Materion Corp (MTRN) 2005 Q2 法說會逐字稿

OPERATOR INSTRUCTIONS . Good day everyone. Welcome to the Brush Engineered Materials, Inc. second quarter 2005 earnings release conference call. Today's call is being recorded. With us today for opening marks 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 and Chief Executive Officer and John Grampa, Vice President of Finance and Chief Financial Officer. Jim Merritt, Vice President and Corporate Controller who normally participates on this call is on vacation.

Our format for today's conference call is as follows. John Grampa will comment on the second quarter 2005 results and the outlook. Thereafter, we'll 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 3162104. The call will also be archived on the company's website, BEMINC.com. 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 yesterday, July 28th.

And now I'll turn it over to John Grampa for comments.

Thank you, Mike. Good morning, everyone and welcome to our second quarter call. Thanks for joining us today.

As in the past, I'll review the quarter and comment on the outlook. Then we'll open the call for questions.

I would like to try to reinforce some of the comments made in the press release today and especially those related to mix and margins. I'll also comment on the key changes in the balance sheet and talk in more depth about mix and its impact on the quarter, as well as the outlook. And hopefully I'll be able to preanswer some of your key questions.

As you know, yesterday we reported results that were slightly better than expectations. Sales for the quarter were up 5% to 134.7 million, our strongest revenue quarter in over four years. EPS was 29 cents per share, our second strongest quarter in over four years.

You'll recall that we entered the second quarter with weaker conditions than we would have liked in segments of the automotive, electronics and telecommunications and computer markets. These conditions did not improve in the quarter. In fact, conditions in automotive weakened further in the U.S., as well as in Europe during the quarter.

Helping to mitigate this were three factors. Stronger conditions in many of our other markets, the gains we made with new products, and additional shipments of our materials for the James Webb Telescope program.

While sales were better than our expectations and better than prior year, earnings were below prior year by about $1.1 million. The benefit of the higher sales was offset by a very unfavorable product mix, a problem we've had now for three consecutive quarters. In addition, higher copper prices, exchange losses and evaluation adjustment of a financial derivative combined to hurt earnings by about $1.6 million in the quarter compared to the prior year.

To be more specific, volume added about 1.8 million of margin in the quarter while mix hurt margins by about $1.6 million. Mix and higher copper prices combined to drive margins down, gross margins down by 1.3 points compared to the prior year.

To explain the mix further, let me share some specific data. In the first half, compared to the prior year, sales in our business units that are largely dependent on the computer telecom and automotive market segments, which represented about half of the company's total revenue in the first half of 2004, have declined by approximately 11% in the first half of this year. This is a tough comparison because our sales here actually grew by over 26% in last year's first half. And were actually up about 7% compared to the second half of last year.

Coming into the year, we felt that these markets would be stronger and that we would be flat to up slightly in these areas, not down by 11%. The weaker performance in this segment is driven by U.S. auto builds being down and order pushouts now in Europe. Telecom infrastructure orders have been weak and there is some slowdown visible in China as well.

Our current estimates suggest that the second half of the year will be up 5% in these areas, bringing the total year to a net down of 4% in these markets. Our margins inside these markets are down 2.5 points versus the first half of last year, driven by mix inside the market and higher copper prices.

Our bulk for materials business to the oil and gas, industrial components, aerospace, and heavy equipment markets grew by approximately 18% in the first half of the year, aided by new products. These markets started to grow in the second half of 2004 and continued to look good.

Williams Advanced Materials grew 10% in the first half, with their magnetic media and semiconductor businesses growing almost 2X. This was driven by new products. The wireless and traditional businesses at Williams are gaining momentum now, following a weaker start to the year.

The Webb Telescope materials added about 3.5 points of growth at good margins, aided in part by shipments that were originally expected to be made in the third quarter.

