Steelcase Inc (SCS) 2009 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, Director of Investor Relations

Thank you, Jenna.

Good morning, everyone.

Thank you for joining us for the recap of our second quarter fiscal year 2009 financial results.

Here with me today are Jim Hackett, our President and CEO; David Sylvester, our CFO; Mark Mossing, Corporate Controller and Chief Accounting Officer; and Terry Lenhardt, Vice President North America Finance.

We also asked Mark Baker, our Senior Vice President of Global Operations, to join us on the call as well.

Our second quarter earnings release dated September 29, 2008, crossed the wires this morning and is accessible on our website.

The conference call is being webcast and is a copyrighted production of Steelcase Inc.

Presentation slides that accompany this webcast are currently available on Steelcase.com and a replay of this call will be posted to the site later today.

Our discussion today will include references to non-GAAP financial measures.

Reconciliations of such measures to the most comparable GAAP measures are also included in the earnings release and webcast slides on Steelcase.com.

This conference may include forward-looking statements.

There are risks associated with the use of this information for investment decision making purposes.

For more information about these statements and the associated risks, please refer to today's earnings release, our Form 10(K) for the year ended February 29, 2008, and our other filings with the Securities and Exchange Commission.

We are incorporating by reference into this conference call the text of our Safe Harbor statement included in the morning's release.

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

Thank you, Raj.

Today's good news is that Steelcase continued to maintain solid performance in a challenging environment is due to the fact that our business model redesign in the 2003 recession did make us more resilient to some of the current negative forces.

While we could see the challenging environment emerging in the banking sector, the unprecedented realignment in the country's financial system is an effect that we have to deal with.

Some of the companies that have been in the headlines this month are among our long-term customers.

And we believe the nature of the bail out and government intervention will stabilize the industry.

But, like you, it's too early to the judge the impact on short-term demand.

However, let me emphasize that this news this morning about the government's involvement is very positive.

In addition to the business model changes at Steelcase in the last recession, we are happy that many of our strategic initiatives also have had a positive dampening effect on the negative changes in the financial sector.

For example, there are three specific areas that continue to give us confidence for the future and illustrate the effectiveness of our strategies.

The three are first, a diversification of our markets not only vertically but geographically.

A growth through new products that we're introduced and operational efficiencies that we continue to pursue.

I want to touch on the continued recognition also this morning of our efforts to be a more sustainable enterprise and to help our customers do the same.

Now, as I talk about these three points, let me start with the fact that Steelcase is less dependent on large corporate customers than we were at the start of the decade.

They are still very important to us, but growth in sectors such as technical, professional and higher education and the continued growth in our healthcare business are helping to offset the reduced demand from the financial sector.

We also recently secured a very large five-year US government contract award with further news to be detailed under the government's discretion.

We can't specify the nature of that until the press release is finished, but it's evidence that our efforts to build market share in the government sector are paying off.

This summer we jump started our new Coalesse premium brands with a collection of the products from some of the top designers in Europe while also enlisting top talent to create a new portfolio just for us.

Last quarter with some disappointing news in that segment, we worked hard on the back end consolidation of the FDP label brands.

These were the brands that were folded into the Coalesse name, and there had been some disruption in the previous quarter which contributed to an operating loss.

Today, I'm happily confirming that the Coalesse group has returned to profitability in the second quarter despite the fact that we are not done with all the transformation that we had undertaken.

We expect these restructuring activities to be completed by the end of November.

Dave Sylvester will describe more detail on this as we promised during our last call.

The restructuring action that is we announced in March of this year are also on plan.

On the operation side the plant closures are on target to be completed by the end of the third quarter.

This will allow to us begin to relies a large portion of the estimated $40 million in pretax annualized savings from all the restructurings that were planned.

You will recall that we have a drive to reinvent our business model and this extends beyond our factories into every facet of our business.

We've recently reengineered processes in specific white color areas which will allow to us better utilize what we are calling our captive shared service center.

In fact, I am going to Kualu Lumpur soon to cut the ribbon on our recently relocated shared service center which will provide internal efficiencies while providing a showcase for our products and knowledge.

