Herman Miller F2Q08 (Qtr End 12/01/07) Earnings Call Transcript

Herman Miller Inc. (MLHR)

F2Q08 (Qtr End 12/01/07) Earnings Call

December 20, 2007 9:30 am ET

Executives

Brian Walker - President and CEO

Curt Pullen - EVP and CFO

Joe Nowicki - Treasurer and VP, IR

Analysts

Matt McCall - BB&T Capital Markets

Chris Agnew - Goldman Sachs

Budd Bugatch - Raymond James

Todd Schwartzman - Sidoti & Company

Presentation

Operator

Good morning, everyone, and welcome to the Herman Miller Incorporated second quarter fiscal 2008 earnings results conference call. Today's 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 Forms 10-K and 10-Q, and the other reports filed with the Securities and Exchange Commission.

Today's presentation will be hosted by Mr. Brian Walker, President and Chief Executive Officer and Mr. Curt Pullen, Executive Vice President and Chief Financial Officer. Mr. Walker and Mr. Pullen are joined by Mr. Joe Nowicki, Treasurer and Vice President, Investor Relations. Ms. Walker and Mr. Pullen will open the call with a brief presentation, which will be followed by your questions.

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

Brian Walker

Good morning, everyone. As always, I will open our presentation with a few introductory remarks and turn the call over to Curt and Joe for a more detailed review of our results.

As you can tell from our press release, we have been busy this quarter. Our business performance has been strong, and we made substantial progress in furthering our mission around performance innovation. We previously shared our intent to improve our underlying business performance and to accelerate our investment in our growth initiatives. We said we would move quickly, and we have. We've made significant steps forward in both areas this quarter.

First, let's talk about improving our business performance. We told you there were two areas we were looking to improve upon, increasing our operating income, and utilizing our balance sheet more effectively. At the end of November, we described a plan and set specific actions towards a goal of increasing operating income, to 13% of sales.

These actions are always difficult, but we recognize they were necessary to maintain our competitiveness and to enable greater and faster investment in our growth initiatives. Then yesterday, we outlined a series of actions we are taking to utilize our balance sheet more effectively. We have taken advantage of the current favorable interest rate environment to change our capital structure.

We issued $200 million in private placement notes, and we utilized these proceeds to repurchase our stock through an Accelerated Share Repurchase agreement. We are also increasing our syndicated revolver to $250 million providing a further financial flexibility to continue to invest in our strategic growth initiatives.

Some of that why now, we management and the Board are confident that we have a compelling strategy and business model that will create long-term value for our shareholders and employee-owners. We have capacity in our balance sheet, and we believe the valuation is at a compelling point to invest.

One of the strategic growth initiatives is the acquisition of the Brandrud a great strategic fit that will expand our healthcare product offer and add management talent and depth to our efforts.

Brandrud is a quality manufacturer of healthcare furnishings with an emphasis on seating products for patient rooms, patient treatment areas, and public spaces, such as lobbies and waiting areas. We have shared a successful marketing alliance with them since 2005 and look forward to further gains going forward.

I would like to take a moment to recognize the great work of our employee-owners over this past quarter. Not only did we move quickly to get traction on some big initiatives, everyone continued to deliver on our day-to-day objectives. This work not the big initiative is what enabled us to drive solid earnings in EVA growth and a very modest top line improvement.

Our commercial teams have done a terrific job of finding and closing opportunities. The organization responded to our call to more closely manage costs and eliminate ways. And our manufacturing teams continued to improve productivity and deliver solutions to our customers on time with impeccable quality. While we accomplished a lot this past quarter, our agenda remains very full.

First, our people will be focused on completing them [fruition] of the changes, we recently announced. While the people changes were announced, we still have work to do. Second, we have a very full queue of new products for the core business international and healthcare. Many of these products will be introduced over the next 18 months. Third, we will continue to expand our international business, which is growing in a very good pace.

Last, we will be ramping up our Convia business. This past quarter, we opened a show-case facility for Convia in Buffalo Grove, Illinois just outside of Chicago. This space has really enabled prospective customers to experience the full potential and benefits of Convia. As a result, we have a growing [from our] prospective customers and have begun to supply some inventory into the distribution network.

We also continue to get external conformation that Convia is a big idea with real and compelling customer benefits. Just this past month, architectural record magazine recognized Convia as one of the most innovative new products of 2007. I’m sure, we will talk more about this during the Q&A, but our outlook has not changed.

Given the current economic environment, we remain conservative in our assessment of the US markets near term growth potential. The actions we took this past quarter were in part a response to this assessment. Having said that, they were primarily driven by our long-term goals. We are very bullish on the long-term potential for Herman Miller and the US office furniture industry. We simply are concerned that the economy faces several headwinds that may result in slower growth. If the short-term proves to be more robust than anticipated, we are well positioned to serve our customers needs.

