MillerKnoll Inc (MLKN) 2017 Q1 法說會逐字稿

Welcome to the Herman Miller Incorporated first-quarter FY17 earnings results conference call. This call is being recorded.

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

Today's presentation will be hosted by Mr. Brian Walker, President and CEO; 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 the callers limit their questions to allow time for all to participate. At this time, I would like to begin the presentation to by turning the call over to Mr. Walker. Please go ahead.

Good morning everyone. Thank you for joining us today. Yesterday, we announced our financial results for the first quarter of FY17.

Our consolidated sales and orders for the quarter were $599 million and $596 million respectively, and earnings per share were $0.60 per share. As a reminder, our Q1 results include an extra week of operations. Adjusted for this impact as well as foreign currency and dealer divestiture, organic sales and order growth rates were in the low single digits.

Having a diversified business that serves multiple audiences means that each of our business segments have different rhythms. While our overall sales this quarter were slightly below our expectations, I'm very encouraged by the order momentum within the ELA, specialty and consumer businesses. In North America, while order levels were just below last year, we continue to view industry dynamics as largely supportive of continued growth, and our internal indicators reflect this same conclusion.

Jeff and Kevin will provide a more detailed breakdown of our financial results by business segment, but as I normally do, first I'd like to share my thoughts on the current economic backdrop and the overall direction of the business.

Over the past five years, we've been diligent in our pursuit to expand our addressable markets and build a multi-channel business, which provides us a platform to deliver our leading designs and innovations to new audiences, virtually anywhere in the world. This approach in the infrastructure is a differentiator for us, and as we continue to execute on our key strategic initiatives, we believe we are well-positioned for sustainable sales and profit growth.

While the macroeconomic backdrop of the business is generally positive, there are areas of challenges in the US and abroad. Pressures in the energy sector, rising steel prices, and general uncertainty surrounding the upcoming presidential election persist as headwinds in the US. With that said, on balance, the industry metrics we track remain largely supportive for the North American contract business.

In particular, service sector employment, non-residential construction activity, and the architectural billings data have continued to turn positive. Consumer confidence has also picked up, and low interest rates remain a catalyst for the housing market, supporting generally positive trends in existing home sales and housing starts.

Outside of North America, the economic picture is more mixed. Economies in Latin America have continued to be [racked] by political turmoil and commodity price pressures, particularly centered on oil-producing regions.

The Brexit referendum in June took markets by surprise, and created a major source of uncertainty in the economic future of the UK and Europe. While the near-term impact of Brexit has been less dramatic than we initially feared, the longer-term implications for the region and beyond are very unclear. Conversely, we continue to foresee favorable long-term demographic trends in the Asia-Pacific region, which remains a key area of growth for international business.

As we've expanded our business to new channels and markets, we have deliberately coupled this effort with our hallmark excellence in design and innovation. This powerful combination provides a real differentiation from our traditional competition, and uniquely positions us to serve customer audiences that would have been missed opportunities, had we not embarked on the strategic shift.

As I mentioned at the outset, our diversity of offerings means that the different businesses often move at different rhythms. Let me spend a few minutes providing some color on our results for the quarter.

In North America, we really felt the project-based nature of the contract industry this quarter. Order levels were softer than expected throughout the first two months of the quarter, which showed a marked improvement toward the end of the period. Weaknesses in the energy sector continue to pose a notable challenge, particularly in certain regions of the US and Canada.

More positively, the healthcare sector remained an area of strength this quarter. Overall we remain encouraged by the level of project opportunities and customer interest we are seeing. Despite the relative softness we experienced to start this quarter, we feel generally good about the macro backdrop, and our team's ability to compete effectively for new business.

The priorities we communicated last year remain our focus this fiscal year. In particular, we are committed to the continued evolution of the Living Office framework, which includes the launch of new product and smart solutions, research to quantify the results of applying these concepts, and the extensive training of our sales force and dealers. As further proof of the power of this framework and the innovation leadership of Herman Miller, Wallpaper Magazine recently named the Living Office one of the finest design innovations of the past 20 years.

