10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________
FORM 10-Q
(Mark One)
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ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended April 1, 2016
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¨ | 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 001-15885
MATERION CORPORATION
(Exact name of Registrant as specified in charter)
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Ohio | | 34-1919973 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
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6070 Parkland Blvd., Mayfield Hts., Ohio | | 44124 |
(Address of principal executive offices) | | (Zip Code) |
Registrant’s telephone number, including area code:
216-486-4200
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 þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer þ | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of April 21, 2016 there were 20,031,904 common shares, no par value, outstanding.
PART I FINANCIAL INFORMATION
MATERION CORPORATION AND SUBSIDIARIES
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Item 1. | Financial Statements |
The consolidated financial statements of Materion Corporation and its subsidiaries for the first quarter ended April 1, 2016 are as follows:
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| First quarter ended April 1, 2016 and April 3, 2015 | |
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| First quarter ended April 1, 2016 and April 3, 2015 | |
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| First quarter ended April 1, 2016 and April 3, 2015 | |
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| April 1, 2016 and December 31, 2015 | |
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Materion Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)
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| | | | | | | | |
| | First Quarter Ended |
| | Apr. 1, | | Apr. 3, |
(Thousands, except per share amounts) | | 2016 | | 2015 |
Net sales | | $ | 235,511 |
| | $ | 290,024 |
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Cost of sales | | 192,154 |
| | 237,669 |
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Gross margin | | 43,357 |
| | 52,355 |
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Selling, general, and administrative expense | | 30,487 |
| | 37,933 |
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Research and development expense | | 3,452 |
| | 3,348 |
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Other—net | | 1,886 |
| | (2,158 | ) |
Operating profit | | 7,532 |
| | 13,232 |
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Interest expense—net | | 415 |
| | 657 |
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Income before income taxes | | 7,117 |
| | 12,575 |
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Income tax expense | | 1,749 |
| | 3,591 |
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Net income | | $ | 5,368 |
| | $ | 8,984 |
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Basic earnings per share: | | | | |
Net income per share of common stock | | $ | 0.27 |
| | $ | 0.45 |
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Diluted earnings per share: | | | | |
Net income per share of common stock | | $ | 0.27 |
| | $ | 0.44 |
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Cash dividends per share | | $ | 0.090 |
| | $ | 0.085 |
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Weighted-average number of shares of common stock outstanding: | | | | |
Basic | | 20,018 |
| | 20,144 |
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Diluted | | 20,228 |
| | 20,489 |
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Refer to Notes to Consolidated Financial Statements.
Materion Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
(Unaudited)
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| | | | | | | | |
| | First Quarter Ended |
| | Apr. 1, | | Apr. 3, |
(Thousands) | | 2016 | | 2015 |
Net income | | $ | 5,368 |
| | $ | 8,984 |
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Other comprehensive income: | | | | |
Foreign currency translation adjustment | | 1,284 |
| | (1,570 | ) |
Derivative and hedging activity, net of tax | | (923 | ) | | 503 |
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Pension and post-employment benefit adjustment, net of tax | | 1,575 |
| | 902 |
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Net change in other comprehensive income | | 1,936 |
| | (165 | ) |
Comprehensive income | | $ | 7,304 |
| | $ | 8,819 |
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Refer to Notes to Consolidated Financial Statements.
Materion Corporation and Subsidiaries
Consolidated Balance Sheets
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| | (Unaudited) | | |
| | Apr. 1, | | Dec. 31, |
(Thousands) | | 2016 | | 2015 |
Assets | | | | |
Current assets | | | | |
Cash and cash equivalents | | $ | 18,868 |
| | $ | 24,236 |
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Accounts receivable | | 112,921 |
| | 97,236 |
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Inventories | | 213,218 |
| | 211,820 |
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Prepaid expenses | | 12,855 |
| | 12,799 |
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Total current assets | | 357,862 |
| | 346,091 |
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Long-term deferred income taxes | | 26,971 |
| | 25,743 |
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Property, plant, and equipment | | 848,495 |
| | 833,834 |
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Less allowances for depreciation, depletion, and amortization | | (581,200 | ) | | (570,205 | ) |
Property, plant, and equipment—net | | 267,295 |
| | 263,629 |
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Intangible assets | | 12,167 |
| | 13,389 |
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Other assets | | 5,996 |
| | 6,716 |
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Goodwill | | 86,725 |
| | 86,725 |
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Total Assets | | $ | 757,016 |
| | $ | 742,293 |
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Liabilities and Shareholders’ Equity | | | | |
Current liabilities | | | | |
Short-term debt | | $ | 23,109 |
| | $ | 8,990 |
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Accounts payable | | 32,619 |
| | 31,888 |
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Salaries and wages | | 15,803 |
| | 27,494 |
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Other liabilities and accrued items | | 21,087 |
| | 22,035 |
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Income taxes | | 4,007 |
| | 2,373 |
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Unearned revenue | | 3,442 |
| | 3,695 |
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Total current liabilities | | 100,067 |
| | 96,475 |
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Other long-term liabilities | | 18,241 |
| | 18,435 |
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Retirement and post-employment benefits | | 90,298 |
| | 92,794 |
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Unearned income | | 44,807 |
| | 45,953 |
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Long-term income taxes | | 1,293 |
| | 1,293 |
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Deferred income taxes | | 111 |
| | 110 |
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Long-term debt | | 14,052 |
| | 4,276 |
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Shareholders’ equity | |
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Serial preferred stock | | — |
| | — |
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Common stock | | 210,175 |
| | 208,967 |
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Retained earnings | | 503,226 |
| | 499,659 |
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Common stock in treasury | | (150,137 | ) | | (148,559 | ) |
Accumulated other comprehensive loss | | (78,769 | ) | | (80,705 | ) |
Other equity transactions | | 3,652 |
| | 3,595 |
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Total shareholders' equity | | 488,147 |
| | 482,957 |
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Total Liabilities and Shareholders’ Equity | | $ | 757,016 |
| | $ | 742,293 |
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Refer to Notes to Consolidated Financial Statements.