Renowned author, Thomas Friedman, has a new book out and, of course, he's the author the best seller of The World is Flat.

In his new book he foretells what we'd have to do in order to build organizations that can compete globally.

And he's establishing that he believes sustainability or the green discussion is the next movement in establishing the quality of companies as they compete.

The sustainability is going to be a big deal.

Said another way, it won't be okay for companies to profit and pollute.

At Steelcase we think we are ahead of this game and we are particularly pleased to be recognized this quarter for our sustainability efforts.

The US Environmental Protection Agency names Steelcase as its partner of the year in the large business category for waste reduction and recycling.

We're in lead with previous winners like Disney, IBM and Anheuser Bush.

Our Ontario plant also won a major award given by the Canadian Counsel of Ministers of the Environment.

This represents a commitment not just from the company but from thousands of employees who make us proud every day with their commitment to sustainability.

So, in summary, from my point of view, yes, these are times that remind that unattended event management is as critical as strong and predictable performance.

We are going to be cautious in the light of recent events but not lose site of our goals.

I think that you'll find that Steelcase will do a great job of navigating through these tumultuous times.

Now I will turn it over to our CFO, Dave Sylvester.

Thank you, Jim.

Today we reported a second quarter profit of $31.4 million or $0.23 per share which compares to $37.7 million or $0.26 per share in the second quarter of last year.

These results were better than the earnings estimate of $0.15 to $0.20 per share that we provided last quarter.

Revenue growth of 9.3% over the prior year was also better than the estimated range of 3% to 7% we provided last quarter.

In total, second quarter revenue included a $22 million benefit and currency translation effects and a $4 million unfavorable impact from net dispositions as compared to the prior year.

The international segment reported another quarter of strong sales growth over the prior year or 34%.

North America revenue increased 2.1% compared to the prior year, including the negative effects of dealer deconsolidations completed within the last 12 months and the disposition of a non-core business, Custom Cable, in July of the current year.

Operating income, excluding restructuring costs, was $55 million or 6.1% of sales compared to $53.3 million or 6.5% of sales in the prior year.

While we were able to improve our operating expense leverage as a percentage of sales by 130 basis points compared to last year, cost of sales increased by 170 basis points primarily due to higher commodity inflation which was within the estimated range of $15 million to $20 million we provided last quarter.

In addition, the cash surrender value, or CSV, of our company owned life insurance which is recorded in both cost of sales and operating expenses, decreased by approximately $2 million this quarter which compares to no change in CSV during the second quarter of last year.

Restructuring costs of $5 million after tax primarily related to the strategic actions communicated in March.

Recall that we announced three plant closures, one in North America and two within the Other category and certain other products moves that we plan to complete by the end of November 2008.

We also announced white collar reinvention initiatives targeted for completion over an 18 to 24-month period.

While the net charges incurred this quarter were below our estimate of approximately $7 million after tax as some activities were rescheduled to the third quarter, the announced initiatives overall remain on track to be completed in the same time frames and with the same costs and benefits as outlined in previous calls.

Other income net decreased by $6.5 million compared to the prior year quarter.

Interest income decreased by approximately $5 million compared to the prior year because of lower cash and investment balances and lower interest rates earned on those balances.

In addition, the current quarter included non-operating gains of approximately $4 million which compares to $6.6 million in the prior year.

Our effective tax rate of 31.7% for the quarter included $1.6 million of favorable tax adjustments associated with the sale of Custom Cable.

Income tax expense was otherwise consistent with the 35% estimate we communicated during our last call and which continues to be our estimate for the full fiscal year taking in to consideration the other assumptions we communicated in March.

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

Our cash and short-term investment balances approximated approximately $129 million at the end of the quarter, a $14 million decrease from total cash and short-term investments at the end of the first quarter.

The decrease in cash was primarily driven by working capital needs associated with the strong international growth we experienced during the quarter.

Compared to the second quarter of the prior year cash and short-term investments decreased by approximately $350 million primarily due to the payment of a special cash dividend in January 2008 and share repurchases over the past four quarters.

Capital expenditures of $27 million during the second quarter included a $12 million progress payment associated with the purchase of a replacement aircraft.

