Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Joe Gingo – Chairman, President and CEO

Paul DeSantis – VP of Finance, CFO and Treasurer

Analysts

Rosemarie Morbelli – Ingalls & Snyder

Saul Ludwig – KeyBanc

Christopher Butler – Sidoti & Company

Dmitry Silverstein – Longbow Research

Robert Felice – Gabelli & Company

A. Schulman, Inc. (SHLM) F1Q09 (Qtr End 11/30/08) Earnings Call Transcript January 12, 2009 10:00 AM ET

Operator

Good morning, and welcome to this A. Schulman First Quarter 2009 Conference Call. Before we begin, the company would like to remind you that statements made during this conference call which are not historical facts, may be considered forward-looking statements.

Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied. In addition, this conference call contains time-sensitive information that reflects management’s best analysis only as of the date of this live call. A. Schulman does not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information, or circumstances that arise after the date of this call.

For further information concerning issues that could materially affect financial performance related to forward-looking statements, please refer to A. Schulman’s quarterly earnings release and periodic filings with the Securities and Exchange Commission.

I would now like to turn the presentation over to your host for today’s call, Mr. Joe Gingo, CEO and President. Please proceed.

Joe Gingo

Thank you.

I hope everyone received a copy of our first quarter earnings release on Friday. We typically prefer to do our conference call on the same day that we issue the release, but because of filing requirements and business commitments, we were forced to do them on different days this quarter. If you have not seen the release, you can access it on our website or send us a request and we will give it to you.

The first quarter of fiscal 2009 was extremely unusual and challenging. We continue to move forward with our strategy to cut costs, realign resources and focus on higher margin businesses. However, the market downturn was much more severe and rapid than we had anticipated. While our September performance was very similar to the pattern that occurred throughout fiscal 2008 and October showed just a slight decline, November turned significantly worse, particularly the latter half of the month. That is when our European the Mexican businesses began to experience the full effects of the global economic recession. And of course, the poor performance of the North American automotive market continued.

On a positive note, we are seeing benefits from our fiscal 2008 initiatives that helped us reduce cost and capacity in North America. We were able to hold operating losses essentially flat in our North American engineered plastics business even though volume declined significantly compared with the first quarter of last year. And while half of that volume decline was due to the market slowdown, the other half of the decline resulted from our planned elimination of lower margin business. In addition, the working capital program we initiated last year has continued its success in fiscal 2009. Cash flow was very strong in the first quarter, while our cash position and liquidity remain excellent.

I will now turn the meeting over to Paul DeSantis, Chief Financial Officer, to discuss our first quarter financial performance. After Paul speaks, I will provide some additional insights on our strategic activities and business outlook. Then we will address any questions you may have. Paul?

Paul DeSantis

Thanks, Joe. Good morning, everyone.

There are four main subjects I wish to review this morning that have had a large impact on our performance for the first quarter of fiscal 2009. They are, one, the economy’s effect on our volume and margin declines; two, foreign currency gains recorded during the quarter; three, non-operating costs and restructuring plans; and four, cash flow from operations and liquidity.

Let me start with volume and margin declines. For the quarter and in the month of November in particular, we experienced significant volume declines across all of our business units. Our total tonnage decline was almost 28%, with half of that occurring in November as the markets began to severely deteriorate. The largest tonnage decline was in our North American engineered plastics operation, particularly as a result of our strategic decisions made last year to cut back on unprofitable business and partially due to the market weakness.

In terms of market weakness, we are seeing two forces at play. First, as commodity prices have plunged, our customers have delayed and minimized the quantity of their purchases in an effort to avoid being trapped with high cost inventory. Under other conditions, this might result in a timing issue rather than a net volume drop. But we are also feeling the effects of the second force, as our customers are seeing their own order intake drop-off significantly, which ultimately requires them to purchase less from is. Margins have followed suit with gross profit as a percentage of sales falling to 10.6% from 11.2% last year. The greatest decline for Schulman in the quarter was in Europe where gross profit margin will from 12.7% to 12.2%. This decline was caused by two factors, both of which we are addressing with the actions we announced in December.

The first factor was a decline in European selling prices that was more rapid than the decline in our average cost of goods. As you may be aware, we account for the value of our inventory on an average basis. During November, the average selling price per pound of our product declined compared with October as market prices were swept into the sentiment created by the steeply declining market prices of commodities. This decline was greater than the decline in our average cost of goods for the month, so we were not able to hold on to margins.

Additionally, we made a conscious effort in November to move as much of the inventory as possible given the market conditions to minimize the amount of higher cost inventory in the event prices continue to fall. We now expect our raw material cost to stabilize in this new much lower band as our suppliers take capacity out of the system in the face of sagging demand. Also the average price of inventory purchased during November was below the prior month's level. This decline in average price of inventory purchases was larger than the level of selling price declines. If those prices relative to each other would continue to hold, other things being equal, we would have a positive impact on our profit compared with November’s results.

The second major contributor to the margin decline relates to the impact of the lower volume levels at our European facilities. In addition to selling of inventory in anticipation of further price declines, we also reduced production to bring the on hand inventory down. Pounds in the European inventory declined more than 9% from October to November. Unfortunately, we were not able to reduce our fixed costs in our facilities as quickly as the volume declined. We have initially addressed this issue with the line closures, elimination of jobs, and movement to short work week schedules as announced on December 10. These initiatives will help to reduce our manufacturing cost going forward.

