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EX-32 - EXHIBIT 32 - MATERION Corpmtrn-ex32_201573q210q.htm
EX-95 - EXHIBIT 95 - MATERION Corpmtrn-ex95_201573q210q.htm
EX-11 - EXHIBIT 11 - MATERION Corpmtrn-ex11_201573q210q.htm
EX-31.2 - EXHIBIT 31.2 - MATERION Corpmtrn-ex312_201573q210q.htm
EX-31.1 - EXHIBIT 31.1 - MATERION Corpmtrn-ex311_201573q210q.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 July 3, 2015
 
¨
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  þ
Accelerated filer   ¨
Non-accelerated filer  ¨
Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨        No  þ
As of July 23, 2015, there were 20,124,806 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 second quarter and six months ended July 3, 2015 are as follows:
 
 
 
Second quarter and six months ended July 3, 2015 and June 27, 2014
 
 
 
 
 
 
Second quarter and six months ended July 3, 2015 and June 27, 2014
 
 
 
 
 
 
July 3, 2015 and December 31, 2014
 
 
 
 
 
 
Six months ended July 3, 2015 and June 27, 2014


1



Materion Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)
 
 
 
Second Quarter Ended
 
Six Months Ended
 
 
Jul. 3,
 
Jun. 27,
 
Jul. 3,
 
Jun. 27,
(Thousands, except per share amounts)
 
2015
 
2014
 
2015
 
2014
Net sales
 
$
276,855

 
$
287,965

 
$
566,879

 
$
546,894

Cost of sales
 
225,528

 
238,164

 
463,197

 
451,631

Gross margin
 
51,327

 
49,801

 
103,682

 
95,263

Selling, general, and administrative expense
 
34,884

 
34,685

 
71,825

 
65,945

Research and development expense
 
3,586

 
3,443

 
6,934

 
6,230

Other—net
 
36

 
(2,895
)
 
(2,122
)
 
(2,533
)
Operating profit
 
12,821

 
14,568

 
27,045

 
25,621

Interest expense—net
 
650

 
672

 
1,307

 
1,367

Income before income taxes
 
12,171

 
13,896

 
25,738

 
24,254

Income tax expense
 
3,293

 
3,922

 
7,231

 
6,949

Net income
 
$
8,878

 
$
9,974

 
$
18,507


$
17,305

Basic earnings per share:
 
 
 
 
 
 
 
 
Net income per share of common stock
 
$
0.44

 
$
0.48

 
$
0.92

 
$
0.84

Diluted earnings per share:
 
 
 
 
 
 
 
 
Net income per share of common stock
 
$
0.43

 
$
0.47

 
$
0.90

 
$
0.82

Cash dividends per share
 
$
0.090

 
$
0.085

 
$
0.175

 
$
0.165

Weighted-average number of shares of common stock outstanding:
 
 
 
 
 
 
 
 
Basic
 
20,153

 
20,642

 
20,149

 
20,625

Diluted
 
20,461

 
21,001

 
20,453

 
20,983





















Refer to Notes to Consolidated Financial Statements.


2



Materion Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
(Unaudited)
 
 
 
Second Quarter Ended
 
Six Months Ended
 
 
Jul. 3,
 
Jun. 27,
 
Jul. 3,
 
Jun. 27,
(Thousands)
 
2015
 
2014
 
2015
 
2014
Net income
 
$
8,878

 
$
9,974

 
$
18,507

 
$
17,305

Other comprehensive income:
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
316

 
126

 
(1,254
)
 
715

Derivative and hedging activity, net of tax
 
(1,104
)
 
80

 
(601
)
 
87

Pension and post-employment benefit adjustment, net of tax
 
902

 
542

 
1,804

 
9,925

Net change in accumulated other comprehensive income
 
114

 
748

 
(51
)
 
10,727

Comprehensive income
 
$
8,992

 
$
10,722

 
$
18,456

 
$
28,032





































Refer to Notes to Consolidated Financial Statements.


3



Materion Corporation and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
 
 
Jul. 3,
 
Dec. 31,
(Thousands)
 
2015
 
2014
Assets
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
20,629

 
$
13,150

Accounts receivable
 
117,178

 
112,780

Inventories
 
229,232

 
232,409

Prepaid expenses
 
18,992

 
14,953

Deferred income taxes
 
13,806

 
13,402

Total current assets
 
399,837

 
386,694

Long-term deferred income taxes
 
17,722

 
17,722

Property, plant, and equipment
 
811,645

 
800,671

Less allowances for depreciation, depletion, and amortization
 
(557,369
)
 
(553,083
)
Property, plant, and equipment—net
 
254,276

 
247,588

Intangible assets
 
15,717

 
18,559

Other assets
 
4,985

 
4,781

Goodwill
 
86,725

 
86,725

Total Assets
 
$
779,262

 
$
762,069

Liabilities and Shareholders’ Equity
 
 
 
 
Current liabilities
 
 
 
 
Short-term debt
 
$
3,427

 
$
653

Accounts payable
 
31,508

 
36,239

Other liabilities and accrued items
 
48,687

 
59,151

Income taxes
 
5,875

 
3,144

Unearned revenue
 
4,597

 
4,879

Total current liabilities
 
94,094

 
104,066

Other long-term liabilities
 
18,060

 
18,203

Retirement and post-employment benefits
 
100,782

 
103,891

Unearned income
 
48,523

 
51,796

Long-term income taxes
 
1,750

 
1,750

Deferred income taxes
 
3,377

 
617

Long-term debt
 
41,213

 
23,613

Shareholders’ equity
 


 


Serial preferred stock
 

 

Common stock
 
203,125

 
202,104

Retained earnings
 
491,262

 
476,277

Common stock in treasury
 
(144,185
)
 
(140,938
)
Other comprehensive income (loss)
 
(82,288
)
 
(82,237
)
Other equity transactions
 
3,549

 
2,927

Total shareholders' equity
 
471,463

 
458,133

Total Liabilities and Shareholders’ Equity
 
$
779,262

 
$
762,069


Refer to Notes to Consolidated Financial Statements.

