Knoll, Inc.'s (KNL) CEO Andrew Cogan on Q3 2018 Results - Earnings Call Transcript

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About: Knoll, Inc. (KNL)
by: SA Transcripts

Knoll, Inc (NYSE:KNL) Q3 2018 Earnings Conference Call October 30, 2018 10:00 AM ET

Executives

Andrew Cogan - Chairman, President and Chief Executive Officer

Charles Rayfield - Chief Financial Officer

Analysts

Greg Burns - Sidoti and Company

Budd Bugatch - Raymond James

Matt McCall - Seaport Global Securities

Kathryn Thompson - Thompson Research

Operator

Good morning, everyone, and welcome to Knoll Incorporated Third Quarter 2018 Conference Call. This call is being recorded. This call is being webcast. Presentation slides accompany the webcast. In addition, the call may offer statements that are forward-looking, including without limitation, statements regarding Knoll's future outlook for the industry and economy and expectations with respect to future leverage. These forward-looking statements are based largely on the company's expectations and are subject to a number of risks and uncertainties, certain of which are beyond the company's control.

Actual results may differ materially from the forward-looking statements as a result of many factors, including the factors and risks identified and described in Knoll's annual report on Form 10-K and its other filings with Securities and Exchange Commission. The call today is also included references on the non-GAAP financial Securities and Exchange Commission. Reconciliations of these measures to the most comparable GAAP financial measures are included in the presentation slides and will be accompanied to the webcast.

And now I’ll turn the call over to Andrew Cogan, the Chair, President and CEO of Knoll. Thank you.

Andrew Cogan

Thank you and good morning everybody and welcome to our third quarter earnings call. I'm very pleased to report that the bold actions that we've taken in the past year from the acquisition of Muuto, the launch of new platforms like Rockwell Unscripted and the reorganization and expansion of our selling capacity have enabled us to respond to changing design trends and allocation of space within the workplace, penetrate faster-growing ancillary categories and continue to drive top line growth.

Coupled with concurrent initiatives to increase the share of revenue we derive from our high design, high-margin global lifestyle businesses, which now represent approximately 40% of our revenues, we are building a unique constellation of design-driven brands with durable competitive advantages and superior profitability. This quarter, the benefit of these initiatives combined with favorable price realization and efforts by our supply chain team to offset continued inflationary pressures led to 100 basis points of adjusted EBITDA margin expansion from 13.4% to 14.4% and adjusted EPS growth of 20% from $0.40 to $0.48. Excluding the favorable accretion and margin mix benefit of Muuto on our adjusted EPS and adjusted EBITDA margins, these metrics showed organic improvement too as did our adjusted growth in operating margin.

We continue to target 15% EBITDA margins as our mid-term goal over the next couple of years. Growth in the quarter remains spread across both of our business segments. As reported, sales grew a strong 12.5% over prior year as we continue to benefit from the acquisition of Muuto and the acceleration of our overall lifestyle segment are just under 5% organically as we would began to lap some stronger revenue comps in our Office segments. Lifestyle growth of 31% or just under 9% organically compared favorably to the 25% total and 5% organic growth we reported in Q2.

And as anticipated, adjusted EBITDA margins expanded by 80 basis points from 20.4% in Q3 of 2017 to 21.2% in Q3 2018, our best levels of the year. Muuto saw an acceleration of its growth and momentum in the quarter commensurate with the increased exposure in North America that benefits them from being part of the Knoll constellation as sales in the quarter grew over 30%; growth that on their own, they simply would not have been able to realize.

Now with the NeoCon Muuto introduction in the rear view mirror and showroom and dealer displays across North America shipping, Muuto’s breadth and depth of engagements both at the day to day dealer level and on some of our large – largest corporate accounts expanded significantly. In September alone, we saw Muuto’s orders grow over 50% globally as they more than quadrupled in North America.

With our sales and dealers confidence in Muuto’s differentiated designs, European sourcing, extended warranty, North American in-stock position and complementary fit with our modern designs growing, it's not taking long to see Muuto well on the way to realizing the potential we saw in the brand. That said we are just scratching the surface with Muuto on our overall penetration of ancillary spaces. And as we continue to sign on more corporate, hospitality and retail clients to Muuto’s standards, we should see even bigger impact in 2019 and beyond.

