MillerKnoll Inc (MLKN) 2011 Q2 法說會逐字稿

Good morning, everyone, and welcome to this Herman Miller, Inc. fiscal year 2011 second-quarter earnings 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 Mr. Jeff Stutz, Treasurer and Vice President of 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 asked the 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 and welcome, everyone. Although questions of economic strength and sustainability still frequent the financial headlines here and abroad, we again saw clear signs of recovery in our business this quarter. The past several months have witnessed an improvement in customer demand that has driven three consecutive quarters of sequential and year-over-year order growth. Order entry was up across our entire business this quarter, increasing 34% over the prior year and 17% sequentially.

This improvement has come at a time when the key economic indicators for the industry are mixed with certain measures continuing to hinder demand. For example, the rate of new office construction remains very low and despite some improvement in service sector employment, the overall job picture remains sluggish.

On the positive side, improved profitability and conservative spending have left corporate balance sheets flush with cash and now available to support new investment. Additionally, high office vacancies have driven rental rates down offering businesses attractive opportunities to relocate and reconfigure their space. Finally, perhaps most importantly, measures of both business and consumer confidence are improving.

Beyond the broader economic drivers a renewed focus and energy in our own collaborative selling process is a factor that I am confident is contributing to our success. I have seen many examples of this in recent months and in all cases the comments read has been improved communication with our dealers, our sales teams, our suppliers and our customers. This has helped us more clearly define the roles and resources within our sales organization and improve the coordination between business units, both of which enhance our selling process.

Our focus here is critical especially given the strategic investments we have made in recent years to broaden our position in fast-growing market segments and geographies. As with all such efforts, there is always room to improve. Still, I'm very proud of the good work our teams are doing in this area and I am confident it is paying off in the form of improved win rates.

To be sure the pricing environment and our business remains highly competitive, as Greg will describe to you in more detail, discounting levels have continued to negatively affect our margins relative to normal leverage expectations.

With that said I think it is important to point out that pricing trends like this are not atypical in our industry as demand patterns shift. Discounting levels generally increase during periods when large projects comprise a relatively high percentage of sales. This is often the case near the bottom of an industry cycle when the mix of government sales tends to be high. It is also typical to see this during early stages of a recovery as the size and frequency of commercial projects increase.

This is exactly what we are experiencing today and while it is not inconsistent with past experience you can be sure we are watching it closely with an expectation that the trend will moderate over time.

Importantly, price is only part of the way we compete in the marketplace. We have always pursued a strategy of differentiation by investing in thoughtfully designed products that solve problems better than the competition. Our commitment to this pursuit has been widely recognized and the resulting designs, particularly our seating products, set us apart.

In the 1980s, the Equa chair was named the design of the decade by Time Magazine. We filed this in the '90s by introducing the now iconic Aeron chair, which went out to earn design of the decade honors by the Industrial Designers Society of America. And just last week, that same organization named our Setu chair the best sustainable design solution for the last decade.

This recognition comes at a time of increasing environmental awareness among businesses and consumers, a factor that makes receiving this honor all the more meaningful. That each of these award-winning products continue to be some commercially successful is a testament to the fact that we are not in the business of producing museum pieces. Rather, our products are meant to be as functional and durable as they are delightful. This philosophy has led to many successes through the years and we have recently achieved an impressive milestone with one product.

In October, we produced our one millionth Mirra chair. Not only does this number speak to the tremendous success this product has been over the past eight years, but it is special for another reason. Mirra was our first product launched on the design for the environment protocol, a program that has guided all of our product introductions since.

This protocol is one of many business practices that together have earned us a reputation for environmental thought leadership. It is a reputation we are committed to maintaining and I am confident will continue to be an important part of our differentiation as we compete for new business in the future.

I'll conclude my opening remarks with an update on our most recent innovation in seating. In October at the ORGATEC tradeshow in Cologne, Germany, we officially launched SAYL, a new family of work inside chairs. The feedback and market response since the show has been amazing with SAYL drawing global praise for its combination of sustainable design, innovative use of materials and user comfort, all at a remarkable price.

It has already graced the covers of multiple magazines and online publications and has garnered international coverage from Asia, the Middle East, Europe and the Americas. This coverage has emphasized our collaboration with Industrial Designer, Yves Behar, as being the next great example of a Herman Miller seating leadership. And best of all, the chair has set a record pace for pre-orders from retail buyers in advance of our manufacturing launch.

