MillerKnoll Inc (MLKN) 2010 Q2 法說會逐字稿

Good morning, everyone, and welcome to this Herman Miller, Inc. second-quarter fiscal 2010 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 Mr. Brian Walker, President and Chief Executive Officer, and Mr. Greg Bylsma, Executive Vice President and Chief Financial Officer. Mr. Walker and Mr. Bylsma are joined by Jeff Stutz, Treasurer and Vice President Investor Relations.

Mr. Walker and Mr. Bylsma 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 would like to begin the presentation by turning the call over to Mr. Walker. Please go ahead, sir.

Good morning and welcome, everyone. As we were preparing for today's call, I was reminded of a quote from baseball manager Casey Stengel; "Never make predictions, especially about the future." If the past year has taught us anything, it is just how unpredictable the global economy can be. Currently, measures of economic health are mixed but seem to suggest the beginning of a rebound. Nonetheless, on our call today I will heed Mr. Stengel's advice and avoid offering any significant predictions about the direction of the economy.

These quarterly updates typically focus on the performance of our business over a relatively short time frame. Unfortunately, this can make it easy to miss the progress made under a strategy that is deliberately long-term in nature. In a few minutes, I will turn the call over to Greg and Jeff to review our second-quarter results in detail. However, before I do this I want to share with you a few thoughts on the progress of our business, not just in the past quarter but over the past year.

This perspective is important because it speaks to our capability to achieve remarkable results in times of challenge and uncertainty. When you think back to where we were just one year ago, it is hard to argue that overall conditions in the market haven't improved. At that time, stock markets around the world were in freefall with the Dow at 8800 and on its way to 6500 in just a few short months.

Many global institutions, once revered for their financial strength and commercial success, had either already failed or on the brink of insolvency, prompting unprecedented government intervention. And still many more businesses, including ours and others in the industry, were restructuring to rapidly shed costs and weather what would prove to be the worst recessionary period since the Great Depression.

As the economic turmoil unfolded, companies around the world took a defensive posture by cutting not only payrolls and overhead expenses, but also capital investments as a means of conserving cash to ensure liquidity. In our business, we were compelled to do much the same. We implemented an aggressive workforce reduction plan that would ultimately impact more than 1100 employees.

Further actions were taken to reduce expenses, including across the board wage reductions, modification to employee benefits, and the consolidation of manufacturing facilities. As customer demand for our products pulled back, we committed ourselves to remaining profitable. We established and communicated a goal of maintaining operating margin percentages in the mid-single digits.

Given declining revenues and a general concern in the business community that access to credit markets would remain tight, we took steps to conserve cash and improve balance sheet flexibility. To this end, we lowered our quarterly dividend rate, suspended share repurchase activity, and amended our revolving credit facility.

We also delivered our balance sheet by retiring $75 million of public debt. While each of these actions was necessary -- was a necessary defense against an economy in crisis, our response was also balanced with an energetic offensive game plan designed to position us for growth beyond the downturn.

We announced a strategic alliance with POSH which significantly expanded our distribution footprint in Hong Kong and mainland China. We acquired Nemschoff, a bold move forward in our strategy to strengthen and grow our healthcare business.

Finally, we demonstrated our commitment to innovation and leadership by introducing nine new products at our annual industry trade show, with awards earned in multiple categories. And for all of the challenge we faced during this period, we were able to generate a positive cash flow and meet our goal for profitability.

Today we are hopeful that conditions are beginning to improve. The US economy is growing, corporate profits have improved, and trends in the equity markets are positive. There is plenty of encouraging signs at Herman Miller as well. The Nemschoff integration and our plant consolidations are progressing on schedule. We have continued to effectively manage costs in line with the revenue levels, and our newest products are gaining market acceptance.

Equally encouraging this past quarter was a seasonal increase in order entry, which as Greg pointed out in the press release reached the high end of the range we were expecting. Regardless of the uncertainties that remain in the global economy, we are committed to investing for the long term and generating solid financial performance along the way.

While we can't predict the future, we can point to recent history as evidence of our ability to do just that. That is it for my introductory comments, which I hope provide some useful and broader context as you analyze our second-quarter results.

I will turn the call over to Greg and Jeff to cover the numbers in more detail.

