Materion Corporation (MTRN) Q1 2018 Earnings Report, Transcript and Summary

Greetings and welcome to the Materion Corporation’s First Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host today, Mr. Steve Shamrock, 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 an update on key initiatives. 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, 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 number 5 in this morning’s press release. The adjustments are made in both the current year and prior year periods for comparative purposes and removed certain non-recurring legacy, legal and environmental matters, certain income tax adjustments, CEO transition costs, cost reduction actions and merger and acquisition costs. And now, I will turn it over to Jugal for his comments.

Thank you, Steve and a good day to everyone. I am pleased to report that we are off to a great start in 2018 as we build on a successful 2017. Today, we reported value-added sales for the quarter at $181.3 million, an all-time high and a 22% year-over-year increase. Adjusted earnings are up 76% from prior year at $0.51 per share. This is the fifth consecutive quarter of year-over-year growth in both value-added sales and earnings. Our Commercial Excellence strategy is working as we delivered 14% growth in value-added sales excluding the Heraeus target materials business acquisition. We reached double-digit growth rates across the majority of our end-markets, with industrial components and the commercial aerospace markets leading the way with 36% and 52% growth respectively. New product sales reached $31 million, accounting for 17% of value-added sales. Our robust pipeline of new differentiated products continues to enable market share gains and new application wins. ToughMet Bushings for aircrafts and copper beryllium rod and wire are two of the products contributing to the strong sales growth. Consumer electronics, our largest end-market grew 16% overall and 6% organically as we continue to have meaningful success establishing Materion as a key business partner. Our focus on the customer has led to two prestigious awards. First, we were recognized by Texas Instruments for Supplier Excellence and second, we received Skyworks, Supplier of the Year award. Success in growing the top line is accelerating the benefits from our operational excellence strategy. Productivity enhancements and yield improvement initiatives deliver benefits ahead of schedule when production volumes are growing double digits. We are employing disciplined execution in establishing the previously announced pillars for sustainable profitable growth. We have recently added digital as the newest pillar which will lead to an enhanced customer experience and product innovation along with productivity improvements. Our newly appointed Chief Information Officer is leading the framework, which will position us as a market leader. Our investments and organizational changes positioned us well to continue executing our strategic priorities and to deliver sustainable profitable growth. As a result, we are affirming our prior guidance of $1.95 to $2.10 per share. We remain focused on delivering both near-term and long-term shareholder value. At this time, I will turn the call over to Joe.

