SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|☒||ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
For the Fiscal Year Ended December 31, 2020
|☐||TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
For the Transition Period from to
Commission File Number 1-15885
(Exact name of registrant as specified in its charter)
|(State or other jurisdiction of|
incorporation or organization)
6070 Parkland Blvd., Mayfield Heights, Ohio 44124
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
|Title of Each Class||Trading Symbol(s)||Name of Each Exchange on Which Registered|
|Common Stock, no par value||MTRN||New York Stock Exchange|
Securities registered pursuant to Section 12(g) of the Act:
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
|Large accelerated filer|| ||x|| ||Accelerated filer|| ||¨|
|Non-accelerated filer|| |
| ||Smaller reporting company|
|Emerging growth company|
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262 (b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
The aggregate market value of common shares, no par value, held by non-affiliates of the registrant (based upon the closing sale price on the New York Stock Exchange) on June 26, 2020 was $1,175,158,375.
As of January 29, 2021, there were 20,330,126 common shares, no par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2021 Annual Meeting of Shareholders are incorporated by reference into Part III.
TABLE OF CONTENTS
Forward-looking Statements: Portions of the narrative set forth in this document that are not statements of historical or current facts are forward-looking statements. Our actual future performance may materially differ from that contemplated by the forward-looking statements as a result of a variety of factors. These factors include, in addition to those mentioned elsewhere herein: the ultimate impact of the COVID-19 pandemic on our business, results of operations, financial condition, and liquidity; the global economy, including the impact of tariffs and trade agreements; the impact of any U.S. Federal Government shutdowns and sequestrations; the condition of the markets which we serve, whether defined geographically or by segment; changes in product mix and the financial condition of customers; our success in developing and introducing new products and new product ramp-up rates; our success in passing through the costs of raw materials to customers or otherwise mitigating fluctuating prices for those materials, including the impact of fluctuating prices on inventory values; our success in identifying acquisition candidates and in acquiring and integrating such businesses, including the integration of Optics Balzers; the impact of the results of acquisitions on our ability to fully achieve the strategic and financial objectives related to these acquisitions, including, without limitation, the acquisition of Optics Balzers being accretive in the expected timeframe or at all; our success in implementing our strategic plans and the timely and successful completion and start-up of any capital projects; other financial and economic factors, including the cost and availability of raw materials (both base and precious metals), physical inventory valuations, metal financing fees, tax rates, exchange rates, interest rates, pension costs and required cash contributions and other employee benefit costs, energy costs, regulatory compliance costs, the cost and availability of insurance, credit availability, and the impact of the Company’s stock price on the cost of incentive compensation plans; the uncertainties related to the impact of war, terrorist activities, and acts of God; changes in government regulatory requirements and the enactment of new legislation that impacts our obligations and operations; the conclusion of pending litigation matters in accordance with our expectation that there will be no material adverse effects; the disruptions on operations from, and other effects of, catastrophic and other extraordinary events including the COVID-19 pandemic; and the risk factors set forth in Part 1, Item 1A of this Form 10-K.
Item 1. BUSINESS
Materion Corporation (referred to herein as the Company, our, we, or us), through its wholly owned subsidiaries, is an integrated producer of high-performance advanced engineered materials used in a variety of electrical, electronic, thermal, and structural applications with $1.2 billion in net sales in 2020. The Company was incorporated in Ohio in 1931. Our products are sold into numerous end markets, including semiconductor, industrial, aerospace and defense, automotive, energy, consumer electronics, and telecom and data center.
Our businesses are organized under four reportable segments: Performance Alloys and Composites, Advanced Materials, Precision Optics (formerly called Precision Coatings), and Other. Our Other reportable segment includes unallocated corporate costs. Additional information regarding our segments and business is presented below.
Performance Alloys and Composites
Performance Alloys and Composites (PAC) globally provides advanced engineered solutions comprised of beryllium and non-beryllium containing alloy systems and custom engineered parts in strip, bulk, rod, plate, bar, tube, and other customized shapes produced at manufacturing facilities located throughout the United States and Europe and sold through distribution hubs globally. This segment operates the world's largest bertrandite ore mine and refinery, which is located in Utah, providing feedstock hydroxide for its beryllium businesses and external sales. In addition to the products described below, this segment globally provides engineering and product development services to help our customers and partners with product design, including delivering prototype parts and other data to demonstrate that the products will perform under the specified design conditions. PAC operates through three global product lines: Advanced Alloys, Specialty Materials, and Performance Solutions:
•Advanced Alloys manufactures and globally provides to our customers three upstream (primary) product lines: alloyed metals, high-performance beryllium products, and beryllium hydroxide. Alloyed metals are made with copper and/or nickel (with or without beryllium) in ingot, shot, billet, plate, rod, bar, tube forms, and customized shapes. Depending on the application, the materials may provide one or a combination of superior strength, specific strength, wear and corrosion resistance, thermal and electrical conductivity, tribological benefits, and machinability. Applications for alloyed metals products include oil & gas drilling and production components, bearings, bushings, welding electrodes, plastic injection or metal die casting mold tooling, and electrical or electronic connectors. Major end markets for alloyed metals include industrial, automotive, aerospace and defense, energy, and telecom and data center. Alloyed metals compete with companies around the world that produce alloys with similar properties. High performance beryllium products are primarily beryllium metal products, which may also be alloys or other mixtures with aluminum and may be beryllium oxide. The materials are manufactured in billet, ingot, plate, sheet, powder, and customized shape forms. These materials are used in applications that require high stiffness and/or low density or high thermal conductivity and/or high electrical resistance, which are provided from the unique combination of material properties, or in applications requiring specific interactions with sub-atomic, high-energy particles, or in applications requiring strong affinity for oxygen such as in the manufacture of primary aluminum and magnesium. Beryllium hydroxide is produced at our milling operations in Utah from our bertrandite ore mine and purchased beryl ore. The hydroxide is used primarily as a raw material input for beryllium-containing alloys and, to a lesser extent, beryllium products. Key competitors include NGK Insulators, IBC Advanced Alloys Corp., Ningxia Orient Tantalum Industry Co., Ltd., Le Bronze Alloys, Minotti Metals, SA, KME AG & Co. KG, Aurubis AG, MKM Mansfelder Kupfer und Messing GmbH, AMPCO Metal, Chuetsu Metal Works Ltd, American Beryllia Inc., CBL Ceramics Limited, CoorsTek, Inc., and Ulba Metallurgical.
•Specialty Materials produces and provides our customers various thicknesses of precision strip products as well as various diameters of rod and wire products. The strip, rod, and wire products are beryllium and non-beryllium containing alloys that are made primarily with copper and nickel to provide unique combinations of high conductivity, high reliability, and high formability for use as connectors, contacts, springs, switches, relays, shielding, and bearings. In addition, Specialty Materials also produces and provides unique engineered strip metal products, which incorporate clad inlay and overlay metals, including precious and base metal electroplated systems, electron beam welded systems, contour profiled systems, and solder-coated metal systems. These engineered strip metal products provide a variety of thermal, electrical, or mechanical properties from a surface area or particular section of the material. Our precision cladding and plating capabilities allow for precious metal or other base metals to be applied in continuous strip form, only where it is needed, reducing the material cost to our customers as well as providing design flexibility and
performance. Major end markets include consumer electronics, telecom and data center, automotive, aerospace and defense, industrial, and energy. Key competitors include NGK Insulators, Wieland Electric, Inc., Aurubis Stolberg GmbH, Diehl Metall Stiftung & Co. KG, Nippon Mining, Wickeder Group, Heraeus Inc., AMI Doduco, Inc., and other North American continuous strip and plating companies.
•Performance Solutions provides engineered end-product technologies to our customers, including near-net shape and finished machined beryllium containing and non-beryllium containing products. These products and materials are used in applications that require high stiffness and/or low density due to their unique combination of properties. Performance Solutions provides beryllium metal and beryllium alloy components mainly to the aerospace and defense and energy end markets. Beryllium foil products are provided for radiographic and acoustic applications, beryllium oxide ceramics are provided for a wide range of heat sink and high temperature industrial applications, and our copper beryllium products meet the demanding strength and corrosion resistance specifications required for sub-sea telecommunication equipment. In addition, our engineering teams have developed several innovative non-beryllium materials to meet demanding wear resistance or strength-to-weight applications used in a variety of industries. Our ToughMetTM alloys provide extended life for industrial bushings and bearings and tremendous wear resistance in oil and gas rig components. Our SupremEXTM products offer the industry’s highest quality aluminum silicon carbide metal matrix composite formulation, well suited for a wide range of applications from high performance engine components and aerospace structural components to high-stiffness consumer electronic components. Direct competitors include IBC Advanced Alloys, NGK Metals, CBL Ceramics Limited, and CoorsTek, Inc.
PAC's products are primarily sold directly from its facilities throughout the United States, Asia, and Europe, as well as distributed internationally through a network of company-owned service centers, outside distributors, and agents.
Advanced Materials produces advanced chemicals, microelectronics packaging, precious metal, non-precious metal, and specialty metal products, including vapor deposition targets, frame lid assemblies, clad and precious metal pre-forms, high temperature braze materials, and ultra-pure wire. These products are used in micro-electromechanical systems and power management integrated circuits, radio frequency devices, storage, display, architectural glass, solar, optical coating, and other applications within the semiconductor, energy, and industrial end markets. Advanced Materials also has metal recovery operations and in-house refining that allow for the recycling of precious metals.
Advanced Materials products are sold directly from its facilities throughout the United States, Asia, and Europe, as well as through direct sales offices and independent sales representatives throughout the world. Principal competition includes companies such as Honeywell International, Inc., Praxair, Inc., Solar Applied Materials Technology Corp., Grikin, Solaris, Ametek Electronic Components and Packaging, and Tanaka Holding Co., Ltd., as well as a number of smaller regional and national suppliers.
The majority of the sales into the semiconductor end market from this segment are vapor deposition targets, lids, wire, other related precious and non-precious metal products, advanced chemicals, and other microelectronic applications. These materials are used in wireless, light-emitting diode, handheld devices, and other applications, as well as in a number of applications within the energy and industrial end markets. Since we are an up-front material supplier, changes in our semiconductor sales levels do not necessarily correspond to changes in the end-use consumer demand in the same period due to down-stream inventory positions, the time to develop and deploy new products, and manufacturing lead times and scheduling. While our product and market development efforts allow us to capture new applications, we may lose existing applications and customers from time to time due to the rapid change in technologies and other factors.
The Precision Optics segment included the following businesses at December 31, 2020:
Precision Optics produces sputter-coated precision thin film coatings and optical filter materials. Based in Westford, Massachusetts, the group has manufacturing facilities in the United States and China. This business also includes Optics Balzers AG (Optics Balzers), which was acquired in July 2020. See Note B to the Consolidated Financial Statements for additional discussion regarding our acquisition of Optics Balzers.
Large Area Coatings (LAC) produced high-performance sputter-coated precision flexible thin film materials. Based in Windsor, Connecticut, the business manufactured and distributed coated and converted thin film material solutions primarily for medical testing and diagnosis applications. As of December 31, 2020, the LAC business was shut down. See Note E to the Consolidated Financial Statements for further discussion.
Precision Optics' products are sold directly from its facilities throughout the United States, Europe, and Asia, as well as through direct sales offices and independent sales representatives throughout the world. Principal competition includes companies such as Viavi Corporation, II-VI, MKS Newport Optics, Alluxa, and a number of smaller regional and national suppliers.
The Other segment is comprised of unallocated corporate costs.
OTHER GENERAL INFORMATION
We are committed to providing high-quality, innovative, and reliable products that will enable our customers’ technologies and fuel their own technological breakthroughs and growth.
Our products include precious and non-precious specialty metals, inorganic chemicals and powders, specialty coatings, specialty engineered beryllium and copper-based alloys, beryllium composites, ceramics, and engineered clad and plated metal systems.
We are constantly looking ahead to realign product and service portfolios toward the latest market and technology trends so that we are able to provide customers with an even broader scope of products, services, and specialized expertise. We believe we are an established leader in our markets.
Approximately 750 customers purchase our products throughout the semiconductor, industrial, aerospace and defense, automotive, energy, consumer electronics, and telecom and data center end markets. No single customer accounted for more than 10% of our total net sales for 2020.
Availability of Raw Materials
The principal raw materials we use are beryllium, aluminum, cobalt, copper, gold, nickel, palladium, platinum, ruthenium, silver, and tin. Ore reserve data can be found in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations." The availability of these raw materials, as well as other materials used by us, is adequate and generally not dependent on any one supplier.
Patents and Licenses
We own patents, patent applications, and licenses relating to certain of our products and processes. While our rights under these patents and licenses are of some importance to our operations, our business is not materially dependent on any one patent or license or on all of our patents and licenses as a group.
The backlog of unshipped orders as of December 31, 2020, 2019, and 2018 was $279.2 million, $176.4 million, and $266.0 million, respectively. Backlog is generally represented by purchase orders that may be terminated under certain conditions. We expect that substantially all of our backlog of orders at December 31, 2020 will be filled over the next 18 months.
On July 17, 2020, the Company acquired 100% of the capital stock of Optics Balzers, an industry leader in thin film optical coatings. The purchase price for Optics Balzers was $136.1 million, including the assumption of debt. This business operates within the Precision Optics segment and the results of operations are included as of the date of acquisition. Refer to Note B to the Consolidated Financial Statements for additional detail on the Company's acquisition.
We are subject to a variety of laws that regulate the manufacturing, processing, use, handling, storage, transport, treatment, emission, release, and disposal of substances and wastes used or generated in manufacturing. For decades, we have operated our facilities under applicable standards of inplant and outplant emissions and releases. The inhalation of airborne beryllium particulate may present a health hazard to certain individuals.
