Executives
Myles Odaniell – President and Chief Executive Officer
Randy Martin – Executive Vice President and Chief Financial Officer
Analysts
Mike Harrison – First Analysis
David Begleiter – Deutsche Bank
[Robert Bova]
Spartech Corporation (SEH) F3Q08 Earnings Call September 11, 2008 11:00 AM ET
Operator
Welcome to the third quarter 2008 Spartech earnings conference call. (Operator Instructions) I’d like to now turn the presentation over to your host for today’s conference, Miles Odaniell, President and CEO.
Miles Odaniell
Thank you for joining on Spartech’s Q3 2008 earnings conference call. Randy and I welcome the opportunity to speak to you today regarding our current performance, our progress, and our outlook for the balance of the fiscal year. After my comments, Randy will provide some highlights and specifics on our quarter results, and then we will both be pleased to take questions.
In the first quarter of this year, we announced the framework and major elements of our strategic and financial turnaround. In June, we completed this assessment and we have now created a detailed roadmap for transforming Spartech. In regards there, we have made very substantial progress in many of our key initiatives already in the third quarter.
As previously communicated, this assessment included the development of a comprehensive set of portfolio plans, including individual business unit strategies and an assessment of core and non-core operating assets. It also included the development of broad organizational restructuring plans, including identifying what was required from a talent, skill set, organizational leadership, and overall staffing levels for Spartech. In addition, it included a broad-based cost reduction initiative, including substantial conversion cost reduction and structural cost elimination focused on building a low cost-to-serve model in Spartech.
Our financial turnaround program is based upon a diversified portfolio of performance improvement initiatives spanning commercial, manufacturing, asset restructuring, cost reduction, and procurement. We have adopted this broad-based approach with an expectation that we will energize and involve the entire organization in our turnaround. We have already announced and made progress in 2008 on initiatives that will generate at least $25 million in annualized benefits.
Over overall strategic roadmap is focused on components that we believe will result increased portfolio focused casual improvement in our competitive advantage and true leadership positioning in our core business areas. This will in effect drive an important transformation of our Company that embodies a change in management mindset and value generation that we believe will result in measurable enhancements to our shareholder value.
Let me discuss some highlights and major takeaways from today’s call and from our third quarter. We’re making steady progress on key initiatives directed and managing through the current economic downturn, improving financial performance and better positioning our Company for the long-term. Our entire team is energized on executing our financial turnaround and transforming Spartech, and upfront I would like to recognize their hard work and thank them for the contributions.
Based on our current volumes and current raw material costs, on an annualized basis, Spartech is now managed through more than $200 million in lower demand and nearly $150 million in annualized raw material cost increases. Clearly these are some challenging times, but we are making very meaningful progress, and I would characterize Q3 as stabilized performance in the face of continued economic headwinds.
Because of our decentralized approach to managing our plants and our business, business units, we have never fully captured synergies from being $1.5 billion Company or from our successful rollup strategy in the last ten years. I believe Spartech has many truly unique improvement opportunities that do not exist elsewhere in this space to improve our cost and operating efficiencies to consolidate manufacturing, to eliminate duplication of resources, and gain value from building a single company operating culture. This is a central theme of our financial turnaround.
This quarter we completed our detail organizational assessments and are taking specific actions based on that work. 60% of our leadership are now new to their position and helping to lead the organizational change process and build our performance culture. We are making investments in new people, particularly in operations and commercial functions to insure we maintain our leadership and strive to provide customers with the highest level of service, product quality, and innovation. I previously commented on some of our major changes designed to upgrade our organization.
We are ahead of our previously announced staffing and cost reduction plans and are now establishing some more aggressive targets. We will complete the shutdown of our Mankato plant this month and announced a plant closure of the St. Clair Compounding plant yesterday as part of our continued efforts to streamline costs, reduce our manufacturing footprint, and establish a sustainable cost advantage. We have commenced a detailed evaluation of our entire manufacturing footprint and that work is ongoing.