Thanks, Brian, and good morning, everyone. Despite the fact that sales and orders remained below prior-year levels, we were encouraged this quarter to see a continued pattern of seasonal trends in the business. Net sales in the second quarter were $344 million, down 28% from the prior year and up 6% from the first quarter.

North American sales in the quarter were $283 million, which is down $106 million or 27% from the second quarter last year. Declines were experienced across all components of our North American operation, with our healthcare and retail businesses showing the most resilience to the downturn.

Sales in our non-North American business regions reported deeper year-over-year declines. In total, sales of $49 million were down 32% from last year. Orders of $346 million in the second quarter declined $80 million or 19% from the prior-year level.

The year-to-year comparison of order levels is affected by the timing of a general price increase which became effective in August of last year. The timing of this price change accelerated an estimated $35 million of orders into the first quarter that would otherwise have entered in Q2 of last year. Adjusting for this impact, the year-over-year decrease in consolidated orders was 25%.

Our retail business posted year-over-year order growth in the quarter, bolstered by improved customer confidence and our broadening of the sales channel over the past year. Exclusive of the additional orders from Nemschoff, our core healthcare business remains down in comparison to last year. However, the percentage decline has continued to be less than that seen within the contract office sector in North America.

While we posted a 15% year-over-year decline in orders within our non-North America segment this quarter, we were encouraged by the relative strength of order activity within certain regions, including Continental Europe, Asia and South America. Sequentially, consolidated orders in the second quarter improved 7% from the first-quarter level, reflecting a seasonal ramp-up in business levels which typically pick up in Q2 due to year-end spending by the GSA.

Now on to gross margin. Our second-quarter gross margin was 32.2% of sales compared to 32.6% of sales in the same quarter last year. Despite a decrease in consolidated sales of $133 million, the decline in margin was limited to only 40 basis points.

The loss of leverage from lower sales volume and higher discounting was largely offset by lower commodity and fuel prices versus the prior year. We have also continued to realize significant savings in labor and overhead spending relative to year-ago levels, as a result of the restructuring actions implemented over the past several months.

The benefit from the lower material cost was primarily seen in the categories of steel and aluminum components. Lower material prices drove an estimated $10 million reduction in the cost of goods sold relative to the second quarter of last year. Fuel prices in the quarter which on average were 22% lower than the same period last year helped offset the loss of volume as well.

Manufacturing and overhead expenses were again lower across virtually every category this quarter compared to last year. The largest reductions continue to be employee wages and benefits, which have been markedly reduced over the past year as a result of our restructuring efforts.

Given the decline in the top line, however, overhead expenses as a percent of sales were 190 basis points higher than Q2 of last year. On a sequential comparison, gross margin in the quarter decreased 100 basis points from the first-quarter levels of 33.2%.

As expected, competitive pricing pressures negatively impacted us this quarter. Higher price discounting reduced our second-quarter gross margin by an estimated $3 million from the first-quarter level.

We also recognized expenses this quarter related to a wage recovery provision under our current reduced workweek arrangement. This past spring we instituted an employee furlough program in order to reduce salary and wage expense by 10% across the business. Employees affected under this arrangement have an opportunity to earn back their lost wages if the Company achieves a certain level of profitability in a given quarter.

Payments under the program cannot exceed the amount of wages foregone as a result of the reduced work schedule. Based on our operating results in the second quarter, we recognized approximately $2 million within our cost of goods sold associated with this program, or a payment of 8.4% of base compensation. No such expenses were recognized in the first quarter of the fiscal year.

Operating expenses in the second quarter were $90 million, down 10% from the $100 million reported in the same quarter last year. Expenses in the current quarter included approximately $3 million related to the wage recovery program and a full 13 weeks of operating costs for Nemschoff.

On a sequential quarter comparison, operating expenses in the second quarter were almost $1 million lower than the first-quarter amount. Recall that expenses in the first quarter of this year included $4.5 million for the premium paid on our debt tender offer, but did not include any costs related to wage recovery.

Restructuring expenses in the second quarter of approximately $2 million related to employee severance benefits and move costs associated with our previously-announced factory consolidation project.

Operating earnings in the second quarter were $19 million or 5.4% of sales. Excluding the impact of the restructuring expenses, adjusted operating earnings in the quarter were $21 million or 6.1% of sales.

