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Edited Transcript of KNL earnings conference call or presentation 25-Jul-19 2:00pm GMT

Q2 2019 Knoll Inc Earnings Call

EAST GREENVILLE Aug 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Knoll Inc earnings conference call or presentation Thursday, July 25, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew B. Cogan

Knoll, Inc. - Chairman & CEO

* Charles W. Rayfield

Knoll, Inc. - Senior VP & CFO

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Conference Call Participants

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* Beryl Bugatch

Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research

* Gregory John Burns

Sidoti & Company, LLC - Senior Equity Research Analyst

* Matthew Schon McCall

Seaport Global Securities LLC, Research Division - MD and Furnishings & 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 Incorporated Second Quarter 2019 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 and expectations with respect to future leverage. These forward-looking statements are based largely on the company's expectations and are subject to a number of risks and uncertainties, certain of which are beyond the company's control. Actual results may differ materially from the forward-looking statements as a result of many factors including the factors and risks identified as described in Knoll's Annual Report, 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 Chairman and CEO of Knoll.

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [2]

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Thank you, everybody, and good morning and welcome to our second quarter earnings call. I hope you were able to review the video release posted concurrently with the earnings release yesterday. Frankly, it's a lot more fun to talk about Knoll when you can see what we're talking about than just listen to a call or reading the numbers.

It features a tour of our flagship Fulton Market Space in Chicago and is accessible on our Knoll Investors Relations website.

Florence Knoll once wisely commented that Knoll became successful because it was unique, not just another furniture company. That could not have been truer than the second quarter of 2019 when we departed the Merchandise Mart in NeoCon for our inaugural Design Day celebration in our new flagship home in the emerging Fulton Market neighborhood of Chicago. The move to Fulton Market, a millennial-friendly neighborhood that epitomizes the mix of living and working that is driving workplace design today, was the perfect environment to exhibit the breadth and depth of our constellation of design-driven brands and demonstrate to architects and designers, dealers and clients how Knoll can uniquely help them create a modern workplace experience that blends the hospitality, resimmercial and high-performance individual products they crave. And boy, come to see us they did, as we were overwhelmed by the thousands of visitors that made and continue to make the trip to Fulton Market.

The feedback was universally positive from large clients planning major new headquarter projects to architects and designers inspired by the space to our dealer partners who viscerally experienced our strategies and why we want and deserve a greater share of their business. Our own people are often our harshest critics and they too were energized by the buzz and spirit in the space. It was the youngest crowd I've experienced in Chicago, and it's heartening to see both Knoll and the industry inspiring a new generation, which bodes well for business as the workplace is a space ripe for reinvention and re-imagination. And we intend to make sure that Knoll remains at the heart of that conversation.

Our 30,000 square foot Fulton Market Space, flooded with natural light and fresh air, represents a culmination of a multi-year journey to position Knoll to take advantage of the changing workplace and bring together, through both organic product development and M&A, the best in hospitality-based workplace design and high-performance furnishings for everyone from individuals to intimate groups to large teams. We designed Fulton Market to be a living laboratory where clients can experience an active workplace and holistic approach to total workplace design and the tremendous variety of settings, which Knoll can help clients create.

It's a space that wouldn't have been possible to envision without the hospitality solutions using re-imagined KnollStudio residential classics and new solutions like Rockwell Unscripted and its architectural lounge setting that include integrated acoustic products from Spinneybeck FilzFelt. The space also showcases our range of up-to-date workplace solutions from DatesWeiser's conference and meeting solutions, our new island wood tables, to high-performance height-adjustable tables to mobile power beams and benches for teams and individuals. Muuto's new perspective on ancillary furnishings allows us to create everything from café and meeting settings to individual high-back upholstered pieces equipped with power to support focused work. And our expanded line of Pixel training tables offers the high-performing and cost-effective training and application setting. All these settings were tied together, of course, by what Florence Knoll described as a total design vision and a fresh and vibrant approach to natural materials, textiles, colors and ubiquitous and subtle technology.

