Joshua S. Young - Sensata Technologies Holding NV Martha N. Sullivan - Sensata Technologies Holding NV Paul Vasington - Sensata Technologies Holding NV.

Amit Daryanani - RBC Capital Markets LLC Wamsi Mohan - Bank of America Merrill Lynch Shawn M. Harrison - Longbow Research LLC Christopher Glynn - Oppenheimer & Co., Inc. (Broker) Craig M. Hettenbach - Morgan Stanley & Co. LLC Matthew Sheerin - Stifel, Nicolaus & Co., Inc. Mark Delaney - Goldman Sachs & Co. William Stein - SunTrust Robinson Humphrey, Inc.

Jeremie Capron - CLSA Americas LLC Samik X. Chatterjee - JPMorgan Securities LLC Jim Suva - Citigroup Global Markets, Inc. (Broker) Richard M. Kwas - Wells Fargo Securities LLC Ambrish Srivastava - BMO Capital Markets (United States).

Good morning and welcome to the Sensata Technologies Third Quarter 2016 Earnings Conference Call. At this time, I would like to inform you that this call is being recorded. For opening remarks and introductions, I'd like to turn the call over to Joshua Young, Vice President of Investor Relations. Mr. Young, you may begin..

Thank you, Beth. Good morning and welcome to Sensata's Third Quarter 2016 Earnings Conference Call. At this time, I'd like to inform you that this call is being recorded. As we begin the call today, joining me on the call will be Martha Sullivan, Sensata's President and CEO; and Paul Vasington, Sensata's Chief Financial Officer.

In addition to the earnings release we issued earlier today, we will be referencing a slide presentation during today's conference call. The PDF of this presentation could be downloaded from Sensata's Investor Relations website. We'll also post a replay of today's webcast shortly after conclusion of today's call.

Before we begin, I'd like to reference Sensata's Safe Harbor statement on slide number 2. During the course of this conference call, we will make forward-looking statements regarding future events or the financial performance of the company that involve risks and uncertainties.

The company's actual results may differ materially from the projections described in such statements. Factors that might cause such differences include but are not limited to, those discussed in our Forms 10-Q and 10-K, as well as other subsequent filings with the SEC. On slide number 3, I show Sensata's GAAP P&L for the third quarter of 2016.

We encourage you to review our GAAP financial statements as part of today's presentation. Most of the subsequent information that we will discuss during today's call will be related to non-GAAP financial measures. A reconciliation for each of our GAAP to non-GAAP financial measures is included in our earnings release and in our webcast presentation.

Martha will begin today's call with an overall business summary. Paul will then cover our financials for the third quarter 2016 in more detail and provide fourth quarter and full-year 2016 guidance. We'll then take your questions after our prepared remarks. Now, I'd like to turn the call over to Sensata's President and CEO, Martha Sullivan..

Thank you, Joshua, and thank you all for joining us this morning. I'd like to start by highlighting our financial performance for the quarter on slide 4. Sensata delivered strong margin expansion and organic EPS growth in the third quarter despite facing challenging markets.

We reported quarterly revenues of $789.8 million, which represented growth of 8.6% year-over-year and was at the midpoint of the guidance we provided for the third quarter.

We generated organic revenue growth of 1.7% in the third quarter of 2016 with both our Performance Sensing and Sensing Solutions businesses generating low-single-digit organic revenue growth. After a 5% organic revenue decline in the first half of 2016, I am pleased that Sensing Solutions resumed organic revenue growth this quarter.

We continue to deliver on our promise of expanding margins and growing our earnings per share. Our adjusted earnings per share was $0.74 in Q3 2016, which was above the midpoint of our guidance and 2.8% higher than the third quarter of 2015.

Excluding the effects of currency and acquisitions, net of exited businesses, we generated 11% organic earnings per share growth compared to the third quarter of 2015. Our adjusted net income margins of 16% expanded sequentially by 100 basis points compared to the second quarter of 2016.

This improvement reflects net productivity gains in our base business and acquisition synergies. Another key highlight of the quarter is that we are rapidly paying down our debt due to our strong free cash flow. Earlier this year, we committed to getting Sensata's net leverage ratio to between 3.7 and 3.9 times by the end of 2016.

I am pleased to report that we further reduced our net leverage ratio and are on track to achieve this target for the full year. I would note that through the first nine months of 2016, we have consistently executed on meeting our operational targets, as well as our investors' expectations.

Despite top-line headwinds from weaker markets, our organic earnings growth and cash flow performance demonstrate we are executing to our guidance. Finally, I want to stress that Sensata has a sustainable multiyear path to expand our adjusted net income margins. This margin improvement is primarily driven by Sensata's robust operating model.

This model is based on driving continuous operating improvements, capturing efficiencies and cost reductions, and leveraging the model to successfully integrate and increase the margin profile of acquisitions. Over time, we believe we will achieve our long-term target of 20% to 23% adjusted net income margins.

Slide 5 shows how we are delivering on our commitment to improve our margins. Since the first quarter of this year, we have improved our adjusted net income margins by 180 basis points or 210 basis points, excluding currency.

