Greetings, and welcome to the Materion Corporation Year-End 2018 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, Investor Relations. Thank you, sir. 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 and Chief Financial Officer. Our format for today's conference call is as follows. Jugal Vijayvargiya will provide opening comments on the company's 2018 performance and the strategic direction and outlook as we move forward into 2019. Following Jugal, Joe Kelley will review detailed financial results for the quarter and full year highlights, 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 five in this morning's press release. The adjustments are made in both the current year and prior year periods for comparative purposes and remove special non-recurring items, non-cash pension settlement charges and certain income tax adjustments. And now, I'll turn it over to Jugal for his comments.

Thanks, Steve, and welcome, everyone. On today's call, I'm very pleased to report record results for the fourth quarter and for the full year. Earnings for the quarter improved by 27%, a fourth quarter record of $0.65 per share while value-added sales grew to $186 million, also a fourth quarter record. This represent the eighth consecutive quarter of both top and bottom line growth. Our PAC business delivered all-time quarterly records for value-added sales, operating profit and operating profit margin. For the full year, we delivered record earnings of $2.38 per share, a 38% improvement from the prior year and the second consecutive year of greater than 30% earnings growth. All three businesses reported double-digit operating profit margins for the first time ever, including record operating profit margins for our PAC and PC businesses. Value-added sales reached an all-time high of $739 million, representing 9% growth from prior year. Joe will cover additional detail on the financials. Let me shift gears and provide a progress update on our multi-pillar strategy, reviewed with you on previous calls. As a reminder, we established pillars around commercial excellence, operational excellence, innovation, inorganic growth and digital transformation, all supported by a laser-like focus on performance-based culture. Our global teams have made substantial progress establishing these pillars and evidenced by the results I just reviewed. In commercial excellence, our focus on value-based pricing, improved sales mix, addressing underperforming businesses and creating a global sales force has led to record value-added sales and operating profit. We're in the midst of creating a world-class sales force, essential to achieving our aspirations of consistently delivering profitable growth. In operational excellence, safety has been our overriding priority, leading to the best safety rates in history, with 19 sites achieving zero incidents. With our focus on improving working capital, we've…

Thank you, Jugal. And welcome to everyone joining us on the call today. During my comments, I will cover fourth quarter and full-year 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 2019. Following my remarks, we will open the line for questions. Fourth quarter 2018 was a very strong quarter for Materion, and marks the eight consecutive quarter with year-over-year growth in value-added sales and adjusted operating profit. Our consistent delivery of profitable growth is driven by the multi-pillar strategy Jugal referenced. And it is this continued execution of this strategy, which provides momentum as we head into 2019. Fourth quarter 2018 value-added sales, which exclude the impact of pass-through precious metal costs were $185.8 million, up 3% versus the prior year fourth quarter. We set a fourth quarter value-added sales record, despite the drop-off in demand in our largest end market of consumer electronics. The record fourth quarter value-added sales exemplifies our market diversification, differentiated product portfolio and success in commercial execution. New product sales in the fourth quarter of 2018 were $27.3 million, or 15% of value-added sales. We delivered year-over-year value-added sales growth in six of our top seven end markets, with particularly strong performance in energy, medical and telecommunications infrastructure. The growth in these markets was due to a combination of new business wins and stronger overall demand. Consistent with previous quarters, the decrease in consumer electronics was due to lower sales in the display and wireless portion of this market, as customers continue to rebalance inventory levels in response to weaker consumer demand. Despite softness in consumer electronics, commercial execution initiatives related to product mix and market share gains, combined with favorable end-market demand in other end…

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

Hi. Good morning, everyone. I wanted to see if you can provide a little bit more detail and color around the headwinds in consumer electronics. I know you called out, some of this is due to displays in smartphones, maybe how you see that trending quarter-on-quarter and into 1Q? And then how the supply chain is adjusting to that? I'd be curious, when the destock started and whether you think that's getting close to the bottom or we're going to see continued headwinds over first half '19?

