Materion Corp

NYSE:MTRN

Earnings Call Transcript 2021-Q1

[Operator]

Greetings and welcome to the Materion's First Quarter 2021 Earnings Conference Call. [Operator Instructions] This conference is being recorded. I would now like to turn the conference over to your host, Andrew Vento, Manager, Investor Relations and Corporate Development. You may begin.

[Andrew Vento, executive]

Good morning and thank you, everyone, for joining us on our first quarter 2021 earnings conference call. This is Andrew Vento, Manager, Investor Relations and Corporate Development for Materion Corporation. Before we begin our remarks this morning, I would like to point out that starting this quarter, we will be utilizing presentation materials alongside our quarterly earnings conference calls. We have posted those materials on the company's website that we will reference as a part of today's review of the quarterly results. You can also access the materials through 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 provide an update on key initiatives. Following Jugal, Shelly will review detailed financial results for the quarter and 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 removes special items, non-cash charges and certain income tax adjustments.

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

[Jugal Vijayvargiya, executive]

Thanks, Andrew and welcome everyone. I hope that all of you are in good health and have had a good start to the new year. I'm pleased to report that we delivered a very strong first quarter, achieving record quarterly value-added sales and our fourth quarter of sequential top line growth. Many of our markets continue to expand and we believe we outpaced end market growth in several sectors including semiconductor, automotive and industrial. Our Advanced Materials business delivered a quarterly record for value-added sales with strong market demand and new business wins. The supply chain and staffing shortages that are prevalent all around us have not had a meaningful impact on our business.

Performance was strong across the company as all 3 segments reported double-digit EBIT margins for the third consecutive quarter. I'm very impressed with our team's passion to serve our customers and their drive to return Materion to pre-pandemic levels of performance. We continue to execute well on our key strategic growth initiatives. Let me talk through a few highlights.

Our customer-funded precision clad engineered strip project remains on track. We completed a second quarter of shipments from our existing facility, and the construction of our new leading-edge manufacturing facility remains on schedule. Our Optics Balzers integration is nearly complete. Our teams continue to work collaboratively on combining the businesses and on identifying customer opportunities in support of our overall growth objectives. We have several synergistic initiatives underway. We continue to build a strong pipeline of organic growth opportunities across all 3 segments. Our increased investment in R&D and our customer-focused initiatives are driving organic projects that will continue to position the company for above-market growth. And finally we're investing in our facility capabilities to support that growth.

As you know, our capital spending this year is expected to be around $100 million, which is significantly higher than our average run rate. We have a strong portfolio of projects lined up that will deliver new capacity, enhanced capabilities and improved yields to support our growth objectives. These important strategic initiatives, along with many others, are positioning us as a high-performing advanced materials company that enables next-generation applications.

For the past few quarters we have talked a lot about our pipeline of organic growth opportunities. This quarter, we're highlighting some recent wins and advancements that are helping to enable next-generation capabilities for our customers.

On Slide 7 of our materials, you will see 4 examples that I'm really excited about. First, we have been awarded a contract from Visteon to supply thin-film coated plastic lenses in next-generation automobiles. These lenses are a key component of an optical module enabling a 3D digital cockpit instrument cluster. Next, we continue to support space observation, exploration and aerospace missions with advanced solutions across all 3 of our businesses.

We recently announced that we outfitted NASA's Perseverance Rover with an array of advanced technologies from our broad portfolio including AlBeMet, a highly engineered alloy made of aluminum and beryllium which provides a superior combination of high stiffness and low density; Combo-Lid hermetic packaging solutions used in Perseverance's power, communication and sensing systems; and high-performing optical filters that enable spectral imaging in addition to dust characterization and daily weather reporting.

On the bottom left, you will see our aluminum scandium targets. These highly engineered targets are being used by the semiconductor industry to support increased bandwidth and higher frequencies required for the global rollout of 5G and accelerating growth of IoT.

Finally, our alloy strip products continue to enable evolving smartphone technologies. Our materials form spring solutions to support smartphone camera lens movement and enable faster autofocus features.

