Greetings. Welcome to the Materion Corporation Second Quarter 2019 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] Please note, this conference is being recorded. I will now turn the conference over to your host, Steve Shamrock. Mr. 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 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 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 non-recurring special items for pension curtailment, legacy, legal and environmental matters and certain income tax adjustments. And now, I'll turn it over to Jugal for his comments.

Thanks, Steve, and welcome, everyone. I am once again extremely pleased to report record financial results for the quarter. We delivered all-time records for value-added sales, operating profit, operating margin and earnings per share in the second quarter. EPS for the quarter was $0.88 a share, representing a 63% increase over prior year. I can't stress enough how impressed I am with our team and their ability to execute on our multi-pillar growth strategy. We have now delivered 10 consecutive quarters of both top and bottom-line growth, an impressive milestone. Our strong second quarter performance provides significant momentum heading into the second half. Despite uncertainty around macroeconomic environment and headwinds in select end markets and geographies, we are raising our full year earnings guidance a second time this year. Joe will provide financial details for the quarter and the full year. Let me spend a few minutes reviewing strategic commercial actions underway to deliver continued profitable growth. Last quarter, I reviewed some commercial excellence initiatives. And now I will expand on those by providing an update on our One Materion go-to-market strategy. You may be aware that we issued a press release last week announcing the recategorization of commercial end markets. This announcement was more than simply reclassifying how we externally report end market sales. It highlights changes in how we are identifying new business opportunities and better positioning Materion to deliver solutions our customer’s desire. This end market focus is driving new business opportunities and leveraging the complete One Materion product portfolio. For example, our deep customer relationships and market knowledge in the defense and aerospace market in the PAC and PC segments is allowing us to identify new opportunities for the AM segment. Likewise, market knowledge and position in the semiconductor space for the AM segment is helping…

Thank you, Jugal, and welcome to everyone joining us on the call today. During my comments, I will cover second quarter 2019 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. I am very pleased to report record financial results for the second quarter of 2019. This represents the 10th consecutive quarter with year-over-year growth in both value-added sales and adjusted operating profit. Second quarter 2019 value-added sales, which exclude the impact of pass-through precious metal cost were $194.9 million, an all-time record and up 3% versus the prior year second quarter and up 4% sequentially. New product sales were $30.8 million, or 16% of value-added sales. As Jugal mentioned earlier, we re-categorized how we view our end markets and related go-to-market strategy. Accordingly, we plan to report value-added sales in this revised format going forward. Strong commercial execution in energy and industrial end markets drove our second quarter growth. The improved performance in these end markets more than offset continued weakness in the automotive and semiconductor end markets. The semiconductor end market remains weak primarily due to reduced demand for smartphone devices, while the automotive end market remains soft, particularly in Europe and Asia. Despite our second largest end market being down 9%, we delivered the 12th consecutive quarter of year-over-year value-added sales growth. Strong commercial execution and ability to leverage our differentiated product portfolio has continued to deliver profitable growth. Gross profit was $69.6 million in the second quarter, an increase of 13% from $61.8 million in the prior year. Expressed as a percentage of value-added sales, gross margins expanded 320 basis points to 35.7% driven by favorable sales mix and…

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question is from Edward Marshall, Sidoti & Company. Please proceed with your question.

Hi, guys. How are you? Good morning.

Good morning, Ed. How are you?

Good morning, Ed.

Good. So I'm looking at AMT to start. I guess there's been plenty news about a troubled customer there. Many of your customers, many of your people that you supply have seen some revision to their outlooks. I'm not seeing it in your results. I'm just kind of curious how you've been able to kind of navigate those waters and maybe what you're seeing and maybe how you look at the balance of the year around that particular customer.

Yeah. Ed, we -- as we've already reported, we had another quarter of year-over-year sales growth and 12 consecutive quarters. And then, Joe mentioned that even though semiconductor, which is what that customer that you were referring to falls under, even that market was down 9% for us for the quarter, we were able to still deliver year-over-year growth. And I think that's where the very, very strong diversification efforts that we have in the company are paying off. And we are very focused on making sure the diversification continues across the company. Now with that said, let me just comment a little bit, I think, on that customer as well as maybe perhaps China in general, because obviously that fits into the overall China situation. For us, our sales into China are less than 10% of our total value-added sales. Now even though it's a meaningful number, I mean it's not a significant part of our sales. So, we don't have necessarily the exposure that maybe perhaps others that may -- you may have heard about that had overall for the China situation as well as perhaps to that customer. The second thing is that we are probably two or three or four sort of links back from the main supply chains that occur into that market. So, the impact that we feel is typically lagging. So maybe it's lagging two to three months. We are starting to see some slowdown in that market from China and from that customer in both, I'll say, direct sales as well as indirect sales that we'll feel the effect of here in the third quarter and perhaps in the fourth quarter, depending on how long it goes. But I think I just want to continue to emphasize, though, that we are really focused on diversification and making sure that we've got a very diversified market and especially focusing in on what we would consider higher-margin type of markets. And as a result, we're able to deliver the year-over-year growth and we're committed to deliver year-over-year growth topline for the balance of the year. I mean that's our focus.

