U.S. Markets closed

Edited Transcript of MLHR earnings conference call or presentation 23-Mar-17 1:30pm GMT

Thomson Reuters StreetEvents

Q3 2017 Herman Miller Inc Earnings Call

ZEELAND Mar 23, 2017 (Thomson StreetEvents) -- Edited Transcript of Herman Miller Inc earnings conference call or presentation Thursday, March 23, 2017 at 1:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Brian Walker

Herman Miller, Inc. - President, CEO

* Jeff Stutz

Herman Miller, Inc. - CFO

* Kevin Veltman

Herman Miller, Inc. - VP IR, Treasurer

================================================================================

Conference Call Participants

================================================================================

* Steven Ramsey

Thompson Research Group - Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good morning, everyone, and welcome to this Herman Miller, Inc., third quarter of fiscal-year 2017 earnings results conference call. This call is being recorded.

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

Today's presentation will be hosted by Mr. Brian Walker, President and CEO; Mr. Jeff Stutz, CFO; and Mr. Kevin Veltman, Vice President of Investor Relations and Treasurer. Mr. Walker will open the call with brief remarks, followed by a more detailed presentation of the financials by Mr. Stutz and Mr. Veltman. We will then open your call to 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, Herman Miller, Inc. - President, CEO [2]

--------------------------------------------------------------------------------

Good morning, everyone, and thank you for joining us today. I'd like to begin with an overview of our recent performance and some strategic initiatives and hand the call over to Jeff and Kevin to review the financials in greater detail.

Yesterday, we announced our financial results for the third quarter of fiscal 2017. Consolidated sales and orders for the quarter were $525 million and $543 million, respectively, and GAAP earnings per share were $0.37 per share. Revenue was within the range we expected and adjusted EPS of $0.39 exceeded our expectations, due to well-managed operating expenses in part as we began implementing a portion of the cost savings we alluded to last quarter.

While organic sales growth was flat compared to the same quarter last year, we were encouraged by the acceleration in consolidated order pacing throughout the quarter, which in total came in 5% above last year on an organic basis.

When we look broadly at our business, the project nature of the industry was reflected in the order levels by segment. Strong order growth in the North America contract business was partially offset by lower demand levels in our specialty and international businesses. The focused effort within our consumer business to accelerate growth across digital, physical, and wholesale channels continues to gain traction and that business again delivered solid sales and order increases relative to last year.

Earlier in the quarter, we announced several changes to our organizational structure, aimed at better positioning us to execute against our growth strategy. I'd like to highlight a few key aspects of this realignment. First, as we continue to increase our market opportunity through geographic and customer segment expansion, we're being deliberate in our efforts to identify and capitalize on the natural synergies between business segments. This will enable greater leverage of resources on our vertical segments, while continuing to allow us to bolster the strength of our individual brands.

The realigned structure also increases our agility by placing more decision-making autonomy into the business units. We believe these changes will aid us in our cost structure. We know we need new investments in certain areas and eliminating redundancies will help us fund those investments.

With these objectives in mind, we made the following changes to our executive leadership team. Greg Bylsma was appointed President, North America contract, which brings together responsibilities for the work, healthcare, and education businesses. Steve Gane was appointed President, specialty brands, to lead the combined efforts of the Geiger, Herman Miller collection, and Maharam businesses. Ben Watson was appointed Chief Creative Officer, adding research and development to his existing responsibilities as Executive Creative Director; and Jeremy Hocking was named Executive Vice President of Strategy and Business Development, combining his existing responsibilities for strategic planning and M&A with channel development, information technology, and dealer distribution.

Now I'd like to share my perspectives on the macro environment and the performance of our individual business segments. The contract furniture industry in North America is mixed. Industry data for sales and orders remains choppy, but macro indicators, including service sector employment, architectural billings, and nonresidential construction activity, continue to be generally supportive and sentiment measures have moved positively since the US election. The new administration's plans for lower taxes, cash repatriation, and capital investment incentives have potential to drive employment and related investment spending over the longer term.

While revenue levels within our North American contract sentiment reflected the cautious atmosphere we saw throughout the first half of the fiscal year, the level and pace of new orders improved consistently throughout the quarter and we ended the period up nearly 7% on an organic basis from the third quarter of last year.

