Steelcase Inc (SCS) 2006 Q2 法說會逐字稿

Good day, everyone, and welcome to the Steelcase second-quarter fiscal 2006 earnings release 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 Mr. Terry Lenhardt, Vice President, North American Finance and Corporate Strategy. Sir, the floor is yours.

Thank you, Dena. Good morning, and thank you for joining us for the recap of our second-quarter fiscal 2006 financial results. Here with me today are Jim Hackett, our President and Chief Executive Officer; Jim Keane, our Chief Financial Officer; and Mark Mossing, Vice President and Corporate Controller.

Our second-quarter earnings release, dated September 19, 2005, crossed the wire earlier this morning. That same release is accessible on our website.

This conference call is being webcast. Presentation slides that accompany this webcast are available on steelcase.com. A replay of this call will also be posted to the site later today.

In addition to our prepared remarks, we will respond to questions from investors and analysts.

Our discussions today will include references to non-GAAP financial measures. These measures are presented because management uses this information to monitor and evaluate financial results and trends, and believes they may also be useful for investors. Reconciliations to most comparable GAAP measures are included in the webcast slides.

At this time we're incorporating by reference into this conference call and subsequent transcript the text of our Safe Harbor statement as incorporated in this morning'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 this morning's release and Form 8-K, the Company's Form 10-K for the year ended February 25, 2005, and for our other filings with the Securities and Exchange Commission.

This webcast is a copyright production of Steelcase Inc. Any reproduction, publication or rebroadcast without the express written permission of Steelcase is prohibited, copyright 2005, Steelcase Inc..

Now I will turn the call over to our President and CEO, Jim Hackett.

Thank you, Terry. Before I comment on this quarter's results and our progress, I'd like to take a moment to comment on the impact Hurricane Katrina has had in our enterprise.

Like so many in the world, our Company and its people were anxious to help as quickly as possible and in terms that were needed to reduce the impact of the tragic chaos. We cared less, frankly, about the impact on the business; we just focused on what we could do to help the human suffering. In that vein we asked our employees to make gifts to the American Red Cross and the Steelcase Foundation matched their gifts up to $1000. We've raised a tremendous amount of money.

It's been extremely rewarding to see the compassion and spirit of Steelcase in action. We were fortunate that no Steelcase employees lost their lives, but clearly those who lived in the Gulf area lost much of their life as they knew it. From destroyed homes to displaced families, there is an incredible amount of strength coming from them as they observe what was truly important.

Four of our dealers in the region sustained various levels of damage to their facilities. They have already established a way for their operations to run. Yes, we have had dealerships lose their business to fire or bad storm in the past. We have faced replacing our client space due to total destruction. But Katrina is the first time that all three groups -- our employees, our customers and our dealers -- have been impacted with this total destruction.

Yet with the bleakness of that comment, let me assure you that the indomitable human spirit and pride is alive and well. Our dealers are working through e-mail and cell phones in coordination with our own Steelcase capabilities. We're more than ready to respond to any urgent responses from any of these people groups.

I do suspect there will be a fair amount of replacement activity over the next two years as that region is rebuilt. We do not expect any one period to be inordinately impacted by this recovery. If that changes, we will certainly let you know. Later in our Q&A I will be happy to answer any questions relative to this crisis.

The report you will hear today on Steelcase is about good news. At our annual meeting in June we talked about focusing the Company on improved results. You will note that we have improved sales, improved cost of goods, better margins, reduced our operating expense as a percentage, and grown our cash balances.

Yes, there continues to be positive momentum in our financial performance. This was our fifth consecutive quarter of profitable growth. Our second-quarter results capped a solid start to 2006.

As expected, though, there is some short-term disruption from our industrial rationalization activities in North America. But We're making great progress towards our longer-term goals, and the absolute number of disruptions, which we measure, improved within this quarter. I am particularly pleased to see the 10% sales growth from our international segment. All three of our business segments had solid year-over-year growth.

Now growth was an integral part of this year's strategy. And as I have said, we experienced solid revenue growth this quarter. But we want to grow even faster. You will recall we said that our large corporate customers are key to the Steelcase performance. The data shows our growth in this segment is exceeding the overall growth of the market. This would suggest, as we have said, that their health helps us.