Overall, beyond the favorable Muuto impact, it was a very, very strong quarter for our lifestyle segment. Globally, Knoll’s studio experienced double-digit growth, split pretty evenly between contract and consumer/residential end markets. DatesWeiser continue to grow double-digits. As with Muuto, they continued to benefit from exposure to our corporate clients and distribution. KnollTextiles and Spinneybeck Filzfelt, both delivered strong top-line growth. Relatively flat sales at HOLLY HUNT were mostly timing related as during the quarter we moved to a significantly larger warehouse to accommodate the expanded needs of this business.

As you may recall, HOLLY HUNT is now 50% larger and twice as profitable as when we acquired the business. Orders at HOLLY HUNT did grow double digits and backlog is up significantly versus prior year. It's important to note that today with the current mix of lifestyle businesses and multiples and the multiple channels we sell into from our own direct to consumer online business in New York and LA shops to our Knoll’s space residential network in North America and retail partners in Europe plus the extensive network of HOLLY HUNT showrooms across North America and into Europe that we see the consumer and residential opportunity as a significant high margin business and growth opportunity for Knoll.

Today about half of our lifestyle sales and approximately 20% of our total sales go into residential settings. Including Muuto these residential sales were up approximately 25% versus prior year. Equally important to note, particularly in light of the resimmercialization of the workplace is that these same lifestyle products increasingly play a role in our workplace sales as the rigid boundaries between office and home break down. With our constellation of lifestyle brands, we believe we are uniquely positioned to benefit from this trend. In fact, in Q3, the contractor workplace half of our lifestyle portfolio experienced just under 40% growth. This is one reason segment reporting aside that we think is also relevant to share with you how our workplace business performed.

This includes our office segment plus the half of our lifestyle sales that are sold to and or in conjunction with these office projects, for instance, when an office client includes Muuto, KnollStudio, DatesWeiser, Spinneybeck Filzfelt even KnollTextiles on the same project. Remember too that [indiscernible] redefinition of the total market now suggests that these ancillary opportunities represent almost half of the contract furniture market. Here in Q3, our total workplace sales grew 10% even though our pure Office segment reported just under 3% growth.

Year-to-date workplace growth including Muuto is up approximately 15% significantly outpacing the reported industry growth of just below 4%. Important to note too is that with the consolidation of sales responsibility for the contract portion of many of these businesses with our office regional leaders, we have tied their incentive performance into the achievement of our total workplace results and not just the Office segment portion.

Growth in our Office segment this quarter was supported by both the continued stabilization of our legacy products and then particularly the investments we have made in upgrading our wood capabilities plus continued strong growth in Rockwell Unscripted and our broadened range of height adjustable tables. These newer platforms now represent more than half of our sales and have margins that exceed those of our legacy products.

Our day to day Knoll Essentials program driven by our dealer partners’ also experienced strong sales growth. As we entered 2019, we're looking at selective investments to accelerate our penetration of both day to day and ancillary sales within our dealer partners. Within the Office segment, price realization from our recent increase plus the absorption benefit fixed cost leverage from higher volumes together with our ongoing lean and CI initiative, we're able to offset challenging commodity inflation and transportation inflation to deliver 40 bps of adjusted EBITDA margin improvement as margins here expanded from 11.4% in last year’s Q3 to 11.8% this quarter, a nice improvement from our year-to-date adjusted EBITDA margins of 10.1%. While we are heartened by this progress, we are also aware of the inflationary pressures and the additional impact tariffs may have on the profitability.

It's one reason why we put through an additional mid-year increase – price increase. As we noted on our last release, it's also become clear that as our lean initiatives build on each other that there is a more transformational opportunity to re-envision and redesign our entire supply chain. That study continued into the third quarter and some of the first actions, including the just announced discontinuation of our Morrison system product in 2019 are part of the effort to shed less profitable products and inefficient square footage in our plants to put these assets to better use.

