Ladies and gentlemen, thank you for standing by, and welcome to the Stoneridge Third Quarter 2019 Conference Call. At this time all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator instructions] I would like to hand the conference over Matt Horvath, your speaker for today. Thank you. Sir, you may begin.

All right. Thank you. Good morning, everyone, and thank you for joining us to discuss our third quarter results. The release and accompanying presentation was filed with the SEC yesterday evening and is posted on our Web site at www.stoneridge.com in the Investor section under webcasts and presentations. Joining me on today's call are Jon DeGaynor, our President and Chief Executive Officer, and Bob Krakowiak, our Chief Financial Officer. Before we begin, I need to inform you that certain statements today may be forward-looking statements. Forward-looking statements include statements that are not historical in nature and include information concerning our future results or plans. Although we believe that such statements are based upon reasonable assumptions, you should understand that these statements are subject to risks and uncertainties and actual results may differ materially. Additional information about such factors and uncertainties that could cause actual results to differ may be found in our 10-Q, which has been filed with the Securities and Exchange Commission under the heading Forward-Looking Statements. During today's call, we will also be referring to certain non-GAAP financial measures. Please see the appendix for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures. After Jon and Bob have finished their formal remarks, we will then open up the call to questions. I would ask you that you keep your question to a single follow-up. With that, I'll turn the call over to Jon.

Thanks, Matt, and good morning, everyone. Let me begin on Page 3. In the third quarter, we continued to drive financial performance through operational improvements, and reduced costs to offset the macroeconomic headwinds we have seen during the quarter and expect to continue throughout the remainder of the year. More specifically, reduced production volumes, the GM strike, and continued currency impacts reduced revenue in the quarter by $6.9 million and operating income by $2.5 million. Our second quarter sales of $203 million resulted in an adjusted gross margin of 26.7%, translating to an adjusted operating margin of 6.7%. Adjusted EPS for the quarter was $0.37. This quarter, we continued to make significant progress in the commercialization of MirrorEye. We received our second OEM award, which is estimated to be $10 million of peak annual revenue at a 10% to 15% penetration rate, with a start of production in 2021. Additionally, I'm pleased to announce that we expect a major global commercial vehicle OEM to start prewiring our MirrorEye systems early next year. I'll provide additional detail regarding new developments later in the call. In addition to the progress we're making with systems like MirrorEye, we continue to work to ensure that our overall product portfolio aligns with both our long-term strategic goals and our targeted financial performance. We have completed our strategic review of the switches and controls business within electronics, and this morning, we will provide an update on our plans for the business. Finally, this morning we are updating our full-year adjusted EPS guidance to a midpoint of $1.55 to reflect current macroeconomic and market conditions, as well as the actions we have put in place to offset these headwinds. Bob will provide additional detail regarding our third quarter financial performance and guidance for the remainder of 2019…

Thank you, Jon. Turning to Slide 11. Sales in the third quarter were $203.4 million, while sales, excluding divested product lines were $192.6 million, a decrease of 3% relative to the third quarter of 2018. Excluding divested product lines, adjusted operating income was $12.6 million or six and a half percent of sales. More specifically, control devices' sales, excluding divested product lines was $99.1 million, which was approximately equal to the third quarter of 2018. Resulting in adjusted operating income, excluding divested product lines, of $12.3 million or 12.4% of sales. Electronics sales of $87 million decreased by 4%, resulting in adjusted operating income of $6.9 million or 8% of sales. PST sales of $16.5 million resulted in adjusted operating income of $500,000 or 3% of sales. As a result of reduced production forecasts, unfavorable forecasted currency rates and the GM strike, we are revising our full-year revenue guidance to a midpoint of $817.5 million. Due to our reduced revenue expectations, we are forecasting continued gross margin pressure and have reduced the midpoint of our gross margin guidance by 175 basis points. With that said, we expect to partially offset the reduced gross margin through continued cost-cutting measures, and therefore, have only reduced the midpoint of our adjusted operating margin by 62.5 basis points. Finally, we are expecting a reduced tax rate in the fourth quarter as a result of the continued evaluation of our tax position relative to the current U.S. tax environment. And as such, we have reduced the midpoint of our full-year adjusted tax rate by 375 basis points. Due to the GM strike, reduced production forecasts and the impact of currency, offset partially by our continued cost reduction measures and more expected effective tax rate for the year, we are reducing our 2019 full-year adjusted EPS…

[Operator instructions] And your first question comes from the line of Justin Long with Stephens.

