Steelcase Inc (SCS) 2011 Q3 法說會逐字稿

Good day, everyone, and welcome to Steelcase's third-quarter fiscal 2011 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, Mary. Happy holiday season, everyone. Thank you for joining us for the recap of our third-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.

Our third-quarter earnings release, which crossed the wires yesterday, is accessible on our website. This conference call is being webcast and presentation slides that accompany this webcast are also available on our website at IR.Steelcase.com and you can find a replay of this call 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 yesterday's release and Form 8-K and the Company's 10-K for the year ended February 26, 2010, and our other filings with the Securities and Exchange Commission.

This webcast is a copyrighted production of Steelcase Inc.

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

Thank you, Raj, and good morning to all. Happy holidays as well.

We are never sure on these calls who might be following our discussions for the first time. So some of you veterans may have heard me say this before, but let me remind you what history in our industry tells us.

When there are recessions our industry enters the downturn later and it exits later as well. So we have been saying that as you saw other parts of the economy show improvement and wondered when that good news would reach into our sector, it now has.

We are reporting for the second straight quarter performance that exceeded our own expectations. Now some are wondering how we can see relatively low-growth GDP in the Western economies, yet also have the growth rates in this quarter's report be so high.

Dave Sylvester, our CFO, will contrast the differences in quarters and the previous year for you. But I want to make the point that most of the world's corporations that make up our client base did exceptional work during the downturn to engineer costs out and to build large cash positions. This left them in great shape to now invest.

And I think we've had global GDP growth somewhere near 4.5%. So even though this urge by large companies to invest is still tempered somewhat, I believe that more and more projects are getting greenlighted.

The principle behind these investments transcends the short term and they believe and support that many see the turnaround in mid-decade. So, in other words, it is okay to get started now in projects that would affect our industry.

Now there is still some significant issues in the economy that could alter our momentum. And like everyone else we're watching the challenge in European countries that are working very hard to solve their debt and related economic issues.

I should point out that the particular nations most often in the headlines that have this challenge in their capital ratios and banks, they represent a small piece of the overall international business, and we are doing very well in the larger markets that are a lot more stable.

In fact, almost all of our marketed segments contributed to the 15% organic growth that you will hear about later in this discussion, and as we said on our call at the end of Q2, our decision to invest in growth during the downturn is really paying off now.

Now that is particularly true as we look at our Asia-Pacific business, which has consistently shown much higher growth rates than the average of other countries in our business, just consistent.

We have had some especially significant wins in China during the quarter. Simple indicators tell us a great deal as well. The roster of large corporate customers who visited our campus in Grand Rapids over the past quarter has been a very impressive list. I have been very enthused by the number of customers who want to address their legacy office spaces that need to change.

All the trends in our society around mobility and technology have pointed at this, but the recession dampened that transition. It seems like it is not contained anymore.

Our newer products continue to be well received around the world. Three of our chairs won awards in the Spark International Design Competition this month. This node chair -- this is the special chair we made for the education market -- earned the event's highest honor.

As we move to the fourth quarter, you're aware that there is a normal seasonal drop in our business, because January and February tend to be a little slower in our industry.

We think we will be a lot closer to normal seasonality this year without the impact from the recession in the past. And despite the sequential drop in revenue, we are still projecting very strong organic growth in Q4 over the prior year.

You have seen mentioned in our business -- excuse me -- you have seen mentioned in our release of some items that will contribute to our fourth-quarter cash balances. And I want to take just a minute to talk about one of those items, it's the IDEO partnership that is being created.

We have seen IDEO grow over the last two decades into an organization that is renowned around the world for its human-centered design. And we announced a little more than two years ago that Steelcase and IDEO had agreed on a plan by which the IDEO management team would gradually increase its ownership share and Steelcase would take a minority position in this new partnership structure.

We are really happy to report that the IDEO management overperformed and is now in a position to take controlling interest. This does not end our relationship by any means. This has been a special relationship. We share a history of bringing innovation to market and a passion for design thinking.

