Spartech Corporation F4Q08 (Qtr End 11/01/08) Earnings Call Transcript

Dec.16.08 | About: Spartech Corporation (SEH)

Spartech Corporation (NYSE:SEH)

F4Q08 Earnings Call

December 16, 2008 11:00 am ET

Executives

Myles S. Odaniell - President and Chief Exec. Officer

Randy C. Martin - Chief Financial Officer

Analysts

Michael Harrison - First Analysis Corp.

Michael Sison - Keybanc Capital Markets

Jeffrey Bronchick – RCB Investment Management

David Begleiter - Deutsche Bank Securities

Eugene Fedotoff - Longbow Research

Operator

Welcome to the fourth quarter Spartech earnings conference call. My name is Ann and I will be your coordinator for today’s call. (Operator Instructions) I’d like to now turn the presentation over to Mr. Myles Odaniell, President and CEO.

Myles S. Odaniell

Good morning and thank everyone for joining us on Spartech’s Q4 2008 earnings conference call. Randy and I welcome the opportunity to speak to you today regarding our current performance, our progress, and our outlook. While these are challenging times, even unprecedented in many respects, they are providing us with the opportunity to make substantial improvements in the near term and position ourselves for enhanced future performance. After my comments, Randy will walk you through some highlights and specifics of our quarterly results, and then we will both be pleased to take questions.

In summary, take-aways from today’s fourth quarter conference call are as follows. In the face of continued market weakness and lower volumes we continue our progress on structural cost reduction, we made measurable improvements in our margin and improved our product mix, and we are generating solid operating cash flows.

Net sales of $346.1 million compared to prior-year quarter of $366.2 million and represented a 5% decrease, reflecting weak end-market demand, partially offset by higher selling prices from the pass-through of resin cost increases and some sales mix changes.

Sales volumes were down 21% in the fourth quarter of 2008 compared to the prior year, reflecting demand declines in the transportation and recreation leisure markets and general inventory reductions across most of our end markets.

Our $0.02 per share EPS, which excluded special items, was below last year’s $0.08 per share and certainly well below the earnings potential of Spartech. Lower earnings were a result of volume decreases and weak end-market demand, but clearly much of the positive improvements planned and fully executed in 2008 are still just partially offsetting the negative impact of the weak U.S. economy.

Quarterly operating earnings were lower by $3.8 million, inclusive of several one-time adjustments.

As part of our financial turnaround, which was initiated early in the year, our cost reduction and margin improvements have positioned us to better address some of today’s very challenging market conditions and improve future operating leverage while helping us build a solid foundation for long-term success.

We are aggressively working on additional activities directed at helping Spartech reach our full earnings potential.

Today we are summarizing our progress on the previously announced $25.0 million improvement plan and announcing another $25.0 million, much of which is already underway for delivery in 2009 and 2010. These actions allow us to respond to current market conditions but also, and importantly, to capitalize on unique improvement opportunities still existing at Spartech.

In addition to our structural improvements and cost reduction activities that are part of our financial turnaround, we are taking further short-term actions to align operating costs with current demand levels and these efforts include additional cost reduction and a significant amount of production and staff flexing.

Fourth quarter 2008 results include a $254.0 million non-cash charge for goodwill and asset impairments and Randy will discuss that in further detail in a few minutes.

This morning I will be providing comments on our general business conditions, including a discussion of the external markets, demand, and raw materials, actions taken in the short-term to respond to those current demand situations, providing an update on our transformational activities, including the financial turnaround initiatives, and I will be providing a discussion on the outlook for what we see going into 2009.

I would like to reiterate one of my initial tenets since I have here, which is we are managing what we can control. We have not and will not use external factors as a justification for weak performance and the focus of this organization is to perform well at all parts of the cycle, and certainly position ourselves for superior and sustainable long-term performance.

As you will hear, there continues to be a great opportunity to improve our company, and while we are making progress, we still have much work to do.

Now, let me start with a perspective on the external environment. While the U.S. economy has just turned into what potentially will be a deep recession, the manufacturing sector, including many of our markets that we serve, has been experiencing weak demand and volume declines for at least a year.

With the global credit and U.S. housing prices, the industry has now seen an accelerated decline in demand starting significantly in September/October time frame as consumers retrench to weather the recession.

Sharply falling raw material costs have now further complicated our near-term situation as many customers are destocking in anticipation of lower resin-related costs in 2009.

As expected, market demand was very challenging in the fourth quarter. Volumes were 21% lower than prior Q4 and sequentially 7% lower when compared to our Q3 2008. Our 5% decline in sales represented the lower volumes and continued weakness in our major end markets of automotive, residential construction, and rec and leisure.

