MillerKnoll, Inc. (MLKN) Q1 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Herman Miller Inc First Quarter Fiscal Year 2019 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the conference over to Kevin Veltman, Vice President, Investor Relations and Treasurer. Sir, you may begin.

Good morning, everyone. Welcome to Herman Miller’s first quarter 2019 earnings conference call. Joining me on the call today are Andi Owen, our President and Chief Executive Officer; and Jeff Stutz, our Executive Vice President and Chief Financial Officer. We have posted today’s press release on the Investor Relations website at hermanmiller.com. Some of the figures that we will discuss today are presented on a non-GAAP basis. We reconciled the comparable GAAP to non-GAAP figures which we have included in a supplemental data file that can also be accessed on the IR 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 most recent annual report on Form 10-K and any subsequent filings with the SEC. 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 three to allow time for all to participate. With that, I will now turn the call over to Andi.

Thank you, Kevin. Good morning, everyone and thanks for joining us. It’s been about a month since joining Herman Miller, and it’s been an incredible time working with our leadership team to transition into my new role. I have had the opportunity to engage with key stakeholders across the organization as well as with the number of dealers and customers. It’s already very clear to me that Herman Miller’s rich heritage is grounded in design and innovation excellence, which has enabled us to establish and maintain a world class portfolio of leading brands, but as equally impressive is the talented leadership team with expertise across all elements of our business. These two pillars will continue to drive all opportunities that lie in front of us for Herman Miller, our employees, our valued dealers and customers and our shareholders. As I look ahead, I view my role as CEO with setting a direction for the business that both solidifies our near-term growth opportunities and sets the stage for an acceleration of our long-term business strategy. I have spent most of my career where business and creativity come together and I look forward to bringing the perspective I have developed over 25 years at a leading global retailer as we continue to evolve our capabilities and products. Our ultimate success will depend on our ability to make it easy for our dealers and our customers to engage with our entire portfolio of brands. The customer-centric mindset is an integral component of our organizational culture and I am committed to executing the strategy that further advances the objective. Through the transition period so far, I have spent a significant amount of time with the leadership team reviewing our five strategic priorities. As a reminder, these priorities include: realizing our vision of what we call the Living Office; delivering on our innovation agenda; leveraging our dealer ecosystem; scaling our consumer business; and finally, driving profit optimization. I am happy to report that significant progress has been made during the quarter. So, let me take a few minutes and highlight these areas. First, the Living Office research-based framework remains core to our contract business and represents a tremendous opportunity to help our customers create compelling and high-performing workspaces. This framework drives our innovation roadmap. This quarter, we launched both Cosm and Lino as important additions to our leading lineup of high-performing task seating. Cosm sets a new standard for instant and personalized comfort, while Lino brings a great combination of comfort and value. There are also a number of exciting launches on the horizon that will further expand our range of performance seating and desking products as well as provide new solutions to the fast-growing enclosures category. Our innovation roadmap extends not only to physical products, but to the Live OS digital platform as well. This technology provides real-time data insights to help individuals and organizations improve workspace performance and achieve wellness goals. This quarter, we entered pilot installations with a number of leading companies and we are very excited by the opportunity this platform provides to engage in deeper ongoing dialog with our customers. We also advanced our progress on the development of expanded digital sensor technology for conference rooms and soft seating to enable the platform to provide full floor play [ph] coverage and unlock powerful insights for our customers. We expect this new sensor capability to be available later this calendar year. Turning to the dealer ecosystem, we continue to drive meaningful progress making it easier for our dealers to do business with us as well as expanding our product offering in both core contract furnishings and ancillary designs. An integrated set of digital tools across all of the Herman Miller brands is simplifying the process for our dealers to help customers discover, select, and ultimately purchase our products. This quarter, we launched a user-friendly tool that allows dealer designers and sales team members to quickly select products across the entire portfolio and place them in visual presentation tools to share with our end customers. We are also expanding the capability of virtual and augmented reality selling tools that allow customers to experience and design their future space without the complexity and cost of physical markups. We have also been working with our dealers to expand our offering into fast-growing product categories. For example, our recently announced investment in Maars Living Walls will help bring the architectural glass offering from this leading European brand to North America. The transaction closed at the end of August and we are working quickly with our dealers to integrate and scale