Materion Corp (MTRN) 2003 Q4 法說會逐字稿

Good day, everyone. Welcome to the Brush Engineered Materials year-end 2003 earnings release conference call. With us today for opening remarks and introductions, we have Mike Hasychak. Mr. 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 the fourth quarter and 2003 results and the outlook. Thereafter, we will open up the teleconference call for questions.

A recorded playback of this call will be available for 15 days by dialing area code 719-457-0820, access code number 529-622. 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 different from that contemplated by the forward-looking statements as a result of a variety of factors. Those factors are listed in the 2003 earnings press release issued this morning.

And now, I will turn it over to John Grampa for comments.

Thank you, Mike. Good afternoon, everyone, and thank you for joining us today. As Mike indicated, I will review the fourth quarter, as well as the full-year, and then comment on the outlook. Then, we will open the call for questions.

As I have in past conference calls, I would like to reinforce several of the comments made in today's press release, in part to add clarity, but more importantly, because they have implications for the outlook. I would also like to review, as I have in the past, the progress in the five key areas that are important to our future. By doing both, I hope to pre-answer some of your key questions.

As you well know, the fourth quarter is often an uncertain period for our business, due to the holiday-driven seasonal patterns, both domestically and internationally. We entered the quarter with a weaker backlog than we had hoped for, due to a weaker order entry pattern in the third quarter of the year. Late in the third quarter, our order entry started to improve, and our book-to-bill ratios started to climb, due principally to a long-awaited-for improvement in the electronic equipment market. The improvement gained momentum as the fourth quarter progressed, especially late in the fourth quarter.

As a result, the fourth quarter's revenue was stronger than expected. The improvement translated to solid gains in pre-tax results as well. As indicated in the press release, after considering the charges, pre-tax results improved by $7.2 million on a revenue increase of $16.6 million. When you consider that approximately 2.8 million of the sales increase was metal price, 52 percent of the revenue growth fell to the bottom line in the fourth quarter.

Since the mid-2001 downturn in the computer and telecom equipment markets, which affected our quarterly revenues by about 40 percent, we have maintained that there are five keys to our turnaround. And during the fourth quarter, we continued to advance in each of the five areas. I would like to review some of that progress with you now.

The first area was reducing debt. This was to be through better working capital management and control of capital spending. We are in our 10th quarter of continued debt reduction. Total balance sheet debt, plus off-balance sheet equipment leases and precious metal consignment obligations, have been reduced by over $60 million since the end of 2001. In the fourth quarter, that reduction was approximately $2.5 million, and for the year 2003, the reduction is approximately $25 million.

The second area was reducing overhead. We targeted a reduction of 10 million per quarter from the first quarter 2001 levels. That reduction was targeted to come from headcount as well as spending for services. We have exceeded that target in each of the last four quarters.

The third area was margin improvement. This was to be through operating improvements, especially in our alloy business, using Six Sigma and lean manufacturing techniques. You will note that gross profit is up 20 percent in the fourth quarter, and up by approximately 5.4 points for the year. I'm sorry -- gross margin is over 20 percent in the fourth quarter, and up 5.4 points for the year.

The fourth area 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 job geographies. While out revenue targets were modest for 2003, we are progressing with qualifications and field trials with most of our programs. One important accomplishment in the year was the previously-announced James Webb (ph) telescope contract, which will add $15 million of revenue in 2004 and 2005.

Another is the success we are having with our geographic reach into Asia, where our sales growth helped to offset the sluggish domestic economy.

A third is that our new toughnet (ph) bearing material is starting to find its way into aircraft, helicopters and drilling tool applications. The announced introduction of a new alloy for our high-powered applications, alloy 390 (ph), is finding its way into those applications as well. Approximately 20 percent of the fourth-quarter growth in our alloy business was from these new products.

