Materion Corp (MTRN) 2004 Q2 法說會逐字稿

Good day everyone and welcome to the Brush Engineered Materials Incorporated Second Quarter Earnings Release Conference Call. Today's conference is being recorded. With us today for opening remarks and introduction, we have Michael Hasychak. Mr. Hasychak, please go ahead sir.

Good morning. This is Mike Hasychak, Vice President, Secretary and Treasurer. With me today is Gordon Harnett, Chairman, President and Chief Executive Officer and John Grampa, Vice President, Finance and Chief Financial Officer. Jim Marrotte, Vice President and Corporate Controller is on vacation this week and will not be participating on the call. Our format for today's conference call is as follows. John Grampa will comment on the second quarter 2004 results and 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 608318. The call will also be available on the Company's Web site beminc.com for 30 days. To access the replay, click on Quarterly Earnings Conference Call under the Investors page. The broadcast requires RealPlayer 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 second quarter 2004 earnings press release issued this morning. And now, I will turn it over to John Grampa for comments.

Thank you. Good morning and thank you for joining us today. As Mike indicated, I will review second quarter and comment on the outlook and then we will open the call for questions. As I had in past conference calls, I would like to reinforce the comments made in the press release. It's hard to add some clarity, but more importantly, because they have implications for the future. I would also like to review as I have in the past the progress in the key areas that has been important and continue to be important to our future. And as always, I will try to pre-answer some of your key questions as well. To begin, I would like to step back one quarter. You will recall that we entered the first quarter of 2004 with an improving backlog due to the stronger order entry patterns seen during the fourth quarter of 2003. Our order entry rate was climbing then due principally to a long awaited core improvement in the electronic equipment market place. The improvement in this market gained momentum in the first quarter and continued into the second quarter. In the first quarter, sales grew 26% and we delivered a nice profit of $0.22 per share, the first real profit since the second quarter of 2001, three years ago when the computer and telecom market turned down. Late in the first quarter, we saw growth start to appear in many of our other markets as well. And as a result, our second quarter sales also grew by 26%. Sales in the second quarter were stronger than initially expected. The favorable conditions continued throughout the quarter. The improvement in revenue translated to solid gains in operating results as well. And as indicated in the press release, results improved $6.6m on the 26% revenue increase. Earnings per share was $0.38 on sales of $128.6m.

Interesting to note is that the Q2 sales of $128.6m were about identical to Q2 of 2001 sales. In Q2 of 2001, we earned only $0.08 per share compared to the current quarter's $0.38 per share. During the first and second quarters, we continued to advance in each of the key areas that we've been telegraphing as important to our progress. I would like to review each of those areas with you now. The first was strengthening the balance sheet and reducing debt. By the end of last year, total balance sheet debt plus our key off-balance sheet building and equipment leases as well as our precious metal consignment obligations had been reduced by almost 40% or just over $80m since the end of the year 2000. Much of that was to improve working capital management. I would like to share a data point with you. Sales in the second quarter of 2001 again were identical to the sales we reported this quarter. Three years have passed and today, inventory receivables are almost $51m lower than they were in the second quarter of 200. We are turning inventory almost twice as fast, and collecting receivables on average about two weeks earlier. In the first quarter of this year, due to the sales growth, inventory and receivables climbed approximately $21m, which drove our total balance sheet debt up about $9m. That increase was expected to be temporary. We expected that the Q1, increase would be eliminated through cash from operations in the second and third quarters of the current year. And that in fact, has occurred. While inventory and receivables increased by about $6m, in the second quarter of this year, operating cash flow drove debt down about $4m, and cash on hand increased $5m. The excess cash was used to pay down debt, the week following the end of the quarter.

The second quarter inventory increase is in specific areas, much of which will come out in the second half of the year. The combination of refinancing the Company, in the fourth quarter of 2003, and the equity offering announced in the second quarter of 2004, and closed in early Q3, of 2004, have strengthened the Company's balance sheet. The refinancing lowered borrowing costs, improved earnings, improved cash flow, added flexibility and added liquidity. During the second quarter, Management and the Directors of the Company, decided to issue equity. We believe that this is in the best interest of our shareholders, as it strengthens the balance sheet, reduces debt further, reduces cost, and improves earnings and cash flow, broadens our investor base, adds trading liquidity, raises our market cap, and provides additional liquidity.

