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EX-95 - EXHIBIT 95 - MATERION Corpmtrn-ex95_2017q310q.htm
EX-32.1 - EXHIBIT 32.1 - MATERION Corpmtrn-ex32_2017q310q.htm
EX-31.2 - EXHIBIT 31.2 - MATERION Corpmtrn-ex312_2017q310q.htm
EX-31.1 - EXHIBIT 31.1 - MATERION Corpmtrn-ex311_2017q310q.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 29, 2017
 
¨
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 Heights, Ohio
 
44124
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code:
216-486-4200
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  þ        No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  þ        No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer  þ
 
 
Accelerated filer  ¨
   Non-accelerated filer  ¨ (Do not check if a smaller reporting company)
Smaller reporting company ¨
 
 
 
Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨        No  þ

Number of Shares of Common Stock, without par value, outstanding at September 29, 2017: 20,043,474.





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 29, 2017 are as follows:
 
 
Third quarter and nine months ended September 29, 2017 and September 30, 2016

 
 
 
 
 
 
Third quarter and nine months ended September 29, 2017 and September 30, 2016
 
 
 
 
 


 
September 29, 2017 and December 31, 2016
 
 
 
 
 
 
Nine months ended September 29, 2017 and September 30, 2016
 




1



Materion Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)
 
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 29,
 
Sept. 30,
 
Sept. 29,
 
Sept. 30,
(Thousands, except per share amounts)
 
2017
 
2016
 
2017
 
2016
Net sales
 
$
294,268

 
$
249,619

 
$
830,779

 
$
734,906

Cost of sales
 
239,065

 
198,864

 
678,023

 
595,488

Gross margin
 
55,203

 
50,755

 
152,756

 
139,418

Selling, general, and administrative expense
 
36,415

 
34,177

 
108,118

 
97,101

Research and development expense
 
3,429

 
3,237

 
10,103

 
9,860

Other—net
 
3,801

 
3,190

 
9,823

 
8,997

Operating profit
 
11,558

 
10,151

 
24,712

 
23,460

Interest expense—net
 
533

 
490

 
1,721

 
1,417

Income before income taxes
 
11,025

 
9,661

 
22,991

 
22,043

Income tax expense
 
1,705

 
1,616

 
3,308

 
3,081

Net income
 
$
9,320

 
$
8,045

 
$
19,683

 
$
18,962

Basic earnings per share:
 
 
 
 
 
 
 
 
Net income per share of common stock
 
$
0.47

 
$
0.40

 
$
0.98

 
$
0.95

Diluted earnings per share:
 
 
 
 
 
 
 
 
Net income per share of common stock
 
$
0.46

 
$
0.40

 
$
0.97

 
$
0.94

Cash dividends per share
 
$
0.100

 
$
0.095

 
$
0.295

 
$
0.280

Weighted-average number of shares of common stock outstanding:
 
 
 
 
 
 
 
 
Basic
 
20,040

 
19,957

 
20,007

 
19,996

Diluted
 
20,411

 
20,192

 
20,361

 
20,209





















The accompanying notes are an integral part of the consolidated financial statements.





2



Materion Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income
(Unaudited)
 
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 29,
 
Sept. 30,
 
Sept. 29,
 
Sept. 30,
(Thousands)
 
2017
 
2016
 
2017
 
2016
Net income
 
$
9,320

 
$
8,045

 
$
19,683

 
$
18,962

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
271

 
467

 
1,649

 
2,918

Derivative and hedging activity, net of tax
 
(120
)
 
132

 
(755
)
 
(489
)
Pension and post-employment benefit adjustment, net of tax
 
881

 
673

 
2,397

 
2,923

Other comprehensive income
 
1,032

 
1,272

 
3,291

 
5,352

Comprehensive income
 
$
10,352

 
$
9,317

 
$
22,974

 
$
24,314





































The accompanying notes are an integral part of the consolidated financial statements.




3



Materion Corporation and Subsidiaries
Consolidated Balance Sheets
 
 
(Unaudited)
 
 
 
 
Sept. 29,
 
Dec. 31,
(Thousands)
 
2017
 
2016
Assets
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
22,486

 
$
31,464

Accounts receivable
 
125,417

 
100,817

Inventories
 
220,223

 
200,865

Prepaid and other current assets
 
19,115

 
12,138

Total current assets
 
387,241

 
345,284

Long-term deferred income taxes
 
40,332

 
39,409

Property, plant, and equipment
 
877,002

 
861,267

Less allowances for depreciation, depletion, and amortization
 
(632,435
)
 
(608,636
)
Property, plant, and equipment—net
 
244,567

 
252,631

Intangible assets
 
10,771

 
11,074

Other assets
 
6,312

 
5,950

Goodwill
 
89,720

 
86,950

Total Assets
 
$
778,943

 
$
741,298

Liabilities and Shareholders’ Equity
 
 
 
 
Current liabilities
 
 
 
 
Short-term debt
 
$
767

 
$
733

Accounts payable
 
44,678

 
32,533

Salaries and wages
 
30,889

 
29,885

Other liabilities and accrued items
 
27,950

 
21,340

Income taxes
 
2,953

 
4,781

Unearned revenue
 
5,859

 
1,105

Total current liabilities
 
113,096

 
90,377

Other long-term liabilities
 
18,968

 
17,979

Retirement and post-employment benefits
 
92,014

 
91,505

Unearned income
 
37,991

 
41,369

Long-term income taxes
 
1,593

 
2,100

Deferred income taxes
 
279

 
274

Long-term debt
 
3,010

 
3,605

Shareholders’ equity
 
 
 
 
Serial preferred stock
 

 

Common stock
 
219,817

 
212,702

Retained earnings
 
531,683

 
517,903

Common stock in treasury
 
(161,030
)
 
(154,399
)
Accumulated other comprehensive loss
 
(82,890
)
 
(86,181
)
Other equity transactions
 
4,412

 
4,064

Total shareholders' equity
 
511,992

 
494,089

Total Liabilities and Shareholders’ Equity
 
$
778,943

 
$
741,298

The accompanying notes are an integral part of the consolidated financial statements.




