MATERION Corp 10-Q

Item 1. Financial Statements Materion Corporation and Subsidiaries Consolidated Statements of Income (Unaudited) Second Quarter Ended Six Months Ended (Thousands, except per share amounts) July 1, 2022 July 2, 2021 July 1, 2022 July 2, 2021 Net sales $ 445,295 $ 370,999 $ 894,340 $ 725,385 Cost of sales 357,868 301,418 731,622 589,008 Gross margin 87,427 69,581 162,718 136,377 Selling, general, and administrative expense 42,047 38,060 83,708 74,836 Research and development expense 7,592 6,604 14,666 12,810 Restructuring expense (income) — — 1,076 ( 378 ) Other—net 5,928 4,194 11,801 8,668 Operating profit 31,860 20,723 51,467 40,441 Other non-operating income—net ( 1,168 ) ( 1,277 ) ( 2,337 ) ( 2,553 ) Interest expense—net 4,701 858 8,437 1,619 Income before income taxes 28,327 21,142 45,367 41,375 Income tax expense 5,072 3,274 8,093 6,740 Net income $ 23,255 $ 17,868 $ 37,274 $ 34,635 Basic earnings per share: Net income per share of common stock $ 1.13 $ 0.87 $ 1.82 $ 1.70 Diluted earnings per share: Net income per share of common stock $ 1.12 $ 0.87 $ 1.80 $ 1.68 Weighted-average number of shares of common stock outstanding: Basic 20,517 20,429 20,491 20,402 Diluted 20,723 20,651 20,743 20,647 See notes to these consolidated financial statements. 2 Materion Corporation and Subsidiaries Consolidated Statements of Comprehensive Income (Unaudited) Second Quarter Ended Six Months Ended July 1, July 2, July 1, July 2, (Thousands) 2022 2021 2022 2021 Net income $ 23,255 $ 17,868 $ 37,274 $ 34,635 Other comprehensive income (loss): Foreign currency translation adjustment ( 6,343 ) 3,193 ( 8,390 ) ( 5,664 ) Derivative and hedging activity, net of tax 1,894 ( 273 ) 4,164 972 Pension and post-employment benefit adjustment, net of tax 16 83 ( 224 ) 247 Other comprehensive income (loss) ( 4,433 ) 3,003 ( 4,450 ) ( 4,445 ) Comprehensive income $ 18,822 $ 20,871 $ 32,824 $ 30,190 See notes to these consolidated financial statements. 3 Materion Corporation and Subsidiaries Consolidated Balance Sheets (Unaudited) July 1, Dec. 31, (Thousands) 2022 2021 Assets Current assets Cash and cash equivalents $ 32,175 $ 14,462 Accounts receivable, net 222,811 223,553 Inventories, net 422,376 361,115 Prepaid and other current assets 29,606 28,122 Total current assets 706,968 627,252 Deferred income taxes 5,018 5,431 Property, plant, and equipment 1,164,273 1,132,223 Less allowances for depreciation, depletion, and amortization ( 739,776 ) ( 723,248 ) Property, plant, and equipment, net 424,497 408,975 Operating lease, right-of-use assets 68,045 63,096 Intangible assets, net 148,364 156,736 Other assets 30,228 27,369 Goodwill 319,994 318,620 Total Assets $ 1,703,114 $ 1,607,479 Liabilities and Shareholders’ Equity Current liabilities Short-term debt $ 15,333 $ 15,359 Accounts payable 113,708 86,243 Salaries and wages 22,239 37,544 Other liabilities and accrued items 49,148 53,388 Income taxes 1,700 4,205 Unearned revenue 8,097 7,770 Total current liabilities 210,225 204,509 Other long-term liabilities 15,846 14,954 Operating lease liabilities 62,474 57,099 Finance lease liabilities 14,360 16,327 Retirement and post-employment benefits 30,992 33,394 Unearned income 108,126 97,962 Long-term income taxes 1,206 1,190 Deferred income taxes 28,766 27,216 Long-term debt 481,965 434,388 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 both July 1 st and December 31 st ) 281,296 271,978 Retained earnings 725,918 693,756 Common stock in treasury ( 218,356 ) ( 209,920 ) Accumulated other comprehensive loss ( 44,619 ) ( 40,169 ) Other equity 4,915 4,795 Total shareholders' equity 749,154 720,440 Total Liabilities and Shareholders’ Equity $ 1,703,114 $ 1,607,479 See the notes to these consolidated financial statements. 4 Materion Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Six Months Ended July 1, July 2, (Thousands) 2022 2021 Cash flows from operating activities: Net income $ 37,274 $ 34,635 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion, and amortization 26,070 19,063 Amortization of deferred financing costs in interest expense 780 364 Stock-based compensation expense (non-cash) 3,694 3,512 Deferred income tax expense (benefit) 1,966 367 Changes in assets and liabilities: Accounts receivable ( 2,566 ) ( 13,941 ) Inventory ( 67,304 ) ( 40,651 ) Prepaid and other current assets ( 2,462 ) ( 1,718 ) Accounts payable and accrued expenses 8,897 28,403 Unearned revenue ( 141 ) 3,246 Interest and taxes payable ( 1,765 ) 2,868 Unearned income due to customer prepayments 13,059 8,043 Other-net 3,913 ( 126 ) Net cash provided by operating activities 21,415 44,065 Cash flows from investing activities: Payments for purchase of property, plant, and equipment ( 37,730 ) ( 57,712 ) Proceeds from sale of property, plant, and equipment 105 603 Payments for acquisition, net of cash acquired ( 2,971 ) — Net cash used in investing activities ( 40,596 ) ( 57,109 ) Cash flows from financing activities: Proceeds from borrowings under revolving credit agreement, net 52,794 22,500 Proceeds from issuance of long-term debt 2,059 — Repayment of long-term debt ( 7,177 ) ( 1,654 ) Principal payments under finance lease obligations ( 1,334 ) ( 1,512 ) Cash dividends paid ( 5,112 ) ( 4,791 ) Payments of withholding taxes for stock-based compensation awards ( 2,812 ) ( 3,021 ) Net cash provided by financing activities 38,418 11,522 Effects of exchange rate changes ( 1,524 ) ( 11 ) Net change in cash and cash equivalents 17,713 ( 1,533 ) Cash and cash equivalents at beginning of period 14,462 25,878 Cash and cash equivalents at end of period $ 32,175 $ 24,345 See notes to these consolidated financial statements. 