Steelcase Inc (SCS) 2019 Q2 法說會逐字稿

Good day, everyone, and welcome to Steelcase's Second Quarter Fiscal 2019 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. Mike O'Meara, Director of Investor Relations, Financial Planning and Analysis.

Thank you, Heather.

Good morning, everyone.

Thank you for joining us for the recap of our second quarter financial results.

Here with me today are Jim Keane, our President and Chief Executive Officer; and David Sylvester, our Senior Vice President and Chief Financial Officer.

Our second 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.

A replay of this webcast will be posted to ir.steelcase.com 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 details regarding the risks associated with the use of forward-looking statements are included in our earnings release, and we are incorporating by reference into this conference call the text of our safe harbor statement included in the release.

Following our prepared remarks, we will respond to questions from investors and analysts.

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

Thanks, Mike, and good morning, everyone.

We had a very good second quarter.

All 3 regions exceeded our profit expectations.

All 3 regions had strong order growth with EMEA growing orders more than 20%.

Our reported results include a gain on the sale of some land and some benefits from the recent acquisition of Smith System.

But even without those benefits, the quarter was very strong.

On a reported basis, it was our highest quarterly operating income in more than a decade.

Earnings were stronger than we expected, primarily because of stronger than expected operating performance of each of our segments.

It's really that simple.

Operating expenses were better because of really good control over spending, better than we expected.

Our warranty and product liability cost went down because of better quality performance over time.

Our ongoing operational stability has helped us reduce worker's compensation costs.

All these things came together in a way that showed in results this quarter, and there were very few unfavorable items other than inflation, and we had already considered that in the outlook we had provided.

Even the Smith System acquisition, which contributed about 2 cents to our results, beat our own expectations because of really good performance in the period since we closed the transaction.

So while we did better than we expected, we were in fact expecting to see our performance improve.

So that's not a surprise.

In recent calls, we've been talking about why we expected to see profitability improve.

We launched a large number of new products, some to fill gaps and others to anticipate where we believe demand is present.

We've responded quickly to inflation driven by tariffs, by implementing 2 price increases this year.

We've talked about the momentum we are feeling in Europe as more customers visit our Munich link.

We've talked about all those things, and we can see the positive impact developing.

But until this quarter, it was difficult for investors to see it in our numbers.

That's changed.

The sales and order growth we reported is related to improved project wins, and the new products were key to those wins.

And we believe the Munich link is an important factor in many of the wins contributing to our growth in EMEA.

In fact, we're expecting EMEA to be profitable during the second half of the year.

We're also expecting the impact of the global price increases to offset the impact of rising material costs in the second half of the year, though we are facing new challenges from rapidly rising freight costs in the U.S. With strong order growth, strong backlog and some major wins not yet in our backlog, but feeling confident heading into the second half of the year.

Of course, there are headwinds, like inflation, but we will continue to manage that as we have.

There are rising uncertainties about trade and the state of the global economy, and our customers don't like uncertainty.

We can't control that, but I feel pretty good about the things we can control.

That starts with new product development.

New products and products we've enhanced in the last 3 years make up about 1/3 of our sales.

In seeding, we broadened our product line with new launches like SILQ and Series 1. We've been selling Series 1 long enough that we can now see that 40% of its sales are to new customers, which shows that the lower price point helped us address a broader market.

Products like Answer Fence launched last year, have been successful on their own, while we've also noticed a significant slowing in the decline of our legacy Answer panel sales since we launched Fence and other Answer extensions.

We have also invested in building stronger customer relationships, particularly in EMEA.

This quarter, EMEA grew sales 11% organically and orders grew 22%.

Western Europe was the biggest driver of that growth, and we've seen 14 consecutive months of year-over-year growth in those countries.

The underlying economies are only growing low single-digits.

So this is really related to ongoing improvements in our operational performance and our win rates on major projects.

APAC had a good second quarter after a slow start in the first quarter.

We're pleased with the order growth and backlog as we head into the second half.

This quarter, we completed the acquisition of Smith System, which extends their education business to more fully addressed customers in the K-12 segment.

As I mentioned earlier, Smith System got off to a good start with modestly stronger results in the quarter than we had expected.

Our relationship with West Elm is making great progress.

Our teams are working on operationalizing the first products to be developed under this relationship.

We expect to see our first sales in our fourth quarter going to more significant levels next fiscal year.

The market-leading customers and dealers are very excited about our work with West Elm and we are too.

Yesterday, we announced the acquisition of Orangebox, which was started by some alumni of our Steelcase business in Europe, back when it was a joint venture called Steelcase Strafor.

They've done a great job focusing on furniture that supports collaboration away from the desk, as desired by today's customers.

Orangebox is an innovator, having developed one of the first pod-type products to flexibly support individual or small group collaboration.

