Materion Corporation (MTRN) Q2 2012 Earnings Report, Transcript and Summary

Greetings. And welcome to the Materion Corporation Second Quarter 2012 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Michael Hasychak, Vice President, Treasurer and Secretary for Materion Corporation. Thank you, Mr. Hasychak. You may begin.

Good morning. This is Mike Hasychak. With me today is Dick Hipple, Chairman, President and CEO; John Grampa, Senior Vice President, Finance and Chief Financial Officer; and Jim Marrotte, Vice President and Corporate Controller. Our format for today's conference call is as follows, John Grampa will comment on the second quarter 2012 results and the outlook, and Dick Hipple will give a market update. Thereafter, we will open the teleconference call for your questions. A recorded playback of this call will be available until August 11th by dialing area code, 877, the number is 660-6853 or (201) 612-7415, account number, 286, and conference ID number 396978. 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 morning. And now, I’ll turn it over to John Grampa for comments.

Thank you, Mike. Good morning, everyone. Thank you for taking the time to join us this morning. For your convenience, today’s agenda is unchanged from that of our past calls. I’ll review the results for the quarter and then comment on the outlook for the third quarter, as well as the balance of the year. And then following my comments, Dick Hipple will review the current state of our key markets, status of the startup and ramp up of the new beryllium plant and some of our new growth initiatives. Following Dick, we will open the call for your questions. I’ll begin with the usual brief summary of the key points that are in the press release. Then as I normally do, I'll cover the factors affecting the reported sales, highlighting the effect of pass-through metal price changes, which as most of you are already aware, can in our company cloud organic business level changes, particularly in an environment where pass-through metal prices are moving up or down significantly. I will also review the sales change by market comparing to the second quarter of the prior year and more importantly, comparing sequentially as well to the first quarter of this year highlighting the key changes, especially any significant changes in the trends. In addition, I’ll disclose the earnings per share impact of the cost associated with the startup and ramp up of the new beryllium plant, as well as the cost associated with the integration of the late 2007 EIS Optics acquisition and the cost related to the relocation of our microelectronic packagings business to Singapore. And I'll review the balance sheet, cash flow and our cash flow projections for the balance of the year as well. And then, I'll wrap up by reviewing our current view of the outlook for the balance of the year. Let me now begin with a brief summary of the release. Overall, we reported stronger than expected results for the second quarter of the year on weaker than expected sales levels. The higher profit on the lower sales was driven by higher margins. As we reported at the beginning of the quarter, the level of business we were seeing coming into the quarter had improved nicely from the late 2011 levels. Macroeconomic conditions began to change during the second quarter though, resulting lower than expected sales levels overall and a weaker start to the second half than what we had previously expected. Thus we also announced that we are reducing our guidance for the year. Sales and earnings levels for the second quarter were down and the levels that we were achieving one year ago. This was expected and previously announced. A decrease in pass-through metal prices lowered sales in the second quarter by approximately $12 million. Net of the pass-through metal impact, real business levels were down from second quarter 2011 levels by approximately 21%. Comparing the second quarter sequentially to the first quarter of the year, sales were also down. In this case by approximately 6% after considering the impact of lower pass-through metal prices. While sales were lower, orders entered did exceed shipments in the second quarter by approximately $24 million and our book-to-bill was positive 1.07. The reported earnings for the quarter was $0.38 a share, again as expected, this is lower than the $0.67 a share reported in the prior year second quarter. But was up 8% a share sequentially, first quarter reported $0.30 per share. The primary factor in the lower EPS when comparing to the prior year second quarter is the fall-off in business levels from the prior year’s record levels. This was driven by macro economic conditions. Certain specific non-recurring type items were also factors in the lower year-over-year earnings level. I will review those later. The $0.08 per share sequential improvement in the quarter was slightly better than our internal expectations due to higher margin levels. Gross margins in the quarter improved by 150 basis points compared to the prior year, and by 230 basis points sequentially when comparing to the first quarter. I will provide additional insight to the margin improvements in a moment, but before I do that let’s review the overall business activities by market in a bit more detail. The reported 21% decline in sales, net of metal pass-through compared to the second quarter of the prior year is due primarily to significantly weaker demand for the company’s materials from the telecom infrastructure, defense, consumer electronics and automotive electronics market. These markets normally account for about half of the company’s value-added sales. Value-added sales were down year-over-year by 30% in telecom infrastructure, 26% in defense, 11% in consumer electronics and 8% in automotive electronics, helping to offset those declines for year-over-year increases of about 3% in medical and continued strong demand from energy. Comparing sequentially to the first quarter of the year, second quarter sales were down approximately 6%, net of metal pass-through. The 6% sequential decline is reflective of the weakening global market conditions. We did not expect this sequential decline as the quarter began. The sequential decline was driven primarily by shipments into defense applications. Defense was sequentially down by about 9% from first quarter levels. Shipments of materials for applications in consumer electronics, automotive electronics and medical were up sequentially from first quarter levels by between 1% and 4% for each. Dick will comment more on demand levels during his review of the current state of the markets. As you