Herman Miller Q1 Earnings Call Transcript

123jump.com Staff
25 Sep, 2010
New York City

The office furniture systems maker net sales rose 17.5% to $380.7 million in the quarter. Net quarterly earnings surged 91.7% to $16.1 million reflecting higher revenues across geographies. Earnings per share grew to 22 cents compared to 14 cents per share in the previous year.

Herman Miller, Inc. ((MLHR))
Q1 2011 Earnings Call Transcript
September 17, 2010 9:30 a.m. ET

Executives

Brian C. Walker – President and Chief Executive Officer
Gregory J. Bylsma – Executive Vice President and Chief Financial Officer
Jeffrey M. Stutz – Treasurer and Vice President, Investor Relations

Analysts

Budd Bugatch – Raymond James & Associates
Todd Schwartzman – Sidoti & Company
Matthew McCall – BB&T Capital Markets
Leah Villalobos – Longbow Research

Presentation

Operator

Good morning, everyone and welcome to the Herman Miller Incorporated Fiscal Year 2011 First Quarter 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 Chief Executive Officer and Mr. Greg Bylsma, Executive Vice President and Chief Financial Officer. Mr. Walker and Mr. Bylsma are joined by Mr. Jeff Stutz, Treasurer and Vice President, Investor Relations.

Mr. Walker and Mr. Bylsma will open the call with a brief presentation which will be followed by your questions. We will limit today''s call to 60 minutes and ask that caller''s 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 C. Walker

Good morning and welcome, everyone. Despite lingering questions on the durability of the economic recovery, we had a strong start to the new fiscal year with solid first quarter results reflecting both operational and strategic progress.

Order entry rates showed remarkable consistency throughout the quarter, in total improving 22% over the prior year and 8% on a sequential basis. In contrast to our experience over the past several quarters, customer demand within our core North American work business improved broadly across a variety of industry sectors and geographic regions.

Net sales for the quarter totaled $381 million. This is the highest we’ve reported in almost two years. The improved topline helped drive manufacturing leverage that was needed to offset additional cost pressures resulting from price discounting, commodity increases and employee benefit programs.

While operating expenses in the period were higher in both a year-over-year and sequential comparison, operating earnings in the first quarter improved relative to the prior year and prior quarter. Apart from our financial results which we will cover in greater detail shortly, we made meaningful progress towards the operational strategic goal we set out to achieve in the first quarter.

In June, we officially launched the Thrive portfolio, a collection of ergonomic products and services which include the technology and support products gained through the acquisition of Colebrook Bosson Saunders, is what we call CBS. Strategically, Thrive represents a bold move in our pursuit of new areas to serve our traditional customers and dealers. We made great progress during the first quarter on our two primary goals with Thrive.

First, we completed the integration of the Colebrook Bosson Saunders order entry and inventory management systems, giving us seamless order processing capability. Second, we successfully hired and trained a dedicated commission-based sales force. We''re absolutely confident that the combination of Thrive products with a dedicated sales team and our strong dealer network will further our position as an industry leader in ergonomic solutions.

We also advanced the strategic direction of our Convia business this quarter. As you know in 2009, we announced an alliance between Convia and Legrand to broaden the reach of our energy management solutions for commercial buildings. Today, we are as convinced as ever that Legrand has the right combination of knowledge, products and distribution to successfully commercialize this technology outside the office furniture industry.

For the past several months, we’ve been working with Legrand to establish a long-term plan in pursuit of this goal. To that end, we''ve signed a letter of intent to license Convia''s intellectual property rights to Legrand for use in commercial building applications.

Under this arrangement, Legrand will take independent responsibility for the ongoing advancement and integration of Convia technology in building controls and programmable environments. At the same time, we will retain exclusive rights to the use of Convia''s technology and furniture product solutions.

We expect to finalize the terms of this arrangement within the next few weeks. One of our strategic priorities over the past several years has been to extend the reach of our residential furniture applications to consumers.

This first began with a focus on developing network of specialty retailers. Early in fiscal 2009, we broadened this effort by establishing a supplier relationship with Costco. More recently, we began laying the groundwork for the establishment of a direct-to-consumer e-commerce store through our website, hermanmiller.com.

During the first quarter, we put the finishing touches on this site which we plan to have up and running next month. Our primary focus on this effort is to build awareness and communicate the entire Herman Miller story to a greater number of retail consumers.

At the same time, we continue to place great value on our relationships with our distribution partners. And we will also utilize a new website to direct customers to their local or preferred online retailer.

We hope to move forward this quarter on objectives around employee compensation and benefits. There is no doubt the economic hardship of the past two years took its toll on our people. Nonetheless they helped shoulder the burden of financial sacrifice with grace and commitment as we moved the business toward recovery.

Late in fiscal 2009, we implemented a series of temporary cost cutting measures including a 10% wage reduction. With business conditions showing steady improvement in the fourth quarter of last year, we reinstated one half of the reduced wages and to the remaining portion will be brought back as soon as business conditions permitted.

Given the relative strength of sales and orders throughout the first quarter, we feel the business today can support such a move. In fact, we recognized and expend the full equivalent of this wage increase in the first quarter as a result of our wage recovery program. Based on these results, we are moving ahead with a full reinstatement of base wages for the majority of our employees, effective at the start of the second quarter.