5 Materion Corporation and Subsidiaries Consolidated Statements of Shareholders' Equity (Unaudited) Common Shares Shareholders' Equity (Thousands, except per share amounts) Common Shares Common Shares Held in Treasury Common Stock Retained Earnings Common Stock in Treasury Accumulated Other Comprehensive Loss Other Equity Total Balance at April 1, 2022 20,511 ( 6,637 ) $ 278,589 $ 705,255 $ ( 217,549 ) $ ( 40,186 ) $ 4,855 $ 730,964 Net income — — — 23,255 — — — 23,255 Other comprehensive income — — — — — ( 4,433 ) — ( 4,433 ) Cash dividends declared ($ 0.125 per share) — — — ( 2,592 ) — — — ( 2,592 ) Stock-based compensation activity 13 13 2,671 — ( 676 ) — — 1,995 Payments of withholding taxes for stock-based compensation awards ( 1 ) ( 1 ) — — ( 95 ) — — ( 95 ) Directors’ deferred compensation — — 36 — ( 36 ) — 60 60 Balance at July 1, 2022 20,523 ( 6,625 ) $ 281,296 $ 725,918 $ ( 218,356 ) $ ( 44,619 ) $ 4,915 $ 749,154 Balance at April 2, 2021 20,414 ( 6,734 ) $ 264,940 $ 645,468 $ ( 206,845 ) $ ( 46,087 ) $ 3,860 $ 661,336 Net income — — — 17,868 — — — 17,868 Other comprehensive income — — — — — 3,003 — 3,003 Cash dividends declared ($ 0.120 per share) — — — ( 2,453 ) — — — ( 2,453 ) Stock-based compensation activity 25 25 3,215 ( 32 ) ( 1,144 ) — — 2,039 Payments of withholding taxes for stock-based compensation awards ( 2 ) ( 2 ) — — ( 183 ) — — ( 183 ) Directors’ deferred compensation 1 1 50 — ( 682 ) — 723 91 Balance at July 2, 2021 20,438 ( 6,710 ) $ 268,205 $ 660,851 $ ( 208,854 ) $ ( 43,084 ) $ 4,583 $ 681,701 6 Common Shares Shareholders' Equity (Thousands, except per share amounts) Common Shares Common Shares Held in Treasury Common Stock Retained Earnings Common Stock in Treasury Accumulated Other Comprehensive Loss Other Equity Total Balance at December 31, 2021 20,448 ( 6,700 ) $ 271,978 $ 693,756 $ ( 209,920 ) $ ( 40,169 ) $ 4,795 $ 720,440 Net income — — — 37,274 — — — 37,274 Other comprehensive loss — — — — — ( 4,450 ) — ( 4,450 ) Cash dividends declared ($ 0.245 per share) — — — ( 5,112 ) — — — ( 5,112 ) Stock-based compensation activity 108 108 9,243 — ( 5,549 ) — — 3,694 Payments of withholding taxes for stock-based compensation awards ( 34 ) ( 34 ) — — ( 2,812 ) — — ( 2,812 ) Directors’ deferred compensation 1 1 75 — ( 75 ) — 120 120 Balance at July 1, 2022 20,523 ( 6,625 ) $ 281,296 $ 725,918 $ ( 218,356 ) $ ( 44,619 ) $ 4,915 $ 749,154 Balance at December 31, 2020 20,328 ( 6,820 ) $ 258,642 $ 631,058 $ ( 199,187 ) $ ( 38,639 ) $ 3,756 $ 655,630 Net income — — — 34,635 — — — 34,635 Other comprehensive loss — — — — — ( 4,445 ) — ( 4,445 ) Cash dividends declared ($ 0.235 per share) — — — ( 4,791 ) — — — ( 4,791 ) Stock-based compensation activity 152 152 9,474 ( 51 ) ( 5,911 ) — — 3,512 Payments of withholding taxes for stock-based compensation awards ( 45 ) ( 45 ) — — ( 3,021 ) — — ( 3,021 ) Directors’ deferred compensation 3 3 $ 89 $ — $ ( 735 ) $ — $ 827 $ 181 Balance at July 2, 2021 20,438 ( 6,710 ) $ 268,205 $ 660,851 $ ( 208,854 ) $ ( 43,084 ) $ 4,583 $ 681,701 See notes to these consolidated financial statements. 7 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Note A — Accounting Policies Basis of Presentation: 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. These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's 2021 Annual Report on Form 10-K. The interim period results are not necessarily indicative of the results to be expected for the full year. Business Combinations: The Company records assets acquired and liabilities assumed at the date of acquisition at their respective fair values. Any intangible assets acquired in a business combination are recognized and reported apart from goodwill. Goodwill represents the excess purchase price over the fair value of the tangible net assets and intangible assets acquired in a business combination. Acquisition-related expenses are recognized separately from the business combination and are expensed as incurred. The amounts reflected in Note B of the consolidated financial statements are the results of a preliminary purchase price allocation and will be updated upon completion of the final valuation. The Company is required to complete the purchase price allocation within 12 months of the acquisition date. If such completion of the allocation results in a change in the preliminary values, the measurement period adjustment will be recognized in the period in which the adjustment amount is determined. New Pronouncements Adopted: In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting . This guidance is intended to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burden related to the expected market transition from the London Interbank Offered Rate (LIBOR) and other interbank offered rates to alternative reference rates. This guidance is available immediately and may be implemented in any period prior to the guidance expiration on December 31, 2022. The Company has applied this guidance in accounting for the interest rate swap discussed in Note N. Any additional reference rate reform impacts will be accounted for in accordance with ASU 2020-04. New Accounting Guidance Issued and Not Yet Adopted: In November 2021, the FASB issued ASU 2021-10, Government Assistance (Topic 832) . ASU 2021-10 is intended to increase transparency related to governmental assistance by requiring entities to disclose the types of government assistance, the entity's accounting for government assistance, and the effect of government assistance on an entity's financial statements. This new guidance is effective for all entities for annual reporting periods beginning after December 15, 2021. The Company is in the process of evaluating the impact of the guidance on its annual disclosures. 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. 8 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Note B — Acquisition On November 1, 2021, the Company acquired the industry-leading electronic materials business of H.C. Starck Group GmbH (HCS-Electronic Materials) for a cash purchase price of approximately $ 398.9 million, on a cash-free, debt-free basis, subject to a customary purchase price adjustment mechanism. During the six months ended July 1, 2022, acquisition-related inventory step-up expense was $ 7.5 million and classified in Cost of Sales and transaction and integration costs were $ 2.6 million and classified in Selling, General and Administrative expenses in the accompanying consolidated statements of income. The Company financed the purchase price for the HCS-Electronic Materials acquisition with a new $ 300 million five-year term loan pursuant to a delayed draw term loan facility executed in October 2021 and $ 103 million of borrowings under its amended revolving credit facility. The maturity date on the revolving credit facility was also extended to October 2026. The interest rate for the term loan is based on LIBOR plus a tiered credit spread that is indexed to the Company's quarterly leverage ratio. This acquired business operates within the Performance Materials and Electronic Materials segments, and the results of operations are included as of the date of acquisition. The combination of Materion and HCS-Electronic Materials enhances the Company's position as the leading supplier to the high growth semiconductor industry. The fair value estimates of the assets acquired are subject to adjustment during the measurement period (up to one year from the HCS-Electronic Materials Acquisition Date). The primary areas of accounting for the HCS Acquisition