4



Materion Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited) 
 
 
Six Months Ended
 
 
Jul. 3,
 
Jun. 27,
(Thousands)
 
2015
 
2014
Cash flows from operating activities:
 
 
 
 
Net income
 
$
18,507

 
$
17,305

Adjustments to reconcile net income to net cash provided from operating activities:
 
 
 
 
Depreciation, depletion, and amortization
 
20,117

 
22,093

Amortization of deferred financing costs in interest expense
 
331

 
356

Stock-based compensation expense (non-cash)
 
2,655

 
3,027

Changes in assets and liabilities net of acquired assets and liabilities:
 
 
 
 
Decrease (increase) in accounts receivable
 
(4,622
)
 
(8,680
)
Decrease (increase) in inventory
 
2,150

 
(16,559
)
Decrease (increase) in prepaid and other current assets
 
(4,037
)
 
(2,658
)
Decrease (increase) in deferred income taxes
 
2,177

 
58

Increase (decrease) in accounts payable and accrued expenses
 
(16,882
)
 
(8,965
)
Increase (decrease) in unearned revenue
 
(283
)
 
1,637

Increase (decrease) in interest and taxes payable
 
3,240

 
5,432

Increase (decrease) in long-term liabilities
 
(1,801
)
 
(11,419
)
Other-net
 
(509
)
 
(3,111
)
Net cash provided by (used in) operating activities
 
21,043

 
(1,484
)
Cash flows from investing activities:
 
 
 
 
Payments for purchase of property, plant, and equipment
 
(16,564
)
 
(12,859
)
Payments for mine development
 
(10,100
)
 
(337
)
Proceeds from sale of property, plant, and equipment
 
18

 
3,009

Other investments-net
 

 
(2
)
Net cash (used in) investing activities
 
(26,646
)
 
(10,189
)
Cash flows from financing activities:
 
 
 
 
Proceeds from issuance (repayment) of short-term debt
 
2,346

 
(4,886
)
Proceeds from issuance of long-term debt
 
51,000

 
33,170

Repayment of long-term debt
 
(33,110
)
 
(15,492
)
Principal payments under capital lease obligations
 
(404
)
 
(328
)
Cash dividends paid
 
(3,523
)
 
(3,405
)
Repurchase of common stock
 
(2,748
)
 
(2,672
)
Issuance of common stock under stock option plans
 

 
360

Tax benefit from stock compensation realization
 

 
109

Net cash provided by financing activities
 
13,561

 
6,856

Effects of exchange rate changes
 
(479
)
 
105

Net change in cash and cash equivalents
 
7,479

 
(4,712
)
Cash and cash equivalents at beginning of period
 
13,150

 
22,774

Cash and cash equivalents at end of period
 
$
20,629

 
$
18,062


Refer to 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 of Materion Corporation and its subsidiaries (Company) contain all adjustments necessary to present fairly the financial position as of July 3, 2015 and December 31, 2014, and the results of operations for the three months and six months ended July 3, 2015 and June 27, 2014. All adjustments were of a normal and recurring nature. Certain amounts in prior years have been reclassified to conform to the 2015 consolidated financial statement presentation.
In May 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU), Revenue from Contracts with Customers, which supersedes previous revenue recognition guidance. The new standard requires that a company recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those goods or services. Companies will need to use more judgment and estimates than under the guidance currently in effect, including estimating the amount of variable revenue to recognize over each identified performance obligation. Additional disclosures will be required to help users of financial statements understand the nature, amount, and timing of revenue and cash flows arising from contracts. This ASU is effective beginning in fiscal year 2018 with a provision for early adoption in 2017. The standard can be adopted either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company is currently evaluating the impact of adopting this new guidance on the consolidated financial statements.
On April 1, 2015, the Financial Accounting Standards Board issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires companies to present debt issuance costs associated with a debt liability as a deduction from the carrying amount of that debt liability on the balance sheet rather than being capitalized as an asset. The standard is effective for interim and annual periods beginning after December 15, 2015, and retrospective presentation is required. The Company will adopt ASU No. 2015-03 as required. The ASU will not have a material effect on the Company's results of operations, financial condition, or liquidity.
Note B — Inventories
Inventories on the Consolidated Balance Sheets are summarized as follows:
 
 
Jul. 3,
 
Dec. 31,
(Thousands)
 
2015
 
2014
Principally average cost:
 
 
 
 
Raw materials and supplies
 
$
35,536

 
$
39,559

Work in process
 
153,200

 
155,377

Finished goods
 
40,496

 
37,473

Net inventories
 
$
229,232

 
$
232,409

The Company recognized last-in, first-out (LIFO) liquidation benefits of $0.8 million and $1.9 million in the second quarter and first six months of 2015, respectively, due to a forecasted reduction in year-end inventory.

