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spk02: Greetings. Welcome to the GemTherm Inc. Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, EJ Brentano, Senior Vice President of Investor Relations. Thank you. You may begin.
spk01: Thank you and good morning, everyone, and thank you for joining us today. Jentham's earnings results were released earlier this morning, and a copy of the release is available at jentham.com. Additionally, a webcast replay of today's call will be available later today on the investor relations section of Jentham's website. During this call, we may make forward-looking statements within the meaning of federal securities laws. Statements reflect our current views with respect to future events and financial performance, and actual results may differ materially. We undertake no obligation to update them, except as required by law. Please see Gentham's earnings release and its SEC filings, including the latest 10-K and subsequent reports, for discussions of our risk factors and other risks and uncertainties underlying such forward-looking statements. During the call, we may discuss non-GAAP financial measures as defined by SEC Regulation G. Reconciliations of these non-GAAP financial measures to the comparable GAAP financial measures are included in our earnings release or investor presentation. On the call with me today are Phil Eiler, President and Chief Executive Officer, and Mateo Anversa, Chief Financial Officer. During their comments, Phil and Mattel will be referring to a presentation deck that we have made available on our website at jensum.com slash events. After their prepared remarks, we will be pleased to take your questions. Now, I'd like to turn the call over to Phil.
spk04: Thank you, Yijing. Good morning, everyone, and thank you for joining us today. I'm pleased with the continued strong execution of the GenTherm team despite the unprecedented global supply chain disruption and production volatility. The automotive industry continues to face semiconductor-related customer volume reductions and plant shutdowns, escalating freight costs, and other inflationary factors. In addition, volatile changes in customer production levels are creating significant near-term challenges predominantly related to managing variable production costs. For example, light vehicle production in our key markets in the third quarter was 19% lower than what was expected just three months ago. While our automotive revenues declined 8% in the third quarter, excluding the impact of foreign currency translation compared to a year ago, we outperformed light vehicle production in our key markets by 15 percentage points. In addition, we continued our momentum on automotive awards, securing $260 million in awards from global OEMs in the third quarter. On the cost front, we continued our disciplined approach to expense and working capital management while increasing our R&D investments. In addition, we've been negotiating with our customers and suppliers on reimbursements and price increases to partially offset the near-term material cost changes that we're experiencing as a result of the supply disruptions. We are now starting to realize some financial benefits from these discussions. In spite of the significant supply chain headwinds, on a year-to-date basis, we delivered adjusted EBITDA margin rate of 15.8% and generated $117 million in cash flow from operations, 60% more than the first nine months of 2020 and nearly 40% more than the first nine months of 2019. Mateo will provide more details on our financial results in a few minutes. Now, turning to the automotive highlights on slide four. In the third quarter, we launched our automotive solutions on 11 different vehicles across six OEMs, including General Motors, Great Wall, and Nissan. We continued to see momentum on our CCS product and launched on the GM Hummer EV, Great Wall Way, and the Nissan Infiniti QX60. On the technology front, I'm pleased to share that GenTherm was recognized in our partnership with Lear as a 2021 Automotive News PacePilot Innovations to Watch award winner for the N2 thermal comfort seat powered by our ClimateSense technology. Receiving this award is the outcome of our joint efforts that has resulted in a smart solution that delivers faster passenger comfort. On the battery performance solutions front, The fastest growing product in our portfolio is our cell connecting technologies. Our production program with BMW, scheduled to launch next year, is progressing well. We also continue to win additional development projects with several customers around the world, including our very first prototype samples with embedded cell censoring. Just last week, we announced our partnership with Datong NXP Semiconductors, to jointly develop a new cell connection system, leveraging the unique capabilities of both companies. This first-of-its-kind cell connection system will integrate the Datong