Steelcase F3Q08 (Qtr End 11/23/07) Earnings Call Transcript

Dec.20.07 | About: Steelcase Inc. (SCS)

Steelcase, Inc.(NYSE:SCS)

F3Q08 (Qtr End 11/23/07) EarningsCall

December 20, 2007 11:00 am ET


Raj Mehan - IR

Jim Hackett - President and CEO

Dave Sylvester - CFO


Chad Bowen - Raymond James

Chris Agnew - Goldman Sachs

Matt McCall - BB&T CapitalMarkets


Welcome to Steelcase's thirdquarter conference call. As a reminder, today's call is being recorded. Foropening remarks and introductions, I would like to turn the conference callover to Mr. Raj Mehan in charge of Investor Relations.

Raj Mehan

Thank you, Jenna. Good morning,everyone. Thank you for joining us for the recap of our third quarter fiscalyear 2008 financial results. Here with me today are Jim Hackett, our Presidentand Chief Executive Officer; Dave Sylvester, our Chief Financial Officer; MarkMossing, Vice President and Corporate Controller; and Terry Lenhardt, VicePresident, North America Finance.

Our third quarter earningsrelease dated December 19, 2007 crossed the wires after the market close yesterdayand is accessible on our website. This conference call is being webcast.Presentation slides that accompany this webcast are available on,and a replay of this call will also be posted to this site later today. Inaddition to our prepared remarks, we will respond to questions from investorsand analysts.

Our discussion today will includereferences to non-GAAP financial measures. These measures are presented becausemanagement uses this information to monitor and evaluate financial results andtrends. Therefore, management believes this information is also useful forinvestors.

Reconciliation to the mostcomparable GAAP measures are included in the earnings release and webcastslides. At this time, we are incorporating by reference into this conferencecall and subsequent transcript the text of our Safe Harbor Statement includedin yesterday's release.

Certain statements made withinthe release and during this conference call constitute forward-lookingstatements. There are risks associated with the use of this information forinvestment decision-making purposes. For more details on these risks, pleaserefer to this morning's release and Form 8-K; the Company's 10-K for the yearended February 23, 2007; and other filings with the Securities and ExchangeCommission. This webcast is a copyrighted production of Steelcase, Inc.

With those formalities out of theway, I'll turn the call over to our President and CEO, Jim Hackett.

Jim Hackett

Thank you, Raj, and happyholidays to everyone, and good morning. I am pleased, today, to report that thecompany is in excellent shape. There is a great deal to be proud of with our Q3performance, and I want to share with you some of the highlights.

We have been reporting in ourpast calls that we are quite excited about the continued improvement in theindustrial system. Now, this is the system that, once an order is taken,product is built and then shipped. That end-to-end system has gone through amodernization and adoption of Lean manufacturing principles.

As many of you have read orlearnt about this system, it is the gift that keeps on giving. The Lean is amethod, it's a process, it's a mindset, that enhances operational performance.Allow the adoption of Lean signals a start; there really is no end to thiseffort. The gains continue to appreciate, and we continue to see them showingup in our numbers.

From this call, we have reportedon a number of gains that we have made in this area in the past. One, today, Iwant to highlight. I was in our West Michiganwood facility last week, which is one of many that has gone through thismodernization. For me, the strong adoption of Lean principles is a key to theturnaround in the operating performance of this segment, and we are pleased toconfirm, as we told you we would, we met the goals that we set out forourselves a year ago.

Our North American manufacturingteam led by [Hammed Carmen], has had a stellar performance. Congratulation to [Hammed].

The modern notion of thisprinciple is that it can be highly efficient. And I want to point this out;manufacturing can also be a sustainable operation. Our wood factory uses a UVFinishing Process that provides not only the best finishing process in ourindustry, but you know what…it's a state-of-the-art, sustainable process withinthe industry, today.

From my view, I suspect that inthe near future furniture makers who haven’t adopted sustainability standardswill be challenged by customers to demonstrate their commitment to this. Candidly,less sustainable products won't be acceptable, it's becoming expected, and weare already there.

This lean and sustainablemanufacturing mindset flows through our whole global system. And, as you hearmore of our investments in Asia production, Iwant to confirm it to you that we will be faithful to those principles all overthe world. Steelcase has built a global supply system that allows us to competefor business on every continent. It can also be a hedge to currencytranslations, as well as advantage for parts in assembly configurations. But Iwant to expand the notion to a concept called “best showing”. It's a term thatwe borrowed from others, which means that you can move production to the placeof a best advantage to serve your customers.

The company has already startedbuilding a shared service centre in Malaysia that has allowed us tomanage our growth with a shared resource across multiple geographies. Now, truethere is a cost advantage, or what is known as labor arbitrage; but the more welearn about this captive centers, and the more we benchmark to other companies,the more we learn that the shared capability is the key to serving our globalcustomers, wherever they might be around the world.

