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A. Schulman, Inc. (NASDAQ:SHLM)

F3Q08 Earnings Call

July 2, 2008 10:00 am ET

Executives

Joseph M. Gingo - Chairman of the Board, President & Chief Executive Officer

Paul F. DeSantis - Chief Financial Officer, Vice President - Finance, Principal Accounting Officer & Treasurer

Analysts

Rosemarie Morbelli - Ingalls & Snyder LLC

Saul Ludwig - Keybank Capital Markets

Robert Felice - Gabelli & Company

Christopher Butler - Sidoti and Company

Eugene [Fetigoff] - Longbow Research

Operator

Welcome to the A. Schulman third quarter 2008 conference call. (Operator Instructions)

Before we begin the company would like to remind you that statements made during this conference call which are not historical facts may be considered forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied.

In addition this conference call contains time sensitive information that reflects management's best analyses only as of the date of this live call. A. Schulman does not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after the date of this call. For further information concerning issues that could materially affect financial performance related to forward-looking statements please refer to A. Schulman's quarterly earnings releases and periodic filings with the Securities & Exchange Commission.

I would now like to turn the call over to Mr. Joe Gingo, Chairman, President and CEO.

Joseph M. Gingo

I welcome my second opportunity to speak to you about the performance and direction of A. Schulman Incorporated. I have now worked for this company for six months. I am extremely pleased with the progress we have made in that short period of time. My 100-day plan is basically completed and we are rapidly implementing my 265-day plan. Our results for the first nine months of our fiscal year are especially encouraging in light of the very difficult economic environment we are facing in North America. Our significant presence in Europe has allowed us to take advantage of our steady performance and a strong euro.

I will now turn the meeting over to Paul DeSantis, Schulman's Chief Financial Officer, to walk through our financials. After Paul gives his presentation I will return to provide my comments and to take any questions you may have.

Paul F. DeSantis

As you can see from today's press release we had a number of unusual items. In total we booked a net $4.3 million of unusual after tax items for the quarter bringing our year-to-date total to $17 million. These charges are primarily the continuation of our restructuring activities kicked off in Joe's 100-day plan. By comparison in fiscal 2007 we booked less than $200,000 of unusual items in the third quarter and $2.7 million during the first nine months. I will not go through the details since they are in the press release and our soon to be filed 10Q. We believe we'll complete Joe's current program by the end of our fiscal year. However, if economic conditions continue to decline, we'll do what's necessary to protect profitability and shareholder value.

Reported earnings per diluted share for the third quarter, these are earnings including all of the unusual items, were $0.26 compared with $0.37 reported last year. Year-to-date we reported earnings of $0.49 compared with $0.52 last year. Excluding unusual items we would have reported EPS for the quarter of $0.42 per diluted share compared with $0.37 per diluted share last year. In addition please recall that last year's number included a positive impact of $1.4 million after tax or $2.4 million pre-tax for a claims accrual reversal in Europe. That accrual reversal accounted for $0.05 per share in last year's quarterly results. On a year-to-date basis our adjusted earnings would be $30.3 million or $1.11 per diluted share up almost 80% from last year's $16.8 million or $0.62 per share. The majority of this increase was driven by Europe's consistent performance along with the translation effect of foreign exchange which contributed approximately $6.6 million for the nine month period.

One of the new items we've added to this quarter's reporting is a more detailed breakout of the four business units in our North American segment. As we announced in March we eliminated a layer of our North American management and Joe is now directly managing these businesses. As a result we're providing more detail on the individual performance of the North American poly batch, distribution services, engineered plastics, and Envisioned business segments. We are also reporting that direct administrative expense related to those businesses.

Looking at the North American segment the strategy we are adopting becomes a bit clearer. The engineered plastics business is under the greatest market stress. In an effort to bring that business capacity in line with sales we have closed the Canadian plant and sold the Texas tolling facility. The engineered plastics business is most exposed to the auto market. The steps we have taken will help to address this segment's performance challenges.

The poly batch business has the best margins in North America but there's still plenty of room for growth. Much of the sales of that business unit are produced in Mexico and some are shipped to the US. With rising freight costs we're having a negative impact on the margin. We believe over time we can bring this business unit's margins to be in line with those in Europe which are significantly higher.

In terms of the distribution business it's a low capital, low SG&A business that makes a significant contribution to the company. Meanwhile, Envision continues to record losses as we refocus its strategy toward non-automotive markets. We have made efforts to reduce the spending at Envision and you can see the results. Our operating loss for the quarter is down more than half a million compared with last year's third quarter.

For the company as a whole we saw a decline in tonnage for both the quarter and the year-to-date period. In North America our engineered plastics business unit was down 35% for the quarter and 16% for the year-to-date period. The majority of this decline was due to the Orange, Texas rolling facility. The facility was sold at the beginning of the third quarter. We expect tonnage declines to continue in our North American engineered plastics business as we feel the full affects of the Texas sale and the Canadian plant closure, as well as the impact of our other efforts to weed out unprofitable volume.

