Materion Corp (MTRN) 2008 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Brush Engineered Materials third quarter 2008 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded.

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

Good morning. With me today is Dick Hipple, President, Chairman and CEO; John Grampa, Senior Vice President, 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 2008 results and 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 until November 14th, by dialing area code 877-660-6853, account number 286 and conference ID 299961. 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 RealPlayer 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 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 John Grampa for comments.

Thank you, Mike. Good morning everyone and welcome to our third quarter 2008 call, and thanks for joining us today. Today's format is the same as that of past calls. I'll review the quarter and then comment on the outlook, and following my prepared comments, Dick Hipple will provide you with a market update. Dick will be focusing on the effect that the recent economic developments are having on our businesses and then we'll open the call for questions.

I'll focus on several of the key points that were identified in the press release, covering both the quarter, as well as the outlook. I'll also attempt to pre-answer certain specific questions, some of which we have already received.

First, I'll cover the factors affecting the reported sales compared to the prior year, including the progress that is embedded in those numbers once you remove the influence of metal price and the media market factors.

Then I'll review the factors affecting the reported profit comparison, especially the prior year non-recurring gains, the current year level of lower of cost or market charges, and the third quarter discrete tax items. These items do distort the operating performance comparisons and need to be understood.

Third, I'll provide some specifics on the trends in media and as most of you know, here significant swings in ruthenium material prices, material sources and demand factors, new product qualifications, as well as requalifications and market ramp rates can and have dramatically affected our comparisons. Dick will be updating you on both the status of our product requalification process and where we have made good progress and the unfortunate problem that developed with a material supplier late in the third quarter.

Fourth, I'll review our balance sheet, which is very strong, strengthened further in the third quarter, and is expected to continue to strengthen.

And fifth, I'll update you on the status of our share repurchase authorization, including the specifics of the repurchases to date.

Following my comments on those five points, I'll review the outlook identified in the press release and along the way I'll cover an anticipated question or two in each of these areas.

As I begin the review of these points, let me call your attention to the table in the non-GAAP financial measures section on page five of the press release. In this table, we reinforce what most of you should already know and that is that the third quarter and nine-month comparisons to the prior year are affected by a number of factors that cloud the performance of the Company's baseline business. We've discussed these in the past and present them here again for reference. The most impactful is last year's sizable benefit from the sale of ruthenium-based materials into the media launch that included a sizable non-repeat cash gain related to a significant and sudden increase in the market price of ruthenium that had been purchased in 2006 at a much lower cost.

This factor generated a $0.04 per share gain in the third quarter of the prior year and a $0.70 per share gain in the first nine months of the prior year. Also to be noted in that table is the lower of cost or market charges taken in specific subsequent quarters of both prior years, as ruthenium prices have fallen significantly. In effect, we've given back $0.31 of the $0.70 per share gain.

My comments today will focus on the operating run rate, which excludes these and the other factors identified in the table. Let's begin. Related to the factors affecting sales, as you know, this morning we reported sales for the third quarter that were about $10 million or 4% ahead of the prior year's third quarter level. Metal price inflation or said differently, that portion of both precious and non-precious metal price increases that we were able to pass on to our customers raised sales approximately 7 percentage points for the quarter and 8 percentage points for the nine months. As in the first two quarters, a major factor that negatively affected our growth was lower shipments to the media market, which is directly linked to the requalification process we've been reporting to you on.

In the third quarter, sales due to this factor were approximately $28 million below the prior year. Approximately $5 million of this is due to lower ruthenium metal prices and the balance, $23 million, related to lower volume. The media falloff negatively affected the sales comparisons by 12 percentage points in the third quarter and 15 percentage points for the nine months. Net of these factors, that is excluding both the metal price and media effects, sales increased in the Company by 9% in the quarter and on the same basis, the year-to-date growth is approximately 7%.

