MillerKnoll Inc (MLKN) 2007 Q2 法說會逐字稿

Good morning everyone and welcome to this Herman Miller Inc. second-quarter fiscal year 2007 earnings results conference call. Today's 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 statements. These risks and uncertainties include 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 Mr. Brian Walker, President and Chief Executive Officer. Ms. Nickels and Mr. Walker are joined by Mr. 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 questions. We will limit today's call to 60 minutes and ask that callers limit their 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. 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 results. We will keep our prepared comments brief so that we have time for any questions you may have.

As you have already seen in our press release, we had another great quarter; in fact, a record quarter for earnings per share. We closed the quarter with $0.56 in earnings per share, surpassing the $0.54 we earned back in 2001 when our sales were 23% higher than they were this past quarter. These results clearly demonstrate the positive impact of the changes we made to our business model to drive our higher level of operating income, coupled with our efforts to change our capital structure and reduce our share count.

On the top line, our orders remained very strong throughout the quarter. The average pace we saw in Q1 even accelerated during Q2. Our weekly orders for the quarter averaged more than $40 million for the first time since 2000. It was also the second quarter in a row that we topped $500 million in orders. This high level of orders allowed us to build a substantial backlog as we head into Q3. We ended the quarter with a backlog of $324 million, a 21% increase over the prior year Q2, a 10% increase over our first quarter. As a result, we are confident our Q3 sales forecast for growth of 13% to 18% over the prior year.

Our strong performance did not stop with the top line. We were able to continue to grow our gross margin percentage, reduce our operating expense percentage and also to record operating income 11.8% for the quarter. While we have reached our 2010 goal of at least 11%, we're not yet prepared to set a new target.

We have a growing level of confidence in our ability to sustain operating income at 11%. Our ability to drive higher levels will in part be impacted by the mix of new products and new ventures, which have lower operating income during ramp-up.

I also want to remind you that as an EVA company, our primary goal is to drive more dollars of operating income over our capital base. The higher level of earnings per share and a lower revenue base is reflective of this improvement.

We continued to face headwinds this quarter from increased raw material costs for steel, plastics, wood and aluminum, although we are optimistic as we look ahead to Q3 that we have passed the peak for raw material costs. In addition, with the startup of several new products, we're still working through some learning curves on the manufacturing floor. And, we are also continuing to invest in our new manufacturing capability in China. It is just about ready to go and we should begin building chairs there early next year.

Also, as you can see from our operating expenses, we continue to fund the high-level investments in research and development. We're very encouraged by the excitement and order activity we're seeing from the products we released this year and we are committed to build on that momentum.

This quarter, we formally launched a new business called Convia. We had previously described it to you under the code name Purple. It's our second subsidiary birth from the Herman Miller Creative Office. It represents a modular programmable electrical and data infrastructure for building interiors that delivers plug-and-play power and data access virtually anywhere within a space without requiring the hardwiring of devices or switches. It allows users to create flexible, sustainable environments that can be easily modified or upgraded. The excitement at the Greenville show where it was launched was tremendous.

We also continue to closely monitor the economic news. The macroeconomic drivers of our industry have remained favorable, namely corporate profits, nonresidential construction and office vacancy rates. It also looks like the Fed and Wall Street are betting that a recession next year is unlikely. This provides us with confidence in our ability to meet our strategic goal of reaching $2.6 billion in revenue by 2010.

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

Thanks, Brian. Once again, we hit the targets we established and even set some new records here at Herman Miller. We were at just about the middle of our projected sales range, at $499 million, thanks to solid performance in North America and an outstanding effort in the international markets.

As Brian mentioned, our gross margin performance improved to 34.1% and our operating income as a percentage of sales was above our 2010 target of 11%. As a result, we ended up delivering $0.56 of earnings per share, our highest ever recorded in a quarter.

Now let's get into the specifics of sales and orders. Sales of $499 million provided for both year-over-year and a sequential growth in our top line. This represents our 12th quarter in a row of year-over-year growth and our highest level of sales since May of 2001. Sales increased almost 14% from the prior-year same period and increased 11% from the first quarter.