We continue to estimate fiscal 2009 capital expenditures will approximate $100 million, including the aircraft, compared to $80 million in fiscal 2008.

However we also anticipate selling the aircraft that is being replaced and estimate that the net proceeds will more than offset the year over year increase in capital expenditures.

As mentioned earlier we, completed the sale of Custom Cable during the second quarter.

Total proceeds including limited seller financing are expected to approximate $18 million.

We recorded a $1.8 million pre tax operating loss within operating expenses and recorded $2.3 million of net tax benefits in connection with the sale.

As a result, the net income impact of the disposition was a $500,000 gain.

For reference, Custom Cable generated approximately $35 million of revenue and was profitable in fiscal 2008.

During the quarter we repurchased 802,000 shares of common stock at a total cost of $7.8 million or at an average price of $9.77 per share.

In addition, we paid quarterly dividends of $20.2 million or $0.15 per share.

Over the past four quarters we have returned $440 million to the share holders through quarterly dividends, a special cash dividend and share repurchases.

As of the end of the quarter we had $220 million remaining under the $250 million share repurchase authorization we announced in December 2007.

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

Again, North America revenue increased by 2.1% compared to the prior year, including a $14 million negative effect from dealer deconsolidations in the prior year and the sale of Custom Cable in July of this year.

Adjusting for these items, we estimate organic growth in the North America segment approximated 4% in the second quarter which is better than the flat estimate we provided during last quarter's call.

While demand within financial services remains very soft, we experienced increases in revenue as compared to the prior year across a variety of other sectors including energy, government, higher education, healthcare and technical professional.

In addition, Turnstone had a strong quarter posting double-digit sales growth.

During our last call we noted that the decrease in project related orders within the financial services sector during the first quarter was severe.

However, we also noted that we were experiencing strength in a number of the other sectors which, in total, essentially offset the decline of financial services and resulted in an ending first quarter backlog that was slightly higher than the prior year.

During the second quarter the same story largely continued.

The decrease in project related orders within the financial services sector remained significant but we continued to experience strength in a number of other sectors.

These order patterns along with an increase in orders prior to the September 1 effective date of our commodity surcharge caused ending backlog to be slightly higher than one year ago.

Overall, pretty good performance, all things considered, especially if you recall that prior year second quarter orders and ending backlog grew at double-digit rates compared to the previous year.

Customer visits followed similar pattern, strength in some sectors offset by weakness in others.

Operating income, excluding restructuring costs, was $45.8 million or 9.2% of sales compared to $49.5 million or 10.1% of sales in the prior year.

While the North America segment experienced a 90 basis point improvement in operating expense leverage, it was more than offset by increased commodity inflation within cost of sales which was the primary driver of the increase in cost of sales as a percentage of revenue.

The dollar decrease in North American operating expenses as compared to the prior year was primarily due to $3 million of prior year spending related to dealer deconsolidations and Custom Cable.

In the international segment sales increased 34% compared to the prior year quarter.

We experienced growth in a number of countries again this quarter including Germany, China, the UK, Angola, Mexico, India, Russia and Australia.

Currency translation had the effect of increasing revenue by approximately $21 million as compared to the prior year and current year revenue also included $10 million from net acquisitions completed during the past 12 months.

Adjusting for the impact of currency translation and net acquisitions, we estimate organic revenue growth in international for the quarter approximated 18% which is well ahead of the mid to upper single-digit growth rate we estimated during last quarters call.

You will recall that total international orders during the first quarter were essentially the same as the previous year stated in terms of local currency and adjusted for net acquisition impacts and reflected mixed results.

That is strength in a variety of markets was offset by weakness in three core markets, France, Japan and Spain.

Nevertheless, the outlook for the second quarter anticipated the continuation of organic revenue growth as backlog remained relatively strong and order patterns in total had regained some momentum through the date of our last quarter.

Thereafter, total orders continued to outpace the prior year growing in total at a rate better than expected.

In addition, we were awarded a couple of large projects late in the quarter which helped build a nice beginning backlog going into the third quarter.

International operating income, excluding restructuring items, was $12.9 million or 5.1% of sales compared to $4.3 million or 2.3% of sales in the prior year.

