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Knoll (NYSE: KNL)
2020 first quarter earnings call
Apr 27, 2020, 5:00 pm. ET
Content:
- Prepared observations
- Questions and answers
- Call participants
Prepared observations:
Operator
Good afternoon everyone, and welcome to Knoll, Inc. Q1 session of Q1 2020. This call is being recorded. This call is also being broadcast on the web.
In addition, this call may offer statements that are forward-looking statements, including, but not limited to, statements about Knoll’s long-term profitability and revenue growth goals, future prospects for the industry and the economy, the ability to integrate acquired companies, and expectations regarding future leverage. These forward-looking statements are based on the current expectations of the company and are subject to a number of risks and uncertainties, some of which are beyond the control of the company. Actual results may differ materially from forward-looking statements as a result of many factors, including the factors and risks identified and described in Knoll’s annual report on Form 10-K and its other documents filed with the Securities and Exchange Commission. These warning statements are particularly relevant in today’s environment where the COVID-19 pandemic has created significant uncertainty.
All of our forward-looking statements today must be viewed within the context of that uncertainty. Today’s call may also include references to non-GAAP financial measures. Reconciliations of these measures to the most comparable GAAP financial measures are included in the earnings chart released today. I will now pass the call on to Andrew Cogan, Knoll President and CEO, for his opening remarks.
Andrew Cogan – President and CEO
Thank you and good afternoon everyone. I hope this finds you all on this call safe and well. In addition to the improved comment in our earnings post, I thought it would make sense to start this call with a few brief comments on current trading conditions. Understandably, April orders are tracking about 35% compared to the previous year.
On the residential side, with Europe, including many of our dealers, as well as our two largely closed Italian plants and most HH showrooms and our two closed Knoll stores, declines are higher. Hopefully, as these companies can start reopening in May and June, these trends will improve. On the workplace side, we have continued to see a greater number of orders rejected and even, in some cases, canceled as customers reevaluate their needs, but at the same time, new opportunities emerge as some of our largest customers, in In particular, they plan to order safe displays, partitions, and other workplace improvements as they prepare to bring employees back to their offices in the coming weeks and months. A bright spot on the work-from-home front has been our comprehensive e-commerce business, which is experiencing weekly demand increases of 50% to 100%.
And as we noted in our release, we are accelerating our other e-commerce initiatives to take advantage of what we believe will be an increasing part of our clients’ work strategies. There’s as much volatility in overall activity here as I’ve seen, making it difficult to draw too many longer-term conclusions starting in April. However, we do know that, compared to the period dot-com / 9/11 or the financial crisis of ’08 -’09 where the industry decreased by approximately 30%, we did not have the accumulation of bubbles in demand by 2020 that contributed cantilevered for several years in those collisions. We have clearly spent considerable time looking at a variety of scenarios in terms of how this might unfold.
With the benefit of the actions we have taken, we believe that, depending again on the combination in any quarter between the office and the lifestyle segments, we will experience negative deleveraging of 40% to 50% on the gross margin line and approximately 20% to 25% on the adjusted EBITDA line. In these scenarios, we expect to maintain positive cash flow. Obviously, there is a lot of uncertainty regarding the economy and how all of this unfolds. But today, we don’t see leverage rising beyond what is allowed under our line of credit.
We have enjoyed a relationship of more than 20 years with our group of loans and we have worked in previous recessions and, in some cases, exemptions, without hindering our ability to grow or invest in the business. We would not expect the current environment to create different behavior with our lenders, especially given their continued support for our business. So if we needed relief, we don’t think getting a problem is a problem, particularly given our extensive line of credit and liquidity that runs through 2024. Now, let us open the line for your questions.
Questions and answers:
Operator
[Operator instructions] And our first question comes from Greg Burns of Sidoti & Company.Greg Burns – Sidoti y Compañía – Analyst
Good afternoon. Can you give us an update on your operations? What facilities are, I mean, still closed? What are open? Or perhaps a better way to look at it is, what percentage of your manufacturing capacity is currently online?
Andrew Cogan – President and CEO
Of course. Hi Greg, I hope you do well. So overall, right now, in … when we started with North America. Therefore, our four main plants in North America, which include two in Michigan, one in Toronto and one in Pennsylvania, are fully open and operational, as are all of our warehouses for everything from Fully to Edelman to KnollTextiles, Spinneybeck , they are all operational.
