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 30, 2005
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 a shell company
(as defined in Rule 12b-2 of the Exchange Act).
Yes No x
----- -----
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 30, 2005:
COMMON STOCK, $.75 PAR VALUE PER SHARE 31,951,719
SPARTECH CORPORATION AND SUBSIDIARIES
INDEX
JULY 30, 2005
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. CONSOLIDATED CONDENSED BALANCE SHEET - as of July 30, 2005 and
October 30, 2004 3
CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS - for the
quarter and nine months ended July 30, 2005 and July 31, 2004 4
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS - for the nine
months ended July 30, 2005 and July 31, 2004 5
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 17
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 30
Item 4. CONTROLS AND PROCEDURES 30
PART II. OTHER INFORMATION
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 32
Item 6. EXHIBITS 32
SIGNATURES 33
CERTIFICATIONS 34
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SPARTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEET
(Dollars in thousands)
JUL. 30, 2005
(UNAUDITED) OCT. 30, 2004
------------- -------------
ASSETS
CURRENT ASSETS
Cash and equivalents $ 13,830 $ 48,954
Receivables, net 193,596 188,427
Inventories 144,394 142,035
Prepaids and other 17,053 20,718
---------- ----------
TOTAL CURRENT ASSETS 368,873 400,134
Property, plant and equipment 519,844 538,271
Less accumulated depreciation 203,337 207,526
---------- ----------
PROPERTY, PLANT AND EQUIPMENT, NET 316,507 330,745
GOODWILL 358,382 361,957
OTHER INTANGIBLE ASSETS, NET 42,330 44,067
OTHER ASSETS 18,409 12,711
---------- ----------
$1,104,501 $1,149,614
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt $ 18,315 $ 18,027
Accounts payable 121,226 116,386
Accrued liabilities 45,947 44,223
---------- ----------
TOTAL CURRENT LIABILITIES 185,488 178,636
---------- ----------
Convertible subordinated debentures 154,639 154,639
Other long-term debt, less current maturities 253,277 301,425
---------- ----------
TOTAL LONG-TERM DEBT 407,916 456,064
Deferred taxes 90,525 94,825
Other long-term liabilities 9,024 2,357
---------- ----------
TOTAL LONG-TERM LIABILITIES 507,465 553,246
---------- ----------
SHAREHOLDERS' EQUITY
Common stock, 33,131,846 shares issued in 2005 and 2004 24,849 24,849
Contributed capital 197,646 196,264
Retained earnings 215,619 220,136
Treasury stock, at cost, 1,180,127 shares
in 2005 and 952,073 shares in 2004 (27,451) (23,653)
Accumulated other comprehensive income 885 136
---------- ----------
TOTAL SHAREHOLDERS' EQUITY 411,548 417,732
---------- ----------
$1,104,501 $1,149,614
========== ==========
See accompanying notes to consolidated condensed financial statements.
3
SPARTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS
(Unaudited and dollars in thousands, except per share amounts)
QUARTER ENDED NINE MONTHS ENDED
------------------- ---------------------
JUL. 30, JUL. 31, JUL. 30, JUL. 31,
2005 2004 2005 2004
-------- -------- ---------- --------
NET SALES $348,672 $288,035 $1,030,842 $817,089
-------- -------- ---------- --------
COSTS AND EXPENSES
Cost of sales 308,839 247,078 917,981 698,997
Selling and administrative 16,923 15,274 52,739 44,359
Restructuring & exit costs 4,639 -- 12,258 --
Former CEO retirement 3,645 -- 3,645 --
Fixed asset charge 206 -- 10,592 --
Amortization of intangibles 1,264 749 3,936 1,950
-------- -------- ---------- --------
335,516 263,101 1,001,151 745,306
-------- -------- ---------- --------
OPERATING EARNINGS 13,156 24,934 29,691 71,783
Interest 6,362 5,981 19,214 18,486
-------- -------- ---------- --------
EARNINGS BEFORE INCOME TAXES 6,794 18,953 10,477 53,297
Income Taxes 2,505 7,241 3,450 20,360
-------- -------- ---------- --------
NET EARNINGS $ 4,289 $ 11,712 $ 7,027 $ 32,937
======== ======== ========== ========
NET EARNINGS PER COMMON SHARE:
Basic $ .13 $ .36 $ .22 $ 1.06
======== ======== ========== ========
Diluted $ .13 $ .36 $ .22 $ 1.04
======== ======== ========== ========
DIVIDENDS PER COMMON SHARE $ .12 $ .11 $ .36 $ .33
======== ======== ========== ========
See accompanying notes to consolidated condensed financial statements.
4
SPARTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS
(Unaudited and dollars in thousands)
NINE MONTHS ENDED
-----------------------------
JUL. 30, 2005 JUL. 31, 2004
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings $ 7,027 $ 32,937
Adjustments to reconcile net earnings
to net cash provided by
operating activities:
Fixed asset charge 10,592 --
Restructuring & exit costs 10,764 --
Former CEO retirement 831 --
Depreciation and amortization 30,633 25,484
Change in current assets and
liabilities, net of the effects
of acquisitions 4,750 (43,953)
Other, net (2,263) 2,181
-------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 62,334 16,649
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (31,267) (22,695)
Retirement of assets 89 --
Business acquisition (1,224) (1,418)
Outsourcing acquisition -- (8,141)
-------- --------
NET CASH USED FOR INVESTING ACTIVITIES (32,402) (32,254)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Bank credit facility payments, net (48,020) (27,199)
Issuance of common stock -- 60,922
Payments on bonds and leases (624) (99)
Cash dividends on common stock (11,547) (10,297)
Proceeds from stock option exercises 1,980 2,518
Treasury stock acquired (6,846) (677)
-------- --------
NET CASH (USED FOR)/PROVIDED BY
FINANCING ACTIVITIES (65,057) 25,168
-------- --------
Effect of exchange rate changes on cash
and equivalents 1 75
-------- --------
(DECREASE)/INCREASE IN CASH AND EQUIVALENTS (35,124) 9,638
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 48,954 3,779
-------- --------
CASH AND EQUIVALENTS AT END OF PERIOD $ 13,830 $ 13,417
======== ========
See accompanying notes to consolidated condensed financial statements.
5
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 October 30, 2004 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 historically seasonal in
nature and are not necessarily indicative of the results expected for the full
year.
NOTE B - ACQUISITION
On October 1, 2004, the Company completed the acquisition of substantially
all of the assets of three divisions of VPI, based in Sheboygan, Wisconsin. The
operations purchased included (1) the Sheet Products Division, a custom extruded
sheet manufacturer serving the graphic arts, medical packaging, and specialty
retail markets; (2) the Contract Manufacturing Division, a provider of
non-carpet flooring and sound barrier products to the transportation industry;
and (3) the Film & Converting Division which calenders, prints, and laminates
products for distribution to various markets including the Medical and
Recreation & Leisure industries. The Sheet Products Division was added to the
Company's Custom Sheet & Rollstock segment, and the Contract Manufacturing and
Film & Converting Divisions were added to the Color & Specialty Compounds
segment. Sales within these three acquired divisions totaled approximately $110
million for the 12 months prior to acquisition.
