Q3 2021 Sensata Technologies Holding PLC Earnings Call
Good day, and welcome to Dustin Sada Technology, Q3, 2021 earnings call.
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I'd now like to turn the Pumpkin 17, Mr. Jacob Sayer VP Finance. Please go ahead.
Thank you Sarah and good morning, everyone I would like to welcome you to <unk> third quarter 2021 earnings Conference call. Joining me on today's call are Jeff <unk>, CEO and President Paul <unk>.
<unk> 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 <unk> 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 would like to reference inside a safe Harbor statement on slide two.
During this conference call, we will make forward looking statements regarding future events.
Performance of the company.
All risks and uncertainties.
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.
On slide three we show us inside of the GAAP results for the third quarter of 2021.
Courage you to review our GAAP financial statements. In addition, today's presentation.
Most of the subsequent information that we will discuss during today's call will relate to our non-GAAP financial measures.
Conciliations of our GAAP to non-GAAP financial measures are included in the earnings release and in our presentation materials.
The company provides details of its segment operating income on slides 12, and 13 of the presentation, which are the primary measures management uses to evaluate the performance of the business.
Jeff will begin today's call with highlights of our business during the third quarter of 2021, followed by a quick review of our first sustainability report published recently.
He will then provide an update on recent progress and our key electrification inside it.
Some sites strategic growth areas.
Paul will cover our detailed financials for the third quarter of 2021, including organic revenue growth and market outgrowth by business.
As well as the segment performance and he will also provide financial guidance for the fourth quarter of 2021, we will then take your questions. After our prepared remarks.
Now I'd like to turn the call over to <unk>, CEO and President Jeff <unk>.
Thank you, Jason and welcome everyone.
I'd like to start with some summary thoughts on our strong performance during the third quarter of 2021 as outlined on slide four.
The business recovery that began this time last year continued during the third quarter.
We responded effectively to increase customer demand, which drove 26% revenue growth from the prior year period to 951 billion.
Slightly above the guidance range, we provided in July.
Well automotive production was constrained during the quarter due to supply chain shortages, we were able to deliver our customers orders and produce strong financial results for shareholders.
Looking at our performance year over year, we once again produced strong market outgrowth, well above our target ranges.
As a company, we delivered 1100 and 90 basis points of outgrowth during the quarter.
However, outgrowth is something that we monitor over a longer period of time than one quarter and since 2018 on average we have produced 570 basis points about growth as a company.
Driven by a 1050 basis points of outgrowth in our heavy vehicle off road business and 650 basis points of outgrowth in our automotive business.
This demonstrates the vital role we provide for our customers in these key markets.
Paul will discuss our strong revenue outgrowth in more detail.
Since idose revenue outgrowth to market will increasingly be driven by our enhanced positioning and megatrend areas.
We continue to invest in these growth initiatives, both organically and Inorganically.
With <unk> and now the pending acquisitions of <unk>.
<unk> power systems, and smart witness expanding not only our capabilities, but also our access to end markets.
Product portfolios in these pivotal areas.
Already we have seen strong revenue growth coming from our electrification activities with more than $220 million in estimated revenue this year.
We expect continued significant growth in our megatrend areas over the coming years.
Driven by electrification trends the infrastructure requirements to support electrification and the proliferation of Iot on stationary and mobile equipment.
Some sign up today is in a very strong financial position in part because of our excellent performance over the past year.
We have generated more than $530 million in free cash flow over the past 12 months.
And our current cash balance up $2 billion enables <unk> to continue to acquire targeted innovative businesses that will expand our presence in our targeted growth factors.
During the third quarter, we benefited from a resilient flexible and focused organization that continues to successfully navigate the ever changing supply chain landscape.
And deliver on our customers' needs.
Not surprisingly, we continue to see elevated costs related to the worldwide material shortages and logistics costs.
We are working diligently to limit those effects, including a different commercial approach with our customers.
This was a challenging exercise, but very necessary under the current circumstances.
Despite these elevated cost we delivered $201 million and adjusted operating income during the quarter reps.
Representing 21, 1% and operating margin.
Substantially higher than the prior year period.
I'd like to recognize the innovation agility and hard work of our entire team.
These strong results during the third quarter.
During the quarter since <unk> published its first sustainability report and we're very proud of our progress in these areas.
Virtually every products and Saddam makes today results in a cleaner safer and more efficient world.
We also take our responsibility to reduce the carbon emissions from our own operations and our supply chain very seriously.
And we are targeting a 10% reduction in our greenhouse gas emissions intensity by 2026, and we have established a goal to be carbon neutral by 2050 in line with leading companies around the world.
In addition, our reported dresses sustainability topics core just inside his mission, including diversity equity and inclusion and responsible sourcing.
We believe that diversity benefits, our employees customers and shareholders and that a diverse workforce provides or makes us a better company.
We've established goals for our leadership team to improve female representation in management roles, that's insider to 30% and to reach 25% racial diversity U S management roles by 2026, while reducing turnover improving internal development and promotion rates.
We are serious about achieving meaningful progress against these goals and consequently are tying a portion of senior executive short term incentive compensation to annual improvements.
We look forward to keeping all our stakeholders updated on these and other important ESG initiatives in the coming years.
Moving to slide six since auto is making excellent progress in winning new business in electrification components in part because we take a holistic view of electrification.
Growing impact on all the segments we serve.
Electric light vehicles capture a lot of attention and it's inside of provides the manufacturers of these vehicles with not only new evs specific components, but also with many of our innovative and differentiated components from traditional vehicles like breaking tire and environmental control.
Specific to Evs, we also provide in our developing several components that enable safe and efficient operation of <unk>.
Fried platforms, such as high voltage electrical protection advanced temperature sensing.
Highly sensitive electric motor position in next generation current sensing.
