Steelcase Inc (SCS) 2003 Q3 法說會逐字稿

Good day, everyone.

Welcome to the Steelcase third quarter earnings conference call.

As a reminder, the call is being recorded.

For opening remarks and introductions, I will turn the call to Mr. Jim Keane, Chief Financial Officer.

Please go ahead, sir.

Thank you.

Good morning, everyone.

I'm starting the call today to introduce you to Terry Lindheart (ph) who is assuming responsibilities for inverse it relations.

I want to thank Perry Gruber (ph) who did a wonderful job.

Terry has been with Steelcase for eight years and is vice president of corporate strategy.

In addition to strategy projects, Terry's team handles all M&A activity and coordinates our annual planning process.

Terry personally led our recent acquisitions of PolyVision and Custom Cable (ph).

Working with Terry will be Raj Mehan, also in the strategy group.

Raj will be able to answer your day to day questions.

I will turn the call to Terry who will start with a few formalities.

hank you.

Thank you for joining us.

I want to add that Raj and I look forward to working with you.

Our phone number is (616)-698-4734 or reach us through the investor line at (616)-247-2200.

This information will be found on the investor relations section of our Web site.

I'm pleased to join the recap of our third quarter and fiscal 2003 results.

Here with me is Jim Hackett, our president and Chief Executive Officer, Mark Mausding, VP and Corporate Controller, and you heard from Jim Keane, our financial officer form you should have received and read our third quarters earnings release dated Wednesday, December 18th, 2002.

It crossed the wires at about 5:30 p.m. eastern standard time.

That same release is now accessible on our website.

This conference call is being live webcast.

A replay will be available at our investor relations section of our Steelcase.com web site after it concludes.

In addition to our prepared remarks today, we well respond to questions from analysts.

At this time, we are incorporating by reference into this conference call and any subsequent transcript the text of our Safe Harbor Statement as incorporated in last night's release.

Certain statements made within the release and during this conference call constitute forward-looking statements.

There are risks associated with the use of this information for investment and decision making purposes and for more details on these risks, please refer to last night's release, the company's Form 10-K for the year February 22nd 2002 and other filings with the SEC.

Finally, this webcast is a copyrighted production of Steelcase Inc.

Any reproduction, publication or rebroadcast is copy right 2002, Steelcase, Inc.

With those formalities, I will turn the call back to Jim Keane.

Thank you, Terry.

Yesterday we reported a quarterly loss of $12 million before non-recurring items.

That is in line with the guidance we previously provided for the quarter.

Revenue for our third quarter was $647 million.

That includes $18 million of revenue related to a deal we began consolidating this quarter.

Adjusting that out, sales would have been $629 million in the quarter and in line with our expectations shared in last quarter's call.

Let me elaborate on the dealer we consolidated.

We completed a transaction to help transition a dealership to new ownership.

We own 100% of one class of stock and control the board.

We consolidated the dealer into our financial statements which added $18 million of revenue, $7 million of gross margin, and $2 million of operating income to our third quarter results.

However, since earnings do not accrue to our class of stock, we eliminated 100% of the operating profits on another line called equity and net income or joint ventures and dealer transitions.

As a result, there was no effect on net income.

We will continue this accounting treatment on a going forward basis.

It is not our intent to own dealerships, however, we sometimes are equity partnerships for dealers working through an ownership change.

I'm going to go back to sales for a moment to touch on a point.

Two years ago our sales were over $1 billion in the third quarter of fiscal year 2001.

That's about when we believe the downturn started.

If you exclude the consolidated dealer as well as the PolyVision acquisition, our sales have fallen above 40%.

That tracks closely with the decline in the industry in the United States.

Of course, if you include the PolyVision acquisition, our top line has done better.

You can go and adjust for the international segment and change in the physician hall services business, but you would be getting started and we didn't go through that.

We wanted to show, if you looked at the changes from peak to trough, our sales decline is typical of the overall industry.

Jim Hackett will speak more directly on market share in North America during his comments.

Pretax earnings before non-recurring items were adversely affected by $16 million of unforecasted pretax charges related to increased reserves for lease credit issues, dealer transition financing and worker's compensation.

These are operating costs and we are not calling them nonrecurring.

However, since earnings were near our guidance even though we had these unforecasted charges, you can see the rest of our business doing better than expected.

Of the $16 million charge, $5 million related to dealer transaction financing and is reported as a non-operating item.

The $31 million pretax charge for non-recurring items is substantially higher than the guidance we provided and is primarily related to severance.

Globally, we reduced approximately 800 salaried positions during the quarter, more than anticipated.

For example in North America we said we would implement 500 to 800 salary work force reductions in Q3 and Q4.

In fact, we implemented more than 600 of these reductions in Q3 alone.

We, basically, pulled the reductions forward and will end up with more total North American than we previously announced.

We moved more quickly because we didn't want to put our people through a long period of uncertainty.

As a result , Frank Merlotti Jr, president of Steelcase North America has been able to spend his energy on building on the future.

He has organized the sales and marketing groups to get things done with a smaller team of people.

We also reduced global hourly headcount by 1100 workers and our total work force by about 1900 during the quarter.

Of these 1900 total reductions, about 70% were related to cost of goods sold, and 30% were related to operating expenses.

Of the 800 salaried reductions alone, 70% were related to operating expenses and 30% related to cost of goods sold.

Excluding acquisitions, we have reduced our total global work force 36% over the last two years.