The cash price for this acquisition of approximately $87.5 million was
allocated to the assets acquired and liabilities assumed of $97.7 million and
$10.2 million, respectively. The assets acquired include $39.4 million of
property, plant, and equipment, $17.8 million of identified intangibles, $22.8
million of working capital assets, and $17.7 million of goodwill. All of the
goodwill is deductible for tax purposes. Identified intangibles and respective
straight-line weighted average amortization periods include $15.4 million of
customer contracts and relationships (ten years), $1.4 million of technology
(ten years) and $1.0 million of non-compete agreements (three years). The
purchase price was finalized in the second quarter of fiscal 2005, and the
Company paid an additional $1.2 million as an adjustment for closing working
capital.
6
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
NOTE C - RESTRUCTURING
In the second quarter of fiscal 2005, the Company initiated several
operational changes to enhance short-term operating performance and longer term
operating efficiencies. The plan, which involves the closing or sale of certain
plant facilities, can be segregated into three categories: (i) the elimination
of non-core operations, (ii) the consolidation of capacity for similar
operations, and (iii) the transfer of synergistic or new business to other
existing operations.
The effect of the plan is to reduce our operations by seven facilities. In
addition, the Company had three properties held for sale at the end of fiscal
2004. Of these ten facilities, as of July 30, 2005, we had completed the exit of
two, and had the remaining eight facilities held for sale (two of which include
the sale of a portion of business as noted in the table below). Subsequent to
July 30, 2005, the Company finalized the sale of one facility and one business,
and entered into a contract to sell one additional facility which is scheduled
to close in the fourth quarter of fiscal 2005. We estimate that the sale of the
three entities will result in a pretax gain of approximately $2.0 in the fourth
quarter of fiscal 2005.
The major classes of assets and liabilities in these disposal groups as of
July 30, 2005 include current assets of $4.4 million, property, plant and
equipment of $8.2 million and current liabilities of $2.0 million. The following
table summarizes the facilities held for sale as of July 30, 2005 by reporting
segment:
CUSTOM SHEET COLOR & SPECIALTY ENGINEERED
& ROLLSTOCK COMPOUNDS PRODUCTS
- ----------------------- ----------------- -----------------------
Cornwall, ON (Business) Conneaut, OH El Monte, CA (Business)
Redlands, CA Conshohocken, PA
Taylorville, IL Goddard, KS
Conneaut, OH
In addition to the reduction in operating facilities, the Company made a
decision in the third quarter of fiscal 2005 to sell an extruded film line that
had recently been added to the Color & Specialty Compounds segment which
resulted in a fixed asset impairment charge of $3.7 million. The decision was
made possible as a result of the late 2004 VPI acquisition and analysis of the
capabilities and capacity within the newly acquired facilities. Also, in the
third quarter of fiscal 2005, the Company terminated the lease on its airplane
which resulted in termination fees and selling expenses of $.8 million.
7
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
The following table summarizes the restructuring & exit costs presented in
the Consolidated Condensed Statement of Operations for the third quarter and
nine months ended July 30, 2005:
QUARTER NINE MONTHS
ENDED ENDED
------- -----------
Non-cash Charges:
Fixed Asset Impairment $3,674 $ 9,345
Goodwill Impairment -- 1,419
------ -------
3,674 10,764
Cash Charges:
Facility Restructuring 215 744
Airplane Lease Buy-Out 750 750
------ -------
965 1,494
------ -------
$4,639 $12,258
====== =======
The fixed asset impairment represents charges incurred to adjust the
related assets to fair market value, less costs to sell. The following table
summarizes the fixed asset impairment charges recognized in the third quarter
and nine months ended July 30, 2005 by reporting segment:
QUARTER NINE MONTHS
ENDED ENDED
------- -----------
Custom Sheet & Rollstock $ -- $2,018
Color & Specialty Compounds 3,674 6,120
Engineered Products -- 1,207
------ ------
$3,674 $9,345
====== ======
The goodwill impairment represents charges incurred to write off goodwill
related to two businesses which are held for sale. The following table
summarizes the goodwill impairment charges recognized in the third quarter and
nine months ended July 30, 2005 by reporting segment:
QUARTER NINE MONTHS
ENDED ENDED
------- -----------
Custom Sheet & Rollstock $-- $ 896
Color & Specialty Compounds -- --
Engineered Products -- 523
--- ------
$-- $1,419
=== ======
8
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
Facility restructuring charges represent exit costs including severance,
equipment moves, relocation, and other related costs. The majority of these
restructuring charges incurred during the nine months ended July 30, 2005 were
settled in cash by the end of the period. The Company will incur an additional
estimated $.3 million of cash restructuring costs in the fourth quarter of
fiscal 2005 related to the closing and sale of the eight facilities previously
discussed. In addition, the Company will incur an additional estimated $.3
million of other restructuring expenses related to the consolidation of two
compounding facilities into one of the Company's facilities located in Donora,
PA in the fourth quarter of fiscal 2005. The following table summarizes the
facility restructuring charges incurred during the third quarter and nine months
ended July 30, 2005 by reporting segment:
QUARTER NINE MONTHS
ENDED ENDED
------- -----------
Custom Sheet & Rollstock $ 67 $161
Color & Specialty Compounds 143 428
Engineered Products 5 155
---- ----
$215 $744
==== ====
The $750 airplane lease buy-out charge was recorded as a Corporate expense.
The Company continues to evaluate other operations for opportunities which
provide short and longer term efficiencies. These evaluations may lead to
further plant restructuring decisions, related exit costs, and property, plant
and equipment write-downs. Any such charges would be recorded when those
decisions are made and the plan is initiated.
NOTE D - FORMER CEO RETIREMENT
The Company entered into a Retirement Agreement and Release (Retirement
Agreement), effective on May 6, 2005, with its former Chairman, President, and
Chief Executive Officer, Bradley B. Buechler. This Retirement Agreement replaced
Mr. Buecher's Amended and Restated Employment Agreement dated November 2, 2002
(Employment Agreement).
The Retirement Agreement includes various terms and conditions pertaining
to Mr. Buechler's retirement. The payments and benefits paid to Mr. Buechler
under this Retirement Agreement include the following major provisions:
- A cash settlement paid June 3, 2005, based upon a multiple of Mr.
Buechler's former annual salary plus his previous deferred
compensation arrangement, totaling $2.7 million.
- A bonus to be paid based on the Company's fiscal 2005 results
pro-rated for Mr. Buechler's employment through the effective date of
the Retirement Agreement, adjusted for certain non-recurring items.
- An amendment to the terms of Mr. Buechler's vested Stock Options to
treat his resignation as a retirement before having reached the
minimum retirement age of 60 specified in his option agreements,
resulting in a new measurement of the options for accounting purposes
and a non-cash expense of $0.8 million.
9
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
The provisions of the Retirement Agreement resulted in a $3.6 million
charge to operating earnings in the third quarter of fiscal 2005.
NOTE E - FIXED ASSET CHARGE
As part of the Company's Sarbanes-Oxley process, management initiated a
complete physical count of the Company's property, plant and equipment in the
first quarter of fiscal 2005. The counts were reconciled to balances recorded in
the Company's books and records, and $8.7 million of equipment that no longer
existed was identified and written off.
Management believes that the cause of the $8.7 million in non-existing
equipment was mostly related to transactions for plant shutdowns and transfers
of equipment between plants. Although the Company is not required to report
under the Sarbanes-Oxley rules which require management to identify material
weaknesses in the Company's internal controls until October 29, 2005, the
control issue over property, plant and equipment would be considered a material
weakness in the Company's internal controls. Due to the number of transactions,
passage of time since many of them occurred, and the weaknesses in documentation
and controls over these activities, management cannot specifically identify or
allocate these asset write-offs to distinct fiscal years with any certainty. In
the third quarter of fiscal 2005, management took corrective actions to
institute new policies and procedures for the tracking of equipment disposals
and transfers of equipment between plants, including periodic physical
inventories of our property, plant and equipment at each location.
