Knoll, Inc.
Q1 2017 Earnings Call Transcript

Published: 25 Apr 2017

[Operator:]

Good morning, everyone, and welcome to the Knoll, Inc. First Quarter 2017 Conference Call. This call is being recorded. This call is also being webcast. Presentation slides accompanying 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. 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 how many factors, including the factors and risks identified and described in Knoll’s Annual Report on Form 10-K and as 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 President and CEO of Knoll. Thank you.

[Andrew Cogan:]

Good morning, everybody. As expected we had a slower start to the year as declines in our Office segment offset continued growth in our high-design Studio segment and stability in our coverings business. Lower year-end backlog coupled within Knoll ship week at the end of the quarter affected our Office segment most acutely. Furthermore, we made the decision to vary lightly load the start of April to give a new system time to ramp up which will also result in a loss of almost a week of Office shipment in Q2. Importantly, the new system is up and running well with no impact on any of our client or supplier facing activity. The next phase of our implementation is scheduled for the back half of 2018. Our Q1 results well down versus a very strong start to 2016 do demonstrate the benefits of our continuing strategy to diversify our sources of revenue into higher-design, high margin, more residentially oriented segments which do not have the volatility of our Office business. In the quarter, these non-Office segments collectively grew and improved their profitability. Margins in our Studio segment held at just under 15% and coverings remain north of 20%. While Office margins fell from 10.7% to 5.9%, overall at the Knoll Inc. level we were able to protect our industry-leading profitability. While down 220 basis points from prior-year, non-percent operating margins are historically good for its seasonally lower first quarter. Growth in Europe and our North America Studio business were the primary drivers of our Studio growth. While sales at HOLLY HUNT were relatively flat, orders there grew double digits. Studio sales were modestly helped year-over-year by our DatesWeiser and Vladimir Kagan acquisitions, they both were drives in our bottom line as we invested in rolling these products out to our respective Knoll and HOLLY HUNT networks. At near time we will be moving DatesWeiser into the standalone showroom on the 11/4 of the merchandise mart that used to be occupied by our Edelman business. Edelman will be retaining their residential showroom in the building and we are on track with rolling out DatesWeiser nationally and hiring dedicated sales reps in key targeted markets. Already we are seeing a positive impact on client engagement from this added capability and are securing business from Knoll client during the past, have gone elsewhere to meet their ancillary conference and meeting room requirements. As we've mentioned in the past, demand in our Office segment can be skewed by the timing of large projects. In late 2015, a large surge of fourth quarter orders translated into significant first half 2016 project shipments. The largest of these were carryover projects from the energy booms that have been committed to before the downturn in this sector began. In Q1 last year the top five projects alone represented just over 20 million of sales. This surge do no repeat itself at the end of 2016, so our backlog was lighter to start the year. In Q1 of 2017, we experienced both decline in the total dollar value and number of million dollars plus projects. Additionally - we estimate we lost about 12 million of sales capacity given the Knoll ship week. So while our headline declined of 19% sounds large on a trailing 12-months basis, the decline is more like 1% and on a trailing two and three year basis, the CAGRs are positive 1.3% and 4.6% respectively. From a geographic standpoint, we were encouraged to see our east coast and more financial service regions start to turnaround. We continue to see year-over-year weakness in energy, and weakness southwest which we expect to be relatively short lift. In the Office segment, expense controls even the face of increased sales and marketing spending, coupled with actions to rebound laboring the plans, helps to mitigate the impact of lower sales. Given our expectations of our rebound in demand later in the year, we've been careful not to overreact in the short-term and do anything that would undermine our ability to accommodate growth. We remain optimistic as a combination of improving industry demand, coupled with our significant initiatives to gain share and ancillary categories with our Rockwell Unscripted launch, the expansion of the breadth and price points of our organic offering, and the seeding and adjustable table markets and more feet on the street and underpenetrated market was right growth in the back half of the year. In fact, we are already seeing signs of these actions gaining traction. Our funnel has awarded businesses up nicely versus prior year. Mock ups in part driven by the launch of Rockwell Unscripted are up year-over-year and while we still see fewer multimillion dollar projects out there, our increased feet in the street are supporting better coverage of the numerous and growing small and mid-size projects that are usually more profitable. We continue to be heartened by the strong reaction to Rockwell Unscripted as measured by growing at significant client engagement, as well as the highest levels of dealer participation and training on any comparable introduction that I can recall. This month the remaining balance of the Rockwell Collection is available for entry and we expect the product to the start the impact to our top line in the back half of the year. In addition at NeoCon, we’ll be introducing most significant enhancement to our wood systems capability with a major out price to our finishing line Toronto that improves the range of our finishes and also improves the efficiencies and reduces cost. In the quarter, our lean investment continue to grow and we had nine cognizant events and three out of four of our plans. These events resulted in increased throughput and reduced space headcount and inventory. On average, we are seeing over 100,000 of benefit per lean event and as the excitement in our capacity will affect this transformations bill, we are encouraged that’s the potential for improved Office margins. Now let me turn the call over to Craig for some more details on the quarter. Craig?