know, given the significant lower levels of business seen in the fourth quarter of last quarter, margins came down to levels below what would -- we would consider to be normal. Sequential improvements have appeared in both the first quarter and again in the second quarter of this year. Gross margin was 16.2% in the second quarter, 150 basis points higher than the second quarter of the prior year’s level and sequentially, 230 basis points higher than the first quarter level. A number of factors contributed to the improvement, including improved pricing, primarily in our Performance Alloys segment, as well as lower manufacturing costs. On a value-added basis, that is removing pass-through metal, our gross margins have historically been above 40% and historically, our value-added operating profit margin has been in the low teens between 13% and 14%. On this basis, gross margins were equal to prior year levels at about 40% and were 360 basis points sequentially higher than those of the first quarter. Operating profit margin has also improved nicely in the second quarter. After excluding the effect of the non-recurring factors, value-added operating profit margins improved 260 basis points when comparing sequentially to the first quarter. As business levels returned to more normal levels and the impact of the initiative costs are behind us, we expect that the value-added margins will return to and exceed historical levels. Let’s now turn to the earnings impact of the initiatives the company has been undertaking. There are 4 specific initiatives that are affecting earnings. These include the startup of the company’s new beryllium plant, the integration of the EIS Optics, which was acquired in the fourth quarter of 2011, the relocation of our microelectronics packaging operations and severance related to workforce reductions. We had previously disclosed that we expected these costs to be in the range of $0.15 to $0.20 a share for the year. After $0.17 per share in the first half, we now expect up to another $0.10 a share in the second half, bringing the total for the year to the $0.27 per share range. The increase is due to startup costs and severance related to additional workforce reductions than we had initially contemplated. The actual impact on the reported second quarter results was approximately $0.09 a share. With $0.05 of that $0.09 being related to the startup of the new beryllium plant, approximately $0.01 being related to the integration of the acquisition and $0.03 related to the restructurings including severance. Now let’s turn to the cash flow and the balance sheet. Both the balance sheet and the statement of cash flows are attached to the press releases. Consistent with our normal seasonal pattern, debt net of cash increased by approximately $31 million in the first half. In the second quarter, debt net of cash decreased by about $5 million and debt to total capital at the end of the second quarter was about 22%. For the balance of the year, we do anticipate the normal strong positive cash flows that we typically see in the second half. By year end, debt to total capital is expected to fall to the mid-teens level. The quality of our balance sheet continues to be a source of pride in the company. We are pleased to have the liquidity we do and the flexibility to support our long-term growth expectations, plus important strategic initiatives such as acquisitions and new product introductions. The quality of our balance sheet should provide significant flexibility throughout the balance of 2012 and beyond. The strength was further reinforced with the initiation of a dividend during the second quarter. The company declared a second quarter dividend in the amount of $0.075 per share, a yield of about 1.5%. The company subsequently announced the payment of a third quarter dividend of the same amount. The dividend is a reflection of our continued confidence and strength of our business, its prospects for long-term growth and our ability to continue to grow the business organically, as well as through acquisitions, while returning cash to shareholders. Prior to moving onto the outlook, I’d like to pre-answer a couple of the other financial model questions that we usually are asked. For the year, we expect EBITDA to be in range of $90 million to $95 million, depreciation to be in the range of $40 million to $45 million, capital spending to be in the range of $30 million to $35 million, free cash flow to be above $40 million and our tax rate to be in the range of 31% to 32%. Now, I’ll turn to the outlook. As we noted in the press release, significant progress has been made in resolving the startup issues associated with the new beryllium facility and it is anticipated that the output of the plant will support demand levels through 2012. In addition, the initial steps in the integration of the EIS acquisition are complete and the previously announced shutdown and relocation of the microelectronic packaging operations is progressing on schedule. The costs associated with these initiatives are expected to be lower in the second half when comparing to the first half. Through the latter part of the second quarter and to date in the third quarter, the global macroeconomic environment has become very unclear and uncertain. Visibility is short. While order entry did increased by approximately 12% in the first quarter of the year when compared to the fourth quarter of 2011 and was increasing further as the second quarter began, the pattern shifted as the quarter developed. The second quarter order entry did exceed sales by approximately 7%, but after a good start, order entry declined from first quarter levels. Order entry has recently been inconsistent from week-to-week and the order rate was not as strong entering the second half of 2012 as we had previously anticipated. Thus while sales and earnings levels in the second half are still expected to be stronger than those of the first half, we are revising the earnings outlook for the full year. The earnings levels for the second half is now expected to be in the range of $0.82 to $0.92 per share, which compares to the $0.68 per share reported for the first half. Results for both quarters of the second half are expected to be approximately the same with the fourth quarter a few cents per share higher than the third quarter. This brings the full year to the range of a $1.50 to $1.60 per share from the previously announced range of $1.95 to $2.10 per share. The full-year range includes up to $0.27 per share of costs related to the aforementioned initiatives. That concludes my remarks. I’ll now turn the call over to Dick Hipple.

