MillerKnoll Inc (MLKN) 2014 Q2 法說會逐字稿

Good morning, everyone, and welcome to this Herman Miller, Incorporated, second-quarter fiscal year 2014 earnings results conference call. This call is being recorded.

This presentation will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. These risks and uncertainties include those risk factors discussed in the Company's reports on Form 10-K and 10-Q and other reports filed with the Securities and Exchange Commission.

Today's presentation will be hosted by Mr. Brian Walker, President and Chief Executive Officer; 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 the financials by Mr. Bylsma. Mr. Stutz will then open the call to your questions.

We will limit today's call to 60 minutes and ask that callers limit their questions to allow time for all participants. At this time I would like to begin the presentation by turning the call over to Mr. Walker. Please go ahead, sir.

Good morning, everyone. Happy holidays and thanks for joining today's call.

Overall we are pleased with Herman Miller's solid performance in the second quarter and the operating results we achieved. Sales and earnings were in line with our previous guidance while order growth and strong margin contribution from key categories and initiatives again proved that our strategic initiatives are making immediate and meaningful contributions to results.

Importantly, this quarter we also reached new milestones in our stated objectives to strengthen our balance sheet, invest in innovative products and strategic growth opportunities, and further increase the cash we return to shareholders. I want to expand on the operating highlights and strategic accomplishments further; but it is first worth noting that these gains were achieved despite the quarter's backdrop of mixed global economic conditions and continued uncertainty in the direction of US government policy, coupled with a further decline in federal government demand for furnishings.

That said, we generally share the view released in the recently revised BIFMA forecast and anticipate that slow growth in calendar 2014 will improve through the next year, with a further strengthening of the economy and accelerating furniture demand for 2015 both domestically and globally. Recent better-than-expected US GDP and job growth, the pending budget deal in Washington, and signs of improving international conditions, particularly in Europe, are encouraging.

These are complemented by industry-specific indicators including a positive ABI, significant commercial vacancy rates that encourage office additions and moves, and strong corporate profits and balance sheets to support facility spending. In total, we see strategic opportunities and an improving landscape both domestically and globally, and are working hard to strengthen Herman Miller's position to our greater advantage.

Greg will offer greater segment detail within our most recent results, but I want to take a few moments to review some notable highlights. Consolidated net sales for the quarter were $471 million, up 6.5% from last year while new orders grew 6% to just over $500 million.

Within our North American segment we saw modest organic growth in sales and orders. Although weakness in US federal government purchases has remained a drag on overall growth rates, we were encouraged at this quarter by the relative strength of demand across other commercial sectors and within focused growth areas including ergonomic accessories, educational furnishings, and small and medium business.

Meanwhile, we continue to invest in our global Living Office product and service portfolio, a powerful research-based point of view grounded in new insights that are already helping our clients realize greater potential in their facilities and people. Major new furniture platforms and work seating are moving forward on schedule and continue to garner positive recognition including national broadcast coverage, print features, and digital media praise, with more expected.

The new Living Office furniture programs are also receiving positive reviews from select pilot customers, and we anticipate the new systems to begin standard order entry in the first half of calendar 2014. Our next-generation Mirra 2 chair has begun to ship under limited order entry status and will launch in full for both commercial and consumer markets in January.

This positive response to our latest designs are consistent with a just-released trade magazine survey, a commercial architect and interior designers, which has again confirmed Herman Miller's position as the preeminent brand for the largest product categories in our industry. This year we were named a number-one brand in the categories of furniture systems, work seating, healthcare furniture, and textiles as well as capturing multiple top-five recognition in others. Nemschoff and Maharam were clear brand winners in their respective categories, demonstrating that our most recent acquisitions were well targeted for industry leadership.

Turning to our Specialty and Consumer segment, we again recorded strong growth in quarterly sales and orders, up 58% and 40%, respectively. This growth was driven by the addition of Maharam, where the team continues to prove their strategic value and operating excellence and are a very welcome addition to the Herman Miller family.

Excluding Maharam, net sales and orders decreased 3% and 17%, respectively. This was primarily driven by the timing of project-related business in our Geiger brand. We continue to see positive growth and momentum in our collection and consumer businesses.

Our International business segment had a standout quarter, posting a significant turnaround and operating performance in Q1 of this year and completing a significant milestone in respect to advancing our manufacturing reach and capacity. Adjusting for currency translation, net sales increased 13% and orders were up 6% versus the year-ago quarter.

The regions exhibiting the greatest strength were EMEA and Latin America. It is still early in Europe's economic recovery, but our team there is optimistic that they can build on this momentum.

Sales in the Middle East were again up nicely over the prior year. And we continue to develop plans in Latin America aimed at expanding our operational capability in order to better serve that region and drive more opportunity in the future.

In Asia, we again posted year-over-year declines in Australia, where the general economy is highly dependent on economic conditions in China. POSH, however, recorded solid sales and order growth in the quarter, which helped offset relative weaknesses in the balance of our business in the PRC.

We also marked an important strategic step this quarter by completing the acquisition of our Chinese partner's manufacturing and distribution operation in Dongguan, China. Going forward this provides us with expanded operational capability and an established workforce of employees to serve China and Greater Asia. We are happy to welcome the Dongguan team members to the Herman Miller family.

