Steelcase Inc (SCS) 2008 Q2 法說會逐字稿

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

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

For opening remarks and introductions, I would like to turn the conference call over to Mr.

Raj Mehan in charge of investor relations.

Thank you, Dave.

Good morning, everyone.

Thank you for joining us for the recap of our second quarter of fiscal year 2008 financial results.

Here with me today are Jim Hackett, our President and Chief Executive Officer; Dave Sylvester, our Chief Financial Officer; Mark Mossing, Vice President and Corporate Controller; and Terry Lenhardt, Vice President, North America Finance.

Our second-quarter earnings release dated September 20, 2007 crossed the wires early 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, and 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.

Therefore, management believes this information is also useful for investors.

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

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 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 10-K for the year ended February 23, 2007; and our other filings with the Securities and Exchange Commission.

This webcast is a copyrighted production of Steelcase, Inc.

With those formalities out of the way, I'll turn the call over to our President and CEO, Jim Hackett.

Thank you, Raj, and I'm happy to report to you today that we have had a pretty good second quarter.

You will hear later from our Chief Financial Officer, Dave Sylvester, how we have gotten to this point.

My purpose at this point of the presentation is to highlight progress within our organization that supports our strategic growth initiatives, but that don't come out clearly in the financial statements.

They demonstrate progress in areas such as research, sustainability, and emerging markets, and link to other news that is out there are about the company, the nature of impact of the liquidity challenges in the American economy, and how it impacts our business.

The best point at which to draw your perspective is to remind you that Steelcase is truly a global player in this industry.

And while you will see how important our International performance is to our overall story, we believe there is more we can do to leverage growth opportunities there.

The first area of progress is in emerging markets.

Late last week, we announced that we entered into a definitive agreement with Ultra Group Holdings, Ltd.

subject to shareholder approval to purchase all the stock of Ultra Group Company, Ltd.

Now Ultra is a Chinese furniture manufacturers that sells a wide offering of seating, desks, systems, and storage products.

The simple point of this move is to add to our earlier moves in China, where we have already established our own manufacturing operations in Shenzhen, and to broaden our sales and distribution footprint.

The acquisition will enhance Steelcase operations in China with a factory in the Guangdong province showrooms and sales offices in Hong Kong, Beijing, Shanghai, and Guangzhou.

Let's keep in mind that China is a huge, complex collection of very different markets -- I think there's about 1,400 different suppliers of furniture in that country -- and that this news won't materially impact our operating performance in the short-term.

But it is the key component of our strategy, and it allows us to continue to represent to a stable of very important customers that we are positioned to follow them all over the world as they expand.

The second area of progress is in leveraging our research.

I'm proud of the fact that we have broadened the impact of our insight-driven research into adjacent fields, where there are parallels to the historic work environment.

Yes, we have told you about our Nurture division's growth and the health-care markets, both in the traditional office market and in the clinical area.

I would like to emphasize today that Nurture is doing very, very well.

But in July, we demonstrated our concentration on the higher education market by officially launching the LearnLab environment to an important gathering of educators at a national conference in July.

Now this announcement amplified a series of research projects we have completed at real college campuses, where we tested the long-held notion of how classrooms are best configured.

It's a peculiar question that the dominant classroom design hasn't changed a great deal up until this news.

And we expect our insights into this domain to be widely adopted with our strong exposure this fall at many colleges and universities.

The third area of progress is in the area of sustainability.

Now no doubt, the topic of sustainability has garnered a significant amount of attention in all parts of the world from governments to industry.

And yet surprisingly, our relatively small industry has been a leader among other industries in initiating practices for sustainability.

It's odd to talk about a competitive feature of who we are, yet also acknowledge the role our competitors have also played in this important movement.

Frankly, I'm proud of the industry.

Sustainability is good for all, and takes all of us to make an impact.

I believe that we are leaders in this area, and the recognition from outside agencies have proven that Steelcase practices go well beyond the hype or greenwashing that might exist today.

It was just announced that Steelcase has won a Gold Achievement award -- this is a project stewardship category -- from the U.S.

Environmental Protection Agency for the third consecutive year.

We also earned what is called a WasteWise award for the sixth consecutive year in recognition of our efforts to reduce industrial waste.

Probably as exciting is the news that our wood plant recently switched to using any type of finishing process to make Steelcase the first and only wood manufacturer to meet the industry standard -- BIFMA's new indoor air quality requirements.

All standard case goods products at our wood plant in Grand Rapids, Michigan now use this new finishing process.

Until this point, we used a hybrid finishing process of water and solvents.

