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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

OR

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            

Commission File No. 001-12907

KNOLL, INC.

1235 Water Street

East Greenville, PA 18041

Telephone Number (215) 679-7991

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

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 August 4, 2011, there were 47,815,939 shares (including 1,562,219 shares of non-voting restricted shares) of the Registrant’s common stock, par value $0.01 per share, outstanding.

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KNOLL, INC.

TABLE OF CONTENTS FOR FORM 10-Q

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PART I - FINANCIAL INFORMATION

ITEM 1.  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

KNOLL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except share and per share data)

See accompanying notes to the condensed consolidated financial statements

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KNOLL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except share and per share data)

See accompanying notes to the condensed consolidated financial statements.

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KNOLL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(dollars in thousands)

See accompanying notes to the condensed consolidated financial statements

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KNOLL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

NOTE 1:  BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of Knoll, Inc. (the “Company”) have been prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to such rules and regulations.  All condensed consolidated financial statements contained herein are unaudited and reflect all adjustments which are, in the opinion of management, necessary to summarize fairly the financial position of the Company and the results of the Company’s operations and cash flows for the periods presented.  All of these adjustments are of normal recurring nature.  All intercompany balances and transactions have been eliminated in consolidation.  These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2010.

NOTE 2: NEW ACCOUNTING PRONOUNCEMENTS

In June 2011, the FASB issued guidance amending the Other Comprehensive Income topic of the FASB Codification. The guidance provides an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance will be effective for the Company in the first quarter of 2012 and is not expected to have an impact on the Company’s financial position, results of operations or cash flows.

NOTE 3: INVENTORIES

Inventories, net consist of:

Inventory reserves for obsolescence and other estimated losses were $8.1 million and $8.3 million at June 30, 2011 and December 31, 2010, respectively.

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KNOLL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

NOTE 4: INCOME TAXES

As of June 30, 2011, the Company had unrecognized tax benefits of approximately $2.2 million.  The entire amount of the unrecognized tax benefits would affect the effective tax rate if recognized.  As of June 30, 2011, the Company is subject to U.S. Federal income tax examinations for the tax years 2007 through 2010, and to non-U.S. income tax examinations for the tax years 2003 through 2010.  In addition, the Company is subject to state and local income tax examinations for the tax years 2003 through 2010.

The Company’s income tax provision consists of federal, state and foreign income taxes.  The tax provisions for the three months ended June 30, 2011 and 2010 were based on the estimated effective tax rates applicable for the full years ending December 31, 2011 and 2010, after giving effect to items specifically related to the interim periods.  The Company’s effective tax rate was 34.1% for the three months ended June 30, 2011 and 11.9% for the three months ended June 30, 2010.  The Company’s effective tax rate was 35.2% for the six months ended June 30, 2011 and 20.4% for the six months ended June 30, 2010. The increase in the effective tax rate was mainly due to a $2.5 million tax benefit related to foreign tax credits that was recognized as a discrete item due to amended tax returns being filed during the second quarter of 2010.  The Company’s effective tax rate is also affected by the mix of pretax income and the different effective tax rates of the tax jurisdictions in which it operates.

NOTE 5:  DERIVATIVE FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments, to reduce its exposure to adverse fluctuations in foreign currency exchange rates and interest rates.

On May 21, 2008, the Company entered into four interest rate swap agreements for purposes of managing its risk in interest rate fluctuations. These agreements each hedged a notional amount of $150.0 million of the Company’s borrowings under its revolving credit facility. Two of the agreements were effective June 9, 2009 and expired on June 9, 2010. On these two agreements, the Company paid a fixed rate of 3.51% and received a variable rate of interest equal to three-month London Interbank Offered Rate (LIBOR), as determined on the last day of each quarterly settlement period. The other two agreements were effective on June 9, 2010 and expired on June 9, 2011. The Company paid a fixed rate of 4.10% on these two agreements and received a variable rate of interest equal to three-month LIBOR as determined on the last day of each quarterly settlement period.

The Company elected to apply hedge accounting to these swap agreements.  Changes in the fair values of the effective portion of the interest rate swap agreements were recorded as a component of accumulated other comprehensive income (loss) in the equity section of the balance sheet.  The net amount paid or received upon quarterly settlements was recorded as an adjustment to interest expense, with a corresponding reduction in other comprehensive income (loss).