Now we are always cautious to reach conclusions on the basis of one quarter of activity; however, this improvement does square with the project activity and contract activation levels we had been tracking earlier in the year. These same measures remained strong throughout the third quarter, which gives us some confidence that the improvement in order levels can be sustained in the near term.

To be sure, the competitive pricing environment remains challenging and we again felt the impact of higher price discounting on our sales and margins this quarter. This only highlights the need for us to remain diligent around driving productivity and efficiency improvements across the organization. This is something we've proven we have the ability to do well and, as I'll describe shortly, we are redoubling our efforts here.

The specialty segment reported organic sales and orders that were 2% and 4% lower, respectively, than the same quarter last year as the project nature of the business impacted results. Order growth for the Herman Miller Collection at Maharam was offset by lower demand for Geiger, partially tied to a large project last year that created a challenging comparison.

As we look to the future, we believe this segment is well positioned to serve us as a growth and profit engine for our business, particularly as industry trends continue to embrace inclusion of collaborative spaces and office design and a strong slate of product launches across each of the specialty brands, including the recently launched Maharam leather line.

The ELA business posted organic sales and orders that were slightly below last year. Lower demand in Asia-Pacific, Latin America, and the Middle East was partially offset by solid growth from mainland Europe. While the weakening of the British pound has had an unfavorable foreign currency translation impact on reported sales for the segment, demand in mainland Europe has benefited from a relative cost advantage tied to our UK manufacturing operation, where costs are largely pound denominated.

Despite the persistent macroeconomic and geopolitical headwinds, particularly from the lingering uncertainty in the UK and oil-producing regions, such as the Middle East, the international team has performed incredibly well. We continue to see higher long-term growth potential in Asia-Pacific and we are poised for several new product launches for both Herman Miller and POSH brands across the region. This includes expanding to new price points and product categories, including a broader assortment of collaborative furnishings, such as those we have access throughout our partnership with naughtone.

Moving onto the consumer segment, while mortgage rates are beginning to rise, existing home sales and new housing starts are showing year-over-year improvement and the possibility of lower tax rates should benefit this sector as well. Our consumer business mirrored this upswing, with sales and orders up 4% and 13% over last year, respectively. Order levels were concentrated toward the end of the quarter, as the initial week of the Design Within Reach semiannual sale fell on the last week of the quarter. By comparison, last fiscal year this same event began in the first week of our fiscal fourth quarter. Admittedly, this shift in timing had a positive impact on the order comparison to last year. Normalizing for this change, the growth in orders over last year was closer to 10%.

Several factors are contributing to the improved demand picture within our consumer business. First, we've greatly improved the efficiency of our direct-to-consumer catalog program. Second, we've launched over 100 new proprietary products designed for DWR and Herman Miller this fiscal year, significantly enhancing our total offering with these higher-margin designs.

We also continue to expand the volume of Design Within Reach proprietary products sold through our contract dealer channel. The expansion of our Design Within Reach real estate footprint continues to be a growth driver for the consumer business as well. This quarter, we opened new studios in Portland, Oregon, and Westport, Connecticut, and have a larger repositioned Atlanta studio under contract to open by the end of the fiscal year.

Because we're opening new studios at a faster rate than in previous years, there is a drag on profitability from preopening costs and the ramp-up it takes for new studios to build towards full productivity within the first 12 to 18 months. This unfavorable impact to the consumer business was approximately $2 million during the quarter. In addition, we've also been deliberate in putting in place the organizational structure and capability to realize the longer-term potential we see for growth across the consumer channels.

These are the right decisions for the business longer term, but, to be frank, the trade-off has been lower profitability in the short run. This is particularly acute during periods of relatively low sales volume, such as the third quarter. That being said, we continue to believe the value drivers to increased operating margins remain in place as we scale the consumer business. We also believe there's an opportunity to reduce operational costs and to further integrate the consumer operations within the Herman Miller group of companies.

Before I turn the call over to Jeff to review the results in detail, I want to take a few minutes to highlight what our leadership team sees as the primary areas of focus for the business going forward. As I've described, we've made targeted investments aimed at positioning our consumer business for long-term profitable growth. This represents one of our top priorities and we remain confident in our strategy of scaling the business by expanding our real estate footprint for Design Within Reach studios, increasing the mix of exclusive product offerings, and growing our contract, catalog, and digital channels.

