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Executives

Michael C. Hasychak - VP, Treasurer and Secretary

Richard J. Hipple - President, Chairman and CEO

John D. Grampa - SVP, CFO

Analysts

Charles Murphy - Sidoti and Co.

Avinash Kant - Broadpoint Capital

Phillip Gibbs - Keybanc Capital Markets

Rob Young - WM Smith Securities

Brush Engineered Materials Inc. (BW) Q4 2007 Earnings Call February 8, 2008 2:00 PM ET

Operator

Greetings, ladies and gentlemen, and welcome to the Brush Engineered Materials fourth quarter 2007 earnings conference call. (Operator Instructions) 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 begin.

Michael C. Hasychak - Vice President, Treasurer and Secretary

Good afternoon. This is Mike Hasychak. 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 fourth quarter and 2007 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 February 23 by dialling (877) 660-6853, Account Number 286 and Conference I.D. 270860. 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 D. Grampa - SVP, CFO

Good afternoon. Thank you, Mike. Welcome to our fourth quarter and year end 2007 teleconference.

Today's format is identical to the format that we've used in the past. I'll review the quarter as well as the year and then comment on the outlook. My comments are prepared, and following those comments Dick Hipple will provide you with a market update, then we'll open the call for questions.

I'll attempt to adequately reinforce and expand on the key points that were made in the press release today, both about the quarter and the year. I'll comment on eight specific items:

First, the continued strong organic growth we experienced in 2007 and what drove it, including the factors that affected the fourth quarter and what we currently expect will drive our growth looking forward.

Second, I'll review the specifics of the growth in Media. Since significant swings in ruthenium metal prices, material sources and demand factors, as well as new product and market ramp rate can and, as most of you know, has dramatically affected quarterly results, it's important to review what is happening with our materials that support the perpendicular media recording launch that continues to occur.

Third, I'll review the volatile cell phone handset market, where lower than expected third quarter and fourth quarter demand levels from a key customer has had a negative impact on earnings comparisons to prior periods in our Specialty Engineered Alloy segment.

Fourth, I'll review the favorable EPS impact from the sale of product containing the low-cost ruthenium inventory that was in the production system at the beginning of 2007 and the related abnormal material price movements that resulted in offsetting non-cash lower-cost or market charges. These factors affected quarterly results significantly, adding variability, and will affect future earnings comparisons, especially the comparisons in early 2008.

Fifth, I'll review the balance sheet.

And sixth, the favorable litigation settlement announced in the fourth quarter.

Seventh, the acquisition of the assets of Techni-Met.

And then finally, I'll review earnings and the items identified in the press release to reconcile the differences between the GAAP reporting and the operating run rates for both 2006 and 2007.

Following my comments on those eight points, I'll review the outlook where, as identified in the press release, we are currently expecting continued gains in 2008 in spite of weaker macroeconomic outlooks.

Let's begin.

First on growth, as you know, this morning we reported sales for the year that were up 25%, or about $188 million, to the $951 million level - another record year.

Fourth quarter sales were up 14%, or about $28 million, to the $236 million level. This was the second consecutive year of organic growth above 20%, the 20th consecutive quarter where sales were higher than the comparable quarter of the prior year, and the 9th consecutive quarter of double-digit growth.

Over the past two years, the company's revenue has grown by 76% or by about $410 million to the $950 million level from the $540 million level. Earnings on a comparable basis have nearly tripled in the two years.

Metal price inflation - or, said differently, that portion of both precious and nonprecious metal price increases that we were able to pass onto customers in the quarter had a bit more of an effect on reported sales increase than in the earlier periods of the year. Approximately 7 percentage points of the reported 14% growth in the fourth quarter is due to higher metal values. Thus real growth or organic growth was approximately 7% in the quarter.

For the year-to-date, metal prices represent about 5% of the growth, thus organic growth was approximately 20% for the year 2007.

Growth net of metal prices was 28% in 2006, thus our real growth for the two years is close to 50%.

We continued to see solid growth in many of our key markets throughout the year. Growth of our new products remains very strong. I'm going to address the media market and the cell phone handset market here, and Dick Hipple will follow later with additional comments on both, as well as comments on our other markets and our other new products.

Turning to media, as you know, the most significant factor driving our growth in both 2007 as well as our expected growth in 2008 is the growth our new magnetic media materials for the perpendicular media recording segment of the data storage market. The growth here is being driven by the rate at which the market and the customers we serve transition to the new perpendicular media recording technology and our ability to capture a share of their business with new products and production capabilities.

These materials accounted for approximately $130 million of our growth in the year, reaching a sales level of approximately $160 million. That represents approximately 70% of the company's $188 million of sales growth for the year.

You'll recall that following a more rapid than expected product launch which resulted in very high sales and profit levels in the first quarter, our second quarter sales levels in this market were driven down by a combination of factors. The factors that drove second quarter results down include some softer overall disk drive demand levels, slower than expected PMR transition rates at our customers, inventory corrections due to the supply chain filling that occurred during the initial ramp up, and some lost business due to the internal issues we had.

Many of the factors that drove second quarter performance in this market to below the first quarter levels began to reverse in the third quarter, and while we didn't enjoy the third quarter demand level we thought we'd see, it was clear by the end of the third quarter that demand levels had increased significantly, leading to an improved third quarter end and a solid beginning to the fourth quarter.

Then, as previously announced, during the fourth quarter the company again experienced softer than expected demand from this market. This softness was driven primarily by changing material specification at a key customer, which in turn resulted in manufacturing process changes and a lengthy product requalification process.

