Steelcase Inc. (SCS) today reported third quarter revenue of $901.0 million and net income of $37.3 million, or diluted earnings of $0.31 per share which represented a 41 percent improvement compared to the prior year.
The results included an $11.2 million charge related to participation in a multi-employer pension plan, and excluding this charge, net of related variable compensation and income tax effects, adjusted earnings were $0.36 per share. In the prior year, Steelcase reported $772.1 million of revenue and net income of $25.7 million, or diluted earnings of $0.22 per share.
Revenue increased 17 percent, or 13 percent on an organic basis, in the third quarter compared to the prior year. The Americas posted 16 percent revenue growth, or 12 percent on an organic basis, driven by strong project business from both large and small customers. EMEA posted revenue growth of 21 percent, or 12 percent on an organic basis, driven by strong customer order backlog at the beginning of the quarter. Revenue in the Other category increased 17 percent, or 20 percent on an organic basis, driven by strength in most markets across Asia Pacific.
Orders (adjusted for constant currency, acquisitions and divestitures) grew 10 percent in the third quarter compared to the prior year, primarily driven by project business, with 14 percent growth in the Americas, and 12 percent growth in the Other category. Orders in EMEA declined by 6 percent compared to the prior year, with weaker order patterns earlier in the quarter which improved through the quarter and into the beginning of the fourth quarter.
"The successful implementation of our growth strategies to broaden our product offering contributed to another quarter of strong organic revenue growth, which continued to outpace recent industry trends in the U.S. and many other markets,” said Jim Keane, president and CEO. “The 41 percent improvement in earnings per share in the third quarter was even stronger than the 32 percent growth in the second quarter and was driven by our target to expand earnings through revenue growth while continuing to drive fitness across our business model."
Third quarter operating income of $45.4 million (or 5.0 percent of revenue) increased by $8.9 million compared to operating income of $36.5 million (or 4.7 percent of revenue) in the prior year. The comparison was negatively impacted by $7.5 million (or 0.8 percent of revenue) related to the pension charge, net of related variable compensation expense. The Americas reported operating income of $52.0 million (or 8.1 percent of revenue) compared to $45.3 million (or 8.2 percent of revenue) in the prior year. Adjusted for the $8.4 million net impact of the pension charge, operating income in the Americas increased by $15.1 million driven by the $85.8 million increase in revenue for the segment. EMEA reported an operating loss of $0.7 million, which included $1.4 million of initial effects of purchase accounting related to Orangebox.
"In the Americas, we achieved strong operating leverage from the $68 million of organic revenue growth even though revenue from our recent pricing actions was offset by inflation," said Dave Sylvester, senior vice president and CFO. "In EMEA, we were pleased to report year-over-year improvement in our operating results again this quarter, despite political and economic uncertainty in the U.K. and France, which may have negatively impacted demand patterns across the region. Our profitability was also negatively impacted by unfavorable shifts in business mix and some operational inefficiencies associated with the higher volume in the quarter."
The pension charge recorded in the quarter related to a multi-employer pension plan in the U.S. in which the employees and retirees of one of the company’s subsidiaries participate. During the quarter, the plan asserted that the subsidiary’s absence of hiring additional union employees over the past ten years, coupled with restructuring of the subsidiary’s business, constituted an adverse selection practice and, if not remedied, will result in the assessment of a withdrawal liability. As a result of the plan’s assertion, the subsidiary recorded an $11.2 million charge related to its estimated future obligations under a withdrawal liability.
Gross margin of 30.9 percent in the third quarter represented a decline of 160 basis points compared to the prior year, with 110 basis points of the reduction being attributable to the pension charge. Gross margin decreased by 190 basis points in the Americas, with 160 basis points of the reduction attributable to the pension charge. The remaining decrease was driven by pricing benefits which approximately offset $13 million of increased commodity, freight and labor costs (which represented 60 basis points of the decrease) and unfavorable business mix, partially offset by benefits from the higher volume and $3.1 million of favorable adjustments to customer incentives recorded in accrued promotions. EMEA gross margins decreased by 60 basis points due to operational inefficiencies and unfavorable business mix, partially offset by benefits from the higher volume and recent pricing actions. Gross margin in the Other category decreased by 120 basis points due to a strong mix of large projects that were more heavily discounted.
Operating expenses of $232.9 million (or 25.9 percent of revenue) in the third quarter represented an increase of $18.6 million compared to $214.3 million (or 27.8 percent of revenue) in the prior year. The increase was driven by $14.8 million from acquisitions, net of divestitures (including $3.9 million of amortization expense), and $1.6 million of higher variable compensation costs.
Other income, net decreased by $0.9 million compared to the prior year, driven by lower net periodic pension and post-retirement credits.
Income tax expense of $7.9 million in the third quarter reflected an effective tax rate of approximately 17 percent compared to 32 percent in the prior year. The reduction was driven by tax reform in the U.S. and a $3.6 million favorable adjustment recorded in the quarter, which had the impact of increasing diluted earnings by approximately $0.02 per share, after consideration of the related variable compensation effect.
As previously announced, the company's acquisition of Orangebox Group Limited was completed on September 19, 2018, and was funded by $78.9 million of borrowings under the company's global committed bank facility.
Total liquidity, comprised of cash, cash equivalents and the cash surrender value of company-owned life insurance, aggregated $205.7 million, and total debt was $321.4 million, at the end of the third quarter. Cash generated from operations and proceeds from the sale of an asset held for sale were used to reduce borrowings on lines of credit to $27.5 million as of the end of the quarter.
The Board of Directors has declared a quarterly cash dividend of $0.135 per share, to be paid on or before January 14, 2019, to shareholders of record as of December 28, 2018.
Outlook
Orders (adjusted for constant currency, acquisitions and divestitures) in the Americas grew 14 percent in the third quarter, and backlog at the end of the quarter was 16 percent higher than the prior year. EMEA orders declined 6 percent but improved during the quarter and backlog at the end of the quarter was 11 percent higher than the prior year. Orders in the Other category grew 12 percent.
The company expects fourth quarter fiscal 2019 revenue to be in the range of $860 to $885 million. Adjusted for the impact of acquisitions, divestitures and unfavorable currency translation effects, the projected revenue range translates to expected organic growth of 9 to 12 percent. In the fourth quarter of fiscal 2018, the company reported revenue of $772.7 million.
Steelcase expects to report diluted earnings per share between $0.24 to $0.28 for the fourth quarter of fiscal 2019. The estimate for the fourth quarter reflects an expectation that pricing benefits will begin to outpace the increase in commodity, freight and labor costs and unfavorable business mix will continue. In addition, the estimate includes a modest sequential decrease in operating expenses compared to the third quarter. The company does not expect earnings accretion in the fourth quarter from its recent acquisitions due to seasonality. Steelcase reported breakeven net income and adjusted earnings per share of $0.24 in the fourth quarter of fiscal 2018. Prior year results included non-operating gains of $13.9 million related to an investment in an unconsolidated affiliate, which had the effect of increasing adjusted diluted earnings by approximately $0.05 per share.
“We remain focused on growing revenue at a higher rate than industry trends through our industry-leading innovation and global scale,” said Jim Keane. “Our fiscal 2019 earnings are on track to represent one of our strongest years in more than a decade, and we are targeting to grow revenue and earnings again in fiscal 2020, consistent with the mid-term targets we shared at our Investor Day in October.”