Looking ahead, I'm excited about what I'm seeing for the next few quarters. While economic uncertainty still exist, we see increasing opportunities in our organic pipeline, good demand across many of our end markets, and well-positioned businesses ready to respond to what lies ahead.

Overall, I'm extremely proud of what the team has delivered thus far. Our first quarter performance provides significant momentum for the rest of the year. I would like to thank our employees for their hard work, dedication and commitment. Our strong results our thanks to them. Now let me turn the call over to Shelly to cover the financial details.

[Shelly Chadwick, executive]

Thanks, Jugal and welcome to everyone joining us on the call today. During my comments, I will reference the slides posted on our website this morning, and I'll start on Slide 11. As Jugal noted, we delivered very strong first quarter 2021 results. Value-added sales, which exclude the impact of passthrough precious metal cost, reached a record $198.6 million, up 29% versus the first quarter last year. The increase was driven by strong demand across several end markets including semiconductor, automotive and industrial, which more than offset weakness in the energy end market and reduced sales related to the closure of our LAC business.

In addition, sales were aided by a large defense order late in the quarter, which would typically come later in the year. One item I'd like to point out is that we have updated the calculation of our passthrough metal cost to include additional precious metals, namely ruthenium, iridium, rhodium, rhenium and osmium, to be more inclusive with our definition of value-added sales. Our business related to these materials has increased to more meaningful levels over recent periods. The costs related to these metals follow the same passthrough process as the previously included metals of gold, silver, platinum, palladium and copper. Prior period passthrough costs and value-added sales amounts have been revised to reflect this change and those details are included in the appendix of the Slide deck issued today.

We delivered an adjusted EBIT margin of 10.8% and adjusted earnings per share of $0.82, both significant improvements over Q1 of last year.

Looking at Slide 12, our improved profitability was impacted by several key factors. Adjusted EBIT in the quarter was $21.4 million, up from $9.9 million last year. Adjusted EBIT margin of 10.8% represents a 430 basis point increase from a year ago. The increase in EBIT was largely driven by higher volumes, favorable price mix and improved operating performance, offset partially by higher SG&A and R&D expenses. We benefited from favorable operating performance as our manufacturing team responded well to the increased customer demand. And the SG&A and R&D increase in the quarter represents an increase in variable compensation and continued investment in R&D to drive profitable growth. Even with the increased investments, SG&A expense improved 150 basis points year-on-year as a percentage of VA sales.

Now, let me review our first quarter performance by business segment. Starting with our Performance Alloys and Composites business on Slide 13. Value-added sales were $100.8 million, an increase of 20% compared to last year. The year-over-year increase was due primarily to strong performance in the industrial and automotive end markets, as well as sales to the new precision-clad engineered strip customer. In addition, sales were aided by the large order in the defense market that I mentioned earlier. EBIT, excluding special items, was $13.4 million or 13.2% of value-added sales compared to $6.9 million or 8.4% of value-added sales in the prior year. The increase was due mainly to higher sales volumes, favorable mix and strong operating performance. PAC reported double-digit adjusted EBIT margins for the fourth consecutive quarter, up 480 basis points from the prior year.

Now let's turn to Advanced Materials on Slide 14. Value-added sales in the first quarter of 2021 were a quarterly record of $63 million, up 16% versus the prior year. The increase was driven by higher sales to the semiconductor end market led by commercial performance initiatives and increased market demand. Growth in the Asia-Pacific region and strong demand for targets serving the data storage and mobile phone markets were significant factors that drove the top line to new highs. EBIT, excluding special items, was $8.9 million in the quarter compared to $5.1 million in the first quarter last year. Adjusted EBIT margins improved year-over-year by 500 basis points to a strong 14.3%. The improvement in adjusted EBIT margins was due to higher volume, favorable product mix and strong operating performance. We are excited about the progress made and remain focused on Advanced Materials' margins as we go forward.

Turning finally to the Precision Optics segment on Slide 15. First quarter value-added sales were $35.6 million, up 109% compared to the first quarter last year. The business saw increases in every key end market with both our legacy optics business and new Optics Balzers acquisition performing well. EBIT, excluding special items, was $5.1 million or 14% of value-added sales, up 720 basis points from prior year. Strong demand and product mix drove the margin performance.

