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Good morning, and welcome to the Herman Miller Second Quarter Earnings Conference Call. As a reminder, this conference call is being recorded.
I would now like to introduce your host for today's conference, Kevin Veltman, Vice President of Investor Relations and Treasurer.
Good morning, everyone. Joining me today on our second quarter earnings call are Andi Owen, our President and Chief Executive Officer; and Jeff Schultz, our Executive Vice President and Chief Financial Officer.
We have posted today's press release on our Investor Relations website at hermanmiller.com. Some of the figures that we'll cover today are presented on a non-GAAP basis. We've reconciled the comparable GAAP and non-GAAP amounts in a supplemental file that can also be accessed on the website.
Before we begin our prepared remarks, I will remind everyone that this call will include forward-looking statements. For information on factors that could cause actual results to differ materially from these forward-looking statements, please refer to the earnings press release we issued last night as well as our annual and quarterly SEC filings.
At the conclusion of our prepared remarks, we will have a Q&A session. We will limit today's call to 60 minutes and ask that callers limit their questions to no more than 3 to allow time for all to participate.
With that, I'll now turn the call over to Andi.
Good morning. And thank you all for joining us today. With this quarter being my first full quarter with Herman Miller, I found it appropriate to open with a few comments describing how I had spent my first 100 days in the role. As I'm sure you can imagine it's been a whirlwind schedule, but I thoroughly enjoyed engaging with stakeholders across all of our businesses and around the globe.
My travels have taken me to each of our primary office and manufacturing locations around the world and have given me an opportunity to meet and speak with our diverse and talented employees. I've had the opportunity to engage with our customers, our dealer partners and investors, tour our retail studios and spend quality time with each of our executive leaders focusing on ways to amplify our progress.
In many ways, this first 100 days has been about actively listening and building an understanding of what's going well and where there may be opportunities ahead that we can capitalize on. It's been an amazing experience overall, and I'm encouraged and energized by the opportunities I see for our company.
My team and I are focused on accelerating our path to these opportunities and I look forward to sharing more about our strategy in the months ahead.
In the meantime, I'd like to share a few thoughts on our results for the second quarter and progress on several key initiatives. After that, I'll turn the call over to Jeff and Kevin to share the details of the financials. So let me start with the global macroeconomic picture. While volatile equity markets and uncertainties around U.S. and China trade policy and Brexit persist, underlying economic indicators are generally positive. We were encouraged to see the recent postponement of higher tariff rates to allow for further negotiations between the U.S. and China. And while not reflected in our current quarter results, lower market prices for U.S. steel during the quarter were a positive development that will begin to layer into our gross margins in the third quarter. This supported demand environment was reflected in our results for the quarter. We were very encouraged by the magnitude and broad-based nature of our sales and order growth this quarter, both of which achieved record levels for our business.
Consolidated sales of $653 million were up 7% organically over the same quarter last year and new orders in the quarter totaled $703 million, representing an organic increase of 10%. This order growth is particularly notable as it was on top of the 10% organic increase that we delivered in the second quarter of last year.
Our focus on profit optimization is helping to stabilize our performance at the gross margin level, and our teams remain diligent in managing operating expenses. Combined with sales growth, these factors helped drive operating margin expansion over the same quarter last year.
We reported EPS on a GAAP basis of $0.66 during the quarter. On an adjusted basis, which excludes certain restructuring and other charges, we recorded EPS of $0.75 in the second quarter, which reflected an increase of 32% over the same quarter of last year.
We continue to make great progress in our current strategic priorities. So let me share a few highlights from the quarter.
Our innovation pipeline has been very active. The Cosm performance task seating chair was launched late last quarter and is pacing well ahead of its business trend. Its sophisticated ergonomic design that brings instant comfort is generating critical acclaim as Cosm has won a number of awards, including the Fast Company Innovation by Design Award and the Orgatec Innovation Award.
