Steelcase Inc (SCS) 2008 Q3 法說會逐字稿

Good day, everyone and welcome to Steelcase's third-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.

Good morning, everyone.

Thank you for joining us for the recap of our third-quarter 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 third-quarter earnings release dated December 19, 2007 crossed the wires after the market closed yesterday 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 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.

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

Reconciliations 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 yesterday'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 23rd, 2007 and other filings within the Securities and Exchange Commission.

This webcast is a copyrighted production of Steelcase Inc.

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

Thank you, Raj, and happy holidays to everyone and good morning.

I am pleased today to report that the Company is an excellent shape.

There is a great deal to be proud of with our Q3 performance and I want to share with you some of the highlights.

We have been reporting in our past calls that we are quite excited about the continued improvement in the industrial system.

This is the system that once an order is taken, product is built and then shipped.

That end-to-end system has gone through a modernization and adoption of Lean manufacturing principles.

As many of you have read or learned about this system, it is the gift that keeps on giving.

Lean is a method, it's a process, it's a mindset that enhances operational performance.

While the adoption of Lean signals a start, there really is no end to this effort.

The gains continue to appreciate and we continue to see them showing up in our numbers.

From this call, we have reported on a number of gains that we have made in this area in the past.

One today I want to highlight.

I was in our west Michigan wood facility last week, which is one of many that has gone through this modernization.

For me, the strong adoption of Lean principles is key to the turnaround in the operating performance of this segment.

And we are pleased to confirm, as we told you we would, we met the goals that we set out for ourselves a year ago.

Our North American manufacturing team, led by [Hamid Kromium], has had stellar performance.

Congratulations to Hamid.

The modern notion of this principle is that it can be highly efficient.

I want to point this out.

Manufacturing can also be a sustainable operation.

Our wood factory uses a UV finishing process that provides not only the best finishing process in our industry, but you know what, it's a state-of-the-art sustainable process within the industry today.

From my view, I suspect that in the near future, furniture makers who haven't adopted sustainability standards will be challenged by customers to demonstrate their commitment to this.

Candidly, less sustainable products won't be acceptable.

It's becoming expected, and we are already there.

This Lean and sustainable manufacturing mindset flows through our whole global system.

And as you hear more of our investments in Asia production, I want to confirm to you that we will be faithful to those principles all over the world.

Steelcase has built a global supply system that allows us to compete for business on every continent.

It can also be a hedge to currency translations as well as advantage for parts and assembly configurations.

But I want to expand the notion to a concept called best shoring -- it's a term that we borrowed from others -- which means that you can move production to the place of the best advantage to serve your customers.

The Company has already started building a shared service center in Malaysia that has allowed us to manage our growth with a shared resource across multiple geographies.

Now, true, there is a cost advantage or what is known as labor arbitrage, but the more we learn about this captive center and the more we benchmark with other companies, the more we learn that this shared capability is key to serving our global customers wherever they might be around the world.

It's a way to add value.

Dave Sylvester will point out other highlights in our financials.

But I want to underscore that you will hear we are dialing up our longer-term performance goals and in working with our Board, we have firmed up our go-forward financial policy.

The Company has systemically worked down its reliance on capital.

This has allowed us to pursue investments in our business like the Ultra acquisition in China and returning value to shareholders through dividends and buybacks.

In the end, though, with all of this, our employees' commitment to serving their customers brings to mind a well used phrase from one of our founders in 1912.

He said, "serve your customers well and profit thereby." It reminds us that we will continue to work to be better, to achieve more yet never lose sight that what makes a great Company is a commitment to the customers we serve and the people who are associated with this enterprise.

So with those positive comments and enthusiasm I hope you can see and hear I want to turn it over to our Chief Financial Officer, Dave Sylvester.

Thank you, Jim.

Today, we reported a third-quarter profit of $31.3 million or $0.22 per share.

These results included a $21.1 million charge related to goodwill and intangible asset impairments, which, after reduction of related variable compensation expense and income taxes, reduced net income by $11.3 million or $0.08 per share.

While I will review the impairment charges in greater detail later in the call, it is important to note that our third-quarter earnings guidance of $0.27 to $0.32 per share did not anticipate these charges.

Accordingly, our net income performance for the quarter is otherwise in line with the guidance we provided in September.