Orders were an even better story. As Brian mentioned, this was the second quarter in a row our orders topped $500 million, something we haven't seen in six years. Our orders totaled $529 million for the quarter, an increase of 22% over the prior year same quarter. They also accelerated from the high pace we saw last quarter, increasing over 5% from our first quarter numbers. This represents the 13th quarter in a row of year-over-year growth and the highest level of orders since November of 2000.

Our North American business posted a year-over-year gain in orders of almost 20% for the quarter and an increase in sales of approximately 8%. There were three main reasons for the gap between this quarter's orders and sales.

First, a good portion of our business in the second quarter is government-related. As we have mentioned before, we work with the government on a direct basis. Accordingly, we recognize revenue upon completion of the installation, not just when the product leaves our docks, which is the case with our standard dealer business. At the end of this quarter we had $13 million more than last quarter in government business that was shipped but not yet recognized in revenue as it wasn't completely installed. This shows up in our backlog and also in our inventory, which I will talk about later.

Second, we had between $6 and $9 million of product sitting in trucks waiting to be big up by carriers at quarter end. Much of this was due to a snowstorm that blanketed the Midwest that weekend and didn't allow the carriers to pick it up before our cutoff.

And third, in the prior year, we had a price increase effective at the end of the first quarter. This pulled ahead a significant amount of orders into the first quarter of fiscal '06 and out of the second quarter fiscal '06, so our comparable orders for the prior year's second quarter were lower. That is a lot of detail, but the important message is that our year-over-year increase in orders is fantastic, even if you adjust for last year's price increase, and the orders we didn't ship are still in our backlog and will make for a great for third quarter.

Our business outside of North America demonstrated phenomenal performance again this quarter with sales up almost 70% year-over-year. I think that bears repeating -- sales outside North America increased 70%. In addition, orders increased almost 40% from the prior year. We continued to see broad over overperformance across most regions this quarter. France, Italy and Singapore all reported substantial increases in sales. We are seeing growth not only in multinational accounts, but also in many large local companies. In fact, of our top 10 international customers this quarter, only two were on our U.S. global account listing. We're doing a great job of diversifying our business as a result of some new and enhanced international product offerings and a more extensive distribution channel.

Let me give you a quick update on some of our new products. My Studio Environments has orders and commitments that put it right on track with our initial business plan estimates. We have recently won two additional awards from U.S. trade magazines -- Interior Design Magazine Best in Systems and Building Magazine Top Product Picks of 2006. And on the international front, My Studio was named the Best Workspace Systems at the FX International Interior Design Awards last month in London.

The product has been successful at opening doors to key influencers in A&D community with whom we have not connected well previously.

The other new system, Vivo, is performing beyond our initial expectations in terms of volume. Activity is high and our win rate is high. It's helping us to win smaller size projects and in geographic markets and competitive accounts where we have not been successful in the past. In January, we will be launching an Aeron work stool. It has sparked great interest at our prelaunch activities and won the Attendees Choice Award at the National Ergonomics Conference and Exposition two weeks ago.

Brian already mentioned our Convia launch, so I won't go into further detail on that one. Overall, we couldn't be more pleased with the great performance of our expanding new product portfolio.

Now regarding our backlog -- ending consolidated backlog was the highest since November of 2000. It was $324 million, up 21% from last year's second quarter level, and up over 10% sequentially from this past first quarter. As I mentioned earlier, our backlog benefited from government business that has not yet been recognized in revenue, and also product that was in trucks but not picked up by our carriers before quarter end. But again, the year-over-year increase is impressive, even if you factor out these items. Our high backlog augurs well for a strong third quarter.

Now let's talk about gross margin. Gross margin at 34.1% of sales improved substantially from the prior year's second quarter level of 32.8%, and up slightly 0.2 of a point from the first quarter level of 33.9%. We continue to see the favorable impact of the pricing changes put in place last year. In addition, we gained significant benefit from the leverage of overhead due to additional volume generated both year-over-year and sequentially. In fact, our overhead costs as a percentage of sales were also a record low this quarter.

Raw material commodity prices overall had an unfavorable impact on gross margin this quarter compared to the prior year, but were pretty consistent with what we saw last quarter. Once again, we experienced increases in aluminum, wood, plastics and steel. The good news is that if what we are seeing in the market today holds, the year-over-year impact from commodities should be less in the third quarter. It will still be a year-over-year increase, but not [as significant] as we have seen in the last two quarters.