that are not yet finalized relate to the fair value of contingencies, income tax accruals, and the impact on residual goodwill. The fair values of these net assets acquired are based on management’s estimates and assumptions, as well as other information compiled by management, including valuations that utilize customary valuation procedures and techniques. While we believe that such preliminary estimates provide a reasonable basis for estimating the fair value of assets acquired and liabilities assumed, we will evaluate any additional information prior to finalization of the fair value. During the measurement period, we will adjust preliminary valuations assigned to assets and liabilities if new information is obtained about facts and circumstances that existed as of the HCS Acquisition Date that, if known, would have resulted in revised values for these items as of that date. The impact of all changes, if any, that do not qualify as measurement period adjustments will be included in current period earnings. During the period subsequent to the HCS-Electronic Materials acquisition, we made certain measurement period adjustments to the acquired assets and liabilities assumed due to clarification of information utilized to determine fair value during the measurement period. Additionally, we paid a working capital true-up of approximately $ 3.0 million during the second quarter of 2022 which increased the total purchase price. The preliminary purchase price allocation for the acquisition including these measurement period adjustments is as follows: 9 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) (Thousands) Initial Allocation of Consideration Measurement Period Adjustments Updated Allocation Assets: Cash and cash equivalents $ 3,685 $ — $ 3,685 Accounts receivable 28,352 — 28,352 Inventories 70,681 — 70,681 Prepaid and other current assets 660 ( 355 ) 305 Property, plant, and equipment 44,681 355 45,036 Operating lease, right-of-use assets 6,120 — 6,120 Intangible assets 107,800 — 107,800 Other long-term assets 4,528 — 4,528 Goodwill 178,181 3,688 181,869 Total assets acquired $ 444,688 $ 3,688 $ 448,376 Liabilities: Accounts payable $ 12,139 $ — $ 12,139 Salaries and wages 2,516 435 2,951 Other liabilities and accrued items 28 — 28 Income taxes 2,183 79 2,262 Other long-term liabilities 5,543 215 5,758 Operating lease liabilities 6,042 — 6,042 Deferred income taxes 20,300 — 20,300 Total liabilities assumed $ 48,751 $ 729 $ 49,480 Net assets acquired $ 395,937 $ 2,959 $ 398,896 Assets acquired and liabilities assumed are recognized at their respective fair values as of the acquisition date. The Company engaged specialists to assist in the valuation of inventories, property, plant, and equipment, and intangible assets. In determining the fair value of the amounts above, inventory is fair valued based on the comparative sales method for work in process and finished goods at the selling price less cost to dispose and remaining manufacturing effort. The remaining working capital accounts' carrying values approximate fair value. For property, plant and equipment and intangible asset values, the Company utilized various forms of the income, cost and market approaches depending on the asset being valued. The Company used a relief from royalty method under the income approach to value its trade names and the developed technology and the multi-period excess earnings method under the income approach to value customer relationships. The significant assumptions used to estimate the fair value of these intangible assets included the discount rate and certain assumptions that form the basis of forecasted future cash flows (including revenue growth rates, royalty rates for trade names and developed technology, and attrition rates for customer relationships). Inputs were generally determined by taking into account independent appraisals and historical data, supplemented by current and anticipated market conditions and are considered Level 3 assets as the assumptions are unobservable inputs developed by the Company. As part of the acquisition, the Company recorded approximately $ 181.9 million of goodwill allocated between its Electronic Materials and Performance Materials segments based on the relative fair values. Goodwill was calculated as the excess of the purchase price over the estimated fair values of the tangible net assets and intangible assets acquired and primarily attributable to the synergies expected to arise after the acquisition dates. The goodwill is not expected to be deductible for U.S. tax purposes. The following table reports the intangible assets by asset category as of the closing date: 10 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) (Thousands) Value at Acquisition Useful Life Customer relationships $ 50,200 13 years Technology 35,300 13 years Trade name 22,300 15 years Total $ 107,800 The amounts of revenue and income (loss) before taxes of HCS-Electronic Materials in the second quarter of 2022 consolidated statements are $ 43.6 million and $ 7.6 million, respectively. Full year revenue and income before taxes total $ 86.9 million and $ 6.0 million, respectively. Income before taxes includes the purchase accounting inventory step-up expense recorded in the first quarter of 2022. Had the HCS-Electronic Materials acquisition occurred as of the beginning of fiscal 2020, the Company's sales and income (loss) before taxes would have been as follows: (Unaudited) Three months ended Six months ended July 2, 2021 July 2, 2021 Net Sales $ 409,202 $ 794,586 Profit income (loss) before taxes $ 22,138 $ 41,135 The unaudited pro forma financial information has been calculated after applying our accounting policies and adjusting the historical results with pro forma adjustments that assume the acquisition occurred on January 1, 2020. These unaudited pro forma results do not represent financial results realized, nor are they intended to be a projection of future results. The transaction accounting adjustments and other adjustments are based on available information and assumptions that the Company’s management believes are reasonable. Such adjustments are estimates and actual experience may differ from expectations. The pro forma income (loss) before taxes for the second quarter ended and six months ended July 2, 2021 includes approximately $ 4.3 million and $ 7.2 million, respectively, of additional interest expense related to committed financing to fund the acquisition and acquisition-related intangible asset amortization expense of $ 2.0 million and $ 4.0 million, respectively, as if the acquisition