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Herman Miller, Inc. (NASDAQ:MLHR)

F1Q09 Earnings Call

September 18, 2008 9:30 am ET

Executives

Brian Walker - President and Chief Executive Officer

Curt Pullen - Executive Vice President and Chief Financial Officer

Joseph Nowicki - Vice President, Investor Relations

Analysts

Matt McCall - BB&T Capital Markets

Christopher Agnew - Goldman Sachs

Budd Bugatch - Raymond James

Todd Schwartzman - Sidoti & Company

Mark Rupe - Longbow Research

Jim Casagrande - Pike Place Capital

Dennis Salvo - Jodocus Capital

Todd Schwartzman - Sidoti & Company

Operator

Welcome to the Herman Miller Incorporated first quarter fiscal 2009 earnings results conference call. (Operator Instructions)

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

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

At this time I would like to begin the presentation by turning the call over to Mr. Walker.

Brain Walker

As always I’ll open our presentation with a few introductory remarks and then turn the call over to Curt and Joe for a more detailed review of our results.

With all the events that have occurred in the financial markets recently I know you’ve all have been very busy. I’ll try to keep my comments brief and let Curt get right to the specifics of our quarter’s results. As our results demonstrate our team did a great job of executing this past quarter. As we expected overall conditions have been challenging, but our strategy to diversify our revenue enabled us to find areas of growth and our employee owners did a great job of managing cost.

We ended the quarter with a modest decline in revenue, but managed to increase our operating income percentages to 11.8% of sales diluted and 11% increase in earnings per share and maintained our strong balance sheet. Orders were better than we expected and benefited from the pull-forward effect of our price increase.

While we are very pleased with the past quarters operating performance and the backlog we take into the next quarter, we understand and are aware that the events of the past few weeks may add to an already challenging environment. You can be sure that we have a firm handle on the levers we control and we will continue to maximize the opportunities presented to us.

The changes we made last November in anticipation of a tougher environment are paying real dividends today. This is reflected in our operating results and is ensured we have the headroom to continue to aggressively invest in our long-term strategic plan.

As I’ve stated in the past, our mission is to improve the performance of human habitats. We do this through performance innovation, inventing new and original ways for our customers and our own business to perform better. We believe this mission and focus will enable us to diversify our revenue base and find new areas of growth and opportunity in the core market we serve.

This past quarter we achieved some significant steps towards this long-term vision. First, we completed the strategic alliance with POSH Office Systems. POSH is a leader in the design, manufacture and marketing of office systems and furniture across the Asia Pacific region. The agreement allows Herman Miller and POSH to access each others product portfolio and distribution network in the region. This will provide us with both new products and new distribution within Asia.

Second, we announced a new retail distribution agreement as part of our Herman Miller for the home business and looking to continue to diversify and grow in the consumer market we have been began working with Costco, the leading warehouse club retailer who is a fluent member demographic allianced closely with our retail customer target.

Third, we finish the development of the new generation of high performance work seating from Herman Miller, the Embody chair. We are greatly encouraged by the positive feedback we’ve received through the early customer engagements. The official introduction of this chair will be at the Orgatec Furniture Fair in Germany in October and we’ll begin to take orders from our U.S. customers in the next few weeks.

The new storage products we introduced at Teneo in June are in production and off to a good and there are still more innovations in the pipeline for the coming year they will continue to grow our presence across multiple markets and geographies. We continue to be excited and confident about the long-term future of Herman Miller and you can be confident we know how to manage through challenging conditions in a manner that balances the need for short-term results with the need to invest for the long-term.

Now I will turn it over to Curt and Joe to take you through the detail of our first quarter financial results.

Curtis Pullen

As you saw in the press release we are off to a good start to the new fiscal year, particularly in light to the continuing challenging environment around us. We did experience a modest decline in sales for the quarter which was not unexpected, but we are encouraged by the strength in order entry for the quarter, up 11% over the prior year.

Gross margins held very well considering a $9 million year-over-year increase in commodity cost. We also did exceptionally well in controlling our operating expenses; they were down $8 million from the same quarter last year. All of that drove a 90 basis point improvement in operating income up to 11.8% of sales. Combine this with a 10% lower share count we ended the quarter with EPS up 11%.

Let’s look at sales and orders for the quarter. First quarter sales of $479 million are slightly lower than last year, but inline with our expectations and about the middle of the range of our guidance. North American sales experienced a decrease of 2.6% over the prior year. The modest decline was primarily in our U.S. office furniture market and is consistent with the challenging macro environment that we are all facing in which this week events only highlighted.

This was partially offset by substantial gains in our healthcare business which posted improvement from organic growth as well as from the acquisition of Brandrud. In addition our North American business also saw continued strength in Canada and Mexico.

In the past few quarters we have been able to offset softer sales in the U.S. with stronger gains in our non-North American business; that was not the case this quarter. We have several large projects in the U.K. and other parts of our international business were orders were recognized this quarter, but the revenue will not be recognized until Q2. As a result of the timing of these projects we saw a decrease in our non-North American sales of 4.5% from the prior year first quarter.