But we're also determined to be more successful in serving smaller or convenience-oriented customers. Turnstone had very strong double-digit growth this quarter over prior year, much faster than the overall North America segment. This comes on top of its historic success where it posted compounded annual growth rates in the double digits from fiscal year '02 to fiscal year '05. And the good news is we don't trade lower margins with this growth in business.

We've also formalized our effort into health care markets. While we have been there for years, we have intensified our efforts for the off-carpet piece since we already have a strong presence in the area we call on-carpet. I look forward to sharing with you our progress in this important segment.

Now I will turn it over to Jim Keane, our Chief Financial Officer, who will take you through the details of our second-quarter financial results. Jim?

Thank you, Jim.

Today we reported a second-quarter profit of $13.8 million or $0.09 per share. This is a significant improvement over the prior-year profit of $7.3 million, even though restructuring charges were higher this year. The improvement was driven primarily by an increase in North America operating income. These second-quarter results were within the range we estimated last quarter of $0.08 to $0.13 per share.

Revenue was $702.9 million in the quarter, an 8% increase over the prior-year quarter. Sales growth was lower than our expectation of approximately 10 to 15% growth, mainly because a higher-than-expected percentage of North America orders received during the second quarter had ship dates in the third quarter. Total North America orders came in 12 to 15% higher than the prior year and were actually slightly higher than we had expected. But because of ship dates, we believe about $10 million of revenue shifted from the second quarter to the third quarter.

North America owned dealer sales were $5 million less than expected after eliminations. And revenue for other segments were as expected. Reported revenue includes $11 million from service businesses in our North America segment that were not reported in revenue in fiscal-year 2005. In the prior year these activities were reported on a net basis in operating expenses. This is something we discussed in detail during the first-quarter teleconference. On a year-to-date basis revenue included $22.2 million from these service businesses. There is no impact on operating income from this change, but it does slightly reduce operating income as percent of sales.

Revenue also included $3.8 million related to two small acquisitions completed early in the quarter. In one case we acquired a UK-based dealership and are consolidating it with another dealer we already own in London. In the other case, a dealer we own in the US acquired a small technology services company.

Revenue is reported net of a $6 million reserve for contract-related contingent liabilities in North America. The reserve covers a period during which North America recorded revenue of about $1.9 billion. In that context, the reserve is less 0.5% of North America revenue during the applicable time frame, but it does affect year-over-year comparisons for Q2.

The combination of these three items had the effect of increasing quarterly revenue by 1.4% as compared to the prior-year quarter. There was very little effect of currency translation on year-over-year revenue comparisons.

Each of our reportable segments grew sales in the second quarter and year to date as compared to last year. The other category saw a decline in revenue, primarily because construction and bid activity in PolyVision's core education markets were weaker than the prior year. This decline was partially offset by increased revenue at IDEO.

Now I will talk about profitability. The $13.8 million profit we earned this quarter compares to a profit of $7.3 million last year. Included in our reported profits are after-tax restructuring charges of $6.1 million compared to $1.4 million last year. So reported profit increase by $6.5 million even though restructuring charges increased by $4.7 million. The $6.1 million of after-tax restructuring charges were in line with the 3 to $7 million we had estimated last quarter.

The North America charges of $3.1 million after-tax relates to the plant consolidation activity announced early in Q1. International restructuring charges were $3 million after-tax, and primarily related to headcount reductions for previously announced manufacturing moves and severance costs related to outsourcing certain business process.

Cost of sales, which does not include restructuring costs, was 58.5% of sales, an improvement from 59.8 percent of sales in the prior-year quarter, primarily due to a 2.3 point improvement in North America cost of goods sold.

North America cost of goods sold included a $3.9 million benefit from an inventory adjustment. This involved an increase in estimated overhead included in the book value of inventory. And, because we're beginning to use the new estimate this quarter, it reduces cost goods sold and increases gross margins within the quarter. The effect of the change in future quarters is expected to be immaterial.

We also obtained a commitment to receive a refund of property taxes paid in earlier years of approximately 4.1 million. This reduced cost goods sold by $2.9 million.

We also had some items that negatively affected cost of goods sold. For example, we booked $2.6 million of accelerated depreciation on equipment used to make products that will be culled. We also had a $1.1 million increase in our workers' compensation reserve related to specific cases.

So if you net out the positives and negatives I described, they had a combined effect of reducing cost goods sold by $3.2 million, and that was all within the North America segment.

