Steelcase Inc (SCS) 2016 Q3 法說會逐字稿

Good day, everyone, and welcome to Steelcase third-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 call over to Mr. Raj Mehan, Director of Investor Relations, Financial Planning, and Analysis and Assistant Treasurer.

Please go ahead.

Thank you, Ashley.

Good morning, everyone.

Thank you for joining us for the recap of our third-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 third-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 this 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'll respond to questions from investors and analysts.

Now, I'd like to turn the call over to our President and Chief Executive Officer, Jim Keane.

Thank you, Raj, and good morning, everyone.

Our third-quarter results included another year-over-year improvement in net income and operating income.

Our Asia-Pacific region delivered record performance for the quarter, despite a challenging economy in many of those countries.

Still, we know we could have done better as a Company.

Our results in both EMEA and the Americas were lower than we were expecting, and we will discuss that in detail this morning as well as the actions we are taking to improve performance.

Let's start with EMEA.

You know we're in the midst of reinvesting our business model, from consolidating our manufacturing footprint to redesigning our sales deployment.

We're also continuing to launch new products.

These initiatives, along with some help from stronger Western European economies, helped us grow orders organically by approximately 20% in the quarter.

Demand was very strong for the new products during the quarter, and we extended lead times for these products while we work to add supply chain capacity.

In fact, it's possible orders would have been higher still if we had not been capacity constrained.

Last quarter, we talked about emerging issues we were facing as we ramped up production in our new factory in the Czech Republic.

At the time of that call, we were over the hump and had cleared a large part of finished goods inventory that had backed up in our Rosenheim distribution facility.

We continued to improve our performance in both Stribro and Rosenheim during the quarter, and our Teams did a good job following up with dealers and completing all the disrupted orders.

Unfortunately, the actual cost of addressing these issues was much higher than what we included in our estimates for the third quarter.

For example, we ended up reimbursing some dealers for out-of-pocket costs they incurred because of late and split shipments.

It was the right thing to do, but we should have anticipated that better in our estimates.

We also made some design specification errors on large special orders that led to higher rework costs.

These are totally unrelated to the restructuring work and show we have plenty of opportunities to improve our performance.

Finally, we saw a reduction in revenue in the Middle East, where many of our customers are directly affected by declining oil prices.

At the same time, we saw growth in demand in Western Europe, where margins have historically been lower.

The resulting mix shift put downward pressure on our overall EMEA gross margins.

That's the brief analysis of what happened in EMEA.

Now I'll talk about what's next.

Today, the final production lines are being installed in Stribro and will be ramping up in the coming weeks.

Once complete, we will have more capacity than we had before.

We have added capacity through the supply chain to support the new products.

We will be working to continue the learning curve to reach higher levels of production efficiency.

Our operations leaders have captured the learnings from the issues we experienced earlier this year and are implementing corrective actions for the future.

We're also taking steps to improve our EMEA gross margins through new products and be better yield management.

I'm working with some our Senior Executives to rethink our marketing mix to improve our gross margins across the region.

This also mirrors work we did in the Americas many years ago that helped us reshape our offering and improve long-term margins.

The fourth quarter will be important for getting all the new lines up and running consistently and reducing our lead times to more normal levels.

In FY17, we expect to shift our energies towards continuous improvement of quality, reliability, and cost efficiency, begin the journey of capturing the benefits of the new footprint.

And we also expect to continue to build deeper relationships with customers and continue to lead with innovative new products that are relevant to their needs.

Our Munich Learning + Innovation Centre is under construction and expected to open in the second half of the fiscal year, an important moment as we end this period of restructuring and begin a new era of continuous improvement of our competitiveness in EMEA.

In the Americas, we are dealing with two issues.

First, business capital spending growth is slowing, and our industry's growth is also slowing.

Second, Steelcase is growing more slowly than the industry because of our customer mix and some product gaps we are working to address.

I'm not going to talk much about the broader economy since you all watch the economic news as closely as we do.

As you know, BIFMA has reported a marked deceleration in order growth, from 10% early in the year to 3% growth over the last several months.

Our orders grew faster than the industry in September, but by November, we were actually seeing year-over-year declines.

It's not across the board.

In the past when the economy has slowed, we've seen the largest customers are often the first to cut back, and that's what we're seeing this quarter.

We didn't see the end-of-calendar-year order surge we often see from some of our larger accounts.

We've seen a reduction in large projects, both in terms of what we booked, but also as we look into the pipeline of future opportunities.

We also see less of our overall business coming from our larger customers than in the past, and orders from our larger customers were down in the quarter.

As we've discussed before, we probably have more of our business from large customers than the overall industry, so we are probably feeling the effect of the slowing economy a little earlier than others might.

And in fact, our mid-size project orders continue to grow at or above overall industry growth rates.

Our Turnstone brand, which is aimed at this segment, had very good growth in the quarter, and while some regions of the country are facing challenges, certainly the oil regions like South Texas and Western Canada, there are other regions where our dealers continue to see strengthening demand and a robust pipeline.

As I mentioned earlier, we are working to address some product gaps that have emerged as customers adapt to increased mobile work, more shared spaces, and a shift towards collaboration.

