MillerKnoll Inc (MLKN) 2013 Q2 法說會逐字稿

Good morning, everyone and welcome to the Herman Miller, ncorporated second quarter fiscal year 2013 earnings results conference call. This call is being recorded. This presentation will conclude -- include forward-looking statements that involve risks and uncertainties that could actual -- 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 Brian Walker, President and Chief Executive Officer; Mr. Greg Bylsma, Executive Vice President and Chief Financial Officer; and by Mr. Jeff Stutz, Treasurer and Chief Accounting Officer. Mr. Walker will open the call with brief remarks followed by a more detailed presentation of financials by Mr. Bylsma and Mr. Stutz. We will then open your call to your questions. We will limit today's call to 60 minutes and ask that 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, everyone. We're glad to have you with us today. Let me start by acknowledging there are a lot of moving parts that affected our results this quarter. The short summary is that orders and operating income as a percentage of sales were in line with the guidance we provided in September. However, we underperformed our revenue and EPS guidance. This resulted from an unusually large number of orders that were not converted to revenue during our typical timeframe.

To offset this shortfall, our folks did a good job of managing expenditures during the quarter. Last, the operating results were offset by a large non-cash charge related to our previously announced plan to terminate our defined benefit pension plan. To be frank, we were disappointed with the top line and EPS miss. However, we were pleased with the order growth and the level of activity across each of our reportable segments and the double-digit growth in our backlog.

The guidance we provided you back in September called for net sales in the second quarter of between $445 million and $465 million. We base this estimate on a beginning backlog plus an expectation around the order level in the first six weeks of the quarter. As it turned out, the level and pacing of new orders entered throughout Q2 lined up with our expectations. Unfortunately, weather-related delays on the East coast prevented us from recognizing revenue on a handful of projects. To be specific, the primary issue was projects where we were billing the customer direct. In those cases, we do not recognize revenue until installation is complete.

As a result of disruption and lack of power, installations were delayed. We estimate the storm delayed $5 million to $7 million in revenue. Additionally, some of the orders were scheduled with longer than anticipated lead times so these orders won't ship until the second half of fiscal 2013. While we don't like missing for any reason, ultimately, orders and backlog will become revenue. So if orders are moving in the right direction, we will convert them into revenue and profit growth for the balance of the year.

Greg and Jeff will cover the consolidated results further but I'll touch briefly on the performance of the segments and our view of how macroeconomic factors are and will affect us as we move forward. In the North American reporting segment, revenue was down approximately 5% while orders were up more than 7% from the second quarter of last fiscal year. This reflects real strength in commercial customers and continued weakness in demand from the US government. The year-over-year order growth was driven by our investments in innovative design and expanding customer channels. This included gains in key office product categories highlighted by growing momentum from our Canvas Office Landscape system. Our Thrive Portfolio of ergonomic tools and furnishings is another component of the segment and continues to gain ground, both with our dealers and customers.

Building on the successful sales model that we first established with Thrive, we recently introduced a new addition focused on small and medium business customers. The SMB team is now well underway, working in coordination with our dealer channel to ensure great service in specification and delivery. We serviced small customers for many years but we believe we have found the formula for product and service that is going to see this market grow in importance to us over the coming years.

While sales to Healthcare-related customers remained below our expectations, if you exclude the Federal Government, revenue has stabilized and this quarter, we had sequential order growth in orders. We are pleased with the progress the team is making in stabilizing the business and building for the future. We're confident that the underlying demographics are there to make that business a strong component for our future growth.

Our Specialty and Consumer segment also contributed significantly to the quarter with sales and orders up 22% and 11% respectively. Both our Retail and Herman Miller Collection business together, key elements of our brand and marketing activities, posted double-digit growth in sales and orders relative to last year. Retailers have reported their sell-through was good during the Christmas season and our semi-annual sale. So we expect good levels of restocking in the third quarter.

We're also getting optimistic reports from our dealers and sales executives as to their success with our Herman Miller Collection with contract customers. Our Geiger subsidiary also enjoyed a strong sales into executive and premium office environments in this quarter. We are really pleased with the growth and profitability of this segment.

Let's now turn to our International segment, which, with the addition of POSH, reported solid sales and order growth over the prior year. While Europe was a significant drag in the quarter and frankly, weaker than we expected, we continue to perform well in the Middle East. The key element in International's performance this quarter was our expanding momentum and presence in Asia, driving a substantial increase in sales and orders for the region. This was achieved not only through the addition of POSH but also through organic sales growth in key markets including China, India and Australia.

The POSH integration continues on plan and we see much more opportunity ahead. We know China and other fast-developing markets in Asia and elsewhere are critical elements in our future. Be assured, we will continue to strategically invest in those markets, building the teams, products and operational infrastructure to grow with them. I should note that profitability in this segment was down from the same period of last year. This is primarily due to the loss of cost leverage in Europe and increased integration costs in Asia.

