Materion Corp (MTRN) 2005 Q3 法說會逐字稿

Good day, everyone, welcome to the Brush Engineered Materials Incorporated third quarter 2005 earnings conference call. Today's call is being recorded. With us today for opening remarks and introductions we have Mr. Mike Hasychak. Please go ahead, sir.

This is Mike Hasychak, Vice President, Secretary, and Treasurer. With me today is Dick Hipple, President and Chief Operating Officer, John Grampa, Vice President of Finance and Chief Financial Officer, and Jim Marrotte, our Vice President and Corporate Controller. Our format for today's conference call is as follows: John Grampa will comment on the third quarter 2005 results and the outlook, thereafter we will open up the teleconference call for questions.

A recorded playback of this call will be available for 15 days by dialing area code 719-457-0820, access code number 2045078. 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 from the free icon as indicated. Any forward-looking statements including those in the outlook session, 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 third-quarter call, and thanks for joining us today. As I have in past calls, I'll review the quarter and then comment on the outlook. And then following my prepared comments, we will open the call for questions. I would like to reinforce the key points made in the press release, especially those related to sales growth, cost, mix, and margins. I'll also comment on the key changes in the balance sheet and talk in more depth about material and energy costs, the related actions we have taken, and the impact on the quarter, as well as the outlook. Hopefully I will pre-answer some of your key questions.

As you know, this morning, we reported sales that were better than expectations. Sales for the quarter were up 8% or about $10 million to $135.6 million for the quarter. That's our strongest revenue quarter in over four years. Net income was up 14% and EPS was up to $0.20 a share from $0.18 in the prior year. The third quarter was the 11th consecutive quarter where sales were higher than the comparable quarter of the prior year.

You'll recall that we entered the third quarter with overall order entry improving, but with a weaker mix, due to weaker conditions than we would have liked for the applications that we serve in the U.S. automotive electronics market, telecommunications infrastructure, and defense.

While there was some improvement, these conditions did not materially change in the quarter. In fact, conditions in the U.S. automotive market weakened further, and we continue to see delays in defense spending for the new programs that include our materials. Helping to mitigate this and leading to the good growth was continued strength in demand for our products in the magnetic media, wireless photonics, handset, semiconductor, and industrial component markets, which include oil and gas, aerospace, and heavy equipment.

I should point out that the third quarter is usually a weaker quarter for the Company. Third-quarter sales are generally negatively affected compared to the second quarter, by about 7% due to seasonal factors in Europe, and seasonal factors in the U.S. automotive market. This year, the third quarter actually grew by about 1 percentage point from the second quarter. In the second quarter, the Company had shipped approximately $4 million of high-margin optical mirror material for NASA's James Webb Space Telescope program.

Excluding the Webb business from the comparisons, the third quarter growth in the remainder of the Company, was in the range of 4% compared to the historical 7% drop that we would have expected. While sales were better than expectations and better than prior year, earnings were negatively affected by higher-than-expected material costs, especially copper, which alone negatively affected earnings by about $800,000 in the quarter, and $2 million to-date in the year.

To be more specific, volume added about $1.6 million of margin in the quarter, while copper hurt margins by about $800,000. This along with a weaker mix, and higher costs of other materials, combined to drive gross margins down by about 2 percentage points, compared to the same quarter of the prior year. And about 2.5 points compared to the second quarter of this year. About half of this was the impact of copper . The remainder is mix. To explain the margin deterioration further, let me share some specific data.

Our higher margin business units, those that are largely dependent on the computer, telecom infrastructure, U.S. automotive, and defense market segments, represented about 55% of the Company's total sales in the prior year's third quarter. Sales here were down by approximately 8% in the quarter compared to last year.

Year-to-date sales were down 10% in these segments. This is a tough comparison because our sales here actually grew by over 20% in the first three quarters of last year. Some of which we now know, was an inventory build at customers. Our margins inside these markets are down 2.5 points versus last year, driven by mix inside those markets, and copper prices as well.

