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MTRN > SEC Filings for MTRN > Form 10-Q on 6-Aug-2013All Recent SEC Filings

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Form 10-Q for MATERION CORP


6-Aug-2013

Quarterly Report


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 markets, including consumer electronics, industrial components and commercial aerospace, defense and science, energy, medical, automotive electronics, telecommunications infrastructure and appliance.

Second quarter 2013 sales of $306.1 million were 6% lower than sales in the second quarter 2012. The majority of this sales decline was due to lower pass-through metal prices in the second quarter 2013.

Shipments into a number of key markets, including defense and science, automotive electronics and industrial components and commercial aerospace, improved in the second quarter 2013 over the second quarter 2012. Medical market sales softened temporarily in the second quarter, but are anticipated to grow in the third quarter 2013.

Gross margin was $52.8 million in the second quarter 2013 compared to $53.0 million in the second quarter 2012. Improved manufacturing performance, including the output from the new beryllium plant, helped offset the unfavorable change in product mix and other factors affecting margins in the quarter.

Operating profit was $13.4 million in the second quarter 2013, an 8% improvement over the second quarter 2012. Earnings per share were $0.43 in the second quarter 2013 compared to $0.38 in the second quarter 2012.

We increased the quarterly dividend to $0.08 per share and paid $1.6 million to shareholders in the second quarter 2013.

Cash flow from operations was $18.1 million in the first half of 2013. Total debt, after increasing in the first quarter 2013, declined in the second quarter 2013, primarily due to the improved cash flow in that period. As of the end of the second quarter 2013, debt was up $1.8 million from year-end 2012, but the debt-to-debt-plus-equity ratio was 18% compared to 19% at year-end 2012.

During the second quarter 2013, we secured a new revolving credit facility to replace the existing facility that was scheduled to mature in 2016. The borrowing capacity is $50.0 million higher and the borrowing spreads are lower under the new facility than they were under the prior facility. The new facility matures in 2018.

RESULTS OF OPERATIONS

                                       Second Quarter Ended         First Half Ended
                                      June 28,       June 29,     June 28,     June 29,
(Millions, except per share data)       2013           2012         2013         2012
Sales                               $    306,141    $ 325,088    $ 605,310    $ 678,718
Operating profit                          13,390       12,445       22,912       22,329
Income before income taxes                12,577       11,625       21,271       20,811
Net income                                 8,909        7,929       15,694       14,047
Diluted earnings per share          $       0.43    $    0.38    $    0.75    $    0.68

Sales of $306.1 million in the second quarter 2013 were $19.0 million, or 6%, lower than sales of $325.1 million in the second quarter 2012. Sales from three of our reportable segments - Performance Alloys, Beryllium and Composites and Technical Materials - grew in the second quarter 2013 over the second quarter 2012, while sales from Advanced Material Technologies declined. The prices of key raw materials, including gold, silver and copper, were lower in the second quarter 2013 than the second quarter 2012 and the lower pass-through metal prices reduced sales in the second quarter 2013 by an estimated $22.0 million.


Sales in the first half of 2013 of $605.3 million were 11% lower than sales of $678.7 million in the first half of 2012. Lower pass-through metal prices accounted for an estimated $25.2 million of the $73.4 million decline in sales in the first half of the year.

The comparisons of sales in the second quarter and first half of 2013 to the respective periods in 2012 were also affected by changes in foreign currency translation rates, a change in the amount of customer-supplied precious metals, the discontinuation of a non-strategic product line and other items.

Domestic sales declined approximately 7% in the second quarter 2013 from the second quarter 2012 and 15% in the first half of 2013 from the first half of 2012. International sales were 3% lower in the second quarter 2013 than the second quarter 2012 as softer sales in Asia and other parts of the world were partially offset by higher sales in Europe. International sales were down approximately 1% in the first half of 2013 from the first half of 2012.

Sales order entry over the first two quarters of 2013 was approximately equal to sales.

The cost of gold, silver, platinum, palladium and copper are typically passed through to customers and therefore movements in the prices of these metals will affect sales, but may not have a commensurate impact on margins. Internally, we manage our business on a value-added sales basis. Value-added sales is a non-GAAP measure that deducts the cost of these pass-through metals from sales and removes the potential distortion caused by differences in metal values sold. Value-added sales were $159.3 million in the second quarter 2013, a 3% increase from value-added sales of $154.5 million in the second quarter 2012. Value-added sales were $310.6 million in the first half of 2013 and $312.0 million in the first half of 2012. A reconciliation of sales to value-added sales is provided in a later section of this Management's Discussion and Analysis.