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 second quarter and first six months of 2015 and 2014 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
 
 
Second Quarter Ended
 
Second Quarter Ended
 
 
Jul. 3,
 
Jun. 27,
 
Jul. 3,
 
Jun. 27,
(Thousands)
 
2015
 
2014
 
2015
 
2014
Components of net periodic benefit cost
 
 
 
 
 
 
 
 
Service cost
 
$
2,231

 
$
1,936

 
$
29

 
$
34

Interest cost
 
2,500

 
2,444

 
138

 
169

Expected return on plan assets
 
(3,354
)
 
(3,013
)
 

 

Amortization of prior service cost (benefit)
 
(112
)
 
(109
)
 
(374
)
 
(374
)
Amortization of net loss
 
1,819

 
1,275

 

 

Net periodic benefit cost (benefit)
 
$
3,084

 
$
2,533

 
$
(207
)
 
$
(171
)
 
 
 
 
 
 
 
 
 
 
 
Pension Benefits
 
Other Benefits
 
 
Six Months Ended
 
Six Months Ended
 
 
Jul. 3,
 
Jun. 27,
 
Jul. 3,
 
Jun. 27,
(Thousands)
 
2015
 
2014
 
2015
 
2014
Components of net periodic benefit cost
 
 
 
 
 
 
 
 
Service cost
 
$
4,461

 
$
3,872

 
$
58

 
$
69

Interest cost
 
5,000

 
4,888

 
276

 
337

Expected return on plan assets
 
(6,708
)
 
(6,025
)
 

 

Amortization of prior service cost (benefit)
 
(224
)
 
(218
)
 
(748
)
 
(749
)
Amortization of net loss
 
3,639

 
2,550

 

 

Net periodic benefit cost (benefit)
 
$
6,168

 
$
5,067

 
$
(414
)
 
$
(343
)
The Company made contributions to the domestic defined benefit pension plans of $4.0 million in the first six months of 2015.
In 2014, the Company amended its 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 Sheet 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 proceedings where the plaintiffs allege they have contracted chronic beryllium disease (CBD) or related ailments as a result of exposure to beryllium. The Company will record a reserve for CBD or other litigation when a loss from either settlement or verdict is probable and estimable. Claims filed by third-party plaintiffs may be covered by insurance subject to deductibles which vary based on when the exposure occurred. Reserves are recorded for asserted claims only and defense costs are expensed as incurred. There were two CBD cases outstanding as of the end of the second quarter of 2015, and the Company does not expect the resolution of these matters to have a material impact on the consolidated financial statements.
The Company has an active environmental compliance program and records reserves for the probable cost of identified environmental remediation projects. The reserves are established based upon analyses conducted by the Company’s engineers and outside consultants and are adjusted from time to time based upon ongoing studies, the difference between actual and estimated costs, and other factors. The reserves may also be affected by rulings and negotiations with regulatory agencies. The

7


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


undiscounted reserve balance was $4.9 million at July 3, 2015 and $4.9 million at December 31, 2014. Environmental projects tend to be long term, and the final actual remediation costs may differ from the amounts currently recorded.
During the second quarter and first six months of 2015, the Company recognized gains of $1.3 million and $5.1 million, respectively, from settlement agreements on insurance claims regarding construction of the Company's beryllium pebble facility located in Elmore, Ohio. The Company recognized this benefit in Other-net in the Consolidated Statement of Income.
Note E — Segment Reporting
 
 
 
 
 
 
 
Other
 
 
(Thousands)
 
Performance
Alloys and
Composites
 
Advanced Materials
 
Other (1)
 
Corporate (2)
 
Subtotal
 
Total
Second Quarter 2015
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
107,682

 
$
131,370

 
$
38,265

 
$
(462
)
 
$
37,803

 
$
276,855

Intersegment sales (3)
 
365

 
16,129

 

 

 

 
16,494

Value-added sales
 
91,511

 
46,705

 
25,203

 
(1,060
)
 
24,143

 
162,359

Operating profit (loss)
 
9,327

 
7,436

 
564

 
(4,506
)
 
(3,942
)
 
12,821

Second Quarter 2014
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
109,647

 
$
145,025

 
$
34,088

 
$
(795
)
 
$
33,293

 
$
287,965

Intersegment sales (3)
 
181

 
11,040

 

 

 

 
11,221

Value-added sales
 
89,864

 
44,984

 
24,916

 
(198
)
 
24,718

 
159,566

Operating profit (loss)
 
6,293

 
12,534

 
490

 
(4,749
)
 
(4,259
)
 
14,568

 
 
 
 
 
 
 
 
 
 
 
 
 
First Six Months 2015
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
210,941

 
$
281,287

 
$
74,882

 
$
(231
)
 
$
74,651

 
$
566,879

Intersegment sales (3)
 
542

 
33,514

 

 

 

 
34,056

Value-added sales
 
177,101

 
98,432

 
49,767

 
(310
)
 
49,457

 
324,990

Operating profit (loss)
 
16,130

 
16,339

 
2,239

 
(7,663
)
 
(5,424
)
 
27,045

Assets
 
430,268

 
149,062

 
120,643

 
79,289

 
199,932

 
779,262

First Six Months 2014
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
206,803

 
$
274,364

 
$
67,987

 
$
(2,260
)
 
$
65,727

 
$
546,894

Intersegment sales (3)
 
413

 
22,127

 

 

 

 
22,540

Value-added sales
 
169,888

 
86,654

 
48,835

 
(950
)
 
47,885

 
304,427

Operating profit (loss)
 
12,502

 
17,679

 
4,613

 
(9,173
)
 
(4,560
)
 
25,621

Assets
 
417,336

 
166,086

 
147,770

 
59,662

 
207,432

 
790,854

(1) 
The Other reportable segment includes the results of our Precision Optics and Large Area Coatings operating segments, which do not meet the quantitative thresholds for separate disclosure and are collectively referred to as our Precision Coatings group.
(2) 
Costs associated with our unallocated corporate functions have been shown separately to better illustrate the financial information for the businesses within the Other reportable segment.
(3) 
Intersegment sales are eliminated in consolidation.

