Continental Aktiengesellschaft (OTCPK:CTTAF) Q3 2020 Results Earnings Conference Call November 11, 2020 7:00 AM ET

Company Participants

Bernard Wang – Head, IR

Wolfgang Schafer – CFO

Stefan Scholz – Head of Finance and Treasury

Conference Call Participants

Tom Narayan – RBC

Gabriel Adler – Citigroup

Victoria Greer – Morgan Stanley

Henning Cosman – HSBC

José Asumendi – J.P. Morgan

Thomas Besson – Kepler Cheuvreux

Horst Schneider – Bank of America

Tim Rokossa – Deutsche Bank

Operator

Dear ladies and gentlemen, welcome to the conference call of Continental. At our customers’ request, this conference will be recorded. As a reminder, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]

May I now hand you over to Bernard Wang who will lead you through this conference. Please go ahead.

Bernard Wang

Thank you, operator. Welcome everyone to our nine-month 2020 results presentation. Today’s call is hosted by our CFO, Wolfgang Schafer. Also here in the room with us is Stefan Scholz, Head of Finance and Treasury. If you have not done so already, the press release and presentation of today’s call are available for download on our Investor Relations website.

Before starting, we’d like to remind everyone that this conference call is for investors and analysts only. If you do not belong to either of these groups, please kindly disconnect now. Following the presentation, we will conduct a question-and-answer session for sell-side analysts. To provide a chance for all to ask questions, we would ask you to limit yourself to no more than three questions each. We know that many of your have another call directly afterwards, so it would be great if we could conclude this call on time.

With this, I would now like to hand you over to Wolfgang Schafer.

Wolfgang Schafer

Thank you, Bernard. Let me begin today’s presentation on Slide 3, starting with an overview of market developments in the third quarter in contrast to the lockdown included downturn in the second quarter the third quarter demonstrated a strong sequential recovery in car production and demand. Light vehicle production volumes rebound over the course of the summer ending the quarter with only 3.5% below prior year.

China continues to be the leading region 11% year-over-year growth always in the quarter and North America production was able to slightly beat its prior year level. Europe remained the lagging region at minus 8% with our key German and French markets down by 16% respectively 23%. We attribute this weak production levels to conservative inventory management by our European customers and principals good news given we continued highly uncertain business environment. We saw demand growth mainly in line with production growth.

In replacement, tire markets we saw an equally strong sequential recovery with the same region [indiscernible] as with vehicle production. Third quarter volumes in China were well ahead of last year, compared with the period North America also bounced back on prior year level and European demand improved though less than in the other regions. Weaker demand for winter tires had a major impact in Europe.

Outside of Automotive, OE and replacement tires activity in industrial markets also improved sequentially versus the second quarter with demand in China, especially robust and well above the prior year level.

Major topics regarding the period are summarized on the right side of this slide. To meet the demand rebound we were able to quickly and successfully ramp up our activities in our businesses and regions. In parallel we maintain strict management of our cost. Example given here are our fixed cost as well as investments. We are well on track to meet our full year targets in both areas, namely our fixed cost reduction excluding D&A of more than 5% and a reduction in CapEx of at least 25%.

In terms of restructuring, as announced on September 30, the Supervisory Board has approved the discontinuation of the German tire production site in Aachen, the electronics component production site in Karben and the transformation of the Regensburg site. Regarding the restructuring expenses of €687 million for the period also based on reduced business planning assumptions mainly and regarding light vehicle production, goodwill impairments of €649 million recognized in the business area VNI. Significant portion of the goodwill impairments is attributable to acquisitions we made before 2008.

Slide 4, the status of our ongoing structural program is covered on this slide. The implementation of our expanded transformation program is making progress as targeted with the resolutions approved by the Supervisory Board in September further measures for reaching our target of €1 billion of gross cost savings have been made. As seen on the chart, roughly 60% of the savings will accrue in Automotive Technologies, about 25% in Rubber Technologies, and the remainder in Powertrain Technologies.

A sizeable proportion of the savings will be realized during 2022 and 2023. One-time costs of approximately €1.8 billion are anticipated. As a reminder, program expenses of €788 million have been booked so far this year and €665 million were booked in 2019. Further expenses for restructuring and asset impairments related to this program are expected to be recognized in the fourth quarter of 2020, though the amounts are not clarified at this time. As for cash related effects, cash outflow of over €700 million is expected in 2021 while the amount in 2022 should be somewhat lower and actually for 2020 we foresee around €100 million.

Let me now move on to some of our highlights from the period starting with the Volkswagen ID.3 on Slide 5. Many of you are already aware that our iCar high performance computer for the whole vehicle connectivity is at the heart of the new electronics architecture of the ID.3 Vitesco server based drive control unit controls in the vehicles electric drive. In addition, we supply many key components into this and other vehicles on this MEB platform which includes not only single products such as safety and added sensors, digital displays and control units, but as well innovative components tailored specifically for electric vehicles.

For example, the ID.3 features our newly developed drum brake, components for thermal management of the battery as well as vehicle specifics, summer, winter, and all-season tires featuring the Conti CU [ph] technology. These products demonstrate the importance of our technologies in enabling key applications such as electrification, autonomous driving, and networking.

