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KNL > SEC Filings for KNL > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for KNOLL INC

Form 10-Q for KNOLL INC


9-Nov-2012

Quarterly Report


ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Management's discussion and analysis of financial condition and results of operations provides an account of our financial performance and financial condition that should be read in conjunction with the accompanying unaudited condensed consolidated financial statements.

Forward-looking Statements

This Quarterly report on Form 10-Q contains forward-looking statements, principally in the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations," and "Quantitative and Qualitative Disclosures About Market Risk." Statements and financial discussion and analysis contained in this Form 10-Q that are not historical facts are forward-looking statements. These statements discuss goals, intentions and expectations as to future trends, plans, events, results of operations or financial condition, or state other information relating to us, based on our current beliefs as well as assumptions made by us and information currently available to us. Forward-looking statements generally will be accompanied by words such as "anticipate," "believe," "could," "estimate," "expect," "forecast," "intend," "may," "possible," "potential," "predict," "project," or other similar words, phrases or expressions. This includes, without limitation, our statements and expectations regarding any current or future recovery in our industry. Although we believe these forward-looking statements are reasonable, they are based upon a number of assumptions concerning future conditions, any or all of which may ultimately prove to be inaccurate. Important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation: the risks described in Item 1A and Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2011; changes in the financial stability of our clients or the overall economic environment, resulting in decreased corporate spending and service sector employment; changes in relationships with clients; the mix of products sold and of clients purchasing our products; the success of new technology initiatives; changes in business strategies and decisions; competition from our competitors; our ability to recruit and retain an experienced management team; changes in raw material and commodity prices and availability; restrictions on government spending resulting in fewer sales to the U.S. government, one of our largest customers; our debt restrictions on spending; our ability to protect our patents, copyrights and trademarks; our reliance on furniture dealers to produce sales; lawsuits arising from patents, copyrights and trademark infringements; violations of environment laws and regulations; potential labor disruptions; adequacy of our insurance policies; the availability of future capital; the overall strength and stability of our dealers, suppliers, and customers; access to necessary capital; and currency rate fluctuations. The factors identified above are believed to be important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement. Unpredictable or unknown factors could also have material adverse effects on us. All forward-looking statements included in this Form 10-Q are expressly qualified in their entirety by the foregoing cautionary statements. Except as required under the Federal securities laws and rules and regulations of the SEC, we undertake no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events, or otherwise.

Critical Accounting Policies

The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires us to make estimates and assumptions that affect the reported amounts of certain assets, liabilities, revenues and expenses and the disclosure of certain contingent assets and liabilities. Actual results may differ from such estimates. On an ongoing basis we review our accounting policies and procedures. A more detailed review of our critical accounting policies is contained in our Annual Report on Form 10-K for the year ended December 31, 2011.


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Overview

Net sales for the third quarter decreased 8.2% from $239.5 million during the third quarter of 2011 to $219.8 million during the third quarter of 2012. Sales declined across all three segments with the largest percentage declines occurring in the Studio segment. Despite increased sales in North America, the Studio segment was negatively impacted by the current economic situation in Europe. Decreased demand from government and financial services clients was the primary cause for the decline in sales for the Office segment.

For the third quarter of 2012, gross profit as a percentage of sales increased 90 basis points to 33.8% versus the comparable quarter of the prior year. The increase in gross margin from the third quarter of 2011 largely resulted from a more profitable mix in our business as we saw government shipments, which are generally at higher discount rates, make up a smaller portion of our overall sales. Continuous improvement projects in our factories also positively impacted our gross margin.

Operating expenses for the quarter were $50.7 million, or 23.1% of net sales, compared to $53.9 million, or 22.5% of net sales, for the third quarter of 2011. The decrease in operating expenses during the third quarter of 2012 was primarily due to lower variable compensation spending due to our lower sales, but was partially offset with continued spending on new product and growth initiatives, and technology infrastructure upgrades.

Operating income for the third quarter of 2012 was $23.5 million, a decrease of 6.0% from the third quarter of 2011. The decrease in operating income during the third quarter of 2012 is primarily attributed to the Coverings segment. The operating income decline in the Coverings segment during the third quarter of 2012 resulted from lower demand from certain markets such as hospitality and transportation, coupled with increased spending on growth initiative programs.