As an example during the third quarter, we were awarded new E motor position business with a large European OEM, representing $2 6 million of annual revenue.
In addition, we benefit from the upgrading of certain systems and Evs for example, when the climate control system is upgraded to a heat pump to manage the temperature of both the cabin as well as the battery pack the sensor packages upgraded and since Saddam benefits.
In the important area of breaking since <unk> is a global leader.
During the quarter, we won two new business opportunities that were significant one with brake system leader Continental for new electronic stability control systems, covering both traditional internal combustion engine vehicles as well as a greater than $11 million in new business on electric vehicles that further extends our.
Our leadership position in that market.
We've described the revenue increase that we received from Evs as compared to internal combustion vehicles in terms of an average 20% uplift in content per vehicle.
This is a demonstrated figure.
Just on actual revenues in vehicle production.
Our design win activity within electrification has been growing rapidly.
We saw an 80% rise in electrification wins last year.
And so far this year approximately 50% of our automotive design wins are with electric vehicles.
Another dramatic uptick from the prior periods.
Looking forward based upon the business wins, we are gaining and the products. We are developing we estimate that our battery electric vehicle content is on path to double that of a neutral combustion engine vehicle on average within five years.
On slide seven we show how <unk> is expanding and clean energy solutions moving up the stack from high voltage components used by large customers with the resources to design these into their electrified offerings to sub systems and full battery energy storage systems for our customers.
Multitude of end markets.
Electrification is happening everywhere.
Not just in passenger vehicles manufacturers, our bikes heavy trucks material handling equipment marine vessels, and even aircraft and spacecraft are addressing ever tightening greenhouse gas emissions regulations, and taking advantage of falling battery costs should provide electrified solutions.
To their customers.
However, not all of these customers can design all aspects of the electrified solution in house. Thanks.
Thanks to capabilities, we have added the acquisition since <unk> can now provide either the sub system of assembled components to manage battery charging in the form of a power distribution unit, where we're using technology from lithium balance and spear power. We can provide the full energy storage system, including battery management and.
They customize battery pack.
By providing a full suite of offerings, our electrification and clean energy solutions serviceable addressable market expands dramatically.
<unk> 15 billion by 2030.
As an example of the solutions we offer during the quarter, a large premier European heavy vehicle OEM awarded since some of the design for a megawatt sized charging unit to help power their future electric commercial vehicles.
This strategically important business win is worth more than $20 million in annualized revenue once it reaches its expected production run rate.
As pivotal development means we can increase our content per heavy truck from the current 100 to 200 on average to more than a thousand per electric heavy vehicle.
In addition through the pending acquisition of spear power, we can provide full battery storage systems for a variety of specialty transportation markets for.
For example, spear is powering electric ferries, including the upgrading to electric of the Washington State Ferry system.
These are highly demanding solutions that include very robust safety features proprietary to sphere and we are excited about the role spear is playing in these and other land sea and air Transportation markets.
Similar to what we did for our insights group back in June and early 2022, we'll webcast a teach in covering our electrification components and clean energy solutions initiatives. So listeners can gain a better understanding of our offerings the evolving market and our go to market strategies in these key grow.
Vectra sourcing Sato.
Look forward to sharing more details about these rapidly growing and evolving areas then.
On slide eight we share an update on our continued progress instant insights.
The insights initiative addresses a fastest growing market and we're pleased by the traction we are gaining with both current and new customers across various sectors.
The ongoing widespread semiconductor shortages constraining, our insights business and we are unable to deliver on all of that expanding demand youll.
Youll recall that these solutions are designed into customers fleets that revenue is sticky.
So our orders are billing building for future delivery.
Once these shortages subside.
Our insights order book for delivery over the next 12 months now stands at more than $85 million as.
As evidenced by the value added nature of our solutions. We were recently awarded new business with Telematics service providers and large a large global shipping company together worth more than $9 million of revenue over the next 12 months.
I'm also pleased to announce the expansion of our insight offering with the pending acquisition of smart witness.
A privately held innovator of video telematics technology for heavy and light duty fleets.
Smart witness solutions comprised of proprietary software and hardware.
Purpose build for telematics service providers, providing a complementary fit with our insights business since its founding in 2007 Smart witness has been a pioneer in video telematics that expands on traditional offerings to include contextually aware data capture.
That enhances the monitoring of vehicles, there surrounding and their surroundings to increase safety and.
Lower insurance costs for fleets.
Smart witness systems are logging 15 billion miles of information every day.
In sum we were really encouraged by our continued progress in our megatrend growth initiatives as I've said before we see numerous opportunities to utilize our strong financial position, our engineering capabilities, our supply chain and our customer relationships to meaningfully enlarge our addressable markets through organic.
Efforts as well as bolt on acquisitions and partnerships within these megatrends.
I'd now like to turn the call over to Paul.
Thank you Jeff.
Key highlights for the third quarter as shown on slide 10 include.
Revenue of $951 million.
An increase of 26% from the third quarter of 2020.
Organic revenue increased 16, 6%.
The acquisition of <unk> increased revenue by two 3%.
And changes in foreign currency increased revenue by one 7%.
Adjusted operating income was $201 million in.
An increase of 29, 8%.
Compared to the third quarter of 2020.
Primarily due to higher revenues.
Offset by elevated costs.
Related to the industry wide supply chain shortages.
<unk> spend to support megatrend growth initiatives.
And higher incentive compensation aligned improved financial performance.
Adjusted net income was $138 6 million and <unk>.
<unk> of.
33, 8% compared to the third quarter of 2020.
Largely due to the significant increase in operating income.
Adjusted EPS was <unk> 87 cents in the third quarter and.
An increase of 31, 8% compared to the prior year quarter.
Now I will discuss our performance by end market in the third quarter of 2021.
As outlined on slide 11.
Our organic revenue increase of 16, 6% year on year.
