Materion Corporation (NYSE:MTRN)
Q4 2015 Earnings Conference Call
February 18, 2016 4:00 PM ET
Michael Hasychak – Vice President, Treasurer and Secretary
Joe Kelley – Vice President-Finance and Chief Financial Officer
Dick Hipple – Chairman, President and Chief Executive Officer
Edward Marshall – Sidoti & Co.
Martin Engler – Jefferies
Marco Rodriguez – Stonegate Capital Markets
Phil Gibbs – KeyBanc Capital Markets
Greetings and welcome to the Materion Corporation’s Fourth Quarter 2015 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. I’d now like to turn the conference over to Michael Hasychak. Thank you. Mr Hasychak. You may begin.
Good afternoon. This is Mike Hasychak. With me today is Dick Hipple, Chairman, President and CEO; and Joe Kelley, Vice President of Finance and Chief Financial Officer.
Our format for today’s conference call is as follows: Joe Kelley will review the financial results for the fourth quarter, year end and the outlook. Following Joe, Dick Hipple will provide comments. Following Dick, we will open up the call for your questions.
A recorded playback of this call will be available until March 4 by dialing area code 877, the number is 660-6853 or area code 201 and the number is 612-7415. The conference ID number is 13628049. The call will also be archived on the company’s website, materion.com. To access the replay, click on Events & Presentations on the Investor Relations page.
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 afternoon.
And now, I’ll turn the call over to Joe Kelley.
Thank you, Mike. And good afternoon everyone for joining us on the call today. During my comments, I will cover our fourth quarter 2015 financial highlights, review profitability by segments including fourth quarter and full year 2016 results, make some brief comments on the balance sheet, cash flow and modelling assumption, and finally cover the earnings outlook for 2016. Following my remarks Dick Hipple, Chairman, President, and CEO, will provide comments on the Company’s key strategic initiatives.
Before I begin, let me remind investors to follow my comments with regards to operating profit, net income, and earnings per share reflect the adjusted numbers shown in attachment four and five in today’s press release. The adjustments are made in both current year and prior-year periods for comparative purposes and remove non-recurring restructuring cost and the net benefits recorded from insurance and legal settlement gains and certain income tax adjustments.
Let me now review our fourth quarter and full-year 2015 financial performance. Fourth quarter 2015 financial results were in line with our forecasted earnings and guidance provided to the Street. However, both sales and earnings in the fourth quarter of 2015 trailed our strong performance in the same period last year when economic and end market conditions were much stronger.
Fourth quarter 2015 value-added sales which excludes the impact of pass-through metal costs fell 14% from the prior-year fourth quarter value-added sales and down 4% sequentially from the third quarter of 2015 to $143.4 million. The decline in value-added sales can be attributed to two primary factors: first, we continue to see weakness in our oil and gas business, here we saw value-added sales decrease $9.7 million or 80% from the same period last year. As a reminder, during the fourth quarter of 2014 we saw record shipments into the oil and gas market.
The second factor was a slowdown in Asia, most notably China. Value-added sales into the Asian region decline $6.5 million or 22% from the fourth quarter of 2014. These two factors accounted for a year-over-year decline in value-added sales of approximately 10%. Looking at the value-added sales declined strictly from a volume in FX perspective, fourth Quarter 2015 sales volumes were down 17%, below the prior-year fourth quarter volumes. And foreign exchange rate differences unfavorably impacted value-added sales by 1%. The offsetting increase was attributable through price mix changes.
Gross margins came in at $43.1 million in the fourth quarter of 2015, down from $55.8 million in the prior-year fourth quarter. Expressed as a percent of value-added sales, gross margins contracted 330 basis point from 33.4% in the fourth quarter of 2014 to 30.1% in the fourth quarter of 2015. The lower profit margins were driven primarily by lower volumes and the related lack of leverage, less favorable product mix and foreign exchange impacts, which deteriorated gross margins approximately 60 basis points. A portion of the unfavorable exchange rate difference impact on 2015 gross margins was offset by foreign exchange rate hedge gains recognized in other income.
Adjusted operating profit in the fourth quarter of 2015 was $8.9 million, 38% below 2014 fourth quarter adjusted operating profit of $14.4 million. Adjusted operating profit expressed as a percentage of value-added sales was 6.2%, a 240 basis points deterioration from the prior-year fourth quarter operating profit margins.
Reduced performance based compensation expense reported in the fourth quarter of 2015 combined with favorable FX hedge gains compared to the prior-year same period helped mitigate the decrease in quarterly profitability.
