Materion Corporation (MTRN) Q1 2017 Earnings Report, Transcript and Summary

Greeting and welcome to the Materion Corporation First Quarter 2017 Earnings Conference 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. It is now my pleasure to introduce your host Steve Shamrock. Vice President, Corporate Controller and Investor Relations for Materion Corporation. Thank you, Mr. Shamrock. You may begin.

Good morning. This is Steve Shamrock, Vice President, Corporate Controller, and Investor Relations. With me today is Dick Hipple, Executive Chairman, Jugal Vijayvargiva, President, and Chief Executive Officer; and Joe Kelley, Chief Financial Officer. Our format for today's conference call is as follows; Dick and Jugal will provide opening remarks and comment on key strategic initiatives. Following Dick and Jugal's remarks, Joe will review the financial results for the quarter and the outlook. Following Joe, we will open up the call for questions. Before we begin, let me remind investors that 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 we issued this morning. Additionally, comments with regard to operating profit, net income and earnings per share reflect the adjusted numbers shown in attachment four and five in this morning's press release. The adjustments made in the current year for comparative purposes remove non-recurring items such as CEO transition cost, acquisition and integration cost, cost structure realignment actions and legacy environmental matters. And now, I’ll turn the call over to Dick.

This is a special occasion for me as it marks the final time I will join this call as a regular participant after 43 consecutive quarters. As most of you know, Materion completed the planned and orderly leadership succession in March. After nearly 11 years as President and Chief Executive Officer those responsibilities have been handed to my successor Jugal Vijayvargiva. I am staying on as Materion's Executive Chairman to support Jugal and this transition until my retirement from the company within a year. Jugal joined us from Delphi Automotive where he had a successful 26-year international career. Most recently he was President of Delphi's Electronics and Safety Segment, a $3 billion global business headquartered in Germany. Jugal has a terrific combination of integrity, proven strong commercial M&N and operational experience and a passion to grow the business. I believe you will find him to be an outstanding leader and committed steward of this organization. Thank you for your interest and support in Materion and for the encouragement and goodwill you have always shown the executive team and me. I take tremendous pride in personal satisfaction in knowing how well you will be served with Jugal at the helm supported by the great culture of the Materion employees. I will now turn the microphone over to Jugal.