During the third quarter of 2012, we increased our quarterly dividend from $0.10 per share in the previous quarter to $0.12 per share. This quarter we also continued to aggressively reduce our debt by paying down an additional $15.0 million of senior indebtedness. Interest expense during the third quarter of 2012 increased $0.4 million when compared with the prior year as our overall effective interest rate increased slightly as a result of our new credit agreement completed during the first quarter of 2012. See Note 11 of the condensed consolidated financial statements included in this quarterly report on Form 10-Q for further information regarding the new credit agreement.

Net income was $12.2 million during the third quarter of 2012 compared to $18.4 million during the third quarter 2011. Diluted earnings per share was $0.26 for the third quarter of 2012 and $0.39 for the third quarter of 2011. During the third quarter of 2012 foreign exchange losses, negatively impacted earnings per share by approximately $0.04 while foreign exchange gains positively impacted earnings per share by approximately $0.06 in the prior year.

Capital expenditures were $4.0 million during the third quarter of 2012 compared to $2.5 million during the third quarter of 2011. The increase in capital expenditures during the third quarter of 2012 when compared with the prior year was due mainly to continued investment in our information technology infrastructure as we continue to design and implement a new enterprise resource planning system.

Despite the sales decline this quarter, we are encouraged by the overall sales activity and believe we continue to develop and offer the right product solutions to position ourselves for sales growth as industry conditions improve. In addition, our improvement in gross margin is encouraging as we now have had three consecutive quarters of year-over-year expansion in our gross margin. However, heading into the fourth quarter and next year there is a lot of uncertainty in the industry and the economy as a whole. The Business and Institutional Furniture Manufacturer's Association, our industry trade association, is forecasting low single digit increases in sales for 2012 and 2013. During this period of uncertainty we will continue to do the things that we believe will make us successful long term. We will continue to invest in new products and growth initiatives and our information technology infrastructure, which we believe will ultimately help us reduce costs and improve our customers' overall experience of doing business with us.


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Results of Operations



Comparison of Three Months and Nine Months Ended September 30, 2012 and 2011



                                            Three Months Ended                    Nine Months Ended
                                     September 30,      September 30,      September 30,      September 30,
                                         2012               2011               2012               2011
                                                                 (in thousands)
Consolidated Statement of
Operations Data:
Net sales                           $       219,794    $       239,543    $       637,473    $       699,052
Gross profit                                 74,216             78,851            211,675            223,746
Restructuring charges                             -                (18 )                -                696
Operating income                             23,522             25,015             59,776             69,255
Interest expense                              1,635              1,226              4,778              8,615
Other (income)expense, net                    2,786             (4,077 )            3,723             (1,473 )
Income tax expense                            6,904              9,477             18,766             21,547
Net income                          $        12,197    $        18,389    $        32,509    $        40,566

Statistical and Other Data:
Sales (Decline) Growth from
Comparable Prior Period                        (8.2 )%            18.5 %             (8.8 )%            22.7 %
Gross profit margin                            33.8 %             32.9 %             33.2 %             32.0 %

Sales

Sales for the third quarter of 2012 were $219.8 million, a decrease of $19.7 million, or 8.2%, from sales of $239.5 million for the same period in the prior year. Sales for the nine months ended September 30, 2012 were $637.5 million, a decrease of $61.6 million, or 8.8%, over the first nine months of 2011. The decrease in sales for the quarter and nine months ended September 30, 2012 was mainly due to lower levels of sales from government and financial services clients, as well as lower sales in the Studio segment which was impacted by the current economic situation in Europe.

Although on the decline, sales to U.S., state, and local governmental agencies continue to represent a large portion of our overall sales. During the nine months ended September 30, 2011 and 2012, approximately 18.6% and 16.0%, respectively, of our sales were to U.S., state, and local governmental agencies.

