Materion Corp (MTRN) 2003 Q3 法說會逐字稿

Welcome to the Brush Engineer Materials third-quarter 2003 earnings release conference call. As a reminder, today's conference is being recorded. At this time, I will turn the conference over to Mr. Michael Hasychak. Please go ahead, sir.

Good afternoon. This is Mike Hasychak, Vice President, Secretary and Treasurer. With me today is Gordon Harnett, Chairman, President and Chief Executive Officer; John Grampa, Vice President of Finance and Chief Financial Officer; and Jim Marrotte, Vice President and Corporate Controller. Our format for today's conference call is as follows. John Grampa will comment on third-quarter results and the outlook. Thereafter, we will open up the teleconference call for all questions.

A recorded playback of this call will be available for 30 days by dialing area code 719-457-0820, access code number 789960. The call will also be available on the Company's Website, beminc.com, for 30 days. To access the replay, click on Quarterly Earnings Conference Call under the investors' page. The broadcast requires Real Player software, which is available as a free download from the icon as indicated. Any forward-looking statements made in this announcement, including those in the outlook section and during the question-and-answer portion, are based on current expectations. The Company's actual future performance may materially differ from that contemplated by the forward-looking statements as a result of a variety of factors. Those factors are listed in the third-quarter 2003 earnings press release issued this morning. And now, I will turn it over to John Grampa for comments.

Good afternoon, everyone, and thank you for joining us today. As Mike indicated, I will review the third quarter and comment on the outlook. I will be brief; then we will open the call for questions. Again, I would like to reinforce several of the comments made in today's press release, part to add clarity, but more importantly, because they have implications for the outlook. By doing that, perhaps I will also pre-answer some of your key questions.

As you well know, the third quarter is the seasonal low period for our business. We entered the quarter with a weaker backlog than we had hoped for due to a weaker order entry rate in May and in June. In addition, late in the quarter, defense order pushouts reduced revenue further. Nonetheless, we continue to make the progress, as it is evident by the significant improvement in pretax results. Since the mid-2001 downturn in the computer and telecom equipment markets, which affected our quarterly revenue by 40 percent, we have maintained that there are five keys to our turnaround. I would like to review our third-quarter performance in each of these five areas.

The first was reducing debt. This was to be through better working capital management and capital spending control. We are in our ninth quarter of continued debt reduction. Total balance sheet debt, off balance sheet leases and precious metal consignment obligations have been reduced by over $50 million since the end of 2001. In the third quarter, that reduction was approximately $8 million and thus far in the year 2003, the reduction is just under $18 million. The second area was reducing overhead. We had targeted a reduction of $10 million per quarter from the first quarter 2001 levels. That reduction was targeted to come from headcount and spending for services. We have exceeded that target in each of the last three quarters.

The third area was improving margins. This is through operating improvements, especially in our alloy business, using Six Sigma and lean manufacturing techniques. You will note that gross margin is up 2.4 points in the third quarter and approximately 4 points for the first nine months. The fourth area of concentration was broadening and adding to our revenue base. Our goal here is to lessen our dependency on a computer and telecom market recovery. This is a longer-term goal, focused on new products as well as new markets and new geographies. While our revenue targets were modest for 2003, we are progressing with qualifications and field trials with most of our programs. One important accomplishment is the previously announced James Webb telescope contract, which will add $15 million of revenue in 2004 and 2005. Another is the success we are having with our graphic reach into Asia, where our sales growth is helping to offset the sluggish domestic economy. A third is that our new ToughMet bearing material is starting to find its way into aircraft, helicopters and drilling tool applications. And we recently announced the introduction of a new alloy for high-power applications, Alloy 390.

Lastly, important to our improvement is the state of the general economic environment. This is not entirely within our control. We, like many, are disappointed with the state of the U.S. economy and the softness that has been evident in the second and third quarters. However, manufacturing started to expand in the third quarter and it seems that the expansion is broadbased. Almost all of the goals we have set in each of the five key areas continue to be either met or exceeded. While sales were up only slightly in the third quarter, they were within the range that we had provided in July. In addition to the weaker order entry coming into the quarter, one factor was the pushout of about $2 million of defense orders.