While we continue to focus on maintaining overall share and believe our sales volumes continue to trend largely with our end markets, and that is an assessment we validate regularly through our customers and through our suppliers who track resin sales into our markets. Of course, as I had indicated before, we have previously shed some very low-margin, mostly automotive, business allowing us to cut deeper on the cost side, improve our mix and overall profitably, particularly in our Color & Compounding business.

In our transportation end market, which represents 18% of our sales, and includes auto and light trucks, heavy trucks and aircrafts, Spartech’s volume was down approximately 40%. Sales to the automotive sector have been particularly weak due to lower build rates, compounded by our heavy exposure and accruals in numerous SUVs. Consistent with end-market demand, our sales to the RV segment are down almost 53%.

Our building and construction market accounts for 18% of our sales and is largely linked to both residential and industrial construction and all of our external indicators indicate that volume should be down about 30% there. Our sales in that sector were off about 13%, as weak market demand was only partially offset by continued stability in parts of our business, including our TPO roofing business.

We are taking short-term actions to manage the current situation and also doing more structural work. I’m not sure exactly where you draw the line anymore, but I want to communicate that we started most of the structural work ten months ago so we have a good jump start.

In addition, we are doing what is necessary to flex staffing costs and manage overall spending in the short term while we continue addressing opportunities to improve our longer-term cost footprint and importantly, build an organization with the right people and the right capabilities to better position our company for the future.

During our fiscal first quarter 2009 we are shut down most of our facilities for two weeks in November and we will be doing so for another two weeks in December. This is consistent with what many of our customers and suppliers have announced and necessary to align our production with current demand levels.

Most of our major suppliers have announced shutdowns for the second half of December and many have no firm restart dates until they get clarity on their demand.

In light of these volume decreases, we are taking decisive actions to permanently reduce our labor and we have been optimizing the use of flex time and schedule reductions to respond to the lower demand. As a result, we saw a 14% reduction in our labor component of our conversion costs in Q4 2008 compared to Q4 2007.

We are streamlining our overall organization structure and have permanently eliminated approximately 440 full-time equivalents as we work to reduce our fixed-cost base. In addition, we have a significant amount of work schedule reductions in response to the current demand situation.

Concurrent with the reductions, our operations teams are working to ensure we improve operational efficiencies and are positioned to handle line recovery without add-backs.

Resin costs, which are our primary variable cost component, have started to decline in Q4 and subsequently fallen sharply in November and December. January outlook is for further substantial reductions. This is somewhat in response to falling crude oil-related input costs, but largely, I believe, a function of weak underlying demand and uncertain demand outlook.

It is somewhat difficult to predict the net impact of falling prices, but clearly Spartech will see some margin expansion in the next couple of quarters due to lagging formula prices.

As we did with our customers in the rapidly escalating raw material pricing situation last summer, we are working very closely to manage through this downturn but the bottom line here is that situation remains very dynamic and the industry’s ability to forecast is at best poor.

Let me now talk a little bit about our transformational activities and our financial turnaround. At the beginning of 2008 we announced the frame work and major elements of our strategic and financial turnaround. In June we completed this assessment and have now created a detailed road map for transforming Spartech.

Over the last twelve months we made substantial progress on many key initiatives. As previously communicated, this assessment included the development of a comprehensive set of portfolio plans, including individual business unit strategies and an assessment of our core and non-core operating assets.

It included the development of a broad organizational restructuring plan, including identifying what was required from a talent, skill set, organizational leadership and overall staffing level, and it included a broad-based cost reduction initiative, including sustainable cost reductions and structural cost eliminations focused on a low-cost-to-serve model.

Our overall strategic road map is focused on components that we believe will result in increased portfolio focus, tangible improvements and competitive advantage and true leadership positioning in our core businesses. This will, in effect, drive an important transformation of our company that embodies a change in management mind set and value generation that we believe will result in measurable enhancement in our shareholder value.

Now an update on our progress, and let me start with our organization first. In the quarter we completed a redesign of our operations group and appointed Mark Roberts to a newly-created position of Senior Vice President of Operations. Mark now has responsibility for all of Spartech’s manufacturing operations and his primary focus will be to create and lead a world-class manufacturing organization at Spartech by implementing best practices to standardize our manufacturing and ensure we have a low-cost manufacturing footprint.

His experience in operations and management provides us with a unique opportunity to improve not only our quality, safety costs and productivity, but also to ensure we have common processes and procedures that we will use to manage and measure our business.

Given our decentralized structure in which we have historically operated, we believe there is very significant opportunity to further improve efficiencies, reduce costs, and better position our company for the future.

We are pleased to announce that Mr. Robert Burns has joined Spartech this month as Vice President and Chief Information Officer. He will be responsible for providing strategic direction for the implementation and execution of innovative and cost effective information solutions. His initial efforts will be directing accelerating deliverables from our Oracle and business intelligence investments.

