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Edited Transcript of ROG earnings conference call or presentation 31-Jul-19 9:00pm GMT

Q2 2019 Rogers Corp Earnings Call

ROGERS Aug 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Rogers Corp earnings conference call or presentation Wednesday, July 31, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bruce D. Hoechner

Rogers Corporation - President, CEO & Director

* Michael M. Ludwig

Rogers Corporation - Senior VP, CFO & Treasurer

* Stephen Haymore

Rogers Corporation - Director of IR

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Conference Call Participants

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* Craig Andrew Ellis

B. Riley FBR, Inc., Research Division - Senior MD & Director of Research

* Daniel Joseph Moore

CJS Securities, Inc. - Director of Research

* J. Ho

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector

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Presentation

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Operator [1]

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Good day. My name is Jason, and I will be your conference operator today. At this time, I would like to welcome everyone to the Rogers Corporation Second Quarter 2019 Earnings Call. (Operator Instructions)

I will now turn the call over to your host Mr. Steve Haymore, Director of Investor Relations. Sir, you may begin your conference.

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Stephen Haymore, Rogers Corporation - Director of IR [2]

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Thank you, Jason. Good afternoon, everyone, and welcome to the Rogers Corporation Second Quarter 2019 Earnings Conference Call. The slides for today's call can be found on the Investors section of our website, along with the news release that was issued today.

Please turn to Slide 2. Before we begin, I would like to note that statements in this conference call that are not strictly historical are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and should be considered as subject to the many uncertainties that exist in Rogers' operations and environment. These uncertainties include economic conditions, market demands and competitive factors. Such factors could cause actual results to differ materially from those in any forward-looking statement.

Also, the discussions during this conference call may include certain financial measures that were not prepared in accordance with generally accepted accounting principles. Reconciliation of those non-GAAP financial measures to the most directly comparable GAAP financial measures can be found in the slide deck for today's call, which is posted on the Investors section of our website.

Turning to Slide 3, with me today is Bruce Hoechner, President and CEO; Mike Ludwig, Senior Vice President and CFO; and Bob Daigle, Senior Vice President and CTO.

I will now turn the call over to Bruce.

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Bruce D. Hoechner, Rogers Corporation - President, CEO & Director [3]

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Thanks, Steve. Good afternoon, everyone, and thank you for joining us on today's call.

Please turn to Slide 4. Rogers delivered strong Q2 results, achieving record quarterly net sales of $243 million and adjusted earnings of $1.64 per share, which exceeded the top of our guidance range.

The results for the quarter were driven primarily by demand for 5G wireless infrastructure applications. As we indicated on our last earnings call, meaningful 5G demand emerged in Q1 and orders accelerated into Q2. Solid demand for 4G wireless infrastructure and growth in portable electronics also contributed to the strong quarter for advanced connectivity applications.

Advanced mobility applications, specifically Advanced Driver Assistance Systems, or ADAS, and EV/HEV battery pads, also helped to drive our Q2 performance. Following a return to growth in Q1, ADAS market demand remained strong in Q2 and grew for a second consecutive quarter.

The uncertainty that followed on sales to Huawei had some impact on the quarter. We had a short interruption to ensure compliance with the U.S. rules before resuming shipments to our direct fabricator customers. However, as I'll discuss later, the collateral effects of these restrictions and the ongoing trade tensions are creating uncertainty in our outlook for the second half of the year.

In addition, our Q2 results were tempered by weakness in general industrial and conventional automotive markets, which correlates with a number of recent reports pointing to declines in these sectors in Europe, China and other regions; high tariff costs, which, as Mike will discuss later, affected gross margins; and operational challenges in our PES business, which I will discuss in more detail shortly.

Despite these near-term challenges, we remain very confident in the opportunities for Rogers in the advanced mobility and advanced connectivity markets. We have aggressively cultivated a leading position in these areas over the past several years and are poised to execute as we work through the short-term market dynamics that are influencing our cautious Q3 outlook.

Turning to Slide 5. As I mentioned, we continue to see significant long-term growth opportunities for Rogers in the areas of advanced connectivity and advanced mobility. In advanced connectivity, we are encouraged by the strong 5G demand that we saw in Q2 and the growth opportunity associated with the expected 5G build-out over the next several years. A number of recent data points validate that the long-term global 5G rollout is moving forward.