Finally, I want to briefly review two significant corporate actions we completed this past quarter that together strengthen our balance sheet, create greater financial flexibility for further strategic investments, enable us to increase the cash returned to Herman Miller shareholders. For several quarters we have been detailing our plans to terminate our previous defined-benefit pension plan and move the majority of our US employees to a defined contribution program. That work is now complete; and the related cash and non-cash charges are detailed in the release and Greg's comments to follow.

I am pleased to note that our final cost associated with the plan termination, both in terms of expense and cash funding, came in better than earlier estimated. We also delivered on a smooth and orderly transition of our employees that was well managed by our people services team and well received by our workforce.

With this critical work now completed, the health of our balance sheet is significantly improved, giving us greater control and visibility to make further strategic investments and to return more cash to shareholders. As proof of that intent, we are pleased to announce a 12% increase in our quarterly shareholder dividend, raising our payout rate to $0.14 per share, payable in April.

This represents the third such action in the past 18 months, over which time we have raised the dividend payout by more than 500%. We hope you welcome the increased dividend, and the confidence and optimism it reflects in our assessment of the business and our overall strategic direction.

Before we review the details of the quarter I want to step back for a moment and comment on what we see as a generally positive macro environment for the business. While our growth in total has been tepid, we are seeing solid from commercial customers and, outside of lagging federal government demand, the business is demonstrating organic growth.

Economic conditions are generally trending positive both here and abroad. And the traditional indicators for our industry, including architectural billings, corporate profitability, and service sector employment, are supportive of improving market conditions.

This improving environment, combined with the strategic investments we're making, put us in a good position as we begin the second half of the fiscal year. With that, let me turn the call over to Greg and Jeff.

Thanks, Brian. To begin, I will remind you all that we have provided supplemental financial information specific to the quarter on our investor website at HermanMiller.com. This information includes details relating to our performance by segment, organic growth calculations, and reconciliations of non-GAAP financial measures.

And now for the details on the quarter. Consolidated sales in the second quarter of $471 million were 6.5% higher than the same quarter last year. Orders in the period of $503 million were 6% about the prior-year level.

The acquisition of Maharam last April added approximately $28 million of sales and $27 million of orders to our consolidated results in the second quarter. On an organic basis, excluding the impact of Maharam, the dealer divestitures, and foreign currency translations, sales and orders increased approximately 3% from the second quarter of last year.

As Brian mentioned, our overall growth rates were again negatively impacted by downward trending demand from the US federal government. In total, sales to the US government comprised roughly 5% of our consolidated revenue this quarter, and the rate of decline exceeded 25% for both the sales and orders from the levels we reported in Q2 of last year.

This decline in government business reduced our year-over-year organic growth in both sales and orders by between 2% and 3% this quarter. Sequentially, net sales increased just under 1% while orders improved 7% from the first quarter of 2014.

Within our North American segment we saw sales of $297 million in the second quarter. This represents a decrease of 2.5% from Q2 of last year. On an organic basis, adjusting for the impact of dealer divestitures and foreign currency translation, segment sales were essentially flat with last year.

New orders in this segment total $334 million in the second quarter, an amount 1.5% higher than last year but up 4% on an organic basis. While the negative trend in federal government demand has posed a significant challenge to our growth in North America over the past two years, we are encouraged this quarter by the level of activity outside the federal government sector, where organic sales and orders were up 3% and 9%, respectively, from last year.

Our Non-North American segment reported sales of $103 million for the quarter. This represents an 11% increase from Q2 of last year with the largest contributors of this growth coming from the EMEA and Latin American regions.

New orders in the quarter of $104 million were up 4% from last year. Adjusted for the impact of changes in foreign currency translation, segment sales increased 13% while orders were up 6% from the prior-year second quarter.

Although total sales and order activity was down across the Asia-Pacific region relative to last year, our POSH subsidiary has continued to deliver solid results, posting year-over-year growth in the period. As Brian described, we took an important step during the quarter towards implementing a long-term manufacturing strategy in China by acquiring the existing POSH production facility and related manufacturing equipment.

Completing this transaction allows us to forgo plans to build a new manufacturing and distribution facility on previously acquired property in Ningbo. While this decision required us to recognize a $4 million charge in the second quarter, it provides us with a number of long-term benefits.

It eliminates the risk inherent in relocating and consolidating production and significantly reduces the total investment required. Most importantly, it provides us a solid manufacturing base to grow the business in the future, both in China and in key export markets such as India.

Within our Specialty and Consumer segment, sales in the quarter totaled $70 million, an increase of almost 59% over the same quarter last year. By comparison, new orders of $65 million in the quarter increased 40% on a year-over-year basis.

In both cases the growth came from the addition of Maharam, which was not included in our consolidated numbers this time last year. Excluding the impact from this acquisition, segment sales decreased 3%; and despite strong growth within our Herman Miller collection business, total segment orders were down 17% from the second quarter of fiscal 2013.

These decreases were partly driven by a reduction in large project business at our Geiger subsidiary. We also took fewer orders this quarter from some of our large retail distributors who, unlike last year, accelerated the timing of their holiday stocking orders into the first quarter. This timing drove significant order growth last quarter within our Consumer business but resulted in a year-over-year decrease in Q2.

It is perhaps more telling to view this data on a year-to-date basis in order to normalize for the timing of this shift. On that basis, including the first two weeks of December, orders at our Consumer business are up 3.5% compared to last fiscal year.

We estimate the translation impact from changes in currency exchange rates reduced our consolidated net sales and orders in the quarter by approximately $3 million and $4 million, respectively, relative to the second quarter of last year. This resulted from a general strengthening of the US dollar against other major currencies compared to a year ago.

