Steelcase Inc.
Q2 2010 Earnings Call Transcript

Published: 24 Sep 2009

[Operator:]

Good morning ladies and gentlemen my name is Misty and I will be your conference operator today. At this time I would like to welcome everyone to the Steelcase Second Quarter Fiscal 2010 Earnings 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 Raj Mehan, Director of Investor Relations.

[Raj Mehan:]

Thank Misty, good morning everyone. Thank you for joining us for the recap of our second quarter fiscal year 2010 financial results. Here with me today are Jim Hackett, our President and Chief Executive Officer; David Sylvester, our Chief Financial Officer; Mark Mossing, Corporate Controller and Chief Accounting Officer, and Terry Lenhardt, Vice President, North America Finance. Our second quarter earnings release dated September 24, 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 www.ir.steelcase.com and a replay of this call will also be posted to the site later today. I did want to mention, in the spirit of increased transparency and simplicity we have enhanced the disclosure in our webcast slide, so I would encourage you to review these in addition to our normal disclosures. 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 statement 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 27, 2009, and our other filings with the Securities and Exchange Commission. This webcast is a copyrighted production of Steelcase, Inc. Now, with those formalities out of the way, I will turn the call over to our President and CEO, Jim Hackett.

[Jim Hackett:]

Thank you, Raj, and good morning. If you take the time to compare our impressions of the second quarter with the transcript of this call after the first quarter you are going to see a similar story. The effects of the global recession have not abated, however we are pleased to be profitable this quarter before restructuring even though we didn’t hit our revenue target for the quarter. The work we have done as a company to enable us to make money, even when our top line declines as far as it has, is an indication of the outstanding efforts of the Steelcase people around the world. They truly exceeded our expectations in reducing and deferring costs. Now three months ago I told you we believed there was a good chance our industry had hit bottom in this recession. Even though there is still a great deal of volatility in our business, we continue to think it’s possible that we will be able to look back at Q1 of this fiscal year as a low water mark. Now, certainly in the financial sector, specifically the banking industry, where more than 2/3 of the stress test losses have been realized, there are signs that bode well for eventual stability in the economy. When you look back at where the economy was a year ago, and the potential precipitous decline that we all did experience, I think you can see our company has fared pretty well in an extraordinary situation. The game now is to continue positioning Steelcase for the broader economic recovery. Now here is just one indicator

[David Sylvester:]