Gross margins of 30.4% were up slightly from 30% in the prior-year quarter. In addition to the benefit of reduced cost of sales which I discussed a minute ago, North America also captured a better yield from earlier list price adjustments. The improvement in price deals was partially offset by the contract related contingency reserves and higher restructuring charges.

Operating expenses, which do not include restructuring costs, were 26.5% of sales compared to 27.3% of sales in the prior-year quarter. The improvement is primarily due to the impact of continued cost control and leverage from higher sales volume. Operating expenses were net of $2.3 million related to the gain on sale of a corporate jet and $1 million related to the property tax refund discussed earlier.

The impact of foreign currency fluctuations on operating expenses in our international segment was insignificant for year-over-year comparisons.

Our reported operating income of $25.3 million compares to $16.8 million in the prior year. We included a chart in our release and webcast slides that shows operating income without restructuring charges, which is a non-GAAP number, but it's something we do focus on internally. This number was $35 million for the quarter, an 86% improvement over $18.8 million in the prior-year quarter.

That chart also shows operating income without restructuring charges as a percent of sales. We have reached the 5% mark this quarter, up from 2.9% a year ago. Our goal is 10%, and these results show we are continuing to make progress towards that goal.

Our effective tax rate was 37.5% for the quarter.

Next I will talk about the balance sheet and cash flow. Our cash balance was $287 million at the end of the quarter, a $49 million increase from our cash balance at the end of the first quarter. That's following the normal seasonal pattern.

Capital expenditures were $20.9 million in the quarter compared to $28.3 million in depreciation expense. The difference represents a source of cash. We continue to carefully manage our capital expenditures.

As we have discussed in the past, we have two corporate aircraft which we primarily use to bring customers to and from Grand Rapids. This quarter we purchased a new aircraft and sold our oldest aircraft. Capital expenditures in the quarter include the final $9.7 million installment payment for the purchase of the new aircraft. We received $14.8 million for the old aircraft. And these are included in the cash flow statements under proceeds from the disposal of fixed assets. There was a $2.3 million gain from this sale included in operating expenses, as I mentioned earlier.

Now I will discuss the operating results for each of our segments, starting with North America. In North America sales were $401.3 million in the quarter, up 9.8% from the prior year. Revenue included $11 million in revenue from our service businesses that were reported net in operating expenses in the prior year, $2 million in acquisition related revenue, partially offset by the $6 million reserve. North America's operating income more than doubled versus the prior year despite higher restructuring charges.

The items we discussed earlier related to revenues, cost of sales and operating expenses had a combined effect of decreasing North American operating income by $0.1 million, so they largely offset each other.

North American gross margins were 27.6% compared to 25.8% in the prior-year quarter. Restructuring charges included in gross margin were $5 million in the current quarter compared to $2.8 million in the prior-year quarter.

North American operating expenses were 22.5% of sales, a 0.5 point improvement over the prior year.

SDP sales were $85.9 million for the quarter, a 6.4% increase compared to the prior-year quarter. Sales grew in key customer segments and because of some big project wins that shipped during the quarter.

SDP gross margins of 38.2% were down slightly from 39.3% in the prior year, primarily because of a mix shift.

SDP operating expenses as a percentage of sales improved from 29.7% in the prior-year quarter to 28.6% in the current-year quarter. This improvement was primarily due to increased volume.

SDP recorded an $8.2 million operating profit in the quarter versus $7.7 million in the prior year. As a percent of sales SDP operating income was 9.5%, which is consistent with the prior-year quarter.

International sales were $145.1 million in the quarter. This represents a 10% increase compared with the prior-year quarter. Revenue included $1.8 million related to an acquisition. Foreign currency effects did not have a significant impact on the year-over-year revenue increase. We saw sales growth in nearly all markets. International had the highest sales growth of any of our segments this quarter, and we're seeing positive signs of growing sales momentum in several markets.

International reported an operating loss of $4.1 million compared to a loss of $2.5 million in the prior year. The current-year loss of 4.1 million includes 4.8 million in restructuring charges. The prior-year loss included $0.8 million in restructuring gains.

International gross margins were 28.9% in the quarter. Restructuring charges had the effect of reducing gross margins by 1.8%. In the prior year gross margins were 32%, but that included the restructuring gains that had the effect of increasing gross margins by 1%.

International operating expenses were $43.9 million, or 30.3 percent of sales. This compares to operating expenses of $44.2 million or 33.5 percent of sales in the prior-year quarter.

