Steelcase Inc.

Good morning. My name is Michelle and I will be your conference operator today. At this time, I would like to welcome everyone to the Steelcase fourth quarter and fiscal 2021 conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, please press the pound key. I would now like to turn the call over to Mr. Romero. You may begin your conference.

Thank you, Michelle. Good morning, everyone. Thank you for joining us for the recap of our fourth quarter in fiscal 2021 financial results. Here with me today are Jim Keen, our President and Chief Executive Officer, and Dave Sylvester, our Senior Vice President and Chief Financial Officer. Our fourth 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 webcast will 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 gap 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 the testers and analysts. I will now turn the call over to our President and Chief Executive Officer, Jim Keene.

Thanks, Mike, and good morning, everyone. Our fourth quarter EPS was a little better than we expected because of stronger revenues in the Americas and some tax benefits, partially offset by higher freight costs. We also had a significant increase in our work-from-home business this quarter that helped drive some profits. Dave will talk about the fourth quarter in more detail. I'd like to spend a couple minutes reflecting on the year we just finished and then focus on what we see going forward. It was just a year ago we were reporting on fiscal 2020, which is one of our best years in two decades. But we didn't have time to celebrate because COVID was causing factory shutdowns first in Asia, then in Europe and the Americas. Our customers also began to shut down their offices. And while some projects went forward, many were paused. For several weeks, we focused on serving customers in essential industries and helped out by making PPE for local hospitals in the US. As we reopened factories and offices, we adopted new protocols and processes to keep employees safe. We reduced our fixed costs by temporarily reducing salaries and working hours, and then later by reducing headcount when it became clear the first wave of the virus wasn't going to be the last wave. We reduced discretionary spending, but continued to invest in selective new product development. We protected our liquidity through a series of actions, including a reduction in our dividend and aggressive actions to conserve working capital. Because of all those actions, we were able to report a profit for the full year, despite more than a $1 billion drop in revenue. We are an office furniture company, and we were able to deliver a profit in the year when many of our largest customers were not using their offices. We will share some of those profits with our employees for our annual bonus, and they deserve it because they really helped us get through the year. The decisions we made during the crisis put us in a strong position as we entered this next year. We have a lot of new products that are relevant to the post-COVID workplace. We invested in our relationships with customers, dealers, and designers, and we maintained our strong liquidity position to support future investments. So we feel prepared to capitalize once demand returns more strongly. On our call last time, I talked about the importance of the vaccine rollout because CEOs were eager to put their real estate investments back to work. We were having conversations about the post-COVID workplace with our customers throughout the year, but when January came, the rising confidence in the vaccine brought more urgency to those conversations. And now we're seeing an increase in actual projects. In these last several weeks, particularly in the Americas, we have seen more new opportunities as well as restart the projects that have been put on hold last year. The project opportunities we track and the customer RFPs we've received saw double-digit increases in February versus January, and our customer visits to Grand Rapids, including both physical and virtual visits, more than doubled. And those trends have continued through the first few weeks in March. So our salespeople are very busy. Our pricing and quoting people are busy. And our leadership team is busy as customers want to know how we see the new workplace emerging. We're hearing the same thing from the design firms we work with. They are busy and expect to continue to get busier through the spring. I really believe we're seeing the positive impact of the rapid rollout of the vaccine in the U.S. CEO confidence is very high as measured by the business roundtable. Many CEOs are getting the vaccine themselves, and promoting it to their employees because they see it as key to getting fully back to work. Previously, many were targeting September 1 as their return to office date, and now we're hearing more talk about early summer or even spring as the beginning of their first waves of returning. Many states have released restrictions, and