Our effective tax rate in the quarter was 34% compared to 33.5% in the prior-year second quarter. Through the first half of the fiscal 2010, our effective tax rate was only 21%. So it was driven downward by a 0.7% income tax benefit reported in Q1 as a result of the closure of the IRS audits for the years 2005 through 2008. We expect a full-year effective tax rate to be between 27% and 29%.

Net income in the quarter was $10 million or $0.17 per share. Excluding the per-share impact of the restructuring charges, adjusted EPS in the quarter was $0.20. That is the income statement overview for the quarter, and now I will turn the call over to Jeff to give us a brief update on our cash flow and our balance sheet.

Thank you, Greg. Good morning, everyone. Our cash and equivalents balance increased $21 million this quarter, ending the period at $122 million. Of this amount, approximately $50 million is held within our international entities. Cash flow from operations in the quarter was $27 million. Changes in working capital drove a $3 million source of funds, the result of increases in AP and accruals for compensation and income taxes, offset in part by investments in AR and inventory.

In the second quarter of last year, cash flow from operations was $42 million, with changes in working capital driving a $6 million use of funds in that period. Capital expenditures in the quarter of $6 million were down from $8 million spent in the same period last year. And through the first half of fiscal 2010, capital expenditures have totaled $11 million, and we are targeting a full-year spend of between $25 million and $30 million.

We made just over $1 million in dividend payments during the quarter, and this compares to roughly $5 million in the second quarter of last year. Also, consistent with our recent practice, we made no outside share repurchases during the second quarter.

We remain in compliance with all debt covenants and are currently running at a gross debt to EBITDA ratio of approximately 2.5 times. We currently have $139 million of unused capacity on our revolving credit facility, with the only usage being from outstanding insurance related letters of credit.

Given our current cash balance, ongoing cash flow from operations and borrowing capacity, we remain confident that we have a sufficient flexibility to meet the financing needs of the business going forward. That is the balance sheet overview for the quarter.

I will now turn the call back over to Greg to share some thoughts on the outlook as we move through Q3.

Thanks, Jeff. Consistent with recent quarters, we aren't providing specific forward-looking sales and earnings guidance. However, we thought it would be helpful to share with you some general thoughts on the trends we will be looking at as we move through the third quarter.

We generally see a sequential period decline in sales between Q2 and Q3 attributable to a slowdown in business activity through the holiday period. Last year, the pressures of the recession drove ourselves in this period down more than 25%, an amount obviously not reflective of normal seasonal business patterns. A more typical seasonal decline has been between 2% and 4%.

Consistent with the holiday slowdown, we normally see a drop in orders in Q3 relative to Q2. In fact, the decrease in orders is normally greater than that of sales, resulting in an overall decline in the backlog. Lower sales and factory production schedules tend to drive lower gross margins in the third quarter relative to Q2, though sales mix, discounting levels and commodity pricing clearly factor into our margin performance over any given timeframe.

We are continuing to keep a close eye on commodity pricing and trends in discount levels, and view these as outlook risks, although at this point we do not anticipate a significant change from the second quarter. For the first half of fiscal 2010, we have done a good job of holding the line on core operating expenses, and we tend to remain diligent in managing these costs going forward.

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

(Operator Instructions) Mark Rupe, Longbow Research.

Hey, guys. On the pricing pressure, the $3 million impact that you experienced in the fiscal second quarter, can you kind of frame that versus maybe the last downturn or expectations on the magnitude of that?

Mark, it is Brian. I don't know if I've got exact data from the last time. I don't think the pattern is wholly different than what we have seen in the past. Pricing always gets a little -- as you might imagine gets a low more tough when you are at the point in the cycle when demand is down.

I would say expectation wise, it is fairly close to where we thought it would come in, in the sense that you never know when it falls as fast as demand fell this time what you're going to see. But I would say overall, while it is obviously not a good impact, on the other hand I don't think that as we see it, it is not at least rampant, if you will.

Okay. As far as the trend through the quarter, has it been consistent?

Mark, it does bounce around a bit because it will depend on what the project load is and how significant specific projects are at any particular point in time.

Okay. So is it fair to say the composition of the price pressure is kind of broad-based and kind of in line with what you expected then?

