Steelcase Inc (SCS) 2004 Q3 法說會逐字稿

Good day everyone and welcome to Steelcase's third-quarter earnings conference call.

As a reminder, today's conference call is being recorded.

For opening remarks and introductions, I would like to turn the conference call over to Mr. Terry Lynhart (ph), Vice President of Corporate Strategy and Investor Relations.

Thank you, Michelle, and good morning everyone.

Thanks for joining us.

I am pleased to join the recap of our third quarter and fiscal year 2004 year-to-date results.

Here with me today are Jim Hackett, our President and Chief Executive Officer;

James Keane, our Chief financial Officer, and Mark Mosting (ph), Vice President and Corporate Controller.

You should have received and hopefully have read our second-quarter earnings release dated Thursday, December 18, 2003 which crossed the wires yesterday afternoon.

That same release was posted to and is now accessible on our website.

This conference call is being Webcast.

A replay will be available at our Investor Relations section at Steelcase.com shortly after this event concludes.

The presentation slides that accompany this Webcast are also available on our website.

In addition to our prepared remarks today, we will respond to questions from investors and 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 decision-making purposes.

For more details on these risks, please refer to last night's release and Form 8-K, the Company's Form 10-K for the year ended February 28, 2003 and our other filings with the Securities and Exchange Commission.

Finally, the Webcast of this call is a copyrighted production of Steelcase Inc..

Any reproduction, publication or rebroadcast without the express written permission of Steelcase is prohibited, copyrighted 2003 Steelcase Inc..

With those formalities out of the way, I would like to turn the call over to our President and Chief Executive Officer, James Hackett.

Good morning to everyone and happy holidays.

This week at our Steelcase Board of Directors meeting I described to our Board of Directors that the Company is focusing on creating stable, predictive and positive results.

We also want to get beyond the recession or depression in this case in this industry, and we want to focus on important strategic questions.

I would like to address two of these three areas today, talking about stable and predictive results and getting beyond the recession.

The strategy work that we are involved in is just a continuation of some of the things that we have discussed in previous calls.

In terms of enhancing results, as you know, we have been in the midst of strategic restructuring.

It is not just about improving short-term profitability, but it has been about improving our global competitiveness for the long haul, and this requires fundamental changes in our business.

The focus of our fiscal year '05 and beyond plan is on restoring this consistent profitability and predictive result.

We are doing that through three initiatives.

The first is we are working very hard to drive complexity out of the business.

This involves leaning the factories, offices and offices and processes such that we have excellent flow and lower costs.

We are also working on product and pricing rationalization throughout the marketing of the products that we have.

Complexity is an issue in this business that comes as a result over time of two things.

The first is the nature of the way customers standardize on systems products.

It's our commitment to continue products for them over time, and because of that, we have long-lived product lines.

That adds complexity to the business.

The second thing is, of course, as you offer choice, which is an important value in our product and our marketing mix, that can add complexity to the business as well.

So these are areas that have emerged out of good intent but need attention, and I want to emphasize today it's an area of effort.

The second point of concentration is the global environment, and essentially Steelcase believes to be globally competitive is to actually compete around the world in an essential way.

In other words, we have to be where our customers are, and we have oftentimes don't talk I believe deeply enough about how important this is to our business today.

But Steelcase has a strong brand and image around the world, and it is becoming even more important to our customers that we are able to serve them around the world.

They want to tap into our knowledge.

In places, not only like Chicago, Illinois but in the middle of the UK or in Italy or in Asia as well, they are talking to us all the time about effectiveness and efficiency in their workplace.

For example, we are helping the global auto company establish a consistent brand identity in its showrooms around the world.

It is very interesting that the product lines we are using actually translate around the world and work quite well in dealerships, auto dealerships, all over the world.

A growing percentage of our customer visits in Grand Rapids are by U.S. companies that want to set up facilities in other parts of the world.

As you might expect, many of the corporations we serve see the growth in markets like India and Asia right now, and so they are spending a fair amount of time talking to us about expanding their business and using us to do that.

They want to tap into our knowledge about space requirements and other cultural differences in the workplace, and we have a lot of knowledge about doing business in those markets because we have been there and we are resident in those markets.

Steelcase has been global for more than three decades, and because we build products in different locations around the world, we have also been able to develop a global supply base, and we are proud of how that supply base is being used to our advantage around the world in order to serve such a diverse geographic base.

