Knoll, Inc.
Q2 2013 Earnings Call Transcript

Published: 17 Jul 2013

[Operator:]

Good morning, everyone. And welcome to the Knoll, Inc. Second 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. Reconciliation of these measures do not -- to the most comparable GAAP financial measures are included in the presentation slides that accompany the webcast. Now, let me turn it over to Mr. Andrew Cogan, the CEO of Knoll. Please proceed.

[Andrew Cogan:]

Good morning, everybody. It was a whirlwind of a quarter as we pressed forward with our strategic investments in people, product and capabilities around the globe to drive a more balanced mix of business within and among our different segment. As you may recall, these investments were focused on targeting underpenetrated and emerging categories and markets for growth maximizing our Office segment profitability, expanding our reach into consumer and decorator channels and investing in the Knoll brand as we celebrate our 75th Anniversary. In April we returned to Salone del Mobile in Milan for the first time in over eight year. Salone primarily targets European residential dealers and we are the only one of the major North America players to be present there. We coupled our Salone display with a special event at Prada headquarter to launch in collaboration with Prada our 75th Anniversary collection of work by the international Rem Koolhaas and its firm OMA. Unlike Knoll -- NeoCon, Salone is a show where you write dealer order and we were thrilled with the number of dealers that participate in purchasing displays of our new residential introduction and classic KnollStudio designs for their showrooms. We demonstrate to the European dealers and architect and designers the seriousness of our commitment to their market. Since Salone we have seen strong double-digit growth in our KnollStudio business in Europe. In the Studio segment results, you can see the cost of these incremental investments was not insignificant. While Europe was the top and bottom line drag in the overall Studio segment results. Studio in North America did grow mid single digits. I still like we bottomed in Europe this quarter and are expecting better things from them going forward. In May we were back in New York City for the opening of our new flagship showroom offices in first ever direct-to-consumer retail space. All of these spaces at 1330 Avenue of the Americas just around the corner from The Museum of Modern Art have been extremely well received. Our new Office space allows us to demonstrate directly to client our leadership position in the evolution of the modern workplace. In fact, we have put together a compelling case study which we share with clients, demonstrating how one can create a more space efficient, high performance workplace through innovative planning with our workplace design. It is a thrilling dynamic space. We have already had great success in presenting our work to end-users, architect and designers. The shop at 1330 is also been very well-received as well and we’ve already hosted some wonderful events and found new consumers for our KnollStudio design. Startup costs here are also contributed to our increase Studio spending in the quarter. We open the shop with a focus on our Richard Schultz outdoor designs. Our various sales, marketing, advertising and training investment in the Schultz product have resulted in strong double-digit global sales growth this year. We launched our new website www.knoll.com in May as well. This significant investment over the past 18 months resulted in a powerful new site that makes Knoll more accessible directly to consumers, as well as presents our contract products and capabilities in a crisp easy to navigate format. It is truly consistent with our design driven brand promise. To drive traffic to the site and raise awareness for our offerings we simultaneously launch a multimillion dollar 75th Anniversary modern always online and print ad campaign. The trade and campaign and consumer campaign posits our new work from KnollStudio to Office to Textile as part of the continuum of work we have been doing for 75 years. The ads also highlight how our designs are modern always and our branding go-to-market strategy is also modern in all ways. What is the impact so far been from all these investments? Well, since the launch of our new site total visits are up over 50% versus the comparable period last year. Pages per visits have grown dramatically and new content has driven up unique page views more than two-fold and we are tracking right on with our initial revenue expectations for the consumer side. So, all in all very encouraging at this early stage. Along the way in the quarter we opened up our third standalone KnollTextiles residential showroom. So we now have spaces in decorator buildings in New York, LA and Chicago. It was hard not to know all the interest of late in the textile space, where we play for over 60 years. As we have learned here, success here is so much more than hiring a designer and putting some product out there or even another acquisition. It takes much more holistic approach from design to sales, marketing, distribution, fulfillment, logistic and the talent experience in each of these areas to really succeed. Here we have continued to aggressively ramp up our product offerings and