Knoll, Inc.
Q1 2013 Earnings Call Transcript

Published: 18 Apr 2013

[Operator:]

Good morning, everyone and welcome to the Knoll, Inc. First Quarter 2013 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 also include references to non-GAAP financial measures. Of these measures, the most comparable GAAP financial measures are included in the presentation slides that accompany the webcast. Now, let me turn it over to Andrew Cogan, the CEO of Knoll.

[Andrew B. Cogan:]

Thank you. Good morning everybody. As expected, our first quarter results showed low single-digit revenue growth, which when combined with our stepped up strategic investments resulted in lower levels of profitability. Strong growth in our Studio segment driven by our consumer business in North America and Europe was in part offset by a slight decline in our Office and Covering segments. Gross margins fell by 40 basis points as price erosion offset favorable foreign exchange and continuous improvement progress in Office. The operating expense increase of almost $6 million was spot on with our expectations as we kept to our planned program of incremental investments designed to achieve our longer-term revenue and margin objectives. The combination of these factors drove an operating margin of 5.1% and EPS of $0.13. From a segment standpoint, the Office business strong double-digit growth in seating and our Knoll Essentials dealer day-to-day activity could not overcome a mid single-digit decline in system sales. The systems decline was primarily driven by an over 20% decline in government shipments offset by high single-digit increase in commercial shipments. In general, overall activity remained good and the bulk of our leading indicators after bottoming in December showed nice improvement through the quarter and ended up above our 12-month running average. However, we continue to believe that the bulk of the larger commercial project activity won’t really impact our shipments until the back half of 2013 and well into 2014. In addition, the combination of the sequester and continuing resolutions means that we are looking at significant and ongoing declines in our government sales for the balance of the year. Q2 was a strong government quarter last year and this poses a particularly acute short-term challenge. A major focus of ours in the front end of the Office side has been to drive investments to increase our penetration of larger commercial accounts while simultaneously driving more day-to-day dealer sales. To these ends in Q1, we completed staffing up both our global business team and our Essentials sales team, and those teams are now actively engaged with clients. We already seeing positive trends on the Essentials side, but of course the GBD effort will take longer to impact our results. Our supply chain team continues to do excellent work on the supply chain transformation, and the first phase of our wood modernization effort is nearing completion. Initial signs are suggesting we will see dramatic gains in productivity and reductions in costs in our woodshop is the full program its completed later this year. Spending will continue to ramp up sequentially in Q2, as we complete our move into our new flagship showroom and office space at 1330 Avenue of the Americas in New York City later this month, and then prepare of a NeoCon in June. Our Studio segment got off to a fast start in 2013 with double-digit growth in North America and mid single-digit growth in Europe. On the North America side, we benefit from very strong sales growth in our consumer channel, as well as from the addition of the Schultz collection for the full quarter. In the quarter, we made continued progress on our Web launch and flagship retail store, and both these will open in Q2. In addition, we will launch our Modern Always print and online campaign this quarter. We think this broad-based campaign will help generate awareness and traction around our new points of distribution and our 75th anniversary. In Europe, conditions continue to be challenging particularly on the corporate side of our business, and we do not expect to generate growth again in Q2. Last week I had the chance to be with our European team, as we fundamentally relaunched Knoll in Europe. What do I say relaunch, well for the first time in eight years, we actively participated in Salone del Mobile in Milan. This is the premier global design show for high design residential companies, and thanks to a brilliant booth designed by Rem Koolhaas and the team from OMA. We made an enormous splash and demonstrate to our dealer partners in Europe the seriousness of our commitment. Unlike NeoCon, this is a show where you write orders for dealer inventory and displays and we were very excited with the level of dealer participation. In addition to participating in Salone, we had a special preview of our 75th anniversary work with Rem Koolhaas titled Tools for Life. This powerful exhibit in partnership with Prada was featured on the cover of Interni Magazine and a numerous online and print publications, from Cool Hunting to the international Herald Tribune. It was the highlight of the week and again supported our brands commitment to innovative modern design. Of course all this spending will be incremental as well to our Q1 run rate. Lastly, on the Coverings side, growth in textiles and felt could not offset declines in our leather businesses, as we face headwinds from lower demand from many of our contract furniture partners. Importantly, from a strategy direction, we filled out the balance of our textile sales team in the quarter with a not insignificant increase in people and we opened our second residential showroom, this one in LA. From increases in both the number of orders and the request for samples, I see incipient signs that this business is going to be very well positioned as these new reps get up to speed and our ongoing stream of new product introductions continues. Collectively that we remain confident that all these initiatives across Knoll will in the years ahead, help us maximize our Office segment profitability, target under-penetrated and emerging categories for growth and expand our reach into consumer and decorator channels around the world as we continue to invest in the Knoll brand. Before I turn the call over to Barry, I wanted to share some other news with you. After 22 years of service, Barry has indicated his desire to retire from Knoll. Barry has been a phenomenal partner for me, a great resource for all of you and a trusted colleague and respected adviser to all of us at Knoll. We will miss Barry’s leadership, advice and good humor. Barry has assured me that he will work with us to facilitate a smooth transition, and I’m grateful for that in all his years of service. We’ve retained the firm of Crist/Kolder to lead a comprehensive search for our next CFO, and I view this is an opportunity to continue to build and invigorate our leadership team. Now let me turn the call over to Barry.

