A. Schulman F1Q08 (Qtr End 01/12/07) Earnings Call Transcript

Jan. 6.08 | About: A. Schulman, (SHLM)

A. Schulman (NASDAQ:SHLM)

F1Q08 Earnings Call

January 4, 2008 2:00 pm ET

Executives

Terry Haines - Chairmanof the Board

Paul DeSantis - CFO, VP-Finance, Principal AccountingOfficer, Treasurer

JoeGingo - CEO, President

Analysts

Robert Felix - Gabelli and Company

Christopher Butler -Sedoti and Company

Saul Redwick -KeyBanc

Gregory McCostal - Lord Abbott

Operator

Good afternoon and welcome to this A. Schulman’s FirstQuarter 2008 conference call.

Before we begin, the company would like to remind you thatstatements made during this conference call which are not historical facts maybe considered forward-looking statements. Forward-looking statements involverisks and uncertainties that could cause actual events or results to differmaterially from those expressed or implied. In addition, this conference callcontains time-sensitive information that reflects management’s best analysisonly as the date of this live call. A. Schulman does not undertake anyobligation to publicly update or revise any forward-looking statement toreflect future events of information or circumstances that arise after the dateof this call.

For further information concerning issues that couldmaterially affect financial performance and related forward-looking statementsplease refer to A. Schulman’s quarterly earnings releases and periodic filingswith the Securities and Exchange Commission.

I would now like to turn the call over to Mr. Terry Haines,Chairman of the Board, please proceed, sir.

Terry Haines

Thank you very much. I would like to thank everyone fortuning in. I think we have a nice, large group on the phone today.

This will be my last call with the analysts and investors.I’d like to take this time to say thank you for the past associations with thepeople on the phones. It goes back many years and I have enjoyed theassociation. I do thank you.

I’d like to do a real quick review of our first quarter, andthen I’ll be turning it over to Paul DeSantis to give a comprehensive review ofthe financials and the press release.

Also later, I will be introducing Joe Gingo, our newPresident and CEO for the company. Then we’ll open it up for Q&A, answerany questions that you may have about the company. I’ve been advised that wewill not be able to take any questions that would relate to any of the proxyissues. I wanted to get that out there.

I’d first like to congratulate Joe Gingo for his start inreviewing all of our businesses and all of our business units worldwide, and Ithink even our best opportunities for the company in the future. I think thisno-stone-unturned approach is not only necessary to make sure that we have theright strategies for these businesses we have worldwide and continue theimprovements that we’ve seen in the company’s performance in the two quarters.I commend Joe strongly for this important effort.

The quarter, to me, confirms the right candidate for the CEOposition for Joe’s expertise, not only his technical background andunderstanding of polymers and understanding the plastics business as well asthe rubber. His international experience and his understanding, certainly ofour company, has allowed him to make this quick start.

In the quarter, in my opinion, it was an excellent quarter.I believe this confirms the effectiveness of our cost improvement programs,including getting the best cost savings in SG&A and I congratulate theemployees and the company for this first quarter improvement, in fact, on topof our strong fourth quarter for our last fiscal year. We promised that we’d make improvements andprofit this year and I think that we’re on track for our expectation of $36million in net income for fiscal year 2008.

I’d like to add that I believe that this performance for thefirst quarter was done in a somewhat difficult marketplace and certainly achallenging economy here in North America. I’m pleasedwith what we have for a report for the first quarter. I am getting really proudof our team and what they’ve achieved and the fundamentals for the quarter werepositive for gross profit, sales and tonnage. The positive translation effectthat we had for the most part was offset by certain charges to the P&L thatPaul’s later going to detail.

The 30 basis point improvement in gross profit is the resultof the company successfully passing through the raw material price increases toour marketplace. I would expect that we would see additional improvement in ournext quarter if, in fact, our volumes continue to hold at high levels. Ibelieve this gross profit improvement and other performance improvements willbe an ongoing focus for the company in the future under Joe’s direction.

With that, I’d like to turn it over quickly to Paul DeSantisfor his detail of the financials. And then I’d like to introduce Joe Gingo andthen again have an opportunity to answer questions you may have about thecompany.

Paul DeSantis

Thanks, Terry.

We have a few unusual items to report during the quarter. Wehad a $1 million pre-tax charge for approximately 700,000 after-tax related toemployment termination costs in Europe. And we had a$400,000 pre and after tax charge in North Americarelated to the final settlement of an insurance settlement claim related to HurricaneRita.