I like this way of new products shown at the NeoCon tradeshow earlier this summer was received with tremendous enthusiasm. Despite two years of financial decline, the 18 new products we showcased ranked among the broadest line of introductions in our history. Importantly, it demonstrated in clear form our strategy of addressing the evolving needs of our customers by filling product gaps in existing categories and expanding into new categories previously ignored by innovation.

While I can''t cover each of these new products in today''s call, I will offer a few highlights. The Celle family of work and side chairs developed in collaboration with renowned designer, Yves Behar, is a new addition to our industry-leading portfolio of seating solutions.

It combines inventive design and affordability with the quality and durability one expects from Herman Miller. Simply put, it''s a high design family of chairs offering what we believe will reset the customer reference point for value and comfort.

We held an invitation-only sneak peek of Celle during NeoCon and the feedback we received from customers, dealers and designers was incredibly positive. We expect it to be a big hit at its formal public launch during the Orgatec tradeshow in October.

Our NeoCon offering showcased a new product solution aimed at the growing demand for furniture that can be utilized across the entire office landscape. This new product line, the official name of which has not yet been announced, utilize systems and storage elements to address multiple work applications, from open floor plan to private office, all with a uniform and consistent aesthetic. We are moving aggressively through the final development phase of this new line and anticipate the official launch in our upcoming third quarter.

Along with product displayed at NeoCon, perhaps none received more attention than Compass, a modular, wall-based healthcare furniture system. This new product offers breakthrough flexibility in the way storage and utilities are delivered inside the patient room.

The market responses at tradeshow has been tremendous with significant early interest coming from the healthcare designers and potential customers. In fact, we’ve already booked a number of orders since official order entry began September 1.

I''ll conclude my comments by addressing some exciting news from earlier in the week. On Tuesday, the Michigan Economic Growth Authority approved a package of tax incentives for Herman Miller associated with two proposed investments within our West Michigan facilities.

The incentives are valued at $7.8 million over seven years and will ultimately depend on the growth of employment levels in the state. The first of these projects will redevelop portions of our Holland Design Yard facility into a working lab that will showcase the customers our vision for the future of work.

The second involved the creation of dedicated space within our GreenHouse facility to effectively communicate and display our full complement of healthcare products and capabilities. These investments represent critical elements of our business strategy. And we plan to move aggressively toward their completion.

Importantly, I want to be clear that these projects will not result in changes to our manufacturing footprint or employment levels in or outside of West Michigan. We expect that over time, these investments will play a key role in our growth strategy and will ultimately result in more jobs being created in Michigan and our other locations.

In all, it''s been a busy and productive summer at Herman Miller and we are extremely pleased with the progress we''ve made as an organization. These efforts have built momentum for the business as we enter the new quarter and I can assure you, we intend to keep the pedal down in the coming months.

That''s it for my introductory comments. I''ll turn it over to Greg to cover the numbers in more detail.

Gregory J. Bylsma

Thanks, Brian. Good morning, everyone. The strength and consistency of order pacing was definitely a highlight in the quarter.

On a consolidated basis, orders in the first quarter of $394 million were 22% above prior year level and 8% higher on a sequential basis relative to the fourth quarter. Within our North American reporting segment, orders improved 22% compared to the same quarter last year.

As Brian mentioned, we saw a notable improvement in order activity within the core North American office furniture market. In recent quarters, this part of our business has lagged relative to our other vertical markets. So we were encouraged to see some additional traction here.

Equally encouraging was the fact that the increase in orders was not isolated to a few geographic regions or industry sectors, rather it was fairly broad-based across all our North American sales regions. Orders within our non-North American business segment increased 33% relative to last year.

The largest percentage gains were once again seen in the Asia-Pacific region with China and Australia topping the list this quarter. We are also pleased with the relative strength of our order activity in the U.K. which increased 11% over the prior year.

Consolidated net sales in the first quarter of $381 million were up 18% compared to both the first and fourth quarters of last year. Within our North American business segment, sales of $311 million were 15% higher than the prior year and 23% above the prior quarter.

As with order activity, sales within the core office furniture market were particularly strong and fairly broad-based geographically. We also posted double-digit sales growth relative to the prior year in both our healthcare and learning vertical markets in the quarter.

We continue to see significant year-over-year sales growth within our non-North American business segment which in total reported net sales of $59 million in the first quarter. This was flat on a sequential basis but up over 40% from the first quarter of last year, led by double-digit increases in Asia, Latin America and continental Europe.

Our retail business was down year on year in both sales and orders. While business levels within our specialty retail channel have remained relatively strong, the overall decrease was the result of a product line changeover in our Costco business.

This month, we are launching a new chair unique to this channel and expect to resume a more normalized order pattern in the upcoming months. In total, changes in exchange rates from year ago drove an estimated $800,000 decrease in net sales relative to the first quarter of last year. I''ll now move on to gross margins.

Despite the significant increase in net sales, our first quarter gross margin of 32.5% decreased 70 basis points from the same quarter last year. Price discounting in the quarter was deeper than we experienced last year, in total reducing our Q1 gross margin by an estimated $7.5 million.

The majority of this was driven by a few large projects. Higher commodity prices this quarter primarily related to steel and aluminum components drove an estimated $3.5 million increase in cost of goods sold relative to last year.

