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EXCEL - IDEA: XBRL DOCUMENT - MATERION CorpFinancial_Report.xls
EX-31.2 - 31.2 - MATERION Corpmtrn-ex312_2014926xq3.htm
EX-32 - MATERION Corpmtrn-ex32_2014926xq3.htm
EX-10.3 - 10.3 - MATERION Corpmtrn-ex103_2014926xq3.htm
EX-31.1 - 31.1 - MATERION Corpmtrn-ex311_2014926xq3.htm
EX-10.2 - 10.2 - MATERION Corpmtrn-ex102_2014926xq3.htm
EX-11 - MATERION Corpmtrn-ex11_2014926xq3.htm
EX-95 - MATERION Corpmtrn-ex95_2014926xq3.htm
EX-10.1 - EXHIBIT - MATERION Corpmtrn-ex101_2014926xq3.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
____________________________________________ 
FORM 10-Q
(Mark One)
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 26, 2014
 
¨
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)
 
Ohio
 
34-1919973
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
6070 Parkland Blvd., Mayfield Hts., Ohio
 
44124
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code:
216-486-4200
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  þ        No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  þ        No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ¨
Accelerated filer   þ
Non-accelerated filer  ¨
Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨        No  þ
As of October 15, 2014, there were 20,154,663 common shares, no par value, outstanding.




PART I FINANCIAL INFORMATION
MATERION CORPORATION AND SUBSIDIARIES
 
Item 1.
Financial Statements
The consolidated financial statements of Materion Corporation and its subsidiaries for the third quarter and nine months ended September 26, 2014 are as follows:


1



Materion Corporation and Subsidiaries                                
Consolidated Statements of Income
(Unaudited)
 
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 26,
 
Sept. 27,
 
Sept. 26,
 
Sept. 27,
(Thousands, except per share amounts)
 
2014
 
2013
 
2014
 
2013
Net sales
 
$
291,570

 
$
275,434

 
$
838,465

 
$
880,744

Cost of sales
 
236,727

 
230,951

 
688,359

 
741,930

Gross margin
 
54,843

 
44,483

 
150,106

 
138,814

Selling, general and administrative expense
 
34,823

 
31,804

 
100,768

 
97,910

Research and development expense
 
3,243

 
3,190

 
9,473

 
9,901

Other—net
 
(644
)
 
4,161

 
(3,177
)
 
9,592

Operating profit
 
17,421

 
5,328

 
43,042

 
21,411

Interest expense—net
 
764

 
715

 
2,132

 
2,356

Income before income taxes
 
16,657

 
4,613

 
40,910

 
19,055

Income tax expense (benefit)
 
4,217

 
(379
)
 
11,165

 
3,123

Net income
 
$
12,440

 
$
4,992

 
$
29,745


$
15,932

Basic earnings per share:
 
 
 
 
 
 
 
 
Net income per share of common stock
 
$
0.61

 
$
0.24

 
$
1.45

 
$
0.78

Diluted earnings per share:
 
 
 
 
 
 
 
 
Net income per share of common stock
 
$
0.60

 
$
0.24

 
$
1.42

 
$
0.76

Cash dividends per share
 
$
0.085

 
$
0.080

 
$
0.250

 
$
0.235

Weighted-average number of shares of common stock outstanding:
 
 
 
 
 
 
 
 
Basic
 
20,490

 
20,604

 
20,579

 
20,551

Diluted
 
20,827

 
20,931

 
20,927

 
20,874
















See Notes to Consolidated Financial Statements.


2



Materion Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
(Unaudited)
 
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 26,
 
Sept. 27,
 
Sept. 26,
 
Sept. 27,
(Thousands)
 
2014
 
2013
 
2014
 
2013
Net income
 
$
12,440

 
$
4,992

 
$
29,745

 
$
15,932

Other comprehensive income:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
(2,170
)
 
478

 
(1,455
)
 
(2,902
)
Derivative and hedging activity, net of tax
 
1,480

 
(428
)
 
1,567

 
(273
)
Pension and post employment benefit adjustment, net of tax
 
540

 
1,232

 
10,465

 
3,670

Net change in accumulated other comprehensive income
 
(150
)
 
1,282

 
10,577

 
495

Comprehensive income
 
$
12,290

 
$
6,274

 
$
40,322

 
$
16,427


































See Notes to Consolidated Financial Statements.


3



Materion Corporation and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
 
 
 
 
 
 
 
 
Sept. 26,
 
Dec. 31,
(Thousands)
 
2014
 
2013
Assets
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
19,610

 
$
22,774

Accounts receivable
 
126,950

 
113,012

Inventories
 
227,286

 
232,800

Prepaid expenses
 
17,231

 
16,353

Deferred income taxes
 
9,965

 
10,325

Total current assets
 
401,042

 
395,264

Long-term deferred income taxes
 
5,502

 
5,941

Property, plant, and equipment—cost
 
793,983

 
782,879

Less allowances for depreciation, depletion, and amortization
 
(545,183
)
 
(520,986
)
Property, plant, and equipment—net
 
248,800

 
261,893

Intangible assets
 
20,046

 
24,248

Other assets
 
4,693

 
3,874

Goodwill
 
86,725

 
86,725

Total assets
 
$
766,808

 
$
777,945

Liabilities and shareholders’ equity
 
 
 
 
Current liabilities
 
 
 
 
Short-term debt
 
$
6,613

 
$
35,566

Accounts payable
 
32,158

 
36,556

Other liabilities and accrued items
 
59,562

 
54,851

Income taxes
 
7,955

 
1,564

Unearned revenue
 
1,239

 
479

Total current liabilities
 
107,527

 
129,016

Other long-term liabilities
 
16,187

 
16,531

Retirement and post-employment benefits
 
53,493

 
80,275

Unearned income
 
52,970

 
56,490

Long-term income taxes
 
1,576

 
1,576

Deferred income taxes
 
4,895

 
1,469

Long-term debt
 
43,780

 
29,267

Shareholders’ equity
 


 


Common stock
 
201,030

 
197,576

Retained earnings
 
466,047

 
441,518

Common stock in treasury
 
(134,281
)
 
(118,151
)
Other comprehensive income (loss)
 
(49,311
)
 
(59,888
)
Other equity transactions
 
2,895

 
2,266

Total shareholders' equity
 
486,380

 
463,321

Total liabilities and shareholders’ equity
 
$
766,808

 
$
777,945

See Notes to Consolidated Financial Statements.