Now, let's review the factors affecting the profit comparisons. The earnings we reported this morning were, on a GAAP basis, equal to the prior year at $0.48 a share diluted. Excluding the previously reported prior year ruthenium inventory benefit and accounts receivable correction and this year's discrete tax item, the operating run rate for the quarter was $0.41 a share compared to $0.39 a share in the prior year. The operating run rate of $0.41 a share was higher than our expectations for the quarter, as revised in our October 2nd press release. The improvement was due to margins -- better margins and lower expenses.

Ruthenium prices dropped in the second quarter from $415 an ounce to $300 an ounce, resulting in a $6 million charge taken then. In the third quarter, ruthenium prices were reasonably stable and had only a minor effect on the results for the quarter. However, since the end of the third quarter, ruthenium prices have fallen to below the $250 an ounce level. If that price level holds through year-end and assuming no significant change in inventory levels, the Company will incur a lower of cost or market inventory charge in the range of $0.07 a share in the fourth quarter.

In the third quarter of the current year, the Company recorded a discrete tax benefit of approximately $0.07 a share. This was anticipated and was due to specific one-time events, including adjustments to the Company's tax reserves related to prior year tax returns. In the fourth quarter, the tax rate is expected to return to the second quarter levels and be in the 33% to 34% range.

Again, in the press release issued this morning, we've embedded a table that illustrates the impact of these non-operating factors. And again, I call your attention to this table, as we consider the presentation of the operating results in this manner to be a better representation of our baseline business for our operating run rate.

Now, turning to media. As you know, the most significant factor that drove our growth in 2007, as well as the expected growth in 2008 is the growth of our new magnetic media materials for the perpendicular media recording segment of the data storage market. The growth here is dependent on the rate at which the market and the customers we serve transition to the new perpendicular media recording technology and our ability to both capture and maintain a share of that business with our new products and our production capabilities.

You'll recall that a rapid product launch resulted in very high sales and profit levels in the first half of 2007. Then, as previously announced, during the fourth quarter of 2007, the Company experienced a significant setback in this market. The setback was driven primarily by a changing material specification at our largest media customer, which in turn resulted in necessary manufacturing process changes and a lengthy product requalification process. This resulted in lower shipments while the requalification process was underway.

Media volumes were approximately 20% of the prior year's volume in the first quarter of this year and began to recover reaching approximately 70% of the prior year's volume in the second quarter. Volumes in the second quarter were 60% ahead of first quarter volumes, as the lengthy requalification process progressed. We ended the third quarter expecting the level of business to continue to increase. Late in the third quarter, we temporarily suspended shipments to a key customer due to a problem with a raw material supplier. While we expect that this problem will be resolved, it is not clear when the substantial shipments will resume. And at this time, we do not expect significant shipments to occur in the fourth quarter. Dick Hipple will provide additional information on the media market in a moment.

I'll now comment on the balance sheet. The Company's balance sheet has been strong and continued to improve in the third quarter. Even considering the acquisition made earlier in the year, the Company continues to have significant financial flexibility. Our debt-to-debt plus equity ratio remains very healthy at 13%. While the Techni-Met acquisition was approximately $87 million, balance sheet debt has increased by only $23 million to date. The Company came into the year having increased its precious metal consignment lines by $85 million and its revolving credit agreement by $115 million to the $240 million level, adding both financing capacity and significant flexibility. The increased capacity and flexibility add to the liquidity to support the expected organic growth and to take advantage of acquisition and augmentation opportunities, plus other capital considerations as they surface, including the announced share repurchase plan. And certainly we're pleased to have the liquidity that we do and the flexibility that we have to support our strategic initiatives, as we enter these uncertain economic times. That completes my comments on the third quarter.

I will now comment on the share repurchase plan and then the outlook. As previously announced, the Company's Board of Directors has authorized the Company to repurchase up to 1 million shares or 5% of the Company's outstanding shares of common stock. The primary purpose of the repurchase is to offset the dilution created through shares issued under Company's stock-based compensation plans. The authorization provides the Company the flexibility to use its balance sheet to repurchase shares over time, while maintaining an appropriate level of liquidity to support the Company's primary strategic goals, which include utilizing available capital for organic growth and strategic acquisition opportunities. The presence of this plan to repurchase shares does not represent a deviation from the Company's strategic focus and the Company does not see any change in its long-term growth expectations and acquisition opportunities at this time.