In addition our North American distribution business unit experienced slight declines in volume as well resulting primarily from the weak market and our efforts to increase pricing to maintain profitability. In Europe we saw these efforts reflected in a slight volume decline in our third quarter as we eliminated some less profitable sales primarily in our engineered plastics business line.

Interestingly enough on a per pound basis for the quarter gross profit increased year-over-year in the North American distribution and engineered plastics business unit as well as in Europe on a local currency and US dollar basis as we focus on more profitable sales. For the quarter gross profit was up $2.9 million year-over-year. Most of that increase was in Europe which was up $1.5 million excluding the effects of foreign exchange and last year's $2.4 million pre-tax accrual reversal.

The North American businesses are showing declines in gross profit primarily driven by the inability to pass on the full effect of cost increases. As a result the company has announced pricing increases for both North American poly batch and engineered plastics in an effort to offset the increasing input costs. For the year-to-date period the gross profit was $176 million up almost $21 million from the same period last year.

Gross profit margins were flat at 11.8% of net sales for the nine-month period from 11.7% a year ago. Foreign exchange contributed a benefit of $18 million while operating performance was up $3 million. Gross profit margin in Europe for the nine months increased to 13.5% of sales from 13.2% a year ago driven by pricing increases and favorable mix as we continue to pursue our strategy of being the number one global master batch provider. As mentioned last year's results included the $2.4 million accrual reversal. The North American segments have generally seen declines in gross profit over the nine-month period primarily driven by the inability to pass on sufficient price increases to offset the rising raw material costs as well as reduced volume in some segments.

Year-to-date SG&A was up $13.4 million. However, this increase includes $9 million of foreign exchange effect, $4.2 million of unusual items reported during the second quarter, a write-off of $800,000 in North America for two large customer bankruptcies also in the second quarter, and more than $700,000 in product expenses. All-in-all SG&A is a very good story for the company as we're seeing the effects of our cost-savings plan. For example, North American SG&A which excludes corporate spending is down almost $4 million in total compared with the first nine months of last year.

Segment operating income for the quarter was about flat with last year at approximately $23 million. Foreign exchange contributed a benefit of $3.5 million. Recall last year included $2.4 million of the one-time accrual reversal benefit. Excluding these effects total company operating income was down about a million dollars with the entire shortfall coming from the North American segments except for Envision as earlier discussed. Europe's performance excluding last year's $2.4 million benefit increased slightly on a local currency basis.

Segment operating income on a year-to-date basis is up $12.9 million to $59.9 million. The entire increase is due to foreign exchange. Recall that the $59.9 million includes $4.2 million of unusual SG&A items mentioned earlier and last year's number included the $2.4 million accrual reversal. Excluding these items and foreign exchange operating income would have been up almost 44% year-over-year. Europe operating income for the year-to-date period increased by $13 million while the North American segments' operating losses were about 10% worse excluding last year's unusual accelerated depreciation costs. Given the market pressures this performance could have been worse but our SG&A reductions helped offset the gross profit weakness.

Taxes were $6.1 million favorable for the year-to-date period compared with last year. The reported effective tax rate was just about 44% for the first nine months which compares favorably with the reported rate of 54% last year. However, if we remove the effect of the significant unusual items, the vast majority of which are in North America where we get no tax benefit, we see an effective tax rate around 31% for the year-to-date period, a great improvement over the comparable period last year. The decrease in effective tax rate was driven by recently-implemented tax planning strategies and increase in foreign pre-tax income and lower rate jurisdictions and recently enacted tax legislation in Germany which reduced the German statuary rate by approximately 10 percentage points.

Cash and working capital are a good story for us as we're beginning to see the effects of our ongoing working capital initiative. At the end of May we had $84 million of cash compared with $81 million at the end of last May and $43 million as of the end of August 2007 our fiscal year end. Net debt has increased to $84 million compared with $68 million a year ago and $83 million at the end of August 2007. The increase in net debt from the end of last year is primarily due to the share repurchase plan and dividend payments almost completely offset by favorable cash flow from operations.

As noted in our press release cash flow from operations was $66 million for the first nine months of fiscal 2008 compared with $61 million in the same period last year. This increase was due to higher cash earnings once the non-cash impairment and other charges are included and was also affected by the early results of our working capital initiative. Days in total were 90 flat with fiscal 2007 year end and up slightly from last May. Note: In February of this year we were sitting at 102 days. Depreciation for the nine months was $12 million up from the $19 million reported in last year's comparable period. Capital expenditures were $18.7 million down from $20.1 million reported for the nine-month period a year ago as the spending for our US poly batch facility is less than the spending on Envision during the last year.