Outside of North America, while the initial impact of Brexit on our ELA segment has been less than we originally anticipated, we're continuing to monitor the situation closely to ascertain the long-term impact, and determine where new opportunities and challenges may exist, as a result of the change. For the quarter, organic order growth for ELA was led by continued strength throughout Asia and improved demand in Continental Europe.

We also have a robust pipeline of new product launches across the POSH and Herman Miller brands to fuel future growth. Our new partnership with UK-based naughtone is also very promising, as it will increase our global collaborative furnishings offer, and expand our operational capabilities to better serve the EMEA region.

The specialty business, with a strong connection to architect and design specifiers, delivered order growth led by Geiger and the Herman Miller collection. This segments continued to benefit from a consistent cadence of new products, as well as the trend towards the convergence of work and home.

On the consumer front, while we're not declaring victory yet, we are encouraged by the positive momentum we saw in the top line this quarter. The channel and brand initiatives we outlined last quarter, including changes to our catalog prospecting approach, are gaining traction. And as such, we continue investing in promotional activities to drive business through our consumer channels.

We also remain focused on the growth drivers of this business, including the expansion of our real estate footprint, and an ongoing cadence of exclusive new product launches. This quarter, we opened studios in Manhattan, New York; Austin, Texas; and Washington DC, and we have another six studios under contract to open this year.

Austin and Washington DC, we're repositioning existing locations to the new model, so our store count increased by one in the quarter. In Q2, we will also open our first Herman Miller retail store in North America, inside the Park Avenue flagship showroom in New York City.

Consolidated gross margin was slightly lower this last quarter, in large part due to the rising cost of steel. To offset the fluctuation of the commodity costs, we continue to implement a number of LEAN initiatives to drive operational improvements across the business. And, as we noted last quarter, we intend to implement a price increase during our typical timeframe this year.

On the operating expense front, we aim to sync our spending levels with the demand patterns that we see across our business. At the same time, it's necessary to ensure appropriate levels of investment, to support key long-term initiatives, such as Design Within Reach studio openings, and new product launches.

We have a robust pipeline of new products under develop, a number of which will launch over the coming 3 to 6 months. And our longer-term pipeline is very strong, with a particular focus on expanding our leadership in seating.

Finally, we continue to focus on maintaining an efficient capital structure. In addition to the 15% increase in our dividend last quarter and ongoing share repurchases, we recently refinanced our revolving credit facility, which will both lower our costs and create financing capacity for the future.

I'd like to close by emphasizing our unique value proposition. At its heart, Herman Miller is a Company driven by a culture centered around its employees, a sense of purpose, and a motivation to create inspiring designs to help people do great things. It's why we have been and will continue to be at the center of every game-changing innovation in the office furniture industry.

Our value proposition is anchored by a powerful combination of world-renowned design brands, industry-leading R&D, and unrivaled multi-channel capabilities. As we look to the future, we are the only Company in our space that is positioned to seize opportunities across a broad range of addressable markets, and deliver a complete side of solutions to consumers and organizations across the globe.

With that as a background, I'll turn the call over to Jeff, who will provide more detail with the financial results for the quarter.

Thanks, Brian, and good morning, everyone. When we spoke with you in June, we pointed to a couple of important factors to consider when modeling our first-quarter numbers. These include the extra week of operations, and the impact of the divestiture of our dealership in Australia at the end of the fourth quarter of last fiscal year.

As a reminder, our first-quarter results reflect 14 weeks of operations rather than the normal 13 weeks, though the relative timing of scheduled summer holidays reduced the impact of this extra week to four incremental shipping days, relative to the first quarter of last year. This is a change we make every five years, in order to our realign our fiscal cutoff dates with the calendar months. So as I talk through the details, I would note that our organic sales and order rates consider the impact of both the extra week and the dealer divestiture, along with the impact of changes in foreign exchange rates.

So to begin, consolidated net sales in the first quarter of $599 million were 6% higher than the same quarter last year. On an organic basis, sales increased 1.5% from the prior year. Orders in the period of $596 million were also 6% higher than last year, and on an organic basis, orders increased 2.5% from the first quarter a year ago.

