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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 January 29, 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 an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes x No
Number of shares outstanding as of January 29, 2005:
Common Stock, $.75 par value per share 32,208,342
SPARTECH CORPORATION AND SUBSIDIARIES
INDEX
January 29, 2005
PART I. FINANCIAL INFORMATION PAGE
Item 1. CONSOLIDATED CONDENSED BALANCE SHEET -
as of January 29, 2005 and October 30, 2004 3
CONSOLIDATED CONDENSED STATEMENT OF
OPERATIONS - for the quarter ended January 29,
2005 and January 31, 2004 4
CONSOLIDATED CONDENSED STATEMENT OF
CASH FLOWS - for the quarter ended January 29,
2005 and January 31, 2004 5
NOTES TO CONSOLIDATED CONDENSED FINANCIAL
STATEMENTS 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 13
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT 22
MARKET RISK
Item 4. CONTROLS AND PROCEDURES 22
PART II. OTHER INFORMATION
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE 23
OF PROCEEDS
Item 6. EXHIBITS 23
SIGNATURES 26
CERTIFICATIONS 27
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
SPARTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEET
(Dollars in thousands)
ASSETS
Jan. 29, 2005
(unaudited) Oct. 30, 2004
------------ -------------
Current Assets
Cash and equivalents $ 11,933 $ 48,954
Receivables, net 189,792 188,427
Inventories 159,689 142,035
Prepaids and other 24,840 20,718
---------- ----------
Total Current Assets 386,254 400,134
Property, plant and equipment 552,077 538,271
Less accumulated depreciation 216,820 207,526
---------- ----------
Net Property, Plant and Equipment 335,257 330,745
Goodwill, net 361,029 361,957
Other Intangible Assets, net 45,118 43,967
Other Assets 20,152 12,811
---------- ----------
$1,147,810 $1,149,614
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt $ 18,029 $ 18,027
Accounts payable 115,643 116,386
Accrued liabilities 42,830 44,223
---------- ---------
Total Current Liabilities 176,502 178,636
---------- ---------
Convertible subordinated debentures 154,639 154,639
Other long-term debt, less
current maturities 292,882 301,425
---------- ---------
Total Long-Term Debt 447,521 456,064
Deferred taxes 95,396 94,825
Other long-term liabilities 9,638 2,357
---------- ---------
Total Long-Term Liabilities 552,555 553,246
---------- ---------
Shareholders' Equity
Common stock, 33,131,846
shares issued in 2005 and 2004 24,849 24,849
Contributed capital 195,784 196,264
Retained earnings 219,089 220,136
Treasury stock, at cost, 923,504 shares
in 2005 and 952,073 shares in 2004 (22,391) (23,653)
Accumulated other comprehensive income 1,422 136
---------- ----------
Total Shareholders' Equity 418,753 417,732
---------- ----------
$1,147,810 $1,149,614
========== ==========
See accompanying notes to consolidated condensed financial statements.
SPARTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS
(Unaudited and dollars in thousands, except per share amounts)
QUARTER ENDED
-----------------------------
Jan. 29, 2005 Jan. 31, 2004
------------- -------------
Net Sales $304,512 $241,463
-------- --------
Costs and Expenses
Cost of sales 276,096 208,040
Selling and administrative 16,875 14,030
Amortization of intangibles 1,258 594
-------- --------
294,229 222,664
-------- --------
Operating Earnings 10,283 18,799
Interest 6,474 6,330
-------- --------
Earnings Before Income Taxes 3,809 12,469
Income taxes 991 4,763
-------- --------
Net Earnings $ 2,818 $ 7,706
======== ========
Net Earnings Per Common Share:
Basic $ .09 $ .26
======== ========
Diluted $ .09 $ .26
======== ========
Dividends Per Common Share $ .12 $ .11
======== ========
See accompanying notes to consolidated condensed financial statements.
SPARTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS
(Unaudited and dollars in thousands)
QUARTER ENDED
-----------------------------
Jan. 29, 2005 Jan. 31, 2004
------------- -------------
Cash Flows from Operating Activities
Net earnings $ 2,818 $ 7,706
Adjustments to reconcile net earnings
to net cash provided by
operating activities:
Depreciation and amortization 10,296 8,335
Change in current assets and
liabilities, net of the effects
of acquisitions (26,257) (19,901)
Other, net 1,059 592
------- -------
Net cash used for
operating activities (12,084) (3,268)
------- -------
Cash Flows from Investing Activities
Capital expenditures (13,474) (5,231)
Business acquisition - (1,515)
Outsourcing acquisition - (2,150)
------- -------
Net cash used for investing activities (13,474) (8,896)
------- -------
Cash Flows from Financing Activities
Bank credit facility (payments)/
borrowings, net (8,499) 13,943
Payments on bonds and leases (44) (34)
Cash dividends on common stock (3,865) (3,229)
Stock options exercised 852 1,798
Treasury stock acquired __ (72) (52)
------- --------
Net cash (used for)/provided by
financing activities (11,628) 12,426
------- --------
Effect of exchange rate changes on cash
and equivalents 165 89
------- --------
(Decrease)/Increase In Cash and Equivalents (37,021) 351
Cash and Equivalents at Beginning of Period 48,954 3,779
-------- --------
Cash and Equivalents at End of Period $ 11,933 $ 4,130
======== ========
See accompanying notes to consolidated condensed 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 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 traditionally 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 $86.6 million was allocated to the assets acquired
and liabilities assumed of $98.6 million and $12.0 million, respectively. The
assets acquired include $39.7 million of property, plant, and equipment, $17.8
million of identified intangibles, and $18.8 million of goodwill, all of which
is deductible for tax purposes. Identified intangibles and respective straight-
line weighted average amortization periods include $15.3 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 final cash price
will change upon completion of a working capital adjustment which is expected to
occur by the end of fiscal 2005.
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
NOTE C - Restructuring
Subsequent to January 29, 2005, the Company initiated some comprehensive
operational changes to enhance our results for both short term performance and
longer term operating efficiencies. The plan, which involves the closing of
certain plant operations, can be broken down into three categories: (1) the
elimination of two non-core operations, (2) the consolidation of capacity for
two operations, and (3) the transfer of three synergistic or new business to new
operations. These plans to dispose of seven of our existing facilities are
designed to eliminate approximately $9 million of annual pre-tax costs and
generate operational efficiencies for our remaining facilities to more
effectively serve our growing customer base. The cost of implementing these
actions over the second and third quarters of fiscal 2005 is estimated to total
as much as $5 to $6 million and includes asset write-downs, severance, moving
expenses, and lease buy-out costs. Approximately two-thirds of the costs will
be non-cash expenses.
NOTE D - 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 January 29, 2005 and October 30, 2004
are comprised of the following components:
2005 2004
-------- --------
Raw materials $ 97,077 $ 82,571
Finished goods 62,612 59,464
-------- --------
$ 159,689 $ 142,035
========= =========
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
NOTE E - Goodwill and Other Intangible Assets
Changes in the carrying amount of goodwill for the three months ended
January 29, 2005 are as follows:
Custom Color & Molded & Total
Sheet & Specialty Profile
Rollstock Compounds Products
---------- --------- --------- ---------
Balance, October 30, 2004 $ 212,850 $ 111,015 $ 38,092 $ 361,957
Reclassifications (1,367) 439 - (928)
--------- --------- -------- ---------
Balance, January 29, 2005 $ 211,483 $ 111,454 $ 38,092 $ 361,029
========= ========= ======== =========
Reclassifications represent adjustments to the preliminary allocation of
the cash price of the VPI acquisition to the assets acquired and liabilities
assumed. At January 29, 2005 other intangible assets, with definite lives, are
as follows:
Gross Carrying Amount Accumulated
Amortization
Jan. 29, Oct. 30, Jan. 29, Oct. 30,
2005 2004 2005 2004
---------- --------- --------- --------
Non-compete agreements $ 3,712 $ 3,960 $ 1,507 $ 1,242
Customer contracts 21,264 18,981 3,063 2,380
Product formulations 18,209 17,811 2,397 2,063
------- ------- ------- -------
$43,185 $40,752 $ 6,967 $ 5,685
======= ======= ======= =======
Amortization expense for our existing other intangible assets over the next
five years is estimated to be: $4,728, $4,554, $4,076, $3,201 and $2,926 for the
annual periods from January 30, 2005 to January 29, 2010. The Company has a
$8,900 trademark included in other intangible assets which has an indefinite
life.
