Earnings Call Transcript - ST Q2 2021

Operator, Operator

Good day, and welcome to Sensata Technologies Second Quarter 2021 Earnings Conference Call. I would now like to turn the conference over to Mr. Jacob Sayer, Vice President of Finance. Please go ahead, sir.

Jacob Sayer, Vice President of Finance

Thank you, Keith. Good morning, everyone. I'd like to welcome you to Sensata's Second Quarter 2021 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.

Jeffrey Cote, CEO

Thank you, Jacob, and welcome, everyone. I'd like to start with some summary comments on our strong performance during the second quarter of 2021, as outlined on Slide 4. The business recovery we have experienced beginning in midyear 2020 continued during the second quarter. We responded effectively to increased customer demand, which drove 72% revenue growth from the prior year to a record $993 million, slightly above the guidance range we provided in April.

Paul Vasington, CFO

Thank you, Jeff. Key highlights for the second quarter, as shown on Slide 8, include record revenue of $992.7 million, an increase of 72.2% for the second quarter of 2020. Organic revenue increased 62.9%. The acquisition of Xirgo increased revenue by 4.4%. And changes in foreign currency increased revenue by 4.9%.

Jeffrey Cote, CEO

Thanks, Paul. Let me wrap up quickly with a few key messages as outlined on Slide 19. Sensata has responded very well to the rapid improvements in many of our end markets, demonstrating the strength, flexibility and reliability of our business and organizational model. It's enabled us to capitalize on the recovery in the end market demand and deliver on customer orders. Our quick response to shifting demand positions us well as a trusted resource for our customers. We are delivering consistently robust end market outgrowth. We remain confident in our ability to sustain this attractive end market outgrowth into the future based upon our strong levels of new business awards and our large and expanding pipeline of new opportunities. We continue to invest in our megatrend-driven growth initiatives that are opening large and rapidly growing opportunities for Sensata across all of our end markets. We are making excellent progress in Sensata Insights and Electrification, as evidenced by the results so far this year as well as our new business wins in both areas. We continue to believe that the overall business environment provides interesting opportunities to further strengthen our portfolio through strategically important, value-creating acquisitions or joint ventures. In addition, we are pursuing new technology collaborations and partnerships with third parties to expand our capabilities and accelerate our megatrend growth. We expect to continue to deliver industry-leading margins for our shareholders while also increasing investments in our growth opportunities and our people. And finally, I'm excited about Sensata's long-standing mission to help create a cleaner, safer and more connected world, not just for our customers' products, but also through our own operations. We believe we are meaningfully contributing to a better world. We are incorporating ESG considerations into our strategy to bolster our long-term sustainability and success of the company for all of its stakeholders. We look forward to reporting more in the future on this topic. Now I'd like to turn the call back to Jacob.

Jacob Sayer, Vice President of Finance

Thank you, Jeff. Operator, please assemble the Q&A roster.

Operator, Operator

And the first question comes from Wamsi Mohan with Bank of America.

Wamsi Mohan, Analyst

Congrats on the solid results. I was wondering if you could delve a bit deeper into your inventory assessment that you have broken out, which is very helpful. Where do you think this incremental inventory is building? And do you think that gets absorbed in calendar 3Q? Or does the guide include some further buildup of inventory? And just a follow-up on that. You noted the sort of more conservative auto outlook versus IHS. Is that just purely based on supply constraints? And does that set up for a better '22 given the fact that your auto production view has come down materially for the rest of '21?

Paul Vasington, CFO

Sure, Wamsi, Jeff and I will address that. Regarding the inventory estimate, we have some centers with a strong market share. By comparing the number of units shipped to production, we estimate how many of our parts are going into customer inventory versus those used for vehicle production. While this is just an estimate, we believe it is quite accurate. In the heavy vehicle sector, we know some customers are initially stocking their NS VI-compliant platforms, and that inventory will remain on their balance sheets. We have a good understanding of the situation, though it’s not a flawless answer, it’s a reasonable estimate. Looking at the second half of this year, we do anticipate some inventory unwind. Reflecting on last year, during the third and fourth quarters of 2020, we observed that our customers' inventory levels were decreasing, and they began building inventory in the first half of this year. We expect some unwinding in the second half, which will influence our revenue sequentially in the automotive sector.