Sequentially, net sales in the first quarter increased approximately 3% from the fourth-quarter level, while orders were 2% below the previous quarter. Excluding the impact of the extra week and dealer divestiture, sales decreased by 2%, while orders were 7% below the fourth quarter.

These organic sequential declines are below the average seasonal trends we've seen in the business over the past five years. In addition to the inherently project-based nature of the business, we believe the softness in orders we experienced at the start of the quarter, particularly in July, reflected an initial pause in activity as companies digested complexities surrounding uncertain interest rate policies, Brexit results, and the pending US presidential election.

Within our North American segment, sales were $365 million in the first quarter, representing an increase of 8% from the same quarter last year. Adjusting for the impact of foreign currency translation and the extra week, segment sales were up 1% on a year-over-year basis.

New orders for this segment totaled $348 million in the first quarter, reflecting an increase of 5% from last year, while decreasing 1% on an organic basis. Orders from project sizes above $1 million were down compared to last year, primarily driven by large project activity last year in the energy sector.

Overall, order growth by industry sector was mixed. We saw strong growth in healthcare, business services, and electronics, while the energy sector continued to be a particularly challenging environment. We also saw lower order levels in a few other sectors this quarter, including wholesale and retail, utilities and financial services.

Our ELA segment reported sales of $97 million in the first quarter, reflecting a decrease of 5% from last year. New orders totaled $110 million, an amount 1% higher than the same quarter last year. Although on an organic basis, which excludes the impact of the dealer divestiture, the extra week, and foreign currency, segment sales were slightly above last year, and orders were up an impressive 12%.

This year-over-year order growth was led by strong demand across Asia, including China, India, and Japan, along with growth in Continental Europe. This growth was partially offset by softer year-over-year demand in the UK, tied to the region's challenging economic backdrop, made all the more uncertain following the Brexit referendum in June.

Sales in the first quarter with our Specialty segment were $61 million, an increase of 5% from the same quarter a year ago. New orders in the quarter of $67 million were 15% higher than the year-ago period and on an organic basis, segment sales declined slightly, while orders were 8% higher than the first quarter of last year. Order growth within this segment was led by double-digit organic growth from both Geiger and the Herman Miller collection.

The consumer business reported sales in the quarter of $75 million, an increase of nearly 13% compared to last year. New orders for the quarter were $71 million, which was 10% ahead of the same quarter a year ago. On an organic basis, segment sales increased almost 6%, and orders were nearly 4% higher than the first quarter of last year.

On a comparable brand basis, revenues for the quarter were up just over 1% for DWR. We were encouraged to see order demand accelerate for the second quarter in a row, as our marketing investments, particularly in the area of catalog and digital, began to gain traction. Our consolidated gross margin in the first quarter was 38.4%, which is slightly higher than the first quarter of last year.

As expected, the recent increase in steel prices had an unfavorable impact on us compared to the same quarter last year, but we also felt the impact of comparatively deeper discounting this quarter. These factors were offset however by continued operational improvements.

I'll now move on to operating expenses and earnings for the period. In total, operating expenses in the first quarter were $174 million, compared to $162 million in the same quarter last year. The majority of this increase relates to the extra week of operations; however, there was also additional spending on new product development and marketing initiatives, and pre-opening costs related to new DWR studios.

Operating income for the quarter was $56 million or 9.4% of sales, compared to $55 million or 9.7% of sales in the prior-year period. The effective tax rate in the first quarter was 32%, this compares to an effective rate of 33.6% reported last year. And finally, net earnings in the first quarter totaled $36 million or $0.60 per share on a diluted basis, which was 7% higher than earnings of $0.56 per share in the first quarter of last year.

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

Thanks, Jeff. As Bryan mentioned, we refinanced our revolving credit facility shortly after the end of this quarter, and I thought I would start by providing a few more details of the transaction. We put two components of financing in place.

First, we upsized our revolver by $150 million from $250 million to $400 million and extended the maturity of the facility to September, 2021. Second, we took advantage of the current low interest rate environment by putting in place a 10-year interest rate swap arrangement. This swap carries a notional amount of $150 million, and will become effective in January 2018, when we pay off our current private placement debt that matures at that time, by borrowing on the revolver.

