Steelcase Inc (SCS) 2007 Q1 法說會逐字稿

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

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

For opening remarks and introductions, I would like to turn the conference call over to Mr. Terry Lenhardt, Vice President, Corporate Strategies, Investor Relations.

Thank you, Dave.

Good morning, everyone.

Thank you for joining us for the recap of our first-quarter fiscal year 2007 financial results.

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

Jim Keane, our Chief Financial Officer;

Frank Merlotti, our President, Steelcase North America;

Mark Baker, our Senior Vice President and Global Operations Officer and Mark Mossing, our Vice President and Corporate Controller.

Our first-quarter fiscal 2007 release dated June 26, 2006 crossed the wire early this morning and is accessible on our website.

This conference call is being webcast.

The presentation slides that accompany this webcast are available on Steelcase.com.

A replay of this call will also be posted to this 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 and believes they may also be useful for investors.

Reconciliations to the most comparable GAAP measures are included in the webcast slides and the earnings release.

At this time, we are incorporating by reference into this conference call and subsequent transcript the text of our Safe Harbor statement included in this morning's release.

Certain states 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 24, 2006 and our other filings with the Securities and Exchange Commission.

This webcast is a copyrighted production of Steelcase Inc.

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

Thank you, Terry and good morning to everyone.

I am pleased to report that we are off to a solid start this fiscal year with sales up more than 7% over the same quarter last year.

We reported net income of $18.2 million, a sizable improvement over the $6.7 million we earned in the first quarter of the previous year.

(indiscernible) was profitable quarters for North America, International and the SDP.

At the global level, we saw improvements in most of the key metrics we track each quarter for example such as gross margin and operating expense as a percent of sales.

You know, if I am proud of anything today it is that we understand how much better we need to be in order to continue to be the world's largest and best company in this industry.

The temptation when you see so much evidence of our Company's positive momentum or improvement in the stock price and the dividend it might be to relax.

But my attitude is that we have to be more demanding, tougher about what we face given the distance we have come and relentlessly aggressive in seeking new levels of performance.

I would like to note for you some of the things that I mentioned last week in our annual meeting and emphasize them with today's call.

In May, we announced the launch of our newest company, Nurture by Steelcase.

We jumpstarted the launch of Nurture with an incredible showroom at our tradeshow, NeoCon, that generated a great deal of positive energy.

We are building credibility around the principle of understanding the power of improving the patient and caregiver experience.

For years, we have served healthcare customers through our Steelcase family of companies, but today Nurture enables us to provide customers with a dedicated, single source for our considerable research, existing product offering and new product development.

As an industry, healthcare continues to grow in size and sophistication and we want to serve this market aggressively and insightfully.

We were also pleased to have many of you visit our showrooms in Chicago.

In addition to successfully launching the Nurture brand, the Company won six product awards at NeoCon and our Turnstone brand continues to gain share in its pursuit of the simple but value-centered customer experience.

Turnstone has helped us serve smaller companies, which represent a sizable part of the overall furniture market.

The same principles that have allowed us to understand how to deliver great customer experience in our core domestic and international markets can also be applied we think to other geographies such as China.

While we have been doing business with partners in China for over two decades, in the very near future, we will be doing business solely by ourselves serving the Chinese market.

I am very pleased with the job being done internationally and want to note that today.

While steady growth is fueling our optimism, we continue to focus on being even better at delivering great customer experiences in reaching new markets and developing a world-class global supply chain.

We must successfully execute these strategies to sustain the positive trends we are experiencing.

In summary, it was a good quarter.

But we can be better in many areas of our business and those areas are under our watchful eye and attention and I look forward to reporting to you throughout this year on our progress.

And now I'll turn it over to Jim Keane, our Chief Financial Officer, who will take you through the details of our first-quarter financial results.

Jim?

Thank you, Jim.

Today, we reported a first-quarter profit of $18.2 million or $0.12 per share.

This is a significant improvement over prior year profit of $6.7 million.

The improvement was driven primarily by an increase in North America and International operating income.

These results were within the range of $0.10 to $0.15 per share we estimated last quarter.