As indicated in the press release, after considering last year's onetime item, results before tax improved by approximately $3.8 million compared to the third quarter of the prior year. Year-to-date pretax results improved by $8.8 million on the sales growth of 11.7 million. That is a 75 percent flow-through to the bottom line. The improvement shows the extraordinary leverage from the actions we have taken, and the leverage was visible in early quarters as well. This is the fifth straight quarter of very meaningful quarter-over-quarter improvement in our operating performance.

The year-to-date gross margin growth of approximately 4 points is due to a combination of factors that include lower overhead, favorable foreign exchange, favorable mix and improvement in yields and operating costs. On an $11.7 million increase in sales for the year-to-date, gross margin dollars increased by 12.9 million or 34 percent. That is the result of our ongoing efforts to reduce costs and improve manufacturing efficiency. We continue to improve internal lead times, inventory turns and customer service levels as well in the quarter. Year-to-date total overhead, including overhead captured in both cost of sales and SG&A, is flat compared to the prior year. Excluding onetime favorable items that were in the prior year's figures, overheads are down approximately $2.5 to $3 million to date this year versus the prior year.

As for the outlook, we are encouraged by our progress and the recent signs of strengthening in our markets. As we have reinforced in the past, there is a lack of visibility in our markets and lead times are short. During the second and early third quarters, domestic order entry weakened. While we are able to respond to the shorter lead times, they do make near-term forecasting difficult, and short-term results in EPS terms volatile. For example, revenue movement of about $5 million translates to over $2 million of EBIT, or 12 cents per share, in earnings. The benefits of the strengthening that began to appear in the global economy and in our key markets in the third quarter were too late to offset the early Q3 order entry weakness. But our book-to-bill is up the last six weeks and electronic equipment orders are climbing, which is very encouraging.

We expect that revenue will continue to improve and that we will continue to see the good leverage we have seen through the first nine months of this year. Fourth-quarter revenue should be up 3 to 8 percent versus the prior year's fourth-quarter revenue of about $89 million. And overall, the year's revenue for the Company is currently expected to be approximately 5 percent above the prior year. Now operator, with that, we would like to open the conference to questions.

(OPERATOR INSTRUCTIONS) Anthony Sorrentino with Sorrentino Metals.

When would you expect to have the refinancing completed by?

As we had indicated in the press release, we anticipate having decisions made prior to year-end.

Okay, so the decisions would be made prior to year-end, but would the refinancing be completed at that time or early in 2004?

No, we would anticipate that it would be completed by year-end, not early 2004.

Okay. Now, based on your forecast for fourth-quarter revenue of plus 3 percent or plus 8 percent versus last year's fourth-quarter revenues of 89 million, it would seem like the sales for the fourth quarter would only approximate the third quarter level of sales. Wouldn't that seem to be a little low based on some of the signs of pickup that you are seeing?

The fourth quarter, Anthony, is difficult to predict, particularly as you approach the month of December. It is really uncertain what customers will do at year-end with their own inventory management and how that would influence the revenue that we ultimately are able to ship. So you are correct in that the range of 3 to 8 percent would suggest a number similar to the third quarter number, but that is again volatile and really difficult to predict.

Okay. What it then be fair to assume that the fourth quarter results would mean a continued loss similar to the third quarter?

We haven't commented specifically on earnings in the past. I'd suggest, again, that a movement $5 million in revenue affects earnings before tax by around $2 million. And as I just indicated, that oftentimes translates in about 12 cents a share. And we can see a swing of $5 million fairly easily in almost any quarter. Assuming that the revenue levels are approximately the same and there are no differences in mix, currency or how we operate our own factories, you would anticipate the earnings level to be about the same as well -- that is correct.

Okay. Fine. Thank you very much.

(OPERATOR INSTRUCTIONS) Kyle Stults with William Smith and Company.

Just had a couple of questions. Your gross margin looks like you're up slightly for the quarter year-over-year but down a little bit versus relative to the first two quarters. Is that just because of the seasonally weak order?

I think there are probably two factors there, Kyle. One, you are correct -- the seasonally weak quarter does have an impact. But secondly, we did have the factory -- the alloy business had the factories shut down a little longer than we initially anticipated. Thirdly, in the quarter, mix wasn't as favorable as it was in the second quarter. So there were probably three factors there that affected margin.