many more are expected to in the coming weeks. So when does this translate to higher orders? The sales process takes several weeks to go from project initiation through design, bid, selection, specification, and finally an order. So we expect to see orders build later in our first quarter and into our second quarter. Some good news is we believe many of these projects seem to be operating towards a faster installation deadline than we normally see, probably because many of these projects were originally scheduled to be completed by now, so there's some pent-up demand. We also believe many customers will return to their offices without making significant changes, as they will wait to assess the challenges of the hybrid workplace and then begin projects to update the office. So we expect those projects are likely to develop in the second half of our fiscal year. Samia, unfortunately, appears to be on a different timetable because of the challenges they've seen with rising case counts leading to new shutdowns and a slower rollout of the vaccine. The stimulus efforts have also lagged in boosting the economies so far. We expect to have a clearer picture next quarter of the trajectory of the EMEA recovery. APAC continues to recover nicely. Our new project opportunity level has been very strong for the past two months, and our fourth quarter orders in China were up 11% versus the prior year. We believe APAC is on track to have a strong year ahead. As we enter our first quarter, We have a relatively low backlog and we have not yet seen an inflection in our order rates. We are also facing some higher costs due to commodity inflation and because of a number of temporary global supply chain challenges, including a foam shortage caused by the Texas ice storm a few weeks ago. So we expect to report an operating loss in the quarter, but it's largely consistent with the scenario we've been managing toward. At the same time, We're also seeing really strong pre-order activity levels, which is why we didn't want to take any additional cost reduction actions that could interrupt our participation in the recovery. We are targeting to be approximately break-even on a year-to-date basis by mid-year, with a second quarter profit that approximately offsets the expected first quarter loss. As we consider the rest of the year and beyond, we are quite optimistic about the future of the office and the implications for our business. Everyone seems to be talking about the hybrid office, the idea of offering employees the option of working from home one to two days per week. Initially, there were articles about companies hoping to save money by making significant permanent reductions in their office space needs. But we were skeptical. And KPMG's recent CEO Outlook Post survey shows only 17% of CEOs think they will downsize their footprint. compared to 69% back in August of last year. We agree completely with the principles of a hybrid workplace, but as employees return to offices, companies will discover that hybrid is hard to get right. Every meeting might have a remote participant, but it's not going to feel the same as when everyone was remote, and it's not the same as when everyone was in the same room. Individual work will be different too, as it will often include the need to jump on a video call without distracting others. During the crisis, we've learned how much we miss all the important connections we make when we are together in an office, before meetings, after meetings, or when we're just moving through our offices. But many offices could do a better job helping make these connections happen. As employers offer more choice to their employees, the office has to compete with the home It has to be worth the commute. Offices have to help people work better. So we don't see the office getting smaller, and we believe companies will have to make investments in the office so that people can work better. Offices have to be safe and feel safe, and we can help with that. Offices have to be more productive for collaborative work, but also for individual work, and we have new products designed for that. Offices have to be flexible, So flexible the users can reconfigure the space based on what they need right now. And offices have to be inspiring, helping people reconnect with each other and with the purpose and culture of the company. I think CEOs get that, and it's why they're less interested in reducing their office footprint now. The recovery is right in front of us. Every company is going to have to be more competitive during the recovery. It's not just about attracting and retaining talent. but it's also about helping every person, every team, every part of the business reach its full potential. CEOs understand how important it is to get their people back together safely and productively. We're here to help, and this is why we're targeting double-digit revenue growth for the second half of our year. Now I'll turn it over to Dave to cover the financials.

