Earnings Call Transcript - ROG Q2 2021

Operator, Operator

Good day. My name is Todd, and I will be your conference operator today. At this time, I would like to welcome everyone to the Rogers Corporation Second Quarter 2021 Earnings Call. I will now turn the call over to your host, Mr. Steve Haymore, Director of Investor Relations. Sir, you may begin your conference.

Steve Haymore, Director of Investor Relations

Thank you, Todd. Good afternoon, everyone, and welcome to the Rogers Corporation Second Quarter 2021 Earnings Conference Call. The slides for today's call can be found on the Investors section of our website, along with the news release that was issued today. On Slide 2, note that before we begin, there are statements in this conference call that are not strictly historical, but are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and should be considered as subject to many uncertainties that exist in Rogers operations and environment. These uncertainties could include economic conditions, market demands, and competitive factors. Such factors could cause actual results to differ materially from those in any forward-looking statement. Also, the discussions during this conference call may include certain financial measures that were not prepared in accordance with generally accepted accounting principles. Reconciliation of those non-GAAP financial measures to the most directly comparable GAAP financial measures can be found in the slide deck for today's call, which is posted on the Investors section of our website. Turning to Slide 3. With me today is Bruce Hoechner, President and CEO; Ram Mayampurath, Senior Vice President and CFO; and Bob Daigle, Senior Vice President and CTO. I will now turn the call over to Bruce.

