Brush Engineered Materials Inc. Q1 2009 Earnings Call Transcript

| About: Materion Corporation (MTRN)

Brush Engineered Materials Inc. (NYSE:BW)

Q1 2009 Earnings Call Transcript

April 30, 2009 11:00 am ET

Executives

Michael Hasychak – VP, Treasurer and Secretary

John Grampa – SVP, Finance and CFO

Dick Hipple – Chairman, President and CEO

Analysts

Avinash Kant – D.A. Davidson & Co.

Richard Dearnley – Longport Partners

Rob Young – WM Smith Securities

Operator

Greetings ladies and gentlemen and welcome to the Brush Engineered Materials first quarter 2009 earnings conference call. At this time, all participants are in a listen-only mode and a brief 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, Mr. Michael Hasychak, Vice President, Treasurer and Secretary for Brush Engineered Materials. Thank you. Mr. Hasychak, you may now begin.

Michael Hasychak

Good morning. This is Mike Hasychak, with me today is Dick Hipple, Chairman, President 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 first quarter 2009 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 May 15th by dialing area code 877 the number is 660-6853, account number 286 and conference ID number 319 480. The international replay number is 201 612 7415. 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 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 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 John Grampa for comments.

John Grampa

Thank you, Mike. Good morning everyone and welcome to our call. Thanks for taking the time to join us today. Today's format is the same as that of our past calls. I'll review the quarter and then comment on the outlook. Then following my prepared comments, Dick Hipple will provide you with a market update and a review of other key company factors. Both Dick and I will comment on the effect that the economic developments of the past several months have had on our businesses, the aggressive actions that we've taken and will continue to take if necessary to ensure that the company remains healthy, and our current view of the economic environment which leads to the improved outlook for the second quarter and the second-half of the year, then we'll open the call for questions.

I'll focus specifically on some on some of the key points identified in the press release, covering both the quarter and the outlook. I'll also comment briefly, only briefly on the year which while improving is in this environment simply too uncertain to be specific about. I'll also attempt to pre-answer certain specific questions which had come to us already. First, I will review the sales and earnings level along with the key items affecting them, the comparisons to the prior period including metal prices, currency, certain market factors and the items that are not expected to repeat.

Second, I will review our cash flow and the state of our balance sheet which as you know is very strong and it ended the quarter where we thought it would and is expected to strengthen even further as the balance of 2009 unfolds. Then I will cover the cost reduction initiatives, their scale, and try to provide some added insight to how they will affect margins and profitability looking ahead. And following my comments in those areas, I will review the outlook. Let’s begin with sales and earnings.

As you know, this morning we reported sales for the first quarter that was about $91 million or 40% below those of the prior year. The first quarter sales were below the fourth quarter of last year’s levels by $61 million or 31%. Metal price movement had more of an impact on the overall revenue comparisons than in recent periods. Metal price deflation, or said differently, that portion of both precious and non-precious metal price declines that we normally pass on to customers lowered sales by approximately 7 percentage points in the quarter compared to the prior year.

Therefore, while reported sales were down 40% in the quarter, the real decline excluding the metal price movements was 33% and the foreign exchange impact I should note was diminimus. 16 points of the 33 point real decline or volume drop if you will was in our advanced material segment and 14 points were in our engineered outlook segment. As we noted in the press release, these declines were driven solely by the macro economic conditions and primarily by the conditions in the consumer oriented markets we serve.

Sales to our defense and medical markets were actually up in the quarter. Dick Hipple will provide additional information on markets in a moment. The reported net loss for the quarter was $8.1 million or $0.40 a share. The net loss for the quarter was expected by the company and included $2.4 million pretax for inventory charges and expenses related to the implementation of the company’s cost reduction initiatives as well as $1.1 million pretax pension benefit. The net inventory valuation charge was $0.05 a share. Severance expense related to the manpower reductions was $0.03 per share and the pension benefit also driven by the significant reduction in workforce was $0.04 a share.

The rapid decline in business levels obviously had a significant effect on our bottom line. Excluding the unusual or nonrecurring items that we have reported on in the past, the $61 million sequential drop in revenue from the fourth quarter of 2008 to the first quarter of 2009 negatively affected earnings by $0.52 a share. That is about $0.08 to $0.09 a share for each $10 million of revenue movement. The impact was cushioned somewhat by our ability to get cost out.

Now I will turn to the balance sheet it is attached to the press release. Our balance sheet has been strong and it remained strong in the quarter. After making the pension plan contribution and payments for incentives earned in 2008 both of which were expected and totaled about $21 million, our debt increased by only $11 million or to the $53 million level. We were cash positive from operations in the quarter excluding those two items. The company’s debt net of cash to capital ratio was approximately 10% at the end of the quarter.