So global environment is an important aspect of who we are today.

The third aspect is around preparing now for growth.

This is getting beyond the depression in the industry.

In this quarter, we have seen a rebound of large account business as a percent of our business.

It is up in an important way right now, quarter on quarter.

These large accounts are quite important to Steelcase's marketshare because we believe that is the sweet spot of our business and is the place at which our marketshare is I would say more enhanced.

We are going after business in new markets using some of our capability, and I will talk about a few examples in a moment.

Then we believe that in preparing for growth, you've got to have not only the products but the knowledge and services to deliver on the brand promise of helping people work more effectively.

Again, the large accounts that come to see us, in addition to wanting value, want to make smart and solid decisions, and so Steelcase is a good source for that.

We are quite hungry to grow our marketshare in all of our businesses and to be a lean and aggressive competitor.

The message about Steelcase now coming out of the depression and being aggressive has permeated the Company.

I said I would make a couple of comments about examples that represent some new markets, two of which have been reported in the press so we can talk about.

One is the University of Memphis opened a new FedEx Institute of Technology.

This is a facility that is part of the University but highly and heavily sponsored by Federal Express.

It incorporates much of the science of how people learn with a variety of Steelcase brand products, Vecta, Polyvision and Brayton.

Fred Smith, the Chairman of Federal Express; the Governor of Tennessee; the U.S.

Senate Majority Leader, myself and others were there to see how this new Institute of Technology represents the cutting-edge in educational facilities, and it received a tremendous amount of press in the south because it is a incredible space.

But in addition to what is going on in Memphis, we made the news in California because there the President of Fresno State announced a new project called the Classroom of the Future and how he had joint ventured with Steelcase along with Polyvision to build a prototype of this new classroom.

In these two cases, both of them representing higher end settings, it's amazing how well our insight into how teams work and the effectiveness of teams in physical space connect to the growth in higher education and the desire to make classrooms better.

So the Company is quite excited about the performance we have had in this higher end market, and we would suspect today that our marketshare in this higher end segment is higher than our commercial office furniture share, which is pretty good.

So it says that there is a lot of receptivity to these ideas.

As I mentioned also, we have not forgotten that the large companies still are a major source of revenue, and that, of course, explains a great deal of the shrinkage in our revenue as large customers are not buying.

Jim Keane will talk more about some of the market outlook.

But one of the large corporate customers that just made a big decision to buy Steelcase for their new corporate headquarters asked me to come speak to their management team about their transition to this new space.

It is instructive today for our call because I think it represents why the Steelcase value proposition is a very important and strong value for large corporate customers.

This was a highly competitive product.

Some of our best competitors from West Michigan were involved.

This customer built a special lab for its employees to experiment with all the products -- ours and our competitors.

This is different than the traditional kind of mockup process that companies go through where they just set up settings of the product and view it.

In this case, the users actually lived in the product for a number of months and, at the end of the day, evaluated Steelcase to be the best product.

This job is very large.

It will initially be about 2000 people, and as this company's business grows, the space could grow to 5000 people in this setting.

So it's an important endorsement of our notion about understanding users and how they work effectively, putting product in place and then voting for us.

Of course, we were quite enthused about that.

While this single kind of event is not a material thing to our forecast, of course, it's a great endorsement of our strategy.

Finally, along the lines of good news about our ideas and the market's acceptance, the University of Texas just released a final -- excuse me, the final result of a research study showing that office workers can be healthier and more productive when they are given a leap chair on ergonomic training.

The preliminary results of this study were reported in 2002, but now the final version of the study is being published this month in the journal that is called Spine, obviously dealing with ergonomics.

The participants in the study reported less pain and discomfort and were 18 percent more productive in their jobs because they were not dealing with as many health problems.

The leap technology obviously has distinguished itself in these settings, and as you now know, from other press places, the technology has been licensed for cars, and today we can share with you that leap has been licensed for the next generation of airplane seats that are going to be constructed.

In both of the licensing agreements, the Company will not be manufacturing the products but sharing in royalties for the transition -- transmission of our intellectual property.

In both cases, the benefits to the Company, which are important, are not material to earnings going forward.

So in summary, these customer interactions are what we use as a way for inspiration to keep us positive and focused in the areas that we know we can be successful.