For the first quarter of last year we had several unusualitems as well, including a pre-tax charge of approximately $1 million or$600,000 after tax for writing off costs associated with an acquisition in Europethat was not completed. And charges totaling $400,00 in North America with $100,000 related to restructuring costs and $300,000to accelerated depreciation.

Overall, net income in the quarter was $10 million, or $0.36per diluted share, up $7.6 million from last year’s $2.4 million or $0.09 perdiluted share. The benefit of a strong Euro accounted for 1.6 million of theincrease. The remaining $6 million breaks down as follows: gross profit for thequarter was up 7.6, excluding the 4.8 million for foreign exchange gross profitwas up about 3 million. I’ll talk more about gross profits and gross marginslater in the call. SG&A was up approximately 600,000 for the quarter withthe translation effect of foreign exchange increasing SG&A by 2.4 million.Excluding foreign exchange effect, SG&A was very favorable, which reflectsthe efforts of the organization to control costs. For the company as a whole,SG&A as a percentage of sales had declined to 8.2% this year from 9.1% ayear ago.

Net interest expense was favorable by 300,000 driven byslightly lower borrowing levels throughout the quarter. Other income wasunfavorable by 300,000 due primarily to the final insurance settlement fromHurricane Rita mentioned previously. Currency losses for the quarter were100,000 which compares unfavorably with the gain reported in the first quarterof last year. As I also mentioned previously, last year we recordedapproximately 400,000 restructuring expense, including 300,000 of accelerateddepreciation.

Finally taxes were $1.2 million favorable for the quarterwith an effective tax rate for the first quarter of 30.6%, a decrease from the70.2% in last year’s comparable period. The decrease in the effective tax ratewas driven by four items: the decrease in the USpre-tax loss; an increase in foreign pre-tax income from lower ratejurisdictions; recently implemented tax planning strategies; and recentlyenacted tax legislation in Germanywhich reduced the German statutory rate by approximately 10 percentage points.

Excluding the previously mentioned significant unusual itemsin the quarter, net income would have been 11.1 million or $0.39 per dilutedshare compared with 3.4 million or $0.12 a share a year earlier, excludingunusual items. The improvement reflects a favorable gross profit and SG&Aperformance. We’ve added a new schedule to the press release to reconcile thesenon-GAAP measures and to detail the amounts and segments affected by thesignificant unusual items. We’ll keep a running tally throughout the year tomake it easier for you to understand what’s happening with our underlyingperformance.

Total sales were 496.6 million, up 53.9 million from lastyear’s 442.7 million. Tonnage continued to be a positive story for both North America and Europe in the first quarterwith increases of 8.6% and 1% respectively. Foreign exchange, primarily theEuro accounted for 36.1 million of 8.2% of the increase.

For the first quarter gross profit was 57.2 million comparedwith 49.5 million in last year’s comparable quarter. Foreign exchange contributeda benefit of 4.8 million while operating performance was up nearly 3 million,with Europe contributing about half and North America contributing about half.

European performance was negatively impacted by the millionpre-tax cost of terminations as previously mentioned and North American resultsincluded additional expense of 700,000 related to Envision. Excluding theEnvision effect, North American gross profit was up more than $2 million.Losses in gross profits for Envision were 1.6 million during the first quarterof ’08 compared with 900,000 during the comparable period of ’07.

In the first quarter SG&Q expense declined by 1.7million, excluding the effect of foreign currency translation of approximately2.4 million. The decline was primarily due to the company’s North Americansegment which reported a decrease of 1.8 million in SG&A expenses includingforeign currency. This was largely the result of the companies North America restructuring and efforts to control the overall level ofselling, general and admin expenses.

As mentioned previously interest expenses decreased to 1.6million in the first quarter from 1.8 million a year ago due to lower levels ofborrowing. We anticipate beginning our share repurchase in the new calendaryear and expect to repurchase 2 million shares throughout the course of theyear. The share repurchase will contribute incremental interest expense duringthe remainder of the year of a little bit more than $1 million.

Operating income for Europe includingAsia, increased to 22.6 million for the first threemonths of fiscal ’08 compared with operating income 18.8 million for lastyear’s first quarter. The $3.8 million increase was primarily due to thetranslation effects of foreign currencies of 2.4 million and the 1.5 millionincrease in gross profit, excluding the translation effect. SG&A was aboutflat excluding the effect of currency.

The North America operating losswhich now excludes general corporate expense decreased 3 million from 6.2million last year to 3.2 million this year. This decrease in loss was due toboth an increase in gross profit margins and a decrease in SG&A expense ofapproximately 1.7 million compared with the same period last year. As mentionedearlier this was primarily a result of the North American restructuringefforts.