Important, copper. After increasing about $0.70 a pound over the previous seven quarters, copper increased another $0.30 a pound in the third quarter, about 30% or $0.30 of the $1 increase we've seen over the past two years, occurred in the third quarter of this year. This is very significant when you consider that approximately 45% of the Company's business is in copper-based materials.

Our Bulk Form materials businesses, to the oil and gas, industrial component, aerospace and heavy equipment markets, grew by approximately 17% in the third quarter, aided by our new product initiatives. These markets started to grow in the second half of 2004, and continued to look very good. Year-to-date, these markets are up 18%.

WAM grew 34% in the quarter, with their magnetic data storage, handset, semiconductor, and photonics businesses growing significantly, driven by many of the initiatives to penetrate new markets. The wireless and traditional businesses at WAM are gaining momentum as well, now following a weaker start to the year. About one-third of the sales growth is metal price, that we were able to pass on to our customers. The Webb telescope mirror shipments added about 2.5 points of growth year-to-date in 2005 at good margins, all in the first two quarters. There was no Webb telescope mirror business in the third quarter of the year, as we completed that program, prior to the end of the second quarter. I would also like to comment on continued progress in some other important areas.

Just as our initiatives abroad in our base helped the quarter, so did our continuing efforts and focus on lowering costs and improving our balance sheet. To that end, we have continued to make good progress as well. For example, while sales have grown 5% through the end of the third quarter, employment is actually down 1%.

SG&A as a percent of sales dropped to 15% compared to 16.5% for all of 2004. Inventory and receivables, while up in dollars from year-end due to seasonal factors, are down as a percentage of sales by almost 2 points, compared to the year-end 2004. Thus far this year, debt has been lowered an additional $14 million. Debt-to-debt plus equity now stands at a very respectable 20% level. Cash in the third quarter increased by $12 million to $23.2 million, from $11.2 million at the beginning of the quarter.

I would also like to reconcile the most obvious and significant changes in the financial statements. First, our cash balance declined by 26.5 million to date in this year, from about $49 million at the beginning of the year, to about $23 million at the end of the third quarter. Most of this decline occurred in the first quarter. Again, our cash balance climbed about $12 million in the third quarter. Over half of the year's change in cash went to reduce debt.

In addition, we made a planned $5 million contribution to our pension plan in the first quarter of the year, both of those were previously announced. The remainder, about $12 million, supported the growth in working capital to support the higher level of businesses to date. In our segment reporting, which was included in the press release, there are two points worth noting. You will notice a $1.7 million drop in the all other profit for the quarter. This is driven principally by a $1 million one-time gain, related to the sale of an asset that occurred in the prior year.

In addition, mark-to-market valuation differences of an interest rate swap, and various corporate expenses including Sarbanes-Oxley compliance costs, affected that comparison, comparing the profit in the quarter for the two years. You'll also note in the segment reporting that there was a flat operating profit on an $18 million year-to-date sales increase in the microelectronics segment. This is due to the previously discussed negative mix effect, plus inventory evaluation differences between the two periods. Metal prices and higher costs earlier in the year which were in part due to the introduction of new products.

After the balance of the year, we are confident that we will 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 do remain cautious. We now believe that sales growth for the year, will be closer to the high end of our previously stated range of 4 to 8%.

We also believe that gross margin will be down for the year compared to the prior year, by as much as 1.5 points for the full year. That's due to what we've seen so far this year in copper prices, material and energy costs, and mix. We had previously indicated that we expected margins to be down, but by less than 1 point, due to these same factors. Going forward, we expect to continue to control overhead growth to less than half the sales growth rate.

To date, in 2005, overheads are actually down 2% compared to the prior year. We anticipate making continued progress in working capital, and believe that capital spending will remain well below depreciation rates. Given the debt reduction that we saw in 2004, and in early 2005, we expect interest expense for the entire year to be approximately $2 million lower than in prior year in total.

