MillerKnoll Inc (MLKN) 2015 Q4 法說會逐字稿

Good morning, everyone, and welcome to the Herman Miller Incorporated fourth-quarter and year-end FY15 earning results conference call. This call is being recorded.

This presentation will include forward-looking statements that involve risk 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. Jeff Stutz, CFO; and Mr. Kevin Veltman, VP of Investor Relations and Treasurer. Mr. Walker will open the call with brief remarks, followed by a more detailed presentation of the financials by Mr. Stutz and Mr. Veltman. We 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 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. Thank you for joining us today. Our results this quarter are encouraging on a number of fronts, and we are pleased to end the fiscal year on a note of steady improvement.

This capped a year highlighted by strategic milestones, including acquisition of Design Within Reach, investments in new products and selling tools, and the expansion of our global manufacturing capabilities. At the same time, FY15 brought with it clear challenges, including sluggish growth rates in our North American contract business and significant global currency pressures.

I will begin this call this morning with a review of these areas by business segment, both for the quarter and fiscal year. I'll then turn it over to Jeff and Kevin to cover the Q4 financials in more detail.

To begin, consolidated net sales in the fourth quarter are $551 million, were in line with guidance that we provided back in March, and adjusted earnings per share of $0.47 came in ahead of our expectations, driven by continued gross margin improvements. As expected, growth rates across our international operations were again negatively impacted by the relative strengthening of the US dollar. With that aside, we delivered year-over-year organic sales growth and order growth on a constant currency basis in all of our segments this quarter.

Importantly, the initiatives we outlined last quarter to reignite the growth of our North American segment are progressing at an impressive pace, and while it is unlikely these actions impacted our fourth-quarter sales in a significant manner, we are pleased by the positive feedback from our dealers and our sales team. Clearly, work remains on this front. Nonetheless, we were encouraged by an acceleration of order rates in the fourth quarter in our North American segment.

Taking a step back, the economic backdrop to our business remains mixed globally, but there are a number of factors that give us reason for optimism in the near term. The US continues to experience a strong labor market, businesses are reporting healthy cash positions, and growth in nonresidential construction remains encouraging.

All of these factors are helping fuel business industry growth expectations for the balance of this calendar year and next. Despite these positive indicators, we remain cautious on the near-term outlook for key economies outside the US, particularly in light of these slower-than-expected growth in China, and the ongoing struggles in the Euro zone.

Before taking a closer look at our segment results, I want to address two special items which impacted our reported GAAP earnings per share for the fourth quarter. The first of these is a non-cash charge of approximately $11 million or $0.15 per share related to the write down of the POSH trade name carrying value. You may recall, we recognized a similar charge last year at this time, driven by the same factors under GAAP accounting rules, which require that we evaluate certain intangible assets for impairment.

While POSH performed well this past year, posting a year-over-year improvement in profitability, it has not kept pace with its original business plan. Accordingly, we are required to recognize an impairment charge.

Having said this, I want to be clear that POSH remains core to our Asian strategy. It represents a leading furniture brand in China, with a powerful dealer network and great products, all of which positions us for further growth in Asia.

The second item relates to the implementation of a new international holding company structure aimed at supporting our strategic emphasis on global growth. This project reduced our effective tax rate during the fourth quarter, and had the effect of increasing GAAP earnings per share by $0.07 in the period.

Moving to a review of our other segment results, I will begin with our North American contract business. As we outlined for you last quarter, we have launched a number of initiatives to reinvigorate order growth in this segment, all with a focus on getting closer to our customers and dealers, with solutions needed to create the office for today's changing landscape.

We implemented changes within the structure of our sales organization, and announced key leadership appointments to effectively oversee this plan. We have resolved gaps in our selling capacity, launched key new products, and reset our showrooms to better reflect the solutions we offer, including our newest products and Living Office insights. I'm pleased to report that we made good progress in all of these areas.

While the benefit of these actions will take some time to fully materialize, we are encouraged by the acceleration in North American order rates in the fourth quarter, which were up nearly 4% on an organic basis over the same period last year. This represents a clear improvement over the growth rate we reported last quarter, and you can be sure we are intensely focused on driving toward higher level of growth in the near term. As I said in March, we have our arms around the issues, the right strategy in place, and a talented leadership team to execute our strategy as we move forward.

Now, in this near-term focus across the North American business, we made meaningful progress throughout the year implementing and refining our Living Office initiative. As a reminder, Living Office is a research-based suite of knowledge, tools, products and services, designed to help our customer realize higher performing environments. It represents the first element of our shift strategy, aimed at transforming Herman Miller from a product provider to a solutions provider.

Earlier in the year, we invested heavily in training both our sales team and dealers in this insight-led approach. We matched this investment in our people with an aggressive new product development agenda, launching several important new products that complement the Living Office story, including the Mirra 2 chair, Locale, Public Office, Landscape, Renew Sit-to-Stand tables, and most recently, Canvas desk. Collectively, these initiatives represent a bold step forward in establishing a leadership position in the new landscape of work, and we've been encouraged by the positive reaction from our customers, designers, and dealers.