So where do we go from here? As you know, the global macroeconomic environment remains mixed. While the United States economy has been tepid, it is growing. Housing appears poised for a rebound and employers are beginning to hire as productivity gains are nearly exhausted. Finally, office vacancy rates remain high so companies continue to have good incentives to move, which typically leads to demand for our products and services.

This relatively encouraging picture is offset by uncertainty with the so-called fiscal cliff and our political leaders' inability to come to a resolution. Of course, if no deal is reached, the impact of going over the cliff will likely be worse than the uncertainty we are currently experiencing. While the fiscal cliff would impact the other regions of the world, Asia continues to grow, albeit at a slower rate than the past few years. But ultimately, demographics will continue to drive growth in the big -- BRIC countries. Europe remains weak and there appears little prospect of recovery in the near term. While Europe will impact us, we do not have a significant presence on the continent. We leverage our capabilities in the UK to serve the Middle East and other countries in the region where we are -- which are in better shape.

In summary, assuming a deal is struck on the fiscal cliff, we expect the US Office Furniture will continue to grow in calendar 2013. A housing recovery should also help our consumer business. We believe the long term-demographics of US Healthcare in BRIC countries are positively aligned with our strategy. And if no deal is reached, we have proven in the past that we know how to adjust our business and our balance sheet is in great shape. In any case, we believe that we must continue to implement our strategic plan as it will serve us well no matter the economic environment.

Greg will cover Q3 guidance in detail but I want to remind you that last year, we committed to some long-term growth and performance targets. At the same time, we indicated that the next 18 months would be a period of investment with a robust new product pipeline, investment in customer facilities, and regional operations in Asia and the UK, and new marketing initiatives in the Collection and Small Business. For the first six months of this year, that has primarily been focused on capital expenditures. In the third and fourth quarters, we will incur additional operating expenses as these programs begin to ramp towards launch.

Before wrapping up my introductory remarks, I want to add one more highlight that speaks to the power of our products, our strategy and our brand today. In our business, the architecture and interior design community is a critical customer audience, driving the specification and selection for a large portion of industry sales. For some years, there's been an annual brand survey connected in -- conducted in this audience and published annually in December by a leading trade magazine.

The survey results are a credible report card on manufacturers' rankings, using random sampling and an unaided recall questionnaire to determine leading brand across more than a dozen major product categories and vertical markets. Once again, as in every year since its inception, this month, Herman Miller and our subsidiaries rank multiple number one and top three brand ranking in the survey's largest product and vertical market categories. In recent years, the magazine has asked a further general question of A&D respondents, which reads-- when thinking about brands that inspire you to create your best commercial design solutions, who are the top three companies that come to mind?

Herman Miller has finished in the top three for this question in the past but we have never captured the overall top ranking. This year I'm pleased to say, we were the number one response among A&D specifiers. I believe this is a further validation of our strategy to win the hearts and minds of A&D community to great product design, complemented by a concerted marketing effort that emphasizes our unmatched heritage and continued commitment to design excellence. This may be best illustrated by the Herman Miller Collection. We can see the Collection resonates in the sales and orders it is generating in our Specialty and Consumer segment and I'm confident it's creating new value across the entire business.

While we have work to do, I'm confident we're building momentum. With that, let me turn it over to Greg and Jeff for more details on the quarter.

Thanks, Brian. On a consolidated basis, net sales in the quarter were $442 million. This represents a decline of 1% from the year-ago period and a sequential decrease of 2% from the first quarter of this year. The clear bright spot in our results this period was in the orders, which totaled $476 million on a consolidated basis. This is an 8% increase over the second quarter of last fiscal year and represents a 5% sequential quarter improvement.

As Brian described, we again experienced a contrast in demand this quarter between the US Federal Government and Commercial customers. In total, sales within our North American reportable segment of $305 million were down 5% from the prior year. New orders in the second quarter were $329 million, reflecting an increase of more than 7% in the same period last fiscal year. Sequentially, North American segment sales decreased 5% while orders improved 7% from the first quarter level.

Our non-North American reportable segment reported net sales of $93 million for the quarter. This represents a 6% increase over the second quarter of fiscal 2012 and a decrease of approximately 2% from the first quarter of this fiscal year. The revenue growth over last year was driven by the acquisition of POSH. This was partially offset in the quarter by lower sales in Europe compared to Q2 of last year. New orders in the second quarter of $101 million were up 9% on a year-over-year basis. Sequentially, segment orders were up 2% from the first quarter level.

Net sales within our Specialty and Consumer segment totaled $44 million in the quarter. That's a 22% improvement over the year-ago period. Segment orders of $46 million were up 11% on a year-over-year basis. Compared to the first quarter of fiscal 2013, sales for this segment increased 27% and orders were up approximately 1%.