Thank you, Jim, and good morning, everyone. My comments today will include details related to our fourth quarter results and outlook for the first quarter, as well as some highlights related to our targets for the second quarter and back half of fiscal 2022. I will focus largely on comparisons to the estimates we provided last quarter and sequential changes in our results as the year-over-year comparisons were covered in the earnings release. Versus the outlook we provided in December, Fourth quarter revenue finished $27 million higher and earnings per share were favorable by six cents. While order levels were largely in line with our expectations for the quarter, the timing and requested delivery dates were a little earlier and faster than expected. At the same time, our operations team recovered from the temporary shutdown in Q3 and navigated several supply chain challenges we outlined in the release. The operating income benefit from the higher than expected revenue was somewhat dampened by higher freight and labor costs associated with the supply chain challenges, as well as higher variable compensation expense associated with some favorable tax items. The favorable tax items in the quarter were driven by tax planning and optimization strategies implemented during the quarter, which increased carryback benefits available to us under the CARES Act. as we'll report a tax loss for U.S. income tax purposes in fiscal 2021. With respect to the sequential comparison of the fourth quarter results versus the third quarter, adjusted operating income decreased by $3 million despite revenue increasing by $60 million. The sequential change in revenue included organic growth of approximately $50 million and was driven by the delayed revenue from Q3 related to the shutdown. Order levels only declined modestly compared to the third quarter, which was better than historical seasonality and suggests we may have reached the bottom of this cycle. The $3 million sequential decrease in adjusted operating income was driven by the following items, which more than offset the incremental operating leverage from the organic increase in revenue. First, we incurred higher aggregate costs in the fourth quarter related to the supply chain disruptions and catching up from the operation shutdown last quarter. Second, we began to see increased inflationary pressures across a number of commodities in the fourth quarter, which negatively impacted the sequential comparison and we expect will impact us more significantly in the first quarter in advance of a price adjustment planned to take effect in April. Third, operating expenses increased by approximately $10 million driven by investments in the areas of marketing, product development, and information technology. Plus, we received lower government subsidies related to continued employment and incurred modest severance costs related to a few organizational changes around the world. Fourth, we incurred approximately $7 million of stock compensation and operating expenses related to the discretionary incentive awards I mentioned last quarter. Plus, we recorded higher variable compensation expense related to the favorable tax items. Moving to the outlook and our targets for next year, we are projecting a net loss for the first quarter and we are targeting earnings in the second quarter that would approximately offset the first quarter loss. And in the back half of the year, we are targeting double-digit revenue growth. For the first quarter, we expect to report revenue within a range of $540 to $570 million, which is lower than the $677 million of revenue we reported in the fourth quarter. The estimated sequential decline is being driven by the following factors. First, our year-end backlog of customer orders is approximately $100 million lower than at the start of the fourth quarter, which included approximately $60 million of delayed shipments from the operation shutdown in Q3. The remaining decrease was driven by typical seasonality in our business, but the timing of orders and requested shipment dates in the fourth quarter that I mentioned earlier also contributed to the decline. Second, supply chain disruptions continue to impact the company and are expected to result in a delay of some shipments from the first quarter of fiscal 22 to the second quarter. We are doing all we can to minimize customer impacts, including procurement and delivery of materials outside our normal supply chain processes, which is expected to continue impacting our costs in the near term. We expect order levels to improve sequentially in the first quarter, Typically, we see a seasonal improvement driven in part by Smith's system and the rest of our education business as orders build for the peak summer months. We are also projecting orders to begin benefiting from the increased sales activity Jim mentioned in his remarks, but much of that is projected to end up in backlog for the second quarter and back half of fiscal 2022. Taking this range of revenue into consideration, Along with the other projections we highlighted in the earnings release related to inflation net of pricing benefits or operating expenses between $190 to $195 million and an effective tax rate of 28%, we expect to report a first quarter net loss between 27 to 34 cents per share. For the second quarter, We are targeting higher revenue from seasonality and improved order patterns as companies begin returning to their offices more broadly and increase capital spending for their workplaces. With the higher revenue, plus the benefit of a projected $15 million land gain, we are targeting earnings in the second quarter to approximately offset the first quarter net loss and bring us to approximately break even halfway through the year. Thereafter, across the second half of fiscal 2022, we are targeting double-digit revenue growth as customers return to their offices and a recovery in our industry begins to play out more significantly. From an earnings standpoint, we're targeting relatively strong operating leverage from this targeted revenue growth in the second half of fiscal 2022, as compared to the first half of the year. as we're targeting operating expenses before the projected land gain to remain at or below $200 million per quarter for the balance of the year. Lastly, a couple of other data points for your fiscal 2022 modeling. We expect interest expense to approximate $6.5 million per quarter for next year, assuming current levels of debt for the entire year, and we expect minimal investment income given the low level of market interest rates. And for other income net, which includes income from our unconsolidated affiliates, foreign exchange gains and losses, and other miscellaneous items, we're targeting $1.5 million or more per quarter across the fiscal year. As I mentioned earlier, our first quarter outlook includes an estimated effective tax rate of approximately 28%, which represents our current estimate for the full fiscal year. And lastly, We expect depreciation and amortization to approximate $80 million and capital expenditures to fall between $60 to $70 million for fiscal 2022. In closing, our fourth quarter results were better than we expected while navigating several supply chain challenges during the quarter. The outlook for the first quarter projects increased inflation and some continued supply chain constraints. but we've announced a price increase that will begin to offset some of the inflation, and we expect the supply chain challenges to reduce over the next several months. Our optimism continues to build as we progress into fiscal 2022, and we're targeting seasonally higher revenue in the second quarter and net income that would approximately offset the estimated first quarter net loss. And for the second half of fiscal 2022, We're targeting double-digit revenue growth versus prior year and relatively strong operating leverage from the targeted growth. From there, we will turn it over for questions.

