Material Sciences Corporation F1Q09 (Quarter End 05/31/08) Earnings Call Transcript

Material Sciences Corporation (MSC)

F1Q09 Earnings Call

July 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

Presentation

Operator

Welcome to the Material Sciences Corporation first quarter 2009 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host Cliff Nastas, Chief Executive Officer for Material Sciences Corporation.

Cliff Nastas

Also on the call with me today are Jim Froisland, Senior Vice President and Chief Financial and Information Officer and Bob Rogowski, Corporate Controller. Jim will review our financial results and then I will discuss the quarter and provide an update on our strategy. After that we’ll be happy to take your questions.

Now let me turn the call over to Jim.

Jim Froisland

The preliminary results I will be reviewing were presented in a press release issued earlier today and are discussed in more detail in our form 10Q which will be filed tomorrow.

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 declined 5.8% to $57.2 million in the first quarter of fiscal 2009 compared with $60.7 million in the prior period. Sales of acoustical applications which are mainly to automotive manufacturers fell 6.2% this quarter to $29.3 million, down from $31.2 million in the first quarter of last year. Sales of body panel laminate decreased 8% to $16.0 million in the quarter from $17.4 million in the prior period as new QuietSteel applications were insufficient to counter significantly lower automotive production.

We also experienced a significant decrease in sales to floor for truck and sport utility vehicles. Brake sales grew 3.8% during the quarter to $7.0 million from $6.7 million in the first quarter of last year due to continued strength in European brake sales. Sales in Europe increased 35.4% in the first quarter. Sales of coated materials, which are primarily in the automotive and building industries, declined 5.3% to $27.9 million in the first quarter of fiscal 2009 from $29.5 million in the first quarter of fiscal 2008.

Fuel tank sales decreased 17.3% to $8.9 million from $10.8 million in last year’s quarter due to the weakness in the U.S. automotive market. Appliances and HVAC sales declined 28.1% to $5.4 million in the first quarter from $7.5 million in the prior quarter due to overall weakness in the U.S. housing market.

Finally, sales of building products increased 37.8% to $5.5 million from $4.0 million in the prior quarter primarily due to increased sales volumes of one of our largest customers.

Gross profit for the first quarter declined $1.9 million to $6.8 million or 11.9% of net sales compared to $8.7 million or 14.4% of net sales in the prior period. This decline is primarily due to lower sales volume as well as the $0.4 million increase in quality costs related to an issue at our Walbridge facility. These factors were partially balanced by a $0.9 million increase in scrap sales and $0.4 million reduction in fixed costs.

SG&A expenses for the quarter were $10.4 million or 18.1% of net sales compared to $10.3 million or 17% of net sales in last year’s quarter. The increase this quarter was primarily due to a $0.7 million charge for a superfund site that was partially offset by cost containment actions taken to reduce expenditures in year-over-year lower sales volumes.

The company’s effective income tax rate was a benefit of 41.0% in the first quarter of fiscal 2009 compared with a benefit of 40.2% in fiscal 2008 quarter. This year’s rate included benefits of utilizing some of the net operating loss carry over from our German subsidiaries.

The company recorded a net loss of $1.9 million or $0.14 per diluted share compared to a loss of $0.5 million or $0.04 per diluted common share in the first quarter of fiscal 2008.

MSC has no long-term debt as of May 31 and cash and short term investment balance of $14.9 million. During the quarter the company purchased 363,800 shares at a total cost of $2.7 million. Of the 1 million share repurchase authorized in February 2006 all shares have been repurchased.

On January 7, 2008 the company’s Board of Directors approved an additional share repurchase program of up to 1 million shares of the company’s common stock of which approximately 922,600 shares remain available for repurchase.

Accounts receivable day sales outstanding were 49 days compared to 65 days from the year ago with overall working capital of $45.9 million or 80.3% of net sales versus $65.9 million or 92.2% of net sales for the first quarter of last year.

Net cash provided by operations for the quarter was $4.4 million. The company had $1.6 million of capital expenditures primarily for planned equipment transporter.

This completes my financial review. Now I will turn it back to Cliff.

Cliff Nastas

Our financial results show that the decline in the North American automotive industry coupled with severe weakness in the construction market continue to impact our business leading to a net loss for the quarter.

In automotive the problem is not isolated to just planning production. Changes in sales mix can also have a dramatic impact on MSC sales. During our first quarter GM, Ford and Chrysler reported year-over-year declines of 36%, 12% and 22% respectively. The domestic three has historically been strong in SUV and truck segments and MSC has shared in that success. With gas over $4 per gallon consumers are flocking to smaller cars where we have lower percentage of body panel and power train parts.

Unfortunately we don’t see a better picture in the building industry where MSC’s product sales are roughly 55% residential and 45% commercial. In May housing starts were down 3.3% from April and 32.1% from May 2007. This adversely impacts our sales of appliance and construction products.