the offering to take advantage of the growing North American enclosures category. Our ongoing progress of scaling our consumer business was evidenced by organic revenue growth of 13% and operating margin improvement of 200 basis points over last year. We have continued to expand our Design Within Reach footprint, and during the quarter, we opened a new studio in Nashville and repositioned our Palo Alto studio to a location 3x larger than the previous space. For the full year, we expect to open 7 new or expanded DWR Studios, along with our third outlet store in Vero Beach, Florida. Improved product mix with higher margin exclusive designs continued to make a meaningful impact on segment results as well. Following the June announcement of our investment in HAY, the team is well underway in launching the brand in North America. Specifically, the North American HAY website is granted go-live on November 1. Second, we are on schedule to incorporate a curated selection of HAY products into our Design Within Reach studios by the end of October. Third, we are building out dedicated HAY studios. The first two of these locations, Portland, Oregon and Costa Mesa, California, are slated to open later this quarter. Finally, the HAY portfolio is currently available to order through DWR contract business. The process is also underway to localize manufacturing for certain products in North America in the back half of fiscal 2019. The team and I are very excited about the growth prospects for HAY. In the past, we have projected a North American annual revenue opportunity at $75 million to $100 million in the next 5 years, and the more we learn, we believe there’s potential it could be even bigger. This is in addition to the equity income we will earn for our 33% interest in the existing HAY business outside of North America. The collaboration between the Herman Miller and HAY teams have been tremendous thus far and both organizations have a shared set of values that gives me great confidence in our partnership. The addition of this authentic leading design brand at democratic price points could be leveraged across our global consumer and contract distribution channels to reach a whole new range of consumers and support our existing customers more fully. Lastly, we remained focused on our profit optimization initiative, which was implemented to help fund these growth initiatives, offset inflationary pressures and support our corporate operating margin objective. Since the team unpacked this in detail for you last quarter, I will simply point out that we continue to make progress against the plans we have laid out. The initial phase, which focuses on corporate-wide cost reductions is nearing completion as we finalize our facility consolidation projects in the UK and China. The second consumer-focused initiative is progressing well and we expect the benefits from this work to ramp up as we move through the fiscal year. Finally, our most recent work, which is centered on profit optimization within our North American contract business, has moved from the scoping to implementation stage. In all, we remain highly confident that each of these phases will achieve the goals we have established. Last quarter, the team also discussed with you the impact of rising steel and other commodity costs. This factor combined with the more recent announcements of tariffs between the U.S. and China have highlighted the critical role that optimization savings are playing to help us offset near-term inflationary pressures. Our tariff exposure is primarily related to components imported by Herman Miller and its suppliers from China. As we said in previous quarters, we have proactively developed and refined contingency plans to help us navigate this situation. In addition to our profit optimization work, we are finalizing our planned price increase scheduled for this upcoming January and we have an additional range of pricing actions that we have developed as potential approaches to address this pressure in the near term. The Q2 outlook that Jeff will cover later reflects our expectation of the pending tariff impact. Given the recently announced tariff levels and effective dates, we expect a fairly minimal impact on the second quarter. As we look beyond Q2, we have developed mitigation strategies that we believe will offset the impact of these tariffs in the medium to long term. Additionally, it is important to note that potential further weakening of the Chinese yuan relative to the U.S. dollar could also assist to mitigate these pressures going forward. That said, we will continue to focus on the actions that we can control and put proactive solutions in place. Before turning it over to Jeff and Kevin, I want to provide just a few key highlights of our first quarter financial performance, which I believe underscore the progress we are making. Organic sales growth of 8% and order growth of 5% were both broad-based across all categories of our business segments. While gross margin pressures persist, the organization continued to manage core operating expenses well supported by our profit optimization initiatives. We also reported EPS on a GAAP basis at $0.60 during the quarter compared to $0.55 in the same quarter last year. On an adjusted basis, which excludes certain restructuring and other special charges for the quarter, we reported EPS at $0.69, reflecting a 21% increase in adjusted EPS compared to last year. In closing, there is a compelling opportunity ahead for Herman Miller to expand our addressable market, while continuing to deliver on product innovation and service that our dealers and customers have come to expect. I am confident that our ability to execute will position us to drive positive financial return and ultimately deliver value to our shareholders, while staying true to our mission of inspiring designs to help people do great things. So, with that, I will turn it over to Jeff Stutz, our CFO.