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

Joseph M. Gingo

As we look at our North American performance versus 2007 almost our entire decline has been experienced in our fiscal third quarter as we continue to see a worsening in the North American market. Fortunately our early actions on eliminating excess capacity while walking away from unprofitable business and reducing sales and administrative expenses has helped us to offset these declines. But in order to keep ahead we have accelerated the closing of our Canadian plant originally scheduled for the end of this year. All operations in this plant ceased effective June 30, 2008. Along with the sale of our rolling facility in Orange, Texas this allows us to keep our capacity much more aligned with a lower demand as we go forward. This reduction in capacity also allowed us to cut unprofitable product lines from our portfolio rather than manufacturing them merely to cover fixed plant costs.

At the same time we continue to focus on administrative expenses. As you are aware we previously eliminated the corporate airplane and our retiree medical benefits resulting in more than $2 million annual savings. We have just initiated actions that will reduce our active employee medical benefits to market levels. These activities will be implemented over the next six months. This should result in an annual savings of $750,000 beginning next calendar year.

I am also pleased with the initial results of our working capital initiative. Although compared to last year we are essentially the same in terms of days, we have made significant improvement of 12 days since our last opportunity to speak to you. This improvement occurred in all categories -receivables, inventory, and payables. I am confident we are now installing a disciplined process that will show a steady improvement over the next years.

Looking into the future ongoing improvements over the remainder of this year and into 2009 will be driven by our four key initiatives: working capital, global purchasing, a new product initiative, and continuous improvement. As I mentioned previously we are definitely seeing traction in our working capital initiative. Working capital training is now being given to all of our salaried employees globally. As each of these individuals become more aware of what they can personally do to contribute to control working capital through a disciplined process, they will make significant contributions to our goal of achieving 60 days over the next two years.

Our global purchasing organization is now in place led by a seasoned procurement veteran. We have also put our distribution organization under his direct control so that we can take full advantage of leveraging our global purchases. Global data has now been collected and we are beginning face-to-face negotiations with each of our key suppliers. In light of the unprecedented escalation in pricing of petroleum-based products this initiative could have not been started at a better time. We firmly believe we will be able to buy raw materials at very competitive pricing with appropriate terms.

Our new product initiative has begun. We have held two global meetings for each of our business lines, engineered plastics and master batch. The degree of cooperation is unparalleled in the experience of this company. Our poly batch technology led by our Belgian technical center will focus on providing products that allow us to maintain our leadership position in Europe and Mexico and pave the way for penetration into the United States and Canadian markets. To support this effort our first poly batch plant in the United States producing additives will be operational in October of this year, ahead of our original schedule. Considering our global position there is good reason to expect that we should be a significant player in all of North America, not only Mexico. In engineered plastics our new product direction will be focused on niche high-value added products where the volumes and specifications are more attractive to a company of our size than a major resin producer with compounding capability. We expect to begin to see results from our new productive initiative in a relatively short time frame.

Finally, regarding our continuous improvement initiative our outside consultant has reviewed all of our North American operations. He has determined which metrics will best link plant operating results to product line financials. This month he will be visiting our European operations to fine tune the performance metrics and ensure they have universal application. We will roll them out globally beginning in a few months.

Regarding Envision, as I previously mentioned we have redirected our efforts to our non-automotive applications. Our premise that this unique product would have more potential for application in these markets has proven to be correct as we already are supplying three customers on a regular basis. However, the volumes are small and in this economic environment we are concerned growth could be very slow. Therefore, I have asked the consultant with a great deal of plastics marketing experience to examine Envisions potential with our team. We intend to make a final decision regarding future direction by the end of this fiscal year.

In terms of our outlook for the rest of 2008 we are closely monitoring our European performance in the marketplace as well as the continuing weak North American market. We have accelerated all of our savings programs which we can to help offset any market and [inaudible]. We are creating contingency plans for both North America and Europe in case they are needed. For the full year of fiscal 2008, unless global economic conditions become significantly worse, the company continues to expect net income to exceed $36 million excluding the unusual items that Paul has mentioned.

In closing, I am very optimistic regarding the outcome for A. Schulman in both the short and long term. We have dedicated employees who have embraced the culture change that we've started and we are all moving forward in one direction focused on profitable performance for our shareholders. Thank you for this opportunity to speak with you.

Paul and I are now ready to address any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Rosemarie Morbelli - Ingalls & Snyder LLC.

Rosemarie Morbelli - Ingalls & Snyder LLC

How much capacity you have eliminated in North America since the end of 06 and how much is left at this stage?

Paul F. DeSantis

We've closed down the Canadian plant and we've sold the Texas facility, so those two plants, I'm thinking through the capacity of each individual plant. The Canadian plant was about 75 million pounds. This is what I think we disclosed in our 10-K. And I think the Texas plant was slightly larger than that, so that's a significant piece of the total capacity in North America that's gone now. So we would expect then, as I think we've said, we'd expect to see our capacity utilization in North America go up as a result of that.