During the fourth quarter, we anticipate finishing the North American salaried reductions and, in addition, we announced today we are moving ahead with 350 to 400 hourly layoffs also in North America.

By reducing our cost structure we have lowered our break-even point significantly.

As we enter the next quarter of fiscal year, we target a break-even point less than $625 million including the consolidated dealer or $610 million excluding the dealer.

That represents a deeper and faster reduction in the breakeven point than we had previously communicated.

This better positions us to be profitable next year.

Before I go into more detail on the nonrecurring charges, I will explain the changes we made in our segment reporting.

In the past, we reported three segments, North America, international and financial services in a separate column for corporate eliminations.

Beginning this quarter we are reporting four segments in addition to an other category which provides you with a more detailed view that matches the way we look at our business internally.

For example, we have created a separate segment for the Steelcase design partnership or SDP (ph).

This is a group of five companies that focus on higher end design and niche applications such as lobby, reception areas, conference rooms and learning environments.

This segment reports to Mike Love.

Previously, this group was reported as part of the North American segment.

We also moved PolyVision, Attwood and IDEO from the North American segment into the other category because of differences between these businesses and the rest of the North American segment.

The new North America second meant includes Steelcase and Turnstone (ph) brands in the United States and Canada.

It includes the Custom Cable business acquired last year and three consolidated dealers.

This segment reports to Frank Merlotti Jr.

The international segment is unchanged to prior reporting and reports to Bob Black.

Financial services is also unchanged.

This segment includes our leasing business and our dealer working capital and project financing activities.

Financial services reports to Gary Mahlberg (ph).

The other category includes PolyVision, Attwood, IDEO, Illuminations and other corporate entities.

Although PolyVision and Attwood report to Mike Love, we report these separately from SDP.

We have a number of corporate shared services like legal, finance, human resources and information technology.

More than 85% of the costs of these shared services gets allocated to the segments.

The unallocated in these costs is reported in the other category.

Now, I will go back to the $31 million of nonrecurring charges and break them out by segment.

Of this charge, $6 million relates to cost of goods sold, $23 million relates to operating expenses and $2 million is in nonoperating. $23 trillion was charged to the North American segment and relates to the severance activity I discussed earlier. $5.7 million of the $31 million charge relates to international restructuring activities.

Of this charge, $3.4 million was for severance and facility rationalization $2.3 million related to future lease costs in a facility no longer fully utilized.

$2.3 million of the $31 million charge relates to the relocation of our Tuscan (ph), California, facility and doesn't show up in any of our segment data because it is a non-operating charge.

Manufacturing operations were recently moved from our Tuscan facility to a new location in city of industry.

During the third quarter, we incurred asset write-offs of $9.5 million and reported a gain of $7.2 million on the sale of a portion of the Tuscan property.

We currently expect to close the sale of the larger portion of the facility in the fourth quarter.

We expect net proceeds of $31 million and a non-recurring pretax gain of $20 million in the fourth quarter.

Cumulatively, in the fourth quarter we expect proceeds of $39 million from the sale of Tuscan net of closing costs and a net gain of $18 million.

The new facility in city of industry (ph) has been designed around lean principals and is a model for our new manufacturing strategy.

Just to give you a sense of the impact, the longest cycle time through the plant is two and a half hours.

The new facility is 400,000 square feet and handles about the same amount of finished goods production that used to take up 1.2 million square feet at Tuscan.

Including these non-recurring items we reported a net after tax loss of $31 million or 21 cents per share in the quarter.

EBITDA was positive $28 million in the quarter, a decline of $16 million from the previous quarter.

EBITDA is calculated before nonrecurring charges.

At the end of the third quarter, we carried $361 million in debt and $52 million in cash.

That represents a $69 million reduction in debt an $8 million increase in cash versus the prior quarter.

Our debt is now at its lowest level in more than three years.

We expect to reduce our debt again in the fourth quarter using the proceeds from the Tuscan sale and the sale of additional lease assets.

$245 million of our debt relates to our financial services segment, which continues to operate with a debt do equity ratio of 6:1.

We are continuing to sell these receivables and use the proceeds to retire debt. $116 million of the debt relates to the operating company, which has a debt to total capitalization rate of 9%.

Of the $361 million in total debt at the end of the quarter, $10 million was drawn against the $400 million back-stop facility provided by a syndicate of banks.

That facility includes three covenants.

We completed negotiation of the interest covenant shortly after our last analyst call and we discussed it in our 10-Q for the second quarter.

We are in in compliance with all three covenants in the quarter and expect to remain in compliance going forward.

We generated $53 million in positive cash flow in the quarter.

Our capital spending totaled just $19 million during the quarter.

We continue to carefully control our capital expenditures and are on track to spend less than $100 million for the total year.

Because of changes in our product development and manufacturing model, we believe we can sustain about the same level of capital investment into next year.

We generated $8 million in cash from the sale of leases.

As expected, we also significantly reduced receivables.

Receivables of $366 million are down $44 million from last quarter, primarily because last quarter sales were unusually back-end loaded as we discussed in the last conference call.

We expect receivables to fall again in the fourth quarter due to lower anticipated shipments in January and February.

Now, I will discuss the operating results for each of our segments using the new definitions.

Since this is the first time we are using the new definitions, I will spend less time on the quarter and instead give you an overview of the longer term economic characteristics of each segment.

We will be including detailed historical financial data for each of these segments in our 10-Q filing.

In North America, sales were $372 million in the quarter, including the $18 million of revenue related to the newly consolidated dealer.