Okay. Thanks, Andi and good morning, everyone. Before we take a closer look at our consolidated results for the quarter, let me start with some context on the current macroeconomic backdrop, which remains generally positive and supportive of future growth. In the North America contract space, macroeconomic measures, including GDP growth rates, low unemployment, CEO confidence, and architectural billings data continue to point positive. While the new U.S. federal tax regulations have the potential to be an industry tailwind through higher employment levels and increased investment spending, the global tariff situation is creating near-term uncertainty. Putting all these factors together, the latest BIFMA industry forecast is projecting 6% industry growth in North America for calendar 2019, reflecting a net near-term positive outlook. Outside of the global trade pressures, the ELA regions are generally stable overall. We continue to monitor pockets of political uncertainty, particularly related to the final timeline and resolution of Brexit and the outcome of NAFTA negotiations. On the consumer front in North America, strong consumer sentiment, which recently reached the highest level since 2000, along with low unemployment, relatively low interest rates and favorable projections for existing home sales and new home construction make for a generally positive environment. So, moving to our results for the quarter, consolidated net sales in the first quarter of $625 million were 8% above the same quarter last year. Orders in the period of $631 million represented year-over-year growth for approximately 6% on a reported basis and 5% organically. Within our North America segment, sales were $344 million in the first quarter, representing an increase of 5% from last year on a reported basis and an increase of 4% organic. New orders were $345 million in the quarter, reflecting an increase of 3% on a reported basis and up 2% organically. The order growth in North America this quarter was led by smaller project sizes with the strongest sectors being financial services, healthcare and transportation. This was partially offset by lower demand levels in wholesale, retail and communications. Our ELA segment reported sales of $115 million in the first quarter, an increase of 24% compared to last year on a GAAP basis and up 22% organically. New orders of $125 million were 15% higher than last year and 14% up on an organic basis. The strong year-over-year order performance was led by growth in India, China and throughout the EMEA region. Sales in the first quarter within our specialty segment were $77 million, an increase of 3% over last year on a reported basis and up 2% organically. New orders in the quarter of $80 million were 6% higher than a year ago period. Encouragingly, the increase in orders this quarter was driven by higher demand levels across all four businesses that comprise the specialty segment. The consumer business reported sales in the quarter of $88 million. This is up 6% from last year on a reported basis and represents 13% organic growth. These results were driven by strong growth across our studio, catalog, outlet, e-commerce and contract channels. New orders for the quarter of $81 million were 6% ahead of the same quarter last year. Design Within Reach comparable brand sales for the period were 9% higher than last year. While the first quarter for our consumer business is generally a seasonal low point from a volume perspective, operating margins have continued to expand. The combination of executing the strategy around studio growth and enhanced product mix, along with our profit optimization work are gaining traction. We remain focused on our objective of full year operating margins of between 8% and 10% for this business in fiscal 2020. Consolidated gross margins in the first quarter was 36%, which was 140 basis points below the same quarter last year. Approximately 60 basis points of this reduction relates to the adoption of new revenue recognition accounting rules which became effective for us at the start of Q1. Under this new guidance we are now recording certain dealer payments as expense within cost of goods sold that were previously classified as a reduction in net sales. It’s important to note that while this classification change has zero impact on reported gross profit dollars, it does impact our gross margin percentage and this will be an important point to keep in mind as you view our fiscal 2019 gross margin performance in relation to prior periods. Beyond the impact of this accounting change, we have continued to experience the impact of increased commodity costs primarily related to steel as well as higher freight expenses and other margin pressures within one of our specialty businesses. As Andi shared earlier, we have identified a range of actions that we are planning to help mitigate these pressures including the estimated impact of pending tariffs. Operating expenses in the first quarter of $178 million compared to $166 million in the same quarter a year ago. This amount includes approximately $5 million in special charges which primarily relate to the CEO transition and consulting fees supporting our profit enhancement initiatives. The remaining year-over-year increase of $7 million was driven primarily by higher variable selling and employee benefit costs as well as higher occupancy and staffing costs related to new DWR studios that have been put in place in the last 12 months. Restructuring charges recorded in the first quarter related to previously announced facility consolidation projects in both the UK and China. These projects are progressing on schedule and we expect to begin realizing the benefit from the improved efficiency and lower costs as we move to the back half of fiscal year 2019 and into the early part of fiscal 2020. On a GAAP basis we reported operating earnings of $46 million this quarter compared to operating earnings of $49 million in the same quarter last year. Excluding restructuring and other special charges, adjusted operating earnings this quarter were $52 million or 8.4% of sales. And by comparison we reported adjusted operating income of $51 million or 8.8% of sales in the first quarter last year. The effective tax rate in the first quarter was 20%. This compares to an effective rate of 30.5% last year in the first quarter. And the lower tax rate this quarter primarily reflects the impact of lower ongoing U.S. tax rate as a result of the U.S. tax reform. And finally net earnings in the first quarter totaled $36 million or $0.60 per share on a diluted basis compared to $33 million or $0.55 per share in the year ago period. Excluding the impact of restructuring and other special charges adjusted diluted earnings per share this quarter totaled $0.69 compared to adjusted earnings of $0.57 in the first quarter of last year. And with that overview, I will 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 $102 million, which reflected a decrease of approximately $100 million from last quarter. This reduction was primarily related to the use of $77 million for the first quarter equity and licensing agreement investments in HAY and Maars Living Walls. Cash flow from operations in the first quarter were $34 million compared to $90 million generated in the same quarter of last year. The increase in cash flow from operations was primarily driven by $12 million cash contribution to our UK pension plan made in the first quarter of last year. Capital expenditures were $22 million in the quarter. For fiscal 2019 we anticipate capital expenditures of $90 million to $100 million for the full fiscal year including an estimated $5 million to $7 million to build out the HAY e-commerce and studio footprint in North America. Cash dividends paid in the quarter were $11 million. As a reminder, last quarter we announced the 10% increase in our quarterly dividend rate that will be paid beginning in October. This increase brings our expected annual payout level to approximately $47 million. We also repurchased $21 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 1.121. The available capacity on our bank credit facility stood at $165 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 will now turn the call back over to Jeff to cover our sales and earnings guidance for the second quarter of fiscal 2019.