The stock repurchases will be made from time to time through brokers on the New York Stock Exchange. The repurchase program may be suspended or discontinued at any time. To date, we have repurchased approximately 12% of the authorized amount. Looking ahead there are no changes. At this time, in our stated intentions, which are to repurchase up to 1 million shares over time to offset the dilutive effect of employee and director's stock ownership plans.

We are mindful of the current stock price. We are also mindful of our liquidity and do expect that it will continue to grow. And we have confidence in our business model. However, the current economic environment can threaten the performance of organizations that do not have strong balance sheets. This environment can also provide extraordinary opportunities to those of us that do. We will be diligent through this period and cautious in the use of our cash and debt capacity. To comment any further at this point on our repurchase plans would be too speculative.

I'll now turn to the outlook. As you know, the specific guidance we provided in the press release today is unchanged from the update that was provided on October 2nd. As you might expect, the current global financial crisis and related economic downturn is making it extremely difficult to forecast the near term. Following a strong and encouraging beginning to the second half, a significant decline in our business levels began to appear in our order book later in the third quarter. We began to see widespread weakness in the global consumer electronics, telecom, and automotive markets that was affecting demand in both the Specialty Engineered Alloys and Engineered Material Systems segments of the Company.

Historically, following the slower seasonal summer period, order entry in these segments increases in the late summer and early fall, as manufacturers increase production levels and electronics producers prepare for the holiday season. Rather than an increase, we noted a significant decline, which affected the third quarter performance. The third quarter was also affected somewhat by reduced shipments to the oil and gas market due to the impact of Hurricane Ike and shipments to the commercial aerospace market due to the Boeing strike. This will affect fourth quarter performance as well.

At this time, assuming no additional decline in the Company's key markets, other than that anticipated in the guidance previously provided, the Company expects earnings for the full year to be in the range of $1.15 to $1.30 per share on a GAAP basis. This includes the negative effect of the charges taken in the first and second quarters of the year and a positive effect of the discrete tax items recorded in the third quarter. Excluding these factors, the operating run rate for the full year is in the range of $1.45 to $1.60 per share.

It is important to continue to reiterate that though the Company's earnings estimates are subject to significant variability, metal price changes, metal supply conditions, fluctuations in demand levels driven by such factors, as customers inventory swings, product qualification rates, and new product ramp up rates are critical in markets such as the media market and can have a significant effect on actual results. The outlook for the remainder of the year is based on the Company's best estimates at this time and is subject to significant fluctuations due to these factors, as well as other factors.

I'll now turn the call over to Dick Hipple. Dick will provide you with a market update.

Thank you, John. I'd like to address our general market conditions that impacted our lowering the earnings estimate on October 2nd for 2008. As John mentioned, usually coming out of the summer season we see our general order book pick up heading into the Christmas consumer product build cycle. This year this did not happen.

Due to the turmoil in the housing and financial markets and concern regarding consumer spending, I am sure that consumer products manufacturers are not planning nor building products for a particularly robust holiday season. And if recent auto sales are a precursor of consumer sentiment and buying patterns, then caution is certainly understandable. We were also hit with several transitory and temporary reduced sales and order patterns in the quarter. Sales and orders into the oil and gas sector declined after Hurricane Ike substantially wiped out the Houston area's ability to transact business for a significant period of time. And to a lesser degree of impact, the Boeing strike reduced sales and orders into the commercial aerospace market. And as you are well aware, the Boeing strike was recently settled and the negative impacts of Hurricane Ike in Houston are now waning. And obviously depending on where energy prices settle out will ultimately determine the robustness of growth in the oil and gas sector.