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KNOLL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

NOTE 5:  DERIVATIVE FINANCIAL INSTRUMENTS (Continued)

The effect of derivative instruments on the condensed consolidated statement of income for the three months ended June 30, 2011 and 2010 were as follows (in thousands):

The effect of derivative instruments on the condensed consolidated statement of income for the six months ended June 30, 2011 and 2010 were as follows (in thousands):

The fair value of the Company’s derivative instruments included in current liabilities was $5.1 million (of which $0.9 million is not designated as a hedging instrument) at December 31, 2010.  The Company had no outstanding interest rate swap contracts as of June 30, 2011 as the contracts settled on June 9, 2011.

The Company will continue to review its exposure to interest rate fluctuations and evaluate whether it should manage such exposure through derivative transactions.  See Note 12 of the condensed consolidated financial statements for additional information regarding the fair value of the interest rate swaps.

Foreign Currency Contracts

From time to time, the Company enters into foreign currency forward exchange contracts and foreign currency option contracts to manage its exposure to foreign exchange rates associated with short-term operating receivables of a Canadian subsidiary that are payable by the U.S. operations. The terms of these contracts are generally less than a year. Changes in the fair value of such contracts are reported in earnings as a component of other (expense) income, net.

As of June 30, 2011 and December 31, 2010, the Company had no outstanding foreign currency contracts.  The Company entered into one foreign currency contract on June 27, 2011 that settled on June 30, 2011.  On this contract the Company received a net settlement of $0.5 million.  The Company did not enter into any other foreign currency contracts during the six months ended June 30, 2011 and 2010.

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KNOLL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

NOTE 6: CONTINGENT LIABILITIES AND COMMITMENTS

The Company is currently involved in matters of litigation, including environmental contingencies, arising in the ordinary course of business.  The Company accrues for such matters when expenditures are probable and reasonably estimable.  Based upon information presently known, management is of the opinion that such litigation, either individually or in the aggregate, will not have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

At June 30, 2011, the Company employed a total of 3,058 people.  Approximately 13.6% of the employees are represented by unions.  The Grand Rapids, Michigan plant is the only unionized plant within the U.S and has an agreement with the Carpenters Union, Local 1615, of the United Brotherhood of Carpenters and Joiners of America, Affiliate of the Carpenters Industrial Council (the “Union”), covering approximately 223 hourly employees. The Collective Bargaining Agreement expires August 28, 2011.  Certain workers in the facilities in Italy are also represented by unions.

The Company offers a warranty for all of its products.  The specific terms and conditions of those warranties vary depending upon the product sold.  The Company estimates the costs that may be incurred under its warranties and records a liability in the amount of such costs at the time product revenue is recognized.  Factors that affect the Company’s liability include historical product-failure experience and estimated repair costs for identified matters for each specific product category.  The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.

Changes in the warranty reserves for periods indicated are as follows:

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KNOLL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

NOTE 7: PENSIONS

The following tables summarize the costs of the Company’s employee pension and post retirement plans for the periods indicated.

NOTE 8: OTHER COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) consists of net earnings, plus other comprehensive income which includes pension liability adjustments, foreign currency translation adjustments, and unrealized gain (loss) on derivatives.  Comprehensive income was approximately $16.4 million and $2.8 million for the three months ended June 30, 2011 and June 30, 2010, respectively.  For the six months ended June 30, 2011 and June 30, 2010, comprehensive income totaled $31.7 million and $4.2 million, respectively.  The following presents the components of “Accumulated other comprehensive income (loss)” for the period indicated, net of tax (in thousands).

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KNOLL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

NOTE 9: COMMON STOCK AND EARNINGS PER SHARE

Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period (excluding unvested restricted shares).  Diluted earnings per share reflect the additional dilution for all shares and potential shares issued under the stock incentive plans (including unvested restricted shares).

