Materion Corporation: Q3 2016 Form 10-Q
Business context and period: Materion produces engineered materials for electronics, industrial, medical, automotive, defense, energy and other markets. This filing reports the quarter and nine months ended September 30, 2016; comparisons are with the quarter and nine months ended October 2, 2015. Unless noted, amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $249.6 | $244.4 | $734.9 | $811.2 |
| Value-added sales (non-GAAP) | $157.0 | $148.8 | $454.8 | $473.8 |
| Gross margin | $50.8 | $44.0 | $139.4 | $147.7 |
| Operating profit | $10.2 | $10.9 | $23.5 | $37.2 |
| Net income | $8.0 | $7.4 | $19.0 | $25.4 |
| Diluted EPS | $0.40 | $0.36 | $0.94 | $1.24 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $26.4 | $44.8 |
Q3 gross margin was 32% of value-added sales, up from 30% a year earlier; nine-month gross margin was 31% in both periods. Q3 net sales rose 2% and value-added sales rose 5%, while nine-month net sales declined 9% and value-added sales declined 4%. Pass-through precious-metal and copper price changes increased reported sales by $14.1 million in Q3 and approximately $8.2 million over the first nine months; value-added sales excludes pass-through metal costs.
Q3 performance reflected higher volume, improved manufacturing yields, and favorable price and product mix. Higher SG&A, including increased stock-based and incentive compensation, and higher other-net expense more than offset gross-margin improvement, leaving operating profit below the prior-year quarter. Nine-month operating profit fell 37%, reflecting weaker volume and mix as well as the change in other-net items.
Segments and material changes
- Performance Alloys and Composites: Q3 value-added sales increased 10% to $87.2 million, but operating profit slipped to $4.4 million from $4.5 million, partly due to a $1.4 million adverse foreign-exchange impact. Nine-month operating profit dropped to $6.1 million from $20.7 million, with lower volume and a $4.9 million adverse foreign-exchange impact cited.
- Advanced Materials: Q3 value-added sales increased 3% to $46.0 million and operating profit rose 19% to $8.2 million, supported by product mix and improved yields. Nine-month value-added sales declined 6% to $135.0 million and operating profit declined 11% to $20.7 million, primarily due to lower volume.
- Other, including Precision Coatings and corporate costs: Q3 operating loss widened to $2.5 million from $0.6 million, mainly reflecting higher corporate compensation costs. For nine months, the operating loss narrowed to $3.4 million from $6.8 million; Precision Coatings improved, including a $0.7 million gain on equipment disposal.
Nine-month other-net was $9.0 million of expense versus $0.5 million of income in the prior period. The comparison included prior-year foreign-exchange gains and $5.6 million of insurance and legal settlement gains, versus foreign-exchange losses in 2016. Q3 other-net expense was $3.2 million versus $1.6 million, including prior-year currency gains and a legal settlement gain.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $26.4 million, down from $44.8 million. The company cited lower net income, a $12.0 million pension contribution versus $8.0 million, and $18.7 million of cash used for working capital.
- Investing cash outflow was $27.6 million, including $20.1 million for property, plant and equipment and $8.9 million for mine development. Financing cash outflow was $7.7 million. Cash declined $8.4 million from year-end to $15.8 million.
- At September 30, 2016, total debt was $16.6 million, cash was $15.8 million and net debt was $0.8 million, compared with net cash of $11.0 million at December 31, 2015. Available borrowing capacity was $215.2 million; the debt-to-debt-plus-equity ratio was 3%. The company reported compliance with debt covenants.
- Unused capacity under metal-financing lines was approximately $166 million. The notional value of off-balance-sheet consigned precious metals and copper was $283.9 million, versus $214.7 million at year-end.
- For the first nine months, dividends paid were $5.6 million and share repurchases were $3.8 million. The repurchase authorization had $16.8 million remaining at September 30.
Outlook, risks and other notable items
Management reported sequential value-added sales growth for a third consecutive quarter and emphasized new product development, sales-pipeline growth, cost control and improving product mix. It described global manufacturing conditions as uncertain and noted that the timing and quantity of high-purity beryllium orders and raw-material beryllium hydroxide sales remain uncertain. Approximately $8 million of beryllium hydroxide was sold on a spot basis in Q3; management cautioned that such sales may be less consistent quarter to quarter than historically. No earnings or revenue guidance was provided.
For full-year 2016, expected payments for property, plant and equipment were $25 million to $30 million, with mine-development expenditures of approximately $9 million. The company stated that operating cash flow, borrowing capacity and cash were expected to support operations, capital spending, pension contributions, dividends, repurchases, environmental projects and strategic acquisitions.
- Risks and contingencies: Beryllium-related litigation remained ongoing. One case was settled in Q3 for an immaterial amount; a separate case involving four plaintiffs was remanded to trial court. Management did not expect the outstanding matter to have a material financial impact, but noted litigation outcomes are uncertain and future results could be affected. Environmental remediation reserves were $6.0 million, undiscounted, at September 30, 2016.
- Market and operating risks: Management identified uncertain end-market demand, raw-material availability and pricing, foreign exchange, product mix, beryllium supply negotiations, pension costs, and execution of new products and strategic plans as factors that could affect results.
- Tax and accounting items: The nine-month 2016 effective tax rate was 14.0%, including a $1.0 million net benefit from discrete items, primarily international tax planning initiatives. Materion adopted the inventory measurement update early with no material effect and was evaluating forthcoming lease, revenue-recognition and share-based-payment standards.
- Controls: Management concluded disclosure controls were effective as of September 30, 2016 and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether beryllium hydroxide and high-purity beryllium sales stabilize or remain uneven, and progress on the long-term supply discussion with the largest beryllium hydroxide customer.
- Whether Q3 improvements in value-added sales, manufacturing yields and product mix persist amid weak or uncertain industrial, energy and other end markets.
- Drivers of the steep nine-month decline in Performance Alloys and Composites operating profit and the effect of foreign exchange on subsequent results.
- Cash conversion and working-capital trends, including receivables, pension contributions, capital spending and the impact on cash and debt.
- Use of borrowing capacity and metal consignment facilities, covenant headroom, and the financial exposure associated with off-balance-sheet metal arrangements.
- Resolution of beryllium litigation and environmental projects, including whether actual costs or outcomes differ from recorded reserves and management expectations.
- Non-GAAP value-added sales trends alongside reported revenue, and whether tax benefits and other unusual items recur.