The next highlight move to Slide 6, shows how Vitesco Technologies continues to strongly benefit from increasing demand for electrification to recent successes in this area shown here. First we are seeing very solid demand for our EMR3 E-axle, our fully integrated system combining an E-motor, inverter and reducer. By virtue of its high power density compact size and high integration, the EMR3 reduces engineering efforts for vehicle manufacturers.

This is the key reason why we have been chosen to supply it to numerous OEMs and orders such as PSA, MA and [indiscernible]. Second, we recently won a more than €2 billion order from a major OEM for our new high-voltage box product. This product integrates numerous high voltage functions to enable onboard charging and DC/DC conversion in a compact package. Winning this order will not only support future growth, it also underlines our ability to redeploy our confidence in the field of electronics integration into new high-voltage electrification applications.

I’ll move on to really of our performance KPIs starting on Slide 7. Reported sales in the nine months of the year came in at €26.8 billion down 19.7% versus the prior year period on a reported basis and down 18.1% on an organic basis. Exchange rate effects have gradually become more material due to the stronger euro resulting in a headwind of €578 million year-to-date.

The significant sales drop was the main cause of the substantial decline in adjusted EBIT to €629 million and resulting margin to 2.4%. These numbers imply a year-on-year operating leverage of around 26% which has been successively improving over each quarter during the year. Special effects totally — total minus €1.563 billion due to restructuring costs, goodwill impairments and carry forward effects. These items weighed on net income after taxes which came in at minus €1.168 billion as well as trailing ROCE which was minus 4%.

Free cash flow excluding acquisitions and carve-out effects came in at €105 million as the negative working capital effects from the second quarter were neutralized by the improved business activities in the third quarter. I will address these topics on later slides. The gearing ratio and equity ratios reflect both the adjustments in business results as well as the dividend dis-imbursement of €600 million in July. Net indebtedness stood at €4.9 billion at the end of September.

Let me now move to the Q3 performance by Group sector starting on Slide 8. Reported sales in the period declined by 7.3% year-on-year mostly due to FX headwinds. Group organic sales were down only 2.7%. This decline was driven by lower sales in Automotive Technologies and Rubber Technologies, while Powertrain Technologies recorded positive organic growth in the period.

Despite the organic sales decline, the adjusted EBIT margin in the quarter reached 8.1%. The continued implementation of cost measures initiated starting last year, as well as in the second quarter and the positive tailwind from raw materials contributed to this result. Sequentially, comparing the third quarter against the second quarter we achieved an incremental operating leverage of 40%. This was much better than the decremental operating leverage of 34% that was achieved between Q2 and Q1.

Let me now review organic sales performance for Automotive and Powertrain with slower vehicle production on Slide 9. As mentioned earlier, the European market experienced the softest growth with light vehicle production in the region falling year-on-year by 8% and even weaker growth in our key markets, Germany and France. The disadvantages mix was the main reason for the 14% organic decline in automotive sales in Europe. In contrast, organic growth in Powertrain declined only 3%, bolstered by increased demand for electrification products.

In contrast Automotive was able to keep pace with growth in North American production while Powertrain underperformed slightly. Last, but not least, both Automotive and Powertrain were able to outperform in the fast growing Chinese market. Taken together, net on a global level, Automotive slightly underperformed its regionally weighted average due to our high European sale share while Powertrain outperformed by 6 percentage points.

Now, Slide 10 shows individual review of the business areas starting with AMS sales totaled €2 billion, 13% below the prior year level, excluding the deconsolidation effect of negative €123 million from our Chinese HBS joint venture and the fixed effects organic growth was minus 5%. Weak sales in Europe, particularly in Germany was the main reason for the decline by growth in both China and North America outpaced local vehicle production.

Despite the sales decline AMS profitability remained quite resilient with adjusted EBIT coming in at €125 million equivalent to a margin of 6.3%. This result was thanks to the continuation of fixed cost saving measures initiated in Q2, this is evidenced by the sequential operating leverage of 43%.

As for order intake, we continue to see delays in sourcing decisions by our customers most notably for ADAS related projects, despite this AMS recorded an order intake of $3.3 billion in Q3. The most significant order intake of around €1.8 billion was recorded for our next-generation one-box integrated brake system, MK C2. This innovative product will be numerous vehicles of a premium OEM starting in 2024.

VNI, Vehicle Networking and Information is covered on the next slide, number 11, organic growth at VNI was at minus 7.9% in Q3 negatively impacted by weak European production and softer sales in North America, as well as continuing sales decline in our HMI business unit. In contrast, organic growth in China was double-digits. In terms of adjusted EBIT, though the significant recovery in sales versus Q2 and continued strict fixed cost management helped profitability in the quarter.

This was counterbalanced by both for license fees and legal costs related to our networking business. This impeded the development of this sequential operating leverage which was only 30%. Just as in AMS order intake in VNI was restrained by continued delays in customer sourcing decisions most notably for HMI systems. Nevertheless, we were able to win further future business for body and telematic control units helping us to achieve an order intake of €1.2 billion for the period.

Moving to Slide 12, I will cover Rubber Technologies starting with tires. FX headwinds restrained, with order growth in tires to 3.4% below the prior year level. Organic growth in the tire business area was positive at 0.5% the positive figure was supported by only a slight decrease in volume of 1.8% which was ahead of the more negative conditions and weaker production and replacement tire markets, I described earlier, but the bigger growth driver was, we saw the price mix of 2.4% supported by significantly positive mix and pricing attainment in replacement tires.

