Document
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 June 30, 2017
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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 Heights, 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, 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.
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Large accelerated filer þ | | | Accelerated filer ¨ |
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | 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 is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
Number of Shares of Common Stock, without par value, outstanding at June 30, 2017: 20,038,672.
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 second quarter and six months ended June 30, 2017 are as follows:
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| Second quarter and six months ended June 30, 2017 and July 1, 2016
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| Second quarter and six months ended June 30, 2017 and July 1, 2016
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| June 30, 2017 and December 31, 2016 | |
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| Six months ended June 30, 2017 and July 1, 2016 | |
Materion Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)
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| | | | | | | | | | | | | | | | |
| | Second Quarter Ended | | Six Months Ended |
| | June 30, | | July 1, | | June 30, | | July 1, |
(Thousands, except per share amounts) | | 2017 | | 2016 | | 2017 | | 2016 |
Net sales | | $ | 295,842 |
| | $ | 249,776 |
| | $ | 536,511 |
| | $ | 485,287 |
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Cost of sales | | 241,285 |
| | 204,470 |
| | 438,958 |
| | 396,624 |
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Gross margin | | 54,557 |
| | 45,306 |
| | 97,553 |
| | 88,663 |
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Selling, general, and administrative expense | | 38,075 |
| | 32,437 |
| | 71,703 |
| | 62,924 |
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Research and development expense | | 3,544 |
| | 3,171 |
| | 6,674 |
| | 6,623 |
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Other—net | | 3,204 |
| | 3,921 |
| | 6,022 |
| | 5,807 |
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Operating profit | | 9,734 |
| | 5,777 |
| | 13,154 |
| | 13,309 |
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Interest expense—net | | 695 |
| | 512 |
| | 1,188 |
| | 927 |
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Income before income taxes | | 9,039 |
| | 5,265 |
| | 11,966 |
| | 12,382 |
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Income tax (benefit) expense | | 1,726 |
| | (284 | ) | | 1,603 |
| | 1,465 |
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Net income | | $ | 7,313 |
| | $ | 5,549 |
| | $ | 10,363 |
| | $ | 10,917 |
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Basic earnings per share: | | | | | | | | |
Net income per share of common stock | | $ | 0.37 |
| | $ | 0.28 |
| | $ | 0.52 |
| | $ | 0.55 |
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Diluted earnings per share: | | | | | | | | |
Net income per share of common stock | | $ | 0.36 |
| | $ | 0.27 |
| | $ | 0.51 |
| | $ | 0.54 |
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Cash dividends per share | | $ | 0.100 |
| | $ | 0.095 |
| | $ | 0.195 |
| | $ | 0.185 |
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Weighted-average number of shares of common stock outstanding: | | | | | | | | |
Basic | | 20,012 |
| | 20,015 |
| | 19,991 |
| | 20,016 |
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Diluted | | 20,347 |
| | 20,214 |
| | 20,348 |
| | 20,220 |
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The accompanying notes are an integral part of the consolidated financial statements.
Materion Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
(Unaudited)
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| | | | | | | | | | | | | | | | |
| | Second Quarter Ended | | Six Months Ended |
| | June 30, | | July 1, | | June 30, | | July 1, |
(Thousands) | | 2017 | | 2016 | | 2017 | | 2016 |
Net income | | $ | 7,313 |
| | $ | 5,549 |
| | $ | 10,363 |
| | $ | 10,917 |
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Other comprehensive income (loss): | | | | | | | | |
Foreign currency translation adjustment | | 275 |
| | 1,167 |
| | 1,378 |
| | 2,451 |
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Derivative and hedging activity, net of tax | | (174 | ) | | 302 |
| | (635 | ) | | (621 | ) |
Pension and post-employment benefit adjustment, net of tax | | 759 |
| | 675 |
| | 1,516 |
| | 2,250 |
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Other comprehensive income | | 860 |
| | 2,144 |
| | 2,259 |
| | 4,080 |
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Comprehensive income | | $ | 8,173 |
| | $ | 7,693 |
| | $ | 12,622 |
| | $ | 14,997 |
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The accompanying notes are an integral part of the consolidated financial statements.
Materion Corporation and Subsidiaries
Consolidated Balance Sheets
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| | (Unaudited) | | |
| | June 30, | | Dec. 31, |
(Thousands) | | 2017 | | 2016 |
Assets | | | | |
Current assets | | | | |
Cash and cash equivalents | | $ | 18,497 |
| | $ | 31,464 |
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Accounts receivable | | 133,674 |
| | 100,817 |
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Inventories | | 215,987 |
| | 200,865 |
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Prepaid and other current assets | | 22,162 |
| | 12,138 |
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Total current assets | | 390,320 |
| | 345,284 |
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Long-term deferred income taxes | | 40,543 |
| | 39,409 |
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Property, plant, and equipment | | 872,618 |
| | 861,267 |
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Less allowances for depreciation, depletion, and amortization | | (622,351 | ) | | (608,636 | ) |
Property, plant, and equipment—net | | 250,267 |
| | 252,631 |
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Intangible assets | | 12,074 |
| | 11,074 |
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Other assets | | 6,183 |
| | 5,950 |
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Goodwill | | 90,035 |
| | 86,950 |
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Total Assets | | $ | 789,422 |
| | $ | 741,298 |
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Liabilities and Shareholders’ Equity | | | | |
Current liabilities | | | | |
Short-term debt | | $ | 3,140 |
| | $ | 733 |
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Accounts payable | | 46,064 |
| | 32,533 |
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Salaries and wages | | 28,541 |
| | 29,885 |
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Other liabilities and accrued items | | 25,878 |
| | 21,340 |
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Income taxes | | 3,195 |
| | 4,781 |
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Unearned revenue | | 2,797 |
| | 1,105 |
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Total current liabilities | | 109,615 |
| | 90,377 |
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Other long-term liabilities | | 17,700 |
| | 17,979 |
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Retirement and post-employment benefits | | 94,549 |
| | 91,505 |
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Unearned income | | 39,076 |
| | 41,369 |
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Long-term income taxes | | 1,994 |
| | 2,100 |
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Deferred income taxes | | 277 |
| | 274 |
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Long-term debt | | 23,254 |
| | 3,605 |
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Shareholders’ equity | | | | |
Serial preferred stock | | — |
| | — |
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Common stock | | 218,902 |
| | 212,702 |
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Retained earnings | | 524,367 |
| | 517,903 |
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Common stock in treasury | | (160,785 | ) | | (154,399 | ) |
Accumulated other comprehensive loss | | (83,922 | ) | | (86,181 | ) |
Other equity transactions | | 4,395 |
| | 4,064 |
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Total shareholders' equity | | 502,957 |
| | 494,089 |
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Total Liabilities and Shareholders’ Equity | | $ | 789,422 |
| | $ | 741,298 |
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The accompanying notes are an integral part of the consolidated financial statements.
Materion Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited) |
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| | Six Months Ended |
| | June 30, | | July 1, |
(Thousands) | | 2017 | | 2016 |
Cash flows from operating activities: | | | | |
Net income | | $ | 10,363 |
| | $ | 10,917 |
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Adjustments to reconcile net income to net cash provided from (used in) operating activities: | | | | |
Depreciation, depletion, and amortization | | 20,725 |
| | 23,497 |
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Amortization of deferred financing costs in interest expense | | 440 |
| | 281 |
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Stock-based compensation expense (non-cash) | | 3,507 |
| | 1,919 |
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(Gain) loss on sale of property, plant, and equipment | | 147 |
| | (695 | ) |
Deferred income tax expense (benefit) | | 658 |
| | (1,489 | ) |
Changes in assets and liabilities net of acquired assets and liabilities: | | | |
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Decrease (increase) in accounts receivable | | (30,882 | ) | | (13,013 | ) |
Decrease (increase) in inventory | | (6,498 | ) | | 1,153 |
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Decrease (increase) in prepaid and other current assets | | (9,267 | ) | | (782 | ) |
Increase (decrease) in accounts payable and accrued expenses | | 15,519 |
| | (7,871 | ) |
Increase (decrease) in unearned revenue | | 1,685 |
| | (743 | ) |
Increase (decrease) in interest and taxes payable | | (1,115 | ) | | 1,310 |
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Increase (decrease) in long-term liabilities | | (3,891 | ) | | (6,221 | ) |
Other-net | | (1,088 | ) | | 1,598 |
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Net cash provided by operating activities | | 303 |
| | 9,861 |
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Cash flows from investing activities: | | | | |
Payments for purchase of property, plant, and equipment | | (11,252 | ) | | (14,326 | ) |
Payments for mine development | | (509 | ) | | (7,806 | ) |
Payments for acquisition | | (16,504 | ) | | — |
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Proceeds from sale of property, plant, and equipment | | 27 |
| | 827 |
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Net cash (used in) investing activities | | (28,238 | ) | | (21,305 | ) |
Cash flows from financing activities: | | | | |
Proceeds from issuance of short-term debt, net | | 2,387 |
| | 5,805 |
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Proceeds from issuance of long-term debt | | 45,000 |
| | 10,000 |
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Repayment of long-term debt | | (25,362 | ) | | (399 | ) |
Principal payments under capital lease obligations | | (383 | ) | | (425 | ) |
Cash dividends paid | | (3,899 | ) | | (3,704 | ) |
Deferred financing costs | | (300 | ) | | — |
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Common shares withheld for taxes | | (2,302 | ) | | (827 | ) |
Repurchase of common stock | | (1,086 | ) | | (2,663 | ) |
Net cash provided by financing activities | | 14,055 |
| | 7,787 |
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Effects of exchange rate changes | | 913 |
| | 406 |
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Net change in cash and cash equivalents | | (12,967 | ) | | (3,251 | ) |
Cash and cash equivalents at beginning of period | | 31,464 |
| | 24,236 |
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Cash and cash equivalents at end of period | | $ | 18,497 |
| | $ | 20,985 |
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The accompanying notes are an integral part of the 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 (referred to herein as the Company, our, we, or us) 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 2017 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 2016 Annual Report on Form 10-K. The interim period results are not necessarily indicative of the results to be expected for the full year.