We are pleased with the result of the equity offering. The offering was very well received. It was significantly oversubscribed, in number of existing shareholders participated, and new shareholders were attracted. In addition to all of the benefits I just outlined, the sale of the equity brought with it a good mix of new and existing shareholders, a good balance between new retail and institutional shareholders, added exposure and broadened geographic exposure. You may have also noticed that we have attracted additional research coverage as well. The coverage is well known, very respected and well qualified. The equity offering raised $35m. The $35m was used to pay down debt, which in turn adds to liquidity and reduces borrowing cost by about $2m annually. The equivalent of $0.10 per share in added earnings, were about $1 per share on the incremental shares.

Our debt to total capital ratio is now close to 25%, down from around 40%, before the offering. A second area important to our turnaround into our future, was the area of reducing overhead. You will recall what we targeted a reduction of around $10m, per quarter from the Q1, 2001, levels. That reduction was to come headcount and spending for services. We were close to that target in both the first and second quarters of this year, in spite of the rapid increase in sales, and we exceeded that target in each of the previous four quarters. We expect Q3, to be on track as well. While SG&A was up in the second quarter, when comparing to prior year, it is essentially flat compared to the first quarter, and manufacturing overheads are down. Total overhead in the second quarter was down $9m, compared to the $10m target. In spite of the negative effect of foreign exchange, higher incentive compensation accruals, and some higher costs, support the higher sales.

The third area of concentration was the area of improving margins. And this is occurring in all of our businesses. Most notably in our alloy business, which was the first of our businesses to use the Six Sigma, and Lean manufacturing techniques. Gross margin percent was up approximately 6.3 points in the first quarter, compared to the first quarter of 2003. Gross margin was also up 4.4 points in the second quarter, compared to the second quarter of 2003. And year-to-date gross margin percentage is up 5.3 points. That's a solid margin progress in spite of about a 1 point negative affect on margin due to currency and metal prices. the second quarter improvement team in a quarter where our mix was weak. The weaker mix affected margins by about one percentage point as well. The fourth area of concentration for us was broadening and adding to our revenue base. Our long-term goal is to broaden our base and thus lessen our dependency on the computer and telephone market and its recovery. We've been focusing on new products as well as new markets and new geographic regions, particularly in Asia. We've made good progress here too. One important accomplishment last year was the previously announced James Webb Telescope contract, which will add about $15m of revenue some of it in late 2004, and most of it in early 2005. Another year's of success we are having was our geographic reach. Our international business led by growth in Asia was up 39% in the first quarter and 28% in the second quarter.

A third is that our new Alloy 390 and our ToughMet materials are starting to find their way into new applications as well, and we are also making progress at Williams Advanced Materials with materials for depositing thin-film layers on silicon wafers and new steel for military and communications and with materials for magnetic data storage. Roughly, one-third of our first quarter and second quarter growth in our Alloy business was from our new products in our geographic initiatives. For the company in total, new products are adding about $4m per quarter to revenue and our other initiatives are adding about $3m per quarter to revenue. And fifth, important to our improvement is the state of the general economic environment in the markets we serve, particularly the economic drug environment in the US. While this half has been totally within our control, we certainly work to ensure that we participate as the market turns. We've improved internal processes, response times, and service levels. We're faster, more reliable, and more competitive.

Like many, we've been disappointed with the state of the US economy and the softness that was evident over the last couple of years. However, with manufacturing expanding late last year and that expansion accelerating and becoming broader based, it led to a Q1 domestic growth of 12%, and in the second quarter our domestic growth was 26%. Almost, all the goals we set in each of these areas have been met, were exceeded, and we continued to make good progress with each. The second quarter of 2004 was the sixth consecutive quarter where sales were higher than the comparable quarter of the prior year. It was the eighth straight quarter of very meaningful quarter-over-quarter improvement in our earnings and the third with a topline growth at the 20% level or above. The second quarter gross margin of 4.4 point is due to a combination of factors that include lower factory overhead versus prior year plus ongoing improvement in yields and operating cost and the volume growth. This 4.4-point gain incurred in spite of a negative impact from higher copper prices that we've have not been able to completely pass on to our customers. Next was also weaker in the quarter affecting margins by about one point. On the $26.8m increase in sales for the quarter compared to the prior year, gross margin dollars increased $10.6m or roughly 40%. Approximately $5.2m sales growth in the second quarter was metal price with currency related. After considering the effect of currency and metal price 37% of the sales growth flowed to operating profit. That improvement confirms the leverage from the actions we've been taking. The leverage has been visible in the past six quarters and is expected to continue. As per the outlook, we continued to be encouraged by our progress and the strengthening that exists in our end-use market. The benefit of the strengthening is appearing in our key markets and in our order book or is received in the second quarter, exceed orders bill by approximately $5m. Our lead times continue to remain short , meaning that changes in order rates and quickly translates to higher or lower sales and we are entering our seasonal slow period. Assuming that the strong markets continue to favorably effect the Company's order entry rate throughout the entire third quarter, we would expect sales to be at least 20% above the prior year's third quarter level in the coming quarter.

