MillerKnoll Inc (MLKN) 2016 Q4 法說會逐字稿

Good morning, everyone, and welcome to the Herman Miller, Inc. fourth-quarter FY16 earnings results conference call. This call is being recorded.

The presentation will include forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. These risks and uncertainties include those risk factors discussed in the Company's report form on 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 CEO; Mr. Greg Bylsma, Executive Vice President and Chief Operating Officer; Mr. Jeff Stutz, Executive Vice President and CFO; and Mr. Kevin Veltman Vice President, 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 participants.

At this time I would like to turn the presentation over to Mr. Walker. Please go ahead.

Good morning, everyone. Thank you for joining us. I will begin the call today by sharing my thoughts on our performance, highlight areas of accomplishment, and summarize some of the areas where we still have work to do. Last, I will provide some color on industry dynamics as we enter FY17. Then I will turn it over to Jeff and Kevin to cover fourth-quarter financials in more detail. As the operator noted, we also have Greg Bylsma, our Chief Operating Officer of our North American contract business joining us for the Q&A portion of the call to offer his perspective on current conditions and opportunities we see for further growth in that segment.

As we announced yesterday our results this quarter cap a fiscal year in which we delivered all-time record net sales of $2.260 billion, representing an increase of approximately 6%. This is despite currency pressures along with a 19% full-year increase in adjusted earnings per share. We had a high quality of earnings and generated very strong operating cash flow.

We finished the year on a strong note with revenue this quarter of $583 million, coming in above the high end of our expectations for the quarter. Adjusted earnings of $0.56 per share also exceeded our guidance and reflected a 19% improvement over the same quarter of last year.

In all, we achieved a return on invested capital of 22% on the full year, and generated more than $210 million in cash flow from operations, allowing us to fund strategic investments and reduce outstanding debt levels. Yesterday we announced a 15% increase in our quarterly dividend payout, a decision that reflects the confidence of our Board and management team and the power of our strategy and the strength of our financial position. Importantly, it reflects confidence in our ability to reach even higher greater heights in the year ahead.

Our performance this year was led by a significant turnaround in our North American segment. Growth in the segment was broad-based with notable strength in commercial offices and healthcare. In particular, we had one of our best years in healthcare in recent memory.

Our specialty businesses, Geiger, Herman Miller Collection, and Maharam, continued to grow nicely and posted improved profitability. In total, our North American commercial interiors business has outpaced the overall industry.

Our Europe, Latin American and Asia team did a great job of overcoming significant economic and currency headwinds to post increased profitability. The relative strength of this business was in Asia where our POSH acquisition has rebounded to be a solid contributor.

Our consumer segment fell short of our goals for the year in terms of both sales and profitability. To be frank, we took a number of actions that we believe are critical to our long-term health in this segment that did not play out as expected in the short run. And we are behind in our conversion to the new studio model. We finished the year with fewer studios and about the same amount of square footage compared to where we were this time last year. The team has worked very hard to get these issues back on track, and we expect improved performance in this segment in 2017.

We believe Herman Miller has a strong foundation to create shareholder value that is built on our high ambition culture, our ecosystem of leading brands, our capacity for innovation, a growth strategy that is catalyzed by an industry-leading multichannel distribution system, and a proven track record of operational excellence and financial management and stewardship. For the past five years we've consistently and diligently pursued a strategy to increase the size of our addressable market and position us for faster growth and higher margins. To achieve these objectives we've used a combination of internal development and targeted acquisitions.

This past year we had a number of accomplishments that furthered implementation of our long-term strategy, solidified our foundation for growth, and improved our operating results. Those accomplishments including, we created and delivered a series of boot camps designed to equip our dealers and our field sales folks with the product knowledge and tools they need to best position our products to win. While we had a number of boot camp events this past year, this is a long-term capability that is needed to keep our teams up to speed with our fast evolving offer and the knowledge we are creating through research.

We refined our sales deployment model to ensure we're best aligned to serve dealers and increase our share of their business and increase our share of the government, healthcare, education, customer spend on furnishings. In response, we developed and launched the new channel sales manager role and team. These folks have the responsibility of representing all of our brands to the dealers. We are pleased by the early progress of this team and think it holds great promise.

We also reorganized our sales efforts around healthcare, government and education. These changes led to better coverage of opportunities and better alignment of skill sets. This enabled us to put additional resources on the largest healthcare and government organizations. This has and will pay great dividends as we offer all of Herman Miller's expanded capabilities to these large and complex organizations.

We implemented a new product commercialization process and structure to ensure we will continue to be the innovation leader in our space. While we still have much work to do, we have clear signs that these changes are making a difference.

This year at NeoCon we launched in excess of 20 new products. This included new products from our R&D studios at Herman Miller, Geiger, Herman Miller Collection, Nemschoff, Herman Miller UK, and Maharam.

The focus of our work over the past year has been to expand the breadth of our offering into new categories where we're currently underpenetrated. The breadth and quality of the work was impressive, and we were recognized with a number of awards. And we have a very robust pipeline of new ideas that will continue to propel us forward over the next fiscal year and for years to come.