It should also be noted that included in the loss for thecurrent year quarter was a total of 1.9 million in costs related to Envisionwhile last year’s quarter included about 1.2 million in Envision related costs.You’ll notice starting in the first quarter fiscal ‘08we began to excludecorporate and other charges from the North American and European operatingsegment results to better reflect the actual operating performance of the twosegments. The supplemental segment table included in the release provides thisinformation for fiscal first quarters for both ’08 and ’07.

Corporate operating losses for the current year’s quarterwere 3.4 million compared with 3.5 million a year ago. This number approximatesour annual run rate, giving us an expected number in the 14 to 15 millionrange. Corporate is composed principally of the CEO, Board of Directors, CFO,corporate finance, tax, treasury, risk management and internal auditdepartments. We’re making a significant effort to ensure that direct businessunit expenses are not included in our corporate number and have spent some timereclassifying expenses on an actual basis.

Historically in our segment reporting we allocatedapproximately 1/3 of the corporate expenses to Europeand the remainder went to North America. In this year,neither Europe nor North Americaare showing any North America expenses in theirsegments. At the end of the first quarter of fiscal 2008 we had 41.8 million ofcash on hand compared with 43 million at the end of fiscal ’07. Net debtincreased to 92.2 million compared to 82.8 million at the end of the lastfiscal year.

As noted in our release, cash flow from operations was 8.8million for the first quarter of fiscal ’08 compared with 19.6 million in thefirst quarter of last year, with the decline due primarily to an increase inboth the cost receivable and inventory offset by an increase in accountspayable.

Working capital which includes inventory, cost receivable,accounts payable and accruals was up 42.4 million over fiscal 2007 year end.First quarter days receivables were 63 days compared with 62 days at year end.Days in inventory increased slightly from 62 days from 60 days at year end2007. Last November we reported 64 days of inventory.

Receivables were up 30.8 million as a result of strongersales in the first quarter fiscal ’08 particularly in Europe,along with the effect of foreign which contributed almost $18 million of theincrease. Inventories were also up 29 million from year end with the foreigncurrency effect primarily the Euro increasing inventory by almost $15 million.Lastly, accounts payable increased by 19 million due primarily by thetranslation effect of currencies and higher production levels. We recognizethat inventory and receivable levels are not where we want them and arecontinuing with our ongoing efforts to reduce them.

Depreciation for the first quarter was 7.1 million, up fromthe 6.2 million reported in last year’s comparable quarter. Capitalexpenditures were 8.2 million; up from the 5.3 million reported a year ago, dueprimarily to our continued investment in Envision. And more specifically in ourGreenfield site in Finley. CAPEXfor Envision was 3.4 million for the quarter compared with 2.1 million a year ago.As noted in today’s release, the company expects challenging marketingconditions throughout the remainder of the fiscal year as a result of high andvolatile oil prices and a slowing automobile market, both of which put pressureon our results. To offset this pressure the company expects to see continuedbenefits from both it’s ongoing savings initiatives and it’s newly reorganizedNorth American business units.

For the full year of fiscal year 2008, we continue to expectnet income to exceed $56 million. This would be a significant improvement overlast year’s net income; however the agreements to the CEO transition are notfinalized. The company will provide more details related to any charges duringthe second quarter fiscal release.

With those comments, I’m going to turn the call back over toTerry.

Terry Haines

Thank you, Paul, well done.

Before we move into our Q&A, I am actually delighted tobe able to introduce Mr. Joe Gingo our new CEO and President for A. Schulman.

Joe Gingo

Thank you, Terry, thank you very much. And thank you foryour contributions to the corporation over these many years.

I really look forward to this opportunity to speak to theanalysts and investors. And I thought I might start out by giving just a verybrief description of my own business experience, just for those that are notaware of it. Actually I worked for 41 years for the Goodyear Tire and Rubbercompany and during that period I had the pleasure of operating both businessunits and technical operations and quality operations for Goodyear. Fourteen ofthe last 20 years I have headed four strategic business units for the GoodyearCorporation, in each case reporting directly to the CEO of the corporation.

The business sizes ranged from 300,000 million to 1.2 billion.Three of these businesses were global and one was regional. The size of thenumber of employees that were in my region in my operations were anywhere from3,000 to 10,000. I also had the opportunity during 2003 when Goodyear wasfacing some very difficult financial situations, to be a team member of theturn-around team that developed the strategic plan. That was with outside helpfrom both Bing and Blackstone.

