Overview

The Company is an innovator of emulsion polymers, specialty chemicals, and decorative and functional surfaces for a variety of commercial, industrial and residential end uses. As discussed in Note K to the Company's Consolidated Interim Financial Statements, the Company operates in two reportable business segments: Performance Chemicals and Decorative Products. The Performance Chemicals segment produces a broad range of emulsion polymers and specialty chemicals based primarily on styrene butadiene, styrene butadiene acrylonitrile, styrene butadiene vinyl pyridine, polyvinyl acetate, acrylic, styrene acrylic, vinyl acrylic, glyoxal and fluorochemical chemistries. Performance Chemicals' custom-formulated products are tailored for coatings, binders and adhesives, which are used in paper, carpet, nonwovens, construction, adhesives, paper tape, tire cord, floor polish, textiles, graphic arts, plastic parts and various other applications. The Decorative Products segment develops, designs, produces and markets a broad line of decorative and functional surfacing products, including commercial wallcoverings, coated and performance fabrics, vinyl, paper and specialty laminates and industrial films. These products are used in numerous applications, including commercial building refurbishment, remodeling and new construction, residential cabinets, flooring and furnishings, transportation markets including school busses, marine and automotive, recreational vehicles, manufactured housing and a variety of industrial film applications.

The Company's products are sold to manufacturers, independent distributors and end users through internal marketing and sales forces and agents.

The Company has strategically located manufacturing facilities in the United States, United Kingdom, China and Thailand.

The Company has historically experienced stronger sales and income in its second, third and fourth quarters, comprised of the three-month periods ending May 31, August 31 and November 30. The Company's performance in the first quarter (December through February) has historically been weaker due to generally lower levels of customer manufacturing, construction and refurbishment activities during the holidays and cold weather months.

The Company's chief operating decision maker evaluates performance and allocates resources by operating segment. Segment information has been prepared in accordance with the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures About Segments of an Enterprise and Related Information." The Company's two operating segments were determined based on products and services provided. Accounting policies of the segments are the same as those described in Note A of the Company's Consolidated Financial Statements. For a reconciliation of the Company's segment operating performance information, please refer to Note K of the Company's Consolidated Financial Statements.

Key Indicators

Indicators

Key economic measures relevant to the Company include coated paper production, print advertising spending, U.S. commercial real estate and hotel occupancy rates, U.S. office furniture sales, manufactured housing shipments, housing starts and sales of existing homes and forecasts of raw material pricing for certain petrochemical feed stocks. Key OEM industries which provide a general indication of demand drivers to the Company include paper, commercial building construction, housing, furniture manufacturing and flooring manufacturing. These measures provide general information on trends relevant to the demand for the Company's products but the trend information does not necessarily directly correlate with demand levels in the markets which ultimately use the Company's products.

Key operating measures utilized by the business segments include orders, sales, working capital turnover, inventory, productivity, new product vitality and order fill-rates which provide key indicators of business trends. These measures are reported on various cycles including daily, weekly and monthly depending on the needs established by operating management.

Key financial measures utilized by management to evaluate the results of its businesses and to understand the key variables impacting the current and future results of the Company include: sales, gross profit, selling, general and administrative expenses, operating profit before excluded items, consolidated earnings before interest, taxes, depreciation and amortization as set forth in the Net Leverage Ratio in the Company's $150,000,000 Term Loan Credit Agreement ("EBITDA"), working capital, operating cash flows, capital expenditures and earnings per share before excluded items, including applicable ratios such as inventory turnover, average working capital, return on sales and assets and leverage ratios. These measures, as well as objectives established by the Board of Directors of the Company, are reviewed at monthly, quarterly and annual intervals and compared with historical periods.

Results of Operations for the Three Months Ended February 28, 2009 Compared to the Three Months Ended February 29, 2008

The Company's net sales in the first quarter of 2009 were $160.2 million compared to $190.6 million in the first quarter of 2008. The Company's Performance Chemicals business segment revenue decreased by 20.4% while the Decorative Products business segment revenue decreased 8.5%. Contributing to the sales decrease in 2009 were lower volumes of $48.2 million as a result of weak market conditions, and unfavorable foreign exchange translation of $5.7 million, partially offset by favorable pricing of $11.1 million and sales of $12.4 million from the Decorative Products Asian operations. The Decorative Products Asian operations were acquired in January 2008 and report to the Company on a one month lag. Therefore, the first quarter of 2008 includes one month of consolidated sales while the first quarter of 2009 includes three months of consolidated sales.

