Michael O'Meara - Director of IR, Financial Planning & Analysis James Keane - President & CEO David Sylvester - SVP & CFO

Budd Bugatch - Raymond James & Associates Matthew McCall - Seaport Global Securities Kathryn Thompson - Thompson Research Group Greg Burns - Sidoti & Company

Good day everyone, and welcome to Steelcase's Second Quarter Fiscal Year 2018 Conference Call. As a reminder, today's call is being recorded. For opening remarks and introductions, I'd like to turn the conference call over to Mr. Michael O'Meara, Director of Investor Relations and Financial Planning and Analysis. Please go ahead. Michael O'Meara: Thank you, Nicole. Good morning, everyone, thank you for joining us for the recap of our second quarter fiscal 2018 financial results. Here with me today are Jim Keane, our President and Chief Executive Officer; Dave Sylvester, our Senior Vice President and Chief Financial Officer; and Mark Mossing, Corporate Controller and Chief Accounting Officer. Our second quarter earnings release which crossed the wires yesterday is accessible on our website. This conference call is being webcast and this webcast is a copyrighted production of Steelcase, Inc. A replay of this call will also be posted to ir.steelcase.com later today. Our discussion today may include references to non-GAAP financial measures and forward-looking statements. Reconciliations to the most comparable GAAP measures and details regarding the risks associated with the use of forward-looking statements are included in our earnings release and we are incorporating by reference into this conference call the text of our Safe Harbor statement included in the release. Following our prepared remarks, we will respond to questions from investors and analysts. I would now like to turn the call over to our President and Chief Executive Officer Jim Keane.

Thanks, Mike, and good morning everyone. We're reporting today on a solid second quarter with steady revenue growth and stronger profitability than we expected 90 days ago. Some unusual items helped our bottom line but even without those effects our results were better than we were expecting, primarily because of stronger performance from the Americas segment and a successful effort to improve operating expense efficiency. Our Asia Pacific segment had another strong quarter, and EMEA delivered a better than expected loss in Q2 and we expect to breakeven in the second half of the year. I am going to use my time this morning to elaborate further on questions you've asked in previous calls or in investor meetings. These relate to Steelcase and our strategies but also how we see things changing in our industry and the opportunities we see for growth. Last time, we told you that large customers seem to be delaying or reducing spending, and at that point we were seeing fewer large projects on the Horizon. 90 days later, we're seeing some signs of improvement as the Americas pipeline of project activity has strengthened modestly over the last few months, and global account orders in the Americas were up slightly in Q2 after two quarters of significant year-over-year declines. As a result, Americas order rates and revenues were essentially flat against the prior year, which is improvement versus the 3% order decline we saw in the first quarter. We also spoke last time about the shift in customer demand, away from legacy furniture and seating products supporting traditional applications like private offices, panel based cubicles, and even [indiscernible] recent solutions like fixed height benches. Demand remains strong for height adjustable solutions, applications that support mobile work, and across a broader range of price points. Over the last 18 months, we've increased our product development pipeline to respond to these trends. The products we launched and enhanced over the last three years are doing very well against our expectations and it helped us improve our project win rate. Revenues from these products now represent nearly one-third of our total revenues and we believe we are approaching the point where the growth of new products will offset the decline in revenue associated with legacy products and applications. In each of the next several quarters, we expect to launch innovative new products that respond to the breadth of demand we are feeling from customers. Increasing our spending on new product development was not an easy decision but a few quarters later as we see these results, I know it was the right decision. Some of you have asked us if we feel some customers are shifting to lower price points, and certainly there’s examples of that, but overall, I believe it's more accurate to say that more customers are buying across a wider range of price points than they have in the past. There is still plenty of demand for high performance task chairs and Gesture is doing well, but there is also demand for lower price chairs like Series 1 because it supports a different kind of work without compromising safety or quality. So you can expect to see Steelcase offer more new products at lower price points but also expect to see new high performance products, we are doing both. Together a broader range of products helps us increase our addressable market. We've responded before to questions about whether we could efficiently increase our product development capacity, would there be growing pains; and it's a fair question. Here at the midway point of the year in which we expect to launch more new products than in recent memory, nearly all our projects are on-time, are hitting their innovation goals, are hitting their gross margin targets, and related spending is at/or under their project budget. We're spending more in product development in total including investments in our manufacturing capabilities and agility but our productivity and efficiency is very good. I mentioned earlier that we took some steps to reduce operating expenses in Q2, but we didn't pull back on product development; we reduced spending elsewhere so we can continue our momentum. Nearly every quarter there is a question about pricing in our industry. Our industry has always been competitive, but as we discussed last time, we believe we're seeing more instances of certain of our traditional competitors discounting major projects to new levels, and now we're seeing that in every region. One has even broadly announced their explicit intent to use deeper discounts to win business, and of course word travels fast. All the majors are fueling market share pressure because of the demand shifts I talked about earlier and some are fueling it more than others which likely fuels more aggressiveness on pricing. We are also committed to competing aggressively in our core business, but for us that means investing more in product development, building stronger and deeper relationships with customers through investments like our new Learning and Innovation Center in Munich and continuing to drive better speed, quality and cost in every aspect of our business. We don't try to win on price but when we feel we've earned the right to serve a client through insights, innovation, and relationships, we do what we must to defend our position. And despite the higher pressure on pricing, we've held or improved our share versus the peer group of major competitors and our win rates have also improved recently. Our Americas gross margins are down but that's more because of recent material inflation in product mix shifts than higher discounting. On the last call, I discussed another industry trend around the shift to non-corporate looking designs that draw from hospitality and residential influences. We believe the aesthetics of this trend will continue to evolve but the underlying forces are related to offering more choices to users and more control to users over how they work. Another underlying force is how these spaces allow clients to express unique notions around the direction of their brand and culture. These are spot on our own insights, things we've talked about for years. Those of you who have been to our spaces in Grand Rapids see how we've done this ourselves by using our own product offering. At its route, this trend is really good news, a complete projection of the idea that office furniture is just a commodity and that work places should be cost reduced or outsourced. But in the short run, customers are seeking even more choice than we or any other major manufacturer have offered and that has led to the reduced share wallet. While that has happened, we see a significant opportunity for us to respond to this trend, and we are doing so in multiple ways. We are launching new products like Umami, of course, which will be shipping soon. We are globalizing relevant products we currently offer in only one region so we can meet customer needs in other regions. We are forming partnerships by Bluedart, which we announced last fall and now three new relationships announced just in the last few days which involves Bob Williams, offers a very broad and relevant line of high quality furniture products, FLOS is a very well respected provider of lighting including architectural lighting, and Bolia is a European based manufacturer of design forward residential furniture which is very relevant to today's demand for commercial customers. We see an opportunity to leverage our scale and integrate these products with our existing products to increase the range of our offering and provide more choices to our customers. We will also leverage our two market capabilities and our operational capabilities to make it easier for customers to access this broader set of choices. Again, you can expect to see more activity in this space, both in terms of new relationships and new business models. Over time, we hope to more fully embrace the trend towards choice and control to the point where it becomes an important growth engine for our company. These actions are intended to enlarge our addressable market as we expand our products offerings to our own product development, to relationships, and potentially through acquisitions. And remember, those new segments we're addressing are going faster than the core, so we see opportunities for sustained growth. Finally, we're excited to be launching this month our first wave of products related to our smart and connected strategy as work process have become more dynamic, customers need a new way of assessing what's working and what's not, there is growing demand by customers for data and some have already expanded with sensors already available in the marketplace to gather that data. We did similar experiments using existing sensors but thought that customers would really need a better end-to-end solution that gathers data, analyzes data and makes sense of the data to drive change. We also felt customers wanted solutions that were robust and secure, we knew individually users wanted comfort that personal information about where and how they work will be treated responsibly. Our teams may be working with teams at Microsoft to develop a scalable solution using Microsoft's Agile [ph] platform. Over the summer we've learned from alpha and beta sites and are ready to now offer to our customers in a broader way. This is just the first of a series of products and services from Steelcase aimed to augmenting work, worker and workplace; it will take some time before it materially affects our results. We believe a potential for future growth is significant. I'm hoping that this approach of updating our answers to your previous questions help you see where we are on our journey as we position Steelcase for a new era of competitiveness and growth. Now I'll turn it over to Dave to talk about our performance in Q2.