Rosemarie Morbelli - Ingalls & Snyder LLC

And go up to where just based on that and all other things being equal, not considering further decline in the marketplace and so on?

Paul F. DeSantis

We would expect to see at least a 5 point increase in capacity utilization if not slightly more than that.

Rosemarie Morbelli - Ingalls & Snyder LLC

Let's look at engineered plastics since this is more or less where this went out. It was only at 5% so is that enough to really improve the North American businesses or do you need to take a lot more?

Paul F. DeSantis

Rosemarie, let me be clear, that 5% was for the total North American business. On the engineered plastics business we'd expect to see a bigger pick up.

Rosemarie Morbelli - Ingalls & Snyder LLC

And then just going back to my last question, first of all do you need to eliminate more and if you don't need to eliminate more, do you have enough in terms of the bottlenecking in order to meet future market growth whenever that happens?

Joseph M. Gingo

Rosemarie, that's a very good question and let me explain it like this, when we shut down the Canadian plant in order to meet demand, some of the Canadian lines had to go to our other operations in Bellevue, Ohio and Nashville, Tennessee and even to Mexico. What we've done is we've moved those lines but we've not installed them. So we're going to be watching the market and determining if there's a need to install those lines. Now eventually I personally believe there will be a need. Is it going to occur over the next 12 months? I think that's a very difficult question to answer in terms of the environment that we're currently facing. However, what I would say, with what I expect to face I'm in very good position to flex up. And if I have to flex up more, I'll accelerate the program or reinstate the program of reinstalling those lines. I hope that answered your question.

Rosemarie Morbelli - Ingalls & Snyder LLC

And if I may ask one last one regarding Europe? Obviously as we read everywhere, Spain and Italy and the UK have already slowed down and France and Germany are on their way. What are you eliminating capacities there? What are you doing in Europe in order to offset these negative trends?

Joseph M. Gingo

Well, I would describe our situation in Europe as steady on average as compared to last year, however, with fluctuations around the average each month. We've actually seen no significant growth or decline. However, as you mentioned, like everyone else with a major exposure we remain concerned. So therefore we are developing plans to address any possible situation in Europe even including growth but obviously definitely including capacity optimization.

Operator

Our next question comes from Saul Ludwig - Keybanc Capital Markets.

Saul Ludwig - Keybanc Capital Markets

Let's first talk about North America. As we look forward to the fourth quarter clearly on the negative side is the sort of external environment and maybe on the plus side is your SG&A cuts that you've put in place and the early closing of the Canadian plant. And when you closed the Canadian plant I think you previously said you expect to save upwards of about $8 million annually. Should the fourth quarter be the first tranche of savings from the completed Canadian plant? And when you look at sort of the pluses and the minuses as they relate to North America do you see the trends let's say in gross profit and operating income being worse than they were in the third quarter or do you see a little better conditions because of the actions that you've taken to mute the external environmental effects?

Joseph M. Gingo

I think I'm going to let Paul answer that question with relationship to what we expect to see from the effects of the Canadian plant in the fourth quarter, the closing of that plant, and then I'll address your more general question.

Paul F. DeSantis

Saul, to answer your question, we are definitely expecting to see some benefit in the fourth quarter from that Canadian plant closure. As we started to watch the environment decline in the US we accelerated that closure to get it done as quickly as we could so that we could start to see that benefit. And so our expectation is that that's going to help bolster our fourth quarter performance in North America.

Joseph M. Gingo

And as I look forward to the outer years on this, then taking your caveat about the thing we can't control, the economy does not get significantly worse, we would expect substantial improvement based upon the cost-cutting actions we've taken not only in capacity but SG&A as well as the start of the first master batch additive plant in the USA. So I'm optimistic about next year, but of course you would be imprudent if you didn't worry about the economy.

Saul Ludwig - Keybanc Capital Markets

And you mentioned to the prior question about Europe, what are some of the plans, the contingency plans, you have in place? Look, we've already completed one month of your fourth quarter in the month of June. Did you see any further deterioration in June and if you were to see deterioration, what would be some of the steps that you could take in Europe? It's not so easy there to get rid of people as it is here in North America.

Joseph M. Gingo

Well I'll tell you, as I said, you know you sit on pins and needles on this one but so far we haven't seen any significant deterioration in the last few months versus the first few months of this year. We see fluctuations around last year's average. Now we're not seeing growth, okay? But we're not seeing decline. And of course you sit here worrying when and if that occurs. I mean, you have to. But as of now we're not seeing it. And I can only answer the question in that way. And of course, what would you do?

Absolutely costs are higher to do anything in Europe but you have to do what you have to do. And if I was faced with the worst economic environment in Europe, I would surely be doing the things that I have done here. The first thing I'm going to always look at is capacity. I doubt that I would shut a plant but I would suspect that probably reducing hours worked, cutting lines, things of that sort, any outside tolling that we're doing in Europe would not probably but would be brought in-house to fill our own capacity. We are doing some outside tolling work in Europe.