occurred on January 1, 2020. Note C — Segment Reporting The Company changed two segment names during the first quarter of 2022: Performance Alloys and Composites became Performance Materials, and Advanced Materials became Electronic Materials. The Company believes these names better represent the markets served and the advanced next-generation product solutions provided to our customers. Other than the name changes, there were no changes in the composition or structure of the Company's reportable segments in the first half of 2022. The Company has the following reportable segments: Performance Materials, Electronic Materials, Precision Optics, 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 Materials provides advanced engineered solutions comprised of beryllium and non-beryllium containing alloy systems and custom engineered parts in strip, bulk, rod, plate, bar, tube, and other customized shapes. Electronic 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 Optics produces thin film coatings, optical filter materials, sputter-coated, and precision-converted thin film materials. 11 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) The Other reportable segment includes unallocated corporate costs and assets. Beginning with the first quarter of 2022, the Company began using earnings before interest, taxes, depreciation, depletion and amortization (EBITDA) as the main operating income metric used by management to measure the financial performance of the Company and each segment. The Company made this change because recent acquisitions have resulted in increased purchase accounting amortization expense, which in turn has affected the comparability of results across periods and when compared to other companies. Management believes EBITDA is useful to investors as it better represents the Company's performance excluding the effect of the recent acquisition of significant intangible assets that are now being amortized. EBITDA is not a measurement of financial performance under U.S. GAAP. Although the Company uses EBITDA to assess the performance of its business and for various other purposes, the use of this non-GAAP financial measure as an analytical tool has limitations, and it should not be considered in isolation or as a substitute for analysis of the Company’s results of operations as reported in accordance with U.S. GAAP. The below table presents financial information for each segment and a reconciliation of EBITDA to Net Income (the most directly comparable GAAP financial measure) for the second quarter of 2022 and 2021: (Thousands) Second Quarter 2022 Second Quarter 2021 First Six Months Ended 2022 First Six Months Ended 2021 Net sales: Performance Materials (1) $ 154,889 $ 125,294 $ 304,520 $ 239,437 Electronic Materials (1) 260,971 213,114 531,807 417,758 Precision Optics 29,435 32,591 58,013 68,190 Other — — — — Net sales 445,295 370,999 894,340 725,385 Segment EBITDA: Performance Materials $ 27,229 $ 22,318 $ 52,021 $ 39,110 Electronic Materials 22,337 10,412 34,484 21,342 Precision Optics 3,544 5,547 5,735 13,018 Other ( 7,191 ) ( 5,813 ) ( 12,366 ) ( 11,413 ) Total Segment EBITDA 45,919 32,464 79,874 62,057 Income tax expense 5,072 3,274 8,093 6,740 Interest expense - net 4,701 858 8,437 1,619 Depreciation, depletion and amortization 12,891 $ 10,464 $ 26,070 $ 19,063 Net income $ 23,255 $ 17,868 $ 37,274 $ 34,635 (1) Excludes inter-segment sales of $ 0.2 million for the second quarter of 2022 and $ 0.5 million for the first six months of 2022 for Performance Materials and $ 2.7 million for the second quarter of 2022 and $ 8.2 million for the first six months of 2022 for Electronic Materials. Also excludes inter-segment sales of $ 3.2 million for the second quarter of 2021 and $ 5.9 million for the first six months of 2021 for Electronic Materials. Inter-segment sales are eliminated in consolidation. 12 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) The following table disaggregates revenue for each segment by end market for the second quarter and first six months of 2022 and 2021: (Thousands) Performance Materials Electronic Materials Precision Optics Other Total Second Quarter 2022 End Market Semiconductor $ 2,446 $ 213,742 $ 1,530 $ — $ 217,718 Industrial 41,701 11,957 7,608 — 61,266 Aerospace and defense 27,615 1,284 3,666 — 32,565 Consumer electronics 16,212 280 5,814 — 22,306 Automotive 24,855 1,465 2,708 — 29,028 Energy 10,679 25,361 — — 36,040 Telecom and data center 16,223 21 — — 16,244 Other 15,158 6,861 8,109 — 30,128 Total $ 154,889 $ 260,971 $ 29,435 $ — $ 445,295 Second Quarter 2021 End Market Semiconductor $ 1,806 $ 166,968 $ 563 $ — $ 169,337 Industrial 30,264 10,687 7,634 — 48,585 Aerospace and defense 19,250 1,660 5,597 — 26,507 Consumer electronics 10,722 266 6,964 — 17,952 Automotive 25,766 1,757 2,107 — 29,630 Energy 4,880 24,216 — — 29,096 Telecom and data center 13,025 39 — — 13,064 Other 19,581 7,521 9,726 — 36,828 Total $ 125,294 $ 213,114 $ 32,591 $ — $ 370,999 13 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) (Thousands) Performance Materials Electronic Materials Precision Optics Other Total First Six Months 2022 End Market Semiconductor $ 4,246 $ 428,664 $ 2,857 $ — $ 435,767 Industrial 82,520 27,823 16,041 — 126,384 Aerospace and defense 51,299 3,898 8,812 — 64,009 Consumer electronics 29,215 605 11,126 — 40,946 Automotive 47,091 3,122 5,026 — 55,239 Energy 20,778 54,481 — — 75,259 Telecom and data center 32,303 65 — — 32,368 Other 37,068 13,149 14,151 — 64,368 Total $ 304,520 $ 531,807 $ 58,013 $ — $ 894,340 First Six Months 2021 End Market Semiconductor $ 2,803 $ 322,029 $ 1,034 $ — $ 325,866 Industrial 54,294 23,277 15,009 — 92,580 Aerospace and defense 41,092 3,058 12,173 — 56,323 Consumer electronics 20,766 431 16,424 — 37,621 Automotive 49,273 3,426 4,300 — 56,999 Energy 9,017 51,406 — — 60,423 Telecom and data center 24,368 109 — — 24,477 Other 37,824 14,022 19,250 — 71,096 Total $ 239,437 $ 417,758 $ 68,190 $ — $ 725,385 Note D — 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 a 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. Transaction Price Allocated to Future Performance Obligations: Accounting Standards Codification 606, Revenue from Contracts with Customers, requires that the Company disclose the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied at July 1, 2022. Remaining performance obligations include non-cancelable 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 July 1, 2022, the aggregate amount of the transaction price allocated to remaining performance obligations was approximately $ 76.3 million. 