We also recognized expenses totaling $1.8 million related to employee incentive bonuses and wage recovery benefits. By comparison, there were no such bonus or wage recovery expenses in the first quarter of last year.

Our Q1 gross margin decreased 30 basis points relative to the fourth quarter of last year. Here as well, deeper than expected price discounting drove an estimated $6.5 million decrease in gross margin dollars in the period relative to Q4. Higher commodity prices and employee bonus and wage recovery accruals also contributed to the sequential period decrease gross margin percentage.

I''ll now move on to operating expenses and earnings for the quarter. Operating expenses in the first quarter of $93.5 million increased just under $3 million from the prior year period. As a reminder, operating expenses in the first quarter of last year included a pre-tax charge of $4.5 million associated with the early retirement of debt through a tender offer transaction.

Excluding this charge, the year-over-year increase in Q1 operating expenses was approximately $7 million. Roughly $4 million of this increase relates to incremental operating expenses from the consolidation of CBS and Living Edge, both of which were acquired in the fourth quarter of last year.

We recognized $3 million in expenses in the quarter related to employee incentive bonuses and wage recovery benefits. In addition, development and marketing expenses associated with upcoming product launches and other volume related increases also contributed to the year-over-year growth in operating expenses.

Partially offsetting these items in the quarter were $5 million in favorable adjustments related to the contingency-based components of the Nemschoff purchase price. By comparison, we recorded $1 million in favorable adjustment to these acquisition-related liabilities in Q1 of last year.

On a sequential quarter basis, operating expenses increased approximately $2 million from the fourth quarter of last year. The prior quarter expenses included a $5 million charge related to the write-off of receivables in connection with the Living Edge acquisition.

Excluding the impact of this write-off, our first quarter operating expenses increased approximately $7 million on a sequential basis. As mentioned, employee incentive and wage recovery expenses drove $3 million of this increase.

Incremental operating expenses related to the fourth quarter consolidation of CBS and Living Edge contributed $1.7 million to the increase. The remainder was driven primarily by higher variable selling expenses, non-LEF related bad debt expenses and increased costs related to employee benefit programs. Overall the topline growth in the quarter, the sequential increase in operating expense was consistent with what we expect to see in our variable cost model.

We recognized restructuring charges in the first quarter of almost $1 million. This related to our previously announced plant consolidation projects as well as employee severance benefits.

Operating earnings in the quarter were $29 million or 7.7% of sales excluding the impact of restructuring expenses and changes to the contingent purchase liabilities, adjusted operating earnings the quarter were approximately $25 million or 6.5% of sales.

Net other expenses in the first quarter reflected a foreign currency transaction loss of $900,000. This compares to a currency related loss of $100,000 in Q1 of last year and a net gain of $700,000 in Q4 of fiscal 2010.

Our effective tax rate in the first quarter was 30.8%. This was lower than the U.S. statutory rate due to continued benefit received from the manufacturers’ deduction under the 2004 American Jobs Creation Act.

We also recognized a foreign tax credit in the quarter as a result of completing the intercompany cash dividend. The effective tax rate in the prior year first quarter was a net credit of 0.7%. This resulted from reductions in income tax reserves totaling $2.9 million which were prompted by the closure of IRS audits.

Net income in the quarter was $16 million or $0.22 per share on a diluted basis. Excluding the per share impact of the restructuring charges, adjusted EPS was $0.23 in the quarter. As required under GAAP for purposes of calculating diluted EPS, we have excluded from net earnings the favorable valuation adjustments related to the Nemschoff purchase price components.

That''s the income statement overview for the quarter. And I’ll now turn the call over to Jeff to give us a brief update on our cash flow and our balance sheet.

Jeffrey M. Stutz

Thanks, Greg. Good morning, everyone. Cash flow from operations in the first quarter was $10 million with changes in working capital driving a $16 million use of funds in the period.

The movement in working capital related to the ramp-up in sales and production levels during the quarter. This drove increases in trade receivables, inventory and prepaids which were only partially offset in the period by higher trade payables and accrued liabilities.

In the first quarter of last year, cash from operations was $27 million with changes in working capital driving a net source of approximately $10 million in that period. Capital expenditures in the first quarter of approximately $6 million were unchanged from the prior year level.

Likewise, dividend payments in the first quarter were consistent with last year''s level, totaling just over $1 million. We ended the quarter with total cash and equivalents of $139 million which is up $4 million from the end of fiscal 2010.

As Greg mentioned, we did repatriate some foreign held cash during the quarter through the completion of an intercompany dividend. This dividend which totaled just under $12 million reduced the amount of cash held within our international entities to approximately $39 million as of the end of the quarter.

We remain in compliance with all debt covenants and are currently running at a gross debt to EBITDA ratio of approximately 2.6 times. The available capacity on our revolving credit facility stands at approximately $140 million with the only usage being from outstanding insurance related letters of credit.

Given our current cash balance, ongoing cash from operations and our borrowing capacity, we remain confident that we have sufficient flexibility to meet the ongoing financing needs of the business. That''s the balance sheet and liquidity overview for the quarter. I''ll now turn the call back to Greg who will share some thoughts on the outlook as we move through Q2.

Gregory J. Bylsma

Thanks, Jeff. Order entry pacing during our first quarter was fairly consistent, averaging roughly $30 million per week. In the first two weeks of Q2, orders averaged about same level. Taking this into consideration along with a portion of our beginning backlog not scheduled to ship until after Q2, we would expect our second quarter sales to be flat to up 5% from the first quarter level.