Value-added sales to the consumer electronics market, our largest market with approximately 27% of our total value-added sales in the second quarter 2013, were 3% lower in the second quarter and first half of 2013 than the comparable periods of 2012. The phase-out of an application for disk drive arms was a main cause for the decline in the second quarter and first half of 2013 while lower shipments of copper-based alloys in the first quarter 2013 contributed to the fall-off in value-added sales in the first half of the year. Shipments of precious metals for semiconductor and other microelectronic applications improved slightly in the first half of 2013. Value-added sales to the consumer electronics market improved approximately 6% in the second quarter 2013 over the first quarter 2013 after growing 7% in the first quarter 2013 over the fourth quarter 2012.

As a material supplier to this market, we sell to stamping houses and sub-assembly shops and we are several steps removed from the end-use consumer. Our sales to this market in a given period, therefore, are affected by downstream inventory levels and production schedules and changes in market share of the intermediaries within the supply chain, not necessarily by changes in sales of the final product or in consumer demand for that period. Technologies can change quickly in this market and applications can have short life spans.

Value-added sales to the industrial components and commercial aerospace market improved approximately 3% in the second quarter 2013 over the second quarter 2012. Value-added sales to this market in the first half of 2013, however, were 2% lower than the first half of 2012. Value-added sales of our ToughMetŪ products for heavy equipment and other applications, which were a key driver for the growth in this market in 2012, have been relatively flat throughout the first half of 2013. The industrial components and commercial aerospace market is our second largest market, accounting for 18% of our value-added sales in the second quarter 2013.

Value-added sales to the medical market, after growing approximately 20% in the first quarter 2013 over the first quarter 2012, softened approximately 12% in the second quarter 2013 from the second quarter 2012. The softness in the second quarter 2013 was due to lower shipments for blood glucose test strip and x-ray window applications.

Value-added sales to the defense and science market in the second quarter 2013 were approximately 21% higher than the second quarter 2012 and 30% higher than the first quarter 2013. Value-added sales to this market were 5% lower in the first half of 2013 than the first half of 2012 as a result of the softer first quarter 2013. The improvement in the second quarter 2013 was largely due to increased shipments of beryllium products. Shipments of optics throughout the first half of 2013 were lower than the first half of 2012 primarily as a result of government spending cut-backs.

Energy market value-added sales grew 3% in the second quarter 2013 over the second quarter 2012. Value-added sales to this market were 8% lower in the first half of 2013 than the first half of 2012. The growth in the second quarter 2013 was partially due to architectural glass applications. The value-added sales to the oil and gas sector, which were weak in the first quarter 2013 due to market conditions, improved in the second quarter 2013 over the first quarter 2013.


Automotive electronics market value-added sales grew approximately 21% in the second quarter 2013 over the second quarter 2012 after growing 13% in the first quarter 2013 over the first quarter 2012. The growth was due to improved market conditions and new application development. Value-added sales to the automotive electronics market were approximately 12% of our total value-added sales in the second quarter 2013.

Gross margin was $52.8 million, or 17% of sales, in the second quarter 2013 compared to $53.0 million, or 16% of sales, in the second quarter 2012. Gross margin in the first half of 2013 was $101.2 million, or 17% of sales, versus $102.4 million, or 15% of sales, in the first half of 2012. Gross margin as a percent of value-added sales was 33% in the second quarter 2013 compared to 34% in the second quarter 2012. Gross margin was 33% of value-added sales in the first half of both 2013 and 2012.

The gross margin in the second quarter 2013 benefitted from the margin generated by the higher value-added sales, higher production volumes, improved efficiencies at various operations and other factors offset, in part, by slightly higher manufacturing overhead costs, an unfavorable change in product mix and an unfavorable movement in currency translation rates.

The volume impact on gross margins in the first half of 2013 was slightly unfavorable as were the change in product mix and the movement in currency translation rates. We recorded a physical inventory loss at our Albuquerque, New Mexico facility of $2.3 million in the first quarter 2013. The impact of these items was partially offset by manufacturing improvements at several facilities and lower manufacturing overhead costs.

Gross margin in the second quarter 2013 and first half of 2013 benefitted from the improved manufacturing performance of the new beryllium plant in Elmore, Ohio. The plant had its highest output to date in the second quarter 2013 and output levels have increased for four consecutive quarters.