These shifts have broadened customer demand across a wider range of products.

For example, while we still see good demand for premium task chairs, we are seeing stronger demand for mid-market task chairs where our offering has not been as complete.

Many customers are still driving demand for higher performance desks and benches, including a wider range of height adjustability options and work tools, while other customers are looking for simpler solutions, where again we're not as strong as we could be.

There are other trends related to aesthetics, including increased interest in blending residential furniture into informal settings in the workplace, and these products are often provided by a wide range of manufacturers outside our traditional industry.

We've lost a few projects because of these gaps, but that's not the main issue.

It's more likely that we're not capturing as much of the projects we win and that we're losing some day-to-day business to smaller manufacturers.

And this hypothesis is supported by BIFMA data that shows smaller manufacturers growing more quickly than the traditional majors.

We saw these trends developing earlier this year, and we responded quickly by accelerating some existing product development projects and initiating new projects to address our gaps.

The first of these projects launched in the US market this month, with more coming they January and throughout the first half of FY17.

In fact, we expect to have 12 new furniture products launching between now and next summer.

A few additional products requiring longer development cycles are expected to launch in the next 18 months, which is very fast for those particular types of products.

While it's a little too early to talk about NeoCon, you can expect additional product launches in 2016 aimed at helping Steelcase and its dealers hit a variety of price points.

Meanwhile, some of the products in our portfolio which are outside of BIFMA reporting, like architectural solutions, the no chair, technology products like RoomWizard and Thread for electrical power distribution, are growing faster than our larger product categories.

Before I turn it over to Dave, I want to highlight again our performance this quarter in Asia-Pacific, which, as you know, rolls up in the other category of our results.

In terms of revenue and profitability, this was a record quarter for Uli Gwinner and our Team in Asia, with strength throughout most of the countries that make up this region.

With that, I'll turn it over to Dave.

Thank you, Jim.

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

Overall, as Jim said, we are disappointed in our third-quarter results, which reflected 1% organic revenue growth and $0.30 of adjusted earnings per share, both of which were lower than the estimated ranges we provided last quarter.

Our results fell outside of our expected ranges for the following reasons.

Organic revenue growth of 3% in the Americas was approximately half of what we expected, and two things drove most of the shortfall.

First, solid order growth in the first half of the quarter included a couple of large orders with requests for December delivery dates.

Second, orders in the second half of the quarter softened compared to the prior year, reflecting an apparent pullback in business from our corporate customers as we did not receive the same level of year-end business we have experienced in the past couple of years.

We don't know the motive of each customer purchasing decision at the end of the year, but we suspect that some of the recent economic uncertainty may have contributed to the pullback.

The organic revenue decline of 8% in EMEA was also a little higher than we had forecasted, despite organic order growth of approximately 20%, which was better than expected and broad-based.

We have had great success with some of our new product launches in EMEA where demand has exceeded the levels that our supply chains were initially configured to support.

In addition, capacity related to some of our offerings has been impacted by equipment moves related to our manufacturing footprint changes.

This has led to extended lead times for these products, resulting in fewer orders in the third quarter being converted to revenue in the same quarter.

As a result, we are expanding capacity for new products and expect capacity to increase related to the other offerings once the equipment moves are completed.

It is also important to keep in mind that the organic revenue decline in EMEA in the current quarter compares to 14% organic growth in the prior year, which was primarily driven by a number of project orders received in the first half of last year for which revenue was recognized in the third and fourth quarters.

Within the other category, revenue growth in Asia-Pacific exceeded our internal estimates, but softness at Designtex and PolyVision more than offset the gains.

As it relates to adjusted earnings, $0.30 per share fell short of our estimated range, primarily due to adjusted operating losses in EMEA, which were significantly higher than we anticipated.

As we said in the earnings release, there were three primary factors.

First, we incurred approximately $4 million of additional costs as we worked through the manufacturing and distribution issues in EMEA which arose in the second quarter, and reimbursed our dealers for any related impacts and provided incentives to sustain their loyalty.

Second, we estimate unfavorable shifts in business mix reduced gross margins by more than 200 basis points of revenue, or approximately $3 million, compared to our forecast.

These shifts include higher sales of vended products and lower day-to-day business in markets which were more significantly impacted by the manufacturing and distribution issues.

In addition, we have experienced a decrease in the mix of business from certain export markets that have historically generated higher-than-average gross margins in EMEA.

Third, operating expenses included approximately $3 million related to unforecasted severance costs and other items.

We believe approximately $2 million of such costs are nonrecurring.

These items increased our adjusted operating loss by approximately $10 million.

We also experienced approximately $5 million of disruption costs and inefficiencies associated with our manufacturing footprint changes in EMEA, which are nearing completion.

We have a lot of work ahead of us, but we believe many of these issues will be resolved in the coming quarters, and we are confident in our sales strategies, which are gaining more and more traction each quarter.

Elsewhere, adjusted operating results were significantly better than expected in Asia-Pacific, which benefited from strong sales growth, improved gross margins, and lower operating expenses, but these gains were offset by the impact of lower-than-expected revenue in the Americas.

