MillerKnoll Inc (MLKN) 2012 Q2 法說會逐字稿

Good morning everyone and welcome to the Herman Miller Incorporated second-quarter fiscal year 2012 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 report 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 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.

Good morning and welcome. Our second quarter marked a continuation of the solid financial performance we reported last fiscal year and in the first quarter of this year. I will open the call this morning with a focus on some of the highlights as well as a few personal observations on the challenged economic backdrop we anticipate as we begin the second half of the fiscal year. We posted net sales in the period of $446 million and in doing so notched our seventh consecutive quarter of year-over-year revenue expansion. Adjusting for the extra week of operations, we reported in Q1 of this year, our results also mark our sixth quarter of sequential sales growth.

Perhaps most encouraging in the numbers was a significant improvement in gross margins which at 34.1% was the highest we have achieved in three and half years. Improved gross margins combined with well-controlled operating expenses helped drive solid year-over-year improvement in both operating margins and earnings per share. In all we are pleased with this performance. However there were some challenges along the way. One area that caused us some concern was a lower than expected seasonal ramp-up in US federal government business. While government order activity did increase in advance of the September year-end, the magnitude of this rise was significantly less than we saw in the second quarter of last fiscal year, when we benefited from some very large project wins.

As we analyze the results, it's important to keep in mind the particularly difficult year-over-year comparison that we face this quarter. Last year's 34% order increase was the single largest quarterly growth percentage we've reported in at least 12 years. As a reminder, that unusually strong increase was enhanced by some very large government and government related healthcare projects that were added as orders in Q2 of last year.

Beyond the federal government, the remainder of our non-North American commercial sectors including healthcare were stable year-over-year in terms of orders. As we note in the press release, our non-North American and Specialty and Consumer segments both posted double-digit order growth. This was led by our non-North American business that had order growth of over 25%. While the year-over-year comparison in North America was difficult, our sales team continued to be positive about the number of project opportunities and large project wins that we have yet to enter into our order book.

The view ahead is certainly clouded by our Q2 order pacing and more broadly the tenuous health of the global economy. BIFMA's most recent forecast provision offers a rather sobering perspective on how this economic uncertainty may impact our industry's near-term growth. In short the forecast points to a general lack of momentum in the key drivers of furniture demand. This conclusion is hard to argue against given the day-to-day volatility we all see in the economic headlines. To be sure, global economic fears are running high fueled by the serious political and economic challenges in Europe. On the other hand the health of the US economy continues to show signs of improvement including positive trends in overall employment, manufacturing output, and consumer confidence to name a few.

Companies continue to hold large amounts of cash and overall corporate profitability is still strong. These are all positive signs for the economy and for our industry. But the question remains whether they can be sustained. Of course timing is everything but we remain optimistic that they can and ultimately market fundamentals will overcome today's economic fears. As I commented in last night's press release, regardless of what the macroeconomic situation brings in the coming months, our collective focus at Herman Miller remains at implementing the elements of a long-term business strategy.

I'll conclude my opening comments with a brief update on two of these. As you know, for several months we have been working on putting in place the legal and operational structure necessary to complete the acquisition of Hong Kong-based POSH Office Systems. While this process has proven more time-consuming than we initially expected, the delays have allowed us to make adjustments which we believe will better position us for long-term success in the region. Our POSH project team cleared a number of structural hurdles this quarter and we now expect the deal to close in the spring.

The next item relates to a new initiative aimed at leveraging on our rich design heritage. Earlier this month we previewed the Herman Miller Collection at the prestigious Art Basel in Miami Beach, an annual celebration of contemporary art showcasing artists and dealers from around the globe. The collection combined a range of products including both classics and new designs that will enable customers to furnish collaborative environments in a wide variety of settings. In all the collection will include more than 150 thoughtfully designed products with additional introductions been planned for the future. At its core the Herman Miller Collection is aimed at building and articulating our unique story for architects, designers, and brand oriented consumers.

Needless to say we are incredibly excited to see its launch and momentum in the months ahead. These are just two important pieces of a broad strategy unfolding here at Herman Miller. I'm encouraged by the progress our teams are making across a wide range of important initiatives and I look forward to sharing more of their accomplishments with you in the future. With that I'll turn the call over to Greg to cover our second-quarter results in more detail.