4



Materion Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited) 
 
 
Nine Months Ended
 
 
Sept. 26,
 
Sept. 27,
(Thousands)
 
2014
 
2013
Cash flows from operating activities:
 
 
 
 
Net income
 
$
29,745

 
$
15,932

Adjustments to reconcile net income to net cash provided from operating activities:
 
 
 
 
Depreciation, depletion, and amortization
 
32,333

 
30,842

Amortization of deferred financing costs in interest expense
 
627

 
501

Stock-based compensation expense
 
4,123

 
4,103

Changes in assets and liabilities net of acquired assets and liabilities:
 
 
 
 
Decrease (increase) in accounts receivable
 
(15,184
)
 
3,143

Decrease (increase) in inventory
 
(24,148
)
 
(13
)
Decrease (increase) in prepaid and other current assets
 
(579
)
 
2,055

Decrease (increase) in deferred income taxes
 
8

 
249

Increase (decrease) in accounts payable and accrued expenses
 
2,315

 
(21,216
)
Increase (decrease) in unearned revenue
 
760

 
(1,082
)
Increase (decrease) in interest and taxes payable
 
6,017

 
108

Increase (decrease) in long-term liabilities
 
(14,976
)
 
1,152

Other-net
 
(14
)
 
2,741

Net cash provided from operating activities
 
21,027

 
38,515

Cash flows from investing activities:
 
 
 
 
Payments for purchase of property, plant, and equipment
 
(19,843
)
 
(19,830
)
Payments for mine development
 
(670
)
 
(4,407
)
Proceeds from sale of property, plant, and equipment
 
3,084

 
23

Other investments-net
 
(2
)
 
20

Net cash used in investing activities
 
(17,431
)
 
(24,194
)
Cash flows from financing activities:
 
 
 
 
Repayment of short-term debt
 
(291
)
 
(13,263
)
Proceeds from issuance of long-term debt
 
33,252

 
70,333

Repayment of long-term debt
 
(18,739
)
 
(62,789
)
Debt issuance costs
 

 
(1,554
)
Principal payments under capital lease obligations
 
(497
)
 
(491
)
Payment of dividends
 
(5,156
)
 
(4,847
)
Repurchase of common stock
 
(15,615
)
 

Issuance of common stock under stock option plans
 
360

 
1,075

Tax benefit from stock compensation realization
 
109

 
1,664

Net cash used in financing activities
 
(6,577
)
 
(9,872
)
Effect of exchange rate changes
 
(183
)
 
(348
)
Net change in cash and cash equivalents
 
(3,164
)
 
4,101

Cash and cash equivalents at beginning of period
 
22,774

 
16,056

Cash and cash equivalents at end of period
 
$
19,610

 
$
20,157

See Notes to Consolidated Financial Statements.

5


Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)



Note A — Accounting Policies
In management’s opinion, the accompanying consolidated financial statements contain all adjustments necessary to present fairly the financial position as of September 26, 2014 and December 31, 2013, and the results of operations for the three months and nine months ended September 26, 2014 and September 27, 2013. All adjustments were of a normal and recurring nature. Certain amounts in prior years have been reclassified to conform to the 2014 consolidated financial statement presentation.

In May 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update, 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. The new standard will become effective for Materion Corporation (the Company) beginning with the first quarter 2017 and can be adopted either retrospectively to each prior reporting period presented or as a cumulative effect adjustment as of the date of adoption. The Company is currently evaluating the impact of adopting this new guidance on the consolidated financial statements.
Note B — Inventories
Inventories on the Consolidated Balance Sheets are summarized as follows:
(Thousands)
 
Sept. 26,
2014
 
Dec. 31,
2013
Principally average cost:
 
 
 
 
Raw materials and supplies
 
$
40,845

 
$
39,201

Work in process
 
150,140

 
152,645

Finished goods
 
36,301

 
40,954

Net inventories
 
$
227,286

 
$
232,800


The December 31, 2013 balance reflects a reclassification of $19.4 million from prepaid assets to inventory. The Company determined it was more appropriate to reflect the fair market value adjustment related to certain of its precious metal inventory as inventory. The reclassification did not impact previously reported total current assets or total assets in the accompanying Consolidated Balance Sheets, net income in the Consolidated Statements of Income or net cash provided by operating activities in the Consolidated Statements of Cash Flows.

The Company repaid a precious metal-denominated loan totaling $28.7 million as of December 31, 2013 and $31.3 million at the end of the second quarter of 2014. This debt reduction was completed by transferring 23,781 ounces of gold held in inventory to the lender as repayment for the outstanding short-term debt. There is a corresponding decrease in inventory of $31.3 million related to this transaction, which was treated as a non-cash item in the Consolidated Statement of Cash Flows.

6


Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)


Note C — Pensions and Other Post-employment Benefits
The following is a summary of the net periodic benefit cost for the third quarter and first nine months of 2014 and 2013 for the domestic pension plans (which include the defined benefit pension plan and the supplemental retirement plans) and the domestic retiree medical plan.
 