Without the effect of consolidating the dealer, sales declined 23% versus the prior year and 6% decrease versus the second quarter.

North America operating margins, excluding nonrecurring charges, were negative 1.5% in the third quarter.

I'm going to talk in general about gross margins and operating expenses as we go through the segments.

As before, we will provide the numbers in our 10-Q.

North American gross margins are much lower than historical levels because of the under-absorption of fixed overhead related to excess plant capacity and inefficiencies from operating individual plants at less than half their capacity.

In the third quarter, American gross margins were adversely affected by worker's compensation expense that was $7.2 million higher than normal.

About half the charge was a catch-up from earlier estimates based on recent claims activity.

We understand it is typical for the company to see higher claims activity when layoffs are imminent.

We are taking steps to manage these costs but we expect to see elevated worker's compensation costs to continue into next year.

We have taken action in California and have other plant activities underway as well as others being evaluated.

For example, we are consolidating production of two Grand Rapids facilities into one.

These moves will need to a 1.5 million square foot reduction in floor space.

Together with supply chain improvements and full implementation of lean manufacturing, we are targeting to get North American gross margins back to the mid-30s in the next few years even with modest volume growth assumptions.

If we have a stronger recovery in demand, we will get there sooner.

Operating expenses are being addressed by the recent headcount reductions.

We saw only a slight benefit from these reductions in the third quarter and see more impact in the fourth quarter and full benefit as we enter our next fiscal year.

In the longer run, we are targeting this segment to deliver operating margins at or above 10%.

STP sales were $79 million in the quarter, a 2% decrease compared to the prior year and a 6% increase compared to the second quarter.

STP operating margins, excluding non-recurring charges were 9.5% in the quarter.

STP is able to deliver strong profitability even in the downturn in part because the cost structure of these businesses are more variable, meaning they can adjust the cost structure to changes and district in demand.

We expect to see improvements in margins because we continue to find ways to be more efficient.

A recover in demand will see STP margins to improve but to the same extent as we expect to see in North America.

We don't show EBA (ph) assets and segment reporting but these STP businesses are less asset intensive than our other manufacturing segments.

We continue to look for opportunities to expand the STP model through acquisitions and investments in new product development.

In the long run, we expect STP operating profit margins to be above 10%.

International sales were $124 million in the quarter, a 14% decrease compared with the prior year and a 6% increase compared to the second quarter.

International reported an operating loss of $6.7 million, which includes $5.7 million of non-recurring restructuring charges.

International operating margins, excluding non-recurring charges, were negative 1% in the quarter.

That margin is net of $2.1 million of operating charges related to dealer credit issues and other adjustments.

Last quarter, we shared our concern that economic conditions in certain countries were putting pressure on some of our dealers.

This quarter we saw that situation deteriorate further and took charges to reflect the possible risk associated with those receivables.

As a result of a lot of hard work over the summer, international is back to break-even performance.

Our international business is less vertically integrated than North America, but because it takes longer to adjust the size of the international workforce, the cost structure is still pretty fixed during a downturn.

As in North America, international is taking steps to address redundancies and make its operations competitive.

International has a higher operating expense as a percent of sales than our other business segments.

This is a function of serving customers in so many places around world but also relates to credit risk in some markets, a less developed dealer network and other costs of doing business enter internationally, though not shown in the segment reporting, international receivable days are much higher than other segments but in line with the local practices in the countries they operate.

We regularly review how and where we do business to be sure the long-term benefits of serving our customers around the world out weigh the costs.

The international management team is very focused on achieving positive EVA wherever we do business.

In the long run, international is targeted to achieve operating income margins approaching 10%.

Next I will talk about financial services.

Steelcase financial reported an operating loss of $3.5 million on revenues of $6.5 million.

We accrued $6.5 million in lease credit reserves in the quarter.

This is approximately $5 million higher than the run rate in recent quarters and reflects a decline in credit quality of two of our largest lease customers.

One of these customers defaulted on a payment and we are working with them to resolve the situation.

We believe our reserves are adequate, but recognize that as the overall economy remains weak or weakens further, we can see more credit issues and additional reserve charges.

We sold about $8 million of lease receivables during the quarter.

There was no material impact on operating income from this transaction.

We expect to continue to sell these receivables in the fourth quarter.

The proceeds from these sales are used to reduce related debt.

Now, I will review our order trends and outlook for the next few quarters for Steelcase, Inc.

It is typical that North America and STP fourth quarter shipments track below the third quarter.

It varies quite a bit from year to year.

We have seen about a 5% decline historically.

In our North American business, our most recent orders and quote activity are weakening more than seasonality alone would explain.

That could mean that overall demand is continues to contract or it could just be part of the normal volatility in order patterns.

On the other hand, we see some strengthening in our international order trends in the last few weeks.

We have chosen to build our guidance up of a very conservative volume outlook that calls for a modest decline in Q4 over Q3, even though there is a extra shipping week in Q4.

Given the lower anticipated volume in the fourth quarter, we expect a loss before non-recurring charges in the range of 5 cents to 10 cents per share.

It is always difficult to forecast future non-recurring charges since, by definition they relate to future business decisions or transactions.

We will give you our best guess.

If the Tustin (ph) sale occurs as planned, we should realize a pretax gain of $20 million in the quarter.

This gain could be offset by 8 million to $13 million in pretax restructuring charges and other activities that could potentially occur.

So we currently expect to have a net pretax gain on non-recurring items of 7 million to $12 million in the quarter.