Common stock activity for the six months ended June 30, 2011 and 2010 included the repurchase of approximately 677,670 shares for $13.7 million and 464,525 shares for $5.6 million, respectively.  Common stock activity for the first six months of 2011 also included the exercise of 849,908 options for $12.9 million and the vesting of 48,305 restricted shares.  Common stock activity for the first six months of 2010 also included the exercise of 512,980 options for $5.5 million and the vesting of 39,817 restricted shares.

NOTE 10: RESTRUCTURING CHARGES

On March 18, 2010, the Company announced a restructuring plan to better align its manufacturing footprint with demand while further focusing the particular manufacturing activities of each of its North American production facilities. The Company elected to undergo this restructuring in order to better utilize its manufacturing capacity, eliminate duplication of capabilities and reduce associated costs. The Company based its accounting and disclosures on the applicable accounting guidance. As a result, charges to operations were made in the periods in which restructuring plan liabilities were incurred.

In connection with the plan, the Company incurred approximately $0.2 million of restructuring charges during the second quarter of 2011 related to facility realignment.  During the six months ended June 30, 2011, the Company incurred approximately $0.7 million of restructuring charges which included $0.1 of employee termination costs and $0.6 million of costs associated with facility realignment.  During the second quarter of 2010, the Company incurred $2.1 million of restructuring charges associated with employee termination costs.  During the six months ended June 30, 2010, the Company incurred approximately $5.8 million of restructuring charges which included $3.5 million of employee termination costs and $2.3 million of costs associated with the write-off of fixed assets.  To date, the Company has recorded restructuring charges totaling $8.2 million related to the plan. The Company estimates that the remaining charges related to the plan will not be significant.

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KNOLL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

NOTE 10: RESTRUCTURING CHARGES (Continued)

Below is the summary of the changes in the restructuring liability during the six months ended June 30, 2011:

NOTE 11:  FAIR VALUE OF FINANCIAL INSTRUMENTS

The following methods and assumptions are used to estimate the fair value of each class of financial instruments for which it is practicable to estimate:

Cash and Cash Equivalents

The fair value of the Company’s cash and cash equivalents approximates the carrying value of the Company’s cash and cash equivalents, due to the short maturity of the cash equivalents.

Long-term Debt

The fair value of the Company’s $230.0 million revolving credit facility approximates its carrying value, as it is variable-rate debt and the terms are comparable to market terms as of the balance sheet dates.

Interest Rate Swap Contracts

The fair value of the Company’s interest rate swap contracts were measured as the present value of all expected future cash flows based on the LIBOR-based swap yield curve as of the date of the valuation, subject to a credit adjustment to the LIBOR-based yield curve’s implied discount rates.

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KNOLL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

NOTE 12:  FAIR VALUE MEASUREMENTS

Accounting Standards Codification 820, “Fair Value Measurements and Disclosures,” establishes a hierarchy that prioritizes fair value measurements based on types of inputs used for the various valuation techniques (market approach, income approach, and cost approach).  The levels of the hierarchy are described below:

The following table sets forth the assets and liabilities measured at fair value on a recurring basis, by input level, in the condensed consolidated balance sheet at December 31, 2010 (in thousands):

The fair value of the interest rate swaps were based on observable prices as quoted for receiving the variable three month London Interbank Offered Rates (“LIBOR”) and paying fixed interest rates and, therefore, were classified as level 2.

The interest rate swaps referred to above were included in current liabilities within the condensed consolidated balance sheet at December 31, 2010.  At June 30, 2011 the interest rate swaps had no value as these agreements expired June 9, 2011.  See Note 11 for further details about the fair value of financial instruments.

NOTE 13:  SUBSEQUENT EVENT

On August 5, 2011 the Company entered into a foreign currency forward exchange contract to manage its exposure to the Canadian dollar.  This contract has a notional amount of $75.0 million which represents the Company’s short term operating receivables of its Canadian subsidiary that are payable by the Company’s U.S. operations.  The contract settlement date is August 31, 2011.

