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

Okay. It looks like we can get going now with our next presentation. Very happy to have here with us Stoneridge with exposure to the commercial vehicle industry as well as the light vehicle industry. Pleased to have President and Chief Executive Officer Jon DeGaynor; and Chief Financial Officer, Matthew Horvath. Jon and Matthew, thanks so much for coming to the conference.

Ryan, thank you, and it's really a pleasure to be here. We appreciate the opportunity. So why don't I spend just a couple of minutes for those of you that don't know Stoneridge and just give you a little bit of background? So if you think about Stoneridge, Stoneridge is a now a 57-year-old company that was really established making wiring harnesses for commercial vehicles and off-highway activities. And it has transformed over this last 57 years to be a global supplier for the commercial vehicle and pass car space. We've spent the last 7 years really continuing to transform the organization. And what comes out of that is a very strong backlog in the $3.4 billion with the backlog that you see on the slide. And also what we see is a sales growth -- based on that backlog of over 9% compound annual growth rate. I think it's important to note for a business this old that it's also really set up as drivetrain agnostic. So as we see the dynamics in the market space, Stoneridge has adjusted its portfolio to really be agnostic to whatever the motive force is, be it a hybrid electric vehicle or an internal combustion engine. To go in a little more detail, as we talk about the business, let's start first with how the business is broken down. It's relatively diverse with regard to both its end markets, the segments in which it supports and geography. So we'll talk about Control Devices and Electronics. The way to think about that really is our electronics businesses, our commercial vehicle business, the control devices is really our light vehicle business. By then, by end market, you'll see whether it's commercial vehicle pass car, or aftermarket are relatively significant balance between those and geographically also split across the world. It was one of the things that, as I looked at diversification, is one of the things that attracted me to Stoneridge 7 years ago was the opportunity to have multiple markets, multiple product lines and multiple customers such that we could adjust our portfolio and there was no one customer or no one product that would put the company at risk. In the last 7 years, we've transformed a lot. It started with the divestiture of that wiring business. So the business that founded the company, we divested in 2014 and that really set on a series of moves in getting out of the switches and connectors business, getting out of the sensor business, exiting our joint venture in India. And then with the addition of technology with the acquisition of Orlaco and the acquisition of the balance of our joint venture in PSG, now known as Stoneridge Brazil as well as making some strategic investments in things like Autotech Ventures, which gives us a point of view into Silicon Valley without having to set up an office out there. One of the other transformations for the company is really the transformation of people. We moved the headquarters from the founding location in Warren, Ohio and moved it to Novi, Michigan, and that really gave us a chance to change not only the leadership team, but the engineering organization and build an advanced technology organization around that. If you think about the transformation of the company, I think this slide probably is probably is -- probably is the most important aspect of what's changed for Stoneridge. The Stoneridge was built as a respond to a customer, a phone call or a customer RFQ and build to print sensors, switches and connectors and in the wiring business really in response to a customer. What we've done over the last 7 years has transformed that from respond to a customer to how do we anticipate the customer's needs, adjust that with the megatrends and really bring solutions ultimately from -- to subsystems, systems and then into future anticipated solutions to the marketplace. And you'll see that in what we talk about with regard to MirrorEye, but you'll also see it in some of the actuation activities and some of the other sensing activities that we have and how we've anticipated the market needs and moved the portfolio that way. I mentioned to you that the business has a diverse portfolio. I think the thing to take away here is what we've done is we've adjusted our portfolio with what we see as the megatrends in the space, which is vehicle safety and security, vehicle efficiency, that has fuel economy and emissions and vehicle intelligence and then the emissions portion specifically for sensing. Everything that we looked at in the portfolio when we joined the company and when we started this transformation was filtered against how does it address those megatrends and where do we go. Control Devices, again, is roughly 47% of the company. Electronics is 45% and Stoneridge Brazil is 8%. Really, the way to think about Stoneridge Brazil and SRI is it's 2 electronics businesses that just has the geography in between. So as we think about the future, I mentioned to you that this portfolio is 85% motor-force-agnostic. I think the thing to take away from this is really we're utilizing our core competencies to address market needs today and in the future. And we've been able to take our actuation competencies that would have been developed with the pickup truck or in pass cars and apply it in needs with the electric vehicles with the integrated park module or what we refer to as park by wire. And you see a couple of programs where we've got significant growth that's coming from that, and we're seeing that also grow, not only in North America, but in China. The other aspect is some of our old technologies like trailer tow connectors, which would have been thought as just very, very rudimentary technologies also become an enabler for advanced safety systems in pickup trucks. So when you see the commercial for the Ford pickup truck that -- where the driver is able to back up his trailer through just a little dial on the dash, if you don't have the right connector between the truck and the trailer, that's not possible. So what we've sought to do is look at, again, what are the products in our portfolio, how do we use the core competencies that we have and apply against the megatrends that are out there. One of the biggest and best examples of that clearly is MirrorEye. That product was started in Europe as a fuel economy solution, first one into production with Daimler and is now in production also with DAF in Europe. What we've sought to do is expand that product and make it into a system that really not only drives fuel economy improvements, but drives safety improvements and driver retention improvements and really support both in the European market and in the North American market. And what we see here is by both an OE approach and a retrofit fleet approach, we have been able to get approval for FMCSA. The first -- we are the only ones that had that approval to take the mirrors off a truck. It allows us to work directly with the fleets and get market feedback. And it also has supported us with winning 75% of the awarded commercial business and commercial vehicle business in North America we've won. So we use the OE programs and the fleet programs to work together really to drive the growth of the business and continuing for what's next beyond that. So in summary, as you think about Stoneridge, Stoneridge is a -- really is a transformation story. It's -- these last 2 years have certainly stressed the organization like any automotive supplier. But as we step back and look at where has Stoneridge come from and where is Stoneridge going to, the story is still the same. It's a growth story. We're outgrowing the market based on the moves that we've made and the technologies that we have. It's a profitability story that the investments that we made allow us to drive that growth and turn that into a significant profit margin into 2025 as those investments come to fruition and ramp up. And it is a future story where we're aligned with the megatrends. We're working on systems. We're anticipating the needs in the marketplace, be they on a commercial vehicle, be it on a passenger car vehicle or in an off-highway like with forklifts or cranes or construction equipment. So it's an exciting company to be part of. It's exciting transformation that we've driven so far and we really look forward to the next steps. So with that, Ryan, I'll turn it over to questions.