Moving now to cash debt and liquidity on Slide 16. We ended the first quarter of 2021 with a net debt position of $34 million and approximately $250 million available on the company's credit facility. The year-on-year increase in net debt was primarily related to the Optics Balzers acquisition; however, we remain well below our target leverage range of 1.5 to 3x net debt to EBITDA. We continue to have significant available liquidity and a strong balance sheet.

Regarding capital allocation, we maintain a disciplined and balanced approach to capital deployment, focusing on organic growth opportunities, returning capital to shareholders through our dividend and looking for strategic inorganic opportunities. Consistent with our comments in Q4, we expect to complete the year with capital spending of around $100 million in 2021.

The higher amount is attributed to our strong pipeline of organic growth opportunities, particularly the new engineered strip project, as well as promising opportunities in each of our segments. We also continue to evaluate acquisition candidates that fit with our strategy and long-term objectives.

Now let's turn to the guidance summary on Slide 17. While economic uncertainty remains, we see strength in our organic pipeline and good underlying demand in several key end markets including semiconductor, automotive and industrial while other end markets are also seeing steady or improving demand from 2020 lows. With that, we feel comfortable resuming full year guidance at this time in an effort to provide some further insights into our expectations.

Looking first at the second quarter, we expect adjusted earnings per share in the range of $0.72 to $0.76 per share, which is up about 68% from last year at the midpoint. As I previously mentioned, we had a large onetime defense order in the first quarter, which was expected later in the year. This is driving modest sequential decrease in Q2.

For our full year 2021 guidance, we expect adjusted earnings per share in the range of $3 to $3.30, which is an increase of over 55% from last year at the midpoint. This guidance includes an estimated $0.20 to $0.25 per share impact resulting from startup costs related to the construction of our new precision-clad engineered strip facility. On this slide, we have also noted a few modeling assumptions for you.

Overall, we feel very optimistic about 2021. Our markets are showing strength, our organic pipeline is building and we're investing in our business while executing on our key strategic initiatives. We believe that these factors have us well positioned for 2021 and beyond. And we're excited about the opportunities that lie ahead.

This concludes our prepared remarks. We will now open the line for questions.

[Operator]

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

[Marco Rodriguez, analyst]

I was wondering if we can spend a little bit more time on the gross margin. It was very good showing here across the aggregate as well as obviously some of the segments. In your presentation, it seems like -- it looks like the volume price mix played the biggest role, but I was wondering if you maybe can provide a little more color surrounding that. Was this just more of a fixed cost absorption due to the volumes or were there any other sort of onetime drivers that kind of helped accelerate that performance in the quarter?

[Jugal Vijayvargiya, executive]

Yes, Marco. Let me start with this and then Shelly can jump in and add more color to it. As we noted in our remarks, although Q1 was a very strong quarter for us, there's a number of factors that drove that. The end markets have really been recovering, and in particular, I would say semiconductor and automotive were really good strong end markets for us. The defense order that was referenced is one that helped us as well. Certainly our performance in our plants. I think as the volumes came in, our plants just did a fantastic job of taking on the additional volumes, taking into account, I think, all the challenges that we hear about and being able to deliver those products. So I think it's a number of factors that have contributed to the gross margin improvement. The points that I think that are highlighted on the slide speak to that, but I'll have Shelly comment in more detail on that.

[Shelly Chadwick, executive]

Yes, sure, happy to. So I think you've hit the high points and certainly we're very pleased with the margin performance for this quarter. I think we also saw good cost management as we're growing and continuing to keep our focus on managing our cost structure. And particularly in our advanced materials business, we had really good operational performance, good yields getting out of that. So we were able to move a lot of products that would certainly help our margin.

[Marco Rodriguez, analyst]

Understood. And is there any way you can perhaps quantify the defense order's impact on the quarter from a margin and an EPS perspective.

