Steelcase Inc (SCS) 2011 Q1 法說會逐字稿

Good day everyone, and welcome to Steelcase's first quarter fiscal 2011 conference call. As a reminder, today's call is being. For opening remarks and introductions, I would like to turn the conference over to Mr. Raj Mehan, Director of Investor Relations.

Good morning everyone. Thank you for joining us for the recap of our first quarter fiscal year 2011 financial results. Here with me today are Jim Hackett, our President and Chief Executive Officer; Dave Sylvester, our Chief Financial Officer; Mark Mossing, Corporate Controller and Chief Accounting Officer; and Terry Lenhardt, Vice President, North America Finance.

As many of you may have noticed, this quarter we made a change to our quarterly reporting and analyst call process. The practice we adopted for this quarter and our intent going forward will be to release our earnings report after market closes and then to have our analyst call the following day at 10 a.m. By releasing our financial results the night before our call, we believe it provides the investment community additional time to review and fully understand our results.

In addition, we have significantly enhanced the content of the webcast slides which accompany the earnings release. Much of the sequential and year-over-year comparisons are now incorporated into the webcast slides. This will decrease the amount of prepared remarks made during this call.

Again, we made this change to enable a deeper understanding of our results faster and allow greater time for dialogue and Q&A during this call. We hope this is an enhancement for your processes as well, and welcome any feedback.

Our first quarter earnings release which crossed the wires yesterday is accessible on our website.

This conference call is being webcast. Presentation slides that accompany this webcast are available on IR.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 then 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 -- or excuse me -- yesterday's release and Form 8-K, the company's 10-K for the year ended February 26th 2010, and our other filings with the Securities and Exchange Commission.

This webcast is a copyrighted production of Steelcase Inc.

Now with those formalities out of the way, I am excited to turn the call over to our President and CEO, Jim Hackett.

Thank you, and good morning everyone. I still want to make comments and help answer questions with our new format. So let me get started.

Our industry as a whole is usually upbeat at this time of year because we are all still feeling the glow from our tradeshow, NeoCon. This year the combination of the great response in Chicago to our new products and specialized applications, plus the performance we are reporting today, makes us even more optimistic.

But we've suggested on several of these calls that we would be able to look back at Q1 of last year as a low watermark in the downturn. It now appears that intuition was correct. I don't say that obviously to boast about our forecasting ability, because forecasting in today's world is perilous. Yet I want to acknowledge that it's a pleasure to talk about a modest level of organic growth after six consecutive quarters of year-over-year revenue declines.

And we are encouraged that our adjusted operating income has improved by $20 million compared to this same time last year. Again, that's with 1% of growth. Dave is going to provide more color in a few moments.

As I inferred a moment ago, there is some ongoing uncertainty in the global economy, and we believe the recovery is gaining traction, albeit slowly. We've started on a path toward a year of continued and likely modest growth.

During the downturn, it's important to remind everyone, that we protected our investment in growth initiatives. We didn't opt for just short-term profit. And we believe we're starting to see the benefits of that decision.

One exciting example is the launch of a product called the node chair -- n-o-d-e, node. It was our first product developed specifically for the classrooms in the education market. This little product won a Best of NeoCon Innovation Award last week. It also got some positive media attention in Fast Company, BusinessWeek and other channels. The crowd really loved this chair.

It was one of five Steelcase Inc. products that illustrated elements of that strategy to continue to invest even in the downturn, as we won Best of NeoCon awards.

Now, the Steelcase brand received awards for technology and storage solutions that support our theme of harder working spaces. That included the enhanced version of our RoomWizard scheduling tool and a new vertical storage product called FlexFrame.

And the Coalesse brand won two awards as well, including the innovation award for a new approach to conferencing and an award for the enhanced Topo furniture system.

The traffic through the showroom was steady, and the customers that came to this year's show were there to talk about real projects. I saw a difference from a year ago in that regard.

As companies become more confident about the recovery, we believe the pent-up demand should start to break loose. And again, we are seeing good indication of that.

