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KNL > SEC Filings for KNL > Form 10-Q on 10-May-2013All Recent SEC Filings

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Form 10-Q for KNOLL INC


10-May-2013

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 and publicly announced plans for increased capital and investment spending to achieve our long-term revenue and profitability growth goals. 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, 2012; 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 and disclosures in the condensed consolidated financial statements. 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, 2012.


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Overview

Net sales during the first quarter of 2013 increased 2.0% from $196.7 million during the first quarter of 2012 to $200.6 million. During the first quarter of 2013, net sales increased 15.9% in the Studio segment while net sales decreased 0.6% and 2.0% in the Office and Coverings segments, respectively, when compared with the prior year period. The increase in net sales for the Studio segment for the first quarter ended March 31, 2013 resulted from increased demand in our consumer business in North America and Europe as well as a full quarter of sales from Richard Schultz, Inc. which was acquired March 1, 2012. In the Office segment, growth in our commercial business was more than offset by the decline in government purchases. Seating experienced double digit growth during the quarter but was offset by the decline in systems sales.

For the first quarter of 2013, gross profit as a percentage of net sales decreased 40 basis points to 31.7% versus the comparable quarter of the prior year. The decrease in gross margin from the first quarter of 2013 largely resulted from price erosion. Continuous improvement projects in our factories helped to offset some of the impact to gross margin.

Operating expenses for the first quarter of 2013 were $53.3 million, or 26.6% of net sales, compared to $47.6 million, or 24.2% of net sales, for the first quarter of 2012. The increase in operating expenses during the first quarter of 2013 was primarily due to increased spending in conjunction with our announced programs of strategic investments designed to achieve our longer-term revenue and profitability goals. This includes increased spending to improve the profitability of our supply chain, invest in the Knoll brand, maximize office segment profitability, expand our reach into consumer and decorator channels around the world, and target underpenetrated and emerging categories and markets for growth.

Operating profit for the first quarter of 2013 was $10.3 million, a decrease of 33.5% from the first quarter of 2012. The decrease in operating profit during the first quarter of 2013 is mainly attributed to increased spending associated with our announced strategic investment plans as well as some price erosion in the Office segment.

Net income was $6.1 million during the first quarter of 2013 compared to $7.3 million during the first quarter of 2012. Diluted earnings per share was $0.13 for the first quarter of 2013 and $0.15 for the first quarter of 2012.

During the first quarter of 2013, we paid a quarterly dividend of $5.6 million or $0.12 per share. Capital expenditures increased $3.6 million during the first quarter of 2013 to $6.6 million, when compared with the same period in the prior year, primarily due to capital improvements to our new flagship showroom, offices and shop in New York City. Outstanding debt under our revolving credit facility was $193.0 million at March 31, 2013 and December 31, 2012.

Although current activity has improved this quarter as reflected in client visits, mock-up activities, as well as the overall pool of business we track, we believe that near term profits will continue to be challenged by lower government sales and our on-going investment spending to achieve our future long-term growth and profitability goals. We began these initiatives during the first quarter of 2013 and do not believe we will see results from these programs until next year.


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Results of Operations



Comparison of Three Months ended March 31, 2013 and 2012



                                               Three Months Ended
                                             March 31,    March 31,
                                                2013         2012
                                                 (in thousands)
Consolidated Statement of Operations Data:
Net sales                                    $  200,586   $  196,662
Gross profit                                     63,627       63,053
Operating profit                                 10,294       15,452
Interest expense                                  1,495        1,506
Other (income) expense, net                      (1,291 )      2,200
Income tax expense                                4,016        4,489
Net income                                        6,074        7,257

Statistical and Other Data:
Sales growth from comparable prior year             2.0 %      -11.0 %
Gross profit margin                                31.7 %       32.1 %

Net Sales

Net sales for the first quarter of 2013 were $200.6 million, an increase of $3.9 million, or 2.0%, from net sales of $196.7 million for the same period in the prior year. The increase in net sales for the three months ended March 31, 2013 was mainly due to higher sales in our Studio segment as well as increased sales of our seating products.

A continued decline in our government business negatively impacted our sales performance in the first quarter of 2013, and we expect will negatively impact sales for all of 2013. However, 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 three months ended March 31, 2013 and 2012, approximately 13.0% and 15.4%, respectively, of our sales were to U.S., state, and local governmental agencies.

Gross Profit and Operating Profit

Gross profit for the first quarter of 2013 was $63.6 million, an increase of $0.5 million, or 0.8%, from gross profit of $63.1 million for the same period in the prior year. As a percentage of net sales, gross profit decreased from 32.1% for the first quarter of 2012 to 31.7% for the first quarter of 2013. The decrease in gross profit margin in the three months ended March 31, 2013 is primarily a result of price erosion in the Office segment.

