Greeting and welcome to the Materion Corporation Third Quarter 2016 Earnings Call. At this time, all participants are in a listen-only mode. A brief 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, Mike Havlicek. Please go ahead.

Good morning. This is Mike Havlicek, Vice President, Treasurer and Secretary. 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 quarter and the outlook. Following Joe, Dick Hipple will provide his comments. Following Dick, we will open up the call for your questions. A recorded playback of this call will be available until November 11 by dialing area code 877, the number is 660-6853, or area code 201, the number is 612-7415. The conference ID number is 13646413. 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 during the question-and-answer portion, are based on current expectations. The company’s actual future performance may materially differ from that contemplated by the forward looking statements as a result of a variety of factors. Those factors are listed in the earnings press release issued this morning. And now, I’ll turn it over to Joe for comments.

Thank you, Mike and good morning to everyone joining us on the call today. During my comments, I will cover our third quarter 2016 financial highlights, review the third 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, Chairman, President and CEO will provide comments on the company’s key strategic initiatives. Let me start with the third quarter financial highlights. I am pleased to report that our third quarter 2016 financial performance was the second consecutive quarter of sequentially growing value-added sales and profits. Our success in new product sales improved, manufacturing yields and favorable [audio gap]. For the third quarter of 2016, value-added sales, which exclude the impact of pass-through metal cost totaled $157 million growing 5% over the third quarter 2015 value-added sales of $148.8 million. The growth in value-added sales was due to strong demand in the consumer electronics, telecommunication infrastructure and science and markets, plus the return of raw material beryllium hydroxide sales after the absence of beryllium hydroxide sales in the first half of the year. Value-added sales from new products defined as those introduced in the last three years, totaled approximately $24.5 million and represented 16% of our total value-added sales in the third quarter of 2016. New product sales were 34% over the prior year period. Gross margin dollars in the third of 2016 expanded 15% to $50.8 million from $44 million in the third quarter of 2015. Expressed as a percentage of value-added sales, gross margins were 32.4% in the third quarter of 2016 an approximate 200 basis point expansion from the prior year period. As you will hear in my later comment each of our three business groups delivered improved gross margin…

Thank you, Joe. I thought I would depart from my customary practice of commenting on major markets and new product introductions and instead summarize some of the strategic moves Materion is making to reposition itself for the future. First of these is our M&A pipeline. As we announced earlier, Materion has been in negotiations to acquire the high performance target materials business of the Heraeus Group of Hanau Germany. We are very close to reaching a definitive agreement that will allow us to proceed with regulatory approvals and other pre-closing steps toward an anticipated close in early 2017. Teams from both companies are in the finals steps on an agreement on a number of factors including the relocation of Heraeus' target manufacturing operation in Hanau Germany to a new Materion site nearby as well as overall integration planning into advanced materials business. As we have completed the diligence and become very familiar with our Heraeus partners and their target business, we are even more excited about the potential of this transaction. There are both the complementary and unique aspects inherent to Materion's and Heraeus' target materials offering and capabilities. Combining them will enable us to enhance our position in our traditional markets and drive additional growth in new markets. Specifically, we will gain target manufacturing capability in both Europe and Asia as well as design centers Europe and Asia and a highly experienced, talented workforce. Looking at this from a market perspective, we expect to be able to accelerate and solidify our global materials offering with enhanced technology and capacity in semiconductor, while expanding capability in several new markets. Outside of semiconductor the acquisition immediately provides us with diversification and critical mass in a number of attractive target related businesses segments and technologies where Materion has not historically enjoyed a…

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Edward Marshall with Sidoti Company. Please proceed.

Hey guys. Good morning.

Good morning, Ed.

So I wanted to ask about I guess the change in strategy with the hydroxide shipments. I know you've been working on an agreement for some time. I think price was the big negotiator there. Why the change now after several quarter of trying to get that price negotiation? I know we've talked about the potential for this to go this route before, but just curious what the thought process is or maybe what the pushback from the customer was regarding a potential contract?

Well I guess I'm not feel free to discuss confidential conversations with the customer. However as we look forward, there is a lot of common sense on our part to change the whole dynamics of that supply situation where we would go back -- actually go down in the supply chain supply to supply semi finished over time versus just the raw material and obviously that would drive more value to us through our primary end and hopefully bring other efficiencies throughout the supply chain of the industry. So I think it will ultimately create a win-win and it's a totally different way of thinking about the business and I think we'll get there over time.