This has and will continue to result in lower shipments to that customer while the requalification process is underway. This process is not yet complete, but it is expected to be completed with shipments resuming late in the first quarter of 2008.

I'll turn now to the cell phone handset cell phone handset market. As you know, the cell phone handset market has historically been one of our most volatile and unpredictable markets. 2007 was no different. Demand from quarter to quarter and inside quarters can be and was choppy.

We serve this market with products for specific customers and specific applications from both our Williams Advanced Materials unit and our Specially Engineered Alloy segment. Williams continued to see strong growth in this market throughout the year, but while the overall handset market was strong, the products and the applications we supply from the Specially Engineered Alloy segment of our business did not live up to our expectations in the year and in the fourth quarter due to a number of factors, including inventory corrections and most significantly, lower demand for a key customer's handsets.

As with the magnetic media market, there was stronger demand here as the fourth quarter began, but that demand weakened again as the quarter progressed and came to a close.

In the aggregate, conditions in media and in cell phone hurt sales by $15 to $20 million and profits by over $0.15 a share in the fourth quarter. And as our guidance for 2008 suggests, this will carry into early 2008 as well.

Now I'd like to shift to the one-time EPS benefits, in particular, the one-time inventory benefit. As for the reported EPS benefit related to the sale of product containing the low-cost ruthenium inventory, it was in the production system at the beginning of the year. You'll recall that this was a cash benefit of $0.52 in the first quarter, $0.14 a share in the second quarter, $0.04 a share in the third quarter, bringing the year to approximately a $0.70 per share cash benefit.

The $0.70 per share benefit was partially offset during the year by lower of cost or market charges of approximately $0.15 per share, $0.13 of which occurred in the second quarter, and an additional $0.02 of which occurred in the fourth quarter.

Net-net, 2007 earnings benefited by approximately $0.55 from these two factors.

The balance sheet - the company's balance sheet continued to strengthen in 2007, and the company ended the year with significant financial flexibility. The debt net of cash position improved during the year by approximately $30 million. As a result, the debt-to-debt-plus-equity ratio improved to approximately 9% in spite of an increase of over $35 million in inventory and receivables supporting the substantial increase in sales.

In addition, the company increased its precious metal consignment lines by $95 million and increased its revolving credit agreement by $150 million - $115 million to $240 million, adding both financing capacity and significant flexibility.

The increased capacity and flexibility adds the liquidity to support the expected organic growth and take advantage of acquisitions and augmentation opportunities as they surface.

As previously announced, the company reached an agreement to settle its lawsuit against certain of its London market insurers. The company recorded a onetime $0.27 a share benefit to earnings in the fourth quarter due to that settlement.

I'd like to now spend a moment on the recent acquisition. Earlier this week, the company completed the acquisition of substantially all of the assets of TechniMet, Inc., a manufacturer of precious metal coated films headquartered in Windsor, Connecticut. This highly complementary business extends the company's leadership and geographic reach into high growth, technically demanding, thin film markets and allows the company to pursue strategic growth opportunities in the medical diagnostics market as well as other targeted markets.

The purchase price of the acquisition was approximately $90 million, and it is anticipated that the acquisition will be accretive in 2008.

I understand that many of you would like us to disclose more financial information about the acquisition, and in particular, the accretion level we expect. However, as you know, we as a rule do not disclose line of business or product line financial data, especially competitively sensitive information.

While we will not disclose the expected accretion level, I will offer the following: The transaction trailing EBITDA multiple was consistent with the historic multiples the company has paid for its acquisitions in the past and thus in the 5 to 7 range.

Sales levels for the company will increase by less than 3% due to this acquisition since Techni-Met was a customer and previously sales to Techni-Met will now be eliminated in consolidation.

Operating margins are very high, well above those of the Advanced Materials and Services segment, and interest expense in 2008 will increase by approximately $2.5 million due to this transaction.

I'd like now to review the operating run rate for both 2006 and 2007. This was defined in the press release.

To get a proper view of the company's real operating performance trend, it's important to remove the unusual items that increased reported GAAP earnings in both 2006 and 2007. Reported results for the fourth quarter of 2007 included a previously announced benefit related to the litigation settlement and a lower of cost or market inventory charge, the net of which favorably affected reported earnings by approximately $0.25 a share.

The prior year's fourth quarter earnings per share was $1.48, and included in that was a non-cash benefit of $1.04 per share related to the reversal of a deferred tax valuation allowance. Absent the deferred tax valuation allowance, the company earned $0.44 a share in the fourth quarter of 2006.

Fourth quarter 2007 earnings were negatively affected when compared to the prior year due to two factors. First, lower production, poor yield and a weak mix resulted in lower profits in Specially Engineered Alloys. And second, lower sales were recorded in the Beryllium and Beryllium Composite segment when compared to the prior year due to a sizeable non-repeat high-margin program that was completed in the prior year. Combined, these factors hurt the fourth quarter earnings comparisons by approximately $0.20 a share.

Net income for the year was $53 million or $2.59 a share compared to net income of $49.6 million or $2.45 per share for 2006. Excluding the reversal of the deferred tax valuation allowance, the company earned $1.38 per share in 2006.

Earnings in 2007 were affected by the aforementioned litigation settlement, lower of cost of market charges, a loss on the sale of a small business, and a gain on the sale of the low-cost ruthenium purchased in 2006.