Reported profits would be at or just below break-even.

Again, I want to emphasize the degree of uncertainty regarding non-recurring items.

Looking ahead to next year, we are not yet ready to provide any full-year guidance.

I'm not going to give EPS forecast today.

Here is what we can say about next year broken into four categories.

First, we believe during the first and second quarters of next year we will see a rebound from fourth quarter levels because of seasonality.

We don't know how much of a rebound and we are not saying the industry is recovering from the downturn.

We won some big orders lately and we know of big projects out there, but that's always true.

The recovery of our industry depends largely on overall business capital expending and anxiously awaiting signs of a rebound in that metric.

In the meantime, we are taking specific actions to stimulate the demand and compete in the business.

We want to win market share and we believe we can.

Secondly, we believe our quarterly break-even point will be less than $610 million as we enter the next fiscal year.

That's a little better than we said last time, and we're not counting the consolidated dealer in that number.

That means we should be profitable even with a modest rebound.

In doing the math, some of you might think the break-even point should be lower, but we are including modest merit increases for our people next year and as we improve profitability we will pay bonuses.

We are figuring that in as well.

Third, as we said before, we believe our volume leverage is 50%.

Every dollar of revenue generates about 50 cents of additional pretax operating income.

If volume rises more than 10%, that level ranch factor goes down because bonuses become a bigger factor.

Finally, well have non-recurring charges next year associated with the work we know is ahead of us to further rationalize our operations in North America and enter nation at, to implement lean and improve the sup employ chain.

We will fund the charges by less strategic assets.

That's if for next year.

One comment on this year.

We said at the beginning of the year we would respond to the industry resection by improving our break-even point, improving the cash flow and strengthening the balance sheet.

This has been a challenging year in the history of Steelcase.

This past quarter was the difficult emotionally because of the headcount reductions, but we worked through those decisions in a way that is consistent with our values, and I believe we have done all the things we said we would do at the beginning of the year.

Our break-even point will soon be 5% less than our peak sales quarter from two years ago.

Our balance sheet is stronger today than at the beginning of this difficult year and we continue to strengthen it through cash management.

We are prepared to be profitable again soon and profit will help us reward the employees and shareholders who have stuck with us during this tough period.

I would like to ask Jim Hackett to add some comments on the business and progress for implementing our strategy

Thanks.

Happy holidays to everyone.

My time in a recent CEO conference confirmed anecdotally what we are reading and hearing.

The business environment regarding capital expenditures continues to show constriction.

By a show of hands in the meeting, most of the participants said they expect to not spend more in capital than they did this past year, but they also confirmed they don't expect to spend less.

So we see that as a hedge, that if companies in North America saw some sort of stimulus and confidence could build, we think they would invest ahead of signs of literal improvement.

However, we can add we are now seeing a steady improvement in corporate earnings relative to year on year.

This should start the year, albeit slowly, to improve consideration for our products.

But we know that the furniture environment continues to be depressed, and Jim has relayed to you the impact this has had on all parts of operations.

My goal at this point is to add comment and perspective to the performance.

Today, we are dealing with the reality that we did a great job in getting our costs in line.

Given the size and complexity of our operations on a worldwide basis, we hit the second improvement in break-even on schedule.

In fact, we improved the number a slight bit.

However, it is also clear with these numbers this quarter that market share has slipped in North America slightly.

You are going to ask me how much and where.

To try and parse (ph) it out to when the categories are somewhat ambiguous and there are non-furniture products in our sales, I'm not going to do that this morning.

I'm also going to suggest there are certain segments we think our business has not declined in market share, certain geographies around the world, and we believe in the corporate buyer here in, North America.

It is clear upon reflection that office furniture has made its way into education and health care, and we relate in developing specific solutions for those markets.

I can report today the strong efforts exist in those areas, and we have won some significant projects with those products and ideas.

A great example is the launch of our new Polyvision LTX board which was a development project between Polyvision and IDO that revolutionizes the way white board will be used in a classroom.

That will naturally drag interest in other products we make that work quite well in that environment.

And there is a historical fact that during recessions like this, our dealers will substitute very low insistence products for the intense budget buyer.

I think that's probably happened in the last six months.

I also think it is human nature that all the distractions that caused Steelcase as we have gone through the massive amount of change in the company, candidly, we got too internally focused.

That, too, has changed.

We have been very active in our client locations and we are confirming what we believe when we talk to them about what users need to have a better day at work.

Finally, and probably just intuition on my part, I think the brand that steel Steelcase has a great presence in terms of share of mind in the marketplace.

It is one reason why used furniture today, particularly Steelcase used furniture, is high lie coveted.

That has to hurt some of our new sales.

Steelcase is a changed company, one that had to realize that permanent employment was a true gift that we had for a long time, and that our downsizing was a reality we had to face.

We committed in a big way to lean systems thinking all over the world, and we have results to prove this as Jim mentioned in his comments.

There is much more to come in the rationalization of our industrial system, and there is a concerned effort to turn our aggression and energy from shrinking costs and internal focus to growing our top line.

Our people are challenged and energize.

New products like tech wall and post and beam are being launched as we speak today.

As Jim ended his comments, he confirmed that Steelcase is in better shape, more fit, if you will, as it now looks back from a year ago.

It is often said a recession can be a catalyst for change.

It has been a catalyst for improvement.

Before we take questions, I also want to suggest that the people who left in our most recent downsizing were people who performed their jobs very well.

