MillerKnoll Inc (MLKN) 2006 Q4 法說會逐字稿

Good morning, everyone, and welcome to this Herman Miller, Inc. fourth-quarter fiscal 2006 earnings results conference call. This call is being recorded. This presentation will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statement. These risks and uncertainties included those risk factors discussed in the Company's reports on Form 10-K and 10-Q and other reports filed with the Securities and Exchange Commission.

Today's presentation will be hosted by Ms. Beth Nickels, Executive Vice President and Chief Financial Officer, and Brian Walker, President and Chief Executive Officer. Ms. Nickels and Mr. Walker are joined by Joe Nowicki, Treasurer and Vice President of Investor Relations. Ms. Nickels and Mr. Walker will open the call with a brief presentation, which will be followed by your question. (OPERATOR INSTRUCTIONS). At this time, I would like to begin the presentation by turning the call over to Mr. Walker. Sir, you may begin.

Good morning, everyone. As always, 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 financial. We plan to keep our prepared comments short, so that we have ample time for any questions you may have.

We closed this year in the same way we started it, with continued growth in both our top line and bottom line. To be frank, we did not achieve the same level of operating leverage in Q4 as we had in earlier quarters. This was entirely driven by increased operating expense. A good majority of this was anticipated by us. It is normal for us to see a ramp-up in operating expenses in Q4 as we prepare for NeoCon, our industry tradeshow. This year, we had expected the ramp-up to be higher due to the large number of new products we are introducing at the show.

In addition to these expected increases, we also had some unanticipated expenditures that pushed operating expenses up even further. Fortunately, these costs were largely offset by favorable gross margin performance and a lower-than-anticipated tax rate.

In summary, we are happy with the net result for the year and the quarter. And I assure you, we are doing what is necessary to maintain our ability to leverage top-line growth into expanded operating earnings. At the same time, we are confident that our investments in new products and new markets will pay off handsomely in the future.

Many of you saw the breadth of new products that we just launched at NeoCon -- the new My Studio Environments, which took gold in systems and also the Overall Best of Show Award among over 350 products introduced; the innovative Leaf LED Light, which took gold in lighting, the Foray Executive Task Chair from Geiger, which took silver in seating; and finally, the new Vivo Frame-and-Tile System, which our dealers and sales team cannot stop talking about.

Many of you also had the opportunity to hear Don Goeman, our Executive Vice President of Research and Design, speak at the NeoCon investor meeting. To reiterate Don's major theme, we're not done yet. We have even more great products in the queue that we are just as excited about as those we launched at NeoCon.

Like all of you, we are watching the economic news with great interest. At this point, industry dynamics still appear to be favorable and customer activity is solid. Coupled with the investments we have made in new products and new markets, we believe after adjusting for the extra week of sales in 2006 we will again register double-digit growth in 2007 and will continue to expand our operating margin as a percentage of sales.

With that, I will turn the call over to Beth and Joe for additional discussion of our fourth-quarter results.

Thanks, Brian. Again this quarter, we did what we said we were going to do and hit the targets we established. We're in the middle of our projected sales range at 444 million thanks to solid performance across the board in our North American and international markets. We had stronger gross margin performance than we anticipated due to the pricing actions we took earlier in the year. However, we had slightly higher operating expense levels due mostly to the launch costs associated with our new product initiatives. We also got a year-end benefit of favorable tax adjustments. As a result, we ended up at the high end of the range for our EPS guidance at $0.38.

Now let's get into the specifics of sales and orders. Sales of 444 million represent the highest quarterly sales level recorded in the last five years. This represents a 9% increase over the prior-year fourth quarter. And as we mentioned in the press release, for comparison purposes, it's important to remember that the prior year included over 11 million in sales from three dealers that we no longer own or consolidate under FIN 46. After removing the sales for those dealers, comparable sales actually grew 12% -- once again double-digit growth.

Orders were up about 5% from the prior-year fourth quarter. But once again for comparison purposes, if you exclude the 15 million in orders from the three dealers that we no longer consolidate, comparable orders actually grew about 9%. On a sequential basis meaning third quarter to fourth quarter, sales and orders were up about 5% and 11% respectively, which reflects the typical traditional seasonal sales increase.

Our domestic businesses posted a year-over-year gain in sales and orders of approximately 3%. The three dealers that are no longer owned or consolidated were all located in North America, so the reported growth percentages don't represent comparable performance. If you remove these dealers from our results, domestic comp sales increased more than 6% year over year and domestic orders grew more than 7% year over year.

