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MTRN > SEC Filings for MTRN > Form 10-Q on 1-Nov-2013All Recent SEC Filings

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Form 10-Q for MATERION CORP


1-Nov-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.

Sales in the third quarter 2013 were $275.4 million, a 5% decline from sales in the third quarter 2012. Shipments to several markets and applications improved in the third quarter 2013 over the third quarter 2012, including automotive electronics, medical and energy. However, shipments to the defense and science market softened due primarily to shipment delays and government spending cutbacks, while sales to the consumer electronics market declined in total, although some sectors showed improvement. Sales to the industrial components and commercial aerospace and telecommunications infrastructure markets were also lower in the third quarter 2013 than the third quarter 2012.

Operating profit was $6.0 million in the third quarter 2013 compared to $13.4 million in the third quarter 2012. The reduced profit was caused by the margin impact of the lower sales, facility consolidation costs and other factors. The effective tax rate was only 2.7% in the third quarter 2013, largely as a result of adjustments to the projections for the year and discrete items recorded during the period. Earnings per share were $0.24 in the third quarter 2013 and $0.39 in the third quarter 2012.

Cash flow from operations was $38.5 million in the first nine months of 2013. The cash flow was used to fund capital expenditures of $24.2 million, dividends to shareholders of $4.9 million and a reduction in debt of $5.9 million. Cash on hand also increased by $4.1 million.

During the third quarter 2013, we renewed our metal consignment agreements and extended the maturity dates out one to three years. These renewals followed the securing of a new revolving credit agreement in the second quarter 2013 that extended the maturity date and increased our borrowing capacity.

RESULTS OF OPERATIONS

                                                  Third Quarter Ended                  Nine Months Ended
                                               Sept. 27,          Sept. 28,        Sept. 27,        Sept. 28,
(Millions, except per share data)                 2013              2012             2013             2012
Sales                                      $     275.4          $     290.6     $    880.7        $     969.3
Operating profit                                   6.0                 13.4           28.9               35.7
Income before income taxes                         5.3                 12.6           26.5               33.4
Net income                                         5.1                  8.1           20.8               22.2
Diluted earnings per share                 $      0.24          $      0.39     $     1.00        $      1.07

Sales of $275.4 million in the third quarter 2013 were $15.2 million, or 5%, lower than sales of $290.6 million in the third quarter 2012, while sales of $880.7 million in the first nine months of 2013 were $88.6 million, or 9%, lower than sales of $969.3 million in the first nine months of 2012.

The comparisons of sales in the third quarter and first nine months of 2013 to the respective periods in 2012 were affected by lower precious metal and copper prices, 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 increased approximately 1% in the third quarter 2013 from the third quarter 2012, but were 11% lower in the first nine months of 2013 than the first nine months of 2012. International sales were down 17% in the third quarter 2013 from the third quarter 2012 and down 6% in the first nine months of 2013 from the first nine months of 2012. Growth in European sales during the first nine months of 2013 was offset by softer sales in Asia and other parts of the world.


The sales order entry rate exceeded sales by approximately 11% in the third quarter 2013, as the order entry was the highest quarterly total since the second quarter 2012.

The costs 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 proportionate 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 $148.7 million in the third quarter 2013 compared to $152.3 million in the third quarter 2012. Value-added sales were $459.3 million in the first nine months of 2013, a 1% decrease from the value-added sales of $464.2 million in the first nine months 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 28% of our total value-added sales in the third quarter 2013, were 5% lower in the third quarter 2013 than the third quarter 2012 and 4% lower in the first nine months of 2013 than the first nine months of 2012. The phase-out of an application for disk drive arms was a main cause for this decline in the third quarter and first nine months of 2013. While the total value-added sales to this diverse market were down, value-added shipments of advanced chemicals for LED applications and copper-based alloys for other applications have grown over the first nine months of 2013.

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, after growing 3% in the second quarter 2013 over the second quarter 2012, declined 10% in the third quarter 2013 from the third quarter 2012. Value-added sales to this market in the first nine months of 2013 were 4% lower than value-added sales in the first nine months of 2012. A portion of this decline is attributable to a change in distribution strategies as inventories in the supply chain are worked off. The industrial components and commercial aerospace market is our second largest market, accounting for 17% of our value-added sales in the third quarter 2013.

Value-added sales to the defense and science market, after strengthening in the second quarter 2013, declined 16% in the third quarter 2013 and 9% in the first nine months of 2013 from the respective periods in 2012. Sales of optics for defense applications have been significantly impacted by government spending cutbacks and shipment delays. Sales of beryllium products for defense and science applications were also affected by delays in orders being released and other factors in the third quarter 2013.