Thank you, Jugal and welcome to everyone joining us on the call today. During my comments, I will cover first quarter 2018 financial highlights, review profitability by segment, provide brief comments on the balance sheet, cash flow and modeling assumptions, and finally, cover the earnings outlook for 2018. Following my remarks, we will open the line for questions. I am pleased to report strong first quarter 2018 financial results which exceeded the earnings guidance provided and represents the fifth consecutive quarter with year-over-year growth in both value-added sales and operating profit. First quarter 2018 value-added sales, which exclude the impact of pass-through precious metal costs, were a record $181.3 million, representing an improvement of 22% versus the prior year first quarter. As a reminder, the Heraeus acquisition which closed late in the first quarter of 2017 contributed $12.2 million of incremental value-added sales in the first quarter of 2018. Excluding the impact of the acquisition, the base business grew 14% year-over-year driven by new product sales, improved product mix and end-market demand. New product sales in the first quarter of 2018 were $30.7 million or 17% of value-added sales in the quarter. Our largest end market, consumer electronics grew year-over-year 6% organically, which is very impressive considering the inventory correction that took place in sub-segments of the market. Sales into industrial components, commercial aerospace and telecommunications infrastructure, all grew organically more than 25% over the prior year period. Our commercial performance around new product introductions and market share gains combined with improved economic demand is driving above market organic growth rates. Gross profit margin was $58.3 million in the first quarter, an increase of 35% from $43.1 million in the prior year first quarter. Expressed as a percent of value added sales, gross margins expanded over 300 basis points from 29% to 32.1% driven by performance improvements and leveraging the sales growth. Selling, general and administrative expenses totaled $38.5 million, up $5 million over the prior year first quarter of $33.5 million due primarily to increased cost associated with the acquired Heraeus target materials business, variable expense directly related to value-added sales growth and improved financial performance and strategic investments. As a percentage of value-added sales, SG&A expense decreased to 21% in the first quarter of 2018 down from 23% in the prior year period. Operating profit totaled $13.3 million in the first quarter of 2018. Adjusted operating profit, excluding a legacy legal matter, was $14 million, up 75% compared to the prior year first quarter adjusted operating profit of $8 million. Performance improvements related to commercial and operational initiatives, along with sales growth led to the year-over-year increase. Looking at income taxes, we recorded $1.5 million of tax expense in the first quarter of 2018, which includes a $600,000 discrete tax benefit related to U.S. tax reform. Excluding the impact of this discrete tax item, the effective tax rate on adjusted earnings was approximately 17%; in line with the full year guidance provided. Adjusted net income for the first quarter of 2018 totaled $10.6 million or $0.51 per diluted share, up 76% from $0.29 per share recorded in the first quarter of 2017. We have now delivered $0.50 a share or more for three consecutive quarters. Now, let me review 2018 first quarter performance by business segment. Starting with Advanced Materials, value-added sales in the first quarter of 2018 were $58.3 million, up 23% versus first quarter 2017 value-added sales of $47.3 million. Excluding sales related to the acquisition, value-added sales declined 3% due primarily to softer demand in the consumer electronics end-market. Operating profit for first quarter 2018 totaled $5.9 million compared to adjusted operating profit of $7.4 million in the prior year quarter. The decrease in segment operating profit was due to a combination of lower demand in the consumer electronics end-market, unfavorable product mix and planned integration expenses related to the relocation of the Heraeus target business in Germany. If you recall, we previously communicated that we successfully integrated the HTB Arizona site into our Albuquerque facility and consolidated two facilities in Taiwan. We recently completed construction of a new state-of-the-art target manufacturing facility in Alzenau, Germany. We expect to complete the move and commence production at the new facility later in 2018. Looking now at our Performance Alloys and Composites business, first quarter 2018 value-added sales exceeded $100 million for the second consecutive quarter, an increase of 27% versus the first quarter of 2017. Excluding hydroxide sales, value-added sales improved 22% versus the prior year with success in new product introductions commercial execution and improved end-market demand all favorably impacting results. Operating profit in the first quarter of 2018 totaled $9.9 million or 10% of value-added sales, the highest level in the last 3 years. Commercial and operational improvements combined with meaningful sales growth led to the significant improvement versus the prior year. We also benefited from a richer-than-normal product mix in the first quarter, particularly with respect to our bulk alloy products. This business continues to make meaningful progress on the recovery plan introduced in 2016. Although we expect more of a normalized product mix in future quarters, we remain committed to be in a position to consistently deliver operating profit margins at historical levels. Turning finally now to the Precision Coatings segment, first quarter value-added sales were $23.6 million compared to $23.3 million in the first quarter of 2017. Medical end-market sales were down year-over-year 6%, while the Precision Optics business recorded near double-digit growth driven by strong sales into the defense and consumer electronics market. Operating profit for the Precision Coatings segment totaled $3.4 million in the first quarter of 2018 or 14% of value-added sales compared to $2.2 million in the first quarter of 2017. Operating profit margin in the current quarter was the highest in 2 years driven partially by a very favorable product mix being sold into the defense and consumer electronics market. Moving now to the balance sheet and cash flow, the company ended the first quarter of 2018 with a net cash position of $16.6 million compared to a net debt position of $16.3 million at the end of the first quarter of 2017. Operating cash flow improved $9 million in 2018 compared to the prior year due to stronger earnings and reduced working capital requirements. We continue to maintain a very strong balance sheet and have significant available liquidity to support capital allocation priorities mentioned on previous calls, including organic growth opportunities, further inorganic growth opportunities and to consistently return capital to shareholders. For financial modeling purposes in 2018, capital spending should run approximately $30 million to $35 million, mine development investments should be $5 million to $10 million, annual depreciation and amortization should run approximately $35 million to $40 million, and assume a 16% to 18% effective tax rate. And finally now the earnings outlook for 2018, based on our current order entry activity and end market outlook, we remain cautiously optimistic about continued growth in 2018. We are focused on executing commercial and operational performance improvements to drive top and bottom line year-over-year growth, while at the same time make strategic investments to position the business to consistently deliver profitable growth over the long term. Based on these factors, we are confirming our full year 2018 earnings guidance of $1.95 to $2.10 per share. The midpoint of this range represents an 18% improvement over 2017 adjusted earnings. From a quarterly guidance perspective, we expect second quarter 2018 earnings to be comparable to first quarter 2018 earnings, which would represent the sixth consecutive quarter of meaningful year-over-year earnings growth. This concludes our prepared remarks. We will now open the line for questions.