The new finish is called clarity.

It's almost completely waterborne, and it provides an exceptionally durable and beautiful finish for our customers' products and increases our commitment to the environment.

It can also help our customers contribute to earning LEED certification for low-emitting furniture.

I think many of our customers who purchase wood products would be surprised to hear how unsustainable many of the legacy finishing methods are.

This makes our new finish method a real breakthrough, and makes our wood plant, which had already been the first manufacturing facility of any factory, frankly -- any factory in any industry in the world to receive a Silver LEED Award, is now in that great factory able to produce a leading LEED-certified product.

Now these are some of the great stories of what is behind the numbers that Dave will describe today.

On our last call we were tasked with attempting to project the likelihood of some sort of recession.

Some analysts to cover our industry or stock by the volatility struck by the volatility of the BIFMA forecast.

They had been volatile.

I would add that with this news today that we are reporting that our business is vibrant and on course.

We, like everyone else, watch with great interest the moves by the Federal Reserve in the United States to affect policy to address the burgeoning liquidity problems.

And while it appears at this point to mostly have affected consumers versus businesses, as businesses continue to report great profits, it would not have been long before the pneumonia caught by the consumers would have given businesses a nasty cold.

Thus, as we take questions today, I want to emphasize we're optimistic that the fundamentals that drive our business toward better performance are still there.

Now let's hear from Dave Sylvester on the strength of this quarter.

Dave?

Thank you, Jim.

Today, we reported a second-quarter profit of $37.7 million or $0.26 per share, which represents better than a 40% increase over the prior year profit of $26.6 million or $0.18 per share.

And it represents the highest level of quarterly net income that we have reported in almost seven years.

These results compare to the earnings estimate of $0.21 to $0.26 per share that we provided last quarter.

Revenue of $825.2 million in the quarter represented a 4.5% increase over the prior year, and was slightly better than the estimate we provided last quarter that year-over-year growth would be relatively flat.

North America revenue, which represents approximately 61% of total revenue, was up slightly compared to the prior year.

And our International segment, which approximates 23% of total revenue, reported 18.8% sales growth over the prior year, representing its fourth consecutive quarter of strong results.

Compared to the prior year, current quarter revenue included a favorable impact of $11.5 million from currency translation effects and an unfavorable impact of $10.9 million related to dealer deconsolidations net of acquisitions completed within the last four quarters.

Operating income for the quarter was $55 million compared to $42.4 million in the prior year.

Included in our second-quarter operating income were pretax restructuring credits of $1.7 million compared to pretax restructuring charges of $4.4 million last year.

Operating income excluding these restructuring items was $53.3 million or 6.5% of sales in the current quarter compared to $46.8 million or 5.9% of sales in the prior year.

This represents a 13.9% increase in operating income, excluding restructuring items, over a very strong prior-year comparison.

The improvement was driven by better performance in both our International and North America segments, offset in part by lower operating income in the Other category.

The current-quarter restructuring credits of $1 million after tax related to the favorable resolution of certain environmental contingencies associated with the pending real estate sale in the International segment.

Cost of sales, which does not include restructuring items, declined 200 basis to 66.5% of sales compared to 68.5% in the prior year.

North America reduced its cost of sales percentage by 280 basis points versus the prior year, and International and the Other category also improved their cost of sales over the same period.

Improved sales mix and pricing yield, benefits from prior restructuring actions, and favorable reserve adjustments which aggregated $4.9 million and related to product warranty accruals and the resolution of certain contract contingencies all contributed to the improvement.

These factors, in addition to a net restructuring credit in the current quarter, versus net restructuring charges in the prior year, increased gross margin to 33.7% in the second quarter from 30.9% in the prior-year quarter.

Operating expenses of $222.8 million, which do not include restructuring items, were 27% of sales up from $202 million or 25.5% of sales in the prior year.

The $20.8 million increase over last year was driven by several factors, including $7.8 million of increased variable compensation expense; approximately $4 million of increased spending and longer-term growth initiatives; $3.4 million in currency translation effects; and $3.4 million of adjustments to self-insurance reserves and lease impairments.

In addition, second-quarter deconsolidations of dealers net of acquisitions had the effect of decreasing operating expenses by approximately $4 million.

As we have said on previous calls, we remain focused on controlling our operating expenses, but we also expect to continue investing in initiatives that we believe will contribute to growing our topline.

Other income net was $10.8 million for the quarter compared to $6.7 million in the second quarter of last year.