4



Materion Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited) 
 
 
Nine Months Ended
 
 
Sept. 29,
 
Sept. 30,
(Thousands)
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net income
 
$
19,683

 
$
18,962

Adjustments to reconcile net income to net cash provided from (used in) operating activities:
 
 
 
 
Depreciation, depletion, and amortization
 
33,444

 
34,379

Amortization of deferred financing costs in interest expense
 
670

 
417

Stock-based compensation expense (non-cash)
 
4,303

 
2,880

(Gain) loss on sale of property, plant, and equipment
 
207

 
(601
)
Deferred income tax expense (benefit)
 
1,073

 
(676
)
Changes in assets and liabilities net of acquired assets and liabilities:
 
 
 

Decrease (increase) in accounts receivable
 
(21,572
)
 
(19,781
)
Decrease (increase) in inventory
 
(9,953
)
 
3,294

Decrease (increase) in prepaid and other current assets
 
(6,077
)
 
(956
)
Increase (decrease) in accounts payable and accrued expenses
 
17,991

 
(2,207
)
Increase (decrease) in unearned revenue
 
4,746

 
(2,546
)
Increase (decrease) in interest and taxes payable
 
(2,083
)
 
898

Increase (decrease) in long-term liabilities
 
(5,611
)
 
(9,320
)
Other-net
 
(1,324
)
 
2,479

Net cash provided by operating activities
 
35,497

 
27,222

Cash flows from investing activities:
 
 
 
 
Payments for purchase of property, plant, and equipment
 
(17,759
)
 
(20,052
)
Payments for mine development
 
(620
)
 
(8,934
)
Payments for acquisition
 
(16,504
)
 

Proceeds from sale of property, plant, and equipment
 
53

 
1,366

Net cash used in investing activities
 
(34,830
)
 
(27,620
)
Cash flows from financing activities:
 
 
 
 
Proceeds from issuance of short-term debt, net
 

 
3,777

Proceeds from issuance of long-term debt
 
55,000

 
10,000

Repayment of long-term debt
 
(55,608
)
 
(10,517
)
Principal payments under capital lease obligations
 
(644
)
 
(549
)
Cash dividends paid
 
(5,903
)
 
(5,601
)
Deferred financing costs
 
(300
)
 
(1,000
)
Common shares withheld for taxes
 
(2,397
)
 
(868
)
Repurchase of common stock
 
(1,086
)
 
(3,798
)
Net cash used in financing activities
 
(10,938
)
 
(8,556
)
Effects of exchange rate changes
 
1,293

 
524

Net change in cash and cash equivalents
 
(8,978
)
 
(8,430
)
Cash and cash equivalents at beginning of period
 
31,464

 
24,236

Cash and cash equivalents at end of period
 
$
22,486

 
$
15,806


The accompanying notes are an integral part of the consolidated financial statements.



5


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



Note A — Accounting Policies

(Dollars in thousands)
Basis of Presentation: In management’s opinion, the accompanying consolidated financial statements of Materion Corporation and its subsidiaries (referred to herein as the Company, our, we, or us) contain all of the adjustments necessary to present fairly the financial position, results of operations, and cash flows for the interim periods reported. All adjustments were of a normal and recurring nature. Certain amounts in prior years have been reclassified to conform to the 2017 consolidated financial statement presentation.
These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's 2016 Annual Report on Form 10-K. The interim period results are not necessarily indicative of the results to be expected for the full year.
Business Combinations: The Company records assets acquired and liabilities assumed at the date of acquisition at their respective fair values. Any intangible assets acquired in a business combination are recognized and reported apart from goodwill. Goodwill represents the excess purchase price over the fair value of the tangible net assets and intangible assets acquired in a business combination. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred.
The amounts reflected in Note B to the Consolidated Financial Statements are the results of the preliminary purchase price allocation and will be updated upon completion of the final valuation. The Company is required to complete the purchase price allocation within 12 months of the acquisition date. If such completion of the allocation results in a change in the preliminary values, the measurement period adjustment will be recognized in the period in which the adjustment amount is determined.
New Pronouncements Adopted: In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, which impacts several aspects of accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Under the new standard, income tax benefits and deficiencies are to be recognized as income tax expense or benefit in the income statement, and the tax effects of exercised or vested awards will be treated as discrete items in the reporting period in which they occur. An entity will also recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the reporting period. Excess tax benefits will be classified, along with other income tax cash flows, as an operating activity. In regard to forfeitures, the entity may make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures as they occur. The ASU, which is required to be applied on a modified retrospective basis, will be effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2016. The Company adopted the new guidance during the first quarter of 2017. An impact of adoption was the recognition of excess tax benefits in Income tax expense rather than Shareholders' equity in 2017. As a result, the Company recognized discrete tax benefits of $129 and $503 in Income tax expense during the third quarter and first nine months of 2017, respectively. The cash flow classification requirements of ASU 2016-09 were applied retrospectively. As a result, for the nine months ended September 30, 2016, cash flows from operating activities increased by $868 with a corresponding decrease to cash flows from financing activities. None of the other provisions in this ASU had a material effect on the Company's consolidated financial statements.
New Pronouncements Issued: In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which amends and simplifies existing guidance to allow companies to more accurately present the economic effects of risk management activities in the financial statements. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those periods, with early adoption permitted. The Company is currently evaluating the impact of adopting this new guidance on its consolidated financial statements.
In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires an employer to report the service cost component of net benefit cost in the same line item as other compensation costs arising from services rendered by pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations. The amendments also allow only the service cost component to be eligible for capitalization. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within