[Barry L. McCabe:]

Thank you, Andrew for the kind words, and thank you for the leadership and support you have provided me over the years. Since this is going to be a transition without a specific date in mind, I look forward to continue to work with everyone within the company and also the people on this call. First quarter sales increased 2% above a year ago as discussed previously by Andrew. We still see the first half of this year as a challenge with continued government spending headwinds and challenging business conditions in Europe. Business activity has improved from the fourth quarter as reflected in presentations, client visits and mock up activities, as well as the overall poor business we are tracking. The continued improvement in ABI is consistent with the activity we are seeing. The question is, with a flattish start to 2013 how much of this increased activity will manifest itself in the second half of this year or is it more of a 2014 benefit. I don’t believe it’s a question of will business get better, but a question of when. Gross profit as a percent of sales decreased 40 basis points from a year ago, primarily as a result of pricing pressure in the Office segment due to the flattish environment. Inflation has not been a factor and our factory operations are realizing continuous improvements through efficiencies and better planning. The benefits associated with our glide path initiatives, factory modernizations, process improvements et cetera will not begin to kick in until later in this year and next. Operating expenses were $5.7 million higher than a year ago in support of our long-term strategic objective of higher sales and operating margins. Spending will continue to increase in the second quarter. As we move into our new showroom and offices in New York, complete and open our website, participate in both European and NeoCon design and furniture shows and continue adding sellers and new product additions and enhancements. Operating profit was 5.1% as a result of the flattish sales, some price erosion and the increased spending and support of our growth initiatives. We would expect our operating margins to remain challenged until industry conditions improve or until our strategic investments and initiatives begin delivering results in 2014 and 2015. Interest expense was approximately $1.5 million, the same as a year ago. Other income was favorable compared to a year ago due to foreign exchange gains related primarily to the Canadian dollar. Our tax rate for the quarter was 39.8% due to the varying rates and mix of earnings in the countries we operate. Earnings per share was $0.13 for the quarter. In the quarter, in spite of the increased spending and flattish sales, we held our outstanding debt to a $193 million. Our net leverage ratio as calculated under our bank agreement is 1.83 to 1. We are comfortably in compliance with our bank covenants and at quarter end had $12.7 million of cash. Capital expenditures were approximately $6.6 million for the quarter higher than a year ago, as we complete work on our new offices and showrooms and modernize our factories. Andrew?

[Andrew B. Cogan:]

We’ll now open up the call to questions. Operator?

[Operator:]

Thank you. (Operator Instructions) Your first question comes from the line of Budd Bugatch, Raymond James.

