Spartech Corporation F3Q09 (Qtr End 08/01/2009) Earnings Call Transcript

Sep.10.09 | About: Spartech Corporation (SEH)

Spartech Corporation (NYSE:SEH)

F3Q09 Earnings Call

September 10, 2009; 11:00 am ET

Executives

Myles Odaniell - President & Chief Executive Officer

Randy Martin - Executive Vice President & Chief Financial Officer

Mike Marcely - Senior Vice President of Planning & Controller

Analysts

Jason Miner - Deutsche Bank

Mike Sison - KeyBanc

Steve Schwartz - First Analysis

Joshua Zaret - Longbow Research

Jeff Bronchick - RCB Investment Management

Operator

Good morning. My name is Marsha and I will be your conference operator. At this time I would like to welcome everyone to the third quarter 2009, Spartech earnings conference call. All lines have been placed on listen-only mode. Later we will conduct an interactive question-and-answer session. (Operator Instructions)

I would now like to turn the conference over to Mr. Mike Marcely, Senior Vice President of Planning & Controller. Thank you Mr. Marcely, you may begin your conference.

Mike Marcely

Thanks Marsha. Good morning. Thank you for taking the time to listen to our comments on our financial performance for our third quarter ended August 1, 2009. This morning Myles Odaniell, our President and CEO, will open the discussion with some observations on our progress with the improvement initiatives executed to-date, and then provide some high level points from our current quarters results. Then Randy Martin, our Executive Vice President and CFO will follow with a more in-depth look in our financial results before we open up the lines for any questions that you may have.

Before we begin our formal comments, I would like to remind you that we are webcasting this call. You can access this through our website at www.spartech.com. Also we have provided some supplemental presentation slides, which are also posted on this website along with the press release that we issued last night, which announced our third quarter results. Finally, Spartech’s Form 10-Q was also filed this morning and is available on the website.

During this call we may make certain forward-looking statements. These statements are based on management’s current expectations and are subject to change, and our actual results may differ materially from these expectations. Please read our commentary on forward-looking statements at the end of our press release or the statements in our quarterly and annual SEC fillings.

In our discussion today, we include references to non-GAAP financial measures for a reconciliation of our non-GAAP measures to our GAAP figures. Please see the schedules in our earnings release and contained in the supplemental slides.

You will also note that as a result of our progress in our restructuring and portfolio activities, our results include a distinction between continuing operations and discontinued operations. Typically our discussion will relate to continuing operations and exclude restructuring and exit cost, to provide you a consistent comparison to our historical results.

Now, I will turn the call over to Myles Odaniell.

Myles Odaniell

Good morning and thank you for joining us on Spartech’s third quarter 2009 earnings conference call. Randy, Mike and I welcome the opportunity to speak to you today regarding our current performance and our continued progress on transforming our company.

As you will see, we continue to make solid progress, executing on our improvement program in Spartech, which has allowed us to enhance our organizational capabilities, substantially reduce our cost structure, improve our operating margins, and delever our balance sheet, concurrent with making investments for future growth.

There are several key take-aways from Spartech’s third quarter results in today’s call. First, highlights of our Q3 2009 results were continued positive earnings trends, margin expansion and solid cash flow performance in the face of what continues to be very weak end market demand.

Second, we continue to execute our previously announced company-wide improvement initiatives to reduce our overall cost structure and accelerate our efforts to build a low cost to serve model. Our results now reflect the effect of executing structural cost reductions and other earnings improvements, which provide about $80 million of anticipated annualized benefits.

To some degree, our third quarter was about completing many of the major cost reduction initiatives started in Q1 and Q2, and then validating our ability to operate with our lower staffing and new operating cost structure. I believe we’ve done a good job in both of those areas. In addition to these activities, this quarter we announced additional plant consolidations and progress on our portfolio restructuring.

As we indicated last quarter, this is not just a cost reduction story. We are improving the capabilities of this organization and generating improvements that will impact the growth of Spartech, and enhance quality of our future earnings. These investments will continue to provide a positive momentum and earnings benefits in 2010 and beyond.

We have by many measures chosen a challenging time to drive this level of structural change in our company, as much of our positive results were offset by the impact of the recession and lower demand for our products. However, the lower volumes in this economic environment have allowed us to accelerate our actions and go even deeper in our cost reductions.

We are as you will see, making very positive progress with our change process and developing an organization with the capability and cost structure to grow, and certainly leverage market recovery. These actions are helping to mitigate the impact of the recession and to better position Spartech for the long term.

Our expectation is that Spartech will be profitable at all points in the economic cycle and certainly perform at significantly higher levels when demand recovers. We had significantly raised the bar on earnings potential with normalized demand.