Okay. On your defense order pushouts, you mentioned a couple million dollars. Any sense of -- were those pushed out for a quarter or a couple quarters or -- ?

Actually, again, that is difficult also to get a firm read on. But it in fact was orders related to the F-22 program and missile defense systems; some of our circuitry for ground-based radar systems were also involved in that. We would anticipate that the majority of that would appear early in 2004, some of it in 2003.

Okay. I wanted to clarify on the Webb telescope, it said in your press release three years as far as the length of recognition of that $15 million. I think you said 2004 and 2005 -- I just want to make sure I understood. Is that a two-year period or a three-year period over which that revenue (multiple speakers)?

It could be up to three years, and I did say 2004 and 2005. But it could be up to three years and the lion's share would be in 2004 and 2005. But again, like most government-oriented programs, that is always subject to delay.

Okay. One last question. The other expense category, what goes into the category?

There are a couple of things that happen there that caused the wild swings. We had a higher expense in the quarter of about half $1 million and about $2.5 million for the year. The first factor is currency exchange gains were lower in 2003 than they were in 2002 due to the weaker dollar. Most of that difference occurred in the first half of the year, and that totaled about 1 million 6 for the first nine months. The other issue is the Company has a deferred compensation plan for our directors that is tied to our stock price. As the stock price increased this year, our liability increases, and therefore we have to record additional expense. Last year, our stock price declined; therefore, our liability declined as well, and we were able to take some money back to income. So that swing between income last year and expense this year caused a difference of $600,000 in the third quarter and almost $1.3 million for the year.

Okay. Great.

John Walthausen with Paradigm Capital Management.

A couple of questions. The first one is a simple one, because I wasn't sure whether I heard you talking about -- heard you correctly -- talking about the overhead reduction. We've targeted 10 million for the year. What did you say we have achieved year to date?

It was 10 million per quarter, John, from the peak business period of the first quarter of 2001. We referenced that period because that was the period just before the downturn in computer and telecom hit our business. We had targeted $10 million a quarter, or, if you will, $40 million a year, and for the first three quarters, we are in excess of $30 million on an apples-to-apples basis.

Right. And versus last year -- ?

Versus last year, I don't have that number readily available, but Jim Marrotte might. No, we don't have that number readily available. But it is down versus last year or -- on an apples-to-apples basis after you exclude onetime items, I think it is down about 3 to $4 million versus last year.

And on the initiative to broaden the product base, I kind of had in my notes that we were targeting getting $10 million of new business this year. Is that a correct target, and how are we doing versus that?

You are right, that was what we had targeted. I would say we are not running at that level compared to where we had hoped to be at this point in time. Probably going to capture maybe half or slightly more than that. Not that we are not getting wins, but what we are finding is that the domestic economy is just not as receptive to switching over to new products as rapidly as we had originally hoped or expected. So we remain encouraged and are heavily focused on a number of these new applications, such as the ToughMet for bushings and bearings, oil and gas applications, as well, and have had some good success in getting specified into some new applications and believe that we will see real volume in those. Not really, though, probably having much effect until next year.

We have been successful, as we had hoped, in gaining market share and we remain very pleased with our performance in Asia. Our international sales year-to-date are up over 20 percent, which is a reflection of the shift of business into the Asian market. So we are comfortable that we are capturing business as it moves to Asia, but I would say that we remain a little bit frustrated that we have not achieved the pace of new applications and the penetration of some of these new markets as rapidly as we had hoped.

That is real helpful. In your comments there, you talked about gaining market share. Can you be more specific about where you have been picking up share?

This is mostly in applications that are using Beryllium copper, when supply was very tight back in the year 2000 that we lost some business or where we might have enjoyed a significantly higher share, we may have lost a little bit. So we have been very diligent to going back to customers and really trying to establish ourselves as the preferred supplier, and have enjoyed success in doing that both in North America and in Europe, and increasingly in Asia as well. So we have just been alert to every opportunity possible to sell Beryllium copper and make Brush Wellman the preferred source.

And I take it that you are really talking about the core telecom computer marketplaces?

