SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2004
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______
Commission File Number 1-5911
SPARTECH CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 43-0761773
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
120 S. Central Suite 1700, Clayton, Missouri, 63105
(Address of principal executive offices)
(314) 721-4242
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months, and (2) has been
subject to such filing requirements for the past 90 days.
Yes x No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes x No
Number of shares outstanding as of July 31, 2004:
Common Stock, $.75 par value per share 32,130,779
SPARTECH CORPORATION AND SUBSIDIARIES
INDEX
July 31, 2004
PART I. FINANCIAL INFORMATION PAGE
Item 1. CONSOLIDATED CONDENSED BALANCE SHEET -
as of July 31, 2004 and November 1, 2003 3
CONSOLIDATED CONDENSED STATEMENT OF
OPERATIONS - for the quarter and nine months
ended July 31, 2004 and August 2, 2003 4
CONSOLIDATED CONDENSED STATEMENT OF
CASH FLOWS - for quarter and nine months ended
July 31, 2004 and August 2, 2003 5
NOTES TO CONSOLIDATED CONDENSED FINANCIAL
STATEMENTS 6
Items 2&3. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 12
Item 4. CONTROLS AND PROCEDURES 22
PART II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 23
SIGNATURES 24
CERTIFICATIONS 25
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
SPARTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEET
(Dollars in thousands)
ASSETS
July 31, 2004
(unaudited) Nov. 1, 2003
Current Assets
Cash and equivalents $ 13,417 $ 3,779
Receivables, net 172,655 149,546
Inventories 128,462 99,671
Prepaids and other 8,909 11,052
------- --------
Total Current Assets 323,443 264,048
Property, plant and equipment 482,584 457,732
Less accumulated depreciation 197,137 173,808
------- --------
Net Property, Plant and Equipment 285,447 283,924
Goodwill 334,392 334,392
Other Intangible Assets 28,842 24,974
Other Assets 15,822 13,250
------- --------
$987,946 $920,588
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt $ 32,996 $ 32,991
Accounts payable 107,730 97,586
Accrued liabilities 26,399 35,178
------- --------
Total Current Liabilities 167,125 165,755
------- --------
Convertible subordinated debentures 154,639 154,639
Other long-term debt, less current maturities 168,936 196,189
------- --------
Total Long-Term Debt 323,575 350,828
Deferred taxes 84,542 78,568
Other long-term liabilities 2,656 3,079
------- --------
Total Long-Term Liabilities 410,773 432,475
------- --------
Shareholders' Equity
Common stock, 33,131,846
shares issued in 2004 and
30,460,682 in 2003 24,849 22,846
Contributed capital 197,362 139,243
Retained earnings 214,553 191,912
Treasury stock, at cost, 1,001,067 shares
in 2004 and 1,108,381 shares in 2003 (24,320) (27,142)
Accumulated other comprehensive loss (2,396) (4,501)
------- --------
Total Shareholders' Equity 410,048 322,358
------- --------
$987,946 $920,588
======== ========
See accompanying notes to consolidated financial statements.
SPARTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS
(Unaudited and dollars in thousands, except per share amounts)
QUARTER ENDED NINE MONTHS ENDED
July 31, Aug. 2, July 31, Aug. 2,
2004 2003 2004 2003
-------- -------- -------- --------
Net Sales $288,035 $238,870 $817,089 $703,058
-------- -------- -------- --------
Costs and Expenses
Cost of sales 247,078 205,780 698,997 604,703
Selling and administrative 15,274 13,216 44,359 39,246
Amortization of intangibles 749 565 1,950 1,601
-------- -------- -------- --------
263,101 219,561 745,306 645,550
Operating Earnings 24,934 19,309 71,783 57,508
Interest 5,981 6,487 18,486 18,858
-------- -------- -------- --------
Earnings Before Income Taxes 18,953 12,822 53,297 38,650
Income Taxes 7,241 4,675 20,360 13,804
-------- -------- -------- --------
Net Earnings $ 11,712 $ 8,147 $ 32,937 $ 24,846
======== ======= ======== ========
Net Earnings Per Common Share:
Basic $ .36 $ .28 $ 1.06 $ .85
======== ======= ======== ========
Diluted $ .36 $ .28 $ 1.04 $ .84
======== ======= ======== ========
Dividends Per Common Share $ .11 $ .10 $ .33 $ .30
======== ======= ======== ========
See accompanying notes to consolidated financial statements.
SPARTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS
(Unaudited and dollars in thousands)
NINE MONTHS ENDED
July 31, 2004 August 2, 2003
------------ --------------
Cash Flows from Operating Activities
Net earnings $ 32,937 $ 24,846
Adjustments to reconcile net earnings
to net cash provided by
operating activities:
Depreciation and amortization 25,484 23,376
Change in current assets and
liabilities, net of the effects
of acquisitions (43,953) (8,221)
Other, net 2,181 1,584
------- ------
Net cash provided by
operating activities 16,649 41,585
------- ------
Cash Flows from Investing Activities
Capital expenditures (22,695) (17,742)
Business acquisition (1,418) (23,588)
Outsourcing acquisitions (8,141) -
Retirement of assets - 293
------- ------
Net cash used for investing activities (32,254) (41,037)
------- ------
Cash Flows from Financing Activities
Bank borrowings for acquisitions 9,559 23,588
Net payments on revolving
credit facilities (36,758) (17,975)
Issuance of common stock 60,922 -
Payments on bonds and leases (99) (116)
Cash dividends on common stock (10,297) (8,776)
Stock options exercised 2,518 1,155
Treasury stock acquired __ (677) (1,767)
------- ------
Net cash provided by/(used for)
financing activities 25,168 (3,891)
------- ------
Effect of exchange rate changes on cash
and equivalents 75 198
------- ------
Increase/(Decrease) In Cash and Equivalents 9,638 (3,145)
Cash and Equivalents at Beginning of Period 3,779 7,511
------- ------
Cash and Equivalents at End of Period $ 13,417 $ 4,366
======== ========
See accompanying notes to consolidated financial statements.
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
NOTE A - Basis of Presentation
The consolidated financial statements include the accounts of Spartech
Corporation and its controlled affiliates (the Company). These financial
statements have been prepared on a condensed basis, and accordingly,
certain information and disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission. In the opinion of
management, the financial statements contain all adjustments (consisting
solely of normal recurring adjustments) and disclosures necessary to make
the information presented therein not misleading. These financial
statements should be read in conjunction with the consolidated financial
statements and accompanying footnotes thereto included in the Company's
November 1, 2003 Annual Report on Form 10-K.
Certain prior year amounts have been reclassified to conform to the
current year presentation. The Company's fiscal year ends on the Saturday
closest to October 31. Operating results for any quarter are traditionally
seasonal in nature and are not necessarily indicative of the results
expected for the full year.
NOTE B - Inventories
Inventories are valued at the lower of cost (first-in, first-out) or
market. Inventories at July 31, 2004 and November 1, 2003 are comprised of
the following components:
2004 2003
-------- ---------
Raw materials $ 77,713 $ 57,414
Finished goods 50,749 42,257
--------- ---------
$ 128,462 $ 99,671
========= ========
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
NOTE C - Other Intangible Assets
At July 31, 2004 other intangible assets are as follows:
Total other Accumulated Net carrying
intangible amortization amount
assets
Amortizable
Non-compete and $ 8,501 $ 3,031 $ 5,470
customer contracts
Product formulations
and trademarks 16,236 1,764 14,472
------ ----- ------
24,737 4,795 19,942
------- ------- ------
Not Amortizable
Trademark/Tradename 8,900 - 8,900
------- ------- -------
Total $33,637 $ 4,795 $28,842
======= ======= =======
Amortization expense for our existing other intangible assets over the
next five years is estimated to be: $2,963, $2,580, $2,496, $1,626 and
$1,306 for the annual periods from August 1, 2004 to July 31, 2009.
Note D - Comprehensive Income
Comprehensive Income is an entity's change in equity during the period
from transactions, events and circumstances from non-owner sources. The
reconciliation of Net Earnings to Comprehensive Income for the quarters
ended July 31, 2004 and August 2, 2003 is as follows:
QUARTER ENDED NINE MONTHS ENDED
July 31, Aug. 2, July 31, Aug. 2,
2004 2003 2004 2003
--------- ------- -------- --------
Net Earnings $ 11,712 $ 8,147 $ 32,937 $ 24,846
--------- ------- -------- --------
Foreign currency
translation adjustments 1,154 585 (729) 3,958
Cash flow hedge adjustments 991 1,005 2,834 1,796
------- ------- -------- --------
Total Comprehensive Income $ 13,857 $ 9,737 $ 35,042 $ 30,600
======== ======= ======== ========
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
Note E - Segment Information
The Company's forty-eight facilities are organized into three
reportable segments based on the nature of the products manufactured.
QUARTER ENDED NINE MONTHS
July 31, Aug. 2, July 31, Aug. 2,
Net Sales * 2004 2003 2004 2003
-------- --------- --------- ---------
Custom Sheet & $ 196,525 $ 158,949 $ 545,481 $ 461,987
Rollstock
Color & Specialty 75,053 64,319 219,365 192,212
Compounds
Molded & Profile 16,457 15,602 52,243 48,859
Products
------ --------- --------- ---------
Total Net Sales $ 288,035 $ 238,870 $ 817,089 $ 703,058
======== ========= ========= =========
Operating Earnings
Custom Sheet & $ 21,026 $ 15,978 $ 58,025 $ 46,620
Rollstock
Color & Specialty 6,153 4,665 18,472 15,197
Compounds
Molded & Profile 1,417 1,342 5,242 3,810
Products
Corporate/Other (3,662) (2,676) (9,956) (8,119)
------ --------- --------- ---------
Total Operating $ 24,934 $ 19,309 $ 71,783 $ 57,508
Earnings ========== ========== ========== ==========
* Excludes intersegment sales of $12,711 and $9,646 for the three months
ended July 31, 2004 and August 2, 2003, respectively, and $38,376 and
$26,466 for the nine months ended July 31, 2004 and August 2, 2003,
respectively, primarily from the Color & Specialty Compounds segment.