Before I cover our gross margin performance in the period, I'll update you on our plans to close and ultimately, terminate our domestic defined benefit pension plans. During the second quarter, we completed an important step in the transition process by moving current employees to a new retirement program based on a defined contribution format. Concurrent with this move, we ceased ongoing benefit accruals under the legacy defined benefit plans. We also settled a portion of the legacy pension obligation by distributing benefits to certain plan participants. Since these benefit distributions were made from the investment of the pension plan, they did not impact our consolidated cash flows in the period.

Just as expected, the benefit settlement triggered the recognition of certain non-cash expenses. In total, our second quarter results reflect approximately $19 million in pre-tax non-cash expenses related to the legacy pension plan scheduled for termination. Approximately, $18 million are recorded within operating expenses. A remaining portion is included in cost of sales and thus reducing our gross margin in the period by 20 basis points. The split between operating expenses and margin differs from what we told you last quarter but the amount was in line with our estimate.

Our consolidated gross margin in the quarter was 33.6%, or 33.8% after excluding the impact of these pension expenses. This fell short of our expectations coming into the period, primarily due to lower than anticipated net sales. Relative to the second quarter of last fiscal year, our gross margin was down 50 basis points. Approximately, 20 basis points of this reduction relates to the impact of this pension expenses recorded in cost of sales. Commodity pricing did improve compared to the second quarter last year. However, this was more than offset by changes in product, and channel mix including the impact of POSH, which, together, drove a reduction in gross margin compared to last year.

I'll move on to operating expenses now for the period. Operating expenses in the second quarter were $130 million. Excluding the impact of the legacy pension cost, operating expenses the quarter were $112 million. They were approximately $1 million higher than Q2 of last fiscal year. Marketing and new product development expenses were higher this quarter compared to a year ago. Additionally, our results in the second quarter included operating expenses associated with POSH, which we had not yet acquired at this time last year. These increases in the quarter were partially offset by a year-over-year decrease in product warranty expenses.

We recognized a $700,000 charge in pre-tax restructuring expenses in the second quarter. These charges were related to two previously announced factory consolidation projects associated with the operations of our Nemschoff subsidiary. On a consolidated basis, operating earnings this quarter were $18 million, or 4% of sales. Excluding restructuring and legacy pension expenses recognized in the period, adjusted operating earnings were $37 million, or 8.4% of net sales. As we indicated in the press release, the profitability of our International business segment was negatively impacted this quarter by a loss of leverage, resulting from a year-over-year organic sales decrease and the addition of POSH, which contributed $13 million of revenue at roughly breakeven operating performance.

The effective rate in the second quarter was 34.9% compared to 33.4% in the same quarter last year. The change in tax rate over the second quarter last year was driven primarily by a change of mix of earnings across our domestic and foreign entities. Finally, net earnings in the second quarter totaled $8 million, or $0.14 per share on a diluted basis. Excluding restructuring and special pension charges recognized in the quarter, adjusted earnings per share totaled $0.35. And with that, I'll turn the call over to Jeff and he can give us an update on the balance sheet and our cash flows.

Okay, thanks, Greg. Good morning, everyone. Cash flows from operations in the second quarter were approximately $19 million. Net changes in working capital drove a $15 million cash use in the period with the biggest contributors to this being state and federal tax payments as well as increases in net inventory and AR balances. Capital expenditures in the second quarter were $13 million, which brought the total year-to-date capital expenditures to $29 million. Dividend payments in the quarter reflected the increased payout level that we announced at the start of the fiscal year. In total, cash dividends paid were approximately $5 million in the quarter compared to the previously quarterly run rate of just over $1 million.

We ended the quarter with total cash and equivalents of $186 million, an increase of approximately $1 million from the end of Q1. As of quarter [end], we remain in compliance with all debt covenants and our debt-to-EBITDA ratio was approximately 1.5 to 1. The available capacity on our bank credit facility remains at $142 million with the only outstanding usage being related to letters of credit. Given our current cash balance, ongoing cash flows from operations and our total borrowing capacity, we remain confident that we can meet the financing needs of our business as we move forward.

That's the balance sheet liquidity overview. Now I'll turn the call back over to Greg who will cover our Q3 earnings guidance.

Thanks, Jeff. We expect our sales to range between $430 million and $450 million in the third quarter. This would imply an anticipated revenue growth between 7.5% and 12.5% over Q3 of last fiscal year. Earnings in the third quarter are expected to be between $0.22 and $0.26 per share on a diluted basis. This guidance reflects the impact of additional legacy pension expenses in the quarter which we anticipate will total approximately $5 million, of which 85% will be recorded in operating expenses. Excluding the impact of these pension costs, adjusted earnings per share in the quarter are expected to be between $0.27 and $0.31. This assumes an effective tax rate of between 32.5% and 34.5%.

