Q3 2019 Earnings Call
Good day was counted essentially technologies Q3, two jobs nine gene earnings call.
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To turn the conference call, but to me so Josh for young Vice President Investor Relations. Please go ahead.
Thank you Francesca and good morning, everybody I'd like to welcome you to coincide this third quarter 2019 earnings Conference call. Joining me on today's call. Our Martha Sullivan Sensata CEO Jacko takes Sensata is president and Chief operating officer impose Barrington Sensata is chief financial Officer and it is.
The earnings release, we issued earlier today, we will be referencing a slide presentation. During today's call. The pediatric this presentation can be downloaded from Sensata Investor Relations website, we will post a replay of today's webcast. Shortly after the conclusion of today's call.
Before beginning on like the reference inside of the Safe Harbor statement on slide number two during the course of this conference call. We will make forward looking statements regarding future events, where the financial performance as a company that involve risks and uncertainties. The company. The actual results may differ materially and the projection is described in such statements factors that might cause such differences in.
Include but are not limited to those discussing all forms 10-Q in 10-K as well as others subsequent seem to be filings on slide number three we show some thought as GAAP results. The third quarter of 2019, we encourage you to review our GAAP financial statements. In addition to todays presentation. Most of the subsequent information that we.
I'll discuss during today's call will be related to non-GAAP financial measures reconciliations of our GAAP to non-GAAP financial measures are included in our earnings release and in our webcast presentation. The company's provides details of its segment operating income on slide 15, and 16, which are the primary measures management uses to it.
<unk> the business Martha will begin today's call with an overall business summary, Jeff will then provide more details on our investments in our smart connected initiative and Paul will then cover our financials for the third quarter 2019, upper I got into the fourth quarter as well update full year 2019 got it will then take your.
Questions. After our prepared remarks, now I'd like to turn the call over to subside as CEO , Martha Sullivan, Nike basketball and thanks to everyone on the call for joining us this morning.
We continue to effectively manage our operations in the third quarter and generated solid margin EPS and free cash flow despite facing meaningful end market decline, particularly in our industrial in age feel our businesses as well is unfavorable movements in foreign currency.
On slide four I lists some of the key highlights of the third quarter.
For the third quarter, we reported revenues of 849.7 million, which represents an inorganic revenue decline of 2.8%.
We adjusted we delivered adjusted EPS of 90 cents, which was ahead of our guidance midpoint after accounting for on favorable movement of foreign currency relative to our guidance.
We continue to outgrow our end markets hosting outgrowth of 140 basis points in auto and 160 basis points in H.B.R.
Well our level of outgrowth relative to end market production slowed from Q2 19 much of this is related to launch delays from age you are customers as they work to reduce their inventories in response to lower demand.
We generated adjusted operating margins of 23.5% in the third quarter, which was 30 basis points higher than our guidance, despite generating approximately 9 million of lower than expected revenue.
This reflects the operating discipline, we have in the business.
We are focused on quickly driving expense and productivity initiatives in order to align our costs lower revenue.
Our adjusted EPS of 90 cents reflected a tailwind from foreign currency, a forced them, which was three cents lower than our expected tailwind of 78 cents, primarily due to the weakening of the Chinese renminbi.
After adjusting for this effect, our EPS was approximately three cents better than the midpoint of the guidance we provided for the third quarter of 2019.
We continue to make important long term investments for future growth.
Jeff will talk later in the call about investment on our smart and connected initiative and how we believe the solution will bring significant value for commercial truck and trailer OEM as well as fleet managers.
Finally, our free cash flow grew 15% year over year totaling 140 million, which was 97% of our adjusted net income in the quarter.
This represented a significantly higher conversion rate than we have posted in recent quarters as a result of better working capital efficiency.
My four shows organic revenue performance by end market in the third quarter.
I will begin with auto which posted an organic revenue decline of 40 basis points in the quarter.
This was 140 basis points above and end market decline of 1.8% in the third quarter.
For the full year 2019, we expect our automotive business to outgrow it end market by approximately 500 basis points.
We generated solid organic revenue growth and our China auto business during the third quarter, which was a significant sequential improvement from the second quarter of 2019.
Most of this improvement was driven by the China auto end market, which declined 5% on the corner compared to a 20% decline last quarter.
We continue to sustain robust double digit content growth in China.
Our North American auto business generated organic revenue growth in the quarter, but was adversely affected by the G.M. strike.
We estimate that the G.M. strike represented a 1% revenue headwind for the auto business in Q3 and will be a 3% revenue headwind for our overall auto business in the fourth quarter.
In Europe , we continue to be affected by a volatile end market, primarily as a result of a general market decline.
No our age you our business hosted in organic revenue decline of 6.2%, which was <unk> 160 basis points above at 7.8% and market decline during the third quarter.
We experienced considerable end market decline for both the on and off road portion of the H. view our business.
Large construction and add customers announced multi quarter efforts to reduce their inventories because the falling demand.
We're seeing a similar trend of inventory reductions and weaker end market demand from our on road customers in North America in Europe .
Well, our China on road business continues to post healthy growth as a result of strong content performance.
A number of our off road H. view, our customers are pushing out plan product launches by as much as 12 nine to 12 month as they continue to work down their equipment inventory.
These delays have lowered our overall level of outgrowth relative to end market production.
Finally, I turn to our aerospace industrial and other end markets, which are served by or something solutions segment [noise].
For the third quarter 2019, we posted a 6.3% organic revenue decline in this business as a global industrial demand weekend.
