MillerKnoll Inc (MLKN) 2007 Q3 法說會逐字稿

Good morning, everyone, and welcome to this Herman Miller Inc. third quarter of fiscal 2007 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 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 our 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 we would like to begin the presentation by turning the call over to Mr. Walker. Please go ahead.

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 seen in our press release, we had another quarter of year-over-year double-digit growth in both sales and orders. We also ended the quarter with the highest Q3 order backlog in our history with growth in both our North American and non North American markets. And based on what we see in our business right now, we are forecasting continued topline strength into the fourth quarter.

As noted in the press release, we did experience more volatility in our weekly order rates this quarter. This was driven by the typical seasonality of the third quarter and was further exacerbated by our holiday shutdown and a price increase which was effective on the 5th of February. While the higher degree of volatility and a mixed macroeconomic picture in the United States increases the difficulty of forecasting, we are pleased with overall activity levels.

In addition, while most recent industry data has pointed to softer growth, the macroeconomic factors that drive our industry such as corporate profits are still favorable.

We believe Herman Miller's favorable performance is a reflection of the investments we have made in both new products and new markets. Our strategic intent has been to diversify the business. That is the path we headed down three years ago and we are making progress. This is best demonstrated by our international business, which grew 20% this past quarter and 30% for the first nine months of the year. This growth has been driven by investments in new products and expanding our distribution footprint, both contract and retail. We are extremely pleased to announce that our manufacturing plant in China is now producing and shipping products to new customers in China and the rest of Asia.

We are also pleased with the growth of our two new office furniture systems, My Studio Environments and Vivo, which reached different segments of the office furniture market. While the sales of these products are still modest in comparison to our total sales, they are gaining momentum.

We are also very excited by the prospects of our new business, Convia, our latest innovation from the Herman Miller Creative Office that was publicly unveiled in November. Convia is a modular programmable electrical and data infrastructure for building interiors that delivers plug and play power and data access virtually anywhere within a space at a fraction of the installation and ownership cost of traditional wiring solutions. To be frank, our operating income this quarter was not as good as we had expected. This is primarily driven by lower gross margins. Beth will cover this in detail, but the primary driver was simply lower production levels. We were also impacted by the cost of ramping up the production of new products and opening our new facility in China.

Overall our manufacturing folks continue to do a great job of improving efficiencies and offsetting the cost of rising commodities. Therefore, we expect to see improvement in Q4. Having said that, we will face the challenge of seasonally higher operating expenses in Q4 as we ramp up our marketing programs in advance of NeoCon. We also have a very full pipeline of new product ideas that will continue to require investment.

In summary, we had a very good quarter. Overall business dynamics are still favorable. We continue to invest in and make progress towards our strategy. And you can be assured we will continue to be diligent about managing our costs and investments while ensuring that we will achieve our long-term strategic objectives.

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

Thanks, Brian. With a 14% increase in sales, a 15% increase in orders, a 23% increase in backlog and a 52% increase in earnings per share, we have a lot of good things to talk about this quarter. But, as Brian mentioned, we also have some hard work ahead of us. The third quarter is traditionally a challenging quarter, and this year was no exception.

Let's get right into the specifics of sales and orders. Sales of $485 million represented our 13th quarter in a row of year-over-year revenue growth. Orders of $458 million represent the 14th quarter in a row of year-over-year order growth and also the highest third-quarter orders in six years. Both third-quarter sales and orders reflect the traditional seasonal decline from the second quarter. On a sequential basis, our third-quarter sales were down 3% from the second quarter, and our orders were down 13% from the second quarter. But it is important to note that our second quarter was our highest level of orders in over five years, though it was a challenging comp.

As Brian mentioned, we experienced increased volatility in our weekly order rates this quarter. The lower order rates in December and early January that we mentioned in the press release were one of the reasons we finished the quarter at the low-end of our forecasted sales range. As you know, there is generally a six to eight-week leadtime from the time we take an order to when it ships. The higher orders taken at the end of January and into February were not shipped within the third quarter. The good news is they are in the backlog and will help us in the fourth quarter.