And with the news that the economy is starting to improve and, of course, factoring in the normal lag that our industry has with that, we believe these ideas support the ongoing value proposition of Steelcase.

So with that, let's take a look in more detail about the actual results, and I will turn that over to James Keane, our Chief Financial Officer.

Yesterday we reported a third-quarter loss of $9.5 million or 6 cents per share.

These results were within the range we estimated in our October 24 press release.

Revenue was $614 million in the quarter.

That is down about 3 percent from the prior year and about the same as the second quarter.

Revenue was also within the expected range.

First, I will talk about the 3 percent revenue decline from the prior year.

This is made up of a 10 percent decline in North America and an 11 percent decline in SDP, offset by a 20 percent increase in international. 18 points of the international increase or nearly $22 million was driven by currency translation effects.

Next I will cover the slight increase in third-quarter revenue versus the second quarter.

By segment, North America and SDP were down slightly, and the other category was down significantly, primarily because of seasonality in our Polyvision subsidiary.

These declines were offset by a substantial increase in international sales.

Currency translation did not have a material effect on sequential quarter comparisons, so this represents real growth in our international business.

Now I will talk about profitability.

Again, our policy is to give you plenty of information about the factors affecting our profitability.

You can use that information as you wish, but we are not providing pro forma earnings per share.

There were $9.1 million of pre-tax charges related to restructuring and dealer transition activities, of which $8.4 million were noncash charges.

This was higher than the $5 to $7 million range previously estimated.

About $5 million of these charges affected cost of goods sold. $2 million affected operating expenses and 2 million were non-operating items.

There is a chart included on our Webcast that shows these charges by segment. $2.9 million of the charges reflect asset impairments related to ongoing plant rationalization activities in North America. $2.4 million of the charges relate to plant consolidation activity in our international segment. $700,000 of the charges relate to lease impairments in the SDP segment.

There were severance charges of $700,000 in our other category, and finally, we had $2.4 million of nonoperating charges related to a dealer transition.

Although these items were higher than expected, earnings per share was within the range we estimated for the third quarter.

Operating expenses were $173 million, including all charges and continue to decline both in total and as a percent of sales.

Operating expenses declined by about $36 million.

Approximately 60 percent of that decline came from lower restructuring charges this quarter.

Next, I will talk about the balance sheet and cash flow.

We increased cash and decreased debt in the quarter.

Our cash balance was $201 million at end of the quarter, a $28 million increase from the second quarter and the highest level of cash since we have been a public company.

Included at the end of the Webcast slides is a supplemental schedule summarizing our cash flow data by quarter for the current year.

We reduced debt by $8 million to a quarter-end balance of $308 million.

That's the lowest amount of debt we have had in over four years.

Debt, net of cash, now stands at $107 million.

Capital expenditures were $11 million in the quarter compared to $32 million in depreciation expense.

The difference represents a source of cash.

We also generated cash through improvement in working capital balances.

We plan on maintaining a healthy cash balance.

In the short run, it helps us keep a strong balance sheet.

In the medium-term, it will help fund the working capital we will need as sales begin to grow.

We have no plans to buy back stock at this time.

Now I will discuss the operating results for each of our segment, starting with North America.

In North America, sales were $336 million in the quarter, down about 10 percent from the prior year and down about 3 percent from the second quarter.

North America's operating loss in the quarter was $2.3 million, including the $2.9 million of restructuring charges described earlier.

Without these charges, North America earned a small operating profit.

In the same quarter of the prior year, North America reported an operating loss of $28.1 million, including restructuring charges of 22.5 million on sales of 372 million.

This improvement in profitability is a result of a lot of hard work by our people over the last year.

Order rates were essentially flat in the third quarter versus the second quarter.

Discounts and dealer incentives continued to increase, in part because of an increase in government business.

Gross margins continued to be negatively affected by inefficiencies related to plant consolidation activity, but improved slightly over the prior year.

North America operating expenses were $79 million in the quarter or about 23 percent of sales.

There were no restructuring charges included in North America operating expenses this quarter.

That represents a $28 million reduction in operating expenses from the prior year.

Prior year operating expenses included $17 million of restructuring charges.

SDP sales were $70 million in the quarter, an 11 percent decrease compared to the prior year and a 4 percent decrease versus the second quarter.

