Steelcase - 10-Q quarterly report FY

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes x          No o

      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

      Large accelerated filer x          Accelerated filer o          Non-accelerated filer o          

      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o          No  x

      As of September 28, 2006, Steelcase Inc. had 78,000,998 shares of Class A Common Stock and 70,977,072 shares of Class B Common Stock outstanding.

See accompanying notes to the condensed consolidated financial statements.

See accompanying notes to the condensed consolidated financial statements.

See accompanying notes to the condensed consolidated financial statements.

      The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions in Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals and adjustments) considered necessary for a fair presentation of the condensed consolidated financial statements have been included. Results for interim periods should not be considered indicative of results to be expected for a full year. Reference should be made to the consolidated financial statements contained in our Annual Report on Form 10-K for the fiscal year ended February 24, 2006 (“Form 10-K”)as amended by the Form 10-K/ A, filed with the U.S. Securities and Exchange Commission on July 12, 2006. As used in this Report, unless otherwise expressly stated or the content otherwise requires, all references to “Steelcase,” “we,” “our,” “Company” and similar references are to Steelcase Inc. and its majority owned subsidiaries.

      Unless the context otherwise indicates, reference to a year relates to the fiscal year, ended in February of the year indicated, rather than the calendar year. Additionally, Q2 and Q1 reference the second and first quarter, respectively, of the fiscal year indicated. All amounts are in millions, except per share data, data presented as a percentage or unless otherwise indicated.

      Certain amounts in the prior year’s financial statements have been reclassified to conform to the current year presentation.

      In July 2006, the Financial Accounting Standards Board (“FASB”) adopted FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition of positions taken or expected to be taken in income tax returns. Only tax positions meeting a “more-likely-than-not” threshold of being sustained are recognized under FIN 48. FIN 48 also provides guidance on derecognition, classification of interest and penalties and accounting and disclosures for annual and interim financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. The cumulative effect of the changes arising from the initial application of FIN 48 is required to be reported as an adjustment to the opening balance of retained earnings in the period of adoption. We are currently evaluating the impact, if any, of the adoption of FIN 48 on our financial statements.

      In June 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 04-5,“Investor’s Accounting for an Investment in a Limited Partnership When the Investor is the Sole General Partner and the Limited Partners Have Certain Rights” (“EITF 04-5”),which states that the general partner in a limited partnership should presume that it controls and, thus, should consolidate the limited partnership, unless the limited partners have either (a) substantive ability to dissolve the limited partnership or otherwise remove the general partner without cause or (b) substantive participating rights. EITF 04-5 was effective for the first reporting period in fiscal years beginning after December 15, 2005. As a result of adopting EITF 04-5, during Q2 we consolidated certain non-furniture partnerships related to one of our consolidated dealers that were not previously consolidated. The consolidation had the effect of increasing our sales during Q2 by

      On February 25, 2006, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment (revised 2004),using the modified prospective transition method. Prior to the adoption of SFAS No. 123(R), our policy was to expense stock-based compensation using the fair-value based method of accounting for all awards granted, modified or settled in accordance with SFAS No. 123, Accounting for Stock-Based Compensation. Prior to 2004, our stock-based compensation consisted only of stock options, and we accounted for them under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees,and related interpretations. Given the terms of the plans, no stock-based employee compensation cost was recognized, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

      The adoption of SFAS No. 123(R) had the following impact in 2007: Income before income taxes was reduced by $1.1, net income was reduced by $0.7, cash flow from operations was reduced by $2.2 and cash flow from financing activities increased by $2.2. There was no impact on basic or diluted earnings per share.

      On November 10, 2005, the FASB issued FASB Staff Position (“FSP”) 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards,that provides a practical transition election related to accounting for the tax effects of share-based payment awards to employees. The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS No. 123(R). We are in the process of evaluating whether to adopt the provisions of FSP 123(R)-3 and will make our election before the end of 2007.

      The following table details the effect on net income and earnings per share had stock-based compensation expense been recorded for the three and six months ended August 26, 2005 based on the fair-value method under SFAS No. 123,Accounting for Stock-Based Compensation. The reported and pro forma net income and earnings per share for the three and six month periods ended

      In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We have not determined the effect, if any, the adoption of this statement will have on our results of operations or financial position.

      In September 2006, the FASB adopted Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 106, and 132(R).” SFAS No. 158 requires companies to recognize a net liability or asset and an offsetting adjustment to accumulated other comprehensive income to report the funded status of defined benefit pension and other postretirement benefit plans. SFAS No. 158 requires prospective application, and the recognition and disclosure requirements are effective for the Company’s fiscal year ending February 23, 2007. Additionally, SFAS No. 158 requires companies to measure plan assets and obligations at their year-end balance sheet date. This requirement is effective for our fiscal year ending February 27, 2009. We are currently evaluating the impact of the adoption of SFAS No. 158 on our financial statements.