Got you. And you gave the details on semi. I also understand there's some telecom with the 5G rollout as well that may go to that customer, but you've talked about telecom being very, very strong in backlog. Have you seen any impact on the telecom side at all from--?

No. In general, I mean we're not seeing a direct impact. We have a very diversified customer base when it comes to the telecom and data side. So that customer is not the only customer for us. In fact, we have very little, I would say, direct sales to that customer. And so we are -- I would say, going into the second half, I would classify probably neutral in that overall market.

Got it. And then finally, as we look at the reorganization of the segment levels, and I understand the kind of the One Materion focus. I'm curious as you look across the three different larger, bigger segments that you have, Advanced Materials, PC, and Performance Alloys and Composites, where do you think you'll have maybe the initial successes of that cross-branding of Materion? For instance, maybe automotive and -- or aerospace and one of the -- in, say, Advanced Materials. I mean, where do you think you potentially will see the most growth and -- the soonest?

Yes. So, I can talk about two, three markets, in fact, that I think we're actively involved in. Defense market is a big area for us, as you know, and we're actually actively involved in leveraging our relationships that we have on the PAC side. And particularly, we have relationships on the PC side as well, but we're really leveraging the PAC relationships to pull in our microelectronic packaging business into the defense sector much more. We're looking at the semiconductor side. We've got really good relationships on the AM side with a number of customers, particularly in Korea. And so we've got a concerted effort and being able to take advantage of those relationships and pull in PAC. So, those are just maybe very real-time, specific examples I can give you of the semiconductor space, particularly in Korea, as well as the defense market here in the U.S. for our AM business where we're looking at how we can expand our business. What we did, we've actually taken senior leaders. And I -- very, very senior leaders within our company, and we've appointed Market Vice Presidents or Market Leaders, Market Executives, whatever titles you want to give them, to really look at what is the business that we have within that market today, what are the potential that we could have as we go forward and how do we step-by-step bridge to those -- to achieving those potentials. And I can tell you that our teams are excited about it. Our technology rollout work that we're doing across the company is starting to come together in terms of putting those three businesses and the teams together so they can start to leverage each other from a technology perspective. And so hopefully we can start to see some real good opportunities. We have and -- in support of this, by the way, and in general, I mean we are accelerating our efforts for investment to be able to take advantage of this. We have sizable, really meaningful investments, growth investments planned for the second half in both our R&D and in our commercial arm to support all of these initiatives. So, I think the opportunities are there for us to get and we're putting the steps in place to be able to get those.

Good to hear. That would be fun to watch. Joe, just real quick, depreciation jumped in the quarter just about $4 million. Is that depletion? And if so, should I think about maybe PAC's margin actually potentially being a little bit higher in the future? I'm just trying to think that through.

Yes. So, that's due to our revision of our activity in the second half out at the mine. So, we will be extracting more ore than previously anticipated. And so what that does is that drives mine amortization, which, as you're aware, re-categorizes it up into inventory. So, it won't put any pressure on margins from a historical run rate in the PAC business. It will pressure our working capital percentage as it moves it up into inventory.

Got it. Okay, okay, that's fair. Thanks guys. Appreciate it.

Thank you.

Thanks Ed.

As a remainder, we're now conducting a question-and-answer session. [Operator Instructions] Our next question comes from Phil Gibbs, KeyBanc Capital Markets. Please proceed with your question.

Hey, good morning.

Good morning, Phil

I was interested in the commentary on auto specifically. I know it was down pretty heavily, but you also talked a lot about targeted mix improvements in PAC. And I know a lot of this is beryllium copper, strip. So, are these, also some of the areas where the mix has been light historically in the past, as you've really shifted it?

Yeah. I think as it relates to mix in automotive; our comments were we saw it particularly down in Asia and in Europe. I would say a portion of the Asia, down is not just the market but intentional pruning as we are driving improvement to our mix. And I think in my comments, I mentioned strip sales in Asia were down approximately 30%. And that's more than just the market decrease. That was also driven by our strategic decision to prune lower-margin business.