As we move into 2019, we will be making more of these kinds of optimization moves to position ourselves for larger savings in 2020 or 2021. The good results we're reporting are a result of more than just a solid strategy. They reflect the hard work and execution of a very talented team. In this context, I'm particularly pleased to have announced earlier this month that Chris Baldwin joined our leadership team as the Chief Operating Officer and President of our Office business. Chris, whose addition helps to expand our management bandwidth comes to us most recently after 13 year career at Kohler, where he was leading their large kitchen and bath business in North America.

Chris has led sales, marketing, product development and manufacturing teams over his 20 plus year career and has strong experience working with both dealer partners in the A&D community. As I hand over the day to day reins of our office business to Chris, I look forward to more time to help drive the continued pivot of Knoll mix of business towards the high design high margin spaces, which uniquely fit our very special global brand.

We've recently begun our 2019 planning process and our teams are working aggressively to offset continued inflationary pressures in 5 million to 10 million of potential tariff headwinds, primarily in our seating business. Overall supported by continued increase in both the total dollars and quantity of opportunities in the funnel of business that we are tracking, we will be targeting solid mid single digit organic growth driven by continued ancillary share gains with 50 basis points to 100 basis points of margin expansion from continuous improvement, price realization, favorable absorption and product mix. Furthermore, our interest rates hedges kicking next year and will help insulate us from any significant spike up in rates.

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

Charles Rayfield

Thank you, Andrew. Knoll, Inc. third quarter net sales increased $36.5 million or 12.5% from a year ago. Gross margin in the third quarter was 37.5% compared to 36.6% 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. Total adjusted operating expenses in the third quarter were $85.9 million compared to $78.3 million in 2017. The increase was due primarily to incremental operating expenses for 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 excluding $2.1 million of amortization of intangible assets related to our acquisitions of the Muuto, HOLLY HUNT and Edelman businesses, $1.2 million of restructuring charges and acquisition related expenses of $0.7 million. Acquisition related expenses included retention agreements for key Muuto employees, customary acquisition costs and the reduction of an acquisition related liability. The restructuring charges were related to the supply chain optimization initiative that will result in greater operational efficiency.

Adjusted EBITDA for the third quarter of 2018 was $47.2 million, up from $39 million or 21% for the third quarter of 2017. The increase in adjusted EBITDA was due primarily to higher sales volume in the lifestyle segment, net price realization in both the office and lifestyle segments and the inclusion of three months of Muuto operations. The adjusted EBITDA margin increased to 14.4% in the third quarter of 2018 from 13.4% in 2017. The increase in adjusted EBITDA margin was due primarily to gross margin improvement as the lifestyle segment represents a larger percentage of the total Knoll, Inc. sales combined with lower operating expenses as a percentage of sales.

Interest expense was up $3 million from a year ago due primarily to increased debt levels as a result of the Muuto acquisition and higher interest rates. The effective tax rate for the quarter was 26.1% down from 29.9% in Q3 of 2017. Effective tax rate for the third quarter of 2017 was favorably impacted by the reversal of evaluation allowance against certain foreign jurisdiction deferred tax assets. Excluding the impact of the valuation allowance reversal in 2017, the effective tax rate for the third quarter of 2018 decreased significantly from the third quarter of 2017 primarily due to the passage of the U.S. Tax Cuts and Jobs Act in December of last year.

The company expects its full year effective tax rate to be between 25% and 26% for fiscal year 2018. 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 third quarter of 2018 was $23.7 million, up from $19.6 million for the same period in 2017. Adjusted net earnings is exclusive of the $3.4 million of tax-affected net earnings adjustments that were previously discussed related to amortization from acquisitions, restructuring charges, acquisition related expenses and a pension settlement charge.

Adjusted diluted earnings per share was $0.48 and $0.40 for the third quarter of 2018 and 2017 respectively. Capital expenditures for the quarter were $5.3 million compared to $8.7 million in the third quarter of 2017. Capital expenditures related primarily to our information technology infrastructure and manufacturing equipment. Regarding our balance sheet and cash flow, cash and cash equivalents were approximately $7.3 million at the end of the quarter and our outstanding debt balance was reduced to approximately $480 million.