So it would be those traditional things and we'd take a very strategic look at our overall back office structure in Europe and that would probably be where I'd go which is not much different, Saul, as you're well aware of what I've already done in North America.

Saul Ludwig - Keybanc Capital Markets

Paul, what do you expect the special charges to be in the fourth quarter which certainly are not a part of your $36 million operating profit number, but what do you think the special charges might be in the fourth quarter?

Paul F. DeSantis

We're still looking at that right now. Something in the range of maybe $2 million to $3 million, $2 million to $4 million, as we get our way through the process but clearly as we go through implementing the rest of Joe's plans and cleaning up the plans that we've already implemented we'll have a better number.

Saul Ludwig - Keybanc Capital Markets

With regard to the surging raw material costs and your attempts to raise prices here in North America, in the third quarter if you looked at the ratio of price to raw material margin, just that, was there deterioration from a year ago and what do you expect to happen in the fourth quarter, meaning are you able to get the prices to keep your variable margin constant?

Paul F. DeSantis

One of the things I mentioned in the script and I said interestingly, it really was, we saw, I'm looking at gross profit pennies per pound so it's not quite the material margin you're talking about but I saw gross profit pennies per pound actually up in our distribution business and our engineered plastics businesses in the US and I would have expected that. As we said we lost a little volume in distribution because we took pricing and we've started the major surgery on the engineered plastics business of getting rid of all the low margin and then bringing our capacity in line with higher margin sales. So we're actually beginning to see the effects of that in the P&L and so we didn't see that in the poly batch business but in the other businesses we did.

Joseph M. Gingo

And Saul, to go further, since the price increase announcement I've been keeping close tabs with the heads of my business unit on what's happening. We're still continuing to see decline and demand because of the economy but prices are holding. The price increase is being accepted in the market. From personal experience I can tell you that I've seen more acceptance even at the automotive account of indexing, reluctant acceptance but acceptance. I think that what's come across now and I don’t' think it's unique to A. Schulman is these raw materials are rising at an unprecedented rate and I think that people just understand that everybody's coming in and saying, just read the newspaper, what major companies have done. I think the inevitability that you're going to have to accept a price increase if you want material has come to the market.

Operator

Our next question comes from Robert Felice - Gabelli & Company.

Robert Felice - Gabelli & Company

I first wanted to follow up on North America. You know, there's a lot of moving parts there in terms of the initiatives that you've been taking so maybe I'll try to step back and ask the question from a broader perspective. Joe, if I think back about six months ago, you originally said that North America should be break-even by fiscal 09 and then on the last call you had tapered that expectation due to the economic conditions. Could you update us on your thoughts there in light of the accelerated Canadian closure?

Joseph M. Gingo

Unfortunately what's happened, as you well know, is yes, the Canadian closure would have absolutely actually made me much more confident of break-even in 09 but even further deterioration of the economic condition puts me into the same statement that I gave to you last quarter. I've got to temper it. It's really going to be where the economy ends up. But I will say this, we are going to be tremendously better positioned than we were six months ago.

Robert Felice - Gabelli & Company

You haven't really changed that expectation; it hasn't lengthened in any way or shortened in any way.

Joseph M. Gingo

No, I think I'm right there. I think it's now more a function of the economy than what we've done internally because what we've done on my 100-day plan has really been implemented. I mean, it's there, the cost savings are real, we've given those numbers out before, you know what they are. It's now the economy forced more slowdown. It's an economic question now.

Robert Felice - Gabelli & Company

And you discussed the raw material cost environment a little bit but I guess I'm wondering, given the pricing that you have in place as of today and where raw material costs are, do you feel comfortable with your price-cost gap that it won't widen from the third quarter to the fourth quarter or do you think you need additional pricing?

Joseph M. Gingo

I think in light of what I'm seeing in raw materials there will be additional pricing, not only in North America but in Europe. It's unprecedented. You can talk to anyone. If you would talk to my procurement officer, a gentleman with 16 years of running a major buy for a company, he's never seen anything like it.

Robert Felice - Gabelli & Company

And then I guess speaking of your procurement officer, I guess Gary's been in for now what, three or four months, so I was hoping you could elaborate on the procurement side and I guess, more specifically hopefully quantify the magnitude of cost savings or benefit in terms of terms that you think you can get over the next six to 12 months?

Joseph M. Gingo

I think Gary came aboard in April and he's grabbed hold. He's revamping our global purchasing process. But I would say in light of your comment, in light of the unprecedented rise in petroleum-based raw materials, I think Gary would tell you he's expecting more rapid progress to be made in payment terms and cost reductions for the non-petroleum-based products. And we have seen some improvements in both those areas. Paul alluded to some of them and maybe you can elaborate a little more, if you would Paul.

