Materion Corp (MTRN) 2006 Q3 法說會逐字稿

Greetings ladies and gentlemen. And welcome to the Brush Engineered Materials third quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS]

It is now my pleasure to introduce your host, Mr Michael Hasychak, Vice President, Treasurer, and Secretary of Brush Engineered Materials. Thank you Mr. Hasychak you may begin.

Good afternoon this is Mike Hasychak. With me today is Dick Hipple, President, Chairman and CEO, John Grampa, Vice President of Finance and Chief Financial Officer, and Jim Marrotte, Vice President and Corporate Controller. Our format for today's conference call is as follows: John Grampa will comment on the third quarter 2006 results in the outlook. And Dick Hipple will give a market update.

Thereafter we will open up the teleconference call for questions. A recorded playback of this call will be available for 15 days by dialing 877-660-6853 account number 286, and conference ID 216562. 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 the factors, those factors are listed in the earnings press released issued this morning. And now I'll turn it over to John Grampa for comments.

Thank you Mike. Good afternoon everyone and welcome to our third quarter conference call. Thanks for joining us today. As in the past, and as Mike indicated, I'll review the quarter and then comment on the outlook, And then following my prepared comments, Dick Hipple will review with you an update of the market. Then we'll open the call for questions.

I'll reinforce and expand on the key points that we made in the press release today, especially those related to sales growth as well as margins, and the affect that copper and precious metal prices have had on both sales and margins. I'll also review the effect that our acquisitions have had on the quarter, as well as how the previously announced change in the accounting treatment, of the Company's deferred asset allowance affects the year-over-year comparisons. Then I'll review the outlook including the announced increase in our projections and the factors driving the increase for the fourth quarter and thus the full years numbers.

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 revised outlook that we published on October 9th. Sales for the quarter were up 48% or about $65 million to just over $200 million, which was a new quarterly high. Net income was up 82%, $7.1 million or $0.35 a share which compares to the $0.20 a share reported in the third quarter of the prior year.

I'd like to call to your attention again two important factors that continue to affect the year-to-year-- year-over-year comparisons. First metal price or metal price inflation, and said differently, that portion of both precious and nonprecious metal price increases that we were able to pass on to our customer base in the third quarter, had a similar affect on reported sales increase as it has had in recent periods. Approximately 17 percentage points of the reported 48% growth is metal price. Real growth including acquisitions was approximately 31% in the third quarter which is the strongest real growth rate of the year. Organic growth, that is growth excluding metal prices and excluding the influences of acquisitions, was 26% in the quarter. Also the strongest organic growth quarter of the year.

Second the previously announced change in the income tax accounting, as you know, negatively affects our year-over-year comparisons. In the third quarter the reported earnings per share improvement of $0.15 per share negatively affected by approximately $0.04 per share due to the prior year having a lower effective tax rate. A more appropriate measure of the Company's year-over-year performance improvement is pretax income. And pretax income grew approximately 130% in the quarter on the 31% real sales growth.

You'll recall that we entered the third quarter with most of our markets having delivered strong overall order entry with our new products and with our initiatives to penetrate new markets delivering solid top line benefits. And our margins were expanding in spite of the metal price pressures. We expected that these conditions would help counter the lower seasonal demand that the Company often sees in the third quarter. That did occur and in fact third quarter sales actually exceeded our estimate by a wide margin, and exceeded the second quarter quarter sales as well. Instead of being down by about 7% compared to the second quarter, which is what we forecasted coming into the quarter, sales were actually up 7%.

In the quarter the markets that we serve that were stronger through most of the first half of the year continued to develop nicely. These are our fastest growing markets, much of which is driven by consumer electronics. They include magnetic data storage, wireless photonics, hand sets, semiconductor, industrial components, oil and gas, and heavy equipment. Again we grew by approximately 48% compared to the third quarter of the prior year, and again net of metal prices our growth in the quarter was 31%.