Thank you, Jim. Today we reported break even net income for the second quarter of fiscal 2010 which was consistent with the estimate we communicated last quarter. Excluding restructuring costs operating income of $16.4 million significantly exceeded our estimate of approximately break-even results. These results were achieved despite second quarter revenue falling $22 million short of our $600 million estimate. Income from company owned life insurance, or COLI, played a large role by delivering approximately $10 million more than we typically expect in a quarter. In addition, we recorded a $3 million gain in connection with settling a domestic property tax dispute. For COLI, consistent with the overall performance in the capital markets, our cash surrender values increased again this quarter following significant declines in the third and fourth quarters of fiscal 2009. Like any other quarter, our earnings estimate for the second quarter contemplated a $2 million increase in COLI consistent with what we would normally expect over a longer-term investment horizon. Setting aside COLI and the property tax gain, it is important to note that we remain profitable at the operating income line before restructuring costs even though revenues came in short of our estimates. Strong cost control efforts, deferred spending patterns, and better than expected manufacturing performance served to offset the volume shortfall. What I mean by deferred spending patterns is that we believe the first half of the year has benefited somewhat from deferral of activity to the back half of the year. Some of this effect is simply a function of project timing and some is likely due to the distraction of restructuring activities which have been very high for the past several quarters and are now starting to ramp down. While we won’t quantify any specifics today, we do anticipate that operating expenses, primarily related to product development, may increase modestly over the second half of the year. From a revenue perspective we experienced a 6% sequential improvement compared to the first quarter and expect this seasonal improvement pattern to continue into the third quarter. While the next several quarters will remain challenging for our industry, we continue to believe that the first quarter of this fiscal year may have been the low water mark for our revenues in this downturn. Compared to last year the $39 million decrease in operating income before restructuring costs was largely driven by loss contribution margin relative to our fixed costs associated with the $324 million decline in revenues. Decreased variable compensation expense softened the contribution margin effect of lower volume as variable compensation is tied to levels of profitability and EVA and accordingly was reduced by approximately $29 million in the quarter as compared to the prior year. Other factors which offset a portion of the negative volume effects included benefits from recent restructuring activities and strong cost control efforts, $12.4 million of COLI income compared to a loss of $2.1 million in the prior year; approximately $15 million of lower commodity costs compared to last year, and a benefit of nearly $10 million from temporary reductions in employee salaries and retirement benefits which took effect March 2. As compared to the first quarter operating income excluding restructuring costs increased by $19 million driven largely by the seasonal improvement in North America revenue, lower commodity costs, and additional benefits from our cost reduction efforts. Lower COLI income offset a portion of these benefits. We have substantially completed all of the restructuring actions announced in March 2008 as well as the headcount reductions announced in early December. Each targeted to reduce our annualized operating costs by approximately $40 million, or $80 million in total. In addition, the temporary reductions to employee salaries and changes to retirement benefits announced in February and June of 2009 were implemented with an effective date at the start of the fiscal year; therefore our results are benefiting from these temporary actions by nearly $10 million per quarter while these actions remain in effect. Regarding the additional reductions to our global white-collar workforce and the continuation of various smaller facility consolidations that we announced in June, we have substantially completed the white-collar workforce reductions during the last three months. Including the completion of negotiations related to the international workforce reductions, which occurred earlier than expected, pulling the associated restructuring costs forward into the second quarter. And, we continue to make progress against the smaller facility consolidations. You will recall that these additional actions in total were expected to decrease our annualized operating costs by $20 million, or $5 million per quarter. A small portion of these savings began to be reflected in our second quarter results while the balance is expected to be realized over the third and fourth quarters. For your reference we have included a supplemental webcast slide which summarizes all of the major actions we have taken since the start of this downturn

[Operator:]

(Operator Instructions) Your first question comes from Chad Bolin with Raymond James.

[Chad Bolin:]

I have a couple of questions. Last quarter I think you said you saw a modest pricing benefit. Could you quantify what pricing was in this quarter and are you seeing any significant changes or anything new on the competitive front?

[David Sylvester:]

From a pricing perspective we really didn’t see any kind of additional benefit this quarter; last quarters was quite small. With respect to the second part of your question, I would say that we haven’t seen any dramatic changes in pricing patterns. It remains highly competitive, as you would expect in a downturn, especially around the few projects that are out there.

[Terry Lenhardt:]

That’s right. We talked about it last quarter, the markets being competitive and that environment is pretty similar to last quarter.

[Chad Bolin:]

Okay and talking about operating expenses, it sounds like, at least on a sequential basis and certainly through the back half of this year, you will get a more significant benefit from that last piece of cost reductions with a white collar workforce and facilities consolidations, but that will be offset to a certain extent by some of the deferred spending, maybe product development that you talked about. Could you perhaps help us maybe quantify what incremental savings you would see in the second half and maybe give us a sense of that in comparison to that increased spend?

[David Sylvester:]

Let me start with the restructuring actions that are yet to be completed. If you go to that webcast slide that we included where we laid out all of the actions we have taken since the beginning of the downturn, the March actions are 100% in our run rate as of this quarter and probably even as of the previous quarter. The December actions I would say are largely in, maybe a tad yet to be realized and I can’t tell you whether those are going to come in OpEx versus restructuring, but very little of them may be an additional $1 million kind of quarterly benefit comes in from the December actions. The temporary reductions in employee salaries as well as benefits, those are in 100% and have been in since the beginning of the fiscal year. So it is just this last piece in June that we announced of the workforce reductions and the smaller facility consolidations were $20 million, or $5 million a quarter. I would say roughly $1 million is in our second quarter results and the balance of $4 million probably comes in evenly over Q3 and Q4. The split between OpEx and COGS I would be guessing, but 50/50 would probably not be too far off.