In the prior year, we reported third-quarter net income of $32.8 million or $0.22 per share, which included $3.6 million of after-tax restructuring charges, primarily related to the consolidation of our manufacturing activities in North America.

Revenue of $885.9 million in the current quarter represented a 10.5% increase over the prior year, which exceeded the guidance of 3 to 7% we provided last quarter.

Sales growth in all segments was higher than our expectations as was the impact of foreign currency translation.

North America revenue, which represents approximately 58% of total revenue for the quarter, was up 9.4% compared to the prior year.

And our international segment, which approximates 26% of total revenue, reported 15.6% sales growth over the prior year, representing its seventh consecutive quarter of reported double-digit sales growth.

Compared to the prior year, current quarter revenue included a favorable impact of $23.2 million from currency translation effects and an unfavorable impact of $25.2 million related to dealer deconsolidations net of acquisitions completed within the last four quarters.

Operating income for the quarter was $52.7 million compared to $40.5 million in the prior year.

Included in our third-quarter operating income were pretax restructuring credits of $100,000 compared to pretax restructuring charges of $5.7 million last year.

Operating income, excluding restructuring items, was $52.6 million or 5.9% of sales in the current quarter compared to $46.2 million or 5.8% of sales in the prior year.

This represents a 14% increase in operating profit over the prior year, which was driven by better performance in all of our segments, offset in part by the impairment charges recorded in the "Other" category.

We have included two webcast slides to more clearly illustrate the impact of the impairment charges and related reductions in variable compensation expense on operating income by segment, along with the consolidated impact on net income and earnings per share.

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

North America reduced its cost of sales percentage by 230 basis points versus the prior year and international improved by 30 basis points over the same period.

Benefits from prior restructuring actions and increased volume primarily contributed to the improvement.

These factors, in addition to a net restructuring credit in the current quarter compared to net restructuring charges in the prior year increased gross margin to 33.5% in the third quarter from 30.8% in the prior-year quarter.

Operating expenses of $244.2 million, which do not include restructuring items, were 27.6% of sales, up from $206.6 million or 25.8% of sales in the prior year.

The $37.6 million increase over last year was driven by several factors, including the $21.1 million impact of the goodwill and intangible asset impairment charges, again, as more clearly illustrated in our webcast slides; $6 million in increased sales, marketing and new product development spending; $6 million in unfavorable currency translation effects; and $4 million of additional investments in longer-term growth initiatives.

In addition, third-quarter deconsolidations of dealers net of acquisitions completed in the last 12 months, had the effect of decreasing operating expenses by approximately $7 million.

As we have said in 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 top line.

Other income net was $3.6 million for the quarter compared to $13.9 million in the third quarter of last year.

As you will recall, last year included $4.9 million of gains related to a dealer transition and a minority investment in a European dealer.

During the current quarter, we repatriated an additional $30 million of cash from our Canadian subsidiary, which resulted in foreign withholding taxes of $1.5 million that were recorded as a non-operating expense.

We expect to recover these taxes through utilization of a U.S.

foreign tax credit recorded within our current quarter provision for income taxes.

Lastly, interest income was lower this year due to lower average interest rates.

Our year-to-date effective tax rate was increased to 37.9% during the quarter, up from 37% at the end of the second quarter, resulting in nearly a 40% effective tax rate for the current quarter.

The increase during the third quarter was primarily driven by the goodwill impairment charges recorded during the quarter, which were not deductible for tax purposes and thus no related income tax benefit was recorded.

In addition, the favorable impact of foreign tax credits related to the repatriation of cash from our Canadian subsidiary was essentially offset by other adjustments during the quarter.

As a result of the impairment impact, we now expect our full year effective tax rate to approximate 37 to 37.5% for fiscal 2008.

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

Our cash and short-term investments balance approximated $544 million at the end of the quarter, a $65 million increase from the end of the second quarter and a $19 million increase from the same quarter last year.

We generated $105 million of cash from operations in the third quarter, which was influenced primarily by strong profitability adjusted for the non-cash impairment charges, non-cash accruals for variable compensation and benefits and improvement in working capital metrics.

Capital expenditures of $21.4 million during the third quarter represent an increase over recent quarters, which is consistent with our guidance that we expect capital expenditure investments to increase in the near-term as we ramp up new product development efforts, invest in our showrooms and corporate facilities and plan to replace an existing aircraft.

We estimate that fiscal 2008 capital expenditures will approximate 75 to $85 million.