Outside of North America, our Europe, Latin America and Asia business segment continues to deliver solid performance despite currency headwinds, and pockets of economic uncertainty in the key regions around the world. On a constant currency basis, this segment posted order growth in the fourth quarter of 8%, bringing organic growth for the full year to 9%. Equally encouraging are the improvements we have made in segment profitability, in the face of the currency headwinds, with operating margins for the full-year improving more than 100 basis points from year-ago levels.

This ELA segment performance highlights the successful execution against another key element of our shift strategy, our focus on leveraging our brands and capabilities to enhance profitable growth around the world. To further support this ambition we made progress this fiscal year on a number of facilities projects, aimed at improving our operational efficiency and global reach.

In the second quarter, we broke ground on our consolidated UK manufacturing distribution site which is expected to be operational later this summer. We're also nearing completion on construction of a new lease facility in India, which we expect to be fully operational beginning with chair assembly later next month.

Our specialty and consumer businesses represent some of the most exciting areas of growth within our business. These segments directly address the final two elements of our shift strategy. Moving beyond the traditional office to serve customers in a variety of environments, and expanding the reach of our brands to the consumer.

Our specialty segment continued to gain momentum in the fourth quarter, posting year on year growth in sales, orders, and profitability. Our Geiger subsidiary delivered its best financial performance in years during FY15, with strong sales growth and improved profitability.

The team's relentless focus on improving quality and operating efficiency has helped Geiger bolster its reputation as a benchmark in craft wood furnishings for the contract market. Three years following its initial launch, the Herman Miller Collection has found its stride, delivering double-digit sales and order growth in FY15, driven by a focused selling model, diverse slate of new products, and like Geiger, an impassioned focus on quality and detail.

Maharam, our third specially business, in an industry-leading brand for performance textiles remains a key contributor to segment profitability and long-term growth potential. Maharam provides a great platform for us to leverage the brand and penetrate new categories, offering attractive growth and margin opportunities.

Our consumer segment delivered solid results this quarter, with strong sales growth anchored by the addition of Design Within Reach and our fast growing e-commerce platform. For the quarter, the segment as a whole posted organic sales growth and a sequential operating margin improvement of 170 basis points.

Since completing the acquisition of Design Within Reach last summer, we've made significant progress integrating our combined consumer offer. The transition has gone extraordinarily well; I couldn't be happier with the combined effort an attitude of our team under the capable leadership of John Edelman and John McPhee.

For the full year, excluding purchase accounting adjustments, the addition of DWR to our combined consumer businesses was accretive to earnings-per-share by approximately $0.03. At our investor event last July, we outlined our rationale for the Design Within Reach acquisition, along with two drivers that we saw as key delivering the long-term shareholder values. As we approach the one-year mark, I thought it would be helpful to review our progress against those drivers.

First of these relates to DWR's real estate strategy, which centers on the conversion of its legacy, small format studios to larger footprint locations, which have thus far proven to be a much more efficient selling model. At the time of the acquisition, Design Within Reach had a total of 39 studios and outlet locations, of which only nine were large format studios.

Throughout FY15, the team reached its goal of converting or opening two new locations plus a new outlet store in Brooklyn. Today, Design Within Reach has a total of 35 studios and outlets, 4 fewer than we began with, but has increased its retail square footage by 11%. Going forward, we will be aggressive in our studio conversion plans, with six additional locations anticipated for FY16.

The second value driver we outlined was our intent to increase Design Within Reach's mix of product designs, including Herman Miller brand products. These products offer incrementally higher gross margins than a non-exclusive design, sold through Design Within Reach.

Our consumer team has made good progress to this end, and today our exclusive product mix stands at around 62%. Our longer-term goal is to increase this mix to around 70%, and we are working aggressively to achieve this.

Overall, FY15 has been a productive year at Herman Miller. I'm encouraged by the sum total of what we've accomplished strategically, and what we have delivered financially.

Net sales for the full year exceeded $2.1 billion, representing an increase of 14%, despite currency pressures. This growth in the top line helped drive a 14% increase in adjusted EBITDA, as well.

We generated $168 million in cash flow from operations, and achieved a return on invested capital of 20% for the full year. We also made significant progress paying down debt we incurred to fund the Design Within Reach acquisition. Even after three years of significant investment and acquisition and new product development, our liquidity and cash flow profile remains healthy, and today, are well positioned to return more cash to shareholders.

Accordingly, we have announced an increase in our quarterly cash dividend, moving into just under $0.15 per share beginning in October of this year. This represents an increase of over 5% from the current level. In short, we enter FY16 with positive operational and financial momentum, a clear strategy in place to drive the business forward.

With that brief introduction, let me turn the call over to Jeff for more details on the quarter.

Thank you, Brian. Good morning, everyone. Consolidated sales in the fourth quarter of $551 million were 13% higher than the same quarter last year. Excluding the impact of DWR, dealer divestitures, and foreign currency translation, sales increased almost 4% from the prior-year. Sequentially, net sales in the fourth quarter increased 7% from the third-quarter level, while orders improved 11%.

Within our North American segment, sales were $310 million in the fourth quarter, representing a 1% increase from the same quarter last year. Adjusting for the impact of foreign currency translation and divestitures, segment sales were up nearly 3% on a year on year basis.