Looking at the second quarter results, it's clear that a lot of what we're doing is resonating with our clients and dealers. Furthermore, our strategy to diversify our sources of revenue into higher-margin lifestyle categories with both residential and crossover workplace applicability combined with efforts to improve the profitability of our Office segment is continuing to deliver strong top-line growth, margin expansion and EPS growth. In the period just completed, sales grew over 13%, adjusted EBITDA increased 15% and adjusted EPS was up double digits.

On the Workplace side, we grew 18% driven by 27% growth in the sale of Lifestyle products to Workplace clients. This growth was led by a record quarter for Muuto in North America with over 75% growth plus increased ancillary penetration by KnollStudio, Spinneybeck, FilzFelt and Holly Hunt. Combined with just under 15% growth in our reported Office segment led by continue strength in height-adjustable tables, storage systems, DatesWeiser and Rockwell Unscripted, you get the 18% result.

Lifestyle products as a percent of total Workplace increased from 24% last year to 26% in Q2; further proof of our share gains and accelerating traction in ancillary spaces. The durability of this trend was also validated in the most recent dealer share data we received for 2018. This showed a meaningful uptick of almost 400 basis points in our share of our top dealers representing over 80% of our total Workplace sales. We're particularly pleased with that progress. And remember, the 2018 data had minimal benefit from the Muuto acquisition so our belief is that in 2019 our share gains in our dealers have accelerated. The ongoing rollout of our new 3D specification tools will also make it easier for dealers to simultaneously integrate and visualize the full breadth of our Workplace and ancillary offerings in real time as they work with a designer and client and should be supportive of further share gains too.

On the Lifestyle front, sales grew just under 12% to a record Q2 rate of $144 million and represented approximately 40% of our total business. Growth was led by Muuto, KnollStudio and Spinneybeck FilzFelt, all 3 brands strongly benefitting from the resimmercialization of the workplace. When you break apart the Lifestyle growth by residentially-focused channels, sales were down 1.8% as we continue to see some of the similar higher-end residential headwinds that others have reported both in Europe and here in North America. As expected, our Lifestyle EBITDA margins rebounded back over 21% in the quarter. It's important to note that while others are talking about expanding their lifestyle businesses, we are really the only one for whom this is accretive not dilutive to our overall enterprise margin.

Muuto continued to deliver on the promise we saw in the brand when we acquired it 18 months ago. Q2 was just another record quarter for Muuto as worldwide sales grew over 30%. About half of this growth was attributable to increased traction in North America where sales to Knoll dealers increased four-fold and total shipments grew by over 75%. We are now tracking well north of $100 million with EBITDA margins accretive to both the Lifestyle segment and consolidated Knoll with meaningful incremental EBITDA contribution margin from that growth. In the quarter, we continued to expand our inventory position in North America, rolled out a major wave of additional product samples and opened a dedicated Muuto flagship space on the fifth floor of our Fulton Market Space. Indicative of the forward momentum particularly in North America, orders increased over 2-fold and were above a record $10 million. And remember, we have yet to target the consumer opportunity in North America that we see for the brand as we continue to build out the IT capabilities that will be required for the consumer launch sometime in the back half of 2020.

Looking ahead to the balance of the year on the Workplace side, we remain encouraged by the double-digit growth in both the number and dollar values of opportunities we are tracking as well as those that have been awarded and not yet booked. Additionally, in June, the ABI Commercial and Industrial Index posted its third consecutive month of improvement and at 52.3 is in solidly positive territory. This, we believe, speaks to both the solid demand environment as demonstrated by the positive industry growth being reported coupled with the particular relevance of our solutions and the fact that with our expanded ancillary offerings, coordinated sales efforts and increased dealer share, we are expanding the amount of white space we can serve, increasing our share of our clients' furnishing budgets and improving our win rates too. Residentially, we continue to expect somewhat flatter results, but if you've seen year to date, we can leverage our Workplace position to drive continued Lifestyle growth. We feel inflation has peaked and, while we will continue to invest in the select expansion of our sales force, expanded visualization capabilities, IT infrastructure and showrooms, we feel good about our ability to continue to deliver improved profits in the back half of the year.