One of the other trends we saw at NeoCon is that other manufacturers are now pursuing vertical markets such as health care and education. We believe Steelcase has a significant head start based on our research insight, the commitment to continue to fund growth initiatives in the downturn, and partnerships with highly respected organizations that enhance the product and design and performance in these new categories.

scape and the eno board from PolyVision.

As always, our NeoCon presence is a tribute to hundreds of Steelcase people who design, build, install and support showrooms and products like that, and so I want to thank all of them this morning for doing a great job.

Given that our annual shareholder meeting is just two days away, I'm going to reserve some of the other comments about our future direction for that event. And I'll turn it over to Dave Sylvester, our Chief Financial Officer, for a closer look at the first quarter.

Thank you Jim. As Raj stated, we've changed the format of our call this quarter to allow more time for Q&A. Our webcast slides provide the detailed explanations regarding year-over-year and sequential quarter comparisons. I will start with a few high-level comments, provide some additional color commentary around our order patterns and our outlook for the second quarter, and then we will move to your questions.

Let me start by repeating what Jim said. We were pleased with the results of the first quarter. Revenue was slightly higher than the estimate we provided last quarter, primarily due to strong North America orders early in the quarter and double-digit growth at IDEO.

While international orders were also stronger than expected in the quarter, many orders are scheduled for shipment in Q2, and thus this segment posted a revenue decline that was larger than our expectation.

In total, we realized organic revenue growth of 1% compared to the prior year, which feels pretty good, given the last six quarters of year-over-year declines.

Improvement in operating income compared to last year was masked by how the company now records variable life COLI income. In the prior year we recorded variable life COLI income as an operating item, and therefore it had the effect of reducing our operating loss by $16.8 million, whereas in the current year we now record variable life COLI income as a nonoperating item.

The largest contributors to the $20 million improvement in adjusted operating income include benefits from restructuring activities initiated in June 2009, which are now substantially complete, and lower commodity costs of approximately $5 million.

Regarding the $11.4 million tax charge recorded in the quarter, you've likely noticed that many other companies are taking similar charges in connection with the new healthcare legislation in the US. The charge was linked to retiree drug costs covered under the Medicare Part D subsidy and resulted in the reversal of related deferred tax assets, as the retiree drug costs will no longer be deductible for purposes of determining taxable income in future years.

This change will have the effect of increasing our effective tax rate beginning in fiscal 2014, when this part of the legislation goes in to affect.

Excluding the $11.4 million charge, we had slightly positive net income for the quarter compared to the estimate of a loss of $0.09 to $0.05 per share we communicated last quarter. This better than expected performance was driven largely by higher than expected variable life COLI income of approximately $3 million, better than expected operating improvements across a number of businesses, and lower than anticipated spending in our North America segment.

As it relates to orders, I will start with North America, where we experienced year-over-year order growth in the first quarter of approximately 7%. After a strong start in March, April and May orders grew modestly versus last year. Backlog however, is lower compared to one year ago, as average lead times have fallen given current volume levels.

Within our product categories, seating was the strongest performer again this quarter, generating broad-based, low double-digit order growth, while most of the other product categories experienced low single-digit growth compared to the prior year.

Wood was the only exception, but orders since April have picked up considerably, resulting in a modest overall decline for the entire quarter.

Across vertical markets our historical core office verticals grew at a low double-digit rate. Financial services was the leader within this group, boasting significant order growth in the quarter, after more than two years of quarter-over-quarter declines.

Within our group of growth verticals, federal government, education and health care orders all grew compared to last year, while state and local government continued to lag, resulting in a modest growth rate in total for this group.

While customer visits were up significantly on a sequential basis versus the fourth quarter, they were down year over year in the high single-digit range, likely due to the high level of A&D visits targeted towards sharing our research and insights underlying our new products in Q1 of the prior year.

Regarding pricing, large project activity remains highly competitive, especially in the federal government sector. However, we estimate the effect of our ongoing efforts to move customers to more current price lists had the effect of slightly increasing our year-over-year gross margins.

International orders in constant currency increased approximately 16% in the quarter compared to the prior year. Within Western European markets, which grew in total by approximately 4%, Spain and France were up, while Germany and the UK were down.