Towards the end of this quarter, we also launched 2 exciting new products. The first is Canvas Vista, a desking system that trims the size of a workspace to free up space for more people, or a more diverse setting. By using every square inch of space smartly, it provides compression without compromise.
The second product launched was Overlay, which is a system of freestanding movable walls used to help define space, designed to create visual clarity in open plan offices, Overlay gives organizations the agility to evolve and adapt quickly.
As we look ahead, our research-based Living Office framework will continue to shape our innovation agenda and help our customers create high-performing workspaces that meet very unique needs.
As you know, our focus on the dealer ecosystem centers on being as easy to do business with as we can be. This effort has been led by the development of technology tools that make interactions more seamless for our dealers. We've developed new digital search and access tools that help sellers understand the full offering across all of our brands. The ecosystem effort has also included targeted product launches that aid our dealers in winning new business every day.
In August, we finalized our investment in Maars Living Walls, a global leader in architectural glass walls. This transaction provides an important addition to our dealer ecosystem, both here in North America and elsewhere around the world.
During the second quarter, our teams and dealer partners made good progress in their onboarding and market strategy development process. This early integration work has also included incorporating Maars award-winning products into our Herman Miller showrooms. We're already seeing project wins with this new capability and have growing confidence in the long-term potential of this business.
On the Consumer front, we've seen further progress in scaling this business with another strong quarter of revenue growth. With the investment we made this past June, our teams are well underway launching the HAY brand in North America. The HAY North America website went live, started November, and we are in the initial stages of marketing investments to drive traffic to the new site. We also opened our first 2 dedicated HAY studios in Portland, Oregon; and Costa Mesa, California at the end of November. At the same time, we've made HAY products more widely available throughout our Design Within Reach retail studios. We're pleased by the remarkable job by our HAY teams to meet aggressive time lines and deliver fabulous initial results. HAY's combination of influential design and democratic pricing creates a tremendous opportunity to leverage our multichannel platform across commercial and consumer audiences.
Finally, as we've unpacked our profit optimization initiative in detail the past 2 quarters, let me reiterate that we are successfully executing on this initiative and remain confident that we are on track to achieve our savings targets. This growth plays a critical role in helping fund growth initiatives, offsetting inflationary pressures and driving operating leverage as we move forward.
In the near term, this growth plays a critical role helping to offset tariff pressures. With the recent deferral of the potential 25% tariff rate on goods imported by Herman Miller and its suppliers from China, near-term tariff pressures have lessened. While uncertainty remains how trade tensions will ultimately conclude, we continue to believe that our profit optimization work and January price increase will fully offset these pressures. And we will continue to evaluate additional contingency plans to help navigate the situation in the longer term.
With that brief introduction and overview, I'll now turn the call over to Jeff to provide more detail on the financial results for the quarter.
Thanks, Andi, and good morning, everyone. Consolidated net sales in the second quarter of $653 million were 8% above the same quarter last year on a GAAP basis and up 7% organically, which adjusts for the impact of year-over-year changes in foreign currency rates and the impacts of adopting new revenue recognition rules earlier this fiscal year.
New orders in the period were 12% above last year on a GAAP basis and up 10% organically.
Within our North America segment, sales were $353 million in the second quarter, representing an increase of 7% from last year. New orders were $371 million and were up 9% on a reported basis and increased 7% organically over last year. The order growth in North America this quarter was led by small- and medium-size projects, with the strongest geographic increases coming from the Central and Western regions of the U.S.
Our ELA segment reported sales of $119 million in the quarter, an increase of 5% compared to last year. New orders totaled $137 million, representing growth of approximately 16% over last year's second quarter. The strong year-over-year order performance was led by growth in Asia Pacific, Mexico and the Middle East.
Sales in the second quarter within our Specialty segment were $82 million, an increase of 10% from the same quarter last year. New orders in the period of $87 million were 13% higher than the prior year. Encouragingly, the increase in orders this quarter reflected higher demand levels across all 4 businesses that comprise the Specialty segment.