Net income in the fourth quarter of 2015 totaled $6.7 million, which is reflective of a 10.6% effective tax rate in the quarter. This includes the anticipated, full-year impact of [Audio Dip] which was approved by Congress in the fourth quarter of 2015 and made permanent.
While the quarterly tax rate is low, given the timing of the annual R&D credit the full year tax rate of approximately 25% is reflective of our going to annual effective tax rate, giving the mining depletion credit, R&D credit and mix of foreign sourced income.
Earnings per share fell from $0.60 in the fourth quarter of 2014 to $0.33 in the fourth quarter of 2015. On an adjusted basis, fourth quarter 2015 earnings were $0.36 per share, down 29% from $0.51 per share of adjusted earnings recorded in the fourth quarter of 2014.
Let me now briefly comment on our full-year 2015 consolidated financial performance. Value-added sales of $617.2 million in 2015 fell 3% versus 2014 value-added sales. On a constant dollar basis, annual value-added sales decreased $10.3 million or 2%. The primary driver of the decrease in value-added sales was the $23.2 million or 59% decline in value-added sales into the oil and gas end market. Offsetting a portion of this decrease was the growth in value-added sales from new products.
New products defined as those introduced in the last three years, grew 13% to $71.9 million and represented 12% of consolidated 2015 value-added sales. Adjusted operating profits totaled $45.8 million in 2015 compared to adjusted operating profit of $49.1 million in 2014. The U.S. dollar strengthening against the euro in the end negatively impacted 2015 operating profit results by approximately $4 million.
On a constant dollar basis, adjusted operating profits remained consistent with the prior-year, despite the decline in value-added sales and the macroeconomic headwinds that challenged the business in 2015.
It is important that investors properly understand our exposure to a strengthening U.S. dollar. Approximately 10% of our annual value-added sales are denominated in euro or yen. And only an immaterial amount of our total costs are denominated in euro or yen. Acknowledging the structural imbalance, the company maintains an active foreign exchange hedging program that enters into cash flow hedges, which mature 12 months to 18 months in the future and reduces short-term volatility.
This strategy was effective in 2015 and that the changes in foreign exchange rates negatively impacted sales and profits by approximately $10 million. This loss was partially offset by the realization of foreign currency hedge gains totaling approximately $6 million or roughly $0.20 per share. However, this program does not protect the long-term profitability of the business from sustained step changes and exchange rates like we have seen over the past 12 months to 16 months. The euro and yen both were approximately 20% weaker against the U.S. dollar in 2015, than what both currencies averaged for the five-year period prior to 2015.
It is this step change and the sustained strength of the U.S. dollar against the euro and yen which generated significantly gain from our foreign exchange hedges in 2015. Unfortunately, these foreign exchange cash flow hedge gains will not repeat in 2016, based on the sustained strength of the U.S. dollar.
For 2016, we are hedged against the euro, at the rate of approximately $1.11, which is comparable to today’s exchange rate which is significantly different from 2015, when our forecasted cash flows were hedged at approximately $1.30 to the euro.
In summary, our sequential financial performance in 2016 is being challenged, by an approximate $6 million headwind resulting from the sustain strength of the U.S. dollar primarily against the euro.
Let’s turn now to review our Q4 and full year 2015 financial performance by business group. Our performance in Alloys and Composites segment sales were $90.3 million in the fourth of 2015, down from $112.3 million in the same period last year. Value-added sales for the fourth quarter of 2015 in the segment were $78.4 million a 17% decrease from $93.9 million in the fourth quarter of 2014. Almost all of the segments’ Value-added sales decrease can be attributed to lower sales in to oil and gas exploration, weaker sales in Asia and unfavorable exchange rates most notably the weaker euro.
This segment houses 100% of the Company’s exposure to the oil and gas end market and a vast majority of the foreign exchange exposure. Sales in the fourth quarter of 2014 into oil and gas end market were near record levels, while in the fourth quarter of 2015, given the lower oil price resulting in a significantly reduced rig count decrease value-added sales into this market were 80% off from the prior-year fourth quarter.
Asia sales, which for this segment, primarily go into the China connector and telecommunications end market were down $3.4 million or 30% compared to the prior-year fourth quarter. The remainder of the decrease in value-added sales was driven by the strength of the U.S. dollar.