Thank you, John. We certainly are in unpredictable times and taking a fundamental assessment of the global economy, we find ourselves with essentially the whole world slowing down as evidenced by the majority of PMI indexes being in negative territory. A lot of this I am sure is being driven by a slowdown in consumer spending led by both Western Europe and the U.S. At the beginning of the year, we had forecasted a stronger uplift than has occurred in the consumer electronics sector. Recent earnings reports by many of our customers bear this out including a rather flat forecast heading into the balance of the year. Another surprise has been the fairly depressed levels of the telecom infrastructure market versus last year. Also the defense sector has been soft in the first half seeing many pushouts although not cancelation of orders. On the positive front, we have record sales in 2 strategic markets in the first half. These were the commercial aerospace and the oil and gas markets. And we certainly expect these 2 markets to see ongoing strength throughout the balance of the year. As John reviewed with you, even given the unstable global situation, we still expect our second half sales and profits to be stronger than the first half. The stronger second half performance will be driven by several factors. First, our new pebbles plant continues to come up the production ramp. We are still on track to be at a production rate to meet our market requirements by the end of the year. In addition to an improvement in cost due to the higher operating level, our bookings are much stronger in the second half, which will result in a higher sales volume, the stronger bookings are in both our defense and medical markets. Second, our thin film coatings business is expected to be stronger in the second half from stronger bookings in our medical glucose testing product. Also, we’re seeing stronger bookings in defense in our Optics operations driven by our new array technology used in a myriad of advanced reconnaissance and surveillance platforms. And our new optics EIS acquisition in Shanghai is expected to be accretive in the second half of 2012, driven by stronger bookings from the core digital light processing business, which typically has a stronger second half seasonally. And third, we have instituted numerous cost reductions and restructuring initiatives that we expect to have positive results particularly in the fourth quarter. For now, we are assuming that the overall consumer electronic sector will remain relatively flat for the balance of the year. So there could be some upside from this area. Aside from macro economic conditions, we continue to build a strong foundation for growth with new products across a broad portfolio of markets. A few examples include our liquid metal initiative which offers a lower cost direct cast solution to replace other machine metals, a new solution for connecting dissimilar metals such as copper and aluminum in a high temperature environment of lithium ion batteries and next generation automobiles. Further developments with our ToughMet alloy which extends applications particularly in the oil and gas market and now we’re finding widespread use throughout camera stabilization systems in smartphones. Our new array technology, I mentioned earlier in optics enabling even higher resolution for surveillance. Along with optics, focused on gesture control technology which is beginning to extend applications beyond just gaming. Nitrite compounds used in the formation of colors for phosphorus used in LED lighting. Our biggest challenge with our new AMC acquisition is properly prioritizing our new product opportunities, which are many. And finally, we expect the government to rebuild its strategic stock pile of beryllium starting next year or the year after. We are definitely bullish on our new horizons for growth with a strong balance sheet that can support ongoing developments. Thank you and we’re ready to take questions.