Business Combinations: The Company records assets acquired and liabilities assumed at the date of acquisition at their respective fair values. Any intangible assets acquired in a business combination are recognized and reported apart from goodwill. Goodwill represents the excess purchase price over the fair value of the tangible net assets and intangible assets acquired in a business combination. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred.
The amounts reflected in Note B to the Consolidated Financial Statements are the results of the preliminary purchase price allocation and will be updated upon completion of the final valuation. The Company is required to complete the purchase price allocation within 12 months of the acquisition date. If such completion of the allocation results in a change in the preliminary values, the measurement period adjustment will be recognized in the period in which the adjustment amount is determined.
New Pronouncements Adopted: In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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 regard 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. The Company adopted the new guidance during the first quarter of 2017. An impact of adoption was the recognition of excess tax benefits in Income tax expense rather than Shareholders' equity in 2017. As a result, the Company recognized discrete tax benefits of $82 and $374 in Income tax (benefit) expense during the second quarter and first six months of 2017, respectively. The cash flow classification requirements of ASU 2016-09 were applied retrospectively. As a result, for the six months ended July 1, 2016, cash flows from operating activities increased by $827 with a corresponding decrease to cash flows from financing activities. None of the other provisions in this ASU had a material effect on the Company's consolidated financial statements.
New Pronouncements Issued: In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires an employer to report the service cost component of net benefit cost in the same line item as other compensation costs arising from services rendered by pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations. The amendments also allow only the service cost component to be eligible for capitalization. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those periods, with early adoption permitted. The amendments should be applied retrospectively for the presentation of service cost and other components of net benefit cost on the income statement and prospectively for the capitalization of service cost and net periodic postretirement benefits in assets. The Company is currently evaluating the impact of adopting this new guidance on its consolidated financial statements.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
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 its 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 and can be adopted either retrospectively or as a cumulative-effect adjustment as of the date of adoption. To evaluate the impact of adopting this new guidance on the consolidated financial statements, we established a cross-functional implementation team to assess our revenue streams against the requirements of this ASU. In addition, we are in the process of identifying and implementing changes to our processes and controls to meet the standard's updated reporting and disclosure requirements. The Company plans to adopt the standard as of the first quarter of 2018 using the modified retrospective approach and will record a cumulative adjustment to equity for open contracts as of January 1, 2018. The Company continues to update our assessment of the impact of the standard and related updates to its consolidated financial statements, and will disclose material impacts, if any.
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 — Acquisitions
On February 28, 2017, the Company acquired the target materials business of the Heraeus Group (HTB), of Hanau, Germany, for $16.5 million. This business manufactures precious and non-precious metal target materials for the architectural and automotive glass, electronic display, photovoltaic and semiconductor markets at facilities in Germany, Taiwan, and the United States. This business will operate within the Advanced Materials segment, and the results of operations are included as of the date of acquisition.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
The Company will make adjustments to the purchase price allocation prior to completion of the measurement period, as necessary. Only items identified as of the acquisition date will be considered for subsequent adjustment. The purchase price allocation for the acquisition is as follows:
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(Thousands) | Amount |
Assets: | |
Inventories | $ | 7,140 |
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Prepaid and other current assets | 902 |
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Long-term deferred income taxes | 1,450 |
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Property, plant, and equipment | 7,637 |
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Intangible assets | 3,236 |
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Goodwill | 2,891 |
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Total assets acquired | $ | 23,256 |
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Liabilities: | |
Other liabilities and accrued items | $ | 1,030 |
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Other long-term liabilities | 430 |
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Retirement and post-employment benefits | 5,292 |
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Total liabilities assumed | $ | 6,752 |
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Total purchase price | $ | 16,504 |
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As part of the acquisition, the Company recorded approximately $2.9 million of goodwill. Goodwill was calculated as the excess of the purchase price over the estimated fair values of the tangible net assets and intangible assets acquired. Also, the Company acquired approximately $3.2 million of other intangible assets, which will be amortized using the straight-line method over an average life of about ten years. The following table reports the intangible assets by asset category and accumulated amortization from the closing date through June 30, 2017:
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(Thousands) | | Value at Acquisition | | Accumulated Amortization | | Useful Life |
Customer relationships | | $ | 1,861 |
| | $ | (41 | ) | | 15 years |
Technology | | 1,375 |
| | (154 | ) | | 3 years |
Total | | $ | 3,236 |
| | $ | (195 | ) | | |
Note C — Segment Reporting
The Company has the following operating segments: Performance Alloys and Composites, Advanced Materials, Precision Coatings, and Other. The Company’s operating segments represent components of the Company for which separate financial information is available that is utilized on a regular basis by the Chief Executive Officer, the Company's Chief Operating Decision Maker, in determining how to allocate the Company’s resources and evaluate performance.
Performance Alloys and Composites produces strip and bulk form alloy products, strip metal products with clad inlay and overlay metals, beryllium-based metals, beryllium, and aluminum metal matrix composites, in rod, sheet, foil, and a variety of customized forms, beryllia ceramics, and bulk metallic glass materials.
Advanced Materials produces advanced chemicals, microelectric packaging, precious metal, non-precious metal, and specialty metal products, including vapor deposition targets, frame lid assemblies, clad and precious metal preforms, high temperature braze materials, and ultra-fine wire.
Precision Coatings produces thin film coatings, optical filter materials, sputter-coated, and precision-converted thin film materials.
The Other reportable segment includes unallocated corporate costs and assets.
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(Thousands) | | Performance Alloys and Composites | | Advanced Materials | | Precision Coatings | | Other | | Total |
Second Quarter 2017 | | | | | | | | | | |
Net sales | | $ | 108,541 |
| | $ | 157,044 |
| | $ | 30,257 |
| | $ | — |
| | $ | 295,842 |
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Intersegment sales | | 4 |
| | 13,247 |
| | — |
| | — |
| | 13,251 |
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Value-added sales | | 92,686 |
| | 62,041 |
| | 22,613 |
| | (1,241 | ) | | 176,099 |
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Operating profit (loss) | | 5,548 |
| | 8,670 |
| | 2,314 |
| | (6,798 | ) | | 9,734 |
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Second Quarter 2016 | | | | | | | | | | |
Net sales | | $ | 97,696 |
| | $ | 113,557 |
| | $ | 38,523 |
| | $ | — |
| | $ | 249,776 |
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Intersegment sales | | 117 |
| | 17,429 |
| | — |
| | — |
| | 17,546 |
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Value-added sales | | 83,350 |
| | 46,993 |
| | 25,111 |
| | (1,520 | ) | | 153,934 |
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Operating profit (loss) | | 234 |
| | 7,320 |
| | 2,272 |
| | (4,049 | ) | | 5,777 |
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| | | | | | | | | | |
First Six Months 2017 | | | | | | | | | | |
Net sales | | $ | 201,094 |
| | $ | 271,780 |
| | $ | 63,637 |
| | $ | — |
| | $ | 536,511 |
|
Intersegment sales | | 59 |
| | 29,694 |
| | — |
| | — |
| | 29,753 |
|
Value-added sales | | 171,897 |
| | 109,329 |
| | 45,914 |
| | (2,060 | ) | | 325,080 |
|
Operating profit (loss) | | 5,737 |
| | 15,117 |
| | 4,532 |
| | (12,232 | ) | | 13,154 |
|
First Six Months 2016 | | | | | | | | | | |
Net sales | | $ | 188,325 |
| | $ | 221,677 |
| | $ | 75,285 |
| | $ | — |
| | $ | 485,287 |
|
Intersegment sales | | 179 |
| | 32,605 |
| | — |
| | — |
| | 32,784 |
|
Value-added sales | | 161,552 |
| | 89,059 |
| | 49,745 |
| | (2,564 | ) | | 297,792 |
|
Operating profit (loss) | | 1,746 |
| | 12,503 |
| | 6,371 |
| | (7,311 | ) | | 13,309 |
|
Intersegment sales are eliminated in consolidation.