NXP single-cell monitoring integrated circuit with the proprietary design of GenTherm's foil-based conductor to replace complex sensor cable harnesses. We see this partnership as an important milestone that will significantly advance electric vehicle battery performance safety, longevity, and improved user feedback. We're excited that OEMs and battery manufacturers are increasingly interested in our innovative mechanical structuring process because of the increased design flexibility and the ability to enhance overall safety of the lithium ion battery pack. On the climate sense front, we continue to see growing interest from global OEM customers, and we're making great progress on advanced development projects. And more importantly, our first production program is progressing very well. Our microclimate platform incorporates multiple thermal effectors, including next-generation CCS, neck conditioning, footwell and surface heating, all coordinated by our electronics and software, which utilizes GenTherm's proprietary thermal physiology-based algorithm. As the transition to electric vehicles accelerates, GenTherm is perfectly positioned with our breadth of solutions, including our core climate comfort products, climate sense, as well as our battery performance solutions, to help OEMs achieve their electrification goals by increasing vehicle range and energy savings, all while delivering a best-in-class personalized thermal experience. Now on to slide five to discuss automotive awards. In the third quarter, we continued our business award momentum and secured $260 million in new program awards across 13 different OEM customers. Our global team won 70% of the opportunities available to us. Of note, our win rate was negatively impacted because we did not win one opportunity against an incumbent due to the very short time to launch. Importantly, I'm pleased to share that nearly 40% of our awards in the quarter were for electric vehicles. We won multiple CCS awards, including platform wins with the Dodge Ram 1500, Ford Explorer EV, and the Lincoln Aviator EV. I'd like to congratulate our Stellantis customer business unit for winning both CCS and seat heater awards for the next generation Ram 1500. I'm pleased to share that we are now the exclusive thermal seat provider for this platform as a result of this conquest win. During the quarter, we received four steering wheel heater awards across multiple OEMs, including the Buick Enclave, Ford Mustang, Great Wall Way VV7, and the Geely Lincoln Co. eSUV. On the battery performance solutions front, we continue to make progress in expanding our business, winning air cooling battery thermal management awards for the Hyundai Kona and Renault Sunwoda. While our award dollars and win rate are lower in the third quarter compared to the first two quarters of the year, we continue to see strong momentum in quoting activities leading into the fourth quarter. Now let's turn to slide six for a discussion of our medical business. During the third quarter, we saw increased demand for our medical products, especially our flagship product, Blanketrol. I'm pleased to share that we secured a large Blanketrol purchase order to replace competitive devices at the Mayo Clinic in Rochester, Minnesota. In addition, we also secured a large upgrade award from Massachusetts General in Boston. These are just two examples of how we're driving market share growth in our medical business. In addition to growth in Blanketrol unit sales, we're also seeing increased demand from hospitals that are using our Hematherm equipment to treat COVID patients. As an example, in the third quarter, HCA Healthcare in Nashville, Tennessee bought 20 hemotherm devices for use throughout their network. In the third quarter, supply chain disruptions caused by parts shortages and production labor constraints impacted our ability to fulfill all of the strong customer demand in medical. We're working hard to address these constraints in order to meet the continued strong demand going forward. To summarize, I'm proud of the GenTherm team for consistently outperforming light vehicle production in the key markets we serve. Despite the headwinds in the global supply chain, we generated significantly higher cash flow compared to the third quarter of last year. While uncertainty remains about where production rates will be for the next 12 months, we believe there is significant pent-up demand that will need to be met once the unprecedented supply chain constraints are resolved. I'm extremely proud of our team's agility, flexibility, and dedication to deliver on all of our commitments to our stakeholders in spite of these tremendous challenges. We will remain focused on operational execution, innovation, and cash flow generation, all of which position us well to continue to deliver over the long term. With that, I'll turn the call over to Matteo for a little more color on our financial results.
