Steelcase Inc (SCS) 2016 Q1 法說會逐字稿

Good day, everyone. Welcome to Steelcase First Quarter FY16 Conference Call. As a reminder, today's call is being recorded. For opening remarks and introductions, I would like to turn the conference over to Mr. Raj Mehan, Assistant Treasurer and Director of Investor Relations.

Thank you, Kelly. Good morning, everyone. Thank you for joining us for the recap of our first quarter financial results. Here with me today are Jim Keane, our President and Chief Executive Officer; Dave Sylvester, our Senior Vice President and Chief Financial Officer; and Mark Mossing, Corporate Controller and Chief Accounting Officer.

Our first-quarter earnings release, which crossed the wires yesterday, is accessible on our website. This conference call is being webcast, and this webcast is a copyrighted production of Steelcase, Inc. 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.

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're 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.

I'll now turn the call over to our President and Chief Executive Officer, Jim Keane.

Thanks, Raj. Good morning, everyone. I want to begin with some comments about our performance in the first quarter, and then talk about what we're seeing in the industry and the overall economy. We're pleased with our overall performance, with order growth in all of our segments, and with a 10% operating income margin in the Americas. It's been more than a decade since we hit 10% in Q1, which is typically the lower revenue quarter in our Americas business.

We saw modest growth in sales in the Americas while orders increased by 8%, so we're building a backlog that is setting us up nicely for the rest of the year. We've spoken before about how in the Americas we are seeing a longer period between orders and shipments, and as we expected, that pattern continued this quarter. We are getting a better sense of why this is happening.

It's clear that customers are taking on more ambitious changes to their work environments, instead of simply refreshing the existing design. These changes often involve more construction, even when they're only renovating an existing space. These customers place orders earlier than normal since their design is complete earlier, and planned shipment dates of furniture are often delayed because of construction issues not involving furniture.

There are other reasons, as well. Today we have better tools than in the past for our dealers to see our production capacity. With demand increasing, they have every reason to place their orders early to reserve capacity in the system.

Finally, we also are seeing strong double-digit growth in products that normally carry longer lead times, like wood solutions and Coalesse products. Taken together, these factors are leading to longer-dated backlog. Again, we have adjusted the sales growth estimates we give you to take these patterns into account.

It was good to see many of you at NeoCon, our annual trade show this year. Our show room was as busy as any of us can remember, and we continued to have high traffic and quality appointments through Wednesday, the final day of the show.

We were very pleased by customer reactions to the new Brody Work Lounge, and the Thread power distribution system, both of which received Best of NeoCon awards. Customers were also excited about a new concept we showed that incorporates sensing and display technology into furniture and work tools to better support users.

I want to recognize our folks at Designtex, who received two awards for health-care-related products; and our own James Ludwig, who is Vice President of Global Design and Product Engineering, as he was personally honored with a HIP award in the category of Creative Director. I love that our people are being recognized by their peers for their innovative work.

Shifting now to the overall US economy, the GDP data shows the first quarter was challenging because of weather and other factors. Certainly, sectors like energy and financial services were facing their own secular head winds, and in a survey of large-company CEOs by the Business Roundtable, it noted a decline in capital investment expectations. Our analysis of BIFMA data and our own order patterns suggests demand from mid-market customers may have grown faster than from the larger customers.

On the other hand, the recent progress on TPA legislation should increase confidence among business leaders that important trade agreements will also pass later in the year. BIFMA data shows the furniture industry is growing faster than the overall economy.

At Steelcase, our 8% order growth in the first quart and our project pipeline leads us to expect we will grow faster than the estimates for the overall economy. Overall, we're feeling good about how our Americas business is developing for the rest of this year.

As for the European economy, questions remain of course about Greece and the impact of Russian sanctions. Our business in eastern Europe has been affected by the political turmoil, and our Middle East business is softer because of lower oil prices. However, we are also seeing signs of strength in export markets in western Europe, and our order patterns in many of those countries are reflecting that strength.