Okay. At this time, if anybody would like to ask a question, please press star 1 on your telephone keypad. Again, that would be star 1 on your telephone keypad. Your first question comes from Bud Bagach. Private Investor, your line is open.

Good morning. I'm now with Water Tower Research. Thank you for taking my questions. First, best wishes to everybody there, all of you and your families and the entire Steelcase family. It has been quite a year. About this time last year, I guess you said, Jim, the impact was tremendous. becoming unmistakably clear. And also, congratulations for navigating this difficult period. I didn't think many people would have thought you could have come out with $660 million of liquidity and pretty much no net debt, with revenues down about a third. So that's an incredible performance, I think. My first and overriding question area goes to the future, Jim. You addressed it with in a broad sense talking about the office in the first and second quarter still distorted by the pandemic. What can you tell us? I think you're on the business roundtable. What can you tell us in your conversations with CEOs about what they're thinking about the way the office will look if it is a hybrid office? It's got to affect the way the spaces are utilized and what products are there. So maybe you can give us some color as to what you're thinking or what –

the products will look like for the future and for the new world sure and first of all thank you bud for your kind comments and i also wish the same for you and your family um so ceos are uh super engaged on this topic i mean i i have attended ceo conferences business roundtable conferences and others recently where where this topic is not meant to be on the agenda and suddenly it's on the agenda everyone's talking about it uh there's been others where There's been panels put together that even though I'm part of the group, it's other CEOs that are kind of given our talk about how they see the office changing. So I'm excited about that. I think I'd have to say that it all changed in January. If you go back to September, October, November, we were having conversations with clients. We had done our research. We had a lot to share, and people were interested. But they were interesting in kind of, I'd say, a curiosity sort of a way. They weren't really going to do anything right now, but sure, they'd be willing to sit down and talk about it and learn something. We came back from the holidays in January in the Americas, and everything had changed. It's suddenly the customers that wanted to have these conversations. And that's continued to build through January into February, and now it's projects, actual projects that they have. So I think that's the first thing. big shift I've seen. And I think that happened largely because of CEOs. I think CEOs came back. And it's funny, there was a period there for a few weeks that every time I would talk to, it seemed like every time I talked to the head of real estate or one of our clients, that person had just come out of the CEO's office where the CEO was asking, what are we going to do about this? What's our office going to look like? So I think there's a lot of energy ramping up. And what CEOs are talking about is They don't start with how is the furniture going to be organized. They start with how are we going to get our people back together. We need to get people re-energized. We've done a great job getting through work from home, but this is not what we want to do going forward. We need every advantage. We need to get our people back together. So we hear that a lot. CEOs also recognize that their view into their own organizations is much narrower today. The number of people that you get a chance to interact with on video calls and so on is much smaller than what you get when you're one meeting to your space, one meeting to another. So getting a sense of what's happening in your organization is much tougher in these days. So I think there's a lot of interest by CEOs in this topic. And these days, when I ask a CEO if they'd be interested in talking, it's an immediate yes, and they pull together the meeting with two or three other people and have been doing those calls almost on a weekly basis. So there's a lot of that going on. In terms of how the office is going to look, we have strong ideas about that. So we think, for example, that for some people working from home, they've had a home office this is maybe for more senior executives who have dedicated home offices or they've got a spare bedroom they have enough room where they've actually been able to go into a room and close the door they've got the benefit of privacy and uninterrupted concentration and as they come back to the office they're not going to accept going back into an environment where they can't find that where somehow it's less effective in supporting that kind of work so i think offices are going to have to be better It's supporting concentrated work, providing more places where people can go, whether they're enclaves or pods or new kinds of furniture to provide less distraction, less interruption. I think that's going to be an important aspect of it. Secondly, we think that team spaces have to accept that every meeting is going to include a remote participant and therefore access to video conferencing. And that's not just about the technology. It's the braiding together of the digital and the physical. How does the physical space have to be reconfigured to support video conferencing as kind of a given in any meeting? So that's the second example. And maybe I'll end with flexibility. We've all learned that we all have to learn how to be more resilient in our business models, and that includes the real estate and the physical environment of the office. So having furniture and architecture that's more reconfigurable even reconfigurable, as I said earlier, by the users themselves, products like Flex, which you've seen before. We think those are going to be very relevant in the post-COVID workplace. Thanks for your question, Bud.

