MillerKnoll Inc (MLKN) 2008 Q1 法說會逐字稿

Good morning, everyone, and welcome to this Herman Miller Inc. first-quarter fiscal 2008 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 forward-looking statements. These risks and uncertainties include those risk factors discussed in the Company's reports on Form 10-K, 10-Q and other reports filed with the Securities and Exchange Commission. Today's presentation will be hosted by Mr. Brian Walker, President and Chief Executive Officer, and Mr. Curt Pullen, Executive Vice President and Chief Financial Officer. Mr. Walker and Mr. Pullen are joined by Mr. Joe Nowicki, Treasurer and Vice President of Investor Relations. Mr. Walker and Mr. Pullen will open the call with a brief presentation which will be followed by your questions. We will limit today's conference to 60 minutes and ask that all callers limit their questions to allow time for all to participate.

At this time I would like to begin the presentation by turning the call over to Mr. Walker. Please go ahead.

Good morning, everyone. As always, I will open our presentation with a few introductory remarks and then turn the call over to Curt and Joe for a more detailed review of our results.

As you saw in our press release, we started the fiscal year with a good first quarter. Our high backlog heading into the period, along with a solid order entry early in the quarter, enabled us to drive great topline sales performance. We were able to capitalize on that volume and saw improved leverage within our gross margins and operating expense percentages. As a result, our operating income, net income and earnings per share were some of the highest levels we have recorded.

We continue to see great demand for the new product that we launched in the past year which reinforces our strategic direction to focus on bringing innovation to the marketplace.

In addition, our international business had another outstanding quarter in orders, sales and profitability. Our emphasis on new markets, new products and new channels within this segment of our business is clearly driving results as it now plays a key role in our overall financial performance.

Our success in these areas strengthens our resolve in the growth strategy we have previously outlined. We are on the right long-term path.

The challenge for the quarter was in our North American order entry rates. In the first quarter of the prior year, we recorded a disproportionately high amount of large project orders in our North American business segment. This included orders for several large government projects that we talked about during prior investor calls, as well as several large commercial opportunities. While our level of overall project business was still relatively high this quarter, we did not have the same volume of big projects as we had in the prior year. This difficult comparison to our prior year performance lead to our modest decline in total orders and backlog.

It is not unusual for the timing of project activity to vary month by month and for our results to deviate from the overall industry like we have seen this quarter. Yet we believe the recent lowering of the industry forecast and the debt general state of the US economy could be signs of an emerging softness in the North American market.

We recognize that we are in a cyclical industry. In fact, we have built our current business model around that reality. We have incentive compensation systems that naturally adjust to volume. We have a manufacturing model which flexes with volume through temporary labor and overtime. And we know how to rationalize our operating expenses and capital expenditures to align with our sales volume.

With that said, we're already taking steps on the above items to immediately align our cost structure to the current volume levels we are seeing in North American. We believe it is possible that our North American business may see flat to low single digit revenue growth for our fiscal 2008, and we are making the appropriate operating cost adjustments as we always have to maintain our profitability and preserve our long-term future.

In addition to these near-term operating steps, we are evaluating alternatives to create value for shareholders by leveraging the strength of our balance sheet, adding scale in high-growth areas and exploring a variety of actions to further improve operating efficiencies. Long-term we remain confident in our strategy for growth and intend to continue investing in opportunities that will drive topline growth and create value for shareholders.

We are now mapping out the actions to get us to these objectives. Let me assure you that this will not be a year-long analysis. We intend to announce our plans by the end of our fiscal second quarter. I look forward to sharing those with you soon.

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

Brian, thanks. It is a pleasure to be with you all this morning. As Brian mentioned overall, we had another really great first quarter. Sales were up 9% from the prior year, operating income expanded to about 11% of sales, cash flow from operations totaled nearly $32 million, and earnings per share increased 26% over the prior year. We will spend some time walking through what drove these results, and I will also talk about the outlook.

First-quarter sales of $492 million represented our 15th quarter in a row of year-over-year revenue growth. On a sequential basis, first-quarter sales were up about 1% from the prior year. Often we have a few (inaudible) on our shelves we are moving from the fourth quarter to our first quarter. That did not happen this year, partially due to our very strong beginning backlog, which was up over 20% from the prior year and which helped provide a solid start to our new fiscal year.