Yes. So, Martin, let me give you some numbers and then try to give you some color around that. Our consumer electronics business in total, at the company level, we were basically flat year-over-year. However, in the fourth quarter, we were down about 9%. As you know, the destocking was really starting probably about Q1. We started to see the headwinds around that time. And then throughout the year, there was expectation that the destocking and just general sales would start to improve maybe in the back half of the year. Unfortunately, I think, the market just didn't recover to the level that maybe everybody was expecting. As we look at our order entry and where we see things going, I think consumer electronics will continue to face some headwinds. First of all, Q1 is a very low consumer electronics quarter anyway, just based on seasonality. So, you've got the headwinds, just general headwinds and market headwinds, both for seasonality. And then I think, we expect that the headwinds will continue into Q2. There's some expectation that maybe in the back half of this year, it will start to recover, but I just want to caution us that there was the same type of commentary last year as well and it didn't materialize. So, I think we just have to be very, very cautious. We're looking at, from our standpoint, we're making sure that we have the right cost measures in place, the right pricing and measures in place to be able to make sure that from a profitability standpoint, we can weather the storm, sort of speak, as it happened this year as well. But I think, the great thing about our market, our market positioning is that we're very diversified. As you know, we've got really good positions in industrial and defense, and energy and medical and automotive and telecom infrastructure, et cetera. And I think that allows us to maybe deal with some of the headwinds in consumer electronics. So, even though consumer electronics was down 9% in Q4, for example, we still were able to hit a 3% year-over-year increase in our overall value-added sales. So, I mean, it is an issue for us, but it's one that we're basically dealing head-on and are trying to get more value-added sales through other markets, as well as making sure that the cost side of the equation is dealt with.

Thank you. I appreciate all the detail on that. Kind of delving into the year-on-year. So, it was flattish for the group. Can you talk about what is factored in for consumer electronics in your guide for 2019 on value-added sales?

Yes. So, I think, we're going to see a challenging environment, I think, for the value added sales. As I indicated, I think, in the first half of the year, we expect consumer electronics to be down. And then perhaps in the second half of the year, I could see maybe a flat, perhaps a slight uptick, but I would expect it to be very, very close to just really just being flat. So, in general, a slight negative is for the full year is what I would expect consumer electronics to be right now. But, let's see, I mean, let's see, as the year progresses and see if the market recovers and reacts hopefully better than what I'm saying.

Thanks again for that detail. And if I could one last one. Could you discuss what you're seeing regarding the base price across some of your product portfolio and maybe what you've been able to achieve with the price increases as we move through 2019 here?

Yes. So, value-based pricing has been a major initiative for us as part of our commercial excellence pillar. I mean, we've really gone through and looked at contract-by-contract and using a pricing database and tool that we have to understand what type of value we're planning for our customers and that, are we getting the right type of pricing for that value. And I will tell you that, that has been a major initiative for us, and we made significant improvements in '18. We believe that there are still some opportunities for '19, certainly not to the level that we experienced in '18. But this is a very important item for us. And then, the second thing that we're focused on is making sure that we don't get any new contracts with our customers, where the pricing model that we have doesn't reflect the value that we're providing. So, in general, it's a very important element for us in our commercial excellence pillar.

Okay. Thanks, again. And congratulations on the robust results throughout the course of the year.

Our next question comes from the line of Edward Marshall with Sidoti. Please proceed with your question.

Hi, gentlemen. Good morning.

Hi. Good morning.

So, I want to start, I guess, on the AM. Given the guidance that you talked about from a revenue perspective and the commitment that you talked about the 15% range for operating margins, I'm curious, timing, if you can kind of put any timing to that margin discussion, so that we can kind of get a sense as to maybe what's embedded in your 2019 guidance for that business, but then also kind of the outlook and when you kind of get to the recovery there.

