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Knoll, Inc. (NYSE:KNL)

Q1 2008 Earnings Call

April 17, 2008 10:00 am ET

Executives

Andrew Cogan – CEO

Barry McCabe – EVP and CFO

Analysts

Analyst for Michael Rehaut – J.P. Morgan

Matt McCall – BB&T Capital Markets

Budd Bugatch – Raymond James

Christopher Agnew – Goldman Sachs

[John Emrix] – [Ironworks Capital]

Todd Schwartzman – Sidoti & Company, LLC

[Justin Osuka] – First Q Capital

Operator

Good morning, everyone, and welcome to the Knoll, Inc. First Quarter 2008 Conference Call. (Operator Instructions) This call is also being webcast at knoll.com. Presentation slides accompany the webcast.

In addition, this call may offer statements that are forward-looking. These forward-looking statements are based largely on the Company’s expectations and are subject to a number of risks and uncertainties, certain of which are beyond the Company’s control. Actual results can differ materially from the forward-looking statements as a result of many factors, including the factors and risks identified and described in Knoll’s Annual Report on Form 10-K and it’s 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 Company’s earnings release dated April 16, 2008, and presentation slides that accompany the webcast.

Now let me turn it over to Mr. Andrew Cogan, the CEO of Knoll, Inc. Please proceed.

Andrew Cogan

Thank you, operator. Good morning, everybody. On behalf of Barry McCabe and me, welcome to our first quarter 2008 Earnings Call. Before I turn the call over to Barry to discuss the results we reported yesterday, I wanted to make a few introductory comments.

First, as it relates to the quarter we just reported, I’m very, very pleased that we’re able to kickoff 2008 by reporting continued growth in our sales, profit, and earnings per share. The increasing diversity of our client base, product lines, and sales geography is driving better than industry performance. This coupled with our disciplined management of our operating expenses and the benefit of significantly reduced interest expense and share count has led to continued double-digit EPS growth for our shareholders.

I think it’s fair to say that we’re facing a more challenging market environment then anytime in the last couple of years. The combination of a weakening in industry demand and unrelenting inflationary and foreign exchange pressures will in doubt create headwinds for 2008 and 2009. The good news today is that, as you can see from our results and guidance, we’re continuing to profitably grow our sales and earnings. This is a kind of environment that we at Knoll are prepared for and are well positioned to continue to outperform in.

Since 2000, we have engineered a very significant change in our product mix. Back then almost 70% of our sales came from office systems, a category that tends to get hit a bit harder in a downturn. In the first quarter of this year, office systems represented under 50% of our sales, a significant change since 2000. This is not a result of any real share change in the systems category, but rather reflects our teams’ focused strategy on growing the sales we get from complimentary seating and storage products, our very high margin specialty businesses, and our international efforts.

In the first quarter, these categories combined represented over 50% of our sales versus approximately 30% at the state of the decade. In fact, our Q1 sales growth and better than industry top line performance is directly attributable to initiatives in these areas: be they the acquisition of Edelman Leather, the expansion of our Knoll Studio Distribution, or our international growth in expanding markets like Europe and the Middle East.

Additionally, our focus on vertical markets, like government, hospitality, education, and healthcare, is also helping to diversify our sources of revenue. We are convinced that these efforts have made Knoll much less vulnerable to purely North American office system demand trends than any time in the past decade.

The second point I’d like to make is that our management team has well over a decade long track record of delivering strong industry leading margin performance in a variety of market conditions. In fact, even during the industry depreciation of 2001 to 2003, we at Knoll did not have a single unprofitable month, quarter, or year. At bottom, our operating margin stayed above 10%. So we know how to scale and flex our cost structure and have a track record and willingness to do without incurring excessive restructuring charges from over expansion.

In fact, as Barry will discuss in more detail, we did take some actions in this regard early in Q2 to scale our costs such as to mitigate the near-term inflationary pressures that we are seeing. We did so while protecting the long-term investments in new products and markets, which have us greeting this coming year coming next with great excitement as we rollout some wonderful new and innovative products and capabilities.