I will now review expenses and earnings in the quarter. Our consolidated gross margin included $50 million in legacy pension expenses recorded within cost of sales.

Excluding the impact of these expenses, our adjusted gross margin was in line with our expectations at 36%. By comparison, adjusted gross margin in Q2 of last year was 33.8%.

Operating expenses in the second quarter were $240 million, compared to $130 million in the same quarter last year. Excluding the impact from legacy pension charges, adjusted operating expenses totaled $129 million in Q2 of this year and $112 million in the prior-year period.

Approximately $13 million of this increase relates to our acquisition of Maharam. The remaining increase was driven primarily by higher incentive accruals and increased spending on new product launch activities.

On a GAAP basis, including legacy pension expenses and the impairment charge relating to the Ningbo property, we reported an operating loss of $125 million for the second quarter of 2014. Excluding these charges, adjusted operating earnings this quarter were $40 million or 8.5% of sales.

In the second quarter of last fiscal year, operating earnings totaled $17.5 million on a GAAP basis. In that same period, adjusted operating earnings were $37 million or 8.4% of sales.

Our effective tax rate in the second quarter was 37.6%, compared to 34.9% in Q2 of last year. This change was driven primarily by the legacy pension charges we recognized this quarter, which resulted in a book income tax benefit calculated at our blended US marginal rate.

Excluding the legacy pension impact our effective rate would have been approximately 32% in the second quarter. This rate is below the level we expect due to a one-time benefit resulting from an election that allows us to step up our tax basis in certain depreciable assets.

Finally, we reported a net loss during the second quarter of $81 million, or $1.37 per share on a diluted basis. On an adjusted basis, diluted earnings per share in the quarter were $0.42.

With that, I will turn the call over to Jeff to give us an update on our cash flows and the balance sheet.

Thanks, Greg. Good morning, everyone. We ended the second quarter with total cash and cash equivalents of $73 million, a decrease of approximately $37 million from the end of August.

In completing the final phase of the pension termination we made additional cash contributions to the plans of approximately $49 million. Including this pension-related outflow, net cash used for operating activities in the quarter totaled $11 million.

Changes in working capital in the quarter resulted in a net cash use of $9.5 million, driven mainly by increases in trade receivables and inventory, and a net reduction in accrued income taxes. Capital expenditures in the quarter totaled $13.5 million, bringing the total for the first half of the fiscal year to $20 million.

Additionally, cash used for the acquisition of the POSH facility and related equipment in Dongguan, China, totals approximately $6 million. Including this investment in plant and equipment for POSH, we expect our full-year capital spending to range between $55 million and $60 million.

Cash dividends paid in the quarter were $7.4 million compared to roughly $5 million paid in Q2 of last year. The dividend increase we announced in last night's press release will be reflected in the April payment and will increase our annual payout by approximately $4 million.

We remain in compliance with all debt covenants; and as of the end of the quarter our gross debt-to-EBITDA ratio was approximately 1.3-to-1. The available capacity on our bank credit facility stands at $143 million, with the only outstanding usage being from letters of credit.

We are also confident we can meet the financing needs of the business as we move forward given our current cash position, expected cash flows from operating activities, and available borrowing capacity. With that brief overview I will now turn the call back over to Greg to cover our sales and earnings guidance for the third quarter of fiscal 2014.

Okay. Thanks, Jeff. There are several items that increase the level of uncertainty in our forecast this quarter, and I want to talk a minute about the factors we considered when developing our forecast.

The first relates to the timing of Christmas and New Year's holidays, both of which fall midweek this year. While this only represents a shift of one day from last year's calendar, it has the potential to reduce the number of available order entry days depending on how our business and consumer customers schedule time off. This places even greater importance on the level of orders that come in during the first two weeks of January, which can vary widely based on our past experience.

Another factor relates to the timing of orders and shipments on the large energy project that we have talked about in recent quarters. This past quarter we began recognizing revenue on the first shipments relating to this project; and we anticipate the cadence of future orders and shipments to layer into our result evenly over the next several quarters. With that said, the actual timing of this revenue will depend on factors such as building construction schedules and insulation, which are a bit outside of our control.

Finally, while consolidated order entry has been rather encouraging in the first two weeks of Q3, the lower end of our estimated sales range reflects a level of organic growth consistent with what we have seen in the business through the first half of fiscal 2014. Given these factors, we expect sales to range between $445 million and $465 million in the third quarter.

This implies total revenue growth between 5% and 10% over the third quarter of last fiscal year. On an organic basis this suggests year-over-year growth of flat to 5%. It also assumes a rate of decline in the federal government business similar to what we experienced in the second quarter.

Earnings per share in the quarter are expected to be between $0.30 and $0.36. This assumes an effective tax rate of approximately 34.5% in the period.

As a reminder, our effective tax rate in the third quarter of last year was significantly lower than this year due to the renewal of the R&D tax credit legislation which was signed into law in February. The retroactive application of these income tax credits had the effect of increasing our Q3 net earnings by approximately $0.02 a share.

We expect our consolidated gross margin in the third quarter to be down slightly from the second-quarter level. This is partially due to the relative slowdown in factory production that we normally experience around the holiday period and in the month of January.

In addition, we expect to feel increased pressure from rising material costs as we move through the third quarter. We began to feel the early effects of this in the latter part of the second quarter, particularly in the area of steel and steel components.

