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KNL > SEC Filings for KNL > Form 10-Q on 12-Nov-2013All Recent SEC Filings

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Form 10-Q for KNOLL INC


12-Nov-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 environmental 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.


Table of Contents

Overview

Net sales during the third quarter of 2013 were $216.9 million, a decrease of $2.9 million, or 1.3%, over the third quarter of 2012. Sales to governmental agencies continued to decline on a year-over-year basis which drove the overall decline in sales in the Office segment. Office segment sales decreased 5.9% during the third quarter of 2013 when compared with the prior year. The Studio and Coverings segments, however, both experienced growth during the quarter. Studio segment sales increased 14.2% while the Coverings segment experienced 7.5% growth. In the Studio segment, growth in Europe outpaced the growth in North America during the third quarter of 2013 when compared with the prior year. In the Coverings segment, both our leather and textiles subsidiaries experienced growth during the quarter.

For the third quarter of 2013, gross profit as a percentage of net sales decreased 40 basis points to 33.4% versus the comparable quarter of the prior year. The decrease in gross margin from the third quarter of 2012 largely resulted from the impact on fixed cost absorption as a result of our lower sales as well as pricing pressures in the Office segment. Continuous improvement projects in our factories helped to offset some of this decline. Sequentially, gross profit as a percentage of net sales increased 80 basis points when compared with the second quarter of 2013.

Operating expenses for the third quarter of 2013 were $55.3 million, or 25.5% of net sales, compared to $50.7 million, or 23.1% of net sales, for the third quarter of 2012. The increase in operating expenses during the third quarter of 2013 primarily resulted from our previously announced strategic initiatives partially offset by lowered levels of incentive compensation accruals.

Operating profit for the third quarter of 2013 was $17.1 million, a decrease of 27.2% from the third quarter of 2012. The decrease in operating profit during the third quarter of 2013 is mainly attributable to increased spending associated with our announced strategic investment initiatives and our lower sales.

Net income was $8.6 million during the third quarter of 2013 compared to $12.2 million during the third quarter of 2012. Diluted earnings per share was $0.18 for the third quarter of 2013 and $0.26 for the third quarter of 2012. During the third quarter of 2013, non-cash charges relating to foreign exchange losses decreased earnings approximately $0.03 per share.

During the third quarter of 2013, we paid a quarterly dividend of $5.6 million or $0.12 per share. Capital expenditures decreased $0.3 million during the third quarter of 2013 to $3.3 million, when compared with the same period in the prior year. During the quarter, we reduced our outstanding debt by an additional $5.0 million bringing our total outstanding debt under our revolving credit facility to $183.0 million at September 30, 2013. During the last twelve months, we have reduced our outstanding debt by $20.0 million.

This quarter we saw improvement in our Studio and Coverings segments. The Office segment, however, continues to be challenged by mediocre growth in part as a result of declining federal government sales. During the quarter, we experienced an improvement in our internal leading indicators such as client visits and mock-ups that is very encouraging. However, we expect the fourth quarter will continue to be pressured by the reduced government demand and the delay of some larger projects.


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Results of Operations

Comparison of Three and Nine Months ended September 30, 2013 and 2012

                                                  Three Months Ended                               Nine Months Ended
                                      September 30, 2013      September 30, 2012      September 30, 2013      September 30, 2012
                                                                            (in thousands)
Condensed Consolidated Statement of
Operations Data:
Net sales                            $        216,898        $        219,794        $        631,796        $        637,473
Gross profit                                   72,339                  74,216                 205,847                 211,675
Operating profit                               17,051                  23,522                  39,753                  59,776
Interest expense                                1,484                   1,635                   4,496                   4,778
Other expense (income), net                     2,224                   2,786                  (1,273 )                 3,723
Income tax expense                              4,793                   6,904                  14,018                  18,766
Net income                                      8,550                  12,197                  22,512                  32,509

Statistical and Other Data:
Sales decline from comparable prior
year                                             (1.3 )%                 (8.2 )%                 (0.9 )%                 (8.8 )%
Gross profit margin                              33.4                    33.8                    32.6                    33.2

Net Sales

Net sales for the third quarter of 2013 were $216.9 million, a decrease of $2.9 million, or 1.3%, from net sales of $219.8 million for the same period in the prior year. Net sales for the nine months ended September 30, 2013 were $631.8 million, a decrease of $5.7 million, or 0.9%, from net sales of $637.5 million for the same period in the prior year. The decrease in net sales for the three and nine months ended September 30, 2013 was mainly due to lower governmental purchases and some price erosion in the Office segment.

A continued decline in our government business negatively impacted our sales performance, particularly in the Office segment, during the first nine months of 2013, and we expect will negatively impact sales for the remainder of 2013. During the nine months ended September 30, 2013 and 2012, approximately 13.1% and 16.0%, respectively, of our sales were to U.S., state, and local governmental agencies.

