Knoll, Inc.
Q2 2018 Earnings Call Transcript

Published: 31 Jul 2018

[Operator:]

Good morning, everyone, and welcome to the Knoll Incorporated Second Quarter 2018 Conference Call. This call is being recorded. This call is also being webcast. Presentation slides accompany the webcast. In addition, this call may offer statements that are forward-looking, including without limitation, statements regarding Knoll's future outlook for the industry and the economy and the speculations for prospective future leverage. These forward-looking statements are based largely on the company's expectations and are subject to a number of risks and uncertainties, certain of which are beyond the company's control. Actual results may differ materially from the forward-looking statements as a result of many factors, including the factors and risks identified and described in Knoll's annual report on Form 10-K and its other filings with the Securities and Exchange Commission. The call today will also include references to non-GAAP financial measures. Reconciliations of these measures to the most comparable GAAP financial measures are included in the presentation slides that will accompany the webcast. Now, let me turn the call over to Andrew Cogan, the Chairman, President and CEO of Knoll. Thank you.

[Andrew Cogan:]

Thank you. Good morning, everybody and welcome to our second quarter earnings call. I'm very, very pleased to report that the bold actions we've taken past year from the recent acquisition of Muuto, the launch of new platforms like Rockwell Unscripted and the reorganization and expansion of our selling capacity have enabled us to respond to changing design trends and allocation of space within the workplace, penetrates faster growing ancillary categories and now accelerate our top line growth. Coupled with concurrent initiatives to increase the share of revenue we derive from our high design, high margin global lifestyle businesses, which now represent over 40% of our revenues, we are building a unique constellation of design driven brands with durable competitive advantages and superior profitability. This quarter, the benefit of these initiatives combined with efforts by our supply chain team to offset continued inflationary pressures led to 100 basis points of adjusted EBITDA margin expansion from 12% to 13% and adjusted EPS growth of 40% from $0.30 to $0.42. Excluding the favorable accretion in margin mix benefit of Muuto on our adjusted EPS and adjusted EBITDA margins, these metrics showed organic improvement too. Growth in the quarter was increasingly broad based, as both of our segments delivered strong organic growth. In the office segment, sales grew by 17%, with double digit growth in North America well above reported industry rate and even faster growth in Europe. In North America, while we are still benefiting from easier prior year comps, it is clear that our investments in new products and expanded sales coverage are driving more market visibility opportunities and wins. Growth in the quarter was driven by our newer product platforms and expanded price options in ergonomic category such as height adjustable tables and seatings. These newer platforms now comprise over 50% of our office sales, up from less than half a year ago. This past unit at NeoCon, we expanded our entry level offerings with the introduction of our [indiscernible], both of these products will begin shipping in the fourth quarter. Rockwell Unscripted continues its strong ramp up and we are flattered by attempts by our competitors to mimic both the product and positioning of this introduction. The margins on our newer platforms expanded year-over-year as our manufacturing efficiencies improved, as volumes climbed. For the second quarter in a row, we saw our efforts to stabilize demand in our legacy platform Succeed. The formal introduction of Muuto last month at NeoCon was an all-out success. It's one thing to talk about Muuto's new perspective on Scandinavian design, but it's quite another to allow our dealers, corporate clients and design clientele to see the breadth and quality of these designs first hand. While it did seem at NeoCon like everyone had a new Danish friend, what truly differentiates Muuto and proves that all ancillary is not alike is the contract quality, European sourcing, extended warranty in-stock position and custom capability that Muuto offers and its particular complementary set with our modern designs. And it's not taking long to see Muuto well on