Domestic sales of $386 million increased 14% year-over-year but were down 2% from the previous quarter. Our vertical markets of healing and home both posted year-over-year and sequential revenue growth. To give you an idea of that growth, the fast-growing market for the health care furniture helped increase our healing sales 26% from the prior year and 8% from the prior quarter. Sales for the home had a strong holiday season, posting a 48% increase over sales a year ago and up 13% from the prior quarter. A portion of Herman Miller for the Home's increased sales was due to the price increase. Non-North American work sales were up 20% year-over-year, aided by a weakening US dollar which favorably impacted the quarter by $2 million. European sales were up 29% year-over-year with broad overperformance across most of the regions. We are seeing this growth reach into Eastern Europe thanks to our continued effort to expand our dealer network.

Asia was another shining star for us this quarter with an increase in revenue of 48% from the prior year. Orders for Asia were even stronger with a 74% year-over-year increase and sequential order growth from the second quarter of 16%. As planned, this quarter our factory in China began both production and shipments within China. Truly an outstanding job by our operations team as this was accomplished in less than a year. And despite the startup costs in China, Asia in total was again profitable this quarter. We continue to absorb these inefficiencies within the region and pace our investments at prudent levels.

Mexico also continued its strong performance with sales up 35% from the prior year and 22% from the second quarter. We have enjoyed strong wins in both the private sector and the government. The wins pushed orders up 44% year-over-year and 10% higher than the second quarter.

Finally, we have also started to see some good progress in India. Sales are up 18% from the prior year, and orders are up well over 100%. A strong backlog is beginning to form, although India still represents a very small number in relationship to our total business. We will be incorporating an Indian subsidiary in the fourth quarter which will sell within India. This entity will begin trading directly with dealers and customers early next fiscal year.

Now let me shift gears and talk about our backlog. Ending consolidating backlog remained very strong at $297 million. Backlog grew over 23% from the prior year third quarter. In fact, the balance in the ending backlog is the highest backlog heading into the fourth quarter in Company history. As mentioned, we believe the timing of our most recent price increase influenced the order pacing in the quarter and consequently the level of our ending backlog.

Sequentially the backlog balances down from its six-year high recorded last quarter of $324 million. However, remember last quarter we did have a significant amount of finished goods in the backlog that we could not recognize in revenue due to a snowstorm in the Midwest at the end of the quarter.

Last quarter we also talked about the $13 million year-over-year increase in our backlog due to the significant amount of government business which was shipped but not yet recognized in revenue as it was not completely installed. A good portion of that did get recognized in the quarter. But we also had another great quarter of new government business. As a result, our third-quarter ending backlog also has approximately $8 million more than the prior year third quarter due to government-related shipments that have not been recognized. The significant number of large government projects has made this part of our business very challenging to forecast.

Now let's talk about gross margin. Gross margin at 33% of sales improved .5 percentage point from the prior year third-quarter level of 32.5% but was down just over 1 full percentage point from the second-quarter level of 34.1%. The third quarter generally poses a challenge to gross margins given the uneven production schedule around the holidays. We also entered into the quarter with a fair amount of product that was in trucks that had not been picked up by our carriers in time to recognize in the second quarter. Those sales were recognized during this quarter, but the production happened during the second quarter. This results in a lower amount of production volume as compared to sales for the third quarter, which created a loss of leverage on the fixed cost negatively impacting gross margin.

Our margins benefited again this quarter from the favorable impact of the pricing changes put in place last year, and discounting also improved slightly. Raw material commodity prices overall had an unfavorable impact on gross margin this quarter compared to the prior year. However, the negative impact did improve on a sequential basis from the prior quarter.

On a year-over-year basis, we once again experienced increases in aluminum, wood and steel. Fuel costs were relatively flat compared to last year, and we did see a small improvement in plastics year-over-year. Fuel costs continued to decrease in the quarter, and we hope to actually see favorable comparisons on a year-over-year basis in steel in the fourth quarter.

Our transportation and distribution costs declined again this quarter as a percent of sales from the prior year third quarter and also sequentially from the second quarter. We continue to benefit from the efforts of our distribution team to increase [tube] utilization, increase consolidation of shipments and increase capacity with lower-cost carriers. Compared to the third quarter of the prior year, we also saw more favorable shipping patterns, less product going into California and Florida and more product going to the Midwest.

