Materion Corp (MTRN) 2006 Q1 法說會逐字稿

Good day everyone and welcome to the Brush Engineered Materials Incorporated first quarter 2006 earnings conference call. Today's call is being recorded. With us today for opening remarks and introductions we have Mr. 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 CEO, Dick Hipple, President and Chief Operating Officer; John Grampa, Vice President of Finance and Chief Financial Officer; and Jim Marrotte, Vice President and Corporate Controller. Our format for today's call is as follows. Gordon Harnett will make a couple of brief comments. John Grampa will discuss the first quarter 2006 results and the outlook. And Dick Hipple will give a market update. A recorded -- 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 4978090. The call will also be archived on the Company's web site, beminc.com. To access the replay, click on Quarterly Earnings Conference Call under the Investor's Page. The broadcast requires real player software which is available as a free download from the icon as indicated.

Any forward-looking statements made in this announcement including those in the outlook section and during the question and answer portion are based on current expectations. The Company's actual future performance may materially differ from that contemplated by the forward-looking statements as a result of a variety of factors. Those factors are listed in the earnings press release issued this morning. And now I'll turn it over to Gordon Harnett for comments.

Thanks Mike. I'd like to take a few minutes at this time to say a few words as I approach retirement. Next Tuesday at our annual meeting, I will be stepping down as Chairman and Chief Executive Officer of Brush Engineered Materials. It has been a rewarding and challenging 15 years as Brush's CEO, and I believe leave the Company stronger, better prepared to compete in a global marketplace. I know I leave the Company in good hands. Dick Hipple, who will replace me and become Chairman and CEO next Tuesday; John Grampa, as our CFO; and Dan Skoch, as Senior Vice President make a very strong team. It has been great to work with them, and I know they will provide strong leadership to this Company going forward. I would also like to thank our investors for their interest and support during my tenure. As you will hear, the Company is doing well, and I believe, and I think the management here believes, that we have a strong, bright, and exciting future. John?

Thanks, Gordon. As in the past, I'll review the quarter, and then I'll comment on the outlook. Following my prepared comments, we'll pass the commentary over to Dick Hipple, who will talk with you about the market outlook. I'll reinforce the key points made in the press release, especially those that are related to sales growth as well as margins and the effect that escalating copper and precious metal prices have had on both our sales and our margins. I'll also review the effect that our acquisitions have had on the quarter's results as well. And I'll also review the previously announced change in the accounting treatment of the Company's deferred tax asset allowance and how that affected the year-over-year comparisons.

Let's begin. As you know, this morning we reported sales and earnings that were well ahead of the expectations that we had coming into the quarter. Both sales and earnings were consistent with the revised outlook we published on April 3rd. Sales for the quarter were up 29% or about $37 million to approximately $186 million which is a new quarterly high for the Corporation. Net income was 5.2 million or $0.27 a share, an increase of 21% compared to the $0.22 per share reported in the prior year. The change in income tax accounting negatively affected the year-over-year comparison by approximately $0.05 a share. A more appropriate measure of the Company's year-over-year performance is earnings before income tax. Pre-tax income grew 60% in the quarter on the 29% sales increase.

The first quarter was the 13th consecutive quarter where sales were higher than the comparable quarter of the prior year. You'll recall that we entered the first quarter with overall order entry improving and with mix showing some signs of improvement from the weaker mix that we had seen through most of 2005. The weaker mix in 2005 was driven by softer demand from the applications that we serve in the automotive, electronics, and the computer and telecommunications infrastructure markets. There is notable improv -- notable improvement in these markets. The improvement began in the fourth quarter of 2005 and continued through the first quarter of this year. As a result, in the first quarter, mix was not a factor in the comparisons to the prior year's first quarter. We grew by approximately 16% in these markets in the first quarter after growing 12% in the fourth quarter of 2005. The two growth quarters followed these markets declining by about 10% through the first three quarters of 2005. And net of metal price in currency, our growth in the quarter in these marketings, was in the 13 to 14% range.

