Steelcase Inc. (SCS) Earnings Call Transcript & Summary

Good morning, and welcome to this fireside chat. I'm Budd Bugatch, Senior Analyst with Water Tower Research. Water Tower is dedicated to modernizing stakeholder communication and investor engagement. We work to create, deliver, maintain the information flow required to build and preserve relationships with all stakeholders and potential investors. The format for today's chat will be as follows. One, the time allotted for the chat is about 30 minutes. Two, I will introduce our guests and the topics and then pose a series of questions to them. If you are listening live to this chat and have a question or questions for our guests, please use the question feature at the bottom of the screen. I will, time permitting, attempt to incorporate these. Three, if you are listening to an archived version of this, which will be posted to our website and have a question, please forward it to me by e-mail, and I will also forward that to Steelcase for their attention. Four, if time does not permit us to get to your question or your questions, I will forward those to Steelcase for their attention. And lastly, if you would like to meet and/or talk directly with Steelcase, please forward that request to me, and I will forward it to the company. This morning, I am thrilled to have a conversation with 2 senior leaders of Steelcase. Allan Smith, who was recently promoted to Senior Vice President and Chief Revenue Officer of Steelcase. Previously, Allan had served as its Vice President of Global Marketing; and two, Dave Sylvester, Senior Vice President and the company's Chief Financial Officer. Those of you who have followed our work for some time know that I follow Steelcase now for several decades, shortly after its February 1998 IPO. Steelcase is a global leader in the contract commercial furniture market. It should come as no surprise that the pandemic caused significant upset to this market as businesses, schools and other organizations shut down their facilities and operations. Associates were required to work from outside of their respective offices, and students were forced into remote learning while the country and the world dealt with the coronavirus.

So my question is first for you, Allan. First, congratulations, of course, on your promotion and your new responsibilities. Well, I will ask you to comment on what may be different at your new role, one thing I don't think is all that different is the fact that you talk often and extensively to customers. I would think that includes your visit to the delayed, but just concluded annual NeoCon. So first, what have you been hearing from customers?

Well, first of all, Budd, thanks for having us as part of your fireside chat series. Part of our competitive advantage at Steelcase is our global scale and our research approach to really understand the customers end markets more deeply. So you asked about my new role. It's really designed to ensure that we really fully leverage our research in our end-to-end go-to-market process. So what that means is that we're researching the right things and coming up with what I would call unique insights, having those insights embed their way throughout the product development process and then finally, ensure that we're marketing and selling those insights and unique products in a way that helps our customers work better than they did before. So you asked a little bit about customers. When I talk to customers, what I hear is that different organizations are really navigating new hybrid ways of working and really kind of each company is approaching this differently based on their unique needs, their culture and also what they do in work, day in and day out. So we're kind of charting new ground at this point as we learn more and our ideas evolve. Ultimately, really, for us, it's about helping our customers create a much more agile, resilient workplace.

I'm a bit confused by the variety of different reports we hear and we read from companies. Some notable examples have said that work from home is now permanent. Others have delayed their return to office, sometimes month by month. And still others have said, hey, they really miss having and want their people together. But one word that came up new, at least to the office for us, is the word hybrid. What does that mean?