 
Pension Benefits
 
Other Benefits
 
 
Third Quarter Ended
 
Third Quarter Ended
(Thousands)
 
Sept. 26, 2014
 
Sept. 27, 2013
 
Sept. 26, 2014
 
Sept. 27, 2013
Components of net periodic benefit cost
 
 
 
 
 
 
 
 
Service cost
 
$
1,931

 
$
2,356

 
$
34

 
$
76

Interest cost
 
2,449

 
2,353

 
169

 
311

Expected return on plan assets
 
(3,013
)
 
(2,996
)
 

 

Amortization of prior service cost (benefit)
 
(109
)
 
(85
)
 
(374
)
 
29

Amortization of net loss
 
1,275

 
1,951

 

 

Net periodic benefit cost (benefit)
 
$
2,533

 
$
3,579

 
$
(171
)
 
$
416

 
 
 
 
 
 
 
 
 
 
 
Pension Benefits
 
Other Benefits
 
 
Nine Months Ended
 
Nine Months Ended
(Thousands)
 
Sept. 26, 2014
 
Sept. 27, 2013
 
Sept. 26, 2014
 
Sept. 27, 2013
Components of net periodic benefit cost
 
 
 
 
 
 
 
 
Service cost
 
$
5,794

 
$
7,066

 
$
103

 
$
229

Interest cost
 
7,345

 
7,060

 
506

 
932

Expected return on plan assets
 
(9,038
)
 
(8,989
)
 

 

Amortization of prior service cost (benefit)
 
(326
)
 
(255
)
 
(1,123
)
 
86

Amortization of net loss
 
3,825

 
5,816

 

 

Net periodic benefit cost
 
$
7,600

 
$
10,698

 
$
(514
)
 
$
1,247

 
The Company made contributions to the domestic defined benefit pension plans of $15.8 million in the first nine months of 2014.

The Company has notified participants of changes to the domestic retiree medical plan, including changing the benefit formula for participants covered by the plan. The revised benefit formula is designed to lower costs for the Company and the majority of plan participants. As a result of this change, the plan liability on the Company's Consolidated Balance Sheets was reduced by $14.0 million in the first quarter of 2014, with the offset increasing other comprehensive income, a component of shareholders' equity. The liability reduction will be recognized in earnings over the average remaining service life of participants.
Note D — Contingencies
Materion Brush Inc., one of the Company's wholly owned subsidiaries, is a defendant from time to time in legal proceedings where the plaintiffs allege they have contracted chronic beryllium disease (CBD) or related ailments as a result of exposure to beryllium. The Company will record a reserve for CBD or other litigation when a loss from either settlement or verdict is probable and estimable. Claims filed by third-party plaintiffs where the alleged exposure occurred prior to December 31, 2007 may be covered by insurance subject to an annual deductible of $1.0 million. Reserves are recorded for asserted claims only and defense costs are expensed as incurred. A CBD case outstanding at the end of the second quarter of 2014 was settled for less than $0.1 million during the third quarter of 2014. A second CBD case filed in a prior period remained outstanding at the end of the third quarter of 2014, and the Company does not expect the resolution of this matter to have a material impact on the consolidated financial statements.
The Company has an active environmental compliance program and records reserves for the probable cost of identified environmental remediation projects. The reserves are established based upon analyses conducted by the Company’s engineers and outside consultants and are adjusted from time to time based upon ongoing studies, the difference between actual and estimated

7


Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)


costs, and other factors. The reserves may also be affected by rulings and negotiations with regulatory agencies. The undiscounted reserve balance was $4.8 million at September 26, 2014 and $4.8 million at December 31, 2013. Environmental projects tend to be long term, and the final actual remediation costs may differ from the amounts currently recorded.

During the third quarter of 2014, the Company collected $4.0 million as part of a settlement agreement with a contractor for an outstanding dispute regarding construction of the Company's beryllium pebble plant located in Elmore, Ohio. The cash received and the benefit of this settlement was recorded in the third quarter of 2014 in Other-net in the Consolidated Statements of Income.
Note E — Segment Reporting
 
(Thousands)
 
Advanced
Material
Technologies
 
Performance
Alloys
 
Beryllium and
Composites
 
Technical
Materials
 
Subtotal
 
All
Other
 
Total
Third Quarter 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales to external customers
 
$
177,483

 
$
80,863

 
$
17,946

 
$
15,278

 
$
291,570

 
$

 
$
291,570

Intersegment sales
 
1,895

 
473

 
110

 
100

 
2,578

 

 
2,578

Operating profit (loss)
 
7,691

 
6,529

 
992

 
1,445

 
16,657

 
764

 
17,421

 
 


 


 


 


 


 


 


Third Quarter 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales to external customers
 
$
176,294

 
$
69,578

 
$
13,685

 
$
15,877

 
$
275,434

 
$

 
$
275,434

Intersegment sales
 
523

 
443

 
67

 
156

 
1,189

 

 
1,189

Operating profit (loss)
 
4,146

 
4,520

 
(3,306
)
 
1,421

 
6,781

 
(1,453
)
 
5,328

 
 


 


 


 


 


 


 


First Nine Months 2014
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales to external customers
 
$
519,793

 
$
224,289

 
$
50,041

 
$
44,342

 
$
838,465

 
$

 
$
838,465

Intersegment sales
 
2,971

 
1,475

 
420

 
319

 
5,185

 

 
5,185

Operating profit (loss)
 
26,790

 
15,307

 
282

 
2,586

 
44,965

 
(1,923
)
 
43,042

Assets
 
280,208

 
275,778

 
147,537

 
22,965

 
726,488

 
40,320

 
766,808

First Nine Months 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales to external customers
 
$
566,158

 
$
218,435

 
$
42,194

 
$
53,957

 
$
880,744

 
$

 
$
880,744

Intersegment sales
 
2,048

 
1,484

 
200

 
600

 
4,332

 

 
4,332

Operating profit (loss)
 
5,211

 
18,654

 
(3,780
)
 
5,246

 
25,331

 
(3,920
)
 
