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Water Tower Research

Water Tower Research is a leading equity research firm that provides research on micro, small and mid cap companies.

Water Tower Research was founded by Wall Street veterans after witnessing a fundamental shift in the investment research industry with the result being a declining knowledge base among investors, a lack of awareness and a shrinking pool of fundamental research being conducted on companies across the small-cap and micro-cap spectrum. The same issues are now increasingly occurring in the mid-cap space. This sea change within the investment community is impacting not only the companies themselves but also current shareholders and potential investors. With significantly less active sell-side sponsorship by Wall Street, a substantial information gap has developed between companies and various constituents in the financial community. The net result is fewer channels for insight and information to flow between companies and investors.

Research from Water Tower Research

Equity Research Firm

Equity Bottom-Up

<h3>KEY POINTS</h3>
<ul>
<li>After market close on September 21, Steelcase reported results for its 2QFY23, which ended August 28. In its earnings release, management also gave its 3QFY23 outlook. It will host its earnings conference call today at 8:30 am EDT. We will refresh and publish new estimates after the call. We review 2QFY23 results in the next few bullets and summarize management guidance for 3QFY23 on page two and suggest several issues that may be of interest for the earnings call and stock action. Our variance analysis is on page three.</li>
<li>Gross margin improvement and cost control were key positives in 2QFY23. GAAP EPS was $0.17, exceeding our $0.10 estimate. Adjusted EPS of $0.21 beat our $0.15 estimate and consensus of $0.13.</li>
<li>Consolidated sales of $863.3 million grew 19% Y/Y versus $724.8 million in 2QFY22 but were ~$15 million below our $878.5 million estimate. Given a better-than-forecast operating margin, the revenue miss had a negligible effect on EPS versus our estimate. 2QFY23 organic revenues grew +20% and were positive in all three reporting segments: +21% in Americas, 12% in EMEA, and 21% in Other.</li>
<li>Overall organic order growth slowed, yet was +5% Y/Y. By segment, organic order Y/Y changes were: Americas +7%, EMEA +4%, and Other -8%. The drag in Other orders was due mainly to the Asia-Pacific markets, with volume declines in all geographies except India. Americas order growth remained positive against a backdrop of flat to falling orders across the industry, exemplified by BIFMA. At 2QFY23 end, the backlog of undelivered orders was ~$946 million, still elevated and +38% Y/Y. The rate of order fulfillment remains hampered by supply chain disruptions.</li>
<li>Estimated price realization of $80 million less implied inflation of $50 million yielded a $30 million benefit and boosted gross margin to 29.1%, +60 bp versus 2QFY22, adding ~$0.05 per share versus our estimate. Operating expenses of $221.4 million were ~$5 million below our estimate. Given lower sales than forecast, the op expense ratio met our forecast.</li>
</ul>
<h3>COMPANY OVERVIEW</h3>
<p>Steelcase is one of America’s great companies. Named 15 times by&nbsp;Fortune Magazine&nbsp;as one of the world’s most admired companies, Steelcase is a global market share leader for commercial/contract furniture. Its global capabilities and research-based approach make it a preferred partner for organizations in any part of the world.</p>
<p>Steelcase sees its purpose as “unlocking human promise by transforming work, worker, and workplace”, thereby affirming its mission to the workplace. Today, the company’s family of brands include Steelcase®, Coalesse®, Designtex®, Smith System®, AMQ®, Turnstone®, and Orangebox®.</p>
<p>The Steelcase growth strategy is to translate research-based insights into products, applications, and experiences. Today, Steelcase goes to market through ~800 independent and company-owned dealer locations (~400 in its Americas segment, ~340 in its EMEA segment, and ~60 in its Other segment). The company has 65 locations in 17 countries, of which 15 are dedicated to manufacturing (seven in its Americas segment, five in EMEA, and three in Other).</p>
<h2>3QFY23 Guidance</h2>
<ol>
<li>Consolidated sales of $825-850 million, up 12-15% versus $738.2 million in 3QFY22 and +13-16% organically (ex $20.1 million Halcon acquisition and estimated -$26.1 million in currency translation). Our current in-print estimate is $852.8 million, modestly above the top end of management’s new guidance range. Management noted that for the first three weeks of 3QFY23, incoming orders declined 20% versus 3QFY22.</li>
<li>Gross margin of 29.0% to 29.5%. This guidance detail includes a price minus cost benefit expectation of ~$55 million, which mathematically equates to a 647 to 667 bp improvement on the guided sales level. Management noted, however, that an unfavorable business mix and lower manufacturing efficiency caused by decreased production volumes affect its expectation sequentially.</li>
<li>Operating expenses of $215-220 million, including $7 million of amortization of purchased intangibles and net of a $7 million gain on the sale of property it expects to book in 3QFY23. Unstated but included will be additional operating expenses associated with the Halcon acquisition that will be completely included in 3QFY23 and were partially included in 2QFY23 after the June 10, 2022 effective date.</li>
<li>Restructuring charges of $8 million associated with the reduction of up to 180 salaried positions in its Americas segment and Corporate functions. The amount represents cash severance payments and other separation costs, and management expects to complete the reduction during 3QFY23.</li>
<li>~$5 million of interest expense, net of investment, and other income.</li>
<li>A consolidated, effective income tax expense rate of 27% of consolidated pre-tax income.</li>
<li>EPS: GAAP EPS (as reported): $0.08-0.12. Non-GAAP EPS (as adjusted): Adjusting for the after-tax effects of the amortization of purchased intangibles and the after-tax impact of the $8 million restructuring expense translates to non-GAAP EPS of $0.17-0.21, which at the top end is below our $0.25 pre-2QFY23 report non-GAAP estimate and current consensus of $0.23.</li>
</ol>
<h2>2QFY23 Earnings Call Issues</h2>
<ol>
<li>In its 1QFY23 earnings release, CEO Armbruster said, “…we remain committed to achieving our fiscal 2023 financial targets and are implementing necessary pricing actions and other measures to mitigate the impacts of the escalating inflationary pressures.” That language was missing from the 2QFY23 earnings release. Expect management to be asked its view on the balance of FY23 and, by inference, 4QFY23.</li>
