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Edited Transcript of KNL earnings conference call or presentation 7-Feb-19 3:00pm GMT

Q4 2018 Knoll Inc Earnings Call

EAST GREENVILLE Feb 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Knoll Inc earnings conference call or presentation Thursday, February 7, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew B. Cogan

Knoll, Inc. - Chairman, President & 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

* Brian Biros

Thompson Research Group, LLC - Associate Equity Analyst

* 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, Inc. Fourth Quarter 2018 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 limitations, 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 and described in the 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 Chairman and CEO of Knoll. Thank you.

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

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Thank you, operator. Good morning, everyone, and welcome to our year-end 2018 earnings call. We ended our 80th anniversary year on a strong note as we delivered a record quarter of shipments in a record year of sales with 120 basis points of adjusted EBITDA margin improvement and the strongest adjusted EPS performance of the year.

For the full year, we delivered sales of just over $1.3 billion, an increase of 15% versus prior year and an organic increase, excluding Muuto, of just over $83 million, a very strong 7.4% increase.

Our Office segment grew by 8.2%, and Lifestyle by 26.9% or 6% organically. Total workplace sales, which as you recall, include Lifestyle products sold into workplace settings, grew by 13%, significantly exceeding the 4.7% reported by BIFMA. And Lifestyle sales for the full year represented a record 40% share of our revenues and 63% of our adjusted EBITDA. While organic growth slowed in the fourth quarter, workplace growth remained a strong 10%, and we entered 2019 with backlog up double digits as orders growth rates exceeded shipment growth rate in Q4.

Adjusted EBITDA of $176.5 million increased $32 million or 22% versus prior year. And adjusted EPS, including the benefit of a lower tax rate, increased by 30% from $1.42 to $1.85.

Our brand proposition, that good modern design has a meaningful impact on the quality, well-being, productivity and happiness of the way people live and work remains as relevant today as it did back when Hans and Florence founded Knoll in 1938. In fact, today, I would argue that the value of our constellation of design-driven brands is more relevant than ever as the boundaries between how we live and work, the environments in which we live and work and the range of generations that live and work come closer together than ever before. It's proof I see when I walk into some of our most dynamic client environments and observe products like the Cesca chair, designed 80-plus years ago, cohabiting in a beautiful and functional way with designs of ours like Rockwell Unscripted that were just introduced in 2017. And it's backed up by a growth rate meaningfully greater than that of the markets in which we play. The resimmercialization of the workplace and the blending of products that are accompanying it is frankly an environment tailor-made for Knoll. And the evidence of our growing relevance is in the record number of clients and dollars spent on Knoll designs this past year. And the fact that we are able to monetize that interest to generate both improved and industry-leading levels of profitability, particularly in a year where external forces challenged our margins like never before. But it's a lot more than the products and culture that have helped Knoll thrive over the past 80 years, and that's the 3,541 associates at Knoll around the world. Some of whom have been with us for over 45 years like Jane Rozanski, who leads our KnollStudio supply chain. To those at Muuto who just joined us this past year that make these great results possible. I want to first thank all our people for their commitment to our mission and results and then our dealer partners, architect and design enthusiasts and clients that come to Knoll to allow us the privilege of helping shape the environments where they live and work.

This morning, I'll let Charles walk you through the year-end results more specifically, and wanted to instead use my time with you to focus on a few key topics. A year into the Muuto acquisition, the results-to-date have validated the thesis upon which we based the acquisition, namely that we could drive the sales of Muuto's fresh perspective on Danish design through our North America workplace distribution and A&D and client relationships to fill a significant void in our ancillary offerings to both grow Muuto and increase our share in these more social and collaborative areas of today's workplace. And that we could do so at 20%-plus levels of adjusted EBITDA margins, while simultaneously funding the investments and rolling out the business in North America. Over the course of the year, as we've established a deep inventory of Muuto products in North America, trained our sellers and dealers in how to position Muuto and introduce Muuto to our installed base clients, we've seen Muuto's momentum accelerate.

In Q4, orders grew at the fastest rate of the year, just a smidge shy of 50%, and we entered 2019 at Muuto with a backlog up 40% versus prior year. This marked a meaningful improvement over the full year order's growth rate of a not-too-shabby 23%. While Muuto continues to perform well outside of North America too, our investments in additional products, sales resources, local supply chain and channels is just beginning to impact the business. And we have tremendous white space in the consumer/residential market both here in North America and elsewhere, that is in the tens of millions of dollars that we intend to target as we complete the foundational workplace and contract investments.