[Beryl Bugatch:]

Good morning, Andrew. Good morning, Barry. Barry, best of luck and I hope it takes some time to find your successor.

[Barry L. McCabe:]

Well, thank you Budd.

[Beryl Bugatch:]

Because we like working with you. Let me ask a couple of questions, if I could. Andrew, can you give us an example of the price erosion you talked about in the gross profit section of the release?

[Andrew B. Cogan:]

Yes, I don’t think it was very significant. There were some minor price erosion probably a little bit greater discounting, but nothing I would say it’s that significant.

[Beryl Bugatch:]

So, it’s discounting on projects, on bids, or is a discounting on…

[Andrew B. Cogan:]

Yes, it was Budd we had a fairly large number of – orders ship in the first quarter versus the first quarter of last year. And so I think that primarily is what drove a little bit of price erosion from a discounting standpoint.

[Beryl Bugatch:]

And primarily in Office?

[Andrew B. Cogan:]

Extremely favorable pricing in the first quarter of last year, so it’s little bit less of a run rate issue from where we ended the year pricing-wise, and more I think a year-over-year comp issue, Budd.

[Beryl Bugatch:]

Okay. Also, can you talk a little bit about the greater revenue headwinds on the government side? Is that just primarily due to sequester or are there other things going on?

[Andrew B. Cogan:]

I think it’s a combination of sequester and continuing resolution in terms of the government’s ability and agencies ability to initiate new projects and new work while that continuing resolution is funding the government. So I think it’s the combination of both of those factors. It’s the completion of all the BRAC work and the tail of that, which now is done. So I think it’s a variety of factors. I think in the first quarter, government was down we talked about over 20%. I think, unfortunately, as we look at the second quarter that rate could increase significantly, and we could see government down north of 35%, 45% from prior year. So that gives us an incremental headwind really in the second quarter, which was a pretty good government quarter last year, and I think, overall the government business could be down by more like a third for the full year, and we may be were a little more optimistic at the start of the year that some of that decline would dissipate as we went through the year.

[Beryl Bugatch:]

And last year in the second quarter, what were government revenues?

[Andrew B. Cogan:]

I don’t have them off the top of my head, but it was a pretty good government quarter. We did – I think last year on the government we did about a $150 million or something like that. So I you know you can…

[Beryl Bugatch:]

And was it seasonally highest in the second?

[Andrew B. Cogan:]

I don’t think it was seasonally highest, but it was certainly stronger on the first half of the year than the back half of the year.

[Beryl Bugatch:]

Okay. And Studio margins were a bit lower than kind of we’ve expected. What’s driving those down?

[Andrew B. Cogan:]

Yes, remember, Studio includes Studio in North America and then all of our European business. And we’ve really stepped up the investment in Knoll Europe. So there was about a million and million and a half of incremental investment in the first quarter, as we went through this leadership change with a new President over there and we had overlap with the existing President. So we had some double comps there. We started to ramp up the team particularly on the Studio residential side with some new sales leadership, and we began the investment in a lot of the marketing tools and programs that we then presented in April at Salone. So I think for the next two quarters or for the first quarter and now going into the second, you will see lower Studio margin very much of function of that incremental investment, particularly acute in Europe, but also here in studio in North America as we open the retail store and launch the Web effort.

[Beryl Bugatch:]

So, of the $6.1 million of spending as you say a $1 million to a $1.5 million is in Studio? Can you parse the other pieces of that?

[Andrew B. Cogan:]

Yes, in general of the $6 million increase, I’d say about $3 million or $4 million was in the office part of the business, and I’d say $2 million or $3 million were in the specialty parts of the business.

[Beryl Bugatch:]

All right. Thank you very much. Good luck on the second quarter and the rest of the year.

[Andrew B. Cogan:]

Okay. Thanks Budd.

[Operator:]

Thank you. Our next question comes from the line of Todd Schwartzman, Sidoti & Co. Please proceed.

