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Carlisle Companies Inc (NYSE:CSL)

Q3 2008 Earnings Call

October 21, 2008 9:00 am ET

Executives

David Roberts - Chairman, President and CEO

Steve Ford - CFO

Analysts

Mark Zeff - Goldman Sachs & Co

Peter Lisnic - Robert Baird & Co

Saul Ludwig - KeyBanc Capital Markets

Wendy Caplan - Wachovia Securities

Operator

At this time, I would like to welcome everyone to the Carlisle Companies Incorporated third quarter earnings conference call. (Operator Instructions).

Thank you. At this time, I’d like to turn the call over to the Chairman, President and CEO of Carlisle Companies, Mr. David Roberts. Sir, you may begin.

David Roberts

Thank you. Welcome to our third quarter 2008 earnings call. With me this morning is Carol Lowe, our new President of Trail King, obviously a previous CFO. Kevin [Zimo] who is our Treasurer and then Steve Ford, who was our General Counsel who has now become our CFO.

Before I turn the call over to Steve for a detailed explanation of the third quarter, what I’d like to do is, make a few comments on the Carlisle operating system, the performance of our acquisitions and then the raw material cost increases that we’re continuing to face.

We continue to make nice progress implementing the Carlisle operating system this quarter. It’s probably difficult for you to see the progress, but we took significant strides that really have put us on the path to our ultimate goal of 15% operating margins and the cash conversion rate in excess of 120%.

The visible steps are obviously the announced closing of the five manufacturing plants and the four distribution centers that were detailed in the press release. And we’ll talk a bit about that in more detail during the conference call.

You also know that we bought Dinex and Carlyle earlier this year and frankly we are very pleased with the performance of these acquisitions. Both businesses are contributing to our sales, adding 7% to our top line growth and both are positive on the operating earnings line. We’ll continue to integrate these acquisitions and expect them to make a significant contribution in the future.

On the negative side in the quarter, raw material costs were a nemesis again in this quarter. While we’re starting to see material costs relief in many of our businesses, we still have capitalized material variances that will have to be expensed over the next two quarters. These will continue to put short-term pressure on our margins. Steve will go to it in more detail, so with that I’ll just turn the call over to Steve.

Steve Ford

Thanks, Dave and good morning. Carlisle reported a year-over-year increase in sales of 14% for the third quarter 2008, with organic sales and acquisitions each contributing 7%. Of the total, $102 million increase in sales for the quarter, volumes represented 3%, price represented 42%, and acquisitions represented 53%.

Operating income decreased 8% for the third quarter 2008 compared with 2007. A 15% reduction in income from our core operation was offset by 7% of additional operating income from the Dinex and Carlyle acquisitions. The combination of unrecovered raw material cost increases and a decline in unit volume within the transportation products and Applied Technologies segments caused a reduction in our operating margins from 12.2% for the third quarter ‘07 to 9.8% for the third quarter 2008.

For the quarter, costs increased for almost all of our raw materials and due to market softness and competitive challenges, we were not able to pass along all of these increases. Although raw material costs appear to be stabilizing, our margins will continue to be under pressure over the next two quarters as we sell inventories that include these higher raw material costs. For the quarter, we reported net income from continuing operations of $50.6 million or $0.83 per diluted share. Income from continuing operations for the third quarter 2007 was $84.3 million and included an after tax gain of $29.4 million from the sale of our interest in Icopal.

Our Construction Material segments increased sales organically by 7% of which 4% was price and 3% volume. The decline in operating margin, 13.6% for the third quarter 2008 compared with 15.3% for the third quarter 2007 was attributable to the increase in raw material costs as price increases only covered approximately 75% of the raw material increases.

The Transportation Products segment reported a 6% increase in sales for the quarter from increased selling prices. Operating income of $8.7 million for the third quarter of 2008, compared with operating income of $15.5 million for the same period of 2007. The decrease was primarily attributable to un-recovered raw material costs, lower unit volumes, a $1.7 million inventory write-down, and $2.2 million of increased SG&A expense.

Our tire and wheel operation experienced third quarter year-over-year increases of 45% for natural rubber, 86% for synthetic rubber, 75% for steel, and 30% for carbon black. Applied Technologies reported a 70% increase in sales for the quarter, with the Dinex and Carlyle acquisitions accounting for all the growth.