In the quarter, the markets we served that were stronger through most of the prior year continued to develop nicely. These markets include magnetic data storage, wireless photonics, handsets, semiconductor, industrial components, and heavy equipment. Here we grew by 45% compared to the first quarter of the prior year. Net of metal prices, our growth in the quarter in these markets was in the 33 to 35% range. Our new product initiatives were important in the overall growth in this area. Overall, in the first quarter, metal prices accounted for about seven points of the 29 point growth. Our acquisitions added another seven points. In the first quarter of 2005, we were shipping materials for the James Webb telescope program. That program was substantially complete by the end of the year 2005 and thus the first quarter of 2006 had essentially no shipments of those materials which in turn negatively affects the year-over-year comparisons by about $6 million or five points of growth. And currency translation hurt sales comparisons by an additional two points. Netting these suggests that our base business, our business excluding our acquisitions and excluding those factors, grew 21% in the quarter. In other words, we did see strong real growth in the quarter. Real growth or organic growth was 21% for the Company.

We were pleased to see that our gross margins as a percent of sales improved by 1.5 points in the quarter compared to the Company's fourth quarter 2005 gross margin. The improvement was due to a combination of factors, including improved mix, better pricing, our acquisitions, and real volume growth. While gross margin improved as a percent of sales compared to the fourth quarter, gross margin as a percent of sales and thus earnings in the current quarter continue to be negatively impacted compared to the prior year by higher precious metal and base metal prices, primarily copper. The Company continues to only be able to pass through to customers a portion of those higher costs. Copper prices increased an additional 15% during the first quarter of 2006 after increasing over 40% in 2005. And that inflation continued into the second quarter. Precious metal and base metal costs passed through in sales without any margin benefit coupled with the portion of the cost that could not be passed through combined to lower the first quarter 2006 gross margin as a percent of sales by 1.6 points compared to the first quarter of 2005. The majority of this decline in the margin rate is due to the inflated value of the top line.

As we announced in December of last year and reinforced in several communications since, the Company expected to record a higher provision for income tax in 2006. This negatively affects the quarterly earnings comparisons to the prior year. This change was due to a change in the accounting treatment of the Company's deferred tax asset allowance. It's important to note that, since the Company continues to have significant net operating loss carry-forwards, most of the additional tax provision is non-cash. A 32% effective tax rate was applied to the current quarter's income before income taxes. This compares to 11% effective tax rate for the first quarter of 2005. The major difference between the two rates is in domestic federal tax expense, which, in 2005, was offset by the reversal of a portion of the comp -- of the Company's deferred tax asset allowance. As I indicated earlier, the first quarter 2006 earnings per share comparison to the prior year is negatively affected by approximately $0.05 per share due to the prior year having the lower effective tax rate. On a pretax basis earnings were 7.7 million in the quarter, compared to 4.8 million in the first quarter of 2005, an increase of 60%.

While we do not disclose the sales and profitability of individual sub segments of our business, I'll share with you the status of the three acquisitions. You'll recall the aggregate purchase price of the three acquisitions was approximately $38 million. You should also recall that these acquisitions support and expand the physical vapor deposition capabilities of Williams Advanced Materials, which is today our largest, most profitable, and fastest growing set of businesses. For 2006, we expected sales from the three acquisitions to be in the range of 37 to $39 million. In the first quarter, sales were $8.7 million. We're on target thus far. Operating profit from the three -- the three was to be in the range of six to $7 million, and again we're on track to be within that range for the year as well. We're pleased with the progress of the acquisitions. They were closed at attractive multiples and are clearly on track to deliver the performance that we expected.

