KIMBALL INTERNATIONAL INC - Quarter Report: 2008 December (Form 10-Q)

Business Overview

Kimball International, Inc. provides a variety of products from its two business segments: the Furniture segment and the Electronic Manufacturing Services (EMS) segment. The Furniture segment provides furniture for the office and hospitality industries, sold under the Company's family of brand names. The EMS segment provides engineering and manufacturing services which utilize common production and support capabilities globally to medical, automotive, industrial control, and public safety industries.  

Both of the Company's segments have been adversely impacted by the continued weakening in the global economy.  The Company experienced reduced order trends during its fiscal year 2009 second quarter ending December 31, 2008.  Open orders at December 31, 2008 were 16% lower in the EMS segment and 11% lower in the Furniture segment compared to the beginning of the second quarter.  

The EMS industry sales projection for calendar year 2009 (the average projection by IDC, iSuppli, and Technology Forecasters) is for growth of 3.2%.   Semiconductor sales, though, are expected to decline approximately 7% in calendar year 2009 representing declines in end market demand for products utilizing electronic components.  Generally, as electronics end markets decline, EMS industry sales improve as customers outsource a greater portion of their electronics manufacturing to free up capital for design and marketing programs and to gain cost advantages.  However, if customers elect to in-source a greater portion of their electronics manufacturing during this economic downturn, the EMS industry could see negative growth in calendar year 2009. 

The Company continues its strategy of diversification within the EMS segment customer base as it focuses on the four key vertical markets of medical, automotive, industrial control, and public safety.  The state of the automotive vertical market is the most uncertain at this time.  The Company expects the automotive demand to continue to decline but is uncertain as to how long and to what extent.  The industrial control vertical market is showing weakness due to the slowing of commercial activity along with reduced residential construction and remodeling.  The medical vertical market and the public safety vertical market both continue to send signals of strength.  Sales to customers in the medical industry are the largest portion of the Company's EMS segment with sales to customers in the automotive industry being the second largest. The Company's sales to customers in the automotive industry are diversified between more than ten domestic and foreign customers and represented approximately 29% of the EMS segment's net sales for the quarter ended December 31, 2008.  The amount of sales of electronic components that relate to General Motors, Ford, and Chrysler automobiles sold in North America were approximately 11% of the Company's EMS segment net sales during the quarter ended December 31, 2008.

Within the Furniture segment, order volumes continue to tighten and decline in both the office furniture and hospitality furniture industries.  The Business and Institutional Furniture Manufacturer Association (BIFMA International) is projecting an approximate 10% year-over-year decline in the office furniture industry for calendar year 2009.  While the Company expects its contract office furniture brand to decline at a more rapid pace than its mid-market brand due to the project nature of the contract market, it cannot predict future overall office furniture order trends at this time due to the short lead time of orders and the volatility in the global economy.  The Company expects a continued decline in order rates for hospitality furniture also as hotel occupancy rates and per room revenue rates are declining on lower consumer spending.

Competitive pricing pressures within the EMS segment and on select projects within the Furniture segment continue to put pressure on the Company's operating margins.  In addition, demand for several of the Company's office furniture products which carry a lower profit margin is outpacing demand for other higher margin products, and the office furniture sales mix is thus shifting to a less profitable mix of products.

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The current economic conditions and the tightening of the credit markets have also increased the risk of uncollectible accounts and notes receivables.  Accordingly, the Company heightened its monitoring of  receivables and related credit risks during the quarter ended December 31, 2008.  The Company believes its accounts and notes receivables allowance for uncollectible accounts is adequate as of December 31, 2008.  Given the current market conditions and limited credit availability, the economy could decline further potentially requiring the Company to record additional allowances.

The Company is continually assessing its strategies in relation to the significant macroeconomic challenges including the instability in the financial markets, credit availability, and demand for products.  The Company implemented various initiatives during the fiscal year 2009 second quarter in response to the deteriorating market conditions including reducing operating costs, more closely scrutinizing customer and supply chain risk, and deferring and cancelling capital expenditures that are not immediately required to support customer requirements.  The Company will continue to closely monitor market changes and its liquidity in order to proactively adjust its operating costs, discretionary capital spending, and dividend levels as needed.

The Company continues to have a strong balance sheet which includes a minimal amount of long-term debt of $0.4 million and Share Owners' equity of $377.7 million.  The Company's short-term liquidity available, represented as cash, cash equivalents, and short-term investments plus the unused amount of the Company's revolving credit facility amounts to $110.6 million at December 31, 2008.

In addition to the above risks related to the current economic conditions, management currently considers the following events, trends, and uncertainties to be most important to understanding the Company's financial condition and operating performance:

Although the Company has seen recent moderate declines in the cost of some commodities, commodity and fuel prices are expected to be a challenge the Company will continue to address in the near term.

The Company currently has under-utilized capacity at select operations.

Globalization continues to reshape not only the industries in which the Company operates but also its key customers.

The nature of the electronic manufacturing services industry is such that the start-up of new programs to replace departing customers or expiring programs occurs frequently, and the new programs often carry lower margins. The success of the Company's EMS segment is dependent on the successful replacement of such customers or programs. Such changes usually occur gradually over time as old programs phase out of production while newer programs ramp up.