Our transportation and distribution costs declined again this quarter as a percent of sales from the prior-year second quarter, and also sequentially from the first quarter of this year. We benefited from lower fuel costs and also a moderate shift from higher-cost transportation lanes to lower-cost lanes. We also continued to make progress on our initiatives to increase cube utilization, increase consolidation of shipments and increased capacity with lower-cost carriers. Clearly, we are seeing the benefits of great work by our distribution team.

I also want to provide some additional insight into the startup of our manufacturing plants in China. As we discussed last quarter, we're on a fast-track from breaking ground to manufacturing. Currently, we're actually ahead of schedule and plan to begin manufacturing chairs in January. The building is finished, we have inventory in stock, the computer systems are in place and we even started limited selling of imported product in R&D this quarter. So far this year we have spent approximately $725,000 in overhead and distribution costs to get this plan up and running.

The good news is that the outstanding performance in the rest of our Asian operations, like Singapore, Australia and Japan, have more than covered the startup costs in China. As a result, we've been able to remain profitable in Asia in total, even while starting up an entirely new manufacturing capability.

Let's move on now to operating expenses. For the quarter, operating expenses were approximately $112 million, or 22.4% of sales, compared to $100 million, or 22.8% of sales last year. Most of the increased spending in the current quarter was a result of research and development costs associated with new product initiatives, new business introductions, variable selling costs driven by the higher sales levels and incremental employee compensation and benefit costs. We were also impacted year-over-year by FAS 123R, the stock-based compensation accounting standard. We recorded $1.1 million stock-based comp costs compared to approximately $600,000 in the prior-year under APD 25.

When you roll this all up, operating income rose to 11.8% of sales, up from the 10.1% recorded in the second quarter of last year and up sequentially from the 10.2% recorded in the first quarter of this year. It's the highest operating income percentage we have reported since the fourth quarter of fiscal 2000 and represents the first quarter we've broken through the at least 11% operating income goal that we established as part of our 2010 strategic plan.

Our effective tax rate for the quarter was 34.6% compared to 32.7% in the prior-year second quarter. You may recall, the prior-year effective tax rate was lower than normal due to the recognition of a deferred tax asset and refund from our Japanese tax return. The current year effective rate does not include a federal tax credit for research expenditures. Congress passed this extension package after the end of our quarter, and as a result, it will be picked up retroactively in the third quarter.

Consolidated net earnings for the quarter were $36.6 million, or $0.56 per share. This represents a 40% increase over last year's EPS and is an all-time high earnings per share for Herman Miller.

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 drove a source of funds of $30.6 million this quarter as compared to $44.2 million in the prior year. The year-over-year change was primarily due to an increase in working capital requirements for accounts receivable in inventory. Accounts receivable increased almost $19 million over the first quarter. The increase was in support of the higher volumes in both our domestic and international markets. As we mentioned before, our international entities also have traditionally longer terms and collection cycles. Our North American accounts receivable DSO is down from a year ago and our North American AR greater than 60 days is also at a five-year low, so we don't believe there's any deterioration in the quality of our AR.

Inventory increased by about $14 million over the first quarter. It's important to note that in our business model, all of our orders are based on a specific customer request. And as Beth mentioned, a large portion of the inventory buildup was due to a federal government work in process and also shipments in trucks at quarter end that did not get picked up due to weather-related transportation constraints that weekend.

Capital expenditures for the quarter were $10.2 million, down from $11.6 million in the prior year. This is an area where HMPS initiatives continue to have an impact, not only in our facilities, but also at our vendor tooling as part of the first mile HMPS work we're undertaking with our suppliers.

Moving onto our liquidity and cash position, after buying back a significant amount of stock last quarter, we did moderate our share purchases slightly this quarter. We bought back approximately 90,000 shares at a cost of $30.7 million for the quarter at an average price of $33.77 per share. We still have approximately $126 million remaining on our Board authorization. Our ending cash balance was $52.7 million, which was in the range of the overall targets we've established as part of our capital structure plan.