Great. I thought to maybe ask sort of hot button topic on all of the inflationary costs that suppliers have seen and their attempt to pass on that cost to customers. Maybe you can just review what your raw material cost protections look like, your pass-through arrangements, et cetera. And then I think where the supplier industry was kind of caught off guard a little bit was how much inflation there was in these non-raw material costs over the past couple of years, how much diesel, freight, logistics, labor, natural gas, electricity have gone up and maybe there's not a formalized way to recapture those costs in the contracts as they stand. So with regard to the current contracts, have you been engaged in negotiations with your customers to receive higher pricing and recoveries and how have those negotiations tracked? And then secondly, with regard to like the new contracts that you're signing today, do they look any different than the contracts that were signed in the past to provide maybe more flexibility if cost should track differently in the future?

Yes. So I'll start on the material cost piece. When you think about it, there's really 3 primary buckets of incremental costs that we've incurred over the last several years. The first is what we call spot buys. We referred to that several times publicly. And that's really going outside of our traditional supply chain of secure material that is not available through a traditional supply chain, right? And that's at generally tremendous incremental costs. For the first half of 2021, that was a net headwind to us pretty significantly, several million dollars. We've put agreements in place with our customers to pass that through when necessary. So to-date, we've offset about 97% of those spot buys. So the first was kind of stop the bleeding on the incrementals and make sure that we keep our customers in production and make sure that we're able to supply the material that they need, right? The second piece of that is normal supply chain, material cost rising, inflationary increases or supply demand increases. Like Jon mentioned, our portfolio has shifted and it has shifted into some of these headwinds in the short-term here, right, because we focus more on the systems, which means more electronics, more systems integration. So we end up in a situation where a large portion of our material buy is subject to some of these supply chain issues that have hit over the last couple of years. So on that side on the customer side, those are normal suppliers, what we deal with regularly. We get price increases. We go back to customers, our OE customers generally and talk about what does that mean for our portfolio of products with them. So there's a little bit of a time lag that is required, but between recognizing incremental material costs, which is on the second half of last year for us and offsetting those material costs with improved contracts or contracts that more accurately reflect the market, okay? So year-to-date, we've offset about 90% of those incremental costs, which is tremendous for our industry. That's -- when you look across the industry, being able to offset a significant portion of overall material costs, we feel really proud about that 90%. There is a time lag to that because material costs are not accelerating as quickly as they were previously, but it's still in a headwind to us. So we're in constant communication with customers going back and forth on what do we see the incrementals to be now? What do we expect them to be in the future and how do we make -- help offset some of that cost, again, not all of it, but a very large portion, right? And the third piece, like you mentioned, is kind of the other bucket of not only direct labor inflationary costs and logistics and the things that are easy to quantify, but manufacturing and efficiency, opportunity cost of our resources if you think about our procurement team. Our procurement team is fighting every day to get back to 0, not necessarily do the things that we've done historically around increased productivity and efficiency in our supply chain, supply chain strategy to get volume discounts and scale. So right now there's a tremendous opportunity cost in the industry that I think people are missing when you look at margin profile that is just fighting every day to get to that 90%. And I don't know, Jon, maybe if you want to talk a little bit about future contracts and how you think?