These products have attracted customers and new competitors as they rise in popularity.

They also have a well-developed task and multi-use seeding portfolio, which will fill gaps in our product line.

What they haven't had is significant distribution beyond the U.K., and that's where we can help.

We see opportunity to extend their products to other parts of Europe, in the Americas, in Asia, where we are well established.

There's very little product overlap in their existing products and they complement the partnerships we've developed in EMEA and the Americas.

Based in the U.K., Orangebox will be affected in some way by Brexit.

But since our value-creation plan is related to globalization, and therefore localization, we expect the synergies we've identified will not be effected.

Plus, we could use the Orangebox factory in Wales to localize some Steelcase production depending on how Brexit materializes.

In closing, let me say that, while we feel good about the reported results this quarter, it's really not about this quarter, it's about all the work that came before.

Our investors have had to be patient through all of that, and we aren't done of course.

We are expanding our business through acquisitions.

We're hard at work to create value from those investments.

But I'm really glad that we've been able to show the results and look forward to keeping this momentum going to create more opportunities for our employees, deliver more value to our customers and return more value to shareholders.

Our upcoming Investor Day on October 3rd in New York, we look forward to sharing our thoughts in more depth about the changes in our industry and how we're positioned to capitalize on that change, and what our shareholders could expect in future financial results.

It's an exciting time at Steelcase.

Thanks for your interest in the company.

And now I'll turn it over to Dave for a deeper look at our results.

Thank you, Jim, and good morning, everyone.

I will cover our second quarter financial results first, noting where results differed from our expectations and highlighting year-over-year and sequential quarter comparisons.

And then I will talk about our balance sheet and cash flow, before getting into our order patterns and outlook for the third quarter and the full fiscal year.

As Jim said, we're excited to report double-digit growth in revenue, orders and backlog, along with 32% growth in earnings in the second quarter.

Revenue of $876 million was in line with the estimates we provided in June, while earnings of $0.41 were significantly higher than the top end of our guidance for the quarter.

Before I get into the detailed results, I want to share a few additional highlights, some of which Jim just referenced.

First, the organic order growth of 12% included 9% growth in the Americas, 22% growth in EMEA and 15% growth in the other category.

I will share more details about our order patterns in a few moments, but wanted to start with referencing this double-digit strength as it drove the strong revenue growth in the quarter and the high levels of order backlog at the end of the quarter, which contributes to the strength of our outlook for the third quarter.

Second, the $0.41 of earnings included a $7.5 million property gain in the current year, along with $5.3 million of lower cost related to warranties, product liability and worker's compensation.

But we also had a $4 million property gain and a $3.9 million favorable tax adjustment in the prior year.

And these items contributed approximately $0.05 to our earnings in both quarters.

So the earnings growth was big with or without these unusual items.

The Americas reported a strong 11.8% operating margin in the quarter compared to 9.8% in the prior year.

The land gain and the lower cost, I just mentioned, had a significant impact, but the operating margin before taking these items into account was still very strong and would have exceeded 10%.

Fourth, EMEA continued to report year-over-year improvement in operating results, excluding the property gain in the prior year.

This improvement was better than we were expecting, but less than the year-over-year improvement in the last 2 quarters.

As I said in the release, and Jim mentioned a minute ago, we are currently projecting a strong back half of the year in EMEA, which could result in the segment approaching breakeven operating results for the full year.

Achieving another year of significant improvement in fiscal 2019 is an important step towards our longer-term goal of reaching a mid-single-digit operating margin, which would return our cost to capital in the region.

And lastly, we completed the acquisition of Smith System during the second quarter and announced the acquisition of Orangebox yesterday.

Plus, we entered into our partnership with West Elm and expanded our partnership with Bolia in the quarter, adding significantly to our potential to drive additional growth.

As it relates to our second quarter results relative to our expectations, revenue was largely in line with our estimates across the segments.

The completion of the Smith System acquisition on July 12th, compared to our original target for the end of June, had a negative effect.

But they recorded higher than expected revenue in August.

Plus, EMEA revenue was also slightly higher than projected, so our consolidated revenue remained within our estimated range.

The earnings, however, were much higher than our estimated range of $0.28 to $0.33 per share, with all segments positively contributing to our performance.

Within the Americas, the lower warranty product liability and worker's compensation cost contributed approximately $0.02 to the favorability after consideration of variable compensation and income tax effects.

In addition, post-acquisition earnings from Smith System were better than expected despite revenue being lower due to the delayed closing.

In total, the acquisition contributed approximately $0.02 to our second quarter earnings compared to $0.01 we had included in our estimates.

Beyond these 2 items, operating expenses were also lower than we anticipated, in part due to timing as we expect a sequential increase in spending for the third quarter.