Successful execution of the Company's restructuring plans is critical to the Company's future performance. The success of the restructuring initiatives is dependent on accomplishing the plans in a timely and effective manner. A critical component of the restructuring initiatives is the transfer of production among facilities which contributed to some manufacturing inefficiencies and excess working capital. The Company's restructuring plans are discussed in the segment discussions below.

The EMS segment's operation in China started production in June 2007. The continued success of this start-up operation is critical for securing additional customers and increasing facility utilization.

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The increasingly competitive marketplace mandates that the Company continually re-evaluate its business models.

The regulatory and business environment for U.S. public companies requires that the Company continually evaluate and enhance its practices in the areas of corporate governance and management practices.

The Company's employees throughout its business operations are an integral part of the Company's ability to compete successfully, and the stability of its management team is critical to long-term Share Owner value.

To address these and other trends and events, the Company has taken, or continues to consider and take, the following actions:

As end markets dictate, the Company is continually assessing under-utilized capacity and developing plans to better utilize manufacturing operations, including shifting manufacturing capacity to lower cost venues as necessary. o   During the first quarter of fiscal year 2009, the Company approved a restructuring plan to consolidate production of select office furniture manufacturing departments.  The consolidation is expected to reduce manufacturing costs and excess capacity by eliminating redundant property and equipment, processes, and employee costs. o   During the fourth quarter of fiscal year 2008, the Company approved a plan to expand its European automotive electronics capabilities and to establish a European Medical Center of Expertise in Poznan, Poland. The Company presently has an operation in Poznan. The Company completed the move of production from Longford, Ireland, into the existing Poznan facility during the second quarter of fiscal year 2009.  As part of the plan, the Company will also consolidate its EMS facilities located in Bridgend, Wales, and Poznan into a new, larger facility in Poznan. o   In fiscal year 2008, the Company also completed the consolidation of U.S. manufacturing facilities within the EMS segment due to excess capacity resulting in the exit of two facilities.

To support diversification efforts, the Company has focused on both organic growth and acquisition activities. Acquisitions allow rapid diversification of both customers and industries served.

The Company has taken a number of steps to conform its corporate governance to evolving national and industry-wide best practices among U.S. public companies, not only to comply with new legal requirements, but also to enhance the decision-making process of the Board of Directors.

The preceding statements could be considered forward-looking statements under the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties including, but not limited to, a significant change in economic conditions, loss of key customers or suppliers, or similar unforeseen events.

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The following discussions are based on income from continuing operations and therefore exclude all income statement activity of the prior year discontinued operations.

Financial Overview - Consolidated

Second quarter fiscal year 2009 consolidated net sales were $327.6 million compared to the second quarter fiscal year 2008 net sales of $347.8 million, a 6% decrease which was due to decreased net sales in both the EMS segment and the Furniture segment. The Company recorded income from continuing operations for the second quarter of fiscal year 2009 of $8.2 million, or $0.22 per Class B diluted share, inclusive of after-tax restructuring charges of $0.7 million, or $0.02 per Class B diluted share. The second quarter fiscal year 2009 restructuring charges were primarily related to the European consolidation plan.  Second quarter fiscal year 2009 results also include two non-recurring income items: a $4.8 million after-tax gain, or $0.13 per Class B diluted share, related to the sale of a portion of the Company's undeveloped land holdings and timberlands; and $1.6 million of after-tax income, or $0.04 per Class B diluted share, for earnest money deposits retained by the Company resulting from the termination of the contract to sell the Company's Poland building and real estate. Second quarter fiscal year 2008 income from continuing operations was $4.2 million, or $0.11 per Class B diluted share, inclusive of after-tax restructuring charges of $0.4 million, or $0.01 per Class B diluted share. 

Net sales for the six-month period ended December 31, 2008, of $667.1 million were down 2% from net sales of $681.7 million for the same period of the prior year due to declines in both segments. Income from continuing operations for the six-month period ended December 31, 2008, totaled $10.4 million, or $0.28 per Class B diluted share, inclusive of $1.3 million, or $0.03 per Class B diluted share, of after-tax restructuring costs primarily related to the European consolidation plan; $4.8 million after-tax gain, or $0.13 per Class B diluted share, related to the sale of a portion of the Company's undeveloped land holdings and timberlands; and $1.6 million of after-tax income, or $0.04 per Class B diluted share, for earnest money deposits retained by the Company resulting from the termination of the contract to sell the Company's Poland building and real estate. Income from continuing operations for the six-month period ended December 31, 2007 totaled $10.8 million, or $0.29 per Class B diluted share, inclusive of $0.6 million, or $0.01 per Class B diluted share, of after-tax restructuring costs.

Consolidated gross profit as a percent of net sales declined 2.0 percentage points to 17.2% for the second quarter of fiscal year 2009 from 19.2% for the second quarter of fiscal year 2008. For the year-to-date period of fiscal year 2009 gross profit as a percent of net sales declined to 17.2% compared to 19.7% for the year-to-date period of fiscal year 2008. Both the EMS segment and the Furniture segment contributed to the declines as discussed in more detail in the segment discussions below.   