In addition to internal developments, we recently announced a strategic partnership with United Kingdom-based naughtone. This partnership will augment our internal development of furnishings for those work points on the floor plate that are beyond our historical focus on individual workstations. And naughtone will add to our operational capabilities needed to serve the EMEA region.

We made a number of steps which will enhance our ability for us to deliver on the promise of the Living Office. At NeoCon we began to roll out a number of case studies which provide evidence of how the application of the Living Office can improve our customers' businesses and the lives of their people.

We also began the introduction of a number of new products and partnerships that will enable us to deliver our three-part strategy for the connected and quantified office -- smart furnishings, smart settings and smart places. These capabilities, combined with our growing breadth of solutions beyond the workstation, significantly enhance our ability to deliver on the promise of the Living Officer introduced four years ago.

Enriching the way customers experience Herman Miller and our ecosystems of the brands is a long-term objective. Starting in the fourth quarter of last year we reset all of our global showrooms to better serve our customers and dealers. This past year we opened new showrooms in Washington DC and New York. The New York showroom is our first flagship location that unites our Herman Miller, Geiger, Collection and Maharam brands. This location will serve as the home for our talented folks in this region and create a unique experience for both our contract and consumer customers.

We fell short of our goal this year of opening six new DWR Studios. However, we did open or expand DWR Studios in Arizona and California. And we enter 2017 with a strong pipeline of nine new studios that are under contract and in our plans.

Last, we invested in new capabilities to enhance our ability to serve our dealers, corporate customers and consumers. Our made-to-measure program significantly improved our ability to respond to our customers' needs for customized solutions. We implemented new information technology systems at Design Within Reach, Nemschoff and a number of international locations. These systems will enhance the operation of the business to make us easier to do business with.

At the close of the fourth quarter we launched a new and improved e-commerce store for Design Within Reach. In this coming year we will upgrade the Herman Miller e-commerce store with the same technology.

This year we also completed the opening of our new manufacturing and logistics facilities in the United Kingdom and India. In North America we invested in new manufacturing process equipment that improves our quality and cost.

To be frank, we experienced some growing pains in our consumer segment this year and there is more work to do. That said, we continue to believe the strategic drivers that led us to invest in the segment are intact. As a reminder, those remain the convergence of work and home environments, the power of having a multichannel capability for increasing the size of our addressable market, and last, the permission the Herman Miller brand has to play in this segment of the furnishing space.

The recent NeoCon event further confirm the convergence we predicted with the launch of the Living Office is happening. More specifically, we remain confident that Design Within Reach was a great fit with Herman Miller as it contained the capabilities needed for us to make the strategic move, the brand was congruent with Herman Miller, and they have a talented leadership team.

While we are disappointed with the results of the quarter and year, I am pleased to report that we made significant progress on a number of fronts this year, and we're well positioned for future growth and improved profitability. As a part of our real estate transformation we closed a number of smaller legacy retail studios during the year and developed an exciting pipeline of new and expanded studios for the next year.

We're beginning to see the impact of our investments in brand awareness and channel initiatives, and we expect to realize further benefits over the next couple of quarters. These efforts included a mobile optimized web platform rolling out a new sourcebook to highlight the breadth of our offer for our trade partners. We also implemented a new ERP system during the second quarter of the year to bring significantly improved capabilities. In the fourth quarter we reached an agreement with Amazon.com that expands our wholesale market coverage.

Finally, our growing contract business continues to be a bright spot as we expand volumes to the Herman Miller dealer network, a great example of the potential that exists with our multichannel strategy. The negative operating results of this quarter in the segment were driven by increased investments in marketing, an unfavorable mix of trade and contract business, and year-end accounting adjustments and pre-opening studio costs.

Looking to next year, we're confident we have the right foundation in place for executing on our consumer growth strategy. Our plans for FY17 include ramping up our DWR studio footprint by approximately 100,000 square feet by the end of next year, and launching several exclusive product designs.

We recently implemented changes to our catalog program which we believe will significantly improve the efficiency of new customer prospecting. And later this fall we have exciting plans for the launch of a new retail store to anchor our New York flagship showroom, the first Herman Miller branded retail store in North America.

Let me close with a few comments about the macro environment. While pressure in the energy sector and political uncertainty persist as headwinds, the core industry metrics for the North American contract business remain generally supportive. In particular, service sector employment, nonresidential construction activity, and the Architecture Billings Index have all been positive and form a BIFMA forecast for low to mid single-digit annual growth through 2017. There is a good deal of construction activity in the healthcare space which augurs well for this sector.

On the consumer front in North America, recent BIF and consumer confidence has been offset by strong housing activity, low interest rates and rising household incomes. As you might expect, regions impacted by the energy sector have been challenging.

Outside of North America, the economic picture remains mixed. While the impact of strong dollar headwinds has lessened, uncertainty in Europe and various oil producing regions persists. That said, our confidence in the long-term growth potential of our business in key global regions has not wavered.

On the commodity front, we're starting to see some increase in input costs, such as steel, so in addition to our ongoing lean manufacturing emphasis on identifying operational improvements we're moving ahead with plans for a price increase later in FY17.

On balance, while there are challenges in the rest of the global economy, we believe the current cycle of growth should continue through FY17. And we believe the accomplishments from 2016 and the plans we have for 2017 should enable us to stay on pace with our long-term objectives.