Thank you. [Operator Instructions] Our first question comes from Edward Marshall with Sidoti & Company. Please proceed with your question.

Good morning, Jugal, Joe and Steve. How are you guys doing?

Yes, good morning.

Good morning. So I have a question, the guidance in the outlook for 2Q, it looks like very similar to the comp rates. If I take the midpoint of your guidance for the year and I know it leaves about $1 remainder – for the remainder of the year, the midpoint kind of suggests that – I mean am I thinking about this right? It looks like about $0.50, $0.52 a quarter for the remainder – for the balance of the year is kind of how you are thinking about quarter-to-quarter, I know you don’t give necessarily quarterly guidance, but that’s what the math says?

Yes. I mean, Ed, if you do the math and back into it the way that you just explained, I mean that’s what it would suggest to the midpoint. And as you indicated, we provide some indication of what the second quarter is which Joe just did. And then we have given of course the full year guidance. We are focused on making sure that we continue the strong performance that we had here in the first quarter and what we build from 2017 into the second quarter and then into the full year, but yes if you do the math, I mean that’s what the math would lead you to.

Okay, okay. When I look at the AMT business, I wanted to understand a little bit better, if I could talk about – you talked about organically down 3%. There has been a few handset suppliers that have seen some issues and some pressures. I am curious if you have an idea of the length of de-stocking. Did it continue into 2Q as the month of April, I guess or has it subsided?

Yes. So first all, as you – I know you indicated the handset suppliers and talking about what they maybe going through, we don’t comment specifically on any customer or maybe a specific area, but what I can tell you on that business, couple of things. One, obviously we have seasonality with general consumer electronics business in Q1, so that’s one. Second is there was a – I would say a de-stocking or inventory correction that the business went through in Q1. We believe that, that is starting to be behind us and maybe on a go forward basis, it would start to come back to maybe a normal mode, but of course, there is more to see as we continue to work with our various customers. I mean, the good thing with our consumer electronics business in total is that it’s a pretty diversified business. So, you saw that overall consumer electronics for the company, organically, we grew 6%. With the acquisition that we did, it was 16%, but I think overall, we will continue to do well in the consumer electronics market and hopefully the inventory correction that was there in Q1 is going to slowdown and get back to normal as we move forward rest of the year.

Got it. The margin improvement that you saw in PAC, I am curious if you can kind of maybe break – maybe look at mix, price and efficiencies, because I know there has been some efforts there. Can you talk about those three buckets and maybe what was the most meaningful impact in the PAC margins in Q1?

Yes. So, all the things that you indicated, first of all, led to the margin improvement. We had – I would say a little bit of a tailwind in Q1 for the PAC business. One, we did have a richer mix, particularly in our bulk products that really helped us in Q1. We also were able to initiate a new distribution agreement with a company in Europe that helped some of our sales activities. Pricing and just commercial activity for us has been a very strong focus making sure that we are getting the right value for the products that we provide. And then we have had a lot of focus on operational improvement with some of the organizational changes that we have made and just in general, driving year-over-year and sequential improvement on our operations. So I would say all of them, all the things that you mentioned contributed to the improvement in PAC. I mean it is our hope, because I mean we are nowhere near declaring victory, but it is our hope that some of these things will continue as we move forward in Q2 and later in the year and we remain committed to have this business at double-digit margins by the end of the year.