Note F - Stock Based Compensation
The Company has adopted the disclosure-only provisions of SFAS 123.
The following table illustrates the effect on net earnings and net earnings
per share if the company had applied the fair value recognition provisions
of SFAS 123 to stock-based employee compensation. The fair value estimate
was computed using the Black-Scholes option-pricing model. Most of the
Company's options are subject to a four-year vesting period. Beginning in
fiscal 2004, the Company is recognizing pro-forma expense for the fair
value of the options as they vest pro-ratably for each quarter of the
fiscal year. In previous years the vast majority of pro-forma expense was
recognized in the first quarter of the year as the options passed their
annual vesting date.
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
Quarter Ended Nine Months Ended
July 31, Aug. 2, July 31, Aug. 2,
2004 2003 2004 2003
------- -------- -------- ---------
Net Earnings as $11,712 $ 8,147 $32,937 $24,846
Reported
Pro Forma Impact of 442 84 1,326 1,467
Expensing Stock Options
-------- ------- -------- --------
Pro forma net earnings $11,270 $ 8,063 $31,611 $23,379
======== ======= ======== ========
Earnings per share:
As Reported
Basic $ 0.36 $ 0.28 $ 1.06 $ 0.85
Diluted $ 0.36 $ 0.28 $ 1.04 $ 0.84
Pro forma
Basic $ 0.35 $ 0.28 $ 1.01 $ 0.80
Diluted $ 0.34 $ 0.27 $ 1.00 $ 0.79
Assumptions Used:
Expected Dividend 2% 2% 2% 2%
Yield
Expected Volatility 35% 35% 35% 35%
Risk-Free Interest 3.7% 2.6% 3.7% 3.5%
Rates
Expected Lives 5.5 Years 5.0 Years 5.5 Years 5.0 Years
Note G - Equity Offering
Effective February 3, 2004, the Company completed a common stock
offering (priced at $24.00 per share) for 2.7 million shares. Proceeds
from the offering (net of expenses) totaled approximately $61 million with
approximately $41 million used to pay down debt and $20 million used to
fund capital expenditures and strategic expansions. After the offering,
the Company's common issued shares increased by 8.8% to 33,131,846.
Note H - Bank Refinancing
On March 3, 2004, the Company refinanced its unsecured bank credit
facility that provides aggregate availability of $200 million and expires
on March 3, 2009. Interest on the bank credit facility is payable at a
rate chosen by the Company of either prime or Eurodollar Rate plus a 0.5%
to 1.125% borrowing margin. The agreement requires a fee of 0.10% to
0.275% for any unused portion of the facility.
Note I - Recently Issued Accounting Standards
In December 2003, the FASB issued a revised version of FASB
Interpretation No. 46 (FIN 46R), "Consolidation of Variable Interest
Entities," which defines when a business should consolidate a variable
interest entity. The Company adopted FIN 46R on January 31, 2004. As a
result, we no longer consolidate our trusts which were formed solely for
the issuance of trust preferred securities to outside investors. The
effect of this deconsolidation was to: 1) eliminate the Convertible
Preferred Securities issued by the trusts; 2) record the Convertible
Subordinated Debentures issued to the trusts; 3) recognize the Company's
equity investment in the common stock of the trusts; and 4) reclassify the
distributions on the preferred securities to interest expense on the
debentures. The Convertible Subordinated Debentures and equity investments
were previously eliminated in consolidation. The debentures, totaling
$154.6 million, are now included in the Consolidated Condensed Balance
Sheet as a separate component of long-term debt and the equity investment
of $4.6 million is included in other assets. The adoption of FIN 46R had
no impact on the Company's net income or earnings per share. The previous
year's financial statements have been restated to reflect the affect of the
deconsolidation required by FIN 46R.
Note J - Commitments and Contingencies
On April 30, 2004 the Company entered into loan guarantees related to
the expansion of our Donchery, France facility. The maximum amount to be
guaranteed will not exceed 5.7 million Euros or approximately US$7.0
million. We expect the construction to be completed by the end of our
fourth quarter at which time we will enter into a lease for the amount of
the expansion.
In September 2003, the New Jersey Department of Environmental
Protection issued a directive and the United States Environmental
Protection Agency initiated an environmental investigation related to over
70 companies, including a Spartech subsidiary, regarding the Lower Passaic
River. Management has agreed to participate along with thirty-one other
companies in an environmental study to determine the extent and sources of
contamination at this site. The Company has $325 accrued as of July 31,
2004 related to this issue and management believes it is possible that the
ultimate liability from this issue could materially differ from this
amount. This accrued amount includes estimated costs associated with
participation in the environmental study and legal fees. Due to
uncertainties inherent in this matter, management is unable to estimate the
Company's possible exposure upon the ultimate outcome of this issue which
is not expected to occur for a number of years. These uncertainties
primarily include the outcome of the environmental study and the percentage
of contamination attributable to Spartech and other parties.