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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 a discussion 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,” “goals,” “if,” “intend,” “may,” “plan,” “possible,” “potential,” “predict,” “project,” “should,” “will,” 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 our projections and estimates with respect to our planned restructuring activities.  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, 2010; changes in the financial stability of our clients or the overall economic environment, resulting in decreased corporate spending and service sector employment; changes in relationships with clients; the mix of products sold and of clients purchasing our products; the success of new technology initiatives; changes in business strategies and decisions; competition from our competitors; our ability to recruit and retain an experienced management team; changes in raw material and commodity prices and availability; restrictions on government spending resulting in fewer sales to the U.S. government, one of our largest customers; our debt restrictions on spending; our ability to protect our patents, copyrights and trademarks; our reliance on furniture dealers to produce sales; lawsuits arising from patents, copyrights and trademark infringements; violations of environment laws and regulations; potential labor disruptions; adequacy of our insurance policies; the availability of future capital; the overall strength and stability of our dealers, suppliers, and customers; access to necessary capital; and currency rate fluctuations. The factors identified above are believed to be important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement. Unpredictable or unknown factors could also have material adverse effects on us. All forward-looking statements included in this Form 10-Q are expressly qualified in their entirety by the foregoing cautionary statements. Except as required under the Federal securities laws and rules 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.

Overview

The second quarter of 2011 represented the third consecutive quarter of year-over-year double digit percentage growth in all our product categories.  Net sales were $238.7 million for the quarter, an increase of 24.1% from the second quarter of 2010.  Backlog of unfilled orders at June 30, 2011 was $164.6 million, an increase of $32.1 million, or 24.2%, compared to backlog at June 30, 2010.  Diluted earnings per share in the second quarter of 2011 increased 47.4% to $0.28 per share when compared to $0.19 per share during the same period in the prior year.

For the quarter, gross margin fell 70 basis points to 32.1% versus the comparable quarter of the prior year.  The decrease from the second quarter of 2010 largely resulted from material and transportation inflation and unfavorable movements in foreign exchange of the Canadian dollar.  Sequentially, when compared with the first quarter of 2011 gross margin rose 110 basis points.  This improvement mainly resulted from improved pricing and more favorable customer mix.

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Our operating profit for the second quarter of 2011 was $23.3 million, an increase of $11.4 million, or 95.8%, over the same period in 2010.  During the second quarter of 2011, we incurred restructuring charges of $0.2 million.  These charges consisted of costs associated with the facility realignment plans we announced in 2010.  Operating expenses for the quarter were $52.9 million, or 22.2% of sales, compared to $49.0 million, or 25.5% of sales, a year ago.  The increase in operating expenses during the second quarter of 2011 was in large part due to increased sales commissions and selling related expenses associated with our higher sales volumes as well as increased spending on our NeoCon trade show.

We continued to aggressively manage our balance sheet.  During the second quarter of 2011 we reduced accounts receivable by $15.0 million and our accounts receivable days outstanding by eight days.  We used this available cash to pay down an additional $12.0 million of our outstanding debt.  During the quarter we also increased our dividend 66.7% from $0.06 per share to $0.10 per share when compared with the first quarter of 2011.

Interest expense for the quarter decreased $1.0 million when compared with the second quarter of 2010.  The decrease in interest expense is due to our lower outstanding debt and the expiration of our remaining two interest rate swap agreements on June 9, 2011.  See Note 5 of the condensed consolidated financial statements included in this quarterly report on Form 10-Q from further information regarding the interest rate swaps.

Our effective tax rate was 34.1% for the quarter, as compared to 11.9% for the same period last year.  The increase in the effective tax rate from last year was mainly due to a $2.5 million tax benefit related to foreign tax credits that was recognized as a discrete item due to amended tax returns being filed during the second quarter of 2010. In addition, 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.

Business activity remains strong as measured by mock-ups, presentations, day-to-day business activity, and projects we are tracking. We are encouraged by this activity and, despite some reports of slower economic and job growth, we believe we will continue to experience growth during the second half of this year.  This quarter we were honored to receive an award from the Smithsonian’s Cooper Hewitt, National Design Museum for Corporate and Institutional Achievement.  We are the only furniture company ever to be bestowed this honor and we join a very short and prestigious list of the most highly respected brands in design across all industries and categories.  This award is meaningful to us as we have always strived to put design at the forefront of our culture.  Hans Knoll founded our company in 1938 on the conviction that good design enriches lives, and in 2011 we continue to believe that good design is good business for our clients, our associates and our shareholders.