The increase includes nonoperating gains totaling $6.2 million which resulted from dealer transitions and the disposition of an equity interest in a company outside of our industry.

Our effective tax rate for the quarter increased to 39.0%.

Income tax expense for the quarter included $3 million of charges related to a change in strategy regarding repatriation of earnings from the Company's Canadian subsidiary and the revaluation of deferred tax assets in Germany and United Kingdom due to the enactment of lower tax rates during the second quarter.

As a result of these factors, the Company now expects its effective tax rate to approximate 36 to 37% for fiscal year 2008.

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

Our cash and short-term investment balance aggregated $478.7 million at the end of the quarter, a $28.8 million increase from the end of the first quarter.

Following a net use of cash from operations in the first quarter due to typical seasonal patterns and an increase in the working capital required to fund the 11% sales growth experienced in that quarter, we generated $107 million of cash from operations in the second quarter.

This increase was driven primarily by strong profitability, non-cash accruals for variable compensation, and the utilization of tax receivables.

Capital expenditures of $18.6 million in the second quarter included a $6 million progress payment for the replacement of an existing aircraft.

We expect our fiscal 2008 capital expenditure investments to increase compared to recent years as we ramp up new product development efforts, invest in our showrooms and corporate facilities, and replace an existing aircraft.

Therefore, we continue to estimate that fiscal 2008 capital expenditures will approximates 70 to $90 million.

During the quarter, we also repurchased 2.2 million shares of common stock under our repurchase authorizations at a total cost of $40 million, or at an average price of $18.27 per share.

In addition, we've paid quarterly dividends of $21.6 million or $0.15 cents per share.

Over the past four quarters, we have returned approximately $245 million to shareholders in the form of quarterly dividends and share repurchases.

At the end of the quarter, we had $77.5 million remaining under our share repurchase authorizations.

Lastly, because some of you have already asked and others are certainly reading and hearing about the stress in today's credit markets, I would like to make a couple of comments about our cash and short-term investments.

Currently, we do not believe that we have any significant exposure in our investment portfolio.

But we do have two areas that I would like to highlight related to investments and auction rate securities, and one Canadian commercial paper investment.

In the case of auction rate securities, our typical practice has been to only invest in highly rated securities and put them at the next auction, which ranges from 7 to 28 days in most cases.

However, recent auctions related to $26.5 million of these securities have not cleared due to lack of liquidity in the marketplace.

Accordingly, we still hold the longer-dated securities, and are due interest at a higher penalty rate.

We also have one Canadian $5 million asset-backed commercial paper investment where the issuer was unable to refinance the maturing paper, and to date has not paid accrued interest.

However, because there are more than 20 trusts in Canada that are currently affected in the same way, we believe that a stabilizing restructure will result from the major Canadian financial institutions that are currently collaborating to develop a solution.

We have not provided any reserves against these investments to date, as we view the likelihood of any principal loss as fairly limited at this time.

Now we will discuss the quarterly operating results for each of our segments and the Other category.

In North America, sales were $504.2 million in the quarter compared to $500 million in the prior year, which had in turn reflected a 15% growth rate over the previous year.

Current-quarter revenue included a $7.5 million unfavorable impact from the deconsolidation of various dealers during the quarter net of acquisitions completed in the last four quarters.

We experienced revenue growth in our seating, work tools, architecture and technology, and wood product categories within the Steelcase group and across various product lines sold under the Turnstone and Nurture brands.

During last quarter's call, we noted that our order rates had moderated over the second half of the first quarter.

And as a result, first-quarter orders grew by low single digit levels, and ending backlog finished the quarter slightly less than the prior year, while early in the second quarter, our orders strengthened, spiking just before a mid-July price list adjustment and remaining steady thereafter and into the third quarter.

Accordingly, second-quarter orders and quarter-end backlog for North America grew at double-digit rates over last year, in part influenced by the prior-year order pattern which softened for several weeks after the July 2006 price adjustment.

The order growth in the current quarter was relatively broad-based across most sales regions, and reflected increased project business versus the prior year.

Operating income for the quarter was $51 million which, for the first time in many quarters, did not include any restructuring charges.

Prior-year operating income was $42 million, including $3.6 million of pre-tax restructuring charges.

Operating income excluding restructuring charges was 10.1% sales in the current quarter compared to 9.1% of sales in the prior year.

The increase in operating income was influenced by higher gross margin, offset in part by higher operating expenses as a percent of sales.

North America gross margin was 33.0% compared to 29.5% in the prior-year quarter.

Cost of sales, which is reported separately from restructuring costs, improved 280 basis points over the prior-year quarter.