Lastly, I also want to remind you of the very strong financial position from which we face the challenges ahead. Our leverage ratio at the end of Q1 was 2.2 to 1. We have $124 million of liquidity in our revolver; we’re in compliance with all our covenants, and we’re benefiting significantly from a dramatic drop in our borrowing costs.

Now let me turn over the call to Barry.

Barry McCabe

Thank you, Andrew. We were very pleased with our results when you consider the current economic environment where industry sales are slowing, where several key commodities are experiencing inflationary pressures, and where the Canadian dollar had appreciated significantly over the first quarter last year.

As we review our results, sales for the first quarter were $267.8 million, an increase of 8% over the prior year period, reflecting double-digit growth in our Specialty businesses, high single-digit growth in our International business, and slightly negative growth in our North American Office business. Again, we are pleased that our diversification strategy is allowing us to grow despite the issues facing the office category.

Backlog for the first quarter was $204.4 million, a 5.6% increase over prior year. We continued to see client visits, mockup activity, and orders greater than $1 million ahead of last year, but order sizes are getting smaller.

Gross margin for the quarter was 33.7%, a decrease of 40 basis points from a year ago. The decrease was primarily due to the appreciation of the Canadian dollar; and in Europe, the appreciation of the euro against the British pound. In total, foreign exchange cost us 210 basis points of gross margin. Price realization, continuous improvement in our factories and global sourcing not only offset inflation, but most of the foreign exchange as well. We were pleased with our progress in offsetting exchange and inflation, but recognized that these will be ongoing challenges.

Operating expenses were $58.4 million, or 21.8% of sales, an increase of 10 basis points above last year. Actual spending increased $4.7 million, which was primarily the SG&A related to the Edelman Leather acquisition completed in the fourth quarter last year and not in last year’s first quarter operating expenses.

Operating income as a percent of sales was 11.9% for the quarter, a decrease of 50 basis points from last year. This decrease is due primarily to the lower gross margin. Interest expense was $4.9 million, a decrease of $1.6 million from a year ago due to lower rates despite $16.7 million of higher debt. Other expense was $195,000, which compares to other expense of $376,000 for the first quarter 2007, and primarily represents foreign exchange gains and losses on currency.

Our tax rate for the quarter was 35.5% compared with 38% a year ago. The decrease in the rate is due to the mix of pretax income in the countries in which operate. All of this resulted in net income of $17.3 million or 6.5% of sales and a 20% growth in EPS to $0.36, which compares to net income of $14.8 million, and an EPS of $0.30 a year ago.

Year-to-date net cash provided by operations was $6.2 million of which $24.6 million was provided from net income plus non-cash amortizations offset by $18.4 million of changes in working capital. Inventories increased by approximately $8.3 million due primarily to the higher sales, while liabilities decreased by approximately $8.5 million primarily due to employee compensation and income tax payments.

Accounts receivable balances also increased approximately $6.9 million and other assets and liabilities decreased approximately $5.3 million. We expect this first quarter decrease in liabilities to abate throughout the year as compensation and income tax accruals increase.

Capital expenditures were $2.4 million for the first quarter. Cash used and financing activities was $7 million, which included net borrowings of $4.7 million, offset by $6 million of common stock purchases and $5.7 million of dividend payments.

If we look at liquidity, we have $14.5 million in cash at quarter end and another $123.8 million available under our revolver. We are pleased with our top line performance and our double digit earnings and EPS growth. Our diversification strategy is working, but we are concerned about the uncertain economic and inflation pressures we read and hear about daily.

Individuals and companies are facing unprecedented levels of inflation as a result of escalating oil prices, increasing commodity costs, and the weakening U.S. dollar. In spite of our recent price increases, continuous improvement, and global sourcing efforts, we believe we will be unable to completely offset these unprecedented cost and margin pressures across our North American Office business.

Therefore, during the first week of April, we took the following actions to reduce our fixed costs: Eliminated 55 salaried positions, eliminated temporary positions, stopped filling non-essential open positions and reduced discretionary spending. Additionally, we discontinued a small systems product line. We estimate restructuring costs will be approximately $3.3 million with better than a one-year payback, and all these actions combined will save us approximately $10 million annually.