We continue to see growth in most of the emerging markets this quarter, especially in the Middle East, Eastern Europe and South America and we remain confident in our ability to continue to generate growth in the international business. In fact our non-North American orders that I’ll talk about in a moment were up 10% for the quarter.

While the U.S. dollar has show recent strengthening, our current quarter benefited by the weaker dollar relative to one year ago; our international sales were boosted by about $4 million as a result. About half of that was in the non-North American business unit, Europe primarily; the other half Canada and Mexico. The weaker dollar versus year ago levels also increased the operating income of the international businesses by approximately $1.5 million for the quarter.

Looking at orders; in total orders in Q1 were $535 million compared to $484 million last year, an increase of a 11%. While that’s a solid order performance it’s important to note that we did implement a price increase which became effective August 4. As is normally the case we did experience some pull-forward of orders before the price increase took effect. We estimate that amount to be approximately $35 million of orders entered this quarter that probably would have occurred in Q2, but even after excluding that estimate we still demonstrate growth and each of our segments.

On a sequential basis, first quarter orders were up 8% from our fourth quarter total of $498 million. If we remove the effect of the price increase we are about flat with the fourth quarter.

Looking more closely at the order information orders then North America increased about 9% versus the prior year. Some of that increase here was due to that effect that I just mentioned although our healthcare business demonstrated very solid order growth. Our other indicators remain positive as we continue to have a high percentage of our business and projects. In fact we saw an increased in the amount of large projects and an increase in the total volume in our sales flow, but the feedback from our recent annual dealer meetings remains positive.

As I mentioned earlier, orders for the Non-North American component of our business increased over 10% for the quarter, with the strongest growth coming from Europe and South America. In addition as Brain talked about in his opening we have also just for us the strategic alliance with POSH which should augment our growth an Asia. We usually don’t spend much time talking about the other category of revenues which primarily contains our Herman Miller for the home business.

This quarter our home business had a substantially year-over-year increase in orders partially due the price increase we’ve already talked about, but in addition we also start to see the benefit from the new retail distribution alliance with Costco which Brain mentioned, as well as increased order activity from our specialty retailers.

Gross margin is next; our gross margin performance for the quarter ended at 33.9% of sales and represents a decrease of 20 basis points from the prior year of 34.1%. This was truly a significant accomplishment as our margins faced the head wins of both lower volume leverage and significantly higher commodity costs, while at the same time not yet realizing benefit from our recently and active price increase which we expect to begin to see in Q3.

We were able to offset the incremental cost through our focus on continuous improvement and we also had a mix shift away from lower margin services we recorded last year during the same period. On a sequential basis gross margin declined from the 34.9% recorded in the fourth quarter primarily due to the commodity cost increases. I share more later on our specific cost increases.

I’m sure the story will sound familiar as it’s probably the same thing you’re hearing from all manufactures. We were successful in holding of the increases until now, but certain of our contracts have been updated with new pricing and this quarter, we’ve really start to see the impact of these increased cost. We saw significantly increased cost in steel, aluminum and fuel for the quarter, which in total increased $9 million over last year.

While these costs cycled in during the quarter, they ramped up more significantly in August, as we had expected. Thus, we will likely see a further negative impact as we move through Q2, plus these costs will likely be with us for the entire quarter. There were some indication that both steel and oil prices have began this often, which would helps in a long-term; however, even with some moderation from current levels, these cost will likely remain significantly above year ago levels. I’ll take you through our forecast later and we’ll discuss more specifics on this.

Regarding operating expenses for the quarter, the teams did an excellent job of managing costs. Operating expenses totaled $106 million or 22.1% of sales, compared to $114 million of 23.1% of sales last year. This represents a year-over-year decrease of about $8 million or 100 basis points. A majority of the improvement is from the restructure actions we took last November; in addition we also recorded lower incentive compensation cost.

Sequentially, operating expenses decreased $9 million from the $115 million recorded in Q4. This decrease was partially due to lower variable expenses associated with the volume decrease. In addition, our Q4 results reflected higher spending in connection with the 2008 NeoCon Trade Fair. The good news is that even with the lower volumes and resulting loss of leverage and significantly higher commodity cost we’re still able to increase our operating income as a percentage of sales by 90 basis points to 11.8% for the quarter, a great accomplishment.

Effective tax rate for the quarter was 35%, down slightly from the prior quarter of 35.1%, but up from the previous year’s first quarter rate of 33.5%. The expiration of the U.S. R&D tax credit contributed to this higher year-over-year tax rate. Consolidated net income for the quarter was $33.4 million, which is 7% of sales and just about the same amount of net income we generated later last year on 3% lower volume.

Earnings per share for the quarter totaled $0.60, an 11% improvement over the $0.54 per share reported at this time last year. The work we did back in January to change the capital structure helped us drive an improvement in EPS on basically flat earnings, due to the 10% reduction in our average share count.