With that I'll turn the call over to Jeff who will provide more detail on the financials.

Thank you, Brian. Good morning, everyone. Consolidated net sales in the fourth quarter of $583 million were 6% higher than the same quarter last year. Orders in the period of $606 million were 9% above the prior-year level. These amounts reflect a strong finish to the year as they represent our highest quarterly sales and order levels in the past 15 years.

As I mentioned last quarter, as well, with respect to our year-over-year order comparisons, one important point to consider is the relative impact of general price increases that went into effect during the third quarter of last fiscal year. Our best estimate is that this had the effect of shifting upwards to [$20 million] of orders into the third quarter that would have otherwise been entered in the fourth quarter of last year. By contrast, we made no significant price changes in the third quarter this year and, accordingly, no comparable shift in the timing of order entry.

Net, this had the impact of limiting our reported order levels in the fourth quarter of last year. To be clear, given the level of estimation required to quantify this, we have not adjusted for it in our calculation of organic order growth for the period. Still, we do believe it is a factor worth considering as you evaluate our numbers.

Sequentially net sales in the fourth quarter increased approximately 9% from the third quarter level, while orders increased 19%. These sequential improvement are slightly above the average seasonal trends we've seen in the business over the past five fiscal years.

Within our North America segment, sales were $333 million in the fourth quarter, representing an increase of 8% from the same quarter last year. New orders in the segment totaled $359 million in the fourth quarter, reflecting an increase of nearly 12% from last year.

Project sizes above $1 million were particularly robust during the quarter. And order growth by industry sector was fairly broad based, led by healthcare, business services and state and local government. The energy sector continues to be a notable exception as that industry grapples with a difficult economic climate.

Our ELA segment reported sales of $111 million in the fourth quarter, reflecting an increase of 7% compared to last year. New orders totaled $102 million, an amount 9% higher than the same quarter a year ago. This year-over-year order growth was led by strong demand in Continental Europe, South Africa and China. These areas of relative strength were partially offset by softer demand in the UK and in Latin America, both of which are regions facing acute political and economic uncertainty.

Sales in the fourth quarter within our specialty segment were $62 million, an increase of almost 4% from the same quarter last year. New orders in the quarter of $62 million were 7% higher than the year-ago period. Consistent with what we have seen throughout the fiscal year, our growth within this segment was led by strong momentum at both Geiger and the Herman Miller Collection.

The consumer business reported sales in the quarter of $78 million, a decrease of 2% compared to a year ago. On a comparable brand basis, revenues for the quarter were up approximately 1%. I would note that we have revised the comparable sales measure that is provided in our supplemental materials this quarter, moving from a comparable studio measure to a comparable brand sales metric. We believe this better reflects sales results across the multiple channels that DWR serves.

New orders for the consumer segment in the quarter were $84 million, slightly ahead of the same quarter last year. Relative to the fourth quarter, operating results were unfavorably impacted by a number of year-end closing adjustments, primarily around inventory and accounts receivable. In addition, we ramped up our marketing spend in the quarter in the areas of catalog and digital. And we were encouraged to see order demand accelerate in the consumer segment in the month of May.

Our consolidated gross margin in the fourth quarter was 38.7%, a 60 basis point improvement over gross margin of 38.1% in the fourth quarter last year. The year-over-year improvement was fueled by favorable commodity costs, production leverage and ongoing operational improvements.

We had a relatively high mix of large projects this quarter, both in the US and abroad, and consequently our gross margins reflected the impact of deeper average discounting versus where we ran last quarter. Additionally, with the recent uptick in steel and oil prices, we began to feel moderation in the comparative year-on-year favorability in commodity costs. These factors aside, the relative strength of our gross margin performance remained a highlight in our consolidated results for the quarter and for the full fiscal year.

I will now cover operating expenses and earnings for the period. In total, operating expenses in the fourth quarter were $169 million compared to $162 million in the same quarter a year ago. Our current quarter expenses reflect the impact of pretax gains totaling approximately $6 million associated with the sale of a former manufacturing facility in the UK, as well as the divestiture of Living Edge Furniture, our dealership in Australia.

Excluding these gains, operating expenses in the fourth quarter were approximately $13 million higher than the same quarter last fiscal year. The majority of this increase relates to spending on new product launch and marketing initiatives, higher incentive accruals, product warranty expenses, and general variability on higher revenue.

Operating income in the quarter was $57 million or 9.7% of sales, compared to $37 million or 6.7% of sales in the prior-year period. Excluding the impact of the gains that I just described, adjusted operating income was $51 million or 8.7% of sales. And by comparison we reported adjusted operating income of $48 million or 8.7% of sales in the fourth quarter last year.

The GAAP basis effective tax rate for the fourth quarter was 24.9%. The rate for the quarter was lower than previously forecast due principally to the impact of a favorable transfer pricing adjustment totaling $2 million recorded in the quarter.

As this transfer pricing benefit reflected the full-year benefit for FY16, approximately $1.5 million or $0.02 per share of the benefit was not attributable to the fourth quarter. This compares to an effective tax rate of 29.5% reported in the same quarter last year. Excluding the impact of the transfer pricing adjustment, the effective tax rate in the fourth quarter was within the range we provided at the beginning of the quarter.