We declined in operating margin from 13.9% for Q3 ‘07 to 9.7% for the current quarter, was primarily attributable to lower unit volumes resulting from the delay in the Boeing 787 program, and a slowdown in in-flight entertainment retrofits, as well as an increase in SG&A expense related to the Dinex healthcare operation. We are actively taking steps to reduce facility costs and SG&A expense.

Specialty Products had a solid quarter, with sales increasing 12%, and earnings increasing 11% over third quarter 2007. In response to current market challenges and to increase operating margins, we are streamlining our operations as follows: Within transportation products, we are consolidating our California wheel manufacturing operations into a single location. We are also consolidating three distribution centers in the Southeast into our new distribution center in McDonough, Georgia, and consolidating two of our distribution centers in Texas into a single facility.

In Applied Technologies, our foodservice business is consolidating its janitorial sanitation manufacturing facilities into a single facility. And in Construction Materials, we are closing two of the insulation facilities acquired as part of the Insulfoam acquisition. In total we’re closing nine facilities. The aggregate cost pre-tax is estimated at $14.5 million, with approximately 12.5 million to be incurred in the fourth quarter, and the remaining $2 million in the first quarter of 2009.

For the nine months ended September 30, 2008, our operations provided $142.1 million of cash, resulting in a cash conversion rate of approximately 105%, compared with cash of $134.6 million for the same period 2007.

Our balance sheet remains strong; our debt-to-capital was 34% at September 30. Our full year capital expenditures are forecasted $75 million; depreciation and amortization is forecasted at about $70 million; our interest expense for the full year is estimated at $22 million, and our projected tax rate for the full year is 33%.

And with those remarks, I’ll turn the call back over to Dave.

David Roberts

Okay, we would like to go ahead and open the floor for questions if we would, please.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Deane Dray.

Mark Zeff - Goldman Sachs & Co

Good morning. This is Mark Zeff calling on behalf of Deane. Dave, I was wondering if you could put the restructuring moves in context. How much of the $14.5 million here is just within the normal course of business of the Carlisle operating system, and how much is specifically related to changes in your end markets in reacting to market conditions?

David Roberts

If you look at that, the COS, probably of the $12 -- the $14.5 million, about $10 million of it is through the COS, and the other $4 million is basically the closure of the Insulfoam plant just because of the residential construction.

Mark Zeff - Goldman Sachs & Co

Okay. And then have you identified the cost savings expected to be realized in 2009, and then what the full year annualized run rate going forward would be on a cost-savings basis?

David Roberts

Yeah, we think that probably in ‘09, there’s going to be in an area of about a $9 million cost savings, and then you’ll annualize that as you get into the following year. Most of these have, with the exception of the Insulfoam operations, have about a year payback on the closing cost. So, as you get into -- in the future years, that’s going to be in the $10 million range for the consolidation of the wheel plants. Insulfoam has a little bit longer payback. I think it was almost 2.5 years payback on the closure of the Insulfoam operations. So that payback will take place over the next basically 2.5 years.

Mark Zeff - Goldman Sachs & Co

Okay, that’s helpful. And then just quickly, if you could comment on the specifics you are seeing in the price/cost dynamic in construction. If you roll the clock back a few months, oil was at $140 and there were a slew of price increases announced for the fall. Have those price increases stuck at the competitive response? And then going forward, are you looking at having to roll back some of those price increases with the raw material costs coming down as sharply as they have?

David Roberts

Yes. Actually, the earlier price increases, with certain percentages we got most of those. It’s the ones that we announced for October 1st, we are continuing to go with those, but frankly it’s becoming more difficult to get them. Competitive pressure has really caused us to be a high-cost player in the market with our new price increases. We plan to hold where we can. We’ll be competitive where we can, but my estimate going forward is that the October price increases which were 5% are going to be very difficult to get. And December I think will be difficult as well particularly with the [upticks] of materials coming down or raw materials declining.

Now we haven’t seen that yet in our cost line and the problem is that people are looking at what’s happening with oil prices. We’re starting to see some indication that those material costs will start to come down, but we really haven’t seen it yet flowing into the product that we’re buying.

Mark Zeff - Goldman Sachs & Co

Great, thank you very much.

David Roberts

You are welcome.

Operator

Your next question comes from the line of Peter Lisnic.

Peter Lisnic - Robert Baird & Co

Good morning, everyone.

