Materion Corporation — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 25, 2020; comparisons are to the quarter and nine months ended September 27, 2019. Amounts below are in U.S. dollars unless stated otherwise.
Business context and key financial metrics
Materion produces engineered materials serving semiconductor, industrial, aerospace and defense, automotive, consumer electronics, energy, and telecom and data-center markets. It acquired Optics Balzers AG on July 17, adding thin-film optical coatings to Precision Coatings.
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $287.2m | $306.0m | $836.6m | $905.3m |
| Value-added sales | $167.5m | $188.6m | $487.8m | $571.2m |
| Gross margin | $46.6m | $65.2m | $140.3m | $204.1m |
| Gross margin / value-added sales | 28% | 35% | 29% | 36% |
| Operating profit | $0.7m | $6.3m | $4.9m | $50.4m |
| Net income | $6.5m | $3.5m | $10.1m | $35.9m |
| Diluted EPS | $0.32 | $0.17 | $0.49 | $1.74 |
Q3 interest expense was $1.3m versus $0.4m; nine-month interest expense was $2.8m versus $1.4m, primarily reflecting revolving-credit borrowings. Tax benefits materially affected reported net income: the nine-month 2020 tax benefit was $5.2m, including a $3.8m discrete benefit, primarily from releasing a valuation allowance. Nine-month 2019 included a $1.3m discrete tax expense.
Nine-month operating cash flow was $79.4m, compared with $59.5m. It included $40.4m of customer prepayments. Investing cash outflow was $173.7m, including $130.7m net cash paid for Optics Balzers and $46.3m of capital expenditures. Financing cash inflow was $86.3m, including $120.0m net revolving-credit borrowings.
At September 25, cash was $117.8m and total debt was $128.6m, resulting in net debt of $10.9m, versus net cash of $122.8m at December 31, 2019. Available borrowing capacity was $233.9m. Current assets were $504.4m and current liabilities $251.6m. Total shareholders’ equity was $611.8m.
Material changes versus comparable periods
- Q3 sales declined 6%, while value-added sales fell 11%; nine-month sales fell 8% and value-added sales fell 15%. Higher metal prices boosted reported sales by $24.2m in Q3 and $63.8m year to date, but did not offset lower underlying volumes.
- Lower volumes and $7.3m of mine-development costs weighed on gross margin. The company expects a further approximately $6.0m of related mine-development costs in Q4 2020.
- Performance Alloys and Composites was particularly weak: Q3 sales fell 30% and operating profit declined to $0.7m from $18.8m. Advanced Materials value-added sales rose 4% in Q3 but operating profit edged down. Precision Coatings returned to Q3 operating profit of $1.4m from a prior-year loss that included impairment charges; its nine-month operating loss was $6.1m.
- Optics Balzers was acquired for $136.1m, including assumed debt. Its post-acquisition revenue and operating results were described as not material for the reported period. The preliminary allocation included $71.5m of goodwill and $48.6m of intangible assets. Acquisition-related transaction and integration costs were $4.7m in Q3 and $6.1m year to date.
Outlook, risks, contingencies, and unusual items
- Management expected reduced demand to continue at least through the remainder of 2020, but said the duration and extent could not be reasonably estimated. COVID-19 affected several markets, especially consumer electronics, automotive, energy, aerospace and defense, and industrial; management reported no significant supply-chain disruptions at the time.
- For full-year 2020, expected property, plant, and equipment payments were approximately $25.0m, excluding capital expenditures funded by customer prepayments. The company expected approximately $2.5m of additional costs in the remainder of 2020 for the Warren, Michigan and Fremont, California closures.
- A customer investment agreement provides for approximately $70m of prepayments to support equipment and infrastructure for future production. $45.1m was recorded as unearned income at quarter-end; it is expected to be applied as commercial shipments are made.
- The company intends to close its Large Area Coatings business; closure costs were expected to be immaterial. It recorded a $9.1m goodwill impairment and $1.7m asset impairment for that reporting unit during the first nine months of 2020.
- The share-buyback program was suspended amid the pandemic. The company paid $6.9m of dividends in the first nine months and said ongoing quarterly dividends remained subject to review. It reported compliance with debt covenants.
- Environmental remediation reserves were $5.9m. Two beryllium cases were outstanding; the company did not expect their resolution to materially affect its financial statements. COVID-19, customer demand, acquisition integration and returns, metal financing capacity, and execution of restructuring and capital projects were identified as risks.
Most important facts for investors to verify
- Whether demand and margins recovered after quarter-end, particularly in the weaker end markets and Performance Alloys and Composites.
- Whether the $3.8m discrete tax benefit and other tax items are nonrecurring, and how underlying earnings compare with reported net income.
- Optics Balzers’ finalized purchase-price allocation, subsequent contribution to sales and operating profit, and integration costs.
- Use and repayment of revolving-credit borrowings, covenant headroom, and whether customer prepayments translate into profitable commercial shipments.
- Actual Q4 mine-development and restructuring costs, capital spending, and progress on the Large Area Coatings closure.