The combined effect of these items is approximately $0.80 per share. Excluding these items, the operating run rate was $1.79 per share in 2007, an increase of 30% compared to the prior year's $1.38. And for reference on the same basis, 2005 was $0.62 a share.

That completes my comments on the fourth quarter and the year. I'll now comment on the outlook.

As you know, the specific guidance we provided in the press release today is guidance on the outlook for the full year only. This is consistent with the change in practice that we announced in mid-2007.

The year 2007 brought significant growth in sales and profits, especially in the first half. Managing the growth we've seen over the last nine quarters has not been without its challenges. We did not execute flawlessly in 2007, and did have lost opportunity. The company's global markets, however, continued to present double-digit growth opportunities, and we're expecting that the company continue to see considerable opportunity in 2008 and beyond.

The strong organic growth seen in 2007 was aided by strong demand across many of the company's key markets. Important in 2007 was the success of the company's new product programs, which are targeted at new markets and at faster-growing and higher technology applications in existing markets.

The consumer electronics related markets, which include portions of telecommunications and computer as well as magnetic data storage, were especially strong early in the year.

The company's oil and gas, heavy equipment, aerospace and defense markets also continued to show strong demand throughout the year.

As 2007 came to a close and 2008 began, the company did expect stronger demand than what it is currently experiencing in two of its key markets - demand from customers and for applications served by the company's Specially Engineered Alloy segment in the cell phone handset market are well below expectations.

In magnetic media or hard disc drives, product qualifications are not where the company expected them to be, and thus the demand from the customers the company supplies in supporting the industry conversion to perpendicular media technology is below the company's previous expectations.

In spite of these weaker markets and weakening conditions in the economy in which had additional uncertainty, growth in data storage, together with the growth brought by the recent acquisition are at this time expected to more than offset the negative conditions I noted, thus leading to growth in both sales and earnings for 2008.

The company at this time expects sales growth rate in 2008 to be above 10%. In our sales growth assumptions is metal price and mix deflation in 2008, primarily due to the current price of ruthenium versus prices one year ago, and customer sourced versus purchased metal.

Thus real growth in 2008 is expected to be well into the double digits. The potential is for earnings to be as much as 30% above the 2007 operating run rate and therefore in the range of $1.80 to $2.30 a share. This, of course, assumes a significant macroeconomic downtrend does not occur.

Early in the year comparisons to the prior year will not be favorable due to the aforementioned business conditions, the strong early 2007 media [ramp] rate and reported ruthenium inventory benefit in metal prices.

First quarter 2008 demand in data storage as well as in our other key markets at this time appears to be similar to that of the fourth quarter. It is important to continue to reiterate that the company sales and earnings estimates are subject to significant variability. Metal price changes, metal supply conditions, fluctuations in demand levels, driven by such factors as inventory swings in the market and new product ramp up rates in critical markets such as the media market can, as we have seen, have a significant effect on actual results from quarter to quarter.

The outlook for the year is based on the company's best estimates at this time and is subject to significant fluctuations due to these as well as other factors.

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

Richard J. Hipple - President, Chairman and CEO

Thank you, John. As we 2007 behind us, and like to say I'm proud of the Brush organization for again achieving another year of strong organic growth, strong earnings growth, strong global expansion, and adding new capabilities through acquisitions.

I'd now like to provide some further comments on the two key disappointments in our recent performance.

First, there are two dynamic affecting their performance in the Specially Engineered Alloy cell phone market. As recently published by our largest customer, Motorola, their cell phone sales declined by 38% in the fourth quarter of 2007 as compared to the fourth quarter of 2006. This obviously has had a major impact on our sales into this market.

Another longer-term trend which has slowed growth is the design trend towards thinner material. As phones get smaller, the designs require smaller connectors. Although this is a good trend from demanding higher grade materials like ours, there is also a negative impact when the thickness of the design is reduced. Essentially, more funds are made with less material.

We are obviously not sitting still and are aggressively engaged in pursuing the cell phone supply chain of the growing cell phone companies such as Samsung in Korea.

We also had lower production yields in the fourth quarter in Alloy which negatively affected performance. Our yield has since recovered, and we are off to a good start in 2008.

Meanwhile, our cell phone business in the physical vapour deposition applications, in our Williams Advanced Material group remained strong and has not been impacted by individual customer issues.

Bookings remain strong, and we anticipate global growth of cell phones to 1.2 billion units this year.

Now with regard to the media market for hard disk drives, we took us the backwards in the fourth quarter as we needed to requalify ruthenium-based target materials for one of our key customers. Specification changes are occurring rapidly as the technology evolves, and we needed to modify production processes. We have modified our processes and their new targets and now being requalified. We are very confident regarding their ability to meet and exceed customer requirements.

Simultaneously, we are very excited about our numerous qualifications currently underway at several customers for the media oxide layer. As they mentioned before, the oxide layer represents an equivalent market opportunity to the ruthenium layer. We also believe that we have developed superior technology for oxide targets that should be attractive to our media customers.

We also recently announced an additional expansion of our media capacity of our Brewster facility. In light of the recent decline in ruthenium media sales, the additional commitment to a further expansion reinforces our view that we have had a temporary setback and have a lot of runway ahead of us in the media market for new oxide layer sales, recovery of our ruthenium share, and later in the year, after our capital is in place, expansion in the soft underlayer materials.

With regard to the general hard disk drive market, industry forecasts expect at least a 10% growth in 2008, and the conversion to the new PMR technology is expected to be completed before the end of this year.

