Steelcase Inc (SCS) 2006 Q3 法說會逐字稿

Good day, everyone and welcome to the Steelcase third 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 to Mr. Terry Lenhardt, Vice President North American Finance and Corporate Strategy.

Sir, the floor is yours.

Good morning everyone.

Thank you for joining us for the recap of our third 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 third quarter release dated December 16, 2005 crossed the wire earlier this morning, and 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 discussion 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.

We believe this information may also be used both for investors.

A reconciliation to the most comparable GAAP measures are also included in the webcast slides and earnings release.

We're incorporating by reference into this conference call and subsequent (technical difficulty) the text of our Safe Harbor statement included 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 accompanying Form 10-K for the year ended February 25, 2005, and our other filings with the Securities and Exchange Commission.

This webcast is a copyright production of Steelcase Inc.

With the formalities out of the way, I will turn this call over to our President and CEO, Jim Hackett.

Good morning to everyone.

I'm pleased to report to you today our results this quarter and the continued good news that is year to date.

This was our sixth consecutive quarter of profitable growth.

Now being profitable in business forces of course is a given, so I don't want to over dramatize this fact.

However, as the CEO of a business that has gone through a series of major changes as it works to make itself better, being profitable confirms progress.

I'm here today to strongly confirm we're making progress on a number of fronts.

All three of our business segments saw growth in revenue and had substantial improvement in operating income as compared to last year.

This quarter we continued to see the benefits of prior actions flow through at the operating income level.

Overall we are on track (technical difficulty) our facility rationalizations in advancing our lean manufacturing efforts across the whole enterprise.

We're continuing to reduce complexity from our product portfolio and progressing with our global supply chain efforts.

Yes, there still a lot of hard work ahead.

And we have had some minor disruption in our service levels due to a product rationalization.

That might be some of the negative news.

The good news is that we have gotten that behind as, and today we're reporting that we have improved our change management to ensure our customer and dealer experience is a key priority for us.

Growth continues to be a primary focus.

The comps will continue to get tougher year-over-year and the pace of growth will appear slow when compared to the very strong fourth quarter we had last year, along with normal seasonality.

Going through a recession two years ago has made us in this Company acutely aware of what signs we should continue to look for regarding any kind of change in economic conditions.

Today I would report to you that I can see all the signals are still very positive.

Beyond the basic strong signs in the economy we serve, we're confident that the strategies we're implementing around serving smaller customers in vertical markets like health care and new global markets such as China will generate continued growth.

These seem to go grow despite the other cyclical pressures.

For example, our Turnstone brand grew at strong double-digit pace this quarter, and has experienced double-digit growth year to date.

Turnstone's focus is on sales to smaller customers, and this was an area that was quite strong.

Our health care efforts continue to gain great momentum.

And we have forecasted growth in this segment well beyond the (indiscernible) forecast.

I'm also pleased to report that I am bullish on the positive signs out of Japan.

Steelcase has been Japan for almost three decades.

And our team in that market continues to improve their performance.

We have accomplished a tremendous amount over the past two years thanks to the commitment and hard work by all Steelcase employees, and the results show it.

We care about sustainable growth in our financial results, and as well in environmental initiatives and product innovation.

We have talked about our new Think chair.

It is a great example of our belief that designing for one environment can never be at the expense of another.

Steelcase just became the first office furniture company to receive the McDonough Braungart Design Chemistry new Cradle to Cradle product certification for the Think chair.

At the same time Think was selected as the recipient of the 2000 Design for Asia Award, an international design competition that awards companies for designs that reflect or have an impact on the Asian lifestyle.

Think has also won innovation awards in Europe and North America as well.

In summary, the focus in the Company is on making steady progress towards our long-term profitability goals, and maintaining our strong balance sheet.

From this solid foundation we will invest to accelerate innovation-based growth in our core markets, and expand our business model to capture opportunities in adjacent markets.

I'm pleased to now turn this over to Jim Keane, our CFO, who will take you through the details of this good third quarter.

Today we reported a third quarter profit of $19.1 million or $0.13 per share.

This is a significant improvement over the prior year profit of $10.1 million, particularly given that restructuring charges were higher than last year.

The improvement was driven by significant operating income improvements in all of our major business segments.

These third quarter results were consistent with our estimate of $0.10 to $0.15 per share.

Revenue was $750.7 million in the quarter, an 11.4% increase over the prior year quarter, also consistent with our previous estimates.

