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Edited Transcript of KNL earnings conference call or presentation 25-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Knoll Inc Earnings Call

EAST GREENVILLE Apr 28, 2017 (Thomson StreetEvents) -- Edited Transcript of Knoll Inc earnings conference call or presentation Tuesday, April 25, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew B. Cogan

Knoll, Inc. - CEO, Acting President and Director

* Craig B. Spray

Knoll, Inc. - CFO, CAO, SVP and Controller

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Conference Call Participants

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* Kathryn Ingram Thompson

Thompson Research Group, LLC - Founding Partner, CEO, and Director of Research

* Matthew Schon McCall

Seaport Global Securities LLC, Research Division - MD of Building Products and Furnishings and Senior Analyst

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Presentation

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Operator [1]

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Good morning, everyone, and welcome to the Knoll Inc. First Quarter 2017 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, including without limitation, statements regarding Knoll's future outlook for the industry and economy. These forward-looking statements are based largely on the company's expectations and are subject to a number of risks and uncertainties, certain of which are beyond the company's control. Actual results may differ materially from the forward-looking statements as a result of how many factors, including the factors and risks identified and described in Knoll's annual report on Form 10-K and its other filings with the Securities and Exchange Commission.

The call today will also include references to non-GAAP financial measures. Reconciliations of these measures to the most comparable GAAP financial measures are included in the presentation slides that will accompany the webcast.

Now let me turn the call over to Andrew Cogan, the President and CEO of Knoll. Thank you.

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [2]

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Good morning, everybody. As expected, we had a slower start to the year as declines in our Office segment offset continued growth in our high-design Studio segment and stability in our Coverings business. Lower year-end backlog coupled with the no ship week at the end of the quarter affected our Office segment most acutely. Furthermore, we made the decision to very lightly load the start of April to give the new system time to ramp up, which will also result in a loss of almost a week of Office shipment in Q2. Importantly, the new system is up and running well with no impact on any of our client- or supplier-facing activities. The next phase of our implementation is scheduled for the back half of 2018. Our Q1 results, while down versus a very strong start to 2016, do demonstrate the benefits of our continuing strategy to diversify our sources of revenue into higher design, high-margin, more residentially oriented segments, which do not have the volatility of our Office business.

In the quarter, these non-office segments collectively grew and improved their profitability. Margins in our Studio segment held at just under 15% and Coverings remain north of 20%.

While Office margins fell from 10.7% to 5.9%, overall at the Knoll Inc. level, we were able to protect our industry-leading profitability. While down 220 basis points from prior year, 9% operating margins are historically good for a seasonally lower first quarter. Growth in Europe and our North America Studio business were the primary drivers of our Studio growth. While sales at HOLLY HUNT were relatively flat, orders there grew double digits.

Studio sales were modestly helped year-over-year by our DatesWeiser and Vladimir Kagan acquisitions, though both were drags in our bottom line as we invested in rolling these products out to our respective Knoll and HOLLY HUNT networks. At NeoCon, we will be moving DatesWeiser into a stand-alone showroom on the 11th floor of a merchandise mart that used to be occupied by our Edelman business. Edelman will be retaining their residential showroom in the building. And we are on track with rolling out DatesWeiser nationally and hiring dedicated sales reps in key targeted markets. Already we are seeing a positive impact on client engagement from this added capability and are securing business from Knoll clients who in the past have gone elsewhere to meet their ancillary conference and meeting room requirements. As we have mentioned in the past, demand in our Office segment can be skewed by the timing of large projects. In late 2015, a large surge of fourth quarter orders translated into significant first half 2016 project shipment. The largest of these were carryover projects from the energy boom that had been committed to before the downturn in this sector began. In Q1 last year, the top 5 projects alone represented just over $20 million of sales. This surge did not repeat itself at the end of 2016, so our backlog was lighter to start the year. In Q1 of '17, we experienced both a decline in the total dollar value and number of million dollar plus projects. Additionally, we lost -- we estimate we lost about $12 million of sales capacity, given the no ship week. So while our headline decline of 19% sounds large, on a trailing 12-month basis, the decline is more like 1%. And on a trailing 2- and 3-year basis, the CAGRs are positive 1.3% and 4.6%, respectively. From a geographic standpoint, we were encouraged to see our East Coast and more financial service regions start to turn around.

