Steelcase Inc (SCS) 2022 Q3 法說會逐字稿

Good morning. My name is Dexter, and I will be your conference operator today. At this time, I would like to welcome everyone to the Steelcase Third Quarter Fiscal 2022 Conference Call. (Operator Instructions)

Thank you, Mr. O'Meara, you may begin your conference.

Thank you, Dexter. Good morning, everyone, and happy holidays. Thank you for joining us for the recap of our third quarter fiscal 2022 financial results. Here with me today are Sara Armbruster, our President and Chief Executive Officer; and Dave Sylvester, our Senior Vice President and Chief Financial Officer. Our third quarter earnings release, which crossed the wires yesterday, is accessible on our website. This conference call is being webcast and this webcast is a copyrighted production of Steelcase Inc. A replay of this webcast will be posted to ir.steelcase.com later today.

Our discussion today may include references to non-GAAP financial measures and forward-looking statements. Reconciliations to the most comparable GAAP measures and details regarding the risks associated with the use of forward-looking statements are included in our earnings release, and we are incorporating by reference into this conference call the text of our safe harbor statement included in the release.

Following our prepared remarks, we will respond to questions from investors and analysts. I will now turn the call over to our President and Chief Executive Officer, Sara Armbruster.

Thanks, Mike, and good morning, everyone. With my time today, I'll share a summary of our third quarter financial results and then provide an update on our strategic priorities, before handing the call over to Dave to discuss our results in more detail. Our third quarter results saw very strong order growth, but we continue to be impacted by a significant number of supply chain challenges and inflationary costs in our Americas segment, which impacted our results.

Our order growth of 40% was broad-based across all segments, including in all of our main geographic markets and across

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markets. Similar to last quarter, several parts of our business approached or exceeded pre-pandemic order levels in our third quarter. Specifically, orders at Smith System, AMQ and in our Asia Pacific region were all higher than in the same period in FY '20. And orders in our EMEA segment were within 6% for the third quarter of fiscal '20 levels. These businesses have been a key part of our growth strategy, and it's good to see that growth materialize. I'm really proud of how our teams have remained hyper-focused on keeping our commitments and delivering results in these areas.

It's this kind of dedication that gives me confidence as we look to implement our broader growth strategies going forward. Unfortunately, and similar to last quarter, due to ongoing supply chain challenges, we did not ship everything we'd expected to ship in the third quarter, which caused more of our revenue to shift out of the quarter than we'd anticipated.

Labor and raw material shortages are impacting some of our suppliers, ocean freight continues to be challenged by availability and port congestion as we continue to experience trucking availability and other logistical challenges. These issues are causing extended lead times, production delays and adjustments to delivery schedules. We know supply chain issues are impacting many industries, including ours, and our teams are working every day to overcome these challenges and meet our customer commitments.

Our operations teams have been pursuing numerous actions of these challenges, including sourcing more products locally, transitioning to new suppliers, utilizing overtime to stay on schedule, increasing inventory levels as buffers and utilizing expedited freights to compensate for transportation delays. And we have not experienced any significant change in our order or project pipeline cancellation levels as these issues are impacting our industry more broadly.

So although our revenue was below our expectations for the quarter, our strong order growth supports our confidence in the recovery. And that confidence is bolstered by our aspiration to help people do their best work by creating places that work better. We believe work is going through one of the most significant transitions in our lifetime and solving for what people want and need to thrive at work remains a rich source of opportunity. So that's why our strategy remains centered on work.

And as I talk with CEOs and business leaders, they resoundingly continue to express a broad desire to bring employees together in person to strengthen their culture, support learning, assimilate new employees and offer more inclusive career experiences. So while return-to-office plans vary from company to company, they almost without exception, involve some aspect of hybrid work, and we believe that provides incredible opportunities for Steelcase.

As decision-makers visit our work-life centers and talk with our researchers and designers, they're hungry for our insights and looking for help in navigating how to make hybrid work. And for most, that answer will involve changing and reequipping the office. It will require new ways of supporting privacy, rethinking of how to support individual places to rebuild social connections and new kinds of spaces that bring people together to collaborate and innovate even if those people aren't co-located. We believe all of this translates into a long-term growth opportunity for us because no matter what an organization's workplace strategy is, they'll need help to manage the shift in work.

So we remain optimistic that as the pandemic recedes and COVID becomes endemic, companies will do two things: ask their employees to spend time in the office and make significant changes in their current office environments to support hybrid work, which we believe will drive further stimulation in demand.

As we look ahead to how we're planning to drive growth in the future, we're focused on 4 overarching strategies. First, as I mentioned, we believe we are best positioned to lead the hybrid work transformation, and this is a top priority. We plan to leverage our insights and our hybrid work to drive innovation and to advise our customers.