Yes. So let me talk a little bit about our research. During the pandemic, we conducted 10 different global research projects. We talked to over 52,000 people during the pandemic at different times. And I really think it's probably the largest research project of its kind. And the idea was we wanted to more deeply understand what our customers were experiencing because we really know customers look to us as a trusted resource and want to know more about how should they return to the office safely and when they should go back and also, how to make the office better than something they had left kind of pre pandemic. So just generally, what we found in our research is people really liked this idea of working for home because they like no commute and the ability to focus. But what happened over time was they had kind of increasing feelings of isolation, and many reported that they were over time, gradually less productive as the months went on. So from our research, people and organizations reported a 14% drop in engagement, that's huge, and a 12% productivity drop. So this is really important that we try to understand this more deeply. So we dove in and we wanted to understand this idea of hybrid work. And when we talk to these 52,000 people around the world, 54% of respondents said they would like to work from home one day a week or less. What I really think that means is that people are looking for more flexibility in their work arrangements. When we talk to decision-makers at organizations, 72% of the companies we spoke with said that they would have a hybrid work arrangement. So that means maybe 3 days a week in the office, 4 days a week in the office, but 1 day or 2 days a week at home for employees to have flexibility. 23% of the employers we spoke with were looking to be in the office 5 days a week and just 5% of companies were actually looking to go fully remote. So we learned a lot about how people thought about hybrid. We learned a lot about people's perceptions of work. And as people thought about coming back to the office, interestingly enough, 73% of all respondents mentioned that their #1 concern in coming back was indoor air quality. The research went on to demonstrate that people are looking, hey, for changes in their work environment, they want more postures. They want different kinds of seating. They wanted furniture that was able to be moved. And ultimately, when they come back, they wanted what they would call a distraction-free environment. Mainly when people are coming back, they're looking to reconnect with their teams, with their coworkers and also with their organization's shared purpose. So that was pretty revealing in the research.

Those insights, you usually try to incorporate that into some new product. And NeoCon is typically where the industry players showcase new introductions. And as I said earlier, it got delayed this year because of the pandemic and all of that -- those issues. Can you speak to some of those new product introductions enduring the pandemic? As you noted, with that extensive research, you spearheaded, you've got those insights. So take a few minutes and describe some of those with you and describe the process of how those new products fit into the identified needs. And it looks like as people do return to their office, either full or part time, have any of those findings been modified or changed? What's different? That's always a question investors ask is what's different with what you found now?

