Knoll, Inc.
Q3 2014 Earnings Call Transcript

Published: 17 Oct 2014

[Operator:]

Good morning, everyone. And welcome to the Knoll, Inc Third Quarter 2014 Conference Call. This call is being recorded. This call is also being Webcast. Presentation slides accompany the Webcast. In addition, this call may offer statements that are forward-looking. 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 could 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 be 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 accompany the Webcast. Now, let me turn over to Andrew Cogan, the CEO of Knoll. Please proceed.

[Andrew Cogan:]

Good morning, everybody. I am pleased with the results we reported this morning, as we delivered better than industry growth and operating margin. The combinations of the continued turn of our North America Office business, double-digit organic growth, and the addition of our HOLLY HUNT acquisition are coming together to start to deliver the kind of performance we would expect. Overall, including HOLLY HUNT, sales were up 23.7%. On an organic basis, sales were still up a strong 10.1%, well above the BIFMA growth rate. Gross margin expanded 200 basis points compared to the prior year third quarter. Sequentially, the greater mix of office sales in the quarter modestly pressured gross margins, which is what we would expect as mix moves around. Operating profit were up 36% to $23.3 million and operating margins came in at 8.7%, up both sequentially and year-over-year. EPS was a strong $0.33, up 83% as we were helped by the appreciation of the US Dollar relative to the Canadian Dollar. An increase in the number of orders greater than $1 million as well as a very large international order, orders growth exceeded shipment growth. On a segment basis, I am particularly pleased with performance of our Office business. In fact, it was the best quarter of office sales operating profits, and operating margins since 2012. On the top line, office shipments grew double digits, at strong growth in new workplace models and office systems grew consistent with what we would expect to see with a greater number of larger projects. In terms of verticals, financial services, media and international were the strongest performers offset by modest declines in government and energy. Year-to-date, government shipments are running at 11% of sales versus 13% a year ago. On the bottom line, office operating margins were 5%, up 120 basis points over prior year and 100 basis points sequentially. We still have a lot work to do to achieve our upper single digit margin objective in this segment, but the pieces continue to fall into place to do just that. As we wrap up 2014, the pool of business, mockups, client visits, and requested rendering are all up versus prior year. Interest in our recent NeoCon introductions, specifically as it relates to our adjustable table and bench offerings is strong, and our best of NeoCon Gold award-winning Remix chair is on track to begin shipping in the first quarter of 2015. Studio had another strong quarter of growth in sales and profit as each piece in our strategy here is working well. Overall, segment sales almost doubled, and excluding the HOLLY HUNT acquisition, we still grew a strong 13.3%. Growth in this segment was led by Knoll Europe as both our residential and contract business grew double digits. On a country basis, our two largest geographies, France and the UK, both performed well. While the appreciation of the US Dollar relative to the EURO will have a modest negative impact on our reported European results on an overall Knoll, Inc. basis, it is a meaningful help as we purchase more KnollStudio and Coverings material in EUROS than we sell our earn in that currency. In North America, KnollStudio sales also grew double digits as we experienced growth across both our consumer and contract channel. On the consumer side, traffic and commerce direct to Knoll continued to grow nicely, and our conversion rate continue to improve. Our outside dealer partners also had a strong annual sale in September. And on the contract side, we benefited from the increase in large project activity in size. Heading into 2015, we have a robust collection of meaningful new product launches which should fuel another leg up in sales. HOLLY HUNT continues to perform above expectations with double digit top line growth in operating margins. This quarter, we opened a beautiful new 13,000 square feet Dallas showroom and continued building out new spaces in London and Washington DC which will come online in the fourth quarter. What I am learning to appreciate even more about HOLLY HUNT is its unique ability to provide decorators and designers with a one stop shop capability to furnish a residence with furniture, textile, leathers, lighting, rugs, and art accessories at a level of design that is unmatched in the industry. We look forward to building on this competitive advantage in the years ahead. In our Covering segment, growth was pretty much in line with overall industry trend as above average growth in our leathers and felt businesses offset lower sales in textiles as we lapped two particularly large projects in that business last year. Operating margins remained above 20%. In the quarter, we went live at KnollTextiles with the first deployment of our ONEKnoll ERP system. I am pleased to report that during this implementation, we continued to booking ship textiles. As a test for a series of larger implementation and the rest of the business over the next two years, this was an encouraging start. Overall, looking ahead into 2015, constructive contract and residential trend, demand trends and drivers, the strengthening of the US Dollar relative to the CAD and the EURO and the completion of our laminate transformation in East Greenville should allow us to continue to make progress towards our double digit margin goals. Now let me turn over the call to Craig to walk you through our results in more detail. Craig?