The fifth and final point, and important to our improvement, is the state of the general economic environment in the markets we serve. While this is not within our control, we certainly work to ensure that we participate as these markets turn. We have improved our internal processes, improved our response times and our service levels. We, like many, have been disappointed with the state of the U.S. economy and the softness that was evident most of the year. However, manufacturing started to expand in the third quarter, and it seems that the expansion accelerated in the fourth quarter, and is even more broad-based. That is encouraging for us as we look forward. Almost all of the goals we sat in each of the five key areas have either been met or exceeded.

As indicated in the press release, after considering the charges taken in both 2003 and 2002, results before tax improved by 16.1 million, year-over-year, on a sales growth of 28.2 million. That is a 57 percent flowthrough to the bottom line. The flowthrough is even greater when you consider that over 7 million of the sales growth was metal price. The improvement confirms the extraordinary leverage from the actions we have been taking. The leverage was visible in the fourth quarter and in the earlier quarters of the year as well.

This is the sixth straight quarter of very meaningful quarter-over-quarter improvement in our operating performance, and the first with meaningful topline growth. The year-to-date gross margin growth of approximately 5.4 points is due to a combination of factors that include lower factory overhead, better mix and improvement in operating yields and operating costs.

On the $28.2 million increase in sales for the year-to-date, gross margin dollars increased 25.1 million, or approximately 90 percent. The results of the ongoing efforts to reduce costs, improve margins and improve manufacturing efficiencies is very visible here.

You will note that in the fourth quarter, reported SG&A grew by $5.4 million, compared to the prior year's fourth quarter. That was driven by several events. First, the cost of the company-owned life insurance program was higher by $1.8 million, compared to the prior year. Second, incentive compensation was higher by 1.7 million due to the improved performance. And thirdly, you may recall that in the fourth quarter of 2002, the company reported a benefit of $2 million from the legal reserves due to favorable events in the CBD (ph) caseload. Without these factors, SG&A would have been flat to down slightly, compared to the prior year, and about the same as the run rate for the first three quarters of the year.

As for the outlook, we have many good reasons to be encouraged by the progress, and the recent signs of strengthening in our domestic end-use markets. The benefit of the strengthening that it is appearing in our key markets is now appearing in our order book. We expect that revenue will continue to improve and that we will continue to see good leverage. First-quarter revenue, at this time, is expected to be up 15 to 20 percent, versus the prior year's first-quarter revenue of $99.5 million.

With that, operator, I would like to open the conference to questions.

(OPERATOR INSTRUCTIONS). Mark Parr, McDonald Investments.

Good morning, or good afternoon, I guess. Time flies. I was wondering, Gordon or John, if you could talk about the sources of growth in the first quarter, in terms of where you're really getting the impact? And also, if you could just talk a little bit about -- I don't know if you want to quantify the book-to-bill -- but just talk about order momentum you are seeing, as opposed to the outlook for -- our in the context of the shipment growth? Are orders growing faster than shipments or less than shipments -- I guess that's what I'm trying to get at.

I will comment briefly, Mark, and then Gordon can expand on my comments. Relative to the order book, the book-to-bill is in the neighborhood of 1.2 to 1, the last four to eight weeks. So the backlog is climbing a little bit. And the shipment rate is flowing with that. So, the 15 to 20 percent growth forecast is suggestive of that order trend.

Secondly, I will comment that the order entry is -- the increase is across most markets. But, the most obvious increase is in the electronics and the telecommunication and computer equipment market, where we are seeing growth there of -- depending upon who's metric you use -- anywhere from 25 to 35 percent, whether it be wireless or whether it be in the equipment infrastructure itself.

Just to kind of follow on to that, does the addition of this business to the shipment mix enhance the mix, keep the mix the same? You know, from a profit contribution perspective?

It enhances the mix.

Okay.

You know, Mark, in the quarter, I would say that, with the exception of our electronic products business, you really saw good growth in every one of the businesses. I mean, alloy was up 22 percent. Beryllium up 30 percent. TMI, 7. And WAM, up 23. And, as we indicated in the WAM case, there was some metal price movement there. But still, even if you back that out, you would see very good growth in there.

