Greeting and welcome to the Materion Corporation’s Second Quarter 2016 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Michael Havlicek, Vice President, Treasurer, and Secretary. Thank you. You may begin.

Good morning. This is Mike Havlicek. With me today is Dick Hipple, Chairman, President, and CEO, and Joe Kelley, Vice President of Finance, and Chief Financial Officer. Our format for today’s conference call is as follows: Joe Kelley will review the financial results for the second quarter and the outlook. Following Joe’s comments, Dick Hipple will review the current state of our key markets. Following Dick, we will then open up the call for your questions. A recorded playback of this call will be available until August 12th by dialing area code 877, the number is 660-6853, or area code 201, the number is 612-7415. The conference ID number is 13640503. The call will also be archived on the company’s website, Materion.com. To access the replay, click on events and presentations on the Investor Relations page. Any forward-looking statements made in this announcement, including those in the Outlook section, and those in 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 Joe for comments.

Thank you, Mike and good morning to everyone joining us on the call today. During my comments, I will cover our second quarter 2016 financial highlights, review second quarter profitability by segment, make some brief comments on cash flow, and finally cover the earnings outlook for the remainder of 2016. Following my comments, Dick Hipple will provide comments on the company’s key strategic initiatives and market conditions. Let me start with the second quarter financial highlights. We are pleased to report that our second quarter 2016 financial performance was in line with the guidance we provided, and at the high end of the street estimate. We delivered both sequential top line sales growth and earnings growth compared to the first quarter of 2016. For the second quarter 2016 value-added sales, which excludes the impact of pass through metal costs, grew 7% sequentially over the first quarter of 2016 to $153.9 million. The sequential growth was driven by success in our largest end market, consumer electronics, plus growth in both science and telecommunications infrastructures and markets, all three posting double digit or greater sequential improvement. The second quarter 2016 value added sales compared to the prior year, same period value added sales decreased 5%. The vast majority of the decrease year over year is attributable to the lack of raw material, beryllium hydroxide sales, in the current year period. Value added sales from new products defined as those introduced in the last three years totaled approximately $18 million, and represented 11% of the total value added sales in the second quarter of 2016. Our selling, general, and administrative expenses were $32.4 million or 21.1% of value-added sales, and $2 million higher than the first quarter of 2016 selling, general, and administrative expense. The sequential increase was attributable to a $1.9 million…

Thank you, Joe. During my conference, [Technical Difficulty] end markets and share some of our new product development initiatives. Following this, I’ll provide and update on our [indiscernible] activity and make some business unit specific comments. First, to provide some perspective on our value-added sales quarter versus quarter and by market. Sales were in line or sequentially higher in key end-markets including consumer electronics, industrial components, defense, commercial aerospace, science, and appliance. In consumer electronics growth was up by about 2% with some strength in Asia driving demand for alloy strip from optics and phosphor wheels for the projection market and a key smart phone image sensor application, offset to some degree by softness in the data storage market. Defense sales were strong coming in at 32% ahead of last year, and were up across Materion’s businesses including performance alloys and composites, with new applications on the Bradley fighting vehicle and sales optical targeting system applications and missile guidance systems served by our optics group. Sales for products serving the commercial aerospace market were up 3% year on year with PAC winning new applications and continuing to add more pounds of raw materials on new or retrofitted commercial airliners. Well, I guess the small base our sales in the science were up nearly 60% aided by strong beryllium sales to the nuclear test reactor sector and from space related applications supplied through our optics group. Our medical sales were off by low-single-digits, while our automotive electronics sales were lowered by about 10%, with reduced sales of rod and wire into the commercial truck business, some pullback in orders from our automotive customers and pruning of low margin products in our optics business. We did see sequential growth in automotive however from the first to the second quarter. Finally, sales to…

Thank you. At this time we will be conducting a question and answer session. [Operator instructions]. Our first question is from Edward Marshall from Sidoti Company. Please proceed with your question.

So, I had a question on the beryllium hydroxide and maybe what’s causing that stuff, I guess the increase in supply out there, or the increase in inventories out there that need to be worked through a destocking theory. I’m curious if the April announcement from Apple had anything to do with that potential build up.

The April announcement by us, no that’s totally independent issues connected to Apple and the hydroxide situation. I think we’ve talked about this before is that we actually sold quite a bit of hydroxide last year, and we believe that the key customer overbought in anticipation of higher prices this year. So, I think it’s just simply an inventory liquidation situation from an overbuy and settling out as we go forward.

Last year as you remember was the end of a ten year contract and so the customer the last two years of that contract bought in excess of the annual needs, perhaps such that he could hold off here for several quarters, now it’s been prior to ordering, when the new contract renews at a different price.