For second quarter of 2008, we expect sales to be in the $275 to $285 million range, an increase of 1% to 4.8% over the second quarter 2007. We expected adjusted EPS without restructuring to be $0.39 to $0.41. We will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Michael Rehaut from J.P. Morgan.

Analyst for Michael Rehaut – J.P. Morgan

Yeah, this is actually Analyst for Mike. Congratulations on a nice quarter. Just a couple questions: [inaudible] the Canadian dollar was at about $0.91 last year, looks like steel’s up about 20% year-over-year. Just trying to get an idea of what you guys are modeling to your second quarter guidance in terms of inflation?

Barry McCabe

Well on the Canadian, it was actually $0.86 in the first quarter of last year and began to appreciate in the latter part of the second quarter to where it was close to par by the fourth quarter of last year. In terms of our modeling, we used a current exchange rate which is anywhere from $0.98 to about a par as we look into the second quarter. In terms of commodity, inflation that’s been primarily in metals that we read about as well as oil pressure, as well as oil-related commodities, we work hard with all of our suppliers, not just in those categories, to do everything we can to mitigate some of these inflationary pressures; and we will do so not only in the second quarter but in the second half of the year.

Analyst for Michael Rehaut – J.P. Morgan

Do you guys have like long-term supply contracts for steel?

Barry McCabe

We have a variety of contracts with a variety of suppliers.

Analyst for Michael Rehaut – J.P. Morgan

Then just lastly, if you guys could give a breakout of what the organic sales were and possibly if you can give out what International did and North America and how much Edelman Leather contributed in the quarter.

Andrew Cogan

I can tell you this: We had organic growth, but clearly on top of the organic growth, Edelman was a big help. The acquisition continues to perform better than we anticipated. It’s working well both in the marketplace and in the backend of the business, so we’re very pleased with how that’s going. Again, as Barry talked about, growth was led by our specialty businesses followed by our international efforts and then in the North America where we were pretty flattish to down a little bit in the Office end of the business.

Analyst for Michael Rehaut – J.P. Morgan

Then for second quarter are you kind of also modeling in that flattish North American growth?

Andrew Cogan

I think North America will be flat to down a point or two. I think you’re going to see continued strong International growth. I think we’ll see continued strong specialty group. I think our sales team in North America is doing an outstanding of targeting a variety of segments where we think there’s real opportunity for growth. We saw nice progress in our healthcare initiative, strong performance in areas like energy and utilities. So we’re very encouraged and I think our people are being really smart about where they’re investing their time and where they’re going to find growth.

Analyst for Michael Rehaut – J.P. Morgan

Great. Thanks, guys.

Operator

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

Matt McCall – BB&T Capital Markets

Thanks. Good morning, everybody. So let’s see the double-digit growth in Specialty, I think you reported pretty strong results there and also in International for a number of quarters now. Can you tell us when… Have the costs already become more difficult and you’re reporting strong growth on top of strong growth, or do we run into more difficult comps as you move into Q2 and Q3?

Andrew Cogan

Well the comps get hard as we move through the year, so I definitely think the comps in those areas will be challenging. I wouldn’t expect that rate of growth in all those businesses as we go forward. I’m sure our specialty growth as we move towards the end of the year will slow a little bit year-over-year. But International is continuing to grow well and as we look into the second quarter, international looks very strong. We’re just at the beginning of our initiatives really outside of Europe. So Europe’s still the bulk of our International sales. But our president of our International business is in, is living in the Middle East right now. We’re aggressively beefing up our sales organization. We’re opening up this quarter our first really sales office in the Middle East. We’ve got a lot of activity going on there. So we’re just at the beginning of some of those initiatives.

But the diversification has really worked. I think if you take one thing away from this call, everybody, I would just, this is a very different company right now than we were in 2000. Anyone who goes back and looks at what happened to our business in the last cycle down, in the ’01 to ’03, in the ’01 to ’03 downturn, I think is making a big mistake because we really changed the mix of business significantly and I think this is a much healthier, much stronger, much more diversified company from a revenue standpoint than we’ve ever been in our history. That diversity very much aligns up with more diverse sources of operating profit, so we’re just less vulnerable to any one particular category; and all these initiatives have helped...