Note F - 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
January 29, 2005 and January 31, 2004 is as follows:
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
QUARTER ENDED
--------------------------
2005 2004
--------- --------
Net Earnings $ 2,818 $ 7,706
Foreign currency translation
adjustments 1,207
(707)
Cash flow hedge adjustments _ 81 907
-------- --------
Total Comprehensive Income $ 4,106 $ 7,906
======== ========
Note G - Segment Information
The Company's 51 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 being included in the Color & Specialty Compounds segment. All
prior period segment results have been restated to be consistent with the
current period presentation. The following presents the Company's net sales and
operating earnings by segment:
QUARTER ENDED
January 29, January 31,
Net Sales * 2005 2004
--------------- ----------------
Custom Sheet & Rollstock $ 189,639 $ 155,329
Color & Specialty Compounds 97,103 71,304
Molded & Profile Products 17,770 14,830
--------- ----------
Total Net Sales $ 304,512 $ 241,463
--------- ----------
Operating Earnings
Custom Sheet & Rollstock $ 7,658 $ 14,457
Color & Specialty Compounds 5,699 6,246
Molded & Profile Products 617 1,230
Corporate/Other (3,691) (3,134)
---------- ----------
Total Operating Earnings $ 10,283 $ 18,799
========= ==========
* Excludes intersegment sales of $11,018 and $12,497 in the first
quarter of fiscal 2005 and 2004, respectively, primarily from
sales of the Color & Specialty Compounds segment.
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
Note H - 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
-------------
January 29, January 31,
2005 2004
------------ ------------
Net Earnings as $ 2,818 $ 7,706
Reported
Pro Forma Impact of 535 443
Expensing Stock Options
------- -------
Pro forma net earnings $ 2,283 $ 7,263
------- -------
Earnings per share:
As Reported
Basic $ .09 $ .26
Diluted $ .09 $ .26
Pro forma
Basic $ .07 $ .25
Diluted $ .07 $ .24
Assumptions Used:
Expected Dividend 2% 2%
Yield
Expected Volatility 35% 35%
Risk-Free Interest 3.6% 3.7%
Rates
Expected Lives 5.5 Years 5.5 Years
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
Note I - 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 fourth quarter of 2005. The approximate impact of the
adoption of this standard on our historical net income and earnings per share is
disclosed in Note H.
Note J - Commitments and Contingencies
The Company has guaranteed 5.6 million Euros associated with the local
government's financing of our 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
$221 accrued as of January 29, 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
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 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 attributable to our subsidiary and other parties.
As part of our Sarbanes-Oxley compliance efforts, we initiated a complete
physical count of the Company's fixed assets in the first quarter of fiscal
2005. We are in process of reconciling the physical counts to balances recorded
in our financial statements and it is possible that we will be required to
record a non-cash charge for specific items for which we cannot verify physical
existence. Due to uncertainties associated with completion of this
reconciliation process, we are unable to estimate the
SPARTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited and dollars in thousands, except per share amounts)
ultimate outcome of this issue at this time. We expect to substantially
complete our reconciliation process in the second quarter of fiscal 2005.
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
In addition to the 5.6 million Euro commitment recorded in the first
quarter of fiscal 2005 (see Note J), on February 16, 2005 the Company 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 matches Euro denominated
debt with the Euro denominated assets of our Donchery, France facility.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
Net sales for the first quarter of fiscal 2005 increased 26% over the first
quarter of fiscal 2004 driven primarily by moderate internal growth, selling
price increases and the impact of the VPI acquisition. Despite the sales
increase, net earnings decreased to $2.8 million in the first quarter from $7.7
million in the similar period of the prior year due to unprecedented increases
in raw material costs and certain conversion cost increases which resulted in a
significant decrease in margins. Due to the unacceptable first quarter results,
we have initiated operational changes involving the closing of certain plants.
The operational changes will include elimination of non-core operations,
consolidation of capacity in similar operations and transfer of synergistic or
new business to new operations. We estimate that implementation of these
actions will cost $5.0 to $6.0 million over the second and third quarters of
fiscal 2005 and going forward, will eliminate an estimated $9.0 million of
annual pre-tax expenses. The estimated costs will include asset write-downs,
severance, moving expenses, and lease buy-out expenses, and approximately two-
thirds of the costs will represent non-cash expenses.