Got it. And then it was just broad over – large wide-brush kind of question on the business in general. Rising commodity prices as we see the inflation, I know you pass a lot on to your customers, but how do you see that first affecting your business, but secondarily, how do you to see it affecting your customer’s business in the longer term?

Yes. So, first of all, as you said, majority of these we actually go through and pass to our customers. So, we don’t have, let’s say, a direct impact – an immediate direct impact, meaningful impact for these. So I think that’s obviously a good thing for us as we work with our customers. We also, for any impact that we do have, I mean we’ve got a really robust process in place where we can take into account, where we can take into account increases that are coming in and then figure out what we want to do with them, including if that’s something that we want to work with the customer on. With regard to the overall market situation and particularly I think you look at the industrial market; I mean, we continue to see strength in the industrial market, as you saw with our Q1 sales and with our order entry. So, from a customer side, right now, we don’t necessarily see a downturn in this market. We hope that some of the uptick that we have seen in Q1 will continue the rest of the year as well.

Got it. Appreciate the comments. Thank you very much.

Thanks, Ed.

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

Hi, good morning everyone. Can you provide a little bit more detail as far as the strength within industrial components there what end markets specifically are you seeing that in?

Well, yes, I mean there is a number of things I think in the industrial component section. I mean we don’t breakdown specifically the subsegments of industrial side, but what I can tell you is that as we look at our ToughMet business, ToughMet business is having a very strong start to the 2018. As we look at our rod and wire business, it’s having a very strong start to the 2018 timeframe. So, we think that those types of businesses with some of the new applications that we are getting in. So, I believe we are making good headway into getting some new applications and adding on to our existing applications. Hopefully we will continue. We are really focused on – continue to push our new product pipeline into the various sub-segments of industrial.

I would add to that, Martin, specific products, I mean, you think about bearings, bushings, plate for plastic injection molding, welding and brazing alloys, welding tip heads products of that nature is where the demand is coming from.

Okay, thanks. That’s helpful. And kind of circling back on Performance Alloys and the margin trends there and you had commented on the mix. It sounds like fairly favorable, but probably some step back on the mix near-term here into 2Q. Is that a fair assumption, do you think it will still remain high single-digits?

Yes. Look, right now what we have stated I know in the past is that we want that business to be at historical margins by the end of the year, which is roughly the double-digit 10% margin. We were fortunate to be able to deliver that here in Q1 due to a number of tailwinds that we experienced. And it’s our goal to continue and do everything we can to deliver those types of margins, but with the mix which did help us in Q1, it’s hard to say at this stage if that mix will continue throughout Q2 or not, but I think our focus is on commercial excellence and operational excellence for that business to make sure that we keep making improvements and that we absolutely exit the year with that double-digit margin. But I would love to have the double-digit margins, of course as you can imagine, continue throughout the year, but at this stage, we do need to recognize that we experienced some richer mix that is yet to be determined if it will continue.

Okay, that’s helpful. And one last one if I could, can you provide some updated thoughts on your capital allocation, how you are thinking about the dividend and share buybacks looking forward here?

Yes. So I mean our capital allocation strategy, let me just comment on that and Joe can certainly add to it. Our capital allocation strategy remains the same. We are very focused on making sure that we get organic growth. We want to make sure that we are investing the appropriate investments in the inorganic side. Certainly dividend and share buyback are important elements for us. But I would say from a business perspective, I mean, we are really focused on organic and inorganic growth. As you saw Q1, our organic growth 14% excluding the Heraeus target materials business that we had done acquisition on and we want to make sure that we can really deliver strong organic growth going forward.