Let me thank our employees of Spartech and express my appreciation for their efforts and significant contributions in the quarter. Everyone in this organization continues to manage through a very challenging set of external conditions and has approached these challenges proactively and with a high level of professionalism and personal resolve to succeed. We greatly appreciate those efforts.

Let me now highlight our key points from our release last night. Net sales declined 30% as volumes were down 25% in third quarter of 2009, compared to the third quarter of the prior year, reflecting continued impact to the recession and weak end market demand. As a general statement, we have seen some stabilization in our overall demands, albeit at continued low levels and as we highlighted in our release, volumes have been fairly stable at this low level for about six months now.

We are seeing pockets of demand improvement and we are encouraged by improved customer sentiment, but since we continue to have rather poor demand visibility, we still remain cautiously optimistic about timing and magnitude of overall demand recovery.

Our operating plans still assume the recessionary effects will continue through 2009 and that end market demand will remain weak. We certainly hope this turns out to be a conservative approach, but I believe this also allow us to keep the urgency in pressure on our cost reduction and improvement initiatives, rather than waiting around for demand recovery.

Operating earnings excluding restructuring and exit costs increased to $14.1 million from $11.5 in the third quarter of 2008, as the impact of improvement initiatives has offset the very significant impact of lower volume and the negative impact of the US economic recession. These initiatives reflect an array of activities and include approximately $80 million of previously announced improvement program, which is nearly complete now.

Gross margin per pound sold increased to $15.06 from $11.06 for the quarter, reflecting improved operating performance in our custom sheet and packaging technology segments. Improved margins reflect our cost reduction benefits and some segment patient benefits, offset by a less favorable product mix, which reflects a lower demand of what tend to be your higher value products.

Excluding restructuring, results of continued operations related to the closure of our marine business and the shutdown of our toll compounding business in Arlington, Texas. EBITDA for the quarter increased 7% to $24.8 million in comparison to Q3, 2008 and Randy will speak about our earnings performance in further detail in a couple minutes.

Diluted EPS excluding restructuring and exit costs were $0.18 compared to $0.16 in the prior year quarter. We believe, achieving stable operating earnings as comparable to the prior year with 25% lower volume, is a function of our ability to reduce cost and a testament to our result and ability to implement our strategy and execute on our previously communicated improvement initiatives.

Cash flow from operations was $26.9 million, and funded debt pay down of $26.5 in the quarter. Importantly, in the last four quarters the company has generated $81.8 million of free cash flow, and paid down $76.7 million of debt. Despite weak external conditions, we continued to generate solid cash flow.

We ended the quarter was $73.8 million of borrowing availability, which is very positive progress and I believe we have addressed any liquidity concerns that many have existed a couple of quarters ago. We continue to execute on our company-wide improvement initiatives direct that improving our cost and profitability, while positioning the company with a more highly leveragable cost structure to support volume recovery and long term growth.

During the quarter the company completed the consolidation of our Atlanta, Georgia sheet plant in the existing facilities, and the shutdown of our Arlington, Texas, toll compounding operation, as well as shutdown of our marine business, a market dramatically impacted by the recession.

In addition, yesterday we announced the planned consolidation of our Lockport, New York compounding operation into existing facilities, and the pending sale of our Profile Extrusion business in Canada. With the completion of these initiatives, we will have reduced our operating footprint by nine plants or roughly 25% in the past 18 months. Our progress to-date and success with execution of structural improvement activities at Spartech, provides us with a continued confidence that we remain fully on the right track.

As stated, we remain cautiously optimistic about the near term demand outlook, as we continue to have poor visibility from our customers. We also expect to face some short term pressure on increasing feedstock, but as a general statement, we have drastically improved our process, and focused on passing though higher costs on a real time basis, but commodity feedstock prices, at least in the near term remain volatile.

Several other important initiatives remain fully on track. In the fourth quarter we expect to complete implementation of our Oracle ERP system. This multiyear after will provide Spartech, with dramatic enhancements in our data availability and information from managing and improving almost all aspects of our business. Our focus will then transaction to business intelligence efforts.

Completion of Oracle implementation will that allow us to complete the financial shared service transaction in the fourth quarter. This activity started 12 months ago and essentially involved consolidating field financial resources into a smaller centralize group in St. Louis.

We’re also continuing our efforts on building operational and commercial excellence, rejuvenating technology and new product development. We’re working on a hundreds of improvement projects across Spartech, the impact of which will be added to our cost reductions and market recovery. We should expect to see benefits from those investments in 2010 and beyond.

With that I’ll turn it over to Randy, who will now provide some further details on our Q3 performance.

Randy Martin

First I’ll provide more details on key income statement components and then will offer some comments on our balance sheet and cash flow performance in the quarter, and the year-to-date.

Starting with income statement components, for sales, I want to provide a little more details to Myles comments regarding our sales volume decline of 25%. While volumes were down across all industries due to end market demand weakness, we saw particularly weak demand in three markets in our third quarter.