And, finally, net earnings in the fourth quarter totaled $41 million or $0.67 per share on a diluted basis. Excluding the partial year of tax transfer pricing benefit and gains associated with the dealership and UK property sales, adjusted diluted earnings per share in the quarter totaled $0.56. This compares to adjusted earnings of $0.47 per share in the fourth quarter of last year and reflects a 19% year-over-year increase in earnings per share.

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

Thanks, Jeff. We ended the quarter with total cash and cash equivalents of $85 million, which reflected an increase of $30 million from last quarter. Cash flows from operations in the period were $85 million, representing an increase of 46% from the fourth quarter of last year.

The primary contributors to the increase in operating cash flows for the quarter were higher net income, as well as working capital inflows from higher accounts payable and lower inventory levels, offset by higher accounts receivable. For the full fiscal year cash flows from operations were $210 million, reflecting an increase of 25% over the prior year.

Capital expenditures were $30 million in the quarter, bringing the year to date total to $85 million. Looking ahead to next fiscal year we anticipate capital expenditures of $80 million to $90 million for the full fiscal year.

Cash dividends paid in the quarter were $9 million and $35 million for the full year. The dividend increase we announced yesterday increases our expected annual payout level to approximately $41 million. The new quarterly payout level also brings the dividend in line with our yield target and is in keeping with our commitment to balance our capital structure priorities, including funding internal growth investments, reducing outstanding debt levels and enhancing cash returns to our shareholders.

We also continued the share repurchase program during the quarter at a level aimed at offsetting dilution from share-based compensation programs. In total, we made repurchases of $6 million during the quarter and $14 million for the full year.

We remain in compliance with all debt covenants, and as at quarter end our gross debt to EBITDA ratio was approximately 0.8 to 1. The available capacity in our bank credit facility stands at $219 million. Given our current cash balance, ongoing cash flows from operations and total borrowing capacity, we continue to be well positioned to meet the financing needs of the business moving forward.

With that I'll turn the call back over to Jeff to cover our sales and earnings guidance for the first quarter of FY17.

Let me begin with two important factors that you should consider in developing your models for our first quarter. First, you should bear in mind that our FY17 year will include 53 weeks of operations. The addition of this extra week is required approximately every five years to realign our fiscal periods with the calendar months. As a result, our first quarter will include 14 weeks of operations. So, the relative timing of scheduled summer holidays will reduce the impact of this extra week to four incremental shipping days relative to the first quarter of last year.

The second factor relates to the relative impact of the Australian dealership divestiture, which occurred at the end of the fourth quarter as the culmination of a long-term plan to transition ownership to the local management team. This will, of course, impact our year-over-year revenue and order comparisons in the first quarter. Net of inter-Company eliminations, that dealership contributed approximately $9 million of revenue in the first quarter of last fiscal year.

Considering these factors, we anticipate sales in the first quarter to range between $600 million and $620 million. On an organic basis, adjusted for the extra week and dealership divestiture, this forecast implies revenue growth of approximately 3% at the midpoint of the range.

Consolidated gross margin in the first quarter is expected to range between 38% and 39%. And this forecast incorporates the expected impact from a recent uptick in market prices for key commodity inputs. The extra week of operations in Q1 will add incremental expenses of $9 million to $10 million, partially offset by the elimination of operating expenses from the dealer sale.

In total, operating expenses in the first quarter are expected to range between $174 million and $177 million. We anticipate earnings per share to be between $0.60 and $0.64 in the period, and this assumes an effective tax rate of between 32% to 33%.

With that overview I'll the turn the call back over to the operator and we'll take your questions.

(Operator Instructions)

Matthew McCall, BB&T Capital.

Thank you. Good morning, everybody. Maybe, Brian, start with you. You gave some cyclical commentary. I wondered if you could give more detail. I think that, Jeff, you talked about project strength in Q4, but maybe, Brian, talk about your outlook, what kind of visibility you have, and what comfort you have with BIFMA. I know you referenced it but I just wanted to get more detail there.

Matt, overall, if you look at -- we almost have to take this by segment -- if you take the North American contract segment, activity levels were really good with customers in the fourth quarter. In fact, a good-sized increase over last year in terms of visits, not necessarily is a perfect correlation but I would say that gives you some indication of activity level.

Certainly NeoCon, I think you were there, NeoCon activity was pretty darn good. From what we can see in terms of project activity in the fourth quarter, large projects are a fairly good level of big project that we saw coming through in order entry in the fourth quarter.

So, from all I can see right now, activity levels look generally good. I would say healthcare continues to be very hot, at least compared to where it's been the last few years. It's not obviously gotten back to its peak, but that area in particular has been good.

Certainly in the North American contract market, there are some headwinds. I know some folks have talked about what's going on in areas that are petroleum-based. We certainly have seen that not only domestically but globally.

That part of the country, at least in our data, it's virtually almost gone away at one level, when you look at activity levels compared to where we were a year ago or two years ago. It's a pretty big drag on the overall numbers for us. And I'm sure it's a pretty good-sized drag on the overall industry, both in the US and in Canada, in fact.