Broad-based in the sense -- yes, although in the sense that it ends up being almost project specific and almost even competitive situation specific more than I would say everything is just that much deeper in pricing, if you follow what I mean.

I do, thank you. You mention in the press release that you saw some encouraging signs on the relative strength of orders in retail, healthcare and international. Is that something that you guys are doing, or is that kind of just an end market kind of issue?

Well, I think it is a combination of all three of those. I mean, I think it is related specifically to the strategy we have had over the last four or five years of upping our emphasis in those marketplaces, both our presence and the products that we have there.

Right.

So I think you look at healthcare, we have got a much bigger bandwidth of products there than we have had in the Company's history. You look at international, we have significantly increased our distribution footprint and the spread of that over time. Then, of course, we have also got some new products that are stoking that up.

On the retail side, of course, we are also benefiting a bit from the recovery that is happening in retail, in the sense that we are at least not in a period where people are just simply trying to bleed inventory now. I think overall, what we see is when we listen while the architectural world is not back to where it was and they certainly wouldn't describe themselves as healthy, you do hear more at least discussion about people moving spaces than you were before.

Certainly the financing crisis in healthcare isn't over, although I think there is more ability for folks to get financing in the healthcare world today. So there is some of those underneath things that are just beginning to shake loose. I wouldn't say they have impacted greatly yet, but certainly where before we were trying to figure out how to predict where the bottom was, at least seeing that sequential increase gave you a little bit of confidence that you are no longer bucking normalized trends.

Got it, okay. Then just last on the wage recovery, should we expect that to be fairly consistent going forward, assuming that you guys are meeting your plan?

It really is going to bounce around, depending on what profitability and volume levels look like in any one period. So I wouldn't expect, to be frank, it will be quite as big in dollar terms as it was this past quarter in the third quarter because we simply -- what we are talking about with the volume numbers that Greg mentioned in terms of being down typically sequentially, it will generally moderate itself.

Perfect. Best of luck, thanks.

Thanks, Mark.

Budd Bugatch, Raymond James.

Good morning, Brian. Good morning, Greg. Good morning, Jeff. Can you make sure I understand the order comparisons? Orders ex-Nemschoff on a same location or same business kind of basis, what were they?

27, Budd.

But if you take out the price -- the impact of last year's price increase and Nemschoff, the comparisons I think are 27%, 28%.

27%, 28%. It was 25%, just excluding the pricing -- price comparison?

Correct.

So Nemschoff added about 2% to 3%?

Correct.

How would you characterize the composition of sales, project business now versus day to day? It was last year at this time when the real day-to-day business or the CFOs of your customers could really just grab that business and say we are not spending that money right now, if I remember right. So the day-to-day business really fell off a cliff right about this time last year. So how is the composition of business now?

Budd, this is Jeff. In the quarter the project business was down slightly on a sequential basis, but actually fairly consistent with where we were last year at this time.

So what is the composition project versus day-to-day?

We have been running in that low to mid-40% range, and we dipped down back to the low 40% this quarter.

Projects down.

Projects down, yes.

I do think, Budd, to your guess and maybe not necessarily just numerically, but I do think there is a sense that partly what has given you a little bit more stability is the fact that the kind of smaller day-to-day stuff looks like it is coming back more than where it has been, especially last year at this time.

So when you're looking at customer visits and those kind of metrics that are really the harbingers of project business in the future, what is that looking like?

It is fairly steady. Jeff, you've got the actual data?

Actually, we were down in Q2, but we dropped due to the holiday timing right at the end of the quarter. It was really more just a scheduling issue. So it's actually remained quite steady through Q1 into Q2.

Steady determined by steady sequentially, steady year-over-year; what are we --?

Steady sequentially. Down year-to-year still, but steady sequentially which if you recall last quarter, we actually saw an improvement from the fourth-quarter level. So it has remained quite steady, though again the holiday period we saw a dip, just due to the scheduling impact.

The holiday period of?

Thanksgiving -- end of the quarter Thanksgiving period.

Thanksgiving, okay. Can you give us kind of a percentage down year-over-year?

Yes, I can. Down about 35% year-to-year.

