Materion Corp (MTRN) 2005 Q1 法說會逐字稿

Good day, everyone. Welcome to the Brush Engineered Materials Incorporated first-quarter 2005 earnings release conference call. Today's call is being recorded. With us today for opening remarks and introductions we have Michael Hasychak.

Good afternoon. This is Mike Hasychak, Vice President and Secretary-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 first-quarter 2005 results and the outlook. Thereafter, we will open 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 6489882. 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 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 welcome to our call and thank you for joining us today. I will review the first quarter and then comment on the outlook, and then we will open the call to questions.

As I have in the past, I would like to reinforce the comments that were made in the press release. I will also review the key changes in the balance sheet and in the P&L and talk in more depth about mix and its impact on the quarter as well as the outlook. Hopefully, I will be able to preanswer some of your key questions.

You will recall that as we entered the first quarter of this year, we entered with a weaker backlog than we would have liked. Automotive electronics had weakened in the second half of last year and there were mixed signals coming from the telecommunications and computer markets. Japan had also weakened and Southeast Asia began to experience a slower growth in the second half of last year as well.

Following four consecutive quarters of strong growth, growth that averaged 26%, we grew 8% in the fourth quarter of last year, and during our last teleconference, we indicated that we expected a growth rate of up to 8% for the first quarter of this year, below our own expectation at a minimum sustainable ongoing growth rate of about 8% over time. We expected earnings for the first quarter to be in the $0.25 to $0.30 per share range. We subsequently reinforced the sales range for the first quarter, and estimated the earnings would be in the $0.20 to $0.25 per share range due to a mix shift that developed late in the quarter.

As you know, today we reported earnings consistent with those expectations. Sales for the quarter were up 4% to 130 million and net income was up 14%. Earnings or EPS was near the middle of the published range at $0.22 per share, equal to prior year's EPS. Excluding the $600,000 or $0.03 per share non-recurring, non-cash charge related to the prepayment of debt, our net income would have grown by 30% on the 4% sales increase. We did see good leverage from the added revenue in spite of mix and margin pressures.

To be clear, the $0.03 per share charge is not the reason our earnings were below our original forecast range. The reason was a difference in our revenue expectations by market and products mix within markets, which drove our margins down. This became obvious late in the quarter. Weaker conditions than we had expected in the electronic equipment market coupled with soft automotive segment translated into a weaker mix inside metal systems and, in turn, yielded lower contribution margins than we would have otherwise expected, which in turn affected gross margin for the Corporation by about 1 percentage point in the quarter.

The full impact of the weaker mix was partially offset by growth in other areas plus lower overheads and lower interest expense. The conditions in the weaker markets were offset also by stronger demand for our materials in the magnetic media, semiconductor, and industrial component markets. Another offsetting positive factor was sales of materials for the optical mirrors for the NASA James Webb space telescope program.

We also continued to make good progress in the quarter with our new products, as well as with our initiatives to reduce costs, lower working capital, and lower debt.

To explain the mix further, let me share with you some specific market data. In the first quarter, compared to prior year, sales to our computer, telecom, and automotive market declined by approximately 8%. Again, that is comparing to the first quarter of last year. This is a tough comparison because our sales to these markets actually grew over 25% in last year's first quarter, and were actually up about 10% compared to the previous two quarters. We were expecting more growth.

Our bulk form materials business to the oil and gas and industrial component and aerospace and heavy equipment markets grew by approximately 20% compared to the prior year. This was aided by new products. These markets started to grow in the second half of last year and continue to look good.

WAM grew 5%, with their media and semiconductor business growing nearly 30%, driven by new products. WAM's wireless and traditional business was down about 5% versus prior year, again due to softness in computer and telecommunications. And the Webb telescope business added about 5 points of growth overall for the Company.

I would also like to now comment on the first quarter's progress in some other important areas. Just as the initiative to broaden our base helped the first quarter, so did our continuing effort and focus on lowering costs and improving the balance sheet. To that end, we continue to make good progress. For example, in the first quarter, while sales grew 4%, employment dropped 1%. SG&A as a percentage of sales in the quarter dropped to 15.3%, compared to an average of 16.5% for all of 2004.