During the count process, management also identified equipment that exists
and that management has decided to liquidate. The decision to liquidate these
assets resulted in a $1.9 million fixed asset impairment charge. This impairment
charge, combined with the non-existing asset write-off charge is presented as a
total non-cash fixed asset charge of $10.6 million in the Consolidated Condensed
Statement of Operations for the nine months ended July 30, 2005. The following
presents the fixed asset charge by reporting segment for the third quarter and
nine months ended July 30, 2005:
QUARTER NINE MONTHS
ENDED ENDED
------- -----------
Custom Sheet & Rollstock $ -- $ 6,468
Color & Specialty Compounds -- 1,675
Engineered Products 206 1,824
Corporate -- 625
---- -------
$206 $10,592
==== =======
10
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
NOTE F - INVENTORIES
Inventories are valued at the lower of (i) actual cost to purchase or
manufacture the inventory (specific identification) or (ii) the current
estimated market value. Inventories at July 30, 2005 and October 30, 2004 are
comprised of the following components:
JUL. 30, OCT. 30,
2005 2004
-------- --------
Raw materials $ 85,576 $ 82,571
Finished goods 58,818 59,464
-------- --------
$144,394 $142,035
======== ========
NOTE G - GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for the nine months ended July
30, 2005 by reporting segment are as follows:
CUSTOM COLOR &
SHEET & SPECIALTY ENGINEERED
ROLLSTOCK COMPOUNDS PRODUCTS TOTAL
--------- --------- ---------- ---------
Balance, October 30, 2004 $212,850 $111,015 $38,092 $361,957
Impairment Charges (896) -- (523) (1,419)
Reclassifications (1,137) (1,019) -- (2,156)
-------- -------- ------- --------
Balance, July 30, 2005 $210,817 $109,996 $37,569 $358,382
======== ======== ======= ========
Impairment charges result from the Company's plan to close and sell certain
facilities as discussed in Note C. Reclassifications represent adjustments to
the preliminary allocation of the cash price of the VPI acquisition from
goodwill to other assets acquired and liabilities assumed.
At July 30, 2005 other intangible assets with definite lives are as follows:
GROSS ACCUMULATED
CARRYING AMOUNT AMORTIZATION
------------------- -------------------
JUL. 30, OCT. 30, JUL. 30, OCT. 30,
2005 2004 2005 2004
-------- -------- -------- --------
Non-compete agreements $ 3,680 $ 3,960 $1,953 $1,242
Customer contracts 21,571 18,981 4,662 2,380
Product formulations & other 17,766 17,911 2,972 2,063
------- ------- ------ ------
$43,017 $40,852 $9,587 $5,685
======= ======= ====== ======
11
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
Amortization expense for the Company's existing other intangible assets
over the next five years is estimated to be: $4,395, $4,274, $3,147, $2,688 and
$2,637 for the annual periods from July 31, 2005 to July 31, 2010. The Company
has a trademark of $8,900 included in other intangible assets which have
indefinite lives.
NOTE H - 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 quarter and nine
months ended July 30, 2005 and July 31, 2004 is as follows:
QUARTER ENDED NINE MONTHS ENDED
------------------- -------------------
JUL. 30, JUL. 31, JUL. 30, JUL. 31,
2005 2004 2005 2004
-------- -------- -------- --------
Net Earnings $4,289 $11,712 $7,027 $32,937
Foreign Currency Translation Adjustments 824 1,154 667 (729)
Cash flow hedge adjustments -- 991 81 2,834
------ ------- ------ -------
Total Comprehensive Income $5,113 $13,857 $7,775 $35,042
====== ======= ====== =======
NOTE I - SEGMENT INFORMATION
The Company's 43 facilities are organized into three reportable segments
based on the nature of the products manufactured. Beginning in fiscal 2005,
Spartech PEP, which formerly was reported in the Custom Sheet & Rollstock
segment, is now included in the Color & Specialty Compounds segment. All prior
period segment results have been restated to be consistent with the current
period presentation. The Company's former Molded & Profile Products segment was
renamed to the Engineered Products segment effective in the second quarter of
fiscal 2005. The following presents the Company's net sales and operating
earnings by segment:
12
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
QUARTER ENDED NINE MONTHS ENDED
------------------- ---------------------
JUL. 30, JUL. 31, JUL. 30, JUL. 31,
2005 2004 2005 2004
-------- -------- ---------- --------
NET SALES (A)
Custom Sheet & Rollstock $221,815 $190,837 $ 649,597 $529,613
Color & Specialty Compounds 106,577 80,741 317,109 235,233
Engineered Products 20,280 16,457 64,136 52,243
-------- -------- ---------- --------
TOTAL NET SALES $348,672 $288,035 $1,030,842 $817,089
======== ======== ========== ========
Note to table:
(a) Excludes intersegment sales of $11,315 and $12,711 for the three months
ended July 30, 2005 and July 31, 2004, respectively, and $39,030 and
$38,376 for the nine months ended July 30, 2005 and July 31, 2004,
respectively, primarily from the Color & Specialty Compounds segment.
QUARTER ENDED NINE MONTHS ENDED
------------------- -------------------
JUL. 30, JUL. 31, JUL. 30, JUL. 31,
2005 2004 2005 2004
-------- -------- -------- --------
OPERATING EARNINGS
Custom Sheet & Rollstock $18,714 $19,858 $ 36,174 $55,427
Color & Specialty Compounds 2,851 7,321 11,337 21,070
Engineered Products (181) 1,417 (1,285) 5,242
Corporate (8,228) (3,662) (16,535) (9,956)
------- ------- -------- -------
$13,156 $24,934 $ 29,691 $71,783
======= ======= ======== =======
Refer to Notes C, D and E for impacts of the Restructuring & Exit Costs,
Former CEO Retirement and Fixed Asset Charge on operating earnings for each
segment.
13
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
NOTE J - STOCK BASED COMPENSATION
The Company has adopted the disclosure-only provisions of SFAS 123. The
table below 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.
QUARTER ENDED NINE MONTHS ENDED
--------------------- ---------------------
JUL. 30, JUL. 31, JUL. 30, JUL. 31,
2005 2004 2005 2004
--------- --------- --------- ---------
Net Earnings
as Reported $4,289 $11,712 $7,027 $32,937
Pro Forma Impact of
Expensing Stock Options 579 442 1,649 1,326
--------- --------- --------- ---------
Pro forma net earnings $3,710 $11,270 $5,378 $31,611
========= ========= ========= =========
Diluted Earnings per share:
As Reported
Basic $0.13 $0.36 $0.22 $1.06
Diluted 0.13 0.36 0.22 1.04
Pro forma
Basic $0.12 $0.35 $0.17 $1.01
Diluted 0.12 0.34 0.17 1.00
Assumptions Used:
Expected Dividend Yield 2% 2% 2% 2%
Expected Volatility 35% 35% 35% 35%
Risk-Free Interest Rates 3.6% 3.7% 3.6% 3.7%
Expected Lives 5.5 YEARS 5.5 Years 5.5 YEARS 5.5 Years
14
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
NOTE K - RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board (FASB) issued a
revised version of Statement of Financial Accounting Standards (SFAS) 123,
"Share Based Payment," (SFAS 123R) which replaces the original SFAS 123,
"Accounting for Stock-Based Compensation" and supercedes Accounting Principals
Board (APB) Opinion 25, "Accounting for Stock Issued to Employees." SFAS 123R
requires public companies to recognize the costs associated with the award of
equity instruments to employees in the results of operations over the service
period related to the award. The cost is based on the fair value of the equity
instrument at the date of grant. The provisions of SFAS 123R will be effective
for the Company in the first quarter of 2006. The approximate impact of the
adoption of this standard on our historical net income and earnings per share is
disclosed in Note J.