Quarters remained stronger in the quarter, but because we are now up against stronger prior year comparisons, the year-over-year growth is back to single digits.

We said before that revenue this year includes the results from service business in our North America segment that were not reported in revenue in fiscal year 2005.

Previously these activities were reported on a net basis in operating expenses.

Revenue from the service businesses amounted to $12.8 million in the third quarter, and $35 million year to date.

This change has no impact on operating income, but it does slightly reduce operating income as a percent of sales.

During the second quarter we completed two small acquisitions.

Revenue from those acquisitions were $8.4 million for the third quarter, and $12.2 million year to date.

For the quarter currency translation effects reduced net sales $6 million compared to the prior year.

Together service revenue, acquisitions and currency had a net effect of increasing quarterly revenue by 2.3% as compared to the prior year.

Now we will review profitability.

The $19.1 million profit we earned this quarter compares to a profit of $10.1 million last year.

Last year's results included a tax benefit from a $6.5 million reduction to a specific tax reserve, so the percentage improvement in pretax profits is much higher.

Included in our reported profits are after-tax restructuring charges of $4.6 million, which is at the higher end of the 2 to $5 million range we estimated last quarter.

The $4.6 million of after-tax charges compares to $1.2 million last year.

The North America charges include $1.8 million after-tax, related to the continuing plant consolidation activities announced early in the first quarter, and $0.7 million after-tax from for impairments taken against two idle facilities.

These facilities are being idled as part of earlier plant consolidation activities.

International restructuring charges were $0.9 million after-tax, and primarily related to severance charges and asset impairments related to changes in our European distribution model, and outsourcing of certain business processes.

Finally, we had $1.2 million of after-tax restructuring charges related to a plant consolidation at PolyVision.

The charges primarily related to severance and relocation costs, as we combined PolyVision's K-12 blackboard fabrication into a single facility.

Cost of sales, which does not include restructuring charge costs, was 69.4% of sales, an improvement of 250 basis points from the prior year, including a 400 basis point improvement in North America, and a 210 basis point improvement in international.

Gross margins of 29.8% were up significantly from 27.9% in the prior year quarter.

Lower cost of sales were partially offset by higher restructuring charges.

This year's change in accounting for service revenue had the effect of reducing the gross margin percentage in the quarter by 0.3 points as compared to the prior year.

On a sequential quarter basis, gross margins were down slightly as expected because of move costs and disruption from operations changes, and a higher mix of larger projects, both primarily in North America.

Higher fuel and material costs were also a factor.

Operating expenses, which do not include restructuring costs, were 25.2% of sales compared to 27% last year.

The improvement is primarily due to the impact of continued cost control and leverage from higher sales volumes.

The absolute level of operating expenses in the third quarter increased slightly versus the prior year, because of higher variable compensation accruals, costs related to the acquired businesses, and the change in accounting for service revenue.

The impact of foreign currency fluctuations had the effect of reducing operating expenses $1.7 million compared to the prior year.

Our reported operating income of $32.7 million was a significant increase from the $6.2 million in the prior year, despite higher restructuring costs.

This was our highest reported quarterly operating income in over four years.

As in the past, we included a chart in our release and webcast slides showing operating income without restructuring charges, which is a non-GAAP number, but it is something we do focus on internally.

This number was $40 million for the quarter or 5.3% of sales, a dramatic improvement over $7.9 million or 1.2% of sales in the prior year quarter.

Our year to date effective tax rate was revised to 38% during the third quarter, up from 37.5% at the end of the second quarter.

The increase is due to expected higher permanent businesses, primarily related to the sale of real estate in Cherbourg, France.

The tax expense for the third quarter includes the catch up effect from the first two quarters of the year.

We expect the tax rate will be 38% in the fourth quarter and for the full year, but we continue to believe that our long-term effective tax rate is between 37 and 37.5%.

Next I will review the balance sheet and cash flow.

Our cash balance was $332 million at the end of the quarter, up $45 million from the second quarter.

This increase is consistent with our normal seasonal patterns.

Cash exceeded debt by $64 million at the end of the quarter.

Capital expenditures were $14.8 million and depreciation expense was $27.8 million in the quarter, the difference represents a source of cash.

We continue to carefully manage our capital expenditures.

We currently have $250 million in outstanding term notes that are due in November 2006.

Since the maturity date of these notes is now less than 12 months out, we have classified this debt as a current liability.