SDP gross margins of 36 percent were down from the prior quarter because of an increase in inventory reserves.

The SDP operating expenses were $22 million, including restructuring charges of $700,000.

Expenses were down slightly versus the prior year but higher as a percent of sales because of the revenue decline.

SDP reported a $3 million operating profit, which is down from the prior year, primarily because of lower volume.

International sales were $148 million in the quarter.

This represents a 20 percent increase compared with the prior year. 18 points of the increase is due to favorable currency translation.

On a sequential quarter basis, international sales were 23 percent higher in Q3, and currency was only two points of the increase.

As we said earlier, we saw real growth in international this quarter versus the seasonally lower second quarter.

The increase is attributable in part to a few large but lower margin projects that shipped in the third quarter.

International gross margins were 28.4 percent, including $1.7 million in restructuring charges.

These charges reduced margins by 1.2 percent.

Margins were strong, even though we had those lower margin projects I mentioned earlier.

International operating expenses were higher compared to the second quarter, in part because of $1.6 million in charges for increased credit reserves in Europe.

International reported an operating loss of $1.6 million in the quarter, including the $2.4 million in restructuring charges.

As with North America, international would have earned a small operating profit excluding the restructuring charges.

Now I will review our outlook.

We are seeing several positive signs in the overall economy.

Business confidence and business capital spending continued to increase, though as we expected, most of the initial increase in spending is on technology rather than office furniture.

Employment data is beginning to become more positive as well, and sustained white-collar worker growth is an import driver of office furniture sales.

We believe that an increase in competition for white-collar workers will help trigger a recovery in the office furniture industry.

These external factors are more positive than they have been in years.

However, the office furniture industry typically lags the overall recovery until actual job growth begins.

Then it's particularly true for the large customers we serve.

We are seeing a significant increase in customer visits, but we are not yet seeing a recovery in order rates.

In fact, it is typical for orders to weaken in the fourth quarter, and we are seeing that pattern in December orders.

Competition remains intense in both domestic and international markets.

We are estimating Steelcase fourth-quarter sales to be down 3 to 5 percent from the third quarter, reflecting seasonal patterns.

In the prior year fourth quarter, we reported sales of $624 million, but that was a 14 week quarter.

If you adjust for the extra week, we expect the fourth quarter of the current fiscal year to show sales growth versus the prior year.

However, that increase is due to expected foreign currency translation benefit.

We expect to report a fourth-quarter loss before the cumulative effect of accounting change related to FIN 46 of between 6 cents and 11 cents per share, primarily because of lower volume.

I will talk about FIN 46 in a minute.

Included in the estimated loss is about $3 to $8 million of net after-tax charges.

This represents the net effect of significant charges related to North America and international restructuring activities, less favorable income tax liability adjustments.

The restructuring activities include a number of projects that are currently in the planning stages, so we will not be more specific at this time.

As with previous profit improvement actions, we expect an average payback of less than two years and an average cash payback of less than one year.

The favorable tax adjustment relates to an audit of previous year's returns, which is nearly complete, and the permanent tax differences, which may reduce our current year effective tax rate.

These tax benefits are not expected to change our longer-term effective tax rate.

All of these estimates are still preliminary.

The components may change, but the range we provided reflects our best estimate at this time.

Over the last few days, the FASB has continued to refine its proposed FIN 46, which establishes new rules for accounting for variable interest entities.

As we discussed in the last year's 10-K, we have an synthetic structure that qualifies as a variable interest entity.

The leases were set up in fiscal 2001 to finance the purchase of two company airplanes and were part of a sale leaseback transaction that resulted in a gain on sale that was amortized over fiscal years 2001 through 2003.

The new FIN 46 rule requires that we reverse that sale and record the airplanes and related debt on our balance sheet.

Since the net book value of the asset is less than the book value of the liability, we record the difference on our income statement in a separate line called cumulative effect of accounting change.

In effect, this reverses the gain on sale from the prior years.

We estimate the after-tax effect will be about 3 cents per share.

There is no cash effect of this change in accounting and so we do not expect any significant impact on our reported results on an ongoing basis.

Three of our four debt covenants already include the debt related to these leases, so there is no effect on those covenants.