It’s a way to add value. DaveSylvester will point out other highlights in our financials. But I want them toscore that you will hear, we are dialing up our longer term performance goalsand in working with our board, we've firmed up our go-forward financial policy.The company has systematically worked down its reliance on capital. This hasallowed us to pursue investments in our business, like the Ultra acquisition inChina,and returning value to shareholders through dividends and buybacks.

In the end, though, with all ofthis, our employees’ commitment to serving their customers brings the mind ofwell used phrase from one of our founders in 1912. He said, "Serve yourcustomers well, and profit thereby." It reminds us that we will continueto work to be better to achieve more. You never lose sight that--what makes a greatcompany is a commitment to the customers we serve, and the people who areassociated with this enterprise.

So, with those positive commentsand enthusiasm I hope you can see in here, I want to turn it over to our ChiefFinancial Officer, Dave Sylvester.

Dave Sylvester

Thank you, Jim. Today we reporteda third quarter profit of $31.3 million, or $0.22 per share. These resultsincluded the $21.1 million charge related to goodwill and intangible assetimpairments which, after reduction of related variable compensation expense andincome taxes, reduce net income by $11.3 million, or $0.08 per share.

While I will review theimpairment charges in greater detail later in the call, it is important to notethat our third quarter earnings guidance of $0.27-$0.32 per share did notanticipate these charges. Accordingly, our net income performance for thequarter is otherwise inline with the guidance we provided in September.

In the prior year, we've reportedthird quarter net income of $32.8 million, or $0.22 per share, which included$3.6 million of after-tax restructuring charges primarily related to theconsolidation of our manufacturing activities in North America.

Revenue of $885.9 million in thecurrent quarter represented a 10.5% increase over the prior year, whichexceeded the guidance of 3%-7% we provided last quarter. Sales growth in allsegments was higher than our expectations, as was the impact of foreigncurrency translation. North American revenue, which represents approximately58% of total revenue for the quarter, was up 9.4%, compared to prior year, andour international segment which approximates 26% of total revenue, reported15.6% sales growth over the prior year.

Representing its seventhconsecutive quarter of reported double-digit sales growth, compared to theprior year, current quarter revenue included a favorable impact of $23.2million from currency translation effects. And an unfavorable impact of $25.2million, related to dealer deconsolidation, net of acquisitions completed within the last four quarters.

Operating income for the quarterwas $52.7 million, compared to $40.5 million in the prior year. Included in ourthird-quarter operating income were pre-tax restructuring credits of $100,000,compared to pre-tax restructuring charges of $5.7 million last year.

Operating income, excludingrestructuring items was $52.6 million, or 5.9% of sales in the current quarter,compared to $46.2 million, or 5.8% of sales in the prior year. This representsa 14% increase in operating profit over the prior year, which was driven by betterperformance in all of our segments, offset, in part, by the impairment chargesrecorded in the other category.

We've included two webcast slidesto more clearly illustrate the impact of the impairment charges and relatedreductions in variable compensation expense on operating income by segment,along with the consolidated impact on net income and earnings per share.

Cost of sales, which does notinclude restructuring items declined 200 basis points to 66.5% of sales,compared to 68.5% in the prior year. North Americareduced its cost of sales percentage by 230 basis points, versus the prioryear, and international improved by 30 basis points over the same period.Benefits from prior restructuring actions and increased volume primarilycontributed to the improvement. These factors, in addition to a netrestructuring credit in the current quarter, compared to net restructuringcharges in the prior year, increased gross margins to 33.5% in the thirdquarter, from 30.8% in the prior year quarter.

Operating expenses of $244.2million, which do not include restructuring items, were 27.6% of sales, up from$206.6 million, or 25.8% of sales in the prior year. The $37.6 million increaseover last year was driven by several factors, including the $21.1 millionimpact of the goodwill and intangible asset impairment charges. Again, it'smore clearly illustrated in our web cast slides.

$6 million in increased sales,marketing and new product development spending, $6 million in unfavorablecurrency translation effects, and $4 million of additional investments inlonger term growth initiatives. In addition, third quarter deconsolidations ofdealers--net of acquisitions completed in the last twelve months--had theeffect of decreasing operating expenses by approximately $7 million. As we'vesaid in previous calls, we remain focused on controlling our operatingexpenses, but we also expect to continue investing in initiatives that webelieve will contribute to growing our top line.

Other income net was $3.6 millionfor the quarter, compared to $13.9 million in the third quarter of last year.As you will recall, last year included $4.9 million of gains related to adealer transition, and a minority investment in a Europedealer. During the current quarter, we repatriated an additional $30 million ofcash from our Canadian subsidiary, which resulted in foreign withholding taxesof $1.5 million that were recorded as a non-operating expense.

We expect to recover these taxes throughutilization of a U.S foreign tax credit recorded within our current quarterprovision for income taxes. Lastly, net interest income was lowered this year,due to lower average interest rates. Our year-to-date effective tax rate wasincreased to 37.9% during the quarter, up from 37% at the end of the secondquarter, resulting in nearly 40% effective tax rate for the current quarter.