So part of -- to answer your question with regard to the future contracts, Ryan, what we've tried to do historically is deal with things that were typically inflationary that we're on an index. So currency had some adjustments in there, particularly in electronics, metals had some adjustments in there. The largest portion of the buy is electronics. And historically, that's been a deflationary buy. So what we haven't done is we haven't gone in and put a contractual hedge in place because in that situation, if you think about the industry, it's typically a deflationary pricing, you've got to have some level of deflationary material costs in order to deal with that pricing. So if we lock in a number today, then any deflationary pricing ends up coming out of very small portions, whether it's overhead or direct labor costs or other structural things. So we've thought -- been thoughtful about it, but in the thing that's been most inflationary in the last 2 years, we've just gone back to customers specifically on that and as Matt said, 90-plus percent of it that we've gotten covered.

Great. And obviously, the macro environment has been very challenging in the last couple of years. Of course, the supply chain difficulties and inefficiencies, premium costs, volatility of production schedules, et cetera. At the same time, how -- while this has impacted you near-term, do you think it has any kind of longer-term impact on your potential margin, et cetera?

So that's why we've been so clear on what we see as our future EBITDA margins and what we see whether that growth. This balance of how you handle the customers and pushing it as hard as possible, but protecting the future making sure that we're continuing to win new business. That's why the bookings are so important, indicator is still important. As a signal of that, we haven't lost programs as a result of the activities over the last 2 years. So we see -- and we've had the support of our Board to continue to make the investments in the engineering for these new products during these last 2 years. So we rotated into more electronically dense products, but at the same time, right, as we are finishing development and launching a whole series of new programs is right as COVID and the supply chain crisis happened. And so we had a choice, continue to invest and know what that means in the short-term or take those cuts and there is just no way thankfully that we could take the cuts and keep all the growth going. So we're very confident in what we see as the margin expansion. We know the investment that we've already made in the engineering, and we see where the opportunities are with regard to the backlog in the book business we have.

Okay. So you made a lot of progress on the pricing side and the contract side. On the cost side, it sounds like you don't want to cut deeply into your growth drivers and your R&D and your investments. What cost mitigation actions have you taken over the past couple of years, over the past year? And what is the potential for continued cost mitigation going forward and impact on margins?

So we did an overall SG&A structural cost reduction in 2020. We've continued to adjust our structural cost. We've also worked really hard on simplifying the business. That's where -- to making decisions on things like getting out of joint ventures and some of the other stuff is as much as anything. What is the cost of our time and what's the cost of that effort to focus the business and refine what we're doing. So we continue to refine our management structure, close facilities, adjust facilities and take cost out while at the same time not burning the seed corn, which is the advanced development activities.

Yes. And we've discussed the pricing. We've discussed the cost actions. Given that and maybe layering on some discussion of the end markets too, how do you think it all adds up into the back half of this year and sets you up for profitability, et cetera, as you move into next year?

