Business context and reporting period
Materion Corporation is an integrated producer of engineered materials serving electronics, industrial, aerospace, defense, medical, energy and other markets. This Form 10-Q covers the quarter and first half ended June 27, 2014; comparisons are with periods ended June 28, 2013, except balance-sheet comparisons, which are with December 31, 2013.
Key financial metrics
| Metric | Second quarter 2014 | First half 2014 |
|---|---|---|
| Net sales | $288.0 million; down 6% | $546.9 million; down 10% |
| Value-added sales | $159.6 million; up 5% | $304.5 million; essentially flat |
| Gross margin | $49.8 million; 17% of sales | $95.3 million; 17% of sales |
| Operating profit | $14.6 million; versus $6.6 million | $25.6 million; versus $16.1 million |
| Net income | $10.0 million; versus $4.2 million | $17.3 million; versus $10.9 million |
| Diluted EPS | $0.47; versus $0.20 | $0.82; versus $0.52 |
- Interest expense, net, was $0.7 million for the quarter and $1.4 million for the first half. Effective tax rates were 28.2% and 28.7%, respectively.
- First-half operating cash flow was negative $1.5 million, versus positive $18.1 million a year earlier. Capital expenditures and mine development totaled $13.2 million.
- Cash was $18.1 million at June 27, down from $22.8 million at year-end. Current assets were $421.6 million and current liabilities $123.3 million.
- Balance-sheet short- and long-term debt totaled $80.3 million, versus $64.8 million at year-end. The company reported $176.6 million of available borrowing capacity; it was in compliance with debt covenants. The debt-to-debt-plus-equity ratio was 14%.
- Shareholders’ equity was $487.9 million, versus $463.3 million at year-end. The quarterly dividend increased to $0.085 per share.
Material changes versus prior periods
- Sales declined, principally reflecting lower pass-through metal prices, which reduced reported sales by an estimated $8.1 million in the quarter and $33.7 million in the first half. Value-added sales, which exclude pass-through metal costs, rose in the quarter and were nearly unchanged year to date.
- Profit improved, supported by stronger value-added sales, improved precious-metal refining yields and efficiencies, consolidation savings, lower retirement costs, and favorable non-recurring items. A $6.8 million insurance recovery and a $2.6 million gain on equipment disposal contributed to first-half results and are not expected to recur in the second half.
- Consumer electronics and medical value-added sales strengthened, while defense and automotive electronics were weak. Technical Materials’ first-half sales fell 24%; Performance Alloys’ operating profit fell to $8.8 million from $14.1 million; Beryllium and Composites reported a first-half operating loss of $0.7 million.
- Inventory increased $22.0 million to $254.8 million from year-end, and receivables increased $8.8 million. Management attributed inventory growth to mining cycles, planned buffers and materials for future production.
Outlook, commentary, risks and unusual items
- Management described market conditions as mixed and economic growth as slower than previously expected. No specific revenue or earnings guidance was provided.
- Management expects continued defense-related pressure and shipment variability, while noting opportunities in consumer electronics, medical and oil and gas. Automotive electronics demand was soft amid customer inventory overhang; future sales may also be affected by competition and technology changes.
- Management plans to improve working-capital utilization and reduce debt during the rest of 2014. It anticipated approximately $19.0 million of 2014 domestic pension contributions, of which $11.8 million had been made in the first half.
- The company had a material weakness in physical-inventory-count reconciliation controls as of June 27; management said remediation was underway but not complete, and disclosure controls were therefore not effective.
- Risks include potential tighter beryllium exposure standards, which could affect customer demand; two outstanding chronic beryllium disease cases had a recorded reserve of $0.2 million. Environmental remediation reserves were $4.8 million, with actual costs potentially differing from estimates.
- The company had $235.4 million outstanding under precious-metal and copper consignment arrangements. A new revenue-recognition standard was issued and was to become effective for the company beginning in 2017; the company was evaluating its impact.
Important facts for investors to verify
- Reconcile debt disclosures: the balance sheet and financial-position discussion show $80.3 million of debt at quarter-end, while the overview states $86.0 million.
- Assess how much reported profit improvement came from the $6.8 million insurance recovery and $2.6 million equipment-sale gain, and compare underlying operating performance without these items.
- Track the physical-inventory control weakness, remediation progress and any effect on inventory reporting or disclosure controls.
- Monitor working capital, operating cash conversion, inventory levels and management’s stated plan to reduce debt.
- Check progress on pension funding and exposure to beryllium litigation, regulatory changes and environmental remediation costs.