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Steelcase Inc. (NYSE:SCS)
Q2 2019 Earnings Conference Call
Sept. 21, 2018, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, everyone, and welcome to Steelcase's Second Quarter Fiscal 2019 Conference Call. As a reminder, today's call is being recorded. For opening remarks and introductions, I would like to turn the conference over to Mr. Mike O'Meara, Director of Investor Relations, Financial Planning, and Analysis.

Mike O'Meara -- Director of Investor Relations, Financial Planning, and Analysis

Thank you, Heather. Good morning, everyone. Thank you for joining us for the recap of our second-quarter financial results. Here with me today are Jim Keane, our President and Chief Executive Officer, and David Sylvester, our Senior Vice President and Chief Financial Officer. Our second-quarter earnings release, which crossed the wires yesterday, is accessible on our website. This conference call is being webcast and this webcast is a copyrighted production of Steelcase, Inc. A replay of this 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. Reconciliation to the most comparable GAAP measures and details regarding the risks associated with the use of forward-looking statements are included in our earnings release and we are incorporating by reference into this conference call the text of our Safe Harbor statement included in the release. Following our prepared remarks, we will respond to questions from investors and analysts. I will now turn the call over to our President and Chief Executive Officer, Jim Keane.

James P. Keane -- President and Chief Executive Officer

Thank you, Mike, and good morning, everyone. We had a very good second quarter. All three regions exceeded our profit expectations. All three regions had strong order growth, with EMEA growing orders more than 20%. Our reported results include a gain on the sale of some land and some benefits from the recent acquisition of Smith System, but even without those benefits, the quarter was very strong. On a reported basis, it was our highest quarterly operating income in more than a decade.

Earnings were stronger than we expected, primarily because of stronger-than-expected operating performance of each of our segments. It's really that simple. Operating expenses were better because of really good control over spending, better than we expected. Our warranty and product liability costs went down because of better quality performance over time. Our ongoing operational stability has helped us reduce workers' compensation costs. All these things came together in a way that showed in results this quarter, and there were very few unfavorable items other than inflation, and we had already considered that in the outlook we had provided. Even the Smith System acquisition, which contributed about $0.02 to our results, beat our own expectations because of really good performance in the period since we closed the transaction.

So, while we did better than we expected, we were, in fact, expecting to see our performance improve, so that's not a surprise. In recent calls, we've been talking about why we expected to see profitability improve. We launched a large number of new products -- some to fill gaps and others to anticipate where we believe demand is headed. We've responded quickly to inflation driven by tariffs by implementing two price increases this year. We talked about the momentum we were feeling in Europe as more customers visit our Munich LINC.

We've talked about all those things, and we can see the positive impact developing, but until this quarter, it was difficult for investors to see it in our numbers. That's changed. The sales and order growth we reported is related to improved project wins, and the new products were key to those wins. And, we believe the Munich LINC is an important factor in many of the wins contributing to our growth in EMEA. In fact, we're expecting EMEA to be profitable during the second half of the year. We're also expecting the impact of the global price increases to offset the impact of rising material costs in the second half of the year, though we are facing new challenges from rapidly rising freight costs in the U.S.

With strong quarter growth, strong backlog, and some major wins not yet in our backlog, we're feeling confident heading into the second half of the year. Of course, there are headwinds, like inflation, but we will continue to manage that, as we have. There are rising uncertainties about trade and the state of the global economy, and our customers don't like uncertainty. We can't control that, but I feel pretty good about the things we can control. That starts with new product development. New products and products we've enhanced in the last three years make up about a third of our sales.

In seating, we've broadened our product line with new products like SILQ and Series 1. We've been selling Series 1 long enough that we can now see that 40% of its sales are to new customers, which shows that the lower price point helps us address a broader market. Products like Answer fence, launched last year, have been successful on their own, but we've also noticed a significant slowing in the decline of our legacy Answer panel sales since we've launched fence and other Answer extensions.

We have also invested in building stronger customer relationships, particularly in EMEA. This quarter, EMEA grew sales 11% organically and orders grew 22%. Western Europe was the biggest driver of that growth, and we've seen 14 consecutive months of year-over-year growth in those countries. The underlying economies are only growing low single digits, so this is really related to ongoing improvements in our operational performance and our win rates on major projects. APAC had a good second quarter after a slow start in the first quarter. We're pleased with the order growth and backlog as we head into the second half.

This quarter, we completed the acquisition of Smith System, which expands our education business to more fully address customers in the K-12 segment. As I mentioned earlier, Smith System got off to a good start, with modestly stronger results in the quarter than we had expected. Our relationship with West Elm is making great progress. Our teams are working to operationalize the first products to be developed under this relationship. We expect to see our first sales in our fourth quarter, growing to more significant levels next fiscal year. The market -- meaning customers and dealers -- are very excited about our work with West Elm, and we are too.