We believe these two European issues had a negative impact of approximately $5 million pretax in November. As a result of the volume declines across each business unit, as well as the drop in capacity utilization, gross profit declined by $14.5 million to $41.1 million in the quarter from $55.6 million a year ago. Although we had favorable reductions in SG&A, they were not favorable enough to offset the gross profit decline resulting in operating profit of $6 million compared with $16 million in the first quarter of last year.

There is some relative good news in the P&L. In spite of the North American 40 plus percent volume decline, the combined North American segments reported an operating loss of $3.4 million compared with a loss of $3.2 million in the prior year. The loss of $3.4 million includes approximately $400,000 of plant startup costs and $300,000 of incremental bad debt expense. The flat operating earnings on such a significant volume decline are the results of the successful cost reduction initiatives we took last year.

The second topic I’ll discuss is the foreign currency transaction gain. We recorded foreign currency transaction gains of $7.3 million for the first quarter. We reported foreign currency transaction gains and losses in our P&L from time to time over the years and sometimes the numbers have been quite significant as they are today. These foreign currency transaction gains and losses arise when we hold or owe liabilities in currencies other than the local currency in that country. During the quarter, this effect was most pronounced in Canada and Mexico. Our operations in both countries hold US dollars because sometimes they transact business in their local currencies and sometimes in the US dollar.

During the early part of the quarter, the US dollar appreciated very rapidly with both currencies. For example, the Mexican peso lost more than 20% of its value as a result of these changes. These foreign currency transaction gains or losses are noncash in nature. They occur because the local operation needs to revalue the US dollar balances in their local currencies. In the case of Mexico, for example, the significant US dollar cash position was worth 20% more Mexican pesos from period to period although the amount of US dollar we as a company hold remains unchanged. The local operation has to account for more pesos when it translate that US dollar position. As a result, we recorded gain or a loss for the change in value that flows through that local profit and loss statement.

These foreign currency transaction gains or losses are different from the forward exchange translation gains or losses we regularly talk about. The foreign exchange translation gains or losses we typically discuss occur when we translate each line of our financial statements from our many currencies in which we do business to the US dollar. There is no impact on the local affiliates booked for this translation. The offset is recorded in accumulated other comprehensive income line of the retained earning section of the balance sheet and is not in the P&L directly as in the case of the foreign currency transaction gains and losses.

If you look at the accumulated other comprehensive income line of the balance sheet, you will note that the balance decreased from $18 million at the end of August to $21 million at the end of November. This is a result of the foreign exchange losses we have experienced, mostly from the dollar’s increase against the euro. Subsequent to the $7.3 million foreign currency transaction gains being recorded, we have liquidated our Canadian long position in US dollars and have begin to hedge the Mexican long US dollar position.

The third topic I want to discuss is non-operating cost and the impact of our restructuring plans. We announced on December 10, an additional restructuring plan to try to address the current volume and profit shortfall in North American engineered plastics, as well as the capacity and fixed manufacturing cost position in Europe. As a result of the restructuring plan to eliminate approximately 130 full-time positions, and to idle lines in Europe and North America, we announced we would be taking charges of $11 million to $15 million of which $4 million to $6 million would be in cash. During the first quarter we took approximately $600,000 of these charges. The balance of these charges is expected to be incurred during the second and third quarters of 2009.

We’re also seeing the effect of last year’s restructuring and cost savings plans in the results for this quarter. SG&A was down $4.4 million of which $1.4 million was due to currency. The remaining $3 million of the SG&A decrease was the result of the following items. We recorded a benefit of approximately $900,000 compared with the cost of $1.4 million last year for our equity compensation cost. This benefit was the result of our normal mark to market adjustment on restricted share units outstanding, primarily for our European team, which is based on the stock price at the end of the quarter. You will notice that we added a new table in the 10Q to begin summarizing equity comp cost. This quarterly adjustment will move as the stock price moves. Since we generally expect increases in the stock price, this should typically be a charge like last year.

We also recorded a charge of $1.6 million for the first quarter in corporate for spending with CRA Associates. This spending is related to the development of our strategic plan and to support our purchasing group. We incurred expenses of $500,000 in Europe in outside consulting expenses for the initial design and development of our shared service center. The balance of the decrease is the result of other savings initiatives we have underway. For example, spending in the North American segments declined by more than 25% from last year.

The fourth and last topic in my prepared remarks is cash flow from operations and liquidity. We reported approximately $44 million of cash generated from operating activities for the quarter compared with $8.8 million last year. The increase is due to two factors. The first is the decline in receivables. As the economy has declined, so have our sales, resulting in low receivables compared with the end of August. With the weaker economy and our sales decline, we would expect the cash flow impact on the receivable component of working capital to be positive.

The second reason for the increase in cash continues to be our focus on reduced working capital. Days of working capital decreased to 72 days from 73 at fiscal year end in August and down from 94 days last November. It may not appear to be a very significant decrease; however, given the sharp decline in sales volume at the end of November, it is still positive. One would typically expect inventory declines in these circumstances; however, our inventory accounts and stock are down approximately 9% from the end of August, reflecting our continued efforts to reduce inventory and keep it low. This is a good achievement, especially in the face of steeply falling demand.