Reported interest expense will increase, which will increase our interest coverage covenant, but we have a solid cushion related to that covenant as we look forward.

The FASB expects to issue final rules by the end of the month revising several other provisions of FIN 46.

The revised rules may be effective for our first quarter next year.

These roles may require Steelcase to consolidate certain dealers to whom we have provided equity or debt financing.

We will evaluate the impact of those rules when the final version is issued, but we do not expect a material impact on net income.

Next I will talk about the results of our annual planning process, which was recently completed.

We're planning our business for fiscal 2005 assuming a 5 percent increase in volume over the current year, which is slightly higher than (inaudible) estimate for the coming calendar year.

We don't have enough visibility to provide a forecast for fiscal 2005 sales, but we make assumptions based on what we do know when we do our planning.

So the FIVE percent increase is not a forecast, but it's a basic assumption we're using to plan our business.

With that topline assumption, we're planning for a profit of 5 cents to 10 cents per share.

That profit includes the impact of estimated pretax restructuring charges of $15 to $20 million.

The actual charges could very well be different, but we are providing this information to give you a sense of the expected profitability of the underlying business.

These improvements in profitability reflect work we have already done but also depend on work that is ahead of us to implement lean principles across our enterprise and several other initiatives.

Through the planning process, we also set performance targets for three years.

Again, we assumed conservative single digit percentage increases in years two and three, so we believe there is some upside potential in the longer-term plan.

For fiscal 2007, we are targeting 35 percent gross margins and 10 percent operating income margins.

Those targets had previously been set for fiscal 2006 but moved out a year because the downturn has been longer and deeper than previously expected.

Again, there is a lot of work ahead of us to achieve those targets, and since these our longer-term targets, there are several risk factors and uncertainties involved in reaching these goals.

So the purpose of sharing this with you is not to provide a forecast per se but to give you a sense of what we are working toward.

Now we will turn it over for questions.

(OPERATOR INSTRUCTIONS).

Margaret Whelan.

Good morning.

It is actually Susan McClary from UBS for Margaret.

Can you guys give us a sense of where your breakeven is at the end of this quarter?

I guess the best way of answering that question is either refer you back to the second quarter, and then it is up to you how you decide to consider restructuring charges.

But we think we are operating these things very close to breakeven, and again, it depends on how you consider those restructuring charges.

Would you still say it's around that 610 to 620?

Sales for second quarter were 612 million, sales for the third quarter at 614 million. and again, if we go through the analysis again, depending on how you handle restructuring charges, I think you could argue that we are operating close to breakeven.

However, as you compare those breakeven numbers with previous numbers, remember that a lot of the historical data is going to be affected by currency translation, so it makes complex to give comparisons of where that breakeven is today versus where it's been in the past.

Can you give us a sense of where you think you are as you approach your year-end and your three year restructuring plan?

I know that you have moved up some charges from fiscal '05 into the end of fiscal '04.

Are you about where you that you would be?

Are you ahead of plan?

Can you give us a sense of that?

In many ways, we are head of where we expected to be.

If you think back six months ago, we expected to be at a certain point in a variety of these projects, and as time went by, we are making progress faster in some of the consolidation activities.

That faster progress is part of because some of those charges to move into this year from next year.

So we are feeling good about that project.

We have a lot of work ahead of us.

The work that we have been focused on today has largely been this consolidation activity.

We have been working on lean manufacturing, but if we get into the next three years, you'll see some of the efforts shift from consolidation toward implementation of lean and also the elimination of complexity in our business which Jim talked about earlier.

Finally, on that idea, can you give us a sense of what percent of your costs now have been a result of the recent downturn in the industry versus your move toward the last vertically integrated business model?

How much of this is really going to be sustainable as demand improves?

Can you ask that question one more time?

What percent of the cost cutting that you have done is a result of the recent downturn in demand versus your move toward mean?

You say that in fiscal '05 you are going to have another 15 to 20 million in charges, but it just seems like a lot given all the changes you have already done over the past three or four years or so.

So going forward, now are we getting more toward the lean part versus the consolidation piece of that?

Yes.

It is hard to break those into their components because volume will fall, and when volume falls, you would expect things like materials and direct labor to fall naturally.

There might be some other costs that fall naturally with volume, and so if you say how much of the cost reduction is because of that, there would be some portion of that.