Our international business had exceptional performance again this quarter. In fact, our international sales were $100 million, representing almost 23% of Herman Miller consolidated sales. As a percentage, international sales jumped 36% over the prior-year fourth quarter with gains recorded across the board in all regions. We have now gotten to the point where we are not solely dependent on one region for our international business. The work we have done to strengthen our dealer network, develop international products and create new programs like FasTrak in the UK are paying off. This broad-based strength will be a great backdrop as we develop our presence in the emerging markets of China and India to fuel a new wave of growth.

Now regarding our backlog, ending consolidated backlog was over 238 million, up 4% from last year's fourth-quarter level. The prior-year fourth quarter included approximately $16 million from those three dealers that we no longer consolidate. After adjusting for those three dealers, our backlog is up over 12% from the prior year. Sequentially, backlog declined about 1% from the third quarter due mainly to some large orders in the UK that shipped during the quarter.

Now let's talk about gross margin. Gross margin at 34% of sales was up 0.9% from the prior-year fourth quarter and reached the highest level in five years. Discounting erosion year over year was more than offset by the benefits from the price increase, resulting in a substantial net price benefit again this quarter. We also experienced a significant improvement in the leverage of overhead from the additional volume. These benefits were partially offset by increases in fuel and raw material costs.

Raw material commodity prices overall had an unfavorable impact on gross margin this quarter. We recorded increases in aluminum, wood and plastics. Steel was still a favorable year-over-year impact, but we expect that will change in the first quarter. The steel market improved in calendar year 2005 but strengthened considerably this spring. As most of our steel prices are on a quarter lag, we have not seen much of the steel increase as of yet.

Transportation costs continue to be a challenge with diesel cost up over $0.50 a gallon from the prior year. Freight as a percentage of sales is up year over year as a result of the higher fuel costs combined with shipping patterns again this quarter into higher cost shipping regions.

Moving on now to operating expenses, for the quarter, operating expenses were 113.5 million or 25.6% of sales compared to 89.7 million or 22% of sales last year. It is important to remember that the prior year included a $13 million benefit from a reduction in GSA reserves and also 4 million of increased costs from dealerships that are no longer owned or consolidated. Even after accounting for those, our operating expenses were still high. We know it. We told you we would have a lot of costs to get the new products launched and we certainly did. Based on the excitement we saw at NeoCon, we definitely believe the new product cost will be worth the investment.

But let me give you some further insight into the operating expense increases. First, on a year-over-year basis in the fourth quarter, our operating expenses increased $15 million after adjusting for last year's GSA accrual reversal and the three dealers that we no longer consolidate. This $15 million increase was the result of a 4.5 million increase in research and development and marketing; a 6 million increase in warranty, bad debt, legal and pension; a $2 million increase in variable costs; and a $2 million increase in comp and benefits. Now if we look at OpEx sequentially from the third quarter to the fourth quarter, operating expenses increased about 13 million. The 13 million sequential increase was comprised of a 7.6 million increase in R&D and marketing; a 3 million increase in warranty, bad debt, legal and pension; a 3.2 million increase in variable costs; and about 400,000 of an increase in incentive costs.

As Brian mentioned, some of these increased costs were anticipated; some were unexpected. But fortunately, we had positive news in both gross margin and taxes to offset the increases. We assure you we will continue to manage our operating expenses as we go through 2007. It is important to recognize that for the full year 2006 after adjusting for the 13 million GSA benefit in fiscal '05, we were able to expand our operating earnings as a percent of sales by almost 2 full percentage points.

Moving on, as I mentioned earlier, we benefited this quarter from a lower-than-anticipated effective tax rate. We experienced favorable adjustments to tax expense with the filing of our final 2005 tax return, primarily from increased R&D tax credits and the tax incentive for export sales. Our results also include tax benefits from new incentives for domestic manufacturing and the federal subsidy for certain prescription drug plans. As a result, the effective tax rate for the quarter was only 27.9%. This compares to 49.1% in the same quarter last year. But keep in mind, last year's rate included additional tax charges of $5.6 million, primarily associated with the planned repatriation of cash under the American Jobs Creation Act. As a favorable adjustment for the filing of our final 2005 tax return as a onetime event, we expect the effective tax rate going forward to be in the range of 33 to 35%.

When you roll this all up, net earnings for the quarter were $25 million or $0.38 per share. This represents a 23% increase over last year's EPS on a 9% increase in net sales, once again demonstrating our ability to leverage our top-line growth.

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

Thanks, Beth. Cash flow from operations was a very strong $48.1 million for the quarter, and that includes an outflow of $2 million for voluntary pension contribution to our UK defined benefit plan. That compares to $36 million in cash flow from operations for the same period last year. Higher net earnings combined with lower working capital requirements drove the improvement. Working capital provided a source of funds of 10.2 million, primarily due to higher accounts payable and comp and benefit accruals.