For the quarter, in particular for the fourth quarter, we are encouraged by the current order trends. Our current estimate is for sales to grow by 8% to 12% compared to the prior year. As we indicated in the press release, if you exclude the Q4 2004 non-repeating James Webb mirror telescope business from the comparison, we are expecting growth of from 13% to 17% in the fourth quarter, compared to the fourth quarter of the prior year in the remainder of our businesses.

I have to continue to remind everyone, though, it is really difficult to get a clear short-term signal, from our varied and geographically dispersed markets. Our lead times continue to be short, meaning the changes in order rates quickly translate to higher or lower sales in a given quarter. With generally high 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 are subject to significant upside gains, and potential downside risks in individual quarters. Assuming that our order entry pattern continues as is, we would expect revenue for the fourth quarter, to be in the range of 125 million to $130 million. We've taken and we will continue to take a number of actions, to counter the effect of the externally driven material cost increase, and the impact they are having on our margins.

We expect some benefit from our actions in the fourth quarter, but the most significant benefit will occur in subsequent periods. Gross margins are expected to improve by up to 1 point, from the third quarter's level of 19% in our fourth quarter. The most significant actions that we have taken to-date include an alloy product price increase announced yesterday of 8 to 10%. This was announced again this week, and will take effect November 1.

Price increases are on-going in our other businesses as well, and they range from 3 to 5% across the Company. Other cost reductions including some manpower reductions, are already taken prior to the end of the quarter, and the realignment of production to save energy, will also effect margins favorably in the fourth quarter.

Before we take questions, I want to review two other important subjects that could affect the fourth quarter, as well as 2006 and beyond. First, you'll recall that the Company has a sizable off balance sheet deferred tax asset. As a result, the Federal tax expense on domestic income has been limited. We expect the total tax, which includes Federal tax plus foreign taxes, as well as state and local taxes, to be in the range of 300,000 to $400,000 in the fourth quarter. We also continue to assess the valuation allowance.

The balance of the valuation allowance at the end of the third quarter was approximately $20 million. It's possible that we may reverse to income, some of that balance in the fourth quarter. The accounting guidelines are complicated, but since we have established a profitability trend, with an earnings history and an earnings outlook, a portion of that asset may no longer be impaired.

While we can not estimate a number at this time, we may book an amount possibly a significant favorable amount, back to the balance sheet through income in the fourth quarter. If this were to occur, then it is important to recognize that this would be an increase to income in the quarter, possibly a significant increase. And if this were to occur. It is also important to note that as a result, the amount available to be reversed in future accounting periods, would be significantly lower than the amounts reversed in 2005, and in 2004. Thus, quarterly earnings in 2006 would be taxed at rates closer to the statutory rates.

Second, you should also recall that our $30 million sub debt becomes prepayable in December of this year. Consistent with our earlier comments, we are assessing its prepayment. Prepayment of this debt would result in a noncash write-off of $2 million of related deferred financing costs, and a cash prepayment penalty of $1.8 million. This would then result in a total charge of approximately $4 million in the fourth quarter if the debt is retired, and if we retire the debt, it would yield a significant annual cash interest savings, and thus a sizable annual pretax earnings improvement of over $4 million, for 2006 and beyond.

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

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Anthony Sorrentino with Sorrentino Metals.

Good afternoon, everyone.

Good afternoon.

You had said that higher copper prices have negatively impacted earnings by about $2 million on a year-to-year basis, and about $800,000 in the third quarter. Was there any offsetting gain from copper hedging?

Anthony, this is Jim Marrotte. That will be net of the copper hedge effect.

Okay. Net of the copper hedge effect. So what was it before the copper hedge effect.

The hedges were a rather minor amount, a few hundred thousand dollars off the top of my head.

Okay. With regard to the price increases that you've announced, the 8 to 10% on premium performance Alloy Products, effective November 1. Do you have any indication yet, how customers are responding? Or is it too early?

This is Dick Hipple, and it is too early to tell right now. I would say we would have a good assessment on that during the next four to six weeks.