For example, in early June, China granted 5G spectrum licenses to the country's major telecom operators, an important step that will allow for full commercial deployment of 5G. Subsequently, one of the leading telecom operators in China announced that they plan to launch 5G services in more than 50 cities by the end of this year.

In addition, industry experts project that the total combined 2019 and 2020 global 5G deployments, primarily in China, will exceed 800,000 base stations, reinforcing their prior projections.

Taken together, there is more clarity and strong momentum behind the 5G rollout.

There have also been signals that 5G deployments in the U.S. could accelerate. Recently, the FCC approved the auction of an unused portion of the 2.5-gigahertz band. Until now, the availability of mid-band spectrum, which is critical to widespread 5G deployment, has been limited. This move to free up additional spectrum is an important step towards an initial 5G build-out in the U.S.

Near-term visibility to wireless infrastructure demand is clouded by the collateral effects of the restrictions on Huawei and its impact on the rate of 5G deployment in China. It is uncertain whether Huawei will be able to access critical components needed to continue with 5G deployments and to what extent they may try to utilize Chinese suppliers. Also not clear yet is how Huawei's share of the China market may be impacted.

Despite these uncertainties, we are encouraged by the ongoing 5G orders as we move into Q3. Rogers is well positioned to benefit from the 5G deployment due to our design wins with all major telecom equipment providers.

Turning to advanced mobility, the outlook for EV/HEV growth remains strong, and we continue to see this as a substantial long-term opportunity. Year-to-date, our EV/HEV power semiconductor substrate business has continued to grow at a double-digit rate compared to 2018, and market demand remains much stronger than the conventional automotive market.

Automakers are also increasingly shifting their future production plants to encompass more EV and HEV models. For example, a recent IHS market analysis found that based on announced plans by automakers the number of EV/HEV models available in Europe is expected to triple by 2021, to more than 200. The study also concluded that by 2025 EV/HEVs could comprise more than 20% of all vehicles produced in Europe, with consumer demand driving sales in global markets and momentum behind the transition to EVs and HEVs continues to grow.

The longer-term outlook for ADAS demand growth continues to be robust, despite the near-term slowdown in global conventional automotive sales. IHS market forecasts that automotive radar units will grow at nearly 20% compounded annual growth rate over the next 5 years as ADAS penetration of new vehicles grows and as the number of sensors per vehicle increases.

Turning to Slide 6, I'll discuss results for each of the business units. ACS achieved record net sales of $93 million in the second quarter, a sequential increase of 15%. As mentioned, these strong results were driven by 5G and 4G wireless infrastructure demand and strength in ADAS applications.

This is the second consecutive quarter that ACS has achieved record quarterly revenue. This is due in great part to our emphasis on developing innovative solutions to meet our customers' 5G performance requirements and the strategic investments which have enabled us to support a rapid increase in demand. Our operational excellence initiatives, combined with improved utilization, have also helped to drive significant improvements in operating margin. We continue to move ahead with product innovations, new capacity additions and further operational improvements in order to position Rogers to take advantage of the 5G rollout.

For Q3, we expect softer 4G and 5G demand due to uncertainties discussed. In addition, we believe that the weaker auto market will have some impact on ADAS sales. For the full year, we expect ADAS to grow at high single digits relative to 2018.

Please turn to Slide 7. In Q2, EMS net sales were $94 million, a slight increase compared to Q1. The higher revenue was a result of growth in portable electronics, EV/HEV and mass transit applications, which was mostly offset by weaker demand for general industrial and conventional automotive applications.

We are especially pleased with the performance of applications for EV/HEV battery pads and battery pack sealing systems. 2019 year-to-date sales in this segment are up over 40% relative to 2018. This growth has been driven by significant design wins in battery pad applications and the performance of our innovative products, such as our new PORON EV extend material which enhances lithium-ion battery life.

In addition, EMS operating performance improved meaningfully in Q2. Our efforts to optimize the operations of acquired companies is progressing well, and gross margins are improving as a result.

Lastly, as it relates to our Q3 outlook, we expect to see a lower-than-normal seasonal increase in sales due to the weak portable electronics market.

Turning to Slide 8. PES second quarter net sales were $52 million, a decrease of 14% from Q1. The decline in PES revenue was primarily due to weak end-market demand for power semiconductor substrates and industrial power and vehicle electrification applications for conventional automobiles.

