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EX-95 - EXHIBIT 95 - MATERION Corpmtrn-ex95_2018q310q.htm
EX-32.1 - EXHIBIT 32.1 - MATERION Corpmtrn-ex32_2018q310q.htm
EX-31.2 - EXHIBIT 31.2 - MATERION Corpmtrn-ex312_2018q310q.htm
EX-31.1 - EXHIBIT 31.1 - MATERION Corpmtrn-ex311_2018q310q.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 28, 2018
 
¨
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 every Interactive Data File required to be submitted 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 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  ¨
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 28, 2018: 20,244,285.





PART 1 - FINANCIAL INFORMATION

Item 1. Financial Statements

Materion Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)
 
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 28,
 
Sept. 29,
 
Sept. 28,
 
Sept. 29,
(Thousands, except per share amounts)
 
2018
 
2017
 
2018
 
2017
Net sales
 
$
297,193

 
$
294,268

 
$
909,745

 
$
830,779

Cost of sales
 
232,258

 
238,821

 
724,692

 
677,398

Gross margin
 
64,935

 
55,447

 
185,053

 
153,381

Selling, general, and administrative expense
 
38,872

 
36,253

 
115,807

 
107,702

Research and development expense
 
4,250

 
3,429

 
11,753

 
10,103

Other—net
 
3,147

 
3,801

 
10,384

 
9,823

Operating profit
 
18,666

 
11,964

 
47,109

 
25,753

Interest expense—net
 
613

 
533

 
2,010

 
1,721

Other non-operating expense—net
 
800

 
406

 
1,679

 
1,041

Income before income taxes
 
17,253

 
11,025

 
43,420

 
22,991

Income tax (benefit) expense
 
(2,713
)
 
1,705

 
1,746

 
3,308

Net income
 
$
19,966

 
$
9,320

 
$
41,674

 
$
19,683

Basic earnings per share:
 
 
 
 
 
 
 
 
Net income per share of common stock
 
$
0.99

 
$
0.47

 
$
2.06

 
$
0.98

Diluted earnings per share:
 
 
 
 
 
 
 
 
Net income per share of common stock
 
$
0.97

 
$
0.46

 
$
2.02

 
$
0.97

Cash dividends per share
 
$
0.105

 
$
0.100

 
$
0.310

 
$
0.295

Weighted-average number of shares of common stock outstanding:
 
 
 
 
 
 
 
 
Basic
 
20,241

 
20,040

 
20,199

 
20,007

Diluted
 
20,648

 
20,411

 
20,607

 
20,361


















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. 28,
 
Sept. 29,
 
Sept. 28,
 
Sept. 29,
(Thousands)
 
2018
 
2017
 
2018
 
2017
Net income
 
$
19,966

 
$
9,320

 
$
41,674

 
$
19,683

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
116

 
271

 
285

 
1,649

Derivative and hedging activity, net of tax
 
125

 
(120
)
 
1,213

 
(755
)
Pension and post-employment benefit adjustment, net of tax
 
1,507

 
881

 
4,081

 
2,397

Other comprehensive income
 
1,748

 
1,032

 
5,579

 
3,291

Comprehensive income
 
$
21,714

 
$
10,352

 
$
47,253

 
$
22,974





































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




3



Materion Corporation and Subsidiaries
Consolidated Balance Sheets
 
 
(Unaudited)
 
 
 
 
Sept. 28,
 
Dec. 31,
(Thousands)
 
2018
 
2017
Assets
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
53,612

 
$
41,844

Accounts receivable
 
133,894

 
124,014

Inventories
 
199,913

 
220,352

Prepaid and other current assets
 
19,894

 
24,733

Total current assets
 
407,313

 
410,943

Deferred income taxes
 
22,311

 
17,047

Property, plant, and equipment
 
896,626

 
891,789

Less allowances for depreciation, depletion, and amortization
 
(642,931
)
 
(636,211
)
Property, plant, and equipment—net
 
253,695

 
255,578

Intangible assets—net
 
7,156

 
9,847

Other assets
 
7,114

 
6,992

Goodwill
 
90,762

 
90,677

Total Assets
 
$
788,351

 
$
791,084

Liabilities and Shareholders’ Equity
 
 
 
 
Current liabilities
 
 
 