I’ll turn the call over to Joe and he’ll take us through an update of the balance sheet.

Joseph Nowicki

Regarding the current quarter balance sheet metrics, the company’s cash position at the end of the quarter was a $148 million; of this approximately $54 million located internationally. Cash flow from operations for the quarter totaled $3.9 million compared to $31.8 million for the same period last year. The current quarter’s operating cash flow reflects a working capital and use of funds of $45.2 million due primarily to reductions and accruals for the payment of prior years incentives, which by the way totaled over $38 million.

As you’ve seen in prior years it is not uncomments for us to have low cash flow from operations in the first quarter to the timing of the payment of our incentives. Last year first quarter first is a little different and we also had some offsetting increases in our tax accruals, including an adjustment related to the adoption of FIN48 accounting for uncertainty and income taxes.

Capital expenditures of $8.2 million from the quarter are inline with $8.9 million spending during the prior year and as a quick update on the $200 million accelerated share purchase agreement we enter in January, this has officially been completed as of September 4. In total we repurchased approximately $7.5 million shares at an average price of $26.61.

We received $5 million share of stock in the prior year and on September 9, we just received the remaining $2.1 million, which will be reflected in our Q2 share count. In total PSR reduced our shares outstanding by 12%. Outside of the DSO there were no additional share purchases this quarter. We still have $171 million of share repurchase authorization remaining from the Board.

We also have a strong liquidity position having just renewed our revolver last winter. We currently have approximately $237 million in unused capacity in that revolver. We’re in compliance with all of our debt covenants and currently running with the leverage ratio of approximately 1.3 times EBITDA and just towards the low ends of our targeted range of one to two times of debt-to-EBITDA, but given the current market conditions it’s appropriate relative to our strategy.

That’s it for now on the balance sheet for this quarter; I’m going to hand it back to Curt.

Curt Pullen

We are starting with a solid backlog of $332 million which is 19% higher than last year. Although keep in mind the pull effective of the price increase did help to drive some of that increase. A portion of that backlog will not ship in Q2 based on the customer requirements.

On the positive side we do expect to see our traditional increase in government year end sales this quarter and our international business had several large projects that are shipping this quarter plus the new distribution agreements in Asia and in our U.S. retail business are expected to drive improvements there. All of this bring us to expect second quarter revenue to be in the range of $490 million to $515 million, essentially flat with the prior year.

As I mentioned earlier gross margins in our next quarter are expected to face continued head wins from higher commodity prices and while we expect to realize some benefit from our no going product cost improvement initiative in place and we’ll start to see benefit of the price increase, these efforts or not likely to offset all of the anticipated upward commodity pricing pressure.

As a result our gross margins are unlikely to decline in the short-term from where they have been in the past couple of quarter and be more in the range of 33% to 33.5%. However operating expenses are expected to lower than the second quarter year as a result of the cost structure changes we’ve implemented.

Effective tax rate for the second quarter is expected to be higher than the prior year with some of it to the current quarter as a result of the expiration of the research tax credit and as a result will be in the range of 34.5% to 35.5%. Putting all that together in term of earnings guidance with relative flat revenues, higher anticipated commodity costs and lower operating expenses, higher taxes, we expect earnings per share to be in the range $0.59 to $0.66 per share for the second quarter.

Let me turn the call back to the operator and we’ll take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matt McCall - BB&T Capital Markets.

Matt McCall - BB&T Capital Markets

Curt on the gross margin guidance, maybe if you can help a little more there; I think last quarter or Q1 ’09 you were expecting 32.5 to 33.5, a little bit of an upside surprises their. As you look at Q2 you get a seasonally stronger period on the top line; historically we got a seasonally stronger period sequentially on the margin line as well. A little bit more price sounds like coming through. Maybe give me some idea of what type of pressures you’re expecting. You quantified $9 million this last quarter, how is that going to change and then how much of that is expected to be offset by price?

Curt Pullen

On the price piece, we will start to see a little impact of that in Q2, but more of that is likely to show up in Q3. So, we’ve been fairly conservative in our estimate on how quickly that rolls in. We know that a portion of our current backlog is not scheduled to ship until we get into Q3 as well. So, we’re not expecting a great deal of price impact, it might start to show up in Q2.

On the commodity piece, we probably have a $3 million or $4 million impact relative to what we’ve seen in Q1 that’s going to hit us in Q2, because what we really saw as I mentioned is this timing for us. We’ve got through the first two months of the first quarter with less impact than we saw in August and so we’re going run more like August run rates through the whole of Q2. So, $3 million to $4 million more in Q2 on the commodity side, offset a little bit by the pricing, but more of that pricing effect in fact is going to show up in Q3, that’s how we get to these 33 or 33.5 numbers in Q2.

Brian Walker

Just two things to add a bit of color to it; first of all, as I listen to other folks, I think our situation is similar and that while people are talking about commodities backing off; their backing off in some ways from where people thought they were going to go more than they’re backing of year-over-year. So, you have to be careful as you listen to a folks talk about that.