Lastly, the speed of implementation of our recent pricing actions has exceeded our expectations, which were based on historical experience.

As a result, the shortfall between estimated price yield and approximately $10 million of increase in commodity and freight costs was reduced through a few million dollars in the quarter.

EMEA results were also better than expected.

I mentioned favorable revenue a moment ago, but gross margins and operating expenses were also better than we expected, in part due to some delayed spending.

The other category also reported better than expected profitability in the second quarter, nearly tripling the operating income reported in the first quarter.

Seasonal strength from PolyVision, mostly as expected, contributed to the sequential improvement, but we also saw improvement in our Asia-Pacific business, which was better than expected following the slow start in the first quarter.

Orders grew by more than 30% in the region, including replacement orders from a large customer which canceled certain orders in April.

Corporate costs were also lower than expected, driven by gains related to COLI maturities, which occurred during the quarter.

And lastly, other income net continued to benefit from stronger than expected income from our joint ventures and other unconsolidated affiliates.

Switching to year-over-year comparisons.

Operating income increased by $15.5 million in the second quarter, which included a $22 million increase in the Americas, offset in part by reductions in EMEA and the other category as well as higher corporate cost.

The $22 million increase in the Americas was driven by an $86 million increase in revenue.

The property gain and lower cost, previously mentioned, contributed approximately $9 million to our operating income after taking into consideration related variable compensation expense.

The acquisitions of Smith System and AMQ net of a small divestiture in the prior year accounted for another $4 million of the improvement in operating income and contributed approximately $46 million net to the revenue growth in the Americas during the quarter.

Smith System was a big contributor as 2/3 of their annual revenue is typically realized in the summer months of June, July and August, but AMQ also reported strong results.

The operating income from these acquisitions was reduced by approximately $7 million of purchase accounting effects, $6 million of which was related to the step-ups of acquired inventory and backlog from Smith System, which were almost fully amortized in the quarter.

The balance of the improvement in the Americas operating income of approximately $9 million was attributable to the remaining revenue growth of approximately $40 million, which was driven by project business.

Increased pricing from our recent list price adjustments drove part of the revenue growth, but was not enough to offset the increase in commodity and freight costs.

There is still a relatively significant effect on our gross margin, but we feel good about the pace at which our sales teams are driving customer agreements to more recent list prices.

We also experienced some unfavorable shifts in business mix, which negatively impacted our gross margin in the second quarter, but we held our operating expenses, excluding variable comp, relatively flat at the same time so the contribution margin associated with the volume growth was still quite strong.

In EMEA, the $6 million operating loss in the current quarter compared to a loss of $3.6 million in the prior year, which included a property gain of $4 million.

Benefits from the revenue growth in the quarter were partially offset by unfavorable shifts in business mix and a small loss related to a divestiture.

In the other category, we reported $4.9 million of operating income or 5.6% of revenue, which represented a $2 million reduction compared to a strong prior year.

We continue to target a mid-single-digit operating margin in the other category given our plans to continue investing for longer-term growth in the Asia-Pacific region.

And lastly, higher corporate costs were driven by higher deferred compensation costs, which were unusually lower than prior year offset in part by gains related to COLI maturities in the current year.

Sequentially, second quarter operating income nearly tripled compared to the first quarter.

This improvement was driven by seasonality and momentum in our business, the property gain, the acquisition of Smith System and lower warranty, product liability and worker's compensation costs.

Operating expenses before variable compensation reflected a sequential decrease of a few million dollars as operating expenses from Smith System were more than offset by the land gain and some delayed spending across all of our segments.

As mentioned a moment ago, we expect a sequential increase in third quarter spending.

Moving to the balance sheet and cash flow.

We used domestic cash in a $75 million borrowing under our global credit facility to fund the acquisition of Smith System in July.

But we were able to pay down our borrowings on lines of credit to $10 million by the end of the quarter due to the strong cash generation in the quarter, which totaled $79 million.

In addition, we received $12 million in connection with policy maturities under COLI.

Working capital growth in the quarter approximated $51 million, driven by a $58 million increase in accounts receivable, excluding acquisition impacts.

The increase was driven by the strong growth in our business, which was more heavily weighted in the back half of the quarter.

At the end of the second quarter, DSO was only modestly higher compared to the first quarter and most of the increase was driven by a higher mix of business from direct sale customers, which have longer payment terms.

Inventory levels, excluding acquisition effects, also increased in the quarter to support the growth in our business, but accounts payable balance was increased by a higher amount, so the impact on cash was favorable.

Capital expenditures totaled $26 million in the second quarter, and we continue to expect fiscal 2019 to fall within a range of $80 million to $90 million, driven by our intention to sustain a high level of product development, strengthen our industrial capabilities, enhance our information technology systems and invest in our customer-facing facilities.

