BRUSH ENGINEERED MATERIALS INC - 10-Q Quarterly Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

------------------------

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the quarterly period ended April 2, 2004

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 001-15885

BRUSH ENGINEERED MATERIALS INC.
(Exact name of Registrant as specified in charter)

OHIO 34-1919973
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)

17876 ST. CLAIR AVENUE, CLEVELAND, OHIO 44110
(Address of principal executive offices) (Zip Code)

216-486-4200
Registrant's telephone number, including area code

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]

As of April 26, 2004 there were 16,763,734 shares of Common Stock, no par
value, outstanding.

PART I FINANCIAL INFORMATION

BRUSH ENGINEERED MATERIALS INC. AND SUBSIDIARIES

ITEM 1. FINANCIAL STATEMENTS

The consolidated financial statements of Brush Engineered Materials Inc.
and its subsidiaries for the quarter ended April 2, 2004 are as follows:

Consolidated Statements of Income --
Three months ended April 2, 2004 and March 28, 2003

Consolidated Balance Sheets --
April 2, 2004 and December 31, 2003

Consolidated Statements of Cash Flows --
Three months ended April 2, 2004 and March 28, 2003

1

CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

See notes to consolidated financial statements.
2

CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

See notes to consolidated financial statements.
3

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

See notes to consolidated financial statements.
4

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE A -- ACCOUNTING POLICIES

In management's opinion, the accompanying consolidated financial statements
contain all adjustments necessary to present fairly the financial position as of
April 2, 2004 and December 31, 2003 and the results of operations for the three
month periods ended April 2, 2004 and March 28, 2003. All of the adjustments
were of a normal and recurring nature. Certain items in the prior year have been
reclassified to conform to the 2004 consolidated financial statement
presentation.

NOTE B -- INVENTORIES

NOTE C -- COMPREHENSIVE INCOME (LOSS)

The reconciliation between net income (loss) and comprehensive income
(loss) for the three month periods ended April 2, 2004 and March 28, 2003 is as
follows:

NOTE D -- SEGMENT REPORTING

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NOTE E -- INCOME TAXES

A tax provision or benefit was not applied against the income or loss
before income taxes in the first quarter 2004 and the first quarter 2003 for
certain domestic and foreign taxes as a result of the deferred tax valuation
allowance recorded in previous periods in accordance with SFAS 109, "Accounting
for Income Taxes" due to the uncertainty regarding full utilization of the
Company's deferred income taxes. The valuation allowance was reduced offsetting
a portion of the net tax expense in the first quarter 2004 while the valuation
allowance was increased in the first quarter 2003 offsetting the net tax benefit
in that period. The Company intends to maintain the valuation allowance until
additional realization events occur, including the generation of future taxable
income, that would support reversal of a portion of the allowance. The $0.1
million of expense in the first quarter 2004 and the $0.2 million of expense in
the first quarter 2003 represent taxes from various state and local
jurisdictions and foreign taxes from Japan and Singapore only.

NOTE F -- PENSIONS AND OTHER POST-RETIREMENT BENEFITS

NOTE G -- STOCK-BASED COMPENSATION

The Company has adopted the disclosure only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" and applies the intrinsic value method
in accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations in accounting for its stock incentive
plan. In accordance with SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure," the following table presents the effect
on net income/(loss) and net income/(loss) per share had compensation cost for
the Company's stock plans been determined consistent with SFAS No. 123.

6

The fair value was estimated on the grant date using the Black-Scholes
option pricing model with the following assumptions for options issued:

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

OVERVIEW

We are an integrated producer of engineered materials used in a variety of
electrical, electronic, thermal and structural applications. Major applications
and markets for our materials include telecommunications and computer,
automotive electronics, optical media, industrial components, appliance,
aerospace and defense.

Our financial results for the first quarter 2004 were the best in three
years. The positive sales and order entry trends that began in 2003 continued
throughout the first quarter 2004; total sales were 26% higher than the first
quarter 2003 as each of our major product lines grew over the comparable period
last year. Our major markets showed signs of strengthening and our new product
development efforts continued to generate new sales opportunities. Gross margins
increased, not only from the higher sales volumes, but from improved
manufacturing efficiencies at various facilities as well. As a result of the
increased sales and margins, we generated the largest quarterly operating profit
and net income since the first quarter 2001. Working capital investment, in
terms of accounts receivable and inventories, climbed in support of and as a
result of the significant increase in sales. With our debt refinanced in the
fourth quarter 2003, we have the available capacity to finance this growth.

RESULTS OF OPERATIONS

Sales of $125.9 million in the first quarter 2004 were 26% higher than
first quarter 2003 sales of $99.5 million. This was the fifth consecutive
quarter that sales were higher than the comparable period in the prior year.
First quarter 2004 sales were the highest since the second quarter 2001, which
is when the significant decline in demand from the telecommunications and
computer market began. First quarter 2004 sales were also 19% higher than sales
in the fourth quarter 2003.