In total, we expect our gross margin to range between 35% and 36%. Total operating expenses in the third quarter are expected to range between $127 million and $130 million.

Finally we are planning to implement a general price increase in the upcoming quarter effective on February 3. The adjustments will vary by product line and business unit, but on average will increase commercial list prices by approximately 2.5% for most Herman Miller and Nemschoff products. The increases for Geiger products will be slightly above this level.

Given the effective date, we do not anticipate this pricing action to have a significant impact on sales in the third quarter. With that I will turn the call back over to the operator so we can take your questions.

(Operator Instructions) Josh Borstein, Longbow Research.

Hi, Brian, Greg, and Jeff. Thank you for taking my questions here.

Just starting off, ex-Maharam, orders in the Specialty and Consumer segment were down 17%; and that was a swing from some nice gains last quarter. You mentioned in the press release some timing issues, also some issues related to Geiger.

But I was just hoping you can go over those again, what exactly you saw in the quarter.

Yes, Josh; Brian. I will let Greg maybe give it to you in detail, but I will give you the general scope and he can dig into the numbers a little bit if we need to. But basically some of it was -- a big chunk of it was you caught from the release and from all of our comments Geiger just was lumpiness of when projects came in. So that is pretty typical in that particular business; but this quarter it moved around maybe more than normal.

The biggest factor in the non-Geiger piece was we had a large number of orders and some shipments in the retail business that would have normally or in prior years fell into the second quarter that happened in the first quarter. Particularly on the order front, and particularly for one large retailer who actually we went to and said: if we can plan further ahead we can do a better job of leveling out production levels prior to the sale. So some of those orders came in late in the first quarter; then they were shipped over the balance of the second quarter.

So that was the big -- where you saw the big movement around in orders.

If you look at overall growth in the Consumer business it has actually been pretty good if you look at it -- I think Greg mentioned -- on a year-to-date basis. The other place that we saw a bit of a flip from first quarter to second quarter was in the collection business, which of course is selling some of those same products but more to the A&D channel.

There we actually saw pickup in orders from Q1 to Q2, but it was too late in the cycle to actually see that show up in the revenue number. So you had a little bit of movement between those different things.

Okay. Thanks for that clarification. That definitely helps.

Then on the price increases, can you just remind us how long it takes price increases to show up on the P&L after they have been implemented?

Sure. That usually layers in on a pretty consistent 12-month pattern from the time that it starts for one full year. So we tend to see that layer in.

You don't, obviously, get anything the first three or four weeks because of existing backlog, so we won't see really anything in February. But then we should see a cadence that really shows up equally over a 12-month period.

Okay. Do you think that 2.5% price increase is sufficient to offset the raw material cost increases you have seen so far?

That is what we based it on. And obviously if you get something that comes out of commodities or something else that is much different than recent patterns, that is always up for debate. But that is what we based it on, yes.

Okay, thanks. Then just one more for me. On the balance sheet, you've done a nice job improving it, which should help you in the future; you mentioned with some acquisition potential there.

And you have spoken a lot about diversing your portfolio. Obviously you recently added Maharam.

Now what other niches, whether it is perhaps outdoor furniture or something else, might you be interested in when looking to round out your portfolio?

Josh, I don't know if I want to go into any specifics about what we might be thinking about. But of course what we are going to look at -- and we have been pretty clear in the strategy -- we are looking for overall growing the business either in areas where we think the demographics are positive such that we can get above-average growth rates, or areas where we think there are opportunity for us to get into categories that have a richer margin potential, which of course you can see both with the case of Maharam; when we looked at healthcare it was really driven by our view of what we saw in demographics. In the case of ergonomic tools it was going in that direction.

So you will generally see us look at the direction we are headed in the business and ask what things can help us. And what we are going to look for, besides the general structure of growth in margins, we will look for areas that can either give us a product capability into a segment that we are already in, that furthers our capability; or a place, either product or channel capability, that actually help us further the work that we are already doing. So you will see it more in that general terrain.

Down to specifics beyond that, I really wouldn't go into that.

Okay. No, that's helpful. Actually if I can squeak one more in, on the Non-North America segment, last quarter you mentioned you saw some improvement in the UK. I was just wondering if that had continued in this quarter.

Yes, the UK had reasonable. We had good activity in the Middle East. And it is kind of funny, because if you look underneath the numbers they bounce around; whether you are talking about orders or shipments, you get kind of a different pattern.

Overall, EMEA in general was pretty decent. Now again, you got to remember that we play in a very small basis in any single country throughout EMEA other than the UK. So different than maybe some of our friends and neighbors, we are not playing in the core of that. We are finding projects and capabilities around it.

The other thing that I would say to you, the other area that was really quite positive was Latin America overall; and again spread through several different geographic countries, if you will that did it. So it wasn't one particular location.

Okay. You mentioned strengthening your capabilities in Latin America. What do you have planned there?

Well, some of the things we have already done, we have been building our team out down there. We actually are now -- we went from a period that we really managed Latin America almost country to country, where we have now put together a combined management structure around Latin America which is letting us leverage some great talent that we have throughout the region.

We have actually just added a small distribution and assembly capability down in Brazil which is helping us get a little closer to that market from both a time of getting to market, also helps us with some of the cost of getting product into the country. So we will continue to look for places where we can either build out operational footprint close enough to the customer where we can serve those markets; but more importantly: how do we both build the brand of Herman Miller as well as the distribution channels that are available to us?

