Steelcase Inc (SCS) 2014 Q2 法說會逐字稿

Good day, everyone, and welcome to Steelcase's second quarter fiscal 2014 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. Good morning, everyone. Thanks for joining us for the recap of our second quarter financial results. Here with me today are Jim Hackett, our Chief Executive Officer; Dave Sylvester, our Chief Financial Officer; Mark Mossing, Corporate Controller and Chief Accounting Officer; and Terry Lenhardt, Vice President of Finance for the Americas, EMEA and Asia Pacific.

Our second quarter earnings release which crossed the wires yesterday is accessible on our website. This conference call is being webcast, and the webcast is a copyrighted production of Steelcase Inc. The presentation slides that accompany this Webcast are available on Ir.Steelcase.com and a replay of the call will also be posted to the site later today.

Our discussion today may include references to non-GAAP financial measures and forward-looking statements. Reconciliations to the most comparable GAAP measures, and the risks associated with the use of forward-looking statements are included in our earnings release and webcast slides. We are incorporating by reference into this conference call, the text of our Safe Harbor statement included in yesterday's release. Following our prepared remarks, we will respond to questions from investors and analysts. And with that, I will now turn the call over to our Chief Executive Officer, Jim Hackett.

Thank you, Raj, and good morning to everyone. For the last few quarters, I have emphasized on this call that I believe our business is situated at the crossroads of great opportunity. It is the intersection of outdated spaces, and our ideas about how customers can not only upgrade their spaces, but modernize how they work. This is the primary topic of my conversations with leaders in major corporations today.

I am a bit reflective today, as this will be my second to last call in the role as Chief Executive Officer of Steelcase. As I have done close to 50 of these calls in my tenure, I realize that the ceremony is really critical to helping our shareholders understand not just what is behind our performance, but also the opportunities and the risks that we see.

So there is no doubt in my mind that Steelcase is a much stronger Company today than a few years ago. And that's in no large part due to the hard work of our people around the world to reinvent the industrial model, develop new products based on the knowledge of the workplace, which really has changed the very nature of our business. Thus we are reporting on another good quarter today, specifically because of the better than expected results in the Americas segment. In fact, I think they are extraordinary, given the recent history.

Now as Dave will explain it a few moments, several factors aligned in Q2 to create outstanding performance in the Americas. In any case seeing a 14% operating margin, which is the highest for any segment in a decade, it makes me very proud of all of the work we have done to improve our fitness and to change our business model. I am proud that we have demonstrated our ability to anticipate the future for the targeted customers that we serve.

We saw the trend from individual work to collaborative work, or as we call it from I to we space. We saw the shift from fixed to mobile work, with the office becoming a place where people can now work anywhere, but want to come together and collaborate. And now we are implementing ideas supporting the deeper integration of technology into everything that they want to do.

This is a message that continues to gain traction with our customers, and as you see especially in the Americas. We believe its acceptance in other parts of the world is being delayed a bit by economic conditions that makes price a factor. But that is going to change with the eventual recovery in these other geographies.

And because we have made the tough decisions to navigate our way out of two major downturns, we are confident that we can make the necessary adjustments to safeguard our competitiveness in Western Europe. We are applying portions of our playbook from the Americas transitions, including the alignment of our salesforce, and ramping up the level of what we call global integration.

Like you, we are far from satisfied with our EMEA results, and we took steps to reduce operating expenses earlier this year that will show up in future quarters. And as noted in our release yesterday, there is more to do. But first we need to work with the teams and the countries involved to define potential projects aimed at protecting our competitiveness. And therefore we can't really get into more information today. I want to emphasize that. We are working on projects aimed at protecting our competitiveness, and we can't really provide more information today.

I do want to stress that while we are not happy with the competitiveness in Europe, we are very confident in our people, and our market strategy in this region. I am proud of our teams for staying afloat in some very stormy economic seas. We are also proud of our people in Asia Pacific, because they have been facing their own economic up and downs, but they are continuing to build for the future as well.

So let me move to an update on our new products. We have talked about them in past calls. And we have been telling you all year, there would be some significant launches in this year. We are excited about the upcoming move from the pilot phase into full production, which will require we spend more of the incremental dollars that we have been talking about since the start of the year. This is a good thing, because we are getting to market.

