Material Sciences F3Q08 (Qtr End 11/30/07) Earnings Call Transcript

Material Sciences Corp. (MSC)

F3Q08 Earnings Call

January 9, 2008, 10:00 am ET

Executives

Cliff Nastas – Chief Executive Officer

Jim Froisland – Senior Vice President, Chief Financial Officer

Analysts

Steve Schwartz - First Analysis Securities Corporation

Tom Spire – Spire Capital Management

Presentation

Operator

Greetings and welcome to the Material Sciences Corporation third quarter 2008 earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Cliff Nastas, Chief Executive Officer of Material Sciences Corporation. Thank you, Mr. Nastas, you may now begin.

Cliff Nastas

Thank you, Jackie. I would like to thank everyone for joining us today. Also on the call with me are Jim Froisland, Senior Vice President and Chief Financial Officer; and Bob Rogowski, Corporate Controller.

Jim will review our results for the third quarter ended November 30, 2007 and then I will discuss the quarter and provide an update on our strategy. After that, we would be happy to take your questions.

Now let me turn the call over to Jim.

Jim Froisland

Thanks, Cliff.

The results that I will be reviewing were presented in a press release issued earlier today and are discussed in more detail on our Form 10-Q, both of which are available on our website www.MatSci.com.

Before I begin, I must remind everyone that this conference call may contain certain forward-looking statements that are subject to Safe Harbor language contained in the news release and that the information and statements made during the call are made as of this date and that MSC undertakes no obligation to publicly update forward-looking statements. Let’s now review the quarter’s results.

Net sales increased 7.3% to $65.1 million in the third quarter of fiscal 2008. This is up from $60.7 million in the third quarter of fiscal 2007. Sales of acoustical applications, which are mainly to automotive manufacturers, increased 7.2% in the third quarter to $32 million, up from $29.9 million in last year’s quarter.

Sales of body panels grew 10.3% to $19.2 million in the quarter, up from $17.4 million in the prior period primarily due to new QuietSteel applications.

Brake sales continue to be impacted by the weakness in the domestic auto industry and a reduction in the quantity of inventory carried by our customers. Brake sales declined 20% in the third quarter of fiscal 2008 to $6.8 million from $8.5 million in the third quarter of last year. Continued strength in Europe brake sales partially offset this decline, growing nearly 60% in the third quarter.

Sales of coated materials, which are primarily in the automotive and building industries, increased 7.4% to $33.1 million in the third quarter of fiscal 2008 up from $30.8 million in the third quarter of fiscal 2007.

Gas tank sales increased 28.4% to $11.3 million up from $8.8 million in last year's quarter, due to a new program with an existing customer and a significant one-time sale to fill a shortage for a customer.

Sign sales increased 2.9% to $7.2 million in the third quarter, up from $7 million in the prior year due to additional customer programs.

Finally, sales of building products in the third quarter increased 6.6% to $8.1 million up from $7.6 million as the quarter benefited from a customer opening new service centers and the filling of their pipeline thereof.

Gross profit for the third quarter increased $1.5 million to $9 million, or 13.9% of net sales compared to $7.5 million or 12.3% of net sales for the prior year period. This was primarily due to an increase in sales volume.

Other factors that contributed to the improvement include a $0.7 million increase in scrap sales and $0.2 million in fees from an operating agreement with Hae Won in South Korea.

SG&A expenses for the quarter were $8.4 million, 12.8% of net sales compared to $8.5 million or 14.1% of net sales in the last year’s quarter. The decline in this quarter was the result of lower professional fees of $0.4 million which were partially offset by higher compensation costs of $0.3 million.

The company’s effective tax rate was a provision of 28.4% in the third quarter of fiscal 2008 compared to a benefit of 79.8% in fiscal 2007. The decline in the effective tax rate versus last year is primarily due to research and development tax grants.

The company reported net income of $0.7 million or $0.05 per diluted common share compared to a loss of $0.2 million or $0.01 per diluted common share in the third quarter of fiscal 2007.