New orders in this segment totaled $322 million in the fourth quarter. This reflects an increase of almost 2% from last year on a GAAP basis, and an organic increase of nearly 4%, a marked improvement over the year on year order trend we reported to you last quarter.

It's also important to note that orders in the fourth quarter of last year reflected an incremental $10 million from one particularly large project in the energy sector. This project alone pressured our year-on-year growth comparison by a full 3 percentage points in the North American segment this quarter.

Our ELA segment reported sales of $103 million in the fourth quarter, reflecting a decrease of 6% compared to last year. New orders totaled $93 million representing a slight year-over-year decrease. Excluding the negative impact of currency translation, segment sales increased 3%, and orders were up over 8% relative to the fourth quarter of last year.

Sales in the fourth quarter within our specialty segment totaled $59 million, representing an increase of 12% over the same quarter last year. New orders in the period of $58 million increased 8% from a year ago. Importantly, sales and order growth that we reported in the quarter was broad-based across each of these three business units that comprised the segment.

Our consumer segment reported sales of $79 million in the quarter, an increase of $61 million from the same quarter last year. Now, of course, the addition of DWR drove the majority of this year-on-year sales growth. New orders in this segment totaled $84 million, an increase of $70 million over last year.

As Brian mentioned in his opening comments, we continue to experience headwinds from the strengthening of the US dollar. The translation impact from changes in currency exchange rates had an unfavorable impact on consolidated net sales of $13 million in the quarter.

Our consolidated gross margin in the fourth quarter was 38.1%, a 140 basis point improvement over last year's fourth-quarter gross margin of 36.7%. The addition of higher-margin DWR products, operational improvements within our specialty and ELA business segments, net price realization and favorable commodity trends all combined to more than offset the pressure from foreign exchange of approximately 45 basis points.

I'll now move on to operating expenses and earnings in the period. In total, operating expense in the fourth quarter of $162 million, compared to $132 million in the same quarter a year ago. This represents a year-over-year increase of $30 million, the majority of which relates to the acquisition of DWR.

On a GAAP basis, operating income this quarter was $37 million, or 6.7% of sales, compared to $26 million or 5.4% of sales in the prior-year period. Excluding the impact of impairment expenses discussed earlier, adjusted operating income was $48 million or 8.7% of net sales. By comparison, we reported adjusted operating income of $45 million or 9.2% of sales in the fourth quarter of FY14.

Also, as Brian mentioned at the start of the call, during the quarter, Herman Miller implemented a new holding company structure for certain non-US subsidiaries. This structure facilitates more efficient utilization of cash held outside the US, providing a platform to fund foreign investments, such as our new Melksham manufacturing facility in the UK. In connection with establishing this new structure, we recognized a $3.9 million income tax benefit in the fourth quarter, the cash benefit of which will be realized over the next few quarters.

Inclusive of this benefit, our GAAP basis effective tax rate in the fourth quarter was 29.5%. Excluding this one-time tax benefit, and the impact of asset impairment expenses, the effective tax rate was 35% in the fourth quarter, and 33.9% on the full fiscal year. Finally, net earnings in the fourth quarter totaled $23.4 million, or $0.39 per share on a diluted basis.

Adjusted diluted earnings per share in the quarter, excluding the one-time tax benefit and impairment expenses were $0.47. This compares to adjusted earnings of $0.50 per share in the fourth quarter of last year. I would also note that the translation impact from changes in currency exchange rate had an unfavorable impact on EPS of approximately $0.05 in the quarter relative to the FY14 comparison.

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

Thank you, Jeff. We ended the quarter with total cash and cash equivalents of almost $64 million, an increase of $2 million from where we ended last quarter. Cash flows from operations in the period were $58 million, which reflects an increase of $19 million over the same quarter of last year.

Changes in working capital resulted in a net cash inflow of $12 million in the quarter, with the largest contributor being higher accounts payable levels. For the full fiscal year, cash flows from operations were $168 million.

Capital expenditures in the quarter were $20 million, bringing the year-to-date total to $64 million. We also made meaningful progress paying down the debt incurred in the July acquisition of Design Within Reach, with repayment of $87 million in borrowings during the fiscal year.

Cash dividends paid in the period and full-year were $8 million and $33 million respectively. The dividend increase we announced yesterday increases our expected annual dividend payout level to approximately $35 million.

We remain in compliance with all debt covenants, and as of quarter end, our gross debt to EBITDA ratio was approximately 1.3 to 1. The available capacity on our bank credit facility stands at $152 million. Given our current cash balance, ongoing cash flows from operations, and our total borrowing capacity, we are confident we can meet the financing needs of the business moving forward.

With that, I will now turn the call back over to Jeff to cover our sales and earnings guidance for the first quarter of FY16.

Thank you, Kevin. We anticipate sales in the first quarter to range between $545 million and $565 million. This implies revenue growth of between 7% and 11% over Q1 of last year.

We estimate the year on year impact of foreign exchange on sales for the quarter to be approximately $12 million, so on an organic basis, adjusted for both DWR and foreign exchange translation, this forecast implies revenue growth of approximately 4% at the midpoint of the range. The consolidated gross margin in Q1 is expected to be relatively consistent with the fourth-quarter level, ranging between 37.5% and 38.5%.