[Craig Spray:]

Thank you, Andrew. Third quarter sales increased 23.7% when compared to a year-ago. This quarter marked the third quarter in a row that we experienced increased sales across all of our reported business segments. Organically, sales increased 10.1% from a year-ago and were driven mainly by increased shipments in the Office segment and stronger activity both in Europe and North America in the Studio segment. Our Office segment sales increased 10.8% as commercial sales improved on a year-over-year basis, while sales for the federal government marginally declined. This quarter was the first quarter of double digit growth in the Office segment since 2012. Organically, Studio segment sales were up 13.3% with sales increasing in North America and Europe. Including HOLLY HUNT, sales in the Studio segment were up 92%. Coverings sales grew 2.1% during the quarter. Gross profit as a percentage of sales increased 200 basis points to 35.4%. This improvement was primarily driven by richer mix of business due to the addition of HOLLY HUNT. This improvement was partially offset by a higher mix of large projects in our Office segment. During the quarter, operating expenses were $71.7 million, or $16.4 million higher than a year-ago. The increase in operating expenses during the third quarter of 2014 was primarily due to the addition of operating expenses from HOLLY HUNT and addition of commission and incentive compensation accruals incurred as a result of higher sales and profits. Sequentially, when compared with the second quarter of 2014, operating expenses were down $3.4 million. This is mainly due to timing of industry trade shows in North America and Europe in the second quarter of 2014. Knoll, Inc.’s operating profit margin increased 80 basis points this quarter when compared to prior year as a result of leverage of fixed costs on the higher sales and the addition of HOLLY HUNT. Operating margins in office improved to 120 basis points to 5% when compared to the prior year. Studio operating margin was 12.6% and the Coverings segment was 20.1%. These margins are consistent with their expectations for where we should be at this point in a multiyear program. Interest expense was approximately $1.9 million, $0.4 million higher than a year-ago, primarily due to the higher outstanding debt as a result of the purchase of HOLLY HUNT in the first quarter of 2014. We are able to further reduce our outstanding debt this quarter by $5.9 million, bringing our leverage ratio to 2.73

[Operator:]

(Operator Instructions) Your first question comes from the line of Budd Bugatch from Raymond James. Please proceed.

[Budd Bugatch:]

Hi, Andrew. Good morning, Craig. And congratulations on the sales and the earnings beat. Question, I've got a couple of questions. One, the contribution margin in office even with the nice performance, looks a little bit lower than what we were thinking and perhaps little bit lower than maybe you were thinking, are there any specific expenses or items in there that might have depressed it and that won't continue or that will continue?

[Andrew Cogan:]

Budd, I think as we said before, the Office business is a business in transition, and the goal this year is to move from 2%, 2.5% to 4% to 5% and next year 6% to 7%. I feel we are very much on that -- and then 8% to 10%. And I very much feel like we are on that trajectory here. And so, I am encouraged by where it's headed. Specifically in the quarter, we did have a larger mix of -- a greater mix of larger projects, and so that had some negative price ramifications. And so, that's somewhat depressed margins. But other than that, I think the Office business generally is trending in the right direction as you have more large projects that tends to kind of pull the margin down a little bit from a price standpoint.

[Budd Bugatch:]

Okay, that's helpful. Secondly, the Covering segment, though I am just curious as to where that is in your -- versus your expectations? We've put some more feet on the street over the last two years, and we've done some, a lot more SKU implementation there. So I am curious as to how it is performing versus your expectations?