Operational improvements in PES remain a top priority, and we are executing the detailed recovery plan that we previously developed. However, we did not make the progress expected in Q2, for 2 primary reasons. First, the pace of implementing our recovery plan was disappointing, and as a result, we made several key organizational changes. Second, the lower production volume compounded the operational challenges and more than offset the progress we did make. To mitigate the impacts of the lower demand, we are flexing our cost structure to minimize the margin impact.

As I mentioned, the EV/HEV market opportunity is extremely compelling and we are committed to making the necessary operational improvements and adding capacity in PES in order to take advantage of this opportunity.

Please turn to Slide 9. We remained focused on the 4 strategic elements of our growth strategy which serves as a road map to our long-term financial objectives. We continue to drive towards achieving a net sales run rate of $1.2 billion, subject to additional acquisitions, and an adjusted operating margin run rate of 20% in 2020.

We have achieved strong Q2 results and are optimistic about the growth opportunities in advanced mobility and advanced connectivity. We will continue to execute our disciplined strategy to best position Rogers for the future.

Now I'll turn the call over to Mike to report on our Q2 results in greater detail. Mike?

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Michael M. Ludwig, Rogers Corporation - Senior VP, CFO & Treasurer [4]

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Thank you, Bruce, and good afternoon, everyone. In the slides ahead, I'll review our second quarter 2019 results, followed by our third quarter guidance.

Turning to Slide 11, we will review the financial results for Q2 2019. Second quarter revenues, as previously noted, were $242.9 million, within our Q2 guidance range of $240 million to $250 million. Q2 revenues increased slightly on a sequential basis but increased 13% over the second quarter 2018.

The wireless infrastructure market for both 4G and 5G applications, along with ADAS, portable electronics and mass transit markets, were strong contributors to the sequential revenue increase. The company experienced weaker demand and lower revenues primarily from power semiconductor substrates for general industrial applications as well as conventional vehicle electrification applications.

While we were able to achieve a gross margin of 35.3%, within our guidance range of 35% to 36%, our continued execution challenges in PES, exacerbated by lower volumes in the PES business, offset significant improvements in ACS gross margin and improved gross margin performance in our EMS segment. The company's gross margin was also measurably impacted in the quarter by the increased tariffs resulting from an escalation of the trade tensions between the U.S. and China.

Adjusted operating income for Q2 2019 was $41.7 million, or 17.2% of revenues, compared to $41 million, or 17.1% of revenues, for Q1 2019.

Adjusted operating expenses decreased by $0.3 million in the second quarter compared to the first quarter.

GAAP EPS of $1.30 per fully diluted share and adjusted EPS of $1.64 per fully diluted share for Q2 2019 were at and above, respectively, the upper end of our guidance range for Q2 but below Q1 levels. This strong earnings performance both on a GAAP and an adjusted basis resulted primarily from good expense control and a slightly lower-than-forecasted effective tax rate for the second quarter.

Turning to Slide 12, our Q2 2019 revenues increased $3.1 million versus the first quarter of 2019. The sequential increase was experienced in both our ACS and EMS business segments, with our ACS revenues growing 15% and our EMS revenues growing 1%. The PES business segment saw its revenues decrease by 14% sequentially.

The increase in ACS revenues resulted primarily from strong wireless infrastructure applications demand, growing greater than 20% compared to Q1, as both 4G and 5G revenues grew significantly in the quarter, led by strong antenna application demand.

The strong 4G revenues were driven by the previously announced 416,000 China Unicom 4G LTE installations we highlighted in our previous conference call. In fact, 4G has held steady through the first 6 months of 2019, as it was basically flat compared to the same period of 2018.

As Bruce noted, 5G orders accelerated in the second quarter and we were able to act quickly to mitigate the negative impact in the quarter to both 4G and 5G revenues resulting from the restrictions on sales to Huawei.

Revenues from ADAS showed continued strength in the second quarter, with a slight sequential quarterly increase but growing approximately 15% over the second quarter of 2018.

Revenues in our EMS segment increased sequentially due to strong demand in both portable electronics and automotive applications. The increase in portable electronics revenues, up 9% sequentially and 44% compared to Q2 2018, was due to the timing of our customers' commercialization of new handset and tablet designs.