The stable pricing environment in the European replacement tire markets also continued. These sectors more than compensated for negative pricing in OE. The positive organic growth supported the positive development and adjusted EBIT to nearly €500 million equating to a margin of 17.1%. This was largely aided by significant reduction in fixed costs which were down 8% year-on-year and a strong tailwind from raw materials of about €90 million.

These effects positively expanded sequential operating leverage versus the second quarter to 47%. Not that we do not expect the positive tailwinds to be sustainable as many of our cost saving measures are short-term in nature and raw material prices have recently experienced considerable increases, for example for natural rubber and [indiscernible].

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ContiTech on Slide 13, sales or pronounced improvements versus the second quarter, they did remain organically 5% below the prior year level. On the OE side the organic sales decline was 6.4% as Mobile Fluid and Surface Solutions experienced nice rebounds in volumes versus the historically weak Q2, but did not reach prior year level.

Industrial and aftermarket developed comparatively better with an organic decline of 3.5%. This was supported by strong growth in air springs. In regional terms both customer groups benefitted from solid demand out of China where our business grew organically at a double-digits rate.

Thanks to the previously implemented performance and hands on measures and supported by sort term fiscal savings as well as the recovery in volumes, ContiTech achieved a strong sequential operating leverage of 38%. The adjusted EBIT margin achieved 10.6%. Further restructuring measures are in place or implementation and proceeding according to plan to support future profitability.

Last but not least, let me cover Powertrain Technologies on Slide 14. Sales of €1.9 billion were organically up 2.4% versus last year’s figure. This was impressively driven by the business unit Electrification Technology which doubled its sales to €130 million versus Q3 2019. Sales of Power electronic products as well as our high-voltage E-axle driver especially brisk, moreover the business units, Electronic Controls and Sensing and Actuation also outperformed lightly in production. Adjusted EBIT in the quarter reached €111 million equivalent to a margin of 5.8%.

In addition to benefit from restructuring short-term fiscal savings measures were also important in achieving this sequential operating leverage of 38%. Excluding Electrification Technology, the adjusted EBIT margin for Powertrain would have been nearly 10%, reflecting the underlying strengths of the electronic controls and Sense and Actuation business. Our intake in the period amounted to an impressive €3.9 billion which includes the previously mentioned above €2 billion order for the high-voltage box.

Let me continue through the overview of the Q3 cash flow on Slide 15. Free cash flow before acquisitions and carve-out effects for the Group amounted to €1.8 billion, well ahead of last year’s comparable figure of €348 million, and probably the best quarter ever in the last 150 years for Continental. As expected, the increase resulted from an improvement in business activities, which reversed the negative working capital, basically the same amount, which we saw in the second quarter of fiscal year 2020. This effect is visible in the strong operating cash flow figure of nearly €2.2 billion. Investing cash outflow was also lower due to the lower capital expenditures.

As for our financing cash flow, the outflow of €1.6 billion reflects the payment of the €600 million dividend this year in Q3, the redemption of a €750 million bond in September, as well as the purchase of the remaining shares of an already fully consolidated company for €170 million in Korea.

Side 16 shows the liquidity bridge in free cash flow and financing cash flows were roughly on par with each other in the third quarter. Our overall liquidity situation at the end of September was basically unchanged from that at the end of June, and after the redemption in September the next bond maturity of only €200 million will be in next April, and all other redemptions to occur only in September 2023 or even later.

Now let me continue with our market expectations for the fourth quarter and full year 2020 on slide 17. Though we would like to be cautiously optimistic that the progressively improving markets conditions we saw through the course of the third quarter will continue in the fourth quarter, with the re-initiation of social and movement restrictions in many of our key geographic uncertainty is one again increasing and visibility is becoming more challenging. Therefore, the assumptions shown here are based on our current best assessment of the market situation for the remainder of the year. They do not include unexpected impacts from the ongoing COVID pandemic on production or the supply chain or demand should they occur.

For light vehicle production in Q4, just as in Q3, three weeks that many of our weak customers to continue to constantly manage their production facilities to avoid overstocking in this environment. Thus we anticipate that year-over-year production growth in Q4 will be between minus 4% and minus 6% on a worldwide basis with all regions contributing to the decline.

For passenger car replacement tire demand, we expect demand in Europe to remain soft, mainly due to the previously mentioned winter tire situation. We anticipate North America to be down in the same magnitude in contrast the growth trend in China is expected to continue in the fourth quarter.

For commercial vehicles we anticipate that production in Q4 will be down by 9% to 14% globally. Meanwhile, truck replacement tire volumes in Europe and North America are expected to be only slightly below the previous year’s level.

And I conclude today’s presentation with our updated outlook for 2020 on Slide 18. It assumes stable exchange rates on September 30 level, it also assumes that there are no unexpected impacts from COVID-19 as already mentioned. Based on these assumptions, we expect consolidated sales to be around €37.5 billion, and the adjusted EBIT margin is anticipated to be around 3%. Sales of the three automotive business areas consisting of AMS, VNI and Powertrain are expected to be around €22 billion.