[Andrew Cogan:]

I think the leather and felt businesses are performing better than our expectations, and our initiatives have really worked there. The textiles is also a little bit more of kind of wait and sees here. We haven't gotten as much growth there as we would have liked originally to get. And we will -- we are making some tweaks and adjustments to our strategy and approach there, but two thirds of it is working better than expectations, and one third I would say a little bit below.

[Budd Bugatch:]

Okay. And finally from the -- congratulations on getting some of the debt down, what's the plan on the balance sheet? How do you plan to use cash in the future?

[Craig Spray:]

Well, we continue with the same trend that we've communicated in the past. We will continue to pay down debt, and we'll continue to invest organically and we always are disciplined in any acquisition discussions. So, I think that's still the intent as we move forward.

[Budd Bugatch:]

Okay. And if I could sneak one more in. We had a little bit of a tailwind or we had a nice tailwind from I think currency with the weaker Canadian Dollar. Just remind us how that goes through the financial statements, that’s mostly through cost of goods or is there an impact elsewhere as well?

[Craig Spray:]

So, there are two places where you see that, Budd. First, it does run through our COGS on the operating side as we have one of our factories in Canada. So, with the translation on the daily FX rate, we do see benefit from that running to our cost of goods sold. The other benefit we see is we have a receivable with Canada as well, and as we revalue that at the end of the quarter with that spot rate, we see some benefit to that secondarily below the COGS line. So that's in other income line.

[Budd Bugatch:]

That asset revaluation doesn't go through comprehensive, that's what I was a little confused about.

[Craig Spray:]

So that goes through the other income line below the operating profit.

[Budd Bugatch:]

Okay. Not through comprehensive income.

[Craig Spray:]

Right.

[Budd Bugatch:]

Okay, thank you very much.

[Andrew Cogan:]

The other thing, Budd, I would just add to point out there is -- we benefit at Knoll from a stronger US Dollar, so both relative to the EURO and relative to the Canadian Dollar, that will be quite supportive of gross margins going forward if it stays at these levels relative to where it has been over the average course of the year.

[Operator:]

Your next question comes from the line of Todd Schwartzman from Sidoti & Company. Please proceed

[Todd Schwartzman:]

Hi, Andrew. Hi, Craig. I wanted to just ask about the order rates, if you could maybe quantify within the Office segment, the North American order rates both overall for the segment and maybe ex-government if you could?

[Andrew Cogan:]

What would I say here is the government business looks like it's going to be pretty flat for the year. So again that's very much in line with our expectations. I think where we are doing very well and orders as I mentioned in the call grew nicely -- at a nice rate greater than the rate that shipments grew. And so, we’ve built a nice backlog in the Office business. A lot of that was driven by some real success on the international side of things, and that's where we've seen some real upside performance this year above our expectations.

[Todd Schwartzman:]

So just on the commercial side, ex the government, you will be looking at a low teens kind of order growth?

[Andrew Cogan:]

I think we don't get into quantifying that, but they grew faster than shipments grew and we gained that --

[Todd Schwartzman:]

Understood. On the OpEx, I know you kind of called out the sequential decline due to the timing of trade shows in the second quarter. Just wanted to get a feel maybe if you could kind of quantify what a normalized quarter moving forward with HOLLY HUNT now kind of full quarter plus of ownership under your belt, how should we think about modeling SG&A?

[Andrew Cogan:]

We have been using something in the $75 million range a quarter, it can be higher, and it can be lower, but I don't think that's a crazy number to be using.

[Todd Schwartzman:]

Okay, that helps. Lastly, what can you say about leather costs, both what you are seeing now for Q3 and also your outlook moving forward?

[Andrew Cogan:]

Well, I mean the best thing I can comment on is that they are mostly EURO denominated, so to the extent that the dollar continues to appreciate against the EURO, I would expect those costs to come down. There is some rawhide elements that move around, but FX is the single biggest driver of our leather costs.