Thank you, Jim. I will cover our second quarter financial results; first, noting where results differed from our expectations and highlighting year-over-year and sequential quarter comparisons. And then I will talk about our balance sheet and cash flow, before getting into our order patterns and outlook for the third quarter. We were pleased to report second quarter revenue near the top-end of our guidance and earnings which were better than the estimates we've provided last quarter. The $0.31 of earnings were better than our estimated range, both with and without the $0.05 attributable to the property gain and discrete tax credit recorded in the quarter. Before I get into the details of our results, I want to first share a couple of highlights, some of which Jim just mentioned. First, we are seeing a few positive signals in our order patterns and pipeline that suggest the level of demand from our largest corporate customers may be poised for improvement following the significant decline we experienced in the first quarter and through much of the second quarter. Based on our review of publicly available information, we are still seeing reductions in total capital investment across this group of customers, but total orders from these customers declined at a lower year-over-year rate compared to the decline we experienced in the first quarter. In addition, large project activity from some of these customers included notable increases late in the quarter. Second, the level of demand for our new products in the Americas has remained strong, continuing to grow by a strong double-digit percentage compared to the prior year. In addition, revenue from products which have been significantly enhanced during the last three years also grew and the rate of growth was solid. Over the balance of the fiscal year, we have approximately 50 additional new products and enhancements expected to launch; and that's beyond more than 300 products which will be available through our new partnerships, which Jim just mentioned. Third, we were pleased that EMEA returned to posting year-over-year improvements in their operating results which included a 280 basis point improvement in cost of sales as a percentage of revenue and was driven by continued benefits from cost reduction and other gross margin improvement initiatives. Looking forward, these initiatives and modest sales growth are expected to drive breakeven operating results in EMEA in the second half of fiscal 2018. Fourth, Asia Pacific posted strong revenue growth and solid operating income again this quarter accounting for much of the year-over-year improvement in the other category. Although order growth in the region slowed in the second quarter, our level of customer order backlog and estimated pipeline of project activity remains strong. As it relates to revenue in the second quarter, the organic growth of approximately 2% was at the high end of our expected range and included exceptional strength in Asia Pacific which drove 19% organic growth in the other category this quarter. EMEA and Designtex also grew revenue in the quarter, while revenue in the Americas was flat with last year. I will make a few additional comments about our business mix and other factors in the Americas, EMEA and Asia Pacific. For the Americas, the flat revenue growth in the second quarter was somewhat better than expected and included mid-single-digit percentage growth in business generated from our continuing agreements, offset by a similar percentage decline in project business. We are pleased to see the growth in continuing business but it's worth noting that the prior year comparison was relatively easy, as it reflected a double-digit percentage decline. Revenue from our marketing programs was relatively flat, following several quarters of declines, suggesting that our efforts to regain share of wallet in day-to-day business may be starting to pay-off. For EMEA, the 4% organic revenue growth was driven by growth in several markets including the UK, Iberia, Eastern & Southern Europe, and the Middle East and Africa, while Germany and the Central European markets declined. With the improvement of economic and political sentiment in France and Germany, we are continuing to see improvement in our pipeline of project activity compared to the prior year and we believe our new Learning and Innovation Center in Munich will contribute to an improvement in our win-rate as we compete for larger projects across the region. In Asia Pacific; India drove the exceptional revenue growth this quarter, but we also posted strong double-digit growth rates in China, Southeast Asia and Australia, and our optimism in this region continues given the current level of customer order backlog, our estimated pipeline of project activity, and growing demand for our new products. From an earnings perspective, the $0.31 per share in the quarter was much better than expected and included $0.05 related to the $4 million gain from the sale of our property in the EMEA segment and the $3.9 million favorable tax adjustment after consideration of related variable compensation expense. Operating income exceeded the level contemplated in our earnings estimate due to favorable operating expenses and higher revenue, partially offset by higher costs of sales as a percentage of revenue. Beyond the property gain, which was not included in our earnings estimate for the quarter, we recorded a $2 million reduction in deferred compensation expense driven by the decline of our stock price in the quarter. In addition, spending was significantly lower than our estimates due to a shift of activity from the summer to the fall, plus our efforts to pullback on non-essential spending in areas outside of sales and product development. The higher than expected cost of sales was driven by some of the same factors that impacted the year-over-year comparison, which we detailed in the release and I will summarize again in a moment. Other income, net was unfavorable to the typical $1 million to $2 million estimate we have communicated in the past largely due to foreign exchange losses driven by the weakening US dollar, plus various smaller charges. Regarding our effective tax rate, excluding the $3.9 million tax adjustment we recorded in the quarter the effective rate approximated 35% which was largely in-line with the 36% estimate we communicated in recent quarters. Switching to year-over-year comparisons, operating income decreased by $8 million, primarily due to a 140 basis point increase in cost of sales as a percentage of revenue. Volume leverage associated with the 2% revenue growth was offset by higher operating expenses net of the property gain I mentioned earlier. Regarding the increase in cost of sales, it is important to first note that the prior year represented the lowest cost of sales as a percentage of revenue that we have seen at the consolidated level or within the Americas segment in more than a decade. EMEA and the other category both posted year-over-year decreases