It is likely that we will eventually replace this debt with a new long-term obligation.

We repurchased 250,000 Class A shares on the open market during the third quarter under our outstanding share repurchase program.

We have said before that we may use both share repurchases and dividends as vehicles to return value to shareholders.

During this past quarter we saw an opportunity to buy some shares at an average price of $13.75.

We have a remaining authorization to repurchase approximately 3.6 million shares, but will continue to be opportunistic as we make repurchase decisions.

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

North America sales were $433 million in the quarter, up 17.4% from the prior year, driven by increased sales across most of our product categories.

Revenue included $12.8 million in revenue from our service businesses that were recorded net in operating expenses in the prior year, and $5.6 million from acquisitions.

Within North America growth came from large customers as well as customers served by Turnstone.

We continue to our business in the health care and education segments.

North America operating income grew substantially to $19.5 million from $2.6 million a year ago, despite higher restructuring charges.

Higher revenue and improvements in cost of sales and operating expenses as a percent of sales combined to generate this performance.

Cost of sales improved 4% (technical difficulty) as an improved pricing yellow, leverage from higher sales volumes, increase to labor productivity, and lower overhead spending.

Cost of sales was negatively impacted by inefficiencies related to the startup of new production lines and continuing disruption from previous consolidation efforts.

We anticipated disruptions from these activities and talked about them on last quarter's call, but the cost this quarter was higher than we had expected.

We also incurred an estimated $2 million increase in energy costs, primarily related to diesel fuel.

The 4 percentage point improvement in cost of sales was also partially offset by $3.2 million in higher restructuring costs.

But North America still improved gross margins from 23.3% in the prior year quarter to 26.6%.

This year's change in accounting for service revenue had the effect of reducing the North America gross margin percentage in the quarter by 0.5 points as compared to the prior year.

North America's operating expenses were 22.1% of sales, an (technical difficulty) improvement over the prior year.

SDP sales were $86.8 million for the quarter, a 4.6% increase compared to the prior year quarter.

SDP revenue did not follow as far during the downturn, so we don't expect to see the same bounce as North America during the recovery.

Revenue grew in key customers segments, such as hospital, hospitality, education and health care, and because of an increase in project business during the quarter.

We're very pleased to report that SDP operating income reached 11.5% of sales in the quarter, a strong improvement over 9.3% in the prior year.

The improvement was both in cost of goods sold and operating expenses.

This is the highest quarterly operating income and operating income percentage performance by the SDP in four years.

International sales were $167.4 million in the quarter.

This represents a 7.7% increase compared with last year.

Currency translation had the effect of reducing revenue by $6 million, or 3.5%, as compared to the prior year.

Revenue included $2.8 million related to a second quarter acquisition.

International returned to profitability this quarter reporting operating income of $6.6 million compared to a loss of $1 million in the prior year.

The current year income includes $1.4 million in restructuring charges compared with $0.3 million in the prior year.

Operating income as a percent of sales rose to 3.9%, up 450 basis points from a loss in the prior year.

International gross margins were 31.4% in the quarter versus 29% in the prior year.

This improvement is driven by the benefits realized from prior restructuring activities, better fixed cost absorption due to the higher volumes, and lower restructuring costs impacting gross margin.

International operating expenses were $44.6 million or 26.7% of sales.

This is a 3 point improvement over operating expenses of $46.2 million, or 29.7% of sales, in the prior year quarter.

Current year operating expenses include $1.4 million of restructuring charges, which we expect will contribute to lower costs in future periods.

Compared to the prior year, operating expenses were reduced $1.7 million because of favorable currency translation effects.

So it was a very good quarter across all three of our reportable segments.

Strong sales growth and gross margin improvement in North America, very strong operating income performance in SDP, and a return to profitability for international even after restructuring costs.

Each quarter we are seeing the financial benefits from the work we have done over the last few years.

We recognize we're not finished, and in fact, the current quarter was negatively affected by charges, inefficiencies and disruption costs related to ongoing changes, but it is very satisfying to see the results continue to improve even as we work through those issues.

Now I'll review our outlook.

We begin the fourth quarter with a strong backlog in North America and a strengthening business in several international markets.

At the Inc. level our order rates are following the normal seasonal pattern, softening a bit in the fourth quarter.

However, as we discussed earlier this year, our fourth quarter revenue was very strong last year.

The recovery was well underway, and our year-over-year sales growth in that quarter was 22.6% over fiscal 2004.

