Knoll, Inc.
Q4 2018 Earnings Call Transcript

Published: 7 Feb 2019

[Operator:]

Good morning, everyone, and welcome to Knoll Inc. Fourth 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 economy and expectations with respect to 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 the Knoll's annual report on Form 10-K and its other filings with 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. And now let me turn the call over to Andrew Cogan, the Chairman and CEO of Knoll. Thank you.

[Andrew Cogan:]

Thank you, operator. Good morning everyone and welcome to our year end 2018 earnings call. We ended our 80th Anniversary year on a strong note as we delivered a record quarter of shipments and a record year of sales with a 120 basis points of adjusted EBITDA margin improvements and the strongest adjusted EPS performance of the year. For the full year we delivered sales of just over $1.3 billion an increase of 15% versus prior year and an organic increase excluding Muuto of just $83 million, a very strong 7.4% increase. Our Office segment grew by 8.2% and Lifestyle by 26.9% or 6% organically. Total workplace sales which as you recall includes Lifestyle product sold into workplace settings grew by 13% significantly exceeding the 4.7% reported by BIFMA. And Lifestyle sales for the full year represented a record 40% share of our revenues and 63% of our adjusted EBITDA. While organic growth slowed in the fourth quarter, workplace growth remained a strong 10% and we entered 2019 with backlog of double-digit as orders growth rates exceeded shipment growth rates in Q4. Adjusted EBITDA of $176.5 million increased $32 million or 22% versus prior year and adjusted EPS including the benefit of a lower tax rate increased by 30% from a $1.42 to a $1.85. Our brand proposition that good modern design has a meaningful impact on the quality wellbeing, productivity and happiness of the way people live in work remains as relevant today as it did back when Hans and Florence founded Knoll in 1938. In fact today, we’d argue that the value of our constellation of design driven brands is more relevant than ever is the bounder between how we live in work, the environments in which we live in work and the range of generations that live in work come closer together than ever before. It’s proof I see when I walk in December of our most dynamic fine environments and observed products like the Cesca chair designed 80 plus years ago cohabiting in a [beda phone] functional way with designs of ours Rockwell Unscripted that were just introduced in 2017. And it’s backed up a growth rate meaningfully greater than none of the markets in which we play. The constellation of the workplace and the blending of products that accompanying it is frankly an environment tailor-made for Knoll and the evidence of our growing relevance is in the record number of clients and dollar spent on Knoll designs this past year. And the fact that we’re able to monetize that interest to generate both improved and industry leading levels of profitability particularly in the year where external forces challenged our margins like never before. But it’s a lot more than the products and culture that has helped Knoll drive over the past 80 years and that’s 3,541 associates at Knoll around the world. Some of them have been with us for over 45 years like Jane Rozanski, who leads our Knoll stereo supply chain. To those that moved out and who just joined us this past year can make these great results possible. I want to first thank all our people for their commitment to our mission and result and then our dealer partners, architect and design enthusiasts and clients that come to Knoll to allow us the privilege of helping shape the environment with a live in work. This morning I’ll let Charles walk you through the year end results more specifically and -- instead use my time with you to focus on a few key topics. A year into the Muuto acquisition, the results to-date have validated the thesis upon which we base the acquisition namely we could drive the sales of Muuto’s fresh perspective on Danish design through our North America workplace distribution and A&D in client relationships to fill a significant void in our ancillary offerings to both grow Muuto and increase our share in these more social and collaborative areas of today’s workplace. And that we could do so at 20% flat levels of adjusted EBITDA margins while simultaneously funding the investments in growing out the business in North America. Over the course of the year as we’ve established a deep inventory of Muuto products in North America, trained our sellers and dealers and had a position at Muuto and introduced Muuto to our installed based clients, we’ve seen Muuto’s momentum accelerate. In Q4 orders grew at the fastest rate of the year just a smidge shy of 50% and we entered 2019 at Muuto with a backlog up 40% versus prior year. This marked a meaningful improvement over the full year orders growth rate of a not too shabby 23%. While Muuto continues to perform well outside of North America too, our investments in additional products, sales resources, local supply chain and channels is just beginning to impact the business, and we’ve tremendous wide space in the consumer/residential markets both here in North America and elsewhere that is in tens of millions of dollars that we intend to target as we complete the foundational workplace in contract investments. Since the closing of the Muuto acquisition we’ve reduced the debt we took onto acquire Muuto by over $80 million and combined with our improved results across the constellation we ended the year with a leverage ratio of 2.64

