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ROGERS CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge)
The following discussion and analysis of our financial condition and results of
operations should be read together with the Selected Financial Data and our
Consolidated Financial Statements and the related notes that appear elsewhere in
this Form 10-K.
Forward Looking Statements
Certain statements in this Form 10-K may constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements are based on management's expectations, estimates,
projections and assumptions. Words such as "expects," "anticipates," "intends,"
"believes," "estimates," "should," "target," "may," "project," "guidance," and
variations of such words and similar expressions are intended to identify such
forward-looking statements. Such forward-looking statements involve known and
unknown risks, uncertainties, and other factors that may cause our actual
results or performance to be materially different from any future results or
performance expressed or implied by such forward-looking statements. Such
factors include, but are not limited to, changing business, economic, and
political conditions both in the United States and in foreign countries,
particularly in light of the sovereign debt crisis being experienced globally
and the uncertain outlook for global economic growth, particularly in several of
our key markets; uncertainty regarding resolution of the United States fiscal
cliff and debt ceiling issues; increasing competition; any difficulties in
integrating acquired businesses into our operations and the possibility that
anticipated benefits of acquisitions and divestitures may not materialize as
expected; delays or problems in completing planned operational enhancements to
various facilities; our achieving less than anticipated benefits and/or
incurring greater than anticipated costs relating to streamlining initiatives or
that such initiatives may be delayed or not fully implemented due to
operational, legal or other challenges; changes in product mix; the possibility
that changes in technology or market requirements will reduce the demand for our
products; the possibility of significant declines in our backlog; the
possibility of breaches of our information technology infrastructure; the
development and marketing of new products and manufacturing processes and the
inherent risks associated with such efforts and the ability to identify and
enter new markets; the outcome of current and future litigation; our ability to
retain key personnel; our ability to adequately protect our proprietary rights;
the possibility of adverse effects resulting from the expiration of issued
patents; the possibility that we may be required to recognize impairment charges
against goodwill and non-amortizable assets in the future; the possibility of
increasing levels of excess and obsolete inventory; increases in our employee
benefit costs could reduce our profitability; the possibility of work stoppages,
union and work council campaigns, labor disputes and adverse effects related to
changes in labor laws; the accuracy of our analysis of our potential
asbestos-related exposure and insurance coverage; the fact that our stock price
has historically been volatile and may not be indicative of future prices;
changes in the availability and cost and quality of raw materials, labor,
transportation and utilities; changes in environmental and other governmental
regulation which could increase expenses and affect operating results; our
ability to accurately predict reserve levels; our ability to obtain favorable
credit terms with our customers and collect accounts receivable; our ability to
service our debt; certain covenants in our debt documents could adversely
restrict our financial and operating flexibility; fluctuations in foreign
currency exchange rates; and changes in tax rates and exposure which may
increase our tax liabilities. Such factors also apply to our joint ventures. We
make no commitment to update any forward-looking statement or to disclose any
facts, events, or circumstances after the date hereof that may affect the
accuracy of any forward-looking statements, unless required by law. Additional
information about certain factors that could cause actual results to differ from
such forward-looking statements include, but are not limited to, those items
described in Item 1A, Risk Factors, in this Form 10K.
Business Overview
Company Background and Strategy
We are a global enterprise that provides our customers with innovative solutions
and industry leading products in a variety of markets, including portable
communications, communications infrastructure, consumer electronics, mass
transit, automotive, defense and clean technology. We generate revenues and cash
flows through the development, manufacture, and distribution of specialty
material-based products that are sold to multiple customers, primarily original
equipment manufacturers (OEMs) and contract manufacturers that, in turn, produce
component products that are sold to end-customers for use in various
applications. As such, our business is highly dependent, although indirectly, on
market demand for these end-user products. Our ability to forecast future sales
growth is largely dependent on management's ability to anticipate changing
market conditions and how our customers will react to these changing
conditions. It is also highly limited due to the short lead times demanded by
our customers and the dynamics of serving as a relatively small supplier in the
overall supply chain for these end-user products. In addition, our sales
represent a number of different products across a wide range of price points and
distribution channels that do not always allow for meaningful quantitative
analysis of changes in demand or price per unit with respect to the effect on
sales and earnings.
Strategically, our current focus is on three mega trends that we believe will
fuel the future growth of our Company - continued growth of the internet and the
variety of ways in which it can be accessed, expansion of mass transit, and
further investment in clean technology. These trends and their related markets
all require materials that perform to the highest standards, which has been a
key strength of our products over the years. We are also focused on growing our
business both organically and through
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strategic acquisitions or technology investments that will add to or expand our
product portfolio, as well as strengthen our presence in existing markets or
expand into new markets. We will continue to focus on business opportunities and
invest in expansion around the globe. Our vision is to be the leading
innovative, growth oriented, and high technology materials solutions provider
for our selective markets. To achieve this vision, we must have an organization
that can cost effectively develop, produce and market products and services that
provide clear advantages for our customers and markets.
2012 Executive Summary
2012 was a year of transition for Rogers Corporation. Under the direction of our
management team, led by our new President and CEO, Bruce Hoechner, we
implemented several measures to streamline our organization and rationalize our
cost structure in order to better position the Company for profitable growth in
the future. The goal of these actions is to become a more streamlined company,
both from an organizational and cost perspective, that is focused on customer
needs, with efficient manufacturing capabilities and an empowered workforce.
The initiatives we implemented occurred over the course of 2012 and touched all
areas of the Company. These initiatives included the
following: (i) implementation of an early retirement program for certain
eligible employees; (ii) realignment of our organizational structure by
consolidating a number of senior executive positions, reorganizing certain
business functions and redeploying resources across the Company; (iii) shutting
down the Power Distribution Systems start-up operation in North America; (iv)
liquidating the outstanding auction rate security investments; (v) beginning to
close down and relocate certain production at the High Performance Foams
manufacturing facility in Bremen, Germany (to be completed in the first quarter
of 2013); (vi) shutting down the operations of the non-woven composite materials
product lines in Rogers, Connecticut; and (vii) initiating a plan to relocate
the final inspection operations of the Curamik Electronics Solutions' operating
segment from its facility in Eschenbach, Germany to a lower cost region in
Hungary. We also introduced internal programs for our employees to help build a
culture of accountability that we believe will drive us to higher levels of
employee and customer satisfaction.
As a result of these streamlining and rationalization initiatives, we have
incurred approximately $20.4 million of net pre-tax charges in 2012. We
initially anticipated that these actions would result in annualized cost savings
of approximately $13.0 million by the end of 2012. However, actual savings began
to exceed those projections in the third quarter of 2012, and we now estimate
that annualized savings as a result of these initiatives will approach $20.0
million. Some of these savings will be used to reinvest in certain areas of the
Company, such as research and development, and in adding resources in strategic
areas of the Company, such as sales and marketing, in order to drive future
growth. However, we believe that our overall cost structure will remain lower
than it was prior to the implementation of these initiatives. Going forward, we
will continue to pursue other initiatives aimed at further streamlining our
business and reducing our overall cost structure, enabling us to continue to
profitably grow the Company.
From an operations perspective, net sales were $498.8 million in 2012, a decline
of 9.0% from $548.3 million in 2011. These results are primarily attributable to
the decline in sales in the Power Electronics Solutions operating segments, as
the Curamik Electronics Solutions (CES) operating segment achieved sales of
$92.4 million in 2012, a decline of 30.5% from $132.9 million of net sales in
2011, and the Power Distribution Systems (PDS) operating segment had net sales
in 2012 of $41.9 million, an 11.5% decline from $47.3 million in 2011. These
declines are primarily attributable to the slowdown of capital infrastructure
spending in mass transit, wind energy, and industrial motor drive markets,
primarily in Europe and China. We anticipate that these markets will remain at
these levels in the near term, but the long term outlook remains positive. Net
sales in the High Performance Foams (HPF) operating segment increased by 1.0% to
$179.4 million in 2012 from $177.6 million in 2011, while net sales in the
Printed Circuit Materials (PCM) operating segment declined by 2.7% from $166.4
million in 2011 to $161.9 million in 2012. We believe that the long term outlook
for these segments remains strong as spending in wireless infrastructure and
other key markets is projected to increase in the future.
Over the course of 2012, we experienced a steady increase in sales volumes over
the first nine months of the year, and achieved improved profitability
performance over that time as our streamlining initiatives lowered our overall
cost structure, enabling greater profitability per sales dollar. These results
were tempered by a decline in sales in the fourth quarter, as we experienced a
considerable drop off in orders across all of our businesses at the end of the
year. We believe that this decrease in demand was likely related to the broader
economic environment, including concerns over the U.S. fiscal cliff issues. The
market indices appear to be more positive as we enter 2013, and we believe we
will see improved growth as the year unfolds. The outlook for 2013 remains
strong, particularly with the build out of 4G/LTE in the telecom space and as
the China stimulus package benefits the mass transit and energy markets.
Going forward, we will continue to pursue initiatives aimed at further
controlling our cost structure in order to maintain our improved operating
leverage. We will also continue to focus on profitable growth as we focus on
expanding our application base for current products, while pursuing new
opportunities externally. We believe that the actions taken in 2012, as well as
our internal initiatives and focus, will enable us to achieve our strategic
goals to grow the Company, while increasing value to our shareholders.
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--------------------------------------------------------------------------------Results of Continuing Operations
The following table sets forth, for the periods indicated, selected operations
data expressed as a percentage of net sales.
2012 2011 2010
Net sales 100.0% 100.0% 100.0%
Gross margins 31.8% 32.6% 36.7%
Selling and administrative expenses 20.0% 18.9% 23.5%
Research and development expenses 3.9% 3.9% 4.8%
Restructuring and impairment charges 2.8% 0.1% -
Operating income (loss) 5.1% 9.7% 8.6%
Equity income in unconsolidated joint ventures 1.0% 1.0%
2.3%
Other income (expense), net -% 0.4% 0.4%
Realized gain (loss) (0.7)% -% (0.1)%
Interest income (expense), net (0.9)% (0.9)% -
Gain on acquisition or disposal - - 0.9%
Income (loss) from continuing operations before
income taxes 4.5% 10.2% 12.1%
Income tax expense (benefit) (9.3)% 2.1% 1.6%
Income (loss) from continuing operations 13.8% 8.1% 10.5%
2012 vs. 2011
Net Sales
Net sales in 2012 were $498.8 million, a 9.0% decrease from $548.3 million of
sales in 2011. The decline in sales in 2012 is primarily related to the
performance of the Curamik Electronics Solutions operating segment, which
experienced a 30.5% decrease in sales from $132.9 million in 2011 to $92.4
million in 2012, as well as an 11.5% decline in sales in the Power Distribution
Systems operating segment from $47.3 million in 2011 to $41.9 million in 2012.