Operating expenses in the quarter are expected to range between $163 million and $167 million, and we anticipate earnings-per-share to range between $0.44 and $0.48 in the period. This also assumes an effective tax rate of between 32% and 34%.

Before we open the call for your questions, I do want to take a moment to update you on some factors that we are considering in our outlook for the business beyond the first quarter of FY16. First, as we have described, foreign exchange translation improved to be a significant headwind to our growth this past year. This was particularly true during the back half of the fiscal year, as the US dollar strengthening accelerated, relative to the functional currencies of our international subsidiaries.

Considering current exchange rate forecasts, we expect these year-on-year headwinds to continue, with the most significant impact expected in the first half of the fiscal year, and extending into the early part of Q3. We estimate the full-year impact on sales will range between $25 million and $30 million, with a corresponding impact on EPS of between $0.10 and $0.12 per share, relative to the FY15 comparison.

Second, our sales growth this past year benefited from a number of large project wins. Many of you are aware of one notable project in the energy sector, which is now mostly complete.

The absence of this project in our sales run rate will make our growth comparisons this next year particularly challenging. The net year-over-year comparison impact from this single product is expected to be approximately $35 million, and will be most significant in the second half of the fiscal year.

The third factor to consider relates to the timing of the DWR acquisition, which was completed in July 2014. Accordingly, Q1 of this fiscal year will reflect a full quarter of activity, whereas the comparable period last year included only five weeks of DWR revenue.

This is expected to contribute approximately $40 million of non-organic sales growth in the upcoming quarter. We expect the operating contribution margin on these additional sales to be around 5%.

We also plan to invest in a number of areas this year in support of our strategy, and these investments will drive incremental expenses. Given the success of the large format studios for DWR, we will pursue an aggressive conversion schedule in FY16, with plans to open six new studios, three more than we completed this past year. The opening of these stores will require incremental conversion costs, as well as increased spend on marketing and promotional support.

We're also continuing to invest in our showrooms and are commencing plans to open a new Herman Miller contract and retail flagship showroom in New York City. This new space will enable the consolidation of our existing New York contract showrooms and design offices and will serve as a product showcase for both the contract and consumer side of the business.

Additionally, achieving our operating plans for the upcoming fiscal year will drive incremental incentive-based compensation expenses over last year's level. On a collective basis, these factors are expected to add incremental operating expenses of between $14 million and $16 million in the year.

Ultimately, we are making these investments to drive further growth in areas where we see the opportunity for significant long-term value creation. At the same time, we do remain focused on maintaining an efficient cost structure, and will continue to seek opportunities to realize cost savings across the business.

Finally, while our gross margins over the past several quarters reflect a generally stable discounting environment, we continue to see aggressive competitive pricing within key markets and certain product categories and project sizes. While pricing is only one aspect of our overall value proposition, this is an area we're watching closely as we move forward.

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

(Operator Instructions)

Our first question comes from the line of Josh Borstein with Longbow Research.

Congrats on a nice quarter. A few questions for you. Back in the third quarter, you plugged the staffing gaps, and you said at the time that it would take a little bit of time to go from wins to orders to revenue. Just curious where you are on that spectrum now.

This is Brian. I would tell you that as we said, I don't think we saw much impact from the things we did in terms of showrooms and products and those kinds of things. There is a little bit, we saw some on Canvas stock as an example in the quarter, from an orders perspective. But I would say we hear from dealers and from our sales folks, and we are seeing on the win side, but most of that stuff, I would say, we'll start to see it impact order entry, I would think late part of the first quarter and into second quarter before we will really know how much traction we've got.

Great. Another piece of the puzzle here, getting back to the more normalized levels was greater focus on small to medium sized projects. Could you discuss your efforts there, also, if you're just seeing more of those types of jobs on the market, relative to large projects?

Certainly that continues to be, in our view, a trend at least from what we've seen from order entry standpoint, on the small to mid-sized projects. It is part and parcel of the whole thing -- the sales deployment model, you have to make sure you have enough folks to cover those rather than fewer large things, you just need more folks to get around to cover all those.

That also means deployment with the dealers becomes more important, because often, they're the ones on the front lines of that. So we've spent, as an executive team, a tremendous amount of time out in the field with dealers over the last 90 to 120 days, to make sure that not only do we know what their needs are, but to make sure we're tuning our offer and all aspects of the company from products to the way that we approach those opportunities from a contract and pricing standpoint, to the way that our options or custom business is lined up to make sure where we need to tweak product or a solution, we can do it most effectively. So it's really on all of those fronts.

So, we're feeling good that we're in better shape. I'd also say, by the way, there is a good number of -- not a super large, but large opportunities out there across the marketplace, that also are encouraging, as we get into next year. Now, whether most of those will impact next year is a real question mark, because again on those larger ones, they take a little longer to work through the system as you guys saw with the big energy one we did a couple of years ago, but there are some good-sized opportunities out there, with a number of companies looking to reset their corporate headquarters or expand.

Okay. Great. Just last from me -- Restoration Hardware is introducing a new home furnishings collection centered on the modern aesthetic, which seemingly would represent a direct competitor to DWR. One, do you think that's the case? And two, do you have any plans on addressing that at all? Thanks.