Our new product initiatives are an important part of the overall growth in these markets and on a year-to-date basis represented 6 points of the 21 point real growth. Coming into the quarter, we were pleased to see that the continued improvement in the Company's gross margin. Gross margin as a percent of sales, had improved by approximately 2.5 points during the first half of the year, compared to the-- those margin levels that we were operating at at the end of 2005. The improvement we were seeing was due to a combination of factors including better mix, better pricing, our acquisitions, operating improvements and the real volume growth.

Factors that help drive gross margins up during the first six of the month-- six months of the year have not changed, but gross margin in the third quarter while higher than the same quarter of the prior year, was lower than what we would have expected by about one percentage point due to factors that we believe should not repeat. A less favorable product mix, higher than expected new product ramp up costs, due to a stronger than expected initial demand level which is actually good news, and other manufacturing costs were the factors that drove the quarters gross margins below our expectations. Although gross margin as a percent of sales continued to be affected by higher precious and base metal prices, we've made good progress in our efforts to pass along a higher percentage of copper cost increases that we've seen.

The third quarter brought with it even more visible progress. In the quarter an increased pass through level combined with our hedging programs as well as more stable copper prices, lowered the negative impact that copper has had on our P&L to less than $200,000. This compares to a negative impact of approximately $3 million in the first half of the year. The good news is that we expect to be over 90% effective with metal price pass through in the fourth quarter, neutralizing the metal price risk to Company margins.

Precious metal and base metal cost pass through in sales without any margin benefit coupled with the portion of the cost that could not be passed through, combined to lower the third quarter reported gross margin as a percent of sales by approximately 2.6 points compared to the third quarter of the prior year. Majority of this margin decline 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 was due to a change in the accounting treatment of the Company's deferred tax asset allowance. It's important to note and to continuously reinforce that since the Company continues to have significant net operating loss carry forwards, most of the additional tax provision is noncash expense. A 26.6% effective tax rate was applied to the current quarters income before income taxes. That compares to a 7.6% effective tax rate for the third quarter of the prior year. The major difference between the two rates is found in the domestic federal tax expense, which in 2005 was offset by the reversal of a portion of the Company's deferred tax asset allowance.

As I indicated earlier, the third quarter 2006 earnings per share comparison to the prior year, was negatively affected by approximately $0.04 a share due to the prior year having that lower effective tax rate. On a pretax basis, earnings were $9.7 million in the quarter compared to 4.3 million in the third quarter of 2005 an increase of approximately 130%. Year-to-date this factor affects the earnings per share comparisons by approximately $0.17 a share. Year-to-date pretax income is actually up 86%.

Now I'll turn to the outlook. Most of our markets were stronger than expected during the first three quarters of the year, and we continued to make good progress with our new products in our efforts to penetrate new markets. We also made good progress in the first three quarters with our initiatives to improve margins and our acquisitions are adding to our growth and our growth and profits as well. These positive factors have continued to thus far in the fourth quarter. As with the third quarter we believe these conditions will help cushion the effect of the normal seasonal factors, in this case the holidays, which can result in lower revenues in the fourth quarter relative to the third.

At this time we are raising the outlook for the fourth quarter and thus the year. Sales for the fourth quarter are now expected to be in the range of 180 to $190 million up approximately 28% to 35% compared to the same quarter of the prior year, and earnings are expected to be in the range of $0.34 to $0.42 per share. Sales for the year are thus expected to be in the range of 735 to 745 million up 35 to 38% compared to the prior year. And earnings for the year are now expected to be in the range of $1.30 to $1.38 a share compared to the mid-year estimate of $1.09 to $1.17 and the previous estimate of $1.20 to $1.28.

I have 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 remain short. Being that changes in the order rate can quickly translate to higher or lower sales in a given period. With generally high incremental margins, small changes in revenue can have a rapid noticeable effect on earnings, as can changes in mix. As we've all seen we are very sensitive to volume and mixed shifts as well as program shifts, and are subject to significant upside gains of potential down side risks in any individual quarter. We'll continue our practice of communicating what we believe and communicating significant changes as they become clear. Now l'll turn the call to over to Dick Hipple. Following Dick's market update we'll take questions.