Now, while their value as people isn't a function of their work in Steelcase, I can tell you they were great employees.

Our severance packages were quite generous.

The intent in that benefit was to thank those important people for their dedication and contribution to our success.

I don't think it would be right to complete a call today that appropriately emphasizes a magnification of numbers and quantitative data without thanking the people and the quality of Steelcase.

Those are both past and present employees.

We are anxious to get to questions, so why don't we do that right now.

Terry.

Michelle (ph), we are ready for questions.

Thank you.

Ladies and gentlemen, the floor is open for questions.

If you have any questions or comments, press No. 1 followed by 4 on your touch tone phone.

Pressing 1, 4 a second time will remove you from the queue.

Last, we ask you please pick up your hand set for optimum sound quality.

Please hold while I poll for questions.

Your first question is coming from Chris Husley (ph).

Please announce your affiliation and pose your question.

Hi, it's Chris Husley with Goldman Sachs.

Guys, maybe you could walk through in more detail what you have been seeing the last few weeks in the marketplace that -- Miller indicated they saw a deterioration.

What is the magnitude in deterioration you have seen in the past few weeks.

I have a second question on dealer revenue

Chris, hello.

It is Jim Hackett.

I would suggest that last quarter we were neutral to somewhat negative about the outlook, if you remember.

We didn't see the signs in the corporate profits and in capital investment that would say the industry was anywhere near to coming back.

Now what we face is while there were some purchases at the end of the year, let's say, for people to beat their calendar budget closure, we have the seasonal effect of orders being slow in January and February.

It is one of those things, up until the last minute, I was witnessing to see -- late last week I was traveling -- but to see if there was indication of orders picking up at all because we had to announce today a small but important layoff of Grand Rapids steel and wood employees that confirmed that there was, in fact, a seasonal dip.

But we are telling those employees, and I relay this to you, that we think it will be short lived because a lot of the work we are forecasting is confirming that there is business out there and early this year

Okay.

So , really, in terms of December, December has been coming in line with what you guys were expecting in terms of people trying to get the cap ex plans in toward the end of the year, but given where the environment is, expecting January and February to fall off as they always do?

This is Jim Keane.

We saw the normal kind of increase in orders you get early in the quarter for shipments in December, and then when December orders start to come in, the typical seasonality is they begin to weaken since those are for deliveries out in January and February.

Customers have polled their orders forward.

We saw that basic trend.

Although, I will tell you as we said in the release, week to week orders are volatile.

They bounce all over the place.

When we talk about trends, you need to see three weeks, four weeks before you get comfortable that you spotted a trend, versus a weekly blip.

And also, we are seeing different things in international.

International order patterns have picked up a little bit.

They would see the same kind of seasonal decline.

It is volatile within the segments and also volatile across segments

Chris, in one of those order weeks, it is important in a contrast basis without trying to pinpoint the exact week, one of those order weeks people were approaching to beat the calendar year deadline, we had an order intake that was the highest in 22 previous weeks.

The very next week it dropped back off again.

So that's what Jim means by the volatility.

Great.

Then the second question was on the dealer revenues, the dealer you mentioned now there are three dealers you guys are consolidating.

Could you quantify what the total revenue is on all three dealers.

Are all three dealers being treated the same way with a hundred percent back-out.

Why are you, to explain it briefly, what is the accounting rule that allows you to not consolidate the income?

Do you own ...

There are three dealers.

The dealer we are consolidating this quarter is the one we broke off.

The change was important for you to guys to understand in the changes from second to third quarter results.

The reason for not consolidating the net income is because the nature of that transaction is such that there's two classes of stock.

We own one class of stock.

Earnings do not accrue to our class of stock.

We are required to consolidate them because of GAAP, because of the control we have.

In fact, we don't get credit for the net income because we don't have the stock that gets credit for the net income.

We get paid through dividend distributions that is we turn our equity in debt as well as a turn in equity in debt over time.

We do not pick those up until the distributions start to come.

The other dealers are different.

We want quantify them because we've had them in our numbers a long time.

The other two dealers we do not have in a transition plan.

We own the majority of the shares and simple consolidation accounting would require that.

The new dealer is a control issue which requires consolidation, but, as Jim mentioned, the specifics of that transition agreement our agreement was held in accordance with that agreement

If you had to guess, how long do you think this new dealer will be sitting on your books?

I think the degree of investment will probably drop over time.

It's fair to say maybe a couple years, maybe longer

Great.

Thanks, guys.

Yes.

Thank you.

Your next question is coming from Bud Gugash (ph).

Please announce your affiliation, then pose your question.

Good morning, it's Bud Gugash (ph) with Raymond James.

A couple of questions.

One, the break-even that you detailed, Jim, at $610 million, can we parse that a little bit by the four operating platforms.

Would we assume it is relatively higher at international than it is for north American and STP?

I won't parse the number out because it does get confusing as you try to do that.

As we explained in the segment comments, the three segments have slightly different characteristics in terms of fixed costs and variable costs.

The STP companies have the most variable cost structure of the three.

International and North America are more similar in terms of fixed costs and variable costs in that the fixed costs are higher.

Directionally you get a sense of how they are from a break-even perspective.

In terms of giving break-even metrics, I'm going to say at the inc. level.

We wouldn't be wrong to assume it is somewhat more at international than it is in the U.S., the north American total?

I wouldn't say necessarily -- I wouldn't necessarily conclude that.