Needless to say we are thrilled by the early response to SAYL and we are incredibly excited to see it and other new products gain traction in the months to come.

With that, I will now turn the call over to Greg to cover our second-quarter results in more detail.

Thanks, Brian, and good morning, everyone. Consolidated net sales in the quarter of $412 million were up 20% or $69 million from the prior year level. Relative to Q1 of this year, sales increased over $31 million or approximately 8%. Orders in the quarter, which totaled $462 million exceeded net sales by $50 million and drove the ending backlog up 35% from the last year level.

Orders within our North America reporting segment improved 36% over Q2 last year and 19% compared to the first quarter of this year. As expected, order activity from the federal government was strong in the quarter contributing significantly to the ramp up in business within both our core office and healthcare operations.

However, the improvement in order rates was not limited to government customers alone, as commercial demand remains strong and fairly broad-based across industry sectors and sales regions. Orders within our non-North America business segment improved 31% relative to last year and 5.5% sequentially. Business levels were up throughout most of our international locations this quarter including the UK with the largest percentage points coming from the Asia-Pacific region.

Net sales for the North American business segment were $327 million in the second quarter. This is 18% higher than the year ago period and up 8% from Q1 of this year. We experienced the highest year-over-year growth percentages in our core office furniture businesses this quarter.

That said, sales within our healthcare vertical market were also up significantly compared to last year. Our non-North America segment posted second-quarter net sales of $73 million. This represents a year-over-year increase of 31% and sequential period growth of 9%.

We estimate the translation impact from changes in currency exchange rates increased our consolidated net sales in the quarter by approximately $1 million relative to the second quarter of last year. On an average rate basis, the US dollar has generally weakened against major world currencies compared to a year ago. The notable exceptions to this have been the pound sterling and the euro. These factors largely offset each other in the quarter resulting in a relatively low translation impact.

Moving onto our gross margin performance for the quarter. The ramp up in net sales and production levels this quarter drove a significant year-over-year improvement in our gross margin percentage. This was achieved despite ongoing pressures from price discounting and commodity costs. Our gross margin in the second quarter was 32.9% representing a 70 basis improvement over the second quarter of last year.

As Brian mentioned in his opening remarks, the mix of large projects invoiced in the quarter was again high relative to last year. This resulted in comparatively deeper price discounting which we estimate reduced our Q2 gross profit by approximately $9 million. We also experienced higher commodity prices this quarter primarily for steel and steel components which drove an estimated $3 million increase in cost of goods sold compared to the same quarter last year.

Finally, expenses in the quarter related to employee incentive bonuses were approximately $2 million whereas no such bonus expenses were accrued in the second quarter of last year.

Our gross margin this quarter also compared favorably on a sequential period basis, improving 40 basis points from the first-quarter level. Here again we benefited from improved cost leverage as a result of increased sales and production. While commodity costs remained relatively stable between periods, we did experience deeper price discounting this quarter. However, we sold a higher mix of seating products in the period which helped our margin percentage relative to Q1.

Cost of goods sold in the second quarter also included roughly $1 million in incremental employee bonus expense compared to Q1.

I will now move on to operating expenses and earnings for the quarter. Our second-quarter operating expenses of $102 million were approximately up $12 million from the same quarter last year. Much of the increases relate to the improvement in sales volume between periods, which drove higher variable selling expenses.

We also had approximately $3.5 million in ongoing SG&A expenses this quarter for Living Edge and Colebrook Bosson Saunders, both businesses which we acquired in the fourth quarter fiscal of 2010.

In addition we recognized higher costs in the current period related to program marketing and new product development as well as approximately $4 million for employee incentive bonuses. These increases were partially offset in the quarter by adjustments to the contingent components of the Nemschoff purchase price which had the effect of reducing operating expenses by $4.4 million.

Relative to the first quarter of this year, operating expenses in Q2 were up $9 million. This was primarily due to increased variable selling expenses and higher costs associated with product launches, the ORGATEC tradeshow and employee incentive accruals.

We recognized $2 million in restructuring charges this quarter which relate to previously announced actions. Operating earnings in the quarter were $32 million or 7.6% of sales. Excluding the impact of the restructuring expenses and changes to contingent purchase liabilities, adjusted operating earnings in the quarter were approximately $29 million or 7.1% of sales.