Jeffrey Cote, CEO

On the second part of your question about the automotive outlook, you are correct that supply chain constraints are the primary reason for our more cautious perspective. This issue has been widely reported, and there are significant challenges linked to it. Consumers are experiencing this through longer lead times for vehicles and a historically low number of inventory days in North America. Having navigated these challenges over the past year, we are adopting a more conservative outlook for the remainder of the year. Your comments about next year's outlook are also accurate. Even if we see a global recovery of 5% in the automotive sector year-over-year, it would still be significantly below historical peak market levels. Therefore, there remains considerable potential for automotive market growth similar to what we observed in 2021.

Operator, Operator

And the next question comes from Samik Chatterjee with JPMorgan.

Samik Chatterjee, Analyst

Jeff, I just wanted to ask you kind of more on the acquisition comment that you had. And I think it sounds like given where the leverage is and given the kind of the success you're having, you sounded a lot more aggressive about full-swing acquisitions. Can you give us some color about the pipeline of opportunities you're looking at? What areas are you more focused on? And besides Insights and Electrification, are you looking at any other pillars of growth that you want to kind of also invest in?

Jeffrey Cote, CEO

Yes. Great. So I'm not sure it's a more aggressive stance on M&A. We have a strong pipeline. We've had some good execution on M&A and joint venture-related activity already this year with Lithium Balance, Xirgo, the Churod joint venture. So we feel that we've got some really good momentum. We will stay very disciplined. The focus areas are around megatrends. So that's the exclusive focus of our M&A-related and joint venture-related activity. There'll be more bolt-on cereal. So the goal is to create more M&A growth every year rather than lumpy M&A growth. And the criteria for M&A will be accretive revenue growth, differentiated margins. And again, we'll maintain our discipline in terms of evaluating opportunities and making sure we're highly confident we'll be able to generate returns for shareholders as well as expanding our presence in these markets that we're pursuing. Hopefully, that's helpful.

Operator, Operator

And the next question comes from Luke Junk with Baird.

Luke Junk, Analyst

Jeff, just wondering if it would be possible to break out the $200 million in forecast 2021 Electrification revenue that you had in the deck by these 3 major end markets, so auto, industrial and heavy vehicle. And maybe also if you could speak to the relative growth rates you're seeing this year between those as well at least qualitatively.

Jeffrey Cote, CEO

Yes. So it's going to be more disproportionately weighted toward auto given that's where the business is focused in terms of the ratio of our overall company revenue. So I would say broadly, apply the same end market exposure. We're seeing very substantial growth there. We've quoted that last year, we had about $120 million of Electrification business, so you can see it's substantial growth. Now some of that is coming as a result of the shift from internal combustion engines to electrified, but we see a lot of content growth there. We've talked in many other occasions regarding the fact that the transition to electrified platforms is a tailwind for us in terms of content per vehicle and also content per piece of equipment. And the opportunities, we see them as being even more significant outside of light vehicle auto. When you talk about power distribution units for commercial vehicles, the amount of opportunity we have to serve broad infrastructure plays in terms of charging stations, we've talked about that. So we see this as being a pretty broad-based play in terms of growth opportunity for us as a company.

Operator, Operator

The next question comes from Joe Spak with RBC Capital Markets.

Joseph Spak, Analyst

To revisit the auto restock, last year you mentioned a restock of about $30 million to $35 million, and now it appears to be another $35 million. Should we view this as the total impact of the inventory buildup, or did some of last year's stock already get resolved? Additionally, when conversing with automakers, it doesn't seem they plan to halt product acceptance, as they want to ensure they can complete vehicles with missing modules. I'm curious if your cautious approach to unwinding suggests that this situation might unfold differently, possibly leading to a gradual unwinding of that inventory build over time.

Paul Vasington, CFO

Last year, we discussed how inventories were running low in the third and fourth quarters, with expectations for those inventories to be replenished in the first half of this year. We assess this impact using data from high market share sensors that we are shipping at increased production levels. It appears that our components are being stored in warehouses to ensure that automakers can finalize their vehicles once they receive the last necessary modules. We have observed a significantly stronger growth trajectory due to this inventory increase and believe that if some of it decreases, it may happen in the second half of the year. However, this is our best estimate, and we will need to monitor how it unfolds in the third quarter.