Revenue was a $727.3 million in the quarter, a 7.6% increase over the prior year and within the estimated range of 7% to 11% sales growth we provided last quarter.

Current quarter revenue included $4.8 million of unfavorable currency effects versus the same quarter last year.

Current quarter revenue also included $5.4 million related to acquisitions in our North America and International segments that were completed in the prior year, but after the first quarter.

Operating income of $28 million compares to $15.2 million in the prior year.

The improvement was due to better performance in our North America and International segments, as well as lower restructuring charges.

Included in our operating income are pretax restructuring charges of $4.3 million compared to $10.8 million last year.

Operating income, excluding restructuring charges, was $32.3 million compared to $26 million in the prior year.

As a percent of sales, operating income, excluding restructuring charges, was 4.4% in the current year, which is an improvement over 3.8% in the prior year.

Operating income, excluding restructuring charges, is a non-GAAP measure.

As Terry mentioned, our earnings release and our webcast slides include a reconciliation between the various GAAP and non-GAAP measures we will discuss today.

Current quarter restructuring charges of $2.7 million after-tax were in line with our estimate of less than $5 million.

North America restructuring charges of $1.3 million after-tax relate to continued planned consolidation activities.

International restructuring charges were $1.3 million after-tax and were primarily related to a $0.9 million after-tax impairment charge for our Strasbourg site.

During the quarter, we had preliminary discussions with a potential buyer for the site and the estimated selling price from these discussions was lower than the recorded book value resulting in the charge.

Cost of sales, which does not include restructuring charges, was 69.2% of sales, which is consistent with the prior year quarter.

International improved cost of sales percentage by 1.4 percentage points over the prior year.

North America saw a modest improvement of 0.5 points, which shows that our pricing actions are helping to offset material cost increases over the last 12 months.

Cost of sales increased as a percentage of revenue for both PolyVision and SDP due to higher discounting for certain product lines and some operating inefficiencies.

PolyVision results are included in the other category.

Gross margins of 30.3% were up from 29.5% in the prior year quarter due to lower restructuring charges in the current year quarter.

Operating expenses, which do not include restructuring costs, were 26.4% of sales compared to 27% of sales in the prior year quarter.

Operating expenses increased by $9.5 million.

The increase was driven by several factors, including $3.6 million of increased variable compensation expense, $2.7 million in higher sales and marketing spending in International, $2.4 million from acquisitions completed in the prior year, but after Q1, and $1.3 million related to the launch of our new Nurture healthcare brand.

These increases were partially offset by $1.9 million in favorable currency translation effects as compared to the prior year.

Other income net was $4.9 million for the quarter compared to $0.8 million in the prior year quarter.

The increase was primarily due to an increase in interest income of $2.6 million because of higher cash balances and higher interest rates.

We also had a number of small gains on currency derivatives that added up to $1.7 million.

Our effective tax rate was 37% for the quarter.

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

Our cash balance was $386.3 million at the end of the quarter, a $37.5 million decrease from the total of cash and short-term investments at the end of the fourth quarter, but in line with our expectations.

Compared to the prior year, cash increased by $148 million as a result of strong cash flow over the last 12 months.

We had a significant use of cash related to changes in operating assets and liabilities.

A portion of this is related to increased working capital needs.

We also make a number of large cash payments in the first quarter of each year that are large in total.

These include the bonus payments and contributions to employee retirement funds.

Capital expenditures were $11.4 million in the quarter compared to $24.4 million in depreciation expense.

The difference represents a source of cash.

We continue to carefully manage our capital expenditures.

We have $250 million in outstanding term notes that are due in November of this year.

We expect to refinance the debt prior to its maturity.

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

In North America, sales were $407.4 million in the quarter, up 7.2% from the prior year driven by increased sales across most of our product categories.

Current year revenue also included $3.7 million from an acquisition that was completed during the second quarter of the prior year and $2.2 million from favorable currency impacts compared to the prior year related to our operations in Canada.

Much of the growth in North America was from Turnstone and the architectural product line both of which saw double-digit growth.

The systems, seating and storage business had good order patterns during the quarter, but a relatively high percentage of these orders were for second-quarter shipments.

Operating income was $22.5 million, including $2 million of pretax restructuring charges.