Gains were realized through improved sales mix and pricing yields, benefits from prior restructuring actions and continued plant deficiencies, as well as favorable reserve adjustments, which I stated aggregated $4.9 million and related to product warranty accruals and resolution of certain contract contingencies.

North America operating expenses, which are reported separately from restructuring charges, were 22.9% sales in the current quarter compared to 21.9% of sales in the prior year.

Operating expenses increased $9.8 million compared to the prior year, primarily due to $3 million of increased variable compensation expense, increased spending of approximately $3 million on longer-term growth initiatives and $2 million in the areas of new product development and marketing, and a $1.8 million unfavorable adjustment to self-insurance reserves.

In addition, second-quarter deconsolidations of dealers net of acquisitions completed in the past four quarters, had the effect of decreasing operating expenses by approximately $3 million.

International sales were $188.9 million in the quarter, which represented an increase of 18.8% compared to the prior-year quarter.

Sales increases in France, Germany, Latin America, Central Europe, and the UK drove the growth compared to last year.

In addition, currency translation had the effect of increasing revenue by $10 million as compared to the prior year quarter.

International reported operating income of $5.9 million in the current quarter, which includes $1.6 million of pre-tax restructuring credits related to the favorable resolution of certain environmental contingencies associated with pending real estate sale.

In the prior-year quarter, International reported an operating loss of $0.4 million, which included $900,000 of pre-tax restructuring charges.

Operating income excluding restructuring items was $4.3 million or 2.3% of sales compared to $500,000 or 0.3% of sales in the prior year.

While the International results in the second quarter reflect typical seasonality associated with the summer holiday period in Europe, we're pleased with the continued expansion of operating margins, which remained relatively broad-based across many markets, and were influenced by both improvements in gross margin and operating expense leverage.

International gross margin was 33.2% of sales in the quarter compared to 31.3% in the prior year.

Gross margin excluding restructuring impacts was 32.4%, a 50 basis point improvement over 31.9% in the prior year.

The improvement reflects volume leverage, restructuring benefits in certain markets and better operational performance.

Positive mix effects between certain markets and product categories were less significant this quarter compared to recent quarters.

International operating expenses, which are reported separately from restructuring charges, were $56.9 million or 30.1% of sales.

This compares to operating expenses of $50.2 million or 31.6% of sales in the prior-year quarter.

The increase in year-over-year operating expense dollars includes $3.2 million of unfavorable currency effects as compared to the prior year; a $1.6 million reserve adjustment related to a lease impairment in the UK; and approximately $1 million in growth-related spending in Asia.

Our Other category, which includes the Design Group PolyVision, IDEO, and Financial Services, reported revenue of $132.1 million in the quarter or an increase of 1.1% compared to the prior year.

The increase in revenue reflects growth at IDEO and across the Design Group companies, offset in part by decreases in revenue at PolyVision and the Financial Services group.

The decrease in revenue at PolyVision was primarily influenced by low-margin business which the Company is no longer pursuing, while the decrease in Financial Services is directly linked to our strategy to reduce asset-based lending and other dealer financing as well as transfer risk as it relates to customer releasing.

The Other category reported operating income of $4.8 million during the second quarter, which was $2.3 million lower than the prior year.

Financial Services represented $1.4 million of the decrease, and is directly linked with our strategy, while the balance was comprised of improvements in the Design Group and lower income at PolyVision and IDEO.

While PolyVision is currently lagging our initial expectations of a faster turnaround due to the continuation of intense price competition in the U.S.

static whiteboard business and other operational challenges, their overall results reached breakeven in the quarter despite the decrease in revenue.

This breakeven result compares to modest profitability in the prior-year quarter.

Regarding IDEO, we have entered into an agreement which provides for the potential transfer of a controlling interest of the Company to certain members of its management over a period of approximately five years.

During the first phase of the transfer, which will happen over the next two years, management will earn higher levels of variable compensation relative to income, and use such amounts to purchase a minority interest in IDEO.

In the event that a certain percentage ownership is achieved through attaining a corresponding level of profitability over the next few years, the management group will have a limited option to purchase a controlling interest in the Company.

The current-quarter results include the increased variable compensation for the first six months of the year, as the agreement was finalized in the second quarter, but was retroactive to the beginning of the fiscal year.

Now I will review our outlook for the third quarter of fiscal 2008.

Overall, we expect revenue to be 3 to 7% higher compared to $802 million of revenue reported in the third quarter of the prior year.

This estimated range reflects the following four factors.