We are very bullish regarding our prospects with the unfolding opportunities in the hard disk drive media market, led by several new product offerings. You may also remember that Williams has a long and strong presence in the hard disk drive magnetic and materials market, and this market is very strong and reflects the general strong industry conditions.

I would like to quickly update you on several other key markets. Our telecom infrastructure market remains strong. In fact, last year our undersea repeater housing business came back in Alloy as new undersea optical cable lines are being installed again. We expect this market to remain strong, and we expect to see additional growth in 2008.

Our industrial markets - oil and gas, aerospace, heavy equipment - all remained strong and we expect ongoing growth as well as an expanding application base for our ToughMet products. In addition to the normal heavy loaded applications in large equipment, we are now seeing ToughMet applications going into areas like food processing and general factory bushings and bearings.

The defense business also remains strong, and we are gaining traction through new products and applications. Our newest product, [AlbuMet], grew in sales of over 40% in 2007 from 2006, and we are also seeing strong defense growth in their new acquisition in California, GFT, from specialized optical coatings used in infrared devices.

As I mentioned before, one of our key strategic thrusts is to continue to broaden our market base while providing new opportunities for growth. Our new acquisition Techni-Met gives us new strategic position in the medical market through a strong position in the diabetic glucose testing market. We supply, precious metal coated substrate to test strip providers. We have the unique process know-how required to meet the quality demands of the medical market. We expect to leverage this technology into new market opportunities.

In 2008, we expect to continue to strongly grow the company's top and bottom line for the fifth consecutive year. We are well-positioned in many strong markets and for continued global expansion, and their balance sheet provides us with the opportunities to continue to leverage acquisitions into new, profitable growth platforms.

And I think we're ready to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line Chuck Murphy with Sidoti and Co. Please proceed with your question.

Charles Murphy - Sidoti and Co.

Good afternoon, guys.

Richard J. Hipple - President, Chairman and CEO

Good afternoon.

Charles Murphy - Sidoti and Co.

I guess it's safe to say never a dull moment?

Richard J. Hipple - President, Chairman and CEO

Yeah, it seems to be that.

Charles Murphy - Sidoti and Co.

Just to check my facts here, you said media or ruthenium sales were $160 million for the full year?

John D. Grampa - SVP, CFO

Media.

Charles Murphy - Sidoti and Co.

Media.

John D. Grampa - SVP, CFO

It's just dominated by ruthenium.

Charles Murphy - Sidoti and Co.

Okay. Okay.

John D. Grampa - SVP, CFO

Today.

Charles Murphy - Sidoti and Co.

Okay. As far as your '08 sales guidance goes, what kind of contribution are you assuming there from the oxide layer?

John D. Grampa - SVP, CFO

In the 2008 plan?

Charles Murphy - Sidoti and Co.

Uhm.. uhm..

John D. Grampa - SVP, CFO

When you say contribution, Chuck, are you asking for profit information?

Charles Murphy - Sidoti and Co.

No, basically sales. How much in sales do you expect from the oxide layer in 2008?

John D. Grampa - SVP, CFO

I don't have that information in front of me. The ramp rate on oxide is not going to be unlike the ramp rate of ruthenium once it begins. The question becomes the timing of when it begins, and while we're reporting actuals to you as we move forward on ruthenium because of its significance, we'll begin to do that when oxide gets significant. But we will not share that level of detail on our business plan.

Charles Murphy - Sidoti and Co.

Okay. I guess I'm just trying to get a sense, you know, if ruthenium-type sales were $160 million in 2007 and you're saying that oxide could be a similar opportunity, at what point are we getting that $160 million?

Richard J. Hipple - President, Chairman and CEO

We have to be very careful, Chuck, because, you know, we get trapped in these  you've got to stay away from revenue. It's really profit. That's what we're about here.

You've got totally different metals in the oxide layer than you do in the ruthenium layer, and it's a different dynamic. I mean, sales revenue, if a target's not a target, it's not a target. You've got different material sets and the, you know, the oxide targets don't have the same metal constituencies as the ruthenium targets.

So the revenues aren't equal, but we're after margins here.

John D. Grampa - SVP, CFO

I think that what needs to be clear is that we're really referencing real growth, and ruthenium, for example, at the beginning of 2007 was over $800 an ounce. Today it's more like $500 an ounce.

Richard J. Hipple - President, Chairman and CEO

$415 an ounce.

John D. Grampa - SVP, CFO

$415 an ounce today. Whenever we buy the metal direct from the seller, it ends up becoming our metal in the accounting transaction and it appears in sales. Whenever we use metal provided by a customer, it's his metal and not recorded in sales. And as time goes on, more and more of the refined recycle stream ends up in our top line with margin and without a sales value.

So the same - that really makes the comparisons from a revenue perspective look difficult.

Charles Murphy - Sidoti and Co.

I got you.

John D. Grampa - SVP, CFO

And at the same time makes the growth look like it's less than what it might otherwise be.

Unfortunately, that's the nature of our business, and we don't have direct line of sight over, first of all, what's going to happen with ruthenium metal prices, and secondly, when our customer will supply us the metal versus us buying the metal and supplying it to the customer.

It makes it really hard to do what you're trying to do with the estimates.

Charles Murphy - Sidoti and Co.

Okay. Yeah, no, that helps. But, you know, if could just elaborate a little bit, you know, as far as the profit-type opportunity, when would you expect to, you know, claim 50%, 80% of the total profit opportunity for the oxide layers?

