James P. Keane
Thanks Mike and good morning everyone.
We are reporting today on our first quarter results that were in line with the revenue and EPS estimates we outlined in March.
We expected our sales momentum to continue and it did with order rates growing by 6% in the Americas and 7% in EMEA. I will begin with a few comments about EMEA and then talk about our business in the Americas and all the news we announced in the first part of June.
Our operating results in EMEA improved by almost $7 million over the prior year. Top line revenue grew nicely and operational performance was strong.
As we have said in the past we are targeting the level of operating expenses in EMEA to stay relatively flat, so as we plan to grow revenue and continue to drive gross margin improvement through cost reductions and other initiatives, we expect to be able to continue to improve profitability. EMEA revenue levels had been relatively flat for a long time but that's beginning to change.
Our orders in Western Europe have been growing consistently, our win rates have improved, the major markets of France and Germany are doing well economically and have political stability, and all of this is leading to a healthy project pipeline. We're also doing better at launching many of our new products on a global scale so we're getting these products into the EMEA market more quickly than in the past. And the link in Munich has been open long enough now that we can begin to connect customer business a few months ago with recent wins in orders. In the Americas new products are just part of the story.
Some of you were at NeoCon last week and you saw how the elements of our strategy are coming together.
You saw our investment in new products, you saw the integration of new partner products into our offering, and you saw the validation from the design community that we're on the right track as we received six product awards and two showroom awards. From a product perspective the biggest buzz in our showroom was around Mackinac, a new furniture solution with a cantilever work surface that makes it easy to shift from one work mode to another. That's a great example of our innovation around workplace performance, materials, and advanced engineering, and it represents our commitment to a faster product development process to bring our innovation to market. And in fact, Mackinac won the Best NeoCon award for innovation.
Our new SILQ chair was another Best of NeoCon innovation award winner and we're now taking orders down that chair in the Americas and Asia-Pacific, with EMEA to follow. I mentioned 6% order growth in the Americas, which is a nice improvement over 2% order growth in Q4 and a 6% decline in Q3. In the first quarter we saw orders for our legacy panel solutions decline by less than 5% while the Go Forward portfolio grew about 8%.
We continue to see growing demand for furniture to support informal, collaborative, and social spaces in the workplace. Customers and A&D firms initially sourced solutions from a broad number of residential furniture suppliers but have been disappointed in the quality, cost, and reliability of these products, plus the specification and ordering process is very complex and costly for design firms and our dealers. In Chicago we showed new products from Steelcase, Coalesse, and Turnstone designed to address this trend and we also showcased products from some new and existing partners. These partnerships allow our dealers to specify, order, and receive product just as they do with Steelcase products. We can leverage our scale to negotiate volume discounts and priority lead times. Where appropriate, we can test products and business standards and help our partners improve their products to meet commercial furniture expectations. And in some cases, we can help our partners reach markets in other parts of the world where their products may meet local demand. The planned partnership with West Elm we announced in June is a good example. The West Elm design team has a strong sense of how emerging trends will be embraced by their target customer and we bring the engineering, product platforms, operations, and logistics to develop and support those products for commercial use. The plan is for our dealers to sell West Elm workspace products as well as other products in the West Elm retail line.
We also announced a new partnership with Extremis, a Belgian company that specializes in outdoor furniture which is a nice complement to our Coalesse outdoor offering. We developed a new online portal for our dealers to see at a glance all of the partner products we can provide through our network.
As we bring on additional partners in the future we can quickly add them to this platform which leverages our scale to drive efficiencies for our dealers and customers.
Our list of early June announcements also included a definitive agreement to acquire Smith System, a leading maker of furniture for the preK-12 market.
Our educational business has historically been aimed at higher education but we've seen growing demand from high school and even middle schools as local brands help to fund needed improvements in the U.S. educational infrastructure. Still, we knew this was a very different market and we’d need new capabilities if we were to compete successfully. The Smith System acquisition will bring a team of people who know this market and have deep relationships with key decision makers across the country.
We expect to keep the business largely separate from the rest of Steelcase, helping them where needed.
For example our operations team can help expand their capacity to support rapid growth. We can also activate our dealers starting with dealers who like us have focused primarily on higher education but see the opportunity to expand. The business is highly seasonal and we can more easily fund the working capital demands during the busy summer months. We believe some Smith System products will be applicable to our higher education and corporate customers and some Steelcase products could be rescaled to meet K-12 needs.
So the growth synergies are significant but we expect cost reduction synergies are limited since Smith System's EBITDA margins are already quite strong and the company is very well run. We believe the acquisition will be modestly accretive this year as purchase accounting negates a portion of the second quarter profitability with more significant EPS accretion thereafter.