The full year adjusted EBIT margin is expected to be around minus 1.5%. This also includes among other factors expected provisions for warranty claims, and higher than expected net research and development expenditures that will noticeably reduce adjusted EBIT in the fourth quarter.

For Rubber, we expected to be around €15.5 billion for the full year and the adjusted EBIT margin to be around 10.5%. This outlook includes an expected tailwind for raw materials in the fourth quarter of about €70 million.

Further expenses for restructuring and asset impairments related to the transformation 2019 to 2029 program, I expect it to be recognized in the fourth quarter of 2020, though the amounts are not clarified at this time as they very much depend on the status of the negotiations with our partners at the locations and the unions at the year end. So these effects will not affect adjusted EBIT. They will mature the impacts reported EBIT and net income attributable to shareholders.

CapEx excluding financial investments for the year is expected to be around 6.3% of sales. Lastly by free cash flow before acquisitions and excluding carve-out effects is expected to be positive for fiscal 2020. The value is expected to be significantly lower than in the prior year.

And with this, I would like to conclude today’s presentation, and open the line now for your questions. Thank you.

Question-and-Answer Session

Operator

Thank you. [Operator instructions] Our first question is from Tom Narayan, RBC. Your line is now open.

Tom Narayan

Hi yes, Tom Narayan, RBC. Thanks for taking the questions. I have three. The first one is on tires. It seems that you gained market share in replacement tires. I was wondering if you could comment on what’s driving this? Perhaps how imports coming into Europe from Asia may have declined. Second one, customer delays in ADAS, what is driving this specifically? Is it the OEMs prioritizing electrification budgets and do you expect this to return in 2021?

And the third, what was behind the decision not to do fuel cells? And I’m wondering if you could reverse this decision. It seems like a very compelling space, particularly as it relates to heavy duty commercial trucks or maybe you should that the OEMs would do this in-house. Thank you.

Wolfgang Schafer

Thank you, Tom. The first question tires gained market shares, your assumption is, the correct assumption. This is in Europe where imports from the Asian markets are reduced. And I think we mentioned this in the last call, we have this situation that tire dealers are narrowing their cash positions and don’t feel in a position to buy bigger lots which they have to do from imported tires. They prefer to get basically the tire delivered just in sequence when the customer wants it. And this makes us and those which are producing within Europe, the more attractive partner for them as we obviously can deliver those smaller lots.

There is some gain in the North American market, but the main topic is coming from Europe. And in ADAS, actually we don’t see any order which we wanted to get which we did not get. Meaning that it is indeed as you were assuming it is a topic of customers not putting these orders on the market versus which would be bad news, but if not, then we would get now those orders which are on the market.

And the customers are — none of them is canceling projects to our knowledge now. For most of the projects it is a delay and the reason the OEs are getting these delays, is just capacity which they have available for it as they are in the last very volatile quarters had to concentrate on other topics. We expect them to be in the market, latest in the first half of 2021. At least this is what we hear from our customers regarding specifically these ADAS orders.

And we do work on fuel cells your last question. We have by the way fuel cells overall in the car would give many opportunities as well for ContiTech as if you look at the fuel cell car, the whole lining and structure of the engine including the fuel cell elements is at least for those products which ContiTech is delivering closer to today’s combustion and in a pure electric vehicle. We are very closely following this and I think we do agree that there might be an entry for the fuel cells business more on the truck side than it is on the pass car vehicle side and yes, we are working on that.

Tom Narayan

Okay, thank you.

Operator

Our next question is from Gabriel Adler, Citi Group. Your line is now open.

Gabriel Adler

Yes Gabriel from Citigroup. Three questions please. My first is on the guidance. Can you just elaborate on the reason to the margin pressure on the automotive side in Q4 that is implied by your guidance? How much of this relates to low R&D reimbursements? How much capitalization and how much more provisioning? And then, how should we think about these impacts going forward into 2021 if at all?

My second question is on the VNI outperformance, the slowdown in organic growth was attributed in your presentation there to technology transition. Can you comment on your expectations to the transition going forwards when it will be complete and when the drag on growth from the changeover should begin to ease?

And then my last question is on tire replacement outlook. And I understand the caution on Europe and your comments on the winter season were useful. And could you also clarify why North America specifically is expected to be down 4% to 6% given the market was flat in Q3 and the reasons there would be helpful? Thank you.

Wolfgang Schafer

To start with margin pressure on Automotive actually you actually gave the right answers already. And specifically in Q4, we see two topics, one which is more on the Powertrain Vitesco business which is warranty topics, there is not the one they claim, but there are some which we are basically clearing up for the year end and for the fourth quarter. And then we have and this is what you were referring to, in the R&D area we have altogether, we have lower capitalization in R&D foreseen for the fourth quarter, which we already tried to install and tried to stick to in the beginning of the year. You might have noticed we have lower R&D reimbursements.

There by the way partly have been a little bit in Q3, so some of them were higher. And then we have, we do see the bigger software projects which are there which overall put some pressure on R&D overall R&D jobs which have to be done, so these two have R&D on the one hand side and warranty on the other hand side together. And are those which have an effect on Q4, the majority of time should not continue in Q1. Total amount is a very rough number, very round number. I think I would not give this number on the phone when you caution this, somewhat around 200 million, I think which we have as a burden there.