Include market growth of 470 basis points.
Outgrowth.
1190 basis points.
Again, demonstrating <unk> ability to consistently outgrow the end markets.
Our heavy vehicle off road business posted organic revenue increase of 58, 9%.
Representing end market growth of 31, 4%.
In 2004 hundred basis points of market outgrowth in the third quarter.
Our China on road truck business continued to post better than expected growth.
From the adoption of NSX emission regulations.
And we are also benefiting from a wave of electrical.
Operator controls being.
Being installed a new off road equipment.
Our.
<unk> business posted an organic revenue increase.
Increase of five 2%.
Representing end market contraction of 21, 6%.
And 1150 basis points of market outgrowth.
Our automotive business benefited from new product launches and powertrain emissions safety.
And electrification related applications and systems.
Recall, we saw an approximate $35 million.
Inventory contraction a year ago.
Automotive industry ramped up production from slowdowns and shutdowns earlier in 2020.
In addition, we were able to fulfill customers orders within the current quarter.
Even if those shipments exceeded the eventual production in the quarter due to other components of ways.
Within the third quarter of 2021, we estimate an incremental build quarter over quarter of approximately $35 million of inventory at our customers.
Our industrial business revenue increased 17, 9% organically.
As global industrial end markets continue to recover in the quarter.
Strong growth in new electrification launches and heating ventilation and air conditioning enabled our industrial business to grow faster than market this quarter.
Our aerospace business increased eight 3% organically.
Reflecting somewhat improved OEM production and air traffic that later drives our aerospace aftermarket business.
New product launches, primarily in defense and improvements in aftermarket enabled our aerospace business to grow faster than market this quarter.
Now I'd like to comment on the performance of our two business segments in the third quarter of 2021.
Starting with performance sensing on slide 12.
Our performance sensing business reported revenues of $706 5 million and.
An increase of 21, 6% compared to the same quarter last year.
Excluding the positive impact from foreign currency of one 8%.
And the positive impact from the <unk> acquisition of three 1%.
Performance sensing delivered 16, 7%.
Organic revenue growth.
Performance sensing operating income was $193 7 million an increase of 27, 8%.
As compared to the same quarter last year with operating margins of 27, 4%.
The increase in segment operating income was for apparel was primarily due to higher revenues.
Somewhat offset by elevated costs related to the industry wide supply chain shortage.
Performance sensing generated incremental margin of 37% in the quarter on higher organic revenue.
Compared to the prior year period.
As shown on slide 13, sensing solutions reported revenues of $244 6 million in the third quarter of 2021.
An increase of 17, 9%.
As compared to the same quarter last year.
Excluding the positive impact from foreign currency of one 5%.
Got it thank solutions delivered 16, 4% organic revenue growth.
Sensing solutions operating income was $75 3 million.
An increase of 29, 3% from the same quarter last year.
With operating margins of 38%.
The increase in segment operating income was primarily due to higher revenues.
Sensing solutions generated incremental incremental margin of 46% in the third quarter.
Higher organic revenue as compared to the prior year period.
On slide 14, corporate and other operating expenses not included in segment operating income were $72 7 million in the third quarter of 2021.
Excluding charges added back to our non-GAAP results corporate and other costs were $65 7 million.
An increase of $12 3 million from the prior year quarter.
Reflecting higher research and development and business development spend.
To support our megatrend growth initiatives.
Higher global incentive compensation costs.
Turning to our improving financial performance.
Slide 15 shows <unk> third quarter 2021 non-GAAP results.
Adjusted operating income increased 29, 8% compared to the same quarter last year.
And adjusted operating margin increased 150 basis points to 21, 1%.
The increase in both adjusted gross margin.
Adjusted operating margin largely reflects the rapid increase in revenue.
From depressed levels experienced last year due to the COVID-19 pandemic.
Offset somewhat by increased costs related to industry wide supply chain shortages net of recovery of some of these costs from customers.
We've included on this slide and adjusted operating income margin walk.
In the third quarter of 2020 to the third quarter of 2021.
As shown on slide 16.
We generated $80 million and free cash flow during the third quarter.
Free cash flow was impacted in the quarter by our decision to increase raw material purchases early in the quarter in order to maximize production flexibility.
Given the widespread part shortages in our supply chain.
For the full year.
We currently expect free cash flow conversion to be approximately 80%.
Adjusted net income as a result of higher inventory levels.
For the full year 2021, we expect capital expenditures to be in the range of 145.
$155 million.
And finally, the net debt to EBITDA ratio was two five times at the end of September.
The bottom end of our target operating net leverage range.
Since all of its primary use of cash on hand to acquire businesses that will extend our market position.
Within our key growth vectors of electrification and insights.
In addition.
We intend to resume our share repurchase program within the fourth quarter and as noted.
Mm 302 million available on our term purchase authorization.
We are providing financial guidance for the fourth quarter 2021 as shown on slide 17.
Our expectations are based upon the end market outlook and I will discuss momentarily.
We expect to generate revenues between $895 million.
$925 million in the fourth quarter 2021.
Representing a reported revenue change between the 1% decline.
And 2% growth compared to the fourth quarter of 2020.
With the impact of foreign currency, increasing revenues at the midpoint of guidance by about $2 6 million.
And the impact of foreign currency and the <unk> acquisition.
We expect an organic revenue change ranging from a 3% decline.
Flat in the fourth quarter.
Our current fill rate of approximately 95% of the revenue guidance midpoint for the fourth quarter.
We expect to report adjusted operating income between 180 and $190 million.
At the midpoint adjusted adjusted operating income margin.
As expected to be 23%, which includes.
100 basis points of increased operating cost associated with global supply chain shortages net of customer recovery actions.
On the bottom line, we expect to report adjusted net income between $121 million.
$31 million.