Operating profit for the first quarter of 2013 was $10.3 million, a decrease of $5.2 million, or 33.5%, from operating profit of $15.5 million for the first quarter of 2012. Operating profit as a percentage of net sales decreased from 7.9% in the first quarter of 2012 to 5.1% for the same period of 2013. This decrease in operating profit was primarily driven by an increase in operating expenses for the first quarter of 2013, which increased to $53.3 million, or 26.6% of net sales, compared to $47.6 million, or 24.2% of net sales, for the first quarter of 2012. The increase in operating expenses during the three months ended March 31, 2013 was primarily due to increased spending in conjunction with our announced plans to reach our long-term revenue and profitability goals.


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Interest Expense

Interest expense for the three months ended March 31, 2013 and March 31, 2012 was $1.5 million. The weighted average interest rate for the first quarter of 2013 was 2.5%. The weighted average interest rate for the same period of 2012 was 2.3%.

Other (Income) Expense, net

Other (income) expense for the first quarter of 2013 consisted of $1.3 million of foreign exchange gains. Other (income) expense for the first quarter of 2012 consisted of $1.8 million of foreign exchange losses, and $0.5 million related to the write-off of deferred financing fees, offset by $0.1 million of miscellaneous income.

Income Tax Expense

The effective tax rate was 39.8% for the first quarter of 2013, as compared to 38.2% for the same period in 2012. The increase in the effective tax rate for the first quarter ended March 31, 2013 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



                     Three Months       Three Months
                        Ended              Ended
                    March 31, 2013     March 31, 2012
NET SALES
Office             $        137,480   $        138,297
Studio                       38,438             33,174
Coverings                    24,668             25,191
Total              $        200,586   $        196,662

OPERATING PROFIT
Office             $          2,002   $          6,933
Studio                        4,142              3,983
Coverings                     4,150              4,536
Total (1)          $         10,294   $         15,452



(1) The Company does not allocate interest expense or other (income) expense, net to the reportable segments.

Net sales for the Office segment for the first quarter of 2013 were $137.5 million, a decrease of $0.8 million, or 0.6%, when compared with the same period in 2012. The decrease in net sales in the Office segment for the first quarter ended March 31, 2013 was primarily the result of decreased government spending. Office segment net sales in the first quarter of 2013 were also negatively impacted by $0.1 million due to changes in foreign exchange rates when compared to the same period in the prior year. Operating profit for the first quarter of 2013 for the Office segment was $2.0 million, a decrease of $4.9 million, or 71.0%, when compared with the same period in 2012. The decrease in operating profit for the first quarter ended March 31, 2013 was mainly attributed to price erosion in the Office segment as well as spending associated with our announced strategic investment plans. As a percentage of net sales, the Office segment operating profit for the first quarter ended March 31, 2013 and 2012 was 1.5% and 5.0%, respectively.


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Net sales for the Studio segment for the first quarter of 2013 were $38.4 million, an increase of $5.2 million, or 15.7%, when compared with the same period in 2012. The increase in net sales for the Studio segment for the first quarter ended March 31, 2013 resulted from increased demand in our consumer business in North America and Europe as well as a full quarter of sales from Richard Schultz, Inc. which was acquired March 1, 2012. Studio segment net sales in the first quarter of 2013 were negatively impacted by $0.1 million due to changes in foreign exchange rates when compared to the same period in the prior year. Operating profit for the first quarter of 2013 for the Studio segment was $4.1million, an increase of $0.1 million, or 2.5%, when compared with the same period in 2012. As a percentage of net sales, the Studio segment operating profit was 10.8% for the first quarter ended March 31, 2013 down from 12.0% for the first quarter ended March 31, 2012. Increased operating expenses in Europe drove the decline in the Studio segment operating margin during the first quarter of 2013, as we incurred additional expenses associated with our renewed participation in Salone Internazionale del Mobile, Europe's large industry trade show.

Net sales for the first quarter of 2013 for the Coverings segment were $24.7 million, a decrease of $0.5 million, or 2.0%, when compared with the same period in 2012. The decrease in net sales for the Coverings segment for the first quarter ended March 31, 2013 was mainly the result of lower demand from our contract furniture partners. Coverings segment net sales in the first quarter of 2013 were minimally impacted by changes in foreign exchange rates compared to the same period in the prior year. Operating profit for the first quarter of 2013 for the Coverings segment was $4.2 million, a decrease of $0.3 million, or 6.7%, when compared with the same period in 2012. The decrease in operating profit in the Coverings segment during the first quarter ended March 31, 2013 is the result of the lower sales coupled with increased costs associated with growth initiative programs. As a percentage of net sales, the Coverings segment operating profit was 16.8% for the first quarter ended March 31, 2013 and 18.0% for the first quarter ended March 31, 2012.