We finished the third quarter with the leverage ratio of 2.75. Operating activities provided $31.1 million of cash in the quarter compared to $27.2 million in the prior year. Total cash and – total cash used in financing activities was $23.4 million. We used cash in financing activities during the third quarter of 2018 to pay down $16.2 million of debt and quarterly dividends to $7.3 million. Consistent with past quarters, we use excess cash generated from operating activities to invest in the business, pay dividends and reduce outstanding debt. Looking ahead to the end of the year, we expect to continue to grow the business, expand our margins and reduce our leverage.

Thank you. We'll now take any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Greg Burns from Sidoti and Company. Your line is open.

Greg Burns

Good morning. So in terms of – could you just maybe I guess – I think you mentioned a year-over-year growth rate for that business, but if you could just repeat that? I missed the number. And then can you just talk about kind of the uptake among your North American dealers? What percent of your channel is currently selling Muuto relative to kind of your expectations when you bought the asset? How was the business performing relative to where your thought will be at this time? Thank you.

Andrew Cogan

Great, thanks, Greg. Yeah, we are very, very pleased with how Muuto is performing. I think I talked on the call script of their growth being up about just over 30% in the quarter. I think what's exciting is when we look at the impact of where they're growing, they’re continued on their own growth very nicely, but we're really bringing incremental growth. So when you even look at our organic numbers, it's almost misleading because I think Muuto is getting some of the growth, a big chunk of the growth they're getting because we're moving them through our network.

The penetration of our dealers has been very strong. We're now in our 9th or 10th month of owning Muuto. Every month we've seen a greater number of dealers engage and we've seen the dollars of those engagements to grow. What's also exciting is now we're starting to get Muuto on some of our corporate standards and our largest project. So as we look at the Muuto pipeline for 2019, we're starting to see a real backlog of millions of dollars of project business that will start to flow through what they're doing.

So we are really encouraged where Muuto is. The margins continue to be very strong. The uptake amongst our dealers has been extremely positive and we're really seeing the results start to come in. Again as I mentioned on the call script, orders in September in the U.S. were up four times what Muuto get a year ago and overall the business was up 50%. So the momentum is accelerating as we move through the year, which is frankly exactly what we thought we would happen as we started to move that into our system. We've got a large warehouse in the U.S. that's fulfilling orders in very short lead time. We're in the process now of increasing that warehouse beyond what we initially anticipated to respond better to demand we see coming. We're working on the ability to customize Muuto products so clients want to do their own [COM] [ph] and other fabric that's coming. And additionally, Muuto has a very exciting pipeline of new products. And importantly a lot of – the bulk of Mutto’s furniture is made in Europe. And so we’ll not be subject to any of the tariff stuff that I think some of the other Danish brands that are more Chinese-based will suffer. So we're, as you can tell, excited. And it's a great management team that has worked very collaboratively with our folks here at Knoll.

Greg Burns

Okay, great, thanks. And then just flipping to the Office segment, it sounds like there's some office business flowing through lifestyle and I guess you’ve kind of delineated as workplace sales. But could you just give us a sense of maybe kind of what the order growth in the quarter maybe for the Office segment or for workplace as a whole? Just give us a kind of a near-term view on your outlook for demand. Thanks.

Andrew Cogan

I think it was all very consistent. Orders and shipments are pretty much aligned in everything. So I don't think there much of a disconnect there. I think it is important. As we go forward and I was visiting some [indiscernible] we were involved in last week. And what was exciting to see was the increased level of ancillary penetration.

So I think one of the metrics we're all going to need to be thinking about and we'll be talking about more regularly now is this workplace number because it's not just about the traditional office part of the business, which continues to grow led mostly by some of our newer introductions. We – Rockwell continues to kill it in terms of accelerating growth. All of the investments and adjustability, all those things are good. But I think what's going to really drive the higher growth rates is this ancillary penetration and given that that's about half the lifestyle sales.