The company has no long-term debt as of November 30 and a cash balance of $3.9 million along with short-term investments of $6 million. Starting in our third quarter of fiscal 2008, the company made short-term investments in triple-A rated option rate preferred securities that are designed to provide better returns and serve as liquid assets that can be easily converted to cash. All income generated from these short-term investments is classified as dividend income and included in the $0.1 million interest income for the quarter.

Also during the quarter the company purchased approximately 98,000 shares for a total of 0.9 million. Of the 1 million share repurchase authorized in February 2006 420,000 shares remain to be purchased. On January 7, the company’s board of directors approved an additional share repurchase program of up to 1 million shares of the company’s common stock. No shares have been purchased on this program as of today.

Receivables decreased 21.8% to $10.5 million during the third quarter to $37.6 million with 48 days sales outstanding for the quarter compared to52 days for the second quarter fiscal 2008.

Overall working capital was $56.7 million or 87% of net sales versus a $51.9 million and 93% of net sales for the second quarter of 2008.

Net cash provided by operations for the third quarter was $3.4 million. The company spent $1.5 million on capital improvement projects which was down $0.1 million or 6% from the preceding quarter.

That completes my financial review, and now I’ll turn the call back to Cliff.

Cliff Nastas

Thanks, Jim. Wewere pleased to see that sales into the North America auto industry this quarter exceed those from the same period last year, while the production of vehicles containing QuietSteel declined. We also bucked the trend versus housing starts in the Midwest and Northeast. While new construction was down, we managed to improve sales of coil-coated products into the appliance, building construction and furniture market. Our growth is directly attributed to winning new business at both new and existing customers over the past year.

During the third quarter, we continued to make progress with the Japanese trans plant and received OEM approval for four new QuietSteel applications that will begin production over the next six months. Also, we are making good progress with numerous coated metal customers in the appliance, HVAC and construction markets. Additional details surrounding both fronts will be provided during our year-end call.

We are delighted that the QuietSteel brand continues to strengthen. Our customers use QuietSteel as both an advertising and point-of-sale marketing tool. This month QuietSteel will be featured in displays at the North America Automotive Show in Detroit for the Chevy Cobalt and the Ford F-Series pickup truck. Ford is also featuring QuietSteel in the F-series viewer displays around the country and Nissan highlights the use of QuietSteel in Maxima advertising brochures and on their website.

This quarter I’d again like to structure the discussion of MSC strategy in the context of 360 degrees of value creation strategy. As I explained in the past, this strategy is built upon four pillars: technical leadership, product and customer base diversification, operational excellence and globalization, which are designed to create value for our shareholders, customers, employees and suppliers.

Technical leadership, the first pillar, reflects our commitment to providing unmatched product development and NVH problem-solving expertise. It is at the center of everything we do, whether we’re solving a complex noise and vibration problem or developing an innovative product to meet a specific customer need, we strive to be the best in the industry.

The opening of the application research center in Michigan last year and the expansion of our European application development in Germany has helped solidify our position as a technical leader. We’ve resourced both facilities with the best people and equipment available, which enabled MSC to demonstrate the value of QuietSteel, DecoSteel and our innovative coated-metal solutions. In Asia, we just hired our first MVH technical manager and are in the process of evaluating the best way to support the needs and requirements of customers within this region.

The second pillar, product and customer-based diversification, captures MSC’s focus on diversifying our product portfolio and customer base to reduce our dependence on the domestic automotive industry. We continue to make significant headway in this area. I’m pleased to announce that our new rubber coated grey-shim product is now commercial and significant customer interest exists.

Over the holiday shutdown, we modified our manufacturing facility in Elk Grove Village to enable cost competitive production of rubber-coated products and we’ll also scale up these products in Malaysia for distribution throughout Asia. Having access to this rubber coated technology enables MSC to compete more effectively in the global market.

During our last call, I introduced two new innovative products: Electro-Brite and DecoSteel. Both provide low cost alternatives to stainless steel and can be engineered into high-value applications by integrating noise and vibration dampening technology into the products. We continue to make progress in qualifying these products at several customers and we are extremely optimistic about their future. Additional announcements will be made when appropriate.