I'd also like to comment on our continued progress in some other areas. Just as the initiatives to broaden our base helped the quarter, so did our continuing efforts and focus on lowering costs and improving our balance sheet. For example, while sales have grown 4%, employment is essentially flat. SG&A as a percent of sales dropped to 15.1% compared to 16.5% for all of 2004. Inventory in receivables, while up in dollars from year end 2004 due to seasonal factors, are down on an average basis as a percent of sales. Thus far, this year, debt has been lowered an additional $19.4 million. Debt to debt plus equity stands at a very respectable 19 to 20% level.

And we completed a new expanded precious metal credit facility which adds flexibility at a lower cost. This completes a series of refinancing transactions put in place over the past 18 months which, together with the mid 2004 equity transaction, have reduced interest costs substantially while adding significant financial flexibility and liquidity.

I'd also like to reconcile three of the most obvious and significant changes in the financial statements that were published yesterday.

First, our cash balance declined by $38 million in the half from about $49 million at year end 2004 to about $11 million at the end of the second quarter. Most of this occurred in the first quarter. Our cash balance actually climbed in the second quarter by about $2 million. Approximately half of the year's change went to reduce debt. In addition, we made a planned $5 million contribution to our pension plan in the first quarter. These were both previously announced.

The remainder, about $13 million, supported the seasonal growth of working capital and payments of other accruals.

In our segment reporting, included in the press release, there are two points worth noting. You'll notice a $2.2 million drop in the all other segment profit for the quarter. This drop is driven principally by mark to market valuation differences of an interest rate swap and various corporate expenses including Sarbanes-Oxley compliance costs comparing to the prior year.

You also note in the segment reporting a flat operating profit on a $4.5 million second quarter sales increase in microelectronics. This is due to inventory valuation differences between the two periods of approximately a half a million dollars. Metal prices and higher costs which are in part related to our acquisition in Ireland.

As for the balance of the year, we're confident that we'll continue to advance the company. Our global markets are expected to continue to present solid growth opportunities.

While there are encouraging signs for the near term, we're cautious. We believe that sales growth for the year will be consistent with our previously stated range of 4% to 8%. We believe that gross margins will be flat to down by as much as a half a point. That's due to the impact of mix and copper prices that we've seen thus far this year. It is also dependent upon the mix the balance of the year.

We had previously expected margins to grow, along with higher growth in the computer and telecom and automotive segments. We expect to continue to control overhead growth to below the sales growth rate. We anticipate making continued progress with working capital, and believe the capital spending will remain 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 for 2005 in total, which means that the second half interest should be approximately the same to a little bit less than the first half of the year.

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 $300,000 to $400,000 per quarter in the second half.

Our $30 million subdebt becomes prepayable in December. As the second half the year progresses, we will assess its prepayment. Our forecasts and planning at this time suggest that we will do that. If done, it will yield an interest savings on an annual basis of approximately $4 million as we move into 2006.

For the second half, our current estimate is for the sales to grow by up to 10% compared to the prior year, and be up slightly compared to the first half, with an upside or downside in dollars of about 5% compared to the first half. This is good growth and it is counter to the usual trend of a slower second half compared to the first half due to continued growth in our industrial markets, continuing rapid growth in media and semiconductor, and some improvement in telecom infrastructure and computer electronics.

As for the third quarter, our order pattern is up slightly and there are some early encouraging signs.

I have to continue to remind everyone though, that it is really difficult to get clear, short-term signals from our varied and geographically dispersed markets. Our lead times continue to be short. The changes in order rates quickly translate to higher or lower sales in a given period. With generally higher incremental margins, small changes in revenue can have a rapid, noticeable effect on earnings, as can changes in mix as we have seen. We are very sensitive to volume and mix shifts and we do have significant upside potential.

Assuming that our order pattern continues as is, and our mix and operating conditions remain about the same, we would expect revenue for the coming quarter, the third quarter, to be in the range of 5% up or down of last year's third quarter. Operating margins are expected to be similar to the prior year's levels.

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

Thank you, sir. OPERATOR INSTRUCTIONS Our first question today will be from George Nissan with Merrill Lynch. Please go ahead.

Thank you very much. Gordon, a couple of questions.