Just reminding Martin we as you know are dividend payer and have increased our dividend now for the last 5 years. So, we have been committed to that dividend and increasing the dividend as a form of returning capital to shareholders. As it relates specifically to share buyback, we do have a $50 million authorization, of which about $16 million remains available for share buybacks. That being said, we haven’t been active for the last several quarters in the buyback market. We have been more focused on the organic growth and prioritizing those opportunities.

Could you touch quickly on some of the capital spending on organic opportunities internally for the year?

Yes. I mean one of our large opportunities for the capital spending is the new plant that we have going on in Germany for our business where the Heraeus target materials business that we had acquired. We were actually spending quite a bit of money to make sure we have got our own state-of-the-art facility. We have got that transition started. We expect that transition to now commence here in the second quarter and then in the back half of the year, they would have launched that new plant. So that’s a large part of our capital allocation that we have internally and then we have capital allocation across really all three of our businesses, because we are focused on making sure that all of our businesses are growing organically year-over-year.

I mean, you asked about, as did Ed on the previous call, the improvements in PAC and so that’s been – the gross margins there have been expanding sequentially for the last five quarters now as we execute on our PAC recovery plant and there is some capital investments there to improve yields, but now we are at the point where capacity is also an issue at some particular product lines and so some investments there to support the growth. Recall, that business grew year-over-year greater than 25%, so some of the organic investments are to help support that growth.

Okay. Thanks for the added detail.

Okay. Thanks, Martin.

Our next question comes from Phil Gibbs with KeyBanc Capital Markets. Please proceed with your question.

Hi, good morning.

Good morning, Phil.

Can you touch a little bit on these plant integration expenses in Q1 for Advanced Materials, what that may have been in terms of the headwind to the quarter and how we should think about the flow through over the remainder of the year?

Yes. So, the main driver – that was not the main driver, if you look at the margins in the AM business. The main driver there was the mix and is the mix particularly within the consumer electronics end market as previous caller was talking about. Now, that being said, as we prepare for exiting the Heraeus facility where we have been operating for the last year and move into our new facility, there has been some operating inefficiencies in Q1, which will continue in Q2 as we prepare to move into the new facility. So they are temporary in nature is how I would think about them, but they were not the – they were a contributor, but they were not the primary contributor. The primary contributor was the 3% decrease in consumer electronics sales, excluding the Heraeus acquisition and a mix deterioration within that consumer electronics bucket primarily driven by the destocking that was referenced earlier.

Okay, I appreciate that. And can you provide a little bit of color on the – what you are seeing in the oil and gas and defense markets, please?

Yes. So in the defense market, we saw good positive growth in the first quarter in the defense market, I believe is around 3%. We continue to see the defense market as a good market for us for the rest of the year. I think the environment for the administration is supportive of our product portfolio and so we expect the market to continue to be a favorable item for us and a tailwind. I think on the oil and gas side, the rig count is almost – I think in Q1, it was almost around 1,000, I believe 993 versus 800 or so a year ago. So, we continue to see improvement in the oil and gas side and again, that’s an area that we see as a good positive momentum for us for the rest of the year as well. So both markets we expect to see hopefully tailwind the rest of the year.

How big is the oil and gas market now for you as it relates to the overall business versus maybe 2014, where I know it was probably a stronger contributor, because I know you diversified the business?

Yes. So I would tell you, Phil, at that point, it was $30 million to $40 million business for us in ‘14. And some of this was a peak there in the back half of ‘14. We have not recovered to that level. We are at a run-rate, I would say, about $20 million to $25 million in terms of oil and gas sales.

And Phil, what I would comment on and as we have indicated before, we are not banking on the oil and gas market to recover to those ‘14/15 levels. And so to be able to get to the type of performance that we need to get to, we sort of recognized that, hey look, this is where the market is and we need to make sure our business is structured accordingly. So when we talk to you about our overall plans, I think it’s not banking on the market recovering to the ‘14/15 levels.

Okay, I appreciate that. And then my last question is just on the free cash flow outlook, I know you have given pieces parts to that in terms of the buildup, but any specifics on what you are anticipating in terms of free cash this year? Thank you.