From my standpoint, I was the head of the divestiture teamand I was a member of the restructuring team. I did not get involved in therefinancing, thankfully. On the divestiture team, my recommendations includedthe sale of one of the divisions that I headed the engineer products division.That was successfully concluded last year, when we made a $1.475 billion saleof that division. In addition, another division in which I have been veryinvolved, our fabric division, was also sold for a smaller amount.

In addition to that background I was responsible fortechnology and all new product development within Goodyear and that includedthe new product engine that we feel was very key to the turn-around. I had theresponsibility from concept to market introduction; advertising and pricingwere handled regionally. I led the 20% budget cut in 2003 when we were forcedto reduce our R&D expenditures. We did that without really missing a beatin terms of new product development. I also was responsible for our fixed jointventure with our Japanese partners.

In addition I thought I’d take just a few seconds to tellyou as I look forward, what I’ll be focusing on in the next 100 days. I’ve beenvery fortunate to have been a member of the Schulman board since 2000. It wasnot an unknown entity to me when I stepped into this new position. Terry complimentedme on being able to get on and run fast from the start, well that backgroundsure allowed me to do it.

What I’ve seen over this period of time is the similaritiesbetween Schulman and other North American manufacturing companies are verysimilar. What I’m suggesting to do at Schulman are actually key elements ofwhat we did at Goodyear and what many people do in North Americamanufacturing companies. I’m first of all going to take a hard look at a moreefficient and effective utilization of North American manufacturing facilities.That potentially could include restructuring if that was financially justified.

What we leave in our plant has to be high-value-added. Ifyour plant’s in high cost locations, you’ve got to be running products throughthose plants that will provide you profitable growth. That’s where we’re goingto focus in both the polybatch and engineered compound segments, both in North America and Europe. We’re going to enter areassessment of Schulman’s North American automotive business to emphasizeprofitable areas.

The one thing that I am probably more sensitive to than evenTerry is the automotive market. The business area I came out of was veryaffected by the cyclic nature of automotive. That is an area to which I amfairly sensitive. We’re going to take a hard look to see what type ofbusinesses we are in in automotive and what type of businesses we want to stayin.

That really leads to the next item, because what we’re goingto do, I want to make this clear, we’re not stopping our investment inEnvision, we are going to delay any further capital expenditures on Envisionuntil we have a marketing strategy that is a little more balanced betweenautomotive and non-automotive. In the past Envision has been focused onautomotive. I’ve already told you in my previous point, that’s just not one ofthe areas that I generally like to focus on. There are a lot of reasons forthis.

What we’re going to do, And Sherman had already started thework before I got involved, of looking at other non-automotive applications. Iwould like to look at how much that could be accelerated. I’m going to befocusing on that. I think also our European operations, as many operations in Europe,has some additional efficiencies in sale and administrative structure that giveus opportunities for cost reduction. We have done a good job in North America of already accomplishing that. You can see that throughsome of Paul’s comments on the results.

Finally, I’m going to ensure that the best leadership teamis in place to execute our strategy. That’s really my comments.

Terry Haines

Thank you very much.

At this time I’ll open it up for the Q&A and we’ll tryto answer any questions you have about the company.

Question-and-AnswerSession

Operator

[Operator instructions] Thefirst question comes from theline of Mr. Robert Felix with Gabelli and Company, please proceed, sir.

Robert Felix - Gabelliand Company

Hi, guys, just a couple of quick questions. I was hoping youcould elaborate a little more on the decision to suspend CAPEX on Envision. Inthe release that you’re still seeing strong customer interest, yet you’resuspending further investment just a couple of weeks ago. You were prettygung-ho about continuing with it. Is the demand not ramping up as quickly asyou had hoped?

Joe Gingo

Let me clarify where I stand on Envision. I believe it’s afantastic product, I think it has a fantastic future. I’m very comfortable thatthe process is in very good shape for manufacturing the product. If I look atwhat we’ve done in Envision, it’s a 100% automotive focus up to now. Automotiveis an unbelievably difficult market. There’s a long approval process, manyspecifications along the way. In addition, it’s very capital intensive due tovolume requirements.

As we all well know, it’s really right now probably one ofthe worst markets that we’ve ever seen 14.9 million units. When is this marketgoing to recover? One other concern I have is what do Envision’s competitors doto cover their fixed costs in this environment? Traditionally in mostautomotive businesses, what they do is cut their cost and even in some cases godown to variable. I believe that non-automotive, which I mentioned Shermanwas looking at, but maybe not in the depth that I would like, you have an advantageto mix up. The specifications are much easier to meet. The process is veryflexible and very good on short runs which also is very good for non-automotiveand margins are higher.