It is also important to note that we still have a lot of financial flexibility in our balance sheet. Our debt levels are now down to only $180 million, or approximately 7% of our total enterprise value, and we have approximately $137 million available capacity on our bank revolver.

Thanks, Joe. Let's turn to the outlook for the third quarter of fiscal '07. We ended the second quarter with a very strong backlog which provides us with a solid base as we enter the third quarter. It's also important to note, we've announced a price increase that goes into effect at the beginning of February. Historically, we've seen orders pulled ahead in advance of new prices. This should help our order rates in the third quarter. Offsetting this to some extent will be the company-wide shutdown that is scheduled for the week between Christmas and New Year.

Taking all of this into consideration, we anticipate another strong quarter with sales in the range of $480 million to $500 million, representing an increase of 13% to 18% over the prior year.

In terms of earnings guidance, we expect earnings per share between $0.50 and $0.54, which represents an increase of 52% to 64% over the reported EPS of the prior year, once again demonstrating our ability to drive great leverage from our top-line growth. This estimate includes a projected earnings per share impact of approximately $0.01 related to the extension of the U.S. research tax credit.

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

(OPERATOR INSTRUCTIONS). Budd Bugatch, Raymond James.

Good morning, and congratulations on a good quarter and an even better outlook. Just two questions. The weekly order pacing was terrific for the quarter at just I guess under about $41 million. Can you talk about how that progressed over the quarter, what it looks like moving into this quarter?

It's always a little bit stronger in the first part of the second quarter because you have a lot of the government business that pops into that -- the end of the federal government fiscal year, and so you get a little bit of a bump in that earlier part. So it does tail off a little historically throughout the end of the second quarter. But once you got through the government season, it got fairly consistent, is the way I would describe it. This is the part of the year though that always is a little hard to read, because December also is sort of a funny period of time. So I think we'll have a better read once we get back from the holidays really about what the rest of the year looks like. But I would say, generally consistent, especially in international. The U.S., you do get that kind of pull forward in the first month or so because of the federal government.

You and I talked about this quarter being essentially, instead of a 13 effective weeks, almost more like 12 effective weeks.

You got it. And you not only have the shutdown, you do have this kind of -- a little bit of -- people start to turn their attention to other things, even in these first few weeks. So it's always one of those that we'll know more when we get back. Again, we haven't seen anything trend-wise that would tell us it's different, but it is a little lumpy.

And in terms of the project funnel and customer activity, that still stayed extremely strong.

And the percentage of business is still close to 50/50, or 45/55?

Project business is very similar to I think to where it was last quarter, in the low 40 percentile, I think, 43 to 45.

44% for the quarter.

My follow-up has to do with the 11.8% versus the 11%. And I know your reluctance at this moment to kind of beat through your target, but 2010, I would remind you, is still a few years away and you have beaten that threshold. I might ask if you're going to get to your doubling threshold that fast, but I don't think I will. I'd rather just talk about the margin threshold. What is the key to not raising the threshold or to maintaining that? What is the issue there?

As I said to you in my prepared comments, there's very much a growing level of confidence in maintaining it at that level to where we are at right now. Again, you might see some movement around quarter to quarter of course, but I think overall, we're pretty comfortable that this level, the 11% can be consistent. Here is the one thing you have to remember. We run up the margin curve faster than we expected, largely because we ran up the volume curve faster than we expected. And as I've always said to you guys, if we get a bigger increase in sales in a shorter time horizon, the leverage factor is actually stronger at that point. It happens sort of naturally because you don't get some of the inflationary pressures built into that. So we're ahead of schedule because of the higher revenue.

I think the question that we still have to evaluate is, as we got lots of new product launching which are going to become a bigger part of the mix I would guess as we move into the second half of the year. We also some of these new ventures, like Convia and others that in the beginning will tend to have lower operating margins. So what they do to that mix question to really be able to push it up I think is one that we have to continue to evaluate, as well as, we are just in the process of kicking off our planning for next year and looking at what are the key strategic investments we need to make. So I would say we are confident and positive about where we have gotten to. We're pleased with it, we think the folks are doing a good job, especially the margin number has been better than we expected. So assuming raw materials hang in, we don't see anything crazy going on there and we continue to see good demand levels, 11% looks pretty doable from here of course. Then the question is where we go from there, and we will know more as we kind of close out this year.