This 280 basis points improvement in operating margin was driven by a significant improvement in operating expense leverage partially offset by increases in cost of sales as a percentage of revenue.

In addition to recent increases in inflation, international cost of sales continued to be negatively impacted by several factors, albeit to a lesser extent than the first quarter.

First, negative currency impacts are continuing to effect our UK business results as we primarily import from our Euro zone industrial model in western Europe.

Second, there is a dilution effect of consolidating ultra which currently has lower gross margins than average and has experienced rising costs driven by regulatory reforms.

And, third, we are experiencing somewhat of a different mix of business in certain markets as compared to the prior year.

International operating expenses were $65.9 million or 26% of sales in the current quarter compared to $56.9 million or 30.1% of sales in the prior year quarter.

That's a 410 basis points improvement in operating expense leverage.

The $9.0 million increase in year over year operating expense dollars includes approximately $6 million in unfavorable currency translation effects as compared to the prior year and $3 million from net acquisitions completed within the past 12 months.

The Other category which includes the Coalesse group, PolyVision and IDEO reported revenue of $148.9 million in the quarter or a 1.2% increase compared to the prior year.

The increase in revenue reflects growth within the Coalesse group and at IDEO offset in part by a decrease in revenue at PolyVision driven by our decision to exit a portion of the public bid contractor white board fabrication business where profit margins are the lowest.

Operating income excluding restructuring costs for the other category was $4.7 million or 3.2% of sales compared to $6.2 million or 4.2% of sales in the prior year.

While these results reflect a marked improvement for the Coalesse group compared to the first quarter operating loss they, nevertheless, continue to lag prior year performance primarily due to inefficiencies associated with the consolidation of manufacturing activities announced in March of this year and operating expense investments related to the launch of the Coalesse brand and a number of new products which we previewed at NeoCon.

PolyVision results continue to improve despite lower sales.

Now I will review outlook for the third quarter of fiscal 2009.

Overall, we expect revenue to be within a range of $840 million to $875 million compared to $886 million in the prior year.

This projected range takes into consideration the following factors.

First, based on exchange rates at the end of the second quarter, our third quarter revenue estimates do not contemplate any significant currency translation effects compared to the prior year.

This is a dramatic swing versus the last several quarters where in currency has increased our top line by more than $20 million compared to prior year periods.

Second, we expect the negative impact of dispositions completed within the past 12 months to nearly offset the positive effect of acquisition completed in the same period.

Third, North America revenue estimates in the third quarter are based on a challenging financial services sector across our industry, growing economic uncertainty in the US and a strong comparable period last year where in North America revenue grew nearly 10% compared to the previous year.

In addition, orders thus far in the third quarter adjusted for the estimated pull forward effect of the September 1 surcharge are tracking somewhat lower than the prior year.

Therefore, we are currently estimating North America organic revenue to decline in the third quarter by low to mid single digits.

Fourth, international revenue in the third quarter is expected to benefit from a relatively strong beginning backlog and continued order growth in total orders resulting in an estimated organic growth rate in the mid single digits.

As you know, we are in the midst of implementing the strategic actions we announced in March.

As a result, the operational inefficiencies we experienced in the first and second quarter associated with the facility rationalizations are expected to continue until these actions are completed during the third quarter.

In addition, commodity inflation is estimated to increase our global costs in the third quarter by another $15 million to $20 million compared to the prior year.

While we have implemented a commodity surcharge on orders placed after September 1 in the US in addition to second quarter list price adjustments around the world, it will take several quarters, as you know, to realize the full impact of these pricing actions and, therefore, they will only begin to offset some of this inflationary impact in the third quarter.

We expect reported EPS for the third quarter will be in the range of $0.16 to $0.21 per share including after tax restructuring costs of approximately $6 million.

We reported earnings of $0.22 per share in the third quarter of the prior year including goodwill and intangible asset impairments which, after the reduction of related variable compensation expense and income taxes, reduced net income by $11.3 million.

Regarding the overall US economy and the spill-over effects around the globe we, like you, continue to wonder what the full extent of the economic environment will bear on our industry.

