Office and workplace furnishings giant Herman Miller Inc.'s (MLHR 2.83%) fiscal fourth-quarter 2018 earnings report, released earlier this week, pleasantly surprised investors on the strength of the company's order flow and healthy fiscal 2019 outlook. Let's review three insights from management's earnings conference call on Tuesday that illuminate Herman Miller's near-term success. Each of these quotes, from CEO Brian Walker's comments, demonstrate the tactics the organization is using to expand within an improving global economy.
1. It's capitalizing on furnishings trends
Regarding our drive for innovation, 2018 was an active year for new product launches. New products introduced over the past four years accounted for 29% of total sales for the year, well above our annual target of 20%.
While Herman Miller derives core recurring revenue from classic offerings such as the ergonomic Aeron chair, the company's growth depends on supplying new solutions for office environments that feature open plans and draw inspiration from co-working aesthetics. Walker's quote above quantifies the pace at which the company is selling into an evolving market.
In recent weeks, Herman Miller has set itself up to further capitalize on office design trends, by spending a total of $72 million to acquire equity stakes in Dutch glass wall and enclosure specialist Maars Living Walls, and ancillary office furnishings retailer Nine United Denmark A/S (HAY). Maars will add to Herman Miller's expanding line of enclosures within office spaces, which allow for privacy in open environments. During the earnings call, Walker discussed the company's upcoming Overlay product line, which allows organizations to create free-standing enclosures through movable wall and ceiling elements.
HAY will assist Herman Miller in widening the reach of its fast-growing consumer business, especially within the market opportunity that management refers to as HENRY (i.e. High Earners, Not Rich Yet). HAY's products are sold below typical corporate-office price points, making it ideal for Herman Miller's outreach to thrifty yet style-conscious millennials.
Image source: Getty Images.
2. Consumer growth -- and profits -- could be significant over the long term
...[F]iscal 2018 was a year of great progress for our consumer business. Revenues in this business grew by 12% over last year as we grew comparable-brand sales each quarter and expanded our selling square footage by 40,000 square feet.
To elaborate on this Walker quote, Herman Miller's ELA segment (Europe, Middle East, Africa, Latin America, and Asia-Pacific) currently leads company growth. This second-largest division (after North America) chalked up 30% revenue expansion in the fiscal fourth quarter of 2018. But over a longer time period, the company's consumer business may hold the most promise. Herman Miller uses a dual strategy in this division, employing design studios as well as direct-to-consumer sales to reach both third-party dealers and noncorporate customers.
Despite the top-line promise, the company still must execute on its task of improving the profitability of consumer sales. In recent quarters, the consumer segment has posted operating margin only in the low to mid single digits. Last quarter, however, consumer operating margin improved by 450 basis points to 8.4%, partly through the company's engagement of a consulting firm to lift profits. Management believes that productivity measures could result in sustained operating margin of 8% to 10% over time, which, as the division grows, could significantly boost the company's bottom line.
3. It has a well-reasoned plan to deal with commodity inflation
In addition to these profit optimization actions, we plan to implement an additional price increase in January 2019 ... Having said that, we will be implementing tactical pricing actions that don't require a list-price change and recognition of the higher input costs. And we'll continue to train our sales professionals and dealers in how to best position our ever-broadening range of price points and solutions to maximize our collective competitiveness and profitability.
In the quote above, Walker refers to companywide productivity and cost-cutting initiatives that aim for $60 million to $90 million in annual savings. The organization has realized $30 million in savings so far, but these have been eaten up by rising manufacturing costs, due in part to rising commodity prices resulting from the Trump administration's tariffs on imported steel and aluminum.
During the earnings call, Walker quantified the annual negative impact of the tariffs at $15 million to $20 million, but projected a complete offset due to the $30 million to $60 million in annual productivity savings still to be realized.
As you can infer from the comments I've isolated here, Herman Miller will also pass on some of its widening cost-of-goods-sold burden to customers. Unlike competitor Steelcase Inc. (SCS +0.00%), which is simply adjusting customer list prices to offset higher costs, Herman Miller is taking a more nuanced approach, seeking to integrate selective price adjustments within project work via its sales force and dealer network.
I believe the company's two-sided strategy of significant productivity initiatives and subtle price increases will allow it to maintain the favorable economic equation that is generating organic revenue growth of 6% alongside higher operating profits.
Shareholders apparently also like the company's approach to cost inflation, as shares have soared more than 13% in the trading sessions following the July 2 earnings release.