21,411

Assets
 
312,110

 
267,232

 
142,183

 
23,734

 
745,259

 
55,854

 
801,113

Note F — Stock-based Compensation Expense
Stock-based compensation expense was $1.1 million in the third quarter of 2014 and $1.4 million in the third quarter of 2013. For the first nine months of the year, stock-based compensation expense was $4.1 million in 2014 and $4.1 million in 2013.
The Company granted approximately 144,000 stock appreciation rights (SARs) to certain employees in the second quarter of 2014 at a strike price of $33.29 per share. The fair value of the SARs, which was determined on the grant date using a Black-Scholes model, was $12.48 per share and will be amortized over the vesting period of three years. The SARs expire in seven years from the date of the grant.
The Company granted approximately 38,000 shares of restricted stock units to certain employees in the second quarter of 2014 at a weighted-average fair value of $33.29 per share. The fair value was determined using the closing price of the Company's common stock on the grant date and will be amortized over the vesting period of three years. The holders of the restricted stock units will forfeit their shares if their employment is terminated prior to the end of the vesting period.
The Company granted approximately 25,000 performance-based restricted stock units to certain employees in the first quarter of 2014 at a fair value of $26.02 per share. The fair value will be expensed over the vesting period of three years. The final share payout to the employees will be based upon the Company’s total return to shareholders over the vesting period relative to a peer group’s performance over the same period.
The Company received $0.4 million for the exercise of approximately 21,000 options during the first nine months of 2014 and $1.1 million for the exercise of approximately 69,000 options during the first nine months of 2013. Exercises of stock appreciation rights totaled approximately 50,000 in the first nine months of 2014 and 120,000 in the first nine months of 2013.

8


Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)


Note G — Other-net
Other-net income (expense) for the third quarter and first nine months of 2014 and 2013 is summarized as follows: 
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 26
 
Sept. 27
 
Sept. 26
 
Sept. 27
(Thousands)
 
2014
 
2013
 
2014
 
2013
Foreign currency exchange gain (loss)
 
$
450

 
$
126

 
$
(25
)
 
$
1,271

Amortization of intangible assets
 
(1,208
)
 
(1,359
)
 
(3,841
)
 
(4,001
)
Metal consignment fees
 
(1,770
)
 
(1,640
)
 
(5,481
)
 
(5,158
)
Net gain (loss) on disposal of fixed assets
 
(225
)
 
(252
)
 
2,384

 
(251
)
Recovery from insurance
 

 

 
6,750

 

Legal settlement
 
4,000

 

 
4,000

 

Other items
 
(603
)
 
(1,036
)
 
(610
)
 
(1,453
)
Total
 
$
644

 
$
(4,161
)
 
$
3,177

 
$
(9,592
)
Note H — Income Taxes
The Company recorded income tax expense of $4.2 million in the third quarter of 2014, an effective tax rate of 25.3% against income before income taxes, and an income tax benefit of $0.4 million in the third quarter of 2013, an effective tax rate of (8.2%) against income before income taxes.
In the first nine months of 2014, tax expense of $11.2 million was recorded, an effective tax rate of 27.3%. Tax expense was $3.1 million in the first nine months of 2013, an effective tax rate of 16.4%.
The differences between the statutory and effective rates in the third quarter and first nine months of both years was due to the impact of percentage depletion, the production deduction, foreign source income and deductions, executive compensation, state and local taxes, discrete events, and other factors. The research and experimentation credit also provided a benefit in the third quarter and first nine months of 2013, but there was no tax benefit recorded in the first nine months of 2014 as the U.S. Congress has not extended the credit for 2014.
The tax expense in the third quarter of 2014 included net favorable discrete items of $0.6 million that resulted from the finalization of the 2013 Federal tax return at a lower liability than what was previously recorded in the financial statements, the reversal of tax reserves due to the lapse of the statue of limitations, and other items.
Discrete items were a favorable $1.3 million in the first nine months of 2013 resulting from the finalization of the 2012 Federal tax return during that period, the research and experimentation credit, and the impact of the lapse of the statue of limitations, and other items.
In the third quarter of 2014, the Company recorded an adjustment of $2.0 million to increase deferred tax assets and reduce goodwill to correct the amount of deferred tax assets recognized in connection with the acquisition of EIS Optics Limited (EIS) in 2011 which is part of the Advanced Material Technologies segment. This adjustment was not material to previously issued financial statements as it had no net impact on total assets, equity or cash flows and had an immaterial impact on the Consolidated Statements of Income. The Company has reflected this adjustment in the accompanying 2013 Consolidated Balance Sheets.
Note I — Depreciation and Amortization
The Company received $63.5 million from the U.S. Department of Defense (DoD) in previous periods for reimbursement of the DoD's share of the cost of capital equipment acquired by the Company under a Title III contract. The Company recorded the cost of the equipment in property, plant, and equipment and the reimbursements as unearned income, a liability on the Consolidated Balance Sheets. The equipment was placed in service during the third quarter of 2012, and its full cost is being depreciated in accordance with Company policy. The unearned income liability is being reduced ratably with the depreciation expense recorded over the life of the equipment.
In the nine months ended September 26, 2014, the depreciation expense on the equipment subject to reimbursement was $3.5 million. Unearned income was reduced by $3.5 million, accordingly, with the offset recorded as a credit to cost of sales. Depreciation, depletion, and amortization expense on the Consolidated Statements of Cash Flows is shown net of the reduction in unearned income.

