Materion Corporation — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 26, 2020; comparisons are with the corresponding 2019 periods. Amounts are in millions of dollars except per-share data.
Business context and results
Materion produces engineered materials for semiconductor, industrial, aerospace and defense, automotive, consumer electronics, energy, and telecom and data-center markets. COVID-19 reduced demand across several markets, while semiconductor sales grew.
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Net sales | $271.5 | $297.8 | $549.4 | $599.3 |
| Value-added sales | $161.6 | $194.9 | $320.2 | $382.6 |
| Gross margin | $48.1 | $69.6 | $93.7 | $138.9 |
| Gross margin as % of value-added sales | 30% | 36% | 29% | 36% |
| Operating profit | $8.7 | $22.8 | $4.1 | $44.1 |
| Net income | $6.7 | $15.5 | $3.6 | $32.4 |
| Diluted EPS | $0.32 | $0.75 | $0.17 | $1.57 |
Value-added sales is a non-GAAP measure that removes pass-through metal costs. Metal-price changes increased reported net sales by $19.3 million in Q2 and $39.2 million in the first half, but did not offset volume and mix weakness. Lower volumes were the principal cause of the gross-margin decline.
Material changes and segment performance
- Performance Alloys and Composites: Q2 net sales fell 25% and operating profit fell 57%; first-half sales fell 24% and operating profit fell 66%. Lower volumes and restructuring costs weighed on results.
- Advanced Materials: Q2 net sales rose 13% and first-half sales rose 12%, largely reflecting higher pass-through metal prices. Value-added sales declined 6% in Q2 and 2% in the first half; operating profit fell 29% and 31%, respectively, amid lower volumes, unfavorable mix, and reduced yields. Semiconductor demand was stronger.
- Precision Coatings: Q2 sales declined 33% and operating profit declined 47%. First-half sales fell 36%; the segment reported a $7.5 million operating loss, including $9.1 million of goodwill impairment and $1.7 million of held-for-sale impairment related to Large Area Coatings (LAC).
- SG&A expense decreased 18% in Q2 and 20% in the first half, mainly due to lower variable compensation and cost controls. R&D expense increased 11% in both reported periods.
Cash flow, debt, and liquidity
- First-half operating cash flow was $36.4 million, compared with $30.0 million a year earlier. Investing cash outflow was $32.0 million, including $32.0 million of capital expenditures; financing cash inflow was $135.6 million.
- Operating cash flow included $26.7 million of customer prepayments. Inventory growth used $20.6 million of cash.
- At June 26, cash was $265.1 million and total debt was $151.8 million, leaving reported net cash of $113.3 million. Available borrowing capacity under the revolver was $179.1 million; the company reported compliance with debt covenants.
- In April, Materion borrowed $150 million under its revolving facility as a precaution related to COVID-19. The company reported $30 million of expected 2020 capital spending, excluding customer-prepayment-funded projects, and approximately $14 million for mine development.
- In July 2020, after quarter-end, Materion completed its acquisition of Optics Balzers for approximately $160 million, including assumed debt. It was funded with cash on hand, including part of the revolver borrowing. Quarter-end liquidity figures therefore precede the acquisition.
Outlook, risks, and unusual items
- Management expected reduced demand to continue at least through the remainder of 2020, but said the pandemic’s extent and timing could not be reasonably estimated. It reported no significant supply-chain disruptions at the time of filing and warned that facility shutdowns could occur.
- COVID-19-related costs were $2.7 million in Q2, primarily premium pay for essential onsite production workers. First-half inventory reserves included $1.3 million tied to reduced oil-and-gas demand.
- The company recorded $4.6 million of first-half restructuring expense for planned closures of its Warren, Michigan and Fremont, California locations and expected about $4 million of additional related costs during the remainder of 2020.
- Materion committed to sell LAC, classified it as held for sale, and recorded the impairments noted above. The filing identifies successful completion of the disposition as a risk.
- The company suspended its share-repurchase program due to the pandemic. It continued to intend quarterly dividends, subject to the board’s determination that they remain in shareholders’ best interests.
- Two beryllium-related cases were outstanding at quarter-end; management did not expect their resolution to materially affect the financial statements. Environmental remediation reserves were $6.0 million, and actual costs may differ.
- The filing provides no earnings or sales forecast. It identifies COVID-19 effects, market demand, acquisition integration and returns, raw-material costs, yields, and LAC disposition as key uncertainties.
Important facts for investors to verify
- Whether demand and margins recover, particularly in aerospace and defense, automotive, energy, industrial, consumer electronics, and telecom/data center markets.
- Whether semiconductor growth and new-product introductions translate into improved value-added sales, manufacturing yields, and segment profitability.
- Actual restructuring costs and savings, and the timing and proceeds of the LAC sale.
- Optics Balzers’ final funding, integration, and contribution to results relative to management’s acquisition expectations.
- Liquidity and covenant headroom after the acquisition, including the effect of revolver borrowings and customer prepayments.
- Capital spending, inventory levels, environmental remediation costs, and any developments in litigation or COVID-19-related operating disruptions.