We ended November with $116 million of cash and $109 million of debt, giving us a net cash position of $7 million. This compares favorably to our position at the end of August, when we had cash of $98 million and debt of $114 million for a net debt position of $16 million. In total, our net cash and debt position swung favorably by $23 million. In addition to the $116 million of cash on hand, we had are more than $300 million available to us on our credit line which are essentially undrawn. Capital spending was $11.3 million for the first quarter compared with $8.2 million last year. Spending was primarily for maintenance as well as the spending required to finish the Akron plant, which is now substantially complete. We will not be making significant capital purchases on anything other than for the basic needs of the equipment. We expect to spend approximately $25 million to $30 million for the full year.

With respect to our share repurchase program, during the quarter, we bought approximately 79,000 shares at an average price of $15.50 per share. Approximately 2.9 million shares remain available for repurchase under the current board authorization. We will evaluate the market share price and our liquidity position among other things and may continue to buy opportunistically.

As our results indicate, we are being significantly affected by the general economic slowdown. However, between our excellent liquidity position and our strategic cost reductions, we are well positioned for the anticipated continuing downturn and expect significant earnings to reach the bottom line, once the markets begin to pick up. At the same time, we will continue our initiatives to improve working capital and increase cash flows. We will continue to monitor the economic scenario situation and we’ll quickly implement additional cost savings initiatives if they become necessary.

With those comments, I’ll turn the call back over to Joe. Thank you.

Joe Gingo

Thank you, Paul.

We are pleased with the progress we continue to make during the first quarter in the areas we could control. As Paul mentioned, our cash flow was much improved, driven primarily by our tireless efforts to reduce working capital. Our net cash and liquidity positions also remain excellent. We are dedicated to maintaining our strong cash position and using it to our advantage, along with our distinctive technologies and products to secure leading positions in attractive markets.

In addition, our SG&A expenses declined $4.4 million from last year’s first quarter. Approximately one third of that decline was related to foreign exchange rate decreases, with the remainder resulting primarily from our fiscal 2008 cost reduction initiatives in North America. Indeed as mentioned previously, our cost control activities have allowed our North American businesses to largely offset the declines in volume that we have seen in the current economic environment. Those initiatives along with the additional actions we announced in December are successfully strengthening our North American operations as we continue to pursue our long-term strategy of growing our masterbatch business and focusing on profitable niches in engineered plastics. As a result, we believe our North American positions are positioned for at least breakeven performance during the last half of this fiscal year and a return to profitability when the economy improves.

In Europe, as Paul mentioned, we have proactively taken our initial steps to reduce capacity and rationalize our overall operations. With these actions, we are realigning our production capabilities to better serve evolving customer needs in the current market environment. If further action is required in our European operations, rest assured it will be taken and taken quickly. We also showed improved performance in our Invision sheet business which recorded operating losses of $1.1 million for the quarter compared with $1.9 million a year ago. We have reduced all non-essential spending on Invision as we refocused the business to non-automotive markets and continue to look for a strategic partner or buyer for the business.

We also announced last week the naming of Dr. Irvin D. Reid to our Board of Directors. Dr. Reid fills a position that was vacated when Dr. Peggy Miller retired. He was recommended by the Special Selection Committee and was unanimously appointed by the Board under the selection process that was announced as part of our agreement with Ramius in November. Dr. Reid has broad experience in strategic planning, management, marketing, finance and education. We are pleased to have him as another independent voice on the Board and we look forward to his contributions.

For the rest of fiscal 2009, we anticipate the uncertain economic environment to continue, and our focus will remain on sustaining liquidity to protect our shareholders. The poor market performance of November has continued into December, and we’re not expecting any significant recovery in January. Therefore February, the last month of our second quarter will be a key month in determining our outlook for the remainder of the fiscal year.

If demands to the very moderate level we experienced in October 2008, we will be able to stand by our prior guidance of $30 million to $35 million in net income excluding unusual items for fiscal 2009. However, if February demand shows no improvement from November and December levels, we will have to take further actions to align our capacity with demand and further reduce our SG&A costs. While we do not anticipate further significant capacity reductions in North America for fiscal 2009, as I mentioned, the situation in Europe may have to be addressed again as the economic situation unfolds. Regardless of what happens in the rest of the year, we remain committed to delivering superior returns in any economic environment.

On that note, we would like to open the call for any questions you may have.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Rosemarie Morbelli with Ingalls & Snyder. Please proceed.

Rosemarie Morbelli – Ingalls & Snyder

Good morning, all.

Joe Gingo

Hello.

Paul DeSantis

Good morning, Rosemarie.

Rosemarie Morbelli – Ingalls & Snyder

So, what was the capacity utilization in November and December at that particular level of business?

Joe Gingo

Paul?

Paul DeSantis

I don’t have the month of November handy. Let’s see if we can dig that out. We will have to dig it out. It was significantly lower than the capacity utilization we reported for the quarter though.

Paul DeSantis

Rosemarie, we can’t find that right now. We will surely get it to you.

Rosemarie Morbelli – Ingalls & Snyder

Okay. And as a follow-up to that, why wait until you see February environment before you actually decide to cut some more. It sounds to me and I don’t have the number I just asked for, but it sounds to me as though you still have a lot of excess capacity both in Europe and North America, so why not take those steps that you need to take right now?