Thank you, Dick for those introductory comments and for your valuable role in acclimating me to Materion. Let me extend a very warm welcome to all of you on the phone. I'm very excited to have joined the Materion team and for the opportunity to follow Dick in leading this great company to its next level of long-term success. During my time at Delphi, I had the privilege to serve in a number of leadership roles in Europe and North America. Those experiences include delivering profitable growth across multiple product lines, global customers and regions, identifying and harnessing market trends. There are numerous areas where my background dovetailed with Materion. Materion is an organization with highly differentiated technologies and products, dispersed across a global manufacturing base. It has evolved and transformed from legacy businesses to an innovative leader in advanced materials. Materion is deeply engaged in multiple global markets be it consumer electronics, industrial, defense or automotive. During my short tenure here, I've been highly impressed with the quality and passion of our people. The vital role that our advance materials play in improving the world, the proud and consequential history of the organization and most importantly, the bright promise for Materion's future. Materion has many compelling strengths to make me very confident in what lies ahead. These include a rich and differentiated product portfolio, diversity across a number of long-term growth markets, an organization that is universally recognized for its innovation and material design, a company well-placed with strong market positions and significant competitive advantages and an unlevered balance sheet to support organic and inorganic growth. There will be more report all subsequent calls, but for today, I would like to provide a glimpse into my priorities for Materion in the months and years to come. Materion is in the business to provide innovative solutions for our customers. With this goal in mind, there are four key focus areas I would like to highlight. First, its operational excellence in everything we do by working safely, smartly and more efficiently. For this we'll expand on our successful lean Six Sigma principles and other proven operational measures. Operational excellence is at the core of the plan. Without this, we'll not be able to satisfy customers, suppliers, shareholders or our people. Second is commercial excellence in finding new applications and creative ways to capture more value from unique and differentiated technologies and materials. This involves the company heightens the speed of execution to better serve our very demanding and deserving customers. Next is innovation excellence, the hallmark of Materion and the lifeblood of our future. Focus will be to identify trends that combined with our technological capabilities will drive growth and position the company for stronger long-term success. Relentless new product and application development will remain critical to markets and customers, resulting in sustained organic growth. And finally, focus must be on inorganic growth excellence, swiftly and smartly. One only has to compare today's Materion with the markedly different enterprise it was just 10 years ago to see the president and potential that's already been established. With our balance sheet, complementary technologies and well-established industry leadership, Materion can continue to attract new and exciting possibilities inorganically for results that cannot be achieved by organic growth along. To anchor these priorities, we're building a performance-based mindset and culture throughout the organization. There is a heightened emphasis on challenging ourselves on target setting, ownership, accountability and teamwork, while embracing the change that is ahead of us. These priorities will lead Materion to deliver for all of our stakeholders, customers, partners, shareholders and our people. During my visits to our facilities and meeting with my new colleagues, I've become even more convinced that we can build on our past successes and accelerate long-term sustainable growth and with it much greater financial performance. Let me now briefly comment on the quarter, Beyond the growth and value-added sales quarter-on-quarter and sequentially, I'm pleased to inform you that we delivered an EPS of $0.29 a share that's $0.02 higher than the same period last year and $0.01 better than the previous quarter. I'm also able to confirm our previously announced earnings guidance of $1.45 to $1.60 per share for the year. Again, I appreciate your interest in Materion and look forward to joining you on future calls and investor events. Now, I'll turn the call over to Joe.

