Stoneridge, Inc. (SRI) Earnings Call Transcript & Summary

Good afternoon, everyone, and thank you for joining this year's virtual UBS Industrials and Transportation Conference. This is Neeraj Dhanoa from UBS speaking, and I will be monitoring today's fireside chat with Stoneridge. Representing the company today are Jon DeGaynor, President and CEO; and Matt Horvath, Director of Corporate Development and Investor Relations. Matt and Jon, thank you for joining us today. How about you kick us off with an overview of Stoneridge, and then we can jump into Q&A.

Yes, great. Thanks for having us, and thank you, everyone, on the phone for joining us. Looking forward to some Q&A. I'll give you a quick overview of the company for those that don't know us as well. The story really starts with the transformation of the business, which began when Jon and the team joined the company a little more than 5 years ago. So the company has been a public company for decades, but it was really focused on -- the large business was a wiring business and was really focused on some very specific product lines. Starting in 2014 with the divestiture of that wiring business, the company began a transformation focused on technology and that driving, really setting the stage for some of the performance improvements that have been made since that time. Over the last several years, the company has continued to transform with the acquisition of Orlaco in 2017, several smaller divestitures of some noncore products, particularly to Standard Motor Products in the beginning of 2019, and really an overall development of a suite of technologies that has really elevated our products from components to system-based solutions. Along with that, product transformation really has been led by an entirely new executive management team. At this point, everyone that reports directly to Jon is new to the company or new roles and that has really led both the executional and technology transformation that we've seen over the last couple of years. Along with that, we've made several investments in those advanced technologies, which I'm sure we'll talk about more as we get into some of the Q&A. With -- when we think about the technology of the company, we really focus on really the 4 kind of global megatrends that are driving growth. We consistently say that we expect to outperform our underlying markets by 2 to 3x over the life -- over a cycle in the industry. And that's focused on our products aligned with the safety and security, intelligence, fuel efficiency and emissions areas of the market. Over the last 5 years, we've migrated our product portfolio to what we call smart products aligned with those industry megatrends. Five years ago, our product portfolio was less than 50% smart products, which is kind of defined as embedded logic electronics or software-based systems. Today, over 75% of our products are aligned with that categorization and growing. As we look at our backlog, our backlog is almost exclusively those smart products. We have an extremely strong backlog, over $3 billion of awarded business over the next 5 years, which represents about 5x our previous OEM sales -- our prior year OEM sales. So extremely strong backlog. Along with that backlog has come some significant financial performance. You've seen margin improvement -- significant margin improvement over the last several years, top line growth driven both organically and inorganically and obviously, creation of a tremendous amount of shareholder value. Just briefly, if you look at really the segments that we focus in, there's really 2 primary segments. Our Electronics group is about 50% of our sales. That is focused primarily on commercial vehicle applications in really 3 primary product categories: The first is what we call driver information systems. You can think about those like the instrument clusters that sit behind the steering wheel in a commercial vehicle cabin. The second is connectivity and controls business. Within that segment, we have our telematics and tachograph units as well as some body ECUs and powertrain ECUs for commercial vehicle applications. And then finally, our vision and safety system product line, which we'll talk a little bit more about MirrorEye, I'm sure, as we go through the Q&A, but that also includes our off-highway vision and safety systems. The second segment is our Control Devices segment. That segment is primarily focused in 2 areas today between powertrain actuation. You can think of that as electromechanical actuators that are replacing historically mechanical devices. So as the powertrain becomes more electrified, we see more opportunity to do things electromechanically and replace some inefficiencies in mechanical products of yesterday. And a sensing group, which is primarily focused on emission sensing and position sensing, where we see opportunity as engines become both more fuel-efficient and with better emission standards. We're seeing the opportunity to put more sensors in the vehicle and more complex sensors to meet those standards. So we have a third segment that we call Stoneridge Brazil. Stoneridge Brazil is a Brazilian-based electronics group, primarily focused in 2 areas today. One is the track and trace business, which is effectively an asset tracking device that goes in a piece of high-value cargo or equipment that allows for stolen asset or stolen vehicle recovery. And secondly, an aftermarket audio and alarm business. That business, for all intents and purposes, looks very similar to our global electronics business. And we have utilized that Brazilian footprint to really drive OEM growth in the region. So with that, maybe, Neeraj, I'll turn it back to you if there's any Q&A.

Great. Thanks for that, Matt. I'll kick this off with a few questions here. If anyone in the audience has any questions, please submit them through the Q&A portal, and I will read them aloud on the call here. So to start, can you please provide an overview of the expected impacts of COVID-19? And how the company has responded from both a production and cost perspective?