Okay. Thank you. You've got this relationship with Microsoft. We've watched the industry go to benching over the last couple of years where there was less private space. So what you're saying is This is really going to require a significant change in the way that the office has been thought of for the last 15 years. Am I understanding that correct?

Yeah, I think it's going to be a new era. I really do. I think this last year is going to change us all forever in the way we think about how we work. And we need to take the best things we learned from the last year, the things that work better, and bring those back to the office. And then we have to We also have to see the things we miss the most, like the value of collaboration and interaction with our colleagues, and make sure that the office is stepping up and handling that. You mentioned the Microsoft relationship. They've done a lot in trying to help the digital tools get better, but they also are recognizing the opportunities that we have to make those tools work better in the context of physical meetings where people are physically together as well as connecting remotely. And we continue to have a great working relationship with Microsoft across a number of fronts. The Surface Hub product that is mounted on our Roam product is a great example of a product that we see having increasing relevance in this post-COVID world. And by the way, Microsoft's recently published their own research about their experiences and what they've learned over the last year about how work is changing. And I encourage you all to go check that out because a lot of the principles in there are quite consistent with the things that we've been seeing. And we've been sharing a lot of our research back and forth with Microsoft.

David, in your comments, you referenced Smith Systems and the educational market that you've been doing. What's going on in that vector with so much stimulus money being now legislated for schools that we apparently haven't seen spent? Are you seeing the back... What percentage of the backlog is now for education, or can you disclose that?

I don't know the specific percentage, but I will share that... customer visits related to education have really been tremendous. Our teams have been doing them virtually and physically. We've had a number of people from around the region that have drove in to talk about education, and I think that has to do with the need for classrooms to change and the belief that a lot of the stimulus money that's going to end up in state and local government is going to be directed toward the education sector.

Sorry about that. We had dogs here.

Classic work from home.

The dogs are excited.

We're all excited.

In the Great Recession, one of the hallmarks of Steelcase was the fact that you did invest while still pulling in your horns. And I think if I read the numbers right, you reduced the headcount lower than you did revenues. What can you tell us about what you're investing in Where will we see it in the financials? Is it just in people costs?

Yeah, I mean, you're exactly right, Bud. I mean, we talk about that comparison a bit internally as well, recalling that during the financial crisis, because of what we saw in front of us, because of the changes we saw that were going to impact the workplace, we chose to stay invested in a number of new products, as well as feet on the street as we navigated through that crisis. And we came out strong, gaining share in the industry for the better part of three or four years, not every quarter, but pretty consistently. And we see the same possibilities in front of us now. There is a tremendous amount of change we think that's in front of the workplace, and that's part of – it contributed to how we navigated through the – the last year. We did reduce our headcount, but we did not reduce it at the level that we likely would have if we didn't see the changes in front of us. We've stayed invested in a number of new product initiatives that we think are very relevant for the post-COVID world in the workplace. So we're pretty excited for things to get started because we have a lot to talk about and we have a lot of products behind those ideas.

Okay. Just a couple more for me. China showed an 11% improvement in orders in the fourth quarter. Is that a harbinger for the rest of the world? They're coming out faster. They're going in faster. They're coming out faster than the rest of the world. What are we seeing?

Yeah, overall, our Asia business is doing quite well. It's not And it's different in every country in Asia, of course. Everybody's going through something. India has faced recent challenges with the coronavirus. But it felt like for China, they went through a pretty dramatic shutdown at the very beginning of the crisis. But then people went back in their offices without the kind of second and third waves that we've seen in Western countries. So the China recovery has been more gradual and sustained. And we continue to serve a lot of Chinese headquartered companies that are global companies today and are continuing to grow. And that's really where that growth is coming from. So I think part of it is the fact that they weren't touched as dramatically in the last few months, but also the work of our teams in building those relationships. But I'm also encouraged by some of the growth we're seeing in other markets. Again, some of it might be based on local economies, but it could also just be based on our teams doing a good job developing relationships with customers and winning business. We might not have won in the past. And that's been true kind of broadly across the region.