The increase in automotive application revenues resulted from increase in EV/HEV battery pads and battery pack sealing systems, which grew slightly compared to Q1 and almost 75% compared to Q2 2018. The growth in the application is another example of where Rogers' technical capabilities have amplified our growth by solving our customers' difficult technical challenges.

General industrial application revenues were down slightly compared to the first quarter.

As noted in Bruce's prepared remarks, PES experienced weaker demand and lower revenues primarily from power semiconductor substrates for general industrial applications as well as conventional vehicle electrification applications, as revenues for these applications decreased sequentially by 10% and 7%, respectively, and each declined by 11% compared to Q2 2018.

For power semiconductor substrates for EV/HEV applications, demand remained strong in the second quarter, but revenues declined sequentially due to production challenges that were separate from ongoing yield challenges. These issues were resolved in the quarter but resulted in revenues being down 6% compared to Q1 for these applications. Even with the production and yield challenges, revenues for EV/HEV power semiconductor substrate applications were up 45% compared to Q2 2018 and year-to-date are greater than 35% ahead of 2018.

Despite the slowdown in our power semiconductor substrate business for general industrial and vehicle electrification applications, we continue to see increased current demand and expect to see significantly increasing demand over a multiyear period for our wide band gap semiconductor substrate business serving EV/HEV applications. As a result, we will continue to bring on additional capacity to address the increasing demand.

Currency exchange rates negatively impacted 2019 second quarter revenues, by $0.5 million compared to Q1 2019.

Turning to Slide 13, our gross margin for Q2 2019 was $85.8 million, or 35.3% of revenues, 30 basis points lower than our first quarter gross margin of 35.6%. The decrease in gross margin percentage was due to a significant decline of the gross margin in the PES business and meaningful increases in tariffs resulting from the U.S. and China trade tensions combining to offset the increases in gross margin of both the ACS and EMS businesses.

We were pleased with the increased gross margin percentage from the ACS business in Q2 resulting from a favorable product mix, increased efficiency and improved factory utilization. The excellent results were delivered in the midst of a significant demand increase, which was planned and invested for beginning in 2018.

In the second quarter, the EMS gross margin percentage also increased, due to increased efficiency, improved factory utilization and progress on EMS performance issues discussed on past calls. We expect to see further gross margin improvement in Q3 and Q4 from resolving the EMS consolidation and optimization issues.

Consistent with comments from our prior calls, we anticipated the decline of the gross margin in PES in Q2 due to the continued challenges with productivity and yield issues with our new-generation wide band gap semiconductor silicon nitride product. In addition, the PES gross margin was negatively impacted in Q2 by the significantly reduced volumes resulting from the reduced demand in general industrial and conventional vehicle electrification applications.

We continue to follow our yield, productivity and commercial recovery plans. As Bruce discussed in his remarks, we made organizational changes to address the pace of the execution of our PES gross margin recovery plan and anticipate seeing progress in the second half of 2019 into the first half of 2020. In addition, we are addressing our cost structure in PES to compensate for lower volume, while still maintaining our ability to support the increasing demand in the wide band gap semiconductor power applications.

The increase in tariffs due to trade tension escalation during the second quarter impacted our gross margin by over 60 basis points compared to the first margin (sic) [quarter], due to both the increase in the tariff rate and the increased shipment of inventory subject to tariffs, primarily ACS inventory. In total, tariffs impacted gross margin in the second quarter by over 80 basis points.

We are working aggressively to leverage our factory footprint and to optimize our supply chain to mitigate the effect of tariffs. We expect to see the benefit of these actions in the form of lower tariffs as a percent of revenues in the first half of 2020.

The headwinds on company gross margin from performance issues from the PES and EMS business segments increased to approximately 230 basis points, from approximately 175 basis points discussed in our Q1 call, due primarily to greater inefficiencies from the lower volume of power semiconductor substrate business discussed earlier.

The achievement of our financial target of 20% adjusted operating profit in 2020 is predicated on a gross margin of greater than 39%. The path to the higher gross margin is through improved operational execution in PES and EMS, which we expect to contribute 230 basis points; mitigating the impact of tariffs, which can contribute from 40 basis points with the actions described above to 80 basis points if trade tensions are resolved favorably; and an incremental 100-plus basis points from increased volumes in all businesses, particularly 5G revenues.