So although we're still seeing strong order patterns, we expect year-over-year orders in sales to grow at single digit rates versus the prior year's quarter.

The stronger dollar also had the effect of reducing the local currency growth rates we were seeing in our international segment.

In North America and SDP we're implementing a previously announced list price increase in mid-January, and ending the metal surcharge at that time.

We don't expect that to have any significant effect on fourth quarter shipments.

And although it should not affect orders in total, it could make order patterns more volatile for a few weeks.

Considering all these factors, we're estimating revenue growth of 4 to 8% in the fourth quarter versus the prior year.

Revenue is expected to be slightly lower than Q3, which is consistent with the normal seasonal pattern.

We expect to have restructuring charges and restructuring credits in the fourth quarter, but we expect that in total they will offset and the net effect will be immaterial.

Restructuring items in the fourth quarter include assumptions regarding the sale of one of our idled manufacturing facilities in Michigan.

We expect reported earnings per share to be between $0.07 and $0.12 per share in the fourth quarter.

That compares to $0.01 per share in the prior year.

Included in that estimate are assumptions that we will continue to see improvements in operating efficiency as we work to reduce destruction in certain areas.

We're also assuming less overhead absorption as we see the normal seasonal dip in revenues.

We expect to continue to see good improvements in year-over-year operating margins percentages, but margins may be slightly lower than the third quarter.

For the full year we expect to report earnings per share between $0.34 and $0.39 per share, including net after-tax restructuring charges of about 16 to $18 million.

In the first quarter of this year we announced plans to consolidate several of our North America factories in the Grand Rapids, Michigan area.

At that time we estimated 25 to $30 million in pretax costs in 2006 and 2007 combined.

That estimate included both restructuring costs such as severance costs or asset impairment, and relocation costs.

We have completed our annual planning process and are reconfirming that range.

Further, we estimate slightly more than half of those costs have already been incurred and the remainder will be incurred in fiscal 2007.

We periodically update you on our long-term operating targets.

It is a three-year horizon, which at this point would be about the end of fiscal 2009.

Today we're confirming that our long-term goals remain at 10% operating income as a percent of sales.

And the components we're targeting are 35% gross margins and 25% operating expense as a percent of sales.

That is the same long-term goal we set last year.

As before, our model grows revenue at a rate that approximate published industry growth rates plus growth in specific initiatives.

You already know about some of those initiatives such as our Turnstone brand and expanding our position in the health care segment.

The target considers that we made a lot of progress over the last year in improving our cost structure, but it also considers some factors that continue to make 10% a challenging goal.

First, compared to last year we are now assuming some base level of inflation.

Even if you assume that our yields from price increases exactly offset inflationary cost increases, the simple math of this offset creates a downward pressure on margins as a percent of sales.

So margin dollars can be the same or higher, but margin percentages are more challenging.

The reclassification of service business revenue had no effect on operating income, but again put downward pressure on gross margin and operating income as a percent of sales.

Finally, our targets include spending that is earmarked for initiatives that will help us create new growth platforms.

These can include new geographies, new productlines and new business models to reach new customers.

It is likely that these new businesses will create topline growth, but lower than average operating margins until they achieve scale, which is likely after the three-year planning horizon.

These investments are important.

Today our Turnstone business is an important growth engine, which started back in the 1990s with a little investment and a lot of patience.

We are reinvesting some profits for long-term growth.

We're incorporating inflation and service revenues.

And we still believe 10% is an appropriate long-term operating income target.

Sometimes we have been asked if the target could be higher than 10%.

First, we believe that as the industry recovery continues, competitive forces will limit cost margins at some point.

So we don't just keep increasing the margin target, even though we plan on continuing to improve our efficiency.

Second, the target is intended to be something we could sustain, not just achieve in a peak year.

We are also sometimes asked to talk about one year targets and two year targets, and we choose not to do that because it begins to feel like a forecast.

Instead, as we have done today, we share any updates to the three-year target, and share some of the assumptions so you can draw your own conclusions about the years in between.

Then, of course, we thoroughly cover current results so you know how we're doing.

On that point, through three quarters we are about where we thought we would be in terms of sales and profits.

In the fourth quarter we expect to continue to deliver solid improvement over the prior year.

Now we'll take your questions.

(OPERATOR INSTRUCTIONS).

Susan Maklari.

UBS.

Can you talk a little bit about the balance sheet?

