MATERION Corp Q2 FY2025 Earnings Call

Greetings. Welcome to the Materion Second Quarter 2025 Earnings Conference Call. Please note, this conference is being recorded. I will now turn the conference over to your host. Kyle Kelleher, Director of Investor Relations and Corporate FP&A. You may begin.

Good morning, and thank you for joining us on our second quarter 2025 earnings conference call. This is Kyle Kelleher, Director, Investor Relations and Corporate FP&A. 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. Following Jugal, Shelly will review the detailed financial results for the quarter in addition to discussing expectations for the remainder of 2025. 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 call press release 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 remove special items, noncash charges and certain discrete income tax adjustments. And now I'll turn over the call to Jugal for his comments.

Thank you, Kyle, and welcome, everyone. It's a pleasure to be with you today to discuss our second quarter results and provide an update on our outlook for the remainder of 2025. Our business performed very well in the quarter, delivering record second quarter margins and strong free cash flow. Although sales were down 2% organically, we experienced solid growth in aerospace and defense and energy as well as in semiconductor outside of China. EBITDA was strong at $56 million, and we continue to deliver margins above 20% despite some pockets of softness still moving through our top line. I am particularly proud of our Electronic Materials team as they delivered an all-time high EBITDA margin of 23.4%, demonstrating the power of the work that has been done to optimize the cost structure and improve operational efficiencies in that segment. We have reached a new level of performance with EM, and I expect the business to deliver very good margin expansion for the full year. Precision Optics also showed a significant improvement in the second quarter as the transformation continues. Sales improved 14% sequentially, and EBITDA increased more than $2 million, marking the second consecutive quarter of improvement. Beyond the cost structure improvements that have been implemented, the business is making excellent progress on new business initiatives that should begin contributing by the end of the year. As we have discussed over the last few quarters, cash flow generation remains a key focus for us as evidenced by our Q2 results. We generated $36 million in free cash flow, the strongest we've seen in any second quarter. Our disciplined approach to managing working capital and pacing capital investments is driving the performance. Earlier this month, we acquired the manufacturing assets for tantalum solutions from Konasol, a Korean manufacturer serving the semiconductor and adjacent markets. This acquisition expands our semiconductor footprint in Asia, allowing us to better serve the large Tier 1 chip manufacturers in that region and in-source more of the target manufacturing value chain. This move expands our position as a leading global supplier of deposition materials. The integration is progressing well, and we have begun producing samples for customer qualifications. While the results for the quarter were very strong, what is perhaps more encouraging are many positive signs we're seeing in order rates, signaling promising momentum as we move through the back half of '25 and into '26. As the broader semiconductor market is showing signs of improvement with wafer starts up and customer inventories coming in line, our order rates are improving, especially within data storage, power, and communication devices. Sequentially, our order rates improved double digits, excluding China, where the customers are still showing tariff-related hesitancy. Defense is an area that is getting a significant amount of attention globally, and this is leading to many new opportunities for Materion. Our pipeline of new business opportunities is rapidly accelerating with over $100 million of requests for quotations received in the second quarter alone. In the first half of '25, we saw record bookings of $75 million, and our initiative to grow our defense business outside the U.S. has resulted in a 60% year-on-year sales increase. I expect the pace of defense-related activity will continue picking up for the back half of the year. In space, we continue to win new applications and expand our reach. Our order backlog has more than doubled in the last year, and we recently won a new application for ground station equipment with a leading U.S. space customer. Leveraging our larger space propulsion systems win in the U.S., we also secured an order for the same application for the customer in Europe. I also want to highlight our business activity in the energy end market. Our sales are up 28% year-on-year for the first half of '25 as we are growing new and existing business to meet the world's increasing energy demands. We have a particular focus on initiatives in new energy where our first half sales have exceeded the full year sales of 2024. As our business is well aligned to this global megatrend, we expect this area to be a growth driver for the company for the foreseeable future. When we released our first quarter earnings in late April, there was considerable uncertainty surrounding the tariff environment, which we noted as a qualifier to our guidance. While much remains to be finalized, we are more confident affirming our initial full-year earnings guidance despite the risk that remains. Thanks to our strong year-to-date performance, new business wins, and the increased order activity we are seeing. I would like to thank our global team for their unwavering commitment to driving our business forward while navigating the current environment. 