Certainly, we are talking primarily stripped products. But even in bulk applications there are certain applications where we can be supplying Beryllium copper competitively. But your point is correct, that it is primarily in strip, which translates into connectors and a heavy amount of that is computer and telecommunications.

Right. It is kind of perplexing to me at this point, because when we fell off the cliff in 2001, I think we all assumed that some of this was an inventory correction. And I would think with final demand starting to pick up and as we see in some, say, passive components and things like that where the volumes are picking up, I would expect to see our sales into that marketplace starting to pick up. Is there still an inventory overhang in the system that is plaguing us?

There probably is some in odd spots. I would think and expect that most of that, as you suggest, is gone or behind us. I think what we are finding is that there are pieces that are strong now -- handset market is clearly coming back. We see that largely in Williams Advanced Materials, where they have been supplying vapor deposition materials to that marketplace. I think the infrastructure side is still relatively soft, so that has not been as strong as some other areas. I think we also tend to lag a little bit as the market starts to pick up. As John indicated, we did, in September, start to see the book-to-bill start to pick up. We are now operating at a book-to-bill at better than 1.1. So I think we are hopeful that we will start to pick up volume as you suggest.

And the better than one-to-one book-to-bill, is that true if we look at the quarter overall or are we just talking about September there?

That was mostly September.

Unidentified Speaker. The last six weeks.

Okay. In electronics, they are constantly trying to take costs out. Have we gotten designed out in significant applications over the past two years as they are trying to bring their costs down?

The interesting thing is that our sales of gold strip, which tends to be our high margin, most profitable product, is up this year significantly -- double-digit growth in our gold strip product line. Some of that may be market share, but I think it is also interesting to note that high reliability applications continue to grow and our products are in demand there. I would say the most challenging area for us remains the mid-priced, mid-performance alloys. The alloys priced in the $4 to $5 a pound range is a highly competitive area, and it is there where, as you suggest, we constantly are having to be vigilant because there is alloys that have reasonably close performance and perhaps at times significantly lower price. So that would be the area where I would say the battleground remains very competitive for our products.

So it would be right to construe that we're probably seeing some price erosion this year?

Not actually. In fact, I would say the pricing has probably been up a little bit on average, in part because we enjoyed slightly higher prices internationally that we do domestically. I would say probably year-over-year our pricing has remained relatively stable.

Okay. Lastly, are they are changes in nuance or more than that in the strategy as we move into the new year?

No, not at all. I would say that we are very comfortable with what we are doing strategically. I am very excited about Williams Advanced Materials and their focus on physical vapor deposition targets. We are seeing, with their new alloys, with their service levels, that I believe that they will remain quite competitive in the marketplace on thin film products. I see our Beryllium products business, particularly in the defense area, we are well specified. I think we will believe that the Iran effect that kind of, I think, plagued us in the third quarter will abate as we go into a new fiscal year for the government. And so I think we believe we are going to be strong in defense, both the fourth quarter but going into next year, particularly obviously with the Webb being basically additional business there. So I think Beryllium Products is well-positioned. I am quite comfortable with that. Technical Materials, Inc., despite being down volume-wise, it has remained profitable, and I think there is every reason to believe that the market will recover for them and that they will continue to be positive contributors to earnings.

For us, I think the big deal remains the one you started your questioning about, which is now well are way going to do vis-a-vis getting new products and applications specified. The market recovery, I think we see signs of it starting to happen. I think the businesses are well-positioned to capitalize on that. And I think the opportunity remains for us is to capture new business with these new products, new alloys and our continued focus on new market opportunities.

Darren Hightman (ph) with Schneider Capital.

To follow up on that last comment, would you care to estimate how much revenue you can add in '04 from new market opportunities?

I think that, as Gordon had just suggested, we are obviously north of $5 million through this year in revenues from new products into new markets, and I will exclude the geographic reach into Asia from that. We had what we thought was a modest target of $10 million this year. I would think that given the $5 million rate, we should expect to see $10 million next year. Add to that the Webb telescope and a portion of the Webb telescope being shipped in the year 2004, and at this point it is difficult for us to pin that number exactly down. But if half of it were to be shipped next year, that would be another 7 million that would be in the new product category. So 15 to $20 million in total companywide is not unrealistic.

