Materion Corp (MTRN) 2004 Q3 法說會逐字稿

Good day, everyone, and welcome to the Brush Engineered Materials Incorporated third-quarter earnings release conference call. Today's call is being recorded. With us today for opening remarks and introductions, we have Michael 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 third-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 719-457-0820; access code number, 914290. 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 investor’s 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 2004 earnings press release issued this morning.

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

Thank you, Mike. Good afternoon everyone and thank you for joining us today. As Mike indicated, I will review the third quarter and then comment on the outlook. Then we will open the call for your questions.

As I have in past conference calls, I would like to reinforce the comments made in today's press release. I would also like to review as I have in the past the progress in the key areas that have been and are important to the Company's future. And as always I will try to pre-answer some of your key questions as well.

To begin, let's step back one quarter. You'll recall that we entered the third quarter of 2004 with a strong backlog due to the stronger order entry pattern seen during the previous 3 quarters. Beginning with the fourth quarter of last year, our order entry rate and our sales levels improved significantly due principally to improvement in the electronic equipments market. We saw momentum and improving conditions in our other markets as well, beginning in the second quarter of this year. These market conditions continued into the third quarter.

In the first half our sales grew 26 percent, and we delivered a nice profit of 60 cents per share. During the first and second quarters we advanced in each of the key areas that we've been telegraphing as important to our progress. We continued to advance in most of these areas during the third quarter, as well.

One very important area was strengthening the balance sheet and reducing debt. By the end of 2003, total balance sheet debt plus key off balance sheet building and equipment leases and precious metal consignment obligations have been reduced by approximately 40 percent or over $80 million since the end of the year 2000. Much of this was through improved working capital management, and over time we have accomplished a lot with our programs to improve our working capital management and as a result, we've extracted cash of over $50 million from working capital over the past 3 years.

The combination of this plus refinancing in the fourth quarter of 2003 and the equity offering closed early in the third quarter and this year have significantly strengthened the Company's balance sheet. The refinancing lowered borrowing costs, improved earnings, improved cash flow, and added flexibility as well as liquidity. The equity offering was very well received. It was oversubscribed. A number of existing shareholders participated and several new shareholders were attracted. The sales of equity brought with it a good mix of new and existing shareholders and a good balance between new retail and new institutional shareholders, added trading liquidity, increased visibility to institutions, and increased demand for our stock post the offering.

The equity offering raised $39 million. 31 million of the $39 million was used to pay down debt in the third quarter, which in turn added to our liquidity and reduced our borrowing cost by approximately $2 million annually.

Our debt to total capital ratio is now approximately 25 percent, down from around 40 percent before the offering. In addition due to continued strong operating cash flow in the third quarter, our cash balance climbed by $17 million to $27 million at the end of the third quarter. 9 million of this increase was from operations with the remaining 8 million from the equity offering.

Another important focus of ours has been on reducing overhead. You will recall that we've been quite successful at controlling overhead over the past several quarters. SG&A in the third quarter was down by about $300,000 or 1.5 percent compared to the first half of the year rates.

A third key area is our effort to improve margins. This is occurring in all of our businesses, most notably in our alloy business, which was the first of the Company's businesses to use Six Sigma and lean manufacturing techniques.

Gross margin percent in the first half of the year was up about 5 points compared to the first half of 2003. In the third quarter, gross margin percent was up about 6 points compared to the third quarter of 2003. That solid margin progress in spite of about a 2 point negative effect on margins due to proper and precious metal prices. The third-quarter improvement compared to prior year also came in a quarter where our manufacturing performance was weaker than it had been in the earlier quarters of the year.

Margins and thus profits in the quarter were also affected negatively by a reduction in inventory and the related overhead absorption through the P&L.

