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, medical and health care products 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 Nine Months Ended August 31, 2009 Compared to the Three and Nine Months Ended August 31, 2008

The Company's net sales in the third quarter of 2009 were $186.1 million compared to $239.5 million in the third quarter of 2008. The Company's Performance Chemicals business segment revenue decreased by 28.2%, while the Decorative Products business segment revenue decreased 13.1%. Included in the third quarter 2009 results are four months of financial results for the Decorative Products Asian businesses which were previously reported on a one-month lag, but are consolidated on a current basis beginning with the third quarter of 2009. This resulted in additional sales and segment operating profit of $8.0 million and $0.2 million, respectively. Contributing to the sales decrease in 2009 were net volume declines of $23.3 million as a result of weak market conditions, lower pricing of $34.8 million as a result of lower raw material costs and unfavorable foreign exchange translation of $3.3 million, partially offset by the Decorative Products Asian sales mentioned above.

The Company's net sales in the first nine months of 2009 were $507.6 million compared to $649.8 million in the first nine months of 2008. The Company's Performance Chemicals business segment revenue decreased by 26.6% while the Decorative Products business segment revenue decreased 14.8%. Contributing to the sales decrease in 2009 were volume declines of $109.0 million, lower pricing of $38.6 million and unfavorable foreign exchange translation of $15.0 million, which were partially offset by additional sales of $20.4 million from the Decorative Products Asian operations. The Decorative Products Asian operations were acquired on December 31, 2007. Net sales in the first nine months of 2009 includes ten months from the Decorative Products Asian operations as compared to the first nine months in 2008, which includes seven months.

Gross profit in the third quarter of 2009 was $44.0 million with a gross profit margin of 23.6% compared to gross profit of $39.1 million and a gross profit margin of 16.3% in the third quarter of 2008. The improved margin was primarily due to lower costs for raw materials and a reduction in manufacturing costs as a result of cost reduction initiatives and lower volumes.

Gross profit in the first nine months of 2009 was $115.7 million with a gross profit margin of 22.8% compared to gross profit of $103.3 million and a gross profit margin of 15.9% in the first nine months of 2008. The improved margin was primarily due to lower costs for raw materials and a reduction in manufacturing and cost variances as a result of cost reduction initiatives and lower volume. The Company expects volumes to improve gradually over the next four quarters. Included in gross profit for the first nine months of 2009 is a pension plan curtailment charge of $0.7 million.

Selling, general and administrative expense in the third quarter of 2009 was $25.7 million, or 13.8% of sales compared to $26.7 million, or 11.1% of net sales, in the third quarter of 2008. The decrease was primarily due to lower employee expenses and cost saving initiatives.

Selling, general and administrative expense was $74.3 million, or 14.6% of sales in the first nine months of 2009 compared to $79.2 million, or 12.2% of net sales, in the first nine months of 2008. The decrease was primarily due to lower employee costs, lower advertising expense and other cost saving initiatives and a pension plan curtailment gain of $1.4 million. Included in the first nine months of 2008 is a gain of $0.6 million related to a settlement with an insurer.

Interest expense was $2.0 million and $3.0 million for the third quarters of 2009 and 2008, respectively and $6.2 million and $9.9 million for the first nine months of 2009 and 2008, respectively. The decrease in both the third quarter and first nine months of 2009 was due to lower average interest rates and lower average debt levels. Total debt at August 31, 2009 was $144.6 million, down $43.7 million from November 30, 2008.

Other expense was $0.1 million in the third quarter of 2009 compared to income of $0.5 million in the third quarter of 2008. Included in 2009 are flood related costs of $0.6 million. Other expense was $0.3 million in the first nine months of 2009 compared to income of $1.7 million in the first nine months of 2008. The change is primarily due to an asset write-off of $0.7 million, flood related costs of $0.6 million and foreign exchange losses of $0.8 million.