At this time, we do expect the balance sheet to improve through the remaining quarters of the year. The company has a committed revolving line of credit totaling $240 million that matures in 2012. We ended the quarter with about $25 million drawn on that revolver. In these economic times we are pleased to have the liquidity that we do and the flexibility to support our operations and our important strategic initiatives as we navigate these times.

I will now turn to the cost reductions. During the fourth quarter of 2008 as the downturn began to take hold, the company responded quickly and effectively with a number of initiatives to reduce costs and to assure that the company’s balance sheet remained strong. The measures implemented included headcount reductions that reduced total employment by approximately 400 which is 17% of our workforce globally. Initially the company also eliminated planned executive and senior management salary increases, implemented a general pay freeze, reduced work hours, suspended the 401(k) match, reduced discretionary spending, and deferred lower priority initiatives. In addition, the company subsequently reduced the salaries of the senior executives of the company and the annual cash retainer fees of the company’s Board of Directors by 10%, and the salaries of other senior managers by 7%. Efforts to reduce working capital and targeted capital spending deferrals have also been implemented.

The company believes that the result of these initiatives is a leaner, more efficient operating structure. The working capital and capital spending reductions are yielding cash benefits. The cost reduction initiatives have had a favorable impact on results to date and are expected to result in more clearly visible benefits in the second quarter. While the scale of these initiatives is sizable, the company is taking care to not disrupt investment in the pipeline of new products that will help during the difficult macroeconomic environment of 2009 and provide solid growth opportunities for 2010 and beyond.

The annualized impact of the cost reductions is in the range of $45.0 million to $50.0 million or about $12 million a quarter when fully implemented. While the initiatives began in the fourth quarter of 2008 they continue to be implemented through the first quarter and into the second quarter. Their full impact will be felt by the middle of that second quarter. The initiatives affect factory direct costs and factory overheads as well as SG&A. Approximately 50% of the reductions are in factory direct costs, 20% are in factory overheads, and 30% are in SG&A.

I'll now turn to the outlook. As noted in the press release, the widespread weakness in the majority of our global markets has created an environment with minimal visibility. It is extremely difficult to predict the impact of these challenging market conditions on the outlook for the full year. While we have suspended our practice of providing guidance as many others have we do feel that it is important to express our current view in spite of and considering the vagaries of the environment that we are operating in. Recent activity in our key markets suggests that the level of business has bottomed and is improving.

The first quarter ended stronger than it began and the level of business to date in the second quarter is stronger than that of the first. While it cannot in this environment be said that anything is for certain, we are seeing improvement in order entry especially from the consumer electronics orientated market. At this time, we expect second quarter sales to improve by approximately 15% and thus be in the range of $150 million to $160 million, an increase in the range of $15 million to $25 million from first quarter levels. Part of the second quarter sales increase from the consumer electronics oriented market is driven by the reduction of inventory levels in the supply chain during the first quarter.

Usually, the third quarter is stronger than the second in the consumer oriented market as the supply chain begins to fill to support the holiday season. The higher volume and additional impact from the cost reduction activities should result in a noticeable improvement in performance beginning in the second quarter. While we still expect a loss in the second quarter that loss should be no more than half of first quarter loss. Assuming the improving order trend continues and there is no change in seasonal factors or other economic events, we do expect to generate a profit in the second half of the year. Given the cost reductions that we have implemented each $10 million of incremental revenue adds between $0.10 and $0.14 a share of earnings depending on mix.

It is important to continue to reiterate that the company’s outlook is subject to significant variability especially given the current economic environment. Changes in demand levels, metal price changes, metal supply conditions, new product qualification in ramp rates, swings in customer inventory levels, changes in the financial health of key customers, and other factors can have a significant effect on actual results. The outlook provided here today is based on the company’s best estimate at this time and is subject to significant fluctuations due to those as well as other factors.

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

Dick Hipple

Thank you, John. We certainly have come through a very difficult first quarter with unprecedented demand destruction continuing from the fourth quarter of last year into the first quarter of 2009. Many recent earnings releases by our key customers in the electronic sector indicate sales revenues down 30% to 40% versus last year and we certainly saw similar demand declines as our customers drew down their inventories. In addition to the electronic sector, the oil and gas, automotive, and commercial aerospace markets have suffered similar declines. The rapid decline in oil prices has resulted in drilling activities declining over 40%, and air traffic miles have declined with a recession causing much lower airline rebuild maintenance activities, and we all know the sorry state of affairs in the auto industry.

The only islands of serenity have been the defense and medical markets. I will say we have leveraged our position in the defense and medical markets particularly with our new acquisitions as we expect higher sales in 2009 than 2008 in these areas. We began aggressive cost reductions in the fourth quarter last year which have continued through April of this year. John has outlined the majority of these actions which I will not repeat but I would like to reinforce my appreciation to our global organization with respect to the speed of response and understanding as we battle our way through these tough market conditions.

