MillerKnoll Inc (MLKN) 2011 Q3 法說會逐字稿

Good morning, everyone, and welcome to this Herman Miller Inc. fiscal year 2011 third-quarter 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 Form 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 also 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 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. Last quarter I outlined for you a number of reasons for our growing optimism about the pace and direction of recovery in our business. Overall economic conditions at the time including measures of business and consumer sentiments were trending in a positive direction. A broad-based improvement in customer demand had once again driven solid growth in both sales and orders.

I also offered my belief that a renewed focus and energy around collaborative selling throughout our organization was driving improved win rates. Finally, I described the excitement around our latest product introductions including the Celle family of chairs all of which we believe hold great promise for the future.

These same messages are echoed in our third-quarter financial results. We again experienced strong demand across virtually all areas of our business headlined by a 26% increase in sales and significantly improved earnings per share over the same quarter last year.

To be sure, there are many challenges to contend with both here and abroad and the key economic indicators within our industry while improving, remain mixed. Strong corporate profitability and low office rental rates have helped boost furniture consumption in recent months. However, service sector employment and non-residential construction continue to lag their pre-recession highs.

More recently, political unrest in North Africa and ongoing tensions in the Middle East have driven a surge in oil prices that threatens to disrupt the pace of economic recovery around the world. This has been accompanied by rising prices for other key commodities including steel which have a direct impact on our business.

Like all of you, we are watching closely the developments unfolding in Japan following last week's devastating earthquake and tsunami. The social and economic impact of this event are difficult for any of us to imagine though it seems certain at this point there will be a long-term effect on both measures. All of our team members in the region are safe and accounted for. Our retail store in Tokyo did sustain some property damage though none of it was significant.

At this phase, we are currently evaluating the impact of the disaster on our independent dealer network in Japan. Despite these clear challenges, our financial performance in recent quarters and the strategic advances we are making give us confidence that we are heading in the right direction.

I would like to take a few minutes to update you on some of these advances and their relevance as building blocks towards our strategic vision.

In North America, growth within our core office business has outpaced the broader industry throughout the past year. We have also always maintained it is difficult to discern meaningful changes in market share over short timeframes; however given these results, we believe it is clear that our thoughtfully designed products and collaborative selling efforts are proving effective at winning in the market place. Perhaps most encouraging is that we have achieved these comparative growth rates before many of our newest products have had time to gain traction.

Much of our focus on new products over the past few years has been aimed at accessing a broader base of customers within the core office market. These efforts have led to both internally developed and acquired products that we believe help earn a larger share of the business transacted each day through our dealers. Many have only recently been introduced including the Celle and Advo seating line and the Thrive Ergonomics portfolio featuring the technology support products we acquired from Colebrook Bosson and Saunders.

We also just recently launched our newest systems line, Canvas Office Landscape, a collection of desking and storage elements designed to address multiple work applications from open plan to private office.

We are also making great progress on our healthcare business strategy. Last fall we launched Compass, an innovative modular wall unit for use inside the patient room. Although we are still in the early days of its release, Compass is already opening doors on new projects and is helping us find opportunities to package and cross sell with products in the rest of our healthcare lineup.

More broadly, we are continuing to develop our selling capabilities for the healthcare business as a whole. This includes the development of new products and the construction of a dedicated healthcare showroom here in West Michigan. This new showroom which will being open for business later this month will provide an entirely new platform for demonstrating our market leading healthcare offering to customers, designers, and dealers.

Another key element of our strategy is our international business where we see some of the most exciting opportunities for growth and expansion in the years ahead. As Greg will describe to you in more detail, this business posted solid year-over-year sales and order growth again this quarter.

Consistent with our experience over the past several quarters, the Asia-Pacific region again posted some of the largest percentage gains. This dynamic and fast-growing region represents enormous potential for the future of our business and our international team has done a great job building our presence here over the past several years.

We have always believed that achieving our long-term vision for growth in Asia would require us to partner with an established leader. Last week we reached that milestone with the announcement that we will acquire POSH Office Systems, the leading manufacturer of quality office furniture in China and a growing presence in Greater Asia. Our relationship with POSH began in 2008 with the formation of a strategic distribution alliance. This gave us the capability to address a broader set of our customer needs, build combined recognition and strengthen our selling network.