We saw improvements in EMS in the second quarter and believe with the management changes in PES we are on an enhanced, more timely path to executing on the performance opportunities. We discussed our plans to mitigate the impacts of tariffs, and we remain confident in the 5G ADAS and EV/HEV markets and expect them to continue to grow into the future. As a result, we remain confident in our path to achieve a gross margin of greater than 39% and an adjusted operating profit margin of 20% in the back half of 2020.

Slide 14 details the changes to adjusted net income for Q2 2019 of $30.7 million, compared to adjusted net income for Q1 2019 of $34.6 million. As discussed earlier, the adjusted operating income for Q2 2019 was slightly higher than Q1's adjusted operating income, both on a dollar and a percent of revenue basis.

Adjusted operating expenses for Q2 of $44.1 million, or 18.2% of revenues, were $0.3 million lower than Q1 adjusted operating expenses of $44.4 million, or 18.5% of revenues. The lower expenses resulted from reduced SG&A costs.

Other income and expense for Q2 was unfavorable compared to Q1 2019 as a result of increased expenses from currency and commodity hedging activities.

Lastly, our effective tax rate for Q2 2019 was 22.9%, compared to our Q1 2019 effective tax rate of 14.2%. The first quarter 2019 effective tax rate incorporated discreet tax benefits that were not expected to and did not repeat in the second quarter. In the second half of 2019, we expect the effective tax rate to be between 24% and 25%, excluding the impact of discreet tax items.

Turning to Slide 15, we ended the second quarter 2019 with a cash position of $173.1 million, an increase of $11 million from March 31, 2019, and an increase of $5.4 million from December 31, 2018.

In Q2, the company spent $11.4 million on capital expenditures. We have spent $24 million year-to-date. We continue to guide capital spending for the year in the range of $50 million to $60 million as we continue to add capacity for increasing demand for products serving 5G and EV/HEV applications.

The company paid down $28 million of debt in the quarter and has paid down $33 million of debt in 2019 through June 30. As of June 30, we are in a net debt position of $22.4 million.

The company generated $50.4 million from operating activities in Q2, including a decrease in working capital of $11.2 million. Through June, the company generated $67.5 million from operating activities, net of an increase in working capital of $13.9 million primarily from the increase in accounts receivable due to both strong revenues and the timing of revenues in the second quarter.

Taking a look at our Q3 2019 guidance, on Slide 16, as we have discussed, we are seeing a decline in the demand for our power semiconductor materials for general industrial and vehicle electrification applications that will extend into the second half of 2019, and there continues to be uncertainty regarding the collateral effects of the U.S. sanctions against Huawei and how those will impact our wireless infrastructure application revenues in the second half of 2019. Therefore, revenues for Q3 are estimated to be in the range of $225 million to $235 million.

We expect performance improvements made in our EMS and PES segments and slightly lower tariffs from reduced ACS volumes to be offset by lower factory utilization from the reduced volumes. As a result, we are guiding gross margin in the range of 35% to 36% for Q3.

We guide GAAP EPS for Q3 in the range of $1.05 to $1.20 per diluted share. On an adjusted basis, we guide fully diluted earnings in the range of $1.30 to $1.45 per diluted share.

I will now turn the call back over to Bruce.

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Bruce D. Hoechner, Rogers Corporation - President, CEO & Director [5]

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Thanks, Mike. In summary, we achieved strong results in the second quarter despite trade-related uncertainties, market headwinds and operational challenges, which we are focused on improving. The outlook for advanced connectivity and advanced mobility market opportunities is strong, and we are well positioned to take advantage of these growth areas.

This concludes our prepared remarks, and we'll now open the line for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Patrick Ho from Stifel.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [2]

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Maybe first off in terms of your ACS business and the comments you made about both the 5G and the 4G deployment that we're seeing today. You're still seeing good strength in the 4G side of things. A 2-part question there is, how sustainable do you believe that is? And secondly, given some of the issues with the Huawei ban in the U.S., does that have any impact related to the 4G business?

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Bruce D. Hoechner, Rogers Corporation - President, CEO & Director [3]

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Patrick, it's Bruce. With regard to 4G, what we're seeing is we had a good first half with 4G. We believe that as the focus turns towards 5G that there will be perhaps less sales into the 4G area, less build-out as the operators and as the OEMs move towards the 5G side.