Consolidated selling and administrative costs for the three and six months ended December 31, 2008 declined 19% and 15%, respectively, compared to the three and six months ended December 31, 2007. The improvements were primarily related to benefits realized as a result of the previously announced restructurings; lower incentive compensation and certain employee benefit costs which are linked to Company profitability; lower sales and marketing incentive costs; and lower travel costs.  Partially offsetting these cost declines were increases in employee healthcare costs and bad debt expense. Additionally, during the second quarter and year-to-date period of fiscal year 2009, the Company recorded $2.2 million and $3.4 million, respectively, of favorable adjustments due to a reduction in its Supplemental Employee Retirement Plan (SERP) liability resulting from the normal revaluation of the liability to fair value compared to the $0.3 million and $0.2 million income, respectively, that was recorded in the second quarter and year-to-date period of fiscal year 2008. The result for the second quarter and year-to-date period was a favorable variance in selling and administrative costs of $1.9 million and $3.2 million, respectively.  The gain resulting from the reduction of the SERP liability that was recognized in selling and administrative costs was exactly offset by a decline in the SERP investment which was recorded in Other Income as non-operating income/(expense), and thus there was no effect on net earnings. The SERP investment is primarily comprised of employee contributions.

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Other General Income in the second quarter of fiscal year 2009 included the $8.0 million pre-tax gain on the sale of a portion of the Company's undeveloped land holdings and timberlands.  The gain was included in Unallocated Corporate in segment reporting.  The auction took place during November 2008. A portion of the land tracts sold via the auction were finalized during December 2008. The remainder of the land tracts sold via the auction have final closings scheduled to be complete in the Company's fiscal year 2009 third quarter with an estimated approximate additional pre-tax gain of $23 million. In addition, the Company had a conditional agreement to sell and lease back the facilities and real estate that house its current Poland operations. However, during the second quarter of fiscal year 2009, the buyer was unable to close the transaction.  As a result, the Company was entitled to retain approximately $1.9 million of the deposit funds held by the Company which was recorded as pre-tax income in Other General Income.  This income was recorded in the EMS segment. 

The Company recorded other expense of $3.9 million and $4.6 million during the three and six months ended December 31, 2008 compared to other income of $0.3 million and $2.6 million during the three and six months ended December 31, 2007, respectively. The aforementioned $1.9 million and $3.2 million variance in SERP investments contributed to the increased other expense. In addition, Other income/expense was unfavorably impacted by foreign currency movements when compared to the prior year which are partially offset by a favorable impact within operating income.  First quarter fiscal year 2008 other income also included $1.3 million pre-tax income relating to funds received as part of a Polish offset credit program for investments made in the Company's Poland operation.

The Company's effective tax rate of 34.4% for the six months ended December 31, 2008 was comparable to the rate for the six months ended December 31, 2007. The fiscal year 2009 rate was favorably impacted by a $0.9 million tax benefit related to its European operations and a $0.5 million adjustment to the research and development tax credit.  The effective tax rate for fiscal year 2009 was negatively impacted by losses generated in select foreign jurisdictions which have a lower tax rate.

Comparing the balance sheets as of December 31, 2008 to June 30, 2008, the Company's accounts receivable, inventory, and accounts payable balances all declined. The decrease in the Company's inventory balance is driven by a focus on managing working capital. At June 30, 2008, the Company's accounts payable and accounts receivable balances were high due to an agreement with select customers from which the Company also purchases materials that allowed the Company to extend accounts payable terms if those customers extended the timeframe in which they paid the Company. The Company's accounts payable balance also decreased since June 30, 2008 in relation to the declining inventory balances. The assets held for sale line increased as the tracts of undeveloped land holdings and timberlands that were auctioned in November 2008 for which the closings had not occurred as of December 31, 2008 have been classified as held for sale as of December 31, 2008.  The land was previously shown on the other assets line of the balance sheet. The increase in property and equipment is primarily due to the construction of the new EMS segment facility in Poland and other EMS segment manufacturing equipment. Accrued expenses as of December 31, 2008 declined when compared to June 30, 2008 primarily due to a significant portion of accrued bonus related to the prior year being paid, a reduction in the restructuring accrual and funding to the retirement trust occurring during the first half of fiscal year 2009. Borrowings under credit facilities increased since June 30, 2008 in order to fund short-term cash needs.

The variance in the additional paid-in capital and treasury stock lines was primarily attributable to the fulfillment of requests by Share Owners to convert approximately 876,000 shares from Class A shares to Class B shares. The decline in Accumulated Other Comprehensive Income (Loss) was related to the Company's derivative financial instruments. See Note 1 - Summary of Significant Accounting Policies of Notes to Condensed Consolidated Financial Statements for more information on Derivative Instruments and Hedging Activities.