Together we have had some great wins especially in China and India. We strengthened our alliance late last year with the introduction of [ARRIS], an innovative desking solution co-developed with and manufactured by POSH. This acquisition represents the next logical step in our relationship with POSH. They offer dedicated distribution network that reaches across China an established brand with market appropriate price points, an experienced management team and efficient product development capabilities. Together we will offer one of the most extensive product portfolios in the Asia-Pacific region.

POSH is headquartered in Hong Kong where the company operates five show rooms. They also have more than 20 franchisee dealerships in Mainland China and a manufacturing operation in Dongguan. With the completion of the acquisition which we expect will be finalized in the first quarter of next fiscal year, POSH's 1200 highly talented employees will become members of the Herman Miller family.

Deepening our relationship with POSH is a key building block in our business strategy and we are thrilled about the opportunity it is sure to bring. I would however like to make clear one important point about what this acquisition does not represent. Our plan to expand in Asia shouldn't be viewed as a signal that we will eventually move manufacturing from the US and Europe into China. Our strategy has been and will continue to be to establish operations within those markets necessary to serve our customers with speed, reliability and choice. We believe this strategy will strengthen our global brand and improve our ability to serve customers both local and multinational in a way that will help us grow not just in Asia but in all areas of the world.

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

Thanks, Brian. Good morning, everyone. Consolidated net sales in the third quarter were $415 million, up $85 million or approximately 26% from the prior year level. In comparison to Q2 of this fiscal year, sales were up $3 million. This sequential improvement in net sales while small represents a departure from the normal seasonal declines we generally see during this timeframe and can be attributed to the strong backlog we had coming into the period.

Orders in the third quarter of $368 million were up 27% on a year-over-year basis but decreased 20% in relation to Q2 of this fiscal year. This sequential quarter decrease reflects typical seasonality in our business and was consistent with our expectations coming into the period.

Orders within our North America reporting segment totaled $284 million, an improvement of 28% over Q3 last year but was down 24% on a sequential period basis. Consistent with our experience in recent quarters, the year-to-year order growth in the quarter was again fairly broad-based both geographically and across industry sectors including both federal and state and local governments.

Orders within our non-North American business segment improved 22% relative to last year and were down 4% sequentially. Business levels were again up throughout most of our international locations this quarter including the UK and Central Europe but with the largest percentage gains continued to come from Asia and Latin America.

Net sales for the North American business segment were $331 million in the third quarter. This is 26% higher than the year ago period and represents essentially flat performance with Q2 of this year. Similar to last quarter, the largest year-over-year percentage gains were again experienced in our core office furniture business.

Our non-North American segment posted second-quarter net sales of $68 million. This represents a year-over-year increase of 25% and a sequential period decline of approximately 7%.

We estimate the translation impact from changes in currency exchange rates increased our consolidated net sales in the quarter by approximately $2 million relative to the third quarter of last year. On an average rate basis for the quarter, the US dollar generally weakened against major world currencies compared to a year ago period. The notable exceptions to this were the pound sterling and the euro.

Moving onto gross margin performance for the quarter, despite an $85 million increase in net sales over the prior year, our third-quarter gross margin of 32.1% was 30 basis points higher than the prior year level. Comparatively, deeper price discounting in the current period reduced our Q3 gross profit by an estimated $11 million. The price of key direct materials including steel and steel components remained above last year's levels throughout the third quarter. This drove an estimated $1 million increase in cost of goods sold compared to the same quarter last year. Cost of goods sold in the third quarter also included $3.6 million in expenses related to employee incentive bonuses whereas no such expenses were accrued in the third quarter of last year.

Our gross margin percentage decreased 80 basis points relative to the second quarter of this fiscal year, a deeper decline than we expected. As anticipated, the seasonal decrease in order entry drove reduction in production schedules and lower leverage of fixed costs. Additionally, employee bonus expenses recorded in the third quarter were $1.4 million higher than in Q2.