So it is really on those three fronts, looking at how we get source of supply close; how do we build channels. Those tend to be the two big drivers beyond product.

The good news is we have really strong R&D capabilities in the US, Europe, and in Asia. And we can use all of those capabilities to pick what are the best things to do for any one of those markets.

That's helpful. Thank you very much.

Matt McCall, BB&T Capital Markets.

Thank you. Good morning, everybody. Greg, maybe for you first on the SG&A guidance, if I just plug in to the top line the midpoint of the guidance, I get to a number that is a little less than that -- the low end of your range -- less than that $127 million. Is there anything that -- maybe it is an error in my model; but is there anything that could be called out there that would cause it to be outside of the normal pattern?

The $127 million to $130 million guidance, Matt?

Correct.

You know, this is always -- because of a wider range on the revenue number you are going to get swings. If you are at the low end of that revenue number you are going to get numbers that are going to adjust; incentive comp is one that will adjust fairly significantly as that thing moves around within the range. So maybe that is what is driving your model to look a little funky.

Okay, but nothing out of the ordinary next quarter?

No.

The only other thing, Matt, that I would point out -- that I don't know if it is out of the ordinary -- is where we might want to drive more variability typically in operating expenses from Q2 to Q3. Because we are in a heavy launch period around the Living Office we have a fair amount of marketing-related launch expenses that, to be frank, we just can't -- if we defer them we defer getting traction with a product. So it just doesn't make good sense to do.

Okay, okay. Is there a number -- have you given a number there?

No, we have not.

Okay. Then, Brian, I think -- or maybe it was Greg that brought up the North American orders, if you adjust out the government up 9%. That just [whole] -- a couple quarters now.

But any change in the mix there? Are you seeing any more? I know there are several buildings that are finishing up, and you talked about one in the energy space. But is there anything that is changing from a mix perspective and giving you more project activity as a percent of the mix?

I know, Jeff, this is a number you have given in the past. But anything changing that tells you the late-cycle activity is picking up?

I don't think we see anything if you look at the project pricing stuff. You don't see anything particular in that math that I would point to.

I think what you do see, though, if you -- whether you look at it consolidated or look at it in North America, I think the picture is somewhat the same. Is that we do see organic growth if you take out the government.

That to me is encouraging, given that we are seeing better overall economic data. It is also that -- while it is hard to call the government as being at the bottom, because we're still doing business with them and you never know when you reach bottom in one of these, as we've learned over the last 10 years or so.

On the other hand, if you look at order patterns after -- over a four-quarter rolling basis with the government, it looks like -- and again I say look like with lots of caveats, that you never know quarter to quarter -- it looks like it has evened out.

Now next quarter, as Greg mentioned in his comments, it will again negatively impact, we would believe, our organic growth rates both in North America and consolidated. On the other hand, it looks like it is starting to even out.

So that as we get into the fourth quarter, for sure, into first quarter of next year, we should start to anniversary in where that big down-slope should at least start to come out of the numbers, which I think will be helpful, because we will be able to see through that for you guys to at least see what is really going on underneath it with the business.

From our perspective, we feel pretty good about what we are seeing on the commercial side. International, obviously, we have seen some bounce-back there. In fact order patterns, if you look quarter to quarter, their orders were pretty good from first to second; we had a very light quarter in the first for revenue.

A little bit of softness in Asia, particularly the PRC and Australia; and we think those are interrelated. What you are seeing in Australia is actually the problem in the PRC. There is just not enough industrial production going on.

But good signs that Europe is at least coming to life. It may not be running full ahead, but it is starting to move.

And then, healthcare has been, I would call it, much more consistent than it's been over the last couple of years. That's again been really heavily impacted by the amount of business we did with the federal government in that particular little micro-segment.

So overall, I think there are positive signs that we see in our numbers; and we see positive signs from the things we have done. And assuming that the government can get their act together and find some level of bargain -- it may not be a grand bargain, but some level that we don't keep going through these shocks and the economy continues to turn over, there were some pretty good numbers out from the Fed yesterday about what they are seeing in employment, I think those things over the next 12 to 24 months we should start to play in favor of the industry. And by virtue of the things we are doing, we think us as well, maybe even more so.

And, Brian, a lot of those comments really spoke to the cycle, right, the cyclical potential? As you look at the initial response to the Living Office, what conclusions can you draw about maybe the pace of the secular trend tied to that office modernization theme that we have talked a lot about?

Any initial thoughts on acceptance, and whether or not that trend is gaining or maintaining if not gaining momentum?

You know, Matt, as always, this is a -- I was listening to somebody did an interview with Mickey Drexler earlier, and said our business is often about developing new ideas that we don't know how they are going to do in the market till they get out there. And I would say in some ways we are always in that same spot, that when you are developing something new.

On the other hand, I would say the response we saw both at NeoCon and since then said the ideas we're talking about in the Living Office to us seem to be on target with questions people have about: how are we going to create not only the workplaces but the companies of the future?

So we think we are in the right ZIP Code with what we have done. We think the designs themselves are actually in the right direction.

We also feel the same way about Mirra 2. So I think we feel really good about the product programs we are about to launch. And if you see them as bigger than product programs, the way we are thinking about it -- and, you know, Matt, we have been on a journey that I think we are starting to see things gel together between what we did with the collection -- that was sort of a first step towards rethinking the way space will be done in the future. Combining that with what we are doing with the Living Office, the addition of Maharam into the softer side of that, I think it is the combination of those things that will eventually create the momentum we are talking about.