The third quarter may also be favorable or unfavorably effected by the mark- to market evaluations that negatively effected our first quarter 2004 results. This depends on interest rates and the Company's stock price. We can't project what interests would do nor could we project what our stock price would do. But to date in Q3, both have been reasonably stable and if these conditions hold, then Q3 would be neutral from these two factors. With that operator I will now turn the call over to question.

Thank you, the question and answer session will be conducted electronically. If anyone in the phone audience does have a question for our presenters, you can by pressing star one on your touch-tone telephone. If you are on a speakerphone, please make sure your mute function has been turned off to allow your signal to reach our equipment. Once again, it is star one if you do have a question. We will take our first question from Anthony Tarantino with Tarantino .

Good morning everyone.

Good morning.

On the -- the balance sheet that you provided -- you would show that long -- that short-term debt was $25.5m and long-term debt was $78.6m. What are those figures after taking into account. The use of the proceeds of the common stock offering?

The proceeds of the common stock offering, roughly $35m was used to reduce debt. So, in the that balance sheet, you would lower the total by about $35m. The difference between short and long-term really is difficult to speak to, I don't have those specific figures. The short-term debt moves around defending for an overnight borrowing in an anticipated payment of schedule payments of debt, but I would think that the majority of that would reduce, certainly short-term debt would go down balance on a long-term debt.

Okay and now that your debt-to-equity ratio is down to 25%. What would be your priorities for future cash flow, would it be any type of capital expenditures that you are looking at or possibly it was assumption of dividends on the common stock?

No, I would say that our priorities would remain as stated in the previous quarter teleconference and that is to continue to reduce debt first and then secondly any excess of cash that would be generated will probably first we applied to borderline acquisitions if they were available to. So, our first priority would be a reduced debt.

Okay, thank you very much and congratulations on a great first half.

Thank you.

We will move next to Mike Parr with Kim McDonald. I'm sorry, Mark Parr with Kim McDonald.

Did you change that and call me Mark at the end.

As you said, you have probably identified.

I even or so, that's okay, however I guess you can't win for loosing. That was a good update. John, there was one question that I had. Did I hear you say that you were able to pay down a bunch of additional debts in the first week of the third quarter?

That's correct.

Okay, and then that affected that is a $0.10 per share pickup as far as reduction in interest expense?

The net effect of the we offering was a $0.10 per share pickup as a result of interest expense, that's correct $2m a year of interest.

Okay now and okay so that's $2m bucks all right. Okay, another thing I just wonder if you could help us get a sense of where the strength of your order book is for the third quarter if there are any mix shifts you are expecting that's one question. Another question is it might related to the copper raw material situation. My impression has been over the years that copper is always a pass through as I am just curious as to, you know, how you could have a 100 basis point negative impact from not being able to pass through rise in copper costs. Thank you.

To your first question and then I will come to the second one, you recall the third quarter seasonally weaker, with a part of that seasonal weakness is in our international business, and our international market has a tendency to have more alloy unit and higher prices in your margins. The seasonal movement is also generally that at least dramatically in the alloy business as well, which is also a higher margin business. So, we would think that the order book right now is not inconsistent with that. The order book on balance is recently consistent with prior period. So, we would think that going into the third quarter, that we would anticipate margin levels similar to what they were in the second quarter, not necessarily any weaker, but certainly the second quarter was also a little weaker mix than the first quarter. So, that's kind of what the order book looks like right now as the third quarter begins.

To another point on copper price.

What I was referring to when I talked about margin being lower by one point in the current quarter in the quarter just affected, I was referring to currency and metal prices, and in that particular case not the inability to pass on copper, that's a separate factor. Currency levels and metal price levels raise the sales dollar at not necessarily any more margin dollar, and as a result of that compared to prior year there is about a one point difference in margin.

Okay.

Second point I made about margin was that the weaker mix that occurred in the second quarter affected margin by about one point as well.

