Stoneridge, Inc. (SRI) Q3 2022 Earnings Report, Transcript and Summary

Good day, and thank you for standing by. Welcome to the Stoneridge third quarter 2022 conference call. [Operator Instructions]. I would now like to hand the conference over to our speaker today, Kelly Harvey, Director of Investor Relations. Please go ahead.

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

Thanks, Kelly, and good morning, everyone. Turning to Page 3. In the third quarter, we began to see the impacts of improving material availability on our top line performance, which drove significantly improved earnings performance. Excluding the impact of currency rates, adjusted sales increased by 6.2% in the quarter, while adjusted EBITDA margin improved by 580 basis points. Margin expansion was driven by fixed cost leverage on revenue growth, the continued benefit of material cost mitigation actions, including historical customer recoveries and a continued focus on strong operating performance. Each of our segments drove revenue growth and above breakeven operating performance in the quarter. Our third quarter adjusted sales of $214 million resulted in an adjusted gross margin of 23.1%, translating to an adjusted operating margin of 2.9% and adjusted EBITDA margin of 5.6%. Adjusted EPS for the quarter was $0.03. We continue to effectively offset incremental material and supply chain-related costs through pricing and supply chain actions resulting in the recovery of both current and historical costs in the quarter. While incremental material costs have started to moderate, we expect material cost headwinds to persist for the remainder of the year and into 2023. We will continue to evaluate macroeconomic conditions and expect ongoing discussions with our customers to offset cost headwinds. We remain focused on our key growth initiatives. During the quarter, customer demand continued to be strong for our first OEM MirrorEye program. Take rates were slightly improved at approximately 40%, despite being moderated by material availability. That said, we've made significant progress against those material constraints and expect continued improvement in our MirrorEye production capability for the remainder of the year. We expect to be able to support take rates on this and that are forecasted to exceed 50% in 2023 as well as additional launches planned for 2023. This morning, we are updating our full-year guidance. Our updated full-year guidance implies fourth quarter midpoint revenue of $239 million or approximately 11.5% growth relative to the third quarter, and midpoint adjusted EPS of $0.24 or a $0.21 improvement relative to Q3. Our guidance also implies fourth quarter adjusted EBITDA margin of approximately 8%, which would be a 240 basis point improvement over the third quarter and a 670 basis point improvement over the fourth quarter of last year. We remain on a positive trajectory from both the top line and margin perspective, and expect to continue this trajectory in 2023. Matt will provide additional details on our full-year guidance later in the call. Page 4 summarizes our key financial metrics where we saw significantly improved performance versus the prior quarter. During the quarter, we saw strong revenue performance as material constraints eased creating less customer production volatility and improvements in our own ability to meet strong end market demand. Excluding the impact of foreign currency relative to Q2, adjusted sales improved by 6.2% quarter-to-quarter. The continued ramp-up of new programs, including control devices actuation programs on electrified vehicles, our digital instrument cluster programs, and the first OEM MirrorEye program contributed to higher sales during the quarter. Excluding the impact of foreign currency, third quarter adjusted gross margin improved by 480 basis points, adjusted operating margin improved by 620 basis points and adjusted EBITDA increased by 580 basis points or $12.7 million relative to the second quarter of 2022. This was primarily due to strong margin performance as a result of our ability to offset incremental material costs, the recovery of historical costs, continuous improvement in our manufacturing facilities, and the continued impact of reduced operating expenses. We expect these margin trends to continue in the fourth quarter on stronger revenue performance, creating a strong run rate into 2023. Slide 5 provides our current view on the macroeconomic outlook for the remainder of this year and into next year. Material availability continues to stabilize, which is driving improved production capability. We expect that the material headwinds that have been most challenging this year will continue, but at a more moderate-level for the remainder of the year. Similar to material availability, material costs continue to create headwinds; however, pricing fluctuations have become less volatile. We have effectively offset a significant portion of incremental material costs this year. We expect that additional pricing actions and supply chain strategies will be necessary going forward. Looking ahead, we expect continued improvement in end market production, driven primarily by historically low inventory levels, large customer backlogs and improving material availability. Stoneridge is aligned with platforms likely to perform well against overall market dynamics, including our content on electrified vehicle platforms, and our North American passenger car exposure being more heavily-weighted to light truck, SUV and CUV platforms. We