The international business, although it is -- it takes a little bit longer to adjust the size of the work force, which means certain costs are fixed for longer periods of time, although that's true, it is a less vertically integrated model.

You consider those things together.

I don't know that I would conclude that relative break-even point would be much different

Okay.

Secondly, you are reducing the capital exposed in the financial services segment by selling off some leases.

How far does that go?

You mean how much further are we going to go?

Yeah.

We are going to continue to reduce that portfolio.

We expect some significant sales in the fourth quarter and we continue to move in that direction.

We will continue to sell leases when we can get what we believe is a fair value for those leases.

That's really the path we have taken.

We continue to group them and approach them and financial buyers and when we get a fair price, we sell them.

I don't want to communicate how far we'll go because it depends on how marketing the leases are

Okay.

When you look at what's going on with North America and Frank Marloty (ph) is coming in, can we talk about what is happening in the organization?

Jim, you made some reference to the fact of a reorganization.

Can you put some flesh on that or color to it?

Sure.

Hello, Bud.

Frank hit the ground running.

He has had a great impact.

I traveled with them last week and he's getting great reception from our field and dealers form the essence of his work has moved the development organization in a more fast track direction.

It is design led in terms of project management which is a subtlety in this business that we think our center focus.

It kind of is a dominant feature in the development.

He has organized the field in the operations and development and the dealer coordination underneath his structure.

Things are going very well.

I'm happy with his progress

I'm not sure what all that means.

I didn't know if that's what you were asking me.

You wanted to know who is reporting to him or what he had control of?

That's he done?

You said he's changed the sales organization.

How many --

Well, I'm not going to tell you what size the specific organizations are, you can rest assured when you look at the number of people we took out of the business and the acceleration, he had a huge impact on those decisions

Okay.

But you changed the structure of the sales organization?

Is that what you have done?

Tell me what you are looking to find out

I'm looking for the dealer organization is matching with the sales organization at Steelcase, what is the benefit you are trying to achieve

What we did, Bud, is we were able to deploy people more directly in client relationships and dealer relationships.

It was more line oriented and a lot of staff support went away.

We took out layers of management that I found them very valuable but not affordable in this kind of climate.

I would say the net of it is we have a very aggressive sales oriented struck structure we ended up with.

Okay.

And -- okay.

Thank you very much.

You're welcome.

Thank you.

Your next question is coming from Susan McLarry (ph).

Announce your affiliation.

Susan McLarry (ph), UBS Warburg.

Can you guys talk about the product mix you saw during the quarter?

What kind of product mix we saw?

Yeah.

Did you see more systems selling versus CD?

Did you see any shifts?

I will tell you what I will be willing to share with you.

As we look at this downturn and go back over a year even longer, 23 months, and you couple this with the comments I made about where maybe we lost some share, the one segment that's been hit the hardest is the systems business.

Its constriction has been stronger than other parts of our business, the seeding and storage and work tools and things like that have not declined as much as the business systems.

We think that's consistent with the demographic and dynamics of the recession, the demographics being that companies took people out of the work force.

That's a relative number where files could still be added in a company that's being downsized.

Systems generally are not added.

We also believe that there has been a higher inventory of used furniture after the dot coms failed and some of the large corporate failures we have been part of -- we all witnessed, I should say.

I know there are a lot of used systems furniture being moved out of those corporations.

I can say to you that systems was the and has been and continues to be the driver of profitability in the industry.

It has the biggest share or profit.

Because it is the most severely constricted it has the negative impact on profits

To build on that, also, what we saw, which is actually kind of typical, when you get that boost of orders there for those December shipments, customers when they mace the orders are often not starting a big systems project but more likely to place orders like seating or storage that are more stand alone products.

We saw that pattern this year.

So, a slight increase in seating in that part of the business that shipped out in November and December

Okay.

And then kind of switching gears, can you talk about your cash position going forward?

I know you have been focusing on reducing your debt.

Is that going to remain your focus?

Will you repurchase stock more?

Our focus is to continue to reduce our debt, probably down below $300 million.

At that point, we would begin to reach a structure level where we would sustain.

Excess cash flow from that point would be used to increase cash balances.

We are comfortable having cash balances that rise up to a $100 million.

As earnings come back and as our debt is down and our cash position is back to that sort of level, we will begin locking at ways to return value to shareholders.

Dividends is frankly one of the first things we would look at.

We reduced our dividend a year ago.

We would look at with the boards' decision we would look at increasing dividends.

We would look at other ways of returning value to shareholders, which could include stock repurchases.

We haven't taken stand on that one way or another.

We know the priority, to reduce our debt and bring our cash back up

Okay.

Thank you.

Thank you.

Your next question is a follow up question from Bud Gugash (ph).

One question I want to explore is your rationalization would go on in the fourth quarter, if I heard you correctly.

Does that mean when you come to us at the end of the fiscal year, the break-even would go down further or is that in contemplation of the rationalization you are expecting to do?

At this point the break-even number I gave you includes everything we know about that will happen in the third quarter and fourth quarter.

As we would expect, it takes a while for the activity to translate into lower coasts and, therefore, a lower breakeven.

We are not done.

We are going to keep working on things.

The consolidation of the two Grand Rapids plants we mentioned is underway during the fourth quarter.

Obviously, we won't see the cost savings for a while.

When those cost saving are captured our break-even point should follow more.

Some of the work going on in the fourth quarter would reduce the break-even but maybe not underlie second or third quarter of next year

So do you have -- obviously, you want to return to profitability as quickly as possible.