[Charles Rayfield:]

Thank you, Andrew. Since Andrew covered the year end review early, I’ll give details on the fourth quarter results as well as some additional commentary. Net sales in the fourth quarter for Knoll Inc. increased $38.5 million, a 12.2% from a year ago. Adjusted gross margin in the fourth quarter was 37.4% compared to 35.5% in 2017. The margin expansion was primarily due to growth of the higher margin Lifestyle segment sales as percentage of total Knoll Inc. sales and whereas the experience positive volume growth, price realization and positive continuous improvement contributions to margin these were largely offset by transportation of materials inflation versus the prior year. Adjusted gross margin excludes $0.7 million seating product discontinuation charge from the disposal of inventory and fixed assets related to the discontinued product. Total adjusted operating expenses in the fourth quarter were $93.2 million compared to $80.3 million in 2017. The increase was due primarily to incremental operating expenses from Muuto as well as increased investments in warehouse and showroom costs which we believe will create a stronger foundation for continued growth. Adjusted operating expenses exclude $2.5 million of amortization of intangible assets related to our acquisitions of the Muuto, DatesWeiser, HOLLY HUNT and Edelman businesses and acquisition related expenses of a $1 million. Acquisition related expenses include retention agreements for key Muuto employees and other customary acquisition costs. Adjusted EBITDA for the fourth quarter of 2018 was $50.4 million, up from $41 million from the fourth quarter 2017. The increase in adjusted EBITDA was due primarily to the inclusion of three months of Muuto operations, higher sales volume in the Lifestyle segment and net price realization in both the Office and Lifestyle segments. The adjusted EBITDA margin increase to 14.2% in the fourth quarter of 2018 from 13% in 2017. The increase in adjusted EBITDA margin was due primarily to gross margin improvements, as Lifestyle and sales represent a larger percentage of total Knoll Inc. sales. Interest expense was up $3.1 million from a year ago due primarily to increased debt levels as a result of the Muuto acquisition and higher interest rates. The company's effective tax rate for the fourth quarter of 2018 was 23.3% down from 39.2% in the fourth quarter of 2017. The 39.2% rate in Q4 2017 is exclusive of the one-time impact of the tax cuts and Jobs Act also known as tax reform where the company recognized a one-time tax benefit of $26.6 million from the regiment of net deferred tax liabilities at the new corporate income tax rate of 21%. The significantly lower effective tax rate in the fourth quarter of 2018 was primarily due to the passage of tax reform in December of 2017. The tax rate was also affected by the mix of pre-tax income in the varying effective tax rates in the countries and states in which we operate. Adjusted net earnings for the fourth quarter of 2018 were $28.2 million up from $18.1 million for the same period in 2017. Adjusted net earnings is exclusive of the tax effective net earnings adjustments that were previously discussed totaling $3.7 million that were related to a seating product discontinuation charge, amortization from acquisitions, acquisition related expenses and a pension settlement charge. Adjusted diluted earnings per share were $0.57 and $0.37 for the fourth quarter of 2018 and 2017 respectively. Capital expenditures for the quarter were $19 million compared to $11.2 million for the fourth quarter of 2017. Capital expenditures related primarily to our information technology infrastructure, manufacturing equipment and showroom investments. Regarding our balance sheet and cash flow cash and cash equivalents were approximately $1.6 million at the end of the quarter and our outstanding debt balance was reduced to approximately $461 million. We finished the quarter with a leverage ratio of 2.64 times. Operating activities provided $44.5 million of cash in the quarter compared to $44.3 million in the prior year. Total cash use and financing activities was $20.1 million. We use cash and financing activities during the fourth quarter of 2018 to pay down $15 million of debt and quarterly dividends of $7.2 million. Consistent with past quarters we used excess cash generated from operating activities to invest in the business, pay dividends, and reduce outstanding debt. For the full year 2018, cash flow from operations was $108.2 million compared to $103.7 million in 2017. Capital expenditures for full year 2018 were $40.3 million compared to $40.6 million in 2017 and a full year 2018 effective tax rate was 25.4% down from 31.8% for 2017 exclusive of the one-time tax reform benefit in 2017. As we move into 2019 and further to the comments that Andrew made previously, I'd like to make a few points around interest and taxes. We entered into a forward interest rate swap arrangement at the beginning of 2018 with $300 million of variable raised LIBOR based debt being swapped for a fixed LIBOR rate starting on January 1, 2019. The swap arrangement will be in effect until the maturity of the current credit agreement in early 2023 and the swap amount will reduce by $50 million each year. During 2019 approximately 60% of our average debt will be covered by this interest rate swap. We expect our average interest rate to be approximately 3.8%. In addition we expect our full-year effective tax rate to be between 25% and 26%. We expect to use our available cash for investments in the business, the payment of dividends and the repayment of outstanding debt. Thank you. We'll now take any questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Budd Bugatch with Raymond James. Your line is now open.