Net other expenses in the quarter reflected a foreign currency transaction loss of approximately $700,000. This compares to an immaterial currency gain in the prior year second quarter and a net transaction loss of approximately $900,000 in Q1 of this fiscal year.

Our effective tax rate in the first quarter was 32%(sic- see press release). This compares to 34% in the prior year and 30.8% in Q1 of this year. Looking ahead, we expect our effective rate for the full fiscal year to be between 30% and 32%. This rate expectation does not consider any potential impact from tax code provisions currently being considered for renewal by Congress.

Net income in the quarter was $18 million or $0.26 per share on a diluted basis. Excluding the per share impact of restructuring charges, adjusted EPS was $0.29 in the quarter. As required under GAAP for purposes of calculating diluted EPS, we have excluded from net earnings the favorable valuation adjustments related to the Nemschoff purchase price components.

That is the income statement overview for the quarter. 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, and good morning, everyone. We reported cash flow from operations this quarter of $22 million. Changes in working capital balances during the period provided a net source of cash of just under $2 million. While this net impact was relatively small in total, we did experience some fairly sizable movements from Q1 levels in the components of working capital. These included significant increases in trade payables and accrued liabilities which were largely offset in the period by volume driven increases in AR.

Our cash flow results this quarter also reflect approximately $9 million in cash contributions to our primary defined benefit pension plan. By comparison, cash from operations in the second quarter of last year was $27 million with changes in working capital driving a net source of approximately $3 million in the period.

Capital expenditures in the second quarter were approximately $6 million, an amount equal to our spending in the year ago period as well as Q1 of this year. Likewise, dividend payments totaling just over $1 million were the same on both a year-over-year and sequential quarter comparison.

We ended the quarter with total cash and equivalents of $154 million which is up $15 million from the August 2010 level. Of this amount, approximately $40 million is held within our international entities. We remain in compliance with all debt covenants and are currently running at a gross debt to adjusted EBITDA ratio of approximately 2.5 times.

Finally, as mentioned in our press release last night, we finalized plans this quarter to refinance a portion of our upcoming $100 million debt maturity. March 15, 2011 marks the date of maturity on the remaining portion of our 2001 public bond issue. Earlier this week, we entered into an agreement to issue $50 million in senior unsecured notes in connection with a direct private placement transaction. The notes, which will fund on March 1, 2011, will carry a 10-year bullet maturity and bear annual fixed interest of 6%.

The proceeds from this transaction, combined with our current cash balance and additional available borrowing capacity, give us confidence that we have sufficient flexibility to meet the financing needs of the business going forward.

That is the balance sheet and liquidity overview for the quarter and I will now turn the call back over to Greg to share some thoughts on the outlook as we move through Q3.

Thanks, Jeff. We normally expect a seasonal decrease in net sales between the second and third quarters. Based on historical experience, this sequential period decline would typically run between 2% and 4%. However, given the relative strength of our beginning backlog and our most recent order entry levels, we are expecting sequential patterns to look different this year. Our expectation is that the third-quarter sales will approach or may slightly exceed the Q2 level.

While the pricing environment is sure to remain highly competitive, we don't anticipate the impact on gross margin to be as significant as we experienced in the second quarter. Commodity prices are not expected to be substantially different from Q2 levels though the longer-term view on commodities remains a clear outlook risk to the business.

As is typical for this time of the year, we will likely have lighter production schedules in the third quarter. This will drive some overhead inefficiency in the quarter relative to the full production calendar we maintained in Q2. All together these factors are expected to yield a third-quarter gross margin personage at or slightly below the second-quarter level.

Operating expenses in the third quarter are expected to remain at roughly the same level as we saw this quarter excluding the impact of the adjustments to the Nemschoff contingent purchase liabilities. We expect our effective tax rate in the quarter to be between 30% and 32%.

Finally, earlier this week, we announced plans to implement a general price increase effective April 2011. This adjustment will increase commercial list prices for most Herman Miller and Nemschoff products by an average of 2.4%. The increase for Geiger products will be slightly above this level. Given the effective date, we do not anticipate this pricing action to have any impact on sales or order pacing in the third quarter.

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

(Operator Instructions) Mark Rupe, Longbow Research.