Okay. Thanks, Kevin. With respect to the forecast, we anticipate sales in the second quarter to range between $635 million and $655 million. The midpoint of this range implies an organic revenue increase of 5% compared to the same quarter a year ago. We expect consolidated gross margin in the second quarter to range between 35.9% and 36.9%. Again, this estimate includes the impact of adopting the new revenue recognition standard in fiscal 2019 that lowers our gross margin percentage by approximately 60 basis points. Excluding this change in comparability, our expected gross margin in the second quarter at the midpoint is slightly higher than the same quarter last year. I want to reemphasize that this only impacts comparable gross margin percentage and has no impact on reported gross profit dollars. Importantly, this estimate reflects our latest view on commodities and tariffs, as well as the impact of our profit optimization work and other actions to help offset these pressures. As Andi discussed, we do expect the range of actions that we have identified to offset the pressures. Operating expenses in the second quarter are expected to range between $177 million and $182 million and we anticipate earnings per share to be between $0.70 and $0.74 per share for the period and this assumes an effective tax rate in the quarter of 21% to 23%. So, with that overview, I will now turn the call back over to the operator and we will take your questions.

Thank you. [Operator Instructions] Our first question comes from Kathryn Thompson of Thompson Research. Your line is open.

Good morning. This is Steven Ramsey on for Kathryn.

Good morning.

Good morning. I wanted to clarify something or maybe you can flesh this out on the margin improvement projects. Do these include any impact from Maars and HAY and how does bringing those assets in – does that challenge or improve what you are doing on the profit optimization works?

Hi, Steven, this is Jeff. So, the optimization work that we are really alluding to does not specifically include the impact from HAY or Maars. I think certainly both of those are expected over time to be accretive to earnings per share. We are not expecting any positive impact from those in the first year of operation. Obviously, there is a lot of noise that runs through that we had to do believe it or not purchase accounting on these even though they are equity investments. So, that’s exclusive of our commentary on profit optimization, but without a doubt going forward beyond that, we expect those to be accretive.

Excellent. And then just thinking about the specialty segment and kind of the improvement that is going on there, I guess on gross margin specifically showing expansion, what factors and inputs are different in this sector that drove gross margin expansion while the North America and ELA segments’ gross margins slipped?