Unexpectedly, discounting was approximately $1 million deeper than Q2 and we also experienced inefficiencies from new product startups as well as weather-related plant shutdowns this quarter. Together these items reduced our gross margin by an estimated 50 basis points.

That said, despite recent increases in the price of steel and other materials, overall commodity prices had little incremental impact on our third-quarter gross margin relative to the second quarter. This was primary due to the duration of our pricing terms under our key supply contracts which affords us protection from near-term swings and direct material costs.

Moving forward, we do expect to see some negative pressure on gross margins in the fourth quarter as we phase into higher contract prices. Now that we have announced a general price increase which becomes effective May 1, we don't expect it to begin to offset rising material costs until midway through the first quarter of fiscal 2012.

I will now move onto operating expenses and earnings for the quarter. Operating expenses in Q3 were $102 million which is approximately $16 million higher than the year ago quarter. A large portion of the increase was driven by variable expenses resulting from the year-over-year growth in sales and profitability. Additionally in contrast to our normal operating leverage, we recognized $3.7 million in ongoing operating expenses related to Living Edge and Colebrook Bosson and Saunders, both businesses which we acquired in the fourth quarter 2010.

These increases were partially offset in the quarter by adjustments to the contingent components of the Nemschoff purchase price which had the effects of reducing our third-quarter operating expenses by approximately $5 million. By comparison, adjustments to these reserves in the third quarter of last fiscal year reduced operating expenses by just under $2 million.

In January, we settled all of the remaining contingent elements of the Nemschoff purchase price in return for a final cash payment of $3 million. Accordingly, our financial results going forward will no longer reflect the periodic valuation adjustments that were required prior to this settlement.

Consistent with our expectations, total operating expenses in the third quarter were relatively flat in relation to Q2 of this year. Overall, operating earnings this quarter were $31 million or 7.5% of sales. Excluding the impact of changes to the contingent purchase liabilities, adjusted operating earnings in the quarter were approximately $26 million or 6.2% of sales.

Our effective tax rate in the third quarter was 24.4%. This compares to 33% in the prior year period and 32% in Q2 of this year. The rate in the current quarter was lower than we anticipated due to the benefits from the R&D tax credit legislation that was signed into law in December. The extension of this legislation allowed us to recognize R&D benefits related to the third quarter as well as retroactive credits for the period January through November 2010.

Looking ahead, we expect our effective rate for the full fiscal year to be between 29% and 30%. Net income in the quarter was $20 million or $0.29 per share on a diluted basis. As required under GAAP for purposes of calculating diluted EPS, we have excluded from the net earnings the favorable valuation adjustments related to the Nemschoff purchase price components.

That is the income statement overview for the quarter. I will now turn the call over to Jeff to give us a brief update on our cash flow on our balance sheet.

Thanks, Greg, and good morning, everyone. Cash flow from operations in the third quarter was $21 million and reflected a networking capital use of approximately $3 million in the period.

Favorable reductions in both AR and inventory were more than offset by a net reduction in trade payables and accrued liabilities. Our cash flow results this quarter also reflect $3 million in cash contributions to our primary defined benefit pension plan. By comparison, cash from operations in the third quarter of last year (inaudible) $8 million and reflected a networking capital use of approximately the same amount.

We did experience a ramp up in capital expenditures this quarter which totaled just under $10 million. Through the first half of the fiscal year, we averaged roughly $6 million in spend per quarter. The increase in Q3 related largely to showroom construction and remodeling projects here in West Michigan. Capital spending in the prior year third quarter was approximately $4 million.

We paid just over $1 million in dividends this quarter, an amount that remained consistent on both a year-over-year and sequential quarter comparison. We ended the quarter with total cash and equivalents of $165 million which is up $11 million from the November 2010 level. Of this amount, approximately $50 million is held within our international entities.

Subsequent to the end of the quarter, we completed a partial debt refinancing transaction. Just this week we paid off the remaining $100 million of our 2001 public bond issue. The transaction was completed using existing cash in combination with $50 million in proceeds from newly issued senior unsecured private placement notes. These 10-year notes funded on March 1 and carry a fixed annual coupon rate of 6%. The completion of this refinancing reduces our total long-term debt balance to $250 million, none of which is current.

