Knoll, Inc.
Q3 2007 Earnings Call Transcript

Published: 18 Oct 2007

[Operator:]

Good morning, everyone, and welcome to the KnollIncorporated Third Quarter 2007 Conference Call.  This call is being recorded.  This call is also being webcast at knoll.com.  Presentation slides accompany the webcast. In addition, this call may offer statements that are forwardlooking.  These forward-lookingstatements are based largely on the Company's expectations and are subject to anumber of risks and uncertainties, certain of which are beyond the Company'scontrol.  Actual results could differmaterially from the forward-looking statements as a result of many factors,including the factors and risks identified and described in Knoll's annual reporton Form 10-K and its other filings with the Securities and Exchange Commission. The call today will also include references to non-GAAPfinancial measures.  Reconciliations ofthese measures to the most comparable GAAP financial measures are included inthe Company's earnings release dated October 17, 2007, and presentation slides that accompany the webcast. Now, let me turn it over to Andrew Cogan, the CEO of Knoll.  Please proceed, sir.

[Andrew Cogan:]

Good morning, everybody.  Thank you for joining us.  I thought as we approach the third anniversaryof our December 2004 IPO that it would be worth taking a look back at whatwe've achieved since Knoll became public and try and frame where we believe weare headed. Since 2004, assuming the midpoint of our full-year guidance,we've increased sales by over 40% compared to 28% for BIFMA.  Our adjusted EPS is up over 113%.  Latest 12-month EBITDA is up 84% and leveragehas decreased dramatically from over 4.5 to 1 to now at the end of Q3, lessthan 1.9 to 1, even as we bought back over 7.5 million shares of our stock andincreased our dividend. The overhang from our former private equity owners hascompletely disappeared.  We see improvedliquidity in the stock with an average of approximately 500,000 shares tradinghands daily, and we've developed a strong track record of delivering theresults we guide. Results, I should point out, that continued to set thebenchmark of profitability in our industry and that are up over 300 basispoints since our IPO in spite of the challenges of unprecedented inflation andthe appreciation of the CAD.  The Knollteam is extremely proud of this record. What has our stock done since the IPO?  Well, it has peaked this spring.  We have seen our shares appreciate by about66%.  Since then, they've fallendramatically and are now up less than 20% from our IPO price in spite of thedramatically stronger business results.  Infact, we're trading at what historically has been trough EBITDA in PE multiples. Why?  Well, I thinkyou all are probably better positioned to answer that question than we are, butthere's clearly an assumption being made about our future prospects that we donot share internally.  In fact,personally, I've never been more optimistic or excited about our prospects thanI am today.  We are building a greatdesign-driven company and people are taking notice. In September, we were called one of the three greatdesign-driven brands in Americain an article that we noted in the cover of our webcast.  The recently closed acquisition of EdelmanLeather is a perfect example of using our strength and balance sheet tosupplement our own strong organic growth initiatives with the addition ofanother great high margin, design-driven specialty business, and it opens up anew channel of decorator showrooms for us to experiment in, much as we havedone with our very successful Knoll Space retail effort. Edelman, as we said in our announcement of the acquisition,will be accretive in the first year as we realize synergies on both the top andbottom lines.  Going forward, theseunique design-driven businesses, now including KnollStudio, KnollTextiles,KnollExtra, Spinneybeck, and now Edelman, should represent approximately 21% ofour revenues, up from under 13% at the start of the decade with great prospectsfor continued growth. Yes, it's fair to say the market in North Americais slowing down, but we do not expect it to free fall like it did in 2001 to2003.  Rather, we believe that thecombination of some capacity constraints in certain markets as a result ofreduced vacancy rates and the increased level of business uncertainty makesflat to modest single-digit growth a reasonable industry outlook for 2008. This does not mean that this is our expectation for Knoll aswe go forward.  As opposed to where wefound ourselves in 2001, we have seen a dramatic improvement in our product mixas we have implemented strategies to make us much less dependent on any singleproduct category.  Complementary productslike seating and storage represent almost 19% of our sales, up fromapproximately 12% at the start of the decade. And we are just now starting to play in the case goodscategory with the rollout of our Graham Collection this month.  Higher margin specialty sales, as I saidearlier, are an equally big part of our mix, and these are all categories whereeven in the context of a slowing North America market,we'd expect to continue to gain share and generate better than the industrygrowth. We have made huge strides in our international markets.  Today, these represent our fastest growingsegment and are now up over 10% of our revenues with unlimited potential as wecontinue to ramp up our focus and attention on these high-opportunity markets.  As a result of all of the above, systems nowrepresent just under 53% of our revenues compared to almost 68% back in 2000,making us much less vulnerable to a category that can be more volatile.  And within the systems category, our lineuphas never been stronger. AutoStrada has set the standard for design leadership in ahigher-end systems market. And now, with the introduction of Dividends Horizon,we believe we have done that again at an entry-level price point.  Horizon is now just hitting all our showroomfloors, and we have high expectations for the impact it could make on oursystem sales in 2008 and beyond.  And, ofcourse, we're not done.  Our productdevelopment pipeline is as full as it's ever been with innovative and excitingenvironmentally responsible designs that we will bring to market next year andbeyond. The other big change in Knoll is our broadened client mix.  While government sales, broadly defined,continues to be one of our largest categories with strong growth prospects,we've also significantly expanded our focus on other growing areas likehealthcare and pharmaceutical, hospitality and education and are having greatsuccess in these segments. Perhaps, one of the biggest misnomers is our exposure to thefinancial services sector. Yes, financial services broadly defined representsjust over 20% of our North American sales.  However, when you carve that up further, youfind it can be split into three categories, including firms engage in a wholevariety of money management and mutual fund activities, commercial banks andthen the investment banks, not all of which will be impacted by the recentmarket turbulence equally or at all. In fact, some of our biggest opportunities for the end ofthis year and 2008 and 2009 continue to be in this sector, and those projectscontinue to remain on track.  Legal,consulting, and accounting firms, which seem to thrive in all different typesof economic environments are another large and vibrant sector. What does this mean to our shareholders?  It means that we're as committed as ever tocontinue to build a stronger, healthier, more profitable, and differentiateddesign-driven company that continues to generate industry-leading levels ofprofitability.  You know our 10-year plusnow track record of managing Knoll to maximize both growth and profitability ina wide range of market condition is truly unparalleled. Over time, I believe that investors will see the value thatwe have in our creating and will one day reward Knoll with an appropriatemultiple.  In the meantime, we'll keepdoing what we've always done, and we will be proactive in using all ourfinancial, creative, and human resources to build this great company and createvalue for our shareholders. Now, I'm going to turn the call over to Barry to take youthrough our results and guidance for the rest of the year.