6


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


those periods, with early adoption permitted. The amendments should be applied retrospectively for the presentation of service cost and other components of net benefit cost on the income statement and prospectively for the capitalization of service cost and net periodic postretirement benefits in assets. The Company is currently evaluating the impact of adopting this new guidance on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases, which eliminates the off-balance-sheet accounting for leases. The new guidance will require lessees to report their operating leases as both an asset and liability on the balance sheet and disclose key information about leasing arrangements. The ASU, which is required to be applied on a modified retrospective basis, will be effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the impact of adopting this new guidance on its consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which supersedes previous revenue recognition guidance. The new standard requires that a company recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those goods or services. Companies will need to use more judgment and estimates than under the guidance currently in effect, including estimating the amount of variable revenue to recognize over each identified performance obligation. Additional disclosures will be required to help users of financial statements understand the nature, amount, and timing of revenue and cash flows arising from contracts. This ASU is effective beginning in fiscal year 2018 and can be adopted either retrospectively or as a cumulative-effect adjustment as of the date of adoption. To evaluate the impact of adopting this new guidance on the consolidated financial statements, the Company established a cross-functional implementation team to assess its revenue streams against the requirements of this ASU. In addition, the Company is in the process of identifying and implementing changes to its processes and controls to meet the standard's updated reporting and disclosure requirements. The Company plans to adopt the standard as of the first quarter of 2018 using the modified retrospective approach and will record a cumulative-effect adjustment to equity for open contracts as of January 1, 2018. The Company continues to update its assessment of the impact of the standard and related updates to its consolidated financial statements, and will disclose material impacts, if any.
No other recently issued or effective ASUs had, or are expected to have, a material effect on the Company's results of operations, financial condition, or liquidity.

Note B — Acquisitions

On February 28, 2017, the Company acquired the target materials business of the Heraeus Group (HTB), of Hanau, Germany, for $16.5 million. This business manufactures precious and non-precious metal target materials for the architectural and automotive glass, electronic display, photovoltaic, and semiconductor markets at facilities in Germany, Taiwan, and the United States. This business operates within the Advanced Materials segment, and the results of operations are included as of the date of acquisition.



7


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


The Company will make adjustments to the purchase price allocation prior to completion of the measurement period, as necessary. Only items identified as of the acquisition date will be considered for subsequent adjustment. The purchase price allocation for the acquisition is as follows:
(Thousands)
Amount
Assets:
 
Inventories
$
7,221

Prepaid and other current assets
1,107

Long-term deferred income taxes
1,450

Property, plant, and equipment
7,637

Intangible assets
3,236

Goodwill
2,605

Total assets acquired
$
23,256

 
 
Liabilities:
 
Other liabilities and accrued items
$
1,030

Other long-term liabilities
430

Retirement and post-employment benefits
5,292

Total liabilities assumed
$
6,752

 
 
Total purchase price
$
16,504


As part of the acquisition, the Company recorded approximately $2.6 million of goodwill. Goodwill was calculated as the excess of the purchase price over the estimated fair values of the tangible net assets and intangible assets acquired. Also, the Company acquired approximately $3.2 million of other intangible assets, which will be amortized using the straight-line method over an average life of about ten years. The following table reports the intangible assets by asset category and useful life:

(Thousands)
 
Value at Acquisition
 
Useful Life
Customer relationships
 
$
1,861

 
15 years
Technology
 
1,375

 
3 years
Total
 
$
3,236

 
 

Note C — Segment Reporting
 
The Company has the following operating segments: Performance Alloys and Composites, Advanced Materials, Precision Coatings, and Other. The Company’s operating segments represent components of the Company for which separate financial information is available that is utilized on a regular basis by the Chief Executive Officer, the Company's Chief Operating Decision Maker, in determining how to allocate the Company’s resources and evaluate performance.
Performance Alloys and Composites produces strip and bulk form alloy products, strip metal products with clad inlay and overlay metals, beryllium-based metals, beryllium, and aluminum metal matrix composites, in rod, sheet, foil, and a variety of customized forms, beryllia ceramics, and bulk metallic glass materials.
Advanced Materials produces advanced chemicals, microelectric packaging, precious metal, non-precious metal, and specialty metal products, including vapor deposition targets, frame lid assemblies, clad and precious metal preforms, high temperature braze materials, and ultra-fine wire.
Precision Coatings produces thin film coatings, optical filter materials, sputter-coated, and precision-converted thin film materials.



8


The Other reportable segment includes unallocated corporate costs and assets.

(Thousands)
 
Performance
Alloys and
Composites
 
Advanced Materials
 
Precision Coatings
 
Other
 
Total
Third Quarter 2017
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
109,393

 
$
157,770

 
$
27,105

 
$

 
$
294,268

Intersegment sales 
 
54

 
12,814

 

 

 
12,868

Value-added sales
 
90,637

 
60,391

 
21,896

 
(1,542
)
 
171,382

Operating profit (loss)
 
6,786

 
9,756

 
1,613

 
(6,597
)
 
11,558

Third Quarter 2016
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
103,699

 
$
107,250

 
$
38,670

 
$

 
$
249,619

Intersegment sales
 
47

 
21,505

 

 

 
21,552

Value-added sales
 
87,247

 
45,960

 
25,803

 
(2,009
)
 
157,001

Operating profit (loss)
 
4,357

 
8,245

 
3,432

 
(5,883
)
 
10,151

 
 
 
 
 
 
 
 
 
 
 
First Nine Months 2017
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
310,487

 
$
429,550

 
$
90,742

 
$

 
$
830,779

Intersegment sales 
 
113

 
42,508

 

 

 
42,621

Value-added sales
 
262,534

 
169,720

 
67,810

 
(3,602
)
 
496,462

Operating profit (loss)
 
12,523

 
24,873

 
6,145

 
(18,829
)
 
24,712

First Nine Months 2016
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
292,024

 
$
328,927

 
$
113,955

 
$

 
$
734,906

Intersegment sales 
 
226

 
54,110

 

 

 
54,336

Value-added sales
 
248,799

 
135,019

 
75,548

 
(4,573
)
 
454,793

Operating profit (loss)
 
6,103

 
20,748

 
9,803

 
(13,194
)
 
23,460


Intersegment sales are eliminated in consolidation.