Yes. So first, let me just start off and say that we are absolutely committed to getting that business back to historical margins. And we're doing everything we can to make sure that we're going to do that. And now let me provide a little bit of color, I think of, sort of what's happened with that business and where we see it going. So, there are really two big things that hit that business in '18. One, consumer electronics. We just talked about it, right? I mean it's a major, major part of that business, is roughly 50% of the sales are consumer electronics for that business. So, any type of headwind is certainly going to have an impact. The second thing is, we went through this transition from the Heraeus business over to our factory in Germany. And as we did that, number of things, one, general inefficiencies of a move from one plant to another plant. The second thing is, we had to go through and validate our entire glass business and customers with the glass business and then customers with the semi-conductor business. So, those combination of sales drop as a result of that, the sales drop is a result of the consumer electronics headwind and then the cost impacts of the actual move were just major, major impact items for us on that business. Now, as we get into '19, let me kind of give you a flavor of how we see things. Well, consumer electronics, I just commented, based on Martin's question kind of how we see consumer electronics as a market. From a cost perspective, we've actually made significant improvements on the cost side as, and in particular, the restructuring that we did, taking out about a third of the workforce in our German operation and that is complete by the way. We completed that in Q4. And so, we should realize the full benefit of that here in '19. And then the third is the actual sales recovery of that business based on qualifying with our customers on the glass side, which we have now done a very good job. And I would say, for the most part, we really requalified with the glass customers and we're starting to get that sales back. About the semiconductor customers, it just takes longer. So, that's going to run. That's going to run during the year. So, as I see, as I see this business, I see every quarter would be my estimate that it will continue to improve. Our expectation is that we're reaching 15% at some point during the year. I would think it's going to be in the back half of the year, probably toward the fourth quarter. But every quarter, I expect that we're going to improve and exit the year going into 2020 at the historical margins.

And can you confirm for me that, that 15% by the fourth quarter is embedded in the guidance, look that you have for, is that what you just said? I'm just curious.

Yes. I mean, all the things that I just mentioned to you. The sales recovery, the glass business, the semiconductor, all of that I would say is really what we are, what we've included in our estimation of what the business is going to do.

Got it. And so on the German facility, specifically to the fourth quarter, can you talk about maybe the revenue impact that the transition and if you want to break it down glass and semi, that would be great? And maybe the earnings or profit margin impact that, that business might have had on the transition from the one facility to the other.

Yes. I can talk a little bit about the sales side. So, first of all, as you know, we don't break out specifically our sales and profit for a site or that part of the business. But I'll give you some general flavor around it. Certainly, we had more of an impact from the semiconductor side than we did from the glass side based on the requalification, but there was clearly sales impact. We expect that sales impact to now go away as we get into '19, and as we continue to qualify more and more of our customers. So, there was an impact. In terms of the profit impact, I would say, is a fairly substantial impact. I mean, as I indicated, we adjusted about a third of our workforce, which should give us about a $3 million run rate improvement starting in '19. So that right away, you can look at as a potential. I mean, you want to classify that as a hit in '18 and then, of course, the hit associated with the lower sales. So, it was a fairly substantial impact to our overall AM business. And that's why we feel that during the year, as we now get the customers back and as we have the full impact of this restructuring, we feel that we should be able to exit the year with historical margins.

Got it. And if I can, to what, I think, seems to be driving the business and the results right now is PAC, some pretty good color there on what the business is doing. But I'm curious. Could you specifically talk about which pillar in particular is working in that to really drive the margin? I know some of that's market demand and so forth, but you've done a good job of getting to margins. And then the second part, follow-up to that is, you've talked about historical profit levels. As I kind of walk back in the model, it looks kind of like high-single digits. You're already producing above that. So, do you assume that margin goes down? I just wanted to get some clarity on that. Thank you.

Yes. So, let me just first talk about what's really, I think, some of the key contributing factors in our PAC business is to drive the improvement. So first, I have to say from a pillar standpoint, commercial excellence has really been a core part of what we've done in our business. And that goes from evaluating businesses that we shouldn't have perhaps been in or maybe the pricing wasn't the correct pricing. And so making sure that we go through and evaluate value-based pricing. Looking at our mix that we have in different parts of the world, as we price new products that we are pricing them appropriately and then knocking on customers' door. I mean, let's face it, that business delivered 17%, I mean 17%, 17% year-over-year growth. Right? So, that's a substantial growth and that certainly wasn't just based on the market. So, our sales force, knocking on doors and promoting our products was a contributing factor. So clearly, commercial excellence was a big player. Operational excellence who has been a very, very important element for us, both from the operating profit side, as well as from a cash flow and balance sheet side. We focused a lot on what the clients are doing and maybe looking at yields of certain operations, especially where we had bottlenecks, efficiency improvements. We've really done a substantial amount of work, getting the lean initiatives. We utilized, in fact, an outside firm that work with us and it's continued to work with us on lean initiatives and so operational excellence and then associated cash flow impact, as I said, with the inventory improvements as well. So, that's been a, that's been a major improvement. Certainly, the market mix, by the way helped us as well. I mean, defense and energy, which…