I think one more as well. Greg, you have mentioned, I think, the strength of orders thus far in the quarter. Any more details you can provide there?

Yes, we are only two weeks in so it is a little hard to tell. I would say that we saw a continuing trend like we saw towards the end of the second quarter into the first couple of weeks of the third quarter, Matt, without trying to get into numbers because week to week things move around. So I would say if it continued like we saw in the first two weeks we would be very -- we feel pretty good about our guidance. We would start to feel stronger and stronger if that continued.

Of course, as Greg said, the real wildcard is going to be the next couple of weeks as we go into two short weeks, and we pop back from the holiday period and see are people hungry on the other side. And that is going to be the real big question.

Okay. Thank you, Brian.

Budd Bugatch, Raymond James.

Good morning, Greg, Brian, Jeff. Happy holidays to everybody there.

I guess, just if I could go back, just for modeling purposes on the guidance for the revenues, can you give us any color segment by segment, either sequentially or year-over-year, what your thinking is, how they will play out? Maybe rank them or give us some flavor in your planning assumptions.

Yes, I think, Budd, if you look at it, the one place we think we will continue to see strength that we saw this past quarter is on the International side, because we left the quarter with a reasonable backlog. Of course some of that doesn't get -- Western Europe does, Asia doesn't get as involved in some ways with the Christmas holiday, although we have Chinese New Year in there. So there is some offset to that.

But we think International will have another good quarter on the top line. We expect some turnaround in the -- not in absolute dollars but in terms of growth we will see some turnaround in the US business from what we saw this quarter.

I would say the one wild card in that or dependent, which I think Greg mentioned, is we have a fair amount of business that is going out the door that is direct. So will we get that through the invoicing cycle as well as the shipping cycle is one of those we won't know till we get down to the end.

We are on the completed contract method. As you know, it is a little harder to predict exactly when we get to recognize the revenue.

Is this on the large energy project?

Yes, and actually some other projects beyond that. We have a couple large -- besides that one some other large things that are going on that are direct business. And just trying to figure out, in that case not only do we have to get the product shipped, we have to get it installed and get it signed off by the customer.

But that is usually in the federal government, I thought, the percentage of completion. You're using that on some other direct (multiple speakers) ?

Well, we have to do it whenever we are involved in the direct sale and we are responsible all the way through the install.

I see. You mentioned the large energy project. And this has some sensitivity, I am sure, but you've started to ship in the second quarter and you're going to ship in the third.

As I remember, the cadence of those shipments lasts until sometime mid next year; at least that was the original plan. Is that correct?

Yes, that is correct, Budd. It is about a 14-month or 15-month time frame as we know it right now.

And any change to that, Greg? And can you quantify maybe what shipped in this quarter and what you think will ship in next?

You know, Budd, what we recognized as revenue in this quarter was pretty minor, so it really didn't have a significant impact on the revenue front. But we expect that from an order perspective, and this is what -- it is easier to call the orders because we know when the orders are coming in versus when we're going to get revenue. But orders and shipments, not counting revenue, we think they'll be very consistent over the size of the project over that 14- to 15-month period.

To make sure I understand, there is going to be a balloon recognition as you get that percentage of completion, as you go through?

No, not necessarily, Budd. I think -- I will just make up numbers for purposes. Let's just say we have shipped more than we recognized in revenue in this quarter; but once we get on a cadence the amount ordered, shipped, and recognized in revenue should be pretty consistent over the 14- to 15-month period.

The first -- this quarter and next quarter we probably have a little bit of build in the queue to make that all be pretty consistent over the 14- or 15-month period.

Budd, the completed contract is not for the whole project. It is sort of floor by floor.

I see. And the other side of that then becomes the expense recognition, which is always tricky on those kind of accounting methods. What is the likelihood of that?

Primarily our expense recognition is cost of sales and a little bit of installation costs. So that is not a big deal.

So that basically flows with revenues?

Yes. It is not like a government development program, if you will, like you might see in one of the military guys. It is pretty straightforward. Essentially what you are doing is you are just deferring the entire revenue recognition between sales and cost of sales, until the point that the customer says it's in, it's installed.

Okay. Manufacturing in China, I know you decided not to build the additional facility in Ningbo. The $4 million, did you recognize that in last quarter, or this quarter? When did we recognize that charge?

All this quarter.

All this quarter. I am not sure I understand why there was a charge. What was the charge for? How does that work?

We had purchased some land in Ningbo. You know we have a small facility there.

I know.

We bought some land to build a new building there, which -- as always in China, there were some other things associated with buying that land. And actually as we have now looked at it, Budd, and decided not to build there, we had to write the land down to what we think the net realizable value will be.

Are you planning to sell it?

Yes.

Okay. I see. A couple of other just hopefully quick questions. Vacation time this year; don't you normally take a week off between Christmas and New Year's? Is that the same plan this year?

We did not shut down for a full week, because if you did it was kind of funny, with where the holiday fell. So actually I think we are open two days a week for both weeks, which makes it a pretty uneven period. But we had enough -- we kind of guessed we would have enough business that we would want to stay open for those two days.

So you're not shutting for any of the weeks. You are just shutting parts of the weeks?

Correct.

Oh, boy. The management of that is a challenge, I'm sure.

Yes, but the problem was if you did it you almost end up with two weeks if you were. You follow what I mean? I had to pick which week, so we decided we would just straddle the two weeks.

