Greetings, and welcome to the Materion Third Quarter 2023 Earnings Call. At this time, all participants are on a listen-only mode, and a question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to your host, Kyle Kelleher, Manager, Investor Relations. Sir, you may begin.

Good morning, and thank you for joining us on our third quarter 2023 earnings conference call. This is Kyle Kelleher, Manager, Investor Relations. Before we begin our remarks this morning, I would like to point out that we have posted materials on the company's website that we will reference as 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, as well as an update on key strategic initiatives. Following Jugal, Shelly will review the detailed financial results for the quarter, in addition to discussing our expectations for the remainder of 2023. We will then open up the call for questions. Let me remind investors that any forward-looking statements made in the presentation, including those in the outlook section and during the question-and-answer portion, are based on current expectations. The company's actual 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, taxes, depreciation, depletion, and amortization, net income, and earnings per share, reflect the adjusted GAAP numbers shown in attachments 4 through 9 in this morning's press release. The adjustments are made in the prior-year period for comparative purposes and removed special items, non-cash charges, and certain discrete income tax adjustments. And now I'll turn the call over to Jugal for his comments.

Thanks, Kyle, and welcome, everyone. It's great to be with you today. Our record performance in the third quarter is a testament to the strength of our company, the effectiveness of our strategy, and the talent of our people. We are successfully leveraging our diverse portfolio and unique technical capabilities to capitalize on new organic growth opportunities. In addition, our global team continues to raise the bar for operational excellence, delivering for our customers and executing on our outgrowth initiatives, while pursuing targeted cost improvements and driving improved performance across our plants. These trends are offsetting the impact of softer demand conditions in the semiconductor and industrial end markets and enabling Materion to deliver in a challenging environment. The third quarter represented our 12th consecutive quarter of year-over-year earnings growth, achieving record earnings of $1.51 per share. It was also the second consecutive quarter outperforming our adjusted EBITDA margin target of 20%. Excluding the continued softness in the semiconductor market, our value-added sales were up 8%, which speaks to the substantial diversity of our portfolio and the significance of the contributions from our organic pipeline. Strength in aerospace, including the emerging space market, defense, telecom and data center, and meaningful contributions from precision clad strip drove the differentiated performance. We continue to benefit from improved aerospace build rates and, more importantly, are increasing content per plane. Additionally, we're gaining significant content in the emerging space market. For telecom and data center, increasing 5G adoption is fueling our growth in the undersea cable market. As for the semiconductor market, softness has persisted into the third quarter, pushing the recovery out beyond our previous expectations as we continue to see inventory correction in memory, logic, and communication devices. We believe the third quarter was a low point for semiconductor demand and remain encouraged by some positive signs of recovery we've seen in the broader industry, as well as some modest recovery in our order rates. Our expectation is that we will start to see gradual improvement in demand in the fourth quarter with a broader recovery next year. As we have said before, we are extremely excited about opportunities in the semiconductor market, including our expanding content per chip. We also recognize that semiconductor cycles can lead to strong upturns, and we remain well positioned to support that volume as it returns. Leveraging our diverse portfolio, our team continues to unlock new organic growth opportunities aligned with global mega trends. One such trend is the emerging space market that is driving significant new opportunities for us. Our sales into this growing market have more than tripled in the last two years. Let me highlight a few of the exciting opportunities. To start, we recently secured a third order to supply critical materials for space propulsion systems, valued at $13 million. That brings the total amount awarded to $35 million for the past year. Our partnership with this important customer is strengthening, and we see the potential for additional orders in the coming year. We're also projecting that our ToughMet product sales into the space market will double to approximately $10 million next year. We have new customer commitments for this important material as the high strength and corrosion-resistant properties have proven to be ideal for next-generation space applications, which require robust performance in exceptionally harsh conditions. Growth in this market is also benefiting our Precision Optics business, which has secured approximately $8 million in new contracts across both the space and defense markets. Our optical components serve as key enabling technologies essential for space-based implementation and imaging across various applications. We continue to be an important supplier for critical defense programs, bringing our unique expertise in technically demanding materials. We've recently been notified of a new $10 million award to supply critical materials for a space-related defense program. I'm also pleased to announce that we have received a $5 million investment from the U.S. Air Force Research Laboratory that will enable us to accelerate the development of our additive manufacturing capabilities, also known as 3D printing, for beryllium and aluminum beryllium alloys. Additive manufacturing capabilities will enable significant advantages in the production and performance of optic structures, guidance systems, and thermal management applications used in defense and aerospace markets. This investment will propel us into a new phase of development that will accelerate our ability to operationalize these specialized manufacturing techniques. I'm very proud of our team's performance, and I remain confident in our ability to execute and deliver another year of record results. With the wins we've achieved through our diverse portfolio, uniquely relevant technical capabilities, and our team's unrelenting focus on operational excellence, we are continuing to build on the earnings power of Materion. Now, let me turn the call over to Shelly to cover more details on the financials.