We look forward to future collaboration in such diverse domains as education, healthcare and, of course, technology.

David Kelley, who is the founder of IDEO and the d.school at Stanford, and Tim Brown, the President and CEO of IDEO and now a best-selling author on design, have a solid plan for IDEO's continued global success.

In closing, I want to reinforce that we are happy and we are very pleased with the quarter. I also want to wish everyone a very happy and safe holiday. We appreciate your continued interest in our Company and hope you have a chance to enjoy the company of your friends and family during this holiday season.

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

Thank you, Jim. I will start with a few high-level comments about the third-quarter results and the balance sheet, provide some additional color commentary around our order patterns and outlook for the fourth quarter, and then we will move to your questions.

Again, as Jim mentioned, we are pleased with the results of the third quarter. Revenue and earnings exceeded our expectations again this quarter as order patterns throughout the quarter were stronger than we anticipated.

Consolidated revenue of $673 million was higher than we estimate -- than the estimate we provided last quarter, primarily due to strong North America and international orders throughout the quarter, which helped drive year-over-year organic revenue growth rates of 16% and 20% in these markets, while sustaining levels of backlog that are significantly higher than the prior year.

Adjusted operating income compared to the second quarter increased by $15 million, largely due to operating leverage associated with the $64 million sequential increase in organic revenue. This improvement was somewhat offset by increased spending compared to the second quarter, including $2 million of higher bad debt provisions related to a few dealers in North America and international.

Within the segments the sequential comparisons of second- and third-quarter adjusted operating income are also impacted by the individual items disclosed last quarter.

You will recall I referenced last quarter to the very strong results in the other category, as well as our discussion surrounding a product specific warranty provision and relatively low variable compensation expense in North America during the second quarter.

While these items essentially offset each other at the consolidated level, they did impact the sequential comparisons in North America and the other category.

Compared to the prior year, adjusted operating income improved $20 million due to operating leverage from the $88 million of organic revenue growth in the quarter and benefits from previous restructuring activities offset in part by approximately $6 million of commodity cost inflation, $3 million of higher bad debt provisions compared to last year, and other miscellaneous increases in operating costs, including the reinstatement of base salaries to fiscal 2009 levels.

Restructuring costs in the quarter reflected higher-than-expected costs in France as additional people elected to participate in the social plan launched earlier this year in connection with the plant closure.

Below the operating income line, variable life COLI income exceeded our expectations as the equity markets rallied for most of the quarter. And our effective tax rate was reduced by favorable adjustments related to the IDEO ownership transition as well as miscellaneous discrete items.

The year-to-date effective tax rate estimate did not contemplate retroactive reinstatement of the US research tax credit which, if enacted into legislation, could further improve our effective tax rate in the fourth quarter.

We finished the quarter with higher cash in COLI balances and slightly lower debt compared to the second quarter. You will recall that we reclassified our senior notes as current on our balance sheet last quarter.

Based on discussions with our advisors and our current assessment of the debt capital markets, we remain confident in our ability to refinance these notes at or prior to maturity.

However, if the debt markets where to dramatically turn prior to our refinancing, we believe in the worst case our cash and COLI balances plus our existing credit facilities are sufficient to manage the maturity of the existing notes and provide adequate liquidity ahead of the later refinancing.

Just two other brief comments on our balance sheet and cash flows before I move to orders. First, you likely noted $13 million of proceeds associated with an asset disposal in the quarter.

The disposition was related to our manufacturing facility in Malaysia, which we are leasing back for a minimum of six years. We chose to complete this transaction as we currently utilize only half of the facility and the current sub tenant helped maximize the property's value during a time when the Malaysian ringgit was relatively strong to the US dollar.

Second, I want to highlight that total capital expenditures of $17 million in the quarter included $7 million of progress payments related to a replacement corporate aircraft, which we have mentioned on previous calls.

As it relates to orders, I will start with North America, where we experienced broad-based year-over-year order growth in the third quarter of approximately 26%.