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Results of Operations by Segment - Three and Six Months Ended December 31, 2008 Compared to Three and Six Months Ended December 31, 2007

Electronic Manufacturing Services Segment

During the first quarter of fiscal year 2009, the Company acquired privately-held Genesis Electronics Manufacturing of Tampa, Florida.  The acquisition supports the Company's growth and diversification strategy, bringing new customers in key target markets.  The operating results of this acquisition were included in the Company's consolidated financial statements beginning on September 1, 2008 and had an immaterial impact on the fiscal year-to-date 2009 financial results. See Note 2 - Acquisition of Notes to Condensed Consolidated Financial Statements for more information on the acquisition.

During the fourth quarter of fiscal year 2008, the Company approved a plan to expand its European automotive electronics capabilities and to establish a European Medical Center of Expertise in Poznan, Poland. The Company completed the move of production from Longford, Ireland, into the existing Poznan facility during the fiscal year 2009 second quarter. As part of the plan, the Company will also consolidate its EMS facilities located in Bridgend, Wales, and Poznan, Poland, into a new, larger facility in Poznan, which is expected to improve the Company's margins in the very competitive EMS market. The plan is being executed in stages with a projected completion date of December 2011. 

See Note 7 - Restructuring Expense of Notes to Condensed Consolidated Financial Statements for more information on restructuring charges.

Also during the fourth quarter of fiscal year 2008, the Company had signed a conditional agreement to sell and lease back the facilities and real estate that house its current Poland operations.  The Company planned to lease back the building until December 2011 at which time it will have completed the consolidation of its European operations into a newly constructed facility in Poland. The closing on the sale of the existing Poland facility was expected to occur before December 31, 2008. The buyer was unable to close the transaction. Pursuant to the agreement, the Company was entitled to retain approximately $1.9 million of the deposit funds held by the Company which was recorded as pre-tax other general income in the Company's second quarter of fiscal year 2009. The Company will continue to market the facilities and real estate.

EMS segment results were as follows:

	At or for the Three Months Ended				For the Six Months Ended
	December 31,				December 31,
	2008		2007	% Change	2008		2007	% Change
(Amounts in Millions)
Net Sales	$     166.9		$ 177.4	(6%)	$    349.8		$  355.4	(2%)
Income (Loss) from Continuing Operations	$       (0.7)		$   (2.1)	66%	$      (1.5)		$    (1.3)	(12%)
Restructuring Expense, net of tax	$         0.5		$     0.1		$        0.9		$      0.1
Open Orders	$     167.7		$ 179.3	(7%)

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Net sales to customers in the public safety industry were higher in the second quarter of fiscal year 2009 compared to last year while net sales to customers in the automotive and industrial control industries experienced double digit percentage declines compared to the prior year. Sales to customers in the medical industry declined slightly when compared to the second quarter of fiscal year 2008. The decreased EMS segment net sales for the first half of fiscal year 2009 as compared to the first half of fiscal year 2008 are due to decreased sales to customers in the automotive and industrial control industries more than offsetting increased sales to customers in the public safety and medical industry. Due to the contract nature of the Company's business, open orders at a point in time may not be indicative of future sales trends.

Second quarter and year-to-date fiscal year 2009 EMS segment gross profit as a percent of net sales declined 1.0 and 1.7 percentage points compared to the second quarter and year-to-date fiscal year 2008, respectively. The EMS segment gross profit decline is primarily related to lower volumes and the segment's European operations which are currently being consolidated into one facility.  Contractual customer price reductions on select products also negatively impacted gross profit.   Partially mitigating the lower margins are benefits the segment realized on the North American consolidation activities which were completed late in fiscal year 2008.

Despite the lower sales volumes and reduction in gross margins, the EMS segment reduced its net loss in the second quarter fiscal year 2009 compared to the prior year due to a 26% reduction in selling and administrative costs.  On a year-to-date basis, selling and administrative costs were reduced 21%. Costs for the three and six months ended December 31, 2008 as compared to the three and six months ended December 31, 2007 decreased in both absolute dollars and as a percent of net sales, and the improvement was primarily related to benefits realized from restructuring activities, reduced spending on travel, lower incentive compensation costs which are linked to Company profitability, and lower depreciation/amortization expense.

The restructuring expense recorded in the second quarter and year-to-date periods of fiscal year 2009 was primarily related to the European consolidation plan.

Other General Income for the second quarter of fiscal year 2009 included the aforementioned $1.9 million pre-tax, which equated to $1.6 million after-tax, amount retained due to the buyer being unable to close on the sale of the existing Poland building.

The year-to-date fiscal year 2008 income from continuing operations included $1.3 million of pre-tax, or $0.7 million after-tax, income relating to funds received as part of a Polish offset credit program for investments made in the Company's Poland operation.

Included in this segment are a significant amount of sales to Bayer AG affiliates which accounted for the following portions of consolidated net sales and EMS segment net sales:

	Three Months Ended		Six Months Ended
	December 31,		December 31,
	2008	2007	2008	2007
Bayer AG affiliated sales as a percent of consolidated net sales	10%	10%	11%	10%
Bayer AG affiliated sales as a percent of EMS segment net sales	20%	20%	22%	20%

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The nature of the electronic manufacturing services industry is such that the start-up of new customers and new programs to replace expiring programs occurs frequently. New customer and program start-ups generally cause losses early in the life of a program, which are generally recovered as the program matures and becomes established. This segment continues to experience margin pressures related to an overall excess capacity position in the electronics subcontracting services market.