Joe Gingo

Rosemarie, actually I don’t think we have a lot of excess capacity in North America at this point in time with the cuts we announced in December which were fairly significant cuts. I think your question is very relevant with regard to Europe, and let me assure you that we are looking very hard at the situation in Europe right now. As soon as I have specific plans, they will be announced, and there’s a strong possibility that will be before February.

Rosemarie Morbelli – Ingalls & Snyder

Okay. And then lastly if I may, just a quick question. What triggered your separating European and Asian results considering that Asia is still a very small number?

Paul DeSantis

We have a General Manager of Asia that we appointed as of September 1 to manage Asia. That General Manager reports directly to Joe who is our chief operating decision maker when it comes to looking at segments and evaluating performance. And as a result of that, we felt it was necessary to break that out as a separate segment.

Joe Gingo

Well, also, Rosemarie, to your point, I think in the future, not in the short term, Asia is going to have to be a growth region for this company, and I wanted to begin to develop a specific Asian strategy now and I felt it would be better placed by having an individual responsible for it who didn’t have responsibility for our much larger European operation and our much smaller Asian operation. So a lot of my decision was based on strategy development.

Rosemarie Morbelli – Ingalls & Snyder

Okay. Thanks a lot. I’ll get back in the queue.

Operator

Your next question comes from the line of Saul Ludwig with KeyBanc. Please proceed.

Saul Ludwig – KeyBanc

Hi. Good morning, everybody.

Joe Gingo

Good morning, Saul.

Saul Ludwig – KeyBanc

Paul, with the $7.3 million currency gain, any tax on that or is that pre-tax equals after-tax?

Paul DeSantis

There was some tax on the gain I believe in Canada – and Mexico, actually both of them.

Saul Ludwig – KeyBanc

So what do you think the after-tax impact was?

Paul DeSantis

I am going to have to think through that.

Joe Gingo

Paul’s got his calculator out here, Saul.

Saul Ludwig – KeyBanc

Okay.

Paul DeSantis

Between $5 million and $5.5 million, I don’t have the exact…

Saul Ludwig – KeyBanc

That’s close enough.

Paul DeSantis

Yes.

Saul Ludwig – KeyBanc

Okay. Joe, you mentioned you spent $1.6 million incremental this quarter versus last quarter for the CRA. That’s a lot of money. That is $0.06 a share. How much longer will you be using CRA and when will you be able to report to us on what its findings and outcome are?

Joe Gingo

Well actually, first of all, let me say that I have been delighted with the services of CRA. As you know, Saul, I have a long experience with consultants and I really have never ever in my career dealt with any better than I’m dealing year. But we are in the final stages of finalizing the strategy and presenting that to the Board of Directors. We will probably not be keeping CRA on at the same level of activity that we have up to now. As soon as the Board is comfortable, we will release the findings and our strategic plan.

Saul Ludwig – KeyBanc

What do you estimate the timing on that might be? And I’ll take your answer as a maybe not a commitment.

Joe Gingo

I would say over the next few months. We’re very close to being in position to outline where we’re going from here. Obviously, we’ve made a lot of changes in 2008. Right now my focus is on operations, Saul, because of just the very uncertain environment that we are in. But I am very comfortable with where we’re on a strategic plan development today versus where I was, let’s say even three months ago.

Saul Ludwig – KeyBanc

But what we can conclude is that this $0.06 of share impact that it cost you in the first quarter should gradually lessen to nothing by the end of the year?

Joe Gingo

Well, it will lessen to some smaller amount definitely. Nothing, I’m not so sure about, because I probably will keep them on some type of retainer, but it will be much less than $0.06.

Saul Ludwig – KeyBanc

Thank you. The next question, Paul, with regard to you put that inventory charge in your FF [ph], and I know you’re trying to move out all of your high cost inventories, not only from Europe, but also from North America. Was there any such impact of any special charges for inventory reduction in North America? Is there any lower cost of market adjustment that might be required in the second quarter, or is your inventory now in a cost position where it is lower than what market prices are?

Paul DeSantis

So, I’ll try to answer all those at the same time, Saul. In North America, we took a charge for a couple hundred thousand dollars for the lower cost to market for adjusting that inventory balance at the end of November. In terms of on a go forward basis for the second quarter, what we saw was a very, very significant decline, very steep and significant decline in raw material prices over the last really month, month and a half, two months. But it appears now that, we think it is going to start trading in a new and lower band. So we do not anticipate taking another lower cost to market charge at this time based on what we can see.

Saul Ludwig – KeyBanc

Okay. That’s good. Joe, with Invision, it kind of sounded like, if we go back three or four months ago, that may be by January, February, probably we are going to have a resolution of that. Are those sort of opportunities sort of fizzle in the current economic environment and kind of what do you see happening from here?

Joe Gingo

I think (inaudible) actually no. We still have a lot of active interest in Invision. I probably was optimistic on how fast I could push that through the process, but I really expect that within the next couple of months we should have this result and we have had a lot of interest in the product. I would say at this point in time, there is an equal interest between actually buying Invision versus having a JV and that is a decision we are going to have to make as we go forward.