Now I'll review our outlook. First let me comment as well on the financial effect of Hurricane Katrina.

Damage to Steelcase assets was immaterial, and we do not expect any material charges against earnings at this time. We do have some independent dealers in the affected areas, and they're still in the process of assessing damage. We have less than $1 million in receivables related to those dealers, and we believe those amounts are collectible, although we will extend our terms as necessary.

There are a handful of situations where dealers have taken delivery of furniture for customers whose facilities are now uninhabitable. Our dealers will hold that furniture until the customer is ready to accept delivery. We're going to do everything we can, as Jim said, to help our customers and dealers get back into business.

In the short run, the effect on sales will be immaterial since the affected regions represent only 1% of our North America business. In the longer run, we may see an increase in orders as customers begin to rebuild. We are already receiving requests to rapidly ship new product to customers setting up temporary facilities, but it is also possible we will see higher inflation in construction materials, including steel and wood.

Unrelated to the effects of Katrina, we announced an annual price list adjustment in North America last week. Over the last year we've seen ongoing increases in commodity prices and we expect those increases to continue. Steel prices, which rose sharply over a year ago, have been volatile but have remained above historical levels and have risen again recently. We absorb some of these increases through productivity improvement efforts and because our own price increases usually lag behind the higher costs we're paying for raw materials. But our annual price increase is a very important way for us to protect our profitability.

So this price increase was designed to recoup some of the material cost inflation we've already seen, and to deal in a more permanent way with the increased cost of steel. The temporary steel surcharge we put in place back in April of 2005 will be eliminated at the same time the new price increase takes effect in January of 2006. Since costs will probably continue to rise between now and January, we expect the combined effect of net price increases and cost increases to largely offset.

When the surcharge is eliminated, the effect will be immediate on all orders received after that date. The new price increase will take effect more gradually for some customers because of price hold agreements and other factors. However, at the same time, last year's price increase continues to take effect gradually for the same reasons.

Finally, the details of this price adjustment were determined long before Hurricane Katrina. If we see sustained extraordinary increases in our costs because of the rebuilding effort or spikes in fuel prices, we will respond as appropriate.

We expect the third quarter to benefit from strong backlogs at the end of the second quarter. North America backlog is higher because a higher percentage of orders received in June were scheduled to ship in Q3. Order rates weakened a bit in July and then strengthened again in August, also helping to build backlog as we enter Q3. In the first three weeks of September orders were up more than 10% from a year ago. So we expect strong volume in Q3 for North America.

We're also encouraged with the strength we're seeing in international. Certain markets are still slow, but overall volume is picking up. We idled several European plants for two weeks during the August vacation period, so this segment also has a strong backlog as we enter September.

Despite tougher comparisons from last year, we still expect Steelcase Inc. revenue to be up approximately 8 to 12% from the third quarter of the prior year. A number of factors are expected to reduce our profit leverage in the third quarter. First, we're seeing more project business in the beginning backlog, and that means higher average discounts than we've been seeing. We're not saying that competitive pressure is having a pricing effect, but just that we're seeing a mix shift. Second, in North America we will be starting the next phase of our restructuring effort during which a number of lines will be relocated, and that usually causes some loss of productivity. Third, we have increase in fuel cost, which could reduce third-quarter margins by more than $2 million as compared to the prior year.

We expect to incur restructuring charges of 2 to $5 million after-tax in the third quarter, and we expect reported earnings per share will be between $0.10 and $0.15 per share. We're expecting another improvement in net income.

For the fourth quarter, we expect 1 to $3 million in after-tax restructuring costs. That brings the total for the full year to 16 to $20 million after tax.

Finally, when we announced the North America plant restructuring work back in the spring, we estimated 25 to $30 million in charges in 2006 and 2007 combined. We now believe some of the costs we originally expected to incur in fiscal 2006, the current year, will now shift out of 2007. The total cost may be in the range we estimated, but we aren't reconfirming the number. Next quarter we will have completed the signing process for 2007, and we may have an update at that time.

So that's it. To the first half of the year, we're right where we expected to be. Volume is picking up and profits are improving.

Thanks for your attention, and now we will open it up for questions.

(OPERATOR INSTRUCTIONS) Susan McLary (ph).

Calling from UBS. Can you talk a little bit about -- you said that you're seeing a better mix of large project business in your orders, in your backlog. Can you give us a sense in terms of industries and different kinds of customers where you're especially seeing strength?