Let's move on now to operating expenses. For the quarter operating expenses were approximately $111 million or 22.9% of sales compared to $101 million or 23.9% of sales last year. Most of the increased spending in the current quarter was the result of investments into the business for new ventures, research and development costs associated with new product initiatives, variable selling cost 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 $600,000 more in stock-based compensation cost as compared to the prior year under APB 25. Operating expenses in the third quarter also increased over the prior year by approximately $800,000 due to changes in currency exchange rates.

When you roll this all up, operating income rose to 10.1% of sales, up from the 8.7% recorded in the third quarter of last year but down sequentially from the 11.8% recorded in the second quarter of this year. We said last quarter we were not yet ready to increase our minimum operating income target. We knew we would face some challenges associated with the manufacturing startup of our new products and we did. And as we will talk about more in just a few minutes, we will face some of those same issues in the fourth quarter. We do plan to continue to make strides towards our goal of consistently providing at least 11% operating income, and we are pleased to again report that our international operating margins are at the same level as our North American business.

Our international operations are stronger and more diverse than ever. We have doubled the number of independent dealers representing Herman Miller outside of North America in the last four years. Our new [Arbuck] environments is driving the growth in Singapore and Netherlands in France, while the new dealers are driving the growth in India, China, Japan and the UK.

Moving on now to taxes, our effective tax rate for the quarter was 30.3% as compared to 34% in the prior year third quarter. As we mentioned in our second-quarter report out, the third-quarter effective tax rate was lowered as a result of the passage of the R&D credit legislation passed after our second-quarter closing. The current quarter effective tax rate also reflects an increased deduction for the domestic manufacturing incentive under the American Jobs Creation Act of 2004. Consolidated net earnings for the quarter were $32.3 million or $0.50 per share. This represents a 51.5% increase over last year's EPS.

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 $67.2 million this quarter as compared to $37.3 million in the prior year. The year-over-year change was primarily due to an increase in net income, coupled with reductions in working capital requirements for Accounts Receivable and inventory. In addition, the prior year included the negative impact of a $20 million voluntary pension contribution.

Accounts Receivable decreased $13.5 million from the second-quarter level. At the end of February, our consolidated days sales outstanding was 34.3 days, which was the lowest on record. Inventory decreased by approximately $13.3 million from the second quarter. As Beth mentioned earlier, there was a significant amount of products sitting in trucks at the end of the second quarter due to a snowstorm. As these sales were recognized in the quarter, they also had the immediate impact of reducing inventory.

In addition, the reduction in governmental orders shipped but not invoiced also helped to reduce our total inventory balance. Capital expenditures for the quarter were $9.7 million, down from the $11.8 million in the prior year. We continue to rationalize our capital needs across the business.

Moving onto our liquidity and cash position, as you probably recall, we significantly ramped up our stock repurchases during the first and second quarters of the fiscal year. Due to the favorable pricing at that time, we got ahead of our annual planned share repurchases. We slowed down our share repurchases in the third quarter as we mentioned we would on the last call. We did repurchase enough to offset dilution. As we were getting ready to resume a higher level of our purchases, our blackout period began.

In total for the quarter, we bought back over 400,000 shares at an average price of $37.83 per share for a total cost of $16.2 million. At the end of the quarter, we still have approximately $110 million remaining on our board authorization. As a result of the strong cash flow from operations and limited share repurchases, this quarter we grew our ending cash balance to $103.5 million, up significantly from the $52.7 million we had at the end of the second quarter. We also continue to have adequate financial flexibility in our balance sheet, our debt levels are $180 million and we have approximately $137 million available capacity on our bank revolver.

Thanks, Joe. Let's turn to the outlook for the fourth quarter of fiscal '07.

Given our high ending backlog, we anticipate another strong quarter for sales. We expect the fourth-quarter sales to be in the range of $485 million to $505 million, representing an increase of 9 to 14% over the prior year. This assumes a slight reduction in the amount of government business in our backlog, as well as weekly order entry rates of approximately 34 to $37 million per week for the first half of the quarter.