Will that happen in Q1 of next year or Q2, or are you unwilling to kind of say when?

I'm unwilling to say when exactly.

What I will tell you is we believe we will be profitable next year.

I don't think that the back half of the year or first half of the year is going to be that different.

I'm looking at that pretty evenly across the year

So to make sure I understand.

The rationalization you are talking about in Q4 you gave us a ballpark number for, that's -- in your 6610 that's included in your thinking?

... the impact is already included into the 610

That includes the other category which is IDO and Polyvision?

Yes.

That 610 includes that revenue from those segments?

Includes everything except the consolidated dealer.

We will report the dealers, you have to add 15 million to the break-even point to get that.

The one thing I wanted to follow up on the consolidated deal, how much capital did you put into the dealer to consolidate it?

What kind of capital do we have in that investment of that special class of stock?

Well, Bud I'm going to suggest that's probably not something I would pinpoint.

The reason is the capital is a function of our credit lines, some equity, and there is even project financing at different times in our dealerships

That wasn't paid to the owner to transition him out?

That's not his ownership interest or some ownership interest of some transitioning owners to help them, you know, with maybe their estate planning or whatever else was going on.

That's actually your capital maybe for other reasons?

Yes.

Just as I said, sometimes we are financing projects and sometimes the dealer is just in a normal arrangement, just so we are clear, a dealer that owns their own business where we are not involved will take a project that's larger than their net worth of the business.

So we have a mezzanine structure or work with banks on that.

Sometimes there is a position where that is financed.

To parse out what happened in this particular case could be misleading if we gave you a total capital number.

Mark, you could add to that.

Bud, it is more we had financing capital with the former owner, and now we have converted that to financing in equity with the new owner.

So, there really is no additional cash out as it relates to the transition.

We are just -- we have a capital position.

As Jim said, it varies between debt equity and normal --

So does that change its location on the balance sheet, Mark?

Yeah.

It was in the notes and receivable and other investments.

So it slipped out of there.

It is being consolidated primarily in the AR and inventory lines because our dealers don't have high capital elements to them

So it is in the accounts receivable.

It didn't flip to other assets?

No, no.

The small amount we have as equity investment is in there, but the rest of the balance sheet is -- all our financing gets eliminated form the investment is in that JB line

Has the other owner been named?

Have you got the other owner already in place and it is just that's the transition or are you looking for an owner?

No.

We completed the transaction.

I see.

Thank you very much.

Thank you.

Your next question is coming from Robin Brady (ph).

Announce your affiliation.

Hi.

This is Robin Brady from Olson Capital.

I just had a question for you guys.

I was wondering if you could talk about the pension funding and if you plan to add to that throughout the second half of the year.

You have to understand that, for the most part, our retirement benefits to our employees are in a defined contribution plan.

We don't have very many defined benefit plans.

At least year end the total liability worldwide was about 70 million and the funding position was not significantly out of line.

We are looking at those lance and they primarily are international plans.

I wouldn't expect major changes in that area through the balance of the year, but it is not a significant issue for us

Okay.

Thank you.

If there are final questions or comments, please indicate now by pressing one four on your touch tone phone.

Your next question is coming from Eduardo Bree (ph).

Please announce your affiliation, then pose your question.

Yes.

Good morning.

Sterling Capital Management.

A few questions.

The first one is maybe you could take us through directionally where you were maybe a couple years ago and, if I can keep it just crudely in total square footage and where you think you are headed in square foot j of your manufacturing base.

Also, what that might mean as far as capital spending in relation to sales on a more structural basis.

I can give you some gross perspective, Eduardo.

Globally, the company in its filings you'll see space in excess of 25 million square feet.

That included warehousing and some officing with production.

Clearly, we have enough capacity in our system to handle almost anything in the industry right now.

What we are about is shrinking the capacity and consolidating it all around the world using the lean systems.

The consequence of that is that this can be a bit of an albatross, and it can be an asset.

Let me talk about both sides of that.

To shrink the capacity to the extent we destroy all the future earnings we don't want to do it.

We will do it at a pace the business can afford to constrict.

Separately, the asset part of it is some of the space can be used by supply suppliers who are part of the supply chain system and are quite interested in it to be approximate to our manufacturing.

We still are, by far, the largest manufacturer in this industry.

There is a lot of interest from suppliers to be part of our flow.

So there is a lot of discussion and work in mapping out that future.

What's why we are beginning to lead you down a path that says there is going to be more happening here as those plans become firm and one huge consideration is impact on all of our people.

We are in great shape now in the sense we can make consolidations given the size of the work force we now have, that we don't negatively impact people because of the consolidations.

I also want to add that the effort to consolidate and the cost to consolidate is even more enabled because the lean output, the lean experiments, the lean results are actually working.

Our productivity is going to be up very high this year, even in a downturn market.

We have yielded a much higher productivity.

Our flow, as Jim talked about, one factor went from days to hours.

That experiment was outstanding.

The acceptance in our Grand Rapids facilities, which was the last place and largest place to invest in the lean systems is much higher by our work force.

They have been a great supporter of it and are seeing the results.

So, I want to tie the question into the whole systems thinking we have there, the complete problem we are trying to manage through

Okay.

And the -- I would imagine the capital spending of a 100 million next year, even in a recovery in the furniture market should not rise materially from there?

Yeah.

As we said in the call, we expect to be able to sustain this level of capital spending well into next year.

Let me explain that a little bit.

Our capital not just a function of growth and sales seen.