First, we think it's, probably if nothing else, it's a validation of our strategy and the belief that modern as a category within residential is growing. And at one level, we'd say more folks validating that in fact, and talking more about modernism and the attraction to it, we think does nothing but actually probably expand the consumer's knowledge of that segment. And as they expand their knowledge, we believe we're the world's leader in authentic modern, we believe that move simply helps us -- they'll help us seed a market that we believe we're the leader in.

So, we don't believe we have any need to do any direct response to them, other than the things that we already had planned for Design Within Reach, in terms of expanding our offer, expanding the number of studios that we have, implementing the large studio model, which enables people to envision better their places. Those things that we have planned will continue to be on our agenda, regardless of what Restoration Hardware or anyone else does.

And the plan for this year is six net new stores, is that right?

It's not six net new, because it is six total stores that will be converted or new. I think it is four of those are conversions and two are new. So when we say six, in some cases, take Scottsdale, Arizona just as an example of one of the six, it's a new location.

It's not as if we have a quote-unquote additional store, but we'll have a new location that will be significantly larger. I think in the case of Palo Alto, it's actually an expansion in the current space, or a space nearby. So, some of them are conversions where we're moving to a new location within the same geography, we have a couple that will be new geographies, or additions to a market we're already in.

And the two new locations that you're talking about, where are those locations going to be?

I don't think we've gone public with those. We've got several different locations we're looking at, but that is probably competitive information we wouldn't want to give out in public. I would say we have a number of areas the team is looking at, and we think we've got some great opportunities there.

Got it. Great. Thank you very much.

Our next question comes from the line of Matt McCall with BB&T.

Good morning, everybody. Jeff, you mentioned in your outlook for 2016 you talk about discounting pressures. I think you said categories, product types, project sizes -- I think I wrote that down right. Can you talk about more specifically where you're seeing that discounting pressure increase?

This probably won't be a surprise to you, but the greatest pressure in those areas of the business where we have talked before, where it's getting increasingly difficult to differentiate, so you've got ongoing pressure around some of the benching-type applications. Case goods remains an area where it's highly competitive. And other areas, like even just simple product categories like tables. Those would be the ones I would point to. Brian, I don't know if you would add anything to that?

Yes, I don't think it's -- it's not necessarily -- I wouldn't necessarily describe it by category. I would say it is increased pressure. I think that, partly as we talked in the third quarter, we believe the industry has already become a little bit more aggressive, and we were a little late responding to that. So I think in some ways, that is what we outlined in the third quarter, is we recognized that we needed to get a little bit more aggressive, especially in that mid to small size project.

So I would describe it more from that end than I would necessarily a product line perspective. And certainly ground zero for competition in the industry tends to be really heavily into the systems world, where folks are trying to get the anchor at the center of the offer. And that's not new news, but certainly as we look at -- as we came through the second quarter and into the third, we recognized people were a little bit more aggressive in that zone than we had been, and we've been tuning our offer to make sure we can respond.

So, you mentioned the mid-and small sized project. As you look at the industry data, it looks like some of the smaller competitors may be performing a little bit better, and I'm assuming they operate with smaller customers, and maybe smaller and mid-sized projects. As that volume continues to improve, do you anticipate this discounting pressure to dissipate? I recall that's historically how it's worked, but is there something that's different this time from a product perspective, or competitive, or foreign exchange? Anything like that, that's changed that dynamic?

First, Matt, I'd say, I think we can see the growth in the smaller competitors. I don't think that's all just related to project size. I think what you're seeing is -- and this directly relates to some of the things we've done, is many of the smaller competitors didn't play as heavily in things like the systems world that played in the other areas around systems, and certainly some of the other categories have been growing faster.

Hence the move we've seen with Geiger and with the Collection, where I'd say our growth rates are probably in the same kind of neighborhoods when you look at them. So I think it's more a rotation toward what are the areas of solutions that are growing faster, more than I think that the growth rate tied to the size of the customer necessarily, would be my guess. Now there may be some of that related to the smaller companies growing faster than large companies or projects, but I think it's probably more a category issue, and the changing dynamic of what's on the floor play.

And Matt, Jeff. I might just tag on -- you asked about exchange. Without a doubt, with the crazy movements we've seen those last year on the exchange front, that does create some advantages and disadvantages, depending on where you source, and where you manufacture, so that is a factor. And if you happen to be in an area where, let's take Canada as an example, where you get a built-in advantage from a cost standpoint, that works in your favor. Now, as we all know, that moves around and none of that is necessarily permanent, but it has certainly been the trend of late.

Matt, I guess the end of your question was -- do you think the current trend towards more aggressive pricing is going to dissipate over time?

Correct.

To be frank, that's not our planning assumption. Our assumption is that, that is the way that competitors are choosing to compete, and I guess our service stance is, we're not going to let anybody beat us simply by trying to play a price card. We think we're as efficient operators as anybody, and if that's the way the industry's going to compete, then we'll compete.

Okay. Got it. Brian, you mentioned something about facilities, efficiency efforts. I think this is in ELA. Have you talked about projected savings from what you are doing over there, or is that the way to think about it?