While we do expect the pricing environment to remain highly competitive in the second quarter, we do not anticipate the impact on gross margins to be as significant as we experienced in Q1. That said, one of the deeply discounted projects that negatively affected our gross margin this quarter will carry over into the second quarter.

Accordingly, we expect our second quarter gross margin percentage to be just above the first quarter level. Operating expenses in the second quarter are expected to be roughly the same level as in the first quarter excluding the impact of adjustments to Nemschoff contingent purchase liabilities.

We anticipate volume and profit-related cost increases to be largely offset in the period by reduced bad debt and Convia-related expenses. Finally, we expect our effective tax rate in the second quarter to be between 30% and 32%. And with that, I''ll turn the call back over to the Operator and we''ll take your questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, if you do have a question, please press star then one on your touchtone telephone. If your question has been answered or if you wish to remove yourself from the queue, you may press the pound key. Our first question comes from Budd Bugatch from Raymond James.

Budd Bugatch – Raymond James & Associates

Good morning, Brian, good morning Greg and good morning Jeff.

Gregory J. Bylsma

Hey Budd. How are you doing?

Budd Bugatch – Raymond James & Associates

I’m well. Hope you are. I was pleased to see the revenues and hear about the order pacing and the orders but I''m wrestling with the gross margin because I think on the last quarter call, you had indicated that you thought gross margins would be sequentially flat to up a bit. And some of the things that you have pointed out like the deeply discounting and at least maybe some of the commodity side or the EVA side, the benefit side, would have been known factors going into the quarter, at least I would''ve thought they would have been known. What''s different? What happened during the quarter to make gross margins come in sequentially down?

Brian C. Walker

Budd, that''s a great point. The real issue is as either we look into the second quarter, the large project that we referred to that will also negatively impact the second quarter, we did not anticipate that we would get any revenue from that project in the first quarter. And it turned out we shipped a little bit more and recognized a little bit more revenue in the first quarter than we thought relative to that project.

Budd Bugatch – Raymond James & Associates

So, if it wasn''t in your revenue number, Greg and it wouldn''t have been in your gross margin number either, then did it -- was it accretive to earnings?

Brian C. Walker

Yeah. It drove dollars but it just drove percentages down.

Budd Bugatch – Raymond James & Associates

I understand, but then the numbers -- then the implied numbers of your EPS would have even been less than what the implied numbers were of your EPS guidance going into the second -- into the first quarter from your fourth quarter call? I would wrestle with that side of it as well. And the EVA side, was that not known as well or that was known, you had figured that out?

Brian C. Walker

No, we had figured that piece out. The big driver from what we expected was discounting and it was that one big cut. I mean, as you know, we start the quarter with a backlog of 200 and some million dollars and so the -- there''s some ins and outs about what ships and what doesn''t ship relative to that discounting factor. And we just had more deeply discounted stuff ship in the quarter than we thought relative to when we started.

Budd Bugatch – Raymond James & Associates

Could you quantify some of that or just help me again? Was that the $3.5 million of difference in gross margin to what you would''ve normally gotten? Had it been at a normal margin?

Brian C. Walker

Had it been at a normal margin? Well, the incremental amount we saw from Q1 to -- from Q4 to Q1was $6.5 million. We expected to see about half of that.

Brian C. Walker

I think but partly what you''re seeing is we are coming out of this thing, the mix if you will of some of that large project-based business that was deeply discounted was a little heavier than we thought it would be in the quarter. The good news is that helped us on the top line and it certainly helped us in terms of dollars coming through.

Now remember, the other thing is -- I think the thing you''ve got to remember is not only did we drag some more margin into the quarter dollars, we also dragged some more expenses in the quarter because some of that stuff of course as you know is variable with sales. So that''s why dollars were better, percentages were not necessarily better than we thought. And then we had some other things like Greg talked about with LEF and some others that we were bringing through in the quarter.

Budd Bugatch – Raymond James & Associates

Okay. Got you. And what do you think the impact will be on the second quarter of the deeply discounted large projects?

Brian C. Walker

We think it''s going to get -- right now what we''d say, it''s going to get better.

Gregory J. Bylsma

Sequentially better.

Brian C. Walker

We would anticipate our margin percentage to be -- my take is up 30 basis points or so.

Budd Bugatch – Raymond James & Associates

Talk a little bit for me -- my last question -- just talk a little bit about Celle. What''s the launch look like? What''s the -- give us any idea of the revenue potential here and when will it be start to ship?

Brian C. Walker

The launch date, Budd, right now is intended at Orgatec. It''s going to be -- like always, it will have a ramp-up so that it won''t really hit its stride. There will be some impact in the second half of the year if we make that date. Of course, like always, you are running down to the end to get it finally out. It will be a worldwide launch which we have never done before. So the launch in Asia, Europe and the U.S. at the same time which is one of the reasons that the expenses were a little heavier this quarter on the R&D side, not just because of Celle but we''ve got Celle, one other new seating platform which is even a little bit lower price point than where Celle will be, which is actually going to be like four chairs essentially in that platform because it''s two task chairs and a series of side chairs.