We're very excited about recent product introductions that support how people work now, such as our [Flex Personal Workstation] and the [Flex Work Wall] plus new Pod products from Orangebox. We're also collaborating with leading technology companies such as Microsoft and Zoom about how to integrate digital solutions more optimally into physical spaces as more of us are working in mixed presence modes. Partnering with other industry leaders remains a part of our innovation process and allows us to move quickly and build on each other's insights and solutions to deliver value for our customers.

We've also increased our investment to drive our work from home business through new products, enhanced digital experiences and increased capabilities such as speed of delivery.

We also see opportunities to grow by deepening our presence in key adjacencies, which is a second priority. Many of our enterprise customers value Steelcase for the depth and the solutions and service we provide, but we believe we can also serve customers that desire speed and simplicity.

We are seeing great growth in our AMQ business, which we acquired in part due to its quick delivery capability. So we're leveraging learnings from AMQ and applying those learnings to our other brands. We're also expanding new relationships geared towards small and medium businesses. And with West Elm, for example, we're working on efforts to build on our successful retail relationship.

In Asia Pacific, our presence has continued to deepen to serve a broader customer base, and we believe we will continue to drive outsized growth in our largest APAC markets of China and India. We've also built on the success of our Smith System business in the Americas and use that momentum to grow our education business significantly in Asia. And we'd like to expand our education business even more broadly geographically.

Our third priority is to continue creating value by using our business as a force for good, preserving the planet, empowering people and running our business with integrity and empathy, are core to who we are. And those values have never been more integrated into how we do business than they are today with our customers, how we design and manufacture our products and how we attract and engage our employees. We've met our goal to become carbon neutral and we're continuing to work toward our goal of a 50% reduction in emissions from Steelcase owned and controlled facilities by 2030, using third-party verified science-based targets.

Lastly, we are keenly focused on accelerating our profitability trajectory. We've implemented several recent pricing actions in response to the current inflationary headwinds. We've controlled our operating expenses, and we've seen strong order growth while we work to overcome supply chain challenges. We have a long-standing focus on fitness, which we think of as the organizational capacity to deliver outsized results relative to our cost structure, and we plan to continue to vigorously reallocate resources and investments toward our highest priorities as well as to expand our organizational capacity to achieve results.

We are seeing strong interest from organizations around the globe to redesign and equip their offices as they tackle the new needs demanded by the transition to hybrid work. So while there are still challenges that lie ahead, this intense interest in work, combined with our talented, committed organization and our focus on growth gives us optimism as we move into the new year. We're feeling the pulse of change and believe our long-term results will reflect our optimism.

I'd now like to turn it over to Dave to cover the financials and our outlook for Q4.

Thank you, Sara, and good morning, everyone.

My comments today will cover our third quarter results in comparison to the outlook we provided in September, the sequential comparisons to the second quarter and some notable comparisons to fiscal 2020 before the pandemic. I will also cover the balance sheet and cash flow and our outlook for the fourth quarter. As Sara said, our performance in the quarter was negatively impacted by supply chain disruptions, and I'll talk more about that in a few minutes. But first, I want to highlight a few other areas of our business and performance that were more directly within our control, as we feel quite good about these areas of our business. And overall, we remain optimistic about our prospects next year.

We posted year-over-year organic order growth of 40% in Q3, which included 36% growth in the Americas with strong growth in every regional market. 31% growth in EMEA with order levels nearing fiscal year 2020 levels and exceptional growth of over 125% in our Asia Pacific region, with the region's orders exceeding third quarter fiscal 2020 levels by over 40%.

Our research and new products are resonating with customers. We are pleased with the growth of our recent acquisitions, EMEA is benefiting from achieving the growth objectives included in our turnaround strategy and our investments in Asia Pacific are also paying off.

Our EMEA segment achieved over $8 million of operating income and nearly a 5% operating margin in the third quarter, which exceeded its highest level of quarterly

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in fiscal 2020, and is confirmation that our strategies to improve profitability in that segment are working.

Our sales organization is working diligently to negotiate the contractual adoption of our recent pricing actions, and we are beginning to see increasing yield from their efforts, which supports our belief that price yield will offset current levels of inflation in fiscal 2023.

Our operations teams have remained resilient in the face of mounting supply chain challenges. Sara summarized the long list of actions they've implemented in response to this dynamic environment. But for every challenge resolved, new challenges seem to arise and yet they remain resilient and continue to meet customer commitments at a high rate. Our performance isn't quite at the level we expect, but we hear from customers and dealers that we're performing consistent with or better than other industry suppliers.