Yet, I wouldn't say it's as much of savings issue, Matt, as much at is was making sure that we have the capabilities and market the service people on a local basis. Take India as an example. We've largely imported into that market in the past, pretty much 100% of the offer. We'll get closer to the customer as we built a nice distribution channel across most of India. It will just give us a better ability to service that marketplace as it grows.

The UK, we will see some efficiencies. It's not super significant, but essentially, we're going in the UK from two facilities to one on the operational side. There will be efficiencies that come from that.

Of course, that will be offset from some higher depreciation rates, because we're going to own the building. And you're going to have brand-new equipment, so from an EBITDA cash flow basis, we'll feel it. You may not see it at an EPS level as much as we'll see on the cash flow basis, and as we get a few years under our belt, that will start to really pay some dividends, we think. And that facility, I think, as you know, we use our bases in the UK to really service all of Europe and a good chunk of the Middle East and Africa as well.

Then, the last one -- since you brought up the full-year 2016, I'll ask more about the full-year 2016. Can you talk about, maybe the first one for you, Brian, the baseline assumption that you're using for the industry this year? And then in your planning, and Jeff, maybe from an incremental margin perspective after a year of sub-10%, I understand some of the pressures you talked about, but does that create an opportunity for a bit of a rebound on the incremental margin, net of all these pressures in 2016? Thank you.

Well, Matt, first of all I think we're not wildly different than what we said for the forecast this year. We probably used the 4% 5% number, is what we think is out there for our fiscal year. All that, of course, depends on what happens with the economy overall, but I think that's a reasonable spot to start with.

Of course, for us, the two things you're going to have to factor into that, is part of that US number for us, as a North American number, does include Canada, which we have a little bit of currency headwind inside of that number, which Jeff mentioned. A lot of the currency hits are non -- are ELA segment, but a bit of it does hit North America.

The other thing -- we do have some hurdles to get over in terms of business that we did this year, that won't necessarily repeat to that kind of scale. That doesn't mean we have said we won't, but that's the challenge in front of us, and have to get after, especially as we get outside of the first quarter, we've got some business to go make up.

Matt, this is Jeff. To your second question, I understand the order of your question makes sense, because we're not giving a full-year revenue guide, you'll have to decide what you want to model to. But I get that once you have that assumption, the question is, operating leverage.

As you know, historically, we've talked about this business, and I'm particularly talking about the core business here. We been able to structurally between that 20% to 25% level at the operating income line. Those factors that I listed for you today were very intentionally meant to point out that those would be some incremental spend that would go against that typical leverage factor.

So you'll have to pick your revenue number to get you there, but we felt it was important to point out things like, if you hadn't already done so, DWR impact, right? Which is non organic growth in the quarter. The currency pressures, which we don't have perfect visibility, but certainly what we have in terms of the line of sight right now, says we expect some pretty significant currency pressure, both in the top line, and as we reported here, and as we talk about in the outlook, we expect we'll have a bottom-line impact.

Then the incremental spend on the OpEx side, do keep in mind that in the short run, we do have variable costs in our structure, up to and including incentive bonuses, right? That if you don't pay a full target in one year, and if we deliver on our plans in the next year, you are going to see some incremental spend. So all of those factors will be incremental levels of spend against that historical normal leverage. But we're not going to give you a full-year revenue guide, nor are we going to give you a full earnings guide at this point.

I think, Matt, what I would add to that is, we told you in the third quarter we had a bunch of actions we were going to take. Really, as I said in my opening comments, I'm really pleased with how the organizations responded. I'm encouraged by what I'm hearing from the dealers.

But because we're only 90 days into that, it's a little hard to predict yet exactly how that's going to play out for the year. So the year is a little bit harder to predict than I would say normally at this point. I think as we get into the first quarter, we're feeling pretty good about that first-quarter forecast, in terms of what we're seeing. If we continue to see the dynamics be good, we'll know a lot more coming out of that period about what the balance of the year's going to look like.

Okay. Thank you Brian and Jeff.

Our next question comes from the line of Budd Bugatch with Raymond James.

Thank you for taking my questions. I'm a bit confused on the guidance, at least for the guidance you've given, and I was hoping maybe we could get more clarity on the cost factors, too, but let's just go to the first quarter. I think you've given us a range of revenue and a range of EPS.

If I did the math at the midpoint, it says to me that the operating margin is down something over 100 basis points, or about 100 basis points year-over-year. Am I correct on that? Is that the way to do the math?

Budd, I guess I don't have the numbers in front of us.

I get to about an 8.4% operating margin, and last year's adjusted operating margin was 9.3%, if I remember right, if I have it right in my model. I guess that math is down about 90 basis points, or 100 basis points.

Certainly the midpoint of the guide for Q1, you are on for sure.

Okay. So, what is in there? You've given us a $12 million impact on foreign exchange, right? What are the other impacts -- what's the impact on earnings of foreign exchange?

We expect that to be on the order of about $0.05.

$0.05 in the quarter?

Yes. Budd, our guide for revenue pressure on currency is about the same. About the same as what we experienced in the fourth quarter.

I got that. In fact, it looks like you're using in about an $0.80 or an $0.81 Canadian dollar and $1.09 or so for a euro?

You've got it, Budd. This is Kevin. Both of those are what are in our model.

Okay.

Probably the biggest part of that delta is in the year-over-year budget in the operating income line.