Yes. So I gave the guidance there on CapEx being $30 million to $35 million, mine development being $5 million to $10 million and then from a free cash flow standpoint also cash flow from operations, I would anticipate approximately $60 million maybe to $65 million.

Thanks, Joe. Appreciate it guys.

Thanks.

Our next question comes from Marco Rodriguez with Stonegate Capital Markets. Please proceed with your question.

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

Hey, Marco.

I was wondering if maybe we could circle back around in terms of some of the strengths you guys saw in the CE industrial and commercial aerospace side. I think you guys referenced obviously new products taking share and market demand. Can we talk a little more about the taking share aspects are these like new client wins or perhaps gaining greater wallet share from existing clients. Any kind of color there?

Yes. I mean look, when we have greater applications into those areas, we are replacing existing products that those markets maybe using. So when we talk about commercial aerospace and some of our material being used that is replacing some current type of material whatever that particular material may happen to be right. And when we did the same thing on the oil and gas side or the industrial side, we are in that scenario we are either taking the application that we already have and expanding the application into more areas or we are actually going in and replacing and in that case with a new activity and taking share away. So, I think there is number of initiatives that we have underway where we are gaining – that’s what we mean by gaining market share with some of our product portfolio.

Got it. And then maybe you could share a little bit of color there in terms of the marketing or sales efforts that you are kind of putting forward to ramp that objective?

Yes. So, we have a marketing communications team that is engaged with our sales and marketing team that goes out. We are working with our customers in terms of providing them samples, so they have an opportunity to take those samples and actually do testing on them. We are taking results from customers that we know we can share and then we share that with some of the other customers and be able to tell them what our products can deliver in terms of durability just general quality, cost performance and we are able to demonstrate to them why our products at the end of the day lead to a better value than their existing portfolio using all these various techniques. So, it’s actually been just an all-out effort from a number of our teams. At the same time, we are working with them to develop I will call it the next generation type of products as well in some of those cases, which maybe either more cost effective or even a better quality and performance. So we have got the engagement through their engineering team, through their sales team, marketing team etcetera in a number of different angles that we are approaching.

That’s helpful. And in regard to the new product that you guys had been selling into the market, is there any sort of color you can provide as far as maybe how many additional new product launches you are expecting for the rest of the fiscal year or any sort of color to kind of give us an idea as far as how that is projected to kind of move?

Yes. I mean, we have a number of different areas that the new products fall under, whether it’s a ToughMet or copper beryllium or our phosphor wheel sales on consumer electronics or [indiscernible] optical filters for defense or clad products for thermal management that we do to our technical materials business. And so there is a number of activities that we are involved in. I mean, as you know, we have finished this quarter at 17% and it is our objective to be within the 15% to 20% range I would say for this year. On a long-term basis, we have stated that our objective would be to go past the 20% to accelerate our organic growth, but I would expect that this year we will be in the 15% to 20% range.

And I would also add I mean if you think – you asked about the pipeline of new products. We have actually been narrowing that as opposed to expanding that and trying to accelerate the commercialization of those new products. And so we have a robust pipeline, but we are really trying to focus on those that can rapidly commercialize and deliver the top line growth. And I would also add we talked a lot about product mix and you were asking about the commercial strategies and marketing strategies. When you see improved product mix within these segments, it is our performance as we continue to focus on the more value providing products that we offer and making sure that we are selling and pricing for the value that we provide. And when you look at our portfolio of products, there are some products frequently compete with alternative materials and in different applications, the value proposition is different. And so when we reference improved mix within the PAC organization that is reflective I would tell you partially of the commercial focus that we have and pushing through the value proposition and selling the value.

Got it. That’s helpful. And last question here just kind of following up on a prior question in terms of I guess just the overall raw material inflation that a lot of companies out there are experiencing now and obviously we realized that you pass through obviously the precious metal movements I guess pretty easily. Just kind of wondering, if you are getting any sort of push back and if they can push back in terms of some of that pass through to precious metals? And then also if you could perhaps comment on your ability or if you are getting any sort of push from clients in terms of just inability for you to kind of raise your prices?