So, this is Jeff again. Within specialty, this really has everything to do with mix of business within the specialty segment. Within there, one of our business is Maharam textiles company has actually got some nice momentum going. They are growing the top line nicely, and with that, they have structurally higher gross margins and that’s really the big driver there. Longer term, within specialty, we alluded in our prepared commentary that we have one of the businesses within specialty that is we are having some issues with still struggling, and it was actually one of the factors that caused margin in the quarter to be a bit lower than we had anticipated. That is getting a lot of internal focus and we absolutely believe that addressing that over time will be further tailwind to the gross margin within that segment. And I am sorry, did you have a follow-on question on ELA specifically?

No, just thinking about the different factors that drove specialty difference versus the margin declines in the other two segments in the quarter?

Got it, got it. Yes, that would be the biggie that I would point to. But we have had nice growth by the way beyond that across all of the specialty businesses, and with that, you get some leverage. So, they are all contributing with the exceptions of the one. We have got a healthcare company, Nemschoff, where we are still really working to turn that business around. But so, we have some leverage from the other businesses along with the overall mix across the businesses with Maharam contributing more this quarter than a year ago.

Right. And then can you maybe, last question on specialty, operating margins kind of discussed if you didn’t have the problem unit of Nemschoff right now about where operating margins would be?

Yes. So we – I think we were going from around 4% in the quarter. I think you would see close to between 50 basis points and 100 basis point improvement if weren’t feeling some of the effects of the struggle we are having with Nemschoff in the quarter, rough order of magnitude.

Okay, great. Thank you.

Our next question comes from Matt McCall of Seaport Global. Your line is open.

Thank you. Good morning everybody and welcome Andi.

Thank you. Good morning.

So, maybe start with the North American business looking at the – the reported growth was okay, but if you look at it on a stack basis, it was about the best 2-year stacked order growth number you’ve had or it was the best one you have had in four quarters, is there anything that seems like you are pretty bullish or optimistic about the macro, but is there anything that you are seeing kind of improve in the past quarter they would be noteworthy because you do have some more difficult comps coming up, and I am just trying to get a handle on kind of taking into account the comps, taking into account the macro, how we should be thinking about the order pattern for the rest of your fiscal in North America?

Matt, that’s a great question. I think if you look at North America and you look at the macro factors that are impacting this business. I think we have a lot of things lining up in our favor. I think you see GDP growth that’s above average, you see private office construction that’s above average. The service sector employment is above average. BIFMA’s forecast has been good, I think CEOs in the industry are all confident. I think when you line up all the macroeconomic factors, we feel very optimistic about where this is going for the next quarter or two and beyond. And I would say from an order pattern, we have a really talented team. We see orders on a very consistent basis. So, we are pretty confident about this business going forward. And would you add anything to that Jeff?

Yes. I think I would say company specific, Matt, that comes to mind. I think obviously very, very competitive marketplace, but we feel really good about some of the recent product introductions. We think we’ve kind of – we’ve hit the mark. Some of our recent introductions, they are being well received by the marketplace. Well certainly, coming together at a time as Andi said where we have got a really nice supportive backdrop for the industry in general. We think we have targeted our product development in the right places and so we are hitting our stride.

Okay, very helpful. So I guess on cost side you talked about tariffs and incentives like, [if I heard you correctly you are pretty confident that the medium-term and longer term, I think that’s what you said around one of addressing the potential pressures, what about the near-term, how do we handle the back half when the increase in the tariffs should start to show up in your Q3 and maybe the way I would think about it is, one part of the question would be if you have no abstracts what will be the impact, I am just trying to get order of magnitude on what the risk is?