During the quarter, we invested $14 million to complete the acquisition of the Ultra Group's office furniture business.

Ultra is one of the leading office furniture companies in China, which again, is one of our targeted emerging growth markets.

This acquisition will broaden our capabilities in distribution, product portfolio and manufacturing to support the expansion plans of our customers throughout Asia.

Also during the quarter, we completed the sale of our manufacturing campus in Strasbourg, France, which we had exited in connection with previous restructuring activities.

We received net proceeds from the sale of approximately $11 million and recorded related net restructuring credits of $500,000 in the quarter.

We paid quarterly dividends of $21.2 million or $0.15 per share.

And early in the quarter, we also repurchased approximately 806,000 shares of common stock at a total cost of $14.7 million or an average price of $18.25 per share.

For the balance of the quarter, however, we operated under a self-imposed trading blackout, ceasing share repurchases while we evaluated the capital structure changes announced yesterday.

The declaration of a special dividend in the amount of $1.75 per share and the approval of an additional share repurchase authorization of $250 million, were enabled by the cash generated from our operations as well as the completion of our restructuring activities over the past several years.

These announcements are a testament of our ongoing commitment to improve the efficiency of our capital structure and return value to shareholders.

In fact, over the past four quarters, we have already returned in excess of $250 million to shareholders in the form of quarterly dividends and share repurchases.

With these announcements yesterday, I would also like to provide some color around our financial policy in general, as we are asked from time to time how we think about various debt ratios, cash and investment levels, and allocations of earnings.

Our intent has always been to manage our capital mix consistent with investment-grade companies.

In doing so, we determine our target debt levels based on two primary metrics, which in order of importance are debt to EBITDA and adjusted debt to total capital.

Note by adjusted debt, we mean debt plus a capitalized amount for operating leases.

Our target for debt to EBITDA is to not see a ratio of 2 to 1.

And our target for adjusted debt to total capital approximates 35 to 45%.

We are comfortable with debt being even a slightly higher mix of our total capital, as long as our expected cash flows are strong.

With respect to cash and investment levels, we currently estimate our core cash needs are approximately $50 million though the balance will fluctuate throughout the year based on the timing of certain disbursements such as dividends, taxes, variable compensation, et cetera.

In addition, we intend to maintain a minimum of $100 million of cash and investment cushion above our core cash needs for the foreseeable future.

This represents a progressive reduction in our cash cushion from previous years.

We are comfortable with this reduction after having completed the redesign of our business model and developed a more variable cost structure and we intend as an added contingency to maintain ready access to additional liquidity.

Our first priority for cash generated from operations will continue to focus on reinvestments in the business, which may include additional acquisitions that support our growth strategies.

Our second priority is the maintenance of a strong quarterly dividend, which we are targeting over the longer term to move into a payout ratio relative to earnings of approximately 35 to 40%.

Our business reinvestment may be higher or lower at any given time depending on opportunities and our earnings may fluctuate based on economic conditions.

We will continue to use share repurchases as the balancing factor for our third priority, which can be flexed up or down as appropriate depending on business requirements, reinvestment opportunities and our economic outlook.

Lastly, I would like to update you regarding two areas of concern within our cash and short-term investment portfolio that we highlighted last quarter.

In the case of the auction rate securities we mentioned, recurring auctions related to the $26 million of these securities that we hold have continued to fail due to a lack of liquidity in the marketplace.

Accordingly, we still hold the longer dated securities and have been receiving interest at higher penalty rates.

We continue to monitor the market dynamics underlying these securities and have recently become aware of some sentiment that a modest discount may be necessary in order for future auctions to clear the market.

We also continue to hold the Canadian $5 million asset-backed commercial paper investment that defaulted during the second quarter as the broader Canadian market for this type of paper effectively shut down.

Though we have not yet received formal information, preliminary reports suggest that the committee seeking to bring liquidity back to this market will propose that investors accept some discount under a restructuring and exchange of their short-term notes for new classes of healthier, long-term notes.

The committee has delayed their formal response for a second time until the first calendar quarter of 2008.

As it is too early to estimate a range of potential loss that these discounts may warrant, we have not provided any reserves against these investments to date.

Further, we have not contemplated any estimated impact in our earnings guidance for the fourth quarter.

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

In North America, sales were $513.6 million in the quarter or 9.4% higher than the third quarter of last year.