Further, we expect to begin seeing the economic benefits of our manufacturing restructuring work in the second half of our fiscal year. Overall, strong first quarter with the momentum carrying into our outlook for Q2.

Thank you for joining our call today, and I will turn it over now to Dave Sylvester.

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

Overall, as Jim said, we feel good about our first-quarter results, which reflected 3% organic revenue growth, and $0.17 of adjusted earnings per share, both of which were within the estimated ranges we provided last quarter. First-quarter order growth of 8% in the Americas was stronger than expected, out-pacing organic revenue growth in the first quarter.

As a result, backlog at the end of the quarter was up 15% over the prior year. Orders continued to include a significant amount of project business with requested delivery dates more than 90 days from the order date, similar to the previous quarter.

In the fourth quarter, a few specific customers drove most of the extended backlog, therefore we concluded it was somewhat of an anomaly, and did not entirely project the same trend in our first-quarter revenue estimate. However, in the first quarter we received additional orders from one of the same customers, along with orders from a couple of other customers with extended delivery dates into the third quarter or later. As a result, the Americas organic revenue growth of 3% in the first quarter was a little lower than expected.

Revenue in the other category was also a little short of our internal estimates, driven by timing of project deliveries at PolyVision, and a soft patch at Designtex in February and March. For EMEA, we posted 1% organic revenue growth in the first quarter, compared to an estimated modest decline.

Adjusted earnings of $0.17 per share was better than expected, and was driven by lower than expected operating expenses, which more than offset the modest shortfall in organic revenue growth. Gross margins were largely consistent with our expectations, and a favorable effective income tax rate helped to offset some unfavorable non-operating items.

Shifting to year-over-year comparisons, our first-quarter adjusted operating income of $35.4 million was approximately $9 million better than last year, driving most of the $0.05 improvement in year-over-year adjusted earnings per share. The improvement was driven by the Americas segment, which posted an adjusted operating margin of 10%, representing a 180-basis-point improvement over the prior year, largely driven by lower cost of sales.

You will recall that prior-year cost of sales in the Americas was impacted by relatively high warranty, freight, distribution, and overhead costs. Throughout last year, we reported on our progress to reduce costs and increase operational efficiencies, which continued into the first quarter, and drove a big part of the improvement in year-over-year cost of sales.

Beyond these items, we also experienced year-over-year benefits from improved pricing and continuous cost-reduction efforts; but these were largely offset by an unfavorable shift in business mix, which reflected a higher percentage of project business, and revenue from products with lower than average gross margins.

Elsewhere, we reported improved profitability in the other category, driven by Asia Pacific; and lower corporate costs, largely due to lower deferred compensation expense. But these improvements were offset by a larger adjusted operating loss in EMEA, which was mostly associated with disruption from the manufacturing footprint changes that we expect to complete later this fiscal year.

Beyond adjusted operating income, our effective tax rate of 36.5% in the current quarter was approximately 500 basis points lower than the prior year, which more than offset lower other income net, due to higher foreign exchange losses and lower equity and income of unconsolidated ventures. More on the effective tax rate in a minute.

Sequentially, first-quarter adjusted operating income decreased by approximately $8 million compared to the fourth quarter. The impacts of seasonally lower volume and the unfavorable shifts in business mix I mentioned earlier were reduced in part by lower operating expenses.

Switching to restructuring costs, in total they were a little better than expected in the quarter, as move costs associated with the exit of the French facility are coming in a little better than expected. The net restructuring credit in the Americas was driven by a $3-million gain associated with the sale of our former research and development center in western Michigan.

The effective income tax rate of 36.5% reflects the impact of implementing the new transfer pricing model in EMEA during the fourth quarter of last year. As I said last quarter, the transfer pricing changes in EMEA were driven by how we are now running Steelcase as more of a globally integrated enterprise, versus a regionally independent organization.

For tax purposes, this means that our US parent Company has become the principal in a contract manufacturing model between the US and the European legal entities. Therefore the US legal entity bears all residual economic benefits and costs associated with the model.