As you know, Germany was one of the last countries to enter the recession, and within the UK we anticipate increased project activity later this year.

Elsewhere we experienced strong order growth in Asia, the Middle East, Latin America and Africa, which contributed to an international backlog which is significantly higher than the prior year.

Finally, the Coalesse Group posted a mid-to-high single-digit order growth rate in the quarter due to increased activity in a couple of our largest customers.

Regarding our outlook for the second quarter of fiscal 2011, we expect to report revenue between $560 million and $585 million. This compares to $578 million in the second quarter of fiscal 2010, which included $13 million from dealers that have since been consolidated.

This revenue estimate is based on a euro to US dollar exchange rate assumption of 1.23, which compares to an average exchange rate of 1.33 in the first quarter and 1.41 in the second quarter of the prior year. This and other currency assumptions included in our second quarter revenue estimate will have a negative effect on the sequential and year-over-year comparisons of approximately $8 million and $14 million, respectively.

After giving effect to the recent deconsolidations of dealers and assuming a euro to US dollar exchange rate of 1.23, we currently estimate the level of revenue necessary for us to generate breakeven operating income before restructuring costs is within a range of $530 million to $540 million per quarter.

With respect to commodity costs, we are expecting a modest increase in the second quarter compared to the first quarter, as well as compared to the prior year.

As a result of these factors, we expect to report second-quarter net income within a range of $0.01 to $0.05 per share, including approximately $4 million of pretax restructuring costs associated with a number of smaller actions initiated in the last 6 to 9 months.

In addition, we expect to begin accruing variable compensation expense in the second quarter, as this earnings estimate implies we would begin to surpass related thresholds.

Finally, as you know from our 8-K filing in April, we initiated a formal procedure of discussions with local work councils regarding a project to reorganize our European manufacturing operations. Initial reactions by affected employees included work stoppages and slowdowns, and therefore we initiated backup manufacturing plans, which increased our costs in the quarter.

In addition, local work councils have filed claims which if not satisfactorily resolved could negatively affect our implementation plans or increase the costs associated with this restructuring.

Our second-quarter earnings estimate assumes continuation of our backup plans and related costs but does not include any restructuring costs associated with the project, given the current status of the procedure.

Now I will turn it over for questions.

(Operator Instructions). Budd Bugatch, Raymond James.

Congratulations on the quarter. And I also want to thank you for the additional detail and the new format. Very good.

I guess the first question I would have, it would be, talk a little bit about the -- maybe quantify if you can kind of the savings you are going to get from some of the spending and the actions you have taken in the second quarter for this year, for modeling purposes, and maybe even beyond.

Well, I would break it into buckets. First is the relatively small actions that we've communicated in previous quarters. They will have a runoff of a -- I would say maybe in the neighborhood of another few million dollars, some in Q2, and maybe a little bit more in Q3, and then those would be complete.

And the other bucket would be associated with the proposed restructuring in Europe, which I wouldn't -- I certainly don't anticipate any savings next quarter and most likely not even this fiscal year. They would start to feather in sometime next year, depending on the -- our success of actually implementing that structure.

And I think you've communicated in the past an incremental margin assumption of -- as you're starting to see year-over-year gains of around 40% at the onset of that, and then probably lowering down to the 30% level. Is that still intact?

Yes.

Okay. My second question has to do with kind of characterizing Europe and the likely scenario going forward. I was pleased to see that orders kind of strengthened as the quarter progressed, but obviously there's been a European financial crisis, and people are concerned about how that will affect potential orders and business going forward.

Yes Budd. Jim here. I am sure you may have -- saw the wire this morning with Geithner working in the G20 and the question of the Hoover moment, where -- should Europe start to retrench and manage the deficit? Or keep the stimulus going?

So that tells us volumes about the tipping point here of how challenging this moment is in these economies.

And my observation is that the work that we are about and the kind of order improvement we have seen is because those markets fully don't understand the implications of what might happen -- which is a good thing. In other words, they haven't preceded with effort of canceling orders or stopping, anything like that.