On January 9, 2017, the U.S. Occupational Safety and Health Administration (OSHA) published a new standard for workplace exposure to beryllium that, among other things, lowered the permissible exposure by a factor of ten and established new requirements for respiratory protection, personal protective clothing and equipment, medical surveillance, hazard communication, and record keeping. Materion was a participant in the development of the new standards, which fundamentally
represent our current health and safety operating practices. On July 6, 2018, OSHA issued a Direct Final Rule that amended the text of the new standard to clarify OSHA’s intent with respect to certain terms and provisions of the standard, and on December 11, 2018, OSHA issued a Notice of Proposed Rulemaking concerning additional modifications to the standard “to clarify certain provisions and to simplify or improve compliance.” Other government and standard-setting organizations are also reviewing beryllium-related worker safety rules and standards, and will likely make them more stringent. The development, proposal, or adoption of more stringent standards may affect the buying decisions by the users of beryllium-containing products. If the standards are made more stringent and/or our customers or other downstream users decide to reduce their use of beryllium-containing products, our results of operations, liquidity, and financial condition could be materially adversely affected. The impact of this potential adverse effect would depend on the nature and extent of the changes to the standards, the cost and ability to meet the new standards, the extent of any reduction in customer use, and other factors. The magnitude of this potential adverse effect cannot be estimated.
In addition to laws that regulate the manufacturing, processing, use, handling, storage, transport, treatment, emission, release, and disposal of substances and wastes used or generated in manufacturing, we are subject to various laws around the world. For example, trade regulations, including tariffs or other import or export restrictions, may increase the cost of some of our raw materials or cross-border shipments, and limit our ability to do business in certain countries or with certain individuals. We are also required to comply with increasingly complex and changing laws and regulations enacted to protect business and personal data in the United States and other jurisdictions regarding privacy, data protection and data security, including those related to the collection, storage, use, transmission and protection of personal information and other consumer, customer, vendor or employee data. With respect to the laws and regulations noted above, as well as other applicable laws and regulations, the Company's compliance programs may under certain circumstances involve material investments in the form of additional processes, training, personnel, information technology, and capital.
Human Capital Management
Materion employees are located throughout the world. Employee levels are managed to align with the pace of business and management believes it has sufficient human capital to operate its business successfully. We employed approximately 3,072 people globally as of December 31, 2020. Approximately 651 were in the Asia–Pacific region, 428 were in the Europe, the Middle East, and Africa (EMEA) region, and 1,993 were in the North America region. Among our total global employee population, approximately 2,224 were employed in manufacturing. Our strong employee base, along with their commitment to customer service excellence and uncompromising values, provide the foundation for our Company’s success.
Our employees are responsible for upholding our core values, which include working safely and collaboratively, conducting all aspects of business with the highest standards of ethics and integrity, leveraging processes and data to drive continuous improvement, empowering individuals and teams, embracing change, attracting and developing diverse global talent, and partnering for the betterment of the communities where we live and operate.
Health and Safety
The health, safety, and well-being of our employees is our highest priority and is a Materion core value. We have a strong Environmental, Health, and Safety (EHS) program that focuses on implementing policies and training programs, as well as performing self-audits to ensure our colleagues leave their workplace safely, every day. On an annual basis, our corporate strategic long-range strategies are reviewed and updated, improvement plans are developed for each global location, progress is tracked, and daily critical safety statistics and metrics are published internally. Our corporate intranet site is visible to all global employees, where we share detailed descriptions of serious injuries and near misses and their corrective actions, as well as other proactive measures to promote lessons learned and ensure worker safety. Safety awareness and employee engagement programs have been implemented at all global facilities. We also have onsite medical teams at two key manufacturing sites to provide medical testing for employees to determine any potential exposure to beryllium, of which Materion is a leading global supplier.
The COVID-19 pandemic has underscored for us the importance of keeping our employees safe and healthy. In response to the pandemic, the Company has taken actions aligned with the World Health Organization and the Centers for Disease Control and Prevention to protect its workforce so they can more safely and effectively perform their work. Our health and safety focus is evident in our response to the COVID-19 pandemic around the globe:
•adding work from home flexibility;
•encouraging those who are sick to stay home;
•increasing cleaning protocols across all locations;
•initiating regular communication regarding impacts of the COVID-19 pandemic, including health and safety protocols and procedures;
•implementing temperature screening of employees at all of our manufacturing facilities;
•establishing new physical distancing procedures for employees who need to be onsite;
•providing additional personal protective equipment and cleaning supplies;
•modifying work spaces with plexiglass dividers and touchless faucets;
•implementing protocols to address actual and suspected COVID-19 cases and potential exposure;
•prohibiting all domestic and international non-essential travel for all employees; and
•requiring masks to be worn in all locations where allowed by local law.
We manufacture products which are deemed essential to the critical infrastructure and all production sites have continued operating during the COVID-19 pandemic. As such, we have invested in creating physically safe work environments for our employees.
Diversity and Inclusion
As part of our human capital management initiatives to attract, develop, and retain diverse global talent, we track and report internally on key talent metrics including workforce demographics, critical role pipeline data, and diversity hiring analytics. This data-driven approach helps ensure that we stay aligned to our goal of creating a positive and dynamic global work environment where all employees can flourish. A truly innovative workforce needs to be diverse and leverage the skills and perspectives of a broad range of backgrounds and experiences. To attract a global workforce, we strive to create and embed a culture where employees can bring their whole selves to work.
Our employee resource groups (ERGs) are Company-sponsored groups of global employees that support and promote the specific mutual objectives of both the employees and the Company, with emphasis on the inclusion, diversity, and professional development of employees. The ERGs provide opportunities for employees to connect, develop, and grow together in a supportive environment. As of December 31, 2020, we had three ERGs: ELEVATE (Women), V.E.T. (veterans and allies of the military), and United Voices of Materion (all ethnic backgrounds). Our focus continues to be on the recruitment of diverse candidates as well as the development of our internal cadres of diverse leaders so that they can advance their careers and move into leadership positions throughout the Company. Additionally, in 2020, we launched professional development training for our female leaders in partnership with the PRADCO organization. We plan to offer professional development training again in 2021 with a new cohort of female leaders.
We continue to prioritize professional development and training for all global employees. By providing employees with wide-ranging development programs, opportunities, and paths to success, we empower them to realize their full potential. We strongly encourage employees to create a career development plan with focused milestones and ongoing two-way communication with their managers and supervisors. Apprenticeship programs have been implemented in some of our large plant sites, and we continue to introduce similar programs throughout the Company.
We are committed to identifying and developing the talents of our next generation of leaders. Our robust and fully integrated talent and succession-planning process supports the development of our talent pipeline for critical roles in operations management, commercial excellence and finance. On an annual basis, we conduct organizational reviews with our Chief Executive Officer and all business unit and function senior leaders to identify and evaluate our high potential diverse talent and succession plans for our most critical roles.
We are subject to the informational requirements of the Securities Exchange Act of 1934. Therefore, we file periodic reports, proxy statements, and other information with the Securities and Exchange Commission (SEC).
We use our investor relations website, https://investor.materion.com/, as a channel for routine distribution of important information, including news releases, analyst presentations, and financial information. As soon as reasonably practicable, we make all documents that we file with, or furnish to, the SEC, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to these reports, available free of charge via this website. The content on any website referred to in this Form 10-K is not incorporated by reference into this Form 10-K unless expressly noted.
Executive Officers of the Registrant
Incorporated by reference from information with respect to executive officers of Materion Corporation set forth in Item 10 in Part III of this Form 10-K.
Item 1A. RISK FACTORS
Our business, financial condition, results of operations, and cash flows can be affected by a number of factors, including, but not limited to, those set forth below and elsewhere in this Form 10-K, any one of which could cause our actual results to vary materially from recent results or from our anticipated future results. Therefore, an investment in us involves some risks, including the risks described below. Although the risks are organized by headings, and each risk is discussed separately, many
are interrelated. The risks discussed below are not the only risks that we may experience. If any of the following risks occur, our business, results of operations, or financial condition could be negatively impacted.
Risks Relating to the COVID-19 Pandemic
Our business, results of operations, financial position, and cash flows have been and are expected to continue to be adversely affected by the coronavirus (COVID-19) pandemic.
In December 2019, there was an outbreak of a novel strain of COVID-19 in China that has since spread to the majority of the regions of the world. The outbreak was subsequently declared a pandemic by the World Health Organization in March 2020. To date, the COVID-19 outbreak and preventative measures taken to contain or mitigate the outbreak have caused, and are continuing to cause, business slowdowns or shutdowns in affected areas and significant disruption in global financial markets. Although we are unable to predict the ultimate impact of the COVID-19 outbreak at this time, the pandemic has adversely affected, and is expected to continue to adversely affect, our business, results of operations, financial position, and cash flows. Such effects may be material and the potential impacts include, but are not limited to:
•disruptions to our facilities, including as a result of facility closures, reductions in operating hours, labor shortages, and changes in operating procedures, including additional cleaning and disinfecting procedures;
•disruptions in our supply chain due to transportation delays, travel restrictions, raw material cost increases, and closures of businesses or facilities;
•reductions in our operating effectiveness due to workforce disruptions resulting from “shelter in place,” “stay at home” orders, the need for social distancing, and the unavailability of key personnel necessary to conduct our business activities; and
•volatility in the global financial markets, which could have a negative impact on our ability to access capital and additional sources of financing in the future.
In addition, we cannot predict the impact that COVID-19 will have on our customers, employees, suppliers, and distributors, and any adverse impacts on these parties may have a material adverse impact on our business. The impact of COVID-19 may also exacerbate other risks discussed below, any of which could have a material effect on us. This situation is changing rapidly and additional impacts may arise that we are not aware of currently.
Risks Relating to Economic Conditions
The businesses of many of our customers are subject to significant fluctuations as a result of the cyclical nature of their industries and their sensitivity to general economic conditions, which could adversely affect their demand for our products and reduce our sales and profitability.
A substantial number of our customers are in the semiconductor, industrial, aerospace and defense, automotive, energy, consumer electronics, and telecom and data center end markets. Each of these end markets is cyclical in nature, influenced by a combination of factors which could have a negative impact on our business, including, among other things, periods of economic growth or recession, strength or weakness of the U.S. dollar, the strength of the semiconductor, automotive electronics, and oil and gas industries, the rate of construction of telecommunications infrastructure equipment, and government spending on defense.
Also, in times when growth rates in our markets are lower, or negative, there may be temporary inventory adjustments by our customers that may negatively affect our business.
Risks Relating to Our Business and Operations
Because we experience seasonal fluctuations in our sales, our quarterly results will fluctuate, and our annual performance will be affected by the fluctuations.
We expect seasonal patterns to continue, which may cause our quarterly results to fluctuate. If our revenue during any quarter were to fall below the expectations of investors or securities analysts, our share price could decline, perhaps significantly. Unfavorable economic conditions, lower than normal levels of demand, and other occurrences in any quarter could also harm our results of operations. For example, we have experienced customers building inventory in anticipation of increased demand, whereas in other periods, demand decreased because our customers had excess inventory.
A portion of our revenue is derived from the sale of defense-related products through various contracts and subcontracts. These contracts may be suspended, canceled, or delayed, which could have an adverse impact on our revenues.
In 2020, 13% of our value-added sales was derived from sales to customers in the aerospace and defense end market. A portion of these customers operate under contracts with the U.S. Government, which are vulnerable to termination at any time, for convenience or default. Some of the reasons for cancellation include, but are not limited to, budgetary constraints or re-appropriation of government funds, timing of contract awards, violations of legal or regulatory requirements, and changes in political agenda. If cancellations were to occur, it would result in a reduction in our revenue. Furthermore, significant reductions to defense spending could occur over the next several years due to government spending cuts, which could have a significant adverse impact on us. For example, high-margin defense application delays and/or push-outs may adversely impact our results of operations, including quarterly earnings.
The markets for our products are experiencing rapid changes in technology.
We operate in markets characterized by rapidly changing technology and evolving customer specifications and industry standards. New products may quickly render an existing product obsolete and unmarketable. For example, for many years thermal and mechanical performance have been at the forefront of device packaging for wireless communications infrastructure devices. In recent years, a tremendous effort has been put into developing simpler packaging solutions comprised of copper and other similar components. Our growth and future results of operations depend in part upon our ability to enhance existing products and introduce newly developed products on a timely basis that conform to prevailing and evolving industry standards, meet or exceed technological advances in the marketplace, meet changing customer specifications, achieve market acceptance, and respond to our competitors’ products.
The process of developing new products can be technologically challenging and requires the accurate anticipation of technological and market trends. We may not be able to introduce new products successfully or do so on a timely basis. If we fail to develop new products that are appealing to our customers or fail to develop products on time and within budgeted amounts, we may be unable to recover our research and development costs, which could adversely affect our margins and profitability.
The availability of competitive substitute materials for beryllium-containing products may reduce our customers’ demand for these products and reduce our sales.
In certain product applications, we compete with manufacturers of non-beryllium-containing products, including organic composites, metal alloys or composites, titanium, and aluminum. Our customers may choose to use substitutes for beryllium-containing products in their products for a variety of reasons, including, among other things, the lower costs of those substitutes, the health and safety concerns relating to these products (despite numerous studies affirming the safety of beryllium in these products), and the risk of litigation relating to beryllium-containing products. If our customers use substitutes for beryllium-containing materials in their products, the demand for beryllium-containing products may decrease, which could reduce our sales.
Our long and variable sales and development cycle makes it difficult for us to predict if and when a new product will be sold to customers.