We can lie in all geographic regions is signaling continued demand contraction and our customers are lowering inventory and slowing production.
Our industrial performance in China is particularly weak as a result of global tariff and trade action.
Our age CAC end market continued to see declined due in part to slow down in the production of refrigerated truck.
The strongest performance sensing solutions continues to be our aerospace business, which is hosting content growth on top of an expanding end market. We are poised to generate high single digit organic growth in our aerospace business for the full year.
Turning to slide six I show some of the specifics of our end market outlook for the fourth quarter of 2019 compared to our previous assumption.
We expect our end markets to become in CRE incrementally weaker in the fourth quarter and we expect our customers to continue to lower their inventories through the end of the year.
One of the primary drivers of this lower revenue outlook is the negative effect of the G.M. strike, which will reduce our north American auto performance.
We expect the North American auto end market will be down 12% to 13% and the fourth quarter of 2019, primarily due to the effects of the GM strike.
This is significantly weaker than the low single digit decline. We previously previously expected in North America auto.
We're also lowering end market expectations for the European Auto H. feel our and industrial end markets for the fourth quarter.
As a result, we're forecasting 830 million a revenue in the fourth quarter at the midpoint of our guidance, which is approximately $50 million less than what we previously expected.
This lower outgrowth is largely driven by weaker market demand and unfavorable changes in foreign exchange.
Before turning the call over to Jeff I want to close up a few key messages they show on slide seven.
We have a long history of generating solid levels of margin earnings and cash flow dream. Many types of end market environments, including periods, a more meaningful end market decline.
And you saw this strong operating discipline reflected in our third quarter results as we quickly aligned our costs with customer demand to Bruce to produce.
All in margin and E. P S. Despite reporting lower than expected revenue.
In the past five years, we experienced periods of difficult end market environment, but still managed to deliver a five year adjusted EPS CAGR of 8%.
We've done a lot of work to strengthen our balance sheet over the past few years and our net leverage ratio of 2.8 times is at the low end of our historic range, which should be reassuring for our investors.
Our business model generates a lot of free cash flow, which gives us a much better cash flow profile than most of our peers, serving the auto and industrial markets.
So we are less susceptible to major swings in demand.
I'd also point out that are stronger balance sheet has occurred even as we have deployed more than 900 million towards M&A in share repurchases over the past 18 months.
We continue to have a balanced returns driven approach to capital deployment, we continually evaluate opportunities to put capital to work and M&A share repurchases and other investment alongside our focus to sustain a healthy leverage ratio.
This is what enables us to accelerate our investments and initiatives such as electrification and smart and connected in order to drive future growth.
In the face of weakening end markets and other external pressures are historically low net leverage ratio and higher pace of returning cash to shareholders speaks to the strength of our organization.
This results from the effectiveness of our operating strategy to outgrow our end markets to continually improve our operating performance to invest in our future growth and to deliver sustained shareholder value.
I'd like to now turn the call over to Jeff to talk more about our smart and connected initiative, Jeff. Thank you murtha. It is a pleasure to join you today.
Im going to talk in detail about the investments we are making it our smart and connected initiative and the value. This solution brings to our customers.
We believe that this initiative is one of our most strategic growth investments.
It has the potential to establish a new customer segment for Sensata, well further strengthening our relationships with truck and trailer Oems as well as tier one system partners.
On slide nine I show, an overview of the broad portfolio of Sensata sensors that are deployed on trailers and honored trucks today.
We are clear industry leader, providing sensors for everything from drive train and suspension systems to trailer and cabin comfort applications.
We have a strong brand with blue chip customers and we have a track record of success.
Since 2017, our Hbr business has averaged 11% organic growth.
While outgrowing its end markets by nearly 700 basis points.
One of the areas, where we have a leadership position is in wireless sensing.
Specifically around tire pressure monitoring.
As legislation requires Oems to include Tms, our new trucks and trailers.
Our OEM customers will be leveraging our capabilities.
To significantly expand the data they are capturing on their vehicles and trailers beyond just tire pressure using our vehicle area network solution.
We quickly recognized that this type of solution could also bring tremendous value directly to fleet managers.
Hey, growing and less cyclical part of the overall logistics value chain.
Well, we believe the total available market for our solution sold into truck and trailer Oems today.
Is around 1 billion the potential market for fleet managers is nearly six times larger.
Today, there are almost 80 million commercial trucks and trailers in North America, and Europe alone that could be retrofit with our solution.
Well many fleet managers are currently using telematics solutions.
They have a desire to capture valuable data that can only be delivered through high performing sensors and embedded software algorithms in areas such as breaks weight wheel lens and other applications.
Consequently, our market and technology leadership in Tms is creating an important new opportunity for us to broaden our value proposition.
And evolve into a more strategic data insight partner for both Oems and fleet managers.
On slide 10, I show the Sensata vehicle area network, which consist of high performing sensors developed by Sensata and those provided by third parties.
Hey, wireless gateway device to collect and process the data.
In a high bandwidth wireless tractor trailer lake to ensure that data between the truck and trailer is exchange seamlessly.
Sensata is uniquely positioned to deliver on this opportunity because we understand the sensors that generate the data.
As well as the vehicle applications and the productivity, enabling use cases.
The portfolio that we are developing for this market.
As generally categorized into areas one.
Mechanical condition and safety and to load and environmental monitoring.
I show examples of sensor applications, we are focused on for a trailer on the left hand side of the slide.
And the prioritize sensor applications for a truck on the right hand side of the slide.
These sensor applications are brought together in the Sensata vehicle area network.