Prior year operating income was $14.1 million, including $5.9 million of pretax restructuring charges.

Operating income, excluding restructuring charges, improved to 6% of sales compared to 5.3% of sales in the prior year.

Higher revenue, improved price yield management and improvements in operating expenses as a percentage of sales combined to improve our performance despite an inflationary cost environment and lower margins in the wood category.

North America gross margins were 27.8% compared to 26.2% in the prior year quarter.

Pretax restructuring charges included in gross margin were $2 million in the current quarter compared to $5.9 million in the prior year quarter.

Cost of sales, which is reported separately from restructuring charges, improved 0.5 points over the prior year quarter.

The improvement is the result of improved pricing yields, benefits from reducing the complexity of our product lines, benefits from prior restructuring activities and improved overhead absorption.

These improvements were partially offset by lower margins in our wood category.

Also, North America experienced higher costs related to energy and non-steel material costs compared to the prior year.

These were partially offset by steel deflation versus the prior year.

North America operating expenses were 22.3% of sales, a 0.2 point improvement over the prior year.

In dollars, operating expenses increased $5 million compared to the prior year primarily due to a $2.6 million increase in variable compensation expense, $1 million related to the launch of the Nurture healthcare brand and $0.8 million related to our acquisition.

North America continues to make good progress implementing our operational improvements like lean, product line simplification, leveraging outside supply partners and facility consolidations.

However, as we mentioned in our 10-K, we have an opportunity to improve the profitability of our wood category.

On a fully allocated basis, the wood category reduced the operating income of our North America segment by nearly $10 million in the first quarter, which was worse than expected.

A portion of this loss was due to one particularly unprofitable order largely because of aggressive pricing relative to the complexity of that job.

We still have some contracts that were negotiated back then when the industry was in the early stages of its recovery and we had to be quite aggressive to support our dealers.

We also have had operational issues in the wood category and wood was part of the overall industrial system improvement work we have been doing over the last few years.

In fact, during that time, we consolidated three wood factories into one to reduce excess capacity.

We captured the overhead savings from these actions, but saw higher costs because of the increase in complexity in the remaining plant.

We know the issues, have identified the root causes and have launched a number of operational and marketing initiatives that we expect will help the category return to a breakeven run rate in about a year.

During Q1, we entered into a nonbinding letter of intent with Ashley Capital for the sale of the majority of our Grand Rapids campus.

The sale is contingent upon the successful completion of negotiations with Ashley Capital and the satisfaction of customary conditions to closing.

We expect to close on the sale by the end of the calendar year and do not expect a significant gain or loss on this transaction.

For SDP, sales were $83.9 million in the quarter, a 1.3% increase compared to the prior year.

We expected less than 5% growth in the quarter.

Remember that SDP sales did not fall as far as our other segments during the downturn and so we haven't expected the same sales growth from SDP during the recovery.

As with North America, many of the brands within SDP saw good order trends during the quarter, but a high percentage of these orders are scheduled for second-quarter shipments.

SDP gross margins of 36.9% were down from 38.3% in the prior year.

The decline in margins was primarily due to higher discounts on some larger orders that shipped during the quarter.

SDP is also seeing some cost pressure related to materials such as foam, corrugated packaging and particle board.

SDP operating expenses as a percentage of sales was 28.9% in the current year quarter, which was consistent with 28.6% in the prior year quarter.

SDP reported a $6.7 million operating profit in the quarter versus $8 million in the prior year.

As a percentage of sales, SDP operating income was 8% compared to 9.7% in the prior year.

International sales were $167.4 million in the quarter.

This represents a 9.6% increase compared with the prior year quarter.

Currency translation had the effect of reducing revenue by $7 million as compared to the prior year, so growth in local currency was even stronger.

Current year revenue included $1.7 million from prior year acquisitions that were completed after the first quarter.

We experienced year-over-year sales growth in all of our major markets, but particularly strong growth rates in Asia, Latin America and the U.K.

International reported operating income of $4.6 million in the current year quarter, which includes $2.1 million of pretax restructuring charges.

In the prior year quarter, International reported an operating loss of $2.6 million, which included $4.9 million of pretax restructuring charges.