And I would say with regard to the situation that I outlined with Huawei, the reason as we look forward we have some unknowns, the ability of Huawei to get all the components that they need to build out the 5G base stations is still up in the air. Now there is obviously talk that they've built inventory over time, but we will see how that plays out as we move through the second part of the year.

As I mentioned in my prepared remarks, we also saw certainly in the beginning here of Q3 continued strength in 5G demand for our material.

So again, it's just the cloudiness as we move through the quarter and into Q4 with regard to ability of Huawei to continue. That's a question for us.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [4]

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Great. That's really helpful. And maybe as my follow-up question, on the PES business, you talked about the vehicle electrification still being somewhat soft on the demand side of things. I guess from a big-picture perspective can you give a little color on what you believe the catalysts or the inflection that's needed to, I guess, spark that market segment and then, obviously, in turn, drive your PSS (sic) [PES] business?

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Bruce D. Hoechner, Rogers Corporation - President, CEO & Director [5]

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Thanks for the question. On the x-by-wire or vehicle electrification, again this is internal combustion engine automobiles going to stop/start and so forth as well as the other systems, air conditioning and so forth, going to electrical motors.

The situation is really related to numbers of vehicles being produced and, particularly, the higher-end models. And so there has been when you look at the data from China, when you look at the production data of automotive output in Europe, there is a decline there, and that's what we believe this is related to; that it's really the number of units being produced of the internal combustion engines with the x-by-wire capability, generally higher-end models, and that's what we're seeing suffer on the volume side. So when we see a return there in terms of sales growth of internal combustion engines at the higher end, we should see this pick back up.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [6]

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Great. And maybe final question from me in terms of kind of the management of your different facilities and the different businesses to help the gross margin profile. Mike, that's been a key initiative for you. Can you, I guess, give a little color on how you adjust both the manufacturing changes within the businesses themselves where it's stronger in one area, weaker in another, how you can adjust some of the manufacturing capacity but also on the supply chain to help boost up gross margins over the long term?

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Bruce D. Hoechner, Rogers Corporation - President, CEO & Director [7]

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So there's a number of initiatives underway. First of all, we're really pleased with the performance of ACS. If you recall, if you go back probably 6 quarters or so, we had some operating issues there. We focused on them. We've improved substantially in that business. And we've carried that model forward into the EMS business, where we also saw some very good performance in the quarter, in Q2, on the operating side as we continue to integrate the acquisitions that we've made over the last couple of years. So the 2 businesses, ACS, EMS, we're seeing -- our plans have been executed well and we're seeing those results.

The PES business, which is, I would say, more complex from a processing perspective, has had some struggles, as we've outlined over the last couple of quarters. We decided to make a change in operations leadership there and with bringing in some experienced people from the outside. And we think we'll see some good results. As Mike pointed out, it will take us through the end of the year to see some of that come to fruition, but we have those plans in place and we believe the execution should go well.

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Michael M. Ludwig, Rogers Corporation - Senior VP, CFO & Treasurer [8]

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On the supply side, Patrick, I think there are a couple of things that we continue to focus on. So reformulation of materials that we use within our products, we are continuing to look for reformulations that lower our cost, and I think we've made some good progress here early in the year. I think we'll have better progress as we move throughout the year. So that's certainly one.

And then in terms of trying to address -- not "trying" but in terms of addressing tariffs, again we're looking at supply chain and supply chains in different geographies that we can utilize that will, again, mitigate impacts of tariffs, should those continue to be significant and the trade tensions, let's say, not resolve themselves favorably.

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Operator [9]

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Your next question comes from the line of Craig Ellis from B. Riley FBR.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [10]

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Congratulations on the strong revenue performance in ACS in the quarter. The first question is really a clarification. What I wanted to do was understand some of the comments, Bruce, that you had when you talked about guidance. I think at least once, maybe twice, you talked about the third quarter outlook being cautious. And Mike, you yourself noted that you were factoring in the potential for an impact from macro issues. The question is, is the guidance set based on trends you're seeing in the order book? Or have you taken the order book and, based on concerns you have based on whatever is going on with trade or at the macro level, have you made an extra allowance for some of the things that would cause you to be conservative? Just trying to get a better sense of how you're looking at the outlook this particular quarter.