In North America. Actually, the only facilities we have closed are DatesWeiser in Buffalo, which is where we produce the DatesWeiser product; and then the HOLLY HUNT workrooms in Chicago and Texas. The good news is that we just found out that it looks like the HOLLY HUNT space in Texas will be able to open in the middle of this month, as well as DatesWeiser in Buffalo, so we are encouraged. In Europe, our two plants in Italy are closed.
However, both will open this week, first in the south and then a bit more in the north. Basically, at the end of this, in late mid-May, everything but HOLLY HUNT in Chicago, where we have another workshop on the upholstery side, everything will be open except that, and we expect the End of May to open. So we are really fundamentally operational. And in terms of personnel capacity, I would say that we are running around 75% or 80% of our usual capacity, Greg, which is in line with demand right now.
Greg Burns – Sidoti y Compañía – Analyst
OK. And I guess you gave an incremental color to the order patterns in April. I don’t know if you could look much further than that. But overall, I suppose, what are you hearing from your customers because there seem to be some positives to them? Looking back at their office spaces, they bring clients back.
But are you perhaps seeing delays in purchasing decisions, orders being ejected? What are you hearing from your customers? Do you feel like you will get through this, and is it more like a V-shaped recovery that would return to normal? Or do you think this has caused a longer-term slowdown than it may take longer to recover from the industry?
Andrew Cogan – President and CEO
Well I would say all of the above, Greg. Again, I think three weeks a month is really too difficult to judge. What I will say is this. I think the residential piece has been hit harder initially, and I think it’s understandable when you think of all the HOLLY HUNT showrooms that are closed.
You have: decorators cannot enter those buildings. We have people working remotely and / or without permission. Our Knoll stores are closed. Our residential distributors throughout Europe are practically closed.
So even if, and Muuto is, incidentally, fully operational. But even there, dealers are not necessarily open. And similarly, Knoll Europe’s residential distributors are closed. So I think residential has really closed more, faster, and decreased more.
I think in that regard, as things start to reopen, we would expect to see activity pick up gradually. And in fact, many of those companies have a good backlog of orders to ship, but they’re struggling with the fact that customers simply can’t receive the product. HOLLY went into this with a very strong order book, and they just can’t ship much of that product to their customers and all. So I think that’s the image of the residential side.
On the workplace side, I think, once again, people are just trying to control what’s happening. I think some clients are using this, frankly, to complete the work they had in progress. Others, where they have made a real estate commitment, are moving forward. Now they may lag in their ability to accept that.
And clearly, as more states begin to consider or allow construction, that will allow us to ship some of that product. So we have more products than usual and everything. Clearly, as we look beyond this immediate period and everything, whenever there is a change or interruption, it often ends up creating demand for furniture. And we spend a lot of time looking at our clients, and ourselves, frankly, looking at what the future of work will be like, what the workplace will be like, how we help our clients return in a healthy way. and safely and what does that mean in terms of partitions and screens and different forms of planning, materials.
And those are all the things that our teams are really aggressive about. We are co-creating a lot with some of our larger clients, and that could result in incremental demand, particularly as clients can be extended to more facilities. So I think there is a chance, clearly, that all of this disruption will lead to increased demand. Listen, I want to say that the reality is also that our clients: many clients are saving capital, conserving cash and where they have a discretionary investment.
They’re postponing it, so I’d say we’ve seen a handful of cancellations. We have seen many more postponements. And I think depending on how this unfolds, that will determine how long those deferrals will persist. Looking at the absorption data in the first quarter, I was glad today to see the positive absorption in the first quarter.
That means that there are people who have signed leases and are going to fill that space. Now what they fill it up with and how they fill it up may be different, and I think that is causing a pause in the orders that we are seeing right now. But we do believe that people will move on. And if you have signed a lease, you will finish building those facilities.
Much beyond that, Greg, it’s really hard to predict.
Greg Burns – Sidoti y Compañía – Analyst
OK. Thanks for that color, I appreciate it. And then I just want to mention the investments you are making in e-commerce, in Fully and Muuto. Do the investments you are making there include the $ 65 million you hope to save? Or is it an incremental investment you must make, perhaps reinvest some of that $ 65 million into the business? And so what is the time frame, now with the Muuto side, rolling out the residential side of that business?
Andrew Cogan – President and CEO
Yes. You’ve been stressing Muuto’s point for a long time, Greg, so I appreciate your question. In terms of incremental investment, I don’t think it’s tremendous. What we have decided to do, and again, we have seen success with Fully.
