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September 30, 2008

Steelcase Inc. F2Q09 (Qtr End 08/29/08) Earnings Call Transcript

Filed under: Conference Call Transcript — Tags: — admin @ 12:00 am


Raj Mehan – Director, Investor Relations

Jim Hackett – President and Chief Executive Officer

Dave Sylvester – Chief Financial Officer

Mark Mossing – Corporate Controller and Chief Accounting Officer

Terry Linhardt – Vice President, North America Finance

Mark Baker – Senior Vice President, Global Operations


Budd Bugatch – Raymond James

Matthew McCall – BB&T Capital Markets

[Peter Walstrum] – Unidentified Firm

Todd A. Schwartzman – Sidoti & Company, LLC

[Margot Murtoch] – Unidentified Firm

Steelcase Inc. (SCS) F2Q09 Earnings Call September 29, 2008 11:00 AM ET


Welcome to Steelcase’s first quarter conference call. (Operator Instructions) For opening remarks and introductions, I would like to turn the conference call over to Raj Mehan, Director of Investor Relations.

Raj Mehan

Here with me today are Jim Hackett, our President and CEO, Dave Sylvester, our CFO, Mark Mossing, Corporate Controller and Chief Accounting Officer, and Terry Linhardt, Vice President, North America Finance. We’ve also asked Mark Baker, our Senior Vice President, Global Operations, to join us on the call as well.

Our second quarter earnings release dated September 29, 2008 crossed the wires this morning and is accessible on our website. This conference call is being webcast and is a copyrighted production of Steelcase Inc. Presentation slides that accompany this webcast are currently available on and a replay of this call will be posted to the site later today.

Our discussion today will include references to non-GAAP financial measures. Reconciliations of such measures to the most comparable GAAP measures are also included in the earnings release and webcast slides on

This conference may include forward-looking statements. There are risks associated with the use of this information for investment decision-making purposes. For more information about these statements and the associated risks, please refer to today’s earnings release, our Form 10-K for the year ended February 29, 2008, and our other filings with the Securities and Exchange Commission.

We are incorporating by reference into this conference call the text of our safe harbor statement included in the morning’s release.

With those formalities out of the way, I’ll turn the call over to our President and Chief Executive Officer, Jim Hackett.

Jim Hackett

Today’s good news that Steelcase continued to maintain solid performance in a challenging environment is due to the fact that our business model redesign in the 2003 recession did make us more resilient to some of the current negative forces. Now while we could see the challenging environment emerging in the banking sector, the unprecedented realignment in the country’s financial system is an effect we have to deal with.

Some of the companies that have been in the headlines this month are among our long-term customers, and we believe the nature of the bailout and government intervention will stabilize the industry. But, like you, it’s too early to judge the impact on short-term demand. However, let me emphasize that this news this morning about the government’s involvement is very positive.

In addition to the business model changes at Steelcase in the last recession, we are happy that many of our strategic initiatives also have had a positive dampening effect on the negative changes in the financial sector. For example, there are three specific areas that continue to give us confidence in the future and illustrate the effectiveness of our strategies. The three are first, a diversification of our markets, not only vertically but geographically; a growth through new products that we’re introducing, and operational efficiencies that we continue to pursue. I want to touch on the continued recognition, also, this morning of our efforts to be a more sustainable enterprise and to help our customers do the same.

Now, as I talk about these three points, let me start with the fact that Steelcase is less dependent on large corporate customers than we were at the start of the decade. They’re still very important to us, but growth in sectors such as technical professional and higher education and the continued growth in our health care business are helping to offset the reduced demand from the financial sector.

We also recently secured a very large, five-year U.S. government contract award with further news to be detailed under the government’s discretion. We can’t specify the nature of that until the press release is finished, but it’s evidence that our efforts to build market share in the government segment are paying off.

This summer we jumpstarted our new Coalesse premium brand with a collection of products from some of the top designers in Europe while also enlisting top talent to create a new portfolio just for us. Last quarter, with some disappointing news in that segment, we worked hard on the backend consolidation of the SDP labeled brands. These are the brands that were folded into the Coalesse name, and there had been some disruption in the previous quarter which contributed to an operating loss. Today, I’m happily confirming that the Coalesse Group has returned to profitability in the second quarter, despite the fact that we’re not done with all the transformation that we had undertaken.

We expect these restructuring activities to be completed by the end of November, and Dave Sylvester will describe more detail on this as we promised during our last call.