In summary, while we're watchful of the mixed economic climate in the near term, we are very confident in our long term strategy, and we are taking the necessary steps to secure our future. Now, I’ll let Curt and Joe take you through the details of our second quarter financial results.

Curt Pullen

Thanks, Brian. Good morning, everyone, and thanks for joining us. There is a lot to talk about this quarter so let me briefly hit the highlights. As we ended the quarter, we experienced an increase in order rates, which proved to be sustainable throughout the quarter. Overall, we ended our second quarter with order rates having increased by more than 18% from first quarter levels.

This increased order activity allowed us to end the quarter with sales above our guidance and also drove a significant increase to our ending backlog. Gross margin improved by 150 basis points above our first quarter as a result of improved pricing as well as material cost improvements. Reduced program spending and overall great cost control reduced operating expenses by 140 basis points from Q1.

These elements combined to result an operating income of 12.9% for the quarter and drove our earnings per share to a record of $0.67, up 20% from our previous record of $0.56 one year ago. Included in these results is the $5 million restructuring charge, which if removed would have resulted in operating income of 13.9% and EPS of $0.72, an increase of 29% over the prior year. We also produced solid cash flow from operations increasing over 80% to $56 million for the quarter.

Let’s look at sales and orders. Second quarter sales of $506 million represented our 16th quarter in a row of year-over-year revenue growth. Although our growth was modest at 1.4%, we exceeded the top of our previously provided guidance of $475 million to $500 million. This is due both to an increase in weekly order rates, which we began to experience at the beginning of the quarter as well as continued strong growth from our non-North American segment.

Last quarter, we described that our order rates were down year-over-year, which prompted cautions in our forecast for our second quarter. As we entered the quarter, we experienced an uplift in activity levels that was greater than our normal seasonal pattern. This improved order pacing contributed to our ability to exceed our revenue expectations since we are able to translate a portion of these orders into shipments during the quarter. On a sequential basis, second quarter sales were up 3% from our first quarter.

North American sales were flat year-over-year as well as sequentially from the first quarter. This was primarily the result of slower first quarter order rates. Non-North American sales continued to experience double-digit growth over the prior year showing growth of 18%. This strong performance was led by the UK and China both of which grew at more than 60% for the quarter.

We should note that we experienced the benefit to our international sales of approximately $7 million due to the foreign exchange impact with a weakening US dollar. The weak dollar also increased the operating income of our international businesses by approximately $1.6 million.

Orders for the second quarter were the highest level we have seen in seven years ending the quarter at $573 million, an increase of over 8% compared to year ago levels. In fact throughout our second quarter, as I mentioned, we experienced overall weakly average order rates that were 18% above our first quarter levels.

Let's unpack this a little. Orders in North America rose 10% over the prior year and 20% sequentially compared to our first quarter. We realized the biggest year-over-year gains in our eastern and northern regions of the United States as well as outstanding increases in Canada and Mexico. Some of this is attributed to seasonal increases in order activity partially due to the Federal Government, but we also experienced an increase in a volume of non-government large project business.

Sequentially, it is not unusual for us to experience a 7% to 8% increase in order rates in our second quarter versus our first quarter due to these seasonal factors. This year our uplift of 20% nicely exceeded that trend.

Orders for the non-North American component of our business increased over 12% with the strongest gains in China, Japan and the UK. The growth in order levels throughout the second quarter resulted in a healthy ending backlog of $347 million, this is a 7% improvement from year ago levels and a 24% improvement from the end of our first quarter.

Going to gross margin, we are very pleased that our gross margin performance for the quarter which ended at 35.6% and represents an improvement of 150 basis points over the prior year of 34.1%. The strong performance was primarily the result of our ability to capture price improvements as a result of the previously inactive price increase as well as favorable material pricing during the quarter.

On a sequential basis, gross margin equally improved by 150 basis points from the 34.1% recorded in our first quarter. The sequential gains were driven by high production volumes and a mix shift towards more profitable product and service lines. Looking forward, we are mindful of recent increases in crude oil prices and the effect that this could have on diesel and other commodities.

Operating expenses for the quarter totaled a $110 million or 21.7% of sales compared to $112 million or 22.4% of sales last year. This represents a year-over-year decrease of $2 million or 70 basis points with only a modest increase in sales. We experienced year-over-year increases in compensation costs, FAS 123 stock-based comp costs and tax related accruals. These increases were more than offset by lower program spending and overall cost control.

The cost reductions announced at the end of November resulted in our recording of a $5 million restructuring charge during the quarter. These one-time costs were all related to employee severance. Gains in gross margins and operating expenses drove operating income as a percentage of sales to 12.9% for the quarter, the highest level we have reported since May of 1999. Excluding the restructuring charges, operating income was 13.9% a quarterly record for the company.

Our effective tax rate for the quarter was 34%, which was at the top of the range of 32% to 34% that we were forecasting and was driven higher by our increased net earnings in the quarter.