8


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


Note F — Stock-based Compensation Expense
Stock-based compensation expense was $1.6 million in the second quarter of 2015 and $2.9 million in the second quarter of 2014. For the first six months of the year, stock-based compensation expense was $4.7 million in 2015 and $5.0 million in 2014, which includes awards settled in shares and in cash.
The Company granted approximately 40,000 stock-settled restricted stock units (RSUs) in the first quarter of 2015. These shares will be amortized over a vesting period of three years using the closing price of Materion's common stock on the date of grant of $36.81. Additionally, approximately 21,000 cash-settled RSUs were granted to employees in the first quarter of 2015. Because these shares were settled in cash, the liability and related expense were adjusted based on the closing price of Materion’s common stock over the vesting period of three years.
The Company granted approximately 18,882 stock-settled RSUs in the second quarter of 2015. These shares will be amortized over a vesting period of three years using the closing price of Materion's common stock on the date of Materion's annual meeting of shareholders of $38.13. Additionally, approximately 13,950 cash-settled RSUs were granted to employees in the second quarter of 2015. Because these shares are settled in cash, the liability and related expense are adjusted based on the closing price of Materion’s common stock over the vesting period of three years.
The Company granted approximately 160,000 stock appreciation rights (SARs) to certain employees in the first quarter of 2015 at a strike price of $36.81 per share. The fair value of the SARs, which was determined on the grant date using a Black-Scholes model, was $13.27 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.
Exercises of SARs totaled approximately 65,000 in the first six months of 2015, and 38,000 in the first six months of 2014.
The Company granted approximately 77,000 stock-settled performance-based restricted stock units (PRSUs) to certain employees in the first quarter of 2015 at a weighted-average fair value of $33.31 per share. The fair value will be expensed over the vesting period of three years. In addition, approximately 39,000 cash-settled PRSUs were awarded to employees in the first quarter of 2015. The liability for cash-settled PRSUs is remeasured at fair value each reporting period, and the expense is recorded accordingly. The final payout to the employees for all PRSUs will be based upon the Company’s return on invested capital and the total return to shareholders over the vesting period relative to a peer group’s performance over the same period.
Note G — Other-net
Other-net (income) expense for the second quarter and first six months of 2015 and 2014 is summarized as follows: 
 
 
Second Quarter Ended
 
Six Months Ended
 
 
Jul. 3,
 
Jun. 27,
 
Jul. 3,
 
Jun. 27,
(Thousands)
 
2015
 
2014
 
2015
 
2014
Foreign currency exchange/translation (gain) loss
 
$
(1,729
)
 
$
423

 
$
(3,313
)
 
$
475

Amortization of intangible assets
 
1,257

 
1,310

 
2,513

 
2,433

Metal consignment fees
 
1,833

 
1,846

 
3,868

 
3,712

Net (gain) loss on disposal of fixed assets
 
234

 
27

 
308

 
(2,610
)
Recovery from insurance
 

 
(6,750
)
 
(3,800
)
 
(6,750
)
Legal settlements
 
(1,325
)
 

 
(1,325
)
 

Other items
 
(234
)
 
249

 
(373
)
 
207

Total
 
$
36

 
$
(2,895
)
 
$
(2,122
)
 
$
(2,533
)
Note H — Income Taxes
The Company recorded income tax expense of $3.3 million in the second quarter of 2015, an effective tax rate of 27.1% against income before income taxes, and income tax expense of $3.9 million in the second quarter of 2014, with an effective tax rate of 28.2% against income before income taxes.
In the first six months of 2015, income tax expense of $7.2 million was calculated using an effective tax rate of 28.1%, while income tax expense of $6.9 million in the first six months of 2014 was calculated using an effective tax rate of 28.7%.

9


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


The differences between the statutory and effective rates in the second quarter and first six 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.
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 first six months of 2015, the depreciation expense on the equipment subject to reimbursement was $3.3 million. Unearned income was reduced by $3.3 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.
Note J — 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.
The following table summarizes the financial instruments measured at fair value in the Consolidated Balance Sheet as of July 3, 2015: 
 
 
 
 
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
 
 
 
 
 
 
 
 
Deferred compensation investments
 
$
2,600

 
$
2,578

 
$
22

 
$

Foreign currency forward contracts
 
2,522

 

 
2,522

 

Total
 
$
5,122

 
$
2,578

 
$
2,544

 
$

Financial Liabilities
 
 
 
 
 
 
 
 
Deferred compensation liability
 
$
2,626

 
$
2,626

 
$

 
$

Foreign currency forward contracts
 
19

 

 
19

 

Total
 
$
2,645

 
$
2,626

 
$
19

 
$

The Company uses a market approach to value the assets and liabilities for financial instruments in the table above. Outstanding contracts are valued through models that utilize market observable inputs, including both spot and forward prices, for the same underlying currencies and metals. The carrying values of the other working capital items and debt in the Consolidated Balance Sheet approximate fair values as of July 3, 2015.