Materion Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited) |
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| | Three Months Ended |
| | Apr. 1, | | Apr. 3, |
(Thousands) | | 2016 | | 2015 |
Cash flows from operating activities: | | | | |
Net income | | $ | 5,368 |
| | $ | 8,984 |
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Adjustments to reconcile net income to net cash used in operating activities: | | | | |
Depreciation, depletion, and amortization | | 11,308 |
| | 11,909 |
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Amortization of deferred financing costs in interest expense | | 151 |
| | 148 |
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Stock-based compensation expense (non-cash) | | 888 |
| | 2,282 |
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(Gain) loss on sale of property, plant, and equipment | | (720 | ) | | 74 |
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Deferred income tax (benefit) expense | | (1,118 | ) | | (7 | ) |
Changes in assets and liabilities net of acquired assets and liabilities: | | | | |
Decrease (increase) in accounts receivable | | (14,689 | ) | | (5,467 | ) |
Decrease (increase) in inventory | | (527 | ) | | (5,925 | ) |
Decrease (increase) in prepaid and other current assets | | (7 | ) | | (2,480 | ) |
Increase (decrease) in accounts payable and accrued expenses | | (15,085 | ) | | (18,494 | ) |
Increase (decrease) in unearned revenue | | (255 | ) | | 5,510 |
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Increase (decrease) in interest and taxes payable | | 1,009 |
| | 1,314 |
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Increase (decrease) in long-term liabilities | | (2,920 | ) | | (1,520 | ) |
Other-net | | (847 | ) | | (395 | ) |
Net cash used in operating activities | | (17,444 | ) | | (4,067 | ) |
Cash flows from investing activities: | | | | |
Payments for purchase of property, plant, and equipment | | (5,714 | ) | | (7,196 | ) |
Payments for mine development | | (4,782 | ) | | (3,748 | ) |
Proceeds from sale of property, plant, and equipment | | 752 |
| | — |
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Net cash used in investing activities | | (9,744 | ) | | (10,944 | ) |
Cash flows from financing activities: | | | | |
Proceeds from issuance of short-term debt | | 14,103 |
| | 13 |
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Proceeds from issuance of long-term debt | | 10,000 |
| | 41,103 |
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Repayment of long-term debt | | (227 | ) | | (13,929 | ) |
Principal payments under capital lease obligations | | (241 | ) | | (230 | ) |
Cash dividends paid | | (1,801 | ) | | (1,708 | ) |
Repurchase of common stock | | (462 | ) | | (768 | ) |
Net cash provided by financing activities | | 21,372 |
| | 24,481 |
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Effects of exchange rate changes | | 448 |
| | (682 | ) |
Net change in cash and cash equivalents | | (5,368 | ) | | 8,788 |
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Cash and cash equivalents at beginning of period | | 24,236 |
| | 13,150 |
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Cash and cash equivalents at end of period | | $ | 18,868 |
| | $ | 21,938 |
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Refer to Notes to Consolidated Financial Statements.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
Note A — Accounting Policies
(Dollars in thousands)
Basis of Presentation: In management’s opinion, the accompanying consolidated financial statements of Materion Corporation and its subsidiaries (the Company) contain all of the adjustments necessary to present fairly the financial position, results of operations, and cash flows for the interim periods reported. All adjustments were of a normal and recurring nature. Certain amounts in prior years have been reclassified to conform to the 2016 consolidated financial statement presentation.
These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's 2015 Annual Report on Form 10-K. The interim period results are not necessarily indicative of the results to be expected for the full year.
New Pronouncements Adopted: In April 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires companies to present debt issuance costs associated with a debt liability as a deduction from the carrying amount of that debt liability on the balance sheet rather than being capitalized as an asset. The Company adopted this ASU effective January 1, 2016 and applied the new guidance on a retrospective basis which resulted in a decrease to Intangible assets, Short-term debt, and Long-term debt, at December 31, 2015, of $347, $8, and $339, respectively.
In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory. Inventory within the scope of this update is required to be measured at the lower of its cost or net realizable value, with net realizable value being the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This ASU is effective prospectively for fiscal years and interim periods beginning after December 15, 2016, with early adoption permitted. We early adopted this ASU effective January 1, 2016. The adoption did not have a material effect on the consolidated financial statements.
New Pronouncements Issued: In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which impacts several aspects of accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Under the new standard, income tax benefits and deficiencies are to be recognized as income tax expense or benefit in the income statement and the tax effects of exercised or vested awards will be treated as discrete items in the reporting period in which they occur. An entity will also recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the reporting period. Excess tax benefits will be classified, along with other income tax cash flows, as an operating activity. In regards to forfeitures, the entity may make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures as they occur. The ASU, which is required to be applied on a modified retrospective basis, will be effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted. The Company is currently evaluating the impact of adopting this new guidance on the consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases, which eliminates the off-balance-sheet accounting for leases. The new guidance will require lessees to report their operating leases as both an asset and liability on the balance sheet and disclose key information about leasing arrangements. The ASU, which is required to be applied on a modified retrospective basis, will be effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the impact of adopting this new guidance on the consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which supersedes previous revenue recognition guidance. The new standard requires that a company recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those goods or services. Companies will need to use more judgment and estimates than under the guidance currently in effect, including estimating the amount of variable revenue to recognize over each identified performance obligation. Additional disclosures will be required to help users of financial statements understand the nature, amount, and timing of revenue and cash flows arising from contracts. This ASU is effective beginning in fiscal year 2018 with a provision for early adoption in 2017. The standard can be adopted either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company is currently evaluating the impact of adopting this new guidance on the consolidated financial statements.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
No other recently issued or effective ASUs had, or are expected to have, a material effect on the Company's results of operations, financial condition, or liquidity.
Note B — Segment Reporting
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| | | | | | Other | | |
(Thousands) | | Performance Alloys and Composites | | Advanced Materials | | Other (1) | | Corporate (2) | | Subtotal | | Total |
First Quarter 2016 | | | | | | | | | | | | |
Net sales | | $ | 90,629 |
| | $ | 108,120 |
| | $ | 36,762 |
| | $ | — |
| | $ | 36,762 |
| | $ | 235,511 |
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Intersegment sales (3) | | 62 |
| | 15,176 |
| | — |
| | — |
| | — |
| | 15,238 |
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Value-added sales | | 78,202 |
| | 42,066 |
| | 24,634 |
| | (1,044 | ) | | 23,590 |
| | 143,858 |
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Operating profit (loss) | | 1,512 |
| | 5,183 |
| | 4,099 |
| | (3,262 | ) | | 837 |
| | 7,532 |
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First Quarter 2015 | | | | | | | | | | | | |
Net sales | | $ | 103,259 |
| | $ | 149,917 |
| | $ | 36,617 |
| | $ | 231 |
| | $ | 36,848 |
| | $ | 290,024 |
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Intersegment sales (3) | | 177 |
| | 17,385 |
| | — |
| | — |
| | — |
| | 17,562 |
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Value-added sales | | 85,590 |
| | 51,727 |
| | 24,564 |
| | 750 |
| | 25,314 |
| | 162,631 |
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Operating profit (loss) | | 6,803 |
| | 8,903 |
| | 1,675 |
| | (4,149 | ) | | (2,474 | ) | | 13,232 |
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(1) | Other represents the Precision Coatings group, which is a business included in the Other reportable segment. |
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(2) | Costs associated with the Company's unallocated corporate functions have been shown separately to better illustrate the financial information for the businesses within the Other reportable segment. |
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(3) | Intersegment sales are eliminated in consolidation. |
Note C — Other-net
Other-net (income) expense for the first quarter of 2016 and 2015 is summarized as follows:
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| | First Quarter Ended |
| | Apr. 1, | | Apr. 3, |
(Thousands) | | 2016 | | 2015 |
Foreign currency exchange/translation gain | | $ | (9 | ) | | $ | (1,584 | ) |
Amortization of intangible assets | | 1,148 |
| | 1,256 |
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Metal consignment fees | | 1,533 |
| | 2,035 |
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Net (gain) loss on disposal of fixed assets | | (720 | ) | | 74 |
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Recovery from insurance | | — |
| | (3,800 | ) |
Other items | | (66 | ) | | (139 | ) |
Total | | $ | 1,886 |
| | $ | (2,158 | ) |
Note D — Income Taxes
The Company recorded income tax expense of $1.7 million in the first quarter of 2016, an effective tax rate of 24.6% against income before income taxes, and income tax expense of $3.6 million in the first quarter of 2015, with an effective tax rate of 28.6% against income before income taxes.