Our higher ANI margins have come primarily from cost synergies that we have achieved from integrating acquisitions, as well as net productivity improvements in our core business, as a result of best cost sourcing and production efficiencies. As a part of our integration process, we continue to streamline our global footprint.

During the quarter, we made the difficult decision to close our production facility in Minden, Germany by second half of 2017. This is one of the sites that we acquired through our CST acquisition. We are also on track to close our Springfield, Tennessee plant in the first half of next year, which we have previously announced.

The key message I would leave with you is that we are steadily delivering the margin improvement that we committed to earlier this year. Long-term sustained margin improvement will continue to be a key part of Sensata's performance over the next few years.

I illustrate this on slide 6 where I show Sensata's reported and core adjusted net income margins since 2013. There are a couple of key takeaways on the slide. First, you can see how our adjusted net income margins, shown in blue, are diluted as a result of the DeltaTech, Schrader and CST acquisitions that we completed and are shown below the chart.

A key part of our strategy centers around acquiring companies where we can extend our product reach, globally expand into new markets and create cost synergies by combining manufacturing, supply chain and back office functions. We rarely find acquisition targets that operate at the same high-margin levels as Sensata.

As a result, acquisitions initially reduce our margins due to their lower profitability, up-front integration investment and interest burden. And you can clearly see this effect on the slides.

Although our reported ANI margins are diluted in the short term from acquisitions, margins grow to the target range over time, as we complete integration activities resulting in strong returns and value creation for our shareholders. In the process, we create scale and increased operating efficiencies in our assets.

Additionally, we use our significant free cash flow to repay the debt incurred to finance acquisitions. The second key takeaway on the slide is that our core adjusted net income margins which exclude the acquisition effects have grown to north of 20% over the past few years.

In Q3 2016, our core ANI margins were 20.8%, 80 basis points above the low end of our long-term target. This is important because it shows that our margin expansion opportunity is highly achievable and demonstrates our proven capability to elevate the profitability of acquired businesses to the level where Sensata's core business operates today.

As we achieve cost and revenue synergies and as integration expenses wind down, we have a clear path to generating ANI margins of 20% or more.

While improving our margins remains an important part of value creation at Sensate, I also want to stress that we continue to invest and win important orders that will drive future revenue growth opportunities which I show on slide 7.

Many of Sensata's businesses are tied to the global trends of improving energy efficiency and helping to create a cleaner environment. A good example of where this trend is playing out is in our Performance Sensing business where we have developed a sensor for customers' gas direct injection application.

Gas direct injection or GDI is a fast-growing application, where Sensata has established an expanding leadership position and is already serving nine major global automotive OEM manufacturers.

The reason for this success is that Sensata sensors provide distinct technical advantages like vibration resistance and accuracy that allow the OEM a more robust, reliable and precise gas direct injection system. The enablement of the GDI system helps OEMs drive significant fuel efficiency savings.

During the quarter, we secured two important GDI wins against key competitors, totaling approximately $10 million per year. These types of wins will help us drive revenue growth in the future. On our fourth quarter earnings call, I talked about how we are increasing our sensor content in vehicle electrification.

We have been investing in this area to help fuel our long-term growth. In the third quarter, we closed a large order with one of the leading electric vehicle manufacturers. Sensata developed a dual-function sensor that addressed the complex requirements of our customers' highly efficient and innovative thermal management system.

We won this business because our sensors provide industry-leading accuracy that enables the manufacturer to achieve their demanding targets for efficiency. We expect to see our first revenues from this transaction sometime within the next two years. This is a great example of how Sensata can benefit from the growth in vehicle electrification.

Over the past two years, we have been investing to extend our leadership position in tire pressure sensing in China. A key hurdle to achieving this growth is the approval of new TPMS legislation that would mandate the use of tire pressure systems in new passenger cars.

During the third quarter, the China Automotive Technology & Research Center, or CATARC for short, finalized a mandate that provided specific details on what companies would need to do in order to comply with tire pressure regulation.

This mandate has been in process since 2010, and its approval represents an important milestone towards passing TPMS legislation in China. CATARC recommends that China OEMs start to comply with TPMS in 2019. And we are starting to see an uptick in sales activity, particularly with multinational OEMs.

This would help drive revenue growth beginning in 2019. We have a lot of attractive growth opportunities in the aerospace market, especially after the CST acquisition doubled the size of our aerospace business.

Major customers have now made Sensata a strategic supplier and our product portfolio along with our global footprint and product quality have led to a number of new wins that will drag revenue growth over the next few years.

Finally, one of the more exciting investments we are making for growth is our partnership with Quanergy to develop LiDAR sensors for the autonomous driving market.

At this point, we are only seven months into the partnership but we have been validating strong customer desire for solid-state LiDAR sensors given the attractive market for autonomous vehicles. We continue to make technical progress and are collaborating closely with Quanergy.

We believe that this market has great potential and that we have a fundamental advantage with our approach to solid state LiDAR sensors. We will provide you additional updates next year. An update on Sensata's market and business trends are summarized on slide 8.