The direct answer to that would be what we call the FIRE Group -- that's the finance, insurance and real estate organizations. Those have been quite healthy and continue to be so.

And was there -- were they stronger this quarter, it seems, than they were maybe in the last few quarters?

I think that industry has been the most expansive over the last two years. I really would say since the .com kind of collapsed that those segments have been as healthy as any single part of our industry.

Can you give us an update of where you are in terms of your restructuring program? You said that some of the costs you thought would be in '06 are now going into '07. You've made lots of progress on the front over the last several years. Can you just give us an update in terms of kind of the five-year plan that you had laid out where you are, and maybe what we can expect to see over the next few years?

Let me just give you the update on the things we announced earlier this year. So back in the beginning of the first quarter we announced that we were going to be taking out some restructuring efforts in North America, and we sized those for the 2006-2007 period. So that was really just a two-year outlook. That project has been moving along, I would say, on schedule.

Now what happened is we said back then, we put together the project and then after we made the announcement a team of people began working through all the details which involves which lines exactly move and in what order they move. So you have some timing differences as you go through that process. So even though we kind of lay out what we expect our charges to be, the actual charges depend on how decisions are made and when actions are taken.

The main thing we have been seeing now that is maybe different from what we said originally is just that some of the charges that we expected in 2006 have likely shifted out to 2007. It doesn't mean that the project is moving at a different pace because some of those actions that generate charges can be different than other things we can be doing that don't generate charges. So I would say we are on track, so the basic plan is the same.

And those efforts are limited to North America. We've also been taking actions in our international segment along the same lines really, and those projects are also on track.

So all of these are a necessary part of what is going to take to help us get to those long-term gross margin goals of 35% that we have talked about before. It is only one part of it. We have to do this as well as reduce complexity in our product line. We would also have to take steps to have a more global supply chain. But we feel good about where we are right now.

And then one last question. Given the balance sheet is very strong, you've got a strong cash balance there, and you recently announced that you're increasing the dividend, has there been any consideration around maybe some share repurchases or anything along those lines?

I would say that each quarter we talk about and consider all the options we have available. And as we have said before, the Company's general posture on these things is that our first priority is to return value to shareholders through dividends. So the increase in dividend is a strong signal that the Board is looking at the Company and seeing the outlook for profitability, and based on everything they can see believe that increase in the dividend was appropriate. We will consider all the other options as well, but we do that on a quarterly basis.

Budd Bugatch.

It's Raymond James. A couple of questions. Let's start with the revenue side.

If I understand the comments, it's going to be 1.5% or about $10 million of the 8 to 12 is already booked in from the orders that are going to shipped in the third quarter that didn't get shipped in second. Is that about right, Jim?

Let me say it with my -- my words would be what we -- when you look at the orders that come in in Q2, and you consider what we would normally see in terms of ship dates for those orders, we saw that an unusual amount of those were actually going to ship in Q3. And that amount we're sizing at about $10 million.

So that's 1.5% of it or about 1.5% of that 8 to 12?

Yes, that's about right.

When you look at the backlog now, can you characterize the backlog, either year-over-year in terms of percentage gain dollars or quarter-over-quarter?

I don't have the percentages to give you, but we believe our backlog is strong. And the characterization we would make is that we have the prior mix of projects (indiscernible) is related to some of those things Jim was talking about as we're seeing some of this business pick up. The downside, of course, is that project business tends to be more highly discounted than the day-to-day business or smaller customer shipments. So we do expect to see some increase in discounts. Again, not because we think the competitive landscape is changing, but just because of the shift in mix.

Understood. And you think the backlog is maybe 55% project business instead of what, a more normal 40 or 45?

I really don't have an estimate of that, but there was enough that it does change our discount assumptions a little bit. I don't have a quantification of that, though, for you.

And a last issue on revenues. How about by segment? You have given us an 8 to 12. What do you think it is? Does international still grow faster than the rest of it -- rest of the segments in the third quarter?

What we are actually thinking now in the third quarter is that because North America has this mix shift, and it's really just in North America segment that that ship date effect occurs, North America should have pretty good growth in the third quarter. We would expect North America to be higher than the overall average (indiscernible). And international is still seeing strong growth. SDP is going to be up against some tough comps for the prior year, and so in order that's kind of what we would be saying. North America is going to be a little bit better than the average, SDP might be a little bit lower than the average.

