Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

The Company's order rates and results of operations for the first nine months of 2012 continue to be adversely impacted by economic conditions and the related impact on tax receipts and budgeted expenditures for public schools. Uncertainty related to the recent presidential and congressional election, proposed state and local tax legislation, structural budget challenges, and a "fiscal cliff" has coincided with a downturn in order rates. Publicly-funded entities continue to suffer serious budget challenges. Reduced tax revenues and structural spending deficits have proven difficult to correct, with the result that many of our largest and most stable public school customers have been forced to reduce their day-to-day expenditures for replacement furniture. In addition to challenged operating budgets at schools, completions of bond funded projects have declined.

Order rates for the three month period ended October 31, 2012 declined by 11% compared to the same period last year. However, because the third quarter is a relatively slow period compared to our seasonally higher first and second quarters, and because order rates for six months ended July 31, 2012 were flat compared to the same period last year, order rates for the first nine months of 2012 only declined by 2.6% compared to the same period last year. We are cautiously hopeful that the decline in third quarter order activity reflects uncertainty related to the election and the "fiscal cliff" rather than continued budgetary constraints placed on our publicly funded schools.

As previously discussed in our Annual Report on Form 10-K dated January 31, 2012 (the "Form 10-K") and in prior quarterly reports, in the prior year the Company executed a restructuring plan, featuring a voluntary early retirement program. Approximately 150 employees accepted the offer, and coupled with attrition, the Company reduced its employee count by approximately 20% from 1,045 at February 1, 2011 to 825 at February 1, 2012. As part of the restructuring the Company pursued a strategy of more aggressive utilization of temporary labor during the seasonally busy summer months supported by a smaller permanent workforce. We have now concluded our first summer delivery season utilizing this new model. Spending for the first nine months of 2012 is approximately $7.7 million less than the same period last year and the Company continued to provide quality product and excellent service to our customers. In addition, we did this with reduced levels of inventory.

For the three months ended October 31, 2012, the Company earned a pre-tax profit of $2,757,000 on net sales of $56,642,000 compared to a pre-tax loss of $3,124,000 on net sales of $53,074,000 in the same period last year. These changes are due to the increase in net sales, increase in gross margin and decrease in selling, general and administrative expenses as described below.

Net sales for the three months ended October 31, 2012 increased by $3,568,000, a 6.7% increase, compared to the same period last year. This increase was the result of a modest increase in selling prices, combined with a small increase in unit volume. Incoming orders for the same period declined by approximately 11% compared to the prior year. Backlog at October 31, 2012 decreased by $7.3 million compared to the prior year.

Gross margin as a percentage of sales was 34.1% for the three months ended October 31, 2012 compared to 30.2% in the same period last year. The gross margin was favorably affected by a modest increase in selling prices and a reduction in factory spending related to prior year restructuring. Factory production rates for the quarter ended October 31, 2012 increased by nearly 2% compared to the prior year. When coupled with reduced levels of spending achieved by the prior year restructuring, manufacturing overhead decreased as a percentage of sales by more than 3%. Raw material costs were stable for the period.

Selling, general and administrative expenses for the three months ended October 31, 2012, decreased by approximately $2,701,000 compared to the same period last year. The decrease in selling, general and administrative expenses was attributable to $3,901,000 of expenses related to the prior year voluntary retirement program offset by increased variable freight costs, increased variable selling costs, and an increase in retirement plan expense. Interest expense increased modestly due to increased effective borrowing rates and bad debt declined modestly due to a reduced provision related to a bankruptcy.

For the nine months ended October 31, 2012, the Company earned a pre-tax profit of $5,199,000 on net sales of $140,702,000 compared to a pre-tax loss of $5,721,000 on net sales of $140,147,000 in the same period last year.

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Net sales for the nine months ended October 31, 2012 increased by $555,000, a 0.4% increase, compared to the same period last year. This increase was the result of an increase in selling prices, combined with a reduction in unit volume. Unit volume declined largely as a result of general economic conditions, which negatively impacted tax receipts and the funded status of public schools. Incoming orders for the same period decreased by approximately 2.6% compared to the prior year.

Gross margin as a percentage of sales improved to 34.9% for the nine months ended October 31, 2012 compared to 30.5% in the same period last year. The improvement in gross margin was attributable to an increase in selling prices and reduced factory spending. Factory production rates for the nine months ended October 31, 2012 decreased by nearly 3% compared to the prior year primarily due to the decline in order rates during the quarter. Although production levels dropped, reduced levels of spending achieved by the prior year restructuring resulted in manufacturing overhead decreasing as a percentage of sales by more than 3%.

Selling, general and administrative expenses for the nine months ended October 31, 2012 decreased by approximately $4,677,000 compared to the same period last year. The decrease in selling, general and administrative expenses was primarily attributable to the $3,901,000 of expenses related to the voluntary retirement program incurred in the prior year. Other reductions are attributable to the prior year restructuring, offset by increased freight expense, increased variable selling expense, and increased retirement plan expense. Interest expense increased modestly due to increased effective borrowing rates and bad debt declined modestly due to a reduced provision related to a bankruptcy.

During the fourth quarter of 2010 the Company established a valuation allowance on the majority of deferred tax assets. Because of this valuation allowance the effective income tax expense / (benefit) is expected to be relatively low, with income tax expense / (benefit) being primarily attributable to alternative minimum taxes combined with income and franchise taxes required by various states.

In response to the recent reduction in order rates and order backlog, the Company has taken several measures to reduce spending during the seasonally slow fourth quarter. Our permanent workforce, which numbered 825 at the beginning of the year, has been further reduced to 780. Additional measures include reduced workweeks, temporary reductions in compensation, and our traditional Holiday closures that mirror the days when schools are closed for Thanksgiving and Christmas vacations.