Yes, this is [John Silverstein]. I am actually a private shareholder. A couple of questions. Can you provide some color on your e-commerce vision going forward? How do you plan to sell more goods and services on hermanmiller.com?

Yes, John, the primary purpose behind the online store, first and foremost was to add to our total marketing effort to drive our retail business. We are not actually -- it wasn't really a primary drive in terms of revenue as much as we thought it was one of the key ways that we have seen other folks be able to drive customers and awareness of our products both back to our other retailers as well as their online sellers. Of course, we will do some business on there and that is a good thing.

One of the things that we had found over time is that a lot of folks would visit our website, especially the younger generation, and they were doing comparison shopping and they would become frustrated when they couldn't easily buy while they are there. And our overarching goal has been to find ways that we can meet the customer where they want to buy versus where we want to be and this is just one of those efforts.

Are you running into any competitive issues with your actual retailers or resellers -- where you are trying to sell the same products and the customer really doesn't know where to go to buy that Herman Miller product?

You know, we have tried to be very careful to work with those retailers and e-tailers to make sure that they understood the purpose of what we were doing and to make sure that we didn't end up in competitive situations with them. Certainly whenever you do something new it raises a level of concern that you have to work your way through. And I would say we are still in the period of cutting our teeth on this and understanding how we can best position it to actually drive value for this those e-tailors and retailers that are out there.

And final question, being a shareholder for the last five years, Herman Miller is a great Company to be a part of. What are we doing to expand the presence? Are we doing anything in social media or mobile to expand the Herman Miller great products that they have so customers can either find them through better retailer channels, go on our website, buy products, what have you? What are we doing in that area to really expand the great brand that we have?

Yes, great question. We've actually done a lot of work, John, in the social media area. If you go out, you can find us on Facebook, you can find us on Twitter. We in fact have one of the highest levels of following on both of those social media programs, of not only our industry but actually amongst much bigger brands even.

We think that is an important part of not just the store but an important way for us to reach out to both current and future customers and particularly the next generation who as you know, that is where they are getting a lot of their influence from. And we have combined that with some interesting marketing contests and other things to get a personal connection with those customers including cases where they have done some of their own designs and those things that have been submitted for contests.

Can I download a mobile app? Or do you have any mobile apps in store for us to be able to download to look at the specific product?

We do not at this time.

Okay. Thank you very much.

[Barry Lieberman], Morgan Stanley. Please check your mute button, Mr. Lieberman. Would you like to go to the next question?

Yes, sure.

Budd Bugatch, Raymond James.

Good morning. It is me. My first question really goes to talking about the leverage issue. Thanks for some of the quantification. I hope maybe you can go back over that and give us what might persist or not persist and maybe quantify what you're thinking is, how that persists and affects cost of goods sold. I think you gave us $9 million, $3 million and $2 million if I remember right for three different items. Is that right, Greg?

Yes, $9 million was the income incremental discounting year on year.

$3 million commodities.

$3 million commodities, and $2 million.

Incentive comp.

$2 million?

Yes, correct.

Okay, and so what do we look like in the third and the fourth quarter is on these items? How would you pen those in?

I mean, broadly, Budd, I would look at the Q3 number -- we don't expect much change in commodities really at all. Discounting we expect -- what we can see in our backlog right now is better, a little bit, and then the wild card really is going to be about production levels with the shutdown week and just how busy we are those first really the second half of January as orders come in the first couple of weeks of January is always really difficult to predict.

So that inefficiency in overhead absorption in January is difficult so sequentially, we would say margin looks to be about the same, maybe down a little bit. But the wild card is what are we going to ship in the quarter of the discounting that we can't -- that we haven't even gotten as an order yet.

Yes, typically you ship about 80% of the backlog in the quarter, right? And then on a piece of the order pacing that goes on in the quarter, so is that the right way to look at it?

Yes, that is a pretty good rule of thumb. I don't know -- we were actually talking about this this morning, I don't know if this bears out, but because we typically have a build of deferred invoicing stuff that's shipped that hasn't recognized as revenue into Q2 --

What is that? That should be -- for the US government, right?

Yes, but any direct -- but yes, that is primarily the federal government, so maybe that number is maybe 82% or something, 83%. It might be a little higher than the 80% but that that is one of the moving factors.