Yes. Well, it's a great question. What we found a lot, which is something that's not necessarily a new concept at Steelcase, is that employees have always asked for more choice and control over how they work. So as I mentioned, most of the companies we work with said they want to be back in the office. It could be 4 days a week, it could be 3 days a week. But again, the bulk of the time is going to be back in the office because they recognize people need to come together to collaborate both formally and informally, really, for ideas to prosper. And Budd, you'll remember this over the years, we've done a ton of research on how work gets done. And interestingly enough, almost every business process in the office, whether that's innovation, communication, decision-making, they always need a social network for the work to progress. And some of that's possible on technology. But really, especially as you have new folks in the organization, they have no established networks. So it's really hard to do that only on a 2-dimensional screen. Plus people are social creatures and work is inherently social experience. So our job is to create spaces where people can really do their best work. And we also want to make it worth their time come back into the office because they can actually work better there. So you asked about some of the research that we did and how it resulted in new products. So we took the time during the pandemic to really think very deeply about what people would need to do their best work, and I think we're leading the hybrid work transformation. And Dave will mention this, but we also stayed quite invested in the downturn. And I can show you a couple of products that really, I think, should help organizations return to the office safely, but also recognizing that people are working from home, we also wanted to create products that worked equally well in the home office. And again, everything is around employees' productivity and satisfaction in mind. So I'll show you the first one. It's a slide of our newest and latest chair. The first product is called Karman. This new chair is really unique. And I would say is the new leading innovation and task seating. We use a new textile that is very high-performing and a flexible frame to deliver what I would call best-in-class performance. And not to mention, it weighs a fraction of what other typical ergonomic seating ways and it has less environmental impact because we use less materials and the materials we do use are actually quite sustainable. And one other thing I'll mention is it outperforms all other leading mesh chairs in the market from a comfort perspective, and we priced it really well to both attract new customers as well as consumers to our offer. So that's our new chair called Karman. The next, you see, I'm also sitting in this space. We see what we're calling Flex Personal Spaces. We introduced the Flex portfolio just before the pandemic, but we wanted to actually reflect how people's perception of safety changed during the pandemic. So this project that's sitting behind me, this is called Flex Personal Spaces, is based on a research project we did from our work with MIT. And in this project, we were looking to provide both privacy and a great backdrop for video calls but we also wanted to contain any exhalation from people in the office. So we work with the world's leading principle on liquid fluid dynamics as well as she's also an epidemiologist. And MIT helped us create this angle top to the screen so it could really contain everybody's breadth or costs. We patented the solution. It's backed by real science. But most of all, it allows our customers to retrofit their existing solutions. So maybe they have a huge installed base of answer, it makes their existing solutions much more resilient. I'll show you a couple of other things that we're excited about. Other new solutions developed during the pandemic were our new pods from Orangebox. What we learned from our research was that people wanted the same privacy and focus they were able to achieve at home, but they wanted that in the office. So the first one is called On the QT. It's kind of a clever name for a phone booth that's both acoustically private and offers 2 different postures. It's really a great way to do a video call without disturbing your coworkers. And the other solution, which is the next slide, is called Campers&Dens. And this was inspired by the idea of really being able to kind of fully outfit small spaces for high-performing teams. So this is what I would call on-demand architecture to be able to put up small freestanding spaces, conference rooms on the floor plate that you can do in a couple of hours, and it really takes full advantage of the area directly adjacent to the space. So you see these for pre or post meetings, also ideal for education environments. And as I mentioned, education, the last innovation we worked on during the time, it's another area of strength for us, has been education and our solutions for hybrid classrooms. This has been incredibly well received. We are continuing to invest in our education portfolio and it's really paying off for us. We created new table shapes for collaboration and places that teachers could get close to the students, created new products for outdoor use because you saw a ton of classrooms moving outside during the pandemic. And we also worked on new technology products with our partner, Microsoft, to better host hybrid and distance learning environments. And one other thing I'll show you, which I think was fun and also incredibly important was we developed using HEPA technology to be able to filter out most viruses, bacteria and mold as small as 0.3 microns with 99.99% efficiency. So we were able to kind of take the air and clean it 6 to 8 times per hour in addition to what a building's HVAC does, making both classrooms and offices safer and containing and mitigating the risk of any viruses. So that's some of the insights we worked on during the pandemic. And I think just -- maybe I'll close by saying we really think Steelcase is best positioned to lead the recovery in the office due to our insights and research that we worked on during the pandemic. I think also the solutions that we developed and the strong customer and commercial relationships we have, especially as people are starting to come back. Our customers are coming back to the office now, as we've seen through the Kastle badge data in cities all around the country, it's increasing every week, and Steelcase is here to help.

Fascinating, Allan. Those are really interesting products. David, let me turn to you for a few minutes, if I can. And for you, the last quarter results began to show some of the evidence that the return to revenue demand that you have been predicting. Your orders grew 20% year-over-year. But you're facing some of the same issues as many companies we hear, particularly during earnings season with supply chain challenges and inflation, which dampened your results. Can you explain that a little more to our audience and what actions you had to put in place?