The difference between the statutory and effective rates in the first quarter of both years was primarily due to the impact of percentage depletion, the foreign rate differential, and other items. The research and development credit also had a favorable effect on the Company's first quarter 2016 effective tax rate.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
Note E — Earnings Per Share
The following table sets forth the computation of basic and diluted EPS:
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| | | | | | | | |
| | First Quarter Ended |
| | Apr. 1, | | Apr. 3, |
(Thousands, except per share amounts) | | 2016 | | 2015 |
Numerator for basic and diluted EPS: | | | | |
Net income | | $ | 5,368 |
| | $ | 8,984 |
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Denominator: | | | | |
Denominator for basic EPS: | | | | |
Weighted-average shares outstanding | | 20,018 |
| | 20,144 |
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Effect of dilutive securities: | | | | |
Stock options and stock appreciation rights | | 62 |
| | 192 |
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Restricted stock units | | 108 |
| | 110 |
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Performance-based restricted stock units | | 40 |
| | 43 |
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Diluted potential common shares | | 210 |
| | 345 |
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Denominator for diluted EPS: | |
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Adjusted weighted-average shares outstanding | | 20,228 |
| | 20,489 |
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Basic EPS | | $ | 0.27 |
| | $ | 0.45 |
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Diluted EPS | | $ | 0.27 |
| | $ | 0.44 |
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Stock appreciation rights with exercise prices in excess of the average market price of common shares totaling 1,018,778 for the quarter ended April 1, 2016 and 386,323 for the quarter ended April 3, 2015 were excluded from the dilution calculation as their effect would have been anti-dilutive.
Note F - Depreciation and Amortization
The Company received an aggregate of $63.5 million from the U.S. Department of Defense (DoD) in previous periods for reimbursement of the DoD's share of the cost of the equipment in property, plant, and equipment, and the reimbursements are reported as unearned income, a liability on the Consolidated Balance Sheets. The equipment was placed in service during 2012, and its full cost is being depreciated in accordance with Company policy. The unearned income liability is being reduced ratably with the depreciation expense recorded over the life of the equipment.
In the three months ended April 1, 2016, the depreciation expense reimbursed for this equipment was $1.1 million. Unearned income was reduced by $1.1 million, accordingly, with the offset recorded as a credit to cost of sales. Depreciation, depletion, and amortization expense on the Consolidated Statements of Cash Flows is shown net of the reduction in unearned income.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
Note G — Inventories
Inventories on the Consolidated Balance Sheets are summarized as follows:
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| | | | | | | | |
| | Apr. 1, | | Dec. 31, |
(Thousands) | | 2016 | | 2015 |
Raw materials and supplies | | $ | 37,443 |
| | $ | 37,463 |
|
Work in process | | 177,851 |
| | 180,458 |
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Finished goods | | 40,791 |
| | 38,135 |
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Subtotal | | $ | 256,085 |
| | $ | 256,056 |
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Less: LIFO reserve balance | | 42,867 |
| | 44,236 |
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Inventories | | $ | 213,218 |
| | $ | 211,820 |
|
The liquidation of last in, first out (LIFO) inventory layers reduced cost of sales by $2.7 million and $1.1 million in the first quarter of 2016 and 2015, respectively.
Note H — Pensions and Other Post-employment Benefits
The following is a summary of the net periodic benefit cost for the first quarter of 2016 and 2015 for the domestic pension plans (which include the defined benefit pension plan and the supplemental retirement plans) and the domestic retiree medical plan.
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| | Pension Benefits | | Other Benefits |
| | First Quarter Ended | | First Quarter Ended |
| | Apr. 1, | | Apr. 3, | | Apr. 1, | | Apr. 3, |
(Thousands) | | 2016 | | 2015 | | 2016 | | 2015 |
Components of net periodic benefit cost | | | | | | | | |
Service cost | | $ | 1,946 |
| | $ | 2,230 |
| | $ | 26 |
| | $ | 29 |
|
Interest cost | | 2,595 |
| | 2,500 |
| | 141 |
| | 138 |
|
Expected return on plan assets | | (3,488 | ) | | (3,354 | ) | | — |
| | — |
|
Amortization of prior service benefit | | (115 | ) | | (112 | ) | | (374 | ) | | (374 | ) |
Amortization of net loss | | 1,431 |
| | 1,820 |
| | — |
| | — |
|
Net periodic benefit cost (benefit) | | $ | 2,369 |
| | $ | 3,084 |
| | $ | (207 | ) | | $ | (207 | ) |
The Company made contributions to the domestic defined benefit pension plans of $4.0 million in the first quarter of both 2016 and 2015.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
Note I — Accumulated Other Comprehensive Income
Changes in the components of accumulated other comprehensive income, including the amounts reclassified, for the first quarter of 2016 and 2015 are as follows:
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| | | | | | | | | | | | | | | | |
(Thousands) | | Foreign Currency | | Pension and Post-Employment Benefits | | Foreign Currency Translation | | Total |
Balance at December 31, 2015 | | $ | 1,579 |
| | $ | (76,796 | ) | | $ | (5,488 | ) | | $ | (80,705 | ) |
Other comprehensive income (loss) before reclassifications | | (1,543 | ) | | — |
| | 1,284 |
| | (259 | ) |
Amounts reclassified from accumulated other comprehensive income | | 75 |
| | 1,014 |
| | — |
| | 1,089 |
|
Net current period other comprehensive income (loss) before tax | | (1,468 | ) | | 1,014 |
| | 1,284 |
| | 830 |
|
Deferred taxes on current period activity | | (545 | ) | | (561 | ) | | — |
| | (1,106 | ) |
Net current period other comprehensive income (loss) after tax | | (923 | ) | | 1,575 |
| | 1,284 |
| | 1,936 |
|
Balance at April 1, 2016 | | $ | 656 |
| | $ | (75,221 | ) | | $ | (4,204 | ) | | $ | (78,769 | ) |
| | | | | | | | |
Balance at December 31, 2014 | | $ | 3,578 |
| | $ | (81,662 | ) | | $ | (4,153 | ) | | $ | (82,237 | ) |
Other comprehensive income (loss) before reclassifications | | 2,636 |
| | 14 |
| | (1,570 | ) | | 1,080 |
|
Amounts reclassified from accumulated other comprehensive income | | (1,837 | ) | | 1,395 |
| | — |
| | (442 | ) |
Net current period other comprehensive income (loss) before tax | | 799 |
| | 1,409 |
| | (1,570 | ) | | 638 |
|
Deferred taxes on current period activity | | 296 |
| | 507 |
| | — |
| | 803 |
|
Net current period other comprehensive income (loss) after tax | | 503 |
| | 902 |
| | (1,570 | ) | | (165 | ) |
Balance at April 3, 2015 | | $ | 4,081 |
| | $ | (80,760 | ) | | $ | (5,723 | ) | | $ | (82,402 | ) |
Reclassifications from accumulated other comprehensive income of gains and losses on foreign currency cash flow hedges are recorded in Other-net in the Consolidated Statements of Income. Refer to Note L for additional details on cash flow hedges.
Reclassifications from accumulated other comprehensive income for pension and post-employment benefits are included in the computation of the net periodic pension and post-employment benefit expense. Refer to Note H for additional details on pension and post-employment expenses.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
Note J — Stock-based Compensation Expense
Stock-based compensation expense, which includes awards settled in shares and in cash, was $1.2 million in the first quarter of 2016 and $4.1 million in the first quarter of 2015.
The Company granted 221,065 stock appreciation rights (SARs) to certain employees during the first quarter of 2016. The weighted average exercise price per share and weighted average fair value per share of the SARs granted during the three months ended April 1, 2016 were $25.19 and $8.07, respectively. The Company estimated the fair value of the SARs using the following assumptions in the Black-Scholes model:
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| | | |
Risk-free interest rate | | 1.25 | % |
Dividend yield | | 1.4 | % |
Volatility | | 38.0 | % |
Expected term (in years) | | 5.7 |
|
The Company granted 42,743 stock-settled restricted stock units (RSUs) and 24,780 cash-settled RSUs to certain employees during the first quarter of 2016. The Company measures the fair value of grants of RSUs based on the closing market price of a share of Materion common stock on the date of the grant. The weighted average fair value per share was $25.19 for stock-settled RSUs granted during the three months ended April 1, 2016. Cash-settled RSUs are accounted for as liability-based compensation awards and adjusted based on the closing price of Materion’s common stock over the vesting period of three years.