Value-added sales to the medical market grew 24% in the third quarter 2013 over the third quarter 2012 and 10% in the first nine months of 2013 over the first nine months of 2012. This growth was primarily due to increased shipments for blood glucose test strip applications due to increased market share and other factors.

Automotive electronics market value-added sales improved 23% in the third quarter 2013 and 19% in the first nine months of 2013 over the comparable periods in 2012. The growth was due to improved market conditions and new application development. Value-added sales to this market were 11% lower in the third quarter 2013 than the second quarter 2013 partially due to seasonality. Value-added sales to the automotive electronics market were approximately 11% of our total value-added sales in the third quarter 2013.

Energy market value-added sales grew 13% in the third quarter 2013 over the third quarter 2012, but declined 2% in the first nine months of 2013 from the first nine months of 2012. The growth in the third quarter was due to improved shipments to the oil and gas sector and to a lesser extent architectural glass applications.

Gross margin was $45.1 million, or 16% of sales, in the third quarter 2013 compared to $52.4 million, or 18% of sales, in the third quarter 2012. Gross margin in the first nine months of 2013 was $146.3 million, or 17% of sales, versus $154.8 million, or 16% of sales, in the first nine months of 2012. Gross margin as a percent of value-added sales was 30% in the third quarter 2013 compared to 34% in the third quarter 2012. Gross margin was 32% of value-added sales in the first nine months of 2013 and 33% of value-added sales in the first nine months of 2012.


The majority of the $7.3 million decline in gross margin in the third quarter 2013 from the third quarter 2012 and the $8.5 million decline in gross margin in the first nine months of 2013 from the first nine months of 2012 was due to the lower sales volume. The impact of foreign currency translation rates had an unfavorable impact on gross margin in the third quarter and first nine months of 2013, while higher selling prices in portions of our business have provided a margin benefit throughout the first nine months of 2013. The gross margin in the first nine months of 2013 benefitted from manufacturing improvements, primarily in the first half of the year. The gross margin for the first nine months of 2013 was also unfavorably impacted by a physical inventory loss of $2.3 million at our Albuquerque, New Mexico facility in the first quarter 2013.

Margin in the third quarter 2013 and first nine months 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 third quarter 2013 and output levels have increased for five consecutive quarters.

Facility consolidation and closure costs under the program initiated in 2012 totaled $0.9 million in the third quarter 2013 and $1.5 million in the first nine months of 2013. These costs included asset write-offs, severance and other related items. Closure costs recorded in cost of sales totaled $0.8 million in the third quarter and $0.9 million in the first nine months of 2013. Closure costs recorded within selling, general and administrative expense were $0.2 million in the third quarter 2013 and $0.7 million in the first nine months of 2013. A net gain of $0.1 million was recorded in other-net during the first nine months of 2013. One small facility was closed in the fourth quarter 2012. A second facility closed during the third quarter 2013 and its business was relocated to an existing facility. Consolidation activities at two other operations were underway and are scheduled to be completed during 2014. Facility consolidation and closure costs totaled $0.6 million in the first nine months of 2012, all of which was recorded in selling, general and administrative expenses during the second quarter of that year.

Selling, general and administrative (SG&A) expenses were $31.8 million in the third quarter 2013 and $32.8 million in the third quarter 2012. SG&A expenses totaled $97.9 million, or 11% of sales, in the first nine months of 2013 and $98.9 million, or 10% of sales, in the first nine months of 2012. SG&A expenses were 21% of value-added sales in both the first nine months of 2013 and 2012.

The expense for the domestic defined benefit pension plan was $0.9 million higher in the third quarter 2013 than the third quarter 2012 and $2.7 million higher in the first nine months 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 expense and cost of sales.

The incentive compensation expense under cash-based plans was $0.5 million lower in the third quarter 2013 than the third quarter 2012 and $0.9 million higher in the first nine months of 2013 than the first nine months of 2012. These changes were 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 $1.4 million in the third quarter 2013 and $1.5 million in the third quarter 2012. Stock-based compensation expense in the first nine months of 2013 was $4.1 million compared to $4.3 million in the first nine months of 2012. Movements in stock-based compensation expense between periods may be caused by differences in the number of grants, the fair value of the grants and other items.