Over the past year, a lot of your competitors have recently been implementing some new strategic initiatives to reduce their raw material costs in a very challenging economy that we're seeing, by establishing a better line of communication, opening a more collaborative approaches with their supplier base.

I'm interested if you can provide some color today as to what you plan on doing for the remainder of the year, in the next couple of years as well, in terms of reducing raw material costs by establishing a better line of communication with your suppliers.

The major raw material that we are obviously exposed to is copper. In that case, we're working with our major copper suppliers daily and have agreements in place with them relative to supply availability, stocking of our materials.

But all of those prices on copper are clearly indexed to the metal exchanges, and so while we have great availability and terms, we're certainly still locked in to the markets that we are faced in copper.

So, for us, I think we have good relationships. I don't know that there is a lot we can do on pricing. So, for us, most of what we work on internally is making sure we drive yields up and improve our utilization of materials.

I guess to follow up on what you're saying utilization, what I meant by pricing, how are you making sure those pass-throughs are keeping your supply chain costs down? Your entire supply chain? Are you keeping some of your plants closer to suppliers to reduce logistic cost? What are you doing to make sure those overall costs are lower than your supply chain costs?

Well, again, in the case of copper, we have a very close working relationship with a couple of our key vendors, one of which actually consigns inventory for us at a stocking location which is relatively short distance from our Elmore plant facility. So, we have very short delivery times and are not certainly exposed to having to carry large quantities of copper to meet our production requirements.

One thing I've noticed for the past couple of years by following your company is quality has always been a top priority over your company.

What are you guys doing to make sure your supplier base is meeting your quality standards? Are you scorecarding them on a regular basis to make sure they meet your objectives? Are you meeting with them through global supply forms? What are you doing to make sure they're meeting your strong metrics?

Again, as you point out, we have adopted and have really, I think, been rigorous in our lean sigma (ph) techniques and clearly look to our vendor base as also adopting those same principles so that we have reliability of supply from them and can achieve our input quality that we need. So, again, in our case, because we are a primary metals producer, input material frequently almost by definition meets our requirements.

In other words, we're buying pure copper chopped rod or we're buying precious metals from our vendors there that are four nines or five nines pure so we have very clear standards and vendors that meet those standards.

Are your logistics costs continuing to be a concern or be under pressure? What's your feeling on those?

Typically not. Again, we have, as an example, in our alloy business, a very strong working relationship with a transport company. Again, we have continually looked at the costs associated with that, and I believe, although I'm not the expert on the logistics side, everything I get from our guys would indicate they're extraordinarily pleased with the quality of service because, in our case, again, to your point about efficiency, our alloy business, as an example, has dropped dramatically its working capital as it has achieved literally a 50% reduction in its cycle time.

The time to reliably replenish materials into our metal service centers has dropped from over 40 days to around the mid 20s now. And that's a function of many things, operating our own facilities, but also finding effective ways to get product to where it needs to be quickly.

And final question. What's been your supplier feedback? Do they feel like, obviously, copper prices what they are, do they feel like they're getting squeezed by you guys, or are they willing to work with you in this challenging economy? What's been their feedback?

On the copper side?

Yeah, on copper, any type of supplier cost you're looking at.

Well, I think on the copper side, again, our key point there is to try to gain a view of where copper markets are going. And we have an active hedging program. The good news is going forward, we now have about 50% of our copper hedged so we -- it starts to now allow us to take of some the variability out of our -- out of our input materials.

Okay. Thank you very much. Good luck down the road.

Thanks.

At this time, we have one question remaining. As a reminder, if you would like to ask a question, please press star one to signal. We'll take our next question from Anthony Sorrentino with Sorrentine Metals. Please go ahead.

Good morning, everyone.

Hi, Anthony.

Hi. How has the strength of the U.S. dollar this year impacted your company, not only in terms of financial reporting, but also in terms of your competitiveness and your ability to pass along higher copper prices?

Anthony, it has actually been difficult in the foreign markets to get quick response to passing along not only the higher prices of copper in those environments, but also the impact, as you point out, of the dollar. The foreign markets, especially those in Asia, are relatively price sensitive, and so we're finding that as we attempt to pass on both copper prices, as well as impact of currency, that it is taking more time although we're making progress, it is taking more time.

