Material Sciences Corporation (MSC)

F2Q09 Earnings Call

October 9, 2008 10:00 am ET

Executives

Clifford D. Nastas – Chief Executive Officer and Director

James M. Froisland – Chief Financial Officer, Senior Vice President, Chief Information Officer & Corporate Secretary

Robert R. Rogowski – Vice President and Corporate Controller

Analysts

Steven Schwartz – First Analysis

[Tim Spiral – Spiral Capital]

Presentation

Operator

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

Clifford D. Nastas

Also on the call with me are Jim Froisland, Senior Vice President, 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.

James M. Froisland

The preliminary results that I will be reviewing were presented in a press release issued earlier today and discussed in more detail on our Form 10Q. Before I begin I must remind everyone that this conference call may contain certain forward-looking statements that are subject to the 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 MSC undertakes no obligation to publically update forward-looking statements.

Let’s now review the quarter’s results. Net sales increased 1.1% to $56.8 million in the second quarter of fiscal 2009 compared with $56.2 million in the second quarter of last year. Sales of acoustical applications which are mainly to automotive manufacturers declined 1.5% this quarter to $25.7 million from $26 million in the second quarter last year due to additional production cuts by auto makers.

The decline is mainly due to a 42.9% decrease in engine sales which were $3.2 million in second quarter of fiscal 2009 versus $5.6 million in the prior quarter. This was partially offset by a 7.3% increase in sales of body panel laminate to $13.3 million in the quarter from $12.4 million in the prior period primarily due to closing of two new programs. Brake sales grew 2.9% during the quarter to $7.2 million from $7 million in the second quarter last year due to growth in aftermarket and continued strength in European brake sales. Brake sales in Europe increased 47% during the quarter.

Sales of coated materials which are primarily in the appliance, automotive and building industries grew 3.3% to $31.1 million in the second quarter of fiscal 2009 from $30.1 million in the second quarter of fiscal 2008. Fuel tank sales fell 10.1% to $9.8 million from $10.9 million. Sales of building products decreased 13.6% to $5.7 million from $6.6 million. Appliance and HVAC sales remain flat while other products increased primarily due to higher gasket, furniture and fixture sales.

Gross profit for the second quarter increased to $6.1 million or 10.7% of net sales from $5.4 million or 9.7% of net sales in the prior period. This increase is primarily due to favorable operating efficiencies relating to labor and overhead, claims and other quality improvements that were partially offset by unfavorable product sales price mix. SG&A expenses in the second quarter were $9.4 million or 16.5% of net sales compared with $8.6 million or 15.4% of net sales in the second quarter of last year.

The increase is due to higher compensation costs of $.9 million and an increase in depreciation of $.1 million which were partially offset by lower bad debt expense of $.4 million. We reported other income this quarter of $1.1 million versus $.4 million in the second quarter of fiscal 2008. The increase this quarter is mainly due to a gain on the sale of stock of [Manulife] Financial Corporation, a financial investment.

The company’s effective income tax rate was a benefit of 42.6% in the second quarter of fiscal 2009 compared with a benefit of 40.3% in the second quarter of fiscal 2008. This year’s rate included the benefit of utilizing the net operating loss carry forward of our German subsidiary. The company recorded a net loss of $1.3 million or $0.09 per diluted common share compared with a loss of $1.7 million or $0.12 per diluted common share in the second quarter of fiscal 2008.

MSC has no long term debt as of August 31^st and a cash balance of $12.5 million. On January 7, 2008 the company’s board of directors approved a share repurchase program of up to one million shares of the company’s common stock of which approximately 869,000 shares remain available for repurchase. During the quarter the company purchased 53,623 shares at a total cost of $.4 million.

Accounts receivable days sales outstanding were 47 days compared to 54 days from a year ago. With overall working capital of $42.3 million or 74.5% of net sales versus $52.8 million or 94% of net sales in the second quarter last year. Net cash provided by operations for the quarter was $1.1 million. The company had $1.2 million of capital spend mainly for plant equipment during the quarter.

This completes the financial review. Now, let me turn the call back to Cliff.