The transportation market was down approximately 47%, primarily related to domestic automotive, recreation; and leisure market decreased 36%, mostly related to declines in RVs, spas and boat sales, and the building construction market was down 38%, largely related to residential construction. These three markets still represent 40% of our sales mix. These declines are consistent with what is being reported across the sector for sales volumes into these end markets compared to a year ago.

While we still have poor visibility to the timing and magnitude of our overall economic recovery, these volumes declines highlight the significant impact of the recession on our business and should indicate to some degree, the potential future improvement opportunity on Spartech’s business overall, when we do see recovery. All the markets we serve continue to be weak, and demand is uncertain, but to further support our statements about the recent stabilization, our third quarter volumes were only 1% or 2 million pounds lower than our total in the second quarter.

We continue to monitor the activities in the automotive market and its potential impact on us. First, the automotive market represents 9% of our sales today. This is down from a peak of 16% just a year ago. Over the past year, we have reduced our cost footprint for this market and the consolidation of our Lockport facility announced in today’s release, is an example of continued cost reductions for plants serving this sector. We are managing our cost to lower level of business, but the extent and timing of automotive demand is uncertain.

Of the decline in volume in June and July for the summer, automotive company shutdowns maybe followed by a small bump in demand, related to the Cash for Clunkers program in August, but we suspect that this is just pulling in demand from later in the year. Overall, North American automotive builds stand at $5.2 million in the first eight months of 2009, which annualizes to $8 million in ’09 compared to $13 million units build in 2008 or a 40% decline.

From a balance sheet perspective, we have approximately $9 million of receivables, $8 million net of reserves related to suppliers to automotive companies, representing approximately 30 different customers for us. We believe we have taken actions to manage through the automotive crisis, and we will continue to monitor the industry and our customers, and make adjustments were necessary, and believe we are taken appropriate measures to manage through issues with this challenging end market.

Looking at sales in our core segments: Our sheet volumes were down 12% in the third quarter, compared to the prior year third quarter, considerably better than the second quarter comparison, which had sales down 29%, but still reflecting weakness in the overall markets offset by growth in a couple of material handling and appliance applications, where we have strong positions.

The Color and Specialty Compounds segment volumes declined 41% from the third quarter of 2008, similar to the second quarter comparison and reflecting the particularly weak early summer automotive demand, which still represents 19% of this segment’s mix. In the packaging segment, underlying packaging volume was only down 6%, consistent with our assessment of the overall rigid packaging market our non-packaging business that still was produced from plants in this segment declined 9%.

Next, I’ll talk about profit margins and costs: Our gross margin per pound increased from $11.06 in last year’s third quarter to $15.06 in the current year quarter, similar to the $16.00 achieved in the second quarter related to continuing operations. This increase was driven by our improvement initiatives. These initiatives consist of permanent structural improvements as well our shorter term cost reductions and spending control measures.

In our supplemental presentation slide, we show our bridge of EBITDA, that provides a breakout of the impact to the initiatives on our third quarter, reflecting approximately $2 million positive impact from the temporary reductions in compensation and benefits and $20 million from the structural cost reductions and other profit for the improvement initiatives that have been executed in the year.

We have indicated that we expect more than $80 million of annualized benefits from these structural actions that we’ve taken to-date. We expect the full quarter effect of the structural cost improvements that have been implemented will serve to replace the impact of shorter term or one-time benefit that ultimately will be restored. However, I also want to acknowledge that we are not yet complete with our overall cost footprint, manufacturing efficiencies, quality improvements, and other longer term earnings improvement initiatives many of which Myles just referred to you earlier in the call.

SG&A cost of $19.6 million, decreased $2.1 million from the prior year second quarter, resulting from both the impact of our move to our shared service model for accounting and transaction processing and the shorter term actions in the quarter. Total bad debt expense is included in SG&A for the year, it was $4.1 million, compared to $2.1 million for the first nine months of 2008 and we expect it will continue to experience bad debt experience a higher levels in the prior depending on developments in certain depressed markets, such as automotive and the impact on our specific customer base.

Reviewing operating earnings for our core segments, the amounts I’ll refer to will be excluding restructuring and exit costs, and on a continuing operations basis. Our sheet segment showed the strongest improvement with operating earnings of $10.3 million, a 47% increase over the prior year. Spartech Packaging Technologies was also strong with $8.1 million in earning, $3 million or 60% higher than the third quarter of 2008.

Our results in these two segments reflected the benefit of our improvement initiatives, which offset the impact of the lower volumes. The Color and Specialty Compounds Segment reflected at a decrease of $3.5 million largely from the low levels demand from most of the sectors, particularly automotive and this segment is impacted more than our other businesses by the summer shutdowns.