It is a function of some other things, including the model we use for new product development and to set up manufacturing.

One of the benefits of lean is that because it is a flow based system, there is less need to build, you know, that single big manufacturing point through which all volume flows.

You maybe have smaller machines distributed around the plant.

You also find, therefore, you have quicker paybacks on new product development, less capital spending and so forth.

It is not that we are becoming more capital conscious, although is true, too.

It is really we are thinking the way we do product development, to do it in a less capital intensive way and thinking the way we do manufacturing to make it less capital intensive.

Those three things combined are the reasons we think we can keep our capital spending down

Okay.

Next question we had was just, you know, on the market share erosion.

It is clear it accelerated in other quarters.

Relative to Herman Miller (ph) and relative to import pressure to the extent there is a greater degree of import pressure in office furniture -- I don't know if there is or not.

Is it huge, large orders lost?

Was it contained in this educational institutional market?

Can you give more color on the relative disappointment in the revenue trend?

Yeah.

I would say that -- I'm going to confirm what I told you that I think the -- you have to understand the Steelcase dealers by far are the strongest distributors in the industry.

They have the largest share in the relative markets to go market by market, and they have been key partners.

In a lot of cases, they probably are contained -- containing some of the share that we are losing.

They are actually keeping by switching products, maybe lower cost products or used furniture that they source.

So I think a portion of the share erosion is in the systems business which we just talked about a moment ago, which is the hardest hit segment, is because of that dynamic.

When we look at some of the large com pet terse, some today reported higher growth, let us say, relative to share.

In previous quarters we weren't seeing that from all the competitors that are in the systems business with us.

I think it kind of supports my notion that where the shift was happening was as Steelcase dealers were making trade-offs to lower cost products.

The education in the health care is a point I want you to be considerate of as you start to think about the company's competitiveness.

I think these segments are actually very healthy, particularly higher education is booming around the country in terms of the expansion.

There are some smaller competitors in our industry that have done quite well, been quite well positioned to capitalize in those segments.

Our SDP companies, if you look at their relative decline, has not been as great as the big systems company, and that's part of parcel to the same force.

SDP companies have done well in higher education.

Health care, likewise, we started an initiative ten years ago that got shelved as we approached the growth in the '90s because of the focus on core market.

As I look back on that decision, I think we should have stayed where we were because we now reignited that.

Health care went through a pretty dull time as we know in the early Clinton years is back.

It is growing again.

Hospitals are being built.

A lot of revolution in the delivery they are bringing to patients.

I'm optimistic that both of those segments will continue to add growth to the industry and I'm convinced that Steelcase won't lose, long term, won't lose that opportunity.

We were a little slow at the switch as that started to happen

I guess I'm a little confused on the dealers.

Are they exclusive dealers or can they sell competitor furniture?

They are quite exclusive, but their lines of products that we wouldn't deem as competitive to us they are allowed to carry and are able to switch in the setting I'm describing.

Okay.

These are -- you know, you asked a question about imports.

I want to address that.

B-u-d has done a tremendous amount of research about the residential industry at Raymond James that's an outstanding summary of what happened there.

We are quite -- all of us that run companies in North America are sensitive to that or aware it.

The nature of the flow of finished goods in this industry make it difficult for finished goods to be completed and imported, but there is a lot of components that are brought into north American markets from other parts of the world.

That's going to only grow.

They are going to get better as competitors.

We are making the assumption there are lower cost competitors in this market.

I would not suggest to you that that explains all the Steelcase share erosion we are talking about.

I in the last quarter said to you that it wasn't clear we were losing share in our core markets.

I would say today that it looks like that happened, but it is not clear that this sub substantial part of that was from the core markets.

That's what's so difficult about the way the industry reports.

It is hard to get a handle on that.

I also want to emphasize what we are doing about it is we are quite aggressive about it.

We don't like that trend.

We think we know why it's happened and what we need to do about it to turn it around.

I'm confident we are going to address positive change there as we talk to you in the future

One last one.

I don't mean to hog the call.

The bits ma has a 7 or 8% growth in the industry next year.

They look at a number of different, I guess, leading indicators of that demand.

Historically, is that -- have they been fairly reliable as a forecasting body, or are they -- any comments there?

Eduardo, you heard that in the other calls with your manufacturers?

Oh, I haven't heard anything.

I'm just asking the question now.

The web site has 2003 sales growth for the industry of 7 point something percent

They have a model used for forecasts that's worked pretty well in the long term but didn't work well predicting the down turning the beginning of, and throughout it has under estimated the depth and extent.

We extent to be a better indicator of what they will this will (inaudible).

We don't rely on that bidmap (ph) forecast.

We look at actual orders, actual bid activity, actual customers.

Our conversations with our dealers and customers to get a sense of what we think is going to happen.

Thanks very much.

Thank you.

There appear to be no further questions.

Do you have any closing comments you would like to finish with?

Yes.

I would like to suggest that the work and effort that's been put forth inside the company to hit these improved cost goals have re energized the corporation about being able to prove success in a time when the other indicators are showing negative trends.

The company has a great attitude and enthusiasm as we hit this year.

We are planning to make money, planning to pay bonuses.

We are planning to win share.

We are planning to take care of our customers.

I want you to leave this call with the confidence that management has got its eyes on the right issues.

I wish you all the best holiday.

Let's all pray for peace.

Thank you, ladies and gentlemen.

This does conclude today's conference call.

You may disconnect your phone lines.

Have a wonderful day.

Thank you for your participation.