Greetings, and welcome to the Materion Corporation Third Quarter 2021 Earnings Conference Call [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, John Zaranec, Vice President of Corporate Controller, Investor Relations. Please go ahead, sir.

Good morning, and thank you, everyone, for joining us on our Third Quarter 2021 Earnings Conference Call. This is John Zaranec, Vice President, Corporate Controller and Investor Relations for Materion Corporation. Before we begin our remarks this morning, I would like to point out that we have posted materials on the company's Web site that we will reference as a part of today's review of the quarterly results. You can also access the materials throughout the download feature on the earnings call webcast link. With me today is Jugal Vijayvargiya, President and Chief Executive Officer; and Shelly Chadwick, Vice President and Chief Financial Officer. Our format for today's conference call is as follows. Jugal will provide opening comments on the quarter and an update on key strategic initiatives. Following Jugal, Shelly will review the detailed financial results for the quarter, and then we will open the call for questions. Let me remind investors that any forward-looking statements made in this presentation, 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 regarding earnings before interest and taxes, net income and earnings per share reflect the adjusted GAAP numbers shown in attachment 5 in this morning's press release. The adjustments are made in the prior year period for comparative purposes and remove special items, noncash charges and certain discrete income tax adjustments. And now, I'll turn the call over to Jugal for his comments.

Thanks, John, and welcome everyone. We are really excited to be with you this morning to share details of our third quarter record performance and to talk more about the acquisition of HCS-Electronic Materials, which closed yesterday. This is an exciting time at Materion. Our sales are at an all time high, our pipeline of organic growth projects is robust and contributing significantly to top line growth. Our plants are performing well and delivering for our customers in some challenging conditions, and we just closed from the largest and most strategically important acquisition in our company's history. We are delivering on all fronts and it's all thanks to our dedicated employees around the world. In the third quarter, we delivered a record $216 million in value added sales, up 31% from prior year. Underlying market demand continues to be strong across many of our key end markets, and we're starting to see recovery in aerospace and oil and gas. Aerospace has now grown year-on-year for two consecutive quarters. Oil & gas saw a second consecutive quarter of growth. But what's most exciting to us is we are outgoing markets as a result of our organic initiatives. Our focus on investments and R&D over the past few years is paying-off as we are launching more new products and applications than ever before. Applications, which span across all key markets and in support of important megatrends. Our sales into the EV market are doubling for the second consecutive year. Growth in the semiconductor space is far outpacing market as we forge ahead with new applications in support of increased electronics content. Introductions of new products, such as ToughMet 2, are increasing our total addressable market. And our earnings are even more impressive, up 120% year-on-year delivering highest level of EPS at date.…

Thanks, Jugal, and welcome to everyone joining us on the call today. During my comments, I will reference the slides posted on our Web site this morning. Starting on Slide 11. As we mentioned, Materion delivered a record quarter for value added sales adjusted EBIT and adjusted EPS. Value added sales which exclude the impact of pass through precious metal costs reached an all-time high of $215.8 million, up 31% from the prior year. The increase was driven by robust demand across several end markets, including semiconductor, automotive, industrial and energy. We delivered an adjusted EBIT margin of 12.9% and record adjusted earnings per share of a $1.10. Looking at Slide 12, our profitability was impacted by several key factors. Adjusted EBIT in the quarter was $27.8 million, up from $14.1 million last year. Our adjusted EBIT margin of 12.9% represents 430 basis point increase from a year ago. The increase was largely driven by higher volumes, including organic outgrowth, positive mix, improved pricing and favorable operating performance, partially offset by higher SG&A and R&D expenses and plant startup costs related to our new engineered precision clad strip facility. Our team continues to deliver despite operational and supply chain challenges. The increase in SG&A and R&D this quarter represents higher variable compensation and our continued investments in R&D. Despite increased investment, SG&A expense, as a percent of VA sales improved 200 basis points year-on-year when adjusted for special items. Now let me review third quarter performance by business segments, starting with our Performance Alloys and Composites business on Slide 13. Value added sales were $115.2 million, an increase of 41% compared to last year. The year-over-year increase is driven by strong performance in the automotive, industrial and aerospace and defense end markets, as well as sales to the new engineered…

[Operator Instructions] Our first question is from Marco Rodriguez with Stonegate Capital Markets.