First, dealer deconsolidations net of acquisitions completed within the last four quarters will negatively impact our topline by 25 to $30 million.

Second, based on second quarter end exchange rates, our third-quarter revenue estimate contemplate approximately $10 million of currency translation benefits compared to the prior year.

Third, North America growth estimates are based on a double-digit increase in beginning backlog coming into the quarter plus the continuation of recent order rates which, if sustained, will result in mid to high single digit sales growth, excluding the effect of dealer deconsolidations.

Fourth, while International results in the third quarter should continue to reflect expansion versus the prior year, revenue growth rates are expected to moderate from recent quarters as we begin to compare year-over-year sales to prior quarters that were very strong.

And we do not anticipate any significant impact in the third quarter from the consolidation of the Ultra Group, our recently announced acquisition in China, which is expected to close late in the third quarter.

Thus, while we expect reported revenue in the third quarter to the 3 to 7% higher than last year, if you adjust for the impact of the dealer deconsolidations net of acquisitions, we expect comparable revenue to be 6 to 10% higher than the third quarter of the prior year.

We expect reported earnings per share for the third quarter will be in the range of $0.27 to $0.32 per share.

We reported earnings of $0.22 per share in the third quarter of the prior year, including after-tax restructuring charges of $3.6 million.

We feel quite good about our year-to-date results, as well as our near-term outlook for the third quarter.

Nevertheless, like you, we are reading and hearing daily mixed sentiment surrounding the North American economy in the midterm.

One camp has expressed concern linked to ongoing housing problems, the tightening credit markets, and erosion of consumer confidence, while the other camp believes that the housing and financial problems will not infect the broader economy or dampen business investment and hiring.

Only time will tell, but we were encouraged by the Fed's decision earlier this week to lower rates by 50 basis points.

And we also feel pretty good about the current levels of corporate profits; fixed nonresidential investment, including new office construction; and office vacancy rates.

In addition, we have not seen any significant order cancellations or deferrals, and we again enjoyed a double-digit increase in customer visits in the second quarter versus the prior year.

So for now, we remain focused on expanding our gross margins.

And as we have discussed in the past few quarters, we continue to invest in longer-term growth initiatives related to new product development in our core markets, expansion in the vertical and emerging markets and strengthening of our brands around the world.

So in summary, we achieved strong results in the second quarter, and our third-quarter outlook is positive.

While there is some uncertainty thereafter which limits our visibility, we continue to expect fiscal 2008 will mark our fifth year in a row of improved profitability and another step toward achieving our long-term goal of 10% operating income as a percent of sales.

Now, we will turn it over for questions.

(OPERATOR INSTRUCTIONS) [Chad Bolen].

This is Chad Bolen filling in for Bud this morning from Raymond James.

I had a quick question for you.

The EPS guidance implies some sequential improvement from margins.

Would you say that that's more driven by operating expense improvements or gross margin improvement?

Could you give me a sense of the mix there?

Could we see gross margins flat on a sequential basis in the quarter?

I don't know if I want to get too specific about the breakdown of our earnings guidance.

But I think you should expect to see improvement on the gross margin line.

Okay.

And you had mentioned growth at Turnstone.

Could you elaborate a little bit on the performance there in the quarter?

I would love to, but we have been pretty protective of keeping that one under the vest.

You know it's better than a couple hundred million in size.

And we have been talking about nice growth in it over the last several quarters.

I think we had a quarter, maybe Q4 or Q1, where it flattened out for a short period of time.

But it has since picked up again.

So it's not in the double-digit category, but it's pretty good.

Okay, and then lastly, I think on last quarter's conference call, you had mentioned that the wood business was essentially breakeven.

Was that the case in this quarter as well?

Yes, on an operational level, they were pretty close to breakeven again this quarter.

But we are frankly investing -- continuing to invest back in that business in order to get it to the next stage of the turnaround effort, which is what I described in previous calls as an acceptable level of profitability.

So operationally, they're in pretty good shape.

And we feel good that the dealers -- dealer confidence in our new products is strengthening, as evidenced by the sales growth we're showing.

Todd Schwartzman.

What percentage of sales did project business represent in 2Q?

We don't break that out publicly.

But we do look at and talk about our trends in, for instance, project orders versus continuing [kind of] annuity business.

What we did see for orders in the second quarter is an uptick in product orders versus the first quarter sequentially and versus last year.

Was that uptick commensurate with the overall allusion that you gave to growth earlier for total orders?

If you look at -- we were talking about in the call earlier that we're looking for strong single digit growth rates in North America in the third quarter.