Note D — Other-net
Other-net expense for the third quarter and first nine months of 2017 and 2016 is summarized as follows: 
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 29,
 
Sept. 30,
 
Sept. 29,
 
Sept. 30,
(Thousands)
 
2017
 
2016
 
2017
 
2016
Metal consignment fees
 
$
2,436

 
$
1,665

 
$
6,183

 
$
4,851

Amortization of intangible assets
 
1,179

 
1,148

 
3,456

 
3,444

Foreign currency exchange/translation loss (gain)
 
(201
)
 
336

 
(794
)
 
977

Fixed asset impairment
 
114

 

 
314

 

Cost reduction initiatives
 
189

 

 
189

 

Net loss (gain) on disposal of fixed assets
 
60

 
94

 
207

 
(601
)
Other items
 
24

 
(53
)
 
268

 
326

Total
 
$
3,801

 
$
3,190

 
$
9,823

 
$
8,997




9


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



Note E — Restructuring
In 2017, the Company completed cost reduction actions in order to align costs with commensurate business levels. These actions were accomplished through elimination of vacant positions, consolidation of roles, and staff reduction. Costs associated with these actions within the Other and Precision Coatings segments included severance associated with approximately twenty-three employees and other related costs.
In 2016, the Company initiated a plan to close the Fukuya, Japan service center, which is a part of the Performance Alloys and Composites segment. Costs associated with the plan included severance associated with approximately twelve employees and related facility exit costs.
These costs are presented in the Consolidated Statements of Income as follows:
 
 
Third Quarter Ended
 
Nine Months Ended
(Thousands)
 
Sept. 29, 2017
 
Sept. 30, 2016
 
Sept. 29, 2017
 
Sept. 30, 2016
Cost of sales
 
$
346

 
$

 
$
463

 
$

Selling, general, and administrative (SG&A) expense
 
127

 

 
1,259

 

Other-net
 
189

 

 
189

 

Total
 
$
662

 
$

 
$
1,911

 
$

Remaining severance payments related to these initiatives of $0.3 million are reflected within Other liabilities and accrued items in the Consolidated Balance Sheets. The Company does not expect to incur additional costs related to these initiatives.

Note F — Income Taxes
The Company recorded income tax expense of $1.7 million in the third quarter of 2017, an effective tax rate of 15.5% against income before income taxes, and income tax expense of $1.6 million in the third quarter of 2016, an effective tax rate of 16.7% against income before income taxes.
In the first nine months of 2017, the Company recorded income tax expense of $3.3 million, an effective tax rate of 14.4%, and income tax expense of $3.1 million in the first nine months of 2016, an effective tax rate of 14.0%.
The Company recorded discrete benefits of $0.5 million and $1.3 million, respectively, in the third quarter and first nine months of 2017. Of these amounts, $0.4 million related to the reversal of uncertain tax positions due to a lapse in the statute of limitations in the third quarter of 2017. Also, $0.1 million in the third quarter and $0.5 million in the first nine months of 2017 related to the adoption of ASU 2016-09, Improvements to Employee Share-based Payment Accounting.
The Company recorded discrete items in the first nine months of 2016, resulting in a net tax benefit of $1.0 million, primarily due to international tax planning initiatives.
Income tax expense in the third quarter and first nine months of both 2017 and 2016 was lower than the U.S Federal statutory income tax rate of 35% primarily due to the impact of percentage depletion, foreign rate differential, research and development credit, discrete benefits, and other items.



10


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


Note G — Earnings Per Share (EPS)
The following table sets forth the computation of basic and diluted EPS:
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 29,
 
Sept. 30,
 
Sept. 29,
 
Sept. 30,
(Thousands, except per share amounts)
 
2017
 
2016
 
2017
 
2016
Numerator for basic and diluted EPS:
 
 
 
 
 
 
 
 
Net income
 
$
9,320

 
$
8,045

 
$
19,683

 
$
18,962

Denominator:
 
 
 
 
 
 
 
 
Denominator for basic EPS:
 
 
 
 
 
 
 
 
Weighted-average shares outstanding
 
20,040

 
19,957

 
20,007

 
19,996

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Stock appreciation rights
 
149

 
70

 
148

 
66

Restricted stock units
 
94

 
82

 
95

 
86

Performance-based restricted stock units
 
128

 
83

 
111

 
61

Diluted potential common shares
 
371

 
235

 
354

 
213

Denominator for diluted EPS:
 

 

 
 
 
 
Adjusted weighted-average shares outstanding
 
20,411

 
20,192

 
20,361

 
20,209

Basic EPS
 
$
0.47

 
$
0.40

 
$
0.98

 
$
0.95

Diluted EPS
 
$
0.46

 
$
0.40

 
$
0.97

 
$
0.94


Stock appreciation rights (SARs) totaling 219,292 and 982,588 for the quarters ended September 29, 2017 and September 30, 2016, respectively, and 370,917 and 993,418 for the nine months ended September 29, 2017 and September 30, 2016, respectively, were excluded from the dilution calculation as their effect would have been anti-dilutive.

Note H — Inventories
Inventories on the Consolidated Balance Sheets are summarized as follows:
 
 
Sept. 29,
 
Dec. 31,
(Thousands)
 
2017
 
2016
Raw materials and supplies
 
$
44,924

 
$
36,233

Work in process
 
181,553

 
169,327

Finished goods
 
37,671

 
38,147

Subtotal
 
$
264,148

 
$
243,707

Less: LIFO reserve balance
 
43,925

 
42,842

Inventories
 
$
220,223

 
$
200,865

The liquidation of last in, first out (LIFO) inventory layers did not impact cost of sales in the third quarter of 2017 or 2016. In the first nine months of 2017, cost of sales were increased by $0.2 million. In the first nine months of 2016, cost of sales were reduced by $3.2 million.

Note I — 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 2017 and 2016 for the domestic pension plans (which include the defined benefit pension plan and the supplemental retirement plans) and the domestic retiree medical plan.