Depreciation and amortization for the quarter was only 9.5 million. Capital expenditures for the quarter were 16.3 million, up from 11.8 million in the prior year due primarily to new product development initiatives that both Beth and Brian described. For the full year, our capital expenditures totaled only approximately 51 million.

Now moving on to our liquidity and cash position, we continued with our share repurchase plan this quarter although at a slightly slower pace. We saw a lot of volatility in the stock markets. Plus, we expect traditionally higher cash outflows during the summer for our bonus and profit-sharing plans. We repurchased $21.6 million of stock, 0.7 million shares during the quarter. We still have approximately 103 million remaining on our Board authorization.

We also made a scheduled $13 million payment on our long-term debt. Our current remaining debt balance is just 179 million. With all that, our high cash flow from operations kept driving balance at over 106 million. We plan to continue to implement the capital structure changes previously announced by the Board with the goal to work down our cash balance to approximately 60 to $70 million at next fiscal year end.

Thanks, Joe. Let's turn to the outlook for the first quarter of fiscal '07. We closed fiscal '05 on a strong note. And as Brian mentioned in the opening, we are not finished yet. After accounting for the extra week we had in 2006, we can see our way to another double-digit growth year in fiscal '07. Our backlog at the end of Q4 is strong, and our order entry rate the first few weeks of Q1 have been great. Our estimates for the first quarter should help set the right tone for the year.

We anticipate sales for the first quarter to be in the range of 435 to 455 million. Although that is only a 1 to 6% increase over the prior year's first-quarter reported sales, it is again important to note that the prior year's first-quarter sales of 431 million included the impact of an additional week of sales based on the Company's accounting calendar. Excluding the impact of the extra week, first-quarter revenue estimates represent a 9 to 14% increase over the prior year.

In terms of our earnings guidance, we expect earnings per share between $0.38 and $0.42, which represents a 12 to 24% increase over the reported EPS of the prior year. As I mentioned earlier, our gross margins will be negatively impacted by continued increases in raw material costs. However, we do anticipate operating expenses to be lower now that we have most of the new product launch costs behind us.

We also began implementation of FAS 133 in Q1 and as a result will be reflecting the impact of expensing stock options in our earnings. This is not a significant amount for us but will reduce pretax income by a little under $1 million. Our effective tax rate should be back to a more normal range of 33 to 35%.

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

(OPERATOR INSTRUCTIONS). Susan Maklari, UBS.

I would just like to drill down a little bit more into the margins. It seems like you're finally getting some good traction with the price increases that you've put through. Can you just talk about what you think the biggest factors are that are inhibiting that from getting even stronger as we go forward?

I think the short answer to that is competition. We are still in a business that most every -- this is Brian by the way -- that almost every project we do at one level or another is a competitive bid situation other than base business. So customers certainly aren't going to let us off the hook that easily that we are not going to be in that bid situation.

What has made pricing I think more favorable than we have seen in a number of years is the fact that I think most companies have seen these increases in commodity prices to the same extent that our industry has, so they have been at least understanding of the increases. And because that has also hit the industry somewhat uniformly, almost everyone in the industry announced a price increase. And as the demand curve has been favorable, people have worked hard to capture some of it.

Okay, in terms of the discounting, did you see any changes over the last quarter or the last few quarters?

On a year-over-year basis, discounting was still deeper than last year, but that was significantly more than offset by the price increase. So from a trending perspective, I would say there was really not much change.

Okay and then just finally, can you comment on the level of project business versus more the smaller day-to-day kind of projects?

Sure, I think project business was up about 2 percentage points or so from where it was running earlier, so more project business but also more day-to-day business. It has been a pretty uniform increase from where the top line is coming from.

Budd Bugatch, Raymond James.

Just on Susan's last question on project business, Beth, over the last time, I think you gave us the percentage of project business was at 45%. So are you telling us it is now 47% of the composition?

Yes, it is actually 46% of the total.

Last quarter, it was 45. But a year ago, it was at 43%, so it is up a few points from a year ago and up even where it was sequentially from last quarter.

Okay, and the quality of the backlog, how would you describe that now? Is it more near-term backlog or are we looking out beyond this quarter in terms of the backlog?

I think there is about 7 million worth of projects in the backlog that are scheduled for shipment beyond the end of the first quarter, so it is not all that different from where it has been running. Usually, there is somewhere between 5 and $10 million in the backlog that is scheduled for that.

Europe -- or the overseas business or international business was very strong. What are you seeing there? I may have missed it but I don't think so. Did you kind of give us more of a flavor there?

