Sensata Technologies Holding plc (NYSE:ST) Q4 2022 Earnings Call Transcript

Sensata Technologies Holding plc (NYSE:ST) Q4 2022 Earnings Call Transcript January 31, 2023

Operator: Good day, and welcome to the Sensata Technologies Fourth Quarter 2022 Earnings Call. All participants will be in listen-only mode. . After today's presentation, there will be an opportunity to ask questions. . Please note this event is being recorded. I'd now like to turn the conference over to Mr. Jacob Sayer, Vice President, Finance. Please go ahead.

Jacob Sayer: Thank you, Jason, and good morning, everyone. I'd like to welcome you to Sensata's fourth quarter 2022 earnings conference call. Joining me on today's call are Jeff Cote, Sensata's CEO and President; and Paul Vasington, Sensata's Chief Financial Officer. In addition to the financial results, press releases we issued earlier today, we will be referencing a slide presentation during today's conference call. The PDF of this presentation can be downloaded from Sensata's Investor Relations website. This conference call is being recorded, and we'll post a replay webcast on our Investor Relations website shortly after the conclusion of today's call. As we begin, I'd like to reference Sensata's Safe Harbor statement on Slide 2.

During this conference call, we will make forward-looking statements regarding future events or the financial performance of the company that involve risks and uncertainties. The company's actual results may differ materially from the projections described in such statements. Factors that might cause these differences include, but are not limited to, those discussed in our Forms 10-Q and 10-K as well as other subsequent filings with the SEC. We encourage you to review our GAAP financial statements in addition to today's presentation. Most of the information that we will discuss during today's call will relate to non-GAAP financial measures. Our GAAP to non-GAAP financials, including reconciliations are included in our earnings release and in the appendices of our presentation materials.

The company provides details of its segment operating income on Slides 9 and 10 of the presentation, which are the primary measures management uses to evaluate the performance of the company. Jeff will begin today with highlights of our business results during the fourth quarter and full-year 2022. He will then provide updates on our new business wins and key growth initiatives. Paul will cover our detailed financials for the fourth quarter, and he will also provide financial guidance for the first quarter 2023. We'll then take your questions after our prepared remarks. Now, I'd like to turn the call over to Sensata's CEO and President, Jeff Cote.

Jeff Cote: Thank you, Jacob, and welcome, everyone. I'd like to start with some summary thoughts on our performance during the fourth quarter and full-year as outlined on Slide 3. During the fourth quarter, we produced $1,015 million in revenue, up 8.6% from the prior year period, despite a 360 basis point headwind from foreign currency. Adjusted operating margins moved higher by 70 basis points sequentially to 20.1%, as we continue to focus on improving our margins to our target level of 21%. For the full-year 2022, we produced a record $4,029 million in revenue, which is up 5.5% from the prior year. Our underlying markets were pressured last year by continued supply chain disruptions and we experienced a 240 basis point headwind associated with foreign currency.

Nevertheless, for the full-year, we produced 820 basis points of market outgrowth, continuing our above target performance for the third consecutive year. We appreciate the dedication and expertise of our Sensata team members who contributed to these results. Quoting activity for new business awards was extremely active during the year. As a result, we achieved a second consecutive year of record wins. In 2021, we achieved record new business wins of more than $640 million. And in 2022, they exceeded $1 billion. Even more notable is that approximately 70% of these wins are in our electrification growth factor, which will drive Sensata's future revenue outgrowth and are directly due to the incremental investments we have made over the past several years.

During 2022, we also made substantial progress toward our environmental, social and governance goals. We reduced our greenhouse gas emissions intensity by more than 10% last year, reaching our 2026 target four years earlier than anticipated. In addition, Newsweek named Sensata as one of America's Most Responsible Companies for 2023, 2023 overall ninth in the technology hardware sector and first in Massachusetts. All of us anticipate more change in the end markets Sensata serves over the next 10 years than we have seen in the past 50 and as our customer transformed their business and product portfolios to adjust to decarbonization trends. Many equipment categories are electrifying and significant investment is being made global infrastructure to support this trend.

It is a strategic imperative to enable this transformation for our customers, and we are very pleased with our accomplishment thus far as we execute on this strategy. As shown on Slide 4, over the past three years, we have made significant investments including both acquisitions and internal development efforts to develop our products, technology and capabilities our customers need as they transform their businesses. The commercial success resulting from these investments is clear. Last year's awards included the single largest business win in the company's history and represented a substantial shift in our business toward electrification related areas. Sensata largely serves long cycle end markets, which underscores the benefit of pivoting to where the market is going, and we appreciate our investors' patience through this investment cycle to secure our bright future.