I think it's important that we're not just focused on what the Office segment is doing, but how is Knoll’s workplace business doing. And I can tell you internally as we're aligning and moving forward. And Chris and I are thinking about, you know, what we want to do here. That's going to be a bigger part of the focus and everything and so I think it's important you all are aligned with that as well.

Greg Burns

Okay. In terms of I guess disclosures, I know we just realigned along office and lifestyle, but it sounded – will you be giving more color or detail around workplace going forward? Or how do you view – what's your view on kind of giving that detail to the street?

Andrew Cogan

Yeah, we will give you the workplace sales and so you can get a sense of how that's going, but we’ll not make it into a formal reporting structure because frankly it mixes businesses from different segments together into a kind of a more of a use classification in terms of – or an application in the office. So I think we'll give you that number from a sales growth standpoint, but we will not take it to a P&L or EBITDA standpoint.

Greg Burns

Okay, great. Thank you.

Operator

Our next question comes from Budd Bugatch from Raymond James. Your line is open.

Budd Bugatch

Good morning, Andrew. Thanks for taking my questions. Just making sure I understand Muuto so far in the numbers in U.S. dealer sales, what – of the $22.5 million that you posted in third quarter what – how much of that came out of the U.S. dealer base?

Andrew Cogan

Right, I'm not going to break out Muuto specifically like that, but what I can say is it's an increasing share of the overall Muuto business and growing significantly – probably twice as fast as Muuto’s overall business is growing.

Budd Bugatch

Let me try it this way. Sequentially, Muuto grew about $1.5 million from Q2 to Q3, was that pretty much all U.S. or can you…

Andrew Cogan

I think that's probably fair to say.

Budd Bugatch

Okay. And next, what do you think Muuto will do in Q4? How do we think about that to kind of project our model for…

Andrew Cogan

I think Muuto will continue to accelerate both sequentially and year-over-year as we move through the balance of the year and into next year. And again, basing that on activity, I mean Muuto is – we’re having a very strong October with Muuto. And I look at the pipeline of projects Muuto’s won and the corporate standards they're now on and those programs really won't start rolling out until 2019. So I don't see anything that says that is doing anything, but accelerating.

Budd Bugatch

Okay. And as we look at the workplace residential reconciliation you gave us in the slides…

Andrew Cogan

Yeah…

Budd Bugatch

Is that – does that workplace map pretty much to BIFMA, as BIFMA is now reporting for that [indiscernible]?

Andrew Cogan

Thank you for reminding me that and just to Greg's question. That reconciliation is in the webcast and we will provide that going forward in the webcast. So, yes, that data is there. And yes, I think that is the number, but that maps to the new BIFMA data that's being reported. It's not the pure office number anymore. So, you know, as I look at that, we're growing 2x BIFMA when I compare our workplace to the BIFMA reported data.

Budd Bugatch

Okay. And just going back to the legacy office, you are discontinuing Morrison beginning in next year. What's the installed base of Morrison? And what does that represent in sales? And are you nervous about discontinuing it?

Andrew Cogan

Yeah, I mean, Morrison today is less than 1% or 2% of our sales. So I don't see a huge impact there. We've worked really closely with our clients. This has been something that's been going on for really the last two or three years as we've been raising prices and starting to move people away. And we've worked with – and it will be producing probably through the middle of 2019. So we're giving clients ample opportunity to transition and we’re working very closely with, but it's really now down to a handful of clients with meaningful installed bases. So, I think that's going to go fine that frees up significant square footage in our facility in East Greenville. And that's the beginning of some of the footprint transformation moves over the next few years that we've identified are out there to be made.

Budd Bugatch

It is equity and rev, remind me it is compatible with Morrison, so you will be able to at least handle clients that may have that or is that – do I recall that incorrectly?

Andrew Cogan

First of all equity we can just – we discontinued I think four or five years ago.

Budd Bugatch

Oh my – okay, it shows where I am.

Andrew Cogan

That’s been – now, you got to catch up, Budd, here. That's been gone for awhile. And we can – rev continues to do really well and perform really strongly, dividends is our largest system platform doing very, very well. So we have lots of things that we can help clients, who are buying Morrison transition into. So I don't expect. Yeah, it's 1% or 2% revenue headwind, but it's not anything that is going to be material or impactful on our client relationships. I think it's the right thing to do. And again, it frees up a lot of square footage that we have better use for.