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. In the second quarter, value-added sales, which exclude the impact of pass-through precious metal costs, were $269 million, down 2% organically from prior year and up 4% sequentially. This year-over-year slight decrease was largely driven by lower precision clad strip shipments and semiconductor demand from China. Excluding the impact of these items, value-added sales would have been up 2% versus the prior year. Strength in aerospace and defense, energy and semiconductor sales outside of China are driving the year-over-year sales increase. When looking at earnings per share, we delivered quarterly adjusted earnings of $1.37, down 4% from prior year, but up 21% sequentially. Moving to Slide 11. Adjusted EBITDA was $55.8 million or a second quarter record of 20.8% of value-added sales, down 3% year-over-year with 10 basis points of margin expansion despite the lower volume. This decrease was driven by lower volume, partially offset by strong operational performance and structural cost improvements. Favorable pricing was realized in the quarter, offsetting unfavorable mix from hydroxide shipment timing. Moving to Slide 12. Let me review second quarter performance by business segment. Starting with Performance Materials, value-added sales were $168.5 million, down 3% year-over-year, but up 5% sequentially. The year-over-year decrease was driven primarily by lower precision clad strip shipments as the expected inventory correction continues. Excluding precision clad strip, sales were up 3%, driven by strength in energy and aerospace and defense. Adjusted EBITDA was $41.5 million or 24.6% of value-added sales, down 4% compared to the prior year period. This decrease was driven by lower volume and unfavorable mix, partially offset by strong operational performance. Looking out to the second half of 2025, we expect to see continued strength across the aerospace and defense and energy end markets. In addition to higher volume, we expect to see continued strong operational performance and cost management. Now turning to Electronic Materials on Slide 13. Value-added sales were $76.1 million, down 6% from the prior year, driven by lower semiconductor sales to China. Excluding this impact, the remainder of the semiconductor market was up 6% from prior year, signaling market strength with improving demand across many subsectors. EBITDA, excluding special items, was $17.8 million or a record 23.4% of value-added sales in the quarter, up 4% from the prior year with 230 basis points of margin expansion. This record margin and year-over-year increase was driven by continued operational performance, including the impact of our cost improvement initiatives and strong price mix despite lower volume. As we look out to the remainder of the year, we expect the semiconductor market to improve in the second half and continue the momentum seen during the quarter. While some uncertainty remains around our semiconductor sales to customers in China, we are confident that our balanced and global semi portfolio will help offset some softness there. And as demonstrated so far this year, we expect to deliver considerable margin expansion as demand increases and the impact of our improved cost structure takes hold. Turning to the Precision Optics segment on Slide 14. Value-added sales were $24.4 million, down 5% compared to the prior year and up 14% sequentially. The year-over-year decrease was driven largely by order timing in the defense market. EBITDA, excluding special items, was $2.2 million or 9% of value-added sales in the quarter, approaching double-digit margins with 950 basis points of sequential improvement. The increase was driven by improving performance and the impact of the structural cost changes. This quarter brings the second consecutive quarter of improved results, and we expect to continue this trend as new business initiatives advance and we continue to improve our business performance. Moving now to cash, debt and liquidity on Slide 15. We ended the quarter with a net debt position of approximately $413 million and approximately $257 million of available capacity on the company's existing credit facility. Our leverage remains below 2x as cash flow generation is an important focus. We delivered approximately $36 million of free cash flow during the quarter, bringing our year-to-date conversion to more than 70% of adjusted net income. While continuing to invest organically, we also repaid $26 million of debt and repurchased 100,000 shares at an average of $78 per share, further demonstrating our balanced and disciplined approach to capital allocation. As we look out to the remainder of the year, we are well on our way to deliver free cash flow that exceeds 70% of adjusted net income with strong first half cash generation and second half cash initiatives on track. Lastly, let me transition to Slide 16 and address the full year 2025. We are pleased with our business performance in the first half of the year, having delivered strong results despite a volatile macro environment, and we are encouraged by improving market dynamics and new business opportunities won as we look to the second half of the year. With that, we expect Q3 will be similar to slightly better than Q2 and we are on track to deliver a strong Q4 with improving demand and the timing of defense shipments. As a result, we are affirming our initial guide of $5.30 to $5.70 adjusted earnings per share for the full year. This concludes our prepared remarks. We will now open the line for questions.

And the first question today is from Phil Gibbs at KeyBanc Capital.

We have seen a really strong performance in Electronic Materials regarding their margins. Jugal, you mentioned a new level of performance and expected some upside for the full year. How sustainable do we think the recent quarters' EM margins are? I also noticed a solid sequential increase in consumer electronics. It seems like there can be a positive mix impact for you, even though it might seem counterintuitive regarding a pickup in clad, given its relevance. Could you discuss that from a broader perspective?