Gross profit in the first quarter of 2009 was $31.7 million with a gross profit margin of 19.8% compared to gross profit of $30.5 million and a gross profit margin of 16.0% in the first quarter of 2008. The improvement in gross profit was primarily due to lower raw material costs.

Selling, general and administrative expense in the first quarter of 2009 decreased $2.1 million, to $23.0 million, or 14.4% of sales, compared to $25.1 million, or 13.2% of net sales in the first quarter of 2008. The decrease was primarily due to a year-over-year reduction in the number of employees.

Interest expense decreased $1.2 million, to $2.2 million, for the first quarter of 2009 compared to $3.4 million for the same period a year ago, due to significantly lower average interest rates. The effective interest rate on the Company's debt was 4.4% during the first quarter of 2009, compared to 7.2% in the first quarter of 2008. Total debt at February 28, 2009 was $174.1 million, down $14.2 million from November 30, 2008 and down $22.5 million from February 29, 2008.

Income tax expense of $0.2 million in the first quarter of 2009 and $0.1 million in the first quarter of 2008 was primarily related to foreign income taxes. No domestic federal tax provision was provided in either the first quarter of 2009 or 2008 due to the Company's net losses. Valuation allowances have been provided for deferred tax assets in the U.S. as a result of the Company's prior losses. At present, the Company has $134.7 million of domestic federal net operating loss carryforwards that expire by 2025.

The Company had a net loss of $0.1 million or $0.00 per diluted share in the first quarter of 2009 compared to a net loss of $3.0 million or $0.07 per diluted share in the first quarter of 2008.

Segment Discussion

The following Segment Discussion presents information used by the Company in assessing the results of operations by business segment. The Company believes that this presentation is useful for providing the investor with an understanding of the Company's business and operating performance because these measures are used by the chief operating decision maker in evaluating performance and allocating resources.

The following table reconciles segment sales to consolidated net sales and segment operating profit to consolidated income (loss) before income taxes:

                                                          Three Months Ended
                                                    February 28,       February 29,
  (Dollars in millions)                                 2009               2008
  Segment Sales:
  Performance Chemicals                            $         94.6      $       118.9
  Decorative Products                                        65.6               71.7

  Consolidated net sales                           $        160.2      $       190.6


  Segment Gross Profit:
  Performance Chemicals                            $         18.2      $        13.1
  Decorative Products                                        13.5               17.4

  Consolidated gross profit                        $         31.7      $        30.5


  Segment Operating Profit:
  Performance Chemicals                            $          7.8      $         2.6
  Decorative Products                                        (2.9 )              (.1 )
  Interest expense                                           (2.2 )             (3.4 )
  Corporate expenses                                         (2.6 )             (2.0 )

  Consolidated income (loss) before income taxes   $           .1      $        (2.9 )

Performance Chemicals

Performance Chemicals' net sales decreased $24.3 million, or 20.4%, to $94.6 million during the first quarter of 2009 compared to $118.9 million during the first quarter of 2008. The lower sales were driven by weaker volume of $32.0 million as customers took significant downtime to reduce inventories, and unfavorable foreign exchange translation of $2.0 million partially offset by higher selling prices of $9.7 million. Net sales for the Paper and Carpet chemicals product line decreased to $61.9 million during the first quarter of 2009 compared to $77.6 million during the first quarter of 2008. Net sales for the Specialty Chemicals product line decreased to $32.7 million during the first quarter of 2009 compared to $41.3 million during the first quarter of 2008.

This segment generated an operating profit of $7.8 million in the first quarter of 2009 compared to $2.6 million in the first quarter of 2008. The increase in segment operating profit was primarily due to lower raw material costs of $2.1 million, improved pricing of $9.7 million and lower other manufacturing costs of $0.5 million partially offset by lower volumes of $7.0 million. The segment operating profit also includes items which management excludes when evaluating the results of the Company's segments. Those items for the first quarter of 2009 include workforce reduction costs of $0.1 million.