And adjusted EPS between <unk>, 76, and <unk> 82.
Which includes a <unk> <unk> increase.
Currency at the guidance midpoint.
At the bottom of the slide we have provided adjusted and adjusted operating income margin walk.
Fourth quarter of 2022.
For the fourth quarter of 2021.
On slide 18, we provide a revised estimate for OEM production growth for 2021 as compared to the expectations. We shared in late July.
We currently expect automotive production to be down approximately 3% this year from last year.
Given ongoing production slowdowns caused by global supply chain shortages.
Our outlook is more conservative than IHS automotive production estimates for the fourth quarter.
We do not see production constraints on the global supply chain shortages lifting in the near term.
While we are not sharing specifics yet the current IHS global automotive production expectations of 10% growth in 2022.
Suggest that supply chain shortages will be considerably next year.
View, we do not share given current trends.
We intend to provide detailed financial guidance for 2022 during our fourth quarter earnings call in early February.
However at a high level. We currently expect <unk> revenue growth in 2022 to align with the growth framework, we have previously shared.
Since <unk> revenue by end market should grow consistent with each market production growth.
Plus our targeted outgrowth of approximately 400 500 basis points across the whole company.
In addition, we intend to continue our cereal M&A approach to further expand our market position and our megatrend areas and we aim to have this activity at a material amount.
<unk> growth each year.
Now, let me turn the call back to Jeff for closing comments. Thanks.
Thanks, Paul let me wrap up with a few key messages as outlined on slide 19.
Since <unk> has responded very well to the rapid changes in many of our end markets demonstrating the strength resiliency and reliability of our business and organizational model, which enabled us to capitalize on this recovery in the end market demand and deliver for our customers.
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 on 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 up large and rapidly growing opportunities for <unk> across all of our end markets.
We are making excellent progress in electrified components clean energy solutions, and some sort of insights.
Both through organically.
Targeted areas around new business and through inorganic activity associated with bolt on acquisitions.
We continue to believe that the overall business environment provides interesting opportunities to further strengthen our portfolio our portfolio through strategically important value, creating acquisitions <unk> joint ventures.
In addition, we are pursuing new technology collaborations and partnerships with third parties to expand our capabilities and accelerate our megatrend driven growth potential.
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 <unk> longstanding 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 as illustrated in our new sustainability report to bolster the long term sustainability and success of the company for all of its stakeholders. We look forward to reporting more about our progress in these areas in future updates.
Now I will turn the call back to Jacob.
Thank you Jeff will now move to Q&A, given the large number of listeners on the call. Please limit yourself to one question. Each Sara. Please go ahead and assemble the Q&A roster.
Thank you.
To ask a question you May Press Star then one on your Touchtone phone.
If youre using a speakerphone please pick up your handset before pressing.
Q.
To withdraw your question. Please press Star then two.
This time, we will pause momentarily, while we assemble.
Our first question comes from one being married with Bank of America. Please go ahead.
Hi, yes. Thank you.
I was wondering if you could maybe just give us some more color on the channel fill dynamics, how broad based that says if we used 30 to $40 of content per vehicle, where we're talking about roughly a million units.
The production changes are quite large and Jeff you you noted that going into 'twenty two.
It seems that IHS, maybe ease a bit too optimistic so.
Is the guide for Q Encapsulating, all the channel inventory dynamics or do you think this persist into 2022 and if I could just could you also just maybe quickly talk about that.
The China.
Issues bolt around power rationalization and resurgence of Covid, if youre seeing any impact from that thank you so much.
Sure. So let me let me touch on on Q4, so IHS forecast automotive production at about 16 516 six week.
We've called it lower than that about $15 million. In addition, given that we know there has been some of our part parts built up an inventory we are expecting a little bit of depletion on that I think that's a little bit of a conservative guide, but we're watching it closely we want we want to make sure that we're not.
Going above and beyond to deliver for customers. So they could just havent sit in inventory, we would rather address that as it occurs and serve other customers because of the shortage is impacting all of our customers and all of the end markets.
As it relates to 2022.
A couple of dynamics there, obviously, we're not providing guidance for 'twenty two but we like to look ahead as everybody does.
Specific as it relates to the automotive market.
The call right now.
Traditionally IHS has been a little bit more aggressive in terms of their call. When we look at the supply chain challenges that we're facing.
The Bad news is I think it will extend into 2022. The good news is that based upon the committed levels that we're seeing from our suppliers, which suggest that fourth quarter may be the low point in terms of the ability to deliver so as some of that capacity increase capacity comes online we think there will be a.
<unk> from the fourth quarter levels. So it will start to taper a little bit.
So, we'll keep monitoring that and give a perspective, but we're very mindful of that we're mindful of the inventory. That's been built we're also mindful of the fact that North American vehicle inventory is at an all time low 24 days, so that's going to need to be replenished at some point. So there were a lot of.
Moving parts in terms of the overall look.
And obviously you have to look at the other end markets that we serve automotive is a big one that we serve when you look at the others. There is continued opportunity for growth in those markets as we go into Q4 and also into 2022.
And last question on China, I think is just around what's happening there in terms of COVID-19 and so forth.
The business is operating quite well there it's amazing how resilient.
We have been but everybody has been in terms of managing through this we don't see any impact right now in terms of.
Covid other than we're continuing with protocols in the U S. We're addressing.
The executive order associated with vaccine mandates, so theres still a lot of.
Stuff, that's happening in terms of engagement with our employees and making sure we keep them safe.
But all in I feel as though it's become a little bit of the new norm for us and we're managing through that very well hopefully that answered. Your question onesie. Thank you what I'm, saying.
Yeah.
Paul Please go ahead.
Yes, Thank you and good morning, I guess I just wanted to ask.
Regarding your comment about doubling the EV content in them.