We remain in compliance with all debt covenants and as of quarter end our gross debt to adjusted EBITDA ratio was approximately 2.3 to 1. Given the timing of the debt refinancing, this measure is based on a total debt level of $300 million as opposed to the reduced balance.

The available capacity on our revolving credit facility remains at approximately $140 million with the only usage being from outstanding insurance related letters of credit. Given our current cash balance and ongoing cash from operations and borrowing capacity, we remain confident that we have sufficient flexibility to meet the financing needs of the business moving forward.

That is the balance sheet and liquidity overview for the quarter and I will now give the call back to Greg to share some thoughts on the outlook as we move through Q4.

Normally we expect to see a seasonal increase in net sales between the third and fourth quarters. However, given the relative strength of sales this quarter which countered normal seasonality, we are expecting sales in Q4 to be flat or up slightly on a sequential basis.

As Brian mentioned in his opening remarks, the economic impact from political unrest in the Middle East and the earthquake in Japan are clearly uncertain. With that said, it is important to keep in mind that our sales in these regions are relatively small in relation to the total. While we may feel some near-term impact from these events, the broader risk to our business lies in the potential for longer-term spillover effects on the global economic recovery.

We expect our fourth-quarter gross margin to benefit from improved manufacturing efficiencies as a result of heavier factory production schedules. However, much of this benefit will likely be offset by higher fuel and commodity prices which as I mentioned earlier are likely to impact our near-term results.

All together these factors are expected to yield a fourth-quarter gross margin percentage near the third-quarter level.

Operating expenses in the upcoming quarter are expected to increase slightly as we prepare for the annual NeoCon trade show and as we incur expenses associated with the planned acquisition of POSH.

Finally, we expect our effective tax rate in the quarter to be between 29% and 30%. And with that, I will now turn the call back over the operator and we will take your questions.

(Operator Instructions). Budd Bugatch, Raymond James.

Good morning, Brian. Good morning, Greg and Jeff. This is actually Chad filling in for Budd who is traveling. A quick question, Greg, just to clarify the comments on the outlook you mentioned OpEx up slightly. Was that year-over-year or sequentially?

That was sequentially, Chad.

Okay so up slightly sequentially. Then just another clarification. We talked about the surprise versus your original gross margin guidance you said of the three factors, about $1 million of price discounting, product startup and efficiencies and weather impact. Was it all three of those that was a 50 basis point or was it the last two?

Yes, all three of those together were about 50 basis points, Chad.

Okay, great. I guess, Brian, probably a question for you. Talk a little bit about POSH. Could you remind us or give us a sense of kind of the size and growth profile of the office furniture market in China?

First of all, it is very difficult to get any kind of numbers on the market size in China because as you know it is fairly -- it is such a formative nature compared to the US. There is no trade association or anything like that that you can actually put your fingers on.

What I can tell you though if you look at it and you think about our industry back in the sort of the '70s and '80s, what you saw was furniture, the office furniture business growing at a multiple of GDP by probably somewhere around 1.75 to 2 times the growth rate in GDP. I think that is what you feel when you are in China. You can't help but just watch the number of buildings go up and watch a conversion from factory and farms into the office to see that same sort of secular trend that we felt back then in the US.

That is probably the best gauge that you can get to is by looking at what is happening with GDP and employment growth rather than just an easy market size. I can tell you our own data keeps telling us that the market is growing very, very rapidly. It is still a relatively small market on a world scale but it is where it is going is probably the most interesting part of the whole thing.

Got you. As we try to model kind of the impact on the financials in the next fiscal year, you talked about $50 million of revenue from the company. I think that was for 2010. Given that they were already selling some Miller product, how much incremental revenue would you expect to contribute to your results? And could you give us a sense of kind of the relative profitability of that versus your fleet average?

Chad, this is Greg. About $5 million of their number came from us -- from a topline perspective.

And the relative profitability of that business?