Inventory receivables, while up from year-end 2004 due to seasonal factors and due to the growth in the business, is down as a percentage of sales. Debt was lower at an additional 19.4 million in the quarter. Debt to debt plus equity now stands at a very respectable 20%.

And in the quarter we completed a new, expanded precious metal credit facility, which adds flexibility at a lower cost. This facility completed a series of refinancing transactions put in place over the past 16 months that reduce costs substantially while adding significant flexibility and significant liquidity.

Now I would also like to reconcile two of the most obvious and most significant changes in the financial statements. First, our cash balance. Our cash balance declined by $40 million in the quarter, from about 50 million at year-end to about 10 million at the end of the quarter. Approximately half, or 20 million, of the decline went to reduce debt. We had previously announced our plans to do this. In addition, we made a planned $5 million contribution to our pension plan. This, too, was previously announced. And finally the remainder, or about 15 million, supported the seasonal growth in working capital and payment of other accruals.

Second is in our segment reporting shown in footnote D in the press release, you'll notice a $1.8 million drop in the microelectronics segment profit compared to prior year, and a 2.1 million improvement in all other. The $1.8 million drop in the microelectronics segment is 0.5 million of costs allocated by corporate, 0.5 million of margin loss due to mix, and about $1 million of inventory valuation differences between the two periods. The $2.1 million improvement in all other is driven by higher corporate allocations to both segments, lower corporate center costs, and differences in the marked-to-market valuations of an interest rate swap and a deferred compensation plan.

Before moving on to the outlook, let me close on the first quarter by saying that while we did not get all of the growth in revenue and net income that we expected, the first-quarter sales level was the highest in over four years and the net income was the second-best in four years. In addition, new sales order entry exceeded shipments in the first quarter.

As for the balance of the year, we are confident that we will continue to advance the Company. Our global market continues to present solid growth opportunities. We do, however, believe that sales growth will be below our previously stated long-term goal of 8 to 12%. We had previously indicated that with a slower start to 2005, the lower end of that range may be more realistic. Given current market conditions, we now believe that a growth rate of 4% to 8% is more realistic for this year.

We expect to continue to control overhead growth to below the sales growth rate. We believe that gross margin will grow by up to a point, and that is dependent upon mix the balance of the year. We anticipate making continued progress in working capital and believe that capital spending will continue to be well below depreciation rates.

Given the debt reduction of 2004 and early 2005, we expect interest expense to be approximately 2 to $2.5 million lower in 2005 compared to 2004. Since the Company has sizable off-balance sheet deferred tax assets, the federal tax expense on domestic income will continue to be limited. We expect the total tax, which includes federal tax plus foreign tax, as well as state and local taxes, to be in the range of 300 to $500,000 per quarter.

Our $30 million sub-debt becomes prepayable in December of this year. As the year progresses, we will assess its prepayment. Our cash forecasts in our planning at this time suggest that that is doable. If done, it would yield an interest savings of over $4 million annually.

Therefore, for the year, our current estimate is for sales to grow by 4 to 8% and for 2005 earnings to be up significantly, but below the $1.30 low end of the previously provided range.

As for the second quarter, given the mix shifts and the softness we saw in certain markets in the latter part of the first quarter, we are seeing a second quarter that is similar to the first. Our order entry pattern is up slightly and there is a little mix improvement. I have to continue to remind everyone, though, that it is really difficult to get clear signals from the varied and geographically dispersed markets we serve. Our leadtimes are short. Changes in order rates can quickly translate to higher or lower sales in a given quarter.

With incremental margins in the 35 to 50% range, small changes in revenue can have a rapid, noticeable effect on earnings, as can changes in mix, as we just saw in the first quarter. We are very sensitive to volume and mix shifts. Assuming that our order entry pattern continues as is and our mix and operating conditions remain the same, we would expect revenue for the second quarter to be in the range of up or down 5% from first-quarter levels.

Operator, those are my prepared comments. We will take questions now.

(OPERATOR INSTRUCTIONS) Anthony Sorrentino of Sorrentino Metals.

Good afternoon, everyone. Would be fair to say that your margins are likely to remain under pressure until we see some kind of improvement in your largest markets?

That is correct, that would be fair.