So we have got a lot of work going on there as well as on the system side which drove R&D costs and marketing costs up a little bit higher this quarter than we anticipated. But we decided, now is the time to get some of this stuff done so that as the market continues to improve. We have got them out there in the heat of the battle, if you will. And so we''ll see the normal ramp up.

We should start taking orders for Celle coming out of Orgatec. So around November 1, early December for sure we should be out there. The other one comes in a little after that I think in January. And then we''ll begin to see the new systems line or work environments line if you will towards the back half of the third quarter.

Budd Bugatch – Raymond James & Associates

All right. Thanks Brian. Good luck on the quarter. Good luck on the rest of the year.

Brian C. Walker

Thanks Budd

Operator

Our next question comes from Todd Schwarzman from Sidoti.

Todd Schwartzman – Sidoti & Company

Hi. Good morning, everybody.

Brian C. Walker

Good morning, Todd

Todd Schwartzman – Sidoti & Company

First off, on the wage recovery that you mentioned, the remainder kicked in the beginning of this quarter. How does that ramp? When do you get up to speed?

Brian C. Walker

Well essentially, Todd, this is Todd, right?

Todd Schwartzman – Sidoti & Company

Yes.

Brian C. Walker

We had full wages for the most part. There is a few business units that are not back there. But the bulk, 95 or so percent of the population worldwide is now at -- was essentially at full wages in the first quarter between what they get in their weekly paycheck to their base pay and what they got in the wage recovery program.

So essentially, this quarter included sort of the full cost structure with the one exception being 401-k contribution. Other than that, we were completely back. So you won''t really see a ramp from first quarter to second. It will just convert from the wage recovery idea to normalized base pay. So i.e. it becomes fixed to -- variable to fixed, but it was already in there at the full value in the first quarter. Does that make sense?

Todd Schwartzman – Sidoti & Company

Yes, it does. Thanks. With respect to the gross margin, you talked a lot about the price discounting, can you talk about mix as well with the project activity picking up a bit? Was there an increase in the mix of systems among total sales?

Brian C. Walker

Yes, there was.

Todd Schwartzman – Sidoti & Company

Was that much to speak of in terms of margin impact?

Brian C. Walker

That had an impact. That''s another thing when we were answering with Bud, that was another thing that the systems mix was heavier than we forecasted which is directly related by the way to the fact that we had more project activity, right? So I mean, Greg and I were talking about this actually this morning is that even if you look back for the last cycle when we went through this, the mix tended to shift towards things like seating which makes sense because in the bottom of the cycle, we''ve also seen a shift towards international and towards retail and some of the other areas as part of our overall customer mix and those areas are much more heavily weighted towards seating to start with as well as you see more fill-ins with customers with seating.

So I think it naturally pushes the mix in that direction and then when you start doing big projects where are you doing the full environment for the customer, we see a little bit of a return on the system side.

Todd Schwartzman – Sidoti & Company

Can you quantify that in dollars, that incremental contribution relative to your expectations?

Brian C. Walker

The contribution or the negative impact from the mix?

Todd Schwartzman – Sidoti & Company

The incremental -- well both actually.

Gregory J. Bylsma

Relative to Q4, Todd, off the top of my head, the mix impact to us in the quarter was a 60 basis point decline in gross margin. And typically with the starting backlog, with our relatively small starting backlog relative to our total shipments, it''s pretty hard to predict mix 13 weeks in advance.

Todd Schwartzman – Sidoti & Company

Right. And if order entry was strong, I gather August about as strong as June or July. Was there any incremental improvement there?

Gregory J. Bylsma

It increased slightly in August but very small relative to the first two months and then as you know, as we enter into the September timeframe, we always expect that last two weeks of September, the week we are in and I guess the next two weeks, to be a big push on GSA.

Brian C. Walker

I think the other thing that looks a little different this time than we have seen in the past, Todd, is that coming into the quarter, we certainly had what we thought our overall expectations were and again as Greg said, difference in the old days, when you walked into the quarter and everything was sitting in the backlog, you now book a lot of the business within the quarter that you ship in the quarter.

We also saw a fair amount of rotation from what we had been seeing in the fourth quarter in terms of where which customers are, our business was coming from as well. So we didn''t see mix in terms of product lines but the business that had been showing the least relative strength had actually been the core North American work business. It was sort of like starting June 15 all of a sudden we saw a real takeoff in that business relative to the others as well.

So, you got a lot of movement happening within. So -- and that said -- we didn''t see it, you could see almost every business had year-over-year increases. But we started to see mixes moving all over the place and that''s I think a good sign in some ways that we''re seeing a lot more project activity take picking up as we move along.

Todd Schwartzman – Sidoti & Company

And on the raw material side, could you share your outlook for the balance of the year?

Gregory J. Bylsma

Balance of the year, that''s a fairly long outlook. I think as we -- as you guys know, our contracts tend to be three months in length. The peak of steel was -- steel prices was kind of in that May timeframe. So we should actually see the price that we pay for steel and steel components to come down a little bit in the second quarter.

Again, our inventory at year -- quarter end is sitting with the old price and we will start getting new prices running through our sales line really in the second half of the quarter.

Todd Schwartzman – Sidoti & Company

All right. Thanks guys.

Operator

Our next question comes from Matt McCall from BB&T Capital.