I was wondering if maybe you guys can spend a little bit of time on some of the constraints that obviously everybody is experiencing and specific maybe on the labor challenges that you might have also been experiencing. And in relation to that if may be you can talk the rising wages that you've kind of had to experience here, and wondering how you are maybe thinking through that rising costs and how you might be able to reduce that impact in the long term?

Marco, as you noted, I mean, those challenges, I think, are in the industry that seems to be everywhere, both on the supply chain side as well as the labor side. Our team has just done a fantastic job of working through in each of our plants, getting people, getting them trained. It has clearly been a challenge. Training, as you can imagine, has been probably the biggest challenge after finding people. We view there is many creative ways to be able to have job fairs, to incentivize people, to interview with us and then further incentivize people to join our company. And then our team has done a nice job of putting together the training programs, because these jobs require that the folks come in, get the proper training. Safety being our overall overriding priority, making sure that we can do things in a safe way. And so training is important and then getting those people started. So it has been a challenge, no question. But I think the team has done a very nice job, as is demonstrated by I think the sales that we've had across the board and really in all of our markets. With regard to, I think, some of the cost impacts and things, I'll let Shelly maybe just comment on the cost side.

So on the wage side, I think every company is dealing with the challenges of how to not only attract but also retain their talent. And so we've been more selective with going through and trying to make sure that our wage rates are at market and keeping up with market. So we've done increases where we felt they were needed to keep rewarding our people and keep them energized to stay with Materion. So not only are we trying to attract but we're also trying to retain.

I think the other thing to note on that related to what Shelly is indicating is we've got a model that we’ve really established within the company to ensure that if we're experiencing costs pressures, whether it's supply chain type pressures, labor pressures, anything like that. But we really are taking a look at those in a very careful way and working with our customers in an appropriate way to recognize those. So I think the teams build a good model around that and is demonstrated by, I think, our margin performance.

And then in regard to that also kind of an offshoot, if you will. A lot of individuals are obviously impacted by these rising inflation costs and a lot of companies are raising their prices. Suppliers like yourselves are also pushing through the additional costs. I'm assuming, and I saw some remarks about price mix, were benefit for you guys this quarter. Are you finding it relatively easy ,if you will, to kind of push through price increases to counteract the inflation you might be receiving?

Well, I wouldn't necessarily just say relatively easy, because I think anytime you're looking at pricing, it's an issue, whether it's a supplier that's coming to us that's clearly a challenge. We don't just simply accept the price that they bring forward and I'm sure that's the same with our customers as well. I think it's really important for us to go to build the right story and help our customers understand what the situation is and be able to demonstrate the clear market dynamics. Of course customers kind of have that feeling today, just because they're probably experiencing that from really all of their suppliers, but I think we've done, again, a nice job where we demonstrate to our customers what the dynamic is and why we are doing what we're doing and then have a have a thoughtful discussion, and then from that be able to process those pricing. But I wouldn't say it’s necessarily easy but I think it is something that we're able to have a good thoughtful discussion with them on.

And one of the things that's really beneficial about our company, as you know, is that we have the metal pass-through. So we're seeing inflation. It's kind of other materials, some utilities, some shipping rates. So we're not experiencing big raw material increases that we need to go out and recover, because we've got those pass through mechanisms straight to our customer. So while it's not easy, never easy to get priced, we're dealing with a bit of a smaller impact than maybe the [other] company.

And then switching gears here to the closing of the Starck acquisition. Can you maybe walk through some of your near term integration efforts and any specific goals you're looking to achieve here?

I think one of the things that, Marco, we have a really good handle on it, because a year ago, we did the Optics Balzers acquisition. And so we established a model that I think worked very well during that, and we're basically using as much of that model into the integration efforts here with HCS-Electronic Materials. We've got an integration leader that we've put in place, full time integration leader. We've got functional support and really we're looking at integration from two fronts. One is more of a process integration and the other one is more of a business integration. But at the same time, we want to make sure that HCS-Electronic Materials continues to do well what they have done, which is support customers, deliver great products, great quality, on time, and so we don't want to disrupt that. So we do have a fairly detailed integration model that we put together, both from a process side and from a business side with a leader and with functional support and at the same time, making sure that the business continues to run and perform well like it has over the last several years.