Now let me turn the call over to Charles to walk you through our results in more detail. Charles.

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [3]

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Thank you, Andrew. As Andrew discussed, we have continued to expand our sales growth through our constellation strategy. I'll walk through some additional details relating to margins, operating expenditures and key financial metrics.

Adjusted gross margin expanded during the quarter by 110 basis points due primarily to fixed cost leverage in our manufacturing facilities from higher volume absorption, continuous improvement activities and favorable product mix. These positive drivers were offset partially by inflation in transportation and commodities. The impact from tariffs in the quarter was minimal due to the strategic planning and sourcing of the products impacted by tariffs currently in effect. Sequentially, second quarter inflation decelerated moderately compared to peak inflation in the first quarter of this year.

Total adjusted operating expenses increased $15.1 million driven primarily by incremental volume-related expenditures, increased information technology spending and selling and showroom initiatives. Early in the second quarter, we successfully deployed the second phase of our ERP implementation, going live with the order management functions that support the front end of the business including order entry and customer service. We did not experience any significant disruptions to our business and have received positive feedback from our dealers. In addition, we made several showroom-related investments in various areas of the business, most notably in our new Chicago flagship showroom as Andrew previously outlined as well as Muuto-related expansion. We also increased our sales headcount and, while not nearly the level we expanded the sales force in 2017, it's a worthwhile investment to help fuel our ancillary growth in key markets across North America. Adjusted operating expenses exclude $2.1 million of amortization of intangible assets related to our acquisitions of the Muuto, Holly Hunt and Edelman businesses and Muuto-related integration expenses of $0.1 million.

Adjusted EBITDA margins increased to 13.2% in the second quarter of 2019 from 13% in 2018. The increase in adjusted EBITDA margin was due primarily to gross margin improvements that were offset by increased incremental volume-related expenses and strategic investments for future growth. From a segment perspective, adjusted EBITDA for the Office segment increased 50 basis points from 9.3% in Q2 of 2018 to 9.8% in Q2 of 2019. The increase was primarily driven by sales volume growth and continuous improvement initiatives partially offset by increased IT investment spending and volume-related selling expenses. Adjusted EBITDA for the Lifestyle segment increased sequentially by 220 basis points and decreased 10 basis points from 21.6% in Q2 of 2018 to 21.5% in Q2 of 2019. The decrease in adjusted EBITDA margin was mainly due to mix shift amongst our various Lifestyle businesses, additional investment spending in new product initiatives and our infrastructure footprint.

Interest expense was up $0.2 million from a year ago due primarily to higher interest rates partially offset by the decreased outstanding debt levels. The effective tax rate for the quarter was 25.1%, down from 26% in Q2 of 2018. The mix of pretax income and the varying effective tax rates in the countries and states in which we operate directly affects our consolidated effective tax rate.

Adjusted net earnings for the second quarter of 2019 was $23.6 million, up from $20.8 million for the same period in 2018. Adjusted net earnings is exclusive of the $1.9 million of tax-affected net earnings adjustments that were previously discussed related to the amortization from acquisitions, acquisition-related expenses and a pension settlement charge. Adjusted diluted earnings per share was $0.48 and $0.42 for the second quarter of 2019 and 2018 respectively.