Yesterday, we announced the acquisition of Orangebox, which was started by some alumni of our Steelcase business in Europe back when it was a joint venture called Steelcase Strafor. They've done a great job focusing on furniture that supports collaboration away from the desk, as desired by today's customers. Orangebox is an innovator, having developed one of the first pod-type products to flexibly support individual or small-group collaboration. These products have attracted customers and new competitors as they rise in popularity. They also have a well-developed task and multiuse seating portfolio, which will fill gaps in our product line.

What they haven't had is significant distribution beyond the U.K., and that's where we can help. We see opportunity to extend our products to other parts of Europe, the Americas, and Asia, where we are well-established. There's very little product overlap with our existing products and they complement the partnerships we've developed in EMEA and the Americas. Based in the U.K., Orangebox will be affected in some way by Brexit, but since our value creation plan is related to globalization -- and therefore, localization -- we expect the synergies we've identified will not be affected. Plus, we could use the Orangebox factory in Wales to localize some Steelcase production depending on how Brexit materializes.

In closing what we stated, while we feel good about reported results this quarter, it's really not about this quarter, it's about all the work that came before. Our industries have had to be patient through all of that, and we aren't done, of course. We're expanding our business through acquisitions, we're hard at work to create value from those investments, but I'm really glad we've been able to show the results and look forward to keeping this momentum going to create more opportunities for our employees, deliver more value for our customers, and return more value to shareholders.

Our upcoming Investor Day on October 3rd in New York, we look forward to sharing our thoughts in more depth about the changes in our industry and how we're positioned to capitalize on that change, and what our shareholders can expect in future financial results. It's an exciting time at Steelcase. Thanks for your interest in the company, and now I'll turn it over to Dave for a deeper look at our results.

David C. Sylvester -- Senior Vice President and Chief Financial Officer

Thank you, Jim, and good morning, everyone. I will cover our second-quarter financial results first, noting where results differed from our expectations and highlighting year-over-year and sequential-quarter comparisons, and then I will talk about our balance sheet and cash flow before getting into our order patterns and outlook for the third quarter and the full fiscal year.

As Jim said, we're excited to report double-digit growth in revenue, orders, and backlog, along with 32% growth in earnings in the second quarter. Revenue of $876 million was in line with the estimates we provided in June, while earnings of $0.41 were significantly higher than the top end of our guidance for the quarter. Before I get into the detailed results, I want to share a few additional highlights, some of which Jim just referenced.

First, the organic order growth of 12% included 9% growth in the Americas, 22% growth in EMEA, and 15% growth in the Other category. I will share more details about our order patterns in a few moments, but wanted to start with referencing this double-digit strength, as it drove the strong revenue growth in the quarter and the high levels of order backlog at the end of the quarter, which contributes to the strength of our outlook for the third quarter.

Second, the $0.41 of earnings included a $7.5 million property gain in the current year along with $5.3 million of lower costs related to warranties, product liability, and workers' compensation, but we also had a $4 million property gain and a $3.9 million favorable tax adjustment in the prior year, and these items contributed approximately $0.05 to our earnings in both quarters, so the earnings growth was big with or without these unusual items.

The Americas reported a strong 11.8% operating margin in the quarter compared to 9.8% in the prior year. The land gain and the lower costs I just mentioned had a significant impact, but the operating margin before taking these items into account was still very strong and would have exceeded 10%. Fourth, EMEA continued to report year-over-year improvement in operating results excluding the property gain in the prior year. This improvement was better than we were expecting, but less than the year-over-year improvement in the last two quarters.

As I said in the release and Jim mentioned a minute ago, we are currently projecting a strong back half of the year in EMEA, which could result in the segment approaching break-even operating results for the full year. Achieving another year of significant improvement in fiscal 2019 is an important step toward our longer-term goal of reaching a mid-single-digit operating margin, which would return our cost of capital in the region.

Lastly, we completed the acquisition of Smith System during the second quarter and announced the acquisition of Orangebox yesterday, plus we entered into our partnership with West Elm and expanded our partnership with Bolia in the quarter, adding significantly to our potential to drive additional growth.

As it relates to our second-quarter results relative to our expectations, revenue was largely in line with our estimates across the segments. The completion of the Smith System acquisition on July 12th compared to our original target for the end of June had a negative effect, but they recorded higher-than-expected revenue in August, plus EMEA revenue was also slightly higher than projected, so our consolidated revenue remains within our estimated range.

The earnings, however, were much higher than our estimated range of $0.28 to $0.33 per share, with all segments positively contributing to our performance. Within the Americas, the lower warranty, product liability, and workers' compensation costs contributed approximately $0.02 to the favorability after consideration of variable compensation and income tax effects. In addition, post-acquisition earnings from Smith System were better than expected despite revenue being lower due to the delayed closing. In total, the acquisition contributed approximately $0.02 to our second-quarter earnings compared to $0.01 we had included in our estimates.

Beyond these two items, operating expenses were also lower than we anticipated, in part due to timing as we expect a sequential increase in spending for the third quarter. Lastly, the speed of implementation of our recent pricing actions has exceeded our expectations, which were based on historical experience. As a result, the shortfall between estimated price yield and approximately $10 million of increasing commodity and freight costs was reduced to a few million dollars in the quarter.