Okay. I have a bunch of other questions, but I will see. I just want to talk a little bit about the dividend, and then I'll cede the floor to others. You did cut the dividend. You've increased it a little bit. What's the outlook for dividend? Are there any thoughts about acquisitions or any opportunities showing up in this period?

So I can't really comment on the future of the dividend. That's a decision the board takes each quarter based on our financial performance. But as you know, it's an important part of how we return value to shareholders, has been a long part of our history, and continues to be an important way to return value. So, yeah, we were at $0.145 per quarter before the pandemic. The board chose to go to $0.07. at the start of the pandemic or a year ago, in part, I think, because at the same time we were cutting salaries across much of the global workforce by about 50%. So we cut the dividend by 50%. We certainly had the ballast in our liquidity to carry it at 14.5 for at least another couple quarters while we evaluated how deep, how long the pandemic was going to, we were going to be in it. And then when we reinstated salaries, they at the same time also brought the dividend back to the level that we've been tracking at, which is $0.10 per quarter. On the acquisition front, before the pandemic, we were becoming more acquisitive because we were focused more, I would say, on growth across our business, and we were looking for acquisitions that we thought could bolt on to an existing growth strategy and help accelerate that initiative. And I wouldn't say we took the year off completely. We still had some conversations about some targets that we were looking at. But certainly as things start to ease up, we are getting back into that world of looking at ways to accelerate some of our growth ideas and acquisitions are likely to be part of that go forward like they were in the past.

Thank you very much. I'll see you before the others. Thank you.

Thanks, bud.

And your next question comes from Steve Ramsey from TRG. Your line is open.

Hey, good morning. I wanted to think about the near-term context, Q4, Q1, and with the high and low end of the guide, trying to think through how much of the near-term guidance is driven by demand challenges and ramping up or supply chains. challenges clearly you're not the only one with the supply chain issues but um trying to think about if you're losing any sales for uh for the supply chain issues or are they mostly sales deferrals um you know that you're seeing already and how that plays into the guidance yes this is dave i'll start maybe jim will add a few comments you know first i'd remind you that when we have had

material impacts, you know, on quarter to quarter, like the shutdown related to the cyber attack that delayed revenue into the fourth quarter, because that was material, we quantified it. We didn't quantify this because it's not, we don't believe it's anywhere near that level of magnitude, but there are a number of supply chain disruptions we're managing through. So we felt like it is certainly possible that we could feel some of that in the in our revenue, where we could see either lead times push out or potentially not be able to fulfill every single order on the expected delivery date. So there's a little bit of that contemplated in the guide. What we're really doing is we're managing through the supply chain challenges, leveraging every means possible, including things like air freight and procurement of materials outside of our normal course, which means we're buying on the spot market and and incurring higher costs in order to meet our delivery commitments to our customers, in order to sustain that level of business. So I don't feel like we're putting any business at risk. We're actually spending money to protect that business and continue to serve our customers as they expect to be served. I think what you're feeling in the absolute level of the revenue guide for Q1 is that we're just at the bottom. We're seeing typical seasonality. Q1 is typically a little softer than Q4. And we don't have any benefit like we had in the fourth quarter where $60 million of revenue was shifted from Q3 to Q4. So I think you're just feeling the fact that we're at the bottom right now. It's possible that we could see some quick shipment orders. come in related to return to the office. For those customers that are thinking about getting back into the office in the spring or early summer, they might have quick shipment requests, accelerate some changes in their offices beforehand. But without any significant evidence of that in our existing order patterns, it's kind of hard to build that into a Q1 guide.

Yeah, I would agree with all that. I think we're seeing slightly longer lead times, and that can cause you to lose some business without even knowing you're losing it if your lead times are too long. But I don't think we're at that point. And I think part of it is because we have this combination of the softness in demand because of the seasonality plus the softness in demand because offices are still largely closed. I mean, there's a lot of activity going on, but that hasn't converted into shipment. So our activity levels in our factories are down because of demand. And we're navigating through these supply chain issues, which would be a bigger deal if we were at normal volumes. But because we're at lower volumes, we're able to manage through it so far.