Matt McCall – BB&T Capital Markets

Andrew, you mentioned that you’re just beginning in some of these other countries outside of Europe, do you expect any of those other countries or initiatives to show up in a meaningful way anytime in ’08.

Andrew Cogan

Yeah, I mean if we can win some of the things we’re working on, they’ll show up more. I’m encouraged; and I don’t think they show up overnight, but we’re working hard at it. We didn’t just start this year. The team’s been working on those initiatives for the last year or two and I think they’re doing a really nice job.

Matt McCall – BB&T Capital Markets

You talked a lot about the mix of your business and how it’s different than in 2000. Can you talk a little bit about how the cost structure is different; what you’ve done maybe to take out these costs or just give us a rundown of what might’ve changed?

Barry McCabe

Well I think on the cost side, clearly by the actions we have taken in the first week of April is really in response to what we see really in the North American Office business, and we will continue to look and evaluate where that business is heading.

In terms of our International efforts, our new product development efforts, we have not touched costs on that side. One of the things that we do is we look at, really when we look at the mix of business, we look at the performance and the cost issues.

On the Specialty side, where we’re performing extremely well, and we’ve said over and over again, “Those businesses have gross margins anywhere from 45% to 55%, maybe on average say 50%,” and to some extent our SG&A costs are a little higher than the Office business but they deliver well north of 20% operating margins. So we’ll look at those businesses.

Our International business, for the most part, is just as profitable, if not today, a little more profitable than the North American Office business when we look at the costs that are associated with those businesses as well. So we just don’t look at the overall macro margins on cost of business. We do break it down by the different categories. I don’t know if I answered your question or not. I’m sorry, Matt.

Matt McCall – BB&T Capital Markets

No, that helps. I think the way you worded it in the release is interesting that you cited the inflation trends is really what you’re trying to offset by taking these actions, and I think there in the text sheet or during the prepared comments, you talked about your cost structure now be aligned or better aligned to offset the inflationary pressures. I guess what demand level or level of demand are you assuming before you’ll need to make other actions to adjust your cost structure?

Andrew Cogan

Matt, this is Andrew. I think that’s right. We did phrase it exactly as we took the actions because that’s why we took the actions because we’ve really seen them on the gross margin front. We’re assuming the industry kind of bounces along at negative 1% or 2% growth in North America, kind of flattish right now. I mean if it moves, takes a step level down, we’ll adjust, we’ll take whatever actions we need to at that point and time. But we think we’re in good shape for kind of what we’re seeing right now and for the pacing of the business overall.

I also think from a cost standpoint, we’re trying to manage SG&A around 21% /22% of sales and the real variable that we’re struggling with more now than anything else is just all the gross margin pressures and all the varied inflationary pressures that we’re facing and our operations teams are doing an extraordinary job at [inaudible] us. I was very proud when you hear Barry talk about 210 basis points of foreign exchange and yet we only 50 basis points of gross margin. That’s heroic work that are people doing and we’re just going to keep plugging away at it.

Matt McCall – BB&T Capital Markets

One last question…

Andrew Cogan

I think the wildcard right now is a little bit more, frankly, on the gross margin end of things. I think we’ve got a good handle and are sized appropriately based on where we see demand.

Matt McCall – BB&T Capital Markets

That’s helpful. Then last question on the Specialty business, was the organic growth positive in Specialty this quarter?

Andrew Cogan

Yes.

Matt McCall – BB&T Capital Markets

Any quantification, rough?

Andrew Cogan

No.

Matt McCall – BB&T Capital Markets

No rough, okay. All right, thank you, guys.

Andrew Cogan

I mean overall we had organic growth. No, it wasn’t… I mean we had a couple points of organic growth, and that was good.

Matt McCall – BB&T Capital Markets

That’s helpful. Thank you, guys.

Operator

Your next question comes from the line of Budd Bugatch from Raymond James.