Matthew McCall – BB&T Capital Markets

On the pricing front, I understand -- well I guess how aggressive are we talking about when you''re talking about these orders? You''ve given some -- I don''t know the size of the projects that you were talking about. You talked about some of the pricing pressure but when you talk about the discounting that you are willing to give at this point, I guess two parts tot he question.

Is it pretty consistent with what you''re seeing from your peers and then how would you compare the discounting environment at this point in the cycle to the discounting environment at this point in previous cycles?

Brian C. Walker

Yeah. It’s Brian, first of all, I''ve always said to you guys, we have a very competitive and fairly transparent industry as it relates to how the bidding process works. I don''t think we are out of step with any particular peer nor did we take some strategic action to go after pricing. So you shouldn''t hear that.

I think simply all we are saying is that we happen to have a larger than normal number of those large projects all ship at the same time. So I wouldn''t say that taking projects at those prices were unheard of or different than what we''ve seen in different periods. It is just we happen to have a lot of them ship all together. So it''s more of that effect.

Compared to past times, other than the general direction of what you''ve seen in pricing over the last 10 or 15 years, I don''t think it''s any different than what we have seen in the last downturn. Everybody''s aggressive. Project to project, geography to geography, depending on whether it is a customer that fits there, particular strengths better than another or it''s somebody that they have a particular interest in, in getting a foothold in.

So I don''t think it''s anything particularly unusual other than like I say, it just -- the thing that''s unusual is we had more that shipped in one quarter than we would have thought. Now, the great news is, we had a lot of stuff ship yet we still hung on and built backlog because we actually saw the base orders also pick up.

I mean, if we had come through this and we would have shipped the heavier mix and would have been sitting here with a lower backlog, I would say this isn''t necessarily good news. On the other hand, we were able to get a lot of big stuff through the pipeline, come out with a relatively strong backlog and with improved order pacing. So to me, net net I think all of it''s actually good signs rather than bad signs.

Matthew McCall – BB&T Capital Markets

Okay. Okay. next question, still I kind of have an opinion on this. But if you look at the hiring picture, two of the important drivers in this industry are the demand for the (inaudible) share employment in construction and hiring still I guess modest on the service sector side, construction obviously still very weak. So, can you talk about what''s driving the strength in this industry and then how healthy is the pipeline of activity as you look out a couple quarters?

Brian C. Walker

Well first, I think we all have to keep in mind that we''ve got an industry that went through a very deep bottom. So I would liken this to what happened in automotives, right? They were producing 16 million units a year. They went to what? Seven or eight? You know, they are back up to 10 or 11 and it feels like a big jump. I mean, it''s still way down from where they were, but at some point, you get to people that as their corporate profits get better like consumers have gotten at least relatively better. They begin to go out and at least replace if not improve the things they once had. I think there''s part of that going on. I think that''s part of it.

I think the other thing that is going on is if you are in a big city and you are looking around and you''ve done employment reductions and rental rates are very low and you are at the end of your lease, now is a great time to move. So I think you see some of that too. That''s what I''ve always said, construction matters, but construction matters in the long run, it doesn''t matter necessarily in the short run of the turn.

So my guess is partly what we''re seeing in the industry numbers is some of that bounce off of the bottom which is a good thing. It probably wasn''t sustainable at that level. That''s good news. I would like to believe that some of this is related to things we said we were going to do strategically whether that is investing in Asia where we have seen great growth rates. We saw that drop off during the downturn. That''s come back faster.

Whether that''s healthcare where we put a lot of money in resources and we''ve seen that pay off, as well as very particular effort by Curt Pullen and our North American team to say, how do we get into new product categories? And in fact, how do we sharpen the capabilities of our dealers and salespeople to go out and win business? So some of this is industry related, some of it I would like to believe we have done a good job executing this quarter.

Matthew McCall – BB&T Capital Markets

Okay. That''s a good transition into the next portion and that really tied to Convia, tied to Thrive, I guess the first question is, is Thrive new product? Is Thrive -- is it just a new marketing plan and the way you''ve combined some products? And then on the Convia side, what has really changed there? I didn''t understand that they''re going to handle the office side but tell me about the -- what has changed strategically. And then from a financial perspective, what was the impact this quarter if any and what are the expectations as you look forward?

Brian C. Walker

Okay. As it relates to Thrive, you''ll remember in the fourth quarter we did an acquisition of a company called Colebrook Bosson Saunders who had a large portfolio of ergonomic tools -- monitor arms, other video support capabilities, things to support laptops, so on and so forth. They were in our minds really the market leader in the U.K. and had a reasonable size footprint in the rest of Europe, but very, very little in the U.S.

We took their -- we acquired the company in the U.K. We took their product portfolio in the U.K. that they had in the U.K., combined it with our portfolio that we already had of accessories. We did some product development towards the tail end of last year with a whole new table line as well as some soft seating products, other ergonomic tools and we combined that all together and created a new, if you will, strategic business unit that has an entirely new sales force that is focused on selling those product capabilities both to our end customers and through to our dealers.

It was a category that generally we''ve been underrepresented as a market share but one that we thought was strategically important for us and an opportunity. So we launched that whole package of capabilities at NeoCon. The sales force has only been in place since about the fourth of July. So it''s early days in terms of a ramp up in the U.S., but we think an important addition to our overall portfolio. Is that one clear?

Matthew McCall – BB&T Capital Markets

That''s clear, yes. Convia?