And VNI as well as right interpretation, the outperformance is the technology transition. It is unfortunately already mentioned for a while the HMI topic and towards digital displays will last during 2023 and hopefully then we are at a level which allows to see the growth of other attractive products kicking in, not over compensated by these reductions. The last question I have not fully understood just out here in the room if I could just let me…

Bernard Wang

Yes, Bernard here. So your question is about truck tires in North America. Right?

Gabriel Adler

Yes, exactly, the slowdown or lower volumes?

Bernard Wang

Yes, this is just based on our own channel checks and our fuel for how the demand has been developing. We don’t see the growth yet in Q4 the same way we saw it in Q3. I mean, we can maybe take a shot at different hypotheses, right. But I think to a degree, North America, lockdown did last longer. Hence the pent up demand came later. A lot of that was potentially fulfilled in Q3 plus leaving a little bit less for Q4 there. But to me so far it’s the indication from October is that it’s a little bit slower than it was into the Q3.

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Gabriel Adler

Okay, thank you guys, very helpful.

Operator

Our next question is from Victoria Greer, Morgan Stanley. Your line is now open.

Victoria Greer

Hi there. Yes, a just on the tires, first of all, and quite strong price mix in Q3 and could you talk about the drivers for that, please? And then on your Q4 outlook, it seems like your guidance was for a little bit of a larger decline in terms of revenues in Q3. Is that volumes, we touched on the North America weakness potentially on volumes already or is it a bit weaker price mix in Q4 or is it both? And if you could comment also on tires and raw materials for Q4 that will be helpful?

And then second question on the ID.3, could you talk about what’s your content per car there particularly for ICAS M and what can we expect there for 2021 as ID.3 volumes ramp up? And then the last question, we’ve seen quite a lot of OEMs announcing discontinuing model lines or Powertrain variants like PSA, for example coming out of the mini category, Honda discontinuing diesel in Europe from next year. Are you seeing any changes there on startup production or in existing contracts that we should think about? Thanks.

Wolfgang Schafer

Thank you, Victoria. These are more than three questions and good questions, but inside, price mix in Q3 is very much the nice pricing, which we see in Europe. We saw replacement tire markets in Europe stable in prices and this is obviously a comparison to prior year. This price mix and then prior year, you might remember we saw quite some price pressure in Europe specifically, replacement tire markets. And for the rate mix is good. We are further moving to the high performance tires up though winter tires are weaker, significantly weaker than they have been in the prior year and this is one reason as well.

Your next question for Q4 winter tires is part of it. And obviously what we discussed about the U.S. before. Raw materials, we see a tailwind of €90 million in Q3, that’s up in the total year to €130 million tailwind, and then there is left to the €200 million guidance another 70 million for Q4 and the Continental car for the ID.3, I’ll ask Bernard.

Bernard Wang

Yes, we’ve not given a number on it. But I think if you just look at the content that’s there and make your own guesstimate Victoria you can probably come to a pretty decent number. More important than just the number is probably the quality of the content we have there. She pointed out ICAS, again not in a position to give a specific number there. But it’s a good chunk of content in there because the ICAS is not replaced as a conventional part that we would sell in there, but also other things that are in there. So there’s a lot more value including software that’s put in there plus the integration work that we put in on that product.

You asked about the next year, about the next year that, I mean I would just look at the ID.3, right? We, a lot of these products will make their way throughout the entire MEB platform. So you can scale that along the platform expectations as well.

Wolfgang Schafer

And your question regarding discontinuing model lines, actually we are not worried about that and don’t see bigger impact on our business for next year.

Victoria Greer

Great, thank you.

Wolfgang Schafer

Thank you.

Operator

Our next question is from Henning Cosman, HSBC. Your line is now open.

Henning Cosman

Yes, good afternoon Mr. Schafer. Henning from HSBC. Thanks for taking the question. First of all, thanks for clarifying the €200 million impact implied in the fourth quarter guidance that’s super useful to understand. And maybe just to clarify, in terms of how that continues on into 2021 or indeed it doesn’t continue on? Would you just be able to confirm that, therefore, a number more similar to the Q3 margin or indeed the implied Q4 executing that €200 million impact such a run rate is a more sensible assumption for the first half of 2021 as well, that’s the first question.

And secondly, maybe still on the guidance, the free cash flow guidance is, of course, a little bit vague. But when I assume that implies maybe a small inflow for the fourth quarter, that’s still relatively uncharacteristic for you, because you normally have quite a large inflow in the fourth quarter. Could you just talk about that if that’s just because you had effectively a pull forward of the working capital inflow into Q3 already, so naturally, that won’t repeat. And that also includes some of the collection of receivables and the tires or why you may only see a relatively small inflow in Q4?

And the fourth question is, if you allow me around the Capital Market Day and the potential succession of Dr. Degenhart, if at all, you can say anything about the press rumors around the potential Supervisory Board meeting in the middle of November, so potentially next week, to decide about potential successor and implications that may have on your Capital Market Day. And if it does, or doesn’t happen, what that means for your midterm targets, which I suppose you were going to announce at that Capital Market Day? And any color around this would be super appreciated. And obviously, in that context, we wish Dr. Degenhart very well as well. Thank you.