That would be great. With the international revenues being up 20 percent, is that all unit or is there some foreign currency impact?

Yes, there is some foreign currency effect there, some favorable translation effect of probably around $4.5 million for the year.

Okay, so what would that percentage be, do you think?

Probably change it 3 to 4 points from the 20 (multiple speakers) be 16.

Okay. That is still --

Most of Asia, of course, given that the dollar is pretty well pegged to those currencies, you are not seeing a translation effect there. Most of that is going to be yen and euro. And a lot of that was Euro, although the yen is now strengthening too.

Okay, thanks. A book-to-bill of 1.1 is very good. Yet your fourth quarter revenue guidance is from what you say roughly flat. Does that imply that you should be building backlog throughout the fourth quarter and that your visibility for the first quarter is pretty good, under the circumstances -- I understand it is not good yet, but -- ?

I think we are encouraged. The plants are expecting to operate right through December, so that will help us in the fourth quarter as well, just from an operating cost perspective. But I think the businesses are expecting a good first quarter, and at this point, are planning to operate through December.

Just to add to that, as we had already indicated, what is difficult to get our arms around is the defense push-outs, again, plus what happens with customers in the month of December.

Okay. Is a rise in copper pricing good for you in any way? Or maybe it is bad for you?

Actually, for the most part it is neutral, as we pass that price through to the customer. Obviously, they can get to a point that if the copper prices rise too much, the customers can't absorb it. But our P&L, it is a neutral impact.

What about from a competitive standpoint? Does it make competing materials more or less --?

Most of the competing materials are copper-based alloys as well.

Yes, and they would have --

They would have an identical amount of copper and as we have, right.

Okay, thanks.

Martin Halbern (ph) with Winchester Group.

Just want to take that copper question one step further. The copper scrap price has been quite strong. Has that had any effect, especially in your scrap recovery?

No, because most people would much prefer to recycle Beryllium copper scrap back to us because they're going to get much better pricing from us based on its Beryllium content than putting it into the normal common copper stream. We have no issue in terms of getting our customers to recycle Beryllium copper scrap back to us.

And obviously from the standpoint that you are getting more copper back at probably a better level, so you could probably benefit from a higher scrap price?

I don't know about that. I have never stopped to think about whether that has any material affect -- I doubt it, given the relative differences -- you know, a few cents a pound in copper.

You mentioned the foreign sales being up 20 percent. What has Europe been doing? I am sure they warmed up probably as much as 2 or 3 percent.

Europe has been no more than 2 or 3 percent, and depending upon the precision relative to the third quarter numbers, maybe flat to up 2 or 3 percent.

I don't have the exact data right in front of me, but last I looked, unit volume was flat to down slightly in Europe, and the euro was bringing it up just slightly. But your point is correct, that most of the real volume increase is in Asia.

So in effect, the Asian revenues are probably up more like 25, 30 percent?

It is not 30. It is north of 20.

Unidentified Speaker 23 maybe.

Okay. Now, assuming we go back into the black next year, the deferred tax item when you moved from the balance sheet, when you start making -- when you are profitable, the tax savings from that -- one, I assume it's going to be a direct increase to the earnings surplus accounting and you are not going to take that through on your income statement? Secondly, when you start showing improved earnings and expectations of further improvements in the coming months, will some of that deferred tax item move back into the balance sheet?

Yes, you have the idea there. When we are profitable, we will not record any deferred -- I mean any federal income taxes during that period. So essentially, our pretax income will flow straight through to the after-tax line, with the exception of the small amount of state and local taxes and certain foreign taxes. Once we establish a trend of profitability over a period of number of quarters -- and we can't really define how long that would be -- we would then be able to take back that whole remaining balance of the deferred tax write-off that we took last year back through the P&L and put that back on the balance sheet.

Okay, thank you.

(OPERATOR INSTRUCTIONS) It appears there are no further questions at this time.

We would like to thank all of you for participating on this call this afternoon. I will be around for the remainder of the afternoon to answer any other questions. My direct-dial number is 216-383-6823. Thank you.

That does conclude today's conference. Thank you for your participation. You may now disconnect.