Materion Corp (MTRN) 2017 Q2 法說會逐字稿

Greetings, and welcome to the Materion Corporation Second Quarter 2017 Earnings Conference Call. (Operator Instructions) It is now my pleasure to introduce Steve Shamrock. Thank you. You may begin.

Good morning. This is Steve Shamrock, Vice President, Corporate Controller and Investor Relations. With me today is Jugal Vijayvargiya, President and Chief Executive Officer; and Joe Kelley, Vice President of Finance and Chief Financial Officer.

Our format for today's conference call is as follows. Jugal Vijayvargiya will provide opening comments on the quarter and update on key strategic initiatives and the outlook for the remainder of the year. Following Jugal, Joe Kelley will review detailed financial results for the quarter, and then we will open up the call for questions.

Before we begin, let me remind investors that any forward-looking statements made in this announcement or contained in today's press release, 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 we issued this morning.

Additionally, comments with regard to operating profit, net income and earnings per share reflect the adjusted GAAP numbers shown in Attachment #5 in this morning's press release. The adjustments are made in the current quarter for comparative purposes and remove CEO transition costs, merger and acquisition costs and nonrecurring cost-reduction actions.

And now I'll turn it over to Jugal for his comments.

Thank you, Steve, and a very warm welcome to everyone on the call. I'm pleased to report second quarter results of $0.42 per share, up 35% year-over-year and up 45% from first quarter this year.

Looking at the top line. Value-added sales in the quarter set a record at $176 million. That's a 14% increase year-over-year. This marks the fourth consecutive quarter of year-over-year sales growth.

New product sales growth set a benchmark, accounting for nearly $27 million or 15% of value-added sales for the quarter. This is an increase of 52% over the same period last year. ToughMet sales reached record levels, providing technical solutions for customers in the aerospace, energy and consumer electronics markets.

Overall growth for the quarter was broad-based with year-over-year and sequential increases in 7 of our 10 largest markets.

In addition, we delivered double-digit year-over-year growth in the consumer electronics and industrial components markets. Higher customer demand for existing products and the addition of new revenues from the Heraeus target materials acquisition also contributed to increased sales.

Record sales for the quarter, combined with product mix improvement, led to significant increase in profitability. Operating profit for the quarter came in at $11.7 million, an increase of 44% year-over-year and 52% sequentially.

Now let me take a few minutes to provide status of 2 important initiatives underway. These initiatives contributed to strong results for the quarter and are key to maintaining the momentum for the rest of the year. Performance Alloys and Composites profitability improvement plan continues to gain traction, delivering $6 million improvement in adjusted operating profit year-over-year. Value-added sales in this business improved 11% year-over-year. Key actions underway as part of the turnaround plan are: implementation of value-based pricing; optimization of the cost structure, including exiting of the Japan service center; and executing a long-term supply agreement of beryllium hydroxide and resumption of shipments to a long-standing customer. These actions, combined with strong growth in new products, resulted in much improved financial performance for the segment.

Second initiative I would like to comment on is the status of the Heraeus acquisition. Over the last 4 months, we've made substantial progress integrating and positioning for achievement of targeted synergies. As part of this, consolidation of the Chandler, Arizona site into the Albuquerque operation has been completed. This adds larger glass target manufacturing and an enhanced suite of materials for the growing architectural and automotive glass markets.

In Taiwan, consolidation of 2 facilities has been completed to serve joint customers in Asia.

In Alzenau, Germany, construction of a new state-of-the-art target manufacturing facility has started. This will be the headquarters for Europe target business. And most importantly, we've gained a team of colleagues committed to smooth integration and driving business growth.

Finally, let me provide a quick update on my onboarding. I have substantially completed a review of our operations around the globe, meeting customers and a large portion of our workforce. I am more encouraged today than ever about the potential to leverage our many great assets and grow Materion. We are implementing our core pillar strategy of operational excellence, commercial excellence, innovation and inorganic growth. This, combined with a disciplined performance-based culture, will capitalize on Materion's existing strengths and deliver increased shareholder value.

The strong second quarter results are an important step as we embark on consistently delivering profitable growth. I'm pleased with our performance in the first half of 2017 and expect the momentum to continue into the second half. Accordingly, we are affirming the full year guidance.

Now I will turn the microphone over to Joe.