Current quarter revenue included an unfavorable impact of approximately $21 million from the deconsolidation of various dealers net of acquisitions completed in the last four quarters.

Adjusting for the impact of these net divestitures, organic growth in the North America segment approximated 15% in the third quarter.

We experienced revenue growth in virtually all of our product categories, geographic locations and vertical markets.

However, project business with large customers and growth within our wood and architecture and technology product categories were particularly strong.

During last quarter's call, we noted that our order rates had strengthened early in the second quarter, spiked 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 prior year order pattern, which softened for several weeks after the July 2006 price adjustment.

During the third quarter, we saw order rates remain relatively steady through October, reflecting upper single digit growth compared to the prior year.

However, order growth slowed in November.

The orders during the quarter also reflected somewhat shorter lead-times, which enabled a quicker shipment pattern associated with September and October orders.

This factor along with the lower order growth in November contributed to a beginning backlog going into the fourth quarter that was flat versus the same timeframe last year.

Operating income for the quarter was $53.6 million, including $300,000 of restructuring charges.

Prior-year operating income was $26.6 million, including $5.2 million of pre-tax restructuring charges.

That's clearly a 70% year-over-year increase in operating income, excluding restructuring items.

Operating income, excluding restructuring charges, was 10.5% of sales in the current quarter compared to 6.8% of sales in the prior year.

The significant improvement in operating income was influenced by higher gross margin and lower operating expenses as a percent of sales.

North American gross margin was 31.7% compared to 28.4% in the prior-year quarter.

Cost of sales, which is reported separately from restructuring costs, improved 230 basis points relative to sales over the prior-year quarter.

Gains were primarily realized through better volume leverage and benefits from prior restructuring actions and continued plant efficiencies.

However, these gains were somewhat masked by lower appreciation of cash surrender value or CSV on Company-owned life insurance policies this quarter versus a year ago.

You may recall we experienced a significant increase in CSV during the third quarter of last year, which was driven by a strong stock market during that quarter.

While appreciation of CSV recorded in cost of sales during the current quarter was not dramatically out of line with our current-year expectations, compared to the prior year, it was approximately $3 million lower, resulting in a 60 basis point impact on cost of sales as a percent of revenue.

These investments were initiated years ago as a long-term funding source for retiree medical benefit obligations.

Accordingly, we [matched] the accounting for their performance with the related employee benefit cost allocations to cost of goods sold and operating expenses.

North America operating expenses, which are reported separately from restructuring charges, were $109 million or 21.3% of sales in the current quarter compared to $107 million or 22.7% of sales in the prior year.

The current quarter variation in operating expense dollars was primarily influenced by $6 million of increased spending on new product development and longer-term growth initiatives and approximately $2 million of lower appreciation of CSV recorded in operating expenses, offset in part by the favorable impact of deconsolidations of dealers net of acquisitions completed in the last four quarters, which had the effect of decreasing operating expenses by approximately $6 million.

In addition, increased variable compensation expense driven by improved operating results was more than offset by the reductions associated with the impairment charges recorded in the "Other" category, again, as more clearly illustrated in our webcast slides.

The international segment enjoyed another great quarter, posting its highest level of operating income this decade.

International sales were $230.8 million in the quarter for an increase of 15.6% compared to the prior-year quarter.

Sales in Germany, Latin America, and Eastern and Central Europe made up the majority of the growth compared to last year.

In addition, currency translation had the effect of increasing revenue by $19.4 million as compared to the prior-year quarter.

Order growth was again strong this quarter, nearly reaching double-digit growth rates in local currency, reflecting strength in Germany, Latin America, Eastern and Central Europe, China, and India.

International reported operating income of $20.2 million in the quarter, which includes $500,000 of pre-tax restructuring credit related to the sale of property.

In the prior-year quarter, international reported operating income of $15.8 million, which included $400,000 of pre-tax restructuring charges.

Operating income, excluding restructuring items, was $19.7 million or 8.5% of sales compared to $16.2 million or 8.1% of sales in the prior year.

What makes this operating margin expansion all the more impressive is that it has been accomplished while funding our growth initiatives in emerging markets.

International gross margin was 34.8% of sales in the quarter compared to 34.1% in the prior year.

Gross margin, excluding restructuring impacts, was 34.6% or a 30 basis point improvement over 34.3% in the prior year.