Income tax benefit was $0.1 million in the third quarter of 2009 compared to expense of $0.2 million in the third quarter of 2008. Income tax expense was $0.6 million in the first nine months of 2009, compared to $0.5 million in the first nine months of 2008. Included in the third quarter and first nine months of 2009 is a tax benefit relating to a reversal of a previously recorded uncertain tax position of $0.3 million, offset by foreign, federal alternative minimum tax and state income tax expense. Income tax expense in the third quarter and first nine months of 2008 is primarily related to foreign income taxes. The company's effective tax rate of 3.9% in 2009 is lower than its statutory rate due to utilization of 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 losses in prior years. At present, the Company has $146.6 million of domestic federal net operating loss carryforwards that expire by 2025.

For the third quarter, the Company had net income of $10.1 million or $0.23 per diluted share in 2009 compared to $3.1 million or $0.07 per diluted share in 2008. For the first nine months, the Company had net income of $15.1 million or $0.35 per diluted share in 2009 compared to a net loss of $3.0 million or $0.07 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           Nine Months Ended
                                                         August 31,                   August 31,
(Dollars in millions)                                2009           2008          2009          2008
Segment Sales:
Performance Chemicals
Paper and Carpet Chemicals                         $    64.5       $  94.2      $   178.4      $ 251.6
Specialty Chemicals                                     39.9          51.3          107.6        138.0

Total Performance Chemicals                        $   104.4       $ 145.5      $   286.0      $ 389.6


Decorative Products
Commercial Wallcovering and Coated Fabrics         $    58.5       $  70.2      $   160.0      $ 187.1
Decorative Laminates and Performance Films              23.2          23.8           61.6         73.1

Total Decorative Products                               81.7          94.0          221.6        260.2

Consolidated Net Sales                             $   186.1       $ 239.5      $   507.6      $ 649.8


Segment Gross Profit:
Performance Chemicals                              $    25.3       $  21.7      $    67.4      $  47.5
Decorative Products                                     18.7          17.4           48.3         55.9

Consolidated Gross Profit                          $    44.0       $  39.1      $   115.7      $ 103.4


Segment Operating Profit:
Performance Chemicals                              $    14.8       $  10.5      $    34.0      $  15.0
Decorative Products                                       .6          (2.2 )         (2.0 )       (1.2 )
Interest expense                                        (2.0 )        (3.0 )         (6.2 )       (9.9 )
Corporate expense                                       (3.4 )        (2.0 )        (10.1 )       (6.4 )

Consolidated Income (Loss) Before Income Tax       $    10.0       $   3.3      $    15.7      $  (2.5 )

Performance Chemicals

Performance Chemicals' net sales decreased $41.1 million, or 28.2%, to $104.4 million in the third quarter of 2009 compared to $145.5 million in the third quarter of 2008. The decrease in sales was driven by lower selling prices of $35.3 million as a result of lower raw material costs, volume decreases of $4.5 million and unfavorable foreign exchange translation of $1.3 million. While volumes were weaker year-over-year, the Company has experienced higher volumes in the third quarter of 2009 compared to the second quarter of 2009 and expects volumes in the fourth quarter of 2009 to be higher than in the fourth quarter of 2008. Net sales for the Paper and Carpet chemicals product line decreased to $64.5 million during the third quarter of 2009 compared to $94.2 million during the third quarter of 2008. Net sales for the Specialty Chemicals product line decreased to $39.9 million during the third quarter of 2009 compared to $51.3 million during the third quarter of 2008.

This segment generated an operating profit of $14.8 million and segment operating profit margin of 14.2% in the third quarter of 2009 compared to $10.5 million and segment operating margin of 7.2% in the third quarter of 2008. The increase in segment operating profit was due to lower raw material costs of $40.6 million, partially offset by lower pricing of $35.3 million and a reduction in volumes of $1.6 million. Included in the third quarter of 2009 is an increase of the LIFO inventory reserve of $0.4 million.