With regard to our balance sheet in cash flow, free cash flow for the third quarter was $25.3 million compared to $29.1 million in the prior year third quarter. The $3.8 million decrease was related to some initial improvements in working capital last year and while, we improved working capital in the quarter by $11 million the prior year improved by $17 million.

In addition, in the third quarter of 2009, we funded $3 million in cash charges related to the consolidation shutdown and discontinued operation restructuring activities that we either completed or initiated in the quarter that Myles, referred to in his earlier comments. For the year-to-date, we have generated $39.4 million free cash flow compared to $36.9 million in the first nine months of 2008, allowing us to pay down $37 million in debt.

Our working capital management has been solid. With working capital as a percentage of sales at 10% and contributing $2.4 million of cash flow for the year, we continued to affectively mange our capital expenditures and believe we can continue to spend at the rate below last year’s $17 million level, while this level is lower.

We continued to invest in resources to support future growth and organizational improvements. After the pay down from this quarter, we have total debt of $239 million and borrowing availability of $74 million.

Myles will now provide a few comments, before I turn over to the operator for questions.

Myles Odaniell

Thanks, Randy. Just to summarize again in the improvement initiatives at Spartech have positioned us to better manage through the challenging environment and I believe build a solid foundation for long term success. We would be very pleased to take questions at this point.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jason Miner - Deutsche Bank.

Jason Miner - Deutsche Bank

I know that your view on the restocking, destocking cycle sort of continued to revolve. Maybe could you help us think about with the summer shutdowns in autos, what are customers telling you, what do you think about inventories knowing that no one has those numbers, but what’s your sense at this point I guess, what I am really getting at is, will there be some restocking coming what we see a bump that transitory? What are your thoughts?

Myles Odaniell

Jason we talked about that a couple of times and while I acknowledge what you said is accurate, I think everybody’s destocked at this stage. We haven’t seen any clear indication from our customers that there is going to be a onetime restocking or permanent restocking of any consequence.

I think its fair to say that automotive will need to do that given the significant sales ahead over the last two months, but our sense was that is just pulling orders ahead that may have otherwise occurred in the fourth quarter or into 2010, so at this stage and again it maybe a very conservative approach to life we’re not banking on a restocking over the course of the next couple of quarters.

Jason Miner - Deutsche Bank

Then just shifting gears a little bit you mentioned some shift in mix. I wonder higher value products that you have seen decline, and do you think that’s cyclical and they return or have we lost some luxury products if you will that won’t comeback what do you think?

Myles Odaniell

Let me give a little more color to that because in essence, the shift in mix is really a function of what is think is starting to comeback first and we tend to have some, but I would characterizes lower margin business in some of our larger volume accounts that would be servicing say appliances or material handling applications and that business is actually started to pick up a bid over the course of the last quarter.

I wasn’t implying that some of our higher margin application have in fact gone away, they have gone down similar to everybody else, but some of the lower margin business is started to comeback first, we continue to be leave that as the economy recovers and will see recovery mix, probably commensurate with what we saw when it fell off last year.

Although I would also add but given the improvements in our overall cost structure, every pound of volume that we saw when volumes decline are going to generate a higher level of contribution when those volumes comeback, given the lower cost structure that we built here.

Randy Martin

Jason another element of mix that I may just comment on, if you looked at the bridge in our slide presentation, you’d see an element of mix they’re offset by foreign currency. The mix impact there which was about $1.4 million is related to the larger percentage of sheet and packaging business. For example, sheet was 47% of our business quarter, compared to 41% in the prior year, whereas carbon compound was down about 10%.

So the shift in mix to more sheet and packaging had a favorable effect in our quarter that was somewhat offset by a $1.2 million negative effect on foreign currency and we just chose to show that together in that slide, but does another element of mix that does affect us in the quarter.

Jason Miner - Deutsche Bank

Two other quick ones and I’ll get back in queue. You mentioned that you would see some feedstock headwinds. Is there way for us to think about, what the EPS hit might be in Q4 given what you’re seeing from resins?

Myles Odaniell

Yes, I think the simple answer is, no at this stage and we really put that asset just to continue to highlight that there’s a lot of moving pieces in the business, but I think we all have that reasoned that well. I think what we’ve seen is some announcements from most of the suppliers at this stage trying to push up our prices. I believe, some of those will ultimate stick and we’ll pass those on our customers, I think equally show or seeing some signs and a lot of these announcements are going to happen at all.

So it’s more just to continue to highlight that there is a lot of volatility in our raw materials and that brings some level of uncertain in terms of kind of those short term outlook, but I said, since we’ve prove those process is dramatic as we’ve commented on another calls, we restructured many of our contracts in the packaging space it tended to have the lengthy lags, they’re not all eliminated, but many of those price pass through formulas has been shortened in terms of the speed.

