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 manufacturing facilities located 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 over the holidays.

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.

Effective March 2009, the Company realigned product lines in its Decorative Products segment to integrate cross-functional business team structures. The Contract Interiors and Coated Fabrics lines were combined into the Commercial Wallcovering and Coated Fabrics product line and performance film products were moved from Coated Fabrics and combined with Laminates products into the Decorative Laminates and Performance Films product line. All prior period amounts have been reclassified to conform to current year presentation.

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 and residential construction and refurbishment, 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 and Six Months Ended May 31, 2009 Compared to the Three and Six Months Ended May 31, 2008

The Company's net sales in the second quarter of 2009 were $161.3 million compared to $219.7 million in the second quarter of 2008. The Company's Performance Chemicals business segment revenue decreased by 30.5% while the Decorative Products business segment revenue decreased 21.4%. Contributing to the sales decrease in 2009 were net volume declines of $37.5 million as a result of weak market conditions, lower pricing of $14.9 million as a result of declining raw material costs and unfavorable foreign exchange translation of $6.0 million.

The Company's net sales in the first half of 2009 were $321.5 million compared to $410.3 million in the first half of 2008. The Company's Performance Chemicals business segment revenue decreased by 25.6% while the Decorative Products business segment revenue decreased 15.8%. Contributing to the sales decrease in 2009 were volume declines of $85.7 million, unfavorable foreign exchange translation of $11.7 million and lower pricing of $3.8 million, partially offset by 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 half of 2008 includes four months of consolidated sales while the first half of 2009 includes six months of consolidated sales.

Gross profit in the second quarter of 2009 was $40.0 million with a gross profit margin of 24.8% compared to gross profit of $33.8 million and a gross profit margin of 15.4% in the second quarter of 2008. The improved margin was primarily due to lower costs for raw materials and a reduction in manufacturing costs. Gross profit for the second quarter 2009 includes a pension plan curtailment charge of $0.7 million.

Gross profit in the first half of 2009 was $71.7 million with a gross profit margin of 22.3% compared to gross profit of $64.3 million and a gross profit margin of 15.7% in the first half of 2008. The improved margin was primarily due to lower costs for raw materials and a reduction in manufacturing and cost variances, partially offset by the pension plan curtailment charge.

Selling, general and administrative expense in the second quarter of 2009 was $25.7 million, or 15.9% of sales compared to $27.5 million, or 12.5% of net sales, in the second quarter of 2008. The decrease was primarily due to cost saving initiatives and a pension plan curtailment gain of $1.4 million.

Selling, general and administrative expense was $48.6 million, or 15.1% of sales in the first half of 2009 compared to $52.6 million, or 12.8% of net sales, in the first half of 2008. The decrease was primarily due to lower employee costs and other cost saving initiatives and the pension plan curtailment gain of $1.4 million. Included in the first half of 2008 is a gain of $0.6 million related to a settlement with an insurer.

Interest expense was $2.0 million and $3.5 million for the second quarters of 2009 and 2008, respectively and $4.2 million and $6.9 million for the first half of 2009 and 2008, respectively. The decrease in both the second quarter and first six months of 2009 was due to lower average debt levels and significantly lower average interest rates. Total debt at May 31, 2009 was $156.6 million, down $31.7 million from November 30, 2008.

Other expense was $0.2 million in the second quarter of 2009 compared to income of $0.7 million in the second quarter of 2008. Included in 2009 are asset write-offs of $0.7 million. Other expense was $0.2 million in the first half of 2009 compared to income of $1.2 million in the first half of 2008. The change is primarily due to the asset write-off of $0.7 million.

Income tax expense was $0.5 million in the second quarter of 2009 and $0.7 million in the first half of 2009, compared to $0.2 million in the second quarter of 2008 and $0.3 million in the first half of 2008. Income tax expense is primarily related to foreign income taxes. No domestic federal tax provision was provided in either the first six months of 2009 or 2008 due to the company's net operating loss carryforwards. Valuation allowances have been provided for deferred tax assets in the U.S. and U.K. 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.

For the second quarter, the Company had net income of $5.1 million or $0.12 per diluted share in 2009 compared to a net loss of $3.1 million or $0.07 per diluted share in 2008. For the first six months, the Company had net income of $5.0 million or $0.12 per diluted share in 2009 compared to a net loss of $6.1 million or $0.14 per diluted share in 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           Six Months Ended
                                                           May 31,                     May 31,
(Dollars in millions)                                2009           2008          2009         2008
Segment Sales:
Performance Chemicals
Paper and Carpet Chemicals                         $    52.0       $  79.8      $  113.9      $ 157.4
Specialty Chemicals                                     35.0          45.4          67.7         86.7

Total Performance Chemicals                        $    87.0       $ 125.2      $  181.6      $ 244.1

Decorative Products
Commercial Wallcovering and Coated Fabrics         $    52.0       $  67.0      $  101.5      $ 116.9
Decorative Laminates and Performance Films              22.3          27.5          38.4         49.3

Total Decorative Products                          $    74.3       $  94.5      $  139.9      $ 166.2

Consolidated Net Sales                             $   161.3       $ 219.7      $  321.5      $ 410.3