[Chad Bolin:]

Okay and can you give us a sense of the magnitude of any of the spending increase planned for the second half?

[David Sylvester:]

Well I said we wouldn’t quantify specifics, but we do see operating expenses going up in the second half of the year. So, if you are doing a sequential analysis you are going to take OpEx down a little bit next quarter for the cost reduction benefits, but then you are going to take it back up something more in order to account for what we are saying is going to happen; which is we think they are going to increase modestly.

[Chad Bolin:]

Great, well that is very helpful. Thank you very much.

[Operator:]

Your next question comes from Matthew McCall of BB&T Capital Markets.

[Matthew McCall:]

Dave, you hit on the temporary costs. I think I ask this question every time I talk to you, but Jim, as you look at the way you see the world, you said you see the business up next year, talk about how we should anticipate some of these costs coming back into the models.

[Jim Hackett:]

Dave is not going to give a lot of specifics, but let me broadly paint a pictur5e for you of what causes that. For a moment consider that the kinds of costs that the Company might expand are principally around product development and it is an important indicator that they are in areas where we are seeing good results even in a down turn with some of our new products. They are just starting, so they are kind of de minimus to effect of top line, but being in the business as long as a number of us have, you can just read this that these are products that are going to be of high acceptance. So, there are categories in products that are getting continued investment because of this early good start. They are on plan. They are hitting the projections that we imagined even in spite of the downturn. So, we have this touchy tipping point which is starting to expand investment in that so that we have these ideas and notions ready to go when the market really picks up again. That is the broadest view of why expenses come back. It is mostly because of product development. What won’t happen is that much of what we built in terms of support structures and systems to help the business, I am vaguely referring to the shared service structures that we have invented and created over the last 2 ½ years, those costs that have been able to be shifted to those setting don’t come back; that is a good thing and it is making us very competitive globally. A third area which is a temporary kind of reduction is the employee salaries. In Michigan, where of course we are headquartered, we saw where one automotive company just announced that it was going to increase the salaries, or bring them back, and I feel that pressure to address that, but this isn’t a quarter call where I am. There are a number of indicators that we are going to be using to make that decision. The first people we have to tell is our employees and that line item is a big number back in our business when it comes back, but the good news is we have the choice of when to put it back so that we don’t destroy value or destroy profitability. Those are kind of the three areas I would have you think about. Product development, their shared service centers are going to allow us to have persistent cost reduction and then we have a management decision of when to bring the salaries back.

[Matthew McCall:]

Okay, thank you Jim that was helpful. I think you said there is a similar message this quarter versus last and it is kind of a message of stability. If you look a little deeper and you talk about the order patterns that you are seeing, Dave, I think you mentioned that day-to-day business is a little stronger, but is the volatility in the business stabilizing at all or are we bouncing along a very volatile bottom?

[David Sylvester:]

Let’s let Terry take that because he has been studying that very question.

[Terry Lenhardt:]

Volatility does continue and we talked about that in our script. When you look at the volatility though, you are not getting as severe of the volatility if you say look at our weekly order patterns and our two-week rolling average. They are not as severe as they were prior to mid first quarter

[Jim Hackett:]

If you go across the ocean and get into the international markets you almost have to go country by country. I guess what I would call out is that I think that Germany and most of Eastern Europe are still quite volatile. As we have said before, France, Spain, and the UK, who is now laughing, at the beginning of the recession they are starting to see somewhat less volatility, but still volatile and I guess I would stop there.

[Matthew McCall:]

Okay. I am going to sneak one more in. The amended facility, any costs associated with that in the quarter, Dave?

[David Sylvester:]

No. We have a good relationship with our bank group and they have been very supportive in the way we are running the business and our capital structure and so they were comfortable giving us an amendment through the middle of November for free. I think they are going to try to make up for it in the new facility.

[Matthew McCall:]

Okay, thanks guys.

[Operator:]

Your next question comes from Todd Schwartzman with Sidoti & Company, LLC.

[Todd Schwartzman:]

Will you quantify the second quarter year-over-year benefit in commodity pricing relative to the $15 million, I think you said, year-over-year benefit you expect to see in 3Q?