Thank you, Jugal and good morning to everyone joining us on the call. My comment today will cover first quarter 2017 financial highlights, a review of profitability by segment, brief comments on the balance sheet cash flow and modeling assumptions and the earnings outlook for 2017. Starting with the financial highlights, the first quarter 2017 we reported year-over-year growth in both topline value-added sales and adjusted operating profit for the first time in the past seven quarters. First quarter 2017 adjusted earnings exceeded our internal forecast and earnings guidance provided to the street. First quarter 2017 value-added sales of $149 million increased approximately 4% versus the prior-year first quarter value-added sales of $143.9 million. The Heraeus acquisition late in the first quarter of 2017 accounted for $2.9 million of value-added sales growth, while the base historical business value-added sales grew 2% over the prior year period. As a reminder to investors, value-added sales removes the impact of pass-through precious metal cost. The company continued to experience positive momentum with new product value-added sales, which totaled $20.3 million in the quarter and grew 22% over the prior-year first quarter. A modest recovery in end market demand also continued, particularly in our two largest end markets, consumer electronics and industrial components. These favorable trends were largely offset by decreased sales into the medical and defense end markets. As you may remember, it was mentioned on the year-end earnings call that Materion's largest medical customer began the transition from a legacy product to a next-generation product in the fourth quarter of 2016. This product transition continued during the first quarter of 2017, negatively impacting year-over-year value-added sales in the medical end markets. As for sales in the defense end market, although defense sales in the first quarter of 2017 were solid in historical terms at $12.9 million, this represents approximately a 10% decrease from the prior-year first quarter, which saw very strong defense sales. As a reminder to investors, the timing of sales in the defense end market can vary quarter-to-quarter related to large government programs, particularly with respect to high purity beryllium sales. While value-added sales grew year-over-year and sequentially in the first quarter of 2017, the changing sales mix was unfavorable leading to a slight deterioration in gross margin. Selling, general and administrative expense increased $3.1 million over the prior-year first quarter of $30.5 million. Excluding nonrecurring cost related to the CEO transition, cost reduction initiatives and the acquisition and integration cost, adjusted SG&A expense was down approximately $1 million or 3% versus the 2016 first quarter and down 6% sequentially from the adjusted fourth quarter 2016. Operating profit totaled $3.4 million in the first quarter of 2017. Adjusted operating profit excluding special items was $7.7 million, a 3% improvement from the $7.5 million recorded in the prior-year first quarter and a 7% improvement from the $7.2 million of adjusted operating profit recorded in the fourth quarter of 2016. The growth in adjusted operating profit was due to sales growth and cost reduction initiatives, offset partially by unfavorable product mix. Net income for the first quarter of 2017 was $3.1 million or $0.15 per share diluted. On an adjusted basis, excluding the nonrecurring cost, first quarter 2017 earnings were $0.29 per share up 7% versus $0.27 per share in the first quarter of 2016. The first quarter 2017 effective tax rate was negative 4% as two timing issues related to executive and share-based stock compensation were recorded in the quarter. The full year 2017 effective tax rate is forecasted to be in the range of 18% to 20%. Please note the adjusted first quarter 2017 earnings per share of $0.29 is reflective of an effective tax rate of approximately 19%, comparable to the forecasted full year effective tax rate. Now, a review of our first quarter 2017 performance by business segment, starting first with advanced materials. This segment delivered value-added sales in the first quarter of 2017 totaling $47.3 million, a 12% increase over the $42.1 million recorded in the first quarter of 2016. Excluding sales related to acquisition, value-added sales increased 5% versus the first quarter of 2016. End market demand was strong across most of the segment's major end markets. Adjusted operating profit for the first quarter of 2017, excluding acquisition and integration costs was $7.4 million or 16% of value-added sales, compared to $5.2 million or 12% of value-added sales during the prior-year period. This significant 42% improvement in adjusted operating profit was due to a combination of higher sales volumes and improved product mix. This business continues to perform well. The favorable outlook for the consumer electronics end market and continued integration of the Heraeus business should serve to further bolster growth in this segment. We are now approximately 60 days into the integration of the global Heraeus business and we are pleased to report that customer, employee and operations integration initiatives are progressing on schedule. Management continues to be very excited about how this acquisition strengthens the commercial and technical capability of our advanced materials business. Now a review of performance alloy and composites. First quarter 2017 value-added sales were $79.2 million, a 1% increase from $78.2 million in the first quarter of 2016. The modest year-over-year sales increase is reflective of continued growth in strip product sales, primarily in the electronic connector market in Asia, offset by reduced sales of high purity beryllium products in defense and science applications. Adjusted operating profit in the first quarter of 2017 excluding special items related to the closure of the Japan service center was $700,000 compared to $1.5 million in the first quarter of 2016. The decrease in profitability was driven primarily by unfavorable product mix as low high-purity beryllium sales were offset by higher copper beryllium strip product sales. The results of this business segment in the first quarter of 2017 were disappointing. However, looking at the current order book and actions already initiated, both sales and profitability for this segment are forecasted to sequentially improve each quarter as we move through the remainder of the year. The business segment is on track to close the service center in Fukaya Japan at the end of the second quarter, which is expected to generate approximately $2 million of annualized savings. From a topline perspective, continued actions to improve product pricing and appropriately capture the value provided to customers are being taken. The company remains focused on maintaining a robust pipeline of new products to drive growth and improved mix. Additionally, the return of consistent raw material beryllium hydroxide sales is forecasted to resume later in 2017. As a result of the combination of all these factors and actions, quarterly value-added sales and operating profit margins for this segment are forecasted to consistently improve during 2017. Turning now to precision coatings, this segment recorded value-added sales of $23.3 million in the first quarter of 2017. This compares to $24.6 million of value-added sales in the same period last year. The decrease in value-added sales is due primarily to lower sales volume into the medical end market. As previously referenced. a significant customer began a product transition to a next-generation product late in the fourth quarter of 2016. This product shift has negatively impacted value-added sales in the past two quarters. Operating profit for the precision coatings segment totaled $2.2 million or 9% of value-added sales in the first quarter of 2017 compared to $4.1 million in the first quarter of 2016. The decrease in segment operating profit was due primarily to lower sales volume of precision coated products for blood glucose testing and unfavorable sales mix. I remind investors that the precision coatings segment has delivered four consecutive years of improving profits and the first quarter of 2016 was the peak level of profitability. Full-year 2016 profit margins as a percentage of value-added sales finished at 12%. This segment is forecasted to again deliver double-digit profitability in 2017. Turning now to the balance sheet and cash flow, the company ended the first quarter of 2017 with a net debt position of $16 million, $2 million below the prior year net debt level. Materion continues to have significant available liquidity to support meaningful organic growth opportunities further inorganic strategic growth and consistently return cash to shareholders through a combination of dividends and share buybacks. Cash flow from operations in the first quarter of 2017 was negative $16.8 million, which was consistent with the prior-year first quarter cash used due to normal seasonal investments in working capital and the timing of cash payments for annual accruals. Cash flow from investing activities includes the $16.4 million cash investment associated with the Heraeus acquisition. This amount is approximately $13 million shy of the agreed purchase price because of working capital levels and assume liabilities transferred at closing. For financial modeling purposes in 2017, cash flow from operations will run approximately $50 million to $60 million. Capital spending should run approximately $25 million to $30 million, mine development investments should be less than $3 million, annual depreciation and amortization should run approximately $43 million to $45 million and effective tax rate of approximately 18% to 20% should be assumed. And finally, now the earnings outlook for the remainder of 2017. Based on our first quarter performance and the current order entry rate, the company confirms the full year 2017 earnings guidance range of $1.45 to $1.60 per share. The midpoint of this range represents a 15% increase over 2016 adjusted earnings. The substantial sequential improvement in quarterly profitability implied by the annual guidance is driven by increased sales volume, supported by the current order entry rate, contribution from the Heraeus acquisition, resuming sales of raw material beryllium hydroxide and cost saving initiatives. Looking specifically at the second quarter 2017 earnings, we are forecasting a sequential earnings increase of approximately 25% to 35% compared to the first quarter of 2017 adjusted earnings. This concludes the review the financial performance and my prepared remarks. The line will now open for questions.