Our sales are affected by metal prices, as changes in precious metal prices
and a significant portion of changes in base metal prices (primarily copper and
nickel) are passed on to customers. Sales are also affected by foreign currency
exchange rates, as a weaker dollar will result in an increase in the translated
value of foreign currency denominated sales. Metal prices on average were higher
while the dollar was weaker on average versus the applicable currencies in the
first quarter 2004 as compared to the first quarter 2003. We estimate that these
two factors combined accounted for approximately $6.4 million of the $26.4
million increase in sales.

International sales, including direct exports from the United States as
well as sales from foreign operations, were $41.3 million, or 32.9% of sales in
the first quarter 2004 and $29.7 million, or 29.9% of sales, in the first
quarter 2003. International sales grew 39% in the first quarter 2004 over the
first quarter 2003 while domestic sales grew 21%.

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The majority of the sales growth was fueled by higher demand from the
telecommunications and computer market, the automotive market (particularly in
Europe), the optical media market and defense applications.

Sales order entry rates remained strong throughout the first quarter 2004
and the total orders received exceeded the orders shipped during the quarter by
approximately 9%.

The gross margin was $29.6 million, or 24% of sales, in the first quarter
2004, and $17.1 million, or 17% of sales, in the first quarter 2003, as the
gross margin improved $12.5 million on a $26.4 million increase in sales. The
contribution margin on the higher sales volumes accounted for approximately $8.3
million of the improvement in margins. Manufacturing efficiencies have allowed
various operations to increase their output without a proportional increase in
direct manufacturing costs (i.e., labor, supplies, maintenance and utilities),
thereby improving margins. Higher base metal prices, particularly copper and
nickel, could not be passed through to customers in all cases due to price
contracts, pricing practices in the international markets and/or competitive
pressures, reducing first quarter 2004 margins by approximately $2.1 million as
compared to the first quarter 2003. This negative impact on margins was largely
offset by the favorable impact from the translation of foreign currency
denominated sales. Manufacturing overhead costs and inventory provisions were
$0.3 million lower in the first quarter 2004 as compared to the first quarter
2003.

Selling, general and administrative expenses (SG&A) were $19.0 million, or
15% of sales, in the first quarter 2004 compared to $17.3 million, or 17% of
sales, in the first quarter 2003. Incentive compensation expense accounted for
approximately sixty percent of this increase as the expense was higher in 2004
due to our significantly improved profitability. The currency impact on the
translation of the foreign subsidiaries' expenses was an unfavorable $0.3
million. Other expenses increased slightly in order to support the higher sales
volumes.

Research and development expenses (R&D) were $1.3 million in the first
quarter 2004, slightly above the $1.1 million expense in the first quarter 2003.
R&D expense was 1% of sales in both periods. Our R&D efforts remain closely
aligned with our marketing and manufacturing operations to develop new products
and improved processes.

Net-other expense was $3.2 million in the first quarter 2004 compared to
$0.7 million in the first quarter 2003. Three main factors contributed to this
change in expense levels. Exchange losses were $1.2 million higher in the
current year due to the weaker dollar as compared to the yen, euro and pound
sterling. The unrealized loss on the valuation of the directors' deferred
compensation plan was $0.7 million higher as a result of the increase in our
stock price in the first quarter 2004. We also recorded an unrealized loss of
$0.5 million on the fair value of an interest rate swap contract that does not
qualify for hedge accounting; the unrealized loss was caused by a decline in
long-term interest rates during the first quarter 2004. Net-other also includes
metal financing fees, bad debt expense, gains and losses on the disposal of
fixed assets, amortization of intangible assets, cash discounts and other
non-operating items.

We earned an operating profit of $6.1 million in the first quarter 2004, an
$8.1 million improvement over the $2.0 million operating loss in the first
quarter 2003. The improvement resulted from the margin earned on the higher
sales and increased manufacturing efficiencies offset in part by higher
expenses.

Interest expense was $2.2 million in the first quarter 2004 versus $0.8
million in the first quarter 2003. The increased expense was mainly due to the
higher level of outstanding debt. Balance sheet debt increased as a result of
the purchase of previously leased assets as part of the December 2003
refinancing and due to changes in working capital. Interest expense was also
higher due to a $0.2 million increase in the amortization of deferred financing
costs.

The income before income taxes was $3.9 million in the first quarter 2004
versus a loss before income taxes of $2.8 million in the first quarter 2003, a
$6.7 million improvement.