Our Consumer business segment reported sales in the quarter of $99 million, an increase of 15% from the same quarter a year ago. These results were driven by strong growth across our studio, catalog, e-commerce and wholesale channels. New orders for the quarter of $108 million were 16% ahead of the same quarter last year. Design Within Reach comparable brand sales for the period were 5% higher than last year, reflecting 11 straight quarters of comparable brand sales growth for DWR.
From a currency translation perspective, the general strengthening of the U.S. dollar relative to year ago levels was a headwind to sales growth this quarter. We estimate the translation impact from year-over-year changes in currency rates had an unfavorable impact in consolidated net sales of $4 million for the period.
Consolidated gross margin in the second quarter was 36.1%, which was 60 basis points below the same quarter last year. This decrease was driven by the impact of adopting new revenue recognition rules at the start of the current year. As we noted last quarter, under the new guidance, we are now recording certain dealer payments as expenses within cost of goods sold that were previously classified as a reduction in net sales. While this classification has 0 impact on reported gross profit dollars, it reduced our gross margin percentage compared to last year.
Operating expenses in the second quarter were approximately $182 million compared to $170 million in the same quarter last year. This amount includes $6 million in special charges, primarily associated with the consulting fee supporting our profit enhancement initiatives and CEO transition costs. The remaining year-over-year increase of $6.5 million was driven mainly by higher variable selling expenses as well as occupancy, marketing and staffing costs related to new retail studios and e-commerce platforms, including the launch of the HAY brand in North America.
Restructuring charges recorded in the second quarter of $300,000 related to previously announced facility consolidation projects in both the U.K. and China. These projects are progressing on schedule, and we expect to begin realizing benefits from improved efficiency and lower costs as we move through the back half of fiscal year 2019 and into the first half of next year.
On a GAAP basis, we reported operating earnings of $53 million this quarter compared to operating earnings of $50 million in the year ago period. Excluding restructuring and other special charges, adjusted operating earnings this quarter were $59 million or 9.1% of sales; and by comparison, we reported adjusted operating income of $52 million or 8.6% of sales in the second quarter of last year.
The effective tax rate in the second quarter was 22.6%. The rate in the current quarter included an adjustment related to recently clarified guidance regarding the adoption of the U.S. Tax Cuts and Jobs Act. Excluding this adjustment, the effective rate in the period was 21%. This compares to a rate of 30.5% in Q2 of last year.
And finally, net earnings in the second quarter totaled $39 million or $0.66 per share on a diluted basis compared to $34 million or $0.55 per share in the same quarter last year. Excluding the impact of restructuring and other charges, adjusted diluted earnings per share this quarter totaled $0.75 compared to adjusted earnings of $0.57 per share in the second quarter of last year.
With that, I'll now turn the call over to Kevin who will give us an update on our cash flow and balance sheet.
Thanks, Jeff. We ended the quarter with total cash and cash equivalents of $114 million, an increase of $12 million from last quarter. Cash flows from operations in the second quarter were $59 million compared to $63 million generated in the same quarter of last year. Capital expenditures were $19 million in the quarter and $41 million year-to-date. For fiscal 2019, we anticipate capital expenditures of $90 million to $100 million for the full year.
Cash dividends paid in the quarter were $12 million, and we repurchased 17 million of shares during the quarter.
We remain in compliance with all debt covenants and as of quarter end, our gross debt-to-EBITDA ratio was approximately 1.1:1. The available capacity on our bank credit facility stood at $164 million at the end of the quarter. Given our current cash balance, ongoing cash flow from operations and total borrowing capacity, we remain 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 third quarter of fiscal 2019.
Great. Thank you, Kevin. So with respect to the forecast, we anticipate sales in the third quarter of fiscal 2019 to range between $615 million and $630 million. The midpoint of this range implies an organic revenue increase of 7% compared to the same quarter last fiscal year.