Okay, and with regards to copper prices, would you expect to fully recover the higher copper prices over the course of this year?

No, Anthony. I think that, as you well know, our ability to pass on copper prices has been under some pressure now for four or five quarters and our margins are being squeezed as a result. Our anticipation is that about half of the copper price that we saw in the first quarter of this year was not passed along. We would anticipate perhaps doing a little better than that as the year progresses, but if copper remains as high as it is and continues to climb, we might see additional market squeeze -- or margin squeeze.

Okay. Have you put into effect some kind of copper price hedging program?

Yes, Anthony. We do have some hedging out there to help protect us from further escalation in price.

But we are not 100% hedged.

Okay. Thank you very much.

Bob Schenosky with Jefferies & Company.

John, Gordon, when we sat down probably a month ago, the tone seemed more bullish obviously than we see today. Can you -- I have a couple questions. The first one, can you point out are there any specific substantial customers in some of these markets that have pulled back? And do you sense it's cancellations or is it simply pushing orders back?

My guess is that -- first off, I don't know of any major one customer that has really pulled back in any way or in any -- that would be responsible for the overall shift. I think what was surprising in the quarter, particularly towards the end and in March, was the softness that we saw related heavily to computer and the telecom segment, and automotive to some extent as well. And it showed up not just in North America but, interestingly enough, in Asia as well.

Admittedly most of what we're selling in Asia is exported back out of the country, either to Europe or North America, so it is probably a fundamental reflection on demand here. And I think we feel that most of this is a function of inventory adjustments that are continuing to go on, that customers are running very tight and are avoiding putting any amount of excess in. And so small changes in end-use demand manifests itself in slowing demand for our materials.

Let me add a bit to that to reinforce my earlier comments and maybe even clarify. While we were down in computer, telecom, and automotive by 8% versus the prior year's first quarter, compared to the second half of 2004, our shipments into these markets were up 9%. So the real problem in the first quarter was not the volume was up, but not up as much as we had anticipated that it would grow in that segment, and the majority of the miss versus what we anticipated occurred with a drop in the order entry rate late in the quarter. So we did see some growth in the segment in the first quarter.

Thanks, John. Part 2 to that -- and this kind of builds into what you're talking about for the balance of the year then -- in the 4 to 8% you talked about just below $1.30 or below, can you give us a sense of -- if let's say we are looking at $1.25, $1.30, just below that range, what are you building in to get there? Is it the 4%? Is it the 8%? Based upon what you're seeing today and a much more conservative stance that you're taking, where do you think the risk lies in the forecast? Is it if this is just inventory, the risk lies to the upside? Or are you being a little bit more optimistic than maybe you should be that the risk is going to lie to the downside? I know that is a difficult question, but looking at your budget for the second half based upon what you see here today.

I think the risk is equal on both sides. The growth rate that we put into the press release of 4 to 8% for the year would represent at 35 to 50% kind of variable margins, a shift in either way will have a significant impact on the earnings with the flowthrough rate that we have been seeing of around 30%. It could be significant impact on the bottom line either side of that number.

I think we tried to pick the middle road here. I don't think we either tried to be optimistic nor conservative. Yes, there are factors that could take it either way. I am encouraged, as John in his remarks talked about, the growth that we are seeing outside of our traditional products; the bulk product area in particular was very encouraging in the quarter. Our ToughMet products going into oil and gas, heavy machinery, and aerospace were all very positive. Williams had a good quarter with some of their new products. The sputtering materials going into the magnetic media and semiconductor markets.

So there was a lot of positive news in the quarter and I have no reason to feel that those won't continue to help us for the balance of the year.

But as you know, we still do remain very heavily dependent on computer telecom as a primary market, north of 40% of our total revenue. So it does have a real impact on the business. But to your earlier point, I don't see anything fundamentally wrong with those markets, but I do think that it is clearly not growing at the pace that we would have seen a year ago. And it is clear that there is a skittishness in the market, as you have seen some companies reporting reasonably good results and others not seeing those same results. So it just tends to be difficult for us to read with any level of certainty.