I have a bunch of other questions, but I will ceded the floor and come back in queue if I can.

Todd Schwartzman, Sidoti & Company.

How much of, in retrospect now, how much of last year's price increase have you realized?

I think in terms of percentage, we are probably at about that 20% to 40%, around the one third of the price increase, and that has always been our goal if we can drop that much of it, we are pleased.

For the current quarter, Todd, probably we gained somewhere between $6 to $8 million as a net improvement in our gross margins as a result of pricing. So I think as Beth said, in total, we're running probably around that third to half of what we actually were expecting to get.

In terms of your planned increase, list price increase for February in percentage terms, about the same as last year's?

Close to -- I think it's about 4%.

How should we think about the tax rate for the back of this year?

I think for the full year this year, we are saying between 32.5% and 34.5%. I believe next quarter, it's probably in the 32% to 33% because we have a little bit of catch-up from the research credit.

Okay. And finally, can you give us a little color on the Aeron work stool?

Todd, it's essentially the same chair, if you will, from the top up. The innovation is in the way that the mechanism works to enable to the place you put your feet to be able to come up with the chair as it rises, which doesn't sound like a big deal, but it is for people who use stools, because often they find their feet sort of dangling off of the chair, so they get it up to a higher level. It is one of those great product extensions off of a fantastic brand that is not a huge amount of money, but in fact, it's a problem that heretofore has not been solved well by anyone, we believe, and in fact hasn't been solved well by us with Aeron in particular. The cool thing about this, this idea is also platformable, so will be able to look at it in terms of our other seating lines too, which will give us essentially a portfolio of work stools eventually, as well as task seating.

And what will this product initially list for?

I don't remember off the top of my head. It's an up-charge off of the basic Aeron price, and I don't remember that off the top of my head, Todd.

Thanks a lot, guys.

Matt McCall, BB&T Capital Markets.

My congratulations as well. Let's talk about international growth a minute. The order run rate is going to 120 per quarter, up from the low 80s last year, pretty impressive growth obviously. When you start talking about your goal for $2.6 billion on the top line in -- or fiscal year [10], what does that order run rate, or what does the international market look like as a percent of that total?

There are two different ways we define international, and historically in our disclosures, we have designed international to include Canada and Mexico. Beginning last year with our 10-K at the end of the year, we started to disclose how we were doing it from a management perspective, or how we managed the business, and that puts Canada and Mexico into the North American business. Now in our disclosures, you will see both numbers. The percentage increases I was giving you related to the management definition of international, which didn't include Canada and Mexico.

Just to provide you a little bit of clarity there, Matt, on that one, if you were looking at it the way we were reporting it, last quarter, we talked about it from more of a location-specific U.S. versus non-U.S., if that's how you were looking at it. Our non-U.S. numbers really were an increase of roughly in orders 23%. So not pacing at the $120 million number you said, but really pacing it at about a $105 million number is what the order numbers were for the quarter.

Okay. Thanks for that. I guess I'm trying get an understanding on what you see, how important, obviously it's very important, but how important the international segments are to that $2.6 billion number, and what it looks like as a part of the whole pie in 2010.

It's definitely growing. Our international sales, using the management definition, were 14% of our consolidated sales this quarter versus 10% last year.

It's not as if we expect that to become like 50% of the mix or anything. I think it will be bigger mix, but it's not -- we don't have a view that that's going to be -- our bigger goal that we set, rather than mix of U.S. versus domestic, was what kind of growth could we get outside of the core North American office furniture business. So we've really set our sites in saying, it's not just about domestic versus international, it's what can we do in health care, what can we do on the retail side and some of those new ventures. So, one of the reasons you hear us hesitate a little bit, we actually haven't really as much targeted that as looking at specific markets we want to enter in international, rather than trying to say, this is about a blanket global strategy.

Okay. Joe, we have talked in the past, I think you monitored to your sales force some construction project updates and if you were seeing any types of delays. I think there has been some rumblings about what does the non-res cycle look like. Brian, you had some good comments about the macro environment overall, but Joe, that specific measure that you have mentioned in the past, can you give me an update on what your sales force is seeing from a project standpoint on the construction side?