The restructuring actions that we announced in March of this year are also on plan. On the operations side, the plant closures are on target to be completed by the end of the third quarter. This will allow us to begin to realize a large portion of the estimated $40 million in pre-tax annualized savings from all the restructurings that were planned.

You will recall that we have a drive to reinvent our business model and this extends beyond our factories into every facet of our business. We’re recently reengineered processes in specific white-collar areas which will allow us to better utilize what we’re calling our captive shared service center. In fact, I’m going to Kalumpur soon to cut the ribbon on our recently relocated shared service center that will provide internal efficiencies while providing a showcase for our products and knowledge.

You know, renowned author Thomas Friedman has a new book out. And, of course, he’s the author of the bestseller, "The World is Flat." In his new book, he foretells of what we’d have to do in order to build organizations that can compete globally, and he’s establishing that he believes sustainability or the green discussion is the next movement in establishing the quality of companies as they compete. Sustainability is going to be a big deal. Said another way, it won’t be okay for companies to profit and pollute.

At Steelcase, we think we’re ahead of this game, and we’re particularly pleased to be recognized this quarter for our sustainability efforts. The U.S. Environmental Protection Agency named Steelcase as its Partner of the Year in the large business category for waste reduction and recycling. We’re in league with previous winners like Disney, IBM and Anheuser-Busch. Our Markham, Ontario plant also won a major award given by the Canadian Counsel of Ministers of the Environment. This represents a commitment not just from the company, but from thousands of employees who make us proud every day with their commitment to sustainability.

So, in summary, from my point of view, yes, these are times that remind us that unintended event management is as critical as strong and predictable performance. We’re going to be cautious in the light of recent events, but not lose sight of our goals. I think that you’ll find that Steelcase will do a great job of navigating through these tumultuous times.

Now I will turn it over to our CFO, Dave Sylvester.

Dave Sylvester

Today we reported a second quarter profit of $31.4 million or $0.23 per share, which compares to $37.7 million or $0.26 per share in the second quarter of last year. These results were better than the earnings estimate of $0.15 to $0.20 per share that we provided last quarter.

Revenue growth of 9.3% over the prior year was also better than the estimated range of 3% to 7% we provided last quarter.

In total, second quarter revenue included a $22 million benefit from currency translation effects and a $4 million unfavorable impact from net dispositions as compared to the prior year.

The International segment reported another quarter of strong sales growth over the prior year or 34%. North America revenue increased 2.1% compared to the prior year, including the negative effects of dealer deconsolidations completed within the last 12 months and the disposition of a non-core business, Custom Cable, in July of the current year.

Operating income excluding restructuring costs was $55 million or 6.1% of sales compared to $53.3 million or 6.5% of sales in the prior year. While we were able to improve our operating expense leverage as a percentage of sales by 130 basis points compared to last year, cost of sales increased by 170 basis points, primarily due to higher commodity inflation, which was within the estimated range of $15 to $20 million we provided last quarter.

In addition, the cash surrender value or CSV of our company owned life insurance, which is recorded in both cost of sales and operating expenses, decreased by approximately $2 million this quarter, which compares to no change in CSV during the second quarter of last year.

Restructuring costs of $5 [point] million after tax primarily related to the strategic actions communicated in March. Recall that we announced three plant closures, one in North America and two within the other category, and certain other product moves that we plan to complete by the end of November, 2008. We also announced white-collar reinvention initiatives targeted for completion over an 18 to 24-month period. While the net charges incurred this quarter were below our estimate of approximately $7 after tax, as some activities were rescheduled to the third quarter, the announced initiatives overall remain on track to be completed in the same time frames and with the same costs and benefits as outlined in previous calls.

Other income net decreased by $6.5 million compared to the prior year quarter. Interest income decreased by approximately $5 million compared to the prior year because of lower cash and investment balances and lower interest rates earned on those balances. In addition, the current quarter included nonoperating gains of approximately $4 million, which compares to $6.6 million in the prior year.

Our effective tax rate of 31.7% for the quarter included $1.6 million of favorable tax adjustments associated with the sale of Custom Cable. Income tax expenses was otherwise consistent with the 35% estimate we communicated during our last call and which continues to be our estimate for the full fiscal year taking into consideration the other assumptions we communicated in March.

Next I’ll talk about the balance sheet and cash flow. Our cash and short-term investment balances approximated $129 million at the end of the quarter, a $14 million decrease from total cash and short-term investments at the end of the first quarter. The decrease in cash was primarily driven by working capital needs associated with the strong international growth we experienced during the quarter. Compared to the second quarter of the prior year, cash and short-term investments decreased by approximately $350 million, primarily due to the payment of a special cash dividend in January of 2008 and share repurchases over the past four quarters.