Which is a scalable platform that fuses data from various sensors to provide a one stop shop for valuable vehicle and trailer information.
This information ultimately leads to data insights that improves efficiency for all customers.
Customers can choose to deploy the entire portfolio along with advanced embedded software features or elect to only deploy one of the applications.
This makes it a highly customizable solution that can scale to customer specific needs.
Each of the use cases has a compelling value proposition.
For example, our waste sensors help fleet managers reduce scale fees.
Saved driver yard and dark time and increased utilization.
Our break sensors decrease maintenance cost and roadsides checks to name a few of the benefits.
These applications have a rapid and compelling payback for fleet managers.
We have already had a number of wins and proof points demonstrating the value of the solution.
Including the decision by leading truck OEM to deploy our vehicle area network on all of their new trucks in North America.
We have secured a multimillion dollar agreement with a leading trailer manufacturer to deploy our solution on their trailers in Europe .
In the third quarter, we initiated engagements with many top use fleet managers to evaluate our solution in live field tests.
And finally, we have significant pull from partners seeking to integrate with our solution.
For example, we recently formed a partnership with Hendrickson, a leading suspension and the actual manufacturer in the us to power their wheel and sensor using our vehicle area network.
While it can take three to four years to see revenue once we close new opportunities with our typical OEM customers.
We expect the timeline to generate revenue with fleet customers will be much shorter, possibly as fast as 12 to 24 months from the time, we close in new business win.
On slide 11, I show, how the Sensata vehicle area network will feed a telematics ecosystem that is hungry for valuable sensor data.
While we have simplified this slide there is a lot of complexity in the telematics ecosystem that is required to capture data off the truck and trailer to bring it to the cloud for analytics.
We expect to be an important partner for both on road telematics hardware and cloud service providers that offer fleet management software solutions.
We will integrate our solution with their onboard devices in order to pull data off the vehicle and into the cloud to facilitate valuable insights for fleet managers.
To ensure our offering is strong we are investing to meet the requirements of Oems and fleet managers.
This investment began two years ago, and we expect our spending to accelerate in the next 12 months.
In 2020, we expect to double our investment on this initiative.
This speaks to the tremendous potential that the initiative has to accelerate our long term growth as well as unlock new opportunities in the broader logistics ecosystem.
On slide 12, I did pick how sensata has evolved over the past two years and our aspiration to continue to evolve into a data insight partner for our OEM and fleet customers.
This evolution has included moving from sensor design and development to onboard wireless systems, such as Pbms to an integrated vehicle area network solution.
We are leveraging our differentiated position and sensor designs, our expertise and embedded in wireless systems.
And our industry knowledge and analytics to broaden the value that we can bring to customers and move up the Io T. stock.
More to come on this very exciting opportunity in the coming quarters.
I'd now like to turn the call over to Paul to review, our third quarter results in more detail and to provide guidance for the fourth quarter and full year 2019, Paul. Thank you, Jeff key highlights for the third quarter.
As shown on slide 14 include.
Revenue of 849.7 million in the quarter.
A decrease of 2.7% from the third quarter 2018.
Changes in foreign currency decreased revenues by 0.3%.
The net effect of our valves investor and the acquisition of gigabyte increased revenues by 0.4% year over year.
The net result, with a 2.8% organic revenue decline in the quarter.
Adjusted operating income was 199.5 million in the quarter, a decrease of 3.9% compared to the third quarter 2018.
Due primarily to lower revenue.
Productivity headwinds, partially due to new product launches and the net effect of acquisitions and divestitures.
Somewhat offset by favorable currency.
Adjusted net income was 144.6 million in the quarter, a decrease of 6.1% compared to the third quarter 2018.
Adjusted EPS was nine cents in the third quarter, the decrease of 1.1% compared to the prior year quarter.
Now I'd like to comment on the performance of our two business segments in the third quarter 2019.
I will start with performance sensing on slide 15.
Our performance sensing business reported revenues of 628.6 million for the third quarter, a decrease of 3.2% compared the same quarter last year.
Reflecting both the negative impact from foreign currency of 0.3% and the net effect of acquisitions and divestitures, which reduced revenue by 1.2%.
Excluding these factors performance sensing reported inorganic revenue decline.
Of 1.7% relative to the prior year.
Our automotive business reported and organic revenue decline of 0.4 present in the third quarter, but outpaced the end market by 140 basis points.
Organic revenue growth in China, and North America was offset by an organic revenue decline in Europe .
Our Hbr business reported inorganic revenue decline of 6.2% in the third quarter outpacing the market by 160 basis points.
Hey market decline combined with lower content growth due to launch delays drove most of the decline in its VR revenues during the quarter.
Performance sensing operating income was 165.1 million a decrease of 7.5%.
As compared to the prior year.
Performance sensing profit as a percentage of revenue was 26.3% in the third quarter.
The decline of 120 basis points in the same quarter last year.
The decline in segment operating income in margin was primarily driven by the decline in organic revenues.
Productivity headwinds, partially due to the effect of scaling new product launches and the impact of acquisitions and divestitures.
This was somewhat offset by positive factor foreign currency.
As shown on slide 16.
Sensing solutions reported revenues of 221.1 billion in the third quarter.
Decrease of 1.3% as compared to same quarter last year.
Inorganic basis.
Factoring in a negative impact from foreign currency, a 0.6% and a positive contribution from the acquisition of Digger back of 5.6% we reported in organic revenue decline of 6.3%.
The decline was driven by our industrial business as a result of lower end market demand and inventory reductions in major geographic region.