9


Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)


Amortization of mine development costs are initially recorded in inventory and subsequently recorded in cost of sales in the period the inventory is sold. Depreciation, depletion, and amortization depicted on the Consolidated Statements of Cash Flows, including the mine development costs amortized into inventory, totaled $32.3 million in the nine months ended September 26, 2014 and $30.8 million in the nine months ended September 27, 2013. Depreciation, depletion, and amortization expense recorded in operating profit in the Consolidated Statements of Income totaled $29.7 million in the nine months ended September 26, 2014 and $29.0 million in the nine months ended September 27, 2013.
Note J — Fair Value of Financial Instruments
The Company measures and records financial instruments at their fair values. 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.
The following table summarizes the financial instruments measured at fair value in the Consolidated Balance Sheets as of September 26, 2014:
 
 
 
 
 
Fair Value Measurements
(Thousands)
 
Total
 
Quoted Prices
in  Active
Markets  for
Identical
Assets
(Level  1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Financial Assets
 
 
 
 
 
 
 
 
Directors’ deferred compensation investments
 
$
381

 
$
381

 
$

 
$

Foreign currency forward contracts
 
2,379

 

 
2,379

 

Total
 
$
2,760

 
$
381

 
$
2,379

 
$

Financial Liabilities
 
 
 
 
 
 
 
 
Directors’ deferred compensation liability
 
$
381

 
$
381

 
$

 
$

Foreign currency forward contracts
 

 

 

 

Total
 
$
381

 
$
381

 
$

 
$

The Company uses a market approach to value the assets and liabilities for outstanding derivative contracts 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 on the Consolidated Balance Sheets approximate their fair values as of September 26, 2014.
Note K — Derivative Instruments and Hedging Activity
The Company uses derivative contracts to hedge portions of its foreign currency and precious metal exposures. The objectives for using derivatives in these areas are as follows:
Foreign Currency. The Company sells products to overseas customers in their local currencies, primarily the euro and yen. The Company uses 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 dollar value of the 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, the hedge contract may limit the benefits from a weakening U.S. dollar.

10


Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)


The use of forward contracts locks in a firm rate and eliminates any downside 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 they can be structured to be cash neutral. The Company will primarily hedge with forward contracts due to the relationship between the cash outlay and the level of risk.
The use of foreign currency derivative contracts is governed by policies approved by the Audit Committee of the Board of Directors. A team consisting of senior financial managers reviews the estimated exposure levels, as defined by budgets, forecasts and other internal data, and determines the timing, amounts, and instruments to use to hedge that exposure within the confines of the policy. Management analyzes the effective hedged rates and the actual and projected gains and losses on the hedging transactions against the program objectives, targeted rates, and levels of risk assumed. Hedge contracts are typically layered in at different times for a specified exposure period in order to minimize the impact of rate movements.
Precious Metals. The Company maintains the majority of its precious metal production requirements on consignment in order to reduce the 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 and that price forms the basis for the price to be charged to the customer.
In certain circumstances, a customer may want to establish the price for the precious metal when the sales order is placed rather than at the time of the shipment. Setting the selling 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 a stated quantity of precious metal at a fixed price on a specified date in the future. The price in the forward contract serves as the basis for the price to be charged to the customer. By so doing, the selling and purchase prices are matched, and the Company’s market 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 to be paid for a number of orders over a period of time. The Company may then enter into a hedge contract, either a forward contract or a swap, to fix the price for the estimated quantity of refined metal to be purchased thereby reducing the exposure to adverse movements in the market price of the metal.
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 their fair values. If the derivative is designated and effective as a cash flow hedge, changes in the fair value of the derivative are recognized in other comprehensive income (OCI) until the hedged item is recognized in earnings. The ineffective portion of a derivative’s fair value, if any, is recognized in earnings immediately. If a derivative is not a hedge, changes in the fair value are adjusted through income. The fair values of the outstanding derivatives are recorded on the balance sheet as assets (if the derivatives are in a gain position) or liabilities (if the derivatives are in a loss position). The fair values will also be classified as short-term or long-term depending upon their maturity dates.
The outstanding foreign currency forward contracts had a notional value of $39.0 million as of September 26, 2014. All of these contracts were designated and effective as cash flow hedges. The net fair value of the outstanding contracts was $2.4 million, with the asset recorded in prepaid expenses and other assets on the Consolidated Balance Sheets as of September 26, 2014.
There was no ineffectiveness associated with the contracts outstanding at September 26, 2014, and no ineffectiveness expense was recorded in the third quarter or first nine months of 2014 or 2013.
Changes in the fair value of outstanding cash flow hedges recorded in OCI totaled $2.4 million at September 26, 2014 and $0.1 million at September 27, 2013. The Company expects to relieve substantially the entire balance in OCI as of September 26, 2014 to income on the Consolidated Statements of Income during the twelve-month period beginning September 27, 2014. See Note L to the Consolidated Financial Statements for additional OCI details.

11


Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)


Note L — Accumulated Other Comprehensive Income

Changes in the components of accumulated other comprehensive income, including the amounts reclassified out, for the third quarter and first nine months of 2014 and 2013 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
Accumulated other comprehensive income, as of June 27, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
31

 
$

 
$
31

 
$
(61,597
)
 
$
1,002

 
$
(60,564
)
 Deferred tax expense (benefit)
 
(1,390
)
 

 
(1,390
)
 
(10,013
)
 

 
(11,403
)
 Net
 
$
1,421

 
$

 
$
1,421

 
$
(51,584
)
 
$
1,002

 
$
(49,161
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Third quarter 2014 activity
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassifications
 
$
2,365

 
$

 
$
2,365

 
$

 
$
(2,170
)
 
$
195

Amounts reclassified from accumulated other comprehensive income
 
(17
)
 

 
(17
)
 
833

 

 
816

Net current period other comprehensive income (loss) before tax
 
2,348

 

 
2,348

 
833

 
(2,170
)
 
1,011

Deferred taxes on current period activity
 
868

 

 
868

 
293

 

 
1,161

Net current period other comprehensive income (loss) after tax
 
$
1,480

 
$

 
$
1,480

 
$
540

 
$
(2,170
)
 
$
(150
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income, as of September 26, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
2,379

 
$

 
$
2,379

 
$
(60,764
)
 
$
(1,168
)
 
$
(59,553
)
 Deferred tax expense (benefit)
 
(522
)
 

 
(522
)
 
(9,720
)
 

 
(10,242
)
 Net
 
$
2,901

 
$

 
$
2,901

 
$
(51,044
)
 
$
(1,168
)
 
$
(49,311
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income, as of December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
(87
)
 
$
(19
)
 
$
(106
)
 
$
(77,301
)
 
$
287

 
$
(77,120
)
 Deferred tax expense (benefit)
 
(1,433
)
 
(7
)
 
(1,440
)
 