Some of that is caused by the uptick seen in the orders -- in project orders, project business.

In terms of those orders for the quarter, did all of geographic markets do about equally well?

You mean within the U.S., or around the world?

Within North America, yes.

Some of it -- when you talk about project business, it gets a little uneven, because depending on what's going on with what large customer around the region.

If you look at it in a little different way -- look at, say, Fortune 1000 versus other companies, we saw in the second quarter good, strong double-digit -- I'm sorry, single-digit order growth in the Fortune 1000, and low double-digit order growth beyond the Fortune 1000.

It was pretty broad-based in the end.

I don't know that every single market around the U.S.

grew at the same rate, but it was fairly broad-based, as I remember.

So no pockets of strength or weakness that would be worth highlighting?

Not at this time.

Could you also break out and maybe quantified the components of other income, and maybe discuss how much, if any, nonoperating gains are embedded in your 3Q EPS guidance?

In connection with that, we do break it out in the Q, so you get a little bit more color there.

But the big drivers of the other income are interest income, which is relatively comparable to the prior year, because our cash balances are comparable at this point.

This quarter, we did have the nonoperating gains that we had highlighted in our previous guidance.

And to the extent that we forecast or anticipate things like that, we would call them out to you.

So you should not expect any unusual items at this point that we are going to call out.

So that 27 to 32 is relatively clean, for lack of a better word?

Yes.

Okay, great.

How large can your education business becomes ultimately?

It's Jim Hackett here.

I would say that historically, the Company has enjoyed as a portion of its current sales, sales to what we would say -- beyond K-12, so colleges, universities, learning centers and corporations.

So we have had a decent history there.

With the addition of PolyVision, the digital part of PolyVision, to furniture that has done well, and new science, new applications, I think that it has a great, great potential.

We haven't sized it, because we haven't even announced yet the full details of some of our strategy.

But I would say to you that one way to think about this is that the nature of the classroom design that I mentioned in my comments hasn't changed, what, in 50 years.

It's kind of odd to think that way -- as much as we all care about our kids and their education are in terms of what we experienced in education.

But technology ended up shaping much of what now happens in colleges, and the spaces did not catch up.

Now they are.

And there's not -- there wasn't a historical leader in that field, you know, in terms of classroom fit out.

So it's a natural place for Steelcase to expand and create a lot of credibility.

Are there any substantive margin differences between these products and your other product categories?

No.

Lastly, any plans for additional price increases in the back half of the year?

Well, you know, we can't signal something like that for obvious reasons.

But one thing that we have said in previous calls is that the nature of inflation is something we keep close watch of.

And if we have to take action, we will.

(OPERATOR INSTRUCTIONS) Matt McCall.

One of the last questions, I think, characterized the guidance as "clean." Help me understand -- what level of other income is assumed in that, what level of foreign exchange is assumed in that?

Some other things like warranties and some items you broke out showed up.

What other items are we talking about there?

I think you -- I'm sorry; you gave me the foreign exchange.

But any -- maybe you can talk about other income and some of those other items first?

I would tell you we haven't been in the practice of giving specific other income guidance.

Last quarter, we called out for you that we saw a couple of big items coming.

And they did come through.

And we just said they were $6.2 million.

I think go forward, unless you hear specifically from us, you can kind of look back and (technical difficulty) [questions] what normal operating, nonoperating income ought to be.

The other thing we adjusted below the line our outlook on was tax rates.

So we raised that a little bit given some of the tax rate changes in the international markets, as well as a different point of view on repatriation of earnings from Canada.

Outside of that, it is a clean outlook.

It's a little complicated because of the deconsolidations.

And we decided this quarter that we just would be better off, I think, if we laid out clearly what our guidance contemplated from an FX perspective.

We have kind of told everybody how we do that math in the past, and let you do it yourself.

And not in all cases is that math done correctly, so we thought we would just kind of transparent about that.

Outside of that, it's normal course.

Matt, I would just comment -- you mentioned the reserve adjustments.

Dave did call them out.

There were some favorable ones up in gross -- in the cost of sales, and there were actually comparable sized ones down in OpEx.

So those are situational.

That happens based on the facts and circumstances in the quarter.

So we call them out so you can see them as either significant or unusual, but for the most part, I think if you looked at them this quarter, they netted to a relatively small amount.

Okay, I'm watching -- obviously, there's some concern about [the main] trends, given what Herman Miller just talked about.

And I'm watching the stock kind of fall a little bit on some decent numbers, and I think there's some concern out there of what was actually assumed -- maybe going back to the Q2 guidance, what was really assumed in that Q2 guidance, and how clean the number that you just reported is.