11


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


 

Pension Benefits

Other Benefits
 

Third Quarter Ended

Third Quarter Ended


Sept. 29,

Sept. 30,

Sept. 29,

Sept. 30,
(Thousands)

2017

2016

2017

2016
Components of net periodic benefit cost (benefit)








Service cost

$
2,106


$
1,946


$
23


$
26

Interest cost

2,372


2,595


99


140

Expected return on plan assets

(3,678
)

(3,488
)




Amortization of prior service benefit

(42
)

(115
)

(374
)

(374
)
Amortization of net loss

1,623


1,431





Net periodic benefit cost (benefit)

$
2,381


$
2,369


$
(252
)

$
(208
)
 
 
 
 
 
 
 
 
 
 
 
Pension Benefits
 
Other Benefits
 
 
Nine Months Ended
 
Nine Months Ended
 
 
Sept. 29,
 
Sept. 30,
 
Sept. 29,
 
Sept. 30,
(Thousands)
 
2017
 
2016
 
2017
 
2016
Components of net periodic benefit cost (benefit)
 
 
 
 
 
 
 
 
Service cost
 
$
6,188

 
$
5,838

 
$
69

 
$
77

Interest cost
 
7,098

 
7,785

 
297

 
422

Expected return on plan assets
 
(11,007
)
 
(10,464
)
 

 

Amortization of prior service benefit
 
(236
)
 
(345
)
 
(1,122
)
 
(1,122
)
Amortization of net loss
 
4,821

 
4,292

 

 

Net periodic benefit cost (benefit)
 
$
6,864

 
$
7,106

 
$
(756
)
 
$
(623
)
The Company made contributions to the domestic defined benefit pension plan of $8.0 million and $12.0 million in the first nine months of 2017 and 2016, respectively.
Beginning in 2017, the Company has elected to use a spot-rate approach to estimate the service and interest cost components of net periodic benefit cost for its defined benefit pension plans. The spot-rate approach applies separate discount rates for each projected benefit payment in the calculation. Historically, the Company used a weighted-average approach to determine the service and interest cost components. The change is being accounted for as a change in estimate and, accordingly, is being applied prospectively. The reduction in service and interest costs for 2017 associated with this change approximated $0.3 million and $0.8 million during the third quarter and first nine months of 2017, respectively, and is expected to total approximately $1.0 million.

Note J — Accumulated Other Comprehensive Income (Loss)
Changes in the components of accumulated other comprehensive income, including the amounts reclassified, for the third quarter and first nine months of 2017 and 2016 are as follows:
 
 
Gains and Losses on Cash Flow Hedges
 
 
 
 
 
 
(Thousands)
 
Foreign Currency
 
Precious Metals
 
Total
 
Pension and Post-Employment Benefits
 
Foreign Currency Translation
 
Total
Balance at June 30, 2017

$
1,109


$
93


$
1,202


$
(80,842
)

$
(4,282
)

$
(83,922
)
Other comprehensive income (loss) before reclassifications

(324
)

(205
)

(529
)



271


(258
)
Amounts reclassified from accumulated other comprehensive income

433


(94
)

339


1,345




1,684




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
Net current period other comprehensive income (loss) before tax

109


(299
)

(190
)

1,345


271


1,426

Deferred taxes on current period activity

41


(111
)

(70
)

464




394

Net current period other comprehensive income (loss) after tax

68


(188
)

(120
)

881


271


1,032

Balance at September 29, 2017

$
1,177


$
(95
)

$
1,082


$
(79,961
)

$
(4,011
)

$
(82,890
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at July 1, 2016
 
$
958

 
$

 
$
958

 
$
(74,546
)
 
$
(3,037
)
 
$
(76,625
)
Other comprehensive income (loss) before reclassifications
 
(126
)
 

 
(126
)
 

 
467

 
341

Amounts reclassified from accumulated other comprehensive income
 
336

 

 
336

 
1,015

 

 
1,351

Net current period other comprehensive income (loss) before tax
 
210

 

 
210

 
1,015

 
467

 
1,692

Deferred taxes on current period activity
 
78

 

 
78

 
342

 

 
420

Net current period other comprehensive income (loss) after tax
 
132

 

 
132

 
673

 
467

 
1,272

Balance at September 30, 2016
 
$
1,090

 
$

 
$
1,090

 
$
(73,873
)
 
$
(2,570
)
 
$
(75,353
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016

$
1,837


$


$
1,837


$
(82,358
)

$
(5,660
)

$
(86,181
)
Other comprehensive income (loss) before reclassifications

(1,205
)

30


(1,175
)



1,649


474

Amounts reclassified from accumulated other comprehensive income

219


(182
)

37


3,655




3,692

Net current period other comprehensive income (loss) before tax

(986
)

(152
)

(1,138
)

3,655


1,649


4,166

Deferred taxes on current period activity

(326
)

(57
)

(383
)

1,258




875

Net current period other comprehensive income (loss) after tax

(660
)

(95
)

(755
)

2,397


1,649


3,291

Balance at September 29, 2017

$
1,177


$
(95
)

$
1,082


$
(79,961
)

$
(4,011
)

$
(82,890
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
 
$
1,579

 
$

 
$
1,579

 
$
(76,796
)
 
$
(5,488
)
 
$
(80,705
)
Other comprehensive income (loss) before reclassifications
 
(1,571
)
 

 
(1,571
)
 

 
2,918

 
1,347

Amounts reclassified from accumulated other comprehensive income
 
793

 

 
793

 
3,045

 

 
3,838

Net current period other comprehensive income (loss) before tax
 
(778
)
 

 
(778
)
 
3,045

 
2,918

 
5,185

Deferred taxes on current period activity
 
(289
)
 

 
(289
)
 
122

 

 
(167
)
Net current period other comprehensive income (loss) after tax
 
(489
)
 

 
(489
)
 
2,923

 
2,918

 
5,352

Balance at September 30, 2016
 
$
1,090

 
$

 
$
1,090

 
$
(73,873
)
 
$
(2,570
)
 
$
(75,353
)



13


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


Reclassifications from accumulated other comprehensive income of gains and losses on foreign currency cash flow hedges are recorded in Other-net in the Consolidated Statements of Income. Reclassifications from accumulated other comprehensive income of gains and losses on precious metal cash flow hedges are recorded in Cost of sales in the Consolidated Statements of Income. Refer to Note M for additional details on cash flow hedges.
Reclassifications from accumulated other comprehensive income for pension and post-employment benefits are included in the computation of the net periodic pension and post-employment benefit expense. Refer to Note I for additional details on pension and post-employment expenses.