The improvement reflects volume leverage and better operational performance, offset in part by the costs associated with enhancing our supply chains in support of our growth initiatives.

International operating expenses, which are reported separately from restructuring charges, were $60.2 million or 26.0% of sales.

This compares to operating expenses of $52.2 million or 26.1% of sales in the prior-year quarter.

The increase in year-over-year operating expense dollars includes $5.1 million of unfavorable currency effects as compared to the prior year and approximately $1.5 million in growth related spending in Asia.

Our "Other" category, which includes the Premium Group formally described as the Design Group, along with PolyVision, IDEO, and financial services, reported revenue of $141.5 million in the quarter or an increase of 6.6% compared to the prior year.

The increase in revenue reflected growth at IDEO, Brayton and Designtex is offset in part by decreases in revenue at Metro and PowerVision.

Metro faced a strong comparable quarter last year while the decrease in revenue at PowerVision continues to be influenced by a strategic decision by the Company to not pursue low margin business in the contractor white board market in the U.S.

The third-quarter operating loss of $13.9 million reported by the other category included the $21.1 million non-cash impairment charge associated with certain intangible assets and goodwill relating to PowerVision.

Plus, a $2.1 million charge related to building and leasehold improvements associated with one of our manufacturing facilities.

For several quarters now, we have discussed the intense price competition in the U.S.

contractor white board business at PowerVision.

While most other segments within the PowerVision business are improving, the financial performance in the contractor white board segment continues to lag our expectations.

Accordingly, during our annual three-year strategic planning process completed earlier this quarter, we began evaluating a number of alternative strategies to address this segment's lagging financial performance, which remains under study and review by our leadership team.

However, it became apparent during these strategy reviews that in any scenario, the intangible assets and a portion of the goodwill associated with this particular portion of PowerVision's business was impaired.

Accordingly, we completed the detailed valuation work necessary to quantify and record the impairment charge.

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

Overall, we expect revenue to be 10 to 14% higher compared to the fourth quarter of the prior year.

This projected range reflects the following factors.

First, the fourth quarter of this year reflects an additional week of shipments due to the timing of our fiscal year end, which is tied to the last Friday in February.

Accordingly, the fourth quarter will include 14 weeks of shipments versus a typical 13-week quarter.

What's important to keep in mind is that this extra week comes at the end of the quarter, which coincides with one of our lowest seasonal months of shipments.

Second, based on third-quarter end exchange rates, our fourth quarter revenue estimates contemplate approximately 20 to $25 million of currency translation benefits compared to the prior year.

Third, dealer deconsolidations, net of acquisitions, including Ultra, that have been completed within the last four quarters, will negatively impact our top line in the fourth quarter by approximately $10 million.

Specific to Ultra, we would expect this business to approximate breakeven operating results for at least the next few quarters as we move through post-merger integration plans and amortize acquired intangible assets.

(technical difficulty) North America growth estimates are based on the flat beginning backlog coming into the quarter, along with an expectation that fourth-quarter orders will reflect modest growth over the prior year and continue to reflect relatively short lead-times and quicker shipments patterns.

Fifth, (technical difficulty) results in the fourth quarter should continue to reflect organic expansion versus the prior year.

Revenue growth rates in local currency are expected to remain in the single digits as we continue to compare year-over-year revenues to prior-year periods that were very strong.

(technical difficulty) while we expect reported revenue in the fourth quarter to be 10 to 14% higher than last year, if you adjust for the extra week of shipments, estimated currency translation benefits and the impact (technical difficulty) consolidations net of acquisitions, you will note that we expect comparable revenue to reflect organic growth of low to mid single digits.

We expect reported earnings per share in the fourth quarter will be in the range of $0.23 to $0.28 (technical difficulty) per share.

We reported earnings at $0.20 per share for the fourth quarter of the prior year, which included $6.1 million of after-tax restructuring charges, primarily related to the consolidation of our manufacturing activities in North America.

In addition, the prior year included favorable tax adjustments totaling $24.8 million and intangible asset and goodwill impairment charges totaling $7.7 million after tax.

These adjustments combined with related variable compensation expense of $6.3 million after tax had the net effect of increasing last year's fourth quarter net income by $10.8 million.

We continue to feel good about our year-to-date results as well as our near-term outlook for the fourth quarter.