Sales in the Printed Circuit Materials operating segment also declined slightly,
from $166.4 million in 2011 to $161.9 million in 2012. These declines were
partially offset by a slight increase in sales in the High Performance Foams
operating segment from $177.6 million in 2011 to $179.4 million in 2012. See
"Segment Sales and Operations" below for further discussion on segment
performance.
Gross Margin
Gross margin decreased by approximately 80 basis points from 32.6% in 2011 to
31.8% in 2012. The primary drivers of the decrease in margins was the decline in
sales volumes from 2011 to 2012, which contributed approximately 25 basis points
to the decline, as well as a 6.5% decline in overall inventory levels from 2012
to 2011 resulting in unfavorable absorption during the period. This decrease is
primarily attributable to our focus on working capital management and lowering
inventory levels to better match current demand. This decline was partially
offset by improved operating leverage on sales as a result of the streamlining
activities that occurred throughout 2012. These activities favorably impacted
margins by approximately 70 basis points in 2012. We expect that margins will
continue to improve as the impacts of the streamlining initiatives are realized,
particularly when and if sales volumes increase.
Selling and Administrative Expenses
Selling and administrative (S&A) expenses were $99.7 million in 2012, a decrease
of 3.7% from $103.5 million in 2011. 2012 S&A expenses included approximately
$5.8 million of special charges comprised primarily of a $2.9 million charge
taken as a result of increasing the forecast period on asbestos related
liabilities from 5 to 10 years during the fourth quarter of 2012, as well as a
charge of $2.0 million related to the settlement of a pension obligation with
the former Chief Executive Officer of the Company. 2011 results included
approximately $3.1 million of special charges primarily associated with the
acceleration of compensation
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expense related to the change of Chief Executive Officers during the year. The
overall decline in spending, excluding these charges, of $6.8 million can be
attributed primarily to a reduction of $8.8 million of incentive and equity
compensation costs due to the lower level of performance of the business in 2012
as compared to 2011. This decline was partially offset by a $4.2 million
increase in costs related to the defined benefit pension and retiree medical
plans in 2012 as compared to 2011 as the projected long term liability on the
benefit plans increased as a result of unfavorable market conditions. Excluding
these charges, S&A as a percentage of sales increased slightly from 18.2% in
2011 to 18.7% in 2012, mainly due to the decline in sales volumes experienced
during 2012, partially offset by cost savings from our streamlining initiatives,
which did not fully impact results until the second half of 2012.
Research and Development Expenses
Research and development (R&D) expenses were $19.3 million in 2012, a decrease
of 10.3%, from $21.5 million in 2011. As a percentage of sales, R&D expenses
were 3.9% in 2012 and 3.9% in 2011. Historically, we have targeted a 6% R&D
investment as a percentage of net sales; however, in the past few years these
percentages have been in the 3.5% - 4.0% range. Going forward, we intend to
increase the investment in R&D initiatives, and believe that we will migrate
closer to the 6% target over the course of time. R&D will continue to be an
important driver to growth for the Company. We intend to reinvest in this area
to improve our existing technologies and find new applications for existing
materials, as well as to explore new, emerging technologies that we believe will
complement or extend our existing product portfolio.
Restructuring and Impairment Charges
Restructuring and impairment charges were $14.1 million in 2012 as compared to
$0.4 million in 2011. In 2012, these charges were comprised primarily of the
following: (i) $7.1 million in severance related charges resulting from the
streamlining initiatives that took place throughout the year, including the
early retirement program implemented in the first quarter of 2012; (ii)
approximately $2.3 million related to the shut-down of the Bremen manufacturing
facility in Germany and relocation of certain production to the manufacturing
facility in Carol Stream, Illinois; and (iii) $3.8 million in severance related
charges resulting from actions taken to move of the final inspection operations
of Curamik from Germany to Hungary. The 2011 charge relates to the write down to
fair value of a dormant facility located in Richmond, Virginia that was acquired
in 2009 as part of the MTI acquisition. This facility was sold in the second
quarter of 2012.
Equity Income in Unconsolidated Joint Ventures
Equity income in unconsolidated joint ventures was $4.7 million in 2012, a
decrease of 13.0% from $5.5 million in 2011. The decline is driven primarily by
the softening in certain domestic and export markets in Japan, particularly in
LCD televisions, domestic mobile phones and general industrial applications.
Other Income (Expense), Net
Other income (expense), net was an expense of $0.2 million in 2012 as compared
to income of $1.9 million in 2011. 2011 results included a gain of $1.9 million
on the sale of a building in China. Excluding this gain, results were relatively
consistent year over year.
Realized Gain (Loss)
Realized gain (loss) represents the portion of the auction rate security
impairment that relates to credit losses and is required to be recorded in the
consolidated statements of income (loss). The amount of loss recognized in 2012
was $3.2 million as compared to a loss of $0.2 million in 2011. The increase in
the loss in 2012 is due to the liquidation of the auction rate securities
portfolio in the first quarter of 2012, which resulted in the Company receiving
net cash proceeds of approximately $25.4 million.
Interest Income (Expense), Net
Interest income (expense), net was expense of $4.3 million in 2012 as compared
to expense of $4.9 million in 2011. This expense relates to the interest expense
on our long-term debt, as well as the interest expense on the long term
obligation related to the leased facility in Eschenbach, Germany that contains
most of the CES manufacturing operations. The overall decline in the expense is
driven by a decline in the long term debt during 2012, as we paid down the
facilities by $24.5 million from $122.5 million at December 31, 2011 to $98.0
million at December 31, 2012.
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Income Tax Expense (Benefit)
Our effective tax rate was (205.2%) in 2012 and 20.7% in 2011. In both 2012 and
2011, our tax rate was favorably impacted by the tax benefit associated with
certain discrete rate items recorded during the year and also benefited from
favorable tax rates on certain foreign business activity. In 2012, the rate was
primarily impacted by the following items: (i) 232.5% benefit related to the
reversal of the valuation allowance on the US deferred tax assets; and (ii)
15.1% benefit related to foreign source income which is taxed at lower rates
than income generated in the US. In 2011, the rate was primarily impacted by the
following items: (i) 8.3% benefit related to the international tax rate
differential; (ii) 3.6% benefit related to changes in the valuation allowance on
the US deferred tax assets; (iii) 1.8% benefit related to foreign source income
that is tax at lower rates than income generated in the US; and (iv) 1.5%
benefit from other general business credits.
In 2009, we established a valuation allowance against substantially all of our
U.S. deferred tax assets as we concluded that we did not have sufficient
evidence to support the position that these assets would be utilized in the
future. This conclusion was reached primarily due to the presence of recent
cumulative losses in the US and upon consideration of all other available
evidence, both positive and negative, using a "more likely than not standard" in
accordance with applicable accounting guidance. As of the end of the third
quarter of 2012, we concluded that a valuation allowance against these assets is
no longer necessary as we are no longer in, nor are we expecting to be in, a
cumulative loss in the forseeable future. Also, in appropriate circumstances we
have the opportunity to undertake a tax planning strategy to ensure that our
deferred tax assets do not expire unutilized. This strategy is based upon our
ability to make a tax election to capitalize certain expenses that will result
in generating taxable income to allow us to utilize our deferred tax assets
before they expire. We would undertake such a strategy to realize these deferred
tax assets prior to expiration only if we determined it was reasonable, prudent,
and feasible. This, along with other positive evidence, such as our recent
history of positive taxable income, led us to conclude in 2012 that it is more
likely than not that we will ultimately be able to realize our deferred tax
assets.
In 2012, we incurred a $2.0 million net operating loss for German income tax
purposes. Under German law, tax losses may be carried forward indefinitely. We
also incurred a $1.0 million net operating loss in one of our Chinese entities
which has a 5 year life. We believe that we will generate sufficient taxable
income in both jurisdictions such that both of these carryforwards should be
fully realized.
Further, our effective tax rate benefited from the tax holiday on the earnings
of our subsidiaries in China, which expired at the end of 2011. Under the
business license agreement granted to Rogers Technologies (Suzhou) Company
(RSZ), a wholly-owned subsidiary of ours, the first two years of cumulatively
profitable operations were taxed at a zero percent tax rate followed by a
reduced tax rate in subsequent years that gradually increased to the 25% full
rate of tax beginning in 2012. In 2012, RSZ reported pretax income of $19.4
million which was subject to the full tax rate of 25%. In 2011, RSZ reported
pretax income of $17.9 million, which was subject to a reduced tax rate of 24%.
Also, under the business license agreement granted to Rogers (Shanghai)
International Trading Company Ltd. (RSH), also a wholly-owned subsidiary of
ours, RSH was subject to a reduced rate of tax that gradually increased to the
25% full rate of tax beginning in 2012. In 2012, RSH reported pretax income of
$1.5 million which was subject to the full tax rate of 25%. In 2011, RSH
reported pretax income of $2.4 million which was subject to a reduced tax rate
of 24%.
Backlog
The backlog of firm orders was $43.3 million at December 31, 2012, as compared
to $33.1 million at December 31, 2011. The increase at the end of 2012 was
primarily related to the CES operating segment, which experienced an increase in
backlog of $10.7 million at December 31, 2012 as compared to December 31, 2011.
2011 vs. 2010
Net Sales
Net sales in 2011 were $548.3 million, an increase of 46.9% from $373.2 million
of sales in 2010. 2011 sales included approximately $132.9 million related to
Curamik, which was acquired at the beginning of 2011. Excluding Curamik, organic
growth was approximately $42.2 million, or 11.3%. This sales increase was
attributable to volume improvement across all of our Core Strategic segments,
led by High Performance Foams, which increased by 18.6% from $149.7 million in
2010 to $177.6 million in 2011; Printed Circuit Materials, which increased by
18.0% from $141.1 million in 2010 to $166.4 million in 2011; and the Power
Distribution Systems segment, which increased by 12.4% from $42.1 million in
2010 to $47.3 million in 2011. A primary driver of these increases was the
strong demand for the industry leading products and materials produced by these
segments, particularly over the first nine months of 2011, as volumes declined
in the fourth quarter. Additional factors impacting these results are discussed
in greater detail in the "Segment Sales and Operations" section below.