In terms of earnings guidance, we expect earnings per share of between $0.47 and $0.51, which represents an increase of 24 to 34% over the prior year. We anticipate that the higher production volumes will provide increased leverage and allow us to improve our gross margins, despite a higher mix of new products. However, offsetting this leverage will be our traditional fourth-quarter incremental operating expenses associated with new product development, marketing programs and the annual furniture trade show in Chicago. We did a great job in the first half of this year to postpone spending until absolutely necessary, and now we're at the point where we need to invest to continue to launch new products and grow our topline. As a result, in total we believe our operating income will be at about the same level as this quarter. Our effective tax rate for the quarter will increase from the third quarter and be in the range of 31.5% to 32.5% for the quarter as the benefit from the R&D credit catchup is complete.

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

(OPERATOR INSTRUCTIONS). Budd Bugatch, Raymond James.

This is actually [Chad Bolen] filling in for Budd who is traveling overseas. How are you doing? (multiple speakers)

We were wondering if you could give us a little bit more clarity on the operating margin progression throughout the quarter equipment? Now we know that December was impacted by the seasonal factors you mentioned, and then we had the price increase in February. Could you give us a little more color on that?

You know really I would tell you, first of all, we don't disclose inter-quarter numbers on margin. I would also tell you that it bounces around because we are in a 4-4-5 kind of scenario. So we had five weeks in the last month. So it always bounces around, and it depends on project activity.

But, to be honest, even if we gave it to you, I don't think it would be useful in your decision-making other than we had a lot of volume in the back end of the quarter, which would mean margins would generally go up. But I actually don't think there is anything within that data, quite frankly, that would help you with thinking about where we're going from here.

Okay. If I could, another quick one. Could you give us a little bit of color on the order activity for some of the new products like My Studio and the Vivo and the percentage of project business for the quarter?

We don't disclose the individual sales of the product lines, but we can say that we're very pleased with the order levels that we're receiving on both the My Studio and Vivo, and they are both expected to hit their first year business plans. So that's very positive for us.

In terms of project business, Joe is going to jump in.

In the project business here, we are still quite strong this quarter. We saw roughly 42% of the business was project related, so that compares to the prior quarter 44, and that's what the prior year was as well, too. So still a very strong high-level of project business.

Thank you very much.

It is interesting to note that in international our percent of project business is actually going down, which is a good thing because in international we used to be extremely project dependent. But, because of the broader base of dealers that we have now, we're getting more base business, which is a little bit better from the standpoint of the volatility in the international side.

Matt McCall, BB&T Capital Markets.

I cannot trust the hotel phone sometimes. I wanted to get an idea -- you spoke about the volatility in the quarter. It sounded like just to make sure I understood things kind of smoothed out later in the quarter and in the January/February timeframe? Is that correct?

You know, this is always the quarter that is the hardest to kind of get a read on. I think we even told you guys last quarter, we always go into the Christmas holiday season, and even though some of us who have been around here for nearly 20 years, you always still go through that period a little uneasy because it is hard to tell -- I'm looking at normal seasonality what is going to happen. As I said to you in my opening comments, if you add to that the shutdown where we have not only production folks working but we don't have order entry folks working and, in fact, some of our sales locations are closed down as well, well okay, so what is the impact of that with that happening? And then we had the price increase at a time of year that is atypical for us. Generally we have done those at the end of the first quarter has been fairly traditional within the first quarter. So we have never seen one of those done in the third quarter. So I would tell you when we saw the orders come in in the beginning of February, which looked price increase related, the question is, were we getting the normal pull-forward? It's just a little bit of a cloudy picture to be perfectly frank.

Right I guess the picture still remains cloudy is what you're telling me. And the pull-through in advance, would you think -- how much of an impact do you think that had on Q3 order patterns?

Well, if you looked at our weekly order rate, we had a $20 million spike in the week that the price increase took effect. Then, of course, it declined for the next few weeks, and now we're waiting to see when that pickup happens again. And on that $20 million, because it happened in the first part of February, some of it had a chance to work through. So we don't think that the backlog is actually up by $20 million. It is probably up more by $5 million to $10 million from what would have been expected.