Brian C. Walker

Convia, what we are in the process of finalizing with Legrand and is that to date, the way it has worked with Legrand is we produced certain components, things like boards and those kind of things, that had our technology, our software embedded on it. We sold those components to Legrand which they combined into their product lines, as well as we sold certain interface components, the wand, the gateway product and those things.

We sold those directly to Legrand''s distribution channel and of course, we then maintained the entire capability to develop both the software and hardware on the Convia side as well as marketing and sales on our end to market and sell those products to Legrand. We have as many of you know done some integration of those technologies into our systems furniture products with a thing we called the Herman Miller Energy Manager over time and we sort of have a two-step process in all of this.

Where we will end up on the other side, if we complete the arrangement as contemplated in the LOI is Legrand will take over the extension off of and enhancements of the software platform that we developed as well as the hardware. So we will no longer be in the business of selling the Convia products to their distribution nor will we be in the business of extending the software that is embedded in their products. So they will essentially take over that whole end of things. What we will continue to do is work with Legrand on developing the products that we can integrate into our furniture products, if you will. As well as we will continue to work on joint marketing to customers where we believe the combined bundle between what they provide and we provide can help our customers create a better environment overall that is more energy efficient.

What essentially we are doing is finding a way to streamline the cost of both of us going to market with a technology. It will enable us to leverage more deeply the embedded knowledge that Legrand has on the electronic side which is obviously not our core strength. We will, at the same time, retain some of the Convia technical staff on our end to help us with our overall quest to develop capabilities where we can effectively help our customers enable the technology that they put in their work environments to more effectively let their people get their work done. Is that clear?

Matthew McCall – BB&T Capital Markets

It is. I was just asking about the financial impact. Was there any in the quarter with this change or is there any expected? Any other financial details, you can provide at this point on where we stand with Convia?

Brian C. Walker

There was no impact change wise, if you will, on the quarter. Most of that won''t happen until we get into the second quarter as we begin. And it won''t have a huge impact in the second quarter because we''ll still have some transition back and forth. We don''t have -- we haven''t had a lot of assets in that business. And we have got a few people which we''re working through how to best make sure that those people have the right opportunity to help take this thing forward.

We collectively, us and Legrand, continue to believe that the technology that we have in Convia is unique in its capabilities and does have the ability to carve out a pretty significant position in what is an emerging world around building controls and energy management. We simply collectively tried to figure out what was the best way that we could let it get to scale which we have fought very hard for and have not been able to get to.

So we look for a way -- we thought we could get the scale. And our thing here will be, we will be big supporters of Legrand to help them and connect with our customers because if they get the scale, we will do quite well from our returns through the licensing arrangement.

Matthew McCall – BB&T Capital Markets

Okay. Thank you, Brian.

Operator

Our next question comes from Mark Rupe from Longbow Research.

Leah Villalobos – Longbow Research

This is Leah Villalobos in for Mark this morning. Just one additional question on the gross margin, if you take kind of a longer term outlook and assume there aren''t any major swings in commodities but kind of looking more at the pricing and volume side of things, as projects do continue to recover, our gross margin''s kind of able to expand, can some of that volume offset some of the price discounting? How do we kind of think about that longer term?

Gregory J. Bylsma

Hi, Leah, this is Greg. I think that as we -- our normal relationships relative to today''s pricing hold, obviously if all the volume growth is large projects at deep discounts, obviously those don''t hold but our models would say moving forward from today''s level that incremental volume plays out just like it for the most part has in the past. And again whenever we have a big mix shift to systems in any one period, that often is followed up with a mix shift proceeding in subsequent periods and it sort of plays on that cycle.

Brian C. Walker

The one thing that I would add, Greg, is I think one of the things everyone has to remember is when we went into this downturn, one of the ways that we remained -- maintained our profitability and our financial liquidity was we took some fixed costs and made them act variable and we were very open with everybody that we took some fixed costs out.

There was a point that we thought if we took more out, we would not be able to come back up. And I would say with the kind of fast ramp-up we''ve seen, that was a wise choice. So we took some fixed costs and made it variable. Part of what you see this quarter or the reason we don''t see the leverage we normally would''ve seen at this point in the cycle is we had to layer some of those fixed costs back or those what were fixed costs back on this quarter whether that was through bringing folks back to their full wages, whether that was actually getting back to recording some level of variable incentive compensation which we haven''t paid in a couple of years which is not sustainable forever as well as we''ve ramped up R&D and other things.

The other side of that is the investments we''re making in seating and those kinds of things we think longer term will help us continue to rise those margins up. So once we get through this kind of next phase, we should be able to see ourselves get back to a much stronger leveraging, particularly on the gross margin side.

Leah Villalobos – Longbow Research

Okay. That''s helpful. And then kind of digging into a little bit more on the orders, it''s great to hear about some growth in the North American core office. I''m just kind of wondering if specific to the orders in North America and core office, if those orders were kind of stable throughout the quarter and kind of how sustainable you see current levels at this point.

Brian C. Walker

They were certainly very consistent through the quarter. I think they mirrored our overall pattern. As far as the very near-term outlook, folks are fairly positive. And like I said, the first two weeks of this month and even what we''ve done through the first four days had remained remarkably consistent and positive.