[Barry McCabe:]

Thanks, Andrew.  Ourthird quarter reflected strong results despite slowing growth.  Over prior year, sales grew 4.3%, backlog wasflat, gross profit increased by 140 basis points to 34.7% of sales, operatingincome increased by 110 basis points to 13.5% of sales, net income grew by17.9% and adjusted EPS for the quarter increased by $0.04 or 12.1% over thethird quarter of 2006. Sales for the third quarter were $254 million, an increaseof 4.3% over the prior-year period, reflecting strong growth from our specialtyand international businesses.  In thequarter, our North American office business saw a nice increase in client visitsand markup activity, both sequentially and year over year.  This is supportive of our belief that we arein the midst of a mid-cycle slowdown rather than a precipice of a major declineall of 2001. Backlog for the third quarter was $169.8 million, essentiallyflat with prior year.  Gross profit forthe quarter was 34.7%, 140 basis points better than the 33.3% reported a yearago.  We were pleased with thisimprovement as we offset the negative impact of a stronger Canadian dollar.  Better pricing, moderating inflation, andimproved factory performance all contributed to the improvement in grossprofit. Gross profit dollars increased from $81.2 million a year agoto $88.2 million this quarter under higher sales and improved performance, anincrease of $7 million.  We expect year‑over-yeargross profit performance to improve as we continue to see the benefit of theprice increases, global sourcing, and continuous improvement efforts offsettingthe stronger Canadian dollar. Also, we are optimistic that some of the recentfavorable trends in commodity prices will continue into next year. Operating expenses were $54 million or 21.3% of salescompared to $51.1 million or 21% of sales a year ago, an increase of 30 basispoints due primarily to increased compensation cost related to improvedoperating performance and increased growth initiative spending in productdevelopment and sales.  On an annualbasis, we still expect operating expenses to remain in our targeted range of20% to 21% of sales. Operating income was 13.5% for the quarter, 110 basis pointsbetter than the 12.4% earned in the third quarter last year.  This increase was the result of the grossprofit improvement from a year ago.  Operatingincome dollars increased $34.3 million from $30.2 million a year ago, anincrease of $4.1 million. Interest expense was $5.6 million, a decrease of $0.4million from prior year due to lower debt and lower borrowing costs from ourall new revolver credit facility completed last quarter.  Other expense was $0.8 million in the thirdquarter, which compares to $0.3 million last year and represents primarilyforeign exchange losses on currency. Our tax rate for the quarter was 33.9% compared to 34.5% ayear ago.  The lower rates reflectadjustments to our contingent tax reserves for the statute closing of 2003 and2002, respectively.  All this resulted anet income of $18.4 million, 7.2% of sales and an EPS of $0.37, which is animprovement over net income of $15.6 million, 6.4% of sales and an adjusted EPSof $0.33 a year ago. Year-to-date net cash provided by operations was $64.5million, of which $75.4 million was provided from net income plus non-cashamortizations offset by $11 million of changes in assets and liabilities,primarily accounts payable.  Capital expenditureswere $10.8 million for the nine months, which compares with $7.4 million a yearago. Financing activities used $53.3 million, which included debtpayments of $41.8 million, $30 million of common stock purchases, $16 millionof dividend payments and $2.6 million of refinancing fees offset by $28.2million of stock option proceeds and $8.9 million of related tax benefits.  If we look at liquidity, we have $18.7 millionin cash and another $188.5 million available under our new all-revolver bank facility. We are in compliance with all our debt covenants and see noissues going forward.  Our current debtis $308.5 million, and our leverage ratio is under 2 to 1.  After giving effect to the Edelman Leatheracquisition on October 2nd, our debt increased to approximately $376 millionwith approximately $120 million available under our revolver.  Our leverage ratio is forecasted to remainbelow 2.5 to 1. In the fourth quarter of 2007, we expect sales to be in therange of $265 to $275 million, basically flat with last year's very strongfourth quarter.  We expect earnings pershare to be $0.36 to $0.38.  For the fullyear, we expect sales to be in the range of $1.30 billion to $1.40 billion, anincrease of 4.9% to 6% over 2006.  Thisis consistent with the midpoint of the full-year guidance $1.30 billion ofsales we gave for the full year last quarter, and when you factor in theEdelman acquisition, it should push us up above that midpoint. We expect adjusted earnings per share to be $1.40 to $1.42,which compares to $1.17 for 2006.  Again,this is consistent with the midpoint of our $1.35 to $1.45 range we gave youfor the full year last quarter and moves above the midpoint as we see theaccretion from Edelman. Andrew?