Regarding our balance sheet and cash flow, cash and cash equivalents were approximately $2.9 million at the end of the quarter and our outstanding debt balance was approximately $450 million. Consistent with our focus on reducing leverage significantly within 18 months of strategic acquisitions, we further reduced our leverage during Q2, ending the quarter at just over 2.4x. Leverage reduction during the quarter was primarily driven by use of free cash to reduce outstanding debt as well as strong adjusted EBITDA growth. Cash provided by operating activities was $36.8 million in the quarter, largely offset by investments from capital expenditures of $12.7 million and cash used in financing activities of $23.6 million. Capital expenditures during Q2 related primarily to our showroom and information technology infrastructure and cashed used in financing activities in the quarter was primarily related to payments on our outstanding debt and the payment of dividends of $8.3 million. In the second quarter of 2019, we announced a 13% increase to our Q2 quarterly dividend based on our confidence in the effectiveness of our strategy financial position to continue to investment in our business and reduce our debt.

As we enter the back half of the year, we expect to continue to grow our top and bottom lines and improve our leverage ratio as we grow adjusted EBITDA and use free cash flow to pay down debt. We continue to focus on lean initiatives to drive our continuous improvement activities as well as actions to offset increased tariffs.

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Questions and Answers

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [1]

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As a new initiative this year, we've partnered with SAY.com to provide Knoll shareholders a platform to directly engage in the quarterly earnings call. We'll begin our Q&A portion of the call by answering the questions we received on SAY.com. We'll answer 3 questions, and the first question is as follows: It's great to see the dividend increase in May. How do you think about managing an increased dividend and continuing to invest enough capital into growing the business?

First, we're glad to see that you noticed the increased dividend. Our priority has been and remains to continue to invest organically in the business to drive growth and improve our profitability. This includes investments in new products, showrooms, selling tools and feet on the street as well as investments in our IT infrastructure to make Knoll easier to do business with as well as investments to lean out our supply chain. Today, we spend about $30 million of cash on dividend payments, which leaves ample free cash flow to invest in the business and simultaneously pay down debt. Given our free cash generation, we feel it's appropriate to return the excess cash to our shareholders in the form of a dividend payment. And as a reminder, we still have access to $200-plus million of available capital under our revolving credit facility for strategic opportunities and continued M&A such as the successful acquisition of Muuto in 2018.

The next question is: How does Knoll plan to attract more millennial customers in the face of competition with direct-to-consumer furniture companies like Feather pushing alternative furniture and purchasing-rental models? Andrew.

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [2]

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Thanks, Charles. Thanks for the question. It's interesting to talk about other channels, but we find today that with our core corporate clients employ the greatest number of millennials, and exactly these clients who are driving demand by competing to create more residential and hospitality-based workplaces that help it attract and retain millennial employees. It's one of the reasons we acquired Muuto and increased our focus on ancillary spaces with new designs like Rockwell Unscripted and our just-opened flagship Fulton Market Space in Chicago. We also believe it's one of the reasons we've been gaining market share as our offerings appeal to clients trying to attract millennials. Specifically to the question around alternative go-to-market models, we're in the process of commencing, actually, a test with Feather to support their business and it will be interesting to see how that goes. We are also devoting time and effort in 2019 and early 2020 to the development of more B2C capabilities, most notably with Muuto, but also with Holly Hunt. These capabilities will serve both the individual consumer, designer and small business markets with the latter being an area we've not historically played much in. So a considerable opportunity there as well.

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [3]

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Great. The last question from SAY.com is: How has the rise of augmented reality for showcasing interior design affected Knoll's future plans?

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [4]

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Very much so. With regard to augmented reality, we're excited by the potential of AR functionality in our direct-to-consumer home design shop at knoll.com where we're testing, and you can go on and see this, a selection of our most popular classic designs in AR for those using iPhones, who want to see these products in their space. On the Workplace side of our business, we see huge potential for just-in-time visualization through configure and see to designer software. The ongoing rollout of this 3D specification tool makes it easier for our dealers to simultaneously integrate and visualize the full breadth of our Workplace and ancillary offerings in real time as they work with a designer and client. As we build out this capability, we have the potential to continue to leverage AR and virtual reality functioning as well. Now we'll turn the call over to the operator for some live questions.