A tax provision or benefit was not applied against the income or loss
before income taxes in the first quarter 2004 and the first quarter 2003 for
certain domestic and foreign taxes as a result of the deferred tax valuation
allowance recorded in previous periods in accordance with SFAS 109, "Accounting
for Income

8

Taxes", due to the uncertainty regarding full utilization of the deferred income
tax assets. The valuation allowance was reduced, offsetting a portion of the net
tax expense, in the first quarter 2004 while the valuation allowance was
increased in the first quarter 2003 offsetting a net tax benefit in that period.
The $0.1 million of expense in the first quarter 2004 and the $0.2 million of
expense in the first quarter 2003 represent taxes from various state and local
jurisdictions and foreign taxes from Japan and Singapore only.

Net income was $3.8 million in the first quarter 2004, an improvement of
$6.8 million over the net loss generated in the first quarter 2003. Diluted
earnings per share were $0.22 in the first quarter 2004 and a loss of $0.18 in
the first quarter 2003.

We aggregate our businesses into two reportable segments -- the Metal
Systems Group and the Microelectronics Group (MEG). Our mining and extraction
operations, as managed by Brush Resources Inc., a wholly owned subsidiary, and
various corporate and administrative functions and their related expenses, are
not part of either group and are included in the "All Other" column in the
segment reporting details in Note D to the consolidated financial statements.
The operating loss within All Other increased in the first quarter 2004 over the
first quarter 2003 primarily due to the unrealized losses on the directors'
compensation plan and the interest rate swap as previously described.

METAL SYSTEMS GROUP

The Metal Systems Group, the larger of the Company's two reportable
segments, consists of Alloy Products, Technical Materials, Inc. (TMI) and
Beryllium Products. The group's sales and earnings significantly improved in the
first quarter 2004 over the first quarter 2003. The following chart summarizes
sales by business unit within the Metal Systems Group:

Alloy Products manufactures two main product families. Strip products
include precision strip and thin diameter rod and wire copper and nickel
beryllium alloys sold into the telecommunications and computer, automotive and
appliance markets. Major applications for strip products include connectors,
contacts, switches, relays and shielding. Bulk products are copper and
nickel-based alloys manufactured in rod, tube, plate, bar and other customized
forms that are sold into the industrial component, plastic tooling, undersea
telecommunications and heavy equipment markets. The majority of bulk products
also contain beryllium. Applications for bulk products include plastic mold
tooling, bushings, bearings and welding rods.

Sales by Alloy Products of $52.5 million in the first quarter 2004 were
approximately 30% higher than the year ago period. Strip volumes grew 42% while
bulk volumes grew 12% in the first quarter 2004 over the first quarter 2003. The
majority of this improvement was due to growth in the underlying markets that
Alloy Products serves, primarily the telecommunications and computer market.
Demand from the automotive market for strip products, particularly in Europe,
was stronger in the first quarter 2004 as well. Sales into the industrial
component market grew in the current quarter. New products and applications also
contributed to the sales growth, including sales of ToughMet(R), a
non-beryllium-based alloy system for heavy equipment applications. Demand from
the plastic tooling market remained soft, as were sales into the undersea
telecommunications market, although customer inquiries and other market research
indicate that shipments into this market may increase later in the year.
International sales accounted for the majority of the total growth in Alloy
Products' sales in the first quarter 2004.

9

TMI manufactures specialty strip products, including clad inlay and overlay
metals, precious and base metal electroplated systems, electron beam welded
systems, contour profiled systems and solder coated systems. Applications for
TMI products include connectors, contacts and semiconductors. TMI's sales of
$13.8 million in the first quarter 2004 were 15% higher than in the first
quarter 2003. The increase in TMI's sales was caused primarily by improved
demand from the telecommunications and computer market while sales into the
automotive market were relatively flat. TMI also continued to develop
applications in new markets, including energy (i.e., fuel cells), which offer
additional growth opportunities.

Beryllium Products manufactures pure beryllium and beryllium aluminum
alloys in rod, tube, sheet and a variety of customized forms. These materials
have high stiffness and low density and tend to be premium priced due to this
unique combination of properties. Sales by Beryllium Products were $9.7 million
in the first quarter 2004, a 10% increase over the year ago period. The majority
of the increase was due to the first shipments under the material supply
contract for the James Webb Space Telescope program. Shipments for defense
applications, the largest market for Beryllium Products, remained strong in the
first quarter 2004. Sales into the electronics market for acoustic components
and medical market for x-ray equipment components also contributed to the growth
in the first quarter 2004 while automotive sales were down slightly. Shipments
from the Fremont, California facility, the smaller of the two Beryllium Products
manufacturing facilities, established a record high in the first quarter 2004.