The Company granted stock-settled and cash-settled performance-based restricted stock units (PRSUs) to certain employees in the first quarter of 2016. The weighted-average fair value of the stock-settled PRSUs was $22.77 per share and will be expensed over the vesting period of three years. The liability for cash-settled PRSUs is remeasured at fair value each reporting period, and the expense is recorded accordingly. The final payout to the employees for all PRSUs will be based upon the Company’s return on invested capital and the total return to shareholders over the vesting period relative to a peer group’s performance over the same period.
At April 1, 2016, unearned compensation cost related to the unvested portion of all stock-based awards was approximately $7.3 million and is expected to be recognized over the remaining vesting period of the respective grants.
Note K — Fair Value of Financial Instruments
The Company measures and records financial instruments at fair value. A fair value hierarchy is used for those instruments measured at fair value that distinguishes between assumptions based on market data (observable inputs) and the Company’s assumptions (unobservable inputs). The hierarchy consists of three levels:
Level 1 — Quoted market prices in active markets for identical assets and liabilities;
Level 2 — Inputs other than Level 1 inputs that are either directly or indirectly observable; and
Level 3 — Unobservable inputs developed using estimates and assumptions developed by the Company, which reflect those that a market participant would use.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
The following table summarizes the financial instruments measured at fair value in the Consolidated Balance Sheets as of April 1, 2016 and December 31, 2015:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | |
(Thousands) | | Total Carrying Value in the Consolidated Balance Sheets | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) |
| 2016 | | 2015 | | 2016 | | 2015 | | 2016 | | 2015 | | 2016 | | 2015 |
Financial Assets | | | | | | | | | | | | | | | | |
Deferred compensation investments | | $ | 1,739 |
| | $ | 2,524 |
| | $ | 1,739 |
| | $ | 2,503 |
| | $ | — |
| | $ | 21 |
| | $ | — |
| | $ | — |
|
Foreign currency forward contracts | | — |
| | 462 |
| | — |
| | — |
| | — |
| | 462 |
| | — |
| | — |
|
Total | | $ | 1,739 |
| | $ | 2,986 |
| | $ | 1,739 |
| | $ | 2,503 |
| | $ | — |
| | $ | 483 |
| | $ | — |
| | $ | — |
|
Financial Liabilities | | | | | | | | | | | | | | | | |
Deferred compensation liability | | $ | 1,739 |
| | $ | 2,524 |
| | $ | 1,739 |
| | $ | 2,503 |
| | $ | — |
| | $ | 21 |
| | $ | — |
| | $ | — |
|
Foreign currency forward contracts | | 1,186 |
| | 180 |
| | — |
| | — |
| | 1,186 |
| | 180 |
| | — |
| | — |
|
Total | | $ | 2,925 |
| | $ | 2,704 |
| | $ | 1,739 |
| | $ | 2,503 |
| | $ | 1,186 |
| | $ | 201 |
| | $ | — |
| | $ | — |
|
The Company uses a market approach to value the assets and liabilities for financial instruments in the table above. Outstanding contracts are valued through models that utilize market observable inputs, including both spot and forward prices, for the same underlying currencies and metals. The carrying values of the other working capital items and debt in the Consolidated Balance Sheet approximate fair values as of April 1, 2016.
Note L — Derivative Instruments and Hedging Activity
The Company uses derivative contracts to hedge portions of its foreign currency exposures and may also use derivatives to hedge a portion of its precious metal exposures. The objectives and strategies for using derivatives in these areas are as follows:
Foreign Currency. The Company sells a portion of its products to overseas customers in their local currencies, primarily the euro and yen. The Company secures foreign currency derivatives, mainly forward contracts and options, to hedge these anticipated sales transactions. The purpose of the hedge program is to protect against the reduction in the dollar value of foreign currency sales from adverse exchange rate movements. Should the dollar strengthen significantly, the decrease in the translated value of the foreign currency sales should be partially offset by gains on the hedge contracts. Depending upon the methods used, hedge contracts may limit the benefits from a weakening U.S. dollar.
The use of forward contracts locks in a firm rate and eliminates any downside risk from an adverse rate movement as well as any benefit from a favorable rate movement. The Company may from time to time choose to hedge with options or a tandem of options known as a collar. These hedging techniques can limit or eliminate the downside risk but can allow for some or all of the benefit from a favorable rate movement to be realized. Unlike a forward contract, a premium is paid for an option; collars, which are a combination of a put and call option, may have a net premium but can be structured to be cash neutral. The Company will primarily hedge with forward contracts due to the relationship between the cash outlay and the level of risk.
The use of foreign currency derivative contracts is governed by policies approved by the Audit Committee of the Board of Directors. A team consisting of senior financial managers reviews the estimated exposure levels, as defined by budgets, forecasts, and other internal data, and determines the timing, amounts, and instruments to use to hedge that exposure within the confines of the policy. Management analyzes the effective hedged rates and the actual and projected gains and losses on the hedging transactions against the program objectives, targeted rates, and levels of risk assumed. Hedge contracts are typically layered in at different times for a specified exposure period in order to minimize the impact of rate movements.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
Precious Metals. The Company maintains the majority of its precious metal production requirements on consignment in order to reduce its working capital investment and the exposure to metal price movements. When a precious metal product is fabricated and ready for shipment to the customer, the metal is purchased out of consignment at the current market price. The price paid by the Company forms the basis for the price charged to the customer. This methodology allows for changes in either direction in the market prices of the precious metals used by the Company to be passed through to the customer and reduces the impact changes in prices could have on the Company's margins and operating profit. The consigned metal is owned by financial institutions that charge the Company a financing fee based upon the current value of the metal on hand.
In certain instances, a customer may want to establish the price for the precious metal at the time the sales order is placed rather than at the time of shipment. Setting the sales price at a different date than when the material would be purchased potentially creates an exposure to movements in the market price of the metal. Therefore, in these limited situations, the Company may elect to enter into a forward contract to purchase precious metal. The forward contract allows the Company to purchase metal at a fixed price on a specific future date. The price in the forward contract serves as the basis for the price to be charged to the customer. By doing so, the selling price and purchase price are matched, and the Company's price exposure is reduced.
The Company refines precious metal containing materials for its customers and typically will purchase the refined metal from the customer at current market prices. In limited circumstances, the customer may want to fix the price to be paid at the time of the order as opposed to when the material is refined. The customer may also want to fix the price for a set period of time. The Company may then elect to enter into a hedge contract, either a forward contract or a swap, to fix the price for the estimated quantity of metal to be purchased, thereby reducing the exposure to adverse movements in the price of the metal.
The Company may from time to time elect to purchase precious metal and hold in inventory rather than on consignment due to potential credit line limitations or other factors. These purchases are typically held for a short duration. A forward contract will be secured at the time of the purchase to fix the price to be used when the metal is transferred back to the consignment line, thereby limiting any price exposure during the time when the metal was owned.
The Company will only enter into a derivative contract if there is an underlying identified exposure. Contracts are typically held until maturity. The Company does not engage in derivative trading activities and does not use derivatives for speculative purposes. The Company only uses currency hedge contracts that are denominated in the same currency as the underlying exposure and precious metal hedge contracts denominated in the same metal as the underlying exposure.