Wolfgang Schafer

Thank you, Henning for the wishes to Elmar Degenhart. I will give this to him. To your question, the auto margin excluding the €200 million, well you can make your calculations how much the margin would have been there, and I talked about some increase for new project software related these R&D increases will stay, they will be there as well in Q1, but a bigger chunk of the rest should be clearing up in Q4 and then allow us for a cleaner start in 2021.

The free cash flow guidance, again I fully accept if we say more than zero this is a big range which is sadly included in this number. We are in so far cautioned that we have not very good feeling about what happens at the yearend with payments coming from our customers, DOEs actually as this is an unusual situation, we saw quite different behavior in end of Q2 and end of Q3 and therefore, we would like to leave this open and in the engine over 30 to 40 days on average payment terms, which is our OE business, basically two months from OE business overall of whatever – if you take all OE business in ContiTech and tires included more than €25 billion.

This is a significant amount which might change the number and this is why we are somewhat more careful than that. And there is no principal change that Q4 for Conti in the midterms will stay and already next year again will stay as strong cash generating quarter. And I think with the performance we see coming back as well in tires, the Continental will be a company to generate nice cash flow starting next year again.

Capital saw and all this is a little bit vaguer answer, but I hope that you understand at least why we are a little bit vaguer than we have been in the past. Capital Markets Day and you might understand I cannot give any insights on the decision about a successful meeting. There will be a Supervisory Board meeting by the way, tomorrow. And I think our Supervisory Board will do its job as they have to do to make sure that Conti is not running in days in these difficult days without any top management.

And so, there will be hopefully decision in decent time. And so we assume that the Capital Markets Day will take place. There are no rumors. No information from Conti side that this would not take place, that it would not include our strategy, that this will not include a strategy which is fully backed by the new CEO then and that is not a strategy which would not as well provide midterm targets.

Henning Cosman

Thank you very much. I appreciate it.

Operator

Our next question is from José Asumendi, JPM. Your line is now open.

José Asumendi

Thank you. Thanks, Wolfgang and I have around, José, JPMorgan, three questions please. The first one on Powertrain and as we think about the dilution you have in margins due to electrification, how do you expect this margin dilution to progress in the coming sort of 12 months? Obviously very, very strong margins on Powertrain, but that electrification side is waiting there. So how do you expect that? And then also, in the light of the very strong Powertrain margins, can you remind us of the logic of the Vitesco spin-off? That will be question 1.

Question two, a simple one, restructuring cash outflows, please for 2020 and 2021? You mentioned them before, I wasn’t able to catch them, the restructuring and cash outflow. And then question three on VNI, the book-to-Bill ratio looks challenged on the quarter, past two quarters. Can you maybe explain in your own words like what is happening going on, on the quotes as you’re pitching the products to the OEMs? What is changing within Continental to get that order book, rising in the coming six, nine months again, that growth back in this division which will allow us to rerate margins. Thank you.

Wolfgang Schafer

Powertrain electrification José is still not at breakeven, I think this cannot be the expectation though we see this nice sales increase and it will not be a breakeven in 2021. It will be a Capital Markets Day of Vitesco as well. Soon this will be in January and…

Bernard Wang

In advance of the spin-off.

Wolfgang Schafer

In advance of the spin-off. So it’s probably somewhat later, but this will give more details on that but it will stay negative but it will be less negative than it has been before. So we see an improvement in this negative margin and this is helping the Powertrain margin to come back to the level which we have seen now. We already mentioned spin-off. We have explained when we delayed it that this delay was only due to high cost financing and what are the tire markets, capital markets. We do see this disappearing in 2021. This is our firm belief and therefore this delay which we have yes, is there, but we are fully working on a spin-off and respectively IPO for the business in 2021. And I think well, you have an opinion on the markets, but I think we would all agree that the markets would be in a position and not be hindering to do that.

The VNI business book-to-bill ratio and again, similar answer to Advanced Driver Assistance Systems, we are getting those orders which we wanted to get, those orders which we did not book are those orders which we did not find any place on the market. We see this in a wide range of orders that there was a delay for the last half year, significant delay in orders. But again, no message from OEs we are cancelling a model, which we expected to do, they’re just delaying. And some of the delays are still argued with words like, we won’t delay the start of production, we only delay the start of development or in the end the placement of these orders to the market.

So expected that R&D time is somewhat shortened and therefore should not be worrying. And this book-to-bill ratio therefore and this year probably does not really make sense. Yes, expectation is to pick that up finally in next year, and I think lots of it in the first half already of next year. So we do expect a stronger order intake there.

José Asumendi

Cash outflow restructuring please?

Wolfgang Schafer

Restructuring, yes cash outflow mentioned 2020, about €100 million we see for next year, it is about a €700 million. And it will be about now this is I mean quite an early number. We did not do the negotiations, but the number which is lower than that, but still significant in 2022.

José Asumendi

Thank you very much. Very helpful, thank you.

Wolfgang Schafer

I’m sorry?

José Asumendi

Very helpful, sorry, apologies. I cut you off there, sorry please continue.

Wolfgang Schafer

Overall cost I would say the €1.8 billion, which we have announced for the whole program there. And you can probably expect something like three quarters of that finally to be cash relevant, the rate in impairments on assets, which are no longer used in locations which are closed down.

José Asumendi

Thank you. Thank you very much.