If you shift gears internationally, Asia has been pretty darn strong for us overall, and I would say fairly broad-based, with the one exception really being Japan has not been that great. But that's not surprising given the longer-term economic malaise that they have been in.

It's not bad business for us, it just has not been a big grower; whereas, the remainder of Asia has actually been pretty good, including China despite all of the news around China. We've actually felt pretty good about China at least over the last year or so.

Europe, I would say, for us, we look at it by region. EMEA as a region for us has been pretty good, but I would say is moving all over the place. The UK is difficult, for sure. It seems like a lot of people have pulled back with some anticipation of what might happen with Brexit.

Middle East is, I would say, moderate. I think people are trying to read which way oil goes. I think as we see some continued improvement in oil that area should get better.

But we've been able to move around enough in that region to offset the negatives with some positives. I think the overall tone of EMEA, if you backed up and looked at it from 100,000 feet, Matt, I would say is flat to down, is the way I would describe it.

The most difficult region in the world for us has been Latin America, particularly everything in South America. Mexico has not been too bad. Activity level there is reasonable. But I think when you get down to places like Brazil and others, it's pretty darn quiet.

So, I think mixed packed, globally. US still feels like it's leading the pack in terms of economic activity for us, followed by probably Asia.

On the consumer front, as you know, I think that's also been a little mixed overall in terms of trying to read the signals. Certainly the one overarching trend in the consumer furnishings market, and our belief, is promotional activity is still a big driver of that business in an area that we've got to do work on.

And that actually leads to my next question. DWR profitability a little bit weaker than we expected, 3% for the year was the EBIT. As we look out in the next year, can you talk about the outlook for profitability? How much is dependent upon the top line? How much is dependent on some of the issues getting behind you? What kind of visibility do you have into DWR next year?

By the way, let me just make sure that we're -- while one level is DWR, I would say you got to look at the consumer business as a full segment rather than just that because it's moving between the two. But let me say, from the broad view, certainly the profitability we saw in the fourth quarter was not only disappointing, it's just not acceptable and we can't be there for long.

It will take a bit of a ramp, I think, Matt, before we get back to the levels where we would expect, and get back to the kind of plans that we had from the beginning. It certainly has a heavy dependence on we have to get some revenue growth, in particular on the direct to consumer part of that business.

What I feel good about in terms of getting back to growth is we know we have a number of store openings and we have a lot of those that are under contract. So, it's not like a year ago we're hoping to get the contracts, we're hoping to get planning approval. This year we got really hung up in a lot of those areas.

We have a number of the studios open. Of the nine that I mentioned, a good number will open in the second quarter. I think it's six of the nine will open in Q2. Timing of that, beginning or end, is a little bit harder to predict, but I would say by the time we roll out of Q2 we should have those in line.

So, that feels good. We know where we're going there, so I think we at least have that element is well within our control. That certainly is a big help.

I would also say that we had a number of flesh wounds this year, if you will, not only from the ERP system, from these quarter-end adjustments or year-end adjustments to inventory that should not hit us again. They weren't really operating things. They were much more things that got caught up in accounting systems and that kind of stuff as we got to our new ERP system.

I think we'll have a lot of those things. My gut is we ought to be able to see, if we were at 3% this year, I would like to come out of next year at least double that number, up in the 6% range. I don't think you'll see that in the first quarter, though. I think it will take a bit of a ramp as those new studios come on.

One of the other keys, Matt, is going to be increased productivity on prospecting with catalogs. That's a big deal. And we think the trend on that, while you can't really see it in the revenue numbers yet, the returns we're starting to see are getting better. And we're not fully implemented. We will implement over the next two months, the final few steps. So, I think we've gotten the right things in place, and we will know more as we get through this next quarter.

Okay. Let me ask some more quick ones here. The SG&A is also higher than we thought. I believe it was you, Jeff, or maybe it was you, Brian, that went through some of the realignment, the sales force realignment, the leadership realignment. I know that some of that has been ongoing but can you talk about what really drove the delta? I think it was outside of your guided range. And then as you look out in the next year, I know you've got some spending. how should we think about the SG&A outlook in general?

Matt, let me take the first part of your question here. For the quarter, yes, we were a bit higher. When you adjust for the gains, obviously, that I called out, we came in a bit above the guide, a bit above our own internal expectations for operating expenses. Really two primary drivers.

Obviously, we beat on the top line, so we had some variability that just is natural with that higher revenue, versus the midpoint of the guide that we gave at the start of the quarter. So, that's one factor.

The other probably bigger factor is warranty costs. And I want to be clear on this one. This is a calculated warranty cost related to our lag schedule process that we have, as any company that has a long-term warranty program. We factor in recent quarter data into your lag calculations and out of that came an identified need to increase some warranty accruals in the business. So, that was the other major driver in the quarter.

Jeff, it is important, Matt, to know this is a little bit of impact of the change we made mid year this year on the accounts were requiring us to account for warranties between goodwill and hard-core warranty costs. We traditionally book goodwill as a period cost and we did not accrue it with the belief that it was related to future sales, not really warranty.