Jeffrey Cote, CEO

Joe, to add some color to what we're experiencing on this front, I think your observations are absolutely accurate, that our customers are going really deep on this. We're having multi-party conversations to make sure that we're being as coordinated as we possibly can regarding what we build to make sure that we can serve the customer. Because at the end of the day, it doesn't help if there are parts that are not in inventory and the vehicle can't be produced because of another supplier. So there's a lot of coordinating activity that's occurring on that front to make sure that we can deliver what was a record revenue quarter. So a lot of work is being done to manage that process.

Operator, Operator

And the next question comes from Matt Sheerin with Stifel.

Matt Sheerin, Analyst

I wanted to ask about your commentary about the input costs, particularly semiconductor costs for you and your ability or inability to pass them along. Have conditions maintained the same or worsened? And do you have any visibility into when your own supply picks up? And then in terms of passing through those costs, how are those discussions with customers going?

Paul Vasington, CFO

The discussions with customers are progressing as anticipated. It's a challenging dialogue, but we are a reliable partner and supplier for them. As we share some of the costs, they are willing to cooperate, and we've seen some positive outcomes from that. In the second half, while the underlying gross costs are increasing, the recoveries are balancing that out. We've made good progress, so the net impact remains largely consistent with what we communicated in April. On the supplier front, Jeff may want to elaborate, but we're being particularly proactive in the second quarter to secure inventory and ensure our strong position in terms of supply. We've engaged in the spot markets to procure materials and believe we are well-positioned to meet the demand we anticipate in the second half. Our inventory levels are slightly elevated, but we are comfortable with this given the current supply chain disruptions.

Operator, Operator

And the next question comes from Amit Daryanani from Evercore ISI.

Amit Daryanani, Analyst

I guess my questions will be around the calendar '21 guide. And if I think about the auto production estimate that you have, I think you're taking it down by 700 basis points versus what you had 90 days ago. So I guess the 2 parts will be, a, what is driving such a big reduction in your estimate for auto production numbers, and I think the lowest number from any auto ecosystem company? But secondly, you really haven't changed your overall top line assumption. So what is the offset to auto production coming down 700 basis points versus what you had 90 days ago? But the overall top line seems to hold up pretty well.

Paul Vasington, CFO

We wanted to clarify that the auto production numbers for Q3 remain flat compared to Q2, as we do not see any significant changes regarding the supply chain challenges facing the industry. We anticipate an improvement in Q4, though it will not be as robust as the projections from third-party forecasts. The evidence indicates that these forecasts are not adjusting quickly enough to reflect actual quarterly developments. We believe our estimate for automotive production is accurate and aligns well with the current supply chain conditions and feedback from customers about their difficulties in increasing capacity. On the positive side, our heavy vehicle and industrial businesses continue to perform well, more than compensating for the decline we are observing in the automotive sector.

Operator, Operator

The next question comes from Brian Johnson with Barclays.

Brian Johnson, Analyst

Yes, just want to get a sense, and thank you for the update on Sensata Insights, both on this deck and the teach-in on how you're going after the $800 million pipeline, kind of the timetable for translating that into bookings. And then given, as you pointed out at the teach-in, this is a fragmented market around telematics, kind of what are you finding is the winning formula to secure bids versus ones that go to competitors?

Jeffrey Cote, CEO

Great question. Let me start by mentioning that the pipeline refers to contract value rather than typical sales or valuation. This is a different approach from how we usually describe the opportunity pipeline. This terminology is often used for subscription-based or recurring revenue models. It's more than just telematics; at the core, we can collect data from vehicles and send it to the cloud via telematics devices. Our customer engagement is expanding as we merge our offerings from Xirgo and our internal Smart & Connected value proposition, resulting in a more comprehensive solution beyond just telematics. Sensata, as discussed earlier, provides the ability to extract information from various equipment through robust sensing capabilities. Xirgo complements this by gathering that information, transferring it to the cloud, and analyzing it to deliver valuable insights. This constitutes our value proposition. While they excel in telematics and OBD port translation, the true long-term value lies in the actionable insights generated once data reaches the cloud. We're seeing increased interest from customers as we offer a more extensive solution, and this integration with the Sensata portfolio is progressing well. There's more to come; it's still early, but we are enthusiastic about the opportunities ahead.