While we estimate the financial services sector will continue to be negatively impacted for the next several quarters, we also believe our revenue diversification strategies will allow us to continue growing in other geographic, vertical and customer segments of our business.

With the economic uncertainty we plan to behave conservatively, maintaining the strength of our balance sheet and modestly building cash levels over the next couple quarters.

At the same time we will behave aggressively toward implementing our announced restructuring actions and improving our operating income margin.

We will continue as well to invest in longer term growth initiatives related to the expansion into vertical and emerging markets, strengthening of our brands around the world and new product development in our core markets as evidenced by the significant portfolio of new products and solutions we introduced at NeoCon.

In the end we don't know how long the economic climate in the US will remain uncertain or the extent of the spill-over effect around the globe, but what we do know is that Steelcase will continue to modernize its industrial system and product offering, improve its fitness across front-end business process and invest in strategies we believe will serve to strengthen our global leadership position in this industry.

Now we will turn it over for questions.

(OPERATOR INSTRUCTIONS) Our first question is coming from Budd Bugatch from Raymond James.

Morning, Jim.

Good morning, Dave, and everyone else that is there.

A couple of questions.

On the revenue guidance, as I do the math on versus last year I get to the high end of guidance pretty simply but to get to the low end, the $840 million piece, I can't quite get there unless I take something fairly significantly out of the other classification.

What am I missing, Dave, if you can help me there?

I used like 475 for North America, 240 for international, and that gets me to 715 million and then to get, if you just assume flat for other, that gets to you like 870.

Yes, I'm not sure what you used in the North America revenue guidance whether you used low or mid.

I used 5% as a reduction versus the 500 million last year.

The other factor is the fact that times are quite uncertain right now, in North America in particular.

In the other category specifically, you're right, I mean you can plug to a decline there.

It's not anything too dramatic and I would expect it will continue to be more than the more of the same that we've been experiencing, so some decline in PolyVision offset by some potential increases elsewhere.

Yes.

Coalesse should grow as well in other, correct?

I don't know if I want to pin it down to that exact level but we don't see Coalesse going back to the first quarter or anything like that.

Could you give us a little help maybe on healthcare and maybe quantify what that grew in the quarter and how that's doing?

It continues to grow nicely.

It didn't grow at the high-end of double digits this quarter like hit in the last couple of quarters but we feel quite good about where it continues to progress.

So I wouldn't look at this quarter of lower single digits growth rates of any indication that things are softening.

When you went over international did you give strength by declining order of when you started with Germany down to Australia?

Yes, you know that's our typical pattern that will reference the most significant contributor first down to the least significant.

Okay.

I have some other questions, but I will let others ask and get back in queue.

Thank you.

Our next question is coming from Matt McCall.

Your line is live.

Thanks.

Good morning, everybody.

Sounded like you are still seeing net inflation over the pricing actions that you've taken, both the list price increase and the surcharge.

If I just subtract the stated inflationary pressure and assume that you are not offsetting any of that in price, it looks like it would have been about an 8% operating margin without that $15 to $20 million of pressure just taking that mid point.

So I guess this question is more about the restructuring benefits and how much will be recognized, are you yet to see benefits because it sounds like there's still some inefficiencies that you're facing and how should that start to play out as we move through the year?

The restructuring I'll start and then maybe Mark Baker will add a little bit of color.

I will tell you in the restructuring the lion's share of the benefits have not accrued yet.

We've seen some modest benefits as we took out some headcount in manufacturing early and we've already started to see some benefits of the white collar reinvention initiatives that we launched.

But the lion's share of those benefits will really start to accrue at the end of the third quarter, early in the fourth as the plant closures are finalized.

I'm sorry, so you are seeing benefit above the efficiencies or the inefficiencies are kind of offsetting those in the near term?

In the second quarter it may be a push, the inefficiencies are a little higher than the benefit.

Okay.

But they come in different spots, we have efficiencies in the other category and, if anything, the benefits are probable until North America.

Matt, it's Mark Baker.