I think the other thing, Phil, to note here. When we talk about mix and good mix and continued improvement in the PAC business, we got to recognize that we're really pushing a lot, on the aerospace side, on the defense side and on the energy side. I mean those are very important markets for us. Of course, telecom is more of an emerging market with 5G coming in. But we've got share gains that we're delivering, in really all three areas: aerospace, defense and energy. More ToughMet, for example, in all three drilling exploration side, more parts, more material into the aerospace with the content per plane, as well as just additional planes that we're getting content on. And all of that business is business that we want to be in at the long-term -- to long-term type of contracts that we end up having with these types of markets. So, with auto experiencing some of the downturn like you mentioned. And then, -- and the downturn that we're experiencing as well, particularly in the Asia market, China market, I think the positive developments in these other markets and our focus on those other markets is balancing the drop.

Okay. That's kind of what I hoped or thought you'd say on that. In terms of the expected margin targets in AM, by the end of the year, I think mid-teens, you reiterated that perhaps a couple of times. But that's also where a lot of the macro challenges are with semiconductor. And perhaps consumer electronics in the short term, smartphones, et cetera.

Yeah.

I'm trying to think about how you get there with the macro challenges that you may not have seen …

Right.

…a quarter or two ago.

Yeah. No, that's a great point that you bring up, because we are very focused on delivering top line growth in that business, despite the macro challenges, right? I mean, semiconductor in total, like you mentioned, the customer that Ed mentioned earlier in China, the overall China market, I mean, so that area has a lot of external factors. They're sort of pressing on it. But I think a couple of things. One, we're very focused on delivering our new products in that business. So we have a number of new products that we're -- especially on the memory side that we're really challenging our team to launch and launch quickly. We already are in, I'm going to say, launch phase on some of them and pushing to deliver even more faster. So even though we may have some downturn on some of the things that you highlighted and then I've highlighted, we're trying to push other things that we can do to balance on that business. I think the second thing is that we can continue to see improvements in our integration and acquisition that we did. We've mentioned to you guys in the last few quarters about the new plant that we had opened, making sure that we were doing the proper integration of that plant, launching of that plant. I think that's starting to go well and we continue to see improvements there. And then, of course, qualifying customers so that we're able to have a good continued growth from that plant. We also have a good growth in the energy market in that business. We have a really nice new business on the target side for smart window applications. That business is progressing really nicely well. We're -- we've developed, you could almost say, a partnership with one of the key customers. And so that business growth is starting to now come in. And then in the second quarter, we did have some -- as far as these new products, we did have some yield issues, because as you can imagine, anytime you're launching new products, there's some challenges on the manufacturing side. And so we did have some yield issues in the second half, which we are really focused on and making sure that we're putting those to bed. So when you put all those things together, all those number of things together, I mean we feel that we'll continue to make progress on this business and exit the year at mid-teens. But I will tell you, it is very, very challenging. And in fact, it's probably becoming a lot more challenging than what we thought at the beginning of the year, because of I think, the continued headwinds from the overall end market side. But you know us, we're not giving up. We're making sure that we've got all the levers that we can pull to exit in mid-teens by the end of the year.

That's really helpful. And so sounds like an approach kind of on all sides in terms of booking products and then also some of the integration and cost efforts, too. So that's good to hear. On the pension comments, I think, Joe, you had made some in terms of the annuitization. You guys have done some really good work with the balance sheet, and I guess on a lag here, because pension expense, I think has been pretty stable the last couple of years. You expect to see some improvement in 2020. Can you just remind us what that net expense is right now? And then just give us a little flavor of what it could be?

Yes. So when you look at the net expense now for our U.S. pension plan, it's running around, let's say, $7 million on an annualized run rate. And so going forward, that service cost will go away, component of it. It will be replaced with the DC contribution. So from an OP standpoint, there won't be a benefit. Where the benefit will come is down in other non-operating expense. There you'll see a benefit of approximately $2 million year-over-year. But as you know, that depends on asset return assumptions and discount rates. But based on where we sit today, we would anticipate approximately a $2 million savings year-over-year.

Thanks, guys, very much.

Thanks.

Thank you, Phil.

We have reached the end of the question-answer session. And I will now turn the call back over to Steve Shamrock for closing remarks.

Thank you. This is Steve Shamrock, and this concludes our second quarter 2019 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.

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