Then as a continued general statement, we endeavor to and I believe, we’re recently successful at this to pass through raw materials on a real-time basis for all of our non-contract customers. So, if a supplier announces an increase, we go out and we work to get that in the marketplace.

Jason Miner - Deutsche Bank

Lastly, Randy could you just comment maybe on the tax rate it was higher than I expected and what do you expect to going forward?

Randy Martin

Yes, there is three items it affected. One is the loss in Donchery that can’t be tax affected. We typically do our tax return to provision true-up in this timeframe as well. We had one other item that impacted us from deductibility from a permanent standpoint. Given the lower taxable income that we have that has a more impact on the rate right now, but those three items impacted.

We do see 37% to 39% rate is being more typical, that can’t be impacted by losses in a particular quarters through Donchery, but we see those diminishing after the shutdown of our Donchery Sheet business earlier in the year, but those items can impact it, but over the longer term that 37% to 39% is a more reflective typical rate.

Operator

Your next question comes from Mike Sison - KeyBanc.

Mike Sison - KeyBanc

In terms of material cost or raw material cost, were they up in the third quarter of ’09 versus the second quarter of ’09?

Randy Martin

I think, you think about that across to all of the resins, Mike. I would say up from the third quarter slightly, but most of the analysis that we see more in the late July, August timeframe, that’s were the heaviest increases has been, but I think on balance overall we were slightly up in cost from second quarter to third quarter.

Myles Odaniell

Mike, I would add. I don’t have the number in front of me, but clearly we saw some raw material increases over the course of second quarter.

Mike Sison - KeyBanc

In the third quarter you were squeezed or there was any negatives from the recent rises that impacted you in the quarter?

Randy Martin

No, maybe a little bit end of July, Mike, but not really for the quarter overall, I wouldn’t say we’re negatively impacted by resin to any material amount.

Mike Sison - KeyBanc

Is the lag sort of a month now, meaning that is their price increases come up in August and September, they happen to stick, you might just be squeezed from month, but any catch up in the first quarter of 2010?

Myles Odaniell

I would say, if we were to try to aggregate all of the pricing mechanisms that we have in place. The ones that are kind of real time, the ones that are contractually a quarter, there are still a couple that might lag, a month kind of thing. A month is probably is a good fair number.

Although I think for the most part, certainly in our sheet business and certainly in the color and compounding business, those tend to be closer to real time, but again, anytime you see an increase, you’ve got to chase it down and it doesn’t happen continuously, although we’re getting closer and closer to that, there’s going to be a little bit squeeze.

Mike Sison - KeyBanc

So when you think about the fourth quarter, in terms of demand, when you referred some other companies, it seems to me that demand should be sequentially better through your businesses in the fourth quarter versus third? So sales should continue to sequentially improve a little bit?

Randy Martin

Yes. I think Mike, we’ve stated that, we’ve made the assumption that’s going to be flat or stable I guess more accurately, but there are indications in certain markets, where you are seeing some pickup, but we’re still going with the assumption that they’re going to be relatively stable to third quarter.

Mike Sison - KeyBanc

So if sales were up in the fourth quarter versus a third, which our earnings or say op income or gross margin per pound, continued to improve given cost savings and such throwing through the income statement?

Randy Martin

I think, but for any of that temporary impact on for that, 30 days or whatever you want to try to qualify for resin. I think that’s reasonably accurate statement. We do have some further initiatives. We announced the Lockport closure this quarter. So, I think that would be true except for mix and resin pricing.

Mike Sison - KeyBanc

As we enter into 2010 Myles. Given and just sort of set a base case, if your volumes were sort of flattish, which I sure you would be disappointed, but all the cost savings you generated and given that the first quarter of ’09 was sort of unusually bad quarter, your profitability should be up next year on very low growth if you will?

Myles Odaniell

I think that’s very accurate. I mean that the first quarter for everybody was pretty [abysmal], and I would include ourselves in that assessment. Given the kind of the run rate and the ramp up of all our cost reductions, you should expect to see in the first quarter of the next year’s fiscal year, a significant benefit from, a full quarter’s benefit of the cost reduction improvements. Even, if you don’t see any kind of volume recovery and certainly if you look at the volumes in the first quarter they were pretty poor last year, I would certainly hope we have a better quarter from the volume perspective as well.

Mike Sison - KeyBanc

If I think about the pure volumes that you have lost in ’08 and ’09 though to end it up, it’s roughly 500 million pounds and so if you get good portion of that back? Do we apply that contribution margin of 0.25 to 0.30 per pound to sort of try to figure out? Where the earnings potential for Spartech going forward?

Myles Odaniell

Let me give you my prospective on that. If you, look at peak to trough off demand and I would describe the peak, probably somewhere between the ’06 and ’07 timeframe because, if you recall we went into the recession in the fourth quarter of ’07, I think the data would indicated at this stage. Our volumes were down 516 million pounds from that peak to today’s trough and than we’ve been in the trough for a quarter till now.