 
Short-term debt
 
$
807

 
$
777

Accounts payable
 
42,712

 
49,059

Salaries and wages
 
38,160

 
42,694

Other liabilities and accrued items
 
28,934

 
28,044

Income taxes
 
8,176

 
1,084

Unearned revenue
 
7,805

 
5,451

Total current liabilities
 
126,594

 
127,109

Other long-term liabilities
 
13,828

 
14,895

Capital lease obligations
 
15,864

 
16,072

Retirement and post-employment benefits
 
56,068

 
93,225

Unearned income
 
33,649

 
36,905

Long-term income taxes
 
3,064

 
4,857

Deferred income taxes
 
210

 
213

Long-term debt
 
2,331

 
2,827

Shareholders’ equity
 
 
 
 
Serial preferred stock (no par value; 5,000 authorized shares, none issued)
 

 

Common stock (no par value; 60,000 authorized shares, issued shares of 27,148 at September 28 and December 31)
 
232,846

 
223,484

Retained earnings
 
571,350

 
536,116

Common stock in treasury (6,904 shares at September 28 and 7,042 shares at December 31)
 
(174,532
)
 
(166,128
)
Accumulated other comprehensive loss
 
(97,358
)
 
(102,937
)
Other equity transactions
 
4,437

 
4,446

Total shareholders' equity
 
536,743

 
494,981

Total Liabilities and Shareholders’ Equity
 
$
788,351

 
$
791,084

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. 28,
 
Sept. 29,
(Thousands)
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income
 
$
41,674

 
$
19,683

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
 
Depreciation, depletion, and amortization
 
26,506

 
33,444

Amortization of deferred financing costs in interest expense
 
720

 
670

Non-cash compensation expense
 
8,965

 
7,958

Deferred income tax (benefit) expense
 
(5,341
)
 
1,073

Changes in assets and liabilities net of acquired assets and liabilities:
 
 
 

Decrease (increase) in accounts receivable
 
(10,274
)
 
(21,572
)
Decrease (increase) in inventories
 
19,754

 
(9,953
)
Decrease (increase) in prepaid and other current assets
 
4,648

 
(6,077
)
Increase (decrease) in accounts payable and accrued expenses
 
(10,290
)
 
17,991

Increase (decrease) in unearned revenue
 
2,365

 
4,746

Increase (decrease) in interest and taxes payable
 
5,557

 
(2,083
)
Domestic pension plan contributions
 
(38,000
)
 
(8,000
)
Other-net
 
2,959

 
(2,383
)
Net cash provided by operating activities
 
49,243

 
35,497

Cash flows from investing activities:
 
 
 
 
Payments for purchase of property, plant, and equipment
 
(21,809
)
 
(17,759
)
Payments for mine development
 
(5,192
)
 
(620
)
Payments for acquisition
 

 
(16,504
)
Proceeds from sale of property, plant, and equipment
 
26

 
53

Net cash (used in) investing activities
 
(26,975
)
 
(34,830
)
Cash flows from financing activities:
 
 
 
 
Proceeds from issuance of long-term debt
 

 
55,000

Repayment of long-term debt
 
(513
)
 
(55,608
)
Principal payments under capital lease obligations
 
(573
)
 
(644
)
Cash dividends paid
 
(6,262
)
 
(5,903
)
Deferred financing costs
 

 
(300
)
Repurchase of common stock
 

 
(1,086
)
Payments of withholding taxes for stock-based compensation awards
 
(3,006
)
 
(2,397
)
Net cash (used in) financing activities
 
(10,354
)
 
(10,938
)
Effects of exchange rate changes
 
(146
)
 
1,293

Net change in cash and cash equivalents
 
11,768

 
(8,978
)
Cash and cash equivalents at beginning of period
 
41,844

 
31,464

Cash and cash equivalents at end of period
 
$
53,612

 
$
22,486

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

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 periods have been reclassified to conform to the 2018 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 2017 Annual Report on Form 10-K. The interim period results are not necessarily indicative of the results to be expected for the full year.
New Pronouncements Adopted: In March 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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. This ASU requires non-service cost components of net benefit cost to be presented in a caption below the Company's Operating profit and allows only the service cost component to be eligible for capitalization. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those periods, with early adoption permitted. The Company adopted the new standard as of January 1, 2018 and applied its amendments 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 application of ASU 2017-07 resulted in an increase to Operating profit of $0.4 million and $1.0 million for the third quarter and first nine months of 2017, respectively, which was offset by a corresponding increase in Other non-operating expense, net. The adoption of this ASU did not have a material effect on the Company's financial condition or liquidity. The Company utilized this ASU's practical expedient, which permits the Company to use the amounts disclosed in its Pensions and Other Post-employment Benefits note for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASC 606), which supersedes previous revenue recognition guidance. The Company adopted the new standard using the modified retrospective method as of January 1, 2018. Prior periods were not retrospectively adjusted. This approach was applied to all contracts not completed as of January 1, 2018. The new standard primarily impacted the Company's timing of revenue recognition for certain contracts and subcontracts with the United States (U.S.) government that contain termination for convenience clauses, and due to the cumulative impact of adopting ASC 606, the Company recorded a reduction to beginning retained earnings of $0.4 million, net of tax as summarized below:
(Thousands)
 