Yes, Phil, regarding Electronic Materials, we've been discussing this for about a year and a half. Despite the market downturn, our team has effectively enhanced operational performance and adjusted our cost structure. This has positioned us to benefit now that volumes are beginning to rise. Initially, we saw increases in the logic and memory segments, and now we're also noticing a rise in power and data storage volumes. This trend is fostering confidence and contributing to the improved margins we observed in Q2. While the margins around 23.5% may not be sustainable every quarter, it is encouraging and suggests ongoing improvement. I anticipate year-over-year performance and margin growth in this business, especially as the market continues to recover. We're optimistic about the future of Electronic Materials, not only for the remainder of this year but also looking ahead to 2026 and 2027 as we expect the market to rebound further. The recent uptick in consumer electronics can be attributed partially to increased shipments in our PMI business. As we've mentioned, our full-year outlook aligns with customer expectations from earlier communications, though there are always timing variances from quarter to quarter. Overall, we're committed to driving performance across all our markets.

Regarding energy, you mentioned it briefly in your opening statements. It appears to have improved significantly compared to last year. There are several subsegments within your energy business, so could you elaborate on what you're observing there that excites you?

Yes. So as you know, we've had traditional energy. We're an impactful player in the oil and gas market. Our content per rig has continued to improve. We provide, in fact, more content, especially as the new drilling technologies come on board and more and more electronics and more and more AI is implemented on the traditional energy side. So that makes us feel good, I think, in terms of that side of it. But last couple of years, we've talked a lot about alternate energy, new sources of energy, in particular, clean nuclear energy. We've talked about our partnership with Kairos. But in addition to that, we have a number of other initiatives that we're involved in that we're not able to talk about the customer names, but we are involved in those here in the U.S. as well as globally. And we're excited about that. We're excited about where that can take us over the next 3, 5, 7 years because, as we know, the trend and the world's expectations of energy is increasing. The demand is increasing at a rapid rate, and the world has to be able to conform to that demand. And I think we are a key player with our materials in the energy sector. So not only are we excited about our content on the traditional energy side, I think we're even more excited about the role that we can play on the new sources of energy that I think are coming forward with the number of different projects that we have.

You clearly outlined the potential tariff risks associated with China last quarter. It seems you believe you have fully mitigated those risks in your current outlook. I'm curious about what has changed from your overall perspective and what gives you confidence in the landscape aside from the cyclical pickup in the semiconductor business.

Yes. As you are aware, during our Q1 earnings call, we were facing significant tariff rates for materials coming into the U.S. and those going from the U.S. to China. However, during the quarter, these rates were considerably reduced. This allowed us to ship some products in Q2 that we initially thought we wouldn't be able to. We continued producing to ensure we could adapt to any changes in the tariff situation, and indeed, we were able to leverage those changes. While we faced some impact in Q2, it was less severe than we initially anticipated, and we expect some ongoing impact in the latter half of the year. However, I am very proud of our team's efforts in making operational and commercial enhancements that will help offset any remaining impact we face in the second half of the year, allowing us to meet our original guidance. Our incoming order rates have increased by 4% from Q1 to Q2, and non-China semiconductors have risen by 15% sequentially. We achieved record defense bookings of $75 million, and our space backlog has doubled compared to this time last year. New energy sales have also surged; we've already surpassed last year's total in the first half of this year alone. All these factors provide encouraging signs for the second half and position us well for 2026. While we still have uncertainties ahead, it is promising to see the strong results from the second quarter and their potential impact for the remainder of the year.

The next question will be from Daniel Moore from CJS Securities.

Congrats on the results. Maybe just talk a little bit more about Konasol. Tell us a little bit more about the facility and the capabilities you're acquiring relative to your deposition capabilities here in the U.S. And how do we kind of think about either current revenue EBITDA or the scope of the opportunity set over time?

Yes. I think this is a great move that our team has been able to make. As you know, we've been talking, Dan, for the last few years about continuing to gain more capacity and capability outside the U.S., particularly in our semiconductor business. The largest semiconductor suppliers tend to be in Asia. We want to make sure we're local, and we're providing the local support to those customers. Konasol fits right in for that. It's a facility in Korea. We're able to support not only the Korean chip manufacturers but also chip manufacturers in Taiwan, in China, in Japan, etc. And it really gives us a full value stream for our tantalum business, but it also gives us a facility that we can build up for our other semiconductor business as well down the road. So we were able to close on that here in the second quarter. Now we're really, really excited and busy about making samples and qualification products that we can give to those many customers in the Asia region. As you know, in this space, of course, it takes a little time to get the qualifications done. So perhaps in some cases, at 6 months, other cases in maybe 12 months. We would expect to see some level of sales starting in the '26 timeframe and the associated EBITDA with that. But it positions us very well for, I think, the general growth that we see that we always talk about for the semi space over the next 3 to 5 to 7 years.