Bruce Hoechner, President and CEO

Thanks, everyone, for joining us today. In Q2, Rogers reported revenues of $235 million, reflecting a 2.5% increase compared to the prior quarter, which aligns with our guidance. We experienced strong demand across much of our business, particularly in the EV/HEV market, where sales significantly increased. However, we faced global supply chain challenges that affected many manufacturing companies in the second quarter, causing greater impact than expected, which slowed our revenue growth and resulted in margins and earnings per share being below our guidance. The challenges included supply constraints, labor shortages, and rising raw material costs, all of which we are actively managing. Our operational improvements and expansion projects are progressing well, and as supply conditions improve, we anticipate reaching our 40% gross margin goal. Now, looking at our markets, we saw strong growth in several strategic areas in the second quarter. The EV/HEV market continued to grow rapidly, with quarterly revenues rising at a mid-teens rate compared to the previous quarter. Clean energy sales have benefited from increased demand for solar and wind, showing double-digit growth sequentially. Revenue in the defense market also showed strong performance, with a high single-digit increase. Sales in the industrial market remained relatively flat after a significant rebound in the first quarter. ADAS sales declined from the prior quarter due to inventory adjustments following three strong growth quarters, but we view this as temporary since the outlook for ADAS remains strong, and we maintain a leading position in that market. Sales in the portable electronics market dipped slightly in Q2 compared to Q1 due to disruptions at our UTIS facility. However, excluding UTIS sales, portable electronics revenue rose 5% quarter-over-quarter, illustrating the ongoing strength in that market. Overall, we are very optimistic about the solid demand across much of our portfolio, particularly in the EV/HEV sector. Our competitive positions are robust, and we are reaping the rewards of our strategy to utilize our innovative, high-performance solutions in markets with favorable long-term trends, such as advanced mobility. Turning to Slide 5, I'll provide an update on the longer-term growth outlook for advanced mobility. I'll begin first with ADAS before discussing the EV/HEV outlook. In ADAS, we continue to expect a mid-teens growth opportunity in auto radar units over the next five years, driven by further market penetration and increasing levels of vehicle autonomy. Next-generation radar technologies are essential to the future of autonomous vehicles, and Rogers is helping to drive innovation in this space. We continue to strengthen our leading position in this market with design wins in both current and next-generation programs. Moving next to the EV/HEV market. The long-term outlook continues to be very robust with an expected annual growth rate of more than 30% over the next five years. Recent trends continue to support this strong outlook. For example, year-to-date sales of plug-in EVs and HEVs in Europe accounted for 15% of the market. In China, electric vehicle sales reached a new milestone in the second quarter, exceeding 10% of the market. Third-party analysis also points to an acceleration in EV/HEV adoption, driven by growing consumer preference for non-ICE vehicles and supportive policy changes. Our recent E&Y report highlighted that combined plug-in EV and HEV sales in the U.S., China, and Europe are now expected to surpass sales of all other powertrains five years earlier than previously anticipated. In addition, growth expectations for full electric vehicles also continued to accelerate. For instance, the latest projections from IHS estimate that full electric vehicle production will reach close to 40 million units globally over the next four years. This is an increase of 25% or about 8 million vehicles compared to their forecast from only two years ago. Reflected in these estimates are the growing number of automakers who have announced plans to transition their entire fleet to full EVs within the next decade. To take advantage of the strong growth outlook in advanced mobility, we are investing aggressively in new capacity and capabilities. We plan to double our capital spending this year in order to invest in new capacity to support growth in the EV/HEV market. I'll next highlight Rogers' strong portfolio of products for this market and how we are positioned to benefit from both the acceleration of the market and the trend towards rising degrees of electrification. Please turn to Slide 6. Both our AES and EMS business units are focused on the significant growth opportunities in advanced mobility. For EV/HEV manufacturers, reliability, safety, and performance are critical design elements, and Rogers' solutions address these needs. In the AES business, we have content opportunities with both our ceramic substrate and power interconnect products. Increasingly, EV and HEV designs are incorporating wide band-gap semiconductors to improve vehicle efficiency and range. These semiconductors require high-performance packaging that our ceramic substrates provide. Our substrate content increases with higher degrees of electrification and is more than 5x higher in a full EV compared to a mild hybrid. We are encouraged by our success in this market, and recent design wins are adding to our growth. Power interconnects provide an additional content opportunity in EV/HEV. They are critical components that distribute power and are essential to the performance and reliability of the vehicle. We have secured design wins with several leading entrants to the EV market. This opportunity is expected to grow as these customers ramp up volumes in the coming year. In our EMS business, we have leveraged our expertise in polyurethane and silicone materials to develop innovative solutions that improve the performance and reliability of EV batteries. Our content opportunities include battery compression pads for plug-in HEVs and EVs and other solutions, such as vibration dampening pads and battery pack sealing systems, which can be used across all battery types and sizes. Battery compression pads have a larger content opportunity, which increases with battery size. Sales of our other EV battery solutions have increased significantly this year, driven by a number of important design wins. In addition to the opportunities in advanced mobility, there are also compelling growth opportunities in other areas of our market portfolio, such as clean energy, portable electronics, and defense. These markets comprise approximately 30% of Rogers total sales, and we expect these markets to grow at a high single-digit rate over time. In clean energy, we have exposure to both solar and wind energy markets with our ceramic substrates and power interconnects. Year-to-date growth has been strong, and the combined solar and wind market is expected to grow at a 10% CAGR over the next five years. In the portable electronics market, sales of 5G smartphones are expected to nearly double this year as the overall market grows at a mid-single-digit rate. The higher performance and advanced features of 5G smartphones means that our content can range from 10% to 30% higher versus the previous generation of phones. Our near-term portable electronic sales are tempered by lower UTIS capacity, but we expect 5G demand to remain robust for the next several years, which provides Rogers with a good growth opportunity, especially as we rebuild our UTIS capacity. The longer-term outlook in the defense market continues to be promising as funding of technology programs such as missile defense and radar systems is expected to drive increasing demand for Rogers advanced circuit materials. Turning to Slide 7, I'll recap the key messages from today's call. We are encouraged by the strong market demand that we continue to see across much of our business. This includes faster-growing markets such as EV/HEV, but also in other attractive market opportunities like clean energy and defense. Near-term, we are not isolated from the current global supply chain challenges, but we are making progress managing these issues, and our operational excellence programs remain on track. We continue to add to our strong competitive positions with new design wins, and we are seeing the results of our strategic focus on growth opportunities in our market portfolio, especially in advanced mobility. We are moving forward rapidly with our investments in new capacity and related capabilities to help ensure our leadership in the EV/HEV market and to take advantage of the significant growth ahead. Now I'll turn it over to Ram to discuss our Q2 results in more detail.