market coverage and it was hearten by the significant surge in sampling we have been seeing. If history is the precedent, this bodes extremely well for strong growth in Coverings next year. We find when clients are thinking about Coverings, they want to consider more than just one material or application. So the breath of our offer within our Coverings segment from fabric to leather itself remain singular. Both Edelman and Spinneybeck performed well in the quarter driving the bulk of the Coverings growth. In addition, much like with Schultz with one year under our belt, Schultz start to establish the strong reputation and track record with our Coverings clients. In June we moved on to NeoCon for a very successful show in Chicago where we continue to build out the breath and depth of our workplace offering, highlighting everything from the most progressive to aspirational. Heading into NeoCon, our sales team was pumped up by one of our greatest global business division successes today. This included a global evaluation for one of the world’s largest technology company. It was a competitively held accounts that as long as I can remember we have never been able to penetrate. But the combination of our new GBT team and capability coupled with this client’s desire for fresh start gave us an opening that we capitalized on. This should result in meaningful incremental business as the program gets going globally. Remember the strategic sales division is another area in which we are investing to offset declining government revenue. I’m seeing increasing coordination success amongst our sales teams and partners in North America, Europe and Asia. In NeoCon, we continue to build out our antenna platform for the emerging workplace with important additions and an innovative way to divide space in both open plans and private offices with antenna interpol. We added to our Toboggan line of collaborative furnishing and introduced it, very well received in competitively price family of LED lights for KnollExtra. We also continue to invest in enhancements to our high profile and efficient work place models because not everyone is going to work at a bench. And our new anchor storage enhances our lower cost storage capabilities and a great variety of workplace setting. Collectively, I expect these new products have strong market impact later this year and beyond. We were quite busy at NeoCon with substantive client presentations and good traffic, a trend consistent with our growing pool of business as well as the year-over-year growth respond Q2 markup renderings and client visit. It definitely feels like the industry is stuck in neutral as some nice project opportunities can offset lower levels of government business, an inevitable fact that takes more unit sales to get the level of revenue per person that we use to see just five or six years ago. That is why rounding at our workstation offerings with product like seating and accessories is increasingly important. In fact, seating remains another bright spot generating double-digit growth. More and more clients are coming around to see the ergonomic benefit with the family of chairs like generation which was the first product in the industry when it was introduced just a few years ago to Knoll that technology was driving people to work in a greater variety of postures and position. The generation family continues to gain share in the market. We do believe that as employment improves it will eventually reach a tipping point and push the market into a higher gear. Rather than just churn, increased levels of commercial construction, accelerating absorption, lower vacancy rate will all be signs of this happening. Until then we will continue to work all the levers that are disposal to drive office revenue growth from our global business division to our Knoll Essentials dealer marketing program targeting small and midsize businesses. Well obscured by a 40% decline this past quarter in our government sector sales, our commercial business continue to outperform the overall market. We’ll continue to pace in the quarter on both our supply chain transformation and ONEKnoll implementation. On the supply chain side, major initiatives relate to process movements, strategic sourcing and a reduction of manufacturing and distributions footprint remain on pace to deliver long-term cost service and quality objectives. More specifically phase 1 capital equipment for wood manufacturing and monetization has now in place and productivity gains are starting to be realized. Phase 2 equipment is on order with an estimate installation date towards the end of this year. We expect meaningful gross margin benefits will be seen in 2014. We continue to identify opportunities to further consolidate some operations and reduce our manufacturing distribution footprint which will likely involve exiting lease spaces later this year and next. And ONEKnoll begins to move from design towards data development, eventually implementation beginning in late 2014. I hope this gives you just a small sense of the work going on around our company as we implement the full program investment we outlined earlier this year that aimed to drive revenue growth and margin improvement over the longer term. Now, let me turn the call over to Barry to walk you through our results in more detail. Barry.

