Materion Corp

NYSE:MTRN

Earnings Call Transcript 2018-Q1

[Operator]

Greetings, and welcome to the Materion Corporation's First Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host today Mr. Steve Shamrock, you may begin.

[Stephen Shamrock, executive]

Good morning. This is Steve Shamrock, Vice President, Corporate Controller and Investor Relations. With me today is Jugal Vijayvargiya, President and Chief Executive Officer and Joe Kelley, Vice President of Finance and Chief Financial Officer.

Our format for today's conference call is as follows; Jugal Vijayvargiya will provide opening comments on the quarter and an update on key initiatives. Following Jugal, Joe Kelley will review detailed financial results for the quarter and then we will open up the call for questions.

Before we begin, let me remind investors that any forward-looking statements made in this announcement, including those in the outlook section and during the question-and-answer portion, are based on current expectations. The company's actual future performance may materially differ from that contemplated by the forward-looking statements as a result of a variety of factors. Those factors are listed in the earnings press release we issued this morning.

Additionally, comments with regard to operating profit, net income and earnings per share reflect the adjusted GAAP numbers shown in Attachment number 5 in this morning's press release. The adjustments are made in both the current year and prior year periods for comparative purposes and remove certain non-recurring legacy, legal and environmental matters, certain income tax adjustments, CEO transition costs, cost reduction actions, and merger and acquisition costs.

And now I'll turn it over to Jugal for his comments.

[Jugal Vijayvargiya, executive]

Thank you, Steve, and a good day to everyone. I'm pleased to report that we're off to a great start in 2018 as we build on a successful 2017. Today, we reported value-added sales for the quarter at $181.3 million, an all-time high and a 22% year-over-year increase.

Adjusted earnings are up 76% from prior year at $0.51 per share. This is the 5th consecutive quarter of year-over-year growth in both value-added sales and earnings.

Our Commercial Excellence strategy is working, as we delivered 14% growth in value-added sales excluding the Heraeus target materials business acquisition. We reached double-digit growth rates across the majority of our end markets, with industrial components and the commercial aerospace markets leading the way with 36% and 52% growth respectively. New product sales reached $31 million, accounting for 17% of value-added sales. Our robust pipeline of new differentiated products continues to enable market share gains and new application wins.

ToughMet Bushings for aircrafts and copper beryllium rod and wire are 2 of the products contributing to the strong sales growth. Consumer electronics, our largest end market grew 16% overall and 6% organically as we continue to have meaningful success establishing Materion as a key business partner. Our focus on the customer has led to 2 prestigious awards. First, we were recognized by Texas Instruments for Supplier Excellence. And second, we received Skyworks, Supplier of the Year award.

Success in growing the top line is accelerating the benefits from our operational excellence strategy. Productivity enhancements and yield improvement initiatives deliver benefits ahead of schedule where production volumes are growing double digits. We're employing disciplined execution in establishing the previously announced pillars for sustainable profitable growth.

We have recently added digital as the newest pillar which will lead to an enhanced customer experience and product innovation along with productivity improvements. Our newly appointed Chief Information Officer is leading the framework, which will position us as a market leader.

Our investments and organizational changes position us well to continue executing our strategic priorities and to deliver sustainable profitable growth. As a result, we are affirming our prior guidance of $1.95 to $2.10 per share. We remain focused on delivering both near-term and long-term shareholder value.

At this time, I will turn the call over to Joe.

[Joseph Kelley, executive]

Thank you, Jugal, and welcome to everyone joining us on the call today. During my comments, I will cover first quarter 2018 financial highlights; review profitability by segment; provide brief comments on the balance sheet, cash flow and modeling assumptions; and finally, cover the earnings outlook for 2018. Following my remarks, we will open the line for questions.

I am pleased to report strong first quarter 2018 financial results which exceeded the earnings guidance provided and represents the 5th consecutive quarter with year-over-year growth in both value-added sales and operating profit. First quarter 2018 value-added sales, which exclude the impact of pass-through precious metal costs, were a record $181.3 million, representing an improvement of 22% versus the prior year first quarter.