Capital expenditures of $27 million during the second quarter included a $12 million progress payment associated with the purchase of a replacement aircraft. We continue to estimate fiscal 2009 capital expenditures will approximate $100 million, including the aircraft, compared to $80 million in fiscal 2008. However, we also anticipate selling the aircraft that is being replaced and estimate that the net proceeds will more than offset the year-over-year increase in capital expenditures.

As mentioned earlier, we completed the sale of Custom Cable during the second quarter. Total proceeds, including limited seller financing, are expected to approximate $18 million. We recorded a $1.8 million pre-tax operating loss within operating expenses and recorded $2.3 million of net tax benefits in connection with the sale. As a result, the net income impact of the disposition was a $500,000 gain. For reference, Custom Cable generated approximately $35 million of revenue and was profitable in fiscal 2008.

During the quarter we repurchased 802,000 shares of common stock at a total cost of $7.8 million or at an average price of $9.77 per share. In addition, we paid quarterly dividends of $20.2 million or $0.15 per share. Over the past four quarters we have returned $440 million to shareholders through quarterly dividends, a special cash dividend and share repurchases. As of the end of the quarter, we had $220 million remaining under the $250 million share repurchase authorization we announced in December, 2007.

Now I will discuss the quarterly operating results for each of our segments and the Other category.

Again, North America revenue increased by 2.1% compared to the prior year, including a $14 million negative effect from dealer deconsolidations in the prior year and the sale of Custom Cable in July of this year. Adjusting for these items, we estimate organic growth in the North America segment approximated 4% in the second quarter, which is better than the flat estimate we provided during last quarter’s call. While demand within financial services remains very soft, we experienced increases in revenue as compared to the prior year across a variety of other sectors, including energy, government, higher education, health care and technical professional. In addition, Turnstone had a strong quarter, posting double-digit sales growth.

During our last call, we noted that the decrease in project-related orders within the financial services sector during the first quarter was severe. However, we also noted that we were experiencing strength in a number of the other sectors which in total essentially offset the decline in financial services and resulted in an ending first quarter backlog that was slightly higher than the prior year.

During the second quarter, the same story largely continued. The decrease in project-related orders within the financial services sector remains significant, but we continue to experience strength in a number of other sectors. These order patterns, along with an increase in orders prior to the September 1st effective date of our commodity surcharge, caused ending backlog to be slightly higher than one year ago. Overall, pretty good performance, all things considered, especially if you recall that prior year second quarter orders and ending backlog grew at double-digit rates compared to the previous year.

Customer visits followed a similar pattern – strength in some sectors offset by weakness in others.

Operating income excluding restructuring costs was $45.8 million or 9.2% of sales compared to $49.5 million or 10.1% of sales in the prior year. While the North America segment experienced a 90 basis point improvement in operating expense leverage, it was more than offset by increased commodity inflation within cost of sales, which was the primary driver of the increase in cost of sales as a percentage of revenue.

The dollar decrease in North America operating expenses as compared to the prior year was primarily due to $3 million of prior year spending related to dealer deconsolidations and Custom Cable.

In the International segment, sales increased 34% compared to the prior year quarter. We experienced growth in a number of countries again this quarter, including Germany, China, the U.K., Angola, Mexico, India, Russia and Australia. Currency translation had the effect of increasing revenue by approximately $21 million as compared to the prior year, and current year revenue also included $10 million from net acquisitions completed during the past 12 months.

Adjusting for the impact of currency translation and net acquisitions, we estimate organic revenue growth in International for the quarter approximated 18%, which is well ahead of the mid to upper single-digit growth rate we estimated during last quarter’s call.

You will recall that total International orders during the first quarter were essentially the same as the previous year stated in terms of local currency and adjusted for net acquisition impacts and reflected mixed results. That is, strength in a variety of markets was offset by weakness in three core markets  France, Japan and Spain.

Nevertheless, the outlook for the second quarter anticipated the continuation of organic revenue growth as backlog remained relatively strong and order patterns in total had regained some momentum through the date of our last call. Thereafter, total orders continued to outpace the prior year, growing in total at a rate better than expected. In addition, we were awarded a couple of large projects late in the quarter which helped build a nice beginning backlog going into the third quarter.