[Barry McCabe:]

Thank you, Andrew. Second quarter sales decreased 3% below a year ago due primarily to less government spending as a result of the sequestration in the United States and legal project business in Europe. Sequentially, sales increased 6.8% over the first quarter, excuse me -- as commercial business continues to improve. Our office segment is impacted by the lower government spending year-over-year minus 3.8% but still grew 7.7% sequentially with the increased commercial business. Overall the studio segment was negatively impacted by the lack of project business in Europe that grew almost 6% in North America as Andrew mentioned earlier. Covering grew 3.9% year-over-year and 17.6% sequentially as we began to see the benefits of our strategic investments. We see the overall environment improving in the second half of this year's sequentially but still see government spending headwinds as a major challenge to year-over-year comparisons. Business activity continues to improve as reflected in presentations, client visits and mock-up activities as well as the overall pool of business we are tracking. The continued improvement in the ABI is consistent with the activity we are seeing. We still believe that this improvement in business activity will manifest itself more in 2014 than 2013. Gross profit as a percent of sales decreased 110 basis points from a year ago primarily as a result of pricing pressure and lower sales and resulting impact on fixed cost absorption. Remember we had two price increases in 2011 benefited shipments in the first half of last year. Sequentially, gross profit percent improved as we realized on average 45% contribution margin. Inflation today has not been a factor and our factory operations are seeing better fixed cost leverage. Remember the benefits associated with our supply chain transformation will not begin to kick in to later in this year and next. Operating expenses were $3.9 million higher than a year ago in support of our long-term strategic objectives. The opening of our new showroom and offices in New York, our new website, Modern always Advertising Campaign, NeoCon as well as some additional headcount in sales and marketing, all contributed to the increased spending in the office segment. Our studio segment was impacted to a lesser extent by the above expenditures but it did absorb the cost for Salone and product shows in Europe. Lower levels of incentive accruals did offset some of the increased investment spending. Spending will continue around these levels as we continue implementing our growth initiatives. Operating profit margin was 5.8% as a result of the lower sales, price erosion and the increased SG&A spending. Our operating margins did improve 70 basis points sequentially over the first quarter as a result of the higher sales in improved factory efficiency. We would expect our operating margins to continue to improve sequentially as we move through the balance of the year. These margins are consistent with our expectations for where we should be at this point in our multi-year program. Interest expense was approximately $1.5 million, a $100,000 below a year ago due primarily to the $30 million reduction in our bank debt from June of 2012. Other income was favorable approximately $1 million compared to a year ago due to the 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 $0.17 for the quarter. In the quarter, we reduced our bank debt to $188 million. Our net leverage ratio as calculated under a bank agreement is 1.94 to 1. We are comfortably in compliance with the bank convenant in that quarter and had $11.1 million of cash. Capital expenditures were approximately $10.5 million for the quarter higher than a year ago as we completed work on our new New York offices and showrooms, our new website and purchased new equipment for our factors. Now, we will take questions.

[Operator:]

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

[Budd Bugatch:]

Good morning, Andrew. Good morning, Barry.

[Andrew Cogan:]

Good morning, Budd.

[Budd Bugatch:]

I guess, let's start it if we could talk a little about office. I know Andrew you have given us a lot of color, hoping maybe we can get some specifics, I think (inaudible) was up for April-May. Order shipments 4.8% and orders 4.2% if I did the numbers right. And you said, I think in the release that excluding the government drag, results were better than the industry. So, could you help a little bit with some of the details, maybe how much better was the industry and can we get some clarity on that?

[Andrew Cogan:]

I think, in general, Budd, I think we know our government business was down north of 40% in the quarter. And our commercial business was up mid-single digit. So, we did a little bit better than the industry on the commercial side, after if you adjusted the industry for the government piece. And the government piece continues to precipitously decline. Government as a percentage of our sales was below it in recent memory, which I think is a good thing. So, back in 2009 as I recall, government was close to 30% of our revenue of the Knoll Inc. level. So even greater percent of Knoll Office and we are down to 10% in the second quarter. I think it is important to note, for us to understand that based on the data we found, first quarter we remained the number one supplier to the Federal government. So from the data I’ve seen, I believe actually we are continuing to hold share within the government sector, but that sector is declining rapidly. And I think we have taken the worst hit to date. And the fact that we’ve been able to offset as much as we have, I think signifies how strong are -- how well our office business is, is actually doing.