[Operator Instructions] Our first question is from the line of Luke Folta of Jefferies & Company.

Got a question, Dick, you talked a lot about moving parts in the second half this year. I probably have to go back and read them again to get them all down but just from a more higher level, can you just talk about what the -- what was the biggest change in your outlook as it turns to why you dropped the guidance? Was it purely volume driven?

Yes. Volume driven and just slightly higher cost on the restructuring initiatives.

Okay. Can you talk about specifically, I know which market you’re saying are weak when it comes to revised second half forecast. Which market did you reduce your forecast for?

Fundamentally from the original plan, the electronics market.

Okay. And when you think about volumes, companywide and it’s probably up to gauge all of the diversification, when you think volumes in the second half versus the first half, directionally, are we headed higher or lower in your forecast?

We are a little bit higher.

Little bit higher. You talked about pricing improving in the second quarter. Can you give us any color on what products you were referring to and then you think that’s sustainable in the second half?

Yes. Actually, pricing is a pretty aggressive program for us right now. So we expect higher pricing in our alloy business. And we’re also taking actions really across the board and in the other divisions.

Okay. Any -- can you give us any sense of what the magnitude of that might be? If we -- I’m just trying to get a sense of what pricing is contributing this year?

Yes. I think that we referenced that in my dialogue where we have in the second quarter of this year, a benefit in that margin growth versus last year’s second quarter for pricing. That number’s order of magnitude, $2 million to $3 million year-over-year, dominated again by the performance of alloy’s business.

Okay. Just couple of quick ones. Advanced materials you talked in the press release about seeing a bit weaker product mix there. Is that -- can you give us some color on that? I think that’s a temporary thing or more long term?

Yes. We sure hope that’s its temporary. It’s driven by – our earlier expectations were the consumer electronics will be significantly stronger and it is driven by semiconductor consumer electronics primarily. So that’s really why the demand level there are giving us some caution. We also think it’s possible there might be some upside there depending upon where that market goes.

Okay. And then just on D&A, that’s down like I think $3.5 million, if my numbers are right here. I heard you -- for your forecast, just curious on what happened there?

That’s -- you talking about sequential in the first quarter or…

Yes.

Yes. We had a mine amortization in the first quarter was a little higher than the second quarter and then -- and our forecast just got down little bit there.

Our next question is from Avinash Kant of D. A. Davidson.

So the first question was you gave us some idea about the order pattern in the quarter. Could you give us -- what was the sequential decline in orders in Q2 compared to Q1?

I will look at up -- it was the few percentage points lower in the second quarter…

Versus the first quarter.

Right.

I think the Q1 was down roughly 12% you said, right, or was it up 12% or so?

The first quarter was up 12%.

12%, right. And then the Q2 dropped like 2%, 3%?

Yes. 4%, 5% I believe.

4% to 5%.