Our expected first order entry for the Gesture chair is a little more than six weeks away. And we have already had commitments from 10 major customers for orders that will ensure our production pipeline is filled from day one. And I believe the media coverage of this chair to the consumer market, with something like 150 articles around the world including a recent feature in the New York Times is unprecedented. We have generated a buzz around this chair, and our research about the implications of the way people are using technology tools is really working.

Our V.I.A. architecture portfolio is also in the pre-sell phase, and we accepted our first significant customer order this week for a pilot space at a major energy company. There has been tremendous momentum around this project and product, since we showed it at NeoCon in June, as there are for products such as Regard, that is the waiting room furniture and healthcare applications, and the new offerings that we demonstrated from Coalesse.

So in summary, we have made good investments into products and applications designed for where work is going in the future, which is going to allow us to build on the good performance we are reporting again this week. But as I said we're also focused on the need to improve our competitiveness in the underperforming EMEA segment. And we will have more to say about that, as soon as we are able to talk about it. I will turn it over to Dave for more details.

Thank you, Jim. I will start with a few high level comments about the second quarter results and balance sheet, provide some additional color commentary around our order patterns, and outlook for the third quarter of fiscal 2014. And then we will move to your questions. On the second quarter results, I will first talk about the results versus our expectations. And then move into the year over year and sequential quarter comparisons.

Overall, earnings per share were consistent with our expectations, despite revenue falling slightly short of the range we communicated last quarter. From a revenue perspective, the Americas PolyVision and Designtex were in line with our expectations, while EMEA and Asia Pacific fell short. From an earnings perspective, adjusted operating income in total was consistent with our expectations, while strength in the Americas -- with strength in the Americas offsetting weakness in EMEA and Asia Pacific, and higher operating expenses in corporate.

Non-operating results were negatively impacted by reductions in the cash surrender value of variable life company-owned life insurance or COLI, which was driven by recent increases in interest rates, and our investment allocation being heavily weighted toward fixed income securities. We expect reduced volatility in variable life COLI income go forward, as we have adjusted our investment allocation to more heavily weight money-market funds, as we expect in the near-term to extract a portion of the value from these policies. Lastly, the effective income tax rate approximated our estimate of 40%, but there were a number of components which I will cover in more detail in a few minutes.

On the segments, in the Americas stronger than normal seasonality in the second quarter was consistent with our expectations. You will recall that first quarter order patterns reflected requested shipment dates that were more heavily weighted toward the second quarter, which resulted in a higher backlog coming into the second quarter. The adjusted operating income margin of 14% was significantly better than expected due to favorable business mix and lower operating expenses which are expected to ramp up in the back half of the year.

For EMEA, the adjusted operating loss was larger than expected, primarily due to volume shortfalls across much of Western Europe as well as shortfalls in Africa. The impact of lower than expected volume was partially offset by lower operating expenses, some of which have been deferred to the back half of the year. Despite the challenging environment and Western Europe, we believe that we are gaining market share in most markets, reflecting the great efforts by our resident teams to align our strategy with the rest of the world, and position our business for eventual economic recovery in the region.

Similar to EMEA, Asia Pacific fell short of our expectations largely due to volume shortfalls, which were linked to the general economic slowdown in China and various project installation delay. The team offset some of this impact by cutting back on operating expenses. In addition, the devaluation of currencies in Japan and India are having negative consequences on our business models in these regions. Lastly, corporate costs were higher than expected due to increased reserves for environmental remediation costs associated with a previously owned manufacturing site, higher accrued earnings on deferred compensation and costs associated with the sublease of excess showroom capacity.

On a year over year basis, revenue in the second quarter grew modestly after adjusting for the favorable impacts of currency translation and net acquisitions, while adjusted operating income increased by approximately $5 million or 10%. Organic revenue growth in the Americas of approximately 4% represented the 14th consecutive quarter of year over year growth, and reflected favorable business mix, recent pricing benefits, restructuring benefits, manufacturing efficiencies and other cost reduction efforts and modest volume growth. The business mix impacts reflected a significant decline in the lower margin federal government sector, and significant growth in the higher margin education vertical market.