Then certainly as our case; our forecast or where they’re going in a longer part of the year, we’re actually more positive to, but in fact they are still much higher than what we had the last year in the next few quarter. So, we’re not really seeing relief, we’re just not seeing them continue to climb as far, so keep that in mind.

The second thing is the price increases as Curt described it, that timing of being a couple of quarters out is very similar to the patterns we’ve seen in the past. It’s not only do we have to get through things that were ordered in that sort of pull-forward period, but as also there is lot’s of customers that have projects that are in process that we’ve committed pricing to them prior to when those products actually shipped and so those things sort of get, if you will grand filed under the old pricing agreements.

Joseph Nowicki

The $3 million to $4 million is about what we saw in the first quarter, so as Curt described in the first quarter we saw that $9 million year-over-year number increase. The second quarter it will be $9 million plus the $3 million to $4 million more.

Matt McCall - BB&T Capital Markets

If we carried that current price and cost environment forward would you start to see a benefit shop in Q3, relative to your price and price net of cost would they then turn to a $12 million to $13 million hit year-over-year into a benefit?

Curt Pullen

I wouldn’t say that. I mean I think it will depend on what happens with commodities for one which is still a bit of an unknown.

Matt McCall - BB&T Capital Markets

I was just saying carried and forward from current levels and make that assumption.

Brian Walker

The real question Matt is going to be capture rate of the price increase. I would tell you that the way that we set the price increase, the one that was just implemented is not enough to fully offset the commodity cost increases.

Now the question will be, will we implement further price increases or be able to capture just simply by what’s going on in the market place around pricing. We have seen some of our competitors do additional price increases or surcharges, but we have not done so yet; so that is I think a question mark that’s out in front of us, but of course we’re also in a period where you’re expecting that pricing or these competitions will be pretty tough, so that’s one of those questions we are watching very carefully.

Certainly commodity is going back up; that’s one of those things that we will keep a share buy to it. Do we need further price increases to be able to make sure that we have the appropriate margins going forward?

Matt McCall - BB&T Capital Markets

You mentioned a couple of things, some part of the backlog that won’t ship; you talked about a one time benefit from the initial Costco orders. Can you provide a little bit more color and I think you also said and maybe this is related to the backlog that some of those non-North American orders that will actually shipping Q2, can you provide any detail or can you quantify any of those for us?

Joseph Nowicki

Yes Matt there is a small portion of the backlog that’s not going to go in Q2 and a part of that is the price increase effect that people push their stuffs to the things in, but we also match that up against when the projects are scheduled to ship, so there’s a small piece of the backlog that’s not going to land in Q2 as shipments. That’s how we backed down to the forecasted sales range for Q2, so a piece of that’s going to blow into Q3.

The Costco piece just so we are clear, that wasn’t a one time benefit; what we saw was the launch of the pilot program which went very well and now we are cycling into broader business with them. So, that wasn’t meant to sound like a one time deal just to be clear on that.

Operator

Your next question comes from Christopher Agnew - Goldman Sachs.

Joseph Nowicki

I’m sorry before I go to Chris, Matt you also had a question on the international stuff. John has done a great job of that 10% growth in orders for the first quarter and the projects pacing of their business is going to give them growth in their second quarter over their first quarter results and we’re confident about that. Okay, Chris over to you.

Christopher Agnew - Goldman Sachs

As you look across your own markets, obviously financial services continues to be weak, but are you seeing any signs of weakness, particular weakness in any deal of end markets, either geography or by industry type?

Brian Walker

First of all, I don’t think the pattern is different than what we talked to you guys about last quarter. If you look at the U.S. and asked about it geographically, there certainly have been differences. The West Coast has been a more difficult place than other parts of the country. Some of the Southwest has also been a bit difficult in some ways, clearly tracking around where the biggest problems are in mortgage crisis.

We’ve also seen a little bit softer levels in London in particular; I wouldn’t say the U.K. necessarily overall, but in particular in London, so its sort of money center driven in some ways when you look outside of the U.S. Japan has been a little bit softer if you’ve been following what’s going on with them economically.

Now the good news is, in the U.K. we were successful on a big U.K. long-term government contract that we hope will help us as well as we’ve expanded the distribution there so, we think we got some offsets in the U.K.; we’ll see whether that’s enough.

From an industry sector, certainly financial services in particular of course, the area that you guys are all familiar with, the sort of the IBank world has been the most challenging and in some way the question is not only what’s going in those sectors, but what are we doing to capture customers within one, so sometimes that data gets a little blurrier.

Curt Pullen

Chris, I’d add to that, that with commodity prices having done what they’ve been doing, we’ve had some very strong results in AG Mining and construction related equipment. Energy, obviously we would expect that to be up for us it is and the state local governments continue to be very strong, so if you look across the patch outside of the comments that I made, there are other areas that we’ve grown with over the past quarter.