Selling, general and administrative (SG&A) expenses totaled $33.3 million in the second quarter 2013 compared to $33.5 million in the second quarter 2012. SG&A expenses were $66.1 million in the first half of 2013, unchanged from the first half of 2012. SG&A expenses were 11% of sales in the first half of 2013 and 10% of sales in the first half of 2012. SG&A expenses were 21% of value-added sales in the first half of 2013 and 2012.

Facility consolidation and closure costs under the program initiated in 2012 totaled $0.3 million in the second quarter 2013 and $0.7 million in the first half of 2013. One small facility was closed in the fourth quarter 2012, while two others are scheduled to be closed with portions of the businesses relocated to other facilities. A fourth operation will be consolidated into a smaller building during 2013. The costs in the first half of 2013 were primarily for employee retention and severance and other items associated with relocating the operations. Facility consolidation and closure costs totaled $0.6 million in the first half of 2012, all of which was recorded in the second quarter of that year.

The expense for the domestic defined benefit pension plan was $0.9 million higher in the second quarter 2013 than the second quarter 2012 and $1.8 million higher in the first half of 2013 than the first half of 2012. The increase was caused by a reduction in the discount rate used to value the plan liability, changes in mortality assumptions and other factors. The increased expense was recorded mainly in SG&A as well as cost of sales.

The incentive compensation expense under cash-based plans was $0.5 million higher in the second quarter 2013 than the second quarter 2012 and $1.6 million higher in the first half of 2013 than the first half of 2012. The increase was caused by differences in the projected level of annual profit relative to the plans' targets in each year and other factors.

Stock-based compensation expense was $1.5 million in the second quarter 2013 and $1.4 million in the second quarter 2012. Stock-based compensation expense in the first half of 2013 was $2.7 million compared to $2.8 million in the first half of 2012. Movements in stock-based compensation between periods may be caused by differences in the number of grants, the fair value of the grants and other items.

Offsetting a portion of the above cost increases were the savings from the plant consolidation program, reductions in expenses in China in response to the current business levels and other cost control measures.

Movements in the exchange rates between periods resulted in a reduction in the translated value of various foreign currency denominated expenses of $0.3 million in the second quarter 2013 and $0.5 million in the first half of 2013 relative to the respective periods of 2012.


Research and development (R&D) expenses were $3.2 million in the second quarter 2013 and the second quarter 2012. R&D expenses of $6.7 million in the first half of 2013 increased 7% over the $6.3 million expense in the first half of 2012. The increase was due to various projects and higher activity levels across portions of our business. R&D expense was approximately 1% of sales in the first half of 2013 and 2012.

Other-net expense totaled $3.0 million in the second quarter 2013 compared to $3.9 million in the second quarter 2012. Other-net expense was $5.4 million in the first half of 2013 and $7.7 million in the first half of 2012. See Note G to the Consolidated Financial Statements for details of the major components within other-net expense.

The metal consignment fee of $1.7 million in the second quarter 2013 was $0.9 million lower than the fee of $2.6 million in the second quarter 2012 while the fee for the first six months of 2013 of $3.5 million was $1.4 million lower than the comparable period of 2012. The lower fee resulted from a reduction in the quantity of metal on hand and lower metal prices.

The net foreign currency exchange and translation gain was $0.2 million higher in the second quarter 2013 and $0.7 million higher in the first half of 2013 than the respective periods of 2012 as a result of the movement in the value of the U.S. dollar versus certain other currencies and their impact on transactions and balances and in relation to the strike prices in currency hedge contracts.

Other-net expense also includes amortization expense, bad debt expense, gains and losses on the disposal of fixed assets, cash discounts and other items.

Operating profit of $13.4 million in the second quarter 2013 was an 8% improvement over the operating profit of $12.4 million in the second quarter 2012. The growth in operating profit resulted from the margin generated by the higher value-added sales and a reduction in metal consignment fees offset, in part, by higher manufacturing overhead costs and other items. Operating profit of $22.9 million (4% of sales) in the first half of 2013 was 3% higher than the operating profit of $22.3 million (3% of sales) in the first half of 2012. Operating profit was 7% of value-added sales in the first half of 2013 and 2012.

Interest expense - net was $0.8 million in the second quarter 2013, unchanged from the second quarter 2012. For the first half of 2013, interest expense-net was $1.6 million compared to $1.5 million in the first half of 2012. Average debt levels and the effective borrowing rates were fairly similar over the first half of 2013 and the first half of 2012.