Budd Bugatch – Raymond James

Good morning, Andrew. Good morning, Barry. Congratulations on the quarter. Just trying to understand, make sure I understand on the gross margin deleverage, what the source of that was, the 36 basis points of gross margin deleverage year-over-year. How much of that was due to the foreign exchange? How much was due to mix? Do you have those kind of…

Barry McCabe

Well what I really said, the bulk was really all foreign exchange, 210 basis points and the rest we had price realization, global sourcing, continuous improvement more than offset inflation; and it was really the foreign exchange on the Canadian dollar as well as the euro and the British pound. I think as you look going forward, on a quarter-to-quarter comparison, in the second half of the year, you won’t see the foreign exchange pressure because that’s self-adjusted. So our continuous improvement efforts and everything we do there will be focused to offset inflation.

Budd Bugatch – Raymond James

So when we look, I think the contribution margin for the operating profit was around 5.5% this quarter, which is really low for you all, and that’s obviously impacted by those issues.

Barry McCabe

That’s correct, Budd.

Budd Bugatch – Raymond James

You’re had a target out there, and I think you still have a target out there, of 15% op margin target, run rate by the fourth quarter of this year. Have you readdressed that or have I missed any update on that?

Andrew Cogan

Budd, out goal, as you know, has not changed. We’d like to get this business to north of 15% gross profit, I mean 15% operating margin. That is our goal and hasn’t changed. What has changed is the environment’s a little more difficult. The foreign exchange and the other material cost pressures are worse, but we’re going to keep getting there.

We’re not going to do anything to get there that will undermine I think the fundamental investments that we are making in transforming our mix even further and investing in a new generation of products which are very excited about or doing anything short-sided to just achieve that goal when the foundation of it on the gross margin side has been really challenged. So we’re not backing of the goal. That’s what we’re trying to get to.

It’s clearly going to be more difficult to get it if oils at $110 or $115 a barrel, the Canadian dollar stays at par, if steel keeps going up 20% or 30%, that’s all going to be more difficult and we’ll just have to work harder to offset it. But again, our associates in the sites are aware of these challenges and I think focused on them.

The other thing I want to point out, yes, your point about contribution margin is correct. But we at Knoll, we’re working all elements. I mean I’m very pleased that we deliver 20% EPS growth. We are working our balance sheet, the renegotiating of the bank agreement that we did last June has been very helpful in lowering our rates and our spread over LIBOR. We are buying shares where we see opportunity to do that at very, very accretive levels. So we are working every element and every lever we have to deliver strong EPS growth and combine it with better than industry top line performance. We’re working all those elements. So I don’t want to select any one and just look at that. I think you got to look at the whole package of what we’re trying to deal with here.

Budd Bugatch – Raymond James

I think we do, Andrew, but we have to always get to the details too. That’s kind of what we do.

Andrew Cogan

I would expect no less from you, Budd.

Budd Bugatch – Raymond James

We deliver no less like as long as you’re delivering these good results. Let me ask a question about inventories. Barry, I think in your prepared remarks, you said inventories were up because of sales growth, but yet inventories faster up than sales growth. If I recall, last year you didn’t have Edelman in the first quarter comparable number.

Barry McCabe

No, but if you look year-over-year, we were still up from the end of the year $8.3 million. The bulk of that I’ll tell you about is in the specialty businesses where it’s a book and build kind of business and I had said the specialties were up over 20% in growth. So it’s really in those categories, not in our factories.

Budd Bugatch – Raymond James

How much was due to Edelman's year-over-year as we look at that?

Barry McCabe

We don’t breakout Edelman.

Budd Bugatch – Raymond James

We can still try.

Barry McCabe

I know.

Budd Bugatch – Raymond James

Thank you very much. Congratulations and keep up the good work.

Operator

Your next question comes from the line of Chris Agnew with Goldman Sachs.

Christopher Agnew – Goldman Sachs

Thank you. Good morning, Andrew. Good morning, Barry. First question, you talked about some of the verticals being energy, utilities, healthcare doing well. What verticals were you seeing weakness in? Also, by geography, is there any differentiation of demand that you saw either in the first quarter or out in the horizon?

Andrew Cogan

I think it’s now surprise to us that segments that were a little more challenged related to kind of financial service categories that have been an important part of our business; they continue to be. But we’re managing through out.