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Operator [5]

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(Operator Instructions) Our first question comes from Greg Burns of Sidoti & Company.

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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [6]

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So the margin leverage was a little bit less than I would have expected given the strong sales growth, and it does sound like you're making some growth investments in the business. But historically, you've talked about looking to expand the EBITDA margin about 50 to 100 basis points a year. Is that still a good way to think about the business for 2019 and 2020?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [7]

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So looking forward, as we discussed, we had a pretty strong first half of 2019. We do think that we had some shipment activity pull into the first half of the year ahead of our ERP go-live. As we look at the remaining pipeline, our shipments are probably more heavily weighted to Q4. Nonetheless, we're seeing positive indicators of pipeline opportunities overall. And on a full-year basis, we expect that the top line is going to grow faster than the industry average. You asked specifically about margins. We're also expecting expansion in adjusted EBITDA margins on a full-year basis for 2019 compared to the prior year. The adjusted EBITDA improvements depended upon continued top-line strength and gross margin improvement to offset our strategic investments in the back half of '19. We anticipate gross margin improvement from continuous improvement activities as well as the dissipation of commodity and transportation inflation and volume absorption. These factors will be offset by tariffs and we'll see what price realization is. So we still expect EBITDA growth.

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [8]

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And Greg, this is Andrew. I would just add a couple things. Actually, in the first half on an operating profit basis, we got over 50 basis points of operating margin improvement. So it was a little bit more diminished at the EBITDA level, but we're getting in that 50 to 60 basis point range on the operating profit side and I would expect to see continued operating profit improvement. It may be a little bit more muted at the EBITDA level, number one. Number two, we are very much in this phase of investing to drive growth. And when you look at what we've done now with Muuto where we've got something working, we've made decisions to lean in heavier and are putting additional investments in place to drive that harder, to get it more broadly exposed. In the second quarter, we had a significant cost, as you can imagine, from the launch of the Fulton Market Space, which was also a significant investment. And we've also decided to do some additional investment in ramping up our sales coverage particularly in our high-opportunity dealers. We did some tests last year and we saw real differentiated performance when we put a Knoll person in a high-opportunity Knoll dealer in moving share our way. When you look at the total share number we reported, and you saw the 400 basis point improvement in dealer share, I think that's evidence that that's working, but we're leaning into more of those people. So I think right now we're in a time where it's a healthy market, our products and designs are resonating; this is exactly when I think we should have our kind of foot on the pedal a little bit in terms of trying to even accelerate investments that we think over the next 2 or 3 years will drive better than industry growth. In terms of what this means for 2020, again we're going to target at least 50 basis points of margin, both operating and EBITDA margin improvement, and I just think it's too early to see exactly how that will play out as we won't really start our planning until the end of the summer.

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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [9]

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Okay. Great. And then in terms of Muuto, really nice growth on that front. Are you seeing, having Muuto in your portfolio, are you seeing that pull the rest -- pull sales for the rest of your business? Are you seeing more opportunities because you now have Muuto? Or maybe are you able to get a larger percentage of a project now that you have Muuto? Can you just talk about that dynamic, having that broader portfolio of products?

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [10]