Light vehicles in the next five years from the date, you said about I guess, 20% incremental content today, where are you in that product portfolio would you see that coming is that from existing products and technologies or are there other incremental products or areas that you're looking at.
A little of both but candidly based upon my comments I think the listeners could probably can appreciate that we tend to be fairly digital in terms of what we've demonstrated we've got a lot of feedback that the 20% uplift was good but not hugely exciting.
We went back and realize that that has demonstrated a capability that we're experiencing right now.
<unk> that we've seen around electrified components with our automotive Oems, but also with our other customers we've talked about power distribution units and other major wins associated with electrification.
And what we've now done is gone back and said okay based upon the transition that we would expect no one's going to get it perfectly right, but we know there's going to be a transition to migration more toward electrified vehicles as we look at that and we also look at what we've sold with customers already we see a line of sight to that doubling.
The thing is we quote net and so when there is a there isn't a new socket.
At the same socket in the in the new application that wouldn't count toward our mbo growth.
And as we've said there is a lot of content on vehicles that applies in battery electric vehicles as well as internal combustion engine. So we don't have to rebuild that pipeline.
On a further <unk>.
Evaluation of that trend continued wins more investment that we're making our partnerships. We're striking allow us to feel very confident in that trend in terms of being able to double the content per vehicle.
Hopefully that's helpful. Thank you Matt.
Our next question comes from Amit <unk>.
Any anyway.
Please go ahead.
Yeah. Thanks, a lot and thanks for taking my question I guess my question would be.
Jeff It to you but.
I think when you talk about the December quarter guide, you're sort of implying that that's been thought of auto revenues will undergo auto production trends.
I assume that's due to depletion of inventory that's sitting in the channel.
Is that is there a way to think about how much extra inventory. It's been thought is out in the channel and how long does it take to normalize.
And then if I could just ask Paul could you just remind me how this week actually went back to the 80% conversion.
And does that happen in December or does that is it more of a calendar 'twenty two narrative.
Yeah. So I'll hit the Q4, and then Paul can hit the other topic.
So we've already stated we were expecting about a million and a half units less than IHS in terms of actual production in the fourth quarter, but we also expect some of the inventory in the supply chain differently.
It's baked into the guide that we provided for the for the fourth quarter in terms of the amount of inventory call. It 100 $125 million of inventory across the company that's been built.
That's been largely over the last year, that's been largely focused in auto.
But I would also point out that if you also look at the North American vehicle inventory up 2004 days, just replenishing that back to a more normalized 50 or 60 would absorb a lot of that inventory at market, but as that production occurs as that production is quoted.
Assuming our customers actually normalize their raw inventory, we will see production exceed our revenue now.
I think it's.
It's a bit of a discussion that we're having with customers because they want all the parts, we can make for them right. They want to make sure that.
Given the complexity of their bills, they're very willing to carry a little bit more raw material now, but we want to make sure again that we're serving all of our customers and it makes no sense for us to pay.
A higher logistics cost and expedite fees to get customer's product that sits in their inventory. So that's an ongoing dialogue that we're having and we'll continue to manage it very closely and give you updates as we see it.
So the question I think is the 80% version relates to 2021, it's lower than we originally anticipated we started the year and we made a conscious decision to build inventory we take on raw materials earlier to make sure that we were able to serve customers.
Such a decision for for next year I mean, we've been looking at.
Free cash conversion.
Right and the mid East and that's what we're going to continue to target has been performance versus the fun right.
Thank you Aman.
Our next question comes from Mark Delaney with Goldman Sachs. Please go ahead.
Yes, good morning, and thanks very much for taking the question. So when you can elaborate on the supply chain dynamic that's underpinning some of the more cautious comments. The company is providing as it thinks about the outlook for <unk> and also into next year, what are some of the most difficult things.
As it relates to supply chain for us it's not any particular.
The ones that are most short for the company.
And if you could talk about the orders youre seeing not only for some thought of it but what do you think is maybe impacting some of your customers as well.
Yeah any added color on that I think would be helpful. Thanks, Yes sure.
First obviously, it's an industry issue I think everybody understands that it's not specific to some sort of its most acute in electronics at the foundry level. So capacity at the foundry level I think these are sort of pretty well known facts that.
Capacity it takes a while to get put in place now over the last 18 months and so that's been happening obviously, our suppliers have been moving their capacity around to serve needs I think.
We.
Done really well in terms of getting our fair share of that allocation. So that's a very positive thing.
It's beyond electronics, though I mean, we all experienced in our everyday everything short today right supply chain issues not only capacity demand question, but just logistics in general was very challenged in terms of finding labor to unload containers trucks and so forth. So.
It continues to be a problem that everyone is experiencing.
As we talked about in the past many of our electronics our customized so we feel as though we've been impacted less as a result of that because in a lot of cases.
Areas that are suppliers would focus on as opposed to a more standard off the shelf electronics.
Candidly, that's what's impacting our insights business a little more of the solution is differentiated and customized but a lot of the electronics that go into where they're more standards. So we're seeing a little bit more of a shortage in a crunch.
There are standard Asics that we're going after.
And then the last point I would make here is.
During 2021 first half of the year, we were being partners with our customers and we didn't go after a lot of this cost recovery, but in the second half of 'twenty one.
We've had more direct conversations with them. We've had some very good success and given that this is going to continue both in terms of raw material costs and logistics costs, we're having those conversations with customers to make sure that is inside our shareholders are not the ones that.
That takes a hit we want to be good partners, we wanted to deliver but we need to.
Sure.
And the costs associated with making sure we can continue to deliver.
Thank you Mark.
Our next question comes from.
Great.
Go ahead, yeah, Thanks, and good morning, Jeff I was hoping you could comment further on the.
The view that that content here is on a path to double I sit in the next five years and I was hoping if we could specifically talk about some of the key levers and drivers that youre looking at in particular any products you see growing in importance for insider and maybe the best ones to look at this would be directionally, if we look at power related products versus.