Great. That's helpful. And then thinking about the back half guide and the general stepping up of demand sequentially that you're calling out, for Q1 into Q2. Is there a general thought that if there's continual stepping up from Q3 into Q4 and kind of going forward, how do you see that playing out? And maybe the helpful context within this is are companies investing in their offices before workers return or in these conversations with customers, how many of them are investing basically saying we will invest in our office products after workers come back and we get a sense of how we want our offices to look then.

Okay. I'll take the first part. Jim, take the second part. On the first part of your question, the way we've planned it is really more of a continued improvement in demand across the back half of the year and into the following year is what we would expect to continue. But we also have conversations with our operations organization to be ready for more significant steps in demand because that is also possible. It really depends on the level of investment companies want to make in advance of their return to the office or how fast they go about thinking of the changes, which I'll let Jim take it from there.

Yeah, I'd say there are a fair number of customers who, have as your default strategy kind of a wait-and-see strategy. Let's get people back, we'll see how it goes, and then we'll take some actions. Now, I'll say that was kind of a nice simple answer that was more true a few months ago than it is today. Because today I think a lot of those customers are saying, yeah, we want to wait and see, but before we bring people back, we want to make sure that we're not walking into something that's not safe. So Steelcase, can you help us with that? And we've got services that we offer that allow people We can go into a client's site, even as it's empty, and we can see the areas that are going to be an issue, and we can offer suggestions for them to make short-term modifications to make sure they're not bringing people back into situations that are overly dense and so on. And OSHA recently has issued some guidelines about safe workplaces. And so I think a few months ago people were kind of guessing at what's safe and what's not safe, but now it's more black and white because of the OSHA guidelines. So we help them by... But looking at that, and in some cases, there's changes that clients choose to make before they come back into the workplace. I think for others, and for really all of them, they'll bring people back and realize, yeah, in safety, there's issues around productivity. So these meetings don't seem to be the same as before. People are complaining about things they weren't complaining about before. Expectations are going to be higher. So we expect that there will be another wave of that kind of work where where clients are calling us and saying, you know, we're back for a few weeks now and this is what we're learning, or can you help us gather information about what we're learning in those first few weeks? And then our hope is that we can fast-track that work and we can convert it into solutions and recommendations and orders and shipments for those clients. Now, there's quite a few others that have work that really is not related to coming back or not coming back or any of that. It was project work that was on the drawing board before Some of that work was supposed to happen last year, but it was put on hold. They're reaffirming that they want to do the project as they planned, or they like making tweaks to the project based on COVID, or in some cases, significant changes. That's a lot of the work that's going on right now are projects that were already planned, or it could be triggered by lease terminations where they were already planning on doing a restack of their space, or relocating from one place to another, or they were building a building and now it's time to move in. So we're seeing a lot of work. I think is in that phase, not just the coming back to the office phase. Does that help?

Very helpful, yes. Thank you for the call. That does it for me. You bet.

Again, if anybody would like to ask a question, please press star 1 on your telephone keypad. That would be star 1 on your telephone keypad. Your next question comes from Ruben Garner from Benchmark. Your line is open.

Thank you. Good morning, everybody. So maybe to start on the gross margin line, obviously you didn't give specific guidance for that, but you can kind of back into a rough level in I think the 26%, 27% range in Q1. And then I think if My math's right that that jumps pretty materially from Q1 to Q2 back into the low 30% range. How do we think about what the gross margin line might look like as we move into the back half of the year when some of these costs subside and you get year-over-year revenue growth again? I mean, I think – like I said, it looks like you're getting back to where you were kind of back in 19 and 20 already in the second quarter, even with some cost pressures or their mix or other cost savings that are helping you guys get back to that sort of level so quickly?

Well, remember in Q2, we always have a sequential benefit of the summer seasonality from the education business and from Smith's system. And it's not that those margins are dramatically higher than the average of the business. It's that we do two-thirds of Smith Systems' typical year is shipped in the summer months. So we have a tremendously high throughput in the summer, which helps our gross margins. What you should expect in the back half of the year is that at least if inflation behaves the way many are predicting, that it will go up more in the summer and then start to come back down. And at about the fall time period, our third quarter, is when we would expect our pricing benefits from the April adjustment to start covering some of the inflation. So we feel like that would come out of the picture. We are also hopeful that the supply chain challenges that we're navigating and incurring incremental costs for will be more in the rearview mirror than in front of us by the third quarter. So it's really an absorption thing in the back half of the year, depending on the level of volume that you model for us in the back half of the year is going to drive the gross margin percentage mostly. And we're not guiding to a specific double-digit growth rate, largely because we don't know. We feel confident about the recovery starting in the back half of the year for all the reasons Jim mentioned in his remarks. And it could be gradual or it could be more significant. So we feel confident that we can target double-digit growth. I just don't know how much it would be. But I know that puts a challenge on you guys, which is why we did the unusual thing to share with you what kind of operating expense level that we're targeting for the back half of the year at $200 million or less per quarter. So hopefully that helps you. build your models based on the revenue growth that you want to project for the company.