All derivatives are recorded on the balance sheet at fair value. If the derivative is designated and effective as a cash flow hedge, changes in the fair value of the derivative are recognized in other comprehensive income (OCI) until the hedged item is recognized in earnings. The ineffective portion of a derivative’s fair value, if any, is recognized in earnings immediately. If a derivative is not a hedge, changes in the fair value are adjusted through income. The fair values of the outstanding derivatives are recorded on the balance sheet as assets (if the derivatives are in a gain position) or liabilities (if the derivatives are in a loss position). The fair values will also be classified as short term or long term depending upon their maturity dates.
The outstanding foreign currency forward contracts had a notional value of $30.0 million and $38.9 million at April 1, 2016 and December 31, 2015, respectively. All of these contracts were designated and effective as cash flow hedges. The net fair value of the outstanding contracts was $1.2 million, recorded in other liabilities and accrued items on the Consolidated Balance Sheet at April 1, 2016. The net fair value of the outstanding contracts was $0.3 million, recorded in prepaid expenses and other liabilities and accrued items on the Consolidated Balance Sheet at December 31, 2015. Refer to Note K for additional fair value details.
No ineffective expense was recorded in the first quarter of 2016 or 2015.
Changes in the fair value of outstanding cash flow hedges recorded in OCI for the first three months of 2016 and 2015 totaled a decrease of $1.5 million and an increase of $2.6 million, respectively. The Company expects to relieve substantially the entire balance in OCI as of April 1, 2016 to the Consolidated Statements of Income during the twelve-month period beginning April 2, 2016. Refer to Note I for additional OCI details.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
Note M — Contingencies
Materion Brush Inc., one of the Company's wholly-owned subsidiaries, is a defendant from time to time in proceedings where the plaintiffs allege they have contracted chronic beryllium disease (CBD) or related ailments as a result of exposure to beryllium. The Company will record a reserve for CBD or other litigation when a loss from either settlement or verdict is probable and estimable. Claims filed by third-party plaintiffs may be covered by insurance subject to deductibles which vary based on when the exposure occurred. Reserves are recorded for asserted claims only, and defense costs are expensed as incurred. One CBD case remains outstanding and one case is on appeal as of the end of the first quarter of 2016, and the Company does not expect the resolution of these matters to have a material impact on the consolidated financial statements.
The Company has an active environmental compliance program and records reserves for the probable cost of identified environmental remediation projects. The reserves are established based upon analyses conducted by the Company’s engineers and outside consultants and are adjusted from time to time based upon ongoing studies, the difference between actual and estimated costs, and other factors. The reserves may also be affected by rulings and negotiations with regulatory agencies. The undiscounted reserve balance was $5.7 million at both April 1, 2016 and December 31, 2015. Environmental projects tend to be long term, and the final actual remediation costs may differ from the amounts currently recorded.
|
| |
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
OVERVIEW
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 consumer electronics, industrial components, medical, automotive electronics, defense, telecommunications infrastructure, energy, commercial aerospace, science, services, and appliance.
RESULTS OF OPERATIONS
|
| | | | | | | | | | | | | | | |
| | First Quarter Ended |
| | Apr. 1, | | Apr. 3, | | $ | | % |
(Thousands, except per share data) | | 2016 | | 2015 | | Change | | Change |
Net sales | | $ | 235,511 |
| | $ | 290,024 |
| | $ | (54,513 | ) | | (19 | )% |
Value-added sales | | 143,858 |
| | 162,631 |
| | (18,773 | ) | | (12 | )% |
Gross margin | | 43,357 |
| | 52,355 |
| | (8,998 | ) | | (17 | )% |
Gross margin as a % of value-added sales | | 30 | % | | 32 | % | | N/A |
| | N/A |
|
Selling, general, and administrative (SG&A) expense
| | 30,487 |
| | 37,933 |
| | (7,446 | ) | | (20 | )% |
SG&A expense as a % of value-added sales | | 21 | % | | 23 | % | | N/A |
| | N/A |
|
Research and development (R&D) expense | | 3,452 |
| | 3,348 |
| | 104 |
| | 3 | % |
R&D expense as a % of value-added sales | | 2 | % | | 2 | % | | N/A |
| | N/A |
|
Other—net | | 1,886 |
| | (2,158 | ) | | 4,044 |
| | (187 | )% |
Operating profit | | 7,532 |
|
| 13,232 |
| | (5,700 | ) | | (43 | )% |
Interest expense—net | | 415 |
| | 657 |
| | (242 | ) | | (37 | )% |
Income before income taxes | | 7,117 |
| | 12,575 |
| | (5,458 | ) | | (43 | )% |
Income tax expense | | 1,749 |
| | 3,591 |
| | (1,842 | ) | | (51 | )% |
Net income | | $ | 5,368 |
| | $ | 8,984 |
| | $ | (3,616 | ) | | (40 | )% |
| | | | | | | | |
Diluted earnings per share | | $ | 0.27 |
| | $ | 0.44 |
| | $ | (0.17 | ) | | (39 | )% |
N/A = Not Applicable.
Net sales of $235.5 million in the first quarter of 2016 were $54.5 million lower than the $290.0 million recorded in the first quarter of 2015. The decrease in net sales in the first quarter of 2016 was due to lower sales volume and lower pass-through precious metal and copper prices. Sales volume was lower due primarily to weaker demand in the oil and gas sector of the energy market, decreased shipments of raw material beryllium hydroxide, and weakness in the consumer electronics, industrial components, and automotive electronics end markets. Changes in precious metal and copper prices negatively impacted net sales in the first quarter of 2016 by approximately $8.4 million when compared to the first quarter of 2015.
Value-added sales is a non-GAAP 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. Internally, we manage our business on this basis, and a reconciliation of net sales to value-added sales is included herein. Value-added sales of $143.9 million in the first quarter of 2016 decreased $18.8 million, or 12% compared to the first quarter of 2015.
Value-added sales to the consumer electronics end market, our largest end market accounting for approximately 26% of our total value-added sales in the first quarter of 2016, decreased $6.3 million or 14% from the first quarter of 2015. This decrease was primarily related to lower sales volume of our products used in hand-held devices and weakness in the projector display market within our Precision Coatings group due to a transition to new technology.
Value-added sales to the energy end market, which accounted for 6% of our total value-added sales in the first quarter of 2016, decreased $3.5 million or 28% compared to the first quarter of 2015. This decrease was primarily related to a decline in exploration in the oil and gas sector of the market within the Performance Alloys and Composites segment.
The industrial components and automotive electronics end market sales, which collectively accounted for 24% of our total value-added sales in the first quarter of 2016, decreased $5.7 million or 14% as compared to the first quarter of 2015.
Gross margin in the first quarter of 2016 was $43.4 million, or $9.0 million below the $52.4 million gross margin recorded during the first quarter of 2015. Expressed as a percentage of value-added sales, gross margin declined from 32% in the first quarter of 2015 to 30% in the first quarter of 2016. The decrease in gross margin was primarily due to a combination of lower sales volume and lower yields related to the precious metal refining process.
SG&A expense was $30.5 million in the first quarter of 2016, or $7.4 million lower than $37.9 million in the first quarter of 2015. The decrease in SG&A expense was due primarily to a $6.2 million reduction in stock-based and annual incentive compensation expense driven by a reduction in operating profit and lower stock prices as compared to the prior-year period. In addition, selling expenses were also lower due to the decrease in sales volume.
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 relatively flat as a percentage of value-added sales at approximately 2% in the first quarter of both 2016 and 2015.