This was partially offset by organic revenue growth in our aerospace business as a result of content growth.
In the healthy end market.
Sensing solutions operating income was 71 million in the third quarter a.
The decrease of 3.2% from the same quarter last year.
The decline in operating income was primarily due to lower organic revenue.
Partially offset by the favorable impact of the acquisition of gigabyte.
The decline in segment margin was primarily related to the dilutive impact of again of the gigabit acquisition, where we are investing heavily in electrification.
Corporate and other costs.
Included in segment operating income were 47.6 million in the third quarter roughly flat with the previous year.
Excluding charges added back to our non-GAAP results corporate and other costs were 34.2 million in the third quarter of 2019.
Slide 17 show some thought as third quarter 2019 non-GAAP results.
Adjusted gross profit declined 5.1% year over year to 303 million.
And gross margins declined 90 basis points to 35.7%.
The decline in gross margin growth the decline in gross profit and margin.
Primarily due to lower organic revenues.
And productivity headwinds related to scaling new product launches.
Mostly offset by foreign currency Tailwinds.
Actually then costs were 9.3 million favorable year over year due to lower variable compensation and selling costs.
As well as lower discretionary spending.
As a result, adjusted operating income was down 3.9% compared to the prior year quarter.
Our tax rate shown on this slide as a percent of adjusted profit before tax.
Was down 40 basis points year over year.
We expect our full year tax rate to be approximately eight have to 9%.
Insistent with our previous guidance of 9%.
Finally, adjusted EPS was down one cents or 1.1% of compared to the third quarter of 2018.
As a declining operating income was mostly offset by the benefit of share repurchases.
On slide 18, I show the progress we have made in strengthening our balance sheet over the past few years.
Since the end of 2015, we have lowered our net debt by 744 million and reduced our leverage ratio from 4.6 times the 2.8 times.
During the quarter, we enhanced our capital structure.
Issuing a new 10 year $450 million bond and refinancing our term loan.
We achieved several positive outcomes when these financing actions.
First we took advantage of favorable markets and secured a 4.375% coupon on our bond financing.
This historically low 10 year rate and high yield market reflects the attractiveness of our business as well as the confidence that bondholders have and our long term operating performance.
In addition, we increased the percent percentage of our fixed rate debt from 72% to 86% of our total debt.
To further reduce interest rate volatility.
Also with this bond financing, we extended the duration of our debt portfolio.
Finally, we reduced the total amount of our term loan and extended the maturity to 2026.
As a result, we have no debt maturities before 2023.
On slide 19, I show, our financial guidance for the fourth quarter of 2019.
Overall, we expect report revenues between 818.
And 842 million, representing a reported revenue decline between one and 3%.
At the midpoint of our guidance, we expect that foreign currency will decrease revenues year over year by approximately 6 million in the fourth quarter 2019.
And the net effect of acquisitions and divestitures will increase net revenues by approximately 9 million.
Excluding the impact of foreign currency and the net effect of acquisitions and divestitures. We expect report inorganic revenue decline of 1% to 4% in the fourth quarter.
Our current fill rate is approximately 88% of the revenue guidance midpoint for the fourth quarter.
We expect reported adjusted operating income between 180 692 million.
On the bottom line, we expect report adjusted net income between 135 and 141 million.
Which would represent a decline of 12% at the midpoint of our guidance.
We expect Q4, adjusted EPS between 85 cents and 89 cents.
This earnings performance is down sequentially from the third quarter of 2919.
Due primarily to lower revenues, mainly from weaker end markets.
Higher investment in new growth program.
And the timing of employee compensation expenses.
Now, let me turn to our guidance for the full year 2019 as shown on slide 20.
Our updated guidance for full year 2019, now anticipates the lower end market outlook that we should we shared earlier with you will recall.
As a result, we expect revenue between 3.4 to 2 billion.
3.446 billion for the full year 2019.
Representing a decline between two and 3%.
We expect foreign currency to decreased revenues by approximately 29 million.
And the net effect of acquisitions and divestitures reduced revenues by approximately 6 million.
Our organic revenue guide represents a decline of 1% to 2% for the full year.
We expect adjusted operating income between 779, and 785 million, which would represent a decline of approximately 6%.
On the bottom line, we expect adjusted net income between 569, and 575 million and adjusted earnings per share between $3.51.
And $3, a 55 cents for the full year 2019.
This represents a decline of 3% to 4%.
We expect to generate free cash flow of approximately 430 to 450 million.
This free cash flow guys assumes annual capital expenditures were approximately 160 to 170 million for the full year 2019.
Now I'd like to turn the call back over to Joshua.
Thank you very much Francesca please assemble the queue in a roster.
Well now begin the question and answer session to ask a question Jewish Press Star then one and you touched on.
Okay using the speakerphone. Please pick up your sense of missile question the keys.
And your question please ask Robyn.
Thanks.
That's.
The next Gen.
Ahead.
Hi, Thanks for taking my question I guess first one for mark and or Jeff.
I guess I'd like to dig into this new initiative to kind of migrate up the stack. If you will and so my question is.
The personnel.
What is the current head count and of that what would you categorize is engineering resources and up those engineering resources what percent.
Darfur engineers.
Great. Good question. So there are some skills that we've been able to use from our core business specifically around the expertise associated with wireless sensor design. So we have reuse there if you will or do redeployed a number of those resources headcount wise, we're talking about 90.
People today with the vast majority of them being engineering, but some very important critical resources in terms of marketing and sales given the new customer base that we're engaging with.
Got it two more questions if I could.
Or one more and then a follow up the.