Oh, okay. A small subject but one that has been out there for a while is Convia. And you have made some changes, strategically I think, in what you are doing with Convia. Any kind of update on what is going on there?

Budd, as you know, the big change we made was about six months ago when we did this connection with Legrand/Wiremold, to really begin to sell through them. And we have essentially what I would describe as almost an Intel Inside strategy, in the sense that we are embedding our products into their wiring products.

Their sales force is coming up to speed rather quickly, where we now have them fully trained which was a big first step. We had a couple of big wins this past quarter, a well-known retail clothing brand that has made a decision to take Convia throughout all of their stores. That, of course, will be one of those things that depends how fast they roll out their upgrade of all of their store locations, but that is a big deal.

So we are starting to see good activity in terms of winning specific projects. It is still relatively small. I was talking to their CEO the other day and he said, we are more and more confident. He was actually at Greenbuild and walked out saying, we are more confident that, in fact, the combination is important for both of us. But it is early enough yet that I would say while we both see better activity levels than what we were having a year ago, it is not to the point that I can tell you it has a material impact yet from an orders perspective.

But no other strategic decisions looming?

No.

And the clothing chain, would that be the same clothing chain that was the original experimenter with Convia? What was the predecessor name of it?

No. This is a new one.

New one, okay. The outlook for expenses and the components of expenses, can you make sure we understand -- are you seeing any changes in material costs? Trying to understand the composition today of those costs.

Right now, Budd, from a material perspective we don't see much change as we look at what Q3 will bring us, although with all of the chatter about things that could be looming, it is something that we are paying attention to.

But right now for Q3, we don't expect a big impact on commodity changes. And as you know, we are typically locked in for a three-month period anyway, so we tend to have about three months of grace when prices do start to go up.

And was there much change in the cost of sales composition between materials, labor, overhead and just D&T that historically has been, or can you kind of give us what that was in the quarter?

Budd, material ticked up just slightly in the quarter sequentially, so we are running about 40.5%. Direct labor was actually down slightly. Overhead was up, largely due to that wage recovery content that Greg discussed. And then our freight costs remain pretty steady with Q1 levels.

Jeff, that move to material, though, was probably more of a mix-driven thing than it's a cost-driven thing.

It's actually mix and discounting, because obviously as the discounting number gets bigger, so does that material percentage.

Because the mix was a little heavier toward seating this quarter, which is going to run a higher material content because it is not as labor rich, Budd.

Yes, and that was one of the questions I had is -- and you looked at the composition of both orders and sales this year, sales deliveries, seating is an increasing percentage. I would think systems still under pressure more than seating?

You know, it hasn't been a huge shift overall. This quarter seating bounced up a little bit, which probably is driven more by the fact that retail is up and international is up, which tend to be heavier in the mix towards seating.

So I don't know that we have seen a major, major shift because in fact -- because the project business has been a bigger piece, which tends to be driven more through these systems world. But the shift this quarter I think is more driven by the fact that the retail side was moving along and international, which both run way heavier towards that world.

When you talk about the retail side, are you talking about the mass channel that you have moved into?

Both actually, both specialty retail and the mass channel. Both.

And they are doing sequentially better and year-over-year better, as I heard it.

Correct.

Okay, that's good. Just on the seating side, can you give us any flavor of how the new products are doing versus your traditional stables?

Setu is off to a very fast start; we are very happy with that. We were a little later in that product getting out into some of the markets, particularly international, but overall we are very pleased of where it is running.

Of course, like anything right now, it's tough to put anything on plan given how far the market has fallen, right, from when we originally were developing those plans. But overall, we are very pleased with what we are seeing in Setu. And Embody is certainly gaining strength as it begins to get more solid traction on the project side.

They are going to play in different ways in some sense, in that Embody is one we are going to have to build installed base with. Setu has got the interesting ability that it can go in a lot of ancillary areas as well as from time to time, we are seeing folks apply it in more of a task setting, because you've got a much broader set of applications. It has been picked up and to be frank, it is at a very attractive price point for what it does.

Yes, and Embody's price point is extremely high if I remember right?

I don't know that I would use the term extremely high, especially now when we have the new textile. If you've seen the new textile, it actually gets the price point back down. To be frank, the feedback from the retailers is not that. The feedback from the specialty retailers is they are not bothered by the pricing at all, especially with the more moderately priced textile.