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Well firstly, I think everyone thought we were crazy when we acquired Muuto and obviously with the price we paid. And we said to everybody we thought we could double the business and double the earnings in 3 or 4 years. We are very much on that path today. So we feel confident that in 1 to 2 years Muuto will be in excess of $150 million with well north of 20% EBITDA margin. So the whole theory is playing out very much as we expected, and it really was based primarily on leveraging our dealers and our corporate relationships here in North America and capturing more of what our clients are spending so that when we win a workstation or kind of a core office project, we can layer in these ancillary pieces. Well as the ancillary is becoming a bigger part, that story and that theory is actually even more impactful. So we're very much seeing Muuto being captured by our clients that we have relationships with and our dealers as they're looking to do more of their complete space. And I've got a bunch of examples I've been involved in here in New York and elsewhere, where we win the system, but we're really focused now on driving that. And clients are saying, “Yes, let's just drop -- let's just drop your stuff in.” So I think that's working really well. The other thing that's really happening within our clients is that there are so many areas that Muuto plays in that we didn't even touch before. So cafes, not our forte, meeting areas. They're putting -- I mean we just came from a wonderful hotel project that's filled with Muuto stacking chairs. Again, a client of ours, but we never could have played in those parts of the opportunity. We're doing a lot more restaurants and hospitality. So clients where we may have done corporate work for them, we didn't do their restaurants, we didn't do their cafeterias. So it's really broadening out the playing field we have. And then again, as we've noted and you've noted, we're not even touching the consumer opportunity in North America right now. And we've got a lot of infrastructure work to do. We've really focused on the corporate side. But the Muuto team is an extraordinary team, great leadership. The partnership between us and Muuto has been phenomenal. They're great people to work with. They're high-quality contract products. It's great and it's going to be greater.

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Operator [11]

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And our next question comes from Bud Bugatch of Raymond James.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [12]

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If I could, the operating expenses in the second quarter increased $15 million, I think, on the adjusted operating expense line. And maybe we could get a little bit more flavor and some detail as to what made into those operating expense increases.

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [13]

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Yes, sure, Bud. So you're right. It was up $15 million this quarter over last year. As we talked about, it's primarily related to volume-related increases for incentives and commissions, dealer compensation, et cetera as well as increased investments in some of the showrooms that we discussed, most notably Chicago, and some North American sales headcount and then some additional spending on strategic investments. Andrew outlined earlier sort of our mentality. We had our ERP go-live in early part of Q2 and once you go live you've got hypercare, where you stop capitalizing those costs and they burn straight through to the P&L. That completed in early July so we're now out of hypercare. But I think the thoughts that we have are we continue to invest and while this is a little bit of an elevated level, we think for the quarter in terms of percentage of revenue, probably come down to maybe the 28-ish% level for the full year.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [14]

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So you're telling me that 50 basis points of 28.5% is what was non-recurring or kind of would not be in the…

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [15]

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I would say we're going to be somewhere between 28% and 28.5 for the full year. I'd say in this particular quarter, there was probably 20 to 30 basis points of things that we think were more onetime-ish. Charles mentioned the ERP. We had the showroom launch and things like that. But I think we're going to be in the 28-28.5% range for the, frankly, for the balance of the year, for the third and fourth quarters. So the first quarter was a little lower. But I still think you'll see it at a bit of an elevated level. And I can just tell you that's the very conscious strategy. When we have things that are working well, I think we want to lean into them. And so could we knock that down 50 to 100 basis points? Absolutely. But I think this is not the moment to do that. And I think we've shown the ability to adjust and scale our SG&A as appropriate. I think right now this is a time to keep investing. And we see great opportunities and we want to take advantage of them. And frankly, I think that's what our shareholders want to see us do as well. This is a good time for us.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [16]

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No, I have no disagreement with that. I'm just trying to understand how much of the increase might be stuff that was non-investing and non-recurring.

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [17]

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Maybe 20% to 30%.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [18]

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Okay. And in Muuto, your initial strategy and your current strategy, as I know it, is more of what I would call an inventory solution. You bring in product from offshore and that is the product that is available domestically. Is that strategy still there? Or are you considering now some additional production strategy or some make the strategy domestically?

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [19]

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Yes. That's a great question, Bud. So yes the initial strategy has been kind of inventory. Now what we're doing is we're taking the highest-volume Muuto products and we're starting to make those in North America. And our goal would be -- what that does is it allows clients to do COM. It opens a lot more of our textiles and leathers to application on Muuto products. And it reduces the lead time when you want to do something non-standard. So that pipeline is now getting put into place and is starting to be operational, was operational in the second quarter. We'll expand it in the balance of the year and add more products. But definitely, we think broadening out the finish and material capabilities with Muuto also broadens out the market potential pretty significantly. So it's a dual strategy.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [20]

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And so to complete the thought on that, those are capabilities that I'm not sure Knoll has internally. Are you outsourcing those capabilities? Or are you building and insourcing for that?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [21]

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Outsourcing. Outsourcing.