(15,792
)
 

 
(17,232
)
 Net
 
$
1,346

 
$
(12
)
 
$
1,334

 
$
(61,509
)
 
$
287

 
$
(59,888
)
 
 
 
 
 
 
 
 
 
 
 
 
 
First nine months of 2014 activity
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassifications
 
$
2,357

 
$

 
$
2,357

 
$
14,034

 
$
(1,455
)
 
$
14,936

Amounts reclassified from accumulated other comprehensive income
 
109

 
19

 
128

 
2,503

 

 
2,631

Net current period other comprehensive income (loss) before tax
 
2,466

 
19

 
2,485

 
16,537

 
(1,455
)
 
17,567


12


Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)


 Deferred taxes on current period activity
 
911

 
7

 
918

 
6,072

 

 
6,990

 Net current period other comprehensive income (loss) after tax
 
$
1,555

 
$
12

 
$
1,567

 
$
10,465

 
$
(1,455
)
 
$
10,577

 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income, as of September 26, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
2,379

 
$

 
$
2,379

 
$
(60,764
)
 
$
(1,168
)
 
$
(59,553
)
 Deferred tax expense (benefit)
 
(522
)
 

 
(522
)
 
(9,720
)
 

 
(10,242
)
 Net
 
$
2,901

 
$

 
$
2,901

 
$
(51,044
)
 
$
(1,168
)
 
$
(49,311
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income, as of June 28, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
553

 
$
23

 
$
576

 
$
(123,789
)
 
$
697

 
$
(122,516
)
 Deferred tax expense (benefit)
 
(1,209
)
 

 
(1,209
)
 
(32,091
)
 

 
(33,300
)
 Net
 
$
1,762

 
$
23

 
$
1,785

 
$
(91,698
)
 
$
697

 
$
(89,216
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Third quarter 2013 activity
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassifications
 
$
(254
)
 
$

 
$
(254
)
 
$

 
$
478

 
$
224

Amounts reclassified from accumulated other comprehensive income
 
(369
)
 
(23
)
 
(392
)
 
1,895

 

 
1,503

Net current period other comprehensive income (loss) before tax
 
(623
)
 
(23
)
 
(646
)
 
1,895

 
478

 
1,727

Deferred taxes on current period activity
 
(218
)
 

 
(218
)
 
663

 

 
445

Net current period other comprehensive income (loss) after tax
 
$
(405
)
 
$
(23
)
 
$
(428
)
 
$
1,232

 
$
478

 
$
1,282

 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income, as of September 27, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
(70
)
 
$

 
$
(70
)
 
$
(121,894
)
 
$
1,175

 
$
(120,789
)
 Deferred tax expense (benefit)
 
(1,427
)
 

 
(1,427
)
 
(31,428
)
 

 
(32,855
)
 Net
 
$
1,357

 
$

 
$
1,357

 
$
(90,466
)
 
$
1,175

 
$
(87,934
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income, as of December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
253

 
$
97

 
$
350

 
$
(127,541
)
 
$
4,077

 
$
(123,114
)
 Deferred tax expense (benefit)
 
(1,314
)
 
34

 
(1,280
)
 
(33,405
)
 

 
(34,685
)
 Net
 
$
1,567

 
$
63

 
$
1,630

 
$
(94,136
)
 
$
4,077

 
$
(88,429
)
 
 
 
 
 
 
 
 
 
 
 
 
 
First nine months of 2013 activity
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassifications
 
$
618

 
$

 
$
618

 
$

 
$
(2,902
)
 
$
(2,284
)
Amounts reclassified from accumulated other comprehensive income
 
(941
)
 
(97
)
 
(1,038
)
 
5,647

 

 
4,609

 
 
 
 
 
 
 
 
 
 
 
 
 

13


Materion Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)


Net current period other comprehensive income (loss) before tax
 
(323
)
 
(97
)
 
(420
)
 
5,647

 
(2,902
)
 
2,325

Deferred taxes on current period activity
 
(113
)
 
(34
)
 
(147
)
 
1,977

 

 
1,830

Net current period other comprehensive income (loss) after tax
 
$
(210
)
 
$
(63
)
 
$
(273
)
 
$
3,670

 
$
(2,902
)
 
$
495

 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income, as of September 27, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
(70
)
 
$

 
$
(70
)
 
$
(121,894
)
 
$
1,175

 
$
(120,789
)
 Deferred tax expense (benefit)
 
(1,427
)
 

 
(1,427
)
 
(31,428
)
 

 
(32,855
)
 Net
 
$
1,357

 
$

 
$
1,357

 
$
(90,466
)
 
$
1,175

 
$
(87,934
)

Reclassifications from accumulated other comprehensive income of gains and losses on foreign currency cash flow hedges are recorded in Other-net on the Consolidated Statements of Income while the gains and losses on precious metal cash flow hedges are recorded in Cost of sales on the Consolidated Statements of Income. See Note K to the Consolidated Financial Statements 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. See Note C to the Consolidated Financial Statements for additional details on pension and post employment expenses.


14



Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
OUR BUSINESS
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 markets, including consumer electronics, industrial components, commercial aerospace, defense, science, energy, medical, automotive electronics, telecommunications infrastructure, and appliance.

EXECUTIVE OVERVIEW
During the three and nine months ended September 26, 2014, the following key factors contributed to our overall results of operations, financial position and cash flows:
Net sales in the third quarter of 2014 were $291.6 million, a 5.9% increase from net sales in the third quarter of 2013. Shipments to several markets and applications improved in the third quarter of 2014 over the third quarter of 2013, including consumer electronics, medical, and telecommunications infrastructure.

Value-added sales increased 11.8% to $165.6 million in the third quarter of 2014 compared to the third quarter of 2013 and increased $18.2 million or 4.0% for the nine months ended September 26, 2014 compared to the corresponding period in 2013. 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 pass-through metal prices. Internally, we manage our business on this basis, and a reconciliation of sales to value-added sales is included herein.