North American sales of $406 million increased 9% year-over-year and were up 4.5% sequentially from the fourth quarter. Also, our healing business continues to post notably strong year-over-year revenue growth. Non North American sales were up over 17% with continued very strong growth in the UK, China, India, Australia and Eastern Mediterranean region. These sales were further aided by a weakening US dollar which favorably impacted sales for the quarter by $2.7 million.

As Brian discussed, our challenge for the quarter was in orders. In total, our orders declined by 3.9% from the prior year, and our backlog ended the quarter down 4.8%. The order decline was entirely in the North American part of our business, which was down 4.5% versus last year.

Conversely orders for our non North American component of our business increased 6%, driven by strong growth throughout the international business.

So what is going on with our domestic orders? For starters and Brian mentioned this, we have a particularly challenging comparative when looking at last year's first quarter, so let's look at that for a minute.

At this time last year, we were entering orders for several very large projects. In fact, our order entry levels for the first two months of last fiscal year -- that is June and July of 2006 -- was approximately 26% above the prior year.

At that same time, the overall industry was reporting growth of about 6%. So we firmly outpaced the industry at this time last year. This is important when we look at the current situation. This year the industry reported order growth of 11.7% for the month of June and July, which compares to a decline of 2.4% in our domestic orders over the same two-month period. The point here is that given the project-driven nature of part of our business we do not always follow the exact cycle of the overall industry when examined over a short time horizon. And even now when we step back and look at our market share for a rolling 12-month period, we see that we are still performing above the industry in both sales and order growth.

Looking more closely at the current quarter, we are experiencing regional variations in order strengths. Our West area, which has always been very strong for us and where there is a large concentration of subprime lenders, has seen a general slowdown in order activity compared to the prior year. While we don't believe that we've carried any degree of significant exposure to that particular industry, we are seeing generally lower levels of activity in these markets right now.

We are also hearing about space constraints in certain West area markets that may be hampering the real estate and facility strategies for certain existing and potential customers.

On the other hand, we continue to see strength in the East and North regions. The A&D firms that we work with are very busy, and our dealers are very active. Our sales funnel remains very strong and, in fact, has increased in both number and dollar volume of projects from our fourth quarter. And we are starting to see moderate increases in our daily order levels during the first few weeks of September when compared to our first-quarter averages. I would not call that a trend, but it has been positive over the last couple of weeks.

We have also had tremendous success during the quarter with several large project wins that have not yet been ordered, and we expect to book these orders over the next couple of months.

So we had good sales for the quarter, and the selling activities during the quarter contained what appear to be several positive indicators. However, the industry forecast is pointing towards slower growth, and the overall economy remains somewhat uncertain. So we don't have a perfectly clear picture of what the future looks like. Therefore, we are approaching the North American business with caution and, as Brian described, have already taken prudent steps to align our business with anticipated market conditions, including the possibility of slowing growth.

Let's go to gross margin. Margin at 34.1% of sales improved 20 basis points over the prior year of 33.9. Benefits from our previously enacted price increases, as well as lower commodity prices primarily in steel, drove the majority of the improvement. These were partially offset by lower margins on service sales and also unfavorable startup costs associated with the new systems products that we have previously discussed with you. We continue to see outstanding demand for our new products and are making solid improvements in the profitability of these new lines.

On a sequential basis, gross margin improved by 50 basis points from the 33.6% recorded in our fourth quarter. Improved pricing driven by the price increases as well as lower discounting and commodity costs resulted in these improvements.

Operating expenses for the quarter totaled $114 million or 23.1% of sales compared to $107 million or 23.7% of sales last year. Careful control of our costs, as well as the increased sales volume, helped us to leverage our operating expenses and drive these costs to a lower percentage of sales. The increased absolute spending in the quarter was due primarily to increased compensation costs from merit increases that were effective with the new fiscal year and increased variables selling costs from the higher sales volumes.

We also experienced an impact -- an increase from the impact of the FAS 123R, which is related to our stock-based compensation. These increases were partially offset by lower bad debt expenses for the quarter.