[Budd Bugatch:]

Just to make sure, I understand it is 10% in the second quarter, it was 10% of Knoll Inc. in terms of what the government was down to?

[Andrew Cogan:]

Approximately.

[Budd Bugatch:]

And that was down 40% from a year ago?

[Andrew Cogan:]

Yeah. The total dollars were down 40%, not the government portion.

[Budd Bugatch:]

And when did that normalize, I mean, I know you just said it continues to precipitously decline but when did the comparisons start for you to get a bit easier or get less relevant for that government comparison?

[Andrew Cogan:]

You know it is very, very hard to answer that because I don’t think anyone knows what is going to happen with sequestration and with when the government will get a budget together and all of that. I think our assumption right now is that there is another -- there could be another 20% drop in our government business as we move through 2014. But then I think it starts to normalize and the reason I believe that is at that point of about half the business will be state and local and half federal. And that is I think a pretty okay number going forward given the size of the government business and all that. So I think that is the reason for expectations. So, I still think there is some downside, but I think we are through the worse of it. I will note that the third quarter was also a very large government quarter for us last year. So we still have some headwinds that we are yet to face.

[Budd Bugatch:]

Can you quantify what it was last year for us although we may be…

[Andrew Cogan:]

For the quarter there, it was not pretty similar, as I recall, to what we did in the second quarter.

[Budd Bugatch:]

Okay. And in on the Studio, you talked about I think in the release the European impact but I think I got confused because you said you received a lot of orders at Salone, I thought that impacted Studio, did I mishear that?

[Andrew Cogan:]

That impacted Europe in the Studio segment. I think if you look at the Studio segment let me try and be clear but overall you can seen in the results, the Studio segment the top line was down about 5% and our operating profits were down a couple of million dollars. Actually, when you look at Studio in North America, they were up as I said I think mid-single digits, but Europe was down double digit. I think the good news is based on the some of the orders we got at Salone and then just a stabilization of demand in Europe and then growth on the Studio side of the European business that actually I expect Europe to grow the balance of the year now.

[Barry McCabe:]

I think some we are through some of the worst in Europe and also we’re through the worst of the incremental spending in Europe. And so I think they will get back to a better financial position.

[Budd Bugatch:]

I have just another question, but just let me make a just a cut to the last one is the SG&A investment spending the up $3.9 million this quarter, I think $5 million or nearly $5 million last quarter, where are we now in that spending plan? Can you update us on kind of the specifics of it and how does that normalize next year?

[Andrew Cogan:]

I think we talked about $5 million to $6 million of incremental spending a quarter. So $20 million to $25 million of where we are headed this year. And I think they are trying much more but we are on track for. And then I don’t have the specifics around. Next year, I think you will see some incremental spending next year as well particularly at ONEKnoll and some of the other things we are doing to ramp up But I don’t think it would be anywhere near the magnitude of the step-up this year maybe half of the magnitude of what we are looking at this year at most.

[Budd Bugatch:]

So I am confused a little bit about the second quarter. It was only up about 4 $million…

[Andrew Cogan:]

But as Barry said his cost objective was lower incentive accruals. So if you back out the lower level and incentive accruals, you are still seeing investment spending up $5 million to $6 million.

[Budd Bugatch:]

Okay. So the net is going to be around $4 million when we have this, is that going to continue into the third and fourth quarter?

[Andrew Cogan:]

Listen, I think you should continue to model up $5 million to $6 million a quarter over where we were last year, maybe up a little more one quarter, a little bit less another quarter. And there are some variable pieces around sales commission and incentive accruals that move around us. But if you actually look at the incremental investment spending, it is somewhere between $20 million and $25 million for the year.

[Budd Bugatch:]

Okay. So on a reported basis, we should expect that and if you perform better than that, we will be positively surprised. Is that the way you think?

[Andrew Cogan:]

I think that is a smart way to do it, Budd.

[Budd Bugatch:]

Okay. And lastly for me just congratulation on the new share remark, I appreciate the courtesies you offered. I think that’s gorgeous there and so congratulations on that.

[Andrew Cogan:]

And anyone on the call is welcome to the same person or two what we gave to Budd.