Risk factors within this segment include, but are not limited to, general economic and market conditions, customer order delays, increased globalization, foreign currency exchange rate fluctuations, rapid technological changes, component availability, the contract nature of this industry, unexpected integration issues with acquisitions, and the importance of sales to large customers. The continuing success of this segment is dependent upon its ability to replace expiring customers/programs with new customers/programs. Additional risk factors that could have an effect on the Company's performance are contained in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2008.

Furniture Segment

During the first quarter of fiscal year 2009, the Company approved a restructuring plan to consolidate production of select office furniture manufacturing departments.  The consolidation is expected to reduce manufacturing costs and excess capacity by eliminating redundant property and equipment, processes, and employee costs.  The consolidation is expected to be substantially complete by the end of fiscal year 2009.  The Company estimates that the pre-tax charges related to the consolidation activities will be approximately $1.1 million, consisting of severance and other employee costs, property and equipment asset impairment, and other consolidation costs.

See Note 7 - Restructuring Expense of Notes to Condensed Consolidated Financial Statements for more information on restructuring charges.

Furniture segment results were as follows:

	At or for the Three Months Ended				For the Six Months Ended
	December 31,				December 31,
	2008		2007	% Change	2008		2007	% Change
(Amounts in Millions)
Net Sales	$       160.7		$     170.4	(6%)	$     317.3		$  326.3	(3%)
Income from Continuing Operations	$           4.0		$         5.8	(30%)	$         7.2		$    10.9	(34%)
Restructuring Expense, net of tax	$           0.2		$         0.2		$         0.3		$      0.3
Open Orders	$       111.1		$     111.5	(0%)

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Decreased net sales of office furniture and flat net sales of hospitality furniture resulted in a net sales decline in the Furniture segment for the second quarter of fiscal year 2009 compared to the second quarter of fiscal year 2008.  Price increases net of higher discounting contributed approximately $3.1 million to net sales during the second quarter of fiscal year 2009 when compared to the second quarter of fiscal year 2008. Second quarter fiscal year 2009 sales of newly introduced office furniture products which have been sold for less than twelve months approximated $7.1 million. For the fiscal year-to-date period, decreased net sales of office furniture more than offset increased net sales of hospitality furniture. Price increases net of higher discounting contributed approximately $6.4 million to net sales during the first half of fiscal year 2009 when compared to the first half of fiscal year 2008. Year-to-date fiscal year 2009 sales of newly introduced office furniture products which have been sold for less than twelve months approximated $15.1 million. Furniture products open orders at December 31, 2008 were similar to the open orders at December 31, 2007 due to increased hospitality furniture open orders offsetting a decline in office furniture open orders. Open orders at a point in time may not be indicative of future sales trends.

Second quarter fiscal year 2009 gross profit as a percent of net sales declined 3.0 percentage points when compared to the second quarter of fiscal year 2008. In addition to the impact of the lower net sales level for the second quarter of fiscal year 2009 compared to the second quarter of fiscal year 2008, gross profit was negatively impacted by higher commodity and freight costs, increased discounting on select product, and a sales mix shift to lower margin product.  Partially offsetting the higher costs were price increases on select office furniture products and a decrease in LIFO inventory reserves resulting from lower inventory levels which positively impacted the second quarter fiscal year 2009 gross profit. Gross profit as a percent of net sales for the six months ended December 31, 2008, declined 3.2 percentage points when compared to the six months ended December 31, 2007 primarily due to higher commodity and freight costs, increased discounting on select product, and a sales mix shift to lower margin product.

Selling and administrative expenses for the three and six months ended December 31, 2008 as compared to the three and six months ended December 31, 2007, decreased in both absolute dollars and as a percent of net sales as the Furniture segment incurred lower sales and marketing incentive costs, lower incentive compensation costs which are linked to Company profitability, and also realized benefits related to the previously announced workforce reduction restructuring activities.

The Furniture segment earnings for the three and six months ended December 31, 2008 were also impacted by higher employee healthcare costs and lower certain other employee benefit costs which are linked to Company profitability.

Risk factors within this segment include, but are not limited to, general economic and market conditions, increased global competition, supply chain cost pressures, and relationships with strategic customers and product distributors. Additional risk factors that could have an effect on the Company's performance are contained in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2008.

Liquidity and Capital Resources

Working capital at December 31, 2008 was $157 million compared to working capital of $163 million at June 30, 2008. The current ratio was 1.5 at both December 31, 2008 and June 30, 2008.

The Company's short-term liquidity available, represented as cash, cash equivalents, and short-term investments plus the unused amount of the Company's revolving credit facility amounts to $110.6 million at December 31, 2008. The credit facility provides an option to increase the amount available by an additional $50 million at the Company's request, subject to participating banks' consent.