Consolidated net income for the quarter was $41 million, a 12% increase over the prior year. And we are extremely pleased with our all-time record earnings per share for the quarter of $0.67. Again this includes a $0.05 per share charge from the restructuring activities, which when excluded, would result in EPS for the quarter of $0.72, a 29% increase over the previous record of $0.56 that we reported at this time last year.

I'll now turn the call over to Joe Nowicki, our Treasurer and VP of Investor Relations. Joe has been extremely busy this quarter as we worked to realign the capital structure. So Joe, take us through your work.

Joe Nowicki

Thanks, Curt. Before I jump into the current quarter metrics, I want to start with the big news on our capital structure. We've completed the analysis and implemented the results of the work that we launched with last quarter's press release. We have announced a series of changes, designed to increase the utilization of our balance sheet, to support the acceleration of our strategic investments, and value enhancement for shareholders.

First, we have taken advantage of the favorable interest rate environment and have agreed to issue $200 million in Senior Unsecured Private Placement Notes, $50 million in Senior Notes of 5.94% due in January 2015 and $150 million in Senior Notes at 6.42% due in January of 2018.

The proceeds will primarily be used to execute an Accelerated Share Repurchase Program to repurchase 200 million of our stock. We'll finally begin the transaction in January of 2008, as mostly probably that an ASR is a tool used by companies to quickly repurchase a large amount of stocks.

The company buys a large block of stock from an investment bank that has borrowed the stock from third parties. The bank closes on the stock loan position over time and a purchase price to the company similar to open market purchases. The exact number of repurchased shares will be determined at the conclusion of the agreement, although the majority of the impact will be included in our share count by the end of the company's fiscal third quarter.

This approach provides for a degree of certainty in terms of the details of the repurchase by enabling upfront share count reduction for most of the shares, which increases our EPS sooner than a purchase of shares overtime.

In addition, we have also replaced our existing $150 million credit facility with a new $250 million Unsecured Revolving Credit Facility. The new facility will be used to refinance existing debt or provide working capital and will allow for a higher level of overall financial flexibility as we continue to invest in our strategic growth initiatives.

These actions demonstrate the confidence we have both in our strategic growth initiatives and the long-term strength of our business. We are also designed to complement our newly authorized 300 million share repurchase and complete the capital structure changes we discussed in our first quarter financial release.

As for the result for this quarter, cash flow from operations was $56 million in Q2 compared to $31 million in the prior year. Higher net income and lower working capital requirements in the current quarter were the main drivers of the year-to-year change. Working capital requirements drove a use of funds of $3 million in the current year as compared to $17 million in the prior year.

Capital expenditures up $10 million for the quarter are even with the prior year and well within our planned levels. We returned $5.3 million to shareholders this quarter in the form of stock repurchases and another $5.4 million in dividends. In total for the quarter, we bought back approximately 200,000 shares at an average price of about $27 per share. It's important to note that we executed very few share repurchases during the quarter because of a self imposed blackout due to our operating income and capital structure review work that was underway.

As at the end of the quarter, we still have approximately $368 million remaining on our board authorization. We ended the quarter with a cash balance of $74.2 million. Of this amount, approximately $64.2 million is currently located in our international entities.

Now, I'll hand it back to Curt.

Curt Pullen

Thanks, Joe. Let's turn to the outlook for the third quarter of our fiscal year. We have discussed our strong order entry during the second quarter, and we're starting the third quarter with a solid backlog. However, we are remaining somewhat cautious with our midterm forecast due to the continued mixed macroeconomic factors, some of which could affect near-term demand in our industry.

Also, our sales teams have done an excellent job of winning certain projects that are currently in our backlog but which are not scheduled to ship until after our third quarter. Additionally, we are scheduled for a full week plant shutdown over the holidays. And although we're expecting to close the Brandrud acquisition sometime in February, it will only have a minor impact on revenues this quarter.

When all of this is combined, we anticipate third quarter sales to be in the range of $475 million to $500 million. We anticipate continued favorable impact on gross margins from pricing and continued improvements in the margins of our new products. Commodity prices could become a bit more challenging during the quarter, and we will also likely lose some leverage due to reduced production volumes during the holiday season.

Operating expenses are expected to remain relatively flat, as cost reductions will be slightly offset by higher planned program spending. The effective tax rate should again be in the range of 32% to 34%.

Additionally, as a result of our Accelerated Share Repurchase Program, our forecast for the quarter also includes a reduction in our weighted average shares outstanding of approximately 3 million shares. In terms of earnings guidance, we expect earnings per share to be in the range of $0.55 to $0.62 per share for the third quarter, which would represent an increase of 10% to 24% over the prior year.

I’ll now turn the call back to the operator, and we’ll take your questions.

Question-and-Answer session

Operator

(Operator Instructions) We'll go first to Matt McCall with BB&T Capital Markets.