You have that $266 million of debt that is going to come due over the next year.

Given you have over $330 million of cash, talk us through kind of the benefits of paying that off versus your suggestion in your comments that perhaps you'll just replace it with a different issue?

Good question.

The debt comes due in November of 2006, and so we have some time to consider our options.

And at this point we're keeping those options open.

And certainly paying off the debt is one of those options.

We think though that it is prudent to keep a certain level of debt on the balance sheet, and it is also prudent to hold a cash balance to give us opportunities if we see opportunities to grow our business.

Sometimes you might see an acquisition that might be related to a strategy we have in place.

And so having a certain amount of debt helps us we think keep the right kind of cost of capital, but also have the resources and liquidity we might need to pursue opportunities like that.

So at this point our plan would be to replace that debt, but again we're keeping our options open.

And then this quarter you started to repurchase your stock.

Can you just us any indication -- have you been doing that since the quarter closed or future results on that?

The repurchases in general what I'm going to do as we go forward is we will talk about repurchases each quarter after we completed the quarter.

I won't be updating in the middle of the quarter for obvious reasons.

In this past quarter we, as we said in the comments, saw an opportunity with the price falling below $14 to buy some shares at an average price of $13.75.

And as it turns out that seems to have been a good decision, since the price has risen since then.

We'll continue to be opportunistic about it.

We do have a 3.6 million shares authorized for repurchase.

I wouldn't interpret this as the beginning of a new repurchase program or change in our philosophy.

We have been talking about that same philosophy for a number of quarters.

But we will continue to be opportunistic.

Matthew McCall.

BB&T Capital Markets.

Just to be clear, Jim Keane, you're talking about your three-year target.

I joked with Roger earlier this morning that shouldn't it be a two-year target?

I just want to make sure that I understand what you're saying.

You're saying that you are on target or on plan, or I think you said about where you thought you would be in moving toward those targets at this point in the year.

And that is not a target that you're going to reach and fall back on -- or fall back from, but that it is sustainable.

Are you now saying that you probably can't get there until the end of '09?

What we do every year is we update the three-year goal.

So each year at this time we have had a history of communicating what we think that three-year goal is.

We don't comment on the two-year goal or the one-year goal.

I guess the best you can do as you think about that is to take some of the comments that I made earlier about the factors that have put downward pressure on operating income percentages, such as the figuring in inflation, figuring in the impact of service revenues and so forth.

Some of those have put downward pressure on percentages, but not necessarily on the dollars.

As you think about your models for one year and two year out, the best I can do is just give you those assumptions that we have used, and then you can make your own decisions.

It was my understanding that the price increase that you are implementing in January was likely going to be a little bit above the normal range because you're now taking into account the new inflationary environment.

Is that still the case?

The price increase that was set for -- in January was set a few months ago.

And so it considered factors such as -- first of all, it definitely considered the fact that we were phasing out the steel surcharge, even though steel prices still remain relatively high.

That was considered in that.

There were other inflationary factors considered.

However, it was done at a point in time before Katrina, before oil prices began to rise.

I wouldn't say that everything we have seen since then is covered in that price increase, but it covered the things we saw at the time we made that decision.

Jim Hackett here.

The last call, or maybe it was the one before that, I remember being explicit about the management team had confidence in the fact that -- and this is across many businesses of course -- that the current term of leadership is finding themselves in an environment where inflation has more rhythmic effects.

The management team is able to react accordingly, which translation was, were they moving quickly enough?

I was confident that we had demonstrated that kind of leadership, and that you would get a confirmation from me that we would watch those inflationary forces and be willing to do what it took in order to mitigate as much as we could the effects of those.

And at a time we made that comment, as Jim just confirmed -- what Jim was suggesting -- we have had these kinds of unforeseen events that were beginning to disrupt some of the commodity markets.

As we now look back on that, we also said that we though we had a good handle on the effect of those, and we had considered them the price increase, so it looks pretty good.

So I just want to confirm that there is a bit of a moving target here based on the way inflation is reacting.

Maybe you could comment a little bit on the current cost environment.

We have seen -- I guess we're still seeing some resin price inflation, but steel is down year-over-year, and diesel is still up, but doesn't seem to be accelerating.

When you see the precious metals are up -- I mean it is adjusting down.

In fact, Terry has a chart here --.

On steel, the steel has been very volatile.

That is the first thing to say.

It hit a peak and came down to trough, which was still much higher than historical levels of steel prices.