Budd Bugatch

Got it. I've got two more areas just quickly. Tariffs are 5%, I think, of cost of goods sold. That's about $40 million or if we get to a 25% number, that's a $10 million headwind. How do you offset that? How much is the price increase? And are there other offsets?

Charles Rayfield

Yes, sure, Budd. This is Charles. So as you discussed, we're expecting maybe $5 million to $10 million impact going into 2019 when the tariff goes up to 25%. We're looking to several options to offset the tariffs. You mentioned price increases. Obviously, we’ll have a price increase coming out at beginning of 2019. And I think we're running still through some of the numbers and can give you some more clarity as we go into the February call. Some of the other things that we're doing are strategic negotiations with our suppliers and looking at alternative sourcing of the supply chain option. So there's several things that we're working on try to reduce the impact.

Budd Bugatch

And does the RMB help you at all? Does the RMB move help to offset some of that?

Charles Rayfield

I don't think very much, no.

Budd Bugatch

Okay. And lastly for me, some of the adjustments you’ve made restructuring and acquisition. What do we look like in the fourth quarter? What add backs do we foresee in the fourth quarter?

Charles Rayfield

Sure. So I think for the fourth quarter obviously we’ll continue to have the amortization from our acquisitions, which is probably the primary thing, probably a few straggling remaining acquisition related costs fairly minimal and probably some [indiscernible] restructuring as we go forward into 2019.

Budd Bugatch

And that amortization number is that shown in the slides.

Charles Rayfield

We have an add back in the earnings release that shows the amount of depreciation and amortization that’s being added back. I don't know that we specifically break it out by acquisition, but the total numbers in there for you.

Budd Bugatch

Well, it’s 2.8 for the acquisition related, which I would think would be the amortization plus other expenses, right?

Charles Rayfield

That's right.

Budd Bugatch

So – okay, so we need to take out just the acquisition related, that's it. Okay, thanks, Charles. We’ll get that later from you.

Charles Rayfield

Sure.

Andrew Cogan

Thanks, Budd.

Operator

Our next question comes from Matt McCall from Seaport Global Securities. Your line is open.

Matt McCall

Thank you. Good morning everybody.

Andrew Cogan

Good morning.

Matt McCall

So, Andrew, you talked about, let's see I'll start with margin. You talked about 50 basis points to 100 basis points kind of being the bogey for next year if I heard you correctly on the EBIT margin expansion front. Can you go into a little more detail there, the volume, you're assuming, I know we're going to get some savings next year, any mix benefits? And then what part of that expansion comes is expected to be gross margin versus SG&A?

Andrew Cogan

Sure. Well, first of all, I think we're talking about EBITDA margins. I think that’s where we’ve tried to move the conversation…

Matt McCall

Okay.

Andrew Cogan

And I'm pleased that as we've moved through this year, we've seen an increasing year-over-year sequential improvement in the rate of EBITDA margin expansion that I would expect to continue to the fourth. So some of it is kind of running that momentum. What is that made of, Matt? It's made up of a couple of pieces. First, we are getting a mix benefit, I mean more lifestyle sales at 21% to 22% EBITDA margins and that's now up to about 40% of our revenue. That will continue to grow as a piece of our revenue. So a nice piece as we're getting favorable mix from where we're growing faster. That's number one.

Number two, we are in spite of, you know, the tariff and the inflation, we are getting gross margin improvement as we drive both CI and our continuous improvement efforts plus the benefit of price realization. Some of the price realization is also a function of mix shift within the business from fewer large projects to more smaller projects, more day to day business at better margins. So, you know, I think the mix stuff going on. And then I would add Matt that the shift from legacy to new platforms, we have newer higher margins in our newer platform.