On a sequential basis, operating expenses declined both as a percent of sales and in total dollars from $119 million or 24.4% of sales in Q4. This was driven by decreases in incentive compensations based on our actual performance during the quarter, as well as lower marketing and development costs which are often lower in the months that follow the industry trade show in early June.

Our effective tax rate for the quarter was 33.5%, which was within the range of 32 to 34% that we were forecasting for the quarter. Consistent with what you've heard from us before, this rate is lower than our statutory rate due to increased benefits from our manufacturing deduction under the American Jobs Creation Act, as well as our increased utilization of foreign tax credits resulting from the profitability of our international business.

Also, important to note on the tax front is that we adopted FIN 48 this quarter, which is accounting for uncertainty for income taxes. As a result, we recognized a $1 million increase in liabilities for unrecognized tax benefits which was recorded as a reduction to beginning retained earnings.

Consolidated net earnings for the quarter were $33.5 million, which represents a 17.5% increase over the prior year. Our earnings per share improvement was more significant due to our share repurchases during the quarter and at $0.54 represents an improvement of 26% over last year.

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

Thanks, Curt. Cash flow from operations was a source of funds of $31.8 million this quarter compared to a use of funds of $6.4 million in the prior year. Higher net income and lower working capital requirements in the current year were the main drivers of the year-to-year change. Working capital requirements for the use of funds of $18.2 million in the current year is compared to $48.1 million for the prior year.

The current year use of funds was primarily driven by reductions in accruals for the payment of prior year incentives, partially offset by increases in tax accruals including an adjustment related to the adoption of FIN 48. Capital expenditures were carefully managed at $8.9 million for the quarter, which were pretty consistent with the prior year at $8.6 million.

We returned $60.8 million to shareholders this quarter in the form of stock repurchases and another $5.5 million in dividends. We took advantage of the low stock price early in the quarter to aggressively buy back stock. In total for the quarter, we bought back almost 1.9 million shares at an average price of $32.38 a share.

At the end of the quarter, we still have approximately $77 million remaining on our board authorization. As a result of the share repurchases and cash flow requirements described above, we worked on our excess cash balance and also began borrowing against our revolving line of credit.

As of the end of the quarter, we had a cash balance of $65.3 million. Of this amount $45 million is currently located in our international entities and not readily accessible without higher tax implications.

In addition, we have borrowings against our revolver of $30 million based on the timing of our quarter end cash flows. We continue to have a high degree of financial flexibility in our balance sheet that is demonstrated by our low leverage ratio and our high interest coverage.

In addition, we have another $107 million of available capacity on our bank revolver. As Brian described earlier, we are exploring additional opportunities to utilize our strong balance sheet to accelerate our growth and shareholder return objectives.

Thanks, Joe. Let's turn to the outlook for the second quarter of our fiscal year. Given our recent order entry rates and our current backlog, we anticipate that our second-quarter sales will be approximately in-line with our sales for the first quarter just ended, in the range of 475 to $500 million. This assumes weekly order entry rates of about 37 to $39 million, which is about what we're seeing today.

In terms of earnings guidance, we expect earnings per share to be in the range of $0.51 to $0.57 per share for the second quarter. We anticipate continued favorable impact in gross margin from pricing, raw material costs and improvements with our new products. Our already income should remain approximately where it was in the first quarter, and the effective tax rate should again be in the range of 32 to 34%.

I will now turn the call back to the operator, and we will take your questions.

(OPERATOR INSTRUCTIONS). [Chad Bolen], Raymond James.

A couple of questions. First, I was obviously intrigued by the statement you made regarding evaluating alternatives for enhancing shareholder value. Could you give us a sense of how much leverage you would be comfortable with in terms of debt to EBITDA as well as interest coverage?

And then in terms of potentially adding scale, what is your filter? What are you looking for? What are the characteristics that you would want to see before making some sort of an investment?

Let me take the second part of that first, and then we will come back to the question on how much is doable.

First of all, we have been pretty on the track for some time since we talked about the strategy that we thought there was some great opportunity for us both in international areas like healthcare, as well as the work that we are doing in our Convia business around infrastructure. I think it is likely that we will look for areas like those that enable us to get platforms in place in the areas that we have targeted for future growth. We don't have anything specific out here that we can talk about in this forum, but it has been a focus as far as in all three of those. We did a small one as you know in Convia late last year, and we continue to look for those kind of opportunities that really essentially supplement what we're doing from an internal development standpoint.