If we look at.
If we look at the aerospace as a proxy for.
The data being generated in a whether its autonomous or a dash whatever the level, maybe that you that you're targeting.
For vehicles or heavy vehicle in off road.
An airplane will generate basically I think a gigabytes going from Boston to San Francisco, but.
A car will generate in a day.
Over a terabyte. So you had mentioned kind of moving that data and storing in the cloud what is your solution in terms of dealing with the massive amounts of data.
We generated.
In terms of this I OTI strategy and then is maybe for Martha I was wondering if you could just update on dollar content.
Per vehicle is that was a major part of this strategy and in auto and we've always done a nice job of kind of breaking that down by a by region with China kinda, representing the growth engine for that I'm wondering what's changed given the.
The end market slowdown thanks.
Yes.
Both of those the.
This is a really interesting space that we're focused on.
Foray into.
Really more of a solutions based offering for sensata, including data.
When you look at what that customer base really need the data intensity is not in the areas that you've talked about like arrow and automotive it's really getting.
Algorithmic insights on what's actually happening on those vehicles and in those trailers.
So the infrastructure today, when you look at telematics purveyors and in some of the cloud platforms that are there is really well scaled to be able to except that data. The challenge is the level of insight and.
Really coming from the vehicle is not what it needs to be to keep those fleet managers happy.
So a little bit of comment on on the initiative that we have I'd say relative to content per vehicle. The progressive has been quite good.
As you know, we're moving rapidly on a small base and easy content will continue to make good progress there a China continues to be the fastest content grower for us and auto. So we are well along our way of doubling that content over the past three years job. So on really good shape.
There.
Some of the parts of the market, where we've seen content growth accelerate and GM happens to be one of those are North America content and John at General Motors is quite strong we're feeling that in the face of the strike right now.
But that's just ties to our clean initiatives that we have in auto as well so can climb make.
Progress there.
Great. Thank you.
The next question.
Tim Horan with Bank of America. Please go ahead.
Yes. Thank you good morning.
In Q3 reported revenues down three and adjusted operating income down for roughly and your guide has revenue down too, but adjusted operating margins down about 10.
You might have mentioned that Paul a little bit about timing of comp, but I just wanted to ask you feel good.
Address what is creating these worse incremental margins and how much of that do you view as controllable that you can take actions on on a have a follow up.
I think it's all controllable questions over what period of time the biggest drop that we saw was Jim was very abrupt. It's a significant drop is 3% of the automotive business. So its significant.
And so the volume drop is what's driving most of the margin degradation and we're starting to align our costs, we have been why our cost to the lower demand profile.
But it doesn't happen instantaneously and so we're working that very quickly and we have confidence our ability to get our margins back up as we exit Q4.
Into 2020.
Hey, Rob Wamsi want one other comment there you know we're spending some time profiling an area, where we are accelerating investments and thats a phenomenon as we move sequentially as well so the GM phenomena is ugly, but its compressed and at the one shot.
And where we're not taking our eyes off of really important growth initiatives. So thats, having some impact as we move sequentially as well.
Okay. Thanks for the color there Mark and if I could ask the street based models you would you say, though the exit rate for Fourq. You is a good base to assume for modeling 2020 seems like Fourq you have some onetime negative I would like Jim that we just spoke about so how should we think about seasonality, particularly into on Q.
Yes that would you add or the seasonality you kind of be the same as you typically Q1 is our lowest margin profile.
So I would expect that seasonality or the profile for 20 to be similar to what you saw.
In 2018, other though I would say Q4 2020, we would expect to be better just given the comments. We just made about the abrupt drop out of volume this quarter, yes. So to answer your question directly now we would not viewed the margin performance in the fourth quarter as sort of an AD reset baseline on sensata.
So we're seeing sequential movements.
Now on.
Operating profit.
70 basis points down that's not our normal profile as we move sequentially. So we would expect.
As we go can you know as we get through the fourth quarter and certainly as we enter into the early days of to 2020.
Okay. Thank you.
The next question.
With Wells Fargo Securities. Please go ahead.
Hey, good morning Moneta.
Oh, just tacking on that Jeff do site.
Yeah tagging on that margin questions.
Strong margin like you pointed out Martha.
This is a broader question doesnt include GM in it.
That's true, but more broader outlooks into 2020 can you talk about how we should be thinking about leverage a contribution margin for sensata and downcast scenario given that initial outlooks for 2020 for auto peers are coming in worse than feared can you talk about some of the cost actions you might have taken are considering.
Yes, we've already taken a number of actions I'm going to let Paul on elaborate a bit more.
But we really focusing on making sure we maintain our high differentiated margins and would expect to do that.
You know even in AD detrimentally down market that now if we get into something that's extremely can have an impact.
But we see an awful lot of market movement down and you can see how we're doing in the third quarter, so putting putting the GM strike aside done a really good job of protecting our margins and we've done that there is some cost actions that we took early in the year impact I think you can say more so we as we mentioned the last call. We've done a lot of restructuring in Q2 two.
Yes, there was more restructuring in Q3, we continue to work to align our cost structure to the lower demand.
Really focusing on fixed cost reduction.
And allowing the variable costs to come down as the volumes come down in their natural discipline in managing the PML demanding managing our cost structure.
Okay. So do these cost come back a one Jim I mean, like Jim's right I mean, right Noah Okay. So they don't look at this specific thoughts are going to come back I mean, clearly when volumes pick up we're going to need to support that volume, but in terms of the fixed costs. Those fixed costs are expected to majority those to go away.
Permanently.