The interest rate swap will fix the interest rate on that $150 million at approximately 2.8%, a level substantially lower than our current private placement rate of 6.42%. While this transaction does not impact FY17 interest rate expense, starting in January 2018, we expect our annual interest expense run rate to be approximately $5 million lower than the current levels as a result of this transaction.

With that background on the refinancing transaction, let me move to the commentary on the first quarter. We ended the quarter with total cash and cash equivalents of $65 million, which reflected a decrease of $20 million from last quarter. Cash flows from operations in the period were $30 million compared to $33 million in the same quarter of last year, primarily due to higher cash outflows from working capital resulting from higher inventory levels and lower accrued liabilities, partially offset by lower accounts receivable.

Capital expenditures were $22 million in the quarter. We anticipate capital expenditures of $80 million to $90 million for the full fiscal year. Cash dividends paid in the quarter were $9 million.

As a reminder, last quarter, we announced an increase of 15% in our quarterly dividend rate, that will be paid beginning in October. This increase brings our expected annual payout level to approximately $41 million. We also continued a share repurchase program at a level currently aimed at offsetting dilution from share-based compensation programs, making repurchases of $7 million during the quarter.

We remain in compliance with all debt covenants, and as of quarter end, our gross debt to EBITDA ratio was approximately 0.9 to 1. The available capacity on our bank credit facility stood at $208 million at the end of the quarter. Given our current cash balance, ongoing cash flows from operations, and our total borrowing capacity, we believe 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 second quarter of FY17.

Okay, with respect to the forecast, we anticipate sales in the second quarter to range between $580 million and $600 million. On an organic basis, adjusted for the dealership divestiture, this forecast implies revenue growth of approximately 2.5% at the midpoint of the range.

As with any forecast, we have based our estimates on a few important inputs, including the level of new contract activations, our assessment of opportunities in the funnel, and perhaps most importantly, reason order trends. As we have stated, we saw significant improvement in average order rates moving from July to August. Our Q2 revenue forecast reflects average invoicing levels roughly in line with the order pacing we saw in the month of August.

Consolidated gross margin in the second quarter is expected to range between 37.5% and 38.5%. This forecast incorporates the expected impact from the uptick in market prices for key commodity inputs, namely steel.

Operating expense in the second quarter are expected to range between $171 million and $174 million, and we anticipate earnings per share to be between $0.52 and $0.56 for the period. This also assumes an effective tax rate of 31% to 33%.

And with that, I'll turn the call back over to the operator, who will take your questions.

(Operator Instructions)

Budd Bugatch with Raymond James.

This is David Vargas on for Budd. I was hoping that you could talk a little bit about where in particular you saw the strength in order growth in the ELA segment?

David, right? David, primarily the biggest growth we saw was actually in Asia, and I would say it's pretty broad-based throughout Asia. As we mentioned, we had pretty good activity levels on Continental Europe. Middle East was a little back end of the quarter, where we saw a better period, but that's always difficult to predict as you are going through some of the holidays that happen over there that time of year.

Got it, and any color on maybe the size of the orders that you were seeing within that segment? And also, if you expect that trend -- how are you viewing that trend, given some of the macro uncertainty in Europe right now? I mean, it's not just in the UK, but it's also on the continent.

Yes, nothing stood out in terms of any one large order or anything like that, that drove it, so it was pretty balanced. Last year, actually, we had one very large order in Australia that's backed out of the organic numbers, because it was actually to a dealer that we sold, but they had one large unusual order last year during the quarter, but nothing this year stood out as a specifically very, very large order. So I would say a pretty typical balance there.

How we're viewing it, I would say we are watching what's going on in Europe, and in the UK very closely. At one level, we think there can be some additional opportunities for us, because as the UK has dropped in value versus the euro, it creates some capability for us because we produce in the UK. So that actually probably at one level makes us more attractive, if you will, or makes us more competitive in Continental Europe.

In the short run, we haven't seen as much impact as we expected from Brexit, although I would say one of the things we wonder is when we saw a little bit of an air pocket in July, with that somewhat related to all the news that was out both here in the US, as well as with Brexit, and wondering whether those two things caused some business people to pause. I can't really prove that, that's a gut unsure. It seems like that was pretty broad based, at least across our industry, from what I'm seeing from others.

