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

Overview

During the second quarter of 2009 we continued to be affected by lower demand caused by the global recession. Net sales were $202.2 million for the quarter, a decrease of 30.9% from the second quarter of 2008. The decrease in net sales was felt across all product categories and geographies. Our largest percentage sales declines occurred in office systems and in Europe. Backlog of unfilled orders at June 30, 2009 was $134.1 million, a decrease of $56.9 million, or 29.8%, compared to unfilled orders at June 30, 2008. Diluted earnings per share in the second quarter of 2009 fell 59.1% to $0.18 per share when compared to $0.44 per share during the same period in the prior year.

For the quarter, gross margin expanded 40 basis points to 35.0% versus the comparable quarter of the prior year despite significantly lower sales. The increase from the second quarter of 2008 largely resulted from favorable movements in foreign exchange and reduced transportation costs. Our global sourcing and continuous improvement programs as well as previously implemented cost reduction programs also aided in the increase.

During the second quarter of 2009, we incurred restructuring charges of $2.1 million. These charges included employee termination costs and costs associated with exiting three leased showrooms. During the second quarter of 2008, we incurred restructuring charges of $3.4 million related to employee termination costs and the discontinuation of a product line. Excluding these restructuring charges operating expenses for the quarter were $50.1 million, or 24.8% of sales, compared to $62.6 million, or 21.4% of sales, a year ago. The decrease in operating expenses during the second quarter of 2009 was in large part due to decreased spending in conjunction with our lower sales volumes; specifically lower commissions and incentive accruals. In addition, we are beginning to see benefits from previously implemented cost cutting measures. Our operating profit for the second quarter of 2009 was $18.5 million, a decrease of $16.6 million, or 47.3%, over the same period in 2008.

We continue to manage our balance sheet. We were able to pay down $23.0 million of debt during the second quarter of 2009. We will continue our efforts to reduce our receivables and inventory balances and use the available cash to pay down our outstanding debt. Maintaining a strong balance sheet and aggressively freeing up working capital remain top priorities. In furtherance of these efforts, we reduced our dividend to $0.02 in the second quarter of 2009. This has provided us with cash to use for other purposes. For the three months ended June 30, 2009, cash generated from operations was $27.8 million. Included in cash from operations was $10.1 million and $11.9 million from reductions in receivables and inventory. Capital expenditures for the quarter were $5.1 million.

We expect the difficult sales environment to continue in the third quarter. Reductions in our commodity costs will help our gross margins. However we believe continued competitive pricing in the marketplace will offset most if not all of these benefits. Lower absorption of our fixed costs and costs associated with new product launches will also negatively impact our margins.

On a positive note, looking in the third quarter, we believe we will begin to see the benefit of sales from our newly introduced Generation by Knoll™ chair. The chair won the Best of Neocon® gold award at our industry's annual trade show. We believe this chair will be a game changer in the industry and will help us gain additional market share in seating.

Critical Accounting Policies

The preparation of the 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, 2008.

Results of Operations

Comparison of the Three Months and Six Months Ended June 30, 2009 and 2008



                                                Three Months Ended              Six Months Ended
                                             June 30,        June 30,       June 30,        June 30,
                                               2009            2008           2009            2008
                                                                  (in thousands)
Consolidated Statement of Operations Data:
Net Sales                                    $ 202,197       $ 292,536      $ 414,806       $ 560,344
Gross Profit                                    70,729         101,087        145,496         191,410
Restructuring charges                            2,073           3,432          8,312           3,432
Operating Income                                18,514          35,098         35,279          66,999
Interest Expense                                 2,856           3,963          5,627           8,898
Other Expense, net                               2,747              64          1,423             258
Income Tax Expense                               4,837          10,154         10,630          19,648
Net Income                                   $   8,074       $  20,917      $  17,599       $  38,195
Statistical and Other Data:
Sales Growth from Comparable Prior Period        (30.9 %)          7.5 %        (26.0 %)          7.8 %
Gross Profit Margin                               35.0 %          34.6 %         35.1 %          34.2 %
Backlog                                      $ 134,136       $ 191,036      $ 134,136       $ 191,036

Sales

Sales for the second quarter of 2009 were $202.2 million, a decrease of $90.3 million, or 30.9%, from sales of $292.5 million for the same period in the prior year. Sales for the six months ended June 30, 2009 were $414.8 million, a decrease of $145.5 million, or 26.0%, over the first six months of 2008. We experienced double digit declines in every product category and Europe continued to decline more than North America. These declines are occurring across the industry as the Business and Institutional Furniture Manufacturer's Association ("BIFMA") is forecasting a 28.6% decline in sales and a 29.3% decline in orders in 2009.