Got it.
My follow up.
As Mark mentioned and we're continuing to talk with you know to invest in these new growth programs and so that will be an offsetting impact.
Got it that's that's a clear thank you so much my follow up.
Your next question from Doug Kelly with Jefferies. Please go ahead.
Good.
Hi, This is Gavin on for David Thanks for taking my question.
Looking at Slide five you noted that auto outgrowth is expected to approve in Q4.
Can you talk about some of the drivers there is that region specific or product specific and then just have a quick follow up.
Yeah. There there are number of drivers and just keep in mind, we have.
Pretty good visibility on to content growth.
Despite the volatility in the end market.
So we do have launches that are underway, so new content actually coming on vehicles, despite things like the GM the dam strike.
China continues to be a very strong content performer for us. So you saw in Q3, we actually delivered organic growth in China.
Despite a said down market of about 6%.
So delivering strong double digit content growth and that will be what continues to drive and overall performance of about 500 basis points.
Great. Thank you and then that that content outgrowth that content growth in China can you just going in more detail there too. Please thank you.
Yes, there are number thats driving that growth. So one of the big ones as we are fulfilling a requirement, helping our customers fulfill a requirement around national six standard I'm you can think of these as being analogous to euro six emission standard.
Thats driving more sensors into both passenger cars and also on road truck.
So some great content there, we're seeing now the mandate around tire pressure sensing play out and that's given us nice share gains in China and additional content.
And then we're just continuing to see kind of a modernization of the fleet in China, So things like sensors and climate control system are adding content growth for us.
The use of oil pressure sensors, which are pretty highly installed in mature markets are continuing to grow in China. So some of that puts and takes.
Great. Thank you.
Next question comes from Dan.
Research. Please go ahead.
Hi, Thanks, a lot for taking my question.
Just wondering if theres anything to report on.
Bidding activity or new business wins on electrification and maybe more broadly.
As we expect hybrid vehicles to be a big part of.
OEM strategies to meet Seo two targets, particularly in Europe can you talk a little bit about your content opportunities on hybrid vehicles.
Yes, So let me address that question on hybrid first we've always talked about the fact that we really like a hybrid solution because it has both power trains available on it and we can provide content into it.
With regard to the progress on the electrified platforms. We continue to see a very strong pipeline of opportunity. The acquisition of gig Evac has really been validated in terms of the innovation.
That we believe that their products bring to the market and that's been really confirmed from our engagement with customers as well as the broader investment case that we underwrote on that investment to help propel us from M&A standpoint, but we talked last quarter about the number of different initiatives.
Product design that we are developing both organically and through acquisition on the electrification front and feel.
Continue to feel very good about our positioning in terms of serving customers on that in that area.
As a pretty it's a pretty competitive market right now so just in terms of any customer announcements will rise a little bit sensitive to talk about where we're winning business because.
It's an incentive there's intense competition to get new platforms into the marketplace and we're enjoying those engagement.
Okay, great and and Paul if you could.
You mentioned some productivity headwinds.
In the quarter from from launches.
You talked about.
Continued investment in R&D out into 2020, and you also talked about kind of fixed cost reductions. If you kind of put those three things together as we look forward do you expect you know costs to be.
Lower on a year over year basis next year.
Taking out the effect of up kind of just general variable cost movements based on production.
So as we look at 2020, and so we're still going through that process planning for next year, just at a high level the scaling of new products for larger we largely behind us.
What is impacting this year the decline in a lot of our higher margin mature products and the scaling up of these new products, which which is more costly. So as we as those new products start to become more mature their margin profile improved for the moment margins next year I expect to be to be better as it relates to that.
With the fixed cost reduction will continue to drive out and cost and truck is aligned to the demand that we're seeing.
We're going to continue looking as Jeff mentioned about increasing our investments more connected that's very very important issue for us so too early to call the margin profile, but I would expect everything to improve the cost to be lower relative demand as we go into 20 and through 20 and it will follow the demand profile that we see from our customers. So thats, the where the heavy lifting is being.
Done right now to better understand the overall demand profile and what that translates to in terms of a 2020 outlook and we'll do the work to make sure that our cost structure is aligned to that.
Thanks, a lot that's really helpful.
Again, if you ever question Press Star then one.
Next question is from having to do.
Evercore. Please go ahead.
Thanks, Good morning, guys all of two questions as well I'll focus on multiple on the Hbr softness and you talked about lower customer forecasts in inventory reductions as well.
For me expense, how long do these corrections typically las into each hotel market. How many quarters is issued typically persist and then from a content perspective do you see a content on the issue or side remaining stay below accelerating over the next few quarters.
Yeah, I know, it's early innings and the market correction when we look across of and end market segments, and we went back and looked at things like 2015, where we saw an overall correction and you know given that it it ranges from about 10.4 to six quarters.
During the time of intensity has never been the same throughout every cycle. So some start very intensely and others sort of build momentum so not sure I can provide a lot of them a lot of.
Visibility on on that what backend looked like the thing that the impacts in content growth now and we think stabilizes you know as the correction gets underway is that you're seeing delays and new equipment coming into the market. As these customers are trying to actually consume older equipment that has less of that.
Content, so as those inventories come down we would expect to see content restored.
And at the same time Weve.
Both programs that are that we would expect to see improved the overall equipment take rate.
Got it and that's really helpful. If I could just follow but Paul Paul the free cash flow conversion was fairly impressive I think high 90% in Q3, My math suggest a it remains high in the high 90% to get in Q4 as well hopefully that's right up I'm wondering is this something onetime in nature, that's helping this high free cash flow from regional the back half.