We do have, of course, lots of internal development going in the product arena than all of those areas, as well as I will call it commercial building, building distribution networks and those kind of things. But we're seeing great success in those areas, so our belief is we need to feed those. So that is kind of a primary objective for us.

In terms of the balance sheet and debt, we have consistently said it is an important thing for us we believe to continue to be investment grade. So that obviously puts an outside parameter over anything that we do. We believe that especially a business that is going to run through cycles, we need to have some flexibility. And certainly when you see what you have seen happen to a lot of companies through this recent credit crunch, making sure that you are in that spot that you've got the flexibility I think is just the right place to be.

Having said that, we clearly have a lot of debt capacity out there that we have not utilized. And I think if anything we have growing confidence as a group in our ability to generate cash flows through the cycle.

So I think we have set this thing of saying that we wanted that -- our goal was to have one to two times debt to EBITDA. One to two times was kind of the range that we thought we could be in and feel comfortable with. So that continues to be where we are at. And within that, of course, we've got lots of room from where we are at today.

Chris Agnew, Goldman Sachs.

I'm a little confused. Given that one of the explanations is the tough comps for Q2. But then you talk about seeing strength in the North and the Northeast, but also talking about a cyclical slowdown. And also reading steel cases results this morning, and they are quite a bit more upbeat. I'm just wondering what is making you so concerned, and why you're looking to take cost actions?

I think it is a great question, and to be frank, I think that we would tell you we think it's a fairly mixed picture out there as well. If you look at our internal data, first of all, you looked at just having negative year-over-year orders is always a reason for -- a moment for pause.

As we have looked at it and looked at order entry rates, they are pretty flat. Now that in and of itself when we get underneath it and then look at this year-over-year issue that Curt detailed out for you around projects and then what would happen with projects last year, we just sort of explained that and say, geez, when you take that into account and you realize that we believe we have a fair number of large projects that have yet to order and if we go out and talk to the salesforce and A&D firms, they are all still fairly buoyant about what they see. And, in fact, the salesforce, their sales are running towards their original plan, and we're saying we're going to hold you guys accountable for that.

On the other hand, if you look what has happened across overall economic activity, as well as the kind of continued step down in the industry forecast, what we're trying to do, quite frankly, is be ahead of that curve. I think when you look back to what happened in the last downturn and every other downturn that has happened in the history of the industry, we have always ended up sort of behind the curve and making adjustments to the business.

At this point for us is we do believe that next quarter looks like it will be flat given where we are coming into it with a backlog and what we see with order entry rates, we've simply said let's get ahead of the curve. We know that we have tons of flexibility to ramp back up.

So if, in fact, we can outperform on the top-line, we can deal with that from a manufacturing standpoint by our ability to flex back up. And certainly nothing we are doing is trying to take capacity out on the front end of the business that it is out there generating revenue. But we are going to look at the things internally where we can from an efficiency standpoint to make sure that, in fact, we can play through the cycle strong, and we have begun to ask ourselves longer-term what can we do to continue to drive more operating performance.

And I guess as a quick follow-up to that, I know you are not going to talk about Q3 but maybe some perspective on the last year. In Q3 last year you had big project, large project activity as well. Is that correct?

You know, Chris, I don't know if I can give you an answer on the third quarter last year in terms of big project activity. That is -- your memory might be better than mine in that specific, and we haven't looked at that one in that much detail.

You know, I think to go back to your question, one of the things we often see and if you go back over time, the inflection point from the industry often happens right after we get through that Christmas time horizon. Because, as you know, all of -- all the companies, most companies set their planning cycles around a calendar year-end.

And the thing that we're trying to be prudent of is that often if you went out and asked salesforce and other folks, of course, they have not seen any of those changes as CEOs and CFOs are planning for calendar 2008. Correct?

So what we're trying to do is make sure that even though the salesforce is there and we are trying to be cheerleaders with them and keep them fired up, at the same time, we are looking at this overall picture that we see emerging out of the econometric models, from the industry, as well as what we all are watching economically, and saying, let's make sure that we don't over-rev the engine in terms of building up our cost structure and, in fact, that we are ready to deal with any eventuality.