Our sales and development cycle, which is the period from the generation of a sales lead or new product idea through the development of the product and the recording of sales, may typically take several years, making it very difficult to forecast sales and results of operations. Our inability to accurately predict the timing and magnitude of sales of our products, especially newly introduced products, could affect our ability to meet our customers’ product delivery requirements or cause our results of operations to suffer if we incur expenses in a particular period that do not translate into sales during that period, or at all. In addition, these failures would make it difficult to plan future capital expenditure needs and could cause us to fail to meet our cash flow requirements.
The availability and prices of some raw materials we use in our manufacturing operations fluctuate, and increases in raw material costs can adversely affect our operating results and our financial condition.
We manufacture advanced engineered materials using various precious and non-precious metals, including aluminum, beryllium, cobalt, copper, gold, nickel, palladium, platinum, ruthenium, silver, and tin. The availability of, and prices for, these raw materials are subject to volatility and are influenced by worldwide economic conditions, speculative action, world supply and demand balances, inventory levels, availability of substitute metals, the U.S. dollar exchange rate, production costs of U.S. and foreign competitors, anticipated or perceived shortages, and other factors. Precious metal prices, including prices for gold and silver, have fluctuated significantly in recent years. Higher prices can cause adjustments to our inventory carrying values,
whether as a result of quantity discrepancies, normal manufacturing losses, differences in scrap rates, theft or other factors, which could have a negative impact on our profitability and cash flows. Also, the price of our products will generally increase in tandem with rising metal prices, as a result of changes in precious metal prices that are passed through to our customers, which could deter them from purchasing our products and adversely affect our net sales and operating profit.
Further, we maintain some precious metals and copper on a consigned inventory basis. The owners of the precious metals and copper charge a fee that fluctuates based on the market price of those metals and other factors. A significant increase in the market price or the consignment fee of precious metals and/or copper could increase our financing costs, which would increase our operating costs.
Utilizing precious metals in the manufacturing process creates challenges in physical inventory valuations that may impact earnings.
We manufacture precious, non-precious, and specialty metal products and also have metal cleaning operations and in-house refineries that allow for the reclaim of precious metals from internally generated or customer scrap. We refine that scrap through our internal operations and externally through outside vendors.
When taking periodic physical inventories in our refinery operations, we reconcile the actual precious metals to what was estimated prior to the physical inventory count. Those estimates are based in part on assays or samples of precious metals taken during the refining process. If those estimates are inaccurate, we may have an inventory long (more physical precious metal than what we had estimated) or short (less physical precious metal than what we had estimated). These fluctuations could have a material impact on our financial statements and may impact earnings. In the past, our gross margin has been reduced by a net quarterly physical inventory adjustment. Higher precious metal prices may magnify the value of any potential inventory long or short.
Because we maintain a significant inventory of precious metals, we may experience losses due to employee error or theft.
Because we manufacture products that contain precious metals, we maintain a significant amount of precious metals at certain of our manufacturing facilities. Accordingly, we are subject to the risk of precious metal shortages resulting from employee error or theft. In the past, we have had precious metal shortages resulting from employee error and theft, which could reoccur in the future.
While we maintain controls to prevent theft, including physical security measures, if our controls do not operate effectively or are designed ineffectively, our profitability could be adversely affected, including any charges that we might incur as a result of the shortage of our inventory and by costs associated with increased security, preventative measures, and insurance. Additionally, while we maintain insurance to cover the theft of our inventory, such coverage may not sufficiently cover any loss.
We have a limited number of manufacturing facilities, and damage to those facilities, or to critical pieces of equipment in these facilities, could interrupt our operations, increase our costs of doing business, and impair our ability to deliver our products on a timely basis.
Some of our facilities are interdependent. For instance, our manufacturing facility in Elmore, Ohio relies on our mining operation for its supply of beryllium hydroxide used in production of most of its beryllium-containing materials. Additionally, our Reading, Pennsylvania and Tucson, Arizona manufacturing facilities are dependent on materials produced by our Elmore, Ohio manufacturing facility, and our Wheatfield, New York manufacturing facility is dependent on our Buffalo, New York manufacturing facility. The destruction or closure of our mine, any of our manufacturing facilities, or to critical pieces of equipment within these facilities for a significant period of time as a result of harsh weather, fire, explosion, act of war or terrorism, or other natural disaster or unexpected event may interrupt our manufacturing capabilities, increase our capital expenditures and our costs of doing business, and impair our ability to deliver our products on a timely basis. In addition, many of our manufacturing facilities depend on one source for electric power and natural gas, which could be interrupted due to equipment failures, terrorism, or another cause.
If such events occur, we may need to resort to an alternative source of manufacturing or to delay production, which could increase our costs of doing business and/or result in lost sales. Our property damage and business interruption insurance may not cover all of our potential losses and may not continue to be available to us on acceptable terms, if at all.
A security breach of customer, employee, supplier, or company information may have a material adverse effect on our business, financial condition, and results of operations.
In the conduct of our business, we collect, use, transmit, store, and report data on information systems and interact with customers, vendors, and employees. Increased global information technology (IT) security threats and more sophisticated and targeted computer crime pose a risk to the security of our systems and networks and the confidentiality, availability, and integrity of our data. Despite our security measures, our IT systems and infrastructure may be vulnerable to customer viruses, cyber-attacks, security breaches caused by employee error or malfeasance, or other disruptions. Any such threat could compromise our networks and the information stored there could be accessed, publicly disclosed, lost, or stolen. A security breach of our computer systems could interrupt or damage our operations or harm our reputation, resulting in a loss of sales, operating profits, and assets. In addition, we could be subject to legal claims or proceedings and/or liability under laws that protect the privacy of personal information and regulatory penalties if confidential information relating to customers, suppliers, employees, or other parties is misappropriated from our computer systems.
Similar security threats exist with respect to the IT systems of our lenders, suppliers, consultants, advisers, and other third parties with whom we conduct business. A security breach of those computer systems could result in the loss, theft, or disclosure of confidential information and could also interrupt or damage our operations, harm our reputation, and subject us to legal claims.
Our defined benefit pension plans and other post-employment benefit plans are subject to financial market risks that could adversely impact our financial performance.
In 2019, the Company's Board of Directors approved changes to the U.S. defined benefit pension plan. The Company froze the pay and service amounts used to calculate the pension benefits for active participants as of January 1, 2020. The Company has defined benefit pension plans in other non-U.S. locations. Our pension expense and our required contributions to our pension plans are directly affected by the value of plan assets, the projected rate of return on plan assets, the actual rate of return on plan assets, and the actuarial assumptions we use to measure our defined benefit pension plan obligations, including the rate at which future obligations are discounted to a present value, or the discount rate. Significant changes in market interest rates and decreases in the fair value of plan assets and investment losses on plan assets would increase funding requirements and expenses and may adversely impact our results of operations.
We provide post-employment health benefits to eligible employees. Our retiree health expense is directly affected by the assumptions we use to measure our retiree health plan obligations, including the assumed rate at which health care costs will increase and the discount rate used to calculate future obligations. For retiree health accounting purposes, we have used a graded assumption schedule to assume the rate at which health care costs will increase. We cannot predict whether changing market or economic conditions, regulatory changes, or other factors will further increase our retiree health care expenses or obligations, diverting funds we would otherwise apply to other uses.
Unexpected events and natural disasters at our mine could increase the cost of operating our business.
A portion of our production costs at our mine are fixed regardless of current operating levels. Our operating levels are subject to conditions beyond our control that may increase the cost of mining for varying lengths of time. These conditions include, among other things, weather, fire, natural disasters, pit wall failures, and ore processing changes. Our mining operations also involve the handling and production of potentially explosive materials. It is possible that an explosion could result in death or injuries to employees and others and material property damage to third parties and us. Any explosion could expose us to adverse publicity or liability for damages and materially adversely affect our operations. Any of these events could increase our cost of operations.
Risks Related to Legal, Compliance and Regulatory Matters
We conduct our sales and distribution operations on a worldwide basis and are subject to the risks associated with doing business outside the United States.
We sell to customers outside of the United States from our United States and international operations. Revenue from international operations (principally Europe and Asia) accounted for approximately 45% in 2020, 37% in 2019, and 40% in 2018 of Net sales. We anticipate that international shipments will account for a significant portion of our sales for the foreseeable future. There are a number of risks associated with international business activities, including:
•burdens to comply with multiple and potentially conflicting foreign laws and regulations, including export requirements, tariffs and other barriers, environmental health and safety requirements, increasingly complex
requirements concerning privacy and data security, including the European Union's General Data Protection Regulation, and unexpected changes in any of these factors;
•difficulty in obtaining export licenses from the U.S. Government;
•political and economic instability and disruptions, including terrorist attacks;
•disadvantages of competing against companies from countries that are not subject to U.S. laws and regulations, including the Foreign Corrupt Practices Act (FCPA);
•potentially adverse tax consequences due to overlapping or differing tax structures;
•fluctuations in currency exchange rates; and
•disruptions in our business or the businesses of our suppliers or customers due to cyber security incidents, public health concerns (including viral outbreaks, such as the coronavirus) or natural disasters.
Any of these risks could have an adverse effect on our international operations by reducing the demand for our products or reducing the prices at which we can sell our products, which could result in an adverse effect on our business, financial position, results of operations, or cash flows. We may hedge our currency transactions to mitigate the impact of currency price volatility on our earnings; however, hedging activities may not be successful. For example, hedging activities may not cover the Company’s net euro and yen exposure, which could have an unfavorable impact on our results of operations.
In addition, we could be adversely affected by violations of the FCPA and similar worldwide anti-bribery laws. The FCPA and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. While policies mandate compliance with these anti-bribery laws, we operate in many parts of the world that have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practices. We cannot assure that our internal controls and procedures will always protect us from the reckless or criminal acts committed by our employees or agents. If we are found to be liable for FCPA violations or other anti-bribery laws, we could suffer from criminal or civil penalties or other sanctions, which could have a material adverse effect on our business.
Changes in laws or regulations or the manner of their interpretation or enforcement could adversely impact our financial performance and restrict our ability to operate our business or execute our strategies.
New laws or regulations, or changes in existing laws or regulations, or the manner of their interpretation or enforcement, could increase our cost of doing business and restrict our ability to operate our business or execute our strategies. In particular, there may be significant changes in U.S. laws and regulations and existing international trade agreements by the current U.S. presidential administration that could affect a wide variety of industries and businesses, including those businesses we own and operate. If the current U.S. presidential administration materially modifies U.S. laws and regulations and international trade agreements, our business, financial condition, and results of operations could be adversely affected.
We are exposed to lawsuits in the normal course of business, which could harm our business.
During the ordinary conduct of our business, we may become involved in certain legal proceedings, including those involving product liability claims, third-party lawsuits relating to exposure to beryllium, claims against us of infringement of intellectual property rights of third parties, or other litigation matters. Due to the uncertainties of litigation, we can give no assurance that we will prevail at the resolution of future claims. Certain of these matters involve types of claims that, if they result in an adverse ruling to us, could give rise to substantial liability, which could have a material adverse effect on our business, operating results, or financial condition.
Although we have insurance which may be applicable in certain circumstances, some jurisdictions preclude insurance coverage for punitive damage awards. Accordingly, our profitability could be adversely affected if any current or future claimants obtain judgments for any uninsured compensatory or punitive damages. Further, an unfavorable outcome or settlement of a pending beryllium case or adverse media coverage could encourage the commencement of additional similar litigation.
Health issues, litigation, and government regulations relating to our beryllium operations could significantly reduce demand for our products, limit our ability to operate, and adversely affect our profitability.
If exposed to respirable beryllium fumes, dusts, or powder, some individuals may demonstrate an allergic reaction to beryllium and may later develop a chronic lung disease known as chronic beryllium disease (CBD). Some people who are diagnosed with
CBD do not develop clinical symptoms at all. In others, the disease can lead to scarring and damage of lung tissue, causing clinical symptoms that include shortness of breath, wheezing, and coughing. Severe cases of CBD can cause disability or death.
Further, some scientists claim there is evidence of an association between beryllium exposure and lung cancer, and certain standard-setting organizations have classified beryllium and beryllium compounds as human carcinogens.
The health risks relating to exposure to beryllium have been, and will continue to be, a significant issue confronting the beryllium-containing products industry. The health risks associated with beryllium have resulted in product liability claims, employee, and third-party lawsuits. As of December 31, 2020, we had two CBD cases outstanding.
The increased levels of scrutiny by federal, state, foreign, and international regulatory authorities could lead to regulatory decisions relating to the approval or prohibition of the use of beryllium-containing materials for various uses. Concerns over CBD and other potential adverse health effects relating to beryllium, as well as concerns regarding potential liability from the use of beryllium, may discourage our customers’ use of our beryllium-containing products and significantly reduce demand for our products. In addition, adverse media coverage relating to our beryllium-containing products could damage our reputation or cause a decrease in demand for beryllium-containing products, which could adversely affect our profitability.
Our bertrandite ore mining and beryllium-related manufacturing operations and some of our customers’ businesses are subject to extensive health and safety regulations that impose, and will continue to impose, significant costs and liabilities, and future regulation could increase those costs and liabilities, or effectively prohibit production or use of beryllium-containing products.
We, as well as our customers, are subject to laws regulating worker exposure to beryllium. OSHA has published a new standard for workplace exposure to beryllium that, among other things, lowered the permissible exposure by a factor of ten and established new requirements for respiratory protection, personal protective clothing and equipment, medical surveillance, hazard communication, and recordkeeping. Materion was a participant in the development of the new standards, which fundamentally represent our current health and safety operating practices. Other government and standard-setting organizations are also reviewing beryllium-related worker safety rules and standards, and will likely make them more stringent. The development, proposal, or adoption of more stringent standards may affect buying decisions by the users of beryllium-containing products. If the standards are made more stringent and/or our customers or other downstream users decide to reduce their use of beryllium-containing products, our results of operations, liquidity, and financial condition could be materially adversely affected. The impact of this potential adverse effect would depend on the nature and extent of the changes to the standards, the cost and ability to meet the new standards, the extent of any reduction in customer use, and other factors. The magnitude of this potential adverse effect cannot be estimated.