EMEA results were also better than expected. I mentioned the favorable revenue a moment ago, but gross margins and operating expenses were also better than we expected, in part due to some delayed spending. The Other category also reported better-than-expected profitability in the second quarter, nearly tripling the operating income reported in the first quarter.

Seasonal strength from PolyVision, mostly as expected, contributed to the sequential improvement, but we also saw improvement in our Asia/Pacific business, which was better than expected following the slow start in the first quarter. Orders grew by more than 30% in the region, including replacement orders from a large customer which canceled certain orders in April. Corporate costs were also lower than expected, driven by gains related to COLI maturities which occurred during the quarter, and lastly, other income net continued to benefit from stronger-than-expected income from our joint ventures and other unconsolidated affiliates.

Switching to year-over-year comparisons, operating income increased by $15.5 million in the second quarter, which included a $22 million increase in the Americas, offset in part by reductions in EMEA and the Other category as well as higher corporate costs. The $22 million increase in the Americas was driven by an $86 million increase in revenue. The property gain and lower costs previously mentioned contributed approximately $9 million to our operating income after taking into consideration related variable compensation expense.

The acquisitions of Smith System and AMQ, net of a small divestiture in the prior year, accounted for another $4 million of the improvement in operating income and contributed approximately $46 million net to the revenue growth in the Americas during the quarter. Smith System was a big contributor, as two-thirds of their annual revenue is typically realized in the summer months of June, July, and August, but AMQ also reported strong results. The operating income from these acquisitions was reduced by approximately $7 million of purchase accounting effects, $6 million of which was related to the step-ups of acquired inventory and backlog from Smith System, which were almost fully amortized in the quarter.

The balance of the improvement in the Americas' operating income of approximately $9 million was attributable to the remaining revenue growth of approximately $40 million, which was driven by project business. Increased pricing from our recent list price adjustments drove part of the revenue growth, but was not enough to offset the increase in commodity and freight costs. There is still a relatively significant effect on our gross margin, but we feel good about the pace at which our sales teams are driving customer agreements to more recent list prices.

We also experienced some unfavorable shifts in business mix, which negatively impacted our gross margin in the second quarter, but we held our operating expenses excluding variable comp relatively flat at the same time, so the contribution margin associated with the volume growth was still quite strong. In EMEA, the $6 million operating loss in the current quarter compared to a loss of $3.6 million in the prior year, which included a property gain of $4 million. Benefits from the revenue growth in the quarter were partially offset by unfavorable shifts in business mix and a small loss related to a divestiture.

In the Other category, we reported $4.9 million of operating income or 5.6% of revenue, which represented a $2 million reduction compared to a strong prior year. We continue to target a mid-single-digit operating margin in the Other category given our plans to continue investing for longer-term growth in the Asia/Pacific region. Lastly, higher corporate costs were driven by higher deferred compensation costs, which were unusually low in the prior year, offset in part by gains related to COLI maturities in the current year.

Sequentially, second-quarter operating income nearly tripled compared to the first quarter. This improvement was driven by seasonality and momentum in our business, the property gain, the acquisition of Smith System, and lower warranty, product liability, and workers' compensation costs. Operating expenses before variable compensation reflected the sequential decrease of a few million dollars, as operating expenses from Smith System were more than offset by the land gain and some delayed spending across all of our segments. As mentioned a moment ago, we expect a sequential increase in third-quarter spending.

Moving to the balance sheet and cash flow, we used domestic cash and a $75 million borrowing under our global credit facility to fund the acquisition of Smith System in July, but we were able to pay down our borrowings on lines of credit to $10 million by the end of the quarter due to the strong cash generation in the quarter, which totaled $79 million. In addition, we received $12 million in connection with policy maturities under COLI.

Working capital growth in the quarter approximated $51 million, driven by a $58 million increase in accounts receivable, excluding acquisition impacts. The increase was driven by the strong growth in our business, which was more heavily weighted in the back half of the quarter. At the end of the second quarter, DSO was only modestly higher compared to the first quarter, and most of the increase was driven by a higher mix of business from direct-sell customers, which have longer payment terms.

Inventory levels excluding acquisition effects also increased in the quarter to support the growth in our business, but accounts payable balances increased by a higher amount, so the impact on cash was favorable. Capital expenditures totaled $26 million in the second quarter, and we continue to expect fiscal 2019 to fall within a range of $80 million to $90 million, driven by our intention to sustain a high level of product development, strengthen our industrial capabilities, enhance our information technology systems, and invest in our customer-facing facilities.

We returned approximately $16 million to shareholders in the second quarter through the payment of a cash dividend of $0.135 per share, and yesterday, the board of directors approved the same level of dividend to be paid in October. Share repurchases during the quarter were minimal. Earlier this week, we funded the acquisition of Orangebox with short-term borrowings under our global credit facility, and we expect cash generation in the third quarter to substantially reduce the borrowing by the end of the quarter.

Turning to order patterns, I will start with the Americas segment, where our orders in the second quarter increased 9% compared to the prior year. Our presentation of order growth is adjusted for constant currency, acquisitions, and divestitures, which is consistent with how we calculate organic revenue growth. Across the months, we posted double-digit order growth in June and July, followed by a modest decline in August.