We've also expended consumable energy to broaden and add to our revenue base. Our long-term goal is to lessen our dependency on any single market, especially the computer and telecom market. We've been focusing on new products as well as new markets and new geographic growth regions, particularly Asia. We've made good progress here, too, and that progress continued in the third quarter. Our international business, led by growth in Asia, was up 44 percent in the third quarter, and we continue to make good progress with our new alloy, alloy 390 and our ToughMet materials.

We also may good progress in the quarter at Williams Advanced Materials with materials from (indiscernible) thin layers on silver silicon wafers as well as with newer hermetic seals for military and telecommunications applications and with materials for magnetic data storage. Roughly one-third of our year-to-date growth in our alloy business and a fourth of the Company's growth is from our new products, the new geographic regions and other revenue enhancing initiatives.

Lastly, important to our improvement is to stay to the general economic environment and the markets we serve. We've worked to ensure that we participate as markets turn and grow. We've improved our internal processes, our response times and our service levels. We're faster, more reliable and more competitive today. With the manufacturing economy starting to expand late last year and that expansion accelerating and becoming broader-based, it led to good growth for us. In Q1, our domestic growth was 12 percent. In Q2, our domestic revenue growth was 26 percent, and in Q3 our domestic revenue growth was 29 percent.

Almost all the goals we've set in each of these areas have been met or exceeded, and we continue to make good progress with each and expect to continue to make good progress in each as well.

The third-quarter of 2004 was the seventh consecutive quarter where sales were higher than the comparable quarter of the prior year. It was the ninth straight quarter of very meaningful quarter-over-quarter improvement in our earnings, and the third when top line growth was up 25 percent. Beginning with the fourth quarter of 2003, our quarter-on-quarter growth has been 19 percent followed by 26 percent, then 26 percent and now 34 percent in the most recent quarter.

On the $31.6 million increase in sales for the third quarter compared to prior year, gross margin dollars increased 12.2 million or roughly 39 percent. Approximately 4.3 million of the sales growth in the third quarter was metal price and currency. After considering the effect of currency and metal prices, 29 percent of the sales growth flowed to operating profit. While lower than what we've experienced in the first half, this improvement still confirms significant leverage from the actions we've taken. The leverage has been visible in the past 7 quarters and is expected to continue.

As for the outlook, we continue to be encouraged by our progress in spite of a recent weakening in some of our end use markets. We expect operating expenses to remain in check during the current quarter and manufacturing performance to improve. Our leadtimes continue to remain short though, meaning that changes in order rates can quickly translate to higher or lower sales, and we are entering the seasonal holiday period where fluctuations can occur. We remain very sensitive to volume.

Although third-quarter sales were stronger than expected, order entries began to slow toward the latter part of the quarter. Automotive electronics has weakened, and there are mixed signals coming from the telecommunications and computer markets in the semiconductor markets. In addition, it appears that Japan has weakened and Southeast Asia is experiencing a slower rate of growth. Thus the Company expects that the fourth-quarter sales growth will be less than the growth experienced thus far in 2004.

Assuming that markets do not deteriorate from current levels and that the related order entry rate holds throughout the entire fourth quarter, we would expect sales to be at approximately 10 percent above the prior year's fourth-quarter level or in the range of 114 to $118 million.

Operator, those are my prepared comments. I will open the call to questions now.

(OPERATOR INSTRUCTIONS) Kyle Stults with William Smith & Co.

Can you talk a little bit more about why manufacturing performance was unfavorable relative to the first half, just seasonality and is that something you can correct here going forward?

Actually we think we have it corrected going forward. More than just seasonality. Factors were involved; yield and performance, especially in our alloy business and in 1 or 2 other locations through the fourth -- through the third quarter was weaker than it had been in the first couple of quarters of the year and clearly below our expectations. I might add that yield or performance was better than was a year ago, but it was below the rates that we enjoyed in the first half of the year.

So going forward here it seems like you think you have remedied the shortcoming there?

We believe that's correct.

Okay. Just trying to get a little bit better understanding of kind of why the drop-off in the growth outlook here and has there been some inventory build or why are you now seeing softness in some of these markets like for example the handset market, which I think is still fairly robust. Can you just discuss the dynamics there?