Note D — Other-net
Other-net expense for the second quarter and first six months of 2017 and 2016 is summarized as follows:
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| | | | | | | | | | | | | | | | |
| | Second Quarter Ended | | Six Months Ended |
| | June 30, | | July 1, | | June 30, | | July 1, |
(Thousands) | | 2017 | | 2016 | | 2017 | | 2016 |
Foreign currency exchange/translation loss (gain) | | $ | (336 | ) | | $ | 650 |
| | $ | (593 | ) | | $ | 641 |
|
Amortization of intangible assets | | 1,232 |
| | 1,148 |
| | 2,277 |
| | 2,296 |
|
Metal consignment fees | | 2,062 |
| | 1,653 |
| | 3,747 |
| | 3,186 |
|
Net loss (gain) on disposal of fixed assets | | 119 |
| | 25 |
| | 147 |
| | (695 | ) |
Other items | | 127 |
| | 445 |
| | 444 |
| | 379 |
|
Total | | $ | 3,204 |
| | $ | 3,921 |
| | $ | 6,022 |
| | $ | 5,807 |
|
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
Note E — Restructuring
In the first six months of 2017, the Company took cost reduction measures in order to align corporate costs with lower business levels. These actions were accomplished through elimination of vacant positions, consolidation of roles, and staff reduction. Costs associated with the plan included severance associated with approximately five employees and other related costs.
In 2016, the Company initiated a plan to close the Fukuya, Japan service center, which is a part of the Performance Alloys and Composites segment. Costs associated with the plan included severance associated with approximately twelve employees and related facility exit costs.
These costs are presented in the Consolidated Statements of Income as follows: |
| | | | | | | | | | | | | | | | |
| | Second Quarter Ended | | Six Months Ended |
(Thousands) | | June 30, 2017 | | July 1, 2016 | | June 30, 2017 | | July 1, 2016 |
Cost of sales | | $ | 117 |
| | $ | — |
| | $ | 117 |
| | $ | — |
|
Selling, general, and administrative (SG&A) expense | | 578 |
| | — |
| | 1,132 |
| | — |
|
Total | | $ | 695 |
| | $ | — |
| | $ | 1,249 |
| | $ | — |
|
Remaining severance payments related to this initiative of $0.3 million are reflected within Other liabilities and accrued items in the Consolidated Balance Sheets. The Company does not expect to incur additional costs related to these initiatives.
Note F — Income Taxes
The Company recorded income tax expense of $1.7 million in the second quarter of 2017, an effective tax rate of 19.1% against income before income taxes and an income tax benefit of $0.3 million in the second quarter of 2016, with a negative effective tax rate of 5.4% against income before income taxes.
In the first six months of 2017, income tax expense of $1.6 million was calculated using an effective tax rate of 13.4%, while income tax expense of $1.5 million in the first six months of 2016 was calculated using an effective tax rate of 11.8%.
The Company recorded discrete benefits of $0.1 million and $0.8 million, respectively, in the second quarter and first six months of 2017. Of these amounts, $0.4 million in the first six months of 2017 related to officer compensation which was previously considered non-deductible and $0.1 million in the second quarter and $0.4 million in the first six months of 2017 related to the adoption of ASU 2016-09, Improvements to Employee Share-based Payment Accounting.
In the second quarter of 2016, the Company recorded a discrete tax benefit of $0.9 million, resulting from international tax planning initiatives. For the first six months of 2016, discrete items amounted to a net benefit of $0.8 million.
In addition to the discrete benefits listed above, the difference between the statutory and effective rates in the second quarter and first six months of both years was primarily due to the impact of percentage depletion, the foreign rate differential, the research and development credit, and other items.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
Note G — Earnings Per Share
The following table sets forth the computation of basic and diluted EPS:
|
| | | | | | | | | | | | | | | | |
| | Second Quarter Ended | | Six Months Ended |
| | June 30, | | July 1, | | June 30, | | July 1, |
(Thousands, except per share amounts) | | 2017 | | 2016 | | 2017 | | 2016 |
Numerator for basic and diluted EPS: | | | | | | | | |
Net income | | $ | 7,313 |
| | $ | 5,549 |
| | $ | 10,363 |
| | $ | 10,917 |
|
Denominator: | | | | | | | | |
Denominator for basic EPS: | | | | | | | | |
Weighted-average shares outstanding | | 20,012 |
| | 20,015 |
| | 19,991 |
| | 20,016 |
|
Effect of dilutive securities: | | | | | | | | |
Stock appreciation rights | | 125 |
| | 63 |
| | 152 |
| | 63 |
|
Restricted stock units | | 102 |
| | 75 |
| | 102 |
| | 90 |
|
Performance-based restricted stock units | | 108 |
| | 61 |
| | 103 |
| | 51 |
|
Diluted potential common shares | | 335 |
| | 199 |
| | 357 |
| | 204 |
|
Denominator for diluted EPS: | |
| |
| | | | |
Adjusted weighted-average shares outstanding | | 20,347 |
| | 20,214 |
| | 20,348 |
| | 20,220 |
|
Basic EPS | | $ | 0.37 |
| | $ | 0.28 |
| | $ | 0.52 |
| | $ | 0.55 |
|
Diluted EPS | | $ | 0.36 |
| | $ | 0.27 |
| | $ | 0.51 |
| | $ | 0.54 |
|
Stock appreciation rights (SARs) totaling 31,835 and 1,018,778 for the quarters ended June 30, 2017 and July 1, 2016, respectively, and 67,761 and 1,018,778 for the six months ended June 30, 2017 and July 1, 2016, respectively, were excluded from the dilution calculation as their effect would have been anti-dilutive.
Note H — Inventories
Inventories on the Consolidated Balance Sheets are summarized as follows:
|
| | | | | | | | |
| | June 30, | | Dec. 31, |
(Thousands) | | 2017 | | 2016 |
Raw materials and supplies | | $ | 41,222 |
| | $ | 36,233 |
|
Work in process | | 178,063 |
| | 169,327 |
|
Finished goods | | 39,858 |
| | 38,147 |
|
Subtotal | | $ | 259,143 |
| | $ | 243,707 |
|
Less: LIFO reserve balance | | 43,156 |
| | 42,842 |
|
Inventories | | $ | 215,987 |
| | $ | 200,865 |
|
The liquidation of last in, first out (LIFO) inventory layers increased cost of sales in both the second quarter and first six months of 2017 by $0.2 million. In the second quarter and first six months of 2016, cost of sales was reduced by $0.5 million and $3.2 million, respectively.
Note I — Pensions and Other Post-employment Benefits
The following is a summary of the net periodic benefit cost for the second quarter and first six months of 2017 and 2016 for the domestic pension plans (which include the defined benefit pension plan and the supplemental retirement plans) and the domestic retiree medical plan.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
|
| | | | | | | | | | | | | | | | |
|
| Pension Benefits |
| Other Benefits |
|
| Second Quarter Ended |
| Second Quarter Ended |
|
| June 30, |
| July 1, |
| June 30, |
| July 1, |
(Thousands) |
| 2017 |
| 2016 |
| 2017 |
| 2016 |
Components of net periodic benefit cost |
|
|
|
|
|
|
|
|
Service cost |
| $ | 2,070 |
|
| $ | 1,946 |
|
| $ | 23 |
|
| $ | 25 |
|
Interest cost |
| 2,370 |
|
| 2,595 |
|
| 99 |
|
| 141 |
|
Expected return on plan assets |
| (3,671 | ) |
| (3,488 | ) |
| — |
|
| — |
|
Amortization of prior service benefit |
| (73 | ) |
| (115 | ) |
| (374 | ) |
| (374 | ) |
Amortization of net loss |
| 1,611 |
|
| 1,430 |
|
| — |
|
| — |
|
Net periodic benefit cost (benefit) |
| $ | 2,307 |
|
| $ | 2,368 |
|
| $ | (252 | ) |
| $ | (208 | ) |
| | | | | | | | |
| | Pension Benefits | | Other Benefits |
| | Six Months Ended | | Six Months Ended |
| | June 30, | | July 1, | | June 30, | | July 1, |
(Thousands) | | 2017 | | 2016 | | 2017 | | 2016 |
Components of net periodic benefit cost | | | | | | | | |
Service cost | | $ | 4,082 |
| | $ | 3,891 |
| | $ | 46 |
| | $ | 51 |
|
Interest cost | | 4,726 |
| | 5,190 |
| | 198 |
| | 282 |
|
Expected return on plan assets | | (7,329 | ) | | (6,976 | ) | | — |
| | — |
|
Amortization of prior service benefit | | (194 | ) | | (230 | ) | | (748 | ) | | (748 | ) |
Amortization of net loss | | 3,198 |
| | 2,861 |
| | — |
| | — |
|
Net periodic benefit cost (benefit) | | $ | 4,483 |
| | $ | 4,736 |
| | $ | (504 | ) | | $ | (415 | ) |
The Company made contributions to the domestic defined benefit pension plan of $4.0 million and $8.0 million in the first six months of 2017 and 2016, respectively.
Beginning in 2017, the Company has elected to use 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 for each projected benefit payment in the calculation. Historically, the Company used a weighted-average approach to determine the service and interest cost components. The change is being accounted for as a change in estimate and, accordingly, is being applied prospectively. The reduction in service and interest costs for 2017 associated with this change approximated $0.2 million and $0.5 million during the second quarter and first six months of 2017, respectively, and is expected to total approximately $1.0 million.