The mechanics of this model result in substantially all EMEA manufacturing costs being billed to the US at cost plus an appropriate mark-up, and the US charging the distribution entities in EMEA an appropriate product cost to allow for customary levels of profitability as distributors. While these changes do not impact our segment reporting or operating results, they do have a favorable impact on our effective tax rate from the utilization of our net operating loss carry-forwards in EMEA, which were completely reserved in prior years.

Moving to the balance sheet and cash flow. Cash used in operating activities in the current quarter included the payment of employee compensation liabilities related to prior-year variable compensation and retirement plan contributions, similar to the first quarter of the prior year. In addition, the current quarter included approximately $26 million of proceeds from the settlement of foreign exchange forward contracts, compared to approximately $3 million of payments to settle similar contracts in the prior year. Beyond these items, operating cash flows in the current quarter also reflect improved operating results compared to the prior year.

Capital expenditures totaled $24 million in the first quarter, including $10 million of additional payments related to a replacement corporate aircraft. We continue to estimate capital expenditures for the full year will approximate $100 million, which is higher than our normal targeted level of approximately 2.5% of sales, primarily due to payments related to the replacement aircraft.

We returned approximately $27 million to shareholders in the first quarter, $15 million through the payment of a cash dividend of $0.1125 per share, and $12 million through repurchasing approximately 600,000 shares, the majority of which represented shares forfeited by participants to cover tax withholding for equity awards that vested in March.

Turning to order patterns, I will start with the Americas, where our orders in the first quarter grew approximately 8% compared to the prior year. As I said earlier, order patterns in the Americas continued to reflect a high mix of project business with extended delivery dates. As a result, customer order backlog for the Americas ended the quarter up approximately 15% compared to the prior year, with a large portion of the growth driven by orders which requested delivery dates in the third quarter or later.

Across quote types, for the first time in several quarters, order growth in the Americas reflected growth from all business types, product, continuing, and marketing programs, suggesting the cyclical recovery may be strengthening. Project activity continues to drive the order growth, with small- to medium-size projects leading the growth for the third time in the last four quarters.

We experienced a double digit percentage increase in orders related to project business, and a mid-to-high single-digit percentage increase in orders from continuing agreements, while orders related to our marketing programs aimed at smaller day-to-day business increased by a few percentage points. Project orders as a percentage of total orders in the Americas remained high, reaching 48% this quarter versus 46% in the prior year, which compares to our longer-term historical average of approximately 40%.

Across vertical markets in the Americas, orders grew in the federal government, insurance, financial services, technical professional, state and local government, and manufacturing sectors, while information technology and health care declined modestly against the prior year. Orders from the energy sector grew modestly in the first quarter, following a significant decline in the previous quarter.

We expect this sector to be challenged for the foreseeable future while oil prices remain depressed. Most energy sector construction projects that were well under way are being completed, but many future projects have been postponed, and continuing business has slowed considerably.

Switching to EMEA, orders in constant currency grew by approximately 1% in total compared to the prior year, which included approximately $7 million of orders related to the large government project in France, which we have mentioned on previous calls. Excluding that impact, orders were up nearly 7%. We experienced solid order growth in Iberia and the United Kingdom, while France grew by a low-to-mid-single-digit percentage, adjusted for the large government project in the prior year, and Germany was relatively flat.

Elsewhere, our orders were down modestly in total, with order growth in the Middle East and central Europe being more than offset by declines in eastern Europe and the Benelux region. Customer order backlog for EMEA ended the quarter down a double-digit percentage compared to the prior year, driven by orders related to the large government project in France I just mentioned. Otherwise, remaining EMEA backlog was nearly flat with the prior year.

Within the other category, order growth was strongest in Asia Pacific, but Designtex and PolyVision also grew orders, resulting in total order growth of approximately 10% for the group. Order growth in Asia Pacific approximated 13%, and was led by strength in India and China.