Bob has spent more than 25 years in various positions with Anheuser-Busch, including seven years as a company CIO and he brings extensive IT and operational leadership experience and will be a valuable addition to our leadership team.

During the quarter we also made significant progress as we continued to build and staff our technology and marketing and commercial development organization, which is expected to be a key driver in enhancing our organic growth and accelerating profitable innovation at Spartech.

We also announced internally and initiated efforts to transition to a financial shared service organization in 2009, replacing much of the decentralized plant-based financial resources with a smaller, more focused organization in St. Louis. This should be completed in 2010 and will provide improved functionality and reduce cost by about $3.0 million annually.

We continue to build a highly capable leadership team and make other organizational changes designed to accelerate our improvement initiatives and position our company for the long term.

Publicly I would like to acknowledge the employees of Spartech who are working to help us manage through what is undoubtedly the most difficult time in most of their business careers. Our team is realistic about the future challenges ahead but remains focused and energized on the opportunity to transform our company.

As we previously discussed, the financial turnaround program is based upon a diversified portfolio of performance and improvement initiative, spanning commercial, manufacturing, asset restructuring, cost reduction, and procurement. For ease of tracking and discussion we have classified various initiatives into those that were announced and completed in 2008 and those we are announcing and implementing for 2009.

During 2008 we started an initiative to streamline our manufacturing cost structure and this has resulted in $25.0 million in annualized labor-related cost reduction, approximately $15.0 million of which occurred in 2008. In addition to the across-the-board labor reduction initiative, we have announced two plant consolidations in 2008, which were completed in our fourth quarter, Mankato, Minnesota, and St. Clair, Michigan.

In today’s release, we are announcing actions to realize an additional $25.0 million in further cost reductions, consolidating procurement, improving our margin segmentation, and further optimizing our plant cost footprint across the company. We have commenced many of these initiatives and made progress in laying the foundation for completing these actions throughout 2009 and plan to communicate specific results as we complete those throughout the year.

Accordingly, in addition to the two plant consolidations finished last quarter, we are announcing two immediate additional consolidations. These are the internal relocation and consolidation of some our compounding production and termination of our Plastics Recycling Center, LLC, a joint venture manufacturing recycled compounds. These activities will generate combined annual benefits of approximately $2.0 million going forward.

In addition, we are nearly complete with a broad manufacturing network optimization analysis that will provide us direction for future sourcing in plant footprint decisions and I believe it will be a critical element in terms of what we do next in terms of further streamlining our operations.

In summary, we have now announced $50.0 million in improvement from the combined 2008 and 2009 turnaround initiatives, of which $15.0 million is already reflected in our 2008 results. We expect to realize another $10.0 million of the 2008 turnaround initiatives and a majority of the 2009 as we implement those throughout our 2009 fiscal year.

These are unique opportunities at Spartech because of our legacy organization structure and decentralized operating model. These actions will help maximize cash flow in a challenging near-term environment, improve our future earnings leverage, and better position Spartech for an economic recovery.

With that, I will turn it over to Randy for some additional details on our fourth quarter performance.

Randy C. Martin

I will be focusing my comments on providing more details on the financial performance in our fourth quarter in comparison to both the prior fourth quarter and the third quarter of 2008.

Before I get into the details, I wanted to mention that we have provided several sources of information relevant to our performance in the quarter, our earnings release was issued yesterday evening and we have also provided supplemental slides that provide more information on our strategy and additional financial metrics that are often of interest to shareholders. Those slides can be found on our website at www.spartech.com, Investor Relations menu under Presentations.

We have also provided a summary of Safe Harbor statements with the factors that could impact our results in the future within the documents that I referenced.

First, I will provide an overview of a key income statement component then I will provide some summary of the results of the asset impairment process and highlights of our cash flow performance achieved for the quarter.

Starting with the fourth quarter 2008 sales levels, Myles covered the overall market environment and the impact on our underlying sales volume, which was down 21%. Overall our sales dollars were only 5% down from the prior year.

Sales revenue was favorably impacted by the Creative acquisition, the pass-through of higher resin costs as higher sales prices, and improved mix. These price/mix increases resulted in sales prices that were $0.19 higher than the prior year, resulting in a $0.14 favorable impact on our sales dollars.

We will likely continue to see a better mix of sales as some of the more commodity and lower-margin business tends to be in the markets that are experiencing the weaker demand and this business is being replaced with higher priced, higher margin business.

Next I will talk about profit margins. With the weaker end-market demand, we are focusing on efforts to improve our mix of business and reducing our overall manufacturing costs and plant footprint. This will allow us to improve our gross margin per pound.

As a result, gross margin per pound was up in our two largest segments. Sheet gross margin was up $0.027 per pound and Color & Compounds was up $0.017 per pound. The consolidated gross margin per pound was $0.114 compared to the $0.093 in the fourth quarter of 2007 and relatively flat with the $0.115 sequential third quarter 2008 number.