Gregory J. Bylsma

You know, I''d probably say, consistent in the quarter but up significantly from end of fourth to the beginning of first and that was again if there''s anything in this quarter that moved a little bit differently than we thought, that was it. And that''s where the revenue beat came from as I said before, we shipped a lot of big projects but we add a lot of back -- we added a lot of replacement backlog, if you will, because of that increase.

Leah Villalobos – Longbow Research

Okay. That''s helpful. Can you talk a little bit about kind of the mix in the backlog and if that''s kind of different from the mix in the backlog the last quarter you reported? As far as project business versus kind of larger project business, I guess.

Gregory J. Bylsma

I think as we''ve tried to certainly indicate throughout, it''s obviously a healthy number. So there''s going to be big projects in there. I think when we look at it at this point -- now remember, we''re talking about the backlog, not necessarily what we will ship in the second quarter because we have got six weeks of orders to go get that could ship this quarter yet, right?

But what''s in the backlog coming in, there is less of that large project business, I''d say the mega large projects, sitting in there right now than there was coming into this quarter. Now again, we could still take some of those in the quarter and ship them. So that''s what I think Greg had talked about. He thinks we will see some improvement in margins in the second quarter because some of that discounting we think will come back to us.

Leah Villalobos – Longbow Research

Okay. Great. Thank you very much.

Operator

Ladies and gentlemen, if you do have a question, please press star then one. We do have a follow-up from Budd Bugatch from Raymond James.

Budd Bugatch – Raymond James & Associates

Just two questions, normally I do ask for you to give us a percentage of project business versus the normal day-to-day business and you normally are…?

Jeffrey M. Stutz

Hey Budd, this is Jeff. It was flat with last quarter, project business at about 43%. So we had the growth in the project business as well as day-to-day that kept that overall mix relatively consistent.

Budd Bugatch – Raymond James & Associates

Okay. And sometimes you also give us the mix or composition of gross margin.

Jeffrey M. Stutz

Sure, I''d be happy to, Budd, materials in the quarter were 41.2%, labor at 7%, overhead was just above 13% -- 13.4%, and freight and distribution at 5.8%.

Budd Bugatch – Raymond James & Associates

Okay. Are you seeing any inflation impact on you on freight and distribution with cost of energy?

Jeffrey M. Stutz

Budd, the cost of diesel is up certainly year to year, up about 14%. But that represents only a portion of our overall freight and distribution cost mix. So certainly the cost of fuel is up but I think beyond that, it''s been fairly consistent at that percentage rate. So, Greg, I don''t know if you have anything to add.

Gregory J. Bylsma

No, I think that''s right. Some of what our cost ends up being is how long we keep both the trucks and where are we shipping to and that number stayed pretty consistent with last quarter.

Brian C. Walker

I think the one point, Budd, you have heard about some increases in freight in particular is stuff in Asia probably back and forth. And I know the guys have spent a lot of time, it''s one of the reasons we''ve pushed very hard on regionalizing some of our manufacturing so that we -- as we increase volumes over there, we''re not seeing as much going back and forth across the ocean.

Budd Bugatch – Raymond James & Associates

Okay. And lastly, you have talked in the past about a margin target and I''m trying to remember whether it was 12 or 13% long term. And to Mark''s colleague''s question about a gross margin target, how do we think about that long-term margin target these days? Is that just something you don''t want to talk about again or…?

Brian C. Walker

I think, Bud, where our sights have been is -- as you know, it''s hard when you''re in the middle of one of those -- in the cycle we''ve been in to figure out how long is the next cycle going to last. We''re very confident that we can if we continue to see reasonable increases in volume, if we can get back anywhere near the volumes we used to run, that we could see ourselves get back to the single -- double-digit level.

One of the things that is a little different right now is some of our revenue increases are coming from acquisitions which, of course, is a little different because you don''t get immediate leveraging on that stuff until you grow on top of their already base, right? And we sometimes forget that because we talk about revenue being up, well some of it, we acquired it. And until we get growth on top of what we acquired, that first round of revenues doesn''t come with lots of leverage on top of it.

So I think longer term, we''re still confident that we can through the combination of growing and the work we can do around HMPS that we can get back into the double-digit range.

Budd Bugatch – Raymond James & Associates

Okay. But you had said some time ago I think a 12% or 13% target and you had come out one of the quarters and said that. That requires you to get very close back to the old volumes or the peak volumes. It''s not the peak volumes but the volumes we got at coming out of the last downturn.

Brian C. Walker

To get to 13, I would say we would have to get back into the -- at least somewhere near that, depending on mix and all those kinds of things and commodities and all the rest of the input. Do I think we need to get that level to get back to double? No, but you know, to get back up to those kind of targets we were at before, we were looking at trying to get to $2.6 billion too. So we''ve come a long way down the track from where we were and certainly, we''re not getting a lot of help from the federal government with new programs around healthcare and those kinds of things that aren''t exactly making it any easier.

Budd Bugatch – Raymond James & Associates

Got it. All right. Thanks again.

Operator

I am not showing any other questions at this time. I would now like to turn it over for concluding remarks.

Brian C. Walker

Well thanks, everyone, for joining us on the call this morning and for your continued interest in Herman Miller. We are off to a solid start in the new fiscal year. And we anticipate a lot of positive changes in the coming months. That''s all for now, we look forward to talking to you again next quarter.

Operator

Ladies and gentlemen, this does conclude today''s program. You may now disconnect and have a wonderful day.