We returned approximately $16 million to shareholders in the second quarter through the payment of a cash dividend of $0.135 per share.

And yesterday, the Board of Directors approved the same level of dividend to be paid in October.

Share repurchases during the quarter were minimal.

Earlier this week, we funded the acquisition of Orangebox with short-term borrowings under our global credit facility, and we expect cash generation in the third quarter to substantially reduce the borrowing by the end of the quarter.

Turning to order patterns, I will start with the Americas segment, where our orders in the second quarter increased 9% compared to the prior year.

Our presentation of order growth is adjusted for constant currency, acquisitions and divestitures, which is consistent with how we calculate organic revenue growth.

Across the months, we posted double-digit order growth in June and July, followed by a modest decline in August.

Customer order backlog at the end of the quarter was approximately 11% higher compared to the prior year.

And through the first 3 weeks of September, order growth has been tracking at a low double-digit percentage.

Orders from our largest customers showed improvement again in the second quarter, growing by a mid to high single-digit percentage compared to the prior year.

Across quote types, orders for project business and orders through our marketing programs drove the growth in the quarter, while orders associated with continuing agreements declined by approximately 7%.

Turning to vertical markets.

We saw order growth in 5 of the 10 vertical markets we track, including insurance services and manufacturing, which had posted year-over-year declines in each of the previous 4 quarters.

And for the sectors that declined in the quarter, it's worth noting that a couple faced strong prior year comparisons, while others have been up and down over the past 5 quarters.

Overall, we feel very good about the second quarter order patterns in the Americas as well as our win rates, which have remained strong and have included some larger opportunities, which we won with some of our newest products.

And we're continuing to see solid year-over-year growth in our pipeline of project opportunities projected to ship over the balance of the fiscal year, which is consistent with the general level of optimism we are feeling from our dealers about their outlook for the balance of the year.

For EMEA, the 22% order growth in the quarter included broad-based strength across Western Europe, reduced in part by a modest decline in the rest of EMEA as a group.

Customer order backlog in EMEA ended the quarter up approximately 34% compared to the prior year, setting up a strong outlook for the third quarter.

We expect the order growth rate in the third and fourth quarters to moderate from these very high levels, in part due to a strengthening prior year comparison.

But our order patterns through the first 3 weeks of September reflected a slow start to the quarter, declining at a high single-digit percentage.

Overall, we remain optimistic in EMEA as our pipeline of project opportunities continues to reflect solid growth and the level of customer traffic in the Munich Learning & Innovation Center remains very high.

For the other category.

Orders in total grew by 15%, driven by strength in Asia-Pacific, which posted order growth of more than 30% compared to the prior year.

I talked earlier about some customer orders, which were canceled in the first quarter and replaced in the second quarter.

But apart from those orders, the growth rate still approximated 20%.

Turning to the third quarter of fiscal 2019.

We expect to report revenue in the range of $885 million to $915 million, which includes the acquisitions of AMQ, Smith System and Orangebox, net of divestitures and approximately $6 million of estimated unfavorable currency translation effects.

The projected revenue range translates to expected organic growth of 11% to 15% compared to the prior year, with acquisitions contributing modestly to the projected range of organic growth.

Taking into consideration the projected revenue growth and typical seasonal patterns, including reductions in business from customers in the education sector and increases in business from the government sector, we expect to report diluted earnings per share between $0.28 to $0.33 for the third quarter of fiscal 2019.

This estimate projects that estimated yield from our recent pricing actions will begin to offset increasing commodity and freight cost in the third quarter.

In addition, the estimate includes a continued negative impact from unfavorable shifts and business mix, and have $15 million to $20 million sequential increase in operating expenses, reflecting the nonrecurring nature of the property gain and other benefits recorded in the second quarter, the expected higher spending, I mentioned earlier, and the effects of acquisitions offset in part by lower variable compensation.

As it relates to the acquisitions, we do not anticipate any additional earnings accretion in the third and fourth quarters, in part due to the seasonality of Smith System.

In addition, the operating results from the acquisitions will be substantially reduced by an estimated $4 million of amortization expense in the third quarter and $3 million in the fourth quarter.

For fiscal 2020, we expect accretion of earnings to become more meaningful as we more fully implement our value-creation plans and the step-ups of acquired inventory and backlog have been fully amortized.

Taking into consideration recent industry trends, our improved win rates, our recent pricing actions and the positive outlook for EMEA and Asia-Pacific, we are currently projecting strong revenue growth to continue in the fourth quarter.

And to provide clarity around the expected impact of our recent acquisitions, our outlook for inflation relative to our pricing actions and other factors, including business mix and the level of operating expenses, we have taken the unusual step to issue full year guidance, which you saw in the release as a range of $1.10 to $1.15 per share.