Thanks.

Justin? I think we may have lost Justin.

And his line is open.

Okay.

Hey, guys. Can you hear me?

Yes.

Okay. Sorry about that. I'm not sure what happened. But good morning and thanks for taking the questions.

Good morning.

Good morning. I wanted to start with the production commentary around the second half and fourth quarter, and maybe look into next year. And I know you're not giving 2020 guidance, but could you maybe comment on what you see as the weighted average end-market expectation in 2020? And then, also add in some commentary about your ability to outperform the end markets next year and what can drive that.

Sure, Justin, I'm happy to talk about that. What you see in the summary in terms of third quarter, fourth quarter that we outlined on Page 5, with respect to next year, so we use IHS and LMC really for all of our projections. You are correct. We are not going to provide specific guidance around next year. But, what I can tell you is if you look at the IHS and LMC projections for our various end markets, so North America pass car right now, if you look at the IHS data, it's down about a tenth of a percent. It goes from 16.6 million to 16.5 million. China passenger car next year is down about 12%. North America commercial vehicle goes from basically -- it was 524 million units in the first quarter, was the third quarter projection; the current projection is 502. And then Europe has gone from 620 to 597, so obviously, significant changes in our various end markets, which is a basis for what we use to pull together our outlook for 2020. But there's a number of -- obviously, there's a number of other factors as well. You've got price-downs, currency, new business awards and then obviously our end market. And then you'd add onto that the MirrorEye retrofit opportunity, that's basically the way to think about 2020.

Justin, with regard to the question on our ability to outperform, we've got a couple of things, which is a whole series of launches that are happening in 2019 and 2020, as well as 2021 in all three of our business segments, as well as the retrofit opportunity, which isn't in any of our backlog. So what you see is content growth, which should give us the ability to outperform, but certainly, we've got some significant headwinds in the base markets.

Yes. And the two primary programs that we talked about for next year, Justin, in terms of what's launching, we've got the park-by-wire program, which is a 2019 launch, which is a peak annual revenue of $31 million; our telematics program for 2019 with peak annual revenue of $24 million. And then in 2020, we have a global driver information system launch with a peak annual revenue of $38 million, and then the MirrorEye program launches late next year and that's peak annual revenue of $12 million as well.

Okay. That's helpful. And I don't think you mentioned the 2021 targets on this call, but you do have that guidance out there for $1 billion of revenue and 15.5% EBITDA margins. Are those targets still achievable in the current environment that we're seeing and based on the current production forecasts the next couple of years?

Yes. So Justin, we're going through our -- basically, through our process right now in terms of updating our outlook. So we're not commenting on the 2021. We'll have more information in the next several weeks and just from our perspective, we just haven't -- we haven't finished going through our process. So I don't have any additional information versus what we've said before.

Okay. And I guess last quick one on MirrorEye. I know there are two other OE awards that you're expecting. I think previously, you had talked about one of those may be occurring before the end of this year and the other one sometime in early 2020. Has the timing around those awards changed at all?

No.

Okay.

We still see it the same way.

Okay. Easy enough. Well, I appreciate the time. Thank you.

Thank you, Justin.

And your next question comes from the line of Chris Van Horn with B. Riley FBR.

Good morning. Thanks for taking my call.

Good morning, Chris.

I just wanted to ask about -- I think you mentioned 50 basis points to 100 basis points margin potential from the electronics switches moving to China. And does that get you closer to kind of a company average margin, or and use the additional upside from that, or is that kind of the end goal?

