Q4 2019 Knoll Inc Earnings Call
EAST GREENVILLE Feb 19, 2020 (Thomson StreetEvents) -- Edited Transcript of Knoll Inc earnings conference call or presentation Tuesday, February 18, 2020 at 10:00:00pm GMT
TEXT version of Transcript
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Corporate Participants
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* Andrew B. Cogan
Knoll, Inc. - Chairman & CEO
* Charles W. Rayfield
Knoll, Inc. - Senior VP & CFO
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Conference Call Participants
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* Gregory John Burns
Sidoti & Company, LLC - Senior Equity Research Analyst
* Steven Ramsey
Thompson Research Group, LLC - Senior Equity Research Analyst
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Presentation
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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [1]
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Good afternoon, everyone, and welcome to the Knoll, Inc. Fourth Quarter Question-and-Answer Session. I am Charles Rayfield, Knoll's, SVP and CFO. And joining me on this call is Andrew Cogan, our Chairman and CEO. This call is being recorded. This call is also being webcast.
In addition, this call may offer statements that are forward-looking, including without limitation, statements regarding Knoll's long-term revenue and profitability growth goals, future outlook for the industry and economy, ability to integrate acquired businesses 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 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 the Securities and Exchange Commission. The call today may also include references to non-GAAP financial measures. Reconciliations of these measures to the most comparable GAAP financial measures are included in the earnings letter released earlier today.
As noted in today's release, rather than reading scripted comments on the earnings call, we have included expanded commentary in our earnings release to shareholders so that shareholders and the investment community can better understand the factors shaping our results.
We will now open the call up for questions.
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Questions and Answers
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Operator [1]
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(Operator Instructions) And our first question comes from Greg Burns from Sidoti & Company.
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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [2]
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Can you maybe talk a little bit about the slowdown you saw in activity in the second half? At what point you started to see that decelerate? And maybe was there any particular segment of the market, larger orders, small and medium, any additional color you can give us on the complexion of the slowdown you saw in the second half would be helpful.
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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [3]
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Sure, Greg. This is Andrew. Good afternoon. I think, I would say, we began to see the slowdown, I really would point you all to the BIFMA data, where really starting around the middle of the year, around June, you saw the trailing 12-month order numbers start to roll over from a kind of a peak in the March to May time frame. So in June, you saw BIFMA orders -- incoming orders declined about 2%, saw a little bit of a rebound in July, then you saw August declined just under 3%, a little bit rebound in September, then another decline in October and no growth in November. So that is where we saw the industry really started to slow down from the June, I'd say, November time frame. I think it was led by a couple of things. One is we definitely saw a decrease in co-working activity. That had been something that had been driving demand to some extent, that we saw that slow down. We continue to see a slowdown in some of our international and more Middle Eastern business. And those are primarily the categories, where we saw the decline. I'd also point out that decline over that kind of May to November period also correlated with, I think, the first quarter of a negative year-over-year absorption in a while and the slowest quarter of leasing activity in about 4 years. And you can see this in the kind of market JLL data. So I think, clearly, whether it was economic uncertainty, tariffs, slowdowns in service sector employment growth, I think, all those factors came together and kind of depressed overall industry demand and we simply weren't immune to that.
Now the flip side of this, I have to say, is that as we've moved into December and into the new year, we have seen a nice pickup in orders growth. And we've seen, since December, the last 3 months, the funnel of business we're tracking, which, in December, was up double digits over prior year, both in dollars and number of opportunities actually has grown each of the next couple of months. So January was up over December and the February funnel was up over January, which was up over December. So I'm not saying there's a V recovery here, but I definitely think we seem to have bottomed in the fourth quarter in terms of kind of the incoming orders rate, and we're seeing a nice pick up here in the last couple of months.
Now that's not going to really ship in the first quarter, and I think as we talked in our earnings release and prepared remarks, we have the challenge of the plant move in Michigan, which will reduce capacity in the fourth quarter. And then I think as you heard from others, our backlog is a little extended out. So we really don't expect some of that backlog to ship to more to the second quarter.
