Sensata Technologies : Earnings Document

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ST.N - Q3 2022 Sensata Technologies Holding PLC Earnings Call

EVENT DATE/TIME: OCTOBER 25, 2022 / 12:00PM GMT

OVERVIEW:

ST reported 3Q22 revenue of $1.018b and adjusted operating income of $197.3m.

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OCTOBER 25, 2022 / 12:00PM, ST.N - Q3 2022 Sensata Technologies Holding PLC Earnings Call

C O R P O R A T E P A R T I C I P A N T S

Jacob A. Sayer Sensata Technologies Holding plc - VP of Finance & CFO of Performance Sensing Gbu

Jeffrey J. Cote Sensata Technologies Holding plc - President, CEO & Director

Paul S. Vasington Sensata Technologies Holding plc - Executive VP & CFO

C O N F E R E N C E C A L L P A R T I C I P A N T S

Amit Jawaharlaz Daryanani Evercore ISI Institutional Equities, Research Division - Senior MD & Fundamental Research Analyst Christopher D. Glynn Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

Gavin Lorne Kennedy Jefferies LLC, Research Division - Equity Associate

James Dickey Suva Citigroup Inc., Research Division - MD & Research Analyst

Joseph Craig Giordano Cowen and Company, LLC, Research Division - MD & Senior Analyst

Luke L. Junk Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

Mark Trevor Delaney Goldman Sachs Group, Inc., Research Division - Equity Analyst

Matthew John Sheerin Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst Shreyas Patil Wolfe Research, LLC - Research Analyst

Travis Robert Bucknall Truist Securities, Inc., Research Division - Research Analyst

Wamsi Mohan BofA Securities, Research Division - MD in Americas Equity Research

P R E S E N T A T I O N

Operator

Good day, and welcome to Sensata Technologies Q3 2022 Earnings Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Mr. Jacob Sayer, VP Finance. Please go ahead.

Jacob A. Sayer - Sensata Technologies Holding plc - VP of Finance & CFO of Performance Sensing Gbu

Thank you, Sarah, and good morning, everyone. I'd like to welcome you to Sensata's Third 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 release 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 will 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 might differ materially from the projections described in such statements. Factors that might cause such 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 subsequent information that we will discuss during today's call will relate to non-GAAP financial measures. Our GAAP and non-GAAP financials are including reconciliations are included

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OCTOBER 25, 2022 / 12:00PM, ST.N - Q3 2022 Sensata Technologies Holding PLC Earnings Call

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 business.

Jeff will begin today with highlights of our business results during the third quarter. We will then provide updates on several of our growth initiatives. Paul will cover our detailed financials for the third quarter, and he'll also provide financial guidance for the fourth quarter. 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.

Jeffrey J. Cote - Sensata Technologies Holding plc - President, CEO & Director

Thank you, Jacob, and welcome, everyone. I'd like to start with some summary thoughts on our strong performance during the third quarter, which is outlined on Slide 3. Our underlying markets returned to growth in the quarter despite continued supply chain disruptions. We produced 650 basis points of market outgrowth and 330 basis points of acquired growth during the quarter. Despite foreign exchange -- currency exchange rate changes representing 330 basis points of headwind to revenue, we produced solid financial results for shareholders, delivering $1.018 million in revenue, up 7.1% from the prior year period, with higher margins sequentially.

Excluding greater headwinds related to unfavorable foreign exchange rates, our results are above the high end of the guidance range we provided in July. Quoting activity for new business awards was extremely active during the quarter as well as year-to-date. And as a result, we have already exceeded the $640 million record level of new business wins we were awarded in all of last year, securing $840 million of new business wins in the first 9 months of this year. Approximately 70% of these wins are in our electrification growth vector, which translates into Sensata's future revenue outgrowth and are a direct outcome of our Megatrend investments over the past several years.

During the quarter, we closed the previously announced acquisition of Dynapower, a leader in mission-critical, highly engineered power conversion solutions focused across renewable energy generation, industrial and defense applications. Dynapower is on a run rate to generate more than $100 million in annualized revenue and approximately 20% operating margins this year. As we have mentioned, we expect market dynamics and Dynapower's offering to provide 30% revenue growth per year over the next several years.

During the third quarter, we benefited from our resilient, flexible and focused organization that continues to successfully navigate the fast-changing supply chain landscape and deliver on our customers' needs. Continued inflationary impacts on input costs have led us to become more agile to offset these costs with commercial pricing actions. As a result, our margins have steadily improved on a sequential basis and we expect this to continue in the coming quarters.