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [22]

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And that goes with the whole light approach to Muuto. So it's very consistent with the brand. And doing it in a very high-quality way. I mean I think that's the other thing about Muuto is that it's not just ancillary; it's high-quality ancillary, and it's contract-quality ancillary. And that's not true of what everyone else is doing in those areas.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [23]

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Okay. And lastly from me, can you kind of give us a feel where your share of wallet in your dealer base? What's the share of wallet for Knoll products?

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [24]

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Yes. I think we're now pushing up to 55% and that's up from the low 50s% to the mid-50s%. And I think our -- we certainly see another 5 to 10 points of share gain within our dealers. Remember, each point of share gain is roughly $15 million. So it's not an insignificant opportunity within our dealers. And it will be driven by all this kind of ancillary stuff because our share of the core workplace products is, I'd say, probably 85% or 90%.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [25]

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Is there much variance among your dealer base in that? Is that a wide standard deviation? Or is that pretty tight?

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [26]

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Well, I think, when you look at the top 40 or 50 dealers, we probably have slightly more share. And then as you broaden it out below the top 40 or 50 dealers, our share is probably less. So it's a strategy that works across the dealer network. But what I would say is we're taking those top 50, 40 or 50 dealers, and even though we may have slightly than average there, share there, that's where the dollars are. And so when we think about deploying what we're calling our dealer brand managers into those markets, we're deploying them into those highest-opportunity dealerships to really sit there and make sure Knoll products are specified. And so -- and again, we did that test last year. It worked well. That's one of the incremental investments that we decided to go ahead with this year that wasn't in our initial thinking. But the data says it works and we're going to keep doing it.

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Operator [27]

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(Operator Instructions) Our next question comes from Matt McCall of Seaport Global Securities.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [28]

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So 28% to 28.5% get you to, I think that would be about 70 to 140 basis points of SG&A deleveraging this year. Can you talk about the outlook for gross margin? You've done a pretty good job in the first half. It looks like the comps get a little tougher. The gross contribution margin comps definitely get tougher in the back half. But what's the outlook for gross margin? I never did hear a net outlook for EBIT and EBITDA margin expansion or contraction this year.

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [29]

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It's Andrew, Matt. I'll go a little bit then I'll let Charles dive in a little more deeply in stuff like that. Listen, I think for the full year, given the incremental investments and the things that we're doing, we're probably going to be in the 20 to 30, 40 basis point improvement in terms of EBITDA margins. I think at the operating -- yes, I mean the operating level probably pretty similar. So and I think you can directly attribute that to some of the incremental investments that we've decided to make. So I think probably 20 to 30 is a more realistic number. It's been a little bit muted by the additional tariffs. The tariffs, for us in the back half, are $3 million or $4 million. So it's not a huge number, but that's probably the difference between getting to the 50 basis points and maybe to 30, 20 to 30, where I think we'll be. So that's kind of the outlook there. And I think again, as we said, we see inflation decelerating. Steel now -- again, we had some collars so we weren't as hit as badly as others last year in steel. But the third quarter we're kind of neutral. The fourth quarter I think we'll get some more margin pop from steel. So I think you'll see the biggest gross margin improvement in the fourth quarter. Also our tariff mitigation efforts we kind of put on hold because at the 10% level they didn't make sense, but at the 25% level they do make sense. So we're about a quarter behind on reacting to that. So that will help fourth quarter. So I would expect that sequentially from the second to the third you'll see some gross margin improvement and then I think from the third to the fourth you'll see some more gross margin improvement. But the fourth is where I think you'll see kind of the greatest year-over-year gross margin improvement from where we've been.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [30]

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Okay, that's helpful. So I guess the next question is really kind of putting together all the top-line commentary. I think you said you're going to outperform the industry and you've got the dealer share of wallet opportunity. You've got Muuto continuing to grow a lot. I guess put it all together. Start with the industry growth and then talk about the expectations beyond that. What's your industry growth expectations, your expectations for growth beyond that? Because while the margin comps appear to get tougher, your top-line comps actually get easier in the back half. So what does that mean from an overall growth rate perspective?