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--------------------------------------------------------------------------------Gross Margin
Gross margin decreased by approximately 11.2% from 36.7% in 2010 to 32.6% in
2011. During 2011, margins were impacted by several factors, many of which were
anticipated and planned for by management. Most notably, such factors included
the start-up costs associated with our new PCM manufacturing facility in Suzhou,
China, and our PDS operations in North America; increased costs of certain raw
materials used in many of our production processes, and unfavorable product
sales mix in certain segments. As we move into the production phase in these new
production facilities, we expect the start-up and qualification costs to decline
and margins to improve over time. Also, margins were negatively impacted by the
acquisition of Curamik, which has historically operated at lower margins than
our legacy operations. However, Curamik has lower operating costs, so overall
profitability is very similar to our core businesses. Further, margins were
negatively impacted by a one-time charge of approximately $1.8 million recorded
in the first quarter of 2011 related to the write up of Curamik inventory to
fair value, as required under the purchase accounting rules. Sequentially,
margins improved over the first three quarter of 2011, but declined
significantly in the fourth quarter due to the decline in sales and a negative
impact from inventory absorption.
Selling and Administrative Expenses
Selling and administrative (S&A) expenses were $103.5 million in 2011, an
increase of $15.9 million, or 18.2%, from $87.6 million in 2010. The increase in
2011 expenses is partially attributable to the acquisition of Curamik, which
added approximately $13.9 million of expense during the year including $1.3
million of costs incurred to acquire the business and approximately $3.5 million
in amortization expense related to the intangible assets created as part of the
purchase. Also contributing to the increase were approximately $3.1 million in
one-time charges incurred in the fourth quarter of 2011 associated with the
acceleration of compensation expense related to the change of Chief Executive
Officers during the quarter. Further contributing to the increase in S&A were
incremental sales and marketing costs of approximately $6.9 million incurred to
support the higher sales volumes and future growth initiatives. These increases
were partially offset by a net decline in incentive and equity compensation
costs of approximately $6.0 million, as well as declines in spending in certain
areas as a result of the cost control measures that were in place due to the
recession. As a percentage of sales, overall selling and administrative expense
declined significantly to 18.9% in 2011 from 23.5% in 2010. This decline was
partially driven by our ability to grow sales organically and absorb a
significant acquisition in Curamik without materially increasing our S&A
spending. Also, Curamik's overall operating costs are lower as a percentage of
sales than our legacy segments' costs, which contributed to the percentage
decline.
Research and Development Expenses
Research and development (R&D) expenses were $21.5 million in 2011, an increase
of $3.7 million, or 20.8%, from $17.8 million in 2010. As a percentage of sales,
R&D expenses were 3.9% in 2011 and 4.8% in 2010. Historically, we have targeted
a 6% R&D investment as a percentage of net sales; however, with our sales growth
we believe that our short term R&D investment rate will be in the 4% range.
Restructuring and Impairment Charges
In the first quarter of 2012, we signed an agreement to sell our facility in
Richmond, Virginia for $1.5 million. We acquired this facility as part of the
MTI acquisition and subsequently moved operations from Richmond to our High
Performance Foams manufacturing facility in Carol Stream, Illinois, so the
facility was vacant and has been classified as held for sale since 2009. This
facility had a book value of approximately $1.8 million prior to the signing of
the agreement, and we recorded an impairment charge of approximately $0.4
million in the fourth quarter of 2011, which represents the write down to the
selling price less approximately $0.1 million of estimated selling costs.
Equity Income in Unconsolidated Joint Ventures
Equity income in unconsolidated joint ventures was $5.5 million in 2011, a
decrease of $3.2 million from $8.7 million in 2010. 2010 results included
approximately $0.9 million of equity income related to the RCCT joint venture,
which was divested in the fourth quarter of 2010. The remaining year-over-year
decrease is attributable to a decline in performance at our foam joint ventures,
Rogers INOAC Suzhou (RIS) in China and Rogers INOAC Corporation (RIC) in Japan.
Other Income (Expense), Net
Other income was $1.9 million in 2011, an increase of $0.5 million from $1.4
million in 2010. The increase is primarily due to a gain of approximately $1.9
million on the sale of a building in China, partially offset by an unfavorable
impact of $0.5 million related to foreign currency fluctuations and our related
hedging program. Also, 2010 results included commission income of $0.6 million
from PLS, which ended operations during the year.
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--------------------------------------------------------------------------------Realized Gain (Loss)
Realized gain (loss) is the portion of the auction rate security impairment that
relates to credit losses and is required to be recorded in the consolidated
statements of income (loss). The amount of loss recognized in 2011 was $0.2
million, a decrease from the $0.6 million loss recognized in 2010. The change
was attributable to market conditions surrounding the securities underlying the
auction rate securities, as well as redemption of a tranche of auction rate
securities during 2011 at less than par value.
Interest Income (Expense), Net
Interest income (expense), net was $0.2 million of interest income in 2010 and
$4.9 million of interest expense in 2011. The interest expense in 2011 was
primarily due to the recognition of $3.8 million of expense related to our
long-term debt obligations resulting from the funding of the Curamik acquisition
in the first quarter of 2011. Additionally, in 2011, we incurred approximately
$0.7 million of expense associated with a capital lease obligation that we
acquired as part of the Curamik acquisition. No such debt obligation existed in
2010.
Income Tax Expense (Benefit)
Our effective tax rate was 20.7% in 2011 and 13.2% in 2010. In both 2011 and
2010, our tax rate was favorably impacted by the tax benefit associated with
certain discrete rate items recorded during the year and also benefited from
favorable tax rates on certain foreign business activity. In 2010, our effective
tax rate was also favorably impacted by the release of a portion of the
valuation allowance against our U.S. deferred tax assets. In the fourth quarter
of 2010, we developed a tax planning strategy that would allow us to recognize
certain deferred tax assets, resulting in a partial reduction of our valuation
allowance. This strategy is based upon our ability to make a tax election to
capitalize certain expenses that will result in generating taxable income to
allow us to utilize our deferred tax assets before they expire. We would
undertake such a strategy to realize these deferred tax assets prior to
expiration only if we determined it was reasonable, prudent, and feasible. In
both 2011 and 2010, we had cumulative losses in the U.S. As the realization of
deferred taxes is principally dependent upon the achievement of future taxable
income, the estimation of which requires significant management judgment, we
concluded that given the weight of both positive and negative evidence, a
valuation allowance should be placed against a significant portion of our U.S.
deferred tax assets, for which there is neither a tax planning strategy nor
source of taxable income against which it would offset.
Our tax holiday on the earnings of our subsidiaries in China expired at the end
of 2011. Under the business license agreement granted to Rogers Technologies
(Suzhou) Company (RSZ), a wholly-owned subsidiary of ours, the first two years
of cumulatively profitable operations were taxed at a zero percent tax rate
followed by a reduced tax rate in subsequent years that gradually increased to
the 25% full rate of tax beginning in 2012. In 2011, RSZ reported pretax income
of $17.9 million which was subject to a tax rate of 24%. In 2010, RSZ reported
pretax income of $18.1 million, which was subject to a tax rate of 22%. Under
the business license agreement granted to Rogers (Shanghai) International
Trading Company Ltd. (RSH), also a wholly-owned subsidiary of ours, RSH was
subject to a reduced rate of tax that gradually increased to the 25% full rate
of tax beginning in 2012. In 2011, RSH reported pretax income of $2.4 million
which was subject to a tax rate of 24%. In 2010, RSH reported pretax income of
$4.8 million which was subject to a tax rate of 22%.
Backlog
Our backlog of firm orders was $33.1 million at December 31, 2011, as compared
to $38.7 million at December 31, 2010. The decrease at the end of 2011 was
primarily related to the decreased customer demand across almost all of our
businesses, with the largest impact at PDS, which experienced a decrease in
backlog of $3.6 million at December 31, 2011 as compared to December 31, 2010.
30
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Segment Sales and Operations
Core Strategic
High Performance Foams
(Dollars in millions)
2012 2011 2010
Net sales $ 179.4 $ 177.6 $ 149.7
Operating income (loss) 25.8 28.3 17.4
The High Performance Foams (HPF) operating segment is comprised of polyurethane
and silicone foam products, which are sold into a wide variety of markets for
various applications, such as portable communications, consumer electronics, and
mass transit markets for gaskets, sealing, and cushioning applications.
2012 vs. 2011- Net sales increased by 1.0% from $177.6 million in 2012 to $179.4
million in 2012. This improvement was driven by strong sales of the segment's
newest product introduction, PORON® XRD® extreme impact materials for molded
applications, which added $3.2 million in incremental sales in 2012, as well as
a 10.8% improvement in sales into general industrial applications, including
protective cases for mobile internet devices and automotive and hybrid electric
vehicles. These increases were partially offset by lower sales into the wind and
solar markets, which declined 40.9% in 2012 as compared to 2011.
Operating income declined by 8.7% from $28.3 million in 2011 to $25.8 million in
2012. 2012 results included approximately $7.8 million of special charges,
including $3.2 million related to the shutdown of the silicone foams
manufacturing facility in Bremen, Germany, $2.2 million of net severance related
charges as a result of our streamlining initiatives, $0.7 million in allocated
pension settlement charges (as further described in the "Selling and
Administrative Expenses" section above) and $1.0 million of allocated asbestos
charges (as further described in in the "Selling and Administrative Expenses"
section above). 2011 results included approximately $1.6 million of special
charges primarily associated with its allocated portion of the acceleration of
compensation expense related to the change of Chief Executive Officers during
the year. Excluding these special charges, operating income increased by
approximately 12.0% from 2011 to 2012 on a 1.0% increase in sales due in part to
lower costs as a result of the streamlining initiatives, which created better
operating leverage on lower sales volumes, as well as an overall favorable sales
mix. These favorable results were partially offset by approximately $1.1 million
of incremental costs incurred in 2012 as compared to 2011 related to the startup
of the PORON® XRD® molded foam product line.
2011 vs. 2010 - Net sales in this segment increased by 18.6%, from $149.7
million in 2010 to $177.6 million in 2011. Operating profits increased
significantly as well, improving by approximately 62.6% from $17.4 million in
2010 to $28.3 million in 2011. The 2010 results include approximately $0.9
million of integration costs associated with the acquisition of Utis in the
second quarter of 2010. 2011 results were driven by strong demand for the
segment's foams across almost all product lines and in geographic regions. In
particular, we continued to experience success with our polyurethane foam
products in cushioning, sealing and energy management for portable electronic
devices, particularly large touch-screen mobile internet devices. Sales of our
silicone foams gained momentum in 2011 due to increased demand in various
markets, including aircraft, communications infrastructure, solar power, and
hybrid electric vehicle applications. HPF also gained traction in one of its
newest product lines, PORON® molded components, primarily for applications in
sports and impact apparel, as well as mobile internet devices. Like most of our
other segments, HPF experienced a decline in sales volumes in the fourth quarter
of 2011, which we believe was driven by the rationalizing of inventory in the
marketplace, as well as global economic trends.