[Todd Schwartzman:]

Hi. Good morning, guys. Barry, lots of luck, congratulations to you.

[Barry L. McCabe:]

Okay. Thank you.

[Todd Schwartzman:]

I think Budd really nailed everything I had in my mind, but one thing regarding your previously stated goals by 2015 of $1 billion in revenue and 12% operating margin, in light of the current environment, are you making any changes to those longer-term goals?

[Andrew B. Cogan:]

No, I think that’s still where we want to be. I mean the challenge is going to be – this will be another big year of government decline. We may end the year at a point where the government business then for us is going to be basically 50% state and local, 50% federal. I really believe at that point, we’re probably at a bottom. I was hopeful may be that bottom would be a little higher up, but I think we do kind of hopefully hit that bottom by the end of this year. So, incrementally may be there is another $20 million to $30 million, $40 million of incremental business we have to offset, but I think if we get a strong rebound as [Disston] was talking about next year and everything that I think we’ll be levered to accelerate on the commercial side. We’re making some very strong investments in terms of expanding our sales and marketing capabilities, I talked about our global business division, which is not only targeting global accounts, but competitively held accounts, and we’re seeing some really good signs of progress and engagement there with clients. We haven’t done any business within the past that are taking a fresh look at Knoll. It’s probably one of the strongest group of sales leaders we’ve accumulated in the Company in that part of the business ever. Recently, just two weeks ago, we participate for the first time ever and for a very large financial institution in a mockup that took place on four continents literally within the same week. And so those capabilities are things we’ve really didn’t have the ability to do a couple of years ago. Now, we have the team and the leadership place to do that. So I’m very encouraged that if we just break one, two, three of those kind of large opportunities, we can easily offset the incremental decline in government business.

[Todd Schwartzman:]

On the commercial side, are there any verticals that you would want to call out – good, bad, indifferent?

[Andrew B. Cogan:]

No, I think in general I mean we had growth in financial services, healthcare, energy, consumer, retail. So I’d say it was pretty much, pretty good across the board.

[Todd Schwartzman:]

Does it seem to you now, Andrew that we might have to get to Q2 of next year of 2014, before we see stabilization on the government side?

[Andrew B. Cogan:]

I think that’s possible Todd. I mean I would hope that by the time we’re over 2013 that we’re through the worst of this in kind of the run rates that we saw earlier on the first quarter kind of all are the run rates we now assuming for the rest of the year and then that’s the basis where we’re talking at 30%, 40% annual decline in government sales.

[Todd Schwartzman:]

Okay. And just looking at the gross margin you just reported for the first quarter. I’m not sure what the dollar effect was of pricing, but with seating outperforming the systems category. Was the gross margin about in line with what you would have expected, if you would known that product mix going in?

[Andrew B. Cogan:]

Yes, absolutely.

[Todd Schwartzman:]

Okay. Thanks a lot.

[Andrew B. Cogan:]

Thanks Todd.

[Operator:]

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

[Josh Borstein:]

Hi, Andrew; hi, Barry. Thanks for taking my questions. Just to touch again on the seating, you mentioned double-digit growth. Could you discuss what accounted for that? Was it due to the sale of a particular chair, or was it more broad-based than that?

[Andrew B. Cogan:]

I think our generation family continues to lead our senior portfolio, and we’re seeing very strong acceptance of generation, frankly of the ergonomic principles behind generation of the idea that you can sit how you want, which was a kind of a bit of a heresy when we introduced it. And now, as I look at what others are doing in the market, I’d certainly see people trying to offer seating that is more flexible and allows people to, in essence sit how they want and sit in a variety of postures that reflect how people are working with technology tools today. So I think we’re – we’ve established a really nice leadership position with Generation, and then build onto that with ReGeneration and MultiGeneration and more good stuff in the pipeline.

[Josh Borstein:]

Okay, great. And do you expect that positive mix to continue in the 2Q and maybe beyond?