Matt McCall - BB&T Capital Markets

Thanks. Good morning, everybody.

Curt Pullen

Good morning, Matt.

Joe Nowicki

Good morning, Matt.

Matt McCall - BB&T Capital Markets

Let’s say, first the question, the clarification on the authorization. I think, you just mentioned that you have got $368 million left on the other authorization, is the accelerated buyback. Is that separate from the $368, is that going to reduce that $368 by $200?

Joe Nowicki

No. Matt, it's not separate. It will actually reduce to $368, when it's completed.

Matt McCall - BB&T Capital Markets

Okay, thank you.

Curt Pullen

This is a vehicle by which we do some of that, sometime.

Matt McCall - BB&T Capital Markets

Okay. Just wanted to make sure, I wasn’t double counting.

Curt Pullen

Right.

Matt McCall - BB&T Capital Markets

Help me reconcile the orders comments, I think you broke down the North American and non-North American numbers and I think they were both north of 10%, but orders overall were only up 8%? Help me understand what I'm missing?

Joe Nowicki

Yes sure, I will give you a couple, this is Joe. I will give you a couple of pieces of that probably for you. One of them in looking at some of the components are we have a Herman Miller for the Home Business. That business was slightly down from where we were year ago, so our Herman Miller of the home component was down. We also, in prior years, had some OEM business, since some OEM sales that we did. And we are no longer doing those and that was a second component that kind of went away and also like of decreased number from the components to that 8% in total.

Matt McCall - BB&T Capital Markets

Okay. When you breakout North America and non-North America, you’re excluding those but you’re excluding the impact to that when you talk about the overall order rates?

Joe Nowicki

Yes, if you look at our total order rates of the 8% increase, there are really three elements to it. The North America that’s up 10%, the non-North America that’s up 12% and the other component which is actually is down year-over-year.

Matt McCall - BB&T Capital Markets

Okay. Thanks that's take care...

Joe Nowicki

Does that help?

Matt McCall - BB&T Capital Markets

Yes, it does. Curt, I think you just talked about, I didn't hear if you quantified it, some of the products that or some of orders that weren’t shipped until the out quarter did you give us a number on that?

Curt Pullen

No, I didn’t give you a number on that, we just have been very successful Matt, and picking up some jobs that have a pretty long cycle time item. So they're in the orders they are in the backlog, but they're not scheduled to go out and sell into the third. So as we rolled up our estimates we've taken that into consideration.

Matt McCall - BB&T Capital Markets

Okay. And then finally, you talked about shares moving down three million in the out quarter I guess just looking at the number in dividing the share price by the $200 million. I know it’s a rough estimate, but it looks like it could be probably double that in the reduction in the share count when everything is finished?

Curt Pullen

Yeah, somewhere in the region, we're not sure what the share price is going to do and that allowed at the end, but we'll take the $200 million and we'll get a big portion of that upfront, despite the way the ASR works.

Matt McCall - BB&T Capital Markets

Right.

Curt Pullen

And then, of course, it's all about how that weighs out during the timing of things.

Brian Walker

Yeah, the three million number is the impact on the weighted average shares outstanding for the quarter.

Joe Nowicki

Which means you won't even kick off the agreement until one month is completely done, and by the time you get the agreement activated, Matt…

Matt McCall - BB&T Capital Markets

Okay.

Joe Nowicki

You are probably more than halfway through the quarter if you just look at it roughly.

Brian Walker

Right. So, I'm looking at the right way when I say 200 million divided by whatever the prices not going to get rough impact.

Joe Nowicki

Yeah.

Curt Pullen

By the time it's already done. You're right.

Matt McCall - BB&T Capital Markets

Got you.

Curt Pullen

How it lays in it will depend on the timing of things.

Joe Nowicki

So that the three million is for the third quarter, we'll see more obviously in the fourth quarter, and then when it's all wrapped up, we'll see the remaining marked portion come through.

Matt McCall - BB&T Capital Markets

Okay. Thank you. And then the final question. Any update, we've talked a lot about the new square footage environment, how a lot new offices are going to be opening. Can you say if that's really what's providing some renewed strength in the order patterns, or are you seeing an improving pipeline from where we were, it sounds like you are, from where we were earlier in the year?

Brian Walker

Well, Matt, this is Brian. I don't know if I will relate it to that specifically. First of all, as Curt said in his comments, it's typical for us to see a bit of a seasonal up tick from Q1 to Q2.

Matt McCall - BB&T Capital Markets

All right.

Brian Walker

That's pretty typical. I think if you look under it, it was better than what we expected.

Matt McCall - BB&T Capital Markets

All right.

Brian Walker

We normally see some of that up tick because of the Federal government, in particular, is stronger in the second quarter. This year we had now and the Federal government that we tick up, but we also had really strong activity in terms of some new corporate business that we won. And I don't think those are necessarily related, just a new square footage as much as they were due to competitive situations, where we had some projects pop into the second quarter. So, overall I'd say our center is still relatively the same as what we've been talking from the beginning.