Sure. So let me – I will start with the kind of back half of your question and say how do we view the growth impact of the tariffs impact. And so let me start first by saying because this is so late breaking, we expect very little impact on our fiscal second quarter, so this is the starting point, not real significant. I think longer term to your question, we would anticipate based on the best data we can get our hands on, we spend a fair amount of time looking at this. But you can look at this $5 million to $6 million gross cost increase per quarter for our business, kind of on an ongoing basis once it’s fully in place. Now I want to quickly follow that up with we are being very, very aggressive pursuing a whole range of steps and that gives us the confidence that we can offset it that we mentioned on the call. In the second half of the year we have got a team of people in place that are reviewing and focusing on the implementation of a number of things including re-gearing our planned January price increase, adjusting discount thresholds. We have got folks looking at value chain analysis in an effort to try to identify where we can minimize tariff impacts and opportunities for things like duty drawback. We are looking at in-country supplier negotiations. And then even longer term depending on how we determine the tariff situation in terms of whether it’s going to be durable or not, potential changes in how we source components from various locations and so all of that is kind of tariff-specific work. And then of course in the back, we have talked a lot about our profit optimization work and that’s already in place and we think that will be a key factor as well in helping to offset. So, a lot of description there, but I just want to make sure I emphasize we have no intention of allowing that $5 million to $6 million per quarter estimate to actually fall to the bottom line in that manner.

Thank you for that detail, Jeff. The sort of $5 million to $6 million, how much of that changed or how much did that change with the news of the 10% going to 25% in January, what did you already kind of have – what did you already work through and what do you have to work through still? Do I just take the math and do the 10% and look at it relative to the 25%?

Yes, Matt, I would say that’s probably the best way to look at it on a ratio. By the way, I should also just make sure we are clear, all of the math I just gave you assumes 25%, so just to clarify.

Yes, exactly.

Okay. Okay, perfect. I guess I am trying to think of what I want to use for my third question. Maybe Andi one for you, I think one of the questions I asked when we had our initial conversation was around any expected investment above and beyond what was in the initial plan, you walked through kind of the five pillars, the five areas of focus. But as you have kind of thought about it is there the potential that you see kind of an increase in investment? Specifically, I think about technology just given your background, but is there any chance that we see investment either on the operating line and the capital spending lines increase as a result of some of the maybe newer initiatives?

I think it’s a great question, Matt. I think its early days for me to say specifically where we will be investing, but certainly, digital enablement is top of mind for me, ease is top of mind for me, supporting our design and innovation process is top of mind. But what I will say is any investment we make, we will make balancing our 10% operating margin goal. So, I don’t expect there to be any dramatic changes. I think it’s our responsibility to figure out how to do that with that goal at the forefront of our mind.

Perfect. Thank you, all.

Our next question comes from Greg Burns of Sidoti. Your line is open.

Good morning. Just a question about the profit optimization initiatives, last quarter, you outlined some target ranges of savings for each of the initiatives and kind of where you were in terms of achieving those. Could you just maybe give us an update in terms of the different buckets and how far along you are towards those goals? Thanks.

Sure, Greg. It’s Jeff. Let me take this one. So, let me step back. I know we spent a fair amount of time on the call last quarter kind of walking through a lot of detail. We were very intentional to not use as much real stake on the call here this time with that detail. But if I take you back, you will recall we unpacked our profit optimization initiatives in three phases. It began with an initial just internal effort kind of drains up review on cost and cost reductions, cost savings. We then had a targeted effort within our consumer business that had a whole range of work streams targeting improvement in profitability. It wasn’t as much a cost reduction effort as much as it was just improved efficiency and there was some cost. And then more recently – and again, we gave details a bit on this last quarter, we have had a similar profit optimization project kickoff focused on our North American contract business. So, those are the three phases. In total, over the entire time period and we have been at this now for going on 2 years, if you add up what our targeted objective profit improvements are, it’s between $60 million and $90 million. We think maybe I am just – in short, we believe we have got about somewhere between $25 million and $55 million of opportunities still ahead of us to implement. And we are making progress on all three of these initiatives. Certainly we are much further along on that cost reduction program that we set in place 18 or so months ago, so we have made continued progress there specifically at point of things like our – I have mentioned it on the call, our facility consolidation efforts in the UK and China are some of the – if you will the last pieces of that that we are putting in place. And we have got some savings that we anticipate realizing as we get towards the kind of latter part of this fiscal year. The consumer project is well beyond the implementation phase and now we are seeing those benefits layer in. We did make some progress this quarter. We would say for that one in particular, there is probably somewhere between $3 million and $8 million remaining on an annualized basis. And then lastly the North American contract project we are still in the implementation phase of that one. So while we are making great progress, we have continued confidence in the potential savings that that’s going to drive. We have not yet captured any of that. We are still in the process of putting all of that in place.