December 31, 2017
 
Adjustments due to ASC 606
 
January 1, 2018
Assets
 


 
 
 


Unbilled receivables
 
$

 
$
2,658

 
$
2,658

Inventories
 
220,352

 
(2,059
)
 
218,293

 
 
 
 
 
 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
Other liabilities and accrued items
 
$
28,044

 
61

 
28,105

Deferred income taxes
 
213

 
113

 
326

Retained earnings
 
536,116

 
425

 
536,541


The adoption of the standard did not have a material impact to the Company's consolidated financial statements. Refer to Note B for additional disclosures relating to ASC 606.



6


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


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 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. This ASU is required to be applied using a modified retrospective adoption method with the option of applying the guidance either retrospectively to each prior comparative reporting period presented or retrospectively at the beginning of the period of adoption. Early adoption is permitted. The Company will adopt this ASU on January 1, 2019 and will apply it retrospectively at the beginning of the period of adoption through a cumulative-effect adjustment to retained earnings. The Company will elect to apply the practical expedients that do not require reassessment of existing contracts for embedded leases or to reassess lease classification or initial direct costs. In preparation for the adoption, the Company, along with an outside consultant, has executed on its project plan to identify a complete lease population, analyze lease agreements, and evaluate technology solutions. The Company selected and began implementing a new lease management system during the third quarter of 2018. Once the transition to the new system is completed, this software will enable us to quantify the full impact this ASU will have on our consolidated financial statements.
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 — Revenue Recognition

Net sales consist primarily of revenue from the sale of precious and non-precious specialty metals, beryllium and copper-based alloys, beryllium composites, and other products into numerous end markets. The Company requires an agreement with a customer that creates enforceable rights and performance obligations. The Company generally recognizes revenue, in an amount that reflects the consideration to which it expects to be entitled, upon satisfaction of a performance obligation by transferring control over a product to the customer. Control over the product is generally transferred to the customer when the Company has a present right to payment, the customer has legal title, the customer has physical possession, the customer has the significant risks and rewards of ownership, and/or the customer has accepted the product.

Shipping and Handling Costs: The Company accounts for shipping and handling activities related to contracts with customers as costs to fulfill our promise to transfer the associated products. Accordingly, customer payments of shipping and handling costs are recorded as a component of net sales, and related costs are recorded as a component of cost of sales.

Taxes Collected from Customers and Remitted to Governmental Authorities: Revenue is recorded net of taxes collected from customers that are remitted to governmental authorities, with the collected taxes recorded as current liabilities until remitted to the relevant government authority.

Product Warranty: Substantially all of the Company’s customer contracts contain a warranty that provides assurance that the purchased product will function as expected and in accordance with certain specifications. The warranty is intended to safeguard the customer against existing defects and does not provide any incremental service to the customer.

Transaction Price Allocated to Future Performance Obligations: ASC 606 requires that the Company disclose the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied at September 28, 2018. Remaining performance obligations include noncancelable purchase orders and customer contracts. The guidance provides certain practical expedients that limit this requirement. As such, the Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less. After considering the practical expedient, at September 28, 2018, the aggregate amount of the transaction price allocated to remaining performance obligations was approximately $33.0 million, of which $4.0 million will be recognized in 2018.




7


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


Contract Costs: The Company recognizes the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that the Company otherwise would have recognized is one year or less. These costs primarily relate to sales commissions, which are included in selling, general, and administrative expenses.
Contract Balances: The timing of revenue recognition, billings and cash collections resulted in the following contract assets and contract liabilities:

(Thousands)
 
September 28, 2018
 
January 1, 2018
 
$ change
 
% change
Accounts receivable, trade
 
$
126,537

 
$
122,393

 
$
4,144

 
3
%
Unbilled receivables
 
6,383

 
2,658

 
3,725

 
140
%
Unearned revenue
 
7,805

 
5,451

 
2,354

 
43
%

Accounts receivable, trade represents payments due from customers relating to the transfer of the Company’s products and services. The Company believes that its receivables are collectible and appropriate allowances for doubtful accounts have been recorded. Impairment losses (bad debt) incurred relating to our receivables were immaterial during the third quarter and first nine months of 2018.

Unbilled receivables represent expenditures on contracts, plus applicable profit margin, not yet billed. Unbilled receivables are normally billed and collected within one year. Billings made on contracts are recorded as a reduction of unbilled receivables.

