Kevin Veltman - Treasurer and VP, Investor Relations Brian Walker – President and Chief Executive Officer Jeffrey Stutz - EVP and Chief Financial Officer.
Reuben Garner - Seaport Global Securities Budd Bugatch - Raymond James Greg Burns - Sidoti & Company.
Good morning, everyone, and welcome to this Herman Miller Incorporated Fourth Quarter 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, Executive Vice President and CFO; and Mr.
Kevin Veltman, Vice President, Investor Relations and Treasurer. Mr. Walker will open the call with brief remarks, followed by a more detailed presentation of the financials by Mr. Stutz and Mr. Veltman. We will then open the call to your questions.
We will limit today's call to 60 minutes and ask that callers to 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..
Good morning, everyone, and thank you for joining us. I'll begin the call today with a brief overview of our results for the quarter and full year. After that I’ll provide a review of our five key priorities for the business including accomplishments from last year [Indiscernible] the work that is ahead of us.
I’ll close with an overview of the current economic backdrop before I turn the call over to Jeff and Kevin to cover the quarter in more detail.
Our results for the quarter reflect progress across a range of initiatives in the business, the net of which helped us deliver year-over-year improvement in adjusted operating margins in each of our business segments.
Throughout this year – throughout this past year, we placed a heavy emphasis on positioning our Consumer business on a path toward profitable growth and we are very pleased with the further steps our team made this quarter delivering meaningful improvements in net sales and operating margins.
More broadly, we began seeing the early benefit of our enterprise-wide focus on cost reductions while at the same time advancing our innovation agenda with a number of important product launches at the NeoCon Show in June.
Net sales for the quarter were within the range we committed to back in March and we delivered a very strong finish to the year on the bottom-line as adjusted earnings per share of $0.64 exceeded our expectations through a combination of better than expected gross margins and well managed operating expenses across the organization.
In total, organic orders in the fourth quarter were essentially flat with last year and reflected a generally mix demand environment across our group of businesses. Relative strength in the Consumer segment was offset by flat year-on-year activity in North America and lower overall demand in both ELA and the Specialty segments.
It’s worth noting that in the fourth quarter of last year we reported organic order growth of 9% making this year’s comparison particularly difficult at the consolidated level. For fiscal 2017, net sales of $2,280 million reflect a record level of sales for our organization.
We saw the impact throughout the fiscal year from increased commodity costs particularly in the area of steel and steel components, as well as heightened competitive price pressures. That said, our team did a fantastic job managing cost, improving efficiency and advancing key objectives aimed at long-term growth.
As it is a result, we delivered adjusted earnings per share in line with last year. Reflecting the strength of our current financial position, we announced a 6% dividend increase yesterday.
Even more importantly to reflect our confidence on our strategy to deliver continued growth by leveraging our unrivaled multi-channel capabilities and design and innovation leadership. As our business and industry continue to evolve, we are constantly focused on staying ahead of the curve and building on the progress we made this year.
With a composition of the office floor plan moving toward a broader variety of furnishing, a greater desire for customization from our customers, new technology and trends towards urbanization, a more seamless transactions in the retail world, we have centered our overall value creation strategy on five key priorities as we move into the coming year.
Before I share more about our progress this year, and next steps for each of these priorities let me remind you what they are. First, scale our Consumer business; two, realize the Living Office; three, leverage our dealer ecosystem; four, drive cost savings;, and last, deliver innovation.
Let me start with scaling Consumer, driving both top-line growth and improved profitability through scaling our Consumer business is a top priority for our team.
Over the past year, we expanded the real estate footprint of our Consumer business significantly opening eight new or repositioned Design Within Reach studios, plus the Herman Miller flagship location in New York. Collectively, these new locations added roughly 70,000 square feet of incremental selling space to our portfolio.
The New York flagship showcases the breadth of our offering through both the retail space and contract showrooms that display the entirety of the Herman Miller group of brands in one place.
We also expanded the mix of exclusive product designs launching over 100 new proprietary products designed for Design Within Reach and Herman Miller, which bring them a higher gross margin profile.
We implemented changes to the way we target and execute our direct to Consumer catalogue mailing program and the results have been dramatic marked by significant improvements in virtually every metric including total circulation, average order value, mailing response rate, and orders per book.
Throughout the fiscal year, we also demonstrated continued growth across our e-commerce platform and within our Design Within Reach contract channel while at the same time optimizing our marketing investments in these areas.
Collectively, these efforts led to accelerate revenue growth as the Consumer business grew sales 16% in the fourth quarter and 10% for the full fiscal year. The upcoming year we’ll focus on driving increased profitability. Our history demonstrates that the sales efficiency of new studio locations take time to build toward maturity.
As our newest locations ramp over their first 12 to 18 months, their profitability is expected to improve significantly. We’ll also continue expand the studio footprint and plan to add approximately 60,000 square feet of incremental selling space next year through six new or repositioned studios.
These studio expansions will be complemented by continued focus on improving margins with a development of exclusive product designs and leveraging additional sales in our contract catalogue and digital channels. To aid our efforts on this journey, we will engage the help of outside experts specializing the retail furnishings business.