And then recently it has been rising again.

So steel has not gone away as an issue.

It all depends on what period you are comparing it to.

Compared to nine months ago or a year ago, in fact, it has been rising.

And then oil prices drive plastics up.

It takes a while for it to make its way through the system, but it does happen.

Diesel prices move in a rhythm that is sometime different than gasoline prices or home oil prices.

So diesel is a big deal for us because of transportation.

These things have definitely had impact on us.

We estimated just in energy costs that in the third quarter our costs were $2 million higher than they were a year ago.

Now the sequential quarter increase from Q2 to Q3 wasn't as great, but the year-over-year increase was significant.

And so, as Jim says, we're going to continue to monitor these things, and it is part of our economics and part of what we have to manage.

Quickly, if you're going to give energy, can you talk about maybe -- are you seeing any relief from steel being down year-over-year, granted in at a higher than long-term average?

We're not -- I don't have the year-over-year comparison handy, but I know that the steel that we were purchasing here in these last few weeks is definitely at a higher price than we have been seeing a short time ago.

Those higher costs did not flow through our P&L yet, because there is inventory in our system, and so it has to make its way through our process to get into the cost of goods sold.

But we are seeing an increase in steel prices.

Again, that is not all that unexpected.

The inflation is the new normal now.

And it is the way we all have to be thinking is that some inflation is just the normal state of things.

I have just two quick questions to finish up.

Jim Hackett, you spoke about the minor disruptions to service levels.

I wondered if you could expand on that a little bit, talk about how -- maybe quantify the impact in the quarter?

And I think you said it was behind you?

There was a product change over that is a great story, because it is a leaning out of factories.

We essentially look to save almost 100,000 square feet in one of our key factories.

We set up a line, and we had a few days disruption.

We are a very large supplier, so a few days was decent.

But all of that is back on track.

And Steelcase has a high ethic in terms of customer service.

For us this is -- this isn't, I guess, an unusual kind of ripple in terms of our performance.

What we do when we make a move like that, we actually submit some financials upfront in our -- should we do it kind of question.

We met all the metrics in the cost of the move, and so we had this cost of disruption.

I don't know that we have measured it, Jim, for the purpose of this call.

Did you --?

No, we didn't size it.

It definitely had an impact -- we anticipated that we would have this impact last quarter.

We were talking about the third quarter profits and we had these moves coming and so forth.

But the good news, as Jim said, is although we went through a period of disruption, we feel like that particular move is back on track.

It is back on track.

And then finally, and I will hop off here.

You spoke about potentially lower costs -- did I hear that right -- in the international segment based on the moves you made.

Did I understand that correctly?

Because they were already at a pretty impressive levels as a percent of sales on the operating line.

So are we expecting lower costs -- did I hear that correctly?

The current year income includes $1.4 million in restructuring charges.

And so what I was referring to whenever we do one of those kinds of decisions where we're going to do a consolidation or take some other actions, it is subject to kind of pretty solid math where it has to have a two-year payback.

And often we find that we have a much shorter payback, and the payback is often under a year from a cash perspective.

These restructuring costs, although we continue to incur them because we think it's going to help us continue to improve our income, but it may be a while before you see that.

(OPERATOR INSTRUCTIONS).

Budd Bugatch.

I am with Raymond James.

The 400 basis point improvement in gross margin for North America had some puts and some takes.

First, can you quantify for us what was the level of puts versus the level of takes?

Was it 600 puts and 200 takes, or can you give it to us that way?

The one that I quantified in particular was we had $2 million of a take I guess from energy costs.

As we compare that -- because that 4 point improvement was versus the prior year.

We had about $2 million of higher energy costs, so that may be just under 0.5 percentage point as a takeaway.

We haven't quantified the disruption effects.

You can get a sense of some of that just from the decrease in the gross margin between Q2 and Q3 for North America.

Most of that change was because of disruptions.

You can get a sense of what the impact was that.

But even after those takes, we're very pleased that we netted out to a 4% improvement.

When you look at the put, can you at least -- are they in the relative magnitude on the order of which you mention them, or how do we read that?

It is relatively true.

We lifted them as pricing yields and levered some higher sales volume.

Those are probably pretty close.

And that I think includes -- labor productivity was something that we are very pleased to see, because that is something you can sustain in an ongoing way, and that would be next on the list.

We have seen lower overhead spending, and that is again because of some of the work we have done over the last year.