Unearned revenue is recorded for consideration received from customers in advance of satisfaction of the related performance obligations.

As a practical expedient, the Company does not adjust the promised amount of consideration for the effects of a significant financing component because the period between the transfer of a product or service to a customer and when the customer pays for that product or service will be one year or less. The Company does not include extended payment terms in its contracts with customers.

Note C — 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.



8


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


The final purchase price allocation for the acquisition is as follows:
(Thousands)
Amount
Assets:
 
Inventories
$
7,221

Prepaid and other current assets
2,270

Long-term deferred income taxes
14

Property, plant, and equipment
6,501

Intangible assets
3,649

Goodwill
3,574

Total assets acquired
$
23,229

 
 
Liabilities:
 
Other liabilities and accrued items
$
984

Other long-term liabilities
449

Retirement and post-employment benefits
5,292

Total liabilities assumed
$
6,725

 
 
Total purchase price
$
16,504


No material measurement period adjustments were recorded upon finalizing the purchase price allocation in the first quarter of 2018.

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



9



(Thousands)
 
Performance
Alloys and
Composites
 
Advanced Materials
 
Precision Coatings
 
Other
 
Total
Third Quarter 2018
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
124,103

 
$
144,072

 
$
29,018

 
$

 
$
297,193

Intersegment sales 
 
2

 
13,265

 

 

 
13,267

Operating profit (loss)
 
16,728

 
6,882

 
3,499

 
(8,443
)
 
18,666

Third Quarter 2017
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
109,393

 
$
157,770

 
$
27,105

 
$

 
$
294,268

Intersegment sales
 
54

 
12,814

 

 

 
12,868

Operating profit (loss)
 
6,786

 
9,756

 
1,613

 
(6,191
)
 
11,964

 
 
 
 
 
 
 
 
 
 
 
First Nine Months 2018
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
372,104

 
$
447,941

 
$
89,700

 
$

 
$
909,745

Intersegment sales 
 
33

 
36,317

 

 

 
36,350

Operating profit (loss)
 
38,898

 
18,352

 
9,107

 
(19,248
)
 
47,109

First Nine Months 2017
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
310,487

 
$
429,550

 
$
90,742

 
$

 
$
830,779

Intersegment sales
 
113

 
42,508

 

 

 
42,621

Operating profit (loss)
 
12,523

 
24,873

 
6,145

 
(17,788
)
 
25,753





10


The following table disaggregates revenue for each segment by end market for the third quarter and first nine months of 2018:

 (Thousands)
 
Performance Alloys and Composites
 
Advanced Materials
 
Precision Coatings
 
Other
 
Total
Third Quarter 2018
 
 
 
 
 
 
 
 
 
 
End Market
 
 
 
 
 
 
 
 
 
 
Consumer Electronics
 
$
24,966

 
$
78,859

 
$
4,733

 
$

 
$
108,558

Industrial Components
 
24,745

 
11,406

 
2,855

 

 
39,006

Energy
 
11,146

 
20,301

 
4

 

 
31,451

Automotive Electronics
 
21,681

 

 
530

 

 
22,211

Defense
 
11,430

 
3,761

 
5,503

 

 
20,694

Medical
 
1,862

 
4,448

 
15,261

 

 
21,571

Telecom Infrastructure
 
9,845

 
6,664

 

 

 
16,509

Other
 
18,428

 
18,633

 
132

 

 
37,193

    Total
 
$
124,103

 
$
144,072

 
$
29,018

 
$

 
$
297,193

 
 
 
 
 
 
 
 
 
 
 
First Nine Months 2018
 
 
 
 
 
 
 
 
 
 
End Market
 
 
 
 
 
 
 
 
 
 
Consumer Electronics
 
$
76,793

 
$
249,139

 
$
14,047

 
$

 
$
339,979

Industrial Components
 
78,291

 
36,206

 
8,247

 

 
122,744

Energy
 
29,152

 
60,048

 
12

 

 
89,212

Automotive Electronics
 
60,530

 

 
1,221

 

 
61,751

Defense
 
32,984

 
11,599

 
14,705

 

 
59,288

Medical
 
5,421

 
13,569

 
48,786

 

 
67,776

Telecom Infrastructure
 
28,829

 
21,989

 
59

 

 
50,877

Other
 
60,104

 
55,391

 
2,623

 

 
118,118

    Total
 
$
372,104

 
$
447,941

 
$
89,700

 
$

 
$
909,745

Intersegment sales are eliminated in consolidation.