David Roberts

Hi. Good morning, Pete.

Peter Lisnic - Robert Baird & Co

Dave, can you give us a sense as to the fourth quarter roofing forecast where you are not looking for any growth. Can you maybe call that out a little bit between re-roofing and new, and specifically what might be happening to the new construction market in relation to what is going on with credit markets?

David Roberts

Yes, Pete. I just don’t have a good feel for exactly what’s re-roofing and what’s new. I think fourth quarter is still going to be evenly split between re-roofs and new construction, 50/50. I think that the challenge is going to be next year.

We haven’t seen anything yet in the order rate to suggest that there’s a dramatic slowdown at this point, but we’re certainly anticipating it and in conversations with many of our distributors and roofers last week, it looks as though they are less optimistic about 2009 than they were prior, but I think in the fourth quarter we’re probably still 50/50.

Peter Lisnic - Robert Baird & Co

Okay and most of the forecasting services at least for their most recent forecast were talking about mid digit to high-single digit or maybe double digit declines in sort of the new construction market. Is that the right way to think about what you’re hearing on the ground from your people for ‘09 or?

David Roberts

Yes, Pete I think those numbers are probably pretty good. In the new construction market, anywhere from high-single digits to very, very low-double digits perhaps.

Peter Lisnic - Robert Baird & Co

Okay and your expectation is that you could probably outperform that given some of your internal initiatives as you always talk about.

David Roberts

Right. If you look at what’s happening in the business, we are still making inroads into asphaltic roofs with TPO and that replacement market continues to be okay.

Peter Lisnic - Robert Baird & Co

And that was actually my next question, can you maybe talk about the relative price differential between membrane and asphalt at this point with oil coming down?

David Roberts

Yeah, still, with oil at $90 to $100 a barrel, it was still to the advantage of the person putting a roof on. They use TPO, where they are getting below $90, it becomes a more competitive product, price wise with asphaltic and I think that as we go forward, I think people will still accelerate the placement at TPO, but I think it becomes less cost competitive as oil remains below about $90 a barrel.

Peter Lisnic - Robert Baird & Co

Okay, great. That is all I have. Thank you.

David Roberts

Okay.

Operator

(Operator Instructions).Your next question comes from the line of Saul Ludwig.

Saul Ludwig - KeyBanc Capital Markets

Well, good morning guys and good morning to the lady.

David Roberts

Good morning.

Saul Ludwig - KeyBanc Capital Markets

Carol, we miss you.

Carol Lowe

Hi, thank you, Saul.

Saul Ludwig - KeyBanc Capital Markets

You got 4% price increase in the fourth quarter. That’s year-over-year in construction materials and that kind of seems a little light given all the prices that you had moved up during the year. Just comment on the 4% price increase year-over-year and why it was seemed to be so modest.

David Roberts

Yeah, I think what’s happening, Saul is that the competitors aren’t playing as well as we would have hoped they would have and we are seeing some price, not to say a price rollback, but no price increase is being put through by the competition. They announced price increase, but they don’t implement it in the field and that has caused us some problems trying to get price.

Saul Ludwig - KeyBanc Capital Markets

And now when we look at the fourth quarter, if you have 4% increase and there’s even some carryover, would you expect in the fourth quarter, your price to be a little higher than 4% year-over-year?

David Roberts

Well, I just don’t know what’s happening in the market in the fourth quarter. Logic would say yes, that should be the case. But frankly, it’s become competitive out there again price wise and frankly we’re anticipating 4%.

Saul Ludwig - KeyBanc Capital Markets

Okay. So, when you make the statement that you do not expect any organic sales growth in Construction Material in the fourth quarter that backs into your expecting a 4% volume decline. And how do you reconcile the expectation of a 4% decline, when you earlier said that you’re not seeing any back-off in demand?

David Roberts

Well, primarily because we’re anticipating what we think is going to happen. The orders that we’ve got don’t indicate that there’s a major slowing, but conversations as I said earlier with the people out there who are selling the product and putting the product on, frankly, they’re very concerned about the fourth quarter. So I think we’re being conservative more than anything.

Saul Ludwig - KeyBanc Capital Markets

So you are going to expect a 4% decrease, and then you would expect volume I would assume to be a negative comp next year offset with some pricing?

David Roberts

Yes.