We introduced several award-winning new products in the third quarter despite significant reductions in spending since the start of the pandemic, and we continue to closely manage operating expenses overall, which kept our rate of spending relatively low and below our estimates again this quarter. We won several large multiyear contracts in the Americas during the quarter, and our win rates remain strong in EMEA and Asia Pacific, which further

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the solutions our customers need.

And lastly, customer visits increased compared to the prior year and approximated pre-pandemic levels. In addition, an increasing percentage of the visits were in-person and included senior executives who are interested in our research and hybrid model experiences.

While we're pleased with our strong performance in these areas, the impact of supply chain challenges on our performance in the third quarter was both significant and higher than our expectations.

For revenue, the supply chain disruptions in the Americas caused extended lead times, delayed shipments and adjustments to delivery schedules, which we estimate caused at least $35 million of shipments to ship from the third quarter into the fourth quarter. As a result of those delays and the stronger order growth in the quarter, our backlog increased significantly by the end of the third quarter, which I'll address in more detail when I cover our outlook.

You'll remember, we estimated at least $40 million of shipments shifted from the second quarter into the third quarter, leading to a strong beginning backlog in the Americas. That shift was split fairly evenly between Smith System and the rest of our business in the Americas. And while shipments at Smith System largely caught up in the third quarter, we estimate that shipment delays in the rest of our Americas business increased sequentially by at least $15 million.

Despite the lower-than-expected revenue, our earnings for the third quarter were within the range we forecasted in September due to lower-than-expected operating expenses and more favorable than expected gross margins in EMEA and the other category, driven primarily by higher revenue in those segments and favorable shifts in business mix.

Gross margin in the Americas was negatively impacted by the lower revenue and higher-than-expected inflation net of pricing and supply chain disruption costs. We incurred approximately $27 million of higher net inflation and approximately $10 million of higher freight costs and inefficiencies associated with the supply chain disruptions in the Americas compared to the prior year. If not for the year-over-year impact of the net inflation and the supply chain disruption costs, we estimate that our earnings would have been 3x higher this quarter.

Moving on to the sequential comparison of the third quarter results versus the second quarter, operating income of $16 million in the third quarter represented a sequential of $18 million, driven by a $34 million decrease in the Americas partially offset by stronger performance in the EMEA and the other categories which generated a combined increase in operating income of $16 million.

The decline in the Americas was driven by $17 million of gains recorded in the second quarter related to a land sale and small investment; a decrease in revenue driven by typical seasonality at Smith System; an increase in inflation net of pricing benefits of approximately $8 million and higher freight and labor costs and inefficiencies associated with the supply chain disruptions of approximately $7 million.

The results in EMEA and the other category reflected improving demand trends across most markets, favorable business mix and strong operational performance, leading to favorable gross margins.

As it relates to cash flow and the balance sheet, we ended the quarter with $275 million in cash and $445 million in total liquidity. Operating cash flow reflected a $39 million increase in working capital, a $19 million payment of prior year FICA taxes that were deferred under the CARES Act and higher customer deposits. Investing activities included our acquisition of Viccarbe and $14 million of capital expenditures. We returned $40 million to shareholders during Q3 through our quarterly dividend of $0.145 per share and the repurchase of additional shares under a 10b5-1 program which was completed on November 30.

Under this program, we repurchased 3.7 million shares, 1.9 million in the second quarter, 1.7 million in the third quarter, and the remainder in the first week of the fourth quarter.

Moving to the outlook for the fourth quarter. We expect to report revenue within a range of $740 million to $765 million, which is approximately 0% to 4% higher than the revenue we reported in the third quarter. And on an organic basis, approximately 9% to 13% growth compared to the prior year, which you'll remember benefited from the temporary global operation shutdown which pushed approximately $60 million of shipments into the fourth quarter.

We expect the sequential and year-over-year increases in revenue to be impacted by the following additional factors: First, our consolidated backlog at the end of the third quarter was approximately $800 million, which was 47% higher than the prior year and 13% or approximately $90 million higher than at the end of the second quarter on an organic basis. Also, more than 20% of our backlog is scheduled to ship after the end of the fourth quarter, which while similar to the third quarter, is higher than historical patterns.

Second, we expect double-digit percentage year-over-year order growth in the fourth quarter. On a sequential basis, orders are expected to decline consistent with typical seasonal patterns as return-to-office-projections remain uncertain.

Third, we expect continued global supply chain disruptions to negatively impact our order fulfillment patterns similar to the third quarter.