So the second thing is that I want to remind everyone, our business with governments in those countries is pretty good. And in many ways the payrolls of the governments improve in these downtimes as they hire people to keep unemployment numbers better.

So those factors make me temper a rush to say it's going to be a big problem. I don't believe that yet. But of course we are watching it really closely and trying to understand the trickle-down effect of the debt restructuring, which isn't clear yet.

If I could sneak in just one more kind of a knitting type question, David, can you give us a feel of what the tax rate is going forward?

I think it's still in the mid-30s for the next couple of quarters if not couple of years. It's not until we get out to 2014 that it might go up 100 basis points or so.

Thank you very much. I'll get back in the queue and ask some more questions.

Todd Schwartzman, Sidoti.

Can you maybe give a little color as to the timing of any additional -- and quantify any additional temporary salary cuts that come back over the next several quarters?

The salary reductions has been fully reinstated. They were fully reinstated effective at the beginning of March. The balance of temporary actions that we took are linked to profit sharing and 401(k) match eliminations. And those would be feathered back in to the extent we had profitability that we believe supported it.

Okay, so based solely on the salaries alone then, you've got a full quarter's worth in Q1 there?

Yes. What we didn't accrue in the first quarter was any variable compensation. We'll start accruing that in the second quarter because we will be surpassing the thresholds in those bonus programs.

Now, what remains to be seen is how we actually implement that. We could choose to implement some of it as a profit-sharing reinstatement or some of it as a short-term bonus. But we will begin accruing go-forward because we are at the threshold level. So you'll see the contribution margin, as Budd was articulating, start to shift down closer to 30% on revenue gains, go-forward.

And based on your assumption for the bottom end of your EPS guidance for Q2, what would be the sequential delta in the gross margin? From the 30.1?

I'm not sure I've got that at my fingertips. That's a pretty specific question. I would say -- what I will tell you is I think even at the bottom end of that revenue guidance, that we would be accruing some modest variable compensation, so our contribution margin would be lower. But I don't know -- I think it would -- the contribution margin would be even lower at the higher end of that range.

Got it. All right. Thanks guys.

Mark Rupe, Longbow.

A question on the seating performance during the quarter, how do you characterize that being so much stronger than the other cat- -- or the other product categories in light of some of the project business (inaudible)? And then secondly, do you -- did you see any kind of pickup in -- or improvement in demand in some of the other product categories as the quarter progressed?

We'll let Terry take that one.

The seating growth was very broad-based. Our grouping of Live Back seating, our growth products, all grew in double digits. That was broad-based across products. You look at it across projects, there's this [continuing] kind of business, or large [and small] companies. It was a good quarter.

Perhaps that's some of the first things companies are buying as they exit the recession.

Great. And then the other product categories that still were down in the mid-single digits [though], is there any kind of change in inflection of demand for those?

I commented in the scripted remarks that the other product categories were generally up. Wood was the only (multiple speakers)

Oh, I'm sorry. Okay. Okay. Fair enough.

On the commodity cost outlook you'd mentioned that you expect it to be up sequentially and year-over-year. Is there any kind of contemplation for pricing at all as we go forward?

We don't talk about that. It's the kind of thing that I always say maybe once a year (multiple speakers)

Yes. Okay.

Let me just get it out. The nature of the industry pricing is transactional. So you're writing agreements that have life to them over a single project, and you're also quoting on projects that only have the life of that pricing apply at that time. So you have the opportunity to make choices about your pricing so that you are not locked into things that maybe aren't profitable.

With that said, it's a very competitive market and can be effective in a -- by pricing and a share explanation. And so we are really attentive to it. That's the background.

What we don't do is we don't talk about what that might be.

Okay. Fair enough. Thank you guys. Good luck.

Jeff Matthews, Ram Partners.

Two things. One is your breakeven rate that you've talked about, 530 to 540, is 10 million to 20 million lower than I think on the previous call. And I wondered why that is, if it's just rounding, if there's something specific in there that added to that.

