Steelcase Inc.
Q4 2009 Earnings Call Transcript

Published: 31 Mar 2009

[Operator:]

Good day, everyone. And welcome to Steelcase's Fourth Quarter and Fiscal 2009 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. Please go ahead, sir.

[Raj Mehan:]

Thank you, Jamie. Good morning, everyone. Thank you for joining us for the recap of our fourth quarter and fiscal year 2009 financial results. Here with me today are Dave Sylvester, our Chief Financial Officer; Mark Mossing, Corporate Controller and Chief Accounting Officer; Terry Linhardt, Vice President, North America, Finance. We typically also have our CEO, Jim Hackett present with us. Unfortunately, he may not be able to join us today as he is dealing with a dental emergency. He has said to express sincere apologies for missing this call and looks forward to joining the next quarter's call. Our fourth quarter earnings release dated March 31, 2009 crossed the wires early this morning, and is accessible on our website. This conference call is being webcast. Presentation slides that accompany this webcast are available on ir.steelcase.com, and a replay of this call will also be posted to the site later today. In addition to our prepared remarks, we will respond to questions from investors and analysts. Our discussions today will include references to non-GAAP financial measures. These measures are presented because management uses this information to monitor and evaluate financial results and trends. Therefore, management believes this information is also useful for investors. Reconciliations to the most comparable GAAP measures are included in the earnings release and webcast slides. At this time, we are incorporating by reference into this conference call and subsequent transcripts the text of our Safe Harbor statements included in this morning's release. Certain statements made within the release and during this conference call constitute forward-looking statements. There are risks associated with the use of this information for investment decision-making purposes. For more details on these risks, please refer to this morning's release and Form 8-K, the company's 10-K for the year ended February 29, 2008, and our other filings with the SEC. This webcast is copyrighted production of Steelcase, Inc. With those formalities out of the way, I'll turn the call over to our Chief Financial Officer, Dave Sylvester.

[David C. Sylvester:]