Switching to year-over-year comparisons, our third-quarter adjusted operating income of $58 million improved by approximately $2 million over last year and reflected improvements of $8 million in the Americas and $4 million in the other category, offset by a $9 million increase in the adjusted operating loss in EMEA and slightly higher corporate costs.

The year-over-year improvement in the Americas was driven by revenue growth and lower cost of sales as a percentage of revenue, which reflected lower material and freight costs and improvements in negotiated customer pricing, partially offset by other cost increases, including higher variable compensation.

Asia-Pacific led the year-over-year improvement in the other category, posting record levels of quarterly revenue and operating income.

Organic growth for Asia-Pacific was broad-based across most geographies.

Their gross margins expanded from favorable currency impacts and business mix, and their operating expenses benefited from cost containment efforts launched earlier in the year.

Year-over-year adjusted operating results for EMEA were impacted by the organic revenue decline compared to a strong prior year, and increases in cost of sales and operating expense as a percentage of revenue driven by many of the same factors I just mentioned.

We expect to complete the exit of the Durlangen facility in the fourth quarter, but because disruption costs and inefficiencies were more significant and extended somewhat longer than initially projected, we expect full realization of the expected savings to be delayed by a few quarters.

In addition, we expect it will take us another quarter or two to stabilize our manufacturing and distribution performance in the new footprint and ramp up our supply chains for certain new products and other offerings, experiencing higher-than-expected demand levels.

Sequentially, third-quarter adjusted operating income was lower compared to the second quarter, primarily driven by lower volume in the Americas and higher operating expenses across most of our segments.

Beyond the operating results, our effective tax rate of approximately 35% in the current quarter continues to reflect the new tax structure implemented during the fourth quarter of FY15.

For the fourth quarter, we expect to record an effective tax rate of approximately 32%, which includes an approximate $2 million benefit associated with the retroactive reinstatement of the US research credit.

In the fourth quarter, we expect the IRS to finish its review of our FY15 tax return, and we will update our longer-term financial plans, both of which, among other factors, will inform our updated assessment of the valuation allowance currently recorded against the net operating loss carry-forwards in France.

It is possible that the reassessment could lead to a reversal in the fourth quarter of the remaining French valuation allowance, which currently totals $54.2 million.

If this were to happen, such a change in judgment regarding our expected ability to realize these tax assets would be accounted for as a discrete tax benefit in the period in which it occurs, and our forecasted effective tax rate of 32% does not reflect the potential impact of such a benefit.

Switching to restructuring costs, they were in line with our estimates and primarily related to the exit of our facility in Durlangen, Germany.

With the commencement of the lease related to the Munich Learning + Innovation Centre, overlapping costs related to facilities and staffing are being incurred and will continue during the implementation of the project.

The amount and duration of these costs are dependent on the pace of recruiting, employee departure dates, completion if the new space in Munich, and exit of our existing facilities.

We estimate that we incurred between $1 million and $2 million of these overlapping costs in the third quarter, including rent expense for the Munich location.

Moving to the balance sheet and cash flow.

Cash provided by operating activities of $77 million in the current quarter represented a significant improvement compared to $24 million in the prior year and was driven by lower cash restructuring costs, improved operating results, and lower growth in working capital.

Capital expenditures totaled $23 million in the third quarter, including $8 million of additional payments related to a new replacement aircraft which we expect to take delivery of in the first quarter of FY17.

We estimate capital expenditures for the full year will approximate $90 million, which is higher than our normal targeted level of approximately 2% to 2.5% of sales, primarily due to $26 million of payments related to the new aircraft in the current fiscal year.

We returned approximately $16 million to shareholders in the third quarter, primarily through the payment of a cash dividend of $0.1125 per share.

Turning to order patterns.

I will start with the Americas, where our orders in the third quarter declined by approximately 1% organically compared to the prior year.

Order patterns during the quarter reflected 7% growth during the first half of the quarter, followed by a 9% decline during the latter half of the quarter, which is when we typically receive an influx of orders from customers looking to take delivery prior to calendar year end.

But as I mentioned earlier, orders in the second half of the quarter reflected an apparent pullback in business from our corporate customers, as we did not receive the same level of year-end business we have experienced in the past couple of years.

We are also seeing a shift in demand to certain product categories where we will be launching new products and taking other actions to improve our competitiveness, starting in the fourth quarter and throughout next fiscal year.

As a result of these factors, customer order backlog at the end of the quarter declined 2% compared to the prior year.

Project orders in the Americas declined by approximately 5% during the third quarter, compared to a strong prior year which grew by a double-digit percentage.

Project orders greater than $3 million declined by more than 20%, while project orders less than $250,000 grew by a mid-single-digit percentage, and those in between were relatively flat.

Orders from continuing agreements grew by a low-single-digit percentage, and orders related to our marketing programs aimed at smaller day-to-day business were relatively flat.

Across vertical markets in the Americas, we experienced order growth in the manufacturing, technical/professional, Federal Government, healthcare, education, and state and local government sectors, while orders declined in insurance services, energy, information technology, and financial services.

Switching to EMEA.

Organic order growth of approximately 20% was driven by Western Europe, with all markets posting year-over-year order growth.