I got you. Just refresh me on what now the priorities of cash are. Now that the balance sheet has kind of stabilized, and Jeff has done his masterful job of terminating the defined benefit plan, what is the priorities of cash?

I suggest or my model today shows like maybe $50 million worth of free cash generation in the balance of the year from operating cash minus CapEx. A, is that reasonable? And B, how are you going to use the free cash going forward?

Well, first of all, I don't know -- Jeff, you have to confirm whether that is exactly the right number. What I would say to you, Budd, is a couple things.

We do have, as we told you guys I think maybe a year ago, we will have a little higher CapEx over the next few years than what we have historically run. Part of that were the facilities investment we're going to make in the UK to combine everything there.

We have got some additional investments in resetting our customer experience in the field, i.e., what we might think of as showrooms today. We will have some additional cash related to that, not necessarily this year, but over the next -- some in the second half of this year but for sure as we get into next year.

We also have a higher than normal investment in manufacturing equipment in the US, partially for things that have simply moved beyond their useful life or are getting there; and creating some new capabilities as some of the technology has moved forward. So CapEx overall is going to be a little higher than we have seen maybe over the last seven, eight years.

The other thing I would say is we continue to -- along the same path of saying: look, in addition to new products, making sure we are tuned on our footprint for manufacturing, investing in the customer experience, the last thing we will look for is, can we find acquisitions like we have done over the last few years that take us forward into some of these areas we are headed towards and/or give us new adjacencies that we can play off of current capabilities.

Brian, I am still showing like $70 million in CapEx for the next couple of years, which is higher than what you have guided. You have sidestepped the question nicely; but I am going to try and ask it again.

What are the priorities of the free cash? I show anywhere between the next year $90 million to $100-and-some-million of free cash after that. What would you -- is the priorities -- could you lay them out maybe just in order?

Very simple, the first priority is we are going to look for things we can acquire and add to the business to take us forward strategically. That is goal number one.

Goal number two will continue to be where we don't find those opportunities, or we think we have consistently free cash flow, we will look for ways to return cash to shareholders, which we have been exhibiting through the dividend increase. And we will continue to look at that as we move forward. Exactly to what degree that will happen and how that will happen, Budd, I don't know the answer to that, yet.

Okay. But leverage is not one of the things you need to reduce? You've got what, $250 million of long-term debt right now and you're comfortable with that one?

Correct. I don't think you will see us reduce leverage. Although the only thing that could happen is we do have some laddering out there in that long-term debt; if we weren't finding other things and we got to a spot that some of the long-term debt was due we might choose just to pay it off for a period of time and try to connect more of it together in a bigger bullet out there in the future. You follow what I mean?

I do. Thank you.

That could happen as we move through the next couple years, because I think the first tranche comes due in 2000-and --?

2015, January of 2015, Budd.

So it could be, Budd, when we got to 2015, if we had excess cash we may use that to pay down that piece and then time it all together at a later date.

Okay. Well, I suspect rates are as good as they are going to be for a while, if we listened to the authorities yesterday.

Well, I think that is the other question we're going to have to ask ourselves, is: when do we look at the bigger picture around that? As you know, to date we have been really focused on getting all those other -- getting our house in order, paying down the debt, getting the pension plan behind us, getting the acquisition things that we wanted to get done, and then starting to return cash to shareholders.

I think so far we have delivered on each one of those things we outlined I think four years ago, five years ago. So I think you will continue to see us march down that same path.

Very nicely. And there are no loose ends of the pension plan; that is done now?

That's done.

It's done, yes.

Okay. Congratulations on that. I know it was a long, long, long process. Thank you very much again and happy holidays.

Long journey and Jeff, Greg and our people services department did a phenomenal job.

Thank you; and again happy holidays to everyone.

Todd Schwartzman, Sidoti & Company.

Hi, good morning, gentlemen. It is pretty clear that your main focus or certainly right up there is external growth going forward. I think on that front, maybe if you could give a little more color on some of those completed acquisitions over the last couple of years -- POSH, for example you spoke to pretty good sales and order growth. I wonder if that could be quantified for Q2.

And also on the Maharam side, maybe what -- how integration went there, what the EPS contribution was for Q2, whether that is on track. And just get a sense of whether some of these recent deals are doing exactly what you had hoped they would. Thanks.

Yes, Todd, first of all, I wouldn't say we are overly focused on external growth. We see that as an accelerator, but not a primary or the only way we're going to grow.

Obviously we are just as focused on making sure that our internal engine, particularly our R&D engines in each of the businesses -- because there is no longer one R&D engine -- are all firing on all cylinders. We are investing as heavily right now in new sales training and new sales methodologies. So I wouldn't see it as one side versus the other; I'd see them as fairly balanced, if you will.

In terms of the past things we have done, maybe I will go back a step further than you did. The first one I think along this Hit Parade we did was CBS in the ergonomic tools side. I don't know that I am going to get into individual numbers.

I will just say if you look at CBS, it has done two things for us. It got us into an entirely new category. Generally the margins of that business are higher than our average; I am talking gross margins.

And we have not only been able to grow that business but surround it with other products and a salesforce that enable us to grow at a faster rate in that kind of micro-segment if you will than we are overall. That's worked quite well. We could do lots of those, it would be good.

Second of all, Nemschoff I think is the one we did shortly thereafter. I would be candid in saying Nemschoff has had some mixed results. I would say there was two things that were difficult with Nemschoff.