[Jugal Vijayvargiya, executive]

Well, as you know, we don't talk about specific customer contracts, the size of the customer contracts or the margin impact of customer contracts. But I think in general, we've talked about in the past, is that we really like sort of the longer cycle, more sticky type of businesses and markets because they tend to contribute perhaps more to a favorable mix. We think we provide a lot of value to those types of end markets and certainly defense falls into that category. So it is a good end market for us and one that we continue to put a lot of focus on. But it's a sizable order. We did indicate, I think, on our guide slide, there's a little bit of sort of an indication of the type of impact that it had on more of an EPS perspective, but it's a good market for us and it's a good order for us.

[Marco Rodriguez, analyst]

Understood. And then just kind of keeping here with the gross margins, the Precision Optics segment. Obviously there has been a little bit of -- some movement there, some noise with the acquisition and divestitures. This 39% gross margin there, is that what we should be expecting going forward given the folding in here of Optics Balzers.

[Jugal Vijayvargiya, executive]

Well, I think on the Precision Optics business what we have to keep in mind is that that business, we tend to have a lot of lumpy orders, a lot of large orders in and out. Mix plays a big factor, just based on that. I mean if you just go back and look at the last couple of years, you will see just even on an EBIT perspective, for example, quarters where we delivered 7% on the low side and quarters where we delivered 17% on the high side. So it tends to move around more so than perhaps some of our other businesses. So I wouldn't say that's a run rate number that I think that business can deliver. I think we really have to look at more of an overall full year type of an impact in that. And we've taken that into account as we provided the guide, which is obviously a very, very strong guide that we provided. But I wouldn't necessarily take that as a run rate just based on some of the factors that I just mentioned.

[Shelly Chadwick, executive]

Yes, and Jugal, those are great points and you were mentioning the 7 to 17, which would be the EBIT margin, your gross margins in line were also very strong and with the lumpy orders you expect that's going to bounce around a little bit. We do still see our way to a path of expanded gross margins for that business this year.

[Marco Rodriguez, analyst]

Got it. And last one for me here, Jugal maybe this is more for you, perhaps. But just kind of regarding long-term goals here of becoming or being a more advanced materials company with that low to mid-teen operating margins, you obviously have made a lot of positive changes that are helping Materion kind of march up that ladder there, if you will. But maybe if you can update us on where you kind of stand versus your initial expectations and maybe how you're thinking has perhaps evolved over this time.

[Jugal Vijayvargiya, executive]

Yes. As you know, I mean, we've made significant progress in the '17, '18 and '19 timeframe towards those objectives that we've highlighted as our sort of the long-term objective of mid-teens type of margin, clearly a very advanced materials, high-tech company. And even during '20 when we had the very tough times, I think that not only we had but around the world had due to the pandemic, we were able to perform well and maintain really the strategic focus for our business,. We were able to do an acquisition, we were able to secure a very large organic growth order, we were able to continue strengthening our business with closures of a couple of facilities, exiting one of our businesses, to really position the company for exactly what you started with, which is this long-term objective that we have.

So I think we're very well on track of that. And our goal and objective is to return as quickly as possible to the pre-pandemic levels that we delivered in '19 and then continue to move beyond that. And I think we've had a really good start to that here in Q1 as outlined by the results that we've indicated. I think the guide and the indication that we've given you for the full year speaks volumes, when you -- especially when you consider the fact that we probably will have about a 20% to 25% impact based on the new facility that we're putting in place. It's a 55% year-over-year increase. I think it really starts to put us back on the pre-pandemic level and then continue the journey. So I'm very excited about it. I think we've got a lot going on, particularly on the organic growth side as we also talk about, of course. our investments. As you know, we're increasing and accelerating sort of our capital deployment towards all of that. So I'm feeling good about that.

[Operator]

[Operator Instructions]. Our next question is with Michael Leshock with KeyBanc Capital Markets.

[Michael Leshock, analyst]

I just wanted to start with maybe a longer-term question on the clad strip project, just given the unique pre-payment structure of that project, I wanted to get a sense. So once the facility is up and running, will the customer have the full supply that they need, or do you see opportunities for further expansion with either that customer in the coming years there with potential new customers in a similar type of structured project?