Operator

Our next question is from Thomas Besson, Kepler Cheuvreux. Your line is now open.

Thomas Besson

Thank you very much. It’s Thomas Besson. I have three questions as well which is, first one is coming back to the contents we get on battery electric vehicles versus ICE, I understand you don’t want to give it specifically for the ID.3. But when you look at your overall contracts, can you comment from the difference between your best content and your ICE content and split that between the core quality and Vitesco please and tell us whether you believe that OEMs are in a trend of reinforcing these products or not? That is the first question.

The second, you have mentioned the possibility of additional one offs in Q4. You’re already if I look at 2019 and 2020 actually that’s €4.5 billion. Can you give us an idea of the magnitude of the one off we could see still in Q4, it is going to be a small quarter or could it be meaningful again? And what are these one offs? Do we get the structural benefits for Conti already please?

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And last question, probably a bit more difficult, you say we are in an extremely volatile environment. I fully agree. Can you share with us your thoughts about Q4 development? Do you believe you have a strong grip on where the quarter is going to end? We are already in November or it’s not clear?

And on 2021, how do you, do your planning assessment because it looks like Q1 could be soft, that the financial markets are hoping for a much clearer second part of the year, is that your feeling as well? Do you still believe we can count on a strong double-digit global demand recovery in 2021 or is it too early to tell? Thank you.

Wolfgang Schafer

Well, the share of battery electric vehicles for Conti is part of I could not give you this number now, but in principle we are — many of the products we are delivering from AMS and VNI are not limited to only combustion engine or only electric vehicles. They can end up in both and I see no bias from us towards the one or other. We are very successful as you saw in the example of the ID.3 to come into plug in hybrids as we are into pure electric vehicles. Obviously this is for Powertrain. It’s a different story as they concentrate on the electrification and the strategy.

And therefore for them, the order intake is very much driven. I mentioned this one big order for these box, high-voltage box, which they do, where you see that these are big orders, which come in finally ending up in electric vehicles. For them, obviously, it’s a completely different story. And yes, they have them and the order intake of much higher share, than the market is for electric vehicles than they do have for the combustion engine. This has to be to support their electrification strategy, but yes, it is supported with their order intake.

The one off, if I understood this correctly, for restructuring in Q4. I mean, if you do the math, it is roughly €400 million or so missing still in Q4 to get to the €1.2 billion, which I am using to get to the €1.8 billion in the end. We just don’t quantify the number as this is in the end, IFRS driven. We need a certain stage of negotiations with our counterparts in the unions or in the local representative of the employees. And it’s, it might be that the negotiation is only at the 5th of January and so in a state that we could book it or it might be already at the 20th of December. So therefore, we leave it up.

The overall number is confirmed, which is €1.8 billion. You know the numbers that I mentioned them, which were booked already. There is leftover and this either all ends up in Q4, this is what we would like most or part of it still might be in Q1 or Q2. The volatile environment, not sure I completely understood the question. It’s almost correctly, but yes, we would agree on your assumption that probably the first half of next year is the one which still might be more volatile as lockdowns and impacts from the epidemic COVID might be there. And we would my personal expectation is as far as that in the second half of next year, we probably with vaccination, other remedies.

The legislation and states can be eased, more eased on any restriction and then we should come back to a type of normal life and then people might and should come back to a more normal consumption probably with some pent up demand. So yes, it could be a strong 2020 run and not giving a guidance now for 2021. It is still volatile as you rightly described it.

Thomas Besson

Thank you very much, Wolfgang.

Operator

Our next question is from Horst Schneider, Bank of America. Please go ahead. Your line is now open.

Horst Schneider

Yes, good afternoon. And thanks for taking my question, I am Horst Schneider. I have got just a few left. The first one is regarding the sequential operating leverage that you also highlight on one of your slides. Can you maybe give us more sorts, how we should think about this operating leverage basically for the future? I know in Q4, you have got this R&D issue, and probably also you’ve got some reversal of SG&A at some point of time, on the other hand you are cutting some stuff and the general level of costs should decline.

So basically, I mean, some guidance on how we should think about this operating leverage going forward, that will be helpful? And maybe the Q3 effect as even representative here for the next few quarters. Then on Powertrain, I mean impressing our performance 6% in Q3, I think a large part of that is due to that electrified content that you supply. Can you maybe separate this outperformance between ICE and EV content? So I want to get the feeling to which extent you still outperforming due to the ICE business.

And the last question that I have relates, again to production outlook because it strikes me you are something like 1% to 2% below the current IHS forecast. You see already that some car makers are leaving earlier for planned holidays just because some regions are again affected by lockdowns. Thank you.

Wolfgang Schafer

Thank you, operating leverage? Schneider, fully the question obviously to make your own rate of guidance for 2021, but please wait until we do the guidance for 2021 before we do some calculation, but obviously this leverage from Q2 to Q3 cannot be the leverage, which we can expect for the rest — next quarters because there we had this great effect of completely unutilized sitting their production sites, filling them up again always a high leverage their menu already on a much closer to 100% level and then moving up.

And the ICE outperformance I think was slightly positive in Powertrain. I think it was around 1% why the electric outperformance was very significant. So, therefore good news regarding the strategy. And finally, the last question was on the…

Bernard Wang

It was on the production out of Q4 versus IHS.