<li>Commentary on pricing versus unit volumes will likely be a topic of extended discussion. That will, undoubtedly, include a conversation about return-to-office (RTO) impacts, sales activity such as visits to Steelcase, and visibility about new projects.</li>
<li>In this report, Armbruster noted, “Our strategy remains unchanged, but we are shifting additional effort to prioritize improvement in our profitability to fund future investments and to add more diversification to the markets and customers we serve.” Expect additional color on these efforts and any near-term and/or intermediate-term financial impacts.</li>
<li>In the release, management noted $270 million of incremental inflation for the last six quarters. And in 2QFY23, price realization of $80 million less implied inflation of $50 million yielded a price minus cost benefit of $30 million. Expect management to be asked to piece the pieces of inflation and price to reach the $55 million guided benefit for 3QFY23. Also expect management to be asked about the projected time frame to cover the cumulative inflation costs.</li>
<li>The surcharge instituted last quarter remains in place. Expect additional color and quantification of its expected impact on revenues for the upcoming quarters.</li>
<li>Commentary about early results of Halcon, acquired effective June 10, 2022.</li>
<li>Discussion about restructuring actions announced in the release. The severance of $8 million will facilitate a reduction of up to 180 salaried positions and “other actions”, yielding an expense reduction of $20 million annually.</li>
<li>Also rationale for dividend cut and criteria for when it might be restored.</li>
<li>Balance sheet issues. Pay down of debt philosophy,</li>
</ol>
<h2>Near-Term Stock Price Issues</h2>
<ol>
<li>Lower-than-guidance estimates are likely most impactful for near-term stock price performance. Management’s view on future quarters may help offset the near-term impact.</li>
<li>The dividend cut may also have an impact on the near term. Yield is a potential offset to that at this level.</li>
</ol>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/299/413/original/image_43971563061663866967065.png?1663866969" class="editor-image img-responsive" data-smartkarma-image-id="299413"></figure>
<h2>DISCLOSURES</h2>
<div></div>
<p>Water Tower Research (“WTR”) is a professional publisher of investment research reports on public companies and, to a lesser extent, private firms (“the Companies”). WTR provides investor-focused content and digital distribution strategies designed to help companies communicate with investors.<br><br>WTR is not a registered investment adviser or a broker/dealer nor does WTR provide investment banking services. WTR operates as an exempt investment adviser under the so called “publishers’ exemption” from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940. WTR does not provide investment ratings / recommendations or price targets on the companies it reports on. Readers are advised that the research reports are published and provided solely for informational purposes and should not be construed as an offer to sell or the solicitation of an offer to buy securities or the rendering of investment advice. The information provided in this report should not be construed in any manner whatsoever as personalized advice. All users and readers of WTR’s reports are cautioned to consult their own independent financial, tax and legal advisors prior to purchasing or selling securities.<br><br>Budd Bugatch and Rex Henderson, CFA who are the writers of this report, covers the Consumer sector for WTR. Mr. Bugatch and Mr. Henderson, CFA including members of their household have no personal or business-related relationship to the subject company other than providing digital content and any ancillary services WTR may offer.<br><br>Unless otherwise indicated, WTR intends to provide continuing coverage of the covered companies. WTR will notify its readers through website postings or other appropriate means if WTR determines to terminate coverage of any of the companies covered.<br><br>WTR is being compensated for its research by the company which is the subject of this report. WTR receives no more than a maximum of $10,500 per month from a given client and is required to have at least a 6-month commitment. None of the earned fees are contingent on, and WTR’s client agreements are not cancellable for the content of its reports. WTR does not accept any compensation in the form of warrants or stock options or other equity instruments that could increase in value based on positive coverage in its reports.<br><br>WTR or an affiliate may seek to receive compensation for non-research services to covered companies, such as charges for presenting at sponsored investor conferences, distributing press releases, advising on investor relations and broader corporate communications and public relations strategies as well as performing certain other related services (“Ancillary Services”). The companies that WTR covers in our research are not required to purchase or use Ancillary Services that WTR or an affiliate might offer to clients.<br><br>The manner of WTR’s research compensation and Ancillary Services to covered companies raise actual and perceived conflicts of interest. WTR is committed to manage those conflicts to protect its reputation and the objectivity of employees/analysts by adhering to strictly-written compliance guidelines.<br><br>The views and analyses included in our research reports are based on current public information that we consider to be reliable, but no representation or warranty, expressed or implied, is made as to their accuracy, completeness, timeliness, or correctness. Neither we nor our analysts, directors, officers, employees, representatives, independent contractors, agents or affiliate shall be liable for any omissions, errors or inaccuracies, regardless of cause, foreseeability or the lack of timeliness of, or any delay or interruptions in the transmission of our reports to content users. This lack of liability extends to direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, losses, lost income, lost profit or opportunity costs.<br><br>All investment information contained herein should be independently verified by the reader or user of this report. For additional information, all readers of this report are encouraged to visit WTR’s website www.watertowerresearch.com.</p>