Paul F. DeSantis

On those particular areas?

Joseph M. Gingo

Yes. Particularly the days and -

Paul F. DeSantis

What you've seen as we looked at the days, we've gone from 112 to 90 in February. In February we were at 112. Now we're at 90. As we look at opportunities for improvement in the short term, there are really two areas. Purchasing, working with payables is a big area. If you notice our payable name, our payables and our receivables are way out of whack. So we're acting as a banker in the industry and that's unacceptable because we're not a bank. And so we can work on both sides of that equation.

I think purchasing is going to make good steady progress against the payable side of that and I think we have other plans in place that are making good and steady progress against the receivables side of that equation. And in this environment in particular, making progress against the receivables side is a good thing given the pressures that are on our customers out in the marketplace.

So if we look at our working capital program and how we expect it to unfold over the next few years, the earlier quicker easier hits are on the payables and the receivables side and then later on we ought to expect to start seeing some big benefit on the inventory side as we start to play out to get to our target 60 days over the next few years.

Robert Felice - Gabelli & Company

So if you do take advantage of some of the terms and you work on the receivables, we should start to see the days for both of those converge on each other.

Paul F. DeSantis

Yes. And I mean, one of the things that our new purchasing group is doing is they recognize that the body is a holistic, it's not only price, it's also term and so they're looking at the entire package as they go and talk with our suppliers.

Joseph M. Gingo

Yes, some suppliers are preferring discounts over terms and if our financial analysis indicates that that's a better deal for us, we're going to take that deal. We're going to look at what's best financially for the company but don't doubt in your mind that our focus is days.

Robert Felice - Gabelli & Company

Just flipping gears to Envision, you mentioned that demand is progressing slower than you expected there and you're reviewing your options. I guess if I read into that, are you suggesting that you could potentially close that business there?

Joseph M. Gingo

Remember we only made the switch to non-automotive six months ago. But we're continuing to confirm that Envision is actually a very attractive product especially in these non-automotive applications. As I've stated previously and what I said in the talk today, we're investigating all of our forward options with respect to Envision and I will make a decision with my team and with the advice of the marketing consultant that I've hired as to what direction we will go. And you know obviously there are only four directions that you can go. One would be to maintain the business and continue to take advantage of this non-automotive growth. Another opportunity would be to sell the business, or a third opportunity would be around some type of joint venture or licensing arrangement. I doubt based on how this is being received in the market, although I have not thrown the option out, that we would just close the facility because we have a product that is being well received. Are we the right company to take that to fruition? That's sort of what we're looking at over the next two months.

Operator

Our next question comes from Christopher Butler - Sidoti and Company.

Christopher Butler - Sidoti and Company

The first question that I have relates to cost cutting and looking at your SG&A line. If we x'd out the foreign currency translation as you did in your press release, we're looking at a flat number year-over-year yet North America you pointed to cost cutting the numbers from the all other segment in the segment breakdown is lower. What's the disconnect there?

Paul F. DeSantis

Well Europe is up slightly. Europe's SG&A spending year-over-year is up. As that business has grown and as Europe has expanded, SG&A spending is up. We also, if you'll recall last year, bought a business in the latter half of year in Europe called Delta Plast and so we're also seeing the SG&A effect of that business on the total.

Joseph M. Gingo

But I would elaborate as I think I mentioned previously to one of the questions. One of the things we're looking at strategically is the back office in Europe. Fundamentally we are a country structure and we're going to look at our structures to see if there is a better way to address that. So the focus that we've had on SG&A in North America, where I think we've actually made significant progress, we're now going to turn to Europe. And my European management team led by my Chief Financial Officer over there is really investigating all of our options.

Christopher Butler - Sidoti and Company

And looking at your guidance for the year, you mentioned that unless things get, I think you had said on the call, considerably worse than expected, that you'd hold to your $36 million net income guidance. I was wondering if you could give us an idea of what, how bad do things have to get before you start to think under that or in relation to the US economy which seems to slow more for you here in the third quarter and also Europe?

Joseph M. Gingo

It's hard to define significant but let's put it this way. We wouldn't be saying $36 million unless we really thought we could get it with everything we know today. If there's some dramatic turn of events, I mean even more dramatic than the trend lines that we are currently seeing, then things could change. And if that happens, we'll come out and we'll say that we saw something different. But I think you've got to read my comment as saying there's no data in our possession today that indicates that that number's not achievable, excluding the unusual items that Paul had mentioned.

Christopher Butler - Sidoti and Company

And sort of touching on that though from a dramatic turn of events standpoint, what we've seen here with oil prices and your raw material costs from when you initially issued the guidance is a fairly dramatic turn of events. Part of it is we heard about [inaudible 05:50.3] overview of what you are doing that's going to allow you to come through this with no real change?