Saul Ludwig - KeyBanc Capital Markets

Okay. And what does this imply in terms of operating rates and fixed cost absorption. Maybe this question about fixed cost absorption, not just related to roofing, but as you think about the entire company, do you think that’s going to be an added headwind in ‘09 versus ‘08, and if so, what magnitude might that be?

David Roberts

Yes. Saul, I think if you look at the individual businesses, certainly we’ve seen that entire in wheels so far. We’ve had the headwind of lower volume through our factories, which has had an impact on our margin rate. I don’t think that’s going to change much next year. I think as we go through and close the wheel factories, we have some other things that we’re looking at. I think that will perhaps be equal to what it is this year, and that’s on the volume side. We still have raw material that we have to flow through Tire and Wheel that will have an impact on the fourth and the first quarter of next year.

The Construction Materials business, there’s no question there will be headwinds on the overheads side. We’ll do everything we can to reduce that overhead. We’re taking two of the Insulfoam plants out, which will have some impact on it. But there will be some headwind next year.

I think in the other businesses, we’re probably okay. I think the only one would be the core food service business that we should have some minor headwinds trying to absorb the overhead. I think in the rest of the businesses we’re okay though.

Saul Ludwig - KeyBanc Capital Markets

This comment that you’re on FIFO accounting, so you’ve got in inventory, your highest cost products because they were put there when these raw material costs surged. How much do you think earnings are going to be impacted by having to expense high cost inventory versus current cost inventory, because your pricing is probably going to be more influenced by current cost in the competitive sense? So what do you think the hit might be; do you have $10 million, $20 million, $30 million? I know you can’t be precise, but what arena would you put it in?

David Roberts

It’s significant. I think we’ll probably see $10 million in the fourth quarter, and perhaps a slight amount less than that in the first quarter of next year in Tire and Wheel. I think the rest of the businesses were not too bad a shape, primarily because our inventory returns are higher. And if you look at the Construction Materials, there might be a little bit of lag in Construction Materials in the fourth quarter, but not dramatic. The vast majority of it will be in Tire and Wheel.

Saul Ludwig - KeyBanc Capital Markets

It kind of sounds like we should be thinking about a pretty ugly-looking fourth quarter for you guys, and probably a less ugly, but ugly first quarter before some of these inventory issues, special charge issues maybe start to work their way through?

David Roberts

I think that’s fair, Saul. If you look at the headwind we’ve got in the fourth quarter, we’ve got this FIFO inventory issue that you talked about, and we’ve got the charges. We’re taking $12.5 million charges in the fourth quarter and another $2.5 million in the first quarter of next year. So, yes, the fourth quarter of this year and the first quarter of next year, I use your term, could be ugly.

Saul Ludwig - KeyBanc Capital Markets

Okay, let’s hope it gets prettier as the year moves on.

David Roberts

It will.

Saul Ludwig - KeyBanc Capital Markets

Thank you.

David Roberts

Okay.

Operator

(Operator Instructions). Your next question comes from the line of Wendy Caplan.

Wendy Caplan - Wachovia Securities

Hi, good morning.

David Roberts

Good morning, Wendy.

Wendy Caplan - Wachovia Securities

Well, this whole ugly question; what makes us think that the ugliness stops in Q1? Aside from some of the actions that you are taking, does your visibility in terms of the softness of your market suggest that things turn around, or are these all the prettiness that we might anticipate coming from internal measures exclusively?

David Roberts

Yeah, I think that what we’ll see next year and what we’re looking at next year is a softening obviously economy. We think that that will have some issue for us. But we also have raw materials that are going to stabilize; in fact we’re starting to see it now that raw material costs are stabilizing. We anticipate those being reduced over the next couple of quarters. We’ve got the lag that we talked about earlier that will have an impact on the first and quarter of next year and the fourth quarter of this year.

There are other cost reductions that are being put in place. As we start to consolidate these factories, there are cost reductions that we will get from that. Two of the plants are being closed basically this week. Those are the Insulfoam plants. There will be cost reductions because of that which will immediately have a positive impact on the bottom line.

There are other things that are occurring that will certainly make the second, third and fourth quarter, barring any major catastrophe in the economy be a heck of a lot better than what the fourth and first quarters are going to be.

Wendy Caplan - Wachovia Securities

Okay and most of the increases that we saw in terms of core growth in the quarter seemed to be pricing related. Given the kind of the comments that you made about specifically in construction for example, are we expecting competitive pressures in the marketplace? Is it too aggressive to assume 4 percentage points of price in the current year, current quarter rather?