Richard J. Hipple - President, Chairman and CEO

Well, I think, as I mentioned, we would consider from a market opportunity the equivalent profit potential in the oxide layer as there is in the ruthenium layer.

Charles Murphy - Sidoti and Co.

I'm saying when would you reach the same profit level for oxide as you're currently doing for ruthenium?

Richard J. Hipple - President, Chairman and CEO

Well, again, we're starting to ramp next year, and, you know, we would expect to get a certain level of market share, probably similar to the ruthenium. But, you know, it's very difficult to predict that curve against the qualifications and penetration and, you know, how much value do we have and differences in technologies. As I mentioned before, we think we have some advantages.

We cannot predict that. That's a variable. We're confident we're going to penetrate this market, and it's a very good market for us. It will be a slow start and it will ramp and we'll report on the ramp as it occurs.

Charles Murphy - Sidoti and Co.

Okay. And have you started shipping any of the oxide layers yet?

Richard J. Hipple - President, Chairman and CEO

They're all in qualification.

Charles Murphy - Sidoti and Co.

I'm sorry?

Richard J. Hipple - President, Chairman and CEO

We are shipping currently oxide targets to one particular application, so we are qualified on oxide with one customer, but we have a lot more in play.

Charles Murphy - Sidoti and Co.

Okay. Okay, and then my final question here, what are your thoughts, I mean, as far as the synergies between the Advanced Materials business and the Alloys business. Is there much synergy there?

John D. Grampa - SVP, CFO

No.

Charles Murphy - Sidoti and Co.

Okay.

Richard J. Hipple - President, Chairman and CEO

It's not operating synergy.

Charles Murphy - Sidoti and Co.

I mean, does it make sense down the road to consider splitting the two companies?

Richard J. Hipple - President, Chairman and CEO

Well, you know, we're not considering that at this time, and we - what's interesting about Brush, it really gets to the models of the businesses, and although maybe we don't have overlap in operations per se, we do have overlap in how the company operates culturally, how you attack the market, how you come up with new applications, where you are on the triangle - we're at the top of the triangle for value add. That's where the Specially Engineered Materials Alloy business and the businesses actually operate very similarly to one another. It becomes the model of the businesses so, you know, are you at the value add, are you on the commodities side?

So that is common amongst the businesses and even if you would dissect Williams, Williams does many different things. They make targets, they make frame lid assemblies. We're now in the coating business. We make inorganic chemicals. You could say, well, why don't we split all those up? I mean, you know, it - because what's going on here is we're able to drive technology synergy within Williams and we have very similar culture and an approach to market in what I call at the highest level for this company is Special Engineered Materials, and that's when we have across the board in every one of our operating units.

Charles Murphy - Sidoti and Co.

All right. We'll, I'll pass it on to somebody else. Thanks.

Operator

Thank you. Our next question comes from the line of Avinash Kant with Broadpoint Capital. Please proceed with your question.

Avinash Kant - Broadpoint Capital

Good afternoon, Dick and John.

Richard J. Hipple - President, Chairman and CEO

Hello, Avinash.

Avinash Kant - Broadpoint Capital

A few questions here. The first one is that you do have a wide range of EPS guidance from $1.80 to $2.30. Could you just elaborate, what is the difference in assumptions between the low end and the high end?

John D. Grampa - SVP, CFO

Well, I think that, you know, that wide range, as we enter this year, you know, the key - the kind of two key elements would be penetration of some new layers within the media business, and we're all sitting here all around the table, no matter which side of the phone, wondering what kind of economy are we going to have this year.

So, you know, there's - none of us can count on exactly what's going to unfold, so there's a lot of unknowns and anytime you have a lot of unknowns, you put a little wider range in.

Avinash Kant - Broadpoint Capital

So basically there is some element of a slowdown in the economy already if you are at the lower end of the guidance?

John D. Grampa - SVP, CFO

Yeah, that's right.

Richard J. Hipple - President, Chairman and CEO

Sure.

John D. Grampa - SVP, CFO

That's right.

Avinash Kant - Broadpoint Capital

Okay, good. The second thing I wanted to touch base is on - I think I'll follow up with the previous question - is that in terms of your assumptions from the oxide layer, what we are trying to get at is the guidance of $1.80 to $2.30 that you have given, does it assume a significant EPS contribution from the oxide layer in calendar year '08 or not?

Richard J. Hipple - President, Chairman and CEO

It assumes some. I wouldn't define it as - it's important, but I wouldn't define it as significant.

John D. Grampa - SVP, CFO

It's important and, you know, it's going to be more significant in the second half.

Avinash Kant - Broadpoint Capital

So in the second half, right? Then you expect to reach the kind of levels we've reached here - you talk about the similar opportunity, you talk about the similar opportunity most likely in calendar year '09, not in calendar year '08.

Richard J. Hipple - President, Chairman and CEO

Well, you know, you start to really ramp the second half of 2008, and it follows in 2009, absolutely. You're correct. That's the plan.

John D. Grampa - SVP, CFO

You're correct.

Avinash Kant - Broadpoint Capital

So the ramp will start in the second half of calendar year '08?

John D. Grampa - SVP, CFO

Yeah.

Richard J. Hipple - President, Chairman and CEO

The noticeable ramp.

John D. Grampa - SVP, CFO

The noticeable. I mean, we're going to be - if we hit what we want to, I mean, we've got a lot of qualifications targets in, and I'd hope they'll start shipping in the second quarter. But, you know, it's - you know how customers work. You qualify and then they try some and they want to make sure that you've got consistency and quality and stability, and then they start to ramp you.