It is really generally anywhere where we hold the contract all the way through installation. So we can't recognize revenue until the installation is complete and signed off. Where typically, as you know, our revenue recognition is when we ship it to the dealer. In the cases where we are billing direct, which is obviously a dealer is involved, and just changes and revenue recognition. The government happens to be a heavy part of that but there are other times we will have large business both domestically and internationally where we are playing in the full cycle if you will, as well as you will see that more when we are selling through our own dealers as well.

Understood. This quarter you have -- if I remember right -- you have 12 production weeks. Is that right?

Yes.

Because you have a shutdown week, right?

Correct.

And how that order weeks -- is it -- how do you calculate that because of the holiday? Is it effectively 12 or is 11. What do you think about that as incoming order rate?

It tends to look like, Budd, it is funny even in the years that you will remember when you and I first started doing this together, even in years where we didn't have a shutdown, if you looked at the patterns, it almost looked like 12 weeks no matter whether we were shut down or not just because you get over that holiday period, there's fewer people making the decisions to actually process orders through during that late December, early January so that typically is the way it looks.

That's what I thought. And how do you think about -- we had the government this year being very active and what percentage of total revenues is government revenues now, US government and other? But also didn't we have a rush to budget cutoff this quarter?

Say that again, Budd. I'm sorry.

Didn't we have a rush to the budget cutoff for this quarter just ended?

Yes, that is pretty typical. That happens every year around that time of year especially on the pieces they do on their P-cards, where they're purchasing off of their government issued cards that they have. That is a pretty typical process. But government as a percentages of the volume has not changed dramatically from prior year. It shifts around a little bit from quarter-to-quarter and period-to-period depending on size of big projects that you happen to be the winner of. But by and large I wouldn't say it has changed significantly for us.

Certainly I would have to say that one of the things when you look underneath the numbers, the strength of the government in this past quarter does have a significant impact on the second quarter and the government has been a more active sector than others both in -- office side as well as in healthcare.

So that certainly has been a help for I think not only us but the whole industry.

Just a couple other quick questions. Have you indicated when SAYL will ship?

We start shipping some stuff I think early February if I remember right.

Okay, and typically you give us some material labor overhead in distribution and transportation as numbers for the quarter. Can we get those?

Sure, Budd. This is Jeff. Let me run you through those. Direct material was at 43% for the quarter. Direct labor came in at 6.3%. Overhead at 12% -- or 11.9% actually. Freight and distribution came in at about 5.9%.

Okay, and finally, I know project has become a larger part and I usually ask the project, what I call over the transom business. Do you have that breakdown?

Sure do. Yes. Project business ran about 41% in our North American business this quarter which is down a bit from last quarter.

Okay. So -- and that is a positive to discounting then, right?

It is. One of the things you are seeing, Budd, is there is not as many -- at least in our case -- not as many super large projects. It is more moderately sized projects so the mix of the projects is a little different than you have seen in some periods.

Okay. And my last question. How is retail -- how is your retail business doing? Business to retailers? You have one major one I know of?

You know, it's -- we were a little light in the first part of this year largely because we were between product launches in the segment where we play with the big box folks. We were in between product lines for them. We just launched a product line with them, so we have seen that pick up.

The specialty side coming into the Christmas has actually been quite good. So we are feeling pretty good about it. Year-over-year that business has not grown like the others, but it took off first, as you know last year was stronger than any other segment and we are feeling pretty good vibes as we get into the Christmas season.

And do you care to quantify the healthcare business year-over-year?

The healthcare business has grown nicely for the year. I would say it grew particularly strong this past quarter.

More above or below the Company average?

Below for the year, above for the quarter, though correct, guys?

Sequentially it grew quite a bit, Budd, probably higher than the Company average. But I think year on year it was below the Company average.

Thank you all very much.

Happy holidays to you.

Same to you, Budd.

Todd Schwartzman, Sidoti & Company.

Hi, good morning, guys. First on the shipments for the quarter, did everything that you expected to ship in Q2 ship? Was there anything pulled forward from third quarter at all?

Generally speaking, Todd, we did maybe a little bit better than kind of the internal forecast was four weeks ago, but not significantly.

And did you speak to the pace of orders throughout the quarter?

We didn't, Todd, but we are happy to talk you through that. We averaged about 32.5 in September, around 40 per week in October and about -- a little over 34 in November.