NOTE L - LONG-TERM DEBT
On February 16, 2005, the Company's French subsidiary entered into a 20
million Euro term loan that matures on February 16, 2010. Interest on the term
loan is payable monthly at a floating rate chosen by the Company equal to either
the one-month, three-month, or six-month EURIBO rate plus a 1% borrowing margin.
The proceeds of this loan were used to reimburse amounts that had been funded by
the U.S. parent and more effectively match Euro denominated debt with the Euro
denominated assets of our Donchery, France facility.
On July 29, 2005, Spartech Corporation was granted a waiver under its
revolving credit facility to ensure compliance with a Fixed Charge Coverage
Ratio. This ratio is calculated using financial information from the Company's
four most recent trailing fiscal quarters and is required to exceed 1.40:1. The
waiver only applies to the third quarter ended July 30, 2005 and automatically
terminates if the Fixed Charge Coverage Ratio is less than 1.25:1. The
Company's actual Fixed Charge Coverage Ratio for the third quarter was 1.38:1.
The primary reason for the waiver was the negative impact on the numerator of
the ratio of the $.8 million one-time cash expenses to terminate the lease of
the Company's airplane and the $2.7 cash retirement payment to the Company's
former CEO, both of which were incurred in the third quarter of fiscal 2005. In
addition, the denominator of the ratio included $33 million of required
principal payments paid during the fourth quarter of 2004 which will decrease
to $18 million in the fourth quarter of 2005. This will benefit the Company's
fourth quarter of fiscal 2005 Fixed Charge Coverage Ratio calculation which is
currently estimated to increase to more than 1.75:1. In addition, management
believes that it is probable that the Company will not be in violation of any
covenants in the next twelve months.
NOTE M - COMMITMENTS AND CONTINGENCIES
The Company has guaranteed 5.6 million Euros associated with the local
government's financing of the Company's Donchery, France facility expansion. The
Company will enter into a lease for the expanded facility and the guarantee will
decrease over the fifteen-year term of the lease. This guarantee was recorded as
an other long-term asset and other long-term liability in the first quarter of
fiscal 2005.
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 39 other companies in an environmental study to
determine the extent and sources of contamination at this site. The Company has
$100 accrued as of July 30, 2005 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 legal fees.
15
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
The Company fulfilled its obligation to fund its portion of the
environmental study in the third quarter of fiscal 2005. Due to uncertainties
inherent in this matter, management is unable to estimate the Company's possible
additional 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, if
any, attributed to our subsidiary versus the 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.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Net sales for the third quarter and first nine months of fiscal 2005
increased 21% and 26%, respectively over the same periods of the prior year. The
increases for both periods were substantially due to selling price increases,
changes in product mix, and the VPI acquisition, partially offset by decreases
in underlying sales volume. Despite the significant net sales increases,
operating earnings decreased in the third quarter and first nine months of
fiscal 2005 compared to operating earnings for the same periods of the prior
year primarily due to (i) restructuring and exit costs associated with the
closing and sale of certain plant facilities, (ii) a fixed asset charge
resulting from our company-wide fixed asset count, and (iii) charges associated
with the retirement of our former CEO (these three items are subsequently
referred to herein as "special items"). Refer to the Special Items Supplemental
Table at the end of this section for the impact of special items by segment.
Excluding special items, operating earnings decreased in the third quarter and
first nine months of fiscal 2005 from the same periods of the prior year
primarily due to increases in conversion costs, most of which occurred in
labor-related and utilities costs, coupled with the decrease in underlying sales
volume. In addition, operating earnings in the first nine months of fiscal 2005
were adversely impacted by sharp increases in resin prices in the earlier
portion of this period and our inability to pass along price increases to
customers as quickly as the material costs increased. Although operating
earnings decreased in the third quarter of fiscal 2005 compared to the third
quarter of last fiscal year, we paid down over $38 million of debt in the third
quarter of fiscal 2005. This pay down was funded from net cash provided by
operating activities of $52.2 million in the third quarter, which is the largest
generation of cash from operations for any one quarter in the history of the
Company.
CONSOLIDATED RESULTS
Net sales were $348.7 million and $1,030.8 million for the quarter and nine
months ended July 30, 2005. These amounts reflect a 21% and 26% increase,
respectively over net sales in the same quarter and nine month period of the
prior year and include the benefit of the VPI acquisition completed on October
1, 2004. The following table presents components of the sales percentage changes
for both periods:
% CHANGE
FROM PRIOR YEAR
------------------
QUARTER 9 MONTHS
------- --------
Underlying volume (4)% (1)%
VPI acquisition 10 10
Price/Mix 15 17
--- ---
21% 26%
=== ===
The lower underlying volume for both periods reflects a decrease in pounds
sold of toll-compounded material and lower-priced dunnage material to two
17
separate major customers. Excluding the negative volume impact in sales to these
two major customers, volume sold was flat in the third quarter and increased
approximately 3% in the nine months to date compared to the same periods of the
prior year. The flat underlying sales volume, excluding the negative impact of
the two major customers, in the third quarter was mostly due to a decrease in
volume sold in our Custom Sheet & Rollstock segment. This decrease was primarily
due to general softness in the third quarter of fiscal 2005 demand compared to
the robust demand in the third quarter of the prior year, and also reflects the
loss of certain business because of our decision to focus on higher margin
business with customers requiring a lower net working capital investment. Most
of the price/mix impact reflects higher selling prices to customers from the
pass through of raw material price increases.
The table below presents the Company's sales and cost of sales in dollars
and on a per pound sold basis for the quarter and nine months ended July 30,
2005 compared to the same periods of the prior year. Cost of sales presented in
the Consolidated Condensed Statement of Operations includes material and
conversion costs. We have not presented cost of sales components as a percentage
of net sales because a comparison of this measure is distorted by changes in
resin costs that are passed through to customers as higher selling prices. These
significant changes materially affect the percentages but do not present
accurate performance measures of the business.