Gross margin was $54.8 million in the third quarter of 2014 compared to $44.5 million in the third quarter of 2013. The increased gross margin represents an approximate 300 basis point margin expansion as a percentage of value-added sales associated with improved sales volume, better product mix, and facility consolidation savings.

Operating profit was $17.4 million in the third quarter of 2014 compared to $5.3 million in the third quarter of 2013. The increased operating profit was driven by the gross margin improvement and a $4.0 million settlement of a legal claim related to our beryllium pebbles facility.

As a result of the aforementioned factors, overall diluted earnings per share increased to $0.60 and $1.42 for the three and nine months ended September 26, 2014, respectively. This increase represents a 150.0% and 86.8% year-over-year improvement as compared to the corresponding periods in 2013.

Approximately 393,000 shares of common stock were repurchased in the third quarter of 2014 for $13.0 million in the aggregate, bringing the year-to-date total to approximately 480,000 shares for a total repurchase price of $15.6 million.

15



RESULTS OF OPERATIONS
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 26,
Sept. 27,
$
%
 
Sept. 26,
Sept. 27,
$
%
(Millions, except per share data)
 
2014
2013
Change
Change
 
2014
2013
Change
Change
Net Sales
 
$
291.6

$
275.4

$
16.2

5.9
%
 
$
838.5

$
880.7

$
(42.2
)
(4.8
)%
Value-added sales
 
165.6

148.1

17.5

11.8
%
 
470.1

451.9

18.2

4.0
 %
Gross margin
 
54.8

44.5

10.3

23.1
%
 
150.1

138.8

11.3

8.1
 %
SG&A expense
 
34.8

31.8

3.0

9.4
%
 
100.8

97.9

2.9

3.0
 %
R&D expense
 
3.2

3.2



 
9.5

9.9

(0.4
)
(4.0
)%
Other—net
 
(0.6
)
4.2

(4.8
)

 
(3.2
)
9.6

(12.8
)

Operating profit
 
17.4

5.3

12.1

228.3
%
 
43.0

21.4

21.6

100.9
 %
Interest expense—net
 
0.8

0.7

0.1

14.3
%
 
2.1

2.4

(0.3
)
(12.5
)%
Income before income taxes
 
16.6

4.6

12.0

260.9
%
 
40.9

19.0

21.9

115.3
 %
Income tax expense (benefit)
 
4.2

(0.4
)
4.6


 
11.2

3.1

8.1

261.3
 %
Net income
 
$
12.4

$
5.0

$
7.4

148.0
%
 
$
29.7

$
15.9

$
13.8

86.8
 %
Diluted earnings per share
 
$
0.60

$
0.24

$
0.36

150.0
%
 
$
1.42

$
0.76

$
0.66

86.8
 %

Third Quarter

Net sales of $291.6 million in the third quarter of 2014 were $16.2 million, or 5.9% above the $275.4 million recorded in the third quarter of 2013. The increase in net sales in the third quarter of 2014 was due to higher value-added sales, partially offset by lower pass-through precious metal and copper prices. Changes in precious metal and copper prices negatively impacted net sales in the third quarter of 2014 by 3.1% when compared to the third quarter of 2013.

Value-added sales of $165.6 million in the third quarter of 2014 increased $17.5 million or 11.8% compared to the third quarter of 2013. The year-over-year improvement in value-added sales was primarily driven by growth in the consumer electronics, medical, and telecommunication infrastructure end markets, which increased year-over-year 13.4%, 16.1%, and 39.3%, respectively. Value-added sales into the defense and automotive electronics end markets declined in the third quarter of 2014 compared to the third quarter of 2013 by 6.4% and 7.4%, respectively.

Gross margin in the third quarter of 2014 was $54.8 million, or 23.1% above the $44.5 million in gross margin recorded during the third quarter of 2013. Expressed as a percentage of value-added sales, gross margin improved 310 basis points from 30.0% in the third quarter of 2013 to 33.1% in the third quarter of 2014. The increased gross margin was a combination of improved leverage on value-added sales growth, improved product mix, and improved manufacturing efficiency related to the rationalization efforts taken in late 2013.

Selling, general and administrative (SG&A) expense was $34.8 million in the third quarter of 2014, an increase of $3.0 million over the third quarter of 2013. The increase is primarily attributable to increased incentive compensation that is based on certain performance metrics, partially offset by product line rationalization savings.

Research and development (R&D) expense consists primarily of direct personnel costs for pre-production evaluation and testing of new products, prototypes and applications. R&D expense was relatively flat at approximately 2% of value-added sales in both the third quarter of 2014 and 2013.

Other-net in the third quarter of 2014 compared to the third quarter of 2013 reflects a $4.0 million favorable settlement of a legal claim connected with the construction of our beryllium pebble facility in Elmore, Ohio. Refer to Note G to the Consolidated Financial Statements for details of the major components within Other-net.

Interest expense - net was $0.8 million in the third quarter of 2014, up 14.3% over the prior year third quarter of 2013. The increase in the expense was driven by the write-off of unamortized financing fees related to the gold-denominated loan that was settled in the quarter.

Income tax expense for the third quarter of 2014 was $4.2 million versus a benefit of $0.4 million in the third quarter of 2013. The effective tax rates for the third quarter of 2014 and 2013 were 25.3% and (8.2%), respectively. The effects of percentage depletion, production deduction, and foreign source income were major factors for the difference between the effective and

16



statutory rates in the third quarter of 2014 and 2013. Additionally, income tax expense was lower in the third quarter of 2013 due to a $0.5 million credit for research and experimentation.

The federal tax credit available under the Internal Revenue Code for research and development expenses expired on December 31, 2013. As of September 26, 2014, the U.S. Congress had not taken action to extend the Research and Experimentation Tax Credit. Accordingly, the income tax provision in 2014 does not reflect the benefit of any research and development tax credits.