We have previously said we think our variable conservation margin is about 50 percent.

So you can use that to say, how much should their costs have fallen specifically because of volume?

But the consolidation of plant is something that we use as fix costs, and although lower volume helps you there, we believe that as we consolidated these plants, we have actually not taken out a lot of functional capacity.

We had been able to consolidate these plants and use lean principles and become more efficient so that we are not really constrained by capacity.

We do not expect to be constrained (inaudible) capacity as volume increases.

So I consider that plant consolidation activity to really be different than just something related to volume.

It's really us reconfiguring our industrial model for a different way of working going forward.

Did I answer your question?

Yes, it did.

Going forward then, given the level of capacity that you expect to have at the end of this three-year plan, what run rate would that support?

What would you estimate that will support?

What run rate --?

Of revenues.

What run rate of revenues in the third year of the three-year plan?

Right.

In the first year, we mentioned that we built in a 5 percent assumption for revenue growth.

Then in the second and third year, we are using single digit revenue growth.

Now that doesn't mean that that is our forecast.

We don't have visibility out that far, but that is the assumption we use as we plan our business.

If volume ends up being higher than that, we have plenty of capacity to deal with that volume, so we don't consider capacity to be an issue as we look forward.

I would like to add that if you just asked that earlier question of industry at large, and particularly manufacturing at large, and you asked yourself what has happened, not just for companies moving from vertical to more supply chain structures but just in supply chain structures at large, there has been a fair amount in the last, I would say, six years of continual reconfiguration and businesses driving for profit improvements.

So the point of that comment is that the recession was a big part of why we had to move faster.

And separate of the recession, we would have been moving this way at any rate, and then because of the way manufacturing and industrial systems are modernizing themselves, you can expect over the next five years industries at large to continue to reconfigure these systems.

I think there is a fair amount of work ahead in all businesses, and we are not going to be a lot different than them in that regard.

Right, but I guess that gets back then -- are we getting to a point where it is just a constant kind of improvement in your manufacturing, or are they actually charges?

That is a fair question and one that we talk a lot about.

And so as the standards in accounting change, what businesses used to do as they approached -- let's call them total re-dos like this, like you find in the IT world when enterprise systems were being put in -- companies would take large charges and doll that out over time.

Now it is quarter by quarter being factored into the business.

From a pure operating basis, it is a little confusing.

So we're still getting used to that, and I think that the one thing you can expect is that there will be a lot of discipline about the rate and the pace at which those kind of charges show up.

We also gave it some sense I think as we were talking about the plan for next year that the pre-tax restructuring charges included in those profits -- profit estimates that I provided were about $15 to $20 million pretax.

You get a sense of the expectations for next year relative to this year, which we have already talked about, more restructuring charges for next year, which gives you hopefully a sense that the costly part of the restructuring activities are beginning to be behind us toward the end of next year.

I don't want to leave you with the idea that the pace of activity is different because, in fact, it shifts.

It shifts from things that lead to asset impairment charges and severance charges.

It shifts from those activities to equally hard work that is involved in implementing lean driving complexity out of our business, improving our supply chain.

We have a lot of work ahead of us, but the charges may be slowly down as we get to the end of next year.

Chris Hussy, Goldman Sachs.

A question for Jim Hackett.

What is your forecast?

You are asking the question of earnings or sales?

revenues. 5 percent is just your assumption, but what is your forecast?

We are forecasting -- right now I would say this that the plan that Jim described is the intersection of what is possible and what is acceptable.

I am not trying to be cute, I am trying to say that there is a fair amount of uncertainty in the economy, a fair amount of evidence that it's starting to improve, and there is the notion that historically we lagged.

So we expected this year to be profitable, and we worked very hard at getting our costs in line for some rebound in volume.

That did not happen in the industry as much as any of us expected.

So next year is about designing a plan around a very conservative improvement in sales, plus further refinement in costs, and I am being as direct and forward as I can about it because of the uncertainty.

Let me ask you a different question.

In your experience in the industry -- you guys have a lot of experience in the industry -- as you come out of cycle like this, what type of growth can investors expect?

Is this a business that in a recovery year grows 5 or 6 percent?

This a year in a recovery year it might grow double digits?

What should we expect in a recovery year?

The first driver of that, which is a force that fuels all of us, is the job recovery.