Avinash Kant - Broadpoint Capital

And you did talk about some advantages that you have over the technology that's existing out there. Could you elaborate on that, please?

John D. Grampa - SVP, CFO

Well, this is a very sophisticated area and it has to do with fluxes and it has to do with permeability and tuning, if you will, of these targets depending on their needs for the responsiveness in the media market. So we think we have some designs there that give you the ability to fine tune these targets a little bit better.

Avinash Kant - Broadpoint Capital

So the end for the customer is they have a better film, they have a thinner film, they can use that material - what is it? Or is it just a cheaper target?

Richard J. Hipple - President, Chairman and CEO

Well, it all depends on how the customer is designing their media products. And this is a very - the oxide layer is very tricky, and, you know, some are designing differently. They have different - some want higher permeability. Some don't. They want, you know, different magnetic properties.

And so it becomes, as you tune those magnetic properties, it becomes very difficult to get those properties within the oxide layer. And so we just think we have more flexibility in our design and we'll, you know, we'll have to prove that in the marketplace.

Avinash Kant - Broadpoint Capital

So basically you would provide them with a better process window, if I understand it right?

Richard J. Hipple - President, Chairman and CEO

Yeah, a more controllable process window, exactly right.

Avinash Kant - Broadpoint Capital

Okay. Good. Now -

Richard J. Hipple - President, Chairman and CEO

That's our plan.

Avinash Kant - Broadpoint Capital

One more question. You have been talking about the cell phone business, especially from a particular customer. Now, I've done some work on your Specially Engineered Alloy business, and if I try to break down to the point, just to figure out the contribution from cell phone customers into that Specially Engineered Alloy segment, it does not come out to be more than 10%.

And I grossly wrong somewhere, or - I'm trying to see how could this impact you so materially? Is it that the margins in that business are significantly higher?

Richard J. Hipple - President, Chairman and CEO

The margins are very high. They're very high.

Avinash Kant - Broadpoint Capital

Okay. So in that case while the revenue in fact may not be that high, the margin in fact is what is impacting the business, right?

Richard J. Hipple - President, Chairman and CEO

Yes.

Avinash Kant - Broadpoint Capital

In terms of growth coming back, though, if your particular customer that you talked about, Motorola, if they don't do very well, you did talk about Samsung. Are you in qualification at Samsung?

Richard J. Hipple - President, Chairman and CEO

We're shipping.

Avinash Kant - Broadpoint Capital

Is this a new development?

Richard J. Hipple - President, Chairman and CEO

No, this is you've just got to go out there and sell your product and, you know, getting the right stampers and go to work.

Avinash Kant - Broadpoint Capital

I'm saying that, you know, you talked mostly about the impact on Motorola, but have you been supplying to Samsung all through?

Richard J. Hipple - President, Chairman and CEO

We have had a very low market share in that area of the world, lower than what it should be.

Avinash Kant - Broadpoint Capital

Has it improved recently?

Richard J. Hipple - President, Chairman and CEO

We're working hard on that, Avinash.

Avinash Kant - Broadpoint Capital

Okay, perfect. Thank you so much.

Richard J. Hipple - President, Chairman and CEO

We're positioned, you know, this is - a lot of this is Korean sales, and we're putting what I call the management and sales sweat equity to make sure we get the proper market share where we're not getting it.

Avinash Kant - Broadpoint Capital

Terrific. I'll let others ask questions and come back later if I have more. Thank you.

Operator

Our next question comes from the line of Phil Gibbs with Keybanc Capital Markets. Please proceed with your question.

Phillip Gibbs - Keybanc Capital Markets

Hello. Good afternoon.

John D. Grampa - SVP, CFO

Good afternoon.

Phillip Gibbs - Keybanc Capital Markets

I had one pretty detailed question, a couple of housekeeping questions. I'll just take care of the housekeeping ones first.

As far as the lower of cost of inventory charge in the quarter, what was the magnitude of that on a pre-tax basis?

John D. Grampa - SVP, CFO

It was $0.02 a share after tax - $500, $600,000 dollars.

Phillip Gibbs - Keybanc Capital Markets

And what about the sequential volume change in ruthenium-based media technology? I mean -

Richard J. Hipple - President, Chairman and CEO

Your question, your specific question, when you say sequential volume change?

Phillip Gibbs - Keybanc Capital Markets

I think you'd mentioned it last quarter somewhere in the range of 65% - the ruthenium-based disc drive sales.

John D. Grampa - SVP, CFO

From the second quarter to the third quarter, the ounces shift increased by 65% to 70%.

The third quarter, the fourth quarter, they increased about 4%. And as I indicated in my scripting, the demand was especially strong in September as the third quarter ended and October, as the fourth quarter began, and then the volume dropped off in November and December.

The sales [inaudible] or the sales value of those sales - and again, as we suggested, we don't think we ought to think too much about sales because of the metal source as well as the metal price question - but in the revenue line to the extent that it's relevant, the revenue in the first quarter was $63 million, the revenue in the second quarter was $33 million, the revenue in the third quarter was $28 million in spite of the ramp in volume. The revenue in the fourth quarter was $37 million.

Phillip Gibbs - Keybanc Capital Markets

Oh, okay. Interesting.

John D. Grampa - SVP, CFO

And again, that's reflective of metal source and metal price. First quarter metal prices certainly averaged $700 or so, and later in the year we were in the $500 range each quarter probably if I had the data in front of me.