Printed Circuit Materials
(Dollars in millions)
2012 2011 2010
Net sales $ 161.9 $ 166.4 $ 141.1
Operating income (loss) 8.2 11.1 11.0
The Printed Circuit Materials (PCM) operating segment is comprised of high
frequency circuit material products used for making circuitry that receive,
process and transmit high frequency communications signals, in a wide variety of
markets and applications, including wireless communications, high reliability,
and automotive, among others.
2012 vs. 2011- Net sales in 2012 were $161.9 million, a decline of 2.7% from
$166.4 million in 2011. The decline was due primarily to a 19.7% decline in
sales into high reliability applications, as well as a 21.1% decline into the
satellite TV market for LNB (Low Noise Blockdown) converters. These declines
were partially offset by a 72.5% increase in sales into the automotive
31
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market primarily for radar safety sensor applications, as our laminate products
continue to gain traction in the market, as well as a 73.2% increase in sales in
new base station antenna applications for communications infrastructure.
Operating income declined by 26.1% from $11.1 million in 2011 to $8.2 million in
2012. 2012 results included approximately $2.3 million of net special charges
comprised primarily of $2.9 million in severance charges incurred as part of our
overall streamlining initiatives, $0.6 million in charges related to pension
settlement accounting (as further described in the "Selling and Administrative
Expenses" section above), and $0.9 million of allocated asbestos charges (as
further described in in the "Selling and Administrative Expenses" section
above). These charges were partially offset by a one-time benefit of $2.1
million related to inventory valuation adjustments and $0.5 million related
to an insurance reimbursement of a previously settled product liability
claim. 2011 results included approximately $1.1 million of special charges
primarily associated with its allocated portion of the acceleration of
compensation expense related to the change of Chief Executive Officers during
the year. Excluding these special charges, operating income decreased by
approximately 13.6% from $12.2 million in 2011 to $10.5 million in 2012. This
decline is primarily attributable to the decline in sales volumes, as well as
the impact from the 15.9% decrease in inventory during the year. These declines
were partially offset by lower spending as a result of our streamlining
initiatives.
2011 vs. 2010 - Net sales in this segment increased by 18.0% in 2011 to $166.4
million from $141.1 million in 2010, while operating income remained relatively
flat year over year. 2010 results included a one-time benefit of $2.5 million
from the recovery of insurance proceeds related to the CalAmp lawsuit, which had
been previously settled in 2008. In 2011, the segments growth was driven by
strong demand in the wireless infrastructure market, primarily due to expansion
of third generation (3G) and fourth generation (4G) systems globally, as well as
for antenna radar applications for the high reliability and automotive markets.
Demand was also strong for materials used in the aerospace, defense and other
high reliability markets, as well as in the automotive market for radar safety
sensors and in satellite televisions. At the end of 2011, particularly in the
fourth quarter, sales in this segment declined significantly from levels
achieved in the first three quarters of the year. We believe this decline was
driven by global economic trends, as well as the rationalization of inventory in
the supply chain.
Power Electronics Solutions
• Curamik Electronics Solutions
(Dollars in millions)
2012 2011 2010
Net sales $ 92.4 $ 132.9 $ -
Operating income (loss) (11.7 ) 7.8 -
The Curamik Electronics Solutions (CES) operating segment is comprised of power
electronic substrate products, which are used primarily in the design of
intelligent power management devices, such as IGBT (insulated gate bipolar
transistor) modules that enable a wide range of products including highly
efficient industrial motor drives, wind and solar energy converters and
electrical systems in automobiles. We acquired the business on January 4, 2011.
2012 vs. 2011- On a year to date basis, net sales declined by 30.5% from $132.9
million in 2011 to $92.4 million in 2012. This decline was due primarily to the
continued lower demand in renewable energy and industrial motor drive
applications, which declined 15.0% and 31.0%, respectively, in 2012 as compared
to 2011, as well as further inventory corrections in the supply chain. We
believe that these markets will remain at these levels for the near term, but
the long term outlook remains positive. Also contributing to the decline in
sales is the impact of foreign currency exchange rates, which contributed
approximately $6.2 million to the overall sales decline as the USD appreciated
against the Euro by approximately 8.7% during 2012 as compared to 2011. The
segment transacted approximately 82% in 2012 in Euro as compared to 77% in 2011.
As CES works through this current downturn, we continue to look for ways to
improve the segment's cost structure and better serve our customers. Early in
the third quarter of 2012, we announced a plan to relocate the final inspection
operations from our facility in Eschenbach, Germany to Hungary. The move is
expected to enable more cost effective performance of the inspecting operations.
We expect the move to be complete in 2013.
Overall, operating results declined from operating income of $7.8 million in
2011 to an operating loss of $11.7 million in 2012. 2012 results included
approximately $7.4 million of special charges consisting primarily of the
following: $3.8 million in severance charges related to the move to Hungary (as
described above); $1.4 million in severance related charges as part of the
Company's streamlining initiatives; $0.6 million related to the reserve of an
uncollectible receivable, $0.6 million related to the allocated portion of one
time asbestos charges (as further described in the "Selling and Administrative
Expenses" section above), and $0.4 million in charges related to pension
settlement accounting (as further described in the "Selling and Administrative
Expenses" section above). Excluding these charges, CES operating loss for 2012
was $4.2 million. This overall decline in results can be directly attributable
to the decline in volumes and the associated contribution loss on those sales,
partially offset by lower spending as a result of our streamlining initiatives.
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2011 vs. 2010 - Net sales in this segment were $132.9 million in 2011 and
operating profits were $7.8 million. These volumes represent a record for the
segment, and its performance for the year exceeded our initial expectations with
sequential growth in the first three quarters of the year, followed by a decline
in sales in the fourth quarter (as experienced by all of our core segments). The
overall 2011 results were driven by strong demand for the segments products
across its primary markets, which consist of energy efficient motor drives, wind
and solar power generations, and HEV/EB applications, and regions, which include
Europe and Japan. At the end of the year, the decline in volumes was due
primarily to lower demand in wind and general industrial applications, as well
as from customers reducing their inventory levels.
Curamik's operating results included approximately $1.3 million of one-time
costs associated with the acquisition and integration of the business, including
consulting, legal and audit fees, as well as severance charges and other
integration costs. 2011 results also included approximately $3.5 million of
non-cash amortization charges related to the intangible assets created as part
of the purchase of the business (see Note 6 to the Consolidated Financial
Statements in the 2011 Form 10-K) and approximately $1.8 million of one-time
non-cash charges related to the amortization of the step-up of inventory to its
fair value at the acquisition date.
• Power Distribution Systems
(Dollars in millions)
2012 2011 2010
Net sales $ 41.9 $ 47.3 $ 42.1
Operating income (loss) (0.4 ) 3.5 2.9
The Power Distribution Systems (PDS) operating segment designs and manufactures
busbars, which are used primarily in power distribution systems products in mass
transit and clean technology applications.
2012 vs. 2011- Net sales in 2012 were $41.9 million, a decline of 11.5% from
$47.3 million in 2011. The decline was due primarily to the significant slowdown
in spending on infrastructure projects in the mass transit and renewable energy
markets, particularly in Europe and China, as sales declined by 28.0% and 25.0%,
respectively, in those regions. Also, overall sales into the renewable energy
market declined by 34.1% as the wind and solar energy markets continue to
lag. These declines were partially offset by strong sales into the mass transit
and automotive markets in North America, which increased in total by 88.4% in
2012 as compared to 2011.
Operating results declined from operating income of $3.5 million in 2011 to an
operating loss of $0.4 million in 2012. 2012 results included $1.8 million of
special charges comprised primarily of $0.7 million of charges related to the
shut-down of manufacturing operations in North America, $0.4 million of other
severance and allocated pension settlement related charges (as further described
in the "Selling and Administrative Expenses" section above), and $0.2 million of
allocated asbestos charges (as further described in in the "Selling and
Administrative Expenses" section above). The remaining decline in operating
performance can be primarily attributable to the lost contribution related to
the decline in sales volumes described above, partially offset by lower spending
as a result of our streamlining initiatives.
2011 vs. 2010 - Net sales in this segment increased by 12.4% from $42.1 million
in 2010 to $47.3 million in 2011, while operating profit increased from $2.9
million in 2010 to $3.5 million in 2011. These increases were driven by strong
demand over the first nine months of the year for this segment's products in
mass transit and power electronic applications. In the fourth quarter of 2011,
this segment began experiencing softening sales in mass transit and wind
turbines. In particular, the PDS segment experienced lower demand for its
products in the fourth quarter due primarily to the temporary suspension of
railway construction investments by the Ministry of Railways (MOR) in China as a
result of their debt issues and the safety investigation initiated after a train
crash in Wenzhou, Zhejiang province in July 2011, in which two high-speed bullet
trains collided. The MOR had decided to continue the railway investment plans
but at a slightly slower pace than their initial plan. China also addressed the
issues with wind and solar energy connections to the grid, all of which are
unrelated to the performance of our products.
Other
(Dollars in millions)
2012 2011 2010
Net sales $ 23.2 $ 24.0 $ 40.4
Operating income (loss) 3.8 2.7 0.3
Our Other reportable segment consists of our elastomer rollers and floats
products, as well as the inverter distribution business.
In the second quarter of 2012, we decided to cease production of non-woven
composite materials products in an effort to redeploy resources to focus on our
Core Strategic segments. At December 31, 2012, manufacturing operations have
been shut down and final sales are expected to occur in the first quarter of
2013. Additionally, during the fourth quarter of 2011, we also ended operations
33
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at our Thermal Management Solutions (TMS) operating segment. These operating
segments are being treated as a discontinued operations and their results are no
longer included in this reportable segment. All prior periods have been recast
to reflect such changes.
2012 vs 2011- Net sales declined 3.3% from $24.0 million 2011 to $23.2 million
2012. The decline in sales is primarily due to a 45.4% decline in sales of
inverter products from our legacy Durel business; which was partially offset by
a 9.1% increase in sales of elastomer component and float products.
Operating results improved by 40.7% from an operating profit of $2.7 million in
2011 to $3.8 million in 2012. 2012 results included approximately $0.5 million
of special charges related primarily to allocated severance and pension
settlement related costs. The improvement in operating profit is due primarily
to the operating performance of the elastomer component and float products,
which improved by 123.6% due to increased volumes and other cost reduction
initiatives.