Christopher Agnew - Goldman Sachs

I guess if I can hear your comments on international. I’m just trying to pick those apart. I mean your orders are up strongly, there’s a couple of projects that shifted around and you actually saw currency benefit and it seems I guess a little bit confusing given what’s happening in the end markets or the European economy slowing in particular. I was just wondering, if there’s more light you can shed around those particular projects or just the general trends you’re seeing in Europe?

Brian Walker

Well, first of all I think Chris, you’ve got to keep in mind there are very few markets outside of the U.S. where we have a significant market share. So, often you are talking about a very small share relative to those markets and so much of the time where we are growing is it’s because we’re either opening new geographies, expanding distribution and/or we’re able to win significant projects on a particular area. So, you’ve got to remember that, we didn’t tell that we can buck the trend of an overall economic cycle; on the other hand it’s not a sort of a direct correlation as we might see in the U.S. business where we’ve got a big footwall, so you’ve got to keep that in mind.

The other thing to keep in mind is, we think of international as one thing, while it’s a fairly diverse thing. So, you’ll see rotation where we’re seeing great growth in places like the Middle East; we’re still seeing a lot of the major oil and sort of commodity guide, there’s still a fair amount of money that’s spent opening up new places for them to go and get new resources; those kind of folks were able to track around and as we build connectivity with them on a global scale we can actually follow them into some of those new opportunity.

So, you have to look at it is being emerging markets, large global multinationals who still are out looking for those kind of resources and you got a couple it with the fact that we’re small player in the lot of places. So, we’re able to kind of follow and pick our shots.

By the way it’s important to note in Curt’s comment, it wasn’t so much that customers moved projects around as just simply was a normal difference between when we get an order when we ship a project. It wasn’t as of they shipped it out because of something that happened in the projects scope, it was just the kind of the normal question mark when you’re a little bit more project driven that it comes a little lumpier than what we might see in the core business, where you have the same thing going on, you just don’t have enough offsets that it just doesn’t show up as much to you guys.

Curt Pullen

Chris to add on that point Brian’s making remember when we beat the top of the range in Q4, a lot of that was driven by projects that we completed faster than we thought we would and some of that was in international, so that contributes to their performance in Q4, but then because of the nature of things they’re expecting a nice increase in Q2 over where they ended in Q1.

Operator

Your next question comes from Budd Bugatch - Raymond James.

Budd Bugatch – Raymond James

Could you help just to make sure, we walk through last year to this year in the SG&A and what were the permanent cost take outs, what other cost take outs were in the quarter and what were the puts and takes and how much of that’s going to be a permanent reduction in cost?

Curt Pullen

Yes, I think last November when we launched that we said it was around a $25 million annual improvement in our cost structure right, remember that, and we’re right where we want to be relative to what the volume was and where the teams came in at and some of that as I mentioned was lower incentive comp because of the results today are not driving as much costs there as what we had in the budget this time last year, but I’d say we’re right where we need to be relative to the actions that were taken and the teams have done a great job of executing their work in the new cost structure.

Budd Bugatch – Raymond James

And that’s both in SG&A and in cost of sales or is it, in one of those buckets?

Curt Pullen

Yes, it’s both. A lot of that cost structure work last year was not an overhead; I mean we’ve done a lot of that work continually. We have realized improvements this quarter versus last year in overhead, but a lot of that work last year was specifically not in the manufacturing area.

Brian Walker

The majority of it really was in the SG&A piece there.

Budd Bugatch – Raymond James

Okay because it looks like you had goods cost take out or efficiencies in manufacturing factoring in the $9 million raw material increase and some effect of the lower volume. You still had at least by my numbers somewhere between $10 million to $12 million of efficiencies in your cost of sales, is that not accurate?

Curt Pullen

No that that’s probably right Budd.

Brian Walker

But part of what drove that Budd, what I would call variable costs rather than fixed cost changes is particular things like incentive compensation, which you know our EVA program is far and wide and so when we are running at these lower levels, we were actually expecting compensation expense down across the company. So that’s part of why you saw the offset in manufacturing.

If you read the press release last year, we had a particular service contract related to the Federal Government that we took. We had a hit on last year in the first quarter, so we got a bit of a one time benefit if you want to think about at that way; that’s why when Curt looks at margins for the next quarter; it’s not that we are seeing raw materials coming up.

Last year we didn’t have the negative side in the second quarter that we had in the first quarter of last year, you follow me. So, that comparison is, the hit this quarter wasn’t as bad as it might appear when you’re looking year-over-year because we had some costs that last year that didn’t repeat.

Budd Bugatch – Raymond James

The other side of my question goes to Joe’s comments about the debt-to-EBITDA being at 1.2 or 3, now to one and being at the lower end of your one to two range, do I take that to mean Brian that you are going to be a little bit more circumspect with reinitiating a share repurchase in this quarter and maybe give that a break until we get through the end of the calendar year?