Thanks Brian. I'll begin with a reminder that our results in the first quarter of this fiscal year included 14 weeks of operations. In discussing our results for the second quarter, I'll quantify this impact where appropriate to assist you in making sequential period comparisons.

On a consolidated basis net sales in the second quarter of $446 million were 8% above the same quarter last year. New orders in the period totaled $440 million and was down 5% on a year-over-year basis. As Brian mentioned, last year's unusually strong order volume made this an especially challenging comparison. This was further amplified by the recent sale of three previously owned dealerships. Last quarter we reported to you the sale of two owned dealerships and more recently during our second quarter we completed the sale of a third dealership, LA-based Workplace Resource. Factoring in the effect of these dealer deconsolidations, pro forma sales in the second quarter grew almost 11% on a year-over-year basis. On this same measure, total orders in Q2 decreased approximately 3%.

On a sequential quarter basis after adjusting for the extra week, sales in Q2 increased approximately 5% over the first quarter level. Orders in the second quarter were down 2% on a comparable 13 week basis. As a reminder, we believe the timing of our most recent price increase had an impact on order pacing between our first and second quarters. At the beginning of the quarter we increased our general list prices an average of 2.5%. As a result we estimate that between $10 million and $12 million of new orders were scheduled in the first quarter that would otherwise have entered in Q2.

I'll now review the sales and order performance by business segments. Sales for the second quarter within our North America reporting segment were $322 million. This represents an increase of 5% from the prior year. Factoring in the impact of dealer deconsolidations, sales for this segment were up 8% on a year-over-year basis. We did see some softening in order activity this quarter in our business with the US federal government. Beyond this, order pacing remained generally strong across the other North American industry categories. In total, new orders in the second quarter within the North American reporting segment totaled $306 million, reflecting a decrease of 13% from the same period last year. Excluding the impact from both dealer deconsolidation and order pull in from the September price increase, orders for the North American segment decreased an estimated 7% from the prior year.

Our International operation again posted strong results with double-digit increases in sales and orders versus the prior year. While the increases were particularly strong in the UK and the Asia Pacific region, we also posted solid year-over-year percentage growth within Central and Eastern Europe. In total our non-North American business segment reported net sales of $88 million in the quarter, an increase of 20% from the year ago period. New orders were also strong, totaling $92 million in the period. This represents an increase of 25% in the second quarter of fiscal 2011. Sales within our Specialty and Consumer segment totaled $36 million in the quarter. This was up 14% from last year. Order activity in the second quarter reflected similar year-over-year growth, increasing from $36 million in fiscal $2011 to $42 million in the current year.

I will now move on to gross margin, which was definitely a highlight for the quarter. At 34.1% our gross margin this quarter is the highest level we have reported in three and a half years. This represents a 120 basis point increase in the second quarter of last year. Benefit captured from our recent price increases, net of incremental discounting, drove the majority of this year-over-year improvement. In addition incentive bonus expenses in the quarter were lower relative to the same period last year. These favorable items were partially offset in the quarter by higher commodity costs, which we estimate increased our second-quarter cost of goods sold by approximately $3 million relative to Q2 of last year. On a sequential comparison, gross margin in the second quarter increased 40 basis points from the first quarter of this year. Higher factory production levels in the second quarter contributed significantly to this improvement. Additionally, incentive bonus expenses reported in the second quarter were lower than the first quarter.

I will now move on to operating expenses and earnings in the period. Operating expenses in the second quarter of $111 million were $9 million higher than the same period last year. Almost half of this increase was driven by adjustments made in Q2 of last year related to the contingent liabilities associated with the Nemschoff acquisition. These valuation adjustments reduced operating expenses in that period by over $4 million. The remaining expense increase was driven primarily by variability against higher net sales and increased employee benefits. On a sequential quarter basis, operating expense in the quarter decreased $1 million from the first quarter level. This was right in line with our expectations coming into the quarter.

Operating earnings this quarter were $41 million or 9.1% of sales. This represents a 200 basis point improvement over our adjusted operating margins in Q2 of last fiscal year. And it also matches the margin percentage we reported in the first quarter of this year. The effective tax rate for the second quarter was 33.4%. Looking ahead to the third-quarter we expect our effective tax rate to be in the range of 32% to 34%. Finally net income in the quarter totaled $23.7 million or $0.41 per share on a diluted basis. And with that I'll turn the call over to Jeff and he can give us an update on our cash flow and our balance sheet.

