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Transcript of

Materion Corporation Second Quarter 2016 Earnings Conference

July 28, 2016

Participants Michael Havlicek – Vice President, Treasurer, and Secretary Richard Hipple – Chairman, President, and CEO Joe Kelley – Vice President, Finance and Chief Financial Officer

Analysts Ed Marshal – Sidoti Company Marco Rodriguez – Stonegate Capital Partners Phil Gibbs – KeyBanc Capital Markets

Presentation Operator Greeting and welcome to the Materion Corporation’s Second Quarter 2016 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Michael Havlicek, Vice President, Treasurer, and Secretary. Thank you. You may begin. Michael Havlicek – Vice President, Treasurer, and Secretary Good morning. This is Mike Havlicek. With me today is Dick Hipple, Chairman, President, and CEO, and Joe Kelley, Vice President of Finance, and Chief Financial Officer. Our format for today’s conference call is as follows: Joe Kelley will review the financial results for the second quarter and the outlook. Following Joe’s comments, Dick Hipple will review the current state of our key markets. Following Dick, we will then open up the call for your questions. A recorded playback of this call will be available until August 12th by dialing area code 877, the number is 660-6853, or area code 201, the number is 612-7415. The conference ID number is 13640503. The call will also be archived on the company’s website, Materion.com. To access the replay, click on events and presentations on the Investor Relations page. Any forward-looking statements made in this announcement, including those in the Outlook section, and those in 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 issued this morning. And now, I’ll turn it over to Joe for comments. Joe Kelley – Vice President, Finance and Chief Financial Officer Thank you, Mike and good morning to everyone joining us on the call today. During my comments, I will cover our second quarter 2016 financial highlights, review second quarter profitability by segment, make some brief


Transcript: Materion Corporation

Second Quarter 2016 Earnings Conference July 28, 2016

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comments on cash flow, and finally cover the earnings outlook for the remainder of 2016. Following my comments, Dick Hipple will provide comments on the company’s key strategic initiatives and market conditions. Let me start with the second quarter financial highlights. We are pleased to report that our second quarter 2016 financial performance was in line with the guidance we provided, and at the high-end of the street estimate. We delivered both sequential topline sales growth and earnings growth compared to the first quarter of 2016. For the second quarter 2016 value-added sales, which excludes the impact of pass-through metal costs, grew 7% sequentially over the first quarter of 2016 to $153.9 million. The sequential growth was driven by success in our largest end-market, consumer electronics, plus growth in both science and telecommunications infrastructures and markets, all three posting double-digit or greater sequential improvement. The second quarter 2016 value-added sales compared to the prior year, same period value-added sales decreased 5%. The vast majority of the decrease year-over-year is attributable to the lack of raw material, beryllium hydroxide sales, in the current year period. Value-added sales from new products defined as those introduced in the last three years totaled approximately $18 million, and represented 11% of the total value-added sales in the second quarter of 2016. Our selling, general, and administrative expenses were $32.4 million or 21.1% of value-added sales, and $2 million higher than the first quarter of 2016 selling, general, and administrative expense. The sequential increase was attributable to a $1.9 million in external professional service costs incurred to support the pursuit of acquisition targets. Excluding these nonrecurring costs, selling, general, and administrative expense was flat, with the first quarter of 2016, and represented only 19.8% of value-added sales, below the 21.3% in the prior-year period. Research and development expense continues to represent approximately 2% of value-added sales, as we are investing and advancing our new product pipeline including specific quarterly investments in our large area coating product offerings for medical sensors, and our eStainless Organiclad [ph] product line, which is currently being sampled at several consumer electronic customers. These R&D efforts are long-term investments and strategic growth platforms. However, the exact timing and magnitude of the end-market acceptance is difficult to forecast. Other-net was expense of $3.9 million in the second quarter of 2016, a $2 million increase sequentially from the first quarter of 2016. The expense increase is attributable to foreign currency exchange losses, a $400,000 increase in our environmental reserve and the absence of a gain on sale of fixed assets as realized in the first quarter of 2016. Other-net expense on a year-over-year basis increased $3.9 million, primarily because of $2.4 million in foreign currency exchange differences as the prior year included a significant FX hedge gain associated with the strengthening of the US dollar against the euro and yen. Operating profits in the quarter totaled $5.8 million compared to the first quarter 2016, operating profits of $7.5 million. Adjusted operating profits, which excludes nonrecurring acquisition and legacy site environmental costs, totaled $8.1 million in the second quarter of 2016, an 8% improvement over the $7.5 million in operating profit recorded in the first quarter of 2016. Management excludes these expense items and views them as nonrecurring in nature. The acquisition costs are only the external professional services incurred for due diligence efforts. Similarly, the environmental reserve adjustment is not reflective of ongoing costs associated with current operations. Rather, the reserve increase relates to a facility that hasn’t been operated by Materion since 1988, yet we maintain responsibility for the environmental remediation




