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

Good afternoon, and good evening, everyone. Thanks for joining us today. My name is Rajat Gupta. I'm a member of the Automotive Equity Research team at JPMorgan. Very pleased to have with us the Stoneridge team today, CEO, Jon DeGaynor; and CFO, Bob Krakowiak. We will kick off the presentation -- we'll kick off the session with a quick presentation from the Stoneridge team, after which we can dive into some topical questions on the company and the industry. Just wanted to remind the audience that there is no live direct Q&A with the company. But if you do have a question, please do ask that on the online portal, and I'll be happy to ask that on your behalf. Or you could also e-mail the question to our team at [email protected]. With that, I'd like to hand it over to Jon.

Thank you very much and for everybody who's joined us today, thanks for your interest. It's really a pleasure to spend a little time introducing you to Stoneridge, for those who don't know the story. So if you turn to Page 2 of the slide deck, let's spend just a couple of minutes talking about Stoneridge and a little bit of background. So Stoneridge was founded in 1965 in Warren, Ohio. And I think 1 of the most important things about the company and actually 1 of the things that has -- that attracted me to the company and has allowed us to attract some really fantastic leaders to the company is 5 years ago, when I joined, it was very clear, of the foundation that the business had, both diversification in its end markets, diversification with regard to those products as well as diversification in -- with its customer base, with no 1 customer at that time over 17% and no 1 customer really dominating or any 1 end market. And what that gives us the ability to do is continue to have a little bit of cyclical balance, but also to apply core competencies in the right way. What we also have seen over the last 5 years is there was tremendous room for improvement, which we've continued to drive and really good technology and that's allowed us, as you see on this slide, it's really allowed us to continue to drive our backlog growth at over 6.5% last year. But really, our backlog that we're tremendously proud of, which is $3.2 billion worth of backlog, which represents, for us, almost 5x our 2019 OEM sales. If you look at Slide 3, to understand a little bit more about the company and its split. We're roughly split 50-50, but 52% for control devices, 40% for our electronics business and those -- and then another 8% for our business SRPs, Stoneridge Brazil. If you think about it as an electronics business and a controls business, it's roughly 50-50: And the control devices business is powertrain, electronics, drivetrain actuation, really focused on the passenger car and light truck segments; where our electronics business is connectivity modules, driver information systems, basically, commercial vehicle electronics that are both vehicle-to-driver interface activities as well as vehicle-to-infrastructure and vehicle-to-the-outside-world, whether it's tachographs, whether it's CLDs, driver information systems connectivity or now with MirrorEye. And our business in Brazil is an electronics business, it is the -- probably the most diverse business, but also the most customer-facing business and what that's built is a really strong electronics capability with regard to customer-facing product development, speed to market and how to take that customer feedback and put it back into product development process. Go to Slide 4. What you'll see is you'll see the evolution of Stoneridge and the path that we've taken since I joined, it's really since 2014. First and foremost is the picture on the left-hand side is the foundation of all of what we do. It starts with the capability of the team, and we've worked as a leadership team, very hard at continuing, refreshing and expanding the capability of the organization, but then allows us to drive the transformation of the company over the last 5 years, continue to drive performance even in a difficult time like we have right now with the pandemic and continue to drive the growth as we show the backlog expansion and the year-over-year growth. That -- what that has also led to is a transformation of our portfolio and really a move from making discrete components or products that follow a customer's ask, pretty much a response to an RFQ activity to making much higher-capability systems and subsystems that are addressing a macro need, and we'll talk a little bit about that in the future. We have made necessary portfolio moves to rotate out of some noncore businesses that started before I joined in 2014 with the sale of the wiring business, but it's continued with our announced activities and the sale of switches and connectors to SMP and other portfolio moves that we've made over the last 5 years. In addition to that, what we've done is we've taken those proceeds and invested it into technologies and organic growth opportunities with the acquisition of Orlaco, with the purchase of the balance of the shares of our SRB business as well as investments in things like auto tech ventures that give us the ability to continue to supplement what we're doing from an internal product development standpoint with both inorganic acquisitions as well as sources into the BC space in ways that a company our size couldn't otherwise do it. As I said to you, the organizational transformation has really been about assembling a leadership team that understands what good looks like and is able to drive that and rationalizing our manufacturing footprint to set the stage for the future and then really also building a capability in the CTO's office to continue to be thinking 1 or 2 steps ahead, which differentiates us from, again, where we were over 5 years ago. If you go to the next slide, Slide 5, what you'll see is all of the work in that backlog, the work in our technology transformation and the work in the organizational transformation and the work in the expansion of backlog has set the stage for a tremendous number of program launches, but really a tremendous amount of organic growth over the next 2 years, 