Which, by the way, Todd, is pretty typical when you look back historically, that's -- October is always the biggest month and November is usually the second biggest with September being the lowest.

And October driven, Todd, largely by that end of government period that Budd talked about.

Okay, and speaking of the seasonality, the lighter production schedules that you are anticipating, is that simply due to the holidays and normal seasonality which you mentioned will -- won't apply this year in terms of the delivered sales?

I think in two -- while we have the shutdown week where we've got a couple extra holidays in there where we are paying folks for the holiday pay, so that is a negative. But also just January production levels, typically the second half of January because there is not a lot of order activity in the last week of December or first week of January to support that. Just there is this less absorption going on in the latter half of January.

Which is one of the reasons we've gotten in the habit of doing the shutdown and we just push the volume in either direction rather than working -- it always tended to be fairly inefficient weeks, we just put the vacation in there and move what would typically be unscheduled holidays into that week and fill the week and then move the production to either side.

And on the government side, how would characterize the demand from the state and local?

It has been -- as a basket, surprisingly good. It all depends because it moves around, right, because you are talking about multiple different government and it is both state and local. But overall, it has hung in there relatively well on a year-over-year basis.

And the product mix there, pretty comparable to the federal in terms of category?

Yes, there is no great difference between what the two of them purchase.

The only difference would be I guess there is one difference in that we do a fair amount of our federal government business is actually on the healthcare side particularly with the military. And that is obviously not true in state and local.

All right, and when SAYL ultimately ships and launches if you do continue to see the discounting increase or pretty much stay at the levels of last quarter, would you expect that offset that you saw in the second quarter to be even better, to have a more meaningful effect? In other words, not much in the way of cannibalization?

Todd, I'm not sure I understood the question, to be honest with you. Can you give me a little more?

Yes. Absolutely. You mentioned, if I heard you correctly, that an increase in the seating products offset a portion of the gross margin impact of the deeper discounting for the second quarter. With SAYL added to the product lineup, does that get better in the next -- as we get into Q4 in particular? Or will that not be too much of an incremental benefit in that there may be some cannibalization of other seating products that you are expecting?

Yes, I would say it is twofold. One, I don't know that there will be a ton of cannibalization because in some ways we are going to an area we have not been in in the past. However, I think what you will find with SAYL, like all new products, there will be a period of ramp up that the margins are never where you think they're going to be in the long run until you get the kinks worked out and you are up to full lines and you are running across the tools. Right?

Because a big chunk of our fixed costs tends to be in tooling and you've got to get up to where you are running it at a reasonable level to offset that fixed amortization, if you will. So I would say fourth quarter is too early because -- while we will start shipping sort of towards the very end of the third quarter, you won't really see significant numbers on SAYL for probably six to nine months after that in a revenue sense. We believe we will start to see those on the order front, Todd, but they won't play out through the revenue cycle until a little bit later than that.

Longer term, I think the question is will SAYL enable us to drive an even greater mix in seating? The answer is we believe so because we are significantly increasing the total span of where we can play in seating not only with SAYL but with other launches we have done like Setu and others that are giving us a broader spread of products in the seating which not only is important domestically but it is also very important in the international market as well as retail.

Great. Thank you very much.

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

Thanks, good morning, everybody. So we haven't yet anniversaried the acquisitions. Can you give us an idea what the organic revenue growth and what the organic order growth look like in the quarter?

Yes, Matt, so speaking specifically to the CBS and [LEF] acquisitions?

Yes, small, but I am just making sure I understand the full impact.

Yes, yes, so I will tell you in dollar terms, we recorded about $10 million in net sales this quarter related to those two acquisitions.

Okay, and then the order would be on the same magnitude, nothing (multiple speakers)?

Yes, yes, same level.

And then -- so I think I heard you right when Budd asked a question about government, Brian, did you say that government as a percent of total hasn't changed that much this year? Did I hear you wrong?

No, you did not hear me wrong. That is correct.

Okay. Well, I thought so. I know we have seen some industry days that shows some pretty good increases there, so government as a percent of total is about the same. It is the --

Yes, you have got to remember -- it is up -- I'm not saying it is not up but as a percentage of our mix, if you looked at orders, it is probably -- especially this quarter -- my guess is the order mix from government is probably higher than the total. But we are talking revenue here and I would say if you are looking at it in terms of the revenue picture this quarter year over year as a percentage of our sales, it has not changed greatly. That does that mean it's not up. You follow what I mean?