Segment operating profit for the fourth quarter was $2.9 million compared to $9.9 million in the fourth quarter of 2014. The decreased fourth quarter profitability was driven by a 22% decline in sales volume plus unfavorable product mix as the sales into the oil and gas market are traditionally higher margin sales.
Looking at the full-year results for Performance Alloy and Composites, value-added sales declined 7% from 2014 levels to $335.1 million. Excluding the unfavorable impact of foreign exchange rates and the $23.2 million drop off in sales into the other oil and gas end market, value-added sales grew 3% over the prior-year levels. Full-year 2015 operating profit for this segment totaled $23.6 million or 7% of value-added sales which compares to $33.3 million or 9.3% of value-added sales in 2014. The 29% decrease in year-over-year profits was primarily driven by an 8% decline in volume and unfavorable impacts from foreign exchange differences.
We will now turn our attention to the advanced material segment. Value-added sales in the advanced material segment in the fourth quarter of 2015 were $39.8 million, down [Audio Dip] 2014 value-added sales of $48.3 million. The decrease in value-added sales is primarily related to economic slowing in the consumer electronics end market and the related precious metal cleaning services. While many of our sales are not direct into the Asian market, the broader decline in the Asian consumer electronics industry during the fourth quarter of 2015 affected the export business of many of our domestic customers.
Segment operating profit in the fourth quarter of 2015 fell $2.7 million or 38% to $4.5 million or 11.3% of value-added sales. The decreased profitability compared to the prior-year period resulted primarily from a 13% decline in volumes.
For the full-year of 2015, the advanced material segment value-added sales grew 1% to $182.8 million from $181 million in 2014.
Double digit percentage growth in the medical, industrial components, defense and energy, primarily solar markets, offset the declines in consumer electronics and telecommunications infrastructure.
Adjusted operating profit was in line with prior-year, coming in at $27.8 million or 15.2% of value-added sales, up slightly from $27.6 million of adjusted operating profit generated in 2014. This segment continues to be our most profitable business and has a robust pipeline of new business opportunities and new products.
Finally, the Precision Coatings group, which includes the Precision Optics and Large Area Coatings businesses, is included in the other segment along with unallocated corporate cost. The Precision Coatings group delivered value-added sales of $26.4 million in the fourth quarter of 2015. This compared to $26.5 million of value-added sales in the same prior-year period.
New growth platforms, coupled with our restructuring initiatives have contributed to expanding adjusted operating profit margin to $3.1 million or 11.7% of value-added sales, which is a 230 basis point improvement from an adjusted operating profit margin 19.4% in the prior-year fourth quarter. This marks the second consecutive quarter of greater than $3 million in operating profit and double-digit operating profit margins.
The Precision Coatings group for the full-year of 2015 reported $101.8 million in value-added sales, which is 1% below the prior-year levels. Although value-added sales decreased slightly, due to weakness in the projector display market, we recognized a significant improvement in product mix, driven by growth in larger area coatings, blood glucose test strip products.
Despite the relatively flat value-added sales for the full-year of 2015, adjusted operating profit expanded 31% over 2014 levels to $8.9 million or 8.7% of value-added sales. This was driven by the improvement in product mix discussed earlier. This proves strong 2015 built upon the momentum [Audio Dip] we established in 2014. A combination of new product wins, improved product mix and a lower cost structure is delivering impressive margin expansion. The new product pipeline in this business group continues to be strong and to continue to drive future profitable growth.
Turning now to the balance sheet and cash flow, the Company maintained a very strong balance sheet ending in a net cash position with $24.2 million in cash and only $13.6 million in debt. We continue to have significant available liquidity to support meaningful organic growth opportunities as well as pursue strategic growth alternatives. The Company’s cash flow from operations for the year totaled $19.2 million which is up $30 million increase over 2014 and represents the highest annual cash flow from operations achieved in the past 20 years.
The primary driver of the increased cash flow year-over-year was a liquidation of working capital based on management initiatives combined with a decline in fourth quarter business levels. Investing activities totaled $52 million and included a $22.6 million investment in mine development and anticipation of forecasted increases in future demand for beryllium and beryllium hydroxide.
For ongoing financial modeling purposes assume approximately 25% to 26% effective tax rate as the mining depletion credit and R&D tax credit are ongoing components of our effective rate. Capital spending in 2016 should run approximately $25 million to $30 million excluding mine development expenditures. Mine development investments should be $20 million to $25 million as we finalize the opening of the second pit started in 2015 and prepare to support the future demand for beryllium hydroxide, given the forecasted change in the competitive landscape. Annual depreciation and amortization should run approximately $40 million to $45 million in 2016.