And what has that got that price point down to?

I think -- don't quote me. I think it is $1100 if I remember right.

All right. My last question, any news on variable comp, any update on that? I know it has been a tough year, but --.

Well, we haven't accrued nor do we expect to accrue any variable comp that I would call as in our normal EVA program as you would know it. What we do have as variable comp right now is in the form of this wage recovery program which, as we said, we did have a good-sized payout this quarter or will have a good-sized payout this quarter related to it, meaning the second quarter. But overall, the EVA program is not likely to pay anything this year for sure.

Good luck. Thank you very much, Brian. Good talking to you.

Thanks, Budd.

Tom Schwartzman, Sidoti.

Good morning, guys. Just to piggyback on Budd's customer visit question for a minute. When you talk about this metric, is it pretty much a corporate end-user phenomenon as opposed to say healthcare, or is it useful to discuss in terms of the vertical markets -- visits by vertical markets?

Well, for sure there is very little impact on the retail side, right? We are not bringing a lot of -- we might get a retailer in here, but because that is a relatively small universe. What we are primarily talking about is end-user customers from an organizational perspective, and that is both corporate, meaning the typical who you would think as corporations. But it is also institutions of higher learning; it is healthcare network; it is hospitals.

So it does hit all of the vertical markets, to be frank. In fact, there is a good-sized weighting right now towards healthcare and institutions of higher learning, especially those folks who have good-sized endowments and are still building out their campuses.

Now that you have had a number of months now to integrate or I guess move along the curve with respect to Nemschoff, what are you learning thus far from that acquisition?

Well, it is obviously still fairly early days, and a lot of our heavy lifting right now has been how to combine the two efforts together from both a sales and a manufacturing perspective.

I think the encouraging signs with Nemschoff are that with the large, integrated healthcare delivery networks, we now can provide to them a bundled solution that includes everything from admin to pharmacies to laboratories to patient rooms to lobbies to lounges. So one of the things a lot of those large institutions want to do is they want to have fewer vendors, but they want to be able to bring a broader scope of what they have for them.

So that capability we think is really important for the future. And we were already beginning to take sort of the combined efforts of Herman Miller on the technology side, especially in the world of seating technology, with what were great designs from the Brandrud side specific to that market. And I think we just see more opportunities to keep doing that with Nemschoff, of using their sort of customer-centered innovation with our more research-based innovation and combining the strengths of those two.

So it is early, but so far I would say the team is very encouraged by what we think the prospects are.

Great. Lastly, as far as the overall project business, is the middle part of the country still relatively the strongest region?

I think from an ups-and-downs standpoint, the answer is yes, it has been. And that is largely because it didn't see the great run-up, right, before the economic crisis. So the coastlines were hit a little harder in terms of change.

Although I do think you are starting to see the tech guys come alive a little bit. And as you get the sort of phase two of the financials stuff and folks are trying to figure out how to consolidate locations, you are starting to see some activity there, although not in a mass way yet.

Thanks, guys.

(Operator Instructions) Matt McCall, BB&T Capital Markets.

Thanks. Good morning, everybody. I want to talk a little bit about I think the same question, kind of the mix of order shipments in the quarter. So the seasonal pattern kind of held. We've talked about how Nemschoff helped that, I think.

But if you look at just the core office business -- and I still call it the core office, I hope that's okay. You can tell me if it's not. But the core office business, can you talk about the seasonal patterns there, what you're seeing? You talked about maybe some improvement in day-to-day, but some softness in project. How did the seasonality play out in that office space?

Well, I think now when we look at core office, obviously GSA plays in that core office. So it was sort of right in line with what we were expecting to see. We probably had fewer projects. We had a couple of big projects, which I think in part you saw which came out in the discounting level.

But what you have seen, Matt, is -- what you are really looking for in some ways, both our core office business as you referred to it, as well as our core healthcare business, both play in the government sector in a big way. So what we did see is that the sort of nongovernment held in there and the government sort of pushed you forward, which is what you were hoping to see happen.

The other thing is that you are seeing the level of projects on hold and cancellations in that core business starting to recede. Again, it doesn't mean that we have got what looks like a super strong period yet in front of us. On the other hand, you're starting to see some of the negatives start to chip away.