Following modest growth rates in April and May, orders grew at double-digit rates for five consecutive months through October before accelerating significantly in advance of the November price adjustment, which resulted in an ending backlog that was approximately 25% higher compared to one year ago.

Project activity and day-to-day business, or continuing purchases off existing contracts, were both very strong in the quarter as were orders from marketing programs targeted towards small to midsized companies.

Within our product categories, third-quarter orders were up across-the-board, but we're particularly strong in seating wood and furniture, which includes systems, desking and storage products.

Seating growth was broad-based and included strength across our Alive Seating portfolio, which includes Think, Leap and Amia, and the wood and furniture categories benefited from strength in the New York and Western regions, as well as large projects in Canada.

Across vertical markets, growth rates were the strongest in technical -- in the technical professional, IT and insurance sectors. Health care and higher education orders also grew by solid double-digit rates, while government in total was relatively flat compared to a strong prior year.

For customer visits, following strength in the second quarter, we experienced a high single-digit percentage decrease in the current quarter compared to last year.

Comparisons to prior year continue to be up against the high level of A&D visits during the downturn, which were targeted towards sharing our research and insights underlying our new products. Excluding A&D fly-ins, customer visits were essentially flat versus prior year.

Regarding domestic pricing, large project activity remains highly competitive, especially in the federal government sector. In addition, we implemented a modest price adjustment in November; however, given the nature of project and annuity contract pricing, the impact will phase in over the next few quarters.

International orders in constant currency increased approximately 22% in the quarter compared to the prior year. Across Europe, Middle East and Africa or EMEA which, in total, grew by 13%, Germany grew slightly better than the average while France orders were relatively flat with the prior year.

Most other markets within EMEA grew significantly, most notably Spain, the UK and various regions within Eastern and Central Europe. The strength in Germany during the quarter was largely driven by day-to-day business, while most other countries and regions benefited from increased project activity.

Elsewhere we experienced very strong order growth in Asia and Latin America again this quarter which, along with the strength in EMEA, contributed to a total international backlog, which remained significantly higher than the prior year.

For the Coalesse Group, orders increased approximately 8% in the third quarter compared to the prior year following a second quarter decline of 6%. Year-over-year order comparisons in the Coalesse Group continue to be negatively impacted by the comparison to large project wins in the prior year.

Regarding the outlook for the fourth quarter, I want to first comment on the subsequent events highlighted in yesterday's press release. As it relates to the gain from the sale of a Canadian facility, which we expect to record as a restructuring credit in the fourth quarter, don't forget to consider in your modeling the incremental variable compensation expense of $4 million that will be recorded in the North America segment as additional cost of goods sold and operating expenses.

We are leasing back only a small portion of the facility to support our current level of activity. And as it relates to the IDEO ownership transition, we expect to record the estimated $9 million pretax gain, which is net of incremental variable compensation expense, and will not be consolidating IDEO beginning in the fourth quarter. Thus our revenue and operating income will be reduced accordingly.

To assist you in your sequential and year-over-year modeling, IDEO revenue and operating income recorded in the other category approximated $33 million and $4 million in the third quarter and $29 million and $3 million in the fourth quarter of the prior year.

In addition, IDEO operating expenses approximated $12 million in the third quarter and $10 million in the fourth quarter of the prior year.

Taking into consideration the IDEO transition and seasonal patterns that typically result in sequentially lower revenue in the fourth quarter, we expect to report revenue between $580 million and $605 million.

This compares to $552 million in the fourth quarter of fiscal 2010, which included $43 million from IDEO and a dealer that has since been deconsolidated.

In addition, currency assumptions included in our revenue estimate will have a negative effect on the year-over-year comparison by approximately $7 million.

After giving effect to the IDEO transition, dealer-deconsolidation impact and currency translation effects, we estimate organic revenue growth in the fourth quarter will approximate 16% to 21% compared to the prior year.

Sequentially, the fourth quarter revenue estimate translates to a seasonal decline in organic revenue of approximately 5% to 9%.