We expect earnings to approximate breakeven, which includes our expectations of gross margin in the range of 26.5% to 27%, including projected inflation net of pricing benefits of approximately $20 million compared to the prior year driven by the Americas as EMEA is projected to fully offset inflation through pricing actions; continued supply chain challenges and related disruption costs similar to our higher -- similar to or higher than the level experienced in the third quarter; unfavorable shifts in business mix compared to the third quarter; the lower production and absorption of our fixed cost due to the significant level of finished goods inventory at the end of Q3; the continued effects of supply chain disruptions and some seasonality in Q4.

Operating expenses are projected to fall within a range of $193 million to $198 million, including the recent Viccarbe acquisition and related intangible asset amortization. And we expect interest expense, investment income and other income net to approximate $5 million in total.

Looking forward to fiscal 2023, while it's difficult to predict the extent to which commodity price increases will moderate and when supply chain challenges could ease, the prospects for next year could include the potential for improved demand driven by a broader return to office and significant gross margin improvements from our pricing actions and some level of improvement in supply chain disruptions. And while we plan to

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spending and investments in our strategy, we remain focused on fitness across our business model aimed at improving our operating expense leverage.

In closing, supply chain disruptions and commodity cost inflation continued to be significant and negatively impacted our revenue and gross margin performance in the third quarter. We remain pleased with our recent orders, our ability to tightly manage costs and the strong performance of our EMEA segment, which provides [evidence as to how our] strategies are working.

And as we expect to see benefits from our pricing actions, potential improvements in supply chains and a broader return to office in the coming months, we remain confident in the recovery of our industry and the prospects for significant improvement in our fiscal 2023 earnings. From there, I'll turn it over for questions.

(Operator Instructions)

Your first question comes from the line of Reuben Garner with Benchmark Company.

But the customer-delayed deliveries, 2-part question. One, what were the reasons cited? Is this because of a delay in the return to the office? Or is it construction, supply chain issues that are pushing it out? And then number two, it looks like you've got more finished goods inventory. So for those customers that did push it out, is there any way for you guys to kind of maybe adjust to this moving forward so that you're -- you obviously have limited materials, limited labor available so that you can, I guess, focus efforts on the customers that will definitely be ready? Or is this like something that you can't predict and adapt to?

Well, let me start with the first part of your question around the delays that were driven by customers. First, I would say that the delayed revenue was driven by a number of factors, and the biggest factor was related to our supply chains, both domestic and long-distance supply chains that is linked to port congestion as well. That was the bigger driver.

But in addition to that, we also have -- have been experiencing a higher rate of what we refer to internally as push out. And what that is, is where backlog gets rescheduled. And we're seeing a higher level, which is coming from our customers, and we believe that it's driven by challenges to complete sites for the readiness of them to accept the products. That could be because of installation challenges. It could be because the project or the construction isn't fully complete or they just don't want it right now because they have pushed back their returned to office. It could be all of those things. We just don't have that intel behind what's driving it. But it was the smaller piece. The larger piece was driven by the supply chain challenges.

Does that answer the first part of your question?

Yes, it does, Dave. And the second part -- well, I'll let you go ahead, but I think I got it based on the first answer.

Well, maybe clarify what more you'd like to hear in the second part.

I'm just curious if there's any way to -- I mean you've -- your backlog is rising even faster than orders and the supply chain is an issue, but you have inventory on hand. So is there any way to kind of, I guess, confirm customers are ready before you guys focus? Or are these things just going to happen in this environment, there's no way to kind of improve on the where you focus your efforts?

Well, I would say, yes, of course, and our operations teams and our order fulfillment teams do that every day, and they're working even more extensively trying to confirm that customers are ready. They're also looking for any opportunity that exists where we can pull things forward. And they're in addition, trying to build ahead as much as possible.

We don't have a tremendous amount of capacity inside of our regional distribution centers. But with the lower level of volume that we've experienced from the pandemic, we do have some capacity. So if we can build ahead, if our suppliers and supply chain can support us and we can build ahead, that can be a good thing and provide some cushion as demand continues to grow with return-to-office. So I'm confident that the operations side of the business is doing everything possible to try to drive efficiencies, pull demand ahead where possible and only make stuff and ready delivery for customers that are ready to accept it.

But it's quite an uncertain environment out there today, not only affecting us and our manufacturing and fulfillment model, but our industry, broader industries and certainly our customer base as well.

Okay. Perfect. And then on the backlog, can you talk about the profitability of what you have in backlog and I guess how that might be impacted if we do see a rollover in steel or other inputs?

If transportation rolls over, would that improve the profitability that you have? Or would it be too late? And then I guess, conversely, if we see further inflation, does that put that product at risk? And I guess, is there a point where your backlog gets too big that you guys maybe don't take as many orders as you otherwise would?