KEY POINTS

After market close on September 21, Steelcase reported results for its 2QFY23, which ended August 28. In its earnings release, management also gave its 3QFY23 outlook. It will host its earnings conference call today at 8:30 am EDT. We will refresh and publish new estimates after the call. We review 2QFY23 results in the next few bullets and summarize management guidance for 3QFY23 on page two and suggest several issues that may be of interest for the earnings call and stock action. Our variance analysis is on page three.
Gross margin improvement and cost control were key positives in 2QFY23. GAAP EPS was $0.17, exceeding our $0.10 estimate. Adjusted EPS of $0.21 beat our $0.15 estimate and consensus of $0.13.
Consolidated sales of $863.3 million grew 19% Y/Y versus $724.8 million in 2QFY22 but were ~$15 million below our $878.5 million estimate. Given a better-than-forecast operating margin, the revenue miss had a negligible effect on EPS versus our estimate. 2QFY23 organic revenues grew +20% and were positive in all three reporting segments: +21% in Americas, 12% in EMEA, and 21% in Other.
Overall organic order growth slowed, yet was +5% Y/Y. By segment, organic order Y/Y changes were: Americas +7%, EMEA +4%, and Other -8%. The drag in Other orders was due mainly to the Asia-Pacific markets, with volume declines in all geographies except India. Americas order growth remained positive against a backdrop of flat to falling orders across the industry, exemplified by BIFMA. At 2QFY23 end, the backlog of undelivered orders was ~$946 million, still elevated and +38% Y/Y. The rate of order fulfillment remains hampered by supply chain disruptions.
Estimated price realization of $80 million less implied inflation of $50 million yielded a $30 million benefit and boosted gross margin to 29.1%, +60 bp versus 2QFY22, adding ~$0.05 per share versus our estimate. Operating expenses of $221.4 million were ~$5 million below our estimate. Given lower sales than forecast, the op expense ratio met our forecast.