the way to realizing the potential we saw on the brand. While Muuto continues to deliver strong organic growth in its home markets, we are starting to move the needle in North America. Every month since we acquired Muuto, the number of Knoll dealers transacting with Muuto grows. Dollar volume has grown in an even faster clip and post NeoCon, we've seen that continue to accelerate as we're securing project wins and standards worth millions from corporate clients and its far ranging verticals in banking, tech, retail, entertainment, hospitality and government. The other thing we saw in NeoCon was it's possible to have too much ancillary. There is no way for a salesperson or a dealer to make sense of the multitude of partnerships or relationships out there. Our belief is that with a few meaningful and 100% owned brand platforms, we can much more deeply penetrate the growing ancillary opportunity. As one of our sales leaders recently put it to me, between Rockwell and Muuto, we're in a whole different place. From a funnel standpoint, we continue to track double digit - track double the increase in the number of opportunities we're pursuing against the high single digit increase in the dollar value of our sales funnel. This is consistent with data that show fewer million dollar plus projects, but more small and medium sized orders that tend to be less deeply discounted. There is another important driver here. In January, we brought our Knoll Studio DatesWeiser and to a lesser extent the Muuto North America sales team together under the auspices of our local office regional sales managers. This change has allowed us to more effectively deploy our sales resources to the AND end user and dealer audiences as an improved our count coordination and accelerated our ancillary growth and market penetration. Within the office segment, the favorable absorption benefit in fixed cost leverage from higher volumes and accelerating continuous improvement initiatives were able to offer investment in expanded sales capacity and challenging commodity inflation and FX headwinds to deliver 130 basis points of adjusted EBITDA margin improvement as margins here expanded from 8% in last year's Q2 to 9.3% this quarter. While we are heartened by this progress, we are also aware of the accelerating inflationary picture and the uncertainty around the impact it has both real and threatened may have on our profitability. It's one reason why we put through a second 2018 price increase this past month. It's also become clear that as our lean initiatives build on each other that there is a more transformational opportunity to re-envision and redesign our entire supply chain. That's why this quarter we kicked off the supply chain optimization study with outside resources that has targeted a minimum of $20 million of fixed and variable cost reductions by the end of 2020 through further rationalizing our plant footprint and rethinking the mix of internal and external production. This initiative coupled with the continued favorable margin mix from the growth of our lifestyle segment will help us achieve our longer term 15% plus EBITDA margin goals for our entire enterprise. We'll keep you updated as these plans come into greater focus later this year. Within our lifestyle segment, sales grew 25% or 5% organically excluding Muuto. Within the segment, our contract facing businesses outpaced the growth in the residential side. Strong performance from DatesWeiser and KnollStudio in Europe plus solid performance from Spinneybeck, FilzFelt and KnollTextiles contribute to the organic growth. More encouraging was the acceleration of orders across the preponderance of our lifestyle businesses, including HOLLY HUNT, which set an all-time orders record in the quarter and KnollStudio, which positions them well for back half growth. On a sequential basis, lifestyle adjusted EBITDA margins increased by 50 basis points to a very strong 21.1%. While down 50 basis points from prior year is ramp up costs from the Muuto rollout, our new LA shop and some unfavorable FX held that margins. We do expect lifestyle margins to show year-over-year improvement in the back half as organic growth should accelerate. On a mix basis, this will also help our overall Knoll, Inc. margins expand. Looking ahead to the balance of the year, we expect to continue to grow our business, expand our margins and reduce our leverage. Now, let me turn the call over to Charles to walk you through our results in more detail. Charles?