Saul Ludwig – KeyBanc

And then you know, in your release, you said that the actions that you have taken in North America have positioned North America for at least breakeven performance going forward. Then in your remarks today you said in the second half of the year, you still would expect a loss in the second quarter before turning to breakeven in the third quarter?

Joe Gingo

Yes, I think – Saul, if I look at the second quarter, I think in my remarks I said it. December and January are not looking very good at all. If there is any turnaround, it is going to start in February. So I’m not really anticipating great results in the second quarter despite the measures that we have taken. Plus the measures that we have taken in the USA, I think we announced will not be completed until April. And so after that period of time, we should be in very good shape.

Saul Ludwig – KeyBanc

And finally, how bad was volume in November?

Joe Gingo

It was – as Paul indicated in his remarks, half of our total decline occurred in November, and the bulk of that decline occurred within the last two weeks.

Saul Ludwig – KeyBanc

So that might be off a number 40%, 45% or something like that?

Paul DeSantis

It would be closer to 40% than 45% in total.

Saul Ludwig – KeyBanc

Okay great. Thank you very much.

Operator

Your next question comes from the line of Christopher Butler with Sidoti & Company. Please proceed.

Christopher Butler – Sidoti & Company

Hi. Good morning guys.

Joe Gingo

Good morning, Chris.

Christopher Butler – Sidoti & Company

Just wanted to clarify to start with, with your comments this morning, you had mentioned as it pertains to your guidance, that you need to see February an improvement from November and December whereas in the press release on Friday you specified you need to see it closer to October. My understanding is November was likely very different from October. Could you give us an idea of where are we looking at here more, an improvement from October – I’m sorry, an improvement from November, December, or some thing closer to October?

Joe Gingo

Well, I’m sorry for any confusion I caused because I really to say the same thing, both in the press release and in the conversation. But fundamentally we did see a slight drop off in September, but it was much more like the normal volumes that we had seen all of 2008, and then we saw a little more of a drop off in October. And then as I just stated, half of the drop off occurred in November. If you would say that half occurred in November and then half occurred in September and October, probably two thirds of that half occurred in October with one third occurring in September. And I am getting approximations. But I felt that with what we have done and what we would probably still do, that October volumes will allow us to retain the guidance that we have out there. If we see the resolve that we saw in November and continue to see in December, I am going to have to relook at what the situation is, and so I hope I have answer that question for you, Chris.

Christopher Butler – Sidoti & Company

One of the difficulties that I have is since October we have seen a deterioration of the auto market here in the US, a lot of questions as to are we going to have a Big Three going forward, further deterioration of the housing market, and the overall US and now European economy. I mean just from the standpoint looking at February if you remove the inventory correction that we’re probably going through in November and December, wouldn’t February be hard pressed to match October levels?

Joe Gingo

No. I think what you have to remember is this. Let’s first of all look – you mentioned North America. First of all, we’re not very much involved in housing at all. So housing is a very minimal impact to us. Automotive is the major impact to us in the USA, it is not a huge impact to us in either Mexico or Europe. In Europe, automotive represents 5% of our total sales. So I think automotive – really we’ve started to see significant drops off in automotive volume in July, and they really haven’t deteriorated much worse than that until we got to in December when people just shut down plants. But from July through November, automotive volume was in the USA for us was fairly consistent. The real issue to me is the packaging market where we’re the dominant player in Mexico and the dominant player in Europe and we did see the drop-off in November as we saw in everything else, and the issue to me is where is packaging in February more than anything else.

Christopher Butler – Sidoti & Company

Okay. And shifting gears here a little bit, so looking at high-level strategic question, the last three months has brought a world of change to your market, to your situation. I noticed that your balance sheet is strong, net cash position, you bought back some shares, any change to the long-term strategy that saw you negotiating a possible purchase last summer now that you may be in a position of strength on the balance sheet side compared to some of your peers out there that aren’t dealing with that successfully?

Joe Gingo

I sort of mentioned to Saul we’re looking now at strategic alternatives and we are in the process of reviewing that with the Board. It is very obvious that our cash position is good, we plan to keep it that way, and it surely gives us a lot more options.

Christopher Butler – Sidoti & Company

I appreciate your time.

Operator

Your next question comes from the line of Dmitry Silverstein with Longbow Research. Please proceed.

Dmitry Silverstein – Longbow Research

Good morning. A lot of my questions have been answered but I would just like to go back to the working capital reduction that you have undertaken in the quarter. Should we expect these levels to continue or is this more a function of foreign exchange and inventory correction and once that is over we should see working capital kind of go back to the same levels of sales percentage?

Paul DeSantis

Well, I’m going to – I’ll answer that question a little differently Dmitry. We are targeted internally on days are working capital. So all of the incentives have been refocused on working capital days, and so you have heard me quote, I think we’re at 94 last November, 73 at the end of the year that. We have only got it down to 72 at the end of the first quarter under kind of exceptional circumstances. Our goal and we have said this in the past is to bring our working capital days down to competitive levels because I think we’re still above competitive levels. And if you look at competitive levels, they are anywhere between 50 and 60 days, and so depending on the nature of the competitor and how they are structured. So we believe that there is opportunity to bring that working capital down, and we’re going to do it. And we’ll continue to be focused on it. So that being said, if the market recovers, and we bring days down, there may still be a cash impact if the balance sheet in place because we now have more receivables and we need some inventory to service them, so that’s going to be a delicate balance that we’re really going to watch very, very carefully.

