| ST E E L C A S E I N C. Management's Discussion and Analysis of Financial Condition and Results of Operations |
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Net sales In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosure about Segments of an Enterprise and Related Information, the Company operates on a worldwide basis within three reportable segments, two of which are geographic furniture segments, and services and other businesses. In prior years, the Company has reported the two geographic furniture segments as being the U.S. and International/Canada combined. Due to the acquisition of the remaining 50% equity interest in Steelcase Strafor and the significant impact of this acquisition on the Company’s consolidated financial statements, the Company has implemented a new reporting structure which focuses separately on North American and International furniture operations. North America includes the U.S., Canada and the Steelcase Design Partnership (“SDP”). International includes the rest of the world, with the major portion of the operations located in Europe. The services and other businesses segment remains largely unchanged, with only insignificant reclassifications (see Note 18). The following table sets forth consolidated and pro forma worldwide net sales by segment for 2000, 1999 and 1998. The segment disclosures for 1999 and 1998 have been restated to reflect the Company’s new reporting structure noted above.
The Company’s consolidated net sales in 2000 posted a 20.9% increase over 1999 net sales, primarily from the acquisition of Steelcase Strafor and other domestic acquisitions. Excluding the impact of all acquisitions, the Company’s net sales in 2000 decreased 0.1% compared to 1999 net sales. During 1999 and 1998, the Company’s consolidated net sales did not include those of Steelcase Strafor and therefore, more closely resembled those of the U.S. office furniture industry. In 1999, the Company, along with the U.S. office furniture industry overall, experienced a slowdown in its growth. The Company posted flat sales for the year, lagging U.S. industry growth as reported by The Business and Institutional Furniture Manufacturers’ Association (“BIFMA”). For 1998, the Company’s consolidated net sales outpaced the industry, increasing by 14.6%. North America. North American sales grew at 3.8%, 0.6% and 16.2% for 2000, 1999 and 1998, respectively. Domestic acquisitions, along with strong SDP sales and an increased momentum in new product sales, provided the bulk of the sales increase across North America in 2000. New product sales doubled their run rates in 2000 over 1999. The sales of the Company’s core Steelcase branded products in North America followed the industry trends in 2000, as sales for the full year declined. Excluding the impact of acquisitions, North American net sales for 2000 increased 0.2%, which is comparable to fiscal 1999 levels, despite an overall decline in the industry of 1%. North American net sales growth in 1998 resulted primarily from increases in unit sales across most product categories reflecting strong industry fundamentals. In 1999, the industry began to soften due to financial volatility in Asian and Latin American markets, which, along with a high level of merger and acquisition activity within the U.S. Fortune 500 companies, contributed to the lack of sales growth. As the industry softened in 1999, the Company’s core Steelcase branded products in North America were impacted by the deferred spending actions within the Company’s large corporate account business, resulting in declines across the same product categories that benefited from a strong industry in 1998. North American Sales by Operation
International. In 2000, due to the effective date of Company’s acquisition of the remaining 50% interest in Steelcase Strafor, the International segment includes nine months of Steelcase Strafor net sales. Steelcase Strafor realized local currency growth of 6.1% in 2000 primarily driven by Werndl BüroMöbeL AG (“Werndl”). However, the devaluation of the euro throughout 2000 offset most of the local currency growth, resulting in 1% growth in U.S. dollars. Net sales outside of Europe declined by 4.0% during 2000, primarily due to a decline in the Company’s export business coupled with the adverse impact of currency devaluation in Brazil, offset by growth in Mexican operations. In 1999, the International segment decreased by 16.7% due to several factors including a reduction in export projects to Latin America and flat sales in Asia, as well as the reorganization of the Company’s Japanese subsidiary. In 1998, the International segment experienced growth of 9.3% due to strong export sales to both Latin America and the Middle East. Steelcase Strafor Net Sales by Country
Services and other businesses. Services and other businesses rose by 17.8% in 2000 after experiencing a decline of 7.9% in 1999. The 2000 sales were positively impacted by growth in IDEO, the Company’s subsidiary that provides product development and innovation services. The decline in 1999 was due to the disposal of a product line and distributor within the Company’s marine business at the end of the third quarter of 1998. Net sales for 1998 were virtually flat. Gross Profit
The Company’s gross profit as a percentage of sales decreased in 2000 from 36.1% to 33.3% after a slight decrease in 1999 from the 1998 level of 36.4%. The Company’s warranty policy offers a lifetime warranty on Steelcase brand products, subject to certain exceptions, which provides for the free repair or replacement of any covered product or component that fails during normal use because of a defect in design, materials or workmanship. In accordance with this policy, the Company recorded a $24.5 million pre-tax charge for expenses related to the field retrofit of beltways and insulation materials within installed Pathways products. Excluding this charge, the Company’s gross margin was 34.0% which was a decrease of 2.1 percentage points from the prior year. This margin decline during 2000 was primarily the result of the unfavorable industry-pricing environment, the impact of new products – which typically have lower initial margins – in the sales mix and major new product introduction and ramp up costs. Additionally, the Company experienced the expected margin decrease of approximately 0.5 percentage points with the consolidation of Steelcase Strafor, which has historically had lower margins. The overall decrease in gross margin for 2000 was partially offset by lower variable compensation. In 1998 and 1999, margins remained relatively flat as the Company’s continued efforts to reduce costs and to improve efficiencies were tempered by upfront investments required to fund cost-reduction efforts to be realized in future periods, as well as the expected disruptions and inefficiencies associated with the Company being in the midst of launching the largest product portfolio in its history. Selling, general and administrative expenses
Interest expense; Other income, net and Income taxes 2000 was impacted significantly by the acquisition of Steelcase Strafor, which was partially financed through short and long-term borrowings. Interest expense increased to $15.9 million from zero in 1999 and $1.7 million in 1998 as a result of the acquisition of Steelcase Strafor. Overall, other income, net did not vary significantly during 1998 and 1999. However, other income, net increased significantly in 2000 due to several gains. First, the Company recognized a gain of $7.5 million in connection with the transition of its customers to new dealers in the United Kingdom, with respect to which the Company had previously written off bad debts. Second, the Company recorded a gain of $10.0 million from the sale of certain non-income producing facilities. Finally, the Company recorded investment income of $7.0 million from the sale of investments in common stock. The above mentioned gains were offset by decreased interest income of $6.6 million in 2000 due to lower cash balances. Also, 1999 included $5.8 million of interest income recorded in connection with the favorable resolution of income tax litigation discussed below. Income tax expense as a percentage of income before taxes (“the effective tax rate”) approximated 39.0% in 2000, 37.0% in 1999 and 38.5% in 1998. During 2000, the effective tax rate increased because of the consolidation of Steelcase Strafor and the recording of non-deductible goodwill. Steelcase Strafor operations are located in Europe, whose countries typically have higher effective tax rates than the U.S. During 1999, the provision for income taxes benefited from the favorable resolution of income tax litigation dating back to 1989, primarily related to investment tax credits and accelerated depreciation on the Company’s Corporate Development Center. The resolution of these matters contributed to a reduced effective tax rate for 1999 and resulted in the recognition of interest income of $5.8 million in 1999. These tax matters increased 1999 consolidated net income by $6.2 million, or $0.04 per share (basic and diluted). Net income For the reasons set forth above, net income decreased from $221.4 million in 1999 to $184.2 million in 2000 after increasing from $217.0 million in 1998. Net income decreased 16.8% in 2000 after increasing by 2.0% in 1999 and 43.5% in 1998.
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