But after we got through that period, things I would say, appeared to have returned a bit to normal. I would say that at the same time, it's a big change, and so you're not going to see that happen overnight, and I think the question is going to be what happens as they sort out the implications around trade deals and those kind of things.

Okay, thanks. And regarding North America, the weakness you saw early in the quarter, can you give a little bit more color on that? Was that maybe a push out or a lengthening of the purchasing cycle? Or was there something else involved there that you saw, and you can point to, that caused some of that weakness?

We didn't see anything about things being pushed out, we didn't have any cases with folks calling us up and saying, hey, you have won this project, and we're going to delay it. We didn't see any delaying type things, at least none that I'm aware of, other than the typical things you get with, you are kind of a bit in the construction business. So you do from time to time see that. But I would say nothing unusual there.

Maybe the thing that is most interesting to us is activity levels, as reported by our sales people, what we looked at, as Jeff mentioned, in terms of contract activations, which is really how many times did we have a new contract that we are putting in place, as either a long-standing contract or a particular order, those actually stayed quite good, and the funnel looked pretty healthy. So I guess from a delay standpoint, it would certainly seem that the other signals that we would typically be tracking to see -- get a pulse of the business, did not seem to match fully what we were seeing in terms of day to day, week by week order entry.

So maybe a delay in that sense, but certainly nothing that was telegraphed by customers, that they were making a decision to delay. Again, you can't really tell with all those other events that are going on, like Brexit, to say did that have an impact on the business. Typically, I would say you don't tend to see that signal strength hit our industry that fast, because if you're already building a building and signed a lease, you are going to move forward. So that would seem to be a little unusual, although certainly something we are paying attention to.

The other thing that was a little bit difficult to read this quarter is our healthcare order entry was very strong in the early part of the quarter, and then cooled, and I would say the non-healthcare part actually played exactly the opposite pattern. So we had some different patterns by industry sector. Also, playing amongst all that, of course the one I think that everybody is talking about, those of us who play there significantly, the most difficult sector overall from an industry perspective was clearly the oil and gas sector, which, if you have been watching what is happening in Texas and in Calgary and those kind of markets, it's pretty quiet in terms of project activity.

Thank you, and then the last question for me, when you were referencing deeper discounting, was that just in the consumer segment, or was that also across all the office furniture in the North America segment? And also, can you give a comment on what you are seeing in residential demand? Is there a change going on there? Is that softening a little bit, or does it remain strong?

First, I think our primary comment around pricing or discounting in particular was related primarily to the contract business in North America, that would cover both healthcare and office. That's what we were primarily talking about there. Certainly, and I would say by the way, that is -- that tends to move around geography by geography. Within in the US, you will see different competitors at different times being more aggressive, based on a particular project. And certainly we get more aggressive from time to time in a geography or a particular customer that we are interested in cracking.

So I wouldn't say there was a consistent pattern, as much as certainly there was some deeper pricing in the quarter. And that's bounced around over the last year or so. I don't know if that's an unusual pattern, but one that -- we are in a very competitive space, and I'm sure when business activity levels look lower, you will see competitors be more aggressive on how to deal with that.

On the consumer side from a pricing standpoint, we did note that margins were a little bit lower. Certainly we had more promotional activity this quarter, so we were on sale, I believe, more days this quarter than we were last year. So that would have been part of the drive in that business, as well as, we made a decision to do some price downs on some things that we wanted to move out of our inventory, which we felt really good about.

So that's the one that I wouldn't say is necessarily directly tied to competitive pressure, other than the fact that one of the things we noted last year is that we had really attempted to back off on the number of promotional days. Our view is that was not a successful move, and that in fact, it's still true that much home furniture is sold really on sale. And so you have to play the promotional game on a regular basis.

We're doing other things that we believe will longer-term bring margins back up in that business, the more we have proprietary products, that certainly helps. The more that -- and as we try to get a broader spread across price points, it takes a little bit of pressure off of discounting products down to hit price points, without the same margin levels. So those couple of things are certainly within our grasp of things that we are looking at.