With respect to commodity costs, our earnings estimate does not contemplate any significant sequential change in the fourth quarter as recent spikes in steel prices will take a few months before impacting our cost of sales.

Compared to the prior year, commodity cost inflation in the fourth quarter is expected to moderate from the estimated $6 million of year-over-year inflation we experienced in the third quarter.

As a result of these factors, we expect to report fourth-quarter net income within a range of $0.11 to $0.15 per share including a net restructuring credit of approximately $4 million pretax or $0.02 per share after tax.

In addition, this estimate includes approximately $0.05 per share after tax related to the IDEO transition gain which, again, is net of incremental variable compensation expense.

The estimated net restructuring credit includes the pretax gain associated with the facility sale in Canada, as low well as remaining restructuring costs associated with the plant closure in France.

From there, we will turn it over to your questions.

(Operator Instructions). Budd Bugatch, Raymond James.

Happy holidays to you all. Our congratulations on the quarter just ended. David, I think you had said -- and I'm going through your prepared remarks -- you talked about visits to the Michigan campus being down in the quarter.

I was curious about that, if you could give us a little bit of color on that, and maybe as to the window and the pipeline of what you're seeing coming down the road.

Thank you for your comments. It is Jim. I want to give you this broad view of it. As I said in my remarks that I was really struck by the quality of the visits this last quarter, based on the size of the businesses that were here. It was -- we always get decent numbers, and I will let Terry tell us where the actual trips were, the number of trips.

This was a unique quarter in terms of the types of customers that were here and the kind of budgets they control. And in a way I want you to understand the signals to me this notion that they are starting to do a lot of significant planning.

So the number of visits sequentially between Q2 and Q3 went up, and previous year they were off just a little bit, I would say, the total number.

If you exclude the A&D visits, they were off a little bit.

You know, one other factor is we did have one of the aircraft in for routine maintenance for a better part of November this year. So that could have impacted the number a little bit. But we are not reading into it too much.

Okay, and my second question goes to talk about government business and I think you said government business was essentially flat.

In total.

In total. (Multiple Speakers). Could you kind of give us some window on that maybe, talk about federal and state and maybe give us a percentage of total company where it looks like there is -- I thought we were seeing some acceleration of government business this year versus last as more normal budget activity or budget because of at the end of the fiscal year, last year, as I recall, there wasn't as much activity in the government as there was this year. At least that was my impression from other channels.

I will let Terry handle that one, because he has the specifics, but last year federal government was actually pretty good, good for us, which is why we are only up a little bit this year, because it was a strong comp.

If you look for sales in the quarter, total government sales were strong growth over prior year, driven by state and local -- actually mostly local.

That business tends to be a little chunky. We had some local governments that were good customers for us in the quarter.

Our order spaces, as Dave said, it was relatively flat. State and local was down again, being chunky, and federal government did show single-digit growth over what was a real strong prior year for us in federal government.

Can you give us an idea of all government as a percentage of total, from domestic total?

I think you'd have to go back to the 10-K and look at what our last disclosure was and what the order of the verticals were. I don't think that that has changed dramatically thus far this year, but we will update that in the 10-K again this year.

Okay, thank you, and good luck on the quarter.

Matt McCall, BB&T Capital Markets.

Thanks, good morning, everybody. Dave, one thing I didn't hear you mention was pricing pressure and discounting. Curious about a, if you can talk about the pressure there, quantify it, and what the trends are like from a project discounting perspective.

Well, I did mention that it remains competitive. Highly competitive, especially in the federal government sector, which is really what we have been saying for the last several quarters. So it is really the same story and no significant change.

Okay, any -- no quantification on what the pressure was on maybe a year-over-year basis?

Now, if I looked at the data with Terry, frankly, the pricing year over year is not that bad. You know that we are constantly trying to move customers to new price lists, so you get a little bit of benefit from that.

And, of course, we had a little bit of normal discount erosion in the increasingly competitive environment that we have been in for the last several quarters.