The balance of Europe, the Middle East, and Africa as a group was flat, with strength in Russia linked to one particular project being offset by a decline in the Middle East, which was particularly strong in the prior year.

Customer order backlog for EMEA ended the quarter up more than 10% compared to the prior year, which included a significant portion of a large government project in France that was shipped over the third and fourth quarters of last year.

Adjusted for this large project in the prior year, remaining backlog grew by nearly 30%, reflecting the strength of orders in the third quarter as well as the effects of the extended lead times for certain products and other offerings that I mentioned earlier.

Within the other category, orders grew in Asia-Pacific in PolyVision, while orders at Designtex declined, resulting in an overall 7% growth rate for the category.

The order growth in Asia-Pacific was broad-based.

To summarize, orders in the Americas declined against the prior year for just the second time in 17 quarters, driven by a reduction in large project business and a lower-than-typical level of year-end business.

Some customers may be reacting to the near-term economic uncertainty, but we continue to see a good level of activity in small- to medium-size projects, and we remain optimistic about the industry demand potential, driven by the need for Companies to modernize their spaces.

We are also excited about the number of new product launches over the coming quarters, which we expect will address certain evolving market demands.

For EMEA, we are pleased with how our order patterns strengthened in the quarter, particularly across Western Europe, and we are nearing completion of our manufacturing footprint changes and expect improvements in our manufacturing and distribution performance as we stabilize the new footprint.

Asia-Pacific orders grew organically again this quarter, so we have now seen year-over-year growth in this business in five of the last six quarters.

While there remains a shadow of macroeconomic uncertainty China, we are pleased with the traction our local Sales Teams continue to demonstrate.

Finally, PolyVision order patterns remained solid, but I should reiterate what I shared last quarter.

That is, our business model could be impacted beginning in FY17 by a recent anti-dumping action filed by five major US steel producers targeting imports by foreign producers of certain cold rolled steel flat products.

The preliminary scope of this action, unfortunately, includes premium enameling grade sheet that PolyVision uses in its business.

Although this imported material represents a very small and specialized segment of the broader market for cold rolled flat steel, if trade relief is ultimately granted in the form of higher import duties across the entire segment, it would increase our material costs accordingly.

Of course, we are evaluating our options, including alternative supply and pricing, but I wanted to give you a heads up of the potential risk this situation creates.

Turning to the fourth quarter of FY16.

Factoring out an estimated $19 million of unfavorable currency translation effects and the impact of a small dealer acquisition net of divestitures, we expect to report organic revenue results within a range of a 2% decline to 1% growth, compared to a strong prior year, which reflected 7% consolidated organic growth and 23% organic growth in EMEA compared to the previous year.

We expect approximately $3 million of disruption and inefficiencies in the fourth quarter associated with the changes in our manufacturing footprint in EMEA.

This compares to approximately $7 million in the fourth quarter of FY15 and $5 million in the third quarter of the current year.

In addition, we anticipate improvements in manufacturing and distribution performance in EMEA compared to the third quarter.

As a result of these factors, we expect to report fourth-quarter earnings within a range of $0.18 to $0.22 per share, including restructuring costs of approximately $0.02 per share, which translates to an adjusted earnings range of $0.20 to $0.24 per share.

We recorded adjusted earnings per share of $0.21 in the prior year.

As I stated earlier, our forecasted effective tax rate of 32% for the fourth quarter does not contemplate any impact from the potential reversal of our valuation allowance currently recorded against the net operating loss carry-forwards in France.

Accordingly, our fourth-quarter earnings estimate does not contemplate any potential impact from the updated assessment we expect to complete by fiscal year end, including any related variable compensation costs which could be recorded in connection with such an earnings benefit.

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 open.

Good morning, everybody.

This is Bobby, actually, filling in for Budd.

Thank you for taking my questions.

Hi, Bobby.

I was hoping to touch a little bit on the EMEA segment and get a little bit more color on when these issues of -- the cost issues actually started to occur during the quarter and maybe the timing of how they progressed during the quarter.

This is Dave, Bobby.

I would tell you, if you go back 90 days ago, recall, we were in the middle of stabilizing a very difficult situation that arose in the second quarter.

In fact, Jim was having daily meetings with operations and sales leaders up until the time of the call regarding the status of the situation and various corrective actions we were putting in place.

Our estimates of the cost to stabilize the situation and reimbursements to dealers for the inefficiencies we caused and incentives to maintain their business with legacy products versus our new products which had extended lead times simply proved more costly than we anticipated.

Maybe we were a bit optimistic at the time, given that we were feeling like we were through the worst of the situation internally.

But as the quarter continued to play out, that's when we started to hear more significantly from our dealers the level of inefficiencies that we caused them and, therefore, the level of reimbursements required to make them whole for the inefficiencies that we caused.

So the cost began at the end of or throughout the second quarter.

They very likely came to a head early in the third quarter.

But the cost for us to rectify the situation and stabilize our relationship with dealers and reimburse them for their inefficiencies played out for the balance of the quarter.

Okay.

And then --

I'll add to that.

I'm sorry; go ahead.