Regardless of market conditions let me emphasize this management team is not satisfied with our financial results and we continue to aggressively pursue ways to build sales and bring our costs in line with the reduced level of market demand. Our top line results don’t necessarily tell the full story and we continue to make progress diversifying our product portfolio and customer base while expanding globally.

As usual I will frame my update around our 360 degrees of value creation strategy. This platform 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.

Beginning with technical leadership, our applications research center in Canton, Michigan and the application development center in Germany remain a powerful competitive advantage. We continue to use these facilities to illustrate the value of our products with both existing and prospective customers in Asia, Europe and North America.

Historically most work performed in our technical centers was for the automotive industry. Over the past couple of quarters we have conducted significant work with OEM’s in the appliance, HVAC and commercial transportation industry. We are quickly establishing MSC as the technical leader for noise and vibration solutions in these industries just as we have done in automotive. It is very comforting to have such excellent facilities and technical resources behind our products as we work diligently to open new markets.

We made notable progress in the second pillar, product and customer base diversification. During the first quarter we closed our first commercial order for Electrobrite with a heating and cooling manufacturer. We also closed two new product sales and two new coil coating applications with other air conditioning and appliance manufacturers. Our new DecoSteel, Electrobrite, ViviColor and Quiet Aluminum products continue to draw significant customer interest and we should be in a position to announce a new close for each product later this year.

Moving to the third pillar, operational excellence, this has been a top area of focus in 2009 with four key priorities; exceeding industry benchmarks for safety, resisting cost of nonconformance, increasing customer satisfaction and aggressively restructuring our operations to achieve profitability within the current level of demand and product mix. In the first quarter the majority of our plants are already performing ahead of our internal targets. Our investments in six segment and lean manufacturing are really beginning to bear fruit and drive down manufacturing costs.

Jim mentioned a quality problem in our Walbridge facility during the quarter. Without MSC’s investment in operational excellence resources over the past two years this issue might have taken months to resolve. However, in this case we quickly identified the root cause of the problem and took corrective action to eliminate the concern during subsequent production months.

For our final pillar, globalization, we entered fiscal 2009 with real momentum in this area. In Europe we delivered yet another strong quarter in the brake market, growing sales 35% while Asian orders for our brake products continue to strengthen. We continue to make meaningful progress in our ongoing discussions with OEM’s in Asia and Europe and I expect we will announce our first body panel application for QuietSteel with a European OEM this fiscal year.

I have also restructured my leadership team to improve focus on globalization. I am pleased to announce the promotion of Matt Murphy to Vice President of Global Transportation. Matt has been with MSC for 7 years and enjoyed success in both commercial and manufacturing roles. Matt has relocated to Asia and will drive our global transportation growth opportunity from this high potential region of the world.

Sticking with organizational announcements, as noted in our July 1 press release the Board of Director approved changes to our Board composition. John Reilly will succeed Dr. Ron Mitsch as non-executive Chairman of the Board. John has served as a director since 2004 and brings deep knowledge of MSC and our end markets. I would like to personally thank Dr. Mitsch for his leadership over the past five years as our non-executive Chairman.

As a result of this change, Patrick McDonald will replace John Reilly as Chairman of the Audit Committee. Pat brings a strong audit and financial background which will be an asset to the company moving forward. I look forward to working with John, Pat and Ron in their new roles.

In closing I am grateful for the persistence and hard work of our employees in these tough industry conditions. I am proud of our progress in transforming MSC into a better diversified global technical leader. However, this management team will not be satisfied until we consistently create shareholder value regardless of prevailing market conditions. At this time I will now turn the call back over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Steve Schwartz - First Analysis Securities Corporation.

Steve Schwartz - First Analysis Securities Corporation

You brought in Mike Wilson I think back in February and as you see it looks like your outlook is that production of QuietSteel to the big three will be down for some time. Has Mike come up with any ideas as far as possibly restructuring or rationalizing facilities further from where you stand today?

Cliff Nastas

We have had a lot of focus on bringing our cost and capacity more on line with market demand and at this point in time we do have several studies underway taking a look at what is the most optimal solution to the conditions in which we face.

Steve Schwartz - First Analysis Securities Corporation

Any idea on what the timing of that might be? Do you think it is something that might happen this fiscal year when you make an announcement and maybe start making changes?

Cliff Nastas

We are constantly making changes to the operation and the SG&A side of the business on a daily basis. That is something that is just part of the culture here at MSC to adjust with demand. However, we are in the process right now of putting together our strategic plan for the next three years and that is presented to the Board in October so I would think any major restructuring that we would look at would probably be as a result of our strategic plan and the approval by the Board of Directors in October.