Great. I appreciate all your comments, guys. Thanks very much.

Thanks, Ed.

Our next question comes from the line of Phil Gibbs with KeyBanc. Please proceed with your question.

Hi. Good morning. Question on the pension annuitization. Should we expect the expense levels to come down in 2019? If so, what's the potential reduction? And then secondarily, what should we be thinking about in terms of your contributions in '19 relative to the $42 million that you had in '18?

Yes. Phil, when you look at our operating profit and you think about the annuitization, what we annuitized was retirees. And so we annuitized a portion of those that were receiving payments. And so that will have no impact on our OP, as it relates to pension expense included in operating profit going forward. What has impact there is the discount rates in the asset return assumptions. And so when we look at '18 to '19, pension expense included in operating profit should be flat, relatively flat year-over-year is the answer.

What about your expected contributions?

On the expected contributions next year in the plan is $6 million of cash contributions.

Okay. So that's nice.

In 2019, still mix up by this year versus last year.

Okay. Got it. So, that's a big change. So, that's good. And then just generally speaking, I know a lot has been right and a lot has been discussed about the potential tariffs between the U.S. and China, who knows how it's all going to play out. But curious if you felt, like the potential for tariffs between the U.S. and China had any impact on the business one way or another in 2018 from a supply chain reorientation, customers asking for material early, that sort of thing because particularly, I think, when we look at your fourth quarter results, certainly very strong in PAC, but bucked a lot of the normal seasonality that we tend to see in that business.

Yes. So Phil, what I would say that for the full-year '18, I would say that I don't think we've experienced really a material impact based on the tariffs. But what I will tell you that I think in the fourth quarter, we started to see direct and indirect impact and in particular, for example, there was a substantial slowdown occurring, as you know, in China. And that substantial slowdown is starting to show up in our order intake. Now, China, in total is not a very large part of our business. I mean, it's less than 10% of our business. So again, a small, smaller amount of impact, but it's still an impact. So, and then the general market uncertainty that's happened, I think, around tariffs, companies and I think, countries don't know exactly how things are going to settle out. I think it's caused just overall market weakness and that certainly played out, I think, in the fourth quarter, as we experienced even in our markets. When you look at the type of growth rates that we had during the first three quarters and then the type of growth rates we had in the fourth quarter, you can see the difference. So, I would say, for the full year, really not a material impact for us, probably some impact in the fourth quarter. And then as we now enter into 2019, some of the, especially, the China concerns and the China market slowdown, which I think have something to do with some of the uncertainty around tariffs, can have some impact on us, but again, it's not a large material impact for us.

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

Good morning. And thank you for taking my questions.

Hi, Marco.

Hi, Marco

Hi, guys. I wanted to kind of follow up on some of the line of questioning on operating margins, not necessarily for near-term specific guidance here. But just kind of bigger picture thinking in terms of the long-term margins, if I'm remembering correctly and then obviously listening to some of the commentary here as far as where you're targeting your operating margins on the various segments. You were looking at kind of a 15, or mid teens, if you will, operating margin on VA sales as kind of like a target, if you will. So first, just want to make sure that I'm thinking about that correctly. And then just kind of listening to the commentary on the call here, it kind of sounds like, hitting that number, assuming there is no major macroeconomic headwinds in the next few years that maybe this is a 2020 event, where you try to kind of hit that normalized goal. Can you maybe talk a little bit about that?