Say that again?

That's going to be a big chunk of that delta that you are seeing year-over-year on the operating income line.

Are there other factors? Are there other factors in the earnings that we haven't yet -- that we can quantify for at least the first quarter? I know you don't want to give -- you've given some guidance beyond the first quarter, but we don't have it in a codified way.

Yet, Budd. The other thing I would point, out and I referenced this in my prepared remarks, but that's why we wanted to make sure that we were straight, on the DWR growth. We are going to pick up some incremental revenue with DWR, and we expect that to come in below the corporate average, right at the op margin level.

I get about $38.6 million incremental to get you to the midpoint to get you to the 4% at the midpoint. So, I think that's the way that math works, right?

Yes, you have got that. That's the other thing that I would point out, that would be a drag year on year, right?

Yes, I think I've got that. I understood that. That wasn't the issue.

I'm just trying to get to the EPS number because the revenue number doesn't let you get to the EPS number unless you've got some other factors in there that we can't see. You've been over some of them in a way that I'm not sure I got them all in my brain. I was hoping maybe to get that.

If there was anything else in the first quarter other than the FX that we need to consider? Those expenses, for example. Any additional operating expenses to open DWRs, or any of those affect the quarter?

Yes, sir, we have got some additional expenses on the OpEx size that are incremental year on year.

You have two factors -- you do have some DWR for stores. The other thing you have is you are doing some ramp up stuff for stores that opened the second quarter. The other thing you've got, Budd, is we are spending more than normal in the first quarter on some dealer training, and around products.

We're actually going to do a national dealer event in West Michigan, where we're bringing dealers in to see all of the new products in one place across the entire Company from Herman Miller to Design Within Reach to Geiger to Maharam, all in one location. We are going to be bringing dealers and their people and our sales people through, and we are going to spend a significantly more money than we normally spend in the first quarter on that kind of training and development, which really relates to the plan we rolled out in the third quarter.

Do we not, then, have significantly more -- can that be a number?

Well, Budd, it's incorporated -- if you look at the sequential move in OpEx in total from Q4 to Q1 -- these factors collectively make up the midpoint guide for the operating expenses. So, I don't think that's part of it.

Then it becomes, Jeff, a question of what's a one-timer and what's continuing so that we can get to either a contribution margin or some way to try to make -- what you told us we had to do is model for ourselves what the quarters two, three, and four look like, and the out years. So we've got to be able to figure out what's continuing, and what's not. Right? That's a rational way to go about it.

It's fair, Budd. Brian is right on, that we do have some we have abnormal -- significantly abnormal spend related to some of this dealer product roll-out. I would say that's sub $1 million, though, in terms of the one timer.

So, it's about $1 million. Okay, that's good. I can deal with that. Okay, thank you.

And I guess finally a couple of areas. Just comps for DWR, I know that it was not in the base last year, but John and John know what the comps are, and I'm sure you know, Brian, what the comps are. How do the DWR comps look, how they are factoring on a pro forma basis?

Budd, this is Jeff. Let me take this one. On a same studio basis in total, their stores, their revenue in the quarter was up 14%.

That's great.

On a large format basis, it's even better than that, which lends to our intent to ramp up, if you will, and be a bit more aggressive on the conversion plans for this next year because it's proven thus far to be working it's closer to 18% comp.

Budd, I want to make sure that we don't overstate. There was a bit of a non-comp move year-over-year within DWR and Herman Miller consumer that the Herman Miller sale this year was in May, or traditionally has been in June. So, we moved the outdoor sale to June, and moved to the Herman Miller sale to May. There's a little bit of a cross over there of those numbers, but overall, though, week-by-week numbers look pretty good, as Jeff said. But I would be careful to say there was a little bit of a movement there that will go the opposite direction next quarter, just so that when we get there, you're not surprised by that.

So, pinging inside of the consumer number, which was 38.6%, I think, in the first quarter of last year, would a number like $80 million be -- to get to the midpoint -- would that be where you were thinking it would be in the first quarter?

Yes, that might be a little over baked but you are not too far out of the ZIP Code by any stretch.

Okay. And one thing you haven't talked about is Maharam. That was what we bought a couple of years ago. How did that do in the quarter? What's the year-over-year look like in that?

Budd, in the case of a Maharam I would say the profitability of Maharam has gotten significantly better throughout the year, and they started to pick up better growth rates in the second half of the year. We did some things on the product side there, the team did a great job of rebalancing some of their portfolio, and that made a difference. So we are really encouraged going into next year, as well as we have some product development in place to get them some new categories in the covering segment generally, that we think are going to be pretty interesting.

Most of that won't help us. We will get a little bit of it next year, and most of it will help the year after. But overall, Maharam is pretty close to where we thought they be. A little light on the top line, and now pretty much in line on the bottom line, as we got through the balance of the year.

Yes, Budd, one other bit of color. It started off lighter than we hoped in the terms of the overall top line momentum, but ended the year stronger, to Brian's point it was around that 6% level year on year for the quarter.

But the bottom line was almost baked in, because we've got the roll-off of some of the purchase amortization right now. So are you talking about operating margin, excluding the PA costs?