14 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Contract Balances : The timing of revenue recognition, billings, and cash collections resulted in the following contract assets and contract liabilities: (Thousands) July 1, 2022 December 31, 2021 $ change % change Accounts receivable, trade $ 213,221 $ 213,584 $ ( 363 ) — % Unbilled receivables 8,916 7,961 955 12 % Unearned revenue 8,097 7,770 327 4 % 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 related to our receivables were immaterial during the second quarter of 2022. Unbilled receivables represent expenditures on contracts, plus applicable profit margin, not yet billed. Unbilled receivables are generally 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. The Company recognized approximately $ 5.6 million of the December 31, 2021 unearned amounts as revenue during the first six months of 2022. 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 E — Other-net Other-net for the second quarter and first six months of 2022 and 2021 is summarized as follows: Second Quarter Ended Six Months Ended July 1, July 2, July 1, July 2, (Thousands) 2022 2021 2022 2021 Amortization of intangible assets $ 3,099 $ 1,005 $ 6,230 $ 2,178 Metal consignment fees 2,871 2,464 5,882 4,614 Foreign currency (gain) loss 28 ( 33 ) ( 305 ) 1,216 Net loss (gain) on disposal of fixed assets 29 24 18 ( 364 ) Other items ( 99 ) 734 ( 24 ) 1,024 Total $ 5,928 $ 4,194 $ 11,801 $ 8,668 Note F — Income Taxes The Company's effective tax rate for the second quarter of 2022 and 2021 was 17.9 % and 15.5 %, respectively, and 17.8 % and 16.3 % in the first six months of 2022 and 2021, respectively. The effective tax rate for each period in 2022 and 2021 was lower than the statutory tax rate primarily due to the impact of percentage depletion, research and development credits and the foreign derived intangible income deduction. The effective tax rate for the first six months of 2022 included a net discrete income tax benefit of $ 0.4 million, primarily related to excess tax benefits from stock-based compensation awards. The effective tax rate for the first six months of 2021 included a net discrete income tax benefit of $ 0.5 million, primarily related to excess tax benefits from stock-based compensation awards. 15 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Note G — Earnings Per Share (EPS) The following table sets forth the computation of basic and diluted EPS: Second Quarter Ended Six Months Ended July 1, July 2, July 1, July 2, (Thousands, except per share amounts) 2022 2021 2022 2021 Numerator for basic and diluted EPS: Net income $ 23,255 $ 17,868 $ 37,274 $ 34,635 Denominator: Denominator for basic EPS: Weighted-average shares outstanding 20,517 20,429 20,491 20,402 Effect of dilutive securities: Stock appreciation rights 81 79 86 75 Restricted stock units 82 93 116 108 Performance-based restricted stock units 43 50 50 62 Diluted potential common shares 206 222 252 245 Denominator for diluted EPS: Adjusted weighted-average shares outstanding 20,723 20,651 20,743 20,647 Basic EPS $ 1.13 $ 0.87 $ 1.82 $ 1.70 Diluted EPS $ 1.12 $ 0.87 $ 1.80 $ 1.68 Adjusted weighted-average shares outstanding - diluted exclude securities totaling 119,744 and 52,709 for the quarters ended July 1, 2022 and July 2, 2021, respectively, and 79,949 and 64,478 for the six months ended July 1, 2022 and July 2, 2021, respectively. These securities are primarily related to restricted stock units and stock appreciation rights with fair market values and exercise prices greater than the average market price of the Company's common shares and were excluded from the dilution calculation as the effect would have been anti-dilutive. Note H — Inventories Inventories on the Consolidated Balance Sheets are summarized as follows: July 1, December 31, (Thousands) 2022 2021 Raw materials and supplies $ 115,970 $ 93,518 Work in process 253,012 221,638 Finished goods 53,394 45,959 Inventories, net $ 422,376 $ 361,115 The Company maintains the majority of the precious metals and copper used in production on a consignment basis in order to reduce its exposure to metal market price movements and to reduce its working capital investment. The notional value of off-balance sheet precious metals and copper was $ 415.0 million and $ 480.2 million as of July 1, 2022 and December 31, 2021, respectively. 16 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Note I — Customer Prepayments In 2020, the Company entered into an investment agreement and a master supply agreement with a customer to procure equipment to manufacture product for the customer. The customer provided prepayments to the Company to fund the necessary infrastructure improvements and procure the equipment necessary to supply the customer with the desired product. The Company owns, operates and maintains the equipment that is being used to manufacture product for the customer. Revenue will be recognized as the Company fulfills purchase orders and ships the commercial product to the customer, as product delivery is considered the satisfaction of the performance obligation. Additionally, during the second quarter of 2022, the Company entered into an amendment to the investment agreement with the same customer to procure additional equipment to manufacture product for the customer. As of July 1, 2022, the Company has received approximately $ 13.1 million in prepayments under the terms of this agreement. As of July 1, 2022 and December 31, 2021, $ 84.6 million and $ 72.6 million, respectively, of prepayments are classified as Unearned income on the Consolidated Balance Sheets. The prepayments will remain in Unearned income until commercial purchase orders are received for product serviced out of the equipment, at which time a portion of the purchase order value related to prepayments will be reclassified to Unearned revenue. As of July 1, 2022 $ 1.0 million of the prepayments are classified as Unearned revenue. Note J — Pensions and Other Post-employment Benefits The following is a summary of the net periodic benefit cost for the second quarter and first six months ended July 1, 2022 and July 2, 2021, respectively, for the pension plans as shown below. The Pension Benefits column aggregates defined benefit pension plans in the U.S., Germany, Liechtenstein, England, and the U.S. supplemental retirement plans. The Other Benefits column includes the domestic retiree medical and life insurance plan. Pension Benefits Other Benefits Second Quarter Ended Second Quarter Ended July 1, July 2, July 1, July 2, (Thousands) 2022 2021 2022 2021 Components of net periodic