2021 and beyond. Really, end of 2020 and 2021 and beyond. What you see is $250 million worth of awarded programs that are launching over the next couple years, with $190 million of that being new business. So as we look -- as we think about our backlog and we think about the things that we're launching, it's where are we -- we don't just look at carry-on programs, we look at how is it driving organic growth, and we're really pleased with how much of this peak annual revenue, of the $250 million is new business and new segments or new customers for us. One of those businesses, if you slide to the next -- if you go to the next slide, Slide 8, is MirrorEye. And MirrorEye is a perfect example of a system that rather than waiting for the customer to define a need, we look -- we found -- as we focus on the megatrends: Safety, fuel economy, vehicle efficiency and vehicle electrification of vehicle automation, we put together a system that actually solves problems for the end consumer of the fleets as well as for the OEs, both in Europe and in North America, which you may not be aware of is the cost of accidents were in North America, vehicle insurance on a commercial vehicle is -- 1 -- is the fastest rising cost in trucking, and it's 1 of the top 5 costs in trucking. So you have a challenge with regard to the safety expenses as well as the fuel economy needs of the truck. And what we've been able to do is combine our capabilities to develop a solution that addresses blind spots, not forward-looking, but the blind spots around the rest of the truck, which represent about 1/3 of the accidents that commercial vehicles face here in North America. The removal of the side mirrors also gives a 2% to 3% fuel economy benefit to the fleets, and that's been validated not only by our own tests, but other fleets doing it in SAE structure testing. So what we've been working on in the commercialization process is not only the OE program wins, but also fleet trials and a retrofit activity, which gives us the ability to continue to get feedback from the people that have to use it in the fleets and the drivers, continuing to refine the product, but also to validate, does it really give the safety, savings and the benefits and it's created a market pull. The way in which we're taking this forward is to first do retrofits, and we've done that with a series of trial fleets where we're retrofitting. We're doing first initial retrofits of their trucks, and then that drives both an expansion of the retrofits, but it drives them to pull in how they order their vehicles. That leads to the second path forward, which is prewire, where those fleets that are buying new trucks are asking the OEs to wire their trucks in advance so that the retrofit can happen more rapidly and then ultimately, OE programs, as we announced in our second quarter call, the retro -- excuse me, the pre-wire activities will start with Daimler Trucks North America, the first of the OEs that have announced that it will start in the third quarter. And we have 2 global OE programs that will launch early in 2021. So we have the retrofit to pre-wire and OE, all launches that are all basically occurring right now. I think 1 important note is as we thought about our backlog and as we think about MirrorEye, what we put in our backlog is what our customers have told us from an OE program volume. And rather than us talking -- putting in our backlog, what we think the entire market opportunity is, so our total awarded programs today are worth about $72 million of peak annual revenue on our backlog, but that represents a 10% to 15% take rate, and that's really what the OEs have said to us. When you start looking at larger opportunities, that's the graph on the right-hand side, to say how big could this be in the size of that market. What we want everybody to take away is we -- of the programs we have been awarded, we have -- that leads us to a 75% market share in North America on the OE programs and around a 50% of the OE programs in Europe and about 1/3 of the European market share. So we're really excited about this product, but it's important to note, as you go to Slide 7 -- I apologize, it said Slide 8, but it is -- if you go to Slide 7, that says Leveraging our Existing Technology. MirrorEye is not just a product in itself, it really is a platform that allows us to start to integrate others of our capabilities. So you take the vision and safety activities, MirrorEye and what's beyond that, you start bringing it together with our driver information systems, which is the instrument cluster and the interface with the driver there and then connectivity, which really is the boxes that are communicating to the infrastructure and are taking care of legal/regulatory tracking of the vehicle, and it gives us the ability to, on a commercial vehicle, control a tremendous number of the functions within the vehicle and also drive a huge level of value, and that's the way we look at it. It is not just the MirrorEye product, but now what do we do beyond that in expanded functionality, expanded capability and additional services. So as we look at, on the next slide, leveraging the portfolio, not only do you have what's on the outside of the truck, but now you start looking at what's on the inside of the truck. And using the real estate in front of the driver with driver information systems on the 8 pillars with the displays for MirrorEye as well as the connectivity modules and the tachographs to really facilitate driver monitoring, facilitate additional communications in the infrastructure or to the fleets and expanding our capabilities there. So with Stoneridge, the best way to think about the company is it's a 55-year old company that has gone through a tremendous transformation in the way in which it approaches the business. We have a global footprint and a global set of core competencies that allow us to deliver value at -- and compete with much, much larger suppliers and do it in a way where our customers are valuing it. Thus, our backlog is expanding, and we can drive value for our shareholders. Bob, I don't know if there's anything I've missed in that, but I'll turn it over to you. Or Rajat, back to you.

