Materion Corporation — Q3 2014 Form 10-Q
Business context and reporting period. Materion produces engineered materials for electronics, industrial, aerospace, defense, medical, energy and other markets. This unaudited report covers the quarter and nine months ended September 26, 2014, compared with the corresponding 2013 periods. Unless noted, amounts are in millions of dollars.
Financial performance
| Metric | Q3 2014 | Q3 2013 | First 9 months 2014 | First 9 months 2013 |
|---|---|---|---|---|
| Net sales | $291.6 | $275.4 | $838.5 | $880.7 |
| Value-added sales | $165.6 | $148.1 | $470.1 | $451.9 |
| Gross margin | $54.8 | $44.5 | $150.1 | $138.8 |
| Operating profit | $17.4 | $5.3 | $43.0 | $21.4 |
| Net income | $12.4 | $5.0 | $29.7 | $15.9 |
| Diluted EPS | $0.60 | $0.24 | $1.42 | $0.76 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $21.0 | $38.5 |
- Q3 gross margin was 33.1% of value-added sales, up from 30.0%; the nine-month rate was 31.9%, versus 30.7%. Management attributed expansion to sales leverage, product mix and manufacturing efficiencies from consolidation and rationalization.
- Q3 net sales rose 5.9%, while value-added sales, which exclude pass-through metal costs, rose 11.8%. For the nine months, net sales fell 4.8%, largely reflecting lower precious-metal prices, while value-added sales increased 4.0%.
- Q3 operating profit included a $4.0 million contractor settlement. Nine-month other-net also benefited from a $6.8 million insurance recovery and a $2.6 million equipment-sale gain. These items contributed to reported profit improvement.
- Q3 effective tax rate was 25.3%; the nine-month rate was 27.3%, compared with 16.4% in 2013. The 2014 provision did not include the expired federal research and experimentation credit.
Financial position, liquidity and cash flow
- At September 26, cash and equivalents were $19.6 million, total debt was $50.4 million, and shareholders’ equity was $486.4 million. Debt was down $14.4 million from year-end 2013.
- Current assets were $401.0 million and current liabilities $107.5 million. Accounts receivable was $127.0 million and inventory $227.3 million.
- Nine-month operating cash flow of $21.0 million declined from $38.5 million, primarily because receivables and inventory increased to support anticipated growth; higher net income partly offset the working-capital use. Capital expenditures were $19.8 million, and investing cash outflow was $17.4 million.
- Unused borrowing capacity under credit lines was approximately $205.7 million, subject to covenants; the revolving facility matures in 2018. The company reported compliance with debt and consignment covenants. Cash and available borrowing capacity were considered adequate by management.
- Outstanding off-balance-sheet metal consignment arrangements totaled $250.9 million; unused consignment capacity was $199.1 million. Approximately 80% of cash was held outside the U.S.; repatriation could incur taxes, though management did not anticipate a need to repatriate it.
- The company repurchased approximately 480,000 shares for $15.6 million year to date under a $50 million authorization, with $34.4 million remaining at quarter-end. Nine-month dividends were $5.2 million; the quarterly dividend was raised from $0.08 to $0.085 per share.
Changes, segments and management commentary
- Advanced Material Technologies’ Q3 operating profit increased to $7.7 million from $4.1 million; nine-month profit rose to $26.8 million from $5.2 million, including the insurance and equipment-sale gains.
- Performance Alloys’ Q3 operating profit rose to $6.5 million from $4.5 million, supported by volume growth. Nine-month profit fell to $15.3 million from $18.7 million, partly due to severe-weather disruption in Q1.
- Beryllium and Composites returned to operating profit: $1.0 million in Q3 and $0.3 million year to date, versus losses in 2013. Management said facility productivity improved 19% year to date and remained on schedule for targeted production levels in 2015.
- Technical Materials’ nine-month sales and operating profit declined, reflecting weaker automotive and consumer electronics demand, including customer inventory destocking.
- Management described conditions as mixed but the order book as favorable, while noting that demand can be seasonal and uneven and that some business has short lead times. It forecast fourth-quarter 2014 earnings growth in the double digits versus Q4 2013, driven by value-added sales growth and margin expansion, and said it remained cautiously optimistic about Q4 and 2015.
Risks, contingencies and unusual items
- Management concluded disclosure controls were not effective at September 26, 2014 because of a material weakness in physical inventory count reconciliation. Remediation actions were underway, but controls had not operated long enough to establish that the weakness was fully remediated.
- Potentially stricter beryllium exposure standards could affect customer demand and materially harm results, liquidity or financial condition; the impact could not be estimated. One chronic beryllium disease case remained outstanding, and the company did not expect it to have a material financial impact. A separate case settled in Q3 for less than $0.1 million.
- Environmental remediation reserves were $4.8 million, unchanged from year-end; ultimate costs may differ. The company also cited market, customer, raw-material, foreign-exchange, pension, regulatory, project execution and other risks.
- A $2.0 million adjustment increased deferred tax assets and reduced goodwill relating to the 2011 EIS Optics acquisition; the filing states it had no net impact on total assets, equity or cash flows and an immaterial income-statement impact. Adoption of the new revenue-recognition standard was expected beginning in Q1 2017; the impact was still under evaluation.
Important facts for investors to verify
- Whether sales and margin growth persist after separating recurring operating performance from the legal settlement, insurance recovery and equipment-sale gain.
- Whether working-capital investment reverses and operating cash flow improves alongside earnings.
- Progress in remediating the inventory reconciliation material weakness and whether control effectiveness is subsequently confirmed.
- Execution of the Q4 earnings outlook, the scheduled Beryllium and Composites orders, and the stated 2015 production targets.
- Developments in beryllium safety standards, litigation and environmental remediation, and any effects on customer demand or costs.
- Liquidity and covenant headroom, metal consignment exposure, and the use of cash for debt, dividends and share repurchases.