But I don't know if there's anything particular in the third quarter of last year. I will tell you that maybe the other one that we have looked at is, of course, the federal government is having a bit of a hard time getting a budget finalized, which while it won't affect the orders that we will get here in the next few months in terms of our government business, longer-term you worry a little bit about that being lengthened out as they don't have new appropriations for new investments beyond the end of the fiscal year.

So there is a number of those factors that while we have not seen it yet in terms of funnels and we have not seen it in terms of sales activity, we are just trying to be prudent and ahead of the curve.

Okay. Thanks. And then maybe just one final question. I think in the quarter you said you had benefited from a recent pricing, some pricing. Can you comment on what you are seeing in terms of pricing industry looking forward? Because presumably if revenue growth rates are slowing down for the industry, it is getting more competitive and tougher to achieve price.

I would say so far pricing has been fairly stable and positive. Because we have been capturing some of the last price increases we have done. So at this point, we are capturing about the same rate that we normally do. As you say, I mean if we do see a softer market, obviously it is likely that things will get even more competitive than they have been in the recent past.

But I think right now there's still a realization that commodity prices, while they were better recently, have still been a bit of a tug on folks, which has made it more likely to be able to pass along those kind of increases.

Chris, this is Joe. Just getting into a little more detail on that one, for the current quarter that just ended, the first quarter, we saw both. We got benefit from the price increase year-over-year. Plus we did also on a year-over-year basis discounting benefited us as well too. So we saw a little better discounting, improved discounting. So both of those two combined to see kind of that net benefit in total that we talked about.

(OPERATOR INSTRUCTIONS). Matt McCall, BB&T Capital Markets.

Could you give us some kind of detail into how the quarter broke down? Was it consistently from an order perspective more so than from a shipment perspective -- but can you just break down the orders as we progress through the quarter as we face some of the credit issues out there? Did you see any change in patterns from releasing orders from a standpoint of releasing orders from the customers? Did they slow in their patterns at all or pause at all?

You know, overall June was a little bit stronger, but I would say June and July were a little stronger. But overall that can be moved on a little bit based on project timing and when a project actually falls into a month. Overall I think our tenor would say, not a lot of change, not a lot of variation. As Curt mentioned, the last few weeks have been a bit better, which is pretty typical that you will see a little bit of an upturn as we get into the fall in particular with some of the government activity that takes place.

But generally I would say to you we have not seen a major change in order rates. I would also say if we talk to the sales team, they would say the funnel has remained fairly consistent and strong as well.

If we have seen any bumpiness around project issues, it has been more out in the areas that Curt mentioned in the West, particularly Southern California, which, of course, is sort of ground zero around this whole subprime issue. And again, not so much that we have customers that are in the subprime game, although we have serviced some of those folks in the past, but not as heavily the last couple of years.

At the same time, it has been more just folks in that general economy that are obviously nervous about what is going on.

Okay. So not (multiple speakers)

I guess what I would add to that, as Brian said, we are relatively stable or you could say flat in our weekly order intake over the last quarter and even going back the couple months prior to that. This first couple of weeks of September have been a little bit above that on a daily basis. So again, it is not a clear picture to us because we have a variety of indicators, and they are not all lining up on the same side of things. So while it is encouraging, as I mentioned in my earlier comments, I don't call it a trend yet. But I don't know that it is a trend, so.

And I guess looking out, you've mentioned a couple of times some large projects showing up next year. I'm trying to get a sense of that pipeline with respect to what you expect to potentially be occurring in the industry. I mean is the large project activity going to be enough to show an acceleration or enough to offset some of the moderating growth you may see in the day to day business, and I think that is one thing I want to maybe understand better is the project versus the day to day business. I know you have provided color on that as well, but first maybe just the large project outlook and what could that do for growth rate.

The one thing that I would draw upon to when you are looking at the comparable, just keep in mind last year for the second quarter we had a huge order entry quarter because a lot of those government projects that came in and came through. So when you're looking at the year-over-year growth, that will be again (inaudible) sales, but from an order perspective, a difficult comp to get at.