Segment Gross Profit:
Performance Chemicals                              $    23.9       $  12.7      $   42.1      $  25.8
Decorative Products                                     16.1          21.1          29.6         38.5

Consolidated Gross Profit                          $    40.0       $  33.8      $   71.7      $  64.3


Segment Operating Profit:
Performance Chemicals                              $    11.4       $   1.9      $   19.2      $   4.5
Decorative Products                                       .2           1.1          (2.7 )        1.0
Interest expense                                        (2.0 )        (3.5 )        (4.2 )       (6.9 )
Corporate expense                                       (4.0 )        (2.4 )        (6.6 )       (4.4 )

Consolidated Income (Loss) Before Income Tax       $     5.6       $  (2.9 )    $    5.7      $  (5.8 )

Performance Chemicals

Performance Chemicals' net sales decreased $38.2 million, or 30.5%, to $87.0 million in the second quarter of 2009 compared to $125.2 million in the second quarter of 2008. The decrease in sales was driven by lower volume of $20.8 million due to weak market conditions, a reduction of selling prices of $15.6 million as a result of lower raw material costs and unfavorable foreign exchange translation of $1.8 million. Net sales for the Paper and Carpet chemicals product line decreased to $52.0 million during the second quarter of 2009 compared to $79.8 million during the second quarter of 2008. Net sales for the Specialty Chemicals product line decreased to $35.0 million during the second quarter of 2009 compared to $45.4 million during the second quarter of 2008.

This segment generated an operating profit of $11.4 million and segment operating profit margin of 13.1% in the second quarter of 2009 compared to $1.9 million and segment operating margin of 1.5% in the second quarter of 2008. The increase in segment operating profit was due to lower raw material costs of $27.4 million and improved manufacturing and other costs of $0.8 million, partially offset by lower pricing of $15.6 million, a reduction in volumes of $4.5 million and asset write-offs of $0.7 million. Included in the second quarter of 2009 is a reduction of the LIFO inventory reserve of $2.4 million and a net pension plan curtailment charge of $0.3 million.

Performance Chemicals' net sales decreased 25.6% to $181.6 million during the first half of 2009 compared to $244.1 million during the first half of 2008. The decrease in sales was driven by lower volumes of $52.8 million, a reduction in selling prices of $5.9 million and $3.8 million of unfavorable foreign exchange translation. Net sales for the Paper and Carpet chemicals product line decreased to $113.9 million during the first half of 2009 compared to $157.4 million during the first half of 2008. Net sales for the Specialty Chemicals product line decreased to $67.7 million during the first half of 2009 compared to $86.7 million during the first half of 2008.

This segment generated an operating profit of $19.2 million in the first half of 2009 compared to $4.5 million in the first half of 2008. The improvement in segment operating profit was due to a reduction in raw material costs of $26.9 million partially offset by lower volumes of $11.5 million, a reduction in selling prices of $5.9 million, asset write-offs of $0.7 million and favorable manufacturing and other costs of $1.3 million. Included in the first half of 2009 is a reduction of the LIFO inventory reserve of $5.0 million, a net pension plan curtailment charge of $0.3 million and restructuring and severance charges of $0.1 million.

Decorative Products

Decorative Products net sales decreased by 21.4% to $74.3 million in the second quarter of 2009 from $94.5 million in the second quarter of 2008 primarily due to lower volumes of $16.7 million and unfavorable foreign exchange translation of $4.2 million, partially offset by favorable pricing of $0.7 million. Commercial Wallcovering and Coated Fabrics net sales were $52.0 million during the second quarter of 2009 compared to $67.0 million in the second quarter of 2008. Net sales for the Decorative Laminates and Performance Films product line decreased to $22.3 million during the second quarter of 2009 compared to $27.5 million during the second quarter of 2008.

This segment generated operating profit of $0.2 million in the second quarter of 2009 compared to an operating profit of $1.1 million in the second quarter of 2008. The decrease was primarily due to lower volumes of $5.1 million, unfavorable manufacturing costs of $1.2 million and an increase in the LIFO inventory reserve of $0.1 million partially offset by lower raw material costs of $2.0 million, price increases of $0.7 million and improved profit at the Asian businesses of $2.9 million. The segment operating loss for 2009 also included restructuring and severance charges of $0.8 million due to workforce reductions and a pension plan curtailment gain of $0.7 million.

Decorative Products net sales decreased by 15.8% to $139.9 million in the first half of 2009 from $166.2 million in the first half of 2008 primarily due to lower volumes of $32.9 million and unfavorable foreign exchange translation of $7.9 million partially offset by $2.1 million of favorable pricing. The first six months of 2008 includes four months of consolidated sales from the Asian businesses, which were acquired in January 2008, while the first half of 2009 includes six months of consolidated sales. The additional two months of 2009 sales amounted to $12.4 million. Commercial Wallcovering and Coated Fabrics net sales were $101.5 million during the first half of 2009 compared to $116.9 million in the first half of 2008. Net sales for the Decorative Laminates and Performance Films product line decreased to $38.4 million during the first half of 2009 compared to $49.3 million during the first half of 2008.