Joseph M. Gingo

I think what I'm considering dramatic, I think pricing as I mentioned, raw material pricing is going to be passed on through and there's more acceptance in the market. But when I'm talking about significant or dramatic, I'm talking about a significant drop on the slope of demand in either Europe or the United States. Now the slope of demand in the United States is down, okay? So I'm anticipating that slope to continue. I'm not anticipating that we're going to have an upsurge. What I'm saying is a dramatic shift from the decline. What I'm saying is we've seen Europe be steady. If it were slightly down over the last couple of months, I don't anticipate that to be a problem. If Europe would make a dramatic drop in demand, that would be significant to me. And so it's more demand driven than anything else and I'm taking into account the economies I'm experiencing to date. I'm not looking toward any you know upward movement in either economy.

Christopher Butler - Sidoti and Company

Now you had mentioned that some of the capacity reductions that you've made allow you to cut some of the less profitable or even unprofitable product lines. I missed whether you said that that was something that occurred already or something you're looking to in the future. Is that part of the tonnage decrease that we've seen here in the quarter?

Paul F. DeSantis

Well as we said we finally closed the Canadian facility at the end of June so the Canadian facility is closed completely. It's earlier than we had anticipated doing so we think we're going to accelerate some benefit that we were expecting next year into this year. The other thing that the closing of the Canadian facility allows us to do is it gives us backbone on pricing because we're not trying to fill a bunch of excess capacity any longer. It allows us to be a little bit tougher on pricing and so that's very helpful for us.

Christopher Butler - Sidoti and Company

And with your conversation on tax rate, did I miss what you think your tax rate might be going forward with some of the planning strategies that you've put in place?

Joseph M. Gingo

I think that we can expect to see tax rates sort of hovering in the range where we are today. What I will do is that I will give better guidance on tax rates for next year as our plans for next year come together and we look at it, I'll try to give you guys some guidance or give everybody some guidance in terms of where we think the overall tax rate to plug into your model should be. But given where we've been progressing so far on the European business, I think that's probably a good basis to compare and then to the extent that the North American business, specifically the US, gets to be more profitable, ultimately we would expect to see the tax rate decline a little bit.

Operator

Our next question comes from Eugene [Fetigoff] - Longbow Research.

Eugene [Fetigoff] - Longbow Research

Coming back to your guidance for this year to the $36 million income, I'm just trying to get an idea you know what assumptions went into that guidance especially as far as pricing assumptions that we have?

Paul F. DeSantis

What we've built in, the thing that we're paying attention to is not necessarily the price and it's not necessarily the cost. It's kind of the pass through or the material margin on a pennies per pound basis. So our assumption built into it is that we're going to get the pricing that we need and our assumption built in is that we're going to get the cost reductions that we planned on getting. So if we can get those through, then we feel pretty confident that we can hit the number. As Joe said, if we have something catastrophic that wasn't part of our planning obviously we won't be able to hit it. Does that answer your question?

Eugene [Fetigoff] - Longbow Research

And then on pricing you mentioned that you have been able to realize some of the price increases, I'm just trying to get an idea you know what you think you will be able to realize from that 20% announced until the end of the year?

Joseph M. Gingo

Well it depends by account and as you saw there are contracts. Some of the words, some of the contracts are indexed. Overall I don't have any very specific data I could give you but I think on an average 10% across the board would be realistic but look better in some areas and worse in others. But a lot of the automotive following index and as you know if you just followed index right now you'd be looking at pretty high percentages.

Eugene [Fetigoff] - Longbow Research

And then on non-auto business in North America, can you just provide some more update than that and what are you seeing out there?

Joseph M. Gingo

What we're seeing is slowing in all markets in North America, automotive and non-automotive.

Eugene [Fetigoff] - Longbow Research

And then just on loss in North America, what was the total volume, price mix and currency components for total segments for North America?

Paul F. DeSantis

We actually don't do that. We don't do a total North America segment any longer so we broke it out separately in the press release and then we're about to file the 10Q and that detail will be in the 10Q as well. So if you can hold off until that's filed which should be in a few hours, then you'll get all that detail.

Operator

Our next question comes from Rosemarie Morbelli - Ingalls & Snyder LLC.

Rosemarie Morbelli - Ingalls & Snyder LLC

You mentioned that two large customers filed for bankruptcy. Could you give us some more details? Are you expecting more to come and what changes have you made to your reserves?

Paul F. DeSantis

Well those two customers that filed were both in the second quarter, not the third quarter, and both of them were big public auto suppliers. So what we have done is that we have stepped up our enforcement policies and our collection policies in North America as well as taking a real close look and a real, we're being much tougher with the business. Again a big benefit from closing the plant gives us the ability to be a little tougher on these aspects of our business.

Rosemarie Morbelli - Ingalls & Snyder LLC

[Inaudible] as an answer to a previous question, you said that you were totally out of whack between the payables and the receivables so it doesn't look as though that has changed that much.