QUARTER ENDED NINE MONTHS ENDED
------------------- -------------------
JUL. 30, JUL. 31, JUL. 30, JUL. 31,
2005 2004 2005 2004
-------- -------- -------- --------
DOLLARS AND POUNDS (IN MILLIONS)
Net sales $348.7 $288.0 $1,030.8 $ 817.1
Material costs 225.1 171.2 663.4 479.2
------ ------ -------- --------
Material margin 123.6 116.8 367.4 337.9
Conversion costs 83.7 75.9 254.6 219.8
------ ------ -------- --------
Gross margin $ 39.9 $ 40.9 $ 112.8 $ 118.1
====== ====== ======== ========
POUNDS SOLD 365.5 350.8 1,093.5 1,017.3
====== ====== ======== ========
DOLLARS PER POUND SOLD
Net sales $ .954 $ .821 $ .943 $ .803
Material costs .616 .488 .607 .471
------ ------ -------- --------
Material margin .338 .333 .336 .332
Conversion costs .229 .216 .233 .216
------ ------ -------- --------
Gross margin $ .109 $ .117 $ .103 $ .116
====== ====== ======== ========
The significant increases in net sales and material costs per pound in
the quarter and nine months ended July 30, 2005 compared to the same periods of
the prior year were mostly due to increases in raw material costs and the impact
of passing on these increases to customers as higher selling prices. Raw
material prices for the Company's major resins increased approximately 25% to
35%, depending upon the type of resin, for the first nine months of fiscal 2005
compared to the same period of the prior year. Material margin per pound sold
increased .5 cent and .4 cent, respectively in the third quarter and first nine
months of fiscal 2005 compared to the same prior year periods. These increases
were due to the mix impact of the decreases in sales of the toll-compound and
lower priced dunnage material, both of which have lower material margins per
pound, and the favorable mix impact of the VPI acquisition. The favorable
impacts of these items on material margin per pound sold more than offset the
negative impact of other mix changes for both period comparisons as well as the
negative impact of the rapid rise in resin prices throughout our first quarter
of fiscal 2005.
18
Conversion costs per pound sold increased 1.3 cents and 1.7 cents in the
third quarter and first nine months of fiscal 2005 compared to the same periods
of the prior year. These increases reflect the mix impact of the lower volume in
sales to the two major customers previously discussed, the impact of the VPI
acquisition and other mix changes. In addition, the increases reflect increases
in labor-related costs and utilities coupled with the decrease in underlying
sales volume, particularly in our first quarter of fiscal 2005. We expect our
restructuring efforts to help mitigate these increases in conversion costs and
as of July 30, 2005, the impact of the restructuring benefits has not been fully
realized.
Gross margin per pound sold decreased .8 cent and 1.3 cents, respectively
in the third quarter and first nine months of fiscal 2005 compared to the same
periods of the prior year. These decreases are due to the reasons previously
discussed. The lower decrease in gross margin per pound sold in the third
quarter comparable period versus the first nine months comparable period
reflects price increases to customers in the later part of fiscal 2005 to date
and the adverse impact of the significant resin price increases and low sales
volume in the first quarter of fiscal 2005.
Selling and administrative expenses of $16.9 million and $52.7 million for
the quarter and first nine months of fiscal 2005 increased from $15.3 million
and $44.4 million for the same periods of the prior year. Substantially all of
the increase in the third quarter of fiscal 2005 compared to the third quarter
of the prior year was due to the VPI acquisition. Excluding the impact of VPI,
selling and administrative expenses increased $.1 million in this period
reflecting higher costs associated with Sarbanes-Oxley compliance efforts and
increased information technology investments, partially offset by savings from
termination of the Company's airplane lease (see the discussion below) and lower
bad debt expense. The VPI acquisition accounted for approximately half of the
$8.3 million increase in selling and administrative expense in the first nine
months of fiscal 2005 compared to the first nine months of fiscal 2004. The
remaining increases were primarily due to costs associated with Sarbanes-Oxley
compliance efforts and increased information technology investments.
In the second quarter of fiscal 2005, we initiated several strategic
changes to enhance short-term operating performance and longer term operating
efficiencies. The plan involves the consolidation, sale or closing of seven
plant facilities and other cost reduction efforts. The following table presents
the charges associated with the plan:
19
NINE
MONTHS
QUARTER ENDED ENDED
------------------- --------
APR. 30, JUL. 30, JUL. 30,
2005 2005 2005
-------- -------- --------
(IN MILLIONS)
Non-cash charges:
Fixed asset impairment $5.7 $3.6 $ 9.3
Goodwill impairment 1.4 -- 1.4
---- ---- -----
7.1 3.6 10.7
Cash charges:
Facility restructuring .5 .2 .7
Airplane lease buy-out -- .8 .8
---- ---- -----
.5 1.0 1.5
---- ---- -----
$7.6 $4.6 $12.2
==== ==== =====
Refer to Note C to our Consolidated Condensed Financial Statements for
additional detail of our restructuring plan.
In the third quarter of fiscal 2005, we entered into a Retirement Agreement
with the former Chief Executive Officer of the Company. This resulted in a $3.6
million charge in the third quarter, of which $.8 million represented a non-cash
charge. Refer to Note D to our Consolidated Condensed Financial Statements for
detail of this charge.
As part of our Sarbanes-Oxley compliance efforts, we initiated a complete
physical count of the Company's property, plant and equipment in the first
quarter of fiscal 2005. We reconciled the counts to amounts recorded in our
books and records and identified $8.7 million of property that no longer
physically existed and therefore was written off. We also identified another
$1.9 million of impairment losses pertaining to property that exists, which we
have decided to liquidate. Of the $10.6 million non-cash charge, $10.4 million
and $.2 million was recorded in the second quarter and third quarter,
respectively, of fiscal 2005. Refer to Note E to our Consolidated Condensed
Financial Statements for detail of these charges.
Amortization of intangibles increased to $1.3 million and $3.9 million for
the quarter and first nine months of fiscal 2005 from $.7 million and $2.0
million in the comparable periods of last year. These increases primarily
reflect amortization of intangibles acquired as part of the VPI acquisition.
Operating earnings for the quarter and first nine months of fiscal 2005
were $13.2 million and $29.7 million, compared to $24.9 million and $71.8
million for the corresponding periods of the prior year. The decreases in
operating earnings for both periods were adversely impacted by the restructuring
& exit costs, fixed asset charge, and former CEO retirement previously
discussed. Operating earnings excluding the impacts of special items for the
quarter and first nine months of fiscal 2005 decreased from operating earnings
in the same periods of the prior year. The decrease in the third quarter
comparable was primarily due to the decrease in underlying sales volume coupled
with the increases in conversion costs, mostly in the labor-related and
utilities areas. The decrease in fiscal 2005 year to date comparable reflects
(i) increases in conversion costs and selling and administrative expenses in the
first nine months of fiscal 2005 compared to the same period of the prior year,
coupled with the slight decrease
20
in underlying sales volume and (ii) lower than expected first quarter fiscal
2005 results from sharp increases in raw materials and our inability to pass
along price increases to customers as quickly as the increase in costs.
Operating earnings excluding special items includes losses from businesses held
for sale of $.8 million and $1.9 million for the third quarter and first nine
months of fiscal 2005.
Interest expense of $6.4 million and $19.2 million in the third quarter and
first nine months of fiscal 2005 compares to $6.0 million and $18.5 million in
the comparable period of the prior year. These increases reflect additional
borrowings primarily due to the VPI acquisition, partially offset by a decrease
in average interest rate due to the expiration of our interest rate swap on
November 10, 2004.
Our effective tax rate was 36.8% and 32.9% in the third quarter and first
nine months of fiscal 2005 compared to 38.2% for both comparable periods of the
prior year. The decrease in tax rate in the first nine months of fiscal 2005
reflects a first quarter reduction in deferred tax liabilities associated with
the implementation of state tax planning strategies that will reduce our
long-term effective tax rate, relative to low earnings before income taxes. We
estimate that our tax rate will approximate 36% in the fourth quarter of fiscal
2005 resulting in an approximate 35% effective tax rate for the fiscal year.