Thank you, Jugal, and good morning to everyone joining us on the call today. During my comments, I will cover a review of our second quarter 2017 financial highlights; profitability by segment; make some brief comments on the balance sheet, cash flow and modeling assumptions; and finally, cover the earnings outlook for 2017. Following my remarks, the line will open for questions.

We are pleased to report strong second quarter results, which exceeded the earnings guidance provided and represented the second consecutive quarter with year-over-year growth in both top line value-added sales and adjusted operating profit. Also, it's important to note that second quarter 2017 value-added sales was the highest levels since we began reporting this metric in 2012. Second quarter 2017 value-added sales of $176.1 million increased 18% sequentially versus the first quarter of 2017 and 14% versus the second quarter of 2016.

Now if you recall, the Heraeus acquisition closed late in the first quarter of 2017. The Heraeus acquisition accounted for $10.6 million of value-added sales in the second quarter of 2017, while the base business grew value-added sales 8% year-over-year.

We experienced strong demand in most key end markets, including our 2 largest end markets of consumer electronics and industrial components. New product sales in the second quarter of 2017 increased to $26.6 million and represented 15% of second quarter 2017 value-added sales. This also is a record high since we began tracking the metric.

During the quarter, we recorded $5.3 million of value-added sales for shipments of raw material beryllium hydroxide. It is good to see this portion of our business resume after being absent for 4 of the last 5 quarters.

The value-added sales growth and profitability mix, combined with productivity enhancements, improved gross profit margin as a percent of value-added sales to 31%, an approximate 160 basis point increase over the prior year gross margin percentage.

Selling, general and administrative expenses increased to $38.1 million, $5.7 million over the prior year second quarter of $32.4 million, due to increased costs associated with the former Heraeus target business and variable expenses directly related to growth and improved financial performance.

Operating profit totaled $9.7 million in the second quarter of 2017. Adjusted operating profit, excluding special items, was $11.7 million, an increase of over 44% versus both the prior year second quarter adjusted operating profit of $8.1 million and the first quarter adjusted operating profit of $7.7 million. A combination of sales growth and favorable product mix led to this increase.

Net income in the second quarter of 2017 totaled $7.3 million versus $5.5 million of net income recorded in the prior year second quarter. The effective tax rate in the second quarter was 19%, which is within the range of the forecasted full year effective tax rate.

Diluted earnings per share were $0.36 in the second quarter of 2017. Adjusted for special items, earnings per share totaled $0.42 per share in 2017 second quarter, which compares to $0.31 per share of adjusted earnings in the second quarter of 2016, a 36% improvement in earnings.

Now a review of our second quarter 2017 financial performance by business segment, starting with Advanced Materials. This segment delivered a record $62 million in value-added sales in the second quarter of 2017, a more than 30% increase over $47 million of value-added sales in the prior year second quarter and $47.3 million in the first quarter of 2017. Excluding sales related to the acquisition, value-added sales growth was a robust 9% increase year-over-year, represented the fifth consecutive quarter with year-over-year growth. New product sales and strong end market demand in the segment's 2 largest end markets of consumer electronics and industrial components drove the increase in sales.

Adjusted operating profit for the second quarter of 2017, excluding acquisition and integration cost, totaled $9 million compared to $7.3 million in the second quarter of 2016. The 23% increase in adjusted operating profit was due to a combination of increased sales volume and favorable product mix.

We remain very pleased with the performance of this business and excited about future growth potential with the recent Heraeus acquisition. As Jugal already reviewed, the integration of the Heraeus acquisition is progressing on schedule, and the business contributed favorably to the segment's profit growth in the quarter.

Turning to our Performance Alloys and Composites business. Second quarter 2017 value-added sales were $92.7 million, up 11% compared to the $83.4 million of value-added sales in the second quarter of 2016 and up 17% sequentially versus $79.2 million of value-added sales in the first quarter of 2017. The increase in value-added sales versus both periods was driven by strong demand in commercial aerospace, consumer electronics and industrial components end markets as well as the resumption of raw material beryllium hydroxide shipments.

Adjusted operating profit in the second quarter 2017, excluding special items related to the closure of the Japan service center, was $6.2 million compared to $0.2 million in the same period last year and $0.7 million in the first quarter of 2017. The increase in profitability was primarily due to sales growth, favorable product mix and improved productivity.