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [31]

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I actually think the top-line comps get a little bit tougher in the back half than the front half, Matt. But anyway, listen, as I look at -- break it a couple ways. The macros are pretty good. And I know that you published some commentary on the macros and stuff like that. But I have to say, absorption remains strong. 19 of the top 20 markets are showing positive absorption over the last 4 quarters. And in fact, year-to-date absorption has been equivalent to what happened the full year in '16, '17 and '18. Leasing activity looks solid. Tech and co-working probably the biggest drivers, but government has been very strong as well. And rents continue to increase, which I think is kind of indicative of demand for space. You can look at the headline ABI, which is skewed lower by residential, but the commercial ABI is really solid in everything. And so we feel good about that. Then you have the secular trends like the resimmercialization of the workplace, the nice safe question about millennials you've got competition for attracting and retaining. So I think that's all a pretty good background for us. And then I look at our pipeline and our funnel of opportunities and they're both up double digits. So I think it's a good background. I don't think we're going to keep growing at kind of a torrid 10% to 15%. I think you settle down into like a mid- to kind of mid- to upper single-digit kind of growth rate quarter-over-quarter for the balance of the year. And then I think as we head into 2020, I think what you'll is if we continue with that mid- to upper-mid single-digit rate, I do think the SG&A spend is going to moderate as we get into 2020 and I think we'll get back in 2020 and beyond to more like the 50 to 100 basis points of contribution margin. Because the other thing going on is the way our mix is evolving, it's also supportive of higher margin. So that's kind of how I would see it playing out over the next couple of quarters and into 2020. If that's helpful.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [32]

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No, it's very helpful. So there's the comp, I guess, confusion. If I look at total sales growth, you're right. The comp -- well I actually still see the comp getting easier. The organic growth looks like around 10% in the first half of last year falling to 4% or 5% in the back half. Maybe I need to -- does that not match your numbers from an organic growth perspective?

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [33]

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I don't have last year broken out like that so I can't give you it off the top of my head. I just think we're going to settle into like a mid- to upper-mid single-digit growth in the back half of the year. That's going to give us upper-single low-double for the full year. As we think about planning for next year, we'll be thinking mid- to upper single-digit growth. And we're not turning down business. Let me put it that way.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [34]

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Okay. The last question I had was really around some of the facility conversation that we had or facilities conversations that we've had in recent quarters and some of the analysis you've been doing there. Is there any update there?

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [35]

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No. I mean we continue to kind of lean out our operations. We're very much in the midst of taking a big picture look at what we're making, where we're making and what we should be doing down the road. And I would imagine as we get into 2020 that will crystalize even further. But I think I have to say I think our sites are doing a nice job of leaning out their operations. We're doing some things like we announced the discontinuation of our Marson system last quarter. That frees up space. So there are a lot of things we're doing to leverage and create space to continue to become more efficient in our manufacturing operations.

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Operator [36]

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And at this time, I have no other questions in the queue. I would like to turn the call back over to Mr. Andrew Cogan for closing remarks.

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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [37]

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Great. Well, thank you, everybody, for the super questions on today's call. And we appreciate the SAY shareholders participating. On behalf of the 3,800 associates at Knoll, I want to thank all of you for your continued interest. And really, really, if you find yourself in Chicago, please stop by Fulton Market and experience the space in person. So have a great summer and we'll talk to you all in the fall.

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Operator [38]

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Ladies and gentlemen, thank you for your participation in today's conference. You may disconnect. Everyone, have a wonderful day.