Thank you, Raj. Today, we reported a fourth quarter net loss of $65.7 million or $0.49 per share, which compares to net income of $30.6 million or $0.22 per share in the same quarter of last year. In addition to after-tax restructuring costs of approximately $11 million, these results included significant non-cash impairment charges, and further reductions in the cash surrender value of company-owned life insurance or COLI. The impairments charges after the related reductions and variable compensation expense and consideration of applicable income tax benefits had the effect of increasing our net loss by approximately $50 million. We've included a webcast slide to more clearly illustrate the impact of the impairments on our net loss in the quarter. The impairment charges and additional reductions in COLI occurred largely as a consequence of the severe decline in the capital markets. As it relates to the impairment charges, the majority were recorded in connection with the decline of the company's market capitalization, and the related requirement to reconcile reporting unit valuations used for impairment analysis with the reduced enterprise value of the company. For COLI, our cash surrender values decreased again this quarter, consistent with the overall decline in the equity markets. Our earnings estimate for the quarter did not contemplate any increase or decrease in cash surrender value. One other significant matter worth noting upfront is related to income taxes, which included a tax benefit of nearly $8 million in the quarter, resulting from the favorable completion of a multi-year audit with the IRS in the United States. Revenue declined by approximately 27% to $655 million in the quarter. The current quarter decline compares to a strong quarter in the prior year, when revenue grew by more than 15% compared to the fourth quarter of fiscal 2007. As further detailed in our webcast slides, the comparability to last year is impacted by an extra week of shipments in the prior year, as well as divestitures and negative currency translation effects in the current year. Adjusting for these factors, we estimate the organic decline in revenue or same-store sales approximated 17%. This decline was substantially less than the decline in orders we experienced during the quarter as revenue benefited from a general reduction of backlog, consistent with what we communicated during last quarter's call. The operating loss before restructuring costs of $79.8 million included $75.4 million of pre-tax impairment charges related to goodwill, intangible assets, corporate aircraft and other investments. We've also included a webcast slide to illustrate the estimated impact of these charges on our operating loss in the quarter. As you will note from the slide, we estimate our operating loss excluding restructuring costs approximated $10 million before the impairment charges and associated variable compensation expense. This $10 million loss, however, includes the additional reduction in COLI during the quarter, which aggregated $10.5 million and continues to be primarily charged to the North America segment. In that same slide, you will also note a variable compensation adjustment, which had the effect of adding back a portion of the variable compensation impact of the impairment charges or increasing our operating loss in the quarter by approximately $19 million. This adjustment relates to the goodwill and intangible asset impairments, which were driven by the recent reduction of the company's market capitalization. For calculation of variable compensation, as it relates to substantially all employees, we have effectively spread those charges over a five-year period, including fiscal 2009. The spreading of the impairment resulted in higher variable compensation in the current year and will result in lower compensation over the next four years. This methodology was recommended by management and approved by the compensation committee of our Board of Directors last week. The recommendation was based on our belief that these impairments had little to do with employee performance in the current year, but rather were driven by equity market forces and accounting rules. And our concern that removing these assets all in one year from the EVA capital charge could potentially result in excessive bonuses in the future as profits improve with no corresponding capital charge. The amortization methodology is also consistent with past practice within the company's spread, the effect of significant impairment charges over several years for purposes of calculating variable compensation for employees. In total, after taking into account this adjustment, variable compensation expense still decreased by approximately $30 million in the quarter and approximately $60 million for the year, as compared to fiscal 2008. Fourth quarter restructuring costs of $17 million primarily related to the actions communicated in March and December 2008. You will recall the March actions included three plant closures and certain other product moves as well as white-collar reinvention initiatives targeted to eliminate 200 to 250 jobs in North America over an 18 to 24 months period, or 100 during fiscal 2009 and 100 to 150 during fiscal 2010. The portions of these actions planned for completion in fiscal 2009, are now substantially complete. And we believe have achieved the targeted annualized savings of approximately $40 million. And then a much lower costs than originally anticipated for approximately $27 million. While some benefits have been realized to-date, the majority will begin to provide economic benefits more fully as we start fiscal 2010. The December actions included the consolidation of additional manufacturing and distribution facilities in North America, completion of the white-collar reinvention initiatives and further reductions of our white-collar workforce and other operating costs globally. We incurred approximately $14 million of restructuring costs related to these actions during the fourth quarter. And continue to estimate the full cost to approximate 20 million to $25 million and to resolve an estimated annualized savings of an additional $40 million once completed. The workforce reductions were substantially completed during the fourth quarter. And we expect to come with the consolidation activities towards the end of the first quarter. In addition to these actions, we have significantly reduced the number of temporary or contract workers utilized throughout our industrial system. And we began implementing layoffs in the fourth quarter against the WARN Act notices previously issued to our hourly employees in North America. Beyond restructuring impairments and COLI related charges, the remaining reduction and operating income compared to the prior year was largely driven by lower volume. There were benefits from current year cost reduction efforts, but they were generally offset by reductions in the quarter associated with the extra week of shipments in the prior year, reduced operating income dollars resulting from divestitures and currency translation effects, and higher commodity cost inflations which continued to outpace recent pricing actions. Commodity prices continued to retreat during the quarter from their recent historic peaks. We began to see the effects of the moderating prices in our operating results in January, but still experienced inflation for the quarter albeit at the lower end of the 5 million to $10 million range previously estimated. In response to the decline in commodity costs, we eliminated the North American based commodity surcharge in January, have then experiencing increased pricing pressures on existing business. Other income and expense net decreased by $1 million, compared