But not anything dramatic. So if you looked at the mix of business, we certainly had pressure on our gross margins from having a higher mix this year versus last year of project business because of project activity returning. But even that wasn't that dramatic.

So the --.

From the role of the contribution margin if you take the organic growth times that 30% contribution margin that we think we should be able to average, and adjust for the commodity cost inflation and the higher bad debt, we are spot on.

Okay, that leads me into the next question that if I do that math it seems like you're still doing that -- you are right about that 30% incremental margin. And it looks like the guidance is assuming some same level.

As we look out in 2012, are there any benefits expenses that are going to come back? Are there any other costs that are going to return that are going to alter that trend at all? Or should we still be looking at a 30% incremental next year?

A couple of comments. First, early in the year we will see the benefits from the French plant closure. So that could help that contribution margin a little bit. And what could hurt the contribution margin is what we have always talked about, and that is a spike in inflation.

And (inaudible) what we are seeing in steel pricing over the last several weeks is a little bit startling, because it has -- it hasn't gone up dramatically.

Now I don't know what it is going to do in the next few weeks; it could settle down or even go back. But you know when we get quick spikes and inflation we can't move fast enough with price adjustments to capture it. So we get hurt for a few quarters.

So that could negatively impact contribution margins; but overall, our modeling that we continue to do as we update our planning for -- actually get into our first pass at planning for next year -- we continue to think that that 30% should be achievable.

And one of the ways that we continue to put a lot of pressure on the organization to achieve it is we are targeting -- continue to target how can we hold operating costs relatively flat while revenue grows?

And one of the ways we do that is by leveraging the shared service centers that we opened during the downturn in Malaysia and in Mexico and have had in Eastern Europe for several years.

Okay. Maybe more of a through the cycle comment on cash flow, and just -- I looked last cycle, it looked like about $300 million. I don't have the percent of [the net] income, but how do you look at the cash flow outlook? There have been some obviously, some alterations to the business, but how do you look at the cash flow outlook through the cycle? And then maybe refresh our memories on the targeted uses of cash. Thank you.

Okay, well, I will comment on a couple of the specifics. First with respect to working capital, we don't see any significant change in that go forward. So I don't think, Mark, we're at net 32 days or something like that on AR inventory in AP?

It might come down a little (inaudible--microphone inaccessible).

So with IDEO coming out of the mix, it might come down a day or two, but I don't see that dramatically changing as we look forward.

And from a CapEx perspective, we are going to continue to target this $40 million range. Last year I think we did closer to $30 million, this year, excluding the aircraft progress payments, probably closer to $35 million. Those are pretty lean, so maybe closer to $40 million. But I wouldn't imagine it is going to be dramatically higher than that on an operational level. So you can run the numbers and pick your volume topline and our business generates cash with those kinds of metrics.

On how we will use the cash, our financial policy hasn't changed. We will continue to look first to reinvest in the business. So you know we have a number of growth strategies and we have talked in the past about the possibility of bolt-on acquisitions to accelerate some of those growth strategies. So you could see us in that regard in some ways.

And you could also see us looking at additional growth strategies. But that is where we are always going to look first.

And, second, we are going to look to continue to sustain a strong quarterly dividend, and to the extent we have excess cash, we will look to return it to shareholders potentially through share repurchases. So, no change on our policy in that regard.

Thank you very much.

Happy holidays.

Todd Schwartzman, Sidoti & Company.

As you look at currently and for Q3, as you look at the middle portion of the country, are there any signs of stabilization or even an upturn as you look at things like the office absorption or the number of projects up for grabs?

It is a pretty good question, pretty detailed question, so let -- give me just a second to let Terry flip to some pages. I did comment that our growth in orders was relatively broad-based. It was the strongest in the Western and -- region as well as New York.

I think there was only one geographic region in North America that was a little off of last year, and all others grew. Or did they all grow, Terry?

If you break it down into six broad regions in which we manage, including Canada, each of those regions had solid double-digit growth year over year. [Some show] was a little bit lower but still real solid double-digit growth. And they did comparatively better in the prior year.