If you remember, mid year they required us to move the goodwill to be part of our general warranty. What happens is, now even that goodwill decision -- so, if it's a customer that we want to do something for, maybe that's even outside of warranty because we think it's the right thing to do to retain them and treat them like we want to -- that falls into this lag schedule now, that Jeff was talking. So, you not only book what you've spent today, but then it essentially changes the prediction of how much you are going to do in the future.

So, that's a little bit of a new factor we're going to have to watch over time, and it could go either way. I don't think it's a big move, but it's one that we will have to pay attention to.

In the long run, by the way, the cash doesn't change. This is much more of a balance sheet true up issue.

And so, Matt, let me get to the second part of your question, going forward in our Q1 guide. I don't know if you recall earlier in the fiscal year, this question came up on operating expense run rate when we were giving, I think, our outlook for the third quarter. We had talked about expecting to see operating expenses back around in line with that 29% of revenue run rate. And that's about the expectation moving forward. I think that's reflected in the guidance for Q1.

Okay. And apologies to Budd and Catherine, but I've got to get one in for Greg since he is there. How are you, Greg? If you talk about the North American manufacturing footprint a little bit. I know there were some additional opportunities when you moved into your new role. Can you just update us there? Is there anything that can offer some margin visibility in the biggest part of your business over the next 12 to 18 months?

Sure, Matt. I think if you step back, our strategy really over the last two or three years has been to say, what are our core competencies, and to really drive those competencies. So, we have taken a look at the things that happened on the outside that maybe we had a core competency in driving those internally as we have product mix shifts away from maybe old legacy products to newer products.

I think if we were sitting here today and steel was still sitting at $580 a ton, we'd be talking about maybe margin improvements going forward. Right now we're working hard to accelerate some of the insourcing stuff we're working on to try to offset some of the big increases in steel.

As I look forward, our prediction is that the current increase in steel is not a demand-driven increase. It's more of a steel folks trying to get higher prices because they didn't make very much minority at $580 a ton. So, I think they're working hard to get that price it.

I don't personally think it's going to sustain at this level. Hard to predict how far, if it falls or it goes up. It's always hard to predict. But we are working hard on the footprint to try to offset some of the costs that are coming.

But I think the margin percentage that you see out of North America reflects the work we've done over the last couple of years. I think there's more to be done. We think we have more opportunity, but it's not something I can promise you the next quarter.

Matt, the other thing that Greg's been doing that I think has been helpful in this front is we've been looking at the total footprint, not only within what we would think of as Herman Miller but also Nemschoff and Geiger in making choices around centers of excellence that we could use so that we can, as we continue to expand the breadth of the product line, how do we use some of those other plans and rely on them. Which, as an example, Geiger is producing a number of products now that actually are in the North American contract segment where they have an expertise in North Carolina in upholstery, and we produce it in that plant even though, from a segment reporting standpoint, that shows up really on Greg's side.

We've been looking at that more and more to make sure that we're getting the right balance, and therefore in the total company are we getting the best cost and utilization of assets. And I think, as we look forward, there's some additional opportunities there, as well as I think Greg has begun to really start to think about how are the leaps that are going forward in things like robotics, how are they going to play longer term. And that's not a tomorrow thing or next four quarters, but how do we begin to look at that, especially I think anybody that's in manufacturing today in the Midwest is struggling with getting labor. And while labor costs per hour aren't going up crazy, there is a difficulty just finding people today.

Okay, perfect. Thank you all.

Budd Bugatch, Raymond James.

Good morning, Brian, good morning, Jeff, good morning, Kevin, and good morning, Greg. A couple of questions from me. First for Herman Miller and the just the composition of sales. Over the last year it's changed. It changed, I think, in one of your most profitable areas, seating. Last year it had a 300 basis point increase as a percentage of its composition of total revenues to, I think, 38%. Can you give us a little bit of color on the composition of revenues this year by product line?

Budd, I don't actually have that data in front of us. We can come back to you on it. Let me say, I will give you my gut feeling. You guys chime in if you think I'm in the wrong place.

I don't think we have seen a major change this year, year over year. What you are continuing to see over time is, as we continue to build out products for the broader floor plate, there is no doubt that you are seeing increases in seating. And I would say that a lot of that is not just task seating now. Where, in the past, we would've played very heavily in task seating and not as much in those other areas.

In fact, if you looked around NeoCon and saw the number of products we were launching of related seating that were in the non-individual workstation area, I think a lot of the increases we felt on the seating side are starting to come in those, what some people call ancillary areas. So, it's a little bit of both of those, in my mind.

That's where I'm trying to go to because I was trying to look at the wins you have had. You talked about projects over $1 million being particularly strong. I think that's notable. And I'm just trying to understand the competencies, what's getting you those wins in the marketplace.

I think in one level, Budd, the ability to help customers -- I do think the Living Offices has had an impact. If you listen to dealers and you listen to folks in the A&D community, our ability to help them envision the whole space has been very helpful. I think historically we didn't really have a sales force that was focused on winning in those additional areas outside of the workstation. So, having people focused on that has really helped.

I would say the one thing we've started to feel the benefits of, although I think it's early days, is this channel sales manager role that we created, I think in the long run is going to really help us, not necessarily a big change against major competitors but in places like at the dealer where, as you know, while we may be 60% of their sales, 70% of their sales, there are literally hundreds of companies in this industry that are going after those other areas. And our ability to have someone at the dealer every day who is helping them understand what's in our total offer, I think is critical.