We expect consolidated gross margin in the second quarter to range between 35.75% and 36.75%. This estimate, of course, includes the impact of adopting the new revenue recognition standard in fiscal 2019, which as I described earlier, impacts year-over-year comparability by about 60 basis points.
Adjusted for this change, this midpoint gross margin forecast is approximately 65 basis points higher than the third quarter of last fiscal year.
This forecast reflects the latest view for sequentially lower steel costs next quarter and a full quarter impact of tariffs on Chinese imports at the 10% level.
Operating expenses in the quarter are expected to range between $177 million and $182 million. And we anticipate earnings per share to be between $0.59 and $0.63 for the period, and our assumed effective tax rate is between 20% and 22%.
So with that overview, I'll now turn the call back over to the operator and we'll take your questions.
[Operator Instructions] Our first question is from the line of Bobby Griffin of Raymond James.
So the first question I had, Jeff, for the revenue rec, is the largest impact of that in the North America segment? I mean, the impact on the gross margin, I guess, that's what I was asking for.
Yes. I know -- yes, good question. So it's 60 basis points roughly speaking at the consolidated level. It's about that magnitude at the gross margin line in the North American contract segment. In fact, the largest impact is in our ELA segment, where the year-over-year adjustments to gross margin percentage is closer to 90 basis points. And then further when you get into the Specialty segment, the gross margin level, it's about a 40 basis point impact, and the combination of those all nets to about a 60 basis points impact at the consolidated level.
Okay. So with -- the gross margin was -- in North America office was down 90-or-so basis points, which was a better than -- better performance than Q1. The largest impact being in that was the revenue rec and then, I guess, the other side would still be steel inflation and maybe a little of the tariffs, is that the other moving parts to get me to the 92?
Yes. Very little tariff impact in the quarter, a little bit. Certainly, year-over-year commodity impact. You've got everything from product mix as a factor in there. We had a really good quarter, for example, in the health care sector, which has an influence on margins, the North American contracts, and those are the big moving pieces.
Okay. And then when I think about steel going forward, is the potential tailwind you're going to get from where steel prices are now. I don't know if tailwind's the best word, but the potential relief that you're going to get from where steel prices are trending. Is that about the same magnitude of impact of what a full quarter-worth of the tariffs would be?
Correct. Yes, let me make sure I say this clearly because it always depends on whether you're talking sequentially year-over-year, Bobby, but -- so I'll answer and then you tell me about getting to your question. If you think about year-over-year impact implied in our guidance for Q3, the commodity impact, which is principally steel, is about a $2 million year-over-year drag. The estimated tariff impact is about a $2 million year-over-year drag, this at the 10% level. And then we think we can offset that with the planned pricing that either already has been implemented or is planned for the early part of Q3.
Okay. Yes, that's very helpful. You explained in a even clear way than I was asking. So I appreciate that. So very helpful. Yes. I'll give you credit. My question wasn't nearly as clear as the response. So I guess, next from me, I just wanted to maybe talk at a high level about the Consumer segment. You mentioned the comps, which have been very impressive. Looking back with that streak of positive comps, what do you think's some of the biggest drivers that you guys have achieved so far that's kind of driven that good performance at DWR? And then I guess, more looking forward, what still has you excited about some low-hanging fruits or some other aspects in that business you're still working towards?
Bobby, it's a great question. And I think if you look at the performance in DWR, it is pretty amazing. I mean, we've had 11 straight quarters of solid comp performance as well as revenue growth. And I think the contributing factors to that are the product assortment. I think the team has done an excellent job of rationalizing the store base. I think we have stores of the right size and the right place. I think we have done a great job increasing our private label products. There was a little bit of a higher margin. So if I look at kind of all the factors understanding our customer, understanding how we're marketing to our customer location, how we're spending our money and where we are, those things are all contributing to a really, really nice run for this business. I also think that the market and kind of residential furnishings is doing well as well, so we are getting a little bit of benefit from that, but we expect this to continue. We're very optimistic about this business.