Since the closing of the Muuto acquisition, we've reduced the debt we took on to acquiring Muuto by over $80 million and combined with our improved results across the constellation, we ended the year with a leverage ratio of 2.64:1 down from 3.12:1 at the end of Q1 '18. We've clearly seen acquisitions that we can move with through both our contract and residential distribution channels, deliver compelling returns and strengthen our position in the marketplace.

2018 was a terrific year for DatesWeiser as we grew the business by 46%, and achieved positive EBITDA results. We can now meet the needs of our clients from meeting and conference spaces that in the past we saw others captured. Like Muuto, DatesWeiser enters 2019 with a significant increase in backlog compared to where they were this time a year ago, and they are now a regular part of our constellation story. Even a relatively small acquisition of the unparalleled Vladimir Kagan business back in 2016 through HOLLY HUNT, turned out to be a goldmine. Not only have we more than doubled Kagan sales as we've leveraged HOLLY's network, but we've done so in amongst the highest levels of profitability of anything we produced at Knoll. In fact, not only did we have record years at Muuto, DatesWeiser and Vladimir Kagan, but past acquisitions like HOLLY HUNT and Spinneybeck, Solstas also delivered record results, as these business leveraged the power of the reorganization of our expanded North America constellation sales team and marketing strategies and execute against their own individual growth plans.

Our European business also enjoyed record sales and profits as did KnollStudio. In fact, globally, our flagship and iconic KnollStudio collection set sales records as workplace clients demonstrated new interest in blending our iconic designs into contemporary workplaces, while we simultaneously drove broader efforts to sell into consumer and residential markets through our existing partners, a new LA shop -- a new Knoll shop in LA and an expanded trade presence in Europe with our first time participation last month in the Cologne furniture fair.

As we look into the New Year, we are watching to see whether weakness in housing in general, overall stock market volatility and uncertainty in Europe impact some more residential and consumer-facing businesses. Similarly, we are attuned to the potential impact of trade wars, global government dysfunction and economics uncertainty on our office business. However, we are heartened that on the workplace side, the funnel of dollars and project count remains nicely up heading into 2019. Our portfolio is increasingly relevant for collaborative and social/hospitality workplaces, and the successful integration last year of our KnollStudio and office workplace sales teams and resources should only continue to yield benefits in 2019.

Investments in higher performance, well-priced ergonomic seating and desking continues to drive well above average growth in the Office segment, new product platforms like Rockwell Unscripted continue to perform strongly with sales more than doubling in 2018, and we believe our efforts to capture a greater share of our client spend and share of our dealer sales, as we expand our ancillary collections and capabilities, is just beginning to bear fruit.

Today, the share of sales from new workplace designs exceeds that we get from our legacy platforms, and we have exciting new product initiatives to deepen our capability across the board coming to the market in the year ahead. I would expect all of the above to help us continue to live our better-than-BIFMA top line workplace performance in 2019, as we gain share in underpenetrated ancillary spaces.

Given uncertainty around potential additional inflation and ultimate tariff levels, it's hard to give -- it's harder to give specific margin guidance for the year. Nevertheless, our goal remains unchanged: namely, to consistently deliver 15% adjusted EBITDA margins, with a target of at least 50 basis points of annual improvement on that journey. We aim to do so through a broad spend of initiatives. These range from organic initiatives to expand the sales and breadth of our high-margin Lifestyle portfolio, acquisitions of margin-accretive businesses like Muuto, new product development efforts that lead to above average margin products like Rockwell Unscripted, initiatives to gain share of higher-margin ancillary spaces in the workplace to actions on both the variable and fixed side to improve our cost position, increase our efficiencies and better leverage our showrooms and sales resources. In 2018, the combination of efforts like these led to 50 bps of adjusted gross margin improvement despite above average commodity and transportation inflation and 80 bps of adjusted EBITDA margin expansion from 12.8% to 13.6%. I'm particularly pleased that in the back half of the year, we averaged adjusted EBITDA margins of 14.3%, closer to our goal of our 15%.

To inoculate ourselves against the uncertain cost environment, we have decided to implement our third price increase in the past 18 months this coming March. Our supply chain reinvention efforts and continuous improvement efforts continue to yield positive near-term results. And we have an exciting roadmap for the years ahead to build a leaner, more efficient Knoll as we reduce excess capacity, prune older, less profitable designs and better leverage our global supply chains.