Nevertheless, like you, we continue to read and hear daily mixed sentiment surrounding the North American economy in the midterm.

One camp continues to express concern linked to ongoing housing problems, sub-prime write-downs in the tightening credit markets, and erosion of consumer confidence; while the other continues to believe that the housing and financial problems will not dramatically affect the broader economy or dampen business investment and hiring.

Only time will tell, but we are encouraged again by the Fed's decision last week to lower rates by another 25 basis points.

And we also feel pretty good about the levels of corporate profits beyond the financial sector, as well as the levels of 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 third quarter versus the prior year.

So for now, we remain focused on expanding our gross margins and as we have discussed in the past several quarters, we continue to invest in longer-term growth initiatives related to new product development in our core markets, expanding into vertical and emerging markets and strengthening of our brands around the world.

So in summary, we achieved strong results in the third quarter and our fourth-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 longer-term financial goals, which I will now take a moment to update.

As you know, we typically update our long-term operating targets in this call following our strategic planning meetings which take place annually during the third quarter.

Our planning horizon is three years, which, at this point, ends with fiscal 2011.

Yesterday, we announced an increase to our longer-term operating income goal, raising the target from 10% to a range of 10 to 11% of sales.

The components include targeted gross margin of approximately 36% of sales and a targeted operating expense range of 25 to (technical difficulty) of sales.

Our (technical difficulty) three-year modeling contemplates organic and initiative related revenue growth, continued cost reduction efforts within cost of goods sold and operating expenses and plans to further improve the operational performance of (technical difficulty) businesses, for example, wooden (technical difficulty) division.

Our top (technical difficulty) include moderate single digit growth rates plus growth in specific initiatives and continued improvement in price utilization.

You already know about some of our growth initiatives, including our Turnstone and Nurture brands, and we will soon unveil more details about a new brand which will launch in 2008.

And as we have referenced in previous calls, we continue to invest in certain high-growth markets, including China, India, and Eastern Europe to create supply chains, showrooms, and sales organizations in order to expand our global customer reach and leverage the volume in these parts of the world.

Finally, with the success of our industrial modernization initiatives this past year, a much higher focus of discretionary spending has shifted toward the front end of our business, resulting in increased research and [ideation] around new areas of growth opportunity in existing markets.

New product development efforts have ramped up.

Customer, dealer and A&D relationships continue to strengthen and our global operations are increasingly variable in structure and reliable and agile in performance.

All in all, it's a fun time to be at n Steelcase.

We developed our plans prudently, however.

(technical difficulty) single digit growth assumptions to ensure clear, achievable objectives were in place to move us toward our targets rather than (technical difficulty) through overly ambitious growth rates.

Efficiency improvement within cost of goods sold and operating expenses will continue to originate from our focus on Lean principles throughout our supply chains and within the offices.

In addition, complexity reduction initiatives across certain product categories post further opportunity to improve our gross margins and operating expense leverage.

And our geographic expansion around the world will also serve to enable increasing leverage of global supply chains.

The management team at Steelcase is committed to delivering the new increased long-term financial targets.

Internal confidence levels are high and continue to be influenced by the momentum our results have demonstrated over the past four years, where even operating income margins, excluding restructuring and impairment charges, have improved from a loss in fiscal 2004 to approximately 7.6% of sales in the third quarter of fiscal 2008.

Nevertheless, these are not risk-free targets and therefore I would like to reiterate a few of the more challenging areas, which include predicting and reacting to economic uncertainty, ongoing realization of price increases and the achievement of growth initiatives that take Steelcase into new vertical markets and geographies around the world.

Lastly, sometimes we are 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 updated the three-year targets and shared some of the assumptions so you can draw your own conclusions about the years in between.

However, I will say that the previously communicated objective of achieving 10% by fiscal 2010 remains well within the crosshairs, especially if the North American economy and our industry can avoid any kind of downturn and sustain its ability to grow over the planning horizon.

Now I'll turn it over for questions.

(OPERATOR INSTRUCTIONS).

Chad Bolen.

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

The sound on the call broke up there for a minute at least for me.

Could you repeat the three-year top line assumption?

Sure.

We said that our top-line assumptions include moderate to single digit or single digit growth rates plus growth from specific initiatives and continued improvement in price yields.

Okay, that's great.

Thank you.

Is that the only part that broke up, Chad?

It was kind of intermittent for me throughout the whole thing, but that was the only specific number that I missed.