Note E — Other-net
Other-net expense for the third quarter and first nine months of 2018 and 2017 is summarized as follows: 
 
 
Third Quarter Ended
 
Nine Months Ended
 
 
Sept. 28,
 
Sept. 29,
 
Sept. 28,
 
Sept. 29,
(Thousands)
 
2018
 
2017
 
2018
 
2017
Metal consignment fees
 
$
2,503

 
$
2,436

 
$
7,520

 
$
6,183

Amortization of intangible assets
 
524

 
1,179

 
1,858

 
3,456

Foreign currency loss (gain)
 
140

 
(201
)
 
1,359

 
(794
)
Fixed asset impairment
 

 
114

 

 
314

Cost reduction initiatives
 

 
189

 

 
189

Net loss on disposal of fixed assets
 
14

 
60

 
37

 
207

Sublease income
 
(119
)
 
(28
)
 
(378
)
 
(83
)
Other items
 
85

 
52

 
(12
)
 
351

Total
 
$
3,147

 
$
3,801

 
$
10,384

 
$
9,823




11


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


Note F — Income Taxes
On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law. The TCJA includes a number of provisions, including: (1) the lowering of the U.S. corporate tax rate from 35% to 21%; (2) elimination of the corporate alternative minimum tax (AMT); (3) the creation of the base erosion anti-abuse tax (BEAT, a new minimum tax); (4) a general elimination of the U.S. federal income taxes on dividends from foreign subsidiaries; (5) a new provision designed to tax global intangible low-taxed income (GILTI), which allows for the possibility of using foreign tax credits (FTCs) and a deduction of up to 50% to offset the income tax liability (subject to some limitations); (6) a new limitation on deductible interest expense; (7) the repeal of the domestic production activity deduction; and (8) limitations on the deductibility of certain executive compensation.

The Company recorded an income tax benefit of $2.7 million in the third quarter of 2018, resulting in an effective tax rate of (15.7)% against income before income taxes, and income tax expense of $1.7 million in the third quarter of 2017, resulting in an effective tax rate of 15.5% against income before income taxes.

In the first nine months of 2018, income tax expense of $1.7 million was calculated using an effective tax rate of 4.0%, while income tax expense of $3.3 million in the first nine months of 2017 was calculated using an effective tax rate of 14.4%.

In the third quarter and first nine months of 2018, income tax expense differed from the U.S. Federal statutory income tax rate of 21% primarily due to the impact of foreign losses in jurisdictions that will not result in tax benefits, percentage depletion, the U.S. research and development credit, the new GILTI income inclusion, the new executive compensation limitations, and discrete income tax benefits of $6.1 million and $7.1 million recorded in the third quarter and first nine months of 2018, respectively. The $6.1 million of discrete income tax benefits recorded in the third quarter of 2018 were comprised of a $7.4 million benefit for the partial reversal of a $9.5 million valuation allowance related to foreign tax credits that were deemed unrealizable as of December 31, 2017, and a $2.4 million benefit for the re-measurement of certain deferred tax assets and liabilities. These benefits were offset by $2.2 million of expense for a valuation allowance related to deferred tax assets that are not likely to be realized for one of the Company's controlled foreign corporations, and a $1.5 million 2017 U.S. Federal income tax return to provision expense adjustment. The $1.0 million discrete income tax benefit recorded in the first six months of 2018 consisted of $0.4 million of excess tax benefits related to share based payment transactions and a $0.6 million benefit attributable to the re-measurement of certain deferred tax assets and liabilities. The Company does not expect to incur a new BEAT minimum tax or an interest expense limitation.

In the third quarter and first nine months of 2017, income tax expense differed from the U.S Federal statutory income tax rate of 35% primarily due to the impact of percentage depletion, foreign rate differential, the U.S. research and development credit, and discrete income tax benefits of $0.5 million and $1.3 million, respectively, related to the reversal of uncertain tax positions due to a lapse in the statute of limitations and the adoption of ASU 2016-09, Improvements to Employee Share-based Payment Accounting.

As disclosed in Note G - Income Taxes in the Company's 2017 Annual Report on Form 10-K, the Company was able to reasonably estimate certain TCJA effects and, therefore, recorded provisional adjustments associated with the deemed repatriation transition tax and remeasurement of certain deferred tax asset and liabilities. As of the third quarter of 2018, the Company recorded a measurement period tax expense adjustment of $1.2 million related to the transition tax and a $2.4 million tax benefit related to the re-measurement of certain deferred tax assets and liabilities. The Company’s accounting for the income tax effects of the TCJA continue to be provisional and the company expects to record the final measurement period adjustment in the fourth quarter of 2018.