No, I think we're ready for questions.

Great. Thanks for that presentation and the overview on the company. Super, super insightful. I just wanted to start off with the company's performance. In the first half of the year, particularly in the context of COVID, how is the pandemic in general? I mean you could give a quick overview of how it's impacted the company in terms of just the volume and just outperformance versus the market, but also like how it's structurally changed the profitability or the cost structure of the company coming out of this? Any color there would be helpful.

So I'll -- thank you, Roger. Thanks for the question. I'll start, and then I'll turn it over to Bob. We have, for the last 5 years, not only have we transformed the company and the product portfolio and the leadership, but we've also really maintained a very clear focus on knowing that something bad is going to happen, none of us predicted something like a pandemic, but we made sure that our balance sheet was managed very conservatively. So anything that we did with regard to M&A or anything we did with regard to capital allocation was, first and foremost, with an anticipation that something could happen. That conservative approach to the balance sheet has allowed us to stay absolutely focused through this pandemic. Obviously, we've had to react to huge sales reductions and the associated impact on profitability. But what it has done, this has allowed us to continue to invest in our R&D and advanced development to continue to feed the pipeline of technology through this time. We haven't had to throw all of that back. We have taken necessary and in some situations, previously planned actions to restructure and refine our SG&A and continue to refine our overall business. But we've been able to react to this externality, continue to focus on where we're going in the future, and that really is a factor of how we were running the company beforehand.

So Raj, first of all, it's great to be here. Thanks for the invite to the conference. In terms of actions, we've been -- we pride ourselves as a leadership team in terms of getting out in front of things and responding as quickly as possible. So we did take 5% of our salaried workforce out in the first quarter, and it was really something that we were anticipating doing. It wasn't necessarily in response to the pandemic, but there was some work that was being done as we continually look at our cost structure and look at refining it, so we've taken that action. And then in addition to that, there's been some things that the pandemic has -- we've really had some opportunities that have been afforded to us as a result of the pandemic around exiting some unprofitable product lines. It's allowing us to build up some bank. It's allowing us to build up banks of components that since we've been running at fairly high utilization rates over the past few years, given the great mix that we have with light truck, SUV and CUV, plants that have been running at high rates. And we've been paying premiums for component allocations and some premium freight. During the downturn, we've took the opportunity to build up some finished goods inventories, and that's positioned us really well as volumes ramp back up. And I'm sure we'll talk about that in more in the Q&A.

Yes, sure. I mean -- and in terms of -- just the impact, I mean, I think Jon talked about this a little earlier, like, so if we think about what impact the pandemic has had in terms of technology investments or just the R&D-related investments? So that's not -- you haven't backed off that, right? Is that a fair assumption or have you gone back?