We continue to see year-over-year weakness in energy and weakness out West, which we expect to be relatively short-lived. In the Office segment, expense controls, even in the face of increased sales and marketing spending, coupled with actions to rebalance labor in the plant, helped to mitigate the impact of lower sales. Given our expectations of a rebound in demand later in the year, we have been careful not to overreact in the short term and do anything that would undermine our ability to accommodate growth. We remain optimistic that the combination of improving industry demand coupled with our significant initiatives to gain share and ancillary category with our Rockwell Unscripted launch, the expansion of the breadth and price points of our ergonomic offerings and the seating and adjustable table market and more feet on the street in underpenetrated markets will drive growth in the back half of the year. In fact, we are already seeing signs of these actions gaining traction. Our funnel of awarded business is up nicely versus prior year. Mockups, in part driven by the launch of Rockwell Unscripted, are up year-over-year. And while we still see fewer multi-million dollar projects out there, our increased feet in the street are supporting better coverage of the numerous and growing small and midsize projects that are usually more profitable. We continue to be heartened by the strong reaction to Rockwell Unscripted as measured by growing and significant client engagement as well as the highest level of the dealer participation in training on any comparable introduction that I can recall.

This month, the remaining balance of the Rockwell collection is available for order entry, and we expect the product to start to impact our top line in the back half of the year. In addition, at NeoCon, we'll be introducing the most significant enhancement to our woods systems capability with our major upgrade to our finishing line in Toronto that improves the range of our finishes and also improves the efficiencies and reduces cost.

In the quarter, our Lean investment continued to grow, and we had 9 kaizen events in 3 out 4 of our plants. These events resulted in increased throughput and reduced space headcount and inventory. On average, we are seeing over $100,000 of benefit per Lean event. And as the excitement in our capacity to affect these transformations builds, we are encouraged at the potential for improved Office margins. Now let me turn the call over to Craig for some more details on the quarter. Craig?

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Craig B. Spray, Knoll, Inc. - CFO, CAO, SVP and Controller [3]

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Thank you, Andrew. Knoll Inc. first quarter net sales decreased $27.8 million or 9.8% from a year ago. Our Office segment was down $35.5 million or 19.2%. The decrease in the Office segment was a result of a decline in both the quantity and average size of larger project opportunities, in addition to a limited ship week at the end of March to facilitate the most recent phase of the implementation of a new ERP system.

Our Studio segment sales were up $7.6 million or 10.6%, primarily driven by Europe and Knoll studio as well as to a lesser extent incremental sales from DatesWeiser, which was acquired in Q4 2016. Coverings segment sales were up $0.1 million or 0.5%. Gross margins decreased 60 basis points from 37.9% a year ago to 37.3%. The decrease in gross margin was due to a reduction in fixed cost leverage in the Office segment that was only partially offset by increased sales and high-margin Specialty businesses. Total operating expenses in the first quarter were $72.6 million compared to $75.9 million in 2016. The decrease is due primarily to lower incentive accruals from decreased profitability and lower sales commissions as a result of a reduction in volume in our Office segment, partially offset by increased investment in training and the rollout of Rockwell Unscripted.

We believe that operating expenses for the year will average around 27% of sales. Operating profit was down 27.7% from $31.8 million in the first quarter of 2016 to $23 million in Q1 2017. Operating profit margin declined 220 basis points from 11.2% to 9%. This decline was primarily a result of a 480 basis point reduction in the Office segment from 10.7% to 5.9%. Interest expense was up $0.1 million from a year ago resulting from an increase in the outstanding balance in our revolving credit facility used to fund our discretionary pension plan contributions in Q4 2016. For the quarter, other expense was $0.2 million compared to $2.6 million a year ago. Other expenses are primarily related to foreign exchange gains and losses. Our tax rate for the quarter was 27.2% down from 37.1% at Q1 2016. The change in our tax rate was due primarily to the early adoption of ASU 2016-9 in Q3 2016, which impacted the tax treatment of the vesting of equity awards. This resulted in the realization of tax benefits recognized as a reduction of income tax expense that were historically recognized within the equity section of the balance sheet. In addition, the tax rate was affected by the mix of pretax income and the varying rates in the countries and states in which we operate. We estimate that our full year effective tax rate will be 35% to 36%, including the tax benefit recognized in Q1 2017.