Maybe just a little bit of added color commentary on that, remember that typically at least the last few years when we have been talking to you all we have done the price increase not only at the beginning of the month, but it is generally been sort of the last week of the quarter. We got the pull-through from the next quarter of orders back into typically the first quarter. Well, this time we did not do it at the last month. We actually did it in the middle month. Do you follow what I mean?

Yes.

So the impact on the quarter probably is less of an issue than it has been in the past as much as it has moved around our intra quarter weekly numbers, if you follow what I mean.

So you kind of recovered within the quarter?

Yes, exactly. Now that, of course, unfortunately also leaves you going okay so how much of what you saw immediately after the price increase is related to that pull-through, and it probably takes four or five weeks for that to shake its way out. Typically we have seen the move back up seasonally. It starts a bit in February, but as we get into March is when it really happens. And so again we just had enough enough abnormal factors this year that, as I said to you, everything we hear from our field sales group, from our dealers, from activity levels, from the macro factors like corporate profitability looked good, it just makes forecasting a little less clear for us right now.

Right.

By the way, on the other hand, the only offset to that I would say is, because we have such a strong backlog, we can feel really confident about the range for the fourth quarter. It is really trying to figure out where we go from here is where that more difficulty in forecasting comes in. This is Joe. The other color I will add to that weekly order stuff is, if you look at the first seven weeks of the quarter, which is really what we used, that we shipped most of during the quarter, that averaged about $30 million a week. In the second half of the quarter, for that last six weeks, it averaged around $41 million a week. You can kind of see that shift that occurred between them.

Now clearly, as Brian mentioned, some of that second six weeks was because of the price increase that Brian had talked about, but that was somewhat in and out as well too. But that gives you an idea of the magnitude of the shift between the first half of the quarter and the second half.

Right. So maybe look at the median over that time period without that $20 million spike, and you still get in that $35 million range that Beth spoke about in the guidance?

Right.

Okay. And, Brian, just to kind of clarify the continued outlook, I think you have talked about double-digit growth many, many times. When you look at the industry, and I like to hear your all's thoughts about the industry numbers and really what that is saying about maybe the two segments in the industry, the higher end and the contract end and you talked about the day to day business. Maybe talk about the differences if you are seeing any there? And then when you look out to '08, I know there's a lot of opportunity overseas, but should the industry slow to low to mid single digits, is double-digit growth still likely?

Well, as we look at what will be our fiscal '08, as we look out that far, we set our sites around a high single digit number, up in the 9s, maybe look double, but for sure around 9% we think is doable from what we can see today. Now again, as we just had a long discussion about patterns, it kind of depends on what we see in this pattern coming up. But right now what I think the industry seems reasonable, although the current data has been a little sketchy, if I believe the numbers I'm hearing out of the Fed and everybody else about GDP growth rates, somewhere around high 2, 3% is the number I'm hearing out there. That should tell us the industry ought to be able to look to 4 to 5 would be my guess off of that number. Which means domestically we set our sights at kind of 6 to 7, and then to lead by the new market stuff we're doing both internationally, health care and some of the other new venture stuff that we can work our way up to 9 based on that, which really plays out to what our strategy has been for the last three years, which is we did not believe we would continue to see double-digit growth rates in the domestic business. But we thought if we could add some other things, we could at least stay in the high single digits. (multiple speakers). Of course, we can't buck the trend completely. But (multiple speakers) that is what we are seeing today.

And then finally, going back to the question about the segments in the industry if you compare the project (indiscernible), I think Beth mentioned that the project business is actually falling as a percent of the total in international. It sounds like its growing in the domestic market. Help me understand what is going -- I know you have got some marketshare opportunities maybe in certain segments, but help me understand, is it because the project business is growing that much? Is it because maybe the middle market down is maybe growing in line with the industry data shows us for January?

Let me touch on international first and clarify what I meant. I met as a percentage the project business is going down. The actual number of projects in international is not going down. It continues to grow. But, as they hit more dealers and dealers who focus on seating, there's a lot more day to day business that is more consistent, and that is balanced towards the project business, and that is a dependent on large projects to carry us at certain times.