We have structurally improved our pricing practices to effectively pass on raw material cost changes on more of a real time basis to the market. We fully passed it through some very large increased incurred in our Q3 and continue to work jointly with our customers through this challenging dynamic. We have a very deliberate effort focused on improving our mix and quality of our sales and our sales organization has done a commendable job keeping pace with the run-up in raw materials. We now look forward to bringing some relief to our customers as soon as prices decline.
Despite weak demand, Spartech continues to generate solid cash flows from operations. We have now completed the necessary amendments. In addition, we have no completed the necessary amendments to our financing arrangements with both our banks and private placement holders to support our operational needs and fund our improvement initiatives. We have the balance sheet strength and flexibility to complete all of our current plans. This was a significant effort in a very challenging financing market, and we appreciate the ongoing support from our lenders as well as the hard work from our folks in the finance group.
Our portfolio assessment was completed and will result some portfolio restructuring in the coming months, allowing us to focus on developing truly advantaged leadership in our core businesses and to exit segments and operations that are viewed as non-strategic. Our packaging business presents a natural growth platform that can be scaled to drive value creation and presents opportunity for staged organic and eventually acquisitive growth. Clearly this is an area where we need to build critical operating and market mass and this will be a primary focus of our growth strategy. We will clearly build on our strong market leadership position and multilayer [inaudible] packaging, but also look to expand beyond our current business footprint.
Our strategy for our custom sheet and roll stock business is fixed and grow. We have a significant focus on restructuring our sheet business where we expect to leverage our market leadership and scale to fully position ourselves as a truly advantaged leader focused on a low cost assert model, world class commercial skills, and a measured transition from a volume focus to a value-add focus.
In the face of soft demands, Spartech continues to make meaningful investments in innovation and technology and this will serve us well as we work to rejuvenate our organic growth. We continue to conduct customer training sessions at the product development center and showcase our unique capabilities on materials, product formulation and thermoforming and new materials such as extreme PPO and expanded material technologies are showing real promise in the marketplace.
As we work to build low cost manufacturing, our world class polyolefin site in Greenville, Ohio, was completed in Q3 with the final transfer of equipment now done. We will soon be receiving our lead silver certification and the Greenville Plant we believe has the lowest structure in North America offering unparallel capabilities in the industry.
Color specialty compoundings competes at a very challenging market where we maintain a strong competitive position. This business also provides some unique advantages to Spartech’s core sheet and packaging businesses. Our primary strategy here is to focus on growing several of our unique technologies while we create a low cost manufacturing and cost-to-serve model and continue to reduce our footprint while we improve our mix by reducing dependency on highly cyclical and commodity compounding businesses. Our engineered product segment is a group of profitable, well positioned, and good performing businesses, but not a core focus going forward. We also have a couple product lines that are weak strategic fits and we’re now in the process of evaluating strategic alternatives for those businesses.
Let me know change gears and talk specifically about our markets, our external climate and a few comments on our outlook going forward. As expected, both the market demand and resin pricing environment continue to be very challenging in our third quarter. Volumes were 17% lower than our prior Q3 and sequentially 10% lower as well when compared to Q2 2008. Our decline in sales volume represents lower overall volumes due to continued weakness in several of our end markets including automotive, residential construction, and recreation and leisure.
Just to be clear, there are no surprises here. Sales to the automotive sector, which represent 13% of our overall sales, have been particularly weak and declined 27% due to lower build rates compounded by our current exposure and approvals in numerous SUVs. Our sales to the RV segment were lower by almost 47%. Both of these statistics are consistent with end market demand and available externally published information. Very clearly, one of our objectives is to focus on improving our sales mix as automotive tends to be our lowest profit segment as well as being highly cyclical. Our exposure to automotive and RVs has clearly not been a positive for Spartech in 2008.
We believe our sales volume continued to trend with end market demand and we continue to focus on maintaining overall market share. We’ve also shed some very low margin business allowing us to cut deeper on the cost side, providing our mix and ultimately our overall profitability. In the case of the St. Clair closure, lower automotive demand has been the enabler for us to justify relocation of production to other facilities, shutdown the plant and significantly increase the profitability of that part of our business.