The increase during the thirdquarter was primarily driven by the goodwill impairment charges recorded duringthe quarter which were not deductible for tax purposes and no net relatedincome benefit was recorded. In addition, the favorable impact of foreign taxcredits related to the repatriation of cash from our Canadian subsidiary waspotentially offset by other adjustments during the quarter. As the result ofthe impairment impact, we now affect our four year effective tax rate toapproximate 37%-37.5% for fiscal 2008.

Next, I'll talk about the balancesheet and cash flow. Our cash and short term investment balance approximated$544 million at the end of the quarter, a $65 million increase from the end ofthe second quarter, and a $19 million increase from the same quarter last year.

We've generated $105 million ofcash from operations in the third quarter, which was influenced primarily bystrong profitability adjusted for the non-cash impairment charges, non-cashaccruals for variable compensation, and benefits and improvement in workingcapital metrics.

Capital expenditures of $21.4million during the third quarter represent an increase over recent quarters,which is consistent with our guidance that we expect capital expenditureinvestments increase in the near-term, as we ramp up new product developmentefforts, invest in our showrooms and corporate facilities, and plan to replacean existing aircraft.

We estimate that fiscal 2008,capital expenditures will approximate $75 million-$85 million. During thequarter, we've invested $14 million to complete the acquisition of the UltraGroups office furniture business.

Ultra is one of the leadingoffice furniture companies in China,which, again is one of our targeted emerging growth markets. This acquisitionwill broaden our capabilities in distribution, product portfolio and manufacturingto support the expansion plans of our customers throughout Asia.

Also, during the quarter we'vecompleted the sale of our manufacturing campus in Strasbourg plants, which we had exited inconnecting with previous restructuring activities.

We received net proceeds from thesales of approximately $11 million, and recorded related net restructuringcredits of $500,000 in the quarter. We take quarterly dividends of $21.2million, or $0.15 per share, and early in the quarter we also repurchasedapproximately $806,000 shares of common stock, at a total cost of $14.7million--or at an average price of $18.25 per share.

For the balance of the quarter,however, we operated under a self-imposed trading blackout, seating sharerepurchases while we evaluated the capital structure changes announcedyesterday.

The decoration of the specialdividend in the amount of $1.75 per share, and the approval of an additionalshare repurchase authorization of $250 million, were enabled by the cashgenerated from non-operations, as well as the completion of our restructuringactivities over the past several years.

These announcements are testamentof our ongoing commitment to improve the efficiency of our capital structureand return value to shareholders. In fact, over the past four quarters, we havealready returned an excess of $250 million to shareholders in the form ofquarterly dividends and share repurchases.

With these announcements yesterday,I would also like to provide some color around our financial policy in general,as we have asked, from time to time, how we think about various debt ratios,cash and investment levels, and amplifications of earnings. Our strength hasalways been to manage our capital mix consistent with investment gradecompanies. In doing so, we determine our target debt levels based on twoprimary metrics, which in order of importance our debt-to-EBITDA and adjusteddebt-to-total capital. Note: by adjusted debt, we mean debt plus a capitalizedamount for operating leases. Our target for debt-to-EBITDA is to, not the rateof two-to-one--and our target for our adjusted debt-to-total capitalapproximates 35%-45%.

We are comfortable with debt beingeven a slightly higher mix of our total capital as long as our expected cashflows are strong. With respect to cash and investment levels, we currentlyestimate our core cash needs are approximately $50 million, though the balancewill fluctuate throughout the year, based on the timing of certain disbursements,such as dividends, taxes, variable compensation, etcetera. In addition, weintend to maintain a minimum of $100 million of cash and investment cushion,above our core cash needs for the foreseeable future. This represents aprogressive reduction in our cash cushion from previous years. We arecomfortable with this reduction after having completed the redesign of ourbusiness model and developed a more variable cost structure, and we intend asan add to contingency, to maintain ready access to additional liquidity. Ourfirst priority for cash generated from operations will continue to focus onreinvestments in the business, which may include additional acquisitions thatsupport our growth strategies.

Our second priority is themaintenance of a strong quarterly dividend, which we are targeting over thelonger term to move into a payout ratio relative to earnings of approximately35%-40%.

Our business reinvestment may behigher or lower at any given time, depending on opportunities; and our earningsmay fluctuate, based on economic conditions. We will continue to use sharerepurchases as the balancing factor or our third priority, which can be flappedup or down as appropriate depending on business requirements, reinvestmentopportunities and our economic outlook. Lastly, I would like to update youregarding two areas of concern within our cash and short-term investmentportfolio that we highlighted last quarter.

In the case of the option ratessecurities we mentioned, recurring auctions related to the $26 million of thesesecurities that we hold has continued to fail, due to a lack of liquidity inthe marketplace. Accordingly, we still hold the longer dated securities, andhave been receiving interest at higher penalty rates. We continue to monitorthe market dynamics underlying these securities, and have recently become awareof some sentiment that a modest discount may be necessary, in order for futureauctions to clear the market.

We also continue to hold Canadian$5 million asset backed commercial paper investment that defaulted during thesecond quarter, as the broader Canadian market for this type of papereffectively shut down.