And finally now the earnings outlook for 2016. There’s a lot of uncertainty in the marketplace and the broader economic environment. Looking at our current order entry rate and forecasted end market demand and new product launches out in the 2016, we are guiding full-year 2016 earnings to range from a $1.30 to a $1.55 per share. The 2016 earnings guidance is reflective of the significant year-over-year headwinds from foreign exchange hedge gains which will not repeat, the oil and gas market remaining depressed, reduced manufacturing efficiencies stemming from the 17% volume decline experienced in the fourth quarter of 2015, which is in sharp contrast to how we exited in 2014, with heightened levels of production and current order entry rate being 10% to 15% below the corresponding prior-year period order entry rate.
First quarter 2016, earnings are forecasted to be the lowest quarterly earnings of the year and in the range of $0.23 to $0.28 per share. The sequential Q4 to Q1 deterioration in quarterly earnings is primarily reflective of fourth quarter 2015 operating profit levels reduced for foreign currency hedge gains of $1.1 million realized in the fourth quarter of 2015, which are not forecasted to repeat, plus a normalized annual, effective quarterly tax rate of 25% to 26% compared to the 10.6% fourth quarter 2015 effective tax rate, which included the full-year benefit of the R&D credit.
Business levels and profitability is forecasted to pick up in the second and third quarters of 2016, driven by demand items which have long lead times and clear visibility in the defense end market. New product launches into the consumer electronics end market and increased volume demand as customers work through excess inventories. This forecasted increase is supported by a recent uptick over the past several weeks in our long lead time orders within our Performance Alloy and Composites business.
This concludes the review of our financial performance and I’d like to now turn the call over to Dick, who will provide updates and several of our strategic initiatives.
Thank you, Bill and good afternoon everyone. Beginning with our investor call last July, we remarked on the building uncertainty and volatility of our end-use markets and the sluggishness of the global economic environment. These signs deteriorated into real headwinds in the second half of 2105, and we were especially – and they were especially menacing in the fourth quarter.
Like many other globally positioned manufacturing companies, Materion is severely challenged and tested. But compared with other downturns, we are weathering this adversity with an underlying strength and resilience that allowed to us to turn into performance that is orders of magnitude stronger then prior time periods, when we sold similar low levels of products from our high fixed cost copper beryllium alloy products operation.
Profitability levels achieved in the second half of 2015, despite the double-digit volume decline is evidence of the improvement in our business model and product differentiation. Joe has already reported on how we aggressively moved on cost and margins, as well as our progress in improving capital utilization.
We’ve also counteracted the effect of [indiscernible], problems in Asia and our strength in U.S. dollar with a rich innovative pipeline of new products and applications that is diversifying a revenue base and increasing our opportunity funnel. We are positioned to see strong upper probability leverage with market turnarounds. To dig deeper in consumer electronics, which is our largest end-market, several of our business groups introduced new products and delivered new by developing additional applications within existing product lines.
Performance Alloys and Composites increased sales of its foil gauge ToughMet alloys by more than 60% in 2015. And our next generation ToughMet tempers are satisfying rapidly growing demand for stronger and more corrosion resistance materials required for high-end smartphones and other devices. A terrific example of this is that our materials are being manufactured into components for the cameras optical image stabilization. Performance Alloys has more than doubled its ToughMet strip output to meet this requirement and fill the demand.
And Precision Optics, our recent, major capital investment in semiconductor type wafer level processing allows us to apply coatings directly on customer sensors, saving them the need for traditional coated glass covers. This technology breakthrough enables thinner and lighter sensors that phone manufacturers require to add new features without sacrificing size or weight. Our success in the coatings arena has enabled us to partner with major OEMs and component suppliers in developing innovative new materials and complex filter designs that enable 3-D sensing technology, iris scanning, and gesture control recognition capability in anticipation of commercial introduction of the next one to two years.
In automotive electronics, our unique dovetailed plaid [ph] copper and aluminum bonded strip continues to gain market acceptance, especially in fuel saving start-stop battery packs and hybrid electric model offerings. In a major milestone dovetailed plaid [ph] was built into a major European automakers 2016 model year and two additional automakers will be adding dovetail equipped vehicles to their fleets. Dovetail Clad will steadily increase its penetration in electric vehicle market as several OEMs have already specified it in as a standard component for platforms through the model year 2020.