So Chris, if you look at it, what we talked about, is that the 1,500 basis points on the entire company. So if you look at the revenue size of that business, it tells you how much the sort of magnitude of financial performance that it changes for that business. What I'd say to you is these are the sort of actions -- when we talk about getting to top-quartile financial performance, these are the sort of actions that we have to take in all places. So we look at every one of our product lines and we make judgments on how to drive the performance, and here's an example of it.

Okay. Got it. Now moving to the MirrorEye, you said it kind of continues to increase fleet evaluation. Would you be able to quantify at all how those evaluations have evolved since earlier in the year, are you seeing that ramp up considerably and if you could disclose kind of your quantification of that.

Well, a couple of things, Chris. I mean, we talked about the number of fleets on the last call, but just from an overall mileage perspective, we're approaching now -- as we have more fleets in the field utilizing MirrorEye, we have almost 6 million miles tested right now on our MirrorEye system. So you're seeing that number growing pretty exponentially as more trucks are in the field evaluating our technology.

Okay. And just to follow on that, so it sounds like the prewire option is interesting, and it sounds like it may have been a retrofit kind of driven decision possibly, you can clarify it for me there. But when the OEMs are going to prewire those, do you see that as a similar take rate in terms of what you've cited before, in that kind of 10% to 15% level, or do you think they might raise that up in the hopes that there's more adoption?

So one thing you need to understand, Chris, this isn't a take rate situation then. This is an option that effectively, the fleets are pulling and saying they want to be able to install a CMS system and the OEs are responding to it. So what I think what we view it as is we view it as a very strong step that our fleet trials are generating pull and that the fleets are pushing the OEs to make it easier for them to install the CMS system.

Yes. I would say, Chris, I think it's important that the fact that the OEs are installing our wire harness in their vehicles at the factory is a testament to the value proposition that the fleets are seeing with MirrorEye and the conversations that they're having with their OE partners relative to the importance of this technology in their vehicles.

Okay. And so they're effectively -- they're going to pay you for the wiring, and then if they decide to go with the MirrorEye, that'll just be an additional revenue component as you move forward?

Yes. We're not talking about how that revenue is getting split, but the way to think about it is that it's an installation of the activities that would require opening up of the interior of the truck will be done in the factory, which makes a post-factory install much, much more efficient.

Okay. Thank you so much for your time guys.

And your next question comes from the line of Scott Stember with CL King.

Good morning, guys.

Good morning.

Could you talk about your expectations of potentially recapturing the business that you anticipate losing in the back half of the year with GM?

Sure, I'm happy to do that, Scott. Thanks for the question. So this is something that we have spent a great deal of time looking at, obviously. So one of the things that's important to mention, anytime one of your customers goes on a labor strike, it's obviously challenging for us, because generally speaking, you incur higher decrementals, because you largely maintain your direct labor on those specific lines, and given the abruptness of the volume fallout and you also want to make sure that you get a smooth ramp-up when once the labor disagreement has been settled. So, that was a drag for us during the quarter and continue to be a bit of a drag in the fourth. So the answer to this obviously is, Scott, it depends, right? There are certain platforms that GM will pretty much running nonstop. So their ability to ramp up and basically, order more was limited because they were pretty much running at full capacity. So there's going to be, depending upon the product line and the number of shifts they were running, it's not a catch-up because a number of the -- for example, a number of the truck products were running at basically at full production prior to the strike. So their ability to make up is relatively limited. But on some of the other platforms, on some of the other pass car platforms and SUV, CUB platforms, they weren't running at full capacity. There's an opportunity to make some of that volume up over time.

Got it. And with regards to shift-by-wire, I know we've been talking about this for a while and park-by-wire is coming on. When do we start to see, I guess, the park-by-wire meaningfully start to replace what we've lost in shift-by-wire?

It's at start of production this year and a ramp-up throughout the end of 2019 and into 2020, so really, on a run rate basis, 2020.

Okay. And back to MirrorEye, I know last quarter, we had pushed out the -- or you were -- I won't say pushed out, but there was a reason for pushing or doing the retrofits on MirrorEye later than expected, as you guys were getting all the necessary feedback. Are we still on track...

Yes.