Actually, it's a fair assumption. In some situations now, where we not backed up but we've accelerated it. We're trying to use this period of crisis as a chance to accelerate what we're doing. Bob talked about it with regard to refining the organization as some portfolio moves, but what we've also done is we've used this time to move forward with product development and make sure that we're not losing the 4 or 5 months, not knowing how long was going to happen, that we weren't losing that time with regard to the pipeline and technologies and the solutions that we're working on.

Got it. Got it. That makes sense. And although you did withdraw your guidance, which I think a lot of -- most of the industry did do the same, you did provide some concrete expectations for the second half and how to think about production and your outperformance, both from a revenue perspective, and you also gave some color on decremental margins and cash flow. Could you just walk through those and give us a sense of how those have been tracking so far? And like, are you -- still feel comfortable with those?

Absolutely. So first of all, correct, we did not update our guidance. We've withdrawn guidance -- that we haven't updated it for the balance of the year, but we always rely on -- we always take third-party information, and we use it as the basis of our guidance. So we use IHS for passenger car, we use LMC for commercial vehicle. And we boil it down at a very granular level at the -- basically by platform, by region and build it up. We have a very bottoms-up approach. And if you look at the -- really our weighted average end markets based upon the IHS and LMC projections, they're going to be down a little over 20%, about 22%, versus the original guidance that we guided this year, which was a midpoint revenue of $760 million. So if IHS, LMC materialized, we'd be down about 22% based upon our weighted average end markets. But if you look at the third quarter run rate -- third quarter run rate right now with the customer orders that are coming in, it looks like we're just at about -- we ended June around $52 million, $51 million, $52 million in revenue in June. Everything that's probably going to be the run rate for the third quarter, and we've seen a very nice conversion as a result. Margins on -- incremental contribution margins have been really strong with the ramp-up, and we are forecasting a contribution margin of about 35% on the incremental revenue in the second half of the year versus the second quarter. So if you look at it all, in totality with respect to cash flow, we went through about $11 million in cash in the second quarter, and we expect at least to offset that in Q3 and continue to build our cash balances for the remainder of the year.

Understood. That's helpful. And I know there is no official guidance for 2021. I mean no one knows how things might actually turn out to be. But how do you see the company performing coming out of this pandemic-driven downturn? What is your sense as you stand here today? Like what's your sense of how the end markets might look like for your company indeed to 2021 and maybe even beyond?

So looking at the IHS and the LMC data for 2021, that would basically mean about a 16% increase next year in our weighted average end markets for 2021. And then on top of the 16%, just in terms of base market growth, Jon had referenced the new product launches, and we've had 3 consecutive years of record new business awards, $200 million of peak annual revenue that is in the process of basically rolling out. And of that, we've got $190 million of incremental revenue that's rolling out as a result of program awards. So we're very excited that we feel like not only are our markets going to be coming back next year strongly, but in addition to that, with the program awards, we really feel like we've got a really great secular growth story to talk about. And then on top of that, we have our first MirrorEye launch early next year, which Jon referenced. And if you look at our backlog, we would see a 10% to 15% take rate on MirrorEye. So to the extent that the take rates exceed that, that's just icing on the cake versus what we've used for purposes of reporting the backlog. But really, if you look at this -- if you look at the strategy, over the long term, this has happened. Since I've been with the company over the cycle, if you look at our markets, which is safety, emissions, fuel efficiency and intelligence, they've basically been outgrowing the vehicle market by about 2 to 3x, and we expect that growth rate to continue over the long term.

Understood. That's helpful color. I mean, clearly, MirrorEye is a key focus for the company and for the investor community. Can you talk about some of the -- I mean, Jon detailed a lot about the technology but could you give us a little more detail on some of the latest updates that you've done to the product and what the time line is or what we could expect going forward with respect to MirrorEye?