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Results of Operations

Comparison of the Three Months and Six Months Ended June 30, 2011 and 2010

Sales

Sales for the second quarter of 2011 were $238.7 million, an increase of $46.4 million, or 24.1%, from sales of $192.3 million for the same period in the prior year.  Sales for the six months ended June 30, 2011 were $459.5 million, an increase of $92.0 million, or 25.0%, over the first six months of 2010.  For the three and six months ended June 30, 2011 we experienced double digit percentage growth in all of our product categories on a year-over-year basis with office systems posting the highest gains.

During the second quarter of 2011, sales to the U.S. government continued to represent a large portion of our overall sales. We expect sales to the U.S. government will continue to be a large portion of our overall sales for the remainder of the year.  However, we believe our customer mix will change so that sales to the U.S. government in the second half of 2011 will decline as a percentage of our overall sales in comparison to last year.

Gross Profit and Operating Income

Gross profit for the second quarter of 2011 was $76.5 million, an increase of $13.5 million, or 21.4%, from gross profit of $63.0 million for the second quarter of 2010. Gross profit for the six months ended June 30, 2011 was $144.9 million, an increase of $25.2 million, or 21.1%, from gross profit of $119.7 million for the same period in the prior year.

Operating income for the second quarter of 2011 was $23.3 million, an increase of $11.4 million, or 95.8%, from operating income of $11.9 million for the second quarter of 2010.  Operating income for the second quarter of 2011 includes restructuring charges totaling $0.2 million.  Operating income for the second quarter of 2010 includes restructuring charges totaling $2.1 million.  Operating income for the six months ended June 30, 2011 was $44.2 million, an increase of $22.9 million, or 107.5%, from operating income of $21.3 million for the same period in 2010.  Operating income for the six months ended June 30, 2011 includes restructuring charges totaling $0.7 million.  Operating income for the six months ended June 30, 2010 includes restructuring charges totaling $5.8 million.  As a percentage of sales, gross profit decreased from 32.8% for the second quarter of 2010 to 32.1% for the second quarter of 2011. Operating income as a percentage of sales increased from 6.2% in the second quarter of 2010 to 9.8% for the same period of 2011.  For the six months ended June 30, 2011 and 2010 gross profit as a percentage of sales was 31.5% and 32.6%, respectively.  Operating income as a percentage of sales increased from 5.8% in the first six months of 2010 to 9.6% in the first six months of 2011.

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Operating expenses for the second quarter 2011 were $52.9 million, or 22.2% of sales, compared to $49.0 million, or 25.5% of sales, for the second quarter 2010.  Operating expenses for the six months ended June 30, 2011 were $99.9 million or 21.7% of sales compared to $92.6 million or 25.2% of sales for the same period in 2010.  The increase in operating expense dollars for the quarter and six months ended June 30, 2011 as compared with the prior year periods was in large part due to increased sales commissions and selling related expenses associated with our higher sales volumes.

Interest Expense

Interest expense for the three and six months ended June 30, 2011 was $3.4 million and $7.4 million, respectively, a decrease of $1.0 million and $1.2 million, respectively, from the same periods in 2010.  The decrease in interest expense for the periods noted above is mainly due to our lower outstanding debt and the expiration of our remaining two interest rate swap agreements on June 9, 2011.  See Note 5 of the condensed consolidated financial statements included in this quarterly report on Form 10-Q for further information regarding the interest rate swaps.  The weighted average interest rate for the second quarter of 2011 was 5.0%. The weighted average interest rate for the same period of 2010 was 5.7%.  The weighted average interest rate for the six months ended June 30, 2011 and 2010 was 5.3%.

Other (Expense) Income, net

Other expense for the second quarter of 2011 was $0.3 million of foreign exchange losses.  Other income for the second quarter of 2010 was $2.3 million which included $2.5 million of foreign exchange gains on currency offset by $0.2 million of miscellaneous expense.  Other expense for the six months ended June 30, 2011 was $2.6 million which included $2.0 million of foreign exchange losses, $1.0 million of expense related to a negative judicial ruling, offset by $0.4 million of miscellaneous income.  Other income for the six months ended June 30, 2010 was $0.9 million which included $1.0 million of foreign exchange gains offset by $0.1 million of miscellaneous expense.