[Budd Bugatch:]

Okay. 6

[Operator:]

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

[Matt McCall:]

Thank you. Good morning, guys.

[Andrew Cogan:]

Good morning, Matt.

[Matt McCall:]

So, Barry you made a comment that you expect EBIT margins to improve in the rest of the year. Can you give us an idea of the pace of that margin expansion, I guess, on a sequential basis and any segment detail either about kind of near-term trajectory, long-term targets, just an update on the expected margin improvement by segment performance?

[Barry McCabe:]

In terms of the margin, it will be small incremental improvement. As you are well aware, the greatest opportunity is in the Office segment as their sales would increase we would get better factory efficiencies and more absorption. When you look at the specialty businesses, since we don’t have factories associated with most of that, their margins remain steady on the gross profit side. So it’s only impacted there by the SG&A spending.

[Matt McCall:]

So, I guess of the $5 million to $6 million increase that we saw this quarter, how does that break out Office versus Studio versus Coverings?

[Barry McCabe:]

When you say $5 million to $6 million…

[Matt McCall:]

I thought there was incremental spending, I thought Andrew just said $5 million to $6 million net of the incentives, lower incentive accruals. So I am just trying to understand what the year-over-year impact by the segment was?

[Andrew Cogan:]

Hey Matt, this is Andrew. I mean, in general it was a little bit heavier weighted towards the Office segment maybe more, more like 50% of the investment was in the Office segment. And then the balance were split between Studio and Covering. It’s pretty spread out.

[Matt McCall:]

Okay. Well I guess trying to lay that with Barry's comments about stable Studio margins, I mean the margins there, if my math is right, we’re 9%...

[Andrew Cogan:]

No, no. I think Barry was talking about gross margins.

[Barry McCabe:]

I’m talking about gross margins.

[Matt McCall:]

I apologize. Okay. Okay. Got it.

[Andrew Cogan:]

Again, the Studio segment in the second quarter, I think remember there is Europe in there and so Europe we had both the significant year-over-year step up and standing with Salone and some of the other things we did over there, plus they had lower revenue and lost money in the quarter. Now we don’t think we lose money in the quarter in Europe going forward and we think actually Europe will breakeven or make a little bit of money for the year. But you also had that loss factored in as well.

[Matt McCall:]

And is the expectation…

[Andrew Cogan:]

I think, again, our expectations on kind of a go forward basis are mid double-digit, 15% margins for the Studio segment, 20% for the Covering segment and then the real opportunity is to move the Office segment from mid to low-single digits to upper-single digits. And if we can do all that, I think we are very much on track for getting to our longer term goal of 12% operating margins. I have to say nothing going on right now, including the government headwinds, which again I think we’re doing an admirable job of offsetting deters my confidence, undermines my confidence in our ability to work towards the goals we set for ourselves in 2015. The team is very focused and very committed to doing that and we’re dealing with obviously a volatile changing demand dynamics, but I think we very much have a path forward to get there and that path always never assumed a lot of progress in 2013. We got the spending and the capabilities in place most of the supply chain transformation has very little impact this year, but should have some nice gross margin impact next year. So in ’14, then in ’15 and I do see us on the path we talked to everybody about the beginning of the year.

[Matt McCall:]

Okay. And on the competitive front you did mentioned a couple times in the release and I think on the call the pricing pressures commentary. Can you give a little more detail there? Is it a continuation of deflationary pressures just that have impacted industry for a while, you see increased competition based on price, just more detail on the pricing comment?

[Andrew Cogan:]

I think there was some modest price headwinds in the quarter on some of the projects -- on some of the project-type business. I don’t think there was anything dramatic. We didn’t have, again as Barry said, we didn’t have an anniversary price increase that we’re benefiting from. Certainly that something as we head into ’14, we will re-look at.

[Matt McCall:]

And on the ’14 comment, what are the leading indicators telling you about? I think these are based on the fact that Barry said. Most of the improvements are going to come in ’14. But last quarter you referenced some of that in your presentations your mockups those types of really indicators. What are they telling you about the project activity both back half and into the first part of next year?