Clifford D. Nastas

The deteriorating economy adversely affected demand in both our sectors again this quarter. We saw production cuts not just among big three automakers but also at Toyota and other transplant manufacturers. In total, production of vehicles containing quite still declined 17% in the second quarter of fiscal 2009. The housing and construction markets also continued to weaken. The US housing starts reaching a 17 year low in August.

Softness in the housing industry affects sales of our appliances and building products which are closely linked to this industry. Looking at the financial markets and their effect on the economy, we expect weakness in the automotive and construction industries to impact our business through fiscal 2010, if not longer.

That notwithstanding, we posted a net loss of $1.3 million for the quarter, more than a $400,000 improvement compared to the second quarter of last year which reflects a substantial improvement in claims and scrap sales. We also expanded our gross margin to 10.7%, a 100 basis point improvement versus the second quarter last year. While these trends are positive, your board and management team are not satisfied and we continue to aggressively pursue sales growth and operational improvement opportunities to increase profitability and cash flow.

What these financial results don’t fully reflect is our continued progress made in diversifying our product portfolio and customer base. Again this quarter I will organize 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 applications development center in Germany continue to be a considerable competitive advantage. For several year these facilities have enabled us to collaborate with existing and perspective customers in Asia, Europe, North America to demonstrate the value of our products. Also, the Canton facility houses our product development group which is responsible for the creation of innovative products such as electrobright, deco steel, vivacolor and quite aluminum.

The revenue gained we posted this quarter includes new sales of these products to appliance and HVAC customers. We continue to make meaningful progress in the second pillar, product and customer base diversification. During our last call I mentioned that electrobright and deco steel were receiving significant customer interest. Since this time we continue to make considerable progress and received our first purchase orders for both deco steel and electrobright.

This material will be used to support large scale manufacturing trials within our customers’ assembly plants which is one of the final steps in the approval process. We remain extremely optimistic about the future of these products. Moving on to the third pillar, operational excellence, this is a top area of focus in 2009 with four key priorities: exceeding industry benchmarks for safety; reducing cost and nonconformance; increasing customer satisfaction; and aggressively restructuring our operations to achieve profitability within the current level of demand and product mix.

In the first half of fiscal 2009 most of our plants are performing ahead of internal targets. We enjoyed improvement in safety and productivity while reducing the cost of nonconformance through the implementation of numerous quality initiatives. With the final pillar, globalization, we have maintained our momentum in this important area as brake friction materials manufacturing shifts from North America and Europe to China, we are well positioned and beginning to win new business.

In Europe, once again we delivered a strong quarter in the brake market with European brake sales growth of 47%. We have begun shipments in to our first power train application in Japan and quite steel can now be found on the Subaru Forrester. Quite steel continues to be evaluated by several automotive OEMs in China, Japan and Europe for both body panel and engine applications. Multiple vehicles are currently undergoing NVH and durability testing across several OEMs.

Shifting focus to the restructuring plan mentioned in our press release. As discussed during prior calls, management has completed their evaluation of our cost structure versus the current economic environment and the adverse impact it has had on demand for coated metal and acoustical products. As a result, this week we announced a corporate restructuring plan that is designed to reduce cost by approximately $4 million in the third and fourth quarter of fiscal 2009.

These savings will be achieved through headcount eliminations and spending cuts at both the cost of sales and selling and general administrative levels. The annual impact of this plan should yield approximately $6 million of cost savings moving forward. We also successfully implemented a price increase across most of our product lines to counter the impact of rising material, freight and energy costs.

Lastly, I would like to take this opportunity to welcome Terry Bernander to MSC’s board of directors. Last week MSC’s board voted to increase the size of the company’s board of directors from eight to nine directors and appointed Terry to fill this newly created position. Terry currently serves as the President and CEO of AZ Automotive and is a director of Polar Corporation. He possesses significant operating experience in the automotive industry and will be an asset to the company.

In closing, I would like to thank our employees for their hard work and perseverance through these difficult market conditions. Implementing a significant restructuring program is not easy but very necessary based on the current global economic environment. I am proud of our progress in transforming MSC in to a more efficient diversified global technical leader. However, this management team will not be satisfied until we consistently create shareholder value regardless of industry conditions.

At this time I will now turn the call back over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Steven Schwartz – First Analysis.