[Budd Bugatch:]

Good morning Andrew, good morning Charles. Congratulations on the year and the quarter.

[Andrew Cogan:]

Thanks Bob.

[Budd Bugatch:]

Couple questions if I could. Muuto, I think the sales in the fourth quarter were set at $26.8 million and I know you talked about the programs that you're getting in the States or in North America. Can you quantify how much of that’s in the U.S. versus or in the North America versus overseas?

[Andrew Cogan:]

The fastest-growing, I'm not going to break it down specifically Budd, what I can tell you is the fastest-growing part of the business Budd is in North America. And in North America we're growing the business four, five times a month versus what they were doing a year ago. So it is scaling very rapidly and very significantly and I'm encouraged even just in January we saw 50% orders growth across Muuto around the world and we saw something like 300%, 400% growth in North America. So it is scaling meaningfully and very much consistent with what we expected when we acquired the business, but it's encouraging to see it accelerate every quarter that we've owned the business.

[Budd Bugatch:]

So would it be fair to think maybe 20% of that is North America? Let me try to figure out a little bit.

[Andrew Cogan:]

I think probably 20%, 25% if you want a round number.

[Budd Bugatch:]

And what about the order rate in the quarter versus the $26 million or $27 million you pose, how's that look?

[Andrew Cogan:]

It looks greater.

[Budd Bugatch:]

You want to quantify that a little bit?

[Andrew Cogan:]

Well, I think all I can quantify is the orders growth rate and the quarter grew just under 50%, which was significantly greater than the shipment growth for the business. So the momentum, I think the takeaway Budd is, the momentum is accelerating with Muuto.

[Budd Bugatch:]

And in Lifestyle, outside of Muuto, Lifestyle grew I think $9.8 million or $10 million elsewhere. You said DatesWeiser had a good order it was pretty small as a beginning. Can you kind of quantify where the growth in Lifestyle outside of Muuto came from?

[Andrew Cogan:]

Sure. I think KnollStudio was certainly a standout for the quarter. We've had real success in leveraging kind of these, our iconic studio designed into contemporary workplaces. And so there are several studio programs now. So I'm really encouraged by the acceleration of studio’s performance as we end the year. So studio certainly was a standout when we look at the business then I think followed by DatesWeiser. HOLLY HUNT also had a very good fourth quarter of growth versus prior year and again as I mentioned, the Vladimir Kagan business has just exploded as we've moved it through HOLLY’s channel and they in January, Kagan set a record for orders. So we've almost tripled that business now and those margins are the highest of anything we do at Knoll. So it was pretty broad-based. It was not just Muuto. It was Studio. It was HOLLY HUNT. We've seen some stabilization and coverings Filzfelt is doing well. So I'd say it’s pretty broad-based, Budd.