Our goal here is simple, to accelerate our path toward sustained growth and profitability across each of our Consumer channels. These actions bring the opportunity to meaningfully increase operating margins for the Consumer business over the next three years.
Our second area of focus aims to elevate our research space Living Office framework to the next level as we help our customers create compelling and high performance work places.
We continue the evolution of Living Office this year by adding new products and technology solutions as well as performing a research that quantify the positive impact of organizations from applying these concepts. Our show at the NeoCon Trade Show in June highlighted the proof points and case studies helping convey the power of this framework.
The next phase of Living Office will include a range of new products and services designed to help our customers deliver on their business objectives in addition to seeding a wide variety of products for collaborative spaces, we are also integrating technology more powerfully than ever before.
At NeoCon, we demonstrated our capabilities in this area with the launch of the live OS, a digital architecture that provides real-time data insight for individuals and organizations to help improve the performance of their workspaces and support achieving their wellness goals. Third, we are working to fully leverage our dealer ecosystem.
As customer needs have evolved towards a greater mix of collaborative furnishings we created dedicated resources this past year under the Herman Miller Elements umbrella to best position the Herman Miller collections, Maharam, Geiger, Design Within Reach in naughtone brands for further growth in this space.
Moving forward, we need to make it easier for contract customers to find, specify and order products from any brand within the Herman Miller group.
We rolled out a digital platform to accomplish this goal in Europe last year and have added the necessary technical talent and expertise to develop and deliver a complete solution for the US contract business in the coming year.
We also continue to evaluate the right structure for our business going forward to ensure offer is best positioned and leverages our inherent capabilities most effectively. As part of this review, we took a deep look at our healthcare strategy and how we approach this customer set with all of our capabilities.
Based on this, we made the decision to move the Nemschoff's Healthcare Business from the North American Furniture Solution segment to the Specialty segment. This change will better leverage the unique skill sets and capabilities of our Specialty business team, particularly in the areas of craft, wood and upholsteries.
Combining Nemschoff’s with our other specialty businesses also provide the strong fit given the focus of these brands on serving the architect and design community.
This strategic decision coincided with our annual asset impairment review where we recorded a non-cash impairment charge of approximately $7 million related to the write-down of the Nemschoff's trade name carrying values. Nemschoff's remains core to our broader strategy.
It represents a leading healthcare furniture brand in North America with a broad dealer network and great products. Achieving our enterprise-wide cost reduction objective represents our fourth priority of the business.
Last quarter we announced the three year cost savings initiative aimed at achieving between $25 million and $35 million in gross annual cost reductions by fiscal 2020.
Our operating expenses during the quarter began to show early results and we recently announced a facility consolidation in the UK that will contribute to these savings removing our administrative teams at the Melksham manufacturing and distribution facility that was opened last year.
The realignment of our organizational structure that we put in place during the third quarter are already contributing to our bottom-line and we expect this to be an enabler of this initiative as we move through fiscal 2018.
Looking ahead, while these efforts will help offset potential wage and material inflation and help fund a number of growth initiatives, these cost improvements will also play a role in achieving our goal to increase operating margins consistently above 10% over the next three years.
We will continue to update you on our progress as we further develop and plan the supporting initiatives behind the savings target. The fifth area of focus for our business is our ongoing commitment to new product innovation.
Over the past year, our innovation agenda remained at the forefront as we launched a number of new products including the remastered Aeron chair with meaningful material and technology innovations that will extend the life of this powerful franchise.
Earlier this month, we showcased two new prospects which is a portfolio of semi-circular freestanding furniture designed to foster collaborative and individual creativity and the Taper executive chair from Geiger both of which won best of NeoCon Gold awards.
New products represent a 24% of our consolidated revenue this past year exceeding our goal of 201%.
Product innovation has been a traditional strength at Herman Miller and we are determined to keep this dimension of our business as a competitive edge with the recent alignment of creative direction and new product commercialization under a common leadership, we will further reduce our time to market and ensure design and developments of Herman Miller which mines our customers’ most critical needs through a robust pipeline of new products and solutions.
Before Jeff reviews the financial results of our business segments, let me provide some context on the current global business environment. In general, uncertainty has been the driving reality in the near-term.
Sales and orders for the North American contract industry remains choppy and as a consequence price competition between industry participants remains intense.
With that said, broader macroeconomic indicators including confidence measures, service sector employment, architectural billing and non-residential construction activity continue to suggest the support of growth outlook in the near-term.
Our existing strategy pursued over the past five years designed to respond to forces now very much in play, changing foreplay, merging work styles, the impact of technology and the convergence from home and office.
While uncertainty persists around the US government’s plans to tax policy change, such reform has the potential to be a meaningful tailwind for our business to higher employment levels and increased investment setting. On the North American Consumer front, positive consumer homebuilder sentiment point in the right direction.
Although existing home sales and new housing starts dips recently, interest rates remain at historically low levels and there is a limited inventory of unsold homes.
The global economic picture is fairly stable overall although there continue to be pockets of disruption like Brexit and the geopolitical problems and lower oil prices that complicate the Middle East and other oil producing regions.