Those who have not yet receivedformal information, preliminary report suggest that the committee is seeking tobring liquidity back to this market. We will purport that investors accept somediscounts under restructuring and exchange of their short-term notes for newclasses of healthier long term notes. The committee has delayed their form ofresponse for a second time, until the first calendar quarter of 2008. As it istoo early to estimate a range of potential loss that this discount may wore, wehave not provided any results against these investment to-date. Further, wehave not contemplated any estimated impact in our earnings guidance for thefourth quarter.

Now, I will discuss the quarterlyoperating results for each of our segments and the other category. In North America, sales were $513.6 million in the quarter,or 9.4% higher than the third quarter of last year. Current quarter revenueincluded an unfavorable impact of approximately $21 million from thedeconsolidation of various dealers net of acquisitions, completed in the last fourquarters.

Adjusting for the impact of thesenet divestitures, organic growth in the North Americasegment approximated 15% in the third quarter. We experienced revenue growth invirtually, all of our product categories, geographic locations and verticalmarkets. However, project business with lot of customer and growth within ourwood and architecture and technology product categories were particularlystrong.

During the last quarter's call,we noted that our order rates have strengthened during the second quarterdespite just before in mid-July price list adjustment and remaining steadythereafter and into the third quarter.

Accordingly, second quarterorders and quarter-end backlog for North Americagrew at double-digit rates over last year in part influenced by the prior-yearorder pattern which softened for several weeks after the July 2006 priceadjustment.

During the third quarter we saworder rates remain relatively steady through October reflecting up asingle-digit growth compared to the prior year, however, order growth slowed inNovember.

The orders during the quarteralso reflected somewhat shorter lead times which enabled a quicker shipmentpattern associated with September and October orders. This factor, along withthe lower order growth in November, contributed to a beginning backlog goinginto the fourth quarter that was flat, versus the same timeframe last year.

Operating income for the quarterwas $53.6 million, including $300,000 of restructuring charges. Prior yearoperating income was $26.6 million, including $5.2 million of pre-taxrestructuring charges. That's nearly a 70% year-over-year increase in operatingincome, excluding restructuring items.

Operating income excludingrestructuring charges was 10.5% of sales in the current quarter compared to6.8% of sales in the prior year. The significant improvement in operatingincome was influenced by higher gross margins, and lower operating expenses asa percent of sales. North America gross marginwas 31.7%, compared to 28.4% in the prior year quarter.

Cost of sales, which is reportedseparately from restructuring costs, improved 230 basis points relative tosales over the prior year quarter. Gains were primarily realized through bettervolume leverage and benefits from prior restructuring actions and continuedplant deficiencies. However, these games were somewhat masked by orderappreciation of caps, which are undervalued, or [CFV] on company owned lifeinsurance policy this quarter versus a year ago.

You may recall we experienced thesignificant increase in [CFV] during the third quarter of last year, which wasdriven by a strong stock market during that quarter. While appreciation of [CFV]recording cost of sales during the current quarter was not [maniacally] out ofline with the current year expectations, compared to the prior year, it wasapproximately $3 million lower, resulting in a 60 basis points impact, and costof sales as a percent of revenue.

These investments were initiatedyears ago as a long-term funding source for retired re-medical benefitobligations, before we mapped the accountant for their performance with therelated employee benefit cost allocations to cost-of-goods sold, and operatingexpenses.

North America operating expenses which are reported separately fromrestructuring charges, were $109 million, or 21.3% of sales in the currentquarter, compared to $107 million, or 22.7% of sales in the prior year. Thecurrent quarter variation in operating expense dollars was primarily influencedby $6 million of increased spending on new product development, and longer-termgrowth initiatives and approximately $2 million of lower appreciation of [CFV]recorded in operating expenses.

Offset impart by the favorableimpact of deconsolidation of dealers net of acquisitions completed in the lastfour quarters, which have effect of decreasing operating expenses byapproximately $6 million. In addition, increased variable compensation expensedriven by improved operating results was more offset by the reductionsassociated with the impairment charges recorded in the other category. Again,it's more clearly illustrated in our webcast slides.

The international segment enjoyedanother great quarter, posting its highest level of operating income thisdecade. International sales were $230.8 million in the quarter, or an increaseof 15.6% compared to the prior year quarter. Sales in Germany, Latin America and Eastern and Central Europe made up the majority of the growthcompared to last year.

In addition, currency translationhad the effect of increasing revenue by $19.4 million as compared to the prioryear quarter. Order growth was again strong this quarter, nearly reachingdouble-digit growth rates in local currency, reflecting strength in Germany, Latin America, Eastern and CentralEurope, China and India.

International reported operatingincome of $20.2 million in the quarter, which includes $500,000 of pre-taxrestructuring credit related to the sale of property. In the prior year,quarter international recorded an operating income of $15.8 million, whichincluded $400,000 of pre-tax restructuring charges. Operating income, excludingrestructuring items was $19.7 million, or 8.5% of sales, compared to $16.2million, or 8.1% of sales in the prior year.