Yes. Matt, I'll take the first piece of that. Good afternoon, everyone, and thanks for your interest. This is Jon DeGaynor. With regard to COVID-19, first and foremost, we were very well positioned for any sort of downturn. None of us expected something like COVID, but we were positioned well from a downturn perspective based on the strength of our balance sheet and the focus of the business with regard to new technology. So when, as we faced the downturn, what we have done is we've taken a series of actions to preserve our financial performance, both with long-term and short-term restructuring as well. But at the same time, continuing to focus on the technology transformation of the business and keeping engineers rolling through this time. So we really -- we sized the business, adjusted the plants and actually made some structural readjustments, but at the same time, kept our engineering organization rolling.

Got it. And kind of looking forward, you withdrew your annual guidance, like many companies in the industry did. But is there any expectations you could provide for the remainder of 2020 from a top line and operating margin perspective? And could you just walk through those expectations?

Yes. I'll start and then Matt, maybe you want to add a little additional color. What we see is we see our end markets down -- our weighted end markets down approximately 23% based on the difference to our sales guidance. And the -- unfortunately, those end markets are still pretty turbulent as plants are struggling -- as customer plants are struggling to start back up and seeing where it is. And so in Q2, we see that as much as 50% lower than previous guidance, and then with incrementally less impact in the third and fourth quarters. And as we discuss on a regular basis, we've been able to scale our costs really on EBITDA margins, approximately, the decremental margins are 2.5 to 3x our EBITDA margins. So we have -- as I said earlier, we've adjusted to the market size, we've taken the appropriate cuts in the plants and we've continued to adjust as we go through it. But certainly, when you come to such an abrupt halt in the second quarter, there's no way that you can get to that adjustment linearity, but we see the markets coming back. All of our plants are back up and running. China is at the better part of 80%. Our European facilities are somewhere between 40% and 60%. And in North America, with all the OEs restarting, our plants are ramping back up. So we're optimistic as we go through the end of Q2 and into Q3.

Yes. And Jon, I would just add a little bit to that on the cost side. You had mentioned in the first response around the cost reductions that we took in the beginning of the second quarter to both position the company for continued profitable growth, but also respond to the market conditions that we saw. We had outlined on our first quarter call the fact that not only was this a reaction, obviously, to what was occurring in the market, but this was part of the continued playbook and the transformation that we talked about in the introduction. So when you look at the cost reductions that we took, we've said that we expected a portion of that to be temporary as we responded to the production environment, like you just mentioned, but that $5 million to $6 million of that cost reduction from an -- annualized $5 to $6 million of that cost reduction, we expect that to move beyond 2020. So while you had mentioned the second quarter and third quarter cadence of those cost savings, obviously, we don't expect the full impact of that -- those savings until the second half of the year. But it's also important for people on the phone to understand that those cost reductions are not only in response to what we've seen, but continue to build on the transformation that we've had over the last several years and really continue to position us for future growth.

Got it. And given the market environment and the actions you've taken with the company, how do you expect your liquidity and overall balance sheet position will play come end of the year?

Yes. We talked about this a little bit, and Bob gave some color on the call. At this point, like Jon said, Stoneridge is, from a balance sheet perspective, from an end markets perspective, Stoneridge is extremely well positioned for a downturn. Like you said, we weren't necessarily looking at a downturn as a global pandemic, but the balance sheet was structured such that we could withstand a downturn. And that was really an important part of the transformation of the company. We remain focused on optimizing our cash position. We continue to look at the balance sheet as conservative as we can. Bob said on the first quarter call in the Q&A that he expected conservatively, $15 million to $20 million of cash burn in the second quarter and that the rest of the year would get better than that, certainly. We didn't give specific guidance. But the thing that I would note is, from a liquidity perspective, Stoneridge remains extremely strong. We had approximately $240 million or so of undrawn commitments as of the end of the first quarter and about $80 million of cash on the balance sheet. So from a liquidity perspective, Stoneridge remains extremely strong. And we're doing everything we can to optimize cash flow as we deal with the ebbs and flows in production as we move through the year.

Got it. Makes sense. And I know you haven't updated 2021 guidance yet, but how do you kind of see Stoneridge performing as we start coming out of the downturn? And do you have any kind of early expectations for the way your end markets may look like going into 2021?