International operating income excluding restructuring items was $12.9 million or 5.1% of sales compared to $4.3 million or 2.3% of sales in the prior year. This 280 basis point improvement in operating margin was driven by a significant improvement in operating expense leverage partially offset by increases in cost of sales as a percentage of revenue.

In addition to recent increases in inflation, International cost of sales continues to be negatively impacted by several factors, albeit to a lesser extent than the first quarter. First, negative currency impacts are continuing to affect our U.K. business results as we primarily import from our Eurozone industrial model in Western Europe. Second, there is a dilution effect of consolidating Ultra, which currently has lower gross margins than average and has experienced rising costs driven by regulatory reforms. And third, we are experiencing somewhat of a different mix of business in certain markets as compared to the prior year.

International operating expenses were $65.9 million or 26% of sales in the current quarter compared to $56.9 million or 30.1% of sales in the prior year quarter. That’s a 410 basis point improvement in operating expense leverage. The $9.0 million increase in year-over-year operating expense dollars includes approximately $6 million in unfavorable currency translation effects as compared to the prior year and $3 million from net acquisitions completed within the past 12 months.

The Other category, which includes the Coalesse Group, PolyVision and IDO reported revenue of $148.9 million in the quarter or a 1.2% increase compared to the prior year. The increase in revenue reflects growth within the Coalesse Group and at IDO, offset in part by a decrease in revenue at PolyVision driven by our decision to exit a portion of the public bid contractor whiteboard fabrication business, where profit margins are the lowest.

Operating income excluding restructuring costs for the Other category was $4.7 million or 3.2% of sales compared to $6.2 million or 4.2% of sales in the prior year. While these results reflect a marked improvement for the Coalesse Group compared to the first quarter operating loss, they nevertheless continue to lag prior year performance, primarily due to inefficiencies associated with the consolidation of manufacturing activities announced in March of this year and operating expense investments related to the launch of the Coalesse brand and a number of new products which we previewed at Neocon. PolyVision results continue to improve despite lower sales.

Now I will review our outlook for the third quarter of fiscal 2009. Overall we expect revenue to be within a range of $840 to $875 million compared to $886 million in the prior year. This projected range takes into consideration the following factors:

First, based on exchange rates at the end of the second quarter, our third quarter revenue estimates do not contemplate any significant currency translation effects compared to the prior year. This is a dramatic swing versus the last several quarters, wherein currency has increased our top line by more than $20 million compared to prior year periods.

Second, we expect the negative impact of dispositions completed within the past 12 months to nearly offset the positive effect of acquisitions completed in the same period.

Third, North America revenue estimates in the third quarter are based on a challenging financial services sector across our industry, growing economic uncertainty in the U.S. and a strong comparable period last year, wherein North America revenue grew nearly 10% compared to the previous year. In addition, orders thus far in the third quarter, adjusted for the estimated pull-forward effect of the September 1st surcharge, are tracking somewhat lower than the prior year. Therefore, we are currently estimating North America organic revenue to decline in the third quarter by low to mid single digits.

Fourth, International revenue in the third quarter is expected to benefit from a relatively strong beginning backlog and continued order growth in total orders, resulting in an estimated organic growth rate in the mid single digits.

As you know, we are in the midst of implementing the strategic actions we announced in March. As a result, the operational inefficiencies we experienced in the first and second quarter associated with the facility rationalizations are expected to continue until these actions are completed during the third quarter. In addition, commodity inflation is estimated to increase our global costs in the third quarter by another $15 to $20 million compared to the prior year.

While we have implemented a commodity surcharge on orders placed after September 1st in the U.S. in addition to second quarter list price adjustments around the world, it will take several quarters, as you know, to realize the full impact of these pricing actions and therefore they will only begin to offset some of this inflationary impact in the third quarter.

We expect reported earnings per share for the third quarter will be in the range of $0.16 to $0.21 per share, including after-tax restructuring costs of approximately $6 million. We reported earnings of $0.22 per share in the third quarter of the prior year, including goodwill and intangible asset impairments, which after the reduction of related variable compensation expense and income taxes, reduced net income by $11.3 million.

Regarding the overall U.S. economy and the spillover effects around the globe, we, like you, continue to wonder what the full extent of the economic environment will bear on our industry. While we estimate the financial services sector will continue to be negatively impacted for the next several quarters, we also believe our revenue diversification strategies will allow us to continue growing in other geographic, vertical and customer segments of our business.