benefit (credit) cost Service cost $ 292 $ 436 $ 20 $ 20 Interest cost 1,213 1,048 39 29 Expected return on plan assets ( 2,378 ) ( 2,474 ) — — Amortization of prior service (benefit) cost ( 18 ) ( 21 ) ( 374 ) ( 374 ) Amortization of net loss (gain) 420 577 ( 68 ) ( 69 ) Net periodic benefit (credit) cost $ ( 471 ) $ ( 434 ) $ ( 383 ) $ ( 394 ) Settlements — — — — Total net benefit (credit) cost $ ( 471 ) $ ( 434 ) $ ( 383 ) $ ( 394 ) 17 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Pension Benefits Other Benefits Six Months Ended Six Months Ended July 1, July 2, July 1, July 2, (Thousands) 2022 2021 2022 2021 Components of net periodic benefit (credit) cost Service cost $ 610 $ 874 $ 42 $ 40 Interest cost 2,436 2,096 78 58 Expected return on plan assets ( 4,778 ) ( 4,948 ) — — Amortization of prior service (benefit) cost ( 38 ) ( 42 ) ( 748 ) ( 748 ) Amortization of net loss (gain) 850 1,154 ( 136 ) ( 138 ) Net periodic benefit (credit) cost $ ( 920 ) $ ( 866 ) $ ( 764 ) $ ( 788 ) Settlements — — — — Total net benefit (credit) cost $ ( 920 ) $ ( 866 ) $ ( 764 ) $ ( 788 ) The Company did no t make any contributions to its domestic defined benefit plan in the second quarter or first six months of 2022 or 2021. 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 (income) expense. 18 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Note K — Accumulated Other Comprehensive Income (Loss) Changes in the components of accumulated other comprehensive income, including the amounts reclassified, for the second quarter and first six months of 2022 and 2021 are as follows: Gains and Losses on Cash Flow Hedges (Thousands) Foreign Currency Interest Rate Precious Metals Copper Total Pension and Post-Employment Benefits Foreign Currency Translation Total Balance at April 1, 2022 $ 2,451 $ 2,485 $ ( 246 ) $ — $ 4,690 $ ( 39,942 ) $ ( 4,934 ) $ ( 40,186 ) Other comprehensive income (loss) before reclassifications 1,117 756 467 — 2,340 — ( 6,343 ) ( 4,003 ) Amounts reclassified from accumulated other comprehensive income (loss) ( 110 ) 238 ( 8 ) — 120 ( 10 ) — 110 Net current period other comprehensive (loss) income before tax 1,007 994 459 — 2,460 ( 10 ) ( 6,343 ) ( 3,893 ) Deferred taxes 232 229 105 — 566 ( 26 ) — 540 Net current period other comprehensive (loss) income after tax 775 765 354 — 1,894 16 ( 6,343 ) ( 4,433 ) Balance at July 1, 2022 $ 3,226 $ 3,250 $ 108 $ — $ 6,584 $ ( 39,926 ) $ ( 11,277 ) $ ( 44,619 ) Balance at April 2, 2021 $ 1,462 $ — $ 320 $ 280 $ 2,062 $ ( 43,309 ) $ ( 4,840 ) $ ( 46,087 ) Other comprehensive (loss) income before reclassifications 183 — ( 239 ) 1,145 1,089 — 3,193 4,282 Amounts reclassified from accumulated other comprehensive income (loss) — — 65 ( 1,507 ) ( 1,442 ) 77 — ( 1,365 ) Net current period other comprehensive (loss) income before tax 183 — ( 174 ) ( 362 ) ( 353 ) 77 3,193 2,917 Deferred taxes 42 ( 40 ) ( 82 ) ( 80 ) ( 6 ) — ( 86 ) Net current period other comprehensive (loss) income after tax 141 — ( 134 ) ( 280 ) ( 273 ) 83 3,193 3,003 Balance at July 2, 2021 $ 1,603 $ — $ 186 $ — $ 1,789 $ ( 43,226 ) $ ( 1,647 ) $ ( 43,084 ) 19 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Gains and Losses on Cash Flow Hedges (Thousands) Foreign Currency Interest Rate Precious Metals Copper Total Pension and Post-Employment Benefits Foreign Currency Translation Total Balance at December 31, 2021 $ 2,348 $ — $ 72 $ — $ 2,420 $ ( 39,702 ) $ ( 2,887 ) $ ( 40,169 ) Other comprehensive income (loss) before reclassifications 1,270 3,868 ( 53 ) — 5,085 — ( 8,390 ) ( 3,305 ) Amounts reclassified from accumulated other comprehensive income (loss) ( 130 ) 353 99 — 322 ( 1,011 ) — ( 689 ) Net current period other comprehensive (loss) income before tax 1,140 4,221 46 — 5,407 ( 1,011 ) ( 8,390 ) ( 3,994 ) Deferred taxes 262 971 10 — 1,243 ( 787 ) — 456 Net current period other comprehensive (loss) income after tax 878 3,250 36 — 4,164 ( 224 ) ( 8,390 ) ( 4,450 ) Balance at July 1, 2022 $ 3,226 $ 3,250 $ 108 $ — $ 6,584 $ ( 39,926 ) $ ( 11,277 ) $ ( 44,619 ) Balance at December 31, 2020 $ 519 $ — $ ( 170 ) $ 468 $ 817 $ ( 43,473 ) $ 4,017 $ ( 38,639 ) Other comprehensive (loss) income before reclassifications 1,268 — 502 2,436 4,206 — ( 5,664 ) ( 1,458 ) Amounts reclassified from accumulated other comprehensive income (loss) 140 — ( 39 ) ( 3,041 ) ( 2,940 ) 234 — ( 2,706 ) Net current period other comprehensive (loss) income before tax 1,408 — 463 ( 605 ) 1,266 234 ( 5,664 ) ( 4,164 ) Deferred taxes 324 — 107 ( 137 ) 294 ( 13 ) — 281 Net current period other comprehensive (loss) income after tax 1,084 — 356 ( 468 ) 972 247 ( 5,664 ) ( 4,445 ) Balance at July 2, 2021 $ 1,603 $ — $ 186 $ — $ 1,789 $ ( 43,226 ) $ ( 1,647 ) $ ( 43,084 ) Reclassifications from accumulated other comprehensive income (loss) of gains and losses on foreign currency cash flow hedges are recorded in Net sales in the Consolidated Statements of Income. Reclassifications from accumulated other comprehensive income (loss) of gains and losses on precious metal and copper cash flow hedges are recorded in Cost of sales in the Consolidated Statements of Income. Reclassifications from accumulated other comprehensive income (loss) of gains and losses on the interest rate cash flow hedge is recorded in Interest expense in the Consolidated Statements of Income. Refer to Note N for additional details on cash flow hedges. 20 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Reclassifications from accumulated other comprehensive income (loss) for pension and post-employment benefits are included in the computation of the net periodic pension and post-employment benefit expense. Refer to Note J for additional details on pension and post-employment expenses. 21 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) Note L — Stock-based Compensation Expense Stock-based compensation expense, which includes awards settled in shares and in cash, was $ 2.0 million and $ 3.8 million in the second quarter and first six months of 2022, respectively, compared to $ 2.2 million and $ 3.8 million, respectively, in the same periods of 2021. The Company granted 45,016 stock appreciation rights (SARs) to certain employees during the first six months of 2022. The weighted-average exercise price per share and weighted-average fair value per share of the SARs granted during the six months ended July 1, 2022 were $ 80.85 and $ 25.87 , respectively. The Company estimated the fair value of the SARs using the following weighted-average assumptions in the Black-Scholes model: Risk-free interest rate 1.56 % Dividend yield 0.59 % Volatility 38.5 % Expected term (in years) 4.4 The Company granted 59,599 stock-settled restricted stock units (RSUs) to certain employees during the first six months of 2022. 