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Adjusted operating profit compared to the prior-year period decreased $5 million resulted primarily from the absence of beryllium hydroxide sales in the second quarter of 2016 and reduced foreign currency hedge gains. Second quarter 2016 adjusted operating profits, expressed as a percent of value-added sales was 5.3%, comparable to the profitability levels recorded in the first quarter of 2016. Our net income in the second quarter of 2016 totaled $5.5 million, which includes a $900,000 tax benefit associated with international tax planning strategies. Excluding this discrete tax item, the year-to-date effective tax rate is approximately 19%. The improved forecasted effective tax rate, excluding special items is being driven by the mix of earnings and recurring tax planning strategies. Earnings per share were $0.27 in the second quarter of 2016 adjusted for the special items in the discrete tax benefits, adjusted earnings per share were $0.31. This compares to $0.27 per share of earnings in the first quarter of 2016, a 17% sequential improvement in earnings. Now, let me review our performance by business. Our performance alloy and composite segment value-added sales totaled $83.4 million in the second quarter of 2016, a decrease of 9% from the $91.5 million of value-added sales recorded in the prior-year second quarter. The entire decline in value-added revenue compared to the prior-year period can be attributable to the lack of raw material beryllium hydroxide sales in the current-year quarter. Second quarter 2016 value-added sales increased 7% from the $78.2 million in value-added sales recorded in the first quarter of 2016. The sequential improvement in value-added sales was led by double-digit growth of sales in the consumer electronics, and industrial components end-markets. Partially offsetting this improvement was yet further deterioration in our sales into the oil and gas markets. From a geographic perspective, sales into the Asian region led the growth posting double-digit growth, both sequentially and year-over-year. Operating profits in the performance alloys and the composite segments totaled $200,000 in the second quarter of 2016, a decrease from the $9.3 million recorded in the prior-year second quarter, and the $1.5 million recorded in the first quarter of 2016. The decrease in year-over-year operating profit resulted from a combination of several factors. First, foreign currency exchanged differences negatively impacted profits by $2.4 million, primarily related to the lack of foreign exchange hedge gains, which were recorded in the prior-year period. Two, the lack of raw material beryllium hydroxide sales in the quarter. Thirdly, unfavorable product mix, with the decline in higher-margin oil and gas-related sales, and the growth in the Asian business, primarily copper beryllium-stripped products, which are lower margin sales. And the final factor was increased operating costs as we liquidate the higher cost inventory generated in late 2015 and early 2016 when production volumes were depressed. Rest assured, management is taking action to address the profit deteriorations this segment, particularly, the unfavorable product mix and increased operating costs. The hydroxide sales volume impact is viewed to be temporary in nature, as our largest hydroxide customer works through excess inventories, as negotiations continue. We have already initiated actions to realign the business along value streams and right-size our cost structure. Our annual guidance includes sequential improvements in this segments profitability as a result of these initiatives, plus the forecasted sequential topline value-added sales growth. Moving now to our advanced material segment. Compared to the same period in the prior year, second quarter 2016 value-added sales and operating profits were relatively consistent. Second quarter value-added sales were $47 million, and operating profit was $7.3 million, or 15.6% of value-added sales. Looking at the sequential comparison with the first quarter of 2016, the segment recorded a 12% increase in value-added sales, and a 40%