We continue to work closely with our customers to jointly manage through the very challenging raw material, the pricing environment, while we continue to do our part to reduce our overall cost as evidenced by our organizational restructuring and plant closures.
In terms of our outlook, we are starting to see some resin cost stabilization and do anticipate some reductions in a couple resins in coming months. As a consequence, we should see some modest margin improvement because of the lack built into some of our pricing formulas.
On the demand side, we continue to forecast very soft demand and certainly continued poor visibility in our four automotive building and construction rec and leisure markets. Hopefully we’ll prove to be conservative planning, but we are assuming no recovery through 2009 and we’re not planning on market recovery or raw material benefits to drive our improvements.
With those comments, I’ll now turn it over to Randy who will provide some specific detail on our Q3.
Randy Martin
I will be focusing my comments on providing more details on the financial performance in our third quarter in comparison to results for both our prior year third quarter and the second quarter of 2008.
Before I get started, I wanted to remind everyone that we have provided several sources of information relevant to our performance in the quarter, our earnings release, and Form 10-Q were issued before this call and we’ve also provided supplemental slides that provide some additional data that are often of interest to our shareholders. Those slides can be found on our website at www.spartech.com, Investor Relations menu under the Presentations indication.
I should also remind you that, as always, we’ve provided our summary of “safe harbor” statement with the factors that could impact our results in the future within the documents that I referred to above.
We have made significant progress on some of our improvement initiatives, and I will highlight their impact on our financial results as I review the results for the quarter. First, I will provide an overview of our key income statement component, then I’ll provide some highlights on cash flow, and finally I’ll give an update on our recently completed amendment to our financing arrangements.
With regard to sales for the third quarter of 2008, Myles covered the overall market environment and the impact on our underlying sales volume which was down 17%, overall our sales were only 3% down in dollars from the prior year. The dollars were favorably impacted by the creative acquisition the pass-through of higher resin costs as higher sales prices, and improved mix. These price mix increases resulted in sales prices that were $0.15 higher than the prior year resulting in an 11% favorable impact on our sales dollars.
We will likely continue to see a better mix of sales at some of the more commodity and lower margin business tends to be replaced with higher priced higher margin business. In addition, we have established more consistent pricing practices to ensure we can effectively pass-through raw material cost increases on a more timely basis. In the fourth quarter of 2007 and first quarter of 2008, we were not prepared for the new pricing environment that we were then entering and didn’t have commercial practice that were effective in passing through the level and frequency of price increases that we’re experiencing in the resin market.
In the first half of this year, we’ve worked on several fronts to change our pricing adjustment mechanisms, contracts, and other standard practices to improve in this area. We have caught up from the lag we experienced in the past and believe we are much more able to keep pace with future price increases on a timely basis. This was demonstrated during the third quarter where we experienced some of the largest resin increases of the past year in June and July and were able to sustain our margin.
These price increases represented approximately $15 million of material cost increases during our third quarter of 2008, which annualizes to $60 million of the $150 in cost increases over the past year that Myles referred to earlier. So $60 million of the $150 million in higher material costs today versus a year ago occurred in this quarter.
Polyethylene and polypropylene saw the largest increases, representing 15% to 20% during the quarter and over 50% from the third quarter of 2007. Polystyrene and ABS were up approximately 10% in the quarter and 20% from the third quarter of 2007.
Next I’ll talk a little bit about profit margins. With the weaker in-market demand, we’re focusing our efforts on improving our mix of business, keeping pace with resin cost increases and reducing our manufacturing cost footprint in order to improve our gross margin per pound. This represents many moving parts occurring simultaneously; although, we were pleased with our progress on several key initiatives that support a foundation for future improvement. In particular, we were able to reduce our conversion costs by almost $6 million from the second quarter of 2008, representing a 7% cost reduction. Our current volume levels are providing more opportunities to reduce our cost today and change our operational footprint to permanently reduce our cost structure for the future as well.