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The Company's internal measure of Accounts Receivable performance, also referred to as Days Sales Outstanding (DSO), for the first six months of fiscal year 2009 of 45.7 days approximated the 46.1 days for the first six months of fiscal year 2008. The Company defines DSO as the average of monthly accounts and notes receivable divided by an average day's net sales. The Company's Production Days Supply on Hand (PDSOH) of inventory measure for the first six months of fiscal year 2009 increased to 64.2 from 57.6 for the first six months of fiscal year 2008. The increased PDSOH was driven by EMS segment increased average inventory balances for the first half of fiscal year 2009 as compared to the first half of fiscal year 2008 primarily due to customers delaying near-term requirements which in turn has postponed the reduction of inventory that was held in support of transfers of production between manufacturing facilities within the EMS segment. The Company defines PDSOH as the average of the monthly gross inventory divided by an average day's cost of sales.

The Company's net cash position from an aggregate of cash, cash equivalents, and short-term investments less short-term borrowings under credit facilities decreased from $29.8 million at June 30, 2008 to $7.6 million at December 31, 2008, as cash flow generated from operations and from the sale of assets was more than offset by cash payments during the first six months of fiscal year 2009 for capital expenditures, the acquisition within the EMS segment, and dividends. Operating activities generated $12.9 million of cash flow in the first six months of fiscal year 2009 compared to $29.8 million in the first six months of fiscal year 2008.  Proceeds from the sale of assets of $11.2 million were received during the first six months of fiscal year 2009, primarily related to the tracts of land which sold prior to December 31, 2008. The Company reinvested $27.6 million into capital investments for the future, primarily for manufacturing equipment, the new Poland facility under construction which is part of the plan to consolidate the European manufacturing footprint, and other facility improvements during the first six months of fiscal year 2009.  The Company also expended $5.4 million for the acquisition within the EMS segment during the first six months of fiscal year 2009. Financing cash flow activities for the first six months of fiscal year 2009 included $11.7 million in dividend payments, which remained flat with the first six months of fiscal year 2008. During fiscal year 2009, the Company expects to minimize capital expenditures where appropriate and will complete construction of the new EMS manufacturing facility in Poland. The land and new facility are expected to cost approximately $35 million of which approximately $8 million was spent prior to December 31, 2008. The Company plans to sell its current Poland facility in the future. The remainder of the undeveloped land and timber sold via auction in November is expected to close in the Company's third quarter of fiscal year 2009 generating additional cash proceeds of $37 million in the third quarter of fiscal year 2009, and estimated cash outflow of $8 million for taxes on the related gain will be paid during the remainder of fiscal year 2009.

At December 31, 2008, the Company had $72.3 million of short-term borrowings outstanding under several credit facilities described in more detail below. At June 30, 2008, the Company had $52.6 million of short-term borrowings outstanding. Cash and cash equivalents and short-term investments exceeded the short-term revolver borrowings by $7.6 million at December 31, 2008 and by $29.8 million at June 30, 2008.

The Company maintains a $100 million credit facility with an expiration date in April 2013 that allows for both issuances of letters of credit and cash borrowings. The $100 million credit facility provides an option to increase the amount available for borrowing to $150 million at the Company's request, subject to the group of participating banks' consent.  The $100 million credit facility requires the Company to comply with certain debt covenants including interest coverage ratio, minimum net worth, and other terms and conditions. The Company was in compliance with these covenants at December 31, 2008.

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The Company believes the most significant covenants under its $100 million credit facility are minimum net worth and interest coverage ratio.  The table below compares the actual net worth and interest coverage ratio with the limits specified in the credit agreement.

Covenant		At or for the Period Ended December 31, 2008		Limit As Specified in Credit Agreement		Excess
Minimum Net Worth		$377,723,000		$362,000,000		$15,723,000
Interest Coverage Ratio		8.9		3.0		5.9

The Interest Coverage Ratio is calculated on a rolling four-quarter basis as defined in the credit agreement.

The outstanding balance under the $100 million credit facility consisted of $7.0 million for a Euro currency borrowing, which provides a natural currency hedge against a Euro denominated intercompany note between the U.S. parent and Euro functional currency subsidiaries, and an additional $57.3 million borrowing, which funded the short-term investments and short-term cash needs. In addition, at December 31, 2008, the Company had $0.7 million of short-term borrowings outstanding under a separate Thailand credit facility which is backed by the $100 million credit facility. The Company also had an additional $4.3 million in letters of credit against the credit facility. Total availability to borrow under the $100 million credit facility was $30.7 million at December 31, 2008.

The Company also has a credit facility for its electronics operation in Wales, United Kingdom, which allows for multi-currency borrowings up to 2 million Sterling equivalent (approximately $2.9 million U.S. dollars at December 31, 2008 exchange rates) and is available to cover bank overdrafts. The facility will be reviewed by the bank in November 2009 and will expire at that time if not renewed. Bank overdrafts may be deemed necessary to satisfy short-term cash needs at the Company's Wales location rather than funding from intercompany sources. At December 31, 2008, the Company had no borrowings outstanding under this overdraft facility.

The Company also has a credit facility for its electronics operation in Poznan, Poland, which allows for multi-currency borrowings up to 6 million Euro equivalent (approximately $8.4 million U.S. dollars at December 31, 2008 exchange rates) and is available to cover bank overdrafts. Bank overdrafts may be deemed necessary to satisfy short-term cash needs at the Company's Poznan location rather than funding from intercompany sources. This overdraft facility can be cancelled at any time by either the bank or the Company. At December 31, 2008, the Company had $7.3 million US dollar equivalent of Euro denominated short-term borrowings outstanding under this overdraft facility.