The gross margin on Metal System Group sales was $19.7 million (26% of
sales) in the first quarter 2004, a $9.9 million improvement over the gross
margin of $9.8 million (16% of sales) in the first quarter 2003. The higher
sales volume generated an additional $5.0 million in contribution margin.
Margins also increased as a result of improved manufacturing efficiencies at our
Elmore, Ohio, Reading, Pennsylvania and Lincoln, Rhode Island facilities, while
the change in product mix was slightly favorable (i.e., sales of higher margin
generating products grew more than the lower margin products). The previously
discussed impact of base metal prices on margins was largely offset by the
foreign currency translation benefit. The purchase of previously leased assets
as part of the December 2003 refinancing reduced manufacturing overhead in the
first quarter 2004 as compared to the first quarter 2003 by approximately $1.6
million, as the depreciation expense on the owned assets was less than the prior
lease expense. Other manufacturing overhead expenses and inventory valuation
adjustments were $0.5 million higher in the first quarter 2004 than in the first
quarter 2003, mainly in manpower costs at the Elmore plant.

The Metal Systems Group's SG&A, R&D and Other-net expenses totaled $16.6
million in the first quarter 2004 and $13.2 million in the first quarter 2003.
As a percent of group sales, expenses were unchanged at 22% in each period. An
increase in currency exchange losses, the unfavorable translation impact on the
foreign subsidiaries' expenses and an increase in incentive compensation expense
were main causes of the higher expense level in the first quarter 2004. Selling
and marketing costs were also higher in the first quarter 2004 than the first
quarter 2003.

Operating profit for the Metal Systems Group was $3.2 million in the first
quarter 2004, an improvement of $6.6 million over the $3.4 million loss
generated in the first quarter 2003. The improvement resulted from the increased
margins generated by the higher sales, manufacturing efficiencies and lower
manufacturing overhead costs offset in part by higher expenses. Each unit
improved its profitability and TMI generated a profit for the ninth consecutive
quarter. The first quarter 2004 operating profit was 4% of group sales.

MICROELECTRONICS GROUP

10

The MEG consists of Williams Advanced Materials Inc. (WAM) and Electronic
Products. The following chart summarizes business unit sales within the MEG:

WAM manufactures precious, non-precious and specialty metal products,
including vapor deposition targets, frame lid assemblies, clad and precious
metal preforms, high temperature braze materials and ultra-fine wire. The cost
of the precious metal sold by WAM is passed through to the customer and WAM
generates its margin on its fabrication efforts and not on the particular metal
sold. Metal prices were higher in the first quarter 2004 than in the first
quarter 2003, continuing the trend from last year, thereby increasing sales
without a proportional flow through to margins. The growth in the underlying
volumes was less than the 38% growth in sales.

Increased sales of vapor deposition targets accounted for the majority of
this growth as demand from the optical media, performance film and the wireless
segment of the microelectronics markets remained strong in the first quarter
2004. Frame lid assembly volumes also increased in the first quarter 2004 over
the first quarter 2003 from sales into various segments of the microelectronics
market. Sales for giant magnetic resistive thin film applications within the
optical media market contributed to the growth in 2004 as well. WAM continued to
develop products for new semiconductor applications that offer growth potential.
WAM is also developing new applications in the defense and medical equipment
markets.

Electronic Products consists of Brush Ceramic Products Inc. and Zentrix
Technologies Inc., two wholly owned subsidiaries. These operations produce
beryllia ceramics, electronic packages and circuitry for sale into the
telecommunications and computer, medical, electronics, automotive and defense
markets. Sales from Electronic Products were $7.8 million in the first quarter
2004, unchanged from the first quarter 2003. Sales of electronic packages
increased in the current year due to improved demand from the telecommunications
and computer market. Circuitry sales declined, however, while beryllia ceramics
sales were relatively unchanged.

The gross margin on MEG sales was $10.9 million in the first quarter 2004
versus $7.4 million in the first quarter 2003, a $3.5 million improvement. As a
percent of sales, the margin also improved from 19% in the first quarter 2003 to
22% in the first quarter 2004. The contribution margin on the higher sales
volumes accounted for approximately $2.7 million of the increased margin.
Manufacturing efficiencies and the change in product mix generated an additional
$0.8 million of margin. Manufacturing overhead costs were slightly higher in the
first quarter 2004 as compared to the first quarter 2003.

SG&A, R&D and Other-net expenses totaled $5.4 million in the first quarter
2004 and $4.9 million in the first quarter 2003. Expenses were 11% of sales in
the first quarter 2004 and 13% of sales in the first quarter 2003. Increased
legal, workers' compensation and other administrative costs within WAM coupled
with the increased incentive expense accounted for the majority of the increase
in expenses.

Operating profit from the MEG was $5.5 million (11% of group sales) in the
first quarter 2004 and $2.5 million (7% of group sales) in the first quarter
2003.

LEGAL

One of the our subsidiaries, Brush Wellman Inc. (BWI), is a defendant in
proceedings in various state and federal courts brought by plaintiffs alleging
that they have contracted chronic beryllium disease or other lung conditions as
a result of exposure to beryllium. Plaintiffs in beryllium cases seek recovery
under theories of intentional tort and various other legal theories and seek
compensatory and punitive damages, in many cases of an unspecified sum. Spouses,
if any, claim loss of consortium.