We are supporting this growth with a recently completed capital project that has added state-of-the-art machining centers and bonding equipment. This investment positions us to meet customers cost and growth road maps, for this pioneering new product well into the future.
In semiconductor applications with our advanced material segment, we’re seeing continued success and expanding our position into 200 millimeter wafer size market and gain further ground in a highly-priced 300 millimeter sector. We are supporting this new demand for our precious metals sputtering materials with capital projects including semiconductor grade clean rooms and other quality enhancements.
In medical, our Large Area Coatings team had a major win with successful qualifications in trials followed by commercial orders from a major global customer in the blood glucose test strip market. Earning this business positions Materion as the global leader in specially coatings for blood glucose test strips. Large Area Coatings also continues to develop innovative new products for other bio sensor applications, such as blood coagulation testing.
Our 38% year-over-year increase in defense sales is due significantly higher demand for material supply by our Performance Alloy and Composites, and Precision Optics group.
We continue to see nice growth in aluminum beryllium investment cast materials for the F-35 fighter jet optical system. We’ve also experienced increased demand for our precision optical filters used in sensor application for the ISTAR defense segment, which is an acronym for intelligence, surveillance, target acquisition and reconnaissance.
In the area of both space and defense, there has been nice additional growth in sales coming from the success of our ArrayTec family of optical filter arrays, increasingly used in space defense and commercial type applications. Introduced just a year-ago ArrayTec is opening up new markets and new applications in smaller and lower cost satellites in un-manned electric vehicles – aerial vehicles, as well as commercial fields such as multi spec role sensing and color matching.
Finally, on the commercial side, I would like to make some brief comments on the status of our largest beryllium hydroxide customer and the renewal of their long-term supply agreement. No difference in 10 years ago, when the contract was up for renewal there was a lag in new orders and excess inventory levels or work through prior to the final contract renewal which is currently being negotiated.
To summarize, Materion’s stability to hold its ground in a volatile 2015 while preparing for recovery ahead marks another mark in our ongoing strategy launched more than 10 years ago to positively transform our organization from a traditional metals and mining company to a leading global advanced materials enterprise.
Today we are in good position with compelling organic growth drivers, highly differentiated products and innovative technologies. Simply said our strategy is intact and serving us well.
While we have entered 2016 against ongoing macro economic uncertainty and lingering weakness in several markets we are focused on those factors within our control and will create our own future, based on the inherent value and growth potential of our unique products and solutions.
And no the inorganic front as we have previously communicated, the Company has invested in dedicated resources to make this a more recurring component of our growth strategy. I am pleased to report that we have a robust pipeline of actionable strategic augmentation targets which are currently being worked on.
In summary, I anticipate good growth as we move through the balance of 2016 and I am very excited about our new product pipeline that is gaining strength and compensating for some of the negative macro conditions. And we are also in very good position now with executable tuck in strategic acquisitions.
This concludes our prepared remarks and as always we appreciate your interest in Materion. And thank you operator, you may open the line for questions.
At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Edward Marshall of Sidoti & Co. Please proceed with your questions.
Good evening guys how are you?
Good. So I typically look at your business as one with short visibility but I guess you’re saying is some of the long-term products and projects that you work on are coming through. I’m just curious if you can kind of talk about may be the split in your business between what are the long-term visible projects and then the short-term visibility?
Well great question. And in my closing comments there was a lot of short-term that we’ve kind of worked over the last couple of years coming to fruition as we speak and that’s why my confidence level is pretty high, we’ve got just great progress in this dove tail I’ve mentioned about the semiconductor platform that we’ve built and seen results now. The F-35, which is really result of our investment casting development that we have, haven’t talked much about it but the OLED inorganic materials we developed, they’ve ramped a very nice last year and into this year.
So and actually ToughMet developments we’ve had, as I mentioned on the strip side, but also we developed a new product on the oil and gas side, which doesn’t sound too good right now, but part of that is in the actual pumping side. So part of what I call near term launch is going on that will continue to build through 2016. And then on the longer-term basis, we still have plenty in our quiver there that we’ll begin to build 2017 and 2018. And these are things like, our – we’re making a lot of progress right now over in Europe with the new automotive standards that they have there with their own CAFE type standards and their carbon emissions standards where the engines have to be totally redesigned which they’re much smaller, higher performance, higher temperatures.
And we actually think that we’re going to be finding our home in the engine components, and on road vehicles obviously that’s a very large market that we’re targeting. And we have some pretty high confidence there. We’ve talked also about our bulk metallic glass product in the past. It’s another emerging product that we have. I don’t think we will see a lot of that in 2016, but there actually are developments in that today, that I see that on longer-term 2018, 2019 basis to just give you a few examples.