Its operating income levels are pretty similar to what we would see in the US overall. Part of -- we are going to have to figure out when we get there is how does that work out in terms of amortization of goodwill and all those things which always takes a little bit until we get down to the final moments of the acquisition to figure out what is amortizable and what isn't. But overall, the earnings power is fairly similar to what we see in the US.

Thanks, guys for taking my questions. I will defer to others in the queue.

Todd Schwartzman, Sidoti & Co.

Good morning, guys. First off wondering if you could talk a little bit about customer visits, what kind of visibility, how they were during the quarter and also what kind of visibility you have into future visits in terms of are they typically booked weeks in advance or months or how do you typically think about that?

Todd, this is Jeff. I will take that. The truth of the matter is this quarter we were actually pleasantly surprised with the level of customer visits we had. If you recall as we stood at the end of Q2, I had made a comment that given the showroom construction projects that we had queued up for the third quarter we fully anticipated to see a bit of a disruption in our West Michigan visits. We did see that and sequentially they were down about 10%. But that said, we were still up I think 36% on a year-over-year basis so a pretty significant increase in Q3 versus Q3 last year even with the scheduling conflicts with the construction.

To your question kind of on the foreword look, I can tell you our customer visit kind of the lead in our customer experience team, they are busy, they have got calendars filling up. I don't know that I can speak to how far out that goes. But I know that the comment has been given some of that description from the construction projects, they are hopping here over the next several weeks.

And that new healthcare showroom is opening would you say, next month?

Later this month actually.

Later this month, okay. Great.

Yes.

In terms of the government business, I wonder if you could speak to the order rates both on the federal and the municipal sides?

Sure, Todd. Obviously [viewing] the Q3 sequentially those numbers go down but both of those were up year on year. The state and local was up a small percentage -- I don't remember off the top of my head -- but it was up year on year. The federal government was up a little bit more.

And any meaningful change in order size, average order?

Not year-over-year, sequentially obviously we had some big orders roll through as we always do in the second quarter. So sequentially, they get smaller but nothing noticeable year-over-year.

Great, thanks, guys.

Mark Rupe, Longbow Research.

I am not sure if you addressed kind of Europe on the international side how that is faring but I would love to get an update there.

Europe in general is not seeing the same kind of recovery we have seen in other parts of the globe. It is actually surprisingly done pretty well in our total EMEA business. But certainly if you compared it to areas like Asia-Pacific or even South America, it is much stronger there. It is up slightly but not nearly to the degree that we see in other places and some of that up is actually related to the acquisition.

Okay, nothing structurally, it is just the marketplace there?

Yes, yes.

And then on the Celle chair, can you just kind of give us an update -- I know it is a big launch; it is three continents and things like that. Any kind of update on the thought process on how incremental it can be and things like that? Where you stand with that and if any of the order balances -- is Celle included in order growth right now or is it still outside of that?

It is not, Mark, it is not really meaningful yet because we really I mean when we said we had some disruptions with it this quarter, that was really doing first the prestocking to the retail side which is as you know is not a huge business although as I think as we have said in the past, it was actually a bigger prestocking in retail than we have seen with previous launches of products by fairly significant amount.

But again, relatively small business overall and we were doing a lot of getting first samples out to dealers and customers a try and those kind of things and we just -- we had some inefficiencies in getting that stuff ramped up. We are doing a lot of things still fairly manually which is pretty typical process where we will start manual until we get a complete flow and go back and put a flow line in place.

But I think what is going to be -- it is going to be important on this one as we get out there is to see how much do we capture and what is a price point that we have not traditionally played in. And we know that that -- we have had a very high share of the upper end of the market but we have not played that strongly in sort of the mid to down side of a market in both Celle and eventually Advo will both play in that area.

So we think it could be a meaningful change to the seating business. Of course the question is going to be what is the overall environment for value and where customers go going forward.

But right now we think it is going to be fairly significant but I don't think you guys will be able to see it in a big way probably until we get into first or second quarter before we are going to really be able to give you much guidance on what we are seeing from it. It just takes that long because remember, we are in the process of putting it in bid situations on projects. You've got to get it ramped up through projects and so it literally takes six to nine months before you got a really, really good read.