Over the past five years, we have focused on expanding our addressable markets and building a multi-channel business as a platform to deliver our leading designs and innovations to new audience virtually anywhere in the world.
We believe our strategy continues to respond well to current and future realities in our markets and is a focus on the five priorities to execute our strategy that I have reviewed with you.
The team at Herman Miller made good progress on these objectives this past year and has already begun further steps to continue this progress over the coming years positioning us to deliver sustainable sales and profit growth going forward.
With that overview, I’ll turn the call over to Jeff to provide more detail on the financial results for the quarter. .
Thank you, Brian. Good morning, everyone. Consolidated net sales in the fourth quarter of $577 million were 1% below the same quarter last year. On an organic basis, which excludes the impact of foreign currency translation and dealer divestitures, sales were 3% higher than last year’s level.
Orders in the period of $568 million were 6% lower than the same quarter a year ago. As we outlined last quarter, 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 by an average of 2%.
As a result, we estimate orders totaling approximately $21 million were pulled ahead into the third quarter that would have otherwise entered during the fourth quarter. On an organic basis, which includes adjusting for this pull ahead impact, orders were flat compared to the fourth quarter of last year.
Our backlog last year included approximately $9 million in orders related to a dealer that was subsequently divested during the fiscal year. Excluding the impacts from that dealer divestiture, the ending backlog in May was 2.5% higher than last year’s level.
Within our North America segment, sales were $338 million in the fourth quarter representing an increase of 1.5% from the same quarter last year. New orders in this segment were $329 million in the quarter reflecting a decrease of 8% from last year.
Organically, we posted year-over-year revenue growth of 4% while orders were flat compared to a year ago. Consistent with what we experienced throughout much of the fiscal year, orders in Q4 from project sizes below $1 million were higher compared to last year while we saw comparatively fewer projects above the $1 million size level.
Sector results in the quarter were mixed showing order growth from the telecommunications, manufacturing and federal government sectors while there was relatively lower demand from financial services, wholesale and retail customers. Our ELA segment reported sales of $93 million in the fourth quarter reflecting a decrease of 16% compared to last year.
New orders totaled $90 million and amount 12% lower than the same quarter last year. On an organic basis, which excludes the impact of dealer divestiture and foreign currency translation, segment sales and new orders were both 5% below last year’s level.
The year-over-year order decline was primarily due to lower demand levels in the Middle East with fewer large project opportunities in this oil producing region as well as in Europe and China. These lower order levels were partially offset by growth in Mexico, India and Brazil.
Our ELA team did an excellent job navigating the unpredictable headwinds globally this year including significant foreign currency pressures. Despite this, the team made meaningful progress in a number of important strategic initiatives from scaling our assembly operation in India to expanding our supply and fulfillment capabilities in Brazil.
At the same time, this segment posted improved adjusted operating earnings over last year. Sales in the fourth quarter within our Specialty segment were $57 million, a decrease of 8% from the same quarter last year. New orders were $59 million or 5% lower than the year ago period.
Excluding the estimated timing impact of the price increase, organic orders were 3% lower than last year’s level. The decrease was primarily due to lower demand for the Geiger and Maharam businesses, partially offset by continued growth within the Herman Miller collection.
The Consumer business reported sales in the quarter of $90 million, an increase of 16% compared to last year. This represents the highest ever quarterly sales level for the segment supported by strong growth across our studio, catalogue, e-commerce and contract channels.
New orders for the quarter of $91 million were 8% ahead of the same quarter a year ago, and on a comparable brand basis, DWR revenues for the quarter were up nearly 19% along with delivering strong top-line growth, the Consumer team is making progress in their commitment to driving improved profitability.
Operating earnings for this segment have been limited this year by the aggressive rollout of new studio locations and other investments that we believe are necessary to support our longer term growth potential.
However with that said, the business delivered markedly improved operating earnings this quarter over last year with a lot of work yet to do in this area, but we see the potential is there and remain committed to continuing our focus and momentum as we move into fiscal 2018.
Consolidated gross margin in the fourth quarter was 38.3%, which is 40 basis points lower than the fourth quarter from last year.
On a year-over-year basis, while we continue to feel the impact of comparatively deeper discounting and higher steel prices, realization from our February price increase and favorable channel mix during the quarter helps mitigate these factors.
Operating expenses in the fourth quarter were $162 million or compared to a $169 million in the same quarter a year ago. The prior year included approximately $4 million in expenses related to dealers divested this year and $6 million of non-recurring gains.
After adjusting for those items, operating expenses were $9 million below last year due to a variety of factors. We are beginning to realize cost savings as part of the initiatives we announced last quarter to find $25 million to $35 million of savings annually over the next three years.
We also recognized comparatively lower expenses this quarter related to favorable trends for certain employee benefit accruals. These reductions were partially offset by higher occupancy and staffing costs related to the new DWR studios.
In addition to the Nemschoff impairment charge described earlier, restructuring actions involves in the quarter involving certain workforce reductions resulted in the recognition of severance and out placement expenses totaling nearly $2 million. On a GAAP basis, we reported operating earnings of $50 million this quarter.