And let me just add to that, those are the new – lot of the new product initiatives with one aspect of our business which you will be familiar with that has a longer lead time is the beryllium, High Purity Beryllium business and lot of that goes into the defense and market. And so those are some of the order rates, orders that we have visibility to which are large and have a longer lead time. And that’s in the Performance Alloy and Composites segment
Got it, is that roughly about 10% of sales?
Here the Performance Alloy and
Not the Performance Alloy it’s with the beryllium it’s the component that goes to defense
Yes, that’s roughly probably 8% to – that goes to High Purity Beryllium businesses roughly about 8% of our value-added sales.
Value-added sales, okay. And then you mentioned currency in the impact on the sequential basis with the hedges. Is it fair to assume that there’s a $0.20 headwind year-over-year because that’s the benefit you receive I don’t think that’s the correct way to look at it. What is baked into your guidance from the currency impact as it related to the hedges for 2016 as a whole?
Sure. So based on the hedges given the fact the exchange rates have been relatively flat throughout 2015 as we laid in our hedges for 2016 we are currently hedged a $1.11 on the euro. And so basically our hedges, if the exchange rates stays where it is at, our hedges will unwind for a zero gain or a zero benefit whereas our hedges last year when we entered 2015 we were locked in at 130. And so the exchange rate movement to 111 negatively impacted sales and margins by about $10 million.
However, we were able to offset the majority of that with a $6 million gain in our hedges. And so those given the fact that the exchange rate now has been relatively flat for over 12 months euro though we will have no gains in 2016. So basically the movement and exchange rate deteriorate our profits about $10 million if you go from 2014 to 2015. And we only experienced about $4 million of that in 2015. And going into 2016 we will experience the full impact of that.
So it is correct to think about the $1.60 we delivered in 2015 has a $0.20 headwind going into 2016.
Got it. And then finally I just wanted to ask on you gave the Chinese – China in energy comps on a year-over-year basis. Can you talk about and do you have them, I don’t’ know I if you have them in front of you, but the sequential impact for those two business lines, are those two regions, that region is business line on a sequential basis third quarter [indiscernible].
I do have those in front of me and so sequentially if you talk about our oil and gas business it was down 14% and if you talk sequentially about our Asia business it was down roughly another 4%.
4% sequentially in the third quarter. Okay. Thanks very much.
Our next question comes from the line of Martin Engler of Jefferies. Please proceed with your question.
Hey, good afternoon everyone.
To the full-year guide, what are your expectations that you have there [ph] for the Value-added sales?
We don’t give specific guidance on the Value-added sales. But I can tell you that, we expect, so as Dick mentioned in his comments sequential growth as we head into Q2 and into Q3
When I think about the sequential move from 4Q to 1Q should I be expecting incremental contraction there both on Value-added sales as well as Value-added operating margins across the segments here?
Yes. I would tell you, our current guidances is Q1 is going to look exactly like Q4 with one exception, we’re missing about $1.1 million of hedge gains that shows up in other income. So that’s what that would tell you and then the tax rates would be different. So the only difference between Q1 and Q4 is a lack of $1.1 million hedge gain and the tax rate.
Okay that’s helpful. And you noted a number of headwinds here everything from within Performance Alloy and Composites segment, advance materials, everything from FX the volume is kind of trailing off and I guess fixed cost absorption there as well as mix. And anything happening with pricing there and I guess also if you had to single out with the biggest headwind has been among those different factors, what would that be?
So the two biggest headwinds, and to not to beat a dead horse, but our oil and gas, I mean dropped off on a year-over-year basis $23.2 million of Value-added sales. And that’s a high-margin product for us, it’s 100% of it’s buried into the Performance Alloy and Composites segment.
The other thing is, if you look 2014 to 2015, we had a $4 million headwind that was realized due to FX, that’s the strengthening of the U.S. dollar against the Euro and the Yen. And as you look at that going into 2015 to 2016, I don’t believe the oil and gas will be nearly as big of a headwind, because it was off in the second half 2015, significantly. But the exchange rate issue is – with out a doubt the biggest headwind, we have going from 2015 to 2016.
And if I could one last one there, working capital expectations, when you think about 2016?