[Budd Bugatch:]

Any disappointments in Lifestyle that’s there?

[Andrew Cogan:]

Not particularly. There's always work to do. We continue to push hard on moving other product products through the Edelman distribution channel. We think there's opportunity there to do more. But in general, I mean you look at Lifestyle outperforming and even BIFMA data, you look at our total workplace number outperforming any of the BIFMA data both on a quarterly and on a full year basis and you look at the orders momentum in the key initiatives and key product categories and it's all I think quite encouraging.

[Budd Bugatch:]

Office margins that were an area, its looks like was challenged and you talked a bit about pressures there. Can you about what your -- I would imagine you’re pressured by raw materials mostly in Office, but maybe you'll give us some color as to what happened in Office and what the outlook is?

[Charles Rayfield:]

Yes sure, Budd. So yes to your point, we had a significant amount of inflation this year, year-over-year which was offset largely by our price increases and some volume absorption as well as a lot of the CI activities we've talked about in the past. So we had good pull through there and then good mix with the help of Lifestyle coming through as well. So going forward when you look at 2019, we still expect to see some year-over-year inflation in both materials and transportation mainly weighted towards the first half of 2019. And then we've also layered in some additional CI activities for 2019, we're hoping to offset. As Andrew mentioned previously we have another price increases set to go in effect in March which should help offset as well. On a basis point comparison basis, we might expect to see 50 to 100 basis points of inflation throughout the year in 2019, again probably weighted to the first half of 2019 and then offset that with the price increases. We're looking for maybe 50 basis points of offset there and then targeting 100 basis points of continuous improvements and cost saving activities.

[Budd Bugatch:]

So, if I read that right Charles, and then first half will have a difficult comparison margin wise in the Office segment. Is that the way to think about it and then perhaps picking that up in the second half?

[Andrew Cogan:]

I think that's right.

[Budd Bugatch:]

And add backs. I'm a little bit confused in add backs. What are you looking at in 2019 for the non-GAAP adjustments for add backs particular as it affects EPS but also as it affects EBITDA?

[Andrew Cogan:]

Sure. The recurring add backs that will probably have going forward obviously this acquisition related expenses, we've begun to add back amortization related to the acquisitions. Most the people in the industry are doing it now.

[Budd Bugatch:]

It looks like it was $2.5 million in the quarter. Is that right?

[Andrew Cogan:]

It was about a million in the quarter for acquisition related expenses and then DNA in total was $9.1 million which is inclusive of some of the acquisitions as well.

[Budd Bugatch:]

No, the acquisition, I think was 3.5 is it affected pre-tax for EPS calculation. It look like on the call it was a million as affecting adjusted EBITDA and then the balance was that, that amortization was in DNA right?

[Andrew Cogan:]

That's correct.

[Budd Bugatch:]

That would have to be $2.5 million for the amortization.

[Charles Rayfield:]

That's right.

[Budd Bugatch:]

So is that continuing? Is it going to be 3.5 each quarter? How do we think about it for 2019?

[Andrew Cogan:]

It will likely be fairly consistent next year. Some of the intangible assets start to wind down over some period of time, but next year it'll likely be fairly consistent.

[Budd Bugatch:]

And at the end of 2019, what do you think debt will be at the end of 2019? You paid off $80 million this year. Where do you think you'll get debt to by the end of 2019?

[Andrew Cogan:]

We think we can pay down another $50 million to $60 million. I think the goal is to get it down to the low two times range.

[Budd Bugatch:]

And you wrote off 700,000 or 900,000 or -- 700,000 in the quarter in a seating product inventory. What product did you discontinue Andrew?

[Andrew Cogan:]

Just in general seating discontinuation, we're doing some pruning of our seating line. We've also as you know announced the discontinuation of the Morrison system to come in the middle of this year and again all of these moves are part of, kind of freeing up space in these Greensville from a manufacturing standpoint. So we focus on the highest margin, most productive use of those spaces.