From there, we will turn it over for questions.

(Operator Instructions) Your first question comes from Budd Bugatch with Raymond James.

A couple of questions, if I could.

I guess, the first question is, over the last year or so, we've watched you develop a number of partnerships and now the West Elm relationship, Orangebox, Smith System.

But I would call it a smorgasbord, I guess, of partnerships.

Could you kind of go through and maybe prioritize what you think are the most important things you have done in terms of those outside relationships and acquisitions?

And maybe give us an idea of what you think the economic impacts of those are going to be over time in a broader sense?

Sure.

So this is Jim, I'll take that question.

So first of all, we love all these acquisition -- or acquisitions and partnerships that we've put together, because when we hear from our clients and that's really where the energy comes from these things is that, they've been dealing with trying to create applications that respond to new ways of working, more robust environments, demand for more residential use of expired furniture, demand for more choice like quite -- than they've had before from the major manufacturers, including Steelcase.

And that choice should extend to a broader range of price points to meet the budget.

And so we were really responding to customer demand.

They're not asking us to do any particular partnership, but they want us to help bring order to this new world because they've been forced to create their own smorgasbord, if you like.

Every customer trying to find ways to meet their needs has led them to have to dramatically broaden the number of manufacturers from purchasing, and that's created problems.

That's created problems in terms of their ability to leverage their buying power.

It creates problems in terms of them really knowing what they're getting in terms of product quality, sustainability and so forth.

It's created problems as they try to put those individual products together and have them work together, and they've been largely on their own.

And operational issues, as those products show up with varying lead times.

Sometimes they don't come in on the date they're supposed to come in.

They come in on separate trucks.

It's been super inefficient for our customers, but also for the rest of the industry.

So we hear the same thing from architects and designers, who've been saying that they are struggling to meet their client's needs with -- and deal with all the extra costs that they've been incurring.

We're hearing it from our dealers as well who have been asked to shoulder the burden for a lot of this.

So that's really where the energy comes from.

And the most important things we've been doing is, first of all, picking really good partnerships.

So companies that we're working with like Mitchell Gold & Bob Williams, like FLOS, like Bolia in Europe, super happy with each of these relationships.

And the most important thing we're doing is then taking those relationships and helping our customers make sense of the application they're trying to develop.

So showing them, for example, in NeoCon last year in our new showroom that we won an award at NeoCon, I think we won because we were able to show people how these kinds of products could come together.

And that just created attractive settings, especially it created attractive settings that support real work.

So that's the first most important thing we do is applying our insights to products that we've put together through these partnerships.

The second thing is making it easier for our customers and specifiers and our dealers to select and order these products.

So we'd be creating tools to allow them to do that.

And then finally, integrating the partnerships into our back end, so that we can consolidate deliveries on to single shipments that meet our customer's expectations.

In terms of impact, they've all had an impact in their own way.

It's hard to compare a legging company versus a seeding company or a broader furniture company.

But we've been happy with the results, and I'll call out Bolia in particularly.

Bolia was probably a brand that's less known here in the U.S., but very well known in Europe.

The degree of adoption by the -- of the Bolia products by our customers was terrific.

We can connect the fact that we had Bolia in our portfolio as directly related to some wins we had with key customers.

So we're really happy with that.

The products themselves are beautifully designed to get intervened influences.

It's been going so well that we've recently announced that we're expanding that partnership to include -- offering those products in the U.S. West Elm is a new announcement.

We just really have been working through the details of that agreement.

We unveiled it to the marketplace back at NeoCon, really no impact yet because we're still working on operationalizing it.

But then we've actually gotten some customers and dealers who's been terrific.

And then I'll add Orangebox to the mix, because even though that's not a partnership but an acquisition, just in the last 24 hours, we've had a number of phone calls -- inbound phone calls from dealers both in the U.S. and in Europe, congratulating us on the deal, excited about the deal.

I got a chance to talk to some of our key customers who were in Grand Rapids, yesterday.

Many of them have already been evaluating Orangebox products to meet some of these needs I'm talking about.

So what I'm most excited about is the way it's all going to come together.

It's not any one particular partnership.

It's really the integration of these to meet customer needs.

And probably we'll begin to see a larger impact of that in terms of revenue and profits next year.

But as you know, sometimes it takes time, like the benefits we're seeing this quarter in our core business is because of the work we've been doing for the last 2 years on new product development, operational stability and the work we're doing this year to build these partnerships, integrate them with our logistics, integrate them with our selection tools.

It should impact and that will probably felt more completely next year.

What I worry about -- and there should have been a whole raft of them is, are you able to control and to integrate them effectively?

Or do we have a risk of losing some of that control as you work your way through and develop the relationships with these partnerships and even the acquisitions?

Yes, it's a good question.