So we think this is more kind of a timing issue than it is a fundamental degradation in the business to our outlook. And again, it's, I think, validated by the strong orders trends we've seen and the improving funnel.
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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [4]
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Okay. Great. That was very helpful. Now thanks for all the color for next year in terms of growth rates and margins. And you kind of gave some explicit numbers around the margin -- the gross margin expansion you expected, but there seems to be a lot of moving pieces in terms of a lot of investments you're making, you have the manufacturing consolidation on the positive side. So -- and maybe some of these timing issues on the revenues. So how should we think about maybe operating margin or EBITDA margin expansion for next year and the cadence of any kind of leverage you might get throughout the year? It feels like it's going to be building throughout the year or more back-half loaded, but maybe you could just walk us through that.
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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [5]
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Yes.
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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [6]
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Charles, why don't you go ahead, Charles.
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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [7]
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Yes. Great. Thanks. So good question, Greg. So I think as we noted in the letter, in the earnings release, there are some factors that would probably drive us to have a little bit more OpEx earlier in the year. So from a weighting perspective, you might have a little bit more OpEx spend earlier in the year. It might even out a little bit more as we go through the back part of the year. So I would expect that the goals that we had around EBITDA expansion would probably be more back-half weighted. And so I think I'd probably look for that to sort of be the driver. And we do have a lot of costs that will be restructured out, but a lot of the activities around the move with Grand Rapids will happen during more the first 6 months of the year, but most of the growth and expansion will probably be weighted more towards the back half.
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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [8]
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Okay. So do you foresee, like, do you want to put a number, maybe on, like, what do you -- like a range on the EBITDA margin expansion? Maybe, like 20 to 50 basis points. I don't know, what do you...
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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [9]
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Well, Greg, this is Andrew. I'd say a couple of things. I think, first of all, I think, we're talking about 10 to 20 basis points of EBITDA margin improvement this year over last year, primarily driven by margin expansion. And then, I think, as we look out to '21, as we get the full benefit of the plant restructuring, there's probably another 60 to 80 basis points of margin improvement beyond that. So our goal remains to get to 15% EBITDA margin. I think we get shy of high 13s in 2020. And then mid- or better 14s in 2021. And I would just kind of point out a couple of things. One is we're still very much in an investment in ramp-up mode, leveraging debts we've made that have proven themselves effective. And I'll take Muuto as an example. So Muuto is up. Muuto grew 35% last year on top of, I think, 25% growth the year before. So we're accelerating that initiative. We made a decision to roll out more products into showrooms. We made a decision to have a national sales meeting last week to really re-up the intensity around the whole ancillary area heated up and left Chicago and Fulton Market as charged up as I've ever seen them in my career at Knoll, feeling that they're armed with everything from Muuto to ancillary, to height adjustable tables, to broader price points to really go and win in the marketplace. We decided -- we could have, listen, in any given year, we could pull 50 basis of operating expenses out. But it's going to hurt some of these incremental growth initiatives. And we just felt that, just because the market slowed down a little bit before, we saw good -- we were encouraged about the data we're seeing for '20 and that we should continue to lean into what we're doing and not get distracted by a couple of months of slower growth. So very much we're playing it for the long game here and very much convinced we can get into the mid-14s or better as we move through '21.
We'll get the plant reconfiguration behind us, that's a significant initiative. We've got investments in some of the lifestyle businesses, like, HOLLY HUNT and things like that, that we're making because they're right for the long term. And then Holly is just beginning to ramp up. And we haven't seen any benefit from that yet. So we've added salespeople, we've added dealer development, dealer brand managers, people that live in the dealers. Last year, we gained 400 basis points of share within our dealers. So that's $70 million or $80 million. So we almost doubled the number of those people and hope to make further share gains into '20. So I think we've got very focused initiatives to invest in. It means operating expenses will be elevated in the mid-28% range this year, probably tick down a little bit next year. Take the gross margin improvement, 20, 30 basis points this year, more like 60, 80 next year, and that's how you get to at least 100 basis points of EBITDA margin improvement in '21 on top of 10 to 20 this year. Is that helpful?