The other thing that we commented on was that, in the quarter, international also was up very strong. So, the pattern has continued with very strong growth from the international segment. The interesting thing was, if I am not mistaken, with the pick-up in the fourth quarter, we finally, year-over-year, did see a slight growth in sales in North America, but it did not occur until the fourth quarter. Through the first three quarters, we were actually down slightly in revenue in North America. So, to the point that we were making earlier, it does now appear that there was some pick-up in the domestic economy that obviously provided some lift.

But, importantly, the growth in the quarter was pretty much across the board, with the exception of electronic products. Part of that was related to a defense push-out that impacted our small-business, CPT (ph), out in San Diego. And also, in our ceramic business, there was one large customer who was in the process of moving operations from the U.S. to Asia, and had built excess inventory to cover that move. And, as a result, did not take any product in the quarter.

Okay. Is there any way you could help us to quantify the potential contribution from 390 and toughnet over the next 12 to 18 months? I mean, how big could these product areas be one or two or three years from now? How big do you think they should be?

390 is an alloy that I think we would believe will be a contributor, but I don't think we see it as a huge -- its not going to open up a whole new growth platform for alloy. It has some very good strength in conductivity properties that we think will help it in certain segments of the market, particularly an application which is called burn-in-test sockets (ph). So, it is going to be a contributor, but not huge.

I still think we believe that toughnet, on the other hand, has the opportunity to become a significant contributor to our total alloy business. Frankly, the industrial components area is one that we have targeted for substantial growth. I could not sit here today and say it is going to be 10, 20, 30 percent of our total. But, I would certainly feel disappointed if it wasn't getting to at least the 10 percent level here in the next year or two.

Okay. Terrific. Congratulations on good progress.

(OPERATOR INSTRUCTIONS). Kyle Stults, William Smith & Company.

Good afternoon, everyone. I would like to first ask what is your plant capacity utilization and your CapEx outlook for the year?

The answer to both questions -- CapEx outlook for the year is consistent with what we had been talking about previously. In the year 2003, we spent about $6 million. And, in looking into 2004, the range would be 10 to $15 million, depending upon needs. Capacity utilization -- we speak in terms of about -- in the alloy business, we may be operating at about 50 percent of capacity.

Okay. Let me ask -- what degree of price increases have you assumed in your Q1 and fiscal year '04 outlook?

Zero. Very limited.

Okay. Can you actually elaborate on the acoustic speaker application you mentioned in your press release? Is that something significant? Or, what is the opportunity there?

It is a small niche, Kyle. I think it is less than a million dollars. What it is, is very high-end professional speakers that we have provided a superior performance for. It is very thin beryllium -- almost a foil-like product that is used in these high-end speakers. So, it is a niche product that has shown some growth. It tends to be high-margin. So, if you can get a million dollars, it can generate a nice little kick to the bottom line.

Okay. One last thing. Could you elaborate a little bit more on your product mix at alloy? Are you still seeing a shift towards the higher beryllium content containing alloys?

Yes. We have had, in the quarter -- and it continues -- the mix was favorable into what we call our gold strip, versus our red alloys. So, that was positive, and continued to be positive in the quarter.

International helps us there, because a great deal of the gold strip is consumed in the international marketplace. So, I think that was partly a contributing factor. So, yes, the mix has been favorable in alloy and gold strip products also kicked an.

The other thing that was good in the quarter -- we're starting to see some pick-up in what we call bulk products as well, which is the ride bar tube and plate that does go into non-electronic applications. So that is a sign that some of these other markets were starting to pick up in the quarter as well.

Okay. Thanks. One more question, actually. What is your growth outlook for the electronic products division? You talk a little bit about why it underperformed in Q4, but what is your outlook there, going into 2004?

I think we are pretty encouraged. The Newberry (ph) Port, which has been our packaging business, which is linked to electronic materials, did well in the year. And, I think they are pretty optimistic.