Customer order backlog at the end of the quarter was approximately 11% higher compared to the prior year, and through the first three weeks of September, order growth has been tracking at a low double-digit percentage. Orders from our largest customers showed improvement again in the second quarter, growing by a mid- to high-single-digit percentage compared to the prior year. Across quote types, orders for project business and orders through our marketing programs drove the growth in the quarter while orders associated with continuing agreements declined by approximately 7%.

Turning to vertical markets, we saw order growth in five of the 10 vertical markets we track, including insurance services and manufacturing, which had posted year-over-year declines in each of the previous four quarters. And, for the sectors that declined in the quarter, it's worth noting that a couple faced strong prior-year comparisons while others have been up and down over the past five quarters. Overall, we feel very good about the second-quarter order patterns in the Americas as well as our win rates, which have remained strong and have included some larger opportunities, which we won with some of our newest products. And, we're continuing to see solid year-over-year growth in our pipeline of project opportunities projected to ship over the balance of the fiscal year, which is consistent with the general level of optimism we are feeling from our dealers about their outlook for the balance of the year.

For EMEA, the 22% order growth in the quarter included broad-based strength across Western Europe, reduced in part by a modest decline in the rest of EMEA as a group. Customer order backlog in EMEA ended the quarter up approximately 34% compared to the prior year, setting up a strong outlook for the third quarter. We expect the order growth rate in the third and fourth quarters to moderate from these very high levels, in part due to a strengthening prior-year comparison, but our order patterns through the first three weeks of September reflected a slow start to the quarter, declining at a high-single-digit percentage. Overall, we remain optimistic in EMEA as our pipeline of project opportunities continues to reflect solid growth, and the level of customer traffic in the Munich Learning and Innovation Center remains very high.

For the Other category, orders in total grew by 15%, driven by strength in Asia/Pacific, which posted order growth of more than 30% compared to the prior year. I talked earlier about some customer orders which were canceled in the first quarter and replaced in the second quarter, but apart from those orders, the growth rate still approximated 20%.

Turning to the third quarter of fiscal 2019, we expect to report revenue in the range of $885 million to $915 million, which includes the acquisitions of AMQ, Smith System, and Orangebox net of divestitures and approximately $6 million of estimated unfavorable currency translation effects. The projected revenue range translates to expected organic growth of 11% to 15% compared to the prior year, with acquisitions contributing modestly to the projected range of organic growth.

Taking into consideration the projected revenue growth and typical seasonal patterns, including reductions in business from customers in the education sector and increases in business from the government sector, we expect to report diluted earnings per share between $0.28 to $0.33 for the third quarter of fiscal 2019. This estimate projects that estimated yield from our recent pricing actions will begin to offset increasing commodity and freight costs in the third quarter.

In addition, the estimate includes a continued negative impact from unfavorable shifts in business mix and a $15 million to $20 million sequential increase in operating expenses, reflecting the non-recurring nature of the property gain and other benefits recorded in the second quarter, the expected higher spending I mentioned earlier, and the effects of acquisitions, offset in part by lower variable compensation.

As it relates to the acquisitions, we do not anticipate any additional earnings accretion in the third and fourth quarters, in part due to the seasonality of Smith System. In addition, the operating results from the acquisitions will be substantially reduced by an estimated $4 million of amortization expense in the third quarter and $3 million in the fourth quarter. For fiscal 2020, we expect accretion of earnings to become more meaningful as we more fully implement our value creation plans and the step-ups of acquired inventory and backlog have been fully amortized.

Taking into consideration recent industry trends, our improved win rates, our recent pricing actions, and the positive outlook for EMEA and Asia/Pacific, we are currently projecting strong revenue growth to continue in the fourth quarter, and to provide clarity around the expected impact of our recent acquisitions, our outlook for inflation relative to our pricing actions and other factors, including business mix and the level of operating expenses, we have taken the unusual step to issue full-year guidance, which you saw in the release, as a range of $1.10 to $1.15 per share. From there, we will turn it over for questions.

Questions and Answers:

Operator

If you would like to ask a question, please do so by pressing *1 on your touchtone telephone. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We will request that you limit yourself to two questions. So that we may answer as many questions as possible in the time permitted, please phrase your question directly and as briefly as possible. Your first question comes from Budd Bugatch with Raymond James. Your line is open.

Budd Bugatch -- Raymond James -- Managing Director

Good morning, Jim. Good morning, Dave. Good morning, Mike. Congratulations on the quarter and the performance. A couple of questions, if I could. I guess the first question is over the last year or so, we've watched you develop a number of partnerships, and now the West Elm relationship, Orangebox, Smith System, but I would call it a smorgasbord, I guess, of partnerships. Could you go through and maybe prioritize what you think are the most important things you have done in terms of those outside relationships and acquisitions, and maybe give us an idea of what you think the economic impacts of those are going to be over time in a broader sense?