Yes. So great question. So obviously the most volatile portion of our business this year after you get through the material costs, understanding how we've gone to offset those incrementals is production volatility in our end markets, right? At the beginning of the year, probably expected the end markets to become more stable earlier than they have been, although we are starting to see some stability in those end markets, both on the CV side and on the North American passenger car side, you've probably heard maybe even today. Our customers are expecting a very strong second half of the year. We're starting to see material availability, which has been the primary constraint to most of that production, ease a little bit. Demand remains really strong. There's a very strong backlog driven by basically the inability to produce cars. Historically the inventory levels in the industry are very low. So we see a tremendous amount of end market demand now that material is starting to become more available. So the second half we're expecting a pretty significant ramp up on the top line in the second half driven by the availability of material, but also some of the things that are specific to our self-help story, right? That's the unique about Stoneridge is the products that we've launched over the last several years, the MirrorEye take rate improving as material becomes more available, we're able to take advantage of that backlog and really drive some strong revenue growth in the second half. The other part that's really important to remember is because of the cost structure actions we've taken because of the fact that we've been able to mitigate a large portion of the material headwind. We're structurally set up very nicely to -- for a strong contribution margin with top line growth. So traditionally, we expect 25% to 30% contribution margin on incremental revenue. But the base being as low as it is, we have the ability to even outperform that we think as we go into the second half of the year, which sets up for a really nice run rate as we head into 2023. By the end of the year, we've said we're expecting high single-digit EBITDA margin run rate as we head into 2023. And with the backlog that Jon walked through, we've got a fairly linear strong growth curve over the next several years that contribution margin can get really accretive pretty quickly. So we do expect, as we probably get in the end of 2023, we'll see some end market demand normalize a little bit because you'll make up some of that backlog of low inventory in the industry. But that's where things like MirrorEye take rate and the incremental products that we're launching on the actuation side and some of the connectivity business that we've got launching in 2023 can really start to impact the business really strong on the top line.

Yes. And you've referenced several times here today and I think in previous years at the conference also this transformation in the product portfolio sort of away from more mechanical products toward the more electromechanical or even electrical products. Obviously MirrorEye gets all the buzz. But what are the biggest drivers, maybe beyond MirrorEye, things that you can point to that are driving the increased capabilities or growth of the company?

So I would break it into a couple of places. I think on the electronics side, you've got our connectivity activities what we refer to as a smart tachograph, which is the next generation of connectivity and vehicle control in Europe. That's a -- it's a government mandated, it's us and one other competitor and we feel really good about where we are there and the growth that comes there. The second one is the transformation from analog to digital instrument clusters in commercial vehicles. That gives us the ability to significantly outgrow the market because the content in digital instrument clusters are lot higher on a per vehicle basis than previous instrument clusters. So that digital display and the secondary displays and how they transform the cockpit of commercial vehicles is another growth driver for us on top of the MirrorEye activity. So both of those in -- on the electronics side, on the Control Devices side, it's really actuation and applying our actuation core competencies into hybrid and electric vehicles and following that growth. So we're not giving up on making front axle disconnect for pickup trucks, but using the core competencies that we have in park lock and in other vehicle control and torque vectoring in electric vehicles, both on the park side and on the torque vectoring as they connect and disconnect motors is growth opportunities for us. And then the last piece is really taking some of our sensing capability and moving it from what do we do to control in internal combustion engine to what do you do to control temperatures in a battery management system.

Yes, this is a part of the business that's probably least understood I think by folks that look at the company. The Control Devices business has a very unique competency in the actuation space. We talked about drivetrain-agnostic. It's clear to see why that's the case of electronics when you look at the cockpit stuff and the MirrorEye things that we're doing. But when you think about the stuff that we're doing on the powertrain for light vehicle on the Control Devices side, having a core competency around software and electronics integration with a mechanical device on electrified powertrain, it's pretty unique to a company -- more certainly of a company of our size is pretty unique. And we've been able to take those companies like the front axle disconnect and apply it in hybrid and fully electric vehicles to do something similar around that competency for a different purpose. It's driven a lot of growth. So the -- if you follow the company, you've seen Shift-by-Wire move to Park-by-Wire. Shift-by-Wire was a device we created for a very specific purpose as a bolt-on to an existing transmission platform that developed a competency around transmission actuation. So the follow-on to that became Park-by-Wire, which is an integrated actuation device inside the transmission that's no longer specific to one application that has spanned several applications on the market and opens the door to several other things that we could do. So I think that competency is probably misunderstood a little bit in the market and probably undervalued a little bit. But that's a big part of that move to drivetrain-agnostic and the development of a system rather than a product or a component is that actuation competency and how we play that into the drivetrains in the future.

And I think there's one way to really translate this tangibly and that's the fact that in the $3.4 billion of backlog, the MirrorEye backlog is like $40 million. It's very small. So that growth, that 9% CAGR is with the -- all the product lines that we've just talked about and the growth in the new business that's been won with those product lines and the expansion with additional take rates and what it means from the MirrorEye is all option on top of that.