Now I'll turn to the outlook. Most of our markets were stronger than expected during the first quarter of the year, and we continue to make good progress with our new products and our initiatives to penetrate new markets. We also made good progress in the first quarter with our initiatives to improve margins. And as I had indicated earlier, our acquisitions delivered the expected results as well. These positive factors have continued thus far in the second quarter. We believe these conditions will continue throughout the second quarter and therefore expect results for the quarter to be similar to those of the first quarter. At this time, sales for the second quarter are expected to be in the range of 160 to $170 million, up approximately 20 to 25% compared to the same quarter of the prior year. Pre-tax earnings are expected to increase in the range of 25 to 50%, and earnings per share are expected to be in the range of $0.25 to $0.30. While our markets are always subject to inventory swings and macroeconomic factors could yield a softer second half compared to the first half, based on the first quarter and the current outlook for the second quarter, we are raising the outlook for the year. Earnings are now expected to be in the range of $0.95 to $1.10 per share, up $0.15 per share compared to the previous estimate we provided.

I have to continue to remind everyone, though, that it's really difficult to get clear, short-term signals from the varied and geographically dispersed markets that we serve. Our lead times continue to be short, meaning 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 down side risks in any individual quarter. Now I'll pass the call on to Dick Hipple, who'll provide you with a market update.

Thank you John. What I wanted to discuss is basically what's driving our growth at this point. And it's coming from two fundamental areas, and it's consumer electronics and industrial equipment defined as oil and gas, aerospace, and heavy equipment. Spending a few minutes on a consumer electronic side of the business, for example, cellphones would represent a large portion of that, and that market itself is expected to be up 15% this year, forecast range from 790 units -- 790 million units sold last year to 900 million this year. And we participate in the cellphone market in applications served by several of our business units including Williams Advanced Materials, Alloy, and TMI. For example, we have TMI serves that market through packaging materials and PVD, physical vapor deposition targets used in power amplifier and compound semiconductors. And our Alloy business produces battery contacts and jacks used in cellphones and other PDA type equipment, portable consumer electronics, and TMI is also participating in some of the higher end cellphone units. So that's one big growth area for consumer electronics. The other is hard disk drives, that market itself is expected to be up 15 to 20% this year. Market forecasts are ranging from about 378 million units last year to 450 this year. And the market itself that we're participating, WAM has participated historically in the hard drive market through the head area. The big side of the story is on the media for us in the disc drive market and WAM has some new PVD products and they're increasing their share in the magnetic media side. And that's an area that they haven't previously served prior to this, so they're increasing applications within a growing market.

Another exciting area for us is in our TMI division who has developed a lightweight high strength cladded metal being used in some of the new disk drive arms for both Hitachi and Segate being used in the new generation laptops and other consumer devices such as the Xbox. So the hard drive market is -- is very good for us right now, so we're really growing applications within a growing market. Flip chip technology is another product used in consumer devices, and this is also -- it's a rapidly growing area within the semiconductor market. And it's really products that are solving miniaturization challenges as the industry goes forward. WAM has a leadership position in the development of PVD materials used in these semiconductors, and they're used right now today in had LCD TVs, but we also see that technology shifting into dram chips and also into LEDs and possibly cellphones in the near future. So the -- between cellphones, hard drives, and the flip chip technology, that's really driving our consumer electronics area.

And in the industrial equipment area, our Alloy bookings are up significantly year to year, and that's from both a sales and an -- and an improved product mix in the oil and gas aerospace and heavy equipment market. And of particular note is our new ToughMet product, which is over -- which is up over 50% year-to-year as we continue to expand our application base really in many industrial segments with the ToughMet product.

What's been a pleasant surprise to us this year which we really didn't expect is in the automotive sector. And in spite the troubles at GM and Ford, we have been working hard to gain business at the nondomestic producers, whose sales are increasing. And we have established some new product capabilities in spot plating at our TMI division which was driving some new applications there. But obviously we have concern going forward with the possible Delphi strike which would certainly impact this segment of our business. A couple of other areas we are pleased with is in the area of our Asian growth. We've had a big focus for Asia, and our sales there are up 34% year-to-year. And certainly John mentioned earlier about meeting our targets right now in our new acquisitions that we've had over the last nine months within Brush. So that's a quick overcap of really what's driving the growth at this point in time, and I would open this up for questions.