10


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


Note K — Derivative Instruments and Hedging Activity
The Company uses derivative contracts to hedge portions of its foreign currency exposures and may also use derivatives to hedge a portion of its precious metal exposures. The objectives and strategies for using derivatives in these areas are as follows:
Foreign Currency.    The Company sells a portion of its products to overseas customers in their local currencies, primarily the euro and yen. The Company secures foreign currency derivatives, mainly forward contracts and options, to hedge these anticipated sales transactions. The purpose of the hedge program is to protect against the reduction in the dollar value of foreign currency sales from adverse exchange rate movements. Should the dollar strengthen significantly, the decrease in the translated value of the foreign currency sales should be partially offset by gains on the hedge contracts. Depending upon the methods used, hedge contracts may limit the benefits from a weakening U.S. dollar.
The use of forward contracts locks in a firm rate and eliminates any downside from an adverse rate movement as well as any benefit from a favorable rate movement. The Company may from time to time choose to hedge with options or a tandem of options known as a collar. These hedging techniques can limit or eliminate the downside risk but can allow for some or all of the benefit from a favorable rate movement to be realized. Unlike a forward contract, a premium is paid for an option; collars, which are a combination of a put and call option, may have a net premium but can be structured to be cash neutral. The Company will primarily hedge with forward contracts due to the relationship between the cash outlay and the level of risk.
The use of foreign currency derivative contracts is governed by policies approved by the Audit Committee of the Board of Directors. A team consisting of senior financial managers reviews the estimated exposure levels, as defined by budgets, forecasts, and other internal data, and determines the timing, amounts, and instruments to use to hedge that exposure within the confines of the policy. Management analyzes the effective hedged rates and the actual and projected gains and losses on the hedging transactions against the program objectives, targeted rates, and levels of risk assumed. Hedge contracts are typically layered in at different times for a specified exposure period in order to minimize the impact of rate movements.
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 who charge the Company a financing fee based upon the current value of the metal on hand.
In certain instances, a customer may want to establish the price for the precious metal at the time the sales order is placed rather than at the time of shipment. Setting the sales price at a different date than when the material would be purchased potentially creates an exposure to movements in the market price of the metal. Therefore, in these limited situations, the Company may elect to enter into a forward contract to purchase precious metal. The forward contract allows the Company to purchase metal at a fixed price on a specific future date. The price in the forward contract serves as the basis for the price to be charged to the customer. By doing so, the selling price and purchase price are matched, and the Company's price exposure is reduced.
The Company refines precious metal containing materials for its customers and typically will purchase the refined metal from the customer at current market prices. In limited circumstances, the customer may want to fix the price to be paid at the time of the order as opposed to when the material is refined. The customer may also want to fix the price for a set period of time. The Company may then elect to enter into a hedge contract, either a forward contract or a swap, to fix the price for the estimated quantity of metal to be purchased, thereby reducing the exposure to adverse movements in the price of the metal.
The Company may from time to time elect to purchase precious metal and hold in inventory rather than on consignment due to potential credit line limitations or other factors. These purchases are typically held for a short duration. A forward contract will be secured at the time of the purchase to fix the price to be used when the metal is transferred back to the consignment line, thereby limiting any price exposure during the time when the metal was owned.

11


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


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 $32.3 million as of July 3, 2015. All of these contracts were designated and effective as cash flow hedges. The net fair value of the outstanding contracts was $2.5 million, with an asset recorded in prepaid expenses and other assets and a liability recorded in other liabilities and accrued items on the Consolidated Balance Sheet as of July 3, 2015.
No ineffective expense was recorded in the second quarter or first six months of 2015 or 2014.
Changes in the fair value of outstanding cash flow hedges recorded in OCI for the first six months of 2015 and 2014 totaled $2.4 million and $0.0 million, respectively. The Company expects to relieve substantially the entire balance in OCI as of July 3, 2015 to the Consolidated Statements of Income during the twelve-month period beginning July 4, 2015. Refer to Note L for additional OCI details.
Note L — Accumulated Other Comprehensive Income

Changes in the components of accumulated other comprehensive income, including the amounts reclassified out, for the second quarter and first six months of 2015 and 2014 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 April 3, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
4,255

 
$

 
$
4,255

 
$
(107,671
)
 
$
(5,723
)
 
$
(109,139
)
 Deferred tax expense (benefit)
 
174

 

 
174

 
(26,911
)
 

 
(26,737
)
 Net
 
$
4,081

 
$

 
$
4,081

 
$
(80,760
)
 
$
(5,723
)
 
$
(82,402
)
Second quarter 2015 activity
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassifications
 
$
(197
)
 
$

 
$
(197
)
 
$

 
$
316

 
$
119

Amounts reclassified from accumulated other comprehensive income
 
(1,555
)
 

 
(1,555
)
 
1,395

 

 
(160
)
Net current period other comprehensive income (loss) before tax
 
(1,752
)
 

 
(1,752
)
 
1,395

 
316

 
(41
)
Deferred taxes on current period activity
 
(648
)
 

 
(648
)
 
493

 

 
(155
)
Net current period other comprehensive income (loss) after tax
 
$
(1,104
)
 
$

 
$
(1,104
)
 
$
902

 
$
316

 
$
114

Accumulated other comprehensive income, as of July 3, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
2,503

 
$

 
$
2,503

 
$
(106,276
)
 
$
(5,407
)
 