Raj, it's really an exciting time for MirrorEye because we've got all 3 aspects happening at the same time. First, we have -- the fleet trials and the expansion of the fleet trials. In this quarter, we've added 3 additional major fleets to the fleet trial portfolio, and 2 of those installs are already done, the other 1 is ongoing. And what that means is we have fleets that now have over 9 plus million miles -- road miles with their trucks. They're building confidence in the technology. We're getting feedback on what the drivers need, what -- how do we make it better. But what we're also seeing is those fleets are asking for their trucks to be preordered. The OEs do not want to prewire a truck. So the reason that they would do this is because the fleets are pulling it. It's a very strong statement on what the fleets think about MirrorEye and the opportunity to pay the money that -- basically, create enough pull that the OEs would start to prewire their trucks. So -- and those first trucks will be delivered at the end of this quarter or into next quarter, the initial pre-wire trucks, pre-wired trucks from BTNA. One important thing for the investors that haven't seen this is the mirrors on trucks are controlled by 2 different, if you will, regulatory agencies. For an OE, it's NHTSA, and once the truck leaves the factory, it's FMCSA. A truck under NHTSA regulations is required to have a 50 square-inch physical side mirror. Stoneridge is the only company that has an exception that allows fleets with the Stoneridge MirrorEye system to pull those mirrors off. It's not yet legal to do it on the production line, the truck must leave the production line under NHTSA regulations with a side mirror, but it can be immediately done in retrofit. The OE program launches that will happen early in 2021, actually, is a hybrid with a side mirror and the MirrorEye camera. Future ones, we would see that coming off. But right now, the regulations in the U.S. won't allow it, the regulations in Europe do. So we're extremely excited about the retrofit, prewire and OE program progress and the partnerships that we're building with the OEs as well as the fleets and what it means for a very robust product and a very robust set of follow-ons -- activities.

Got it. That's helpful. And just looking beyond MirrorEye, you talked a lot about technology and you're leveraging your existing portfolio for what's coming next. But could you expand a little bit more on the core technology portfolio and how that could contribute to even further outperformance going forward?

Well, if you look for those that -- look at that chart with the $250 million for the launches, what you'll see is the majority of those programs are not MirrorEye. And while we talk a lot about MirrorEye as a future powertrain actuation, our emissions portfolio to drive fuel efficiency and emission solutions as well as the driver information and connectivity activities, all of those are growth engines that we believe in for the company. And for example, with the powertrain actuation, that is really allowing us to support the further electrification of the powertrain and the power chain because not everything is going to go to fully battery electric vehicles, there will be a level of hybridization. And the ability to manage the sources of motive force, whether it's a gasoline engine or an electric motor, and to help the driveline guys manage those sources, that's the actuation that we do. So that's a growth hierarchy. Emissions as -- emissions and regulations get more stringent at over time, the emissions activity that we have, particularly in managing evaporative emissions, both in North America and China, that's also a growth area. And then as we've said, how we bring that interface with the driver and driver information systems, the interface with the infrastructure in our connectivity as well as our tachograph and ELD activities, and then weave that all together in the vision of safety actions, which is MirrorEye and what's beyond that, means that we have multiple legs of a stool that are growth-driven, both in the passenger side -- passenger vehicle side as well as the commercial vehicle side.

Got it. Got it. That makes a ton of sense. We're almost bumping up on time, but I just wanted to throw in 1 last question here, just your latest thoughts on capital deployment, the balance between buyback and M&A. How do you see those opportunities in the near term? And I'll wrap up after that.

Rajat, thanks so much. We did have a share repurchase program in place. We suspended it when the pandemic hit. We've maintained a very conservative leverage ratio. I mean we think over the cycle for a supplier like Stoneridge, something in the 2 to 2.5 turns of net leverage is where you want to be to make sure that you've got adequate capacity under any scenario. We've basically -- we stayed in that range. We really like our portfolio. We're out looking for opportunities. We've got over $300 million of liquidity available to us right now under our current credit facility. And if we have the opportunity to do more deals like Orlaco. Orlaco was an absolute grand slam for our company, for our shareholders. So we're looking for opportunities. We're definitely -- we're -- I would say I'm -- Jon and I, we're value shoppers looking for the right opportunity. But right now, we're just being cautious and really focusing on getting the business where we want it to be, so when things get back to normal levels, we're going to be the best company that we possibly can be. So thank you so much for your time, and thanks for your questions.

Great. No, thanks so much for participating and sharing your insights on the company and the industry, and we look forward to having you again at the conference next year. So thanks for joining. And also thanks, everyone, in the audience for joining the presentation.

Rajat, Thank you.

Thank you very much.