Dmitry Silverstein – Longbow Research

Okay.

Joe Gingo

Our focus on working capital remains.

Paul DeSantis

Absolutely.

Joe Gingo

It is really something we look at daily.

Dmitry Silverstein – Longbow Research

Okay. That’s good enough. Thanks for the clarification. And then secondly, when you talked about packaging markets in Mexico and Europe being important to your performance in those regions as well as to the possibility of meeting or not meeting your expectations for the second quarter, not to mention for the balance of the year. In packaging, can you give us a little more information on where you are exposed? In other words, is it more of a consumer exposure, is it more of a kind of shipments between businesses, I mean what has to change or improve in Europe and Mexico for your packaging business to do better than it did over the last couple of months?

Joe Gingo

Well, I think it is just a volume question, and we service all areas of packaging. We service the consumer and we service the industrial. For example, we are very big players in agricultural film, the film that is used over the crops. As I said, if I could see packaging back to what I was experiencing in even in September or October, which were not as good as I would have liked, I am fairly comfortable about my forecast. If they continue at extremely depressed levels that we are seeing in the second half of November and December, you have to remember, when I say exceedingly depressed, people shut down plants. People who used to shut down plants for a week, shut them down for two weeks. People who shut them down for two weeks, shut them down for a month. So I mean it was depressed.

Dmitry Silverstein – Longbow Research

Right. So a lot of that problem had to do with some inventory corrections towards the year-end and also trying to right size their operations to what are expected to be fairly pessimistic behavior of the market over the next six months or so. But assuming that the world is not coming to an end, you do expect with the inventory correction being over to see some recovery here, is that the right way of looking at it?

Joe Gingo

I think you actually hit on it very well. The speculation is this. End of this year for most people, our fiscal year being slightly different, but end of the year being December, did everybody – and then the bad economic environment, did people do their inventory adjustment, and were they more aggressive than they had been with also the dropping price of resin? Did they have write-offs on inventories they have to take as well, and is that going to start coming back in the latter part of January and in February. And I think you’ve got it exactly right or are we in for extended periods of depressed demand.

Dmitry Silverstein – Longbow Research

I understood. And then final question, if I make, – or you know what, that question has already been answered, never mind. That is it.

Joe Gingo

Okay, thank you.

Operator

(Operator instructions) Your next question comes from the line of Robert Felice with Gabelli & Company. Please proceed.

Robert Felice – Gabelli & Company

Hi, guys. A couple of questions.

Joe Gingo

Hello.

Robert Felice – Gabelli & Company

I guess first, I was hoping you can parse through the volume decline in a little more detail. Of the 28% decline, what was due to specific decisions to shed low margin business, what you would say is due to pure end market demand versus some of the inventory de-stocking that we have seen going on so we can get a better handle as to what is Schulman specific, what is end market specific, and what perhaps is volatility that we're seeing in the near term?

Joe Gingo

Okay. Paul, would you – I think you could address that.

Paul DeSantis

Yes. I’ll certainly start to try to address that, Robert. We said that volume for the quarter was down almost 28%. Of that decline, 7% of that was planned decline. In other words, that is capacity that we have taken out of the system by closing plants and reducing capacity. So that means we had a 21% decline from what we anticipated volume to be. That 21% now get a little harder to parse. I don't have in front of me how much of that is coming from the weakness in the market versus customers de-loading inventory.

Robert Felice – Gabelli & Company

Okay. Well, you said 14% came in November, so if we back that out, it seems like the organic run rate was somewhere around 7% or so, is that fair to say?

Paul DeSantis

I'm going to have to think though how you are calculating that. We said half the total decline – I see what you are seeing, half the total decline came in the month of November. In November, the planned decline, we said the planned decline in the quarter was 7%. For the month of November, the planned decline was 6%, which means the market decline was significantly higher. So back to answer your question, I think that quite a bit of what happened in November and I'm assuming what is happening in December is customers doing exactly what Joe said, our plants are closed, we see the material prices declining. We are not ordering.

Robert Felice – Gabelli & Company

Okay. And then Joe, I understand that your guidance is predicated on the turn in volumes in February, but how confident are you that that will actually occur?

Joe Gingo

Really, it comes back to what I said into the last question. If it really was truthfully an inventory adjustment taking place at year end, reflective of all the comments we had, I'm fairly confident. If we are into a period of just totally decreased demand, well, then I have to take a different look. Now in the meantime, I'm not going to sit idle. We have taken action in North America as I had announced, and that actually will be completed by April.

And I am, as I said to Rosemarie, fairly comfortable with my capacity situation in North America, even in light of the reduced demand. And also if you remember, this is really accelerated my shift away from automotive. This has been in a certain way – I mean has accelerated what I intended to do in the long run. So I think that the issue is pure and simple, what kind of demand are we, and almost any other industry, going to see in the second, third and fourth quarter of next calendar-year? I'm fairly optimistic because I am just by nature an optimistic person, but boy, I am going to have to see the numbers this time.

Robert Felice – Gabelli & Company

Okay. And just to help me get a better handle around the second quarter, it seems like the bulk of first quarter's decline in operating profit came during November. So I guess on that basis if I was to extrapolate that continuing as it looks like it has through the second quarter, how much of a decline should we expect, what should we expect the second quarter to look like?