      In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year’s financial statements are materially misstated. SAB 108 becomes effective during our 2007 fiscal year. We do not expect the adoption of SAB 108 to have a material impact on our financial statements.

      Basic earnings per share is based on the weighted average number of shares of common stock outstanding during each period. It excludes the dilutive effects of additional common shares that would have been outstanding if the shares under our stock incentive plans had been issued and the dilutive effect of outstanding restricted shares to the extent those shares have not vested.

      Diluted earnings per share reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock. However, diluted earnings per share does not reflect the effects of 4.3 million shares related to outstanding stock incentive plan awards as of Q2 2007 and 4.4 million shares as of Q2 2006 because those shares or potential shares were anti-dilutive.

      Comprehensive income is comprised of net income and all changes to shareholders’ equity except those due to investments by, and distributions to, shareholders.

      In Q2 and year-to-date 2007, the foreign currency translation income was primarily due to the strengthening of the Canadian dollar and euro to the U.S. dollar. In 2006, the foreign currency translation losses were primarily due to the first quarter strengthening of the U.S. dollar against the euro. In the second quarter of 2006, these losses were partially offset by a gain resulting from the strengthening of the Canadian dollar against the U.S. dollar.

      Inventories are stated at the lower of cost or market. The North America segment primarily uses the last in, first out (“LIFO”) method to value its inventories. Companies in the Steelcase Design Partnership segment primarily use the first in, first out (“FIFO”) or the average cost inventory valuation methods. Companies in the International segment value their inventories using the FIFO method.

      The portion of inventories determined by the LIFO method aggregated $68.1 as of August 25, 2006 and $61.9 as of February 24, 2006.

      Finished goods inventory increased primarily in our North America segment due to increased sales volume and additional finished goods being produced and held at regional distribution centers in North America as part of a strategy to improve customer service. Raw materials inventory increased primarily due to increased sales volumes and currency translation.

      There were no acquisitions or impairments of goodwill during Q1 or Q2 2007. A summary of goodwill, by business segment and category, is as follows:

      In Q2 2007 and 2006, we recorded amortization expense of $2.2 on intangible assets subject to amortization. For the first half of 2007, we recorded amortization expense of $4.4 compared to $4.3 for the first half of 2006. Based on the current amount of intangible assets subject to amortization, the estimated amortization expense for each of the following five fiscal years is as follows:

      As events, such as acquisitions, dispositions or impairments occur in the future, these amounts may change.

      We expect to contribute approximately $3.6 to our pension plans and $10.1 to our post-retirement medical plans during 2007. As of August 25, 2006, contributions of approximately $3.1 and $5.4 have been made to our pension and post-retirement plans, respectively.

      During 2007, we incurred charges of $5.6 in our North America segment as we continued the initiative to consolidate our North America operations. We incurred charges of $3.0 in our International segment which included an impairment to our Strasbourg campus and severance charges related to the exit of certain operations in France and Morocco.

      Restructuring costs are summarized in the following table:

      Non-cash and other adjustments incurred during 2007 primarily relate to asset impairment charges within our International and North America segments. The reserve balance as of August 25, 2006 for business exit and related costs primarily relates to lease termination costs within our International and North America segments and PolyVision.

      We operate under three reportable segments: North America, Steelcase Design Partnership and International, plus an “Other” category. Revenue and operating income for 2007 and 2006 by segment is presented below.

      The increase in assets within Other is primarily due to an increase in corporate cash balances.

      The accrued liability for warranty costs, included within other accrued expenses on the Condensed Consolidated Balance Sheets, is based on an estimated amount needed to cover future warranty obligations for products sold as of the balance sheet date and is determined by historical product data and management’s knowledge of current events and actions.

      The maximum amount of future payments (undiscounted and without reduction for any amounts that may possibly be recovered from third parties) we could be required to make under the guarantees and performance bonds are as follows:

      We are party to performance bonds for certain installation or construction activities of certain Steelcase dealers and joint ventures. Under these agreements, we are liable to make financial payments if the installation or construction activities are not completed under their specified guidelines and claims are filed. Projects with performance bonds have completion dates ranging from one to five years. Where we have supplied performance bonds, we have the ability to step in and cure performance failures thereby mitigating our potential losses. No loss has been experienced under

      We are contingently liable under guarantees to third parties for the benefit of certain Steelcase dealers and joint ventures in the event of default of a financial obligation. The guarantees generally have terms ranging from one to ten years. No losses have been experienced; however, reserves totaling $0.4 are recorded as of August 25, 2006 to cover potential losses for loan and lease guarantees.