On the inflation side there's no question that we continue to still feel a lot of pressure there and, as you described, the pricing actions we took which included a list price increase in July and a further surcharge effective the beginning of the September it's just taking a little bit of time to work through because we have some customers that have contractual situations where we have some periods of time where the older prices may be held for a little bit of time, but I think we believe that by the fourth quarter we will start to see the impact of those price increases that we described.

Okay.

Thanks, Mark.

The SG&A line, a pleasant surprise this quarter.

As a percent of sales how should we start to look at your SG&A line going forward?

Nice improvement both sequential and year over year.

Is this, you talked about being cautious in this environment, is this kind of a number that we should look at going forward or how should we look at that line.

It's obviously dependent on the topline, how is that?

Good answer.

Very strong this quarter and then certainly contributed but we are working hard to contain our costs.

I'll tell you we are working hard to also protect the growth initiatives.

We are trying to shrink and grow, so shrink in nonstrategic areas and continue to invest back in our growth initiatives.

So depending on how the top line behaves, we can see SG&A as a percent of revenue move around a little bit for the next few quarters.

In fact, Matt, Jim here.

We stare back to the last recession with a lot of actions taken when you look at the growth in our sales from 2003 and the resulting expense changes from that period, most of the growth is in, are innovation spending and in bonus payments.

And so I'm really proud of the fact that the productivity really grew as far as it did.

However, that's not good enough given the nature of what I continue to describe as the flat world kind of pressures and I want to emphasize that this reinvention that we talked about over a few quarters is intended to improve that.

So I don't want you leaving the call thinking that we are not really intent on being more aggressive in that line.

We are and we've been very good about managing this growth.

As a followup to that has it become more of a variable, can you break out the variety of that line versus maybe the last downturn, have you changed the structure of your overall expense structure?

Yes, not dramatically though Matt we still have the bonus being the largest variable component and then certain selling expenses are variable but by and large it's relatively fixed.

This is just good cost containment relative to the sales growth.

This is a short one and I will hop off.

You mentioned the pull forwards in orders, any quantification of the pull forward of those orders ahead of that surcharge?

The only thing I will tell you, Matt, is September 1 fell right at the quarter ends so a few days before the September 1 effective date of the surcharge pulled forward and the week after was a little bit light.

We just tried to neutralize that in the color we gave on North America orders thus far in September.

Okay.

All right.

Thank you, all.

Thank you.

The next question is coming from Peter Whalstrom.

Your line is live.

Good morning.

Can you speak to Steelcase's core North American business certainly given the quarterly results which were solid and a little more of a cautious outlook potentially as it relates looking into 2009 in BIFMA, and there are a lot of different moving parts.

Can you help us think about this and is revenue down year over year for '09 a realistic view?

I would say, Peter, the objects in your mirror are further than they appear, to have a play on words.

In other words, in looking ahead I am certain that all the structural things that we are doing, all the strategic things we are doing are going to play well over time.

Now you put that on top of the shifting sands with the news in the last three weeks, pick your forecast.

It's a hard problem.

What we've designed is a different business that can go through that and not only is it diversified geographically and with different vertical markets but there is a higher variable cost structure in the back end of the business than there was the last time.

So I'm not trying to be cute.

I think to try and project '09 performance on this call is just not going to be sound thinking at this point.

But, Peter, too that our typical timing as we go through our strategic planning outlook in the fall and then in December what we do is not give next year guidance on the topline but we give more longer term goals around operating income and then color behind that.

Okay.

Fair enough.

Maybe diving down into one of the sectors more specifically from a financial services perspective you are set to anniversary some of those declines as you head into the fourth based on customer visits or order patterns or even dealer commentary, are you incrementally more cautious or confident than you were a few months and, therefore, have you seen any of this financial services weakness spread into other sectors?

Peter, I will let Terry cover that, Terry Lenhardt.

He leads finance for North America and has obviously been studying the trends quite closely.

Hi, Peter.

Let me draw attention more to the third quarter coming up.

As Jim mentioned earlier in his introduction, we've been working to diversify our business for quite awhile and today our business is much more diversified than it was a few years ago.

For example, international sales is over 30% of our total sales and we are much less dependent on large corporate customers in North America.

If you drill down in the North America market while financial services remain important to us, we have continued growth in a number of other vertical markets including healthcare, higher ed, government and technical professional and it makes us much more balanced and less dependent than we were on any one vertical market just a few years ago.