Sure, Budd. I'll start with inflation, as it's been building since the start of the fiscal year, first, negatively impacting our first quarter results by more than $10 million, followed by a more than $20 million negative impact in the second quarter, and we expect even higher inflation in the back half of the year. And that follows the previous 2 fiscal years, wherein inflationary pressures had really been modest. And thus, our last price adjustment had been in April of 2019. However, the inflationary environment, we all know began to change about 12 months ago. Thus, we announced in January of this year our intention to adjust prices in April. And because inflation continued to increase throughout the spring and summer, we announced in June a second price adjustment, which went into effect in August. And then again in September, we announced the third price adjustment, which goes into effect later this month. On the pricing side, you know that a large portion of our revenue in our -- in the industry is transacted through contracts. And at Steelcase, this represents a very large portion of our core business in the Americas. These contracts do allow us to make price adjustments, but the timing can vary and negotiation is often required. That's why it takes some time for us and our peers to earn enough cumulative pricing benefits to realize gross margin unrelated inflation. So this year, inflation spiked significantly and it continued to rise really at an extraordinary pace for some of our largest commodities, like steel, which is now 3x what it was a year ago. And our initial pricing actions began to generate benefits in the second quarter, and we expect increasing benefits in the third quarter and into next year as we migrate customers to these new price list. We estimate the negative impacts, though, in our current results approximated $10 million in Q1, $20 million in Q2, and we projected the net impact on Q3 would approximate $28 million before potentially beginning to decline in Q4 and reaching a net offsetting Q2 of next year and net positive impacts thereafter. That means we could have a net negative impact this fiscal year and a net positive impact next fiscal year. And if steel pricing were to begin moderating, consistent with external projections, the net positive impact next fiscal year could be even better. I guess it's important to note that these estimates were based on the levels of inflation and projections we provided in September. And they have changed much throughout the year and therefore, it could continue to change. As it relates to supply chain challenges, we had 4 relatively large issues we were managing earlier in the year. Government restrictions due to the state of the pandemic in a few international markets was one. Steel supply constraints, primarily in the U.S., was a second that was affecting us and our suppliers. The third one was disruption across our domestic supply chain for phone. You might remember manufacturing facility went offline in Texas due to the ice storm, which impacted foam production for our industry. And we have port congestion related to ocean freight. The first 3 have eased or been mitigated, while the fourth remains challenged, and it's likely to persist at least for the next couple of quarters. That's in the news all the time about the number of containerships that are in ports, like Long Beach in California, still very, very high and still -- and therefore, the disruption is expected to continue for a bit. We're also managing a number of, I would call, smaller challenges across our domestic supply chain, which were driven by a number of factors that, frankly, worsened in the summer, but which we expected to begin improving into the fall. We're managing through these challenges by in-sourcing production in some areas, increasing raw material and component part quantities and other areas. We're procuring materials and logistics on the spot market where necessary. And even in some cases, we're leveraging airfreight to meet critical customer deliveries, which is one of the big reasons why we incurred $6 million of related inefficiencies in our second quarter. We also had more than $40 million of revenue shift from our second quarter to the third quarter due to the disruption that we're dealing with. But what we hear from our dealers and peers in the industry is that we're not alone, as you said, many are dealing with the same thing. And what we hear from our dealers is that in some ways, we're managing the disruption better than most.

Got you. Okay. Well, refresh our view about management's guidance, if you would. I believe in the last quarterly report, you've also provided a bit of a longer-term outlook, which I think was somewhat new for Steelcase, but are certainly appreciated with investors during these tumultuous times. Can you talk a little bit about that as well? And do you have enough of a crystal ball to go beyond fiscal 2022 in terms of financial outlook?

Sure. I mean, first, for the third quarter, we projected strong revenue growth with revenue falling between $755 million and $785 million and earnings were going to be between -- we projected to be between $0.07 and $0.11 per share, taking into consideration the inflationary and supply chain impacts I just mentioned as well as some continued investment in sales, product development and other growth areas while continuing, of course, to control our operating expenses elsewhere. I don't want to reconfirm these estimates today, and I'm not doing that. We're in the middle of the quarter. And to date, I've only seen September results. But I will point out that the estimated impact of inflation net of pricing that was embedded in our guidance was expected to reduce our range of earnings by more than $0.10. So we don't adjust for stuff like that and provide adjusted earnings or pro forma. But $28 million of projected inflation net of pricing impacted our range by more than $0.10. For the fourth quarter, we're also projecting double-digit revenue growth and -- but earnings will remain impacted by inflation and supply chain disruptions. Hopefully, to a lesser extent, like I mentioned earlier, but still so pretty significant impacts. Thereafter, I mean, I think next year has the potential to be quite interesting. Parts of EMEA and Asia Pacific rebounded to near pre-pandemic levels of orders in the second quarter. The Americas also posted strong order growth in the second quarter. And we can benefit from a growing number of companies planning to return to their offices, which could drive improved demand. Also at current levels of inflation, so if I just project inflation to stay where it's at and assuming historic yield curves for us related to our pricing actions, we would expect pricing to exceed inflation next year. And if steel pricing moderates, like external indices are projecting, we could realize additional benefits. Of course, we'll invest in our business and reinstate some level of travel and other discretionary spending that was virtually eliminated during the pandemic, but we'll closely control the pace and amount of those investments at the same time.