Thanks, Jugal, and good morning, everyone. During my comments, I will reference the slides posted on our website this morning, starting on Slide 10. As Jugal outlined, we delivered record earnings in the third quarter. Value-added sales, which excluded the impact of pass-through precious metal costs, were $270.5 million for the quarter, down 5% from the prior year but up sequentially. Excluding the semiconductor market softness, the remainder of the business was up approximately 8% year-on-year. This growth was driven by strong demand in the aerospace and defense and telecom and data center end markets, along with meaningful contributions from the precision clad strip business. We delivered adjusted earnings of $1.51 per share in the third quarter, a quarterly record for the company, and up 15%, compared to the prior year. Moving to Slide 11, adjusted EBITDA in the quarter was $55.4 million or 20.5% of value-added sales, up 14% from the prior year, with margin expansion of 330 basis points. This significant increase was driven by favorable pricing and mix, as well as strong operational performance, partially offset by the slight decrease in volume. Our targeted cost improvement initiatives also contributed to the step up in earnings, outperforming our midterm EBITDA margin target of 20% for the second straight quarter. Moving to Slide 12, let me review the third quarter performance by business segment. Starting with our Performance Materials business, the value-added sales were $168.9 million, up 13% compared to the prior year. Strong results in aerospace, consumer electronics, telecom and data center, and precision clad strip drove this increase. EBITDA, excluding special items, was $46.5 million, or 27.5% of value-added sales, up 41% when compared to $33 million in the third quarter of 2022, with an impressive 530 basis points of margin expansion. This growth was primarily due to higher volume from our outgrowth initiatives, favorable pricing, and a strong mix, combined with benefits from our operational excellence initiatives. Moving to the outlook. We expect a strong fourth quarter led by aerospace, defense, and telecom and data center with continued contributions from precision clad strip. Next, turning to Electronic Materials on Slide 13. Value-added sales were $75.5 million, down 29% compared to the prior year, resulting from the slowdown in the semiconductor market, where our customers continue their inventory correction. EBITDA, excluding special items, was $13 million or 17.2% of value-added sales in the quarter. Despite this year-over-year decline, we saw a 110 basis points of margin improvement compared to the prior year. This was driven by a favorable mix plus the benefit of our targeted cost reduction initiatives, which do include some short-term actions. As we look forward to the fourth quarter, we expect incremental improvement in semiconductor sales, as well as the continued benefit from the cost improvement initiatives we've implemented. Finally, turning to the Precision Optics segment on Slide 14. Value-added sales were $26.1 million, down 7% compared to the prior year. This decrease was mainly driven by the reduced PCR filter demand, the discontinued product application, and general softening in the consumer electronics market, slightly offset by strength in defense. EBITDA, excluding special items, was $3.4 million or 13% of value-added sales. The decrease in volume was a meaningful driver of this year-over-year decline offset by positive mix and the benefit of our targeted cost improvement initiatives. From a sequential standpoint, we saw EBITDA growth, along with 260 basis points of margin expansion. Looking out to the fourth quarter, we expect new opportunities across defense, space, and automotive to contribute to top-line growth. Moving now to cash, debt, and liquidity on Slide 15. We ended the quarter with a net debt position of approximately $445 million and $151 million of available capacity on the company's existing credit facility. Our leverage at 2 times remains slightly below the midpoint of our targeted range. Lastly, let me transition to Slide 16 to address the full year outlook. With accelerating contributions from our organic pipeline, our strong operational performance, and the continued benefit of our cost reduction actions, we remain confident in our ability to execute and finish out another record year. With that, we are affirming the midpoint of our prior guidance at $5.80 per share, an increase of 10% from 2022. We look forward to closing 2023 on a high note, delivering another year of record results and long-term sustainable value creation for our stakeholders. This concludes our prepared remarks. We will now open the line for questions.