I'd like to recognize the innovation, agility and hard work of our entire team and the support from our customers in achieving these strong results. We recognize that the economic outlook appears weaker today, and we are closely monitoring with our customers across diverse business segments to understand their underlying demand. We are carefully managing our cost structure, including targeted cost reductions to prepare the organization for uncertain market conditions.

Sensata has a very experienced management team, and we have weathered economic challenges successfully in the past, and we are confident we will emerge stronger and with even better growth prospects after any market disruptions. Sensata is continuing to make excellent progress in utilizing in-house and acquired capabilities to better serve a broadening base of customers and win new business in our Electrification growth area. As we outlined during our Electrification teach-in, we are participating in the global efforts to reduce greenhouse gas emissions that are leading to substantial investments in renewable power generation, better ways to store and use energy and the ever-increasing pace of conversion to battery electric light and heavy-duty vehicles. IHS now expects nearly 1/3 of all light vehicles produced in 2026 will be battery electric or plug-in hybrids, up from one quarter at the beginning of this year. That's a multimillion-unit vehicle production jump in just 9 months. We intersect these growth areas with engineered solutions for our customers designing high-voltage electrified systems. We also help our customers convert and store energy with high-voltage converters, inverters and rectifiers to better meet the power demands placed on electricity grids by end users.

In this rapidly growing area for Sensata, we have more than doubled our business wins from last year in the first 9 months of this year. We continue to expect to increase our Electrification revenue to more than $2 billion by 2026, as content on battery electric vehicles grows at twice that of

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OCTOBER 25, 2022 / 12:00PM, ST.N - Q3 2022 Sensata Technologies Holding PLC Earnings Call

traditional combustion engine vehicles and as industrial electrification applications grow rapidly. We are well on track to achieving the near-term goal of Electrification revenue growing 50% this year compared to last year, and we expect this growth rate to continue.

On Slide 5, we highlight our progress in High Voltage Junction Boxes, a specific area of growth for Sensata with in Electrification. Sensata's High Voltage Junction Boxes are system-level solutions that enable customers to electrify their equipment. As we expand our capabilities Electrification, our customers -- and our customers refine their electrification architectures for the future, we are responding to demand for more integrated and thermally efficient system-level solutions that meet increasing power requirements.

We have previously announced meaningful business wins in this area with several global customers, including the single largest piece of business in Sensata's history last quarter. More recently, Sensata was chosen again by a large European heavy vehicle OEM to provide charging units for their electrified platforms that will launch starting in 2025, representing more than $60 million in annual revenue. This is an area of significant growth opportunity for Sensata. The addressable market is growing rapidly and is expected to reach $7 billion by 2030. In addition to the $250 million in annual business we've already won that will launch in the next few years, we are currently discussing with customers potential additional new business representing over $500 million of annual revenue.

While we typically share more information about our new growth vectors in these quarterly updates, it is important to note that our core, safe and efficient growth drivers for Sensata are growing significantly and profitably, providing funding for other investments. Our heavy vehicle business has been outgrowing its markets for several years now, driven by global emissions regulations, increases in electronic control applications and the expansion of our Insights business.

Looking forward, this business will also benefit from global tire pressure regulation in heavy vehicles. As you know, Sensata is a leader in tire pressure sensing and we have won new heavy vehicle tire pressure sensing business for the past few years based upon the robustness of our solution and our ability to solve unique application challenges in the heavy vehicle market. These sensor programs are beginning to launch now. We expect more than 40% annual growth in this application over the next 5 years as it becomes a $100 million annual revenue stream generating great margins for Sensata, given our scale and leadership in this category. This is another example of how Sensata's core sensing activities continue to drive growth for the company.

Now I'd like to turn the call over to Paul. .

Paul S. Vasington - Sensata Technologies Holding plc - Executive VP & CFO

Thank you, Jeff. Key highlights for the third quarter, as shown on Slide 8, include revenue of $1.018 million, an increase of 7.1% for the third quarter of 2021. Revenue growth reflected strong outgrowth across the company of 650 basis points, market growth and acquisitions, partly offset by customer inventory movements and foreign currency headwinds.

Adjusted operating income was $197.3 million, a decrease of 1.8% compared to the third quarter of 2021. This decreased despite higher revenue was primarily due to unfavorable movements in foreign currency, investment in the Megatrends of Electrification and Insights, customer mix and the divestiture of our Connects semiconductor test and thermal business during the quarter. Also, global supply chains continue to be constrained. Margins improved sequentially, and we expect this trend to continue in the coming quarters. Excluding unfavorable foreign currency impacts, results were above the high end of our financial guidance for the quarter.