COMPANY OVERVIEW
Steelcase is one of America’s great companies. Named 15 times by&nbsp;Fortune Magazine&nbsp;as one of the world’s most admired companies, Steelcase is a global market share leader for commercial/contract furniture. Its global capabilities and research-based approach make it a preferred partner for organizations in any part of the world.
Steelcase sees its purpose as “unlocking human promise by transforming work, worker, and workplace”, thereby affirming its mission to the workplace. Today, the company’s family of brands include Steelcase®, Coalesse®, Designtex®, Smith System®, AMQ®, Turnstone®, and Orangebox®.
The Steelcase growth strategy is to translate research-based insights into products, applications, and experiences. Today, Steelcase goes to market through ~800 independent and company-owned dealer locations (~400 in its Americas segment, ~340 in its EMEA segment, and ~60 in its Other segment). The company has 65 locations in 17 countries, of which 15 are dedicated to manufacturing (seven in its Americas segment, five in EMEA, and three in Other).
3QFY23 Guidance

Consolidated sales of $825-850 million, up 12-15% versus $738.2 million in 3QFY22 and +13-16% organically (ex $20.1 million Halcon acquisition and estimated -$26.1 million in currency translation). Our current in-print estimate is $852.8 million, modestly above the top end of management’s new guidance range. Management noted that for the first three weeks of 3QFY23, incoming orders declined 20% versus 3QFY22.
Gross margin of 29.0% to 29.5%. This guidance detail includes a price minus cost benefit expectation of ~$55 million, which mathematically equates to a 647 to 667 bp improvement on the guided sales level. Management noted, however, that an unfavorable business mix and lower manufacturing efficiency caused by decreased production volumes affect its expectation sequentially.
Operating expenses of $215-220 million, including $7 million of amortization of purchased intangibles and net of a $7 million gain on the sale of property it expects to book in 3QFY23. Unstated but included will be additional operating expenses associated with the Halcon acquisition that will be completely included in 3QFY23 and were partially included in 2QFY23 after the June 10, 2022 effective date.
Restructuring charges of $8 million associated with the reduction of up to 180 salaried positions in its Americas segment and Corporate functions. The amount represents cash severance payments and other separation costs, and management expects to complete the reduction during 3QFY23.
~$5 million of interest expense, net of investment, and other income.
A consolidated, effective income tax expense rate of 27% of consolidated pre-tax income.
EPS: GAAP EPS (as reported): $0.08-0.12. Non-GAAP EPS (as adjusted): Adjusting for the after-tax effects of the amortization of purchased intangibles and the after-tax impact of the $8 million restructuring expense translates to non-GAAP EPS of $0.17-0.21, which at the top end is below our $0.25 pre-2QFY23 report non-GAAP estimate and current consensus of $0.23.

2QFY23 Earnings Call Issues

In its 1QFY23 earnings release, CEO Armbruster said, “…we remain committed to achieving our fiscal 2023 financial targets and are implementing necessary pricing actions and other measures to mitigate the impacts of the escalating inflationary pressures.” That language was missing from the 2QFY23 earnings release. Expect management to be asked its view on the balance of FY23 and, by inference, 4QFY23.
Commentary on pricing versus unit volumes will likely be a topic of extended discussion. That will, undoubtedly, include a conversation about return-to-office (RTO) impacts, sales activity such as visits to Steelcase, and visibility about new projects.
In this report, Armbruster noted, “Our strategy remains unchanged, but we are shifting additional effort to prioritize improvement in our profitability to fund future investments and to add more diversification to the markets and customers we serve.” Expect additional color on these efforts and any near-term and/or intermediate-term financial impacts.
In the release, management noted $270 million of incremental inflation for the last six quarters. And in 2QFY23, price realization of $80 million less implied inflation of $50 million yielded a price minus cost benefit of $30 million. Expect management to be asked to piece the pieces of inflation and price to reach the $55 million guided benefit for 3QFY23. Also expect management to be asked about the projected time frame to cover the cumulative inflation costs.
The surcharge instituted last quarter remains in place. Expect additional color and quantification of its expected impact on revenues for the upcoming quarters.
Commentary about early results of Halcon, acquired effective June 10, 2022.
Discussion about restructuring actions announced in the release. The severance of $8 million will facilitate a reduction of up to 180 salaried positions and “other actions”, yielding an expense reduction of $20 million annually.
Also rationale for dividend cut and criteria for when it might be restored.
Balance sheet issues. Pay down of debt philosophy,