[Budd Bugatch:]

Was there much seating in Morrison?

[Andrew Cogan:]

There was seating in that, in the whole Rubin building which is where we do both Morrison and seating. We're clearing up room we have new products coming on. We have the [indiscernible] ramping up. We have a really innovative high performance tier that we hope to bring to market around NeoCon. So there's a lot of rearranging going on and these moves are all part of that kind of multi-year roadmap that we completed in the fourth quarter.

[Budd Bugatch:]

And to that point, most of the gains in the CI come to when the fact that you gain space as you go on the lean journey. Is there any node in the system that looks like it's they need to come out. How much space have you gained by some of your lean journey?

[Charles Rayfield:]

No, again I think as we talked about in the past. The challenge over the last year Q of the lean stuff, when and you pick up 3000 square feet here and 5000 square feet there, but they're not necessarily contiguous or they're right with the network. And so, at some point you get to a point of critical math where you can make a step level change and right now we believe in '20 and '21 we will be at that point. So, in the interim there's still a bunch of kind of smaller moves and I would probably more like a Rubic's cube of work that ultimately again in '20 and '21 will lead to a significant fixed cost reduction.

[Budd Bugatch:]

I understand. And my last question is CapEx expectation in '19, what do you expect to and depreciation?

[Charles Rayfield:]

Sure. So, from a CapEx perspective, so in '18 we had about $40 million of CapEx. We would expect that to go up a little bit to $45 million to $50 in 2019. That increase is driven primarily by onetime cash that outweigh related to an investment in our flagship showroom in port market in Chicago which Andrew talked about during his comments. CapEx spends has broken down but 25% CI maintenance, 30% in distribution activities including showroom activities, 15% product developments, 30% IT related projects. We do have as Andrew mentioned, the next phase of order management going with the ERP. So, you have maybe a little bit more depreciation there next year but relatively consistent otherwise.

[Budd Bugatch:]

So, depreciation consistent with this year you think?

[Charles Rayfield:]

Correct.

[Budd Bugatch:]

Okay. Thank you very much, good luck on the year.

[Charles Rayfield:]

Thanks, Budd.

[Andrew Cogan:]

Thanks, Budd.

[Operator:]

Thank you. Our next question comes from the line of Greg Burns with Sidoti. Your line is now open.

[Greg Burns:]

Hi, good morning. When look your prior portfolio and you've kind of taken this platform approach and adding maybe subscale brands to your platform and you're leveraging your infrastructure. Is there any areas of your prior portfolio that you feel need to be strengthened or areas that maybe you're not in that you can potentially get into?

[Andrew Cogan:]

Well thanks, Greg for the question. I think there is no -- there is a lot of whitespace for us to continue to leverage this whole constellation selling approach though. First it starts organically with just strengthening the core portfolio. We built in three four years a $100 million adjustable payable business. So, I mean they are our organic areas where we see in the individual area at the workplace, the area of higher performing products. We had a very strong year in Phoenix. Then we have some real innovations coming in market later this year. We've done a very major we think of storage in the workplace and what that should be and look like and we'll start to roll that out. So, our first focus is on the organic area and the individual areas and we're doing a lot of work there. Then as we roll out towards is more ancillary and commercial areas where we have significant sharp opportunity, we're doing that both with organic product development, I mean Knoll's studios continues to expand a very strong rapidly growing line of conference and meeting tables that have been really well received. And then, we hike it with an acquisition like Muuto which gives us a significant and critical math in those areas that we can leverage through our sales and distribution network which is what we're doing and then Muuto gives us another R&D capability. So, you will see the middle of this year a significant increase in the scope and relevant Muuto products particularly as it relates to contract ancillary environment. So, we can layer into that. There's more lighting comments. So, we have a lot of a more architectural products coming with our Spinneybeck and Filzfelt areas they deal with providing space in creating acoustic and visual privacy in an open planned environment. So, I think we've a lot to do and then we're always looking at other acquisitions that we can add in or bolt on. I think one of the unique things about knowing our track record is we have an exceptionally strong track record of integrating acquisition that leverage our distribution and client relations are strong dealer relations in our install base. We scale those rapidly. And we've done that with Filzfelt; we've done that with Muuto; we've done that with DatesWeiser; HOLLY HUNT; did it with Vladimir Kagan, very strong ROI, very strong accretion and that's very much another leg of that strategy. So, I think we're happy in that ancillary space and in multiple ways and we do see a lot more white space to go after but not going to give it all away on this call, Greg.