11

The following table summarizes the activity associated with beryllium
cases. Settlement payment and dismissal for a single case may not occur in the
same period.

Additional beryllium claims may arise. We believe that we have substantial
defenses in these cases and intend to contest the suits vigorously. Employee
cases, in which plaintiffs have a high burden of proof, have historically
involved relatively small losses to us. Third party plaintiffs (typically
employees of customers or contractors) face a lower burden of proof than do
employees or former employees, but these cases are generally covered by varying
levels of insurance. A reserve was recorded for beryllium litigation of $2.2
million at April 2, 2004 and $2.9 million at December 31, 2003. A receivable was
recorded of $2.7 million at April 2, 2004 and $3.2 million at December 31, 2003
from our insurance carriers as recoveries for insured claims.

Although it is not possible to predict the outcome of pending litigation,
we provide for costs related to these matters when a loss is probable and the
amount is reasonably estimable. Litigation is subject to many uncertainties, and
it is possible that some of these actions could be decided unfavorably in
amounts exceeding our reserves. An unfavorable outcome or settlement of a
pending beryllium case or additional adverse media coverage could encourage the
commencement of additional similar litigation. We are unable to estimate its
potential exposure to unasserted claims.

While we are unable to predict the outcome of the current or future
beryllium proceedings, based upon currently known facts and assuming
collectibility of insurance, we do not believe that resolution of these
proceedings will have a material adverse effect on our financial condition or
cash flow. However, our results of operations could be materially affected by
unfavorable results in one or more of these cases. As of April 2, 2004, three
purported class actions were pending.

Standards for exposure to beryllium are under review by the United States
Occupational Safety and Health Administration, and by private standard-setting
organizations. One result of these reviews might be more stringent worker safety
standards. More stringent standards, as well as other factors such as the
adoption of beryllium disease compensation programs and publicity related to
these reviews may also affect buying decisions by the users of
beryllium-containing products. If the standards are made more stringent or our
customers decide to reduce their use of beryllium-containing products, our
operating results, liquidity and capital resources could be materially adversely
affected. The extent of the adverse effect would depend on the nature and extent
of the changes to the standards, the cost and ability to meet the new standards,
the extent of any reduction in customer use and other factors that cannot be
estimated.

FINANCIAL POSITION

Net cash used in operating activities was $9.1 million in the first quarter
2004 as increases in working capital items, primarily accounts receivable and
inventory, more than offset net income and the benefits of depreciation and
amortization. Cash balances stood at $5.3 million at the end of the first
quarter 2004, an increase of $0.2 million from the prior year end.

Accounts receivable increased $12.0 million during the first quarter 2004,
the majority of which resulted from the higher sales. Sales in the first quarter
2004 were $20.3 million greater than sales in the fourth quarter 2003. The day
sales outstanding (DSO), a measure of the average time to collect receivables,
was 48 days at

12

the end of the quarter compared to 47 days at the end of 2003. The slower DSO
served to increase the outstanding receivable balance by approximately $1.4
million.

Inventories increased by $7.7 million, or 9%, during the first quarter 2004
in order to support the higher business levels. Despite the increase in
inventory value, the inventory turnover ratio, a measure of how quickly
inventory is sold on average, improved to 3.2 times from 3.0 times as of the end
of last year. The majority of the increase in the FIFO inventory value was in
the Metal Systems Group, and Alloy Products in particular, while the MEG
inventories increased more modestly. A portion of the inventory increase was
also due to the higher metal prices.

Capital expenditures for property, plant and equipment and mine development
totaled $1.4 million in the first quarter 2004 as spending remained limited to
small, isolated projects. The Metal Systems Group accounted for approximately
58% of the spending.

The accounts payable balance increased $4.3 million in the first quarter
due to the higher business levels. Other liabilities and accrued items declined
$3.2 million as a result of the payment in the first quarter 2004 of the
incentive compensation earned by employees in 2003, offset in part by accruals
for the 2004 incentive compensation plans and increases in other miscellaneous
accruals.

The retirement and post-retirement obligation balance was $49.8 million at
the end of the first quarter 2004, an increase of $0.4 million since December
31, 2003. The liability for the domestic defined benefit pension plan increased
$0.7 million in the quarter, as the annual expense under this plan is estimated
at $2.7 million, or $1.0 million higher than in fiscal 2003.

Total balance sheet debt of $108.1 million at the end of the first quarter
2004 was $9.0 million higher than at December 31, 2003, with the increase used
to finance the working capital growth. Short-term debt was $23.8 million at the
end of the quarter compared to $13.4 million at the end of last year, while
long-term debt stood at $84.3 million at quarter end and $85.7 million at
year-end 2003. The majority of the change in long-term debt was due to a
reclassification to short-term debt as additional debt became current. We were
in compliance with all of our debt covenants as of the end of the first quarter
2004.