Meanwhile, many of our other markets have either remained stable or, in fact, are still growing. Our defense, optics, medical, and selective electronic markets such as the LED and undersea cable market, all remain robust. Please keep in mind that in spite of all the great market turmoil, we realized 9% organic growth quarter-to-quarter from last year outside the impact of the media market, which I will now discuss.

With regard to the media market, we have obviously had another major setback with an incoming raw material processor. As soon as we discovered the nature of the problem, we took immediate action to seize ruthenium target supply for any product that might affect our customers. We have taken aggressive steps to find alternative sourcing and to rectify the reliability issue at our current supplier.

I must say our customers commended us for our fast action in this regard to protect them from any problems. In the meantime, we have been able to successfully continue our qualification trials on our new ruthenium product during this time frame. In fact, we are shipping our first production trial orders in the fourth quarter with the anticipation of ongoing production orders in the first quarter. However, I am not prepared at this time to discuss forecasted media business until we are well established back into the media marketplace.

So in summary, while the near-term outlook may be uncertain and the full impact of the global economic crisis unclear, one thing is certain is that our Company is well positioned to weather a storm and to take advantage of opportunities that might surface.

Our business base is broad in terms of products, customers and markets, as well as geographic reach. Our balance sheet is very strong and we have significant liquidity and significant flexibility with even more improvement expected. In these difficult times, our strong financial position should be appreciated. And we are also acting with speed to take out cost where appropriate and while at the same time pursuing many exciting growth opportunities that remain in front of us. Okay.

Okay, operator, we'll turn the call over now for questions.

Thank you. Ladies and gentlemen, we'll now be conducting the question-and-answer session. (OPERATOR INSTRUCTIONS). Our first question is coming from [Anthony Sorrentino] with [Sorrentino Metals]. Please state your question.

Good morning everyone.

Good morning.

Good morning.

Now that copper prices are declining, are you adjusting your copper-based product prices downward?

Yes, the majority of our copper-based business is pass through copper. So, it does go down accordingly.

Okay. And is there any lag effect on the way down in the same way that there was a little bit of a lag effect on the way up?

Yes, there is always -- you have a couple of months lag both ways.

Okay, and --

And if you remember, Anthony, we were able to change our model about two, three years ago where either -- particularly if it went up, it really hurt us and -- but now that it's all kind of passed through, it -- we're kind of independent from an OP standpoint of copper.

Okay, fine. At what average prices were the shares repurchased?

Yes, we'd have to dig that number out for you. Let me find it. It's somewhere around $20.

Okay. And one final question, have you drawn down any of the $240 million revolving line of credit?

No.

Is your question whether or not it's drawn against it --

Yes.

Or is your question, has debt come down?

No, have you drawn against the $240 million revolving line of credit?

Our debt has come down.

Okay, fine.

And we do have about $15 million drawn on the revolver presently.

Okay. And what are the terms of the revolver, what interest rate is it tied to?

LIBOR and 62.5 points above LIBOR, we are borrowing at right now.

Okay.

LIBOR plus 62.5.

Okay, 62.5 basis points. Okay, very good. Thank you very much.

Our next question is coming from [Robert Duchal] with [Duchal Management Group]. Please state your question.

Good morning. I am a new shareholder.

Okay.

I've been buying your stock as it proceeds downwards. My question is, do you pay any dividends at all? I've seen no notification about that?

No, we do not.

Okay. Thank you.

Our next question is coming from Rob Young with WM Smith & Company. Please state your question.

Hi, good morning. Just I'm curious, what's the qualification timeline between you and the supplier for the media business?

You mean what's a typical timeline?

Right.

Starting to -- probably four to five months.

And that's from your end to qualify their raw material?

(inaudible), I would say about a quarter.

A quarter, okay. And then at this economic environment, are you seeing any positive implications on your acquisition pipeline?

Well, we are active there and we would expect multiples that will be coming down in this environment, so we would certainly hope to have an acquisition at a more attractive rate than we would have six months ago. So, it's an active area for us and again, as I've stated many times, that it's got to be right just because something is cheap may not be the right thing for us. It's got to fit strategically also.