So far we haven't seen any concern, and we haven't seen any evidence of losing control.

But we have teams of people that are working actively on that to make sure that we can keep our commitments to clients.

Remember that in this world though, they -- we're being compared to the current state, which is pure chaos, where people are trying to order 2 products through this company and 2 products from that company.

I won't go through it all again, but if we can improve it that will be a massive amount of value creation for them.

It may be some time before we're able to bring the exact same level of reliability that we have in the French, who we've been selling for years, and we're make in our own factories and so on.

But we're going to make a big difference for our clients.

Okay.

Let me ask just 2 quick other detailed questions.

You talked about wins not in the backlog.

Could you quantify that for maybe the second half of the year?

And what that might impact revenues?

I'm going to not -- I won't quantify, I'll just restate what I said in my scripted remarks that it's reflecting growth.

Our pipeline of project opportunity shows solid growth for the back half of the year.

Not being coy, I just -- we found that our data from them -- I'm basically looking at data from our CRM tools, which often reflect change.

And so I just don't want to quote a specific percentage.

But its outlook is like solid growth for the balance of the year.

And I'd add.

When we talk about -- as we look at the data that comes out of the CRM.

But we also complement that data with qualitative information from phone calls we have with dealers and so on, and those conversations are supporting the data as of now.

Okay.

And lastly, tariffs.

I don't think I heard very much about that.

We've heard that on another call recently that tariffs will have a significant impact on results for the second half?

Yes.

We heard that same reference on the call that you're referring to, I think.

And I don't -- we're not seeing the same kind of number that they're talking about, and that could be a function of different supply chains and business models, and they're -- where they're sourcing component parts and finished goods from.

We are affected by tariffs.

The most meaningful impact that we've had on tariffs in the last several quarters was related to PolyVision.

We talked about that over and over.

We saw an exclusion and we're successful in getting that.

And then additional waves of tariffs came in, and we were also pursuing some exceptions.

And dealing with other impacts of tariffs through price adjustments, the biggest issue for us from all the tariff activity has been the fact that steel prices have been able to go up under the cover of the tariffs.

They've gone up dramatically, which drove our decision to take 2 price adjustments in 4 months.

So tariffs are on our radar screen.

Jim and I get weekly updates, if not daily, depending on how things are developing in Washington.

And our teams take action immediately, whether it's working with suppliers about a different approach or whether it's working with our customers about integrating a quick price adjustment, or working with the government on looking for some sort of an exclusion.

But it's not -- that does not seem to be the same level of magnitude for us as it is for the other party that you're referencing.

Your next question comes from Matt McCall with Seaport Global Securities.

So just because I don't want to say the word, if you can exclude the smorgasbord for a second and just maybe look at the order pattern you talked about on the day we broke down, you said project and marketing drove growth, continuing agreements were down.

What can you tell us about the underlying market environment?

I mean, the macro seems to be looking better.

I'm wondering what your customer conversation is?

Clearly you're -- you said the order book and the orders not in backlog are helping your outlook.

But if you just think about the market growth and maybe, Jim, your market growth expectations, given what we think is a better macro environment and clearly you've done a lot on the product side.

But what -- just stripping out all the company specifics, how do you think the market is going to behave over the next few quarters?

Well, I think -- and this is Jim.

So from an underlying market perspective, I think what's driving demand right now is a recognition by customers.

And I'll start at the CEO's level and I'm -- and then coming down to the organization.

Everyone is trying to drive growth.

And as they're trying to drive growth, they are trying to do that through innovation.

And I think everyone would like to find ways to squeeze more operating performance out of their top line, but they're recognizing that they have to grow their top line.

If they're going to grow the top line, they have to innovate.

And if they're going to innovate, they've got a lot of stuff to work on.

So they've got to think about digital technologies and how digital transformation is affecting their companies.

As they think about integrating digital aspects into their products, as they think about using new digital technologies to improve their performance, they're also realizing that software development is becoming a bigger part of who they are.

And as that happens, they're beginning to look at their culture and explore what is going to take for them to be an attractive place for a new kind of worker to join their companies.

So attract and retain has always been a part of the conversation we have with customers, and in some ways that's been true for 20 years.

It's more true in economies like this that are strong.

But I think it's amplified because of this shift in our customers thinking about how digital transformation will affect their business.

It also relates to customers who are trying to grow and innovate by accelerating the speed of their own product development by adopting things like Agile.

So as they adopt Agile processes, not just in software development, but also in product development, and really every part of business development, the same thing happens.

They're saying no, we have to attract a different kind of worker and we have to reinvest in our existing workforce.

We have to find ways to help our existing workforce achieve new levels of productivity since there's a recognition that even as they try to attract new workers, that's kind of a near-term game.

The Western markets are increasingly running out of workers.