We're expecting a fairly typical seasonal decrease in our Q3 gross margin due to sequential quarter dip in factory production schedules. Accordingly, we are forecasting a Q3 gross margin excluding the impact of legacy pension charges in the area of 33%. Our earnings guidance for the third quarter reflects an increase in spending on investments relating to an array of new products currently in development and other strategic initiatives necessary to achieve our long-term growth targets. In total, operating expenses in the third quarter are expected to range between $114 million and $117 million, excluding the impact of legacy pension expenses. With that, I'll turn the call back over to the operator and we can take your questions.

Thank you.

(Operator Instructions)

David MacGregor, Longbow Research.

In the third quarter, typically, you see a good December and then it's quiet in January and February, and December is typically a budget flush month. Just wondered how things are shaping up this month versus what you saw in December a year ago?

After the first two weeks of data that we have -- obviously, we're in the third week right now. Orders are up year-on-year so far about 5%, I think the number is, David.

Okay. Your thoughts on the balance of the month how it could shake out?

It's hard to tell because these things can rain in from the sky, as you know, as people are trying to flush budgets so it's really hard to predict. We're also going to have a difference because we're open through the holiday season this year. We don't have as long of a shutdown period so it's going to be a little bit harder to tell comparisons.

Okay. Now with respect to gross margins, I guess you had a September price increase. Did you get any gross margin benefit in these numbers?

Yes. There was a benefit in overall pricing because you've got to look at that in two ways. You've got to look at what was your added prices versus your net discount impact? But I want to say sequentially, the number was a positive in the neighborhood of, I think it's $2 million.

Okay. In your discussion of gross margins, you referenced changes in product and channel mix. I wondered if I could get you to elaborate a little on that?

Sure. When we -- obviously, when we sell stuff through e-commerce or the retail business, that comes through at a different margin. So movements in those revenues between a contract customer and retail/e-commerce can drive a significant shift. So when the retail business was as strong as it was-- like it was in the quarter, that certainly helps the margin. This was offset by POSH, which, like we said in my prepared remarks, revenues of about $12.5 million at much lower gross margins than would be our average.

Okay. On POSH, how much were the second quarter integration costs that you referenced in the press release? What happens over the next couple of quarters?

Roughly in the quarter that was about $500,000. That continues to get better as we move, obviously. This quarter was a big challenge for us because we moved the manufacturing portion of the acquisition that we didn't buy from -- I get confused if it's from contract to [total]. But we changed the method by which we were actually buying the -- we are now buying the inventory prior to the POSH manufacturer making it for us. That was a challenge for us as we worked through the quarter and [drilled] some costs.

Greg, it's fair to say that when we talk about the integration, one of the things, David, we did with the acquisition, as Greg mentioned, is we didn't buy the manufacturing assets. So our gross margins are going to be a little bit lower than normal until we get our long-term manufacturing plan put in place. We knew that was going to take us somewhere between -- [phase] some products that move faster than others depending on whether we're building them in a current facility or we have to create a new facility.

So that, we knew, was going to take us 12 to 24 months that we'd see lower gross margins. It's probably going to be closer to that 24 months before we get to the other side of that. Now of course, we don't have as many assets tied up right now either as we'll have in the long run as we get to actually owning the manufacturing side. So in some ways, we've got an [entity] that's acting as a contract manufacturer for us today and they are, obviously, taking a bit of the profitability until we get through that.

Got it. Thanks. Last question, just on Europe, if you back into the numbers, my math looks like Europe legacy business was down high single-digits in revenues. I'm just wondering if you could talk about how much of this is category shrinkage versus how much potential share loss versus how much is just timing?

Are you speaking to Europe in particular?

Yes. The non-North American -- excluding the POSH?

What we're seeing in Europe is not a category issue. I think it's -- we're looking at the general economic situation in Europe. I think as you watch each of the competitors who have businesses over there, everybody's talking about it being very difficult on the continent. And quite frankly, in the UK as well, where you're seeing the impacts of, you might say, their own fiscal cliff that's come to fruition through all the austerity. So it's a general downdraft on the whole market side rather than it's a category issue.

When we look at Europe as an economic unit, really the only place we have significant market share is in the UK. We have not seen any change in market share. We have seen a rotation out of the government and into non-government customers, commercial, if you will. In the rest of the continent, we play very small in every single market so market share isn't really the name of the game for us. It's more playing into niches of those markets than it is a market share issue.

Budd Bugatch, Raymond James.

I'd like to go over a couple of things on the revenue. And then I'd like to understand a bit about the incremental margins regarding the guidance and the implications for the revenue and what the incremental margins are. First, on the revenue performance for this quarter, I think you gave us the impact from Sandy was about $5 million to $7 million. Is that right, Brian?

Correct.

So a government impact and healthcare impact year-over-year was what in North America?

Well, first of all, if you look at -- I'm going to take healthcare, because last time, Budd, I think we confused everybody trying to break down numbers you didn't have from-to on. So if you look at healthcare, in particular, the year over change in healthcare was 100% attributed really to what's going on in the government sector. So let's just say what affected negatively the North American segment in total was government, whether it was healthcare-related or non-healthcare related, that was the negative factor. Does that make sense?