For the full-year 2016, we aren't seeing any significant major changes to Sensata's markets, but we are seeing pockets of weaker revenue performance as we enter the fourth quarter. For automotive, which is our largest market, we expect that our core auto business excluding TPMS will grow 5% organically for the full year 2016.

This growth is stronger than the market as a result of strong content growth, particularly in China, where our business has been robust. That being said, as we look ahead to the fourth quarter, we believe we will see a slight downtick in our North American auto business due to end of year inventory corrections.

Additionally, our European TPMS aftermarket business has also been soft due to lower demand for winter-wheel tires, and this will also have a modest negative impact on our Q4 revenues. We have continued to outgrow the market in our heavy vehicle and off-road business.

Through the first nine months of the year, we generated a 3.4% organic revenue decline compared to the same period in 2015. This performance was clearly better than the overall HVOR market due to our content growth. The Class 8 North American truck market has declined throughout the year and was done approximately 27% at the end of the third quarter.

We believe we will continue to perform better than the market in HVOR despite continued weakness entering the fourth quarter. Sensing Solutions' organic revenue growth has sequentially improved each quarter of 2016, improving from a decline of 7% in the first quarter to 2% organic revenue growth in the third quarter of 2016.

For the full-year 2016, Sensing Solutions will largely be on track with our expectations. However, entering the fourth quarter, we are concerned about high inventory levels of compressors and motors, particularly in China, and we expect our revenues will slightly lower than previously expected in the fourth quarter.

We expect foreign exchange rates in the fourth quarter of 2016 to be roughly in line with our previous expectations. Revenues will be lowered by approximately 1% to 2% and EPS will be lowered by approximately $0.05 in the fourth quarter of 2016 due to currency. So, to summarize my comments on slide 9.

Despite challenging market conditions, we are on track to deliver our adjusted net income and earnings per share guidance for full-year 2016. We are making good progress in expanding our adjusted net income margins and generating organic EPS growth. We expect this trend to continue in 2017 and beyond.

We are driving continuous operating improvements, capturing efficiencies and cost reductions and leveraging our operating model to successfully integrate and increase the margin profile of acquisitions.

Finally, we are delivering on our promise to pay down debt and improve our net leverage ratio and we will continue to strengthen our balance sheet over the next few quarters. I'd now like to turn the call over to Paul to review our third quarter results in more detail and to provide financial guidance for the fourth quarter and full year 2016.

Paul?.

one, higher year-end inventories in North American auto market; two, European TPMS aftermarket due to lower winter-wheel tire demand; and three, higher compressor and motor inventories in China, which will affect our Sensing Solutions business.

We are factoring this into our fourth quarter guidance, and as a result, we expect to generate revenues between $765 million and $805 million. The midpoint of this guidance represents revenue growth of approximately 8% and organic revenue growth of approximately 4% compared to the fourth quarter of 2015.

Our current flow rate stands at approximately 82% of the midpoint of this guidance.

Despite the modest change in revenue, we are not changing our annual earnings guidance as we expect to report between $123 million and $133 million of adjusted net income and to report adjusted earnings per share between $0.71 and $0.77 based on our fully diluted share count of 171.6 million.

The midpoint of our EPS guidance represents approximately 12% reported earnings growth, 21% organic earnings growth. We expect foreign exchange rates will lower our revenues by approximately 2% in the fourth quarter compared to 2015, and lower our adjusted EPS by approximately $0.05.

The midpoint of our fourth quarter 2016 guidance assumes that we achieve an adjusted net income margin of 16.3%, slightly better than what we reported this quarter. Our financial guidance for the full year 2016 is shown on slide 15.

Our revenue guidance for Q4 implies that we'd be approximately $10 million lower than the midpoint of our previous guidance for the full year 2016. We are maintaining our full-year earnings per share guidance but narrowing the range. We expect to report revenue between $3.18 billion and $3.22 billion.

The midpoint of this guidance assumes reported revenue growth of 7% to 8% and organic revenue growth of 1% to 2%. We expect to generate adjusted net income of between $487 million and $497 million with adjusted EPS of between $2.84 and $2.90.

The midpoint of our adjusted EPS guidance represents approximately 4% reported earnings growth and approximately 11.5% organic earnings growth. We expect the impact of foreign exchange rates to reduce our adjusted earnings per share by $0.19 to $0.20 for the full year 2016.

I will conclude my remarks by summarizing Sensata's investment summary on slide 16. Sensata's goal is to win in sensing. The sensing market is attractive and growing, and we've been a leader in this space for over 25 years. We expect to generate strong returns from the acquisitions we have completed and by diversifying our end-market exposure.

Future returns from recently completed M&A transactions are a pillar of our growth strategy, and one of the ways we differentiate ourselves. We generate attractive long-term revenue and earnings expansion, and we are poised to sustain this performance in the future. Finally, Sensata is a high-margin, high-cash generation business.

Our margins are born out of long cycle revenue, highly differentiated products and extremely cost effective manufacturing operations. Strong margins, coupled with a low cash tax rate drive strong free cash flow to allow management to generate strong returns for investors. Now, I'd like to turn the call back over to Joshua..