      We occasionally provide guarantees of the performance of certain of our dealers to third parties. These performance guarantees typically relate to dealer services such as delivery and installation of products. In the event that a dealer cannot complete these services in a timely manner, we guarantee the completion of these activities. It is not possible to estimate a potential liability under these types of guarantees because of the conditional nature of our obligations and the unique facts and circumstances involved in each particular agreement.

      Under the Steelcase Inc. Incentive Compensation Plan (the “Incentive Compensation Plan”), the Compensation Committee approved the granting of restricted shares of Class A Common Stock and restricted stock units (“RSUs”) to key employees. Restricted shares and RSUs will be forfeited if a participant leaves the Company for reasons other than retirement, disability or death prior to the vesting date. These restrictions lapse when the restricted shares and RSUs vest three years from the date of grant. When RSUs vest, they will be converted to unrestricted shares of Class A Common Stock.

      Prior to adopting SFAS 123(R), the aggregate market value on the grant date of the restricted shares was recorded as common stock and deferred compensation, a separate component of shareholders’ equity. Upon adopting SFAS 123(R), the deferred compensation account was netted against common stock. Restricted shares are now expensed and recorded in common stock over the three-year vesting period based on the value of the shares on the grant date. RSUs are expensed and recorded inAdditional paid in capital within the Condensed Consolidated Balance Sheets over the three-year vesting period based on the value of the shares on the grant date.

      The restricted stock and RSU expense and associated tax benefit in 2007 and 2006 were as follows:

      Holders of restricted stock receive cash dividends equal to the dividends that the Company declares and pays on the Class A Common Stock, which is included in Dividends paid in the Condensed Consolidated Statements of Cash Flows. Holders of RSUs receive quarterly cash payments equal to the dividend that the Company declares and pays on its Class A Common Stock, which are expensed as paid.

      The 2007 activity for restricted shares of stock and RSUs is as follows:

      As of August 25, 2006, there was $2.4 of remaining unrecognized compensation cost related to restricted stock and RSUs. That cost is expected to be recognized over a weighted-average period of 1.4 years. The total fair value of shares and RSUs vested during Q2 and the first six months of 2007 was $1.1 and $5.4, respectively. Under SFAS 123(R), grants to retiree-eligible employees are considered fully vested. No shares were vested prior to Q1 2007.

      In Q1 2007, the Company made awards of performance shares and performance units (“PSUs”) under the Incentive Compensation Plan. The performance measure for the 2007 awards is based on a combination of a cumulative three-year cash flow calculation and a cumulative three-year operating income calculation which meet the definitions within the Incentive Compensation Plan for performance-based compensation.

      After completion of the performance period for performance shares and PSUs, the number of the shares earned is determined and are issued as Class A Common Stock as they vest. Performance shares granted in 2007 fully vest at the end of the performance period.

      For performance shares and PSUs granted prior to 2007, one-third of the shares vest at the end of the three-year performance period and the remaining two-thirds vest over the next two years. The performance shares and PSUs will be issued as Class A Common Stock as they vest.

      Performance shares and PSUs are expensed and recorded inAdditional paid in capital within the Consolidated Statements of Changes in Shareholders’ Equity over the three to five year performance and vesting period based on the market value on the grant date and the estimated number of shares to be issued.

      For both performance shares and PSUs, a dividend equivalent is calculated on the basis of the actual number of shares earned at the end of the three-year performance period. The dividend equivalent is equal to the dividends that would have been payable on the earned shares had they been held during the entire performance period. The dividend equivalents on performance shares and PSUs are expensed and accrued over the three-year performance period. At the end of the performance period, the dividend equivalents will be paid.

      The actual number of common shares that ultimately may be issued ranges from zero to 886,000 shares based on actual performance levels. The 2007 activity for performance shares and PSUs is as follows:

      As of August 25, 2006, there was $4.2 of remaining unrecognized compensation cost related to non-vested performance shares and PSUs, based on the current estimated number of shares to be issued. That cost is expected to be recognized over a remaining weighted-average period of 2.8 years.

      Information relating to our stock options is as follows:

      The exercise price per share of options outstanding ranged from $10.50 to $36.50 as of August 25, 2006 and February 24, 2006.