Excluding restructuring and asset impairment charges, adjusted operating earnings this quarter were $59 million or 10.2% of sales. By comparison, we reported adjusted operating income of $51 million or 8.7% of sales in the fourth quarter of last year.
The effective tax rate in the fourth quarter was 29.9% which included favorable state tax provision to return adjustments and a better than expected mix of income from lower tax jurisdictions. Excluding the impact of the asset impairment expenses, the effective tax rate was approximately 30.9%.
This compares to an effective rate of 24.9% in the year ago period, a period which benefited from a favorable transfer pricing adjustment during the quarter. Finally, net earnings in the fourth quarter totaled $33 million or $0.55 per share on a diluted basis.
Excluding the impact of restructuring and asset impairment, adjusted diluted earnings per share this quarter were $0.64, an increase of 14% compared to adjusted earnings of $0.56 in the fourth quarter of last year. And with that overview I’ll turn the call over to Kevin and he will give us an update on our cash flow and balance sheet..
Thanks, Jeff. Good morning, everyone. We ended the quarter with total cash and cash equivalents of $96 million, which reflected an increase of $11 million from last year. Cash flows from operations in the period were $80 million, compared to $85 million in the fourth quarter of last year primarily due to changes in working capital balances.
For the full fiscal year, cash flows from operations were $202 million, compared to $210 million in the prior fiscal year. Capital expenditures were $70 million in the quarter and $87 million for the full year. Cash dividends paid in the quarter were $10 million and $39 million for the full year.
The dividend increase we announced yesterday increases are expected annual payout levels to approximately $43 million. We also repurchased approximately $7 million of shares during the quarter and $27 million for the full year.
As we mentioned last quarter, our target for cash returns to investors, a measure which we measure by interest expense, dividend payments and share repurchases as a percentage of trailing three year EBITDA targets 30% to 35% of 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 shareholder value, we expect to achieve this target on an annual runrate basis next year through a combination of the higher dividend level and additional share repurchase activity.
We remain in compliance with all that covenants and as of quarter end our gross debt-to-EBITDA ratio was approximately 0.8 to 1. The available capacity in our bank credit facility stood at $392 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 ten year forward starting interest rate swap in September of 2016 with a notional amount of $150 million that will be effective in January of 2018. It will fix our interest rate on this tranche of debt at 2.8%.
Shortly after the end of this quarter, we entered into an additional ten year forward starting interest rate swap with a notional amount of $75 million at a fixed rate of approximately 3.2% that will also be effective in January of 2018.
This transaction enables us to put financing in place for general corporate purposes that takes further advantage of the current low interest rate environment.
Given our current cash balance ongoing cash flows from operations and our total borrowing capacity, we believe we continue to be well positioned to meet the financing needs of the business moving forward. With that, I’ll now turn the call back over to Jeff to cover our sales and earnings guidance for the first quarter of fiscal 2018. .
All right, thanks, Kevin. With respect to the forecast, we anticipate sales in the first quarter’s range between $570 million and $590 million. We estimate that year-over-year unfavorable impact of foreign exchange on sales for the quarter to be approximately $2 million.
So on an organic basis, adjusted for dealer divestitures and the impact of foreign exchange, this forecast implies a revenue increase of 5% compared to the same quarter last year at the midpoint of the range.
Consolidated gross margin in the first quarter is expected to range between 37.5% and 38.5% and operating expenses in the first quarter are expected to range between $166 million and 170 million. We anticipate earnings per share to be between $0.55 and $0.59 for the period and this assumes that effective tax rate of between 30.5% and 32.5%.
With that brief overview, I’ll now turn the call back over to the operator and we will take your questions..
[Operator Instructions] Our first question comes from Matt McCall with Seaport Global Securities. You may begin..
Thank you, good morning, for taking my questions. This is actually Reuben on for Matt. .
Hey, Reuben..
Hey. So, we keep hearing about the choppy environment in the corporate office space.
Can you maybe give us an update on what your market growth expectations are in North America over your fiscal 2018?.
Hey, Reuben, this is Jeff. Yes, so, there is no doubt our fiscal year we’ve seen what you’ve heard from many others in our industry is this choppy environment. As a general rule, and we’ve tended to talk about this as a longer trend, we think that the North American contract business is a 1% to 3% growth rate industry now.
That assumes – and so, I would tell you that generally, our expectation is in that range as we move forward. Now that would assume and this is an important factor that we don’t get any kind of an uplift from changes in tax policy that are being contemplated in Washington.
If we see some movement there and some progress, we may well see some boost from that, but absent that, I think 1% to 3% probably toward the upper end of that range, I think if you look at the BIFMA forecast that’s out there is higher than that. But based on our recent experience, we are a little more tempered in our outlook. .
Okay, thank you. And then, in your guidance for the fourth quarter, I think you guys on the last quarter’s call talked about $1 million to $1.5 million in price from the February announcement.
Can you talk to us about where it came in and maybe what’s in the guidance or I guess, what’s your outlook for – from a price cost standpoint going forward?.