14


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


Note K — Stock-based Compensation Expense
Stock-based compensation expense, which includes awards settled in shares and in cash, was $1.5 million and $6.2 million in the third quarter and first nine months of 2017, respectively, compared to $2.1 million and $4.4 million in the same periods of 2016.
The Company granted 97,015 SARs to certain employees during the first nine months of 2017. The weighted-average exercise price per share and weighted-average fair value per share of the SARs granted during the nine months ended September 29, 2017 were $35.26 and $10.89, respectively. The Company estimated the fair value of the SARs using the following weighted-average assumptions in the Black-Scholes model:
Risk-free interest rate
 
1.92
%
Dividend yield
 
1.1
%
Volatility
 
34.0
%
Expected term (in years)
 
5.6

The Company granted 62,185 stock-settled restricted stock units (RSUs) and 32,466 cash-settled RSUs to certain employees and non-employee directors during the first nine months of 2017. The Company measures the fair value of stock-settled RSUs based on the closing market price of a share of Materion common stock on the date of the grant. The weighted-average fair value per share was $34.95 for stock-settled RSUs granted during the nine months ended September 29, 2017. Cash-settled RSUs are accounted for as liability-based compensation awards and adjusted based on the closing price of Materion’s common stock over the vesting period of three years.
The Company granted stock-settled and cash-settled performance-based restricted stock units (PRSUs) to certain employees in the first nine months of 2017. The weighted-average fair value of the stock-settled PRSUs was $30.28 per share and will be expensed over the vesting period of three years. The liability for cash-settled PRSUs is re-measured at fair value each reporting period, and the adjustment to income is recorded accordingly. The final payout to the employees for all PRSUs will be based upon the Company’s return on invested capital and the total return to shareholders over the vesting period relative to a peer group’s performance over the same period.
At September 29, 2017, unearned compensation cost related to the unvested portion of all stock-based awards was approximately $5.3 million, and is expected to be recognized over the remaining vesting period of the respective grants.

Note L — Fair Value of Financial Instruments
The Company measures and records financial instruments at fair value. A fair value hierarchy is used for those instruments measured at fair value that distinguishes between assumptions based on market data (observable inputs) and the Company’s assumptions (unobservable inputs). The hierarchy consists of three levels:
Level 1 — Quoted market prices in active markets for identical assets and liabilities;
Level 2 — Inputs other than Level 1 inputs that are either directly or indirectly observable; and
Level 3 — Unobservable inputs developed using estimates and assumptions developed by the Company, which reflect those that a market participant would use.



15


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


The following table summarizes the financial instruments measured at fair value in the Consolidated Balance Sheets as of September 29, 2017 and December 31, 2016: 
 
 
 
 
 
 
 
 
 
(Thousands)
 
Total Carrying Value in the Consolidated Balance Sheets
 
Quoted Prices
in  Active
Markets  for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
 
2017
 
2016
Financial Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deferred compensation investments
 
$
2,149

 
$
1,734

 
$
2,149

 
$
1,734

 
$

 
$

 
$

 
$

Foreign currency forward contracts
 
149

 
691

 

 

 
149

 
691

 

 

Precious metal swaps
 
45

 

 

 

 
45

 

 

 

Total
 
$
2,343

 
$
2,425

 
$
2,149

 
$
1,734

 
$
194

 
$
691


$


$

Financial Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deferred compensation liability
 
$
2,149

 
$
1,734

 
$
2,149

 
$
1,734

 
$

 
$

 
$

 
$

Foreign currency forward contracts
 
669

 
1

 

 

 
669

 
1

 

 

Precious metal swaps
 
197

 

 

 

 
197

 

 

 

Total
 
$
3,015

 
$
1,735

 
$
2,149

 
$
1,734

 
$
866

 
$
1

 
$

 
$

The Company uses a market approach to value the assets and liabilities for financial instruments in the table above. Outstanding contracts are valued through models that utilize market observable inputs, including both spot and forward prices, for the same underlying currencies and metals. The carrying values of the other working capital items and debt in the Consolidated Balance Sheets approximate fair values as of September 29, 2017 and December 31, 2016.

Note M — Derivative Instruments and Hedging Activity
The Company uses derivative contracts to hedge portions of its foreign currency exposures and uses derivatives to hedge a portion of its precious metal exposures. The objectives and strategies for using derivatives in these areas are as follows:
Foreign Currency.    The Company sells a portion of its products to overseas customers in their local currencies, primarily the euro and yen. The Company secures foreign currency derivatives, mainly forward contracts and options, to hedge these anticipated sales transactions. The purpose of the hedge program is to protect against the reduction in the dollar value of foreign currency sales from adverse exchange rate movements. Should the dollar strengthen significantly, the decrease in the translated value of the foreign currency sales should be partially offset by gains on the hedge contracts. Depending upon the methods used, hedge contracts may limit the benefits from a weakening U.S. dollar.
The use of forward contracts locks in a firm rate and eliminates any downside risk from an adverse rate movement as well as any benefit from a favorable rate movement. The Company may from time to time choose to hedge with options or a tandem of options, known as a collar. These hedging techniques can limit or eliminate the downside risk but can allow for some or all of the benefit from a favorable rate movement to be realized. Unlike a forward contract, a premium is paid for an option; collars, which are a combination of a put and call option, may have a net premium but can be structured to be cash neutral. The Company will primarily hedge with forward contracts due to the relationship between the cash outlay and the level of risk.
The use of foreign currency derivative contracts is governed by policies approved by the Audit Committee of the Board of Directors. A team consisting of senior financial managers reviews the estimated exposure levels, as defined by budgets, forecasts, and other internal data, and determines the timing, amounts, and instruments to use to hedge that exposure within the confines of the policy. Management analyzes the effective hedged rates and the actual and projected gains and losses on the hedging transactions against the program objectives, targeted rates, and levels of risk assumed. Hedge