Do you have the full capabilities that your customer currently has and how much capital do you have to sink into the business in order of economy the demand that you see?

None. We have the capacity to supply.

Okay. So I would to also ask about -- make sure I understand the discussion on the new products appropriately. You talked about 16% of value-added sales this quarter 11% last year, how do you define new product? Is that over three years or 12 months I forgot how you correctly define?

Ed, that's new products, those introduced are commercialized in the past three years.

Okay. So it's not appropriate to ex the numbers out to look at the base business.

No.

No. Okay.

Because you constantly have things coming out of the new product category.

Right so you can't get to a clean number I'm assuming.

Right, but we track this internally reported for every one of our businesses to continue to drive the focus on a new product introductions and then also ensure that new products are generating appropriate margin profile.

Got it. And when you talked about the acquisition of Heraeus and you talked about some of the financial characteristics, you mentioned and I think you said 8% to 10% on profitability, was that operating as a percent of the AR or was that EBITDA of a percent of the AR?

Yes so what I said was OP margins or EBIT margins were in the mid-single digits and EBITDA margins were in the 8% to 10% range.

Got it. Okay. Thank you guys very much.

Yeah that's all and just a reminder, that's all their current base business prior to any synergies.

Right.

Thank you. Our next question comes from Marco Rodriguez with Stonegate Capital. Please proceed.

Good morning, guys. Thank you for taking my questions. I wanted to talk a little bit more about the performance alloys segment there and the beryllium sales you had in the quarter also sounds like you pulled some revenue from what you were expecting in Q4 into Q3. Can you help us think about that quantify how much got pulled from Q4 into Q3 and what you might be expecting the margin impact going into Q4?

Yes so basically when you think about our second half year guidance has remained unchanged, yet the third quarter financial performance was better than what we had internally estimated and the primary reason there was the volume of beryllium hydroxide sales. We did forecast that significant of a volume in the third quarter. We had it more evenly throughout the second half. And so the sales on that in the quarter were $7.6 million just value-added sales on the beryllium hydroxide. And then we had two actually large shipments of high purity beryllium that will going into the science end market and again the customer simply was able to accept those earlier will require those earlier. So those were shipped in the Q3 as opposed to Q4. So big picture our full year or our second half guidance remains unchanged. It's just that those two particular product lines came in, timing was different than what we had forecasted.

Got you. And then in terms of the strategic shifts you're making here and obviously the drive to get the operating profit margins on VSL back up to a normalized level first I am assuming normalized level you're talking maybe back to your fiscal '13 fiscal '14 operating margins where you were in like the 9% range. First if you can help me think through that and then second, on these two strategic shifts that you talked about, with the beryllium and then on the alloy strip line, can you give us a sense of timing and if those two specific items are going to get you back up to that normalized operating margin or is there something else that also has to happen?

Yeah, so go ahead Dick.

I would say that the timing we're looking at is over the next couple years to get all that executed on and those are -- and I've talked about two different strategic levers in the business and also I think it makes a lot of common sense that we will see some -- we're not assuming a big boom here, but to assume some recovery in the oil and gas market. And just to calibrate you specifically when we say historical terms, we're talking of '13 and '14 as you referenced when the OP was about 9% of value-added sales and these plans combined with a recovery in the oil and gas market will take us as I said in my comments back to those levels and beyond. Our target is to have that business double digit margins.

Got you. Okay. And then I'm not sure if I caught this, on the Heraeus acquisition you provided some detail there, just trying to get a sense here, is that revenue that you're going to potentially be taking into your and your financials is that going to be all put into the advanced materials, will it be spread throughout your segments or how is that going to happen?

Yes so both of those businesses are exact fits with our advanced materials businesses and share the same product line customer base technologies and so it will be 100% absorbed into the advanced materials business.

Got you. Perfect and the expectation if I heard you correctly, is what a Q1 close date of fiscal '17.

Correct. So we're hoping to sign here in the next couple weeks and then begin the regulatory approval process with the close in Q1 of '17.