      Information relating to option exercises under all share-based payment arrangements is as follows:

      On September 6, 2006, we acquired 100% of the outstanding stock of Softcare Innovations, Inc., a privately-held manufacturer of healthcare furnishings with headquarters in Waterloo, Ontario, and its sister company DJRT Manufacturing Inc. We will finalize the allocation of purchase price to the fair value of the assets acquired and liabilities assumed when we obtain information sufficient to complete the allocation, but in any case, within one year after acquisition.

      On September 6, 2006, we redeemed the $250.0 senior unsecured unsubordinated notes that were due in November 2006, at their face value plus accrued interest of $4.9 and a make-whole premium of $0.4.

      This management’s discussion and analysis of financial condition and results of operations should be read in conjunction with the February 24, 2006 Annual Report on Form 10-K, filed with the U.S. Securities and Exchange Commission on May 2, 2006, as amended by the Form 10-K/ A, filed with the U.S. Securities and Exchange Commission on July 12, 2006. Unless the context otherwise indicates, reference to a year relates to the fiscal year, ended in February of the year indicated, rather than the calendar year. Additionally, Q2 and Q1 reference the second and first quarter of the fiscal year indicated. All amounts are in millions, except per share data, data presented as a percentage or unless otherwise indicated.

      Revenue was $789.7 in Q2 2007, a 12.3% increase compared to the same period last year. Revenue increased for all of our reportable segments driven primarily by strong growth across most product categories in our North America segment. Q2 2007 revenue included $7.6 of favorable currency effects versus the same quarter last year and $3.7 for dealer acquisitions in our International segment that were completed during the last twelve months. During Q2 2007, we adopted EITF 04-5 which required us to consolidate $7.9 of revenue related to certain non-furniture businesses that are subsidiaries of a dealer we consolidate (See Note 2).

     Year-to-date revenue increased $138.1 or 10.0% compared to the same period last year. Revenue increased for all of our reportable segments, primarily driven by growth of 11.5% in our North America segment and 9.6% in our International segment compared to the same period last year. Year-to-date revenue included $3.0 of favorable currency effects versus the same period last year and $13.2 for dealer acquisitions and consolidations that were completed during the last twelve months.

      Cost of sales, which is reported separately from restructuring charges, as a percent of revenue was consistent with the prior year in Q2 2007 andyear-to-date. International cost of sales improved by 1.2 percentage points over the prior year quarter andyear-to-date through better operational performance. North America also saw an improvement of 0.7 percentage points over the prior year

quarter andyear-to-date, due to improved pricing yield and improved operational performance, despite higher material costs over the last twelve months. These improvements were offset by cost of sales percentage increases at PolyVision, due to higher discounting for certain product lines and some manufacturing inefficiencies. Cost of sales for Steelcase Design Partnership (“SDP”) also increased as a percent of sales because of a general increase in project business.

      Restructuring costs were significantly lower in the current year than the prior year. As a percentage of revenue, lower restructuring charges positively impacted gross margins by 0.5 percentage points and 0.6 percentage points in Q2 2007 and for the first half of 2007, respectively, as compared to the prior year.

      Operating expenses, which are reported separately from restructuring charges, were 25.5% and 26.5% of sales during Q2 2007 and 2006, respectively.Year-to-date operating expenses were 26.0% and 26.8% of sales for 2007 and 2006, respectively. Operating expenses increased by $15.2 compared to the prior year quarter and $24.7 year-to-date. The increase was driven by several factors including increased variable compensation expense, investments in growth initiatives, a prior year gain on the sale of a corporate aircraft, and expenses related to acquired businesses.

      Operating income of $42.4 compares to $25.3 in the prior year. The improvement was primarily due to better performance in our North America segment and lower restructuring charges. Included in our operating income are pretax restructuring charges of $4.4 compared to $9.7 last year.Year-to-date operating income of $70.4 increased by $29.9 versus the prior year.

      Non-operating income increased by $4.9 and $10.1 in Q2 2007 andyear-to-date, respectively, compared to 2006, primarily due to higher cash balances and interest rates on cash balances. See Interest Expense and Other Income, Net section below for more information.

      We calculated our tax expense for the quarter using a 37% tax rate, and then added a $1.1 valuation reserve related to deferred tax assets, which results in an effective tax rate of 39.5% for the quarter. For the full year, we expect the effective tax rate to be approximately 37%.

      Net income in Q2 andyear-to-date 2007 improved compared to the corresponding periods in the prior year primarily due to better performance in our North America segment, lower restructuring charges and an increase in interest income.

      Interest expense in Q2 2007 was higher than the prior year due to the issuance of new senior notes in August. The redemption of the existing notes did not occur until September, so the timing of