Year over year, in the first half of the year, we have a $1.3 million benefit to sales from the currency in the top line, but in the bottom line, I'll find the number here, we're impacted year-to-date by about 1.3 million due to copper and another $400,000 due to currency.

Okay. What effect do you expect from the revaluation of the Chinese yuan, in the short term, and in the long run?

In the short term, almost nothing. I think it will take time for the economies and pricing of any kind, manufacturers and distributors, et cetera, to respond to movement there. I think it could take months, if not years, to see significant impact so the short term, we don't anticipate any impact at all.

All right. And what would you expect or -- would you expect your product mix to remain about the same for the rest of 2005?

Our assumption is that it will remain about the same. Perhaps -- perhaps improve slightly, if anything.

Okay. Could you go into a little further detail as to what parts -- how the product mix might be less favorable and where it might be richer?

Well, it has been less favorable in segments of our computer telecom and automotive market for about three quarters now. It's -- we've seen telecom infrastructure be weaker than it had been in the first half of last year, but we think we'll see modest improvement in the second half of this year in the telecom infrastructure area as an example.

On the consumer electronics front, and on the automotive front, in automotive, there may be some rebound given the aggressive initiatives taken late this spring and into the summer by the U.S. "Big Three", but for now, we're kind of assuming no better than same level as last year in that market as we go forward.

Consumer electronics, most of the signals we're reading suggest there should be a better second half here. In part due to some inventory adjustments that may have been going on in the first half, and also in part due to maybe the seasonal factors related to Christmas coming into the picture.

On the media or the disk drive front, this has been strong and we think it will continue to be strong.

And on the heavy industrial equipment side, for example, where we've had good growth because of our new products, we think the second half will be equal to or better than the second half of last year.

One soft area is defense. It is a little bit of a wild card for us. The -- we see some defense pushouts. We don't know whether they'll push into the first part of 2006 or whether they'll push only into the fourth quarter, latter part of the fourth quarter this year. So it's a little bit of a wild card for the second half, and maybe a question for 2006 as well, depending upon federal budgets.

All right. Fine. Thank you very much.

We'll take our next question from Greg Macosko of Lord Abbott. Please go ahead.

Yes. Thank you very much. I may have missed some of the first half. It was difficult getting the correct number for the conference call. So, I may ask a few questions that were answered earlier.

With respect to the kind of the outlook here, I think you mentioned the fact that there was not much of a turnaround into the third quarter, is that correct? In terms of the first part of the third quarter?

That's correct. Not much but a little. We did say that we saw some lift in order entry coming in the first part of the quarter but our assumption is we're being cautious and it is not a lot.

And is that more Europe than the United States or both?

I would say it is more United States and Asia than it is Europe.

You did mention that Europe had softened as well though.

Europe softened principally in automotive. There were some pushouts in automotive that we noticed in the Euro border entry during the second quarter and a little on the consumer electronics front too, as well, but mostly automotive.

Have you been been able to get any sense of -- there has been a number of mentions about inventory at customer locations and the like. Have you been able to get a better gauge of that going forward than you've had in the past?

I think we feel that particularly on the infrastructure side, which is where I would argue we felt it the most, that that's largely behind us. So, I think that's partly is where John was commenting that there could be some lift in the back half of the year, because we do believe that, to the extent that there was some working off of inventories, that that is largely behind us. Even in the handset market which was weak early in the year, that picked up nicely in the second quarter and we believe it will stay strong through the balance of the year.

So, your sense of in, basically all of your markets, the inventory levels are kind of back to normal?

I'm not hearing anybody talk about excess inventories in the supply chain right now.

Good. And then with regard to microelectronics, there was some -- I guess reasonable growth there. But profit margins, I believe were down.

That's right. I commented on that, Greg. Perhaps before you got on the call. That -- that was one of the key changes in the segment reporting that was real noticeable. The -- let me find my comments and I'll walk back through them.