Thank you very much. Beth, please assemble the Q&A roster..

Thank you, Mr. Young. The first question comes from the line of Amit Daryanani, Capital Markets. Your line is open..

Thanks. Good morning, guys. I guess, two questions from me. One, could you just walk through the timeline and leverage that you have to get your adjusted ANI back towards that 20%, 23% target for the total company.

Is the two cycles that you talked about today enough to get there and what sort of timeline should we expect to achieve those targets?.

I missed the second half of that about the cycles, Amit.

Can you repeat that?.

Yeah.

I was just trying to understand when do you get to the adjusted net income margin target that you have of 20% to 23% for the entire company? And do the two site closures, one in Germany, one in Tennessee, I think that you guys announced that you talked about, is that enough to get the total company within the target or does there need to be more restructuring to get there?.

Got you. Okay. So, there are a number of things still ahead of us in terms of improving the profitability of our acquired businesses. And so those two consolidations are certainly important steps in the direction but by no means are we complete. We generally will talk, Amit, about a three-year cycle to complete integration.

And in the case of Schrader, we actually extended that to four years, because we did little to restructure in the first year of that acquisition. You might recall it was going through a big ramp in Europe. And so, if you look at where we are, that would take us out into the 2019 time horizon on the acquisitions.

I think the other thing to be mindful of is there's a variable on all this and that is what will our overall interest rate expense be and so, that would be one more swing factor. And that's subject to a lot of things that we would want to be thinking through as we look at ways to create value for our shareholders..

Got it. And if I could just follow up, there's been a fair amount of discussion, kind of what auto production numbers look like as we go into 2017.

Would love to get whatever initial assessment you have across the geos and how you think auto production shakes up for the next year?.

I will tell you with one exception, and that exception being China, we're not seeing any sort of significant disruptions in the landscape in auto. We are not expecting much help from mature end-market production as we move into 2017. What becomes really important for us is to get through the quarter and look at what actual backlog is doing.

In the case of China, we're seeing a very strong second half, not surprising given the incentives that are in place there. And we think that growth will slow in China but still be really attractive.

So, if you look at underlying secular demand and the installation rate of vehicles per driver population, it's still very attractive in China, the tax movement notwithstanding. So, we think end-market growth slows there. We continue to grow way above end-market in China and expect to continue to do that as we go forward..

Perfect. Thank you..

Your next question comes from the line of Wamsi Mohan, Bank of America. Your line is open..

Yes. Thank you. Good morning. So, Martha, clearly HVOR is still a headwind, so is TPMS. North American auto seems to be at a high inventory level. So, Performance Sensing is just not growing at the same faster pace that we were hoping for.

Now, in this environment, how are you thinking about the need to maybe accelerate some of the initiatives around integration activities, so potentially not being $0.20 incremental in each of the next two years, but being able to pull forward some of that.

Do you have a plan to do that in case the demand environment continues to be relatively weak? And I will follow up..

Yeah. So, I guess the relatively weak part probably wouldn't drive a major change in our overall cadence on integration. We have continued to pull forward some of that, and you can see that in the steady pace of margin improvement across the business, including in the base acquisitions.

In the event that we saw something quite disruptive, we experienced a demand contraction. That would have us lowering our utilization rates across our asset base and would allow for some significant acceleration. And we have been able to execute in that fashion in past cycles..

Okay. Thanks, Martha.

And then as a follow-up, when you look at sort of the European auto revenues which were weaker both on quarter-on-quarter and year-on-year basis, can you talk about how much of that may be on a quarter-on-quarter basis was seasonality versus the weaker aftermarket that you alluded to on TPMS versus anything potentially Brexit-related? And on China TPMS, it sounded like that was going to contribute to revenue growth in 2019.

I think in the past, you have said some of the OEMs might adopt this earlier. Are you still expecting an earlier adoption despite the official timing? Thanks..

So just to answer the second question first, we are seeing some earlier adoption on that front. Still small but we're actually – we have a run-rate on TPMS now and we expect to have one that's stronger next year. On the European front, the winter wheel effect is fairly significant in the quarter because it is a very seasonal development for us.

So, I'd say that's a fairly significant part of the overall. I think the other thing that we watch carefully, we've talked in the past about headwinds relative to diesel installation. We think that those are slow. We're expecting about a 5% contraction in the take rates over the next three to four years.

And that's about what we're experiencing as well that you might not see in the production rates..

Thanks, Martha..

Your next question comes from the line of Shawn Harrison, Longbow Research. Your line is open..

Morning, everyone. Two-parter, first, just the North American auto situation in terms of the excess inventory, do you believe that will be cleared up exiting the calendar year? And then, second on the Sensing Solutions business, particularly the excess inventory in China.

it's been a theme for probably the better part of two-plus years now, sometimes worse than we're seeing now, sometimes a little bit better.

But is there kind of a thinking that you begin to under-produce the market just to secure yourself from having to talk about higher levels of excess inventory and talking down revenues in future quarters related to this business?.