What makes this operating marginexpansion all the more impressive is, that it has been accomplished whilefunding our growth initiatives in emerging markets. International gross marginwas 34.8% of sales in the quarter, compared to 34.1% in the prior year. Grossmargin excluding restructuring impacts was 34.6%, or a 30 basis pointsimprovement, or 34.3% in the prior year. The improvements reflect volumeleverage and better operational performance, offset, in part, by the costassociated with enhancing our [implied] gains in support of our growthinitiatives.

International operating expenseswhich are reported separately, from restructuring charges were $60.2 million,or 26.0% of sales. This compares operating expenses of $52.2 million, or 26.1%of sales in the prior year quarter. The increase in year-over-year operatingexpense dollars includes $5.1 million of unfavorable currency impacts, ascompared to the prior year, and approximately $1.5 million in growth relatedspending in Asia.

Our other category which includesthe premium group, formerly described as the design group, along with PolyVision,IDEO and Financial Services, reported revenue of $141.5 million in the quarter,or an increase of 6.6%, compared to the prior year. The increase in revenuereflected growth in IDEO, Brayton and Designtex, offset, in part, by decreasesin revenue at Metro and PolyVision.

Metro faced a strong comparablequarter last year, while decrease in revenue at PolyVision continues to beinfluenced by its strategic decision by the company to not pursue lower marginbusiness in the contractor whiteboard market in the U.S

The third quarter operating lossof $13.9 million reported by the other category, included the $21.1 million non-cashimpairment charges associated with certain intangible assets, and goodwillrelating to PolyVision, plus $2.1 million charge related to building and lease holdimprovements associated with one of our manufacturing facilities.

For several quarters, now, wehave discussed intense price competition in the US [manufactured] whiteboardbusiness of PolyVision, while most other segments within the PolyVision businessare improving, the financial performance in the context of whiteboard segment continuesto let to our expectations. Accordingly, during our annual three-year strategicplanning process completed early this quarter. We began evaluating a number ofalternative strategies to address this segments lagging financial performance, whichremain under start and reviewed by our leadership team.

However, it became apparentduring these strategy reviews that in any scenario the intangible assets andportion of the goodwill associated with this particular portion of PolyVision'sbusiness was impaired. Accordingly, we've completed the detailed valuation worknecessary to quantify and record the impairment charge.

Now, I'll review our outlook forthe fourth quarter of fiscal 2008. Overall, we expect revenue to be 10%-14%higher, compared to the fourth quarter of the prior year. This projected rangereflects the following factors.

First, the fourth quarter of thisyear reflects an additional week of shipments, due to the timing of our fiscalyear end which is tied to the last Friday in February. Accordingly, the fourthquarter will include 14 weeks of shipments, versus a typical 13 week quarter. Whatis important to keep in mind is, that this extra week comes at the end of thequarter, which coincides with one of our [bullish] seasonal months ofshipments.

Second, based on third quarterend exchange rates, our fourth quarter revenue estimates contemplateapproximately $20 million-$25 million of currency translation benefits,compared to the prior year.

Third, dealer de-consolidations andnet of acquisitions including Ultra have been completed within the last fourquarters will negatively impact our top-line in the fourth quarter byapproximately $10 million.

Specific to Ultra, we wouldexpect this business to approximate breakeven operating results for at leastthe next few quarters. As we move through post merger integration plans andamortize acquired intangible assets.

Fourth, North America growth estimatesare based on the flat beginning backlog coming into the quarter, along with anexpectation that fourth quarter orders will reflect modest growth over theprior year and continue to reflect relatively shortly times and quickershipments patterns.

Fifth, our [excellent] results inthe fourth quarter should continue to reflect organic expansion versus theprior year, revenue growth rates in local currency are expected to remain inthe single-digits as we continue to compare year-over-year revenues to prioryear periods that were very strong.

Thus while we expect reportedrevenue in the fourth quarter to be 10%-14% higher than last year, if youadjust for the extra week of shipments, estimated currency translation benefitsand the impact consolidation net of acquisition, you will note that we expectcomparable revenue to reflect organic growth of low to mid single-digits.

We expect reported earnings pershare for fourth quarter will be in the range of $0.23 to $0.28 per share. Wereported earnings at $0.20 per share for the first quarter of the prior year,which included $6.1 million of after-tax restructuring charges primarilyrelated to the consolidation of our manufacturing activities in North America.

In addition, the prior yearincluded favorable tax adjustments totaling $24.8 million, and intangibleassets and goodwill impairment charges totaling $7.7 million after-tax. Theseadjustments, which are combined, are related to variable compensation expenseof $6.3 million, after-tax net effect of increasing last fourth quarter netincome by $10.8 million.

We continue to feel good about theyear-to-date results, as well as our near-term outlook for the fourth quarter,nevertheless like you we continue to read and hear daily mix sentiments aroundin the North American economy in the mid-term.