in cost of sales, while the Americas posted a 250 basis point increase. The increase in the Americas was due to increased discounting and incentives, higher commodity costs, investments in support of product development and manufacturing agility, and unfavorable shifts in business mix, each of which contributed similarly to the increase. Sequentially, second quarter operating income was higher compared to the first quarter, primarily due to seasonally higher revenue, favorable business mix and lower operating expenses which included the favorable items in the current quarter I mentioned previously, plus the unfavorable impact of annuitizing the defined benefit plans in the first quarter. Moving to the balance sheet and cash flow; cash generated from operating activities in the first six months of the year was consistent with the prior year, with pluses and minuses being largely attributable to timing. Capital expenditures totaled $20 million in the second quarter and $37 million year-to-date. We continue to expect capital expenditures for fiscal 2018 to fall within a range of $80 million to $90 million, driven by our intention to sustain a high level of product development, strengthen our manufacturing agility, enhance our information technology systems and continue to invest in our customer-facing facilities. We returned approximately $42 million to shareholders in the second quarter through repurchasing 2 million shares at an average price of $13.65 per share and funding a quarterly dividend of $0.1275 per share and yesterday, the Board of Directors approved the same level of dividend to be paid in October. We currently have $99 million remaining under the company's share repurchase authorization, and we will continue to evaluate opportunities to return excess liquidity to shareholders through opportunistic repurchases. Turning to order patterns; I will start with the Americas segment where our orders in the second quarter declined less than 1% compared to the prior year. After posting mid-single digit percentage declines in April and May, we posted modest order declines in June and July followed by 5% growth in August. Customer order backlog at the end of the quarter was 4% lower compared to the prior year, and orders patterns early in the third quarter reflect a mid-single-digit percentage decline compared to the prior year. Across quote types, order patterns related to projects, continuing business and our marketing programs were relatively flat compared to the prior year and order patterns included declines in larger orders offset by growth in smaller orders. Turning to vertical markets in the Americas; order patterns remained mixed and somewhat volatile quarter-to-quarter, reflecting year-over-year growth this quarter from the Information Technology, Financial Services, Government and Energy sectors, while the most notable declines came from the Manufacturing and Technical Professional sectors. For EMEA; order patterns also remained mixed, with growth in some markets being offset by declines in others, but across the month's weakness earlier in the quarter was offset by broad-based strength in August and order patterns early in the third quarter have remained strong. Customer order backlog in EMEA ended the quarter down 7% compared to the prior year. Within the other category, orders in total grew 3% compared to the prior year, and included growth from Designtex and PolyVision. Order patterns in Asia moderated in the second quarter following three consecutive quarters of exceptional growth. Tax changes in India which took effect on July 1st likely contributed to the moderation, and some of the geopolitical tensions in the news over the past several months may have also stressed business confidence. Nevertheless, our customer order backlog is strong, order activity during August and early in the third quarter have been solid, and our estimated pipeline of project activity remains robust. Turning to the third quarter of fiscal 2018 we expect to report revenue in the range of $785 million to $810 million, which includes approximately $11 million of estimated favorable currency translation effects compared to the prior year and reflects a range of an organic decline of 1% to organic growth of 2% compared to the prior year. As we've said in the release, we expect to report diluted earnings per share between $0.21 to $0.25 for the third quarter of fiscal 2018, this estimate includes an expected sequential increase in operating expenses of approximately $10 million compared to the second quarter adjusted for the gain on property sale, as well as an expected sequential increase in cost of sales as a percentage of revenue due to seasonal shifts in business mix. Related to EMEA, recall that the third quarter of the prior year included approximately $2 million of favorable adjustments to accrued liabilities which were non-recurring in nature and primarily impacted gross margins. For the third quarter of fiscal 2018, we expect our gross margin improvement initiatives to provide year-over-year benefits that will largely offset the prior year non-recurring items. We also expect operating expenses in the third quarter to increase compared to the prior year and sequentially compared to the second quarter adjusted for the property gain due to unfavorable currency translation effects, higher levels of product development, investments in a sales and dealer conference and the full unveiling of Munich during the quarter. In the Americas, we expect to report lower gross margin in the third quarter compared to the prior year due to many of the reasons I cited in my explanation of second quarter gross margins; and we also expect a sequential decrease in our gross margin due to unfavorable shifts in business mix, including higher levels of government business, and higher logistics and commodity costs due to the recent hurricanes. For operating expenses, we expect to report a sequential increase in operating expenses compared to the second quarter, as well as a year-over-year increase compared to the third quarter of the prior year. Beyond the third quarter, we are optimistic about the potential for improved growth in the Americas, as we estimate the growth in revenue from new products and partnerships could begin to exceed the declines in legacy applications within the next few quarters. At that point, we could also begin to moderate the level of incremental investments in operating expenses and across our industrial model which would have a positive impact on our operating leverage related to the projected growth. In addition, we expect to continue monitoring commodity cost inflation and take pricing actions, when appropriate, as we have regularly done in the past. However, it is important to note that the competitive environment remains highly dynamic as the industry is competing for a reduced number of large projects and aiming a higher percentage of resources toward small-to-medium sized opportunities. From there, we will turn it over for questions.

