Materion Corporation: Q1 2014 Form 10-Q
Business context and period. Materion produces engineered materials for electronics, industrial, aerospace, defense, energy, medical, automotive and other markets. This unaudited report covers the quarter ended March 28, 2014; comparisons are with the quarter ended March 29, 2013. Unless noted, dollar figures are in millions.
Financial results and liquidity
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Net sales | $258.9 | $299.2 |
| Value-added sales, non-GAAP | $144.9 | $151.3 |
| Gross margin | $45.5; 17.6% of sales | $48.3; 16.2% of sales |
| Operating profit | $11.1; 4.3% of sales | $9.5; 3.2% of sales |
| Income before taxes | $10.4 | $8.7 |
| Income tax expense / effective rate | $3.0 / 29.2% | $1.9 / 22.0% |
| Net income | $7.3 | $6.8 |
| Diluted EPS | $0.35 | $0.33 |
- Sales fell 13%, with about $25.6 million of the decline attributed to lower pass-through metal prices and $14.6 million to lower volumes and other factors. Value-added sales, which exclude designated pass-through metal costs, declined 4%. Gross margin dollars declined 6%, mainly on lower value-added sales and shipment volumes; gross margin as a percentage of sales improved.
- Operating profit rose 16%, supported by plant-consolidation savings, operating improvements and a $2.6 million gain on the sale of used equipment. The gain was recorded in Q1 and is not expected to recur. Consolidation-program savings were estimated at $3.2 million versus the prior-year quarter.
- Net cash used in operating activities was $23.2 million, compared with $4.8 million used in Q1 2013. Working-capital demands—particularly higher receivables and inventory and lower payables/accruals—more than offset net income and noncash charges. Capital expenditures and mine development totaled $6.2 million.
- Cash was $19.3 million at March 28, down from $22.8 million at year-end 2013. Receivables rose to $121.5 million and inventories to $227.0 million. Days sales outstanding increased to 42 days; management said first-quarter collection periods commonly lengthen and described this level as near the high end of its historical range.
- Total debt increased $28.1 million to $92.9 million ($41.8 million short-term and $51.1 million long-term). The debt-to-debt-plus-equity ratio rose from 12% at year-end to 16%. Materion reported compliance with debt covenants and $167.5 million of unused borrowing capacity under existing credit lines; the revolving credit facility matures in 2018. Shareholders’ equity was $478.9 million.
- The company paid $1.6 million in dividends and repurchased approximately 50,806 shares for $1.5 million. The board authorized repurchases of up to $50 million; $48.5 million remained available at quarter-end.
Changes, segments and management commentary
Sales declines across most businesses were partly offset by growth in Beryllium and Composites. Market performance was mixed: consumer electronics, energy and appliance improved, while defense, automotive electronics and medical weakened. Severe winter weather increased utility costs and caused lost time and production inefficiencies.
| Segment | Sales, Q1 2014 vs. Q1 2013 | Operating profit, Q1 2014 vs. Q1 2013 |
|---|---|---|
| Advanced Material Technologies | $163.2 vs. $193.9 | $7.6 vs. $3.4 |
| Performance Alloys | $66.7 vs. $74.5 | $3.5 vs. $7.2 |
| Beryllium and Composites | $15.5 vs. $12.3 | $1.1 vs. $(1.3) |
| Technical Materials | $13.5 vs. $18.5 | $0.2 vs. $1.4 |
Advanced Material Technologies’ profit benefited from consolidation savings and the equipment-sale gain despite lower value-added sales. Performance Alloys’ profit declined with lower volumes and higher expenses. Beryllium and Composites returned to profit on higher sales and favorable product mix. Technical Materials’ profit fell with reduced sales and margin.
Outlook, risks and unusual items
- Management expected value-added sales to improve over the remainder of 2014, citing higher Q1 order entry on a value-added basis, anticipated stronger Q2 demand in most key markets and a view that automotive weakness was temporary. These are forward-looking expectations, not firm numerical guidance.
- Management expected plant-consolidation savings to continue in 2014, while identifying the Q1 equipment-sale gain as a one-time item. It also said it would work to improve working-capital utilization and reduce debt over the balance of the year.
- In early Q2, Materion reached an agreement with its insurer for $6.8 million relating to a precious-metal theft claim. Cash was received, and the benefit was to be recorded in Q2 2014, not Q1.
- The company changed the domestic retiree medical plan for most participants from defined benefit to defined contribution. The change reduced the recorded liability by $14.0 million in Q1, with the offset in other comprehensive income; the benefit is expected to be recognized in earnings over approximately 9.5 years. The company contributed $7.8 million to its domestic pension plan in Q1 and anticipated approximately $19 million of contributions for 2014.
- Risks include potential stricter beryllium exposure standards and reduced customer use of beryllium products; two chronic beryllium disease cases were outstanding, with a $0.2 million reserve. Environmental remediation reserves were $4.8 million, and final costs may differ from estimates. Precious-metal consignment balances were $279.9 million, with $139.3 million of unused consignment capacity.
- Management reported a material weakness in physical-inventory-count reconciliation controls as of March 28, 2014; remediation was ongoing and disclosure controls were deemed ineffective. Other cited uncertainties include market demand, government spending, raw-material and energy costs, foreign exchange, pensions, litigation and execution of strategic plans.
Important facts for investors to verify
- Whether value-added sales and operating performance improved as management anticipated, and how much reported sales movement reflects metal-price pass-throughs rather than underlying demand.
- Whether working capital, receivables and inventory converted to cash and whether debt declined after the Q1 increase.
- The Q2 accounting and cash impact of the $6.8 million insurance settlement, and the extent to which reported profitability depends on nonrecurring gains and consolidation savings.
- Progress in remediating the inventory-control material weakness and any effect on financial reporting reliability.
- Developments in beryllium regulation and litigation, environmental remediation estimates, pension funding and the planned retiree medical changes.