We continue to invest aggressively to position our brand and businesses for success in the years beyond 2019. While in the short-term, these investments pressure SG&A and CapEx spending, we believe they have a potential to help us to continue to deliver better-than-industry top line growth and superior levels of profitability and shareholder returns. In 2019, these include the opening of a new flagship constellation showroom in Living Lab outside the Merchandise Mart, Chicago. As we leave the usual suspects behind, we feel this base will make a compelling case for why Knoll and why Knoll now. We are making significant web investments at both HOLLY HUNT and Muuto to enable those businesses to develop more contemporary, broader, deeper and stickier client engagements. And the office side, our investments in 21st century specification tools will materially shorten and simplify the specification process, while improving our ability to share real time visual simulations and renderings with our clients on the fly.

We are also looking at adding dedicated constellation sales resources into our greatest opportunity dealers to accelerate our share gains and ancillary growth. The next phase of our 1 Knoll ERP implementation, including the sales and order management module will go live in Q2, and the team has done outstanding work to prepare for this important milestone, which will have significant productivity and ease of doing business benefits in the years ahead. And last but certainly not least, as we entered the New Year with the strongest team of leaders I've had the privilege of working with. These folks are super dedicated to our vision for Knoll and delivering to our shareholders the level of superior performance you've come to expect from us.

Charles?

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

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Thank you, Andrew. Since Andrew covered the year-end review pretty thoroughly, I'll give details on the fourth quarter results as well as some additional commentary.

Net sales in the fourth quarter for Knoll, Inc. increased $38.5 million or 12.2% from a year ago. Adjusted gross margin in the fourth quarter was 37.4% compared to 35.5% in 2017. The margin expansion was primarily due to growth of the higher-margin Lifestyle segment sales as a percentage of total Knoll, Inc. sales. And whereas we experienced positive volume growth, price realization and positive continuous improvement contributions to margins, these were largely offset by transportation and materials inflation versus the prior year.

Adjusted gross margin excludes a $0.7 million seating product discontinuation charge from the disposal of inventory and fixed assets related to the discontinued product. Total adjusted operating expenses in the fourth quarter were $93.2 million compared to $80.3 million in 2017. The increase was due primarily to incremental operating expenses from Muuto, as well as increased investments in warehouse and showroom costs, which we believe will create a stronger foundation for continued growth.

Adjusted operating expenses exclude $2.5 million of amortization of intangible assets related to our acquisitions of the Muuto, DatesWeiser, HOLLY HUNT and Edelman businesses and acquisition-related expenses of $1 million. Acquisition-related expenses include retention agreements for key Muuto employees and other customary acquisition costs.

Adjusted EBITDA for the fourth quarter of 2018 was $50.4 million, up from $41 million for the fourth quarter of 2017. The increase in adjusted EBITDA was due primarily to the inclusion of 3 months of Muuto operations, higher sales volume in the Lifestyle segment and net price realization in both the office and lifestyle segments. The adjusted EBITDA margin increased to 14.2% in the fourth quarter of 2018 from 13% in 2017. The increase in adjusted EBITDA margin was due primarily to gross margin improvement as Lifestyle sales represents a larger percentage of total Knoll, Inc. sales.

Interest expense was up $3.1 million from a year ago due primarily to increased debt levels as a result of the Muuto acquisition and higher interest rates. The company's effective tax rate for the fourth quarter of 2018 was 23.3%, down from 39.2% in the fourth quarter of 2017. The 39.2% rate in Q4 2017 is exclusive of the onetime impact of the Tax Cuts and Jobs Act, also known as tax reform, where the company recognized a onetime tax benefit of $26.6 million from the remeasurement of net deferred tax liabilities at the new corporate income tax rate of 21%. The significantly lower effective tax rate in the fourth quarter of 2018 was primarily due to the passage of tax reform in December of 2017. The tax rate was also affected by the mix of pretax income and the varying effective tax rates in the countries and states in which we operate.

Adjusted net earnings for the fourth quarter of 2018 were $28.2 million, up from $18.1 million for the same period in 2017. Adjusted net earnings is exclusive of the tax effective net earnings adjustments that were previously discussed totaling $3.7 million, that were related to a seating product discontinuation charge, amortization from acquisitions, acquisition-related expenses and a pension settlement charge. Adjusted diluted earnings per share was $0.57 and $0.37 for the fourth quarter of 2018 and 2017, respectively.

Capital expenditures for the quarter were $19 million compared to $11.2 million for the fourth quarter of 2017. Capital expenditures related primarily to our information technology infrastructure, manufacturing equipment and showroom investments.

Regarding our balance sheet and cash flow, cash and cash equivalents were approximately $1.6 million at the end of the quarter, and our outstanding debt balance was reduced to approximately $461 million. We finished the quarter with a leverage ratio of 2.64x. Operating activities provided $44.5 million of cash in the quarter compared to $44.3 million in the prior year. Total cash used in financing activities was $20.1 million. We used cash in financing activities during the fourth quarter of 2018 to pay down $15 million of debt and quarterly dividends of $7.2 million.