To summarize, our order patterns in the Americas continued to reflect solid growth, driven by small- to mid-size projects again this quarter. EMEA order patterns remain mixed, but we continue to believe we have seen the bottom of the recession in western Europe.

Asia Pacific orders grew nicely this quarter, so we have now seen growth in year-over-year orders in this business for three of the last four quarters. We did see a soft patch in Designtex orders early in quarter, but they have rebounded nicely since then, and we continue to believe our growth strategies are gaining traction. Finally, PolyVision remains solid.

Turning to the second quarter of FY16, factoring out an estimated $30 million of unfavorable currency translation effects, and the impact of a small dealer acquisition net of a couple small divestitures, we expect to report organic revenue growth between 3% and 6% compared to the prior year. Sequentially, the second-quarter revenue estimate represents organic growth of between 10% and 14%, which is better than our typical seasonality, but expected given the higher levels of backlog.

We expect approximately $6 million of disruption and inefficiencies in the second quarter associated with the changes in our manufacturing footprint in EMEA. This compares to approximately $9 million in the second quarter of FY15, and $6 million in the first quarter of the current year.

In addition, we expect operating expenses to increase sequentially in the second quarter compared to the first quarter. As a result of these factors, we expect to report second quarter earnings within a range of $0.27 to $0.31 per share, including restructuring costs of approximately $0.03 per share, which translates to an adjusted earnings range of $0.30 to $0.34 per share.

From there, we will turn it over for questions.

Thank you.

(Operator Instructions)

Our first question comes from the line of Budd Bugatch with Raymond James.

Thank you. My first question is for you to just define for many of us the difference between the business types of project, continuing, and marketing programs, particularly with the difference between continuing and marketing programs?

Yes, I'll do that Bud. Project and continuing business are typically off a contract that's negotiated with a customer, and typically a continuing agreement is put in place when a project is won. Typically, projects come about when a customer is thinking about a relatively large-scale installation, and they would competitively bid that. Whoever wins it typically would put in a continuing agreement at the same time. Historically, that business has represented in total about 80% of our orders in revenue, split 50/50 -- half project, half continuing -- or 40% and 40%.

Then the marketing programs are really geared for customers that don't have an existing agreement, but allows them access to various discount tiers. That's typically business aimed at smaller day-to-day business. That tends to make up historically about 20% of the business.

Okay, that's helpful for a bunch of people that ask that question to me. Secondly, on the discussion about the change in organization of EMEA, I take it that's primarily tax-driven strategy to try to recoup some of the operating losses that have piled up in EMEA. Is that correct?

Yes, it is. I would tell you while it may be initiated as a strategy, what we quickly learned is that really the way we're running the Company, we need to make that change. It's less of a strategic shift or a strategic change where we're trying to stretch to reach a tax objective. It's more about how we're running the Company, meaning decisions are more centralized out of the US as it relates to product development and the like. Therefore we're organizing around that principal from a tax perspective.

Okay. To the business - I apologize, I'm going to ask a third question. Thread and Brody were I thought well received at NeoCon. What's the estimate for this year, or what's the plan for that in terms of shipping? Will it have a significant impact on revenues for this year?

Budd, it's Jim. I'd say for this year Brody and Thread will not be material to our results, so it won't be something that will show up at that level; but we are very excited about the reaction we've gotten. Really, both products were initially developed to serve a particular part of the market, which was the education vertical. What we discovered during our development and our testing with customers is that the application of it is much broader than that. Now I believe there's applications for it in the corporate sector, as well, as health and so on. We are updating our estimates, and we are updating our capacity to make sure we're going to be able to meet demand. But I don't think it will be material this year.

We are shipping Thread currently, and Brody we'll begin to ship in the second quarter.

Okay, thank you very much. Good luck for the balance of the year.

Thanks Budd.

Thank you. Our next question comes from the line of Josh Borstein with Longbow Research.

Hi, good morning, everyone. Just regarding EMEA, you guys have done a number of things to turn the business around. Are there any opportunities worth looking at to outsource some of your production and accelerate that turn-around at all?