The Company continues to refine the additional measurement-period adjustments related to the transition tax post September 30, 2018 because the total post 1986 earnings and profits (E&P) for its foreign subsidiaries has not yet been completed. The Company is continuing to gather additional information and will complete its accounting for these items in the fourth quarter of 2018. No additional income taxes have been provided for any remaining undistributed foreign earnings not subject to the transition tax, or any additional outside basis difference inherent in these entities, as these amounts continue to be indefinitely reinvested in foreign operations.




12


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


The Company was able to reasonably estimate the remeasurement of certain deferred tax asset and liabilities at an initial provisional amount of $5.0 million of additional income tax expense for the year ended December 31, 2017. The Company made refinements to the calculation during 2018, primarily as a result of information gathered during the preparation of the 2017 U.S. Federal income tax return, leaving a remaining provisional amount of $2.0 million at the end of the third quarter of 2018. The Company is continuing to gather additional information and expects to complete its accounting for these items in the fourth quarter of 2018.

Due to the complexity of the new GILTI tax rules, the Company is continuing to evaluate this provision of the TCJA and the application of the Accounting Standards Codification 740, Income Taxes. Under U.S. GAAP, the Company is allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the period cost method) or (2) factoring such amounts into the Company's measurement of its deferred taxes (the deferred method). The Company's selection of an accounting policy related to the new GILTI tax rules will depend on a number of different aspects of the estimated long-term effects of this provision under the TCJA. Therefore, the Company has not recorded any potential deferred tax effects related to the GILTI in the financial statements and has not made a policy decision regarding whether to record deferred taxes on GILTI or use the period cost method. However, the Company has included an estimate of the 2018 current GILTI impact in the annual effective tax rate for 2018.


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. 28,
 
Sept. 29,
 
Sept. 28,
 
Sept. 29,
(Thousands, except per share amounts)
 
2018
 
2017
 
2018
 
2017
Numerator for basic and diluted EPS:
 
 
 
 
 
 
 
 
Net income
 
$
19,966

 
$
9,320

 
$
41,674

 
$
19,683

Denominator:
 
 
 
 
 
 
 
 
Denominator for basic EPS:
 
 
 
 
 
 
 
 
Weighted-average shares outstanding
 
20,241

 
20,040

 
20,199

 
20,007

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Stock appreciation rights
 
168

 
149

 
183

 
148

Restricted stock units
 
86

 
94

 
84

 
95

Performance-based restricted stock units
 
153

 
128

 
141

 
111

Diluted potential common shares
 
407

 
371

 
408

 
354

Denominator for diluted EPS:
 

 

 
 
 
 
Adjusted weighted-average shares outstanding
 
20,648

 
20,411

 
20,607

 
20,361

Basic EPS
 
$
0.99

 
$
0.47

 
$
2.06

 
$
0.98

Diluted EPS
 
$
0.97

 
$
0.46

 
$
2.02

 
$
0.97


Securities totaling 65,112 and 219,292 for the quarters ended September 28, 2018 and September 29, 2017, respectively, and 65,112 and 370,917 for the nine months ended September 28, 2018 and September 29, 2017, respectively, were excluded from the dilution calculation as their effect would have been anti-dilutive.



13


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



Note H — Inventories
Inventories on the Consolidated Balance Sheets are summarized as follows:
 
 
Sept. 28,
 
December 31,
(Thousands)
 
2018
 
2017
Raw materials and supplies
 
$
37,438

 
$
42,958

Work in process
 
176,792

 
187,719

Finished goods
 
35,660

 
34,418

Subtotal
 
$
249,890

 
$
265,095

Less: LIFO reserve balance
 
49,977

 
44,743

Inventories
 
$
199,913

 
$
220,352

The liquidation of last in, first out (LIFO) inventory layers increased cost of sales by $0.2 million in the third quarter and $0.3 million in the first nine months of 2018. LIFO liquidation had no impact to cost of sales in the third quarter of 2017 and caused a $0.2 million increase to cost of sales in the first nine months of 2017.


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 2018 and 2017 for the domestic pension plans (which include the defined benefit pension plan and the supplemental retirement plans) and the domestic retiree medical plan.
 