As a reminder, the Heraeus acquisition which closed late in the first quarter of 2017, contributed $12.2 million of incremental value-added sales in the first quarter of 2018. Excluding the impact of the acquisition, the base business grew 14% year-over-year, driven by new product sales, improved product mix, and end market demand.

New product sales in the first quarter of 2018 were $30.7 million or 17% of value-added sales in the quarter. Our largest end market, consumer electronics grew year-over-year 6% organically, which is very impressive considering the inventory correction that took place in sub-segments of the market.

Sales into industrial components, commercial aerospace and telecommunications infrastructure, all grew organically more than 25% over the prior year period. Our commercial performance around new product introductions and market share gains combined with improved economic demand is driving above market organic growth rates.

Gross profit margin was $58.3 million in the first quarter, an increase of 35% from $43.1 million in the prior year first quarter. Expressed as a percent of value-added sales, gross margins expanded over 300 basis points from 29% to 32.1%, driven by performance improvements and leveraging the sales growth.

Selling, general and administrative expenses totaled $38.5 million, up $5 million over the prior year first quarter of $33.5 million; due primarily to increased cost associated with the acquired Heraeus target materials business, variable expense directly related to value-added sales growth, and improved financial performance, and strategic investments. As a percentage of value-added sales, SG&A expense decreased to 21% in the first quarter of 2018, down from 23% in the prior year period.

Operating profit totaled $13.3 million in the first quarter of 2018. Adjusted operating profit, excluding a legacy legal matter, was $14 million, up 75% compared to the prior year first quarter adjusted operating profit of $8 million. Performance improvements related to commercial and operational initiatives, along with sales growth led to the year-over-year increase.

Looking at income taxes, we recorded $1.5 million of tax expense in the first quarter of 2018, which includes a $600,000 discrete tax benefit related to U.S. tax reform. Excluding the impact of the discrete tax item, the effective tax rate on adjusted earnings was approximately 17%; in line with the full-year guidance provided.

Adjusted net income for the first quarter of 2018 totaled $10.6 million or $0.51 per diluted share, up 76% from $0.29 per share recorded in the first quarter of 2017. We have now delivered $0.50 a share or more for 3 consecutive quarters. Now let me review 2018 first quarter performance by business segment.

Starting within Advanced Materials. Value-added sales in the first quarter of 2018 were $58.3 million, up 23% versus first quarter 2017 value added sales of $47.3 million. Excluding sales related to the acquisition, value added sales declined 3% due primarily to softer demand in the consumer electronics end market.

Operating profit for first quarter 2018 totaled $5.9 million compared to adjusted operating profit of $7.4 million in the prior year quarter. The decrease in segment operating profit was due to a combination of lower demand in the consumer electronics end market, unfavorable product mix, and planned integration expenses related to the relocation of the Heraeus target business in Germany.

If you recall, we previously communicated that we successfully integrated the HTB Arizona site into our Albuquerque facility and consolidated 2 facilities in Taiwan. We recently completed construction of a new state-of-the-art target manufacturing facility in Alzenau, Germany. We expect to complete the move and commence production at the new facility later in 2018.

Looking now at our Performance Alloys and Composites business. First quarter 2018 value-added sales exceeded $100 million for the second consecutive quarter, an increase of 27% versus the first quarter of 2017. Excluding hydroxide sales, value added sales improved 22% versus the prior year with success in new product introductions, commercial execution and improved end market demand all favorably impacting results.

Operating profit in the first quarter of 2018 totaled $9.9 million or 10% of value-added sales, the highest level in the last 3 years. Commercial and operational improvements combined with meaningful sales growth led to the significant improvement versus the prior year.

We also benefited from a richer-than-normal product mix in the first quarter, particularly with respect to our bulk alloy products. This business continues to make meaningful progress on the recovery plan introduced in 2016. Although we expect more of a normalized product mix in future quarters, we remain committed to be in a position to consistently deliver operating profit margins at historical levels.

Turning finally now to the Precision Coatings segment. First quarter value-added sales were $23.6 million compared to $23.3 million in the first quarter of 2017. Medical end-market sales were down year-over-year 6%, while the Precision Optics business reported near double-digit growth, driven by strong sales into the defense and consumer electronics market.