The Company is also subject to various other claims, lawsuits, and
administrative proceedings arising in the ordinary course of business with
respect to commercial, product liability, employment, and other matters,
several of which claim substantial amounts of damages. While it is not
possible to estimate with certainty the ultimate legal and financial
liability with respect to these claims, lawsuits, and administrative
proceedings, the Company believes that the outcome of these other matters
will not have a material adverse effect on the Company's financial position
or results of operations.
Note K - Subsequent Event
On September 1, 2004, the Company entered into an agreement to acquire
substantially all of the assets of three divisions of VPI, based in
Sheboygan, Wisconsin for a cash purchase price of approximately $83.5
million. These divisions include VPI's Sheet Products Division, Contract
Manufacturing Division, and Film and Converting Division with annual sales
totaling approximately $110 million. The transaction is expected to close
on October 1, 2004, subject to customary consents and approvals. The
Company intends to finance this purchase with proceeds from a $150 million
private placement of unsecured notes at 5.54% with a twelve-year maturity.
The Company expects funding from these notes on or before September 15,
2004, with repayments to begin in September 2012.
Items 2 and 3. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
Net sales increased 21% and 16%, respectively for the three months and
nine months ended July 31, 2004 over the same periods of the prior year.
Internal growth of 15% in the third quarter compared to the same quarter of
the prior year resulted in more than 350 million pounds shipped for the
quarter, 20% greater than last year. For both the three and nine-month
periods, the sales increase was primarily driven by strong internal volume
growth resulting from demand increases in every major market served by the
Company. Demand was particularly strong in the packaging, transportation,
building & construction and recreation & leisure markets. Net earnings
increased 44% and 33%, respectively for the three and nine-month periods
compared to the prior year's equivalent periods. These increases were
driven by strong sales growth, improvement in capacity utilization rates
and improvements in conversion costs from cost containment efforts,
partially offset by raw material price increases. Despite the positive
impact of strong demand and capacity utilization on material margins,
volatile crude oil prices have resulted in increasing raw material costs
that has partially offset these benefits in the first nine months of 2004.
Results of Operations
(in millions) NET SALES OPERATING EARNINGS
Nine Months Ended
Net Sales July 31, Aug. 2, July 31, Aug. 2,
2004 2003 2004 2003
---------- ------- --------- ---------
Custom Sheet & $ 545.5 $ $ 58.0 $ 46.6
Rollstock 462.0
Color & Specialty 219.4 192.2 18.5 15.2
Compounds
Molded & Profile 52.2 48.9 5.2 3.8
Products
Corporate/Other - - (9.9) (8.1)
-------- ------- ------- -------
Total $ 817.1 $ 703.1 $ 71.8 $ 57.5
======== ======== ======== ========
Net sales were $288.0 million and $817.1 million for the quarter and
nine months ended July 31, 2004 resulting in 21% (15% from growth in
internal pounds sold, 3% from acquisitions and 3% from price/mix) and 16%
(9% from growth in internal pounds sold, 3% from acquisitions and 4% from
price/mix) increases from the similar periods of the prior year,
respectively. The strong growth in internal pounds sold primarily resulted
from strong demand in many of the major end-markets served by the Company,
particularly in the packaging, building & construction and transportation
markets.
Cost of sales were $247.1 million and $699.0 million for the quarter
and nine months ended July 31, 2004, compared with $205.8 million and
$604.7 million for the similar quarter and nine months of the prior year.
Cost of sales as a percentage of net sales were 85.8% and 85.5% for the
quarter and nine-month periods of the current year compared to 86.1% and
86.0% for same periods of the prior year. The decrease in percentage for
both periods reflects the impact of the strong sales increases, improvement
in capacity utilization rates, and improvements in conversion costs from
the Company's lean manufacturing efforts, partially offset by higher raw
material prices.
Selling and administrative expenses of $15.3 million and $44.4 million
for the quarter and nine months ended July 31, 2004 increased from $13.2
million and $39.2 million for comparable periods of 2003. These increases
were primarily caused by the variable portion of expenses resulting from
the growth in sales, and increased investments in corporate governance,
information technology, and marketing resources. As a percentage of net
sales, selling and administrative expenses improved from 5.5% and 5.6% for
the quarter and nine months of the prior year to 5.3% and 5.4% for
comparable periods of the current year due largely to leverage from sales
growth.
Operating earnings for the quarter and nine months ended July 31, 2004
increased to $24.9 million (8.7% of net sales) and $71.8 million (8.8% of
net sales) from $19.3 million (8.1% of net sales) and $57.5 million (8.2%
of net sales) for the similar periods of the prior year. Operating
earnings per pound sold increased to 7.1 cents for both the quarter and
nine month period from 6.6 cents and 6.4 cents for the comparable periods
of the prior year. The improvement in operating margin and operating
earnings per pound sold was primarily driven by leverage from the sales
growth coupled with cost containment from the Company's lean manufacturing
efforts.