Results of Operations
(in millions) NET SALES OPERATING EARNINGS
--------- ------------------
Three Months Ended
Net Sales January January January January
29, 31, 29, 31,
2005 2004 2005 2004
---------- ------- --------- --------
Custom Sheet & $ 189.6 $ 155.4 $ 7.7 $ 14.5
Rollstock
Color & Specialty 97.1 71.3 5.7 6.2
Compounds
Molded & Profile 17.8 14.8 .6 1.2
Products
Corporate/Other - - (3.7) (3.1)
------- ------- ------- -------
Total $ 304.5 $ 241.5 $ 10.3 $ 18.8
======= ======= ======= =======
Net sales for the quarter ended January 29, 2005 were $304.5 million, an
increase of $63.0 million, or 26%, over net sales for the quarter ended January
31, 2004. Of the 26% increase, approximately 10% was due to the VPI acquisition
which was effective on October 1, 2004. Internal volume of pounds sold
comprised 3% of the net sales growth and price/mix accounted for the remaining
13% of the increase. Strong demand in the Packaging and Transportation markets
drove the increase in net sales from internal volume growth for the quarter.
Most of the price/mix impact on the net sales increase was from the pass through
of raw material price increases to customers.
Cost of sales were $276.1 million, or 90.7% of net sales, in the first
quarter of fiscal 2005 versus $208.0 million, or 86.1% of net sales, in the
first quarter of fiscal 2004. Material margin (net sales less material costs)
as a percent of net sales decreased 5.1% primarily reflecting sharp increases in
raw material costs and the impact of passing on a majority of the increases to
customers as higher selling prices. Raw material prices for the Company's major
resins increased by over 40% from the first quarter of fiscal 2004 to the first
quarter of 2005. Material margin per pound sold dropped slightly by .2 cent per
pound in the first quarter of fiscal 2005 compared to the similar period of the
prior year. Excluding the impact of sales mix changes of lower-priced dunnage
and toll-compound material, material margin per pound sold decreased 1.3 cents
mostly due to our inability to pass through selling price increases to customers
as quickly as the raw material price increased, as well as the impact of other
mix changes.
Conversion costs as a percent of net sales improved .5% in the first
quarter of this year versus the corresponding period of the prior year due to
sales prices increases. However, on a per pound sold basis, conversion costs
increased 2.4 cents per pound primarily from rate increases in healthcare,
workers' compensation, freight and utilities, and a shift in product mix.
Conversion cost expenses increased $16.0 million in the first quarter of this
year compared to the similar period of the prior year. This increase more than
offset an $11.0 million increase in material margin dollars resulting in a $5.0
million reduction in gross profit. The gross profit comparison in the first
quarter of fiscal 2005 to the first quarter of 2004 was also adversely impacted
by start up costs at the Company's Donchery, France, and Tupelo, Mississippi
facilities associated with capacity increases and production ramp up of new
business.
Selling and administrative expenses were $16.9 million, or 5.5% of net
sales, in the first quarter of fiscal 2005 compared to $14.0 million, or 5.8% of
net sales, in the first quarter of 2004. The improvement as a percent of net
sales primarily resulted from the increase in sales from price increases to
customers. The increase in dollars resulted from the variable portion of costs
and the impact of higher sales. In addition, the dollar increase reflected non-
variable cost increases including the impact of the VPI acquisition, costs
associated with Sarbanes-Oxley compliance efforts, and increased information
technology investments, partially offset by the favorable impact of foreign
currency gains.
Operating earnings were $10.3 million, or 3.4% of net sales, in the first
quarter of fiscal 2005 compared to $18.8 million, or 7.8% of net sales, in the
first quarter of fiscal 2004. The decrease in operating earnings was due
primarily to lost margin from the inability to pass along price increases to
customers as quickly as the raw material prices increased, and the increases in
certain conversion costs and selling and administrative expenses as previously
discussed. In addition, the decrease in operating earnings reflects a $.7
million increase in intangible amortization primarily from the VPI acquisition
and purchase of certain assets of BASF's European Specialty Polystyrene Compound
product line effective on April 15, 2004. As a result, operating earnings per
pound sold totaled 3.0 cents in the first quarter of fiscal 2005 compared to 6.2
cents in the first quarter of fiscal 2004.