Well I'll make one comment, and maybe Jim you can pile on; but we have, at least in the short-term, we have outsourced production to a third party. Remember the transfer of the French plant to a third party puts production in their hands for a period of time while we transition it to another Steelcase facility. But I would also tell you, too, that our supply chain certainly takes advantage of third-party suppliers in eastern Europe to the extent it makes sense. We will continue to look at opportunities to do that more in the longer term. It's enabled by us being more on global platform that gives us higher numbers of common parts; therefore we have interesting, or more interesting levels of volume for third-party suppliers to consider.

Yes, and I'll build on that. All three regions -- Americas, EMEA and APAC -- use third-party manufacturers for finished goods sometimes, and sometimes for components. I don't see it as being a significant change in the utilization of that. Europe has been using it appropriately, and they use it for certain product categories. In the Americas, we went through a shift towards outsourcing for a while. This is going back maybe ten years now. While we are in the transition from the very vertically integrated model to the model we have today, interestingly and now that we've reached higher levels of efficiency in our Americas footprint, we've been able to in-source some of the things that we had previously outsourced.

In EMEA we're putting that model together from the start, so the shift in capacity utilization towards Spain and the shift to our Czech Republic plant will help us reach similar -- a similar kind of structure. That's really the way we're thinking about it. How do we make sure we get the right cost of production through yes the use of third parties, but also the use of our own fit model.

Great, thanks. Just one more, Dave, for you. Your comment in the press release that the cyclical recovery may be strengthening, the language was a little stronger than I've seen you use in the past. Could you elaborate a little bit on that comment what exactly you're seeing to make you give such a comment?

Well, it's been six or seven quarters since we had seen project business, continuing business, and marketing all grow at the same time. It seemed like for a number of quarters we had two out of three or one out of three that were growing, but not all three.

We've also been paying attention to the BIFMA data more recently that has shown that some of the more recent up-tick in order growth across the industry has been driven by smaller companies that report to BIFMA. If you double and triple click on some of the data, what you see is that the companies that are in the $25 million to $50 million of revenue size are the ones that are leading the growth. That suggests to us that it's possible that demand is coming from smaller company. With small companies starting to come into the recovery, its potential that we could be seeing an acceleration of the cyclical recovery. But I very intentionally use the word "may" in my quote because we don't really know; but we like what we're seeing.

Great, I appreciate it. Thanks for the color. I'll defer to others.

Thanks, Josh.

Thank you. Our next question comes from the line of Matt McCall with BB&T Capital Markets.

Thanks, good morning guys.

Good morning.

Maybe -- you talked about the cyclical recovery, Dave, in the US. I think there was some constructive commentary about Europe -- I think western Europe, specifically. Can you give us an update there as we think about that business maybe moving toward break-even and profitability? I know you've talked about some pretty healthy incrementals in the past. What kind of growth and what kind of incremental commentary can you give us as we start to think about how to model that moving forward?

Sure. I'll start with the top line. The order growth that we saw in the quarter I commented overall was 1%, but it was against the tough prior-year comp that had the large French government project that totaled $7 million of orders. When you exclude that, the rest of orders were up 7%. When you double-click on the 7%, the way it plays out is western Europe grew in the neighborhood of 5%, and then eastern, central, southern parts of Europe, Middle East, and Africa -- kind of everything else -- grew at a double-digit percentage.

What we feel really good about is the western European growth. I feel great about the double-digit growth in the rest of the market as well, but when we dive into that a little deeper, what drove that in the quarter was some strength in the Middle East, which we think has some risk to sustain that level of growth as we move into the balance of the year because of where oil prices currently reside. When we look across western Europe and we see growth in the UK, growth in Spain, growth in France excluding the large government project, and a relatively flat environment in Germany, that feels like it's confirming what we've been talking about for really more than a year -- that Europe has moved from a flat to down environment to a flat to up environment -- that feels pretty good.