Other-net was $1.9 million of expense in the first quarter of 2016 as compared to $2.2 million of income in the first quarter of 2015. Other-net in the first quarter of 2015 included a gain of $3.8 million related to the favorable settlement of an insurance claim in connection with the construction of our beryllium pebble facility in Elmore, Ohio, and foreign currency exchange gains of $1.6 million due primarily to the maturity of foreign currency forward contracts. Also, Other-net in the first quarter of 2016 includes a net gain on the sale of equipment of $0.7 million and lower metal consignment fees of $0.5 million. Refer to Note C to the Consolidated Financial Statements for details of the major components within Other-net.
Interest expense - net was $0.4 million in the first quarter of 2016 and $0.7 million in first quarter of 2015 due to lower average debt outstanding.
Income tax expense for the first quarter of 2016 was $1.7 million versus $3.6 million in the first quarter of 2015. The effective tax rates for the first quarter of 2016 and 2015 were 24.6% and 28.6%, respectively. The effects of percentage depletion, the foreign rate differential, and other items were the primary factors for the difference between the effective and statutory rates in the first quarter of 2016 and 2015. The R&D tax credit also had a favorable effect on the Company's first quarter 2016 effective tax rate.
Value-Added Sales - Reconciliation of Non-GAAP Measure
A reconciliation of net sales to value-added sales, a non-GAAP measure, for each reportable segment and for the total Company for the first quarter of 2016 and 2015 is as follows:
|
| | | | | | | | |
| | First Quarter Ended |
| | Apr. 1, | | Apr. 3, |
(Thousands) | | 2016 | | 2015 |
Net sales | | | | |
Performance Alloys and Composites | | $ | 90,629 |
| | $ | 103,259 |
|
Advanced Materials | | 108,120 |
| | 149,917 |
|
Other | | 36,762 |
| | 36,848 |
|
Total | | $ | 235,511 |
| | $ | 290,024 |
|
| | | | |
Less: pass-through metal costs | | | | |
Performance Alloys and Composites | | $ | 12,427 |
| | $ | 17,669 |
|
Advanced Materials | | 66,054 |
| | 98,190 |
|
Other | | 13,172 |
| | 11,534 |
|
Total | | $ | 91,653 |
| | $ | 127,393 |
|
| | | | |
Value-added sales | | | | |
Performance Alloys and Composites | | $ | 78,202 |
| | $ | 85,590 |
|
Advanced Materials | | 42,066 |
| | 51,727 |
|
Other | | 23,590 |
| | 25,314 |
|
Total | | $ | 143,858 |
| | $ | 162,631 |
|
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 are a non-GAAP 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.
Segment Results
The Company consists of three reportable segments: Performance Alloys and Composites, Advanced Materials, and Other. The Other reportable segment includes the results of our Precision Optics and Large Area Coatings operating segments, which do not meet the quantitative thresholds for separate disclosure and are collectively referred to as our Precision Coatings group. The Other reportable segment also includes unallocated corporate costs. Refer to Note B to the Consolidated Financial Statements for additional business segment information.
Performance Alloys and Composites
|
| | | | | | | | |
| | First Quarter Ended |
| | Apr. 1, | | Apr. 3, |
(Thousands) | | 2016 | | 2015 |
Net sales | | $ | 90,629 |
| | $ | 103,259 |
|
Value-added sales | | 78,202 |
| | 85,590 |
|
Operating profit | | 1,512 |
| | 6,803 |
|
Net sales from the Performance Alloys and Composites segment of $90.6 million in the first quarter of 2016 were 12% lower than net sales of $103.3 million in the first quarter of 2015 primarily due to lower sales volume and the impact of lower pass-through metal prices of $3.2 million.
Value-added sales of $78.2 million in the first quarter of 2016 were 9% lower than value-added sales of $85.6 million in the first quarter of 2015. The decrease in value-added sales was primarily driven by lower value-added sales to the energy and other end markets. Value-added sales to the energy end market were $2.7 million lower due to a decline in exploration in the oil and gas sector of the market. Value-added sales to other end markets were lower due primarily to a reduction in raw material sales of beryllium hydroxide.
Performance Alloys and Composites generated operating profit of $1.5 million, or 2% of value-added sales, in the first quarter of 2016 compared to $6.8 million, or 8% of value-added sales, in the first quarter of 2015. The decline in operating profit in the first quarter of 2016 as compared to the first quarter of 2015 was primarily due to lower sales volume and the negative impact of foreign exchange rate movements of $1.8 million.
Advanced Materials
|
| | | | | | | | |
| | First Quarter Ended |
| | Apr. 1, | | Apr. 3, |
(Thousands) | | 2016 | | 2015 |
Net sales | | $ | 108,120 |
| | $ | 149,917 |
|
Value-added sales | | 42,066 |
| | 51,727 |
|
Operating profit | | 5,183 |
| | 8,903 |
|
Net sales from the Advanced Materials segment of $108.1 million in the first quarter of 2016 were 28% lower than net sales of $149.9 million in the first quarter of 2015 primarily due to lower sales volume and the impact of lower pass-through metal prices of $4.7 million.
Value-added sales of $42.1 million in the first quarter of 2016 were 19% lower than value-added sales of $51.7 million in the first quarter of 2015. The decrease in value-added sales was primarily driven by lower value-added sales to the consumer electronics and industrial components end markets. Value-added sales to the consumer electronics end market, which represents approximately 46% of total segment value-added sales, decreased $4.1 million due primarily to lower demand for base semiconductor and data storage applications. Value-added sales to the industrial components end market decreased $1.3 million in the first quarter of 2016 compared to the prior-year period due primarily to customer inventory builds in the prior year.
The Advanced Materials segment generated operating profit of $5.2 million in the first quarter of 2016 compared to $8.9 million in the first quarter of 2015. As a percentage of value-added sales, operating profit was 12% and 17% in the first quarter of 2016 and 2015, respectively. The decrease in operating profit in the first quarter of 2016 versus the comparable period of 2015 was due to lower sales volume and unfavorable yields related to the precious metal refining process.
Other
|
| | | | | | | | |
(Thousands) | | First Quarter Ended |
Apr. 1, | | Apr. 3, |
2016 | | 2015 |
Net sales | | $ | 36,762 |
| | $ | 36,848 |
|
Value-added sales | | 23,590 |
| | 25,314 |
|
Operating profit (loss) | | 837 |
| | (2,474 | ) |
The Other reportable segment in total includes the operating results of the Precision Coatings group and unallocated corporate costs.
Net sales for the Other reportable segment totaled $36.8 million in the first quarter of both 2016 and 2015. Including unallocated corporate costs, the Other reportable segment had an operating profit of $0.8 million in the first quarter of 2016 compared to an operating loss of $2.5 million in the first quarter of 2015.
Within the Other reportable segment, net sales for the Precision Coatings group were $36.8 million in the first quarter of 2016 as compared to $36.6 million in the first quarter of 2015, and value-added sales for both the first quarter of 2016 and 2015 were $24.6 million. Higher sales to the medical, industrial components, and defense end markets were offset by lower sales to the consumer electronics and automotive electronics end markets.
Within the Other reportable segment, the Precision Coatings group reported an operating profit of $4.1 million in the first quarter of 2016 as compared to $1.7 million in the first quarter of 2015. The increase is due primarily to improved product mix, cost reduction initiatives, and a gain on the sale of equipment of $0.8 million.
Within the Other reportable segment, corporate reported operating expense of $3.3 million and $4.2 million in the first quarter of 2016 and 2015, respectively. Lower unallocated corporate costs were primarily due to a $5.0 million decrease in stock-based and incentive compensation offset by the $3.8 million insurance settlement gain realized in the prior-period as discussed above.