2011 vs. 2010 - In 2011, sales in the segment declined by approximately 40.6%
from $40.4 million in 2010 to $24.0 million in 2011. 2010 results included
approximately $13.5 million in sales from distribution activities related to our
former joint venture with Mitsui Chemicals, Inc. of Japan, Polyimide Laminate
Systems, LLC (PLS) distribution activities, which reached end of life in 2010.
The remainder of the decline was related to the further decline in the
electroluminescent lamps (EL) sales. However, even though volumes declined,
operating profit improved from $0.3 million in 2010 to $2.7 million in 2011. The
improvement was driven by sales of inverter products, offset by the end of the
PLS distribution sales.
Joint Ventures
Rogers INOAC Corporation (RIC)
RIC, our joint venture with Japan-based INOAC Corporation, was established over
25 years ago and manufactures high performance PORON urethane foam materials in
Japan. Sales remained consistent from 2011 to 2012, following a decrease of 9%
from 2010 to 2011. The decline in sales in 2011 was due primarily to the
continued weakness in the Japanese domestic and export markets, particularly LCD
TV's, domestic mobile phones and general industrial applications.
Rogers INOAC Suzhou Corporation (RIS)
RIS, our joint venture agreement with INOAC Corporation for the purpose of
manufacturing PORON urethane foam materials in China, began operations in 2004.
Sales declined 15% from 2011 to 2012, and decreased 12% from 2010 to 2011. Sales
declined due to increased softening in the Asian markets it serves.
Discontinued Operations
In the fourth quarter of 2011, we made the strategic decision to end the
operations of our TMS operating segment. We had invested in its operations for
the last few years, but had difficulty gaining traction in the market and
working through issues in the manufacturing process. Therefore, we determined
that we would not achieve future success in this operation and chose to shut
down operations rather than invest further. For the years ended December 31,
2012, 2011 and 2010, operating losses of $0.1 million, $6.8 million and $3.8
million, net of tax, respectively, were reflected as discontinued operations in
the accompanying consolidated statements of income (loss). Net sales associated
with the discontinued operations for the years ended December 31, 2012, 2011 and
2010 were $0.1 million, $0.9 million and $1.0 million, respectively. The tax
related to the discontinued operations was immaterial for 2012 and was $0.1
million and $0.1 million of tax expense for December 31, 2011 and 2010,
respectively.
In the second quarter of 2012, we decided to cease production of our non-woven
composite materials operating segment located in Rogers, Connecticut in an
effort to redeploy resources to focus more on our Core Strategic operations.
Sales of non-woven products have been steadily declining for several years and
totaled approximately $5.3 million for the year ended December 31, 2012 and $4.8
million for the year ended December 31, 2011 and $5.0 million for the year ended
December 31, 2010. Manufacturing operations were complete by the end of 2012 and
last sales out of inventory are expected to end in the first quarter of 2013.
For the year ended December 31, 2012, operating loss of $0.1 million and for the
year ended December 31, 2011 and 2010, operating losses of $0.4 million and $0.2
million, net of tax, respectively, were reflected as discontinued operations in
the accompanying consolidated statements of income (loss). The tax related to
the discontinued operations was $0.1 million , $0.2 million and $0.1 million of
tax expense for December 31, 2012, 2011 and 2010, respectively.
34
--------------------------------------------------------------------------------Product and Market Development
Our research and development team is dedicated to growing our business by
developing cost effective solutions that enable or improve upon the performance
of customers' products, as well as identifying business and technology
acquisition opportunities to expand our market presence. Our long-term plan is
to invest in the range of 6% of net sales annually into research and
development. Currently, R & D spend is in the 4% of sales range; however, going
forward, we plan to invest more in R&D activities as we work to grow the Company
both organically and through external investments.
Liquidity, Capital Resources and Financial Position
We believe that our ability to generate cash from operations to reinvest in our
business is one of our fundamental strengths. While the U.S. financial markets
have grown more stable since the global recession of 2008, significant
volatility still remains in the global markets, particularly in Europe. We
believe that our existing sources of liquidity and cash flows that are expected
to be generated from our operations, together with our available credit
facilities, will be sufficient to fund our operations, capital expenditures,
research and development efforts, and debt service commitments, as well as our
other operating and investing needs, for at least the next twelve months. We
continue to have access to the remaining portion of the line of credit available
under the Amended Credit Agreement (as defined in the Credit Facilities section
which follows), as amended, should any issue or strategic opportunities
arise. We continually review and evaluate the adequacy of our cash flows,
borrowing facilities and banking relationships to ensure that we have the
appropriate access to cash to fund both our near-term operating needs and our
long-term strategic initiatives.
(Dollars in thousands)
Key Balance Sheet Accounts: December 31, 2012 December 31, 2011
Cash and cash equivalents $ 114,863 $ 79,728
Accounts receivable 78,788 77,286
Inventory 73,178 77,935
Outstanding borrowing on credit facilities (short term
and long term) 98,000 122,500
(Dollars in thousands)
Key Cash Flow Measures: December 31, 2012 December 31, 2011
Cash provided by (used in) operating activities of
continuing operations
$ 40,367 22,084
Cash provided by (used in) investing activities of
continuing operations
1,368 (145,836 )
Cash provided by (used in) financing activities of
continuing operations
(8,455 ) 128,266
At December 31, 2012, cash and cash equivalents were $114.9 million as compared
to $79.7 million at the end of 2011, an increase of $35.2 million, or
approximately 44.2%. This increase was due primarily to the following: (i)
liquidation of the auction rate securities portfolio, resulting in net proceeds
of $25.4 million; (ii) $17.0 million received for stock option exercises; (iii)
$1.4 million received for the sale of our facility in Richmond, Virginia; and
(iv) cash generated from operations. These increases in cash were partially
offset by cash outlays of (i) $16.0 million in contributions to our defined
benefit pension plan; (ii) $24.5 million of payments on our debt facility; (iii)
a $6.2 million pension retirement payout to the former CEO; and (iv) $6.6
million of annual incentive compensation payments related to 2011 performance.
The following table illustrates the location of our cash and cash equivalents by
our three major geographic areas as of the periods indicated:
(Dollars in thousands) 2012 2011 2010
U.S. $ 26,813 $ 20,027 $ 27,305
Europe 47,918 35,259 20,954
Asia 40,132 24,442 31,876
Total cash and cash equivalents $ 114,863 $ 79,728 $ 80,135
Cash held in certain foreign locations could be subject to additional taxes if
we repatriated such amounts back to the U.S. from foreign countries that have a
lower tax rate than in the U.S. Our current policy is that the historical
earnings and cash in these locations will be permanently reinvested in those
foreign locations.
35
--------------------------------------------------------------------------------Working capital was $221.7 million, $186.2 million and $155.3 million in 2012,
2011 and 2010, respectively.
Significant changes in our balance sheet accounts from December 31, 2011 to
December 31, 2012 are as follows:
Inventories decreased $4.7 million, or 6.1%, from $77.9 million at December
31, 2011 to $73.2 million at December 31, 2012. This decrease is primarily
attributable to our focus on working capital management and lowering
inventory levels to better match current demand.
Long-term marketable securities, which represents the value of auction rate
securities, had a balance of $25.9 million at December 31, 2011. These
securities were completely liquidated during 2012. As of December 31, 2012,
we do not have any long-term marketable securities on our balance sheet.
Long-term asbestos-related insurance receivables increased from $21.9 million
at December 31, 2011 to $40.1 million at December 31, 2012 and
asbestos-related liabilities increased from $22.3 million at December 31,
2011 to $43.2 million at December 31, 2012. These increases are due to the
change in the forecast period for asbestos-related claims from 5 years to 10
years, which occurred in the fourth quarter of 2012.
Overall, our debt position declined by $24.5 million from $122.5 million at
December 31, 2011 to $98.0 million at December 31, 2012 due to payments made
on the facilities during 2012. Long-term debt decreased by $37.5 million from
$115.0 million at December 31, 2011 to $77.5 million at December 31, 2012,
while the current portion of long term debt increased by $13.0 million from
$7.5 million at December 31, 2011 to $20.5 million at December 31, 2012. This
increase in the short term portion of the debt is due to management
anticipating additional voluntary principal payments combined with an
increase in the scheduled payments for our debt facility over the next twelve
months.
Accrued employee benefits and compensation decreased by 23.0% from $30.1
million at December 31, 2011 to $23.2 million at December 31, 2012. This
decrease is primarily attributable to the $6.0 million decline in the accrual
for the annual incentive compensation plan in 2012 as compared to 2011.
During 2012, we had $1.4 million of net cash provided by investing activities as
compared to $145.8 million of net cash used in investing activities in 2011 and
$22.2 million in 2010 of net cash used in investing activities. The investing
activities in 2012 includes liquidating our auction rate security portfolio,
receiving net proceeds of $25.4 million. For 2011, investing activities included
the acquisition of Curamik, net of cash acquired, for $139.8 million. Investing
activities in 2010 include $25.9 million related to the purchase of Utis.
Capital expenditures were $23.8 million, $21.3 million and $12.2 million in
2012, 2011 and 2010, respectively.
Net cash used in financing activities was $8.5 million in 2012 and net cash
provided by financing activities were $128.3 million and $1.5 million in 2011
and 2010, respectively. 2011 was impacted by the initial draw on the line of
credit for $145.0 million to fund the acquisition of Curamik.
Credit Facilities
On July 13, 2011, we entered into an amended and restated $265.0 million secured
five year credit agreement. This credit agreement ("Amended Credit Agreement")
is with (i) JPMorgan Chase Bank, N.A., as administrative agent; (ii) HSBC Bank
USA, National Association; (iii) RBS Citizens, National Association; (iv) Fifth
Third Bank; and (v) Citibank, N.A. JPMorgan Securities LLC and HSBC Bank USA,
National Association acted as joint bookrunners and joint lead arrangers; HSBC
Bank USA, National Association and RBS Citizens, National Association acted as
co-syndication agents; and Fifth Third Bank and Citibank, N.A. acted as
co-documentation agents. The Amended Credit Agreement amends and restates the
credit agreement signed between the Company and the same banks on November 23,
2010 and increased our borrowing capacity from $165.0 million under the original
agreement to $265.0 million under the Amended Credit Agreement.
Key features of the Amended Credit Agreement, as compared to the November 23,
2010 credit agreement, include (1) an increase in credit from $165.0 million to
$265.0 million with the addition of a $100.0 million term loan; (2) the
extension of maturity from November 23, 2014 to July 13, 2016; (3) a 25 basis
point reduction in interest costs; (4) an increase in the size of permitted
acquisitions from $25.0 million to $100.0 million; and (5) an increase in
permitted additional indebtedness from $20.0 million to $120.0 million.