Thank you.

There was actually a flat operating profit in the second quarter on about a $4.5 million sales increase, as I see the numbers here, and it is due to inventory valuation differences between the two periods of about a half a million dollars. Metal prices, driving the sales level up, prices of precious metal principally and higher costs, in part related to the recent acquisition, but generally a little higher cost inside that business.

So, on the precious metals side, you have not been able to pass the costs on just yet?

No, what we're saying is that inflates -- we do pass it on. Precious metals a direct pass through. It inflates sales without necessarily inflating VA, for example, value add our margin in dollars.

I see. Okay. And then you said finally, then you said the recent order entry in the automotive manufacturers has improved and that's just generally across the board or is that in particular product areas?

I wasn't speaking principally to automotive as much as I was speaking to computer telecom and automotive, all three together improving slightly near the end of the second quarter and into the third quarter to this point. But I also qualified that as well, Greg, with it is difficult to see near term what's going on and that changes fast sometimes for us. But it is all three.

Okay. And then, finally -- and then finally, I guess, what I sense from the quality of your comments and the statements you made in the release, it sounds as if you're putting a great deal more attention on controlling costs.

We've paid attention to controlling costs for several years now. And we have not backed off of any of our initiatives in that area.

There are some cost reductions that we're putting in place in metal systems principally, and possibly a little in microelectronics in the second half of the year, depending upon business levels, but here at this point, from the reduction of people perspective or something like that, it is not relevant in total. Our biggest initiative, our effort is continuous, largest effort is in yield and inside manufacturing.

And that continues to go very well.

Thank you.

At this time, we'll hear from Martin Hillbrun with the Winchester Group. Please go ahead.

Hi. I get a sense that you've become a little bit more optimistic versus the end of the first quarter. Is that a correct assessment?

I would say yes. I think for the reasons we were just talking about, Martin, I think we feel that, to the extent that there was some inventory correction going on, that that is largely behind us, and as John in his comments indicated, we've seen some lift recently in our order, incoming order rate.

Good. Good. I also -- excuse me, I have a cold -- that you has some beryllium hydroxide sales in this quarter.

Correct.

How does that -- what does that fall into the profitability, is it like a corporate average or above, below?

We don't comment on particular pieces of business per se, Marty. It is about the corporate average though. I wouldn't get specific.

Okay. I assume it is going to your Japanese competitor.

Yes.

Okay. A couple of things on your balance sheet. I notice that your equity went up $3 million, shareholder equity, and yet your net income was well in excess of that for the six months. Was that a markdown of international assets and evaluation?

No, no. Let me explain this. This is a little complicated but let me explain it for everybody. It is a good observation.

Earlier in the year, midway through the first half, we made significant changes to our pension plan, and the net effect of the changes was to reduce cash contributions in the future and lower future pension expense for the company. Very wise thing for us to have done.

The net effect of that means that under the pension accounting rules, you remeasure the plan assets at that point in time, as opposed to year end. The significant change caused us to remeasure.

When we remeasured at this point in time, the discount rate is about 25 basis points lower than the discount rate that existed at the last remeasurement point, which would have been year end. That discount rate change affected the future liability of the plan, which then translates into another comprehensive income adjustment. And that adjustment was approximately $6 million.

That's a direct charge (indiscernible).

Direct charge to other comprehensive income, that's correct.

In addition, that causes the deferred or the prepaid piece of the pension plan, which is related to prior service costs which have not yet been amortized, to also be charged to other comprehensive income, so there was $11 million charge to other comprehensive income that reduced equity.

Okay. Okay. I also noticed that you had roughly a $10 million depreciation. And about -- actually your depreciation exceeded your capital expenditures by about $5 million.

That's correct.

And yet your net plant account went -- wait a minute. I misread it. Your net plant account went down.

Yes.

I -- I -- Okay.

Depreciation is exceeding.

Okay, I get it now. I misfigured it. Okay. I was looking at the depreciation line, looking at it as the net line. Okay. I withdraw the question. Okay.