Phillip Gibbs - Keybanc Capital Markets

Okay, and on those numbers, those absolute numbers that you gave me, you're speaking of just the ruthenium-based disc drive sales?

John D. Grampa - SVP, CFO

Media, which is ruthenium.

Phillip Gibbs - Keybanc Capital Markets

Okay. And my last question just for a little bit of elaboration, I mean, basically, the top line estimate, I mean, looks pretty much intact, the 10% year-over-year growth, but it looks like the EBIT's going to get a little bit strained due to what I think you referred to as sort of getting caught in not being able to maybe pass the metal through, I would say, as efficiently maybe with the timing.

Can you elaborate more on the dynamics of the pass through and the timing of metal and --

John D. Grampa - SVP, CFO

I think I know what you're asking, and it's the correct observation. Dick just referenced a moment ago the high value add cell phone handset business, and as you might expect, double-digit margins in the media business. So you'll get margin stress year-over-year and especially in comparable - when you're looking at one quarter and comparing to the same quarter the prior year, you'll get some margin stress until those high value-add products are back in the mix.

Phillip Gibbs - Keybanc Capital Markets

Okay, great. Hello?

John D. Grampa - SVP, CFO

Yes?

Phillip Gibbs - Keybanc Capital Markets

Oh, yeah. Just to follow up that, with a 10% year-over-year revenue growth, how much of that would you attribute to the - is that all organic?

John D. Grampa - SVP, CFO

Yeah. I referenced in my - again, my script that we were talking about above 10%, so 10% is sort of a floor. And I also referenced that there is metal price deflation inside that growth rate so the real growth, if you will, if we were able to tabulate it on a per unit volume basis, which you really can't whenever you're mixing pounds with ounces, the real growth is something significantly above the low end of that 10%. It's significantly into the double digits.

Phillip Gibbs - Keybanc Capital Markets

Okay, great. Perfect. I appreciate the color on that. Have a good afternoon. Thank you.

John D. Grampa - SVP, CFO

You're welcome.

Operator

Our next question comes from the line of Rob Young with WM Smith Securities. Please proceed with your question.

Rob Young - WM Smith Securities

Hi. Good morning.

John D. Grampa - SVP, CFO

Good morning.

Rob Young - WM Smith Securities

First question is, in relation to the raw materials, the customer source as well as the Brush source, what type of changes over time have you seen as far as the mix between the two? And then what type of changes do you expect on a going forward basis?

John D. Grampa - SVP, CFO

Yeah, let me comment on that. It's really a difficult thing to estimate, but think about it this way. When we initially begin to ramp these processes, the material that was starting to feed the entire value chain, if you will, was virgin material coming from the mines.

As that material starts through not only our production process but also the production processes of the customer, there are slurries that come off of the systems, the production systems, that have this metal in it that then in turn starts to head toward refiners.

And the refiners then remove the metal, begin to ship it back to the owner of that metal, whether it's the customer or whether it's us.

Rob Young - WM Smith Securities

Okay.

John D. Grampa - SVP, CFO

Those processes take anywhere from three to six months depending upon whose metal it is and which refiner they're using. So as the year 2008 progressed - 2007 progressed, you saw a significant amount of the metal start to resurface from that recycle stream in the third and fourth quarters of the year.

So it has a tendency to depress recorded sales, and I think -

Richard J. Hipple - President, Chairman and CEO

Let me just add a little to that, John. I get - usually we have a large macro number on that. I don't have the exact one with me, but just to give you a feel, like at the beginning of this ramp up it was 100% virgin material, and today it's less than 50%.

But there's more than kind of 50%, you know, in the stream.

John D. Grampa - SVP, CFO

That's right.

Richard J. Hipple - President, Chairman and CEO

So we used half of the material we were using at the beginning of the year.

Rob Young - WM Smith Securities

Okay. [inaudible] And then in relation to the oxide layers as well as the ruthenium layer on the PMR, who are you running into as far as those two layers from a competitive standpoint?

Richard J. Hipple - President, Chairman and CEO

You know, there are several competitors out there. There's [Arayas], the German company. There's a Taiwanese company called SolarTech out there, and Sanyo Metals. There's about two or three of them out there.

Rob Young - WM Smith Securities

Okay. All right. Well, I believe that's all, and thank you very much.

Richard J. Hipple - President, Chairman and CEO

You're welcome.

John D. Grampa - SVP, CFO

You're welcome.

Operator

Our next question comes from the line of Chuck Murphy with Sidoti and Co. Please proceed with your question.

Charles Murphy - Sidoti and Co.

A couple follow ups, guys. What would you expect the kind of long-term growth of Techni-Met to be about?

Richard J. Hipple - President, Chairman and CEO

Well, the major market today is in the medical diabetes market, so that's a pretty steady growth market unfortunately. I mean, good news, bad news there. Right now the test strip market is growing at around 10% a year.

So that, you know, our objective would be - as is the same objective in all of our businesses - we intend - we hope to grow that faster then. We have the regular macro market growth, and then we will try to get additional share within that market through our technology advantages, we believe.

So you've got that place. You've got the basic glucose test market growing at a good rate - we'll try to grow faster than that - and then you go beyond that. We do think on a longer-term basis that that has some very intriguing technology to us that we think we can leverage into some other markets.

Charles Murphy - Sidoti and Co.

Okay. Any, like, new products you have in mind that you could talk about there?

Richard J. Hipple - President, Chairman and CEO

Again, it would be - we think we have some opportunities in the defense area, and we also think there might be some longer-term plays in the solar market.