James P. Keane -- President and Chief Executive Officer

I'll take that question. First of all, we love all these acquisitions and partnerships that we've put together because we're here for our clients, and that's really where the energy comes from these days. They've been dealing with trying to create applications that respond to new ways of working, more relaxed environments, demand for more residentially inspired furniture, demand for more choice, frankly, than they've had before from the major manufacturers, including Steelcase. And, that choice should extend to a broad range of price points to meet their budgets. So, we're really responding to customer demand.

They're not asking us to do any particular partnership, but they want us to help bring order to this new world because they've been forced to create their own smorgasbord, if you like -- every customer trying to find ways to meet their needs has led them to have to dramatically broaden the number of manufacturers from which they've been purchasing, and that's created problems. It's created problems in terms of their ability to leverage their buying power. It creates problems in terms of them really knowing what they're getting in terms of product quality, sustainability, and so forth. It's created problems as they try to put those individual products together and have them work together, and they've been largely on their own.

And, operational issues as those products show up with varying lead times -- sometimes they don't come in on the date they're supposed to come in, they come in on separate trucks. It's been super inefficient for our customers, but also for the rest of the industry. We hear the same thing from architects and designers, who've been saying that they really are struggling to meet their clients' needs and deal with all the extra costs that they've been incurring. We're hearing from our dealers as well, who've been asked to shoulder the burden for a lot of this.

So, that's really where the energy comes from, and the most important things we've been doing is first of all, picking really good partnerships. So, companies that we're working with like Mitchell Gold + Bob Williams, like Flos, like Bolia in Europe -- super happy with each of these relationships, and the most important thing we're doing is then taking those relationships and helping our customers make sense of the applications they're trying to develop.

So, showing them, for example, at MIACON last year in our new showroom that won at MIACON. I think we won because we were able to show people how these kinds of products can come together to not just create attractive settings, but actually create attractive settings that support real work. So, that's the first most important thing we do, is applying our insights to products that we've put together through these partnerships.

The second thing is making it easier for customers and specifiers and our dealers to select and order these products, so we've been creating tools to allow them to do that, and then, finally, integrating the partnerships into our back end so that we can consolidate deliveries onto single shipments that meet our customers' expectations.

In terms of impact, they've all had an impact in their own way. It's hard to compare a lighting company versus a seating company or a broader furniture company, but we've been happy with the results, and I'll call out Bolia in particular. Bolia is probably a brand that's less known here in the U.S., but very well known in Europe. The degree of adoption of the Bolia products by our customers was terrific. We can connect the fact that we had Bolia in our portfolio as directly related to some wins with our key customers. So, we're really happy with that. The products themselves are beautifully designed -- Scandinavian influences. It's been going so well that we recently announced that we're expanding that partnership to include offering those products in the U.S.

West Elm is a new announcement -- we just have been working through the details of that agreement. We unveiled it to the marketplace back at MIACON. Really, no impact yet because we're still working on operationalizing it, but the reaction we've gotten from customers and dealers has been terrific. And then, I'll add Orangebox to the mix because even though that's not a partnership, but an acquisition, just in the last 24 hours, we've had a number of inbound phone calls from dealers, both in the U.S. and in Europe, congratulating us on the deal, excited about the deal. I had a chance to talk to some of our key customers who are in Grand Rapids yesterday. Many of them have already been evaluating Orangebox products to meet some of these needs I'm talking about.

So, what I'm most excited about is the way it's all going to come together. It's not any one particular partnership, it's really the integration of these to meet customer needs, and probably, we'll begin to see a larger impact of that in terms of revenue and profits next year. As you know, sometimes it takes time. The benefits we're seeing this quarter in our core business are because of the work we've been doing for the last two years on new product development, operational stability, and the work we're doing this year to build these partnerships, integrate them with our logistics, integrate them with our selection tools -- the true impact of that will probably be felt more completely next year.

Budd Bugatch -- Raymond James -- Managing Director

What I worry about -- there's been a whole raft of them -- are you able to control and to integrate them effectively, or do we have a risk of losing some of that control as you work your way through and develop the relationships with these partnerships and even the acquisitions?

James P. Keane -- President and Chief Executive Officer

It's a good question. So far, we haven't seen any concern -- we haven't seen any evidence of losing control, but we have teams of people that are working actively on that to make sure that we can keep our commitments to clients. Remember that in this world, though, we're being compared to the current state, which is pure chaos. People are trying to order two products from this company and three products from that company -- I won't go through it all again. If we can improve it, we'll be a massive amount of value creation for them. It may be some time before we're able to bring the exact same level of reliability that we have in the furniture we've been selling for years that we make in our own factories and so on, but we're going to make a big difference for our clients.

Budd Bugatch -- Raymond James -- Managing Director

Let me ask two quick other detail questions. You talked about wins not in the backlog. Could you quantify that for the second half of the year, how that might impact revenues?

David C. Sylvester -- Senior Vice President and Chief Financial Officer

I won't quantify it. I'll just restate what I said in my scripted remarks, that it's reflecting growth, our pipeline of project opportunities shows solid growth for the back half of the year. I'm not being coy, I just -- we've found that our data from -- basically, looking at data from our CRM tools, which often reflect change, and so, I just don't want to quote a specific percentage, but it looks like solid growth for the balance of the year.