Thank you. Our first question is coming from Dan Moore with CJS Securities. Your line is live.

Hi, good morning. It's Pete Lucas for Dan. First one for me. How is the clad strip project performing relative to your expectations? And has there been any change in timing regarding expected ramp in Phase 2?

Yeah. Let me start with the second part first here. Our timing is in line with what we have communicated before, which is that we expect to have a ramp starting at the end of '24, low volume ramp and then full volume production in the '25 timeframe. Our equipment installation and validation will go on over the next year or so as we go through getting that qualified. In terms of our current program, I would say it's going really well. We are producing at our new facility. We produced at the legacy facility as well, and it's delivering to our expectations. So, with the top-line and the bottom-line contributing, as we had planned, and that's reflected in our results.

Very helpful. Thanks. And then looking at the various program awards you noted, I think it was on Slide 5 of the presentation, when do you expect to begin layering in revenue for each of these awards? And do you expect to record the full amounts listed in fiscal '24? Or are those likely spread over the next one to two years?

Yeah. Well, first of all, I just want to say, I think it's just another testament to our team delivering fantastic organic growth opportunities. Our team just continues to bring in new opportunities. Let me highlight a few of those. First, the $13 million order to supply critical materials for the space propulsion systems, that we expect to be in the '24 timeframe. We announced a Phase 1 and Phase 2 of that previously, and those are being delivered to the customer as we speak. So, this $13 million is another order, bringing the total to $35 million with this customer. So, this opportunity is becoming a really great opportunity for us, and I would expect more orders in the new year for '24 and perhaps '25 timeframe. When I look at the Precision Optics contracts, the $8 million for space and defense, those I would envision as multiyear contracts in the '24, '25 timeframe. The ToughMet materials for space applications are very important for us. We have a number of applications in commercial, aerospace, oil and gas for that material. We have been supplying that material this year. As you can see from the chart, that's roughly about $5 million worth of sales this year, and we expect to double that in '24. The notification regarding the $10 million of the critical materials for the defense-related applications, we expect to recognize partly this year and then into next year. We're looking forward to that. This builds on our capabilities and materials expertise that we have for defense applications. The $5 million investment is awarded to us from the U.S. Air Force for additive manufacturing. This will be done over a two-year period. We've had several initiatives on additive manufacturing over the last three to four years. We've invested quite a bit of money in our facility, and this award will just accelerate our development for beryllium and aluminum beryllium-based materials for additive manufacturing. So, we're very much looking forward to that over the next two years. Great opportunities to continue driving organic growth for our company.

Extremely helpful. Thanks. And just finish it with one housekeeping question here. What tax rate is assumed for your Q4 implied EPS guidance? And what's a good rate as we look out to fiscal '24?

Yeah, that's a great question. Thanks for asking it. We saw the benefit of a reduction in our year-to-date effective tax rate, which we were really pleased with. We saw the tax rate come down by a combination of things. The first being the production credit. The production credit has gone up slightly, due to the increase in the pure beryllium-related products that we have been selling. We talked a lot about a strong mix. Some of that is from our pure beryllium-related products, which drive the production credit and that's tax free. Therefore, all that income is tax-free. In addition, we're seeing higher foreign tax credits based on the global mix of earnings. So, in a sense, we took our tax rate down from mid-16% to roughly 15%. In Q4, what I've assumed is 15.5%, and we'll see how the year shakes out once we have actuals.