David Roberts

I don’t think so, Wendy. I think that’s probably a pretty good number. We’ve put some price increases through that are certainly in excess of that and I think the competitive pressures are causing us to forecast just a 4% price increase. I think that’s probably a pretty good number.

Wendy Caplan - Wachovia Securities

Okay and can you quantify the Boeing strike and the delays. And what we should be thinking about that?

David Roberts

Yes, it’s definitely had an impact on the business at our old Tensolite, our Interconnect Technologies business, we have held on to our people there. Really anticipating that we thought it would be over after 30 days, 60 days at the most, we’re holding folks. We think we’ll have an additional increase in that as soon as it’s over. Hold, Steve has got a?

Steve Ford

About $2 million. The sales impact is about $2 million a month.

Wendy Caplan - Wachovia Securities

Okay and that’s just the strike, not the delays?

David Roberts

Correct.

Steve Ford

Correct.

Wendy Caplan - Wachovia Securities

Okay and is there a way to quantify both?

David Roberts

Well, I think that the strike.

Wendy Caplan - Wachovia Securities

Or does it?

David Roberts

My takedown on the strike is what they are doing is allowing other vendors to catch up and I think as soon as the strike’s over, many of the vendors have been told to continue to ship to try to get to a point where they can start building airplanes. And I think it will be minimal.

Wendy Caplan - Wachovia Securities

Okay and finally before I hang up, I just wanted to, on a personal note say thank you to Carol for many solid years of performance and certainly being a good go-to person for us on the street, and to welcome Steve and let him know that we look forward to working with him as well. Thanks.

Steve Ford

Thanks, Wendy.

Carol Lowe

Yes. Thank you, Wendy.

David Roberts

She’s not going too far, though, Wendy.

Wendy Caplan - Wachovia Securities

That’s pretty far, Dave.

David Roberts

Yes. That’s true.

Operator

There are no further questions in queue at this time. Mr. Roberts, do you have any further remarks?

David Roberts

Yes. Just in closing, as I said earlier, our incoming order rates are slightly below what they have been for the last six months. Looking at each business, it really appears as though we’re reaching the bottom of the trough in Tire & Wheel.

On the aggregated sales basis, we still have the cost headwinds from the inventory or material cost increases in inventory, that we’ll be seeing flowing through in the fourth quarter and the first quarter.

Trail King, we’re starting to see some of the orders there being either put on hold or delayed. I don’t think it will have a dramatic impact on that business, but we’re starting to see some of those orders being delayed. I think people are just anticipating what the financing position’s going to be and so on.

Food Service, I think the current level of business for the core Food Service is going to be down slightly less than what it was in 2007, but that’s going to be offset by our jan/san products, and also the nice increases we’re seeing in Healthcare. We just talked about the strike at Interconnect Technologies. We certainly anticipate orders increasing to the pre-strike levels as soon as the strike is over. And then Specialty Products actually is still having a very good year, and it actually looks like that year will carry over into 2009. Industrial brake and friction has nice growth, and we’ve got a real nice back order now at Johnson Truck Bodies. So we’re optimistic about that business.

I think the wildcard here is Construction Materials. As I said earlier, the orders don’t look too bad today, but conversation with our distributors and roofers over the last few weeks, I think they are less positive about 2009 than they were just the end of the third quarter or the second quarter, so we’re anticipating a slowdown in that area.

So, in a nutshell, I think we will see a decline in revenue or in growth next year over what we’ve seen over the last couple of years. As we go through that, we’re focused on obviously expense reduction and cash flow. We’re doing everything we can to reduce our inventory levels, improve our returns and reduce our operating cost.

We’ve implemented a number of cost reduction programs in ‘08 that will start to pay dividends in ‘09, and we’ve got others that we’re going through for ‘09 as well. We’re starting to see some relief in raw materials cost. We think that we should be able to maintain our margins at the current level with some potential for upside toward the end of ‘09. Obviously, this is barring any major slowdown in the economy as we look forward.

So with that I would like to thank you all for attending the call and look forward to talk to you again for the year-end call in January. Goodbye.

Operator

Ladies and gentlemen, this concludes today’s third quarter earnings conference call. You may now disconnect.

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