Thanks Greg. Our operating cash flows were significantly affected this quarter by a $34 million investment in working capital. This was driven almost entirely by an increase in trade receivables. And as a result, we reported a net $400,000 use of cash from operating activities in the period. While the increase in AR significantly reduced our cash flow, we are confident the underlying cause is one of mere timing rather than collectability. During the second quarter of last year changes in working capital drove a net cash source of $2 million, with total cash flow from operations in that period equaling $23 million.

Capital expenditures in the second quarter were approximately $6 million, an amount that was almost equally offset by the receipt of proceeds from the sale of our LA dealership which closed at the end of October. Dividend payments in the quarter were consistent with the prior year at $1.3 million. We ended the quarter with total cash and equivalents of $181 million, down slightly from our Q1 ending balance. Approximately $38 million of this cash was held within our International entities.

On November 16 we completed an amendment of our existing unsecured revolving credit facility. This new five-year agreement provides us with up to $150 million in revolving variable-rate borrowing capacity. In addition, it includes an accordion feature giving us the option to pursue an additional $75 million in credit subject to the approval of our participating banks. We remain in compliance with all debt covenants and as of quarter end our gross debt to EBITDA ratio was approximately 1.4 to 1, a substantial improvement from the level we were running at a year ago.

The available capacity in our new credit facility stand at approximately $140 million with the only usage being from outstanding letters of credit. Given our current cash balance, ongoing cash flows from operations and renewed borrowing capacity, we're confident in our ability to meet the financing needs of the Business moving forward. That's the balance sheet and liquidity review for the quarter and I'll now turn the call back over to Greg, who will share some thoughts on our outlook for Q3.

Thanks Jeff. The unusual tough comp we faced this quarter in order to entry will translate to a difficult year-over-year sales comparison in the third quarter. We're currently expecting net sales in the quarter to be between $400 million to $420 million. This is based on number of factors including the composition of the order backlog and our current expectations for orders in the rest of December and January. Our consolidated gross margin percentage is likely to be down sequentially from the second quarter due to a seasonal slowdown in factory production; we're currently expecting gross margins to be in the neighborhood of 33%, at the midpoint of our sales range. Operating expenses in Q3 are expected to be down approximately $2 million from the second quarter level. And finally as I mentioned earlier we expect our effective tax rate in the quarter to be between 32% and 34%. With that I will now turn the call back to the operator and we will take your questions.

(Operator Instructions) Budd Bugatch, Raymond James.

First let me just thank you very much for the additional disclosure in the release. I think we said so on our note and appreciate the segment information in the release. My first question goes to the verticals. You talked a little bit about the government. And I was just wondering whether we could get any more color on maybe how -- some quantification of that and the other verticals? You talked to -- I think healthcare was okay. But maybe give us -- and go over that again in a little more detail.

Hey, Budd, it's Brian. If you take the total of all -- of the North American segment as we report it, if you look at the impact of those large government projects it was almost equally split in terms of the impact on both healthcare and I will call it the rest of the North American segment. So in fact if you looked at the order entry, there is an appreciable difference. Meaning both of them saw, once you net it out for price increases and all the other hair that was all over it from price increases and other things, both of those segments had virtually stable order entry year-over-year. Both of those sectors, I would say, if you want to break it into -- that segment into those two pieces.

And by stable you mean flat year-over-year?

Yes.

Okay. Secondly, you did have besides the gross margin, the contribution margin was really pretty impressive this quarter. And I wondered how you all were thinking about that in terms of your variable expense and how about that going forward with the contribution margins?

You know where we've typically been and we've always said, when things work favorably in any one quarter, we can beat that number. And what you are seeing right now on the number, what you don't normally see is at least sequentially commodities getting more than offset by pricing and therefore you get a leverage number that is higher than we would typically expect to see. So we will stick by our kind of 25% range, but know that we can do better than that when commodities and other things work in our favor.

Okay and finally for me, as we often ask, can you quantify materials, labor, overhead, and items?

Sure Budd, this is Jeff. Let me give those to you here. Direct material 42.7% in the quarter. Labor was at 6.6%. Our manufacturing overhead came in at 10.8% of net sales and freight and distribution 5.8%.