[Craig Spray:]

Thank you, Andrew. Knoll Inc. first quarter net sales decreased $27.8 million or 9.8% from a year ago. Our Office segment was down $35.5 million or 19.2%. The decrease in the Office segment was a result of a decline in both the quantity and average size of larger project opportunities in addition to a limited ship week at the end of March to facilitate the most recent phase of the implementation of the new ERP system. Our Studio segment sales were up $7.6 million or 10.6% primarily driven by Europe and KnollStudio, as well as to a lesser extent, incremental sales and DatesWeiser which was acquired in Q4 of 2016. Covering segment sales were up $0.1 million or 0.5%. Gross margins decreased 60 basis points from 37.9% a year ago to 37.3%. The decrease in gross margin was due to a reduction in fixed cost leverage in the Office segment that was only partially offset by increase sales in the high margin specialty businesses. Total operating expenses in the first quarter were $72.6 million compared to $75.9 million in 2016. The decrease is due primarily to lower incentive accruals from decreased profitability and lower sales commissions as a result of a reduction in volume in our Office segment partially offset by increased investments in training and the rollout of Rockwell Unscripted. We believe that operating expenses for the year will average around 27% of sales. Operating profit was down 27.7% from $31.8 million in the first quarter of 2016 to $23 million in Q1 2017. Operating profit margin declined 220 basis points from 11.2% to 9%. This decline was primarily the result of a 480 basis point reduction in the Office segment from 10.75% to 5.9%. Interest expense was up $0.1 million from a year ago resulting from an increase in the outstanding balance on revolving credit facility used to fund our discretionary pension plan contributions in Q4 2016. For the quarter, other expense was $0.2 million compared to $2.6 million a year ago. Other expenses are primarily related to foreign exchange gain and losses. Our tax rate for the quarter was 27.2% down from 37.1% at Q1 2016. The change in our tax rate was due primarily to the early adoption of ASU 2016-09 in Q3 2016 which impacted the tax treatment of investing of equity rewards. This resulted in the realization of tax benefits recognized as the reduction of income tax expense that were historically recognized within the equity section of the balance sheet. In addition, the tax rate was affected by the mix of pretax income and the bearing rates in the countries and states in which we operate. We estimate that our full-year effective tax rate will be 35% to 36% including the tax benefit recognized in Q1 2017. Net earnings for the first quarter of 2017 were $15.4 million down from $17.4 million for the same period of 2016. Diluted earnings per share was $0.31 and $0.36 for Q1 2017 and 2016 respectively. Regarding our balance sheet and cash flow, cash and cash equivalents were down $6.8 million for the quarter at approximately $3 million. Operating activities provided $3.8 million of cash in the quarter. We used the excess cash generate and the operating activity to invest in the business and pay dividends. Investing activities include capital expenditures for the quarter of $10.7 million compared to $7 million in Q1 2016. The increase in capital expenditures are reflective of our strategy and continued commitment to invest in our manufacturing and information technology infrastructure. Total cash used by financing activities was $0.2 million. The primary use of cash in financing activities was a repurchase of common stock for treasury to satisfy employee tax with HOLLY HUNT requirements related to divesting of restricted shares. Other financing outflows during the first quarter of 2017 includes the payment of dividends for $8.4 million. Our balance sheet remains strong. In the quarter the reduction of EBITDA and increased outstanding debt resulted from 2016 incentive compensation pay-outs and timing of collections drove our leverage from 1.37 at year end to 1.53. We remain confident within all debt covenants. We will now take any questions.