[Todd Schwartzman:]

Overall in the marketplace, the price, the leather pricing versus a year ago, would you say that has more or less stabilized?

[Andrew Cogan:]

I am not seeing anything dramatic there. I mean that's how it would be again; a stronger dollar relative to euro continues to improve our gross margins on the leather side of the business and felt.

[Operator:]

Your next question comes from the line of Josh Borstein from Longbow Research. Please proceed, sir.

[Josh Borstein:]

Hi, Andrew and Craig. Congrats on a nice quarter there. A question for you, Andrew. You had mentioned in the press release that office is being driven by new workplace models and office systems. Can you give us a sense, any metric, whether it's over a year or two years, the percentage change in say core systems versus the percentage change in products that would be used for these collaborative, in-between spaces that define the newer office?

[Andrew Cogan:]

One of the nice things going on is that we are seeing growth at both end of the spectrum. So our core dividend, work station which is where we've done some really nice design work and enhancing what you get in a more traditional work station, that has been growing very nicely. And new work place models like Antenna which are much more about more progressive, collaborative environments are also growing very strongly. So we are doing well at both spectrum-- into the spectrum. And I will also comment that every single one of our major system lines say both dividends, our wood systems are new work place model, all of those are growing right now.

[Josh Borstein:]

Okay, great. Thank you for that. And sticking with office, can you discuss a little bit about the trends in the quarter, how they played out, if you saw any greater momentum exiting the quarter?

[Andrew Cogan:]

I think it was pretty much straight across the quarter.

[Josh Borstein:]

And October seems to be playing out similarly?

[Andrew Cogan:]

I don't get into the weekly noise of what goes on this business. And you always have large projects that move things around, but we were very pleased with how office ended the third with the backlog we have going into both the fourth and into the beginning of next year.

[Josh Borstein:]

And then, I know you have particular strengths along the coasts. Are you seeing any differences? My sense is the west coast has been a lot weaker and the east coast has been pretty robust. Is that the case?

[Andrew Cogan:]

No. I think we are doing quite well on the west coast and quite well on the east coast.

[Josh Borstein:]

Great. And Just on Europe, another nice performance there. It's a bit contrary to what all the things we have been reading about in the news lately. What are you seeing in Europe? What is your outlook there and have you seen any slowdown at all with all the news that we've been reading about?

[Andrew Cogan:]

No. We haven't. Again, we are really small in Europe. Half the business is more residential, half the business is office related, on the office related side, UK and France are our two largest market. And both those are performing well. The residential business is a little more spread out across Europe. But in general, we've seen very positive demand trend continue, but remember we are small and I am not sure barometer of Europe.

[Josh Borstein:]

Okay, and last, you had mentioned you are opening a HOLLY HUNT storefront in London. Do you have any other overseas exposures with HOLLY HUNT?

[Andrew Cogan:]

We have a small showroom in Sao Paulo

[Josh Borstein:]

Okay. And any plans on expanding internationally with HOLLY HUNT?

[Andrew Cogan:]

Well, we are going to see how London does. It's a really beautiful space in a great location. It will open in November I believe. And let's see how it goes. It gives us the footprint to Europe. I think it should be value well received and I view it as an exciting test.

[Operator:]

(Operator Instructions) Your next question comes from the line of Matt McCall from BB&T. Please proceed.

[Matt McCall:]

Thanks, good morning, guys. So, Andrew, on the contract front, maybe gives us an idea of your expectations as we move toward 2015. Your comps are going to get a lot more difficult, but it seems like your trends are getting better. How are you thinking about 2015 for office at this point?

[Andrew Cogan:]

Right now I think we are just taking the kind of BIFMA mid single digit growth and using that as kind of baseline from which to plan from.

[Matt McCall:]

And you talked about --

[Andrew Cogan:]

And that just said--yes, Matt, I would just add that's consistent with kind of pool of business data we are seeing with improvements in ABI and some recent signs of life in BIFMA data. I think it's consistent with all that.