Operating income improved in nearly every International market.

Operating income, excluding restructuring charges, was $6.7 million or 4% of sales compared to $2.3 million or 1.5% of sales in the prior year.

That is a 250 basis point improvement in margins.

International gross margins were 31.5% in the quarter.

Restructuring charges had the effect of reducing gross margins by 1.3 percentage points.

In the prior year, gross margins were 29.7% and included restructuring charges, which had the impact of reducing gross margins by 1.7 percentage points.

International operating expenses were $48.2 million or 28.8% of sales.

This compares to operating expenses of $45.7 million or 29.9% of sales in the prior year quarter.

The increase in year-over-year operating expense dollars includes $2.7 million in higher sales and marketing spending, $1.6 million related to our prior year acquisitions and is net of $2.1 million in favorable currency effects as compared to the prior year.

PolyVision, which is included in the other category in our segment reporting, grew revenue 15% over the prior year and is the main reason total sales for the other category increased.

However, this increase was due in part to an aggressive pricing strategy used for traditional whiteboard products at the end of last year, which led to lower than expected gross margins.

As a result, PolyVision's performance had the effect of increasing the operating loss for the other segment by $2.1 million compared to the prior year.

PolyVision has adjusted its pricing strategy and we expect improved performance in the second half of the year.

We recently launched a new brand called Nurture to serve the healthcare market.

At this point, the products included in the Nurture offering are already part of our office furniture portfolio and are included in results for the North America or SDP segment.

Now, I will review our outlook.

For the second quarter, we are expecting revenue growth of 10% to 14% over the second quarter of the prior year.

We had strong backlog as we entered the quarter and we have seen good order patterns over the last few weeks.

Growth is expected to be led by Turnstone and our core product lines in North America and broad strength in international markets.

We expect to incur restructuring charges of $3 million to $7 million after-tax in the second quarter and we expect reported earnings per share will be in the range of $0.13 to $0.18 per share.

We are implementing a mid-year price adjustment effective for North America and SDP orders received after July 17.

This increase is intended to offset continued material cost increases in steel, foam, particle board, energy and other commodities.

We do not expect this price increase to materially affect second-quarter results.

Although there may be some positive effect of the price adjustment in Q3 and Q4, it is likely that continued material cost inflation will offset this effect.

I will take a minute to update on our restructuring activities.

Last quarter, we estimated that after-tax restructuring costs would be about $10 million to $15 million this year and that is still our estimate.

However, we are now expecting the makeup of those charges to be a little different than originally anticipated.

Our original estimates included a placeholder for some restructuring work in our International segment and now we don't believe that is going to happen this year.

On the other hand, we expect to incur higher costs related to restructuring in Grand Rapids.

The costs are higher because the scope and complexity of the moves are greater than we originally estimated.

The scope increase relates to a recent decision to move rather than outsource some processes and to move an additional product line to a different plant.

We expect to recover some additional savings related to these decisions.

In addition, we will be using more third parties for this move in order to meet the aggressive timeline.

When we use third parties for move activities, we include the cost in restructuring, but when we use internal resources, we don't separate it as restructuring costs because it is already in our cost structure and therefore not incremental.

So in summary, we are still seeing good demand patterns and seeing very good growth in International.

North America is seeing the benefits from the restructuring work we have done in the past and international markets have improved nicely.

Our price increases and yield management have helped to offset rising material costs and we can expect continued inflationary pressures.

We have a couple of places where our performance hasn't been as strong as we'd like and we're working on specific improvement plans for those areas.

Now I'll turn it over for questions.

(OPERATOR INSTRUCTIONS).

Todd Schwartzman.

Could you just discuss a little bit some of the operational issues that you are seeing in the wood category?

This is Jim Hackett.

I have asked Mark Baker, Todd, to be here.

Mark is responsible for our global operations.

All the factories that are in our system, in addition to order management, report up to him, so I'm going to let Mark field this one.

As Jim Keane mentioned, we, about 18 months ago, consolidated all of our wood manufacturing for this category principally into one facility here in Grand Rapids.

In doing so, what we have learned is that it has brought to light a significant amount of complexity that we have in the business.

