Knoll, Inc.
Q3 2015 Earnings Call Transcript

Published: 21 Oct 2015

[Operator:]

Good morning, everyone and welcome to the Knoll, Inc. Third Quarter 2015 Conference Call. This call is being recorded. This call is also being webcast and presentation slides accompany the webcast. In addition, this call may offer statements that are forward-looking. These forward-looking statements are based largely on the company’s expectations and are subject to a number of risks and uncertainties, certain of which are beyond the company’s control. Actual results may differ materially from the forward-looking statements as a result of many factors, including the factors and risks identified and described in Knoll’s Annual Report on Form 10-K and its other filings with the Securities and Exchange Commission. The call today will also include references to non-GAAP financial measures. Reconciliations of these measures to the most comparable GAAP financial measures are included in the presentation slides that will accompany the webcast. Now, let me turn the call over to Andrew Cogan, the CEO of Knoll. Thank you.

[Andrew Cogan:]

Thank you, operator. Good morning everyone and thank you for joining us on our third quarter earnings call this morning. Craig and I are pleased to be joined this morning by Demetrio Apolloni, the president of Knoll Europe, who happens to be in town this week for our 2016 planning session. Demetrio and his team are having a record year. If you have any questions about our business over in Europe, I know that he would be happy to answer them. As you saw in the results we just reported, operating profits and margins expanded across each of our business segments. Overall we delivered the highest level of quarterly operating profits since 2008 and operating margin exceeded 11%. As you may recall, back in 2013 we commenced a series of actions and initiatives to deliver improved levels of profitability with the objective of generating 100 to 200 basis points of annual margin improvement. In 2014, adjusted operating margins grew by180 basis points to 8.2 %. We are on track this year to grow at the upper hand of our targeted range, delivering double digit operating margins for the full year. This improvement has been driven by and helped by a number of factors. First, the diversification and expansion of our participation in the high design, high margin residential market in our studio segment has helped change the overall mix of both our revenue and profits. The acquisition of Holly Hunt has been a homerun, coupled with organic growth and profit improvement in our studio residential business here and in Europe. In the third quarter studio segment margin exceeded 15% again. Both Holly Hunt and Knoll Europe delivered record margin and studio margins in North America expanded too. Second, the turnaround of the performance of our North America office business from the mix of clients to improved efficiencies within our plants and supply chain, coupled with the strengthening of the US dollar relative to the Canadian dollar, has helped drive margin improvement in our largest segment. Compared to a year ago, office margins grew by 190 basis points to just under 7%. Lastly, cost control and a refocusing on profitable relationships in our covering segment has driven profit growth and margin expansion here too, with margins reaching 22.5%, up just over 200 basis points. In total, each and every one of our segments is contributing to our double digit operating margin. On the top line, orders exceeded $300 million for the first time ever as better than BIFMA double digits orders growth in North America and strong organic orders growth in our studio segment more than made up for declining Middle East activity and the continued currency headwinds from the translation of European activity into US dollars. Particularly in North America, we’re seeing the larger projects that we’re booking continue to ship out on an extended basis, with deliveries in many cases taking place over several months. Its floor has become ready to handle new furniture installations. On a shipment basis, we’re basically flat on a constant currency basis. However, if we back out some non-recurring large Middle East projects and the discontinuation of a lower volume system line late last year, sales grew more like 2.5%. Year-to-date, reported shipment growth of 4.6% or 6.4% on a constant currency basis, continues to track favorably to the market and the quarterly variability reflects a lumpy project driven nature of our business. By segments, the results varied. Office sales declined 2.8% on a constant currency basis. Positive growth in both commercial and government shipments were not able to offset the aforementioned Middle East decline. Particular areas of strength included our Knoll dealer-driven Knoll Essentials program as well as investments to expand our contemporary storage seating and ergonomic table offerings. Clients are responding very well to our NeoCon introductions, with many of these products starting to ship as planned late this year and early next. Our pipeline of both client activity and new product design remains strong. Studio delivered upper single digit constant currency growth against the 3.8% results reported. Holly Hunt set a record for quarterly shipments and both KnollStudio and Knoll Europe grew on a constant currency basis. Our annual Knoll studio sale here in North America set records, both to our retail partners and our own direct to consumer channel. Covering shipments declined just under 4.9% as headwind from reduced low margin aviation and OEM customers offset strong double digit growth in KnollTextiles and [FilzFelt]. Overall, we are encouraged by the continued strong orders activity across the bulk of our businesses and expect to enter 2016 with a very robust backlog compared to where we began this year. Now let me turn over the call to Craig to walk you through our results in more detail. Craig?