I'm not quite sure. You have a GSA contract and I thought that was a big issue. Because this is like the last quarter where --

Correct. What GSA covers both healthcare and non-healthcare is my point to you. What we're giving you typically is the total reportable North American number which includes healthcare, correct?

Yes, sure.

So if you look at the commercial Healthcare business, it was relatively flat year-over-year.

Okay. So the government side of that was down about what?

Well, let's just talk about government in total. Government in total, Jeff, was down --

Of 30 -- around rough numbers, 30%, Budd, let me just take a look here for you. Yes, we were down 37% in revenue with GSA in total.

If you take out government, Budd, we look at sales being up about -- 0.3% year-over-year for the quarter, okay? If you take government out completely. Orders up about 13%, all right?

So while that 37% -- was that about $20 million, Jeff? Or is it about $15 million?

The decrease, Budd?

Yes, sure.

Yes. That's right.

Is it $15 million or $20 million?

It's right in the middle. It's $18 million.

All right. Thank you. And then if you look at non-North America, I think David said -- if you take non-North America, we're looking at, excluding POSH, something like $87 million last year -- $87.5 million last year versus $80 million this year? Is that primarily Europe or is it also the Australian issue involved?

It's primarily Europe.

So that's all Europe?

Australia was up year-over-year.

Okay. So didn't you have issue last quarter with some -- because of the fire at --

Correct. Yes, we had some stuff that was hung up in inventory which -- that actually came through this quarter. That flushed its way through.

Okay. That's good. Great. And my last area is, if you look at the revenue Delta this year, what you're projecting for the third quarter versus last year, it looks to me like the implied operating margin is about 10% to 12% overall incremental margin. Or if you try to exclude POSH, maybe it gets to the high teens. What's going on there?

How should we think about incremental operating margin going forward? What are the moving pieces in there? Obviously, you have the issue with the ramp-up for the product introductions at NeoCon and some other things but you do have commodity price inflation going your way for the first time in a while. So can you walk us through the moving pieces and how we should think about incremental margin?

Yes. Budd, I think when we launched into our three-year goals of over $2 billion and 10% operating margins, we said at that time, we had traditionally said between, I don't know, 20% to 25% incremental margins. We lowered that number down. But the exact range we gave at the time escapes me right now.

It's about 15%, Budd, the number you're at.

15% or so, so the moving parts really are the investment you referred to, which -- a big product queue coming up for NeoCon, probably bigger than typical. We've got some stuff that we're working through on facilities, customer-facing facilities. We've got some investments going on in the branding side as well as on the IT side. We mentioned the small business investment as well. So I would say that, as you move forward, that, that 15% operating incremental margin is what we could expect to see in the next, I would say, short-term. I'll call that next two or three quarters.

Budd, one thing though specifically that hits next quarter which Greg did mention is you a little bit of sequential drop in margins. That is actually because you've got a fair amount of, we'll take the stuff that got hung up this quarter that we built and that we might even have shipped it to the dealer but wouldn't recognize the revenue because it didn't get fully installed.

Of course, what ends up happening is you're going to bring some of that through to the balance sheet so you don't get as much leverage on your fixed operating costs next quarter. So it's a little bit lower going from second to third than what we'd normally expect. That's because, in some ways, we got a benefit of building stuff and putting in inventories this quarter. It's going to flush through so even though revenue looks flat quarter-to-quarter, production is actually down second to third.

So you have some inefficiencies, I take it? At least you're talking about it?

Well, inefficiencies, if you will, what you got is you've got a higher utilization of overhead in the second quarter than you get in the third which is typically true with the holiday season, right? Because you lose that week. That's why you would normally see a revenue drop and so you'd actually see a much more pronounced drop second to third. This year, it looks like it could be relatively flat second to third but at the same time, while revenue's flat, production is actually down, so your absorption goes down a bit.

That's what I mean by inefficiencies. (multiple speakers) Can you quantify for us some of those investments you're making? What's the dollar of the investments that you're -- that Greg was pointing out that were going on? If you don't want to give me -- if you don't want to parse them give it to us in total?

Well, the number, if you can look, OpEx is up in the -- going to the next quarter of what, $4 million to $5 million? Again, we have a fairly substantial number related to this second phase of redoing the Design Yard, which you know, is where we bring a lot of customers when they come to us in Michigan. Some of that is the expense side of the facilities investment. So you've got that going on. We have a ramp-up in some of our R&D costs.

As we start to move towards taking some of those products from not the drawing board but the massing models to actually getting them through tooling and those things where you ramp up a lot more testing costs, that kind of stuff. We also have additional people costs as we start to see the full size of the team that we're building for both the Collection and for Small Business. So it's really those three factors, primarily, that we'll see a step up as well as in the fourth quarter, we'll start to see some more of the marketing money as we get ready for NeoCon. So pretty typical things.

