Materion Corporation: 2016 Form 10-K Summary
Business context and reporting period
Materion is an integrated producer of advanced engineered materials for electronics, industrial, defense, medical, automotive, energy, aerospace and other markets. This filing covers the fiscal year ended December 31, 2016; quarterly data is also reported. The company had approximately 2,550 employees and reported four segments: Performance Alloys and Composites, Advanced Materials, Precision Coatings, and Other. Precision Coatings became a separate reportable segment in the fourth quarter, and prior-period segment figures were recast.
Financial performance and liquidity
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net sales | $969.2 million | $1,025.3 million | Down 5% |
| Value-added sales, non-GAAP | $599.9 million | $617.2 million | Down 3% |
| Gross margin | $183.5 million | $190.8 million | Down 4% |
| Operating profit | $27.1 million | $45.3 million | Down 40% |
| Net income | $25.7 million | $32.2 million | Down 20% |
| Diluted EPS | $1.27 | $1.58 | Down 20% |
| Operating cash flow | $67.2 million | $90.2 million | Down $23.1 million |
- Gross margin was 31% of value-added sales in both years; SG&A was 22% of value-added sales, versus 21% in 2015. Net sales include pass-through metal costs, so management emphasizes value-added sales, which excludes those costs.
- 2016 quarterly net sales were $235.5 million, $249.8 million, $249.6 million and $234.3 million. Fourth-quarter net income was $6.8 million, compared with $6.7 million in fourth-quarter 2015; diluted EPS was $0.33 versus $0.33.
- Operating cash flow was $67.2 million. Investing cash outflow was $37.4 million, including $27.2 million of capital expenditures and $9.9 million of mine development. Cash increased $7.2 million to $31.5 million.
- Year-end debt was $4.6 million and cash was $31.5 million, for net cash of $26.8 million. Available borrowing capacity under credit lines was $238.9 million; the debt-to-debt-plus-equity ratio was 1%. The current ratio was 3.8, and net current assets were $254.9 million.
- Shareholders’ equity was $494.1 million. Dividends were $0.375 per share for the year, up from $0.355; total dividends paid were $7.5 million. The company repurchased 147,351 shares for $3.8 million during 2016.
Material changes versus prior periods
- Lower volume, weaker product mix and reduced beryllium hydroxide shipments contributed to the sales and profit declines. Metal-price changes increased reported sales by approximately $16.2 million versus 2015, without a comparable effect on profitability.
- Performance Alloys and Composites operating profit fell to $6.6 million from $23.6 million, reflecting unfavorable mix and yields, foreign-exchange effects and a $2.6 million impairment charge. Advanced Materials profit declined to $26.3 million from $27.8 million. Precision Coatings profit improved to $11.6 million from $7.5 million, despite lower sales, on better yields, mix and cost reductions.
- Other-net expense increased to $13.9 million from $2.8 million. 2015 included foreign-exchange hedge gains and insurance/legal settlement gains; 2016 included a $2.6 million impairment related to a planned service-center closure and foreign-exchange losses.
- Operating cash flow declined, partly because working-capital cash benefits were lower than in 2015. Inventory fell by $10.8 million, while receivables increased by $4.1 million.
- The effective tax rate was negative 1.7%, versus 24.9% in 2015, primarily reflecting discrete tax benefits, including foreign tax credits associated with dividends from a Japanese subsidiary, percentage depletion and other items. The resulting tax benefit was $0.4 million.
Outlook, commentary, risks and unusual items
- Management was cautiously optimistic about 2017 and forecast “meaningful earnings growth” and strong operating cash flow, supported by momentum in consumer electronics, industrial components and a potential sequential recovery in oil and gas. This is a directional outlook; the filing does not provide a specific earnings or sales target.
- Materion signed an agreement in December 2016 to acquire the principal portion of Heraeus’s high-performance target materials business for an estimated $30 million. Closing was expected in first-quarter 2017, subject to customary conditions.
- Management cited headwinds from a major medical customer’s transition to a next-generation blood-glucose test-strip product shared with another supplier, and continued customer inventory reduction affecting beryllium hydroxide shipments.
- OSHA published a new beryllium workplace standard on January 9, 2017, lowering permissible exposure limits tenfold and adding compliance requirements. The company said the practices largely reflected its existing operations, but stricter standards or lower customer use of beryllium could materially affect results; the potential impact was not estimable.
- Other principal risks include cyclical end markets, technology and product transitions, volatile metal prices and consignment costs, foreign exchange, customer inventory adjustments, pension funding, acquisition integration, and environmental and product-liability exposure. One beryllium-related case involving four plaintiffs was outstanding at year-end; management did not expect a material financial-statement impact, while noting litigation outcomes remain uncertain. Environmental reserves were $6.0 million.
- The domestic defined-benefit pension plan was underfunded by $76.8 million. The company anticipated contributing approximately $16.0 million to the domestic plan in 2017, above mandatory levels. The filing also identifies $75.2 million of specified contractual obligations, including that planned pension contribution.
- Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.
Most important facts for investors to verify
- Whether the Heraeus acquisition closed on schedule, its final purchase price, and subsequent contribution to sales, margins and cash flow.
- Whether value-added sales, operating profit and cash conversion recover in 2017, particularly in Performance Alloys and Composites.
- How quickly the medical customer transition and beryllium hydroxide inventory drawdown affect shipments and segment profitability.
- Actual effects and compliance costs of the new OSHA standard and any subsequent beryllium-related regulation or customer demand changes.
- Progress on the planned pension contribution, environmental remediation obligations, and available borrowing capacity under debt and metal-consignment facilities.
- How sustainable the unusually low 2016 effective tax rate is; the filing’s tax benefit included discrete items and should not be assumed recurring.