In terms of the price increase, so it was about – we had about a $3 million impact that rolled in year-on-year in the fourth quarter. I think, Kevin, our guide implies on a little more than that, it tends to layer itself in over time probably between $3 million and $5 million for the first quarter when you net it all out.
Again, that was a targeted price increase, but it affected many different product lines. So it wasn’t heavily weighted toward any one. If it was weighted anywhere, it would have been toward product that had a fairly – a relatively high component of steel, because that’s where a lot of the inflationary pressures we face all year has been.
But it was across the board and in those product categories. .
Okay, and then, on the cost front, what’s your outlook for inflation?.
Steel prices – so, we will – our expectation in our guidance is predicated on this idea that we are still comping against, because our supply contracts lag the market price of steel.
We are actually right now, if you look at the cold rolled index we are about where we were a year ago in the total market price, but because our contract put us on a three month lag as a rule, we still have one more quarter of comping against relatively low prices a year ago.
So we expect some steel inflationary pressure still in the first quarter that’s reflected in our guide and as we get towards the back half of the first quarter and as we roll into Q2, assuming no further inflation in the market price we should start to comp those and hopefully see some relief. .
So Jeff increase year-over-year, but inflation quarter-to-quarter we look to be pretty flat, right, we are not looking for, we don’t see a lot of inflationary pressure going in Q4 to Q1?.
Correct..
Got it. And then last one for me, strong growth in the Consumer segment in the quarter.
Can you help us with kind of the buckets of growth going forward? I know there is a lot of pieces with added square footage and the catalog and ecommerce, can you just kind of help us understand how maybe that 10% number that you saw this year, I guess, what the buckets were within the 10% and then what your expectation would be for 2018 and then thanks for taking all the questions..
Sure, yes, Reuben. So, we had – as we mentioned in our prepared remarks, we had pretty good growth across all consumer segments. As you look at kind of underneath that across the components, obviously we had – we put a lot more square footage in place. So we saw a nice uptake in studio growth at or around that kind of average for the total business.
E-commerce was up north of 10%. We had nice growth in our contract business, on the order of 10% to 12% and I am going from memory, these are very close. And you had the virtual studio, our catalogue program.
That was probably the one area where we saw, and Brian alluded to this in his remarks, where we saw a remarkable turnaround from the year ago levels and it varied as we moved throughout the year, but that was up nice solid double-digits north of the average for the business. .
Thank you. Our next question comes from Budd Bugatch with Raymond James. You may begin. .
Good morning and thank you for taking my questions. Hope everyone that’s there is well..
Good morning, Budd. .
Help us on the cost program. Now you’ve got putting some more meat on that bone.
Can you help us now just how to bucket that? How to think about the $20 million to $25 million over the next couple of years of the sources, maybe which segments and how to model it going forward?.
Hey, Budd, this is Jeff. Let me start and I’ll let these guys fill in any color that they think is appropriate. So, the way we talked about this is that’s really it comes down to essentially three categories, Budd, the $25 million to $35 million. What I would tell you is it does not come from any one business unit or segment within the business.
We tasked every area of the business to contribute to this at one level or another and it would be more weighted by size of business segment than it would be outside of that kind of normal size weighting. But the three categories, one of them I would describe is business unit synergies.
By this we mean, and Brian talked about this a little bit in his remarks.
Some of the structural and organizational changes we put in place or Brian put in place in the third quarter had been very much aimed at pushing more decision-making autonomy to the commercial business unit leads for making decisions around the level of resources needed to support that business and that has freed up these business leaders to independent decisions and to drive cost out of their business whereas they see fit.
And we are already seeing that as an enabler to cost savings. We think that’s going to pay dividends going forward. That is included by the way some targeted workforce reduction, very targeted reductions around things like travel and entertainment and just a range of activities across the business. So that’s the first one.
Facilities and logistics – so facilities consolidation and logistics optimization one of which we’ve just recently announced in the UK is another example of it. There are others we are being very cautious not to talk specifics here yet until we get to the point where we are announcing those.
But that is another area of savings that we are counting on and it’s already beginning to some results. And then the last one is just a general cost rationalization across the business.
This would be – and we talked about this at our investor event in New York as – I think I described it as just turning over rocks; when you’ve done business the same way for as long as we have, you kind of fall into patterns and when you reach a moment like this where you step back and you challenge old ways of thinking, you find opportunities and we’ve been very focused and tasked the entire business to do just that.
So those are the three general categories. As in terms of how it layers in, we are running right now at an annualized savings rate of about $8 million we estimate which is in line with our expectations.
I think as we get towards the back half of this fiscal year, we should be on the order of $15 million of annualized runrate and then working our way toward that $25 million to $35 million annualized.
Now that’s a gross number Budd, so I should be cautious here; probably the other thing worth mentioning is our rationale for doing this cost savings problem, we’ve said there is really three reasons. Number one, it’s a hedge against inflationary pressures in the business, right. We’ve been feeling the effects of steel prices all year.
While we are anniversary-ing those hopefully soon, there will be more going forward. We know that and we want to get ahead of it. Secondly, we do have a number of areas of growth investments that we see are necessary for the long-term health of the business, but we don’t want those to be purely incremental expenses and cost to the business.