Note J — Accumulated Other Comprehensive Income (Loss)
Changes in the components of accumulated other comprehensive income, including the amounts reclassified, for the second quarter and first six months of 2017 and 2016 are as follows:
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Gains and Losses on Cash Flow Hedges | | | | | | |
(Thousands) | | Foreign Currency | | Precious Metals | | Total | | Pension and Post-Employment Benefits | | Foreign Currency Translation | | Total |
Balance at March 31, 2017 |
| $ | 1,476 |
|
| $ | (100 | ) |
| $ | 1,376 |
|
| $ | (81,601 | ) |
| $ | (4,557 | ) |
| $ | (84,782 | ) |
Other comprehensive income (loss) before reclassifications |
| (629 | ) |
| 393 |
|
| (236 | ) |
| — |
|
| 275 |
|
| 39 |
|
Amounts reclassified from accumulated other comprehensive income |
| 47 |
|
| (88 | ) |
| (41 | ) |
| 1,156 |
|
| — |
|
| 1,115 |
|
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Gains and Losses on Cash Flow Hedges | | | | | | |
(Thousands) | | Foreign Currency | | Precious Metals | | Total | | Pension and Post-Employment Benefits | | Foreign Currency Translation | | Total |
Net current period other comprehensive income (loss) before tax |
| (582 | ) |
| 305 |
|
| (277 | ) |
| 1,156 |
|
| 275 |
|
| 1,154 |
|
Deferred taxes on current period activity |
| (215 | ) |
| 112 |
|
| (103 | ) |
| 397 |
|
| — |
|
| 294 |
|
Net current period other comprehensive income (loss) after tax |
| (367 | ) |
| 193 |
|
| (174 | ) |
| 759 |
|
| 275 |
|
| 860 |
|
Balance at June 30, 2017 |
| $ | 1,109 |
|
| $ | 93 |
|
| $ | 1,202 |
|
| $ | (80,842 | ) |
| $ | (4,282 | ) |
| $ | (83,922 | ) |
| | | | | | | | | | | | |
Balance at April 1, 2016 | | $ | 656 |
| | $ | — |
| | $ | 656 |
| | $ | (75,221 | ) | | $ | (4,204 | ) | | $ | (78,769 | ) |
Other comprehensive income (loss) before reclassifications | | 98 |
| | — |
| | 98 |
| | — |
| | 1,167 |
| | 1,265 |
|
Amounts reclassified from accumulated other comprehensive income | | 382 |
| | — |
| | 382 |
| | 1,016 |
| | — |
| | 1,398 |
|
Net current period other comprehensive income (loss) before tax | | 480 |
| | — |
| | 480 |
| | 1,016 |
| | 1,167 |
| | 2,663 |
|
Deferred taxes on current period activity | | 178 |
| | — |
| | 178 |
| | 341 |
| | — |
| | 519 |
|
Net current period other comprehensive income (loss) after tax | | 302 |
| | — |
| | 302 |
| | 675 |
| | 1,167 |
| | 2,144 |
|
Balance at July 1, 2016 | | $ | 958 |
| | $ | — |
| | $ | 958 |
| | $ | (74,546 | ) | | $ | (3,037 | ) | | $ | (76,625 | ) |
| | | | | | | | | | | | |
Balance at December 31, 2016 |
| $ | 1,837 |
|
| $ | — |
|
| $ | 1,837 |
|
| $ | (82,358 | ) |
| $ | (5,660 | ) |
| $ | (86,181 | ) |
Other comprehensive income (loss) before reclassifications |
| (881 | ) |
| 235 |
|
| (646 | ) |
| — |
|
| 1,378 |
|
| 732 |
|
Amounts reclassified from accumulated other comprehensive income |
| (214 | ) |
| (88 | ) |
| (302 | ) |
| 2,309 |
|
| — |
|
| 2,007 |
|
Net current period other comprehensive income (loss) before tax |
| (1,095 | ) |
| 147 |
|
| (948 | ) |
| 2,309 |
|
| 1,378 |
|
| 2,739 |
|
Deferred taxes on current period activity |
| (367 | ) |
| 54 |
|
| (313 | ) |
| 793 |
|
| — |
|
| 480 |
|
Net current period other comprehensive income (loss) after tax |
| (728 | ) |
| 93 |
|
| (635 | ) |
| 1,516 |
|
| 1,378 |
|
| 2,259 |
|
Balance at June 30, 2017 |
| $ | 1,109 |
|
| $ | 93 |
|
| $ | 1,202 |
|
| $ | (80,842 | ) |
| $ | (4,282 | ) |
| $ | (83,922 | ) |
| | | | | | | | | | | | |
Balance at December 31, 2015 | | $ | 1,579 |
| | $ | — |
| | $ | 1,579 |
| | $ | (76,796 | ) | | $ | (5,488 | ) | | $ | (80,705 | ) |
Other comprehensive income (loss) before reclassifications | | (1,445 | ) | | — |
| | (1,445 | ) | | — |
| | 2,451 |
| | 1,006 |
|
Amounts reclassified from accumulated other comprehensive income | | 457 |
| | — |
| | 457 |
| | 2,030 |
| | — |
| | 2,487 |
|
Net current period other comprehensive income (loss) before tax | | (988 | ) | | — |
| | (988 | ) | | 2,030 |
| | 2,451 |
| | 3,493 |
|
Deferred taxes on current period activity | | (367 | ) | | — |
| | (367 | ) | | (220 | ) | | — |
| | (587 | ) |
Net current period other comprehensive income (loss) after tax | | (621 | ) | | — |
| | (621 | ) | | 2,250 |
| | 2,451 |
| | 4,080 |
|
Balance at July 1, 2016 | | $ | 958 |
| | $ | — |
| | $ | 958 |
| | $ | (74,546 | ) | | $ | (3,037 | ) | | $ | (76,625 | ) |
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
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. Reclassifications from accumulated other comprehensive income of gains and losses on precious metal cash flow hedges are recorded in Cost of sales in the Consolidated Statements of Income. Refer to Note M 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 I for additional details on pension and post-employment expenses.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
Note K — Stock-based Compensation Expense
Stock-based compensation expense, which includes awards settled in shares and in cash, was $2.4 million and $4.7 million in the second quarter and first six months of 2017, respectively, compared to $1.1 million and $2.3 million in the same periods of 2016.
The Company granted 97,015 SARs to certain employees during the first six months of 2017. The weighted-average exercise price per share and weighted-average fair value per share of the SARs granted during the six months ended June 30, 2017 were $35.26 and $10.89, respectively. The Company estimated the fair value of the SARs using the following weighted-average assumptions in the Black-Scholes model:
|
| | | |
Risk-free interest rate | | 1.92 | % |
Dividend yield | | 1.1 | % |
Volatility | | 34.0 | % |
Expected term (in years) | | 5.6 |
|
The Company granted 62,185 stock-settled restricted stock units (RSUs) and 32,466 cash-settled RSUs to certain employees and non-employee directors during the first six months of 2017. The Company measures the fair value of stock-settled 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 $34.95 for stock-settled RSUs granted during the six months ended June 30, 2017. 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 six months of 2017. The weighted-average fair value of the stock-settled PRSUs was $30.28 per share and will be expensed over the vesting period of three years. The liability for cash-settled PRSUs is re-measured 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 June 30, 2017, unearned compensation cost related to the unvested portion of all stock-based awards was approximately $6.3 million, and is expected to be recognized over the remaining vesting period of the respective grants.
Note L — 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 June 30, 2017 and December 31, 2016:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | |
(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) |
| 2017 | | 2016 | | 2017 | | 2016 | | 2017 | | 2016 | | 2017 | | 2016 |
Financial Assets | | | | | | | | | | | | | | | | |
Deferred compensation investments | | $ | 2,075 |
| | $ | 1,734 |
| | $ | 2,075 |
| | $ | 1,734 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
|
Foreign currency forward contracts | | 72 |
| | 691 |
| | — |
| | — |
| | 72 |
| | 691 |
| | — |
| | — |
|
Precious metal swaps | | 191 |
| | — |
| | — |
| | — |
| | 191 |
| | — |
| | — |
| | — |
|
Total | | $ | 2,338 |
| | $ | 2,425 |
| | $ | 2,075 |
| | $ | 1,734 |
| | $ | 263 |
| | $ | 691 |
|
| $ | — |
|
| $ | — |
|
Financial Liabilities | | | | | | | | | | | | | | | | |
Deferred compensation liability | | $ | 2,075 |
| | $ | 1,734 |
| | $ | 2,075 |
| | $ | 1,734 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
|
Foreign currency forward contracts | | 1,066 |
| | 1 |
| | — |
| | — |
| | 1,066 |
| | 1 |
| | — |
| | — |
|
Precious metal swaps | | 44 |
| | — |
| | — |
| | — |
| | 44 |
| | — |
| | — |
| | — |
|
Total | | $ | 3,185 |
| | $ | 1,735 |
| | $ | 2,075 |
| | $ | 1,734 |
| | $ | 1,110 |
| | $ | 1 |
| | $ | — |
| | $ | — |
|
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 Sheets approximate fair values as of June 30, 2017 and December 31, 2016.