The success that we have achieved to-date from our organic and inorganic investments in the growth sectors demonstrates that we have built a strong foundation for future growth. Now we are focused on leveraging the benefits of these investments. This includes completing the integration of the businesses we've acquired to maximize growth and focusing organic P&L investments in areas where we are having the greatest success. Consequently, as we look to 2023 and beyond, we are focusing on organic growth, improving adjusted operating margins and increasing conversion of earnings to cash flow. While we will continue to return capital to shareholders through our dividend and opportunistic share repurchases, improving free cash flow will naturally allow leverage to decline and returns on invested capital to improve over time.

Paul will speak to the specific capital allocation targets later. During 2022, we posted approximately $460 million in revenue in automotive and industrial electrification areas, up 77% from 2021. Insights posted $175 million in revenues last year, up 133% from 2021. During our electrification teach-in last February, we forecasted that Sensata would produce more than $2 billion in electrification revenue and that Sensata content in battery electric light vehicles would grow to double current content in a comparable internal combustion light vehicle by 2026. We are well on our way to bringing this vision to life. While we still need to deliver on the product designs underlying business wins in hand, these awards coupled with our existing business and expected market growth over the coming three years, is now sufficient to deliver on our electrification revenue target.

The demonstrated commercial success from our investments establishes Sensata very well to assist our customers in their transformational journeys and to realize our own exciting potential. Now, I'd like to turn the call over to Paul.

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Paul Vasington: Thank you, Jeff. Key highlights for the fourth quarter, as shown on Slide 7 include revenue $1,015 million, an increase of 8.6% from the fourth quarter of 2021. Revenue growth reflected strong outgrowth across the company of 1,180 basis points in the quarter, as well as acquisitions, partially offset by foreign currency headwinds and overall market contraction. Adjusted operating income was $204.3 million, an increase of 3.4% compared to the fourth quarter of 2021. This increase is primarily due to higher volumes, pricing, and productivity improvements somewhat offset by unfavorable movements in foreign currency. In fact, from investments in the growth factors of Electrification and Insights and a divesture of our connect semiconductor test in thermal business last year.

Adjusted operating margins improved 70 basis points sequentially to 20.1%. Adjusted earnings per share in the fourth quarter grew 10.3% from the prior year quarter and faster than revenue. We saw approximately the same $5 million decline in channel inventory this quarter as we did a year ago. So channel inventory movements had no impact on our outgrowth in the fourth quarter on a year-over-year basis. Turning to Slide 8. As we entered 2022, inflation significantly impacted our component and logistics costs at a time when we were also increasing investments in our growth vectors. This impacted adjusted operating margins significantly leading down to decrease from the 21% margin level that we delivered during 2021. Substantial improvements in pricing to offset increased costs, better material availability and supply chains slowly improved, productivity improvements and cost control have driven a steady increase in adjusting operating margin through the year.

While our financial guidance for the first quarter includes a sequential decline to 19.5% on lower volumes, we intend to continue these efforts in return to our target margin rate of 21% as quickly as possible. Now, I'd like to comment on the performance of our two business segments in the fourth quarter of 2022, starting with Performance Sensing on Slide 9. Our Performance Sensing business reported revenues of $757.7 million, an increase of 10.6% compared to the same quarter last year. Automotive revenue increased from strong content growth, higher pricing and market growth, partially offset by unfavorable foreign currency. Growth in heavy-vehicle off-road revenue reflects strong outgrowth and the impact of acquisitions in Insights, partially offset by declining markets in unfavorable foreign currency.

Performance Sensing operating income was $196.9 million, with operating margins of 26%. Segment operating margins declined year-over-year due to dilutive impact of unfavorable foreign currency, acquisitions and product mix. As shown on Slide 10, Sensing Solutions reported revenues of $257 million in the fourth quarter, an increase of 3% as compared to the same quarter last year. Industrial revenue decreased from weaker markets, especially in HVAC and appliance and unfavorable foreign currency. Aerospace revenue increased strongly in the quarter due to strong content growth, market and pricing. Sensing Solutions operating income was $74.4 million with operating margins of 28.9%. The decrease in segment operating margin was primarily due to the impact of acquisitions and clean energy.

On Slide 11, corporate and other operating expenses not included in segment operating income were $65.5 million in the fourth quarter of 2022. Adjusted for charges excluded from our non-GAAP results corporate and other costs were $65.5 million, an increase from the prior year quarter primarily reflecting higher research and development and business development spend to support our megatrend growth initiatives, partially offset by lower compensation, incentive compensation and favorable foreign exchange. We invested $70 million in megatrend-related engineering spend in 2022 to design and develop differentiated solutions for the fast growing trends impacting our customers, and we expect to spend about the same level in 2023. The record new business wins of more than $640 million in 2021, and more than $1 billion in 2022, along with our rapid revenue growth in these areas, clearly demonstrates how Sensata's expanding capabilities are appealing to our customers in driving market outgrowth.