Our initial estimate of the 10% labor cost reduction effort and Mankato plant closing that we announced in our March press release was an annual savings of $16 million. We ramped up to an exceeded this level during the third quarter and are now estimating an annual savings of over $20 million. Combined with the newly announced closing of our St. Clair, Michigan, compound facility during our fourth quarter, we expect to save over $25 million in 2009 from these initiatives, approximately $9 million will be included in the fiscal year 2008 results.
With the improved mix, better execution of timely pass-through of resin cost increases and the beginning effects of our cost reduction initiative, we were able to record the second best gross margin per pound in the last seven quarters. The $0.11.5 gross margin per pound for the quarter was better than the $0.11.4 realized in the third quarter of 2007 and improved more significantly from the $0.10.6 level reflected in the second quarter of this year. We will continue to focus on lowering our cost structure while improving our mix of business.
With regard to SG&A costs, SG&A expense was up $600,000 from the prior year, but down $500,000 from the consecutive second quarter. The third quarter of 2008 includes several upfront costs for our continued Oracle implementation, hiring and relocation costs for new executives, and consulting fees related to our strategic planning, financial turnaround, and manufacturing optimization efforts. Our recent reductions in our SG&A is making room for additional investments in people and system resources. We’ve been able to manage our SG&A during this period of weaker volume, initiate several reinvestments in our business that will allow for better execution and results from our improvement initiatives.
Myles mentioned new leadership in our human resources, procurement, and technology and marketing roles and we’re also acquiring additional expertise to assist in specific turnaround initiatives related to consolidated purchasing of materials, manage our energy costs, promoting green initiatives, and improving quality and operational efficiencies. We are continuing our efforts to improve our business processes and financial reporting analysis through our systems. We now have 26 sites implemented on Oracle and our continuing to add components of business intelligence that allow our managers to make better and more timely decisions.
These investments are enhancing our skills sets and capabilities to achieve our targeted improvements. We believe we will demonstrate and effective balance of leveraging our relatively low SG&A spend compared to others in the industry while resourcing our organizational structure in the enhanced commercial business processes that are planned. We believe an approximate 6% to 6.5% sales level for an SG&A is sustainable in the current environment.
Finally, one the income statement, our tax rate is unusually low for the third quarter and the year-to-date 2008 results as we had the benefit of several tax law changes earlier in the year and expiration of statutes on previously unrecognized tax benefits. These items contribute approximately $1 million to our net income for the quarter when compared to our more normalized tax rate of 38% for this year.
Next I’ll highlight a few items on cash flow. Cash flow is an area that continues to reflect solid performance given the earnings performance discussed earlier. In the quarter, we generated $34 million of cash flow from operations, which is higher than both the prior year third quarter of $26 million and the consecutive second quarter of $10 million. After $5 million of capital expenditures, free cash flow was $29 million and we paid down $27 million of debt in the quarter.
We continue to maintain our working capital as a percentage of sales in the 9% to 10% range. This quarter is 9.4%, was better than the prior year’s 9.8% and the second quarter 2008’s 10.0%. We have plans to further reduce working capital for the end of the year to better than the 8.8% realized at fiscal year end last year. We also closely monitor our capital expenditures. We’re projecting approximately $18 million for the year. This level is sufficient for maintaining our operations and supporting the ongoing announced efforts for improving our cost structure.
Finally, I wanted to highlight the progress that we reported in our release of amending our financing arrangements. In March of this year, we obtained an amendment of our second and third quarter covenants and then began to work on obtaining additional financial flexibility needed to provide sufficient liquidity and support our future turnaround improvement and gross initiatives. Effective with this release, we have negotiated the terms of our bank revolving facility and term notes.
With these amendments, we have obtained an increase in our leverage ratio to 4.35 to one starting out and then it works its way back down to 3.51 to one in 2010. This provides added liquidity in the near-term from our 3.5 to 1 level under our previous arrangements. For the flexibility we agree to certain assets as collateral. Certain restrictions on the use of our cash flow, including required pay down of debt from cash flow, it exceeds amounts needed to fund operations, working capital, and the capital expenditures.