spk00: Thank you, Phil, and thank you to everyone joining the call today. So let me turn to slide seven to focus on the items that most significantly impacted our third quarter results. For the quarter, product revenue decreased by 6% compared to the same period last year. And if we adjust for the impact of effects, our overall product revenue decreased by 7%. Starting with the automotive segment, revenue was $233 million, down by 7% compared to the third quarter of 2020. And adjusting for the impact of foreign currency translation, automotive revenue decreased by 8%. In comparison, according to IHS latest data, light vehicle production for our key markets of North America, Europe, China, Japan, and Korea decreased by approximately 23% over the prior year quarter. And as Phil mentioned earlier, we outperformed light vehicle production by approximately 15 percentage points. The majority of our product lines were impacted by the OEM shutdowns related to the semiconductor shortage. And specifically, CCS revenues decreased 7% driven by lower production volume of Stellantis NGM trucks and SUVs. C-THETER revenue decreased 16% due to lower production of GM trucks and SUVs, as well as lower production volume with Ford, Stellantis, and BMW. Electronics revenue decreased 20% due to the lower deliveries of the memory seat module to Ford as a result of their production shutdowns, and this decline was partially offset by higher RV-related sales. These negative effects were partially offset by higher sales in the other pipelines. And specifically, steering wheel heater revenue increased by 9% due to higher volumes with Tesla Model X and Y and Great Wall. Automotive cable revenue increased by 3% due to higher volume with Bosch. BPS revenues increased by 6% due to higher sales of the 48-volt Mercedes C-Class and the BMW e-mini, and other automotive revenue increased by 22% due to higher sales of neck conditioners. If we move to medical, revenues increased by 6% due to higher blanket roll and hemotherm sales, as Phil just mentioned earlier. Moving to the gross margin, gross margin rate for the third quarter was 28.5%. and this compares to 31.8 percent in the year-ago period. The 330 basis point decrease was driven by the negative impact from industry-wide supply chain disruptions, annual customer price reductions, as well as wage and material inflation. These were partially offset by cost recoveries from customers and supplier cost reductions. We estimate that the impact of the supply chain disruptions in the quarter resulted in approximately $29 million in lost revenue for JanTerm and $9 million in higher-cost goods sold due to higher material cost, lost productivity at the factories, and increased premium freight, partially offset by $4.5 million in cost recoveries from customers. Moving to operating expenses, which were $48.7 million in the quarter compared to $44.1 million in the prior year period. The 2021 third quarter amount included $0.7 million of restructuring charges compared to $0.3 million in last year's third quarter. So if we adjust for restructuring and acquisition expenses in both periods, operating expenses were $47.9 million up from $43.8 million in the third quarter of 2020. And the year-over-year increase of approximately 9% was primarily driven by higher research and development costs as we increased investment in climate sense and battery performance solutions, higher SG&A due to the reversal of the temporary austerity measures taken last year to mitigate the impact of COVID, partially offset by higher R&D income. Adjusted EBITDA in the quarter was $30.5 million compared to $50.1 million in the prior year period. And finally, adjusted diluted earnings per share in the quarter was $0.51 a share compared to $0.91 per share in the third quarter of last year. And our effective tax rate was 22.9%. So now moving to the balance sheet on slide eight. Our cash position at the end of the quarter was $195 million, up sequentially from $187 million in the prior quarter. The increase of $8 million was the result of $24 million free cash flow generation, partially offset by a repayment of the revolver and cash expenditures related to acquisition and technology investments. The $24 million free cash flow generation in the third quarter compares to $19 million in the prior year period, and the $5 million year-over-year increase was driven by higher cash flow from operating activities partially offset by higher capital expenditures. And notably, as Phil mentioned earlier, year-to-date, we generated $117 million in cash flow from operations and $88 million in free cash flow significantly strengthening our balance sheet. As of September 30th, the net debt decreased sequentially by $17 million, and total debt stood at $40 million, and we closed the third quarter in a net cash position of $155 million. Based on the trading 12-month consolidated adjusted EBITDA and the September 30th, we had 440 million of remaining availability on our line of credit, up from 432 million at the end of the second quarter. And the total available liquidity as of September 30th was 635 million, up from 618 million at the end of June. So now let me turn to slide nine for the 2021 guidance. And let me start by saying that the semiconductor shortages and related customer volume reductions continue to be extremely volatile, creating significant challenges in the foreseeable future. Based on our performance in the third quarter of 2021, the latest light vehicle production forecast, and the best information that we currently have from our customers and suppliers, we are updating the guidance that we last provided on September 14th. We are now expecting product revenues to be in the range of $1.02 to $1.05 billion, assuming FX remains at the current levels. And the midpoint of our guidance range implies an organic growth rate of approximately 11%. Additionally, we now expect adjusted EBITDA margin rate to be in the range of 14% to 15% in our effective tax rate for 2021 to be between 20 and 22%. Capital expenditures are now expected to be in the range of 40 to 50 million. And with that, I will turn the call back to the operator to begin the Q&A session.
spk02: Thank you. At this time, we will be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Luke Junk with Baird. Please proceed with your question.