But at this time the bigger story was the labor productivity versus the overhead spending.

That is really attributed again to the people out in the plants and their ability to work through all the changes going on.

We had that productivity improvement even though we are having the disruptions.

When we try to measure that, Jim, is it equivalent to the energy cost?

Is it that much of the put?

I won't be able to size it for you, but they were significant enough that they make the list.

So they definitely are important.

You won't size it for us.

I don't believe you can size it for you.

Yes, I can size it for me.

International next quarter will that also be profitable in your guidance?

I don't have a forecast for international specifically that we provide.

But I will tell what, we are pleased you see, as we have said, international break through this quarter and deliver profit.

It is the first profit they have been able to report, including restructuring charges.

They had an operating income without restructuring charges I think last time.

But this is a nice improvement for them.

And it is related to things kind of clipping along in a number of segments.

We've gotten first of a lot of the savings from the restructuring charges we have taken in the past.

We have seen the improvement in operating expenses.

But the thing we are really pleased about, and we have been sort of signaling in the last few quarters that we are seeing signs of improvement in international markets in terms of revenue.

And for the last couple of quarters, this quarter in particular, we are seeing that.

We are seeing, as Jim mentioned, growth in Asia.

We have both Japan, Australia, a large customer business.

We're very pleased with the growth we are seeing in Asia.

We're also seeing some good revenue growth for Steelcase at least even in some of our traditional markets.

But we caution that those traditional markets still maybe don't have the underlying economies yet that are going to fuel strong growth.

But the trends are definitely moving in the right direction.

And those underlying markets, the underlying traditional markets are UK, right?

France, Germany, are important markets for us.

The UK is certainly important.

Germany was a market that you acquired more of which before and --.

And we have become really a key player, probably number two in the market there.

And very happy with the progress that division has been making.

But I was looking for a word or an adjective of sustained profitability out of Europe.

I haven't heard that one.

I haven't heard that sustained word.

The reason is we don't want to provide that guidance.

But I want to give you confidence that the rhythm of operations improvement has been global.

We have been working on this issue around the globe.

As you know, it is a bigger challenge in Europe to make some of the changes as quickly, because the paybacks are longer.

But we have been attentive to that, and it is starting to show up in these results.

It has been a long slug, Jim.

We have taken a lot of capital and put it at that international business, and without a lot to show for it for a long time.

And used it in the Board room, because that group as well is anxious for this to perform.

But it is funny now as we look ahead, as Jim has talked about, I think it is a bright picture because of the nature of the kind of customers we serve.

And we are able to I think maintain relationships with clients because we can take care of them around the globe.

Europe is an important part of that.

The thing, also, if you're looking for a word -- I can't -- I don't know that I'm going to say sustained, but I'm pleased about the way that international came back to profitability.

There is nothing unusual or one timeish about the profits in the third.

It is not as though we had one order that made up a large percentage of the sales and was particularly profitable.

It is just good old-fashioned growth coming from a number of areas, and improved profits at the gross margin line, improvements at the operating expense line.

I wouldn't consider Q3 to be unusual in any way.

A couple of other questions.

One, returns on capital, what are you -- how are you measuring them now?

What do they look like?

If you can give us a number in terms of your results?

And how are they factoring in to the increased variable compensation?

The returns on capital are a function of both, again, the top line, which is the return part and then the capital base.

I don't know that you have ever shared with us whatever adjustments you might make to both the note pads and to the capital.

I was -- hopefully one day you can be good enough to do that.

I don't mean to give you the exact calculation, but let me give you some color on that.

We try to -- what we are talking about is how do we measure return on capital for assessing our performance.

A large part of that is focused on -- we try to focus on things that are more operating income-related rather than interest income, interest expense sorts of things.

It is going to be more focused on operating income.

Sure.

From from a return perspective it focuses heavily on the operating assets, so property, plant and equipment.

How efficiently can we use that, which is an important line for us, and we have been obviously doing a lot of things there.

So like international is in that number, just as you said.

What do you do for restructuring charges?

And do you pull than into capital?

Do you keep them into capital forever, or do you pull them out of capital?

Restructuring charges are charged against income for that purpose.

So they are charged against the note pad.

But they are spread across two years, because often the benefit of those restructuring charges again is a two-year thing.

So if we take a restructuring charge, and we're not going to get a two-year benefit, then it hurts that calculation.

So it is very consistent with the policy we have.