In the past, we didn't really have to think about that because if we just won systems in seating and filing, we were in the main of the project. But as the floor plate has shifted, if we don't have the ability to capture the areas around it, you've got a shrinking part of the pie that you're playing in. I think those things have helped us. In the work business, that certainly has helped.

I think it's also helped in healthcare. Our healthcare team, I think, has done a better job this year than ever of not just trying to win business at the hospital but at the entire organization that is delivering healthcare, which, as you know, includes everything from insurance companies to a doc practice to outpatient clinics to the hospital. And that's certainly gets a different kind of mix because you end up being -- our historical healthcare business had a lot of material handling cars and nurses stations, and certainly we won workstations. But actually, if you looked at healthcare over time, our share on the admin side was lower than our overall share of office business.

So, that certainly is one of the areas that we think longer term has got some potential for us. I don't know if helps. Gives you some color on it at least. Yes. And it's the channel sales that I also wanted to explore because I thought for a long time that your aligned dealer unit, as you correctly mentioned, you get where you are the competitive. Nobody can sell into your competitive set, into your aligned office dealers. But there was a significant amount of that share of wallet that they were selling through others and through the huge diversified composition of the industry. So, maybe you can give us a feel of share of wallet of your aligned dealers. How has that moved year over year? And what is the opportunity there? How much of that revenue, of that 40%, where was that 40% two years ago and where will it be in three years?

Budd, this is Greg. Obviously it varies by dealer a lot, but normally that number probably has moved up a little bit. It was probably in the high 50s. I think this year it's running at about 60. I think we've done a nice job, the development team has done a nice job, to queue up things that maybe don't hit the radar screen of NeoCon, to fit in those areas.

Brian mentioned made-to-measure, which I think it goes a long way towards helping dealers meet the demand of the customer that maybe they served in a different way in the past. So, things in the laminate world, which is really, we had talked to you earlier about a year ago about dealer blitzes, which were one of the big feedbacks from the dealer community. And the other bit would be our options group who is doing specials all the time. The way we approach pricing I think has made a big difference.

So, I think that number has moved up primarily in the last 12 months related to those two areas. But I think what you saw at NeoCon, with the launch of Plex, and some of the other seating that you saw, that is very specifically targeted at growing that number.

In some ways, Budd, I think if you looked at it historically, a lot of people would say if you looked at a typical job, 70% to 80% was probably the individual workstation. And that number, depending on who you talk to, has certainly been driving down. So, the hard work, in some ways, has been not only to grow but to make sure we are not losing share of wallet with the dealers over time. And the areas we used to say were competitive were really those big three areas.

Now the areas we want to be competitive in are a much broader set. So, in some ways, it's us -- this, I think, has been the core part of the strategy from the beginning, is asking how do we increase the addressable market and for sure protect the addressable market within the contract world.

There has been a positive -- and you and I have talked about this a little bit in February during your conference. One of the positives on the DWR side is we just really haven't been able to get fast enough after the dealers' requests to be connected to DWR. We've certainly seen the contract side of DWR grow.

There is more potential there for us to make that easier for them to connect with. And that's one of the things we've got on our objectives list for this next year, is there are areas those guys could get after that are not in our core offer, like areas for dining where they have a much bigger variety. As you know, typically on a corporate campus, they're not going to pick just one dining outfit and do it across. They're going to be much more varied around that. So, the ability to have variety there becomes a big deal.

Yes. I was trying to understand what the opportunity is in 2017, exactly. DWR was a disappointment this year, I believe, or at least ran into challenges. Maybe disappointment is too hard a word. But ran into challenges. And you said you're going to open up six. Do I get that in the second quarter, six of the new studios?

That's right, Budd, by end of Q2. That's the plan.

So, how are you organizationally going to handle that crossover between DWR and Greg's area? And does it have any impact on ELA at all? I don't suspect it does but you'll help frame that.

This is almost, in some ways, a three-part strategy, in my mind, to make sure we can fill out those other areas in the contract world. The first has been, what can we do with internal development at both Geiger, the Collection and core Herman Miller. And you saw at NeoCon products from all of them there. That has been job one and the thing we knew we could get our arms around the easiest because it fits into all of our current sales constructs.

The second one is how do we make DWR available. What a lot of people don't know who don't see the inner workings, we have a separate division within DWR that had a [preedy] acquisition for contracts. It was relatively small for them. They really focused on trade and direct to consumer. But they had a small contract business which, in many ways, served a lot of times hospitality or hospitality within a corporate setting -- IE, dining areas and the like.

The guy who runs that is a really experienced guy on the contract side. He doesn't come, really, from the retail business. He was a contract guy on outdoor contracts. His focus has been to develop the connection with the dealers.

What we believe we'll do over time is, first, we have to develop a sourcebook and some marketing materials to make it easer for the dealers to know when they can apply DWR products and when is it an appropriate application. We think that will start with starting with our settings logic from the Living Office and say -- what are those settings that are typical for a planner to do, and then how do they know when to reach for Herman Miller, Geiger, the Collection or DWR, which all have appropriate times. That's important.