We had the sales force still sees reasonable activity in terms of client visits, in terms of projects that are coming up on the board. But I'd still say overall, we are just a little cautious with what we see going forward given the macroeconomic picture and I think our bigger concern is going to be more around employment and profitability than it is square footage driven.

Matt McCall - BB&T Capital Markets

Okay. And I'm sorry, you just described it as reasonable the activity, is that kind of the way you're saying you've been describing it for the last couple of quarters?

Brian Walker

Yeah, I don’t think -- I think coming out of the first quarter, because of where orders were and especially growth rates than orders. We were a little unsure what we see in the second quarter. Again it picked up more than we thought, but if you go look at it, we are still running about the kind of year-over-year growth rates in total, you guess it is six months that we expected.

It was a little better this quarter. Yes, it was. Are we happy that we are going with a little stronger backlog into the third quarter than we originally would have thought, if you went back in to September, that's true? Personally, I think we'll know a lot as we get through this third quarter about what the direction is. Often as companies are resetting budgets and those kinds of things they had and they were mostly calendar year end companies. We'll get a much better feel as we see what happens with capital spending plans in the New Year.

Matt McCall - BB&T Capital Markets

Okay. Thank you all.

Operator

And we'll next to Chris Agnew with Goldman Sachs.

Chris Agnew - Goldman Sachs

Thank you. Good morning, gentlemen.

Curt Pullen

Good morning, Chris.

Brian Walker

Good morning, Chris.

Chris Agnew - Goldman Sachs

First question on margin, is it possible to break out the contribution to the uplift you got in this quarter by mix volume price and commodity pressures?

Joe Nowicki

I can give you a rough feel for that in detailed by number math or Chris if I can give you a rough kind of breakdown of it. We did get a benefit from the pricing piece of it clearly that kind of helped us out year-over-year and the material performance piece of it from a commodity costs also is one of the big drivers that helped us out as well. So from a year-over-year perspective those were the two big drivers to it.

Chris Agnew - Goldman Sachs

And then maybe as a follow up to that and thinking going forward. When are you anniversarying the price increase? Are you planning another coming up and you talked about a lot of new products in the pipeline is it fair to assume that that is a slightly sort of dilutive effect on gross margins initially until you pick up the volume runs?

Brian Walker

Price increase last one was done in.

Curt Pullen

February

Brian Walker

February of '07. So, that will anniversary in this next quarter Chris, this is Brian. As far as an additional price increase, we are certainly in that mode of evaluating when and to what degree. We don't have any specific plans at this point in terms of the timing. So we'll only nail down, we are looking at of course yeah that's one of the questions we are also trying to figure out where the industry in general is going around those issues. So, that's not one that we have, we've made a final determination about yet.

As far as new products, I'd tell you that somewhat depends on what category the new product is in and it also depends what's the nature of the new product. By that I mean, in some cases the new product are derivatives of current platforms, when you are not only trying to increase customer value, but of course we are also looking at how can, we redesign some of the products that are manufactured to help how they move through the plant to actually improve margins.

So, I wouldn’t necessarily say that’s a general thing that new products dampen them. And also, they tend to be a little bit smaller part of the mix in the early life. The products we have in the pipeline in the near-term are primarily in the areas of storage and seating, which on the seating side, we tend to get ramped up on margins faster than we do in some areas like systems products, which are way more complex in terms of the whole manufacturing and logistics side.

So, at this point, we don't expect a significant dampening and they will come in waves, so you won't see them all hit at onetime, they will happen over, they will be spaced out throughout that 18 months. So, I’m actually fairly confident that we're in pretty good shape there.

Chris Agnew - Goldman Sachs

Okay, thanks. And then two sort of quick questions, I will ask both together. The $250 million facility, will you use that primarily for say long-term strategic objectives. Am I thinking right in terms of acquisitions or would you also consider using some of that facility for additional share buybacks overtime?

And then the other question was you provided some color in terms of geographic distribution and pockets of strength. Is there any by maybe like business line, financial services, healthcare, legal, is there any differentiation in activity that you are seeing in the quarter? Thanks.

Brian Walker

Good question. First of all the $250 million, we'll use it for acquisition share. I don’t think it will be one of those items we've used for share repurchases. But, we should generate some free cash flow as well, in fact after as we get through the ASR period. So, primarily we use it for acquisitions where we need to invest in capital to grow the business those kinds of things more than it would for the share repurchase side.

On the other hand again, we'll generate reasonable cash flow, as you saw this past quarter. So, we should actually have some cash for repurchases beyond what we are at when we get to outside of the ASR period.

Curt Pullen

I think of the revolver, as more of the financial flexibility to Chris. So, that as opportunities come up we can use it to fill in and go out to payoff as we did in the cash flow. Brandrud, is a great example of one that as that one gets kind of closed, we would use the revolver to temporarily fund it and then through cash from operations to be able to come out of it again.