The Amended Credit Agreement provides for the extension of credit in the form of
(1) a $100.0 million term loan (which refinances outstanding borrowings in the
amount of $100.0 million from the existing revolving credit line), as further
described below; and (2) up to $165.0 million of revolving loans, in multiple
currencies, at any time and from time to time until the maturity of the Amended
Credit Agreement, on July 13, 2016. We may borrow, pre-pay and re-borrow amounts
under the $165.0 million revolving portion of the Amended Credit Agreement;
however, with respect to the $100.0 million term loan portion, any principal
amounts re-paid may not be re-borrowed. Borrowings may be used to finance
working capital needs, for letters of credit and for general corporate purposes
in the ordinary course of business, including the financing of permitted
acquisitions (as defined in the Amended Credit Agreement).
36
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Borrowings under the Amended Credit Agreement will bear interest based on one of
two options. Alternate base rate loans will bear interest that includes a base
reference rate plus a spread of 75 - 150 basis points, depending on our leverage
ratio. The base reference rate will be the greater of the (1) prime rate; (2)
federal funds effective rate plus 50 basis points; and (3) adjusted 1-month
London interbank offered ("LIBO") rate plus 100 basis points. Eurocurrency loans
will bear interest based on the adjusted LIBO rate plus a spread of 175 - 250
basis points, depending on our leverage ratio.
In addition to interest payable on the principal amount of indebtedness
outstanding from time to time under the Amended Credit Agreement, the Company is
required to pay a quarterly fee of 0.20% to 0.35% (based upon its leverage
ratio) of the unused amount of the lenders' commitments under the Amended Credit
Agreement.
In connection with the Amended Credit Agreement, we transferred borrowings in
the amount of $100.0 million from the revolving credit line under the November
23, 2010 credit agreement to the term loan under the Amended Credit
Agreement. The Amended Credit Agreement requires the mandatory quarterly
repayment of principal of amounts borrowed under such term loan. Payments
commenced on September 30, 2011, and are scheduled to be completed on June 30,
2016. The aggregate payments due are as follows:
2011 $2.5 million
2012 $7.5 million
2013 $12.5 million
2014 $17.5 million
2015 $35.0 million
2016 $25.0 million
The Amended Credit Agreement is secured by many of the assets of Rogers and our
World Properties, Inc, subsidiary, including but not limited to, receivables,
equipment, intellectual property, inventory, stock in certain subsidiaries and
real property.
As part of the Amended Credit Agreement, we are restricted in our ability to
perform certain actions, including, but not limited to, our ability to pay
dividends, incur additional debt, sell certain assets, and make capital
expenditures, with certain exceptions. Further, we are required to maintain
certain financial covenant ratios, including a leverage ratio of no more than
3.0 to 1.0 and a minimum fixed charge coverage ratio (FCCR) of 1.25 to 1.0. This
ratio measures the Company's ability to cover its fixed charge obligations. The
key components of fixed charges are capital expenditures, scheduled debt
payments, capital lease payments, income taxes paid in cash, rent and interest
expenses.
In the first quarter of 2012, through an amendment to the Amended Credit
Agreement, the FCCR was modified from 2.50 to 1.25 of Adjusted Earnings Before
Interest Taxes Depreciation and Amortization (EBITDA). Several factors
contributed to the need for an amendment to this covenant. The 2.50 ratio was
based on a more robust set of financial projections, and these have moderated to
some extent with the recent events in the marketplace and the overall global
economy, particularly in Europe and China. Additionally, there were no mandatory
term loan payments when the original ratio was determined, which would further
stress the ratio. Finally, we forecasted an increase in planned capital
investment to support certain strategic initiatives, which added pressure to the
ratio as well.
Relevant Fixed Charge metrics are detailed in the table below.
Periods Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012
Covenant Limit (minimum) 2.50 1.25 1.25 1.25 1.25
Actual FCCR 2.60 2.27 2.09 1.93 2.18
As of December 31, 2012, we were in compliance with all of our covenants, as we
achieved actual ratios of approximately 1.35 on the leverage ratio and 2.18 on
the fixed charge coverage ratio.
If an event of default occurs, the lenders may, among other things, terminate
their commitments and declare all outstanding borrowings to be immediately due
and payable together with accrued interest and fees. We are in compliance with
all financial and other covenants as of December 31, 2012.
In connection with the establishment of the initial credit in 2010, we
capitalized approximately $2.3 million of debt issuance costs and, in connection
with the Amended Credit Agreement, as amended, we capitalized an additional $0.1
million of debt issuance costs in 2012. These costs will be amortized over the
life of the Amended Credit Agreement, as amended, which will terminate in June
2016. We incurred amortization expense of $0.5 million for the years ended 2012
and 2011, respectively. At December 31, 2012, we have approximately $1.8 million
of credit facility costs remaining to be amortized.
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In the first quarter of 2011, we made an initial draw on the line of credit of
$145.0 million to fund the acquisition of Curamik. During 2012, we made
principal payments of $24.5 million on the debt. We made $22.5 million of
principal payments in fiscal 2011. We are obligated to pay $12.5 million on this
debt obligation and are scheduling $8.0 million of discretionary revolver
payments within the next 12 months. As of December 31, 2012, our outstanding
debt related to the Amended Credit Agreement, as amended, consists of $90.0
million of term loan debt and $8.0 million on the revolving line of credit. We
have the option to pay part of or the entire amount at any time over the
remaining life of the Amended Credit Agreement, as amended, with any balance due
and payable at the agreement's expiration.
In addition, as of December 31, 2012 we had the following standby letter of
credit (LOC) and guarantees that were backed by the Amended Credit Agreement, as
amended:
• $1.4 million letter of credit to guarantee Rogers workers compensation plan;
• $0.1 million letter guarantee to guarantee a payable obligation for a
Chinese subsidiary (Rogers Suzhou);
• $0.1 million letter guarantee to guarantee a payable obligation for a
Chinese subsidiary (Rogers Suzhou) .
Interest
We incurred interest expense on our outstanding debt of $2.9 million for the
year ended December 31, 2012 and $3.8 million for the year ended December 31,
2011. We incurred an unused commitment fee of approximately $0.4 million for the
year ended December 31, 2012 and approximately $0.2 million for the year ended
December 31, 2011. In July 2012, we entered into an interest rate swap to hedge
the variable interest rate on 65% of the term loan debt, then outstanding,
effective July 2013. At December 31, 2012, the term loan debt amounted to $90.0
million of our total outstanding debt of $98.0 million. At December 31, 2012,
the rate charged on this debt is the 1 month LIBOR at 0.25% plus a spread of
2.25%.
We also incurred interest expense on the capital lease of $0.6 million and $1.0
million for the years ended December 31, 2012 and 2011, respectively.
Capital Lease
During the first quarter of 2011, we recorded a capital lease obligation related
to the acquisition of Curamik for its primary manufacturing facility in
Eschenbach, Germany. We have an option to purchase the property in either 2013
or upon the expiration of the lease in 2021 at a price which is the greater of
(i) the then-current market value or (ii) the fiscal residual book value of the
land including the buildings and installations thereon. The total obligation
recorded for the lease as of December 31, 2012 is $8.4 million. Depreciation
expense related to the capital lease was $0.4 million for the years ending
December 31, 2012 and 2011. These expenses are included as depreciation expense
in Cost of Sales on our consolidated statements of income (loss). Interest
expense related to the debt recorded on the capital lease is included in
interest expense on the consolidated statements of income (loss). See "Interest"
section above for further discussion.
Auction Rate Securities
During the first quarter of 2012, we liquidated our auction rate securities
portfolio, receiving net proceeds of $25.4 million on a stated par value of
$29.5 million. As a result of this liquidation, we recognized a loss on the
discount of the securities of $3.2 million (the remaining difference between the
liquidation proceeds and par value of $0.9 million had previously been
recognized as an impairment loss). Since the markets for these securities failed
in the first quarter of 2008, we had already redeemed $24.9 million of these
securities, mostly at par. However, due to the fact that par value redemptions
had recently slowed with no clear path for full redemption over the next several
years and the rate of return on these securities was very low, management
determined that a discounted redemption of the remainder of the portfolio was in
the best financial interests of the Company.
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Contractual Obligations
The following table summarizes our significant contractual obligations as of
December 31, 2012:
(Dollars in thousands) Payments Due by Period
Less than 1 More than 5
Total Year 1-3 Years 3-5 Years Years
Operating leases $ 5,739 $ 2,457 $ 1,933 $ 908 $ 441
Capital lease 7,484 1,422 1,617 1,616 2,829
Interest payments on capital lease 3,665 537 972 982 1,174
Inventory purchase obligation 10,845 10,845 - - -
Capital commitments 7,342 7,342 - - -
Pension and retiree health and life
insurance benefits (1) 104,227 8,925 17,667 18,909 58,726
Outstanding borrowings on credit
facilities 98,000 12,500 52,500 33,000 -
Interest payments on outstanding
borrowings (2) 7,782 2,954 4,359 469 -
Total $ 245,084 $ 46,982 $ 79,048 $ 55,884 $ 63,170
(1) Pension benefit payments, which amount to $92.1 million, are expected to be
paid through the utilization of pension plan assets; retiree health and life
insurance benefits, which amount to $12.1 million, are expected to be paid
from operating cash flows.
(2) Estimated future interest payments are based on (1) rates that range from
0.32% to 1.56%, which take into consideration projected forward LIBOR rates,
(2) a leverage-based spread and (3) the related impact of the interest rate
swap.
Other long-term liabilities, such as deferred taxes, unrecognized tax benefits
and asbestos-related product liability reserves, have been excluded from the
table due to the uncertainty of the timing of payments combined with the absence
of historical trends to be used as a predictor for such payments.
Effects of Inflation
We do not believe that inflation had a material impact on our business, sales,
or operating results during the periods presented.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have, or are, in the
opinion of management, reasonably likely to have, a current or future material
effect on our financial condition or results of operations.