[Operator:]

[Operator Instructions] And our first question comes from Kathryn Thompson with Thompson Research. Your line is open.

[Kathryn Thompson:]

Hi, thank you for taking my questions today. First, just want to pull string a little bit more on the end market color that you had in prepared comments. More specifically you started to see some improvement in the finance end market. Could you give greater clarity on when you saw that, are there other end markets where you’re seeing some relatively better performance over the past few months. And maybe for categories, continue to underperform any thoughts on, is that why behind that as and then for generic just a slower economy.

[Andrew Cogan:]

Sure Kathryn. I think we were encouraged. We tend to be a little over weighted on the – as we said before on northern, eastern financial services. So for us it's meaningful that we're seeing better activity in that sector, that's one of our largest vertical. So that’s encouraging and we see that activity kind of building as we move through the year. So that's quite encouraging and it's not just financial services, banking and all that but you know legal accounting and some of the other things that go with that as well are also showing some positive signs and I think our products are well-positioned to respond to those particularly some of the things we are doing with some of our wood products, that you’ll see at NeoCon. So we feel well positioned there and some of it is just improving economics in those verticals and then our geographic balance. So that's encouraging. We did see some slow down in some of the tax sectors at west but we believe some of that is more comp and timing related and as we look at the back half of the year, we see some good activity I don’t know west coast and on the tax sectors. We’ve been strong in the central division, in fact that’s where some of our largest projects have been and those are on a variety of consumer kind of categories and businesses. So we’re seeing some good strength in the middle of the country. And then we continue to have the lingering weakness in the South primarily related to energy and when I look at the comparison of our first half last year and particularly our first quarter, there were particularly large energy projects that simply didn't repeat themselves. So we see continued weakness there which should carry through the balance of the year and then as you get into 2018 you probably won’t be anniversarying those anymore.

[Kathryn Thompson:]

Okay, that’s helpful. With Office in the last quarter, you said expectations that things - it was going to be a tougher for the first half of the year. If you look at where the quarter came in and where you are now, are you on expectations based on what you try to set out for the street in mid-February when we last spoke and then these fell relatively better or worse based on kind of bid activity that you’re seeing in the market as we look for the remainder of the year and into 2018?

[Andrew Cogan:]

Right, well several factors. One, I think our view for the year really hasn't changed since February which is that it’s going to be a back half year and it’s kind of momentum built in the industry. We tend to be later to the party and then we stay at the party longer and so I think to some extent as we’re starting to see some signs of life in some of the business stuff and as we look at our funnel of activity which except in the large projects overall is growing nicely. When we look at our pool of awarded business we enter the back half with more won already than we had a year ago. When we look at the kind of trajectory of our new product launches and the real enthusiasm they are generating and how they are helping us capture both incremental dollars on existing accounts, as well as penetrate accounts that historically have not bought from Knoll and those ancillary parts of the market. I think we’re encouraged and we still believe it’s a back half story. We were recently with all our sales division heads on the optimism side of the business. And I think their outlook kind of reconfirmed our point of view that we’ll return to growth in the back half and it just a slow start to the year.