We received $1.9 million for the exercise of approximately 124,000 stock
options during the first quarter 2004 as option exercise activity increased with
the rising price for our stock.

The balance outstanding under the off-balance sheet precious metal
consigned inventory arrangements increased $5.3 million during the first quarter
2004. Approximately 35% of this increase was due to higher metal prices. The
increased quantity of metal on hand was driven by higher production requirements
in order to satisfy the current demand.

There have been no substantive changes in the summary of contractual
payments under long-term debt agreements, operating leases and material purchase
commitments as of April 2, 2004 from the year-end 2003 totals as disclosed on
page 24 of our annual report to shareholders for the period ended December 31,
2003.

Net cash used in operations was $0.2 million in the first quarter 2003 as
the net loss of $3.0 million and an $11.5 million increase in accounts
receivable more than offset the favorable impact of other working capital items.
Total inventories increased $0.5 million in the first quarter 2003. The Metal
Systems Group's inventory declined as a result of the continuing efforts of
Alloy Products to reduce its inventory balance and improve its inventory
utilization. The MEG inventories increased while Brush Resources inventories
increased due to timing differences between the mining of ore and shipments out.
Capital expenditures were $1.7 million in the first quarter 2003. Accounts
payable and other liabilities and accrued items increased $7.6 million due to
changes in business levels and timing differences of disbursements. Balance
sheet debt totaled $64.4 million at the end of the first quarter 2003, an
increase of $0.9 million during that quarter. Balance sheet debt was higher in
the first quarter 2004 than in the first quarter 2003 as a result of the
December 2003 refinancing that included the purchase of assets held under lease
for $51.8 million and the termination of the related off-balance sheet lease
obligation. The cash balance was $3.4 million at the end of the first quarter
2003, a decline of $1.0 million during that period.

13

Funds from operations and the available borrowing capacity are believed to
be adequate to support operating requirements, capital expenditures, projected
pension plan contributions and environmental remediation projects. Despite the
income generated in the first quarter 2004, our ability to raise additional debt
financing above the established credit lines may be limited due to the losses
generated in the previous three years. However, we had approximately $20.0
million of available borrowing capacity under the existing lines of credit as of
April 2, 2004.

We filed an S-3 Registration Statement with the Securities and Exchange
Commission (SEC) on April 2, 2004 for the offering of 1.7 million shares. In
addition, as part of the offering, selling shareholders will be selling 115,000
of our common shares that were issued to them upon the exercise of warrants that
were originally issued in connection with the December 2003 refinancing. The
exercise of the warrants did not materially change our total shareholders'
equity. We anticipate using the net proceeds from the offering to retire a
portion of the outstanding debt. Portions of the proceeds may also be used for
working capital and general corporate purposes, including capital expenditures
and acquisitions of businesses, assets or investments. Pending final use, the
proceeds may be temporarily invested in short-term, investment grade interest
bearing securities or U.S. government obligations. The successful completion of
the offering would reduce our leverage and improve our debt to equity ratio. As
a result of the repayment of debt with the net proceeds, available unused debt
capacity would increase and future mandatory debt repayments would decline. Use
of the proceeds to reduce debt also would result in a reduction to interest
expense in future periods.

CRITICAL ACCOUNTING POLICIES

DEFERRED TAXES: A valuation allowance was initially recorded against
domestic and certain foreign deferred tax assets in the fourth quarter 2002 as a
result of our then recent cumulative losses. The deferred tax benefits related
to losses incurred in the first quarter 2003 were offset by an increase in the
valuation allowance. However, in the first quarter 2004, the deferred tax
valuation allowance was reduced to offset the domestic federal and certain
foreign tax expense that would have been recorded against pre-tax income. In
subsequent periods when we generate pre-tax income, a federal tax expense will
not be recorded to the extent that the remaining valuation allowance can be used
to offset that expense. Once a consistent pattern of pre-tax income is
established or other events occur that indicate that the deferred tax assets
will be realized, additional portions or all of the remaining valuation
allowance will be reversed back to income. Should we generate pre-tax losses in
subsequent periods, a tax benefit will not be recorded and the valuation
allowance will be increased. Despite the valuation allowance, we retain the
ability to utilize the benefits of the domestic loss carry-forwards and other
deferred tax assets on future tax returns.

PENSIONS. The United States Congress recently passed legislation designed
to establish a new interest rate assumption for calculation of required pension
plan contributions. While we have not yet fully evaluated the impact of this
legislation on our defined pension benefit plan, it is possible that our
contribution to the plan in 2004 may be lower than the previously estimated $1.7
million as disclosed in our annual report to shareholders for the period ended
December 31, 2003.

For additional information regarding our critical accounting policies,
please refer to pages 25 to 27 of our annual report to shareholders for the
period ended December 31, 2003.