Okay. And concerning the Defense programs that have been delayed, specifically what programs have been delayed, and what is their current status?

Again, this is Dick Hipple, and the Defense programs, what we have seen is kind of a pushout, not a cancellation of defense orders, and it's certainly related to the Iraq situation, and the overall budget. We are on a lot of programs that have to do with optic systems in aircraft, unmanned vehicles, and those sorts of devices, and also in satellites for the structural parts of satellites.

So these types of programs have been delayed. On the encouraging side, we have seen order book pick up in this area here in the last 30 days or so, the government situation is that their fiscal year ends in September, and then they start to kind of reorder again. So we've seen a booking increase in this area right now, but, again, I still think it is too early to tell how that's going to totally unfold with the Federal budget situation.

The other good news for us in the long term is that as these new programs unfold, our our BE products content within these systems, are higher than they were on a historic basis. So we are encouraged as long as these programs are released. You know we are encouraged that this side of the business should see additional orders, or high intensity for defense spending, if you will, going forward.

Okay. And one final question. I noticed and of course you mentioned that there was a very substantial pickup in Williams Advanced Material sales, and profit in the quarter. Would you go into further detail as to the new applications in magnetic data storage, photonics, handset, and semiconductor markets?

That's really -- again, this is Dick Hipple. That is really an exciting area for us. There is a lot of technology changes going on in the media sector. I will talk to it in two areas.

WAM is well-established in the media sector, particularly on the heads and the disk drives, and they have a very strong market share position. And WAM's strategy is to go now and penetrate into the media side, or the disk side of the product. And they've been able to do that with some new products that they have developed, which actually have higher performance capability than the competitors, and actually has provided, you know, some very good margins and lower costs. So they are starting to penetrate the media side of the business, and as we look forward, there is actually a technology change going on there, from LMR, which is lateral, to perpendicular.

What we will see unfold in the next year or two, actually next year, these Ipod devices and everything else, their capacity is going to go up tremendously by a factor of 5 to 10. And it is all being driven by the new technology that is going into these disk drive units. And this new technology requires new materials, and WAM is right on the front of those -- of the development of those new materials. So we expect that to be a very strong growth area for us, not only this year, but in the next several years going forward, because we are right on the leading edge of the technology shift in the media sector.

In the semiconductor area, again, a similar story where you are know, technology is changing and semiconductors in a lot of areas are trying to get smaller and smaller, and there's a technology shift called flip chip technology, and it really eliminates some of the wire connections between the chip and the base, and it is now being done by sputtered metal, sputtered technologies, instead of wire technologies.

And that allows, you know, a much smaller form factor, and actually lower costs. And WAM has developed new products on both the precious metal side, and now the semi-precious metal side, to be in front of that technology. So we expect that to be growing also in a real strong growth platform in the next several years for WAM.

And we also mentioned about the photonics area. And in the photonics area, that's a very interesting story because that actually, we have a new program called the VisiLid program, and in fact that is tied into our new acquisition with TFT out in California, where WAM has provided a new packaging technology, combined with the sputtering technology, of the coating technology TFT offers. So we provide the entire supply chain right now.

And this is a technology that is going into infrared night vision, for both Defense and Homeland Security. It is a very rapidly growing area, and we expect this also to expand to a new generation of telecom communication devices. So that's a growing area for us right now, and that's impacted this year's sales, and we expect it to continue to grow for the next several years. So hopefully I kind of gave you a flavor for what's going on at WAM.

Yes, you did. Sounds very promising. Thank you very much.

[OPERATOR INSTRUCTIONS] Our next question comes from Mark Parr with Keybanc Capital Markets.

This is actually Joel [Hirsch], how are you doing?

Doing fine, how are you?

Good. I was wondering if the copper impact you guys experienced in the third quarter, would be higher or lower sequentially in the fourth quarter?

Let me give you some insight to copper overall. The short answer to the question is lower in the fourth quarter, not sequentially -- not sequentially higher.

Okay.