Ram Mayampurath, Senior Vice President and CFO

Thank you, Bruce, and good afternoon, everyone. I will begin on Slide 9. As Bruce mentioned in his overview, we continue to grow our top line. Q2 revenue improved 2.5% sequentially to $234.9 million, which was at the midpoint of our guidance range. Gross margin of 38.2% and adjusted EPS of $1.72 were below our guidance range, primarily due to the impact of raw material shortages and cost increases in the quarter. In the slides ahead, I will review our second quarter 2021 results in detail, followed by our third quarter guidance. Turning to Slide 10. Rogers delivered Q2 revenues of $234.9 million, 2.5% higher than Q1. Volume increased 2.8% and was slightly offset by unfavorable currency rates of approximately 0.3%. Q2 sales growth was tempered by raw material supply constraints and disruptions to our UTIS facility. AES revenue increased 6.5% to $140.4 million due to strong demand in power semiconductor substrates and RF solutions. EV/HEV applications revenues accounted for 15% of the segment revenues and increased 34% sequentially. Ceramic substrates used in power semiconductor devices had a very strong quarter, and revenues for the business grew over 40% sequentially. Clean energy sales accounted for 17% of AES revenues and grew 11% sequentially. We believe that renewable energy demand will have a meaningful long-term momentum. Within our solutions, the Aerospace and Defense business was 19% of the business segment revenues and grew 8% versus Q1. Wireless infrastructure revenues grew mid-single digits sequentially and accounted for 16% of the segment revenues. ADAS was 15% of PES revenues and declined modestly versus the prior quarter due to customers adjusting inventory levels. The EMS business finished the quarter with revenues of $89.3 million, 3% lower than the first quarter. Market demand continues to be very strong, but sales for the quarter were impacted by the raw material shortages and lower UTIS revenue. EV/HEV sales, which represent 11% of EMS revenues, were relatively flat compared to Q1 due to order timing. Q2 general industrial sales, which made up 4% to 6% of the segment revenue were also relatively unchanged versus the prior quarter. Lower UTIS production resulted in a 7% decrease in portable electronics revenue. Our plan is to restart production of certain UTIS products by the end of 2021 with full capacity ramp-up from the first half of next year. Turning to Slide 11. Our gross margin for the second quarter was $89.8 million or 38.2% of revenues, 80 basis points lower than both Q1 and the midpoint of our guidance range for the quarter. Our operational excellence programs are on track, and we benefited from the higher volume in the quarter. However, higher-than-forecasted supply chain constraints resulted in the lower Q2 margins. Gross margin for the quarter was negatively impacted by 130 basis points due to raw material shortages in EMS. Additionally, raw material cost increases in both AES and EMS unfavorably impacted margins by 70 basis points. Although the raw material supply situation has since improved, we expect some challenges to continue into the third quarter. As mentioned previously, we have taken commercial actions to mitigate increasing commodity and other raw material costs. These actions will have a positive impact on our Q2 results. Also on Slide 11, we detail the changes to adjusted net income of $32.5 million in Q2 compared to adjusted net income for Q1 of $36 million. The adjusted operating income for Q2 of $40.8 million or 17.4% of revenues, was 160 basis points lower than Q1. Adjusted operating expenses for Q2 of $49.1 million or 20.9% of revenues, were 80 basis points higher than Q1 expenses. The higher adjusted operating expenses were mainly due to an increase in performance-based compensation cost based on a stronger outlook, timing of certain expenses as well as reinvestments in the business. Other income expenses was $1.8 million unfavorable compared to Q1. Although the copper hedging portfolio gains were positive in Q2, it was meaningfully lower than Q1 due to a steep decline in copper prices at the back end of the quarter. The higher adjusted operating expenses and lower other income just described were the primary reasons for the decline of net income and EPS versus the prior quarter. Turning to Slide 12. The Company generated free cash flow of $11.9 million in the second quarter and $44.8 million year-to-date. We ended the quarter with a cash position of $203.9 million. In the quarter, we generated $29.7 million from operating activities, net of an increase of $13.9 million in working capital. We repaid $4 million of our credit facility and ended the quarter with no outstanding debt. In Q2, the Company spent $17.8 million on capital expenditure. We continue to guide our capital expenditure of $70 million to $80 million for the full year 2021. The Company continues to have a very strong balance sheet and generate robust free cash flows that provide us the flexibility to accelerate the investments necessary to support organic and inorganic growth opportunities. Turning now to third quarter guidance on Slide 13. We see continued sales growth across most of our portfolio in the second half of the year, led by EV/HEV. However, this will be tempered by the lack of availability of certain raw materials. Based on these factors, we are guiding our third quarter revenues to be in the range of $235 million to $245 million. We expect Q3 gross margin to improve sequentially, driven by higher volume, continued operational excellence initiatives, and ongoing commercial actions. These items will offset the impact of certain supply chain challenges that will continue into Q3. For these reasons, we guide third quarter gross margin to be in the range of 38.5% to 39.5% with a midpoint of 39%. Q3 operating expenses are forecasted to increase sequentially, mainly due to a $3 million one-time cost to support strategic growth initiatives. We are guiding GAAP Q3 earnings in the range of $1.50 to $1.65 per fully diluted share, and we guide fully diluted adjusted earnings in the range of $1.70 to $1.85 per share for the third quarter. The effective tax rate for the full year is guided to 24% to 25%.