Moving on to the third pillar, operational excellence. We remain committed to improving the efficiency of our operations and the quality of our products. Our investment in both human and capital resources reflects this fact. Over the holiday shutdown, we made capital improvements at both Walbridge and Elk Grove Village to further improve our profit capability and productivity. Even though our cost of non-performance has reduced sequentially each quarter in fiscal 2008 and is down roughly 50% since fiscal 2006, much work remains to be done in this area. Moving into fiscal 2009, we have some exciting plans and investments that I look forward to sharing with you.

Globalization, the last pillar, represents the tremendous opportunity fro MSC outside the United States. This year we made significant headway in expanding our global footprint opening offices and adding resources in Shanghai, Seoul and Yokohama, Japan. We are hopeful that our aforementioned success with the trans plant in North America will translate into business back in Japan, Korea and China with these OEMs.

Our joint venture with Hae Won to produce QuietSteel in South Korea moved forward and completed its first successful laminated steel trial during December. We also made our first shipment of brake products from MSC’s Malaysian line into China.

Our European team continues to deliver great results with great sales growth of 60% in the third quarter. Also, we continue to make progress on many fronts with QuietSteel for power train and body panel applications and hope to announce our first body panel close in fiscal 2009.

In closing, I am pleased with the company’s performance in the third quarter as we achieved sales growth and profitability in the face of challenging industry conditions. I expect the balance of fiscal 2008 to be difficult as many OEMs took extended production shutdowns in December and January. Also, we fully anticipate that the challenges associated with the automotive and housing industries will continue throughout fiscal 2009.

That said, I am very excited about the many products, commercial and operational improvement opportunities in front of us and remain optimistic for the long-term potential of MSC. This management team is committed to unlocking value for our shareholders through the implementation of our four pillar strategy and the numerous strategic initiatives underway.

At this time, I would like to turn the call back over to the operator for questions.

Operator

Our first question is coming from Steve Schwartz of First Analysis Securities Corporation.

Steve Schwartz - First Analysis Securities Corporation

Good morning, gentlemen, Happy New Year and congratulations on the nice revenue and gross margin growth, despite the market.

My first question comes in regard to these new applications. You had nine new applications for QuietSteel in the second quarter. How much of that impacted this nice growth that you saw in this quarter? Is it a large percentage or is there a lot more of that to come in the fourth quarter.

Cliff Nastas

A large percentage of the growth that we saw in the third quarter was the result of the closes that we had in the second quarter. Our second quarter happens to fall during most mild changeovers and product launches at the OEMs. So we generally close a lot of business during that quarter and then we enjoy the growth associated with those closes over the next year.

To answer your question, the majority was from the closes that we had in the second quarter. There weren’t a lot of new closes during the third quarter except the commitments that we received from the Japanese OEMs, which we’ll be able to most likely announce during our fourth quarter year-end call.

Steve Schwartz - First Analysis Securities Corporation

The four new apps in the headline today, are those with the manufacturer you are currently working with or is this someone else?

Cliff Nastas

Steve, at this point in time I’m not allowed to disclose that information due to confidentiality agreements that we have in place.

Steve Schwartz - First Analysis Securities Corporation

Sure, I understand. Do you expect that those will hit the revenue line soon?

Cliff Nastas

We believe we will start seeing revenue from those in the fourth quarter and then ramping up through fiscal 2009.

Steve Schwartz - First Analysis Securities Corporation

Were the approval cycles on these applications a little bit shorter than what you went through with your existing application for the Japanese trans plant? I think in the last call we had discussed how because you’re new working with the Japanese manufacturers, it’s taking a little longer. So is that time lead starting to shorten a little bit or are we still at four or five years?

Cliff Nastas

It’s always four or five years to get the first close with a new OEM. Once you get that first close and they validate your capability to be a good supplier, after that they generally come a little bit quicker. This is a good case right here where we have both several years of work coming to culmination into a new close and then also getting future closes in a shorter time due to some prior business that we’ve had in the past.