In terms of demand, that sounds from what I've read around -- across the space of home furnishings, it looks like demand patterns have been -- would describe them as mixed. Some people are up, some people are down. It doesn't look like there's a very clear picture.

I suppose for us, we believe most of what we're doing right now, while certainly we are impacted by the reduction in the number of folks that are coming over to set up second homes in the United States, as the dollar gets stronger, that's more difficult. And there was a very big pattern of that a couple of years ago, particularly out of South America, as an example, and out of Europe, with people starting second homes either in vacation areas in the US like Miami in Southeast Florida, and/or New York City. So there was a big pattern towards that. That kind of business certainly is not as strong as it was two years ago.

On the other hand for us, a lot of what we did this quarter and believe we'll see next quarter was putting in place the things that we need to drive our demand, regardless of the state of the overall industry. And those things this quarter included getting back to a positive studio growth, which we really haven't had for the last 18 months. We've been treading water or down, generally down.

We knew that we talked a lot about last year, that the catalog efficiency had dropped significantly due to a change we made. We have found a new partner and moved back to a model we had used previously. We saw significant improvements in the efficiency and effectiveness of our catalog drop this quarter; we think that's a sign.

The third thing that was on our agenda was to improve our overall service and delivery, which last year was really impacted by ERP, and that hit really more in the second quarter. But we know that started then and continued to affect consumers' willingness to give us a try, if you will. We have now seen six months or so of much better customer service scores, back up to, by the way, levels higher than what we had historically pre-the ERP change. We have been systematically making those improvements. The guys who run the consumer business and their team have done a great job of staying on task with those things, and that's what's really playing into our order patterns in that business.

This is Jeff. I would add one thing to this, and this is an aside to your question on consumer demand. But the other area that our consumer business leads have been focused on is investing in putting in place the infrastructure they need to grow their contract arm of their business. And so while that is still a -- we are growing off of a small base, we feel very good about all through last year that was one of the bright spots in the business. And the team continues to feel very excited about the growth they are seeing, and the potential we see for that business moving forward. So that's another area that we have put some investment here of late.

That's a good point, Jeff, too, because that will also affect longer-term the way that we report gross margins in that consumer business. The stuff that we do that is more contract-related, or B2B, whether that's in the hospitality area or with office customers, that will tend to be at lower gross margins. But of course, we don't have the load in that business that we do in the retail side of stores and/or the same level of marketing spend that we've got in the traditional retail business.

Okay. Thank you very much for taking my questions.

Kathryn Thompson with Thompson Research Group.

Thank you for taking my questions today. First, focusing on the gross margin performance in the quarter, and digging a little bit deeper into levers, you talked at high level about a few of them, but wanted to just dig a little bit deeper. First, a reminder of how much raw materials consists of cost of goods sold consolidated for the Company? Or you can at least do it ex consumer?

And how much of steel was a drag in the quarter? And what are your expectations in upcoming quarters? And then finally, once again related to margins, how much was volume or mix an impact in the quarter? Really what we're trying to understand are the various puts and takes, and in particular, how to think about raw materials as we move forward.

This is Jeff. Let me take a shot, I may need you to guide me along your questions as we go. Let me start with the raw material question. What we think of it as direct materials tend to run around 40% of revenue as a rule. So you know our average margin, so that can get you to the mix within cost of goods sold.

I'd go one step further than that. Steel is an important input cost of our total material. Now bear in mind, when I gave you -- when we talk about material, keep in mind, we not only purchase raw steel, but we purchase a lot of value-added component parts that have steel. We also, aside from steel, in our direct material number, we have a lot of purchase complete products as well, through the mix of our business. So I just want to give you that as context.

But in terms of steel, the steel buy, and this is primarily a North American answer, but that tends to run about 7% or 8% of our total cost of goods sold in the North American business, just the steel by itself. That would be the single largest category of material. Perhaps a little lower than you might think, but bear in mind, we do have a lot of other purchase-complete type costs in our material line. So that just gives you a little background.

Jeff, that is just steel that we buy raw?

That's raw and component parts. Let me pause there, Kathryn. Keep walking me through your question, so I don't miss anything.