And our next question comes from the line of Greg Burns of Sidoti & Company.
In terms of the ELA segment, it sounds like you called out some nice growth in APAC, Mexico and the Middle East, but could you just give us some color on what's going on in Europe. Are you seeing an impact from Brexit and kind of what's going on in France?
Yes, that's a great question. Our European business is actually still pretty strong, but with the Brexit uncertainty, we have seen orders slow just a little bit. Can you hear that?
Yes, okay. But can you -- just Greg, just to check in. We're getting a little feedback. Can you hear us okay?
Yes. I hear you.
Great. So I think we remain really optimistic about the business. I think Europe is probably although strong, still struggling a little bit from an order standpoint compared to the other businesses in the market, but still performing well.
Yes. I agree with that, Greg. Just maybe a little color. So a lot of uncertainty around Brexit in the Continent and in the U.K., we did see pretty good revenue growth in the quarter. Orders were impacted for sure in the quarter. So that was kind of the one area where we saw some pressure offset in this broader EMEA region by really good strength in the Middle East.
Okay. And turning to the Consumer segment, obviously, like you just discussed, the revenue numbers have been really solid, not seeing as much margin leverage as I would expect given the volumes. So I was just wondering kind of what's your view on when we start to see some of this top line growth fall through more strongly to the operating line?
Yes. I think that if we look at kind of top line margin and operating income, I'll kind of talk about both of those things. I think a couple of things that are impacting our margin performance right now are increased shipping costs. And I think if we look at what the Consumer is expecting from us, everyone wants things shipped for free. So I think right now we are sort of in the place of figuring out how we can more efficiently and effectively provide shipping at a rate the customer is happy with and I think that's a problem that we can solve relatively soon. The other thing that's contributing to margin decline is discounting. So while we've had very, very good top line revenue growth, we have increased our discounting in a number of ways, we think as we look at our promotional plans going forward for the rest of the year and into next year, we need to rein that in a little bit so that we have a good balance of top line revenue growth, but also a nice margin increase. So I think these are things that in the short term, we'll see a little bit of a gradual incline, but long term, we feel really optimistic about the margin potential.
Okay. And then lastly, what percent of the Consumer business is sold into the contract market? And how do you feel about the progress you're making on that side of the Consumer business?
So Greg, Jeff, here. So this is obviously not something we've disclosed as part of the segment disclosure. I can tell you it's less than 20%. Contract continues to be a fast-growing component of the Consumer segment, and we're excited about it. In fact, the addition of HAY moving forward gives us even more confidence that we can supplement our already strong and growing product offer from DWR in the contract space with even more broader price points to leverage growth. But it's certainly not the large component of that business today, but we see great future there.
Is the contract component of the Consumer business growing faster than your North American Contract business?
It's on a much smaller base. So if you look at it from a percent standpoint, it is growing faster, but obviously in a very small size, but we are super optimistic about what it can be in the future.
And your next question comes from the line of Kathryn Thompson of Thompson Research.
This is Brian Biros on for Kathryn. So I wanted to I guess, start with the guidance for Q3. You came in a little above what the Street was anticipating for both revenue and EPS. If you could maybe just touch on that a little bit where it gives you confidence for that higher guide. I think you mentioned steel coming down, tariffs, pricing actions, so if there's anything else that's driving that guide higher, maybe it's pace so far throughout the quarter or change in end market or maybe it's just the Street being too pessimistic looking for a slowdown, but any additional color that would be helpful?