In addition, various projects across other vertical markets were more heavily discounted in the prior year, compared to comparable projects in the current year. These factors contributed significantly to the 280 basis point improvement in cost of sales, and the $17.5 million increase in adjusted operating income which resulted in a 14% operating margin for the quarter. In addition, operating expenses grew less than expected primarily due to timing, which further contributed to the strength of the Americas results in the second quarter.

As you saw in the release, EMEA experienced a 13% organic revenue decline in the quarter which was larger than expected, but not entirely surprising given the prior year organic growth rate of 17%. The revenue decline was broad-based, and was the biggest contributor to the larger operating loss compared to last year. The benefits of lower operating expenses were offset by unfavorable shifts in business mix, and inefficiencies in manufacturing and distribution linked to the lower volumes.

For the other category, adjusted operating income decreased by $1.4 million, while revenue increased by the same amount. The reduced operating results were largely driven by Asia Pacific. And for corporate costs, the $3.9 million increase compared to the prior year, was driven by the factors previously mentioned.

Sequentially, the biggest drivers of the $30.5 million improvement in adjusted operating income were attributable to the seasonally strong organic revenue growth, and the favorable business mix previously mentioned. Restructuring costs in the quarter were somewhat higher than our expectations, and were entirely attributable to the EMEA activities which were initiated during the first quarter. These actions are expected to be completed in the coming months, and yield a few million dollars of annualized savings thereafter. As it relates to the North America plant consolidations, we estimate year over year net benefits approximated $4 million in the second quarter.

Regarding my quote in the press release about EMEA, we are not prepared today to say anything more than what was indicated in the release. That is, we expect to work with our EMEA teams to initiate procedures within the next 30 to 60 days with employee representatives in the countries involved regarding potential projects aimed at safeguarding our competitiveness. Once these procedures have been initiated, we will be in a position to provide more details. But until then, we will respect the processes required to be followed.

Now I will spend a few minutes on income taxes. Last quarter, we communicated that we expected to record unfavorable tax adjustments of approximately $2 million, which could increase our effective tax rate to approximately 40% in the second quarter. We did record approximately $2 million of unfavorable discrete tax adjustments, but we also recorded a $3 million discrete tax benefit associated with a tax planning strategy.

In addition, we recorded an effective tax rate of approximately 40% against pretax income, which we currently estimate to be the effective tax rate for the balance of fiscal 2014. Plus we recorded a year-to-date catch-up adjustment to bring the first quarter effective tax rate to this higher level. The higher rate is being driven by losses in EMEA, which result in deferred tax assets in various jurisdictions that currently warrant full valuation allowances to be recorded against the assets, thus negating the benefit of recording the deferred tax asset. A bit complicated for sure. The takeaway, however, is that our effective tax rate is expected to be closer to 40% for the balance of the year and thereafter, until EMEA achieves breakeven or better operating results.

Moving to the balance sheet and cash flow, we generated $56 million of cash from operations during the second quarter. Working capital increased by $20 million in the quarter, primarily due to higher accounts receivable in the Americas which was linked to revenue growth.

Capital expenditures totaled $18 million, similar to the first quarter, and are currently expected to approximate $80 million for the full fiscal year. We returned approximately $13 million to shareholders in the second quarter through the payment of a cash dividend of $0.10 per share. And yesterday, the Board declared the same level of dividend to be paid in the third quarter.

As it relates to order patterns, I will start with the Americas where our orders in the second quarter grew approximately 10% compared to the prior year. Order patterns were strongest in August, growing 16% over the prior year compared to a modest decline in the prior year. And customer order backlog for the Americas ended the quarter up approximately 19% compared to the prior year.

Across quote types, orders related to large projects and orders from our marketing programs aimed at smaller day-to-day businesses grew significantly, while orders from continuing agreements were flat compared to the prior year. Vertical market order growth rates in the Americas were the strongest in the insurance, energy, and manufacturing sectors. Healthcare, education, technical/professional, financial services and state and local government also grew, while federal government and information technology posted single-digit percentage declines against the prior year.