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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [10]
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Yes. No, that was perfect. Thanks for all the additional color. And then in terms of the manufacturing consolidation, you've always had your continuous improvement initiatives, and this is the first since I've maybe been covering the company, a more structural change. So when you look at your manufacturing footprint beyond this initial consolidation, do you see -- is there room for other -- is there more opportunity for more structural changes to the cost structure?
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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [11]
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Well, I think this is one of the biggest opportunities here. I mean this takes out, I think, as we talk about 20% of our manufacturing square footage. So there's some really significant efficiencies, particularly from shipping things from fewer plants. I think the next big move, frankly, will be some rationalization of our whole logistics approach, where we're mixing products geographically, where we're doing that, and we think there are meaningful opportunities there. Muuto had its own mixing center. We think there's consolidation opportunities and ways of improving both our transportation and logistics costs. So I'd say that's probably our next big focus. But we're not backing off the kind of continuous lean, kaizen work in the plants, which has generated meaningful margin. Look at the gross margin improvement this year. That was a big chunk of the gross margin improvement we delivered in 2019. So those activities continue, I'd say, logistics and transportation, probably are the next big thing to tackle once we get the footprint reset.
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Operator [12]
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(Operator Instructions) And our next question comes from Steven Ramsey from Thompson Research.
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Steven Ramsey, Thompson Research Group, LLC - Senior Equity Research Analyst [13]
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I like the new format. I guess to jump in on Q4 sales on the co-working end market, in particular. Is co-working a meaningful percentage of your sales now that, that industry has built up? Or is that just kind of a specific segment to call out for the quarter?
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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [14]
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Well, I think -- Steven, it's Andrew. First, I'm glad you appreciate the format. We're trying to get more information out there to everybody on a more expedited basis. So I hope this is helpful. Co-working, I would say, was a meaningful tailwind in terms of growth for much of the back half of '18 and the front half of '19. So definitely, that was helping the growth.
In terms of a percent of our overall business, not particularly meaningful, less than a few percentage points. So I don't expect a big enduring headwind from that. But certainly it was helpful over that 4- or 5-quarter basis. That said, co-working, I think, is only like 3% of the total leased activity out there. So it pales compared to where we've seen strong performance in [tech], government business was very strong last year.
We're making really good progress in education, hospitality and even health care. And that all is part of this resimmercialization. We presented to our sales team pictures of hotel lobbies, student centers and offices as well as cafes and co-working spaces. And people couldn't identify which was which. So that overall blending is really playing to our strength. That's why Muuto is doing so well and so on trend. So I think -- and so I think that, that aesthetic has permeated many categories. And frankly, I see plenty of co-working opportunity for us in the years ahead. So -- but I do think it was a headwind in the fourth quarter, and it will be a headwind for the next quarter or so, in terms of a year-over-year comp, that's more challenging.
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Steven Ramsey, Thompson Research Group, LLC - Senior Equity Research Analyst [15]
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Great. And switching to Muuto on the resi side. What are the barriers that really keep you guys from going after this opportunity now? Why do you need to wait? Is it more manufacturing capacity or sales and marketing, on the people side or focus on HOLLY HUNT? I don't know, any color on...