Operator, Operator

And the next question comes from David Kelley with Jefferies.

David Kelley, Analyst

Could you provide some insight into your expectations for growth moving forward, particularly in the auto sector? Should we anticipate an ongoing increase in growth in the second half of the year, and how does that align with your long-term goals of 400 to 600 basis points? Additionally, regarding the factors driving this growth, is there a chance that this ongoing increase in the auto sector is more of a structural change?

Jeffrey Cote, CEO

Yes, it's a great question. We're really excited about exceeding our targets. In our prepared comments, we mentioned the outgrowth over the past 3.5 years, with auto slightly above 600 basis points and HVOR much higher. Specifically for HVOR, the outgrowth is driven by a broad range of opportunities, with two significant factors pushing it above the average of 600 to 800 basis points. One is the NS VI rollout in China, which still has about 6 months to a year until it's fully implemented, so we expect it to normalize somewhat. Regulatory factors will continue to play a role, but NS VI is a major driver. We're hesitant to adjust the 600 to 800 range for HVOR. The second factor is the shift from mechanical hydraulic to electro hydraulic controls, which we’ve seen a significant increase in North America, Europe, and now China. This transition is boosting content and outgrowth values in our HVOR business. Overall, we're pleased to be at or above our targets and will keep monitoring the situation. As we secure new business, we'll provide updates on our outlook.

Operator, Operator

And the next question comes from Joe Giordano with Cowen.

Joseph Giordano, Analyst

Can you discuss your positioning within the electric vehicle market, particularly regarding the different types of platforms for higher-end versus lower-end models with varying power requirements, and how Sensata's products fit into each category?

Jeffrey Cote, CEO

Sure. So you'll recall that when we acquired GIGAVAC back in 2018, we did that because they had premier positions in the highest and most premier vehicles. And by the way, just to make sure everybody understands, when we talk about those higher-end vehicles, they are vehicles that have longer ranges and shorter charge times. It's not necessarily luxury vehicles. In the EV space, when we're talking about the technology that we need to bring to bear to help the customer solve the challenge, it's around charge time and range, which is what consumers are pulling. At the time of that acquisition, we had a belief that, that was going to be the direction where the market was going. We think that's still going to be the case. But there will be a lot of the middle market, sort of EV market that was underserved without having more broad capabilities. So we added the Churod joint venture to the mix to allow us to be able to have a broader portfolio. So now I feel as though we're much better represented across all of those categories of electric vehicles. And we're not done yet, right? So we continue to make organic investments and look for partnerships, JVs, acquisitions that will bring more capability to be able to serve these vehicle platforms as all of these customers adopt new models and they build out their next 5-, 10-, 15-year strategy in terms of product portfolio. So really good success. We feel as though we're well covered now, not only across models, but geographically as well. And we'll keep working on it.

Operator, Operator

And our next question comes from William Stein with Truist Securities.

William Stein, Analyst

One of the things we've recently learned from some of the semi suppliers and our industry contacts is that we're hearing about auto OE customers decontenting in sort of opportunistic fashion in order to complete kits and get cars shipped to customers, essentially rolling back some innovation in order to complete the builds. I'm wondering if you're observing this trend, whether it's affecting your business and if you're contemplating this in the guidance.

Jeffrey Cote, CEO

Yes, it's an interesting situation. Clearly, OEMs are making every effort to increase vehicle production, and one of their strategies involves reverting to previous-generation sensors for various reasons, such as cost or availability of components. Although this doesn't necessarily impact their compliance with regulations, there can be financial consequences. In our product development, we intentionally designed our offerings to provide a lower-cost option going forward. We're engaging in discussions about this approach, but ultimately, our aim is to assist our customers in producing more vehicles to boost their sales. This is one method they are employing, and they are exploring various strategies to obtain a complete chipset for their vehicles.