There's just more of it than what we'd normally see coming together at one time. We would have thought some of that may have hit more in the first half than it did, if you saw operating expenses were relatively flat year-over-year. We'd have thought we had we would have more of it in the first half, which has pushed some of it back to be a little bit more pronounced in the second -- in the third and fourth quarter.

Sure. I may have missed it because I did -- I miss a number there in terms of the Delta of the investment?

Just now?

Yes, sir.

$4 million on the quarter.

$4 million. Okay. Thank you. Thank you very much. With my last thing, I'll sneak one other in and I apologize on this but the ABI has hit an all-time -- not an all-time but four-year high just this month. What are you thinking about that and going forward into 2013 or into calendar 2013?

Well, I think it's actually -- Budd, that was my point about the macro thing. Overall, even if you look at -- and on Global Insight's recent forecast, and you look at what they had in there, they are pointing towards a fairly strong calendar 2013. Again, this is always difficult right now because this all assumes we get some of this uncertainty out of the air and we avoid the fiscal cliff. I think you look at the underlying business strength in the calendar third quarter of this year before we all got nervous again. You were starting to see pretty good signs and when you look at the ABI being up, look at where vacancy rates are, there's a pretty good thesis to say all things considered, and next year could be a pretty decent year. Now, I think the problem right now is -- and you know this better than I do, you just got so many crosswinds right now, it's hard to figure out which thing wins the tide ultimately.

Right. (multiple speakers)

You've heard a lot more talk about businesses being nervous here lately, and people delaying, not necessarily delays on our issue. But when you read the general press, you hear a lot of CEOs talk about posturing for the potential of the fiscal cliff. I don't know if that's -- we're all singing to the press or if that's really what's going on. I think that if there's anything that makes you concerned, it is what is the ongoing impact of that if we can't get our friends in Washington to get their act together? Assuming that gets through, I think it's a pretty good thesis that we should have a decent run in the industry next year.

All right. Thank you very much. Good luck and happy holidays again to everybody at Herman Miller.

Matt McCall, BB&T Capital Markets.

So actually, I'll follow up on that last question from Budd. So the outlook there -- that was more of a macro-related question and answer. What about internally? Some of the indicators of your pipeline held whether it be [vintage] or mock-ups, RFPs, just talk about the pipeline strength right now.

Well, Matt, probably the best thing is to look at -- if you -- I think that's why this quarter was a little difficult. On one level, we're disappointed by the miss. On the other hand, feel -- felt pretty good about where order levels were. We were running right about where we thought we'd be from orders and that gave us a fair amount of confidence. Now, of course, you've got some underneath news like what's happening in areas like the government and Europe and such, but overall, the US looked relatively good and we hear decent things about activity levels.

Customer visits are a little hard to measure right now because we have had a fair amount of down cycle in West Michigan because we've been in the process of redoing a fair amount of facilities. So we've been holding back and saying -- don't bring as many people here because we just don't have as many places to take folks. So I don't know that we got a good read from what we're seeing in the data. It's relatively flat. It's not like it's going nowhere but of course we've been restraining it a little bit at the same time. So maybe that's a good sign. It's flat and we've been restraining it through that period.

So as you look out into, I'll call it calendar '13, there are a couple things, I think, you talked about the projects that are going to ship in the second half that were -- the wins that are going to shift in the second half and the orders that were placed this quarter. You also announced a big win, I think, with Exxon. You've -- I think I've heard of some other large projects. Talk about the visibility that you have from some of these big wins and you getting a lot of lead times, I assume that, that provides us a little bit of revenue visibility. So just talk about first, the revenue visibility and then tie that in to the earnings visibility from things outside of topline, specifically, I wrote down the POSH integration. What other things will help your margin visibility as you move forward?

Well, first of all, it's always great to think about those big wins but while we're very happy and proud to have Exxon, when you look at it, it's going to be -- we don't have the orders in-house yet. It's going to be split probably over a couple fiscal years. So when you really break it down and look at it, it's a big win. But when you look at it in the scope of running $1.8 billion to $2 billion, it's really not a big enough chunk of business that it changes dramatically your visibility. It's always nice to have a bundle.

I wish we had 10 or 12 Exxon Mobils on our hands that we could see that far in advance. Then I think it would affect your visibility, right? On the other hand, I think anybody who's in this business will tell you lead times have shrunk. It's not like we have 13-week lead times, like in the old days, where you can really predict a quarter in advance. We take a lot of business that is going to ship in the next four to eight weeks. That level of visibility really hasn't changed.

So, the best [tenet] typically is looking at activity levels of what's coming in, in orders. If you look when orders are coming in and you can see momentum building, that's usually the best predictor rather than looking at a couple of big, large wins. They're nice to have. They help because you can start to figure out how you're going to schedule those particular orders which can give you some efficiencies in manufacturing. But I don't think it necessarily helps me with visibility on the topline.