One time we continues to expressconcern linked to ongoing housing problems, subprime write downs in thetightening credit markets and erosion of consumer confidence. While we,however, continue to believe that the housing and financial problems will notdramatically impact the broader economy, or dampen business investment and hiring.Only time will tell, but we are encouraged again by the Fed's decision lastweek to lower rate by another 25 basis points. And we also feel pretty goodabout the levels of corporate profits beyond the financial sector, as well asthe levels of fixed non-residential investment including new officeconstruction and office vacancy rates.

In addition, we have not seen anysignificant order cancellations or deferrals, and we again enjoyed a double-digitincrease in customer visits in the third quarter versus the prior year. So, fornow we remain focused on expanding our gross margins and as we have discussedin the past several quarters we continue to invest in longer term growthinitiatives related to new product development in our core markets, expandinginto vertical and emerging markets and strengthening of our brands around theworld.

So, in summary, we achievedstrong results in the third quarter and our fourth quarter outlook is positive.While there is some uncertainty thereafter which limits our visibility, wecontinue to expect fiscal 2008 will mark our fifth year in a row with improvedprofitability and another step toward achieving our longer term financialgoals, which I'll now take a moment to update.

As you know, we typically updateour long-term operating targets following our strategic plant meetings, whichtakes place, annually, during the third quarter. Our planning horizon is threeyears, which, at this point, ends with fiscal 2011. Yesterday, we announced anincrease to our longer term operating income goal, raising the target from 10%to a range of 10% to 11% of sales.

The component includes targetedgross margin of approximately 36% of sales, and a targeted operating expenserange of 25% to 26% of sales. Our current three year modeling contemplatesorganic and initiative related revenue growth, continued cost reduction effortswithin cost of goods sold and operating expenses and planning to further improvethe operational performance of the businesses. For example, wood and PolyVision.

Our [technical difficulty] single-digitgrowth rate. Most groups' specific initiatives and continued improvement inprice deals. You already know about some of our growth initiatives includingour Turnstone and Nurture brands and we will soon unveil more details about ournew brand which will launch in 2008.

[technical difficulty] in previouscall, we continue to invest in certain high growth markets including China,India and Eastern Europe, to create supply chains, showrooms and salesorganization in order to expand our global customer reach and leverage thevolume in these parts of the world.

[Finding] with the success of ourindustrial modernization initiatives these past year, a much higher focus ofdiscretionary spending has shifted towards the front end of our business,resulting in increased research and ideation around new areas of growthopportunity in existing markets.

New product development effortshave ramped up. Customer, dealer and A&D relationships continue tostrengthen and our global operations are increasingly variable in structure andreliable and [add drive] our performance. All in all, it's a fun time to be atSteelcase. We developed our plans prudently, however, marking single-digitgrowth assumptions to ensure clear achievable objectives were in place to moveus towards our targets less [technical difficulty] ambitious growth rates.

Efficiency improvement withincost of goods sold and operating expenses will continue to originate from ourfocus on Lean principles throughout the supply chains and within the offices.

In addition, the complexityreduction initiatives across certain product categories post furtheropportunity to improve our gross margins and operating expense leverage. Andour geographic expansion around the world will also serve to enable increasingleverage of global supply chains.

The management team at Steelcaseis committed to delivering the new increased long-term financial targets.Internal confidence levels are high and continue to be influenced by themomentum our results have demonstrated over the past four years where anoperating income margins excluding restructuring and impairment charges haveimproved from a loss in fiscal 2004 to approximately 7.6% of sales in the thirdquarter of fiscal 2008.

Nevertheless, these are not aspre targets and therefore I would like to reiterate a few of the morechallenging areas which includes predicting and reacting to economicuncertainty, ongoing realization of price increases and the achievement ofgrowth initiatives that takes Steelcase into new vertical markets andgeographies around the world.

Lastly, sometime we were asked totalk about one year targets and two year targets and we choose not to do thatbecause it begins to feel like a forecast. Instead, what we have done today weupdated the three year target and share some of the assumptions so you candrive to your own conclusions about the years in between.

However, I will say that thepreviously communicated objective of achieving 10% by fiscal 2010 remains wellwithin the (inaudible) especially if the North American economy and ourindustry can avoid any kind of downturn and sustain its ability to grow overthe planning horizon.

Now, I'll turn it over forquestions

Question-and-Answer Session


Thank you. (OperatorInstructions). Our first question is coming from Chad Bowen, please state youraffiliation and then pose your question.

Chad Bowen - Raymond James

Good morning, gentlemen this is ChadBowen from Raymond James calling in for Budd.

Jim Hackett

Hi, Chad.

Chad Bowen - Raymond James

The sound on the call broke upthere for a minute, at least for me. Could you repeat the three year top-lineassumption?

Dave Sylvester

Sure, we said that our top-lineassumptions include moderate to single-digit, or single-digit growth rates,plus growth from specific initiatives and continued improvement in priceyields.

Chad Bowen - Raymond James

Okay, that's great, thank you.

Jim Hackett

Was that’s the only part that’sbroken Chad?

Chad Bowen - Raymond James

It was kind of intermittent forme throughout the whole thing, but that was only the specific numbers that Imissed?