are positioned well to outperform our underlying markets and expect continued revenue growth and margin expansion. Slide 6 outlines the most recent IHS production data for our primary OEM end markets for the remainder of 2022 as well as expectations for 2023. IHS continues to reflect production risk in both passenger car, commercial vehicle end markets as fourth quarter forecasts have been slightly reduced relative to the forecast considered in our prior guidance. That said, our weighted average end markets are forecasted to grow by approximately 4.7% in Q4 relative to Q3. In addition to third-party forecasts, we use production planning forecast from our customers to develop our expectations, which are reflected in our updated guidance. Based on these forecasts, we continue to expect sequential revenue improvement in the fourth quarter with our midpoint revenue guidance implying 11.5% growth over the third quarter or approximately 2.5x our weighted average end markets. Looking forward, we expect continued strength in demand in our end markets and continued improvement in customer production in 2023. IHS is forecasting that our weighted average end markets will grow by approximately 4% compared to 2022. We expect to continue to outperform our underlying end markets through the ramp-up of existing programs and new program launches, including the second OEM MirrorEye program. Turning to Slide 7. Over the past several years, Control Devices has transformed from a relatively commoditized traditional automotive components portfolio to a high-margin product portfolio aligned with powertrain electrification. Our electromechanical and electromagnetic actuation business is now more than half of Control Devices total sales and growing, driven primarily by electronic axle disconnect actuator, electronic transmission actuation and various control valve applications. This is a specialized business, bridging electronics and software capabilities with mechanical design capabilities. This combination is unique to Stoneridge and gives us a strong platform to better serve our customers and expand our relationships. Our driveline actuation business will continue to grow as we extend our actuation capabilities to address electrical -- electric vehicle axle disconnect and torque control applications. Similarly our transmission actuation competencies continue to expand allowing us to drive growth in new application areas, including EV shift control and electric park brakes. We will continue to invest in our actuation business as we anticipate greater opportunities as powertrains become increasingly electrified. Similarly our temperature sensor business continues to pivot to better align with industry megatrends and provide a foundation for future growth. While the majority of the business today is focused on coolant and exhaust gas temperature monitoring, approximately 20% of our low-temperature business in 2022 is related to thermal management in hybrid and fully electric vehicles. We are actively transforming our temperature sensing capabilities to adapt to the drivetrains being sold in the market, whether those are internal combustion engines or the electric powertrains that we expect to grow significantly over time. Finally, for our switches and connectors business, we are seeking differentiation in the real estate we currently own on the vehicle. For example, today, we are the market leader in OEM trailer tow applications in North America. As we have discussed on prior calls, that product has evolved to enable the digitized connection required between vehicle and the trailer to facilitate advanced vision and safety solutions. Similarly, our seat track position sensor applications have followed market trends to more safely and efficiently deploy airbags depending on the position of the seat relative to the airbag. The number of these sensors per vehicle application has risen in the past several years, as airbag deployment becomes smarter and safer. While we are not investing heavily in these applications and don't expect to outsize market growth, this is a differentiated business that is generally drivetrain-agnostic and will continue to contribute to the overall success of control devices going forward. Control Devices has transformed to align our products and capabilities with the powertrain applications and industry megatrends that would drive future growth. Driven by the expected growth in our actuation business, the rotation of our temperature-sensing applications and the specific and unique applications in our switches and connectors business, we expect that control devices will continue to deliver a strong margin portfolio on long-term growth that will outpace our underlying end markets. Turning to Page 8. In summary, we are pleased with our performance in the third quarter as we have demonstrated our ability to execute and drive significantly improved financial performance as our end markets and supply chains continue to stabilize. The actions we have taken to create a foundation for profitable growth are at an inflection point with the launch and ramp-up of our MirrorEye and actuation platforms globally. We remain well-positioned to outperform our underlying end markets, resulting in profitable long-term growth for the remainder of 2022 and beyond. We are committed to delivering on our strategic priorities and continuously improving the business to drive strong financial performance. With that, I'll turn it over to Matt to discuss our financial results in more detail.