So maybe (technical difficulty).

Let me speak to that, Matt -- very clean.

The guidance last year was very clean.

If we have a point of view on adjustments, we take them in the quarter that we have a point of view on.

So there was no funny business going on as far as forecasting adjustments.

But as Mark said, they netted.

The reason we gave so much color on them this quarter is because they -- okay, they net to zero, but they influence gross margin in North America.

The OpEx negatives are spread between North America, International and the Other segment.

So at the Inc.

level, they net.

But we felt like you needed to have some color to factor those in or out of your models go forward.

Okay, and the $11 million plus was -- $11.5 million was the assumed FX level last quarter?

Yes, plus or minus -- I think currency was a tad stronger than it was at the beginning of the quarter -- you might have got another million from it, but --

What I take from some of the questions this morning -- is International viewed more casually in terms of its performance?

Why wouldn't the strength of persistence of our performance there be a positive in the quality of earnings?

No, no, no -- I don't doubt that at all.

I'm just trying to make sure that all these things were assumed -- and again, these are based on some of the questions I am getting.

Right, okay.

And given the dollar actually being weaker, I do understand why people wonder if that in fact is inflating earnings.

But the truth is the International performance has been very good.

And I'm just looking last night at GDP forecast there.

They're still healthy.

So part of actually what it is unique when you're talking about Steelcase from a global perspective is that the nature of our International performance, and something we have been proud of -- and the overall economy, I think, weathers some of the liquidity issues.

Our -- overall economy in the U.S.

is benefiting because the world economy has been strong, but it has helped Steelcase.

And now we see the North American operations improving which is -- we projected that.

Dave mentioned that in his last few comments.

So I actually have a sentence in my opening comments that I didn't emphasize, for fear that the syntax of the words would get mixed up.

But it is the notion of quality of earnings that you all have to kind of ferret through.

And this is a quarter where we have some really good results, and the quality is pretty high.

And that's why Dave probably leaned forward in his seat on the last question (multiple speakers) but it is that time at which we want to emphasize that.

Absolutely.

Okay, well, thanks for all the clarification, and good luck, guys.

[Catherine Ragolski].

It's actually Chris Agnew on behalf of Catherine.

Just want to focus on your long-term margin target of 10%.

Obviously, you have achieved that in North America.

I just wonder, how should I be thinking about you achieving your overall target?

Should it be International and Other moving up to the level of North America?

And how do you plan to achieve it in both those businesses?

Or will North America move further ahead to, say, 12% margins, and structurally, International and Other will always be slightly lower?

Good questions.

Let me give you a little color.

And we will formally update those targets next quarter when we talk in December.

Since we did that last year, we have changed our segments a bit.

You remember with the 10-K, we moved some businesses around, and our segments changed.

And we haven't had a chance to formally talk about how that impacts our overall targets.

In total, we are still shooting for 35, 25, 10 -- 10% operating income, 35% gross margin, and 25% operating expenses.

I think what you should assume is that North America will target something stronger than that; International will target something approximating that; and Other, in a similar fashion, something approximating.

And then don't forget we have the unallocated corporate costs as well that will pull some of those overall operating margins down a bit.

And we will go through that the little bit more formally in the next quarter.

And I don't know if you can give us any color like internationally.

Is it particular geographies that you feel need to improve?

Or is it more just a volume story overseas to cover overhead expenses?

And then as a sort of add-on with the Other business, you mentioned that -- the news about IDEO.

But is PolyVision still core -- do you still see that as core to your business?

And is the turnaround part of driving margins to approximately 10% as you mentioned?

Just to comment, IDEO is a jewel.

And it's doing very well.

Actually, the Company has kind of exceeded everyone's expectations, and become kind of a global brand unto itself.

And some of this about releasing some of its value, and in turn, continuing to attract talent.

And as Dave described the structure of this, this is over five years that we're walking more and more management into an ownership position.

PolyVision is, quite candidly, a company that has two stories.

And one story is that -- the digital part of the business is an area we have invested kind of ahead of trends, and been willing to actually kind of eat the startup costs of that, so to speak.

And the data I look -- we have a product line which is a little device that hangs on meeting walls called RoomWizards where the sales have been very strong, and the growth is healthy.

That's our point about the nature of how technology and our industry can be core.

We never set out to be a technology company or to compete with big tech companies, but what we call add a layer of value.

So right now, I would say to you strategically, evidence is that's working.