Yes. So, as you know, we have not and don't give out a long-term projection for margins. But I will tell you and as I indicated in my prepared remarks, we are focused on developing Materion as a high-performing Advanced Materials company delivering superior returns. I think those were the words I used. And so, and we've also stated that, that is approximately mid-teens type of margins. Now, when we look at our historical performance and kind of where things have been, we were at 6% in 2016, we were roughly 7% in 2017, and we are at 9% in 2018, right? I mean that's been the step-up that we've done over the last two-year period. And so, substantial increase, I think, that has happened. What we're focused on, I would say, is that all three of our businesses need to be a double-digit margins. Overall, I would say, mid-teens for the company. I think it's certainly going to take a little bit of time. I mean, we closed out at 9% in 2018. So, we certainly aren't going to get there in '19. And you mentioned '20, I'm not sure. '20 just seems to be around the quarter when you think about it. But I can assure you, we are committed to getting our business to mid-teens margins with all three businesses delivering double-digit margins.

Thanks. That's helpful. And then shifting here to some of the operational excellence that you've been putting into place over the last year or so. If you can maybe talk a little bit more about the yield and efficiency improvements and the working capital improvements. How much more room do you have there to make a big difference, if you will?

Yes. I think, operational improvements and the lean journey is we say, it's a never-ending item, right? I mean, no matter what improvements you make, you can always go in and make more improvements. So, number one, I don't see it as something that, it's a one-time event. I think it's a continuous activity and we're going to keep at it. I think our biggest impacts in operational improvements and sort of the lean journey were in our PAC business. So, I see PAC business continuing to be on this journey and then we got to add in a lot more of the AM business and the PC business as we move forward. We got to look at our footprint rationalization, which is part of our lean journey and kind of where our customers are, where are we producing products, our facilities in general. I think that has to become a part of it. But that's not today or tomorrow. I think our bigger issue right now is just the basic blocking and tackling and getting yield and efficiency improvements across the board. So, I see this as a journey, we started on it and we're going to continue on it.

Got it. And lastly, Jugal, in your prepared remarks, you talked about your sales force kind of in the midst of creating a very efficient sales force. If maybe you could talk a little bit about what sort of activities or what sort of promotions or efforts you're making there to, what sounds like kind of beef up the sales force or make them more efficient?

Yes. So, we've done a number of things already, and we've got a number of things planned for 2019. But let me just highlight a couple of the big items. So number one, we've done a substantial amount of sales force training. We're working actually with an external company where we are doing training in globally. So, we have actually conducted a training in Asia. We've conducted a training in Europe. We've done two sessions in North America, and I think we've got two more coming up here in North America. And so we are going to continue to add it, to really help our people understand how to go and market our products and technologies to our customers and help them understand the value that we provide. I mean, at the end of the day, if our people can't do that effectively, then we're not doing justice to our customers. So, that's number one. Number two is really making sure that our sales people are located in the right places. And we can't have sales people sitting at our plants, because our customers aren't located at our plants. Our customers are located all over the world, and we got to make sure our sales people are located where our customers are. So, either ideally, if we can figure out a way to get our sales people at the customer's location but if not in their backyard. And then, I think the other thing is we've got to make sure we incentivize properly, our sales people to deliver the right type of value-added sales growth. So, growth for the sake of growth, as we know, it can be very dangerous, but making sure that the right type of value-added sales is being delivered so that we can consistently deliver profitable growth. So, I noted some of the, some of the main things I can highlight that we've been working on. But clearly, commercial excellence is a very important part of our go-forward strategy.

Got it. Is there an expectation that you need to grow the size of the sales force? Or you think you can maintain it and now just making them more efficient?

Yes. I think it's being able to make it more efficient. I think it's very, very important. I think making sure the roles and responsibilities of the sales force are clearly defined and understood because you have inside sales, you have outside sales, you have product management, you have marketing management. And so making sure that all those things are properly defined so everybody understands their role, and they can properly block and tackle. And then each one of those individuals has the right skill set and capability through our training process.

Got it. Thanks a lot. Appreciate your time.

Mr. Shamrock, we have no further questions at this time. 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 fourth quarter 2018 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.