[Operator Instructions] Our first question comes from the line of Budd Bugatch of Raymond James. Your line is now open.

Good morning. Jim, in your prepared remarks, you've talked about some changes that you've seen in the landscape versus what you were talking about last quarter among some big large corporate customers. Can you maybe give us a little bit more color on some of the underlying factors that might be behind that and what you've learned in the conversations with them? And does that continue; I see that from what David said that orders grew in the third month of the quarter, but then in the first couple of weeks of the new quarter have moderated back negatively, is that correct and am I right on that as well?

Yes, maybe I will step back and even go back to previous comments in previous calls. So we had been seeing a decline in orders from global accounts as related for the orders in the Americas, and that's what I was really referring to. And in previous calls, we've discussed theories about why that might be happening, could it be related to uncertainty around tax reform, could it be related to other political factors, and I don't know that we've ever been able to completely identify it, but it could be a combination of those things. And it seems that as regarding to this quarter, that is -- July and August, we saw a strengthening in our orders overall and as we analyze the quarterly fee that is in these global accounts that have gone from significant -- like in some cases double-digit year-over-year order declines in previous quarters to moderate or slight growth; and so we see that as a positive thing. Now why is that happening, it's hard to say but maybe people are beginning to look past their expectations for immediate tax reform and are settling in and thinking about the underlying economy; I would only be speculating so I will stop since I'm not an expert of that. As we look at these first few weeks of September, it's too early for us to really do a good analysis of what's growing and what's not growing, but we know overall that the orders are a little soft here in early September, could the hurricanes be a factor, too early to tell, so we're going to continue to watch that but we wanted to give you an update on where we were.

Okay. And the other question goes to how does the future look compared to what the BIFMA forecast came out a couple of days ago talks about it. It looks BIFMA forecast is a lot better, they actually upped their forecast for '17 and '18. How does that comport with what you are seeing and what's your confidence that that forecast may prove to be accurate?