That business is running between 50% and 100% weekly, and we’re just trying to keep up with all the demand for ergonomic products for work from home, well-designed products for work from home, that Fully, And they ship in a day or two, I mean, really, really an excellent model in everything. So we said, well how can we learn from Fully and implement that for our own businesses? So we have a little knollshop.com – knoll.com. We have our own e-commerce store, but the supply is relatively limited at work from home. And as you know, there are no Muuto products available in eCommerce, really, anywhere in North America, certainly not on our site.
So we gave teams a challenge on how, in 90 days, you leverage the platforms we have, the inventory we already have. So there really is very little incremental investment and we extend the reach of our own home office work products and maintain it in 90 days. And we gave that challenge a couple of weeks ago. And the teams, both in Denmark and North America, have put in a lot of effort.
We meet with them a couple of times a week, and I’m very excited about what they’ve discovered, both from a technological and service point of view. And my hope is that we stayed in that 90-day window, which would be, let’s say, just after the July 4 holiday. And that is what the teams are doing, and we are very excited about that. And it could be a good addition to complement the way our clients work from home.
The other thing I would point out is that Fully is there. We can also support some of our corporate clients who said, listen, how do I get this? Get our employees furniture for their home offices? I mean, I had to build a home office very quickly that I didn’t have, and I placed an order with Fully. And three days later, he was in business. Therefore, we are also working with our clients, so that they can access Fully, as well as their employees, in their homes.
That’s the challenge, Greg, I would say, in early July. It’s not soon
Greg Burns – Sidoti y Compañía – Analyst
Thank you.
Operator
[Operator instructions] Our next question is from Steven Ramsey with Thompson Research.Steven ramsey – Thompson Research – Analyst
Good afternoon mates. I suppose to continue Fully’s thoughts, could you speak even broadly about where Fully’s margins were before the acquisition and where you think you may have them this year as you invest to grow and grow on the fixed base and maybe more ? time, maybe long term?
Andrew Cogan – President and CEO
Yes. I mean, out of my head, I think they were at the higher single-digit adjusted EBITDA margin rate. And I think that, obviously, we have been able to help them with part of their cost work and all, take advantage of part of our supply, some type of administrative material that was not a great added value. And I hope that over time we are constantly at double-digit EBITDA margins.
Therefore, Fully should not be lower than the adjusted EBITDA margins for our office segment. That would be our goal, at worst, online, and hopefully maybe even a little bit better.
Steven ramsey – Thompson Research – Analyst
Excellent. And perhaps a more elementary question about Fully, but how much of Fully’s product goes through distributors? How much goes directly to consumer firm Fully? And is there an intention over time that this customer breakup will change?
Andrew Cogan – President and CEO
Yes. I mean Fully is really a very independent channel. I mean, listen, our contract furniture sellers don’t really want to waste time selling someone three desks for their home. I mean, our distributors are phenomenal on larger and more complex projects, where there is a lot of added value, both in the way they serve it and in the ongoing relationship.
And Fully has a lot to do with a guy at home trying to set up an office. That is the bulk of your business. They carry out small projects in the workplace, where they will carry out offices for 10, 20, 30 and 40 people, but in reality it is a different market segment than our distributors. What we have done is where we have extended some of these fully expanded offerings for Fully to support our corporate clients.
We are doing that by laying off part of that to our distributors, so that they can participate where they have the corporate relationship. But you really should think of these as very different channels and solve very different problems.
Steven ramsey – Thompson Research – Analyst
Great Color In reducing capital spending, to understand this better, the reduced capital spending of $ 20 million is geared towards a certain segment, a certain category? And then I suppose, too, could capital spending be further reduced? And what conditions would justify it?
Andrew Cogan – President and CEO
Charles, do you want to move on?
Charles Rayfield – Senior Vice President and Chief Financial Officer
Yes Yes Yes. Excellent. Thanks Steven. So I would say that some of our investment spending has been reduced whenever possible, but our division is still related to 30% IT and probably 45% investment and then 20% maintenance.
Unilaterally in all areas, a little more in the investment area. And yes, we can reduce capital spending a little more, if necessary. I think there are a couple of projects that we want to move forward with for proper investment purposes, obviously some of the maintenance activities. But yes, we can reduce it a little more if necessary.
Steven ramsey – Thompson Research – Analyst
Excellent. And then the last question for me, I guess I’m just pondering. Obviously, there are 1,000 scenarios that could happen. But in a scenario where the economy is open again in the second half of the year and then has deferred work in which it is catching up, so it gets the natural momentum of the reopened economy, but has also retired in operations.
How would you be able to handle that kind of scenario?