For everyone's benefit. Copper has gone to price levels well above the ranges, that almost any forecaster has predicted. Even today, if you look at forecasts, the forward rates are well below current prices. Yesterday, copper closed at $1.96 up from $1.82 at the end of the third quarter.

About 45% of the Company's business is in copper-based materials as I had indicated, and about half of that we are able to pass along on price change, albeit the pass-along is not perfectly timed, nor is it perfect in amount. In the other half, we are exposed. And it is here that we have to work hard, to minimize the effect of these rapid price movements. So in that half, we attempt to hedge.

And over the past several quarters, we have laid in place hedges to help limit the exposure. As you already know in 2005, we cut via hedging the negative effect on the P&L of the rapid movement copper prices essentially in half.

So even in the recent quarter, as Jim had indicated, hedging offset some of that rapid increase. Over the past several months, copper consensus forecast has ranged from $1.25, to as high as $1.80 for next year. And we continue to put hedges in place, and would hope that over time, we can limit the impact of these rapid increases in copper on the Company. We will continue to review all of this carefully, as we can and do. We can get some protection via hedging, and we will continue to do that.

Okay. That's helpful. I was also wondering if you could just discuss your thought process behind announcing price increases, in lieu of surcharge announcements?

Well we -- I will let Dick comment further, but we did put surcharges in place across some of the businesses, about four or five weeks ago.

And I think what we are saying goes far -- I mean copper is an important piece, but I think we all know what's going on, energy has going up rapidly between natural gas and others. There is a lot of supplies coming into Brush Engineered Materials. Chemicals are coming in the process. Chemicals we are using. We have seen very rapid cost increases across the board, so that we just can't pin everything on copper , although copper is a big piece, so that we think it is more appropriate at this point in time, to talk about a general price increase.

Got you. That is very helpful. If I can ask one more question. I was wondering if you could give us an update on your exposure to chronic beryllium disease legal cases.

This is Mike Hasychak. We are down from 16 cases to 15 cases at the end of this quarter, and we dismissed one case for the amount of about $2,000, settled that case. So we are down overall.

Great. That's great. I will hop back in the queue.

[OPERATOR INSTRUCTIONS] Our next question from Martin [Hillbrun] with Winchester Group.

Congratulations on that sales increase, price increase. I am all for that. You have priced quite well in the past. I am glad to see it going up a little bit here. If memory serves me correctly, a few years ago you took a very large asset hit when you removed the future tax savings off the balance sheet, because you didn't -- the sustained earning power to keep it on. So my question is, don't you still have a very large tax loss carry-forward, which should save your taxes over that 20-odd million dollars that you mentioned?

Yes, Marty. That's what I was referencing in my comments a little earlier. We still have a valuation allowance on the books of approximately $20 million.

I mean don't you have tax loss carry-forwards, they are well beyond that valuation allowance.

Yes, we have the tax loss carried forward. They are still there even when we took the charge in 2002. That did not preclude us from using those tax loss carry-forwards. There is a disconnect, if you will, between the accounting for book purpose, versus what we do on our tax return. So they are still there. They are larger than that. We we have the NOLs available to reduce our actual tax payments going forward.

So in effect then, you will be showing taxes, but you won't be paying them? So that will increase your cash flow relative to your reported earnings? Income statements.

Whether we put that, erase the valuation allowance now or a portion of it now, I should say, has no bearing on our cash flow going forward.

Okay. Very good. Then the other question is, which you just touched on, I think historically your futures price is below your spot price, but I think certainly for the last quarter or the last two quarters, your spot price has been, what, 7 or 8% above the futures price. What kind of effect does that have on your costs, income?

It depends. If we have hedged those rates or not, and what the actual copper prices are, at the time that contract matures. The curve has been moving around as the spot prices have changed. But you know we sit there, and have an active hedge program, and have cross-functional team that looks at our hedging strategy, and we take actions accordingly.

So basically then, it doesn't effect your income that much, other than your hedging, and stuff like that?