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 $ 80.87 for stock-settled RSUs granted to employees during the six months ended July 1, 2022. RSUs are generally expensed over the vesting period of three years for employees. The Company granted stock-settled performance-based restricted stock units (PRSUs) to certain employees in the first six months of 2022. The weighted-average fair value of the stock-settled PRSUs was $ 97.79 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 its total return to shareholders over the vesting period relative to a peer group’s performance over the same period. At July 1, 2022, unrecognized compensation cost related to the unvested portion of all stock-based awards was approximately $ 15.2 million, and is expected to be recognized over the remaining vesting period of the respective grants. Note M — Fair Value of Financial Instruments The Company measures and records financial instruments at fair value. A 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. 22 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 July 1, 2022 and December 31, 2021: (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) 2022 2021 2022 2021 2022 2021 2022 2021 Financial Assets Deferred compensation investments $ 2,899 $ 4,426 $ 2,899 $ 4,426 $ — $ — $ — $ — Foreign currency forward contracts 2,942 3,368 — — 2,942 3,368 — — Interest rate swap 4,221 — — — 4,221 — — — Precious metal swaps 214 116 — — 214 116 — — Total $ 10,276 $ 7,910 $ 2,899 $ 4,426 $ 7,377 $ 3,484 $ — $ — Financial Liabilities Deferred compensation liability $ 2,899 $ 4,426 $ 2,899 $ 4,426 $ — $ — $ — $ — Foreign currency forward contracts 627 136 — — 627 136 — — Precious metal swaps 76 24 — — 76 24 — — Total $ 3,602 $ 4,586 $ 2,899 $ 4,426 $ 703 $ 160 $ — $ — 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, metals, and interest rates. The carrying values of the other working capital items and debt in the Consolidated Balance Sheets approximate fair values as of July 1, 2022 and December 31, 2021. The Company's deferred compensation investments and liabilities are based on the fair value of the investments corresponding to the employees’ investment selections, primarily in mutual funds, based on quoted prices in active markets for identical assets. Deferred compensation investments are primarily presented in Other assets. Deferred compensation liabilities are primarily presented in Other long-term liabilities. Note N — Derivative Instruments and Hedging Activity The Company uses derivative contracts to hedge exposure to movements in interest rates associated with borrowings, foreign currency exposures, and precious metal and copper exposures. The objectives and strategies for using derivatives in these areas are as follows: Interest Rate. On March 4, 2022, the Company entered into a $ 100.0 million interest rate swap to hedge the interest rate risk on the Credit Agreement described in Note P. The swap hedges the change in 1-month LIBOR from March 4, 2022 to November 2, 2026. The purpose of this hedge is to manage the risk of changes in the monthly interest payments attributable to changes in the benchmark interest rate. 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, the hedge contracts may limit the benefits from a weakening U.S. dollar. The use of forward contracts locks in a firm rate and eliminates any downside from an adverse rate movement as well as any benefit from a favorable rate movement. The Company may from time to time choose to hedge with options or 23 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) 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 nature of instruments to use to hedge exposures. 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. Foreign currency contracts are typically layered in at different times for a specified exposure period in order to minimize the impact of market 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 product containing precious metal is fabricated and delivered to the customer, the metal content is purchased out of consignment based on the current market price. The price paid by the Company for the precious metal forms the basis for the price charged to the customer for the metal content in the product. 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 consignment fees based upon the value of the metal as it fluctuates while on consignment. Each financial institution retains title to its consigned precious metal until it is purchased by the Company, and it is the Company’s typical practice to purchase metal out of consignment only after a product containing that metal has been purchased by one of our customers. In certain instances, a customer may want to fix 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 out of consignment 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 refined and purchased, thereby reducing the exposure to adverse movements in the price of the metal. The Company may also enter into hedges to mitigate the risk relating to the prices of the metals that we process or refine. 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 in these instances. 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 infrequent and, when made 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 paid when the metal is transferred back to the consignment line, thereby limiting any price exposure during the time when the metal was owned by the Company. The Company will only enter into a derivative contract if there is an underlying identified exposure. Contracts are typically held to maturity. The Company does not engage in derivative trading activities and does not use derivatives for speculative purposes. The Company only uses hedge contracts that are denominated in the same currency or metal as the underlying exposure. 