James P. Keane -- President and Chief Executive Officer

I'd add that when we talk about that, we look at the data that comes out of CRM, but we also complement that data with qualitative information from phone calls we have with dealers and so on, and those conversations are supporting the data as of now.

Budd Bugatch -- Raymond James -- Managing Director

Okay. And, lastly, tariffs -- I don't think I heard very much about that. We've heard that on another call recently, that tariffs would have a significant impact on results for the second half.

David C. Sylvester -- Senior Vice President and Chief Financial Officer

Yeah, we heard that same reference on the call that you're referring to, I think, and I don't -- we're not seeing the same kind of number that they're talking about, and that could be a function of different supply chains and business models, where they're sourcing component parts and finished goods from. We are affected by tariffs. The most meaningful impact that we've had on tariffs in the last several quarters was related to PolyVision. We talked about that over and over. We sought an exclusion and were successful in getting that, and then, additional waves of tariffs came in and we're also pursuing some exceptions, and dealing with other impacts of tariffs through price adjustments. The biggest issue for us from all the tariff activity has been the fact that steel prices have been able to go up under the cover of the tariffs. They've gone up dramatically, which drove our decision to take two price adjustments in four months.

So, tariffs are on our radar screen. Jim and I get weekly updates, if not daily, depending on how things are developing in Washington, and our teams take action immediately, whether it's working with suppliers about a different approach, or whether it's working with our customers about integrating a quick price adjustment, or working with the government on looking for some sort of an exclusion, but it does not seem to be the same level of magnitude for us as it is for the other party that you're referencing.

Budd Bugatch -- Raymond James -- Managing Director

Thank you very much. Good luck on the quarter and the second half.

James P. Keane -- President and Chief Executive Officer

Thanks.

Operator

Thank you. Your next question comes from Matt McCall with Seaport Global Securities. Your line is open.

Matt McCall -- Seaport Global Securities -- Managing Director

Thank you. Good morning, everybody.

James P. Keane -- President and Chief Executive Officer

Hi, Matt.

David C. Sylvester -- Senior Vice President and Chief Financial Officer

Hi, Matt.

Matt McCall -- Seaport Global Securities -- Managing Director

So, just because I want to say the word, if you can exclude the smorgasbord for a second and maybe look at the order pattern you talked about and the way you broke down -- you said project and marketing drove growth, continuing agreements were down. What can you tell us about the underlying market environment? The macro seems to be looking better. I'm wondering what your customer conversations -- clearly, you said the order book and the orders not in backlog are helping your outlook, but if you just think about the market growth and your market growth expectations given what we think is a better macro environment -- and, clearly, you've done a lot on the product side, but just stripping out all the company-specific stuff, how do you think the market's going to behave over the next few quarters?

James P. Keane -- President and Chief Executive Officer

From an underlying market perspective, I think what's driving demand right now is a recognition by customers -- and, I'll start at the CEO level, and then it permeates down to the organization -- everyone's trying to drive growth, and as they're trying to drive growth, they're trying to do that through innovation. I think everyone would like to find ways to squeeze more operating performance out of their top line, but they're recognizing that they have to grow their top line, and if they're going to grow their top line and innovate, they've got a lot of stuff to work on.

So, they've got to think about digital technologies and how digital transformation is affecting their companies. As they think about integrating digital aspects into their products, as they think about using new digital technologies to improve their performance, they're also realizing that software development is becoming a bigger part of who they are, and as that happens, they're beginning to look at their culture and explore what it's going to take for them to be an attractive place for a new kind of worker to join their companies.

So, attract and retain has always been a part of the conversation we have with customers in some ways -- that's been true for 20 years. It's more true in economies like this that are strong, but I think it's amplified because of this shift in our customers toward thinking about how digital transformation will affect their business.

It also relates to customers who are trying to grow and innovate by accelerating the speed of their own product development by adopting things like Agile. As they adopt Agile processes -- not just in software development, but in product development, and really, every part of business development -- the same thing happens. They're saying, "We have to attract a different kind of worker and we have to reinvest in our existing workforce. We have to find ways to help our existing workforce achieve new levels of productivity." There's a recognition that even as they try to attract new workers, that's kind of a zero-sum game. The Western markets are increasingly running out of workers, so the attention is now shifting to "How do I actually help my workforce be more productive?"

In the past, we've sometimes had to spend some time with customers on the question of whether the workplace itself matters. Does furniture really matter? Does the environment really matter? We're having zero conversations about that. They walk in the door already having concluded that the space and the furniture is a key part of helping them reach this next level of performance.

So, I think on top of the overall economic factors, on top of all the things we talked about -- inflation, trade, and all those different things -- you've got this recognition by our customers that they've got to find a way to improve productivity and to increase innovation, and this is an important part of the formula.