Interest expense was $6.0 million and $18.5 million for the quarter
and nine-month periods of the current year compared to $6.5 million and
$18.9 million for the comparable periods of the prior year. The decrease
in interest expense in the current periods resulted from the reduction in
the Company's debt balance partially offset by an increase in average
interest rate. The Company's interest rate swap encompassing $125.0
million of bank debt will expire on November 10, 2004. On this date, the
Company's effective interest rate on this bank debt will revert back to a
variable 30-day Eurodollar rate plus an applicable margin (which was 1.36%
at July 31, 2004 plus .75%) from the fixed swap effective rate of 6.06%
plus the applicable margin.
The Company's effective tax rate for the quarter and nine-month
periods ended July 31, 2004 was 38.2%, which compared to 36.5% and 35.7%
for the comparable periods of the prior year. The lower tax rates of the
prior periods were caused by refunds of research and development credits
recorded as a result of a final agreement with the Internal Revenue
Service. The current effective tax rate also reflects an increase in the
tax rate in Ontario, Canada.
Segment Results
Net sales of the Custom Sheet & Rollstock segment increased by 24% and
18% to $196.5 million and $545.5 million in the quarter and nine months
ended July 31, 2004 compared to the comparable periods of 2003. Volume
growth in pounds sold was 30% (20% from internal growth) and 21% (11% from
internal growth) for the quarter and nine-month periods, respectively.
Internal growth for both periods was primarily generated from strong demand
primarily in the packaging, building & construction and transportation
markets. The fiscal 2003 acquisitions of Polymer Extruded Products and
Trienda's Extrusion acquisitions caused sales volume in pounds to increase
by approximately 10% for both periods. The product mix sold by the Trienda
Extrusion business has an average sales price per pound that is lower than
the group's average, and the increase in mix of this business accounted for
the difference between the 24% net sales increase and 30% volume growth for
the third quarter. Operating margin increased to 10.7% and 10.6% in the
quarter and nine months of the current year from 10.1% in both comparable
periods of the prior year. Operating earnings per pound sold increased to
11.2 cents and 11.1 cents for the quarter and nine month period of the
current year from 11.0 cents and 10.8 cents for the similar periods of the
prior year. The increases in operating margin and operating earnings per
pound sold were driven by increased leverage from sales growth and cost
containment efforts, partially offset by the impact of resin price
increases.
The Color & Specialty Compounds segment's net sales were $75.1 million
and $219.4 million for the quarter and nine months ended July 31, 2004
compared to $64.3 million and $192.2 million for the prior year periods
representing an increase of 17% for the quarter and 14% for the nine-month
period. Internal volume growth represented 11% and 7% of the increase for
the quarter and nine-month period, respectively with sales price increases
due to resin price increases representing the majority of the remaining
growth. The volume growth reflects an extremely soft third quarter in 2003
and was due primarily to strong demand particularly in the packaging,
transportation and appliance markets. Operating margin improved to 8.2%
and 8.4% for the quarter and nine months ended July 31, 2004 from 7.3% and
7.9% in the comparable periods of the prior year. Operating earnings per
pound sold increased to 4.0 cents for both the quarter and nine-month
periods of the current year from approximately 3.5 cents for comparable
periods of the prior year. The double-digit increase in operating earnings
per pound was primarily driven by leverage from the strong sales growth
partially offset by increases in raw materials. This segment's recent
positive trend in internal growth over the past two quarters gives us
encouragement that once the current resin market stabilizes or prices roll
back to more reasonable levels, our traditional operating margins for this
segment will return.
The Molded & Profile Products segment's net sales increased to $16.5
million and $52.2 million for the quarter and nine months ended July 31,
2004 compared to $15.6 million and $48.9 million in the similar 2003
periods. Operating earnings also increased to $1.4 million and $5.2
million for the quarter and nine months ended July 31, 2004, from $1.3
million and $3.8 million for the prior year's similar periods. The
increase in sales and operating earnings were primarily driven by strong
demand in the recreation & leisure and building & construction markets.
Management plans some operational realignments in this group over the next
6-12 months, which should result in improved performance in fiscal 2005.
Other Matters
We operate under various laws and regulations governing employee
safety and the quantities of specified substances that may be emitted into
the air, discharged into waterways, or otherwise disposed of on and off our
properties. In September 2003, the New Jersey Department of Environmental
Protection issued a directive and the United States Environmental
Protection Agency initiated an environmental investigation related to over
70 companies, including a Spartech subsidiary, regarding the Lower Passaic
River. Management has agreed to participate along with thirty-one other
companies in an environmental study to determine the extent and sources of
contamination at this site. We believe it is possible that the ultimate
liability from this issue could materially differ from the Company's $325
thousand accrual as of July 31, 2004. In the event of one or more adverse
determinations related to this issue, the impact on the Company's results
of operations could be material to any specific period. However, it is our
opinion that future expenditures for compliance with these laws and
regulations, as they relate to the Lower Passaic River issue and other
potential issues, will not have a material effect on our capital
expenditures, financial position, or competitive position.