I do think in light of the automotive focus, a furtherinvestment in light of a declining market was the best opportunity – we stillhave a huge amount of customer interest and we hope to be announcing within thenext two to three months further approvals and further sales. I hope thatanswered your question.

Robert Felix - Gabelliand Company

Just to follow-up on it, a couple of months back Paul andTerry expected that Envision would narrow its loss, I want to say by about $5million this year. Yet the loss on Envision picked up year-over-year in thefirst quarter. Given the weak automotive market, do you still think you cannarrow that loss by 5 million, and then perhaps you can also delve into why itincreased on a year-over-year basis.

Paul DeSantis

I think what we said was we’re going to narrow the loss to 5million from I think 6 million that we had last year. The reason that we havean increase now is that we’re expecting to ramp up the business throughout theyear. When we did our last call in the last quarter, we said that we expect tosee sales start earlier in the year and then expect to see sales come in laterin the year and as we go through the year, we expect to see the loss decrease.

When we compare this quarter against the first quarter oflast year the biggest single item is everything that we’re talking about interms of sampling the product. We’re sending lots of product samples out. Thoseare driving up the costs. We’re paying for the material; we’re sending it outso that people can use it and test it. We’re also starting to depreciate thefacility. Those are sort of driving up the costs in this quarter compared tothe first quarter of last year. Our expectation is, as Joe said, as we start toget some programs approved and some material volume flowing through we expectto start offsetting those costs. We’re sort of looking at it quarter byquarter.

Terry Haines

If I could add one perspective to that, as we said on ourlast conference call we’re lagging in the area of ramping up and launching theprograms, maybe by as much as six months. That certainly is disappointing. Theattractiveness of the product and looking at the markets, our anticipation forthe business looking forward, expecting about 75% outside automotive withautomotive appearing to be some of the quickest hits to launch the business.

In fact, we’re lagging a little bit behind, but I’mconfident that the Envision team and what we have out there as expectedapprovals, as Joe mentioned, coming up towards the early spring of the year,that will be on track, we’ll get this launched and absorb some of these highexpenses of development and sampling of product.

Robert Felix - Gabelliand Company

I guess one last question, if I may. If you look at theprice cost after the balance of the year, we see raw materials continue to riseat a pretty fast pace here. You’re not getting much pressure, at least youdidn't during the first quarter, I would imagine you’ve yet to see the highercost work their way through the P&L. So do you look at the balance of theyear, do you either expect that you’ll get pricing enough to offset at leastthe bulk of the raws or that margins will compress. I was hoping that you couldelaborate on that a little bit.

Terry Haines

I’m going to take just a second on this. In looking back, aswe passed through the increases we saw some basis point improvement, I think,30 basis points improvement in the quarter. There are more increases that arefalling in line as we’re going forward. It’s really difficult to predict whatthe markets are going to do in pricing they’re going for. I can tell you thestrategies for the business teams are to pass this on to the marketplace toprevent any erosion and frankly make improvement in the gross margins.

Paul DeSantis

We’re trying to pass on price increases as soon as wepossibly get those price increases in.

Robert Felix - Gabelliand Company

Would you say that the end markets are strong enough tosupport those price increases at this juncture?

Joe Gingo

I actually come from the industry also that has a big tie toraw materials. One of the first questions I asked was how many of yourcontracts are indexed. The answer I got was “close to 75%”. What you generallyhave with an index contract is a lag about 30 days. The key thing you want todo with your customers today in any business where there’s any raw materials isget indexes. It’s the only way to try to stay whole.

I’m fairly on the ability to pass through, particularly withthat number of index contracts.

Robert Felix - Gabelliand Company

Thanks for taking my questions.

Operator

Your next question comes from the line of Mr. ChristopherButler of Sedotti and Company, please proceed.

Christopher Butler -Sedotti and Company

Good afternoon, gentlemen.

The first questin, the improvement that was seen in North America, can you give us an idea how much of that was due to therestructuring efforts. I don’t know if you’ve given that, I must have missedit.

Paul DeSantis

That’s a good question. Clearly we can see what’s going inwith SG&A. We’re somewhere in the range of $2 million of favorability inSG&A. There’s probably another 1 million scattered across the P&L,primarily in some savings that we’re really seeing flow through distributionand gross margin. One of the things, looking at it, when we did those savings,we did those a few months ago, we built them into the budget and we’re holdingpeople accountable for delivering on their budgets. So far people are steppingup to that task and delivering.