Critical Accounting Policies
Our Consolidated Financial Statements are prepared in accordance with U.S.
generally accepted accounting principles, which require management to make
estimates, judgments and assumptions that affect the amounts reported in the
financial statements and accompanying notes. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances and believe that appropriate reserves have been
established based on reasonable methodologies and appropriate assumptions based
on facts and circumstances that are known; however, actual results may differ
from these estimates under different assumptions or conditions. An accounting
policy is deemed to be critical if it requires an accounting estimate to be made
based on assumptions that are highly judgmental and uncertain at the time the
estimate is made, if different estimates could reasonably have been used, or if
changes to those estimates are reasonably likely to periodically occur that
could affect the amounts carried in the financial statements. These critical
accounting policies are as follows:
Revenue Recognition
We recognize revenue when all of the following criteria are met: (1) we have
entered into a binding agreement, (2) the product has shipped and title has
passed, (3) the sales price to the customer is fixed or is determinable, and (4)
collectability is reasonably assured. We recognize revenue based upon a
determination that all criteria for revenue recognition have been met, which,
based on the majority of our shipping terms, is considered to have occurred upon
shipment of the finished product. Some shipping terms require the goods to be
through customs or be received by the customer before title passes. In those
instances, revenues are not recognized until either the customer has received
the goods or they have passed through customs, depending on the circumstances.
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As appropriate, we record estimated reductions to revenue for customer returns
and allowances and warranty claims. Provisions for such allowances are made at
the time of sale and are typically derived from historical trends and other
relevant information.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is established to represent our best
estimate of the net realizable value of the outstanding accounts receivable. The
allowance for doubtful accounts is determined based on a variety of factors that
affect the potential collectability of receivables, including length of time
receivables are past due, customer credit ratings, financial stability of
customers, specific one-time events and past customer history. In addition, in
circumstances when we are made aware of a specific customer's inability to meet
its financial obligations, a specific allowance is established. The majority of
accounts are individually evaluated on a regular basis and appropriate reserves
are established as deemed appropriate based on the criteria previously
mentioned. The remainder of the reserve is based on our estimates and takes into
consideration historical trends, market conditions and the composition of our
customer base. The risk with this estimate is associated with failure to become
aware of potential collectability issues related to specific accounts and
thereby becoming exposed to potential unreserved losses. Historically, our
estimates and assumptions around the allowance have been reasonably accurate and
we have processes and controls in place to closely monitor customers and
potential credit issues. Additionally, we have credit insurance on certain
accounts that mitigates some of the risk of loss. Over the past three years, our
allowance as a percentage of total receivables has ranged from 1.3% to 2.6%. A
50 basis point increase in our current year allowance to receivable ratio would
increase our allowance reserve by approximately $0.4 million.
Inventory Valuation
Inventories are stated at the lower of cost or market with costs determined
primarily on a first-in first-out basis. We also maintain a reserve for excess,
obsolete and slow-moving inventory that is primarily developed by utilizing both
specific product identification and historical product demand as the basis for
our analysis. Products and materials that are specifically identified as
obsolete are fully reserved. In general, most products that have been held in
inventory greater than one year are fully reserved unless there are mitigating
circumstances, including forecasted sales or current orders for the product. The
remainder of the allowance is based on our estimates, and fluctuates with market
conditions, design cycles and other economic factors. Risks associated with this
allowance include unforeseen changes in business cycles that could affect the
marketability of certain products and an unexpected decline in current
production. We closely monitor the market place and related inventory levels and
have historically maintained reasonably accurate allowance levels. In addition,
we value certain inventories using the last-in, first-out (LIFO) method.
Accordingly, a LIFO valuation reserve is calculated using the link chain index
method and is maintained to properly value these inventories. Our obsolescence
reserve has ranged from 8.6% to 18.1% of gross inventory over the last three
years. A one hundred basis point increase to the December 31, 2012 obsolescence
reserve would increase the reserve by approximately $1.1 million.
Goodwill and Other Intangibles
We have made acquisitions over the years that included the recognition of
goodwill and other intangible assets. Goodwill and indefinite lived intangibles
are tested for impairment annually or more frequently if events or changes in
circumstances indicate the carrying value may have been impaired. Application of
the goodwill impairment test requires significant judgment, including the
identification of reporting units, assignment of assets and liabilities to
reporting units, and determination of the fair value of each reporting unit.
Determining the fair value of a reporting unit is subjective and requires the
use of significant estimates and assumptions, including revenue growth rates and
operating margins, discount rates, and future market conditions, among others.
We review goodwill for impairment using a two-step process. The first step of
the impairment test requires a comparison of the implied fair value of each of
our reporting units to the respective carrying value. If the carrying value of a
reporting unit is less than its implied fair value, no indication of impairment
exists and a second step is not performed. If the carrying amount of a reporting
unit is higher than its fair value, there is an indication that impairment may
exist and a second step must be performed. In the second step, the impairment is
computed by comparing the implied fair value of the reporting unit's goodwill
with the carrying amount of the goodwill. If the carrying amount of the
reporting unit's goodwill is greater than the implied fair value of its
goodwill, an impairment loss must be recognized for the excess and charged to
operations.
In 2012, we estimated the fair value of our reporting units using an income
approach based on the present value of future cash flows. We believe this
approach yields the most appropriate evidence of fair value as our reporting
units are not easily compared to other corporations involved in similar
businesses. We further believe that the assumptions and rates used in our annual
impairment test are reasonable, but inherently uncertain. We perform our annual
goodwill impairment testing in the fourth quarter of the year. However, since
the Curamik Electronics Solutions operating segment (also a reporting unit as
defined for this test) results declined substantially in 2012 as compared to
2011, we determined that this decline was an indicator of impairment and
performed an interim impairment test as of September 30, 2012. In accordance
with applicable accounting guidance, we chose to perform Step 1 of the goodwill
impairment test, which compared the fair value of the Curamik Electronics
Solutions operating segment to its carrying amount (including goodwill and
definite and indefinite-lived intangible assets). The fair value of the
operating segment
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was determined using a discounted cash flow model based on our most recent
forecasts of the business, taking into consideration macro-economic and other
market trends known to us at that time. Based on this model, we determined that
the fair value of the operating segment exceeded its carrying amount by
approximately 14.6% and that no impairment of goodwill existed as of September
30, 2012. From a sensitivity perspective, if the fair value of the Curamik
Electronics Solutions operating segment declined by 10% , the fair value of the
operating unit would exceed the carrying value by approximately 3.1% . These
amounts are both significantly lower than the calculation performed in the
fourth quarter of 2011 (our annual impairment test date), which yielded a fair
value that was approximately 55.1% in excess of the operating segment's carrying
value, which reflects the current decline in the segment's results. In the
fourth quarter of 2012, we reviewed the assumptions utilized in the third
quarter of 2012 discounted cash flow model and no facts or circumstances existed
that would cause us to change any of the underlying assumptions in that original
model. Therefore, we concluded that no impairment existed as of December 31,
2012. CES had approximately $78.8 million of goodwill associated with it at
December 31, 2012.
We believe that the assumptions and rates used in the impairment test related to
Curamik Electronics Solutions are reasonable, but inherently uncertain. The key
assumptions used in the discounted cash flow model include a discount rate of
14%, terminal growth rate of 3%, sales growth rate that ranges from 0% to 18.6%
with a compounded annual growth rate of approximately 11% over the projected
period, and an improving operating profit margin driven by current streamlining
initiatives and better leverage on growing sales volumes. These assumptions are
based on our current understanding of the markets, products and customers of
Curamik Electronics Solutions, as well as projections for raw material prices,
sales prices, and incremental cost streamlining initiatives, among others, over
the period of the discounted cash flow model. If we fail to achieve the
forecasted growth rates or the margin improvements assumed in the model or other
assumptions utilized in the model need to be modified, the operating segment's
fair value could become less than its carrying value, resulting in a future
impairment of goodwill, other intangibles and other long lived assets of the
operating segment.
For the two other reporting units with goodwill and intangible assets, High
Performance Foams and Elastomer Components Division (ECD), the 2012 impairment
test was performed in the fourth quarter of 2012. The HPF and ECD reporting
units had allocated goodwill of approximately $24.0 million and $2.2 million,
respectively, at December 31, 2012. No impairment charges resulted from this
analysis. The excess of fair value over carrying value for these reporting units
was 470% for HPF and 170% for ECD. From a sensitivity perspective, if the fair
value of these operating segments declined by 10%, the fair value of the HPF
operating segment would exceed its carrying value by approximately 415% and the
fair value of the ECD operating segment would exceed its carrying value by
approximately 140%. These valuations are based on a five year discounted cash
flow analysis, which utilized a discount rate of approximately 14% and a
terminal year growth rate of 3%.
Intangible assets, such as purchased technology, customer relationships, work
force, and the like, are generally recorded in connection with a business
acquisition. Values assigned to intangible assets are determined based on
estimates and judgments regarding expectations of the success and life cycle of
products and technology acquired, the value of the acquired businesses customer
base, as well as the value of its existing work force, among others. These
assets are reviewed at least annually, or more frequently, if facts and
circumstances surrounding such assets indicate a possible impairment of the
asset exists. In 2012, there were no indicators of impairment on any of our
other intangible assets associated with the HPF and ECD operating segments. The
intangible assets associated with the CES operating segment were tested in
conjunction with the interim goodwill impairment analysis performed during the
third quarter of 2012 and it was determined that no impairment existed on these
assets as a result of that analysis.
Long-Lived Assets
We review property, plant and equipment, and other long-term assets, including
investments, for impairment whenever events or changes in circumstances indicate
the carrying value of assets may not be recoverable. Recoverability of these
assets is measured by comparison of their carrying value to future undiscounted
cash flows the assets are expected to generate over their remaining economic
lives. If such assets are considered to be impaired, the impairment to be
recognized in earnings equals the amount by which the carrying value of the
assets exceeds their market value determined by either a quoted market price, if
available, or a value determined by utilizing a discounted cash flow analysis.
In the future, deterioration in our business could result in additional
impairment charges. Evaluation of impairment of long-lived assets requires
estimates of future operating results that are used in the preparation of the
expected future undiscounted cash flows. Actual future operating results and the
remaining economic lives of our long-lived assets could differ from the
estimates used in assessing the recoverability of these assets. These
differences could result in impairment charges, which could have a material
adverse impact on our results of operations. In addition, in certain instances,
assets may not be impaired but their estimated useful lives may decrease. In
these situations, we amortize the remaining net book values over the revised
useful lives.
41--------------------------------------------------------------------------------Environmental Contingencies
We accrue for environmental investigation, remediation, operating and
maintenance costs when it is probable that a liability has been incurred and the
amount can be reasonably estimated. For environmental matters, the most likely
cost to be incurred is accrued based on an evaluation of currently available
facts with respect to each individual site, including existing technology,
current laws and regulations and prior remediation experience. For sites with
multiple potential responsible parties (PRPs), we consider our likely
proportionate share of the anticipated remediation costs and the ability of the
other parties to fulfill their obligations in establishing a provision for those
costs. Where no amount within a range of estimates is more likely to occur than
another, the low end of the range is accrued. When future liabilities are
determined to be reimbursable by insurance coverage, an accrual is recorded for
the potential liability and a receivable is recorded for the estimated insurance
reimbursement amount. We are exposed to the uncertain nature inherent in such
remediation and the possibility that initial estimates will not reflect the
final outcome of a matter.