Thank you John. This last quarter really highlights both the ongoing progress of our strategic initiatives and our challenges going forward. Our strong organic growth of 26% highlights our strength in the markets applications in geographic regions we have targeted. The technology demands for miniaturization in the consumer electronics area, and reliability demands in the heavy industrial applications such as oil and gas, aerospace and heavy equipment, continues to fuel our growth.

Also the additional staffing investments we have made in Asia to support our customer base has also helped to support our international growth, which now represents 35% of our sales, while growing by 55% over last year. As John mentioned we continued to be satisfied with the ongoing strength of our core markets, while recognizing our visibility remains fairly short. We must always remain on the watch for inventory builds which might cause major shifts in downstream demands.

We were very pleased to see higher profitability in our metal segment in the third quarter. Three key drivers of the higher copper pass through in our alloy division, a better mix of high performance strip products from the ongoing demands for higher performance materials from the trend in miniaturization and consumer electronic products. And third stronger sales and margins from some of our newer products like our disk drive R material produced at our TMI division. Last year at this time, we were working through start up and product development costs there.

Third quarter sales also remained strong across the board in our heavy industrial markets, oil and gas, heavy equipment and aerospace. And we continue to win new applications in all three areas with our new tough [med] alloy systems. Also after a fairly soft first half our high brilliant sale began to gain strength from an improved order book in defense applications while we began shipments of our joint European tourist order, or the jet project, which is a special science project for an experimental fusion reactor.

In microelectronics our PVD, or physical vapor deposition business, continued to grow. Particularly supported by our gains in our new hard disk drive media market. We are ramping up production and working on numerous qualifications. These investments did dampen profitability in the quarter, and we hope to see a good transition to better earnings flow through in the fourth quarter from our new products ramp up. Our products going into wireless or cell phones, and photonics LED markets, also remain strong in the third quarter.

We also see, we're seeing a good rebound in the telecom infrastructure market as compared to last year and most of our operating units have products that serve this marketplace. And as we look forward, our challenge is to continue to invest in our global opportunities while improving our margins. I'd also like to take this opportunity to thank the Brush Engineered Materials employees who are work extremely hard to meet the market opportunities and day-to-day challenges, which are required to support our business growth. Thank you. I guess we're prepared for questions.

We'll take questions now, Operator

[OPERATOR INSTRUCTIONS] Our first question is coming from Avinash Kant with Canaccord Adams. Please proceed with your question.

Good afternoon everybody.

Good afternoon.

A few questions. You had a chance to raise the guidance only two weeks ago I believe, and you're raising your guidance once again. What changed within that last two weeks thats made you change the guidance?

What way saw in the last two weeks was a continuation of the order entry rate that we had observed in late August and early-to-mid September. In the earlier guidance we didn't assume that that would necessarily continue at that pace, and in the first part of the quarter it actually accelerated a little bit. But we changed the guidance.

Any specific segment that you can point where you saw this trend?

The strenth recently?

Yes. Where the upside is coming from?

The upside that we talked about on October 9th or the upside that we put in the press release?

The upside since October 9.

Since October 9th it's across the board.

Generally.

Just your general increase, general increase.

Okay. And you did gave some data about how much was the component in terms of copper prices going up if you compared the same quarter last year. But quarter-over-quarter from Q2 to Q3 could you kind of break up how much was the impact from copper, copper [inaudible]?

On the top line?

Yes, on the top line.

I don't know if we have that available here. My hunch would be that less on the top line, a little less Q2 versus Q3 but probably not a whole lot. If you remember, -- there was a bell shaped curve in QT that leveled--Q2 that leveled off in Q3.

Exactly I'm expecting not much of a change so your 7% growth quarter-over-quarter could be a lot more organic than anything about--

That's correct. It was more organic in the third quarter compared to the second quarter. In the third quarter organic growth was 26%, in the second quarter and first quarter it was about 21 or 22%.

That was compared to last year.

Compared to prior year.

Right, right. I'm trying to gauge it just on a quarter-to-quarter basis. Now you also gave some data about, in terms of the first nine months you talked about 39% growth and out of [inaudible] with 25%. Can you also give the component that is being driven by the acquisitions in the first nine months? Compared to the same nine months last year?

Yes we can, we'll look it up. It's probably five or six points, but we'll check that.