Thanks for the question, Neeraj. I think the challenge with 2021 is there's still so much undefined uncertainty with regard to production forecast in the overall market. But we certainly expect top line growth that will create fixed cost leverage and the moves that we have done in the last weeks will improve that. All along in -- for those who have been tracking our story, we've been talking about the number of program launches that we had in 2020 and 2021 in the ramp-ups. And we've been expect -- we knew that 2019 and 2020 were going to be top years from a revenue perspective in advance of the COVID crisis. So we're really excited about the number of launches that we have in the next 12 to 18 months, things like Park-by-Wire, telematics programs, our largest driver information system and the first MirrorEye OEM program. All of those are hitting basically now into the -- throughout this year and into next year. So we're excited about the future state, but we just can't give exact guidance. We do look at IHS and LMC, and we use those as the basis for our forecasting. And their -- even their forecasts are moving fairly significantly. But we believe, given the number of launches that we have, that going back to the commitment that we've made to investors in the past that we can grow at 2 to 3x our end markets and that we'll be able to do that in this situation as well.

Yes. I think this is a really important topic when you think about opportunity for Stoneridge going forward. Like Jon said, in 2019 and 2020 was always clearly an opportunity, kind of the start of the ramp-up and the set up for the -- for what we expect to come in 2020 and 2021. And I think anybody that knows the transportation industry knows that the wins -- when we're announcing record business awards and all of the executional improvements that we've made, there's a little bit of a lag before you recognize those things in revenue and production. So all of the new business awards that we've announced over the last several years, we expect to start seeing those impact the company late this year and into next year and obviously, paving the way for some significant growth there forward. So while 2020 was always expected to be kind of a set up to 2021, obviously things have changed a little bit from our previous expectations given the COVID-19 pandemic. But I think it's really important to understand the amount of outgrowth possible from Stoneridge over the next 12 to 18 months given the recognition of all of the work and awards that we've won over the last several years.

Got it. That makes sense. And Jon, you touched on it briefly in terms of kind of your trends you're seeing in the product line and MirrorEye is an exciting new product for you guys. Could you just give us an update on that? In particular, where do you stand with retrofit, pre-wire and OEM awards?

Yes. Neeraj, thanks for setting it up that way because I think for everybody to understand, retrofit is just one part of the overall structure for MirrorEye. Retrofit has been used as a demonstration of product viability and really a way to create market pull to validate with the fleets who are so important, validate both the safety and fuel economy benefits. So we've got over 9 million miles with our trial fleets, and we continue to add fleets. Those fleet additions honestly have been impacted by COVID-19, where the transportation of goods has been essential through the crisis. And in many situations, customers that we would have been doing fleet -- customers that we have been doing trials with have effectively closed their maintenance depots to any outsiders. And in some situations, they've slowed down the delivery of new trucks. As we've gotten -- as we continue to get feedback from the fleets and iterated on our product, one of the other pieces of feedback was, we'd really like to have this largely pre-wired or preinstalled where the wiring that supports the retrofit is already in the truck. So we have that under development with one of the OEs. We're working with other OEs to put the pre-wired side-screen sockets together. And those move forward, but those are also impacted by engineering organizations that are shut down during COVID. And then we have multiple OEM programs that we've talked about. As we've said many times, the $75 million of peak annual revenue that we have booked with OEM programs are at our customer-described take rates. We believe they're very conservative, but they're customer described at 10% to 15% -- recorded at 10% to 15% take rates as the customers wanted it. If you go back and look at a little more in-depth discussion that we had with -- on this topic during the Q4 call, you see that we had a little bit of sensitivity on those penetration rates. You start seeing MirrorEye as an OE program along with the retrofits being -- having -- could be as much as a $500 million business line for us. That's just the base MirrorEye. So we're excited about all 3 pieces. To be clear, the -- and why retrofit and preinstall matters is trucks in North America still require -- by regulation, OE trucks still require a side mirror. The -- we are the only ones that can allow the side mirror to be removed after the production line. That's where the FMCSA exemption comes in. But all OE vehicles require a side mirror, albeit a reduced size side mirror. And we're the only one that then allow that mirror to be removed.