MARKET RISK DISCLOSURES

The Company is exposed to movements in base metal prices, primarily copper.
Portions of this exposure are covered by passing the change in prices through to
our customers. We currently do not have any copper swaps or other derivative
financial instruments in place to hedge the remaining exposure due to credit
constraints. Therefore, margins will continue to be adversely affected to the
extent that prices for copper remain high and we cannot pass through this higher
cost in the form of price increases to our customers.

For additional information regarding market risks, please refer to pages 27
and 28 of our annual report to shareholders for the period ended December 31,
2003.

14

OUTLOOK

Sales trends remained strong in the early portion of the second quarter
2004. Key markets served, including telecommunications and computer, have
improved while our application development efforts are also contributing to the
sales growth potential. We also continue to press forward with efforts to
further develop the international markets. As a result, we estimate that sales
in the second quarter 2004 may be 15 to 25% higher than sales in the second
quarter 2003.

Operational efficiencies and manufacturing improvements developed over the
last several years are combining to increase margins and our facilities
generally have sufficient capacity to satisfy the current demand.

Our business plan currently calls for both receivables and inventory levels
to stabilize in the coming quarters. Capital expenditure levels may start to
rise in subsequent quarters, but we do not believe there will be a significant
increase in the near term. We believe cash flows from operations should be
sufficient to start reducing debt accordingly in subsequent periods. The
successful completion of the pending new share offering would also improve our
liquidity and financial flexibility.

FORWARD-LOOKING STATEMENTS

Portions of the narrative set forth in this document that are not
statements of historical or current facts are forward-looking statements. Our
actual future performance may materially differ from that contemplated by the
forward-looking statements as a result of a variety of factors. These factors
include, in addition to those mentioned elsewhere herein:

- The condition of the markets which we serve, whether defined
geographically or by segment, with the major market segments being
telecommunications and computer, optical media, automotive electronics,
industrial components, aerospace and defense, and appliance;

- Actual sales, operating rates and margins in the second quarter 2004 and
for the full year of 2004;

- Changes in product mix and the financial condition of particular
customers;

- Our success in implementing our strategic plans and the timely and
successful completion of pending capital expansion projects;

- Other factors, including interest rates, tax rates, exchange rates,
pension costs, energy costs, raw material costs, and the cost and
availability of insurance;

- Changes in government regulatory requirements and the enactment of new
legislation that impacts our obligations; and,

- The conclusion of pending litigation matters in accordance with our
expectation that there will be no material adverse effects.

Additional risk factors that may affect our results are identified under
the caption "Risk Factors" in the S-3 Registration Statement filed with the
Securities and Exchange Commission on April 2, 2004.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

For information regarding the Company's market risks, please refer to pages
27 and 28 of the Company's annual report to shareholders for the period ended
December 31, 2003.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, the Company carried out
an evaluation, under the supervision and with the participation of the Company's
management, including the Company's President, Chairman and Chief Executive
Officer, and Vice President Finance and Chief Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures pursuant to

15

Exchange Act Rule 13a-15(b). Based upon that evaluation, the Company's
management has concluded that the Company's disclosure controls and procedures
are effective. There have been no changes in the Company's internal control over
financial reporting identified in connection with the evaluation required by
Exchange Act Rule 13a-15(d) that occurred during the Company's last fiscal
quarter that have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.

16

PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company and its subsidiaries are subject, from time to time, to a
variety of civil and administrative proceedings arising out of their normal
operations, including, without limitation, product liability claims, health,
safety and environmental claims and employment-related actions. Among such
proceedings are the cases described below.

BERYLLIUM CLAIMS

There are claims pending in various state and federal courts against Brush
Wellman, one of the Company's subsidiaries by third party individuals (typically
employees of customers or of independent contractors) alleging that they
contracted, or have been placed at risk of contracting, chronic beryllium
disease or other lung conditions as a result of exposure to beryllium.
Plaintiffs in beryllium cases seek recovery under theories of intentional tort
and various other legal theories and seek compensatory and punitive damages, in
many cases of an unspecified sum. Spouses, if any, claim loss of consortium.

During the first quarter of 2004, the number of beryllium cases changed
from 15 (involving 33 plaintiffs), as of December 31, 2003 to 14 cases
(involving 34 plaintiffs) as of April 2, 2004. During the first quarter, one
third party case (involving one plaintiff) was filed. One purported class action
(involving eight named plaintiffs) was filed. One employee case (involving one
plaintiff) was settled and dismissed. Two third party cases (involving seven
plaintiffs) were voluntarily dismissed by the plaintiffs.

The 14 pending beryllium cases fall into two categories: 11 cases involving
third-party individual plaintiffs, with 11 individuals (and five spouses who
have filed claims as part of their spouse's case); and three purported class
actions, involving 18 individuals, as discussed more fully below. Claims brought
by third-party plaintiffs (typically employees of our customers or contractors)
are generally covered by varying levels of insurance.