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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [16]
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No, no. I think it's -- we've been very methodical with Muuto. We laid out a 3-year plan to double the business that really was 100% based on leveraging Muuto through our contract channels and our relationships with architects and designers, and really on the corporate side. And that's really where we focus. That's where we've invested in terms of the sales resources. And frankly, that's where we've invested in terms of the product development. There's been a lot of work to make it easier for our dealers to do business with Muuto. I mean as an example, in North America, in January, our Muuto orders were up 100%. So we're really focused on leaning into that channel. We had to work on the supply chain. We had to work on the inventory. We had to make Muuto easier to do business. One of the things, you'll see now if you're on all our electronic specification tools now and all the configured tools, Muuto now is 100% in those tools. So you now can plan Muuto with the same specification tools that you're planning, KnollStudio and other Knoll products. We've brought the customer service organization together. So if you're a dealer, the same person you're working with manage your Knoll orders, now is managing your Muuto orders.
So there's been a lot of, like, blocking and tackling to get that really to work. And so we think there's one more year of really leaning into that, which will effectively have doubled the Muuto business. And again, I think, we're just scratching the surface. 20% of our dealers are doing 80% of the Muuto volume. We have a much bigger opportunity to blow that out more nationally. And so then we're now starting to look at the work that has to happen to build out a direct-to-consumer Muuto business. We'll learn some of that from Fully. But we're talking about operating and it's a good e-commerce business for Muuto, which is a kind of separate infrastructure, separate leadership based here in North America, and it's just we want to get to that, and we will get to it in '21, but it's just -- it was -- it would have been a distraction from achieving all the things I just talked about with Muuto at 20% plus EBITDA margin.
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Steven Ramsey, Thompson Research Group, LLC - Senior Equity Research Analyst [17]
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Right. Makes sense. Okay. I guess, with Fully too, since we're on it, you're looking to get Knoll and Muuto products in there. Where are you in that story? How much -- how far can it go? What are the key metrics you're looking at? And how you make progress with the Fully asset and merging it with your -- all your brands you already have?
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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [18]
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Yes. Well, as you know -- thank you. Well, Fully is digitally native B corp. I mean it's got wonderful values, and it's a great online platform to really start to leverage things we're doing. So the strategy with Fully has been to first help them improve their cost structure, which is what we've done sharing work surface, vendors and tops and things like that. So we're working on improving their profitability, clearly not at Knoll like levels today, number one.
Then number two, we are trying to take some select Knoll and Muuto products, and again, very select, because Fully targets a totally different client base than we reach at Knoll. I mean the average Fully transaction is under $1,000. The average Fully project when they do a workplace is about $4,000. Our dealers don't want to deal with that kind of business. So it's a very different segment of the market that we think we can move very select Muuto and very select Knoll office seating products through.
We also see an opportunity to use Fully's R&D and supply chain to provide us with some lower cost products, particularly in height adjustable tables and ergonomic accessories and lighting. So there's a nice 2-way street there. But our goal is to kind of invest in Fully's front end, they're just in the process now of revamping their website, building out a much more mobile-friendly offering, broadening the product line and our goal with Fully is to take a $50 million business and make it a $100 million online engine over the next 3 to 5 years. And so -- and then a quite profitable engine. So that's kind of our vision for Fully and using Fully as a way to learn about doing business online that can, kind of, that learning can be shared with other Knoll brands and businesses. So that's the theory behind Fully. It's an underserved segment of the market that we think we can leverage and help grow.
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Steven Ramsey, Thompson Research Group, LLC - Senior Equity Research Analyst [19]
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Great. And then with online sales as a whole for Knoll, it's a mid-single-digit percentage of total revenue. Is that the current level? Or is that where it's going? And, I guess, 2 more questions. What -- is there a certain customer base that's driving it? And is the margin structure of this channel, can it be better than the traditional dealer channel?
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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [20]
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Yes. Well, first of all, the current level is mid-single digits, and that's primarily Fully and then our own knoll.com shop, which is primarily KnollStudio classic. So those are the 2 areas. I can tell you -- again, I just want to be clear, it's a really separate client base. So very different, again, than the complex clients that our dealers are -- the size of them. It's very distinct.