Paul F. DeSantis

No, it's the focus that's changing internally. And so we're not going to see the results immediately right off the bat but internally the way that we're handling our credit and collections has changed and the focus that credit and collections is getting at the top of the organization is different than it was in the past. And our expectation and what we're seeing so far is that we think we're seeing some results to that.

Rosemarie Morbelli - Ingalls & Snyder LLC

Do you see more smaller customers filing? Have you changed your reserves?

Paul F. DeSantis

No, I mean we go through a pretty thorough process of reserve setting and I would say that they're not materially different than they've been in the past.

Rosemarie Morbelli - Ingalls & Snyder LLC

And then that $36 million in net income for the year assumes that the fourth quarter will be lower than the second quarter?

Paul F. DeSantis

The fourth quarter historically remember for us includes the month of August in Europe and Europe is obviously a very significant portion of this company's earnings. So our normal cycle and our normal budget process includes a weaker fourth quarter.

Rosemarie Morbelli - Ingalls & Snyder LLC

On the distribution side your margin is down somewhat but isn't - well in the past distribution was really a pass through cost kind of business. So why is the margin down? Are you being hit on freight or do you have more difficulties passing through the further cost increases than historically?

Paul F. DeSantis

Remember what I said, on a pennies per pound basis we're actually making slightly more money on the gross profit line in distribution. You're going to see a margin as a percent of sales decline because prices are rising so rapidly that even making the same pennies per pound you're going to see a percent margin decline. I think that's just a function of the way it would work.

Joseph M. Gingo

And we have two businesses there, one is a merchant business and one is a roto compounding business that is included in our distribution area. And probably because of the environment we're in, the mix has been more toward merchant and merchant is just a little less margin than any kind of roto compound.

Rosemarie Morbelli - Ingalls & Snyder LLC

Based on all of the changes you are making in North America, is it likely that the margins here are going to approach those of Europe or is that not possible because of the way you are set up?

Joseph M. Gingo

That's our goal. You have named our strategy but it won't be done in one or two years.

Rosemarie Morbelli - Ingalls & Snyder LLC

Is it feasible?

Joseph M. Gingo

In my belief. I made this mention about master batch, you know we are the market leader in Europe and Mexico in master batch. Now we intend to become a much more significant factor in the United States and Canada. Success in the master batch business is dependent on response times to customers. Therefore we needed a facility in the USA and we will have a facility in the United States beginning operations in October. The plan is designed to be very labor efficient and we're going to get an added benefit in reductions in freight and inventory costs because we're now supplying that market out of Mexico.

In addition in Mexico we will be able to divert that capacity and funnel that into Latin America where really we've been constrained. So I have no doubts about that we can be extremely successful in master batch in the entire North American market, not just Mexico. Number two, we are moving and you can see it by our direction into a much more niche active engineered plastics business.

And in that business we're looking very strongly at getting a ratio of automotive and non-automotive of around 50%. We're not there now. I mean it's in excess of 60%, 65%, 70% even, and by the way it used to be more. So what we're trying to do, I think really very logically there is no reason that this company could not be as successful in North America as it is in Europe.

Rosemarie Morbelli - Ingalls & Snyder LLC

On the share repurchase, you have another 500,000 shares so it looks as though you are going to do that in the fourth quarter based on the press release. Could you talk about the share repurchase plan for 2009 when you are done with this particular batch?

Paul F. DeSantis

We'll talk about our 2009 intentions at the next conference call when we give some guidance for the full year of 2009. We're not prepared right now to talk about details on 2009.

Operator

Our next question comes from Saul Ludwig - Keybanc Capital Markets.

Saul Ludwig - Keybanc Capital Markets

Joe, you talked about the master batch here in the US, what type of capacity is added and where's it going?

Joseph M. Gingo

We will make the decision about where it's going probably next month. There's some competition between some incentive programs that are possible for me in different locations but it's not going to delay the start-up because the long lead item was the equipment and the equipment's on order. So the equipment's going to be here in the September time frame for installation and start of operations in October. I'll make the decision next month as exactly where it's going to go. Saul, we're going to start off with one line and I don't recall the specific capacity but I'll be more than willing to get that number and provide it to you.

Operator

And at this time there are no further questions in the queue.

Joseph M. Gingo

Well really I just want to thank you for calling in and giving us the opportunity to continue to tell our story of what we're trying to do, not only to turn around our North American operations but to improve our European operations. Because I think my European team would tell you there is room for improvement and we have plans in place to do that as well. I'm very excited and pleased with the progress that we've made to date. I am really pleased with the acceptance of change that this organization has changed to. We have a new focus, our focus is on continued profitability growth, shareholder value and it's been embraced.

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Source: A. Schulman, Inc. F3Q08 (Quarter End 5/31/2008) Earnings Call Transcript
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