I think from a construction side, what we are seeing is our architect and design clients are still hiring. The actual number of projects in the funnel is not decreasing and the sales force is consistently saying they have not seen any changes in demand in the recent term, and lots of big projects still out there in progress and haven't heard of any of them being pushed off at this point.

I think that to your specific point, Matt, we have not heard, at least I have not heard of anything of any specific size being canceled or delayed unless it's one of those, it's because the building is just late coming out of the ground or something to that effect, which of course just kind of in the normal course of things. But we certainly have not heard any news about major changes in tone.

Okay, that is encouraging. Finally, without trying to ask for some Q4 guidance here, just want to -- just looking at the normal seasonality, it looks like Q4 historically looks a lot like Q2, and I'm not necessarily talking about the top line, although you have given some good indication that things look good. More from a margin perspective, it looks like Q4 has historically been a little bit stronger from an operating margin perspective. Can you remind me why that is the case and why it might or might not be the case in Q4 of this year?

In the fourth quarter, we tend to have higher operating expenses because of NeoCon and a lot of new product launches that end up coming out at the same time. There have been times I think in the last couple of years where we have had some year-end adjustments due to -- we had a GSA settlement that was favorable, a couple of different things like that. But I think that the margins are normally sort of volume-driven, so it would be more tied to any increase and volume.

I would tell you, Matt, I don't think that is driven by any particular seasonal trend or overriding factor. It's probably just happenstance, quite frankly, that you see a margin change in the fourth quarter, unless it is driven by volume. In fact, I would reiterate that point. If nothing else, in fact, anything else withstanding, in fact, you might normally see it go the other direction because of some of the year end push around the industry trade show and products getting out and those kind of things. But even those I would say, by and large, there is nothing about that quarter that drives any kind of seasonal change.

So on a comparable top line, there is really no reason, other than NeoCon. If you saw some spinning there, there's really no reason that Q4 margin, the operating margin, could not approximate or approach the Q2 level you just reported?

The operating expense number is usually pretty significant. In the fourth quarter, I think it's usually a $4 to $7 million increase over that prior quarter.

Over Q3?

Yes, I think it's over Q3 usually, it sequentially increases a significant number.

The other thing is, Matt, as I said in Budd's question about operating margins, we do expect that we'll see a higher mix of some of those new products as we get out there, and we are still going to be kind of ramping up in terms of efficiencies on the shop floor, getting through those kinds of things. So while the products are doing great in terms of serving customers and getting to them on time and with great quality and all of the rest of it, it's still, like any new product, you still have a period of time where your margins are ramping throughout, then you have an oversized sort of capital base and labor base as you're working your way through those kinks. But I think, as Beth said, you also do tend to have a higher level of investment in R&D and marketing stuff in the fourth quarter if there is anything, but that's all driven around being ready for those year-end launches.

Thank you very much.

Chris Agnew, Goldman Sachs.

First of all, in manufacturing in China, is it purely for the Asian market, or will you be looking to import some manufactured product there into the states and into Europe?

Chris, the primary thing we're doing there is to try to serve the Asian market, not just China, but also Northern Asia. We have had a source that we've worked with as a partner for many years in Korea. A lot of that is moving from Korea to China because it's obviously less expensive today to be in China than it is Korea. And, we also see China as kind of a big developing market that we wanted to be close to in terms of lead time and those kinds of things.

Majority of what we do in manufacturing, as you know, is we are largely doing assembly. And my belief is, you always need to be assembly as close as possible to the customer to give them great lead time with a great degree of variety. So I don't expect we'll be bringing whole products back from China to the U.S. What we hope will happen of course is that at the same time that we're serving the Chinese market, we'll be able to develop and even more develop supply base in China, which will probably have some impact on components going both to U.S. and to Europe. I should point out to you that we have been sourcing in China for many, many years. So there are components in every one of our products that come from the Far East today. So that is not completely new and a wholesale change. But of course, as we get closer and more integrated into that marketplace, I'm sure we will find new opportunities that we have not found yet.

Okay. And next question, does your outlook include a positive impact from the weaker dollar? And, can you maybe just walk me through and help me think broadly how the weaker dollar, particularly against the Euro and the pound, helps you?