to the prior year quarter. Interest income decreased because of lower cash and investment balances and lower interest rates earned on those balances. In addition, the current quarter included foreign exchange losses compared to gains last year. And we also recorded 1.2 million of additional impairment charges related to our auction rate security investments during the quarter. These reductions where offset in part by a gain of approximately $4 million recorded in connection with the sale of non-operating investment. The effective income tax rate in the quarter and for the full year included the impact of deferred tax benefits of approximately $22 million associated with the non-cash impairment charges. It also included the effects of non-deductible reductions in the cash surrender value of COLI and the release of nearly $8 million of tax reserves, which resulted from the favorable compilation of the multi-year audit in U.S. We have included a webcast slide in order to illustrate these effects. Looking forward, it is difficult to estimate our effective tax rate for the coming year. While he we continued estimate our longer-term effective tax rate will approximate the mid-30s, the impact of tax credits, potential changes and valuation allowances and non-taxable items in general can have significant impacts relative to lower levels of pre-tax income. Accordingly, we are not providing any specific guidance as it relates to our effective tax rate for Q1 or fiscal 2010. Next, I'll talk about the balance sheet and cash flow. Our cash and short-term investment balances approximated a $194 million at the end of the year, a $26 million decrease from the end of the third quarter. While we generated approximately $50 million of cash from the lowering of working capital during the quarter, a portion of this benefit was simply attributable to timing of our quarter and compared to the third quarter, and the related effects on collections, disbursements and certain accruals such as accrued salaries and wages. We also used cash in the quarter for a number of seasonal disbursements including semi-annual bond interest payments, calendar year-end incentives and promotions, property taxes and other obligations. Finally, we paid approximately $6 million to the internal revenue service in connection with finalizing the multi-year tax audit in the U.S. Capital expenditures totaled $16.8 million during the fourth quarter, bringing year-to-date investments to approximately $83 million. Capital expenditures were lower than expected in the fourth quarter and for fiscal 2009, as we did not make the final $13.5 million progress payment related to the purchase of replacement aircraft due to scheduling delays. We expect to take delivery soon and have reached an agreement to transfer our existing aircraft to the manufacturer at or near the same time. Given the current surplus of used aircraft in the market and the related pricing pressures, we impaired our carrying value of the existing aircraft by $8.5 million at the end of our fiscal year, which reflects the agreed upon trading price. Looking forward, we are targeting approximately $60 million in capital expenditures for fiscal 2010, including the final payment related to the replacement aircraft. During the quarter, we paid dividends of $10.6 million or $0.08 per share. We made no share repurchases in the quarter, given the economic uncertainty and our intent to retain cash during this time of volatility. During fiscal 2009, we've returned approximately $130 million to shareholders through quarterly dividends and share repurchases. As of the end of the quarter, we had $215 million remaining under the $250 million share repurchase authorization we announced in December 2007. Our total liquidity position which includes cash, short-term investments, COLI surrender value and credit facility access approximated $550 million as of the end of fiscal 2009. Cash in short-term investments will reduce in the first quarter due to seasonal payments of variable compensation, retirement plan funding and other obligations. In addition, we anticipate that our borrowing capacity under the unsecured credit facility could be reduced as our trailing four quarter EBITDA levels declined with this recession. But, at the same time, we do not currently anticipate any need to access the revolver in the near term. Accordingly, we remain confident in our liquidity position. Now, I will discuss the quarterly operating results for each of our segments and the other category. North America revenue decreased by 22.7%, compared to the same period last year, which included an additional week of shipments due to the timing of our fiscal year-end. Current quarter revenue included a $12 million negative effect related to the sale of Custom Cable in July, 2008 and $5 million of unfavorable currency translation effects, compared to the prior year. Adjusting for the extra week last year and the negative effects of the disposition in currency translation in the current year, we estimate that the organic decline in the North America segment approximated 13% in the fourth quarter. This decline benefited from a significant reduction in backlog and was consistent with the low-to-mid double digit teen percentage decline we estimated during last quarter's call. We experienced declines in revenue across most regions, vertical markets and product categories. In addition, we experienced deeper declines in day-to-day business, compared to project related revenue. Lastly, while sales to the federal government remained strong, we worked through significant backlog to sustain single-digit growth rates and revenue within the healthcare and higher education vertical markets. As noted in our last call, orders early in the third quarter adjusted for the estimated go-forward effect of the September 1st surcharge. We're tracking somewhat lower than the prior year, than the equity markets drop significantly and business capital spending fell off. We in turn began to feel the related effects in our order patterns, which progressively worsened through the end of the third quarter and into the first few weeks of the fourth quarter. Over the balance of the fourth quarter, the recession deepened and likewise our order patterns fell further, again, across most geographies vertical markets and product categories. Within the vertical markets the most significant declines occurred within information technology and fire were financed, insurance and real estate. While the smallest declines occurred in state local governments, higher education and healthcare, orders from the federal government remained very strong. Backlog finished the quarter approximately 20% lower than last year and orders fell several percentage points further than that when adjusted for the extra week in the fourth quarter of the prior year. Despite the weaker order patterns, we continued to host many visits from current and potential customers; particularly, in the healthcare and higher education vertical markets. And in total, the number of customer visits during the fourth quarter approximated to the same level in the same period last year. Operating income excluding restructuring costs was slightly positive in the quarter compared to $29 million in the prior year. The combined effects of lower volume non-cash impairment charges, reductions in cash surrender value of COLI and commodity inflation, which continued to outpace recent pricing actions more than offset the benefits of cost reduction efforts launched in March and early December. Operating expenses in North America decreased by approximately $19 million. The comparison of fourth quarter operating expense dollars versus the prior year includes the favorable effects from the following