Operating profit for the Precision Coatings segment totaled $3.4 million in the first quarter of 2018 or 14% of value-added sales compared to $2.2 million in the first quarter of 2017. Operating profit margin in the current quarter was the highest in 2 years, driven partially by a very favorable product mix being sold into the defense and consumer electronics market.

Moving now to the balance sheet and cash flow. The company ended the first quarter of 2018 with a net cash position of $16.6 million compared to a net debt position of $16.3 million at the end of the first quarter of 2017. Operating cash flow improved $9 million in 2018 compared to the prior year due to stronger earnings and reduced working capital requirements.

We continue to maintain a very strong balance sheet and have significant available liquidity to support capital allocation priorities mentioned on previous calls, including organic growth opportunities, further inorganic growth opportunities and to consistently return capital to shareholders.

For financial modeling purposes in 2018, capital spending should run approximately $30 million to $35 million; mine development investments should be $5 million to $10 million; annual depreciation and amortization should run approximately $35 million to $40 million; and assume a 16% to 18% effective tax rate.

And finally now, the earnings outlook for 2018. Based on our current order-entry activity and end-market outlook, we remain cautiously optimistic about continued growth in 2018. We are focused on executing commercial and operational performance improvements to drive top and bottom line year-over-year growth, while at the same time, make strategic investments to position the business to consistently deliver profitable growth over the long term.

Based on these factors, we are confirming our full-year 2018 earnings guidance of $1.95 to $2.10 per share. The midpoint of this range represents an 18% improvement over 2017 adjusted earnings.

From a quarterly guidance perspective, we expect second quarter 2018 earnings to be comparable to first quarter 2018 earnings, which would represent the 6th consecutive quarter of meaningful year-over-year earnings growth. This concludes our prepared remarks.

We will now open the line for questions.

[Operator]

[Operator Instructions] Our first question comes from Edward Marshall with Sidoti & Company.

[Edward Marshall, analyst]

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

[Jugal Vijayvargiya, executive]

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

[Edward Marshall, analyst]

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

[Jugal Vijayvargiya, executive]

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

[Edward Marshall, analyst]

The margin improvement that you saw in PAC, I'm curious if you can kind maybe break -- maybe look at mix, price, and efficiencies because I know there's been some efforts there. Can you talk about those 3 buckets and maybe what was the most meaningful impact in the PAC margins in Q1?

[Jugal Vijayvargiya, executive]

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

[Edward Marshall, analyst]

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

[Jugal Vijayvargiya, executive]

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

[Operator]

Our next question comes from Martin Englert with Jefferies.

[Martin Englert, analyst]

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

[Jugal Vijayvargiya, executive]

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

[Joseph Kelley, executive]

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

[Martin Englert, analyst]

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

[Jugal Vijayvargiya, executive]

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

[Martin Englert, analyst]

And one last one, if I could. Can you provide some updated thoughts on your capital allocation, how you're thinking about the dividend and share buybacks looking forward here?

[Jugal Vijayvargiya, executive]

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

[Joseph Kelley, executive]

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

[Martin Englert, analyst]

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

[Jugal Vijayvargiya, executive]

Yes. I mean, one of our large opportunities for the capital spending is the new plant that that we have going on in Germany for our business where we -- the Heraeus target materials business that we had acquired. We were actually spending quite a bit of money to make sure we've got our own state-of-the-art facility. We've got that transition started. We expect that transition to now commence here in the second quarter. And then, in the back half of the year, they would have launched that new plant. So that's a large part of our capital allocation that we have internally and then we have capital allocation across really all 3 of our businesses, because we're focused on making sure that all of our businesses are growing organically year-over-year.

[Joseph Kelley, executive]

I mean, you asked about, as did Ed on the previous call, the improvements in PAC and so that's been -- the gross margins there have been expanding sequentially for the last 5 quarters now, as we execute on our PAC recovery plan and there is some capital investments there to improve yields. But now we're at the point where capacity is also an issue at some particular product lines and so some investments there to support the growth. Recall, that business grew year-over-year greater than 25%, so some of the organic investments are to help support that growth.

[Operator]

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

[Philip Gibbs, analyst]

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

[Jugal Vijayvargiya, executive]

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

[Philip Gibbs, analyst]

Can you provide a little bit of color on the -- what you're seeing in the oil and gas and defense markets, please?