The Company reported net earnings of $4.3 million in the third quarter of
fiscal 2005 and $7.0 million in the first nine months of fiscal 2005. These
amounts decreased from the $11.7 million and $32.9 million of net earnings in
the third quarter and first nine months of fiscal 2004 due to the reasons
previously discussed.
SEGMENT RESULTS
Custom Sheet and Rollstock
The Custom Sheet & Rollstock segment net sales increased by 16% and 23% to
$221.8 million and $649.6 million in the quarter and nine months ended July 30,
2005 from $190.8 million and $529.6 million in the corresponding periods of the
prior year. The following table presents components of the sales percentage
changes for both periods:
% CHANGE
FROM PRIOR YEAR
------------------
QUARTER 9 MONTHS
------- --------
Underlying volume (7)% (1)%
VPI acquisition 7 7
Price/Mix 16 17
--- ---
16% 23%
=== ===
The 7% and 1% decreases in underlying sales volume in the quarter and nine
months ended July 30, 2005 compared to the same periods of the prior year
reflect a decrease in sales of lower-priced dunnage material to this segment's
largest customer due to the expiration of an intermittent supply contract
between this customer and a third party. Excluding this impact, internal volume
of pounds sold decreased approximately 4% in the third quarter and increased 1%
in the first nine months of fiscal 2005 compared to the same periods of the
prior year. This 4% decrease in sales volume in the third quarter was primarily
due to general softness in the third quarter of fiscal 2005 volumes when
compared to
21
robust volume in the third quarter of the prior year, and also reflects loss of
certain business because of our decision to focus on higher margin business with
customers requiring a lower net working capital investment. Specifically, sales
to the Transportation and Pool & Spa markets were soft in the third quarter of
fiscal 2005 compared to the third quarter of the prior year. The majority of the
price/mix impact reflects higher selling prices to customers from the pass
through of raw material price increases.
This segment's operating earnings for the quarter and first nine months
were $18.7 million and $36.2 million which compared to $19.9 million and $55.4
million for the same periods of the prior year. The decreases in operating
earnings for both periods were adversely impacted by the restructuring & exit
costs and fixed asset charge. Operating earnings dollars and per pound sold
excluding special items for the quarter and first nine months of fiscal 2005
were less than the comparable periods of the prior year. The per pound sold
decreases reflect the decrease in underlying sales volume coupled with increases
in conversion costs, specifically labor-related costs and utilities. The per
pound sold decrease was larger in the nine months to date period versus the
quarter due mostly to sharp increases in raw material prices and the impact of
passing only a portion of these increases as higher selling prices in the
earlier portion of fiscal 2005 to date. Operating earnings excluding special
items includes $.3 million and $.8 million of operating losses in the third
quarter and first nine months of fiscal 2005 related to a business held for
sale, and $.3 million of inventory write-downs related to exiting a facility in
the second quarter of fiscal 2005.
Color and Specialty Compounds Segment
Net sales of the Color & Specialty Compounds segment were $106.6 million
and $317.1 million in the third quarter and first nine months of fiscal 2005
representing a 32% and 35% increase over the third quarter and first nine months
of fiscal 2004. The following table presents components of the sales percentage
changes for both periods:
% CHANGE
FROM PRIOR YEAR
------------------
QUARTER 9 MONTHS
------- --------
Underlying volume (2)% (2)%
VPI acquisition 19 21
Price/Mix 15 16
--- ---
32% 35%
=== ===
The decreases in underlying volume of pounds sold of 2% for the quarter and
nine months ended July 30, 2005 compared to the same periods of the prior year
reflect a decrease in sales of toll-compounded material to one customer.
Excluding the decrease in sales volume to this customer, internal volume
increased approximately 3% for the quarter and nine months to date. This 3%
increase in internal volume of pounds sold reflects strong sales to the Building
& Construction market, flat sales to the Transportation market, and lower sales
to the Packaging market. The majority of the price/mix impact reflects higher
selling prices to customers from the pass through of raw material price
increases.
This segment's operating earnings for the quarter and first nine months of
fiscal 2005 were $2.8 million and $11.3 million compared to $7.3 million and
$21.1 million for the same periods of the prior year. The decreases
22
in operating earnings for both periods were adversely impacted by the
restructuring & exit costs and fixed asset charge. Operating earnings dollars
and per pound sold excluding special items for the quarter and first nine months
of fiscal 2005 decreased from the same periods of the prior year. The decreases
in the current period cents per pound sold reflect increases in conversion
costs, specifically labor-related costs and utilities, start-up costs at our
Donchery, France facility, and the decrease in sales volume.
Engineered Products Segment
Net sales of the Engineered Products segment increased by 23% to $20.3
million and 23% to $64.1 million in the quarter and nine months ended July 30,
2005 from $16.5 million and $52.3 million in the corresponding periods of the
prior year. The following table presents components of the sales percentage
changes for both periods:
% CHANGE
FROM PRIOR YEAR
------------------
QUARTER 9 MONTHS
------- --------
Underlying volume 27% 28%
Price/Mix (4) (5)
--- ---
23% 23%
=== ===
The volume increases for both periods were primarily driven by increases in
sales of wheels in the Lawn & Garden Market to new customers. The negative
impact of price/mix reflects higher selling prices, the impact of which was more
than offset by the change in product mix from selling more wheels with a lower
per pound selling price.
This segment's operating losses for the quarter and first nine months of
fiscal 2005 were $.2 million and $1.3 million compared to operating earnings of
$1.4 million and $5.2 million for the same periods of the prior year. The
decreases in operating earnings for both periods were adversely impacted by the
restructuring & exit costs and fixed asset charge. Operating earnings dollars
and per pound sold excluding special items for the quarter and first nine
months of fiscal 2005 were lower than the same periods of the prior year. The
decreases were due to higher than expected start-up costs associated with the
ramp-up of new production capacity and start-up delays for our wheels business.
Operating earnings excluding special items includes $.5 million and $1.1 million
of operating losses in the third quarter and first nine months of fiscal 2005
related to a business held for sale.
CASH FLOW
Our primary sources of liquidity have been cash flows from operating
activities, borrowings from third parties, and equity offerings. 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:
23
NINE MONTHS ENDED
-------------------
JUL. 30, JUL. 31,
2005 2004
-------- --------
(DOLLARS IN MILLIONS)
Net cash provided by
operating activities $ 62.3 $ 16.6
====== ======
Net cash used for
investing activities $(32.4) $(32.3)
====== ======
Net cash (used for)/ provided
by financing activities $(65.1) $ 25.2
====== ======
(Decrease) / increase in cash
and equivalents $(35.1) $ 9.6
====== ======
Net earnings were $7.0 million in the first nine months of fiscal 2005
compared to $32.9 million in the nine months of fiscal 2004. The lower net
earnings in the current period reflects the non-cash $10.6 million fixed asset
charge, $10.8 million non-cash restructuring & exit costs, and $.8 million
non-cash former CEO settlement. Changes in current assets and liabilities, net
of the effects of acquisitions, ("net working capital accounts") provided $4.8
million of cash in the first nine months of fiscal 2005 compared to a use of
$44.0 million in the same period of the prior year. The $4.8 million cash
provided in the first nine months of fiscal 2005 includes $32.1 million provided
in the third quarter, which is the highest cash generation from net working
capital accounts for any one quarter in the history of the Company. The
$32.1 million provided by the net working capital accounts in the third quarter
of fiscal 2005 compared to a use of $3.9 million in the third quarter of the
prior year. This improvement is partially due to the decrease in underlying
sales volume, but also reflects improvement in average days sales outstanding
("DSO") and inventory turnover ("ITO") in the third quarter of fiscal 2005.