Interest expense of $6.5 million for the first quarter of fiscal 2005
increased slightly from $6.3 million in the first quarter of the prior year.
The slight increase in interest expense reflects additional borrowings primarily
from 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 decreased from 38.2% in the first quarter of 2004 to
26.0% in the first quarter of 2005. This decrease reflects a reduction in
deferred tax liabilities associated with 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 effective tax rate will
approximate 37% for the remainder of fiscal 2005 resulting in an approximate 36%
effective tax rate for the fiscal year.
Net earnings were $2.8 million, or $.09 per share diluted, in the first
quarter of fiscal 2005 and $7.7 million, or $.26 per share diluted, in the first
quarter of fiscal 2004. The decrease in net earnings and diluted earnings per
share resulted from the factors previously discussed.
Segment Results
Net sales of the Custom Sheet & Rollstock segment increased 22% to $189.6
million in the first quarter of fiscal 2005 from $155.4 million in the first
quarter of 2004. The net sales percent increase was attributable to the VPI
acquisition (7%) and impact of price/mix (16%), partially offset by a 1%
decrease in internal volume of pounds sold. The majority of the price/mix
impact reflects higher sales prices to customers from the pass through of raw
material price increases. The slight decrease in our internal volume of pounds
sold was primarily caused by a decrease in sales of lower-priced dunnage
material to this segment's largest customer, due to a decline in this customer's
sales volumes, and a decrease in sales volume to customers in the Building &
Construction and Pool & Spa markets. These volume decreases were partially
offset by strong demand in the Packaging and Sign & Advertising markets.
Operating margin for the segment decreased from 9.3% in the first quarter of
fiscal 2004 to 4.0% in the first quarter of fiscal 2005 due primarily to sharp
increases in raw material prices and the impact of passing on a portion of these
increases as higher selling prices, higher health care and workers' compensation
claims, higher freight and utility costs, and start up costs at our Donchery,
France facility.
Net sales of the Color & Specialty Compounds segment increased 36% to $97.1
million in the first quarter of fiscal 2005 from $71.3 million in the first
quarter of 2004. Of the 36% increase, approximately 20% was due to the VPI
acquisition, 9% was driven by price/mix and the remaining 7% was from internal
volume of pounds sold. Most of the price/mix impact was due to price increases
to customers from the pass through of raw material price increases. The
internal volume growth was primarily due to strong demand in the Lawn & Garden
and Transportation markets and reflects incremental business from the purchase
of BASF's European Specialty Polystyrene Compound product line. Operating
margin for the segment was 5.9% and 8.8% in the first quarter of 2005 and 2004,
respectively. The decrease in operating margin was due to increases in raw
material prices and the impact of passing on a portion of the increases as
higher selling prices, higher freight and utility costs, and start-up costs at
our Donchery, France facility.
The Molded & Profile Products segment sales were $17.8 million in the first
quarter of 2005 versus $14.8 million in the first quarter of 2004, representing
a 20% increase for the current quarter. The increase was primarily driven by
increases in sales volumes of wheels to new customers and sales to the Marine
market. In addition, this increase reflects higher selling prices, the impact
of which was more than offset by the change in product mix impact from selling
more wheels with a lower per pound selling price. Operating margin for this
segment decreased from 8.3% in the first quarter of fiscal 2004 to 3.5% in the
first quarter of fiscal 2005. The decrease in operating margin was due to the
impact of passing on a portion of higher raw material costs as higher selling
prices, the change in product mix and start up costs associated with the ramp up
of new production capacity at our Tupelo, Mississippi facility.