With regard to SG&A costs, SG&A expense was up $2.8 million from the prior year. The fourth quarter of 2008 includes higher bad debt expense of $1.9 million to reflect the current environment to customers in the automotive and other depressed markets, and our reserve balance now stands at 2.5% of our receivables, well above last year’s 0.7% level.

Historically, we have had favorable experience in collecting our receivables and 87% of our balance is current today but we have reserved for certain customers that have past-due accounts and other circumstances that warrant further caution.

In addition to bad debts, we recognized $500,000 in costs to hire certain functional executives and an increase of $300,000 for the quarter in Oracle-related costs compared to the prior-year fourth quarter.

With regard to our Oracle business process improvement efforts, we implemented three more operations in the fourth quarter and another two at the first of December. We now have 28 sites implemented, including the last two implementations representing Muncie, Indiana, and Ripon, Wisconsin, facilities, which now completes the implementation for our Spartech Packaging Technologies segment.

By the end of May 2009 we will have five more operations implemented and have 90% of our core operational locations fully on our Oracle system. We believe this is a significant step in our organization development, an enhancement of the way we process, analyze, and use the data to run more efficiently and improve our performance for the business.

Part of that equation is a move to more other shared services environments. We have now announced the organizational plan and definitive time line to move our accounts receivable, credit, accounts payable, payroll, and general accounting to a centralized shared services environment, as Myles indicated in his comments. We have begun that process and expect to complete by the end of 2009.

The tax rate calculated from the reported results in the fourth quarter and year to date 2008 is unusually low because of some of the non-cash impairments. Those are not deductible and therefore do not receive a tax benefit for the reported pre-tax loss. We expect to have a more typical tax rate for the company of 38% to 39% looking out into 2009.

Our annual impairment testing date for goodwill is the first day of our fiscal fourth quarter. That was August 3, 2008, therefore in the fourth quarter we completed a goodwill impairment assessment for all of our reporting units in accordance with the provisions required by generally accepted accounting principles. These principles required us to consider the current market conditions and continuing difference between the company’s market value, based on those current economic conditions, and our current stock price, and compared to our value on the books.

This process resulted in a $238.6 million non-cash charge to write off goodwill. However this non-cash charge does not change our view of the opportunities to improve our businesses nor is it reflective of our view of the earnings potential of our businesses.

It should be noted that all this goodwill relates to acquisitions that were made prior to 2004.

For reasons similar to the goodwill impairment process, we also addressed the valuation of certain identifiable intangible assets and fixed assets. We were required to write off certain intangibles and other fixed assets of non-cooperations that combined totaled $15.4 million.

Overall, we recognized $254.0 million in non-cash impairment charges. These charges were recorded on entities in three of our four operating segments, a total of $119.0 million in our Custom Sheet segment, $113.0 million in our Color & Specialty Compounds segment, and $22.0 million in our Engineered Products segment. There were no asset impairments related to our Spartech Packaging Technologies segment.

After these charges, our goodwill now totals $145.0 million on our ending fiscal year 2008 balance sheet.

Next I will highlight a few items on cash flow. None of these impairments influenced our cash flows so we continued to see a solid performance in this area. We were effective in managing our working capital and capital expenditures such that even with the impact on the volume on earnings, we were able to pay down $57.0 million of debt in the year.

In the quarter we generated $46.0 million of cash flow from operations, which was higher than both the prior-year fourth quarter of $34.3 million and the sequential third quarter of 2008 level of $34.1 million.

After $3.0 million of capital expenditures, free cash flow was $42.0 million, allowing us to pay down $39.0 million of debt in the fourth quarter.

We continue to tightly manage our working capital, particularly in light of the current economic environment. We will continue to use measures of days sales outstanding under 50 days, days payable of more than 45, and inventory turns of more than 11 times as key targets for the business.

Working capital is a constant effort for our operating personnel and we will continue to utilize best practices and new analysis tools using our Oracle and business intelligence products, as we have made investments in these to manage these metrics into the next year.

We will also closely monitor our capital expenditures. We spend $17.0 million for the year compared to $35.0 million last year. While adding to our free cash flow for the year, this level was sufficient for maintaining our operations and supporting the ongoing announced efforts taken in 2008 to improve our cost structure.

From a liquidity and capital structure perspective, at year end we had $56.0 million of availability and we were well within our maximum leverage ratio of 4.25:1. Our debt to EBITDA ratio was 3.55:1 at year end on total debt of approximately $275.0 million.

The amendments to both our bank credit facility and private placements, which we completed in the middle of September, put us in a solid position with our debt covenants. Looking out over the next year, we believe that we are able to meet our debt covenants and have adequate liquidity for our revolving credit facility to support our operations.

I will now turn it back over to Myles to make some final comments.

