Business Context and Reporting Period
Rogers Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2020. The company designs and manufactures engineered materials and components through Advanced Connectivity Solutions (ACS), Elastomeric Material Solutions (EMS), Power Electronics Solutions (PES), and Other. Results were materially affected by the COVID-19 pandemic, weaker automotive and industrial demand, telecommunications market changes, and foreign exchange movements.
Key Financial Metrics
| Metric | Q2 2020 | Q2 2019 | Six Months 2020 | Six Months 2019 |
|---|---|---|---|---|
| Net sales | $191.2 million | $242.9 million | $390.0 million | $482.7 million |
| Gross margin | $70.0 million; 36.6% | $85.8 million; 35.3% | $135.6 million; 34.8% | $171.2 million; 35.5% |
| Operating income | $21.1 million; 11.0% | $33.2 million; 13.7% | $38.6 million; 9.9% | $66.0 million; 13.7% |
| Net income | $14.5 million | $24.3 million | $27.8 million | $52.7 million |
| Diluted EPS | $0.78 | $1.30 | $1.49 | $2.82 |
| Operating cash flow | Not separately provided | Not separately provided | $55.0 million | $67.5 million |
- Q2 sales declined 21.3% year over year; six-month sales declined 19.2%.
- Q2 gross margin expanded approximately 130 basis points, benefiting from lower freight, duties and tariffs, favorable mix, productivity, and a $3.3 million expected recovery of previously paid Chinese duties. Six-month gross margin declined approximately 70 basis points because of lower volume and fixed-cost absorption.
- Q2 operating income declined 36.5%, while six-month operating income declined 41.6%. SG&A and R&D declined in absolute dollars but increased as a percentage of sales.
- Q2 effective tax rate increased to 30.6% from 22.9%; the six-month rate increased to 26.1% from 18.5%, primarily because of higher uncertain-tax-position accruals and other tax mix effects.
- Cash and cash equivalents were $298.7 million at June 30, 2020, compared with $166.8 million at December 31, 2019. Approximately $112.2 million was held by non-U.S. subsidiaries.
- Six-month capital expenditures were $18.2 million, compared with $24.0 million in the prior-year period. Free cash flow, as a defined metric, was not provided.
Material Changes Versus the Prior Comparable Period
- ACS sales decreased 23.3% in Q2 and 21.7% in the first half, driven primarily by weaker 4G/5G wireless infrastructure and automotive demand. ACS operating margin was 22.0% in Q2 versus 19.9% in the prior year, but six-month margin fell to 15.6% from 18.2%.
- EMS sales decreased 23.7% in Q2 and 16.9% in the first half. Q2 operating income fell 80.5%, with margin declining to 4.2% from 16.3%, due to lower volume, fixed-cost absorption, inventory reserves, and accelerated amortization.
- PES sales decreased 12.5% in Q2 and 17.5% in the first half. PES returned to Q2 operating income of $1.4 million from a $1.9 million operating loss, helped by yield, mix, productivity, and lower fixed costs.
- COVID-19-related incremental costs were approximately $3.3 million in Q2 and $4.0 million in the first half, including employee benefits and safety supplies. Management expected substantially lower such costs in the second half.
- The company accelerated amortization of DSP customer relationships and trademarks and trade names so they will be fully amortized by December 31, 2020. Incremental amortization was $3.9 million in Q2 and management expected an additional $11.7 million in each of Q3 and Q4.
- No restructuring or impairment charges were recorded in 2020, compared with $1.1 million in Q2 2019 and $1.9 million in the first half of 2019.
Debt, Liquidity, Outlook, and Risks
Rogers borrowed $150.0 million under its $450.0 million revolving credit facility in Q1 as a precautionary measure during the pandemic and repaid $50.0 million during Q2. Borrowings were $223.0 million at June 30, 2020. The company made an additional $125.0 million discretionary repayment on July 29, 2020, reducing borrowings to $98.0 million as of the filing date. Management stated that available cash, operating cash flow, and credit facilities were sufficient for at least the next 12 months. The credit agreement matures February 17, 2022 and includes a maximum leverage ratio of 3.25:1.00 and minimum interest coverage ratio of 3.00:1.00; management reported compliance and a leverage ratio below the dividend restriction threshold at June 30.
Management did not provide quantified full-year financial guidance. It expected continued but uncertain COVID-19 effects. For Q3, management anticipated lower year-over-year ACS wireless infrastructure and automotive sales, higher aerospace and defense sales, seasonal improvement in EMS portable electronics, continued EMS EV/HEV growth, and higher PES EV/HEV demand as disruptions eased. Management also expected wireless infrastructure growth opportunities to be substantially reduced because of trade restrictions, lower 5G materials content, declining 4G deployments, and completion of more than half of expected 2020 5G base-station installations in the first half.
- Principal risks include the duration and severity of COVID-19, demand reductions, supply-chain and operational disruptions, trade restrictions and tariffs involving China and Huawei, foreign currency volatility, competition, technology adoption, and customer concentration or design changes.
- Asbestos liabilities were $85.7 million and related insurance receivables were $78.3 million at June 30, 2020. Claims outstanding declined to 556 from 592 at year-end; six-month settlements totaled approximately $2.4 million. Actual costs and insurance recoveries may differ materially from recorded estimates.
- The Connecticut environmental remediation accrual was $1.0 million, with aggregate remediation costs of $1.7 million incurred through June 30, 2020.
- Unrecognized tax benefits totaled $14.2 million, of which $13.8 million would affect the effective tax rate if recognized.
- Derivative exposures include foreign currency, copper, and interest-rate contracts. Approximately $1.7 million of pretax net losses in accumulated other comprehensive loss were expected to be reclassified into earnings within 12 months.
Investor Verification Items
- Verify the pace and duration of recovery in automotive, industrial, mass transit, portable electronics, and EV/HEV markets.
- Track ACS wireless infrastructure demand, Huawei-related restrictions, 5G deployment timing, and reductions in materials content.
- Reconcile the planned DSP amortization charges with future operating margins and reported earnings.
- Monitor cash generation, revolving-credit borrowings, covenant compliance, and the February 2022 debt maturity.
- Assess the assumptions supporting asbestos liabilities and insurance receivables, environmental reserves, goodwill and intangible-asset valuations, and uncertain tax positions.
- Confirm whether the $3.3 million Chinese duty recovery is realized and determine how much of the Q2 gross-margin improvement is nonrecurring.