Near-Term Stock Price Issues

Lower-than-guidance estimates are likely most impactful for near-term stock price performance. Management’s view on future quarters may help offset the near-term impact.
The dividend cut may also have an impact on the near term. Yield is a potential offset to that at this level.


DISCLOSURES

Water Tower Research (“WTR”) is a professional publisher of investment research reports on public companies and, to a lesser extent, private firms (“the Companies”). WTR provides investor-focused content and digital distribution strategies designed to help companies communicate with investors.  WTR is not a registered investment adviser or a broker/dealer nor does WTR provide investment banking services. WTR operates as an exempt investment adviser under the so called “publishers’ exemption” from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940. WTR does not provide investment ratings / recommendations or price targets on the companies it reports on. Readers are advised that the research reports are published and provided solely for informational purposes and should not be construed as an offer to sell or the solicitation of an offer to buy securities or the rendering of investment advice. The information provided in this report should not be construed in any manner whatsoever as personalized advice. All users and readers of WTR’s reports are cautioned to consult their own independent financial, tax and legal advisors prior to purchasing or selling securities.  Budd Bugatch and Rex Henderson, CFA who are the writers of this report, covers the Consumer sector for WTR. Mr. Bugatch and Mr. Henderson, CFA including members of their household have no personal or business-related relationship to the subject company other than providing digital content and any ancillary services WTR may offer.  Unless otherwise indicated, WTR intends to provide continuing coverage of the covered companies. WTR will notify its readers through website postings or other appropriate means if WTR determines to terminate coverage of any of the companies covered.  WTR is being compensated for its research by the company which is the subject of this report. WTR receives no more than a maximum of $10,500 per month from a given client and is required to have at least a 6-month commitment. None of the earned fees are contingent on, and WTR’s client agreements are not cancellable for the content of its reports. WTR does not accept any compensation in the form of warrants or stock options or other equity instruments that could increase in value based on positive coverage in its reports.  WTR or an affiliate may seek to receive compensation for non-research services to covered companies, such as charges for presenting at sponsored investor conferences, distributing press releases, advising on investor relations and broader corporate communications and public relations strategies as well as performing certain other related services (“Ancillary Services”). The companies that WTR covers in our research are not required to purchase or use Ancillary Services that WTR or an affiliate might offer to clients.  The manner of WTR’s research compensation and Ancillary Services to covered companies raise actual and perceived conflicts of interest. WTR is committed to manage those conflicts to protect its reputation and the objectivity of employees/analysts by adhering to strictly-written compliance guidelines.  The views and analyses included in our research reports are based on current public information that we consider to be reliable, but no representation or warranty, expressed or implied, is made as to their accuracy, completeness, timeliness, or correctness. Neither we nor our analysts, directors, officers, employees, representatives, independent contractors, agents or affiliate shall be liable for any omissions, errors or inaccuracies, regardless of cause, foreseeability or the lack of timeliness of, or any delay or interruptions in the transmission of our reports to content users. This lack of liability extends to direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, losses, lost income, lost profit or opportunity costs.  All investment information contained herein should be independently verified by the reader or user of this report. For additional information, all readers of this report are encouraged to visit WTR’s website www.watertowerresearch.com.

2QFY23 EPS Beats Estimates; 3QFY23 Guidance Modestly Lower; Quarterly Dividend Cut to $0.10 from $0.145

Steelcase Inc Cl A

2QFY23 EPS Beats Estimates; 3QFY23 Guidance Modestly Lower; Quarterly Dividend Cut to $0.10 from $0.145