Jim Hackett

Okay. If anybody as the rest arelistening, want any more clarity, please let us know we are sorry about that.

Chad Bowen - Raymond James

And you guys mentioned, a strongproject business in North America, could yougive us any additional quantification of that or perhaps a sense of the mixbetween project business or versus the annuity type business?

Terry Lenhardt

Chad, it's Terry Lenhardt.Typically, there is a pretty good balance between continuing in projectbusiness. What we noted in the first half of the quarter was that project werea little bit higher of that mix than we typically see at this time of year; itshould be more to larger customers that drives that increase.

Chad Bowen - Raymond James


Dave Sylvester

Remember, Chad, we talked in thesecond quarter about how that backlog that grew double-digit included quartersrelated to these larger projects, as well.

Chad Bowen - Raymond James

Yes. Okay, and I know you guyshave been somewhat reluctant to do this in the past, but with the strength in North America, could you parse it all for us: growthrates, Steelcase, Turnstone, Nurture?

Jim Hackett

Well, you are right. We have beena little hesitant, and we are going to continue to be a little hesitant, but Iwill reiterate that it was relatively broad based quarter, and that thosebusinesses continued to focus on their growth strategies.

Chad Bowen - Raymond James

Okay. And another quick question.You guys mentioned kind of turmoil in financial services, especially. Have youseen anything notable there? I know you mentioned no notable cancellations indeferrals overall, but what are you hearing from your customers that arespecific to that industry?

Dave Sylvester

Well, specific to the financialsector, I am going to let Terry make a few comments, because he and his teamhave studied it in-depth…so, Terry?

Terry Lenhardt

Thanks, Dave. Yeah, as Davementioned earlier in his comments, that third quarter order growth was prettybroad based-across most product segments and vertical markets. Now, within thevertical market, that included higher ads, professional, technical, and thefinance, insurance and real estate segment, which we call the Fire segment.

Now, we don’t disclose revenuesor orders by vertical market, but the Fire Vertical segment is important to ourNorth America business. Dave described uppersingle-digit order patters of October, and then slowing in November. Well, theFire Segment feels some of that early growth, and it also contributed to themoderating orders in November. And, as we've been talking, you can imagine thatwith all the news within the sector, our field sales force is staying veryclose to our customers and understanding the impact of the sub-prime issues,and what it's having in our current and medium-term prospect for our business.I feel sales force, we believe that some of the November order moderation wasdue to the typical effect that the timing of project orders can have on orderrates and in fact, in the quarter, some fair account showed strong order growthand some decrease.

Based on some of the feedback weare getting, it appears that some of our accounts haven't really fully assessedthe impact of sub-prime issues we will have on their business, or the resultingimpact of their purchase on office furniture. So, we remain conscious about theFire segment. We continue to monitor it very closely, and well, it turned outwith--for some account--as guarded, or conditionals; we continue to work onsolid project opportunities with other accounts in the segment.

Chad Bowen - Raymond James

That's very helpful, guys, thankyou.


Thank you. Our next question iscoming from Chris Agnew. Please state your affiliation then pose your question.

Chris Agnew - Goldman Sachs

Hi, Goldman Sachs. Thank you verymuch, Good morning. First question is, I wonder if you would be able to breakout how much of your international business is in emerging markets, and maybe,secondly, and a little bit in conjunction with that, how should we think aboutyour longer term target, in terms of driving operating margin by differentdivision, should we think about international and the other segment catchingNorth America up, or will North America continue to push ahead over and abovethe current levels? Thanks.

Jim Hackett

Chris, for your definition, whichmarkets do you label as emerging, just so I understand?

Chris Agnew - Goldman Sachs

Well, I guess, everything,excluding Western Europe, so I'd be thinking about Latin America, India, China,Eastern Europe--whichever is the easiest foryou to break out, basically.

Jim Hackett

Well, we've said in the past, Chris,that France and Germany are kind of our biggest markets inWestern Europe, but Spainand the U.K.are also fairly strong. And that Eastern and Central Europe, and NorthernEurope, and the Middle East, account for afairly sizeable portion. That's about all the color we've given -- it's a nicepiece of business, and its nice piece of incremental margin for us. And itcontinues to grow.

On your second question, I don’twant to get into the specific targets by segment but this is the same story isapplied this year that has for the last couple of years. We believe that North America should be able to achieve better than ouroverall company average. International will, probably, be closer to the averagetarget, and that the other segment which will include--continue to include--thepremium group, and a restructured--or a continued improvement--in PolyVision.Along with our IDEO, business should also push for an operating margin a littlebit a better than the overall 10%-11% we're targeting.

So, you say, okay you have gottwo opened and one kind of averaging wise, and only 10%-11%--don’t forgot aboutour corporate segment that we have--that just carry some operating expenses. Sothat's about all the color we would be willing to give.

Chris Agnew - Goldman Sachs

Okay. Thanks. And then, the finalquestion is, can you provide some color on what's happening with commodities atcost. And I am just particularly thinking when is the risk that in the slowingeconomy there is still unfortunately commodity pressures with strictly, steeland oil, and oil related products. Thanks.