That’s where we get out confidence level, if you will onwhere we are going through the end of the year. I don’t know if that answersyour question, it’s fairly difficult, especially as we go forward through theyear it will be fairly difficult to say what kind of basis point improvement isdue to the savings plan and what kind of basis point improvement is due toother aspects because we have new business units that are focused on drivingprofitable higher mixed product.

What we do know is we take the entire savings into ouroutlook for the end of the year and we’re sticking to our outlook.

Christopher Butler -Sedotti and Company

Looking forward a little bit in North Americaas part of the 100 day plan, it was mentioned that there could be potentiallymore restructuring in North America. Tying that into an89% capacity utilization rate in a soft plastics market, it seems that ifcapacity gets taken up further it may limit upsize when we eventually see therebound in plastics in the US.

Joe Gingo

I think therefore mix becomes a very important thing. Whatwe’ll be looking at is this. In our plants we want to run high value-addedproducts. I don’t really want much capacity above high-value added products.You can attain the lower value added products from other people if you’rewilling to give them your technology. Generally that technology is the lowtechnology for commodity type products. I think we’ll be using third-parties tosupport the lower end if we get into that capacity crunch.

The big plus you have is if you have the right level ofcapacity even in a crunch you can even fill your own plant with not onlyhigh-value but any kind of commodity business so you can keep your plant full.My experience is that I really [refer to have my plant full. I also by the wayhave more leverage on price increase than if I have open capacity.

Christopher Butler -Sedotti and Company

On the strategy that focuses on more specialized products,oftentimes you see an up-tick in sales and marketing expenditures as part ofthat in order to segment market and better understand customers. With the 100day plan, you specifically mentioned looking to improve efficiencies in salesand marketing in the European operation, are you moving in different direction,can you help me with that?

Joe Gingo

Slightly so, because if you look at Europe right now, Europeis running at a very level of capacity utilization, in addition to that Europeis piling on automotive with a number in the 5% to 10% range. I think in Europea lot of the things that I focus on and believe in are in place. What I’d liketo do there is take a look and see if there are some efficiencies in the backoffice. By the way, I’m not looking so much at sales and marketing as backoffice. As you might be aware, in Europe many companies are run by country, Asyou go into a European Union you have some real opportunities for synergy inback office activities, purchasing, accounts receivable, things of that sort.I’m not looking to cut the sales and marketing in Europe,I’m really looking at back office.

Christopher Butler -Sedotti and Company

With the focus towards specialized products in the USare we looking at a situation where new investments ad new products are beingearmarked for more specialized products? Are we looking at a situation where wehave that and walking away form specific businesses?

Joe Gingo

I can only go to my past and what I’ve done. In 2003 we cutthe R&D budget at my company by 20%. What we did and I was responsible forit was to run right from technology to marketing, one organization and youfocus. If you really link your technology organization to your marketingorganization and you focus on products you don’t necessarily have to increaseyour costs at all. I cut my costs by 20%. If you look at the track recordyou’ll see that the products being produced by my company, they are consideredcomparable or better in many products. It’s this focus, integration all the wayfrom the concept to market. That is something that we’re going to spend somereal time on because I am familiar with Schulman’s technology, they have verygood technology. I just want to see more focus.

I hope I answered your question there.

Christopher Butler -Sedotti and Company

Yes, thank you, I’ll go back in the queue.

Operator

Your next question comes from the line of Mr. Saul Redwickwith KeyBanc, please proceed.

Saul Redwick -KeyBanc

Good afternoon. Joe, welcome aboard.

Joe Gingo

Thank you, Saul.

Saul Redwick -KeyBanc

Paul, with the company in the taxes that you had somebusiness and low tax rate jurisdictions, the German tax rate cut and also thetax planning strategy, what was the tax rate that was applied to yourinternational earning this quarter compared with last year and what might weexpect going forward?

Paul DeSantis

I’m looking at our tax rate reconciliation that will bepublished in the Q4 that’s coming out. So hopefully I won’t quote this numberwrong. If you remember how we do our reconciliation, we start with statutory USat 35%, we then add domestic losses with no benefit, we then subtract theforeign taxes at less than US statutory rate, the we have an “other” thatreconciles to the US statutory tax rate. Domestic losses with no benefit wasabout 15.7%, say 16%, foreign taxes at less than US statutory rate gave about a22% benefit which was more or less doubled from what last year was that went in70.2% and then some other rounded out the difference to get to 30.6. In termsof outlook for the rest of the year, I think it’s going to range between that30 and let’s say 30 and between 35 or 40 depending on North America’sperformance.