Although operating profit significantly improved on both a year-over-year and sequential basis to the highest level in the last 2 years, we recognize more work still needs to be done. We continue to focus on all areas of the business, including the top line and cost structure. The exit of our service center in Fukaya, Japan was completed in the second quarter of 2017, and the property is being prepared for final sale and disposition. We also continue to focus on other cost-reduction opportunities, including productivity and yield improvements.

Turning finally to our Precision Coatings business. Second quarter 2017 value-added sales were $22.6 million compared to $25.1 million of value-added sales in the second quarter of 2016. The decrease in value-added sales is due primarily to lower sales volumes into the medical end market plus softness in the lamp-based projector display market in Asia. As mentioned on previous calls, a significant customer began a product transition to a next-generation product late in the fourth quarter of 2016, which has negatively impacted value-added sales the last 3 quarters. The customer's product transition is now complete, and we are participating in the next-generation product line.

Operating profit remained flat year-over-year despite the decrease in value-added sales due to improved productivity and lower SG&A expense as a result of cost-reduction initiatives. Operating profit as a percentage of value-added sales improved both year-over-year and sequentially to 10.2%. Precision Coatings operating profit was $2.3 million for the second quarter of 2017, flat versus the second quarter of 2016 and 5% higher on a sequential basis versus the first quarter of 2017.

We made significant progress over the last several years in improving the profitability of the Precision Coatings business through manufacturing efficiencies, product mix shift and cost reduction. This segment is well positioned for profitable growth as we continue our focus on new product introductions and expanding end market applications for our thin film precision coated products.

Moving to the balance sheet and cash flow. The company ended the second quarter of 2017 with net debt position of $8.1 million compared to $16.3 million at the end of the first quarter. Materion continues to have significant available liquidity to support meaningful organic growth opportunities, further inorganic strategic growth opportunities and to consistently return capital to shareholders through a combination of dividends and share buybacks. During the second quarter of 2017, we increased our cash dividend for the fifth consecutive year. Our quarterly cash dividend now stands at $0.10 per share, a 5% increase over the previous levels.

Cash flow provided from operating activities totaled $17.1 million in the quarter and $0.3 million for the first 6 months of 2017. The decrease in year-to-date operating cash flow compared to the prior year same period is due to increased investments in working capital to support the 14% year-over-year sales growth.

And finally, key financial modeling assumptions. Cash flow from operations should run approximately $50 million to $60 million as the back half of the year typically has seasonally stronger cash flows. Capital spending should run approximately $25 million to $30 million, and mine development investment should be less than $3 million. Annual depreciation should run approximately $43 million to $45 million, and an effective tax rate of 18% to 22% should be assumed.

In terms of our earnings outlook for the remainder of 2017. We significantly improved our operating performance in the second quarter compared with our results in the first quarter, as expected. The improvement was driven by a combination of factors, including new product sales growth, favorable product mix, end market demand growth, raw material beryllium hydroxide shipments and improved cost structure and the Heraeus acquisition. We forecast these positive factors to continue for the balance of the year. As a result, we are affirming our full year earnings guidance of $1.45 to $1.60 per share, with the fourth quarter forecasted to be the strongest of the year.

This concludes our prepared remarks. We will now open the line for questions.

(Operator Instructions) Our first question comes from Edward Marshall with Sidoti & Company.

So I wanted to ask about the beryllium shipments. It looks like last time we kind of got some data on the division, it looks like sales were typically between $10 million and $15 million in a year. As I step back and I just look at the quarter itself, if we annualize that, it puts you well over $20 million for the year. Was there something specific in the quarter, catch-up, et cetera, that might have driven that number slightly higher? And what's your anticipation for the full year?

Yes. Our anticipation continues to be the $10 million to $15 million type range. And so to your point, yes, at the $5 million number in Q2, that may have been a little catch-up. As you recall, 4 of the last 5 quarters, we've been negotiating with them, and there's been no shipment. So I expect -- we speculate that Q2 shipment may then a little heavy when you look at an annual run rate of $10 million to $15 million.

Yes. As we noted in the prior communication, we've got this agreement, and it's a 5-year agreement. And as Joe indicated, we expect to have sales in that range. We're very pleased with the agreement that was reached. I think it's good for both parties and -- going forward.

Okay. And when I look at the profit driven off that slightly higher-than-normal sales run rate, what do you think the excess profit was then for -- from just the extra sales?