And even more important, the other thing I would add is that this business has always been one, if you win big projects and then what you really want to hold on to is that customer longer-term for the annuity sales that follow it. In our international business, because for many years it has been sort of a pioneering business where we are going into markets and often serving in some cases our large multinational customers, they go in and open a facility. We are there with them for that facility, but we don't have necessarily an ongoing flow in that market, if you will.

What I think is happening is our international business has continued to get larger, and as our dealer footprint has gotten larger, we're not only winning projects but we're able to do that ongoing annuity business. And I think what Beth was trying to say is the positive while in the US and probably in international, the thing that drives growth rates ultimately is project business, having that annuity business is really, really important for the long-term stability. And so we're pleased in the international side that we think we're building a stronger longer-term base. I don't know if that helps.

And the domestic business, just talk about maybe the growth rates of the two different segments of the market, if you will?

Well, first I don't know that a drop from 44 to 42% of our business in project business is really significant enough to draw any conclusions by at this point. I would say, in fact, that number is so close I would say it is a non-important variation, if you will. It probably tells you the tone is exactly the same.

I would say I have heard some others talk about the fact that the "cash" and carry business through the superstores and others is a little bit lighter. We just don't play in that segment to be honest. I don't think I'm qualified to make a comment about what is going on in that end of the business. I certainly -- as we read things from OfficeMax and Staples and others, we hear that. That seems a little strange given what has gone on in the consumer spending area, which has held in there pretty strong. But, to be honest, we just don't play there.

If you look at our retail business, we're really playing more in a specialty retailer environment, much more than we are in the big box sort of mass retail market. And there still is I think as evidenced by lots of people being able to work much more mobially today than they were in the past, and that no longer being left to folks doing administrative work but being folks like you that are more high-end users, we have actually seen continued pretty strong growth through those specialty folks.

Todd Schwartzman, Sidoti & Co.

Could you give some color on the efficiency issues -- which new products were affected, when you first maybe started to feel this impact and also when might this go away?

Yes. All new products had for the first year or so until they get to a decent enough volume to cover the overhead and the fixed cost of the tooling start out with lower margins. So it is something that we expect. It is something that we talked about before. It happened, and as new products grow, that impact will be felt more. But we start to gain the leverage after that. So it is basically all new products tend to come out at the lower margins. We ramp up a little faster usually on the seating side because the investment is not so high.

But the other difference between seating and systems furniture is, when we do seating, often we are hard tooling stuff right from the beginning because of the number of variations isn't as great. In the case of systems product, particularly in the systems product we did this time, we made a conscious decision to a soft tool a lot of things, and in fact, we worried a lot more about effectiveness than we did efficiency. So that takes some time to work its way through because, in fact, we're not only trying to improve the efficiency over time, we are trying to read which of the options are the customers most interested in, and we will watch the mix.

For instance, between a fiberboard-based cladding versus metal cladding, which way are they going to go will tell us which thing that we want to spend more dollars in capital. I think that is actually a good sign of our EVA focus of saying, let's not put capital in place before we need to, and in fact, we will run more labor if we need to for a period of time.

But I think we should also point out to you the biggest impact on our margins this quarter was not new product. That we knew we were going to get hit by. It was a little bit more than we expected on the new product stuff. On the other hand, the biggest single factor on us was lower production levels overall as Beth mentioned. And that is simply a factor of we had absorbed a fair amount of overhead into inventory that now got shipped this quarter. Normally when we get a dollar of shipments, such incremental shipments, we drop a lot to the bottom line. Well, when it is coming out of inventory, especially out of finished goods inventory in that case, we get much less levered for that incremental dollar of shipments. That is really the primary impact. That combined with the unevenness of the holiday season where early in the quarter we have a lot of people off, not working, and then as we ramp back up, we often run a little bit of overtime here and there trying to make up for the days that folks were off. So it is more of those factors I would tell you that impacted this quarter rather than new products. Does that help?

That is very helpful. Thanks. Did you give earlier in the prepared remarks, did you give any kind of Q4 gross margin guidance?

Yes, we did. I think 33.5 to 34.5.