[Charles Rayfield:]

Thank you, Andrew. Knoll Inc.'s second quarter net sales increased 54.7 million or 20.3% from a year ago. Adjusted gross margin remain consistent year-over-year at 37.2%. Adjusted gross margin excluded an acquisition related inventory adjustment of 0.9 million related to purchase accounting for the Muuto acquisition. Total adjusted operating expenses in the first quarter were 89.6 million compared to 77.3 million in 2017. The increase is due primarily to incremental operating expenses from Muuto as well as incentive compensation due to increased profitability versus prior year. Adjusted operating expenses exclude the 2.1 million of amortization of intangible assets related to our acquisitions of Muuto, HOLLY HUNT and Edelman businesses as well as acquisition related expenses of 2 million and 0.8 million of restructuring charges. Acquisition related expenses include retention agreements for key Muuto employees as well as customary acquisition costs. The restructuring charges were related to supply chain optimization expenses and an organizational realignment in our sales and customer service operations that will result in greater operationally efficiency. Adjusted EBITDA for the second quarter of 2018 was 42.1 million, up from 32.3 million or 30.4%. The increase in adjusted EBITDA was due primarily to higher sales volume in both the office and lifestyle segments and the inclusion of three months of Muuto operations. The adjusted EBITDA margin increased to 13% in the second quarter of 2018 from 12% in 2017. Interest expense was up 3.4 million from a year ago, due primarily to increased debt levels as a result of the Muuto acquisition and higher interest rates. The effective tax rate for the quarter was 26%, down from 35.7% in Q2, 2017. The effective tax rate for the second quarter of 2018 was favorable due to the passage of the US Tax Cuts and Jobs Act during the fourth quarter of 2017. The company expects its full year effective tax rate to be between 25% and 26% for fiscal year 2018. The tax rate was also affected by the mix of pretax income and the varying effective tax rate from the countries and states in which we operate. Adjusted net income for the second quarter of 2018 was 20.8 million, up from 14.7 million for the same period in 2017. Adjusted net income is exclusive of the $7.7 million of tax affected net earnings adjustments that were previously discussed, related to the acquisition related inventory adjustment, acquisition related expenses, restructuring charges and a pension settlement charge. The pension settlement charge is included in other income and is related to our decision to annuitize the portion of our pension liability, which triggered settlement accounting. Adjusted diluted earnings per share was $0.42 and $0.30 for the second quarter of 2018 and 2017 respectively. Capital expenditures for the quarter were 7.6 million compared to 10.1 million in the second quarter of 2017. Capital expenditures related primarily to our information technology infrastructure, manufacturing equipment and showroom investments. Total cash used in financing activities was 37.1 million. We used cash in financing activities during the second quarter of 2018 to pay down 26.8 million of debt, pay quarterly dividend of 7.3 million and to pay accrued dividends on vested shares of 0.4 million. In regard to our balance sheet and cash flow, cash and cash equivalents were approximately 1.4 million at the end of the quarter. Operating activities provided 28.2 million of cash in the quarter compared to 28.4 million in the prior year. Consistent with past quarters, we use excess cash generated from operating activities to invest in the business, pay dividends and reduce outstanding debt. As of the end of the second quarter, our outstanding debt balance was below 500 million, at 491.4 million and our leverage ratio was just over 2.9 times. The reduction of the leverage ratio to below 3 times EBITDA reduced our borrowing rate by 25 basis points, saving approximately 1.2 million on an annualized basis. In summary, we're very pleased that we have experienced solid organic growth and margin improvement in addition to the growth and margin benefit from the acquisition of Muuto. For Q2 2018, Muuto contributed 21 million of our 54.7 million total sales increase over the same quarter in 2017. Consolidated organic growth was 12.5% and while this is led by the volume increases in the office segment in Q2, 2018, the lifestyle segment also experienced organic growth of 5.2% in the second quarter of 2018 compared to Q2 of 2017, excluding Muuto. Muuto adjusted EBITDA was 4.5 million for the quarter and contributed about $0.03 to EPS. As we've noted in our release, we've excluded acquisition related costs from adjusted EBITDA and adjusted EPS calculations this quarter and it recaps prior quarters for comparative purposes. We believe that acquisition related costs such as retention bonuses and amortization of acquired intangible assets are not indicative of ongoing business performance and our results of operations could be more clearly evaluated, exclusive of these costs. Thank you. We will now take any questions.

[Operator:]

[Operator Instructions] And our first question comes from the line of Greg Burns from Sidoti.

[Greg Burns:]

Good morning. In terms of the margin gains you talked this quarter, could you just maybe give us a sense of how much of the EBITDA margin growth was from adding Muuto to the mix versus what the organic business improved by?

[Andrew Cogan:]

This is Andrew. Muuto contributed about 60 basis points of the margin improvement, basically right across the board. So from gross margins to operating margins to EBITDA. So I think what's important is that you see that with solid organic improvement on a, everything from a gross operating to EBITDA margin improvement that was probably led by the office business whereas you saw I believe, we had about 130 basis points of margin improvement year over year.

[Greg Burns:]

And then in terms of Muuto, can you talk about the reception you're seeing with your dealers, maybe hearing the initial reception or uptake of Muuto versus where you saw the Rockwell Unscripted, how is the early growth trajectory of Muuto with your dealers?