Gross Profit and Operating Profit

Gross profit for the third quarter of 2013 was $72.3 million, a decrease of $1.9 million, or 2.6%, from gross profit of $74.2 million for the same period in the prior year. Gross profit for the nine months ended September 30, 2013 was $205.8 million, a decrease of $5.9 million, or 2.8%, from gross profit of $211.7 million for the same period in the prior year. As a percentage of net sales, gross profit decreased from 33.8% for the third quarter of 2012 to 33.4% for the third quarter of 2013. As a percentage of net sales, gross profit decreased from 33.2% for the nine months ended September 30, 2012 to 32.6% for the nine months ended September 30, 2013. The decrease in gross profit margin in the three and nine months ended September 30, 2013 is primarily a result of price erosion in the Office segment and lower absorption of our fixed costs as a result of our lower sales.

Operating profit for the third quarter of 2013 was $17.1 million, a decrease of $6.4 million, or 27.2%, from operating profit of $23.5 million for the same period in the prior year. Operating profit for the nine months ended September 30, 2013 was $39.8 million, a decrease of $20.0 million, or 33.4%, from operating profit of $59.8 million for the same period in the prior year. Operating profit as a percentage of net sales decreased from 10.7% in the third quarter of 2012 to 7.9% for the same period of 2013. Operating profit as a percentage of net sales decreased from 9.4% for the nine months ended September 30, 2012 to 6.3% in the same period for 2013. This decrease in operating profit during the three and nine months ended September 30, 2013 was primarily driven by an increase in operating expenses associated with our previously announced strategic investments partially offset by lower incentive accruals.


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Interest Expense

Interest expense for the three and nine months ended September 30, 2013 was $1.5 million and $4.5 million, respectively, a decrease of $0.1 million and $0.3 million from the same periods in the prior year. The weighted-average interest rate for the third quarter of 2013 was 2.7%. The weighted-average interest rate for the same period of 2012 was 2.6%. The weighted-average interest rate for the nine months ended September 30, 2013 and September 30, 2012 was 2.6% and 2.4%, respectively.

Other Expense (Income), net

Other expense (income), net for the third quarter of 2013 consisted of expense of $2.2 million related to foreign exchange losses. Other expense (income), net for the third quarter of 2012 consisted of expense of $2.9 million primarily related to foreign exchange losses offset by $0.1 million of miscellaneous income. Other expense (income), net for the nine months ended September 30, 2013 consisted of income of $1.3 million related to foreign exchange gains. Other expense (income), net for the nine months ended September 30, 2012 consisted of expense 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.

Income Tax Expense

The effective tax rate was 35.9% for the third quarter of 2013, as compared to 36.1% for the same period in 2012. The effective tax rate was 38.4% for the nine months ended September 30, 2013, as compared to 36.6% for the same period in 2012. The increase in the effective tax rate for the nine months ended September 30, 2013 when compared to the same period in the prior year was due to certain non-deductible items and the mix of pretax income and the varying tax rates in the countries in which we operate.

Business Segment Analysis

                        Three Months Ended         Nine Months Ended
                          September 30,              September 30,
                        2013          2012         2013         2012
                                       (in thousands)
NET SALES
Office               $  150,545    $ 160,032    $ 436,095    $ 452,220
Studio                   37,701       33,035      113,370      105,403
Coverings                28,652       26,727       82,331       79,850
Total                $  216,898    $ 219,794    $ 631,796    $ 637,473

OPERATING PROFIT (1)
Office               $    5,677    $  12,974    $  11,111    $  28,629
Studio                    5,291        5,200       12,707       15,598
Coverings                 6,083        5,348       15,935       15,549
Total                $   17,051    $  23,522    $  39,753    $  59,776

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


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Office:

Net sales for the Office segment for the third quarter of 2013 were $150.5 million, a decrease of $9.5 million, or 5.9%, when compared with the same period in 2012. Net sales for the Office segment for the nine months ended September 30, 2013 were $436.1 million, a decrease of $16.1 million, or 3.6%, when compared with the same period in 2012. The decrease in federal government purchases continues to impact the Office segment. Office segment net sales for the three and nine months ended September 30, 2013 were also negatively impacted by $0.5 million and $0.6 million, respectively, due to changes in foreign exchange rates when compared to the same periods in the prior year.

Operating profit for the third quarter of 2013 for the Office segment was $5.7 million, a decrease of $7.3 million, or 56.2%, when compared with the same period in 2012. Operating profit for the nine months ended September 30, 2013 for the Office segment was $11.1 million, a decrease of $17.5 million, or 61.2%, when compared with the same period in 2012. The decrease in operating profit for the three and nine months ended September 30, 2013 was mainly attributed to increased spending associated with our announced strategic investment plans, price erosion in the Office segment, and lower sales. As a percentage of net sales, the Office segment operating profit for the three and nine months ended September 30, 2013 was 3.8% and 2.5%, respectively. As a percentage of net sales, the Office segment operating profit for the three and nine months ended September 30, 2012 was 8.1% and 6.3%, respectively.