Gross Profit and Operating Income

Gross profit for the third quarter of 2012 was $74.2 million, a decrease of $4.7 million, or 6.0%, from gross profit of $78.9 million for the same period in the prior year. Gross profit for the nine months ended September 30, 2012 was $211.7 million, a decrease of $12.0 million, or 5.4%, from gross profit of $223.7 million for the same period in the prior year. As a percentage of sales, gross profit increased from 32.9% for the third quarter of 2011 to 33.8% for the third quarter of 2012. For the nine months ended September 30, 2012 and 2011 gross profit as a percentage of sales was 33.2% and 32.0%, respectively. The increase in gross profit margin in the three and nine months ended September 30, 2012 is primarily a result of a more favorable customer mix and continuous improvement projects in our factories.

Operating income for the third quarter of 2012 was $23.5 million, a decrease of $1.5 million, or 6.0%, from operating income of $25.0 million for the third quarter of 2011. Operating income for the nine months ended September 30, 2012 was $59.8 million, a decrease of $9.5 million, or 13.7%, from operating income of $69.3 million for the same period in 2011. Operating income as a percentage of sales increased from 10.4% in the third quarter of 2011 to 10.7% for the same period of 2012. Operating income as a percentage of net sales decreased from 9.9% in the first nine months of 2011 to 9.4% in the first nine months of 2012.


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Operating expenses for the third quarter of 2012 were $50.7 million, or 23.1% of sales, compared to $53.9 million, or 22.5% of sales, for the third quarter of 2011. Operating expenses for the nine months ended September 30, 2012 were $151.9 million, or 23.8% of sales, compared to $153.8 million, or 22.0% of sales, for the same period in 2011. The decrease in operating expenses during the three and nine months ended September 30, 2012 was primarily due to lower variable compensation spending due to our lower sales but was partially offset with continued spending on new product and growth initiatives and technology infrastructure upgrades.

Interest Expense

Interest expense for the three and nine months ended September 30, 2012 was $1.6 million and $4.8 million, respectively, an increase of $0.4 million and a decrease of $3.8 million, respectively, from the same periods in 2011. The increase in interest expense for the three month period noted above is the direct result of our new debt facility completed in February of 2012, under which we are paying a slightly higher effective interest rate. The decrease in interest expense during the nine month period noted above is due to the expiration of two interest rate swap agreements in June 2011. These swap agreements, which were in effect from June 2010 to June 2011, caused our interest rate to be higher than the rate under our credit facility. See Note 6 of the condensed consolidated financial statements included in this quarterly report on Form 10-Q for further information regarding the interest rate swaps. The annualized weighted average interest rate for the third quarter of 2012 was 2.6%. The annualized weighted average interest rate for the same period of 2011 was 1.7%. The annualized weighted average interest rate for the nine months ended September 30, 2012 and 2011, was 2.4% and 4.2%, respectively.

Other (Income) Expense, net

Other (income) expense for the third quarter of 2012 consisted of $2.8 million of foreign exchange losses. Other (income) expense for the third quarter of 2011 consisted of $4.1 million of foreign exchange gains. Other (income) expense for the nine months ended September 30, 2012 consisted of $3.4 million of foreign exchange losses and $0.5 million related to the write-off of deferred financing fees offset by $0.2 million of miscellaneous income. Other (income) expense for the nine months ended September 30, 2011 consisted of $2.1 million of foreign exchange gains and $0.4 million of miscellaneous income offset by $1.0 million of expense related to a negative judicial ruling.

Income Tax Expense

The effective tax rate was 36.1% for the third quarter of 2012, as compared to 34.0% for the same period in 2011. The effective tax rate for the nine months ended September 30, 2012 was 36.6% and 34.7% for the same period in 2011. The increase in the effective tax rate for the three and nine months ended September 30, 2012 when compared to the same periods in the prior year was due to the mix of pretax income and the varying effective tax rates in the countries in which we operate.

Business Segment Analysis

Office:

Net sales for the third quarter of 2012 for the Office segment were $160.0 million, a decrease of $13.6 million, or 7.8%, when compared with the same period in 2011. Net sales for the Office segment for the nine months ended September 30, 2012 were $452.2 million, a decrease of $54.6 million, or 10.8%, when compared with the same period in 2011. The decrease in sales in the Office segment for the three and nine months ended September 30, 2012 was primarily the result of decreased government spending and decreased demand from financial services clients. Additionally, for the three and nine months ended September 30, 2012, sales were negatively impacted by $0.9 million and $3.6 million, respectively, due to unfavorable changes in foreign exchange rates associated with the Canadian dollar compared to the same periods in the prior year.