Liquidity and Capital Resources



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



                                              March 31,    March 31,
                                                2013          2012
                                                  (in thousands)
Cash used in operating activities            $    (4,133 ) $  (14,303 )
Capital expenditures, net                         (6,626 )     (3,024 )
Cash used in investing activities                 (6,901 )     (9,167 )
Purchase of common stock for treasury             (2,331 )     (2,490 )
Proceeds from revolving credit facility           63,000      342,000
Repayment of revolving credit facility           (63,000 )   (326,000 )
Payment of dividends                              (5,629 )     (4,661 )
Proceeds from the issuance of common stock         2,134          400
Cash used in financing activities                 (5,643 )      6,521

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 February 2013, we announced a three year plan of strategic investments and initiatives intended to enable us to achieve our revenue and operating profit margin goals of over $1.0 billion in revenues and over 12% operating margins. This plan will require increased expenditures and we expect these increases to negatively impact short-term profits. However, we believe these are the appropriate investments to achieve our long-term goals.


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Net cash used in operations was $4.1 million, of which $11.9 million was provided by net income plus non-cash items, offset by $16.0 million of unfavorable changes in assets and liabilities. During the first quarter of 2012, net cash used by operations was $14.3 million, of which $15.6 million was provided by net income plus non-cash items, offset by $29.9 million from unfavorable changes in assets and liabilities.

For the first quarter ended March 31, 2013, we used available cash to fund $6.6 million in capital expenditures, fund dividend payments to shareholders totaling $5.6 million, repurchase $2.3 million of common stock for treasury, and fund working capital. For the first quarter of 2012, we used available cash, including $16.0 million of net borrowings, to fund $3.0 million in capital expenditures, repurchase $2.5 million of common stock for treasury, fund a dividend payment to shareholders totaling $4.7 million and fund working capital.

Cash used in investing activities was $6.9 million for the three months ended March 31, 2013 and $9.2 million for the same period in 2012. Fluctuations in cash used in investing activities were primarily attributable increased capital spending. The increase in capital expenditures year-over-year is in large part due to expenditures we incurred during the first quarter of 2013 related to our new flagship showroom located in New York City.

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. As of March 31, 2013 and December 31, 2012 there was $193.0 million outstanding under the facility. Borrowings under the revolving credit facility may be repaid at any time, but no later than February 3, 2017.

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 reduced if our trailing consolidated EBITDA (as defined by our credit agreement) would decline. Future principal debt payments may be paid out of cash flows from operations, from future refinancing of our debt or from equity issuances. However, our ability to make scheduled payments of principal, to pay interest on or to refinance our indebtedness, to satisfy our other debt obligations and to pay dividends to stockholders will depend upon our future operating performance, which will be affected by general economic, financial, competitive, legislative, regulatory, business and other factors beyond our control.

Contractual Obligations

Contractual obligations associated with our ongoing business will result in cash payments in future periods. A table summarizing the amounts and timing of these future cash payments was provided in the Company's Form 10-K filing for the fiscal year ended December 31, 2012.


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Environmental Matters

Our past and present business operations and the past and present ownership and operation of manufacturing plants on real property are subject to extensive and changing federal, state, local and foreign environmental laws and regulations, including those relating to discharges to air, water and land, the handling and disposal of solid and hazardous waste and the cleanup of properties affected by hazardous substances. As a result, we are involved from time-to-time in administrative and judicial proceedings and inquiries relating to environmental matters and could become subject to fines or penalties related thereto. We cannot predict what environmental legislation or regulations will be enacted in the future, how existing or future laws or regulations will be administered or interpreted or what environmental conditions may be found to exist. Compliance with more stringent laws or regulations, or stricter interpretation of existing laws, may require additional expenditures by us, some of which may be material. We have been identified as a potentially responsible party pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980 ("CERCLA") for remediation costs associated with waste disposal sites that we previously used. The remediation costs and our allocated share at some of these CERCLA sites are unknown. We may also be subject to claims for personal injury or contribution relating to CERCLA sites. We reserve amounts for such matters when expenditures are probable and reasonably estimable.

Off-Balance Sheet Arrangements

We do not currently have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As a result, we are not materially exposed to any financing, liquidity, market or credit risk that could have arisen if we had engaged in these relationships.


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