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Michael M. Ludwig, Rogers Corporation - Senior VP, CFO & Treasurer [11]

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I think there's a little bit of one in the same, right? I think some of the things that we're seeing in the macro certainly are impacting the order book. And as a result of that, I think we're, again, being somewhat cautious in terms of in beliefs that some of those trends will continue, at least for some short period of time; certainly, through the third quarter, and we'll see how they shape out end of the third quarter and into the fourth quarter.

So I think, Craig, it's -- we're seeing it. We're seeing it in the order book and I think it's, again, reflective of what we're hearing and what we're seeing in the general macro picture.

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Bruce D. Hoechner, Rogers Corporation - President, CEO & Director [12]

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Craig, I would say a lot of it is related to the macro situation, right? We talked about general industrial being down, particularly capital equipment as it's related to our variable frequency drive substrates. But also even handsets, right? If you look at portable electronics it's relatively flat to down. We've had some very good wins in that area. Q2, we had some introduction of new models that helped EMS boost their sales in that area. So we're just looking really at the macro side of it, macroeconomic side, and saying there's some headwinds here for us.

I'll flip it over, though, and make another comment. Where we're seeing strength continuing is EV/HEV. As I mentioned, the orders for 5G early in the quarter look good. So in our focus markets, we're seeing the strength that we had hoped for.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [13]

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Great. That's helpful. So moving on to the first question, Bruce, you noted that there was a consultancy that identified that potentially in China there's demand for 800,000 base stations in 2019 and 2020. My question is, as you speak with your customers and the OEMs that are out there what's your sense for 5G base station demand in 2019 and 2020? And how is the team approaching capacity planning for the back half of this year and next year as you're working with your various customer constituencies on their build plans?

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Bruce D. Hoechner, Rogers Corporation - President, CEO & Director [14]

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So the consultants and contact obviously with OEMs, we're looking at approximately 200,000 base stations in 2019; 600,000 going forward in 2020. From a capacity perspective, we think we're in good shape as this ramps.

Over the last couple of years, we've added about 30% additional capacity into the ACS business primarily between the presses and debottlenecking of the treaters. We're bringing on another treater coming out at the end of the year, early next year, in 2020, as part of the acquisition of our Price Road, the old Isola factory as that gets converted. So we think we're in very good shape, very good position on the capacity side of things, and it certainly matches up with the data that we're getting from the marketplace on base stations.

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Michael M. Ludwig, Rogers Corporation - Senior VP, CFO & Treasurer [15]

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I think to add to that, Craig, is even though, again, as we've talked about some of these uncertainties in terms of how they impact the back half of the year, we are still planning for, again, the 800,000 between the 2 years, 600,000-plus next year. And so we have not slowed down. Despite the uncertainty, we have not slowed down our capacity adds, particularly as they relate to the Isola plant that we had acquired in the back half of 2018.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [16]

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And is there any visibility that you have on that 600,000 for next year, Mike? When do you expect to hit the inflection? Because on a quarterly basis there's clearly a very steep ramp coming at some point. Do you have visibility into that yet?

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Michael M. Ludwig, Rogers Corporation - Senior VP, CFO & Treasurer [17]

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No, I don't think we have that visibility, Craig.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [18]

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Okay. Next question. Both you and Bruce addressed some of the issues that are occurring in PES that relate to gross margins. My question is this. So we've been executing on operational and yield improvements in PES and it's proven elusive thus far, although there have been some exogenous challenges. But can you just recap what gives you confidence that those will be resolved in the next quarter or two? And as you think about that path to the 39% gross margin and the 20% operating margin that you mentioned, Mike, is that a fairly linear path from here? Or is it back end-loaded? And what are some of the bigger dependencies between here and there?

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Michael M. Ludwig, Rogers Corporation - Senior VP, CFO & Treasurer [19]

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So I would say again you're right, Craig, on your initial observation, right? The improvements have been elusive so far. We believe, though, in the last quarter or two we've developed the right recovery plan. As Bruce had mentioned, we are frustrated in some respects by the pace at which that is moving. And so we have made organizational changes that we think will, again, increase the probability of success and increase the speed of success around that plan.

So I think from that perspective that gives us significantly more confidence than maybe as we started the quarter and prior to making those changes. So I don't want to underestimate the impact of the changes that we made there. I think they're fairly significant.