That does. And just a clarification on that operating expense kind of level, I mean, is there a certain revenue growth rate where you're going to have to spend more than the $200 million? In other words, if it ramps faster than you're expecting and you're growing, you know, say north of I mean, is that still the right way to look at operating expenses, or is that based on sort of a low double-digit type recovery?

Well, I mean, at some level, of course, it would kick in. I mean, if it's growing, you know, really significantly, we would have likely higher profits and higher variable compensation expense that runs through operating expenses. So, yeah, there's no ceiling, absolute ceiling on the $200 million, Relative to the double-digit growth that we're modeling, we see a couple hundred million of operating expenses in the back half of the year per quarter as a reasonable estimate.

I'll add to that. When we do our budgeting for this year, you can imagine we looked at every single spend, every single initiative, and we had a strong bias towards shorter payback investments, things that can ring the cash register sooner rather than later. That left a bunch of great investments waiting in that next year. for when volume starts to pick up. So if volume were to pick up, we're going to run this business, and we're going to make sure we don't miss those opportunities. So we have a lot of great ideas. It doesn't mean we're going to spend materially more than what Dave is saying, but we're also not locked into a budget for the whole year based on where we are right now. If we see business picking up, we'll probably spend into that to unlock some of the potential of those projects. And every investor is going to be happy about that.

Got it. And then one more for me. The comments about EMEA, I mean, you're obviously pretty confident in the back half of the year. I mean, is the vast majority of that driven by the Americas in the other category, and you're sort of assuming that EMEA is slower, or are you assuming kind of the same result for EMEA as you move into the back half of your fiscal year as well with the vaccine taking hold over there?

Yeah, I think that's directionally correct. I think the optimism you hear, a lot of the remarks you hear from us talking today about activity is related to the Americas business. The Asia business is doing quite well, as I said, and I expect it to continue to do quite well. They're going to have a good year this year, but they're not having to bounce off the kind of trough that the Americas and the EMEA have to bounce off of. So we're really encouraged by the signals we're seeing in the Americas demand patterns right now. When it comes to EMEA, it's really harder to say. I mean, I don't want to paint an overly negative picture. I woke up this morning to a text message from our EMEA leadership about a bunch of wins we've had just in the last couple of days. So, you know, the EMEA business is definitely operating, and we're winning business and shipping business. But if you step back from the day-to-day order pattern and you say, well, what's happening at more of a macro level, we know that those economies – are going to struggle for a while. All the economists are saying that. It's going to be as likely to come out of the recession later. The stimulus packages that were approved recently are probably not going to start being spent for six months or so. So it's going to be a while before the EMEA core economies are being seen as robust. And meanwhile, from a coronavirus perspective, the lockdowns are getting tougher, not easier. France recently went back into a relatively strict lockdown. Germany is in a relatively strict lockdown. Those are really two of the growth engines for EMEA. So we're being cautious right now, and I don't have a strong point of view about the second half of the year, but we'll have more if they add maybe next quarter.

Great. Thank you, and good luck.

Thank you.

Thanks, Ruben.

And if anybody else would like to ask a question, please press star 1 on your telephone keypad. Again, that would be star 1 on your telephone keypad. At this time, I have no further questions in queue. I turn the call back over to Mr. King for closing remarks.

Thank you, and we're looking forward to this year ahead. As we end the call, I just want to encourage you all to stay safe. We're not out of the woods yet. Get your vaccines if you can or when they're available, and I'm really looking forward to being able to see you guys again face-to-face, and I hope we can do that sometime this year. So thank you for joining the call today. Thanks for your interest in Steelcase, and have a great day. Thank you.

Thank you, everyone, for joining us today. This will conclude today's conference call. You may now disconnect.