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increase in operating profits, as business levels and profitability recover from the reduced demand levels experienced in the fourth quarter of 2015 and first quarter of 2016. This segment’s strategic focus on the broader semiconductor market is clearly working and sales into the consumer electronics end-market grew sequentially 13%, and grew 1% year-over-year. This segment historically has been our most profitable business, and it is good to see it returning to profit margins in the mid-teens, despite the relatively lackluster overall end-market conditions within the consumer electronics market. Moving to the precision coatings group. This group includes the precision optics and large-area coating businesses, which are included in the other segment along with unallocated corporate costs. Value-added sales for the precision coatings group were $25.1 million in the second quarter of 2016, compared to $25.2 million in the prior-year second quarter. Despite the relatively flat sales year-over-year improved product mix and manufacturing yield improvements continued to drive profit growth. Operating profit for the precision coatings group in the second quarter of 2016 totaled $2.3 million or 9% of value-added sales, a significant improvement over the $600,000 of operating profit recorded in the prior-year second quarter. Similar to the performance this segment reported over the last several quarters, the strategy of driving improved profit mix is working. We continue to prune low-margin products such as the color wheel projector display and focus on more profitable new product introductions, like the ceramic foster wheel, and the new blood glucose test strip material just to name a few. Looking at the second quarter performance compared sequentially to the first quarter of 2006, value-added sales were relatively flat and operating profit was down $1.8 million. As I referenced on our conference call last quarter, the first quarter of 2016 precision coatings group performance represented a very favorable product mix, which was not forecasted to repeat. That said, I remind investors, this business group’s profit margins has steadily increased the past three years, and based on our year-to-date 2016 performance, we forecast that 2016 will be the fourth consecutive year of adjusted profit and margin improvement for this group. Turning now to cash flows, the company’s balance sheet remains strong in the second quarter as net debt was reduced to $8 million and the company continues to have significant available liquidity to support meaningful organic growth opportunities, pursue strategic inorganic growth alternatives, and return capital to shareholders. Cash flow, provided from operating activities, totaled $9 million for the first six months of 2016, which represents a $12 million decrease from the prior-year period. The decreased operating cash flow resulted from lower net income and a $4 million increase in pension funding. For the full-year we are forecasting cash flow from operations to be in the range of $50 million to $60 million as the back-half of the year has seasonally stronger cash flows. Cash used in investing activities totaled $21 million in the first half of 2016. $6 million below the prior-year amount. Full-year mine development expenses as forecasted to be approximately $10 million, less than half of what it was in the full-year of 2015. Capital spending, excluding mine development, is forecasted to total approximately $25 million to $30 million for the full-year of 2016. During the second quarter of 2016, we increased our share repurchase effort, and repurchased approximately 90,000 shares for $2.2 million, bringing the year-to-date totals spent on share repurchases to $2.7 million, equal to the prior-year amount. Additionally, year-to-date, we have returned $3.7 million to shareholders in the form of a dividend. During the quarter, we increased our quarterly dividend 6% to $0.095 per share. This marks the fourth consecutive year of annually increasing the quarterly dividend amount. Finally, for modeling purposes, we are forecasting effective annual tax rates, excluding special discrete items of approximately 18% to 20%.




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Turning now to the outlook: as we look to the second half of 2016, we anticipate continued sequential improvement in value-added sales and earnings. Second quarter 2016 marks the second consecutive quarter we delivered sequential value-added sales growth from finished product sales, which exclude beryllium hydroxide sales. This momentum is forecasted to continue into the second half plus we are forecasting beryllium hydroxide sales to resume in the second-half of 2016. We are narrowing our full-year earnings guidance range from the previously issued $1.30 to $1.55 per share to $1.30 to $1.40 per share. Please note, we have not lowered the bottom then. Rather, given the extended delay in hydroxide sales, which we have now experienced through the second quarter of 2016, the softer than expected annual growth in our largest end-markets of consumer electronics, and the more negative outlook related to the pending recovery of the oil and gas markets, we are narrowing the guidance range. This guidance range is reflective of approximately 35% to 45% earnings growth in the second half of 2016 compared to the first half performance. Looking at the quarterly split, the fourth quarter is forecasted to be the strongest earnings quarter of the year. This concludes the prepared remarks. I will now turn the call over to Dick Hipple, who will review the company’s strategic position. Richard Hipple – Chairman, President, and CEO Thank you, Joe. During my conference, [audio disruption] markets and share some of our new product development initiatives. Following this, I’ll provide and update on our [indiscernible] activity and make some business unit specific comments. First, to provide some perspective on our value-added sales quarter versus quarter and by market. Sales were in line or sequentially higher in key end-markets including consumer electronics, industrial components, defense, commercial aerospace, science, and appliance. In consumer electronics growth was up by about 2% with some strength in Asia driving demand for alloy strip from optics and phosphor wheels for the projection market and a key smart phone image sensor application, offset to some degree by softness in the data storage market. Defense sales were strong coming in at 32% ahead of last year, and were up across Materion’s businesses including performance alloys and composites, with new applications on the Bradley fighting vehicle and sales optical targeting system applications and missile guidance systems served by our optics group. Sales for products serving the commercial aerospace market were up 3% year on year with PAC winning new applications and continuing to add more pounds of raw materials on new or retrofitted commercial airliners. Well, I guess the small base our sales in the science were up nearly 60% aided by strong beryllium sales to the nuclear test reactor sector and from space related applications supplied through our optics group. Our medical sales were off by low-single-digits, while our automotive electronics sales were lowered by about 10%, with reduced sales of rod and wire into the commercial truck business, some pullback in orders from our automotive customers and pruning of low margin products in our optics business. We did see sequential growth in automotive however from the first to the second quarter. Finally, sales to the energy market were down about 18% year on year, but with signs that the oil and gas market has bottomed out. Outside of oil and gas, sales of our products into the fuel cell and battery resistor applications were up, while sales to the solar market dropped to a slower than anticipated new technology ramp at a key customer. We are now seeing sequential growth in all of these markets. We continue to populate our pipeline of new products in innovative end use applications that help our customers respond to the ever changing macroeconomic and technology trends. In fact, new product value-added sales were 11% of our total VA sales in the quarter. In the telecommunications infrastructure market, our advanced materials group recently introduced a new air cavity package designed for cell tower base stations, serving not