As we have throughout the recession and the ongoing period of economic challenge and uncertainty that has followed it, we continue to focus on ways to maintain the strength of our balance sheet and strengthen our brand. With respect to brand development, we are continuing the aggressive product development campaign that we launched eight years ago. In an effort to grow sales and increase market share, we continue to aggressively pursue all profitable business in our market and bring new products to market. The Company is accelerating efforts to increase sales to customers who purchase furniture and equipment through the General Services Administration (GSA). To supplement these efforts, we are increasing our efforts to penetrate the market for colleges and universities nationwide. The significant reduction in force in 2011 did not materially affect the size of our direct sales force, and we continue to develop and strengthen our relationships with distributors and resellers of our product.

One of our core strategies is to source as much product as possible from our own U.S. factories. During the last decade, many other manufacturers moved their operations offshore in an effort to reduce product costs. Over this same period, we elected instead to invest in automation, new products, and new service technologies rather than closing our domestic factories. We believe this approach may finally be yielding the financial performance benefits originally envisioned. Specifically, the shorter, better controlled supply chains of our own domestic factories allow us to offer a wider range of product choices with shorter lead times to support the rapidly-evolving environments of 21st century campuses and classrooms.

Liquidity and Capital Resources
Interest expense increased by approximately $208,000 for the nine months ended October 31, 2012, compared to the same period last year. The increase was primarily due to fluctuations in loan balances and higher effective interest rates under the Company's credit facility with PNC Bank.
Accounts receivable was slightly higher at October 31, 2012 than at October 31, 2011, due to increased sales. The Company traditionally builds large quantities of inventory during the first and second quarters of each fiscal year in anticipation of seasonally high summer shipments. In an effort to utilize inventory more efficiently and balance inventory with customer demand, the Company reduced inventory levels by $7,580,000 in 2011 and deferred the increase in production levels for the current year until the second quarter. As a result of these efforts the Company operated with decreased levels of inventory for the first nine months. For the balance of the current year, the Company intends to continue to aggressively control inventory

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levels. At the end of the third quarter, inventory decreased by approximately $2,247,000 compared to January 31, 2012 and by $4,567,000 compared to October 31, 2011. The seasonal fluctuation in inventory levels (including the typically large buildup in inventory during the first and second quarters) was financed through the Company's credit facility with PNC Bank.
Borrowings under the Company's revolving line of credit with PNC Bank at October 31, 2012 decreased by approximately $9,698,000 compared to January 31, 2012 and by $3,605,000 compared to October 31, 2011, primarily due to decreased levels of inventory. The Company established a goal of limiting capital spending to less than $3,000,000 for fiscal year 2012, which is less than the Company's anticipated depreciation expense. Capital spending for the nine months ended October 31, 2012 was $1,486,000 compared to $1,689,000 for the same period last year. Capital expenditures are being financed through the Company's credit facility with PNC Bank and operating cash flow.
Net cash provided by operating activities for the nine months ended October 31, 2012, was $9,571,000 compared to $3,421,000 for the same period last year. The increase in cash provided was primarily attributable to an increase in the pre-tax profit for the first nine months of 2012, and a reduction in the amount of cash generated as a result of reducing inventory levels.
The Company has historically relied upon its cash flows from operations and unused borrowing capacity with PNC Bank (which was $11,757,000 as of October 31, 2012) to fund the Company's debt service requirements, capital expenditures and working capital needs. As of October 31, 2012, the Company was in violation of the financial covenants in the Credit Agreement with respect to its minimum tangible net worth and minimum EBITDA amount for the relevant period ending October 31, 2012. However, on December 6, 2012 the Company entered into Amendment No. 4 (Amendment No. 4) to the Credit Agreement, which waived the violation of the minimum EBITDA and minimum tangible net worth covenants at October 31, 2012 and eliminated the minimum EBITDA covenant at November 30, 2012.
The Company believes that cash flows from operations, together with the Company's unused borrowing capacity with PNC Bank will be sufficient to fund the Company's debt service requirements, capital expenditures and working capital needs for the next twelve months.

Off Balance Sheet Arrangements
During the nine months ended October 31, 2012, there were no material changes in the Company's off balance sheet arrangements or contractual obligations and commercial commitments from those disclosed in the Company's Form 10-K.

Critical Accounting Policies and Estimates The Company's critical accounting policies are outlined in its Form 10-K. There have been no changes in the nine months period ended October 31, 2012.

Forward-Looking Statements
From time to time, including in this Quarterly Report on Form 10-Q for the quarterly period ended October 31, 2012, the Company or its representatives have made and may make forward-looking statements, orally or in writing, including those contained herein. Such forward-looking statements may be included in, without limitation, reports to stockholders, press releases, oral statements made with the approval of an authorized executive officer of the Company and filings with the Securities and Exchange Commission. The words or phrases "anticipates," "expects," "will continue," "believes," "estimates," "projects," or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The results contemplated by the Company's forward-looking statements are subject to certain risks and uncertainties that could cause actual results to vary materially from anticipated results, including without limitation, availability of funding for educational institutions, material availability and cost of materials, especially steel and plastic, available financing sources, the terms and conditions of future financing sources, the acceleration of the debt under the Company's existing credit facility with PNC Bank, availability and cost of labor, demand for the Company's products, competitive conditions affecting selling prices and margins, capital costs and general economic conditions. Such risks and uncertainties are discussed in more detail in the Company's Form 10-K. The Company's forward-looking statements represent its judgment only on the dates such statements were made. By making any forward-looking statements, the Company assumes no duty to update them to reflect new, changed or unanticipated events or circumstances.