Operating income for the third quarter of 2012 for the Office segment was $13.0 million, an increase of $0.2 million, or 1.6%, when compared with the same period in 2011. Operating income for the nine months ended September 30, 2012 for the Office segment was $28.6 million, a decrease of $7.3 million, or 20.3%, when compared with the same period in 2011. The decrease in operating income for the nine months ended September 30, 2012 was mainly the result of our lower sales and increased spending on our technology infrastructure. As a percentage of net sales, the Office segment operating income was 8.1% for the third quarter ended September 30,


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2012 and 7.4% for the third quarter ended September 30, 2011. As a percentage of net sales, the Office segment operating income was 6.3% for the nine months ended September 30, 2012 and 7.1% for the nine months ended September 30, 2011.

Studio:

Net sales for the third quarter of 2012 for the Studio segment were $33.0 million, a decrease of $4.3 million, or 11.5%, when compared with the same period in 2011. Net sales for the nine months ended September 30, 2012 were $105.4, a decrease of $7.2 million, or 6.4%, when compared with the same period in 2011. The decrease in sales for the Studio segment for the three and nine months ended September 30, 2012 is primarily the result of the poor economic conditions in Europe. Additionally, for the three and nine months ended September 30, 2012, sales were negatively impacted by $1.0 million and $3.3 million, respectively, due to unfavorable changes in foreign exchange rates associated with the Euro and the British pound compared to the same periods in the prior year.

Operating income for the third quarter of 2012 for the Studio segment was $5.2 million, a decrease of $0.5 million, or 8.8%, when compared with the same period in 2011. Operating income for the nine months ended September 30, 2012 for the Studio segment was $15.6 million, a decrease of $1.4 million, or 8.2%, when compared with the same period in 2011. The decrease in operating income for the three and nine months ended September 30, 2012 was primarily the result of lower sales in Europe and increased spending on growth initiative programs. As a percentage of net sales, the Studio segment operating income was 15.8% for the third quarter ended September 30, 2012 up slightly from 15.3% for the third quarter ended September 30, 2011. As a percentage of net sales, the Studio segment operating income was 14.8% for the nine months ended September 30, 2012 down slightly from 15.1% for the nine months ended September 30, 2011.

Coverings:

Net sales for the third quarter of 2012 for the Coverings segment were $26.7 million, a decrease of $1.9 million, or 6.6%, when compared with the same period in 2011. Net sales for the nine months ended September 30, 2012 were $79.9 million, an increase of $0.3 million when compared with the same period in 2011. The decrease in sales for the Coverings segment for the three months ended September 30, 2012 and the modest (flat) growth in sales for the nine month period ended September 30, 2012 were mainly the result of lower demand in certain markets such as hospitality and transportation. Additionally, for the nine months ended September 30, 2012, sales were negatively impacted by $0.4 million due to unfavorable changes in foreign exchange rates compared to the same period in the prior year. There was minimal impact to sales for the three months ended September 30, 2012 as a result of foreign exchange translation.

Operating income for the third quarter of 2012 for the Coverings segment was $5.3 million, a decrease of $1.3 million, or 19.7%, when compared with the same period in 2011. Operating income for the nine months ended September 30, 2012 for the Coverings segment was $15.5 million, a decrease of $1.5 million, or 8.8%, when compared with the same period in 2011. The decrease in operating income in the Coverings segment during the three and nine months ended September 30, 2012 is the result of lower sales coupled with increased costs associated with growth initiative programs. As a percentage of net sales, the Coverings segment operating income was 19.9% for the third quarter ended September 30, 2012 and 23.1% for the third quarter ended September 30, 2011. As a percentage of net sales, the Coverings segment operating income was 19.5% for the nine months ended September 30, 2012 and 21.4% for the nine months ended September 30, 2011.