With the economic uncertainty, we plan to behave conservatively, maintaining the strength of our balance sheet and modestly building cash levels over the next couple quarters. At the same time, we will behave aggressively toward implementing our announced restructuring actions and improving our operating income margin. We will continue, as well, to invest in longer-term growth initiatives related to the expansion into vertical and emerging markets, the strengthening of our brands around the world, and new product development in our core markets, as evidenced by the significant portfolio of new products and solutions we introduced at Neocon.

In the end, we don’t know how long the economic climate in the U.S. will remain uncertain or the extent of the spillover effect around the globe, but what we do know is that Steelcase will continue to modernize its industrial system and product offering, improve its fitness across front-end business process, and invest in strategies we believe will serve to strengthen our global leadership position in this industry.

Now we’ll turn it over for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Budd Bugatch – Raymond James.

Budd Bugatch – Raymond James

On the revenue guidance, as I do the math on versus last year, I get to the high end of guidance pretty simply, but to get to the low end, the $840 million piece, I can’t quite get there unless I take something fairly significantly out of the Other classification. What am I missing, Dave, if you can help me there? I used like $475 for North America, $240 for International and that gets me to $715 may and then to get to – if you just assume flat for Other, that gets you to like $870.

Dave Sylvester

Yes, I’m not sure what you used in the North America revenue guidance, whether you used low or mid.

Budd Bugatch – Raymond James

I used 5% as a reduction versus the $500 million last year.

Dave Sylvester

The other factor is the fact that times are quite uncertain right now in North America in particular. On the Other category specifically, you’re right. I mean, you can plug to a decline there. It’s not anything too dramatic, and I would expect it will continue to be more of the same that we’ve been experiencing, so some decline in PolyVision offset by some potential increases elsewhere.

Budd Bugatch – Raymond James

Yes, Coalesse should grow as well in Other, correct?

Dave Sylvester

Yes. I don’t know if I want to pin it down to that exact level, but we don’t see Coalesse going back to the first quarter or anything like that.

Budd Bugatch – Raymond James

Could you give us a little help maybe on health care and maybe quantify what that grew in the quarter and how that’s doing?

Dave Sylvester

It continues to grow nicely. It didn’t grow at the high end of double digits this quarter like it had in the last couple of quarters, but we feel quite good about where it continues to progress. So I wouldn’t look at this quarter as, you know, of lower single-digit growth rates as any kind of indicator that things are softening.

Budd Bugatch – Raymond James

And when you went over International, did you give strength in declining order when you started with German down to Australia?

Dave Sylvester

Yes. You know that’s our typical pattern, that we’ll reference the most significant contributor first down to the least significant.


Your next question comes from Matthew McCall – BB&T Capital Markets.

Matthew McCall – BB&T Capital Markets

So it sounded like you’re still seeing net inflation over the pricing actions that you’ve taken, both the list price increase and the surcharge. If I just subtract the stated inflationary pressure and assume that you’re not offsetting any of that in price, it looks like there would have been about an 8% operating margin without that $15 to $20 million of pressure, just taking that midpoint.

So I guess this question’s more about the restructuring benefits and how much have you recognized. Are you yet to see benefits, because it sounds like there’s still some inefficiencies that you’re facing, and how should those start to play out as we move through the year?

Dave Sylvester

As of restructuring, I’ll start and then maybe Mark Baker will add a little bit of color. But I would tell you in the restructuring, the lion’s share of the benefits have not accrued yet. We’ve seen some modest benefits as we took out some headcount in manufacturing early and we’ve already started to see some benefits of the white-collar reinvention initiatives that we launched. But the lion’s share of those benefits will really start to accrue at the end of the third quarter, early in the fourth quarter as the plant closures are finalized.

Matthew McCall – BB&T Capital Markets

So you’re seeing benefits above the inefficiencies or the inefficiencies are kind of offsetting those in the near term?

Dave Sylvester

No, in the second quarter call, it may be a push. The inefficiencies are a little higher than the benefit. But they come in different spots, right? We’ve got efficiencies in the Other category, and if anything, the benefits are probably in North America.

Mark Baker

And on the inflation side, there’s no question that we continue to still feel a lot of pressure there. And as you described, the pricing actions we took, which included a list price increase in July and then a further surcharge effective the beginning of September, it’s just taking a little bit of time to work through because we’ve got some customers that have contractual situations where we’ve got some periods of time where their older prices maybe held for a little bit of time. But I think we believe that by the fourth quarter we’ll start to see the impact of those price increases that we described.