Our bertrandite ore mining and manufacturing operations are subject to extensive environmental regulations that impose, and will continue to impose, significant costs and liabilities on us, and future regulation could increase these costs and liabilities or prevent production of beryllium-containing products.
We are subject to a variety of governmental regulations relating to the environment, including those relating to our handling of hazardous materials and air and wastewater emissions. Some environmental laws impose substantial penalties for non-compliance. Others, such as the federal Comprehensive Environmental Response, Compensation, and Liability Act, impose strict, retroactive, and joint and several liability upon entities responsible for releases of hazardous substances. Bertrandite ore mining is also subject to extensive governmental regulation on matters such as permitting and licensing requirements, plant and wildlife protection, reclamation and restoration of mining properties, the discharge of materials into the environment, and the effects that mining has on groundwater quality and availability. Future requirements could impose on us significant additional costs or obligations with respect to our extraction, milling, and processing of ore. If we fail to comply with present and future environmental laws and regulations, we could be subject to liabilities or our operations could be interrupted. In addition, future environmental laws and regulations could restrict our ability to expand our facilities or extract our bertrandite ore deposits. These environmental laws and regulations could also require us to acquire costly equipment, obtain additional financial assurance, or incur other significant expenses in connection with our business, which would increase our costs of production.
Risks Related to Our Debt
A major portion of our bank debt consists of variable-rate obligations, which subjects us to interest rate fluctuations.
Our credit facilities are secured by substantially all of our assets (other than non-mining real property and certain other assets). Our working capital line of credit includes variable-rate obligations, which expose us to interest rate risks. If interest rates increase, our debt service obligations on our variable-rate indebtedness would increase even if the amount borrowed remained
the same, resulting in a decrease in our net income. Additional information regarding our market risks is contained in Item 7A "Quantitative and Qualitative Disclosures About Market Risk."
Our failure to comply with the covenants contained in the terms of our indebtedness could result in an event of default, which could materially and adversely affect our operating results and our financial condition.
The terms of our credit facilities require us to comply with various covenants, including financial covenants. In the event of a global economic downturn, it could have a material adverse impact on our earnings and cash flow, which could adversely affect our ability to comply with our financial covenants and could limit our borrowing capacity. Our ability to comply with these covenants depends, in part, on factors over that we may have no control. A breach of any of these covenants could result in an event of default under one or more of the agreements governing our indebtedness which, if not cured or waived, could give the holders of the defaulted indebtedness the right to terminate commitments to lend and cause all amounts outstanding with respect to the indebtedness to be due and payable immediately. Acceleration of any of our indebtedness could result in cross-defaults under our other debt instruments. Our assets and cash flow may be insufficient to fully repay borrowings under all of our outstanding debt instruments if some or all of these instruments are accelerated upon an event of default, in which case we may be required to seek legal protection from our creditors.
The terms of our indebtedness may restrict our operations, including our ability to pursue our growth and acquisition strategies.
The terms of our credit facilities contain a number of restrictive covenants, including restrictions in our ability to, among other things, borrow and make investments, acquire other businesses, and consign additional precious metals. These covenants could adversely affect our business by limiting our ability to plan for or react to market conditions or to meet our capital needs, as well as adversely affect our ability to pursue our growth, acquisition strategies, and other strategic initiatives.
Risks Related to the Execution of Our Strategy
We may not be able to complete our acquisition strategy or successfully integrate acquired businesses.
We are active in pursuing acquisitions. We intend to continue to consider further growth opportunities through the acquisition of assets or companies and routinely review acquisition opportunities. We cannot predict whether we will be successful in pursuing any acquisition opportunities or what the consequences of any acquisition would be. Future acquisitions may involve the expenditure of significant funds and management time. Depending upon the nature, size, and timing of future acquisitions, we may be required to raise additional financing, which may not be available to us on acceptable terms, or at all. Further, we may not be able to successfully integrate any acquired business with our existing businesses or recognize any expected advantages from any completed acquisition.
In addition, there may be liabilities that we fail, or are unable, to discover in the course of performing due diligence investigations on the assets or companies we have already acquired or may acquire in the future. We cannot assure that rights to indemnification by the sellers of these assets or companies to us, even if obtained, will be enforceable, collectible, or sufficient in amount, scope, or duration to fully offset the possible liabilities associated with the business or property acquired. Any such liabilities, individually or in the aggregate, could have a materially adverse effect on our business, financial condition, and results of operations.
Our products are deployed in complex applications and may have errors or defects that we find only after deployment.
Our products are highly complex, designed to be deployed in complicated applications, and may contain undetected defects, errors, or failures. Although our products are generally tested during manufacturing, prior to deployment, they can only be fully tested when deployed in specific applications. For example, we sell beryllium-copper alloy strip products in a coil form to some customers, who then stamp the alloy for its specific purpose. On occasion, it is not until such customer stamps the alloy that a defect in the alloy is detected. Consequently, our customers may discover errors after the products have been deployed. The occurrence of any defects, errors, or failures could result in installation delays, product returns, termination of contracts with our customers, diversion of our resources, increased service and warranty costs, and other losses to our customers, end users, or to us. Any of these occurrences could also result in the loss of, or delay in, market acceptance of our products, and could damage our reputation, which could reduce our sales.
In addition to the risk of unanticipated warranty or recall expenses, our customer contracts may contain provisions that could cause us to incur penalties, be liable for damages, including liquidated damages, or incur other expenses, if we experience difficulties with respect to the functionality, deployment, operation, and availability of our products and services. In the event of late deliveries, late or improper installations or operations, failure to meet product or performance specifications or other
product defects, or interruptions or delays in our managed service offerings, our customer contracts may expose us to penalties, liquidated damages, and other liabilities. In the event we were to incur contractual penalties, such as liquidated damages or other related costs that exceed our expectations, our business, financial condition, and operating results could be materially and adversely affected.
Item 1B. UNRESOLVED STAFF COMMENTS
Item 2. PROPERTIES
We operate manufacturing plants, service and distribution centers, and other facilities throughout the world. During 2020, we made effective use of our productive capacities at our principal facilities. We believe that the quality and production capacity of our facilities is sufficient to maintain our competitive position for the foreseeable future. Information as of December 31, 2020, with respect to our facilities that are owned or leased, and the respective segments in which they are included, is set forth below:
|Location||Owned or Leased|
Approximate Number of
|Corporate and Administrative Offices|
Mayfield Heights, Ohio (1)(2)
Albuquerque, New Mexico (2)
Alzenau, Germany (2)
Bloomfield, Connecticut (3)
Brewster, New York (2)
Buffalo, New York (2)
Delta, Utah (1)
Elmore, Ohio (1)
Farnborough, England (1)
Jena, Germany (3)
Limerick, Ireland (2)
Lincoln, Rhode Island (1)
Lorain, Ohio (1)
Milwaukee, Wisconsin (2)
Penang, Malaysia (3)
Reading, Pennsylvania (1)
Santa Clara, California (2)
Shanghai, China (3)
Subic Bay, Philippines (2)
Suzhou, China (2)
Taoyuan City, Taiwan (2)
Tucson, Arizona (1)
Tyngsboro, Massachusetts (3)
Westford, Massachusetts (3)
Wheatfield, New York (2)
Windsor, Connecticut (3)
|Service, Sales, and Distribution Centers|
Elmhurst, Illinois (1)
Eschborn, Germany (3)
Maastricht, The Netherlands (2)
Port Charlotte, Florida(3)
Seoul, Korea (2)
Stuttgart, Germany (1)
Tokyo, Japan (1)
In addition to the above, the Company holds certain mineral rights on 7,500 acres in Juab County, Utah, from which the beryllium-bearing ore, bertrandite, is mined by the open pit method. A portion of these mineral rights are held under lease. Ore reserve data can be found in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Item 3. LEGAL PROCEEDINGS
Our subsidiaries and our holding company are subject, from time to time, to a variety of civil and administrative proceedings arising out of our normal operations, including, without limitation, product liability claims, health, safety, and environmental claims, and employment-related actions. Among such proceedings are cases alleging that plaintiffs have contracted, or have been placed at risk of contracting, beryllium sensitization or CBD or other lung conditions as a result of exposure to beryllium (beryllium cases). The plaintiffs in beryllium cases seek recovery under negligence and various other legal theories and demand compensatory and often punitive damages, in many cases of an unspecified sum. Spouses of some plaintiffs claim loss of consortium.
As of December 31, 2020, our subsidiary, Materion Brush Inc., was a defendant in two beryllium cases. During 2020, one new beryllium case was filed. In Richard Miller v. Dolphin, Inc. et al., case number CV2020-005163, filed in the Superior Court of Arizona, Maricopa County, the Company is one of six named defendants and 100 Doe defendants. The plaintiff alleges that he contracted beryllium disease from exposures to beryllium-containing products supplied to his employer, Karsten Manufacturing Corporation, where he was a production worker, and asserts claims for negligence, strict liability – failure to warn, strict liability – design defect, and fraudulent concealment. The plaintiff seeks general damages, medical expenses, loss of earnings, consequential damages, and punitive damages. A co-defendent, Dolphin, Inc., filed a cross-claim against the Company for indemnification. On August 12, 2020, the Company moved to dismiss the cross-claim for failure to state a claim upon which relief can be granted. The court denied the motion on October 23, 2020. On December 7, 2020, the Company filed a Petition for Special Action in the Court of Appeals seeking to appeal the motion to dismiss the cross-claim. The Court of Appeals declined to accept jurisdiction on December 30, 2020. The Company believes that it has substantive defenses and intends to vigorously defend this suit.
In 2019, one beryllium case was filed. In Ronald Dwayne Manning v. Arconic Inc. et al., case number 19CI000219, filed in the Superior Court of the State of California, Tehama County, and later removed to the United States District Court, Eastern District of California (Sacramento Division), case number 2:19-CV-02202-MCE-DMC, the Company is one of four named defendants and 120 Doe defendants. The plaintiff alleges that he contracted beryllium disease from exposures to beryllium-containing products during his employment as an auto mechanic, welder, sprinkler installer, and movie projector operator, and asserts claims for negligence, strict liability, fraudulent concealment, and breach of implied warranties. The plaintiff seeks economic damages, non-economic damages, consequential damages, and punitive damages. The Company believes that it has substantive defenses and intends to vigorously defend this suit.
The Company has insurance coverage, which may respond, subject to an annual deductible.
On October 14, 2020 Garett Lucyk, et al. v. Materion Brush Inc., et. al., case number 20CV0234, a wage and hour purported collective and class action, was filed in the Northern District of Ohio against the Company and its subsidiary, Materion Brush Inc. (collectively, the Company). Plaintiff, a former hourly production employee at the Company's Elmore, Ohio facility, alleges that he and other similarly situated employees nationwide are not paid for all time they spend donning and doffing personal protective equipment in violation of the Fair Labor Standards Act and Ohio law. Plaintiff also alleges the Company failed to include all remuneration he and others received for premium and bonus pay when computing overtime pay. The case is currently in the preliminary stages. The Company believes that it has substantive defenses and intends to vigorously defend this suit.
Item 4. MINE SAFETY DISCLOSURES
Information concerning mine safety violations or other regulatory matters required by Section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act and Item 104 of Regulation S-K (17 CFR 229.104) is included in Exhibit 95 to this Form 10-K.
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common shares are listed on the New York Stock Exchange under the symbol “MTRN”. As of January 29, 2021, there were 710 shareholders of record.
The following table presents information with respect to repurchases of common stock made by us during the three months ended December 31, 2020.
|Period||Total Number of Shares Purchased (1) ||Average Price Paid per Share ||Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)||Maximum Dollar Value that May Yet Be Purchased Under the Plans or Programs (2)|
|September 26 through October 30, 2020||— ||$||— ||— ||$||8,316,239 |
|October 31 through November 27, 2020||39 ||60.19 ||— ||8,316,239 |
|November 28 through December 31, 2020||109 ||60.75 ||— ||8,316,239 |
|Total||148 ||$||60.61 ||— ||$||8,316,239 |
|(1)||Represents shares surrendered to the Company by employees to satisfy tax withholding obligations on stock appreciation rights issued under the Company's stock incentive plan.|
|(2)||On January 14, 2014, we announced that our Board of Directors authorized the repurchase of up to $50.0 million of our common stock; this Board authorization does not have an expiration date. During the three months ended December 31, 2020, we did not repurchase any shares under this program.|
The following graph sets forth the cumulative shareholder return on our common shares as compared to the cumulative total return of the Russell 2000 Index, the S&P SmallCap 600 Index, and the S&P SmallCap 600 Materials Index, as Materion Corporation is a component of these indices.
|Materion Corporation||$||172 ||$||214 ||$||199 ||$||265 ||$||287 |
|Russell 2000||196 ||225 ||200 ||251 ||301 |
|S&P SmallCap 600||215 ||244 ||223 ||273 ||304 |
|S&P SmallCap 600 - Materials||196 ||216 ||168 ||202 ||246 |
The above graph assumes that the value of our common shares and each index was $100 on December 31, 2015 and that all applicable dividends were reinvested.
Item 6. SELECTED FINANCIAL DATA
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
We are an integrated producer of high-performance advanced engineered materials used in a variety of electrical, electronic, thermal, and structural applications. Our products are sold into numerous end markets, including semiconductor, industrial, aerospace and defense, automotive, energy, consumer electronics, and telecom and data center.