Yes, it does, we roll it in. Although I have to be honest with you, it has not been a substantial impact to us. As an example, for the quarter, it increased our sales by roughly around $3 million and it increased our operating income by only about $0.5 million. So it is included in ours, but I have to tell you, it's not a significant number.

Those numbers are for the quarter coming up or the quarter past?

That's for the quarter that just passed.

But I think after, there's a significant move in the dollar after the quarter closed, or right at the end of the quarter, wasn't there?

Yes, but we have not factored any of that significant move, per se. We have just taken -- as we did the forecast, what we do is we look at a snapshot of what we saw the quarter before and assume somewhat a continuation of that.

Okay. And is there any long-term impact to the tax rate from these research tax credits, or is it kind of more of a onetime item?

Ongoing, it is about half a point in the tax rate per year.

So relatively limited.

The R&D credit that was extended was for a two-year period of time, so it was calendar year 2006 and calendar year 2007. So it will impact our taxes for both of those two years.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS). Tucker Anderson, Cumberland Associates.

Once again, thanks for the quarter, it was fantastic. A couple of detailed questions and then a more general question. The first question is, Beth, when you referred to $0.01 impact of the R&D extension for the third quarter, is that a retroactive additional impact that normally would have been in the second quarter, or is that the total impact for the two quarters combined?

It's the total for it combined.

So it was basically less than $0.01, therefore, that was transferred from one quarter to another? Second, Brian, in your comments, you said you thought we're past the peak of raw material costs. And Beth then said, the rate of increase year-over-year would be less. Now I can reconcile those comments in two ways; that is, that you were saying what Beth was saying, or that you actually think we're past the peak of raw material costs, but because of the lagged effect, we are not going to see that on a year-over-year basis for a couple of quarters. And I wasn't sure which you were saying.

We believe the costs have leveled out and hopefully will start coming down a little bit. On a year-over-year basis, this quarter, the total impact of the commodity increases was about $4 million. In the next quarter, we expect that to be about a $2 million year-over-year increase.

But not a drop from Q4 -- from Q2 to Q3.

No, I did not think that, but I didn't know whether you were saying going forward, and Beth was saying, at least you think maybe they have also leveled absolutely.

The other question is a broader question that Budd pursued a little and then some other people pursued a little in terms of the margin question. And I understand the mix issue and ramping up the new products and things like that, but I guess my other question would be -- as you look forward and as you point out, your volume and your backlog and your orders have been a pleasant surprise and your leverage has therefore worked in your favor. Are there additional investments that you might consider making? And I'm not just talk about bricks and mortar, but I'm talking about R&D and things like that. And in affect, as part of your reticence to raise your margin targets at this point, besides the fact, this is new and you're in the planning process, that you may reinvest some of that margin to drive future growth now that you're pretty comfortable that you're going to be at least at the 11% level?

Yes, Tucker, I think that's the consideration. What I don't want to do though is, we've heard some people say, Herman Miller has this absolute target on 11%, and they're not going to -- anything above that, they will reinvest. I don't want anybody to have that impression, because that's not where we are at as a team. On the other hand, we're also going to be smart about where we're trying to get on in the long run. And as I said, our goal is to drive dollars of EVA. And in some cases, that might mean in some markets, the margins are not quite as high as they are here. But if I (indiscernible) over the asset base, hallelujah. But your point is right on, is what we are looking at is, we have ambitious plans not only in Asia where we're doing it in China today. We also have them with Convia and in our health care business. So I want to make sure that we're not jumping to conclusions until we get a chance to look at all of those things. We have a very healthy R&D queue right now, we are really happy with what we launched this past year. We are as enthusiastic about the stuff we have in the queue for the upcoming years. And it doesn't make sense to me to just make the decision based on what we're going to try to do in the next two quarters in terms of operating percentage as much as it is to make sure that we're going to be healthy and growing for the next five to 10 years.

I wouldn't have been disappointed if the answer was any different, but I wanted to ask the question, because as you know, I'm there for that long term, as you say, EVA, and I've been there for 30-plus years. So I am happy to hear you say that, because to me, it is all about long-term profit dollars and long-term ROI. So I would encourage you, if there are things at the research queue from my standpoint, run from right now.