Got it.

The update there is I would tell you that based on recent developments as late as this week, we continue to be optimistic or have a high degree of confidence that that order, hydroxide ordering will resume here in the third quarter.

Has the contract been renewed?

The contract has not been renewed as of right now. No.

So, you have not. Just so I’m clear that there has not been a, the order, you haven’t seen any hydroxide orders hit the books as of yet, but I guess what you’re saying is you anticipate they will.

Yes. Our forecast includes hydroxide ordering, selling hydroxide, raw materials in the back half and based on recent developments, there’s a degree of confidence in that aspect.

Got it. Now you reduced the outlook for the strip mine, I guess the second quarter in a row. Did that have any kind of, is that related to this change in the hydroxide that you’re selling.

I’m confused by your question. We reduced the last quarter.

The last quarter

Yes. The strip mine development the last quarter, we said we would spend $8 million to $10 million on mine development. This quarter we’ve confirmed that at $10 million for the year. So, there’s been no change since last quarter in our mine development activity.

Right. But I guess the fourth quarter last year, you were saying $20 million to $25 million.

Yes. So, as we said on the Q1 call, or I think it was the Q4 call actually, we were able to reduce several, basically make some enhancements into our supply chain management of inventory. Some of the purity levels of ore were greater than anticipated such that we could push out some of this mine development. So, we suspended mine development here in the second quarter from what was originally planned back when we were forecasting to spend $20 million to $25 million in ’15. So, that’s what drove that and nothing has changed on that since the last quarter.

In the event of an acquisition, I’m just curious what are the deal multiples that you’re seeing in this phase?

Well, I’d say that right now in that seven to nine multiple range, and obviously when we’re looking at acquisitions a key part of that is what synergies can be driven.

Right. Does that seven to nine include any synergies anticipated, or is that seven to nine on a straight EBITDA?

No, that’s synergies. Yes.

Like a trailing 12 month EBITDA. That’s seven to nine times trailing.

That’s seven to nine times trailing.

Yes.

Okay. Thank you very much.

Thank you, Ed.

Our next question is from Marco Rodriguez from Stonegate Capital Partners.

Good morning, guys. Thank you for taking my questions. I wanted to kind of follow up a little bit on the guidance, I just wanted to make sure I’m understanding some of the moving parts there, specifically on the hydroxide sales. If I’m not mistaken, I thought the anticipation was that those sales would come through in the second half, which if I’m hearing you correctly, is still the expectation yet, we’re talking about a reduction in EPS, because of the hydroxide sales. So, has something kind of changed there a little bit, that I’m just not thinking through correctly?

The prior forecast assumed that hydroxide sales would be the original forecast, assumed that they would actually start to trickle in here in Q2 and they have not started to trickle in in Q2 or the contract would be renewed in Q2, and now it’s looking like that will start in Q3. So, that is a component of that.

Okay, got you, and so there’s no indication that those sales that you had expected in Q2 would be made up in Q3, Q4?

That is correct.

Okay. Okay, and then in terms of the consumer electronic market, I was wondering if you could maybe provide a little more color there in terms of the areas that you’re seeing particular softness in. I mean, you also do call out an increasing improvement in the semiconductor space, which I’m assuming has some overlap into the CE market, so I’m just wondering if you can kind of help me think through that.

I think if you start to look at some of the earnings reports that are coming out recently and I’ll just cite a couple that I’ve run across recently. If you take a look at like a Skyworks, the revenue was down 7% year-to-year. If you look at Apple, their revenue was down 13% year-to-year. So, obviously there’s a slowness that has gone on, particularly in the consumer electronics world, and but yet, in the second half they are coming out, Apple, for example, is coming out with a new models. However, Apple’s taken up their forecast, I think 5% in revenue in the third quarter. So, what we’re seeing I think, and certainly that’s going to be a lot lower than last year. So, what we’re seeing really is a second half growth in electronics, but certainly weaker than what it was last, well in that case within Apple and then Skyworks, it’ll be better in the second half. But, certainly some drag down in what I call overall growth year-over-year is certainly muted in total. So, we expect to see higher sales in the second half based on the normal product lifts that are going on for the holiday sales.

Got you. And are there particular areas in the CE market that you’re seeing softness, whether it’s computers or mobile devices, anything like that, any kind of color there?