In terms of profitability, I can tell you the knoll.com business is right in line with our Lifestyle EBITDA margin. So that's what we would expect. And I would expect Fully, again, as we get it ramped up to scale, to have margins no worse than our Office segment, you can see those are now in the double-digit EBITDA range. So that's how I would look at it today.
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Steven Ramsey, Thompson Research Group, LLC - Senior Equity Research Analyst [21]
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Excellent. And so I guess, ultimately, online sales don't cannibalize the existing business you have with the...
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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [22]
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No, because they are clients we just don't get today. We just don't reach them. Our dealers do not do transactions under $5,000. They certainly don't do transactions of $800. And I think we've put a lot of efforts in kind of segmenting the market, kind of marketing 101 and looking at, okay, this is an underserved channel. We think it's going to grow. How do we participate in it? And frankly, we've looked at a lot of things in this area. And as you know, many online things can grow fast and make no money. Fully grows okay and makes nice money. And so we think we can help them make more money, and we think we can help them grow faster over time. But we just wanted a profitable e-commerce channel.
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Steven Ramsey, Thompson Research Group, LLC - Senior Equity Research Analyst [23]
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Right. Okay. And then last question for me. On the dealer share gain that you mentioned of 400 basis points, is that mostly because of Muuto? Or what are the other contributing brands? And then is that lean to ancillary share gain? Or is that sort of more traditional office products?
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Andrew B. Cogan, Knoll, Inc. - Chairman & CEO [24]
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Thank you. First of all, it's 100% ancillary. I mean, that's really where the gain is coming. We believe our office product share is held very constant there. We have 90% of their workstation business. And so there's not a lot of share, maybe even more, not a lot of share there to be gain. I'd say of the dealer share gain, about half of it's Muuto and then the other half has been DatesWeiser, where we've had success getting our dealers going. It's been more in KnollStudio sales. And those have really been the areas. We've expanded the KnollStudio meeting table line, DatesWeiser continues to broaden their portfolio and then Muuto. And that's where we're gaining share. And that's one of the reasons we're not seeing, even though, there are not as many large projects out there, we're not seeing any more degradation in our average order size because what we're seeing is we're capturing more of what our clients are spending with all these ancillary products. And it's really great to see that validated in the dealer share gain. We'll next get new dealer share data midyear 2020 to see how we did last year. So it's about a 6-month lag, so we get that data, but it's very encouraging.
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Operator [25]
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(Operator Instructions) And we have a follow-up question with Greg Burns from Sidoti & Company.
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Gregory John Burns, Sidoti & Company, LLC - Senior Equity Research Analyst [26]
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I know you've mentioned in the prepared remarks that you're not seeing any meaningful impact on the supply chain in China yet. But could you just maybe let us know what percentage of your COGS are sourced from China? Or maybe what is potentially at risk for disruption from what's going on in China?
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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [27]
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Yes, sure, Greg. So I'll take this one. So we have, as you know, with the tariffs that were introduced last year, we did quite a bit of work and effort around reducing the impact of those, which was pushing things to neighboring Asian countries, moving things back to the United States. So we've reduced the amount of exposure there significantly over the course of 2019. At this point, a lot of the materials we use in our seating and some of our height adjustable tables come from China and the Chinese region. So at this point, we're still monitoring the impact of what's happening there, but relatively minimal in general. And we certainly have a limited exposure from a direct sales perspective. So it's mostly a supply chain perspective. We've gotten some good news out of the region in terms of materials moving and getting out of country. So while we've reduced the exposure, there is some risk there. But at this point, we're still monitoring it, and it doesn't seem to be significant at this point.
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Operator [28]
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Thank you. And I'm showing no further questions. I would now like to turn the call back over to Charles Rayfield, of Knoll's CFO, for closing remarks.
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Charles W. Rayfield, Knoll, Inc. - Senior VP & CFO [29]
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Well, thank you all for joining. We're certainly looking forward to a very prosperous and successful 2020. Thank you.
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Operator [30]
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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.