Performance Chemicals' net sales decreased 26.6% to $286.0 million during the first nine months of 2009 compared to $389.6 million during the first nine months of 2008. The decrease in sales was driven by lower volumes of $57.3 million, lower selling prices of $41.2 million and $5.1 million of unfavorable foreign exchange translation. Net sales for the Paper and Carpet chemicals product line decreased to $178.4 million during the first nine months of 2009 compared to $251.6 million during the first nine months of 2008. Net sales for the Specialty Chemicals product line decreased to $107.6 million during the first nine months of 2009 compared to $138.0 million during the first nine months of 2008.

This segment generated an operating profit of $34.0 million in the first nine months of 2009 compared to $15.0 million in the first nine months of 2008. The improvement in segment operating profit was due to lower raw material costs of $67.5 million and favorable manufacturing and other costs of $1.2 million partially offset by a reduction in selling prices of $41.2 million, lower volumes of $13.1 million and asset write-offs of $0.7 million. Included in the first nine months of 2009 is a reduction of the LIFO inventory reserve of $4.6 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 13.1% to $81.7 million in the third quarter of 2009 from $94.0 million in the third quarter of 2008 primarily due to lower volumes of $10.8 million and unfavorable foreign exchange translation of $2.0 million, partially offset by favorable pricing of $0.5 million. Included in the third quarter 2009 results are four months of financial results for the Decorative Products Asian businesses which were previously reported on a one-month lag, but are consolidated on a current basis beginning with the third quarter of 2009. This resulted in additional sales and segment operating profit of $8.0 million and $0.2 million, respectively. Commercial Wallcovering and Coated Fabrics net sales were $58.5 million during the third quarter of 2009 compared to $70.2 million in the third quarter of 2008. Net sales for the Decorative Laminates and Performance Films product line were $23.2 million during the third quarter of 2009 compared to $23.8 million during the third quarter of 2008.

This segment generated operating profit of $0.6 million in the third quarter of 2009 compared to an operating loss of $2.2 million in the third quarter of 2008. The improvement was primarily due to lower raw material costs of $2.5 million, improved profit at the Asian businesses of $2.4 million, cost reductions and lower manufacturing costs of $1.4 million and price increases of $0.5 million, partially offset by lower volumes of $4.1 million. The segment operating profit for 2009 also included restructuring and severance charges of $0.3 million due to workforce reductions and included in 2008 were asset write-offs and facility closure expenses of $0.4 million.

Decorative Products net sales decreased by 14.8% to $221.6 million in the first nine months of 2009 from $260.2 million in the first nine months of 2008 primarily due to lower volumes of $51.7 million and unfavorable foreign exchange translation of $9.9 million partially offset by $2.6 million of favorable pricing and additional sales at the Decorative Products Asian businesses of $20.4 million. Commercial Wallcovering and Coated Fabrics net sales were $160.0 million during the first nine months of 2009 compared to $187.1 million in the first nine months of 2008. Net sales for the Decorative Laminates and Performance Films product line decreased to $61.6 million during the first nine months of 2009 compared to $73.1 million during the first nine months of 2008.

The segment operating loss was $2.0 million for the first nine months of 2009 compared to $1.2 million for the first nine months of 2008. The decrease was primarily due to lower volumes of $13.5 million, partially offset by improved profit on Asian businesses of $6.2 million, a reduction in raw material costs of $4.4 million, improved selling prices of $2.6 million and lower manufacturing costs of $0.8 million. The segment operating profit for 2009 also included flood-related costs of $0.6 million, restructuring and severance charges of $1.8 million due to workforce reductions and a pension plan curtailment gain of $0.7 million while 2008 includes restructuring and severance charges of $0.4 million due to asset write-offs and plant closure costs.

Interest, Corporate and Taxes

Interest expense decreased to $2.0 million during the third quarter of 2009 from $3.0 million in the third quarter of 2008. Interest expense for the first nine months of 2009 decreased to $6.2 million from $9.9 million in the first nine months of 2008. The decrease is due to lower average interest rates and average debt levels.