Again, I’m very, very pleased with the job our sales organization is doing with some of the moves our sales leadership team have made in terms of reallocating resources towards growing segments and growing geographies. We’re doing nicely on the West Coast. We’re doing better in the technology area; I see great activity there, doing really well in healthcare. We’ve got a terrific team organized around that initiative, so our people are going where the growth is, and they’re very, very good at doing that.

I’m also pleased of some of our regions in particular that in some of the more affected areas of the economy what a good job they’re doing at going after other segments in other areas. So I think we’re holding up well given the challenges out there. The challenges aren’t over. We tend to be a late cycle when we stuff later than others do and so we’re continuing to be cautious and prudent about what we do, but our people working hard and are doing a terrific job.

Christopher Agnew – Goldman Sachs

Thanks. On commodity side, are there any, can you maybe comment on how broad-based that is, or are there any commodities that are lighting up in terms of cost pressure?

Barry McCabe

I think in terms of cost pressures it’s primarily oil-related commodities as well as the metals. I think in terms of the other commodities, we’re concerned about all our commodities but the pressure seems to be in the ones that I mentioned.

Christopher Agnew – Goldman Sachs

A couple sort of final wrap-up questions: Can you remind us when your last price increase was? Did you provide sort of breakout of that, and how much you’re able to realize? We should be expecting that you’ll just have annual, your anniversary, your last price increase, or would you look to do one in between? Then the final point is just on the tax rate, is there any, should we think about the tax rate slightly differently for the full year given where you have the gross coming from?

Barry McCabe

I’ll answer the tax rate question first. There were no unusual items in the tax rate. It was really truly the mix of business. Our Canadian business and our profits there were up and you pay an effective 32% tax rate in Canada; and when you look at the mix of our European businesses and some of our international, the tax rate is lower than the 35% Federal rate that we pay in the U.S. So that’s something we have to look at closely.

I think we gave in our guidance the last time about a 38.5 effective tax rate for the year. If you had asked me to look out today, it’s probably closer to a 38% rate, maybe I’m being a little cautious there but we have only one quarter behind us.

I’ll turn it over to Andrew to talk about the price.

Andrew Cogan

We put a new price increase, Chris, middle of February. We really didn’t see any impact of that in the first quarter. That kind of is on basically a one-year anniversary with our last increase so we should start to see the benefit of that really late in the second, more early in the third. So we still have some carryover benefit from the ’06 into ’07 increase and then we have a new one that picks up where that one left off, ’07 into ’08.

Christopher Agnew – Goldman Sachs

Great. Thank you very much, gentlemen. Thank you.

Operator

Your next question comes from the line of John Emrix from Ironworks Capital.

John Emrix – Ironworks Capital

Thank you. Some random questions: I apologize if you answered this one already. The tax rate, it was lower this quarter than it’s been and that had in my model. Are we changing the outlook at all from 38%, or is that still a good rate to use?

Barry McCabe

I just answered that question.

John Emrix – Ironworks Capital

Sorry.

Barry McCabe

It was the mix of business between our international and our domestic. I would still continue to use 38.

John Emrix – Ironworks Capital

Can you make any comment about what cap ex and DNA will look like for the year?

Barry McCabe

Overall DNA, when you take depreciation and amortization and non-cash compensation, we’ve said that’s in the neighborhood of I think $25 to $27 million in total. I don’t see that changing appreciably. Probably in terms of capital expenditures, it generally starts out lighter, increases throughout the year. I see that somewhere between $17 and maybe $20 million.

John Emrix – Ironworks Capital

How much of that $25 to $27 is the non-cash comp?

Barry McCabe

Around probably $5 to $6 million.

John Emrix – Ironworks Capital

Could you explain, you talked a little bit about the new credit agreement at yearend that you negotiated, and I missed that? Interest expense obviously down a lot year-over-year and I kind of a flat debt level.

Barry McCabe

It wasn’t at year-end. We put at $5 million all revolver facility in place the latter part of June last year. It’s all grid-based and it’s public knowledge. But between 2 and 2.5 times leverage is what we’ve said we’re going to manage to. We pay LIBOR plus 100 basis points, so I believe LIBOR today is around 2.7, so we’re paying an effective 4.7% interest before tax on around $370 million in debt.

