Greetings and welcome to the Materion Corporation Second Quarter 2020 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, Interim Chief Financial Officer. Thank you. You may begin.

Good morning. This is Steve Shamrock, Interim Chief Financial Officer. With me today is Jugal Vijayvargiya, President and Chief Executive Officer. Our format for today’s conference call is as follows. Jugal Vijayvargiya will provide an update on COVID-19 and key strategic initiatives. Following Jugal, I 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 earnings before interest and taxes, 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 the prior year period for comparative purposes and removed special items, non-cash charges and certain income tax adjustments. And now, I’ll turn it over to Jugal for his comments.

Thanks, Steve, and welcome, everyone. I hope all of you and your loved ones remain healthy and safe, as we continue to manage through these challenging times. Today I'll provide a COVID-19 status followed by the update on our key strategic initiatives health and safety of our people continues to remain our overriding priority. Throughout this very difficult time we've taken input from all available sources and implemented protective measures for our people. To-date 11 of our employees have tested positive for the virus and I'm happy to report that they're all doing well at this time. Nine people returned to work while two are quarantined at their home. A majority of our office employees continue to work from home while all of our factories continue to operate. And as you would expect we felt the full impact of COVID-19 in a number of our key end markets in the second quarter including Consumer Electronics, Energy, Industrial, Automotive, and Aerospace. Despite these very challenging market conditions we delivered sequential value-added sales and earnings growth. Defense end market sales rebounded in the second quarter and we continue to see strong demand going forward. Sales in the medical market particularly healthcare equipment used in the fight against COVID-19 contributed to sequential growth. We expect this to continue into the third quarter. In response to reduced demand we actively managed our costs which you can see in our financial results. Sequentially our sales increased 2% while earnings increased 14%. Let me now transition to providing an update on our One Materion multi-color profitable growth initiatives. Once again I have some exciting news to share. You will recall we held a special call announcing the signing of Optics Balzers acquisition. Our teams have looked diligently to close the acquisition in just six weeks. This…

Thank you, Jugal, and good morning to everyone joining us on the call today. During my comments, I will cover second quarter 2020 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 third quarter 2020. Following my remarks, we will open up the line for questions. In the midst of a global pandemic, I am pleased to report second quarter results which exceeded the first quarter. Second quarter value-added sales which exclude the impact of pass-through precious metal costs were $161.6 million, up 2% compared to first quarter value-added sales of a $158.7 million and down 17% versus second quarter of 2019. Compared to the first quarter defense, telecom and data center and medical end-market sales improved, which offset reduced demand and markets impacted by the COVID-19 pandemic including automotive, consumer electronics, aerospace and industrial. We also had higher raw material hydroxide sales on a sequential basis of approximately $4 million. On a year-over-year basis, all major end-markets except semiconductor were down due to the impact of the pandemic. With the consumer electronics, industrial, energy and aerospace end-markets are most severely impacted. Gross margin was $48.1 million in the second quarter compared to $69.6 million in the prior year second quarter. Excluding special items related to COVID-19 adjusted gross margin was $50.8 million or 31% of value-added sales. An improvement compared to the first quarter adjusted gross margin of 30% versus the 2019 second quarter gross margin was down due to lower sales volumes and resulting manufacturing inefficiencies. Selling, general and administrative expense totaled $32.9 million a decrease of $7 million versus the prior year of $39.9 million excluding special items related to the acquisition of Optics Balzers adjusted SG&A expense totaled $31.5 million.…

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Phil Gibbs with KeyBanc. Please proceed with your question.

The question that I had was around optics and the acquisition that obviously closed here very recently, in your guidance commentary for the third quarter, are you anticipating this deal to be accretive, is there any purchase price accounting that we need to be aware of, you know any help on that would be, would be good? And then are you still, of the opinion that this is a $20 million EBITDA business in the next two years to three years?

Yeah. Phil, first of all, I can tell you that, as I indicated you know our teams done just a wonderful job of getting this thing done in such a short period of time six weeks, even though we're in the middle of a pandemic. So I you know the team's got to be congratulated and we're extremely pleased to have optics falters and the people on board. Very excited about what I think the future holds as we've indicated in our call that we had and the few comments that I made already earlier here. You know with regard to how we move forward here, obviously they're going to be, they're going to be in our Q3 for about a couple of months. So we'll have, we'll have that in there. I don't expect, I don't expect really any meaningful impact here in Q3 as we just kind of bring them on board. But I think you know we're committed as we've indicated I think in our earlier call that we would expect this business to be accretive in the first year of, first year of ownership. That's our plan. We’re continues down that plan. As we've also indicated, this is really a growth place for us, we really want to have our two teams work together and drive the maximum possible growth that they can, as we're going to be quite focused on that. But in general, you know I expect this business to be, as I said not really a meaningful impact here in Q3 is just a couple months, but then really starting to hit the ground running here in Q4. And what I would add to Phil to your comments on purchase accounting obviously, I mean, we've only owned the company for less than a week. So you know that's something that we're really focused on here in Q3 and obviously can give you a better update on that on the next call relative to the impact of personal accounting. So …