And then in terms of some of your end markets, semiconductor growth, on one of the slide, looks pretty strong in the quarter. And I know that obviously semiconductors has been a pretty strong market for some time here, a lot of tailwinds pushing that particular market higher but at the same time, everyone is aware that the semiconductor shortages that are out there. And I'm kind of curious if your growth that you've experienced in that market is maybe been somewhat capped because of that. And if not, how should we kind of thinking about those impacts at the semiconductor market and how that relates to your growth?

Well, semiconductor has been a very good market for us, for a number of quarters now. And to your point, there is definitely market tailwind. But I think at the same time, when you look at our girls over the last several quarters, you'll see that our growth is substantially above general market growth for semiconductor, and that's as a result of the great work the team's done on getting organic initiatives. We've talked a lot about our aluminum scandium targets and they've been a really, really growth driver for us. We've also got, what we called, micro electronic packaging, which is basically packaging units where we put -- where the customers, I should say, put semiconductor material and chips inside of it for reliability that's also been a great growth avenue for us in terms of organic growth. So first of all, I think our growth is really built around a number of organic initiatives combined with the general tailwind of the market. With regards to, I think, where it's headed and kind of what's the situation with the backlog maybe that's occurring, clearly, there's there's shortage. We are supporting our customers to the best of our ability that we can. I mean, as we are getting the orders in, I would expect that this backlog will clear out maybe over the next year, some people are predicting maybe even a little bit more than a year. And then as it does, we expect to [consumers] to support. But we are running our facilities to support our customers in a full way. So we continue to be excited about this market.

And last question from me, on the automotive road side, also a really strong number, I believe it was 81% year-over-year. Can you kind of help us to understand -- and I know that's leveraged at the the EV market. Can you help us understand some of the main drivers there? Is that kind of a function of just easier year-over-year comps versus shutdowns, or are you taking market share, new applications? Just any color there and ranking of those drivers would be helpful?

Auto has been a great market for us and we've really been focused on auto the last several years. And I think the growth is, it's certainly the comps are helpful. But when you look at Q3 last year, there was already starting to be a little bit of a recovery, I think. And so I think our growth is coming from a number of different fronts. One, the general market growth that's happening. Clearly, we're having a lot of success on the EV side. As we indicated, we're doubling our sales for the EV specific applications for the second year in a row. We've got a lot of play that we do on the connector side. And as we know, electronics and content, and autos continues to increase. So that means connector usage continues to increase, and therefore, our content continues to increase. So we've -- we're really very fortunate, I think, to have materials that are used in the connector market. We also have a very heavy weight towards our European and Asian OEMs and European and Asian OEMs, I think, are doing a lot better, I would say, in this situation than probably perhaps the North American OEMs. So we've got -- majority of our content is actually on the European and Asian OEM side. And then general content that we keep driving across the board, I think, with global platforms. So a number of things that are contributing to our automotive sales. We're very excited about where automotive is headed for us. In particular, I think the EV content continues to be exciting for us. And then I think the general electronics growth continues to be exciting for us.

Our next question is from Phil Gibbs with KeyBanc Capital Markets.

The energy sales really took off this quarter relative to the rate you've been on the last several quarters, I think probably the highest level since mid-2019, late 2019. So what are you seeing there? How much is related to oil and gas and other things? Because I know you're not just oil and gas but maybe some color there, because I know it's obviously helpful for your mix.

It is. And energy for us, I mean, a couple of big areas for energy fill or oil and gas and then the other one is our Smart Glass applications. Oil and gas, as we indicated, is starting to show signs of recovery. Rig count is up roughly about 550 rig count versus about 350 at the end of last year. So that's certainly helping and I think the recovery in oil and gas is a contributing factor. Smart Glass is really another nice contributing factor for us with building construction, and especially commercial constructions up and remodeling up. And so that's, I think, contributing as well. So it is a good mix for us, both on the Smart Glass side and the oil and gas side.

And then on the net working capital, it was a very large use of cash this quarter, particularly as it relates to inventory and accounts receivable. I mean, was that related to inflation, was that related to getting ahead of the clad ramp? I mean maybe bring us through some of that, that was surprising in terms of the use to us.