I think, it’s fair to say that a piece of that volume will probably never recover, we wouldn’t expect given that we shutdown of our Marine business to see that volume recover and we had some business out of our Arlington, Texas compounding plant that our customer went in to bankruptcy and that volume will not be coming back and certainly there is pieces of that you could certainly take off the 560 and then the question is, how much up to the remainder could comeback with economic recovery and if so how much of that so.

I would say this, when volumes declined, our margin was in the $0.20 to $0.25 a pound range in terms of incremental contribution loss. When volumes comeback assuming a comparable mix, our margins ought to be in the $0.25 to $0.30 range given the improvements we’ve made structurally on our cost.

Real question is, what’s the multiplier that get supply to that and when do you get to apply that. If you assume a couple hundred of million of the 560 never comes back, you still have 350 of volume and if you assume half of that comes back in the next two, three years, you can apply that earnings and look at what the upside ought to be for the company.

Operator

Your next question comes from Steve Schwartz - First Analysis.

Steve Schwartz - First Analysis

Randy, what did your conversion cost look like in this quarter? I think last quarter you guys commented, they were down about 30% year-over-year looking at similar still?

Randy Martin

Yes, obviously some of that’s driven by the volume, but we do our fixed cost reduction as well related to the $20 million of structural cost reductions that we reflected in the slide that we showed in our presentation. So certainly, we’ve seen that continue to go down and it’s at a much lower level than what it was a year ago and even to some degree a lower than it was last quarter.

I think even our per pound basis we performed better in this quarter than what we did at last year’s third quarter. So I think by all the measures, we have definitely taken out the structural cost and those are reflected in both the dollar figures as well as the per pound metrics.

Steve Schwartz - First Analysis

So even you say, even lower than the second quarter.

Randy Martin

Yes, on a dollar basis it’s correct and on a per pound basis, lower than prior year.

Steve Schwartz - First Analysis

On a dollar basis, roughly speaking, are we talking $2 million, $3 million, $5 million?

Randy Martin

Yes, in the quarter, yes, I didn’t actually quantify that we are more comparing the $20 million of structural cost reductions from last year’s quarter, but I think in neighborhood, for discussion, it’s probably greater on the right level.

Steve Schwartz - First Analysis

Then just delving into packaging, the operating margin in that business has fluctuated pretty widely over the pass three quarters, but revenues been about the same level. Is that once again because of a mix issue, or is there something else in there we’re not hearing about?

Mike Marcely

There is the impact and we’ve referred to that market that it has more of the contracts that have a one month or in some cases a quarterly adjustment factor. So you can see some fluctuations quarter-to-quarter on the margins that would be impacted by that. There’s an element of mix.

We have the thermoform containers and then we do some, that we’re not thermoforming out to the packaging market from that group, so that can have a mix impact. So there are certain things that do impact the margins, even though the sales have been relatively stable from quarter-to-quarter.

Steve Schwartz - First Analysis

So where do you expect to that to maybe settle out for the next couple of quarters? Do you think it will stay up in this 15% to 17% range?

Randy Martin

Again I think percents are a little bit problematic given what resin prices may do. So I always caution when we talk about percents and think of it more on a per pound basis, but I think what it sound of the last couple of quarters is not unlike what we should expect going forward on a per pound basis.

Steve Schwartz - First Analysis

Then just lastly to go back to discussion you were having with Mike, about raw material cost. When I just look at where cost were trending, it looks like since February and March, they’ve been gradually moving their way up and yet here through July, your price was declining? What exactly was happening in there? How come there appears that way to be more of a lag that you see eliminated?

Randy Martin

When you say price, you’re referring to the sales price per pound?

Steve Schwartz - First Analysis

No, I should use the work cost, because when I take a look at the cost of polystyrene, polyprop, polyethylene. They’ve just been on this gradual increase, quarter-over-quarter we’re posting double digit gains even in the second calendar quarter and now in the third calendar quarter. So you’ve got your price still negative. Why does that appear to be such a big lag?

Randy Martin

The price negative is referenced to over the prior year period. So because of the dramatic drop in prices that we saw from the fourth quarter to the first quarter, that’s having the biggest impact. Now, we’re rising from those very low levels, but we’re rising gradually and that drop is pretty distinct at the beginning of the year.

So still comparing to the prior year, there’s a negative impact from mix, but you would have compare consecutive quarters, which is somewhere your discussion was leading. You would see more of a gradual trending up, but compared to third quarter of ’08, it’s a little maybe counter intuitive because of the significant drop that we had in prices, but 20% or 30% going from fourth quarter to first quarter in some of those major resins.

Operator

Your next question comes from Joshua Zaret - Longbow Research.