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

Hey guys. Good morning.

Good morning, Ed. So just to clarify the 25% to 35% sequential improvement 2Q to 1Q EPS, were you referring to the GAAP or the pro forma number.

It's an adjusted earnings number Ed.

Okay. Anything to report, I know you're forecasting that the hydroxide shipments will improve throughout the year, is there anything to report from a customer level that gives you that confidence that just the continued discussions or do you think that they're running low on the particular stockpile and therefore will need to repurchase?

Yeah Ed, you're familiar with the situation. We had about 30 plus years of our long-term consistent supply agreement in place that ended in 2015. Since then, we've been negotiating to renew our long-term contract. Last year we had one spot shipment in Q3. We had nothing in Q4, nothing in Q1 of this year. But I can tell you that we have continued to make good progress in our negotiations and our forecast as it was last quarter and our forecast now, includes the assumption that hydroxide sales resume later here in 2015. So, there has been I would call it positive development and momentum in negotiations in the first quarter here and we feel good about our forecast in the future.

Okay. As I look at the coatings division itself and I look at -- and I see revenue down about 9% and I thought about the medical test strip was a larger portion of that business, but I see that the decline in an operating income is as much stronger than the decline in revenue and I am trying to get this -- I'm trying to get a sense as to the kind of the mix there and what might be occurring in the division? If you can kind of get a little granular percentage and give us some idea.