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only todays 4G technology, but also geared to the ultrafast fifth generation or 5G wireless technology expected over the coming years. It provides a nice performance improvement at a reduced cost for our customers and it is expected to support 5G technology for broadened applications such as autonomous vehicles and the internet of things. At the Offshore Technology Conference in May, we officially launched our new ToughMet tempers and large diameter bar products, which are opening up new applications in larger drilling tools. Our ability to help the oil field lower production and maintenance costs has been very favorably received in an environment where spending controls are incredibly tight. While muted, due to the overall activity level, which has our oil and gas business down on a sequential business, we are receiving stock orders from our distributors ahead of orders they are expecting from the field. Meanwhile our new ToughMet TS temper product family is also generating new sales from the directional drilling segment of the industry as equipment makers ride us into their specifications and prototype testing is completed. These new product introductions will support future growth when the oil and gas market recovers. Additionally, we are making new end roads with our CLAD products supporting various customer electronics, especially handheld devices focused on thermal management, and corrosion resistance. In the more limited volumes, especially the smart phone market, Materion has announced the initial production orders for Sirin Labs new high security mobile phone called Soleron. It’s the first use of our SupremEX metal matrix composite material of this kind of application and was selected for the phone’s chassis material, because of its lightweight and superior strength attributes. Finally, our PST segment continues to support new growth in nuclear test reactors, both for material, research, and medical isotope production. Two applications and upgrades include a research reactor in South Korea, and the BR2 reactor in Belgium. Refurbishments and other reactors, including one in Peru are scheduled over this year and into 2017. So, as I have outlined, we remain very active and continue to make good progress in developing advanced material solutions with our customers. Predicting the speed of adoption is always difficult, but we are well positioned for sizable opportunities. Now, to update you on our acquisition process, in mid-May we announced that we were in negotiations to acquire a global high performance target materials business of the Heraeus Group, which is based in Germany. The announcement of this potential acquisition was unusual, however it was to help facilitate proactive communication of the potential transaction with a German works council. By the way of some background, Heraeus manufacturers precious and non-precious metal target materials for the architectural and automotive glass, electronic display, photo metallic, semiconductor, and media data storage markets have facilities in Germany, the United States, Singapore, China, and Taiwan. So, by combining our target business with Heraeus, we will bring two well established, advanced material industry players and provide an unprecedented target manufacturing and services capability. Materion’s current global presence would be significantly broadened with the addition of Heraeus’s European and Asian manufacturing facilities, technical capabilities, and highly regarded talent bench. With that said, our negotiations are continuing and are progressing in a timely manner. This does represent a complex carve out at multiple sites of a large Heraeus organization. As Joe referenced, we conducted extensive due diligence and integration planning work, including external professionals to assist in this acquisitions. We are still working toward a fourth quarter closing. The Heraeus acquisition was not the only targeted pipeline. We have several other strategic acquisition alternatives under active consideration.