[Andrew Cogan:]

I think they were all up double digits. So I think pretty much across the Board they suggest us that ’14 should be pretty good. There’re some nice projects we’ve already won for ’14. As I mentioned, this recently technology, global business division success won’t have much impact this year, but it could add meaningful revenue next year. We’ve a couple other things like that in the pipeline that if we’re successful with, could have a nice impact. So in general, I’m encouraged by the growing pool of business and then some of the general activity that we’re seeing. As I mentioned on Coverings, I’m really impressed with the step up in sampling which is a good leading indicator. So I think a lot of things are saying that. But that said, the back half looks pretty flattish to us as does in Europe.

[Matt McCall:]

And one more follow up there, Andrew. Any change in the mix of activity as it pretends to new buildings versus renovations? Are you, I know, there are some of the leading indicators for construction are getting little better. I think Barry referenced the ABI, but of every 10 customers that come to see you or will talk about a project, how many are actually looking at product for a new building?

[Andrew Cogan:]

I mean, Matt, as I think, you’re absolutely right. We’re seeing a lot of people in churning kind of situation. I will say some of the opportunities for ’14 are new commercial building. So maybe there is a little bit more of a glimmer that will start to see that benefiting us in ’14, but I think right now we’re kind of stuck in neutral here.

[Matt McCall:]

Thank you.

[Andrew Cogan:]

Okay. Thank you, Matt.

[Operator:]

(Operator Instructions) I would now like to -- Todd Schwartzman, Sidoti & Company. Please proceed.

[Todd Schwartzman:]

Hi guys. I wonder if you could just refresh us looking at the back half of ’12, were there any shipments on the commercial front that were particularly larger you would call out that you called out maybe at a time that are not likely to recur in ’13, the back half?

[Andrew Cogan:]

Well, there was certainly some government business is not likely to recur and then we did have some larger commercial projects, particularly in the fourth quarter, that shipped out. So with still pretty robust activity…

[Todd Schwartzman:]

And Andrew in which industry were those on the commercial side?

[Andrew Cogan:]

On the commercial side, at top of my head, Todd, I don’t recall. But I can tell you, as we look at the general segment data, with the exception of the government segment, financial services have been pretty flat. But we’re doing well in education, we’re doing well in healthcare, we’re doing well in consumer discretionary categories, and we’re doing very well in energy. So I mean again government exceptionally poor financial services kind of flat, other areas technology showing good life.

[Todd Schwartzman:]

Are you doing well in energy now because the comps have used a bit?

[Andrew Cogan:]

No. We’ve had some nice wins in that category this year.

[Todd Schwartzman:]

Good. Maybe you could give a little bit color and hopefully quantify the gross margin pick up that you are looking for in ’14 as a result of the supply chain improvements, maybe if you’re having fully detailed some of those actions maybe give us a little bit more color on exactly what you’re doing?

[Andrew Cogan:]

Well, I don’t -- I’m not really willing to be specific at this point of time because a lot of those things are still kind of evolving and taking shape. But in general, as we look at the plans today, our expectation is that there is at least 100 basis points of gross margin improvement from the supply chain transformation program. We are in the midst of executing for ’14 and then an incremental 100 basis points in ’15. So the need is at least 200 basis points right there and then if you factor in, the forecast for topline growth and we don’t think we should do worse than that. Then you get the additional absorption on that level and that ought to be work, I don’t know 50 to 100 basis points over the next two years. So I think there’re very much, it’s solidly identified, 200, 300 basis points of gross margin improvement that we should expect between now and in 2015. And you couple that in with -- where the SG&A trajectory is headed as we just outlined. And I think you can see your way to double-digit operating margins and our revenue base back towards a billion dollars and that’s very much what we are working towards.

[Todd Schwartzman:]

So assuming let say a very modest sequential growth in volume quarter-to-quarter, when do we start to see the initial bump, the initial benefit?