All right. And one -- And lastly on the prewiring opportunity here, you guys have talked about how an OEM installation, while it is definitely nice and accretive to you, the margins are better on the retrofit side. So, if we were to start to see potential OEM or OEM-award types of business coming through the back door, so to speak, through a prewiring situation, could you talk about how the margin -- net-net how the margin situation for you guys could be a lot better than initially expected on MirrorEye and...

Yes. And I don't think that's necessarily the way to think about it. I think what you look at is this gives us the ability to accelerate the retrofit planning in 2020, as they do the prewire, it takes one of the barriers, or one of the considerations that the fleet would have, away. It reduces the risk from an install perspective; it reduces the downtime. And so we look at it as an opportunity to accelerate retrofits with the support of an OE doing the prewire.

All right. That's all I have for now. Thanks.

Thanks, Scott.

And your final question comes from the line of Gary Prestopino with Barrington Research.

Yes. Good morning, everyone.

Good morning, Gary.

Hey, the churn of the electronics switch and control business, was your decision to keep it more or less based on the fact that you couldn't find a buyer, or as your customers heard that you were thinking of jettisoning the product, or the division -- they came back to you and said, no, hey, there's potential here, we like what we're doing, we like what you're doing. And you get your costs down to make it a viable part of your product portfolio?

Gary, it's somewhere in between those two. It wasn't that we couldn't find a buyer. It was the fact that as we went deeper into the evaluation, and as we had conversations with customers, what we saw is there was a growth profile to that business. Secondly, as you see, the continued trends in the space, the core competencies there with that product are additive to what we see as the needs going forward. And with the launch of our new facility in Suzhou, we had the capability and the capacity to make a move and have this impact two years ago when or even a year ago, when we weren't in the new facility, we didn't have the ability to do it.

Okay. And then, this is your second MirrorEye program, right, that you signed with an OEM. Could you just refresh my memory on the first one? What's the annual revenue run rate there, and when does it start?

Yeah, the first one is peak annual revenue of $12 million and it will launch at the end of 2020.

Okay. And then, this prewire program that you've announced, did I heard you say, Jon, that it really does effectively close out a competitive product from coming in once a fleet rewires, is that correct?

Well, so a couple of things. First, with the FMCSA exemption, we're the only ones where it's legal to do a retrofit and pull the mirrors off the truck. So there's a block in that already, the question that many people ask is if you do the prewire, does it actually open a competitive threat. And the answer is no, because it's a Stoneridge-specific wiring system.

Okay. That's great. Thank you very much.

Thanks, Gary.

Our next question comes from the line of Glenn Chin with Buckingham Research.

Good morning, gentlemen. Thanks for taking the question.

Good morning, Glenn.

Just a quick question around the regulatory environment. There's chatter that, or news that, the regulatory wheels around cameras for both passenger cars and commercial vehicles may be in motion. NHTSA is supposedly soliciting public comment as to whether or not they should permit cameras to replace mirrors on both of those. What can you share with us as far as what the timing might be like, or what the regulatory path or process might be like?

Predicting timing in a regulatory activity is difficult. NHTSA has gone on for comment. They're seeking comment for both pass car and for commercial vehicle. I was down at the North American Commercial Vehicle Show earlier this week and had conversations with various OEs, as well as various industry organizations about what's the best way to support this activity and to approach both the DOT and NHTSA. This is something that obviously, we'll be in support of, but it's not something that we at Stoneridge believe will work in partnership with the fleets with industry associations and with the OEs.

All right. Thanks, Jon. And then do you know is the process or the path much different from what it was as far as the FMCSA exemption? Is new legislation much more -- is it much different from getting the exemption?

My guess is, Glenn, there's probably more to it. As you start talking about with vehicle regulations as opposed to a retrofit regulation, let's be honest, that's not an area where we have extensive experience. And it's part of the reason why we work with OEs to do this.

Okay. And then with this prewire option, so it reduces downtime. But other than the downtime that will translate to cost savings for fleets, will it inherently make it -- instead of doing it when the truck is built, will it be cheaper overall to install it into typical retrofit option?