Canada led the way. I think they may have come out of the recession earlier and they rebounded a little bit harder, so we had a very good quarter for orders in Canada.

But if you think about those six regions, they are all pretty close to each other as far as broad-based orders growth. Now if you peel in under that, and look at the cities within each region it is a different story by city, and you can get that in any of those regions (inaudible).

Got it. On the price increase, can you quantify the average or the range of the forthcoming price hike?

We have said before that it is in the low single digit range, plus or minus 2% on average.

And within that by category, is systems consistent with that average?

It is actually a different answer within the system. The marketing groups do a line by line competitive assessment on where the positioning would be. So [if you got us in] systems, it just doesn't go by product. So that plus or minus 2% is a good, broad number.

Great, thanks, guys.

Mark Rupe, Longbow Research.

Hi, guys, good performance. Just had a question on the day-to-day continuing business relative to -- or versus the project business -- how's that flowed relative to expectations and how should we think about that on a go-forward basis?

I'm sorry, Todd. Could you do that one more time?

Sure. It's Mark. On the day-to-day and continuing business commentary it was a little bit stronger, had more of a mix than project in this quarter. Just curious to see what kind of your expectations are on that on a go-forward basis.

Well, we don't see any indications that would suggest that day-to-day is going to slow down. We think that is coming back and will likely sustain.

It is the project activity that we continue to watch closely, and what we feel good about is what we are seeing in the customer visit activity from some of the larger companies or customers. In that that -- that we expect will continue to come back along with the recovery.

We've seen (inaudible) but within the quarter if you look at the order growth projects that was about the average. So it is starting to rebound too.

Then could you remind us what you're anticipating for the cost savings are in the French facility in fiscal 2012?

$6 million to $8 million, I think, was in our 8-K a few months back.

Okay, perfect. Good luck, guys. Thank you.

(Operator Instructions). Jeff Matthews, Ram Partners.

Thanks very much. I just wanted to get your sense on your subjective commentary that you're getting much higher quality of visits or visits from larger companies.

It sounds like you haven't seen that for some time, and I wonder when the last time you got the sense that -- what this reminds you of? If it reminds you of precrisis levels or not?

That's a great question. It reminds me (technical difficulty) what comes to memory are two things or comes to mind is that there is a nuance in the industry as companies look at the historical cubicle product as a dominant design type of space.

So, think of what has happened in our industry is that workstations have gotten lighter. There's less panels that have been deployed. There is more team spaces. [Showcases], we believe, led in a lot of this.

And so what comes to mind is that it was amazing to me how many large companies still hadn't transitioned as fast to some of that. And yes, that was precrisis. Now what I am seeing is a higher interest by larger companies to want to update their spaces.

Second thing, it is likely demographic connected -- demographically connected. So there's been a lot of research by us and others that suggests as younger generations of workers come in, they have learned and behaved with mobile technologies that we all know. And so they are altering the nature of work as they bring these kinds of things into their workspaces inside large corporations. Well, that takes time for that infiltration to be a force.

So precrisis as well, you start to see interest in that. And then with the crisis everything kind of just stopped, you know, the kind of consideration for where the future of spaces might be going and very many companies stopped. This is the issue that I am starting to see abate and the interest in the visitors is around these kind of topics.

Then could I just have a follow-up with the -- when you say that government was flat, does that include -- is that net of education or is education outside of government?

We track education outside of it. Education continued strong double-digit orders growth.

Got it. Okay, thanks very much.

(Operator Instructions).

Sounds like that's it, Mary.

I am not showing any other questions at this time.

Thank you. It is Jim Hackett, just wishing everyone a wonderful holiday and it is nice to be sitting in 2010, two years after that terrible financial crisis, to see things start to achieve some state of equilibrium and promise again. So that is a great feeling going into this holiday. Best to everyone.

Ladies and gentlemen, this does conclude today's program. You may now disconnect and have a wonderful day.