[OPERATOR INSTRUCTIONS] [Chuck Murphy], Sidoti & Company.

Good afternoon, guys.

Chris.

It's Chuck actually but not a big deal.

Hi, Chuck.

Just wanted to wish Gordon best of luck in retirement before I asked my questions here.

Thank you.

Question is two fold, and both of them deal with copper prices. First I was wondering how the direction of copper prices is factoring into your expectations for the second quarter? And the second part of that question would be how the price of copper is affecting Alloy products' ability to sell their premium brand alloys versus the cheaper competitors' brands?

Good question, Chuck. To take the latter one first, I guess on the fortunate side, everybody has copper in their materials that we're competing with. I mean, that's the primary competitors are all copper-type producers. So as this copper price goes up, it's going up for everybody, so everybody's under the same pressures. So the lower priced products, they also have to go up if copper's going up two bucks, they have to go to --up two bucks. And so If you think about it, maybe actually our margin spread differential in the value statement is actually getting less because the spread is getting less from a percentage basis. So I'm really not too concerned about that being an issue because everybody's certainly has to have the pressures.

With regards to the copper impact on the business, obviously that's a key item and a couple things going on there. I've mentioned these in the past. We are aggressively moving more and more customers to pass through copper. At the same time, we have had quite an aggressive hedging program that we started late last year that's helping us significantly, and we certainly are taking prices up. But we did have price increase last year. We expect that we -- not expect it. We've had about 4% to 4.5% from that pricing increase, and we continue to press that side of the equation. So we have an all-out effort to minimize the impact of copper. However, I would say that I am a little bit concerned at this point in time because the copper has gone up so much, so fast that , for example -- I don't -- John, if you had mentioned that copper went up almost a $1.00 in the last 30 days. That's just an incredible amount. So, Chuck, you can imagine what happens there is that you may be pricing copper and getting it passed through, but you can even get hit just in a month's lag because you have the prices up, you have it priced -- and we'll get that back, but we may have, like, a month or two problem before it catches up. Because it's just gone up so rapidly, it's rather incredible.

Would it be possible to institute a second price increase?

Of course. We're -- at this point in time, we are pushing prices every where we can. I mean certainly there's different markets in different areas, oil and gas is a tight market right now, aerospace is, so you have to pick your spots. But we have price increases, we have hedging, and again we're shifting more and more customers into the pass-through copper.

Maybe define what pass-through copper means.

Pass through copper just means that we have a -- kind of a fab price, and wherever copper is, the pricing gets passed immediately through. But even if you have that kind of arrangement, as I mentioned before, you can get into a 30-day lag time. If copper goes up a buck in a month, it becomes insane.

Thank you.

Did that answer your question?

Yes. Thanks.

Anthony Sorrentino, Sorrentino Metals

Good afternoon everyone. What percentage of the sales growth was accounted for by new products and new product applications?

The 29% growth year-over-year did have about seven points of metal price and currency, so the 21% growth is the figure that I quoted for the core growth business. About a third of that would have been new products. New products and/or new applications that went in place over the last 24 months.

Okay. And I would presume that the 26 million-dollar increase in long-term debt was to finance the acquisition of [Sorak]. Was that correct?

That's correct.

Okay and what were the terms of that financing?

We -- we drew against our revolver, so there is no -- there's no permanent or separate financing terms there.

Right. Okay. And is that a floating rate revolver?

Yes.

Yes.

Okay would you have any intention at some later date of refinancing under a long-term fixed rate?

We -- we have none of those plans at this moment.

Okay. Fine. Very good. Thank you. And, Gordon, good luck and be well.

Thank you. I appreciate that.

Bob Schenosky, Jefferies & Company.

Good afternoon. First off, Gordon, congratulations.

I'm looking forward to it. I'll play golf with you sometime.

Yes, I'm ready any time. A couple questions, first one for John would be in terms of the interest expense, what should we assume for the back half of year? Are we going to remain at these kinds of levels? Or would we anticipate with free cash flow you'd be paying some of that down?