Brush Ceramic Products, with the laser bore business -- I think we believe is still a strong segment. We just had that one customer in the quarter -- the fourth quarter -- that was not buying anything. But, they will be back and actually have started to purchase product.

And CPT out in California is, I would say, particularly encouraged because the platforms that they are on are all solid ones. And, we believe that they will be funded. And, as a result of that, their plan is to have good growth in the '04 period.

Great. Thank you very much for all the information.

Anthony Sorentino (ph), Sorentino Metals (ph).

Good afternoon, everyone. With regard to the mix between international sales and domestic sales, how do you see that changing in 2004, compared to 2003? Or, would you expect the mix to be about the same?

Anthony, the business in 2003 was 69 percent domestic; 31 percent international. And, I believe in 2002, you will find that it was maybe 28 percent international. The growth in the fourth quarter was 15 percent domestic and 28 percent international. And, for the year in total, reinforcing the point that Gordon made earlier, the domestic growth for the year was only 3 percent, and international growth was at about 19 percent for the year, in total.

We would think that the fourth quarter relationships are probably relationships that would hold at this point, with about 15 percent domestic growth and international growth of 25 to 30.

Okay. If current trends continue, would it be fair to say that the company will return to profitability?

Well, we have not, traditionally, commented on profitability. But, let me reinforce that we have, in the past, talked about our breakeven point being approximately $105 million of revenue a quarter. Now, the metal prices have affected that breakeven point, by maybe $3 million. So, you could take it to 108 million if you want. But, on the same score, we made some progress throughout the year 2003 to lower cost. So maybe the breakeven point drops back to the $105 million level. So, at $105 million in revenue, we should be breakeven. And to translate what we said about fourth-quarter growth, we should be profitable -- I'm sorry, about first quarter growth, we should be profitable in the first quarter.

Okay. With the five-year debt refinancing, is the interest expense there fixed, variable or a combination?

It's variable.

Okay, so variable --

We should add, Anthony, that we do have interest rate swaps. So, there is a mixture.

Okay. Very good. Thank you very much.

John Walthausen, Paradigm Capital Management.

Yes, good afternoon.

Congratulations on your results. I saw your note on your (indiscernible).

Thank you. Thank you. I guess the question I have is relating to international sales and the effect of currency hedging on them. Can you talk about what effect that had in the fourth quarter? And what effect it will have in the first half of the new year?

Okay, this is Jim Marrotte. We're kind of leery about what to say for next year, obviously. Interest rates can move rather quickly. (multiple speakers)

Yeah, I'm talking more about currency rates.

I'm sorry -- currency rates. For the year, we look at the positive influence it had on sales, offset by the negative impact it had on our foreign currency expenses. We also had exchange losses this year, versus last year where we had exchange gains because of movement in currency. We also need to take into account that we do get some price pressure overseas when the dollar weakens like this, and we might have to make price adjustments here and there on a specific application basis. We are estimating, for the year, we had a benefit of somewhere in the million-and-a-half to two million dollar range because of currency in calendar year 2003. (multiple speakers) -- at the operating profit line.

Going forward, we are not in the business of sitting there and saying how exchange rates are going to affect us. The dollar moves rather rapidly. Obviously, if the dollar is weaker in the first half of '04 than it was in '03, we will continue to see some benefits.

You hedged your comments pretty effectively, too, I think.

(laughter).

(laughter). Okay, well, I will not be that one.

Mark Parr, McDonald Investments.

Thank you. Looking at metal pass-through, I would like to bring this up for a minute. Historically, you have always passed your copper. I just wonder -- and I guess a couple of years ago there was an issue around palladium. There was a quarter or so where you had to either reconfigure or put in some provisions there. I am just wondering, at this point, if there are any metals that you are -- any raw material inputs where you have any exposure? You know, like nickel, for example, or other materials that we may not be aware of?

No, Mark, not anything at all.

Again, Mark, I think you're right. Copper still remains largely, for us, a pass-through. And at Williams, where we deal with almost all of our precious metals -- again, the way they do all of their work, all of their metals are purchased literally on the day that they invoice their customers. So, there should be no exposure on precious metals at WAM.