These agreements also increased pricing in the current term. As a result, these amendments, if you compare our new rate structure, which today would equal 6% weighted average interest rate to the recently completed third quarter interest cost of $5.3 million, we’d be paying $350,000 more for the quarter under these new arrangements. We are pleased that we can work these arrangements out with our existing lender groups and appreciate their continued support that we will allow to realize the benefits of our near-term improvement initiatives and longer term strategic plans.
Myles and I will now take any questions that you may have.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from Mike Harrison with First Analysis.
Mike Harrison – First Analysis
Looking at the material margin that you guys showed, I know creative is responsible for part of the improvement there, but $0.37.9 I think is the highest you’ve ever shown, at least according to my, the information I have. Can you give us a sense for how much of that improvement was related to the improved pricing approach versus how much was related to low margin business that you’ve been walking away from?
Myles Odaniell
I can’t give you an exact breakdown of that, but I would say the following: We’ve worked pretty hard to realign the organization with a focus on gross profit rather than exclusively on material margin and what that’s really cost us to do is focus on the overall quality of our mix, which is driven much of the improvements. If you look at the areas where we in fact have walked away from business, it’s been low or no profit business, much of it centered in our color and compounding business. So inherently that business wasn’t generating gross profit and in many cases, believe it or not, it wasn’t even generating a contribution at the material profit line, so we’ve got that.
Clearly, we’ve also got the impact of what’s happened in the third quarter with raw materials. As I referenced, we so an enormous slug of additional increases in raw material in the third quarter, and I think we kind of had mixed results in terms of our success passing that through. Some goes through pretty readily in the market, others we’ve had to fight out on it and then the third segment we still got some formula lags and things like that, so we’re still… We will cash those up over the course of the next quarter, but we didn’t get those. But I would argue if I was trying to estimate it, I think there’s maybe a 50/50, but we could certainly hunt that down and let you know specifically.
Randy Martin
Yes, Mike, in particular there’s seven to eight-tenths related to the creative mix that you mentioned; so that’s a portion of it, almost a penny. Then you definitely have the better mix from what Miles was referring to and a little bit of catch-up on some of the pricing where we had fallen behind earlier on in the year.
Mike Harrison – First Analysis
That’s fair. It sounds like this is all sort of part of the shift away from a volume pound sold type of mentality and into a more value-added type of mentality. You previously talked about the material margin and having a goal of $0.36 a pound. If you’re sort of switching and looking more at gross profit as a percent of sales now, do you have any targets for where you’d like to push that metric or is there another metric that maybe is more important?
Myles Odaniell
We’re working on tying that out with our turnaround plan and I think… I guess the message is right now: I don’t have one to communicate to you, but we’re working on developing that. Again, I think it’s a much more appropriate measure for us internally and hopefully from an external perspective, folks are looking at that as the right measure because it’s clearly much more aligned with our bottom line. But I would think during the course of our next call, we’ll certainly be able to give you that specifically.
Mike Harrison – First Analysis
Then are you able to quantify how much of the 17% volume decline would be related to business that you weren’t able to get pricing and then intentionally walked away from?
Randy Martin
We don’t quantify it specifically, Mike. I’d say the vast majority is consistent with the markets that Myles mentioned that were down in the automotive, the residential housing, and the RVs, which are down in the 20% to 40% range for those different markets. That’s going to carry the vast majority, maybe two-thirds of that and then the rest is going to be related more to your issue.
Myles Odaniell
I don’t have the number handy either, but I would say the following: We can go through on an account-by-account basis and tick and tie out where we are from a market share perspective; and we also as we do typically in the quarter, we look at our end markets and try to estimate where we view those, demand in those markets and then we tie that back to our participation in those markets. So the lion share of our shortfalls are, as Randy indicated, tied back to market demand; and then we add back some of the low or no margin business that we’ve taken a pass on, we can get to our sales volumes.
Mike Harrison – First Analysis
Then a couple questions on packaging technologies, I am a little bit surprised that you’re still seeing lower volumes in that segment sort of independent of the creative acquisition. Is that based on some end market weakness or are there changes that you’re making that are causing those volumes to be lower?