From a balance sheet perspective again we're improving the property, plant and equipment efficiency through a lot of the work we have been doing.

We are improving receivables stage.

We're improving inventory turns through implementing lean, and some of the consolidation work as well.

That is really where we want to focus.

That is what -- we come in every day trying to improve operating profit, and trying to make sure we are using these assets as efficiently as we can.

Just to make sure I understand it, if you take a $5 million after-tax charge in one period, you will amortize that over two periods, 2.5 million this year, 2.5 million next.

And you will take the 5 million out of the capital immediately?

That's directionally correct.

It's that directional word.

It's that adjective I'm not sure I get there with that.

No, the calculation is very complex, so there are sometimes gains, for example, that we don't count at all.

And there's sometimes costs that we don't count at all, but that is rare.

So it is trying to, as closely as possible, be a measure of true performance rather than things that could be windfalls one way or the other.

All right.

And my last question is you had stated on the balance sheet that you were going to eventually replace that $265.5 million of debt that is going to be paid off shortly with, I guess, the $332 million worth of cash that you've got.

Can you give us an eventually -- timeframe?

It is between now and November.

November of what?

In November of 2006 the current debt comes due.

So between now and November of 2006 we have to make a decision about that.

We have our options open, as I have said before.

But what you try to do is in this kind of a period is you want to make sure that the market conditions are exactly as you want them to be when you're going -- particularly if you're going to issue new debt to replace old debt.

And so we're going to be opportunistic about the as well.

Kind of watching interest rates and watching spreads, and again keeping our options open and trying to do the best job we can in replacing that debt.

I'm just trying to make sure that you won't -- that the mindset isn't to take the debt off the books and leave it off the books and let cash accumulate again, and then go from there with low leverage.

That is kind of -- you do want to replace that, and you will do it --.

We understand the weighted average cost of (multiple speakers).

I know you do.

And he said that in his comments -- and you properly point to the dilemma, which is the Company is starting to get healthy, throwing off a lot of cash here.

It really doesn't need the debt, but we need that layer in our capital structure to improve return for shareholders.

These guys are every good at managing it, but I'm confident that you're going to be happy at the end of the day.

Thank you very much.

Congratulations.

Jeff Matthews.

There are a lot of questions kind of geared towards future operating income levels.

I want to get it at a different way.

What is -- what are you guys going to be compensated on two or three years down the road?

Are there financial targets that you have to hit?

And what are those targets?

Are they return on capital, return on equity, sales growth, earnings growth?

What are they please?

Can you state your affiliation.

I'm with Ram Partners.

We own your stock.

The compensation -- I will start with a layer of compensation that is one that affects almost all employees in the Company, at least all the people in North America, which is based on an EVA-like calculation.

It is return on assets calculation.

And it is based on absolute levels of return on assets.

There's another bonus layer that affects a subsegment of people in North America, which has both an absolute level of EVA performance plus an improvement in EVA performance.

So people who are in the management ranks, or upper management ranks, a segment of them have a major part of their compensation based on that.

The difference there is that we believe senior management is more accountable for that improvement in operating performance versus just absolute performance.

The first layer is really a form of profit sharing, if you want to think of it like that.

And that has long been the history at Steelcase that these bonuses are intended to be closely tied to profitability in a profit-sharing kind of mentality.

The second one just puts a little bit more quirk in there that it is not good enough to be profitable, you have to improve profitability every year.

Can I just ask if that includes or excludes the impact of special charges?

That is what Bud was getting at a minute ago.

The restructuring charges -- for both of those calculations restructuring charges are generally spread across two years.

And for example, if we are going to make -- take a restructuring charge that is intended to consolidate plants, then the cost of that reduces the compensation during the period -- during the period where the charge is taken and the next period.

But then the benefits begin to accrue probably during that same period, towards the end of it.

So we definitely pay the price for that.

But then as I said also there might be windfalls gains and things that are not included in the calculation.

And then there are other factors that are important.

Cash flow, there's some compensation, again, for smaller numbers of people -- now cash flow becomes an important measure of compensation or performance.

All the people in management have goals that affect their merit increases.

So when you think about compensation it is a pretty broad thing and there are a lot of things that figure into it.

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And of course at this time of year we would like to wish you the best in this holiday season, the hope that you and your families enjoy this wonderful time of year.

Thank you very much.

Thank you.

Ladies and gentlemen, this does conclude today's conference call.

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We thank you for your participation.