Thank you. Our next question is coming from Mike Harrison with Seaport Research Partners. Your line is live.

I was wondering if we can talk a little bit about the Performance Materials margin and some of the sources of strength. I know in your comments, you mentioned that mix was particularly strong. And then Shelly, you just mentioned here that the production credit has increased, which I believe flows through that segment level EBITDA line. But maybe, just talk in a little more detail on the puts and takes that we should be thinking about, as we look at that margin in the PM segment for Q4, as we get into 2024.

Yes. Mike, let me start on that, and then Shelly can jump in, especially when it comes to the production credit and things. I think that business, as you know, over the last several quarters, has continued to perform well. One of the things that we continue to be very focused on for that business is value-based pricing, making sure that we're getting the right price for the value that we're providing to our customers. And then certainly, mix has been a very important factor as well. We continue to drive more focus on products that generate more value for us rather than products that don't. So, we're making sure that we're utilizing our assets to drive the best mix possible. And that's also helped us, of course, on operational excellence. But go ahead, Shelly.

Yes. Just a couple of other things. The plants have been running really well. So when our plants are running well, we get better operating performance, and that's helped the mix and the margin as well. Jugal talked about mix and we've highlighted space and defense this quarter, and that is definitely a mix up for us, and we'll see that last into the fourth quarter. Then the production credit, as we just discussed, we previously said roughly $8 million for the year. Now we're looking at roughly $10 million for the year, which means about $3 million in each of the last two quarters. So really a nice benefit for that business.

All right. And then in terms of the Electronic Materials business, it seems like the pace of recovery here is a little bit slower than we might have hoped. Can you give us a little more color on what you're hearing from your customers in both the logic and memory side about their production rates as we get into year-end and start 2024?

Yes. As you know, Mike, we've all been waiting for this inventory correction to start to slow down so that the build rates can start to pick back up. Unfortunately, the inventory correction has taken a little bit longer than I think they had all estimated. That slowdown translates into slower orders for us. Our expectation was that by the end of Q3, we would start to see a little bit of recovery. I think that expectation has now shifted to Q4. We are starting to see, as we're listening to some of the earnings calls from our customers, some small positive incremental benefits that they're highlighting. We're also starting to hear from our customers directly. Depending on the semiconductor types, some order rates are starting to see a slight uptick for Q4. I would say it seems like Q3 is the low point, and Q4 would present a small incremental uptick for us. This aligns with what the semiconductor companies are saying as well. This business is extremely important for us. It's roughly a third of our company, and we're very much looking forward to the uptick. We're prepared to address the uptick. Our workforce and our materials, and our inventory are all ready to go as the uptick starts. So, we're very much looking forward to that.

Well, hopefully, that comes sooner than later. Last question I have is regarding some of your cost actions this year. I'm just curious, are most of these complete or should we think of Q4 as maybe showing some additional benefits? And if you can maybe help us quantify, better think about what portion is structural cost takeout and what portion is more temporary or a reduction in discretionary spend that could come back next year?

Yes. That's a great question, Mike. We look at it that way too, the way you're talking about it, meaning, what are the permanent reductions that we're making to improve our business long-term, and what are the things that are temporary to address the current actions. This really breaks down into two buckets. Some of that is headcount related on the temporary side. But some of it is just tightening the belt a little bit and controlling costs until we see the market pick up. So I would say it's roughly 60-40 in favor of permanent to temporary, with the temporary actions probably around a three-quarters, one-quarter in terms of people-related versus belt tightening.

Sure. That's helpful. And I guess just for my question about Q4 and the benefits being greater than Q3?

Yes. So we're always looking at the organization to see what we can do to improve. I would say, largely, the reductions have been done, and we saw most of that impact in Q3. There will be a little bit that comes into Q4, so I wouldn't see a meaningful step change in Q4.