I'm sorry, I must have misunderstood, so then I guess it was incorrect of me to conclude that you had a problem passing through higher raw material cost in the second quarter set, is that fair?

No, that's not fair because what I was referring to is that the comments I made in my discussion related to other factors, the question relative to passing on copper. first half of this year, we talked about this during the last hour conference as well. We have had more difficulty passing on the higher price copper because of the rapid spike in net copper and some of the contracts that we had in place. We had in the first quarter about a $2m negative effect of our inability to pass on copper in the business that we had in the first quarter. In the second quarter, we would have had a similar number $2m or a little bit less. So, year-to-date we're short in our margin if you will by about $4m because of copper pricing and our inability to pass that copper on.

Just as a followup today John, is this the source of potential earnings up side in '05 if you have changes that you can negotiate in your contracts?

I would say that is correct.

Okay, all right. Congratulations, great job, look forward to more good news in the next quarter.

Thank you.

Next Kyle Stults with William Smith.

Good morning everyone.

Hi, Kyle. Good morning.

My question is given some of the logistics issues that we follow, shipping and railroads in particular, you guys anticipate, have you experienced any problems with your supply chain?

No, we've not.

Okay.

We don't anticipate any.

You don't anticipate any issues going there?

That's correct.

We don't use rail for versioning anything at all Kyle

Okay, and no problems anything overseas in China or anything there either.

No, again that what you're hearing about a lot is to a whole cargo capacity, not containers and in fact we're going kind of backend, we're going the reverse way. So, there is actually benefits going from the US to Asia on containers.

Okay, thanks.

Next we'll take a question from Bob with Jefferies.

Good morning, thank you.

Good morning.

Actually, I have two quick questions and the first, your cost measures are obviously showing through in the reported figures, which is a great sign, but could you also discuss your comments relative to weaker mix, and what's driving it, is it apprehension from the customer CAPEX or early cycle buying patterns, what's driving that?

Actually it's not that. In the second quarter of this year, we had a growth rate in our domestic business that was close to 26%. In the first quarter, our domestic growth was about 12% or so. Domestic margins are a little lighter than our export margins. In addition, the domestic sales growth tends to be more red strip alloy versus gold strip alloy, and that was occurring in the second quarter as well, and we had lower margin product gains in our TMI business with some plated products. In addition to that any significant factor is that comparing to the prior year, we had our products business, which is about 10 from margin points higher than our average or more actually than the 15 points higher than our higher margin had a strong report in the second quarter of last year's sales year-over-year and that business were lower. Combination of those factors resulted in a lower gross profit percent in the second quarter than we might have otherwise expected.

Okay, great. I just wanted to make sure taking place there?

No, there is not.

Great, and just kind of 10,000-foot view question here. Given your visibility, are there any markets that you're seeing today that have been surprising to you either positively or for us more importantly negatively.

I'm Gordon Harnett. I think the interesting thing is I'm surprised by the strength of automotive in Europe. We had very strong growth in Europe and it appears to be automotive electronics driven. So, I mean that was a positive surprise. The only negative I see is, plastic mould materials, which is a relatively small segment for us -- has largely been a domestic segment. It's apparent that, that market is shifting more rapidly to Asia, than I would have thought and we're not capturing as much of that just yet. We're going to have to figure out how to better understand where those tools are being manufactured, particularly in China. It's a segment that we like and we want to try to make sure we capture that volume as it ships out of North America to Asia.

Okay, so, even as it ships over to China though, there'll be enough of a margin threshold to chase the customer?

Yes, for us we can, stock that product locally there and then -- as we do just on the Strip product, we can cut and package and ship. But, the key is to make darn sure we know exactly where those tools are being fabricated, so that we can make sure we've got the opportunity to supply.

Great, Gordon, and just a follow-up on the European auto business. You know build rates don't work all that different year-over-year. So is it a function of you being on new platforms or are you gaining some market share from your competitors there?

It's probably market share as well as just increasing electronic content. But, I think -- I'm guessing that the bigger piece right now is probably share of market.

Okay, great. Thanks for your time.

You bet.

I would like to remind our audience, if you do have a question, you can signal by pressing star one at this time. We'll take our next question from Timothy Hayes with BB&T Capital Markets.

Hi, good morning.

Good morning.

Good morning.

Two questions, first -- what is your capacity utilization rates overall? And then specifically for the segments. And then second question is, how much in sales are you expecting from new products this year and next?