[Craig Spray:]

Thank you, Andrew. Knoll Inc. third quarter sales decreased 1.8% on a year-over-year basis and 0.2% on a currency insurance basis. While sales decreased, operating profits and operating margins improved across all segments. Gross margin improved 300 basis points from 35.4% a year ago to 38.4%. Gross margin improvement was driven by improvements to business, as specialty segment sales outpaced the office segment, foreign exchange benefits, operational improvement and net price realization. Sequentially, gross margin improved 70 basis points. Total operating expenses in this quarter were $72.5 million. During the quarter, we made a decision to freeze all remaining defined benefit pension plans. This freeze eliminates the accrual of future benefits for all participants’ post 2015. Due to the timing of marketing and product development spend, as well as management and sales incentives accruals, we continue to believe that we’ll average about $75 million in operating expenses over the back half of 2015. During the third quarter, we closed the Holly Hunt showroom in Brazil that was opened prior to our acquisition. Knoll continuously monitors showroom locations to assess profitability and growth potential. As a result of this actions, a restructuring charge of $0.4 million was recorded in the studio segment. These charges relate to cash severance and employment termination expenses. We do not expect any additional charges related to this action Adjusted operating profit in the third quarter improved to $29.1 million or 11.1% compared with $23.4 million or 8.7% of the net sales in 2014. Operating profit for the office segment improved 190 basis points to 6.9%. Studio’s adjusted operating margin improved 310 basis points to 15.7%. Operating margin for the covering segment was up 210 basis points to 22.5%. Interest expense was down $0.3 million from a year ago. This is primarily due to lower rates and reduced balance in our term and revolving loan credit facility. Other income that’s primarily related to foreign exchange gains due to the de-evaluation of the Canadian dollar. For the quarter, other income was $1.8 million compared to $3.3 million a year ago. Our tax rates for the quarter was 38%, up from 36.9% at Q3 2014. The change in our tax rate was due to the mix of sales and the varying rates in the countries in which we operate. Net earnings for the third quarter of 2015 were $17.9, million up from $15.6 million for the same period of 2014. Diluted earnings per share were $0.37 for the quarter, up from $0.33 a year ago. Regarding our balance sheet and cash flows, cash and cash equivalents were flat for the quarter at approximately $10 million. Operating activities provided 30.7 million of cash in the quarter. We used the excess cash generated from operating activities to reduce our debt outstanding, invest in the business to pay dividends. Investing activities included capital expenditures in the quarter of $7.2 million compared to $14.3 million in Q3 2014. These expenditures are reflective of our continued commitment to invest in our manufacturing and information technology infrastructure. Total cash used by financing activities was $22.8 million. The primary use of cash in financing activities was the repayment of debt. Other financing outflows during the third quarter of 2015 included the payments of dividends for $5.7 million. Our balance sheet remains strong. In the quarter, a continued combination of increased EBITDA and further reductions in our outstanding debt, drove leverage below 2

[Operator:]

[Operator Instructions] The first question comes from the line of Budd Bugatch with Raymond James. Please proceed.

[Bobby Griffin:]

Good morning, Andrew and Craig. This is actually Bobby filling in for Budd. Thank you for taking my questions and congratulations on another excellent operational quarter. First Andrew, I was just wondering if you can maybe provide a little bit more color on what the Middle East big project comparisons look like as we move into the fourth quarter.