Operator, Operator

Our first question comes from Daniel Moore of CJS Securities.

Daniel Moore, Analyst

I'll start with beyond the $4.6 million impact on gross margin that you called out. Do you have any guesstimate or sense of how much higher revenue would have been were it not for general global supply chain challenges and semiconductor shortages? Just trying to get a sense if that was a meaningful impact and is there any continued impact embedded in the Q3 guidance.

Ram Mayampurath, Senior Vice President and CFO

We would have exceeded the top end of our guidance range without supply chain constraints. We likely would have seen an increase of at least $6 million to $7 million in our revenue.

Bruce Hoechner, President and CEO

Yes. And just to add to that, I think as we look forward, we're a bit constrained in the Q3 outlook as well, and we're taking that into account. But as I opened the call today, the demand remains extremely strong in our markets, and we're working through the supply chain side of this.

Daniel Moore, Analyst

No doubt. And maybe just a little bit more color on the $3 million in one-time costs you expect to incur in Q3 to support growth. And I'll leave it at that.

Bruce Hoechner, President and CEO

Yes. So this is really an investment in analyzing growth opportunities for the corporation and making sure that we're taking full advantage of the opportunities that are out there, making sure that we're applying our resources appropriately.

Daniel Moore, Analyst

Perfect. And maybe one more I'll sneak in really quick. Just industrial. So it gets a little less attention, but still 20% of your business. It flattened out in the quarter. Is that largely on supply chains? What's your sense for just general underlying growth and/or direction of the recovery there?

Bruce Hoechner, President and CEO

Yes, we experienced a strong rebound in the first quarter of the year in the industrial sector. However, supply constraints are affecting the overall industrial business. We anticipate a return to growth as global industries navigate through these supply chain challenges in the latter half of the year.

Operator, Operator

Our next question comes from Jed Dorsheimer with Canaccord Genuity.

Jed Dorsheimer, Analyst

Could you share how you are evaluating the business across different segments in terms of return on invested capital and their lifecycle? I'm asking because you seem to have significant opportunities in some areas, especially in advanced mobility, yet I'm curious about the level of capital expenditures you are allocating to that sector. Is the investment less than expected because resources are being spread too thin?

Bruce Hoechner, President and CEO

So I'll take the first part of that, and Ram will comment maybe a little bit more on the ROI side. We continue to make those investments and monitor where we see these markets going. And I think specifically in the EV/HEV side, in both businesses, both the ceramic substrates as well as the battery pads, we are making significant investments in plants around the world to ensure that we've got the right capacity in place. And of course, that's done against the backdrop of the profitability and the return on investment that we think is extremely compelling at this point. Ram, you might care to add to that, if you like.

Ram Mayampurath, Senior Vice President and CFO

Yes. To give you an idea, we have doubled our capital expenditures in our 2021 forecast compared to 2020, and we plan to keep investing at this level as we prepare for future demand. More than 50% of our investment is directed towards supporting advanced mobility product lines across both our business units, AES and EMS. Additionally, our investments go beyond just capital expenditures; we are also focusing on areas that enhance our capabilities throughout the business. The 40% gross margin target we have set takes these investments into account, which means we are preparing for overall improvements in capabilities and innovation across our operations.