But, as you would expect, we kept a very close eye on the financial services sector so within this segment our clients have been very cautious for quite a while.

As you mentioned, we are heading on almost our one year anniversary.

Overall, day-to-day business has remained steady but it's the incoming project orders that have been down significantly now for almost the past three quarters.

Many of the financial firms that have seen in the news over the past couple weeks are clients of ours and they began pulling back months ago just at about the same rate as the rest of the sector.

As a side note, if you think about the recent merger activity, generally speaking either both sides of the transactions are clients of ours or the surviving entities are our clients which may provide us some mid to long-term opportunities.

But in the short run our third quarter forecast assumes continued weak project business sector in general and for the company in the news in particular and this compares to a prior year quarter, prior year third quarter where project sales in financial services were very strong.

So that's the big reason why we are forecasting a third quarter decrease in sales for the North America segment versus prior year.

Related to all that regarding accounts receivable, we don't believe that we currently have any significant receivable exposure to the companies in the news and, of course, ongoing attention going forward is to stay close to our customers and their activities during these times to help them be more effective and efficient in how they think about their space as they adjust to the new business models.

So when you think about the incoming, the incoming did start coming down last year in mid to late October so really didn't affect our sales for the fourth quarter.

So once we get to the third quarter we will be heading out of one year anniversary of the significant decline in financial project businesses.

Okay.

Thank you very much for that color, appreciate it.

And not to end on a downer certainly, so which sort of verticals and or categories have been exceeding expectations given the challenging environment?

I know that you listed the off energy, in particular, but are there some other areas where you really have seen kind of an uptick above your initial expectations.

Yes, if you think about longer term basis we've seen a nice continued consistent uptick in healthcare and in education and in total government if you take federal, state and local.

Of course, energy has a good sector for us, although smaller than the others and that's been a good uptick over this past 12 months as well.

Okay.

And quickly just on the order patterns from an international perspective I know that you mentioned that had you a large project that came in at the end of the quarter.

Are you seeing some of the large projects internationally or are those more or revenues coming more from the day to day and smaller project sales?

I would say generally it remains pretty balanced.

We just had a couple of very large orders come in late in the quarter that I was referencing.

If you go to France and Spain and Japan, it's pretty soft still.

But that's not to say that it's continuously or continuing to erode.

There still are some projects out there.

It's not line the financial services sector in North America.

It's just still a bit soft.

Okay.

Thanks.

And finally you mentioned that you have about $220 million under the repurchase authorization and with cash down at the let's say $120 million range, has the company reached a point where it would look to build up cash on the balance sheet instead of investments in further share repurchases?

Well, I said in my closing comments that we are going to modestly build cash right now.

It doesn't mean that we are going to turn share repurchases off entirely but we are going to modestly build cash.

Because frankly there could be some opportunities that present themselves for to us reinvest back in the business and that's always our first goal and in times of, times like these, you start to see some things that weren't an opportunity before present themselves as an opportunity today and we'd like to be able to take advantage of them quickly if possible.

Okay.

Thank you.

The next question is coming from Todd Schwartzman.

Your line is live.

Good morning, folks.

A couple of things.

First, can you break out or allocate perhaps the total commodity surcharge by energy, steel and some other inputs that necessitated a surcharge?

No.

We have not broken out any details in the past and we don't want to start doing that today.

As you can imagine, the big driver is teel but fuel and other energy are also contributors, plastics it's a broad commodity surcharge.

And on the international side of the business I'm curious about the customer categories that are doing well.

Was it roughly similar to North America or is there something else going on there?

I would say similar.

No distinct pattern to speak of, I mean energy continues to be a nice contributor in various markets.

Plus we would say that the government in those markets are stronger and it's not as concentrated a financial sector as it is here in North America.

Could you speak to specific regions or countries that are not living up to your expectations right now internationally?

We want to be careful about that for competitive reasons but I would say to you there is a rigorous assessment of that and what we have found that if we can combine a couple of elements that have improvement success that would be products that build off platforms that are then altered for an environment, good distribution and then some of our core customers that transfer around the world and into those markets, those three things coming together usually mean those markets are the strongest for us.