All right thank you very much and again happy holidays and we'll talk to you another time.

Matt McCall, BB&T Capital markets.

This is actually Jack Stimac in for Matt today. If I could start maybe with price/costs. I think you had said it was -- you benefited from it this quarter. Maybe if you could just give us where your outlook for the rest of the year based on --

Jack this is Greg. Typically when we get a price increase in May as you know, and then one in September and what we would historically see is given how contracts roll over, you'd see an incremental build of that benefit over the following 12 month period. And then the question would be within that, how much big project discounts offset that. So we have historically captured in the 30% to 50% range of a given price increase. That feathers in over the 12 month period like I said and we don't see anything today that would tell us that trend doesn't play out the way it has in the past.

Are you still there Jack?

Todd Schwartzman, Sidoti and Company.

On the second quarter commodity costs, could you talk a little bit about how the actual numbers were vis-a-vis your expectations?

Sure, Todd. We had expected probably -- well, steel played out just as we expected and about --while we started paying a lower price in the quarter, by the time what you see runs through the P&L versus what got hung up in inventory, the full benefit did show up in the P&L. So we should see in theory steel prices come down from -- go down from Q2 to Q3. On the flip side we did see some increases that we weren't expecting on the wood side of the business, which in part mitigated a little bit our total expectations for margins in this quarter. Moving forward we would expect -- give or take, we think our number is going to get better to the tune of about $1 million from Q2 to Q3.

Okay thanks, that helps. For the quarter, what was the delta of North American Commercial orders? If you just strip out the government?

It was basically flat. That's not only taking out the government projects that didn't repeat. That's also backing out what we thought the effect of the price increase and the deconsolidation of the dealers. So it's actually like two or three things that are sort of hung up there.

So that flat -- the organic number is roughly flat?

You got it.

Okay. I was wondering if you could speak to the op margin, the rest of the world versus North America. How do you attribute the relative performance -- to what do you attribute the relative performance in the op margin overseas?

It's largely driven by mix of product. We have a higher mix of seating products and other things that just run higher margins in total. To be frank it's also some of the categories in the US, particularly in healthcare, have been a little more challenging on margins. I think when you band the two things together, that's actually receipted separation. Operating expenses are not wildly different one place to another. It really shows up in the gross margin level.

I know you probably wouldn't quantify it explicitly, but is the seating mix non-North America 50% greater than the mix domestically? Is it double? Can you just kind give us directionally some sense there?

It's not 50%. But it is certainly a greater mix; 50% would be way too high. In the US you are looking at a business that on the systems furniture side still runs up in the mid-40%s give or take. And you just don't see that and we're not that heavy. Particularly when you get to Asia. It's a little different if you are in EMEA where we have more of an established presence on the workstation side. When you are in EMEA, what is a little harder to break down specifically, Todd, but to just give you a flavor, you'll also note that the Consumer and Specialty business tends to run a little bit higher particularly in gross margins. That is because that also has a heavy seating mix, when you get to the non-North American piece, you get a mixture of kind of Consumer and Specialty in the core business. Because outside of the US it is a mixed format on both distribution. So it's both selling on the Consumer side in more of a retail format as well as in the contract business. Does that make sense? It's a mixture.

Yes it does. Just to clarify, by mix I meant that if for example in North America seating is 28% of the total, 50% bump from that would be 42% of the mix and 42% exposure overseas. I was just trying to get a feel for the magnitude, the difference. I guess the last thing is just some clarification on the guidance. The gross margin at the $410 million midpoint of the revenue guidance. Did you say 32% or 33%?

33% Todd.

All right, thanks, guys.

(Operator Instructions) Mark Rupe, Longbow Research.

This is Leah Villalobos filling in for Mark this morning. Just kind of looking beyond the next quarter in terms of both the government and the healthcare business, kind of bigger picture, I would be interested to kind of see what your thoughts are sort of longer-term on those two businesses.

Well, first of all, the government sector is a little bit hard for anybody to predict right now, I think, given what is being bantered about in Washington. I think if you drew a line over a number of years, that business has not been way up. It was up last year so we saw a bit of a spike last year. Longer-term it's when you've got to expect that they're going to continue to try to pull in.