Paul DeSantis

Well Robert, that's really a really tough for us to answer because it goes back to what Joe just said. I don't know where we're going to be in the second half of January, and I don't know what February is going to look like. So I have a forecast internally obviously, but I'm not really at a point, nor am I comfortable sharing that at the moment. I think what Joe has articulated is what we are looking at, which is December is always bad.

December was bad last year because as Joe said, customers shut down for a week last year. Now they are shut down for two weeks. But being shut down for a week still makes December a bad month. So we were worse than we were last year in December, but now to me, looking at January, the second half of January and February are really going to tell the story. We are also going to start to see the effect of our cost reductions.

So as Joe just mentioned, we have taken additional cost reductions in North America and we have taken cost reductions in Europe, and so we expect to see those flow through the P&L. We said that North American ones would be done and fully in place by the end of April. What we expect in effect for those to flow into the P&L between now and April. Of course, we expect the European cost reductions to hit. So we have a number of items that are up in the year and makes it very difficult for me to tell you. We're really watching this on a day by day and week by week basis.

Joe Gingo

But there's no question the second quarter of our fiscal year is going to be very difficult.

Paul DeSantis

Oh, yes. It is going to be a difficult quarter. Absolutely, Joe.

Robert Felice – Gabelli & Company

Okay. And then I guess lastly in terms of the FX gain, any clarity you could provide on what we should expect for the full year and for the second quarter?

Paul DeSantis

Well, we expect that to really drop off. As we said, we liquidated one of those positions that was driving slightly more than half I think of the total. The other position we have started to hedge much more aggressively. So our expectation – and plus there was a big period of volatility between the dollar and those currencies. So we have tried to really reduce our exposure to that and we are going to try to keep an eye on it going forward.

Robert Felice – Gabelli & Company

And I'm assuming the gain this quarter is included in your guidance?

Paul DeSantis

Yes. The gain is, just like all the – just like the unfavorable effect from the inventory moves and everything else are included in the guidance as well.

Robert Felice – Gabelli & Company

Okay. Thanks for taking my questions.

Operator

Your next question comes from the line of Rosemarie Morbelli with Ingalls & Snyder. Please proceed.

Rosemarie Morbelli – Ingalls & Snyder

A couple of follow-ups, if I may. Do you still have a feel for what was the level of inventory at your customers’ facilities, and where they are now in order to get a feel for how long they can deplete it if the demand level does not improve?

Joe Gingo

You know, Rosemarie, not a – it is sort of an intuitive feel more than a quantitative feel. Many of these people shut down for extended periods of time. You would feel that based on that if they were doing a normal ordering pattern, and they increase their shutdown period, you would feel that much of the adjustment was behind them. But at the same time, it's going to say, but is there any demand out in front of them. And I think everybody is sort of sitting around and waiting for the order now. I don't think people our pre-buying, Rosemarie. People are waiting for the order before they place the order.

Rosemarie Morbelli – Ingalls & Snyder

Okay. So it doesn't look as though February really is going to be any better?

Joe Gingo

I'm not so sure about that. It is because I think January will flip that out. In other words, if you add inventory and you had a reasonable amount of demand, you are going to deplete that inventory in January and you are to start ordering – at the end of January, early February, you are going to start to order again. What we will see is, is there any demand out there in March. And remember, I'm not asking for a lot of demand, I'm saying we just had to get back to rather a slow October to be in good shape versus a very, very weak November, December.

Rosemarie Morbelli – Ingalls & Snyder

Okay. And then the new masterbatch plant, I mean masterbatch, that goes to the packaging industry, doesn't it?

Joe Gingo

Yes, it does.

Rosemarie Morbelli – Ingalls & Snyder

And so, this is where you have some more pain, and you have a new plant coming on stream, what kind of orders do you have? Do have anything maybe for that plant? Is it going to be kind of idle for a little while? Can you give us a feel for what is happening there?

Joe Gingo

Rosemarie, actually the question will revolve around Mexico more than the plant in the United States, because most of what we put into our plant in Akron was material that was shipped into the United States from Mexico. So fundamentally the plant will run at capacity. I can stage up my capacity too. So while one line is fully operational right now, by the end of January, the second line will be fully operational, and there is demand against those lines.

What we had had before was, we had more demand in Latin America than I had capacity in Mexico to supply. So by bringing this capacity into United States, it was really freeing capacity in Mexico to go into Latin America. Now what will be the question is, what type of demand do I see in Latin America? I will still get a benefit from reduced shipping costs. Right now I am shipping out of Mexico primarily into the Midwest, so I have a plant in the Midwest that will be shipping in there. What I would really have to see is what happens to my Mexican volumes in Latin America.

Rosemarie Morbelli – Ingalls & Snyder

And we talked about the level of demand volume in North America, in Europe, what did you see? What are you seeing, and are you seeing any change in Latin America?

Joe Gingo

We saw the same slowdown in December that we saw everywhere else in the world and that, Rosemarie, we saw it everywhere. We saw it in China. Indonesia, Europe, Eastern Europe, Mexico and Latin America. Again I would go back to people who shutdown one week, they shut down two. People who shutdown two, they shut down a month. So I didn't see anything different anywhere in the world.