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Now, looking at performance alloys composites without question, the past four quarters have been increasingly challenging for our performance alloys and composites business. The disappearance of the oil and gas exploration business, the continued strength of the US dollar and the sharp drop in the Asia connector market in the back half of 2015, have come together to severely impact the profitability of this segment. Rest assured, we have a recovery plan in place, and the second-half of 2016 is forecasted to be better than the first half. We believe the second quarter 2016 financial performance represents the trough in performance for this segment. We are evaluating alternatives to accelerate the profit improvement of this segment, just as we did in 2009 when facing a different set of challenges. Our ability to overcome hurdles has also been demonstrated by the actions we took in 2014 and 2015 to shore up advanced materials and precision coatings, and I think you see the results of that betterment performance of those particular segments. It is frustrating that the fall off and performance alloys and composites obscure some of the terrific progress we have made in recent years and quarters to execute the strategy of driving profit margin enhancements through the combination of new product development, efficiency improvements, and product portfolio management and our advanced materials and precision coatings operations. The external factors influencing our performance alloys and composites have overshadowed the advances of executing the strategy in this segment. Also helping the recovery of this segment and in contrast in the first half of 2016, we are forecasting hydroxide sales in the second half of this year. Based on the most recent acquisitions, I have increased confidence that these sales will resume starting in the third quarter. In summary, much of our business is performing well and we are successfully executing our strategy. However, the financial performance of our PAC business is clouding these results. I continue to be encouraged by the strength and innovation level of our new product pipeline and what that means to our future, and I am pleased that despite the challenges within our PAC business, and some broader global economic challenges, we are able to maintain the lower end of our originally announced earnings guidance. We appreciate your interest in Materion, and for taking this time to join us. Operator, you may open the line up for questions. Operator Thank you. At this time we will be conducting a question and answer session. (Operator instructions). One moment while we poll for questions. Our first question is from Edward Marshall from Sidoti Company. Please proceed with your question. Q: Good morning, guys. Richard Hipple – Chairman, President, and CEO Good morning, Ed. Q: So, I had a question on the beryllium hydroxide and maybe what’s causing that stuff, I guess the increase in supply out there, or the increase in inventories out there that need to be worked through through a destocking theory. I’m curious if the April announcement from Apple had anything to do with that potential build up. Richard Hipple – Chairman, President, and CEO The April announcement by us, no that’s totally independent issues connected to Apple and the hydroxide situation. I think we’ve talked about this before is that we actually sold quite a bit of hydroxide last year, and we




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believe that the key customer overbought in anticipation of higher prices this year. So, I think it’s just simply an inventory liquidation situation from an overbuy and settling out as we go forward. Michael Havlicek – Vice President, Treasurer, and Secretary Last year as you remember was the end of a ten year contract and so the customer the last two years of that contract bought in excess of the annual needs, perhaps, such that he could hold off here for several quarters, now it’s been prior to ordering, when the new contract renews at a different price. Q: Got it. Michael Havlicek – Vice President, Treasurer, and Secretary The update there is I would tell you that based on recent developments as late as this week, we continue to be optimistic or have a high degree of confidence that that order, hydroxide ordering will resume here in the third quarter. Q: Has the contract been renewed? Mike Havlicek – Vice President, Treasurer, and Secretary The contract has not been renewed as of right now. No. Q; So, you have not. Just so I’m clear that there has not been a, the order, you haven’t seen any hydroxide orders hit the books as of yet, but I guess what you’re saying is you anticipate they will. Mike Havlicek – Vice President, Treasurer, and Secretary Yes. Our forecast includes hydroxide ordering, selling hydroxide, raw materials in the back half and based on recent developments, there’s a degree of confidence in that aspect. Q: Got it. Now you reduced the outlook for the strip mine, I guess the second quarter in a row. Did that have any kind of, is that related to this change in the hydroxide that you’re selling. Mike Havlicek – Vice President, Treasurer, and Secretary I’m confused by your question. We reduced the last quarter— Q: The last quarter Mike Havlicek – Vice President, Treasurer, and Secretary Yes. The strip mine development the last quarter, we said we would spend $8 million to $10 million on mine development. This quarter we’ve confirmed that at $10 million for the year. So, there’s been no change since last quarter in our mine development activity. Q: Right. But I guess the fourth quarter last year, you were saying $20 million to $25 million. Mike Havlicek – Vice President, Treasurer, and Secretary Yes. So, as we said on the Q1 call, or I think it was the Q4 call actually, we were able to reduce several, basically make some enhancements into our supply chain management of inventory. Some of the purity levels of ore were greater than anticipated such that we could push out some of this mine development. So, we suspended mine development here in the second quarter from what was originally planned back when we were forecasting to spend $20 million to $25 million in ’15. So, that’s what drove that and nothing has changed on that since the last quarter.