Sure. On the North America front, we're largely calling the quarter based on backlog. And so, as we roll into a quarter, we've got about 82% of it secured in actual order rates. And so, the reconciliation that we do when we look at that order pattern versus where we think production is, it really is how we predict some takeout on inventories.

And we would expect those to be corrected before we move into next year. On the Sensing Solutions piece, not a lot of options to under produce. And so, we're in the position of being sole supplier to many of our customers. We work closely with them to try to understand what their component inventory level is.

The one thing that is somewhat out of our control is how much of their equipment they inventory. And so, that will have us sometimes over-performing and underperforming the market, given the overall compressor and motor buildup, and that's what we're expecting to see in the fourth quarter..

Okay. And then, just one brief follow-up if I may. If you were to rank the impacts on revenue for the fourth quarter in terms of North America, TPMS in Europe or other factors, if you could do that, that'd be a great help, Martha..

Fairly balanced, to be honest if we – I would say particularly for those first two, quite balanced. Probably a little smaller impact just given the size of the business on the inventory in China for Sensing Solutions..

Okay. Very helpful..

Shawn, I'd like to add that Sensing Solutions, if you think about the whole year, the full year of 2016, we're in line with where we thought we're going to be. Actually, might be a little bit better. So, I think that business has performed pretty well, despite this little hiccup in Q4..

Sure. Thank you..

Your next question comes from the line of Christopher Glynn, Oppenheimer. Your line is open..

Thanks. Good morning. Martha, thanks for putting the stake in, so to speak, with the 2019 timeframe for the integrations and the ANI targets.

Is sort of ratable progress the way to think about that?.

No. I would be careful not to assume that. And so, you can see, for example, some of the things that are driving that improvement.

And if you just think through the mechanics of consolidating on the manufacturing level, that involves a process of some significant integration spending, actually building inventory in a high-cost location, going through an approval and validation process into the low-cost location and then drawing down that inventory, which makes it really unlikely that that develops in a linear way.

So, I would be careful on that. And then, I would just say, again, one of the factors in this is what ends up happening with our overall interest expense. So, as we get to 2019, we would expect to see good operating performance in the acquired business, particularly as we exit that year.

It's going to be a question of where we stand in our overall debt burden at that point..

Okay.

Are you starting to suggest that you're seeing the makings of higher cost refinancing?.

No..

No. Not at all. Not all..

Okay..

Absolutely not..

Okay. And then, on FX, I know they're going to change the rates in the next few months.

We don't know which way, but as things stand right now, what are we staring towards for a range of FX impact for 2017 because that was quite a big factor this year that you had to deal with?.

So, next year, in 2017, it's still too early to know for sure as we continue to hedge for the rest of the year and where rates are moving..

Yeah. (39:10)..

...that year-over-year, foreign exchange will probably be a couple of cents negative. So, a couple cents down or a negative impact to earnings. So, we had $0.19 to $0.20 down this year, so next year will be a couple pennies..

Thanks, Paul..

Your next question comes from the line of Craig Hettenbach, Morgan Stanley. Your line is open..

Yes. Thanks. Appreciate the color on North America and inventory you're expecting into your-end. Could you extend that into China and Europe? I mean, certainly, China, the growth is very strong, but just, as you see, OEM suppliers kind of manage inventory into the market that we're seeing right now..

The China phenomenon is not really more on inventory. There's very strong demand right now. I think everyone close to that issue is recognizing there are some incentives that are driving consumer behavior, and I think the swing point is going to be what happens to those incentives as we move to 2017.

We're not seeing significant inventory build in Europe, so not really a factor..

Got it. Thanks.

And then, if you can talk to just the strong free cash flow just delevering the balance sheet versus M&A, clearly, you guys have been very active in recent years on the M&A front but just as you look forward kind of what the priorities are in terms of balance sheet versus looking for growth opportunities?.

Yeah. I think looking forward we're going to be at a normalized rate we think by the time we get to the end of 2017. And so, we'll go back to what's the best way for us to create value for shareholders. Our M&A pipeline is active. We tend to execute proprietary deals, and so the cadence and timing of that will come naturally as those projects advance.

We continue to think it's a great way for us to create value for shareholders. You can see it in the earnings growth that we're delivering in the businesses that we have acquired. But at the end of the day, we'll look at using a repurchase decision as the benchmark for whether or not that's the right way to create value for our shareholders..

Got it. Thanks..

Your next question comes from the line of Matt Sheerin, Stifel. Your line is open..

Yes. Thanks and good morning. So, a question regarding the HVOR market where it sounds like fundamentals are a little bit better than expected despite continued end market weakness and you talked about content growth there.

Is that from new products or additional regulatory mandates? And do you think you can begin actually growing that business into next year even if North America continues to be fairly weak?.

So, let's recognize, the end market is absolutely not incrementally better. It's actually....

Yup..

...Yeah, anticipated some of that. And so, to be declining 3.5% on markets that are down, very strong double digits, I think is a testimony to the content growth. We do expect continued content growth in that business. It's driven by a few things. One is greenhouse gas regulations that are developing.