[Andrew Cogan:]

Yes. Muuto is ramping up faster than Rockwell Unscripted and in North America, through our dealers, is exceeding our expectations. It is ramping up very, very strongly. We're seeing it in terms of each month since we owned Muuto, more and more of our dealers are interacting with Muuto on a day to day basis and the dollar value right there purchasing from Muuto is growing. So as we have proven with DatesWeiser, when we take a product or a business, that we can move and leverage through our sales and distribution network, we can ramp that up very, very quickly. I mean, DatesWeiser is running up 60% plus year over year and that's now in its second full year. Muuto is ramping up even faster, because it's got a breadth of portfolio, it's very differentiated from the other kind of Danish brands out there from both the product service warranty and delivery capability. And what's exciting about Muuto is not just the dealer ramp up, but now we're starting to introduce it in to kind of our core corporate accounts and we've been awarded millions of dollars of corporate standards that can absolutely tell you are opportunities we never ever would have seen with our previous portfolio. So it's super exciting in terms of what's going on and on top of that, Muuto continues to do really well in their home market, so the kind of organic growth that they were experiencing hasn't been disrupted at all and is just continuing.

[Greg Burns:]

Okay. Could you maybe quantify at all, the amount of bookings that you're seeing for Muuto in North America through your dealer channel or I know that you had 15 million of revenue in North America last year, but can you just maybe give us a sense of?

[Andrew Cogan:]

Yeah. I mean I think we don't want kind of overly breaking stuff down, but I would say, in general, in North America, we're running up 40%, 50% year-over-year. And Greg, we've just begun. I mean we're only, it isn't even fully sampled throughout our dealer network, which I think will take about through September. So I think this is going to - listen, our goal when we acquired Muuto was to double the business, which means we had to generate about $75 million of incremental revenue over three years. I believe very much that that is intact and that there's probably upside to that expectation.

[Operator:]

And our next question comes from the line of Matt McCall from Seaport Global.

[Matt McCall:]

So, Andrew, maybe I apologize, I'm just trying to connect all these dots, but - so you talked about re-envisioning the entire supply chain, you've mentioned the $20 million of savings. Can you just step back - last quarter, you had talked about the footprint and now it's supply chain, are all these related and is that $20 million - is that the expected savings from these efforts, just walk me through it one more time? Sorry.

[Charles Rayfield:]

Yeah. Sure, Matt. This is Charles. I'll take a stab at this. So as you noted, we're targeting in the realm of about 20 million of annualized savings and that is savings to gross margin. The study is primarily focused around North American office operations. Obviously, it includes a review of our core competencies, logistics and distribution network as well as cost reduction activities. So yeah, it's all related. We have, on top of that, ongoing CI activities that are independent of this study, but yes, these savings that we've noted are expected to be on an annualized basis.

[Andrew Cogan:]

And Matt, I would just add. I think one of the things we're seeing is we've done all this - started to do all this lean work, we're freeing up a lot of square footage in each of the individual plants. What that ultimately is creating is the opportunity for more consolidation and a step level improvement in our costs. So we've retained some upside help this past quarter that's doing kind of a really ground up thorough review of all our operations of what we're doing where, of what can be combined, of what our core competencies are, what could be done inside versus what we could do more of outside and we're taking a very robust relook at that platform. So all the kind of ongoing day-to-day continuous improvement and we're talking of $10 million to $12 million a year of kind of continuous improvement work. That's ongoing. This is an incremental initiative, which we have just launched, which we believe can generate a minimum of $20 million of improvements, about 200 basis points - 200 to 300 basis points of office margin, gross margin improvement by the end of 2020 above and beyond where we're at. And based on the kind of initial looks at the study, we feel very good about that potential. But it took a really ground up incremental initiative.

[Matt McCall:]

So the 20 million is a result of the evaluation at the outset that help gave you.

[Andrew Cogan:]

Yes. I mean, we believe - we've target actually a little bit more, but as we've looked at kind of the initial assumptions and what we've things out there, we think that's a reasonable goal by the end of 2020 to reduce our, take a $20 million chunk out of our annual managed and fixed cost within our supply chain infrastructure.

[Matt McCall:]

And then how should we look at the way it's phased in and I guess related to that, the 10 million to 12 million of continuous improvement, should I think of that as merely an offset to some of these - maybe some investments or some inflation that you're facing? Go ahead.