I appreciate all the positives in the quarter, Gordon, especially what you're doing with the balance sheet and the cash flows. But if I could just to kind of tie that up then, is it fair to assume then that in the expectations you're building in, you're not accounting for a big positive mix shift? You're certainly taking into account the seasonal patterns in automotive in the third and fourth quarter as well, and not a major step-up in the telecom expenditures for the balance of the year. Is that a fair statement?

That's a fair statement.

Very fair statement.

Mark Parr with Keybanc Capital.

Good afternoon. I wanted to talk a little bit about the copper issue. Do you have an estimate that you can share with us as far as how much of the copper pass-through opportunity was foregone in the first quarter?

About $0.5 million.

A little bit higher than that, yes.

0.5 million to $0.75 million.

Okay. And that was incremental (multiple speakers) -- pardon me?

Margins squeeze -- it appears, as you know, in the margin squeeze.

Okay. So that was incremental to what was there in the second half of '04?

Yes.

And if you take the -- I guess there was some ongoing with lingering pricing levels from copper escalation in '04 as well. Is that fair?

Not sure I understood what you were asking, Mark. Could you clarify?

Meaning that there was some business that you shipped in the second half of '04 or some products that were priced at levels that did not reflect the copper pass-through number. I'm just wondering -- maybe the 750,000 is the only number I need to worry about. That is really --

That is.

Just another question on top of that. What is the cost of your copper hedging program from a P&L perspective?

We normally in -- we have hedges out there, Mark, at different rates and in different months. So there is no impact here on the first quarter; actually the hedges don't even kick in until the second quarter. So there is no current P&L impact of putting this hedge program in place.

All right. One other question. The other income, John, that you talked about that involved some corporate allocation, I guess that was earnings that positively impacted the quarter. Is that right -- what -- $2 million?

You're referencing the other segment? No, there were higher charges from corporate to the segments, so there would have been a shift between segment and the "all other" section of about $1 million of that $2 million movement. So $2 million is not an improvement. The other million is, I believe, two factors. It is the marked-to-markets related to our interest rate swap and the marked-to-market related to our stock-based deferred comp plan. That would have been a year-over-year improvement.

All right, terrific. Thanks for the clarification on that and I will pass it on. Thanks a lot.

(OPERATOR INSTRUCTIONS) Martin Hillbrun (ph) with Winchester (ph).

A couple of questions. One, in your current liabilities, you have the other liabilities and accrued items, which went from 50 million down to 32 million. What is that?

That would include the pension payment that we made, the contribution to the plan, the $5 million that John alluded to, as well as payment of our annual incentive compensation that was earned last year and other miscellaneous accruals.

The other question, you mentioned that 5% drainage around the first quarter earnings. Is that before or after the 3% debt repayments number? In other words, is it $0.22 base or $0.25 base?

First of all, the base would be $0.25, but the 5% is 5% on sales, not on earnings.

Oh, I'm sorry. I misunderstood.

Just to clarify.

Thank you.

Greg Macosko with Lord Abbett.

Yes, could you just clarify with regard to copper and the pricing, could you give us a sense of how new business and existing business are priced? As you look forward, are your prices basically locked in for the next couple of quarters so you can't pass on the copper? And has that changed since the fourth quarter?

I think it depends on geography as much as anything. In North America, most of our copper is priced based on a Comex price. So it moves -- our pricing will move with copper. The bigger challenge tends to be international, where, as you know, our alloy business does -- about half of its total revenue is outside of North America. Particularly in Asia, where we have more local competition and in particular one competitor who has basically not moved their price to reflect shifting copper, we have largely been unable to pass our copper along in that market. Where we can, we do. But to a large extent in Asia, our ability to pass that copper price on has been hindered as much by competitive pressure than it is anything else.

And has that pretty much been the same in the first quarter as it was last year in terms of North America and Asia in terms of the way it's passed on? Or that is the same as it has been all along?

Correct.

And with regard to the 35 to 50% incremental margins, clearly the mix has deteriorated in the first quarter. Given your expectations, are you assuming the first quarter mix and the entire year, or what are your assumptions there with regard to the outlook?

We're assuming close to the first quarter mix with some improvement as the year progresses.

So then the incremental margin that we saw, you had 3.6% top line and about 10 basis points on the operating line. Is that a fair -- just rule of thumb comparison?