We also had other costs related to quality that I mentioned.

These were some recalls or rework of product that we had made previously, and those costs, really, were unrelated to the restructuring, but they continued throughout the quarter.

Yes.

Okay.

And then how should we think about disruption cost when we look at FY17 or even in the fourth quarter here.

What gives you guys the confidence that, A, these were nonrecurring and they're going to be contained to the third quarter, and B, that we won't continue to have these type of issues that might flow through and carry into FY17 when we try to think of a game plan for the profitability flip in EMEA.

That's a fair question, Bobby.

Let's break it into two buckets.

Remember, we call disruption costs and inefficiencies related to the footprint changes, we've been calling those out for several quarters and have provided a webcast slide of what those include and how they've played out and what we project go forward.

And then this second bucket is related to the manufacturing and distribution performance issues that we experienced throughout the second and third quarter and have since largely resolved.

The first bucket, there are many costs in there that are easily quantifiable, and they are linked to the redundancy of overhead that we have while we're in the midst of transferring production.

The redundant direct labor, labor premiums that we're paying to employees in our Durlangen facility.

So as the people come out over the fourth quarter and into next year and as we completely exit the facility, the overhead costs, the labor costs, the premiums, those are quite predictable to come out of our business.

Now, remember, we're a bit delayed from our initial estimate of -- around the footprint changes.

We had hoped to be done by the end of the third quarter initially.

We're now delayed by a quarter or potentially a little bit more, so that's going to leak a little bit into maybe the first quarter.

But those costs are identifiable, and we can see those coming out of our business.

The second bucket of inefficiencies and issues associated with what started in the summer and continued in the third quarter and has since starting to resolve, there are also incremental costs in there that are quite easy to capture and set aside.

As an example, to the extent we don't have additional disruption or inefficiencies that impact our dealers, I wouldn't imagine reimbursements continuing.

To the extent we are able to continue to reduce our lead times associated with new products and the other offerings affected by the equipment moves, we shouldn't need to incent our dealers as much to take alternative legacy products in exchange for the products that they'd like to order.

As we stabilize the business, we would hope that our day-to-day business from our dealers in some of the markets that were affected will return.

So many of those costs are also -- we feel are incremental and should come out of the business.

The part that is still a little bit foggy is around the inefficiencies that we're experiencing in our operations in general, post all of the footprint changes.

We have new employees in the Czech Republic that are learning new manufacturing processes.

We have had more than our fair share of equipment challenges in Europe, much of which has been associated with new equipment.

We'd like to think that those are stabilizing and that our employees' situation is stabilizing, that our efficiency levels will improve, and that we'll be able to begin to work those costs out of our system more aggressively in the coming quarters.

But that's probably the area that has the least amount of predictability around it.

Okay.

So when you look at the slide that you're referencing, the inefficiencies and disruption portion is currently getting modeled to not impact FY17 results; correct?

The first bucket of disruption costs and inefficiencies associated with the footprint changes, that stuff largely comes out.

There could be a little bit that trickles into the first quarter, but it largely comes out.

Okay.

That's helpful.

And then lastly from me, on -- just to pivot and go back to North America real quick for my final question.

Now with the slowdown that we've seen and you referenced in the prepared remarks, how should we think about the growth investments that we've talked about at times in the past for that segment if we are in a slowing environment?

First of all, I'd say the areas where we've invested for growth, things like architectural products, some of the technology products, these are growing faster than the rest of the business.

So we believe those investments in growth are paying off.

We also think -- a lot of our investments have been in benches and desking and height adjustability, and again, the market shifts we are seeing are supportive of those investments we've made.

So we think that's the -- if anything, I would say those are probably going to help us shift and be more relevant as customer demand continues to shift.

Also, the investments we made in Turnstone are aimed at more of this mid-sized project business that we've seen growth in.

So I like the correlation of the investments we make to the places we see the market shifting to.

That was another question behind the question, which is what's overall demand going to do.

We can't really predict that very easily.

I would say, as we've said before, that what we're seeing is large customers and large projects are the places where we've been the most challenged, and mid-sized projects have held up pretty well.

Now, what's going to happen next, we don't know.

Will that decline in large customer business, is that just foretelling a decline that we'll see across the entire industry?

We've had recessions in the past, in the distant past that have been like that, but we've also had times in the past when we've seen this moment where you see one segment fall and then it comes back again.

We can't predict that exactly, but we've seen both occur in the past.

Thank you for answering my questions.

I'll jump back in the queue and best of luck in the fourth quarter and going into next fiscal year.

Thanks, Bobby.

Thank you.

Our next question comes from Matt McCall, BB&T Capital Markets.

Your line is open.

Good morning, guys.

This is Ruben in for Matt.

So just staying on North America, just looking at the market's reaction today, it appears there's some concerns that we may be nearing the end of the cycle.

Can you just talk about your mindset after you saw project activity decline in the second half?

Project activity had been choppy.

You talked about continuing business growing low single digits still.

Did you see a pullback in that activity late in the quarter at all?

Can you just update us on your outlook on the cycle?

I know maybe you're not going to give specifics for next year, but just your thought process about where we are in the cycle in general.