Okay. And would this be primarily as a bolt-on to help existing business or --

I mean we are very flexible. I mean so far, what we've been doing has been augmenting our business units and we've been augmenting particularly on the technology side and also market side. So, we've been able to expand what I call our total opportunity for the future by doing that. So, you can -- when you go into new technologies or new markets that -- and you apply our particularly business model to it, we've been able to really leverage up our acquisitions.

Okay. And then, in this environment are you looking to spend any less on acquisitions over the next year than you may looking forward in future years?

No.

Okay, okay. And then just trying to get a little handle on Q4 and I know that's difficult to predict that near-term guidance. But is there anything that has materially occurred since your 8-K at the beginning of the month that would significantly sway your opinion on Q4 earnings?

No, the only point that I would reference are really the two points that I made in my introduction to the conference call and that is one that the range that we provided for the year is based on the business-level assumptions that we made when we published on October 2nd and our assumption here is that since our estimate has remained unchanged, there has been no change to the level of business. And then secondly, I did mention in my discussions, the one-time charge that we occasionally see from lower of cost or market from ruthenium and if you recall, I talked about the -- that since the end of the quarter, the market price of ruthenium has fallen to below $250 an ounce from the $300 an ounce level and if that -- if it holds that those kinds of levels would represent a charge in the quarter of about $0.07 a share.

Right. Okay. And then just one last one on, relating to a previous question. Given the lag of the two months or so that it takes for pricing increases or decreases and given that the majority of the metal indicators have been falling, would there be any possibility for margin expansion relative to previous levels?

Yes. The answer to that is yes. But recognize that they do move around, they move up and down depending upon what piece of business. But generally there would be some lag and as the price is dropping, some favorable benefit on the other hand, you may not see margin differences in reported results because volume is dropping.

Okay, okay. Well, that's great. That' all I have. Thank you.

Our next question is coming from Chuck Murphy with Sidoti & Company. Please state your question.

Good morning, guys.

Good morning.

Good morning, Chuck.

Just trying to get a sense for what you are thinking as far as sales for the fourth quarter, so we can kind of build the model up from there. I mean what do you think --- why do the EPS guidance and no sales guidance?

Well, Chuck, I think as you well know, the sales number is volatile depending upon metal price. So in the Company, if we were to sit here and say, expect sales levels in the fourth quarter to be similar to third quarter levels, that would be making an assumption that metal prices aren't going to move around. And as you know, they do move around dramatically.

Copper is down, gold is down, platinum is down.

Ruthenium is down and then the other side of that is the source of the metal. As you know in our business, we run from copper, not copper -- ruthenium supplied by customer to ruthenium supplied by us. Gold supplied by customer to gold supplied by us. And when it's supplied by us, it's in the topline or in the revenue line. When it's supplied by the customer, it is not. So, we could see the same profit levels with significant swings in the revenue number. And it's a difficult number to also forecast, but if you want to make an assumption based on all that we've said, why would we assume that fourth quarter sales ought to be reasonably similar to third quarter barring any significant movement in that metal mix and metal price.

Okay. And you mentioned that the media, the sales were down about $109 million for the first nine months year-over-year. Can you say what they were for the first nine months of last year or what they are for the first months of this year?

For roughly?

Yes.

Do you have it there, Jim?

I'd have to look it up.

Okay. Why don't you go with your next question and we'll dig out the detail and come back to you on that.

Okay, okay. You mentioned that potential $0.07 charge for the ruthenium being lower, is that baked into the guidance or --?

In fact, it's baked into the GAAP guidance, yes.

Okay, okay. And I guess I'm just trying to figure out more than anything, I mean what are the chances that media sales are up in 2009?

Compared to 2008?

Yes.

Given that the levels are as low as they are in 2008, we would certainly hope being -- maybe a weak work -- we certainly expect based on what we know they would be up, hopefully up significantly.

Okay. And I guess like any other parts of your business that you feel good that would kind of be able to sustain the downturn, given market penetration or market share gains kind of thing.