Yes. I'll add one thing and then I'll turn it over to Jeff. And I would say from a product launch standpoint, in the last few months we've had several very successful product launches. The last 2 weeks we launched Canvas Vista and Overlay, both have had incredibly successful launches. And then Cosm which we launched in North America in August and have launched globally now has been an incredible performer. And when I look at the innovation pipeline at Herman Miller and something like a Cosm I think only Herman Miller could have envisioned and executed and delivered that share, and it is an amazing innovation. And I see that pipeline continuing, so that gives me confidence and I know it gives Jeff confidence that we can guide where we have for Q3.
Yes, Brian, this is Jeff. I'd just add a little color to that as well. When you take a look at -- probably part of what the -- I mean, to answer your question about what gives us some confidence, is we've been waiting throughout this recovery for signs of stability and order rates in the broader industry and we've seen it here in recent months. And certainly, our results in total, with 10% order growth, backlog up to the level that it's up, I think 11% year-on-year, that certainly gives us some confidence. But it's also supplemented by the broader data points that we see outside, right, you see some competitors of ours showing fairly consistent strong results, which is good for the group. When you look at other data points like contract activations, the activation of new contracts in our business for projects going forward, that relative to year ago levels is up. The overall health of the funnel looks pretty good to us, and it's not just isolated to a handful of large projects. It's really broad-based. Now I always am cautious there, to say that's -- those are projects that we've won, but the point is there's projects to go compete for. You look at customer visit activity, as an example, again anecdotal, but customer visit activity has been strong here in West Michigan compared to year ago levels. And then you step back at the -- considering the broader order trends in the industry and the fact that we haven't seen any kind of notable shift or mix in the data -- the mix of day to day versus project business, which is historically a bit of an indicator that things are starting to shift in the kind of current condition of our space. We haven't seen anything like that. No question though that we would love to see some resolution to some of the kind of macro factors that are out there in the economy that are creating, I guess, concern or nervousness, things like Brexit resolution, things like trade policy. Obviously, a lot of concern and noise here in the last day or so around interest rate policy. So all of those things and they're all beyond under control, but the nature of our business is such that nervousness tends to shake confidence and that's not good for our space. So the sooner we can see some of those things resolve the better, but the broader macro picture for us is, [ things ] support the future growth. So that's really the big picture as to what gives us some confidence.
Yes. And I would just add one more thing to that, which is really the very low unemployment rate, and although that is challenging on one front, for us, as far as our manufacturing and gaining talent ourselves, the flip side of that is we hear from most of our customers, is they are also in the work for talent and space. It's something that they are looking at critically and really trying to be creative and innovative about how they attract talent with their space and that is very helpful for us and makes us optimistic.
Got it. Helps from the guidance and I appreciate the color. Last one, if you can dig a little deeper on the order growth in the quarter? You mentioned small- and medium-size strength. I think last quarter was also led by small projects. But anything you're seeing now in that mix any different from perhaps a few years ago and also during the last downturn? Really just trying to understand where we are today versus a few years ago and the last downturn given that it seems, at least a pause is maybe coming in the next year or 2 for the economy?
Yes, Brian, this is Jeff. I'll give you a few thoughts and then, you guys can add anything obviously, if you like. So generally speaking, we had order growth across really all project sizes. As we noted in the prepared remarks, the greatest areas of strength were in small to medium. That does bounce around from quarter-to-quarter and I -- again, as I said earlier, we're not seeing anything notable that gives us reason for pause in terms of a trend that looks like it will cause nervousness in our business or question the guys going forward in any case. So generally, broad-based growth across all regions or all project sizes and overall, kind of macro data points looking pretty strong. I don't know if you want to add anything to that.
No. I think you captured it.
Thank you. And I'm showing no further questions at this time. I'd like to turn the call back over to Andi Owen for the closing remarks.
Well, thank you, guys. I just want to really thank you for joining us on the call today. We appreciate your continued interest in Herman Miller, and we really look forward to updating you again next quarter. And I want to say on behalf of all of us here at Herman Miller I want to wish all of you and your families a wonderful holiday season. So have a great day and be well. Thank you.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.