It has been very strong. And of course, that number includes Canada. We have been very strong in Canada and Mexico -- both have done very well -- and the Far East, which is not one particular location but a mix of location. Australia has been -- is very strong, and the UK has done well. Probably of everything, Europe continues to be the softest market overall. Although because we are quite small as a player on the continent, we have done pretty well increase-wise but it is still fairly small numbers.

Are we beginning to see some improvement in Germany or is that not even a market that you are a factor in?

Well I can only tell you what I hear from other folks that Germany looks a little bit better than where it was. But still the published reports I have read, which I'm sure you have read from other folks like Sonus and others still talk about Germany being fairly soft but maybe better than what it was. I mean we're such a small player that it is really based on how well we do in the seating business overall. We have expanded distribution on the continent this year -- actually, over the last couple of years. That has helped us be a little bit stronger there.

But again, in terms of the impact on the overall business, it is still fairly modest. And maybe that is an advantage to run our international businesses. It is no one location other than maybe the UK is all that significant. In many cases, we're playing a wide game run rather than a very concentrated game.

Just a couple of housekeeping questions. Can you give us R&D expenditures for the year and what do you think it will be next?

If you want to go on to your next question, we will look for that while you are --

Well, the others are kind of similar -- variable comp expectation for this year and what it might have been this year and what you think it will be next. Those are the two kinds of big variables that we have. Those are my questions. If you want to come back to them and answer them and take somebody else's question, that is fine.

Okay, why don't we do that?

Todd Schwartzman, Sidoti & Co.

Given your raw materials outlook for the year, how achievable is that 34% gross margin for full year of fiscal '07?

Well (multiple speakers) I don't think we have established a specific target for gross margin for the full year. Most of our discussion is revolved just around the quarter's period of time. But I think the thing to talk about in gross margin, you are going to have -- the biggest impact is going to be the raw material prices that Beth described. That is the one, which is going to tend to be a negative impact to us. Offsetting it, we continue to do the improvements as we have in our lean manufacturing processes throughout the facility.

As well, I think the other factor will be how well can we do it capturing price increase which came up earlier as well as we have not made a decision on another price increase. But obviously if we continue to see raw material costs up there and we see others in the industry move forward with price increases, that will give us more confidence that we can do something on the pricing end. But I think -- we think getting to the goal of next year won't be just about seeing gross margins stay up at that level though. It is going to be a combination of that and getting leverage at the operating expense line as well. So it will be a combination of things.

And what should we expect to see with respect to steel prices for the full year?

Full year in '07?

Yes.

We don't have a full-year estimate for steel; it depends on what is going to happen. We do expect it to increase. And in the first quarter, we expect to see an increase of I think probably 1 million or $2 million in steel. We are continuing to manage those costs and look for other ways to save it.

Is it safe to say that your Q2 guidance assumes no further share buybacks?

We've only given Q1 guidance.

In Q1?

Yes, Q1 guidance?

No, it includes some share repurchases. We have continued to do share repurchases. And we've said that this next year, we expect to work our cash balance down to that 60 to $65 million. So you can't assume that there will be additional share repurchases during the year.

Great, that is all I have got.

I want to go back a minute to the incentive comp. Incentive compensation in fiscal '06 was about $51 million compared to about $33 million last year. Expectation for next year would be closer to the last year number, the fiscal '05 number.

Matthew McCall, BB&T Capital Markets.

Let's see. In the gross margin outlook, I know you did not give a real outlook for the full year, but can you give us some kind of idea what -- refresh our memories about what benefits the price increases should continue or how long that you should see price increases flow through? I'm sorry if I have forgotten that.

I think if you look at in total for next year, we do expect to make progress on our operating income goal of 11%. So we hope to get closer towards that 2010 goal of 11%, and we hope to see expansion on both the gross margin line and that operating expense line or improvement in both of those.

The price increase we're still seeing roll through the numbers if you will when you're comparing year over year was related to a price increase we did in September of '06 -- no, '05 -- fiscal year '06. This was September '05 calendar year-wise if you will. So we will continue to see year-over-year comparisons on that that will look a little stronger probably until we got up until end of Q2, somewhere in there.

Because that -- what was announced and implemented in September, of course it takes a couple months, maybe two to three months before it starts to really impact the numbers if you remember much about it. Even think until about midway through the third quarter. We don't right now anticipate doing another price increase in the first half of the year. We think if we do one, it will probably be sometime in the second half, largely because we have a number of as you know new products coming out and the marketing team is pretty focused on getting that stuff in front of customers. But we think if we continue to see a favorable environment for it in terms of others doing price increases, which (multiple speakers) trend, as well as we continue to see commodity prices being unfavorable, we think that there will be more -- we will get more confidence with the fact we can do one. But that will be a decision we will make as we get closer to our second half of the year.