Jed Dorsheimer, Analyst

Got it. As a follow-up, there are some negative issues in two of the advanced mobility segments, particularly concerning negative publicity related to auto OEMs using pouch designs that have faced recalls. Additionally, the ongoing chip shortage is impacting overall volumes. I'm curious about how much these two situations are affecting the potential of that business and whether they have repercussions for Rogers.

Bruce Hoechner, President and CEO

I'll address the chip issue first. We're observing effects on vehicle electrification, particularly regarding the electrification of internal combustion engines. We believe that chip shortages have had some impact, and we've heard from certain well-known electric vehicle manufacturers about potential volume effects due to this. However, the overall volumes remain strong. While there may be some influence from the chip situation, we don’t expect it to significantly hinder our growth. It might be less than we initially expected, but it is still quite substantial. Now I'll turn it over to Bob to discuss the battery situation.

Bob Daigle, Senior Vice President and CTO

Yes. Regarding the question about batteries and long-term reliability, I believe our efforts to enhance reliability and lifespan will be beneficial. I don't foresee any disruptions; the technology is reliable with pass/fail testing. They are addressing challenges, but we are equipped to handle the issues the industry is encountering. Overall, I consider this a positive aspect for our company, as we are adept at solving these types of problems with our products.

Operator, Operator

We'll take our next question from Craig Ellis of B. Riley Securities.

Craig Ellis, Analyst

I wanted to start with a two-part question about ADAS. The first part relates to the near term. What is your perception of where we currently stand in the titration cycle, and how widespread is the titration happening in the longer term? This question could be directed to either Bruce or Bob. As we explore other opportunities beyond radar and imaging, many are looking at LIDAR. To what extent can investors expect that Rogers has a similar opportunity in LIDAR as it does in radar? What would be the advantages and disadvantages of performing equally well with this technology, which seems necessary for achieving level four and level five autonomy in the future?

Bruce Hoechner, President and CEO

So I'll take the ADAS inventory adjustment. As we move through Q3, we think there's still an adjustment going on in Q3 here. But as we move into Q4, we think things should be relatively in balance. There was a lot of early buying in the first part of the year by some of the makers of the radars. And I think probably of the mindset, semis chips, trying to make sure that they had supply. So they're working through that. And like I said, I think fourth quarter, we'll see it get in balance. Bob, you can talk about LIDAR.

Bob Daigle, Senior Vice President and CTO

Yes. Just in general, I guess I'll frame it as the industry has basically come to the conclusion, you're going to have multiple technologies that contribute to autonomous vehicles. Typically, the platforms that we've seen evaluate would have 9 to 11 radar sensors, basically creating that envelope around the vehicle in addition to LIDAR and cameras. So I'd say, as we move towards full autonomous, I think Radar content continues to rise. I think the wild card, which would be a strong accelerator for us is really all the work that's going on into high-definition radar these days. We've got a lot of activity...

Craig Ellis, Analyst

You're talking about 4D, Bob? Or which...

Bob Daigle, Senior Vice President and CTO

Yes. Creating basically a radar image with the advantage, frankly, over LIDAR being it's not susceptible to weather conditions. Radar penetrates boxes, no main versus LIDAR. So for true level five autonomous vehicles, there's a belief in parts of the industry that high-definition radar, basically, radar imaging will play a pretty significant role here. And I'd say that's the bigger opportunity for us long-term is in the high definition radar.

Craig Ellis, Analyst

Yes. That makes sense given the more you've been with radar. The second question is on one of the points that you referred to in characterizing the current market dynamics. Pretty sure it's great to see that there's that 30% CAGR for EV and HEV, but I think that's unchanged from the growth rates that were out there, at least six, if not nine months ago. And subsequently, we've had all of the electrification pull-ins from seemingly automaker after automaker. And so the question is, is your sense that all those pull-ins really mean that that growth rate is really more durable beyond 2025 and maybe into the 2027 to 2030 time frame? Or does it maybe mean that while we've got a 30% CAGR, we've just got a lot more visible momentum underneath that CAGR? Is it something else that you would point to?