Okay. Then just lastly, I know you addressed the input cost inflation, the pricing thought process and when you will start to get a benefit from that. Should we just assume that the price increase will offset the input costs or is there any kind of benefit once it gets put into place where you've priced in a little bit of flexibility (inaudible)?

Mark, I think the answer is we probably 60 days ago, we would as have thought we had priced in some flexibility. Of course, as we continue to watch commodities ramp up, we are really right now probably looking for a push between price and cost.

Greg, is that what you would see?

Yes, there is volatility day to day when oil started to get up to more broadly -- close to 107, 108, you start to get nervous that we would struggle to cover all of that. But right now where it stands yes, that is probably a pretty fair assessment as we start to get the full benefit from that price increase which ends up taking a while due to the timing of contracts. (multiple speakers)

I think that is going to be one of those questions we will have to watch as we get to the balance as to how -- you know, you always watch sort of steel tends to go up and it sort of gets parabolic and then it tends to settle down.

With Greg's point of it getting to a push is we are still essentially assuming we will see some settling. If we don't, we will have to either go in and adjust discount levels or consider what we do on price from there.

The good news is everybody is feeling it. We know some folks have actually done a couple of price increases so we have kind of got a little bit of room there assuming it is broad based and not just related to our industry.

Right. Then on oil, I know that some players in the industry have done surcharges. Is that a thought process or would you guys ever entertain that?

We certainly -- we will entertain almost any lever we can pull. I would say in the past, surcharges have been very difficult to capture in our industry because in a lot of cases, you're not only working on a project but then you also work on this kind of facilities agreement going forward. And as strange as it is, this industry tends to work off a discount level rather than a set price. And surcharges always seem to be very difficult to get purchasing departments' minds around in our industry even though it is common in others.

So I wouldn't say we -- we will consider it. We will consider whatever we think we can do around the commodity increase. On the other hand, they have just not proven that effective in the past but we will try to see which other ways we can go.

Okay, perfect. Thank you and good luck.

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

Good morning, everybody. Brian, so you started out talking about the initiatives for more collaborative selling. Sounds like you're making some good progress there. Can you give us any kind of metric -- is it a dollar per employee? Is it a -- how do we monitor the progress there and gauge the indication of success and then what could it mean from an incremental revenue perspective as we look forward?

It is a great question, Matt. I would tell you, this is really driven a lot by -- Curt Pullen runs the North American business and Curt would say it is going to come down to how much share I can pull and what kind of penetration I can get in the dealers. And so we would say the best way to look at it right now is we have seen the benefit show up in our order growth rates versus the overall and that ultimately I think is the best way you are going to get a handle on it.

When you are looking at selling costs or sales per employee of course, you get this kind of right now we are coming out of a period when sales were relatively low as you know. And so I don't know if yet I can tell from that whether we are seeing just a bounce back off the bottom so those numbers will look really good or whether that is a sustainable thing. I think that will take some ways to play out to see is it actually driven efficiency? We really didn't do this to drive efficiency as much as we did to drive effectiveness.

But I think things like sales per salesperson and those kind of things I think that will take a while to figure out whether that is where we are seeing it. It is pretty early days but Curt is extremely positive that the granularity he is pushing for is starting to have an impact.

So when you are saying your order growth rates versus overall, you are talking about for some of those incremental products that you are trying to add to the Celle versus the growth rates of your other products?

No, for the industry in total.

Oh, okay.

If you look at this decor business because it is a kind of a -- it is a two-pronged approach of new product categories as well as increasing the effectiveness of the sales organization and our connectivity with the dealers. So it is both of those things combined and you really -- in some cases, we have added salespeople particularly around the ergonomics tools and so when you look at it, we have actually got some focus selling resources we didn't have in the past. So that is why I think it is -- what we are really looking at right now is what has happened in terms of market growth rates and how are we faring versus those?