Brian Walker

As far as pockets of strength in terms of business sectors the business has been pretty even in terms of the sectors. I don't think there has been anyone area that’s been a particular standout, we've see. We have had some good wins in the insurance area, which has been positive for us.

We again, this is a heavier period in particular for government business, but it’s been pretty well spread, so far from what we've see. That's talking domestically primarily Chris, I don't know, if you were asking that question specifically about international.

Chris Agnew - Goldman Sachs

What I would say is, yeah principally domestically, but I mean either? But, no, thanks very much.

Curt Pullen

Yeah.

Operator

And we'll go next to Budd Bugatch with Raymond James.

Budd Bugatch - Raymond James

Good morning, Brian. Good morning, Curt. Good morning, Joe.

Brian Walker

Good morning, Budd.

Curt Pullen

Good morning, Budd.

Joe Nowicki

Good morning, Budd.

Budd Bugatch - Raymond James

On the composition of business, can you talk a little bit about project versus non-project? You said you had some good project wins. What's the, I usually ask what's the composition percentage wise of orders or sales this quarter?

Brian Walker

Yeah. The project business was down slightly, it ran around 41% of the total. So, it was a little bit less than what we saw last quarter and the prior quarter. But still in the upper 40s, which is still a pretty good place to be. So, that was pretty good.

Budd Bugatch - Raymond James

Upper 40s or 41.

Brian Walker

41, I’m sorry. But still at a pretty good number being in the 40s.

Budd Bugatch - Raymond James

Okay.

Brian Walker

I think we also did see though from a composition perspective, a lot more big project. So, we define them by different size. There are a lot more million dollar plus kind of projects coming in that we have seen in the past. So, that was another interesting note that was different from the past few quarters.

Budd Bugatch - Raymond James

And when you are winning those projects, I take it what's the composition of product is [seating], systems or allover?

Curt Pullen

It’s all over, but it will be a pretty normalized mix generally. Especially the larger ones and of course those often are there is a project and then it plays out overtime in terms of what you have been ongoing a relationship with that customer.

Budd Bugatch - Raymond James

Understood. When you look at profitability by geography, I think you normally give us of margin North America and non-North America. How does that look?

Brian Walker

I don’t know that we normally give that. I would say that our international profitability is very good and maybe slightly higher this quarter internationally than domestically.

Budd Bugatch - Raymond James

Okay. And if we do the math on your composition of order growth, it looks like order is down about $5 million year-over-year. Is that about right and is Convia in there?

Curt Pullen

Yes, Convia is in there. But that is not a driver to the decrease. The decrease is largely driven by this OEM business that we had before. We were doing some business for one of the white goods manufacturers, where we did some metal casework that we decided to exit that business. That’s the biggest drop off.

Joe Nowicki

And that was, by the way, about $6 million for the quarter that in itself and that was $6 million in last quarters and last year its zero on this year on it.

Budd Bugatch - Raymond James

And next quarter, what would that business have been when we anniversary the reduction of that? I know, I remember that business now which -- how much did it run $6 million a quarter for the next couple of quarters and…

Brian Walker

They will do, actually.

Curt Pullen

Yeah. It was about $6 million a quarter, last quarter we would have seen that. This quarter and I think there are two more quarters?

Joe Nowicki

Yeah. I think the contract ended right around at the end of our fiscal years, when we exited, but…

Budd Bugatch - Raymond James

Okay. And Convia, can you talk a little bit about revenues, can we get some numbers?

Brian Walker

I think, last quarter Curt said to me. Yes, there were revenues. I think that was the quantification…

Joe Nowicki

The comment would be fairly similar this quarter. But it’s still very, very small in terms of actual booked revenue. While we have started to see, we will see some more in the third quarter because, and I think this business runs a little different than our core business where, when a dealer gets an order from a customer they send it to us and we ship at the time and they are looking for the product to be installed, if you will.

This business in the, because a lot of it is going through the electrical contractor deal you actually fill the inventory pipeline into the two step distribution model, so you put it in to the master distributor, who then is having the local wires picked from that inventory, if you will.

Based on the strength of some of the forward activity we see in our third and fourth quarter, we know that the distributor was going to build a little bit of inventory as we go into the third quarter based on the project from what they can see out there. What I would say to you at this point is, we don’t -- we came in here assuming the revenue number would be not really all that material. It’s a good sign that we're starting to see it. The pipeline is getting there in terms of project and I think as we get out of the third quarter what I have really better ability to come back and quantify for you, how much of that stuff were actually being able to get over the transom. It's going to be an important coming three, four months for us.

Budd Bugatch - Raymond James

Do you as you (inaudible) and this we call this material for disclosure purposes in terms of segment or additional reporting?