Steven Schwartz – First Analysis

Cliff, if you could give me some more details on the restructuring it would be helpful. It sounds like you’re expecting basically a quarterly run rate of about $1.5 million savings. Basically, can you just confirm that I guess for the first half of ’09 that’s what we would see, about $3 million in savings?

Clifford D. Nastas

As I mentioned Steve, it’s $4 million for the remainder of this fiscal year. Essentially, those savings are divided between the cost of sales, part of the income statement and SG&A. So, if we’re looking at $6 million, I’d say between those two areas we’d be looking at approximately $1.5 million per quarter for fiscal 2010.

Steven Schwartz – First Analysis

How do you expect that is going to split out between COS and SG&A?

Clifford D. Nastas

It’s about 50/50.

Steven Schwartz – First Analysis

How does it impact – you’ve been expanding the tech centers in Michigan and Germany and adding staff. I take it these cuts are probably going to be more in the production areas?

Clifford D. Nastas

As I said, it’s 50/50. If you take a look just at our SG&A, we eliminated about 40 positions. Those include both heads that were currently open and people that were currently in several of those SG&A roles. It’s a substantial reduction for a company of this size but, like I said earlier it’s shared between cost of goods sold and SG&A.

Steven Schwartz – First Analysis

Any special charges associated with it in the second half of this year?

Clifford D. Nastas

Yes, the restructuring charge will be about $500,000 for the remainder of the year.

Steven Schwartz – First Analysis

That will fall in the third quarter?

Clifford D. Nastas

Yes.

Steven Schwartz – First Analysis

As far as inventories are concerned, it looks like they’re up sequentially here in the second quarter and it seems that they follow a pattern in the second quarter. One year you spend on inventories, the next year you pull cash out and you go through this cycle. What goes on there? Particularly this year where you’ve built up inventories?

Clifford D. Nastas

Well, you know, if there is a cycle there, it’s not because it’s intentional. I mean, at the end of last fiscal year, the last two quarters we had a concerted effort to really bring our inventory levels down. What you’re seeing in this quarter is the fact that the significant rapid drop off in the sales of past year cars and light trucks have affected us because our window for ordering various steel products can be as long as three, four, five months.

We go out and we place purchase orders based on what the automotive companies say they’re going to buy from us. Then, many times the steel comes in and with a two week notice they’ll tell us that a plant is going to take a two or three week shut down. As a result of that, our inventories are up right now because we placed orders that were in line with the demand plans that we received from the automotive customers and those demand plans have not panned out as they had advised us several months ago.

So, our goal is to get back down to the levels that you saw at the end of last fiscal year. Right now we’ve got some programs in place to make sure we’re very careful about what we have in inventory and what we order moving forward.

Steven Schwartz – First Analysis

As far as the pricing actions are concerned, how much of those – because was it in July that you had announced those, if I remember correctly? How much of those fell in to this quarter? How much did you capture and how much could we expect in the third and fourth quarters to still come through?

Clifford D. Nastas

Essentially the majority of the price increases were affective as of the middle of July. However, that does not cover orders that they had existing on our books at that point in time. You’ll see the majority of the impact of the price increase flowing through in the third and fourth quarter.

Steven Schwartz – First Analysis

You posted a few quarters of losses here but, it seems like you’ve got an interesting situation relatively in that natural gas has come down, zinc, nickel, I think even coal rolled steel has come down but now you’ve got these price increases coming through, you’ve got the additional savings from the restructuring. Do you foresee maybe in the third or fourth quarter actually posting a positive EPS number?

Clifford D. Nastas

We don’t provide guidance on earnings so I can’t answer that question. But, what I can tell you is a lot of things that you see like drop offs in zinc and nickel and steel unfortunately, when we go in to the year we have a lot of those things hedged so we have locked prices. So even though zinc and nickel has come down we will not enjoy a reduction in the prices of those commodities this year.

The same thing goes for our price increase. Just because those have come down, customers come to us and say, “Wow zinc and nickel is down. Time for you to bring my price back down.” We explain it to them the same way, that we have contracts in place, our price is not changing and we will not be looking at any price adjustments until we can enjoy a lower procurement cost for those commodities.