Speaking to that, you have in Steelcase demonstrated over the time, what I call and had called exquisite expense control during the pandemic, which was necessary to navigate the pandemic's choppy waters, as you talked about. I get the feeling that management postponed investments that translate into expenses, as analysts and investors look at them. So how should investors think about future spending?

Well, that's a good question, but we've had that a number of times. And so what we've done is we've provided current year guidance for operating expenses, which we said our guidance reflected increasing investments in our business throughout the year. So we expected operating expenses to come up from a low. And we project that they would start coming up at the end of last year and continue to come up through this year. But what we gave investors was a cap. And we said that we really didn't expect them to exceed $200 million in any given quarter, including at the end of this current fiscal year. And so far, we've been tracking lower than our quarterly projections during each of the last 3 quarters, in part because we've been tightly controlling spending in areas outside of sales and product development. So we'll continue to invest in the business. And again, some level of travel and discretionary spending needs to come back. I mean we took travel almost down to zero for the better part of 18 months. But I'll tell you, fitness remains a strategic priority in our business and some of the discretionary spending, frankly, like T&E it may not return to pre-pandemic levels for several years, if ever.

I am hearing that from other companies as well. And so it will be interesting to watch how that happens and if there is expense creep that we, cynical analysts, have always looked at -- talked about. So I want to thank both of you for coming. I'd like each to make maybe a closing comment or 2 in the few minutes we've got left. But just thank you, and I know we've had a lot of time and a lot of -- it's been a challenging time in the world that's changed markedly and continues to change. And Steelcase, obviously, has some new senior leadership, too, with Sara's exceeding to the CEO role. Just if you have a few more comments, we'll close it after that.

Allan, go ahead.

Thanks, Dave. Well, again, we think Steelcase is really best positioned to help our customers return to the office safely. As I mentioned, customers are coming back now. They're talking to us about these new solutions. And we really think it will help not only their employees, but also their teams perform better, especially as they navigate this new hybrid work experience.

Yes. I guess I'll just maybe reiterate how I'm feeling about next year. I mean I do -- I see the trends. I watch them every week. Allan referenced them earlier. Office occupancy continues to improve. We have a lot of conversations with leaders of the Fortune 500 about their plans to return to the office, and they understand that there's need to change some of the applications. Allan and his team have done a terrific job of leveraging the investment that we have retained throughout the pandemic to bring some terrific markets to -- terrific products to market, which I think are very relevant for a post-COVID era. And inflation and supply chain, while an enormous strain this year, I think will turn to net positive for us next year. So if we can have increasing demand, we can sustain increasing demand from return to office and our products are as well positioned as we think they are, we should have a good top line. Our gross margin should be solid because we should have the benefits of our pricing come in. And if external projections are correct, we should see inflationary pressures starting to slow down or stabilize, if nothing else, and maybe steel will actually decline. The supply chain disruption feels like, for us anyway, that it's peaked and is starting to get better. We've got a long runway in front of us, I think, on the port congestion, but still feels pretty good. And like I said, fitness is a strategic priority at Steelcase. So I like the top line, I like gross margins, and I like operating expenses and the recovery is starting. So I think next year is quite interesting for Steelcase.

That will be fascinating to watch. I want to thank you both for this fireside chat. I want to thank our audience for listening and attending to it and to our future audience that comes in through the archived version of this. Well, thank you as well for your attention. And I think we'll just close the fireside chat now, and thanks again.

Thanks, Budd.

Thanks, Budd.