spk03: Good morning. Thanks for taking the questions. Hi, Luke. Good morning, Luke. First wanted to ask about the guidance and specifically I don't know if you'd be able to outline any swing factors within the range. Just trying to think of what range of outcomes you're contemplating in the fourth quarter as we look at the low end versus the high end of guidance.
spk04: Sure, Luke. Let me jump in real quick first and just kind of frame it and then we'll try to answer the specifics there. I think it's pretty clear that the story of Q3 and then leading into the guidance for the remainder of the year, it's really around the supply chain volatility and especially related to semiconductors and the customer cancellations. I really want to emphasize that consumer and OEM demand continues to be very strong and growing for our product, for our thermal solutions product. We believe once the supply chain challenges are resolved, We're going to return to considerable revenue recovery and growth. And I believe a return to high teen EBITDA margin rates. If you take a quick look at Q4 of 2020, Q1 of 2021, I think those are solid proof points of what we can deliver and what we expect to return to. But with that, let me just give a quick view of what has and is transpiring for us specifically in the industry. You're looking back at Q3, the industry expectation is And at that time, the customer information we were getting was that we would expect to see a recovery in Q4. But certainly, late Q3 up until the current moment, we've seen a rapid deterioration in the supply chain situation, especially related to semiconductors, and driven heavily for us by customer order cancellations. Customer volatility and shutdowns are even at a higher rate in Q4 than we've seen previously. This is even though our customer orders are really running high. We feel we have to continue to assume that these cancellations will go on for the foreseeable future for us. Based on this, we really believe the IHS forecast for the fourth quarter is overstated. In addition, we're experiencing even higher volatility from our own semiconductor suppliers on our side. In fact, one of them very recently informed us of a supply gap to be expected in Q4 in this could have a significant impact on our Q4 revenue as well. So our guidance is based on all these points that I just mentioned, which is, as of now, the best information we have. We're continuously monitoring this, as you can imagine. Really proud of our operations and supply chain team and global employees led by Rafael Barcas. They continually find creative solutions to help us keep running. So although we expect this to continue for the foreseeable future, the information we're receiving from customers and our semiconductor suppliers would indicate that in 2022, we should return to a gradual improvement and possibly a recovery by the second half of 2022. So we're keeping our fingers crossed that that maintains and that we see things start to turn around next year. Mateo, you want to add anything to that?
spk00: So, look, specifically trying to narrow down your question on the fourth quarter. So, let me give you a little bit of color on what our thinking is. So, if you look at the midpoint of the annual guidance that we provided would imply a fourth quarter revenue that will be slightly below what we have experienced in the third quarter for the reasons that Phil just mentioned. would imply a revenue of about $235 million with an adjusted EBITDA rate of about 10% for the fourth quarter. So if you compare what we are expecting for the fourth quarter compared to the third, I think in terms of profitability, in addition to the decremental margin that you would normally expect in relation to the decremental revenue, we also expect to have higher cost net of recoveries in the fourth quarter compared to the third, particularly as it relates to spot buy and premium freight. And also, I think an important point to note is that the recoveries that we received in the third quarter actually reflect a cumulative amount from the negotiations that actually occurred that started a couple of quarters ago. So there is always a time lag between when the costs are incurred by GenTerm and when the recoveries are actually negotiated with the customers. And quite frankly, we also follow purposely the sequence as we try to go to our customer with the best and most complete information that we can have in order to actually maximize the amount of the recoveries itself. So that's a little bit the dynamics that are happening as far as the gross margin is concerned. And then one last comment I would make on the OPEC side, in line with what we have seen and also mentioned in prior calls, we are expecting the fourth quarter OPEX to be slightly above the third quarter. And it's going to be primarily, again, around R&D as we continue to invest in parity performance solution, in climate sense, and making sure that we have a successful launch on these awards that we secured in the prior quarters. So that's a little bit about the the dynamic that we're seeing and what we have factored in in the fourth quarter projection.
spk03: Thank you both for that. That was some really great color. Next question I wanted to ask about this quarter's awards. Phil has mentioned both in the press release and in your comments on the call here that 40% of those awards were for electric vehicles. And I'm just wondering if you could expand on what you're seeing in terms of Specific products, packaging, factors similar to that. Essentially the question is, are you seeing a higher hit rate and more content per vehicle on EVs, or is it maybe too soon to tease that out?