So I'll start this, and I want to start by acknowledging that if you talk about sales or orders, you get different answers to these questions because the timing can be somewhat different.

You could also get different answers depending on how you cut large customers versus mid-sized customers, large projects versus mid-sized projects, and we've been looking at all that.

I'll talk about orders, and I'll talk about large customers versus the rest of the market.

In this most recent quarter, the thing that was most pronounced was the drop in the large customers, a decline in orders from large customers and a decline in the large projects.

And it's not that they were doing great in the previous quarters, but we saw this decline.

If you look at this year versus prior years, large customers were not dramatically up or down, but the mid-size and smaller customers are doing pretty well.

What really changed in this last quarter was the drop in the large customer, large projects.

And maybe I'll let Dave comment on continuing business for other parts of that segment.

What I was going to comment on, Bobby, is just reflect back on what I said in my scripted remarks.

The first half of the quarter, five weeks in September and the first two weeks of October were actually quite good and were stronger than we were expecting.

In fact, I think I commented that they averaged 7% growth, and so in the first seven weeks of the quarter.

And then in the last six weeks of the quarter, we saw a 9% decline, and really, it fell off suddenly, and we believe that it was largely linked to not seeing the same level of year-end business from some of our largest customers.

Jim's also referencing the large project slow slowdown that we've seen in our order patterns more recently.

What I looked at as well is the first three weeks of December.

Three weeks we know don't make a quarter, but we, of course, have considered what's going on in the first three weeks of December, and what I'll tell you is they're not -- it didn't drop by the same level of decline that we saw in the last six weeks of the third quarter.

It did drop, but it dropped modestly, versus more like a 9% decline.

We also looked at our business by sector.

We also know that, for example, some of our large energy customers in regions that are heavy with energy customers face challenges related to oil prices, as you could imagine.

And then I'll also comment, I'm a member of various groups where CEOs come together and talk about what they see, and for these large customer CEOs, some of the outlooks, for example, business round tables commentary recently about business capital spending would confirm that large customers are seeing this headwind.

Whether we look at our own data or we look at economic data or we just listen to what other CEOs are saying, we're seeing consistent concerns from that customer group about the economic outlook.

And again, that can change the other direction just as fast as it goes in this direction.

But that's a bit of what we're seeing.

Okay.

And just a quick follow-up.

Some others in the space have talked about seeing similar slowdowns earlier in the quarter, and their overall outlook is for a low- to mid-single-digit growth next year.

Is your -- does this pullback concern you enough that that's at risk, or can you talk about that at all?

Ruben, as Jim said, we really don't have a crystal ball to predict the future with a level of accuracy like that, especially at this point after what we've seen in the last six or eight weeks.

But if you look at what BIFMA data has reported over the last several months, that seems to have stabilized at a 3% year-over-year rate through October.

We'll see whether that continues or not.

You see the same economic sentiment that we see.

There's some positive, some negative.

You know that our industry demand has been and is likely to continue to be positively driven by the need for companies to modernize their spaces.

So we're not -- I would tell you, today we're not, based on six or eight weeks worth of data, we're not beginning to run the Company as if we're entering a recession, but we are very carefully analyzing the data and the trends and trying to get a sense of what we're in store for the next 12 months.

Okay.

Thanks, Dave.

That was very helpful.

And then one last one.

A big chunk of the EMEA losses this year are largely nonrecurring.

There's a lot of moving parts.

Can you update us on your thoughts or timeline for getting back to breakeven?

Is it potentially -- could you do it in the second half of next year?

Can you just give us an update there?

Well, sure.

I'll do my best.

I would say by the second half of next year, we would expect for the manufacturing and distribution performance to be stabilized.

We certainly would have exited entirely the German facility that we've closed.

We would expect our plant in the Czech Republic to be operating more efficiently than it is today.

We would expect capacity expansions to be online, and therefore, lead times to come back in.

So from there, it really depends on volume.

And if we have some economic uncertainty in the Americas, we have more of it in EMEA.

What I feel good about in EMEA is that we have been in a relatively deep recession for five years, and therefore, I believe demand is building, and we saw a little bit of that pent-up demand show itself in the 20% organic order growth rate this quarter.

But profitability or breakeven in the back half of next year is probably more dependent on the top line than it is around our manufacturing performance because I would imagine we would have things stabilized by then.

Great.

Thank you very much, and you guys have happy holidays.

Thank you.

Thank you.

Our next question comes from Kathryn Thompson of Thompson Research Group.

Your line is open.

Hi; thanks for taking my questions today.

Just wanted to step back and talk a little bit more conceptually about what's going on in EMEA and in Americas.

Let's first focus on Americas.

You had, in the prior quarter, had talked about seeing improvements in small- and medium-size orders, which appears to be continuing somewhat in the quarter just reported.

And said in the past, these small- and medium-size orders have been essentially confidence driven.

But also noted that you've seen a larger decline in orders for project orders or large orders.

One just technical question is, what percentage of total orders are these larger orders as of the end of Q3?

And then two, what I'm trying to reconcile is, if it's an issue of confidence, why is it that you're seeing larger orders decline versus that segment, which is typically more confidence driven, which is small- to medium-size orders?