We are particularly pleased, though, with this international performance. We've been talking about how international markets enter the downturn after North America. And we're coming out of the downturn with less vigor and power. And now we're starting to see sustained year-over-year growth in sales in international. It's doing good momentum as we go into the second half.

And North America, is that being powered by Turnstone, as Jim said?

Turnstone is a big part of it, but we're also seeing the pickup in the large customer and large project business. But it's also -- so we're seeing it in terms of order rates themselves. The current order rates remain strong, but then we also have that backlog that I am talking about from Q2.

Just a couple of other nitty questions. Restructuring outlook by segment, how does that breakout third and fourth quarter? How do you -- and by classification in terms of cost of sales versus OpEx?

I don't have the breakout on the forecast. I don't think we usually provide that. The nature of the actions that are being taken are still primarily in North America and international.

Do you think it's 50-50? Would that be a good way to characterize that, like it was in this quarter?

I actually don't have the number in the room even. But we have activity going on in both. I don't want to throw out a number and have it be wrong. The amounts are relatively small, though, too, as we go into Q3 and Q4. So it shouldn't throw off the model too much.

Just trying to do it for modeling purposes. What about CapEx for the year in terms of guidance? And what about disposals? And do you have any other acquisitions planned that will hit third quarter or fourth quarter?

The CapEx through mid-year is 39 million. And we would expect that the second half CapEx would be at or slightly less than that, roughly speaking. And that's not a formal outlook; it's just kind of -- no reason to expect for it to increase a lot. There were some things related to large CapEx -- for example, the airplane -- that caused the first-half number to be a little bit high. So we would actually see kind of a gradual increase, actually, in activity on CapEx in the second half, but the reported CapEx will come in lower because that airplane was in the front half.

And disposals, what are you looking for there?

I have nothing right now formal to talk about on disposals.

Is there much in the way of assets held for sale on the balance sheet that's embedded in the other assets or other current assets?

I'll let Mark just talk quickly about assets held for sale.

We had 28 million in assets held for sale or classified in current assets right now. And that relates primarily to excess properties that we have for sale and expect to be sold in the next year.

The Grand Rapids campus is not in that number. That's still -- as we finish our restructuring here it will go to that classification once we feel we are likely to sell it within the next year.

Any idea what the size of it is, Mark?

That number, as we said in the previous, was (multiple speakers) 30 million?

30?

It's less than 30.

And finally the question on any acquisitions that you used gas (ph) for?

You know, Budd, the kind of answer on that is that we don't speculate on those. But I would say something that confirms as we enter a Board meeting period about, which is we've got a great Board who are committed to looking at the long-term and making investments where there's great upside and great opportunity. They have always been willing to support us in that regard. And we don't feel hampered by anything. In fact, as you can tell, the cash is growing. So the Company wants to be aggressive in its growth, and we will hopefully make good decisions in that regard.

Matthew McCall.

BB&T Capital Markets. Good morning. First, in the remarks you mentioned that you thought that your North America -- North American large project business I guess was growing faster than the market as a whole. And you also said Turnstone is growing faster than the market as a whole. It looks like that entire segment is up about 10%. We don't have all these numbers industry yet, but is 10% going to outpace the industry, or am I looking at that wrong?

I think I want to back up and say that the nature of the way the quarter-over-quarter shifts happen in the industry it is going to be really hard to pinpoint this one data point and make kind of any kind of share assessment. We tend to look at it on a rolling basis. We know when we ended last year we had some improvement.

To clarify, what we're saying is as the mix of our large account business projects are a bigger percentage in what we call the continuing structure, and this is more intuitive in the sense that in a recovering economy and in corporate America in this case deciding to invest in facilities, there's more projects emerging. In fact, after 9/11 there was a fair amount of interest by corporations to separate some of their facilities. I think we benefited from a decision where they took larger facilities and just aggregated them, and they're coming to fruition now.

Some of those projects were agreed to conceptually and then put on hold, and now they're happening. And it explains a little bit about why we won the order but they haven't shipped yet because those kinds of progress projects have longer -- they don't take longer to build per surface, but they take longer for the corporation that is buying them to sequence their moves into those spaces. So that's the reason these cross over different periods.

So the comment that North America is outpacing the industry is -- you're confident that there is no share issues at all?