[Andrew Cogan:]

Yes. I think we should think about continuous improvement as an offset to the kind of ongoing inflation pressures and I would view that supply chain transformation effort as a purely incremental initiative. I - personally I would - really don't think you'll have a lot of - no impact in '18, probably not a lot of impact in '19 and I imagine in '20, in the back half of '20 is where you'll really see those changes kick in.

[Matt McCall:]

Was there any impact on profitability this quarter as a result of the study? I mean I imagine it wasn't that expensive, but anything worth calling out?

[Charles Rayfield:]

Yeah. So Matt, that was part of what was in the restructuring charges. So we had 0.8 million of restructuring. About half of that or so was related to the study.

[Andrew Cogan:]

And there will be more in Q3.

[Matt McCall:]

Okay. Got it. Can you tell me, just because of the segment realignment, what was the year ago comp in North American office and in lifestyle?

[Andrew Cogan:]

Which comp?

[Matt McCall:]

Just the top line growth comp, so the year ago number, are we still having a year ago growth?

[Andrew Cogan:]

Charles will be happy to provide all this. I think we've put it all out there if I'm not mistaken, but office sales a year ago in the second quarter were 162.5 million versus 190.7 million this quarter and lifestyle was 106.1 versus 132.6 this quarter.

[Matt McCall:]

We've got that. I just was wondering what the growth was a year ago? Just looking at the growth -

[Andrew Cogan:]

What I can tell you is the office business shrunk a year ago in the second quarter and I don't recall what the lifestyle business was. I mean, clearly, we're lapping our easiest comps of the year now. So it's kind of done, we've got a little bit more challenging, but I think the good news was, the orders momentum exceeded what we shipped. So, we actually also had a good solid shipment quarter better than the industry and we've built backlog. So I think if you look at the balance of the year, that's good news. Now, some of the office backlog is probably a little more Q4 than Q3, but I think what you'll see in Q3 is an acceleration of the organic lifestyle growth, because there, we really saw a pop in orders, particularly in HOLLY HUNT and KnollStudio.

[Matt McCall:]

And then last one for me, you've given some indication of your gross margin expectations for the year in the past, can you just update your thoughts on how margins will progress this year?

[Andrew Cogan:]

Well, I think what I would say is we feel good that we'll generate at least 100 basis points of EBITDA margin improvements over the full year. We were pleased that gross profit held relatively flat. I think we were frankly one of the few to actually do that in this environment. And obviously, as we said about 60 basis points of that, which helped from Muuto's mix and everything, we think the gross margins with Muuto will continue to trend up from where they were a year ago in the back half, but we're - our kind of - our kind of bottom line belief is that we'll generate at least 100 basis points of full year EBITDA margin improvement and that's kind of the commitment we made at the beginning of the year and that will be a mixture of about 50% Muuto and 50% organic Knoll initiatives.

[Charles Rayfield:]

Yeah. Matt, so just to add to that, for gross margin specifically, price has been relatively flat this year compared to prior year. We're continuing to see sequential quarterly inflation in commodities. CI has offset some of that, but only partially. So we head into the back half of the year, we'd expect the CI, the price increases we've put into place in January and July and some of the forward metal pricing that we put into place have managed to move some inflationary pressures will help us as we hit especially Q4.

[Operator:]

[Operator Instructions] And our next question comes from the line of Kathryn Thompson from Thompson Research.

[Steven Ramsey:]

This is Steven Ramsey on for Kathryn. I guess, can you describe discounting pressures in the contract space and if you are seeing that being more increased or decreased in the last few months?

[Andrew Cogan:]

We don't see much change there.

[Steven Ramsey:]

Okay. And then the enlarged salesforce, are they only selling in office and have they taken on the full product set of Muuto already?

[Andrew Cogan:]

The full product set, as I remember, as we mentioned in our remarks, we brought KnollStudio, DatesWeiser, Muuto to a large extent and obviously the office business under the purview of our office regional managers and they're managing that full capability and then our sales reps have been cross training on that full - our full range of capabilities.

[Operator:]

Thank you. And at this time, I'm showing no further questions. I will now turn the call back over to Andrew Cogan for any closing remarks.

[Andrew Cogan:]

Well, thank you for joining us on this summer morning and we'll look forward to speaking to you at the end of the third quarter. So take care, everybody. Bye.

[Operator:]

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