Note M — Derivative Instruments and Hedging Activity
The Company uses derivative contracts to hedge portions of its foreign currency exposures and uses 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
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
contracts are typically layered in at different times for a specified exposure period in order to minimize the impact of rate movements.
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.
In certain circumstances, the Company also refines metal from the customer and may retain a portion of the refined metal as payment. The Company may elect to enter into a forward contract to sell precious metal to reduce the Company's price exposure.
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.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
The following table summarizes the notional amount and the fair value of the Company’s outstanding derivatives not designated as hedging instruments and balance sheet classification as of June 30, 2017 and December 31, 2016:
|
| | | | | | | | | | | | | | | | |
| | June 30, 2017 | | December 31, 2016 |
(Thousands) | | Notional Amount | | Fair Value | | Notional Amount | | Fair Value |
Other liabilities and accrued items | | | | | | | | |
Foreign currency forward contracts - euro | | $ | 12,223 |
| | $ | (590 | ) | | $ | — |
| | $ | — |
|
Total | | $ | 12,223 |
| | $ | (590 | ) | | $ | — |
| | $ | — |
|
These outstanding foreign currency derivatives were related to intercompany loans. Other-net included foreign currency losses of $0.5 million relating to these derivatives during the second quarter of 2017 and $0.6 million during the first six months of 2017.
The following table summarizes the notional amount and the fair value of the Company’s outstanding derivatives designated as cash flow hedges and balance sheet classification as of June 30, 2017 and December 31, 2016:
|
| | | | | | | | | | | | | | | | |
| | June 30, 2017 | | December 31, 2016 |
(Thousands) | | Notional Amount | | Fair Value | | Notional Amount | | Fair Value |
Prepaid expenses | | | | | | | | |
Foreign currency forward contracts - yen | | $ | 1,450 |
| | $ | 64 |
| | $ | 2,418 |
| | $ | 239 |
|
Foreign currency forward contracts - euro | | 915 |
| | 8 |
| | 6,493 |
| | 452 |
|
Precious metal swaps | | 6,402 |
| | 125 |
| | — |
| | — |
|
Total | | 8,767 |
| | 197 |
| | 8,911 |
| | 691 |
|
| | | | | | | | |
Other assets | | | | | | | | |
Precious metal swaps | | 3,335 |
| | 66 |
| | — |
| | — |
|
Total | | 3,335 |
| | 66 |
| | — |
| | — |
|
| | | | | | | | |
Other liabilities and accrued items | | | | | | | | |
Foreign currency forward contracts - euro | | 10,523 |
| | (476 | ) | | 537 |
| | (1 | ) |
Precious metal swaps | | 2,576 |
| | (42 | ) | | — |
| | — |
|
Total | | 13,099 |
| | (518 | ) | | 537 |
| | (1 | ) |
| | | | | | | | |
Other long-term liabilities | | | | | | | | |
Precious metal swaps | | 188 |
| | (2 | ) | | — |
| | — |
|
Total | | $ | 25,389 |
| | $ | (257 | ) | | $ | 9,448 |
| | $ | 690 |
|
All of these contracts were designated and effective as cash flow hedges. No ineffectiveness expense was recorded in the second quarter or first six months of 2017 or 2016.
Changes in the fair value of outstanding cash flow hedges recorded in OCI for the first six months of 2017 and 2016 totaled decreases of $0.6 million and $1.4 million, respectively. The Company expects to relieve substantially the entire balance in OCI as of June 30, 2017 to the Consolidated Statements of Income within the next 18-month period. Refer to Note J for additional OCI details.
Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
Note N — Contingencies
Legal Proceedings. For information regarding legal proceedings relating to Chronic Beryllium Disease Claims, refer to Note Q ("Contingencies and Commitments") in the Company's Annual Report on Form 10-K for the year ended December 31, 2016.
Other litigation. The Company is party to several pending legal proceedings and claims arising in the normal course of business. The Company records a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. In the event the Company determines that a loss is not probable, but is reasonably possible, and it becomes possible to develop what the Company believes to be a reasonable range of possible loss, then the Company will include disclosure related to such matters. To the extent there is a reasonable possibility that the losses could exceed any amounts accrued, the Company will adjust the accrual in the period the determination is made, disclose an estimate of the additional loss or range of loss, indicate that the estimate is immaterial with respect to its financial statements as a whole or, if the amount of such adjustment cannot be reasonably estimated, disclose that an estimate cannot be made.
Environmental Proceedings. 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 $6.2 million at June 30, 2017 and $6.0 million at December 31, 2016. 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, defense, medical, automotive electronics, telecommunications infrastructure, energy, commercial aerospace, science, services, and appliance.
RESULTS OF OPERATIONS
Second Quarter
|
| | | | | | | | | | | | | | | |
| | Second Quarter Ended |
| | June 30, | | July 1, | | $ | | % |
(Thousands, except per share data) | | 2017 | | 2016 | | Change | | Change |
Net sales | | $ | 295,842 |
| | $ | 249,776 |
| | $ | 46,066 |
| | 18 | % |
Value-added sales | | 176,099 |
| | 153,934 |
| | 22,165 |
| | 14 | % |
Gross margin | | 54,557 |
| | 45,306 |
| | 9,251 |
| | 20 | % |
Gross margin as a % of value-added sales | | 31 | % | | 29 | % | | N/A |
| | N/A |
|
Selling, general, and administrative (SG&A) expense
| | 38,075 |
| | 32,437 |
| | 5,638 |
| | 17 | % |
SG&A expense as a % of value-added sales | | 22 | % | | 21 | % | | N/A |
| | N/A |
|
Research and development (R&D) expense | | 3,544 |
| | 3,171 |
| | 373 |
| | 12 | % |
R&D expense as a % of value-added sales | | 2 | % | | 2 | % | | N/A |
| | N/A |
|
Other—net | | 3,204 |
| | 3,921 |
| | (717 | ) | | (18 | )% |
Operating profit | | 9,734 |
|
| 5,777 |
| | 3,957 |
| | 68 | % |
Interest expense—net | | 695 |
| | 512 |
| | 183 |
| | 36 | % |
Income before income taxes | | 9,039 |
| | 5,265 |
| | 3,774 |
| | 72 | % |
Income tax expense (benefit) | | 1,726 |
| | (284 | ) | | 2,010 |
| | (708 | )% |
Net income | | $ | 7,313 |
| | $ | 5,549 |
| | $ | 1,764 |
| | 32 | % |
| | | | | | | | |
Diluted earnings per share | | $ | 0.36 |
| | $ | 0.27 |
| | $ | 0.09 |
| | 33 | % |
N/A = Not Applicable
Net sales of $295.8 million in the second quarter of 2017 were $46.0 million higher than the $249.8 million recorded in the second quarter of 2016. Changes in precious metal and copper prices favorably impacted net sales in the second quarter of 2017 by approximately $2.2 million when compared to the second quarter of 2016. Net sales in the Performance Alloys and Composites segment increased $10.8 million due to higher sales volume, including shipments of raw material beryllium hydroxide under a new supply agreement with a long-standing customer. Net sales of $32.3 million during the second quarter of 2017 were attributable to the high performance target materials business of the Heraeus Group (HTB). Excluding the HTB acquisition, net sales in the Advanced Materials segment increased $11.2 million due to higher sales volume in the consumer electronics and industrial components end markets. These favorable impacts were offset by lower sales volume in the medical end market in the Precision Coatings segment.
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, the most directly comparable GAAP measure, to value-added sales is included herein. Value-added sales of $176.1 million in the second quarter of 2017 increased $22.2 million, or 14% compared to the second quarter of 2016. Value-added sales from the HTB acquisition totaled $10.6 million in the second quarter of 2017. Value-added sales to the consumer electronics end market, which accounted for 30% of our total value-added sales during the second quarter of 2017, increased $3.2 million from the prior-year period. Also, value-added sales in the industrial components increased $4.0 million from the prior-year period. These increases were offset by weakness in the medical and defense end markets, which lowered value-added sales by $3.0 million.
Gross margin in the second quarter of 2017 was $54.6 million, or $9.3 million higher than the $45.3 million gross margin recorded during the second quarter of 2016. Expressed as a percentage of value-added sales, gross margin increased from 29% in the second quarter of 2016 to 31% in the second quarter of 2017.
SG&A expense was $38.1 million in the second quarter of 2017, or $5.7 million higher than $32.4 million in the second quarter of 2016. The increase related to higher incentive and stock-based compensation expense of $4.3 million. Additionally, the increase is attributable to $1.5 million of HTB expenses.
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 flat as a percentage of value-added sales at approximately 2% in the second quarter of both 2017 and 2016.
Other-net was $3.2 million of expense in the second quarter of 2017, or a $0.7 million decrease from the second quarter of 2016. Other-net in the second quarter of 2017 included foreign currency exchange gains of $0.3 million compared to a foreign currency exchange loss of $0.7 million in the second quarter of 2016. Additionally, Other-net in the second quarter of 2017 included higher metal consignment fees of $0.4 million. Refer to Note D to the Consolidated Financial Statements for details of the major components within Other-net.
Interest expense-net was $0.7 million in the second quarter of 2017, or a $0.2 million increase from $0.5 million in the second quarter of 2016 due to higher average debt outstanding.