[Operator:]

Thank you. (Operator Instructions). We'll take our first question from Matt McCall with BB&T Capital Markets.

[Sean Connor:]

Hi. Good morning. This is actually Sean Connor for Matt. I was hoping, could you... you mentioned the commodity surcharge that you guys eliminated in January I believe. Could you quantify how much the benefit that was in the quarter, was that $6 million of impact with net of that this quarter?

[David Sylvester:]

The 6 million was simply the inflation that we had in the quarter. And we have not quantified the benefit of the commodity surcharge, although it was relatively small.

[Sean Connor:]

Okay. And then just trying to get an idea on... I mean other than that, the pricing pressure that you guys were talking about does that... is there any more color that you can provide there as far as how widespread that is, which markets are seeing the most pressures, the most pushback?

[David Sylvester:]

About the only thing I'd give you Sean is that as you would imagine on the project business, which has declined significantly in the current environment, it's quite competitive. And, as a result, we find that in order to win some of that limited project business, the pricing is just a little bit more severe.

[Sean Connor:]

Okay. Thank you.

[David Sylvester:]

Okay.

[Operator:]

We'll take our next question from Budd Bugatch from Raymond James.

[Unidentified Analyst:]

Thanks. This is actually TJ Macando (ph) filling in for Budd. Dave, I was hoping that you might be able to maybe give us a bit more of a quantification of the difference in the commodity, while inflation that you saw in the beginning of the quarter versus the deflation you saw in the back half, does the guidance assume that the deflation continues at that same rate, maybe give me a little bit more color there?

[David Sylvester:]

Well, just reiterate what you said, we expect in the first quarter for deflation to approximate 5 to 10.

[Unidentified Analyst:]

Okay.

[David Sylvester:]

We also would expect that we would continue to realize some benefit of pricing actions that we implemented last year, albeit relatively small. So, we would expect a good guy so to speak go-forward which is trend of a bad guy for the last several quarters.

[Unidentified Analyst:]

Okay, got you. And then just that $11 million of divestitures; is that all in the North American segment or is it... is there any International there?

[David Sylvester:]

What is Mark there?

[Mark Mossing:]

90% is North America.

[Unidentified Analyst:]

Okay. And one more if I could. The CapEx for the first quarter looks like it's going to include that last airplane payment. For the full year, I know you haven't given guidance on any other line items, but could you maybe give us some color on what you're expecting for the full year of CapEx and maybe depreciation?

[David Sylvester:]

Well, we said CapEx will probably be around 60 million that's what we are targeting for the full year, including the 13.5 million in the first quarter.

[Unidentified Analyst:]

Okay.

[David Sylvester:]

Only other color I would give you TJ is that we would expect first quarter to be a little bit higher than the balance of the year.

[Unidentified Analyst:]

Got you.

[David Sylvester:]

Because we are in the midst of launching a number of new products.

[Unidentified Analyst:]

Okay. Okay, guys. That's very helpful. Thanks for taking my questions.

[Operator:]

We'll take our next question from Todd Schwartzman with Sidoti and Company.

[Todd Schwartzman:]

Hi. Good morning guys. First, of that latest $40 million piece of the cost savings, in which quarter should we expect to see you guys hit the full run rate?

[Mark Mossing:]

I would say towards Q2, Q3, we should get almost all of them. There is really one component that will stretch over the, I would say the entire part of the next year and that's the continuation or completion of our reinvention initiatives. The factory consolidation work should be done by the end of the first quarter. And as I said the head count, the broader head count reductions were substantially completed during the fourth quarter. So, just a little bit of the 40 million will trickle in through the balance of the fiscal year. But the head count reductions, the broader head count reductions and the plant closure should be entirely done by the end of the first quarter.

[Todd Schwartzman:]

Okay. Now, I know you... regarding the revenues, I know you'd mention it high education and healthcare both were up in the single digits. What about shipments to the federal government in Q4?

[Mark Mossing:]

Shipments to federal government grew in fourth quarter. And orders were strong in the fourth quarter as well.

[Todd Schwartzman:]

Okay. So a low single digit kind of growth?

[David Sylvester:]

It's not a huge base, so the percentages can get a little bit out of control. So I don't... to be honest, I don't have it at the top of my head. But it was... it's a nice business to have right now.

[Todd Schwartzman:]

Okay. Regarding customer visits, it sounds like the visits held out better than the revenue in Q4? Is that is the case and would you say that visits are maybe losing some of their predictive value or is it just the macro environment that we are in?

[David Sylvester:]

I would tell you a couple things. One is I think we are starting to lap the prior year decline in customer visits. But also there is a lot of interest in what we're doing in the healthcare segment, what we're doing in higher education segment, as well as the new products that come to market that we showed at NeoCon last year. So even the projects may not be in the absolute near-term, there is still a lot of interest to understand at a deeper level what we showed at NeoCon.