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. Our subsidiary has agreed to
participate along with thirty-nine 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 our $221 thousand accrual as of January 29, 2005. In the event of one or
more adverse determinations related to this issue, the impact on our 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 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 2004 and 2005 which
resulted in dramatic increases in the prices of our raw materials. In prior
years, we had been able to minimize the impact of price increases in raw
material costs by controlling inventory levels, increasing production
efficiencies, passing through price changes to customers, and negotiating
competitive prices with our suppliers. These pricing changes were more
difficult for us to manage and have negatively affected our operating margins in
2004 and 2005. 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 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:
Three Months Ended
------------------
(Dollars in millions) January 29, January 31,
2005 2004
---- ----
Net cash used for
operating activities $ (12.1) $ (3.3)
========== =========
Net cash used for
investing activities $ (13.5) $ ( 8.9)
========= =========
Net cash (used for) / provided by
financing activities $ (11.6) $ 12.4
========= =========
(Decrease) / increase in cash
and equivalents $ (37.0) $ .4
========= =========
Operating cash flows provided by net earnings was $2.8 million in the first
quarter of fiscal 2005 compared to $7.7 million in the first quarter of fiscal
2004. Changes in current assets and liabilities used $26.3 million of operating
cash flow in the first quarter of fiscal 2005 compared to $19.9 million in the
first quarter of fiscal 2004. In the first quarter of this year, the use of
operating cash flow was mostly caused by a $17.7 million increase in inventory
and a $4.1 million increase in other current assets. The increase in inventory
was mostly due to selective pre-buys of raw materials ahead of announced price
increases, normal transition to what is traditionally our highest sales level in
the second quarter of the fiscal year, and the impact of price increases in
inventory. The increase in other current assets was due to increases in rebate
receivables from vendors due to the timing of cash receipts on calendar rebate
programs and prepaid insurance due to the timing of premium payments.
Our 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
quarter of fiscal 2005 were $13.5 million compared to $5.2 million for the first
quarter 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 Molded & Profile
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 the level of expenditures in fiscal 2004.
Cash flows used for financing activities of $11.6 million and a decrease in
cash of $37.0 million in the first quarter of fiscal 2005 were used to fund the
increase in working capital and our capital expenditures for the period.
Financing Arrangements
At January 29, 2005, our total borrowings under our bank credit facilities
were $116.5 million at a weighted average interest rate of 3.6% and we had $77.7
million of total availability under the credit facilities.
On February 16, 2005, we 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 first quarter of
fiscal 2005 and currently expect to be in compliance during 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.
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 second quarter, we expect strong demand to
produce solid sales growth. Despite this, our raw material pricing environment
continues to be a challenge and is causing downward pressure on operating
margins. We will continue to manage this by taking advantage of inventory pre-
buys prior to announced price increases, negotiating prices with vendors,
passing through price increases to customers as timely as possible, and focusing
on our lean efforts. In addition, our operational changes involving the closing
of certain plants in the remainder of fiscal 2005 will help control conversion
costs.
As part of our Sarbanes-Oxley compliance efforts, we initiated a complete
physical count of the Company's fixed assets in the first quarter of fiscal
2005. We are in process of reconciling the physical counts to balances recorded
in our financial statements and it is possible that we will be required to
record a non-cash charge for specific items for which we cannot verify physical
existence. Due to uncertainties associated with completion of this
reconciliation process, we are unable to estimate the ultimate outcome of this
issue at this time. The ultimate non-cash charge related to this issue could be
material to our results of operations for a specific period. However, this
matter will not have a material impact on our financial or competitive position.
We expect to substantially complete our reconciliation process in the second
quarter of fiscal 2005.
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
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, 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
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 2004 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.
(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;
and
(4) Our implementation of planned restructurings will impact our ability to
realize estimated cost savings. The actual cost savings may differ from our
estimates depending upon the level of success of the implementation.
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 was no material change in the Company's exposure to market risks
since October 30, 2004.
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 January 29, 2005, 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 January 29, 2005, that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II - OTHER INFORMATION
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Repurchases of equity securities during the first quarter of 2005 are listed in
the following table:
Period Total Average Total Number Maximum
Number of Price Paid of Shares Number of
Shares per Share Purchased as Shares That
Purchased Part of May Yet Be
Publicly Purchased
Announced Under the
Plans or Plans or
Programs Programs
----------- ------------ ------------ ------------
10/31/04-11/27/04 - n/a - 1,000,000
11/28/04-1/1/05 - n/a - 1,000,000
1/2/05-1/29/05 3,000 $23.87 3,000 997,000
----------- ------------ ------------ ------------
Total 3,000 $23.87 3,000 997,000
----------- ------------ ------------ ------------
The Company's Board of Directors authorized the repurchase of up to 1 million
shares under the October 2004 program. The maximum number of shares that may
yet be purchased under this program is 997,000.