Nine Months

Net sales of $838.5 million in the first nine months of 2014 were $42.2 million, or 4.8% below the $880.7 million recorded in the first nine months of 2013. The comparison of net sales in the first nine months of 2014 versus the prior year period was negatively affected by lower precious metal prices by 4.8%.

Value-added sales of $470.1 million in the first nine months of 2014 increased $18.2 million or 4.0% compared to the first nine months of 2013, driven by growth in the consumer electronics and medical end markets.

Gross margin in the first nine months of 2014 was $150.1 million, or 8.1% above the $138.8 million in gross margin recorded during the first nine months of 2013. Expressed as a percentage of value-added sales, gross margin improved 120 basis points from 30.7% in the first nine months of 2013 to 31.9% in the first nine months of 2014. The increased margin was a combination of improved leverage on value-added sales growth, improved product mix, and improved manufacturing efficiency related to the rationalization efforts taken in late 2013.

SG&A expense was $100.8 million in the first nine months of 2014, an increase of $2.9 million over the first nine months of 2013. The increase is primarily attributable to increased incentive compensation that is based on certain performance metrics, partially offset by product line rationalization savings. SG&A expense expressed as a percentage of value-added sales decreased from 21.7% in 2013 to 21.4% in 2014.

R&D expense was relatively flat at approximately 2% of value-added sales in the first nine months of 2014 and 2013, respectively.

Other-net in the first nine months of 2014 reflects $12.8 million lower expense as compared to the same period in 2013 due to the $4.0 million favorable legal settlement in the third quarter of 2014, a $6.8 million favorable insurance settlement related to a precious metal theft claim in the second quarter of 2014, and a $2.6 million gain on the sale of used equipment in the first quarter of 2014. Refer to Note G to the Consolidated Financial Statements for details of the major components within Other-net.

Interest expense - net for the first nine months of 2014 was $0.3 million lower than the corresponding period in 2013 due to lower average debt levels.

Income tax expense for the first nine months of 2014 and 2013 was $11.2 million and $3.1 million, respectively. The effective tax rates for the first nine months of 2014 and 2013 were 27.3% and 16.4%, respectively. The effects of percentage depletion, production deduction, foreign source income and credits, and federal credits were major factors for the difference between the effective and statutory rates in the first nine months of 2014 and 2013. Additionally, income tax expense was lower in the first nine months of 2013 due to a $1.5 million credit for research and experimentation.





17



Value-Added Sales - Reconciliation of Non-GAAP Measure
    
A reconciliation of sales to value-added sales, a non-GAAP measure, for each reportable segment and for the total Company for the third quarter and first nine months of 2014 and 2013 is as follows:
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 26,
 
Sept. 27,
 
Sept. 26,
 
Sept. 27,
(Millions)
 
2014
 
2013
 
2014
 
2013
Sales
 
 
 
 
 
 
 
 
Advanced Material Technologies
 
$
177.5

 
$
176.3

 
$
519.8

 
$
566.2

Performance Alloys
 
80.9

 
69.6

 
224.3

 
218.4

Beryllium and Composites
 
17.9

 
13.7

 
50.0

 
42.2

Technical Materials
 
15.3

 
15.9

 
44.3

 
54.0

Total
 
$
291.6

 
$
275.4

 
$
838.5

 
$
880.7

 
 
 
 
 
 
 
 
 
Less: Pass-through Metal Cost
 
 
 
 
 
 
 
 
Advanced Material Technologies
 
$
106.3

 
$
108.6

 
$
313.2

 
$
364.5

Performance Alloys
 
14.2

 
12.2

 
39.5

 
43.1

Beryllium and Composites
 

 

 

 

Technical Materials
 
5.5

 
6.6

 
15.8

 
21.3

Total
 
$
126.0

 
$
127.3

 
$
368.4

 
$
428.8

 
 
 
 
 
 
 
 
 
Value-added Sales
 
 
 
 
 
 
 
 
Advanced Material Technologies
 
$
71.2

 
$
67.7

 
$
206.6

 
$
201.6

Performance Alloys
 
66.7

 
57.4

 
184.8

 
175.4

Beryllium and Composites
 
17.9

 
13.7

 
50.0

 
42.2

Technical Materials
 
9.8

 
9.3

 
28.6

 
32.7

Total
 
$
165.6

 
$
148.1

 
$
470.1

 
$
451.9

    
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 directly impact our profitability.

Internally, management reviews net sales on a value-added basis. Value-added sales are a non-GAAP measure that deducts the value of the pass-through metal costs from net sales. Value-added sales allow management to assess the impact of differences in net sales between periods, segments, or markets and analyze the resulting margins and profitability without the distortion of movements in pass-through metal costs. The dollar amount of gross margin and operating profit is not affected by the value-added sales calculation. We sell other metals and materials that are not considered direct pass-throughs, and these costs are not deducted from net sales when calculating value-added sales.

Our net sales are also affected by changes in the use of customer-supplied metal. When we manufacture a precious metal product, the customer may purchase metal from us or may elect to provide its own metal, in which case we process the metal on a toll basis and the metal value does not flow through net sales or cost of sales. In either case, we generally earn our margin based upon our fabrication efforts. The relationship of this margin to net sales can change depending upon whether or not the product was made from our metal or the customer’s metal. The use of value-added sales removes the potential distortion in the comparison of net sales caused by changes in the level of customer-supplied metal.

By presenting information on net sales and value-added sales, it is our intention to allow users of our financial statements to review our net sales with and without the impact of the pass-through metal costs.


18



Segment Results

We operate in four business segments: Advanced Material Technologies, Performance Alloys, Beryllium and Composites, and Technical Materials. The operating results of our business segments are presented in this section. Further information on our business segments is contained in Note E to the Consolidated Financial Statements.

Advanced Material Technologies
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 26
 
Sept. 27
 
Sept. 26
 
Sept. 27
(Millions)
 
2014
 
2013
 
2014
 
2013
Sales
 
$
177.5

 
$
176.3

 
$
519.8

 
$
566.2

Value-added sales
 
71.2