Well, it would be faster, so by definition, it would be less expensive to do the install because it'll be faster. You don't have to do that wiring at the time when you take the truck down. It's already done.

Okay.

I think the important thing to take away here is, one, it will give many fleets more comfort because again, trucks are a piece of production equipment. So any time you make a change on a truck, they're worried about what it could do from a durability standpoint; they're worried about what any change could do from a downtime perspective. So, the fact that it's wired in advance reduces that perceived risk. The second thing is, if we can reduce the -- if we can make the install more efficient, that's going to certainly drive an additional level of comfort. And the third thing is the fact that it's in partnership with the OE to send the signal.

Okay. Very good. That's it for me. Thank you.

Thanks, Glenn. Operator [Operator Instructions] And your next question comes from the line as a follow-up from Justin Long with Stephens.

Thanks for taking the follow-up. I just wanted to circle back on a couple of things that might help from a modeling perspective next year. Bob, if I kind of piece together your answer on the end markets for 2020 that you gave me earlier, is it fair to say that your weighted average end markets will be down high single digits next year? And then, also I wanted to ask about tax rate expectations into 2020.

So Justin, we're obviously going through our guidance process for next year, so I'm not going to comment on it. But we're very transparent in terms of what we use. You know that we use IHS for pass car and we use LMC for commercial vehicle and that's the basis for the guidance that we provide on a regular basis. So, every year at the Deutsche Bank conference, we give you our various end-market exposures and the percentages. Now, we do something at a much more granular level of detail, so the back of the envelope in terms of here's our weighted average market exposure based on the IHS- LMC data. We go to obviously a lot more detail than that. We build it up by platform. We build it up by region. And generally speaking, our platform has been outperforming the underlying market by a pretty substantial amount for several quarters now. So it's not as simple as just taking those end markets and multiplying by the percentages. So it's a process that we go through. This is the normal time that we go through it in terms of putting a plan together. And it wouldn't be appropriate for me to comment on it, given the fact that we're in the middle of it right now.

Okay. That's fair enough. And then on the tax rate for next year, any initial thoughts?

Yes. The tax rate is the same, Justin. We're still going through -- the tax team is still going through that, and we continue to look for opportunities on the tax side. We've found them this year. And it's been a benefit to our shareholders. We will continue to do that and we'll be in a position to provide some more guidance on taxes later in the year, early next year.

Okay. And I guess just last question is on capital deployment. Obviously, the balance sheet is still in pretty good shape, generating a good amount of cash. So, could you just talk about where you stand in terms of capital allocation toward buybacks versus acquisitions and maybe what that acquisition pipeline looks like right now?

Sure. So, we are still going through a $50 million share repurchase program that's outstanding, still a share repurchase program. So that's still in process right now with our counterparty. We stand at all times, this is a company with a really strong capital structure right now if you look at where we're at in terms of our leverage levels, given our cash flow profile. So, really for us, we continue to evaluate that. And obviously, we're very active in looking in the M&A space as well. We're still seeing valuations are pretty high in the space, so, Justin, as you and I have talked about this on several occasions, we really like our portfolio. So, there's nothing out there that we have to do. And we're not going to go and have another like this and do something that we don't know extremely well. So, we're looking for similar businesses that give us either geographic or customer diversification. And we want to pay the right price, just like we did with Orlaco. And Orlaco has been an absolute grand-slam for our shareholders. Those are the types of transactions that we're looking at. And to the extent that we don't find those, we'll do what we did back in the second quarter and return capital via share repurchases.

Okay, great. Thanks again for the time.

Thanks, Justin.

As there are no further calls in queue, I would now like to turn the call back over to Jon DeGaynor for closing remarks.

Thank you all for your participation in today's call. In closing, I can assure you that our company is committed to continue to drive shareholder value through strong operating results, profitable new business and focused deployment of our available resources. This management team will respond efficiently and effectively to manage and control the variables that we can impact and will continue to drive strong financial performance. We're confident that our actions will result in continued success for the balance of 2019 and beyond. Thank you.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect. Thank you. And have a great day.