Matt McCall -- Seaport Global Securities -- Managing Director

So, if you add all that up, you have some cyclical kickers in the form of attract and retain and worker productivity investments. The cycle has been kind of a disappointment for the group just from a growth perspective, but are we finally seeing things line up where the leaders have the right products, the employment environment is tight enough, the corporate profit environment is good enough where you start to see a growth rate for this industry that's maybe sustainable above what's been the average the rest of the cycle?

James P. Keane -- President and Chief Executive Officer

My crystal ball is only as good as yours, and what I would say, though, is if you look at the last few quarters -- let's look back a bit -- you can see the industry beginning to grow and separate from what had been several years of flattish growth or even negative growth. You're seeing Steelcase's performance improve, but also, the performances of some of our competitors are improving. I am seeing a lot of signs that yes, there is competition in our industry, and we're in a super-competitive industry, but everyone's doing better right now.

How long that lasts, what happens next -- I don't know, but I don't think this is something that's related to a furniture replacement cycle or anything like this. I think this is related to the things I talked about a minute ago. Our clients are struggling to find a way to improve productivity, and no longer are they questioning whether the workplace has something to do with it. Those two things together are a really positive sign. I don't know why those things would change, but if those two things remain forces, I think that's good news for our industry and for Steelcase.

Matt McCall -- Seaport Global Securities -- Managing Director

Okay, that's helpful. Dave, maybe one for you. A lot of changes, be it mix or structural changes -- for instance, in Europe -- but how should we look at the contribution margin profile of the different segments today? It's been difficult to model because there have been so many moving parts. Now, it seems like you've got more of the ducks in a row, so how should we think about the incremental profitability, both of the company and the three segments?

David C. Sylvester -- Senior Vice President and Chief Financial Officer

You know our business model pretty well. We've talked over the years that our contribution margin can be as high as in the mid-20% when operating expenses are relatively flat, and we don't have any anomalies going on in the business -- like changes in business mix or inflation -- like we've seen over the last couple of quarters. Europe is maybe a little bit less than that, but not very far off of where the Americas would be.

I can't tell you what the incremental contribution margins will be on growth because you're right, there are so many moving pieces, and we've got some new moving pieces of acquisitions that are also starting to come into the mix, but our overall business model has not changed significantly in the last couple of years, so our variable margins are still quite strong, and we have said in previous quarters that we feel good about the current level of investment in product development. That's no guarantee that we won't increase it if we have additional ideas in front of us that we want to invest in, but we said a few quarters ago that we feel pretty good about the level of investment, and I've been rolling operating expenses forward sequentially for you guys to help you see that outside of variable comp, acquisition effect, and unusual property gains and the like that the underlying base has been relatively flat, which helps contribution margin.

Right now, we've got a couple of factors with pricing net of inflation and business mix that are causing a little bit of a drag on the overall contribution margin. But, as I walked through in my remarks, even when you pull all that stuff out in the Americas, it was still pretty solid. I wish it was simpler for you, Matt, but it's just not right now, so I can't give you a specific percentage to easily model.

Matt McCall -- Seaport Global Securities -- Managing Director

Okay. All right. For the long term, the same target exists. The follow-up question I had -- so, Jim, I think you said that you exceeded profit expectations in all three segments, and I know you talked about EMEA revenue being higher than expected, but was profitability also better than you had expected? For EMEA, it was actually a little worse than we thought, but maybe it was poor modeling. What was the thought heading into the quarter on EMEA?

David C. Sylvester -- Senior Vice President and Chief Financial Officer

It was a little better. The revenue helped a little bit. The order strength was really remarkable. That was significantly better than we were expecting, but a lot of that ended up in backlog, so revenue was slightly higher, gross margins were a little bit better despite some mix shifts, our performance continues to be good -- I love the traction that we're starting to get with Lean in our manufacturing facility.

We are also handling the high level of volume better. It wasn't that long ago that we had some disruption in our factories associated with restructuring that we were in the midst of, so this is the first real significant test for them, and I'd say they're doing quite well in handling that additional volume. So, overall, they've performed a little bit better on the top line and through gross margins, and then, operating expenses also were a little bit less than we were expecting, in part because of some delayed spending into the third quarter.

Matt McCall -- Seaport Global Securities -- Managing Director

Okay, thank you all. Congratulations.

James P. Keane -- President and Chief Executive Officer

Thanks.

Operator

Thank you. Your next question comes from Kathryn Thompson of Thompson Research Group. Your line is open.

Steven Ramsey -- Thompson Research Group -- Analyst

Good morning. This is Steven Ramsey on for Kathryn. Maybe to circle back on the Orangebox deal -- and, maybe I missed this -- can you clarify -- do they only sell in the U.K., or is it throughout Europe, and do you plan to take the Orangebox product set and capabilities across the footprint into Asia or the U.S.?

James P. Keane -- President and Chief Executive Officer

They don't only sell in the U.K., but that's where they're based, and that is where the majority of their volume is located in terms of revenue, so that's where their customers are. So, they have customers in the rest of Europe, and they have some customers in the Americas and Asia, but they were really just getting started with that.