Secondly, I wondered about your healthcare moves and what you're seeing there, whether there was -- there are any new customers you'd highlight? And also whether you're contemplating any joint ventures in the healthcare field with existing equipment suppliers?

I'll take the breakeven, and then I'll defer to Jim on the health care.

On the breakeven the largest contributor to the breakeven going down is simply a lower currency rate between the euro and the US dollar. So I believe when -- 90 days ago when we had our call, we talked about an exchange rate that was in the 1.30's. Now it's in the 1.20's. So that's the biggest contributor.

I would also say that performance across the business was better than expected in the quarter, and that had an impact as well. But the biggest driver is the lower currency rate.

And on healthcare business in general, I commented in the scripted remarks that orders had improved versus last year. Last year at this point was kind of -- we were in the midst of the recession, and funding was a bit of a question mark as continued healthcare expansion, so we felt like we were seeing a pause. But whether that pause has completely lifted now remains to be seen.

But I know Jim spent a lot of time in our Nurture showroom at NeoCon, so maybe he can share some comments about some of the project activity that he was hearing about.

Yes. So clearly the demographic and the nature of this industry has lots of potential. Demographic being the aging of the population, health care being at the later part of people's lives. That's translated into a framework that has this understanding of course at the clinical level, the growth and the need for new kinds of spaces where people are in residence in hospitals.

A fair amount of innovation going on in that category over the last five years. All you have to do is ask yourself if you've been in a hospital or been there to see a loved one or something, that institutionally it performs fairly well, but from a design standpoint, kind of a human-centered standpoint, it hasn't had the effect of what we know we can do in the industry we are in, which is make the spaces feel better, respond better to the way people need them to respond.

So there's been a lot of work going on in that, and a lot of promise because of how, frankly, un-evolved the dominant design has been, the way you just kind of look at healthcare facilities today and expect that they are going to be ripe for improvement, which is -- gives rise to the wise question you had about is there opportunities with others? And that's -- the reason that's a wise question is there's a lot of layers that make that experience important, many of the things we don't control. And so it's a good question.

I don't have anything to report today. In the past we have shared that we've had interactions with other equipment manufacturers to display and market together, Cerner being one example. So those things are still ripe potential.

I think the promise, though, in health care is that the category is beyond just the hospital in terms of the way health care will be distributed and the opportunities that sit there in terms of ideas that we have. So we had a good Nurture experience this NeoCon.

A competitor launched a big effort in that regard, so they created a lot of interest in the category. I think that's good for the whole industry. And we have a -- they have a lot of people coming to see us that talk about transforming these spaces at large.

We used to have kind of visits that would be a hospital in a city, and now whole systems are being updated, and so that's why this has a lot of promise, a lot of growth opportunity.

Could I just follow up on that? And the reason I ask is that there is a big growth in this concierge-type medicine, which is almost like walking into an office building instead of an old-fashioned doctor's office. And in terms of Steelcase's brand name in this area, are you -- do you get a sense that you're getting visibility? Are you getting new customers, people you've never talked to before that you think might yield joint ventures or more business down the road?

I would say yes and yes. The presence of the company in those segments is a combination of what we have learned by studying the way that experience needs to be best. So we have been actually authoring some of that. In some of the designs that are emerging, we've actually been behind that.

In addition, the company that's part of Steelcase IDEO, it does a lot of work in this area. So they have helped us understand how that's growing, the kind of -- your question is, do you see that opportunity? We do. And it was the inference I made about beyond the kind of the hospital as a static place where people go to be housed, there's a longer continuum of healthcare experiences like the one you talk about that are very attractive to us.

Got it. Thank you.

(Operator Instructions). Budd Bugatch.

Yes. I was very interested in your comments about the project business, and certainly the order patterns for North America and international looked good. You also talked about the fact that project Visage looked like they were down year-over-year, because last year you had such significant learnings, and I think you said for your architect and design community. Can you kind of give us a feel of what kind of projects are -- you're seeing now? And I think sequentially visits were up, so when will that likely turn into orders? And maybe talk a little bit about the longer term.

