Rogers Corporation: Q2 2017 Form 10-Q Summary
Business context and reporting period
Rogers Corporation designs and manufactures engineered materials and components for mission-critical applications. Its primary segments are Advanced Connectivity Solutions (ACS), Elastomeric Material Solutions (EMS), and Power Electronics Solutions (PES). The filing covers the quarter and six months ended June 30, 2017, with comparisons to the corresponding 2016 periods.
During the period, Rogers integrated DeWAL Industries, acquired in November 2016, and Diversified Silicone Products (DSP), acquired on January 6, 2017. The company also completed the relocation of its global headquarters from Connecticut to Chandler, Arizona.
Financial performance and key metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $201.4 million | $157.5 million | $405.3 million | $318.1 million |
| Gross margin | 40.0% | 38.2% | 39.7% | 38.0% |
| Operating income | $32.8 million | $18.8 million | $72.2 million | $42.9 million |
| Operating margin | 16.3% | 11.9% | 17.8% | 13.5% |
| Net income | $20.9 million | $5.4 million | $47.9 million | $20.3 million |
| Diluted EPS | $1.13 | $0.29 | $2.60 | $1.11 |
| Effective tax rate | 33.9% | 71.0% | 33.0% | 51.2% |
- Q2 sales increased 27.9%; six-month sales increased 27.4%.
- Q2 gross margin expanded 180 basis points and operating margin expanded 440 basis points. Management attributed the improvement to higher volume, capacity utilization, process improvements, automation, low-cost-country manufacturing, and acquisition synergies.
- Q2 SG&A increased 15.1% to $39.6 million but declined to 19.6% of sales from 21.8%. Research and development expense was $7.1 million, or 3.5% of sales.
- Interest expense increased to $1.9 million in Q2 and $3.2 million for the first half, primarily because of acquisition-related debt.
- Cash provided by operating activities was $64.5 million for the first six months, compared with $51.3 million in 2016. Capital expenditures were $9.7 million.
- Cash used in investing activities was $67.3 million, including $60.2 million for the DSP acquisition. Cash used in financing activities was $51.6 million, including a discretionary $50.0 million debt repayment.
- Cash and cash equivalents were $177.3 million at June 30, 2017, compared with $227.8 million at December 31, 2016. Accounts receivable were $137.0 million and inventories were $102.5 million.
- Borrowings under the revolving credit facility were $191.2 million at June 30, 2017. The facility provides up to $450.0 million of capacity plus a $175.0 million accordion feature and matures February 17, 2022.
Segment performance and material changes
| Segment | Q2 2017 sales | Q2 sales change | Q2 2017 operating income |
|---|---|---|---|
| ACS | $74.3 million | +10.6% | $13.2 million |
| EMS | $77.6 million | +69.5% | $14.1 million |
| PES | $43.9 million | +14.4% | $3.7 million |
| Other | $5.6 million | -8.9% | $1.8 million |
- ACS benefited from automotive radar, portable electronics, and aerospace and defense demand, partially offset by lower wireless telecommunications demand.
- EMS growth reflected 48.1% contribution from acquisitions and 21.4% organic growth. The segment continued to integrate DeWAL and DSP.
- PES benefited from mass transit, laser diode coolers, variable-frequency motor drives, renewable energy, and other clean-energy applications.
- Currency translation reduced total Q2 sales by approximately 2.4% and first-half sales by approximately 2.0%.
- First-half results included $1.6 million of non-recurring purchase-accounting inventory expense and $2.1 million of acquisition and integration costs. Q2 included $1.1 million of restructuring expense related to the headquarters relocation; first-half restructuring expense was $1.8 million.
- A $0.9 million gain on the sale of Belgian land was recorded in the first quarter.
- Adoption of ASU 2016-09 produced a $12.7 million cumulative-effect increase to retained earnings through recognition of previously unrecognized deferred tax assets and generated additional share-based compensation tax benefits.
Guidance, outlook, commentary, and risks
The filing does not provide quantitative revenue or earnings guidance. Management stated that existing cash, expected operating cash flow, and available borrowing capacity should be sufficient for operations, planned capital expenditures, research and development, and debt service. Management expects research and development as a percentage of sales to move closer to historical levels as the acquired businesses are integrated.
- Key execution priorities include integrating DeWAL and DSP, realizing acquisition synergies, maintaining operational improvements, and investing in new platforms and technologies.
- The credit agreement requires a leverage ratio of no more than 3.25 to 1.00, subject to a permitted-acquisition election up to 3.50 to 1.00, and an interest coverage ratio of at least 3.00 to 1.00. The company reported that its dividend-related leverage threshold of 2.75 to 1.00 was not exceeded at June 30, 2017.
- Material risks include end-market volatility, global competition, foreign currency movements, raw-material availability and copper prices, acquisition integration, technology protection, tax changes, covenant compliance, environmental matters, information-technology disruptions, and litigation.
- Asbestos claims outstanding increased to 616 at June 30, 2017 from 605 at December 31, 2016. Six-month settlements totaled approximately $1.2 million. The company recorded projected asbestos liabilities and insurance receivables for a ten-year period, but cautioned that actual costs and recoveries may differ materially.
- Environmental matters include an $1.8 million remaining accrual for remediation at the Connecticut site and a $0.2 million reserve for pond remediation at the Woodstock, Connecticut facility.
- The company identified no material off-balance-sheet arrangements and reported effective disclosure controls as of June 30, 2017. The controls assessment excluded the acquired DeWAL and DSP operations while integration work continues.
Investor verification checklist
- Verify the sustainability of sales growth excluding DeWAL and DSP, particularly the organic growth reported in EMS.
- Assess whether gross-margin and operating-margin improvements persist after acquisition-related and restructuring items normalize.
- Monitor integration progress, purchase-accounting adjustments, goodwill and intangible-asset balances, and expected amortization expense.
- Reconcile operating cash flow with earnings and track working-capital increases, especially receivables and inventories.
- Review debt reduction, interest-rate exposure, credit-facility covenants, and available borrowing capacity.
- Evaluate exposure to currency movements, copper prices, end-market weakness, and foreign cash repatriation taxes.
- Review developments in asbestos litigation, insurance recoveries, environmental remediation, and potential liabilities beyond the company’s current ten-year asbestos projection.
- Confirm the eventual impact of the upcoming revenue-recognition, lease, pension-presentation, and goodwill-accounting standards.