Very helpful. And just sticking with semi. Obviously, you described very well some of the green shoots and improvements you're seeing here or at non-China. Maybe talk about what you're seeing or hearing in China specifically and any confidence in a return to growth as we think about 2016 and beyond?

Yes, we have started to see positive signs in the logic and memory sectors a couple of quarters ago. What is particularly encouraging is the growth we are beginning to observe in our data storage, power semiconductor, and communications devices businesses. These areas are essential to our Electronic Materials division; they significantly contribute to both our revenue and profit. We are optimistic about the continued upward trend in the latter half of the year. Regarding China, they have been building their own semiconductor supply chain for several years and have made notable progress, particularly in final manufacturing. We aim to participate in China's semiconductor manufacturing in the long term but understand that competition from local firms will increase as they advance. We are also monitoring global investments occurring in the U.S., Europe, Korea, and Taiwan. Overall, we believe the semiconductor market will see growth in the mid to high single digits for the foreseeable future.

Super helpful. Last for me, and I'll jump back. It sounds like Philip Morris or PMI has not made any changes to the full year outlook. Do you have any updates on potential timing for Phase 2 of the precision clad strip project and any information you're receiving from the FDA?

Yes. For the full year, we expect it to align with our previous communications and we are on track with that. Typically, we begin discussions in Q3 or sometimes early Q4 about the following year. We will conduct meetings to understand their expectations for the next year. They announced last week during their earnings call that they are still working with the FDA to secure approval. The timing of that approval, whether this year or next, is a matter they are discussing with the FDA, but we are well prepared to support them once they receive the approval.

The next question is coming from Mike Harrison from Seaport Research Partners.

Congrats on a nice quarter. I wanted to go back to the margin performance in the electronic materials business. It kind of sounds like while you're expecting some improvement, maybe Q2 is kind of a high watermark. And I guess I just wanted to understand what kind of temporary or unusual factors could be playing into the margin performance? And specifically, I was curious, is the strength outside of China, something that is a positive for mix, meaning that some of your inside China business is actually a lower-margin business than outside?

Yes. Mike, let me start with that one. So you're hitting on some good points there. With Electronic Materials, the performance has definitely been improving. But as you know, it's not really consistent quarter-to-quarter within a very small band as to what those margins are. And there's different factors that mix certainly is one of the larger ones. As you know, sometimes we talk about our precious metals business versus our non-precious metals business as those carry different margin profiles. But regionally as well, China does tend to be a lower mix item. So when our strong sales are stronger on the other items, that would be a positive mix item.

All right. That's helpful. And then within the Performance Materials business and that precision clad strip business, I think we just kind of touched on it, but I was hoping to get an update on that new precision clad strip facility and kind of where we are in terms of Phase 2 being fully up and running and kind of what that looks like in terms of capacity and utilization? And then the other piece of that is the old precision clad strip facility. Is that still producing anything for PMI? Or maybe just give us an update on where you are in the process of filling that old facility with maybe some new clad strip business?

Yes. First, I want to address the old facility. This facility produces some materials for PMI, but primarily it manufactures for non-PMI customers. We serve several markets, including automotive and consumer electronics, and have been doing so for many years. Therefore, we are still actively producing materials there, as the facility is better suited for specific types of production. Regarding the new facility, we'll be having discussions with PMI over the next 3 to 6 months to understand their needs for the upcoming year. We are ready to meet whatever demand they have, whether it involves entering the U.S. market or other markets with increased volume, or maintaining the same product levels for different reasons. We are well-positioned with our facility, capacity, and workforce to support them based on our upcoming discussions.

But just to clarify, is the equipment associated with Phase I of the new precision clad strip facility already in place? Or are there some pieces of equipment or lines that you would need to add if the orders from PMI were to expand in conjunction with FDA approval?

No. The facility is fully ready. We have the equipment. It's qualified, and we would be prepared to produce as we got orders from them.

Perfect. And then last question for me is just on the Precision Optics business. You had really nice sequential earnings improvement there and kind of some recovery there. Just curious, do you expect that better performance to continue? And can you maybe give us a little bit more color on how you've engineered a turnaround, what seems to be relatively quickly?