Thanks, Jon. Turning to Slide 10. Adjusted sales in the third quarter were approximately $214 million, an increase of 4% relative to the prior quarter. Adjusted operating income was $6.1 million or 2.9% of adjusted sales, which increased by 600 basis points versus the prior quarter. The increase in margin was driven by strong operating performance, including reduced operating expenses and continued pricing and supply chain actions aimed at recovering costs and offsetting incremental material costs. As Jon discussed earlier in the call, we are adjusting our full-year 2022 guidance. Our updated guidance implies fourth quarter performance to be approximately [Technical Difficulty] to $0.27 per share, an adjusted revenue growth of over 11.5% relative to the third quarter. Our guidance also implies fourth quarter EBITDA margin of approximately 8%, which will be a 240 basis point improvement over the third quarter and a 670 basis point improvement over the fourth quarter of last year. I will discuss the specific drivers of our full year adjusted guidance in more detail later in the call. Page 11 summarizes the key items that impacted operating performance during the quarter relative to the expectations we outlined on our second quarter call. Our operating performance resulted in approximately $0.03 of our performance in the quarter relative to our prior expectations. This was driven primarily by favorable material costs as a result of continued cost recoveries as well as a favorable product mix. We continue to focus on a lean cost structure aligned with current market conditions, resulting in reduced operating expenses relative to our prior guidance driving approximately $0.03 of favorability in the quarter. Finally, historical cost recoveries drove approximately $0.05 of benefit relative to our prior guidance. Our positive operating performance more than offset the significant currency headwinds we continue to experience within the quarter, primarily related to our European exposures. Net unfavorable FX exposures drove approximately $0.09 of headwind within the quarter. The bulk of this net headwind is related to noncash exposures created primarily by intercompany balances being revalued to current currency rates. Despite challenging macroeconomic conditions, we continue to perform well, resulting in quarterly performance that slightly outperforms our prior expectations. Page 12 summarizes our key financial metrics specific to Control Devices. Control Devices' third quarter sales were approximately $89 million, an increase of 5.1% versus the second quarter. This was primarily due to the increase in OEM customer production volumes as well as incremental revenue from actuation programs. We expect continued revenue growth going into 2023 for Control Devices as North American passenger car production continues to improve for our key customers, driven by historically low vehicle inventory levels, large customer backlogs and improving material availability. Operating income was $7.5 million for the quarter or 8.4% of sales. Operating margin increased by approximately 360 basis points versus the second quarter of 2022, primarily due to lower material costs driven by favorable sales mix and well-controlled operating expenses. Page 13 summarizes our key financial metrics specific to electronics. Electronics third quarter adjusted sales, excluding the unfavorable impact of foreign currency of $3.3 million were approximately $120.5 million, an increase of 4.7% versus the second quarter. Revenue growth was driven by higher customer production volumes from continued strong demand and improved material availability as well as the continued ramp-up and expansion of recently launched programs. Operating income, excluding the unfavorable impact of foreign currency of $200,000 improved by approximately 690 basis points relative to the second quarter of 2022 due to lower material costs as a result of continued cost recovery as well as a continued focus on variable cost control. We continue to expect strong revenue growth into 2023 with forecasted growth across our commercial vehicle on and off OEM markets and material availability improvement aligned with end market demand. Operating income is expected to continue to improve as we stabilize gross margin with cost recovery actions and carefully control our operating expenses to ensure strong fixed cost leverage with revenue growth. We continue to expect that electronics margin will expand sequentially, creating a strong run rate heading into next year. Page 14 summarizes our key financial metrics, specific to Stoneridge Brazil. Stoneridge Brazil's third quarter sales, excluding the unfavorable impact of foreign currency of $900,000 increased by $1.4 million or approximately 10.3% relative to the second quarter of 2022 due primarily to higher sales in the local OEM business. Adjusted operating income, excluding the unfavorable impact of