Jim Hackett

There is certainly some pressureon some commodities but year-over-year and quarter-over-quarter, the overallinflation isn't too bad, going into the fourth quarter we will take on a littleheadwind. What I think, it will be relatively modest. Overall, we see our steelprices going up a bit; fuel prices are already high. But there are also anumber of other commodities that are okay, or actually decreasing. So, a littlebit of headwind, but not too bad.

Chris Agnew - Goldman Sachs

Okay, great. Thank you.


Thank you. (OperatorInstructions). Our next question is coming from Matt McCall, please state youraffiliation then pose your question.

Matt McCall - BB&T Capital Markets

Thanks, BB&T Capital Markets.Good morning, everybody.

Jim Hackett

Hi, Matt.

Matt McCall - BB&T Capital Markets

Second call I've been on the daywe've heard about large orders becoming a bigger part of the project businessis, sounds like you guys were echoing about North side earlier. And I guess thequestion, if you are seeing some of the smaller order weaken, I guess theconcern is those may have shorter lead times, if we see softening you would seesoftening first in some of those smaller order, sounds like you did see some ofthat softening in November, but am I looking is that the right way and do youthink that could be a leading indicator for some softening trends in the ordersas well?

Dave Sylvester

Matt, I will start--maybe Terrycan add, but really I think the bigger drive on the shorter lead times of someour orders is the fact that our industrial model has improved so significantlythat we've been able to reduce lead times and enable faster shipment patterns.I don't know that we could comment that it was been necessarily driven bycustomer trying to hurry up and get anything done.

Jim Hackett

I will also add, it's JimHackett, that remember the strength of the economy that we've actually had thelast year 18-24 months results in major projects been commissioned by customersthat are now finding their way to the point in which (inaudible) orders and soits actually is a mirror of the cycle where, let’s say, leaving then one thatwe might be entering.

Matt McCall - BB&T Capital Markets

Yeah, that’s kind of what I wasgetting and I guess, Jim, is that we saw, maybe, a pipeline build of projects;those projects are large, we are starting to ship now, and some of thoseprojects maybe wind down. I guess maybe you can comment on the future pipelineof projects of that size, seems like customer orders are still, or customervisits are still up, but are we seeing the same type of projects out there inthe pipeline, 3, 6, 9 months down the line?

Terry Lenhardt

Matt, this is Terry. We talkabout those large projects. We don’t enter the actual order until the projecthas been designed and they want to go into production, so when you talk aboutthat longer connectivity, it doesn’t show up into the order rates that we'vebeen speaking off.

Matt McCall - BB&T Capital Markets


Terry Lenhardt

And we have notices on projectorders. There is always a portion where the customers want a little longer leadtime, longer than our standard lead times. There is a higher percentage that’sbeen requested within standard lead times, now. So, if you look at our backlog,there is a higher percentage leaving in the next four weeks or so. So, Iwouldn't read too much into the big projects winding down at all because theyweren’t in our order numbers in the first place.

Matt McCall - BB&T Capital Markets

Okay. And if I run the numbers,its look like there is a projected sequential decline in the margin from Q3into Q4 in the guidance. Is there anything that I should think aboutsequentially? I know the top-line is a little bit lower, anything else that'sgoing on there that, and maybe I missed, there was some audio difficulty so maybe I missed some of the comment there? Anything I should think about from aprofitability standpoint in Q4 versus Q3?

Dave Sylvester

Matt, it's Dave. A little bit ofseasonal slowdowns, so even though our top-line looks pretty darn good in thefourth quarter, so it's kind of looks like there is no seasonal slowdown. Ifyou back up that extra week there is definitely a seasonal pattern that wetypically see and what happens with that slowdown as we start pulling ourtemporary workers out of the production which increases our overall averagelabor rate during that period. And I've also mentioned that we have some modestinflationary headwinds, not to think, huge, but some modest inflationarypressures going into the fourth quarter.

So, those are couple of bigthings and then lastly, keep in mind that while we are bringing in anassumption or a forecast for Ultra into our guidance the top-line, we are notanticipating any kind of significant operating income from them in the firstfew quarter because of the acquisition accounting and [DMI] stuff.

Matt McCall - BB&T Capital Markets

Okay, alright. Thank you, guys.


Thank you. (OperatorInstructions). It appears we have no further questions in queue. Do you haveany closing comments?

Jim Hackett

Yes, its Jim Hackett, I justwould like to suggest that it's the time of year when, I want to wish everyonea happy and blessed holiday. I also want to comment that in the business that Iam fortunate to run. I often to hear from families who have loved onesoverseas, assigned in areas where there is military conflict and that's a groupof people I don't want to forget this time of year and I would like to thankthem for serving our country and in turn the employees that work here that haveto make deal with (inaudible). It’s a group we don't want to forget. Thank youvery much, and Happy New Year to everyone as well.


Thank you, ladies and gentlemen.This does conclude today's conference call. You may disconnect your phone linesat this time and have a wonderful day. Thank you for your participation.

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