Joshua Zaret - Longbow Research

This is Zaret, calling for Dmitry. Just two quick questions, as free cash flow has been improving and very strong last couple of quarters I was just curious what is the plan for free cash flow going forward is it still debt pay down the focus here?

Randy Martin

I would say we defiantly of the alternative pay down some more debt we certainly have continue to put the focus on our working capital management to continued drive that through and retain that at 10% of sales or loss, we have managed capital expenditures very carefully and certainly the initial implementation of that is to pay down debt.

Now some of that is certainly funding the improvement initiatives that we have talked about the $3 million that we expended this quarter for the restructuring efforts and the close down some of the facilities, but overall its pay down debt first and then funding those initiatives second and as Myles talked in his conversation, we still have an I on making sure that we’re doing that right things from the innovation technology and new product development standpoints so that we are moving that forward at the same time.

Joshua Zaret - Longbow Research

As far as SG&A expense, how much can we still expect further improvement in the next couple of quarter here with your cost cutting initiatives or as some of the temporary things begin to unwind can we expect that to tick up I guess?

Randy Martin

So, I think you have a couple of things in SG&A you do have the temporary initiatives that we have talked about that will start to be restored, you also have investments that we have made in Oracle that Myles referred to that was $27 million is depreciation non-cash, but it has been expended over the last two years that does impact those metrics and in the metrics of investing in other resources for the new product development and innovation.

So, I was say that those are the biggest item that we know will impacted FX can also impact that numbers as we mention this quarter we are negatively impacted by $1.2 million with the Canadian dollar or change. So we do have some fluctuation that can happen quarter-to-quarter there.

So in general I wouldn’t really expect any significant decreases from where we were, and with some of the implementation efforts versus the investment are making maybe are similar right around where we are depending what happens with FX.

Operator

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

Jeff Bronchick – RCB Investment Management

Do you guys have anything is like to add or comment on or update with from your July 23, press releases that suggest about your natural progression of efforts to execute strategy and allows to continued effects structural changes in the business and operating portfolio and in other words divestitures, acquisitions kind of where you mentally stand, now that you’ve made tremendous strides in, now right sizing the business?

Myles Odaniell

Well obviously we communicated last night two activities that would broadly fall under the heading of portfolio restructuring and obviously the completion of the shutdown of our Marine business as well as the sales of our Canadian profiles business. I would say Jeff, above and beyond that our policy has been to not preannounce any type of work we’re doing on the overall portfolio.

We continued to look at each of these businesses individually in terms of today’s potential and I think their future potential under scenario of being improved and then some level of volume recovery and based on that, we’ve gone through the portfolio and kind of assessed where we would like to be like two years from now and we do have some strategic projects were exploring, but nothing that I can give you a specific update on today.

Jeff Bronchick - RCB Investment Management

I mean would you suggest that the stability over the last six months in volumes plus your increasing handle on what you’ve been inherited has lifted your eyes to be the likelihood of being more offensive over the next year or still in defensive mode?

Myles Odaniell

I don’t say somewhere in the defensive mode right now. I believe, we have taken appropriate and necessary actions to as I referred to it capitalize on the opportunity that was hear at Spartech. I mean, shame on us for having a level of cost in efficiencies that we have had and I think this group has cutter under, and chase most of those down pretty effectively.

Having said that, we’re not done with that effort there is still a lot more we believe we can do on the cost side. I do think there will be a gradual transition from what I have refer to last quarter, is kind of pulling the big levers of cost take outs to doing some more of the more elegant continues improvement types activities, but those I think we’re going to carry with them real opportunities well.

So there is more come on the cost side. In terms of us, getting more offence that were do you use. I think, we’re still for the next quarter till than it been clearly focusing on insuring we got a level of appropriate stability continuing to pay down debt and delivered the company and then I think early next year will be I will tell you where we’re going from this point forward.

Operator

Your next question comes from Mike Sison - KeyBanc.

Mike Sison - KeyBanc

When I think about your operating rates, if you end 2009 at about 900 million pounds, it sounds like you sort of have 350 million pounds to 400 million pounds to go after. I would suggest your operating rates would be running around 70%. That seems to be sort of a normal downturn area to be at. Is that sort of the right assessment?

Myles Odaniell

Let me clarify your assessment of 70%, is that your assessment where we are today?

Mike Sison - KeyBanc

Yes, sort of a 900 million pounds run rate and then I added sort of that 350 million to 400 pound notion that you suggested earlier to my question in terms of, but sounds to be would be full capacity.

Myles Odaniell

We’re actually at a lower level. I don’t have the exact number in front of me, but we’re probably at a lower level and 70% today. As we’ve communicated in the past, why we have shutdown a lot of plants and consolidated operations and shutdown physical buildings? We have not really eliminated any of our effective production capacity, with some notable exceptions of course, but for the most part we haven’t taken capacity outline.