So some of the economists have said you could expect -- we should have expected 200,000 jobs a month to emerge out of this recession.

We were last month tracking around 50,000 jobs, so that is one-fourth of the rate that we need to say we're fully deploying workers back in our workforce.

You have a dampening effect, of course, with the IT outsourcing and the BPO outsourcing.

Whether that is going to be a long term negative issue I think is anyone's guess.

So what we normally expect is job growth, and if we had job growth of the rate that I just described, the 200,000 per month you would have rates double I think what BIFMA is actually forecasting.

That may be more normal coming out of a recession.

However, I am going to qualify this saying I don't know anything today that would alter the BIFMA forecast.

So that's why we have used that and enhanced it a little bit based on what we think we are able to achieve with our strategy.

But again, if we are in a year in which the office furniture business is in a recovery -- because the U.S. has been in a recovery since sometime late 2001, and the recession ended people have said November 2001.

But in a year in which the office furniture industry is in a recovery, we would expect in that type of year you might get upwards of 10 percent growth.

I want to qualify, you would not say the technology industry has been in a recovery since 2001.

No.

I am just saying broadly the U.S. economy is not in a recession.

Where we have got to land together is the U.S. recovery, which is corporate profits and earnings, have been largely a jobless improvement, and so I would say let's talk about industries that are tied to job improvement and suggest that if they had that job growth, of course, you're looking at much higher growth rates than GDP I think.

Okay.

So implicit that in your estimates for your fiscal '05, is that fiscal '05 is not going to be a year of recovery for the office furniture industry?

Is that fair?

Because if it were, it seems like it would grow faster than 5 percent.

I think there is a lot of uncertainty about what is going to happen with job growth in '05.

I think what Jim is saying we understand what could cause industry to grow faster.

We also understand there are risks that could cause it to grow slower.

The actual answer will probably be different than 5 percent, and there is probably a wide range around what the actual answer could probably be.

But we have to plan our business around something.

We understand the drivers that are behind the BIFMA assumptions.

We can have a reasonable starting point, and if you are planning your business and you are planning your spending, we picked that number as a number around which that we would assume in those models.

Absolutely fair and I think it is actually prudent of you guys to pick a low number given what happened this year in the industry that you certainly would not want to plan for a robust recovery.

When it comes, you probably can react pretty quickly.

The second question is on the '07 numbers you have provided.

Given single digit revenue growth implicit in your '05, '06, '07 -- yet getting to gross margins 35 percent and 700 basis points above what we are today, am I right in assuming that that implies significantly more cost-cutting between now and '07?

It seems like the revenue growth isn't robust enough to create that kind of operating leverage.

What you should assume is that the efficiency of the organization actually improves by a lot.

We didn't want to count on revenue growth has being the way that we brought our margins back up to these targets, and so, as you pointed out earlier, we pick single digit percentages in part because it really puts the pressure back on us to control the things we can and to improve profitability.

How do we get there?

It is a variety of things, and by cost reduction, I don't want you to think these kinds of cost reduction activities that we have been going through for the last year.

Yes, there will be additional things to restructure our operations, but we are also driving complexity out of the business.

If you are able to do that, you can reduce costs in other ways.

You can reduce your material costs, you can reduce the labor content, you can look at global supply chain and see how supply partners can help you improve profitability.

We are finding these principles to beyond the plant to the areas and our offices and looking at our business processes.

So there are ways to improve your profitability without relying on the things we had to do during the downturn, and that is really what the next three years are about, capturing those efficiency gains.

Will there be an inflection point, Jim, do you think sometime in '06 where we will see margins start to improve even on very little revenue growth but outside margin improvement as the organizational efficiency kicks in?

Is it an '06, fiscal year '06 kick in, or is it sometime fiscal year '05 that maybe later on in the year that it kicks in?

The plan is actually built to show gains in each of the three years.

It's not a hockey stick.

I would use a pretty linear model if you are trying to do the interim years.

I want to point out since we are talking about this, though, that there is a lot of stuff ahead of us, a lot of projects -- a lot of work that has to be done in order to hit those targets, and as we said in my earlier comments, there are risk factors and uncertainties associated with that.

But we think that the plan is the intersection between what is possible and what is acceptable, and that is the target we have set for ourselves.

It's not a simple for us as saying they are going to take $12 million out of SG&A when all the dust settles.