Well, I think the BIFMA forecast is an industry-wide forecast, it includes -- and as you know, they changed the methodology for that, and they're -- as they changed methodology, there seems to be a disconnect between the growth of the legacy traditional large competitors, Steelcase and others like us and what the overall industry is doing. And that disconnect can be explained by lots of things, it seems like imports might be one of those factors. So I'm not -- I don't have an analysis because it's really not possible at this point to try to reconcile the difference between what the total BIFMA industry is and what we're seeing. We look at the data of course, but I do feel that there's a little bit more of a disconnect now than there was in the days when BIFMA’s forecasts were an extrapolation of the members of BIFMA. We are really looking at what we are seeing and that is looking into our backlog, looking into our order patterns, understanding what's in the pipeline, seeing a growth in opportunity creation in some cases and some markets and all these are more positive signs than what we were seeing just a quarter ago.

Okay. And my last question, is Munich now open entirely? What can you see about the early read of that?

Yes. All our employees are in Munich now, so it's open and operating as an innovation center and a learning center. We have three parts of that facility and the third part will be opening in -- about 60 days?

No, four days [ph].

And we're going to have official series of events that continue to open it and that will be a dealer and sales conference in particular that will happen out in November. That will be really the opening for a lot of our market-facing folks to come in and experience the facility and to immerse in all the new products we've been launching and so on. Now, over the course of the summer, we've been bringing customers to the space and doing the best we could to create a good customer experience, even though we don't have the resources of the whole facility open, and we've gotten really good feedback. In fact we want some business, so we had at least one quarter where we see recently which is a direct result to the visit to that facility. I'd say we're at early stages, but I'm really pleased with the feedback we're getting and the progress we're making and we're on time to open.

Thank you very much.

You're welcome.

Thank you. And our next question comes from the line of Matt McCall of Seaport Global. Your line is now open.

Thanks and good morning, everybody. Maybe first, Jim, thank you for the detailed beginning. I liked what you prepared. That was very helpful. The guidance, can you give us a little more detail on the guidance by segment? The revenue growth that's assumed, kind of the progression through the quarter that you have baked in into the guidance and maybe what's driving that? And then anything from a segment margin perspective that you'd like to call out.

Well, Matt, I did give a lot of color in my remarks, so I don't want to reiterate everything I just said. I would just point it so that when you go back to the transcript, what you will note is that we do expect modest revenue growth in EMEA, and we are silenced to what we expect in the other category and in the Americas, and the overall range is down 1%, to up 2% organically, with the midpoint being relatively flat. So, I think you're going to have to make some assumptions from there.

Okay, all right.

Think about this, though. A remark that we have, backlog in both Americas and EMEA are down compared to last year going into the quarter. In the Americas, order patterns in the first few weeks are down mid-single digit versus last year, and then in EMEA, we said orders were strong in August and continued into early September into the third quarter. In order to hit our guidance, we need order patterns to improve in the Americas and stay steady in EMEA.

Okay. So to hit the guidance in your patterns in Americas to improve a little bit, is there something in the pipeline of activity that caused you to assume if that improves, is it more of what Jim is talking about?

More of what Jim is talking about, the improvement that we saw in August, the sentiment from some of our largest customers in all is pointing toward a reasonably good improvement relative to recent order patterns, so we're banking out. And remember, the third quarter is typically one of our better quarters from a revenue perspective going into the fourth quarter. December is always a huge month for us as companies approach calendar year-end, and then January/February fall off. But we're feeling a little bit of an improvement. We've seen growth in continuing business, we have seen our marketing programs, the declines, moderate to flat, we've been pushing on various actions that we talked about last quarter and Jim made reference to again, this quarter, and we're hopeful that that will play out and support our guidance for the third quarter.

Okay. All right, thank you for that. Jim, this might be for you, or Dave, either one, for the Americas business, as we think about it today, the right gross margin, the right SG&A and the things I'm thinking about that have changed, you talked about the competitive dynamic has changed a little bit both legacy and new competitors, the additional partnerships you're adding -I'm trying to think about the impact on the margin structure there. And in the need for new investments and new products and in the mixed shifts, there are a lot of puts and takes I guess, going on. I'm trying to figure out structurally what has changed in the Americas from a gross margin or SG&A perspective as we look forward and how will this all settle out.

That's a good question. I don't see it as being a significant shift in gross margin percentages as a result of the factors that you mentioned. I think the need to make these investments is real, but it actually makes our business stronger and we've seen before that when we make investments like that, it helps us continue to reduce our cost, improve our efficiency and we're still quite committed to fitness. We continue to drive cost reductions every year in our operations whether it's in the Americas or EMEA or APAC. Those investments are good investments and we hold them to pay back targets and return investment targets. The broadening of our offerings will be done both through product development of our own, which should hit the normal kinds of gross margins as well as partnerships, and partnerships aren't bad in terms of gross margins. We bring a lot of value to those partnerships and those relationships in the way we provide two market access and the way we provide operational fitness and efficiency in our liability. Now, if that was the only thing we were doing, that would have a downward pressure because it's not the same as when you're designing, engineering, making your own products. But it helps us cover a wider share of wallet and it has a positive contribution effect. I think those are really good moves to take in as part of a total strategy. And the mixed shifts we're talking about are real, but I don't think those are directionally negative as it relates to gross margin. And the thing you didn't mention was the broadening of price points, but as we shift towards broader price points, some launch products like Series 1 as well as [indiscernible], taken together, again, we don't think that there's a downward pressure on gross margin percentages as a result of those things. But all things considered, I'd say we have the same expectations for our gross margins as we have in the past.