Myles S. Odaniell

Before we do that, why don’t we go to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Harrison - First Analysis Corp.

Michael Harrison - First Analysis Corp.

Looking at the SG&A costs, I understand the breakout there of the management recruitment, it was sort of one-time in nature and presumably some of the bad debt expenses aren’t going to remain too long. But looking at the run rate for next year, what should we be modeling? Something more like the $22.0 million you were showing in the July quarter or more along the lines of the $25.0 million you showed this quarter?

Randy C. Martin

I think certainly the current year fourth quarter is high so I think it’s going to be something lower than the nearly $25.0 million that we had this quarter. $22.0 million was a pretty reasonable number, with some additional investments that we have made and until we get shared services fully implemented we are going to have some redundancy, so I think you might see it a little bit high at the beginning of the year but as we get towards the end of the year I think that $22.0 million will be a more accurate number that we will be targeting.

Michael Harrison - First Analysis Corp.

Historically, when resin prices have been coming down, you have seen customers sometimes hold off on purchases until they see that resin prices are bottoming out, or even ticking higher. Can you blame any of the volume decline that you saw this quarter on that phenomenon or have customers basically been buying on an as-needed basis?

Myles S. Odaniell

I will speak to it and I want to be careful not to overstate our level of accuracy in terms of this assessment, but I can tell you from talking to our suppliers and talking to our customers, what we have seen is raw material prices peaked in the September/October time frame, many customers, and certainly Spartech saw it as well that that was happening, and as a consequence folks stated to destock in anticipation of essentially not wanting to hold high-cost resin or high-cost finished product, and on the flip side being able to buy low-cost resin or lower cost finished product at a later date.

And so what we have seen during the fall, and it has certainly gone on in the October/November time frame, is folks are bringing their inventory levels down as a result of that.

Now, what we have been unable to do is really put a number on that and tell you how significant it is. But certainly as we have talked to our suppliers, there is a broad sense that that is a component to some of the weaker demand. And certainly as we have talked to our customers, they are absolutely telling us that. They are trying to sell off their higher-cost plastics and holding off making more, given the current demand situation, potentially until January, where they would expect costs to be lower.

Michael Harrison - First Analysis Corp.

Presumably we are talking about something in the few percent range of the volume decline, not like half of the volume decline, right?

Myles S. Odaniell

I just don’t know. People have, across a lot of the segments, we’re kind of early out of the box reporting, but what you’re going to see is volumes are off so much. It is probably a major contributor to the volumes but I would argue the largest one continues to be the broader market place today.

Michael Harrison - First Analysis Corp.

And keeping on that theme, you had said last quarter about one-third of the 17% volume decline was probably related to unprofitable business that you were walking away from.

Myles S. Odaniell

Yes.

Michael Harrison - First Analysis Corp.

Was that a similar portion of the volume decline this quarter?

Myles S. Odaniell

We really, to the extent we shed customers and unprofitable business, and just to put it in perspective, those tended to be pieces of business where we not even getting a marginal contribution. So it was the right decision to do.

I think most of that work was done prior to our Q4 and so whatever we had in Q4 was just kind of the carryover from what was Q3. So probably, certainly a similar volume as a percent of the decline, I think it’s probably a smaller piece. Because we have just seen some further deterioration in the overall end markets.

Michael Harrison - First Analysis Corp.

In just maybe looking at what’s going on with the change of administration in Washington, any thoughts on what the potential bailout of the U.S. auto industry could mean to Spartech? And also, how do you think you are positioned to take advantage of additional infrastructure spending that might be your construction and transportation end markets that you serve?

Myles S. Odaniell

Clearly, as I communicated some of the market data, the transportation end market is a significant part of our total business. To the extent that we have been negatively impacted by a turndown in automotive, we would, I believe, be favorably impacted by a more dramatic recovery, which would result from efforts on the bailout.

So I think, from a company perspective, it’s important that we have healthy automotive industries so that we have healthy Tier 1 suppliers who are ultimately our customers. I think the real question is how do you translate a bailout into higher car production and how quickly does that come about, and I don’t think we are in a very good position yet to forecast that.

But clearly, a healthy automotive industry is good for Spartech and just as we saw business slow down, I would expect to see recovery as they get stronger.

In terms of overall infrastructure investments, I will make a general statement in that a lot of our business in the overall construction area tends to be in both residential and commercial. I think what you are going to see from an infrastructure may not necessarily be those two area. You are probably going to see more from, at least as I understand it, roads and some buildings. But I think we would probably have to sit down and calculate that out to see if we thought that would be a big kicker for us.

Operator

Your next question comes from Michael Sison - Keybanc Capital Markets.

Michael Sison - Keybanc Capital Markets

Could you help me reconcile, you know, Packaging Technologies tends to be an end market that shouldn’t show as negative as volumes as you showed in the fourth quarter, down 19%. So could you just sort of walk us through, again, were there some market share losses there? Were there more customers waiting for lower raw materials? Just a little better picture of what’s happening in that part of the business.