You mentioned the new products and I think you talked about more to come. Should we expect -- I know you talked most of the new products that were introduced at NeoCon, you have already seen most of those expenses flow through. I guess there will be some trickle through because NeoCon actually occurred in June, so there will be some incremental expenses in Q1. But going on through the year, what other products are you go to introduce and what do you think the magnitude of those product introduction expenses is going to be?

Well, first of all, the launch costs are not just even really contained around NeoCon. Because of course beyond NeoCon, there's also getting product in the dealer showroom, training a sales force, all of those kind of things. So what ends up happening is NeoCon is such a big event -- and even without NeoCon, the fourth quarter would have been big for us simply. Because whether NeoCon was there or not, sort of at that really big spot of completing a lot of the R&D work -- more driven quite frankly by getting the products to order entry than it was to just get them out there in front of people. Okay? You know I don't think we will see -- I think R&D -- what have we got for R&D next year guys (multiple speakers)?

R&D costs this year were about $43 million. Last year, they were about 40 million. Next year, they will probably be in that similar range. Because if you remember, these products take more than one year to develop.

Yes, we are not expecting a major ramp up in R&D from here. It will flow up kind of (technical difficulty) so to speak. But what will probably be greater next year actually more than R&D dollars will probably be on the (technical difficulty) side for a lot of the past new products. This year, we will have more what I will call exploration costs with getting products up to the point of business plans largely. And then, it will start to really hum in the second half of the year. I don't know if that answered your question exactly.

If you look at our first-quarter guidance that we gave on the top line and EPS and look at the other components of it, gross margin is probably somewhere between that 32.5 to 33.5% operating expenses, somewhere in the 102 to $106 million. And then our operating income was 9% for fiscal '06. As I said, our intent is to continue to get it closer so that we can hit that 11% target by 2010 or (technical difficulty) 11% by 2010.

But did I understand you were hoping to approach that target this year? Did I misunderstand that?

Not getting all the way there but getting us partway there again -- a definite continued expansion in operating income for the year.

(OPERATOR INSTRUCTIONS). [Peter Wolstrom], Goldman Sachs.

This is Pete on behalf of Chris Agnew. A quick question for you on the pre-tax ESO of less than $1 million, was that for the first quarter or for the full year?

Pre-tax ESO?

Yes, you were starting with FAS 133 expensing the stock options going forward?

(multiple speakers) expensing of stock options -- sorry about that. And what was your question?

For the pre-tax and the impact, were you expecting less than 1 million just for the fiscal year first quarter or for the entire year?

That was for the first quarter.

Okay, and do you have some sense for the full year?

For the full year, the year-over-year increase I think is about $3 million -- about $0.03.

Okay, that sounds good. Then with the operating margin impact, most of it was expected. Where were you actually surprised and how do you account for this going forward?

What we expected to increase was the R&D and the marketing dollars. The places where we had sort of the unanticipated increases would have been in the warranty, bad debt and legal areas.

Okay and any sense of that going forward?

Certainly, we don't anticipate it at the level we saw in the fourth quarter going forward. This is one of those funny things that you want to say it is unusual. But in fact warranty, bad debt and legal are part of doing business at the same time. So it is hard to describe it as unusual. For instance in legal, part of it was we're getting ramped up in China and we have a fair amount of costs just figuring out the legal structures over there.

So it was more than we expected, and we did not know -- really expect it all to hit in the fourth quarter. It was just a little higher than we had thought. I would say just overall, we are just redoubling our efforts with the overall organization to say we have got to continue to see leverage on the operating expense line as we move forward to get to our operating income goals and particularly to be able to fund the investments we need to make strategically around both new products and new markets. And the organization is committed to figuring out how to do that.

(OPERATOR INSTRUCTIONS). It appears that we have no further questions at this time. I would like to turn the conference back over to management for any additional or closing comments.

This is Brian. In closing, fiscal '07 was a great year for Herman Miller. We exceeded our top line and earnings goals for the year. We continued to drive improvements in operating earnings, and we made some terrific progress towards implementing our strategy. This progress included a portfolio of award-winning new products, development of new positions in emerging geographic markets and the commercialization of new ideas from the Herman Miller creative office. Last, we assure you that we are focused both on implementing the strategy and delivering results in the near term. We hope you have a great summer. We will see you after the first quarter.

Thank you. Once again, ladies and gentlemen, that concludes today's call. Thank you for your participation. You may disconnect at this time.