Steven Schwartz – First Analysis

Moving on to the balance sheet, you guys have a very good balance sheet but I’m compelled to ask with this credit crunch how are you guys seeing the impact of that in terms of your short term funding and so forth.

Clifford D. Nastas

I’ll let Jim answer that but you know, we just signed a new line of credit in June.

James M. Froisland

We have a new line of credit with a great bank, JP Morgan and it’s asset based and there’s basically limited covenants, if any. We don’t anticipate using that but it’s there. Our cash balance remains strong and we continue to keep it that way. If you look at our receivables, days sales has improved as I reported. Another metric in response to your question about inventory, we not only look at dollar value but we also have a metric days sales in inventory which takes in to account foreseeable sales and prior sales. We feel we are in great shape in terms of working capital and cash balance.

Steven Schwartz – First Analysis

Then just looking at the revenue line and end market demand, you guys reported that appliance and HVAC applications were pretty much flat which is nice, they held up. What’s going on there? Is that related to electrobright? What’s going on?

Clifford D. Nastas

Well, we report things in larger buckets like appliance but within appliance you’ll have coil coating, you’ll have electrobright and deco steel, things of that nature. Overall, coil coating is actually down just because the demand for appliances is down. But, we have enjoyed the start of some sales of electrobright and deco steel as I mentioned in my comment. So, when you aggregate it together, it’s fairly flat to slightly down.

Steven Schwartz – First Analysis

Then body panel applications, Cliff I think you mentioned two new body panel apps? Your revenue were up there, that seems to be counterintuitive given the environment. Can you tell us a little bit more about that?

Clifford D. Nastas

Essentially the two new programs that Jim alluded to in his comments are programs that we’ve picked up at General Motors. As we mentioned on an earlier call, General Motors awarded us a multiyear agreement for 100% of their laminated metal requirements and as a result of it we picked up two new programs that use to be enjoyed by one of our competitors during the last quarter.

Steven Schwartz – First Analysis

Then you had talked in the past about working on closing a European manufacturers body panel app sometime this year. Do you still feel positive about that opportunity?

Clifford D. Nastas

Well, we’re making progress. Unfortunately, we can’t control the number of tests that the OEM wants to do before introducing it in to full scale production. But, we still feel confident that this year we are going to be able to announce the closure of our first body panel program in Europe.

Steven Schwartz – First Analysis

On the cash flow statement you guys reported $1 million from an exclusivity agreement. What is that exactly?

Clifford D. Nastas

Well, Steve as we’ve announced in the past and in our Qs is that we’re evaluating strategic alternatives for the Morrisville facility. We have been approached by a company that is potentially interested in buying that facility from Material Sciences Corporation. While they do their due diligence and investigation they have made a non-refundable $1 million deposit to the company for an exclusivity period for them to complete their due diligence.

Steven Schwartz – First Analysis

Then just some nits and nats there, for cap ex, I think in your last year’s K you listed about $8.3 million in expected spending. Do you still expect that for this year?

Clifford D. Nastas

No, I don’t think that we’re going to be near that level. I think we’ll probably be more in the $5 million to $6 million range for the full year. We’re looking at right now a couple of strategic investments in our business which could have an impact on that. But, just based on our normal run rate barring the short term implementation of either of these strategic investments we’re looking at, we should probably be in the $5 million to $6 million range.

Steven Schwartz – First Analysis

And, the expected tax rate for the year? It seems to be working its way down as we go through the year here?

James M. Froisland

That may be a little higher for the second quarter.

Steven Schwartz – First Analysis

So we’ll call it 43% or 44%?

James M. Froisland

Yes, that works.

Operator

Our next question comes from [Tim Spiral – Spiral Capital].

[Tim Spiral – Spiral Capital]

Just one follow up question to the credit difficulties out there. I was curious whether you were experiencing any bad debt problems or if you are tightening terms, how the receivables look, those kinds of things?

James M. Froisland

No, we’re really not. We stay on top of those things and actually as I reported our bad debt expense was favorable to what we had in our internal plans. We stay on those things but, you have to.

Operator

There are no further questions in queue at this time. I would like to turn it back over to management for closing comments.

Clifford D. 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’re making steady progress in our four areas of focus that we believe will create [inaudible].

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!