Very helpful. And next, just practically speaking, as we seek and look forward in modeling, particularly as we look at a bit lower gross margin guidance for Q2, how much was steel a component of that, versus just pure lower order rate?

We expect the pressure from steel pricing, when you go sequentially from Q1 to Q2, to be on the order of $5 million

Okay.

Worse.

Yes, lower. Let me check. Does that give you what you're after there?

Yes.

Kathryn, one of the things that happened this quarter, Jeff, I think this is the accurate way to think about it, because we have locked in pricing for periods of time, it tends to be that those costs roll in over a period of time. So we started to see some of the steel prices, obviously were moving in the late spring, early summer. We didn't feel the full impact of where it's landed in the quarter, so we'll continue to see a bit of a build as we get into this quarter.

Now from a pricing perspective of steel, steel was at very low levels most of last fiscal year. It peaked in about June or July, I think it hit its peak. It's come back down, like most people predicted. The question from here is, where it trend back down to? I think the low point was $550 a ton, if that's right?

Thereabouts, yes.

And then it got as high as $800 to $850, and it's back down to I think around $750 today, maybe a tad lower. So the question is going to be, does it trend back down below $750? Most people would expect it to cool a bit, but not go back to where it was at $550.

So the levers that we are actively pulling are, what can we do about lean initiatives? What can we do to insource? And then third, where can we and how can we pull the price lever to try to offset some of that? And it's a bundle of those three items.

Kathryn, this is Jeff again. Let me make sure I clarify something to avoid confusion. When we look at our Q2 guide, our gross margin impacts from steel on a year-over-year basis, not a sequential basis, we think it's about $5 million. Sequentially, we think between Q1 and Q2, it's probably closer to $1.5 million or $2 million. Okay?

Okay, that makes more sense. That makes a lot more sense, simply because we've been tracking steel pricing with tariffs being implemented this spring, but prices certainly have come back a bit. Looking just at more on the contract business, and I know you gave some helpful color earlier in the Q&A regarding discounting. But, really given you had a pretty significant increase in seating sales, up 30% or so from several years ago, are you seeing increased discounting in that category? Or is there other, are there other categories which you have seen a disproportionate amount of discounting?

It's really hard to look at discounting necessarily by category, because often, in many cases, you are bundling a whole project together. And you move around your discounting, depending on what area you think you got strength in at that time. So I would just tell you breaking it down to that level of detail can become -- it becomes a little hard, especially when you're looking at it over short periods of time. I would say, overall, I don't believe there's a giant difference in the pattern. Certainly some categories have lower margins, and in fact are more competitive on a day-to-day basis than others. But I don't know that I would say we see any significantly different pattern from one to the other.

Okay, that's helpful. And then in terms of the pattern that you outlined of July not being great, August better, and early September better. For what it is worth, has very much mirrored similar-type feedback we've had from other basic building materials and building product categories that we track regularly.

But when you look at other periods of time, when you've had periods of uncertainty, and this year got started off with a bang and the summer with Brexit, and then we have presidential elections coming up, can you look today versus other major downturns that you've experienced, are there any similar red flags, or any red flags that are different about prior downturns versus what you are seeing in the market? Because what Wall Street is concerned about is, you saw a big drop in July overall, and you are seeing some improvement into August and early September. But is this a head fake? What gives you confidence that this isn't a head fake, versus just the normal choppiness that we've seen in this recovery?

That's a really good question, Kathryn. I guess my answer to you is, the two significant declines of the last 15 or 20 years that we saw, I would say there was much more consistent bad news and an overall feeling of uncertainty that I don't think really exists today. I think even if you listen to the general economic news, you don't hear calls that we are in the midst of the beginning of a recession, or something uglier than that, or a crisis, like in the financial sector.

You hear much more of a discussion about, I would call it malaise. Are we going to move up, are we going to move down? So I don't think there's anything out there today, anything that I can read that would say that the general tenor is that bad.

Of course, when Brexit happened, a lot of people were trying to figure out and read the tea leaves. What is the impact? It doesn't appear to have had a massive impact on the UK or the global economy when it happened immediately, right?