Okay, great. Thanks. So when we think about the remainder of the year – for the full year do you see being able to show some operating margin leverage when you factor in all of these initiatives versus some of the headwinds that you talk about?

We do, yes we do. We think especially as we get into the second half of the year and we start to realize some of the North American contract project savings that we can start to lever more of that at the bottom line.

Yes. I think I will just add to that Jeff. As we look at the consumer business and we start to see some of the cost savings from the supply standpoint, we work through the P&L as we go through higher cost inventory and get lower cost inventory and we will see some leverage there.

Perfect. And then so lastly on the tariffs again, is there anything you could do longer term aside from some of the pricing initiatives and some of the other things you laid out in terms of maybe shifting supply out of China or are you kind of fixed and it’s really going to be up to you to mitigate it in other ways?

I think it’s a great question. I don’t think it’s fixed at all. It’s just like you guys know, we are looking at all of our options and some of them are obviously easier to implement than others. We are looking at other areas to manufacture. You have to layer in freight costs, if we decide to manufacture elsewhere it means it would be a little bit harder to implement in longer term, but we are absolutely exploring those options as well.

Okay, great. Thank you.

Yes.

Our next question comes from Budd Bugatch of Raymond James. Your line is open.

Good morning and my welcome as well Andi. Congratulations on a good first quarter. Let me make a challenge on North America if I could. The BIFMA results for the last 2 months prior to the end of the quarter were organically in terms of orders above where you were in the quarter, I know we have got heavy comparison from last year with the order growth, what’s going on there, I think Jeff if I remember in the last quarter you said you were examining the range of options including less discounts and less aggressiveness in new business, so talk to us about – a little bit about North America in that context if you would?

Yes. Happy to Budd, I would maybe start by – I stand by my comments last quarter. We are exploring a range of those things. These are in connection with this broader profit optimization work. I would be a little cautious in reading through the growth rate in Q1 as a reflection of that work because we are still really in pre-implementation of all of that – those decisions. So I want to just make sure I caution you that it’s part of inherent in the question is did that cause something, I would say no, it did not. What I can tell you about this, first of all I am glad you pointed out. We did have very difficult comparison to the year ago period, right, but that business was up 9% in the year ago period organically, so kind of an uphill comparison, no question. And I think you had pointed out rightly many times in the past, this is a very project driven business, it’s lumpy, we felt the effect of that in the quarter. We felt I would say the typical seasonal pattern of order entry within our North American contract business, but to a bit of an more extreme than in past years things started off reasonably well in June. They fell off like they always do I am talking order patterns in July in a big way. And then what we didn’t feel is in the first half of August, the bounce back that we were expecting to see that would be more typical for the season. It ended very strong. And in the early weeks of Q2, we have continued to be strong. So I guess my longwinded way of saying it was consistent with seasonal patterns perhaps a bit more on the extreme end for us, but I think we attribute it to nothing more than just the timing of projects in the business and the fact that we had a tougher comparison. I don’t know that I would add anything more than that, Budd.

Okay. Without impinging on my second question, as old guys remember a phrase that we used to use called weekly order pacing with Miller. Are you telling us that the weekly order pacing in Q2 is moving above where it was in the beginning of Q1 or significantly above where it was last year?

We have seen an improvement in the first couple of weeks of the quarter, Budd, yes.

Okay, both above where it ended and above last year?

Certainly above where it ended. And yes, I would say both.

Yes, above both.

Yes and yes.

Yes and yes.

Okay. Second area that I wanted to explore was more a little bit on costs. Steel is our major import if I remember right and it looks like at least in the U.S. cold-rolled, the index and cold-rolled starting to move down. Are we seeing any impact on that? As I recall, we are distributor-based so therefore we feel it a little bit late later than you might see it in an index. Help me on understanding that?