Decorative Products

Decorative Products net sales decreased $6.1 million, or 8.5%, to $65.6 million in the first quarter of 2009 from $71.7 million in the first quarter of 2008 primarily due to lower volumes of $16.2 million, and unfavorable foreign exchange translation of $3.7 million, partially offset by improved pricing of $1.4 million. The Asian businesses generated net sales of $20.6 million in the first quarter of 2009 compared to $8.1 million in the first quarter of 2008. The first quarter of 2008 includes one month of consolidated sales from the Asian businesses, which were acquired in January 2008, while the first quarter of 2009 includes three months of consolidated sales. Contract Interiors net sales were $22.1 million in the first quarter of 2009 compared to $31.5 million in the first quarter of 2008. Net sales for the Coated Fabrics product line, excluding the Asian businesses, decreased to $12.7 million during the first quarter of 2009 compared to $16.9 million during the first quarter of 2008. Net sales for the Laminates product line decreased to $10.2 million during the first quarter of 2009 compared to $15.2 million during the first quarter of 2008.

The segment operating loss was $2.9 million for the first quarter of 2009 compared to $0.1 million for the first quarter of 2008. The higher operating loss was primarily due to lower volumes of $4.3 million, higher manufacturing absorption and overhead costs of $1.1 million, and higher utility costs of $0.3 million, partially offset by higher pricing of $1.4 million, lower raw materials of $1.2 million, improved results at the Asian operations of $0.9 million and a LIFO inventory reserve adjustment of $0.1 million. The segment operating profit also includes items which management excludes when evaluating the results of the Company's segments. Those items for the first quarter of 2009 include workforce reduction costs of $0.7 million.

Corporate

Interest expense decreased to $2.2 million during the first quarter of 2009 from $3.4 million in the first quarter of 2008. The decrease is due to lower average interest rates.

Corporate expenses were $2.6 million in the first quarter of 2009 compared to $2.0 million in the first quarter of 2008. Included in the first quarter of 2009 are restructuring and severance expenses of $0.1 million. Included in 2008 is a gain of $0.4 million related to a settlement with an insurer.

The Company recorded tax expense of $0.2 million in the first quarter of 2009 and $0.1 million in the first quarter of 2008. The expense in both 2009 and 2008 was primarily due to foreign taxes.

Financial Resources and Capital Spending

The following table reflects key cash flow measures from continuing operations:



                                                              Quarters Ended
                                                     February 28,        February 29,
(Dollars in millions)                                    2009                2008            Change
Cash provided by (used in) operating activities      $        13.5       $       (13.5 )     $  27.0
Cash (used in) provided by investing activities      $        (1.4 )     $       (28.1 )     $  26.7
Cash (used in) provided by financing activities      $       (13.9 )     $        43.2       $ (57.1 )
(Decrease) Increase in cash and cash equivalents     $        (2.1 )     $         2.2       $  (4.3 )

Cash provided by operating activities was $13.5 million in the first quarter of 2009, compared to cash used of $13.5 million in the first quarter of 2008. The change in 2009 was primarily due to a decrease in working capital and improved operating results. Days Sales Outstanding ("DSO") were 49.7 days at February 28, 2009 compared to 46.2 days at February 29, 2008. The increase was primarily due to the addition of the Decorative Products Asian businesses and extended terms at several customers.

In the first quarter of 2009, $1.4 million was used for investing activities, as compared to $28.1 million in the first quarter of 2008. Included in the first quarter of 2008 is the acquisition of the Decorative Products Asian businesses for $28.0 million which was funded through borrowings under the revolving credit facility. The first three months of 2009 includes $1.4 million for capital expenditures compared to $3.1 million in the first three months of 2008. Capital expenditures were made and are planned principally for asset replacement, new product capability, cost reduction, safety and productivity improvements and environmental protection. The Company anticipates capital expenditures in 2009 to be approximately $12 - $14 million. The Company plans to fund substantially all of its capital expenditures from anticipated cash flow generated from operations during the remainder of the year. If necessary, a portion of capital expenditures can be funded through borrowings under its credit facility, which has $37.9 million available for future borrowings as of February 28, 2009.