The DSO and ITO improvements reflect additional focus on the management of net
working capital levels. The third quarter improvement in cash provided by the
net working capital accounts resulted in $52.2 million of net cash provided by
operating activities for the quarter, the Company's highest level for any one
quarter, and drove the year to date third quarter increase in net cash provided
by operating activities from $16.6 million in the nine months ended July 31,
2004 to $62.3 million in the nine months ended July 30, 2005.
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 fiscal 2005 were $31.3 million compared to $22.7 million for the first nine
months of fiscal 2004. The increase in capital expenditures in the current
period is due to capacity expansions for new sheet and compounding business at
our Donchery, France facility, new wheels business in our Engineered Products
segment, and the addition of certain lines in our U.S. sheet business. In
addition, the increase reflects information technology capital investments
related to Sarbanes-Oxley compliance efforts and our company-wide Oracle 11i
globalization project. We estimate that our capital expenditures for fiscal 2005
will approximate $38 million.
Cash used for financing activities totaled $65.1 million for the first nine
months of fiscal 2005 compared to cash provided of $25.2 million in the same
period of the prior year. The use in the current year mostly reflects pay down
24
of the bank credit facility with the strong cash flow provided by operations and
the decrease in cash balance in this period. Of the $48.0 million pay down of
the bank credit facility in the first nine months of fiscal 2005, $38.2 million
was paid down in the third quarter. In the prior period, we completed a stock
offering that provided $60.9 million, and $27.2 million of these proceeds were
use to pay down the bank credit facility. Other financing activities in the
first nine months of fiscal 2005 include $11.5 million used to pay dividends and
$6.9 million used to purchase treasury stock.
Overall, cash decreased by $35.1 million in the first nine months of fiscal
2005 due to the factors noted above. This decrease compares to a $9.6 million
increase in cash in the first nine months of 2004 which included a common stock
offering that provided $60.9 million of cash. These proceeds were used to pay
down borrowings, fund acquisitions and pay dividends in the prior year period.
FINANCING ARRANGEMENTS
At July 30, 2005, our total borrowings under our bank credit facilities
were $52.8 million at a weighted average interest rate of 4.6% and we had $139.9
million of total availability under the credit facilities.
On February 16, 2005, our French subsidiary entered into a 20 million Euro
term loan that matures on February 16, 2010. Interest on the term loan is
payable monthly at a floating rate chosen by the Company equal to either the
one-month, three-month, or six-month EURIBO rate plus a 1% borrowing margin. We
used the proceeds of this loan to reimburse amounts that had been funded by the
U.S. parent and more effectively match Euro denominated debt with the Euro
denominated assets of our Donchery, France facility.
Our current credit facilities 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 ratios.
While we were in compliance with such covenants through the third quarter of
fiscal 2005 and currently expect to be in compliance for the remainder of fiscal
2005, 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.
On July 29, 2005, Spartech Corporation was granted a waiver under its
revolving credit facility to ensure compliance with a Fixed Charge Coverage
Ratio. This ratio is calculated using financial information from our four most
recent trailing fiscal quarters and is required to exceed 1.40:1. The waiver
only applies to the third quarter ended July 30, 2005 and automatically
terminates if the Fixed Charge Coverage Ratio is less than 1.25:1. Our actual
Fixed Charge Coverage Ratio for the third quarter was 1.38:1. The primary reason
for the waiver was the negative impact on the numerator of the ratio of the $.8
million one-time cash expenses to terminate the lease of the company airplane
and the $2.7 cash retirement payment to our former CEO, both of which were
incurred in the third quarter of fiscal 2005. In addition, the denominator of
the ratio included $33 million of required principal payments paid during the
fourth quarter of 2004 which will decrease to $18 million in the fourth quarter
of 2005. This will benefit our fourth quarter of fiscal 2005 Fixed Charge
Coverage Ratio calculation which we currently estimate to increase to more than
1.75:1. In
25
addition, we believe that it is probable that we will not be in violation of any
covenants in the next twelve months.
We anticipate that cash flows from operations, together with the financing
and borrowings under our bank credit facility, will provide the resources for
(i) satisfying our working capital needs, regular quarterly dividends, and
planned capital expenditures and (ii) managing the capital structure on a short
and long-term basis.
OUTLOOK
As we move forward to the fourth quarter of our fiscal year, we have seen
some volume declines which could be indicative of a broader slowdown in demand
in our markets. In addition, we believe that the recent natural disaster caused
by hurricane Katrina could have an adverse impact on business activity during
our fiscal fourth quarter 2005. Although our facilities in Tupelo, MS and Lake
Charles, LA were only minimally affected physically by the hurricane, the
repercussions related to our logistics costs, raw material supply, and raw
material pricing have yet to be determined. Furthermore, our short term
restructuring efforts in the remainder of the year will be a major focus for us.
Therefore, we are cautious regarding our fourth quarter results due to the
overall economic trends and the potential impact of the recent natural disaster,
as well as the significance of the time and effort involved in our short term
restructuring efforts during the remainder of our fiscal year.
As discussed in Note C to our Consolidated Condensed Financial Statements,
we will continue to implement our operational changes in the fourth quarter of
fiscal 2005. By the end of fiscal 2005, we expect to have disposed of at least
five of the seven facilities that we plan to sell. We estimate that we will
recognize an approximate $2.0 million pretax gain in the fourth quarter for the
sale of three of the facilities. This amount could be partially offset by some
portion depending upon the timing and amount of proceeds received from disposal
of the remaining facilities. In addition, we estimate that we will incur $.3
million of cash restructuring expenses related to exiting the seven facilities
and $.3 million of other restructuring expense related to the consolidation of
two of our compounding facilities into one plant in Donora, PA in the fourth
quarter.
26
Special Items Supplemental Table
The following table presents the impact of special items on segment results
of operations for the quarter and nine months ended July 30, 2005:
PERIOD ENDED JULY 30, 2005
------------------------------------
NINE MONTHS
QUARTER ENDED
-------- -----------
RESTRUCTURING & EXIT COSTS
Custom Sheet & Rollstock $ 67 $ 3,075
Color & Specialty Compounds 3,817 6,548
Engineered Products 5 1,885
Corporate 750 750
------- --------
TOTAL $ 4,639 $ 12,258
======= ========
FIXED ASSET CHARGE
Custom Sheet & Rollstock $ -- $ 6,468
Color & Specialty Compounds -- 1,675
Engineered Products 206 1,824
Corporate -- 625
------- --------
TOTAL $ 206 $ 10,592
======= ========
FORMER CEO RETIREMENT
Custom Sheet & Rollstock $ -- $ --
Color & Specialty Compounds -- --
Engineered Products -- --
Corporate 3,645 3,645
------- --------
TOTAL $ 3,645 $ 3,645
======= ========
SPECIAL ITEMS (SUBTOTAL)
Custom Sheet & Rollstock $ 67 $ 9,543
Color & Specialty Compounds 3,817 8,223
Engineered Products 211 3,709
Corporate 4,395 5,020
------- --------
TOTAL $ 8,490 $ 26,495
======= ========
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SIGNIFICANT ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS
We prepare our 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, liabilities, shareholders' equity, revenues and expenses, and
disclosures of contingent assets and liabilities at the date of the financial
statements. 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 prior to shipment to
ensure that these specifications are met. 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
customer's creditworthiness, 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 credit loss rates that we have in the
past.