In the first purported class action, John Wilson, et al. v. Brush Wellman
Inc., originally filed in Court of Common Pleas, Cuyahoga County, Ohio, case
number 00-401890-CV, on February 14, 2000. The named plaintiffs are John Wilson,
Daniel A. Martin, Jospeh A. Szenderski, Larry Strang, Hubert Mays, Michael
Fincher, Reginald Hohenberger. Mr. Szenderski was voluntarily dismissed by the
court on September 27, 2000. Mr. Szenderski filed a separate claim, which is now
settled and dismissed. The only defendant is Brush Wellman. The trial court
denied class certification on February 12, 2002, and the Court of Appeals, Ohio
8th District, remanded on October 17, 2002. The case is now before the Ohio
Supreme Court, case number 03-0048. The plaintiffs purport to sue on behalf of a
class of workers who belonged to unions in the Northwestern Ohio Building
Construction Trades Council who worked in Brush Wellman's Elmore plant from
1953-1999. They have brought claims for negligence, strict liability, product
liability and ultrahazardous activities. The plaintiffs are seeking that Brush
Wellman pay for a "reasonable medical surveillance and screening program for
Plaintiffs and class members; punitive damages in an amount to be determined,
interest, costs, attorneys fees."

In the second purported class action, Manuel Marin, et al. v. Brush Wellman
Inc., filed in Superior Court of California, Los Angeles County, case number
BC299055, on July 15, 2003. The named plaintiffs are Manuel Marin, Lisa Marin,
Garfield Perry and Susan Perry. The defendants are Brush Wellman, Appanaitis
Enterprises, Inc. and Doe Defendants 1 through 100. The plaintiffs allege that
they have been sensitized to beryllium while employed at The Boeing Company.
Plaintiffs seek "general damages in a sum in excess of the minimum
jurisdictional amount, medical expenses and incidental expenses, loss of
earnings, household services, fear of development of chronic beryllium disease,
and other beryllium-related medical conditions, increased risk of future injury
and disease, diminished quality and enjoyment of life, loss of years of life,
consequential damages for other injuries, pre and post judgment interest,
plaintiffs' costs of suit, such other relief as Court deems, loss of consortium,
punitive damages." Mr. Marin and Mr. Perry represent current and past employees
of Boeing in California; and Ms. Marin and Ms. Perry are their spouses.

17

In the third purported class action, Neal Parker, et al. v. Brush Wellman
Inc., filed in Superior Court of Fulton County, State of Georgia, case number
2004CV80827 on January 29, 2004. The case was removed to U.S. District Court for
Northern District of Georgia, case number 04-CV-606, on March 4, 2004. The named
plaintiffs are Neal Parker, Wilbert Carlton, Stephen King, Ray Burns, Deborah
Watkins, Leonard Ponder, Barbara King and Patricia Burns. The defendants are
Brush Wellman; Schmiede Machine and Tool Corporation; Thyssenkrupp Materials NA
Inc., d/b/a Copper and Brass Sales; Axsys Technologies, Inc.; Alcoa, Inc.;
McCann Aerospace Machining Corporation; Cobb Tool, Inc and Lockheed Martin
Corporation. Mssrs. Parker, Carlton, King and Burns and Ms. Watkins are current
employees of Lockheed. Mr. Ponder is a retired employee, and Ms. King and Ms.
Burns are family members. The plaintiffs have brought claims for negligence,
strict liability and fraudulent concealment. The plaintiffs seek a permanent
injunction requiring the defendants to fund a court-supervised medical
monitoring program, attorneys' fees and punitive damages.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

11 Statement re computation of per share earnings (filed as
Exhibit 11 to Part I of this report).
31.1 Rule 13a-14(a) Certification
31.2 Rule 13a-14(a) Certification
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes Oxley Act of 2002
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes Oxley Act of 2002

(b) Reports on Form 8-K

In a report on Form 8-K filed January 28, 2004, Brush Engineered
Materials Inc. issued a press release, reporting on its earnings for the
fourth quarter of 2004. The press release, with summary financial
information, was furnished pursuant to Item 12.

In a report on Form 8-K filed March 12, 2004, Brush Engineered Materials
Inc. issued a press release announcing that it had updated its website
with current charters for the Audit Committee, the Organization and
Compensation Committee, the Governance Committee and the Retirement Plan
Review Committee. At that time, the Company also posted its Policy
Statement of Significant Corporate Governance Issues and its Code of
Ethics Policy on its website. In addition, the "Current Investor Update"
on the Company's website was updated to include figures through the
fourth quarter of 2003.

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.

BRUSH ENGINEERED MATERIALS INC.
Dated: May 3, 2004

/s/ John D. Grampa
---------------------------------------------
John D. Grampa
Vice President Finance
and Chief Financial Officer