On the profitability, you know from the webcast slide that we've included for the last couple of quarters that we expect or project disruption costs to continue to come down, and savings to -- from the manufacturing footprint changes to start to feather in more significantly in the back half of the year. In fact, last year, when we were reporting our third- and fourth-quarter results, a lot of you were doing pro forma math, where you were saying okay if I take your reported results excluding restructuring and I assume that a year from now that you'll have eliminated disruption costs and begin to see some savings, this business could be at break-even or maybe even better operating results if revenue is relatively flat.

We were doing the same math and we're still doing the same math. There's a lot that has to play out. We have to finish the manufacturing footprint changes. We track them closely. The teams are working really hard, making great progress, but it's very hard work. It's work that even though we've done in other parts of the world, we haven't done it in Europe in several years, so we're proceeding cautiously. But if you play it out, if we are able to achieve less disruption and beginning of savings, and revenue stays relatively flat or better with prior year, we should see some more significant incremental year-over-year improvement in our results, starting in the back half of the year.

Okay. All right, thank you. The other segment for a second, profitability. It looks like you've been stuck in that $5-million plus or minus EBIT range for three years now. Obviously some moving parts have -- I think you've gotten there different ways. But how do we think about that business, given some of the improvements in some of the businesses once they've been set?

Yes. Well, remember the other category includes three separate businesses -- Designtex, PolyVision and the Asia Pacific business for us. What has been going on for the last I'd say year to year and a half, maybe two years, is that our Asia Pacific growth had leveled off. That has since come back, where we are seeing growth in orders for three out of the last four quarters. With the lull in demand we had been experiencing we saw profitability was stressed, and we moved from a closer to break-even level of performance in Asia as we're investing for the long term, to losing a bit of money.

Designtex, we have been intentionally investing behind Susan Lyons and the team to drive growth and get that business back where we think it belongs. Those investments stress profitability in the short term, but are expected to pay dividends through top-line growth over the near term and mid-term go forward. What we're seeing is with Asia growth, we're seeing their profitability or their results improve, so their loss was less this year than it was last year. We're starting to see improvements in our expectations around Designtex, as well.

Is the target there, Dave, similar to what you targeted in EMEA -- maybe that mid-single-digit range over the next couple few years?

Yes, we don't have an official target for that segment, because again it's three separate businesses. But we don't -- we're not intentionally -- we're targeting closer to break-even results in Asia Pacific because we're investing for the long term. Any kind of revenue growth as we get back toward break-even we consider plowing back into investment in that business. PolyVision is a very strong double-digit operating income margin business. We feel very good about them sustaining that level of profitability, at least for the foreseeable future. Designtex is starting to show promise in the top line that should translate to improved profitability in the bottom line.

How that all mixes out really depends on the quarter, right? Next quarter is a very strong seasonal quarter for us in the PolyVision business, so we'll see the benefit of that. But then their business tends to fall off a bit or lag back to a level like we saw this quarter they'll see in Q3 and Q4. There's a lot of moving pieces, but what we look for in the other category in total is they should be improving over prior year. Yes, something netting in that mid-single-digit operating income percentage feels like a reasonable objective.

Okay, all right. I'm going to sneak one more in, I apologize. We got cut off from the call, so if this was asked I'm sorry. Some talk about discounting pressures, heightened discounting pressures in this space. Can you talk about pricing discounting, what you've seen, and what you're expecting for the balance of your fiscal year?

Yes, this is Jim. I'll take that one. The industry is always competitive, and in the Americas that's always been true. As long as I've been in these various roles we've talked about that. There's some great manufacturers out there and we compete. I don't really feel it as being any different today than it ever was. There's some sabre-rattling perhaps, but if you actually think about the -- if you look at what's actually happening in the market place we haven't seen evidence of that.

At Steelcase we're always adjusting, making adjustments of where the market is and where we feel our products need to be priced. You make those adjustments category by category or market by market, and we continue to do that. I would call it business as usual from that perspective, except it isn't like we hold everything steady. The idea is that we're always reacting and always adapting.