The Company believes its principal sources of liquidity from available funds on hand, cash generated from operations, and the availability of borrowing under the Company's credit facilities will be sufficient in fiscal year 2009 and the foreseeable future. One of the Company's primary sources of funds is its ability to generate cash from operations to meet its liquidity obligations, which could be affected by factors such as general economic and market conditions, a decline in demand for the Company's products, loss of key contract customers, the ability of the Company to generate profits, and other unforeseen circumstances. Should demand for the Company's products decrease significantly over the next 12 months due to the weakened economy, the available cash provided by operations could be adversely impacted. Another source of funds is the Company's credit facilities. The $100 million credit facility is contingent on complying with certain debt covenants.

The preceding statements are forward-looking statements under the Private Securities Litigation Reform Act of 1995. Certain factors could cause actual results to differ materially from forward-looking statements.

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Fair Value

The Company adopted the provisions of SFAS No. 157, Fair Value Measurements, which defines fair value, for financial assets and liabilities measured at fair value on a recurring basis at July 1, 2008.  The adoption had an immaterial impact on the Company's financial statements.  During the first six months of fiscal year 2009, no financial assets were affected by a lack of market liquidity. For level 1 financial assets, readily available market pricing was used to value the financial instruments.  For available-for-sale securities classified as level 2 assets, the Company's investment portfolio custodians use a pricing service to value the instruments.  The fair values are determined based on observable market inputs which use evaluated pricing models that vary by asset class and incorporate available trade, bid, and other market information.  The Company evaluated the inputs used by the pricing service to value the instruments and validated the accuracy of the instrument fair values based on historical evidence. The Company's derivatives, which were classified as level 2 assets/liabilities, were independently valued using a financial risk management software package using observable market inputs such as forward interest rate yield curves, current spot rates, and time value calculations.  To verify the reasonableness of the independently determined fair values, the derivative fair values were compared to fair values calculated by the counterparty banks. The Company's own credit risk and counterparty credit risk had an immaterial impact on valuation of derivatives.  See Note 8 - Fair Value of Financial Assets and Liabilities of Notes to Condensed Consolidated Financial Statements for more information.

Contractual Obligations

There have been no material changes outside the ordinary course of business to the Company's summary of contractual obligations under the caption "Contractual Obligations" in Item 7 "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 June 30, 2008.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements other than standby letters of credit and operating leases entered into in the normal course of business. These arrangements do not have a material current effect and are not reasonably likely to have a material future effect on the Company's financial condition, results of operations, liquidity, capital expenditures, or capital resources. See Note 6 - Commitments and Contingent Liabilities of Notes to Condensed Consolidated Financial Statements for more information on standby letters of credit. The Company does not have material exposures to trading activities of non-exchange traded contracts.

The preceding statements are forward-looking statements under the Private Securities Litigation Reform Act of 1995. Certain factors could cause actual results to differ materially from forward-looking statements.

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Critical Accounting Policies

The Company's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles require the use of estimates and assumptions that affect amounts reported and disclosed in the consolidated financial statements and related notes. Actual results could differ from these estimates and assumptions. Management uses its best judgment in the assumptions used to value these estimates, which are based on current facts and circumstances, prior experience, and other assumptions that are believed to be reasonable. The Company's management overlays a fundamental philosophy of valuing its assets and liabilities in an appropriately conservative manner.  Management believes the following critical accounting policies reflect the more significant judgments and estimates used in preparation of the Company's consolidated financial statements and are the policies that are most critical in the portrayal of the Company's financial position and results of operations. Management has discussed these critical accounting policies and estimates with the Audit Committee of the Company's Board of Directors and with the Company's independent registered public accounting firm.

Revenue recognition - The Company recognizes revenue when title and risk transfer to the customer, which under the terms and conditions of the sale may occur either at the time of shipment or when the product is delivered to the customer. Service revenue is recognized as services are rendered. Shipping and handling fees billed to customers are recorded as sales while the related shipping and handling costs are included in cost of goods sold. The Company recognizes sales net of applicable sales tax.

• Allowance for sales returns - At the time revenue is recognized certain provisions may also be recorded, including returns and allowances, which involve estimates based on current discussions with applicable customers, historical experience with a particular customer and/or product, and other relevant factors. As such, these factors may change over time causing the provisions to be adjusted accordingly. At December 31, 2008 and June 30, 2008, the reserve for returns and allowances was $3.8 million and $3.3 million, respectively. Over the past two years, the returns and allowances reserve has approximated 2% of gross trade receivables.
• Allowance for doubtful accounts - Allowance for doubtful accounts is generally based on a percentage of aged accounts receivable, where the percentage increases as the accounts receivable become older. However, management judgment is utilized in the final determination of the allowance based on several factors including specific analysis of a customer's credit worthiness, changes in a customer's payment history, historical bad debt experience, and general economic and market trends. The allowance for doubtful accounts at December 31, 2008 and June 30, 2008 was $1.7 million and $0.8 million, respectively. The December 31, 2008 allowance for doubtful accounts balance is 1% of gross trade accounts receivable while over the preceding two years, this reserve had been less than 1% of gross trade accounts receivable. The increased reserve is driven by the current market conditions.