Okay. Should we expect to see better price realization in Q1 than in Q4?

Q1 than Q4? (multiple speakers) But I think that this most recent price increase that happened in February, remember for the most part, those things tend to layer on six months after the effective date just because of when projects play through. I don't know that we will see a lot in the first quarter versus fourth. We will certainly be able to see something hopefully if we get capture of the price increase. But we have been really pretty happy so far with our price realization. That has not been -- in fact, that has been a positive factor overall.

And what was the growth in the third quarter, what was the growth in non-North American orders?

Non-North American order growth was up 21% in the quarter.

Lastly, what tax rate are you using in your Q4 guidance?

31.5 to 32.5 in the fourth quarter.

Peter Waltram, Goldman Sachs.

Going back to the comments on perhaps operating margin for the fourth quarter, Beth, you mentioned that you expected them to be about the same as third quarter. Is that correct?

Correct.

So then if we think that we -- lower production volumes and levels we're seeing in the third quarter and that is the seasonally weakest, wouldn't you get a little bit more operating leverage from higher production levels given the backlog than into the fourth quarter?

Yes, we will get in on the gross margin line. That will increase, but in the fourth quarter, we have higher operating expense levels also. Every year we tend to run usually somewhere between the 7 and $10 million higher in operating expenses in the fourth quarter because of the annual tradeshow that happens in NeoCon, a ramp-up of marketing programs often related to that and to new product development that is spent at that time.

Okay. And when we then talk about the manufacturing start-up inefficiencies that you saw in the quarter, were these localized to China and/or seating, or did you see them for us maybe broad categories in geographic regions, and could you quantify those?

Those inefficiencies in China in total are actually quite small compared to the rest of the business. The inefficiencies that Brian mentioned are really what drove the margin, and that was more related to the lower production volumes in North America.

Okay. And regarding the cash balance, are you still targeting in the range of $60 million to $75 million? And along the same lines, what are your priorities for the use of free cash?

We're very pleased with the cash that we generated this quarter, and we're committed to operating with a lower cash balance. Share repurchases are our preferred method to return cash to shareholders after we fund our strategic initiatives, and we have been opportunistic about the times when we do that. So yes, we have $100 million in cash right now, and it is our intention to ramp up our share repurchases this next quarter.

Okay. And last question for you. On raw materials, aluminum, wood and steel were the big items for the quarter I am assuming. Do you have a quantification for the impact of each, and perhaps do you see the comps becoming more favorable for aluminum and wood?

I can give you the impact on material this quarter in the fourth quarter year-over-year. The total impact was $2.2 million. Of that steel was about $600,000. Aluminum was just over $1 million. Plastics was about flat. And wood was up $0.5 million. For the next quarter, we're looking at a total of a smaller amount, probably $200,000 or so total year-over-year.

Largely because we get back to where those comps are trying to catch up with one another.

A couple of other points that I would add. One, those dollar amounts, they are all North American, so those are North American kind of totals. It is tougher for us to gain a view into some of the international breakdowns, so those are all via the international ones. And, as Beth and Brian mentioned, sequentially from the quarter that just ended to the fourth quarter, yes, we will see some favorability in the steel pricing. The plastics, aluminum and even wood should stay about the same. They have been stable. They have not been getting a lot better, so we're expecting those to be about the same.

But that is really a comparison of year-over-year. We're not really expecting lots of improvement from where we are in the third to the fourth as much as we're catching up with pricing, correct?

That is correct. The steel should be a sequential kind of improvement from what we saw in this quarter to next quarter. The rest sequentially are going to stay about flat.

(OPERATOR INSTRUCTIONS). We have no further questions at this time. I would like to turn the call back over to senior management for any additional or closing comments.

Well, thank you all for joining us. We believe our results reflect favorably on the strategy we set back in 2004, and we remain confident and committed to those larger goals. Given our gains to date and the still greater potential ahead, we hope you share our excitement for Herman Miller's future.

Thank you for your time and interest this morning. We look forward to sharing our fourth-quarter results when we speak with you again in June. Have a great day.

That concludes today's conference call. Thank you for your participation. You may now disconnect.