Second, we are building in our living office solutions-based approach with a range of new products and services that address the entire floor plate with the emphasis on expanding our leadership in seating and increasing our offer for collaborative spaces.

Lastly, there's untapped potential to integrate a layer of technology to improve user experiences by delivering a comprehensive solution of furnishings and technology tools. We've partnered with several leading technology providers, A/V integrators, and software developers to help our dealers deliver on this capability to customers. We are currently piloting programs in four markets. We plan to be fully operational by the end of fiscal 2018.

Next, we're focused on the integration of our business to ensure optimal leverage of our dealer ecosystem and gain further share of the dealer wallet. Our goal is to reduce the friction that exists for our dealers so they can broadly access our growing product and brand portfolio in its entirety. Specifically, we're enhancing our order fulfillment technology with a universal digital environment that will enable dealers to view, specify, and order any products across the Herman Miller group of companies.

As we mentioned last quarter, we're working on several cost-savings initiatives. Our rationale is threefold. We appear to be headed into an inflationary environment for both materials and wages. Given recent increases in commodities and proposed tax reforms, we want to get ahead of that. While the long-term revenue outlook for mid single-digit organic growth has remained largely unchanged, we want to position the business to drive improved leverage during periods when sales growth falls below this level. Third, we need to free up the operating headroom to fund our long-term growth initiatives without driving significant incremental cost into the business.

We're developing a range of initiatives. Some will have near-term impact, while others will be more structural in nature. While plans are still preliminary, we believe there is a $25 million to $35 million opportunity that will phase in over the next three years.

As I said, some of these savings will offset inflationary pressures and fund needed investments. But we do expect to realize improved profitability as a result. Net, we believe these initiatives will help us deliver consolidated operating margins above 10% within the next three years.

Finally, as we've aligned our creative direction and new product commercialization under common leadership, we'll expand our innovation agenda by reducing our time to market, ensure the development is focused on the customers' most critical needs, while at the same time fueling synergies between these activities.

With our industry-leading R&D investment and capabilities in key regions across the world, we've been developing a robust product development pipeline to meet the increasingly varied demands of the market. The remastered Aeron chair headlines a slate of recent and upcoming product launches worldwide, including the King Chair group, Layout Studio 2.0, Ubi Work Tools, which add functionality to any workstation in the form of thoughtful storage, personal tools, and power access. In addition, our international specialty and consumer teams will launch a number of new products developed specifically for their markets.

Awesomely, what we've done is marry the most comprehensive product offer in the industry with an unrivaled multichannel capability, which enables us to serve a broad and unique audience of architects and designers, dealers, consumers, and large contract customers. We back this up with a regional operating footprint that enables us to provide a fast and reliable service to our customers and dealers around the globe. We don't believe anyone has our breadth of reach.

With that brief overview, I'll turn the call over to Jeff to provide more detail on the financial results for the quarter.

--------------------------------------------------------------------------------

Jeff Stutz, Herman Miller, Inc. - CFO [3]

--------------------------------------------------------------------------------

Okay. Thank you, Brian, and good morning, everyone. Consolidated net sales in the third quarter of $525 million were 2% below the same quarter last year. On an organic basis, which excludes the impact of foreign-currency translation and dealer divestitures, sales were essentially flat with last year's level. Orders in the period of $543 million were 7% higher than the same quarter last year.

As we outlined in our press release yesterday afternoon, we believe the timing of our most recent price increase had an impact on order pacing between our third and fourth quarters. At the beginning of February, we increased our general list prices an average of 2%. As a result, we estimate orders totaling approximately $21 million were pulled ahead into this quarter that would've otherwise been entered in Q4. On an organic basis, which includes adjusting for this pull-ahead impact, orders increased approximately 5% from the third quarter of last year.

This impact was also reflected in our reported backlog for the quarter, which was 6% higher than last year. Last year's backlog included approximately $25 million in orders related to dealers that have subsequently been divested, including the sale of a dealer based in Australia at the start of this fiscal year and the sale of a dealer based in Philadelphia earlier this quarter. Excluding the impact from dealer divestitures and the order pull-ahead, backlog ended the third quarter more than 7% higher than last year, evidencing the strong order pacing during the back half of the quarter.