Coronavirus (COVID-19) Update
The significant macroeconomic impact of the ongoing COVID-19 pandemic impacted several of our markets beginning in the first quarter of 2020 primarily in the form of reduced demand, particularly in the consumer electronics, automotive, energy, aerospace and defense, and industrial end markets. During 2020, we recorded additional reserves for slow-moving and excess inventory of approximately $1.3 million related to the collapse in demand in the oil and gas industry. We also reviewed for any other potential impairment indicators and did not identify any. We still may temporarily shut down our facilities in response to reduced demand, due to employees being impacted by COVID-19, or changes in government policy. We are not experiencing any significant supply chain disruptions. We expect reduced demand to continue at least through the first quarter of 2021, but the extent and timing cannot be reasonably estimated due to the evolving nature of this pandemic.
In 2020, the Company incurred $4.1 million of expense primarily related to premium pay for production workers who were deemed essential to work onsite during the pandemic, as well as for personal protective equipment and temperature-checking services.
The impact of the COVID-19 pandemic is fluid and continues to evolve, and, therefore, we cannot predict the extent to which our business, results of operations, financial condition, or cash flows will ultimately be impacted.
The Company suspended its share buyback program in the first quarter of 2020. The Company subsequently decided to lift the suspension of its share buyback program in the fourth quarter of 2020. In addition, the Company has evaluated the impact of the CARES Act and has determined it does not have a material impact to its consolidated financial statements. See Note H to the Consolidated Financial Statements for additional discussion.
From a liquidity perspective, we believe we are well positioned to manage through this global crisis. In order to ensure we have more than adequate liquidity, we borrowed $150.0 million under the revolving credit facility in April 2020, $116.0 million of which was repaid during the second half of 2020. We ended 2020 with total cash of $25.9 million and $38.5 million of total debt, or in a net debt position of $12.6 million. In addition, we had $245.8 million of available borrowings under our revolving credit facility as of December 31, 2020.
Additionally, in July 2020, we completed the acquisition of Optics Balzers for a purchase price of $136.1 million, including the assumption of debt. The transaction was funded with cash on hand, including a portion of the $150.0 million borrowed under our revolving credit facility during the second quarter of 2020.
RESULTS OF OPERATIONS
During the fourth quarter of 2020, we elected to change our method for valuing inventories that previously used the last-in, first-out (LIFO) method to the first-in, first-out (FIFO) method. Total inventories accounted for under the LIFO method represented approximately 45% of the Company's total inventories as of December 31, 2019 prior to this change in method. We determined that the FIFO method is preferable as it results in uniformity across materially all of our global operations, more closely resembles the physical flow of our inventory, and improves comparability with our peers. The effects of the change in accounting principle have been retrospectively applied to all periods presented in Item 7. Refer to “Note A - Significant Accounting Policies” in the Notes to the Consolidated Financial Statements.
|(Thousands except per share data)||2020||2019||2018|
|Net sales||$||1,176,274 ||$||1,185,424 ||$||1,207,815 |
|Value-added sales||678,567 ||733,689 ||738,958 |
|Gross margin||192,633 ||262,690 ||251,361 |
|Gross margin as a % of Value-added sales||28 ||%||36 ||%||34 ||%|
|Selling, general, and administrative (SG&A) expense||133,963 ||147,164 ||153,489 |
|SG&A expense as a % of Value-added sales||20 ||%||20 ||%||21 ||%|
|Research and development (R&D) expense||20,283 ||18,271 ||15,187 |
|R&D expense as a % of Value-added sales||3 ||%||2 ||%||2 ||%|
|Goodwill impairment charges||9,053 ||11,560 ||— |
|Asset impairment charges||1,419 ||2,581 ||— |
|Restructuring expense||11,237 ||785 ||5,599 |
|Other — net||8,463 ||11,783 ||15,334 |
|Operating profit||8,215 ||70,546 ||61,752 |
|Other non-operating (income) expense — net||(3,939)||3,431 ||42,683 |
|Interest expense — net||3,879 ||1,579 ||2,471 |
|Income before income taxes||8,275 ||65,536 ||16,598 |
|Income tax (benefit) expense||(7,187)||12,142 ||(4,446)|
|Net income||15,462 ||53,394 ||21,044 |
|Diluted earnings per share||0.75 ||2.59 ||1.02 |
2020 Compared to 2019
Net sales of $1,176.3 million in 2020 decreased $9.1 million from $1,185.4 million in 2019. Increased net sales of $97.1 million in our Advanced Materials segment were more than offset by decreased net sales of $106.0 million and $0.2 million in our Performance Alloys and Composites and Precision Optics segments, respectively, driven by lower sales volumes. The change in precious metal and copper prices favorably impacted net sales during 2020 by $94.6 million.
Value-added sales is a non-GAAP financial measure that removes the impact of pass-through metal costs and allows for analysis without the distortion of the movement or volatility in metal prices and changes in mix due to customer-supplied material. Internally, we manage our business on this basis, and a reconciliation of net sales, the most directly comparable GAAP financial measure, to value-added sales is included herein. Value-added sales of $678.6 million in 2020 were down 8% compared to 2019. The increase in semiconductor end market value-added sales was more than offset by the decrease in value-added sales due to reduced demand in the aerospace and defense, energy, telecom and data center, and industrial end markets.
Gross margin was $192.6 million in 2020, or a 27% decrease from the $262.7 million gross margin recorded in 2019. Gross margin expressed as a percentage of value-added sales decreased to 28% in 2020 from 36% in 2019. The decrease was primarily driven by lower volumes, as well as $12.9 million of mine development costs relating to a recent mine expansion, $3.8 million of costs related to the COVID-19 pandemic, and a $1.3 million charge to reserves for slow-moving and excess inventory related to the collapse in demand in the oil and gas industry, all of which were recorded in 2020.
SG&A expense totaled $134.0 million in 2020 as compared to $147.2 million in 2019. The decrease in SG&A expense for 2020 was primarily driven by lower variable compensation expense and cost management actions, partially offset by integration and transaction costs related to the Optics Balzers acquisition. Expressed as a percentage of value-added sales, SG&A expense was 20% in both 2020 and 2019.
R&D expense consists primarily of direct personnel costs for pre-production evaluation and testing of new products, prototypes, and applications. R&D expense was $20.3 million, an increase of 11% compared to 2019 and increased to 3% as a percentage of value-added sales in 2020. The increase in R&D expense reflects additional investment in new product and application development.
Goodwill and Asset impairment charges includes non-recurring charges relating to goodwill and other assets in our Precision Optics segment. Refer to Note N to the Consolidated Financial Statements for additional discussion.
Restructuring expense consists primarily of cost reduction actions taken in order to improve the efficiency of our operations. In 2020, we recorded $11.2 million of restructuring charges. Of this amount, $8.8 million relates to the closure of our Warren, Michigan and Fremont, California facilities in our Performance Alloys and Composites segment and $1.7 million relates to the closure of our Large Area Coatings (LAC) business in our Precision Optics segment.
In 2019, we recorded $0.8 million of expenses related to restructuring actions taken in our LAC business and our Other segment. Refer to Note E to the Consolidated Financial Statements for additional discussion.
Other-net totaled expense of $8.5 million and $11.8 million in 2020 and 2019, respectively. The decrease in Other-net was primarily driven by a $3.3 million foreign exchange hedge gain realized in 2020. Refer to Note F to the Consolidated Financial Statements for the major components within Other-net.
Other non-operating (income) expense-net includes components of pension and post-retirement expense other than service costs. In 2019, other non-operating (income) expense-net included a non-cash pre-tax pension curtailment charge of $3.3 million associated with the pension plan amendment to freeze the pay and service amounts used to calculate pension benefits effective January 1, 2020. Refer to Note P of the Consolidated Financial Statements for details of the components of net periodic benefit costs.
Interest expense - net was $3.9 million in 2020 and $1.6 million in 2019. The increase in interest expense in 2020 compared to 2019 is primarily due to increased borrowings under our revolving credit facility.
Income tax (benefit) expense for 2020 was a benefit of $7.2 million compared to $12.1 million of expense in 2019. The effects of percentage depletion, the research and development credit, and the release of a valuation allowance in a foreign jurisdiction were the primary factors for the difference between the effective and statutory tax rates in 2020. Refer to Note H to the Consolidated Financial Statements for further details on income taxes.
See the Management Discussion and Analysis section of our Annual Report on Form 10-K for the year ended December 31, 2019 for a discussion of our results for 2019 compared to 2018.
The Company consists of four reportable segments: Performance Alloys and Composites, Advanced Materials, Precision Optics, and Other. The Other reportable segment includes unallocated corporate costs.
Performance Alloys and Composites
|Net sales||$||394,195 ||$||500,201 ||$||500,590 |
|Value-added sales||345,335 ||428,084 ||425,471 |
|Operating profit||13,597 ||73,815 ||60,008 |
2020 Compared to 2019
Net sales from the Performance Alloys and Composites segment of $394.2 million in 2020 decreased 21% compared to 2019. The decrease was due to reduced sales into all major end markets, with the largest declines in the aerospace and defense, energy, telecom and data center, and industrial end markets.
Value-added sales of $345.3 million in 2020 were 19% lower than value-added sales of $428.1 million in 2019. The decrease in value-added sales was due to the same factors driving the decrease in net sales.
Performance Alloys and Composites generated operating profit of $13.6 million, or 4% of value-added sales, in 2020 as compared to $73.8 million, or 17% of value-added sales, in 2019. The decrease in operating profit was primarily due to reduced sales volumes, as well as $12.9 million of mine development costs recorded in 2020. In addition, restructuring charges of $8.8 million were recorded in 2020 related to the closure of our Warren, Michigan and Fremont, California facilities.
|Net sales||$||670,867 ||$||573,763 ||$||586,643 |
|Value-added sales||233,958 ||224,254 ||223,714 |
|Operating profit||22,120 ||25,124 ||16,732 |
2020 Compared to 2019
Net sales from the Advanced Materials segment of $670.9 million in 2020 were 17% higher than net sales of $573.8 million in 2019. The increase in net sales was primarily due to the impact of higher pass-through metal prices of $92.6 million.
Value-added sales of $234.0 million increased $9.7 million compared to value-added sales of $224.3 million in 2019 primarily due to increased value-added sales into the semiconductor end market, partially offset by reduced value-added sales into the energy and other end markets.
Advanced Materials generated operating profit of $22.1 million in 2020, compared to $25.1 million in 2019. Decreased operating profit in 2020, compared to 2019, was the result of unfavorable sales mix and reduced manufacturing yields.
|Net sales||$||111,212 ||$||111,460 ||$||120,582 |
|Value-added sales||101,878 ||87,310 ||94,231 |
|Operating (loss) profit||(4,382)||(3,550)||10,707 |
2020 Compared to 2019
Net sales from the Precision Optics segment of $111.2 million in 2020 decreased slightly compared to net sales of $111.5 million in 2019 primarily due to reduced sales volumes related to blood glucose test strip and projection display products and a lower mix of precious metal containing products, largely offset by an increase from sales attributable to our Optics Balzers acquisition.
Value-added sales of $101.9 million in 2020 increased 17% compared to value-added sales of $87.3 million in 2019. The increase was driven by our Optics Balzers acquisition, which was partially offset by reduced value-added sales related to blood glucose test strip and projection display products.
The Precision Optics segment generated operating losses of $4.4 million and $3.6 million in 2020 and 2019, respectively. The 2020 operating loss includes impairment charges of $10.5 million and restructuring charges of $2.1 million primarily related to the closure of our LAC business. The 2019 operating loss included impairment charges of $14.1 million related to our LAC business.
|Net sales||$||— ||$||— ||$||— |
2020 Compared to 2019
The Other reportable segment in total includes unallocated corporate costs.
Corporate costs of $23.1 million in 2020 decreased $1.7 million as compared to $24.8 million in 2019. Corporate costs were 3% of total Company value-added sales in both 2020 and 2019. The decrease in corporate costs in 2020 compared to 2019 is primarily related to lower variable compensation expense and cost management actions, partially offset by transaction costs related to the Optics Balzers acquisition.
Value-Added Sales - Reconciliation of Non-GAAP Financial Measure
A reconciliation of net sales to value-added sales, a non-GAAP financial measure, for each reportable segment and for the Company in total for 2020, 2019, and 2018 is as follows:
|Performance Alloys and Composites||$||394,195 ||$||500,201 ||$||500,590 |
|Advanced Materials||670,867 ||573,763 ||586,643 |
|Precision Optics||111,212 ||111,460 ||120,582 |
|Other||— ||— ||— |
|Total||$||1,176,274 ||$||1,185,424 ||$||1,207,815 |
|Less: pass-through metal costs|
|Performance Alloys and Composites||$||48,860 ||$||72,117 ||$||75,119 |
|Advanced Materials||436,909 ||349,509 ||362,929 |
|Precision Optics||9,334 ||24,150 ||26,351 |
|Other||2,604 ||5,959 ||4,458 |
|Total||$||497,707 ||$||451,735 ||$||468,857 |
|Performance Alloys and Composites||$||345,335 ||$||428,084 ||$||425,471 |
|Advanced Materials||233,958 ||224,254 ||223,714 |
|Precision Optics||101,878 ||87,310 ||94,231 |
|Total||$||678,567 ||$||733,689 ||$||738,958 |
The cost of gold, silver, platinum, palladium, and copper can be quite volatile. Our pricing policy is to directly pass the cost of these metals on to the customer in order to mitigate the impact of metal price volatility on our results from operations. Trends and comparisons of net sales are affected by movements in the market prices of these metals, but changes in net sales due to metal price movements may not have a proportionate impact on our profitability.