So I think it's a bit of a mix. The AR is up with our sales being up, and there's some mix in there. The inventory piece is, I think, a tale of two cities, it's somewhat the pricing. As you know, our inventory balance holds the full value of the inventory, including the pass-through metal and some of those precious metals are up substantially. And then we have -- in some cases, where we're carrying some extra inventory, given the supply chain issues that are prevalent, we want to make sure we're able to service our customers. So you're seeing our safety stocks go up a little bit, but it's really to support this great level of business that we've got going right now.

And my last one, I missed the very, very beginning of the call. But anything you could provide us in terms of the ramp on the new clad facility? I know you mentioned you had some start-up costs this quarter, which were obviously expected. But where are you there and are you poised to hit the ground running in 2022?

Phil, as we noted, I think, in our prior calls as well that we were going to have start-up costs a little bit in the first half of the year but ramping up in the third quarter and fourth quarter, and that's to be expected as we're getting this facility ready to be able to go into higher levels of production into '22. So I would say we've got equipment installed. We're sort of in a commissioning trial phase. Right now, we'll do that here in Q3. We did that in Q3. We're doing that again here in Q4 as we're getting product built. It's going to be a lot of testing, testing on our side, testing on the customer side. And then our intent is to go ahead and start running the facility from a production level, starting in the first half of next year. So I think the team is exactly right on track. It's in line with the schedule that we had developed with the customer and we're quite excited about that.

Our next question is from Marisa Hernandez with Sidoti.

So I wanted to ask about the Optics Balzers integration. How is that going in your view? You mentioned, Shelly, that its project based, so quarter-to-quarter, there are variations. How do you see it tracking versus your initial expectations in terms of potential for margin and addition to sales?

Yes. I think there's two things here. One is the integration and then the second part, you talked about sort of how the business in general, runs with more of project based contracts that we have with our customers. So I think the integration is going really well. We've put the two organizations together. We created a global organization led by Ian Tribick. And I think we've got a strong team of individuals that are focused on the operational side as well as the growth side. And as we indicated when we did the acquisition a year ago, our main purpose for acquiring Optics Balzers was to create this global organization that could drive top line growth. And we would expect to see synergies in the two to three, to four year time frame and I think we're exactly on track of being able to do that. The teams are collectively looking at each end market and how each end market can be serviced with a global organization. So very excited about that. I know the team has actually got to get together that they're doing here in December to consider further work and refine our strategies for that. I think the other part, which is related just strictly to the business. So it's not an Optics Balzers issue or, let's say, the legacy issue, it’s just how that business runs. I mean there is a lot of business that we have there that is a bit more project based. So you see that. And then historically, you've seen that in the margin profile of that business, both the top line and the bottom line. But overall, we're very pleased with how things are progressing and looking forward to some more good things from the team.

Now on the HCS, just a quick question on the accounting. Can we assume that what you are guiding for depreciation for the full year, we strip out those two months and that's a good base number to use for 2022?

So the depreciation, we have a good handle on the purchase amortization as an estimate, as you might expect. We've got the work to do there on the opening balance sheet and the valuation. So we've made an estimate. This is the reason why we provided EPS impact for two months, both with and without amortization. So you can understand the earnings power. And we'll work through the assignment of the purchase price over the next few months.

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

Kind of going off that question, I know you've got a couple of months of HC in this fourth quarter. Is there any implied EPS accretion from the business in the fourth quarter in your guidance or should we expect purchase price accounting impacts to impact that in Q4?

So what we're estimating is that even with the purchase price amortization that it would be $0.05 accretive for the two months, and without the purchase price amortization to be about $0.13. So we've got that work to do, but we wanted to give you a feel for what the month impact would be in our guide.

So when you actually report your numbers a few months from now, is that purchase price accounting going to be included in that guidance range then?

It will. Yes.

And how long should we expect those accounting impacts to last?

I'm not sure if I follow. You mean how long will we amortize the intangibles?

Is that what the difference is? Is it basically the noncash amortization that's going to stick with you for a while?

Yes.

So that's an ongoing then?

As you know, Phil, many companies report EPS without purchase amortization. Companies that are acquisitive that something we're taking a look at. So we wanted to show you what the EPS is without purchase amortization.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back over to John Zaranec for closing remarks.

Thank you. This is John Zaranec, and this concludes our third quarter 2021 earnings call. A recorded playback of this call will be available on the company's Web site, materion.com. We'd like to thank all of you for participating on this 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.

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