Brian Walker

But I think we are at right now is we continue to think there is some real opportunities out there for us to add some capabilities that will move the strategy forward. Given what’s going on in the world around us of course we are trying to make sure that we can do that in a way that does not change the risk profile of the balance sheet, so therefore we are sort of in the mode right now; we are going to hold on to the cash and see how those things play out and quite frankly watch what’s going on in this overall credit market.

It just seems like this is not the time that you want to end up in a situation that you need cash, but you got to go get form somebody else. So we are confident we got good cash flow, we got a nice balance there, we are happy with the size of our debt structure right now. So, as we see some of those opportunity start to look like they’re out there, we want to make sure we got the ability to go capture them.

As I said to you guys last quarter, my belief is in the last downturn in the industry we spent a lot of money and we’re delivered about keeping R&D going; I think we need to do that this time, but rather than all of our attention being to structural changes, my hope is we can add capabilities that actually make sure that we come out of this thing. We are stronger on the other side with even more diversity in the revenue base.

Budd Bugatch – Raymond James

Okay and just I want to sneak one other quick one and can you quantify maybe for us the Costco opportunity?

Brian Walker

Yes, Budd it’s really hard to tell right now to be frank. We started with the couple of chairs. I think we’ll know more as we see that thing ramp up it. We started with very few stores, 20 stores or so. They expanded it to 40; we now think we are going to go for sure nationwide and it will happen in a couple of sequences, because we are not going to do both chairs nationwide at the same time, so we are going to see a ramp up.

In the total business, it may not look like a bid deal for you guys, it’s pretty big to us in terms of getting from two avenues. First of all, it will make a significant impact to our consumer business if you will, our retail business.

More importantly it’s also I think a great opportunity for us to make sure that the Herman Miller brand is able to reach out to a wider audience of folks and so we’ve been as deliberate in this case about the marketing and branding of that opportunity at sort of point of sale.

I think the question longer term will really be beyond the couple of products we’ve done with them; can we do more with them and what is the residual impact back to both the core business and the rest of our retail base and we’re going to be very careful about how we play those three things together, but I think my belief is this could be compound with the way that play together, but it’s a little hard to tell from a dollars and cents standpoint right now, how big the impact will be.

I would say we’re very encouraged by what’s there and very happy with the work at Costco so far and the way it has a dove tailed with both our contract dealers as well as with our specialty retailer; so far that’s working pretty well.

Operator

Your next question comes from Todd Schwartzman - Sidoti & Company.

Todd Schwartzman – Sidoti & Company

I was wondering if you could talk a little bit about the products included in the POSH alliance and whether it seems that the products in question are going to be manufactured by you and POSH respectively. I’m just curious about the branding there and what your roles are if in fact you’re going to market Herman Miller products and as well as POSH. Who’s going to be doing the bulk of the production and who determines which products are sold under this deal?

Brian Walker

The Primary driver behind this is at the starting point was, POSH has in our mind one of the, if not the best distribution network in Mainland China. So, our primary interest was access to a well developed and functioning distribution channel in Mainland China that gets beyond sort of the major cities. A lot of people can get Hong Kong, Shanghai, Beijing, the question is where do you go beyond that, POSH has a broader distribution network which is essentially franchise.

So, they were interested in being able to take Herman Miller branded products particularly seating and to a lesser extent some of our systems products like the Abak Environments products that we sell in the U.K. as well as resolve into their channel. Those products will be made by us by the way, in our factories either in China. We have a factory now in Ningbo, China.

So, what we’ll be doing is, we’ll be selling direct to their distribution and like many of these things there’ll be an alliance feedback to them for their sales and marketing efforts in that way. So, the products will be branded Herman Miller and sell through their distribution.

Likewise we have a fairly large distribution footprint throughout the rest of Asia, which if you looked at our U.S. dealer, we may be as much as 70% of their sales. In Asia we tend to be a little bit lower, because we don’t play across the whole spectrum of products and price points.

POSH gives us the ability to offer to our current dealers throughout the rest of Asia, sort of a second set of products at a lower price point, in some cases different application sets. Those products will be sold to those dealers as POSH products in much like in the case of us selling to their distribution. They’ll manufacture those products and we will be paid an alliance fee.

It also will give us the ability from time-to-time, when we have a large customer be that a state owned enterprise in China or be that a large U.S. multinational to go in and give them a complete solution that often they are looking at both, maybe some of their backroom operations and things where they want a lower level product, a more different application.

So, it’s a very interesting partnership, we’re very excited about POSH. We think they get our values and we think that they’ve got a good brand presence, but very importantly for us they have a strong distribution channel, Mainland China, which was our primary driver.

Todd Schwartzman – Sidoti & Company

Within Mainland China, how much brand value does Herman Miller carry?

Brian Walker

A fair amount, actually you’ll be surprised. The name Herman Miller is extremely well recognized around the globe and I’m always surprised when I’m traveling, how many folks know who Herman Miller is and what the company stands for and it’s particularly connected to things like our classic products and the work we’ve done for many years with some of the best designers in the world, as well as our iconic products like the Aeron chair, the Mirra chair and those things that have the ability to transcend geographic and cultural boundaries. So, the Herman Miller brand has very strong recognition in those markets.

