Materion Corporation — Q3 2017 Form 10-Q
Business context and period: Materion produces engineered materials for electronics, industrial, defense, medical, automotive and other markets. This unaudited filing covers the quarter and nine months ended September 29, 2017, compared with the corresponding 2016 periods. Amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $294.3 | $249.6 | $830.8 | $734.9 |
| Value-added sales (non-GAAP) | $171.4 | $157.0 | $496.5 | $454.8 |
| Gross margin | $55.2 | $50.8 | $152.8 | $139.4 |
| Operating profit | $11.6 | $10.2 | $24.7 | $23.5 |
| Net income | $9.3 | $8.0 | $19.7 | $19.0 |
| Diluted EPS | $0.46 | $0.40 | $0.97 | $0.94 |
| Operating cash flow | — | $35.5 | $27.2 |
Q3 sales rose 18%, while value-added sales rose 9%; nine-month sales and value-added sales increased 13% and 9%, respectively. Gross margin was 32% of value-added sales in Q3 and 31% for the nine months, unchanged year over year in both periods. Net income grew 16% in Q3 but 4% for the nine months. Effective tax rates were 15.5% for Q3 and 14.4% year to date.
Financial position and liquidity
- At September 29, cash was $22.5 million, total debt $4.0 million and net cash $18.5 million, compared with $31.5 million, $4.6 million and $26.8 million, respectively, at December 31, 2016.
- Available borrowing capacity was $266.4 million; the debt-to-debt-plus-equity ratio was 1%. The company reported compliance with debt covenants.
- Current assets were $387.2 million and current liabilities $113.1 million. Inventories were $220.2 million, up from $200.9 million at year-end.
- Nine-month investing cash outflow was $34.8 million, including $16.5 million for the Heraeus target-materials business acquisition. Financing cash outflow was $10.9 million. Cash declined $9.0 million during the period.
Material changes and segment performance
- Q3 Advanced Materials value-added sales rose 31% to $60.4 million and operating profit rose to $9.8 million; results included the acquired Heraeus business (HTB), contributing $11.4 million of Q3 value-added sales.
- Performance Alloys and Composites Q3 value-added sales increased 4% to $90.6 million; operating profit increased 56% to $6.8 million, supported by volume, mix and productivity.
- Precision Coatings Q3 value-added sales declined 15% to $21.9 million and operating profit fell 53% to $1.6 million, principally on lower medical-market volume, including blood glucose test strips.
- For the first nine months, Precision Coatings value-added sales fell 10% and operating profit fell 37%. Medical-market weakness more than offset improvement in defense and industrial components.
- HTB was acquired February 28, 2017, for $16.5 million. Its preliminary allocation included $2.6 million goodwill and $3.2 million of intangible assets.
Outlook, commentary, risks and unusual items
- Management stated that operating cash flow, borrowing capacity and cash were adequate for operations, capital spending, pension contributions, dividends, repurchases, environmental projects and strategic acquisitions. It provided no specific sales or earnings guidance in the supplied filing text.
- For full-year 2017, management expected property, plant and equipment payments below $30 million and mine-development spending below $3 million.
- Nine-month cost-reduction actions, including severance and related costs, totaled $1.9 million; the company said it expected no additional costs from these initiatives.
- SG&A increased year to date partly due to higher incentive and stock-based compensation, including $1.4 million of accelerated stock compensation associated with the CEO transition, and HTB expenses. A change in pension-cost estimation reduced 2017 pension service and interest costs by approximately $0.8 million year to date; management expected an approximately $1.0 million reduction for the year.
- Tax expense included discrete benefits; Q3 included a $0.4 million benefit from the lapse of a statute of limitations and a share-based compensation accounting benefit. Metal consignment fees and foreign-exchange effects also affected other-net expense.
- Key exposures include cyclical end-market demand, successful integration of HTB, raw-material and metal financing costs, foreign exchange, customer/product mix, pension costs, regulatory matters and litigation. Environmental remediation reserves were $6.1 million, undiscounted; actual costs may differ. The filing also discusses beryllium-related claims and other ordinary-course proceedings without providing a clear aggregate potential-loss estimate.
- Precious metals and copper held on consignment had a notional value of $300.7 million at quarter-end. These arrangements reduce working-capital needs and metal-price exposure but depend on available financing capacity.
Important facts for investors to verify
- Whether growth in value-added sales and segment profits continues, particularly in Advanced Materials and Performance Alloys, and whether Precision Coatings recovers from medical-market weakness.
- HTB’s subsequent contribution to revenue, profitability and cash generation, and whether the preliminary purchase-price allocation changes.
- Working-capital trends, especially receivables and inventory, and the sustainability of operating cash flow.
- Availability and covenant terms of borrowing and metal-consignment facilities, alongside the company’s substantial consignment-metal exposure.
- Developments in beryllium litigation, environmental remediation estimates, and any material effects from new revenue-recognition requirements planned for adoption in 2018.