There have been some outlying markets that none of that has happened and so we work hard to get it the other way.

I would also suggest to you that geographically we talked in previous calls that the promise is in Asia and it still is like that.

I mean we believe that Asia, particularly India and China, of course continues to grow, the challenge there of course variance that variables that I mentioned in the first comments, getting distribution right, getting products on platforms designed for those markets.

But we've got a big head start in that region.

So it's not like we are just beginning there.

We've got some experience there plus our experience of growing in western Europe I think that the prospects in Asia are very strong.

And back in North America for just a moment, are there any signs that the financial service sector weakness in New York has spilled over a bit to other customer categories or just, in general, how are the non-financial customers in the New York region holding up in this environment?

Well, generally pretty flat.

I would tell you that there is no other sector that is performing in any kind of way similar to the financial services sector.

To sit here and say that there's been no spill-over effect though I think could be misleading.

But generally we had increases in the sectors I referenced and in the ones that I didn't reference, they were either flat or slightly down outside the financial services.

Great.

Thank you.

We have a follow up from Budd Bugatch, your line is live.

Yes.

Hi, David.

Just again looking, I don't want to harp on the guidance, I guess I do want to harp on the guidance actually, and I want to look at kind of when you drill down into the operating expense and the gross margin or cost of sales, the frame of my question is in your third quarter guidance was your thinking that the inflation impact would actual will be higher, the gross margin would be impacted more in terms of year over year negatively than it was in the second quarter?

I think it was down about 167 basis points in the second quarter if I remember right.

Is it higher in the third quarter?

That impact more?

Budd, go back to last year.

The third quarter was exceptional, North America grew at almost 10%, international had a strong quarter.

So of course we had some volume leverage coming from those results that were that we are not seeing this quarter, this coming quarter.

Okay.

All right.

That's fair.

That's what, I'm just trying to make sure what your thinking was.

You should have some continued gains from your operating expense control, right, in the third quarter over last year?

You had some things that you've done.

You maintained good cost control this quarter, you showed.

From an absolute dollar perspective for sure but, again, don't underestimate that leverage that we saw from the sales growth.

Yes, that deleveraging impact of lower sales.

Okay.

That's helpful.

Thank you very much.

Thank you.

(OPERATOR INSTRUCTIONS) Our next question is coming from Margot Murtaugh.

Your line is live.

Thank you very much.

I was wondering how your orders are going for your new products and when you would starting to ship some of those?

Also you mentioned early in the call about some government business that is coming but hadn't been booked.

Could you go over that?

Sure, I will start and then maybe Jim can jump in.

The orders on the new products I would tell you are just starting with respect to the Coalesse group.

In the Steelcase group with respect to media scapre andc scape and the cobi chair and some of the Nurture new products, those are pre sell mode or will be starting pre sell soon and order entry I believe starts in the first quarter of next year or late in the fourth, but interest remains quite high and we remain quite excited about their launch.

The government reference that Jim had in his opening remarks we really can't get into any more detail until we get the green light from the government with respect to clearing any kind of press release, but it was a significant win for us.

We feel very good about it and it demonstrates our commitment to continue to diversify the top line.

Thanks a lot for all the detail you've given.

It's very helpful.

You're welcome.

There are no further questions in queue.

Okay.

Thank you.

Can I just summarize by saying that we really had a great quarter and we worked hard and the results prove that things are on the right track in a number of areas.

I want to emphasize that.

Second thing is I believe, I said it a few times today, the company is in a good position to handle adversity, whether it comes from the sector kind of pressures we've discussed, whether it comes from the nature of a recession that I'm not forecasting but if something in 2009 presented itself I think we are in strong position to manage through that.

And then, finally, I believe that the initiatives that we are taking for the future kind of without regards to the tumultuous times are and have been about us becoming ever more fit and delighted with the progress that we've been able to describe there.

It's time for a little optimism and for us all to believe that the news today taken in the government's actions are going to get us back into good shape.

So I'm hopeful that we can all share that and kind of pass the word.

Thanks for your attention today.

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.