Off or is this something structural that we should start to think about as the model longer term numbers and free cash for you guys.
Last year, a similar kind of similar with the second half that's for our cash flow conversion in the first half what we're seeing is very strong execution around reducing past dues on receivables.
These are very good very good collections in Q3, we continue to work our inventory.
The streamline our inventory worker inventory levels down improve our terms and conditions with suppliers, so driving better working capital efficiency is a product process improve initiative, we've had for a while you're seeing the results of that but the seasonality or this is relatively the same with the second half is typically stronger in terms of conversion.
Thank you very much guys.
Thanks on it.
Next question Simon.
With JP Morgan. Please go ahead.
Hi, Thanks for taking my question this is but it on for summit.
So my first question relates to the aerospace end market and can you give us a sense of what trends are you seeing in end market you have been reporting very strong organic growth number is dead. So how sustainable is the trend as we particularly move into 2020 is it more a function of favorable and marketing general audit more content through its plus inside Ando and just as a quick follow up.
Can you also give us an update of how much restructuring remains to be undertaken in the fourth quarter. Thanks.
There are why don't I hit the aerospace one and then Paul can hit the second part of the question. So aerospace is one of these end markets that has the luxury of a very long lead time around the booked business and so I suspect that many of you were tracking.
The aerospace industry in the eight to 10 year backlog of of.
Of orders that are out there so that provides for.
Some very very long visibility into the into the revenue stream that we would have associated with that.
We also have similar pipeline around content growth or new products that we're launching into that space that we have high visibility too as well.
So the combination of the very long cycle and the visibility gives us a pretty good look we track a number of metrics cancellation of orders, which there has been some but not anything that would cause with anybody to be alarmed regarding that backlog of business and we also watch things like passenger miles and.
So forth to do really gauge the health of the overall industry and we're seeing that be continue to be quite resilient. Despite some of the challenges associated with grounded aircraft and so forth.
Well at the plant and we have been able to bring new content into that growth rate. So you've seen a combination of the strong end market as well as content.
So you mentioned restructuring so in the third quarter, we did have more restructuring action, we consolidated site in Germany.
And we continue to do repositioning transformation initiatives within our current existing sites and I expect this activity to continue given the weekend up market demand that we're seeing.
Thanks, so much.
Thank you.
Your next question is from Joseph Giordano with Cowen. Please go ahead.
Hi, Good morning. This is Robert in for Joe I, just had a quick question you know as we head into 2020, which end markets do you think from most at risk next year versus your current expectations I have a quick follow up after that.
Yeah, I think as Paul mentioned earlier, we're doing a lot of work to try to understand the landscape for 2020, so I want to be very careful.
To tell you that these are preliminary thoughts and Beth.
I think when we think about whats at risk going forward, we're looking at where we already seen quite a bit a contraction.
And so we're beginning to recognize that things like China PMI are stabilizing it but unfortunately, it's still a contraction rate so probably not risk of accelerated decline like we've seen but we don't see recovery at least in the first half of the year most likely.
The one end market than weve not seen have like a lot of.
Correction is north American auto so the GM strike notwithstanding.
That's a market that has been operating I think above expectations slightly down but above expectation. So that's another area, we're watching quite closely.
When we look at the balance of our end markets and our eighth feel our segment is definitely interaction territory and will probably remain there as they move into 2020, So don't expect a surprise, but definitely not counting on an improved outlook for a good portion of 2020. So those are very preliminary thoughts we would incur.
Average everybody to do their work on those end markets themselves, but those are the ones that effects of that.
Okay Perfect and then my follow up would be just have you seen any sequential bottoming or sign of the sequential bottoming within the industrial end market.
You know for for US what we see in that particular.
End market, just given where we operate in the supply chain, we see an awful lot of inventory takeout and while that occurs our conclusion is that it has and is not yet sort of stabilized.
So we'll be watching that one closely but that's one of the phenomenon that's affecting our re guide in the fourth quarter.
That's great very helpful. Thank you very much.
Next question.
Okay and that would Suntrust. Please go ahead.
Great. Thanks for taking my question.
I'd like to.
Follow up on the investment and smart and connected.
I think most of US are aware that the initial foray into this market is from Schrader in acquisition.
And now there is organic investment it would seem that there maybe opportunities for M&A in this area to broaden and deepen the portfolio.
Should we anticipate this isn't M&A.
Focus area of the company.
Well certainly as you pointed out.
Major element of the foundation of this did come originally through an M&A activity in at the time of that when we acquired trader. We knew there would be more opportunities for use of wireless sensing.
If we do have a healthy pipeline smart and connected in electrification are among that pipeline in terms of opportunities.
So we will continue to look at it I think it's important to note also that it's not just the the wireless capability that was brought to us in terms of the.
Yes ability to serve this this new segment. It's also the strong position, we have with our core SVR business and it's tough to do applications that can be converted into a wireless capability to bring it to this vehicle area network solutions. So it's a combination of those organic and inorganic to really bring.
Thats two to market into where it is today.
Great. Thanks.
So one thing you can really count on is that when we do acquisitions, they're very much aligned to our strategy, you've seen that and electrification with a gig evac acquisition you look at our our acquisition or Schrader very much tied to the sensor strategy said to the extent that your understanding our strategy and we appreciate the work that.
While the duty to do that you will not be surprised by the acquisitions we make.
Okay I appreciate that color one more if I can there there have been other.
One acquisition recently get back you provided a little bit of color a minute or two ago.