Yes. And I would just add to that. When you look at the -- we've been talking about MirrorEye for several years, obviously, and I think people generally understand -- certainly, if you've seen it or been in the truck, you certainly understand the value proposition of the system. There's several opportunities for our fleet to recover costs through fuel or safety or avoided maintenance. But I think what we're seeing in the market is really the fleet trial is paying dividends. Like Jon said, the retrofit is only one way -- retrofit revenue is only one way or one opportunity to work with the fleets. What we're seeing is the fleets want the system on the trucks, which is obviously pulling the OE decisions forward. So at this time, we've talked about the fact that we've got 4 awarded programs launching over the next couple of years. And when you look at the potential market opportunity for those programs, like Jon said, it's $0.5 billion at a standard equipment assumption. But I think a little easier to digest is even the fact that so far, we have not lost a single program in North America. We've been awarded every program in North America, and those programs represent 75% of the production volume in North America. So if the -- with 25% still remaining out in the market to be awarded. So when you look at our opportunity in North America, I think we feel really comfortable with our commercial position. And then when you look at the opportunity in Europe, we've been awarded about 1/3 of the total market in Europe with a little bit larger portion of the market yet to be awarded. But when you combine kind of our market share opportunity now with expectations or the thought process around improved take rates, you can get to some pretty interesting numbers in a pretty short period of time. We've heard from the fleets. Several of our fleets have said they don't know why they wouldn't have this on every truck. We've heard from the OEs that they say, we think this might be standard equipment in the next 5 years. And in fact, the only system currently that's in production in Europe, which is on a Daimler vehicle, one of our competitor systems, is actually standard equipment on the vehicle. So when you look at the way the market is moving and you look at the, frankly, the dominance that Stoneridge has in the OE space and the amount of progress we've made with the retrofits, I think that's where we get the confidence to talk about some of those larger numbers in the future, maybe the not-so-distant future and the opportunity that has to really scale the business up pretty quickly.

It sounds like as an individual product, MirrorEye has a potential to drive significant growth for you guys. Could you also just talk about how MirrorEye potentially plays as a platform for future technologies?

Yes. And this is part of the -- the overall transformation of Stoneridge that Matt talked about at the beginning, which is we think about how the different systems interplay. And MirrorEye really is a platform where -- it's a platform to build upon the electronics capability that we're already -- either we're already working on or we're already providing into the trucks. So integrating with the driver information systems, integrating with the telematics systems. We're integrating with some of the other vehicle -- some of the other vehicle control modules and starting to use now if -- rather than just having the physical replacement for a mirror, now you are streaming the information back to the fleets. Now you are integrating with the display and using the monitors possibly as a way -- as a base for inwardly looking cameras to monitor the driver or doing other value-added activities. So we are working with OEs, and we're working with other advanced technology partners to really look at how all of these pieces play together, both on the things that we do today as well as what we see in our advanced development road map.

Great. And then just outside of MirrorEye, what are some of the other key growth drivers for Stoneridge?

Well, we talked a bit about that earlier. But if you think about within our business, we have growth in the actuation business, the Park-by-Wire programs that we talked about as well as the front axle disconnect programs, we see those as really exciting. We continue to look for ways to expand our electromechanical actuation capabilities broader into beyond the base further into hybrid drivetrains and electric drivetrains as part of the torque vectoring process. Our emissions business really is in support of both evaporative emission standards here in North America as well as in China. So we're seeing growth in both areas within control devices, actuations and emissions. And then within Electronics, both -- as Matt said, both in North -- in Europe, North America and in South America with our Stoneridge Brazil platform, seeing growth in our connectivity activities, growth in our driver information as well as in MirrorEye. So as we've transformed the portfolio and we continue to adjust the portfolio, what we're focused on is what are those platforms upon which we can build, use common core competencies, take them around the world and solve the future problems that customers need solved as opposed to doing one-off products or one-off subsystems.

Got it. And Matt, I think you had mentioned this in your intro, but Stoneridge in general has been actively managing your product portfolio to focus on some core technologies. And just last week, you announced the exit of your soot sensor product line. Could you just provide some color on that exit and also how you're thinking about portfolio management going forward?

I can take the first part of this. I think the -- we announced that the exit of soot senor product line, I think if you look at the reasons that decision was made, obviously, the outlook for diesel passenger cars, I think, the market outlook has deteriorated over the last couple of years. You look at the current and expected profitability of the product line, and we'll talk about that in a second. And you look at really what we talked about in the introduction, which is Stoneridge's continued focus on aligning our resources, both capital and engineering and people with the opportunities that are greatest for the company over time. If you look at this product line, when we put the 8-K out last week, the 2019 performance, it was about $26 million of sales and it was losing more than $1 million. So when you look at the opportunity to deploy resources and capital to our highest growth and highest opportunity product lines, we didn't feel that the soot sensor business was one of those. So you look at that, that was about 30 basis points in 2019 on operating margin. The second thing is, I think this is really important. But when you look at what's going on in the macroeconomic environment, we talked about a lot of things in our introduction, the first couple of questions that were responsive to the market, right? And we efficiently and effectively responded to things that were happening, in some cases, expanded, planned cost reductions to meet market expectations. But this is one where we took a little bit more of an offensive approach. The soot sensor product line, we saw an opportunity with reduced production levels to exit the line faster during this period of time than we would have otherwise in a normal production environment. So this is where -- just another example of the management team making a decisive -- taking decisive action to not only respond to market conditions but to do it in a way that is most efficient and effective to really focus our portfolio and our resources on the areas that we've talked about in the last couple of questions. I don't know, Jon, if you've got any other color you want to add to kind of the overall thought process behind the product line exit.