Income tax expense for the second quarter of 2017 was $1.7 million versus a benefit of $0.3 million in the second quarter of 2016. The effective tax rate for the second quarter of 2017 was 19.1% compared to a negative effective tax rate of 5.4% in the prior-year period. The effects of discrete items, percentage depletion, the foreign rate differential, the research and development credit, and other items were the primary factors for the difference between the effective and statutory rates in the second quarter of 2017 and 2016. Refer to Note F to the Consolidated Financial Statements for further details on income taxes.
Six Months
|
| | | | | | | | | | | | | | | |
| | Six Months Ended |
| | June 30, | | July 1, | | $ | | % |
(Thousands, except per share data) | | 2017 | | 2016 | | Change | | Change |
Net sales | | $ | 536,511 |
| | $ | 485,287 |
| | $ | 51,224 |
| | 11 | % |
Value-added sales | | 325,080 |
| | 297,792 |
| | 27,288 |
| | 9 | % |
Gross margin | | 97,553 |
| | 88,663 |
| | 8,890 |
| | 10 | % |
Gross margin as a % of value-added sales | | 30 | % | | 30 | % | | N/A |
| | N/A |
|
SG&A expense
| | 71,703 |
| | 62,924 |
| | 8,779 |
| | 14 | % |
SG&A expense as a % of value-added sales | | 22 | % | | 21 | % | | N/A |
| | N/A |
|
R&D expense | | 6,674 |
| | 6,623 |
| | 51 |
| | 1 | % |
R&D expense as a % of value-added sales | | 2 | % | | 2 | % | | N/A |
| | N/A |
|
Other—net | | 6,022 |
| | 5,807 |
| | 215 |
| | 4 | % |
Operating profit | | 13,154 |
| | 13,309 |
| | (155 | ) | | (1 | )% |
Interest expense—net | | 1,188 |
| | 927 |
| | 261 |
| | 28 | % |
Income before income taxes | | 11,966 |
| | 12,382 |
| | (416 | ) | | (3 | )% |
Income tax expense | | 1,603 |
| | 1,465 |
| | 138 |
| | 9 | % |
Net income | | $ | 10,363 |
| | $ | 10,917 |
| | $ | (554 | ) | | (5 | )% |
| | | | | | | | |
Diluted earnings per share | | $ | 0.51 |
| | $ | 0.54 |
| | $ | (0.03 | ) | | (6 | )% |
N/A = Not Applicable
Net sales of $536.5 million in the first six months of 2017 were $51.2 million higher than the $485.3 million recorded in the first six months of 2016. Changes in precious metal and copper prices favorably impacted net sales in the first six months of 2017 by approximately $8.4 million when compared to the first six months of 2016. Net sales in the Performance Alloys and Composites segment increased $12.8 million due to higher sales volume, including shipments of raw material beryllium hydroxide. Net sales of $39.3 million during the first six months of 2017 were attributable to the HTB acquisition. Excluding the HTB acquisition, net sales in the Advanced Materials segment increased $10.8 million due to higher sales volume in the consumer electronics and industrial components end markets. These favorable impacts were offset by lower sales volume in the medical end market in the Precision Coatings segment.
Value-added sales of $325.1 million in the first six months of 2017 increased $27.3 million, or 9% compared to the first six months of 2016. Value-added sales from the HTB acquisition totaled approximately $13.5 million in the first six months of 2017. Excluding the HTB acquisition, value-added sales to the consumer electronics end market, which accounted for 30% of our total value-added sales during the first six months of 2017, increased $6.5 million from the prior-year period. Also, value-added sales in the industrial components end market increased $6.1 million from the prior-year period. These increases were offset by weakness in the medical and defense end markets, which lowered value-added sales by $5.9 million.
Gross margin in the first six months of 2017 was $97.6 million, or $8.9 million higher than the $88.7 million gross margin recorded during the first six months of 2016. Gross margin was 30% of value-added sales in the first half of both 2017 and 2016.
SG&A expense was $71.7 million in the first six months of 2017, or $8.8 million higher than $62.9 million in the first six months of 2016. The increase related to higher incentive compensation and stock-based compensation expense of $6.5 million, which included $1.4 million due to accelerated stock compensation expense associated with the transition of the Company's CEO. Additionally, the increase is attributable to HTB expenses of $2.1 million.
R&D expense was flat as a percentage of value-added sales at approximately 2% in the first six months of both 2017 and 2016.
Other-net was $6.0 million and $5.8 million of expense in the first six months of 2017 and 2016, respectively. Other-net in the first six months of 2017 included foreign currency exchange gains of $0.6 million compared to a foreign currency exchange loss of $0.6 million in the second quarter of 2016. Additionally, Other-net in the first six months of 2017 included higher metal consignment fees of $0.6 million. Other-net in the first six months of 2016 included a net gain on the sale of equipment of $0.7 million. Refer to Note D to the Consolidated Financial Statements for details of the major components within Other-net.
Interest expense-net was $1.2 million in the first six months of 2017, or a $0.3 million increase from $0.9 million in the first six months of 2016 due to higher average debt outstanding.
Income tax expense for the first six months of 2017 was $1.6 million, compared to $1.5 million in the first six months of 2016. The effective tax rate for the first six months of 2017 was 13.4% compared to an effective tax rate of 11.8% in the prior-year period. The effects of discrete items, percentage depletion, the foreign rate differential, the research and development credit, and other items were the primary factors for the difference between the effective and statutory rates in the first half of 2017 and 2016. Refer to Note F to the Consolidated Financial Statements for further details on income taxes.
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 six months of 2017 and 2016 is as follows:
|
| | | | | | | | | | | | | | | | |
| | Second Quarter Ended | | Six Months Ended |
| | June 30, |
| July 1, | | June 30, | | July 1, |
(Thousands) | | 2017 |
| 2016 | | 2017 | | 2016 |
Net sales | | | | | | | | |
Performance Alloys and Composites | | $ | 108,541 |
| | $ | 97,696 |
| | $ | 201,094 |
| | $ | 188,325 |
|
Advanced Materials | | 157,044 |
| | 113,557 |
| | 271,780 |
| | 221,677 |
|
Precision Coatings | | 30,257 |
| | 38,523 |
| | 63,637 |
| | 75,285 |
|
Other | | — |
| | — |
| | — |
| | — |
|
Total | | $ | 295,842 |
| | $ | 249,776 |
| | $ | 536,511 |
| | $ | 485,287 |
|
| | | | | | | | |
Less: pass-through metal costs | | | | | | | | |
Performance Alloys and Composites | | $ | 15,855 |
| | $ | 14,346 |
| | $ | 29,197 |
| | $ | 26,773 |
|
Advanced Materials | | 95,003 |
| | 66,564 |
| | 162,451 |
| | 132,618 |
|
Precision Coatings | | 7,644 |
| | 13,412 |
| | 17,723 |
| | 25,540 |
|
Other | | 1,241 |
| | 1,520 |
| | 2,060 |
| | 2,564 |
|
Total | | $ | 119,743 |
| | $ | 95,842 |
| | $ | 211,431 |
| | $ | 187,495 |
|
| | | | | | | | |
Value-added sales | | | | | | | | |
Performance Alloys and Composites | | $ | 92,686 |
| | $ | 83,350 |
| | $ | 171,897 |
| | $ | 161,552 |
|
Advanced Materials | | 62,041 |
| | 46,993 |
| | 109,329 |
| | 89,059 |
|
Precision Coatings | | 22,613 |
| | 25,111 |
| | 45,914 |
| | 49,745 |
|
Other | | (1,241 | ) | | (1,520 | ) | | (2,060 | ) | | (2,564 | ) |
Total | | $ | 176,099 |
| | $ | 153,934 |
| | $ | 325,080 |
| | $ | 297,792 |
|
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. Non-GAAP financial measures, such as value-added sales, have inherent limitations and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP.
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 four reportable segments: Performance Alloys and Composites, Advanced Materials, Precision Coatings, and Other. The Other reportable segment includes unallocated corporate costs.
Performance Alloys and Composites
Second Quarter
|
| | | | | | | | | | | | | | | |
| | Second Quarter Ended |
| | June 30, | | July 1, | | $ | | % |
(Thousands) | | 2017 | | 2016 | | Change | | Change |
Net sales | | $ | 108,541 |
| | $ | 97,696 |
| | $ | 10,845 |
| | 11 | % |
Value-added sales | | 92,686 |
| | 83,350 |
| | 9,336 |
| | 11 | % |
Operating profit | | 5,548 |
| | 234 |
| | 5,314 |
| | 2,271 | % |
Net sales from the Performance Alloys and Composites segment of $108.5 million in the second quarter of 2017 were 11% higher than net sales of $97.7 million in the second quarter of 2016 primarily due to higher sales volume related to shipments of raw material beryllium hydroxide. In addition, sales volume increased in the commercial aerospace, industrial components, and consumer electronics end markets. The impact of higher pass-through metal prices favorably impacted net sales by approximately $2.0 million.