I appreciate the existing clad investment is intact. I think your time line there was late 2021, early 2022, but you do have existing assets that are prime to perhaps should ship greater material into this opportunity later this year and early 2021, maybe give us an update on what you're seeing there, or should we should we anticipate any contribution later this year or early next year should we anticipate any contribution later this year early next year and could it be -- could it be meaningful?

Yeah. So, I can tell you, what we referred to is one of the short-term project to be able to you know fulfill some near-term demand for our customer. We are taking existing capacity. We are having to update that capacity as we mentioned last time, so we're spending some money to get that capacity to be able to produce this product. We expect that we'll be -- we'll be doing that later -- later this year. And if there was an issue and really what that means it’s for pandemic-related or anything then you know it would be early next year. But we really hope that we're going to be able to later this year have some -- have some sales and then really it just comes down to the sooner we can get started the sooner we can have an impact. There will be a ramp, if as you can imagine. So you know if we can get started today then we might be able to have a reasonable impact here in Q4, but if it's later, you know much later in the year then it may not be able to have a meaningful impact in Q4. And that's one of the reasons why we've -- we really just provided more of a near-term overall company guidance. So the project is on track and just to answer and maybe anticipating a potential question for the – the longer-term project, it's on track as I indicated already that we've received you know $31 million from the customer versus the $12 million that we reported last time, so a very, very good progress. And despite again, everything that's going on around us, and the team is just making really, really good progress, we want to hit that at the end of next year perhaps you know in the early 2022.

The last question is just housekeeping. Steve, you mentioned I believe that the mine -- mine spending this year was going to be $14 million. What is your gross -- gross CapEx before that that number?

Yeah. So Phil, we split that out even in terms of providing guidance. So you know what we said on the – I’ll say our normal CapEx, we're still forecasting about a $30 million run rate, if you exclude the project that Jugal referenced earlier for engineered clad strip. So if you segregate that, you know we were at $10 million before on mine development. Now we're forecasting $14 million. And that's really just based on the fact that we finalized our pit opening approach strategy and actually that is to minimize the overall cost, but actually it's accelerated some of the timing into this year versus next year. So – and as you know that that mine development expenditures can fluctuate a lot from year-to-year unlike our, I would say our more steady state normal CapEx. So …

So it's $30 million of CapEx, $14 million of devolvement plus the project…

Correct.

…less the prepayments?

Correct.

[Operator Instructions] Our next question comes from the line of Marco Rodriguez with Stonegate Capital. Please proceed with your question.

Hey, I was going to follow-up on the prior question in regards to the client for the expansion. It was a pretty nice benefit to your cash flow from operations which were receiving the prepayments and then obviously CapEx of roughly $32 million year-to-date. Just kind of wondering, if you can kind of walk us through the impacts you're going to see on your cash flow statements and the prepayments, and then how that kind of dovetails into the additional CapEx you'd need for that arrangement?

Yeah. So Marco, what I would say is, you know what you're going to continue to see even going forward is in our operating section of the cash flow we’ll continue to get additional prepayments from the customer so that number will continue to grow. And then as you’ve seen already from a CapEx or our CapEx line in the cash flow statement it’s up significantly versus just last year due to this project. So you're basically going to see a growth up you know of both lines there as we kind of progress throughout the year. So hopefully that's helpful from that perspective.

And I apologize if I missed this but did you juice segment the $32 million that you spent year-to-date between what is Materion normal run rate versus the prepayment?

No we're not breaking that up separately but obviously that's a significant driver of the increase year-over-year. So.

Got it. Okay. And then kind of sticking along with the PAC segment I’m just kind of wondering looking at the end market breakout that you provided in your press release Automotive well obviously down year-to-year it doesn't seem to be as significant as some of the other areas and just kind of given the fact that most of the automotive manufacturers at least in the US and then obviously at times in Europe or were shut down completely. Just kind of wondering how I would have expected a much larger decline year-over-year. Can you maybe talk a little bit about that segment and what you're kind of seeing there?