Yes, Budd, this is Jeff. Correct. We feel a lag both when the market price and the index price is on the rise and on the decline just because of how our supplier arrangements work. So, all of that is true. Certainly, the good news is the last couple of measurement points for cold-rolled have been trending down, which is great. We are still at I think $967 or something like that latest reference point and we have not yet felt the effects of that. We are still, if you will, because of that delay, we built into still some of the increase in Q1 and we will expect to feel a slight sequential pressure in Q2 that’s implied in our guidance. Yet still before we then hopefully feel the effects, if this continues to trend down, start to feel the effects of steel pricing trending backwards. And I might add, Budd, given where steel price, I mean, we have obviously seen a big ramp-up in the cost of steel since kind of just late spring timeframe. And at current levels, this is not a prediction of where steel is going. I of course have no idea where it’s going, but just to frame it for you, if steel were to revert back to the kind of average levels that it had been running in the latter half of fiscal ‘16 for us and throughout all of 2017, which I think is pretty representative of what we would view as a more normalized steel price kind of that $820 to $850 per ton, I mean, that’s on an order of magnitude, Budd, somewhere between $11 million and $13 million of cost for our business. So, clearly good news for us if we can see that continue to trend downward.

Okay. But, yes, we see steel up 20% or so year-over-year, I think that chart that we said…

Yes.

Yes.

Okay. And so what did you bake into the second quarter then in terms of cost increase year-over-year for steel?

Budd, we assumed $1,000 a ton in our Q2 forecast. I think last year was closer to $825, $850.

And what does that work out in terms of total dollars, Kev?

Total dollars, sequentially, it was about $1 million higher, I think year-over-year, closer to $2 million over.

Okay, that’s helpful. And so the last area for me would be on the tariffs. I am confused, help me understand where tariffs impact you, what are we talking about? Where does it impact? What are you bringing over? POSH is pretty much all China contained, right?

Yes, in the case of POSH, that is true.

So what imports do we have from China that are impacted by the tariffs?

Well what it affects are primarily seating, components of seating and then products that we would source from China, which is not a huge part of our business, but that will be the major impact, yes.

Yes. So, component parts that go in chairs. We have got – you think about things like monitor arms just about to pick one example. Those are manufactured primarily in China.

From CBS, the CBS product was coming out of China.

Yes.

And so there is a raft of things, right. And it’s one level you can argue, I mean, I certainly, when I look at our business, our tariff exposure on a cost of goods sold basis is somewhere between 5% and 6% of consolidated cost of goods sold. So I mean, it’s real dollars as I outlined for you and we have to do all kinds of things to mitigate it, but I think the spirit of your question is you would be surprised to hear that we have a ton of China exposure. And I would argue we really don’t, in the grand scheme of things, but nonetheless at 5% to 6% of your costs of goods sold, it drives a meaningful impact if we can’t find ways to offset it.

So, make sure I understand, you are importing – your tariff exposure is 5% to 6% of $1.6 billion is that what you are telling me?

Consolidated COG, yes. And by the way, Budd, of course these are directional high level estimates, but yes, that’s what I am saying.

So that’s like what, $90 million to $100 million that’s the tariff impact or is that the import impact?

No, that’s just the – if you will the cost that is exposed to tariffs as they are currently defined.

So $96 million at times 25% is the delta, is that the right way to read it?

Yes.

Okay. I am sorry, I just have to do math, it’s a failing I have and so I apologize. And I guess I am going to sneak one question in since I am the last. The HAY Studios, I am excited to hear about that. The one in Portland, Portland is your largest DWR Studio, if I remember right, I was in there. Is that where you are going to put the HAY Studio?

Yes. It’s in the Pearl District and we are really excited about the site. It will open in the beginning of November as well as the studio in Costa Mesa. And we are looking at four other studios this year, Budd, and then we have a couple of other sites that we haven’t yet nailed down or approved. So we are not sure if they will fall into this year or next. And as we mentioned in our opening comments, the website will also go live in the beginning of November. So, I am really excited about the opportunity here, not only what it adds to the B2C business, but what it adds to our contract business as well.

What I am confused Andi, is it going to be co-located within DWR showroom in Portland or no?

Yes.

It is. So it’s going to be operated and same operated under the same umbrella by John and John and under that particular studio?

John and John are running our consumer business in total now, yes. And as we grow HAY, we will determine our leadership structure in the future.

Okay, thank you very much. Good luck on the quarter.

Thank you.

Thank you.

And I am showing no further questions in queue at this time. I would like to turn the call back to Andi Owen for closing remarks.

Great. Well, thank you all for joining today’s call. We will of course be back to you in December with another progress update. In the meantime, I really look forward to meeting you or speaking with you as many of you as possible. We want to hear your feedback and really discuss the exciting future we see at Herman Miller. So until then be well and have a great day.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.