Right. I think, Brian, you mentioned that were some large projects on the horizon that you have yet to book in orders, maybe a better understanding of when that is going to occur and how large are they? Are they big enough to offset some of this moderating -- some of this moderation that we're seeing right now?

That is a great question. First, let me be clear, because it is not any one single large project specifically that I would say is out of normal size range. But what we have had is a number of customer wins that we think are going to add to our ongoing sort of book of not only project business but also base business that we just have not seen. We have not gotten into the point where those contracts are starting to fall into the order entry cycle.

At this point the way I would state it is, that is why I think one of the -- I think it was Chris who asked us, why you guys sound like you are pessimistic? And I would say, I would not describe it as pessimistic at this point. I think what we're trying to do is be realistic with a bunch of data that points in different directions. And you look at all of that different data pointing in different directions and say, well, okay, so what in here can I discern from all of this?

It appears to me that we have a fairly mixed picture which I think is what you hear even on the overall economic front. Now certainly with the recent moves by the Fed and other things, if that increases business confidence so that as we get through this next planning cycle not only does the base business continue to move along but, in fact, some of those new customer wins start to come through, that picture may get better. But simply if you look out and we often tell folks, look, we have pretty good visibility when we're looking out for the next quarter. So we have a fairly good point of view right now around Q2, and I think you heard that in the range. We're pretty comfortable with that.

As you get beyond Q2, quite frankly, the waters are much more murky. And that will I think have to do with a confluence of things of not only those project wins, but also what happens to the general economic tenor in the US. If that comes through this next cycle and people bounce back a bit and we don't see anymore hiccups like you have seen in some places like the UK with the banks, if we don't see anymore of that, I think we might be stronger than what we're predicting today. That would be a good thing, and certainly that is where we have got the sales force focused.

Okay. And, Joe, I think in the past you have provided a breakdown of what percentage of your business was project versus the day to day business. Do you have that number handy?

I do. The project business for the quarter last quarter was actually 45%, so a good strong number. That is consistent with where it was the last quarter and pretty close to where it was the year before. So still hanging in there quite well.

And then finally, going back to the exploring of alternatives, if you could break down -- maybe just tier the opportunities you talked about growing some existing businesses or looking at some newer opportunities or maybe would share repurchases be more of a focus, maybe if you could tier where you are focusing your efforts?

You know, I don't know if I can tier it for you. We're looking at all of those things as a basket. Certainly a prime for us is to make sure that we are putting in place the capability to continue to drive the strategy. Because we think we are on the right track. So if you look at it from that angle, I would say that is probably job one.

On the other hand, I would say job two for us right now is asking the question and figuring out what do we do even if we are in a slower growth period to continue to drive operating efficiencies? Driving operating efficiencies in a period of growth is a much easier task than if you're looking at slow to moderate growth. And what we're challenging ourselves with to say, even in slow to moderate growth, we have got to figure out how to improve operating efficiencies and profitability levels. We don't have that all in hand yet, but I will tell you it is an objective that we set for ourselves.

And then I would add third beyond that is the question of, should we do something beyond that in terms of share repurchases? As you know, we have got $77 million of authorization. We have been I think a consistent believer in our ability to create value that way. We stay committed to that. And certainly if there are opportunities to go further based on what the view of the marketplace is, we will take those as they come.

(OPERATOR INSTRUCTIONS). At this time it appears we have no further questions in the queue. I would like to turn the conference back over to the presenters for any closing or additional remarks.

This is Brian. Let me close by saying thank you for joining us today. I would tell you that -- let me recap our points we shared with you today.

First, we made good progress against our strategic goals over the past year and more, and that is reflected in the first-quarter sales, earnings and margin improvement. But we're not resting on our achievements to date. We're taking actions to align our cost structure to the current volume levels we're seeing in North America. In addition, we believe there is further opportunity to improve our operating performance within the core business and to make more effective use of our balance sheet. We believe this will enable us to accelerate investments in our strategic initiatives while creating additional value for shareholders. We look forward to talking to you more about these plans in greater detail as we finish the second quarter, and we look forward to talking to you all then. Thank you.

Thank you. That does conclude today's conference. We thank you for your participation, and you may disconnect at this time.