As Jim said, there is work going on right now to address that complexity and we expect to see improvements from an operational standpoint as a result of that work over the next 12 months.

And do the issues that you saw in Q1 with respect to lower margins in certain product categories, is that fully contained within the wood category?

For North America, I think that is true that the wood category is a big part of that explanation.

We also mentioned that in the other category we have PolyVision, which also faced some operational challenges and pricing challenges this quarter.

Those are the two we were really referring to with that comment.

And my other question was -- did I hear you correctly say that the Nurture is included in both North America and SDP?

Yes, the Nurture brand, as it starts off here, includes products that have been part of the North America portfolio and the SDP portfolio and therefore, the results of the North America-based products are still going to be reported up in that segment and also the SDP products will show up in the SDP segment.

So we're not changing our segment reporting just because we have this new brand.

Got it.

Thanks a lot.

Susan [McClary].

Can you give us an update in terms of the restructuring that you're going through, you have made a lot of progress on that over the last five years and it sounds like maybe we're coming up to the tail end of things.

Can you give us some perspective on where you are and what you view as the last steps of this?

Yes, it's Jim Hackett again, Susan.

I would use that well-worn phrase, which is that the lean initiative is a journey that started and doesn't have an end.

We keep finding ways to apply that principle around the world and getting great returns on the investment.

But to be right to the point, we did identify, I would say, a metalevel number of consolidations that are coming to a completion with the Grand Rapids complex for example here in Grand Rapids.

And so I'm going to ask Mark again just to give you an update on where we are in all that consolidation.

As you remember last March is when we announced a two-year restructuring in Grand Rapids that was going to allow us to move off of this campus completely and as Jim mentioned, we have reached a letter of intent with Ashley Capital for the land.

So as a result of that letter of intent, our current timeline would take us through the first quarter of next year when we would be completely out of our Grand Rapids facility here.

So that is what we have currently on the books in terms of completing the restructuring that we know about.

But as Jim said, the progress we continue to see with our lean processes and lean activities in all of our facilities and with our supply base continues to offer us opportunities that we will evaluate on an ongoing basis.

Okay.

Just following up on that.

Given where you are now, is there any change to your longer-term margin targets or growth rates that you're forecasting out?

This is Jim Keane.

We only update those typically at the end of our year from December and so we are not going to update that today.

But back in December, we said 35/25/10, 35% gross margin targets long term, 25% operating expenses, 10% operating income percentages and everything that Mark talked about, those restructuring activities, are all part of the work we need to get there.

Matthew McCall.

Going back to the wood issues, it sounds like and I noticed since Mark is on this call, it sounds like you have prepared to discuss this I guess more so than in the past.

It sounds like you were surprised by the magnitude of the pressures that you face there.

Is that true?

This is Jim Hackett.

I would say that the way I'd like to characterize this is the decision to make the consolidation efforts, which were pretty large in their own right and it is not an excuse but just as a context statement is that they were happening simultaneously with the steel plant consolidations that we were making.

The decision to do that I think was really good.

We have achieved the overhead savings that we described and the systems responding in so many ways that are better than it had been before.

The part that was surprising is that when we started consolidating some of the platforms that are built from the various factories together, we learned that as they flow through the plant, it could disrupt things and that is in fact the part that I think as we identified it, we realized that we needed to put more resources against it, which is what Mark just described.

And so we have got a really strong plan to get this on track and candidly my confidence is pretty high about that because we have been able to do this in these other facilities that we have focused on.

Okay.

So the -- okay.

All right.

I think you said you expect pressures to continue or to approach breakeven in the wood segment in the next 12 months.

Should we consider or assume similar pressures in the next three quarters say in the $10 million range?

Is that a good assumption?

We expect to continue to make progress in moving from where our performance was in the first quarter here to a point where we are at a breakeven run rate as we set out about 12 months from now.

So I wouldn't expect it necessarily to continue at this rate and then suddenly improve.

This improvement that we are planning is the result of lots of different initiatives, some of which are already taking some effect.

So we should expect to see that.

Mark, do you want to add to that?

Well, the other thing that Jim mentioned is the results of one job that impacted the first-quarter performance and that will not continue throughout the whole fiscal year.