Pension Benefits

Other Benefits
 

Third Quarter Ended

Third Quarter Ended


Sept. 28,

Sept. 29,

Sept. 28,

Sept. 29,
(Thousands)

2018

2017

2018

2017
Components of net periodic benefit cost (benefit)








Service cost

$
1,674


$
1,813


$
27


$
23

Interest cost

2,397


2,372


99


99

Expected return on plan assets

(3,697
)

(3,385
)




Amortization of prior service benefit

(31
)

(42
)

(374
)

(374
)
Amortization of net loss

1,959


1,623





Net periodic benefit cost (benefit)

$
2,302


$
2,381


$
(248
)

$
(252
)
Settlements
 
359

 

 

 

Total net benefit cost
 
$
2,661

 
$
2,381

 
$
(248
)
 
$
(252
)



14


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


 
 
Pension Benefits
 
Other Benefits
 
 
Nine Months Ended
 
Nine Months Ended
 
 
Sept. 28,
 
Sept. 29,
 
Sept. 28,
 
Sept. 29,
(Thousands)
 
2018
 
2017
 
2018
 
2017
Components of net periodic benefit cost (benefit)
 
 
 
 
 
 
 
 
Service cost
 
$
5,022

 
$
5,309

 
$
83

 
$
69

Interest cost
 
7,191

 
7,098

 
297

 
297

Expected return on plan assets
 
(11,091
)
 
(10,128
)
 

 

Amortization of prior service benefit
 
(92
)
 
(236
)
 
(1,123
)
 
(1,122
)
Amortization of net loss
 
5,878

 
4,821

 

 

Net periodic benefit cost (benefit)
 
$
6,908

 
$
6,864

 
$
(743
)
 
$
(756
)
Settlements
 
359

 

 

 

Total net benefit cost
 
$
7,267

 
$
6,864

 
$
(743
)
 
$
(756
)
The Company made contributions to the domestic defined benefit pension plan of $38.0 million and $8.0 million in the first nine months of 2018 and 2017, respectively. The Company currently anticipates 2018 contributions of approximately $42.0 million in the aggregate.
Beginning in 2018, the Company reports the service cost component of net periodic benefit cost in the same line item as other compensation costs in operating expenses and the non-service cost components of net periodic benefit cost in Other non-operating expenses. Additionally, Pension Benefit Guaranty Corporation premiums are reported within expected return on plan assets.



15


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



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 2018 and 2017 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 29, 2018

$
1,582


$
269


$
1,851


$
(97,018
)

$
(3,939
)

$
(99,106
)
Other comprehensive income before reclassifications

121


330


451




116


567

Amounts reclassified from accumulated other comprehensive income

(169
)

(119
)

(288
)

1,935




1,647

Net current period other comprehensive income (loss) before tax

(48
)

211


163


1,935


116


2,214

Deferred taxes

(11
)

49


38


428




466

Net current period other comprehensive income (loss) after tax

(37
)

162


125


1,507


116


1,748

Balance at September 28, 2018

$
1,545


$
431


$
1,976


$
(95,511
)

$
(3,823
)

$
(97,358
)
 
 
 
 
 
 
 
 
 
 
 
 
 
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

Net current period other comprehensive income (loss) before tax
 
109

 
(299
)
 
(190
)
 
1,345

 
271

 
1,426

Deferred taxes
 
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
)




16


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
Balance at December 31, 2017
 
$
959

 
$
(196
)
 
$
763

 
$
(99,592
)
 
$
(4,108
)
 
$
(102,937
)
Other comprehensive income (loss) before reclassifications
 
(206
)
 
774

 
568

 

 
285

 
853

Amounts reclassified from accumulated other comprehensive income
 
250

 
40

 
290

 
5,183

 

 
5,473

Net current period other comprehensive income before tax
 
44

 
814

 
858

 
5,183

 
285

 
6,326

Deferred taxes
 
(542
)
 
187

 
(355
)
 
1,102

 

 
747

Net current period other comprehensive income after tax
 
586

 
627

 
1,213

 
4,081

 
285

 
5,579

Balance at September 28, 2018
 
$
1,545

 
$
431

 
$
1,976

 
$
(95,511
)
 
$
(3,823
)
 
$
(97,358
)
 
 
 
 
 
 
 
 
 
 
 
 
 
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
 
(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
)

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.



17


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 $4.2 million and $9.4 million in the third quarter and first nine months of 2018, respectively, compared to $1.5 million and $6.2 million in the same periods of 2017.
The Company granted 65,112 stock appreciation rights (SARs) to certain employees during the first nine months of 2018. The weighted-average exercise price per share and weighted-average fair value per share of the SARs granted during the nine months ended September 28, 2018 were $50.35 and $15.73, 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
 
2.58
%
Dividend yield
 
0.8
%
Volatility
 
31.9
%
Expected term (in years)
 
5.5

The Company granted 59,222 stock-settled restricted stock units (RSUs) to certain employees and 14,728 stock-settled RSUs to non-employee directors during the first nine months of 2018. 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 $50.35 and $51.60 for stock-settled RSUs granted to employees and non-employee directors, respectively, during the nine months ended September 28, 2018. RSUs are expensed over the vesting period of three years for employees and one year for non-employee directors.
The Company granted stock-settled performance-based restricted stock units (PRSUs) to certain employees in the first nine months of 2018. The weighted-average fair value of the stock-settled PRSUs was $50.35 per share and will be expensed over the vesting period of three years. 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 28, 2018, unearned compensation cost related to the unvested portion of all stock-based awards was approximately $9.2 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.