The plastic resins we use in our production processes are derived from
crude oil and natural gas, which are available from a number of domestic
and foreign suppliers. Historically, our raw materials have been only
somewhat affected by supply, demand and price trends of the petroleum
industry; however, more recently the unusually high price of crude oil has
had a greater impact on increasing the price of plastic resins, our most
significant raw material. We currently expect this pricing relationship to
continue in the foreseeable future. Past trends in resin pricing, periods
of anticipated or actual shortages of a particular resin, and changes in
supplier capacities can also have an impact on the cost of our raw
materials during a particular period. Price spikes in crude oil and
natural gas along with the political unrest in oil producing countries have
resulted in unusually high pricing pressures during 2003 and 2004. These
pressures resulted in dramatic increases in the prices of our raw
materials. We have generally been able to minimize the impact of past
price increases in raw material costs by controlling inventory levels,
increasing production efficiencies, passing through price changes to
customers, and the negotiating competitive prices with our suppliers.
These pricing changes were more difficult for us to manage and have
negatively affected our operating margins in 2003 and 2004. While we will
continue to implement the actions noted above to help minimize the impact
of price changes on our margins, the direction, degree of volatility, and
our ability to manage future pricing changes is uncertain.
Liquidity and Capital Resources
Cash Flow
Our primary sources of liquidity have been cash flows from operating
activities, borrowings from third parties, and our recent equity offering.
Our principal uses of cash have been to support our operating activities,
invest in capital improvements, finance strategic business/outsourcing
acquisitions, and pay dividends on our common stock. Cash flows for the
periods indicated are summarized as follows:
Nine Months Ended
(Dollars in millions) July 31, Aug. 2,
2004 2003
------------ -------------
Net cash provided by
operating activities $ 16.6 $ 41.6
============ ============
Net cash used for
investing activities $ (32.3) $ (41.0)
============ ============
Net cash provided by/(used for)
financing activities $ 25.2 $ (3.9)
============ ============
Increase/(decrease) in cash
and equivalents $ 9.6 $ (3.1)
============ ============
Operating cash flows provided by net earnings increased 33% to $32.9
million for the nine months ended July 31, 2004 from $24.8 million for the
nine months ended August 2, 2003. Changes in current assets and
liabilities, net of the effects of acquisitions, used $44.0 million of our
operating cash flows in 2004 compared to $8.2 million in the first nine
months of 2003. Operating cash flows used by changes in accounts
receivable totaled $22.7 million due primarily to the funding of strong
growth in sales. Operating cash flows used for changes in inventory
totaled $26.5 million due to increases in business volumes, selective pre-
buys of raw materials ahead of announced price increases and increases in
the price of resins.
The Company's primary investing activities are capital expenditures
and business/outsourcing acquisitions in the plastics industry. Capital
expenditures are primarily incurred to maintain and improve productivity,
as well as to modernize and expand facilities. Capital expenditures for
the first nine months of 2004 were $22.7 million as compared to $17.7
million for the first nine months of 2003. The increase in capital
expenditures is primarily due to expenditures associated with the expansion
of our Donchery, France facility and our new Product Development Center in
Warsaw, Indiana. We currently anticipate total capital expenditures of
approximately $28 million for fiscal 2004. Borrowings for business and
outsourcing acquisitions totaled $9.6 million for the first nine months of
2004 as compared to $23.6 in the first nine months of 2003. The 2004
acquisitions included $1.4 million paid to complete the September 2003
acquisition of Trienda's extrusion business, $2.2 million spent to acquire
certain equipment and working capital assets from the former Quality
Plastic Sheet operation along with a long-term supply contract from its
largest customer, and $6.0 million for certain assets of BASF
Aktiengesellschaft of Germany. The 2003 payment was for the purchase of
Polymer Extruded Products.
Cash provided by financing activities totaled $25.2 million for the
first nine months of 2004. On February 3, 2004 Spartech completed a common
stock offering that provided $60.9 million. Other financing activities
during the first nine months of 2004 included debt repayments funded by
the offering, borrowings for operations of $24.2 million, borrowings for
acquisitions of $9.6 million, and dividend payments with other items
netting to usage of $8.6 million.
Financing Arrangements
Effective February 3, 2004, Spartech completed a common stock offering
(priced at $24 per share) for 2.7 million shares. Proceeds from the
offering (net of expenses) totaled approximately $61 million with
approximately $41 million used immediately to pay down debt and $20 million
invested in short term investments and used to fund subsequent capital
expenditures and strategic expansions later in the second quarter.
On March 3, 2004, Spartech refinanced its U.S. unsecured bank credit
facility providing aggregate availability of $200 million and expiring on
March 3, 2009. Interest on the bank credit facility is payable at a rate
chosen by the Company of either prime or Eurodollar Rate plus a 0.5% to
1.125% borrowing margin and the agreement requires a fee of 0.10% to 0.275%
for any unused portion of the facility. On April 22, 2004, Spartech Canada
refinanced its unsecured bank credit facility providing aggregate
availability of $10 million Canadian and expiring on March 3, 2009.