Got you. Okay. And last quick question, on the Precision Coatings business, pretty good expansion here year-to-date in terms of the margin profile especially on the gross margin on VA sales and revenues are relatively flat sequentially and not huge increase year-over-year. Can you talk a little bit more about what are the issues there that are basically allowing you guys to show up substantially higher VA gross margins on VA sales?

Yeah. So I'll comment on that. First of all, if you recall back in July of last year, we took an initiative to do some restructuring of our Shanghai operation to significantly reduce the cost structure there and centralize R&D efforts in our Westford Massachusetts facility. And so that was to lower the cost structure, but I'll tell you the other thing is we had some advancements in yields, manufacturing yield of our optical coating systems in Westford and then improved product mix and we took some also very specific pricing actions. So it was the combination of those factors and at the same time, there was the fall-off if you go back to the back half of last year, the sharp fall off in the color wheel as the product where margins had deteriorated, price point had commoditized it and as that fell off, we replaced it with a much higher margin, phosphor wheel and that has started to ramp up nicely. So that helps and then I would also tell you, our [large area] coatings business, which is the blood glucose test strip. So in the back half of '15 we were successful in developing a new product and one business with a new customer LifeScan and so as they ramp up, that helps and so it's the new product introductions there and improved yields on that operation. But I would tell you as you see you don't have to look any further than this past year. Margins are as high as 17% at one quarter and as low as 9%. There is still a significant degree of product mix and profitability that could impact any given quarter within the Precision Coatings group as you've seen year-to-date. That being said, in my comments we have -- it's not just this year, over the last four years we've taken actions, mix, yield cost to really restructure this business and for four years have grown profits and the margin profile and so we're forecasting to end here with double-digit operating profit margin, which is a nice story considering back in 2012 it was around 2%.

Got you. That's very helpful. Thanks a lot. Appreciate your time.

[Operator Instructions] Our next question comes from Phil Gibbs with KeyBanc Capital Markets. Please proceed.

Good morning, gents.

Good morning, Phil.

How are you?

Doing well.

Good, the two parts you mentioned acquisition A, acquisition B, those both are within this Heraeus acquisition was that, did I hear that correctly?

That is correct, that is correct, those what have been categorized as the Heraeus acquisition and what we've been working on internally in financial terms and we carve them into two buckets when we talked about the financial returns and profile internally.

Okay. And that wouldn't -- that 8% to10% EBITDA margin on the bigger piece of the revenue base none of that would include purchase price accounting if there's any of that.

That's reflect -- Phil that's reflective of their current forecasted trailing 12 months profitability.

Got it. And then in the fourth quarter I think you point to some general macro malaise in the outlook commentary you provided in the release, is that just year-end inventory adjustments, customers feeling some hesitation in front of the election or is that another destocking in consumer electronics? Can you help us there?

Well I just think that's just an overall comment regarding the whole global world is fairly flat on a growth basis. So that's pretty much it. I would expect automotive appears to be on the softer side and I would expect that to be some destocking going on there. I think you see the forecasts going up by the big automotive companies. I do expect on the other hand to see a little bit of a pickup going on in the oil and gas market. We're starting to see some early signs of that bottoming out and possibly picking up in some spots. That makes common sense with some of their higher oil prices that you see and the rig count is starting to come up very modestly, but it is coming up. So that's bottomed out. The consumer electronics is always difficult to forecast because of how is the consumer going to come in at Christmas time we're not sure and we got all kinds of changing dynamics. When you got Apples whose last quarter sales were down 15%. This quarter sales were down 5%. You got Samsung who is in a mess with their new phone launch. Where all this is going to play, but then Apple comes out with a very, very strong forecast in the fourth quarter. So I guess I would say that we're not backing because of all the turbulence in a cell phone market. We're not counting on a big robust fourth quarter because of all the turbulence there. So you just a lot of the markets are just stirring but if you put everything in a bucket, I would say you come out the other side, I don't forecast a lot of growth. We're really focused on what can we control and which is why we spent so much time on the new products and the focus there.

Great. I appreciate that market color. And on the $7 million that you pointed out Joe in the hydroxide sales in the third quarter, you had also mentioned two specific orders that maybe had gotten pulled in, should we anticipate all else equal, that the revenues associated with that will effectively represent the drop off in value-added sales and performance alloys in the fourth quarter because you essentially received all that in 3Q?