Gross margins are going to improve by 200 basis points because they will have lowered their -- it's not that simple.

It a little bit --?

I would say that if you look at or listen to Susan's comments a moment ago about the charges that have been taken and James Keane's reflectance that largely some of the pigs have gone through the python, so to speak, I know from talking to the operations folks that a lot of the leverage now and the changes we have made in production processes sit there for pay off in the future.

I mean essentially we have taken about 400 square feet of production here in Grand Rapids out and moved everything over it.

That creates some decent chaos, and we think there is a settling down factor that you are going to ask us to try and project what that might be.

And so I think what Jim is saying is that has done layered on over the next three years.

My hope would be it comes sooner than later because the work has happened, and I expect us to start showing some of those results.

But we are projecting it very conservatively and behind the scenes, working very harshly on making it happen faster.

In reference to your last question, I think if you run the model -- I think your question is are we going to see major reductions in operating expenses in order to hit these numbers?

I think if you run your model, you will find that this is really about locking in the cost reductions we have made and being efficient as we grow, capturing that productivity as we grow rather than suggesting there is specific additional reductions that are needed.

Okay.

A little bit more specific now.

What was the foreign exchange impact on profits if you had to quantify it year-over-year?

It is actually very modest.

The international business has its revenue primarily denominated in Euros and has its cost primarily denominated in Euros, and since the operating income of the group was relatively close to zero, there is very little impact on profit.

Finally, on the FIN 46, how many dealers right now do you guys have that you are providing some sort of assistance to that might fall under this new pronouncement?

Might is a good word because the rules still are changing.

So the best guess we have right now is that we have fewer than five, possibly fewer than three in the US.

We have five to 10 internationally, but the international dealers are relatively small.

The rules are changing every few days here, so that could be quite different by the time they finalize it.

In fact, we have not really kick a solid run at trying to figure that out because the rules are so volatile.

So not a major number of dealers?

No.

Marcos Caminas (ph), Standard & Poor's.

I have two questions.

On the international sales side, do you think this growth is something that is sustainable, and is the international market conditions better than North America?

The first part was whether we believe that the growth in revenues is sustainable.

It's typical for international to see a seasonal increase in the second quarter, in the third quarter versus the second quarter, so a portion of this is due to normal seasonal patterns.

International's second quarter was also a little bit lighter than normal, so we're coming off a little bit easier comps when you look at third quarter versus second quarter.

We mentioned that as we look at order rates that we are seeing evidence of a decline in order rates in the fourth quarter versus the third quarter.

It is consistent with seasonality and that December order rates are kind of following this trend.

That is as true for international as it is for our domestic operations.

So we're watching that, and obviously the softness is different in some regions than other regions.

We are watching that, and the forecast we have considers it, but we don't have any other projections for international beyond that.

Okay.

Thanks for clarifying that.

Your second question was about?

My second question I have not asked yet.

Were you about to answer something else?

I thought there was a second half of that question that I missed.

No.

I have a second question.

Can you give tax rate guidance on fiscal '05?

For now, let's just assume the same effective tax rate that you have assumed in the past.

We don't see any reason why our effective tax rate is going to be different next year than it was in fiscal '04.

So it is safe to say that the after restructuring charges or the restructuring charge impact is going to be 7 cents or so?

I would use the standard effective tax rate for that.

I have not calculated it, and I am not allowed to calculate it actually at an EPS number.

I think that's -- you put the earnings guidance at around 12 to 17 cents, which is well below consensus for fiscal '05.

Is that right?

Again, I am going to let you do that math because I am not allowed to provide pro forma EPS.

(OPERATOR INSTRUCTIONS).

Sir, there appear to be no further questions in queue.

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

Yes.

I would just like to say that the Company's employees, I always like to comment, have worked extremely hard to achieve important results, some of which don't always show up in a quarterly report like this.

But I am quite proud of the employees around the world working extremely hard to get this business in proper shape and deal with the effects of the recession.

So I am not only wishing you happy holidays, of course, I want our employees to know that we are delighted with their contributions, and we look forward to brighter results as we go down the road here.

Thank you very much.

Thank you, ladies and gentlemen.

This does conclude today's conference call.

You may disconnect your phone lines at this time and have a wonderful day.

Thank you for your participation.