Legal Proceedings
One of our subsidiaries, Materion Brush Inc., is a defendant from time to time in proceedings in various state and federal courts brought by plaintiffs alleging that they have contracted chronic beryllium disease (CBD) or other lung conditions as a result of exposure to beryllium. Plaintiffs in beryllium cases generally seek recovery under negligence and various other legal theories and seek compensatory and punitive damages, in many cases of an unspecified sum. Spouses, if any, often claim loss of consortium.
As of April 1, 2016, there was one beryllium case (involving three plaintiffs) outstanding and one appellate case (involving four plaintiffs/appellants). The Company does not expect the resolution of these matters to have a material impact on the consolidated financial statements. Refer to Item 1 “Legal Proceedings."
Additional beryllium claims may arise. Management believes that we have substantial defenses in these types of cases and intends to contest the suits vigorously should they arise. Employee cases, in which plaintiffs have a high burden of proof, have historically involved relatively small losses to us. Third-party plaintiffs (typically employees of customers or contractors) face a lower burden of proof than do employees or former employees, but these cases are generally covered by varying levels of insurance.
Although it is not possible to predict the outcome of any litigation, we provide for costs related to these matters when a loss is probable, and the amount is reasonably estimable. Litigation is subject to many uncertainties, and it is possible that some of these actions could be decided unfavorably in amounts exceeding our reserves. An unfavorable outcome or settlement of a beryllium case or adverse media coverage could encourage the commencement of additional similar litigation. We are unable to estimate our potential exposure to unasserted claims.
Based upon currently known facts and our experience with beryllium cases and assuming collectibility of insurance, we do not believe that resolution of future beryllium proceedings will have a material adverse effect on our financial condition or cash flow. However, our results of operations could be materially affected by unfavorable results in one or more of these cases in the future.
FINANCIAL POSITION
Cash Flow
A summary of cash flows provided by (used in) operating, investing, and financing activities is as follows:
|
| | | | | | | | | | | | |
| | Three Months Ended |
| | Apr. 1, | | Apr. 3, | | $ |
(Thousands) | | 2016 | | 2015 | | Change |
Net cash used in operating activities | | $ | (17,444 | ) | | $ | (4,067 | ) | | $ | (13,377 | ) |
Net cash used in investing activities | | (9,744 | ) | | (10,944 | ) | | 1,200 |
|
Net cash provided by financing activities | | 21,372 |
| | 24,481 |
| | (3,109 | ) |
Effects of exchange rate changes | | 448 |
| | (682 | ) | | 1,130 |
|
Net change in cash and cash equivalents | | $ | (5,368 | ) | | $ | 8,788 |
| | $ | (14,156 | ) |
Net cash used in operating activities totaled $17.4 million in the first three months of 2016 versus $4.1 million used in operating activities in the comparable prior-year period. Net income decreased $3.6 million and included a decrease of $1.4 million in non-cash stock-based compensation expense as compared to the prior-year period. The timing of cash payments relating to Unearned revenue activity also unfavorably impacted operating cash flows by $5.8 million.
Working capital requirements were approximately $30.0 million in both the first three months of 2016 and 2015. Cash flows used for inventory decreased $5.4 million compared to the prior-year period due to working capital reduction initiatives. Cash flows used for accounts payable and accrued expenses decreased $3.4 million compared to the prior-year period primarily due to lower incentive compensation payments. Cash flows used for accounts receivable increased $9.2 million. Our three-month trailing days sales outstanding (DSO) was approximately 40 days at April 1, 2016 versus 44 days at December 31, 2015.
Net cash used in investing activities was $9.7 million in the first three months of 2016 compared to $10.9 million in the prior-year corresponding period. Increased payments for mine development activities of $1.0 million were more than offset by decreased payments for property, plant, and equipment of $1.5 million and cash proceeds of $0.7 million for the sale of equipment.
Capital expenditures are made primarily for supporting mining and new product development, replacing and upgrading equipment, infrastructure investments, and implementing information technology initiatives. For the full year 2016, the Company expects payments for property, plant, and equipment to range from $25 million to $30 million and mine development expenditures to range from $5 million to $10 million.
Net cash provided by financing activities totaled $21.4 million in the first three months of 2016 versus $24.5 million in the comparable prior-year period primarily due to a decrease of $3.3 million in net borrowings in 2016 and a decrease in the amount of share repurchases in 2016.
Liquidity
We believe 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 April 1, 2016, cash and cash equivalents held by our foreign operations totaled $17.9 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, available borrowing capacity, and the debt-to-debt-plus-equity ratio, as of April 1, 2016 and December 31, 2015 is as follows:
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| | | | | | | | |
| | April 1, | | December 31, |
(Thousands) | | 2016 | | 2015 |
Total outstanding debt | | $ | 37,161 |
| | $ | 13,266 |
|
Cash | | 18,868 |
| | 24,236 |
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Net debt (cash) | | 18,293 |
| | (10,970 | ) |
Available borrowing capacity | | $ | 185.7 |
| | $ | 221.8 |
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Debt-to-debt-plus-equity ratio | | 7 | % | | 3 | % |
Net debt is a non-GAAP 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. The main cause for the decrease in the available borrowing capacity at April 1, 2016 as compared to December 31, 2015 was the impact of this covenant.
In 2015, we entered into an amendment to our $375.0 million revolving credit agreement (Credit Agreement). The amendment extends the maturity date of the Credit Agreement from 2018 to 2020 and provides more favorable pricing under certain circumstances. In addition, the amendment 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. The Credit Agreement is 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 us 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 Credit Agreement.
The Credit Agreement includes restrictive covenants including incurring 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 April 1, 2016 and December 31, 2015. Cash on hand does not affect the covenants or the borrowing capacity under our debt agreements.
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. As a result we have negotiated increases in the available capacity under existing lines, added additional lines, and extended the maturity dates of existing lines in recent years. The available and unused capacity under the metal financing lines totaled approximately $222 million as of April 1, 2016. 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 required repurchase quantity for a given year, and the repurchases may be discontinued at any time. We repurchased 17,810 shares at a cost of $0.5 million in the first three months of 2016. Since the approval of the repurchase plan, we have purchased 920,314 shares at a total cost of $29.9 million.
In the first three months of 2016, we paid cash dividends of $1.8 million on our common stock. We intend to pay a quarterly dividend on an ongoing basis, subject to a determination that the dividend remains in the best interest of our shareholders.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL 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. The notional value of off-balance sheet
precious metals and copper was $227.9 million as of April 1, 2016, versus $214.7 million as of December 31, 2015. We were in compliance with all of the covenants contained in the consignment agreements as of April 1, 2016 and December 31, 2015. For additional information on our contractual obligations, refer to our Form 10-K for the year ended December 31, 2015.
CRITICAL ACCOUNTING POLICIES
For additional information regarding critical accounting policies, please refer to our Form 10-K for the year ended December 31, 2015. There have been no material changes in our critical accounting policies subsequent to the issuance of our Form 10-K.
OUTLOOK
We have been impacted by the economic slowdown in Asia and the downturn in the U.S. manufacturing sector. In addition, decreased oil prices negatively impacted exploration and drilling activities. The U.S. dollar also continued to remain strong, which negatively impacted our sales and operating profit. Despite these challenging headwinds, we continue to successfully execute our strategy of launching new products and technologies to leverage our materials’ strengths.
Current macro-economic challenges and uncertainties could negatively impact business and consumer spending and, as a result, adversely impact our overall net sales and profits. To counterbalance these trends and to further grow our sales and the breadth of our product reach, we continue to develop an active pipeline of new products and technologies. We believe that these new products and applications will be a key to our growth in the near term, based on our differentiated products with leading positions in long-term global growth markets. Over the long term, we remain confident that our strategy and financial strength will allow the Company to capitalize when end-market demand strengthens and deliver earnings growth that outperforms gross domestic product growth.