spk04: Yeah, I think, well, first of all, the quarter, the number of opportunities in front of us was a little bit lighter in the quarter, just to get to the specific award number. And that's a result of OEMs kind of pushing off some of the decisions. And I think a lot of that's based on their own resource constraints with the supply disruptions. So Q4 looks pretty good. And early part of next year, the pipeline of awards looks good. And definitely, as you say, a lot of EV opportunities in front of us. We're seeing a definitely – a higher uptake of our climate solutions and a higher content per vehicle, both on EVs. And, you know, there's this continuum that OEMs are looking at, kind of a transition from certainly more thermal devices in the vehicle to help them manage the power consumption. And, of course, that leads all the way up to climate sense. Obviously, that's the path we're actively working towards, but Things we're seeing, for example, seeing more cars with interior heated door panels and armrests, definitely higher rates of the seat comfort product and the steering wheels. All these are helping them to reduce the amount of power needed for the HVAC system. So that's certainly the place. And, of course, battery performance products, cell connecting and battery heating. We mentioned air cooling. product. So those all give us an added bit of content going forward.
spk03: And then if I could just squeeze one more in. It's now been three months since you disclosed the first ClimateSense commercial contract. Just wondering, Phil, if you could expand in your comments on the reaction that you're seeing in the market now that a customer has step forward and, you know, looking to commercialize that product. And, you know, in terms of your own capability set, also wondering to what extent you have capacity to take on additional development contracts, let's say, to the extent that there is interest in the market.
spk04: Well, let me start with the production contract we're working on. That is, the momentum on that project is really building with that customer. In fact, two weeks ago we had 20 of the top executives from that customer in our tech center to do a deep dive on the product, and the feedback we got was phenomenal. They're very excited about this, expect this to be a predominant feature in that vehicle when it launches. So that's really, we couldn't ask for better status on that project. When it comes to the development project, you're absolutely right. Now that we have a production project, that's absorbing a lot of resources because we have to do that flawlessly. And we have to prioritize the opportunities that are out there based on the strength of interest and potential upside opportunities with those customers. Luckily, we do have two customers that we're pretty active with in terms of doing development projects, testing, evaluations, and there appears to be some good promise with those. And that's pretty much maxing us out on resources. Obviously, we're continuing to present our solutions to other customers and kind of build that cadence over time. But, you know, I think things are transpiring exactly as we'd like on Climate Sense at this point.
spk03: Okay, great. Thank you for all of that color. I'll go ahead and leave it there. Thank you, Luke. Thanks, Luke.
spk02: Our next question comes from the line of Ryan Sigdell with Craig Hallam Capital Group. Please proceed with your question.
spk00: Good morning, Ryan.
spk07: Thanks for taking our questions.
spk00: Hey, Ryan.
spk07: Bill, you mentioned more conservative industry production outlook for Q4 relative to IHS. Helpful context there. Any sense for 2022 IHS forecasting about 10% production growth? Any directional thoughts at least relative to what you're seeing across the industry?
spk04: Well, you know, we kind of have this immediate short-term view, which is pretty tainted by repetitive, constant order cancellations from our customers, and it's not slowing down into Q4. So that makes it very difficult for us to forecast how this is going to transition into the early part of 2022. So it's really too early for me to speculate on what vehicle production might look like I can tell you that we get information, obviously, from our customers and from our semiconductor suppliers, and we're trying to triangulate that. There appears to be optimism heading into 2022, especially on the back half of 2022, and a gradual increase. But, you know, we have to be careful. We've heard that before, and so I'm a little bit cautious. But, you know, we're certainly – I can tell you what we're thinking and how we're gearing up is we're going to make sure once the floodgates open that we're ready to deliver. And we've been very cautious about keeping our labor in place, keeping our facilities primed for when this volume kicks up. As I mentioned, the feedback we're getting from our OEM customers is that their consumers continue to want our product and to expect this to continue to grow. We also have done consumer studies on our own, and the results on those are phenomenal. Folks who have our product in their vehicles basically refuse to have a vehicle without it going forward. So I think we're in a really good position, and we just have to be careful that we don't overreact on the cost side given the current situation and are ready to come out of the gates running.
spk07: Switching over to the auto awards, you mentioned NextGen, Dodge Ram, CCS, and Seat Heater Awards and exclusivity across that. How does that compare to the previous program? And then is the CCS, is that an active heat cooler or is it heat back?