Additional sensing products is there.
Any additional color would be appreciated thank you.
Sure. Yes. So if you were to rewind the clock three five years.
Most of our components were obviously, serving largely combustion engines, we've been very transparent about the activity that we've been undergoing in terms of M&A activity and additional engineering investments to make sure that we can serve our customers going forward. So.
Thats the backdrop right.
We've always talked about the fact that although we have expertise in individuals' sensing parameters pressure as an example temperature position.
We have thousands of products that we bring to our customers. We said we take.
Modular technology, and we package it in a way that serves the application.
With those traditional sensing parameters, it's not a lot different in the electrified world. So if you think about contact our capability, we have the giga back capability, we have the <unk> capability with higher levitation.
We have E motor position that we've transformed from position sensors that we have.
We have <unk>.
Building capability around current sensing.
A lot of our pressure and temperature apply in terms of the.
The environment for an electric platform. So the goal is not to have one capability that we're relying on it to make sure that we're ubiquitous in terms of an EV platform and a combination of capabilities and product solutions that we have poured over.
Build a built on by the other applications like high voltage current sensor sensing and also protection, we feel as though we've got a really good portfolio right now to be able to go to customers and help them solve the challenges that they're facing we will continue to work at it right I mean, it's a very small portion of the fleet.
Yet there are a lot of wins that we're getting associated with solutions that we're bringing to our customers.
And it's been a very rapid growth of.
Development around opportunities that we're working with those customers to bring things to market very quickly and that that trend has created more confidence in our ability to.
I see this being a real significant tailwind to us as a company.
Thank you Luke.
Yeah.
Okay.
Our next question comes from Brian Johnson.
Barclays. Please go ahead.
Thank you just want to.
Flesh out a little bit more of the inventory question I guess the first question.
A lot of the pure auto suppliers have very severe decrementals to the stop start nature production in the quarter is most of the work you do in automotive from a catalog and therefore, not customized OEM and does that allow you to have smoother decrementals when one model one factories up one factories down on you.
Customer James.
Yes, definitely not every one of our products. We are 15000 different products that we bring to customers they're not drop in they are very much customized to the application many very frequently sole sourced with them.
I would just say that we built inventory.
I think we've managed through this better we're not the bottleneck right with our with our customers, which is a nice place to be.
We are an escalation with water customers, but I'll tell you.
Talked with a lot of them.
The feedback I get is we're not the biggest problem.
Good.
Not being the biggest problem minimum okay with building a little bit of inventory to give that.
Buffer if you will to our customers, but I do want to make sure that it doesn't get out of hand, because eventually it is going to come around right, they're going to take that inventory out at some point and that will lag. The performance. So we don't want great performance. During a tough time to result in a negative in the long term. So we're keeping a close eye on it.
Thanks, Brian.
Our next question comes from Sam make some money.
J P. Morgan. Please go ahead.
Yes, hi.
Hey, Jeff.
Yes.
You outlined the consent form and.
Since 2018, and I think previously it didn't matter if it was about a 400 600 basis points outperformance and you've consistently done.
Better than that in autos as well as maybe because it's so I'm just thinking with the roadmap that you have on electrification and battery life could be acres went up what are you thinking in terms of visibility in terms of raising that outperformance guide is it are there any concerns about hitting the air pocket is the competition happens in the industry or is it pretty much.
Smooth sailing from here on it and that's going to pick out performance should be continuing to build from that level. Thank you.
Yeah, Thanks, Amit so.
Historically, we've referenced outgrowth in automotive and <unk> I think to just make the story simpler.
And by the way, we did that because of mix in the business and how it grows and so forth. We did it to create more transparency, but I fear that we might have complicated.
The story at the end of the day, our goal is to make sure that as a company we have outgrowth.
Over market.
Don't markets will will ebb and flow.
The nature of the end markets that we serve and that's why we've quoted the 570 basis points since 2018 across the company, it's really driven by HBO arent auto, but we do see outgrowth in industrial and aerospace as well.
Just not as pronounced.
Few of the call for 400, 400 to 500, and our go forward and our confidence in that again, it's what we have really strong confidence in.
The more near term outgrowth exceeding the targets. It has a lot to do with your off a smaller base in 2020. So once we get into a more normalized environment. We would expect those outgrowth numbers to normalize a little bit and so.
So we just want more time, where we've demonstrated beating the target before we raise we're going to share what we have.
High level of confidence in.
But certainly we've demonstrated the ability to do better than what we've said we're.
We will aim to keep doing that but we feel really comfortable with the four to.
500 across the company and then the other quotes.
Four to six in auto and six to eight and HBO are.
Going forward.
Hopefully that helps thank you Sammy.
Our next question comes from Michael <unk> with Baird. Please go ahead.
Hi, Good morning, guys. Thanks for the time.
Just on the doubling of the EV content, that's that'd be the dead horse here.
Just the margin profile of that extra content, you're seeing on electric vehicles could you maybe talk about how that will impact sort of the business margin.
And maybe where that margin profile is more attractive within the actual electric vehicle content mix.
Yeah. So we will exclusively focus on really hard to do applications that will get that will achieve differentiated margins.
So we still are very clear.
Monetized applications that use.
Huge commoditized, that's probably unfair applications that can be served with semiconductor packaging that don't require any sophisticated packaging and calibration environmental control for harsh environments.
They're valuable sockets, but others can serve them, where we do really well is in applications that are hard to do in harsh environments, and that's where we bring a lot of capabilities. We always focus on them right and so we're not going to deviate that that generates.
The premier margins that we experience as a company now let me speak to how that will transition on new product launches. We've always seen new products that are at lower volumes have lower margins as they ramp right youre getting the kinks worked out of.