Yeah. I think what you're looking at perhaps you're doing the you're doing the year-over-year comparisons there. So part of that I think is just the baseline comparisons Marco that you're seeing. And part of it is you know which lease is that we deal with them which with customers so it's really just also depending on that. I mean as we've talked before in our automotive business is mainly outside the US. So some of the some of the shutdowns that occurred In the US didn’t have as much as impact on us as perhaps the outside. So, for example, Asia we’re starting to come back, and so some of businesses in Asia and then of course in the Europe. So that I think those factors contribute to us maybe perhaps from your view you know maybe not having add that dramatic of an impact on our [indiscernible].

Got it. That's helpful. And then switching over to the AM segment, last quarter you guys talked a little bit about the negative impacts you saw in Q1 due to new product launches kind of weighing on manufacturing efficiency. Just maybe if you could talk about or update us there whether or not those new product launches have sort of worked their way up the ramp and there’s less of an impact on your margins there, or anything you can kind of provide in terms of color would be appreciated.

Yeah. So I would say that, in general, we’re continued to make progress. As you can imagine the progress is not as much as with life because of I think some of the challenges that we're facing of course on the pandemic side. So one of the things that we're having to do in our manufacturing facilities to that implement many, many safety procedures and protocol to protect our people. So social distancing, shift structure changes and other things, so there's a lot of I’d call negative impact that it happens across the board not just in our Advanced Materials business. Now, of course, we're offsetting that and continue to drive performance improvement on Advanced Materials, so just to give you an idea sequentially our sales are – were down 8% on Advanced Materials. However, our earnings were up 2%. So despite the 8% down in sales, we actually were able to improve our earnings and that is clearly due to the improvement that our teams are making. Of course, they said those improvements are being masked by all the – some of the other issues that we’re dealing with as well as the sales drop of roughly 8% that I mentioned. So progress sequentially and we -- but we’ll continue to make progress into Q3, Q4 et cetera from that perspective.

Got it. And then on the Optics Balzers acquisition, maybe give a little -- if you can kind of paint the picture here in terms of a blueprint, if you will, in terms of the integration efforts that you'll start to undergo here. And then how you're kind of thinking about the synergies, I know that we talked before that the expectation is to have those -- those synergies in a few years to such that, it’s a $20 million EBITDA type business. But maybe if you can talk a little bit more now that the company is under your umbrella now?

Yeah. So, as we have -- as we have you know just brought the company as you said sort of using those words under our umbrella you know this week, our teams have started to work very actively together. We have a integration team that we formed with an integration director, we recently hired just within the last week or so a executive that has come onboard will lead to the integration efforts, dedicated to this -- this very, very important initiative. In that integration team, we have work stream owners from various functions and from various regions that we've defined what the -- what the level of integration that we’re going to do as well as what the level of synergies that we will accomplish and you can imagine you know integration involves synergy-related items and then I'll call non-synergy-related items, right. So just making sure that our teams from them they can work together effectively. We’re starting to drive maybe some common processes and common tools and at the same time driving more top line improvements and perhaps some cost level improvements and those are more -- those are more quantifiable synergy items. So we have the integration team that has been established. They've started to meet. They're developing their you know sort of 30-day, 60-day, 90-day you know 6-month, 12-month type of plan. And then it is our intent to drive that in a very, very disciplined basis. You know with regard to the synergies in general that we've talked about in the past as well. So, our objective that we really want to focus all of our attention on growth and being able to profitably grow the combination of Optics Balzers and our business. And I can tell you that that's one of the key work streams that we have an in integration process. We're starting to look at what kind of objectives we can set for ourselves for next year and beyond. So that the teams can enter – you know put energy around those objectives. So, it's very, very exciting, but of course very preliminary right now just as having it here in the first week and we look forward to be able to provide you and others updates you know in future calls.

Got it. And last question just a housekeeping item on the balance sheet inventory level. So I've been picking up here sequentially for the last few quarters. Can you just talk a little bit of the drivers there?

Yeah. Sure, Marco. I would say from my side you know if you think about it especially with COVID-19 and some of the shutdowns that we had in the second quarter I think basically there were a lot of customer orders that were canceled. So you know from that perspective you know it left us in a little higher inventory position. I can tell you, you know looking forward, looking ahead we are clearly focused on managing our working capital and actually I point out if you look at our cash flow statement we actually had less used working capital this year versus last year. So, again it's something we're very focused on. And you know expect to try to work down those inventory levels in the second half of the year or so.

We have no further questions at this time. Mr. Shamrock, I would now like to turn the floor back over to you for closing comments.

Thank you. This is Steve Shamrock and this concludes our second quarter 2020 earnings call. A recorded playback of this call will be available on the company’s website materion.com. We would like to thank all of you for participating on the call this morning and your interest in Materion. I will be available to answer any follow-up questions. My direct number is 216-383-4010. Thank you very much.

Ladies and gentlemen this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.