Income before income taxes and income tax expense for the second quarter and first half of 2013 and 2012 were as follows:

                                Second Quarter Ended         First Half Ended
                               June 28,        June 29,   June 28,      June 29,
(Dollars in millions)            2013            2012       2013          2012
Income before income taxes   $     12.6       $   11.6   $   21.3      $    20.8
Income tax expense                  3.7            3.7        5.6            6.8
Effective tax rate                 29.2 %         31.8 %     26.2 %         32.5 %

The effects of percentage depletion, the production deduction, executive compensation, foreign source income and credits, state and local taxes and other items were major factors for the difference between the effective and statutory rates in the second quarter and first half of 2013 and 2012.

The tax expense for the first half of 2013 included a net discrete tax benefit of $0.6 million recorded in the first quarter 2013 that primarily represented the estimated full value of the research and experimentation credit for 2012. This benefit was not included in our tax rate for 2012 as accounting regulations require us to record tax expense based upon the laws in effect as of the end of the year and the U.S. Congress did not extend the research and experimentation credit for 2012 until January 2013. The effective tax rate in the second quarter and first half of 2013 also included a proportionate share of the estimated research and experimentation credit for 2013.

The tax expense in the first half of 2012 included $0.1 million for discrete items in that period.

Net income was $8.9 million (or $0.43 per share, diluted) in the second quarter 2013 versus to $7.9 million (or $0.38 per share, diluted) in the second quarter 2012. Net income was $15.7 million (or $0.75 per share, diluted) in the first half of 2013 and $14.0 million (or $0.68 per share, diluted) in the first half of 2012.


Segment Results

Results by segment are depicted in Note E to the Consolidated Financial Statements. The All Other column in the segment reporting includes our parent company expenses, other corporate charges and the operating results of Materion Services Inc., a wholly owned subsidiary that provides administrative and financial oversight services to our other businesses on a cost-plus basis.

The operating loss within All Other in the second quarter 2013 was $0.4 million lower than the second quarter 2012 and $1.5 million lower in the first half of 2013 than the first half of 2012. Incurred costs at corporate were higher in the second quarter and first half of 2013, partially as a result of legal and other administrative costs associated with the investigation into the potential inventory theft in 2012, but these costs were more than offset by an increase in charges out of other costs to the business units.

Advanced Material Technologies
                         Second Quarter Ended              First Half Ended
                        June 28,          June 29,      June 28,      June 29,
(Millions)                2013              2012          2013          2012
Sales              $     196.0           $    221.9    $    389.9    $    463.7
Operating profit           4.5                  7.5           7.9          12.8

Advanced Material Technologies manufactures precious, non-precious and specialty metal products, including vapor deposition targets, frame lid assemblies, clad and precious metal preforms, high temperature braze materials, ultra-fine wire, advanced chemicals, optics, performance coatings and microelectronic packages. These products are used in wireless, semiconductor, photonic, hybrid and other microelectronic applications within the consumer electronics and telecommunications infrastructure markets. Other key markets for these products include medical, defense and science, energy and industrial components. Advanced Material Technologies also has metal cleaning operations and in-house refineries that allow for the reclaim of precious metals from internally generated or customers' scrap. This segment has domestic facilities in New York, Connecticut, Wisconsin, New Mexico, Massachusetts and California and international facilities in Asia and Europe.

Sales from Advanced Material Technologies were $196.0 million in the second quarter 2013, a decline of $25.9 million, or 12%, from sales of $221.9 million in the second quarter 2012. Sales in the first half of 2013 of $389.9 million were $73.8 million, or 16%, lower than sales of $463.7 million in the first half of 2012. Lower pass-through metal prices accounted for an estimated $20.7 million of the decline in sales in the second quarter 2013 from the second quarter 2012 and $24.3 million of the decline in sales in the first half of 2013 from the first half of 2012.

Value-added sales of $72.0 million in the second quarter 2013 were 2% lower than value-added sales of $73.5 million in the second quarter 2012. Value-added sales in the first half of 2013 were $140.7 million, a 2% decline from the value-added sales of $143.0 million in the first half of 2012.