Interest on the bank credit facility is payable at a rate chosen by the
Company of either prime or LIBOR plus a .5% to 1.125% borrowing margin and
the agreement requires a non-use fee of .10% to .275% for any unused
portion of the facility. At July 31, 2004, our total outstanding
borrowings under our bank credit facilities were $125 million at a weighted
average interest rate of 6.9% (including the effect of an interest rate
swap). We had approximately $69 million in borrowing capacity under our
bank credit facilities at the end of the third quarter of 2004. We
anticipate that cash flows from operations, together with the financing and
borrowings under our bank credit facilities, will satisfy our working
capital needs, regular quarterly dividends, and planned capital
expenditures for the next year. Refer to Note K - Subsequent Events for
discussion of the intended $150 million private placement of unsecured
notes related to the VPI acquisition.
If our cash from operations were substantially reduced and our access
to the debt and equity markets became more limited, we might not be able to
repay the obligations as they become due. Our current credit facilities
also contain certain affirmative and negative covenants, including
restrictions on the incurrence of additional indebtedness, limitations on
both the sale of assets and merger transactions, and requirements to
maintain certain financial and debt service ratios and net worth levels.
While we were in compliance with such covenants through the first nine
months of 2004 and currently expect to be in compliance throughout the
balance of the fiscal year, our failure to comply with the covenants or
other requirements of our financing arrangements could result in an event
of default and, among other things, acceleration of the payment of our
indebtedness which could adversely impact our business, financial condition
and results of operations.
Outlook
We expect strong demand in the fourth quarter to continue to produce
solid sales growth, currently estimated at 8-10% over the prior year
period. Despite this strong demand, volatile oil prices have resulted in
increasing raw material costs that could continue to put pressure on
operating margins.
Significant Accounting Policies, Estimates and Judgments
We prepare consolidated financial statements in conformity with
accounting principles generally accepted in the United States. As such, we
are required to make estimates and judgments that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Significant
accounting policies, estimates and judgments which we believe are the most
critical to aid in fully understanding and evaluating our reported
financial results include the following:
Revenue Recognition - We recognize revenue as the product is shipped
and title passes to the customer. We manufacture our products either
to standard specifications or to custom specifications agreed upon
with the customer in advance, and we inspect our products to ensure
specifications are met prior to shipment. We continuously monitor and
track product returns, which have historically been within our
expectations and the provisions established. Despite our efforts to
improve our quality and service to customers, we cannot guarantee that
we will continue to experience the same, or better return rates, than
we have in the past. Any significant increase in returns could have a
material negative impact on our operating results.
Accounts Receivable - We perform ongoing credit evaluations of our
customers and adjust credit limits based upon payment history and the
customers' credit worthiness, as determined by our review of their
current credit information. We continuously monitor collections and
payments from our customers and maintain a provision for estimated
credit losses based upon our historical experience and any specific
customer collection issues identified. While such credit losses have
historically been within our expectations and the provisions
established, we cannot guarantee that we will continue to experience
the same or lower credit loss rates that we have in the past.
Inventories - We value inventories at the lower of actual cost to
purchase or manufacture the inventory or the current estimated market
value of the inventory. We also buy scrap and recyclable material
(including regrind material) to be used in future production runs. We
record these inventories initially at purchase price and, based on the
inventory aging and other considerations for realizable value, we
write down the carrying value to brokerage value, where appropriate.
We regularly review inventory on hand and record provisions for
obsolete or aged inventory. A significant increase in the demand for
our raw materials could result in a short-term increase in the cost of
inventory purchases while a significant decrease in demand could
result in an increase in the amount of excess inventory quantities on
hand. In addition, most of our business is custom products, where the
loss of a specific customer could increase the amount of excess or
obsolete inventory on hand. Although we make every effort to ensure
the accuracy of our forecasts of future product demand, any
significant unanticipated changes in demand could have a significant
impact on the value of our inventory and the operating results.
Acquisition Accounting - We have made several business acquisitions in
recent years. All of these acquisitions have been accounted for in
accordance with the purchase method, and accordingly, the results of
operations were included in our Consolidated Statement of Operations
from the respective date of acquisition. The purchase price has been
allocated to the identifiable assets and liabilities, and any excess
of the cost over the fair value of the net identifiable assets
acquired is recorded as goodwill. The initial allocation of purchase
price is based on preliminary information, which is subject to
adjustment upon obtaining complete valuation information. While the
delayed finalization of purchase price has historically not had a
material impact on the consolidated results of operations, we cannot
guarantee the same results in future acquisitions.
Valuation of Long-Lived Assets - Long-lived assets, which primarily
include goodwill, other intangibles and property plant and equipment
are reviewed for impairment whenever events and changes in business
indicate the carrying value of the assets may not be recoverable. The
Company conducts a formal impairment test of goodwill at the end of
each fiscal year and between fiscal years if events occur or
circumstances change that would more likely than not reduce the fair
value of a reporting unit below its carrying value. We recognize
impairment losses if expected future cash flows of the related assets
(based on our current projections of anticipated future cash flows)
are less than carrying value or where assets that are held for sale
are deemed to be valued in excess of the expected amount to be
realized upon sale. While we believe that our estimates of future
cash flows are reasonable, different assumptions regarding such cash
flows could materially affect our evaluations.