John Emrix – Ironworks Capital

2 to 2.5 times, is that debt to EBITDA?

Barry McCabe

Yes.

Andrew Cogan

Again, if interest costs, and LIBOR’s 2.7, we’re paying 100 basis points. We’re paying about 3.7.

John Emrix – Ironworks Capital

3.7, yeah, nice drop year-over-year.

Andrew Cogan

Yeah, and you know the leverage ratio, we try and keep it between 2 and 2.5. I mean frankly where the stock is more appealing, we take our free cash and we’ll step up and buy more shares. So again, I don’t want to be bound to that 2 to 2.5. If we see an opportunity to step and buy more stock, we will certainly look at doing that.

John Emrix – Ironworks Capital

Yeah, covenants allow you to go higher.

Andrew Cogan

Exactly.

Barry McCabe

Our covenants allow us to go to 4.0.

John Emrix – Ironworks Capital

The last question is cash flow from operations less cap ex defining free cash flow, do you have, before share repurchases and such, do you have an outlook for free cash flow for the year?

Barry McCabe

No. I mean if you could… Look at last year, look at our depreciation and you can make your own estimates.

John Emrix – Ironworks Capital

I will do that. Thank you.

Operator

Your next question comes from the line of Todd Schwartzman from Sidoti & Company.

Todd Schwartzman – Sidoti & Company, LLC

Good morning, gentlemen. Andrew, in listening to your discussion of the North American customer categories, it sounds like, correct me if I’m wrong, it sounds like you’re saying that other than financial services, no other category really is coming close in terms of that magnitude of weakness that much of the industry has seen. Is that a fair assessment?

Barry McCabe

Yeah, I think that’s pretty fair. I think that’s the weakest category by far and away.

Todd Schwartzman – Sidoti & Company, LLC

As far as the cost cutting, should we expect to see that full annual run rate this quarter or that be more of a Q3 event?

Barry McCabe

Well I think if you look at it, you’ll see part of this quarter because we did it in the first week of April, net of the restructuring charge itself, and you’ll begin to see benefits then in the second half of the year and into the early part of next year.

Andrew Cogan

I also would just be [inaudible], it’s not in all SG&A. I mean it really is spread out. A lot of those costs are in gross margin. It’ll be hard to actually find it because those costs are going to be more than… Those costs are trying to offset additional inflation that we see coming at us, so I think it’s going to be hard to exactly find. But we did it based on where we saw input cost going and it was in a variety of areas.

Todd Schwartzman – Sidoti & Company, LLC

Sticking in North America for just a minute, on the Specialty category, what’s going right there particularly? With which customers are these products really resonating where the demand is strong?

Andrew Cogan

Well we’ve done a bunch of things. One is really expanded the distribution of them so we’re not so contract or office furniture centric as we used to be within those businesses. I think that’s been a key, the distribution elements of it. Additionally, a lot of the products we’ve been working on in those areas brought in the segments that we can sell into, so we’ve done a terrific job on healthcare textiles, doing a very strong job earning environmental textiles.

We’re doing a higher end line of textile called Knoll Luxe that we’re launching this quarter that go into office and hospitality segments and residential, and then we’re looking to expanding the distribution for our textile business. So it’s just… We’re doing a whole variety of different things, none of which is a homerun, but a lot of good kind of basic hits and just keep diversifying away from purely office driven specifications.

They’re not invulnerable to that segment, and I think they will see some pressure from the financial service decline and all that, but we’re going out in a lot of different directions – private aviation. Then some very creative things in terms of how you can apply our products in other segments that some of our other businesses that are working on, so it’s pretty cool.

Todd Schwartzman – Sidoti & Company, LLC

Internationally, I realize that you’re starting from a relatively small base in a number of countries, but can you talk about some pockets of strength by country?

Andrew Cogan

Well, I’ll just say Europe’s been a pocket of strength. I mean the major countries in Europe we’re doing business in we’re doing very, very well. Our team over there has done a terrific job of introducing new products of strengthening the sales organization, of broadening distribution across Europe, so that’s going well.