$
(109,180
)
 Deferred tax expense (benefit)
 
(474
)
 

 
(474
)
 
(26,418
)
 

 
(26,892
)
 Net
 
$
2,977

 
$

 
$
2,977

 
$
(79,858
)
 
$
(5,407
)
 
$
(82,288
)

12


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
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income, as of December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
3,456

 
$

 
$
3,456

 
$
(109,080
)
 
$
(4,153
)
 
$
(109,777
)
 Deferred tax expense (benefit)
 
(122
)
 

 
(122
)
 
(27,418
)
 

 
(27,540
)
 Net
 
$
3,578

 
$

 
$
3,578

 
$
(81,662
)
 
$
(4,153
)
 
$
(82,237
)
 
 
 
 
 
 
 
 
 
 
 
 
 
First six months of 2015 activity
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassifications
 
$
2,439

 
$

 
$
2,439

 
$
14

 
$
(1,254
)
 
$
1,199

Amounts reclassified from accumulated other comprehensive income
 
(3,392
)
 
 
 
(3,392
)
 
2,790

 
 
 
(602
)
Net current period other comprehensive income (loss) before tax
 
(953
)
 

 
(953
)
 
2,804

 
(1,254
)
 
597

 Deferred taxes on current period activity
 
(352
)
 
 
 
(352
)
 
1,000

 

 
648

 Net current period other comprehensive income (loss) after tax
 
$
(601
)
 
$

 
$
(601
)
 
$
1,804

 
$
(1,254
)
 
$
(51
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income, as of July 3, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
2,503

 
$

 
$
2,503

 
$
(106,276
)
 
$
(5,407
)
 
$
(109,180
)
 Deferred tax expense (benefit)
 
(474
)
 

 
(474
)
 
(26,418
)
 

 
(26,892
)
 Net
 
$
2,977

 
$

 
$
2,977

 
$
(79,858
)
 
$
(5,407
)
 
$
(82,288
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income, as of March 28, 2014
 
 
 
 
 
 
 
 
 
 
 
 
 Gross
 
$
(96
)
 
$

 
$
(96
)
 
$
(62,058
)
 
$
876

 
$
(61,278
)
 Deferred tax expense (benefit)
 
(1,437
)
 

 
(1,437
)
 
(9,932
)
 

 
(11,369
)
 Net
 
$
1,341

 
$

 
$
1,341

 
$
(52,126
)
 
$
876

 
$
(49,909
)
Second quarter 2014 activity
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassifications
 
$
84

 
$

 
$
84

 
$

 
$
126

 
$
210

Amounts reclassified from accumulated other comprehensive income
 
43

 

 
43

 
461

 

 
504

Net current period other comprehensive income (loss) before tax
 
127

 

 
127

 
461

 
126

 
714

Deferred taxes on current period activity
 
47

 

 
47

 
(81
)
 

 
(34
)
Net current period other comprehensive income (loss) after tax
 
$
80

 
$

 
$
80

 
$
542

 
$
126

 
$
748

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
)

13


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
 
$
1,421

 
$

 
$
1,421

 
$
(51,584
)
 
$
1,002

 
$
(49,161
)
 
 
 
 
 
 
 
 
 
 
 
 
 
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 six months of 2014 activity
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive income (loss) before reclassifications
 
$
(8
)
 
$

 
$
(8
)
 
$
14,034

 
$
715

 
$
14,741

Amounts reclassified from accumulated other comprehensive income
 
126

 
19

 
145

 
1,670

 

 
1,815

Net current period other comprehensive income (loss) before tax
 
118

 
19

 
137

 
15,704

 
715

 
16,556

Deferred taxes on current period activity
 
43

 
7

 
50

 
5,779

 

 
5,829

Net current period other comprehensive income (loss) after tax
 
$
75

 
$
12

 
$
87

 
$
9,925

 
$
715

 
$
10,727

 
 
 
 
 
 
 
 
 
 
 
 
 
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
)
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. Gains and losses on precious metal cash flow hedges are recorded in Cost of sales in the Consolidated Statements of Income in order to offset the impact of precious metal price movements in Cost of sales. The Company has no precious metal hedges as of July 3, 2015. Refer to Note K 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 C 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 end markets, including consumer electronics, industrial components, medical, automotive electronics, energy, telecommunications infrastructure, and defense.

EXECUTIVE OVERVIEW
For the second quarter and first six months of 2015, the following key factors contributed to our overall results of operations, financial position, and cash flows:
Net sales in the second quarter of 2015 were $276.9 million, a 4% decrease from net sales in the second quarter of 2014. The decrease was due primarily to the impact of lower pass-through precious metal and copper prices and the negative impact of foreign exchange rates.

Value-added sales increased 2% to $162.4 million in the second quarter of 2015 compared to $159.6 million in the second quarter of 2014. Excluding the impact of foreign exchange rate movements, value-added sales in the second quarter of 2015 increased 4% compared to the second quarter of 2014. 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 $51.3 million in the second quarter of 2015 compared to $49.8 million in the second quarter of 2014. The increased gross margin represents an approximate 40 basis point margin expansion as a percentage of value-added sales associated with improved sales volume and better product mix.

Operating profit was $12.8 million in the second quarter of 2015 compared to $14.6 million in the second quarter of 2014. Higher gross margins in 2015 were more than offset by a $2.9 million unfavorable change in Other-net. The decrease in Other-net was primarily driven by a $6.8 million insurance recovery recognized in the second quarter of 2014 on our theft claim associated with a precious metal inventory loss at our Albuquerque, New Mexico facility in 2012.