Yeah I think as I would say the profitability of the PAC business exceeded our internal expectations in Q3 because of the larger volume of beryllium raw material hydroxide and those two orders. So when you think about that segment sequentially going into Q3, it will be softer -- going into Q4 will be softer than Q3.

Is that the biggest variant in the bridge in the fourth quarter for you guys right now?

Well the biggest variant -- between our internal forecast of Q3 and excuse me, and the actual, that that is the biggest variant.

I just mean in terms of the expected modest drop off in earnings quarter-on-quarter is the biggest variable in that drop off this absence.

Yes, I would say that that is the largest. I think when you look at some of the other end markets, there is some natural seasonal softness in Q4, but that's normal and was forecast -- included in the forecast.

Okay. Terrific and I have just one more on the defense market, can you help us in terms of what you're seeing there across your defense buckets meaning maybe what your outlook is moving forward and if you've felt any lagging impacts from sequestration just given the fact that we're kind of in this election cycle and whether or not you expect some kind of demand to unfold afterwards thanks.

I think overall we've seen very nice growth in that market. I think year-to-year Joe you have the numbers in front, 14% 15% up year-to-year.

These defense year to date is up 20%.

20% and obviously we see that in our optics business, what we see it really in our optics business we see it certainly in our high BE business and to a much smaller extent to our alloy business, but right now we expect that to remain robust. We're not forecasting that to go backwards at all and to me that would only occur if there was some kind of a significant change on the political front say post election that we would changes those dynamics right now. But the sequestration I think that whole dampening effect on the defense budget was based on some of the actions and Congress was relieved a bit and we're certainly seeing that in our order book as a result, plus I think we're also in different platforms and maybe the way you think about Materion is we're really not supporting, not to say I shouldn't make a black-and-white but we're not really supporting the soldier on the ground. We're supporting the satellites, planes, missiles, targeting systems and that's what we supply and right now that's where they're spending money on. We don't have a lot of troops out in the field.

Makes sense. Thanks so much. Appreciate it.

Thank you, Phil.

Thank you. Our next question comes from Martin Englert with Jefferies. Please proceed.

Hi. Good morning.

Good morning.

So for the pull forward of the hydroxide sales and then there's two large sales into the science end market. Was all of that within your prior guidance?

Yes it's simply a movement from Q4 to Q3.

Okay. What's your sense that this was I guess being purchased maybe more so on the hydroxide side to replenish diminished inventories and is there any possibility that you would see some other unexpected orders in the fourth quarter here?

Yeah and the answer to the second question is there is some uncertainty as it relates to Q4 in terms of the volume and that's why range that we left out there has the $0.10 call it a wide range for Q4. And so that's what I would say regarding that and then as it relates to the -- we do not have clear visibility into inventory levels of the particular customer and so I can't comment as to whether we view the volume to be a replenishment or a stockpiling. At this point we don't have that visibility.

Okay.

But I would say on the science ones when you're selling -- our high purity beryllium business has large one-off orders very frequently either into nuclear medical, some science, some space in science, some defense and so you will see volatility on any given quarter in between of different and market and it was just -- it wasn't driven by our actions as much it was the customer's desire for the material that accelerated that shipment into Q3.

Within you're implied forecast for the fourth quarter, do you have incremental hydroxide sales or do you have hydroxide sales in that and do you have anything.

We have only one customer -- primary customer. So we don't disclose that level of granularity.

Okay. And if I could one quick question I guess thinking about the pension would do you expect the full year contribution to be and then also the expense add back. So what would that overall net impact be for 2016 and do you have any expectations for 2017?

Yes for 2016, we anticipate contributing $16 million to our pension and the expense will be approximately $9 million and then the '17 pension expenses as you're aware is all going to depend on where the discount rate ends at the end of the year. If you look at where the discount rate is today and this were December 31, our pension expense next year on a GAAP basis would increase approximately $3 million.

And a similar cash contribution.

No, not necessarily a similar cash contribution, we are -- as you see, we are contributing cash in excess of the expense and we have been doing that for several years. We maintain above the PBGC premium limit to keep a minimal expense and so I don't anticipate a change in cash contributions.

You don't anticipate any change or do you mean that imply that.

I do not anticipate any change in cash contributions next year.