So we want to free up the operating headroom through these cost savings to fund some of those and then finally, obviously leveraging more to the bottom-line which is the goal and our stated objective is to get sustainably above 10% operating income over the next three years in the business.
And so, ultimately, that’s how we are trying to frame the cost savings initiatives for folks like yourself, but it’s really those three categories that are source of the savings..
Budd, I’d add one thing to Jeff’s description that I mentioned in my notes. We are looking very specifically at the Consumer business to build a longer-term plan around the profitability in that segment. We are talking to several potential outside partners to help us come in and take a look at that. We are making really good progress on the top-line.
We feel much, much better today than we did a year ago with teams’ ability to get catalogue to be productive, get new products out as well as getting studios opened. But none of us are satisfied with our ability to convert top-line to bottom-line as fast as we would like. So we are out engaging some folks to help us with that.
We hope that we are going to have an early look at that work by the time we get out of the second quarter if not, at the beginning of the second quarter so that we got a better plan as to the additional things we need to do in that business to get to our ultimate objective.
So, I think that some of the work we could see already in that business around logistics which Jeff mentioned to in his – he knows that there is work around everything from how do we move products from vendors to DWR to the ultimate consumer.
We know there is a fair amount of opportunity there for optimization, which we are implementing step-by-step, but at the same time, we want to take a deeper look at how do we get towards the ultimate objective to get around operating profit in that business and I think we will have a better idea that as we cross through Q1 but probably more solid as we get into the end of Q2.
.
Okay. Thank you for that explanation. So I got the geography in terms of timing of the $8 million, $15 million, $25 million to $30 million in gross cost savings over the next couple of years, I got that. I don’t understand how it flows between the business unit synergies, the facility optimization and the cost rationalization.
What is your starting on putting numbers to those three buckets over those three years as well? What is – is it a third, a third, a third or is it different?.
Budd, I think that’s one that as we get further into this year, we can get more definitive because some of the detailed plans are coming in and this is where I guess a little – the teams – we know we got objectives, of course as you know, you take objectives bigger than the 25 to 35 to go find the 25 to 35.
The individual details and w are watching those roll out one-by-one. We announced one this quarter with a consolidation in the UK that will affect obviously mostly the International business.
There are other things in international that we are contemplating to look at as we both build that footprint and that business and ask how to most – how to best optimize it. I just mentioned you there is a fair amount of it going to happen in the Consumer side for sure.
And we are looking at the core business and what things we can do with the question right now with how much of that will show up in the administrative side if you will in OpEx versus cost of goods sold. I think as we get through the first half of this year, we will be able to give you much more definition about buckets and exact timing.
Right now, we are very confident that the $8 million looks like it’s rolling and that’s mostly shown up in operating expenses. I think the 15 will largely show up in operating expenses and we will see that roll in this quarter.
A big chunk I think of the first 15 is going to come really between the North American contract businesses meaning the core business in healthcare. I think the next place will be international because we have already made some of those changes.
I think it will – this first 15 will look very much weighted towards those two, no surprise of the two biggest segments. I think Consumer will be the third as we get to the other side. I don’t expect there is much on the Specialty segment to be frank.
I think there we got some other objectives around how we get – as we move Nemschoff over there, how we get Nemschoff to the level of profitability that we need. But it’s not as much cost work in that segment as it is in the other three. That helps..
Okay. That’s how to take up too much more time. There are a couple things that confused me in the release. I wanted to maybe get your commentary on that.
With the higher penetration of mix particularly in Consumer which I – we think we have a higher gross margin than others, I was curious as to why gross margin actually tended down more on a percentage basis with the mix of business being quiet higher, Consumer at higher gross margin. And I was also curious as to the sales per square footage.
It’s just a fact that we’ve added that much more square footage in Consumer that the productivity looks lower and it should rise back to the level it was a year ago or is that – is that’s not an expectation with the larger studios?.
Yes, Budd, let me start with your question on gross margin. So, it’s a little of both and for sure, relative to our expectations coming to the quarter, we had a better mix of the Consumer business and so that drove that along with the product mix favorability drove a bit better gross margins than our guide had provided with one of the contributors.
That said though, Budd, if you look at – and I was assuming you are looking at year-on-year gross margin comparison, remember, we are feeling the effects all year along of steel price inflation and despite the fact that we did our February price increase, still net pricing or net discounting has been deeper this year than last and it’s plagued us all year along.
I am sorry, Budd, say again..
Would you quantify that?.
Certainly, yes, net – net discounting year-on-year, this is net of the price increase, we estimate between $4 million and $6 million and steel pricing at about $2.5 million year-over-year. So those two areas of pressure were really what drove the day in terms of the year-on-year margin comparison.
But relative to this is always a point of what you are comparing against relative to the expectations that we set for our guide back in March, the Consumer mix, the product mix favorability and frankly a little better pricing impact – price increase impact than what we were anticipating that actually helped our gross margins relative to expectations.
And then, Brian, do you want to take the second one?.