As a result of the aforementioned factors, overall diluted earnings per share decreased to $0.43 for the three months ended July 3, 2015 as compared $0.47 for the three months ended June 27, 2014. For the first six months of 2015, the overall diluted earnings per share increased to $0.90, or approximately 10%, versus the same period in 2014.

A total of 51,150 shares of common stock were repurchased in the second quarter of 2015 for $2.0 million in the aggregate. Since the approval of a $50.0 million common stock repurchase plan by our Board of Directors in January 2014, we have purchased 762,214 shares at a total cost of $25.0 million.

15



RESULTS OF OPERATIONS
 
 
Second Quarter Ended
 
Six Months Ended
 
 
Jul. 3,
 
Jun. 27,
 
$
 
%
 
Jul. 3,
 
Jun. 27,
 
$
 
%
(Millions, except per share data)
 
2015
 
2014
 
Change
 
Change
 
2015
 
2014
 
Change
 
Change
Net sales
 
$
276.9

 
$
288.0

 
$
(11.1
)
 
(3.9
)%
 
$
566.9

 
$
546.9

 
$
20.0

 
3.7
 %
Value-added sales
 
162.4

 
159.6

 
2.8

 
1.8
 %
 
325.0

 
304.4

 
20.6

 
6.8
 %
Gross margin
 
51.3

 
49.8

 
1.5

 
3.0
 %
 
103.7

 
95.3

 
8.4

 
8.8
 %
SG&A expense
 
34.9

 
34.7

 
0.2

 
0.6
 %
 
71.8

 
65.9

 
5.9

 
9.0
 %
R&D expense
 
3.6

 
3.4

 
0.2

 
5.9
 %
 
6.9

 
6.2

 
0.7

 
11.3
 %
Other—net
 

 
(2.9
)
 
2.9

 
(100.0
)%
 
(2.0
)
 
(2.4
)
 
0.4

 
(16.7
)%
Operating profit
 
12.8

 
14.6

 
(1.8
)
 
(12.3
)%
 
27.0

 
25.6

 
1.4

 
5.5
 %
Interest expense—net
 
0.6

 
0.7

 
(0.1
)
 
(14.3
)%
 
1.3

 
1.4

 
(0.1
)
 
(7.1
)%
Income before income taxes
 
12.2

 
13.9

 
(1.7
)
 
(12.2
)%
 
25.7

 
24.2

 
1.5

 
6.2
 %
Income tax expense (benefit)
 
3.3

 
3.9

 
(0.6
)
 
(15.4
)%
 
$
7.2

 
6.9

 
0.3

 
4.3
 %
Net income
 
$
8.9

 
$
10.0

 
$
(1.1
)
 
(11.0
)%
 
$
18.5

 
$
17.3

 
$
1.2

 
6.9
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
0.43

 
$
0.47

 
$
(0.04
)
 
(8.5
)%
 
$
0.90

 
$
0.82

 
$
0.08

 
9.8
 %

Second Quarter

Net sales of $276.9 million in the second quarter of 2015 were $11.1 million, or 4% lower than the $288.0 million recorded in the second quarter of 2014. The decrease in net sales in the second quarter of 2015 was due to lower pass-through precious metal and copper prices and the negative impact of foreign exchange rates, partially offset by higher volumes and improved product mix. Changes in precious metal and copper prices negatively impacted net sales in the second quarter of 2015 by approximately $12.4 million when compared to the second quarter of 2014. The strengthening of the U.S. dollar, primarily against the euro and yen, had an approximate $4.6 million negative impact on net sales in the second quarter of 2015 versus the comparable period in 2014.

Value-added sales of $162.4 million in the second quarter of 2015 increased $2.8 million, or 2% compared to the second quarter of 2014. Excluding the impact of foreign exchange rate movements, value-added sales increased 4% in the second quarter of 2015 versus the second quarter of 2014. The year-over-year improvement in value-added sales was primarily driven by sales growth in our defense, industrial components, and automotive electronics end markets. Value-added sales to the defense, industrial components, and automotive end markets increased year-over-year 31%, 6%, and 8%, respectively.

Gross margin in the second quarter of 2015 was $51.3 million, or 3% above the $49.8 million in gross margin recorded during the second quarter of 2014. Expressed as a percentage of value-added sales, gross margin improved 40 basis points from 31.2% in the second quarter of 2014 to 31.6% in the second quarter of 2015. The increase in gross margin was primarily due to improved leverage on value-added sales and improved product mix, offset by the negative impact of foreign exchange. Gross margin also benefited by the recognition of a $0.8 million last-in, first-out (LIFO) liquidation benefit related to inventory reductions.

Selling, general, and administrative (SG&A) expense was $34.9 million in the second quarter of 2015 and relatively flat compared to $34.7 million in the second quarter of 2014. Domestic pension expense increased in 2015 as compared to 2014 due to a lower discount rate used to measure the liability as of December 31, 2014, as well as new mortality rate assumptions that assume retirees are living longer. The increase in domestic pension expense was offset by a decrease in stock compensation expense due primarily to movement in our stock price.

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 as a percentage of value-added sales at approximately 2% in both the second quarter of 2015 and 2014.