Right, okay. I got you.

But it ends up -- because the total is up substantially that would also play through same to there.

Okay, okay, and so is the expectation that maybe -- it sounds like the Q3 margin is going to have the lighter production levels, maybe some continued pressure from the government, but as we move into Q4, that could be when we start to see some margin recovery?

Could we? Sure. It is kind of too early to tell, but we would say that look, some of the big projects that we have had in Q1 and Q2 that invoice in those time frames were very deeply discounted. And as Brian mentioned earlier, we haven't seen at least in our funnel, some of those supersized projects. So the possibility is that they could still occur, sure. But right now we would say, yes, could be discounting maybe getting better by the time you get to Q4.

Hey, Matt. I think it is important to just clarify, though, that the government pricing is not really government pricing that is [affecting] margins. It is size of large projects. Whether that was with government or with anyone else. Those things all fall in the same competitive set if you follow what I mean.

So when we talk about the fact we had large government -- large government projects, effective discounting, it is more the size of the project than who the end customer was. So you have just got to think about -- it all depends on that mix of the big projects as we look to the future.

I know there has been a lot of questions around this thing of leverage these periods versus prior years and I would say to you the pain you have to -- two things that we need to make sure that we remind you all of is first of all, we made choices during the downturn to make what would normally be relatively fixed costs look variable. We did it through wages, we did it through retirement plans. I would even say we did it in some ways through variable compensation that went to zero.

So part of the reason you don't see the leverage as great as you might normally see an incremental sales, is those costs are now coming back and doing their step function back in. The good news is as we get through the third quarter, we will have now put all of those kind of typical costs back in.

The second thing I think you have to keep in mind is while Jeff gave you the year-over-year impact of new acquisitions, we have to remember if you looked at this cycle versus the last one, we have acquired a fair amount of revenue that is not going to have the same yet incremental leverage in and of itself because we are actually acquiring the revenue and we're acquiring the operating income.

Now longer-term and even I would say we are beginning to see signs of this, those acquisitions are one of the things that is driving sales increases not only because of the acquisitions but the pullthrough of the other products. So certainly we get some there but the dollars of leverage are not as great on those at least at this point in their development as they would be if we were just simply growing organically.

So I think you have to think of those two things and the question about when will we see greater leverage will be in and my opinion, now that we have gotten kind of that cost structure built back to a more normalized level where we are able to recruit and retain the folks that we need, that will happen in the next incremental volume from here. And I think if you go back and look in prior periods, it is actually fairly similar to the way it happened in the last cycle as well.

That is very helpful. And it kind of leads to the next question. You mentioned seating was actually better. I was curious to know what the pricing dynamic has been like from a seating perspective. Aeron is a big part of the profitability and just wondering how those margins are holding up and what the outlook is, maybe specifically for that product?

Pricing -- you know, I wouldn't say that we have seen a dramatically different pricing pattern on seating than we have seen in the past. Certainly the workstation businesses is a more difficult business from a margin perspective than seating today. Not necessarily a bad product -- a bad category -- but a different in terms of the ability to generate margins from it.

But pricing is pretty consistent in seating. I don't think we have seen any major changes in one direction or another. Aeron continues to be an important part of our portfolio. At the same time, we are very pleased with what we are beginning to see in Embody and Setu and Mirra, as we said earlier, continues to be a big part. And we are really looking forward to the launch of both SAYL and another product that we have called Advo that will both launch here shortly.

So the net portfolio of seating continues to grow and continues to be a good margin generator.

Okay, and then the final question I have is we really haven't talked about some of your leading indicators, whether it be prime visits or mockups or RFQs or Ps. When you look at those, is there -- I think the projections right now are 8% growth for the industry next year. You guys are trending clearly higher than that.

Is there anything in your leading indicators that would cause you or is causing you to kind of hesitate as you look at the future? Or are you still probably seeing trends in the double-digit range?

Yes, I will lead just give you the data behind some of those things, Matt. I think the thing that I think is still plaguing not just us -- I think it is plaguing all sort of American business at one level is, we are very confident about what we can see through the third quarter because we have got a nice backlog. And we've continued to see reasonably good patterns in order entry.