Perfect that's pretty much it for now.

Six points.

Six points.

Six points. Thank you so much I'll let other people on here.

Our next question is coming from Anthony Sorrentino with Sorrentino Metals. Please proceed with your question.

Good afternoon everyone. Would you go into further detail as to what caused the excessive manufacturing ramp up costs and process development costs? And what you're doing to bring them under control.

We won't go into the specifics because in some cases it's related to programs, and for competitive reasons wouldn't want to be that bold. But the--they were ramp up costs, new product orders that were, that came into the ramp up faster than we anticipated, in fact significantly faster than we anticipated. And as a result we incurred some additional costs, ranging anywhere from overtime to higher scrap rates to additional manufacturing costs to support the ramps. Those are behind us we believe, and they were early in the quarter.

Oaky. And also, are the higher overhead costs that are related to U.S. and international expansion initiatives expected to be brought back down again?

No because we're making an investment for additional people and service overseas, so they will not come down, they're there to support future growth.

Okay fine. And with regard to a couple of tax questions, is your tax rate in the fourth quarter expected to approximate 29.9%?

That's what we believe at this time, right around 30%.

Okay and is your tax rate likely to approximate 30% in 2007, or may you take another look at the deferred tax valuation allowance?

Well those are actually two separate questions. In 2007 the effective tax rate will depend largely on the mix between domestic and international businesses, and may very well climb a little bit. If it were, no more than a point or two, would be our guess at this time. However it could stay at 30% as well, but-- so let's assume 30 to 32% range is reasonable for 2007 based on what we know now.

The deferred tax asset, that you're referring to, we commented previously that this would be re-examined, the remaining portion of the deferred tax asset re-examined in the fourth quarter of the year, consistent with the accounting guideline. There is a little less than $20 million of the deferred tax asset still remaining off balance sheet, that we again will assess in the--due course in the fourth quarter. We would anticipate that perhaps a significant piece of that would be brought back on balance sheet.

Okay. Thank you very much and congratulations on the great results.

Thank you.

Thank you.

Our next question is coming from [Chuck Murphy] with Sidoti & Company. Please proceed with your question.

Good afternoon guys.

Good afternoon.

First congratulations on the great quarter it's been quite the year so far.

Thank you.

I guess that kind of leads to my first question which is basically, how sustainable do you think this 26% organic growth rate is? And in particular, what do you consider a reasonable expectation for Williams's growth over the next couple of years?

Well obviously the sustainability of 26% organic we're into this now three or four quarters and we're predicting that the fourth quarter will give you similar levels, based on the estimates that we put out there. Assuming that market trends do not turn too negative on us or get far more conservative, I would think that we're going to still have-- continue to have good growth going into next year. Again remember we're going in and growing on top of an already elevated number.

In terms of the Williams's growth. The William's growth not unlike the organic growth that we've been seeing there, actually it's a little larger, it's a little heavier as you remember.

Yes.

Williams is growing north of 30, while maybe Metal Systems is growing closer to 20 to give us that 26%. Those markets are very entertaining markets for us and to this point we're very successful with a tremendous amount of -- a huge number of new initiatives, new products and new programs into those-- into that market. So we would anticipate growth in Williams to outpace growth in the Metal Systems segment in-- over the next couple of years.

I think what we're trying to achieve is clearly -- we're, we are participating in some very strong markets and those markets are growing at rates between 10 and 20% and we -- I mean our philosophy as a Company is to try to target these growth markets and grow applications within those markets to try to achieve higher growth rates in the markets themselves. So it all is going to be a function of our success on certain applications that we're attacking.

As you point out 26% is a quite lofty accomplishment we've had. We've been very successful. And we're trying very hard to drive the stronger organic growth and to say, to commit that we can continue this up is questionable. But we're certainly trying hard.

Okay. My other question is you mentioned that the telecom infrastructure market, in particular regard to alloy products seems to be showing some signs of life. I was wondering if there was anything specific there that got you to that conclusion?

Well, got us to our conclusion is higher orders.

Okay.