The second thing that Greg has started to work on with John Edelman and John McFee and the gentlemen who runs their contract business is, could we make it easier around order entry. One of the things we're going to try to get done this year -- I say try because it's not simple to do -- is can we make it easy for a dealer to actually order the products that are more simple, if you will, and are probably the bulk of the opportunity -- can we actually put those into the Herman Miller order entry system so when a dealer is processing their order to the Herman Miller, they can include some of those DWR proprietary products or products that they have the rights to for contracts, and they only have to go one place to go do it. That would just make it simpler. We can then get better control over the total logistics for them.

The third element of this is really the partnership with naughtone, which, in the case of naughtone, we are going to make that easy for the dealers, as well, at least Herman Miller dealers, so that they can order directly those products through Herman Miller, as well. So, we're essentially going to create, if you will, a marketplace between Herman Miller, naughtone, DWR and even, in fact, we will have at the end of this year Geiger on the same order entry system, which will make all of that stuff get to be more streamlined from a dealer's perspective, if that makes sense.

Okay, yes. I've taken much longer than I had planned to. Thank you. We'll talk about some of this off-line, as well. Thanks.

Kathryn Thompson, Thompson Research Group.

Good morning, guys. This is Steve on for Kathryn. I was wondering if you could, sticking with DWR, a couple of questions. Can you talk a little bit more, or give a little more color on your partnership with Amazon and the logic behind it?

It's really not a DWR partnership, it's actually Herman Miller consumer. So, we are selling some Herman Miller products on Amazon.com today. It's pretty much limited to some task seating.

We have always had some form of representation on Amazon, often through one of our other wholesale customers who has stores on Amazon. We believe that the idea of going to Amazon just was another addition to our overarching multichannel strategy. We think you want to be able to meet the customer where they want to shop and Amazon is a place that a lot of people go to shop.

Task seating happens to be one of those things that is often known. People know what they are buying. So, it seemed like it made some sense to work with them. Certainly they have a outstanding logistics capability. So, it looked good from that angle.

We also know that increasingly consumers start often on places like Amazon.com when they are doing a search. In fact, some people would tell you that maybe searches start more on Amazon than they do on a Google search now. So, you are spending a lot of money to do Google AdWords on search; yet, if you're not in the place that they are searching they don't even find your brand there.

So, the idea was could we get the Herman Miller brand represented on Amazon in a way that if people are doing a search, if the products weren't on Amazon that they were looking for, but they found the Herman Miller brand, maybe they found a chair but they wanted another option, that also leads them hopefully back to the DWR site or HermanMiller.com, or one of our other great retail or wholesale customers so that they can see a more expanded offer, if there's additional things that they want.

We saw it as a two-pronged benefit. We think people will buy from that channel. But we also thought it was a great marketing step. To be frank, there's also a third benefit, and that is that often what you find on Amazon, sometimes if you are not represented there you see replicas or knock-offs of your product, and having the real thing there we think actually helps, a bit, discourage the folks that are trying to play off of our brand and the designs of our products.

Great, very interesting. My last question, capital allocation internally for the upcoming year, I think you said CapEx for this past year was $85 million. How do you think of that just total dollar basis for the full year? And then what segments will you be investing the most capital behind? Thank you.

If you look at it -- you guys might have to give percentages, Kevin or Jeff -- but it's always going to heavily be weighted towards the North American contract business in total because it's still the biggest part of our revenue. And I would say this next year we have a very heavy product development schedule, particularly in the areas like seating, which tend to be larger capital outflows in terms of product development.

So, I would guess the majority is still heavily weighted towards the North American business. Last year we had a fairly heavy weighting towards international because we built two new facilities in international. So, I would guess that segment will slide back a little bit this year.

Yes. I think the consumer segment, you've got to bear in mind, if we can get through our anticipated studio opening schedule, those new studios run typically $1 million to $1.5 million or thereabouts of capital per. So, that's probably $9 million or $10 million of CapEx tied to consumer this year. That's in the number.

So the weighting will actually move overall this year from the international business ELA to consumer. That's the shift. And the remainder remains about the same, with a big good deal of that balance being really in the North American work business, largely around new products, some new equipment that Greg talked about. We're working on efficiencies. And I'm sure we'll have some facilities, as well, on that side.

This is Jeff. I would just tag on to that, from a balance sheet standpoint we've done a good job paying down our line of credit. I think we had $22 million or so outstanding at quarter end. We will continue to focus on that. We increased the dividend. That will put probably another $5 million of run rate annual towards the dividend.

And we have been pretty consistent. We started to buy some shares back this year, really aimed at offsetting benefit plan dilution. But we don't have any intention of -- I mean, we've generated great cash. We had terrific cash generation, as Brian called out and Kevin described on the call. And we anticipate we will continue to generate good amounts of cash, but we do not intend to build a big cash balance. So, we will balance that with continued return of cash to shareholders, as well. So, I think in that order of priority, that's our intention.

That's all for me. Thank you.

Thank you. That looks like all of our questions. I would like to turn the conference back over to management for any closing remarks.

Thank you all for joining us on the call today. We appreciate your continued interest in Herman Miller and we look forward to updating you next quarter. Hope you guys have a great day. Thank you.

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