Randy Martin
One thing I’ll point out, Mike, and then Myles may have some additional. In our press release, we did try to split out the impact of some of the non-packaging related business that still exists within those plants that make up our SBT segment. So the amount related to the pure packaging was 4%, but it still may warrant your question, but it’s not as significant as it may appear when you first look at our [inaudible] result.
Myles Odaniell
The other item I would add is we did lose a customer towards the latter part of last year. It was like a December. I guess it was the early part of this year, it was the December/January timeframe and from a comparable standpoint, we’re still behind that one. So we’ve been working and we haven’t replaced that business yet.
Mike Harrison – First Analysis
Sequentially, I know last quarter was down 4% volume as well and historically the packaging market’s been a lot more stable than obviously than what you’re seeing on the automotive side or construction or RV. Looking at the operating margin in packaging technologies, it also remains pretty weak on a year-over-year comparison. Any thoughts as to when we could see that operating margin creep back into double digits?
Myles Odaniell
I think what you do see there and first I would say we’ve had some major progress on this issue, but packaging is till the area where we have historically and the industry historically continues to maintain a lot of these quarterly price formulas. We’ve done a lot to take our six month contracts and move to quarterly and our quarterlies to monthly and some of our monthlies to real time. But given the significant increase in costs in the third quarter, we did see some margin comparison because of the pricing formulas. As you might suspect, if raw materials plateau in our fourth quarter, which is right now and/or decline, you’ll see some margin expansion then. So I think imminent is the answer to your question.
Operator
Your next question comes from David Begleiter with Deutsche Bank.
David Begleiter – Deutsche Bank
Myles, on the restructuring, the $25 million we have so far, is that the bulk of what you expect you’ll be able to realize. I know there’s more to come. How much more is there to come relative to what’s been announced so far?
Myles Odaniell
I would say the following, given the weak external markets and our poor visibility, we’ve chosen not to communicate a specific target but rather to try to get these things done first and then communicate what we’ve accomplished. I would say and I think we probably discussed this before, this is a very leverageable company in the sense that a modest amount of earnings improvement will generate a significant amount of EPS growth.
For example, an additional $25 million of improvements above and beyond what we’ve already announced would translate roughly into an additional $0.50 a share of improvements. Certainly as I look at what we’re working on, I believe that’s certainly achievable given all that we as an organization have to work with. But, again, given the underlying challenge and kind of poor visibility, with poor visibility in the economy, we’re kind of reluctant to just put a number out there and then find out we see continued weakness in automotive or housing and that’s a big takeaway from some of this.
I guess the key message is we’re confident we’re making progress on the things we can control. We’ve in a short period of time carved out a significant amount of cost, improved a lot of the things that had plagued us going back as recently as two quarters ago. But to some great degree that’s still being offset by some of the weak external conditions.
David Begleiter – Deutsche Bank
Myles, as you look at the potential earnings power of Spartech, you made $1.45 back in 2006, is that type of number exceedable in your view over the medium-term?
Myles Odaniell
I think the answer to that is it depends. I think if I just look at, if I had a good sense in terms of the markets and where our volumes were ultimately going to settle, I believe we can get back to those levels. Certainly nothing in our plan assumes economic recovery and stronger volumes. But, again, we make improvements and then we see some takeaway based on continued weakness on the outside here. But I certainly don’t look at those numbers as being a stretch for us as an organization. But, again, that’s [inaudible] in the external climate.
David Begleiter – Deutsche Bank
Lastly, why did the size of the credit facilities come down?
Randy Martin
Basically, Dave, just looking at the whole package, we felt it was most important to get the flexibility that we needed within the current covenants to operate through the turnaround initiative. So we really focused on providing that level of flexibility. We didn’t really need… The original facility was really built on a fairly significant acquisitive platform and needed that additional availability in a very short timeframe to enable us to do those transactions. In those environment where that’s not necessarily the focus in the very near-term, we chose to make sure that we had the flexibility and not focus as much on the capacity.