18


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 28, 2018 and December 31, 2017: 
 
 
 
 
 
 
 
 
 
(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)
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
 
2018
 
2017
Financial Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deferred compensation investments
 
$
2,400

 
$
2,310

 
$
2,400

 
$
2,310

 
$

 
$

 
$

 
$

Foreign currency forward contracts
 
226

 
254

 

 

 
226

 
254

 

 

Precious metal swaps
 
655

 
14

 

 

 
655

 
14

 

 

Total
 
$
3,281

 
$
2,578

 
$
2,400

 
$
2,310

 
$
881

 
$
268


$


$

Financial Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deferred compensation liability
 
$
2,400

 
$
2,310

 
$
2,400

 
$
2,310

 
$

 
$

 
$

 
$

Foreign currency forward contracts
 
170

 
201

 

 

 
170

 
201

 

 

Precious metal swaps
 
97

 
269

 

 

 
97

 
269

 

 

Total
 
$
2,667

 
$
2,780

 
$
2,400

 
$
2,310

 
$
267

 
$
470

 
$

 
$

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 28, 2018 and December 31, 2017.

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



19


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.



20


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 28, 2018 and December 31, 2017:
 
 
September 28, 2018
 
December 31, 2017
(Thousands)
 
Notional
Amount
 
Fair
Value
 
Notional
Amount
 
Fair
Value
Foreign currency forward contracts - euro
 
 
 
 
 
 
 
 
Prepaid expenses
 
$
11,622

 
$
40

 
$
13,981

 
$
127

Other liabilities and accrued items
 
37,027

 
170

 

 

Total
 
$
48,649

 
$
130

 
$
13,981

 
$
127

These outstanding foreign currency derivatives were related to intercompany loans. Other-net included foreign currency gains relating to these derivatives of $0.4 million and $1.6 million during the third quarter and first nine months of 2018, respectively, compared to foreign currency losses of $0.5 million and $1.1 million during the same periods in 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 28, 2018 and December 31, 2017:
 
 
September 28, 2018
 
December 31, 2017
(Thousands)
 
Notional
Amount
 
Fair
Value
 
Notional
Amount
 
Fair
Value
Prepaid expenses
 
 
 
 
 
 
 
 
Foreign currency forward contracts - yen
 
$
1,413

 
$
44

 
$
5,673

 
$
91

Foreign currency forward contracts - euro
 
3,811

 
142

 
5,026

 
36

Precious metal swaps
 
7,198

 
654

 

 

Total
 
12,422

 
840

 
10,699

 
127

 
 
 
 
 
 
 
 
 
Other assets
 
 
 
 
 
 
 
 
Precious metal swaps
 
246

 
1

 
880

 
14

Total
 
246

 
1

 
880

 
14

 
 
 
 
 
 
 
 
 
Other liabilities and accrued items
 
 
 
 
 
 
 
 
Foreign currency forward contracts - yen
 

 

 

 

Foreign currency forward contracts - euro
 

 

 
13,583

 
201

Precious metal swaps
 
845

 
94

 
10,067

 
255

Total
 
845

 
94

 
23,650

 
456

 
 
 
 
 
 
 
 
 
Other long-term liabilities
 
 
 
 
 
 
 
 
Precious metal swaps
 
121

 
3

 
789

 
14

Total
 
$
13,634

 
$
744

 
$
36,018

 
$
329

All of these contracts were designated and effective as cash flow hedges. No ineffectiveness expense was recorded in the third quarter and first nine months of 2018 or 2017.
Changes in the fair value of outstanding cash flow hedges recorded in OCI for the first nine months of 2018 and 2017 totaled an increase of $0.6 million and a decrease of $1.2 million, respectively. The Company expects to relieve substantially the entire balance in OCI as of September 28, 2018 to the Consolidated Statements of Income within the next 18-month period. Refer to Note J for additional OCI details.




21


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


Note N — Contingencies
Legal Proceedings. For information regarding legal proceedings relating to Chronic Beryllium Disease Claims, refer to Note R ("Contingencies and Commitments") in the Company's 2017 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 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 $6.5 million at both September 28, 2018 and December 31, 2017. 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 produc