That one will be wrapping up this quarter during the second quarter.

Okay.

So Q2.

And can you give us an idea of what the magnitude of that job was in the whole grand scheme of things, that pressure this quarter?

Well, it made the list I guess.

I'm not going to give the magnitude of it, but I would say that there are two or three things that are affecting profitability in that business.

You have that job, you have pricing on some other contracts that were negotiated during the downturn.

You also some of the operational issues.

I think those are all significant and you can think of them as being similar in terms of their impact on why we ended up at the -$10 million mark.

And I think someone just hit on your outlook and this may fall into that category and you might not update it, but you talked about a 40% gross contribution margin as kind of assumed in getting to your longer-term target.

Didn't look like this quarter you hit that.

Is that still a good number for us to model I guess excluding these items that will hopefully be ending?

I think 40% to 45% is still a good range for contribution margin.

When you end up sitting -- trying to calculate that in any given quarter, you have to consider things like currency swings, which can sometimes have an impact and also consider the impact of acquisitions.

We do our best to try to cull those numbers out to help you in the calculation and then you can have swings from quarter-to-quarter in individual businesses like the ones we talked about this time back that can throw you off a little bit.

But we are still believing that that is a pretty good number.

And then finally I will get off, but you talked about -- I don't know if you did talk about the Steelcase -- or the Steelcase Design Partnership weakness.

Year-of-year, the operating margin there down about 150 basis points.

Did I miss the color that you provided there?

I might have.

Well SDP -- first of all, we are still very pleased with SDP's operating income.

It remains the highest of the groups.

So the decline from 9.7% in the prior year still leaves us at 8% operating profit.

The color we talked about is that they did have, down at the brand level, you have to go brand by brand now, a couple of the brands had higher discounts in some large orders that shipped during the quarter.

They also saw the same kind of thing going on at the top line.

We mentioned with North America that a relatively high percentage of the orders that came in in the first quarter were for second-quarter shipments and that same trend showed up for SDP.

So their top-line growth volume wasn't as strong in the first quarter as the orders might have indicated.

So the trend should hopefully reverse itself next quarter or this quarter?

I think that's part of the reason why, at the ink level, we're showing better year-over-year sales growth in the second quarter than we did in the first quarter.

Peter [Walstrom].

This is Pete on behalf of Chris Agnew.

Just very quickly, your comments on restructuring for the year and the shipped to international as a placeholder and earmark, should we just assume that this will shift then into fiscal year '08?

And any sense of the magnitude for this restructuring component?

Do you mind doing that again, Pete, just real quick?

I'm sorry?

Certainly.

No problem.

When you spoke about full-year restructuring still being in the $10 million to $15 million range and you originally had a placeholder for the international component, but you're not going to get to that this year, should we then assume that this international component would shift then to fiscal year '08?

I think in fairness it is too far out for us to know that for sure.

As you can tell, it is difficult as it is for us to estimate even a year out when we put restructuring estimates in place.

We put that in there as we said just as a placeholder without having any specific plans.

So I wouldn't say we have any specific plan for next year either at this point.

It is just -- wanted to explain with it wasn't just that we saved money on some other restructuring, but there was restructuring work we had planned we're not going to do.

And as you said, in total, -- therefore, our total restructuring costs for this year are going to come in about where we expected.

Okay.

And tax rate is still around the 37% range for the year?

Yes, that is the number we used in the first quarter.

We still think that is a good number.

Very good.

Thank you.

(OPERATOR INSTRUCTIONS).

Gentlemen, we appear to have no further questions.

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

Sure.

It's Jim Hackett.

In closing, I just want to emphasize that we are delighted with the progress that we continue to make.

We are optimistic that these initiatives that we put in place are at or above the performance expectations.

Then the challenge that I laid to the team today, which is that we can be better as you can see with like the wood situation that we believe we have got our arms around and we're going to get fixed.

So I want to end with the notion that our annual report talks about a new optimism in the Company and I want to emphasize that we are quite upbeat about the future prospects.

Thank you for joining us today.

Thank you very much.

This does conclude today's conference call.

You may disconnect your lines and have a wonderful day.