David Begleiter – Deutsche Bank
The CapEx of $17/$18 million this year, you said it was enough to maintain operating rates. What’s more normalized do you think going forward, $25, in that range or more or less?
Randy Martin
No, I don’t think it requires the $25 million. I would say a couple things, one is the $18 million includes about $3.5 million related to our systems implementation as we were going through the heavy design phase. We’re mostly through that and very little will be capitalized next year. So just looking at that rate, $3 million within that $18 would be available to further maintain and enhance our capabilities even if we just spent the same $18 million next year. So I think a level that’s consistent with that or slightly above is certainly in the range of what we could do and still take in all the improvements initiative that we currently have contemplated and the results that we’re looking at with the improvements that we’ve talked about.
Operator
Your next question comes from Robert Bova.
Robert Bova
I’m very new on the market. When you say automotive has something to do with your company, and I thought it did too, and I watched, normally when GM went up, your Company went up. In the past few weeks, it’s the other way, like GM is up $0.49, you’re down $0.39. So how does the automotive company have to do with your market?
Randy Martin
As a mix of our business, automotive only impacts 13% of our sales mix, so I think that puts it in a little bit relative reference. So I don’t know that you’d be able to draw a direct correlation between automotive. If you break it out to a little bit broader durable goods with automotive, building construction, and rec and leisure, particularly RVs and spas, now you’re about 40% of our business. So that may be a little bit more of an indicator. We still have 25% in packaging and other less cyclical markets, but probably have to look at something certainly broader than automotive; and then really to look at it, you’ve have to factor in the 40% durable goods and then 60% in other markets, namely the largest being packaging.
Operator
Your next question is a follow-up from Mike Harrison with First Analysis.
Mike Harrison – First Analysis
I wanted to ask you about the cash flow performance this quarter. I know that it is typical to see improved cash flow seasonally in the second half. In looking at the balance sheet though, it looks like you got some benefit in receivables and also generated cash from the payables, but inventory was a use of cash in the quarter, presumably that’s, the inventory usage is related to higher resin costs. But how sustainable do you think the cash generation is from the receivables and payables side, and how much of an opportunity is there with resin prices coming down and heading into a seasonally slower time of the year to generate cash on the inventory side?
Randy Martin
Yes, I think you’re focusing in the right area. I think the area that we haven’t necessarily shown as a marked improvement is in the inventory side. We did something in the first quarter that got rid of some additional aged inventory and generated $2 to $3 million of cash from that, but we haven’t seen a consistent performance in inventory in the last two quarters. So that is an area of focus for us. It’s running about 36 days right now. I would really like to target 30. We’re not going to get there in the next quarter or two, but that’s certainly in the area that we are focusing on.
We have each of our segments and regions and plants where have specific targets and goals on that. We focused primarily on inventory and then receivables. Receivables at 51 days is certainly not where I think it can be as well. Every day, just for relative reference, is in the $4 million. So if we could take a couple more days out of inventory and a couple more days out of receivables in the very near-term, I think those are certainly achievable type targets.
So we’re looking at that 9% target of sustaining that. As you know, we tend to fluctuate throughout the year, but we contend that we should be able to maintain a relatively low 9% type level of working capital expenditure of sales on a pretty consistent basis if we get all those metrics working at the same time.
Myles Odaniell
Mike, just to be clear, we do expect to see seasonal improvements as we typically do. But much of what Randy’s talking about is based on a very focused and delivered effort we have on the inventory side. So we’re working pretty hard to reduce that, above and beyond what we would normally get from seasonality.
Mike Harrison – First Analysis
Randy you kind of addressed everything there except for the payable side, your payables versus the end of last quarter went up about $10 million. Any chance we see you having to pay some of those bills and see that as a use of cash in the fourth quarter?
Randy Martin
It really wasn’t necessarily from a complete stretch of payable terms. We have worked on some relationships where we’ve gotten some improved terms overall. I don’t think we’ve stretched anything outside of what is fairly typical. We are being very selective in how we approach bringing in raw materials, particularly in the current cost environment where we do see some leveling off to potential reduction, so we’re very deliberate in not doing any pre buys right now or anything of that nature and then making sure that we look at that as another issue. So those are things that we’re addressing and I don’t think you’ll see anything much different in our payables going into our fourth quarter.