We don’t have the data in front of us. But...

Okay. That’s fine. Roughly in that order, right.

Yes.

Okay. And I think, John, you talked about the directionality for the rest of the year. I believe you mentioned that Q4 is going to be better than Q3, is that what you said?

That’s right. Slightly better than Q3, may be few cents.

And is that primarily because some of the different orders that you see and how were you modeling the electronics market?

Sure. A couple of things, yes, it’s not really related to necessarily monitoring electronics although. You do start to get a seasonality pattern in electronics beginning sometime mid-to-late August through October. But in the fourth quarter, the benefit of some of the cost reductions that Dick and I both mentioned appeared in the P&L fully with some of the cost to get there behind us. And the second thing that happens this year in the fourth quarter is that we will have a little stronger business coming from shipment of a -- expected shipment of hydroxide order to NGK. Those happens twice a year. This year, we think it will happen beginning of the fourth quarter.

What’s the order that -- what’s the magnitude of that order roughly, the NGK order that you are talking about?

The sales value roughly $4 million to $5 million.

That’s the reason, right. And that…

No. No. It’s a combination, the profit on that and the cost reduction.

And the cost reduction, okay. And you talked about the value added gross margin, you kind of stated in the quarter we’re roughly still in the 40% range, right. Could you talk about the operating margins, the value added operating margin in the quarter?

Yes. It was obviously below our historic 13% to 14% by roughly 150 basis points driven by that volume drop off for the current week last year.

It’s roughly 11.5%?

11.5% to 12%, closer to 12%, probably than 11.5%.

But you do expect that to come back up?

As the volume comes back and as the -- that’s correct. As costs continue to come down, we expect that to come back.

So you talked about second half being better than the first half. And you’re talking about Q4 being better than Q3. So basically, can we expect sequential growth in Q3 and Q4 both, is that what you are talking about?

Well, yes. I mean the Q4 growth is really because of the NGK order. If you take that out, I think sequentially probably, it will be about flat.

From Q3?

Q3 and Q4 will be essentially flat if you take the impact of the NGK order out.

But Q3 should be better than Q2?

And that’s correct and Q4 better than Q3.

[Operator Instructions] Our next question is coming from Hendi Susanto with Gabelli & Company.

First one, what is your estimate of break-even revenue in your beryllium business. Do you anticipate that business to reach break-even in 2013 considering anticipation of inventory build by the government?

Sure. Go ahead.

Yes. We would expect sequential improvement in that segment in 2013 and beyond, as the government begins to rebuild the stockpile. We can’t estimate at this time. It will be real premature to temporarily estimate the timing of that by quarter certainly and even by year.

I think…

We do expect a…

I did mention, we’re not sure, which ways it’s going to fall right now and may begin in 2013, it may being in 2014. It’s still yet to be determined. We’ll know that certainly by the end of the year.

Okay. Is there any estimate of the breakeven revenue level?

Well, it would in tens of millions of dollars.

Okay. Okay. Got it. And then what is your expectation of pass-through metal prices in the second half of 2012?

The numbers we presently have, we’re assuming second quarter levels. So obviously the revenue level might move around. But it doesn’t impact or will not affect our estimate of profit.

Got it. And then -- sorry if I miss revenue growth target, if it’s given earlier. If I’m not mistaken Materion was targeting organic growth of 3% to 6%. And then revenue growth of 5% to 10% in light of the new guidance, what is your current revenue growth target?

Well, we provided obviously the earnings guidance. But I would suggest that the second half revenue versus the first half revenue might be up $20 million greater.

Okay. But there is no like update on what type of organic growth you are looking?

Well, no. There would be no.

Roughly down from last year, obviously.

[Operator Instructions] Thank you. There are no further questions at this time. I would now like to turn the floor back to management for closing comments.

This is Mike Hasychak. We’d like to thank all of you for participating on the call this morning. I will be around for the remainder of the day to answer any further questions. My direct dial number is area code 216, the number is 383-6823. Thank you very much.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.