[Kathryn Thompson:]

Okay. Any thoughts on - is your outlook or maybe because you reconfirmed what your thoughts are for Rockwell Unscripted contribution to 2017?

[Andrew Cogan:]

I think again we talk in general of our expectations of Rockwell Unscripted being north of $50 million product line over the next three to four years and I think we are very much on that path. In the first year, you know $10 million, $15 million and you kind of ramp up from there again I think what we talk about now we can start to see both real awarded Rockwell opportunities in our funnel and we can see examples of clients starting to use Rockwell and again I think they breakup into three areas. The first being where we’re capturing some incremental ancillary business that without Rockwell we wouldn’t have done and that can be 5% or 10% of an overall bid. Then we’re seeing standalone Rockwell opportunities with clients that just wouldn’t have even considered Knoll for those areas of the office. And those can be $50,000 to $1 million and $1.5 million and we’re seeing some nice ongoing agreement and initial purchases in that area. And then kind of the longer term projects which were also in the midst of a variety of betas and mock ups and pilots with clients on where people are doing entire facilities with Rockwell. And with those that obviously is the longest cycle part of the ramp up but we're seeing you know many opportunities in that area as well. So as I breakup into those three pieces, I think we’re quite encouraged that our expectations are very much in line with the products being received in the market.

[Kathryn Thompson:]

Okay great. And final question with Studio, Studio saw some good sales growth and operating margins for - remain flat on a year-over-year basis. Any color for flattish margins in light of better topline performance?

[Andrew Cogan:]

No, I think as we’ve always said, the Office margins move around a lot with volume and absorption and the Studio margins basically don't move a lot, it’s much more of a variable cost model business. So you're not getting great absorption in either direction everything and there’s a little bit of mix moving around in the Studio business. But I know again I think the Studio margins, as well as coverings tend to be pretty consistent and it’s office where you have most of the volatility.

[Kathryn Thompson:]

Okay, perfect. Thank you very much.

[Operator:]

[Operator Instructions] And our next question comes from Matt McCall with Seaport Global. Your line is open.

[Matt McCall:]

Thank you. Good morning, guys. So, did you talk about some sales capacity loss and you said that was 12 million was that related to ERP in the quarter?

[Andrew Cogan:]

Yes.

[Matt McCall:]

Okay. So since that was topline - you have an estimate profit impact in Q1?

[Andrew Cogan:]

Listen, I mean I think you can take a 40% contribution margin and kind of flow that through.

[Matt McCall:]

Okay. So maybe Craig for you, you mentioned FX was there an estimated FX impact on the Office margin in Q1?

[Craig Spray:]

It was really minimal Matt. We had a bigger impact prior year running through other income and that was the Delta through the earnings but in terms of margin impact it was minimal.

[Matt McCall:]

Okay. So I think you said Andrew - or may have already - in Q2 should we assume that same type of $12 million impact in Q2 with the 40% flow through?

[Andrew Cogan:]

Yes, I think that's probably fair Matt.

[Matt McCall:]

Okay, all right. So okay, that’s good. So from a margin outlook perspective when I think about ERP, when I think about so that impact we just talked about I think about FX as we look out maybe to Q2 how you want us to think about your margin progression. And then really more going back to your comments earlier about the back half kind of reacceleration, what would you like to think about in terms of margin in the back of half?

[Craig Spray:]

Well in terms of ERP let me speak to that first, really this is a topline discussion. The ERP we're having some systems come on, other systems come off, so I don’t think you’re going to see a significant impact through our operating margin because of the ERP as we bring these phases on.

[Andrew Cogan:]

And Matt in terms of the quarterly progression, I mean I would expect you continue to see kind of sequential improvement couple of 100 basis points each quarter as we move through particularly on the office side that's impacted, then I would hope by the time we get into the back half of the year, you’ll start to see Office margins, you know starting to move ahead of where they were at prior year.