There could be some inventory build that occurred through the first part of this year that may be is correcting itself now and is affecting the order entry rates. I'd have to say that I think that is the case. On the other hand, as you look at the individual markets, we are getting mixed signals. The automotive clearly is weakening and depending upon who you listen to in the semiconductor world, you see some stronger earnings reports, and you see some weaker earnings outlook as well. Clearly our order entry pattern is reflecting that. It is down. It has been down for the last 3 to 4 four weeks.

Do you expect the mixed signals to persist into '05, or do you think it is more of a temporary occurrence?

I certainly hope it is a temporary occurrence, but it is difficult to really predict.

Just one more question, if I may. Were there any other specific factors you would highlight as contributing to this Q4 slowdown? Top line?

No, it is order entry, and it is the weakness and the inconsistency in the order entry pattern coming from the market. There are no other factors.

Thanks, John.

Anthony Sorrentino with Sorrentino Metals.

If current trends continue would it be fair to say that you would experience an unfavorable product mix in the fourth quarter?

I doubt it. I can't think of anything that would be necessarily unfavorable, Anthony. I think our -- I think the only thing that would occur to me is if international stays soft, we typically get a little better margins on the international side. As John pointed out, we had definitely seen some softening there on the international side. But no, there would be no fundamental impact in mix in the fourth quarter either positively or negatively that occurs to me.

On another matter, will Brush be impacted by the corporate tax legislation recently passed by Congress?

Well, as you are aware that is a pretty comprehensive piece of legislation. We're just now starting in it, but I don't think it will have a significant impact on us.

It may be positive in one sense because WAM has been experiencing tariffs in Europe on some of their product that were exported into Europe. So I think it will be beneficial there. We have had a FSK (ph), one of these foreign tax operations that the EU was objecting to. So I think the elimination of that does have a modest effect. But we're not taxpaying right now, so short term it has no effect on the Company.

Thank you very much.

Mark Parr with Key McDonald.

Thank you. Good afternoon. A couple things. John, first of all I was wondering can you quantify the impact of the manufacturing yield issue in the third quarter?

Sure. Mark, it is more of a magnitude -- 1 million to $1.5 million

Okay, and were the issues associated with AEP or were they more with the older line operations?

Mostly related to the AEP.

Mostly AEP and mostly in the cash up (ph), Mark. Two factors there. One, we actually, as John pointed out, were working inventories down during the quarter. So you and up with some yield and performance issues because you're not operating they cash up as extensively as we were in the first half. But we also encountered in the more humid months some challenges of casting our metal efficiently and effectively and not having some product quality problems, which we did in fact encounter. So part of the improvement just comes because you move into less humid conditions. But as John pointed out through some of our work with Lean Sigma, we are also able to start to address some of those quality issues.

Another question I had. Now if you look at the -- I realize fourth quarter is a tougher comparison, so that may be part of the issue. Growth is slowing down a bit.

Fourth-quarter last year had grown 19 percent. 2 years or 30 percent growth.

Right. But I guess one of the questions I would like to ask is if you were seeing any thing that would suggest that the marketing orientation is likely going to be less effective here on a near-term basis or is the slowdown exclusively a function of the end market, the change in the end market dynamics?

It is exclusively in the end markets. I think we are very encouraged by the work that is going on on new product development and our market initiatives. I am frankly really pleased with what I'm seeing going on literally across the Company. WAM is gaining real traction in the semiconductor market with some of their targets. TMI has developed some very good new business in the hard disk drive ARM (ph) business with a clad metal product allow. As John mentioned, has got some good receptivity on some of their new alloy. So I'm very encouraged there.