Saul Redwick -KeyBanc

Would you say that your tax rate was 30% and you had biglosses in North America that meant that your tax rate everyplace else would have been15, 16, 17%, which really contributed a lot of the additional earnings pershare, am I correct?

Paul DeSantis

Actually what really contributed a lot to the additionalearnings per share was SG&A and gross margin. Taxes certainly played theirrole as well. [OVERLAY] tax was certainly favorable and certainly from aninternational perspective we’re expecting big favorability coming in there.

Saul Redwick -KeyBanc

Do you think those numbers, 16, 17, 18% is the right placeto think about your international number.

Paul DeSantis

If I read the tax rate reconciliation that’s exactly the wayit reads.

Saul Redwick -KeyBanc

Next question, Terry, I think you’ve been over to Asiarecently. How would you characterize the plastics business there, are the guysthat open plastics plants in Asia, are they making money, is Schulman makingmoney and if not what do you have to do to reverse the course of results there?

Terry Haines

It’s a challenging market, it’s competitive. We put theplant in, we have the capacity there. It is not profitable for us and the planof course, is looking both at application and growing the business and gettingthe approvals for the large OEMS that are moving from Europeand North America to Chinathat will be able to be a supplier so that it’s a timing issue.

Plus we’re looking at the other issues of cost of livingthat Hoe talked about earlier. It applies also for China.In Asia in total we’re profitable, but we in launchingthe plant in Chinait has been challenging. We’ve talked about that before. The one thing that I’mpleased with, we’ve got such a strong team over there. We’ve built it up withindividuals in the sales, marketing and technical areas that just thrilled withthe expertise and what we have as resources and it won’t be long before thatwill start to be profitable. It hasn’t turned profitable yet.

Saul Redwick -KeyBanc

The next question, the million dollars that you had foremployee severance over the year, was there any change in senior management, orwas this just a lot of personnel reductions and how many people were reduced asa result of that, that's a large charge.

Terry Haines

Related to a key management individual in manufacturing andthat charge was totally just one person.

Saul Redwick -KeyBanc

Two final quickies here, in North Americathe 8% sub-volume increase was an impressive number. Was that primarilymanufactured product or was it heavily related to distribution and merchant.

Terry Haines

Balanced but weighted towards manufacturing. Paul maybe has the breakout there, I don’t havethat. People have done a good job pushing through, we’ve been working on newprograms, and those don’t come overnight. It’s been a successful developmentand I think most of it – half of that would be manufacturing unrelated toautomotive. Automotive is relatively weak. Paul, do you have that number?

Paul DeSantis

I don’t have a breakout between those two, but if I lookacross what I see, we see growth in all three of our business units there.

Terry Haines

Pretty basic, 50% is related to automotive. It’s about thesame balance of distribution, merchant and –

Saul Redwick -KeyBanc

My final question, Joe you were talking about value-addedproduct. With the gross margin in North America, it’sbeen about 10% plus or minus a little bit for the last five years. When youmake only 10% in the gross margin, you can’t make any money. What do you thinkthat the gross margin ahs to get to in North America foryou to consider ti to be a respectable business?

Joe Gingo

Saul, I haven’t had a ton of days here, but I’d like to seeit at the 14 to 15% range at a minimum. That’s what I’d target for in the shortterm.

Saul Redwick -KeyBanc

As you think about how to restructure North America, it’s by looking at all these different projects that youhave in plan. You want to come out of this 100 days with a plan that will getyou closer to that number than where we’ve been.

Joe Gingo

Absolutely, Saul.

Saul Redwick -KeyBanc

Thank you very much.

Operator

Your next question comes from the line of Gregory McCostalwith Lord Abbott, go ahead.

Gregory McCostal -Lord Abbott

Thank you. You spoke about two different things that I’dlike a little clarification on. The utilization today is 95%, it’s 89% in North America, you mentioned that you want to increase the value-addedwhich makes a great deal of sense and will certainly move you toward the 14 to15% gross margin goal. You also mentioned that you want to keep the utilizationhigh and you are suggesting that you might use commodity product to do that.Could you give us a sense of how you’re going to balance that because if youcould cut back in capacity to some extent you automatically have higherutilization of value-added

product?

Joe Gingo

I probably wasn’t clear, so let me try to elaborate. If itstill requires clarity, let me know. Here’s my idea, you do have to cut backcapacity so you can get into utilization rates really in the high 90s. What Ilike to do is be running high value added product through that. If there’s amarket demand for more than that, to take your less high value added and runthem through tolling. What it does give you, if you face a very poor economicsituation, say the whole market shrinks on you, you take the items that youwere tolling and bring them back in. Is that clear?