Switching to EMEA, order patterns in constant currency remained mixed, declining by approximately 12% in total compared to the prior year. We experienced order growth in the export markets of Eastern, Central and Southern parts of Europe, while Northern Europe and Germany were relatively flat. Orders in France, Iberia, and the export markets of the Middle East and Africa also declined, but the comparison was against a strong prior year. Customer order backlog for EMEA ended the quarter up approximately 5% compared to the prior year, which was more a function of low backlog last year than current quarter order patterns.

Within the other category, orders grew by more than 20% in Asia Pacific and at PolyVision, while orders at Designtex declined by a mid single-digit percentage. We are continuing to monitor the Chinese market closely, as order patterns have remained relatively soft. And we expect challenges in Japan and India, given the recent currency devaluations, and the fact that our business models in those markets are largely dependent on imports. To summarize, our order patterns and quarter-end backlog in the Americas remain solid. We continue to face a challenging environment in EMEA, and we are keeping a close eye on a few markets in Asia Pacific.

Turning to the third quarter, we expect to report revenue between $755 million and $780 million, which compares to $727 million in the third quarter of fiscal 2013. After giving effect to currency fluctuations and a recent divestiture, we estimate organic revenue growth in the third quarter will approximate 4% to 7%, compared to the prior year. Sequentially, the third quarter revenue estimate represents a range of down 1% to up 3% on an organic basis, which is somewhat lower than typical seasonality due to the strength of the Americas in the second quarter and ongoing volatility in EMEA.

We expect a mix of project business in general across the Americas, EMEA and Asia Pacific to remain higher than business from continuing agreements. However, we are not anticipating the favorable business mix in the Americas during the second quarter to continue into the third quarter, as higher margin business in certain vertical markets is expected to be replaced by lower margin business in the federal government sector. In addition, the mix of large project business in the third quarter is expected to be more deeply discounted compared to the second quarter.

For operating expenses, on a sequential quarter basis we expect the costs associated with our new product introductions and other initiatives to increase our operating expenses compared to the second quarter. Finally, our third quarter earnings estimate contemplates an effective income tax rate of approximately 40% as previously discussed. As a result of these factors, we expect to report third quarter earnings within a range of $0.23 to $0.27 per share, including restructuring costs of approximately $0.01 per share. This compares to $0.19 per share in the third quarter of the prior year, which included restructuring costs of approximately $0.03 per share. From there, we will turn it over for questions.

Thank you.

(Operator Instructions)

Our first question comes from Budd Bugatch of Raymond James. Your line is now opened.

Hi, it's Bobby filling in for Budd again. Thanks for taking my question.

Hi, Bobby.

Oh, I am sorry. Yes, I just want to kind of get your thoughts on business forecast for the calendar year 2014, where you feel they are at, compared to where you see the industry going?

Well, we are aware of the business calling next year up quite significantly. And I would say for us, it is a bit early for us to comment on calendar 2014. We go through our extensive planning process in the fall. So towards the fourth quarter, we will be in a better position to comment about next year specifically.

Although I would tell you that our thesis remains unchanged. That we think the world is largely installed on an outdated model, and it needs to modernize. And as long as the economies continue to stay reasonably okay, we think companies are going to continue to invest to update their spaces.

Appreciate that. I just had another follow-up question. I know you were talking about in Northern Europe, but just kind of a little bit more color on maybe the trends in Europe? And if you are still seeing some areas strengthening, and if you expect that to carry forward maybe a little bit into third and fourth quarter?

It has really been more of the same story we talked about last quarter, where we suggested that we were seeing positive trends in Northern Europe, which was a change from previous quarters. Those are continuing to play out. Our expectations are that we will continue to see some strengthening of our business in that part of EMEA.

Middle East and Africa and the export markets of Eastern and Central Europe and Southern Europe as a group, we feel -- continue to feel pretty good about. Germany is hanging in, and France is doing okay. Those are really the biggest question marks. If anything maybe Spain notched down another bit, bit of a notch in the past quarter. But it still feels like they are at a sandy bottom, like it's not like they have broken through to a new level. It is just a little squishy along the bottom.