I'll take as much backlog as I can get, and I think everyone else in the company would do the same thing. Now whether or not we can deliver it in the relatively short period of time could be challenged by the supply chains.

But you asked about the profitability of backlog. Remember, the backlog shifts relatively fast. This quarter, similar to last quarter, we have about 20% of the backlog that is scheduled for delivery beyond 90 days. We always have a little bit of that, but 20% is higher than what we typically see. So first of all, it's going to shift pretty quickly. So I don't know whether steel prices, which moderated for the first time in many months in November, I don't know whether we'll see the benefits of any of that moderation fast enough to affect the profitability of our backlog.

The other comment I'll make about the backlog, though, is some of these projects that are in backlog that have finally been ordered were projects that were quoted in one, quarters ago. And so yes, the profitability is a little bit lower, which is why -- one of the reasons why we guided to the level of gross margins in the fourth quarter that we did because we have a shift in business mix that in part is attributable to profitability and backlog.

Great. And last one for me. We talked about the way the pricing works in the contract industry a lot in recent months. Since you last reported, there's been a couple of players in the industry that have made a little bit different moves, and I wanted to get an update on your philosophy. We heard one implemented a surcharge and another is I think, putting out a price increase that takes effect a little faster than typical.

Can you guys just talk about how you guys are approaching it? How it works and flows through, just to remind folks? And then I guess, the reasons why you're addressing it the way that you are?

Reuben, I'll let Mike take that one. You'll remember, he ran pricing and contracts for us for several years before Investor Relations. So he's familiar with that more than I am.

Yes. So Reuben, thank you. We think about the different tactics to implement pricing, whether we should do it through the traditional process of list price and the way the contracts are kind of structured or whether we should do something more different like a surcharge, which we've done in the past.

The surcharge right now, we've decided not to do at this point, we haven't announced any surcharges. It works differently with customers. We have long relationships with customers. And we try to work through the contracts and the terms that we've established.

Sometimes, that means there's a timing difference between when we are experiencing the cost and when we can implement that pricing with the customers. But so far, we've chosen to do it through the kind of more traditional price increase route, which is what most of the industry does. We have seen similar actions across the industry. So, so far, we feel pretty good about the strategy. It's working as far as we're converting at the normal pace even though we've implemented so many, and we'll continue to look at whether we need to do additional price increases, I'm sure, as the inflation changes.

And if I could sneak one more in, guys, just a follow-up. You mentioned EMEA I think was price cost neutral, and I'm sure someone's going to want to ask about the profitability there, so I'll leave that one. But the differences between EMEA and the Americas from a price cost standpoint?

Yes. We've seen significant inflation in EMEA, but not at the level that we're experiencing in the Americas. That's the primary driver. And we don't have the same level of, I would say, long or significant and long-dated customer contracts in Europe that we have in the Americas. We have a lot, but it's a little bit more efficient or easier for us to work through those contracts in Europe. And again, the level of inflation that we've experienced to date, while significant, has not been at the same level or as pervasive as we've seen in the Americas.

Your next question comes from the line of Greg Burns from Sidoti & Company.

Just wanted to get maybe an update on some of the more recent conversations you're having with your customers, given that the headlines are seeing around variants and cases of -- increasing? Has it changed anyway in recent weeks? Are you seeing any softening in any of your leading indicators? Like what's the current outlook look like for you?

Yes. So Greg, I'll speak to that because I have pretty regular conversations with other CEOs and decision makers. And I think throughout the pandemic, I mean, we've seen customers take a variety of approaches to how they're thinking about return-to-office plans, whether that's studying the schedule and then changing them as the situation evolves. Some certainly have set dates and they've really implemented them and have started to bring people back. We do have some customers who never really left the office in any meaningful way. So we've seen quite a variety throughout the pandemic.

And I would say that in my recent conversations with customers, I haven't yet heard a dramatic shift in plans, specifically based on the new variant on recent developments. I think customers generally continually -- they consistently say that they believe their people are better when they're together and they're still thinking about and working on hybrid work plans, whether that's different variations of hybrids. But I do think that as sort of science and society become more accustomed to living with COVID, and we know that those leaders do want to have their people together for at least part of the time that they're still working on various types of hybrid return-to-office plans.

So at this point, and the new variant news is still relatively new. I wouldn't say we've heard a dramatic shift in what customers are contemplating.

Okay. And then in terms of the work-from-home, can you just update us on how you're approaching that market because with some of the Omicron, the headlines we saw Apple push out, but at the same time, they're giving older employees $1,000 to go, set up their work environment. So how is that market evolving in terms of how businesses are approaching work-from-home and kind of what's your strategy to capitalize on that?