Cash used in financing activities in the first quarter of 2009 of $13.9 million was primarily related to payments on borrowings under the revolving credit facility. Cash provided by financing activities in the first quarter of 2008 was $43.2 million which was primarily related to borrowings under the revolving credit facility used to fund the purchase of the Decorative Products Asian businesses and seasonal working capital usage. Total debt was $174.1 million as of February 28, 2009, $188.3 million as of November 30, 2008 and $196.6 million as of February 29, 2008.

Long-Term Debt

The Company's long-term debt consists of the following:



                                                                   Three Months Ended
                                                            February 28,       November 30,
(Dollars in millions)                                           2009               2008
Senior Revolving Credit Facility (interest at 1.7%)        $         26.0     $          39.7
Term Loan B (interest at 3.0% - 7.7%)                               143.5               143.9

                                                                    169.5               183.6
Less: current portion                                                 1.5                 1.5

Total long-term debt                                       $        168.0     $         182.1

On May 22, 2007, the Company entered into a $150 Million Term Loan Credit Agreement due May 2014. The Term Loan carries a variable interest rate based on, at the Company's option, either an alternate base rate or a eurodollar rate, in each case plus an applicable margin. The alternate base interest rate is a fluctuating rate equal to the higher of the Prime Rate or the sum of the Federal Funds Effective Rate plus 0.50%. The applicable margin for the alternate base rate is 1.50%. The eurodollar rate is a periodic fixed rate equal to the London Inter Bank Offered Rate ("LIBOR"). The applicable margin for the eurodollar rate is 2.50%. Annual principal payments consist of $1.5 million, due in quarterly installments, and annual excess free cash flow payments as defined in the Term Loan agreement, with any remaining balance to be paid May 2014. The Company can prepay any amount at any time without penalty upon proper notice and subject to a minimum dollar requirement. Prepayments will be applied towards any required annual excess free cash flow payment. The Term Loan is secured by all real property and equipment of the Company's domestic facilities and stock and equity investments of the Company's non-domestic subsidiaries. The Term Loan contains affirmative and negative covenants, including limitations on additional debt, certain investments and acquisitions outside of the Company's line of business. The Term Loan requires the Company to maintain a net leverage ratio of less than 5.5 to 1. At February 28, 2009, the Company was in compliance with this requirement with a ratio of 3.4 to 1. The Term Loan also requires the Company to maintain an interest rate swap with a notional amount of at least $50 million. Additionally, the Term Loan provides for additional borrowings of the greater of $75 million or an amount based on a senior secured leverage ratio, as defined in the Term Loan, provided that certain requirements are met including an interest coverage ratio. The Company has not utilized these additional borrowings as of February 28, 2009.

On May 31, 2007, the Company entered into a 5 year fixed rate interest rate swap agreement totaling $50 million to convert a portion of the outstanding Term Loan from variable to fixed rates. Under this agreement, the Company will pay a fixed rate of 5.23% and receive a variable rate based on LIBOR effectively converting a portion of its variable rate Term Loan to a fixed rate of 7.73%. The variable rates on the interest rate swap and $50 million of the Term Loan are reset every three months on the same base rate and same date, at which time the interest will be settled and will be recognized as adjustments to interest expense. As of February 28, 2009 and November 30, 2008, the unrealized loss of the swap was $3.9 million and $3.7 million, respectively.

In connection with the Term Loan, on May 22, 2007 the Company amended its Senior Secured Revolving Credit Facility ("Facility"). The Facility was increased to $80 million from $72 million and extended until May 2012. In January 2008, the Facility was increased to $90 million. The Facility is secured by domestic accounts receivable, inventory (collectively the "Eligible Borrowing Base") and intangible assets. Availability under the Facility will fluctuate depending on the Eligible Borrowing Base and is determined by applying customary advance rates to the Eligible Borrowing Base. The Facility includes a $15 million sublimit for the issuance of commercial and standby letters of credit and a $10 million sublimit for swingline loans. The Facility contains affirmative and negative covenants, similar to the Term Loan, including limitations on additional debt, certain investments and acquisitions outside of the Company's line of business. If the average excess availability of the Facility falls below $20 million during any fiscal quarter, the Company must then maintain a fixed charge coverage ratio greater than 1.1 to 1 as defined in the agreement. The Company was in compliance with this requirement and the fixed charge coverage ratio was 2.7 to 1 for the first quarter of 2009. The Company may request an additional increase in available borrowings under the Facility of up to $10 million (for a maximum of $100 million) upon satisfaction of certain requirements.