Consistent with past quarters, we used excess cash generated from operating activities to invest in the business, pay dividends and reduce outstanding debt. For the full year 2018, cash flow from operations was $108.2 million compared to $103.7 million in 2017.

Capital expenditures for full year 2018 were $40.3 million compared to $40.6 million in 2017. And our full year 2018 effective tax rate was 25.4%, down from 31.8% for 2017, exclusive of the onetime tax reform benefit in 2017.

As we move into 2019 and further to the comments that Andrew made previously, I'd like to make a few points around interest and taxes. We entered into a forward interest rate swap arrangement at the beginning of 2018 with $300 million of variable rate, LIBOR-based debt being swapped for a fixed LIBOR rate starting on January 1, 2019. The swap arrangement will be in effect until the maturity of the current credit agreement in early 2023, and the swap amount will reduce by $50 million each year.

During 2019, approximately 60% of our average debt will be covered by this interest rate swap. We expect our average interest rate to be approximately 3.8%. In addition, we expect our full year effective tax rate to be between 25% and 26%. We expect to use our available cash for investments in the business, the payment of dividends and the repayment of outstanding debt.

Thank you. 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) Our first question comes from the line of Budd Bugatch with Raymond James.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [2]

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A couple of questions, if I could. Muuto, I think the sales on the fourth quarter were set at $26.8 million. And I know you talked about the programs that you're getting in the states or in North America. Can you quantify how much of that's in the U.S. versus -- or in the North America versus overseas?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [3]

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The fastest-growing, I'm not going to break it down specifically, but what I can tell you is the fastest-growing part of the business, Budd, is in North America. And in North America, we're growing the business 4 or 5 times a month versus what they were doing a year ago. So it is scaling very rapidly and very significantly. And I'm encouraged even, you know, just in January, we saw 15% orders growth across Muuto around the world, and we saw something like 300%, 400% growth in North America. So it is scaling meaningfully and very much consistent with what we expected when we acquired the business. But it's encouraging to see it accelerate every quarter that we've owned the business.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [4]

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So would it be fair to think maybe 20% of that is North America? Let me try to think about it a little bit.

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [5]

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I think probably 20%, 25%, if you want a round number.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [6]

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Okay. And what about the order rate of -- in the quarter versus the $26 million or $27 million that you post, how does that look?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [7]

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It was greater.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [8]

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You want to quantify that a little bit?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [9]

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I think all I can quantify is, the orders growth rate in the quarter grew just under 50%, which was significantly greater than the shipment growth for the business. So the momentum, I think, the takeaway, Budd, is the momentum is accelerating with Muuto.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [10]

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Okay. And in Lifestyle then, outside of Muuto, Lifestyle grew, I think, $9.8 million, just under $10 million elsewhere. You said DatesWeiser had a good quarter. It was pretty small as a beginning. Can you kind of quantify where the growth in Lifestyle outside of Muuto came from?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [11]

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Sure. I think KnollStudio was certainly a standout for the quarter. We've had real success in leveraging kind of these our iconic Studio designs into contemporary workplaces. And so there are several Studio programs now. So I'm really encouraged by the acceleration of Studio's performance as we end the year. So Studio certainly was a standout when we look at the business, then, I think, followed by DatesWeiser. HOLLY HUNT also had a very good fourth quarter of growth versus prior year. And again, as I mentioned, the Vladimir Kagan business has just exploded as we moved it through HOLLY's channel. And they -- in January, Kagan set a record for orders, so we've almost tripled that business now. And those margins are the highest of anything we do at Knoll. So it was pretty broad-based. It was not just Muuto, it was Studio, it was HOLLY HUNT. We have seen some stabilization in coverings, FilzFelt is doing well. So I'd say it's pretty broad-based, Budd.

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

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Any disappointments in Lifestyle that's there?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [13]

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Not particularly. I mean, there's always work to do. We continue to push hard on moving other products through the Edelman distribution channel. We think there's opportunity there to do more. But in general, I mean, you look at Lifestyle outperforming any of the BIFMA data, you look at our total workplace number outperforming any of the BIFMA data book on a quarterly and a full year basis and you look at the orders momentum and the key initiatives and key product categories and it's all, I think, quite encouraging.

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

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Okay. Office margins though, were an area that looks like it was challenged and you talked a bit about pressures there. Can you talk about what you're -- I would imagine you're pressured by raw materials mostly in office, but maybe you can give us some color as to what happened in office and what the outlook is?