[Andrew Cogan:]

Thank you, Barry.  Beforewe open the call for questions, let me touch on the announcement we madeyesterday regarding Kass' plan to retire sometime in 2008.  Kass has been a singular President at Knollfor almost 30 years and has served as a role model for every one of us at theCompany.  She is an extraordinary personand leader and we will miss her. I am pleased that she intends to continue to serve as a Directorof the Company, and I look forward to continue to work with her in thatcapacity and being able to call on her from time to time to continue to help ussell furniture.  At the same time, one ofKass' many legacies is a terrific team she has been a part of building acrossthe Company. As a result as part of this transition, it is fitting thatwe also announce the promotion of Art Graves to Executive Vice President ofSales and Distribution, Steve Grover to Executive Vice President of Operationsand my colleague over here, Barry McCabe, to Executive Vice President and ChiefFinancial Officer.  We look forward to asmooth transition of Kass' other responsibilities in the coming year as wecelebrate the 70th anniversary of our founding in 1938. Now, without further adieu, let us open the line to yourquestions.  Operator?

[Operator:]

Ladies and gentlemen, if you wish to ask a question, pleasepress "* 1" on your touchtone telephone. If your question has beenanswered or you wish to withdraw your question, please press "* 2".  Questions will be taken in the order they arereceived. Your first question comes from the line of Budd Bugatch fromRaymond James.  Please proceed.

[Budd Bugatch -Raymond James:]

Good morning, Andrew. Good morning, Barry.

[Andrew Cogan:]

Hey, good morning, Budd.

[Barry McCabe:]

Good morning, Budd.

[Budd Bugatch -Raymond James:]

Just a couple of questions, if I could.  Barry, can you kind of walk us through lastyear to this year maybe in SG&A and gross margin, give us some of theelements maybe?  I know you gave them tous in kind of a verbal form, but is there any way to put some numbers to someof the differences?  Because I was alittle surprised by the expenses and pleasantly surprised by the gross margin.

[Barry McCabe:]

We'll start with the gross margin.  I am not going to give you specific dollaramounts, but I will say one of the things that we had identified last year withour tremendous growth was the pressures and efficiencies and really as we rampup our facilities to produce the higher level of production. And we had told everybody we thought we would improvegreatly over that this year at a much slower kind of growth rate, coupled withnot only the factory performance improvements in terms of on time andefficiencies, we're beginning to see the benefit of the price realization fromthe price increases that have been put into place over the last few years.  We're seeing moderating inflation. I think we've mentioned any number of times where averageinflation on material was 8% to 9% a year.  This year, it's more in the 3% to 4%.  Really the only category where you're seeingcontinued inflationary pressure is really in the transportation area and that'sdue to the price of oil.  So, we expectedthe gross profit and improvement. And one of the things now to the SG&A that we said allalong, even though our targeted percentage is 20% to 21%, we had saidthroughout the year when the opportunity presented itself, we were going toinvest in growth initiatives whether it be in product development, collateralmaterial as we look at penetrating more of the international markets.  So, I really believe even though there is aslight up tick, if you will, in SG&A, it's in line with our full guidance.

[Budd Bugatch -Raymond James:]

And so, when you're looking forward, should we expect in thefourth quarter the same kind of more improvement in gross margin year over yearversus the SG&A?

[Barry McCabe:]

I think you're going to see margin improvement year over year,but the overall percentage of gross margin will be dictated by product mix, theCanadian dollar, which we are offsetting.  But again, if the Canadian dollar continues tostay above par with the US dollar, that'll put pressure on gross profit in thefourth that wasn't there in the third.

[Budd Bugatch -Raymond James:]

Okay.

[Barry McCabe:]

And SG&A should be, again, 20% to 21%.

[Budd Bugatch -Raymond James:]

Okay.  And two otherquick questions.  Tax rate assumption forthe fourth quarter, because this tax rate was lower.