Yes so if you think about 2016, we look your improve our working capital efficiency. So as a percentage sales from a cash flow standpoint, as we added in the back half of the year is going to be stronger than front half of the year, we’ll probably investing in the back half of the year in working capitals for the growth. But we do hope to improve the efficiency which we internally define as a percentage of sales, we’re targeting about a 100 basis points of improvement there.
Okay, and I know that it’s going to pretty quick, I guess drawdown in activity with oil and gas trailing off but if this activity would persist like this and you wouldn’t see a pickup in activity I guess are there leverage you can pull here for cost reductions.
Yes, there are, however I would tell you our current forecasting guidance does not have a [Audio Dip] from oil and gas in the back half of the year. We are not as optimistic as some others that that will, for the products we serve and where we are and the supply chain that that will have a – see a big recovery in the back half of the year.
As it relates to a cost reduction we were quite aggressive in 2015 if you recall when we saw some of the slowdown in Asia we aggressively in July took out heads and reduced our manufacturing footprint there in Shanghai related specifically to some of the optical coatings and the projector display. And as it relates to the oil and gas and drop off there we were active throughout 2015 and taking out in a more systematic way than a large one-time restructuring adjusting the workforce there. And we continue to monitor that based on order entry levels.
In fact I like to add is that, we have actually, I think a little bit over reacted and the cost reductions right now we are hiring because we’re actually falling a little behind us. We’ve got a pretty nice order rate coming in right now and the strip products for the electronic side. And so we’re actually building the workforce back-up. So that’s a good sign. We were seeing some things starting to pick up.
Net-net do you know what the percentage change was on your headcount from start to end of the year?
I think we are down about 8% in 2015.
Okay. All right. Thank you.
Our next question comes from the line of Marco Rodriguez of Stonegate Capital Markets. Please proceed with your question.
Good afternoon, guys. Thank you for taking my questions. Just wanted to kind of clarify some answers just to the question on FX and my apologies to comeback around on this. But $6 million headwind those of the FX hedge gains that you’re going – that you saw in fiscal 2015 will not repeat in fiscal 2016. So that is basically if I understand where that component goes in your P&L we’re going to see an increase in basically operating expenses, is that correct?
Yes, so that the hedge gains or losses flow through the other income section
So below the operating line?
Above the operating line.
Okay and that other net category that’s in your P&L?
Got you, okay. And then also just kind of listening to you guys commentary in terms of expectations going to 2016, obviously the EPS number, lower year-over-year versus 2015. With the volume impact it kind of sounds like you’re going to see some contraction on the margin side on the VA [ph] side. Is that correct way to think through that?
I think when you look at our Performance Alloys and Composites segment from a year-over-year standpoint, we did see some contraction there and I think as we head into Q1, given the lack of some of those hedge gains from an operating profit as a percentage of value-added sales, we may see some further contraction in the beginning part of 2016, which would then improve, as we go throughout the year. Their operating profit, as a percentage of Value-added sales, if you exclude the hedge gains in 2015 was about 5.2%.
Okay, and so you expect some contraction in the first half and maybe some return to being closer to normalcy if you will in the second half.
Yes, I think that you would…
You would see Q1 will be the lowest profitability percentage for the PAC and then it will improve as we go throughout the year.
Got you, okay. And then in terms of, obvious your stock price is off, probably related with the overall broad market here, but I don't think I'm looking at your cash flow statement assigning any stock purchased or repurchased, rather. Any kind of commentary you can provide there, in terms how you guys are looking at that?
Yes, we target to offset dilution on an annual basis, in terms of our stock repurchase program and then depending on the pipeline of acquisition targets. And we review on a regular basis our capital allocation strategy. And right now we are focused on as Dick touched on a robust pipeline of M&A targets. And we are actively working on a couple of those, as we speak.
So that is our desired capital application as we move throughout 2015 – we – or sorry 2016. We do have a dividend which we’ve been committed to maintaining and actually growing. And so we will continue that practice, we will continue to opportunistically buyback shares to offset dilution. And then depending on the availability of financially attractive M&A targets we will continue to review our capital allocation strategy and debate the share buyback alternatives.
Gotcha. And last question I’ll come back in the queue. In terms of your acquisition strategy and just given all the turmoil in the market and some of the negativity from the macroeconomic environment, are you seeing any acceleration from potential targets coming to the table quicker or easy in operating terms of their prices any kind of color commentary you can you provide there?
I would first say that multiples are softening so yes, there is certainly a change in the market from that perspective. And we are seeing more opportunities today than we have in the last year or so. So I think this – current economic environment favors those that have a balance sheet that can look at more attractive opportunities at this point in time. So we’re very careful, cautious, but we do see some very good opportunities ahead of us.