Internally, management reviews net sales on a value-added basis. Value-added sales is a non-GAAP financial measure that deducts the value of the pass-through metal costs from net sales. Value-added sales allow management to assess the impact of differences in net sales between periods, segments, or markets, and analyze the resulting margins and profitability without the distortion of movements in pass-through metal costs. The dollar amount of gross margin and operating profit is not affected by the value-added sales calculation. We sell other metals and materials that are not considered direct pass-throughs, and these costs are not deducted from net sales when calculating value-added sales.
Our net sales are also affected by changes in the use of customer-supplied metal. When we manufacture a precious metal product, the customer may purchase metal from us or may elect to provide its own metal, in which case we process the metal on a toll basis, and the metal value does not flow through net sales or cost of sales. In either case, we generally earn our margin based upon our fabrication efforts. The relationship of this margin to net sales can change depending upon whether or not the product was made from our metal or the customer’s metal. The use of value-added sales removes the potential distortion in the comparison of net sales caused by changes in the level of customer-supplied metal.
By presenting information on net sales and value-added sales, it is our intention to allow users of our financial statements to review our net sales with and without the impact of the pass-through metals.
A summary of cash flows provided by (used in) operating, investing, and financing activities is as follows:
|Net cash provided by operating activities||$||101,057 ||$||99,222 ||$||76,374 |
Net cash (used in) investing activities
Net cash (used in) financing activities
|Effects of exchange rate changes||1,612 ||(322)||(140)|
|Net change in cash and cash equivalents||$||(99,129)||$||54,362 ||$||28,801 |
Net cash provided by operating activities totaled $101.1 million in 2020 versus $99.2 million in 2019. Increased operating cash flow from customer prepayments of $49.4 million in 2020 was partially offset by $37.9 million of decreased net income. Working capital requirements used cash of $23.9 million during 2020 compared to using $22.0 million in 2019. Cash flows used in accounts receivable decreased $23.2 million. Three-month trailing days sales outstanding (DSO) was approximately 41 days at December 31, 2020 versus 47 days at December 31, 2019. Cash flows used for inventory were $1.3 million in 2020, compared to providing $20.5 million of cash in the prior year primarily in our Performance Alloys and Composites and Advanced Materials segments. Cash flows used for accounts payable and accrued expenses were $21.9 million compared to the prior-year use of cash of $18.6 million due to incentive compensation payouts. Price movements of precious and base metals are passed through to customers. Therefore, while sudden movements in the price of metals can cause a temporary imbalance in our cash receipts and payments in either direction, once prices stabilize, our cash flow tends to stabilize as well.
Net cash used in investing activities was $194.7 million in 2020 compared to $26.5 million in 2019 due to a $130.7 million payment, net of cash acquired, for the Optics Balzers acquisition. In addition, capital expenditures increased $43.0 million in 2020, compared to 2019, due to investments in new equipment funded by customer prepayments. See Notes B and L to the Consolidated Financial Statements for additional discussion.
Net cash used in financing activities decreased $11.0 million from 2019 primarily due to net borrowings of $34.0 million under our revolving credit facility in 2020, partially offset by the paydown of $20.6 million of long-term debt, most of which was assumed in the Optics Balzers acquisition.
Dividends per common share increased 5% to $0.455 per share in 2020. Total dividend payments to common shareholders were $9.3 million in 2020 and $8.9 million in 2019. In May 2020, the Board of Directors declared an increase in our quarterly dividend from $0.11 to $0.115 per share. We intend to pay a quarterly dividend on an ongoing basis, subject to a continuing strong capital structure and a determination that the dividend remains in the best interest of our shareholders.
We believe that cash flow from operations plus the available borrowing capacity and our current cash balance are adequate to support operating requirements, capital expenditures, projected pension plan contributions, the current dividend and share repurchase programs, environmental remediation projects, and strategic acquisitions. At December 31, 2020, cash and cash equivalents held by our foreign operations totaled $20.0 million. We do not expect restrictions on repatriation of cash held outside of the United States to have a material effect on our overall liquidity, financial condition, or the results of operations for the foreseeable future.
A summary of key data relative to our liquidity, including the outstanding debt, cash balances, and available borrowing capacity, as of December 31, 2020 and December 31, 2019 is as follows:
| ||December 31,|
|Cash and cash equivalents||$||25,878 ||$||125,007 |
|Total outstanding debt||38,506 ||2,218 |
|Net (debt) cash||(12,628)||122,789 |
|Available borrowing capacity||$||245,772 ||$||340,906 |
Net (debt) cash is a non-GAAP financial measure. We are providing this information because we believe it is more indicative of our overall financial position. It is also a measure our management uses to assess financing and other decisions. We believe that based on our typical cash flow generated from operations, we can support a higher leverage ratio in future periods.
The available borrowing capacity in the table above represents the additional amounts that could be borrowed under our revolving credit facility and other secured lines existing as of the end of each year depicted. The applicable debt covenants have been taken into account when determining the available borrowing capacity, including the covenant that restricts the borrowing capacity to a multiple of the twelve-month trailing earnings before interest, income taxes, depreciation and amortization, and other adjustments.
In 2019, we amended and restated the agreement governing our $375.0 million revolving credit facility (Credit Agreement). The maturity date of the Credit Agreement was extended from 2020 to 2024, and the Credit Agreement provides more favorable interest rates under certain circumstances. In addition, the Credit Agreement provides the Company and its subsidiaries with additional capacity to enter into facilities for the consignment, borrowing, or leasing of precious metals and copper, and provides enhanced flexibility to finance acquisitions and other strategic initiatives. Borrowings under the Credit Agreement are secured by substantially all of the assets of the Company and its direct subsidiaries, with the exception of non-mining real property and certain other assets.
The Credit Agreement allows the Company to borrow money at a premium over LIBOR or prime rate and at varying maturities. The premium resets quarterly according to the terms and conditions available under the agreement. The Credit Agreement includes restrictive covenants relating to restrictions on additional indebtedness, acquisitions, dividends, and stock repurchases. In addition, the Credit Agreement includes covenants subject to a maximum leverage ratio and a minimum fixed charge coverage ratio. We were in compliance with all of our debt covenants as of December 31, 2020 and December 31, 2019. Cash on hand does not affect the covenants or the borrowing capacity under our debt agreements.
In July 2020, we completed the acquisition of 100% of the capital stock of Optics Balzers. The purchase price was approximately $136.1 million, including the assumption of debt. The transaction was funded with cash on hand, including a portion of the $150.0 million borrowed under our revolving credit facility in the second quarter of 2020.
Portions of our business utilize off-balance sheet consignment arrangements to finance metal requirements. Expansion of business volumes and/or higher metal prices can put pressure on the consignment line limitations from time to time. In 2019, we entered into a precious metals consignment agreement, maturing on August 27, 2022. The available and unused capacity under the metal financing lines totaled approximately $50.0 million as of December 31, 2020, compared to $140.7 million as of December 31, 2019. The availability is determined by Board approved levels and actual line capacity.
In January 2014, our Board of Directors approved a plan to repurchase up to $50.0 million of our common stock. The timing of the share repurchases will depend on several factors, including market and business conditions, our cash flow, debt levels, and other investment opportunities. There is no minimum quantity requirement to repurchase our common stock for a given year, and the repurchases may be discontinued at any time. We repurchased 158,000 shares of our common stock for $6.8 million during 2020. Since the approval of the repurchase plan, we have purchased 1,254,264 shares at a total cost of $41.7 million, or an average of $33.23 per share.
The following table summarizes contractual obligations as of December 31, 2020:
|$||1.9 ||$||0.5 ||$||0.4 ||$||34.4 ||$||0.4 ||$||0.9 ||$||38.5 |
Interest payments on debt (2)
|— ||— ||— ||— ||— ||— ||— |
Finance lease obligations (3)
|3.9 ||3.8 ||2.5 ||1.6 ||1.5 ||21.9 ||35.2 |
Non-cancelable lease payments (4)
|10.7 ||9.4 ||8.8 ||6.6 ||6.3 ||53.0 ||94.8 |
Pension plan contributions (5)
|— ||— ||— ||— ||— ||— ||— |
Other long-term liabilities (6)
|0.9 ||2.5 ||0.3 ||0.5 ||0.6 ||2.4 ||7.2 |
|Purchase obligations ||23.1 ||3.7 ||3.1 ||1.1 ||0.6 ||0.6 ||32.2 |
|Total||$||40.5 ||$||19.9 ||$||15.1 ||$||44.2 ||$||9.4 ||$||78.8 ||$||207.9 |
(1) Refer to Note O to the Consolidated Financial Statements.
(2) These amounts represent future interest payments related to our total debt, excluding any interest payments to be made on borrowings under our Credit Agreement.
(3) Refer to Note M to the Consolidated Financial Statements.
(4) The non-cancelable lease payments represent payments under operating leases with initial lease terms in excess of one year as of December 31, 2020.
(5) Our domestic defined benefit pension plan is overfunded as of December 31, 2020. Contributions in future periods, if any, will be dependent upon regulatory requirements, the plan funded ratio, plan investment performance, discount rates, actuarial assumptions, plan amendments, our contribution objectives, and other factors. We anticipate funding those contributions with cash on hand, cash generated from operations, or borrowings under our existing lines of credit. It is not practical to estimate the required contributions beyond 2021 at the present time.
(6) Other long-term liabilities include environmental remediation costs. We have an active environmental compliance program. We estimate the probable cost of identified environmental remediation projects and establish reserves accordingly. The environmental remediation reserve balance was $5.5 million at December 31, 2020 and $5.9 million at December 31, 2019. Environmental projects tend to be long term, and the associated payments are typically made over a number of years. Refer to Note T to the Consolidated Financial Statements for further discussion.
Off-balance Sheet Obligations
We maintain the majority of the precious metals and copper we use in production on a consignment basis in order to reduce our exposure to metal price movements and to reduce our working capital investment. Refer to Item 7A “Quantitative and Qualitative Disclosures about Market Risk.” The notional value of off-balance sheet precious metals and copper was $400.0 million as of December 31, 2020 versus $309.3 million as of December 31, 2019. We were in compliance with all of the covenants contained in the consignment agreements as of December 31, 2020 and December 31, 2019. Refer to Note J for additional information.
We have proven and probable reserves of beryllium-bearing bertrandite ore in Juab County, Utah. We own approximately 90 percent of the proven reserves, with the remaining reserves leased from the State of Utah. We augment our proven reserves of bertrandite ore through the purchase of imported beryl ore from time to time. This beryl ore, which is approximately four percent beryllium, is also processed at the Utah extraction facility. Approximately 90 percent of the beryllium in ore is recovered in the extraction process. Estimating the quantity and/or grade of ore reserves requires the size, shape, and depth of ore bodies to be determined by analyzing geological data such as drilling samples. Economic assumptions used to estimate reserves change from period to period, and as additional geological and operational data is generated during the course of operations, estimates of reserves may change from period to period.
The term “proven reserves” means reserves for which (a) quantity is computed from dimensions revealed in outcrops, trenches, workings, or drill holes; grade and/or quality are computed from the results of detailed sampling, (b) the sites for inspection, sampling, and measurement are spaced so closely and the geologic character is so well defined that size, shape, depth, and mineral content of reserves are well-established, and (c) the ore is commercially recoverable through open-pit methods.
The term “probable reserves” means reserves for which quantity and grade and/or quality are computed from information similar to that used for proven reserves, but the sites for inspection, sampling, and measurement are farther apart or are otherwise less adequately spaced. The degree of assurance, although lower than that for proven reserves, is high enough to assume continuity between points of observation.
|As of December 31, 2020|
|Tonnage (in thousands)||7,797 ||962 ||8,759 |
|Grade (% beryllium)||0.246 ||%||0.258 ||%||0.247 ||%|
|Beryllium pounds (in millions)||38.31 ||4.97 ||43.28 |
|As of December 31, 2019|
|Tonnage (in thousands)||7,851 ||962 ||8,813 |
|Grade (% beryllium)||0.246 ||%||0.258 ||%||0.248 ||%|
|Beryllium pounds (in millions)||38.67 ||4.97 ||43.64 |
Based upon average production levels in recent years and our near-term production forecasts, proven and probable reserves would last a minimum of seventy-five years. The table below details our production of beryllium at our Utah location.
|(Thousands of Pounds of Beryllium)||2020||2019||2018||2017||2016|
|Domestic ore||367 ||358 ||368 ||326 ||339 |
|Purchased ore||— ||3 ||— ||12 ||23 |
|Unyielded total||367 ||361 ||368 ||338 ||362 |
|Annual yield||90 ||%||90 ||%||88 ||%||88 ||%||88 ||%|
|Beryllium produced||334 ||324 ||324 ||296 ||318 |
|% of mill capacity||52 ||%||50 ||%||50 ||%||47 ||%||42 ||%|
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the inherent use of estimates and management’s judgment in establishing those estimates. The following policies are considered by management to be critical because adherence to these policies relies significantly upon our judgment.
Net sales consist primarily of revenue from the sale of precious and non-precious specialty metals, beryllium and copper-based alloys, beryllium composites, and other products into numerous end markets. The Company requires an agreement with a customer that creates enforceable rights and performance obligations. We recognize revenue, in an amount that reflects the consideration to which the Company expects to be entitled, when we satisfy a performance obligation by transferring control of a product to the customer. The core principle of the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 606 is supported by five steps which are outlined below with management's judgment in applying each.
1) Identify the contract with a customer
A contract with a customer exists when the Company enters into an enforceable contract with a customer that identifies each party’s rights regarding the products to be transferred and the related payment terms related to these services, the contract has commercial substance, and the Company determines that collection of substantially all consideration for products that are transferred is probable based on the customer’s intent and ability to pay.