Within our North American segment, sales were $310 million in the third quarter, representing a decrease of 1% from the same quarter a year ago. New orders in this segment were $333 million for the quarter, reflecting an increase of 12% from last year.

On an organic basis, adjusting for the Philadelphia dealer sale and foreign-exchange translation, revenue was slightly below the same quarter last year, while orders were 7% higher. Orders from project sizes below $1 million were higher compared to last year, while projects above $1 million in size for slightly down year on year.

Order growth during the quarter was led by business services, manufacturing, and federal, state, and local government, while there was lower demand relative to last year in computer hardware, chemical, and pharmaceutical sectors.

Our ELA segment reported sales of $88 million in the third quarter, reflecting a decrease of 11% to last year. New orders totaled $86 million, an amount 10% lower than the same quarter a year ago. Organically, excluding the impact of dealer divestiture and foreign-currency translation, segment sales were 1% below last year, while on the same measure new orders decreased approximately 2%. This year-over-year decline in orders was primarily due to lower demand levels in the Middle East, where we're seeing fewer large project opportunities, and in Mexico and India, both of which we attribute simply to project timing. This was partially offset by strong demand in continental Europe and in Japan.

Sales in the third quarter within our specialty segment were $54 million, a decrease of 1% from the same quarter last year. New orders for the quarter of $52 million were 3% lower than the year-ago period and, excluding the impact of the price increase on order entry, organic order demand was 5% lower than last year. The decrease in orders was primarily due to a challenging prior-year comparison and a general slowdown in activity within our Geiger business. This was partially offset by order growth within the Herman Miller Collection and Maharam.

The consumer business reported sales in the quarter of $73 million, an increase of approximately 4% from last year. New orders for the quarter totaled $73 million and were 13% ahead of the same quarter last year, although partially impacted by the timing of the promotional event that Brian described earlier.

On a comparable-brand basis, DWR revenues for the quarter were up approximately 3%.

Consolidated gross margin in the third quarter was 37.2%, which is 150 basis points lower than the third quarter last year. On a year-over-year basis, we continue to feel the impact of comparatively deeper discounting and higher steel prices. The price increase at the beginning of February was targeted at products most impacted by the commodity pressures, and these factors were partially offset by lower incentive compensation in the quarter.

Operating expenses for the third quarter were $158 million, compared to $164 million in the same quarter last year. The prior year included approximately $3 million in expenses related to dealers divested this fiscal year, so after adjusting for those expenses, operating expenses were roughly $3 million below last year's level, due to lower levels of incentive-based compensation, a pretax gain recognized in conjunction with the divestiture of our Philadelphia dealership, and a broader effort to begin realizing the cost-savings opportunities that our teams have identified. These reductions were partially offset by higher occupancy and staffing costs related to DWR Studios.

Additionally, restructuring actions involving certain workforce reductions that were announced in the third quarter resulted in the recognition of severance and outplacement expenses totaling approximately $2.7 million. On a GAAP basis, we reported operating earnings of $35 million in the quarter. Excluding the restructuring charges and the gain on the dealer divestiture, adjusted operating earnings this quarter were $37 million or 7% of sales, compared to $44 million or 8.3% of sales in the prior-year period.

The effective tax rate was 29.8% in the third quarter of this year and that same percentage in the year-ago period.

Finally, net earnings in the third quarter totaled $23 million or $0.37 per share on a diluted basis. Excluding the impact of restructuring expenses and the gain from the dealer divestiture, adjusted diluted earnings per share this quarter totaled $0.39. This compares to earnings of $0.46 per share in the third quarter of last year.

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

--------------------------------------------------------------------------------

Kevin Veltman, Herman Miller, Inc. - VP IR, Treasurer [4]

--------------------------------------------------------------------------------

Good morning. We ended the quarter with total cash and cash equivalents of $78 million, which reflected an increase of $7 million from last year.

Cash flows from operations in the period were $28 million, compared to $53 million in the same quarter of last year. Changes in working capital balances resulted in a net cash outflow of $17 million this quarter, driven primarily by lower accounts payable and accrued liabilities, along with higher inventory levels. By comparison, in the year-ago period, changes in working capital drove a net cash inflow of approximately $5 million.

Capital expenditures were $24 million in the quarter and $70 million year to date. We anticipate capital expenditures of $90 million to $95 million for the full fiscal year.