Well, certainly the mobile devices themselves, which really would be the smartphone area primarily. That’s what drives it. You could see from year to year growth, that’s really slowed down, and so that’s one where we used to see a lot higher growth level, and not as much these days. So that’s the key driver, and then we also participate in kind of another world, which is the telecommunications spending world and that is stronger at this point for us and that’s the 4G type builds across the globe. That seems to be stronger, and that just reflects the data storage and data transfer that needs to occur across the backbone of all the wireless systems. Computer sales are down, but we don’t play any more in the computer side, although we do have some participation in the hard disk drive market, and that certainly is soft based on their total consumption in computer sales. So, it’s mixed. I would say overall, it’s been muted from a growth standpoint, but we still expect growth in the second half for what I call normal seasonal factors.

Got you. Can you provide a little more color here on this strategy improvement that you’re blowing out? It’s kind of sounding like the broader semiconductor market. Are you taking share? Are you just trying to enter that market?

Yes. It’s a combination. The best way to think about it is over the years we have really, we’ve always been in the semiconductor market and it’s just how do you describe the semiconductor market? The space that we play strong in is in the particularly the wireless sector, and say the LED sector. Now, so what we’ve done from a strategy standpoint, and the wireless sector would be companies like the Skyworks, the Avagos, Cuervo, those are kind of the representative group that we have very good participation rate with. There’s a broader semiconductor market, which is really reflected by your more tier 1 producers, like Samsung or Intel, or Texas Instruments, and so for us to participate in the materials set there, we essentially have to upgrade to what we call the tier 1 capability. And there’s different expectations in these different markets. So, what we have done is we’ve invested throughout our facilities to be able to participate in a wider set of semiconductor applications. So, it really provides us with the ability to gain market share in areas that we haven’t participated in the past. So, that’s where we’re seeing the growth, and this strategy is quite successful for us.

Got you. Okay. Makes sense. And then last quick question. I’ll jump back into the queue. Just in terms of the acquisitions, the $1.9 million spend, I think which is what you guys called out as far as consultants and experts or what have you for your due diligence there. First off, is that correct? And then number two, are you expecting additional expense levels such as that for the remainder of the year seeing that the acquisitions you’re expecting to close until Q4?

Yes. The answer is 1.9. You did hear that correctly, and that was upfront due diligence and integration prep, so its due diligence on the financial, legal, and environmental side, and I would tell you that’s largely complete, where we are in the discussions and the negotiations. So, we do not anticipate that run rate going forward, throughout the year to complete that. So, it’s not fair to assume we’re going to spend 1.9 for the next two quarters. It will come down significantly.

Got you. And you mentioned in your prepared remarks that there are a couple other or few other potential targets that I guess you’re talking to or looking at. Any sort of color you can provide in terms of where you are there, like at just beginning stages, middles stages, getting towards the end? Anything like that would be helpful.

Yes. There’s one other deal that I would tell you has progressed, we have a signed letter of intent and we’re actively engaged in a due diligence. A portion of that 1.9 was not just the Heraeus, but there was another acquisition which is progressing.

Got you. Perfect. Thanks a lot, guys. I appreciate it.

The other ones in the pipeline aren’t yet at that stage.

Got it. Thanks a lot, guys.

Our next question’s from Phil Gibbs from KeyBanc Capital Markets.

Are you anticipating an improvement in sales in the second half versus the first half? I know you’ve got aspirations of growing earnings, but is it more driven by the cost side, or is it equally driven by the topline. How should we think about that?

Yes. That’s the issue. You should think about that value-added sales are forecasted to improve in the back half compared to the first half.

So, that’s revenue.

Any changes you’re seeing in the oil and gas side right now in terms of inquiry from customers and specifically the, you have a toughmet product?

I would say that in general, I would say that we finally, I think hit the trough in the second quarter and oil and gas sales. But, man, is it, I’m not forecasting anything substantially up from here. But, where we will see the lift is for some of the new products, and I’ve talked about that in a couple of calls where we’ve had, we’re making some progress in the productions side versus the drilling side, which is key to us. Obviously drilling is quite low. I mentioned a couple of new products on the drilling side. Those are getting engineered in. So, I would say as drilling picks up, we’ll see faster growth than maybe the market itself. But, on the production side, I would say, we’re actually pleasantly surprised that we’re actually receiving some very significant orders right now for the new couplings we’re introducing for the lift pump wells and these are orders in the magnitude of several hundred thousand dollars, half a million dollars. So, that’s very substantial. All I can say about oil and gas is that as that lifts, we should lift faster.

Perfect. DD&A, including amortization of finance and costs, what are you anticipating that to be for the full-year, Joe, relative to the, it looks like about twenty-fourish, twenty-three and a half, twenty four million we’ve seen year-to-date?

Yes. So, our full-year forecast for depreciation and mine amortization is approximately, I tell you about $42 million, and again the variable there is the [indiscernible] amortization is not straight lined. It depends on the activity at the open pit mine.