16


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


contracts are typically layered in at different times for a specified exposure period in order to minimize the impact of rate movements.
Precious Metals.    The Company maintains the majority of its precious metal production requirements on consignment in order to reduce its working capital investment and the exposure to metal price movements. When a precious metal product is fabricated and ready for shipment to the customer, the metal is purchased out of consignment at the current market price. The price paid by the Company forms the basis for the price charged to the customer. This methodology allows for changes in either direction in the market prices of the precious metals used by the Company to be passed through to the customer, and reduces the impact changes in prices could have on the Company's margins and operating profit. The consigned metal is owned by financial institutions that charge the Company a financing fee based upon the current value of the metal on hand.
In certain instances, a customer may want to establish the price for the precious metal at the time the sales order is placed rather than at the time of shipment. Setting the sales price at a different date than when the material would be purchased potentially creates an exposure to movements in the market price of the metal. Therefore, in these limited situations, the Company may elect to enter into a forward contract to purchase precious metal. The forward contract allows the Company to purchase metal at a fixed price on a specific future date. The price in the forward contract serves as the basis for the price to be charged to the customer. By doing so, the selling price and purchase price are matched, and the Company's price exposure is reduced.
The Company refines precious metal-containing materials for its customers and typically will purchase the refined metal from the customer at current market prices. In limited circumstances, the customer may want to fix the price to be paid at the time of the order as opposed to when the material is refined. The customer may also want to fix the price for a set period of time. The Company may then elect to enter into a hedge contract, either a forward contract or a swap, to fix the price for the estimated quantity of metal to be purchased, thereby reducing the exposure to adverse movements in the price of the metal.
In certain circumstances, the Company also refines metal from the customer and may retain a portion of the refined metal as payment. The Company may elect to enter into a forward contract to sell precious metal to reduce the Company's price exposure.
The Company may from time to time elect to purchase precious metal and hold in inventory rather than on consignment due to potential credit line limitations or other factors. These purchases are typically held for a short duration. A forward contract will be secured at the time of the purchase to fix the price to be used when the metal is transferred back to the consignment line, thereby limiting any price exposure during the time when the metal was owned.
The Company will only enter into a derivative contract if there is an underlying identified exposure. Contracts are typically held until maturity. The Company does not engage in derivative trading activities and does not use derivatives for speculative purposes. The Company only uses currency hedge contracts that are denominated in the same currency as the underlying exposure and precious metal hedge contracts denominated in the same metal as the underlying exposure.
All derivatives are recorded on the balance sheet at fair value. If the derivative is designated and effective as a cash flow hedge, changes in the fair value of the derivative are recognized in other comprehensive income (OCI) until the hedged item is recognized in earnings. The ineffective portion of a derivative’s fair value, if any, is recognized in earnings immediately. If a derivative is not a hedge, changes in the fair value are adjusted through income. The fair values of the outstanding derivatives are recorded on the balance sheet as assets (if the derivatives are in a gain position) or liabilities (if the derivatives are in a loss position). The fair values will also be classified as short-term or long-term depending upon their maturity dates.








17


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


The following table summarizes the notional amount and the fair value of the Company’s outstanding derivatives not designated as hedging instruments and balance sheet classification as of September 29, 2017 and December 31, 2016:
 
 
September 29, 2017
 
December 31, 2016
(Thousands)
 
Notional
Amount
 
Fair
Value
 
Notional
Amount
 
Fair
Value
Other liabilities and accrued items
 
 
 
 
 
 
 
 
Foreign currency forward contracts - euro
 
$
14,402

 
$
(11
)
 
$

 
$

Total
 
$
14,402

 
$
(11
)
 
$

 
$

These outstanding foreign currency derivatives were related to intercompany loans. Other-net included foreign currency losses relating to these derivatives of $0.5 million and $1.1 million during the third quarter and first nine months of 2017, respectively.
The following table summarizes the notional amount and the fair value of the Company’s outstanding derivatives designated as cash flow hedges and balance sheet classification as of September 29, 2017 and December 31, 2016:
 
 
September 29, 2017
 
December 31, 2016
(Thousands)
 
Notional
Amount
 
Fair
Value
 
Notional
Amount
 
Fair
Value
Prepaid expenses
 
 
 
 
 
 
 
 
Foreign currency forward contracts - yen
 
$
2,000

 
$
59

 
$
2,418

 
$
239

Foreign currency forward contracts - euro
 
6,829

 
90

 
6,493

 
452

Precious metal swaps
 
2,148

 
13

 

 

Total
 
10,977

 
162

 
8,911

 
691

 
 
 
 
 
 
 
 
 
Other assets
 
 
 
 
 
 
 
 
Precious metal swaps
 
1,932

 
32

 

 

Total
 
1,932

 
32

 

 

 
 
 
 
 
 
 
 
 
Other liabilities and accrued items
 
 
 
 
 
 
 
 
Foreign currency forward contracts - euro
 
12,689

 
(658
)
 
537

 
(1
)
Precious metal swaps
 
7,845

 
(170
)
 

 

Total
 
20,534

 
(828
)
 
537

 
(1
)
 
 
 
 
 
 
 
 
 
Other long-term liabilities
 
 
 
 
 
 
 
 
Precious metal swaps
 
1,999

 
(27
)
 

 

Total
 
$
35,442

 
$
(661
)
 
$
9,448

 
$
690

All of these contracts were designated and effective as cash flow hedges. No ineffectiveness expense was recorded in the third quarter or first nine months of 2017 or 2016.
Changes in the fair value of outstanding cash flow hedges recorded in OCI for the first nine months of 2017 and 2016 totaled decreases of $1.2 million and $1.6 million, respectively. The Company expects to relieve substantially the entire balance in OCI as of September 29, 2017 to the Consolidated Statements of Income within the next 18-month period. Refer to Note J for additional OCI details.
Note N — Contingencies
Legal Proceedings. For information regarding legal proceedings relating to Chronic Beryllium Disease Claims, refer to Note Q ("Contingencies and Commitments") in the Company's 2016 Annual Report on Form 10-K.
Other Litigation. The Company is party to several pending legal proceedings and claims arising in the normal course of business. The Company records a liability when it is both probable that a liability has been incurred and the amount of the loss can be



18


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


reasonably estimated. In the event the Company determines that a loss is not probable, but is reasonably possible, and it becomes possible to develop what the Company believes to be a reasonable range of possible loss, then the Company will include disclosure related to such matters. To the extent there is a reasonable possibility that the losses could exceed any amounts accrued, the Company will adjust the accrual in the period the determination is made, disclose an estimate of the additional loss or range of loss, indicate that the estimate is immaterial with respect to its financial statements as a whole or, if the amount of such adjustment cannot be reasonably estimated, disclose that an estimate cannot be made.
Environmental Proceedings. The Company has an active environmental compliance program and records reserves for the probable cost of identified environmental remediation projects. The reserves are established based upon analyses conducted by the Company’s engineers and outside consultants and are adjusted from time to time based upon ongoing studies, the difference between actual and estimated costs, and other factors. The reserves may also be affected by rulings and negotiations with regulatory agencies. The undiscounted reserve balance was $6.1 million at September 29, 2017 and $6.0 million at December 31, 2016. Environmental projects tend to be long-term, and the final actual remediation costs may differ from the amounts currently recorded.