We're also seeing lots of interest in tire pressure sensing in the heavy vehicle market. Just think about what that does for fuel economy gains. For fleet users, that's an exciting opportunity. We see lots of interest in improving the overall efficiency of off-road equipment.

So, when we look at our operator sensing controls, that's an opportunity for us as well. So, despite the end market demand weakness, it's a pretty exciting market for Sensata when we look at the content opportunity..

Okay. Thanks. And just as a follow-up regarding the Quanergy investment and partnership there.

Is there anything you can tell us about when we'd expect any kind of pilot programs, products? And outside of your investment with them, are you actually investing any resources internally in terms of production or R&D outside of that partnership?.

Well, yeah. We have a number of investments, and there's a pretty broad pipeline on the R&D side. I think to speak specifically to timing on solid-state LiDAR sensing, our expectation has not changed a lot. We think that that's still in the 2020 to 2023 timeline where we get to I think real momentum building in revenue, and that's the important thing.

So, plenty of pilots and demos ahead of that, but I think that what's going to be important to investors is actually securing material contracts, and that's the time horizon..

Okay. Thank you..

Your next question comes from the line of Mark Delaney, Goldman Sachs. Your line is open..

Yes. Good morning and thanks very much for taking the questions. The first question is on the two site closures that you announced.

Can you quantify what the annual cost savings would be for each of the two site closures that you announced? And then how long do you think it would take before you get to those full run rate savings?.

No. I really can't quantify that off the top of my head at this point. And so if you look at the accretion that we've predicted for the acquisition, it's an important step. These are important steps, but certainly not the only steps as we look forward..

Okay. Understood. And then a follow-up question on the fill rate. I think the comment was 82% fill rate based on your fourth quarter guidance this year. I think last year, the assumption was an 86% fill rate.

If that's right, can you just help us understand the reason for the change in terms of the guidance versus the fill rate?.

I think the fill rate, if you look back to what we saw in the last quarter, I mean, we're about the same level at this time. So I think the fill and the order flow is fairly consistent what we've seen over the course of the year..

Thanks very much..

Your next question comes from the line of William Stein, SunTrust. Your line is open..

Thanks for taking my question and good morning.

Martha or Paul, can you remind us how much incremental EPS we should think about as still coming from the acquisitions that have been closed? And in particular, what that transition would be expected in 2017 versus 2016? So, for example, if we got no meaningful organic growth in the core business, what the EPS growth should look like?.

I would first start with that we are seeing quite a bit of growth in the core business, and you can see it in the information we've been presenting that we're driving significant margin expansion and productivity gains in the core business. The integrations have been going well. We've been consolidating manufacturing, the back offices.

What hasn't been going so great, and it's partly very obvious, is that the end markets that those businesses are serving are weak.

The incremental EPS that we originally expected from those acquisitions are going to be less, but the EPS benefit from the core business, given all the strength and all the operational improvements we've made is going to be more, which is why we're allowed to hold and stay on the guide for the year.

As we continue to go to next year, we're going to continue to integrate and continue to drive – continue with some improvement initiatives, which will continue to be a tailwind for earnings growth in 2017 and beyond..

Yeah. I think another way to think about that is – we've talked about fewer headwinds as we go from 2016 to 2017 relative to currency. We're coming through a year where we've spent fairly heavily on integration. We'll spend again next year and you can see the overall earnings performance of Sensata.

And so, all of what we just described is within our control, and we don't see things on the horizon that are big discontinuities to our overall ability to impact earnings, even with lackluster end market..

Your next question comes from the line of Jeremie Capron, CLSA. Your line is open..

Thank you. Good morning. I wanted to ask you about your pricing and material cost dynamics in recent quarters, and how you think about it going into next year? Thank you..

Yeah. Our pricing has been in line with expectations, and we don't see again a major transition on that front. We have a couple of phenomenon to think about in pricing. Some are – the way everybody thinks about it where we actually will deliver price downs in a multiyear contract.

And another element, though, is we often will introduce next-generation products that have a lower price point, but higher margin performance. And so, that's part of the overall price movement that you'll see as well. And we're in a period of that right now, which probably extends into 2017 as well.

Overall, we talk about a 2% down framework across Sensata..

What about the material cost side of things?.

The material cost side of things, commodities are not a big portion of our overall material spend..

I think to the question, we continue to drive material cost out of our products, which allows us to continue to have net productivity gain, some greater cost reduction to offset the annual price down, continue to expand our gross margins. It's a core part of our business and something we have a rich history of doing..

Thanks. And, Paul, on free cash flow outlook for the year, any change here? It looks like you're trending slightly above target for the full year.

And how do we think about some of the major moving pieces for free cash flow in 2017?.

Two key things to take away. The cash flow looks like it's going to be in the upper part of the range, so we were $350 million, $400 million. It's looking more like $375 million to $400 million is where we think we'll land. What's driving that is the strong income as well as lower CapEx.

And so, we continue to look for ways to reduce the capital intensity of the business, get more output of existing assets. And so, we've been able to continue support demand with less incremental CapEx this year..