[Andrew Cogan:]

Sure. It looks like we had some -- last year we had a couple of very large Middle East projects that booked at the beginning of the year, shipped out around this time and then we had a few more that booked at this time and shipped out early in ‘15. Right now as I look at it, we still will have headwinds from our Middle East business in the fourth quarter. I don’t think they’ll be as extreme as they were in the third quarter, but I still think that will be a headwind in the fourth quarter of this year. As I look at our Middle East business overall, some of the larger projects that we were hoping to book and ship this year, now look like they’re getting pushed out into next year. And frankly I would say, just given some of the oil and energy trends over there, we’re not counting on that to be as robust a part of our business as maybe we were hoping it would have been a year or two ago. That said, what I’m very encouraged about is how strong both our North America commercial and government businesses are performing, where orders in those segments in the office business are growing double digits and more than twice the rate of the overall BIFMA market. While I do see some weakness in the Middle East and as we said the Middle East was I think in total 3% or 4% of our revenue in general last year, I see a lot of other things more than offsetting it. I think this quarter was probably the worst headwind that we’ll face and I think the other things will offset it more going forward.

[Bobby Griffin:]

Okay, I appreciate that color. That mid-single digits office growth for the full year that we’ve been talking about for the previous couple of quarters is still in line with your thoughts?

[Andrew Cogan:]

Our office business is growing orders double digits. As I did mention, there are some large projects in there which are going to ship out over an extended period. One in particular, which we booked this quarter, one of our largest projects of the year, is going to ship out over about 8 or 9 months and it will run through the middle of next year. Again from a shipment standpoint I still think there is going to be some lumpiness and lag, but what I’m encouraged about is from an incoming order standpoint, we’re competing well. We’re winning and we will have a record backlog as we end the year.

[Bobby Griffin:]

Good news. I appreciate that color. And then when you look -- another question with me. When you look at the studio segment, we see the strong improvement margin wise. Can you maybe help us understand exactly the buckets that are driving that? I know the Euro is a benefit there and that inventory turn is a little bit slower than some of the other inventories. Is that starting to have an impact on that segment?

[Andrew Cogan:]

Actually the Euro turn, that has a little bit more of an impact on the leather and the felt business. Really in the studio segment, I think it’s a couple of things. Firstly, every single one of the studio business is improving their profitability in a year over year basis. Studio in North America is up a couple of 100 basis points. There they are getting some FX benefits so I think that’s helpful there. On the Holly Hunt business, we’re really starting to get nice leverage on all the incremental investments that we’ve been making. There as the business ramps up, as you know we added a lot, 4 or 5 more showrooms since we bought the business. As those showrooms now start to become quite profitable and that business ramps up. We’re getting good leverage on the Holly Hunt side. I think that’s helpful and then in Europe and Demetrio is here, he’s really done a great job of driving the mix of the business and driving more high margin studio business and that’s how that segment comes together. Overall we’re also helped by price in that segment, as some of the price increases have stuck.

[Bobby Griffin:]

I appreciate the color and best of luck through the remaining part of the year.

[Operator:]

The next question comes from the line of Matt McCall with BB&T Capital Markets. Please proceed.

[Reuben Garner:]

Good morning everyone. This is actually Reuben in for Matt. Thanks for taking my question. I wanted to -- you talked about North American office your orders trending double digits. Last quarter, you mentioned marked up activity, suggesting accelerating growth and I wanted to see if you could give us your thoughts as we get into next year mid-single digits. Based on the environment this year what your thoughts are on the cycle as we head into ‘16.

[Andrew Cogan:]

I’m very pleased that mark ups continue to stay quite strong. I think we’ll have a good momentum going into the year. And again based on our forecasts, we should end the year with a very strong backlog, which will get us off to a good start next year. I still think this is a lower mid-single digit growth, 3% to 4% growth industry and whatever we do to grow faster and that is going to have to come from a series of initiatives to gain market share. What I’m particularly pleased about is we’re not doing that with price, but we’re doing that by really focusing on categories that we’re under shared in. When I look at the categories that are performing best for us and I see seating, I see adjustable tables, I see some of the more modern storage products we’ve been investing in. All those areas are driving significantly greater growth. And many of the things we’ve showed at Neocon are also in that general product direction, worked very well in a variety of more group and collaborative spaces, not only the individual part of the workstation. I think we’ve got a good pipeline and an exciting R&D pipeline of new designs that will allow us to continue to gain market share.