Cash dividends paid in the quarter were $10 million and we repurchased approximately $5 million of shares during the quarter. Since November 2015, our share repurchase activity has been primarily aimed at offsetting dilution; however, we have recently increased our target for cash returns to investors, a metric which we measure by interest expense, dividend payment, and share purchases as a percent of trailing three-year EBITDA.

While investing in our business remains our number one priority, based on our strong cash flow generation and consistent with our goal of delivering improved shareholder value we have increased our target for cash returns to investors from 20% to 25% of EBITDA to 30% to 35% of EBITDA. While we have an upcoming capital structure review with the Board to finalize the specifics of the approach we will take, we expect to achieve this target through a combination of higher dividends and share repurchase activity.

We remain in compliance with all debt covenants and, as of quarter-end, our gross debt to EBITDA ratio was approximately 0.9 to 1. The available capacity on our bank credit facility stood at $357 million at the end of the quarter, which includes $150 million set aside to repay the private placement notes that are due in January 2018.

As a reminder, we also entered into a forward starting interest rate swap in September 2016 with a notional amount of $150 million that will be effective in January 2018. While the swap does not impact our interest expense in fiscal 2017, it will fix our interest rate on that portion of our debt at 2.8% and reduce our annual interest expense run rate by approximately $5 million, starting in January 2018. Given our current cash balances, ongoing cash flows from operations, and our total borrowing capacity, we believe we continue to be well positioned to meet the financing needs of the business moving forward.

With that, I'll turn the call back over to Jeff to cover our sales and earnings guidance for the fourth quarter of fiscal 2017.

--------------------------------------------------------------------------------

Jeff Stutz, Herman Miller, Inc. - CFO [5]

--------------------------------------------------------------------------------

With respect to the forecast, we anticipate sales in the fourth quarter to range between $575 million and $595 million. We estimate the year-over-year unfavorable impact of foreign exchange on sales for the quarter to be approximately $5 million. On an organic basis, adjusted for dealer divestitures and the impact of foreign-exchange translation, this forecast implies a revenue increase of about 4% compared to last year, at the midpoint of the range.

As mentioned earlier, we sold our Philadelphia contract dealership at the beginning of January. This transaction will impact year-over-year sales and order comparisons going forward. Net of intercompany eliminations, that dealer contributed approximately $6 million of revenue in Q4 of last year and about $25 million of revenue on an annual basis.

Consolidated gross margin in the fourth quarter is expected to range between 37% and 38%, reflecting the sequential improvement in gross margin in the fourth quarter from production leverage on higher sales volumes.

Operating expenses in the fourth quarter are expected to range between $165 million and $169 million and we anticipate earnings per share to be between $0.53 and $0.57 for the period, and this assumes an effective tax rate of between 31% and 33%.

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

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions). Kathryn Thompson, Thompson Research Group.

--------------------------------------------------------------------------------

Steven Ramsey, Thompson Research Group - Analyst [2]

--------------------------------------------------------------------------------

Good morning, guys. This is Steven on for Kathryn. I had a couple questions in relation to the cost-reduction plan. How do you expect that to impact each segment's operating margin over the time frame? And should we expect that to hit the operating expense line only or should we expect the benefit in the cost of goods side as well?

--------------------------------------------------------------------------------

Jeff Stutz, Herman Miller, Inc. - CFO [3]

--------------------------------------------------------------------------------

Hi, Steven, this is Jeff. Great question. So, we're going to be -- I will tell you we are developing the detailed plans behind this. We've got line of sight to, as Brian said, $25 million to $35 million of savings over the three-year period.

What I can tell you is that these cost savings, they span the business, so they will touch every segment. It's not concentrated in any one segment, but, of course, as it evolves over time, it will hit segment profitability to varying degrees. In total, I think you can generally expect those cost savings to phase in relatively evenly or ratably over the three-year period, but you are going to need to stay tuned for those details.

--------------------------------------------------------------------------------

Steven Ramsey, Thompson Research Group - Analyst [4]

--------------------------------------------------------------------------------

Excellent. And then, a follow-up to that. Would you describe this $25 million to $35 million range as conservative and very achievable or would you consider that more of a stretch goal number?