So if we take that a step further, if you look at the Americas' 11%-12% operating margins over the last few years, is that still the bogey? You hit gross margin, it doesn't seem like there's much concern there, but will SG&A be a source of pressure or will we get to the same spot over time?

I think what's important to remember, Matt, is as we were hitting those 11%-12% and even better operating income percentages in the Americas, we were doing it by pretty thin operating expense investments and we've paid for that a little bit with some product gaps that we have to fill in with more aggressive investment in product development and capability. We've always talked around here about mid-30s gross margin objectives and mid-20s operating expense objectives for double-digit or better operating income performance in the Americas segment. We have hit the 35%, mid-30% objective a few quarters here and there and we had consistently been delivering operating expenses in the lower 20s and with hindsight, we wish we would have done that a little differently and that's why you see operating expense investments increasing. Like Jim, I don't see the mid-30s, mid-20s and double-digit objective being significantly different for us going forward.

The other thing on operating expenses is even though we are increasing our total spend on product development, the shifts we've made over the last several years towards a global product portfolio helps us leverage those investments more completely. Take Series 1 for example. That is an important product development initiative over the last couple of years, but as we launched that product, we launched it almost simultaneously, like within a few months of each other in Americas' EMEA and APAC. The ability to do that means that we can ramp up our global revenue faster for the same kind of investment we would have taken just to do that share for one market. We're going to continue to try to do things like that. More products, design for global markets and launch more as global products than what we've done in the past. This should help us get leverage. To a large degree today, our product development infrastructure is a global product development infrastructure. The teams might be in America, they might be Europe, they might be in Asia, but the products we're working on are really increasingly global products.

Okay, all right. Thank you, guys.

Yes.

Thank you. Our next question comes from the line of Kathryn Thompson of Thompson Research. Your line is now open.

Thank you for taking my questions today. I wanted to circle up on the hurricane potential impact not just this quarter, but really more realistically as we look over the next couple of quarters. How much of the business currently is in the greater Florida and Houston markets? Or maybe put differently, what percentage of your larger dealers are concentrated in these markets? Really what we're trying to understand is potential relative impact from the inevitable destructions that we're already seeing in other lines of business? Thank you.

Thank you, Kathryn. Your question also gives me a moment just to comment on the tragedy of those hurricanes. We all felt together the impact on our country and the impact on people of the devastation that came from those two events. We have Steelcase employees that are based in Texas, of course; we have Steelcase employees in Florida, we have dealers who are affected by the hurricanes, and the people who are affected by the hurricanes in Texas and in Florida and our hearts go out to those folks. We've also taken some steps as a company and also took a foundation independently, had taken steps to provide resources and support to the people in those communities. I appreciate that question. From a business impact perspective, the first thing we can feel are our own actions to delay shipments to divert shipments to store product that we wouldn't normally have been shipping and building, so there is an interruption in our revenue recognition, simply because the product isn't being installed. There's also higher cost for us of handling products that was already on its way to customers. Bringing it back, there's freight cost associated with that and then there's storage cost. So we don't have a full estimate of all that right now. Our first priority has been to make sure that we protected that product and we're working with customers to make sure that we weren't delivering things before they were ready to receive it. That's one piece of it. There's of course also, you'd expect to see - and I don't have numbers to confirm it - but an interruption, an order flow from the markets that were affected most directly. Down the line, what we are typically seeing, this is a little further out, is that there will be products that is already in place that customers that's damaged by events like this and they need replacement product. That can have a potentially positive impact on revenues, at the same time rebuilding process can take labor that would normally be available to our dealers for installations and so on and create a tighter labor market. That can also slow down construction renovation projects that our customers might be seeing. I'm kind of painting a picture of the various courses that are out there. It's hard for me or anyone right now to predict exactly how those will all offset; I'll let Dave take a shot at quantifying some of that.

Specifically on revenue, we did not take a significant hedge against our projected deliveries in either of those markets in the quarter under the belief that by the end of our third quarter in November, we believe matters would have settled down by then and we'd be able to deliver the projected revenues that we have in those markets. We did factor in incremental cost associated with all things Jim described and it was worth noting and it's one of the drivers of the sequential decline in gross margins that we're projecting, but not the biggest driver. The only thing that I would add to what Jim said is all of our estimates were based on what we saw from Hurricane Harvey and Irma. We have nothing included in our third quarter guidance for the potential impact of Maria which moved to a category 5 late yesterday afternoon. We have to wait and see how that might affect our results.

Just to clarify, you included Harvey. Does it also include Irma?

Yes.

Okay. Helpful. Thank you very much. Then shifting the cost that's sold in raw materials, just a reminder of where raw materials is as a percentage of cost gets sold? Perhaps a little bit more detail on the categories that are seeing greater inflation which were due to offset that? Thank you.