So the intention is now shifting to, how do I actually help my workforce be more productive.

In the past, we sometimes had to spend some time with customers on the question of whether the workplace itself matters.

Does furniture really matter, does the environment really matter.

We're having zero conversations about that.

They walk in the door already having concluded that the space and the furniture is a key part of helping them reach this next level of performance.

So I think as half of the overall economic factors, a couple of other things we talk about, inflation and trade and also those different things, you've got this recognition by our customers that they've got to find a way to improve productivity and to increase innovation, and this is an important part of the formula.

So if you add all that up, you have, sounds like, cyclical kickers in the form of attract and retain and worker productivity investments.

I mean, the cycle has kind of been a -- I think a disappointment for the group just from a growth perspective, but is this -- are we finally seeing things kind of line up where the leaders have the right products, the employment environment is tight enough, the corporate profit environment is good enough?

So where you start to see a growth rate for this industry, that's maybe sustainable above what's been the average the rest of this cycle?

Well, I -- my crystal ball is only as good as yours and what I would say though is that if you look at the last few quarters, let's go back a bit, you can see the industry beginning to grow and separate from what have been several years of kind of flattish growth or even negative growth.

You're seeing Steelcase's performance improve, but also the performance of some of our competitors are improving.

And so I am seeing a lot of signs that it's, yes there's competition in our industry and we're always a super competitive industry, but everyone is feeling better right now.

How long that lasts?

What happens next?

I don't know.

But I don't think this is something that it's related to like a furniture replacement cycle or anything like this.

I think this is related to the things I talked about a minute ago.

Our clients are struggling to find a way to improve productivity and no longer are they questioning whether the workplace has something to do with it.

And those 2 things together are really positive sign.

I don't know why those things would change, but if those 2 things remain forces, I think that's good news for our industry and for Steelcase.

Okay, that's helpful.

Dave, maybe one for you.

A lot of changes, be it mix or structural changes, for instance, in Europe.

But what are you -- how should we look at the contribution margin profile of the different segments today?

We've -- it's been, I guess, difficult to model because there've been so many moving parts.

Now it seems like you've got more of the ducks in a row.

So how does -- how should we think about the incremental profitability both of the company, but also the 3 segments?

Well, you know our business model pretty well.

We've talked over the years that our contribution margin can be as high as in the mid-20% range when operating expenses are relatively flat.

And we don't have any anomalies going on in the business, like changes in business mix or inflation, like we've seen over the last couple of quarters.

Europe is little -- maybe a little bit less than that, but not very far off of where the Americas would be.

It's just -- but I can't tell you what the incremental contribution margins will be on growth, because there are -- you're right, there are so many moving pieces.

And I've got -- we've got some new moving pieces of acquisitions that are also starting to come into the mix.

But our overall business model has not changed significantly in the last couple of years.

So our variable margins are still quite strong.

And we are -- have said in previous quarters that we feel good about the current level of investment in product development, that's no guarantee that we won't increase it if we have additional ideas in front of us that we want to invest in.

But we've said few quarters ago that we feel pretty good about the level of investments, and I've been rolling operating expenses forward sequentially for you guys to help you see that outside of variable comp and acquisition effects and unusual property gains and the like that the underlying base has been relatively flat, which helps contribution margin.

It's just, right now, we've got a couple of factors with pricing, net of inflation and business mix that are causing a little bit of a drag on the overall contribution margin.

But as I walked through in my remarks, even when you pull all that stuff out in the Americas, it was still pretty solid.

So I wish it was simpler for you, Matt, but it's just not right now.

So I can't give you a specific percentage for you to easily model.

Okay.

All right.

For the long term, the same target exists.

The follow-up question I had.

So Jim, I think you said that you exceeded profit expectations in all 3 segments.

I know you talked about EMEA being higher -- revenue being higher-than-expected.

But was profitability also better than you had expected on the -- for EMEA?

It was actually a little worse than we thought.

But just maybe it was poor modeling.

What was the thought heading into the quarter on EMEA?

Yes.

It's Dave.

It's a little better.

The revenue helped a little bit.

The order strength was really remarkable.

That was significantly better than we were expecting, but a lot of that ended up in backlog.

So revenue was slightly higher, gross margins were a little bit better despite some mix shifts.

Our performance continues to be good.

I love the traction that we're starting to get with lean in our manufacturing facility.

It's not -- we are also handling the high level of volume better.

I mean, it wasn't that long ago that we had some disruption in our factories associated with the restructuring that we were in the midst of.

So this is the first real significant test for them.

And I'd say they're doing quite well in handling that additional volume.

So overall, they performed a little bit better on the top line and through gross margins.

And then operating expenses also were a little bit less than we were expecting, in part because of some delayed spending into the third quarter.

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

This is Steven Ramsey on for Kathryn.