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

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Charles?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [16]

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Yes, sure, Budd. So yes, to your point, we had a significant amount of inflation this year, year-over-year, which was offset largely by our price increases and some volume absorption, as well as a lot of the CI activities we've talked about in the past. So we had good pull-through there and then good mix with the help of Lifestyle coming through as well. So going forward, when you look at 2019, we still expect to see some year-over-year inflation in both materials and transportation, mainly weighted towards the first half of 2019. And then we've also layered in some additional CI activities for 2019 we're hoping to offset. As Andrew mentioned previously, we have another price increase that's set to go into effect in March, which should help offset as well. On a basis point comparison basis, we might expect to see 50 to 100 basis points of inflation throughout the year in 2019. Again, probably weighted to the first half of 2019, and then to offset that with the price increases, we're looking for maybe 50 points -- 50 basis points of offset there, and then targeting 100 basis points of continuous improvements in cost-saving activities.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [17]

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So if I read that right, Charles, in the first half, we'll have a difficult comparison margin wise in the Office segment, is that the way to think about it? And then, perhaps, picking that up in the second half?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [18]

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I think that's right.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [19]

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Okay. And add-backs, I'm a little bit confused in add-backs. What are you looking at in 2019 for the non-GAAP adjustments for add-backs, particularly as it affects EPS but also as it affects EBITDA?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [20]

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Sure. The recurring add-backs that we'll probably have going forward, obviously, acquisition-related expenses. We've begun to add back amortization related to the acquisitions, most of the people in the industry are doing it now.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [21]

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It looks like it was $2.5 million in the quarter, is that right?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [22]

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It was about $1 million in the quarter for acquisition-related expenses. And then D&A, in total, was $9.1 million, which is inclusive of some of the acquisitions as well.

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

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No, the acquisition I think was $3.5 million as it affected pretax for EPS calculation. It looks like on the callout, it was $1 million, as affecting the adjusted EBITDA, and then the balance was it -- that amortization was in D&A, right?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [24]

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That's correct.

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

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That would have to be $2.5 million to be -- for the amortization, right?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [26]

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That's right.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [27]

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So if that's continuing, is it going to be $3.5 million each quarter? How do we think about it for 2019, and is...

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [28]

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It will likely be fairly consistent next year. Some of the intangible asset starts to wind down over some period of time. But next year, it will likely be fairly consistent.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [29]

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Okay. And at the end of '19, where do you think debt will be at the end of '19? You paid off $80 million this year, where do you think you'll get debt to by the end of 2019?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [30]

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We think we can pay down another $50 million to $60 million. I think the goal is to get it down to the low 2 -- 2x range.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [31]

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Okay. And you wrote off $700,000 or $900,000 in -- $700,000 in the quarter in a seating product inventory, what product did you discontinue, Andrew?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [32]

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Budd, there were just some general seating discontinuations. We're doing some pruning of our seating line. We've also, as you know, announced the discontinuation of the Marson system come the middle of this year. And again, all of these moves are part of kind of freeing up space in East Greenville from a manufacturing standpoint. So we focus on the highest margin, most productive use of those spaces.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [33]

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Was there much seating in Marson, I...

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [34]

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There was seating in that. In the whole Lubin building, which is where we do both Marson and seatings, we're clearing up room. We have new products coming on. We have the Aloe chair ramping up. We have a really innovative high-performance chair that we hope to bring to market around NeoCon. So there's a lot of rearranging going on and these moves are all part of that kind of multiyear roadmap that we completed in the fourth quarter.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [35]

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And to that point, most of the gains in CI come to the -- when the fact that you gain space as you go on the lean journey. Is there any node in the system that looks like it's ready to come out? How much space have you gained by some of your lean journeys?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [36]

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No, again, I think, as we've talked about in the past, the challenge over the last year or 2 of the lean stuff is when you pick up 3,000 square feet here and 5,000 square feet there, but they're not necessarily contiguous or they're spread through the network. And so at some point, you get to a point of critical mass where you can make a step-level change. And right now, we believe in '20 and '21, we will be at that point. So in the interim, there's still a bunch of kind of smaller moves, and I would describe it more like a Rubik's cube of work that ultimately, again, in '20 and '21, will lead to a significant fixed cost reduction.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [37]

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I understand. And my last question is CapEx expectation in '19, what are you expecting? And depreciation?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [38]

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Sure. So from a CapEx perspective, so in '18, we had about $40 million of CapEx. We would expect that to go up a little bit to $45 million to $50 million in 2019. That increase is driven primarily by a onetime cash outlay related to investment on our flagship showroom in the Fulten Market in Chicago, which Andrew talked about during his comments. CapEx spend is broken down by 25% CI maintenance, 30% in distribution activities, including showroom activities. 15% product developments, 30% IT-related projects. We do have, as Andrew mentioned, the next phase of order management going live with ERP. So you have maybe a little bit more depreciation there next year, but relatively consistent otherwise.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [39]

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So depreciation is consistent with this year, you think?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [40]

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Correct.