We have been very aggressive in gaining share, but you'll notice that in the Americas our gross margins have improved. We gain share the old-fashioned way, by getting customers who want to buy our products, by creating new products, by developing great relationships with products, and not trying to do it just by dropping price, et cetera -- in part, because I don't think it works. We've seen before you win because you've got the right products, and you've got the right relationships. When you lose, you might be told you lost because of price. But really, you lost because you didn't have the right relationships and the right products. That is our philosophy on this.

There's also, as Dave mentioned, the idea of price competition probably becomes more acute when you have some very large projects that are defining the market place. That was maybe more true a couple years ago than it is today. Today it's much more broadly balanced between projects continuing, smaller business. The idea that you're going to go out and try to change your market share dramatically by being very aggressive on a project or two doesn't work as well when there aren't that many projects out there.

Overall, we're feeling as though we're doing the right thing. We've been demonstrating the ability to continue to build our business and grow our share, improve our gross margins at the same time, and really focus on innovation and great selling. I was with our sales organization yesterday, a big piece of our Americas sales organization. I'm just so delighted with the strength of those people. The new people who have joined the sales organization are outstanding, and they are very excited about their ability to compete today.

Perfect. Very helpful. Thank you, Jim.

Thank you. Our next question comes from the line of Catherine Thompson with Thompson Research Group.

Thanks for taking my questions today. First is the focus on the Americas segment. Could you give a little bit more color on the drivers for the margin growth? In other words, if you think about broad buckets of volume, price, mix, or other one-times, as you alluded to earlier, that impacted margins in the year-ago quarter, part of it was trying to understand how much is a one-time versus just pure operational improvement or sales mix improvement?

Yes, so Catherine, I'll do a little bit of this based on memory, and then maybe we might have to do a follow-up and dig back into last year a little bit. Last year we actually reported on more anomalies at the time, we thought. I think if I reflect on warranty, as an example, we had seen it trending down and it shot back up on us -- our claims experience, and therefore we had to increase our overall reserve in the quarter. We were conscious of that. We had a few issues going on, but they were resolving themselves, and we weren't quite sure that that was a new sustained trend, and it turned out that it wasn't.

We also had some overhead spend that was linked to a number of things, including the fact that we had a relatively significant disruption in our Athens, Alabama, plant, where a strong tornado had gone through the area -- not necessarily impacting the facility itself, but it impacted a number of our employees who lost homes. Therefore we were running an inefficient operation for a while, as they were taking the time necessary to get themselves back where they needed to be.

We also had relatively high freight and distribution costs, in part because of carrier inflation, but also because of inefficiencies that we were seeing in that part of the business. Since then, the team has done an absolute terrific job driving sustainable improvements in our regional distribution centers, bringing many of them on board back under Steelcase. This is an area that had been out-sourced to a third party, and we were finding it difficult to maintain top talent and the degrees of care that it sometimes requires in handling our product, with the level of turnover we were seeing with employees.

We've since brought many of those back under Steelcase and improved -- made a significant number of improvements in freight and distribution. Most of it I believe is sustainable. The level of pricing improvement that we had year over year was notable, but it wasn't the single largest driver. As you can imagine, price increases are not the easiest things to be pushing through at the moment, because commodity cost inflation is relatively low, if not deflation at the moment. Does that help?

Thank you. That does help. You also made some -- alluded to the energy end market. If the energy end market is less clear on a go-forward basis, what potential impact could this have on orders on a go-forward basis? Tagging along with that, to the best of your ability can you quantify what percentage of the energy end market has been of orders and backlog over this past 12 months versus the historical average?

Those are all fair questions. I will -- give me a second. I'm going back to -- it's in our investor presentation, isn't it, Raj? In our investor presentation, back in the appendix, we provide some insight into our vertical market, our largest vertical markets. Energy is actually not in the top five. It's an important vertical market, but it's not one of our top five. The largest vertical market that we report on does not exceed 13% of the Americas revenue. I think that's the number we disclose in the appendix of the investor presentation. By deduction, I think you can conclude that okay, we'll feel it, but we shouldn't feel it in a significant way, unless it were to go to zero. I don't think any of us believe it's going to go to zero.