Matthew McCall – BB&T Capital Markets

The SG&A line, a pleasant surprise this quarter. As a percent of sales, how should we start to look at your SG&A line going forward? Nice improvement, both sequentially and year-over-year. Is this kind of a – you talked about being cautious in this environment. Is this kind of a number that we should look at going forward or how shall we look at that line?

Dave Sylvester

Well, that’s obviously dependent on the top line. How’s that? It was very strong this quarter and that certainly contributed, but we’re working hard to contain our costs. I’ll tell you, we’re working hard to also protect the growth initiatives. We’re trying to shrink and grow, so shrink in the non-strategic areas and to continue to invest back in our growth initiatives.

So depending on how the top line behaves, we could see SG&A as a percent of revenue move around a little bit for the next few quarters.

Jim Hackett

In fact, Matt, we stare back to the last recession. There was a lot of actions taken. And when you look at the growth in our sales from 2003 and the resulting expense changes from that period, most of the growth is in our innovation spending and in bonus payments. And so I’m really proud of the fact that the productivity really grew as far as it did.

However, that’s not, you know, it’s not good enough given the nature of what I continue to describe as the flat world kind of pressures, and I want to emphasize that this reinvention that we’ve talked about over a few quarters is intended to improve that. And so I don’t want you leaving the call thinking that we’re not really intent on being more aggressive in that line. We are. And we’ve been very good about managing its growth.

Matthew McCall – BB&T Capital Markets

Has it become more of a variable? Can you maybe break out the variability of that line versus maybe the last downturn? Have you changed the structure of your overall expense structure?

Dave Sylvester

Yes. Not dramatically, though, Matt. I mean, we still have the bonuses being the largest variable component, and then certain selling expenses are variable. But by and large, it’s relatively fixed. This is just good cost containment relative to the sales growth.

Matthew McCall – BB&T Capital Markets

You mentioned the pull forward of some orders. Any quantification of the pull forward of those orders ahead of that surcharge?

Dave Sylvester

No, the only thing I’ll tell you, Matt, is September 1st fell right at the quarter end. So the few days before the September 1st effective date of the surcharge it pulled forward and then the week after was a little bit light. So we just tried to neutralize that in the color that we gave on North America orders thus far in September.


Your next question comes from [Peter Walstrum] – Unidentified Firm.

Peter Walstrum – Unidentified Firm

Can you speak to Steelcase’s core North American business, certainly given the quarterly results, which were solid, and a little bit more of a cautious outlook potentially as it relates looking in 2009 and BIFMA? There are a lot of different moving parts. Could you just help us kind of think about this? And is revenue down year-over-year for ’09 a realistic view?

Jim Hackett

Well, I would say, Peter, the objects in your mirror are further than they appear, to have a play on words in that. In other words, in looking ahead, I am certain that all the structural things that we’re doing, all the strategic things we’re doing, are going to play well over time.

Now you put that on top of the shifting sands with the news in the last three weeks, you know, pick your forecast. It’s a hard problem. What we’ve designed is a different business that can go through that, and not only is it diversified geographically and with different vertical markets, but there is a higher variable cost structure in the back end of the business than there was the last time.

So, you know, I’m not trying to be cute. I think to try and project ’09 performance on this call is just not going to be sound thinking at this point.

But you know, Peter, too, that our typical timing is we go through our strategic planning update in the fall, and then in December what we do is give not a next-year guidance on the top line, but we give more of longer-term goals around operating income and then color behind that.

Peter Walstrum – Unidentified Firm

Maybe diving down into one of the sectors more specifically, from a financial services perspective, you’re set to anniversary some of those declines as you head into the fourth quarter based on customer visits or order patterns or even some dealer commentary. Are you incrementally more cautious or confident than you were a few months ago, and therefore have you also seen this financial service weakness spreading to other sectors?

Jim Hackett

Peter, I’ll let Terry cover that, Terry Linhardt. He leads Finance for North America and has obviously been studying the trends quite closely.

Terry Linhardt

Let me talk essentially more to third quarter coming up. As Jim mentioned earlier in his introduction, we’ve been working to diversify our business for quite awhile, and today our business is much more diversified than it was a few years ago. For example, International sales are [something over] 3% of our total sales, and we’re much less dependent on large corporate customers in North America.

And if you drill down within the North America market, while financial services remain important to us, we have continued to grow within a number of other vertical markets, including headcount, higher ed, government and technical professional, and it makes us much more balanced and less dependent than we were on any one vertical market just a few years ago.