Actually for the current year we had -- yes, we had just under 4% on the top line. And when you look at the pretax line, we had 14% because of the interest savings that we will have in each quarter going forward as well. We would believe that that would be slightly better the balance of the year in each subsequent quarter.

No, but the operating profit line (multiple speakers).

Same way, same relationships. Better each subsequent quarter.

So the relationships should basically hold quarter-over-quarter?

Or be better, yes.

In the annual report, Greg, we commented that we this last year saw about a 30% flowthrough of incremental revenue to our operating profit line. I think that is -- forget short-term mix and currency effects, but that is not a bad relationship that we should as a Company continue to see and expect to occur.

As I commented, we had that in the first quarter, if you exclude the impact of the non-recurring, non-cash charge related to the prepayment of debt.

Okay, thanks very much.

Bob Schenosky.

Just to follow up on Greg's question; I may have missed this -- you may have said his earlier, John, so if you did, I apologize. But you talk about the lack of pass-through. You gave the numbers for the first quarter related to copper. What are you building into the model where you will be unable to pass through copper in the second quarter?

We're building the same margin levels in the model looking ahead that we had in the first quarter with only slight improvement.

Okay, great. And secondly if I could, you briefly mentioned Asia. Could you give us a little bit more color geographically? Beyond simply what you said earlier?

Our growth in our international business in the first quarter compared to the first quarter of prior year was 3%. The total corporate growth was closer to 4. I'd have to glance at it to break it down, but regionally Europe is stronger than Asia and Japan. We are having good performance in Europe, especially through Germany and into the European automotive manufacturers. So our strong point internationally would be in Germany, probably higher growth. I don't have the data in front of me, but 3% on average.

That is contrary to almost every industrial company as related to their comments in Europe. Is it just specifically auto or are there other pockets of (multiple speakers)?

I think it is mostly auto and I think electronic componentry on automobiles that are getting exported to support automotives being assembled outside of Europe. I think we are an anomaly there.

Okay, thanks.

Brian Harvey (ph) with Wm. Smith & Company.

You noted that sales have been weaker in the latter part of Q1. Can you just comment on the sales velocity so far in Q2 and the expected linearity for Q2?

Yes. As we had indicated -- and there are three components to this. As we indicated, we expect revenue for second quarter to be (indiscernible) 5% either way of the first-quarter revenue. As we came into the month of March, especially in the computer and telecom segment companywide, about 40% of what we sell in a month, we receive the orders for in that month, and about 60% of what we sell we come into the month with in the order book.

In the second week of March, computer, telecom, and automotive orders dropped precipitously. They returned in early April to higher levels, to levels approximately the same as they were in late February. So in terms of looking at the second quarter, we came into the second quarter with slightly higher backlog than we came into the first quarter. We had orders greater in the second quarter -- in the first quarter than shipments. So we have a slightly higher backlog and a slightly higher backlog developing now in that market.

So we are optimistic, but we have seen these waves. We have seen these waves in each of the last three quarters. And if we get no other waves, then maybe we will be on the high end of that plus or minus 5% range. If we get another wave, we might be on the low end of that plus or minus 5% range. So I think it is safe to assume that plus or minus 5% is reasonable off of the $130 million shipment rate that we had -- or sales rate that we had in the first quarter.

Thanks for the clarification. Quickly also, the cash position was down about 40 million, albeit on expected, planned cash burn. What is the comfort level for your cash position going forward? Is it expected to ramp up or remain at current levels?

It will definitely ramp up. We have a seasonality in our business. We always burn cash in the first quarter, particularly as you consider, for example, our revenue in the fourth quarter was 116 million. In the first quarter it was 130 million. So there's $12 million or so, 12 to $13 million or so going into working capital in the first part of the year, plus the accrual payments and the pension payment, which are non-recurring. All three of those are non-recurring.

So as we move from the 10 million balance that we had at the end of the first quarter toward the end of the year, we fully anticipate having cash on hand in excess of the amount necessary to prepay the $30 million of sub-debt.

Great, thank you.

(OPERATOR INSTRUCTIONS) At this time, it appears there are no further questions. Mr. Hasychak, please go ahead.

We would 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 further questions. My direct dial number is 216-383-6823. Thank you.

That concludes today's conference. Thank you for your participation.