Operator, Operator

And the next question comes from Nik Todorov with Longbow Research.

Nikolay Todorov, Analyst

I understand that could be a hard-to-answer question, but what is your sense how much of your product could be sitting at partially built light vehicles or heavy vehicles right now? And how should that relate to the inventory destocking that you talked about?

Paul Vasington, CFO

I don't think we know where it is in their supply chain, but we estimated about $25 million of production this quarter. The items we shipped did not go into a completed vehicle.

Jeffrey Cote, CEO

Yes. So that's all inclusive, right? It's hard for us to sort of really gauge where it sits. But when we do the math on our revenue growth and we back into the factors we know, including production numbers, we get about $25 million of inventory build in the quarter. Hopefully, that's helpful.

Operator, Operator

And the next question comes from Rod Lache with Wolfe Research.

Shreyas Patil, Analyst

This is Shreyas Patil on for Rod. Just a question, how should we think about bridging from the first half to the second half of this year? End market production should be higher in automotive and you are raising industrial and HVOR production and market expectations, but the guidance is implying about an 8% decline in revenue. And then just quickly, if you could help frame the content benefit from the conversion to electronic hydraulics that you mentioned for HVOR.

Paul Vasington, CFO

Yes, regarding revenue, the decrease in automotive is more than compensated by gains in both industrial and HVOR. The improvements in HVOR and industrial are similar in terms of the sequential increase compared to our previous guidance.

Jeffrey Cote, CEO

On the second part of your question, just to make sure I understand it, are you looking for a little bit more visibility into what this conversion from mechanical hydraulic to electronic hydraulic is? Is that the nature of your question?

Shreyas Patil, Analyst

It was one of the reasons you are exceeding your previous growth target. I just want to understand the benefit to Sensata, either on a per vehicle basis or in another way to frame it.

Jeffrey Cote, CEO

The application involves an electronic joystick or integrated armrest used in agricultural, construction, or material handling equipment. It's not a low-cost item, as the average selling prices can range from $50 to $600, depending on the design complexity. This represents significant content. Although the volumes are much lower than in the light vehicle market, the high average selling prices contribute to substantial content as that unfolds. I hope this clarifies things.

Paul Vasington, CFO

Thank you, Shreyas. And just to be crystal clear, I mean, in the second half versus the first half, we did talk about our industrial business coming back to its normal seasonal pattern, which is a weaker second half than the first half. And in the heavy vehicle business, while it's experiencing great outgrowth in the fourth quarter typically is a little bit lighter seasonally. So that kind of accounts for the first half and second half and then also the automotive business declining a bit due to the low production levels.

Operator, Operator

And the next question comes from Michael Filatov with Berenberg Capital Markets.

Michael Filatov, Analyst

Just a quick question around aerospace. It looks like you're maintaining the market growth expectation for aerospace. But I think there are some indicators that suggest that the market backdrop is improving slightly. So just any commentary around aerospace market growth in the second half and if there's potential for upside, particularly because it's your highest-margin business.

Paul Vasington, CFO

Yes, it's a long-cycle business. Demand is primarily linked to OEM production and air traffic, which is improving. However, this segment is relatively small compared to the rest of Sensata. We anticipate a few million in increased revenue in the second half compared to the first half, and it is quite profitable. While it won't significantly impact our overall performance this year, it is showing positive signs, which is encouraging.

Operator, Operator

Thank you. And at this time, as there are no more questions, I would like to return the floor to Mr. Jacob Sayer for any closing comments.

Jacob Sayer, Vice President of Finance

Thank you, Keith. I'd like to thank everyone for joining us this morning. Sensata will be participating in upcoming virtual investor conferences this quarter, including Jefferies Technology Conference and the RBC Global Industrial Conference during the upcoming quarter. As Jeff mentioned, we're also planning a teach-in about our Electrification initiatives later in the year, and we'll share details of that event ahead of time. We look forward to seeing you at one of those events or on our third quarter earnings call, which will happen in late October. Thank you for joining us this morning and for your interest in Sensata. Keith, you may now end the call.

Operator, Operator

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.