But if you could maybe go a little deeper as to traction with the products coming out of that business in sort of as it's developed a little bit more of a standalone business relative to.
The way you've typically.
Integrated these much more.
Well.
Much more completely let's say as opposed to wedding acquisitions Standalone. So an update there and then also with the partnerships with.
Quanergy and lithium balance any update on those would be helpful. Thank you.
Yes, so on we'll we'll tag team this a bit and they're really important topics inside sensata and just to put the frame around what's happening at give back and the engineering expertise. The technical expertise that we acquired with that businesses is really important but we already have highly co mingled.
Technical teams that we've staffed from legacy Sensata.
Into California, where that the electrification team sets the contactor team said.
We've already launched manufacturing insight for Sensata site in China and in Mexico. For example, and that's an all about expanding our position in the automotive market. So things are progressing quite well and we've had some wins and some design ins.
That would not have happened for Standalone get back just given our ability to engage globally with auto and industrial customers as well. So I think nice nice progress there not a lot to say about quantity, we see the overall level four level five autonomous driving opportunity really pushing out there and so as we.
Think about the pace of our investments.
That's an area, where we probably turned down a bit versus where we've been in the past and in check on on the.
Lithium balance side, we spoke a fair amount on the last call regarding this topic in terms of not only lithium balance, but the other organic activities that we've been undertaking wireless battery management, and so forth and how they fit together to form what is sensata is electrification strategy more to be done there, but we feel.
Really good about the progress and the integration, which varies depending on the partnership or the acquisition that we're talking about to optimize for the outcome rather than having a one size fits all.
And it's been really good progress in terms of lithium balance had the engagement that we've had with our customers and the help that it's provided to us in terms of our continued progress on wireless battery management. So good good progress there.
Thanks as updates.
Your next question from Craig Hettenbach with Morgan Stanley . Please go ahead.
Yes. Thank you I'm just a question on kind of operating margins just thinking longer term and in particular, Jeff as you kind of laid out some of the growth initiatives should we think of is there any kinda reallocating of resources or just kind of within what footprint.
Expected to kind of invest.
Drive margins longer term.
Yes, good great question. So to date, we've talked about the fact that we've been investing in the smart and connected initiative for about 18 months to two years already.
And it's been a sizable investment it's been in the 15 million dollar rate per year that we've been invested and we've done that by doing exactly what you just said, we've reallocated investments to where the biggest opportunities our long term for Sensata I think the question that Martha was sort of getting at when she talked about the frame there.
Is there maybe a point in time, where we need to invest incrementally and we'll speak to that and we'll call. It out we're not talking about huge amounts of money here.
But the example, we gave is we want to double down if you will double the investment on smart and connected if the proof points continue to come in Thats, the kind of range to be thinking about to help transform as well as what other people have mentioned around some of the inorganic activity that we might be able to do there.
Got it and that just follow up question from loss I appreciate the color I kinda that the macro and end markets, but as you said none of these cycles are.
The same in terms of how they play out but just you know the recent deterioration or an inventory adjustments and heavy vehicle industrial any other signals you're seeing from the customers in terms of where they are in terms of the progress to kind of re align inventory to lower demand.
Yes.
They not not much beyond what I've already described is there's generally a phenomena of them.
Keeping our eye really tight eye on what's happening with them with their orders to the extent that we can and then with production and usually it's more what they do versus what they say.
So our call off will often reflect what we can expect to see in terms of inventory takeout and on both their end and also in our and our own component level inventory. So those are the things that we look at.
Okay. Thank you.
Your last question is from Jim Suva with Sidoti. Please go ahead.
Okay. Thanks very much.
I believe it was either Martha Jeff mentioned in inventory correction and Hbr takes about four to six quarters. If I heard that right. So does that put us basically exiting 2020.
Assuming demand doesn't get much much worse, but exiting 2020 is likely the equilibrium for much better growth and I think that was for H. VR the comment.
And on the auto side was there inventory we have to think about working through that and how long should that take I know you mentioned the GM strike a lot on the auto side, but I was curious about the inventory. Thank you.
Hi, Jamess Martha yet I was responding to a question around how long do do we doesn't generally take the h. feel our market to cycle. So that was less about inventory take out relative to those end markets. Then you know just studying past corrections in those end markets and.
How long do they take it play out that wasn't the sort of four to six quarter.
Phenomena I described and you know theres outliers on either side of that so.
It's information, that's probably available for everybody to do their homework on.
On the auto piece. So yes. In addition to that correction, we are seeing inventory correction on top of and order rate.
On the auto side the vehicle inventory is more visible.
Generally speaking the industry is in control on vehicle inventory given the GM straight to actually North America is quite low GM is quite low right now vehicle inventory and they will be trying to build that back and there is much less component level inventory and the overall supply chain. So the places.
As we have to keep our eye on in terms of inventory corrections are in Europe , a that's we're expecting more some of that as we get into the fourth quarter that some of the thinking that than our guide as well.
Great. Thanks, so much for the clarification its greatly appreciated.
Thanks, Jim.
This concludes.
For today's call I'd like to now turn the call back Joshua young for closing remarks.
I'd like to thank everybody for joining us. This morning, Sensata, we'll be attending the Robert Baird Industrials Conference in Chicago next week as well as the Cowen Industrial and Technology Summit on November 19th in New York, We invite you to visit US at these conferences or at our headquarters and out of our Massachusetts. Thank you for joining US this morning and for your.
Interest in Sensata, you may now and the call.
On the phone conference. Thank you for attending today's presentation you may now disconnect.
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