Sensata Technologies Holding plc (NYSE:ST) Q1 2023 Earnings Call Transcript
Sensata Technologies Holding plc (NYSE:ST) Q1 2023 Earnings Call Transcript April 25, 2023
Sensata Technologies Holding plc beats earnings expectations. Reported EPS is $0.92, expectations were $0.87.
Operator: Good day, and welcome to the Sensata Technologies First Quarter 2023 Earnings Call. All participants are in a listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Jacob Sayer, Vice President of Finance. Please go ahead.
Jacob Sayer: Thank you, Jason, and good morning, everyone. I'd like to welcome you to Sensata's first quarter 2023 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. We will post a replay of our webcast on today's -- 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 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 information that we will discuss during today's call will relate to non-GAAP financial measures. Our GAAP and non-GAAP financials, including reconciliations are included in our earnings release and 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 its business.
Jeff will begin today with highlights of our business results during the first quarter. He will then provide a few updates on key growth areas. Paul will cover our detailed financials for the first quarter, and he will discuss our financial guidance for the second quarter of 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'll start today with some summary thoughts on our performance during the first quarter, which is outlined on Slide 3. We began the year on strong footing. During the first quarter, we produced $998 million in revenue, up 2.3% from the prior year period and above the midpoint of our guidance range despite a 230 basis point headwind from foreign currency. Adjusted operating income of $193 million was also above the midpoint of our guidance range. Adjusted operating margins moved higher by 60 basis points from the prior year period as we continue to focus on improving our margins to our target level of 21%. Adjusted net income moved higher by 14% to $141 million, and adjusted earnings per share grew 17.9% from the prior year period to $0.92.
Market outgrowth for the quarter was disappointing at only 20 basis points. However, outgrowth for the fourth quarter of 2022 was 1,180 basis points. And for the last 12 months, outgrowth remained above our expected range at 630 basis points. As we have said, outgrowth can be lumpy in any quarter and the first quarter was impacted by region and platform mix, several launch pushouts by our customers and some production estimate and channel inventory complexities. We continue to have confidence in our long-term range, given past business wins and new product development activities and launch schedules. I'm also pleased to share that we remain on track to achieve our long-term goal of $2 billion in electrification revenue across the company by 2026, with revenue growing strongly in the quarter.
We also remain on track to reach our goal of twice the content per vehicle on battery electric vehicles by 2026 as compared to internal combustion engine vehicles. Last quarter, we outlined a shift in our capital deployment strategy based upon our confidence in our capabilities to effectively intersect the growth vectors of electrification and insights and deliver innovative solutions to our customers. We've executed a portion of that strategy during the first quarter. Paul will share more details shortly. As I've said before, we anticipate a great deal of change in the end markets Sensata serves over the next 10 years, reflecting all the ways our customers are transforming their businesses and product portfolios to adjust to decarbonization trends.
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Electrification is coming to equipment categories beyond vehicles and is leading to significant investment in global infrastructure. As shown on Slide 4, I'd like to highlight areas of growth for Sensata that will help drive our electrification revenue. In renewable power generation, solar developers and others are poised to benefit from last year's Inflation Reduction Act, which provides significant long-term funding to this industry. Dynapower's line of inverters and converters help solar power producers condition the energy produced by the sun, either for battery storage or to be transmitted to the grid. We're seeing increasing interest for new solar and other renewable energy installations and these represent a $2.5 billion addressable market for Dynapower growing more than 15% per year.
We are also seeing increased interest in electromechanical braking for electric vehicles. These braking systems remove heavy hydraulics and replace them with more efficient brake-by-wire solutions that require force and pressure sensors, doubling the sensor content as compared to existing solutions. This is a rapidly growing application with market estimates of $250 million of sensor content by 2027. It is an area where we have developed an early lead by collaborating closely with customers in addressing their needs. In addition to the innovation we are driving in the broad areas of electrification, on Slide 5, I want to highlight yet another new market that we've identified and are pursuing. Recent government regulations meant to reduce greenhouse gases and improve the environment require HVAC manufacturers to switch to new coolants with lower global warming impact known as A2L or A3 refrigerants.
Sensata has leveraged its leadership position in HVAC pressure sensing to create a new category of gas detection sensors that are required by these systems to detect refrigerant leaks. We have already won the $40 million in annual revenue from 2 of the largest HVAC manufacturers, and we expect this solution to be adopted on a widespread basis, creating a very fast-growing sensor category with a $500 million addressable market in the next 5 years. I'd now like to turn the call over to Paul.
Paul Vasington: Thank you, Jeff. Key highlights for the first quarter, as shown on Slide 7 include revenue of $998 million, an increase of 2.3% from the first quarter of 2022. Revenue growth reflected market and market outgrowth in the quarter, partially offset by foreign currency headwinds and the net impact of acquisitions and divestitures. Adjusted operating income was $193 million, an increase of 5.7% compared to the first quarter of 2022. This increase was primarily due to higher volume, pricing and productivity improvements, partially offset by the impact from acquisitions and divestitures last year and movements in foreign currency. Adjusted operating margins improved 60 basis points from the prior year period to 19.3%.
Adjusted earnings per share in the first quarter grew 17.9% from the prior year quarter, faster than adjusted operating income due to lower interest expense, lower cash tax rate and a lower share count. Turning to Slide 8. As a reminder, we entered 2022, inflation significantly impacted our components and logistics costs at a time when we were also increasing investments in our growth vectors. This impacted adjusted operating margin significantly, reducing that from the 21% level that we delivered during 2021. Substantial improvements in pricing to offset increased costs, better material availability and supply chains have slowly improved productivity improvements and cost control drove adjusted operating margin steadily higher through last year.