So if you put all together in the mix trends in our business are all margin favorable. So I think that's a big chunk of it. And then if you take the CI and some of the other things and you layer that in offset by tariffs and inflation, I think this year we're going to have $15 million to $20 million of inflation that we’ll have been able largely with a combination of things to offset and expand our core growth or expand our whole flat basically our core gross margins without Muuto and then got again some of the favorable mix benefits. On SG&A, I think we've done a nice job of managing that in the 26% to 27% of sales ratio and I would imagine that would be a number we'll try and kind of – a range we will try and stick with as we move forward here.

Matt McCall

So that’s very helpful. So as you move closer to these footprint changes, does that have any impact on your continuous improvement efforts in the savings you've been able to generate annually as folks are focused maybe on footprint more so than the ongoing C&I effort – CI efforts?

Andrew Cogan

No, I don't think so. I think there's actually a nice correlation between the lean work we're doing and the freeing up of space plus then the discontinuation of platforms that are less efficient or inefficiently using up footprint, frees up more footprint to do larger changes in terms of our overall infrastructure down the road. So I think they're kind of all sequential and logical. And over the next year I would say we’re probably continue to focus more in the lean CI front of things and that again is a prerequisite to some of the bigger moves that, you know, I think we could look at in 2020 and 2021.

Matt McCall

Okay. The - so, I think you said lifestyle was about half office. As I think about the way I've always thought…

Unidentified Company Representative

I don't want to say…

Andrew Cogan

Go ahead, go ahead…

Matt McCall

Okay…

Andrew Cogan

Yeah, I would just say – yeah, we say about half of lifestyle goes into the workplace area, but I wanted to find that broadly also as hospitality, retail, a variety of applications including workplace.

Matt McCall

Okay, that's fair. That's fair. Good clarification. So I guess the question is the way I've always thought about the lifestyle business, and I guess when you – in the studio and coverings has high margins, but there were variable cost models, which meant they were pretty consistent margins. Does this increase exposure to the workplace changed that dynamic at all?

Andrew Cogan

No. So these businesses are in general the characteristic is they really have very little vertical integration in terms of us manufacturing them. So in terms of a volume basis and all that, the margins don't fluctuate a lot. They also are all collectively 20% to 22% EBITDA margin businesses. So that doesn't change. It's just we're putting them into these workplace applications, which every time we do that improves the profitability of every individual client engagement. And I think that's unique to Knoll in some extent.

Matt McCall

So, okay, thank you. The last one for me, the ancillary growth that you show – I know in your deck for a while, now you've had the pie chart that shows that you are only about 10% penetrated based on 2015 numbers with your dealers, ancillary business. Any update to where that stands given some of the success you've had from Muuto and Rockwell Unscripted and some of these new product introductions?

Andrew Cogan

Well, I don't have a specific data point, but I can tell you directionally it's going up and we look at our share of dealers now. We calculate this every year, but the trend over the last year has been positive and I imagine it will only continue to be positive because again when I look at how those businesses are workplace portfolio is performing against the BIFMA number. We're doing 2x that number. So we have to be gaining share of that category. And then I see it when I go visit client installations and I seem more Knolls designs in areas that we used to not be in. And I see lots of areas where we're still not in where we should be in. So I think there is ample white space for us to expand into and that's been the driver of our acquisition and product development strategy and we’ll continue to be in the years ahead.

Matt McCall

Okay, thank you, Andrew.

Andrew Cogan

Thank you, Matt.

Operator

[Operator Instructions] Our next question comes from Kathryn Thompson from Thompson Research. Your line is open.

Kathryn Thompson

Thank you for taking my questions today. I just really want to take a step back and looking forward into 2019. You could give some color in the prepared commentary and the Q&A. But wanted to get your initial thoughts on the tailwinds and the headwinds as we head into 2019 both from a volume and a price cost standpoint and then after that I have a follow up question just on projects. Thank you.

Andrew Cogan

Sure, Kathryn. I say in terms of – in terms of the headwinds, I think that's all of that kind of stuff everyone has been talking about. Inflation both in kind of metals and transportation costs continue to be problematical. Although I will say as we look out a little bit, maybe some of the rate of increase in that is starting to roll over. So maybe that won't be increasing at the same rate. The tariffs are certainly an additional headwind we haven't faced. Our team is doing a really nice job of proactively addressing those. And we did make the decision to implement yet another price increase in early 2019 to help protect ourselves there. So I think we will – we have a pretty diverse supply chain. We're not overly Asia dependent by any means and we have the ability to move some stuff around.