On the other hand, there continues to be a lot of investment in particular in healthcare facilities within the military. As they figure what we are going to do with all these returning men and women from the field who are going to need a lot of help with their reentry process. So there is still a fair amount of investment in that. The government as well as the base realignment work is still going on. So it's not as if it's going to go away. On the other hand, we have been saying for a while that we expected that that business would not have as strong a dynamics as it had particularly last year.

The healthcare side, if you look at the healthcare construction index which we tend to lag from a little bit, we are behind it. The year before, the construction was pretty good so we saw late last fiscal year beginning of this fiscal year pretty good activity. We think you are going to see a little bit of a soft spot here in terms of it and then construction as forecasted starts to pick up again as you move into our next fiscal year. So we think there's going to be a little bit of a softer demand period as some of the construction gets ramped back up. But long-term, the construction forecast over the next couple of years looks pretty darn good.

That's very helpful, thank you. And also on the incremental price discounting that you saw in the quarter, I was wondering how pervasive that was and sort of how it trended throughout the quarter?

Again, it was basically the deeper discounting was again the large project business I suppose that's where we saw the incremental impact be the severest.

Okay so then going forward without having some of those larger projects we would see some improvement there?

Yes. I know when you say costs that just means you don't have the bigger projects, you don't have quite the manufacturing leverage that you tend to see.

Sure. And then just lastly on the UK business, I was just wondering if you could talk a little bit about how that trended during the quarter and kind of into December here?

In general, our EMEA group including the UK, Central Europe, Eastern Europe, and the Middle East was all up. It was solid. We've had to refocus on certain customer sets that seem to be working for us. So overall, we have the same concerns about given what we will see on the news, but it has been strong.

Okay great. Thanks so much. Happy holidays to you.

Matt McCall, BB&T Capital Markets.

Sorry I got cut off before. I guess kind of following up on the project business side, it sounds like as a percentage of sales it's been a little higher this quarter than it was last year and maybe last quarter. How do you expect that to trend going forward? It sounds like orders or order size is shrinking, but project activity is still pretty good.

Yes; I think the amount of projects business in this quarter's shipments was actually up slightly, it was probably down slightly in orders because of those big projects we talked about from the federal government that didn't come through there which obviously would've had an impact. I don't think we necessarily believe there is going to be a big change one direction or the other. I think to Greg's point to the person before, one is you don't like always the pricing on those large projects, but that's how you build the installed base and committed customers for the long-run. So you need a good mix between the two. If it's all project business, pricing overall gets difficult, if it's all base business you don't get the growth you want. So you need the mix to stay in a fairly balanced way and that's important on both ends.

Okay. And then as we look at maybe your guidance and just maybe looking out over the next year, are there any activities you guys have taken or any plans that you have in place that can provide a little bit of EPS visibility going forward? Maybe some cost takeouts or just some plans in that regard.

We don't have any significant plans because right now we think that and believe that what we're seeing is a bit of a bump. What we kind of have said is a little bit of a transient activity. Some of that we think is a lag from the budget discussions that happened last spring and how they affected companies' mood in the fall. We think some of that will work its way out over the Christmas months. And we are in one of those periods that this time of year where it gets kind of unpredictable, where our visibility gets a little more difficult.

So we tend to not try to make major decisions during this quarter until we get back from the holidays and get into kind of February-March and get a view of where we think things are going from there. I would also say we think we have some significant strategic things like the POSH acquisition and others that are in front of us that right now we need to make sure we get the resources doing the things that we need so that we are positioned for 3 and 5 years from now and not three months from now. That's really our primary focus.

And looking at POSH, has there been -- if we look at your SG&A this quarter versus your guidance, I think you had guided it to being flat to slightly down, it was up a little bit. Is part of that because have you been spending a little bit more on POSH than you anticipated just because of the timing of it?

Just to be clear our guidance was flat to down slightly sequentially and actually we were down $1 million from the first quarter. But yes, there is obviously spending in our number right now related to the work going on to get the other side of POSH for sure. It's not a giant number but it's not insignificant either.

Okay. Thank you.

I am showing no further questions at this time. I would like to turn the conference back over to Management for any closing remarks.

Thank you all for joining our call this morning and for your continued interest in Herman Miller. As we reach the close of the calendar year we wish you and your families a joyful holiday season. That's all we have now. We look forward to talking to you all again in March.

Ladies and gentlemen, this does conclude today's conference. You may now disconnect and have a wonderful day.