No, I think what we are concerned and cautious about is all about just some of these markets and most notably computer telecom showing some signs of softening. There is no doubt, hard to quantify in the first half of the year we benefited by the uptick in these markets, and there was some inventory build just because volumes had grown dramatically. Just the leveling of demand actually allows a more normalized rate of growth occurring. So I think we're seeing some of that as these markets kind of moderate and if not, slow slightly. So I think either it is no additional revenue growth because there are inventories being built or maybe even some liquidation in some of our end use markets.

Pardon me for asking this last question. But if you look at what is happening in your end markets now, could you compare and contrast what was going on versus early to mid 2000 when the economy was moving into a recession?

No comparison. My opinion. What we're seeing now is I think much -- (multiple speakers)

I'm sorry I asked the question, but I'll just -- (multiple speakers)

I think its a good question. They are totally different. Our trendline that we follow on order entry for these end use markets is still well below where it was in the 2000 timeframe. You do not see the multitude of people chasing the same pieces of pie. I don't have any concern that inventories are in anyway close to the excesses that we were looking at 3 or 4 years ago. So if the question is are we looking at another bubble that could really dramatically take us down? I don't see that at all, Mark.

Okay, so I mean is your sense -- Gordon, I know that you've had a little more experience in following these cycles than I have -- not much but a little. Would your sixth sense tell you this is more of a temporary setback or is this something that could persist through the first half of next year?

I think it's a temporary setback, primarily. How long it lasts, I think is a little bit indeterminate. But I think the good news is that we are sensing, Mark, is that corporate spending on technology is growing. We are seeing more and more companies investing in software, hardware to support their agenda. So I don't see any lessening of demand there. I think Asia is moderating but not -- it is not going to not stop growing. So I do believe that the computer telecom which still remains a big part of the Company's end used markets are definitely going to stay I think in reasonably good shape.

And I think we also believe that to the defense business will also start to pick up here. We will be starting to ship and actually show revenue occurring on the Web telescopes here in the fourth quarter and going forward. So I think that is going to be a positive for us as well.

Again I don't want to put words in your mouth and I don't want you to make any kind of an estimate, but I mean what you -- based on what you are seeing right now, would a revenue outlook for '05 of between 10 and 15 percent growth seem reasonable?

Mark, its premature to talk about next year, but there are some things we talked about in the past that are probably worth reminding everyone. First of all, that is you will recall historically we have grown in the range of 8 to 12 percent per year. And that is moderated up or down depending on what has happened in economies. And when turnarounds start and stop in economies.

So 8 to 12 percent is still probably a fair range to expect in our business and in our Company. And if it is stronger than that next year it will be because the new products really kick in and the economy doesn't falter at all.

Secondly, we have controlled overhead and we do -- we are keeping costs in check and I think you can count on the Company seeing overhead costs growing at a third or less of the sales growth rate. And you also recall we talked about copper prices and the effect of copper prices. I'm thinking it was you in particular that asked last quarter about upside from copper prices stabilizing and pricing pass-ons being corrected and I think as you go into 2004, we should see some of the -- 2005, we should see some of that, the pain that we've absorbed this year start to come back.

And also don't forget that 2005 relative to 2004 we are going to see a couple million dollars of interest cost reduction year-over-year as well because of the equity offering and the debt reduction that has either already occurred or will occur.

And finally, I think that we could expect continued margin expansion from our initiatives in the Lean and Six Sigma world or the Lean and Six Sigma arena as well. So whether the revenue grows 10 to 15 percent or 8 to 12 I think is for others to determine other than ourselves. We'll have to see how economies develop but the rest of those factors are clearly under our control, and we are continuing to make progress in those other areas.

Thank you very much, and congratulations on continuing progress.

(OPERATOR INSTRUCTIONS) Rick Etu (ph) with Columbia Management.

Just a couple of follow-ups to some of the prior questions. The gross margin in the quarter, I think I've heard some of the explanation as to why we saw that degrade, and I guess I scratch my head. I assume you've worked in humid conditions in the past. What was different this year to I guess to surprise you on that front if that is the cause of some of the production issues?