That was the driver for the question. Thank you.

Yes.

(Operator Instructions)

Our next question comes from the line of Peter van Roden with Spitfire Capital.

Hi, guys.

Hi, Peter.

A couple questions on Europe. The first one is in the slide deck that you just posted. I didn't see any restructuring costs for the new learning center in there. When do you expect to have a better view on when those will hit, and what they will be?

Well, we provided a high-level estimate of what we thought those could be in our 8-K that we filed in March, middle of March. We will update our estimates and provide a little bit more precision around maybe some quarterly detail once the negotiations are complete with the related workers councils in Europe.

Got it. Then in Europe in terms of revenue growth for the year, my question is you had the large French government project that shipped last year. Given that, do you expect to be able to grow revenue organically this year, even including that impact?

Well, if you went back to last quarter's call when I gave some high-level color on the full year and I talked about Europe, I did reference the fact that we had -- did have that relatively large project that we were going to be comparing against in the current year. We do also have some geopolitical concerns in certain parts of Eastern Europe and then the Middle East, as well. The price of oil will also compound some of the impacts in the Middle East. Our comment was that our organic growth in Europe could be challenged for the full fiscal year. We really stopped short of projecting whether or not we thought we would be on the plus or minus side of growth or decline.

Do the order patterns that you saw this quarter change that view at all?

No, it was positive, but it's been so choppy in Europe. If you went back and charted the organic revenue growth that we've been talking about, or the organic order growth that we've been referencing in each of the analyst calls over the last several quarters, it's up a quarter, it's down a quarter, it's closer to flat, it's nicely strong. It moves around enough that we're pretty cautious about providing a longer-term projection.

Got it. Then I'm going to try it one more way. Have you ever disclosed how much revenue was from the French government projects?

Well I did in my remarks. I mentioned that there was $7 million of orders in the first quarter of last year associated with that large project. If you adjust for that, the orders were otherwise up 7%.

Got it. All right, thanks guys.

Okay.

Thank you. Our next question comes from the line of Davis Paddock with Invesco.

Thanks. I may have missed it, but what were the disruption costs in Q1? How much were they?

$6 million.

You mentioned there was $6 million in Q2. Qualitatively, when do we expect that to start tailing down fairly significantly from this $6-million range a quarter?

Well, it is tailing down. We had $9 million in Q2 and Q3 of last year, then $7 million in Q4, $6 million in Q1 and Q2. Then in our webcast slide we project that in Q3 and Q4 it will move down to $3 million and $1 million.

Got it.

It's really in the back half of the year where it starts -- we expect it to start to reduce closer to nothing.

Okay. Then a couple quarters ago, you had mentioned that you're looking forward to the second half of this year to being profitable in Europe. Is that still something you're expecting?

Yes, well what we've done is we've had a dialogue about that; but we've never come out and said that we expected it to be profitable. What we've said is if you took last year and you assumed we were able to eliminate the disruption and begin to see the savings come in, and revenue and the rest of the business stayed relatively flat, that you could mathematically get to a break-even or better operating result. That's the math we've done.

We're certainly targeting to minimize the disruption by the end of the fiscal year and to begin to see the savings come in. We're targeting to at least have flat revenue, maybe potentially see some organic revenue growth. But it is still a pretty unpredictable top-line environment in Europe, so we've stopped short of giving any kind of specific projection around what we think our operating income will be or not be in the back half of the year.

Thank you.

Thank you. I'm showing no further questions at this time. I would now like to turn the call back over to Jim Keane for closing remarks.

Again, thank you all for joining the call. We appreciate your interest in Steelcase. To summarize again, we think we had a good first quarter, and we think we have good momentum building in the second half, and are pleased by some of the things we're seeing in the overall US economy, which is an important part of our business. Again, thank you for joining the call, and we'll talk to you next time.

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