Moving to Slide 12. We generated $184 million of free cash flow during the fourth quarter and $311 million in free cash flow during the year. Free cash flow this year was negatively impacted by increases in receivables as our business and revenues grew our decision to carry higher inventory levels to ensure continuity of supply in uncertain markets and from acquisition-related compensation payments. For the full-year 2023, we expect free cash flow conversion to be approximately 75% of adjusted net income, reflecting Sensata's long-term average. Capital expenditures are to be in the range of $170 million to $180 million for 2023. As Jeff mentioned previously, acquisitions and organic investments have provided us with the needed assets and capabilities to achieve strong leadership positions and growth in the areas of Electrification and Insights.

Consequently, we expect operating margins to improve and free cash flow to grow, which will naturally lead to lower net leverage over time. As a result, we are updating our target net debt-to-EBITDA range to 1.5x to 2.5x, which will likely take two years to three years to attain. Our net leverage ratio was 3.4x at the end of December 2022. We returned capital to shareholders during the fourth quarter, repurchasing $50 million of our shares under our existing stock repurchase authorization, a reduction from the third quarter, and we recently announced a quarterly dividend of $0.11 per share that is expected to be paid on February 22 to shareholders of record on February 8. In addition, we intend to pay down $250 million of our outstanding variable rate term loan during the first quarter, which is currently the most expensive piece of debt in our capital structure.

Moreover, we will continue to evaluate the company's liquidity needs and manage the capital structure according to our new net leverage target range. We are providing financial guidance for the first quarter of 2023, as shown on Slide 13. Our expectations are based upon the end market growth outlook shown on the right side of the page. We remain more conservative than IHS on automotive production estimates for the fourth quarter because of broad macroeconomic and China COVID-related risks. Foreign exchange represents an expected $27 million headwind to revenue in the first quarter. Our current fill rate is approximately 92% of the revenue guidance mid-point for the first quarter. At the mid-point, adjusted operating income margin is expected to be 19.5%, a sequential decline from the fourth quarter, largely reflecting lower volumes.

This also represents an 80 basis point year-over-year increase from the first quarter of 2021, on flat revenue, primarily due to improved productivity and pricing. Our first quarter guide anticipates that our operating income at the mid-point grows at 4% and earnings per share increases at 10% from the prior year quarter, faster than the rate of anticipated revenue growth. Looking to the balance of 2023, we expect foreign exchange to be a 1.1% headwind to revenue and an $0.08 headwind to earnings per share, given current exchange rates. Given the market and macroeconomic uncertainties facing Sensata and other companies in our sector, we are discontinuing our practice of providing full-year guidance, choosing instead to only guide for the upcoming quarter.

We believe data from third-party market forecasters and our customers is reasonably accurate such that we can forecast the next few months, while visibility into future quarters is currently less clear, given the broader economic concerns. Now, let me turn the call back to Jeff for closing comments.

Jeff Cote: Thanks, Paul. Let me wrap up with a few key messages as we outlined on Slide 14. Sensata's business organizational model and growth strategy are strong, resilient and reliable, as we deliver mission-critical, highly engineered solutions required by our customers. While we expect end markets to continue to be volatile in the near-term due to inflation, rising interest rates, the risk of recession in various geographies, and geopolitical events, we have a strong management team with proven experience in navigating choppy markets. We also expect 2023 to be another year of above target market outgrowth for Sensata. We continue to invest in our growth initiatives as we transform the business to focus on these rapid growth opportunities across all the end markets we serve.

We are making excellent progress as demonstrated by strong new business wins and significant revenue growth. This success allows us to focus on strengthening our financial returns through organic growth, improved margins, stronger free cash flow and return -- increase in returns on capital. Part of this is targeting a new net leverage range of 1.5x to 2.5x over the next two to three years. We continue to innovate on behalf of our customers, solving their hard-to-do engineering challenges and providing differentiated solutions to an ever broader array of customers, while leveraging our expanded product set and capabilities. Solving mission-critical challenges enable Sensata to enhance long-term customer retention and deliver industry-leading margins for shareholders.

And finally, I'm pleased about our results in delivering on Sensata's long-standing vision to help create a cleaner, safer, more electrified and connected world, not just for our customers' product but also through our own operations. We believe we are meaningfully contributing to a better world. We are making good progress on achieving our ESG targets, and we'll look to update them in our upcoming Sustainability Report, bolstering the long-term sustainability and success of the company for all of its stakeholders. Now, I'd like to turn the call back to Jacob.

Jacob Sayer: Thank you, Jeff. We'll now move to Q&A. Given the large number of listeners on the call, please limit yourself to one question each. Jason, go ahead and introduce the first question.

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