So I think the good news is that the data trailing behind Brexit was not followed by a consistent pattern of bad news about the UK or Europe. Certainly there are people worried about it, but to me, that's gone out of the headlines a little bit, as of late. It's still out there lingering, and so I think the question is going to be, do we see a pattern of a number of those bad news events? Certainly the global terrorism stuff that we continue to see doesn't help, because all of those things erode confidence at one level, right? You can't help but be concerned about what all of these events eventually could add up to.

On the other hand, as Jeff said, I think you've got to look at multiple points to get your mind around what you are seeing in the business. If I look at Architectural Billings, those look pretty good. Those guys tend to be a little bit ahead of the industry in terms of what they are feeling. That's hung in there pretty strong.

If you look at generally corporate profitability, while it's not increasing at the rate anybody would like, it's still actually pretty darn good. And capital structures are in great shape, with very low interest rates, right? People can borrow money at very low rates to go do the things they need.

I also think there is a general backdrop for our business, of a need for a transformation of the workplace to enable companies, not just the big tech guys, even though I mean some of them are asking similar questions, but of the companies that are trying to cross the chasm of the impact of the digitization of the world, whether that's the automotive guys, whether it's retailers, whether it's restaurant companies. All of them are trying to figure out how am I go going to play in this new world, and to do that, they have to be able to go get the talent that they need to make that happen. And they realize that their workplaces can't look like they did in 1985, if they're going to make that cross.

That seems to leave a backdrop of not just facilities people, but business leaders asking the question, what do I have to do? And one of the ingredients seems to be, what I do around my facilities? Now, we're not foolish enough to think that if we hit a really sustained downward trend in GDP and business activity, that we can play through that. I think the days when that happened are probably gone. And corporate America in particular is darn good at adjusting cost structures and capital spending. So we're not foolish enough to see that.

On the other hand, I think when we look at the inputs to the industry, when we look at the proclivities of Chief Executive Officers, we look at contract activations, the number of customers that are coming here not only to visit us about projects, but to talk about big ideas of things they need to do, our gut is that while we don't see runaway growth, we see reasonable prospects in the forecasts that we're looking at today still feel reasonable to us overall.

That also combines, by the way, when you look at our overall growth rate, a belief that we're going to continue to get traction that we started to see a bit in the fourth quarter, started better in this quarter, around the consumer business. And certainly, we had a lot of issues in the second and third quarter of last year in the consumer business, that if we keep our act together and do the things that we have put in place and they continue to have impact, we should see some growth in that area too, that's probably outside of the issues related to the contract business.

That's helpful. Final question, this really gets more from some of our various checks that we do. Speaking to a large healthcare architect design firm focus, they had noticed a change in their healthcare demand, shifting from new builds to a greater wave of remodel taking over. And it's just really, I'm curious, are you seeing a similar trend, or are you able to track that trend? Thank you.

That's a good question. I don't know if I know that level of detail, of whether it's remodel or not. I would tell you part of the question, this is a little -- you almost have to know what the architect was referring to. Because I think the way we are defining healthcare, and I think this is increasingly the way healthcare is being delivered and managed, is a healthcare organization today is both a hospital, an outpatient clinic, an outpatient surgery center, a rehab center, an insurance company and on and on and on, right? So you almost have to ask which organizations.

What we see is a lot of these larger healthcare organizations are trying to deal with a two-pronged approach to, I have to deal with cost pressure, but at the same time, I have to increase patient satisfaction if I'm going to get paid. So I can't just cut costs and not have people happy. And by the way, I have an increasing pressure to get talent and keep them healthy.

So I think those combinations of things are what's driving the whole healthcare space. To me, the biggest question about healthcare going forward is what happens with the pressure that's now on the exchanges, and whether the exchanges continue. Because certainly a lot of healthcare organizations are building towards what they believe is a bigger and bigger customer base. That's going to be the question. Does that play out the way everyone expects, given the news out of Aetna and others.

Perfect. Thanks very much.

That concludes today's question-and-answer session. I'd like to turn the call back to Mr. Walker for closing remarks.

Thanks for joining us on the call today. We appreciate your continued interest in Herman Miller and look forward to updating you next quarter. Have a great day.

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