Net earnings for the first quarter of 2017 were $15.4 million, down from $17.4 million for the same period of 2016. Diluted earnings per share was $0.31 and $0.36 for Q1 2017 and 2016, respectively.

Regarding our balance sheet and cash flow. Cash and cash equivalents were down $6.8 million for the quarter at approximately $3 million. Operating activities provided $3.8 million of cash in the quarter. We used the excess cash generated from the operating activities to invest in the business and pay dividends. Investing activities include capital expenditures for the quarter of $10.7 million compared to $7 million in Q1 2016. The increase in capital expenditures are reflective of our strategy and continued commitment to invest in our manufacturing and information technology infrastructure.

Total cash used by financing activities was $0.2 million. The primary use of cash in financing activities was the repurchase of common stock for treasury to satisfy employee tax withholding requirements related to divesting of restricted shares.

Other financing outflows during the first quarter of 2017 included the payment of dividends for $8.4 million. Our balance sheet remains strong. In the quarter, the reduction of EBITDA and increased outstanding debt resulted from 2016 incentive compensation payouts and timing of collections drove our leverage from 1.37 at year-end to 1.53. We remain comfortably within all debt covenants.

We'll now take any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Kathryn Thompson with Thompson Research.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO, and Director of Research [2]

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First just want to pull string a little bit more on the end market color that you had in prepared comments. More specifically, you started to see some improvement in the finance end market. Could you give greater clarity on when you saw that? Are there other end markets where you're seeing some relatively better performance over the past few months? And maybe for categories that continue to underperform, any thoughts on the why behind that as in then the generic just a slower economy?

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [3]

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Sure Kathryn. I think we were encouraging, and we tend to be a little over-weighted on the -- as we said before, on the North and East in financial services. So for us, it's meaningful that we're seeing better activity in that sector. That's one of our largest verticals. So that's encouraging and we see that activity kind of building as we move through the year. So that's quite encouraging and it's not just financial services, banking and all that, but you know legal, accounting and some of the other things that go with that as well are also showing some positive signs, and I think our products are well positioned to respond to those, particularly some of the things we're doing with some of our wood products that you'll see at NeoCon. So we feel well positioned there, and some of it is just improving economics in those verticals and then our geographic balance. So that's encouraging. We did see some slowdown in some of the tech sectors out West. But we believe some of that is more comp and timing related, and as we look at the back half of the year, we see some good activity out in the West Coast and on the tech sectors. We've been strong in the central division. In fact, that's where some of our largest projects have been, and those are in a variety of consumer kind of categories and businesses. So we're seeing some good strength in the middle of the country. And then we continue to have the lingering weakness in the South, primarily related to energy. And when I look at the comparison of our first half last year and particularly our first quarter, there were some particularly large energy projects that simply didn't repeat themselves. So we see continued weakness there, which should carry through the balance of the year and then as you get into '18 you probably won't be anniversarying those anymore.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO, and Director of Research [4]

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Okay, that's helpful. With Office, the last quarter, you said expectations that things were going to be tougher for the first half of the year. If you look at where the quarter came in and where you are now, are you on expectations based on what you tried to set out for the Street in mid-February when we last spoke? And then do you feel relatively better or worse based on kind of bid activity that you're seeing in the market as we look for the remainder of the year and into '18?

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [5]

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Right, well several questions. One, I think our view for the year really hasn't changed since February, which is that it's going to be a back half year and as kind of momentum built in the industry. We tend to be later to the party and then we stay at the party longer. And so I think to some extent as we're starting to see some signs of life in some of the BIFMA stuff and as we look at our funnel of activity, which except in the large projects, overall is growing. I'd say when we look at our pool of awarded business, we enter into the back half with more won already than we had a year ago when we look at the kind of trajectory of our new product launches, and the real enthusiasm they're generating and how they are helping us capture both incremental dollars on existing accounts as well as penetrate accounts that historically have not bought from Knoll in those ancillary parts of the market, I think we're encouraged and we still believe it's a back-half story. We were recently with all our sales division heads on the Office side of the business, and I think their outlook kind of reconfirmed our point of view that we return to the growth in the back half and it's just a slow start to the year.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO, and Director of Research [6]

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Okay. Any thoughts on -- is your outlook -- or maybe could you reconfirm what your thoughts are for Rockwell Unscripted contribution to 2017?