Now I'd like to comment on the performance of our 2 business segments in the third quarter of 2022, starting with Performance Sensing on Slide

9. Our Performance Sensing business reported revenues of $754.5 million, an increase of 6.8% compared to the same quarter last year. Automotive revenue increased from higher pricing, new product launches and market growth lessened by customer inventory movements, all somewhat offset by unfavorable foreign currency. Last year, we estimated approximately $70 million in inventory was built in the third quarter. And this quarter, we estimate approximately $20 million of inventory came out of the channel. Growth in heavy vehicle off-road revenue reflects strong outgrowth and the impact of acquisitions in the Insights, Megatrend, offset somewhat by declining markets, $5 million in inventory built in the third quarter last year and unfavorable foreign currency. Performance Sensing operating income was $188.6 million, with operating margins of 25%. Segment

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OCTOBER 25, 2022 / 12:00PM, ST.N - Q3 2022 Sensata Technologies Holding PLC Earnings Call

operating margins declined year-over-year due to customer mix and favorable foreign currency, the dilutive impact of acquisitions and the impact of persistent supply chain challenges.

As shown on Slide 10, Sensing Solutions reported revenues of $263.7 million in the third quarter, an increase of 7.8% as compared to the same quarter last year. This was driven by strong outgrowth, including the launch of new industrial electrification applications and the benefit of acquisitions in clean energy net of the divestiture of Connects, all somewhat offset by unfavorable foreign currency. Sensing Solutions operating income was $73.6 million, with operating margins of 27.9%. The decrease in segment operating margin was primarily due to the impact of acquisitions in clean energy, inflationary impacts on material logistics tempered by higher customer pricing and the impact of operating in a constrained supply chain.

On Slide 11, corporate and other operating expenses not included in segment operating income were $76.4 million in the third quarter of 2022. Adjusted for charges excluded from our non-GAAP results, corporate and other costs were $63.3 million, a decrease from the prior year quarter primarily reflecting lower incentive compensation and foreign exchange impacts, partially offset by higher research and development and business development spend to support our Megatrend growth initiatives. We expect between $65 million and $70 million in Megatrend-related spend in 2022 to design and develop differentiated solutions for the fast-growing and transformational Megatrend vectors of Electrification and Insights and currently anticipate about the same level spend in 2023. We are confident that this investment is the right long-termtrade-off as it has enabled our record new business wins of $840 million so far this year and the rapid revenue growth we are experiencing in these areas.

Moving to Slide 12. We generated $57.5 million in free cash flow during the third quarter and $242 million in free cash flow over the last 12 months. Free cash flow in the quarter was impacted by our decision to increase inventory to ensure continuity supply in uncertain markets and from acquisition-related compensation payments. For the full year 2022, we expect free cash conversion to be approximately 65% of adjusted net income, reflecting higher inventory levels to ensure continuity of supply for customers. Capital expenditures are expected to be in the range of $135 million to $145 million. .

Sensata's net debt-to-EBITDA ratio was 3.6x at the end of September, just above the top end of our target range. Sensata's primary use of cash on hand is to acquire businesses that will expand our position within our key growth vectors of Electrification and Insights. Our balance sheet is strong with more than $1.1 billion of cash and no debt maturing before October 2024. Absent further M&A, our net debt-to-EBITDA ratio is likely to approach 3.4x by year-end, which is within our target range.

Given this financial strength and expected future free cash flows, we also look to return capital to shareholders. Consequently, we repurchased $98 million of our shares in the third quarter and recently announced a quarterly dividend of $0.11 per share as expected to be paid on November 23, and to shareholders of record on November 9.

We are providing financial guidance for the fourth quarter of 2022, as shown on Slide 13. Our expectations are based upon the end market growth outlook as shown on the right side of the page. We remain more conservative than IHS on automotive production estimates for the quarter because of extended macroeconomic risks. Foreign exchange represents a $15 million greater headwind to revenue in the fourth quarter than we expected in July of this year when we last provided guidance. Our current fill rate is approximately 93% of the revenue guidance midpoint for the fourth quarter.

At the midpoint, adjusted operating income margin is expected to be 19.9% or 9%, a 50 basis point increase from the third quarter of this year and reflects the benefits of higher volumes tempered by persistent supply chain challenges, higher pricing more than offsetting inflationary impacts on input costs, investments for growth in Megatrend-related areas including acquisitions as we rapidly scale these growth vectors, the unfavorable impacts from foreign currency movements and the divestiture of our Connects business. We expect margins will continue to improve sequentially as we work our way back to our medium-term target margin of 21%, while still addressing challenging market conditions, unfavorable foreign currency exchange rates and investing in growth. On a preliminary basis, looking to 2023, we expect foreign exchange to be a 2.9% headwind to revenue and an $0.11 headwind to earnings per share given current exchange rates.

Now let me turn it back to Jeff for closing comments.

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