[Jugal Vijayvargiya, executive]

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

[Philip Gibbs, analyst]

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

[Jugal Vijayvargiya, executive]

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

[Joseph Kelley, executive]

And Phil, what I would comment on and as we've indicated before, we're not banking on the oil and gas market to recover to those '14, '15 levels. To be able to get to the type of performance that we need to get to, we sort of recognized that, "Hey look, this is where the market is and we need to make sure our businesses is structured accordingly." So when we talk to you about our overall plans, I think it's not banking on the market recovering to the '14, '15 levels.

[Philip Gibbs, analyst]

And then my last question is just on the free cash flow outlook. I know you've given pieces parts to that in terms of the build-up, but any specifics on what you're anticipating in terms of free cash this year?

[Joseph Kelley, executive]

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

[Operator]

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

[Marco Rodriguez, analyst]

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

[Jugal Vijayvargiya, executive]

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

[Marco Rodriguez, analyst]

And then, maybe you could share a little bit of color there in terms of the marketing or sales efforts that you're kind of putting forward to ramp that objective?

[Jugal Vijayvargiya, executive]

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

[Marco Rodriguez, analyst]

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

[Jugal Vijayvargiya, executive]

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

[Joseph Kelley, executive]

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

[Marco Rodriguez, analyst]

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

[Jugal Vijayvargiya, executive]

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

[Operator]

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

[Unknown Analyst]

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

[Jugal Vijayvargiya, executive]

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

[Joseph Kelley, executive]

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

[Unknown Analyst]

And then just following that. I mean, kind of taking a sky high view here and look at Performance Alloys' great performance in the quarter, a strong margin improvement. Same for Precision Coatings. Obviously Advanced Materials is a bit softer. Your guidance for the year is to reaffirm it unchanged. I mean what would you really have to be seeing this next quarter or the next quarter or 2 to really kind of push that up, if you will? And sort of following that, what kind of inning would you say you're in with the whole one Materion strategy?

[Jugal Vijayvargiya, executive]

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

[Joseph Kelley, executive]

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

[Unknown Analyst]

Okay. And there's [ not any ] anticipated incremental costs from the new facility in Germany, is there?

[Jugal Vijayvargiya, executive]

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

[Operator]

Our next question comes from Edward Marshall with Sidoti & Company.

[Edward Marshall, analyst]

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

[Jugal Vijayvargiya, executive]

Yes. So we did, we actually went through and did that, I mean, to make sure that we're protecting our customers. So we did build safety stock, and then we have that safety stock that we'll be able to use as we go through this transition. So yes, absolutely we -- any time you go through these transitions, I mean the #1 focus is of course on the customer and making sure that we're protecting them and -- so we did go through and do that.

[Edward Marshall, analyst]

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

[Joseph Kelley, executive]

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

[Edward Marshall, analyst]

Got it. And I guess on the longer-term impacts of your investment, I mean you're investing in people, you're investing in R&D, you've got new facilities coming on. So there is an awful lot of investment in the business, and if I step back to the last Investor Day, we talked about 8% operating margins for the business and I guess if your guidance is accurate, your tire scratching upon that as we kind of exit 2018, so good for you. But what do you think about longer-term. Once this kind of investment starts to really take dividends to the business, where do you think this business would go?

[Jugal Vijayvargiya, executive]

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

[Edward Marshall, analyst]

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

[Jugal Vijayvargiya, executive]

I think there is -- I think it's -- we got to fire on all the pillars that we've highlighted. Acquisitions is one of the pillars that we've gone, but I think there is lot of improvement that the business is going to accomplish by the other pillars that I mentioned; commercial innovation, operational, digital. Certainly acquisitions will be a key element of that, but it's 1 out of 5 pillars that we need to focus on.

[Joseph Kelley, executive]

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

[Edward Marshall, analyst]

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

[Jugal Vijayvargiya, executive]

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

[Operator]

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

[Stephen Shamrock, executive]

Thank you. This is Steve Shamrock and this concludes our first 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 [phone]. Thank you very much.

[Operator]

Thank you. Ladies and gentlemen, you may disconnect your lines at this time and thank you for your participation.