We expect to return our cost of capital within the first two to three years with terrific opportunities for significant value creation as we begin to capture the growth synergies I described. The AMQ acquisition completed in December is on plan. To date we've been realizing the revenue growth we expected, we've seen the Steelcase dealer network respond enthusiastically to this expansion of our portfolio. Many of the initial value creation initiatives we identified are in progress as we're finding opportunities for synergy in areas such as logistics, warehousing, and supplier networks.
We also recently announced that we've expanded our relationship with Microsoft, include developing mounts and stands to be offered for the next-generation Surface Hub they unveiled in May. This collaboration follows our earlier work leading to Creative Spaces and Workplace Advisor subscription.
We have a lot of reasons to be happy with the start of the year.
Our win rates are improving fueled by new products and by customers who are eagerly use space as a means of attracting and retaining talent. Macroeconomic factors such as CEO competence and corporate profits continue to be supportive of expanding. investments as can be seen in recent capital spending analyses.
On the other hand our gross margins are not where we want them to be. This is not an operational issue.
Our plants and overall operations have been very efficient and have been delivering on their annual cost reduction goals. The gross margin shortfall is really related to pricing, business mix, and inflation.
As said before we would adjust pricing as needed to remain competitive and as we've done that our win rates have improved.
Of course as those wins begin to shift we are seeing an impact on gross margin offset somewhat by the positive effects of better fixed overhead absorption in our plants.
We also see a shift in our business from very profitable fully depreciated legacy products to new products with lower initial margins. This is normal and we fully expect these new products will continue to become more profitable and reach target profitability as volume builds. And of course these new products are another factor helping us to improve our win rates. What isn’t normal is the sudden and significant increases we're seeing in the cost of steel and some other commodities including freight. We don't expect to have to pay much for the tariff amounts so far since our Americas supply chain largely buys from the U.S. suppliers.
We are pleased to learn last night the Commerce Department granted PolyVision's request for an exclusion from the Japanese steel tariff. We were one of only 42 exemptions granted in this first wave.
Now the new Canadian retaliatory tariffs will have some effect but it should be relatively small as a direct cost on our total company profitability. The larger impact related to how the tariffs have been a trigger for inflation, just to give you a sense of the impact the cost of coal rolled steel in the U.S. has risen over 20% since January 1st and because the price is rising in the U.S. it's causing increases in other parts of the world as well that took over market place after all.
We are forecasting this increase in steel prices will add about $5 million to our cost of goods sold in the second quarter. That's just steel. Fuel and freight cost are rising for reasons unrelated to tariffs but fuel for example is up over 10% since the beginning of the year.
Moving forward we expect to see a more significant impact from increased freight costs as the capacity shortage is forcing us to pay more to procure some loads. If we consider all the commodities we purchased the impact of inflation has reduced our gross margins in Q1 and appears likely to have a greater effect on Q2.
Our sourcing and operations are doing what they can to minimize the inflation impact on our costs and at the same time we announced the second price increase this calendar year which took effect globally for orders received beginning this week. Over time these price increases should help to offset the inflation we've seen so far. In the short run price increases don't benefit orders already in house and they don't affect recently won projects, some ongoing customer agreements restrict how often we can increase prices.
So we moved as quickly as possible but we could still feel the impact on gross margins for a while.
While commodity forces suggest moderating inflation in the second half of the year, we expect this will depend on whether global trade pressures can be resolved.
We will continue to monitor the situation closely and take actions to protect our profitability as needed. I want to finish my remarks with one additional observation, for the last several years you've heard us talk about restructuring initiatives, necessary first in the U.S. and then in Europe. And we have no major initiatives like that today. The need to shift and resize our manufacturing footprint is behind us. More recently we have talked about the need to address gaps in our product portfolio and the investments we made in product development and acquisitions like AMQ have largely filled those gaps.
Now this is a competitive and pretty innovative industry so we will face new competitive challenges but I really feel this is a new day for Steelcase.
We are not spending much time trying to fix things anymore, that's behind us.
Our customers can feel that shift as our solutions become more relevant to what they need as they improve the work experience for their people to support their own innovation and grow.
We will continue to deal quickly with the short-term issues we faced like rising commodity prices but the bigger picture is how quickly we've already dealt with the fundamental long-term change in customer demand and hoping to lead the thinking in how the modern workplace will evolve. I really do think it's a new day. Thank you for your interest in our company, I'll turn it over to Dave for a deeper look at our results.