[Jugal Vijayvargiya, executive]

Yes, Michael. As you know, we're supporting the customer today from our existing facility and I think the customer is very pleased with what we're doing and we've been able to get good progress on that. We are making extremely good progress on being able to set up the facility and get that up and running. Next year, we'll go through a launch process. As you can imagine as we go through the launch process, it will be a ramp that will go through during the year. So we're quite excited about it and we believe that we'll be able to support the customer in the volumes that they are looking for. We have been working on setting up the facility though that not only can we support this customer, but also be able to grow our general clad strip business globally.

Yes, we've made actually really, really good progress on that, in fact even, yet here from our existing facility. I mean, when you look at the applications for this clad strip type of business, one of the key applications in the -- is in the EV market and we made significant progress on -- in fact, I would say on a year-over-year basis, doubling our business in that space for the EV side. And so, I see this as more of a placeholder that we're doing to support the customer that we're working with, but a fantastic opportunity for us to leverage. I think the need of this type of -- needs of this type of a product as the markets grow around the world.

[Shelly Chadwick, executive]

And maybe just to add on to that, there will be additional capacity and capabilities, out of that facility to service other customers in the same product line.

[Michael Leshock, analyst]

That's helpful. And then, just wanted to get the impact of the Chip shortage within Materion's supply chain and what you might expect at least directionally for 2Q?

[Jugal Vijayvargiya, executive]

Yes, well, as you know, the semiconductor market in general has been really well, not just in Q1, but certainly last year as well and it is continued to do well in Q1. Our representation in that and our year-over-year sales reflect that. We have great participation in the 5G area, IOT. So our aluminum scandium targets, our lithium targets, our gold targets, our packaging products that we provide for hermetic seal packaging, all of those are experiencing, I think, great growth both with the market growth as well as, I think with the new products that we're launching. So we're very excited about the overall semiconductor market and what it's doing for Q1 and I think what it has the potential to do up for Q2, Q3 and sort of beyond.

The chip shortage issue that you highlight, which obviously is there. As you know, we're a component supplier for chip manufacturing. So we are supporting the customers in every way that we can and we'll continue to do that and I would expect that some of the shortages that the -- that's being experienced right now will be made up over the next few quarters and if so, then our business should continue to do well. So we are fully aligned with our customers on this and actually quite excited about, I think where the semiconductor market is and perhaps where it will go here in the near future.

[Michael Leshock, analyst]

And then lastly for me, just wanted to get a broad update on the M&A environment, what are you seeing there and would you be looking more for smaller bolt-ons versus larger acquisitions and what primary end markets would you be targeting?

[Jugal Vijayvargiya, executive]

Yes. So as you know, Michael, I mean we've been talking about this for the last few years. We are focused on M&A, but we are focused on M&A bring significant synergistic value and we took some time to be able to do our Optics Balzers M&A and I'm really glad we did because it gave us a great opportunity to get to know the company, get to know the management team, understand what the possibilities are from a technology, from a regional, from a market, from a customer, all those types of things and I think it's been a good acquisition for us. And so we have the same level of focus and due diligence as we are continuing to look at M&A as we move forward, but I think what I want to highlight though is we are equally as focused on organic growth opportunities, because we think we have a tremendous opportunity here to take advantage of growing markets as well as I think our portfolio of products that we have. So if M&A is able to help us and support that in our quest to become this Advanced Materials business delivering mid-teens type of margins, then we are very much focused and are looking at M&A opportunities. So we're engaged as always on multiple conversations, in some cases it's just maybe initial looks, in some cases it'd mainly be management meetings, in some cases it may be due diligences and we're going to continue to evaluate.

Our general feel that we've talked about before is bolt-ons are obviously something that we feel really good about, because we believe that with the strengthening of the business that we've done, we can take on the bolt-ons, we can understand them, we can deliver value out of them, the larger transformative opportunities, I mean those really have to be really well thought out because if we do something that perhaps goes wrong way, well, we can really significantly negatively impact the company. So we're very much focused on the M&A side. We're -- that can help augment our strategy and equally is focused on the organic side because of the, I think the pipeline that we have and sort of the excitement that we have around the world in customers and products and technologies.

[Operator]

It appears that there are no further questions at this time, I would like to turn the floor back over to Andrew Vento for closing remarks.

[Andrew Vento, executive]

This is Andrew Vento. And this concludes our First Quarter 2021 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]

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