Todd Schwartzman – Sidoti & Company

Is partnering with POSH reduce in anyway the possibility of any Asian acquisition, for you guys?

Brian Walker

No.

Operator

Your next question comes from Mark Rupe - Longbow Research.

Mark Rupe - Longbow Research

Sort of a couple of questions; on the government sales, you mentioned the trends had remained solid. I’m just curious how much visibility is there in the government panel?

Curt Pullen

Well, I think there is visibility not unlike any of the commercial stuff Mark. I mean it’s a part of our sales force that’s dedicated to those pursuits and they tend to buy in different cycles and have different drivers. So, they don’t necessarily follow the same dynamics of other parts of our business, but they do have their traditional sort of buying season, which we’re kind of getting into. So, I’ll tell you visibility is just like any other business.

Mark Rupe - Longbow Research

And is there any election impact at all in out years typically in the past has it’s been?

Curt Pullen

No, not really.

Mark Rupe - Longbow Research

And then secondly on the new upcoming seat launch, any expectations that you’re expecting from the new launch?

Brian Walker

We’re expecting to have the best product in the industry globally. I mean to be frank, we are very excited about the chair. We are getting great reviews from customers. We think that they always take a while before they ramp up because you have to win projects, get installed base. So, we don’t think the chair will have a significant impact in the near-term, but longer-term it’s important because we think it will put the stake in a ground again that we’re the leader in seating and that we’ve leaped forward over everyone else in terms of comfort and performance.

They will have its own unique aesthetic value and in the past whenever we’ve launched a great new chair by Herman Miller, it also helps bring the other chairs along with it because people begin to look at what the family of products are. The other thing I think you always have to think of in the way that we like to look at these products especially when they’re at this level of being a breakthrough, it is a chair, but it also comes whether with several technology platforms.

In the longer-term we’ll begin to ask, how do those work their way throughout our product range not only by the way in we’re feeling, but potential in areas like Healthcare and others. So, what’s really exciting here is, we are really resetting the reference claims for what folks think of in office seating.

Mark Rupe - Longbow Research

Perfect and then just lastly any updates on some of the new initiatives like Convia?

Brian Walker

Our challenge with Convia continues to be, how do we get scale out of that business? We’re seeing early sign that are refocused or there can be a team on the MEP channel, which is mechanical, electrical and plumbing is bearing fruit. We’ve added a number of sales folks this past quarter. What we’ve found was while we certainly have to have electrical distribution partners, their gift is not concept selling or system selling and in fact we’re selling a system and a concept.

We continue to believe strongly that Convia is absolutely in the right place for what we face as a country when we’re dealing with issues like raising energy costs. We believe and in fact there are some new technologies on the Convia side that can help manage electricity; in fact some of the things like load shutting, which you hear more and more about in places like California; we think its right on target with that.

We also think it’s on target with the movement towards sustainable building, as well as figuring how to take waste out of the construction cycle. So we think we’re in the right place, our challenge quite frankly is to get scale on the commercial side and as with the lot of startups, we’re learning a lot along the way and trying to manage it, to where the size of the investment doesn’t out weigh what we can afford to do as we manage our sales through some tough times.

Operator

Your next question comes from Jim Casagrande - Pike Place Capital.

Jim Casagrande - Pike Place Capital

Just two quick questions; you mentioned as one of your offsets in kind of the North American decline in sales was the effect of the Brandrud acquisition which was in December; can you guys give us a sense at all to quantify or give us a sense to the size of the effect that that had?

Brian Walker

Brandrud, is a fairly small acquisition of itself, what I think Curt was referring to is the combined power of Brandrud as an addition to our healthcare businesses really and our additional focus on the healthcare business has made a good seating offset and I will say, we don’t disclose specific information about some of those segments that are not disclosed in the financials and so therefore we don’t want to get into given very specific numbers. We think that competitively it’s important that we stay as much onto the radar screen, quite frankly it’s possible.

I will tell you the Brandrud numbers were essentially offset this quarter by a dealer divestiture where we had one of our own dealers and that person running it was able to work his way through and earn in meaning he earned his way over years to buying the business, so we locked those sales and they virtually offset each other and so that wasn’t a big net impact of acquisitions and divestitures, but what Brandrud’s having an impact on is our ability to gain traction on the healthcare side.

Curt Pullen

And I think the point Brain is making, Jim is that there is growth both in the underlying core kind of healthcare business as well as the impact of Brandrud and Brandrud is growing, so yes both things going on there.

Jim Casagrande - Pike Place Capital

And then just as a quick follow-up to the earlier question about the government sales. I guess, I’m just a little surprised by some of the strength you’re seeing there because it seems we’re reading every other day that the government is facing some severe budget challenges. So, do you have any comment on either I guess what’s been fueling the success there or how does that sector look?