Our next question is coming from Phil Gibbs with KeyBanc. Your line is live.

Regarding Clad Phase 2, when do you actually start commissioning the plant for initial trials?

Yes, I would expect that, Phil, toward the end of Q1, we would start to conduct some trials and start to produce material that we can share with our customers, who would go ahead and evaluate. From Q2 and Q3, we will continue doing that, as well as starting our low-volume production to get the equipment tested out. We've mentioned that we would have some saleable production in Q4.

And this is going into the existing facility that Phase 1 is on?

Yes, this is essentially that, yes, exactly. This is in the same building, same facility. The great thing about it is we're able to leverage the expertise of our folks that have been working on this program for the last couple of years. The additional workforce needed will be mostly new, but many of our engineering development, supply chain, and general management resources will be those who have been with the plant for the last couple of years.

Okay. And then you had a lot of color and commentary on the space and defense awards, which was great, and you highlighted that well in your presentation. But just to be clear, you are saying that 2024 is going to have nicely higher value-added sales in that bucket relative to 2023 as you phase in some of these awards?

Yes. Well, I think space has been an important market for us. We highlighted it about a year or so ago in our calls. I would say, step one, over the last couple of years, we've tripled our sales into the space market, which is fantastic. I see incremental benefits going into '24 as well. I highlighted this one very important customer, the $13 million order, for example, which I expect to be in the '24 timeframe. It's our expectation that as we continue working with this customer, we will secure additional orders. Of course, those are not guaranteed, but we're going to continue collaborating with our customer to ensure that. I'm confident we'll continue to have other materials to get into this market. This is a high-growth market for us, and I can assure you that across all three of our businesses, we're very focused on this.

And then just lastly, in terms of net working capital, what are you anticipating for the fourth quarter?

Yes, I'll take that, Phil. One of the things that Jugal mentioned was that we're ready for the semiconductor upturn. You might see in our results that inventory is up a little bit; we've taken some raw material and pushed that into WIP to be ready so that when we get customer orders, we're not starting from a raw material base. Therefore, we've built a little bit of inventory, and I expect we'll hold that through the end of the year. Accounts Receivable has been a bright spot, and I expect that will be a cash inflow, as we finish out the year in Q4. Accounts Payable was a negative for the quarter, so I expect we'll get some of that back in Q4 as well. It should be a slight positive but not meaningfully impacting inventory before the end of the year.

Our next question is coming from David Silver with CL King. Your line is live.

Several questions to address. I apologize in advance if my wording sounds naive or slightly snide, as that is not my intention. First, regarding Performance Materials, it appears that there have been not only strong results this year but also an increasing number of successful contract wins. I have a couple of inquiries on this topic. First, do you have a traditional backlog figure for Performance Materials, and how does it compare now to the beginning of the year or a year prior, based on your typical tracking methods? Second, I have a potentially naive question: what do you believe accounts for your apparent success in these new contract wins, especially in aerospace and defense? You have always held a strong position in beryllium in this field. Has there been a change in your value proposition or market approach? What factors would you say contribute to your record performance, which indicates that you are becoming a preferred supplier for these high-value opportunities? That's a long question, so I'll pause there.

Yes. First of all, I think our Performance Materials segment, as you indicated, has done really well. Not just this year but looking back five or six years, the business has achieved growth in both top-line and bottom-line performance, which has been remarkable. Regarding the new business, I would say our team is doing a fantastic job marketing our materials and showing the great performance of what we offer. Our technical sales and business development efforts across these markets, particularly in the growth market like space, are noticeable. We understand our materials, which helps the customers recognize their value, thus enabling our value propositions. The team has effectively gauged customer needs and provided suitable solutions, which I believe has significantly contributed to our success. Concerning the backlog, we do monitor that against several metrics from a growth perspective, including many different factors. Our backlog can be influenced by changes in lead times, which makes backlog one of several critical metrics. Some markets have experienced declines, like industrial, while space has remained strong. Our lead times have improved significantly, positively impacting our backlog but not indicating a decline in business, as our sales show increases. The teams have driven numerous new opportunities in all markets with our superior materials.