Budd, I'm -- it's Dave. I'm going to give you just a general answer on that because I don't want to get into the specifics. There project activity is -- we feel is modestly increasing. It's still quite competitive out there. Project activity we hear about is mostly in the back half of the year.

scape, while things were so slow.

But we definitely feel like there is more conversation among our dealers and our sales force about project activity in the back half of the year.

Now, I don't -- I wouldn't suggest we run with that as significant growth. It's just when you go from a time period of very, very little project activity, any kind of project activity can feel like a lot. So I would just temper the overall comments with that.

Dave, can you give us a feel for what dealer deconsolidation impact on revenues will be beyond Q2?

And when you had (multiple speakers) one off? On a comparative basis?

I think in Q3 it's a little higher. I want to -- Raj will call if it's different, but I think in Q3 it's closer to $20 million.

And then -- but then it goes down in the fourth quarter, because one of the dealers was actually deconsolidated at the end of the third quarter last year. So it might be back to the 12 or 13, $10 million, something like that.

I've got two other questions. Restructuring beyond the second quarter, what's the restructuring expenses now? Is it all pretty much this European issue?

Yes. I think beyond the second quarter there might be a little bit a restructuring remaining associated with the smaller actions. But nothing significant. The balance will be driven by the European restructuring.

And is there any color you can give us on those European discussions? I know that's pretty sensitive stuff, so I don't want you to reveal anything that might be sensitive, but (multiple speakers)

The challenge is that there is a protocol in terms of all that communication that makes it kind of touchy in terms of talking about it. But I can say it this way, because I've said this to the -- everyone in the company, the people that Steelcase have working on this, Budd, have a lot of skill and experience, and the company has a history of being a great place to work for in a country that is very conscientious about its social systems.

So I just met with some people in the last few weeks that are experts in this field and got a report that made me feel really good about our -- the reputation at Steelcase and the nature of that system as it rationalizes projects like this.

Finally, I was also impressed with the node chair, and I realize -- I think you're going to start shipping that relatively shortly? Any significant impact on revenues? Or how do we look at that going for the rest of the year?

Well, first order entry was yesterday. And we have presold a number of unit, so they'll start getting into the order system over the next few weeks, and then we will be shipping in July.

Any comment about level of volume?

I would say, Budd, it's still too early to tell at this point as we start ramping up initial production. We will get a better feel over the next month or two.

And the fact that the budgets of the state and local governments are constrained, is that a constraint on that potential volume?

Yes, it's a constraint of our sales overall in that sector, because sales continue to decline. But with the node chair so far it's been different. It's an innovative product in classrooms, and it's starting from scratch, so we've got good, strong initial response.

Thank you very much, and good luck on the quarter.

Jeff Matthews, Ram Partners.

I was just curious if you're hiring at all in the US.

Do you want a job, Jeff?

(laughter) I've got a daughter graduating from school so -- no, just kidding.

(laughter) Now, yes, we are. The company is a very dynamic business, and so if you mean do -- are -- does (multiple speakers)

I guess what I mean is are the -- is -- are layoffs over? And are you actually seeing any kind of incremental hiring in response to business? That's all.

I would say even in the worst of the downturn we were still hiring, by trying to strengthen our talent in the organization. But obviously not in a significant way. We are -- where you'll see us adding resources in manufacturings will be through temporary workers largely until we were to know that the recovery was here to stay. It would be adding headcount through [temporaries].

But generally are we increasing our headcount? No. Jim has talked over the last couple of years about a shrink to grow strategy in our -- across our business, not only in manufacturing but in the front end of our business across operating expenses. To the extent we need to add resources or fund merit increases or other projects, we need to find areas in our business to shrink to help offset that.

Got it. Thanks very much. Good luck.

We have no further questions in the queue at this time. I would now like to turn the conference back to our speakers for any concluding remarks.

Yes, I just want to suggest again that it's nice to be able to report the kind of growth we had this quarter, to come out of NeoCon with the kind of enthusiasm for products like node, and to see evidence that maybe the world is starting to find a way to deal with all of these challenges. If you just think back to a year ago where we were, it's a better space to be in.

So with that, thank you for all your attention today.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.