Let me know if that question makes sense.

We're just trying to reconcile what's really confidence, which is something maybe a little more fundamental.

I would start by saying the large project orders, it's possible that it could be the lumpiness of large projects.

What gives us concern is the fact that the pipeline shows less large projects than it did previously.

You're right on the smaller projects.

I referenced that it grew, and I also referenced that continuing business grew, but our marketing programs were also relatively flat.

On the size of large projects relative to project orders, I don't remember exactly, but I recall it almost looks like a bell-shaped curve when you -- if you were to chart projects greater than $3 million and projects less than $250,000 and all the other projects in between, it's kind of like a bell curve.

So large projects make up -- I don't know the exact percentage, but certainly less than the middle-sized projects.

Does that help?

In the past, you said that project orders, for instance in Q2 was 46%.

It was 48% in Q4.

Oh, yes.

The historical average is around 40%.

So I was hoping to get more of a sense of the trend.

So that mix is still similar.

So it's around -- it's in the low 40%s now, where project business is, say, 43%.

So it's come down a little bit in total.

What I was giving you color on is if you double click on project business.

Okay.

We actually split -- just to clarify that.

Sometimes in the past -- and we continue to do this -- we'll distinguish between project business and continuing or day-to-day business.

And then within projects, you can have large projects and medium-size and smaller projects.

So it's like four quadrants of the orders, project versus day-to-day, and then large versus small.

And in particular, what we saw this time was large projects were down significantly, and also, that year-end order surge, which can look like a project because it can often be quite large and quite quick.

So the fact that the year-end order surge did not develop is a sign of -- perhaps a sign of lacking confidence of large companies.

Again, it's like -- sometimes it's just two or three companies that are placing those kinds of orders at the end, and it didn't happen at all.

I want to be careful we don't over dramatize that, but the fact that it didn't happen and we usually get a couple or three is what happened there.

And to that point, what I was trying to clarify is, what doesn't appear to be the case is that just broad-stroke cyclical, everything is trending down.

That's not the case.

It's more the larger orders, which definitionaly are larger, are either lumpy or there's some certain type decline, but there are still a portion of your orders that are still seeing positive momentum.

So that's fundamentally what people want to know is, is there something more related to the cycle, or is there something more specific to Steelcase that perhaps is fixable.

Unfortunately, I'm going to probably -- let me add a little bit more to that.

I think overall, when it comes to projects, and as we looked across different customer segments, we saw a gradual softening of growth, but the main story was the reduction we saw in large companies.

So it wasn't as dramatic as mid-size companies continuing strong growth while large companies fell.

We did see an across-the-board gradual reduction, but large companies was the most pronounced, and that's really the headline.

And then within projects, we saw large projects go through this decline that I talked about before, while we continue to see pretty good performance of mid-size projects.

The mid-size projects is where we saw a little bit better performance.

And then we had segments like Turnstone and some of these other growth segments like architectural products and technology and so on where we saw good growth.

That's helpful.

Then switching to EMEA, just one technical question.

Just a little bit more color on the severance cost portion.

You talked about the three different buckets that were the driver for the miss in EMEA, and you said $2 million of the $3 million are nonrecurring.

Maybe just helping us understand why that would -- why this was missed, maybe?

Because part of that will lead to the confidence that we won't see this on a go-forward basis.

And then I'll stop there, and then I'll do a follow-up with that.

This is Dave.

I'll tell you, the severance cost did not relate to a restructuring plan that we had previously announced.

If it did, it would go into the restructuring line.

This was related to some decisions that we took recently to change various leaders in our organization, and as a result, we took an accrual for severance costs associated with those changes.

Because that's more run-the-business oriented, we didn't feel like it should be put in the restructuring bucket, so it ran through operating expenses.

Those are decisions that we sometimes make.

We believe we make them for the betterment of our business, and we took them, and as a result, provided the severance accruals.

And I take it that these management, leadership-type changes were made as a result of what we have been seeing in prior quarters in that region.

Not necessarily.

I'd say these are more one-off decisions that are made, were made during the quarter, and I wouldn't want to link it specifically to anything about previous results.

It's really just making a decision to move in a different direction.

Okay.

And then final question related to EMEA, the strategy that you've been working to implement in that region is something that essentially that you had also done in the US in the early 2000s.

It is a little bit slower process just structurally how Europe in particular is set up for a variety of different reasons.

If you were to look at where are we in terms of just stepping back and saying, where are we in terms of innings of executing on your plan, where are we today, and how should we think about fully running on all cylinders as we look forward to the next 12 to 18 months?

This is Jim.

I'll take that one.

First of all, I'd say that in terms of the operation restructuring, we're getting to the closing innings, and I hope we don't have extra innings.

This quarter, the fourth quarter we're in right now is an important quarter to get those new lines up and running in Stribro.

That's really the end of one cycle.

I'm sure, as Dave said, in the first quarter, we'll still be working to get some equipment up and running smoothly and so on.

In the quarters that follow, the first quarter, second quarter, third quarter, and really ongoing is when we shift from doing full-on restructuring work, which is closing factories and moving lines and so on, towards continuous improvement, where now you're trying to improve the productivity of each of those lines.