Okay. My next question would be on Electronic Materials. You've commented on the lingering customer inventory issues. I hoped you could provide a broader perspective. Currently, you've been spending discretionary capital to build out your capabilities in Milwaukee and Newton. I think you had some expectations for demand levels for when that new capability is available. I'm wondering if you could maybe give us your current thoughts about the transition period here, right, especially the sluggish customer demand that seems to have lasted a little longer than initially thought. Do the new capabilities align with the end markets or applications affected?

Yes. If you look at our two facilities, Milwaukee and Newton, our expectation for additional volume was anticipated for the second half of 2024, as we finalize equipment procurement and installation. I believe the timing will align perfectly, as the recovery starts to kick in during Q4, first half of next year—with an even greater recovery in the back half of '24 and into '25. We will be exceptionally well positioned to roll out our emerging ALD products needed for memory applications from the Milwaukee facility and our logic and memory products from Newton. Although this slowdown has affected inventory levels, it has allowed us to allocate resources effectively to ensure that we are ready for the recovery as it begins.

Sorry. That was great color. One more question from a resources or budgeting perspective, but I always think a lot of—October is when many companies begin budgeting for the coming year. You've outlined several new initiatives. I noticed a new project in Precision Optics too. If I were a betting person, I'd say that the $95 million CapEx for this year will likely rise for next year. Beyond CapEx, I'm considering R&D resources, technical selling — aspects you've cited as leading to your success in Performance Materials. But overall, what are your projections for 2024 and 2025 regarding resources like dollars, people, and expertise?

Yes. You're right about the timing. We're starting to think about that and plan for it. We'll be discussing our guidance and 2024 plan in mid-February, and I'm quite excited about that as I think the upcoming year and 2025 will be exciting for us. We have various opportunities that will unfold in '24, '25, and '26. Regarding investments, we have always been keen to invest in business opportunities and will continue to do so, including R&D resources, CapEx, or any suitable M&A opportunities that may arise. We are maintaining our investment in R&D even during slower market conditions, and we expect to do the same with CapEx. I'm looking forward to sharing our plans with everyone as we finalize them.

Our next question is coming from Dave Storms with Stonegate Capital Markets. Your line is live.

So, I just wanted to touch on one of your end markets. I know telecom is probably one of your smallest, but it seems to keep growing. I was wondering if you could talk about your customer acquisition environment here and if there will be any meaningful impact going forward?

Yes. The telecom and data center market is one of our smaller markets, but it has seen nine consecutive quarters of growth. We're optimistic about continued growth here. As you know, bandwidth and data center requirements continue to rise with the demand for cloud services. This is crucial for our business, and we are supplying materials in these areas. We expect to maintain growth over the next few years. The undersea cable market is particularly important for us, where we provide volume-based materials, and we anticipate it will remain robust.

That's very helpful. And just one more for me, if I could. What are you seeing on the labor front? There's been a lot of news about UAW labor negotiations. Your shops are running well now, but if you needed to scale up, how confident are you that you could recruit more labor if necessary?

I think our teams did a fantastic job getting labor into our factories. In 2021, as the ramp-up occurred, they’ll do a great job again in 2024 as the semiconductor recovery happens. We have stayed focused on retaining our labor force to support the anticipated increase in 2024. Should we need additional workforce, we will rely on our HR department to recruit candidates as we did in 2021 and 2022. I'm confident in our ability to support any demand increases.

Thank you. We have reached the end of our question-and-answer session. So I will now turn the call back over to Kyle Kelleher for his closing remarks.

Thank you. This concludes our third quarter 2023 earnings call. A recorded playback of this call will be available on the company's website, materion.com. I'd like to thank you for participating on this call and your interest in Materion. I will be available for any follow-up questions. My number is 216-383-4931. Thank you again.

Thank you. This concludes today's conference, and you may disconnect your lines at this time. We thank you for your participation.