Bruce Hoechner, President and CEO

So we think it solidifies that growth rate. I mean, it's very believable these days. I think two years ago, people would be talking about those kinds of growth. It still would be a challenge to imagine that. I don't think anybody is imagining it anymore. I think what we will see, though, with the announcements of the various OEMs going to full EVs over the course of the next 10 years or so, an extension of that growth rate is going to continue. So your point about a 30% growth rate beyond '26, '27, '28 is not unreasonable given the acceleration that's going to happen as these new models come out and the consumers really get tuned into it. And of course, the networks get built out for the chargers, which is certainly something that we're looking at as well as opportunity.

Craig Ellis, Analyst

And how big would the incremental opportunity in the charger network be to what we see in the automobiles, not to Rogers?

Bruce Hoechner, President and CEO

We're assessing that right now because there's various folks who are out there. Certainly, the large West Coast OEM has their system out there, and it's of interest to us. And beyond that, as the other OEMs come in and other third-party players, there's a lot of work going on in that space right now.

Craig Ellis, Analyst

Okay. So part of the answer is in the point about the $3 million OpEx bump up in the quarter maybe?

Bruce Hoechner, President and CEO

That's a good assumption. Very good.

Craig Ellis, Analyst

Thanks so much.

Bruce Hoechner, President and CEO

Yes, Craig I think this is an important point. We are looking at opportunities that in adjacencies and so forth to build them on our strong market position today, and that's really why we're making those kinds of investments to understand and execute against it.

Operator, Operator

We'll take our next question from Patrick Ho of Stifel.

Patrick Ho, Analyst

This is Brian speaking on behalf of Patrick. I believe the supply constraints affecting the revenue outlook and what you observed in the second quarter, as well as the situation in Korea, could persist into next year. However, through strategic buffering or other remediation efforts, do you think these constraints might be resolved as we approach the fourth quarter?

Bruce Hoechner, President and CEO

So the team has been working through this. And certainly, this is an industry-wide situation, particularly this is in the EMS side of the house in the resins and those materials. And so it's not just one supplier, but we're working across the board looking at alternatives as well. But the real issue is upstream from even those suppliers. The Gulf Coast issues have had an impact. And I think as we work through Q3, we'll see this starting to improve. And certainly, we're seeing it already. And when we get into Q4, we anticipate a bit smoother sailing there. And by the end of the year, things should be in good shape. I'll say that, but there are always issues that pop up, floods, disasters, freezing, and so forth, and we're working to make sure that we have robust supply chain capabilities as backups as well.

Patrick Ho, Analyst

Okay. Yes, that's fair. Won't have you calling it black swan events in the forecast. For industrial, in terms of the impact in Q2, did you call out any particular markets that were maybe more effective within industrial?

Bruce Hoechner, President and CEO

No, we observed that a number of submarkets were relatively quiet during the quarter with not much demand. As we mentioned earlier, this was partly due to the supply chain constraints faced by our customers, which affected the demand for our materials.

Operator, Operator

We'll take our next question from Josh Silverstein with Wolfe Research.

Josh Silverstein, Analyst

You talked about strong demand for your products. I know that you're facing some logistics issues. But how have been the conversations on price? Have you been able to push through any sort of increases because of the challenge in this environment? I'm just kind of curious on that.

Ram Mayampurath, Senior Vice President and CFO

Yes, Josh. This is Ram. We are passing through the increases in our commodity and raw material costs. We began this in Q2, and we expect to see a more significant favorable impact in Q3. Some of these actions will also extend into Q4, but most of the effects will be reflected in our Q3 numbers.

Josh Silverstein, Analyst

Is the $5 million increase in revenue mostly related to pricing?

Ram Mayampurath, Senior Vice President and CFO

No, there's probably about 40% of that in pricing, quarter-over-quarter increases.

Operator, Operator

Thank you. At this time, we have no further questions. I would like to turn the call back to Bruce for closing remarks.

Bruce Hoechner, President and CEO

I'd like to thank everyone for joining us today and have a safe and enjoyable evening. Thanks, everyone.

Operator, Operator

This concludes today's call. Thank you for your participation. You may now disconnect.