Steve Schwartz - First Analysis Securities Corporation

You noted a margin boost on higher scrap sales. The last thing I saw scrap prices were going up, since you are branching out into more applications I guess my original expectation was that with a higher number of changeovers, your gross margin might drop as you created more scrap. So is it the higher scrap pricing that overcame the higher amount of scrap or am I completely off here in thinking of these relationships?

Cliff Nastas

It’s a combination of both volume and increased scrap pricing.

Steve Schwartz - First Analysis Securities Corporation

It looks like brake sales dropped despite the big growth in Europe. Is there something secular there? You had a difficult comp on last year’s third quarter. I’m wondering what’s happening there.

Cliff Nastas

In the brake market, as far as the vehicles that were on the production in our third quarter for the vehicles that have QuietSteel in the brakes, they were down about 3%. Our overall sales were down about 11%.The problem is it’s very difficult for us to get a perfect match between when vehicles are produced coming out of the assembly plant and when we sell. It has to do with the amount of inventory that our customers carry, primarily makes that correlation not directly one to one.

We have closed some new business in the brake market. I think that we’re going to continue to see new growth in North America of our OE brake products. I think this is just a situation of just a little bit of mismatch due to inventory adjustments between what the vehicles were actually down as far as production goes and what our sales were.

Steve Schwartz - First Analysis Securities Corporation

My last question is around the buyback. Are the two programs now combined or does the new 1 million shares override the 400 million plus that is outstanding? What’s your total buyback?

Cliff Nastas

It’s two separate programs. As Jim mentioned, we have about 419,000 shares left under the February 2006 program that was approved by the board, and then early this January the board approved another million. It’s an incremental amount to the original repurchase.

Steve Schwartz - First Analysis Securities Corporation

What’s the term of the program? Is there a finite term, one year over the next two years?

Cliff Nastas

No, no terms yet.

Steve Schwartz - First Analysis Securities Corporation

So open ended. How do you expect that you could pay for these shares? Because you've drawn down your cash at this point and you have no debt, what do you think?

Cliff Nastas

We’re going to fund the repurchase of the shares through cash flow from our operations. So you have cash flow positive at this point in time. We still have quite a bit of cash on the balance sheet and we believe we’re going to continue to generate cash in the quarter.

Steve Schwartz - First Analysis Securities Corporation

Great, okay, thank you gentlemen.

Cliff Nastas

Thanks, Steve.

Operator

Our next question coming from Tom Spire from Spire Capital Management.

Tom Spire – Spire Capital Management

Good morning, everybody. Cliff, in your review of the multi-point strategy, I think when you were discussing operational excellence you said something that made me think we may have a major CapEx program coming up in the next fiscal year. I wondered if that’s a hint that I’m misreading or if in fact something like that is planned?

Cliff Nastas

Absolutely not, Tom. Essentially our capital budget, unless we do something like the applications research center which generally runs between $9 million and $11 million a year, consistent with the drop-off in our depreciation each year. I think the point that I’m trying to get cross is that we have to prioritize our capital budget. Generally, the things that go right to the top of the list after health and safety and environmental mandatory issues are those that help address our cost of non-performance and improved quality.

I don’t think you’re going to see a huge up-tick in CapEx as a result as of us focusing on improving our cost of non-performance.

Tom Spire – Spire Capital Management

What do you think the CapEx will be in the final fiscal quarter of this year?

Jim Froisland

It’s going to pick up a little bit, but as Cliff just said, we’re running pretty constant. There are some initiatives that we’re working on in the fourth quarter. It’s really going to be timing in terms of those projects. Some of them will go over into our next fiscal year.

Tom Spire – Spire Capital Management

Thanks and good luck.

Cliff Nastas

Thanks, Tom.

Operator

There are no further questions. I’d like to hand the floor back over to Cliff Nastas for any closing comments.

Cliff Nastas

Thank you for taking the time to speak with us today and for your interest in Material Sciences. Although the two major industries to which we continue to encounter difficult conditions, we are making progress on multiple fronts with customers in Asia, Europe and North America that we believe will create value for our shareholders.

We look forward to talking with you next quarter and sharing an update on our progress.

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