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Q: In the event of an acquisition, I’m just curious what are the deal multiples that you’re seeing in this phase? Richard Hipple – Chairman, President, and CEO Well, I’d say that right now in that seven to nine multiple range, and obviously when we’re looking at acquisitions a key part of that is what synergies can be driven. Q: Right. Does that seven to nine include any synergies anticipated, or is that seven to nine on a straight EBITDA? Richard Hipple – Chairman, President, and CEO No, that’s synergies. Yes. Mike Havlicek – Vice President, Treasurer, and Secretary Like a trailing 12 month EBITDA. That’s seven to nine times trailing. Yes. Q: Got it. Okay. Thank you very much. Mike Havlicek – Vice President, Treasurer, and Secretary Thank you, Ed. Operator Our next question is from Marco Rodriguez from Stonegate Capital Partners. Q: Good morning, guys. Thank you for taking my questions. I wanted to kind of follow up a little bit on the guidance, I just wanted to make sure I’m understanding some of the moving parts there, specifically on the hydroxide sales. If I’m not mistaken, I thought the anticipation was that those sales would come through in the second half, which if I’m hearing you correctly, is still the expectation yet, we’re talking about a reduction in EPS, because of the hydroxide sales. So, has something kind of changed there a little bit, that I’m just not thinking through correctly? Richard Hipple – Chairman, President, and CEO The prior forecast assumed that hydroxide sales would be the original forecast, assumed that they would actually start to trickle in here in Q2 and they have not started to trickle in in Q2 or the contract would be renewed in Q2, and now it’s looking like that will start in Q3. So, that is a component of that. Q: Okay, got you, and so there’s no indication that those sales that you had expected in Q2 would be made up in Q3, Q4? Richard Hipple – Chairman, President, and CEO That is correct. Q: Okay. Okay, and then in terms of the consumer electronic market, I was wondering if you could maybe provide a little more color there in terms of the areas that you’re seeing particular softness in. I mean, you also do call out an increasing improvement in the semiconductor space, which I’m assuming has some overlap into the CE market, so I’m just wondering if you can kind of help me think through that. Richard Hipple – Chairman, President, and CEO




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I think if you start to look at some of the earnings reports that are coming out recently and I’ll just cite a couple that I’ve run across recently. If you take a look at like a Skyworks, the revenue was down 7% year to year. If you look at Apple, their revenue was down 13% year to year. So, obviously there’s a slowness that has gone on, particularly in the consumer electronics world, and but yet, in the second half they are coming out, Apple, for example, is coming out with a new models. However, Apple’s taken up their forecast, I think 5% in revenue in the third quarter. So, what we’re seeing I think, and certainly that’s going to be a lot lower than last year. So, what we’re seeing really is a second half growth in electronics, but certainly weaker than what it was last, well in that case within Apple and then Skyworks, it’ll be better in the second half. But, certainly some drag down in what I call overall growth year-over-year is certainly muted in total. So, we expect to see higher sales in the second half based on the normal product lifts that are going on for the holiday sales. Q: Got you. And are there particular areas in the CE market that you’re seeing softness, whether it’s computers or mobile devices, anything like that, any kind of color there? Mike Havlicek – Vice President, Treasurer, and Secretary Well, certainly the mobile devices themselves, which really would be the smartphone area primarily. That’s what drives it. You could see from year to year growth, that’s really slowed down, and so that’s one where we used to see a lot higher growth level, and not as much these days. So that’s the key driver, and then we also participate in kind of another world, which is the telecommunications spending world and that is stronger at this point for us and that’s the 4G type builds across the globe. That seems to be stronger, and that just reflects the data storage and data transfer that needs to occur across the backbone of all the wireless systems. Computer sales are down, but we don’t play any more in the computer side, although we do have some participation in the hard disk drive market, and that certainly is soft based on their total consumption in computer sales. So, it’s mixed. I would say overall, it’s been muted from a growth standpoint, but we still expect growth in the second half for what I call normal seasonal factors. Q: Got you. Can you provide a little more color here on this strategy improvement that you’re blowing out? It’s kind of sounding like the broader semiconductor market. Are you taking share? Are you just trying to enter that market? Mike Havlicek – Vice President, Treasurer, and Secretary Yes. It’s a combination. The best way to think about it is over the years we have really, we’ve always been in the semiconductor market and it’s just how do you describe the semiconductor market? The space that we play strong in is in the particularly the wireless sector, and say the LED sector. Now, so what we’ve done from a strategy standpoint, and the wireless sector would be companies like the Skyworks, the Avagos, Cuervo, those are kind of the representative group that we have very good participation rate with. There’s a broader semiconductor market, which is really reflected by your more tier 1 producers, like Samsung or Intel, or Texas Instruments, and so for us to participate in the materials set there, we essentially have to upgrade to what we call the tier 1 capability. And there’s different expectations in these different markets. So, what we have done is we’ve invested throughout our facilities to be able to participate in a wider set of semiconductor applications. So, it really provides us with the ability to gain market share in areas that we haven’t participated in in the past. So, that’s where we’re seeing the growth, and this strategy is quite successful for us. Q: Got you. Okay. Makes sense. And then last quick question. I’ll jump back into the queue. Just in terms of the acquisitions, the $1.9 million spend, I think which is what you guys called out as far as consultants and experts or what have you for your due diligence there. First off, is that correct? And then number two, are you expecting additional expense levels such as that for the remainder of the year seeing that the acquisitions you’re expecting to close until Q4?