Item 6. EXHIBITS
3.1(a) Restated Certificate of Incorporation
3.2(b) Amended and Restated By-Laws, as amended
4(c) Rights Agreement dated April 2, 2001 between Spartech Corporation and
Mellon Investor Services LLC, as Rights Agent
10.1(d) Amended and Restated Employment Agreement dated November 1, 2002,
between Bradley B. Buechler and Spartech Corporation
10.2(e) Transition Agreement and Consulting Agreement dated August 3, 2000,
between David B. Mueller and Spartech Corporation
10.3(f) Employment Agreement dated January 1, 2003 between Randy C. Martin and
Spartech Corporation
10.4(g) Employment Agreement dated January 1, 2003 between David G. Pocost and
Spartech Corporation
10.5(h) Employment Agreement dated December 10, 2003 between George A. Abd and
Spartech Corporation
10.6(i) Employment Agreement dated January 1, 2003 between Phillip Karig and
Spartech Corporation
10.7(j) Employment Agreement dated July 1, 2004 between William F. Phillips
and Spartech Corporation
10.8(k) Employment Agreement dated December 1, 2003 between Jeffrey D. Fisher
and Spartech Corporation
10.9(l) Employment Agreement dated May 1, 2004 between Steven J. Ploeger and
Spartech Corporation
10.10(m) Form of Indemnification Agreement entered into between Spartech
Corporation and each of its officers and directors
10.11(n) Spartech Corporation 2004 Equity Compensation Plan dated December 11,
2003
10.12(o) Form of Incentive
Stock Option
10.13(p) Form of
Nonqualified Stock Option
10.14(q) Form of Restricted
Stock Unit Award
10.15(r) Spartech
Corporation Deferred Compensation Plan, as amended
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.
Notes to Exhibits
(a) Filed as Exhibit 3.1 to
the Company's Form S-8 (File No. 333-60381), filed with the Commission
on July 31, 1998 and incorporated herein by reference.
(b) Filed as Exhibit 3.2 to
the Company's Form 10-K filed with the Commission on January 13, 2005 and
incorporated herein by reference.
(c) Filed as Exhibit 99.1 to
the Company's Form 8-K filed with the Commission on April 5, 2001 and
incorporated herein by reference.
(d) Filed as Exhibit 10.1 to
the Company's Form 10-K filed with the Commission on January 17, 2003 and
incorporated herein by reference.
(e) Filed as Exhibit 10.4 to
the Company's Form 10-K filed with the Commission on January 19, 2001 and
incorporated herein by reference.
(f) Filed as Exhibit 10.3 to
the Company's Form 10-K filed with the Commission on January 17, 2003 and
incorporated herein by reference.
(g) Filed as Exhibit 10.4 to
the Company's Form 10-K filed with the Commission on January 17, 2003 and
incorporated herein by reference.
(h) Filed as Exhibit 10.6 to
the Company's Form 10-K filed with the Commission on January 16, 2004 and
incorporated herein by reference.
(i) Filed as Exhibit 10.7 to
the Company's Form 10-K filed with the Commission on January 16, 2004 and
incorporated herein by reference.
(j) Filed as Exhibit 10.7 to
the Company's Form 10-K filed with the Commission on January 13, 2005 and
incorporated herein by reference.
(k) Filed as Exhibit 10.11 to
the Company's Form 10-K filed with the Commission on January 16, 2004 and
incorporated herein by reference.
(l) Filed as Exhibit 10.9 to
the Company's Form 10-K filed with the Commission on January 13, 2005 and
incorporated herein by reference.
(m) Filed as Exhibit 10.10 to
the Company's Form 10-K filed with the Commission on January 17, 2003 and
incorporated herein by reference.
(n) Filed as Exhibit 4.1 to
the Company's Form S-8 (File No. 333-113752) filed with the Commission
on March 19, 2004 and incorporated herein by reference.
(o) Filed as Exhibit 1.01(2)
to the Company's Form 8-K dated December 8, 2004 and incorporated herein
by reference.
(p) Filed as Exhibit 1.01(3)
to the Company's Form 8-K dated December 8, 2004 and incorporated herein
by reference.
(q) Filed as Exhibit 1.01(4)
to the Company's Form 8-K dated December 8, 2004 and incorporated herein
by reference.
(r) Filed as Exhibit 10.15 to
the Company's Form 10-K filed with the Commission on January 13, 2005 and
incorporated herein by reference
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: March 11, 2005 /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)