Corporate expenses were $3.4 million in the third quarter of 2009 compared to $2.0 million in the third quarter of 2008. For the first nine months, corporate expenses were $10.1 million in 2009 compared to $6.4 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 nine months of 2008 is a gain of $0.4 million related to a settlement with an insurer. Included in the first nine months of 2009 are restructuring and severance expenses of $0.1 million and a pension plan curtailment gain of $0.3 million.

The Company recorded a tax benefit of $0.1 million in the third quarter of 2009 and expense of $0.2 million in the third quarter of 2008. The third quarter of 2009 includes a $0.3 million reversal of a previously recognized tax position in Thailand, partially offset by foreign, federal AMT and state income taxes of $0.2 million. The Company recorded tax expense of $0.6 million in the first nine months of 2009 and $0.5 million in the first nine months of 2008. The tax expense recorded in 2008 was primarily due to foreign taxes. The Company's effective rate of 3.9% in 2009 is lower than its statutory rate due to utilization of the Company's net operating loss carryforwards.

Pension Matters

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 have become fully vested with the affected employees eligible to receive benefits upon retirement, as described in the Plan document. As a result, in the second quarter of 2009, the Company recognized a net curtailment gain of $0.7 million. As required under SFAS No. 158, the Company performed a measurement of the Plan's assets and liabilities as of June 1, 2009. As a result of the remeasurement, the Company recognized a non-cash adjustment increasing its pension liabilities and decreasing Accumulated Other Comprehensive Income by $53.0 million. Additionally, the Company estimates that pension expense will decrease by approximately $0.8 million for the second half of 2009.

Based on current estimates of pension asset performance, interest rate, discount rate assumptions and credit balance, the Company anticipates it will be required, under the Pension Protection Act of 2006, to make a contribution to its pension plan in the range of $5.0 million to $8.0 million in 2010.

Financial Resources and Capital Spending

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



                                                       Nine Months Ended
                                                           August 31,
   (Dollars in millions)                               2009          2008        Change

   Cash provided by (used in) operating activities   $    58.0      $  (6.9 )    $  64.9
   Cash (used in) provided by investing activities   $    (4.5 )    $ (36.3 )    $  31.8
   Cash (used in) provided by financing activities   $   (43.3 )    $  46.6      $  89.9
   Increase in cash and cash equivalents             $    12.2      $   3.8      $   8.4

Cash provided by operating activities was $58.0 million in the first nine months of 2009, compared to cash used of $6.9 million in the first nine months of 2008. The increase in 2009 was primarily due to a decrease in inventories and receivables, and the Company's improved operating results. During the first nine months of 2009, receivables decreased $17.0 million and inventories decreased $5.6 million, primarily due to lower volumes and raw material costs. Days Sales Outstanding ("DSO") were 50.0 days at August 31, 2009 compared to 47.7 days at August 31, 2008. The increase was primarily due to extended terms provided to customers.

In the first nine months of 2009, $4.5 million was used for investing activities, as compared to $36.3 million in the first nine months of 2008. Included in the first nine months 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 nine months of 2009 includes $5.4 million for capital expenditures compared to $11.1 million in the first nine months 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 $65.6 million available for future borrowings as of August 31, 2009.

Cash used in financing activities in the first nine months of 2009 of $43.3 million was primarily related to repayments of debt under the revolving credit facility. Cash provided by financing activities in the first nine months of 2008 was $46.6 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 $144.6 million at August 31, 2009 decreased $43.7 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:



                                                August 31,       November 30,
       (Dollars in millions)                       2009              2008

       Senior Revolving Credit Facility        $         -       $        39.7
       Term Loan B (interest at 2.8% - 7.7%)          142.7              143.9

                                                      142.7              183.6
       Less: current portion                           (1.5 )             (1.5 )

       Total long-term debt                    $      141.2      $       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 . . .