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Operator [41]

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Our next question comes from the line of Greg Burns with Sidoti.

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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [42]

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When you look at your product portfolio and kind of taken this platform approach, and adding maybe subscale brands to your platform and leveraging your infrastructure, is there any areas of your product portfolio that you feel need to be strengthened? Or areas that maybe you're not in that you could potentially get into?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [43]

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Well, thanks, Greg for the question. I think there is a lot of white space for us to continue to leverage this whole constellation selling approach. So first, it starts organically with just strengthening the core portfolio. We've built in 3, 4 years, $100 million adjustable table business. So I mean, there are organic areas where we see in the individual areas of the workplace, the idea of higher performing products. We had a very strong year in seating, and then we have some real innovations coming to market later this year. We've done a very major rethink of storage in the workplace and what that should be and look like and we'll start to roll that out. So our first focus is on the organic areas in the individual areas, and we're doing a lot of work there. Then as we roll out towards these more ancillary and resimmercial areas where we have significant share opportunity, we're doing that both with organic product development, I mean, KnollStudio continues to expand a very strong, rapidly growing line of conference and meeting tables that has been really well received. And then we take it with an acquisition like Muuto, which gives us a significant and critical mass in those areas that we can leverage through our sales and distribution network, which is what we're doing. And then Muuto gives us another R&D capability, so you will see the middle of this year, a significant increase in the scope and relevance of Muuto products, particularly as it relates to contract ancillary environment. So we can layer into that. There's more lighting coming, so we have a lot of -- there's more architectural products coming with our -- coming back and fill so the areas that deal with providing space and creating acoustic and visual privacy in an open-plan environment. So I think we have a lot to do. And then we're always looking at other acquisitions that we can add and then bolt on. I think one of the unique things about Knoll and our track record is we have an exceptionally strong track record of integrating acquisitions that leverage our distribution and client relations, our strong dealer relations and our installed base to scale those rapidly. And we have done that with FilzFelt, we've done that with Muuto, we've done that with DatesWeiser, HOLLY HUNT did it with Vladimir Kagan, very strong ROI, very strong accretion. And that's very much another leg of that strategy, so I think we're attacking that ancillary space in multiple ways. And we do see a lot more white space to go after but not going to give it all away on this call, Greg.

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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [44]

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And then looking at Muuto and the residential opportunity there domestically, what's the time frame that you look at pivoting and expanding in that direction? And what kind of investments, incremental investments do you need to make to go after that segment of the market with Muuto in North America?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [45]

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So our strategy -- we -- Muuto, clearly, is a brand with millennial resonance, with this new perspective on Danish design. But what is unique about Muuto is the contract quality of their product. We've seen others try to do similar things. The products just don't have the contract quality or the durability. So we said with Muuto, let's first focus on maximizing that contract capability. And so that's where we've been investing in terms of warehouse, in terms of localizing some of the manufacturing, in terms of some of the IT work in the training, and really that's where the investment, and really through this year, that's where the focus investment training, hiring is really dedicated. At the same time, we're starting to do some of the foundational, I'd say really more IT-related investment because the products are multichannel, omnichannel can work office and residential, we're starting to do that foundational work this year. Such that I would imagine by the middle of '20 to the end of '20, we will be able to do a major Muuto residential/consumer launch both online and in-store sometime in mid-'20 to mid-'21, and that's basically the timing there. And again, that opportunity is worth tens of millions of dollars. That's our thinking on Muuto.

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Operator [46]

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

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [47]

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So I'll start, Charles, with you. You gave some good detail around some of the components of office margins. I think you talked about inflation expectations, C&I savings -- or CI savings and then the expectation on our price increases. What about the impact of mix leverage from volume growth? Just trying to get a bigger picture on -- the full picture on what you expect from office margins in 2019 and really beyond?

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [48]

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I think that's part of -- that's probably part of the price expectations that we have. So I consider price/mix to be combined together to the extent obviously we get more leverage, there will be a boost to that. But kind of goes up and down.