Okay. And just kind of as a follow-up to John's question regarding foreign currency. You talked about if the dollar continues to weaken, we will benefit. If I can just ask, which weakening against which currencies? I mean, because we have obviously had the dollar/euro effect and the dollar/yen effect. Are there any other significant currency effects that you may have?

Those are the two main ones. We do have some sterling sales, but they are significantly smaller than the yen and the euro. The vast majority is (indiscernible) the yen and the euro.

Okay. And just lastly. If you look at a lot of the base metals out there for things like steel, copper, aluminum, nickel -- there has been this emerging consensus of global shortages. And, it seems to be emanating primarily from this unusually-strong strength in China in demand for everything, pretty much. I am just curious if you are seeing any potential -- I know that, John, you had indicated that you don't have much in the way of pricing built into your outlook for the first quarter for '04. But, I just wonder if that is really an overly conservative outlook in the context of really what we are seeing emerge here for metals, in general. And if you could maybe -- I don't know, Gordon, if you want to make some comments on that? Any of the marketing intelligence would suggest that things may be shifting more to a seller's market?

Well, first off, when we talked about pricing, I'm sure that our response there was pricing in the context of having leverage in the market and expanding margins. Clearly, if copper goes up -- and it has; I mean, its up to almost what? A dollar a pound now -- that does pass through. To your point, the scrap market for copper has really gotten much tighter, and there is no doubt that there is movement of some of these materials into Asia, particularly into China.

As you know, we actively purchase those scrap back from our customers in the form of beryllium copper. And obviously represent a far more attractive market, price-wise, than movement of that material offshore. So, we continue to buy back as much scrap as we can get from our customers, and always have. And that continues to be an active area for us.

As to copper availability, there is plenty of copper; we have no issue there in terms of our primary suppliers of our copper inputs. So, there is no shortage or any issues that we face in the marketplace. And, as we said earlier, because we do pass through any increase on copper, there is no exposure there.

But you are not really -- you are not seeing any tightening from a standpoint of -- seeing opportunities for margin expansion as a result of this appearance of global supply tightening for metals in general?

Well, again, I think if you are in a commodity segment, I would agree that you probably have the opportunity. For us, on the alloy front, particularly -- my way of viewing that is that we're serving markets that are very, very price-sensitive. If anything, the shift to Asia -- it almost makes that worse. And so, I would argue that frequently the comparison for us is always against alternative materials. And therefore, pricing leverage is not, for us, particularly huge.

If there was an opportunity -- I mean, we have, as you know, in the past, clearly had our pricing reflect much more our own economics. So, if it was an odd allow, or if it was a small quantity, we have adjusted prices to make darn sure that those were not going to impact our basic margin structure. But, for larger customers, large applications, I would agree with John's view that it is pretty difficult to see much opportunity to pass on higher prices at this stage.

Okay. Thank you for the color on that very much. Thank you.

Elizabeth Schrieber (ph) Royce (ph) and Associates.

Good afternoon. I just had a quick question on the factors that attributed to the raise and increase in the SG&A for the quarter. I just missed your comments on it. Could you just quickly reiterate that?

Sure. The comments that I had made with reference to two or three items. One was, in the prior year, we had a $2 million -- this was announced in the prior -- $2 million gain in the fourth quarter. Actually a reversal of reserves for our litigation, because cases were settled below reserve amounts. So therefore, last year's SG&A, if you will, was $2 million understated. The current year, we had three items that were -- three events that affected the numbers. One was the cost of the company's owned life insurance program. In comparing to last year, was a $1.8 million difference.

In addition, the performance improvements that the company had all year, and in the fourth quarter of this year, caused a difference in our incentive compensation, year-over-year, of about $1.7 million.

And then finally, there was a third item which was part of the charge that we took in the fourth quarter, due to the refinancing that had a $600,000 impact on the numbers. So, the bottom line is that, year-over-year, SG&A was actually down a little bit rather than up. And, from a run rate perspective, about equal to the average for the first three quarters of the year.