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [7]

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You know I think, again, we talk in general of our expectations of Rockwell Unscripted being north of a $50 million product line over the next 3 to 4 years. And I think we're very much on that path. In the first year, you're doing $10 million -- $10 million, $15 million and you kind of ramp up from there. Again, I think what we’re encouraged about, now we can start to see both real awarded Rockwell opportunities in our funnel, and we can see examples of clients starting to use Rockwell. And again, I think they break up into 3 areas. The first being where we're capturing some incremental ancillary business that without Rockwell we wouldn't have done. And that can be 5% or 10% of an overall bid. Then, we're seeing stand-alone Rockwell opportunities with clients that just wouldn't have even considered Knoll for those areas of the office, and those can be $50,000 to $1 million and $1.5 million, and we're seeing some nice ongoing agreements and initial purchases in that area. And then kind of the longer-term projects, which we're also in the midst of a variety of betas and mockups and pilots with clients on are where people are doing entire facilities with Rockwell. And with those, that obviously is the longest cycle part of the ramp-up. But we're seeing many opportunities in that area as well. So as I breakup into those 3 pieces, I think we're quite encouraged that our expectations are very much in line with how the product's being received in the market.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO, and Director of Research [8]

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Okay, great. And final question with Studio. Studio saw some good sales growth, but operating margins were -- remained flat on a year-over-year basis. Any color for flattish margins in light of a better top line performance?

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [9]

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No, I think as we've always said. The Office margins move around a lot with volume and absorption. And the Studio margins basically don't move a lot. It's much more of a variable cost model business. So you're not getting great absorption in either direction in everything. And there's a little bit mix moving around in the Studio business. But I know -- again, I think the Studio margin as well as Coverings tend to be pretty consistent and it's Office where you have most of the volatility.

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Operator [10]

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(Operator Instructions) And our next question comes from Matt McCall with Seaport Global.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD of Building Products and Furnishings and Senior Analyst [11]

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So I think you talked about some sales capacity loss, and you said that was $12 million. Was that related to ERP in the quarter?

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [12]

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Yes.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD of Building Products and Furnishings and Senior Analyst [13]

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Okay, so I assume that was in top line. Do you have an estimated profit impact in Q1?

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [14]

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Listen, I mean, I think you can take a 40% contribution margin and kind of flow that through.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD of Building Products and Furnishings and Senior Analyst [15]

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Okay. So maybe, Craig, for you, you mentioned FX. Was there an estimated FX impact on the Office margin in Q1?

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Craig B. Spray, Knoll, Inc. - CFO, CAO, SVP and Controller [16]

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It was really minimal, Matt. We had a bigger impact prior year running through other income that was the delta to the earnings. But in terms of margin impact, it was minimal.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD of Building Products and Furnishings and Senior Analyst [17]

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Okay. So I think you said, Andrew, you’re going to ease -- or you may have already eased into Q2. Should we assume that same type of $12 million impact in Q2 with the 40% flow-through?

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [18]

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You know, I can that's probably fair, Matt.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD of Building Products and Furnishings and Senior Analyst [19]

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Okay. All right. So -- okay. That’s good. So from a margin outlook perspective when I think about ERP, when I think about some of that impact we just talked about, when I think about FX as we look out maybe to Q2, how you want us to think about your margin progression. And then, really more going back to your comments earlier about the back-half kind of re-acceleration, what would you like us to think about in terms of margin in the back half?

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Craig B. Spray, Knoll, Inc. - CFO, CAO, SVP and Controller [20]

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Well, in terms of ERP, let me speak to that first. Really, this is a top line discussion. The ERP we're having some systems come on, other systems come off. So I don't think you're going to see a significant impact to our operating margin because of the ERP as we bring these phases on.