Before I answer that question, Bob, let me -- let me take this opportunity to correct a -- a statement that I made earlier. I referenced the first quarter sales as 186 million. Let's save that for a later quarter. The real quarter sales is 168 million. A little transposition in my -- my words are --

He's a little dyslexic.

I'm ahead of myself.

Still the highest quarter in the --

Still the highest quarter in the Company's history. Bob, our free cash flow, as you well see in the numbers, the first three months of the year, because of the need to finance the receivables associated with this growth and the acquisitions, there was essentially no free cash flow in the first quarter. We would anticipate that to change the balance of the year. We would expect free cash flow for the balance of the year to exceed $30 million or to be in the $30 million range, fairly consistent with -- with our appetite or our ability to throw off cash in the past. Now, having said that, interest should be about the same as it was in the first quarter if not slightly lower going forward.

Okay and that's short of any -- any additional acquisitions?

Short of any additional acquisitions or short of any good news like significant increase yet in revenue that requires more financing and receivables.

Sure. And then also can you just -- on a line item in the P&L, your other net was down substantially relative to the first quarter last year and also the fourth quarter. Can you discuss that?

Sure. I'll pass it on to Jim Marrotte, he -- he's prepared to answer that.

Yes, the primary [inaudible] change there was in our foreign currency exchange gain losses. With the strengthening of the dollar this year, we -- we recorded hedge gain for this year versus our hedge losses last year, and that movement there offsets the loss that we had in the translation of the sales and the margin of our foreign subsidiaries business.

So was that a good run rate for the balance of the year at least at this point?

Boy, that's a function of exchange rate, movement, there's -- there's -- there's a lot of hotspots in there. But yes, I wouldn't -- I wouldn't deviate too much off of that. We -- we -- we don't have any -- any known items that would deviate from that pace.

Okay, and then finally, as relates to a question that was asked earlier about the new products, you talked, if I have this correct, it was about seven points of the revenue gain in the first quarter. Is it fair to assume that that will continue to expand as the year progresses? There's another Cleveland company that's talked about the potential in the flip chip business as well from a different aspect, and it seems quite exciting with exponential type growth. Is that fair?

Yes. That's fair. That's the whole model we're after. We're -- we're attacking new products in growing segments, so absolutely that should grow.

So it would be fair to characterize that the potential growth of new products alone this year could be upwards of 10% or better.

We haven't forecasted that, but certainly there is management objectives to grow that number aggressively.

Okay great. Thank you.

Brian Harvey, William Smith & Co.

I just wanted to touch again on the price increase that was instituted in late 2005. I think it was just mentioned there was about 4% to 5% growth attributed to that. Is that kind of tracking how it's planned? What's -- what's been the customer reaction in the marketplace for that price increase?

Well, the customer reaction, obviously they've accepted it, and our business is growing. So we haven't found that to be a problem for us, and the customer base has accepted it, and we're moving forward. Certainly our bookings have been strong, and so the timing is good for price increases.

I think it's obvious that our customer base is well-aware of what's going on in the copper market. It's kind of front page news every day, and I was just over in Asia, and it's very apparent that everybody, as Dick said earlier, is pushing these copper prices through. So it's not -- not meeting with huge problems.

Thanks, and so just going through the press release comments, it said that Beryllium is expected to increase in the second quarter. Could you just expand on that statement? What's the reason behind that? Is there something in the pipeline?

Well we -- we did secure a, what's known as, we call it the jet contract, which -- which is a joint European torch. It's another what I call special science. Remember last year, it's not as big but for the last year we had the James Webb telescope. Similar -- well, again, it's not as large, but it's a -- it's a good project for us this year, and it's a big science type program. We'll start to see sales in that in the second half. And we also expect to see what I call the core defense products also to be growing in the second half.

Okay so we'll probably hear more on that as the year progresses.

Yes.