[Matt McCall:]

Okay. And the final question I had, you’ve mentioned sales force of feet on the street increases in some other investments that you’ve made. Can you quantify that number for us and maybe how that could impact your growth as those new sales folks ramp?

[Andrew Cogan:]

Yes absolutely. Again as the market become more fragmented and we see fewer $1 million to $2 million plus opportunities and I think that by the way is pretty consistent with the leasing activity at where we're looking at where there aren’t the super large leases but there're smaller leases and we just have to have more people out there covering more of the market. And so we’ve kind of targeted about a 10% increase in our feet on the street this year. And I think right now as we sit here we’re about half way towards to that goal and so we’re very focused on that. We think that will help us improve our coverage. On average, a sales person when they’re up to speed can do $4 million or $5 million so it’s not an insignificant addition in terms of our ability to cover the market and handle more smaller opportunities which is you know where we see more of the auction right now.

[Matt McCall:]

Okay. And then finally and this kind of relates to that last question when I look at the SG&A line a little deleveraging this year, it’s a long way away as we look out to 2018 and we think about the additions that you’ve made. Do you expect an initial plan as we sit here today that you'll start to see some leverage return in 2018 as we get some of these investments behind us?

[Andrew Cogan:]

I would hope for some of that absolutely, I wouldn’t say it’s huge but again Craig talked about 27% SG&A and maybe you get 26 to 27 a year from now. I think we’re also still very focused on the gross margin side of the business in terms of the lean, the mix of what's going on there. We've got many issues within our plans. So we still think there is significant opportunity to keep driving margins higher and then prerequisite it relates to the Office business as volume there grows, absorption benefits higher mix. I think the other thing that our quarter like to show is Matt also is that we really benefit by the mix of our businesses and we continue to be very focused on both on bolt-on acquisition and more organic growth in our own coverings and Studio segments. Particularly as DatesWeiser and Kagan and some of the facilities we’ve added, the additional showrooms in HOLLY HUNT, the product categories like outdoor where HOLLY is just now starting to be a player. We also think those businesses can continue to become a greater part of our overall mix. And that helps kind of at the operating margin level let me put it that way, even if it drives SG&A mix a little bit higher because those businesses tend to have SG&A as a higher percentage of their mix.

[Matt McCall:]

One final one, on that operating margin note, when you think about the way you guys just talked about it, kind of the 100 basis points, this year we are taking a little bit of a break maybe it’s flat. But with the reacceleration at back half, do we return to that net 100 basis points or better next year? Just trying to think about how we adjust for these disruptions mostly from ERP in the first half?

[Andrew Cogan:]

Listen, I think our goal is 50 to 100 basis points of operating margin improvement annually. And it’s not hard between the lean initiatives and the Office size of business, as well as the mix evolution and return to growth in Office to kind of plot that forward. I don’t think that’s an unrealistic expectation. What I will say is, there is just a lot of wild card right now, FX, right now that’s actually helping us. We don’t know where our inflation ultimately settles at but right now, that's a little bit of a headwind I think. The good news is we use less steel in some of those commodities than other use. So we are not as impacted by that. So there are a variety of mix within our business in terms of if it’s truly more small projects generally pricing on those tends to me more favorable. So you can lay out a lot of things, but in general, our goal is always to try and generate 50 to 100 basis points of operating margin improvement and other than the pause, maybe a little bit of a step back this year. That’s the journey that we believe our strategy still should result in.

[Matt McCall:]

Got it. Thank you, Andrew.

[Operator:]

And I am showing no further questions. I’d now like to turn the call back to Andrew Cogan for any further remarks.

[Andrew Cogan:]

Okay. Well, thank you all for your continued interest and we really hope you have a chance to come by our showroom in NeoCon. We think it will be a powerful display of not only Rockwell and our overall capabilities, but very exciting in terms of our new wood collection and where we are going in that part of the market. So hopefully we’ll see you all in Chicago. Take care, everybody. Bye.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program and you may all disconnect. Everyone have a great day.