Excess and obsolete inventory - Inventories were valued using the lower of last-in, first-out (LIFO) cost or market value for approximately 15% and 17% of consolidated inventories at December 31, 2008 and June 30, 2008, respectively, including approximately 79% and 85% of the Furniture segment inventories at December 31, 2008 and June 30, 2008, respectively. The remaining inventories are valued at lower of first-in, first-out (FIFO) cost or market value. Inventories recorded on the Company's balance sheet are adjusted for excess and obsolete inventory. In general, the Company purchases materials and finished goods for contract-based business from customer orders and projections, primarily in the case of long lead time items, and has a general philosophy to only purchase materials to the extent covered by a written commitment from its customers. However, there are times when inventory is purchased beyond customer commitments due to minimum lot sizes and inventory lead time requirements, or where component allocation or other procurement issues may exist. The Company may also purchase additional inventory to support transfers of production between manufacturing facilities. Evaluation of excess inventory includes such factors as anticipated usage, inventory turnover, inventory levels, and product demand levels. Factors considered when evaluating inventory obsolescence include the age of on-hand inventory and reduction in value due to damage, use as showroom samples, design changes, or cessation of product lines.

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Self-insurance reserves - The Company is self-insured up to certain limits for auto and general liability, workers' compensation, and certain employee health benefits such as medical, short-term disability, and dental with the related liabilities included in the accompanying financial statements. The Company's policy is to estimate reserves based upon a number of factors including known claims, estimated incurred but not reported claims, and other analyses, which are based on historical information along with certain assumptions about future events. Changes in assumptions for such matters as increased medical costs and changes in actual experience could cause these estimates to change and reserve levels to be adjusted accordingly. At December 31, 2008 and June 30, 2008, the Company's accrued liabilities for self-insurance exposure were $6.3 million and $6.6 million, respectively, excluding immaterial amounts held in a voluntary employees' beneficiary association (VEBA) trust.

Taxes - Deferred income tax assets and liabilities are recognized for the estimated future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. These assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to reverse. The Company evaluates the recoverability of its deferred tax assets each quarter by assessing the likelihood of future profitability and available tax planning strategies that could be implemented to realize its deferred tax assets. If recovery is not likely, the Company provides a valuation allowance based on its best estimate of future taxable income in the various taxing jurisdictions and the amount of deferred taxes ultimately realizable. Future events could change management's assessment.

The Company operates within multiple taxing jurisdictions and is subject to tax audits in these jurisdictions. These audits can involve complex issues, which may require an extended period of time to resolve. However, the Company believes it has made adequate provision for income and other taxes for all years that are subject to audit. As tax periods are effectively settled, the provision will be adjusted accordingly. The liability for uncertain income and other tax positions was $2.4 million at both December 31, 2008 and June 30, 2008.

Goodwill - Goodwill represents the difference between the purchase price and the related underlying tangible and intangible net asset values resulting from business acquisitions. Annually, or if conditions indicate an earlier review is necessary, the Company compares the carrying value of the reporting unit to an estimate of the reporting unit's fair value. If the estimated fair value is less than the carrying value, goodwill is impaired and will be written down to its estimated fair value. Goodwill is assigned to and the fair value is tested at the reporting unit level. During the Company's second quarter of fiscal year 2009, the annual impairment tests were performed for several of the Company's reporting units. Goodwill was also reviewed on an interim basis during the second quarter of fiscal year 2009 due to the disparity between the Company's market capitalization and the carrying value of its stockholders' equity and the uncertainty associated with the economy. The results of the analyses indicated that the Company did not have an impairment of goodwill for any reporting units. The calculation of the fair value of the reporting units considers current market conditions existing at the assessment date. The Company will continue to monitor circumstances and events in future periods to determine whether additional goodwill impairment testing is warranted. The Company can provide no assurance that a material impairment charge will not occur in future periods as a result of these analyses. At December 31, 2008 and June 30, 2008, the Company's goodwill totaled, in millions, $17.2 and $15.4, respectively.

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New Accounting Standards

See Note 1 - Summary of Significant Accounting Policies of Notes to Condensed Consolidated Financial Statements for information regarding New Accounting Standards.

Forward-Looking Statements

Certain statements contained within this document are considered forward-looking under the Private Securities Litigation Reform Act of 1995. These statements can be identified by the use of words such as "believes," "estimates," "projects," "expects," "anticipates," "forecasts," and similar expressions. These forward-looking statements are subject to risks and uncertainties including, but not limited to, current economic global turmoil, other general economic conditions, significant volume reductions from key contract customers, significant reduction in customer order patterns, loss of key customers or suppliers within specific industries, financial stability of key customers and suppliers, availability or cost of raw materials, increased competitive pricing pressures reflecting excess industry capacities, successful execution of restructuring plans, or similar unforeseen events. Additional cautionary statements regarding other risk factors that could have an effect on the future performance of the Company are contained in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2008.