I would venture to say that our effective capacity is probably closer to 60% on average across the company and that certainly that level of volume, whether it’s on the high end or low end of that number, we feel very comfortable we could take that all back on without any further need for capital investment.

Under the presumption that the mix that we lost was the mix it comes back and I suspect different products for different capabilities, but as a general statement, we ought to have plenty of capacity to handle that when it comes back.

Mike Sison - KeyBanc

How many plants will you have by the end of the year?

Mike Marcely

We’re seeing it right at about 34 Mike, from about 42 just about 80 months ago.

Mike Sison - KeyBanc

Myles, cross our fingers, the economy heads back in the right direction in 2010 and 2011, let’s just say low growth. You’ll benefit from that, I’m sure you have some growth strategies that you’re implementing now to sort of not wait around for the economy to recover. What with the growth rate on a top line basis should be for Spartech under an environment where the economy is starting to grow again?

Myles Odaniell

I’m not sure I can answer that I think at this stage, we’re still in a mood as we’ve indicated, where we view the volumes to be at a fairly depressed level Mike in it.

Until we have some clear indication, I can’t tell you whether we’re going to see a restoration in some modest GDP type growth at 2%, 3% or we’re going to in fact kind of get a one-time bump of 20%, which is certainly some people believe it could happen or anything in between those two. I can’t say that, we are focusing on what we control ourselves, which is not waiting around for the economy to drive our growth.

It is managing our new product development and managing all our key account planning and our strategic growth targets, which is our sales activities, and I think it certainly reasonable believe that on a go forward basis we can carve out mid-single digit growth rate just from the kind of things we’re doing our self fully independent of any type of economic recovery.

Mike Sison - KeyBanc

Then last question, Color and Specialty Compounds is a business that certainly more cyclical, it’s recovered, but it hasn’t recovered to the degree that Custom Sheet and Packaging Technologies, and I know historically Spartech has thought that this was a strategic vertical integration strategy.

You added some good value in certain cases being sort of the raw material supplier for the Sheet and Packaging Technologies business. Any changes to that view, is this still a strategic as a business for you guys as it has been in the past and just give us a sense of what you’re thinking about for that sort of business segment though near term?

Myles Odaniell

Let me just first clarify, you made the comment that the other businesses that recovered better than CSC, and let me give you my perspective on that. I actually think for the most part, the packaging business has been recently stable throughout the economic cycle. Our volumes are down somewhat. They’ve only been off to the degree that we’ve been able to more than offset that with cost improvements and other operational improvements.

So the standalone kind of performance of the packaging business is pretty solid in the scheme of things. Equally, so I don’t really think we’ve seen a recover rate in the Custom Sheet business. What I do think, you’re seeing there’s that’s been kind of the central epicenter of a lot of our improvement activities in the company.

The major theme for that business has been fix and grow, and we put a lot of effort in fixing that and I think as a consequent you’re seeing some improved performance, but I think the recovery as you would characterize is yet to happen in that business from a demand standpoint.

I think specific to your comment on CSC. It has certainly on a relative basis has been much more impacted by the downturn, where we talk about volumes being off 15% in packaging and 20% to 25% to 30% in sheet, this has been 45% to 50% in compounding. So it has been much more impacted and we’ve not seen anything in terms of demand comeback there yet.

I think clearly in our portfolio, it is a business we are managing to maximize cash to fund growth and investments in other business. We as you’d indicated, continue to believe there’s a level of integration that is unique and it affords us some value particularly in the sheet business and having that, but having said that, I think it’s one that continues to under perform and as we go forward we’ll continue to assess it as long term role in the portfolio area.

Operator

There are no further questions at this time. Do we have any closing remarks?

Myles Odaniell

We do and I just would like again to summarize that the improvement initiatives that we’ve embarked on to position the company to get through, what continues to be a very challenging set of conditions, but also concurrent, we’re dealing with those situations. We’re working on building a solid foundation for the company.

We will continue to take additional actions to reduce our cost both in response to the market, but importantly, proactively to capitalize on the unique opportunities that continued to exist at Spartech today.

With the execution of our improvement initiatives, we’re now focused on generating growth through technology and providing innovative solutions and then leveraging our lower cost structure to see improved benefits for what we do see demand recover. As Randy and I, both highlighted concurrent with a lot of focus on cost, we are continuing to invest in the future of our business.

We are confident that the discipline and commitment of our employees, which has a lot of us to deliver improved results during the economic downturn. We’ll continued to serve as well as weak transition more to growth and driving future earnings improvement activities. Hopefully, everybody is comfortable as we are that we’ve remain very enthusiastic about our future and we certainly look forward to keeping you updated on our continued progress. We thank you for joining us toady.

Operator

This concludes today’s conference call. You may now disconnect.

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