[Todd Schwartzman:]

So, due to somebody's vertical markets people are coming but maybe for different reasons than they did a couple of years back?

[David Sylvester:]

Maybe, it's hard to say. But I would... the healthcare and the higher education areas still feel okay. I don't know that they are going to grow necessarily in the next several quarters. But none of us would expect them to decline at the same pace as the other vertical markets.

[David Sylvester:]

Okay. Last question is, are there any potential covenant, debt covenant issues that we should be aware of?

[David Sylvester:]

No. I mean other than what I said as the recession continues to play out into our earnings, our trailing four quarter EBITDA is going to continue to come down. And, therefore, our access could shrink. But we can imagine scenarios where there could be a covenant violation. But, we are not forecasting one in the near term.

[Todd Schwartzman:]

How high can you go with the debt to EBITDA?

[David Sylvester:]

Three to one on trailing four quarter and the current EBITDA calculations currently include restructuring costs as well as COLI reductions, which are really a couple of large reductions of EBITDA.

[Todd Schwartzman:]

Got it. Thank you very much.

[David Sylvester:]

Yeah.

[Operator:]

Okay. We'll take our next question is from Mark Rupe with Longbow Research.

[Mark Rupe:]

Hey guys, just had a question on kind of order trends. I know you commented on briefly and then in your Q1 guidance obviously speaks for itself about your peers admissions and stabilization in March. I am just curious to see albeit at a lower level that you've see any kind of stabilization in order patterns?

[Mark Mossing:]

Thanks for the question. When you get into February, March, you expect to see a seasonal uptick and as we noted in our commentary, we actually have seen that. But again, we are already 25 to 30% down, so that stabilized really.

[Mark Rupe:]

Stabilize at the lower level, okay. And then just as it relates to pricing, how rational is it versus kind of the last downturn that you've seen? Obviously, the downturn has happened here real fast. But I mean do you expect to see more aggressive pricing going forward or do you think is that a level where kind of rational versus the lifetime?

[David Sylvester:]

I think that remains rational.

[Mark Rupe:]

Okay. Thank you.

[Operator:]

We'll take our next question from Barry Haimes with Sage Asset Management.

[Unidentified Analyst:]

Yeah. Hi. Actually, this is (inaudible) at Sage. I guess I was asking for some more color on some of the international markets. Did I... two questions I guess, one is very interesting to say that the emerging markets had been holding up just recently rolled over. Did I get that right? And number two; if you can give me some color more on France and your expectations there, why the projects held up? And is that something that will sustain, or is it just a tailwind of some other projects or, what do you think for France?

[Mark Mossing:]

On the emerging markets, you are right, the order patterns slowed considerably during the fourth quarter after holding up. They were moderating in the third quarter, but fell-off considerably in the fourth quarter. And on France, I would tell you that there is a little bit of a couple of things going on. First is, that clearly some of the planning for these projects was relatively long-term, and that planning has not been entirely deferred. So, we have some of that activity or that tail to use your word just coming in. And the other is France has been in the decline for later part of the year. So, they could be potentially stabilizing and starting to come out of it. But it's really too early to tell.

[Unidentified Analyst:]

Thank you.

[Operator:]

We'll take our next question from Matt McCall with BB&T Capital Markets.

[Sean Connor:]

Sean again. I just had a quick follow-up again on the International order patterns. This time I wanted to get a general relationship to how quickly those markets, at least your largest markets react with in response to like the U.S. And those markets seem to come down and weakened on a lag versus what you saw here domestically. Is that expected in a stabilizing environment and even once we eventually see trends improve, or there are other dynamics there that can shift and drive that performance?

[David Sylvester:]

What to expect to go forward is a bit challenging to forecast Sean. But what I would tell you from my experience when I was in the International business during the last recession, if the lag that we experienced in most International markets relative to the U.S. decline seemed longer than what we've experienced most recently in the current decline. This was... this just fell much faster and steeper. Now, whether or not we'll see a different trend as we come out remains to be seen.

[Sean Connor:]

Great. Thank you.

[Operator:]

(Operator Instructions). It appears there are no further questions at this time. Mr. Sylvester, I'd like to turn the conference back over to you for any additional or closing remarks.

[David Sylvester:]

Well, I would just thank everyone for participating in the call. And we look forward to updating you on our first quarter results in late June. Thanks very much.

[Operator:]

That does conclude today's conference call. We thank you for your participation. You may disconnect at any time.