So we will wait and see. But it is kind of the same story for the last several quarters, relatively mixed, flattish in total. Now this past quarter of Q2, you go wait a minute, you were down 13%. But I remind you that last year in the second quarter we were up 17%.

Okay. I appreciate you taking my questions, and good luck going forward for the rest of the year.

Thanks.

Thank you. Our next question comes from Josh Borstein of Longbow Research. Your line is now opened.

Thanks, everyone for taking my questions. With respect to EMEA, I know you are limited on what you can say with respect to the steps you are taking there. But can you tell us if the steps you are trying to initiate represent a change in your thinking about the EMEA business since we spoke three months ago?

No, there is no change in our thinking. We are continuing to push their strategy to be more consistent with our global strategy, focusing on large leading organizations, and building distribution and product platforms to support it. So no change in strategy by any means.

Okay. And the phrase, safeguarding your competitiveness that you mentioned, can you unpack that phrase a little bit, what exactly you mean by that?

It really is left best as that description. It really means that.

Okay, fair enough. And then, what gives you confidence that you are taking market share in Europe right now?

Well, it is not as easy to measure in Europe, as it is in the US. We don't get as often the same amount of information in Europe that we get in the US through BIFMA here. But what we do see from the market data gives us confidence that, not in every market, but in many of the markets we feel like we are gaining share. Now some of that share, frankly, is coming in markets where companies are just simply going out of business, because they can't sustain the downturn any longer. And that, therefore, what is left in the industry is being spread to fewer players. And in some cases to the stronger players, which is us.

Okay, great. And last one for me. In the Americas, can you just tell us the number of customer visits, the total number of mock-ups, as well as the average value of each mock-up in the quarter?

I don't know the actual numbers off the top of my head. But I do know that the patterns that we have been talking about for the last few quarters have remained consistent. Meaning the level of project activity has been very good, and the average dollar value associated with those projects has been up over the prior year. And I can tell you, as also the executive at Steelcase whose has corporate aviation reporting to him, our aircraft are essentially full through the end of February.

Okay, thanks very much, and good luck.

Thank you.

Thank you.

(Operator Instructions)

Our next question comes from Todd Schwartzman of Sidoti & Company. Your line is now opened.

Hi, good morning, everybody. What is your outlook say, 6 to 12 month outlook for steel costs?

I think they are going up. I mean, we had a recent uptick in cold-rolled steel that will affect us in another 90 days or so. If you remember, our contracts lag the market by 90 days. And so, we had a recent uptick. And our forecast is that we do see it increasing modestly go forward.

As far as pricing action?

Well, we have put pricing in place over the last couple of years as needed. And so, if inflation were to continue to go up, or we were to experience -- continue to experience inflation, we would likely deal with that as we have in the past.

Got it. I know there has been a lot of discussion, some disagreement over to what extent construction, non-res construction really is necessary to fuel growth in your industry. But are you seeing any geographic pockets of strength in North America, where you are seeing -- or maybe where there has been a recent pickup in non-res construction, translating at this early juncture to furniture orders?

Not specifically. I mean, anecdotally, Todd, there are -- some of the customer visits are projects we are working on are new construction. But I wouldn't call any of them, necessarily a regional trend.

And Dave, what does your own model indicate for a fiscal '15 tax rate?

Well, it really is a bit early, but it is highly dependent on what EMEA results look like next year and whether or not we are able to book the benefit of deferred tax assets or not. But what I said in my scripted remarks is, I think you should use 40% for the balance of this year and thereafter, until you assume that EMEA will be back to break-even or better.

Okay. And lastly, were there any timing issues, or do you anticipate any timing issues in current quarter that we should be aware of regarding shipments?

No, we had a few slippages here and there, where customers delayed installation. But to be honest, we have that every quarter. I couldn't tell you whether this quarter was higher or lower. It didn't feel like it had more conversation than normal.

Okay. Thanks a lot.

Thanks.

Thank you. And at this time, I am not showing any further questions. I would like to turn the call back to Mr. Jim Hackett for any closing comments.

Thank you, everybody. Appreciate your attention today, and we look forward to reporting improved results.

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