And then as I laid out what needs to happen to get to the 39%, I think, again, we had talked about 50-basis-points improvement. In the last call, we talked about 50-basis-point improvements from the performance improvement at both PES and EMS. We are seeing that in EMS, and I think they're on plan. PES is going to have to -- a couple of things. So PES will have to get back on track. We just talked about that. The volume is going to have to pick back up at PES, as well, because I think volume will play an important part.

And then I think it depends on, again, the acceleration of the 5G. And as we said, we really don't have necessarily great visibility into how that 600,000 units is going to play out.

So I don't believe that it's linear from here, let me say that. I still think it probably becomes accelerated in the first half of 2020 and, again, continues to pick up in the back half of 2020.

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Craig Andrew Ellis, B. Riley FBR, Inc., Research Division - Senior MD & Director of Research [20]

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That's helpful. And then lastly, Bruce, just summarizing the situation as I think I'm hearing it from you with your automotive exposure across the 3 segments. It sounds like where you've got internal combustion engine exposure it's just the unit headwinds that we're seeing globally in the different markets, and some of the reporting there on SAR have been I think very well recognized by most investors. But it sounds like underneath that, where you've got your EV and HEV exposure, those trends seem to be solidly on track. Is that a fair breakdown of what's going on out there?

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Bruce D. Hoechner, Rogers Corporation - President, CEO & Director [21]

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Yes, that's absolutely the way we're seeing it, both in the PES business as well as the EMS business on the EV/HEV where we have some very nice share on the battery side in EMS. So yes, we're very pleased with the uptake that we're seeing on the EV/HEV side.

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Operator [22]

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Your next question comes from the line of Daniel Moore from CJS Securities.

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Daniel Joseph Moore, CJS Securities, Inc. - Director of Research [23]

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A lot of ground covered, obviously. Just wanted to talk about the cadence if we look at kind of the 3 buckets of, one, wireless; two, auto; and three, industrial. Maybe the cadence of orders and demand as we exited May into June and into July and the early part of Q3, between those 3 where you're seeing the most meaningful inflections.

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Bruce D. Hoechner, Rogers Corporation - President, CEO & Director [24]

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So I think, as we talked about, the automotive, let's say the conventional automotive is where we've seen probably the bigger impact, along with industrial. Both of those are areas that we've seen weakness, I would say, or headwinds. On the wireless side, certainly through the early part of the quarter here we've seen strength. So we're pleased with that aspect of it.

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Daniel Joseph Moore, CJS Securities, Inc. - Director of Research [25]

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Helpful. And Mike, I think you alluded to this in your commentary, but as it relates to the 2020 goals, you mentioned H2. I think that was the first time. So should we think of the 19%, 20%, the 20% operating margin, 39% gross margin as kind of a run rate exiting back half of 2020? Is that the right way to think about it at this point? Just to try to understand that update.

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Michael M. Ludwig, Rogers Corporation - Senior VP, CFO & Treasurer [26]

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Yes, it is. I think that's the right way to look at it.

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Daniel Joseph Moore, CJS Securities, Inc. - Director of Research [27]

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And lastly, it's one of those things that comes when it comes, but Bruce, maybe just talk about the M&A pipeline. The balance sheet continues to get stronger every single quarter given the cash generation. I know you've got a lot of internal stuff that you're focused on, but what are you seeing? And what's the likelihood for M&A as we look at the back half of the year and into 2020?

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Bruce D. Hoechner, Rogers Corporation - President, CEO & Director [28]

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Well certainly, as we've been very public about this, we have teams working on this and looking at opportunities. I would say we're probably going into this a bit more cautiously than we had maybe a year ago. Given that we're seeing some weakness in some of the sectors, we want to make sure that we understand fully the valuations of what we're looking at and how that might project forward, given some of the weaknesses in the sectors that we just discussed.

So we're still hammering away at it and looking hard, but I would say a bit more cautious as we enter the second half here.

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Operator [29]

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There are no further questions at this time. I turn the call back over to Bruce Hoechner for closing remarks.

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Bruce D. Hoechner, Rogers Corporation - President, CEO & Director [30]

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I want to thank everyone for joining us today on the call. Have a good day and evening. Thanks a lot.

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Operator [31]

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That concludes today's conference call. You may now disconnect.