Steve Schwartz - First Analysis Securities Corporation

Have you had any formal restructuring activities, any formal programs or things taking place in the past quarter or two outside of as you just described the normal operational adjustments?

Cliff Nastas

We have made a lot of adjustments surrounding headcount and spending and we have been flexing our manufacturing to optimize the costs based on the demand that we are experiencing for our product.

So, is it formal? Yes it is formal because it is something we talk about every single week as a leadership team and a company and we adjust our business based on that. We have done a lot surrounding pushing out hiring, doing some layoffs as I said earlier that are flexing the plan workforce. So it is something that we are very focused on in these difficult times.

Steve Schwartz - First Analysis Securities Corporation

Then from an SG&A standpoint year-over-year for this quarter at least you were at the same dollar level. Do you see that number coming down as you rationalize? I know you are also hiring people and expanding overseas. What do you think the net effect in that area will be?

Cliff Nastas

For the balance of the year I think that SG&A is going to stay right where it is, maybe come down a little bit. When you take a look at the first quarter as Jim mentioned in that number. We had a substantial increase in our environmental reserve for the [Mitco] site and that was a big surprise.

Also we are looking at right, as Jim said, we are growing globally and we are hiring people overseas. So there is going to be a lot of offset between the cost savings actions we are taking with our base business that is going to be offset by a lot of our growth initiatives. So I see SG&A staying where it is to maybe being down just a little bit more as we move on throughout the year.

Steve Schwartz - First Analysis Securities Corporation

You mentioned the Walbridge issue and I might have missed it but did Jim actually throw out a number of what that actually cost you in cogs?

Cliff Nastas

No. We generally don’t share that type of information but it was a substantial issue we encountered. The good news is we know what caused the problem and we have taken action to eliminate it.

Steve Schwartz - First Analysis Securities Corporation

Do you think without that issue your gross margin would have been close to what it was in the quarter a year ago? You were down about 230 basis points on gross margin.

Cliff Nastas

We were talking here internally and I didn’t hear the question but the people are here shaking their heads saying the answer is no.

Steve Schwartz - First Analysis Securities Corporation

Your gross margin quarter-over-quarter year-over-year was down about 230 basis points. I’m trying to figure out how much within that could have been the result of the Walbridge issue.

Cliff Nastas

It is very little. It is not that big of an impact. The majority of the impact comes from just the decline in sales which Jim mentioned and also some increase in raw materials and energy.

Steve Schwartz - First Analysis Securities Corporation

I know you purchase a lot of your materials and natural gas under a long-term contract but do you have an idea from a dollar standpoint what higher raw material costs were this quarter versus a year ago?

Cliff Nastas

We estimate the impact of raw material costs in the first quarter probably to be somewhere around the $500,000 to $600,000 level. Looking out for this year we think it is going to be several million. We have instituted a price increase program which is starting to take effect this month with the majority of our customers in which the raw materials are going up for the products that they procure from us. Our goal as a company is to do our best to break even with any increases we see in raw materials, energy and transportation.

Steve Schwartz - First Analysis Securities Corporation

You mentioned on the last call the exclusive agreement with General Motors to be their laminate supplier and I think you mentioned it would kick in about this time – the middle of this year. When you net out the lower production versus applications you might gain by having that exclusivity, does it net out positive at this point or are you still going to be down for the second half of the calendar year?

Cliff Nastas

Steve that is real hard to tell. It all depends on what GM does as far as overall sales go. You heard the numbers that I presented surrounding General Motors. They were down the most in our fiscal first quarter which was 36% so you are right. We have picked up several new applications there but when their overall builds are down 36% it is very difficult to overcome that.

Now the good news with General Motors is the majority of our large applications for body panels are on passenger cars. Right now passenger cars are exceeding the sales volumes versus SUV’s and pick-ups.

Steve Schwartz - First Analysis Securities Corporation

Again you saw a very nice improvement in the building products with this new customer. I think maybe two or three quarters back we thought that improvement would be the result of them building up their stock and so forth. I would imagine they are past that point so it this just going to be a consistent grower in terms of the business they are doing with you?

Cliff Nastas

First off, we have closed business with a couple of new building construction companies. However, the majority of the increase we talked about is still with our one largest building products company and it is still part of their inventory build with some expansion they have going on across North America.

I think the story here going forward is going to be what happens with housing starts. If that rebounds I think we will see a nice pick up in terms of metal roofing that we do, entry door, garage door, which is what makes up the majority of our sales within the construction industry. Along with that would be a nice up tick in appliance because there is a very strong correlation with housing starts and appliance sales.

Operator

There are no further questions at this time.

Cliff Nastas

Thank you for taking the time to speak with us today and for your interest in Material Sciences. Although we face difficult conditions in both automotive and construction industries we are making meaningful progress each day in our four areas of focus that we believe will create long-term value for our shareholders. We look forward to sharing our progress with you during our next call.

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