Okay.

If anybody, as the rest are listening, want any more clarity, please let us know.

We are sorry about that.

And you guys mentioned a strong project business in North America.

Could you give us any additional quantification of that or perhaps a sense of the mix between project business versus say annuity type business?

Sure, this is Terry Lenhardt.

Typically, it is a pretty good balance between continuing and project business.

What we noted in the first half of the quarter was the projects a little bit higher of that mix than we typically see at this time of year, attributed more to larger customers that drove that increase.

Okay.

Remember, Chad, we talked on the second quarter about how that backlog that grew double digit included orders related to these larger projects as well.

Yes.

Okay.

And I know you guys have been somewhat reluctant to do this in the past, but with the strength in North America, could you parse at all for us growth rates, Steelcase, Turnstone, Nurture?

Well, you're right.

We have been a little hesitant and we're going to continue to be a little hesitant, but I will reiterate that it was a relatively broad-based quarter and that those businesses continue to focus on their growth strategies.

Okay.

And another quick question.

You guys mentioned kind of turmoil and financial services especially.

Have you seen anything notable there?

I know you mentioned no notable cancellations in deferrals overall, but what are you hearing from your customers that are specific to that industry?

Well, specific to the financial sector, I'm going to let Terry make a few comments because he and his team have studied it in-depth.

So Terry?

Thanks, Dave.

As Dave mentioned earlier in his comments that third-quarter order growth was pretty broad-based across most product segments and vertical markets.

Within the vertical markets, that included higher ed, professional, technical, and the finance, insurance and real estate segment, which we call the fire segment.

Now we don't disclose revenue or orders by vertical market, but the fire vertical segment is important to our North America business.

Dave described upper single digit order patterns throughout October and then slowing in November.

While the fire segment fueled some of that early growth and it also contributed to the moderating orders in November.

And as we have been talking, you can imagine that with all the news within this sector, our field sales force is staying very close to our customers and understanding the impact of the sub-prime issues and what's having on our current and medium-term prospects for our business.

Our field sales force believes that some of the November order moderation was due to the typical effects that the timing of project orders can have on order rates.

In fact, in the quarter, some fire accounts showed strong order growth and some decreased.

Based on some of the feedback we are getting, it appears that some of our accounts haven't really fully assessed the impact the sub-prime issues will have on their business or the resulting impact of their purchase on office furniture.

So we remain cautious about the fire segment and will continue to monitor it very closely.

And while our current outlook for some accounts is guarded or conditional, we continue to work on solid project opportunities with other accounts in the segment.

That's very helpful, guys.

Thank you.

Chris Agnew.

Goldman Sachs.

First question is, I wonder if you'd be able to break out how much of your international business is in emerging markets.

And maybe secondly, and a little bit in conjunction with that, how should we think about your longer-term target in terms of driving operating margin by different divisions?

Should we think about international and the other segment catching North America up or will North America continue to push ahead over and above the current levels?

Thanks.

Chris, for your definition, which markets do you label as emerging, just so I understand?

Well I guess Western Europe -- everything excluding Western Europe, so I'd be thinking about Latin America, India, China, Eastern Europe, whichever is the easiest for you to break out basically.

Well we've said in the past, Chris, that France and Germany are kind of our biggest markets in Western Europe, but Spain and the UK are also fairly strong.

And that Eastern and Central Europe and Northern Europe and the Middle East account for a fairly sizable portion.

That's about all the color we've given.

It's a nice piece of business and it's a nice piece of incremental margin for us.

And it continues to grow.

On your second question, I don't want to get into specific targets by segment, but the same story applies this year that has for the last couple of years.

We believe that North America should be able to achieve better than our overall company average.

International will probably be closer to the average target.

And the other segment, which will include -- continue to include the Premium Group and a restructured or a continued improvement in PolyVision, along with our IDEO business, should also push for an operating margin a little bit better than the overall 10 to 11% we're targeting.

So you would say okay, you've got two up and one kind of averaging.

Why is it only 10 to 11?

Don't forget about our corporate segment that we have that just carries some operating expenses.

So that's about all the color we'd be willing to give.

Okay, thanks.

And then, final question is, can you provide some color on what's happening with commodities -- costs?

I'm just particularly thinking is there a risk that in a slowing economy, there's still, unfortunately, commodity pressures with particularly steel and oil and oil-related products.