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Liquidity and Capital Resources



The following table highlights certain key cash flows and capital information
pertinent to the discussion that follows:



                                                     Nine Months Ended
                                              September 30,     September 30,
                                                  2012              2011
                                                      (in thousands)
Cash provided by operating activities        $        29,055   $        31,124
Capital expenditures, net                            (10,088 )          (9,583 )
Cash used in investing activities                    (16,544 )          (9,733 )
Purchase of common stock for treasury                 (3,465 )         (13,881 )
Proceeds from revolving credit facility              491,000           258,000
Repayment of revolving credit facility              (500,000 )        (286,000 )
Payment of dividends                                 (14,925 )         (12,022 )
Proceeds from the issuance of common stock               886            13,006
Cash used in financing activities                    (29,224 )         (39,696 )

Historically, we have carried significant amounts of debt, and cash generated by operating activities has been used to fund working capital, capital expenditures, repurchase shares, pay quarterly dividends and make payments of principal and interest on our indebtedness. Our capital expenditures are typically for new product tooling and manufacturing equipment. These capital expenditures support new products and continuous improvements in our manufacturing processes. In addition, we began growth initiative programs in our Studio and Coverings segments which increased our capital spending during 2012.

Year-to date net cash provided by operations was $29.1 million, of which $54.5 million was provided by net income plus non-cash items, offset by $25.4 million of unfavorable changes in assets and liabilities. During the first nine months of 2011, net cash provided by operations was $31.1 million of which $57.6 million was provided by net income plus non-cash items offset by $26.5 million from unfavorable changes in assets and liabilities.

For the nine month period ended September 30, 2012, we used available cash, including the $29.1 million of net cash from operating activities, to fund $10.1 million in capital expenditures, to pay down debt of $9.0 million net, fund dividend payments to shareholders totaling $14.9 million, and fund working capital.

For the nine month period ended September 30, 2011, we used available cash, including the $31.1 million of net cash from operating activities, to pay down debt of $28.1 million net, fund $9.6 million in capital expenditures, fund dividend payments to shareholders totaling $12.0 million, and fund working capital.

Cash used in investing activities was $16.6 million for the nine months ended September 30, 2012 and $9.7 million for the same period in 2011. Fluctuations in cash used in investing activities were primarily attributable to the purchase of Richard Schultz Design Inc.. The increase in capital expenditures year-over-year is in large part due to expenditures on infrastructure related to information technology as we are designing and implementing a new enterprise resource planning system.

We use our revolving credit facility in the ordinary course of business to fund our working capital needs and, at times, make significant borrowings and repayments under the facility depending on our cash needs and availability at such time. This facility was amended and restated on February 3, 2012 and matures on February 3, 2017. The facility provides for a revolving credit line of up to $450.0 million, but includes the option to increase the size of the facility by up to an additional $200.0 million, subject to the satisfaction of certain terms and conditions. As of September 30, 2012, there was $203.0 million outstanding under the facility, compared to $212.0 million outstanding under the previous facility as of December 31, 2011. Borrowings under the revolving credit facility may be repaid at any time, but no later than February 3, 2017. See Note 11 of the condensed consolidated financial statements included in this quarterly report on Form 10-Q for further information regarding this amended facility.


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Our revolving credit facility requires that we comply with two financial covenants: our consolidated leverage ratio, defined as the ratio of total indebtedness to consolidated EBITDA (as defined in our credit agreement) for a period of four fiscal quarters, cannot exceed 4 to 1, and our consolidated interest coverage ratio, defined as the ratio of our consolidated EBITDA (as defined in our credit agreement) for a period of four fiscal quarters to our consolidated interest expense, must be a minimum of 3 to 1. We are also required to comply with various other affirmative and negative covenants including, without limitation, covenants that prevent or restrict our ability to pay dividends, engage in certain mergers or acquisitions, make certain investments or loans, incur future indebtedness, make significant capital expenditures, engage in sale-leaseback transactions, alter our capital structure or line of business, prepay subordinated indebtedness, engage in certain transactions with affiliates and sell stock or assets.

We are currently in compliance with all of the covenants and conditions under our credit facility. We believe that existing cash balances and internally generated cash flows, together with borrowings available under our revolving credit facility, will be sufficient to fund normal working capital needs, capital spending requirements, debt service requirements and dividend payments for at least the next twelve months. However, because of the financial covenants mentioned above, our capacity under our revolving credit facility could be . . .

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