Management exercises judgment in its assessment that it is probable that the Company will collect substantially all of the payments attributed to products or services that will be transferred to our customers. We regularly review the creditworthiness of our customers considering such factors as the macroeconomic environment, current market conditions, geographic considerations, historical collection experience, a customer’s current credit standing, and the age of accounts receivable balances that may affect a customer’s ability to pay. If after we have recognized revenue, collectability of an account receivable becomes doubtful, we establish appropriate allowances and reserves against accounts receivable with respect to the previously recognized revenue that remains uncollected. Allowances and reserves against accounts receivable are maintained for estimated probable losses and are sufficient enough to ensure that accounts receivable are stated at amounts that are considered collectible.
If management forms a judgment that a particular customer’s financial condition has deteriorated but decides to deliver products or services to the customer, we will defer recognizing revenue relating to products sold to that customer until it is probable that we will collect substantially all of the consideration to which we are entitled, which typically coincides with the collection of cash.
2) Identify the performance obligations in the contract
Performance obligations promised in a contract are identified based on the products that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the product either on its own or together with other resources that are readily available from third parties or from the Company, and are distinct in the context of the contract, whereby the transfer of the product is separately identifiable from other promises in the contract.
Certain of the Company’s contracts with customers may contain multiple performance obligations. As a result, management utilizes judgment to determine the appropriate accounting, including whether multiple promised products or services in a contract should be accounted for separately or as a group, how the consideration should be allocated among the performance obligations, and when to recognize revenue upon satisfaction of the performance obligations.
3) Determine the transaction price
The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring services to the customer. The vast majority of our contracts contain fixed consideration terms. However, the
Company also has contracts with customers that include variable consideration. Volume discounts and rebates are offered as an incentive to encourage additional purchases and customer loyalty. Volume discounts and rebates typically require a customer to purchase a specified quantity of products, after which the price of additional products decreases. These contracts include variable consideration because the total amount to be paid by the customer is not known at contract inception and is affected by the quantity of products ultimately purchased. As a result, management applies judgment to estimate the volume discounts based on experience with similar contracts, customers, and current sales forecasts. Also, the Company has contracts, primarily relating to its precious metal products, where the transaction price includes variable consideration at contract inception because it is calculated based on a commodity index at a specified date. Management exercises judgment to determine the minimum amount to be included in the transaction price. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur.
4) Allocate the transaction price to performance obligations in the contract
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on the relative standalone selling price. The Company typically determines standalone selling price based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, management uses judgment to estimate the standalone selling price taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations.
5) Recognize revenue when or as the Company satisfies a performance obligation
Management applies the principle of control to determine whether the customer obtains control of a product as it is created and if revenue should be recognized over time. The vast majority of the Company's performance obligations are satisfied at a point in time when control of the product transfers to the customer. Control of the product is generally transferred to the customer when the Company has a present right to payment, the customer has legal title, the customer has physical possession, the customer has the significant risks and rewards of ownership, and the customer has accepted the product.
However, for certain contracts, particularly relating to the U.S. government and relating to specialized products with no alternative use, we generally recognize revenue over time as we procure the product because of continuous transfer of control to the customer. This continuous transfer of control to the customer is supported by a termination for convenience clause in the contract that allows the customer to unilaterally terminate the contract, pay the Company for costs incurred plus a reasonable profit, and take control of any work in process. We generally use the cost-to-cost measure of progress for these contracts because it best depicts the transfer of control to the customer which occurs as we incur costs on the related contracts. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Therefore, revenue is recognized proportionally as costs are incurred for these contracts.
The Company recognizes revenue net of reserves for price adjustments, returns, and prompt payment discounts. Management generally estimates this amount using the expected value method. The Company has sufficient experience with our customers that provide predictive value that the reserves recorded are appropriate.
We receive payment from customers equal to the invoice price for most of our sales transactions.
Returned products are generally not accepted unless the customer notifies the Company in writing, and we authorize the product return by the customer.
Unearned revenue is recorded cash consideration from customers in advance of the shipment of the goods, which is a liability on our Consolidated Balance Sheets. This contract liability is subsequently reversed and the revenue, cost of sales, and gross margin are recorded when the Company has transferred control of the product to the customer. The related inventory also remains on our balance sheet until these revenue recognition criteria are met. Advanced billings are typically made in association with products with long manufacturing times and/or products paid relating to contracts with the government. Billings in advance of the shipments allow us to collect cash earlier than billing at the time of the shipment and, therefore, the collected cash can be used to reduce our investment in working capital. Refer to Note D of the Consolidated Financial Statements for additional details on our contract balances.
The annual net periodic expense and benefit obligations related to the Company's defined benefit plans are determined on an actuarial basis. This determination requires critical assumptions regarding the discount rate, long-term rate of return on plan assets, increases in compensation levels, and amortization periods for actuarial gains and losses. Assumptions are determined based on Company data and appropriate market indicators and are evaluated each year as of the plans' measurement date. Changes in the assumptions to reflect actual experience, as well as the amortization of actuarial gains and losses, could result in a material change in the annual net periodic expense and benefit obligations reported in the financial statements.
The Company uses a spot-rate approach to estimate the service and interest cost components of net periodic benefit cost for its defined benefit pension plans. The spot-rate approach applies separate discount rates (along the yield curve) for each projected benefit payment in the calculation.
Our pension plan investment strategies are governed by a policy adopted by the Board of Directors. A senior management team oversees a group of outside investment analysts and brokerage firms that implement these strategies. The future return on pension assets is dependent upon the plan’s asset allocation, which changes from time to time, and the performance of the underlying investments. As a result of our review of various factors, we used an expected rate of return on plan assets assumption of 5.75% at December 31, 2020 and 6.25% at December 31, 2019. This assumption is reflective of management’s view of the long-term returns in the marketplace, as well as changes in risk profiles and available investments. Should the assets earn an average return less than the expected return assumption over time, in all likelihood the future pension expense would increase.
The impact of a change in the discount rate or expected rate of return assumption on pension expense can vary from year to year depending upon the undiscounted liability level, the current discount rate, the asset balance, other changes to the plan, and other factors. A 0.25 percentage point decrease to the discount rate would increase the 2021 projected pension expense approximately $32 thousand. A 0.25 percentage point decrease in the expected rate of return assumption would increase the 2021 projected pension expense by approximately $0.4 million.
Refer to Note P of the Consolidated Financial Statements for additional details on our pension and other post-employment benefit plans.
We record deferred tax assets and liabilities based upon the temporary difference between the financial reporting and tax basis of assets and liabilities. If it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance is established. All available evidence, both positive and negative, is considered to determine whether a valuation allowance is needed. We review the expiration dates of certain deferred tax assets against projected income levels to determine if a valuation allowance is needed. Certain deferred tax assets do not have an expiration date. We also evaluate deferred tax assets for realizability due to cumulative operating losses by jurisdiction and record a valuation allowance as warranted. A valuation allowance may increase tax expense and reduce net income in the period it is recorded. If a valuation allowance is no longer required, it will reduce tax expense and increase net income in the period that it is reversed.
We had valuation allowances of $14.1 million and $17.7 million associated with certain federal, state, and foreign deferred tax assets as of year-end 2020 and 2019, respectively, primarily for net operating loss carryforwards.
Refer to Note H of the Consolidated Financial Statements for additional deferred tax details.
Precious Metal Physical Inventory Counts
We take and record the results of a physical inventory count of our precious metals on a quarterly basis. Our precious metal operations include a refinery that processes precious metal-containing scrap and other materials from our customers, as well as our own internally generated scrap. We also outsource portions of our refining requirements to other vendors, particularly those materials with longer processing times. The precious metal content within these various refine streams may be in solutions, sludges, and other non-homogeneous forms and can vary over time based upon the input materials, yield rates, and other process parameters. The determination of the weight of the precious metal content within the refine streams as part of a physical inventory count requires the use of estimates and calculations based upon assays, assumed recovery percentages developed from actual historical data and other analyses, the total estimated volumes of solutions and other materials within the refinery, data from our refine vendors, and other factors. The resulting calculated weight of the precious metals in our refine operations may differ, in either direction, from what our records indicate that we should have on hand, which would then result in an adjustment to our pre-tax income in the period when the physical inventory was taken, and the related estimates were made.
Goodwill and Other Intangible Assets
We use the acquisition method of accounting to allocate costs of acquired businesses to the assets acquired and liabilities assumed based on their estimated fair values at the dates of acquisition. The excess costs of acquired businesses over the fair values of the assets acquired and liabilities assumed are recognized as goodwill. The valuations of the acquired assets and liabilities will impact the determination of future operating results. Determining the fair value of assets acquired and liabilities assumed requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, revenue growth rates, discount rates, customer attrition rates, royalty rates, asset lives, contributory asset charges, and market multiples, among other items. We determine the fair values of intangible assets acquired generally in consultation with third-party valuation advisors.
Intangible assets other than goodwill are recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed or exchanged, regardless of the Company’s intent to do so. Goodwill represents the excess purchase price over the fair value of the tangible net assets and intangible assets acquired in a business combination and is reviewed annually for impairment or more frequently if impairment indicators arise. Finite-lived intangible assets are reviewed for impairment if facts and circumstances warrant. The Company conducted its annual impairment assessment as of the first day of the fourth quarter.
Goodwill is assigned to the reporting unit, which is the operating segment level or one level below the operating segment. Goodwill within the Advanced Materials segment totaled $50.5 million as of December 31, 2020. Within the Precision Optics segment, goodwill totaled $92.5 million. The remaining $1.9 million is related to the Performance Alloys and Composites segment.
In the first quarter of 2020, we recorded a $9.1 million charge to impair the remaining goodwill related to the closure of our LAC business. We did not identify any other events or circumstances during 2020 that required the performance of an interim impairment assessment.
For the purpose of the annual goodwill impairment assessment, we have the option to perform a qualitative assessment (commonly referred to as "step zero") to determine whether further quantitative analysis for impairment of goodwill or indefinite-lived intangible assets is necessary. In performing step zero for our impairment test, we are required to make assumptions and judgments including, but not limited to, macroeconomic conditions as related to our business, current and future financial performance of our reporting units, industry and market considerations, and cost factors such as changes in raw materials, labor, or other costs. If the step zero analysis indicates that it is more likely than not that the fair value of a reporting unit is less than its respective carrying value including goodwill, then we would perform an additional quantitative analysis. The next step compares the fair value of the reporting unit to its carrying value, including goodwill. An impairment charge is recognized for the amount the carrying value of the reporting unit exceeds its fair value. At our September 26, 2020 annual assessment date, we opted to perform a “step zero” qualitative assessment for each of our reporting units. The results of the step zero indicated that no goodwill impairment existed.
We also compared the market capitalization as of September 26, 2020 to the carrying value of our equity, noting no impairment indicators or triggering events.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to precious metal and commodity price, interest rate, foreign exchange rate, and utility cost differences. While the degree of exposure varies from year to year, our methods and policies designed to manage these exposures have remained fairly consistent over time. Generally, we attempt to minimize the effects of these exposures on our pre-tax income and cash flows through the use of natural hedges, which include pricing strategies, borrowings denominated in the same terms as the exposed asset, off-balance sheet financing arrangements, and other methods. Where we cannot use a natural hedge, we may use derivative financial instruments to minimize the effects of these exposures when practical and cost efficient. The use of off-balance sheet financing arrangements and derivative financial instruments is subject to policies approved by the Audit Committee of the Board of Directors with oversight provided by a group of senior financial managers at our corporate office.
Precious metals. We use gold and other precious metals in manufacturing various products. To reduce the exposure to market price changes, the majority of our precious metal requirements are maintained on a consigned inventory basis. We purchase the metal out of consignment from our suppliers when it is ready to ship to a customer as a finished product. Our purchase price forms the basis for the price charged to the customer for the precious metal content and, therefore, the current cost is matched to the selling price, and the price exposure is minimized.
We are charged a consignment fee by the financial institutions that own the precious metals. This fee is a function of the market price of the metal, the quantity of metal we have on hand, and the rate charged by the institution. Because of market forces and competition, the fee can only be charged to customers in a limited case-by-case basis. Should the market price of precious metals that we have on consignment increase by 20% from the prices on December 31, 2020, the additional pre-tax cost to us as a result of an increase in the consignment fee would be approximately $1.5 million on an annual basis. This calculation assumes no changes in the quantity of metal held on consignment or the underlying fee and that none of the additional fees are charged to customers.
To further limit price and financing rate exposures, under some circumstances, we will require customers to furnish their own metal for processing. Customers may also elect to provide their own material for us to process on a toll basis as opposed to purchasing our material.
The available capacity of our existing credit lines to consign precious metals is a function of the quantity and price of the metals on hand. As prices increase, a given quantity of metal will utilize a larger proportion of the existing credit lines. A significant
prolonged increase in metal prices could result in our credit lines being fully utilized, and, absent securing additional credit line capacity from financial institutions, could require us to purchase precious metals rather than consign them, require customers to supply their own metal, and/or force us to turn down additional business opportunities. If we were in a significant precious metal ownership position, we might elect to use derivative financial instruments to hedge the potential price exposure. The cost to finance and potentially hedge the purchased inventory may also be higher than the consignment fee. The financial statement impact of the risk from rising metal prices impacting our credit availability cannot be estimated at the present time.
In certain circumstances, we may elect to fix the price of precious metals for a customer for a stated quantity over a specified period of time. In those cases, we may secure hedge contracts whose terms match the terms in the agreement with our customer so that the gain or loss on the contract with the customer due to subsequent movements in the precious metal price will generally be offset by a gain or loss on the hedge contract. At December 31, 2020, we did not have a material amount of such hedge contracts outstanding.