Actually, the third quarter typically is a lower gross margin than the first couple of quarters of the year in our business because of our seasonal shutdowns. So a big piece of the lower gross margin, if you are looking at the gross margin compared to the earlier quarters, is related to that. Compared to prior year, the third quarter gross margin had actually grown more than the gross margin in the first couple of quarters. Now we didn't have the margin that we expected to have because of the inventory reduction that we took and the manufacturing problems that we ran into. And while in the past we have had humidity related problems, these problems were not as great as they had been historically. So I think it is a combination of those factors. We are missing a couple of points in our margin this quarter for all of those factors together.

Okay. Based on some of the reasons, it sounds like the Q4 margin ought to be at least consistent with the first half if not better. Is that an accurate statement?

I think that's fair. The only factor that I would caution you to is that as the fourth quarter progresses, we'd have to ask ourselves about inventory levels, as well, and also the volume and lower volume could have an influence on gross margin, too.

Okay. Lastly, you kind of went through your release, and I don't think you got to the line where I am pleased that sales growth exceeded our expectations in the third quarter. Just a quick comment on that. There are, you guys are I think with your offering recently you, as you mentioned, you have a wider audience now, more institutions and more retail. And there is also an additional coverage, and there's more estimate on the Company. To that extent there are other numbers other than revenues out there. And I noticed that there was no reference to your earnings line. And I think that that was not in something to pound your chest about. I think we've heard some of the reasons why, but I just want to point that out that there -- you are getting graded more than you'll see in the marketplace today. But you are getting graded more than just your revenue growth here.

Let me mention to you that when we comment about expectations, we comment about the expectations we set and not the expectations that the analysts set. We had talked about revenue growth in the third quarter compared to the second quarter being greater than 20 percent. And we also signaled that the third quarter in our business is generally weaker versus the second -- than the second quarter because seasonal factors by 8 to 10 percent. And that obviously did not occur in this quarter. And that is what I was referring to and what we were referring to in the press release and in today's comments is that the revenue increase was greater than the expectations we set, not the expectations set by the street.

How about your bottom line versus your expectation?

We did not comment on our expectation for the bottom line because we do not forecast profitability. What we suggest to everyone is that significant changes in volume can have an effect on the bottom line. I'd say to you, however, with hindsight the bottom line may have been a little closer to our expectation coming into the quarter, but certainly isn't what we would have expected with the revenue level that we had.

I would say that is consistent with my thoughts. Thanks.

We would have though that with that revenue level, earnings would have been considerably stronger.

That's all I have.

Kenneth Pounds with Nutmeg Securities.

I just have a quick question. I'm curious about -- you said the new products in the oil and gas sector -- I'm quite focused on that area. Maybe you can expend a little bit about what you think your opportunities are there.

The products -- we have always participated in oil and gas applications but in relatively small areas. A lot of what we have sold in the past have been used in undersea drilling applications where they are doing directional drilling and they have instrument housings and take advantage of our product strength and corrosion resistance and the fact that it is nonmagnetic. Increasingly with our new ToughMet productline, we have products that are increasingly attractive for not only down hole applications but in various recovery productlines that are in test. We are working on a new welded tube product as an example that would be capillary tubes for secondary and tertiary recovery in under sea wells. We are also working on various housings and components particularly in sour gas or sour well applications. So we believe it is a very attractive market opportunity where our products can play well.

It sounds like it would be quite a large market if you could get some more effective penetration there.

We agree. I mean, it is a very long process to get approvals and to ultimately gain traction in this market. But we have had a lot of success. We have just passed a very significant test -- a joint industry program that looked at various different materials for their applicability and corrosion and strength resistance in the oil and gas, particularly sour well applications and came through in good shape so our team is encouraged there.

Great. Thank you.

And it appears there are no further questions. I will turn the call back over to Mr. Hasychak for any additional or closing remarks.

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

That will conclude today's conference call. Thank you for your participation and you may now disconnect.