foreign currency, increased by approximately $1 million or 620 basis points relative to the second quarter. Despite continued macroeconomic challenges in Brazil, we continue to expect revenue and operating margin to remain stable. We remain focused on the ramp-up of local OEM business and efficient management of variable costs to offset economic headwinds. We expect that Stoneridge Brazil will continue to grow as a global business with engineering capabilities supporting our global electronics footprint, allowing us to improve engineering capacity and capabilities without adding incremental total cost. Turning to Page 15. Third quarter net debt was $136.2 million. At the beginning of 2022, we anticipated that the material cost and production headwinds forecasted for the year would result in transient or relatively lower EBITDA and worked with our bank group to amend our existing credit facility and provide the company with the financial flexibility needed to continue investing in the business to drive and support future growth. The amendment, which extends through the first quarter of 2023, waived our leverage ratio for the first 3 quarters of the year and modified the fourth quarter to include a 4.75x leverage ratio. The amendment concluded after the first quarter of 2023, returning to a 3.5x leverage ratio requirement. We are confident the company has ample liquidity and flexibility to operate in the current macroeconomic conditions. As we move into the last quarter of 2022 and into 2023, we remain focused on efficient cash management to help turn our leverage ratios to more normalized rates as we continue to improve financial performance and expand our earnings. We saw a rapid improvement in our financial ratios in the third quarter of 2022 as a relatively stronger third quarter replaced a relatively weaker third quarter from 2021 in the trailing EBITDA calculation. We expect that trend to continue and our net debt-to-EBITDA ratio to return to a more normalized level by the end of the year with an expected leverage ratio of 3x to 3.5x based on our updated EBITDA guidance. We expect to remain in compliance, both during the amendment period and as the amendment period ends in early 2023, and our original covenant ratios are put back in place. Longer term, we are targeting a leverage ratio under 2.5x, which provides us with ample liquidity and a reasonable risk profile. We will continue to strengthen our balance sheet, helping to provide a steady foundation that will allow us to capitalize on our long-term opportunities. Page 16 summarizes our expectations for full-year adjusted EPS. We are reducing our adjusted revenue midpoint guidance by $10 million, which translates to a $0.07 adjusted EPS impact, assuming a contribution margin of 25% to 30%, in line with our historical performance. This adjustment reflects improved, but continued material constraints and our view of current end market demand. We expect continued benefit of the pricing and supply chain actions we took earlier this year to largely offset incremental material prices and remain in conversations with our customer to offset incremental costs, including the recovery of historical costs. We expect strong operating performance as we continue to take actions to make our manufacturing facilities more efficient and maintain our favorability on operating expenses, particularly SG&A. These tailwinds are offset by the retiming of engineering recoveries of approximately $2.4 million from the fourth quarter of 2022 to 2023. These are costs that we expect to be reimbursed for by our customers as a result of product-specific engineering expenses aligned with future programs. These reimbursements are generally based on timing of program hurdles and reimbursed once the program meets certain development criteria. We expect to receive these retimed reimbursements in 2023. Our updated guidance implies fourth quarter performance to be approximately $0.21 to $0.27 per share, an adjusted revenue growth of over 11.5% relative to the third quarter. Our guidance also implies fourth quarter EBITDA margin of approximately 8%, which would be a 240 basis point improvement over the third quarter. We remain focused on creating a strong run rate from both the top and bottom line perspective into 2023. Moving to Slide 17. We expect to continue to build on a strong third quarter in which each segment grew revenue and expanded margins. Our fourth quarter guidance implies continued revenue growth of more than 11%, which is approximately 2.5x expected weighted end market growth. Similarly our implied midpoint guidance for the fourth quarter implies adjusted EPS growth of $0.21 and EBITDA margin expansion of 240 basis points. As Jon discussed earlier in the call, Stoneridge is committed to driving shareholder value and that focus remains at the forefront of all of our strategic initiatives. With that, I will open up the call to questions.