Copper. We also use copper in our production processes. When possible, fluctuations in the purchase price of copper are passed on to customers in the form of price adders or reductions. While over time our price exposure to copper is generally in balance, there can be a lag between the change in our cost and the pass-through to our customers, resulting in higher or lower margins in a given period. To mitigate this impact, we hedge a portion of this pricing risk.
We consign the majority of our copper inventory requirements. As with precious metals, the available capacity under the existing lines is a function of the quantity and price of metal on hand. Should the market cost of copper increase by 20% from the price as of December 31, 2020, the additional pre-tax cost to us as a result of an increase in the consignment fee would be approximately $0.1 million on an annual basis. This calculation assumes no changes in the quantity of inventory or the underlying fee and that none of the additional fees are charged to customers.
Lower of cost or net realizable value. In our manufacturing processes, we use various metals that are not widely used by others or actively traded and, therefore, there is no established efficient market for derivative financial instruments that could be used to effectively hedge the related price exposures. For certain applications, our pricing practice with respect to these metals is to establish the selling price based upon our cost to purchase the material, limiting our price exposure. However, the inventory carrying value may be exposed to market fluctuations. The inventory value is maintained at the lower of cost or net realizable value and if the market value were to drop below the carrying value, the inventory would have to be reduced accordingly and a charge recorded against cost of sales. This risk is mainly associated with long manufacturing lead-time items and with sludges and scrap materials, which generally have longer processing times to be refined or processed into a usable form for further manufacturing and are typically not covered by specific sales orders from customers. We did not record any material lower of cost or net realizable value charges in 2020, 2019, or 2018 as a result of market price fluctuations of metals in our inventories.
Interest rates. We are exposed to changes in interest rates on our cash balances and borrowings under our Credit Agreement. We may manage this interest rate exposure by maintaining a combination of short-term and long-term debt and variable and fixed rate instruments. We may also use interest rate swaps to fix the interest rate on variable rate obligations, as we deem appropriate. There were no interest rate derivatives outstanding as of December 31, 2020. Excess cash is typically invested in high quality instruments that mature in 90 days or less. Investments are made in compliance with policies approved by the Board of Directors.
Foreign currencies. Portions of our international operations sell products priced in foreign currencies, mainly the euro and yen, while the majority of these products’ costs are incurred in U.S. dollars. We are exposed to currency movements in that if the U.S. dollar strengthens, the translated value of the foreign currency sale and the resulting margin on that sale will be reduced. To minimize this exposure, we may purchase foreign currency forward contracts, options, and collars in compliance with approved policies. If the dollar strengthened, the decline in the translated value of our margins would be at least partially offset by a gain on the hedge contract. A decrease in the value of the dollar would result in larger margins but potentially a loss on the contract, depending upon the method used to hedge the exposure. Our current policy limits our hedges to 80% or less of the forecasted exposure.
The notional value of outstanding currency contracts was $90.0 million as of December 31, 2020. If the dollar weakened 10% against the currencies we have hedged from the December 31, 2020 exchange rates, the reduced gain and/or increased loss on the outstanding contracts as of December 31, 2020 would reduce pre-tax profits by approximately $1.6 million in 2020. This calculation does not take into account the increase in margins as a result of translating foreign currency sales at the more favorable exchange rates, any changes in margins from potential volume fluctuations caused by currency movements, or the translation effects on any other foreign currency denominated income statement or balance sheet item.
Utilities. The cost of natural gas and electricity used in our operations may vary from year to year and from season to season. We attempt to minimize these fluctuations and the exposure to higher costs by utilizing fixed price agreements of set durations, when deemed appropriate, obtaining competitive bidding between regional energy suppliers, and other methods.
Economy. We are exposed to changes in global economic conditions and the potential impact those changes may have on various facets of our business. We have a program in place to closely monitor the credit worthiness and financial condition of our key providers of financial services, including our bank group and insurance carriers, as well as the credit worthiness of customers and vendors, and have various contingency plans in place.
Our bank lines are established with a number of different banks in order to mitigate our exposure with any one financial institution. All of the banks in our bank group had credit in good standing as of December 31, 2020. The financial statement impact from the risk of one or more of the banks in our bank group reducing our lines due to their insolvency or other causes cannot be estimated at the present time.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
|Management’s Report on Internal Control over Financial Reporting|
|Reports of Independent Registered Public Accounting Firm|
|Consolidated Statements of Income for the Years Ended December 31, 2020, 2019, and 2018|
|Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2020, 2019, and 2018|
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2020, 2019, and 2018|
|Consolidated Balance Sheets as of December 31, 2020 and 2019|
|Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2020, 2019, and 2018|
|Notes to Consolidated Financial Statements|
|Schedule II - Valuation and Qualifying Accounts|
Management’s Report on Internal Control over Financial Reporting
The management of Materion Corporation and subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Materion Corporation and subsidiaries’ internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Materion Corporation and subsidiaries’ management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020. In making this assessment, it used the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria) in Internal Control - Integrated Framework (2013).
The Company completed the acquisition of Optics Balzers AG (Optics Balzers) on July 17, 2020. As permitted by SEC guidance, the scope of our evaluation of internal control over financial reporting as of December 31, 2020 did not include the internal control over financial reporting of Optics Balzers. The results of Optics Balzers are included in our consolidated financial statements from the date of acquisition and constituted 22% of total assets as of December 31, 2020.
Based on our assessment we believe that, as of December 31, 2020, the Company’s internal control over financial reporting is effective.
The effectiveness of our internal control over financial reporting as of December 31, 2020 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report.
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of Materion Corporation
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Materion Corporation and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and financial statement schedule listed in the Index at Item 15(a) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 18, 2021 expressed an unqualified opinion thereon.
Change in Accounting Principles
As discussed in Note A to the consolidated financial statements, the Company elected to change its method of accounting for certain inventories to the first-in, first-out (“FIFO”) method during the year ended December 31, 2020.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
|Reconciliation of Precious Metals Consignment Inventory|
Description of the matter
At December 31, 2020, the notional value of the Company’s off-balance sheet precious metals was $400.0 million. As discussed in Note J to the consolidated financial statements, the Company uses estimates to measure the precious metal content within various refinement streams which can vary over time based upon the input materials, yield rates, and other process parameters.
Auditing the reconciliation of precious metals consignment inventory is complex due to the highly detailed nature of the inventory reconciliation and the amount of information that is obtained from third parties. A physical inventory is performed by the Company on a quarterly basis to verify the existence of inventory. The precious metals inventory reconciliation includes estimates based on assays, assumed recovery percentages developed from actual historical data and other analyses, the total estimated volume of solutions and other materials within the refinery, data from refine vendors, and other factors. The reconciliation of precious metals consignment inventory presents the resulting calculated weight of the precious metals generated from these estimates within the Company’s refine operations. This calculated weight may differ, from what the Company’s records indicate should be on hand, which would then result in an adjustment to pre-tax income.
How we addressed the matter in our audit
We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s reconciliation of the precious metals consignment inventory processes. This included controls over management's review of the significant inputs into and underlying the reconciliation.
To test the Company’s reconciliation of the precious metals physical consignment inventory, our procedures included, among others, evaluating the significant assumptions and data used to estimate the total value of the precious metal which was identified through the physical inventory. We observed the physical inventory process, tested inventory activity from the date of observation through December 31, 2020, evaluated the underlying data used in the reconciliation, and confirmed the consigned inventory held with the third parties. We assessed the historical accuracy of management’s estimates, which are based on assays, assumed recovery percentages developed from actual historical data and other analyses, the total estimated volume of solutions and other materials within the refinery, data from their refine vendors, and other factors and assessed the historical accuracy of management’s analysis to evaluate the assumptions that were most significant to the calculated weight of the precious metal inventory.
|Accounting for Business Combinations|
Description of the matter
During 2020, the Company completed its acquisition of Optics Balzers AG for a purchase price of $136.1 million, including the assumption of debt, as disclosed in Note B to the consolidated financial statements. The transaction was accounted for as a business combination.
Auditing the Company's accounting for its acquisition of Optics Balzers AG was complex due to the significant estimation required by management and its specialists to determine the fair value of the acquired intangible assets, specifically customer relationships. The significant estimation was primarily due to the subjectivity of the assumptions used by management to measure the fair value of the customer relationships intangible asset and the sensitivity of the respective fair value to the significant underlying assumptions. The Company used a multi-period excess earnings method under the income approach to value this intangible asset. The significant assumptions used to estimate the fair value included the discount rate and certain assumptions that form the basis of future cash flows (including revenue growth rates and attrition rate). These assumptions relate to the future performance of the acquired business, are forward-looking and could be affected by future economic and market conditions.
How we addressed the matter in our audit
We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s accounting for the recognition and measurement of customer relationships intangible assets that address the risks of material misstatement. Our tests included controls over the recognition and measurement of customer relationships, including the valuation models and underlying assumptions, as described above, used to develop such estimates.
To test the estimated fair value of customer relationships, we performed audit procedures that included, among others, evaluating the methods and significant assumptions used by the Company, as described above, and evaluating the completeness and accuracy of the underlying data supporting the significant assumptions and estimates. We also utilized our specialists to review the valuation methodology, discount rate, and attrition rate.
/s/ Ernst & Young LLP
We have served as the Company’s auditor since at least 1958, but we are unable to determine the specific year.
February 18, 2021
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Materion Corporation
Opinion on Internal Control over Financial Reporting
We have audited Materion Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Materion Corporation and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria.
As indicated in the accompanying Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Optic Balzers AG, which is included in the 2020 consolidated financial statements of the Company and constituted 22% of total assets as of December 31, 2020. Our audit of internal control over financial reporting of the Company also did not include an evaluation of the internal control over financial reporting of Optics Balzers AG.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of Materion Corporation and subsidiaries as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and financial statement schedule listed in the Index at Item 15(a) and our report dated February 18, 2021 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Ernst & Young LLP
February 18, 2021
Materion Corporation and Subsidiaries
Years Ended December 31, 2020, 2019, and 2018
Consolidated Statements of Income
|(Thousands except per share amounts)||2020||2019*||2018*|
|Net sales||$||1,176,274 ||$||1,185,424 ||$||1,207,815 |
|Cost of sales||983,641 ||922,734 ||956,454 |
|Gross margin||192,633 ||262,690 ||251,361 |
|Selling, general, and administrative expense||133,963 ||147,164 ||153,489 |
|Research and development expense||20,283 ||18,271 ||15,187 |
Goodwill impairment charges (Note N)
|9,053 ||11,560 ||— |
Asset impairment charges (Note N)
|1,419 ||2,581 ||— |
Restructuring expense (Note E)
|11,237 ||785 ||5,599 |
Other — net (Note F)
|8,463 ||11,783 ||15,334 |
|Operating profit||8,215 ||70,546 ||61,752 |
Other non-operating (income) expense — net (Note P)
|(3,939)||3,431 ||42,683 |
Interest expense — net (Note G)
|3,879 ||1,579 ||2,471 |
|Income before income taxes||8,275 ||65,536 ||16,598 |
Income tax (benefit) expense (Note H)
|Net income||$||15,462 ||$||53,394 ||$||21,044 |
|Basic earnings per share:|
|Net income per share of common stock||$||0.76 ||$||2.62 ||$||1.04 |
|Diluted earnings per share:|
|Net income per share of common stock||$||0.75 ||$||2.59 ||$||1.02 |
|Weighted-average number of shares of common stock outstanding:|
|Basic||20,338 ||20,365 ||20,212 |
|Diluted||20,603 ||20,655 ||20,613 |
*Years ended December 31, 2019 and 2018 amounts have been adjusted to reflect the change in inventory accounting method, as described in Note A to the Consolidated Financial Statements.
The accompanying notes are an integral part of the consolidated financial statements.
Materion Corporation and Subsidiaries
Years Ended December 31, 2020, 2019, and 2018
Consolidated Statements of Comprehensive Income
|Net income||$||15,462 ||$||53,394 ||$||21,044 |
|Other comprehensive income:|
|Foreign currency translation adjustment||9,030 ||(421)||(484)|
|Derivative and hedging activity, net of tax benefit of $28, $5, and $672, respectively||(80)||(4)||138 |
|Pension and post-employment benefit adjustment, net of tax benefit (expense) of $651, ($4,741), and ($13,300), respectively||(2,127)||13,197 ||45,049 |
|Other comprehensive income ||6,823 ||12,772 ||44,703 |
|Comprehensive income ||$||22,285 ||$||66,166 ||$||65,747 |
*Years ended December 31, 2019 and 2018 amounts have been adjusted to reflect the change in inventory accounting method, as described in Note A to the Consolidated Financial Statements.
The accompanying notes are an integral part of the consolidated financial statements.
Materion Corporation and Subsidiaries
Years Ended December 31, 2020, 2019, and 2018
Consolidated Statements of Cash Flows
|Cash flows from operating activities:|
|Net income||$||15,462 ||$||53,394 ||$||21,044 |
|Adjustments to reconcile net income to net cash provided by operating activities:|
|Depreciation, depletion, and amortization||42,384 ||41,116 ||35,524 |
|Amortization of deferred financing costs in interest expense||790 ||962 ||1,009 |
|Stock-based compensation expense (non-cash)||5,528 ||7,170 ||5,313 |
|Amortization of pension and post-retirement costs||(151)||386 ||5,551 |
|Loss on sale of property, plant, and equipment ||466 ||344 ||518 |
|Deferred income tax (benefit) expense||(9,850)||3,945 ||(1,912)|
|Impairment charges||10,472 ||14,141 ||— |
|Net pension curtailments and settlements|