Yes. So first of all, on our general agreement that we have on the pass-through, as you know that’s a fairly standard agreement with our customers where they benefit whether it’s up or down. So I think and different materials vary at a time. So, I think they fully recognize it and they don’t really have any issues with that and we don’t really experience any issues with that. In terms of the pricing side, I mean we have had some issues in discussions with our customers where the pricing, let’s say, hasn’t been looked at favorably. But in other cases, I think we have been able to explain to customer why the pricing makes sense and the value that they are receiving for the pricing that we are delivering. So, I mean if we approach it in a meaningful way with the customer with the value/price relationship, certainly it tends to go better. But as you see from our organic growth that we are delivering, we are not having any type of a meaningful negative impact as a result of some of our general commercial activities.

Got it. Thanks a lot, guys. Appreciate your time.

Okay, thanks.

Our next question comes from [indiscernible] with Gabelli & Company. Please proceed with your question.

Hi, good morning guys. How are you doing?

Hey, good morning.

So I was also going to just check on pricing. Are you able to actually give sort of blended margin rates on the new products and how they impact the kind of core margin and if you give that number out?

Yes. I mean, let me just comment more generally and then certainly Joe can jump in. I mean, what I can tell you is that our focus as we continue to look at creating shareholder value in the short-term as well as the long-term is that our new products are delivering more value than some of our legacy products and that they are delivering the type of value that we want for our company long-term. So, we are very focused on making sure that we understand the cost structure and then are able to – and the value that we are creating for the customer and then therefore are pricing the products for that value. So in general, our objective is with the new products to be able to deliver better performance than the legacy products that they are replacing. So, Joe, I don’t know if you have any...

Right, it’s a formal stage gate as we look at the pipeline of new products and introduced new products ensuring that those margins are an enhancement to that individual business segment. That being said, I will tell you that during the ramp-up and the commercialization of these new products, it frequently takes time to hit the targeted volumes and efficiencies to achieve those margins, but generally speaking, new products carry a better margin for these individual segments than the base business averages.

Okay, understood. And then just following that, I mean, kind of taking a sky high view, I look at Performance Alloys’ great performance in the quarter, a strong margin improvement, same for Precision Coatings. Obviously, Advanced Materials is a bit softer. Your guidance for the year is to reaffirm it unchanged. I mean, what would you really have to be seeing this next quarter or the next quarter or two to really kind of push that up, if you will and sort of following that, what kind of inning would you say you are in with the whole one Materion strategy?

Yes. So first of all, I think some of the tailwinds that we experienced here in Q1, good favorable mix, some new distribution agreements that may lead to some more sales down the road, some of our continued commercial and operational excellence items that we have been working on, less impact based on seasonality – I mean, there is a number of things that we highlighted there in Q1. I mean, those things certainly would need to continue into Q2, Q3 and Q4 for us to be able to have more confidence, our order entry that’s coming in, I mean certainly that will be another factor that we take into account on determining if we can push the envelope higher for the rest of the year. Right now, as we indicated I mean we believe Q2 will be in line with what we have delivered for Q1 and it is our hope and objective of course to how we start improve, but with what we see today, we see the $1.95 to $2.10 guidance.

Yes. I mean when you think about it, I will just add color when you think about our businesses and our visibility out in terms of order entry and backlog. In our AM business, we don’t have a long-term I would say or even medium-term visibility. There is quite a quick turnaround there. When you go to PAC, we have a little bit more visibility, which is why we give the quarterly – refined guidance on a quarterly basis. But again, as Jugal said in his opening remarks, we feel good about our start to the year here in Q1 and about Q2 as well.

Okay. And there is not sort of any anticipated incremental costs from the new facility in Germany is there?

Well, I mean there is. As we go through any type of a launch, I mean especially when you go through a new facility, there will be incremental cost and that’s one of the reasons, when you look at our AM business, we have talked about the number of factors into Q1 and then I would see those factors – some of those factors continuing into Q2 as we launch up the facility. So I do see that. Getting back to your question then, your question was on the one Materion and sort of what inning, I think we still would say that we are probably in the early stages of continuing to drive improvement in all the pillars that we have talked about; commercial and operational innovation, acquisitions and then the newest pillar, digital that we have added. We would see continued push in performance in those here in the short-term as well as in the long-term.