Movements in the exchange rates between periods resulted in a reduction in the translated value of various foreign currency denominated expenses of $0.2 million in the third quarter 2013 and $0.7 million in the first nine months of 2013 versus the comparable periods of 2012.

SG&A expenses were $0.4 million lower at our Shanghai facility in the third quarter 2013 than the third quarter 2012 partially as a result of adjustment to its cost structure and other manpower differences.

The plant consolidation program has resulted in SG&A expense savings in the third quarter 2013 and first nine months of 2013. Various administrative and management expenses at the corporate office were also lower in the third quarter 2013 than in the third quarter 2012.

Research and development (R&D) expenses were $3.2 million in the third quarter 2013 compared to $3.0 million in the third quarter 2012. R&D expenses were $9.9 million in the first nine months of 2013, a 6% increase over the $9.3 million expense in the first nine months 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 third quarter and first nine months of 2013 and 2012.


Other-net expense totaled $4.2 million in the third quarter 2013 versus $3.1 million in the third quarter 2012. For the first nine months of 2013, other-net expense was $9.6 million compared to $10.8 million in the first nine months of 2012. See Note G to the Consolidated Financial Statements for details of the major components within other-net expense.

The primary cause for the higher expense in the third quarter 2013 was the one-time bank fees of $0.9 million associated with the renewal of the metal consignment agreements.

The ongoing metal consignment fee of $1.6 million in the third quarter 2013 was $0.5 million lower than the fee of $2.1 million in the third quarter 2012, while the fee for the first nine months of 2013 of $5.2 million was $1.8 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 $0.5 million lower in the third quarter 2013 and $0.2 million higher in the first nine months 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 was $6.0 million in the third quarter 2013 compared to $13.4 million in the third quarter 2012. The decline in operating profit was primarily due to the lower gross margin that resulted from the lower value-added sales and other factors.

Operating profit of $28.9 million (3% of sales) in the first nine months of 2013 was 19% lower than the operating profit of $35.7 million (4% of sales) in the first nine months of 2012. Operating profit was 6% of value-added sales in the first nine months of 2013 compared to 8% of value-added sales in the first nine months of 2012.

Interest expense - net was $0.7 million in the third quarter 2013, down slightly from a net expense of $0.8 million in the third quarter 2012. Average debt levels were lower in the third quarter 2013 than in the third quarter 2012. For the first nine months of 2013, interest expense-net was $2.4 million compared to $2.3 million in the first nine months of 2012.

Income before income taxes and income tax expense for the third quarter and first nine months of 2013 and 2012 were as follows:

                                 Third Quarter Ended           Nine Months Ended
                              Sept. 27,      Sept. 28,      Sept. 27,      Sept. 28,
(Dollars in millions)           2013            2012           2013          2012
Income before income taxes   $    5.3       $     12.6     $    26.5      $    33.4
Income tax expense                0.1              4.5           5.7           11.2
Effective tax rate                2.7 %           35.7 %        21.6 %         33.7 %

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

The tax expense in the third quarter 2013 also included a net discrete benefit of $0.7 million that resulted from the finalization of the 2012 federal tax return at a lower liability than what was previously recorded in the financial statements, the reversal of tax reserves due to the lapse of the associated statute of limitations, the benefits from amending a prior year tax return and other matters.

In addition to the discrete events recorded in the third quarter 2013, in the first quarter 2013, we recorded a favorable discrete event of $0.6 million that primarily represented the estimated 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 third quarter and first nine months of 2013 also included a proportionate share of the estimated research and experimentation credit for 2013.

The effective tax rate prior to the impact of the discrete events was lower in the third quarter 2013 than the effective tax rate in the first half of 2013 due in part to changes in projections for the full year.


A net favorable discrete event of $0.5 million was recorded in the third quarter 2012 as a result of the lapse of the statute of limitations and book-to-provision differences on the finalization of the 2011 federal tax return.

Net income was $5.1 million (or $0.24 per share, diluted) in the third quarter 2013 compared to $8.1 million (or $0.39 per share, diluted) in the third quarter 2012. Net income was $20.8 million (or $1.00 per share, diluted) in the first nine months of 2013 and $22.2 million (or $1.07 per share, diluted) in the first nine months 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 third quarter 2013 was $0.4 million lower than the third quarter 2012 and $1.9 million lower in the first nine months of 2013 than the first nine months of 2012. Corporate-incurred expenses were lower in the third quarter 2013 than the third quarter 2012 but higher in the first nine months of 2013 than the first nine months of 2012, partially as a result of the legal and other administrative costs associated with the investigation into the potential inventory theft in 2012. However, charges out to the business units were also lower in the third quarter 2013 than the third quarter 2012 and higher in the first nine months of 2013 than the first nine months of 2012.