Gordon on that, I'll talk to the capacity side first. As we discussed during the road show, a good rule of thumb for us, is probably that we are operating at about 50% of our available capacity. That's probably the most appropriate and relevant on the beryllium side of the business, and a particular alloy, where we have the most assets intensity. So, I would say that, on an average 50% is a good number, that's certainly about where alloy is. For the less asset intensive businesses though Williams or TMI, again I think that's probably not a bad number, but, there adding capacity can be done in very small increments and frankly right now it's more about just adding manpower to man -- a second or third shift. So, we have significant available capacity. John mentioned to your second question, about where are we relative to new products in new markets, in his comments and I think he talked in terms of roughly nine or so million per quarter, it is coming right now from either some of our new applications end or our new materials. And we're still gaining momentum there. I mean that is something that is we believe important to us, as we continue to grow this business. So, at any rate, pushing hard to grow those businesses and are pleased with the progress we're making at this stage.

Relative to next year, web shifts -- the majority of web shifts in the first part of next year. So, that would be added to it.

You know that's kind of a one off.

Okay, thank you.

And we'll take a follow-up question from Mark Parr.

Well, thanks. John could you give us some sense of CAPEX for the remainder of the year and your outlook for free cash flow?

I'm not sure the CAPEX for the remainder of the year -- it should be fairly consistent with the first half or a little bit more actually. We have been looking at $8m to $10m as the effective range for CAPEX, this year. Less than $10m, $8m to $10m in total perhaps. A little bit higher rate in the second half from the first. And as for free cash flow, the second half of the year, the free cash flow in part depends upon the growth, and what we have to do to support receivables. If you assume that the business doesn't -- that flattens and doesn't grow beyond the level forecasted for the third quarter, we should have a very positive free cash flow in the second half of the year. I would say that free cash flow for the year could be $20m to $25m.

Okay. And if -- let's assume that, if you had an incremental $25m of free cash flow in the second half of '04, I mean how much ammunition or how much dry powder do you have to grow business via asset acquisitions?

Well, as you know the revolving line of credit is $85m.

Right.

And with the equity offering, we paid down the revolver to zero. So we would have an $85m revolving line of credit there and that's in part driven by our ability to lever inventory receivables to borrow again, and that plus any cash flow generated in the second half of the year, so far liquidity is roughly $50m, plus whatever we had in the second half of the year to that, you could have up to $75m or $80m of liquidity.

Okay. Have you seen any increase in pipeline of potential acquisition opportunities in the last 60 days to 90 days?

I don't think we have seen any active opportunities emerge, we are -- I would say having kind of -- been focused heavily on improving the business in organic growth that has not been a high priority. But I think it is starting to become one and we are starting to kind of open up ideas and starting to kind of explore more fully where those opportunities might be, particularly as it relates to Williams and or Asia would be two priorities that they we're focused on.

Okay. Nice to be getting back in that game again, huh?

Yes.

And one last question, if I could? Many of the metals companies that that we track have, you know have been benefiting significantly from higher based pricing. And I was just wondering if you could talk a little bit about your pricing strategy for '04, how much have you been able to implement, how much is left to go, and what do you think the pricing outlook is for your products moving into '05?

We did talk sometime ago that alloy has put truly price increase mostly on some of their gold alloys of 3% to 5%, and I believe that will have a beneficial effect. Again, in any normal like Williams metal price increase just flows directly through and so we are not affected other than copper that we have talked about earlier, and I think we do want to try to see what we can do to continue to recover those increases in copper pricing. But other than that I would say -- there has been not any real upward movement in our pricing effort. I mean, the margin improvement that we are seeing is coming through mostly improved productivity in our factories and better operating results.

Okay. So, its fair to say then that as far as your, the general underlying tone of the market still remains highly competitive and not conducive to base price increases?

I think that's probably fair. I mean it varies by business, but if I just focus on alloy being the largest one, clearly Asia is a very competitive area, there are competing materials and so I think we are more focused on volume and share than we are on price increases, but are clearly anxious to recover some of the copper pricing that we -- increases that we've seen.

Okay, terrific. Thanks, Gordon.

And we have no further questions in the queue. I'll turn the conference back to over our speakers for additional or closing remarks.

This is Mike Hasychak. We would like to thank all of you for participating on the call this morning. I'll be around for the remainder of the afternoon to answer any other questions. My direct dial number is, area code 216-383-6823. Thank you very much.

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