Product Liability and Workers' Compensation Costs
Workers' compensation liabilities in the U.S. are recognized for claims incurred
(including claims incurred but not reported) and for changes in the status of
individual case reserves. At the time a workers' compensation claim is filed, a
liability is estimated to settle the claim and accrued at that time. The
liability for workers' compensation claims is determined based on estimates of
the nature and severity of the claims and based on analysis provided by third
party administrators and by various state statutes and reserve requirements. We
have developed our own trend factors based on our specific claims experience. In
other countries where workers' compensation claims are applicable, we typically
maintain insurance coverage with limited deductible payments. Because the
liability is an estimate, the ultimate liability may be more or less than
reported.
For product liability claims, we typically maintain insurance coverage with
reasonable deductible levels to protect us from potential exposures. Any
liability associated with such claims is based on management's best estimate of
the potential claim value, while insurance receivables associated with related
claims are not recorded until verified by the insurance carrier.
For asbestos related claims, we recognize projected asbestos liabilities and
related insurance receivables, with any difference between the liability and
related insurance receivable recognized as an expense in the consolidated
statements of income (loss). In order to determine projected asbestos related
liabilities, we have historically engaged National Economic Research Associates,
Inc. (NERA), a consulting firm with expertise in the field of evaluating mass
tort litigation asbestos bodily-injury claims. Further, in order to determine
the projected insurance coverage on the asbestos liabilities, we have
historically engaged Marsh USA, Inc, also known as Marsh Risk Consulting
(Marsh), to develop these projections. Projecting future asbestos costs and
related insurance coverage is subject to numerous variables that are extremely
difficult to predict, including the number of claims that might be received, the
type and severity of the disease alleged by each claimant, the long latency
period associated with asbestos exposure, dismissal rates, costs of medical
treatment, the financial resources of other companies that are co-defendants in
claims, uncertainties surrounding the litigation process from jurisdiction to
jurisdiction and from case to case, and the impact of potential changes in
legislative or judicial standards, including potential tort reform.
The models developed for determining the potential exposure and related
insurance coverage were developed by outside consultants deemed to be experts in
their respective fields with the forecast for asbestos related liabilities
generated by NERA and the related insurance receivable projections developed by
Marsh. The models contain numerous assumptions that significantly impact the
results generated by the models. We believe the assumptions made are reasonable
at the present time, but are subject to uncertainty based on the actual future
outcome of our asbestos litigation. Historically , due to the inherent
uncertainties of the forecast process and our limited amount of settlement and
claims history, we utilized a forecast period of five years, which we concluded
was the most reasonable period for recognizing a reserve for projected asbestos
liabilities, and that costs that might be incurred after that period were not
reasonably estimable at that time. In 2012, we reviewed this assumption and
determined that it was appropriate to extend the forecast period from five years
to 10 years. We reached this conclusion due to the fact that we now have
considerably more experience in addressing asbestos related lawsuits and have a
longer history of activity to use as a baseline to more accurately project the
liability over a longer period than previously disclosed. Further, settlement
trends have become more meaningful in recent years and we believe that we now
have a more meaningful history of data on which to base our projections.
Further, we determined that a 10 year projection period is now appropriate as,
although we have a longer and more consistent history of data over the last few
years, we do not believe we have sufficient data to justify a longer projection
period at this time. As of December 31, 2012, the estimated liability and
estimated insurance recovery for the ten-year period through 2022 was $51.4
million and $48.3 million, respectively, resulting in an additional charge of
$2.9 million recognized in the fourth quarter of 2012 ($0.2 million was
previously recognized throughout 2012). For sensitivity purposes, if the
forecast period was decreased to five years, the projected liability and related
insurance recovery would be $30.1 million and $29.2 million, respectively. Also,
if the forecast period was increased to fifteen years, the projected liability
and related insurance recovery would be $67.9 million and $63.3 million,
respectively.
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Given the inherent uncertainty in making future projections, we plan to have the
projections of current and future asbestos claims periodically re-examined, and
we will update them further if needed based on our experience, changes in the
underlying assumptions that formed the basis for NERA's and Marsh's models, and
other relevant factors, such as changes in the tort system. There can be no
assurance that our accrued asbestos liabilities will approximate our actual
asbestos-related settlement and defense costs, or that our accrued insurance
recoveries will be realized. We believe that it is reasonably possible that we
will incur additional charges for our asbestos liabilities and defense costs in
the future, which could exceed existing reserves, but cannot reasonably estimate
such excess amounts at this time.
Legal Contingencies
From time to time we are a defendant in legal matters, including those involving
environmental law and product liability (as discussed in more detail above). As
required by US GAAP, we determine whether an amount with respect to a loss from
a loss contingency should be accrued by assessing whether a loss is deemed
probable and the loss amount can be reasonably estimated. Separately, we would
analyze any potential insurance proceeds that would be available to offset the
claim amounts. Estimates of potential outcomes of these contingencies are
developed in consultation with internal and external counsel. While this
assessment is based upon all available information, litigation is inherently
uncertain and the ultimate outcome of such litigation could be more or less than
original estimates. Final resolution of such matters could negatively effect our
results of operations, cash flows and financial position.
Pension and Other Postretirement Benefits
We provide various defined benefit pension plans for our U.S. employees and
sponsor three defined benefit health care plans and a life insurance plan. The
costs and obligations associated with these plans are dependent upon various
actuarial assumptions used in calculating such amounts. These assumptions
include discount rates, salary growth, long-term rates of return on plan assets,
mortality rates, and other factors. The assumptions used were determined as
follows: (i) the discount rate used is based on comparisons to various indexes,
particularly the Citigroup bond index; (ii) the salary growth rate is based on
our historical and projected level of salary increases; and (iii) the long-term
rate of return on plan assets is determined based on historical portfolio
results, market conditions and our expectations of future returns. We determine
these assumptions based on consultation with outside actuaries and investment
advisors. Any changes in these assumptions could have a significant impact on
future recognized pension costs, assets and liabilities. The rates used to
determine our costs and obligations under our pension and postretirement plans
are disclosed in Note 9 of the Consolidated Financial Statements of this Form
10-K. Each assumption has different sensitivity characteristics. For the year
ended December 31, 2012, a 25 basis point decrease in the discount rate would
have increased our total pension expense by approximately $0.6 million and a 25
basis point reduction in the long-term rate of return on plan assets would have
increased our total pension expense by approximately $0.3 million.
Income Taxes
The objective of accounting for income taxes is to recognize the amount of taxes
payable or refundable for the current fiscal year and the deferred tax assets
and liabilities for the future tax consequences of events that have been
recognized in our Financial Statements. Deferred tax assets and liabilities
reflect temporary differences between amounts of assets and liabilities for
financial and tax reporting. Such amounts are adjusted, as appropriate, to
reflect changes in tax rates expected to be in effect when the temporary
differences reverse. We establish a valuation allowance to offset any deferred
tax assets if, based upon available evidence, it is more likely than not that
some or all of the deferred tax asset will not be realized. The determination of
the amount of a valuation allowance to be provided on recorded deferred tax
assets involves estimates regarding (i) the timing and amount of the reversal of
taxable temporary differences; (ii) expected future taxable income; and (iii)
the impact of tax planning strategies. In assessing the need for a valuation
allowance, we consider all available positive and negative evidence, including
past operating results, projections of future taxable income and the feasibility
of ongoing tax planning strategies. The projections of future taxable income
include a number of estimates and assumptions regarding our volume, pricing and
costs. Additionally, valuation allowances related to deferred tax assets can be
impacted by changes to tax laws.
Significant judgment is required in determining income tax provisions and in
evaluating tax positions. We establish additional provisions for income taxes
when, despite the belief that tax positions are fully supportable, there remain
certain positions that are likely to be challenged and that may not be sustained
on review by tax authorities. In the normal course of business, we are examined
by various Federal, State and foreign tax authorities. We regularly assess the
potential outcomes of these and any future examinations for the current or prior
years in determining the adequacy of our provision for income taxes. We
continually assess the likelihood and amount of potential adjustments and adjust
the income tax provision, the current tax liability and deferred taxes in the
period in which the facts that give rise to a revision become known.
It is our policy that no U.S. taxes are provided on undistributed earnings of
certain wholly-owned foreign subsidiaries because substantially all such
earnings are expected to be reinvested indefinitely. If circumstances change and
it becomes apparent that
43
--------------------------------------------------------------------------------some or all of the undistributed earnings of our wholly-owned foreign
subsidiaries will not be indefinitely reinvested, provision for the tax
consequences, if any, will be recorded in the period circumstances change. We do
provide deferred taxes for the undistributed earnings of our Japanese high
performance foams joint venture.
Stock-Based Compensation
Stock-based compensation expense associated with stock options and related
awards is recognized in the consolidated statements of income (loss).
Determining the amount of stock-based compensation expense to be recorded
requires us to develop estimates to be used in calculating the grant-date fair
value of stock options. We calculate the grant-date fair values using the
Black-Scholes valuation model. The use of valuation models requires us to make
estimates for the following assumptions:
Expected volatility - In determining expected volatility, we consider a number
of factors, including historical volatility and implied volatility.
Expected term - We use historical employee exercise data to estimate the
expected term assumption for the Black-Scholes valuation model.
Risk-free interest rate - We use the yield on zero-coupon U.S. Treasury
securities for a period commensurate with the expected term assumption as the
risk-free interest rate.
Expected dividend yield - We do not currently pay dividends on our common stock;
therefore, a dividend yield of 0% was used in the Black-Scholes model.
The amount of stock-based compensation expense recognized during a period is
based on the value of the portion of the awards that are ultimately expected to
vest. Forfeitures are estimated at the time of grant and revised, if necessary,
in subsequent periods if actual forfeitures differ from those estimates. The
term "forfeitures" is distinct from "cancellations" or "expirations" and
represents only the unvested portion of the surrendered option. Based on an
analysis of our historical forfeitures, we have applied an annual forfeiture
rate of 3% to all unvested stock-based awards as of December 31, 2012. The rate
of 3% represents the portion that is expected to be forfeited each year over the
vesting period. This analysis is re-evaluated annually and the forfeiture rate
is adjusted as necessary. Ultimately, the actual expense recognized over the
vesting period will only be for those awards that vest.
44--------------------------------------------------------------------------------
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