Yes. I think there is a good number of anywhere from the medical markets to -- or growth in the solar, you got the media there and then the LED materials. The oil and gas market, I still think, is going to grow for us even with lower pricing out there simply the fact because of our growth in applications that are still coming. So, anyway there's numerous areas that we feel very good about. And the defense market is still -- we expect to have, that's a very good area for us in 2009.

Okay.

The media sales number for this year for the first nine months is about $6.2 million.

Okay. All right. That helps. So, I guess it's kind of hard to go much lower than that.

Bear in mind a chunk of that drop-off too is that this year, most of the ruthenium -- a large portion of the ruthenium sales are based on customer's supply, where last year it was our material.

I got you.

What's really going to become more relevant there is the volume into the market and not the sales dollar again, because of last year if you recall some of those sales were -- we averaged over $600 an ounce in the topline in metal price last year and this year prices are under $300 an ounce. You get an immediate 50% drop based on that alone, if you're the metal provider. And then secondly if the customer is providing his metal, all we're going to see in the topline is going to be the value adds.

Okay.

We'll comment on that as quarters progress to try to keep it as clear -- to make it as clear as possible for everyone.

I got you. But it sounds like, I mean $6 million, it's probably like less than 5% of Williams' sales and it sounds like the rest of Williams is growing at pretty strong rates. I mean with --

Right, absolutely.

There is a comment in the press release about that. Okay the --

22%.

22%. Yes, the other growth in the rest of the business has been extraordinary.

So, I mean, I guess that is pretty much washed out and so looking out into 2009, you really wouldn't have the media sales offsetting the growth for the rest of the business like you have for this year. Is that fair to say?

Rest of the business offsetting the media growth?

Well, media coming down so much in '08.

Yes, you're right.

Okay. All right. That's all I had. Thanks, guys.

(OPERATOR INSTRUCTIONS). Our next question is coming from Mark Parr with KeyBanc Capital. Please state your questions.

Hi, this is Phil Gibbs for Mark. Mark is actually in Chicago at a conference. How is everyone doing?

Doing okay, Phil. Good morning.

Good, good morning. I just had a question in the Williams business, given the slowdown in the media market and a lot of this has been alluded to on the call thus far. Where are your efforts in lieu of the near-term graph being kind of redeployed more vigorously in that segment of the business to kind of make up for the weakness we have seen in media in the near term here?

Say it again.

Are there opportunities in Williams, the business looked pretty strong there. Excluding --

The question is outside the media business.

Yes, exactly.

Okay. Well, outside the media business is some of the things that I mentioned a little bit earlier was the advancement in the solar market, the LED materials, which is a very strong growth area right now. It's for energy conservation for light and we're -- we participate in the high-intensity area. I always like to tell the story that if you watched the Chinese Olympics at the opening ceremony and all the fancy LED lights that were going all over the stage and the floor, that was our materials in there, for example, to give you an indication.

Okay.

The medical market is growing very nicely actually through -- our two acquisitions that we made in the last couple of years that we see the medical market growing at north of 10% a year for us. And then we're -- actually -- Williams is actually developing a very nice defense business right now, particularly in the optics area. That's very, very strong right now. We expect that to continue on very robustly through next year. So, there is lots of very interesting segments and some of this has actually all been evolved through our acquisition strategy.

Great. And I see that the beryllium business was very strong in the quarter.

[Our] beryllium business is doing very well right now.

And do you expect that to continue?

Yes. We have a -- it's actually our only business that we can look out a little bit. Just in the nature of that business, the backlog and the forward look on the book on that one is, we feel pretty confident that we can almost look through at least mid-2009 and know that that business is real solid for us.

Okay. Terrific. Thanks, guys. Have a good day.

Thank you. There are no further questions at this time. I'd like to turn the floor back over to Michael Hasychak for closing comments.

We would like to thank all of you for participating on the call this morning. I will be around this 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. You may disconnect your lines at this time. Thank you for your participation.