Studio:

Net sales for the Studio segment for the third quarter of 2013 were $37.7 million, an increase of $4.7 million, or 14.2%, when compared with the same period in 2012. Net sales for the Studio segment for the nine months ended September 30, 2013 were $113.4 million, an increase of $8.0 million, or 7.6%, when compared with the same period in 2012. The increase in net sales for the Studio segment for the three months ended September 30, 2013 was mainly the result of increased sales in Europe. The increase in net sales for the Studio segment for the nine months ended September 30, 2013 was mainly the result of increased sales in North America. Studio segment net sales for the three and nine months ended September 30, 2013 were positively impacted by $0.4 million and $0.3 million, respectively, due to changes in foreign exchange rates when compared to the same periods in the prior year.

Operating profit for the third quarter of 2013 for the Studio segment was $5.3 million, an increase of $0.1 million, or 1.9%, when compared with the same period in 2012. Operating profit for the nine months ended September 30, 2013 for the Studio segment was $12.7 million, a decrease of $2.9 million, or 18.6%, when compared with the same period in 2012. As a percentage of net sales, the Studio segment operating profit was 14.1% for the third quarter ended September 30, 2013, down from 15.8% for the third quarter ended September 30, 2012. As a percentage of net sales, the Studio segment operating profit was 11.2% for the nine months ended September 30, 2013, down from 14.8% for the same period in the prior year. The increase in operating profit for the three months ended September 30, 2013 in the Studio segment was mainly the result of increased sales in Europe. Increased operating expenses in Europe with our renewed participation in Salone Internazionale del Mobile (the major European furniture trade show), as well as increased operating expenses in North America as part of our growth initiative spending, were the main causes of the decline in the Studio segment operating margin for the nine months ended September 30, 2013.

Coverings:

Net sales for the third quarter of 2013 for the Coverings segment were $28.7 million, an increase of $2.0 million, or 7.5%, when compared with the same period in 2012. Net sales for the nine months ended September 30, 2013 for the Coverings segment were $82.3 million, an increase of $2.4 million, or 3.0%, when compared with the same period in 2012. The increase in net sales for the Coverings segment for the three and nine months ended September 30, 2013 was the result of increased sales by both our leather and textile businesses. Coverings segment net sales for the three and nine months ended September 30, 2013 were minimally impacted by changes in foreign exchange rates compared to the same period in the prior year.

Operating profit for the third quarter of 2013 for the Coverings segment was $6.1 million, an increase of $0.8 million, or 15.1%, when compared with the same period of 2012. Operating profit for the nine months ended September 30, 2013 for the Coverings segment was $15.9 million, an increase of $0.4 million, or 2.6%, when compared with the same period in 2012. The increase in operating profit in the Coverings segment during the three and nine months ended September 30, 2013 is the result of increased sales at our leather businesses. As a percentage of net sales, the Coverings segment operating profit was 21.3% for the third quarter ended September 30, 2013 and 19.9% for the third quarter ended September 30, 2012. As a percentage of net sales, the Coverings segment operating profit was 19.3% for the nine months ended September 30, 2013 and 19.5% for the same period in the prior year.


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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,
                                                2013              2012
                                                    (in thousands)
Cash provided by operating activities      $      31,349     $      29,055
Capital expenditures, net                        (20,486 )         (10,088 )
Cash used in investing activities                (20,761 )         (16,544 )
Purchase of common stock for treasury             (2,729 )          (3,465 )
Proceeds from revolving credit facility          206,000           491,000
Repayment of revolving credit facility          (216,000 )        (500,000 )
Payment of dividends                             (16,888 )         (14,925 )
Proceeds from the issuance of common stock         2,234               886
Cash used in financing activities                (27,150 )         (29,224 )

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 results. 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. These increased expenses are reflected in the year-over-year increase in capital expenditures shown in the table above.

Year-to-date net cash provided by operations was $31.3 million, of which $40.7 million was provided by net income plus non-cash items, offset by $9.4 million of unfavorable changes in operating assets and liabilities. During the first nine months of 2012, 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 from unfavorable changes in operating assets and liabilities.

For the nine months ended September 30, 2013, we used available cash, including $31.3 million of net cash from operating activities, to fund $20.5 million in capital expenditures, to repay $10.0 million of outstanding debt, fund dividend payments to shareholders totaling $16.9 million, and fund working capital.

For the nine months ended September 30, 2012, we used available cash, including $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.

Cash used in investing activities was $20.8 million for the nine months ended September 30, 2013 and $16.6 million for the same period in 2012. Fluctuations in cash used in investing activities were primarily attributable to increased capital spending. The increase in capital expenditures year-over-year is in large part due to expenditures we incurred during 2013 related to our new flagship showroom located in New York City, our new website, capital investments in our factories, and technology infrastructure upgrades with the implementation of our 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. As of September 30, 2013 and December 31, 2012, there was $183.0 million and $193.0 million, respectively, outstanding under the facility. Borrowings under the revolving credit facility may be repaid at any time, but no later than February 3, 2017.


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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 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.

Environmental Matters

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