2 versus Q1, just given the fact that Q1 is the extra week quarter, if you will, this year? Normally you'd think that would be up from Q1, but less likely this year, just because of the sheer magnitude of the benefit of the extra week?

Certainly the magnitude of the increase won't be the same as it would have been in past years, you would think.

Probably more-- closer to flat--

Closer to flat?

Yes.

--than it would in prior years.

Chris Hornsbury (ph), Raymond James.

Just a couple quick followups. You mentioned that steel will probably be flat as a-- in terms of cost from third-- fourth quarter to the first quarter. Fourth quarter it was up $3.5 million. Should we look at that a little bit less than that since we started to see steel really move up in the first quarter of last year?

I think what we saw in the first quarter last year was probably a $3 to $4 million increase, year-over-year, versus the $5 million we then started running at when it was fully cycled in. So you'll probably still see $1.1 million to $2 million year-over-year increase in the first quarter.

OK. And how about resin? That was $700,000 in the fourth quarter. What are you looking at for Q1?

My guess is somewhere similar to up, maybe closer to $1 million.

I think the question, Chris, is how fast does the $40 to $45 or the $60 change in oil pop through plastics. That's going to be the question. I mean, some of those contracts are a little longer dated, so hopefully we won't feel all of it, but that's a pretty big change.

That's one that our supply team's out in front of right now, working feverishly with our other vendors to try to understand and mitigate some of the impact.

OK. Also, with the pension expense, you said maybe $5 million more this year. Is that-- is that spread out evenly over the quarters or do you see it kind of lumpy in the next fiscal year?

It's spread out evenly over the quarters, Chris.

OK. And then my last question was, Brian, you mentioned that business at retail was increasing for you guys and it was a growth opportunity for Herman Miller. What was that in terms of if you can give me a percentage or just kind of overall where it is now over the last year and where do you see that trending to?

We don't tend to talk about it as a-- what the percentage of the business is. I think this year retail was up 26% year-over-year. We had a nice run, particularly as Mirra started to be introduced into that channel. So we've seen great growth there as well as some of the retails have been expanding their footprint and that has enabled us to sell more of our plastic products, which, if you've been watching, we've been doing a lot of reintroductions of our plastic products in conjunction with a European company that we've been doing the shared tooling and those kind of things, which has enabled us to expand not only the kind of cast seating offering between Aeron and Mirra, but also bring back more residential products, which we think is important not only in terms of revenue, but in terms of brand building, as well

At this time I'll turn the conference back over to our presenters for any additional or closing remarks.

Thank you all for joining us today. We really do appreciate you joining us. We hope that we've answered all of your questions and given you further insight into our results and what is driving our business. We can't really express to you how excited we are by our financial performance this quarter and for the year and the fact that we are very encouraged and confident about the opportunity that we see in front of us.

We look forward to talk to you all on next quarter's call and we hope you have a great summer.

That does conclude today's conference call. Thank you for your participation.