Thanks.

There's certainly some pressure on some commodities, but year over year and quarter over quarter, the overall inflation isn't too bad.

Going into the fourth quarter, we will take on a little headwind, but I think it will be relatively modest overall.

We see our steel prices going up a bit.

Fuel prices are already high.

But there are also a number of other commodities that are okay or actually decreasing.

So a little bit of headwind, but not too bad.

Okay, great.

Thank you.

(OPERATOR INSTRUCTIONS).

Matt McCall.

BB&T Capital Markets.

The second call I've been on today where we've heard about larger orders becoming a bigger part of the project business.

It sounds like you guys were echoing what [North] said earlier.

And I guess the question, if you are seeing some of the smaller weakened, I guess the concern is that those may have shorter lead-times, if we see softening, you would see softening first in some of the smaller orders.

It sounds like you did see some of that softening in November.

But am I looking at that the right way?

And do you think that that could be a leading indicator for some softening trends in the larger orders as well?

Matt, I will start and maybe Terry can add, but really I think the bigger driver on the shorter lead-times of some of our orders is the fact that our industrial model has improved so significantly that we've been able to reduce lead-times and enable faster shipment patterns.

I don't know that we could comment that it would be necessarily driven by customers trying to hurry up and get anything done.

I would also add -- it's Jim Hackett -- that remember the strength of the economy that we've actually had the last year, 18 to 24 months results in major projects being commissioned by customers that are now finding their way to the point in which furniture is ordered.

And so it actually is a mirror of the cycle we are let's say leaving than one that we might be entering.

That's kind of what I was getting at, I guess, Jim, is that we saw maybe a pipeline build of projects.

Those projects are larger, are starting to ship now.

And as some of those projects maybe wind down, is the -- I guess maybe you can comment on the future pipeline of projects of that size.

It sounds like customer orders are still up or customer visits are still up, but are we seeing the same type of projects out there in the pipeline three, six, nine months down the line?

This is Terry.

We talked about those large projects, we don't enter the actual order until the project has been designed and they want to go into production.

So when you talk about that longer-term activity, it doesn't show up into the order rates that we've been speaking of.

Right.

The thing we have noticed is on project orders, there's always a portion where the customers want a little longer lead-time, longer than our standard lead-times.

There's a higher percentage that is being requested within standard lead-times now.

So if you look at our backlog, there's a higher percentage leaving in the next four weeks or so.

So I wouldn't read too much into the big projects winding down at all because they weren't in our order numbers in the first place.

Okay.

And if I run the numbers, it looks like there's a projected sequential decline in the margin from Q3 into Q4 in the guidance.

Is there anything that I should think about sequentially -- I know the top line is a little bit lower.

Anything else that is going on there that -- and maybe I missed -- there was some audio difficulty, so maybe I missed some of the comment there.

But anything I should think about from a profitability standpoint, Q4 versus Q3?

Matt, it's Dave.

A little bit of seasonal slowdown, so even though our top line looks pretty darn good in the fourth quarter, so it kind of looks like there's no seasonal slowdown, if you back out that extra week, there's definitely a seasonal pattern that we typically see.

And what happens with that slowdown is we start pulling our temporary workers out of the production, which increases our overall average labor rate during that period.

And also mentioned that we have some modest inflationary headwinds -- not anything huge, but some modest inflationary pressures going into the fourth quarter.

So those are a couple of big things.

And then lastly is keep in mind that while we are bringing in an assumption or a forecast for Ultra into our guidance on the top line, we are not anticipating any kind of significant operating income from them for the first two quarters because of the acquisition accounting and PMI stuff.

Okay.

Thank you, guys.

(OPERATOR INSTRUCTIONS).

It appears we have no further questions in queue.

Do you have any closing comments?

Yes.

It's Jim Hackett.

I just would like to suggest that it's a time of year when I want to wish everyone a happy and blessed holiday.

I also want to comment that in the business that I'm fortunate to run, I often get to hear from families who have loved ones overseas assigned in areas where there is military conflict, and that's a group of people that I don't want to forget this time of year and I would like to thank them for serving our country, and in turn, the employees that work here that have to make due with them being gone.

It's a group we don't want to forget.

Thank you very much and happy new year to everyone as well.

Thank you, ladies and gentlemen.

This does conclude today's conference call.

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

Thank you for your participation.