So I think we'll be able to offset a good 50% of some of those of that, $5 million to $10 million impact as we move through the year. So I think those are the pretty obvious headwinds. On the revenue side, listen, I mean there has been – I think you look at some of the leasing data, some of the absorption data, there has been some sequential in year-over-year slowing of some of that activity. So it's still growing. It's still growing nicely, but it may be growing a little bit slower. So I think the key thing for us is going to be – and it is can we continue to gain share within both our dealers and within the clients we're doing business with as well as win the ancillary world.

And I think that will be what – I think yes we can and I think yes we will, but that will be I think the determinant and I think a lot of that is within our power because again as I said I think there's plenty of white space for us to move into. So we are looking at an investment to help drive that. And much like, I think over the last year or so, the addition of headcount into our overall selling organization as we saw fewer large projects and more – need more people to cover for more projects.

I think we have an opportunity to make some selective investments in headcount in the front end of the business to focus particularly within our dealers and particularly on these ancillary areas. And so, I think that's something you'll see us do when we're kind of in the process now of nailing down those numbers, but where we've done that on a beta, on a test basis, we've seen some nice returns from those initiatives. So that's kind of how I would slice and dice the headwinds, tailwinds.

Kathryn Thompson

Yep. And I am assuming the tailwinds you have continued realization of cost takeout, any thoughts and…

Andrew Cogan

Well, I think the biggest tailwinds is really the mix shift within the business. So, again, the categories that are growing faster are all higher margin than the categories that are growing slower. So I think we get a kind of natural mix shift benefit. But again I don't want to underestimate the margin challenges and things like that that we continue to face.

Kathryn Thompson

Great.

Andrew Cogan

But our goal is – our goal remains 15% midterm EBITDA margins both through mix through CI through all the – all the tools in our toolkit.

Kathryn Thompson

And also in your prepared commentary, you talked about going after more, more jobs that are smaller in size. And in general this is something that we've seen as a broader trend in the commercial or non-res end market.

Andrew Cogan

Yeah.

Kathryn Thompson

Could you maybe talk about what trends you're seeing either from project size? What’s the different today versus say 18 months ago? And then also a comment on geographies where you're seeing – and in markets where you're seeing steep and others where maybe you're not seeing as robust growth. Thank you.

Andrew Cogan

Sure. In terms of a project size and all that, I mean there's some stabilization. I think the average project size was down a few points and I'm just looking at the office business and the number of projects was up a few points. So it's not at the rate of decline that we were seeing. So I think that's good, maybe you're getting to – before we were seeing like the number of million dollar plus projects in the quarter was flat year-over-year. So I think that there seems to be some stabilization in that trend. In terms of geography, we continue to do very well on the coasts and you can kind of tech, legal, accounting, finance. I mean those have been pretty good areas for us. We're doing well and kind of the sales and stuff like that. We have a lot of opportunity in the central part, which is other people's hometown, where I think we can do better.

We're investing in a stunning and very powerful flagship. I think it will become our national flagship frankly in Chicago and then we made a kind of bold decision to move out of the merchandise mark to strike out on our own and one of the fastest growing and most exciting areas of the Midwest and in Chicago. And I think that's going to be a really bold statement. So I think that's where we have had some opportunity to better and we're investing against that. We've made some changes in our team in those markets. So in that area, I don't know whether its market – maybe things we've done, but I think we've got a significant opportunity and it is a real focus. I'm very pleased with how we're doing around the coasts and the perimeter down south and everything and into Texas.

Kathryn Thompson

Okay, thank you very much.

Andrew Cogan

Thank you.

Operator

I am showing no further questions at this time. I would now like to turn the call over to Andrew Cogan for closing remarks.

Andrew Cogan

Great, thank you everyone for joining the call and we really appreciate the dialogue and the good questions today. So thank you for your continued interest and we will see you all again in February if not before. Take care, everybody.

Operator

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