Then internally, our priority has been the Middle East. We see that as a terrific opportunity with a lot of North American based design firms operating over there, where we see significant commercial hospitality type construction, very good markets for us and where our brand is relatively well known and recognized for our design and quality leadership, so those are the markets we’re going after. I mean those are the big ones.

Barry McCabe

I will add, Eastern Europe’s been rather strong. We’ve done very well in Moscow and parts of Russia.

Todd Schwartzman – Sidoti & Company, LLC

The Mid East sales office, did you mention when that’s slated to open?

Andrew Cogan

Yeah, it’s opening this quarter. We just hired a new sales director to run that business. I mean up until a year ago, we were running that business out of Europe. Now we’ve got people living there. We hope to have a nice strong presence in each of the major countries over there with our own sales people. We’ve got dealer partners we’re working with over there, strong A&D relationships. Those leverage our factories in North American and Europe, so it’s good for our margins.

Todd Schwartzman – Sidoti & Company, LLC

Finally, assuming LIBOR stays between 2.5% and 5%, let’s say, 4.5%/5%, till what point in time would you keep repurchasing stock or how long could we expect to see the repurchases continue?

Barry McCabe

I don’t think you need to look at it as LIBOR. This industry generates a lot of free cash, and we will as we’ve said previously, opportunistically look at what we do with our free cash. To the extent that we have free cash and buying back shares is very accretive, we will continue to buyback shares.

Todd Schwartzman – Sidoti & Company, LLC

Barry, did you breakout the year-to-date roughly 1.1 million share total repurchase by Q1 and the first ten days of April?

Barry McCabe

Yes, I did. That was in the earnings release. It was 1,657,675 shares at an average price of $12.22. The reason why we did that is to give people when they look at our shares outstanding, the understanding that going into the second quarter pretty much, except for the first ten days or whatever I gave you there, that we have 1,065,000 less shares outstanding.

Todd Schwartzman – Sidoti & Company, LLC

But that is a year-to-date total is it not?

Barry McCabe

It’s the first quarter through ten days of April total, yes.

Todd Schwartzman – Sidoti & Company, LLC

With Q1 850,000 with the balance in the first two weeks of April or something like that?

Barry McCabe

I don’t have that right in front of me. I don’t think those ten days really matter that much.

Todd Schwartzman – Sidoti & Company, LLC

Right. Thank you.

Operator

Then your next question comes from the line of Justin Osuka from First Q Capital.

Justin Osuka – First Q Capital

First question is: Just curious to know if competition from imports has changed in your favor as a result of the weakening dollar?

Andrew Cogan

No, there’s no change. The segments we compete in don’t have enormous competition from imported product. We don’t play in the budget end of the business at all. Everything we do is made to order. There’s a high level of customization, so we really don’t compete against those kind of imported products in mass distribution channels at all.

Justin Osuka – First Q Capital

Thanks. Then on the pricing environment, obviously you guys are still realizing some price increases. But if the market deteriorates further, do you think the competition remains rational?

Andrew Cogan

You know this is always a very competitive industry and I don’t see why it wouldn’t continue to be.

Barry McCabe

Again, keep in mind that when we talk about price competition, it’s primarily on the much larger projects, not the day-to-day kind of business.

Justin Osuka – First Q Capital

Then just one last quick question: Is there any share repurchases assumed in your Q2 guidance?

Barry McCabe

We will continue to look opportunistically at share repurchases if the price is and we have the free cash, we’ll continue to buyback shares.

Andrew Cogan

But we basically use the million shares we purchased as a basis for the share count foundation in our guidance that we purchased already this year.

Justin Osuka – First Q Capital

Makes sense. Great. Thanks, guys.

Operator

There are no further questions at this time. I would now like to turn the call back over to management for closing remarks.

Andrew Cogan

Thank you, everybody. I just want in close appreciate your continued interest in Knoll. I’m really proud of the work that our people across the Company are doing to deal with the challenging environment where we’ve been able to continue to deliver both top and bottom line growth. We’re very pleased at the results. We’re working very hard to keep those, keep that momentum going, and we hope to see many of you at Neacom* where we think we have some very exciting showroom planned and a great couple of days that we’re looking forward to. But thank you everybody.

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Source: Knoll, Inc. Q1 2008 Earnings Call Transcript
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