Secondly, yes, it is our intent to offer those products over time to our customers in all the regions where we are well-established -- so, in the rest of Europe, where we're strong, in the Americas and Asia -- we think those products have relevance, and so do they. And, we have distribution set up in those places and we have customers set up in those places, so we think we can do that faster than they would have done otherwise. It's also our intent -- over time, as we globalize their offering -- to also localize manufacturing as we see fit in different places around the world, so that is exactly the plan.

Steven Ramsey -- Thompson Research Group -- Analyst

Excellent. And then, speaking along the same lines, how the AMQ deal has gone so far, both the integration and the rollout in tracking toward your goal to double sales of that business over the next three to five years, how it's tracking versus expectations.

James P. Keane -- President and Chief Executive Officer

Our primary focus for this year is to offer those products to our channels in addition to the channels that AMQ has sold through before. That's going quite well. We've gotten a great response from our dealers. You can see it show up in their words, but also, you can see it show up in actual orders and revenues, so we're on track versus our expectations for revenue and so on for the AMQ deal.

As you say the word "integration," I just want to go back and say that we're not planning on integrating it per se. We like that AMQ is AMQ; there are some places where we can find synergies, but our first priority is not to do operational integration. They've got their own supply chain, their own business model. We're helping where we can, but our primary focus is to make sure those products are offered to our customers through our dealers.

Steven Ramsey -- Thompson Research Group -- Analyst

Excellent. And then, staying on M&As, last question -- are you still actively looking for deals like the three you've done as far as full acquisitions of AMQ, Orangebox, and Smith, and is there any real ceiling in your capacity to take on more deals of this size in the next year or so?

James P. Keane -- President and Chief Executive Officer

I would say we're always actively looking. You knew I was going to say that. But, we don't really have a discrete acquisition plan. We don't necessarily have a target to say we must buy this many companies or spend this much money. It's ultimately up to our strategies. Our strategies have been about broadening our price points. Our strategies are about extending our markets. So, Smith System allows us to build off of our strong education business that's mostly been aimed at higher ed and extend that now to K-12.

Orangebox is directly related to our desire to expand our offering of furniture that supports people when they're away from the desk, supports collaboration, supports privacy, and so, it's connected with that. AMQ, similarly, allows us to broaden our price points to meet prices of products that customers were already buying. Our customers were already buying it, they just weren't buying it from us.

So, as we see opportunities to do that -- more fully meet our customers' needs -- we'll continue to explore doing products ourselves, working through partnerships, and doing acquisitions as we see fit. I wouldn't want to leave the impression that we think we're going to continue at the pace we were at this year. We've gone from doing fairly few acquisitions to, over the last 12 months, doing three, but I also don't want to leave you with the impression that we've got an upper and lower range. We haven't really done that.

Steven Ramsey -- Thompson Research Group -- Analyst

Excellent. Thank you.

James P. Keane -- President and Chief Executive Officer

Yup.

Operator

Thank you. And, as a reminder, to ask a question at this time, please press *1. Your next question comes from Greg Burns of Sidoti and Company. Your line is open.

Greg Burns -- Sidoti and Company -- Analyst

Hey, good morning. In relation to the lower warranty and workers' comp expenses this quarter, is that something you expect to remain structurally lower at this point, or is that contributing to the sequential increase in operating expenses you're projecting in the third quarter, and in relation to that, can you just give some buckets of where that incremental spend is coming from quarter over quarter? I might have missed it earlier in the call. Thanks.

David C. Sylvester -- Senior Vice President and Chief Financial Officer

Sure. On warranty and product liability and workers' compensation costs, those are reductions in year-over-year costs. We've seen our claims experience continue to trend down. As Jim mentioned, we've invested in that and have been focused on it over the last couple of years, and are seeing some pretty nice results, especially more recently in the last four quarters, and that not only lowers the cost compared to last year, but gives us confidence to reduce our reserves for projected future obligations associated with those claims. So, I would expect that you will hear us mention some year-over-year reductions for another quarter or two, but, of course, we've assumed that reduction now in our guidance for the balance of the fiscal year.

On the increase in operating expenses, that's really more about product development initiatives than anything else. We do have a sales conference in the Americas next quarter -- or, this current quarter -- that we'll spend some money on and a few other things like that that are driving up operating expenses sequentially, but it's mostly related to product development and, of course, the acquisitions.

Greg Burns -- Sidoti and Company -- Analyst

Okay, great. Thank you.

Operator

Thank you. And, I am showing no further questions at this time. I'd like to turn the call back over to Jim Keane for closing remarks.

James P. Keane -- President and Chief Executive Officer

Thank you, and thanks, everyone, again for your interest in Steelcase. We hope to see many of you at our Investor Day in New York in October. Have a great day. Thank you.

Operator

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

Duration: 55 minutes

Call participants:

Mike O'Meara -- Director of Investor Relations, Financial Planning, and Analysis

James P. Keane -- President and Chief Executive Officer

David C. Sylvester -- Senior Vice President and Chief Financial Officer

Budd Bugatch -- Raymond James -- Managing Director

Matt McCall -- Seaport Global Securities -- Managing Director

Steven Ramsey -- Thompson Research Group -- Analyst

Greg Burns -- Sidoti and Company -- Analyst

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