Well, as you know, steel was our biggest commodity and steel prices are public and we've disclosed in the past that our pricing is tied to the market, but lags the market by 90 days. We're feeling the steel inflation that you see from the CRU monitor and the projections are for that to continue to increase at least in the near-term. We're also feeling some pressure on fuel and some of the other related commodities that are impacted by fuel prices. As I said, the year-over-year erosion in gross margin was driven by four buckets and one of them was material cost inflation and it was generally about the same impact. You can use a map and get to somewhere around $3 million to $4 million effect of year-over-year commodity cost inflation. And then I said at the end of my remarks that we're monitoring and we will of course take pricing actions as necessary as we've regularly done in the past.

Okay, great. Thank you very much for taking my questions today.

Okay, Kathryn.

Thank you. Our next question comes from the line of Greg Burns with Sidoti & Company. Your line is now open.

Good morning. When we look at the partnerships that you've been developing with Blue Diamond and some of the others you recently announced. Do you have any targets for what kind of revenue contribution you see those partnerships, bringing over the next 12 to 18 months? And then also, are they fully-integrated into your order systems so that your dealers can easily order across these different partnerships? Thank you.

I'll do the second part first. The intent as we enter into these relationships is to make it easy for our dealers and our customers to access those products using the same selection tools and ordering tools that we use today. Being able to integrate those is really a key part of the value we're bringing, as well as being able to leverage our logistics systems so that we can consolidate shipments and so on. As we enter into the relationships, there is still a time period between when we enter into those relationships and we can actually implement against what I just said. But that work is under way. In terms of the China estimate, the impact - yes we have internal growth targets for these and expectations for these, but these are also new. It's a little bit too early for us. We have no way to really triangulate in, because they're new in our experience. We believe we have a sense of the share of wallet that's available for us to capture within our distribution, but there's a lot of questions about to what extent will dealers actually shift from the source [indiscernible] today because the sources is better-building relationships with. We obviously believe that there's a lot of value we're bringing and there's a lot of reasons why dealers would want to make that shift, but it will take a little while before I have enough data to give you a good answer to that.

Okay, thank you. And then in terms of EMEA, the sales reorganization that you are implementing over there, how far along are you in that process of changing the sales model over there? And maybe have you seen any positive indicators that the changes are having positive impact on your ability to win business there?

To refrain that, I'd say that there's been an ongoing evolution and improvement of our sewing function in EMEA. I would stop short of calling it reorganization because it wasn't quite as dramatic as that. It is a matter of reemphasizing things that have always been important in the sales, like its really important for us to have the right relationships at the right levels and have them early in the process. Those are things that were through 20 years ago and we're taking new steps to reinforce that to help ourselves to develop those sorts of relationships. And I do see progress there, so I was in Europe in the last quarter and we had some good discussions with leaders in every one of our geographies there about sales opportunities and recent wins and recent losses and what causes the wins and what causes the losses, and we can point to things that we're doing as it relates to some of those wins; there are some extraordinary efforts that people do to win business and those are working and we've also learned a lot from losses. So I don't think we're there yet, I think there is still plenty of opportunity for us to get better but the opening of the Learning and Innovation Center in Munich is part of our sales process, it's something we've done in the U.S. with success for a long time and it will be nice to have that tool available to complete our approach to the market but I think we have a lot of opportunity ahead of us continuing to get better. So I hope that answers your question, it's a little less of our new organization and more of a continuous improvement but I'm seeing signs of progress.

All right, thank you.

Thank you. And our next question comes from the line of Budd Bugatch of Raymond James. Your line is now open.

A couple of quick follow-ups if I can. You've given us some forecast on currency and divestitures and that $10 million sequential cost increase. Can you maybe give us a little bit of flavor to the segment breakout for those items, David?

Well, I gave certainly a lot of color about EMEA, right; with projecting modest revenue growth and essentially saying that gross margins could be relatively flat with current year benefits offsetting the prior year non-recurring benefits that we had. And then I commented that operating expenses are expected to increase and we're still targeting breakeven, so I think you can probably get to a pretty good estimate on EMEA. We're -- and if you look in the other category, we've increased our operating expenses a little bit year-over-year but not anything like we have in the Americas segment, so I think if you take the sequential increase in operating expenses that we've highlighted in the release and I talked a little bit more about, and you would allocate a little bit to the other category, a little bit more to EMEA and the balance to Americas, I think you're going to get there.

And the currency, where is that mostly? Is it mostly EMEA or is it also…

It's mostly EMEA but the Canadian dollar has also strengthened; so it's probably 11 I would say, 9 is probably Europe; 8 or 9 is Europe and 1 or 2 might be in the Americas with a little bit in the other category as well.

Okay. And imports; imports are growing, it looks like little bit faster than the industry were -- where is that coming from? What are you seeing in imports -- are you seeing anything in the major items or is it in specific items?