[Greg Burns:]

Okay, great, thanks. And then, look at Muuto on the residential opportunity there domestically. What's the timeframe that you look at you're pivoting and expanding in that direction and what kind of investments or incremental investments you need to make to go after that segment of the market with Muuto and North America?

[Andrew Cogan:]

So, our strategy; we don’t clearly the brand with millennial residence with a new perspective on changing this design. But what was unique about Muuto was the contract quality of their products and we've seen others try to do similar things. The products just don’t have the contract quality or that for their durability. So, we saw with Muuto. Let's first focus on maximizing that contract capability and so that's where we've been investing in terms of warehouse; in terms of localizing some of the manufacturing; in terms of some of the IT work; in the training; and really that's where the investment and really through this year that's where the focus investment training, hiring is really dedicated. At the same time, we're starting to do some of the foundational, let's say more IT related investments. Because the products are multichannel, omnichannel can work office and residential. We're starting to do that mandates work this year. Such that I would imagine by the middle of '20 to the end of '20, we will be on major Muuto residential / consumer launch both online and in store sometime in mid-20 to mid-21. And that's basically the timing there and again that opportunities were tens and millions of dollars.

[Greg Burns:]

Okay, great. Thank you.

[Andrew Cogan:]

That's sort of thinking on Muuto.

[Greg Burns:]

Thanks.

[Operator:]

[Operator Instructions] Our next question comes from the line of Matt McCall with Seaport Global Securities. Your line is now open.

[Matt McCall:]

Thank you. Good morning, everybody.

[Andrew Cogan:]

Hi, Matt.

[Matt McCall:]

So, start -- Charles, with you. You gave some good detail around some of the components of office margins. I think you talked about inflation expectations, C&I savings or CI savings and then the expectation or price increases. What about the impact of mix leverage from volume growth. Just trying to get a bigger picture on the full picture on what to expect from office margins in 2019?

[Charles Rayfield:]

Let me just -- it's part of that's probably part of the price expectations that we have. So, I consider price mix to be combined together to the extent obviously we get more leverage, there'll be a boost to that. But kind of give us up and down.

[Andrew Cogan:]

Yes Matt, the other thing that will help us a little bit as new products continue to exceed legacy margins and new our few 100 basis points higher than on legacy. So, I think mix will be helpful as we move through the year. But again, I think Charles is right. There are a lot of moving pieces, so I don’t think we want to get too granular in the guidance we give here.

[Matt McCall:]

Okay, that's fair. So, maybe I'll move over to lifestyle. So, the way I've always thought about it was that segment had pretty consistently high and consistent margins because of the variable cost nature of the cost structures. As you see more of their products sold into the workplace and I've seen through your more traditional channels, is there any risk that the pricing model has to change and do you see more pressure from discounting, things like that as you see more workplace products sold through lifestyle?

[Charles Rayfield:]

We don’t. I mean, we're very disciplined in how we price those. Maybe, occasionally you'll give a little bit of something with the client where you're bundling. You'll give them a little bit extra a few bundle of whole package together but in general that's not a tremendous margin hit.

[Matt McCall:]

Okay.

[Charles Rayfield:]

There's some additional dealer incentives for them driving their total share of Knoll and our ability to capture the totality of our client spend and the dealer spend. But I think in general, I don’t expect a lot of margin volatility. Those are primarily asset like outsourced businesses where we don’t have a lot of fixed cost exposure.