[Barry McCabe:]

It was lower, but we gave guidance on a lower rate and itwas consistent with the prior year.  Generally,a year-over-year rate to use is around 38%.

[Budd Bugatch -Raymond James:]

Okay.  And just,Andrew, just longer term now, thinking about the future, recognizing maybe theslowing moderating of BIFMA general numbers, what's kind of a good way to thinkabout maybe 2008 from a volume standpoint overall for the Company?  I know you haven't given specific guidanceyet, but how should we think about that in terms of year-over-year growth rate?

[Andrew Cogan:]

Well, you know, I think what – the BIFMA number is about 2%or 2.3% or something, I think, is what BIFMA is guiding for next year, I wouldcontinue to expect us to do a couple of hundred basis points faster than theindustry, particularly as we drive areas of above-average margins like ourspecialty businesses as we drive international growth and as we drive ourcomplimentary products. So, I see no reason why we won't continue to outperformthe industry as we've done the last three years pretty consistently.

[Budd Bugatch -Raymond James:]

Okay. Thank you very much.

[Andrew Cogan:]

Thanks, Budd.

[Operator:]

Your next question comes from the line of Matt McCall withBB&T Capital Markets.  Pleaseproceed.

[Sean Connor -BB&T Capital Markets:]

Good morning.  This isSean Connor for Matt McCall.

[Andrew Cogan:]

Hi, Sean.

[Sean Connor -BB&T Capital Markets:]

A quick question.  Ihope I can get a little bit more detail on the Edelman acquisition.  Do you have any detail on size or what thehistorical margin of that business is?

[Barry McCabe:]

I won't go into the size.  Historical margins, it's in line with ourspecialty businesses, which are more profitable than the office systems or thecomplementary categories.

[Sean Connor -BB&T Capital Markets:]

Can you guys talk about if that specialty products businessis representing about 21% of your overall sales? Do you guys have a goal forwhere you want that to go as you shift around your product mix to that higher margincategory?

[Andrew Cogan:]

I think our goal is to make it as a higher percent of ourbusiness as we can.  And we are veryfocused on driving organic growth initiatives, which is really what's beendriving the growth in that business to date.  We're focused on all sorts of channelopportunities that we believe are under-penetrated, and we're focused on add-onacquisitions and we find something of the quality and profitability of anEdelman.

[Sean Connor -BB&T Capital Markets:]

Okay. And then, I guess looking forward into the Q4 pipelineeven into '08, what's currently in that backlog number?  Are any of the recent sizeable wins that are expectedto ship in the fourth quarter or are they still on track for '08?  How can we look at what's in there versus howwe try and project down into '08?

[Andrew Cogan:]

I think there is nothing unusual in the backlog.  It kind of is what it is.  And I think that we have a nice stream oflarge project orders that we would expect, some of which are booking as wespeak, others, we expect to book as we head into 2008, and a lot of which wewould hope to book in 2008.  So, I thinkthe spread continues to be pretty much as it's been.  I think you have to be a little careful withthings we have got. You can have one super big project, but that doesn'tnecessarily repeat itself.  You can alsohave other smaller projects that drop off.  So, I mean we are in a project.  We're in a project-oriented business.  There's always some choppiness betweenquarters on occasion of those projects, but we do see nice activity goingforward. I would point out that our -- we were very pleased to see asignificant increase in markup activity this quarter. And while the number ofmillion-dollar-plus orders and projects was flat year-over-year and we're notseeing the kind of growth there we've seen in the past, we were encouraged byan increase both in client visits and a nice increase in markups that generallybodes well over time for the future.

[Sean Connor -BB&T Capital Markets:]

Okay.  Then taking alook at maybe the margins for '08, if we carry the current Canadian dollarthrough the whole year and the same net positive/negative of the other itemsthat you just spoke about with Budd, assuming mid single-digit growth, whatdoes the margin look like for '08 potentially?

[Andrew Cogan:]

Well, let me do this. We're in the midst of planning for'08.  So, I know all of you want '08guidance.  We're not going to give it toyou right now.  What I will say is this.  This is a year where we're talking about 4% to6%, 5% to 6% topline growth, and we're generating close to 33% year-to-datecontribution margin on each dollar of incremental sales. That's more than double the contribution rate last year.  And I think it's consistent with what Barrysaid, that in the slowing environment, we actually thought we could be moreefficient.  So, we would hope to continuecontribution margins in the high-20, low-30 range on mid single-digit growth.  And in that scenario, this year, we're goingto generate a little bit north of 20% EPS growth, and that's certainly kind ofthe metrics that we'd like to be able to continue to post.  The Canadian dollar will be a headwind.  We have other things that are plusses andwe'll just have to see as we go through our planning process how the mix of allthat plays out.

[Sean Connor -BB&T Capital Markets:]

Okay.  Great.  Thank you very much.

[Andrew Cogan:]

Thank you.

[Operator:]

Your next question comes from the line of Michael Rehautfrom JP Morgan.  Please proceed.

[Michael Rehaut:]

Hi!  Thanks.  Good morning.

[Andrew Cogan:]

Hey!  Good morning,Michael.