--------------------------------------------------------------------------------

Brian Walker, Herman Miller, Inc. - President, CEO [5]

--------------------------------------------------------------------------------

Steven, it's Brian. I think the -- obviously, we gave the range because we believe we can get within that range, so I don't think it's a giant stretch, and obviously we don't think we'll be done when we get there. We've got more work to go to. That's what we've got a pretty good line of sight to today.

We told you guys last quarter we thought this would get firmer and firmer as we got throughout the fiscal year. From where we were last quarter, I think we got a pretty good view of the actions we have to take. Some of those things, we've got to finish the implementation plans and what the cost is to go and get it. Of course, some of it will get offset over time, as I said, with other inflationary costs and things like that, but we're intent on we're going to go find that and we're also asking ourselves what are the other places we can go drive efficiencies to make sure that we can handle what we think is going to be a little bit of an inflationary period, as well as in the event we have slower growth we want to be able to still get to our profitability target.

--------------------------------------------------------------------------------

Steven Ramsey, Thompson Research Group - Analyst [6]

--------------------------------------------------------------------------------

Excellent. And to confirm, these cost cuts are achievable in spite of what sales do?

--------------------------------------------------------------------------------

Brian Walker, Herman Miller, Inc. - President, CEO [7]

--------------------------------------------------------------------------------

Yes. Of course, how you see them show up in profitability does vary based on what you see with sales, right? But, of course, they are not -- these aren't costs that are variable with revenue necessarily, but at the same time, of course, when you start to look at -- if you are doing it in a model and you are just adding it up, there is a difference of what your profitability will be, depending on volume growth.

--------------------------------------------------------------------------------

Steven Ramsey, Thompson Research Group - Analyst [8]

--------------------------------------------------------------------------------

Excellent. Thank you.

--------------------------------------------------------------------------------

Operator [9]

--------------------------------------------------------------------------------

Budd Bugatch, Raymond James & Associates.

--------------------------------------------------------------------------------

Unidentified Caller [10]

--------------------------------------------------------------------------------

Good morning. This is David on for Budd. Thanks for taking my question, guys. I wanted to dig in on the OpEx a little bit as well. So in the quarter, OpEx came in lower than your guidance, and going in I'm sure you had line of sight on some of the moving parts, the incentive comp and the divestiture and the initiation of the savings plan. Can you give a little detail on what other variances caused it to come in better than your plan?

--------------------------------------------------------------------------------

Brian Walker, Herman Miller, Inc. - President, CEO [11]

--------------------------------------------------------------------------------

First, David, often you have a line of sight that you're trying to get the organization moving on some of these, and, to be frank, I think we got some of the benefits on the cost side faster than we thought we might, and that's partially -- I've always said Herman Miller is an organization if you can point it in the right direction and give it a compelling reason, they will go do amazing things, and I think it's just the beginning of the team getting after some of those things was a chunk of the variance, on top of the ones that you mentioned, which, of course, some of those depend on what -- especially the incentive comp depends a little bit on what your current level of profitability is because it's very much tied to that.

--------------------------------------------------------------------------------

Unidentified Caller [12]

--------------------------------------------------------------------------------

Okay. And then going forward, in terms of the guidance for operating expense and the costs coming out next quarter, right now what are the main drivers of that, of the year-over-year decline in OpEx?

--------------------------------------------------------------------------------

Jeff Stutz, Herman Miller, Inc. - CFO [13]

--------------------------------------------------------------------------------

David, this is Jeff. I just want to make sure I get your question right. Are you talking for the fourth quarter or is this more in relation to the longer-term savings that we outlined?

--------------------------------------------------------------------------------

Unidentified Caller [14]

--------------------------------------------------------------------------------

Kind of both. Initially the fourth quarter and then going forward, what are the major buckets that you are looking to reduce costs in or that you think you can take costs out?

--------------------------------------------------------------------------------

Jeff Stutz, Herman Miller, Inc. - CFO [15]

--------------------------------------------------------------------------------

Let me take the longer-term question first and then I'll pull back to the guide. So we're thinking of these cost reductions in kind of four primary categories. The first one I'd point to would be synergies within and across our business units.

I think some of this is being driven by the organizational alignment that Brian outlined earlier in the call. Some of that we think is going to help streamline costs. We did make some restructuring moves in the quarter that were somewhat tied to that category, so that's kind of one general bucket of savings.