And then just a couple minor things. For the tax rate, the 32%, should that be expected for the remainder of the year?

Brian, you may recall that we talked about that tax rate perhaps being lower than that coming into the year. The reason it is 32% versus our earlier forecast is that the domestic growth was far more significant than we had forecast. And assuming that there is no significant change in the domestic versus international mix of our businesses, the 32% number is a good number.

And then, in the fourth quarter, we will in turn reevaluate our domestic -- I'm sorry, our deferred tax evaluation allowance to determine if any additional portion of our deferred tax asset can be reversed back to income. We cannot comment at this point as to how much, if any, would be reversed. We will do that evaluation at that time.

Thank you very much.

[OPERATOR INSTRUCTIONS] Mark Parr, KeyBanc Capital Markets

Good afternoon.

Hi, Mark.

Gordon, you started when? '91?

'91.

Wow! 15 years.

Yes.

Congratulations!

Thank you.

I hope you get to play a lot of golf. You really deserve it.

Thanks.

And the change in the marketing orientation for the Company over the last 15 years has been amazing.

Well, it's fun to see the successes now that we're really starting to have and have ourselves, I think, nicely positioned in some good growth areas.

That's good. I was going to ask John about free cash flow outlook for the year which he already answered. And one of the -- I guess this is just a recurring theme. I was really excited to see the revenue momentum, but I was a little disappointed in the lack of profit follow through. And I missed the first couple minutes of the call. You may have already addressed this. But is there -- with the kind of outlook that you have given, how much underlying gross margin improvement do you have built into your forecast relative to anticipated revenue growth?

Well, Mark, we had indicated coming into the year that we anticipated we'd grow gross profit on the year compared to prior year by one to two points. Growth profit as a percent of sales.

Yes.

We picked up some of that in the first quarter obviously, and the first quarter growth rate was significantly higher. So I would say that one to two points is a decent range. And our long-term expectations would be to do -- to do better than that, but in the current year, I think for now, it's wise to stay with that range.

Okay now historically I know that you had always characterized marginal contribution, say, in the 35 to 50% range.

Variable margin. Not gross margin. That's correct.

Yes the variable -- I just call for each incremental dollar of revenue, the incremental gross profit would be somewhere between $0.35 and $0.50.

Yes. But keep in mind what you're describing varying businesses with a wide range there.

Correct.

And metal price inflation has put pressure on that -- on that incremental flow through enormously. So using the same kinds of percentages today wouldn't be valid.

And that's particularly true of Williams Advanced Materials where there is a lot of precious metals. So the variable margin, the contribution margin at WAM tends to be lower.

As that segment of the business grows much more rapidly, you can see how that affects that macronumber.

That overall macronumber is declining.

Alright, so if -- if we assume then that copper stays roughly where it is, which is probably a bad assumption but -- but in the absence of any -- of any real knowledge on copper, all we can do is kind of take it where it is, and you can look at the precious metal and the copper component of the revenues.

Correct.

And what it -- what it likely to be going forward if there was no change. What would be a good percentage to use? Would we be looking more at 20% or 20% to 30%? What's a good range to look at now or at least for this year?

Gross margin range or are you talking about the variable contribution?

The variable contribution.

Variable contribution to what line in the P&L?

Gross profit.

The gross profit line.

Yes. Which I thought that's what we were talking about.

25%. 25 to 30%.

Okay. All right. Okay. Listen, hey, thanks. Thanks for that color. I again, I apologize for missing the first part of the call. But, Gordon, I really want to wish you well and look forward to seeing you around town.

Thanks, Mark. Appreciate it.

Thank you. [OPERATOR INSTRUCTIONS] It appears we have no further questions. I would like to turn the conference back over to our host, Mr. Michael Hasychak. Please go ahead sir.

We'd like to thank all of you for participating on the call this afternoon. I'll be around for the remainder of the afternoon to answer questions. My direct number is area code (216) 383-6823. Thank you very much.

And this does conclude today's conference. We thank you for your participation.