[Michael Rehaut:]

A couple questions here.  First, on the gross margin of this quarter, Iwas hoping if you could give us a little more quantitative review of how muchthe Canadian dollar hurt you guys and perhaps from either moderating materialsinflation or the pricing or the global sourcing where that fell out in terms ofmore than offsetting that negative impact.

[Barry McCabe:]

On the Canadian dollar, where the dollar is, that's reallypublic information that anybody can really track.  The Canadian dollar, even though it's abovepar today, still only averaged $0.953 for the third quarter.  The dramatic increase was more in the latterpart of September.  And that compared toabout CAD$0.0895 in the third quarter of last year. So, if you look at it, and we've said publicly that a pennyappreciation in the Canadian dollar is about $1 million of margin, a grossprofit or gross margin headwind on an annual basis.  Just using the math, I would say that theCanadian dollar cost us $1.5 to $2 million probably in the third quarter ofmargin headwind. And the plus to that was with the other initiatives, thepricing, the global sourcing, and the continuous improvement, we were able tooffset that and even actually grow gross profit.  I don't want to get into the specifics of eachof the categories because they vary from quarter to quarter and, in fact, varyfrom month to month.  But needless tosay, that really the only headwind we have is really the Canadian dollar.

[Michael Rehaut:]

Just looking at price, you grew sales 4.2%.  Can you give us an idea of unit growth versuspricing contribution on that 4%?

[Barry McCabe:]

I don't have that in front of me.

[Michael Rehaut:]

Looking forward, I know there has been a lot of questions on'08, but do you continue to expect positive price over the next few quarters?

[Barry McCabe:]

I think price will remain positive because, as we have said,over time, you have buying agreements, especially with some of your largercustomers.  They can be two to three-yearbuying agreements off an older price lists.  And I think to the extent that you have theseolder price lists expiring or these agreements expiring, moving into newagreements, going forward, we will see continued price.  The magnitude, we'll have to wait and see, butwe should see positive price.

[Andrew Cogan:]

This is Andrew.  Ijust want to point out two other things.  One, in the third quarter, we did benefit froma very positive mix as it related to higher shipments of our specialty businesses. We won't see as much favorable mix inthe fourth.  The third tends to be thehighest specialty business.  We're goingto have more Canadian currency pressure in the fourth than we had in the third.  But that said, well, sequentially, grossmargins may dip a little. At the same time, I think you'll still see strongyear-over-year gross margin improvement. I'd also point out that we're really, really, really doing anice job in the sites.  Our plant guyshave made a tremendous progress under the leadership of Steve Grover this year interms of improving our plant efficiency, our on-time performance, the cost ofpoor quality.  We're making real solidimprovement at virtually every single one of our sites right now. And that continuous improvement number dwarfs what we're alltalking about here in terms of Canadian dollar and all that.  And, Michael, one of the reasons we're notbreaking out what everything is, plus or minus, is people then focus in on thatone element and lose the forest for the trees.  And we're trying to keep that from happening,because there's so much other good stuff going on internally and in the siteshere at Knoll.

[Michael Rehaut:]

No, I agree and I appreciate that further detail, Andrew.  I mean I think what would be helpful, andagain, I don't necessarily am trying to pin you for '08, but if you were tokind of give an overview of what you think in general, let's say, the globalsourcing, continuous improvement, higher efficiencies, any way to quantifyperhaps what that represented in '07 and what perhaps more opportunity there isover the next year or two?

[Andrew Cogan:]

I think the improvement we've gotten in some of those areashas been a little more back-half loaded.  I mean we really started to see it steadilyimprove as we got our hands around the capacity and the volume issues in theplants.  And so, the second quarter wasbetter than the first quarter, the third quarter was better than the secondquarter, and we hope on the continuous improvement line, the fourth quarterwill be better than the third quarter. So, we're making progress there.  I think prices continue to be a plus,inflation is running at, as Barry said, at half the rate it ran last year.  So, the big challenge right now is a littlebit the exchange stuff.  But again, we'vegot so many more good things offsetting all that that we're encouraged aboutthat. And, then again, as '08, I can't tell you what those numbersare, because we're sitting here now as we're talking, we're working with oursites, we're doing planning for next year, we're looking at commodity forecasts.So, it's very much a work-in-process right now. But again, I can tell you ourexpectation is, and I think we've proved it this year, on modest 4% to 6% topline growth, we're getting 30% contribution margin -- 30-ish percentcontribution margin and 20% EPS growth.  I'dlove us to try and be able to continue that.  I can't tell you that we are going to, becauseI don't have all the 2008 elements together, but that's really a great performancefor Knoll.

[Michael Rehaut:]

Well, I mean I don't want to harp on this too much, butgiven the momentum and the fact that you have overcome the Canadian dollar, youhad talked about in the past an end of '08 goal of 35% gross margins and 15%operating margins.  Given the momentumand success that you've had in some of these initiatives, is there anything to,outside of maybe industry macro factors, anything to make you think that thosegoals aren't still reasonable?