Sure. So we've been quite focused on supporting people working at home since the start of the pandemic. And we've been approaching that in a couple of different ways. So certainly, we're using direct sales to customers through Steelcase store as one opportunity to help support people working at home, and we've seen nice growth in that business.

At the same time, we've also been working with our major customers, some of whom choose to implement programs to either provide their employees with a stipend or with different types of catalogs that those employees can essentially shop from to support themselves at home.

So we've really been fortunate to have a number of customers in different arrangements to support people working from home in that way, and we, of course, continue to pursue those opportunities.

And then as I mentioned in my comments, we're also continuing to work with partners like West Elm on different retail-oriented ways to promote our products and to make our products available for people who are looking to outfit their homes. And we're really excited about those opportunities and some of the things that we believe will continue to allow us to drive growth through the retail channel. So we've been taking a pretty comprehensive approach to work-from-home, and we intend to continue to pursue that.

Do you have a view on the size like the how big a home office or work-from-home could be in terms of the overall market? Does it detract or add? Like what is your view on kind of how the market evolves from here given your view on hybrid work?

I think it can be beneficial for the overall industry demand because I think you could imagine that people in a hybrid world could potentially work from home some days in the office on other days. And the more that they do that, the more they may want to have a similar setup at home with an ergonomic chair, height-adjustable desk and appropriate work tools.

And frankly, that's what we're seeing through some of the order patterns in the work-from-home business. Some of the order growth in the quarter was driven by this B2B2C that Sara just referenced, where companies are putting programs together to better support their employees at home. And some of it was also driven by the other channels that she pointed out.

It's not the biggest part of our business right now, but it has been growing nicely. We're investing in it, and we think it's a positive story for us in the end. So we're going to continue to funnel some of our strategic investment dollars in that direction.

Okay. Great. And then lastly, in terms of closing the price-cost gap next year, what is the timing on when do you expect to get neutral? And what would be maybe the main drivers that might make it happen sooner rather than maybe more towards the middle to the beginning of the year versus the end? Like what would drive the timing of hitting that target?

Well, a crystal ball would help. I said last quarter that we expected it to get to a push by the second quarter. And what's happened since is non-steel commodity costs continue to go up. There is increasing pressure on labor rates and the like. So that could have -- that may put pressure on it moving out, let's say, a quarter.

But what could be beneficial is if we finally saw steel pricing turn. Finally, we saw in November, steel pricing be less than October pricing. So if we see that again in December and again in January, maybe that pulled it back into Q2. But I think it's somewhere in that realm of possibilities that we're imagining.

And if inflation continues to push on our overall cost structure, then we have a pattern of taking pricing to offset that. So I don't -- I wouldn't want you to think that we who are limited in what kind of pricing we can take. If we have inflation, we have a history of putting in additional pricing to offset it.

We have a question from Rudy Yang from Berenberg.

So obviously, order growth in the APAC region was strong this quarter. But I just -- I guess, any more color you can provide on the trends you've been seeing there? I mean has order sizes been similar to those you've seen in Americas? Have you seen meaningful sales from Smith System develop there? And I guess, do you think there are still many more offices in India and China that haven't yet to kind of commit to reopening?

It's a good question, Rudy. I mean, when I looked at the order patterns in Asia across the quarter, there were a few, I would say, sizable orders, not sizable relative to the Americas. I mean the Americas still leads the way when we have a large order there, it's quite large. And there was nothing in [Asia] that was, I would say, highly unusual. Like what we had last year in the second quarter in EMEA, when we had picked up a $19 million project in the education sector. There was nothing significant like that.

There were a few, I would say, good projects, but there were a lot of just kind of normal, recurring, midsized projects that were spread across the entire region. I mean, I think every single market that we summarize, the way we look at the business in Asia across like 5 or 6 different markets. Every single one of them, the order levels were ahead of FY '20 so it wasn't one particular area.

India and China were the notable ones. They're the largest ones, and they grew more than 100%, which was quite remarkable. It was soft in India last year because of COVID, but still to grow over 100% was pretty remarkable. What our sales leadership tells us is that it is getting back to normal in much of the region, not everywhere. I mean they have the increased threat of the variant and they have countries that have locked down international travel in and out of the country and the like.

But as far as business activity and people getting back to the office, it feels as though it's ahead of much of the other world. EMEA doesn't feel that far behind though. It's the Americas, frankly, where return-to-office, while it's continuing to get better week after week, we look at the Kastle index like you do and look at office occupancy in major city. And it does continue to get better week after week, but not quite at the pace that we're seeing in other parts of the world.