[Matt McCall:]

Okay. So, when you say not a lot of margin volatility, what's the right level, is it plus or minus relative EBITDA, is it plus or minus 22, is it plus or minus 21. I mean if there's a little bit of an improvement through the year, I assume that’s as Muuto layered in and gave a bigger piece of the pie is mix likely the biggest opportunity as we move forward and maybe an inch is higher from here. Is 22 the right number?

[Charles Rayfield:]

I think mix is the biggest opportunity there, you're absolutely right. I think we're super happy with 22% EBITDA margin in this category. But like everything as each of our businesses has targets to do better in the coming year than they did in the past year. All of them has continuous improvement efforts, all of them have cost areas of focus. I think the only thing I would say in lifestyle is and everything relates to Muuto. There is incremental investment as we're driving this kind of rapid level of growth. So, I don’t expect a ton of EBITDA margin improvement for the next I would say two or three years from the strong level they're at today. Because we're really funding that back in in terms of growth initiatives.

[Matt McCall:]

From the level that you did reported in Q4?

[Charles Rayfield:]

Yes, from the level we just reported in Q4. I don’t think they can get worse but I think it's you're not going to get the kind of leverage if we were in a growth mindset with Muuto, we certainly should be backing off a lot of the investments we're making. But we're riding away we want to you know ride it harder.

[Matt McCall:]

Okay, alright. And I guess I probably should ask this with the office question but you talked about the significant cost reduction in '20 and '21, I think Charles we discussed some step function or some expectations on an annual basis over the next few years. Can you give us an update on what the outlook is from a dollars perspective for those cost reductions in '19, '20 and '21?

[Andrew Cogan:]

Well, but tonight. I think we're -- as Charles that were talking about a 100 basis points of continuous improvement opportunities. So, you can dollarize that in terms of CI. And I think that's kind of a recurring level. And then I think as we do look at '21, '20, -- '20 into '21, I think in terms of a step level change, you could probably double that number on an annual basis as we make some of those large, as we pursue some of those larger opportunity. So, it's 13, 10 to 12 -- $13 million is kind of the continuous CI rate. You may have the equal amount of that in a more step level kind of move down the road. That's how I think about it.

[Matt McCall:]

Okay. And then the final question I had, you talked about your leverage coming down, can you talk about the targets where you hope to get by maybe the end of this year and what's the ultimate and new to intermediate that can go in?

[Andrew Cogan:]

Listen. I mean, Matt, we're super comfortable. I mean, leverage in the two, two and a half range, its super comfortable for us. It allows us to pay a robust dividend. We generate a lot of free cash, we have all the CapEx we need to invest in the business organically. We have ample liquidity to do transformational acquisitions to the extent we uncover those. So, we feel pretty unconstraint with leverage where it is and interest rates are all still relatively low. We throw off a tremendous amount of free cash. So, I don’t think there's much need to go that much lower than when we are and then you will look at what the most efficient use of our free cash at that point is.

[Matt McCall:]

Okay, thank you Andrew.

[Operator:]

Thank you. Our next question comes from the line of Steven Ramsey with Thompson Research Group. Your line is now open.

[Unidentified Analyst:]

Hi, good morning. This is Brian Barris on for Steven. Thanks for taking my questions. Want to start with the lifestyle business, strong organic growth in the quarter. But was there any impact from maybe housing uncertainty or volatility in equities market that may play in how Q4 shaped up for outlook for 2019 at all? Is there any connection between those?

[Andrew Cogan:]

Well, I mean not a lot. I mean, as I did say in my comments, I mean probably some of our higher-end businesses take HOLLY HUNT or something like that probably had some exposure at the top of the residential market and probably some psyche around the stock market has had some impact in terms of consumer spending there. But I have to say we really haven't seen much evidence of any negative impact at this point.

[Unidentified Analyst:]

Got you, anything that will continue into 2019, no real negative impact at the moment given what we know now?

[Andrew Cogan:]

Given what we know now, but obviously I don't have a crystal ball so we'll see how it plays out.