Yes. We're really, really pleased with, I think, the progress that this business has made. As you know, we've had some challenges in this business. We acknowledge that. And I think we've taken strong action, including leadership change along with, I think, a number of different other structural cost changes, portfolio adjustments and so on. And we're very, very pleased with the progress that this business has made over the last few quarters reaching almost double-digit EBITDA margins in Q2. We've indicated that we continue to expect sequential improvement. And so that's what we're going to strive for here in the back half of the year is to drive continuous improvement in Q3 and then in Q4 and, of course, into next year. I just want to remind you, Mike, and I know we've talked about this, is that just a few years back, this business was 20% plus EBITDA margins for us. And our goal has not changed. Our goal is to return the business to that level of EBITDA margins. Certainly, it will take some time. But we're very, very pleased with the level of turnaround that this business has given to us so far.

The next question is coming from Dave Storms from Stonegate.

Just wanted to dig into a couple of the end markets here. It's noted that automotive saw a strong sequential quarter from Q1 low point, but you're still seeing some continued market softness. Just would love to get your thoughts on what your outlook is for that market for the rest of the year? Should we continue to see maybe sequential growth? Or is this maybe a plateau before the next leg up?

Yes. Auto, I think as a market for us, has been quite challenging the last couple of years. And certainly, Q1 was the low point for us. We saw encouraging signs here in Q2 sequentially of 15%. We would expect that in the back half of the year, we would be somewhere in the flat to probably slight increases in the back half of the year. I think this market continues to be a bit choppy. There are still some headwinds, I would say, in the European market and certainly in the U.S. and changes have happened between EV and hybrid and traditional ICE. And so I think the choppiness in the auto market could continue for us. But at the same time, it's become a smaller market for us. And so I think the impact to our company from the choppiness is much less. We're very encouraged with what we are seeing on defense and on space, on commercial aerospace, the semiconductor market, the energy market. I think we are very, very impressed and pleased with where those markets can go over the next 3 to 5 years. And automotive, we'll just monitor and support as needed.

That's perfect. And that actually brings me to my next question around the defense backlog. Just hoping if you could give us a little more maybe texture, timeline, and burn rate around that, maybe what the margins look like compared to current margins? Anything like that would be very helpful.

Well, the defense market is a very positive mix market for us. So we enjoy improved performance, I think, on a margin level from the defense market than perhaps some of the other markets. Like we indicated, we have $75 million of bookings approximately in the first half of this year. That's up about almost 30% on a year-over-year basis for defense. And then we see a tremendous number of new inquiries much more than what we have seen in the time that I have been here in the company for defense. There's an increased level of activity from U.S. defense, increased level of spending that's happening in Europe, and that's resulting in, I think, a higher activity and certainly increased activity from some of the countries in Asia as well. Our non-U.S. portion of the defense business continues to grow based on all these initiatives. So I think the level of activity, we expect to continue to increase in the back half of the year, and our expectation is to be able to make sure we're capturing as much of this business as possible and supporting our customers.

And the next question will be a follow-up from Phil Gibbs from KeyBanc Capital.

I am wondering if there are any tax savings, specifically cash tax savings, associated with the big beautiful bill for this year or next year.

Yes. Good question. So we've been going through that, as you can imagine, in some detail and taking a look initially at where we think the benefits are and maybe where we won't have as much benefit. We get a lot of questions around the bonus depreciation. On the bonus appreciation itself, it's possible that could give us some benefit, but it's intertwined with our FDII deductions, our foreign intangible income deduction. So we've got to model that out and really decide where we may want to take the 100% bonus versus a lower amount, but that could be beneficial, as you said, from a cash tax perspective. But there's other areas around interest, the deductions we can take there that are beneficial. And then, as you know, the production tax credit that we have that we enjoy is currently now scheduled to wind down by 2031. That item could change administration to administration. But right now, before it had no end in sight, and now it's showing that it would wind down by 2031.

And then you've talked a lot about the strength in defense. Obviously, it's a critical imperative for this administration. Has there been any discussion around repletion of the strategic stockpiles of beryllium in the country by the government? I don't know where those inventory levels stand, but I would imagine given the activity we've seen globally the last few years, they probably have not gone up. So just anything you have there in terms of your commentary or views.

Yes. Phil, as you know, a large part of our defense business does rely on our beryllium capability and what we're able to do. And so I can tell you that we are actively involved in discussions with the Defense Department, but really all parts of the defense area in the country as well as, I think, with the primes and beryllium supply and overall stockpiles and other types of, let's say, things that are related to this without going into a lot of detail that I can't get into. But we're involved in really all the discussions that are there on defense.

And we have reached the end of the question-and-answer session. I will now turn the call over to Kyle Kelleher for closing remarks.

Thank you. This concludes our second quarter 2025 earnings call. 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. Thank you for your participation.