The difference between the two numbers does not.

Right.

In other words, if it would have been a plus 8, rather than minus8, it wouldn't affect you that you much.

Correct.

Very good. Thank you. I hope the price increase increases your spreads a little -- some good amount. Thank you.

Thank you.

[OPERATOR INSTRUCTIONS] The next question is a follow-up question from Mark Parr with Keybanc Capital Markets.

Hi, guys. I was wondering if you could shed some light on the likely level of pure beryllium volume in '06 versus '05?

It's kind of early to really relate to that. We are early in the entire budgeting process, and I don't think we have a number here that relates to that just yet, but I would not expect it to be significantly different than the sales growth rate that we have.

Okay. And if you can maybe talk about your mix shift between bulk products, and strip products in the Alloy business?

The mix shift -- this is Dick Hipple. We have seen a year-to-year increase, significant increase in the bulk products, because that's going into a lot of the growing markets right now, which is the oil and gas, or heavy equipment, brand-new market for us.

And the strip market has been more flat. If you take a look at the overall electronics market worldwide for connectors, there's been at best, a slight increase year-to-year. Our strip products are down a little bit year-to-year, whereas our bulk products are up, and I think part of that is due to the fact that John mentioned it earlier, that the first half of last year our strip products were up very, very strong. Were up close to 35%. And I think we certainly had a very strong inventory build going on at the time, and we have seen some softness in that area now. Year-to-year, our strip products are down a little bit, and the bulk products are up quite strong.

Good. That's very helpful. And if you don't mind, one last question, and this is back on Williams. Can you maybe talk a little bit about your marketing initiatives for vapor deposition equipment, for the semiconductor manufacturing industry?

Yes, I mentioned a little bit of that earlier when I talked about some of the opportunities in semiconductor. We actually have two major initiatives in the semiconductor area. We actually have two major initiatives in the semiconductor area. One I don't want to repeat it. I will just summarize it again. This is the one for the new technology for a new type of style of semiconductor called the flip chip technology, and that's out new underbump program.

Then we also have an initiative to penetrate what I would call just the core standard target technology for semiconductors, and we are doing that, penetrating that in Asia, and we've got some new products there, and we think we can just -- it is a very large market. We have a very small market share, so that we think we can just grow a market share situation on what I call the standard smaller-sized semiconductor targets, whereas the underbump technology, were to lead in the technology.

To reinforce our whole effort in Williams Advanced Materials, we have taken a very aggressive stand, in moving into all areas of Asia, be it Korea, Japan, China, and Taiwan, to be able to pull through our technology and products, on a more effective basis.

Great. Thank you very much.

Our last question will come from Brian Harvey with William Smith & Company.

Hi. Can you give us some insight on to that inventory build? Has that actually been worked down, stimulating demand in those segments for those end markets, or do you expect them to stay at the levels that they are?

I think right now it is very difficult to be able to pin down inventory levels down out in the industry, but I do believe that those inventory levels have been worked out, and current sales as they would pick up or decline, would be more reflective of current market conditions.

All right, great. And also on the WAM segment. Can you breakdown how much of the growth was organic versus through acquisitions?

Through acquisitions? There's really --

very minor.

Very minor.

Very minor. But how much will those recent acquisitions add to in the future? Add to the sales growth?

Let me talk about both of those for just a minute. OMC was purchased midyear. TFT was purchased in the beginning of the fourth quarter. So their impact on the current year is relatively diminimus.

The total purchase price of both acquisitions is about $13 million. The revenue coming out of those are less than $1 for $1 of purchase price. Looking ahead, I would say order of magnitude, 8 million to $10 million in 2006 from those acquisitions in revenue.

Okay. All right, thank you very much.

There are no further questions. I will now turn the conference back over to our speakers for additional and closing remarks.

This is Mike Hasychak. 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 questions. My direct dial number 216-383-6823. Thank you.

That does conclude our conference for today. We would like to thank everyone for their participation. Please have a wonderful afternoon.