I think the question you keep -- the only thing that is -- if there is any pause is as you look out to the future beyond that, you -- just your visibility is not as long as it would be and that maybe is our visibility was never that long. But when you come out of these periods of a severe deflection point, it is always one of those you wonder is this recovery going to look like the last recovery? And of course everything we hear in the news today is about how the recovery is muted.

To be frank, our own results have been probably better than we would have expected at this point in the cycle. So I think that is somewhat due to the fact that the industry probably went below what was sustainable level of demand. I think our results are partially reflective of some good things we have done strategically both as I mentioned in my opening comments on the -- with some work in our sales team. I think the investments we have made in healthcare, international particularly Asia, even retail have helped us recover a little faster than what the industry has shown overall.

Of course, the one out there that I think -- guys are sort of cycling around is, we hear lots of noise about state and local governments and where they are going to be and the federal government and austerity programs and other locations around the globe. Those things are ones that you just can't yet predict what's the impact and how fast do those things hit? And to be frank, our job right now is to say well, if those things happened how do we make other moves to get us positioned to get business in other sectors and that is what we are spending our time.

We don't know how to predict where it is going to go and we certainly aren't going to walk away from those areas like the government that have had been great parts of our business in the past. And they are good customers that we intend to still be there with. So I think the difficulty right now is just seeing in a longer horizon. Jeff, do you got --?

Yes, Matt, just specific to the customer visits here in West Michigan for the period, they were up 11% versus last year Q2 and then sequentially up 14%. So we saw the double-digit increases there, which felt good about. And I just would add too, a note for future, we are coming into Q3, we have got good schedules set up here for the month of December but we are going to be working around some construction projects and some showroom refresh projects that we have here in Q3.

So that is going to be something that is likely to affect the numbers here specific to West Michigan this next quarter, but it has been strong to this point.

Yes, to that point specifically, we are actually building right now, we are under construction for a new comprehensive showroom to show all of our healthcare capabilities in West Michigan, which we don't have today. We are putting that in a location that used to be the showroom for our work environments business. So we have kind of got the businesses without as much show space right now and we will be implementing a redo of one of our other facilities where we will primarily show products in the work business.

So we do have a little bit of that going on this next quarter that can make those numbers be a little less meaningful.

Okay. Thank you all.

Mark Rupe, Longbow Research.

Mark, are you there?

Blindsided before so I will keep it brief here. I am not sure what was asked. But on some of the cost coming back you mentioned the bonus being a couple million higher. When do we fully lapse some of those costs coming back?

The end of this -- the end of the third quarter we will have it in for a full -- not quite the full quarter. Actually fourth quarter, because we are -- the 401(k) match comes back starting January 1. So we will have part of that this quarter. When we get to the fourth quarter, we will have virtually everything back to what I would say -- at least we will have bonuses at what would be more normalized levels, maybe not quite back to full bonus. But we will be getting pretty close to it when we get to the fourth quarter would be our guest right now.

Okay, and then just on the SAYL chair, so it sounds like it is not shipping now and -- are orders being taken now for it?

We just started taking sort of advanced orders particularly on the retail side because with those folks -- of course, you are doing a stocking program.

Yes.

And I think we are just starting to open up for early adopter customers, folks that we have been working with through the development cycle. So we won't see kind of a full flow of orders probably until we get into the beginning of the fourth quarter would be my guess, just given the schedules. And we are still down to the final stuff you do at the end of a product launch around supply chain and all of those things.

So there is nothing material behind just the slightly -- kind of layers are just kind of -- button down all of the pieces now, is that --?

Yes, just the typical last-minute teething stuff that happens as you are going through it. I wouldn't say anything unusual. This is one of the fastest developments we have ever done for something this innovative, and we are doing something more different than we have ever done that we are launching it worldwide simultaneously. We are launching contract and retail at the same time.

Right, definitely a big initiative.

Yes, and those things all take on their own character. In the past we would have launched contract US and work from there. So with the compressed time as well as doing the other things, it has made it a little tricky.

Okay, perfect. Thanks.

We're learning a lot, though.

Thanks.

Thank you. I show no further questions from the queue and would like to turn the conference back to Mr. Walker for closing remarks.

First of all, thanks, everyone, for joining us today. We continue to be enthused by your interest in Herman Miller and what we do as a business. We also want to take time to wish you all a joyous holiday season and we look forward to talking to you next quarter.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect at this time.