spk04: That's a ventilated solution. We have the CCS previously. We did not have the heat only. So now we've taken that entire package for the Ram.
spk07: Got it. One other one on the Ottawa Awards. You mentioned one award stayed with an incumbent, which impacted the win rate, but it seems a bit surprising, I guess, to go from, call it 90-ish percent down to 70% from that one award. Is there anything else to call out there?
spk04: Yeah, it was a good-sized award. Excluding that, we would have been well north of 80%. That quotation was with a new customer. we kind of shoehorned our way into that discussion with the customer, got them excited about our product, and they allowed us to quote kind of last minute. We did a great job. They loved the product. They loved our pricing. But in the end, they looked at their timeline and said that they didn't have resources and really they didn't feel like they had the time in the development process to move to us. So the good news is we've really, you know, improved our relationship with that customer, and I think it's going to produce opportunities going forward. But, you know, we're very transparent. If we don't win an award, we keep track of that.
spk07: Hey, Phil, maybe a point of clarification. Is that a dollar value win rate, or is that just a pure quantity of opportunities?
spk04: Dollar value.
spk07: Got it. Last one for me, and then I'll turn it over to others. You have a growing and large amount of net cash on the balance sheet. Any updated plans on how you plan to utilize that?
spk04: Well, yeah, I mean, we kind of have following our same strategy. Number one is, you know, make sure we're cautious and protective of the balance sheet because the world is so volatile. as we all see, so that's priority number one. And as I mentioned, we're definitely on the lookout for potential acquisitions that could help us accelerate our growth within our focus growth strategy in the core areas that we're working on. And that continues. We're very active there, and we're hopeful that we can find some potential partners that we could fold in that would help us add to our technology portfolio, expand our scale a little bit, and certainly look at regional expansion. So those are all areas we're looking at, and I'm pretty excited that we're in the position that we can move on things like that. Certainly, if we're watching the stock price and if it makes sense, we'll execute on our approved buyback authorization.
spk07: Great. Thanks, Phil. Natale, good luck, guys.
spk04: Thank you.
spk05: Thanks.
spk02: Our next question comes from the line of Matt Garanda with Roth Capital. Please proceed with your question.
spk05: Hey, good morning, guys. Morning, Matt. Morning, Matt. So, Phil, I think you had mentioned in response to one of the earlier questions that there's a potential supply gap from a semiconductor supplier that could have an impact on 4T revenue. So I just wanted to double check, is that factored into the low end of the revenue guide for, you know, so that's implied in 4Q? And then just any more detail on the component that's seeing the most challenges, I guess.
spk04: Yeah, first part, it is built into the low end. And I can't give you a whole lot of detail, but, you know, it's clearly a critical semiconductor in one of our ECUs that we use. And, you know, we're actively working with that supplier, trying to find solutions. We're looking at redesign and alternative chips and actively engaging with our customer as well. They're scouring their landscape to find solutions. There are some options that are starting to pop up, but it's a little bit too early to tell if we're going to be able to fill that void.
spk05: Okay, that's helpful. And then any other detail on other components where you're seeing the most tightness? I guess, in your supply chain would be helpful.
spk04: Not really that many, to be honest with you, in terms of our supply tightness. I mean, obviously we're seeing inflationary pressures and a lack of willingness by some suppliers to negotiate price downs and value improvements right now. You know, everybody is swamped with just trying to keep things moving. So those are the biggest pressures we're seeing, but not a whole lot. Most of it is semiconductor related.
spk05: Okay, that makes sense. And then just one question on the guidance. So on the adjusted EBITDA margin cut, wondering maybe, Mateo, if you could just bracket out how much is coming from gross margin erosion versus sort of a bit more OPEX. I know you mentioned earlier that probably a step up in R&D spending related to all of the new programs that you're working on. So just wondered if you could maybe help us out on that front. And then I think you also grouped gross margin headwinds, at least in the release, into kind of three primary buckets. So I think they were like supply chain, price reductions, and then wage and material inflation. So just wondering maybe if you could do the same for what's kind of driving the gross margin outlook that's implied in the remaining guidance for 4Q.