[Reuben Garner:]

That’s perfect. And then on the margin side, I know you’ve had this goal of 100 to 200 basis points of expansion this year obviously close to the higher end. As we start to look at next year, what are your initial thoughts and what maybe are some of the key drivers that would take you to the lower or the higher end of that range?

[Craig Spray:]

There are a couple of things going on there. Don’t forget we’ve had some pretty significant help on the FX side and depending on how sustainable that is, that will have an effect on our margins. But independent of that piece, our margins -- there are things that we control and things that we don’t and we’ve continued to improve those margins with some nice pricing actions and some ops efficiencies, et cetera. On the flipside of that, as we’ve continued to bring big orders in, those will tend to have a negative impact on our margins. It’ll bring us gross dollars through, but the percentage will change. It’s really over time you have to look at it more on a continuum I believe. Q to Q you’ll see some ups and downs as we go forward.

[Andrew Cogan:]

Our goal -- I would just add that our goals remains to generate 100 to 200 basis points of operating margin improvement a year. The last two years we’ve been closer to the upper end of that range. I think as we go into our planning for next year, we’re assuming more in the midpoint of that range. Maybe more like 100 basis points instead of 200 basis points, but I think it’s still very early and obviously we’re going to push as you’ve seen us do the last two years to help perform people’s expectations in that regard. I am heartened by the fact that FX has been a nice tailwind and we’re not counting on much incremental appreciation of the US dollar. On the flipside where our operational efficiencies, the way we’re running our plants, some of the initiatives we’ve taken there are really starting to show improvement. This was a -- this fourth quarter as we ramp up, last year we did not ramp up nearly as efficiently as I see us ramping up this year. So I think all those kinds of moves are going to only help drive margins higher sustainably over time.

[Reuben Garner:]

Okay. One quick follow up on that. What was the -- do you know the FX benefit on operating margin line for this full year and if you had -- say you had 200 basis points of margin extension, how much of that was FX driven?

[Andrew Cogan:]

I would guess it’s probably about a third of that increase.

[Reuben Garner:]

All right, perfect. Thanks for taking my questions.

[Operator:]

[Operator instructions]. The next question comes from the line of Kathryn Thompson of Thompson research group. Please proceed.

[Wenjun Xu:]

Good morning this is Wenjun sitting in for Kathryn. For the 300 basis point improvement in gross margin this quarter, we’re wondering how much did product mix, operational improvement and foreign exchange contribute each to this improvement? So last quarter you had indicated margin benefits by about 100 to 200 basis points from foreign exchange and we’re just wondering what’s the breakdown for this quarter.

[Andrew Cogan:]

Sure. We don’t break it down specifically by segment, but in general we had FX and price as probably the two biggest drivers and ops improvements would be the third, but there was a mix component and that mix component manifests in two ways. One, as our higher margin businesses grow faster than office, you get a nice mix impact. And then within the covering segment we had some nice mix as some of the sales that we didn’t get were lower margin and they were replaced with higher margin sales. I think the combinations of those five items are really what drives our margin improvement.

[Wenjun Xu:]

Could you break down a little bit more in details the 300 basis points this quarter?

[Andrew Cogan:]

We don’t break that down in a lot of detail, but again you think about price mix, FX and then ops improvement, I would say in that order.

[Wenjun Xu:]

Okay. All right, thank you so much.

[Operator:]

There are no further questions in queue at this time. I would like to turn the call back over to Andrew Cogan.

[Andrew Cogan:]

Thank you everyone for your continued interest in Knoll. We look forward to a strong end to the year and a good start to 2016 as we continue to execute the multi-year transformational effort of creating a high design, high margin design driven business. Thank you all and we’ll speak to you all in February. Take care everyone. Bye.

[Operator:]

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.