Fortunately we are beginning to see an increase in order rate particularly from the consumer electronics sector. At this time we are not reading this as an upturn in macro economic conditions but simply as a sign that the severe inventory correction by our customers is nearing completion where we will now be seeing actual market demand. Should standard annual hypos prevail, we should see additional demand in the third quarter as modest build for the holiday season begins. Other industrial markets have not shown any recovery at this point such as the oil and gas and commercial aerospace markets.

Oil and gas drilling activity has declined close to 50% and is expected to remain flat for several quarters. The commercial aerospace market has seen a significant decline as air miles have fallen and normal rebuild activities have been reduced. It is expected that this sector should modestly rebound before year end as the new Boeing and Airbus plane platforms build to gain strength although at a level lower than originally expected.

Strategically we continued to forge ahead in many areas to capture targeted growth opportunities particularly focused on medical new age energy technology, and consumer electronics with our strong liquidity positions, our aggressive cost reduction actions, and signs that a significant portion of our markets are improving from the first quarter lows we should begin to see a substantial improvement in our results. Obviously our visibility is limited and our main concern would be the recent order pickup to be short term in nature.

Thank you and we will take questions now.

Question-and-Answer Session

Operator

(Operator instructions) Our first question is coming from Avinash Kant of D.A. Davidson & Co.

Avinash Kant – D.A. Davidson & Co.

Good morning, Dick and John.

Dick Hipple

Good morning.

John Grampa

Good morning.

Avinash Kant – D.A. Davidson & Co.

A few questions here, the guidance that you have given for the second quarter looking at 15% revenue upside, I believe your assumptions for the metal prices are flat in that guidance.

John Grampa

That is correct.

Avinash Kant – D.A. Davidson & Co.

But of course you have noticed that copper prices have been going up meaningfully so you will need to add that to the guidance that you have in order to come to our revenue numbers, right?

John Grampa

Sure if you anticipate that they are going to go up and hold.

Avinash Kant – D.A. Davidson & Co.

Right. Are you going to see assuming where the prices are at this point that it should be meaningfully higher than what it was the last quarter?

John Grampa

We had some higher metal prices in that forecast. The forecast was prepared near the end of the first quarter but we are assuming flat from that point, we don’t predict beyond that.

Avinash Kant – D.A. Davidson & Co.

Okay so basically then you are saying that the metal prices that are in your guidance are based on what we have at this point not what it was during the last quarter?

John Grampa

Yes.

Avinash Kant – D.A. Davidson & Co.

Okay. That is very helpful. Now in the sense of taking the cost out in the margins, could you give us some idea, once all these efforts are in place what kind of model are we looking at, if you could give us some idea at certain amount of margin we could do this much margin or this much net margin, where do you –

John Grampa

Well if that is adjusted $10 million of revenue generates between $0.10 and $0.14 per share in earnings so you should be able to calculate the OP percentages based off of that by backing off of the earnings level. From a gross margin perspective, which is what I think you are asking, as you know, we have high variable margin businesses so the gross margin will move around significantly depending upon our business mix, and where that business comes from, and the extent to which we are successful with the cost reductions that we have identified. If mix does not shift from our current assumptions and if everything holds, we would think that as the business grows through the next three quarters our gross margin should increase 300 basis points to 350 basis points per quarter on average.

Avinash Kant – D.A. Davidson & Co.

Third quarter, right?

John Grampa

Per quarter on average if all those assumptions hold that would be the upside.

Avinash Kant – D.A. Davidson & Co.

Right. And when you are talking about the $0.10 to $0.14 upside you are calling from Q3 onwards from Q2 levels?

John Grampa

No what I said was in my prepared comments was that $10 million movement in revenue is worth anywhere from $0.10 to $0.14 of earnings depending upon mix.

Avinash Kant – D.A. Davidson & Co.

Right but I am saying given that the cost cutting efforts will be kind of halfway through into Q2 we should think of that starting from Q3 onwards, right?

John Grampa

That range would be effective each quarter.

Avinash Kant – D.A. Davidson & Co.

From now on?

John Grampa

From now on and depending upon mix somewhere in that range including the cost reductions.

Avinash Kant – D.A. Davidson & Co.

Okay and if you could just explain the charges that you took how much of that went into SG&A and how much was into cost of goods and everything?

John Grampa

Well the inventory charges would be in the cost of goods.

Avinash Kant – D.A. Davidson & Co.

Right.

John Grampa

The severance would be split between cost of goods and SG&A.

Avinash Kant – D.A. Davidson & Co.

Right that is what I want to –

John Grampa

And the pension would be in –

Dick Hipple

It is split as well.

John Grampa

It is split as well.

Avinash Kant – D.A. Davidson & Co.