But that's real simple. But beyond that, what I think we're saying is that particularly in Asia, and particularly China, there is a lot investment going on on the basic build out of telecom wireless infrastructure to support that economy and support that growth. And I think that's the primary higher kick, if you will, in growth that's going on right now.

Yes that's what I meant. All right well thank you I appreciate it.

Our next question is coming from Bob Schenosky with Jefferies & Company. Please proceed with your question.

Thank you good afternoon.

Good afternoon Bob.

A couple of questions. The first one, I know Gordon, Dick before you took over, Gordon was pushing all the new products which have finally hit in '06. Are there some products you're targeting to accentuate the '07 growths?

Of course that's the model of the Company.

I know, what I'm trying to get to is can we expect the same type of magnitude as we move forward?

I think I just answered-- I think we just handled that question -- that Chuck--that was the same question Chuck asked. It was basically we're trying to attack the markets that are growing very strongly and grow applications within those markets, and that's our objective.

Right but you can't quantify the level of the new product potential?

But I--

That's difficult to do Bob.

You have to be qualified, the customer has to accept that you have to go through this whole drill, as when you're in this new space.

Bob 1/4 of the growth this year has been from new products.

Right.

Can we have 1/4 of the growth next year be from additional new products, that's certainly possible. But I-- until you get closer to the qualification process and then you see the actual order book behind the product, it's difficult. But see now, you remember this is two years in a row where about 1/4 of the growth has been from the new products. So can we do that a third time around? It's possible.

That is our objective.

And that is the objective.

Okay, all right. Fair enough. Automotive is such a small component of your business now as compared to what it used to be, are there any businesses other than automotive that cause your concern as we go into 07?

I don't think so. I think automotive is--

That's a good question, I-- you've got that one is always a wild card, but at this point in time other markets right now that we participate in -- at this point there's no-- I don't see any major market segment that would be that troubling.

Okay but you would share concern about automotive, even though it's, again a small component of your business today?

Right.

And then finally could you just give us an update on any discussions, any indications of where you might be headed toward acquisitions? If there's anything on your plate coming up, anything your interested in, anything-- might happen--

Again, our first priority is our organic growth and that's what we're working on the hardest. And then as you know we picked up three acquisitions last year, and we are currently active looking at other good synergistic acquisitions at right pricing. So if we find something that really fits the business well and provides our key strategic legs which would be augmenting our technology base, customer base, or geographic base, we'll certainly take a hard look. And that's an active piece of our activity is to try to find some new opportunities.

Okay and then finally, I don't know if, John, you have this number yet. But do have the CapEx number for next year yet?

No we don't have any specific numbers, with the priority being keeping pace with this kind of growth organically, we're probably going to see some step up in CapEx on '07,visa via '06, '05, and '04. I'd say to you though not a whole lot more than depreciation if more than depreciation in '07.

Okay great thanks. And great quarter.

Thank you.

Our next question is coming from Joshua Sharf with William Smith & Company. Please proceed with your question.

Thank you. Good afternoon.

Good afternoon.

I have a quick question for, well maybe not a quick question. But in terms of your hedging strategy it seems as though you would-- given that there's been benefit from the, from being able to pass through the costs. Can you describe the hedging a little bit, describe the hedging strategy at all, and perhaps describe whether or not you're perhaps hedging against the decline in prices?

Well at this point in time because of our position of being able to have metal pass through right now it's not necessary to hedge. So that our necessity to have an agressive hedging program just isn't there, it's not necessary at this point.

Okay so when you had said 90% coverage, that assumes then that the hedges aren't going to be allowed to expire and you think you have 90% coverage in terms of pass through ability?

Our risk level is dramatically reduced.

Okay, all right. That's it, thank you very much.

Our next question is coming from Mark Parr with Keybanc Capital Markets. Please proceed with your question.

Hi thanks. Good afternoon.

Hi Mark.

Man you guys are doing a terrible job. Fantastic that's really awesome. You guys have got to be in the running for the biggest growth business in the northern Ohio area in 2006. That's really amazing. Great job. One of the things I wanted to talk about is with a corollary to great topside growth and earnings momentum is return on capital, and I'm wondering in light of some of the marginal contributions, I'm looking at the year-over-year growth, again marginal growth in gross profit looks like it's about 21%, and sequentially you're up about 13 million in revenues from the second quarter, and your operating profits up about 1 million, that's a little less than a 9% marginal contribution. I mean are those profitability metrics an appropriate way to look at your business or is that a satisfactory level? How do you feel about these dynamics?