Yes, first let me add one thing on the margin, Budd, the one thing I would tell you, we actually would expect that Consumer margins longer-term should be a little bit better even on a gross side than they were this quarter.
We had a few things that – to be frank, we saw a much heavier mix on a couple of product lines that we need to do a better job or make some changes on the pricing level and/or as we get up to speed. So let me give you the specifics.
One of the things we got still happening within the Aeron business, Aeron chair business is, we are still running old and new Aeron. And the new Aeron has a slightly lower margin at this point in its ramp if you will and we are carrying overhead to run two production lines. If you follow what I mean.
One of the things that happened in the Consumer business is we have a 100% shift to the new product whereas in the contract business it’s running a spread between the two and once we get fully converted over to new Aeron, we think the margins will be equal or slightly better than older, but we are still in the conversion.
So I would say, that was a bit of a drag on the Consumer business this quarter. We knew that Aeron is growing really well at Consumer and the margins are still very healthy. But we’ve got a little bit of work to do on that side. We also saw a big move within the Consumer business towards Aims XL, the larger version of the lounge chair.
That has had a little bit lower margin, in fact considerably lower margins with a particular level of covering. We got to make some changes there that we hadn’t seen a big mix in that chair and we saw a big mix shift.
So I think couple of those things will actually help us as we get into the second half of the year where actually Consumer margins should get a little better with some work we are doing there. So I just give you that as an added little – I would almost agree with you a little bit. We would have thought it would be a little bit stronger given the mix.
But we had a couple things that pulled us back on the Consumer side more than we would have liked, if that helps a little bit for your understanding..
Thank you very much..
On the store front side, if you look, I think Kevin has probably got the exact detail. But if you look at stores that are opened more than three years, whether they are we know that we are hitting our metrics for both sales per square foot and we are hitting our metrics for occupancy cost as a percentage of sales.
What’s bringing down the overall metric is so many new stores. I mean, something like 25% or 30% of our revenue for the year came from stores opened in the last 18 months. If you look at the back, you actually drive the occupancy cost per sale, above our target and you drive revenue per square foot obviously down.
We think based on the trajectory that as those new stores get fully up to speed, over the next year or so, we will begin to see that metric turnaround. Now, again, next year we will layer in some additional new stores that are going to come at the same problem of – they are going to be in early in their phase.
After we get through next year, we don’t think the store openings will be as great as a lever if you will, a negative lever on sales per square foot. But our underneath data, when we separate out mature stores from non-mature stores, the data looks much better and much more comparable and in the right direction.
Kevin, I don’t know if you got a detail there. .
Yes, yes, Budd, to give you the – if you take the non-comparable studios out, the sales per square foot is about $750. So about 6% higher year-on-year. .
Interesting. Thank you very much..
Thank you. Our next question comes from Kathryn Thompson with Thompson Research. You may begin..
Good morning guys. This is Steven on for Kathryn. In the Consumer segment, it’s been strong all four quarters of this year and less volatile relative to the other segments both orders and sales.
Two questions there in Consumer orders, number one, how much of the growth in Consumer this year would you say was based on ERP issues and catalogue issues being fixed? And secondly, just kind of stepping back, I am surprised that this segment is so order driven given the more retail and residential nature of the units.
So could you help me understand that as well?.
Could you sound on your question and then I want to make sure I follow what you are asking Steven when you say more order driven.
What are you suggesting or asking?.
Well, I guess, just since it’s more residential in nature in the end-market. I guess, I am just surprised that orders are kind of a big driver in that segment.
So just kind of helping understand why orders are a big part of Consumer?.
Well, I mean, I get, in both cases, essentially, I think it’s because you are wondering about – is there – you are thinking of it like a more of a retail – like a fashioned retailer where you walk in and you buy your clothing and you take it. So, you don’t really see a difference between orders and sales.
Is that what you are asking?.
Right, right..
Okay, well, I think there is two things. One, remember we are playing in the premium segment. So there is a fair amount of stuff that people actually special order the fabric, the leather or whatever they want that match their interior décor. So you got to remember that, a fair amount of that business is not going to be cash and carry.
In fact, it’s very, very small on the cash and carry side and even often ecommerce sales start with a person who has been in the studio, look at the stuff in the studio and then ordered online.
Okay, so, I think you have to think about this much more as being a little bit longer cycle than what you would see in, I would call a fashion retail if you want to think about it that way or even the lower segment of home furnishing.
The other thing to keep in mind, if you look at the Consumer business for us, about 20% of that business is to the trade. So, meaning we are selling to a professional designed person who is helping someone design their home or condo. Okay, so, that looks almost more like a contract sale one level in that.
They are coming in, we are building an entire portfolio for them and then shipping it to them when their home is being completed.
About 10% of that business – if I remember right, is going to be contract-related meaning, it’s actually being sold either could be to a Herman Miller dealer partner, could be to a hotel producer or somebody in the other part of the hospitality segment. Okay.
You really get 70% of the business that I would call is traditional retail if you will, but even that often the person that’s coming in, they may be working with a designer or for sure they are working with one of our in-house designer. So the cycle ends up being a little bit longer than you might expect from order to shipment. If that makes sense..