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [49]

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Matt, the other thing that will help us a little bit is as new products continue to exceed legacy, margins on new are a few hundred basis points higher than on legacy. So I do think mix will be helpful as we move through the year, but again, I think Charles is right, there are a lot of moving pieces. So I don't think we want to get too granular in the guidance we give here.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [50]

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Okay. That's fair. So maybe I'll move over to Lifestyle. So the way I've always thought about was that segment had pretty consistently high and consistent margins because of the variable cost nature of the cost structures. As you see more of that product sold into the workplace, and I assume through your more traditional channels, is there any risk that the pricing model has to change? And do you see more pressure from discounting, things like that as you see more workplace products sold through Lifestyle?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [51]

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We don't. I mean, we're very disciplined in how we price those. Maybe occasionally, you'll do a little bit of something with a client where you're bundling. You'll give them a little bit extra if you bundle a whole package together. But in general, that's not a tremendous margin hit. There's some additional dealer incentives for them driving the -- their total share of Knoll and our ability to capture the totality of a client spend and a dealer spend. But I think in general, I don't expect a lot of margin volatility. Those are primarily asset-light outsourced businesses where we don't have a lot of fixed cost exposure.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [52]

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Okay. Okay. So when you say not a lot of margin volatility, what's the right level? Is it plus or minus -- if I looked at EBITDA, is it plus or minus 22%? Is it plus or minus 21%? I mean, there's a little bit of an improvement through the year as soon as Muuto layered in and became a bigger piece of the pie. Is mix likely the biggest opportunity as we move forward and maybe it inches higher from here, is 22% the right number?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [53]

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I think mix is the biggest opportunity there. You're absolutely right. And I think we're super happy with 22% EBITDA margins in this category. But like everything else, each of our businesses has targets to do better in the coming year than they did in the past year. All of them have continuous improvement effort. All of them have cost areas of focus. I think the only thing I would say in Lifestyle is, and particularly as it relates to Muuto, there is incremental investment as we're driving this kind of rapid level of growth. So I don't expect a ton of EBITDA margin improvement for the next, I'd say, 2 or 3 years from the strong level they're at today because we're really funneling that back in, in terms of growth initiatives.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [54]

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From the level that you just reported in Q4?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [55]

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Yes. From the level we just reported in Q4. I don't think it can get worse. But I think it's -- you're not going to get the kind of leverage. If we weren't in a growth mindset with Muuto, we certainly could be backing off a lot of the investments we are making. But we are riding a wave and we want to ride it harder.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [56]

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Okay. All right. And I guess, I probably should have asked this with the office question, but you talked about the significant cost reduction in '20 and '21. I think, Charles, we've discussed some step function or some expectations on an annual basis over the next few years. Can you give us an update on what the outlook is from a dollars perspective for those cost reductions in '19, '20 and '21?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [57]

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Well, listen, I think, as Charles said, we're talking about 100 basis points of continuous improvement opportunity so you can dollarize that in terms of CI, and I think that's kind of a recurring level. And then, I think as we do look at '21, '20 -- '20 into '21, I think in terms of a step-level change, you could probably double that number on an annual basis as we make some of those large -- as we pursue some of those larger opportunities. So if $13 million, $10 million to $12 million, $13 million is kind of the continuous CI rate. You may have an equal amount of that in a more step-level kind of move down the road is how I think about it.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [58]

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Okay. And then the final question I had, you talked about your leverage coming down. Can you talk about the targets where you hope to get, by maybe at the end of this year, and what your ultimate kind of near- to intermediate-term goal is?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [59]

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Matt, we are super comfortable. I mean, leverage in the 2x, 2.5x range is super comfortable for us. It allows us to pay a robust dividend, we generate a lot of free cash, we have all the CapEx we need to invest in the business organically. We have ample liquidity to do transformational acquisitions to the extent we uncover those. So we feel pretty unconstrained with leverage where it is, and interest rates are all still relatively low, we throw off a tremendous amount of free cash. So I don't think there's much need to go that much lower than where we are. And then we'll look at what the most efficient use of our free cash at that point is.

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Operator [60]

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Our next question comes from the line of Steven Ramsey with Thompson Research Group.

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Brian Biros, Thompson Research Group, LLC - Associate Equity Analyst [61]

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This is Brian on for Steven. I want to start with the Lifestyle business, strong organic growth in the quarter. But was there any impact from maybe housing uncertainty or volatility in the equities markets that may play into how Q4 shaped up? Or outlook for 2019 at all? Is there any connection between those?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [62]

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Well I mean, not a lot. I mean, as I did say in my comments, I mean, the -- probably some of our higher-end businesses, take a HOLLY HUNT or something like that, probably had some exposure at the top of the residential market and probably some psyche around the stock market had some impact in terms of consumer spending there. But I have to say we really haven't seen much evidence of any negative impact at this point.