Okay, just on the last piece -- I'm sorry. You rushed through that. The charge in the fourth quarter due to the refinancing, you said?

There was a $6 million charge that we referred to in our press release that was related to the financing. About $600,000 of that number is in SG&A.

Okay. Thank you so much.

Mark Parr, McDonald Investments.

Sorry to keep beating on this. Just for housekeeping, John, could you just give us your best guess as far as depreciation, interest expense and the tax rate for '04?

Well, as you well know, Mark, on this deal with the tax rate -- we are not in a tax-paying position because of the deferred tax charge that we took one year ago. So, the only taxes that we see flow through our P&L would be taxes from foreign income. And, I would expect that with the foreign income growing, you should see a slight increase, year-over-year, in taxes compared to the current year's reported taxes, if you will.

Your other question, relative to depreciation -- with the synthetic lease (ph) coming on the balance sheet, the year-to-year depreciation is -- well, in 2004 it will be somewhere around $23 million of depreciation and (indiscernible) amortization -- both numbers. And, I'm sorry, your third question was -- ?

Just interest expense?

Interest expense is a little more difficult to focus on. As you well know, the refinancing -- as part of the refinancing, we purchased off-balance sheet leased assets. When those come on balance sheet, we begin depreciating. The previous lease expense was in cost of sales. A portion of that lease expense, since we began amortizing, now becomes interest expense on the debt that we have picked up. The net effect of all of that, we believe, is in the neighborhood of about 5 to $5.5 million of increase, year-over-year, in interest expense.

Did you get one-fourth of that in the fourth quarter?

No we did not, because refinancing was done in December.

Okay, so that really hasn't started at all yet?

Di minimus in the fourth quarter of the year.

So, you could see the -- now, the operating lease was essentially off balance sheet. Has that essentially been eliminated entirely and is now an on-balance-sheet item?

What happens is that -- if you were to look at balance sheet debt in 2003 compared to 2002, and add the off-balance-sheet lease to that, year 2002, our debt would have been 118.7 million. And 2003, at year-end, its 99.2 million. We did have debt drop, but we did add 51.8 million for the lease to debt.

Right. Okay.

Okay?

I mean, when you did that, it seemed like it made a lot of sense -- (indiscernible) fully amortized and operating lease. And I think, in this environment, it makes a lot of sense to bring that onto the balance sheet. And, I guess, it just makes life a lot easier for everybody.

It is very visible. It was visible before because it was very well -- we talked about it as part of our obligations (multiple speakers) consistently. And yes, now it's very visible, at least in terms of the balance sheet.

Two other points, relative to the refinancing, that we probably should continue to reinforce while we're on that subject. One, is that the -- by removing $10.4 million -- or actually in the year, 9 to $10 million of leased expense from cost of sales -- and adding back 4 million of depreciation, gross margin increases by about a point and a half as a result of that change. Now obviously, that does not drop all the way to the bottom line because of the interest affect that we just talked about. But, pre-tax profits improve significantly as a result of the leased expense being substituted with a much smaller depreciation number.

The year-over-year impact, as announced in the press release, of the refinancing, is approximately 1.4 to $1.58 million. (multiple speakers) -- benefit pre-tax to the P&L.

All right, that's on an annual basis? The 1 to $1.5 million?

That's the improvement in the P&L, year-over-year, due to the refinancing?

On an annualized basis -- right? Okay. One last question, just again for housekeeping. With the significant increase in the stock price in '03, I was just wondering if you have triggered any stock appreciation rights that we may be looking at potential charges in the upcoming quarters related to that?

No.

Again, thanks again for all your help, and congratulations. Good luck in the first quarter.

And, there are no further questions in the queue at this time. Mr. Hasychak, I will turn the conference back over to you for any additional or closing remarks.

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

And that concludes today's conference call. We do thank you for your participation. You may now disconnect.