spk00: Sure. So let me start maybe from the last part of your question, just taking the the third quarter numbers. So, the 330 bps decline in the gross margin rate year-over-year when you compare the third quarter of 21 versus third quarter of 2020. Let me start with the negative. The supply chain disruptions accounted for almost 390 bps, and this includes, obviously, the decremental margin and the decremental revenue, plus the the higher cost of goods sold that I mentioned in my prepared remarks due to premium freight, lost productivity at the factories and the spot buys. We had the usual annual customer price reduction, which is about 190 BEPs, and then wage and material inflation, which is about 70 BEPs. These are the negatives, and then these were partially offset by the recoveries that I mentioned, which is about 170 BEPs. And then we had other supplier cost reductions, which accounted for about 100 bps positive. So that gives you the landscape of what happened in the third quarter gross margin rate. And actually, I would stress the fact that if you exclude the net impact of the supply chain disruptions from these results, we would have actually achieved gross margin rate between 30% and 31%, which is what Phil mentioned in one of the earlier questions, what you would expect and what we actually proved that we can deliver in a more normal environment. So this is the breakdown for the third quarter. Now, as far as the fourth quarter is concerned, I think the primary driver of the reduction on the EBITDA rate is around, again, centered on the gross margin rate, and that's primarily due to the reasons that I just mentioned. And again, reiterating one point that I made earlier, that we expect in the fourth quarter to have, when you look at the cost of premium freight, lack of productivity at the factories, and spot buys, net of the recoveries, this cost will be a little higher in the fourth quarter compared to the third, just due to the timing of the recoveries. Overall, we have been able right now to recover approximately 50% of our non-inflationary costs, and we are working through with suppliers and customers to hold or increase this level of recoveries moving forward.
spk05: Okay, very detailed. I'll leave it there. Thank you. Sure.
spk02: Thank you. Our next question comes from the line of Scott Stember with CL King. Please proceed with your question.
spk06: Good morning, guys. Hi, Scott.
spk02: Good morning.
spk06: Phil, you said that fourth-core IHS, you obviously think that they're being overly aggressive probably. What are you baking into your guidance? How far off do you think they could be at the end of the day, in particular when you take into account some of the supply gaps that you talked about?
spk04: Well, I think it's difficult to say exactly. We think it's worse than third quarter, kind of, is the way we're thinking about it. And that's all based on the orders we're looking at, the rate of order cancellations, that we're seeing, the abrupt cancellations, kind of building that in. So I would use slightly worse than third quarter as a proxy for our thinking.
spk06: Okay. Got it. And then just lastly on negotiations for price increases, I know this is always a difficult process over the years. Do you feel that you will be able to get all of the relief that you need eventually?
spk04: Unlikely to get all of it. We're gradually chipping away and trying to get more. Kind of taking a four-pronged approach to it, Scott. One is obviously reimbursements for one-time costs, such as expedited freight and spot buys. Those tend to be a little bit easier, more discreet. Definitely looking at selective customers and methodologies to get price increases for inflationary pressure. That's much harder to do. especially given our contractual obligations to customers in certain cases. But where we can, we're using that. The last two are areas that are a little bit more long-term, but areas we find to be a little more successful. Those would revolve around negotiating lower annual price reductions in the next years. That's something that customers are more open to discussing. And then achieving better terms on new business awards. So what does that mean? possibly higher prices, leading to better margins on those and better terms overall. So those are the four ways we're approaching it. There are a lot of difficulties in the discussion, which have led us to only be about 50% successful so far. But I expect that to start opening up, especially as the situation starts easing, because think about the automotive industry. customer purchasing organizations, they're absolutely buried just trying to keep their plants running. And so being able to set up meetings to discuss these complex recovery discussions is not easy.
spk06: Got it. That's all I have. Thank you. Thank you. Thank you, Scott.
spk02: Ladies and gentlemen, we have reached the end of the question and answer sessions. I will now turn the call over to Phil Eiler for closing remarks.
spk04: Great. Thanks, everyone, for joining our call today. The results of the third quarter, I believe, demonstrate our continued focus on innovation, operational excellence, and cash flow generation. While we expect continued industry headwinds for the foreseeable future, our momentum in new awards, along with expanding demand for our new technologies and our continued focus on productivity, position us really well to deliver significant long-term shareholder value. We appreciate your interest and support and look forward to keeping you apprised of our progress.
spk02: Thank you. This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation and have a wonderful day.
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