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Richard Hipple – Chairman, President, and CEO Yes. The answer is 1.9. You did hear that correctly, and that was upfront due diligence and integration prep, so its due diligence on the financial, legal, and environmental side, and I would tell you that’s largely complete, where we are in the discussions and the negotiations. So, we do not anticipate that run rate going forward, throughout the year to complete that. So, it’s not fair to assume we’re going to spend 1.9 for the next two quarters. It will come down significantly. [Indiscernible]. Q: Got you. And you mentioned in your prepared remarks that there are a couple other or few other potential targets that I guess you’re talking to or looking at. Any sort of color you can provide in terms of where you are there, like at just beginning stages, middles stages, getting towards the end? Anything like that would be helpful. Mike Havlicek – Vice President, Treasurer, and Secretary Yes. There’s one other deal that I would tell you has progressed, we have a signed letter of intent and we’re actively engaged in a due diligence. A portion of that 1.9 was not just the Heraeus, but there was another acquisition which is progressing. Q: Got you. Perfect. Thanks a lot, guys. I appreciate it. Mike Havlicek – Vice President, Treasurer, and Secretary The other ones in the pipeline aren’t yet at that stage. Q: Got it. Thanks a lot, guys. Operator Our next question’s from Phil Gibbs for Michael Havlicek. Q: Good morning. Mike Havlicek – Vice President, Treasurer, and Secretary Good morning, Phil. Q: Are you anticipating an improvement in sales in the second half versus the first half. I know you’ve got aspirations of growing earnings, but is it more driven by the cost side, or is it equally driven by the topline. How should we think about that? Mike Havlicek – Vice President, Treasurer, and Secretary Yes. That’s the issue. You should think about that value-added sales are forecasted to improve in the back half compared to the first half. Richard Hipple – Chairman, President, and CEO So, that’s revenue. Q: Any changes you’re seeing in the oil and gas side right now in terms of inquiry from customers and specifically the, you have a toughmet product? Richard Hipple – Chairman, President, and CEO I would say that in general, I would say that we finally, I think hit the trough in the second quarter and oil and gas sales. But, man, is it, I’m not forecasting anything substantially up from here. But, where we will see the lift is for some of the new products, and I’ve talked about that in a couple of calls where we’ve had, we’re making some




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progress in the productions side versus the drilling side, which is key to us. Obviously drilling is quite low. I mentioned a couple of new products on the drilling side. Those are getting engineered in. So, I would say as drilling picks up, we’ll see faster growth than maybe the market itself. But, on the production side, I would say, we’re actually pleasantly surprised that we’re actually receiving some very significant orders right now for the new couplings we’re introducing for the lift pump wells and these are orders in the magnitude of several hundred thousand dollars, half a million dollars. So, that’s very substantial. All I can say about oil and gas is that as that lifts, we should lift faster. Q: Perfect. DD&A, including amortization of finance and costs, what are you anticipating that to be for the full-year, Joe, relative to the, it looks like about twenty-fourish, twenty-three and a half, twenty four million we’ve seen year-to-date? Joe Kelley – Vice President, Finance and Chief Financial Officer Yes. So, our full-year forecast for depreciation and mine amortization is approximately, I tell you about $42 million, and again the variable there is the [indiscernible] amortization is not straight lined. It depends on the activity at the open pit mine. Q: Okay, and I’m correct though that the, we were running at about 24, 24 year-to-date or something like that, right, looking at the right number? Joe Kelley – Vice President, Finance and Chief Financial Officer Yes. You are correct. Q: Okay. And in terms of the mix quarter on quarter in performance alloys, and I don’t mean to beat a dead horse, because we talked about the improvements that you’re targeting for the business and the need to turn it around in terms of mix, but quarter on quarter the sales lifted, but the profits went down. Can you elaborate on that a little bit, why you would have lost leverage there? Joe Kelley – Vice President, Finance and Chief Financial Officer Yes. So, as I said in my prepared comments, a lot of that had to do with the mix primarily, but specifically I would tell you some of the growth in southeast Asia, and our copper beryllium strip product line, the price points there are quite low, and therefore a disproportionate amount of the growth came from that region of the world and then that product line. And so, that is what was meant by the unfavorable mix. Q: Got you. And the foreign exchange headwinds in that business, have they on a net basis, have they subsided, or are they essentially intact with where they’ve been? Joe Kelley – Vice President, Finance and Chief Financial Officer Yes. So, that business houses as you know, Phil, the majority of our FX exposure. So, when we were entering the year, we had affect hedges in place that were at about the current exchange rate entering the year. However, prior year we had $6.2 million of FX hedge gains due to the strengthening of the dollar. So, year-over-year, we entered with a headwind of $6.2 million because of the lack of these FX hedge gains. The only thing that’s changed I would tell you, is actually in the quarter, due to the strengthening of the yen, we actually had a hedge loss in that business this quarter, of about half a million dollars, which negatively impacted the profit to that segment in Q2, more so than historically forecasted. Q: Okay. So, you’re basically saying that $6.2 million saw a little bit more weakness relative to that run rate because of the yen move in Q2. Okay.