Thank you.

Budd Bugatch, Raymond James.

I have just a couple of kinds of questions. First of all, the government business, Beth, that you said that was embedded in the backlog, that $13 million that I think will go into this quarter -- how does that compare against last year? What is that number?

Let me look at that. The $13 million was an increase from sequentially. On a year-over-year basis -- do you want to ask your next question while I look for that?

Sure. Just talk a little bit (indiscernible) -- can you characterize any of the discounting we're seeing? I don't think we've talked about that, or at least if we have, I missed it.

It's pretty consistent, Budd. We're not seeing a lot of movement one way or the other. Of course, it's going to inch up a bit as it eats into a little bit of that price increase, as Beth mentioned, because we're not capturing all of it. But net-net, pricing is reasonable. I don't think we have seen -- if demand is good, which makes sense, it has stayed fairly consistent.

So it's rational?

Yes, rational, and as we've come out with new products that hit the different price points, it has been I think easier for us to answer the market's concerns.

And we have seen over the past couple of years, from your product portfolio, we have seen systems decline as a percentage of three categories in the states that you would monitor from I think about 47% to 43%, and obviously, seating therefore picked up a lot of slack. How would you characterize that trend now?

In terms of our product mix, our product mix this quarter has hardly changed at all. In terms of a longer-term trend, I'll look to Brian to see if he has any.

Budd, what I would [say to find a way], we actually had an interesting little slip a bit in this quarter in that our product mix was fairly consistent, especially in the U.S. In international, in fact, we have actually seen an improvement in our mix of systems, if you will. We've seen more weighting there largely on the strength of some of the new products we've done in that marketplace. So that we view as a positive, because (indiscernible) able to get after some of the installed base question beyond just what we can do on the seating aside.

Longer-term of course, that investment that we've made this past year in systems I think will drive our systems percentage back up, would be our hope. Of course, it's not just systems we wanted to see grow, we want to see seating grow and as the rest. So if the mix stayed the same and we saw all the products move, I would be okay with that, but our investments going forward, we'll start to look at some of those other categories as well and try to bring the same kind of revitalization we've done in the systems to both storage as well as seating, and then some products in international as well. So we're trying to work on all of those fronts right now in terms of what comes next.

That was the genesis of my question. With the investment in Vivo and My Studio, you would have thought that perhaps we're seeing a little bit of a rebound in the systems penetration of your portfolio sales.

Probably not enough yet, because you know, those products are still in terms of sales, well Budd, we're getting great response to them and we're meeting our expectations. There's still in terms of the plan that we set for them, of course there still is a percentage of our sales not going to be that significant yet because you're still in that ramp-up phase. But that certainly is what we believe is going to happen. And in fact, what we are seeing so far would tell us, that is the direction it's headed.

Yes, if you want to talk about, even as a percentage of orders, we'll take it if you want to give it.

I'll jump back in on your question. The amount of deferred revenue this year versus last year for the government is about a $14 million increase this year versus last year.

So that is a big number. And my last question would be, Beth, I think you said, the overhead percentage of sales was a record low. Can you give us what that number is, what it moved to?

12.1%, I'm saying it from memory, so let me look it up.

No, that's correct.

12.1%.

What was it last quarter or last year?

Last year, it was 12.5%; last quarter, it was 14.3%. I'm sorry -- I had those two backwards, by the way. Last year, the first quarter, it was 12.5%. A year ago, it was 14.3%.

Gotcha. Thank you very much, congratulations again. Happy holidays to all of you.

(OPERATOR INSTRUCTIONS). Mr. Walker, there are no further questions at this time. I will turn the call back over to you for any closing remarks.

In closing, we've had another great quarter. Our new products are quickly gaining momentum. We've just launched our new Convia business and our China manufacturing operations will be up and running in January. We're very excited about the future of Herman Miller and we hope that you are.

I'd like to extend my personal thanks to the employee owners of Herman Miller whose continued dedication and hard work are making our progress possible. On behalf of everyone at Herman Miller, I would like to wish all of you a very happy holiday season and peace and prosperity in 2007. We look forward to sharing our third quarter results when we speak to you again in March.

This does conclude today's conference call. We appreciate your participation. You may disconnect at this time.