Okay.

Okay. Next question is your hedging. What kind of cost is involved to hedge? In other words, how much would that increase hedging have cost you?

If you're referring to copper --

Yes.

We do copper swap so we're just paying fixed versus floating. Or we set in and we do pay an average price and that's how it works. So, it is not -- we're not doing an option where we're paying something for the option. If that's what you're asking.

Oh, okay. Very good. Okay. Now, you will have your vacation slowdown this month, am I correct on that?

Actually, Marty, no. In the past, we have had summer shutdowns. You may recall from prior conversations that we have worked ourselves into an environment where we do rolling maintenance and scheduled maintenance on the significant pieces of equipment.

And as a result, we do not take a shutdown in Elmore and we took a short shutdown last year and we're not taking a shutdown this year.

And that's future as well?

Yes.

Okay. Very good. Well, I'm pleased with the results. Thank you.

We have one question remaining in the queue. And that comes from David Trump with Corbin Investment Management. Please go ahead.

Yes, I'm curious about you talking about prices being passed through. You said the prices on the precious metals have passed (indiscernible) but what about copper? In terms of copper, I know it has been hard for a lot people who use this as a raw material. What percentage do you think of your copper price has been able to pass through at this point in time and how do you think you'll ever really catch up?

We're passing through about 60% of our copper, so about 40% of it we cannot pass through.

That's mostly related to competitive factors and in some cases, where we provide annual contracts to customers where we lock in copper for a set period of time which is really why we do our hedging. So that we -- I think what we struggled with was the very rapid movement in copper price and in some cases, competitive factors in Asia in particular, have made it difficult for us to get to fully recover that.

It is something we remain very alert to and any time we have a chance, we'll recapture that and through hedging, which is now we have certain hedges in place that are clearly below the current co-max (ph) price for copper, we'll start to re-claim some of that as well.

Okay, so it always will be slightly the discount because as you say things are kind of tough out there for pricing. So, you might get up to 70%, 75% but you'll always be eating some of that I assume, going forward.

Yeah, and or, it goes both ways, too.

Yeah.

Obviously when copper starts to come down, we do see and expect to see a lift. I think right now, our forecasts are for copper pricing to start to moderate.

Okay. Thank you.

We have one further question from Brian Harvey with Williams Smith and Company. Please go ahead.

Hi, thank you. I just want to talk quickly about Williams segment. Obviously been doing pretty well as it was in the past. As far as the acquisition that was recently done, the OMC Scientific, can you just comment on how that's going to contribute to revenues in the future and any cost synergies there?

Sure. OMC is in the business of what is called shield kit cleaning. As you may recall, Williams is very active in the physical vapor deposition market. The equipment that is used to actually sputter or deposit these materials frequently ends up with the material, not only on the substrates that you're trying to deposit it on, but the actual shields and the chamber itself.

The OMC is in the business of these chamber servicing, so we'll literally receive from customers the full chamber and we re-claim all of the metals off of that chamber, can refurbish the equipment and then send it back to the customer. So, it is a real -- it is a service business whereby we can reclaim metal as well as refurbish the equipment.

OMC has a very strong position serving the U.K. Ireland market where there are semiconductor fabs. We're going to use their technology to both penetrate eastern Europe where we expect to put a facility up in eastern Europe to also help us gain position in Europe and are taking their knowledge and technology to allow us to start to do that here in the United States. So, what it really does is allow us to become an even more full line provider of not only materials, but services to those individuals who are doing sputtering or vapor deposition.

All right, thanks. Actually, just a clarification. I think you mentioned a number 10% sales, not the Williams segment that was just up but going forward, I think you mentioned a reference to the second half of '05.

Second half versus second half of last year.

Okay. Thank you. Thank you.

You bet.

It appears that there are no further questions at this time Mr. Hasychak. I would like to turn the conference back over to you for any additional or closing remarks.

I would like to thank all of you for participating this morning. I'll be around for the remainder of the afternoon to answer any questions. My direct dial number is area code 216-383-6823. Thank you.