[Andrew B. Cogan:]

Yes, I would hope to continue to see seating growth outpacing other product categories, given our investment and focus in the category.

[Josh Borstein:]

Okay, great. And then, you had mentioned that some spending ramp here in 2Q. Could you help us understand what we might expect sequentially in terms of operating expenses?

[Andrew B. Cogan:]

Sure. I think in general, we talked with everyone at the beginning of the year of about $6 million to $7 million a quarter of incremental spending. I think that’s pretty much how it played out in the first quarter. So, I think that gives you a little bit of a framework. Sequentially, it won’t be obviously $6 million or $7 million, but it could be a couple million dollars.

[Josh Borstein:]

Okay.

[Andrew B. Cogan:]

Remember, we have Salone, which we’ve never done in the past. You have NeoCon, a pretty big NeoCon program. So there’s a lot of – we have the showroom move, we have the Web launch. This year, there’s going to be a lot of one-time spending as we get these platform and capabilities in place here.

[Josh Borstein:]

Okay, got it. Thank you. And then on the Studio segment in Europe, you had some sales increases. That was encouraging, given the situation over there. Could you discuss what you are seeing in Europe right now with respect to the Studio segment and how you are…?

[Andrew B. Cogan:]

Sure. I have to break – in the Studio segment in Europe, we’re seeing positive trends. The Studio segment in Europe is about a little over half of our European business, and it’s more of a residential dealer-driven model. The other half of the business is more of a contract furniture type model. We’re seeing continued weakness on the contract furniture side. And I think in the second quarter growth in the Studio product category in Europe. Although, all this is reported in the Studio segment won’t be strong enough to offset some of the commercial headwinds we find. Not unlike here, I’m a little more confident as we move into the back half of the year that there is some pretty decent sized commercial opportunities in Europe and some leveraging of our global relationships, which will help there. But I’m very confident that the strategy we’re following through to build our residential business in Europe is working. We had very, very strong participation from our dealers at the Salone tradeshow. As I mentioned, we have over 600 dealers in Europe on the residential side. Well over half of those visited our booth a significant portion of those North of 20%, gave us a meaningful showroom order for the new products we’re offering. I think we were really the only North American furniture manufacturer, exhibiting in the main Salone de Mobile. And so I think we’re going to really do well in the years ahead there. And, again, our market share and presence, it’s so small there, what’s going on there doesn’t really matter a lot.

[Josh Borstein:]

Okay. Thanks, that’s helpful. And then just last one for me. On the Coverings segment, what’s the percentage of, say, leather versus textiles or contract versus consumer, or whether the margins are different in any of those?

[Andrew B. Cogan:]

The margins within the Coverings segment don’t really vary widely. We really don’t breakout the size of each of the different segments. Obviously, the two leather pieces combined are bigger than the one textile piece. In general, I’d say again I’d reiterate my comments that we’re very encouraged about the traction we’re getting on the textile program. We’ve really now ended the first quarter at our desired headcount. We strengthened the sales leadership there. The products are rolling through and the team is ramping up and the traction in the market is really accelerating. On the leather side, a good portion of our leather sales not a small segment, go to other contract furniture manufacturers, and that was actually the weakest category. And if that had been flat, our leather businesses would have been more or like up versus prior year.

[Josh Borstein:]

Great. I appreciate it. Thanks and good luck.

[Andrew B. Cogan:]

Okay. Thank you.

[Operator:]

Thank you. Sir, you have no further questions at this time. (Operator Instructions)

[Andrew B. Cogan:]

Okay. Operator, are there any other questions?

[Operator:]

There are no questions at this time. I would now like to turn the call over to Mr. Cogan for closing remarks.

[Andrew B. Cogan:]

Okay. Well, thank you everybody for joining us on today’s call. We look forward to seeing you at NeoCon and if you happen to be in the New York area prior to NeoCon or we’re looking forward to opening our showroom the second week of May and our retail store the third week of May. So take care everybody and goodbye.

[Operator:]

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.