Randy C. Martin

I think the first place to start there is that the packing-related business was down 7%. There’s some other non-packaging business that still gets performed by those plants that make up that segment. And in that 7% a good portion of it relates to the film, color concentrates of film and bags. And I think it’s one of those areas with impaction that tends to be a little more highly commodity and less profitable. So some of that volume we did lose would fall into that category.

If you look into some of the more traditional food packaging and things of that nature, that was a little more stable than what that 7% would reflect.

Michael Sison - Keybanc Capital Markets

Then the other piece is not Packaging but it’s in Packaging Technologies?

Randy C. Martin

Basically what we did at this point, we thought a full vision with our Oracle completed, all five plants that make up our Packaging division, they do a majority of packaging but they also still have some legacy production in automotive and some other business and that’s about 20% of the business in that market, and that was down pretty significantly, like the rest of the markets that serve automotive.

Michael Sison - Keybanc Capital Markets

You also talked about customer shutdowns in two weeks in November and two weeks in December. Are these temporary? Or more idle capacity versus permanent?

Myles S. Odaniell

I spoke about customers and suppliers and as a general sense, everybody is trying to find that right balance to deal with lower end-market demand. And it is fairly broad-based that our customer base is shutting down the last couple of weeks of the month. But I am not aware of anything that would be deemed as permanent. I think the issue is how quickly do they come back up in January and do they come back up at an accelerated rate because there is some inventory rebuild that needs to happen in the supply chain, or are there some other positive contributors.

But I don’t see any major customers going out of business. I just see them doing what they have to do to weather the storm in their particular areas.

Michael Sison - Keybanc Capital Markets

You talked about another round of cost savings, that $25.0 million. Do you think the bulk of that will hit in 2009, based on the timing of the initiatives?

Myles S. Odaniell

Yes, two things. We have been pretty deliberate to communicate the specifics, once they are actually done. So that’s an approach we would like to continue to use here. But I would argue that most of the second tranche of $25.0 million should be impacting our 2009. Some of it is going to lag into 2010. Included in there, for example, we talked about the shared service consolidation. We are building that in 2009 and we won’t see any year-over-year improvement in that until 2010. But you will certainly see more than half of the second $25.0 million in 2009.

Michael Sison - Keybanc Capital Markets

Given that it sounds like, and we have seen this from several other companies that have preannounced thus far, that the weakness you saw in the October quarter probably gets worse in the first quarter of your fiscal year, particularly if you consider November and December, so you sort of went back and got some concessions for your debts, in terms of leverage ratios. Could you remind us where you are at there and is there any risk, based on where you see things in the next couple of quarters, that we need to revisit those?

Myles S. Odaniell

We are at 3.5:1, 5:1 on the ratio of 4.25 so we had a fair amount of cushion and availability of $56.0 million at the end of the year. We certainly project out that we will meet those covenants. I don’t think you can say there is absolutely no risk but we feel pretty comfortable giving the projections that we should be able to work within those constraints.

Michael Sison - Keybanc Capital Markets

You commented that you are working through the earnings potential here, given all the cost savings and it’s difficult to see here. Do you think you have the right people to get you to the level you want to see Spartech at, and it seems clear to me that recouping this volume is going to be a good portion of the earnings potential of the company, and maybe just comments on what you think you can do internally to do that, and how much of that is volume, to some degree, you just need for demand to get better?

Myles S. Odaniell

Obviously we are building what I characterized as improved leverage going forward. And what I mean by that is when we start to see volume recovery out of it because we are doing a better job organically growing our business or because we get some tailwinds from the market recovery, we are going to see much enhanced improvement in our business because of what we have done structurally on costs and mix and to some degree, some of the margin improvement work.

So I think, very clearly right now, the benefit we will get from volume recovery is significantly greater than it would have been with the operating model we had just say twelve months ago. So that’s a good thing.

I then think it comes down to what do we get in terms of market recovery and we don’t control that so we are not planning on it yet; it’s going to come whenever it comes. But we do have a lot of work to do in terms of our organic growth and very clearly, I have talked on each of these calls, and you and I have talked as well, that we are building what I believe is the necessary infrastructure from a people standpoint and a process standpoint, to ensure that we are driving our organic growth and doing a better job on innovations.

And so even in the face of what is some pretty challenging external conditions, we are building that organization, we’re adding people, we’re building a marketing organization, we’re retooling what we do a lot with the, what I would broadly characterize as the commercial organizations, and that work is ongoing and we are absolutely, positively going to stay the course because I think that’s important for the future and obviously I think that will be a significant contributor to our accelerated turnaround when the markets start to recover.