What I wanted you to understand is that if we go back we said that our large and our global accounts group is growing faster than the market. That's true. And Turnstone is growing faster than the market. And projects within the large account segment are a greater mix. When you add all that up, it's too early for us to tell what happened because we don't have industry data. I'm conscientious about that, Matt, but I tell you that any one quarter in this industry is a little misleading.

Sure. I just want to make sure I understood the comment.

Does that clear it up?

It does. It's fine. The other question I had, last quarter I believe you said maybe we were a little aggressive in our second half outlook, so I think there was a statement that the second half would approximate the first half of the top line. Given that some of those orders are pushed out in the second half, is that statement still true?

(indiscernible) last time I said that second-half volume usually -- normal seasonal patterns I would say they're at or slightly above the (indiscernible) we saw no reason to believe that that would be different. I would update that just to say that we have had $10 million that we were expecting to have in the first half that will now be in the second half. So you can adjust it to that.

When you say slightly above on a percent rate plus or minus, can you give me an idea of what that means?

I didn't size it other than if you had to pick one versus the other I would say the second half would normally be slightly bigger than the first half, and the reason is because you generally are seeing growth year in and year out. So you're getting just that year-end slope that is just generally moving up. So I'm not going to size it for you, but I would say now (indiscernible) you add the 10 to whatever you had assumed before.

Okay. The surcharge is still in effect, is that correct?

The surcharge will be in effect until January 16th. And that is the day when the new price adjustment takes effect. Orders received after that date would no longer be subject to the surcharge.

Did you quantify what the price increase was going to be?

We didn't quantify it other than to say that we have taken all of these things into account as of the time we did the math for the adjustment. So as of a month or two ago it took into account steel. It also took account the increases in fuel costs and other commodities. So all that was considered in calculating it.

I would say -- and I can hear Budd in the background somewhere -- when you start to do the modeling with regard to the commodities, no doubt all of us are dealing with the period (ph) that I can't recall for the last 20 years where the potential inflationary effects are more dramatic.

The great news is when you look at the surcharge in managing the steel cost, it went fairly well. The energy thing, as lots of others have been in writing about, have seem to have been absorbed in the economy fairly well and it didn't thwart GDP growth. I am concerned, though, that if it persists at this higher level it definitely is going to begin to inflate raw materials.

So the Company's attitude about this is to be on top of this issue and move as quickly is prudent. But you still have the market sensitivities, what the market at-large believes (indiscernible). And then events like Katrina, which we're still not clear what that's going to mean for everything.

Just a quick example, you know that some of the gas that Air Products (ph) imports in the port of New Orleans is used in the creation of steel products. And they're probably moving 10 to 20% of the capacity of that material for the eventual completion of steel production. Now that's going to improve, but we're not sure yet at what rate that starts to improve. So my reason for kind of inserting this at this point is that so all of you -- we want to stay in touch with you about it, but it takes a little patience here because things are moving so quickly in terms of how much of this is persisting and how much of it is just short-term ups and downs.

So the price increase, you have let your dealers and your customer know what price increase is going to be, or it is still a work in progress?

We have begun the communication process, so last week we (indiscernible) customers and so where the process goes, rolling that out.

Okay, but you're not ready to quantify it. Is it probably going to -- considering you're including other, or including all that's been going on in the inflationary environment, is it safe to assume that the price increase will be probably a little bit above last year's?

Well, I think it -- the way I guess I would say that is that the price increase is really intended to help us offset these inflationary forces that Jim talked about. But if you're trying to figure out what to do in your model, it's possible that from one quarter to the next there could be some impact in the long run. But what we're really trying to do is neutralize the effect of inflation. So for modeling purposes I wouldn't consider this to be (multiple speakers) increase in margins. We're trying to simply neutralize it. And if you kind of think about what Jim was saying (indiscernible) it's certainly greater across the board than they were a year ago or two years ago, and so the amount we do in these adjustments are going to reflect those trends.

Okay. I guess -- I'm sorry to keep going on this, but I think in your Q3 guidance you're talking about $2 million in incremental costs from oil, maybe the way -- what assumption do you have for oil prices or fuel prices there in that guidance?

What we're there -- and what let me make sure I clarify this. We are just trying to give some visibility as an example. Fuel is just one commodity, and the $2 million that we upgraded in the release is -- since the impact we think third-quarter costs have seen versus third quarter a year ago we've probably seen more than half of that impact already during the second quarter. But the last time we did a price adjustment, we had not build anything in to that. So what happens is for a while there we end up observing these higher costs, and then when the price increase comes through next year then you begin to offset some of that. In the long run -- and in the long run you're going to have that -- you're certainly going to have those types of things. When in the short run the cost rises and you didn't build it into the last increase and then the increase takes effect. But in the long run all you're trying to do is neutralize these forces.