I think the other thing just -- not only is it proactive, but it's not being afraid to adjust. The soot when it was originally developed, we saw a lot more opportunity because of where the passenger car diesel business was. But as we watch the dynamics in the market, we -- rather than continuing to pour good resources after bad, we made a decision adjusting and get out because we have better things that we can do with our engineering and better things that we can do to get return on our investors' money. We're not a tremendously capital-intense business. And so the most -- rather than -- while return on capital is important, we think about return on engineering as one of those measures that engineering is extremely -- one, it's expensive, and two, it's a constrained resource. So making sure that we're getting the highest level of return on engineering is where -- is the way in which we look at things. And if we can't see a path forward with a high level of profitability with a right level of growth and with a right return on engineering, we will adjust. And that's an example we set.

Great. And one other topic that's kind of top of mind for a lot of management team and investors is just broadly capital deployment. And how are you guys thinking about that, in particular, either via share repurchases or potential M&A opportunities?

Sure. Yes. Thanks for the question. I think we announced a couple of things on the first quarter call. The fact that we have been in the market during the first quarter and had bought back $5 million worth of shares -- approximately $5 million worth of shares that was prior to, obviously, the global impact of the pandemic. At that point, we announced that we temporarily suspended our share purchase authorization. But we continue to monitor that given the macroeconomic environment and how we're looking at the ramp back up and our expectations for the future. I think we obviously see a tremendous amount of growth for all the reasons we talked about during this discussion, but we see a tremendous amount of growth for the company. We see this setting up for a great opportunity in 2021 and beyond. And we will continue to take a look at ways to optimize shareholder value, either through share repurchases or other capital deployment. And to that point, I think we look at M&A in a similar vein. We've been pretty -- we've talked publicly about the fact that we pretty actively looked over the last couple of years for adjacencies or accelerators in our current strategy and our current product road map and our current technologies, perhaps in our end markets or customers. The balance sheet is very well positioned to be able to take advantage of inorganic opportunities. We've even looked at some things over the last couple of years that didn't necessarily pan out, but we remain very active in the way that we look at things. I think it's really important to know that we feel really comfortable and confident in our current product portfolio. This is not a company that needs an acquisition to transform. We've done a significant amount of that and continue to have a strong plan to do that going forward. We don't need an incremental product capability or technology to really drive a lot of growth, like we talked about with the powertrain actuation activities that we're doing, the electronics capabilities that we have in the commercial vehicle, MirrorEye, obviously, we feel like we've got a lot of product lines that are very well positioned to significantly outpace the market as we move forward. That said, given our balance sheet and, frankly, the macroeconomic environment, there could be an opportunity for Stoneridge to take advantage of things that were more expensive a couple of months ago and may not be a couple of months from now. So we will continue to look at things and make sure that we're putting a thought process around each of those potential opportunities to make sure that we're staying ahead of the curve from a technology perspective. That said, obviously, we're being very cautious and prudent with our capital deployment as we look at the rest of the year and the ramp-up. But I think that we've talked about for a couple of years that the opportunity for Stoneridge in a downturn could -- we could come out a lot stronger coming out of the downturn than we went in just because our balance sheet is so strong.

That makes sense. And just given the current market environment, do you see Stoneridge as a potential M&A target? And how would you overall kind of think about that?

The -- so our focus -- this leadership team gets up every day and thinks about how to drive value for our shareholders. And -- but also try to focus on the things that we can control and focus and putting people in place to really drive value. So we believe that we're well positioned as a company, and there's a lot of upside and opportunity. At some point, might there be something else? Yes, of course. And hopefully, what we do every day to make the business better and drive shareholder value as we run the company, also will make it more valuable to somebody who looks at it from the outside, but that's not something we can control. So all we can focus on is how we drive value every day.

Great. That makes complete sense. That concludes all of our questions for today and concludes today's fireside chat. So Jon and Matt, thank you so much for taking the time for joining us today. And thank you, everyone, in the audience for joining us.

Thank you.

Great. Thank you very much.