Mike Harrison – First Analysis
Then question on the Mankato and St. Clair closings, obviously with Greenville now behind you, probably a lot of lessons learned there. But any concern on your part that these two closings that you’re conducting here in September and it sounds like coming up in October could cause any disruptions with the consolidations?
Myles Odaniell
Well, I would echo you’re comment, that we’re a lot of lessons learned out of Greenville and clearly there were some things that we could’ve and absolutely should’ve done better. The Mankato… We’ve tried to apply some of those learnings going forward here. The Mankato consolidation is largely done. Much of that relocation, if you go back to what we announced last quarter, was relocating production to in place capacity and only a modest portion of the total relocation involved actually moving equipment and taking on the associated risks and disruptions with that. So that’s gone extraordinarily well. We had a few weeks delay because some of electrical equipment we needed to put in that we didn’t anticipate, but essentially that went fully according to plan.
The Clair closure is one where have actually transitioned volume out of that facility to some more efficient cost effective operations over the course of the last few months and this really becomes kind of the last push of volume and demand that again is getting moved to in place capacity and we do not need nor are we planning on relocating that equipment in order to be able to maintain the sales that we have. We will keep and we relocate it and put in service if and when we need it, but it’s not critical to the success of the project.
Mike Harrison – First Analysis
Then the last couple of questions I had are sort of on the M&A front. It does sound based on Randy’s comments related to the debt covenants. It does sound like you’re sort of inwardly focused right now on the transformation process. But any update on plans you might have to expand internationally?
Myles Odaniell
Again, I kind of echo your assessment here. If you look at the structure of the new covenants that we have, we are in fact going to be fairly focused internally on generating cash, a desire to pay down debt, can clearly improving the performance of this business. I might argue independent of the refinancing, I think that’s the right thing to be doing right now, not just because that’s what we should be doing, but, again, we have a pretty unique opportunity so it is the primary focus.
Specifically to acquisitions and international growth, the only type of work you’re going to see us doing is probably divesting some of our non-core assets as we go forward. We will not be doing any acquisitions other than potentially some specific arrangements we’re already into that smallish. Then if we look in terms of our investments on the international side, we, as we communicated last month, have brought in, or last quarter rather, brought in a new head of our marketing and business development and technology. One of her missions is really going to be to help us identify where we’ve got some meaningful opportunities to accelerate our growth. I think a piece of that will be international, but that’s clearly not our primary focus right now.
Mike Harrison – First Analysis
Then hypothetically speaking and independent of what’s going on with the debt covenants, A Schulman recently announced that they were looking at strategic alternatives for their envisioned business and I was curious if that business is something that you would view as a good fit or if there is just no interest whatsoever in increasing your exposure to the automotive end market?
Myles Odaniell
We would not view that as something, a priority for ourselves and we’ve not had discussions with them.
Operator
There are no further questions in queue at this time.
Myles Odaniell
Well thanks very much for the questions. I just wanted to offer a couple comments in summary, we continue to forecast a fairly sluggish demand in our end markets coupled with continued volatility in both resin and energy costs. But as I’d indicate, we do expect that at least some of our resins have peaked and we should start to see some relief on cost in Q4 and hopefully beyond. We remain committed to executing the necessary actions to promptly reduce our costs and turnaround the recent trends in the performance of Spartech and certainly to better position the company for sustainable long-term growth.
During the quarter, we made solid progress on our efforts to put into place effective sustainable improvements on our pricing processes and our cost structure as well as continuing to build the infrastructure and bring in the right people to insure our long-term success. Our improvements will continue to accelerate as we engage appropriate resources and execute additional turnaround initiatives, and we obviously look forward to keeping everyone updated on our progress.
So both Randy and I would like to thank you for your participation today and we’ll look forward to keeping you updated as we move ahead. Thank you.
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