So I think the question is how are you going to model it and what’s the number and we just don’t know what kind of volume recovery we’re going to see from the markets. As a general statement, we are planning on 2009 being down and taking out costs in accordance with that and that’s one of the key parts of what we’ve done in terms of our second $25.0 million of improvement initiatives. So we don’t have a plan that says volumes are going to recover and therefore everything will be great. We are taking actions that I believe are prudent and appropriate to be conservative in terms of the overall external market place.

Operator

Your next question comes from Jeffrey Bronchick – RCB Investment Management.

Jeffrey Bronchick – RCB Investment Management

Just looking at next year, is working capital kind of to the bone at this point, or what does it look like on a cash flow line for next year?

Randy C. Martin

I think at the 7.3% level that we ended the year, that is certainly is as low as we have ever had it. We were 8.8% at the end of last year’s fiscal end so we definitely have seen us perform very positively. We are making every effort to make those permanent. As resin costs come down, that helps that to some degree.

So we are definitely making sure that what we have put in place is sustainable. But I would tend to suggest that we are kind of at a level that is fairly close to best-in-class and probably shouldn’t expect a lot of positive out of that. The efforts are mostly to maintain that, particularly in light of some of the challenges that might occur at the customer level.

Myles S. Odaniell

I would just add that we have got some days targets that are appropriate and probably we are going to maintain those, but from a dollar standpoint, as Randy indicated, there is a large benefit we will see from declining raw materials and how that works through working capital.

Jeffrey Bronchick – RCB Investment Management

So on a cash-flow-statement basis it should be a positive number for 2009.

Randy C. Martin

Yes, if the resin prices continue to fall as we have seen starting out in November, that would certain add some benefit.

Jeffrey Bronchick – RCB Investment Management

And again, with timing and volume unknown, is there, in your current mix of business with the cost saves and structure that you’ve put in, if sometime in our lifetime there is a better economy, there is absolutely no reason why this current set of businesses should not exceed the EBITDA margin set in 2006. Is that still a fair statement or there structural things that you see now that have degraded that?

Myles S. Odaniell

I would encourage you to look at it this way. We have taken out about $25.0 million of costs, we are in the process of taking out additional costs and doing some other things that would enhance profitability to the tune of another $25.0 million and I believe that that is structural and permanent in that there is not necessarily any business or market offset that should not allow us to have that be additive to whatever the underlying performance is.

So do we get back to our peak plus $50.0 million? I think the question is do we ever get back to the peak and what causes that to get there. But certainly we will get back to a better place and then inherent in there will be the benefits from a lot of our improvement initiatives.

Jeffrey Bronchick – RCB Investment Management

In light of the economic environment and how certain aspects of your businesses are doing, under the heading of obviously there are businesses that should be doing, or could be doing, better and therefore if you were going to sell one of them it would be at a more opportune time than probably any time than right now, but on the other hand, a lot of work, a lot of effort, how are you thinking about the portfolio? Is it just stupid to even think about it until we get things on track or are things so bad that it’s like well, we might as well see what we can do.

Myles S. Odaniell

We are absolutely not in the situation where we need to be selling any of our assets or taking specific portfolio action so we are certainly not a distressed seller of any kind. We have gone through, as we indicated last quarter, a formal process of defining a company-wide strategy which included a specific portfolio strategy. And as part of that we have defined both individual business unit strategies, as well as defined what are core assets and what are non-core operating assets.

And obviously those non-core businesses are things, over time, that we would look to probably divest. In fact, we continue to look at some of those as we speak, but I think whether we sell them now or whether we do something different with them now is largely going to be a function of valuations and do we think we are getting a fair and appropriate amount of money for those businesses.

In fact, many of the things that we have characterized as non-core tend to be our smaller businesses but they tend to be performing reasonably well so we may find, when we finish those processes, that there is a good value for them and we do sell them. But until such time as we get that done, I can’t tell you for sure.

Jeffrey Bronchick – RCB Investment Management

And competitively speaking, either by geography or by business sector, are any competitive people going out of business? Anything that kind of stands up as a positive or a negative for you?

Myles S. Odaniell

You go back to Q3, one of the regional sheet producers out on the West Coast went out of business and then a competitor ultimately bought those assets and is doing some consolidation. What we see is some of the smaller players out there are struggling to hang on and time will tell whether they’re able to do that. But I think for the most part what you see is people just hunkering down pretty hard to weather this storm.

Operator

Your next question comes from David Begleiter - Deutsche Bank Securities.

David Begleiter - Deutsche Bank Securities

Myles, when you said you expected 2009 to be down, were you referring to your EPS in 2009?

Myles S. Odaniell

No, I was referring to our volume. We obviously, what we have seen throughout the course of 2008 has been a rather steady decline in overall sales volumes, reflective of our end markets so weakening. And from a budgeting perspective, we are planning on additional year-over-year volume reductions. In great part because that’s probably representative of what’s going on in the economy. It is certainly appropriate and prudent conservative planning and what it allows me to do, and the organization to do, is have to go out and find financial offsets to deal with that. So it really drives a lot of the cost take-outs that we have got going up for 2009.