Wolfgang Schafer

Yes, production out of for q4. It is somewhat for us, I would answer twofold, probably once a little bit from more operational. But when we said the minus 4% to minus 6%, actually that says which we saw for our Automotive Division were slightly lower than what we have now in our guidance, so actually we are more with what we show as sales in Automotive for Q4. We are more at the better end of our guidance than on reverse. This gives an indication that in the last days, we are seeing less of these factors which lead to the minus 4% to minus 6%. We are seeing less of them.

Nevertheless, we still have the one or other indication from OE locations that there might be earlier or longer vacation breaks around Christmas time. And this is I think a little bit the background of our guidance, is shortly the choice for us as well as some uncertainty in what is going on even in the next four weeks.

Horst Schneider

Regarding this operating leverage again, can you at least maybe quantify the one off costs which will not repeat again in the next few quarters? Again, regarding Q3?

Wolfgang Schafer

Where we talked about the Q4 guidance and I mentioned the €200 million where I said a bigger part…

Horst Schneider

No not one off course, I mean more one off benefit, sorry, I was not clear.

Bernard Wang

You know I caught up by and question on by [indiscernible].

Horst Schneider

Yes, correct. Yes.

Bernard Wang

I think one way to look at it is, we’ve guided to you what we have in terms of fixed costs, savings targets for the full year. You see the development has been for the nine months, right? Obviously the fourth quarter with pretty normally or indeed times quite normal production levels, that those effects are starting to fade. So that is I think the first indication for you what is short-term in nature, plus of course, the raw materials would not be sustainable.

Horst Schneider

Okay, thanks very much.

Operator

Our next question is from Tim Rokossa, Deutsche Bank. Please go ahead.

Tim Rokossa

Thank you very much. Good afternoon, Mr. Schafer. Good afternoon, Bernard. I’d like to come back to a couple of questions that were already raised by the previous speakers, and that is, firstly, on the production outlook that you gave them for Q4. We had the same discussion with your Q3 production outlook Mr. Schafer on your Q2 call. And also back then when you projected minus 10% to minus 22% you actually said that it rather looks a bit more dull and the last couple of days, maybe a little bit better, but the run rate was rather minus 20% then minus 10%.

And that was middle of August and it ended up being more like minus 7% or minus 8%. Why do you think the reality that we see now for a couple of quarters versus your previous expectation is so different? Is it just that you approach this very conservative? Is it because the customers of yours leave you very much in the dark about call offs and much more than they used to be or is it really just that internally, you plan for very different numbers, than you put on the slides?

And then secondly, when you think about R&D costs, now you spoke about a bit of an escalation point for interesting opportunities on the software side in Q4, I think obviously, everyone would want you to go for any interesting opportunity that’s out there. But you already spent quite a bit of money on R&D now and that number does nothing but going up for a number of years now. I assume there will be many more interesting software opportunities down the road for you over the next couple of years. Can we expect to see R&D as percent of sales even increasing?

Will that be one of the responses also from the midterm targets that you tell us about the big Capital Markets Day? And as a final question, a little bit into Gabriel’s and José’s question as well, I think. I think that the case for Vitesco now gets increasingly clear after this was so disappointing for many years, and there’s certainly a lot of guys that want exposure it to that asset. The rest of auto is increasingly looking at the difficult and when I now hear that the HMI issues are lasting into 2023, I think a lot of people will ask themselves, how you can fix either auto or rest of auto ex Powertrain? Do you have any thoughts from that already? Thank you.

Wolfgang Schafer

Well our production outlook and of course this is I mean, yes probably it is too careful this is why would I wanted to say that we have increased our sales expectations for this quarter in the last days, and this is included in the guidance. So, we are probably more at the upper end of the minus 4% to minus 6% to my knowledge. We are not so different with this from expectations of other automotive suppliers. Are we your question basically, are we constantly wrong with our estimations? I don’t think so. We might have been more on the careful side in the last quarters, which actually in such situation as a company, I think you should be to be prepared for the worst.

As this is the scenario, which is then the more challenging as if it comes the other way around R&D in percentage of sales and while obviously next year we expect the R&D quota to go down, but this is clearly linked to increasing sales expectation versus 2020 where R&D will definitely not increase in the same amount. R&D overall still will increase as the products are more R&D intense are more software including. The actually quota R&D to say it should stay for automotive overall should stay on the level which we are seeing at the moment.

Bernard Wang

Like in a normal ICE year, not in a 2020 end year. And while the answer to VNI, I mean, this is twofold. One question is the restructuring of the [indiscernible] plant? And was the whole HMI topic resolved? Yes, this moves on to 2023. Now this was the answer I wanted to give before, when do we get out of these negative impact on the outperformance from this part on the company overall or at least on the VNI business overall, this I think should be in 2021 finalizing and then already starting 2022 may already, but then in 2022 we should finally see the positive impacts of new orders. Having — can be seen out of the top line development versus what we see at the moment?

Tim Rokossa

Very clear, thank you.

Operator

Our question and answer session has been concluded. I will hand back to the speakers.

Bernard Wang

Thank you, Operator. Thank you everyone for participating in today’s call and cooperating on timing. As always, the IR team is here available for any further questions you may have. Thanks again and most importantly, please stay safe and healthy. Bye-bye.

Operator

Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.



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