Contingencies - The Company is involved in litigation in the ordinary
course of business, including environmental matters. Our policy is to
record expense for contingencies when it is both probable that a
liability has been incurred and the amount can be reasonably
estimated. Estimating probable losses requires assessment of multiple
outcomes that often depends on management's judgments regarding, but
not limited to, potential actions by third parties such as regulators.
The final resolution of these contingencies could result in expenses
different than current accruals, and could therefore have a material
impact on our consolidated financial results in a future reporting
period.
For additional information regarding our significant accounting
policies, see Note 1 to our 2003 Consolidated Financial Statements
contained in our 2003 Annual Report on Form 10-K filed with the Securities
and Exchange Commission.
Cautionary Note on Forward Looking Statements
Statements in this Form 10-Q that are not purely historical, including
statements which express the Company's belief, anticipation or expectation
about future events, are forward-looking statements. Forward looking
statements involve certain risks and uncertainties that could cause actual
results to differ materially from such statements. In addition to the risk
factors discussed in Item 1 (Business, under the headings Raw Materials,
Seasonality, Competition, Government Regulation and Environmental Matters,
and International Operations) of the Company's 2003 Annual Report on Form
10-K other important factors which have impacted and could impact the
Company's operations and results, include:
(1) The Company's financial leverage and the operating and financial
restrictions imposed by the instruments governing its indebtedness may
limit or prohibit its ability to incur additional indebtedness, create
liens, sell assets, engage in mergers, acquisitions or joint ventures, pay
cash dividends, or make certain other payments; the Company's leverage and
such restrictions could limit its ability to respond to changing business
or economic conditions, inability to meet debt obligations when due could
impair its ability to finance operations and could result in default;
(2) The successful expansion through acquisitions, in which Spartech
looks for candidates that can complement its existing product lines, expand
geographic coverage, and provide superior shareholder returns, is not
assured. Acquiring businesses that meet these criteria continues to be an
important element of the Company's business strategy. Some of the
Company's major competitors have similar growth strategies. As a result,
competition for qualifying acquisition candidates is increasing and there
can be no assurance that such future candidates will exist on terms
agreeable to the Company. Furthermore, integrating acquired businesses
requires significant management time and skill and places additional
demands on Company operations and financial resources. If we are unable to
achieve the anticipated synergies, the interest and other expenses from our
acquisitions could exceed the net income we derive from the acquired
operations, which could reduce our net income. However, the Company
continues to seek value-added acquisitions which meet its stringent
acquisition criteria and complement its existing businesses; and
(3) Our products are sold in a number of end markets which tend to be
cyclical in nature, including transportation, building and construction,
bath/pool and spa, and electronics and appliances. A downturn in one or
more of these end markets could have a material adverse effect on our sales
and operating profit.
Investors are also directed to the discussion of risks and uncertainties
associated with forward-looking statements contained in our 2003 Annual
Report on Form 10-K filed with the Securities and Exchange Commission.
Item 4. CONTROLS AND PROCEDURES
Spartech maintains a system of disclosure controls and procedures
which are designed to ensure that information required to be disclosed by
the Company in the reports filed under the Securities Exchange Act of 1934
is recorded, processed, summarized and reported within the time periods
specified under the SEC's rules and forms. Based on an evaluation
performed, the Company's certifying officers have concluded that the
disclosure controls and procedures were effective as of July 31, 2004, to
provide reasonable assurance of the achievement of these objectives.
Notwithstanding the foregoing, there can be no assurance that the
Company's disclosure controls and procedures will detect or uncover all
failures of persons within the Company and its consolidated subsidiaries to
report material information otherwise required to be set forth in the
Company's reports.
There was no change in the Company's internal control over financial
reporting during the quarter ended July 31, 2004, that has materially
affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
PART II - OTHER INFORMATION
Item 6 (a). Exhibits
11 Statement re Computation of Per Share Earnings
31.1 Rule 13a-14(a)/15d-14(a) Certification of CEO.
31.2 Rule 13a-14(a)/15d-14(a) Certification of CFO.
32 Section 1350 Certifications of CEO & CFO.
Item 6 (b). Reports on Form 8-K
The Company filed a Form 8-K dated May 11, 2004 to furnish the press
release providing guidance for fiscal 2004 second quarter sales.
The Company filed a Form 8-K dated June 3, 2004 to furnish the press
release regarding earnings results of the Company for the quarter
ended May 1, 2004.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
SPARTECH CORPORATION
(Registrant)
Date: September 9, 2004 /s/ Bradley B. Buechler
Bradley B. Buechler
Chairman, President and Chief
Executive Officer
(Principal Executive Officer)
/s/Randy C. Martin
Randy C. Martin
Executive Vice President -
Corporate Development and
Chief Financial Officer
(Principal Financial and
Accounting Officer)