[Andrew Cogan:]

We are still going to work hard to achieve those goals bythe end of 2008, and we're committed to that. I will say it was easier beingcommitted to those goals when the Canadian dollar was $0.85 or $0.92, and itgets a little harder when it's over par, but we're not backing off it.  And we will be looking very hard at ways toreduce our Canadian dollar exposure at areas where it makes sense to bring workto other places. We are going to be very creative about how we look and howwe do that and we will accelerate some other efforts to offset that.  I also think the more we do great things likeEdelman, which has very, very strong margins, the more we're going to offsetsome of these pressures as well as through mix.  So, we're not backing off that.  But in some ways, it gets more difficult, butthat's okay.  That's running a businessand adjusting to things we can't control.

[Michael Rehaut:]

Great.  And just onelast question.  The sales growth guidancefor 4Q, does that include Edelman?  Andcan you give us an idea of annualized sales for that business?

[Andrew Cogan:]

It does include Edelman.  And no, we can't.

[Michael Rehaut:]

Okay.  Thank you.

[Andrew Cogan:]

Okay. Thanks, Michael.

[Operator:]

Your next question comes from the line of Chris Agnew withGoldman Sachs.  Please proceed.

[Chris Agnew:]

Thanks.  Good morning,Andrew.  Good morning, Barry.

[Andrew Cogan:]

Chris Agnew for the record.

[Chris Agnew:]

Andrew, you talked a little bit about geographic weakness.  I was wondering if you could expand upon thatpoint.

[Andrew Cogan:]

Yes, I don't think I talked about geographic weakness.

[Chris Agnew:]

I thought you said there were a couple of markets that werea little bit soft there in office vacancy levels where --

[Andrew Cogan:]

In terms of that overall comment, yes, there are differencesin the market where we're continuing to see very strong performance in the Northeast. The middle of the country has been alittle softer.  That said, when I talk toour people in the Midwest, they've got a great pipeline,in some ways, the strongest pipeline from what I'm hearing right now, goinginto next year.  So, I think it all kindof balances out.  In any given year,there always is some variety, but I don't think that there's anything --

[Chris Agnew:]

There's nothing of significance, so as like Californiaor anything, you're not seeing any?

[Andrew Cogan:]

No, we're having an okay year out there.  I mean it's not as strong as the Northeast.  It's not -- it's okay.

[Chris Agnew:]

Okay. Sorry?

[Barry McCabe:]

No, I was just going to say I think one of the things thatwe have said and we are encouraged as you go around and you talk about themidsection of the country, there is a lot of cranes and a lot of constructiongoing on.  And I think it was safe to sayin some of the markets, you'll see more office space coming online into '08 and'09 and that, in some of the markets, the vacancy rates, even though they werestrong nationally overall, were lower in some of the markets where we werestronger.  But they are forecasted tocome back.

[Chris Agnew:]

Okay, okay.  Internationalbusiness, can you talk a little bit about that?  What initiatives you're pushing?  Could you provide us with a growth rates?  And what's the mix within your internationalbusiness, maybe Europe versus Asia?

[Andrew Cogan:]

Sure. I'll be happy to try to.  In the international mix right now, I'd sayabout 75% to 80% of the business is Europe, 20% to 25% wouldbe markets outside of Europe, so Asia Pacific and the Middle East.  In Europe,we're having, I think, our highest OP ever in Europe orclose to it in the recent 10- or 12-year history. We've done a good job of introducing new products there thathave really worked in the local market.  We'vesignificantly strengthened our sales team over in Europe. We've broadened our distribution, andwe're doing a much better job of leveraging global relationships that we havehere in North America, that we have an opportunity tocross-sell into Europe.  So, I think Europe isdoing very well. We're also really driving our specialty businesses in Europe,and that's contributing to strong margin performance out of Europeas well.  Again, I think the studio productshave been under-marketed there and the team is increasingly focusing on havingdedicated people drive and sell those products in the European marketplacewhere our brand is very, very well known.  So, that's what's going on in Europe. In the rest of the world, it's much more development work.  It's much more under Joe MacIsaac, ourPresident of International, who has been doing that now for about nine months.  It's laying the basic foundation.  It's putting in place distribution.  It's putting in place salespeople and agentsto support that distribution.  It's bringingthose dealers into both the USand into Europe for training on the products, and it'sjust kind of the basics. And we're seeing the fastest growth of any of our categoriesin those areas.  And it's also studio isbeing driven in those international markets.  So, it's really just doing the fundamentals,because our presence in those ex-Europe markets hasn't been as great as itcould be.  So we're doing the basics andwe're executing nicely, and I would expect that business to continue toaccelerate.  It's still a fraction ofwhat it should be. Ultimately, international ought to be closer to 15% of ourrevenues, maybe 20% over a longer period of time, and we'll be working hard andinvesting appropriately to do that.  AndI think when some of you comment on the SG&A, just to put it all inperspective, SG&A is up one-tenth of 1% over prior year. And we talk about20% to 21% year-to-date, it's 21.1%.  SoI don't think we should get all worked up about that as an issue.  But some of the incremental spending is goinginto those markets where we're getting a great, great return.