Okay, and I’m correct though that the, we were running at about 24, 24 year-to-date or something like that, right, looking at the right number?

Yes. You are correct.

Okay. And in terms of the mix quarter on quarter in performance alloys, and I don’t mean to beat a dead horse, because we talked about the improvements that you’re targeting for the business and the need to turn it around in terms of mix, but quarter on quarter the sales lifted, but the profits went down. Can you elaborate on that a little bit, why you would have lost leverage there?

Yes. So, as I said in my prepared comments, a lot of that had to do with the mix primarily, but specifically I would tell you some of the growth in southeast Asia, and our copper beryllium strip product line, the price points there are quite low, and therefore a disproportionate amount of the growth came from that region of the world and then that product line. And so, that is what was meant by the unfavorable mix.

Got you. And the foreign exchange headwinds in that business, have they on a net basis, have they subsided, or are they essentially intact with where they’ve been?

Yes. So, that business houses as, Phil, the majority of our FX exposure. So, when we were entering the year, we had affect hedges in place that were at about the current exchange rate entering the year. However, prior year we had $6.2 million of FX hedge gains due to the strengthening of the dollar. So, year over year, we entered with a headwind of $6.2 million because of the lack of these FX hedge gains. The only thing that’s changed I would tell you, is actually in the quarter, due to the strengthening of the yen, we actually had a hedge loss in that business this quarter, of about half a million dollars, which negatively impacted the profit to that segment in Q2, more so than historically forecasted.

Okay. So, you’re basically saying that $6.2 million saw a little bit more weakness relative to that run rate because of the yen move in Q2. Okay.

Correct. Correct.

All right. All very helpful. I look forward to chatting later. I appreciate it.

Thank you, Phil.

We have a follow up question from Ed Marshall of Sidoti.

Hi. Just a follow up. Did you mention the tax rate was effective for the consolidated year, was that 18%, 19%?

Yes. Exactly. I said about 18% to 20%. That’s excluding the discrete item that we benefitted from this quarter, which is about $900,000.

Okay. So, when I look at the business, and I look at the guidance and the adjustments of the guidance and there are and the range, and the fact that you said the median sales on a year over year basis will be up. I’m curious, what do you anticipate, do you anticipate further erosion on the margin side, and is that gross margin, or is that operating margin that you anticipate causing that pressure?

Well, the pressure I was referring to when we were talking PAC had both gross margin in terms of the mix shift and in terms of the FX changes that affected our operating profit margin. And so, we would, the forecast assumes that there would be an improvement in operating profit margins coming sequentially going first half to the second half.

I’m sorry. There was an improvement in the first half to the second half? Is that what you said?

From the first half to the second half, our operating profit margins are forecasted to improve. That’s embedded in the guidance.

Got it. Okay. So, I’m trying to think this through. If we’re seeing increased sales performance, increased margin, and lower tax rate, but yet we’re narrowing to the low end of the range. I’m just trying to rationalize those three.

Well, narrowing to the low end of the range, you‘re looking at compared to our prior-year guidance, when you look at what’s happening Q1 to Q2, our earnings are increasing 30% to 45%.

Okay.

And so that should, I guess you’re doing an apples and oranges there in my opinion. So, when you think about topline sales improving back half compared to first half, margins expanding back half compared to first half, and tax rate, that’s how you get a 30% to 45% earnings top.

Got it. What, when you talk about these two transactions that you’re working on, I’m just trying to get a sense as to maybe the size of these transactions. Do you have any kind of a ballpark range?

Yes. Ballpark, I would tell you the Heraeus one, while it is complex in the sense that is a carve out of multiple locations as we covered in the press release, but from a topline revenue standpoint, you should think about that as a $70 million to $80 million business. And then the other one I would simply characterize as a strategic bolt on acquisition and those are somewhere between $20 million and $50 million in that definition.

Got it. And what’s the liquidity of the business right now? How much access to capital do you have without having to raise anything from an equity perspective?

Yes. We have significant available liquidity, and so we could just looking at our revolver and what’s in place, we have access to approximately $200 million.

Okay. Plenty there, okay great. And what’s the, I’m sorry, I could probably check this out but do you have off the top of your head what’s the rate on your revolvers? 5% or plus?

We’re just taking a quick look there.

So, the rate’s around about four and a half percent.

Is that inclusive of [indiscernible]?

No, that’s just for everything.

That’s combined. Got it. Okay, guys. Combined. Okay, great. Thanks, guys. I appreciate it.

Thank you. Ladies and gentlemen, we have reached the end of the question and answer session. I’d like to turn the call back to Michael Havlicek for closing remarks.