And then finally, you can just answer this however you want. I think your closing remark was you're right where you thought you would be at this point in the year from an operational standpoint. Your target of 10% operating margin, that's I believe a fiscal year '08, sometime in that time frame, on a run rate basis. Can you just talk about if that's what you're implying that you still are on track for that type of operating margin on that type of time frame? And then what are the biggest challenges between now and then? And that's all I have.

The 10% is a number we've used before as a long-term target, and we have generally described it as a three-year target. So that's kind of where it comes from originally.

The reason we put that target together is to help us since we are (indiscernible) internally to make sure that all that actions -- restructuring actions, product simplification, sourcing, implementing lean in our business processes, all these things that we're doing we want to make sure that we have the right activities going on that will help us achieve that goal.

As you said, and as I said, though the first half of the year we're feeling pretty good about where we are. We are right where we would have expected to be. But it's a long road ahead. And the challenges we're going to face are involved implementing all those projects I described. Some of those are -- some of the goals are more challenging than others. The gross margin goal, for example, there is a lot of work to be done to achieve that. But I feel -- I don't feel any less confident about that than we did when we put the goal in place.

I think the short answer is that we're on track to hit the long-term target and we're making good progress against it and pleased with the operating margin performance we had here in the second quarter. And we hope to continue to improve margins as we go forward.

In fact, to add to that, I don't think you went on too much about it. I think the volatility in some of the sourcing issues you're catching are right on. I think if there's any challenge to the 10%, it's the nature of that volatility helps enable many these things that we had the benefit of stability for are moving on us. But one term we like to use around here is managing unanticipated events. So it's kind of having the ability to react and deal with it. So we want to exude confidence that we aren't going to let things like this destroy our economics and we're going to work harder to make sure that we are on top of this.

(OPERATOR INSTRUCTIONS) Budd Bugatch.

Maybe I should have understood this, but I'm not sure I did. In the 8 to 12% that you're guiding for revenue growth in third quarter, can you tell me, is there any price increase built in to that, Jim? There's some residual price increases, right, that's coming to realization?

That's right. The price increase that we announced last week won't take effect until orders received after January 15th. So there's no direct impact of that in Q3.

Of course.

We have been and we expect to continue to see the ongoing benefit from previous price deductions -- you call that a (indiscernible) impact. We do expect to see continued benefits from that. And those benefits for the third quarter we expect to be offset a little bit because of the entire project mix that could cause our discounts to be a little bit higher.

When you're building that forecast that you're communicating to us, are you building it with a sort of order pacing in mind and shipping may be six to seven weeks in the backlog, and then the balance? Or is it built from ground up from of what you know you've got? How do you build that so that you can feel comfortable communicating that to us?

I'll give you an example from a particular segment. We started with -- we do look at order patterns and we make assumptions about what we think the order patterns are going to be. Those assumptions are based both on recent trends, but they're also based on history, as we do have a seasonality in our business. And then there is also some consideration of preorder activity, so (indiscernible) projects and things -- bids (ph) that are out there. And all that goes into what we think the weekly order patterns will be. We also know what our beginning backlog is. So when it comes to putting that in projections, we know that as a fact. So we can start with that. And then yes, there's assumptions in there about what we think backlog will be during the quarter in total. That's a function both of customer order patterns and also our own capacity and lead times. So all those things go into the mix. Each our segments does its forecast considering those things to different degrees, and then we add it up and give it to you at a range.

Just making sure I understand, the backlog -- this isn't a perfect characterization. Should we assume like a six to seven week duration of the backlog?

It would be misleading for me to give you any particular week, because it varies dramatically as you go from steel to wood, Turnstone, SDP companies, international. So I'm not going to give a number like that because it's an oversimplification.

(OPERATOR INSTRUCTIONS) Gentlemen, I'm showing no further questions in the queue at this time. Did you have any closing comments?

It's Jim Hackett again thanking the employees of the Company for their response to the crisis in the Gulf region, confirming that we are very happy with the momentum and the return to profitability on a rhythmic basis, and optimistic about the rest of the year. So we appreciate your attention today. Thank you very much.

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.