Value-added sales of $92.7 million in the second quarter of 2017 were 11% higher than value-added sales of $83.4 million in the second quarter of 2016. The increase in value-added sales was driven by higher raw material sales of beryllium hydroxide of $5.3 million. Also, stronger demand in the consumer electronics and industrial components end markets increased value-added sales by $3.8 million compared to the second quarter of 2016.
Performance Alloys and Composites generated operating profit of $5.5 million in the second quarter of 2017 compared to $0.2 million in the second quarter of 2016. The increase in operating profit was primarily due to higher sales volume, favorable product mix, and productivity improvements.
Six Months |
| | | | | | | | | | | | | | | |
| | Six Months Ended |
| | June 30, | | July 1, | | $ | | % |
(Thousands) | | 2017 | | 2016 | | Change | | Change |
Net sales | | $ | 201,094 |
| | $ | 188,325 |
| | $ | 12,769 |
| | 7 | % |
Value-added sales | | 171,897 |
| | 161,552 |
| | 10,345 |
| | 6 | % |
Operating profit | | 5,737 |
| | 1,746 |
| | 3,991 |
| | 229 | % |
Net sales from the Performance Alloys and Composites segment of $201.1 million in the first six months of 2017 were 7% higher than net sales of $188.3 million in the first six months of 2016 primarily due to higher sales volume related to shipments of raw material beryllium hydroxide. Also, sales volume increased in the consumer electronics and industrial components end markets. The impact of higher pass-through metal prices favorably impacted net sales by approximately $4.1 million.
Value-added sales of $171.9 million in the first six months of 2017 were 6% higher than value-added sales of $161.6 million in the first six months of 2016. Stronger demand in the consumer electronics and industrial components end markets increased value-added sales by $6.8 million compared to the first six months of 2016. Also, the increase in value-added sales was driven by higher raw material sales of beryllium hydroxide of $5.3 million.
Performance Alloys and Composites generated operating profit of $5.7 million in the first six months of 2017 compared to $1.7 million in the first six months of 2016. The increase in operating profit was primarily due to higher sales volume, favorable product mix, and productivity improvements.
Advanced Materials
Second Quarter
|
| | | | | | | | | | | | | | |
|
| Second Quarter Ended |
|
| June 30, |
| July 1, | | $ | | % |
(Thousands) |
| 2017 |
| 2016 | | Change | | Change |
Net sales |
| $ | 157,044 |
|
| $ | 113,557 |
| | 43,487 |
| | 38 | % |
Value-added sales |
| 62,041 |
|
| 46,993 |
| | 15,048 |
| | 32 | % |
Operating profit |
| 8,670 |
|
| 7,320 |
| | 1,350 |
| | 18 | % |
Net sales from the Advanced Materials segment of $157.0 million in the second quarter of 2017 were 38% higher than net sales of $113.6 million in the second quarter of 2016 due to higher sales volume. Net sales of $32.3 million during the second quarter of 2017 were attributable to our HTB acquisition.
Value-added sales of $62.0 million in the second quarter of 2017 were 32% higher than value-added sales of $47.0 million in the second quarter of 2016. This increase included value-added sales of $10.6 million attributable to our HTB acquisition. Also, the increase in value-added sales was driven by higher value-added sales to the consumer electronics end market of $2.5 million due primarily to higher demand.
The Advanced Materials segment generated operating profit of $8.7 million in the second quarter of 2017 compared to $7.3 million in the second quarter of 2016. Operating profit in the second quarter of 2017 was favorably impacted by higher sales volume, and favorable product mix.
Six Months
|
| | | | | | | | | | | | | | |
| | Six Months Ended |
| | June 30, | | July 1, | | $ | | % |
(Thousands) | | 2017 | | 2016 | | Change | | Change |
Net sales | | $ | 271,780 |
| | $ | 221,677 |
| | 50,103 |
| | 23 | % |
Value-added sales | | 109,329 |
| | 89,059 |
| | 20,270 |
| | 23 | % |
Operating profit | | 15,117 |
| | 12,503 |
| | 2,614 |
| | 21 | % |
Net sales from the Advanced Materials segment of $271.8 million in the first six months of 2017 were 23% higher than net sales of $221.7 million in the first six months of 2016. Net sales of $39.3 million during the first six months of 2017 were attributable to the HTB acquisition. Also, net sales increased due to higher sales volume and the impact of higher pass-through metal prices of $3.6 million.
Value-added sales of $109.3 million in the first six months of 2017 were 23% higher than value-added sales of $89.1 million in the first six months of 2016. This increase included value-added sales of $13.5 million attributable to our HTB acquisition. Also, the increase in value-added sales was primarily driven by higher value-added sales to the consumer electronics end market. Value-added sales to the consumer electronics end market, which represents approximately 49% of total segment value-added sales, increased $4.7 million due primarily to higher demand.
The Advanced Materials segment generated operating profit of $15.1 million in the first six months of 2017 compared to $12.5 million in the first six months of 2016. As a percentage of value-added sales, operating profit was 14% in both the first six months of 2017 and 2016. Operating profit in the first six months of 2017 was favorably impacted by higher sales volume and product mix offset by integration expenses of approximately $3.4 million attributable to the HTB acquisition.
Precision Coatings
Second Quarter
|
| | | | | | | | | | | | | | |
(Thousands) |
| Second Quarter Ended |
June 30, |
| July 1, | | $ | | % |
2017 |
| 2016 | | Change | | Change |
Net sales |
| $ | 30,257 |
|
| $ | 38,523 |
| | (8,266 | ) | | (21 | )% |
Value-added sales |
| 22,613 |
|
| 25,111 |
| | (2,498 | ) | | (10 | )% |
Operating profit |
| 2,314 |
|
| 2,272 |
| | 42 |
| | 2 | % |
Net sales from the Precision Coatings segment of $30.3 million in the second quarter of 2017 were 21% lower than net sales of $38.5 million in the second quarter of 2016 primarily due to lower sales volume.
Value-added sales of $22.6 million in the second quarter of 2017 were 10% lower than value-added sales of $25.1 million in the second quarter of 2016. Medical end market sales decreased $1.9 million due to lower volume in the blood glucose test strip segment of the medical end market.
The Precision Coatings segment generated operating profit of $2.3 million in both the second quarters of 2017 and 2016. Operating profit remained flat despite the decline in medical end market sales due to lower SG&A expenses.
Six Months
|
| | | | | | | | | | | | | | |
(Thousands) | | Six Months Ended |
June 30, | | July 1, | | $ | | % |
2017 | | 2016 | | Change | | Change |
Net sales | | $ | 63,637 |
| | $ | 75,285 |
| | (11,648 | ) | | (15 | )% |
Value-added sales | | 45,914 |
| | 49,745 |
| | (3,831 | ) | | (8 | )% |
Operating profit | | 4,532 |
| | 6,371 |
| | (1,839 | ) | | (29 | )% |
Net sales from the Precision Coatings segment of $63.6 million in the first six months of 2017 were 15% lower than net sales of $75.3 million in the first six months of 2016 primarily due to lower sales volume.
Value-added sales of $45.9 million in the first six months of 2017 were 8% lower than value-added sales of $49.7 million in the first six months of 2016. Value-added sales in the medical end market decreased $3.6 million compared to the prior-year period.
The Precision Coatings segment generated operating profit of $4.5 million in the first six months of 2017 compared to $6.4 million in the first six months of 2016. The decrease in operating profit in the first six months of 2017 versus the comparable period of 2016 was due to lower sales volume and the absence of a gain on the sale of equipment of $0.8 million realized during the first six months of 2016.
Other
Second Quarter |
| | | | | | | | | | | | | | |
(Thousands) | | Second Quarter Ended |
| June 30, | | July 1, | | $ | | % |
| 2017 | | 2016 | | Change | | Change |
Net sales | | $ | — |
| | $ | — |
| | — |
| | — | % |
Value-added sales | | (1,241 | ) | | (1,520 | ) | | 279 |
| | (18 | )% |
Operating loss | | (6,798 | ) | | (4,049 | ) | | (2,749 | ) | | 68 | % |
The Other reportable segment in total includes unallocated corporate costs.
Corporate costs of $6.8 million in the second quarter of 2017 increased $2.8 million as compared to $4.0 million in the second quarter of 2016. As a percent of total Company value-added sales, corporate costs increased to 4% in the second quarter of 2017 from 3% in the prior-year period. The increase in corporate costs was due to higher incentive compensation and stock-based compensation expense of $2.6 million and higher SG&A expenses associated with our CEO transition of $0.9 million. This increase was offset by the favorable impact of foreign exchange rate movements of $0.4 million and lower corporate spending of approximately $0.3 million during the second quarter of 2017.
Six Months |
| | | | | | | | | | | | | | |
(Thousands) | | Six Months Ended |
| June 30, | | July 1, | | $ | | % |
| 2017 | | 2016 | | Change | | Change |
Net sales | | $ | — |
| | $ | — |
| | — |
| | — | % |
Value-added sales | | (2,060 | ) | | (2,564 | ) | | 504 |
| | (20 | )% |
Operating loss | | (12,232 | ) | | (7,311 | ) | | (4,921 | ) | | 67 | % |
Corporate costs of $12.2 million in the first six months of 2017 increased $4.9 million as compared to $7.3 million in the first six months of 2016. As a percent of total Company value-added sales, corporate costs increased to 3% in the first six months of 2017 from 1% in the prior-year. The increase in corporate costs was due to higher incentive compensation and stock-based compensation expense of $4.2 million, which included $1.4 million due to accelerated stock compensation expense associated with the transition of the Company's CEO. Also, during the first six months of 2017, the Company incurred additional SG&A expenses associated with our CEO transition of $1.2 million. These increases were offset by the favorable impact of foreign exchange rate movements of $0.5 million.