Great. Thanks so much, guys.

Thank you.

Thank you. Our next question comes from Edward Marshall with Sidoti & Company. Please proceed with your question.

Just a quick follow-up on the investment in the business and particularly a shorter – one shorter term and one longer term question. I want to start with the short-term because you just sort of addressed it, but I wanted to talk about maybe other – with the expansion in facilities in Germany, is there a specific safety stock that’s being built up or customers bought ahead potentially in anticipation of that maybe disruptions in the supply chain as you kind of shift from one facility to another?

Yes. So we did. We actually went through and did that, I mean, to make sure that we are protecting our customers. So, we did build safety stock and then we have that safety stock that we will be able to use as we go through this transition. So yes, absolutely, any time you go through these transitions, I mean the number one focus is of course on the customer and making sure that we are protecting them and so we did go through and do that.

So as that inventory comes down, what’s the type of source of cash that I should be thinking about as you kind of – I don’t want to say liquidate that, but as you kind of peel that off the books?

Yes. Ed, this is Joe. I don’t think while we did that, when you think about our redundant capacity around the globe, we have been able to subsidize some of what you would typically think of with production capacity domestically and then in Asia. And so it’s not as material inventory build and then de-stocking I guess or liquidation, I should call it in Q2, Q3 that you are going to see. So while we did it to protect our customers and it was well planned from a financial standpoint at the consolidated level, I don’t believe it was that material from a cash flow standpoint.

Got it. And then I guess on the longer term impacts of your investment, I mean you are investing in people, you are investing in R&D, you have got new facilities coming on. So, there is not a lot of investment in the business and if I step back to the last Investor Day, we talked about 8% operating margins for the business. And I guess if your guidance is accurate, you are kind of scratching upon that as we kind of exit 2018, so good for you. But what do you think about longer term once this kind of investment starts to really take dividends to the business, where do you think this business would go?

Well, yes, we as you know – I mean we have not provided long-term guidance here recently, but we continue to emphasize the fact that we are an Advanced Materials company and long-term we want to be able to deliver Advanced Materials type of margins. And Advanced Materials type of margins are double-digit margins or whether it’s lower or mid double-digit type of margins down the road. Now that’s not tomorrow, because we got a lot of work to do in all the areas. But at the end of the day, I think our objective is to be a fully Advanced Materials company delivering the type of returns an Advanced Materials type of company does.

And does the business have the structure on its own without acquisition to be able to kind of hit that double-digit range?

I think there is – I think it’s – we got to fire on all the pillars that we have highlighted. Acquisitions is one of the pillars that we have gone, but I think there is a lot of improvement that the business is going to accomplish by the other pillars that I mentioned, commercial, innovation, operational, digital, certainly acquisitions will be a key element of that, but it’s one out of five pillars that we need to focus on.

Ed, I would point to the segments. I mean, Advanced Materials has a history of running around 15%. PC has demonstrated the ability to get up to 12% on an annual basis. So I think the – and then you have PAC who has been under this recovery plan and delivered the 10% margins here in Q1, which is a dramatic improvement from just 2 years ago. So, we have businesses that I would tell you have the components that have the potential.

Got it. By the way, you said historical operating levels for PAC, what do you think is historic operating levels for PAC?

Yes. When we go back a few years and we look at the type of margin profile that the business had, I mean, it had about a – I am going to say around 9.5%, 10% type of a margin is what the historical number was. And like you noticed and like we reported, in Q1 we reported 10% margins. Although there are some tailwinds that helped us on that, we hope that those tailwinds or some of the tailwinds will continue. And then – yes and then during the year, end of the year, we are delivering on a consistent basis, those historical margins.

Got it. Appreciate the comments. Thank you.

Okay, thank you.

Thank you. At this time, I would like to turn the call back over to management for closing comments.