Gotcha, thanks a lot. I appreciate it.
Our next question comes from the line of Phil Gibbs of KeyBanc Capital Markets. Please proceed with your question.
Hey, good afternoon Dick.
Good afternoon, Phil.
Hey, guys. Question on the pension, how was that looking in terms of the non-cash expense this year versus last year and what does a cash contribution look like?
Yes, so from a P&L expense standpoint, Phil that should be down year-over-year $2 million to $3 million. And then from a cash contribution standpoint, it will probably be in the range of $12 million to $15 million.
Okay, that’s helpful. And I know you spoke a bit about the defense market and it did look like it picked up very solidly. Help us again pass-through where you are seeing that in terms of maybe some of the appropriations and where it’s going in terms of either the optics or the missile defense, in the satellites and help us understand why that’s picked up so much?
I would say, probably the – it’s like I talk about these things but where we see probably the biggest surprise to us is in the missile defense side which there’s no question that there’s a lot more missiles being built right now. And we are on pretty much all of these missiles that have targeting systems on them in our optics divisions. So we’re seeing a backlog of orders there, that’s quite nice. And then we have the F-35 is starting to gain some traction. And then also we actually picked up some new platforms in our copper beryllium business with ToughMet into Bradley Fighting Vehicle and lot of their rehabilitations then in the new models that they’re building.
So those are the biggest platforms that we have right now there are some other things going on and at these times sometimes we get these surprise black box type orders which means that they are very classified systems and we don’t – we’re not even told that they want them until we need it right away and there’s no lead times, it’s basically get it now and very highly secretive type program. So I would expect it wouldn’t be a bit surprising, we don’t have those in our production planning or in our forecast, but these are the kinds of times that we see those kind of orders come into. So it’s very active right now.
Okay well it seems like as you said, it seems like there’s lot going on. And then just here on the consumer electronics broadly, you had a lot of successive quarters of the sales tapering off. I’m just wondering how much of that is a destocking, how much of that is related to just the Asian situation, particularly in China being problematic here short-term, given the global trend.
Well, yes we didn’t see this slowdown in the consumer electronic side, as we think about 2015 that was a tailor two halves we had a great first half and then the world fell apart a big part of that was not like oil and gas, but China just slowdown like crazy. And that’s where we saw the consumer electronics slowdown across the board in several of our operating divisions. And I think we’re – certainly that has bottomed out and we’re starting to see the order book in China pick back up again and that into two areas, it’s not only in the consumer electronics area but it’s also in the telecom infrastructure area.
So we saw both of those get extraordinarily weak in the second half and both of those are starting to come back up at this point in time. And I think we’re all reading the same thing as it appears to China is doing some additional stimulus programs right now. And I'm sure we’re seeing part of that as we go forward.
Okay. Thanks so much.
Our next question is from Edward Marshall, please proceed with your question.
Just a few follow-ups from me if I could. I know that, well first I guess we’re having relief from gold, I mean, I know it’s short but it’s had a pretty good run here. And I know it’s a passthrough, but I know clients also our customers tend to want to get in front of that. Increase is there any positive signs on the gold side especially maybe you can all get clean [ph], could you talk to?
Well, that’s a good question. We do – basically our business is pass-through but there’s a piece of the business that we do pickup some additional margin depending on which way the gold goes and that’s in our service cleaning business. So yes, with the increased price of gold we’ll see a little bit of margin improvement in that sector of the business.
And I also notice that the debt came down but I thought the majority of the debt was consignment – gold consignment. Can you kind of walk – is it just a reporting situation or did you really kind of unload some gold there?
Yes Ed this is Joe. We have no the gold denominated debt on the balance sheet. Our gold consignment is off balance sheet arrangement. So the debt reduction was actually a pay down on our revolver. We ended the year with zero borrowed on our revolver and that’s the revolver we renewed it has $375 million of capacity.
All right, I appreciate it. Thanks again.
[Operator Instructions] Mr. Michael Hasychak there are no further questions at this time, would you like to make any closing remarks?
Sure. This is Mike Hasychak, we’d like to thank all of you participating this afternoon. I’ll be around a little bit more here this evening. And also if you would like to set up a call for questions tomorrow, you can either E-mail me at email@example.com or give me a call at 216-383-6823 and we can set something up for tomorrow as well. Thank you very much.
This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time.
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