That is what I am looking –

Dick Hipple

(inaudible).

Avinash Kant – D.A. Davidson & Co.

So could you give me the split?

Dick Hipple

The severance and the pension essentially offset each other in cost of sales and SG&A.

John Grampa

And the inventories are all in cost of sales.

Avinash Kant – D.A. Davidson & Co.

Okay and a little bit about your disk drive business, where are you in terms of customer qualifications and do you think you are starting to see traction once again?

Dick Hipple

We basically have products that have now qualified in all three of the major players and we are clawing our way back into the marketplace. It is a slow crawl obviously for two reasons, one is due to our trips in the market last year and also that the market itself was extremely low in the first quarter as far as the demand side and we do see that turning at this point but the good news is we have a product that is accepted by the marketplace right now and we are about battling our way back in.

Avinash Kant – D.A. Davidson & Co.

So Dick when you talk about the second half recovery you are I believe talking primarily from consumer electronic side.

Dick Hipple

Well the only visibility we have right now is primarily for this company would be the upturn that we are seeing in the consumer area. And again as I mentioned before we have to be very careful here because of the lack of visibility everywhere and my particular view of this is that we must be careful about turning to forecast economic turnarounds and recovery right now there is good logic to say we should see additional volume from inventory correction being pretty much completed because as you take a look at some of these numbers that when you have the demand side down in a lot of customers 50 to 60 firms [ph], 40%, 50%, 60% the consumer is not down that much. So obviously there is a mismatch and we should start to see demand follow-through simply because of that particular mismatch and then we are seeing some of that now.

Avinash Kant – D.A. Davidson & Co.

One more question, you talked about being profitable in the second half, I believe earlier you had said that you will stay make money for the year, does that still hold or not?

Dick Hipple

Well again with the visibility we have that is a difficult call right now. But you know anything is possible I think as you have heard John say that our leverage right now of additional sales is quite high as far as what drops down to the bottom line with how much costs we have out of the company. So we will see how this unfolds and it is impossible at this point in time to be forecasting out for the next nine months in the year because we have to see how this all (inaudible) out but we are well positioned right now to see some nice earnings flow through with an increase in sales.

Avinash Kant – D.A. Davidson & Co.

What should we model for the tax rate going forward?

John Grampa

Model 33%.

Avinash Kant – D.A. Davidson & Co.

33%. Okay thanks so much I would let other people ask questions.

Operator

Thank you. Our next question is coming from Richard Dearnley of Longport Partners.

Richard Dearnley – Longport Partners

Good morning.

John Grampa

Good morning.

Richard Dearnley – Longport Partners

Your $20.5 million of pension and incentive pay suggest – the incentive pay was $8.4 million, what was that?

John Grampa

Those would have been incentives from prior year performance throughout the organization from the shop floor up through middle management. So those were tied to 2008 performance.

Richard Dearnley – Longport Partners

And given the current plan for ’09, what would that incentive number be? I realize this was a guess.

John Grampa

That is not a question that I think is helpful for us to attempt to pick [ph] because it would always obviously depend upon performance and certainly performance is significantly below what we had –

Richard Dearnley – Longport Partners

You are right indefinitely put.

John Grampa

Okay.

Richard Dearnley – Longport Partners

But your operating income was down 65% or so where did most of that incentive go, was that top floor?

John Grampa

Combination of above the gross profit line and below the gross profit line I don’t have the split here with me.

Richard Dearnley – Longport Partners

Okay, thank you.

Operator

Thank you. Our next question is coming from Rob Young of WM Smith and companies.

Rob Young – WM Smith Securities

Hi guys good morning.

John Grampa

Good morning.

Rob Young – WM Smith Securities

I was just hoping that you could talk a little bit on the cost reductions. Was there any excess attrition that you have experienced as a result of these reductions or is that fairly the same?

John Grampa

Same, almost none.

Rob Young – WM Smith Securities

Almost none, okay.

John Grampa

No excess attrition, no.

Rob Young – WM Smith Securities

Okay. And then relative to pension contribution obviously you made some in this most recent quarter, do you have an outlook in terms of further pension contributions that you are expecting for the remaining of the fiscal year?

Dick Hipple

Yes for the balance of the year we are going to contribute just shy of about $6 million according to our most recent estimate.

Rob Young – WM Smith Securities

Okay that is all I have, thank you very much.

Dick Hipple

You are welcome.

Operator

(Operator instructions) Thank you, gentlemen there are no further questions at this time, I would like to hand the floor back over to you for any closing comments.

Michael Hasychak

Yes, this is Mike Hasychak, We would like to thank all of you for participating on the call this morning. I would be around this afternoon to answer any further questions. My direct dial number is area code 216 and the number is 383 6823. Thank you.

Operator

Thank you. This concludes the call, you may now disconnect. Have a nice day.

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