Consumer electronics is Advanced Material Technologies' largest market, accounting for approximately 39% of the segment's value-added sales. Value-added sales to this market in the second quarter 2013 were unchanged from the year ago period and 1% higher in the first half of 2013 than the first half of 2012. On a sequential basis, value-added sales to the consumer electronics market have grown in 2013, as value-added sales in the second quarter were 10% higher than in the first quarter while value-added sales in the first quarter were 19% higher than in the fourth quarter 2012. Value-added sales of phosphors for LED applications grew in the second quarter and first half of 2013 due to the improved performance that these materials provide. However, value-added sales of precious metals for LED applications have declined as manufacturers are redesigning their products to use lower quantities of precious metals in order to reduce costs and the ultimate price to the end-use consumers. Value-added sales for wireless applications improved in the second quarter 2013 over the second quarter 2012 while value-added sales for data storage applications softened.

Value-added sales to the medical market, primarily precious metal coated precision polymer films, declined approximately 10% in the second quarter 2013 from the second quarter 2012. Value-added sales to the medical market had grown in the first quarter 2013 over the first quarter 2012 and value-added sales in the first half of 2013 were 6% higher than value-added sales in the first half of 2012. Manufacturing issues at an outside vendor caused delays in shipments to a key customer in the second quarter 2013. Those issues have been resolved and shipments were resumed late in the quarter. Based upon order entry patterns and other market information, we anticipate that shipments to the medical market will be strong in the third quarter 2013. The medical market is this segment's second largest market, accounting for approximately 16% of value-added sales in the second quarter 2013.


Value-added sales from refining and shield kit cleaning operations grew in the second quarter 2013 and first half of 2013 over the respective periods of 2012. This growth is partially due to capturing additional market share supported by our expanded operations that provide additional capacity and improved processing times. The level of value-added sales from these operations is also partially a function of the ounces in the supply chain available to be reclaimed. The closure of the shield kit cleaning operations in the Czech Republic in the fourth quarter 2012 had a slightly unfavorable impact on our value-added sales in the first half of 2013.

Defense and science value-added sales declined approximately 6% in the second quarter 2013 and 12% in the first half of 2013 from the comparable periods in 2012. The decline was largely due to lower shipments of optics as a result of government spending cut-backs. A number of defense applications for optics are funded and remain active. However, the order entry rate has been soft and orders could be more severely impacted by potential government spending cuts with the beginning of the new federal government fiscal year in October.

The value-added sales to the energy market, after softening in the first quarter 2013 from the first quarter 2012, grew 12% in the second quarter 2013 over the second quarter 2012. The growth in the second quarter 2013 was largely due to shipments of silver-containing products for architectural glass applications as market conditions for these materials have improved. The value-added for solar applications also improved slightly in the second quarter 2013, but the overall shipment levels and market conditions remained weak.

We discontinued sales of silver investment bars in the third quarter 2012, as this non-strategic product line generated extremely low margins that could not justify the associated level of working capital and overhead. This action accounted for a reduction in sales of $4.1 million in the second quarter 2013 and $8.5 million in the first half of 2013 from the comparable periods in 2012. The value-added impact was only $0.1 million in the second quarter 2013 and $0.2 million in the first half of 2013.

The plant consolidation program has had minimal impact on our sales and value-added sales in the first half of 2013. The manufacturing of microelectronic packages was in transition, moving from our small facility in Massachusetts to Singapore (with the relocation scheduled to be completed in the third quarter 2013), but sales of packages from the Massachusetts facility were 5% higher in the first half of 2013 than the first half of 2012.

Gross margin generated by Advanced Material Technologies was $26.1 million, or 13% of sales, in the second quarter 2013 versus $29.7 million, or 13% of sales, in the second quarter 2012. For the first half of 2013, gross margin was $51.0 million, or 13% of sales, compared to $55.8 million, or 12% of sales, in the first half or 2012. Gross margin was 36% of value-added sales in both the second quarter and first half of 2013. Gross margin was 40% of value-added sales in the second quarter 2012 and 39% of value-added sales in the first half of 2012.

The gross margin was lower in the second quarter 2013 and first half of 2013 partially as a result of the margin impact on the lower value-added sales in both periods. Process improvements and yield gains provided a benefit to the gross margin the first half of 2013; the majority of this benefit was achieved in the first quarter 2013 as these efficiencies were not as favorable in the second quarter 2013. The change in product mix was unfavorable in the second quarter 2013 and first half of 2013. Manufacturing overhead costs in the second quarter 2013 were unchanged from the second quarter 2012 and 4% lower in the first half of 2013 than the first half of 2012. A physical inventory loss at the Albuquerque facility of $2.3 million in the first quarter 2013 contributed to the margin decline in the first half of 2013.

Total SG&A, R&D and other-net expenses were $21.5 million (11% of sales) in the . . .

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