Okay. What about on the margin front?

Margin -- again, I think certainly we've got -- we can tell you we know what work is in front of us as it relates to POSH. We know that there are some advantages -- some benefits we'll get as that plays its way through. We've been doing a lot of work, as you know, around healthcare, Nemschoff, in particular. We haven't seen benefits from that.

Those couple of things, we know, ultimately, are going to help. We can see some ability in the Healthcare business where we haven't been able to capture price because we were locked into long contracts, that as some of those contracts begin to expire. If we can move those on to more current price lists, that will give us some boost.

So there are things in there, when we look overall, that we can see where we've got some price leverage and cost leverage coming, that will certainly help as we get into next fiscal year. Most of those won't play very strong this year. It will probably be next year, maybe even into the second half of next year before we'll start to see significant benefits from those.

Okay. Let's see. On the Specialty and Consumer side I think you called out the Retail business, the Collections business. So the 27% growth area, that's pretty good. Is that just an organic number or are we on the floor? Is -- how should I understand 27% revenue growth, order growth of 11%? Is that just pure success of selling more stuff to more people or is there something else going on?

There's no -- it's all organic. There's no -- it's not like we did any acquisitions or we acquired anything. I think it's the combined impact of -- we had some nice wins on the Geiger side for some projects which is great because that is really a project-driven business. So you've got that starting point. Certainly, we're in one of the first heavy-selling seasons, i.e., Christmas season, back-to-school, all that good stuff, where the Collection was fully there, meaning, we had not only the historical Herman Miller products. We had the reissues there as well as the new alliance products.

So you had all of those things, Matt, for the first time in our [quivor] to offer to the retailers. That's a big deal. Of course, we started to put the sales force in place for the Collection. Most of those folks weren't on board until in the summertime and we've been ramping that up in terms of number of people and getting them into the right marketplaces. So I think it's a combination of the factors coming up, the new product launches hitting, having the new sales team in place for the Collection, which, of course enables us to actually capture some project wins on the contract side because we've got people acting in, pitching those products to both dealers and to the A&D community.

So it's a combination that we thought would work of having great products building the channel right, and getting the marketing right. Those things have worked so far. Now we've definitely got some good-sized comps to play with. On the other hand, we've got a good pipeline of new products. We're just really getting the sales team ramped up and integrated into the individual marketplaces.

That leads to my final one, Brian. So the margins in that business are better than the other two. As you talk about that targeted 10% operating margin, talk about it by segment. What's the expectation there. I'm trying to understand how much of a mix shift you're expecting and/or how much incremental margin improvement you're expecting in each one of those segments to get to 10%?

Well, first of all, remember that the reason that you'll see better margins, generally, in the Specialty and Consumer business is particularly, the Collection and the Retail business both have a heavy emphasis on seating. So whereas, if you are looking at both International or the Core business, you get a lot drag on the core workstation business, which we've talked about in the past, are not quite as good of margins as you're seeing on seating. So when you get seating and specialty products, you tend to drive better margins overall. You also, in the case of retail, the pricing is just a little bit better because you're not in the major projects where you're discounting projects in a much bigger way, right?

So if it's that is what drives the Specialty and Consumer side, which is why we actually went after trying to increase the size of that business. So you've got that going on. The International side, if you look, last year, we ran pretty close to the 10%. I think for last fiscal year, it's down a little bit this year as we get through the integration of POSH. Longer term, we actually think we can get that number back up. It will probably take us a couple, two or three years, because we're now going through an investment phase where, up through last fiscal year, Matt, we were largely leveraging things in International and now we've built infrastructure. So it's going to probably take us that 24 to 36 months to get it back up in that snipping 10% range.

If you look at the core North American business, it's actually been pretty darn close to that 10% today. So the places for us to actually get good margin growth are going to be building the mix that we have in Specialty and Consumer. That's going to be important; getting through this investment cycle in international; getting healthcare back to where we got solid profitability in Nemschoff. If we can get those three things done, in particular, we can drive to that 10%. Does that help?

(Operator Instructions)

Todd Schwartzman, Sidoti & Company.

You had spoken to the Sandy-related deferrals of about $5 million to $7 million, I think it was. Has that business shift in the past three weeks, thus far and if not, is that included in your guidance for the quarter?

Todd, this is Greg. Most of it actually shipped already. But because it was tied up and we weren't able to install, it was either sitting at a dealer, waiting to get to the final customer or at the final customer, waiting to actually get installed. So we would expect that, that $5 million to $7 million ships and either ships the product to the final customer and as recognizing revenue in the third quarter almost completely.

Okay. Also, just in terms of quantification, I may have missed this -- you may have called it out but what was the piece of business that was timing-related that you might have contemplated shipping but didn't?