[Andrew Cogan:]

I think I kind of laid it out in terms of what we expect to see in ’14 and ’15. I think again I don’t think we’ll have in ’14 the magnitude of government headwinds we’ve had in ’13. I mean down 40% is pretty unprecedented and we’re thinking maybe that’s not going to be for the full year, but we think maybe there is we’re talking 20% next year at most. So a lessen headwind there and then if you look at all the different data and our own internal dynamics you should say, the industry should grow mid to upper mid single-digit next year. That should give us some lift.

[Todd Schwartzman:]

Got it. Barry, you had previously spoken to CapEx up about $20 million for the full year, from last year, is that still the case?

[Barry McCabe:]

If you look at what we did in the second quarter, yeah, we are still on track. It may be slightly less again based on your timing but our capital expenditures were up substantially.

[Todd Schwartzman:]

Okay. And on input costs specifically leather, I was just wondering what percentage of your leather purchases are satisfied in-house and also what you are seeing on pricing there?

[Barry McCabe:]

I am not sure what do you mean by in-house. We don’t have any factories at all. It is source for us. So we are sourcing globally. Again, we are not seeing any inflation really materially anywhere other than potentially in steel and we will have to see how that ultimately plays out.

[Todd Schwartzman:]

Okay. Thank you very much.

[Barry McCabe:]

Thanks, Todd.

[Operator:]

Your next question comes from the line of Josh Borstein from Longbow Research. Pease proceed.

[Josh Borstein:]

Hi, Andrew and Barry. Thanks for taking my questions. You had mentioned that in Europe, you were -- you think you had seen the bottom there, I was just wondering what leads you to that conclusion. Is it mainly the pickup in orders you saw from Salone or is it something else?

[Andrew Cogan:]

A couple of thing, we really were hurt in the first part of the year by decline in the Office part of the business in Europe. So the projects in Europe really declined on the commercial office side. The Studio business is a larger part of the business over there than the commercial business. So because it didn’t have a bigger impact but it still nonetheless has an impact and that is really what our factories over there make. So, I was just over there early in July and we went to a country by country, project by project review and simply based on the projects we won and the funnel of activity, I feel pretty good in saying that it looks like the Commercial, the Office part of the business in Europe is kind of stabilizing and the worst of the decline, knock on wood are behind us there. So I see some stabilization there yet. There are some countries that are weaker than others. But we are seeing growth in the U.K. now as you are anniversarying the Olympic slowdown. You have got weakness in France. But in general, it is seems to be stabilizing. The real opportunity for us in Europe is on the Studio side where the competition is much more fragmented and your much, your broader [swatch] of dealers is -- [swatch] of dealers is driving the revenue and where we organize our sales force under our new presence there to much more aggressively go after the Studio opportunities and there we are seeing double-digit growth. So, if we can get stabilization on Office together with double-digit growth in Studio, that puts us in a nice position for growth in Europe as we move into 2014.

[Josh Borstein:]

Okay. That’s really helpful. I appreciate that. And then, just on the mark-up activity, I thought at one point you said it was stuck in neutral and at another point I thought you said maybe it was up double digits so just…

[Andrew Cogan:]

All the leading indicators mark-up are up double digits, maybe low double digits. My comment was that the industry seems to me to be me stuck in neutral. I mean, you get this month, up one month, down the next month. We are kind of stuck in at $9 billion, $9.3 billion, $9.5 billion range. So that is what I was referring to.

[Josh Borstein:]

Okay.

[Andrew Cogan:]

Not our leading indicators but the industry.

[Josh Borstein:]

And any reason you think for that dislocation why those are up double-digit mark-up activity when actually flow through to actual orders?

[Andrew Cogan:]

We certainly would love to see that happen. Again, those metrics are kind of, it can be vague. Listen in general I think we are seeing all sorts of good things that suggest, the industry should be -- we should be growing, faster as we move into ‘14 and ‘15. So let’s hope all that plays out and you know that the government gets some stability in terms of its budgeting and not any other shocks -- the system that employment growth continues to accelerate and we get kind of beyond this terminal velocity and things really pick up because the industry has been stagnated for a period of years now.

[Josh Borstein:]

Okay. And then just, and follow up to one of the questions Budd asked on SG&A for 2014? Is the expectation that instead of, it goes up $5 million, $6 million here in 2013 and 2014 it goes up an incremental, say, $2 million is that kind of how we should be thinking about it.