The other side of the PolyVision story is the nature of a competitor coming in the static board business, something that we should be better at handling, and are addressing.

And so I have confidence that the PolyVision efforts that we have initiated will stick, and will improve results.

If you ask, well, why?

I would say the team that I've got has demonstrated the ability to attack these kinds of problems systematically and deliver results.

Before the wood problem inside our business, we were dealing with kind of the factory restructuring.

And before that, we were dealing with international restructuring.

So each one of those, as we picked them off, this team has been able to deliver that kind of value.

So it's premature to tell you that PolyVision has crossed that finish line.

That's why Dave is updating you each quarter.

But you know, the anecdotal kind of confirmation from our customers is this is key to our strategy.

(multiple speakers)

Your first part of your question about how does International get to better than 10%?

It's a little bit of a lot of things.

Volume is certainly part of it.

But you will recall from last year, we didn't let ourselves assume any kind of significant volume increases in our three-year targets, such as it would force the right kind of actions.

Now, they're growing at a much faster rate than kind of mid single digit that we assumed in overall targets.

So that's certainly helping.

But we are also trying to push through the same kind of concepts over in International that have been -- or driven big success here in North America around Lean manufacturing principles and continuous improvement and complexity reductions and leverage of lower-cost country supply chains, as well as some operating expenses strategies.

And I would also tell you that while they're doing very well, they have got a few spots that are not material, necessarily, to the overall company.

But they've got a few spots that they are working on trying to drive better margins in different business segments.

So it's little bit of a lot of things.

But that business, as I said in the outlook -- while the growth rates are going to start bumping up against some pretty strong quarters last year, we still expect to show operating margin expansion over the prior year.

One last question -- I know healthcare is an area that excites you, and you've got the Nurture business.

You gave some color on Turnstone, maybe even just in terms of a couple hundred million dollars in size, and not growing double-digit, but pretty good.

Can you give us some similar color on Nurture, and maybe just give us an overview of what you're hearing and seeing in the healthcare markets?

Let me start with kind of the broader view, and maybe if Dave or Terry want to add to it -- at a broad perspective, there's clearly no secret about the nature of the demographic shift and why healthcare is important.

So I know there's no lack of shared understanding of that.

But what is surprising, I think, is that -- particularly in the U.S., is the speed at which the facilities were being added, and how this all came at once, particularly when you know in some communities, there was a fight to kind of justify certificate of need, as it was called -- additional hospital beds.

Right now, the projections show that there's a continued deficit of facilities based on the population that's going to need these.

So we think the long-term value is pretty high in this category.

We find that in the nature of the way we report sales to you -- we kind of understand inherently that the track of office projects and how a win, for example, in a project shows up in our sales -- how long that's going to take.

So if we give you a sense of how our business is doing and how our forecast might look, we have got a decent handle on the relationship of the way offices are built, and then they convert the orders.

Hospitals, because of the nature of the complexity of the spaces -- they're interstitial spaces with [passes] and fluids and what have you -- take a lot longer construction time.

And yet, the decision to buy furniture is integrated early in the way they purchase.

So what we're finding is we have won, but not booked, orders right now.

We're building a decent backlog.

We couldn't justify for revenue recognition reasons reporting that.

And we're watching it with enthusiasm, because we haven't received the orders yet, but we've been told we are a pick.

We are learning that it's likely that there's no risk in that changing, because the buildings are designed around their decision, in the case of picking Steelcase.

So this is all great news, and what we're using to try and support our enthusiasm.

With that said, I can share with you that Nurture is growing at a faster rate than the overall industry right now.

So it's just as we expected.

And Dave, do you want to add any more to that in terms of (multiple speakers) impact?

The one thing I would point out is internationally, this is a similar opportunity demographically.

But there are a lot of different issues with social medicine and so on and so forth -- but in a similar way, there's potential there, as well.

Thank you, gentlemen.

There appear to be no further questions.

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

Well, I want to emphasize that calls like this, analysts and businesspeople reviewing [kind of] performance in the state of -- in this case, the American economy and the liquidity challenges -- everyone looking for places where there's stability and kind of a sense of how things might happen.

And our management team spent some time thinking about that question as we projected to you the health of the business.

So I want to emphasize that, A, the quality of the earnings today are very high.

And B, the business is vibrant.

And C, we believe the forecast we give you to be pretty good.

We are doing our best to hit or exceed these goals, and I look forward to being able to continue the momentum that we have established here.

Thank you.

Thank you very much, ladies and gentlemen.

That does conclude today's conference.

You may disconnect your lines and have a wonderful day.