[David Sylvester:]

Yes, it is $15 in the second quarter and about $15 in the third quarter, again compared to prior year. No sequential increase or decreases significant going from Q2 to Q3. We did however see some sequential benefit coming into Q2 from Q1.

[Todd Schwartzman:]

Okay and my other question is can you update us on the restructuring actions going on in Europe?

[Jim Hackett:]

Well, I would tell you that as I said we completed our negotiations with the work counsel in France a little bit earlier than we anticipated which ended up pulling forward the restructuring from Q3 to Q2 and they are in the process of implementing now.

[Todd Schwartzman:]

There is nothing else major to speak of?

[Jim Hackett:]

We really can’t get into that on the call. If we had plans, we would need to first discuss them with the work counsel.

[Todd Schwartzman:]

Great, okay thank you.

[Operator:]

Your last question comes from Margo Mertah with Schneider Capital Management.

[Margo Mertah:]

I was curious about the renegotiation of the credit line. Can you talk any more about what kind of covenants might be put in place as opposed to where they are now, what interest rate you might expect? Do you expect to dip into that line? To address the liquidity situation more, what are the priorities? You have cash, you have COLI you can borrow against. When you look at your different scenarios can you tell me more about the sources of liquidity and the priorities?

[David Sylvester:]

Right now what we are continuing to do is to try to operate the business at break even operating income; you and I have gone through the math before. The reason we target that is we believe we are not burning any significant cash, if we are operating at break even before charges, and that has been our objective and so far we are not too far from that, especially when you factor in our guidance for the third quarter. So, it should be through three quarters we will be pretty close to that objective. Restructuring charges uses cash, but so far it also has had a relatively fast pay back so we have kind of held that aside. Our objective of cash is simply to continue to protect the strength of our balance sheet in this downturn, so we have been taking actions in order to operate at the break even level, in order to protect the already strong balance sheet which, as you know, includes a significant amount of cash and COLI, and consistent with our efforts to protect the strength of the balance sheet we have decided to pursue negotiations of a renewed credit facility. We have taken that number down, the amount of the facility down, for two reasons

[Margo Mertah:]

Okay, so you are saying if operating incomes are break even you can maintain your cash level basically and not dip into anything else, is that what you are saying?

[David Sylvester:]

Broadly speaking yes, because if you think about break-even operating income before charges, if you add back $80 million of depreciation and amortization that gives you enough cash generation to cover CapEx at $40, interest expense at $20, and dividends at $20 on an annualized run rate.

[Margo Mertah:]

Okay so you can’t say anything more about what interest rate you might expect on the renegotiated credit line or covenants?

[David Sylvester:]

Well what I expect is a really low one, but what the banks are willing to, I think we are near that.

[Margo Mertah:]

Right, do you have any estimate of how much they might, I mean what is the going rate or how much they might raise?

[David Sylvester:]

Spreads are continuing to tighten, so I just really don’t know, but I would hesitate to even speculate. Let us finish the negotiations. The capital markets are just starting to stabilize versus a year ago. It is amazing to think it is just a short year ago when kind of the devil broke loose and I am seeing some data this week about the stabilization in the banking system, it is just getting better and better. As a company we still have to perform and have those discussions with our lenders about why Steelcase is as solid as it is and as you know, we have a very conservative balance sheet so from that perspective it is not a hard discussion. The perspective is what kind of rate we are willing to take, so we are highly motivated to keep that as low as we can of course.

[Margo Mertah:]

Okay, well thanks very much and good luck.

[Operator:]

With no further questions, gentlemen I would like to turn it back to you for any additional comments or closing remarks.

[Jim Hackett:]

Sure. I would just like to thank everyone for the call and remind you that as David was talking about the break even position that this is an extraordinary achievement in an industry like ours given that the top line did drop. I am really proud of the fact that the Company is focused on profitability. Our employees are very committed to that and the kind of decisions that we have made and the long-term strategy that we are taking, we are turning the Company towards a really nice recovery of profitability when the demand comes back with the recession abating. I just want to underscore that and thank you for your time today.

[Operator:]

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation. (Operator Instructions)