And in some ways that game never ends.

We're still doing that in the US.

Quarter after quarter, we're improving our results in terms of efficiency.

So you're really starting a new journey, and I'll say that some place mid next year, we'll be fully into that mode of starting the new journey.

When it comes to the -- so that's the manufacturing part of it.

As I also said, I should add capacity this to this discussion.

We're continuing to add capacity for the new lines, and as we launch new products, we will continue to be adding capacity.

Again, that's a business-as-usual challenge.

We have those issues in the United States.

We it elsewhere in the world.

We'll continue to have it in EMEA.

There will be plenty of work to be done.

I would say it's not the context of restructuring anymore.

It's more about trying to get productivity improvements we expect.

On the sales side, we are also going through a fairly substantial restructuring.

We talked about some of it last year.

We're continuing to align our salespeople with customers and to make sure we're aimed at the right growing segments of the business.

We're investing in training.

We have the new facility starting in Munich that will create a new customer experience as well as new places for our people to work on innovation, and that's also ongoing.

So I'd say we're not probably in the later innings of that.

We are in terms of like the major costs that are incurred probably.

It's just the training and getting people up to full speed is the challenge we still have ahead of us there.

When it comes the new products, we've been moving the whole Company along at the same pace, moving towards global product platforms, and EMEA is seeing some of the benefits of that as we see strong demand for some of the products that were launched in EMEA.

Some of the products we're launching in Americas in the next few months are products that were originally launched in EMEA.

So the whole Company is really on the same timeline as it relates to new product launches.

In summary, I'd say that the total start to finish of restructuring in EMEA probably went a little faster.

It's obviously more complex for the reasons you noted, but it went a little faster than we went if you count for the start of the Americas restructuring going back to 1999.

But we are moving towards the end of all of the major operational restructuring.

Great.

Thank you very much for the answer.

Have a great day.

Thank you.

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

Your line is open.

Hi, guys.

Hi, Peter.

First question just quickly, on the December trend in large orders, Dave, you said that large order trends were down a lot in the second half of the third quarter and mediated into December.

If they continue along that pace and the rest of your business does okay, does that lead to flattish growth in North America?

I'm just trying to get a sense as to what that means, if large orders continue to decline but the rest of your business does okay, what that means for North America growth.

Let me clarify because what I was referencing was total orders in the Americas, strong through the first seven weeks, weak in the next six weeks, and then the first three weeks of December, so through Friday of last week, they were total orders in the Americas were down modestly.

So large project reference was related to Q3 orders only.

Got it.

Okay.

And so the other question -- two more questions, but hopefully they're quick.

As you think about capital allocation, given the stock's move today and where you sit with net debt, how are you going to think about share buybacks versus CapEx going into next year?

Well, we've said in the past, Peter, that we're an opportunistic buyer of our stock, and we've also been -- have implemented 10B5 programs in the past that have, on occasion, when the stock has taken a -- has had downward pressure, we've been a buyer, and when it hasn't, our 10B5 programs have just at there idle.

We are in the middle of a program, and we will see how the stock continues to behave relative to the buying parameters that we put in that program.

Okay.

That's helpful.

And then the third, final thing I had, I just want to make sure I understand the cash impacts of the valuation allowance in France.

And so let's just say that, for argument's sake, that you do release the valuation allowance.

Obviously, that's non-cash for now.

You may be able to get to use the NOL in the future.

But is there an immediate cash expense from variable comp going up?

Is that the right way --?

There's actually a pretty decent cash benefit of our tax structure, and the reason is because it makes the US the principal in a contract manufacturing relationship.

We essentially charge the costs in Europe to the Americas.

So the losses are deducted in the US.

Now later, when we're through our reinvention of the business and profitable, we'll be paying taxes in the Americas on the manufacturing profitability associated with contract manufacturing relationship.

But right now, it results in losses being deductible in the US.

Again, we have to receive the final approval of the IRS for our 2015 tax return and complete some additional work.

But there's no guarantee, but because of the potential magnitude of a reversal, we wanted to give you a heads up we'll be re-evaluating it.

Got it.

So it would be a pretty nice cash tax benefit for you over the next few quarters because you could write off those or use those losses in the Americas then?

That's right.

Got it.

Okay.

That's all I had.

Thanks, guys.

Thank you.

Our next question comes from Davis Paddock of Invesco.

Your line is open.

My question has been answered.

Thank you.

Thank you.

I'm not showing any further questions in queue at this time.

I'd like to turn the call back over to CEO Jim Keane for closing remarks.

Thank you.

So at Steelcase, we're focusing all of our energy now on improving our gross margins in EMEA as we shift from restructuring towards continuous improvement, and in the Americas, we're in the process of rapidly developing and launching the large number of products we talked about earlier, and these are aimed at these shifts in customer demand.

Thank you all for joining our call today.

We want to wish all of you a wonderful holiday season, and we look forward to talking with you again next year.

Ladies and gentlemen, thank you for participating in today's conference.

This concludes today's program.

You may all disconnect.

Everyone have a wonderful day.