I would say both improved throughout the year, Budd. Some of that stuff rolled off, but I'd also say the team did a great job. Particularly, they got a little higher margin contribution, but the business -- that's why said it's pretty much in line with where we thought we would get to.

Lastly for me, Jeff, I would just encourage you, if you would, you give us a lot of factors after the talk about guidance and effect of Qs 2, 3, and 4, and the second half versus first half. I would encourage you to put something on the website that maybe gives us a break out -- a schedule of some of those expenses to the area that you are comfortable -- I think that disclosure would be helpful for people to understand what are the numbers and where they're going to vary this year, because it looks like you've got the moving parts that are very hard to bake in. At least for this old brain, anyway.

I hear you, Budd. That is a fair request. Understand, some of those factors are hard for us to peg in buckets by quarter. Say it's the outlook commentary around margins, right?

We are simply pointing out that's an area we're looking at closely. That's not something that we can quantify and break out by quarter, but certainly things like foreign exchange, I think we can take a stab at that. The DWR factor, and the large -- that particularly large project that we keep alluding to, we can certainly provide some detail there.

Well, I would just say for a venerable company like Herman Miller, which is such a great company, I know that you can give us some help on that. Thank you.

(Operator Instructions)

We have a question from the line of [Catherine Thomas] with Thomas Research.

Just going back to your initiatives that you outlined in the prior quarter, I wanted to go little bit more into the early indicators that these are, in fact, working. We assumed it would be an improvement in order rates on the quarter, which you saw in the quarter, but are there any other metrics we should pay attention to?

Catherine, this is Brian. The key place we were trying to move was the top line. We didn't do a lot of things on cost -- in fact if we did anything on cost, it as probably going the other direction. So, the majority of this was all tuned around what could we do to get order rates moving, versus what we saw happening in the industry overall.

So, we're primarily talking about the North American contract business. So, that's the metric to watch, of course, on our end, we're trying to watch win rates prior to things turning into orders, and that's why typically, you're going to see a six-month to nine-month lag between when you start to win projects and you actually see those things showing up in orders. So it will take a while to work its way through the system.

The improvement in order rates we saw in the current quarter doesn't really reflect these initiatives?

I'd like to believe that certainly it has some impact, but you're just trying to be realistic with yourself about whether that's really there yet, or not. My gut is we probably -- if the showrooms are better and people are there, it certainly helps, but I don't think we've seen a significant amount yet in the quarter. I think it will start in the first quarter, and then we'll probably see it as we get into the second quarter, more pronounced.

Tagging along with that, how much did higher promotional activity in Q4 drive improvements in orders? Or not?

You're talking about as it relates to Design Within Reach, and the consumer business in particular?

Yes.

Probably not a lot from Q3 to Q4. A little bit, like I said, because of putting the Herman Miller sale in Q4 versus Q1. If I was going to peg it, we are probably talking $3 million to $5 million, in that range.

Okay. Perfect. Then, for us to think about with DWR dynamic, higher gross margins, but also higher SG&A, as you think about the detail that you gave in the prepared comments for that operating expense, and also the gross margin, are you able to parse out how much of the higher gross margin and higher SG&A are from DWR? And it will also help us just put into perspective some color, as we think about the full year.

First, I think that overall, certainly, a movement in our margin -- first of all, you have to be careful, people refer to it as DWR, you got to think about the consumer business in total.

Yes.

Just to be careful -- it's not just DWR, it's the whole sales side that we do from Herman Miller, as well as the web business. So both of them drive the higher gross margin side, as well as higher operating expenses. So you've got to think about it in total, not separate.

There's no doubt that a good chunk of our margin movement over the last couple of years has been driven by higher margin segments, not just the consumer business. That's also true of Maharam, which has much higher margins than the average. It's also true of places where we've invested, like the Collection and that starts to drive higher margins. So if you start to pick it out by piece, I'd say the best place to look at that is to look at the segment reporting, which actually describes that stuff in detail, what the margins are by segment, including operating margins.

Now, to me, the good news is, if you want to step back, this past quarter if you look at EBITDA margin as a percentage of sales, we got to the point that all of the segments were running above that 10% level. That won't necessarily be the case every single quarter, I think the one that was not above 10% was actually the ELA segment.

But we're starting to see that the traction we have in the specialty business is starting to pay dividends on an operating income line. That's important. And that's been after a couple of years of fairly significant investment in both products, channel, channel in this case in terms of sales people.

The consumer side last year, if you look year-over-year, dropped a bit, Catherine. A lot of that is we knew that DWR was at the point where they were at the early stage of their growth. It was going to start to turn margins -- operating margins around.

We certainly saw that as we got into the balance of the year, and remember, the first part of last year, after the acquisition, particularly the month we had them in the first quarter and the second quarter, included some one-time acquisition-related charges, where we had to write up inventory and write it down. So, I think if you look past them, if you look at that segment reporting, which I think was in the prepackaged, you can actually see those margins by segment there.

Great. Thanks for taking my questions today.

I'm showing no further questions. I would like to turn the call back over to Mr. Walker for any further remarks.

Thanks again for joining us for the call. I hope this discussion gives you a deeper understanding of our recent performance, as well as our commitment to positioning the Company for long-term growth and performance. We look forward to updating you again next quarter, and hope you have a great day.

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