Gregory McCostal -Lord Abbott

Yes, the point I’m hearing pretty strongly would be facilityconsolidation in North America going forward from thispoint.

Joe Gingo

At this point, I don’t have all my financials in front ofme, but I would have to say to you that that’s something I’m going to look atvery strongly, again based on my own experience in any area in the world thathas high costs. By the way, North America is where we’regoing to focus now, but if you look at experience, Western Europeeventually faces the same kind of problems.

You fundamentally cannot manufacture commodity products inhigh cost areas of manufacture. Right now we’re in very good shape in Europeand once we can get North America in good shape, we’llbegin actually to look at what we would like to do to shift capacity in Europeto Eastern Europe.

Gregory McCostal -Lord Abbott

With regard to new plant relative to Envision in CentralOhio, I assume there’s been nothing done in that plant. Are there anyexpectations for that plant at this point?

Joe Gingo

The plant is built and at this point, until we have aclearer look at the entire marketing opportunity both automotive andnon-automotive we don’t plan to put any Envision equipment in that plant;however one of the things that we are looking at is this: we have made anannouncement of expansion in our polybatch business, which by the way is 100%non-automotive. We’re looking at a site very close to our Envision plant. Whatwe will most likely do is take advantage of the existing plant facility and putthe polybatch operation there if the number is justified, I haven’t seen it.We’re taking a look at that. That way we would utilize the plant and we wouldnot have to build a new plant.

Gregory McCostal -Lord Abbott

Good, very good. Paul, with regard to the working capitalreduction and goals there, what held things back there to the DIOs and DSOs?

Paul DeSantis

I think where we are, we’re seeing some chop form the end ofthe year. I don’t view us as being materially different from where we were atthe end of the year. I think that going forward to the rest of this year, oneof the things we’ve done, one of the things we’ve talked about, is we’ve linkedincentives to cash flow in the organization. As we go through the rest of theyear, I fully expect the teams to really continue the improvements we’ve madefrom last November to now, to see that continue.

Gregory McCostal -Lord Abbott

Those linkages are new as of the beginning of the fiscalyear?

Paul DeSantis

Actually we had them in last year for the North Americanteam and we saw tremendous cash flow come out of North Americabased on that linkage to the incentive plan. We’ve got that linkage in theincentive plan again this year. We expect to see favorable working capital.

Gregory McCostal -Lord Abbott

That also relates to Europe as well?

Paul DeSantis

Yes, Europe has a balance sheet cashlow component in their incentive comp as well. We expect to see improvementthere as well.

Gregory McCostal -Lord Abbott

Thank you.

Operator

Your next question is a follow-up from the line ofChristopher Butler of Sedoti and Company, please proceed.

Christopher Butler -Sedoti and Company

Thanks for taking my question. I wanted to ask about theEuropean business, tonnage was up 1% for the quarter which was off a little bitfrom what you’ve been able to do in recent quarters. I wanted to get an idea,are we looking with strong utilization is this a shift to a better mix ofproducts, or are we starting to see any sort of softness in Europe?

Terry Haines

I’ll take a crack at that, the utilization numbers sometimescan be a little misleading depending on mix for the business. We’re runningreal, real high volume products through the plants, and phenomenal numbers forutilization. I think the 1% increase is kind of indicative of a strong quarterto quarter comparison from last year to this year. Maybe there was a bit of aslow down relating to customers and inventories. There was a lot pr pre-buyingthose prices weren’t moving up. I don’t know if that’s going to be indicativeof what we expect going forward. I think it’s pretty much what we expected, Itthey had done more I would have been surprised. Next quarter, frankly will be atougher quarter for us in the volume side,

Joe Gingo

[Inaudible] tends to reduce capacity. Going to more highervalue added products they tend to be shorted runs. They’re more profitable toyou and they’re very good. But because of change times and such you lose alittle bit if your capacity. Those losses of capacity, by the way you like alot, they’re very good. We could have seen a little bit of that but I have toadmit to you I’m not into that kind of detail yet, but I will be.

Christopher Butler -Sedoti and Company

Thank you, guys.

Operator

At this time there are no additional questions. At this timeI’d like to turn the call over to Mr. Terry Haines for the final remarks.

Terry Haines

Thank you, I think everybody can see Joe’s capabilities inunderstanding markets, and the company and his digging in quickly to make thenecessary improvements going forward for the company. Being a shareholder, I’mdelighted to have Joe Gingo running this company. I would again just like tothank every body for tuning in, good luck.

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