Charles Murphy - Sidoti and Co.

Okay. And my other question, as far as the requalification goes, I mean, is that something that the other suppliers to this hard drive customer were having to do or was it just for you guys?

Richard J. Hipple - President, Chairman and CEO

Well, I - you know, I can't answer what others are doing. I have no idea.

Charles Murphy - Sidoti and Co.

Okay. And as far as the customer buying the ruthenium rather than you, was that at their request or your request - what was the -

Richard J. Hipple - President, Chairman and CEO

Oh, that's always at the customer's request. It all depends how they want to play it.

Charles Murphy - Sidoti and Co.

I mean, it would seem to me, like, that would actually maybe be a little bit better for you guys, though, just because you don't have the volatility of the metal part.

Richard J. Hipple - President, Chairman and CEO

Yeah, that's right. It's all, you know, we're very responsive to the customer's request. We don't demand one way or the other.

Charles Murphy - Sidoti and Co.

Okay. That's all I had. Thanks.

John D. Grampa - SVP, CFO

You're welcome.

Operator

Our next question comes from the line of Avinash Kant with Broadpoint Capital. Please proceed with your question.

Avinash Kant - Broadpoint Capital

This is a follow up. In your prepared remarks you talked about the qualification activity not going as expected. Do you mean the requalification activity of your customer or the qualification for the oxide layer?

Richard J. Hipple - President, Chairman and CEO

When we referenced that, Avinash, I believe, if it was me that was referencing it, I was talking about the requalification process of the ruthenium layers at the key customer that changed his specifications.

Avinash Kant - Broadpoint Capital

Okay, so not about the oxide layer. You're running on track there?

Richard J. Hipple - President, Chairman and CEO

Pardon me?

Avinash Kant - Broadpoint Capital

You think you're running on track there?

Richard J. Hipple - President, Chairman and CEO

Yes.

Avinash Kant - Broadpoint Capital

Okay. And in terms of the facility extension, though, when do you expect this to be ready?

Richard J. Hipple - President, Chairman and CEO

The Brewster expansion?

Avinash Kant - Broadpoint Capital

Yes.

Richard J. Hipple - President, Chairman and CEO

Well, we've got a couple of different things going on there. The longest lead item is - let me put it this way. We think that we can support, you know, a couple things in the near term basis which would be a ramp up in the oxide and the return of share on the ruthenium side. We're going to need - the longer-lead stuff has to do with the SUL layers, some new developments we have there, and that's really more towards the middle of the year - the SUL, but we can support anything that'll come our way in the oxide or ruthenium.

Avinash Kant - Broadpoint Capital

From the middle of the year, right?

Richard J. Hipple - President, Chairman and CEO

No, SUL we're going to need to get some certain longer-lead items in before the SUL growth. We think we can support on a near-term basis in the first half. Let's say that we get some upside surprises, okay? You know, it'd be nice to have some upside surprises. If that happened to happen, we'll be able to support them in the oxide layers.

Let's say that ramp is quicker than we're forecasting. We're going to be able to support that.

Avinash Kant - Broadpoint Capital

Okay. Okay. And have you quantified your opportunity from SUL alone?

Richard J. Hipple - President, Chairman and CEO

Well, yeah, we've certainly internally qualified. Again, there's market sizes and opportunities and [chairs] and - sure.

Avinash Kant - Broadpoint Capital

Could you give us some idea about how big would that opportunity be?

Richard J. Hipple - President, Chairman and CEO

Well, again, I think we've said before - and this is where it gets really crazy - we've said that the, you know, the market size is in this, you know, billion to a billion and a half, and what does that mean? I mean, what's the price of metals? How much does the customer own? It gets crazy on you.

But it's a very large market, and so, you know, it's that kind of metric.

Avinash Kant - Broadpoint Capital

And who would be your key competitors in the oxide layer? Would it be the same people as the ruthenium or would it be different there?

Richard J. Hipple - President, Chairman and CEO

It changes a little bit, but right now it's Arayas who is the main player, also, in the ruthenium and then solar.

Avinash Kant - Broadpoint Capital

So is there somebody with a very large market share?

Richard J. Hipple - President, Chairman and CEO

Well, Arayas has generally, you know, has been the big media player for many years.

Avinash Kant - Broadpoint Capital

Okay. Okay, perfect. Thank you so much.

John D. Grampa - SVP, CFO

You're welcome.

Operator

You have a follow up question from Rob Young with WM Smith Securities. Please proceed with your question.

Rob Young - WM Smith Securities

Hi, yes, just one more quick one. Are you guys in the qualification process for Nokia by any chance?

Richard J. Hipple - President, Chairman and CEO

Nokia - what application? I mean -

Rob Young - WM Smith Securities

For the cell phone handset market?

Richard J. Hipple - President, Chairman and CEO

We shipped to them today.

Rob Young - WM Smith Securities

You shipped to them today? Okay. Perfect. That's all I have. Thank you.

Operator

There are no further questions at this time. (Operator Instructions)

Michael C. Hasychak - Vice President, Treasurer and Secretary

Operator, I think we're going to conclude.

Operator

Okay. There are no questions anyway.

Michael C. Hasychak - Vice President, Treasurer and Secretary

And this is Mike Hasychak. We'd like to thank all of you for participating this afternoon, and I'll be around the remainder of the afternoon to answer any further questions. My direct line is 216-383-6823.

Thank you.

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Source: Brush Engineered Materials Inc. Q4 2007 Earnings Call Transcript
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