That's really helpful. I appreciate that. And then you mentioned that your new products have invested in pretty well with customers recently. I guess can you just comment to what main type of products have been generally received well? And maybe talk a little bit about your time line heading into 2022 for just your focus on developing and releasing new products just catering to the hybrid space?

Sure. So I think a number of things that we have launched and are talking to customers about are really resonating. And this is all innovation, that's based on the insights that we've developed from the research that we've been conducting throughout COVID. And so just to give you a flavor of the kinds of things that we're working on that customers are quite engaged and are really any kind of solution that relates to privacy. There are lots of reasons that customers are reassessing privacy in their offices, whether it's for safety reasons and keeping people maybe more separated from others at times than they would have been previously, but also to support things like video conferencing and hybrid work, where we know there are different needs for acoustical privacy and other types of privacy.

So that really spans everything from rethinking what an individual workstation looks like and needs to do to perform to lightweight space division to things like Pods and some of the great solutions we've launched out of the Orangebox business, even things like private office solutions.

So we're really seeing interest across that whole range and have been working on a variety of different product solutions that support privacy in some ways.

Maybe one other I'll touch on is social spaces. One of the biggest reasons, I believe many customers as well as employees are interested in being in the office because of the ability to interact and reconnect with colleagues. So there are tremendous benefits in many cases that customers articulate to us about bringing people together to reconnect, to sort of reenergize their people, to rebuild those social connections and trust and all the things that many people value about their work experience. So things like ancillary spaces, different kinds of social settings that are still high performance, but allow people to come together and work in that way are important. And certainly, that's one of the reasons that we are quite excited about the opportunity to acquire Viccarbe and add their solutions to our portfolio.

So those are two examples of things that definitely resonate with customers as we talk to them along with work-from-home solutions and distributed collaboration.

As far as our time line, I mean, we continue to have a healthy product development pipeline. Certainly, as we see strong order growth and we have these conversations with customers, and we observe that there is so much change in this industry. We think it's quite important to stay invested in new ideas to help our customers solve for hybrid.

So we're continuing to invest. We're continuing to focus our innovation efforts on these areas that we think will be particularly important as customers navigate hybrid work, and we expect to continue to be bringing new innovation to the market on a pretty continual basis over time.

Great. And then just last one for me. We've talked a lot about offices already, but can you -- how some of the order trends have evolved for Smith System in the education market? And maybe provide an updated view on what your opportunity -- or how your opportunity in the education vertical has evolved?

Sure. I mean, Smith System, as we said, is already tracking at order levels back above FY '20 levels. I think a few quarters ago, we commented about the number -- the amount of customer visit traffic, both virtual and in-person being significantly higher. They're having a terrific year. Of course, they're impacted by inflation and supply chain disruption. So it would be even better on a bottom line perspective and probably on a top line perspective, if they didn't have those challenges. But we're excited about where they're finishing this year and they're talking about targeting for next year. It's turning out to be a terrific acquisition for Steelcase.

Next question is from Steven Ramsey with Thompson Research Group.

Maybe to start with EMEA profitability. You discussed that a minute ago, but maybe to add on, do you expect orders and delays of orders that you're seeing broadly to affect EMEA in the next couple of quarters? And to remind us, are operating expenses in that segment still reduced for COVID? Or are they already at normalized levels and will kind of remain at those normalized levels going forward?

Well, I think they're certainly still reduced to some extent from COVID, our discretionary spending is still quite low. We are traveling again in and around EMEA, but not at the level that we were. So I think some level of discretionary spending will likely come back in the coming quarters.

And I would also say our product development costs have not been pulled back to pre-pandemic levels, or they've not come back entirely to pre-pandemic levels. So they are somewhat low, but they're intentionally low because we're coming out of this situation.

On the order patterns, your question -- can you restate your question at the beginning around order patterns?

Sure. Are the delays of shipments that seem to be more pronounced in Americas, is that happening in EMEA?

Yes. They're happening, but to a much smaller extent. They're not really even worth calling out, which is why we didn't talk about it in the press release or in our remarks earlier. They have a challenged environment. They're experiencing inflation. They have supply chain challenges, but they are -- so far, they have been more manageable and/or contained inside the quarters.

Okay. Helpful. And then in the third quarter, operating expense is lower than did any of that has to do with the delayed shipments that you talked about? Or was that just broad discipline?

Yes. No, a little bit, of course. There are some variable items in overall operating expenses. And so part of it was that. But we continue to be -- I would say, controlling incremental spending. We have lots of ideas and lots of investments that we want to make in our strategy, but we are timing them or at least trying to time them with improvement in the top line and bottom line. So when we saw the shipment delays and the increasing disruption

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was actually growing non-steel commodity inflationary pressures, we were pulling back to the extent possible on some of the discretionary spending.