Andrew Cogan – President and CEO
Well, we don’t expect a pullback here. I mean, I think we have a good backlog that will help some in the second quarter. Although, again, it will be limited by our openness, which is improving every day and / or by the ability of our clients to accept that product. And then I think, right now, everyone is kind of frozen, so he will have to work on that.
But I don’t see that our capacity is a limitation. It’s not on my top 10 list of concerns at the moment.
Steven ramsey – Thompson Research – Analyst
Excellent. Thank you.
Operator
Thank you. Our next question comes from Colin Casey with Vulcan Value Partners.
Colin Casey – Vulcan Value Partners – Analyst
Good afternoon friends.
Andrew Cogan – President and CEO
Hi.
Charles Rayfield – Senior Vice President and Chief Financial Officer
Hi.
Colin Casey – Vulcan Value Partners – Analyst
Hello, I appreciate the comments on margins and cash flow. What level of income decrease would it take for you to be free of neutral cash flow during the year?
Andrew Cogan – President and CEO
Charles, do you want to take that?
Charles Rayfield – Senior Vice President and Chief Financial Officer
Well thanks for the question. I mean, it’s kind of a theoretical question. I think, as Andrew mentioned earlier, I think that as we look forward to the year, we do expect to have positive cash flow. I think we have to have a pretty significant decrease in revenue to start reaching negative free cash flow.
But currently, we still expect the cash flow to be positive.
Colin Casey – Vulcan Value Partners – Analyst
OK. And yes, certainly, I appreciate that it is a theoretical exercise. I mean, if you dropped a theoretical number, let’s say, revenue would decrease 50% during the year, would it be a positive, negative, or neutral free cash flow in that scenario?
Andrew Cogan – President and CEO
I think there are a billion, as you just said, there are a billion hypotheticals, and I think we are not going to hypothetically go into this or that. All I can say is that we have worked many scenarios. We have: Our models have been modeled, and we also have a really good track record of Knoll’s management through two very significant and sudden declines, 35%, 40% decline, and we had positive cash flow in all of those scenarios. . So I think this is an experienced type of team that knows how to handle Knoll through this and, more importantly, handle Knoll through this to come out stronger on the other side, which we have done every time , and I imagine I will do it again here.
Colin Casey – Vulcan Value Partners – Analyst
OK. And that cash flow, is that free cash flow, just to be clear?
Charles Rayfield – Senior Vice President and Chief Financial Officer
Yes, free cash flow.
Colin Casey – Vulcan Value Partners – Analyst
OK. And I can, I think I lost the flow of the EBITDA margin. You said decreasing gross margins from 40% to 50%. What was the EBITDA margin?
Andrew Cogan – President and CEO
We said from 20% to 25%. And again, I’m using those ranges because the mix has a tremendous impact here.
Colin Casey – Vulcan Value Partners – Analyst
Of course. OK, appreciate that, folks. Stay safe.
Andrew Cogan – President and CEO
Thank you.
Operator
And sir, I’m not showing any more questions. I will call Andrew back for his final comments.
Andrew Cogan – President and CEO
Excellent. Well thank you all for joining us on today’s call. In closing, while these are challenging and unprecedented times, I also want to leave you with reasons for optimism. Our sales teams are working with clients to help them implement best practices for safe work in their offices, and this is creating demand for new displays and furniture panels.
If CNBC is right today that the office of the future is the office of the past, then that is more good news for our cubicle business. We are seeing continued growth, as I mentioned, in our work-from-home e-commerce channels, and the Knoll teams are working hard to expand our offerings here. Like our own customers, we too have begun planning to bring many of our people into our offices and showrooms with the same precautions and preventative measures that we have put in our plants and warehouses, and we are encouraged that many countries and states here at home they are beginning to ease requests to stay home and are allowing construction and manufacturing work to resume. Finally, all this time at home will undoubtedly lead clients to think about investing in their own homes and home offices.
Throughout our constellation, Knoll associates are demonstrating their commitment to teamwork and customer service. I appreciate, I really appreciate how hard everyone at Knoll is working around the clock, and I want to thank you for all that you are doing. Stay safe, and all the best to you and yours, everyone. Talk to you soon.
Operator
[Operator signoff]Duration: 25 minutes
Call the participants:
Andrew Cogan – President and CEO
Greg Burns – Sidoti y Compañía – Analyst
Steven ramsey – Thompson Research – Analyst
Charles Rayfield – Senior Vice President and Chief Financial Officer
Colin Casey – Vulcan Value Partners – Analyst
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