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 34.1% for the second quarter of 2011, as compared to 11.9% for the same period in 2010.  The effective tax rate for the six months ended June 30, 2011 was 35.2% and 20.4% for the same period in 2010.  The increase in the effective tax rate was mainly due to a $2.5 million tax benefit related to foreign tax credits that was recognized as a discrete item due to amended tax returns being filed during the second quarter of 2010.

Liquidity and Capital Resources

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

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, pay quarterly dividends and make payments of principal and interest under our credit facility.  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.

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Year-to-date net cash provided by operations was $12.8 million of which $38.3 million was provided by net income plus non-cash amortizations and stock based compensation offset by $25.5 million from unfavorable changes in assets and liabilities.  For the first six months of 2010 cash provided by operations was $31.3 million of which 27.3 million was provided from net income plus non-cash amortizations and stock based compensation and $4.0 million of favorable changes in assets and liabilities.

For the six month period ended June 30, 2011, we used available cash, including the $12.8 million of net cash from operating activities, to repay $15.0 million of outstanding debt, fund $7.1 million in capital expenditures, fund dividend payments to shareholders totaling $7.4 million, and fund working capital.

For the six month period ended June 30, 2010, we used available cash, including the $31.3 million of net cash from operating activities, to repay $18.0 million of outstanding debt, fund $2.8 million in capital expenditures, fund dividend payments to shareholders totaling $1.8 million, and fund working capital.

Cash used in investing activities was $7.1 million for the six month period ended June 30, 2011 and $3.1 million for the same period in 2010. Fluctuations in cash used in investing activities are primarily attributable to the levels of capital expenditures.  The increase in capital expenditures year-over-year is in large part due to expenditures on infrastructure related to information technology.

We use our existing secured $500.0 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 $200.0 million, subject to the satisfaction of certain terms and conditions.  As of June 30, 2011, there was $230.0 million outstanding under the facility, compared to $245.0 million outstanding under the facility as of December 31, 2010.  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) 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 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.

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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 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, 2010.

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, 2010.

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.

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.

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ITEM 3.           QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We provided a discussion of our market risk in Part II, Item 7A, of our Annual Report on Form 10-K for the year ended December 31, 2010.  During the first six months of 2011, there was no substantive change in our market risk except for the items noted below.  This discussion should be read in conjunction with Part II, Item 7A, of our Annual Report on Form 10-K for the year ended December 31, 2010.

During the normal course of business, we are routinely subjected to market risk associated with interest rate movements and foreign currency exchange rate movements. Interest rate risk arises from our debt obligations and related interest rate hedge agreements. Foreign currency exchange rate risk arises from our non-U.S. operations and purchases of inventory from foreign suppliers.

We have risk in our exposure to certain material and transportation costs. Steel, leather, wood products and plastics are all used in the manufacture of our products. During the second quarter of 2011 we were impacted by higher steel and petroleum prices.  Raw materials inflation was approximately $2.3 million and transportation inflation was approximately $2.0 million during the quarter.  We continue to work to offset these price changes in raw materials and transportation through our global sourcing initiatives, cost improvements and price increases to our products.

Interest Rate Risk

We have variable rate debt obligations that are denominated in U.S. dollars. A change in interest rates impacts the interest incurred and cash paid on our variable-rate debt obligations.

We use interest rate hedge agreements for other than trading purposes in order to manage our exposure to fluctuations in interest rates on our variable-rate debt. In May of 2008, we entered into four interest rate swap agreements in order to manage our interest rate risk. Each agreement hedged a notional amount of $150.0 million of our $500.0 million revolving credit facility. Two of the agreements were effective from June 9, 2009 through June 9, 2010 and the other two were effective from June 9, 2010 through June 9, 2011.  Fluctuations in LIBOR affected both our net financial instrument position and the amount of cash to be paid or received by us, if any, under these agreements. See Note 5 of the condensed consolidated financial statements included in this quarterly report on Form 10-Q for further information regarding the interest rate swaps.