A, the general pullback in healthcare has made that have a bit of a headwind. Also, there has been a little bit more noise than we would have anticipated in the integration at the distribution level, where Nemschoff had a high percentage of its sales in non-Miller dealers. So we have had to go through the transition to not only holding the customers but making the dealer transition.

While that is still ongoing at one level and we still are very interested in serving anybody's -- any dealer who is selling to healthcare, so we have not made a decision that we are trying to go away, but we know there is some pressure from some folks. We have seen that revenue picture stabilize.

And I will say the operations team has gotten real traction over the last probably two quarters on the manufacturing side. We went through a consolidation of manufacturing over there; that made a difference, although we still had the teething that goes on once you take three operations and put them together.

This quarter we started to see more consistency in Nemschoff at the margin level, which gives us good optimism that if we get some additional top line we can start to turn that thing. I would also say they have done a good job on pricing.

But overall, I would be candid in saying Nemschoff has not met all of our expectations, where CBS was on the opposite side of that.

POSH, it is a little earlier to tell, to be frank, because we really just completed the second step of that. If you look at it overall, how well has it gone? We are pretty happy with how it has gone.

And POSH is also enabling us into not only doing business in China but it has enabled us to make a pretty big difference in places like India, a little bit in Australia. We are starting to talk an impact, Latin America.

So overall we are quite pleased with POSH. The brand is very strong. We think we have got some great products.

And overall the profitability is pretty close to what we thought it would be. Top line has been a little softer than we would have liked coming in. But as we get further into it, we think that is going to turn its way around.

So overall, I would say CBS really, really strong. POSH strong. Nemschoff probably a little bit less.

Maharam, again, it is earlier. I would tell you -- Maharam we are extremely pleased, A, with the team. We think we got a phenomenal group of folks, including the two Maharam brothers who have been long-time business partners of ours. We think they are doing a phenomenal job. We think they have built a strong group of successors.

The product lines and the brand are extremely strong. And without getting into details I would say the profitability, the throw-off on the gross margin level and the EBITDA generation of that business is at or above our expectations; and that is a premium to what we get overall.

So I would say we got one that has probably not gone as well as we'd liked; we have got one that has done way better; we've got a couple that are a little earlier on. But so far not too bad.

Sounds good. In terms of pricing, in second quarter what impact did discounting have by geography sequentially from Q1?

Todd, this is Greg. When we look at our margin reconciliation rolling forward from Q1 to Q2, discounting in total really is not a driving factor from the change from Q1 to Q2 at all. So pretty flat.

Okay. Customer visits, what can you tell us there?

Todd, this is Jeff. They were more or less flat year on year, up about 1.5%.

But we always -- let me step back a minute. We are always cautious here because you are calculating percentage on numbers of visits here. So I think you could read that number as flattish and in line with more the organic experience we are seeing, including the government business here in the business year on year.

Got it. Thanks. Brian, I think you had singled out healthcare as becoming a little bit more consistent; or maybe it was you, Jeff. But can you give a little more color on -- maybe I missed some of the puts and takes -- in terms of how broad-based the strength has been in North America regarding either individual industries or sectors or verticals, ex-the government?

Jeff will give you details. I would say -- I wouldn't call healthcare strong right now. I would say what we have done, Todd, is we have gotten through the government piece of that; looks like that has been a big negative drag on that business. It actually had a heavier percentage of our healthcare business was federal government than we had in the core business, so it had a significant impact on that business over the last couple of years.

So as we start to see that wind its way through, that will be helpful. And that business is very project driven, so it bounces around quarter to quarter based on projects.

But -- so I wouldn't say it has been strong. I would say at least we think now it is starting to turn itself, that it is at least not in a declining mode where it has been the last couple years.

If you look at the core business, Jeff, you want to comment on particular sector (multiple speakers)?

Yes, and, Todd, I won't quantify for you here. But qualitatively I can tell you that comfortably when you get outside the government sector by sector -- manufacturing, financial services, energy, of course, as we have talked a lot about, we are seeing year-on-year growth outside of the federal government in each of those. And also it's fairly widespread geographically in North America.

And what has been down?

Well, the federal government has been down. That's --

On the commercial side is anything notable?

No.

Okay. Lastly, on the use of cash question, I think absent from the discussion was share buybacks. Is that off the table for the foreseeable future? Where would that rank?

We always remain flexible. The Board remains flexible to decide what they think the best methodology is, Todd. Are we announcing or working on a specific program? We are not.

We have decided to date that we thought the best way to do that was through dividends and the other things we are trying to do to grow the business. But I would say the Board always has all of those options at their disposal and we talk about them every quarter with them, about what the right methodology is and what the right mix of capital structure is.

What I would say, to go back to Budd's question, we feel like we have done a lot of work on getting the capital structure set. We feel very comfortable in the level of debt we now have, our ability to play through cycles with that level of debt. And actually with the pension played off we have got more flexibility to play up and down that curve a little bit more than we would have before.

So we will always look at -- as we look at where the stock is and what is going on, what's the valuation look like. But for now we've really focused in on making sure that we had a good, solid dividend return that we felt comfortable with.

Sounds good. Thank you all.

Thank you. Gentlemen, I show no further questions at this time. I would like to hand the conference back over for any closing remarks.

Let me close by saying thank you all for joining our call today. We wish you all a great holiday season.

We hope that we have answered your questions fully, and we look forward to talking to you again at the end of the third quarter. Have a great day.

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