Okay. And I know we're just for that way you have fallen to your cash flow these two are netted out. So this year would be about I guess it's about a $7 million net impact right.

Full year cash flow of $7 million unfavorable net outflow included in the operating activities.

Okay. And when I think about CapEx for the next year, should I think of the mine development what's been allocated for that largely gone at this point or do you anticipate ramping that back up at all?

Yeah it will depend but right now I would tell you I anticipate that to be zero next year.

Okay. And possibly a similar range or budget of the $25 million to $30 million for the base.

We've been running around $25 million to $30 million last year. $25 million to $30 million this year. I think we'll probably be closer to the $25 million than the $30 million next year.

Okay. Excellent, thank you very much.

Thank you.

We have a follow-up question from Edward Marshall with Sidoti. Please proceed.

You mentioned signs of oil and gas pickup and I am curious, is that anecdotal like customer inquiries or did you have any meaningful orders at this point?

No, that's orders.

Okay. And they're meaningful.

Anything in the oil and gas market is meaningful at this point, but it's just that our sales pretty much bottomed out in the second quarter and we're starting to see a little bit higher level of order rate coming in. So it's good to see that. So is it meaningful, I would say it's certainly meaningful in that particular market. So anyway I guess that's really the message I would say that it has bottomed out and we're starting to see it tick up, but it's not anywhere near where we were in 2014 obviously.

And Edward all comments are relative, we're coming off of -- we're losing about $30 million in annual sales into the oil and gas. When you see a quarter where it's actually up over the prior year, even if it's only a couple $100,000 that's assigned a life that we're coming off of the bottom.

Got it, so it's meaningful to you.

It's not going to be meaningful to you guys, but it sure feels better.

I am curious your target business, what is the profitability either on a EBIT or EBITDA for your existing target business?

Well our advanced materials business has been running for the last three years at a 15% EBIT to value added sales.

Right, but that's not all the targets right, there is other in there, can we get a little granular. Can we put it different way, is it higher then what your target -- then no point to target that you're looking at in Heraeus?

I've disclosed their EBITDA margins or EBIT margins are in the mid-single digits, ours is running at 15% our AM business runs at 15% and so when we take advantage of some of the synergies we anticipate that that business will -- that acquired business margins will improve significantly. I don't know it will be better than our consolidated corporate margins, but I don't know that it will be given the product mix to that of the 15%.

Got it and the timeframe that you assume that you can make that happen.

Yeah. Our model goes out to 2018 to achieve these targeted level. So run rate at the end of '18.

And I think you said appropriate market multiples

Correct.

But what's appropriate?

Well this business is very much in our space in our sector and you can see what we and our competitors trade at that when we think of market that's what we look for as an indicator of what is market. Our peer group, ourselves.

Got it. Thanks very much.

We have a follow-up question from Martin Englert with Jefferies. Please proceed.

Just a couple quick follow-up, any color that you can speak to regarding the holiday build and also what you would anticipate the impact would be from the Samsung there?

Well I touched on that in my prior comments, I would expect to see the -- a shift that goes on. I think people aren’t going to not buy something because of Samsung. I think they'll -- I would think you would see maybe something bouncing over more towards the Apple side. So the only negative impact for us could be in a certain application or two that we ship into the Samsung supply chain that would be adjusted based on their builds, but the total market, I don't think that's going to drive the total market in the consumer buy. I just think the consumer is going to shift to somebody else in totality. So I don't think Samsung is going to drive the market. They're just going to call customers to go somewhere else for their product and I guess I would just go back to the Apples earnings call, if you want, you should go back and review that. I think they had I think their revenue in the quarter that we just completed it was around $50 billion and I think their forecast for the fourth quarter was like you $75 billion or so. So they're forecasting quite a strong surge in their iPhone 7 sales. So hopefully we would see a bit of that course as late in the season already. The supply chain is already reacting to whatever the builds are coming into the Christmas season at this time and we have that forecast within the forecast that we just provided you that's embedded in there.

Excellent. Thank you.

Thank you. I would like to turn the floor back over to Mike Havlicek for closing comments.

All right. It's Mike Havlicek. We would like to thank all of you for participating on the call this morning. I'll be around for the remainder of the day to answer any questions. My direct dial number is area code 216-383-6823. Thank you very much.

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