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
We are an integrated producer of high-performance advanced engineered materials used in a variety of electrical, electronic, thermal, and structural applications. Our products are sold into numerous end markets, including consumer electronics, industrial components, defense, medical, automotive electronics, telecommunications infrastructure, energy, commercial aerospace, science, services, and appliance.

RESULTS OF OPERATIONS
Third Quarter
 
 
Third Quarter Ended
 
 
Sept. 29,
 
Sept. 30,
 
$
 
%
(Thousands, except per share data)
 
2017
 
2016
 
Change
 
Change
Net sales
 
$
294,268

 
$
249,619

 
$
44,649

 
18
%
Value-added sales
 
171,382

 
157,001

 
14,381

 
9
%
Gross margin
 
55,203

 
50,755

 
4,448

 
9
%
Gross margin as a % of value-added sales
 
32
%
 
32
%
 
N/A

 
N/A

Selling, general, and administrative (SG&A) expense
 
36,415

 
34,177

 
2,238

 
7
%
SG&A expense as a % of value-added sales
 
21
%
 
22
%
 
N/A

 
N/A

Research and development (R&D) expense
 
3,429

 
3,237

 
192

 
6
%
R&D expense as a % of value-added sales
 
2
%
 
2
%
 
N/A

 
N/A

Other—net
 
3,801

 
3,190

 
611

 
19
%
Operating profit
 
11,558


10,151

 
1,407

 
14
%
Interest expense—net
 
533

 
490

 
43

 
9
%
Income before income taxes
 
11,025

 
9,661

 
1,364

 
14
%
Income tax expense
 
1,705

 
1,616

 
89

 
6
%
Net income
 
$
9,320

 
$
8,045

 
$
1,275

 
16
%
 
 
 
 
 
 
 
 
 
Diluted earnings per share
 
$
0.46

 
$
0.40

 
$
0.06

 
15
%
N/A = Not Applicable




19



Net sales of $294.3 million in the third quarter of 2017 were $44.7 million higher than the $249.6 million recorded in the third quarter of 2016. Net sales of $38.6 million during the third quarter of 2017 were attributable to the high performance target materials business of the Heraeus Group (HTB). Changes in precious metal and copper prices negatively impacted net sales in the third quarter of 2017 by approximately $2.4 million when compared to the third quarter of 2016.

Value-added sales is a non-GAAP financial measure that removes the impact of pass-through metal costs and allows for analysis without the distortion of the movement or volatility in metal prices. Internally, we manage our business on this basis, and a reconciliation of net sales, the most directly comparable GAAP financial measure, to value-added sales is included herein. Value-added sales of $171.4 million in the third quarter of 2017 increased $14.4 million, or 9% compared to the third quarter of 2016. Value-added sales from the HTB acquisition totaled $11.4 million in the third quarter of 2017. Value-added sales to the consumer electronics end market, which accounted for 31% of our total value-added sales during the third quarter of 2017, increased $2.9 million from the prior-year period. Also, value-added sales in the industrial components end market increased $4.2 million from the prior-year period. These increases were offset by weakness in the medical end market, which lowered value-added sales by approximately $6.1 million.

Gross margin in the third quarter of 2017 was $55.2 million, or $4.4 million higher than the $50.8 million gross margin recorded during the third quarter of 2016. Gross margin expressed as a percentage of value-added sales was 32% in the third quarter of both 2017 and 2016.

SG&A expense was $36.4 million in the third quarter of 2017, or $2.2 million higher than the $34.2 million recorded in the third quarter of 2016. The increase is attributable to $2.1 million of HTB expenses.

R&D expense consists primarily of direct personnel costs for pre-production evaluation and testing of new products, prototypes, and applications. R&D expense was flat as a percentage of value-added sales at approximately 2% in the third quarter of both 2017 and 2016.

Other-net was $3.8 million of expense in the third quarter of 2017, or a $0.6 million increase from the third quarter of 2016. Other-net in the third quarter of 2017 included higher metal consignment fees of $0.8 million, as compared to the third quarter of 2016. Refer to Note D to the Consolidated Financial Statements for details of the major components within Other-net.

Interest expense-net was $0.5 million in the third quarter of both 2017 and 2016.

Income tax expense for the third quarter of 2017 was $1.7 million, compared to $1.6 million in the third quarter of 2016. The effective tax rate for the third quarter of 2017 was 15.5% compared to 16.7% in the prior-year period. The effects of percentage depletion, the foreign rate differential, the research and development credit, discrete benefits, and other items were the primary factors for the difference between the effective and statutory rates in the third quarter of 2017 and 2016. Refer to Note F to the Consolidated Financial Statements for further details on income taxes.




20



Nine Months
 
 
Nine Months Ended
 
 
Sept. 29,
 
Sept. 30,
 
$
 
%
(Thousands, except per share data)
 
2017
 
2016
 
Change
 
Change
Net sales
 
$
830,779

 
$
734,906

 
$
95,873

 
13
%
Value-added sales
 
496,462

 
454,793

 
41,669

 
9
%
Gross margin
 
152,756

 
139,418

 
13,338

 
10
%
Gross margin as a % of value-added sales
 
31
%
 
31
%
 
N/A

 
N/A

SG&A expense
 
108,118

 
97,101

 
11,017

 
11
%
SG&A expense as a % of value-added sales
 
22
%
 
21
%
 
N/A

 
N/A

R&D expense
 
10,103

 
9,860

 
243

 
2
%
R&D expense as a % of value-added sales
 
2
%
 
2
%
 
N/A

 
N/A

Other—net