24 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) All derivatives are recorded on the balance sheet at fair value. If a 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) and reclassified into income in the same period or periods during which the hedged transaction affects 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 derivative assets and liabilities are classified as short-term or long-term depending upon the contract maturity date. The following table summarizes the notional amount and the fair value of the Company’s outstanding derivatives not designated as hedging instruments (on a gross basis) and the balance sheet classification as of July 1, 2022 and December 31, 2021: July 1, 2022 December 31, 2021 (Thousands) Notional Amount Fair Value Notional Amount Fair Value Foreign currency forward contracts Prepaid and other current assets $ 14,020 $ 533 $ 55,063 $ 2,132 Other liabilities and accrued items 13,466 587 9,425 128 These outstanding foreign currency derivatives were related to balance sheet hedges and intercompany loans. Other-net included less than $ 0.1 million of foreign currency losses in the second quarter of 2022 and $ 0.7 million of foreign currency gains related to derivatives in the first six months of 2022, compared to $ 0.4 million of foreign currency losses and $ 1.2 million of foreign currency gains in the second quarter and first six months of 2021, respectively. The following table summarizes the notional amount and the fair value of the Company’s outstanding derivatives designated as cash flow hedges (on a gross basis) and balance sheet classification as of July 1, 2022 and December 31, 2021: July 1, 2022 Fair Value (Thousands) Notional Amount Prepaid and other current assets Other assets Other liabilities and accrued items Other long-term liabilities Foreign currency forward contracts - yen $ 4,091 $ 453 $ 34 $ 40 $ — Foreign currency forward contracts - euro 31,827 1,827 95 — — Precious metal swaps 6,802 199 15 76 — Interest rate swap 100,000 1,329 2,892 — — Total $ 142,720 $ 3,808 $ 3,036 $ 116 $ — December 31, 2021 Fair Value Notional Amount Prepaid and other current assets Other assets Other liabilities and accrued items Other long-term liabilities Foreign currency forward contracts - yen $ 3,907 $ 131 $ 2 $ — $ — Foreign currency forward contracts - euro 28,412 1,102 — — 8 Precious metal swaps 6,256 116 — 24 — Total $ 38,575 $ 1,349 $ 2 $ 24 $ 8 25 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) All of the contracts summarized above were designated and effective as cash flow hedges. We expect to reclassify $ 3.7 million of net gains into earnings in the next 12 months contemporaneously with the earnings effects of the related forecasted transactions. At July 1, 2022, the maximum term of derivative instruments that hedge forecasted transactions was approximately four years. Refer to Note K for further details related to OCI. The following table summarizes the amounts reclassified from accumulated other comprehensive income relating to the Company’s outstanding derivatives designated as cash flow hedges and associated income statement classification as of the second quarter and first six months of 2022 and 2021: Second Quarter Ended (Thousands) July 1, 2022 July 2, 2021 Hedging relationship Line item Foreign currency forward contracts Net sales $ ( 110 ) $ — Precious metal swaps Cost of sales ( 8 ) 65 Interest rate swap Interest expense - net 238 — Copper swaps Cost of sales — ( 1,507 ) Total $ 120 $ ( 1,442 ) Six Months Ended (Thousands) July 1, 2022 July 2, 2021 Hedging relationship Line item Foreign currency forward contracts Net sales $ ( 130 ) $ 140 Precious metal swaps Cost of sales 99 ( 39 ) Interest rate swap Interest expense - net 353 — Copper swaps Cost of sales — ( 3,041 ) Total $ 322 $ ( 2,940 ) Note O — Contingencies Legal Proceedings . For general information regarding legal proceedings relating to Chronic Beryllium Disease Claims, refer to Note T "Contingencies and Commitments" in the Company's 2021 Annual Report on Form 10-K. One beryllium case was outstanding as of July 1, 2022. The Company does not expect the resolution of this open matter to have a material impact on the consolidated financial statements. As previously reported, a settlement agreement had been reached in one case, and the case was dismissed during the second quarter. 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. 26 Materion Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) On October 14, 2020, Garett Lucyk, et al. v. Materion Brush Inc., et. al. , case number 20CV0234, a wage and hour purported collective and class action, was filed in the Northern District of Ohio against the Company and its subsidiary, Materion Brush Inc. (collectively, the Company). Plaintiff, a former hourly production employee at the Company's Elmore, Ohio facility, alleges, among other things, that he and other similarly situated employees nationwide are not paid for all time they spend donning and doffing personal protective equipment in violation of the Fair Labor Standards Act and Ohio law. Plaintiff filed a motion for conditional certification, which the Company opposed. The motion has been fully briefed, and the parties are awaiting a decision from the court. The Company believes that it has substantive defenses and intends to vigorously defend this suit, absent a negotiated resolution. 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 $ 4.3 million and $ 4.8 million at July 1, 2022 and December 31, 2021, respectively, and is included in Other liabilities and accrued items and Other long-term liabilities on the Consolidated Balance Sheet. Environmental projects tend to be long-term, and the final actual remediation costs may differ from the amounts currently recorded. Note P — Debt (Thousands) July 1, 2022 December 31, 2021 Borrowings under Credit Agreement $ 205,091 $ 152,296 Borrowings under the Term Loan Facility 292,500 300,000 Foreign debt 4,012 2,252 Total debt outstanding 501,603 454,548 Current portion of long-term debt ( 15,333 ) ( 15,359 ) Gross long-term debt 486,270 439,189 Unamortized deferred financing fees ( 4,305 ) ( 4,801 ) Long-term debt $ 481,965 $ 434,388 As of July 1, 2022 and December 31, 2021, the Company had $ 205.1 million outstanding at an average interest rate of 3.56 % and $ 152.3 million outstanding at an average interest rate of 2.12 %, respectively, under its revolving credit facility. The available borrowing capacity under the revolving credit facility as of July 1, 2022 was $ 124.0 million. The Company has the option to repay or borrow additional funds under the revolving credit facility until the maturity date in 2026. The amended and restated credit agreement governing the revolving credit facility (Credit Agreement) includes covenants subject to a maximum leverage ratio and a minimum fixed charge coverage ratio. We were in compliance with all of our debt covenants as of July 1, 2022. The balance outstanding on the term loan facility as of July 1, 2022 and December 31, 2021 wa s $ 292.5 million and $ 300.0 million, respectively. At July 1, 2022 and December 31, 2021, there was $ 46.4 million and $ 46.3 million, respectively, outstanding against the letters of credit sub-facility. 27