Gross Profit and Operating Income

Gross profit for the second quarter of 2009 was $70.7 million, a decrease of $30.4 million, or 30.1%, from gross profit of $101.1 million for the second quarter of 2008. Gross profit for the six months ended June 30, 2009 was $145.5 million, a decrease of $45.9 million, or 24.0%, from gross profit of $191.4 million for the same period in the prior year. Operating income for the second quarter of 2009 was $18.5 million, a decrease of $16.6 million, or 47.3%, from operating income of $35.1 million for the second quarter of 2008. Operating income for the second quarter of 2009 includes restructuring charges totaling $2.1 million. Operating income for the six months ended June 30, 2009 was $35.3 million, a decrease of $31.7 million, or 47.3%, from operating income of $67.0 million for the same period in 2008. Operating income for the six months ended June 30, 2009 includes restructuring charges totaling $8.3 million. Operating income for the six months ended June 30, 2008 includes restructuring charges totaling $3.4 million. As a percentage of sales, gross profit increased from 34.6% for the second quarter of 2008 to 35.0% for the second quarter of 2009. Operating income as a percentage of sales decreased from 12.0% in the second quarter of 2008 to 9.2% for the same period of 2009. For the six months ended June 30, 2009 and 2008 gross profit as a percentage of sales was 35.1% and 34.2%, respectively. Operating income as a percentage of sales decreased from 12.0% in the first six months of 2008 to 8.5% in the first six months of 2009.

Operating expenses for the second quarter 2009 were $50.1 million, or 24.8% of sales, compared to $62.6 million, or 21.4% of sales, for the second quarter 2008. Operating expenses for the six months ended June 30, 2009 were $101.9 million or 24.6% of sales compared to $121.0 million or 21.6% of sales for the same period in 2008. The decrease in operating expense dollars for the quarter and six months ended June 30, 2009 as compared with the prior year periods was in large part due to our cost reduction programs in response to decreased demand for our products. Decreased sales and performance related compensation accounted for approximately $6.0 million of the reduction in operating expenses during the second quarter of 2009.

Interest Expense

Interest expense for the three and six months ended June 30, 2009 was $2.9 million and $5.6 million, respectively, a decrease of $1.1 million and $3.3 million, respectively, from the same periods in 2008. The decrease in interest expense for the periods noted above is due to lower average interest rates. During the second quarter of 2009 two of our interest rate swap agreements which were entered into May 21, 2008 went into effect. Interest expense of $503 thousand was accrued during the quarter. After giving effect to the interest rate swaps, we expect interest expense to be approximately $5.0 million for each of the remaining two quarters of 2009. See Note 5 of the condensed consolidated financial statements for further information regarding the interest rate swap agreements. The weighted average interest rate for the second quarter of 2009 was 2.4%. The weighted average interest rate for the same period of 2008 was 4.2%.

Other Expense, net

Other expense for the second quarter of 2009 was $2.7 million which included $2.8 million of foreign exchange losses on currency offset by $0.1 million of miscellaneous income. Other expense for the second quarter of 2008 was $0.1 million.

Income Tax Expense

The mix of pretax income and the varying effective tax rates in the countries in which we operate directly affects our consolidated effective tax rate. The effective tax rate was 37.5% for the second quarter of 2009, as compared to 32.7% for the same period in 2008. This increase is primarily due to the utilization of approximately $1.4 million of a net operating loss carryforward in one of our foreign subsidiaries. The effective tax rate for the six months ended June 30, 2009 was 37.7% and 34.0% for the same period in 2008.

Liquidity and Capital Resources

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



                                                       Six Months Ended
                                                   June 30,       June 30,
                                                     2009           2008
                                                        (in thousands)
          Cash provided by operating activities    $  12,923      $  47,192
          Capital expenditures                       (10,243 )       (6,644 )
          Net cash used in investing activities    $ (10,233 )       (6,644 )
          Purchase of common stock                      (704 )      (19,872 )
          Net proceeds (repayments) of debt            1,000         (5,000 )
          Payment of dividend                         (6,353 )      (11,389 )
          Net proceeds from issuance of stock             57             61
          Net cash used for financing activities      (6,000 )      (36,200 )

Historically, we have carried significant amounts of debt, and cash generated by operating activities has been used to fund working capital and capital expenditures, repurchase shares and make scheduled payments of principal and interest under our debt. 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.

Year-to-date net cash provided by operations was $13.5 million. $34.1 million was provided from net income plus non-cash amortizations and stock based compensation, offset by a use of cash of $20.6 million from the changes in assets and liabilities, primarily current liabilities.

For the six month period ended June 30, 2009, we used available cash, including the $12.9 million of net cash from operating activities, to fund $10.2 million in capital expenditures, fund dividend payments to shareholders totaling $6.4 million, and fund working capital.

For the six month period ended June 30, 2008, we used available cash, including the $47.2 million of net cash from operating activities, to fund $6.6 million in capital expenditures, pay down debt of $5.0 million, repurchase $19.9 million of common stock for treasury, fund dividend payments to shareholders totaling $11.4 million and fund working capital.

Cash used in investing activities was $10.2 million for the six month period ended June 30, 2009 and $6.6 million for the same period in 2008. Fluctuations in cash used in investing activities are primarily attributable to the levels of capital expenditures.

We use our existing secured $500 million 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 matures in June 2013 and provides us with the option to increase the size of the facility by up to an additional $200 million, subject to the satisfaction of certain terms and conditions. As of June 30, 2009, there was approximately $338 million outstanding under the facility, compared to $363 million outstanding under the facility as of June 30, 2008. Borrowings under the revolving credit facility may be repaid at any time, but no later than June 2013.

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) continues to decline due to deteriorating market conditions. 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 year ended December 31, 2008.

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 arise if we had engaged in these relationships.

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. 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 in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2008; 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 prices and availability; restrictions on government spending resulting in fewer sales to 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 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 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.