There are some facility-related savings that we are pursuing and some of these are going to be in the longer-term category because those take some time, but there are some facility consolidation related actions that are being considered, one of which will occur in the UK that was announced earlier in the quarter for us, our team in the UK pushing a couple of our existing facilities together there.

There is a logistics component to this cost-savings plan that here, too, this is going to be -- some of these are going to be nearer term, some of those are a bit longer term and they spread out over the three-year time period. Some of this, by the way, is within the consumer business, so to the earlier question around business-unit operating margin impact, this would be one that we do believe we've got some opportunity in the consumer business, but it doesn't end there. There are logistics opportunities elsewhere.

And then, the fourth category, I would say, is just general cost rationalization and some of that is the nearer-term impact, David, so I think as we move forward into the fourth quarter, obviously we won't be able to capture some of those longer-term or longer-lead categories, but some of that synergy related to the business units will be more near-term impact. That relates to the restructurings we announced earlier this quarter. And then, we're really looking across the business at pulling back in a range of activities that we expect will -- and are implied in our guidance for the fourth quarter.

--------------------------------------------------------------------------------

Unidentified Caller [16]

--------------------------------------------------------------------------------

Okay. Thanks for that. And then, I want to turn to gross margin now and some of the -- and the price increases. You're guiding gross margin down year over year, but you put through the price increase this quarter. I know that takes some time to flow through, but what -- how long do you think until we see some of the benefit from the price increase? And how much more do you have to go -- or how much longer do you think you are going to feel some price inflation in raw materials, because I know you are offset a little bit terms of the buying, based on your contracts?

--------------------------------------------------------------------------------

Jeff Stutz, Herman Miller, Inc. - CFO [17]

--------------------------------------------------------------------------------

So this is Jeff again, David. So on the price increase, as you know, but it's worth highlighting, that doesn't just happen overnight. It layers itself into the organization or into the results over a period of time as customer contracts expire and then the new pricing takes effect.

We generally see some impact in the immediate quarter following a price increase, but it takes about six months to really start to ramp that up or crank the benefits of that increase up. I would imagine somewhere in the $1 million or maybe $1.5 million range for the fourth quarter would be achievable and implied in our guidance, by the way, in the margin.

That being said, we do expect, as you alluded to, some pressure continuing from commodities. Steel pricing, if you look at the steel pricing index, we ended the month of February on the coldrolled index at about $830 a ton. Just to frame that for you, a year ago it was closer to $560, $570 a ton, so we -- our pricing is -- we've got a bit of a natural hedge because our suppliers give us about -- we're on a three-month lag pricing that we get set on, so that increase doesn't all reflect in our guidance for Q4, but it does average its way in.

I think we've got another couple of quarters of tougher comps on the year-on-year steel pricing and that assumes pricing doesn't move wildly from where it is today. We should start to see feel some relief on the comp as we roll toward the end of our fourth quarter. Maybe toward the midpoint of Q1, it should start to ease for us.

--------------------------------------------------------------------------------

Unidentified Caller [18]

--------------------------------------------------------------------------------

Okay. And then last question from me, you hinted about the pricing environment in the prepared remarks, but where are you seeing the most pressure in pricing right now in terms of the competitiveness in the project business for the contract pipeline, I guess?

--------------------------------------------------------------------------------

Jeff Stutz, Herman Miller, Inc. - CFO [19]

--------------------------------------------------------------------------------

David, it's obviously in the heart of the contract business and I don't think it's just in the US. I think it's -- we are in a very competitive industry. People can move from place to place. If there's one product category that I think is often hotly contested, it's obviously in the workstation side where often that's the anchor to win the rest of the account, so people fight fiercely to go get that. And there is, I would say, downward pressure on particular things like height-adjustable tables where folks have been really fighting it out and that's a hot category.

So it's one of those you just got to stay in front of. You got to constantly look at value engineering. You got to look at ways to differentiate yourselves. You got to work like crazy in your supply base, and that's part of the reason for us saying we think this is an ongoing thing. We have to get better and better over time.

--------------------------------------------------------------------------------

Unidentified Caller [20]

--------------------------------------------------------------------------------

Okay. Best of luck going forward. Thank you for taking my questions.

--------------------------------------------------------------------------------

Operator [21]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Brian Walker, Herman Miller, Inc. - President, CEO [22]

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Operator [23]

--------------------------------------------------------------------------------

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