Brian Walker

Yeah. I do, but I'd think that, Budd, that's probably not in the next few years, just in terms of, it's going to ramp up from, it’s a little different because this is a startup business. I think part of the thing is going to be how much do we get crossed over between the infrastructure business and the core furniture business.

Budd Bugatch - Raymond James

With your profitability of this, that's got to be a drag on earnings right now, you want to quantify that?

Brian Walker

The drag, certainly the drag, I'd say that it's not huge big and a big scheme alike in terms of net profitability. The margins are actually pretty decent on it, the gross margins, when we're actually shipping products. So, it's primarily since we got the ramp up costs and the operating expense right now.

Budd Bugatch - Raymond James

Okay.

Brian Walker

A lot of capital involved either. So, this is not heavy capital business at this point. And it's not a heavy business from an operating structure. We only, I mean it’s very, very few people, you are really talking about a handful of folks, all of the manufacturing is largely our source. So, we're not talking about major, major infrastructure here.

Budd Bugatch - Raymond James

Okay. And just final area is Brandrud you kind of joined alliance with them or a strategic alliance with them I think for a while couple of years, what's the incremental impact on revenues and earnings from that this year or next year.

Brian Walker

Well, it will be fairly small this year and of course it won't really get the acquisition done until the end of the third quarter essentially right at the end, probably the last month. I think you have seen the reports that Brandrud is around $20 million in sales.

Budd Bugatch - Raymond James

And were you booking any of that now yourself or is that all their revenues?

Brian Walker

We were getting a fee from them. So, it's actually fairly modest in terms of what we had in terms of revenue.

Budd Bugatch - Raymond James

Got you. All right Brain, thank you.

Brian Walker

Thanks, Budd.

Operator

(Operator Instructions) We will go next to Todd Schwartzman with Sidoti & Company.

Todd Schwartzman - Sidoti & Company

Hi, good morning, gentlemen.

Brian Walker

Good morning, Todd.

Todd Schwartzman - Sidoti & Company

Just wanted to follow-up on a previous question internationally, which customer segments are the strongest and the weakest right now?

Curt Pullen

I think it really, is around a patch we have had continued very strong growth in the UK as we mentioned Todd and Asia and China. I don't know that we really would say in any one particular industry we do a great job with the government business right now. John Paul, like the guy that runs the international piece would say that. That government business in the UK has picked up pretty nicely in the quarter and I don't know what else we do with that.

Brian Walker

We do a lot of business with large financial institutions around the globe and a lot of tech companies of course moving stuff to both China and India and those kind of places. So we are serving a lot of our core typical industry segment things like high-tech banking. We have done some infrastructure folks, I know in China particularly some of the state owned enterprises have been interesting piece of the business for us.

So, it's a pretty fair spread. I think even in Canada, as Curt talked about had a good quarter as well too.

Todd Schwartzman - Sidoti & Company

Sure.

Joe Nowicki

And in Canada, it was actually an interesting area with several utility companies. So, there is another industry group which we saw some strength in.

Curt Pullen

And that is a good add, because internationally it has also been some of the oil and gas guys, as they have expanded internationally.

Todd Schwartzman - Sidoti Company

And within China, how much of the total is represented by the state owned enterprises?

Brian Walker

Yeah. I don’t know if I can give you a percentage on that. I don’t know if I've got a percentage of the top of my head. But it's been probably a nice little surprise for us at some level as those folks have been more accessible to us than we probably would have thought going in.

Curt Pullen

Yeah. John's comments to me, when I was talking through the results with him Todd were that there has been very strong demand from the Chinese companies and as he felt like there was room to grow on that. Particularly some of the seating products that they are interested in so…

Todd Schwartzman - Sidoti Company

Great. And I didn’t catch it, I don't know if you had mentioned earlier but what was the delta for the quarter of North American shipments versus Q2 a year ago?

Joe Nowicki

North America.

Curt Pullen

We had said that that was flat I think, right year-over-year.

Todd Schwartzman - Sidoti Company

Yeah.

Curt Pullen

Was in my comment, yeah.

Joe Nowicki

That’s correct.

Curt Pullen

We had flat shipments in North America versus the prior year.

Brian Walker

If you look back, we had a very big jump last year and we had a big comparable, where we took a lot of orders in the first quarter of last year than shipped. If you go back and look at it sort of bounced between the two. Again, we had more growth this year in shipments in the first quarter and orders looked a little flat. Well, some of that spilled over when you look at the comparisons between the two quarters.

Joe Nowicki

And that's also the same hurdle, we run into the third quarter. So the third quarter last year sales were quite high comparably. I think they were up 14% or so. So, when you look at this year for the third quarter in our forecast keep in mind that we are against the tough comp from the prior year as well.

Todd Schwartzman - Sidoti Company

Okay, all right. Regarding the February price increase, it's now 10 months or so, what are you realizing on average? I realize it does vary greatly. But what kind of realization are you getting?