Advances under the Facility bear interest, at the Company's option, at either an alternate base rate or a eurodollar rate, in each case plus an applicable margin. The alternate base interest rate is a fluctuating rate equal to the higher of the Prime Rate or the sum of the Federal Funds Effective Rate plus 0.50%. The applicable margin for the alternate base rate will vary from 0.0% to 0.25% depending on the Company's fixed charge coverage ratio and the margin was 0.0% at February 28, 2009. The eurodollar rate is a periodic fixed rate equal to LIBOR. The applicable margin for the eurodollar rate will vary from 1.25% to 2.0% depending on the Company's fixed charge coverage ratio and the margin was 1.25% at February 28, 2009.

The Facility requires a commitment fee based on the unused portion of the Facility. The commitment fee will vary from 0.125% to 0.25% based on the Company's fixed charge coverage ratio and was 0.125% at February 28, 2009.

At February 28, 2009, the Company had $72.2 million of eligible inventory and receivables to support the eligible borrowing base which is capped at $90.0 million under the Facility. At February 28, 2009, outstanding letters of credit were $3.3 million, the interest rate swap reserve was $5.0 million, amounts borrowed under the Facility were $26.0 million and the amount available for borrowing under the Facility was $37.9 million.

Significant Accounting Policies and Management Judgments

The Company's discussion and analysis of its results of operations, financial condition and liquidity are based upon the Company's consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires the Company to make estimates and judgments that affect the amounts of assets and liabilities, revenues and expenses and disclosure of contingent assets and liabilities as of the date of the financial statements. Periodically, the Company reviews its estimates and judgments including those related to product returns, accounts receivable, inventories, warranty obligations, litigation and environmental reserves, pensions and income taxes. The Company bases its estimates and judgments on historical experience and on various assumptions that it believes to be reasonable under the circumstances. Actual results may differ materially from these estimates and judgments under different assumptions.

Except as described below, information with respect to the Company's significant accounting policies and management judgments which the Company believes could have the most significant effect on the Company's reported results and require subjective or complex judgments by management is contained in Management's Discussion and Analysis of Financial Condition and Results of Operations of the Company's Annual Report on Form 10-K for the year ended November 30, 2008, as filed with the SEC. The Company has not made any changes in estimates or judgments that have had a significant effect on the reported amounts.

Effective December 1, 2008, the Company adopted the measurement provisions of SFAS No. 158, which requires that assets and obligations of defined benefit and other post-retirement plans be measured as of the year-end balance sheet date. As a result, the Company will move its measurement date from August 31 to November 30. The Company's net periodic cost (income) during 2009 for its plans is estimated based on the August 31, 2008 measurement, as prescribed by SFAS No. 158, and accordingly, the Company did not remeasure its plan assets or obligations at December 1, 2008.

Based on current pension asset performance, interest rate, discount rate assumptions and credit balance, the Company does not anticipate making cash contributions to the pension fund during fiscal 2009. However, based on estimated asset balances and discount rates at November 30, 2009, the Company expects to begin making cash contributions to the pension fund in 2010.

Environmental Matters

The Company's policy is to conduct its businesses with due regard for the preservation and protection of the environment. The Company devotes significant resources and management attention to comply with environmental laws and regulations. The Company's Consolidated Balance Sheet as of February 28, 2009 reflects an accrual for environmental remediation of $0.4 million. The Company's estimates are subject to change and actual results may materially differ from the Company's estimates. Management believes, on the basis of presently available information, that resolution of known environmental matters will not materially affect liquidity, capital resources or the consolidated financial condition of the Company.

Employee Matters

The Company employs 2,462 employees at offices, plants and other facilities located principally throughout the United States, United Kingdom, China and Thailand. The Company believes its relationship with employees is good. Approximately 17% or 421 of the Company's employees are covered by collective bargaining agreements in the United States. The Company has reduced its global employment by 7% or 185 positions since December 1, 2008, and 12.5% or 351 positions since February 28, 2008.

New Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business . . .