Your next question comes from the line of Samik Chatterjee, JPMorgan. Your line is open..

Hi. Good morning. I wanted to sort of go back to the TPMS opportunity in China. I know with the share of business, you have quite a high market share of the market in North America and Europe. I think you've sort of bucketed that as 50% share in the past.

With the mandate getting passed here in Q3, is sort of a 50% market share still a fair assumption, so eventually things can sort of play out or does the mandate sort of change any expectations as to what share you can have of that market in the payments?.

Yeah. That's a little bit high in our share but it is quite strong, as you point out. So, it's between 40% to 45% on a worldwide basis. And we expect to do that well in China which is why we moved very quickly post the acquisition to put manufacturing there and to begin to engage with customers.

So, we've been achieving design-in opportunities right from the get-go and we're really pleased by the momentum we're having there..

Great. Just one follow-up and more longer term in terms of what you're seeing from automakers in relation to powertrain strategies. We're hearing about set of concerns regarding diesel mix in Europe, and that has been a concern.

But are you – when you mention sensor content – increasing sensor content and electrification, are the powertrain strategies from OEMs looking more inclined towards hybrids or are they looking at more like pure electric vehicles? And if you can remind us of what your sort of content opportunity on each of those are separately?.

Yeah. So, it's a time of a really fluid powertrain strategy across the board. So, we see heavy spending on getting sort of conventional combustion engines to very high levels of efficiency. And everybody has an electrification strategy to go alongside that. So, what we see is we do expect to see some decline of diesels in Europe.

I think what you – that tends to have been overstated if you go back to the Dieselgate eruption. So, we think it's about a 5% share loss in Europe on diesel take rate over time. And that has a gap on our sensor content right now. As we achieve things like design wins and gas direct injection, we're closing that gap.

So, when we get to the three to four year time horizon, we don't think that there's a big difference between Sensate content on gas versus diesel. On the electrification front, we do better overall on sensor content with a hybridized vehicle or as soon as customers move to any level of electrification.

We had conventionally not done well on full plug-in electrics but again we're closing that gap quickly. And we talked about a key win that we saw this quarter. So, we're playing across the landscape on that, on all of those avenues and it's really driving our content opportunity as we look ahead..

Okay..

Your next question comes from the line of Jim Suva, Citi. Your line is open..

Thank you. It's Jim Suva. A strategy question probably for Martha and then just a clarification for Paul. Martha, on the strategy, it sounds like you're making good progress at deleveraging the balance sheet.

As you go by that strategy, is the time line kind of around this time next year, the second half of next year where then your ratios are more comfortable where then the M&A probability increases? And then should we just kind of look at this as kind of like a circular wheel? For example you'd make acquisitions.

You lever up the balance sheet and use the cash flow to pay it down and you integrate it and get synergies. Is that the way to think about the time line? And then for Paul the clarification questions are, for the FX impact, you said a few pennies next year.

Can you just remind us of what rates you're referring to? Maybe that's forward versus spot versus current for the rates. And then on the tax rates, are we looking at still a very low tax rate of say, 7% say through 2025 as I believe, if I remember right, it was from your IPO asset markup days and the amortization of the step-up costs.

Thank you very much..

Sure, Jim. Look, I think on the leverage question, you're right. As we get to the second half of next year, we get back to what's a more natural level for Sensata and the level we're quite comfortable with. Given our cash flow, we're comfortable with where we're operating today.

As it relates to probability of M&A, I think the thing to think about is there are a number of factors that impact the probability of M&A. And right now, we've got a fairly high hurdle rate on M&A given where our leverage is. We would probably reduce that somewhat, our internal hurdle rate, as our debt ratio improves.

But we've really got to make sure that what we're acquiring aligns closely to our strategy, and that we can get it at the right price, and that we can bring it to Sensata's margins in a reasonable time horizon. And those are the other things that can have an impact on what actually gets done over time.

I'll turn it over to Paul then I guess for just the other two..

So, Jim, on foreign exchange, you have to kind of go back a bit when we first started to see this massive decline in the euro. In that 2015 timeframe, we were really well-hedged. We've been hedging out about a year-and-half, two years.

And so, we were protected in 2015 because our hedges kind of held up the value of our euro rate for the company, even though the spot price was dropping dramatically. In 2016, all those – many of those hedges have rolled off. And as we continue to hedge into 2016, we're hedging at lower rates.

And so, what's happening now is the spot rate and the average hedge rate, all-in rate, is coming – they're coming closer together. And all the bad news is really happening in 2016. As against 2017, our hedge rate is going to be closer to what you're seeing euro trade today.

The other big currency, that's helping us quite frankly, is the peso and it's the opposite – sort of the opposite story. So, as we look into 2017, our average hedge rates and our spot rates are coming closer together. I think that's the key takeaway. As it relates to tax, this year, we're 5.5% to 6.5%. We'll probably come in around 6% for the full year.

Next year, the tax rate will stand at 6-ish, 6.5-ish range for a period of time. It will gradually move up as we use tax benefits over time. But I think, over the next three to four years, I'm comfortable to say we're going to be in the 6% to 7% range for quite a while..