FINANCIAL POSITION
Cash Flow
A summary of cash flows provided by (used in) operating, investing, and financing activities is as follows:
|
| | | | | | | | | | | | |
| | Six Months Ended |
| | June 30, | | July 1, | | $ |
(Thousands) | | 2017 | | 2016 | | Change |
Net cash provided by operating activities | | $ | 303 |
| | $ | 9,861 |
| | $ | (9,558 | ) |
Net cash used in investing activities | | (28,238 | ) | | (21,305 | ) | | (6,933 | ) |
Net cash provided by financing activities | | 14,055 |
| | 7,787 |
| | 6,268 |
|
Effects of exchange rate changes | | 913 |
| | 406 |
| | 507 |
|
Net change in cash and cash equivalents | | $ | (12,967 | ) | | $ | (3,251 | ) | | $ | (9,716 | ) |
Net cash provided by operating activities totaled $0.3 million in the first six months of 2017 versus $9.9 million in the comparable prior-year period. Cash used in prepaid and other current assets during the first six months of 2017 was $9.3 million, or $8.5 million higher than $0.8 million of cash used in the first six months of 2016. The majority of the increase was due to prepaid value added taxes.
Working capital requirements used cash of $21.9 million during the first six months of 2017 compared to a use of $19.7 million in the first six months of 2016. Cash flows used for accounts receivable were $17.9 million higher than the prior year-period
due to higher sales volume. Also, accounts receivable from our HTB acquisition attributed to $13.8 million of this increase. Our three-month trailing days sales outstanding (DSO) was approximately 38 days at June 30, 2017 versus 41 days at December 31, 2016. Cash flows used for inventory increased $7.7 million primarily within the Performance Alloys and Composites and Advanced Materials segments to respond to anticipated orders and demand. Cash flows from accounts payable and accrued expenses provided cash of approximately $15.5 million compared to a use of $7.9 million in the prior-year period. Cash used for incentive compensation payouts during the first six months of 2017 was more than offset by a higher accounts payable balance due to the timing of payments. Also, our HTB acquisition attributed $5.8 million to the higher accounts payable balance.
Net cash used in investing activities was $28.2 million in the first six months of 2017 compared to $21.3 million in the prior-year period, reflecting a $16.5 million payment for the HTB acquisition offset by lower payments for property, plant, and equipment and mine development of $10.4 million.
Capital expenditures are made primarily for new product development, replacing and upgrading equipment, infrastructure investments, and implementing information technology initiatives. For the full year 2017, the Company expects payments for property, plant, and equipment to range from $25.0 million to $30.0 million and mine development expenditures to be less than $3.0 million.
Net cash provided by financing activities totaled $14.1 million in the first six months of 2017 versus $7.8 million provided by financing activities in the comparable prior-year period primarily due to higher net borrowings of $6.6 million in 2017.
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 June 30, 2017, cash and cash equivalents held by our foreign operations totaled $16.4 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 results of operations for the foreseeable future.
A summary of key data relative to our liquidity, including outstanding debt, cash, available borrowing capacity, and debt-to-debt-plus-equity ratio, as of June 30, 2017 and December 31, 2016 is as follows:
|
| | | | | | | | |
| | June 30, | | December 31, |
(Thousands) | | 2017 | | 2016 |
Total outstanding debt | | $ | 26,640 |
| | $ | 4,615 |
|
Cash | | 18,497 |
| | 31,464 |
|
Net debt (cash) | | 8,143 |
| | (26,849 | ) |
Available borrowing capacity | | $ | 235,602 |
| | $ | 238,886 |
|
Debt-to-debt-plus-equity ratio | | 5 | % | | 1 | % |
Net debt (cash) is a non-GAAP measure reflecting the Company's current liquidity 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. Non-GAAP measures, such as net debt (cash), have inherent limitations and should not be considered in isolation, or as a substitute for GAAP measures.
Total outstanding debt increased $22.0 million compared to December 31, 2016 due to additional borrowings on our revolving credit facility to support payment for the HTB acquisition, capital expenditures, and working capital needs.
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 period 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 June 30, 2017 as compared to December 31, 2016 was due to higher borrowing levels.
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 the 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 June 30, 2017 and December 31, 2016. 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 $142.8 million as of June 30, 2017. 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 20,000 shares at a cost of $0.7 million in the second quarter of 2017 and 32,409 shares at a cost of $1.1 million in the first six months of 2017. Since the approval of the repurchase plan, we have purchased 1,082,264 shares at a total cost of $34.3 million.
In the second quarter and first six months of 2017, we paid cash dividends of $2.0 million and $3.9 million, respectively, 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 $307.2 million as of June 30, 2017, versus $194.8 million as of December 31, 2016. We were in compliance with all of the covenants contained in the consignment agreements as of June 30, 2017 and December 31, 2016. For additional information on our contractual obligations, refer to our Form 10-K for the year ended December 31, 2016.
CRITICAL ACCOUNTING POLICIES
For additional information regarding critical accounting policies, please refer to our Form 10-K for the year ended December 31, 2016. There have been no material changes to our critical accounting policies subsequent to the issuance of our Form 10-K.
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:
| |
▪ | Actual net sales, operating rates, and margins for 2017; |
| |
▪ | Our ability to effectively integrate the HTB acquisition; |
| |
▪ | 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, with the major market segments being: consumer electronics, industrial components, defense, medical, automotive electronics, telecommunications infrastructure, energy, commercial aerospace, and science; |
| |
▪ | 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; |
| |
▪ | The impact of the results of acquisitions on our ability to fully achieve the strategic and financial objectives related to these acquisitions; |
| |
▪ | Our success in implementing our strategic plans and the timely and successful completion and start-up of any capital projects; |
| |
▪ | The availability of adequate lines of credit and the associated interest rates; |
| |
▪ | 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 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 success of the realignment of our businesses; |
| |
▪ | Our ability to strengthen our internal control over financial reporting and disclosure controls and procedures; and |
| |
• | The risk factors set forth in Part 1, Item 1A of our Form 10-K for the year ended December 31, 2016. |
|
| |
Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
For information regarding market risks, refer to Item 7A. Quantitative and Qualitative Disclosures About Market Risk in our Annual Report on Form 10-K for the year ended December 31, 2016. There have been no material changes in our market risks since the inclusion of this discussion in our Annual Report on Form 10-K.
|
| |
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 June 30, 2017 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 June 30, 2017.
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 June 30, 2017 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.
The information presented in the Legal Proceedings section of Note N ("Contingencies") of the Notes to Consolidated Financial Statements (Unaudited) is incorporated herein by reference.
|
| |
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 June 30, 2017. |
| | | | | | | | | | | | | | |
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) |
| Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (2) |
April 1 through May 5, 2017 |
| 10,425 |
|
| $ | 33.79 |
|
| 10,200 |
|
| $ | 16,041,266 |
|
May 6 through June 2, 2017 |
| 21,037 |
|
| 34.71 |
|
| 6,900 |
|
| 15,803,872 |
|
June 3 through June 30, 2017 |
| 11,430 |
|
| 36.82 |
|
| 2,900 |
|
| 15,703,744 |
|
Total |
| 42,892 |
|
| $ | 35.05 |
|
| 20,000 |
|
| $ | 15,703,744 |
|
|
| | |
(1) | Includes 225; 14,137; and 8,530 shares surrendered to the Company in April, May, and June, respectively, by employees to satisfy tax withholding obligations on equity awards issued under the Company's stock incentive plan. |
|
|
|
(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 June 30, 2017, $15.7 million may still be purchased under the program. During the three months ended June 30, 2017, we repurchased 20,000 shares at an average price of $34.08 per share, or $0.7 million in the aggregate. |
|
| |
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.
Refer to the Exhibit Index herein.
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.
|
| | | | |
| | | | |
| | | | MATERION CORPORATION |
| | |
Dated: July 27, 2017 | | | | |
| | | | /s/ Joseph P. Kelley |
| | | | Joseph P. Kelley |
| | | | Vice President, Finance and Chief Financial Officer |
| | | | (Principal Financial and Accounting Officer) |
Exhibit Index
|
| | |
10.1 |
| Amended and Restated Materion Corporation 2006 Stock Incentive Plan (As Amended and Restated as of May 3, 2017) (filed as Exhibit 10.1 to the Company's Form 8-K filed on May 8, 2017), incorporated herein by reference. |
10.2 |
| Amended and Restated Materion Corporation 2006 Non-Employee Director Equity Plan (As Amended and Restated as of May 3, 2017) (filed as Exhibit 4.3 to the Registration Statement on Form S-8, Registration No. 333-217618 filed on May 3, 2017), incorporated herein by reference. |
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 June 30, 2017* |
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* |
* Submitted electronically herewith.