You bet, so first of all, I'll remind you in Q1 of 2016 this business delivered operating profit at 17% of value-added sales, which was a record and in fact that quarter, I said it was the perfect mix in volume with mainly like our after ceramic foster wheel had very high volumes our blood glucose test strip and the particular products that we serve there were very favorable mix and so it was kind of an ideal situation in Q1. That being said, in 2016 margins of this business improved to 12%, return on value-added sales, which is the fourth consecutive quarter of improving. So when you look at the year-over-year decrease, it's 9% operating profit compared to 17% or $4.1 million as you referenced a number is a pretty tough comparison, but to answer your specific question, yes it was the customer transition in blood glucose test strip, but also on the optical coating side, it was unfavorable mix that we had this month, sorry this quarter compared to last quarter when you look at the phosphor wheel and the after phosphor wheel and the mix shift in overall projector display I would say.

Got it. And is there a price compression too on the test strip you as you shift to maybe a more competitive situation and sharing volume?

The price pressure I would tell you and the topline revenue as they go from a gold to a less gold containing product from a revenue standpoint, there will be some benefits to the customer and some decrease in our results, but from a value-added standpoint, there should not be a significant pressure. So, the main headwind is volume as you go from 100% share to 50% or approximately 50% share and so what's going to offset that volume is the growth and expansion with other customers and the blood glucose test strip market.

Got it. Okay. Thanks very much.

Thank you, Ed.

Thank you. Our next question comes from the line of Marco Rodriguez with Stonegate Capital Markets. Please proceed with your question.

Good morning, guys. Thank you for taking my questions.

Good morning, Marco. Good morning.

Good morning, Dick. Congratulations on your coming retirement and Jugal also congratulations for coming on in.

Thank you.

I was wondering Jugal, if maybe you could talk a little bit more about your priorities. You outlined four steps or four focus points that seem to make sense here, but you also talked about a performance-based culture that I guess I'm kind of curious about it if you can maybe talk a little bit more about that in detail and if this is kind of changing some mentalities if you will across Materion?

Yes, first of all thanks for your question Marco and I would say that I don't think it's something that's changing across Materion. I think Materion has done an excellent job of making sure that the right things are being done in the business over the last several years But as we come on Board and as we look at these priorities, what we need to make sure is that everyone within the company understands what our priorities are and is able to relate to what their role in those priorities is and then they can then take those items that they have to deliver on and actually deliver on those items and I think that's what a good performance-based mindset and good performance-based culture does is that you understand what is expected of you. You understand is that expectation is something that can be delivered on and then you develop the right plans to do it. So, I think it's more I would say associated with making sure that the four priorities that I've outlined are priorities that we can roll out effectively across Materion and then have the right mindset and culture to deliver on those and I'm confident that we'll be able to do that. I've had the pleasure so far to visit four plants on the East Coast. I am going to be doing more plant visits here in fact after this call here in the Midwest area and then we've got a trip lined up on the West Coast in Asia and so far, all my visits have been extremely positive in terms of what the people are looking for and I think what they want to be able to accomplish. So, I expect -- I expect that we're going to be really focused on these four priorities with a really strong performance-based mindset and culture and you've seen the results from this quarter, which are very positive results. The team has done an outstanding job of making sure that the earnings come through and the growth has come through and we're very focused on making sure that the same happens for the upcoming quarters and that's why we're confirming the guidance. We're making sure that you understand what we're going to deliver and then we deliver on it.

Okay. I appreciate that. Then moving into some of the segment reporting here, following up on the precision coating questions earlier, can you talk a little bit more here -- you're talking about the profitability maintaining that double-digit profitability, you're at 12% operating margin on VA sales last year. Obviously just shy of 10% this quarter. You've got some volume headwinds presumably I am assuming as well maybe some margin headwind as well on the gross margin side, can you just talk a bit more, are you really going to be just be picking up volume to kind of get that or are you going to be stripping out more costs?

Let me be clear. So, in Q1 we did 9% and I don't know that from a Q1 forward, there are significant volume headwinds. Q1 is reflective of a transitionary period with this particular blood glucose test strip product line specifically and so we don't forecast or anticipate what I call a volume headwinds going forward. We have shipped the next generation product and in so I really think going forward from here it's not a volume headwind, maybe even a little bit of a volume tailwind as we get later in the year. If you look at some of the seasonality of our optical coating business in particular and some mix improvement going forward.