Your next question comes from the line of Rich Kwas, Wells Fargo Securities. Your line is open..

Hi. Good morning, everyone. Just a couple of follow-ons from me.

On CST, on the transaction, is the expectation that EPS accretion, still reaching that $0.23 to $0.26 range by year three even with the softness, underlying softness, in their business right now?.

Yeah. Rich, I would say that's what we're still targeting, but it does become little bit more challenging with the softness we're seeing in the end markets. But I would say that the integration activities are going really well. We continue to see opportunity there.

So, too early to call that but, certainly we've got – we definitely do have some market headwinds that we've got to deal with..

Yeah. The flip side is we've seen more cost opportunity in that acquisition and are executing on that quickly and well. The other thing to think about, as you can see, as you reach out in time, what's impacting the top line and CST is some of the familiar themes in end markets, so a significant part of their exposure is in HVOR.

And we don't expect that that's going to be a down market for the next three years..

Sure. Understood. And then, Martha, I know it's a little bit early, but if you could just help us think about, at least qualitatively about 2017, you've got key end markets that you're levered to that are either at peak or have already taken a hit. And there's probably some – likely some more deterioration potential in 2017.

So, right now, I understand, that you're probably going through the planning process right now, but as you think about organic growth for 2017, what are the key puts and takes as you see it right now?.

Yeah. Look, I think on end markets on 2017, we're all going to do our work. You guys will, we will do our work. We'll all come to our own conclusion on where that lands. The insight that we have that you don't have is what actually happens in the order patterns as we move into the year.

And we think that that's an important part in calling the overall year. We're going to take our time to make sure we separate out inventory impacts from actual end market demand. And that's particularly important in China just given that we're seeing very, very, very strong growth there.

We have seen it historically where we're at the highest levels we've ever seen. Don't think that's completely sustainable, given what's going on with tax incentives. But a big piece of that is content growth. And we want to make sure that that's on track as we move into next year. So, the puts and takes are familiar themes.

What are end markets going to do and what will happen with the actual launch timing of design-ins that we already have secured and are in place. And I think that's what we're going to have to work through..

Great. Thank you..

Your next question comes from the line of Ambrish Srivastava from BMO. Your line is open..

Thank you very much. Martha, lots of details. I just had two quick clarifications. Talking about the U.S. inventory level, we've seen the data Q3, the published data was levels U.S. light inventory. Vehicles inventory was up, if I recall correctly, four, five days.

And so, are you indicating by your comments that you expect further acceleration in that inventory build and could you please quantify it? And then, my second clarification on China, your crystal ball is definitely well in mind. Year-over-year, what do you expect the unit production to be and then where do you expect it to normalize at? Thank you..

Yeah. I'll hit the China one separately, make sure we're talking about the same thing there. On vehicle inventory, look, at this point, what we're looking at is their actual backlog and who we're shipping to and what it might suggest about their production rate. Now, how that manifests into OEM days of dealer inventory is going to be their choice.

So, we're really not forecasting what happens with vehicle inventory at the end of the year. We're in the time period where our order pattern is the most insightful thing we can use to give you the appropriate guide. I think when we look at China, for the overall year, we're predicting – I'm just looking at my notes here.

We're predicting the overall end production, which is what we monitor to land at something like double digits for the year. I'm just checking my notes on that. And we're seeing something like 30% to 40% growth in the quarter. So, that's not something obviously that sustainable, but a big piece of that is overall content growth. So....

High-single digit..

Yeah. So, I'm sorry..

For the market..

Yeah. We're probably more like 8% to 9% on the overall end market in China..

In Q4.

And then, your business is up 30%, 40%, right?.

Yeah. That was on the year and in this quarter, we're up to that 30% to 40% level..

Sorry..

So, we'll probably end at twice the end production rate..

Got it.

And what do you expect it to normalize at was the second part of the question?.

Yeah. I'm probably not going to give you a useful response to that at this point. The thing I'll tell you is that we did quite a little – quite a bit of work and this goes back to when we saw the big correction in China last year to just try to understand what will happen to secular demand on vehicles.

And when we did that work, we saw something like a 3% to 4% overall production growth over a five-year time horizon. Now, how that translates in any given year, it can be an impact of incentives one year, no incentives the next year. So, I think you need to be really careful in thinking that through..

Okay. Thanks for the transparency. I appreciate it..

We have reached the end of our allotted time for the Q&A session. I'd like to turn the conference call back to Mr. Young for closing remarks. Mr.

Young?.

Thank you, Beth. I'd like to thank everyone for joining us this morning. We appreciate your continued interest in Sensata.

Sensata will be attending the following investor conferences in the fourth quarter, the RBC Tech Conference on November 9 in New York, and the Credit Suisse Tech Conference in Phoenix, and the Bank of America Smid Cap Conference in Boston. We encourage you to meet with us at these conferences or meet with us at our headquarters in Attleboro.

Thank you and good-bye..

That concludes the call for today. You may now disconnect..