The automated manufacturing youre gaining scale on your raw materials, you're utilizing your factory capabilities in terms of absorption.
Yield start to increase dramatically, but we're factoring that in we don't see this transition as being hugely disruptive to long term margin profile of these products that we're engaging with our customers on will continue to have that differentiated margin profile that we have as an organization as a company.
And we will continue to make sure we do that it's not it doesn't just happen right. It's the building of the scale, it's making sure that we're constantly redesigning sourcing differently to make sure that we can drive the margin profile, let's make sure that we're competitive from a cost standpoint.
Thank you Michael.
Our next question comes from William.
<unk> Securities. Please go ahead.
I think pardon me thanks for taking my question.
We've spoken quite a bit about inventory levels.
I still have a question about it I am looking to hopefully distill all of it into one comment.
Can you remind us.
To what degree the inventory.
The excess inventory at your customers that you cited last quarter do you believe was in.
Wrong.
Warm to them in other words, they were holding your part versus in a in a car that was 99% complete.
Waiting for one semiconductor to drop in can you also remind us of the.
Dollar.
Inventory.
Believed was in excess last quarter, what that is this quarter again, because I've heard a couple of numbers.
I might have missed it and then the timing that you expect that inventory to be depleted and if that wasn't enough. Maybe also talk about the planned inventory builds that we've heard Oems want to do for strategic components does that affect your build plans.
Planned sorry for the long winded question. Thank you.
Well I will try to spell this out something simple.
So we built that.
We believe our customers built about $25 million of inventory in Q2 and 35 this quarter.
And so we are shipping to them above production.
With that said given the fact that we think we're very good supplier and we're not all back the assumption would be and there's no facts to support that VAT.
A lot of our parts are probably sitting in vehicles that are work in progress.
That will get released in the market at some point.
And the fact that.
We're shipping well, we're having lots of discussions to meet their winter demand, there's a lot of anxiety in the supply chain.
So.
That's how I would stack it up in terms of what's happening this year.
Say, when it's going to unwind, but to Jeff's point, there's a lot of them.
Inventory levels in the dealerships are very well, so likely that something that will need to get rebuilt.
And so that's positive it's a positive tailwind to the to what being seen right now.
That's going to change much of the current supply chain constraints that we're seeing but it's likely a long longer term mitigating factor to some of the temperature has been building channel today.
Thanks for the question well.
Yeah.
Our next question comes from Nick.
Oh no. Please go ahead.
Yeah, Hi, Thanks, good morning, everyone.
I think I heard you talks about <unk>.
<unk>.
<unk> or different commercial approach to addressing the rising costs.
Maybe you can expand there what are you doing differently.
When you negotiate those with direct customers and maybe can you talk about how much of the the.
Leasing costs, you've seen so far you've been able to pass through the direct customer so far this year and how should investors think about once we started the new calendar year in terms of passing through those things.
Sure. So 2021, we've recovered about half of the cost that we've incurred and given that we're expecting those costs to continue.
Going to aim to get all of that going forward certainly we've been able to achieve that in Q3 and Q4. So I had mentioned that the first half of the year, we sort of held off on that until we determine whether or not it was going to be persistent.
And it's not one size fits all every customer is different.
And the trade offs are unique and so but it's very strategic in terms of how we're engaging with customers too.
To optimize all of the levers that we have available, but we're committed to making sure that.
We serve our customers but.
We share in the costs associated with achieving that now.
Thanks, Nick.
Yeah.
Our next question comes from Rod Lache Wolfe Research. Please go ahead.
Yes.
Okay. Thanks, This is Ryan on for Rod.
So just wanted to clarify a couple of <unk>.
So.
I think you had mentioned earlier there are about there was about $100 million to $125 million of inventory build.
That you've experienced so far this year, so should should we be.
You mean that.
That inventory basically unwind as we go through Q4, and then probably into next year and is that embedded in that four to five points of growth over market.
That you were kind of talking about before and then you mentioned that you're starting to see a recovery in.
Some of the supply chain costs that you've been incurring this year.
So does that suggest that all else equal the headwind that youre experiencing this year would likely moderate if you continue to see those recoveries.
So as Paul.
Couple of things when we talk about year over year impact that cash is king.
Into consideration last year inventories were contracting this year. They are building. So we look at it on a year over year basis, it's bigger than whatever got built this year, because we had inventory contracting last year.
As it relates to Q4 and we've been benefiting from this build shipping above production in Q4, we're assuming we're going to be pretty much delivering to production, but last year, where there was a contraction. So it's how do you want to think about year over year versus sequential but just think of Q4 as largely related to the production.
Being estimate that we're estimating what we're going to serve $50 million of <unk> in the fourth quarter.
The only other thing I'd mentioned is I think you commented about the outgrowth, we exclude inventory from the outgrowth that we all hope right.
Right.
When it's material thanks, Rob.
Our surround I guess.
Our next question comes from Joseph Buckley.
RBC capital markets. Please go ahead.
Thanks, so much.
And not to beat a dead horse here, but.
I know youre sort of talking about your fourth quarter outlook.
Below IHS com and I know, we got to make some adjustments here because you're looking at your mix basis and exclude Toyota et cetera.
But even if you do that it seems like.
Production is.
At least flattish if not still higher than the third quarter and then you're guiding the total revenues down sequentially. So it does seem like you're assuming a good amount of that inventory unwind and I'm just trying to understand that because going back to Paul to your comments I mean.
It seems like automakers might not really be in a position to have that happen in the near term given the dealer inventory situations. So just I just want to try to square those two sentiments just trying to get really simple I mean, our Q3 revenue production was $14 four.
We benefited from it from inventory build in.
In Q4 production is $15 million was up 4%, we're not assuming that inventory build will continue.