Our financial guidance for the second quarter includes a year-over-year improvement in adjusted operating margin to 19.4%. We intend to continue efforts to return to our target margin rate of 21%, while executing on our significant growth opportunities in Electrification and Sensata Insights. Now I'd like to comment on the performance of our 2 business segments in the first quarter of 2023, starting with Performance Sensing on Slide 9. Our Performance Sensing business reported revenues of $751.5 million, an increase of 4.7% compared to the same quarter last year. Automotive revenue increased from market growth and higher pricing, partially offset by unfavorable revenue mix, new product launch delays and foreign currency. Growth in heavy vehicle off-road revenue reflects strong outgrowth and the impact of acquisitions in Insights, partially offset by unfavorable foreign currency.
Performance Sensing operating income was $188.4 million, with operating margins of 25.1%. Segment operating margins declined slightly year-over-year, largely due to unfavorable foreign currency. As shown on Slide 10. Sensing Solutions reported revenues of $246.7 million in the first quarter, a decrease of 4.4% as compared to the same quarter last year. Industrial revenue decreased due to weaker markets, especially in HVAC appliance and unfavorable foreign currency. Aerospace revenue increased strongly in the quarter due to market pricing and content growth. Sensing Solutions operating income was $69.7 million, with operating margins of 28.3%. The increase in segment operating margin was primarily due to higher pricing, largely offset by the impact of acquisitions and divestitures.
Effective April 1, 2023, Sensata created a new Insights reporting segment to provide transparency into the revenue growth and margin progress of this business as well as to align with new management reporting lines. Insight's financial results have previously been reported as part of Performance Sensing. Beginning with the second quarter of 2023, Sensata will report the financial results of 3 segments: Performance Sensing, Sensing Solutions and insights. On Slide 11, corporate and other operating expenses not included in segment operating income were $62.4 million in the first quarter of 2023. Adjusted for amounts excluded from our non-GAAP results, corporate and other costs were $63.4 million, a decrease from the prior year quarter as well as sequentially, primarily reflecting cost controls, timing and megatrend spend, lower incentive compensation and favorable foreign exchange impacts.
We expect to invest $60 million to $70 million in megatrend-related research and development this year to design and develop differentiated solutions for the fast-growing trends impacting our customers' businesses. The record new business wins of more than $640 million in 2021 and more than $1 billion last year, along with our rapid revenue growth in our growth sectors clearly demonstrate that Sensata's expanded capabilities are appealing to our customers. Moving to Slide 12. We generated $60 million in free cash flow during the first quarter and $359 million in free cash flow over the last 12 months. Free cash flow in the first quarter was tempered by the timing of incentive compensation payments and higher working capital. For the full year 2023, we expect free cash flow conversion to be approximately 75% of adjusted net income, consistent with Sensata's long-term average.
Capital expenditures are expected to be in the range of $170 million to $180 million in 2023. We paid down $250 million of our outstanding variable rate term loan during the first quarter, which is currently the most expensive debt in our capital structure. We intend to repay the remaining balance of approximately $200 million this quarter. Our net leverage ratio was 3.3 times at the end of March 2023. We expect this to decline to 1.5 times to 2.5 times over the next 2 to 3 years, as a result of strong free cash flow generation. In addition, we recently announced an increase in our quarterly dividend to $0.12 per share and is expected to be paid on May 24 to shareholders of record on May 10. We are providing financial guidance for the second 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 quarter because of broad macroeconomic and China-related risks. Foreign exchange represents an expected $12 million headwind to revenue and a $0.01 headwind to EPS in the second quarter. Our current fill rate is approximately 93% of the revenue guidance midpoint for the second quarter. At the midpoint, adjusted operating income margin is expected to be 19.4%, a 40 basis point year-over-year improvement from the second quarter of 2022, primarily due to improved productivity and pricing offsetting the dilution from acquisitions and divestitures and foreign exchange. Looking to the full year 2023, we now expect foreign exchange to be 0.7% headwind to revenue and a $0.08 headwind to earnings per share given the current exchange rates.
Now let me turn the call back over to Jeff for closing comments.
Jeff Cote: Thanks, Paul. Let me wrap up with a few key messages as 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 end markets are expected to remain volatile, due to inflation, high interest rates, the risk of recession in various geographies and other geopolitical events. Sensata's strong management team brings proven experience in navigating choppy markets. We continue to execute on 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 in Electrification and Insights as demonstrated by strong new business wins and significant revenue growth.
This success allows us to focus now on strengthening our financial returns through improved margins, stronger free cash flow and higher return on invested capital. As seen in some of the examples I discussed today, we continue to innovate for our customers, solving their difficult engineering challenges and providing differentiated solutions to a widening array of customers while specifically leveraging our expanded product set and capabilities, solving mission-critical challenges enable Sensata to earn long-term customer trust and deliver industry-leading margins for our 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' products, but also through our own operations, we strive to meaningfully contribute to a better world.
We are making good progress on achieving our ESG targets, and we'll update our latest results in our upcoming sustainability report, bolstering the long-term sustainability and success of the company for all of its stakeholders. I'll now turn the call back to Jacob.
Jacob Sayer: Thank you, Jeff. We'll now move to Q&A. Given the number of listeners and questioners on the call, let's try to please limit ourselves to 1 question each. Jason, would you please introduce the first speaker?
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