Maybe to circle back on the Orangebox deal, and maybe I missed this.

Can you clarify, do they only sell in the U.K. or is it throughout Europe?

And do you plan to take the Orangebox products and capabilities across the footprint, like into Asia or the U.S.?

Yes.

This is Jim.

So they don't only sell in the U.K., but that's where they're based.

And that is where the majority of their volume is located in terms of revenue.

So that's where their customers are.

So they have customers in the rest of Europe and they have some customers in the Americas and Asia.

But they were really just getting started with that.

And secondly, yes, it is our intent to over time offer those products to our customers in all the regions where we are well established.

So in the rest of Europe where we're strong and in our Americas and Asia, we think those products have relevance and so today.

And we have distribution set up in those places, and we have customers set up in those places.

So we think we can do that faster than they would have done otherwise.

It's also our intent over time, as we globalize their offering to also localize manufacturing as we see fit in different places around the world.

And so that is the grassroot perhaps.

Excellent.

And then thinking along the same line.

Just how the AMQ deal -- how that has gone so far, both the integration and the rollout in tracking towards your goal to double sales of that business over the next 3 to 5 years, kind of how it's tracking versus expectations?

Yes, so our primary focus for this year is to offer those products to our channels in addition to the channels that AMQ has sold to before.

That's going quite well.

We've gotten a great response from our dealers.

We can see it show up in their words.

But also you can see it show up in actual orders and revenues.

And so we are on track versus our expectations for revenue and so on for the AMQ deal.

As you said the word integration, I just want to go back and say, we're not really planning on integrating it per se.

So we like that AMQ is AMQ in some places where we can find synergies better.

Our first priority is not to do kind of operational integration.

They've got their own supply chain, their own business model.

We're helping where we can.

But our primary focus is to make sure those products are offered to our customers through our dealers.

Excellent.

And then staying on M&A, last question.

Are you still actively looking for deals like what the 3 you've done as far as full acquisitions of AMQ, Orangebox and Smith?

And is there any real feeling in your capacity to take on more deals of this size in the next year or so?

So I would say, we're always actively looking.

So you know I was going to say that.

But we don't really have a discrete acquisition plan, like we don't have necessarily a target to say we must buy these many companies or spend this much money.

It's really all connected to our strategies.

So our strategies have been about broadening our price points.

Our strategies are about expanding our markets.

So Smith System allows us to build off of our strong education business that's mostly been aimed at higher ed and extend that out to K-12.

Orangebox is directly related to our desire to expand our offering of furniture that supports people when they're away from the desk, supports collaborations, supports privacy and so it's connected with that.

AMQ is something that really allows us to broaden our price points.

To meet prices of products that customers are already buying.

Our customers are already buying it, they just weren't buying it from us.

So as we see opportunities to do that and more fully meet our customers' needs, we'll continue to explore doing products ourselves, book in some partnerships and doing acquisitions as we see fit.

I wouldn't want to leave the impression that we think we're going to continue at the pace we're at this year.

This is -- we've perhaps been doing fairly few acquisitions to over the last 12 months, doing 3. But I also don't want to leave you with the impression that we've got like an upper and lower range.

We haven't really done that.

(Operator Instructions) Your next question comes from Greg Burns of Sidoti & Company.

In relation to the lower warranty and workers' comp expenses this quarter.

Is that something you expect to remain structurally lower at this point?

Or is that contributing to the sequential increase in operating expenses you're projecting in the third quarter?

And in relation to that, can you just maybe give some buckets of where that incremental spend is coming from quarter-over-quarter?

I might have missed it earlier in the call.

Sure.

This is Dave.

On the warranty and product liability and workers' compensation costs, those are reduction in year-over-year costs.

We've seen our claims experience continue to trend down.

We've -- as Jim mentioned, we've invested in that and have been focused on it over the last couple of years and are seeing some pretty nice results, especially more recently, and the last 4 quarters.

And that not only lowers the costs compared to the last year, but gives us confidence to reduce our reserves for projected future obligations associated with those claims.

So we -- I would expect that you will hear us mention some year-over-year reductions for another quarter or 2. But of course, we've assumed that reduction now in our guidance for the balance of the fiscal year.

On the increase in operating expenses, that's really more about product development initiatives than anything else.

We do have a sales conference in the Americas next quarter -- or this current quarter that we'll spend some money on and a few other things like that, that are driving up operating expenses sequentially.

But it's more -- mostly related to product development and of course, the acquisitions.

And I'm showing no further questions at this time.

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

Thank you, and thanks, everyone, again, for your interest in Steelcase.

We hope to see many of you at our Investor Day in Europe in October.

Have a great day.

Thank you.

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

This does conclude the program, and you all may disconnect.

Everyone, have a wonderful day.