Rosemarie Morbelli – Ingalls & Snyder

Okay. So now the volume which was going for Mexico into North America is going to be manufactured in Akron, and you have enough capacity to serve all of your customers in Latin America. If Latin America continues slowing down, do have any plan or is it easy to shutdown some lines in Mexico whether temporarily or permanently, is that something that you have to look at?

Joe Gingo

Well, I have a lot of options in Mexico with temporary types of things. I doubt that I would do anything permanently because historically that plant really, really has run full. But if necessary I would take temporary action.

Rosemarie Morbelli – Ingalls & Snyder

Okay, thank you.

Operator

Your next follow up question comes from the line of Saul Ludwig with KeyBanc. Please proceed.

Saul Ludwig – KeyBanc

Hi. Just quickly, at the end of the fiscal year, you had $10 million construction in progress that you showed on your balance sheet. During the first quarter, you only spent $6 million on that spending, yet you show $17 million or $18 million construction in progress. What is going on for $18 million now that the masterbatch plant has finished and why was the increase in construction in progress greater than what your capital spending was?

Paul DeSantis

Well, the construction in progress, the movement in construction in progress is that we continue to spend on the masterbatch plant without putting it into service. So since we haven't put it into service the finishing touches of this spend have gone into the construction in progress. That should be the bulk of the increase in what is in there. In terms of the other piece, we will look up the answer and see what it is and I will get back to you with it.

Saul Ludwig – KeyBanc

Thank you very much.

Paul DeSantis

Thanks, Saul.

Saul Ludwig – KeyBanc

Bye, bye.

Operator

Your next follow question comes from the line of Christopher Butler with Sidoti & Co. Proceed.

Christopher Butler – Sidoti & Co.

Hi, guys. Just a couple of quick questions, did you provide what the savings was during the quarter from your restructuring plans, from past restructuring plans?

Paul DeSantis

We haven't provided that. Specifically, we haven't broken that out specifically. What we have done is we have baked all of those savings plans into our budget, if you will, or our plan that we are following for the year, and so we're actually tracking against that. And both our plant cost and our SG& are tracking slightly favorable to our plan. So our actuals are tracking favorably to the plan. The plan had those costs reductions baked in.

Christopher Butler – Sidoti & Co.

And as far as the volumes that you are letting go, should we expect to see more of that as we move into the second fiscal quarter?

Joe Gingo

I would say this, you know, I am doing a further downsizing in North America, as you are well aware and has been announced. That will be completed in April. We will again be walking away from lower margin business, particularly in the automotive ground. So a little bit more of that will continue through the second quarter, and at that point in time I really feel fairly confident that we will be much more like our European automotive business, primarily niche and high-value add.

Christopher Butler – Sidoti & Co.

Thank you again.

Operator

Your next question comes from the line of Dmitry Silverstein with Longbow Research. Please proceed.

Dmitry Silverstein – Longbow Research

Yes. I just wanted to follow up on your raw material and pricing discussion. It was encouraging to hear that you’ve worked your inventories down aggressively and with the levels of buying that you are doing right now, it looks like the pricing of your raw materials is going to be below what you can get in terms of losses in pricing. Do you expect to be able to maintain positive pricing to raw materials also going forward, or is it going to be kind of a constant battle as the year unfolds, or should it get better as the year unfolds?

Joe Gingo

Dmitry, it is a constant battle no matter what. But let me say it this way. I think it will not be a significant– I think Paul mentioned that. We are going to trade in the lower band of resin prices. So I don't think we're going to see volatility but nowhere near the kind of volatility we saw in the past. Now if demand would come back into the October timeframe, I think our ability to hold pricing is going to be very, very good. If that demand continues into November, December kind of demand, pricing is going to be difficult to hold.

Dmitry Silverstein – Longbow Research

Okay.

Joe Gingo

Because you always do come back in the end to the law of supply and demand.

Dmitry Silverstein – Longbow Research

Absolutely. That's what I'm guess I'm trying to figure out, are the laws working against you on the pricing front less rigorously than they are working against your suppliers on the raw material front?

Joe Gingo

I think right now I'd say to you it is a little early to tell because we don't know what the demand equation really is, and I feel that is going to unfold as we get into the latter half of January and into February. And then I'll have a really good picture as to what that demand looks like. As I said, if that demand is holding up as much as I’ve seen in October, which again I repeat was not strong, I am pretty comfortable we will be able to keep the differential fairly well. If that demand continues at November, December, it is going to be extremely difficult to keep that differential.

Dmitry Silverstein – Longbow Research

Fair enough, thank you.

Operator

With no further questions in the queue, I would like to turn the call back over to Mr. Gingo for closing remarks.

Joe Gingo

Thank you for joining us today. In conclusion, I want to reiterate that we remain focused on keeping our liquidity position strong while responding nimbly to changing market conditions and controlling those performance factors we can control. We're confident that our actions are building a stronger company for the longer term as well as minimizing the effects of the current downturn. We look forward to talking to you again next quarter when I believe we will have a much clearer picture of the economic environment in which we will be operating. Thank you and goodbye.

Operator

Thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: A. Schulman, Inc. F1Q09 (Qtr End 11/30/08) Earnings Call Transcript
This Transcript
All Transcripts