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [21]

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And you know, Matt, in terms of the quarterly progression, I mean, I would expect you to continue to see kind of sequential improvement, a couple of hundred basis points each quarter as we move through, particularly on the Office side that's impacted. Then, I would hope by the time we get into the back half of the year, you'll start to see Office margins starting to move ahead of where they were prior year.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD of Building Products and Furnishings and Senior Analyst [22]

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Okay, okay. And the final question I had, you've mentioned sales force with feet on the street increases, some other investments that you've made. Can you quantify that number for us? And maybe how that could impact your growth as those new sales folks ramp?

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [23]

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Yes, absolutely. You know, again, as the market that has become more fragmented and we see fewer $1 million to $2 million plus opportunities -- and I think that by the way is pretty consistent with the leasing activity that we're looking where there aren't the super large leases, but they're smaller leases, and we just have to have more people out there covering more of the market. And so we've kind of targeted about a 10% increase in our feet on the street this year. And I think right now as we sit here, we're about halfway towards that goal. And so we're very focused on that. We think that will help us improve our coverage. On average a sales person, when they're up to speed, can do $4 million, $5 million. So there, it's not an insignificant addition in terms of our ability to cover the market and handle more smaller opportunities, which is where we see more of the action right now.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD of Building Products and Furnishings and Senior Analyst [24]

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Okay. And then finally, and this kind of relates to the last question. When I look at the SG&A line, a little deleveraging this year, I know that's a long way away, but as we look out to '18 and we think about the additions that you've have made, do you expect in initial plans as we sit here today that you'll start to see some leverage return in '18 as we get some of these investments behind us?

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [25]

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Yes, I would hope for some of that, absolutely. I wouldn't say it's huge. But again, Craig talked about 27% SG&A, maybe you get 26% to 27% a year from now. And I think we're also still very focused on the gross margin side of the business in terms of the Lean, the mix of what's going on there. We've got many issues too within our plants, so we still think there's significant opportunity to keep driving margins higher. And then, as it relates to the Office business as volume there grows, absorption benefits higher mix. I think the other thing that a quarter like this shows, Matt, also is that we really benefit by the mix of our businesses, and we are continuing to be very focused on bolt-on acquisitions and more organic growth in our own Coverings and Studio segments, and particularly at DatesWeiser and Kagan and some of the facilities we've added the additional showrooms in HOLLY HUNT, the product categories like outdoor where Holly is just now starting to be player. We also think those businesses can continue to become a greater part of our overall mix. And that helps kind of at the operating margin level, let me put it that way, even if it drives SG&A mix a little bit higher because those businesses tend to have SG&A as the higher percentage of their mix.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD of Building Products and Furnishings and Senior Analyst [26]

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So on that one final one. On the operating margin note, when you think about the way you guys used to talk about kind of 100 basis points and this year we're taking a little bit of a break, maybe it's flat but reacceleration in the back half. Do we return to the net 100 basis points or better next year? Just trying to think about how we adjust for these disruptions, mostly from ERP in the first half?

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [27]

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Listen, I think our goal is 50 to 100 basis points of operating margin improvement annually. And it's not hard between the Lean initiatives and the Office side of the business as well as the mix evolution and return to growth in Office to kind of plot that forward. I don't think that's an unrealistic expectation. What I will say is, there's just a lot of wild cards right now, right FX, right now that's help actually helping us. We don't know where our inflation ultimately settles at, but right now that's a little bit of headwind, I think. And the good news is we use less steel in some of those commodities than others do, so we're not as impacted by that. So there are a variety of mix within our business in terms of if it's truly more small projects. Generally pricing on those tends to be more favorable. So I -- you can lay out a lot of things. But in general, our goal is always to try and generate 50 to 100 basis points of operating margin improvement. And other than the pause, maybe a little bit of a step back this year, that's the journey that we believe our strategy still should result in.

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Operator [28]

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And I'm showing no further questions. I would now like to turn the call back to Andrew Cogan for any further remarks.

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Andrew B. Cogan, Knoll, Inc. - CEO, Acting President and Director [29]

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Okay, well, thank you all for your continued interest, and we really hope you have a chance to come by our showroom at NeoCon. We think it will be a powerful display of not only Rockwell and our overall capabilities, but very exciting in terms of our new wood collection and where we're going in that part of the market. So hopefully, we'll see you all in Chicago. Take care everybody. Bye.

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Operator [30]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes the program, and you may all disconnect. Everyone, have a great day.