That does. Thank you. And then on Consumer, just thinking…. .
The lead times in that business though are much shorter than what you would see in our traditional contract business. Often we think of that business having a couple of week lead time. It may be as long as three or four weeks when it’s something that’s a special order.
I think like it’s something like a leather sofa coming from Italy if they pick out a special leather, that could take some time although increasingly it is things that are in stock, but the customer is actually picking the portfolio they want and picking the timing for when they want those things delivered.
Okay?.
Excellent.
Thank you, and then on just thinking year-over-year on the positive trends on orders and sales, can you kind of help us even think about don’t even have to be quantify how much of that was the ERP and catalogue issues being fixed versus just kind of natural growth in the business?.
I would tell you, first of all, the ERP is hardest to quantify at one level. But there certainly was a negative impact last year from the ERP system and one of those that takes a while to work through, because you have the initial problem of the delayed things, shipping or delays, getting orders into the system.
The bigger problem is, you get a distracted sales force. It wouldn’t be hard for me to imagine if I think back of the impact of that year-over-year, it primarily impacted the second half of the year. I am just kind of ballpark it. I don’t have any real data. So I am just going to give you my gut feel, probably a couple points of growth.
1% to 2% last year wouldn’t surprise me as we look at the back half of the year. If that makes sense. I would say the catalogue was one of the biggest turnaround we had year-over-year. And it’s a real driver and it’s not just – the biggest thing there is we are finding prospects.
People who have not been a customer or at least haven’t been a customer in a long time that we are trying to spur the activity to get them to come to a studio or go online.
I would tell you that’s probably turnaround the catalogue and again, I am sort of spitball on it here, I’d say, that wouldn’t be surprising if that’s not a 5% or 6% movement from the turnaround in the catalogue. Now, that’s an ongoing thing, right. So that has continued to generate significant sales.
So don’t think that is the total, because we got back to ground zero and then grew from where we were before.
And then, there certainly was a big chunk that related to the new studios being opened even though as we talked earlier from Budd’s questions, not quite as profitable on some of those new studio sales, because we are not at the curve, but having those stores in place, we know that a big chunk of the online business actually has driven around a radius of where a store is.
So getting a store opened helps drive both online, catalogue, as well as studio sales. So those things all combine together, I’d say the one area that started to really get strong in the second half of the year was the contract side and we still think there is room to grow on the contract side, at NeoCon.
One of the big things we did is displayed a fair number of DWR products that are now available to our contract customers and our Herman Miller dealers and one of the things we worked hard to do this year is to make it easy for a Herman Miller dealer is actually order DWR products and we still think there is a fair amount of runway in front of us in that regard as well as we look into next year..
Great. Thank you. .
Thank you. Our next question comes from Greg Burns with Sidoti & Company. You may begin..
Good afternoon.
In terms of the product introductions around live OS, what is currently in market and what is coming, I am thinking in relation to maybe the facility management capabilities as opposed to some of the integrations you are doing with technology into the furniture like adjustable desking and things like that?.
Yes, the first thing that goes to market, Greg, is the desk.
Greg you are at NeoCon correct?.
Yes..
Or no..
Yes, I was..
At NeoCon we demonstrated both the ability to pair to the desk and to be able to control the desk with your smart device and a chair that also paired with the desk so that you got a level of concordancy – in my opinion it was the magic of the user experience where they begin to work together and know you.
The chair will not, the chair component will not be out until the first of calendar year. So in January of 2018 and when the chair will actually get released. The desk is going to be orderable, I believe starting in August. So desk in August. Chair, we get to January.
Remember by the way, the desk element is actually retrofitable to – so for folks who already own a Herman Miller height adjustable table will be able to retrofit that capability into their existing table. So it’s not like we have to go out and just sell new tables.
The other element that we demonstrated was the connectivity with Robin around room scheduling. That I think is already - you can do today in – as you implement the desk, but not fully. As we get into the second half of the year, we will have that fully up I believe where we can start to pull the data between the two..
Okay.
In terms of the desk, is that like a CapEx sale or is that a subscription sale? What’s the economics of that and I guess, what’s the incremental ASP that you will get from something like that?.
It’s largely a subscription sale. Although there is a little bit for the device itself. There is an up charge right, Kevin..
Yes. There is – for the furnishing there is an up charge to the smart version that comes with the sensors required to send data to the cloud and then there is an ongoing subscription element that goes along with it..
Okay.
I guess, would you be willing to – I guess, give a ballpark on like kind of what an average subscription might look like per desk or per office?.
Yes, the up charge for the smart device is probably around 10% and then subscription-wise, there is different incentives for volume and contract terms, but per device you can get a smart device for $50 to $60 a year for the subscription..
Okay. Thank you..
Thank you. This concludes the Q&A session. I now like to turn the call back over to Brian Walker for closing remarks..
Thanks for joining us on the call today. We wish you all a great remainder of your 4th of July holiday. We recognize many of you are off today. We appreciate your continued interest in Herman Miller and look forward to updating you next quarter. Have a great day..
Ladies and gentlemen, this concludes today’s conference. Thanks for your participation. Have a wonderful day..