Well I think we've talked about that a little bit, is that no that's not accept and we did have some margin issues here in the quarter that we reflect in some of these investments we've made from these, some market new--very new product opportunities.

And many times when you're developing the new products and introducing them in the marketplace, you're affected by some early yields and the higher production costs, qualification costs, there's a numerous type higher cost that you can realize versus a stabilized steady production level, because you're dealing in smaller lot sizes, you're dealing with a lot of new products and changes constantly, so it's a disruptive type operation, when you're introducing some major new products and we saw some of that in the quarter but that's certainly not an acceptable level of incremental profitability and you're right on the money there.

I think if you recall, Mark, in the press release we mentioned $2 million of, you could call it missing profit if you will, because of the, the one time kind of issues associated with the ramp ups etcetera, in the quarter. So if you add that back in you get a different marginal contribution, and we would hope to operate north of 20%.

Okay all right. I appreciate that. And I apologize for missing part of your commentary.So thanks for that additional color, I really appreciate it.

[OPERATOR INSTRUCTIONS] We have a follow up question coming from Avinash Kant with Canaccord Adams. Please proceed with your question.

Once again just wanted to touch base on some of the new products. And now you talked about [tough] metal a little bit, could you give us some idea about how big do you think [tough metal] could be this year, and how do you see growth going forward?

Well in that particular product, Avinash, we've been growing that for the last several years at a compounding rate of about 40% a year. So it's been a strong grower and will that growth curve settle out? It's certainly possible but I still think we have quite a ways to go with that particular alloy system for very strong growths for several years, because almost everyday it's expanding its application base.

Would you think that this could be roughly a $15 million business this year or more?

Well in that particular production unit we're close to $15 million, that's out of the Lorraine facility and so we're kind of there now, out of our Lorraine facility. And then we're looking for some good growth ahead of us.

Okay so you are already at 15 by the end of Q3?

No I said, for the year it will be roughly that kind of level.

Okay and also, there's been a lot of talk about [inaudible] media and could you say and could you kind of collaborate how do you play in that market? And how big could it be in opportunity for you?

Well it's a very big opportunity I think we have announced, we're actually dramatically expanding our production capacity at our facility in Brewster, New York to be able to continue to follow that market. And that's a brand new market for us, the technology has changed in the hard disk drive media market. And so that's a big heavy area, in fact that is specifically the area that we talked about some of our margin depression, is attacking that market space.

Historically, Williams was a, still is a leader on the head side of the vapor deposition materials, and the head side of the disk drive market. Now the media is a much larger market, cause you imagine the amount of metals that are sputtered on the disk, is a lot more than the heads. And so that's the market that we're attacking, so it's much larger than even our historic market. And so that's the big challenge right now is to get qualified and there's the different levels-- different layers of product there. There's a soft underlayer, there's an oxide layer, then there's the top layer with the perpendicular layer. And these all have different metals constituents, a very sophisticated alloying systems and these are all the products that we feel we can grow quite strongly on. And again that's going back to a very market that's growing at 15 to 20% a year and there's a major new whole market space, which is the media side that we intend to capture a good piece of it.

And so just to elaborate on that, at this point the head side of the business, mostly on the deposition side, if you have to talk about. How much of the business it is for you? And just to try to understand, if a percentage of that is kind of-- if [inaudible] in the media could grow to a certain percentage of that--

Well I-- for competitive reasons I really can't share those numbers.

Okay. Good enough, thank you so much.

[OPERATOR INSTRUCTIONS] Gentlemen there are no further questions. I will now turn the floor back over to Management for any closing remarks.

This is Mike Hasychak, we'd like to thank all of you for participating on the call this afternoon. I'll be around the remainder of the afternoon to answer any further questions. My direct dial number is 216-383-6823. Thank you very much.

Ladies and gentlemen this does conclude today's teleconference.