What's the difference in our automotive businesses slightly down you're right sequentially. Those are the dynamics, because we're not expecting to get that additional revenue from shipping more than what's being produced at the OEM, Yes, that's auto right. So on HBO or Q3 to Q4, we're expecting the market to contract a little bit industrial Q3 to Q4, we're expecting.
The market to contract a little bit yes.
Yes, that's seasonal right, but that has to be factored into the Q3 Q4 transition as well Errol.
The other one that's up a tiny bit from Q3 to Q4, so when you look at the whole.
Mix of the business.
It's complicated, but when you look at the whole mixed guide makes sense.
It's just a lot of moving.
Phil the 95% little bit less than last quarter, but.
Last quarter, we are expecting more orders to drop out given some of the shutdowns were expecting a little less of that so that's why the film being a little lower we think is appropriate given where we're forecasting the revenue midpoint of guide.
Largely consistent with what we saw in Q3.
Thanks, Joe.
Our next question comes from David Kelley with century. Please go ahead.
Hey, good morning, guys and thanks for taking my question maybe just.
Just a question on the fourth quarter margin guidance.
The sequential view the step down from Q3, I am assuming in part related to the sequential guided revenue step down but could you just give us a sense of.
How are you thinking about some of the sequential input cost levers into the fourth quarter or if there is anything mix related we should be thinking through and modeling.
You got it right the difference from Q3 to Q4 the drop.
About $40 million ish.
And revenue and about <unk> coming out on the bottom line. So if convert a lot of it is just volume conversion and the leverage that we lose.
There was a little bit of expectation of higher logistics costs.
Logistics rates continue.
Eek up just given the constraints are a global logistics channels.
Those would be the two main drivers sequentially.
Thanks, Tim.
Our next question comes from Chris Snyder with UBS. Please go ahead.
Thanks for squeezing me in and also just kind of want to follow up on the commentary on the EV content per vehicle can be double ICU within five years. Because this is a really significant change from the recent plus 20% run rate.
Kind of impact us more.
It's not Super clear to me what is driving that.
80% Delta relative to expectations, just three to six months ago.
That's the market opportunity is stronger than they had been previously thought or share gains accelerating in the kind of based on what youre seeing on orders and then just wanted to confirm that this does not include incremental M&A.
Yes. It does not include incremental M&A.
So.
Again, the 20% is a demonstrated.
Capability, if you take.
2020 in 2021 total revenue from electric vehicles divided by electric vehicles produced at a 20% uplift from the balance of the automotive business right. So it's a demonstrated there's a lot that needs to happen in terms of seeing how those vehicle platforms rollout.
But the a lot of the business is one we are a long cycle business right. So the last several years, we've quoted the amount of new business wins that we've had that are really specifically focused on electric vehicles, we're getting a better feel for what capability or what products that we have will pork right over into the new electrified platforms as our customers start.
To put the finishing touches on their launch schedules associated with those and so we're just providing the visibility into the next three to five years, what we see and how that will transition.
It's no one knows the final answer as to how many electric vehicles, but if you use a $25, 30% total electric vehicle park in five years market's going to grow content is going to continue to grow.
And obviously in electric vehicles, we're going to continue to see.
Incremental content on those vehicles in the light vehicle market, but EBIT more accentuated in some of the.
Stationary equipment and heavy vehicle market, where we're providing more than just sensor content. So it continues to be a really exciting fast moving area.
That will continue to provide data points.
A reference point, so that you can.
Monitor our progress.
Thanks, Chris.
Our next question comes from Geodon or with <unk>.
Please go ahead.
Hey, guys.
I think we've got the most of the things at this point, but I'm just curious.
Your.
When you scale youre content things like that what does that contemplate in terms of megatrend spend associated with that and particularly as you do all these kind of bolt on that does that megatrend number ramp with that how do you kind of see that going over the next several years.
I think for next year, where our current planning model.
Staying at $50 $55 million range per megatrend spent the composition that spend may change. It may it may end up pivoting more towards.
Where we think the risk success will be in terms of scaling growth.
So more to come on that as we develop our guide for next year, but the aggregate number.
Right now the targets about you know keep it at 55 level.
Thanks, Joe.
Our next question comes from Jim Suva.
Uh huh.
Thank you for all the details thus far.
Question on the logistics and the supply chain issues.
Are you having to starting to consider.
Put into your contracts like additional riders or I guess indexing to raw materials are shipping or things like that because I'm. Just wondering if these things are prolonged so it could potentially protect your profitability. So I'm just kind of wondering how that's going because I know you have very long term relationships with your customer.
Or is it a long sighted visibility into the designs. Thank you.
Yes, so it's a great question, Jim typical contracts it was not unusual to have our rate of exchange riders or.
Metal commodity.
Drivers in them, but inflation riders are something that I haven't seen in a lot of commercial agreements, but we're clearly having those conversations.
That's the legal side of it. The reality is is that our customers want us to be able to serve them. We do have very long standing decades long relationships with our customers and we will get to the right answer with them in terms of navigating through this challenge.
Again, it's not it's never an easy conversation to have this type of discussion with customers, but but they understand the world we're living in.
They understand that the world that everybody is living in it.
For the most part we feel good but we will we will drive more into the contractual element, but it's a dialogue with them around how we partner.
Thanks, Tim.
This concludes our question and answer session I would like to turn the conference back over to Jacob Sayer for any closing remarks.
I'd like to thank everyone for joining us this morning and for hanging in there through all of those questions.
We will be participating in upcoming investor conferences, this quarter, including Baird's Industrial conference and Emilia Industrial Conference in New York during the quarter as Jeff mentioned, we also expect to offer a webinar on electrification components.
Energy solutions initiatives early next year.
We look forward to seeing you at one of those events or on our fourth quarter earnings call in early February.
Thank you all for joining us this morning and for your interest in and setup. Operator, you may now end the call.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.