[Andrew Cogan:]

No. I think what I said was $5 million or $6 million a quarter this year and somewhere around half that rate next year.

[Josh Borstein:]

Okay.

[Andrew Cogan:]

But, again, I wouldn’t be that specific on ’14 at this stage.

[Josh Borstein:]

Okay. You don’t see it and when do you see it starting to come down, is it more 2015 or does it start to tail off at the end of 2014, do you think?

[Andrew Cogan:]

I think the rate of increase is greatest this year, it moderates in ’14 and then I think it normalizes in ’15.

[Josh Borstein:]

Okay. Okay. That’s helpful. And then just one last one for me. Could you talk really about how much of your business right now is being driven by companies wishing to update their office furniture environment into this more open collaborative workspace that what’s highlighted so much at NeoCon, just trying to get a sense of how much demand is being driven by this secular trend as oppose to more replacement cycle demand?

[Andrew Cogan:]

Well, listen, I think it’s hard to separate those two quite honestly. I think as you walk around NeoCon, you see everyone moving to all this open environment. I think one of the things we also did at NeoCon and Antenna continues to grow very nicely and that’s kind of our open, our most open platform everything and we are continuing to enhance on it at privacy around it and all that. But you know what, our traditional systems are also doing just fine and we are continuing see interest in a balance environment. So you can walk through NeoCon and I think get somewhat distorted point of view of exactly what people are buying. You see what everyone wants to show, you don’t necessarily see what everyone is buying. And so I think there is a little bit more of a balance that was comment, but everyone, not everyone wanting to work at the bench. So we’ve got I think one of the broadest ranges in the systems world and so, from people wanting aspirational wood to very efficient workplace to open progressive solutions. We are offering runs to gambit and it’s not linked to any single one of those areas. So clients come in. They want to talk about the most progressive -- our showroom in New York is a key study of that kind of blend where some floors are completely open and progressive and others have frankly quite innovative private office environment. And so I think the unique position we have is we can help people with the gambit of workplace models.

[Josh Borstein:]

Great. Thank you for the color and good luck.

[Andrew Cogan:]

Okay. Thank you.

[Operator:]

You have a follow-up question for the line of Budd Bugatch from Raymond James. Please proceed.

[Budd Bugatch:]

Just a couple of detailed questions. Barry, the tax rate this quarter was up substantially from where we expected it. What’s the reasonable number going on?

[Barry McCabe:]

Let’s go back. Budd, it’s probably in the 37%, 38% range. That was the mix of business, Andrew touched on a little bit about Europe. We lost some money and depending on the country where we are in Europe, it impacts our overall rate. So I do expect by the end of the year for rate to move more to its normal levels.

[Budd Bugatch:]

Okay. And you did pay down 5 million additional dollars in debt this quarter. Any additional debt paydown expected this year or next?

[Barry McCabe:]

Well, our goal is always to look at freeing up more cash so we can de-lever. I think it was second quarter last year, we paid down $10 million. But if you kind of look at our capital expenditures and our increased SG&A spending, I’m not sure that debt paydowns will be the same level as a year ago but our goal is to continue to delever.

[Budd Bugatch:]

Okay. And you had those currency gains this quarter. If the dollar, Canadian dollar and euro don’t change from here. Does the map lead you to any more gains?

[Barry McCabe:]

The big change was in June or maybe a little bit of upside if they continue where they are and if they go back up, there’s probably a little bit of downside.

[Budd Bugatch:]

Got you. Thank you very much and good luck.

[Operator:]

Ladies and gentlemen, we have no more questions in the queue. I would now like to turn the conference back over to Mr. Andrew Cogan for any closing remarks.

[Andrew Cogan:]

Well, thank you everybody for your continued interest in what we’re doing here at Knoll and I just want to irritate my offer that if you happen to be passing through New York, please come visit because I think the showroom or our offices is the most powerful demonstration of the range of capabilities in what we can help find tune. It has been a compelling sales for us in the first couple of months. So take care everybody. We’ll talk to you again in the fall. Thank you.

[Operator:]

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