Still we're looking at each other because we've had this discussion and we can't figure it out to be honest. I mean when I look at the data and I think imports are drawing at that rate across the industry and then I figured what we have to be feeling at some place, you would think that we'd be hearing from customers and dealers and sales people that there is something significant happening in that sector. And yes, there are some manufacturers that have been reported products but it's quantified I can't come up with anything like this sort of numbers that we're seeing. Maybe ancillary, residential, hospitality furniture, some of that is coming from overseas but again, there are lot of the suppliers that we see out there are actually either United States based suppliers or Americas based suppliers so they are not -- maybe it's imports but it's not from the places where we normally think about. So I don't have a good answer for you Budd, I didn't even have this conversation and again, we would think we would be hearing a lot of squeaking sounds if we were losing business with that kind of furniture but we're really not seeing yet. One other possibility is, we do have some traditional manufacturers who are yielding imports more frequently than maybe they had in the past but again, I don't know that I can add it up or come up with those numbers.

Yes, I mean the numbers are coming from the HTS system, the harmonic turf [ph] system, and sometimes that data is interesting, let's put it that way.

It's possible it may relate to other segments of our industry that we aren't participating, there -- the office furniture category means a lot of things and people buy furniture in lots of different ways but it's slightly not in our adjustable market [ph].

Okay. All right, thank you very much.

Thank you. [Operator Instructions] Our next question comes from [indiscernible]. Your line is now open.

Hi, good morning and thanks for taking my question. Dave, you gave some good color on your -- let's call it target operating model for the North American business; so sort of mid-30s gross margin in the 20s SG&A spending, so hopefully back to double-digits operating margin. Could you walk us through what the similar analysis might look like for EMEA? You mentioned in your prepared comments that this fiscal third quarter you might hope to achieve breakeven, obviously the third quarter is your strongest quarter from a revenue perspective but perhaps you could walk us through the path to breakeven on a more sustainable basis in EMEA? Thank you.

Well, I think it's indicative in the back half of the year, its indicative what we need for the full year. To get there for a full year we're going to need some incremental revenue growth and continued improvement in our gross margins initiatives while maintaining modest growth in operating expenses. What we've said in the past is that we're targeting a mid-single digit operating income margin in order to turn our cost of capital. And that the way we get to that is we're targeting a mid-30% gross margin which implies that operating expenses might be in the mid to high or higher 20% range to get to that mid-single digit. We've got ways to go on all fronts, we've got to improve our win rate on large projects and regain share and continue to grow on the top line. Then we have to continue to drive the many gross margin improvement initiatives that we've talked about on previous calls and we've got to maintain control over operating expenses. And what I feel good about is, we are entirely through the disruption from the manufacturing footprint changes that we've implemented, the model is even more stable than it was before we launched those changes, or the confidence that we have from our customers and dealers is back to or above levels it was pre-restructuring. And as Jim said, we're leveraging our global product development more and more which allows for localization of global product versus unique product development in EMEA which should help drive operating expense efficiency. And with Munich and with our sales strategy now fully deployed, we are hopeful that that will continue to drive gross margin improvement and growth in the top line. So I think of it as mid-30s on the gross margin objective and high 20s on the OpEx objective as we pursue getting to a mid-single-digit operating income.

And from a volume standpoint it looks as if -- because you achieved breakeven in the fiscal third quarter last year, that you need something like the $575 million revenue level to get there; is that about right?

That's about right. It depends on the currencies but…

Thank you. And that's all the time we have for questions today. I'd like to hand the call back over to Mr. Jim Keane for any closing remarks.

Thank you. So I will just close by adding one more thought on the relationships we're entering into. What this is not about is just trying to go out and create as many different product relationships as we possibly can, access as many proxies we possibly can. You know, that strategy is available but that really isn't our strategy; we took a lot of care in selecting the partnerships and relationships we entered into. As we get it we wanted to make sure that these manufacturers were on trend and had -- and were relevant to the trends we see in our industry. But we also wanted to start by talking about quality and understanding how these relationships would supplement and reinforce the Steelcase brand because our dealers and our customers expect that the products we offer, whether it's directly or through these relationships are carefully curated so that we're offering quality products. I'm really happy with the quality we've seen from the manufacturing we've worked with through these relationships. Also we wanted to pick organizations that weren't just on trying [ph] but we're demonstrating leadership from a denying perspective, they are progressive in their own designs and we're seeing as leaders in their segment. And we wanted to make sure that manufacturers and their products meet the right prices. It's easy to find great products at super premium prices but that's not really where we see the market being, we think leading organizations one of these kinds of spaces but they want to be responsible with their own spending as they create spaces like this. And so we're very happy with the quality, very happy with the design leadership and very happy with the price points of the partnerships and relationships we've entered into. So I encourage you all, if you have a few minutes to go out and look at these website for these manufacturers; look at Bluedart's website, look at Mitchell Gold + Bob Williams, it's really a terrific broad range of products that they are offering across -- again, a broad range of [indiscernible] and market centric price points; FLOS it's a wonderful provider of architectural lighting and other kinds of lighting and Bolia, our European manufacturer, again, very progressive design and very experiential in a way they think about their storage of their customer experiences. So very proud of how we started this and I'd encourage you all to take a few minutes and go out and learn more. Thank you for joining our call today and thank you for your interest in Steelcase.

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Everyone have a great day.