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Joe Kelley – Vice President, Finance and Chief Financial Officer Correct. Correct. Q: All right. All very helpful. I look forward to chatting later. I appreciate it. Joe Kelley – Vice President, Finance and Chief Financial Officer Thank you, Phil. Operator We have a follow up question from Ed Marshall of Sidoti. Q: Hi. Just a follow up. Did you mention the tax rate was effective for the consolidated year, was that 18%, 19%? Joe Kelley – Vice President, Finance and Chief Financial Officer Yes. Exactly. I said about 18% to 20%. That’s excluding the discrete item that we benefitted from this quarter, which is about $900,000. Q: Okay. So, when I look at the business, and I look at the guidance and the adjustments of the guidance and there are and the range, and the fact that you said the median sales on a year-over-year basis will be up. I’m curious, what do you anticipate, do you anticipate further erosion on the margin side, and is that gross margin, or is that operating margin that you anticipate causing that pressure? Joe Kelley – Vice President, Finance and Chief Financial Officer Well, the pressure I was referring to when we were talking PAC had both gross margin in terms of the mix shift and in terms of the FX changes that affected our operating profit margin. And so, we would, the forecast assumes that there would be an improvement in operating profit margins coming sequentially going first half to the second half. Q: I’m sorry. There was an improvement in the first half to the second half? Is that what you said? Joe Kelley – Vice President, Finance and Chief Financial Officer From the first half to the second half, our operating profit margins are forecasted to improve. That’s embedded in the guidance. Q: Got it. Okay. So, I’m trying to think this through. If we’re seeing increased sales performance, increased margin, and lower tax rate, but yet we’re narrowing to the low end of the range. I’m just trying to rationalize those three. Joe Kelley – Vice President, Finance and Chief Financial Officer Well, narrowing to the low end of the range, you‘re looking at compared to our prior-year guidance, when you look at what’s happening Q1 to Q2, our earnings are increasing 30% to 45%. Q: Okay. Joe Kelley – Vice President, Finance and Chief Financial Officer And so that should, I guess you’re doing an apples and oranges there in my opinion. So, when you think about topline sales improving back half compared to first half, margins expanding back half compared to first half, and tax rate, that’s how you get a 30% to 45% earnings top.




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Q: Got it. What, when you talk about these two transactions that you’re working on, I’m just trying to get a sense as to maybe the size of these transactions. Do you have any kind of a ballpark range? Joe Kelley – Vice President, Finance and Chief Financial Officer Yes. Ballpark, I would tell you the Heraeus one, while it is complex in the sense that is a carve out of multiple locations as we covered in the press release, but from a topline revenue standpoint, you should think about that as a $70 million to $80 million business. And then the other one I would simply characterize as a strategic bolt on acquisition and those are somewhere between $20 million and $50 million in that definition. Q: Got it. And what’s the liquidity of the business right now? How much access to capital do you have without having to raise anything from an equity perspective?

Joe Kelley – Vice President, Finance and Chief Financial Officer Yes. We have significant available liquidity, and so we could just looking at our revolver and what’s in place, we have access to approximately $200 million. Q: Okay. Plenty there. Okay. Great. And what’s the, I’m sorry, I could probably check this out but do you have off the top of your head what’s the rate on your revolvers? 5% or plus? Mike Havlicek – Vice President, Treasurer, and Secretary We’re just taking a quick look there. Joe Kelley – Vice President, Finance and Chief Financial Officer So, the rate’s around about four and a half percent. Q: Is that inclusive of [indiscernible]? Joe Kelley – Vice President, Finance and Chief Financial Officer No, that’s just for everything. Q: That’s combined. Got it. Okay, guys. Combined. Okay, great. Thanks, guys. I appreciate it. Operator Thank you. Ladies and gentlemen, we have reached the end of the question and answer session. I’d like to turn the call back to Michael Havlicek for closing remarks. Mike Havlicek – Vice President, Treasurer, and Secretary I’m Michael Havlicek. We’d like to thank all of you for participating on the call this morning. I’ll be around for the remainder of the day to answer any questions. My direct dial number is area code 216, the number is 383-6823. Thank you very much.

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