[Matt McCall:]

Okay, that's fine. You talked about the trajectory of getting your margins from 2.5% to 8% to 10% over the next few years. Can you talk about the components of getting there and how much of it is some of the growth spending ending? How much of it is the return from some of that growth spending? How much of it is volume? Just the different components of how we think about what's within your control and what's kind of based on market trends?

[Craig Spray:]

Yes. I'll speak of that. So we have really kind of a balance view of that. One, there is growth that we are assuming as we get there. And then we continue to move down this path of our supply chain transformation, which we expect to continue to improve our bottom line and efficiency. And I think between the two of those that's the lion share of what you are going to see on the expansion.

[Matt McCall:]

And what was -- did you say what the growth rate was that you are assuming?

[Andrew Cogan:]

Matt, again, I think we are talking about kind of mid single digit growth rate. I think the opportunity for office is to as Budd brought up really continue to improve the contribution margin on the growth we are getting. So right now we are on low 20s, we like to see that more in the 30s. And so I think as we get continued growth and we couple that with the investments we're making on as an example in this whole laminate transformation which is really will be fully operational in the fourth quarter. We've really got no benefit from that whatsoever. That's a good example of investment or our supply chain and our own manufacturing capability that will start to help the contribution margin going forward. So to me it is kind of the interplay of both those elements that should come together to get us to those next year the 6% kind of consistent operating margins in that business. And as we layering more supply chain transformation and other work we are doing across the cost structure in the office business, get us close to the 7% to 8% by time we are into 2016.

[Matt McCall:]

Okay, that's helpful. Thank you, Andrew. Then the final one, taking a look at the Studio business, really two parts to this. New HOLLY HUNT stores, obviously some good growth there, and then it's helpful to margins as you see growth in that part of the business. What is the assumption or what are some of the components of growth that we need to keep in mind when it comes to studio? And then, when you think about the targeted margins for that business that gets you to your double digits overall, how would you have us think about that relative to what you have been putting up in recent quarters?

[Andrew Cogan:]

Well, the formulated double digit margin is really depended on the office business because right now with coverings at 20%, studio around 12%, that really where we think those business will be operating. So I wouldn't look for any big margin changes there, really the leveraging again office is 75% -- it is a big part of the -- 65%-70% of the business. That's where we are looking for the op -- both growth and operating margin improvement in 2015 and 2016. Above and beyond what they have delivered nicely in 2014. So that's how I would look at that. I wouldn't expect the margins in studio and coverings change dramatically. In terms of studio, in terms of the growth, I think there is a fair amount of work on with HOLLY HUNT, and in terms of expanding points of distribution. So we've made that a conscious focus, that investment continues to ramp up. And in 2015, will enter the year with four more points than we had entering 2014. And so I think that's meaningful investment there. And then we are broadening the capability both operationally and within each of the HOLLY HUNT product category. So it's a pretty broad based growth strategy and series of investments there. In studio in North America, we've done a really nice job of diversifying our distribution both contract and residential. So we have two nice channels to go. I would think next year we have a very strong series of product introductions on the contract side of the studio business which is very exciting. And I think will give us another leg up in that piece. And then we would expect continued growth in Europe, probably little bit more driven on the residential side and the contract side. So there is a multi prong growth strategy across each of the studio businesses. But I wouldn't expect them to yield a dramatically different operating margin than we are running today.

[Matt McCall:]

But if we try to ballpark the targeted growth over that forecast period, putting all that together, what are we going to be looking at in studio?

[Andrew Cogan:]

I don't have our multiyear studio numbers in front of me. But again, take your BIFMA as a starting point and I would say we would hope to do nicely better than that in studio in particular.

[Operator:]

I would now like to turn over to Andrew for closing remarks. Please proceed.

[Andrew Cogan:]

Great. Well, thank you, everybody for joining us this morning. And we look forward to a nice end to 2014 and continuing on the trajectory of year-over-year margin improvements which we are now getting in the rhythm of delivering. So we will speak to you in the New Year everybody. Thank you.

[Operator:]

Ladies and gentlemen, that concludes your call. Thank you for participating. You may now disconnect. And have a great day.