Yes. We don't -- as you know, we don't disclose specific profit for customers or specific products. But I would say, of the $6 million that we picked up in the PAC business, majority of the profit was not related to the shipments for that. So that's probably what I think we can share with you.

Okay, fair enough. And the intangibles, I was looking at -- and I was thinking -- i was expecting to see a much higher number. Was the value of that acquisition and the purchase price that you paid that attractive that it didn't add additional intangible assets to the balance sheet?

Yes. So we -- likewise, when you look at that and the intangible assets that we acquired with it, the intangibles and the goodwill was a very small portion of the roughly $30 million total purchase price.

Okay, got it. And you mentioned this $10.6 million in revenue that you got from Heraeus. Did you talk about the profit? Was it profitable?

Yes. It contributed favorably to our Q2 growth. So we were very pleased to see, coming out of the blocks here in Q2, the Heraeus acquisition did contribute favorably to our Q2 profits.

What was the operating profit for the business?

We have not disclosed that, and we're not going to disclose that going forward.

Okay. And finally, you talked about cash flow, and you noted -- or I'll note that it was -- it seems to be about $12 million to $15 million weaker than normal. Was there something that was timing-related in there in the first half that you'll catch up with in the second half? Or was there something else unusual?

Yes. The unusual -- just to go back to the Heraeus acquisition, the one unusual, the way the actual purchase price was paid. They did not deliver the accounts receivable. And so you'll see down in the cash flow from investing activities only $16 million to $17 million spent on the Heraeus acquisition. That's because we had to fund the -- basically the working capital up above. So I would tell you, the way that purchase price -- the cash ended up flowing, it negatively impacted our operating cash flows by about $10 million. And so that's the one difference in the 2.

Our next question comes from Phil Gibbs with KeyBanc.

Did I hear you right? That you had -- did you say at record sales with ToughMet on the quarter?

You did, you heard us right.

Okay. I was just curious on that because I don't think we've talked about ToughMet now for maybe 3 or 4 quarters since the oil crisis. Was the business a lot better from oil? Are you coming up with some new applications? What's the explanation?

Yes. I think we have a couple things: One, as you know, the oil and gas market is recovering, although from a low point, but it is recovering. And so that's helping. Also, there's sales into the aerospace market. So good sales in both markets. And new applications, multiple new applications of the product into those markets. Also, applications in consumer electronics business as well. So we're having good success. And of course, this is a key product segment for us that we want to grow.

Yes, Phil, I would just add to that. When you look at our new product sales growth, which is also a record, to $27 million in the quarter, 15% of total value-added sales. ToughMet -- new ToughMet products was the main driver of that growth. And it was not -- the majority of it was not a recovery in oil and gas and our traditional products, but more of it was new products, as Jugal mentioned, for those markets.

That's helpful. Is this coming vis-à-vis new forms as well, meaning new forms of the metal?

So there is some new tempers that we're serving in the consumer electronics space that are helping. And then I would tell you, it's bushings and bearings in the aerospace, and then it's the coupling for the oil and gas. Beyond the traditional oil and gas products, the coupling also was contributing.

Okay. Any color you could provide on the defense market in terms of sentiment or order book, what you're seeing there in the project side of things?

Yes. So the defense market, Phil, it's been a little bit weak. But I think it's all due to the -- some of the changes -- administration changes that are going on right now. We expect the market to recover as some of the things stabilize with the administration. So I would say, interim temporary weakening, but recovery as we get into the year. And that also -- go ahead.

And so what's the temporary weakening in -- I'm sorry, or in terms of the volatility.

Getting these large projects approved.

Yes.

And so as you recall, I mean, a portion of our defense business is large one-off shipments, primarily around the high beryllium -- high-purity beryllium product line. And so getting those final approvals through requires some political appointees to take place and things of that nature. Relatively typical stall at the change of an administration, whereas our normal steady-state defense business, particularly in the optics coating side, continues and continues to be strong.

Okay. And the euro now is starting to move in your favor. Is that helping the competitiveness of the business now? Or has it just been too sharp and too early to suggest? And let's say it stays between $1.15 and $1.20. Does that help you this year? Does it more or less start to help you next year as some of the hedges come on down a little bit?