And so, you're forecasting with your gross margin on VA sales. Obviously the Q1 compare year-over-year, you highlighted the fact that it was a tough compare, but looking at the last three quarters in fiscal '16 still fairly solid gross margins on VA sales. Are you forecasting similar type rates or are they going to change somewhat?

Yeah, we'll be similar. So, last year we did 39%. On the full year this year was soft at 36%. If you go back in Q4 it's 34%. So, this transition has impacted the margins Q4, Q1 and we anticipate to be recovered by the second half of 2017, back to historical margins of the 38% to 40% type range.

Got you and then switching here to the performance alloys, I'm not sure I caught all of it but I think that there were some mix issues that arose in the quarter. Can you just talk a little bit about that and expectations of mix going forward?

Yes. So, I'll make some brief comments. The mix issue here was the high purity beryllium into the defense and we had a very strong quarter in Q4. So, if you're looking sequentially or even if you look year-over-year that was down. That is again not systematic of lost market share. It is simply timing of delivery of some of these larger defense orders. You can see that in our defense end market sales, which were down both sequentially and year-over-year for the segment. So that mix negatively impacted this particular business. Also, that telecom infrastructure for this business, which is mainly undersea repeater housing, that was down, that's also a high margin. All of that was offset because you saw the value-added sales grow with expansion of our lower margin copper beryllium strip product line and that was primarily in the Asia market for electronic connectors. Big picture the profit improvement plan in PAC, it is working and it's a little bit discouraging, it's hard to see in these Q1 results because that mix shift in beryllium, but if you go specifically to the copper beryllium business, that business itself had sequential $2 million improvement in profitability Q4 to Q1 as we have been initiating pricing improvement initiatives, mix improvement initiatives within copper beryllium and also some of our cost savings initiatives, although the Japan action we made a lot of progress in restructuring the Japan service center, that won't be complete until the end of Q2. But that will deliver going forward $2 million of annualized benefit and then there's a volume pickup. We commented on the order entry rate. The order entry rate in our performance alloy business has been strong the first half of the year and that's partially as the oil and gas market starts to come back a little bit, but as we commented, industrial consumer electronics also have some positive momentum in our current order entry rate. So, we are making progress in the profitability improvement plan within the PAC business. It's just a little bit disguised because our high margin beryllium business was down in the quarter, although it's not forecasted to be down for the full year. It will have a heavy back half of the year similar to what it had in '14 and in '16.

Got it. And then a last quick question just circling back around here on the beryllium hydroxide and I believe you guys are -- you talked about earlier as far as forecasting some revenue or some shipments there. I heard your response to the prior question there, but just wondering if maybe I can ask somewhat differently here, do you have actual orders or orders are coming or is it more of kind of just like a feeling indications of interest if you will?

Yes. Marco, let me let me take that on. I think the discussions that Joe mentioned earlier, we've been having discussions with our customer base and those discussions are progressing very well and as he indicated, we have in our plans to resume shipments here in the second half of the year, but I think that's something that we'll be able to hopefully communicate to you more down the road.

Got it. Thanks a lot guys. I appreciate your time.

Thank you.

There are no further questions at this time.

Okay. So, let me make a couple of summary comments here. So first I like to thank Dick for his outstanding leadership that he's provided to the company for 43 consecutive quarters. That's just phenomenal. So, Dick thank you very much for that and I like to thank of course the folks that have dialed in and participated on the call. I look forward to joining you for the quarters to come ahead and I can assure you that we are focused and committed on the business as you've seen here in the first quarter with the result that we've delivered and the confirming the outlook that we've provided to here for the rest of the rest. So, thank you again.

And think you as well. This is Stephen Shamrock and this concludes our first 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 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.

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