[Unidentified Analyst:]

And then on the Office side, if you just maybe describe the discounting environment in the Office space right now, I know it's a competitive market. But how do we really think about I guess, competing with discounts given the inflation and tariff environment that we're in also?

[Andrew Cogan:]

Well, I think the good news is everyone we are competing against has all those problems as well. In fact, we're probably a little bit less exposed from both the tariff and metal commodity standpoint. So, I don't see a lot of impact from that. And then frankly from a mixed standpoint is we focus more on these ancillary social and hospitality areas those are all margin accretive for us. So that improves with the profitability of every client engagement we have where we can sell them more of those products. So I don't see any major changes there.

[Unidentified Analyst:]

Got you. And one last one on price increases. Looking back in 2018, is there anything with the benefit of hindsight that you might have done differently with the price increases either in timing or magnitude or just the way it’s delivered or anything might have done different and you could think about implementing that in 2019?

[Andrew Cogan:]

Sure. Well, I mean, it was in retrospect if we had known that they would be carved that there would be the kind of protectionism that we saw we would have done more sooner. So I guess, but I don't know how we would have known that. And in terms of this year anticipating that the tariffs are what they are today, but they could be 2.5 after that tomorrow. We have gone a little bit more aggressive in terms of what we'll be doing in March and we would hope to do just one increase as opposed to two in 2019. So that did influence our thinking as we shaped the March increase.

[Unidentified Analyst:]

Got you, appreciate it, thank you.

[Operator:]

Thank you. We do have a follow-up question from the line of Budd Bugatch with Raymond James. Your line is now open.

[Budd Bugatch:]

Yes. Just a couple of very quick questions. I know we didn't acquire Muuto, I think it was mid January of 2018. Remind me what the fourth-quarter pro-forma might have been for Muuto last year in 2017?

[Andrew Cogan:]

Budd, I don't know that we have that right in front of us. We can look that up.

[Budd Bugatch:]

And Andrew did say that you had the inventory model and I think that was the model you were going to. I wonder if you made any changes to that, is it primarily going to be an inventory model with the product continued to be made offshore and inventories in the states for the U.S. or for the domestic market?

[Andrew Cogan:]

Two things, one we've significantly increased the inventory we carry because of the demand. And two, Budd, we're now just beginning and we're actually going to make a decision recently to accelerate our ability to do more of the upholstery here in North America. So we can significantly reduce the lead times and increase our ability to do customers own fabrics and materials.

[Budd Bugatch:]

And is that going to be done by Knoll or you're going to outsource that? How is the thinking on that?

[Andrew Cogan:]

It will be done by an asset light partner.

[Budd Bugatch:]

You mean outsource, is that?

[Andrew Cogan:]

Correct.

[Budd Bugatch:]

Thank you. Thank you, good luck on the year.

[Andrew Cogan:]

Thanks Budd.

[Operator:]

Thank you. We have no further questions at this time. I would like to turn the call back over to Andrew Cogan for any further remarks.

[Andrew Cogan:]

First, thank you everyone on the call for your participation and good questions. In closing I just want to take a moment to acknowledge the recent passing of our co-founder Florence Knoll. Not only was Florence Knoll a woman of impeccable taste and style, but she was a pioneer of the modern workplace. And frankly the entire notion of holistic interior design planning integrating furniture, textiles and architecture which is at the crux of our go-to-market strategy today was invented by Florence Knoll. She viewed design as a problem-solving activity and was intensely focused on the client and delivering an environment that met their workplace needs. As both the Design Director and Executive, Florence was a trailblazer for women in the design and business professions. She invented the motto that good design is good business is both a mentor for Knoll as well as a rationale for clients to invest in Knoll designs. Well, it's been many years since we were last with Florence in person, she remains an inspiration to all of us and the standards of excellence in modern design and interior she set, will always be something that we at Knoll, measure ourselves and our work against. Thank you everybody. We'll talk to you in a few months.

[Operator:]

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