Advanced Material Technologies
                          Third Quarter Ended                Nine Months Ended
                       Sept. 27,         Sept. 28,        Sept. 27,       Sept. 28,
(Millions)                2013              2012            2013             2012
Sales              $     176.3          $     190.5    $    566.2        $     654.2
Operating profit           4.8                  9.2          12.7               22.0

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 of $176.3 million in the third quarter 2013 were 7% lower than sales of $190.5 million in the third quarter 2012. Sales in the first nine months of 2013 were $566.2 million, a 13% decline from sales of $654.2 million in the first nine months of 2012. Lower pass-through metal prices accounted for the majority of the decline in sales in the first nine months of 2013 from the first nine months of 2012. Sales in the third quarter and first nine months of the year were also affected by changes in the level of customer-supplied metal.

Value-added sales of $68.4 million in the third quarter 2013 were 7% lower than value-added sales of $73.3 million in the third quarter 2012. Value-added sales in the first nine months of 2013 were $209.1 million, a 3% decline from the value-added sales of $216.3 million in the first nine months of 2012.

Consumer electronics is Advanced Material Technologies' largest market, accounting for approximately 38% of the segment's value-added sales in the third quarter 2013. Value-added sales to this market in the third quarter 2013 were 7% lower in the third quarter 2013 than the third quarter 2012 and 2% lower in the first nine months of 2013 than the first nine months of 2012. Value-added sales of phosphors for LED applications continued to grow in the third quarter and first nine months 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 of optics for gaming applications grew in the third quarter 2013 over the third quarter 2012. Value-added sales for data storage applications also improved in the third quarter, but were still lower in the first nine months of 2013 than in the first nine months of 2012. Value-added sales of precious metals for various microelectronic applications were softer in the third quarter 2013 than the third quarter 2012.


Value-added sales to the medical market grew approximately 27% in the third quarter 2013 over the third quarter 2012 and 13% in the first nine months of 2013 over the first nine months of 2012. A portion of the growth in the third quarter was due to increased shipments to a key customer as result of a quality problem encountered by one of our competitors serving that customer as we were able to increase production to meet this extra demand. Shipments to our customer are expected to decline from the high levels in the third quarter when the customer and competitor resolve their issue. Value-added sales to the medical market have also grown during 2013 due to market share gains and product development efforts. The medical market is this segment's second largest market, accounting for approximately 22% of value-added sales in the third quarter 2013.

Value-added sales from refining and shield kit cleaning operations declined approximately 20% in the third quarter 2013 from the third quarter 2012 after growing in the first two quarters of 2013 from the comparable periods in 2012. For the first nine months of 2013, refining and shield kit cleaning value-added sales were down slightly from the first nine months of 2012. Value-added sales from refining and shield kit cleaning are affected by a number of factors, including the quantity of products initially sold to customers and the amount of recycle material they generate, the types of materials processed and the retention levels.

Defense and science value-added sales declined approximately 27% in the third quarter 2013 and 17% in the first nine months of 2013 from the respective periods in 2012. The decline was largely due to lower shipments of optics as a result of government spending cut-backs. While a number of defense applications for optics are funded and remain active, there is a high level of uncertainty in the market relative to future spending levels.

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 $9.3 million in the first nine months of 2013, the majority of which was in the first half of the year. The value-added impact was only $0.3 million in the first nine months of 2013.

Value-added sales to the telecommunications infrastructure market, largely microelectronic packages, were relatively unchanged in the third quarter from the third quarter 2012 and slightly higher in the first nine months of 2013 than the first nine months of 2012. The manufacture of these products was transferred from Massachusetts to Singapore during the third quarter 2013 in order to be closer to our customer base.

Advanced Material Technologies' gross margin was $25.5 million, or 14% of sales, in the third quarter 2013 compared to $30.1 million, or 16% of sales, in the third quarter 2012. For the first nine months of 2013, gross margin was $76.5 million, or 14% of sales, compared to $85.9 million, or 13% of sales, in the first nine months of 2012.

Gross margin was 37% of value-added sales in both the third quarter and first nine months of 2013. Gross margin was 41% of value-added sales in the third quarter 2012 and 40% of value-added sales in the first nine months of 2012.

The gross margin was lower in the third quarter 2013 and first nine months of 2013 largely as a result of the margin impact on the lower value-added sales in . . .

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