David Begleiter - Deutsche Bank Securities

I know you don’t give guidance, but would you expect Q1 to be profitable or unprofitable?

Myles S. Odaniell

I think we’re working through that now. If I look at how we started our quarter, which is November, it was kind of like an October number, which would say we would be profitable. But having said that, December is really slow. And January, however, is a month that historically is pretty strong for Spartech. As folks destock toward the end of the calendar year, we tend to see a lot more come back in, in January.

I guess the bottom line is, we don’t know yet. We are obviously doing everything we can to drive sales and drive out costs but at this stage we don’t have firm forecast for Q1.

Randy C. Martin

I would think when you compare it to last year, last year was the first time we had a loss in a quarter and certainly the volumes distressed but some of the cost reductions that we have implemented should be carrying through and into the first quarter of next year and should be helping to offset that. But the real variable there is just where does volume go in the short term, particularly given, as one of the earlier callers mentioned, November and December falling into our first quarter with the extended shutdowns, that adds some further variability that makes it a little bit hard to predict.

David Begleiter - Deutsche Bank Securities

And on the goodwill impairment, what changed between last year’s measurement and this year’s measurement? What were the key assumptions that did move dramatically?

Randy C. Martin

It was the key assumptions related to the current economic conditions and the reduction in volume. We don’t necessarily end projections for goodwill determinations, project any upside or recovery in our model, and therefore if you look at the current economic conditions and the reduction in volume this year compared to last year, that pretty heavily drove the assumptions that we used throughout the whole model.

Operator

Your next question is a follow-up from Michael Harrison - First Analysis Corp.

Michael Harrison - First Analysis Corp.

Looking at the debt to capital following the write-downs, you are now over 50% there. You mentioned that the leverage ratio, just over 3.5x, how do those two metrics compare with what you would see as the optimal capital structure for Spartech?

Randy C. Martin

I don’t know that the book capital structure, given the change, really is the thing to look at. I think optimally going forward we typically assumed a 50% debt, 40% capital structure and that’s kind of how we look at investments and other things and setting our target rates. So I don’t think I would change that because of the changes we’ve had to the book values.

Michael Harrison - First Analysis Corp.

In terms of D&A for next year, am I correct to assume that that would be lower after the write-downs?

Randy C. Martin

It will be a bit lower, but I don’t think dramatically so. I think it’s in the neighborhood of about $4.0 million or $5.0 million lower, looking into next year. Most of what was impaired was goodwill, which didn’t amortize, so you don’t have much difference.

Michael Harrison - First Analysis Corp.

So something in the $40.0 million to $45.0 million range is a good number?

Randy C. Martin

I think $45.0 million is a good target.

Michael Harrison - First Analysis Corp.

And same question for interest expense next year.

Randy C. Martin

I think slightly down from this year. We wouldn’t expect a whole lot of change.

Operator

Your next question comes from Eugene Fedotoff - Longbow Research.

Eugene Fedotoff - Longbow Research

On engineering products, you reported very strong volumes there. Just wondering if you could provide some color on that segment and your expectations for the next couple of quarters there?

Myles S. Odaniell

That segment is driven pretty heavily by one particular business that services the lawn and garden market with wheels, and has a fairly seasonal demand. And in acceleration of being ahead of next year’s build season, which really starts traditionally in November and December, it started up in October, about a month early. So we saw that as a comparatively large increase over last year’s volume.

Operator

There are no further questions at this time.

Myles S. Odaniell

Let me just provide a couple of finishing comments here. And I certainly appreciate everybody joining us today.

In summary, we continue to work on two parallel paths. We are taking what I believe are all the appropriate actions on costs and the operations side to manage through what is a very significant and broad-based economic downturn impacting our business. We are going to continue to be flexible and further adjust our actions as needed to stay ahead of the situation, but I want to assure everybody we are doing what we need to in the short term to manage our businesses properly.

Concurrently, we are staying the course with the major transformational and financial turnaround initiatives, which we began shortly after I arrived nearly 12 months ago. During the quarter we made solid progress on these efforts and these are reflected in our lower operating costs, improved margins, and good cash flow. And going forward they will be reflected in what I would believe would be accelerated profit improvement based on the improved leverage we now have.

We are continuing our efforts and adding the right people and processes to drive future growth and ensure the long-term success and growth of the company. Our improvements will accelerate as we engage the appropriate resources and execute additional initiatives and certainly we look forward to keeping everyone informed of our progress and updates as we move ahead.

So once again I thank you for joining us today and we will look forward to speaking soon.

Operator

This concludes today’s conference call.

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