Brian Walker

Well, I think you’ve got to keep in mind, I don’t think you should hear from us that we’re seeing necessarily a large growth in the government sector. It is a fairly stable sector year-over-year and has been for a long time and the real trick or the real potential there often comes by, is a particular agency hitting a renewal cycle and/or in expansion.

So you’ve seeing certain sectors of the government, not surprisingly over the last couple of years; things like Homeland Security and some of those that are beefing up, so for us it is important as they hit either sort of renewal cycle and/or one of the new areas that’s been focused on and they are trying to organize around it. So its not as if it’s necessarily growing greatly.

Now, Curt was mentioning state government has been one and some of that can be our ability to get into new states where we haven’t necessarily had as big a presence in the past.

Operator

Your next question comes from Dennis Salvo - Jodocus Capital.

Dennis Salvo - Jodocus Capital

Thank you for taking my question. Just a few questions, can you highlight or take us through how the weekly orders rates were trending during the first quarter?

Curt Pullen

Yes, I think we averaged. If you just did that math 535 on 13-weeks, what’s that come out about 41 a week.

Dennis Salvo - Jodocus Capital

Right, but did it have a particular trend on the quarter?

Curt Pullen

The difficult part is in our week nine; we had a $75 million week which was partially the effect of that price increase, so when you look at the week subsequent to that and might that be lower, yes, but you don’t have real clear information as to what was the effect of that pull ahead. So, they were relatively flat for the quarter, as best we can tell ironing out the effect of that price increase.

Dennis Salvo - Jodocus Capital

And secondly given just the weakening economy and the conditions in the commercial real estate market, are you seeing any cancellations of orders at this point?

Curt Pullen

No, nothing that we find interesting.

Dennis Salvo - Jodocus Capital

I guess lastly what has been the customer’s response in the price increases? I know you pushed through a 3% or 4%; do you expect to effectively realize all of that or is there some pushback?

Brian Walker

Well, its been years since we’ve achieved all of it. I mean typically, we would look at something between a 50% and 75% capture rate would be pretty good. It’s really early to tell how that plays out, because of course our business really is a very competitive business on a day-to-day basis; we’re bidding on projects, many of our customers have multiple suppliers.

So, you put through the price increase and then of course what you capture is going to be determined as we get out there and see how everybody is reacting in their day-to-day pricing stands and so, they don’t necessarily react at the initial point of the price increase as much as they react later down the road.

Now, the good news is what was I think hardening to us was to see, the pull forward orders, because usually that’s a good sign to say that folks at least have product and projects in mind that they intend to do, so they are bringing those projects in. If you didn’t see much impact or reaction to the price increase at that point actually, it would have been a little bit more nervous.

Operator

Your final question comes from Todd Schwartzman - Sidoti & Company.

Todd Schwartzman - Sidoti & Company

If you are able to and wanted to ramp up the product offerings at Costco, would the likeliest candidates be additional seating products or would you go storage? I’m assuming that it’s pretty difficult to for systems to translate on that type of retail distribution?

Brian Walker

I don’t think we know the answer to that question. Certainly our focus with Costco is not on things that would compete with contract channel. So it would be more home oriented products, particularly home office oriented products. What those will be, we don’t know. We’re really sort of -- we went through test 1 whether this worked for Costco with the products we had; the answer to that so far seems to be yes.

Another question will be as we ramp up more fully, do we both think that the opportunities there to do more beyond those couple of products. What’s likely I think is that we would design products specifically for that channel aimed primarily at the home buyer.

Todd Schwartzman - Sidoti & Company

And that would be branded Herman Miller, as best you can tell?

Brian Walker

It’s a great question. Again I don’t think we know to answer to all of those questions yet.

Todd Schwartzman - Sidoti & Company

Finally, what kind of volume have you been doing with the Aqua and the Caper multi purpose chairs, through the dealer network?

Brian Walker

I don’t think we want to get into that level of detail around product size. I would say to you, you got to remember what we’re offering to Costco as one part of the Caper chair. We sell a lot of Caper multi or the Caper side chairs in the contract dealer channel and Aqua has been a main stay for many, many years and was designed at the decade, I believe in the 1980’s, so it is an important chair on both sides, but there’s an impact on those two product lines if we get up to kind of volumes at this potential.

Operator

We have no further questions on our roster.

Brian Walker

Thank you all for joining us today and for your continued interest in Herman Miller. I also want to express again my appreciation to all Herman Miller employees for their outstanding work and commitment to our shared success.

Events of this week clearly highlight the challenges we face in the short-term. We are committed and confident that we have the right long-term vision for Herman Miller, the talent of people and network of business partners to make it a reality and the financial resources to keep moving forward.

And one other thing I want to mention, Herman Miller Inc. will be celebrating their 25th Anniversary of our association with NASDAQ and the launch of our new Embody chair when the open market at the NASDAQ site on November 6 at 9.30 am. Watch for more details and your formal invitation. That’s all for now and we look forward to talking to you again next quarter.

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Source: Herman Miller, Inc. F1Q09 (Qtr End 08/30/08) Earnings Call Transcript
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