But, you know, as you’d expect, we’ve kept a very close eye on the financial services sector, so within this segment, our clients have been very cautious for quite awhile. As you mentioned, we’re hitting on almost a one-year anniversary. Overall day-to-day business has remained steady, but it’s the incoming project orders that have been down significantly now for almost the past three quarters.

Many of the financial firms you’ve seen in the news over the past couple of weeks are clients of ours, and they began pulling back months ago just at about the same rate as the rest of the sector.

And as a side note, if you think about their recent merger activity, generally speaking, either both sides of the transactions are clients of ours or the surviving entities are clients, which may provide us some mid to longer-term opportunities.

But in the short run, our third quarter forecast assumes continued weak project business in this sector in general and for the companies in the news in particular, and this compares to a prior year quarter, prior year third quarter, where project sales in financial services were very strong. So that’s a big reason why we’re forecasting a third quarter decrease in sales for the North America segment versus prior year.

And then related to all that, regarding accounts receivable, we don’t believe that we currently have any significant receivable exposure to the companies in the news. Now, of course, our ongoing intention going forward is to stay close to our customers and their activities during these times to help them be more effective and efficient in how they think about their spaces as they adjust to the new business models.

So when you think about the incoming, the incoming did start coming down last year in mid to late October, so it really didn’t affect our sales until the fourth quarter. So once we get through this third quarter, we will be hitting on a oneyear anniversary of the pretty significant decline in financial project business.

Peter Walstrum – Unidentified Firm

And not to end on a downer, certainly, so which sort of verticals and/or categories have been exceeding expectations given the challenging environment? I know that you listed off energy in particular, but are there some other areas where you’ve really seen kind of an uptick above your initial expectations?

Terry Linhardt

Yes. If you think about a longer-term basis, we’ve seen a nice, continued, consistent uptick in health care and in education and total government, if you take federal and state and local. And then, of course, energy’s been a good sector for us, although smaller than the others, and that’s seen a good uptick over this past 12 months as well.

Peter Walstrum – Unidentified Firm

And quickly just on the order patterns from an international perspective, I know that you mentioned that you had a large project that came in at the end of the quarter. Are you seeing some of the large projects internationally or are those more – or revenues coming from the day-to-day and smaller project sales?

Jim Hackett

I’d tell you that generally it remains pretty balanced. We just had a couple of very large orders come in late in the quarter that I was referencing. You know, if you go to France and Spain and Japan, it’s pretty soft still, but that’s not to say that it’s continuing to erode. There still are some projects out there. It’s not like the financial service sector in North America. It’s just still a little bit soft.

Peter Walstrum – Unidentified Firm

And finally, you mentioned that you have about $220 million under the repurchase authorization and with cash down at the, let’s say, $120 million range, has the company reached a point where it would look to build up cash on the balance sheet instead of investing in further share repurchases?

Jim Hackett

Well, you know, I said in my closing comments that we’re going to modestly build cash right now. That doesn’t mean that we’re going to turn share repurchases off entirely, but we’re going to modestly build cash because frankly, there could be some opportunities that present themselves for us to reinvest back in the business, and that’s always our first goal. And in times like these, you start to see some things that weren’t an opportunity before present themselves as an opportunity today, and we’d like to be able to take advantage of them quickly, if possible.


Your next question comes from Todd A. Schwartzman – Sidoti & Company, LLC.

Todd A. Schwartzman – Sidoti & Company, LLC

First, could you break out or allocate perhaps the total commodity surcharge by energy, steel and some other inputs that necessitated the surcharge?

Jim Hackett

No, we have not broken out any details in the past, and we don’t want to start doing that today. You can imagine there the big driver is steel but, you know, fuel and other energy are also contributors, plastics. It is a broad commodity surcharge.

Todd A. Schwartzman – Sidoti & Company, LLC

And on the International side of the business, I’m curious about the customer categories that are doing well. Was it roughly similar to North America or is something else going on there?

Jim Hackett

I would say similar, but no distinct pattern to speak of. I mean, energy continues to be a nice contributor in various markets. Plus we would say that the government in those markets are stronger, and it’s not as concentrated a financial sector as it is here in North America.

Todd A. Schwartzman – Sidoti & Company, LLC

Could you speak to specific regions or countries that are not living up to your expectations right now internationally?