It was about another $5 million to $7 million, Todd. It was almost the same numbers. So in total, we were looking at a $10 million to $15 million miss because of the storm that's coupled with the longer lead-time orders that we took.

Are the lead times there such that it's still, by late February, should be sufficient to get that through?

I can't -- that's one way where, because one of them is a decent-sized government program, the timing of the recognition of the revenue, it will certainly have shipped. But whether or not it becomes revenue because it's completely installed is a bit of a coin toss at this point.

Todd, it's important to note that this is not because our lead times are long. It's just because the customer asked for a longer time frame than what we would typically see.

That was one customer?

It was really two, Todd.

Okay. But they both requested that, that longer delivery?

Right.

Okay. Perfect. Also, I just want to get clear on this, the adjusted order number that you gave ex-government, up 13%, I'm assuming that's just purely North America you were talking about?

It is. Correct. And that excludes Specialty and Consumer as well.

Okay. On the government side, what were the order trends in terms of municipal customers?

This is Jeff, Todd. The -- I'll call it state and local, as a category, have actually -- it's been the same story for several quarters now. It hung in there pretty steady so really, the trends been remarkably intact in the study. There hasn't been a significant erosion in that at all.

Are there any indicators that might suggest you'll see some type of reversal there?

None that I'm aware of that all, Todd. Clearly, this budgetary conversation that Brian talked about in his prepared remarks is the biggest question mark out there, but no.

I think the other thing you see in that number is it does tie into college and university so it moves around a lot, Todd, because they can buy off of that -- off a lot of those contracts. So you'll see a lot of movement. It's a pretty broad customer base. It's not like it's singular. You're just selling to the state governments. It's really broad. There's a lot of people who can buy off of those contract arrangements.

Okay. Since last year, at this time, corporate profits have decelerated somewhat. Just curious as to how you might think about that? For example, is it really -- fully being fully realized by the vacancy-driven opportunities that your customers have to move to new facilities or are there other factors there?

We're -- first of all, I do think that's probably one of the potential -- with all the good news that I think you can see for the industry, there's a potential headwind that's out there of, will people -- because that tends to be one of the first derivatives in the industry is, what's happening with corporate profits? I think the good news is they don't ever look like -- they look like they're backing up. They just look like they're just flattening out. The question is, can we and can customers find places that they can move to that -- at more attractive rental rates that, that for the long time -- long-term, starts to reset their cost structure, either because they have lower rates or because they are able to more efficiently put their folks in. There are a fair amount of those opportunities out there.

So I don't think, so far, we've seen any discussion about that being a big driver right now. But again, I think that a lot of that's going to depend, in my opinion, on what we do as we get into January and February as a country, economically. If the economics look positive, and the fiscal cliff is there where companies start to see growth again, I think then that profit number will turn around as we get -- and people will begin to believe it's going to turn around again as we get into the back half of '13 and into '14. If, in fact, there's no prospects for growth, I imagine that will affect the psyche of businesses much more than if they actually say -- it looks like this thing has gotten at least figured out. We've got some time to start to build longer-term plans.

In terms of your reported results as well as your orders, how -- to what extent is perhaps the energy sector and one or two others really doing, continuing to do the heavy lifting? Can you speak to the strengths and weaknesses by verticals in the commercial side?

Yes. The areas of good growth we've seen is financial services, business services, those areas, Todd, in particular, have been quite good, up to standouts. Then we've mentioned the negatives have been government, healthcare have been relatively flat, if you take out the government. So you look at those two areas as being the big drivers, if you will. Not surprising, because they tend to have a lot of the people.

Okay. And lastly, did you buy any stock, repurchase any stock in the quarter?

No.

Okay. Any intent to possibly offset the fact that the share count just has been creeping up a little bit for a number of quarters now, maybe just to look to offset option issuance?

We have not had specific discussions about that, Todd. Of course, we're constantly looking at the capital structure and figuring out what to do with the cash that we have. I think we're still in the same spot. We still have the pension plan. We have to finish up that move so we know that's going to use some of the cash that we have. We are looking at some strategic ideas that we think are interesting that could help accelerate growth. So those become number two on our list and then last, the Board is constantly looking at the capital structure to make sure we're getting adequate cash returns to shareholders and that remains a topic of discussion at every meeting. We keep looking at it and those three priorities and saying -- when is the best time and best way for us to go do that?

I'm not showing any further questions in the queue.

Okay. In closing, folks, we know we face domestic and global economic challenges and we have work to do in fulfilling our strategic vision, but we believe Herman Miller has many years of strength and promise and a plan that leverages and builds on these to our unique advantage. The orders and backlog generated this past quarter are strong validation of both our strategic direction and momentum domestically and internationally. We hope you share our optimism for the future.

Finally, on behalf of all the people at Herman Miller, I want to wish you and your families a wonderful holiday season and a happy and healthy prosperous 2013. Thanks again for joining us and we look forward to talking to you again in March.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.