Okay. Helpful. And then last one for me. I wanted to look at cash and cash usage and net working capital, it appears inventories taking up more cash year-to-date. Is that inflation for purchasing? Does that reflect unfinished or unshipped products? And maybe how does this naturally unwind or do you -- how do you see this evolving in the coming quarters?

Yes, it's a good question. You'll see in the Q when we file it on Monday that our finished goods inventories are at $150 million right now. And you know we're largely made to order. We do have some made-to-stock businesses with Smith System, AMQ and others. But -- and we always have some level of finished goods that's waiting to be delivered to our customers.

But $150 million is a lot. And that has to do with the supply chain disruptions. Some of our orders are not complete. Some of our dealers and customers don't want them until they're complete. Some of the sites aren't entirely ready. So we're sitting on some of those inventories and waiting for them to be delivered.

You'll also see in the Q that our raw materials are also higher, and that's quite intentional. Where we can, we are trying to get as much component inventory in our factories from our supply base to try to build some increased buffer for the supply chain disruptions that we've been experiencing, and expect will persist into the coming quarters.

Receivables are also higher, Steven, but there's nothing of concern in there. I mean I look at that with our credit people and our controller every month. And while receivables are higher, it's really more linked to the growth in our business than anything else.

(Operator Instructions)

We have a question from Stu Linde from Water Tower Research.

I'm calling in for Budd Bugatch. First, we'd like to congratulate Sara to taking over as CEO. Congratulations to you.

Thank you.

You're welcome. Secondly, we had 2 questions on behalf of Budd. Sara, thank you for the detailed comments about return-to-office. And I know there's been a lot of comments on the call. But we're wondering if there was any product or business that you felt would benefit the most, where you are most excited given what you're hearing from businesses about 2022 and beyond?

And then the second question, which is a quick one, is given the Omicron variant, has Steelcase mandated vaccinations for its associates?

Sure. So let me start with the second question. We are a federal contractor. We enjoy a number of contracts to support the U.S. government. So we have been following the various guidelines that were introduced a few -- several weeks ago relating to federal contractors and vaccines. Those guidelines have been paused temporarily in the federal courts, but we were well on our way to working toward compliance. And I would say that I'm very pleased with where we are right now as far as vaccination and compliance. And at this point, we don't expect any significant disruption to our workforce, whether or not those guidelines are allowed to go forward by the courts or not.

As far as your first question in terms of where I'm most excited about the future. I really do think I'm going to give you maybe a broader answer than you're looking for, but I really do believe that we are well-positioned to support hybrid work and to be partnered with our customers as they navigate this tremendous change in how their organizations work from a traditional 5-day a week in the office model to something that's different.

And as I talked about earlier, I think whether it's privacy, social spaces, distributed collaboration and the integration of technology into physical space to support that, whether it's work-from-home solutions and programs, I believe that we currently have and will continue to invest in a very comprehensive portfolio of offerings to support our customers no matter which direction they move their workforce and their workforce strategy going forward.

And I also know that we have invested heavily over the past 2 years, and we'll continue to focus on the research and the insights globally to help keep us really on the leading edge of those changes and those organizations' needs to help fuel our innovation going forward.

So for me, I'm excited about the opportunities we see there and the things that I think we can do to support our customers.

It's interesting your comments about social interactions unequivocally, I'll agree with that. But I wonder from your conversations and your knowledge of the business and where you see it headed, if people will have short memories, when they get out to '23, '24, or is this hybrid model is really going to be something for the long term and secular for the industry?

It's a great question, and it's one that we discuss all the time here at Steelcase. And I would say, anecdotally, what I'm hearing anyway is it's a mix of things. Certainly, there are some people who believe that all of us collectively will settle into some new hybrid norm that will be a combination of time in the office as well as time at home or in a place like a co-working site.

But it's interesting that I'm already hearing from some customers and even some of our own research suggests that there is for some people, a work-from-home fatigue and what may have seemed great in terms of flexibility and being able to do your e-mail with your dogs sleeping down your feet. After 2 years, maybe after 3 years, starts to feel like it's maybe too much of a good thing.

So again, this is anecdotal. But I would -- I guess, the broader point is that I think what we're hearing continues to be mixed. And I think we certainly believe that, that work is where our strategy needs to center, and so we're going to continue to focus on supporting people at work, whether that work ends up being in the office, at home or some combination.

There are no further questions at this time. Ms. Armbruster, I turn the call back over to you.

Well, thank you. I'd just like to wrap up by wishing everyone a safe and happy holiday season. And thank you for your interest in Steelcase.

This concludes today's conference call. Thank you for participating. You may now disconnect.