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:
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▪ | Actual net sales, operating rates, and margins for 2016; |
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▪ | Our ability to strengthen our internal control over financial reporting and disclosure controls and procedures; |
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▪ | The impact of any U.S. Federal Government shutdowns and sequestrations; |
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▪ | The condition of the markets which we serve, whether defined geographically or by segment, with the major market segments being: consumer electronics, industrial components, medical, automotive electronics, defense, telecommunications infrastructure, energy, commercial aerospace, and science; |
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▪ | Changes in product mix and the financial condition of customers; |
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▪ | Our success in developing and introducing new products and new product ramp-up rates; |
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▪ | 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; |
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▪ | Our success in identifying acquisition candidates and in acquiring and integrating such businesses; |
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▪ | The impact of the results of acquisitions on our ability to fully achieve the strategic and financial objectives related to these acquisitions; |
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▪ | Our success in implementing our strategic plans and the timely and successful completion and start-up of any capital projects; |
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▪ | The availability of adequate lines of credit and the associated interest rates; |
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▪ | Other financial factors, including the cost and availability of raw materials (both base and precious metals), physical inventory valuations, metal financing fees, tax rates, exchange rates, pension costs and required cash contributions and other employee benefit costs, energy costs, regulatory compliance costs, the cost and availability of insurance, and the impact of our stock price on the cost of incentive compensation plans; |
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▪ | The uncertainties related to the impact of war, terrorist activities, and acts of God; |
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▪ | Changes in government regulatory requirements and the enactment of new legislation that impacts our obligations and operations; |
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• | The conclusion of pending litigation matters in accordance with our expectation that there will be no material adverse effects; |
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• | The success of the realignment of our businesses; and |
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• | The risk factors set forth in Part 1, Item 1A of our Form 10-K for the year ended December 31, 2015. |
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Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
For information regarding market risks, refer to our Annual Report on Form 10-K for the year ended December 31, 2015. There have been no material changes in our market risks since the inclusion of this discussion in our Annual Report on Form 10-K.
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Item 4. | Controls and Procedures |
a)Evaluation of Disclosure Controls and Procedures
The Company carried out an evaluation under the supervision and with participation of the Company's management, including the chief executive officer and chief financial officer, of the effectiveness of the design and operation of disclosure controls and procedures as of April 1, 2016 pursuant to Rule 13a-15(b) and 15d-15(b) under the Securities Exchange Act of 1934, as amended (Exchange Act). Based on that evaluation, management, including the chief executive officer and chief financial officer, concluded that disclosure controls and procedures are effective as of April 1, 2016.
b)Changes in Internal Control over Financial Reporting
There have been no changes in the Company's internal control over financial reporting that occurred during the quarter ended April 1, 2016 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
PART II OTHER INFORMATION
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.
Beryllium Claims
As of April 1, 2016, our subsidiary, Materion Brush Inc., was a defendant in one beryllium case (involving three plaintiffs), and one appellate case (involving four plaintiffs/appellants), as described more fully below.
The Company is one of five defendants in a case filed on October 4, 2013 in the Superior Court of the State of Arizona, Maricopa County, titled Parmar et al. v. Dolphin, Inc. et al., CV 2013-012980. One plaintiff alleges that he contracted CBD from exposures that resulted from his employment at manufacturing facilities of Karsten Manufacturing Corporation (Karsten) in Arizona, and asserts claims for negligence, strict liability, and fraudulent concealment. His wife claims a loss of consortium. Another plaintiff alleges that he has been diagnosed with beryllium sensitization that resulted from his employment at Karsten, and asserts a claim for medical monitoring. Plaintiffs seek compensatory and punitive damages and/or medical monitoring in unspecified sums. Trial is set for January 9, 2017.
The Company was one of six defendants in a case filed on April 7, 2015 in the Superior Court of the State of California, Los Angeles County, titled Godoy et al. v. The Argen Corporation et al., BC578085. This was a survival and wrongful death complaint. The complaint alleged that the decedent worked at H. Kramer & Co. in California and alleged that he worked as a dental lab technician at various dental labs in California, and that he suffered from CBD and other injuries as a result of grinding, melting, and handling beryllium-containing products. The complaint alleged causes of action for negligence, strict liability - failure to warn, strict liability - design defect, fraudulent concealment, and breach of implied warranties. Plaintiffs sought punitive damages in connection with the strict liability and fraudulent concealment causes of action. The survival action sought all damages sustained by decedent that he would have been entitled to recover had he lived, including punitive damages. The Company filed a demurrer on May 29, 2015. At a hearing on September 29, 2015, the court granted the demurrer, dismissing all claims against the Company, without leave to amend the complaint. On February 3, 2016, the plaintiffs filed a notice of appeal.
The Company has insurance coverage, which may respond, subject to an annual deductible.
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
The following table presents information with respect to repurchases of common stock made by us during the three months ended April 1, 2016. |
| | | | | | | | | | | | | | |
Period | | Total Number of Shares Purchased (1) | | Average Price Paid per Share (1) | | 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) |
January 1 through February 5, 2016 | | — |
| | $ | — |
| | — |
| | $ | 20,588,268 |
|
February 6 through March 4, 2016 | | 17,002 |
| | 27.21 |
| | 4,795 |
| | 20,467,443 |
|
March 5 through April 1, 2016 | | 29,122 |
| | 26.34 |
| | 13,015 |
| | 20,126,383 |
|
Total | | 46,124 |
| | $ | 26.66 |
| | 17,810 |
| | $ | 20,126,383 |
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(1) | Includes 12,207 and 16,107 shares in February and March, respectively, surrendered to the Company by certain employees to satisfy tax withholding obligations on restricted stock issued under the Company's stock incentive plan. |
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(2) | On January 14, 2014, we announced that our Board of Directors had authorized the repurchase of up to $50.0 million of our common stock. As of April 1, 2016, $20.1 million may still be purchased under the program. During the three months ended April 1, 2016, we repurchased 17,810 shares at an average price of $25.93 per share, or $0.5 million in the aggregate. |
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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 quarterly report on Form 10-Q.
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31.1 | | Certification of Chief Executive Officer required by Rule 13a-14(a) or 15d-14(a). |
31.2 | | Certification of Chief Financial Officer required by Rule 13a-14(a) or 15d-14(a). |
32 | | Certifications of Chief Executive Officer and Chief Financial Officer required by 18 U.S.C. Section 1350. |
95 | | Mine Safety Disclosure Pursuant to Section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act for the period ended April 1, 2016. |
101.INS | | XBRL Instance Document. |
101.SCH | | XBRL Taxonomy Extension Schema Document. |
101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document. |
101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document. |
101.LAB | | XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| | | | |
| | | | |
| | | | MATERION CORPORATION |
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Dated: April 29, 2016 | | | | |
| | | | /s/ JOSEPH P. KELLEY |
| | | | Joseph P. Kelley |
| | | | Vice President, Finance and Chief Financial Officer |
| | | | (Principal Financial and Accounting Officer) |
Exhibit Index
|
| | |
31.1 | | Certification of Chief Executive Officer required by Rule 13a-14(a) or 15d-14(a). |
31.2 | | Certification of Chief Financial Officer required by Rule 13a-14(a) or 15d-14(a). |
32 | | Certifications of Chief Executive Officer and Chief Financial Officer required by 18 U.S.C. Section 1350. |
95 | | Mine Safety Disclosure Pursuant to Section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act for the period ended April 1, 2016. |
101.INS | | XBRL Instance Document. |
101.SCH | | XBRL Taxonomy Extension Schema Document. |
101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document. |
101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document. |
101.LAB | | XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document. |