Okay, okay. That is good. So you talked about CapEx expectations, I think it might have been you, Jeff, but anybody can answer this. I think if my numbers are correct, that number ticked up a little bit. If it did, can you explain the higher number and remind us where that spending is aimed?

I think, Matt, the number that we had in Q2 was I think $5.6 million. I know the full year-to-date number is $11. million something, so that is kind of right in line with Q1. It might have ticked up fractionally, but not enough to point to anything specific.

The forecast -- I am sorry.

The forecast points a little bit higher, and that will be largely driven by the typical seasonality of in particular new product introductions as we head into the spring, with several new products coming, as well as we had some showroom and facilities investments that will come along with that. So that is what drives the second half going up a bit.

Okay, and those are new endeavors, I guess, as you -- I'm looking more at the full-year outlook has gone from the low 20s to the high 20s. And is that a sign that given all of the things we're talking about, there is incremental bullishness among the three of you?

No, I would say the number has always been in that $25 million range. I mean, we came into the year kind of with that same number, so I don't think there is a real change there. We have had -- it is always a matter really of trying to figure out the timing of when some of the product development stuff is going to move beyond the sort of development phase into the commercialization phase. And that really tends to be what drives that number one direction or the other.

We have several new products that are starting to make that flip from development to commercialization as we get in the second half, and we are still trying to mix that timing around exactly what we want the sequence of products to be.

Okay. On the gross margin side it sounded like it was largely where you expected. We looked back -- I think last quarter you referenced that number maybe flat to slightly lower. We were down a point. Some of that was the wage recovery that came back, but I'm trying to put all of these pieces together.

Greg, you talked about typically a step down in gross margin Q2 to Q3. But Brian, you just referenced a couple of large orders that potentially caused a little bit of pressure, and you're talking about project activity ticking a little bit lower.

So net all that out, what is the normal seasonal pattern for gross margin, and is that kind of what you are expecting to play out given all these puts and takes?

Yes, I mean there are a lot of puts and takes, Matt. But I think typically, we would expect to see somewhere around a 30 to 50 basis point drop, give or take, as a result of the production levels that step us down usually in Q3 relative to Q2.

Matt, what you've got to remember, the thing that tends to be hit the third quarter is we build product to one degree or another in the second quarter that ships third. So you don't get -- even when the sales drop is in the normalized range, the impact on margin is usually a little bit greater because your absorption just goes down a bit.

Around the holiday schedule, you are building, and the government business tends to be one that we are more involved in the whole process not only from making it, but we don't tend to be able to recognize revenue until after the installation is complete. So that stuff tends to get recognized a little bit later.

Okay. The last question is on the government side, so it picked up. It supported the core office business, and it sounded like healthcare too. Can you talk about the percent of government business in the mix this quarter and maybe compare that to whatever period you want to pick last year?

Then what is the outlook; what does the pipeline of activity look like for the government sector specifically?

The percentage hasn't changed greatly when you look at it overall. There is some mix if you take total government, meaning obviously federal government was up a little bit and state and local is down because of the pressure on a lot of the local government units. Overall, though, total government mix is not appreciably different from where it has been in past periods, especially if you look year-over-year. So that is not a lot different.

Obviously, the government continues to be one of those areas that fortunately they have the ability to manufacture money, which is a helpful thing at times. So that is one that we do see good prospects in. And especially on the healthcare side, we see there still is a fair amount of activity there building out what they need for the future of the healthcare system.

So there is reasonable and solid activity. The one area that you can't help but be nervous about in the government business is what happens in state and local. That tends to be a smaller part of our government efforts, to be frank. We do more business on the federal side. On the other hand, if the commercial business begins to pick up at the same time, that is not a super big concern.

Okay, thank you all.

We have no further questions in our queue. I would like to turn the call back over to our presenters for any additional or closing remarks.

In closing, I'd like to extend my personal thanks to the employee owners of Herman Miller whose dedication during the past year has been unwavering. It is their hard work and ingenuity that has brought us through the challenges of the past year, and it is those same qualities that will lead us to new heights in the future.

I would like to wish them and everyone on the call a very safe and happy holiday season. Thanks for joining us this morning, and we look forward to seeing you again next quarter.

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