Yes, you are thinking about it correct. I don't know that, that has a benefit this year in this short, quick movement, but it perhaps will next year. What hurt us -- if you go back to '15, it was when it went from $1.32 down to $1.07 and stayed there relative -- in relatively short order. That's what we suffered from in '15 and '16. So this short movement, I don't think that that's helping us in the near term. And if it continues that way, you are correct, it'll help us in future years as hedges unwind.

Our next question comes from Marco Rodriguez with Stonegate Capital.

I was wondering if maybe you could talk a little bit more on some of the drivers that you saw on sales just kind of more from a high level. Just trying to kind of understand a little bit more as far as what is driving your new product sales higher and then the product mix. Is the product mix a function of new sales becoming a bigger percentage of your revenues? Or are there some other types of items that are driving that higher?

Yes. So there are several questions in there. I would tell you, if we take it segment by segment, our PAC business and their revenue growth was largely driven by new sales and improved product mix because as we take these new sales on, we end up also pruning some of the lower-margin business. And so that's why you see the very high incremental margins in the PAC business accompanying with that growth rate. That has had one of the highest increases of -- the $9 million increase in new product sales came in our PAC business. And those are going back to the new applications I touched on, primarily around ToughMet. There also were some new beryllium ceramic product lines that contributed as well. So I would tell you there, it's a combination of new products and therefore, also some mix improvement. Where -- so when you look at our Precision Coatings business, the Medical pulled back, that has a negative impact on product mix. But we had some success in our optics Business with improved productivity and some new products there on the Phosphor Wheel that helped to offset a portion of that drop-off. And then when you go to the AM business, it wasn't as much new products there as it is industrial and consumer electronic uptick in demand. That's growth incremental to the Heraeus acquisition.

Got you. And then maybe if you could talk a little bit about the end market drivers you've kind of seen here. It seems like it was fairly broad-based, where some of your biggest end markets saw pretty good demand. Maybe you can talk a little bit about what you're hearing from your customers and the specific industries where you're seeing the most pickup from end markets.

Yes. So a couple of areas, Marco, that we see a really good pull from the end markets, consumer side and industrial side. And as we talked about, in fact, a couple of things, right? We talked about some of the ToughMet applications into those. We have a number of applications into some of the new launches that our customers are doing on the consumer side. So I think the new market and the new growth I think in those areas is really helping us. So both, I would say, strength is from the consumer side and from the industrial side.

Got you. And do you think you're picking up share there? Or is it just an overall increase in overall demand?

I think there's a combination. Clearly, the demand is there. But I believe the new products that we're introducing are getting in there, we're becoming incumbents and the opportunity to then, of course, to pick up share.

Got you. And based on your conversation with end customers, I mean, can you give us a sense as far as how much you know? Where is there a level of comfort as this year progresses in terms of end market demand? Are they feeling much more confident now? Are they still hedging their bets? Any sort of color there?

Yes. When we look at -- well, in talking with our customers as well as when we look at our order intake for the rest of the year, I would say that there's reasonable, reasonable optimism, although it's cautious, of course. But good feedback, especially in these markets. Our order rate continues to be positive.

Got you. And then last quick question here just on the Medical business. I know you guys have discussed that here for some time now in terms of the volume declines there. I was just a little bit surprised, I suppose, in terms of the year-over-year decline again in that revenue line or for that business, that is. Are you losing additional share there on the Medical side? Or are there some other sort of drivers there that caused the increase in the year-over-year decline on revenues on VA sales?

Yes.

Yes. I just think you're still seeing on a year-over-year basis the result of the product transition that we referenced. Because if you look sequentially, sales are relatively flat. And so it's -- that product transition started hard in Q4. It completed here in Q2. We did begin shipping the next-generation product. So associated with that specific customer's product transition, it was a loss of share. But what you're seeing now is the new run rate. And just on a year-over-year basis, it still is reflective of the 10% down. But sequentially, it's relatively flat. And the Precision Coatings business should remain that way, I would say, through the next quarter before it starts to pick back up with some new products and new applications. And some market share gains hopefully in Q4 is what's expected.

We have now reached the end of our Q&A session. I would like to turn the floor back over to Steve Shamrock for closing comments.

Thank you. This is Steve Shamrock, and this concludes our second quarter 2017 earnings call. A recorded playback of this call will be available on the company's website, materion.com. We would like to thank all of you for participating on the call this morning and your interest in Materion. I will be available to answer any follow-up questions. My direct dial number is (216) 383-4010. Thank you very much.