[Operator Instructions]. Our first question comes from the line of Justin Long with Stephens.

I wanted to start with a question on the implied fourth quarter guidance. You talked about it a few times, but it implies a pretty sizable step-up in revenue sequentially, double-digit growth. Can you talk about how much visibility you have to that step-up and maybe provide a little bit more color on how much of that sequential improvement is coming from Control Devices versus Electronics?

Yes. Thanks for the question, Justin. Obviously, we're into the fourth quarter now. So we've got some actual performance to rely on as we set our guidance. We have looked at various different scenarios for the remainder of the year, both on the top and bottom line to make sure that our guidance considers all of those potential ranges as we see them now. Obviously the market is relatively volatile. So the range is probably a little bit broader than we typically expect in the fourth quarter. But as we see it, that's kind of the expected range for the end of the year, both based on what we've seen in the quarter so far and what we can expect for the remainder. So we've got pretty good visibility to that continued step-up. As for your question on Control Devices versus Electronics, I would say the market is a little bit more volatile on the Control Devices side as the North American past car market has been a little bit more volatile than the market. Both remain stable and growing from what we can see. And we expect continued ramp up across the segments to support that overall step-up in growth. I would say it's a little bit more weighted towards electronics as we go into the fourth quarter, the growth side is, just because the CV market, we've got a little bit more makeup, I'll call it backlog, not in the traditional sense that we typically think about a 5-year backlog. But backlog of customer orders in the short term that we can fill as material availability continue to really, really improve here, and we've got some momentum. So I would say we've got pretty good visibility into the fourth quarter, given where we are in the year. And also I would expect a little bit more on the electronic side as we head towards the end of the year here.

That's very helpful. And maybe shifting to MirrorEye for my second question. Any update on the contribution from MirrorEye that's assumed in the full-year revenue guidance for 2022? And then that comment on the 50%-plus take rate into next year, is that a comment related to just the first contract or is that related to the second contract that will be kicking in as well?

I'll comment on the guidance a little bit. We have set approximately $15 million to $20 million of total MirrorEye revenue when we set our guidance at the beginning of the year. The take rate for the first OEM program has obviously been pretty strong as we continue to ramp up here. So we would expect to be kind of on the high end of that for the year, but still kind of within that range. And maybe I'll let Jon comment on the take rate for the first program there.

So Justin, the 50% take rate is specifically to that first OEM program. As we've said in our backlog, we always use the customer contractual take rates. And what we talked about in each of the earnings calls is -- what we've seen is the sequential outperformance of those, the take rates on a quarter-by-quarter basis versus the contractual take rate. And the point here is right now we're at approximately 40% take rate. And that is constrained by the supply chain. It's not constrained by demand. As we are continuing to break bottlenecks, we're seeing that take rate go up. So what we're envisioning for 2023 is thinking about 50-plus percent take rate for the first program and as we continue to break bottlenecks in the supply chain support, the new program launches as well.

And Justin, I just want to follow up on that. As you think about the trajectory for next year for that first OE program and what the take rate means incremental and all of those things, a couple of things to remember in the math of that. The ramp-up and switch over from old truck to new truck for our first customer occurred over this year. So I would expect more volume on new truck next year, relatively speaking. And also that take rate, remember, we launched early in the year, it's not -- we don't have a fully annualized number on that full-year guidance. So you'll get a little bit of benefit of incremental volume on new truck production. You'll get a little bit of benefit on annualization for a full year, and then you'll get the incremental benefit of what we expect to be stronger take rates for the full year next year. So just as you're thinking comp over comp. Hopefully, that helps the math a little bit.

And I guess, lastly is just a quick follow-up on the MirrorEye question. Could you comment on the level of retrofit activity that you're seeing today and how you're expecting that to ramp as we get into next year just based on conversations you're having with customers?

Yes. Justin, we continue to be excited about it. We look forward to being down in Nashville and talking to you a little bit more at your conference. We've got a lot of interest, nothing -- no announcements that we're prepared to make today. But we see retrofit continuing to grow. And fleets -- as some of our leading fleets are showing more of their results, additional fleets are calling and saying, "Hey, we want the same as what Maverick has or what Schneider has." So nothing from an announcement standpoint today, but retrofit is an important part of our overall MirrorEye strategy and it continues to grow. And we look forward to contributions it has in 2023.

I would now like to turn it back to Jon for closing remarks.

Well, I want to thank you all for your participation in today's call. In closing, I can assure you that our team is committed to continuing to drive shareholder value through strong operating results, profitable new business and focused deployment of our available resources. We're confident that our actions will result in continued success in 2022 and beyond, and we wish you all a very good day.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.