[Chris Agnew:]

And can you provide a growth rate the international businessis growing? And the operating profit, you're saying is full --?

[Andrew Cogan:]

It's our fastest growing category.  The operating margin in Europeis lower than our average operating margin by a couple of hundred basis points,and that's really a function -- they actually have above-average gross margins. But until they get a little bigger andnorth of $100 million, north of $110 million, they really won't leverage theSG&A that we have in each of the countries as efficiently as we leverageour SG&A here. And then, the international business is basically asprofitable as what we do here, because mostly it's an export-driven model atthis point and time.  Although, I imagineover the years, that will change as well.

[Chris Agnew:]

Okay.  And final questionis, is there -- can you comment to sort of order of progression that you sawthrough the quarters?  Is there anythingnotable?

[Andrew Cogan:]

No, there wasn't really anything notable.

[Chris Agnew:]

Okay, great.  Thankyou.

[Andrew Cogan:]

Thanks, Chris.

[Operator:]

Your next question comes from the line of Dan Oppenheim withBanc of America Securities.  Pleaseproceed.

[Dan Oppenheim:]

Great.  Thanks very much. I was wondering if you can talk aboutthe systems business in terms of the dollar growing faster than BIFMA.  If you think about this environment withpotentially slower growth and more cautious investment by businesses, do youthink that there is going to be more of a slowing in systems relative to othercategories?  How do you think about theconcentration in that now?

[Andrew Cogan:]

Well, I think that the fact is that systems has been growingslower than the industry this year.  Ithink if you look at the product line data, and I don't have that in front ofme, that's been going on this year.  AndI think systems through this whole cycle, hasn't rebounded to the extent wewould have hoped or expected at the beginning of the cycle. That said, I am so, so pleased that when you compare wherewe are today to where we were in 2000-2001, we are much less exposed to thatcategory.  I think as I said in mycomments, systems were 68% of our revenues back then, close to 70%.  Now, they're around 50%.  So, we've dramatically reduced our focus,again, on what I think can be a more volatile and at times, under-performingcategory. And so, I think we're in much, much better shape.  And, remember, that's also our lowest marginproduct category.  So, less exposure toyour lowest margin category and more revenue from your higher margin category,I think, is a very good thing that we're presently benefiting from. That said, I think we've got a great, great systems lineup.  We are just rolling out now Dividends Horizon,which, if the sales come in like the reaction has been, it's going to be a hugeaddition to our portfolio.  And then, ourproduct development pipeline has some really great work in the systems areathat we'll start to be talking about and sharing with people some time latenext year.  So, I think we're in reallygood shape.

[Dan Oppenheim:]

Great.  Thanks verymuch.  And then the second question, Iwas wondering about the Canadian dollar and manufacturing facilities and cost.  Is there anything more that you could do onthe cost side?  Are you looking toinitiatives?  Do you think about thelocation of your facilities given to the exchange ratio?

[Andrew Cogan:]

We're committed to manufacturing in Canada. It's our wood facility in Canada. The quality of what we produce there isextraordinarily high.  But that said,there are some things we do in Canadathat, as the dollar gets to the levels that now we may be able to do more costeffectively in other locations, and we're constantly looking at that. We closed, I think, a year and a half to two years ago, oneof our Canadian facilities and consolidated it into our existing footprint.  We still have two separate buildings in Canada. I'm sure there is consolidationopportunity there as we look at that.  Andwe're always pushing to look for opportunities to drive out cost regardless ofwhere a particular currency is or isn't.

[Dan Oppenheim:]

Great.  Thanks verymuch.

[Andrew Cogan:]

Thank you.

[Operator:]

Once again, ladies and gentlemen, if you wish to ask aquestion, please press "* 1" on your touchtone telephone. Your next question comes from the line of Todd Schwartzmanfrom Sidoti.  Please proceed.

[Todd Schwartzman -Sidoti:]

Good morning, gentlemen.

[Barry McCabe:]

Good morning.

[Todd Schwartzman -Sidoti:]

If there was no discernable order trends throughout thequarter for you guys, is it safe to say that your business was a littlesmoother than BIFMA?

[Barry McCabe:]

I'm not sure what you mean by smoother than BIFMA.  Are you talking about BIFMA on a sort of likea June, July, August, September, kind of up 13, up 9, then slowed in August?

[Todd Schwartzman -Sidoti:]

Yes, exactly.

[Andrew Cogan:]

Yes, probably.  And Ithink you've got to be really careful even with the data BIFMA reports.  I think if you look at everyone that'sreported and talked, you can't really find anyone whose numbers relate to theBIFMA data frankly.  So, we're all alittle -- we're not sure we really understand it or anyone really understandsit or that it's even that accurate right now.

[Barry McCabe:]

I think people put too much emphasis on one month of BIFMA.  And we tend to look over three months, fourmonths, five months for overall kind of trends.

[Todd Schwartzman -Sidoti:]

Got you.  Could youmaybe provide a little bit more color on your progress in getting share in theseating and storage categories?  You hadmentioned that the third quarter revenue contribution was 19% of the total.  What was that versus a year ago?