INVENTORIES - We value inventories at the lower of (i) actual cost to
purchase or manufacture the inventory or (ii) 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 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 acquisitions in recent years.
All of these acquisitions have been accounted for in accordance with the
purchase method, and accordingly, the results of operation were included in
our Consolidated Statement of Operations from the respective date of
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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 adjustments upon obtaining complete valuation information. While
the delayed finalization of a 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 - We review the carrying value of our
long-lived assets, which primarily include property plant and equipment,
goodwill, and other intangible assets, annually or whenever events and
changes in business circumstances indicate the carrying value of the assets
may not be recoverable. If we determine that the carrying value of a
long-lived asset may not be recoverable, a permanent impairment charge is
recorded for the amount by which the carrying value of the long-lived asset
exceeds its fair value. Fair value is generally measured based on a
projected discounted cash flow method using a discount rate determined to
be commensurate with the risk inherent in the business. The estimates in
projected cash flows and discount rates are subject to change due to the
economic environment, including such factors as interest rates, expected
market returns, and the volatility of markets served. We believe that the
estimates are reasonable; however, changes in estimates could materially
affect the fair value assessments.
CONTINGENCIES - We are 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
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 2004 Consolidated Financial Statements contained in our 2004
Annual Report on Form 10-K filed with the Securities and Exchange Commission.
CAUTIONARY NOTE ON FORWARD LOOKING STATEMENTS
This Form 10-Q contains "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995 that relate to future
events and expectations. Forward-looking statements include those containing
such words as "anticipates," "believes," "estimates," "expects," "would,"
"should,", "will," "will likely result," "forecast," "outlook," "projects," and
similar expressions. Forward-looking statements are based on management's
current expectations and include known and unknown risks, uncertainties and
other factors, many of which management is unable to predict or control, that
may cause actual results, performance or achievements to differ materially from
those expressed or implied in the forward-looking statements. Important factors
that could cause actual results to differ materially from those in the
forward-looking statements include: (a) adverse changes in economic or industry
conditions generally,
29
including global supply and demand conditions and prices for products of the
types produced by Spartech; (b) material adverse changes in the markets we
serve, including the transportation, packaging, building and construction,
recreation and leisure, and other markets, some of which tend to be cyclical;
(c) our inability to achieve the level of cost savings, productivity
improvements, synergies, growth or other benefits anticipated from acquired
businesses and their integration; (d) volatility of prices and availability of
supply of energy and of the raw materials that are critical to the manufacture
of our products, particularly plastic resins derived from oil and natural gas;
(e) our inability to predict accurately the costs to be incurred or savings to
be achieved in connection with announced production plant restructurings; (f)
adverse findings in significant legal or environmental proceedings or our
inability to comply with applicable environmental laws and regulations; (g) our
inability to achieve operational efficiency goals or cost reduction initiatives;
(h) our inability to develop and launch new products successfully (i) our
inability to predict accurately the start-up costs associated with the new
Donchery, France facility or the expansion of the existing wheel production
capacity; (j) restrictions imposed on Spartech by instruments governing its
indebtedness, and the possible inability to comply with requirements of those
instruments, (k) weaknesses in internal controls; and (l) other risk factors
summarized in reports filed by Spartech with the Securities and Exchange
Commission. Spartech assumes no duty to update its forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to changes in interest rates primarily as a result of our
borrowing activities. Our earnings and cash flows are subject to fluctuations in
interest rates on our floating rate debt facilities. Item 7A of our 2004 Annual
Report on Form 10-K provides more information as to the Company's market risk.
There has been no material change in the Company's exposure to market risks
since October 30, 2004.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES - We maintain a system of
disclosure controls and procedures that are designed to ensure that information
required to be disclosed in our reports filed under the Securities Exchange Act
is recorded, processed, summarized and reported within the time periods
specified under the Securities and Exchange Commission's rules and forms, and
that such information is accumulated and communicated to our management,
including our Chief Executive and Chief Financial Officer, as appropriate for
timely decisions regarding required disclosure. An evaluation has been performed
under the supervision of our management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures (as defined by Rules 13a-15e of the
Securities Exchange Act) as of July 30, 2005. Based on this evaluation, because
we have not completed testing of our remediation process implemented to correct
the property, plant and equipment internal control issue, our disclosure
controls and procedures were not effective in this area as of July 30, 2005 to
ensure that information required to be disclosed for property, plant and
equipment in the reports we file or submit under the Exchange Act are recorded,
processed, summarized, and reported when required. Notwithstanding the
foregoing, management believes that the financial statements included with the
report and adjusted for the resulting fixed asset charge fairly present in all
material
30
respects the financial position, results of operations, and cash flows of the
Company, in conformity the generally accepted accounting principals in the
United States, for the periods presented.
CHANGES IN INTERNAL CONTROLS - Except as noted below, there was no change
in our internal controls over financial reporting during the quarter ended July
30, 2005, that has materially affected, or is reasonably likely to materially
affect, our internal controls over financial reporting.
As part of our Sarbanes-Oxley process, we initiated a complete physical
count of our property, plant and equipment in the first quarter of fiscal 2005.
We reconciled the counts to balances recorded in the our books and records and
identified $8.7 million in non-existing equipment which we then wrote off. We
believe the cause of the $8.7 million in non-existing equipment was mostly
related to transactions for plant shut-downs and transfers of equipment between
plants. Although the Company is not required to report under the Sarbanes-Oxley
rules which require management to identify material weaknesses in the Company's
internal controls until October 29, 2005, our control issue over property, plant
and equipment would be considered a material weakness in the Company's internal
controls.
In the third quarter of fiscal 2005, we implemented new policies and
procedures for the tracking of equipment disposals and transfer of equipment
between plants. These policies include periodically conducting physical counts
of our equipment at each location. While we believe these actions have resolved
the material weakness, we continue to validate the remediation and subsequent
adequacy of the control and compliance therewith as part of our continued
testing and remediation process.
SARBANES-OXLEY 404 COMPLIANCE - We are continuing a comprehensive effort to
ensure compliance with Section 404 of the Sarbanes-Oxley Act of 2002 for our
fiscal year ending October 29, 2005. During the course of these activities, we
have identified certain internal control issues which we believe need to be
addressed. However, we have made improvements to our internal controls over
financial reporting as a result of our review efforts including controls
surrounding our property, plant and equipment noted above and we will continue
to make improvements in other areas. These improvements include the addition of
personnel for increased monitoring and review controls and the assessment of and
improvements to our consolidation process. As we identify other control issues,
we expect to validate these potential control deficiencies and assess whether or
not they rise to the level of significant deficiencies or material weaknesses.
In the meantime, we have established a series of remediation procedures to
investigate these potential control deficiencies, and, where appropriate, to
remediate them.
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PART II - OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
There were no repurchases of equity securities during the third quarter of
fiscal 2005. In October 2004, the Company's Board of Directors authorized a
program to repurchase up to 1 million shares. The maximum number of shares that
may yet be purchased under this program is 656,700.
ITEM 6. EXHIBITS
10.1 Retirement Agreement and Release dated May 6, 2005 between the Company
and Bradley B. Buecher.
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.
32
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)
/s/ GEORGE A. ABD
Date: September 8, 2005 ----------------------------------------
George A. Abd
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)
33