Other-net was approximately break-even in the second quarter of 2015 as compared to $2.9 million of income in the second quarter of 2014. The main factor impacting the movement in Other-net was the recognition of a $6.8 million insurance recovery in 2014 related to a theft claim associated with a precious metal inventory loss at our Albuquerque, New Mexico facility in 2012. In addition, there were foreign currency exchange gains of $1.7 million in the second quarter of 2015 as compared to foreign

16



currency exchange losses of $0.4 million in the second quarter of 2014. Refer to Note G 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 2015 and second quarter of 2014.

Income tax expense for the second quarter of 2015 was $3.3 million versus $3.9 million in the second quarter of 2014. The effective tax rates for the second quarter of 2015 and 2014 were comparable at 27% and 28%, respectively. The effects of percentage depletion, production deduction, and foreign source income were major factors for the difference between the effective and statutory rates in the second quarter of 2015 and 2014.

Six Months

Net sales of $566.9 million in the first six months of 2015 were $20.0 million, or 4% above the $546.9 million recorded in the first six months of 2014. The increase in net sales in the first six months of 2015 was due to higher volumes, partially offset by lower pass-through precious metal and copper prices and the negative impact of foreign exchange rates. Changes in precious metal and copper prices negatively impacted net sales in the first six months of 2015 by approximately $22.1 million when compared to the first six months of 2014. The strengthening of the U.S. dollar, primarily against the euro and yen, had a negative impact of approximately $8.5 million on net sales in the first six months of 2015 versus the comparable period in 2014.

Value-added sales of $325.0 million in the first six months of 2015 increased $20.6 million, or 7% compared to the first six months of 2014. The year-over-year improvement in value-added sales was primarily driven by sales growth in our industrial components, defense, and services end markets. Value-added sales to the industrial components, defense, and services end markets increased year-over-year 18%, 23%, and 21%, respectively.

Gross margin in the first six months of 2015 was $103.7 million, or 9% above the $95.3 million in gross margin recorded during the first six months of 2014. Expressed as a percentage of value-added sales, gross margin improved 60 basis points from 31.3% in the first six months of 2014 to 31.9% in the first six months of 2015. The increase in gross margin was primarily due to improved leverage on value-added sales and improved product mix, offset by the negative impact of foreign exchange. Gross margin also benefited by the recognition of a $1.9 million LIFO liquidation benefit related to inventory reductions.

Selling, general, and administrative (SG&A) expense was $71.8 million in the first six months of 2015, an increase of $5.9 million over the first six months of 2014. The increase is primarily attributable to higher incentive compensation expense driven by an increase in our operating profit and an increase in domestic pension expense. Domestic pension expense increased in 2015 as compared to 2014 due to a lower discount rate used to measure the liability as of December 31, 2014, as well as new mortality rate assumptions that assume retirees are living longer.

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 as a percentage of value-added sales at approximately 2% in both the first six months of 2015 and 2014.

Other-net totaled $2.1 million of income in the first six months of 2015 as compared to $2.5 million of income in the first six months of 2014. Other-net in 2015 included recognized gains of $5.1 million from settlement agreements on insurance claims in connection with the construction of our beryllium pebble facility in Elmore, Ohio, as well as $3.3 million of foreign currency exchange gains. Other-net in 2014 included a $6.8 million insurance recovery related to a theft claim associated with a precious metal inventory loss at our Albuquerque, New Mexico facility in 2012, a gain of $2.6 million related to the sale of used equipment, and $0.5 million of foreign currency exchange losses. Refer to Note G to the Consolidated Financial Statements for details of the major components within Other-net.

Interest expense - net was $1.3 million in the first six months of 2015 and $1.4 million in the first six months of 2014.

Income tax expense for the first six months of 2015 was $7.2 million versus $6.9 million in the first six months of 2014. The effective tax rates for the first six months of 2015 and 2014 were comparable at 28% and 29%, respectively. The effects of percentage depletion, production deduction, and foreign source income were major factors for the difference between the effective and statutory rates in the first six months of 2015 and 2014.




17



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 second quarter and first six months of 2015 and 2014 is as follows:
 
 
Second Quarter Ended
 
Six Months Ended
 
 
Jul. 3,
 
Jun. 27,
 
Jul. 3,
 
Jun. 27,
(Millions)
 
2015
 
2014
 
2015
 
2014
Net sales
 
 
 
 
 
 
 
 
Performance Alloys and Composites
 
$
107.7

 
$
109.6

 
$
210.9

 
$
206.8

Advanced Materials
 
131.4

 
145.0

 
281.3

 
274.4

Other
 
37.8

 
33.4

 
74.7

 
65.7

Total
 
$
276.9

 
$
288.0

 
$
566.9

 
$
546.9

 
 
 
 
 
 
 
 
 
Less: pass-through metal costs
 
 
 
 
 
 
 
 
Performance Alloys and Composites
 
$
16.2

 
$
19.7

 
$
33.8

 
$
36.9

Advanced Materials
 
84.7

 
100.0

 
182.9

 
187.8

Other
 
13.6

 
8.7

 
25.2

 
17.8

Total
 
$
114.5

 
$
128.4

 
$
241.9

 
$
242.5

 
 
 
 
 
 
 
 
 
Value-added sales
 
 
 
 
 
 
 
 
Performance Alloys and Composites
 
$
91.5

 
$
89.9

 
$
177.1

 
$
169.9

Advanced Materials
 
46.7

 
45.0

 
98.4

 
86.6

Other
 
24.2

 
24.7

 
49.5

 
47.9

Total
 
$
162.4

 
$
159.6

 
$
325.0

 
$
304.4

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 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. The reporting of 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 remove