Got it, got it. Okay. And I think Greg, you mentioned the discounting surprise in the quarter of about $1 million and I think that was a year over year. No, that was a sequential number. So my question is more on a year-over-year basis as we look at -- I mean, obviously there has to be I guess some mix impact here and so the question is, if you look at discounting and you look at the impact it has had as we have seen more large projects come through which include more systems, furniture, can you strip out that and then look at how much of it is due to just more large projects, more systems versus the trends in some of the other product categories? Most importantly is obviously seating, what have the margin trends looked like in seating?

So let me see if I can unpack that question. From a year-over-year, discounting was $10 million, $11 million worse. When we give you that number, we strip out the impact of mix on that number. So we talk about it separate from discounting. We are looking at systems discounting versus systems discounting; we are looking at seating discounting versus seating discounting. So a mix shift would not be in the number, that would be a pure discounting number.

Okay. So when we look at seating discounting specifically, can you just give me some more color on what those trends are like on a year-over-year and sequential basis?

Sequentially, Matt, the incremental amount of discounting was driven nearly all by one big seating project. So sequentially I can tell you that seating was definitely deeper than it was in Q2. Year-over-year, I tell you that I don't have the numbers off the top of my head but I can tell you that the systems piece was a bigger piece of the incremental discounting than the seating piece. But nonetheless, the seating piece was up as well. In large part a lot of our shipments in Q3 ended up being GSA shipments which are going to be deeper discounted.

Okay.

You have a customer mix issue as well as a product issue to sort out and some of that pricing thing that you are talking about is a mix customer.

That actually leads nicely so the mix of government -- Brian, I think last quarter you said government as a whole especially federal hadn't really changed that much. That sounds like that did change in Q3?

Yes, it was up a little bit relative to the average, Matt. I don't know off the top of my head how much more than the average increase year-over-year. But government was up a little higher. In orders back in Q2 not shipments and then in shipments in Q3.

Got it, got it. Okay. Then I think we've got one more quarter before we anniversary the acquisition. Did you talk about or can you talk about organic growth trends, what were the organic growth trends in the quarter either from a revenue or I guess from a revenue and order perspective?

Yes, Matt, this is Jeff. From a core work business organic growth, we estimate that to be about 30%, 31% versus prior year. Where do you want to take the question from there?

So that is excluding the acquisitions?

Correct.

Okay, okay. That was the only question. That was the revenue, what about the order trend?

Up a little over 40%. One more comment too on the discounting. Overall from a project versus base business mix just in general, we did have -- we had higher project business in Q3 which is not terribly unusual given -- I am talking versus sequential versus Q2 -- just given the fact that you have got the holiday and so forth in there. A lot of what we are doing is follow on on project larger sized project businesses where you have less day to day just because of the time of the year. So not terribly unusual at least on that measure.

Okay, okay. Then finally, I think I asked this question last quarter too. Just I know there has been some costs have come back and we are talking about the discounting pressures. But as we look forward from here and we are getting to a more normalized environment where you are not having incremental costs returning, can you talk about the incremental margin expectation based on the current cost structure? And I guess maybe excluding any impact from inflation?

That would have been my [hedge] on my comments but, Matt, we look at the business going forward to lever very similarly to how it has operated in the past once we are all in. So we think that is about a 20% to 25% operating leverage on incremental volume.

So when does that commence?

I think that commences from basically right now really -- you can call it third quarter, second quarter. The Q3 number has the all-in kind of return to full benefits and wages and all of the things that we had taken back.

Okay, okay. Final question, sorry. The operating expense outlook you talked about the incremental spend outlook back -- and history tells me it is about a $5 million increase sequentially from Q3 to Q4. But it didn't sound -- maybe it sounds like that was a little more than you were implying.

Yes, that would be more than we were implying.

All right. Thank you all.

I see no further questions in the queue at this time.

Thanks everyone for joining us on the call this morning and for your continued interest in Herman Miller. We are excited about the progress we have been able to share this morning and confident in our ability to continue to execute our strategy. We also hope to see many of you at the upcoming NeoCon trade show in June where you will see further evidence of that work.

For now we wish you a great spring and look forward to talking to you again in June.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may now disconnect. Everyone, have a good day.