The segment operating loss was $2.7 million for the first half of 2009 compared to operating profit of $1.0 million for the first half of 2008. The decrease was primarily due to lower volumes of $9.4 million and unfavorable manufacturing costs of $2.6 million partially offset by a reduction in raw material costs of $3.2 million, improved profit on Asian businesses of $3.8 million and higher pricing of $2.1 million. The segment operating profit for 2009 also included restructuring and severance charges of $1.5 million due to workforce reductions and a pension plan curtailment gain of $0.7 million.

Interest, Corporate and Taxes

Interest expense decreased to $2.0 million during the second quarter of 2009 from $3.5 million in the second quarter of 2008. Interest expense for the first half of 2009 decreased to $4.2 million from $6.9 million in the first half of 2008. The decrease is due to lower average interest rates and a reduction of average debt levels.

Corporate expenses were $4.0 million in the second quarter of 2009 compared to $2.4 million in the second quarter of 2008. For the first six months, corporate expenses were $6.6 million in 2009 compared to $4.4 million in 2008. The change in 2009 is primarily due to higher non-cash compensation expense as a result of the increase in the Company's stock price and the achievement of certain operating results metrics. Included in the first half of 2008 is a gain of $0.4 million related to a settlement with an insurer. Included in the first half of 2009 are restructuring and severance expenses of $0.1 million and a pension plan curtailment gain of $0.3 million.

The Company recorded tax expense of $0.5 million in the second quarter of 2009 and $0.2 million in the second quarter of 2008. The Company recorded tax expense of $0.7 million in the first half of 2009 and $0.3 million in the first half of 2008. The tax expense recorded in both 2009 and 2008 was primarily due to foreign taxes.

Pension Matters

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, 2009 to November 30, 2009. 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.

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 current estimates for asset balances and discount rates at November 30, 2009, the Company expects to begin making significant cash contributions to the pension fund in 2010.

During the second quarter of 2009, with an effective date of June 1, 2009 for salaried employees and August 1, 2009 for its Mogadore, Ohio union employees, the Company suspended the accrual of future service benefits under its Consolidated Pension Plan. All benefits earned by affected employees through the effective dates are or will become fully vested with the affected employees eligible to receive benefits upon retirement, as described in the Plan document. As a result, the Company recognized a net curtailment gain of $0.7 million. As required under SFAS No. 158, the Company will perform a measurement of the Plan's assets and liabilities as of June 1, 2009. As a result of the remeasurement, the Company estimates that it will recognize an increase to pension plan liabilities of $54.0 million with a corresponding reduction in equity. Additionally, the Company estimates that pension expense will decrease by approximately $0.8 million for the second half of 2009.

Financial Resources and Capital Spending

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



                                                      Six Months Ended
                                                           May 31,
  (Dollars in millions)                               2009         2008        Change
  Cash provided by (used in) operating activities   $   39.3      $ (14.7 )    $  54.0
  Cash (used in) provided by investing activities   $   (3.1 )    $ (31.9 )    $  28.8
  Cash (used in) provided by financing activities   $  (31.5 )    $  44.6      $ (76.1 )
  Increase in cash and cash equivalents             $    6.3      $    .5      $   5.8

Cash provided by operating activities was $39.3 million in the first half of 2009, compared to cash used of $14.7 million in the first half of 2008. The increase in 2009 was primarily due to a decrease in working capital, including inventories and receivables, and the Company's improved operating results. During the first six months of 2009, receivables decreased $25.2 million and inventories decreased $10.8 million, primarily due to lower volumes and raw material costs. Days Sales Outstanding ("DSO") were 50.1 days at May 31, 2009 compared to 46.0 days at May 31, 2008. The increase was primarily due to extended terms provided to customers.

In the first half of 2009, $3.1 million was used for investing activities, as compared to $31.9 million in the first half of 2008. Included in the first half 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 half of 2009 includes $3.1 million for capital expenditures compared to $6.9 million in the first half of 2008. Capital expenditures are made for asset replacement, new product capability, cost reduction, safety and productivity improvements and environmental protection. 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 $46.4 million available for future borrowings as of May 31, 2009.

Cash used in financing activities in the first half of 2009 of $31.5 million was primarily related to repayments of debt under the revolving credit facility. Cash provided by financing activities in the first half of 2008 was $44.6 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 of $156.6 million at May 31, 2009 decreased $31.7 million compared to the November 30, 2008 balance of $188.3 million.

Long-Term Debt

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



                                                        May 31,       November 30,
  (Dollars in millions)                                   2009            2008
  Senior Revolving Credit Facility (interest at 1.7%)   $    9.1      $        39.7
  Term Loan B (interest at 3.0% - 7.7%)                    143.1              143.9

                                                           152.2              183.6
  Less: current portion                                     (1.5 )             (1.5 )

  Total long-term debt                                  $  150.7      $       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 May 31, 2009, the Company was in compliance with this requirement with a ratio of 2.8 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 the senior secured leverage ratio, as defined in the Term Loan, provided certain requirements are met including an interest coverage ratio. The Company has not utilized these additional borrowings as of May 31, 2009.

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