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Brian Biros, Thompson Research Group, LLC - Associate Equity Analyst [63]

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Got you. Anything that will continue into 2019, no real negative impact at the moment, given what we know now?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [64]

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Given what we know now, but obviously, I don't have a crystal ball, so we'll have to see how it plays out.

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Brian Biros, Thompson Research Group, LLC - Associate Equity Analyst [65]

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Of course. And then on the office side, if you could just maybe describe the discounting environment in the office space right now? I know it's a competitive market, but how do we really think about, I guess, competing with discounts, given the inflation and tariff environment that we're in also?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [66]

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Well, I think the good news is everyone we're competing against, has all those problems as well. In fact, we're probably a little bit less exposed from both the tariff and metal commodity standpoint. So I don't see a lot of impact from that. And then, frankly, from a mix standpoint as we focus more on these ancillary, social and hospitality areas, those are all margin-accretive for us, so that improves the profitability of every client engagement we have where we can sell them more of those products. So I don't see any major changes there.

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Brian Biros, Thompson Research Group, LLC - Associate Equity Analyst [67]

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Got you. One last one on price increases. Looking back in 2018, is there anything, with the benefit of hindsight that you might have done differently with the price increases, either in timing or magnitude or just the way it's delivered? Anything, you might have done different? And if you could think about implementing that in 2019?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [68]

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Sure. Well, I mean, in retrospect, if we had known that there would be tariffs, that there would be the kind of protectionism that we saw, we would have done more sooner. So I guess, but I don't know how we would have known that. And in terms of this year, anticipating that the tariffs are what they are today, but they could be 2.5x that tomorrow. We have gone a little bit more aggressive in terms of what we'll be doing in March, and we would hope to do just 1 increase as opposed to 2 in 2019. So that did influence our thinking as we shape the March increase.

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Operator [69]

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We do have a follow-up question from the line of Budd Bugatch with Raymond James.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [70]

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I just have a couple of very quick questions. I know we didn't acquire Muuto, I think it was mid-January of '18, remind me what the fourth quarter pro forma might have been for Muuto last year in '17.

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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [71]

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Yes, Budd, I don't know that we have that right in front of us. We can look that up.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [72]

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Okay. And Andrew, you did say that you had the inventory model, and I think that was the model you were going to. I wonder if you've made any changes to that. Is it primarily going to be an inventory model with the product continued to be made offshore and inventoried in the states for the U.S. or for the domestic market?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [73]

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Two things. One, we've significantly increased the inventory we carry because of the demand. And two, Budd, we've also -- we're now just beginning, and we're actually going to, made a decision recently to accelerate our ability to do more of the upholstery here in North America. So we can significantly reduce the lead time and increase our ability to do custom -- customers-owned fabrics and materials.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [74]

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And is that going to be done by Knoll, or are you going to outsource that? What's the thinking on that?

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [75]

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It will be done by an asset-light partner.

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Beryl Bugatch, Raymond James & Associates, Inc., Research Division - MD & Director of Furnishings Research [76]

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You mean, outsourced, is that...

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [77]

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Correct.

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Operator [78]

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Thank you. We have no further questions at this time. I would like to turn the call back over to Andrew Cogan for any further remarks.

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Andrew B. Cogan, Knoll, Inc. - Chairman, President & CEO [79]

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First, thank you, everyone, on the call for your participation and good questions.

In closing, I just want to take a moment to acknowledge the recent passing of our Co-Founder, Florence Knoll. Not only was Florence Knoll a woman of impeccable taste and style, but she was a pioneer of the modern workplace. And frankly, the entire notion of holistic interior design planning, integrating furniture textiles and architecture, which is at the crux of our go-to-market strategy today was invented by Florence Knoll. She viewed design as a problem-solving activity and was intensely focused on the client and delivering an environment that met their workplace needs. As both the Design Director and executive, Florence was a trailblazer for women in the design and business professions. She invented the motto that good design is good business. It's both a mantra for Knoll as well as the rationale for clients to invest in Knoll designs. While it's been many years since we were last with Florence in person, she remains an inspiration to all of us and the standards of excellence in modern design and interior she set will always be something that we in Knoll measure ourselves and our work against.

Thank you, everybody. We'll talk to you in a few months.

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Operator [80]

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Ladies and gentlemen, thank you for participating in today's conference, this does conclude today's program, you may all disconnect. Everyone, have a great day.