Brian Walker

Since we've been running, Todd, in the range of somewhere around up. If we asked for the list price increase was about 4%. And it's been running somewhere around 1% to 1.5% in total. So, we've been getting about a quarter to a third of what we are asking for.

Todd Schwartzman - Sidoti Company

That's nearly no difference from the recent past, right?

Brian Walker

No.

Todd Schwartzman - Sidoti Company

Okay.

Curt Pullen

But what happens, Todd, as those contracts renew, you pick up more and more ground, as you're kind of cycle beyond the announced price increase. So, that's what's really happening.

Todd Schwartzman - Sidoti Company

All right, lastly maybe could you shed some light on in discussing some additional opportunities you have to take cost out of the business that haven't really been discussed thus far?

Brian Walker

Well, Todd, since this is Brian. Essentially we made a lot of the major people moves that we saw out there. The rest of the stuff is going to be much more, I would call a programmatic and the much more difficult work that take continuous improvement activities like the Herman Miller production system work. We're constantly working on it in terms of both manufacturing as well as office areas.

We also think there is some room to do some overall simplification of business processes and some of the product lines by looking back at some of the platforms that we have. So, we see some real benefits in that side of it. Those plans are not completely finalized, but we think we can do some things around platforming that will actually increase satisfaction for the dealers and customers at the same time take in some complexity out of both our marketing efforts as well as manufacturing.

So that's pretty exciting for us and we’re looking at making some changes in fact, how we go to market from a marketing perspectives that we think will drive some great benefits in terms of positioning ourselves more effectively with customers. We actually think by doing in the right way. We don’t have to increase costs in fact we think there will be some cost shake out of that.

Todd Schwartzman - Sidoti Company

Just wanted to have one final question, are you doing anything in the way of outsourcing production of seating products. If so, could you maybe elaborate on that?

Brian Walker

No more than we have always in the past. Remember you always have got to keep in mind that we have been a little different than other folks. Although I think some folks have moved in that direction. In several products categories we are largely a big assembler.

So, when you say outsourcing, we don't really think of it necessarily as outsourcing, but our primary driver in manufacturing has been and will be going forward that we design product and solutions specific to ourselves, we then develop those individual components to fit together as a whole and then we will find folks to make any of those components. That we can and what we will do internally is those processes enable us to offer the customer speed, reliability and choice.

So when you look at what we do around seating, we assemble the majority of the chair together and we buy the components in that are made to our specification. We have not made any significant change there, from a business model perspective. Although there is always little tweaks going on around the business, but feeding is the one that is the most clear today and I'd say you'd see the least likelihood of change in.

Todd Schwartzman - Sidoti Company

Okay. Thanks very much.

Operator

And we will take a follow up from Matt McCall with BB&T Capital Markets.

Matt McCall - BB&T Capital Markets

Thanks. Curt, you just mentioned one interesting point that, you talked about contracts renewing. Can you give us any color on, I know it was a tough inflationary environment there for a couple of years, what the opportunity is as some of those roll over the next couple of years?

Curt Pullen

Yeah, I don’t know, Matt. If we really talk about the specifics, I just would say in a general sense whenever we announce a price increase there are certain contracts that we are locked in to that have durations remaining. So as those renew and that can take months or sometimes longer and it is the renewals where you have that opportunity to then adjust.

So, I think what we're saying is that the pricing influence that we are able to see this quarter is the effect of whatever was that mix of business going on during the quarter, which is just sort of a normal thing that we all experience.

Brian Walker

If you remember, Matt, that in our business, and I'm sure we have one of our friends or neighbors listening. And a lot of time many of those customers are in competitive situation, so it's not as if we have them a 100% to ourselves and they just automatically roll to new prices.

So we're often looking at those things, not only in terms of what can we do pricing, but how do we maintain our relationship or build our share with those customers. So, that's a balancing act that really has to make a choice on customer-by-customer, situation-by-situation and there is no real general rule of thumb there.

Matt McCall - BB&T Capital Markets

Got you, good point. Thank you, guys.

Operator

And there are no further questions at this time. I'd like to turn the conference back over to our speakers for any additional or closing remarks.

Brian Walker

Thank you all for joining us today. In closing, I want to thank you for your sustained interest in Herman Miller throughout this past year. I also want to express my appreciation to all the Herman Miller employees for their outstanding contributions in 2007, and particularly in this most recent quarter.

Working through the changes to our business was a challenge for all of us, but we're proving we are capable of achieving still greater results. As we look to the New Year, we are a stronger company, and well position to further improve our underlying business performance, accelerate our growth and utilize our strong balance sheet more effectively.

I am extremely thankful for this holiday season to be a part of Herman Miller, a great company with great future. That's it for now. We wish you best of wishes for a joyful holiday season and a prosperous happy New Year.

Curt Pullen

Thanks, everyone.

Operator

Thank you everyone. And this concludes today's conference. You may now disconnect.

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