[Andrew Cogan:]

Let me see if I can tell you.  As I mentioned, at the beginning of thedecade, it was more like 12%.  You knowwhat?  I don't have that with me.  It's continuing to grow on a year-to-datebasis.  It's up nicely. We're doing acouple of things.  One is we continue toexpand the products we have.  So, we'velaunched some entry-level, price-point chairs. We enhanced that collectionpretty significantly, this NeoCon. In fact, here in the New Yorkshowroom, we're on our third day of training this week of bringing all ourdealer/sellers in and training them on our new Essentials chair, and the reactionhas been terrific, and it really compliments our work with Dividends Horizon. So, there has been expansion of products.  There are more models of that chair coming.  There is a side chair coming and some otherversions, and then we've got a great pipeline of future-seeing initiatives.  So, one element of it is product and expandingthe product line. The second element is we really do have a dedicated salesforce of seating specialists out there, and we've recently kind of given thosepeople a little bit more management focus. So, now, instead of having oneperson managing them across the country, we've got a team of three peoplegiving them even better day-to-day support and that's working nicely.  And those people are making sure that on everybid we're working on, we're putting our chairs in.  And where we don't win on the systems, we'restill in there competing on the chairs. And then, the third element is broadening our dealerdistribution and our dealers' focus on seating through programs like KnollEssentials, and that program is up double digits this year as well.  So, it's kind of a multi-tiered approach ofproduct, of training, and of expanded sales and distribution focus. And thereis a lot of basic stuff that seems to be working nicely there. And what I'm pleased about is we're starting to run atmeaningful numbers every month of seating.  And seating gross margins, in particular, areabove our average gross margins.  So,those also, as we drive more of those, we get some nice margin and mix benefitin our plants as well.

[Todd Schwartzman -Sidoti:]

And that will be a key reason why you're looking todiversify the business in that direction.

[Andrew Cogan:]

Yes, absolutely.  Imean, again, we were, I think-- everyone's worrying about our financialservices, everyone's worrying about our systems exposure, everyone's worryingabout the Canadian dollar.  Our systemsexposure is the lowest it's been in any time in the last 10 years.  Our financial services exposure is a verybroad-based dispersed exposure, not in any one category.  I mean clearly, mutual funds, we do a lot ofbusiness there.  Those people arethriving.  So I mean we've got a nicediversity there. And there are big projects in a variety of sectors there aswe go forward.  And, yes, the Canadiandollar is a headwind, but we've got lots of good things like continuousimprovement and efficiencies in the plans, price, reduced headwind frominflation that's offsetting all that.  So,I think, overall, we're doing just fine.

[Todd Schwartzman -Sidoti:]

Now, you didn't quantify, and I assume you're not going toquantify expected accretion from Edelman in 2008.  Correct?

[Andrew Cogan:]

Correct.

[Todd Schwartzman -Sidoti:]

Okay.  Can you speakto Q4 '07?  Are we looking at earningsneutral in a very rough sense?

[Andrew Cogan:]

For what?

[Todd Schwartzman -Sidoti:]

What should --?

[Andrew Cogan:]

Overall? For Edelman?

[Todd Schwartzman -Sidoti:]

For Edelman.

[Andrew Cogan:]

Listen, I think Edelman is going to be a very nicelyaccretive transaction.  I think in ourcomments we talk about actually, we expect some accretion from it in the fourthquarter.  We just closed the transactionearly in October.  The guys running itare terrifically talented.  We see somegreat synergies on the topline.  We see somegreat synergies on the cost line. It'll take us a quarter or two to get a great sense of therhythm of it and all that and I think be more fluent in terms of how weintegrate it into our guidance.  But Ithink we feel pretty good about what that's going to be and are really excitedabout the potential for that business.

[Todd Schwartzman -Sidoti:]

So, you do expect some bottomline contribution in Q4 '07?

[Andrew Cogan:]

We do.  Not huge, butyes, absolutely.

[Todd Schwartzman -Sidoti:]

Okay.

[Barry McCabe:]

Keep in mind that as we move into our specialties, for themost part, they're day-to-day kind of businesses, they're not similar to our systemsbusiness where you have backlog, significant, that will ship over weeks or overmonths. I mean, you're really talking about when you move into Edelman and ourother specialties, for the most part, a day-to-day kind of business.  And so, we're very optimistic as to what thateventually will mean for us in the future.

[Todd Schwartzman -Sidoti:]

Okay.  My finalquestion is does your fourth quarter EPS guidance assume the Canadian dollarstays roughly at par?

[Barry McCabe:]

Yes.

[Todd Schwartzman -Sidoti:]

Thanks.

[Andrew Cogan:]

Okay.  Well, thank youall for the time today.  We reallyappreciate the continued interest.  Andhopefully, Barry and I are going to be able to hit the road in October-Novemberand meet as many of you all desirousof meeting us.  Take care, everybody.

[Operator:]

Thank you for your participation in today's conference.  This concludes your presentation.  You may now disconnect, and have a good day.