Foreign Currency Exchange Rate Risk

We manufacture our products in the United States, Canada and Italy, and sell our products primarily in those markets as well as in other European countries. Our foreign sales and certain expenses are transacted in foreign currencies. Our production costs, profit margins and competitive position are affected by the strength of the currencies in countries where we manufacture or purchase goods relative to the strength of the currencies in countries where our products are sold. Additionally, as we report currency in the U.S. dollar, our financial position is affected by the strength of the currencies in countries where we have operations relative to the strength of the U.S. dollar. The principal foreign currencies in which we conduct business are the Canadian dollar and the Euro. Approximately 12.8% of our revenues for the first half of 2011 and 15.6% in the same period for 2010, and 33.3% of our cost of goods sold for the first half of 2011 and 34.3% in the same period for 2010, were denominated in currencies other than the U.S. dollar.  Foreign currency exchange rate fluctuations resulted in a $0.3 million translation loss for the second quarter of 2011 and a $2.5 million translation gain for the same period of 2010.  For the six months ended June 30, 2011 and 2010, foreign exchange rate fluctuations included in other income resulted in a $2.0 million translation loss and a $1.0 million translation gain, respectively.

From time to time, we enter into foreign currency forward exchange contracts and foreign currency option contracts for other than trading purposes in order to manage our exposure to foreign exchange rates associated with short-term operating receivables of a Canadian subsidiary that are payable by our U.S. operations. The terms of these contracts are generally less than a year. Changes in the fair value of such contracts are reported in earnings in the period the value of the contract changes. As of June 30, 2011, the Company had no outstanding foreign currency contracts.  The Company entered into one foreign currency contract on June 27, 2011 that settled on June 30, 2011.  On this contract the Company received a net settlement of $0.5 million.  As of June 30, 2010 the Company had no outstanding foreign currency contracts.  The Company did not enter into any foreign currency contracts in 2010.

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ITEM 4.  CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. We, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 as of the end of the period covered by this report (June 30, 2011) (“Disclosure Controls”). Based upon the Disclosure Controls evaluation, our principal executive officer and principal financial officer have concluded that the Disclosure Controls are effective in reaching a reasonable level of assurance that (i) information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting. Our principal executive officer and principal financial officer also conducted an evaluation of our internal control over financial reporting (“Internal Control”) to determine whether any changes in Internal Control occurred during the quarter ended June 30, 2011 that have materially affected or which are reasonably likely to materially affect Internal Control. Based on that evaluation, there has been no such change during the quarter ended June 30, 2011.

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PART II — OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

During the first two quarters of 2011, there have been no new material legal proceedings or changes in the legal proceedings disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010.

ITEM 1A. RISK FACTORS

During the first two quarters of 2011, there were no material changes in the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Repurchases of Equity Securities

The following is a summary of share repurchase activity during the three months ended June 30, 2011.

On August 17, 2005, our board of directors approved a stock repurchase program (the “Options Proceeds Program”), whereby it authorized us to purchase shares of our common stock in the open market using the cash proceeds received by us upon exercise of outstanding options to purchase shares of our common stock.

On February 2, 2006, our board of directors approved an additional stock repurchase program, pursuant to which we are authorized to purchase up to $50.0 million of our common stock in the open market, through privately negotiated transactions, or otherwise. On February 4, 2008, our board of directors expanded this previously authorized $50.0 million stock repurchase program by an additional $50.0 million.

(1)          There is no limit on the number or value of shares that may be purchased by us under the Options Proceeds Program.  Under our $50.0 million stock repurchase program, which was expanded by an additional $50.0 million in February of 2008, we are only authorized to spend an aggregate of $100.0 million on stock repurchases.  Amounts in this column represent the amounts that remain available under the $100.0 million stock repurchase program as of the end of the period indicated.  There is no scheduled expiration date for the Option Proceeds Program or the $100.0 million stock repurchase program, but our board of directors may terminate either program in the future.

(2)          49,715 shares were purchased under the Options Proceeds Program.  On April 21, 2011 20,000 shares of outstanding restricted stock vested.  Concurrently with the vesting, 6,120 shares were forfeited by the holder of the vested restricted shares to cover applicable taxes paid on the holder’s behalf by the Company.

(3)          These shares were purchased under the Options Proceeds Program.

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ITEM 6.  EXHIBITS

*   Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed   or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

KNOLL, INC.

(Registrant)

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