Jim Hackett

Well, we want to be careful about that, just for competitive reasons. But I would say to you there’s a rigorous assessment of that and what we have found is that if we can combine a couple of elements that have proven success, that would be products that build off platforms that have been altered for an environment, good distribution, and then some of our core customers that transfer around the world and into those markets, those three things coming together usually mean those markets are the strongest for us. There have been some outlying markets that none of that has happened and so, you know, we work hard to get it the other way.

I’d also suggest to you that geographically, we’ve talked in previous calls, that the promise is in Asia and it still is like that. I mean, we believe that Asia, particularly India and China, of course, continue to grow. The challenge there, of course, is these variables I mentioned in the first comments. It’s getting the distribution right, getting the products on platforms designed for those markets. But we’ve got a big head start in that region, so it’s not like we’re just beginning there. We’ve got some experience there, plus our experience of growing in Western Europe. I think that the prospects in Asia are very strong.

Todd A. Schwartzman – Sidoti & Company, LLC

And back in North America for just a moment, are there any signs that the financial service sector weakness in New York has spilled over a bit to other customer categories, or just in general how are the non-financial customers in the New York region holding up in this environment?

Jim Hackett

Well, generally pretty flat. You know, I would tell you that there is no other sector that is performing in any kind of way similar to the financial services sector. To sit here and say that there’s been no spillover effect, though, I think could be misleading. But generally, I mean, we had increases in the sectors I referenced, and in the ones that I didn’t reference, they were either flat or slightly down outside of financial services.


Your next question comes from Budd Bugatch – Raymond James.

Budd Bugatch – Raymond James

Just again looking – don’t want to harp on the guidance. I guess I do want to harp on the guidance, actually, and I want to look at kind of what you get when you drill down into the operating expense and the gross margin or cost of sales, the frame of my question is, in your third quarter guidance, was your thinking that the inflation impact would actually be higher, the gross margin would be impacted more in terms of year-over-year negatively than it was in the second quarter? I think it was down about 167 basis points in the second quarter, if I remember right. Is it higher in the third quarter? Did that impact more?

Jim Hackett

Let me, Budd, go back to last year. The third quarter was exceptional, right? North America grew at almost 10%. International had a strong quarter. So of course we had some volume leverage coming from those results that we’re not seeing this quarter, this coming quarter.

Budd Bugatch – Raymond James

I was just trying to make sure I understood where your thinking was because you should have some continued gains from our operating expense control, right, in the third quarter over last year? You’ve had some things that you’ve done. You’ve maintained good cost control this quarter, you showed.

Jim Hackett

From an absolute dollar perspective, for sure. But again, you know, don’t underestimate that leverage that we saw from the sales growth.

Budd Bugatch – Raymond James

Yes, that deleveraging impact of lower sales.


Your next question comes from [Margot Murtoch] – Unidentified Firm.

Margot Murtoch – Unidentified Firm

I was wondering how your orders are going for your new products and when you would be starting to ship some of those. And also you mentioned early in the call something about some government business that is coming but hadn’t been booked. Could you go over that?

Dave Sylvester

Sure, I’ll start and then maybe Jim can jump in. The orders on the new products, I would tell you, are just starting with respect to the Coalesse Group. In the Steelcase Group, with respect to Mediascape and Seascape and the cobi chair and some of the Nurture new products, those are in pre-sell mode or will be starting pre-sell soon and order entry, I believe, starts in the first quarter of next year or late in the fourth quarter. But interest remains quite high and we remain quite excited about their launch.

And the government reference that Jim had in his opening remarks, we really can’t get into any more detail until we get the green light from the government with respect to clearing any kind of press release. But it was a significant win for us. We feel very good about it. And it demonstrates our commitment to continue to diversity the top line.


Thank you. There are no further questions in queue.

Jim Hackett

Okay, thank you. Can I just summarize by saying we really had a great quarter and we’ve worked hard and the results prove that things are on the right track in a number of areas. I want to emphasize that.

The second thing is, I believe I said it a few times today, the company’s in a good position to handle adversity, whether it comes from the sector kind of pressures we’ve discussed, whether it comes from the nature of a recession that I’m not forecasting, but if something in 2009 presented itself, I think we’re in a strong position to manage through that.

And then finally I believe that the initiatives that we’re taking for the future, without regard to the tumultuous times, are and have been about us becoming ever more fit, and I’m delighted with the progress that we’ve been able to describe there.

So it’s time for a little optimism and for us to all believe that the news today taken in the government’s actions are going to get us back into good shape. So I’m hopeful that we can all share that and kind of pass the word.

Thanks for your attention today.

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