Sensata Technologies

Good day, and welcome to the Sensata Technologies Q3 2021 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touch-tone phone. To withdraw your question, please press star, then two. please note this event is being recorded. I would now like to turn the conference over to Mr. Jacob Sayre, VP Finance. Please go ahead.

Thank you, Sarah, and good morning, everyone. I would like to welcome you to Sensata's third quarter 2021 earnings conference call. Joining me on today's call are Jeff Cote, Sensata's CEO and President, and Paul Basington, Sensata's Chief Financial Officer. In addition to the financial results press release we issued earlier today, we will be referencing a slide presentation during today's conference call. The PDF of this presentation can be downloaded from Sensata's investor relations website. This conference call is being recorded, and we will post a replay webcast on our investor relations website shortly after the conclusion of today's call. As we begin, I would like to reference Sensata's safe harbor statement on slide two. During this conference call, we will make forward-looking statements regarding future events or the financial performance of the company that involve risks and uncertainties. The company's actual results may differ materially from the projections described in such statements. Factors that might cause such differences include, but are not limited to, those discussed in our Forms 10-Q and 10-K, as well as other subsequent filings with the SEC. On slide three, we show Sensata's GAAP results for the third quarter of 2021. We encourage you to review our GAAP financial statements in addition to today's presentation. Most of the subsequent information that we will discuss during today's call will relate to our non-GAAP financial measures. Reconciliations 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. You will then provide an update on recent progress in our key electrification and Sensata Insights 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 segment performance. And he will also provide financial guidance for the fourth quarter of 2021. We'll then take your questions after our prepared remarks. Now, I'd like to turn the call over to Sensata's CEO and President, Jeff Kotak.

Thank you, Jacob, 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 increased customer demand, which drove 20.6% revenue growth from the prior year period to $951 million, slightly above the guidance range we provided in July. While 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 1,190 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 of outgrowth as a company, driven by 1,050 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. Sensato's revenue outgrowth to market will increasingly be driven by our enhanced positioning in megatrend areas. We continue to invest in these growth initiatives both organically and inorganically. with Zergo and now the pending acquisitions of Spear Power Systems and Smart Witness, expanding not only our capabilities, but also our access to end markets and 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. Sensata 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 of $2 billion enables Sensata to continue to acquire targeted, innovative businesses that will expand our presence in our targeted growth vectors. During the third quarter, we benefited from our 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 is a challenging exercise, but very necessary under the current circumstances. Despite these elevated costs, we delivered $201 million in adjusted operating income during the quarter, representing 21.1% in operating margin, substantially higher than the prior year period. I'd like to recognize the innovation, agility, and hard work of our entire team, achieving these strong results during the third quarter. During the quarter, Sensata published its first sustainability report, and we're very proud of our progress in these areas. Virtually every product Sensata 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. To that end, 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 report addresses sustainability topics core to Sensata's mission, including diversity, equity, 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 have established goals for our leadership team to improve female representation and management roles at Sensata to 30% and to reach 25% racial diversity in 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 executives' 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, Sensata is making excellent progress in winning new business and electrification components, in part because we take a holistic view of electrification and its growing impact on all the segments we serve. Electric light vehicles capture a lot of attention, and Sensata provides the manufacturers of these vehicles with not only new EV-specific components, but also with many of our innovative and differentiated components from traditional vehicles, like braking, tire, and environmental control. Specific to EVs, we also provide and are developing several components that enable safe and efficient operation of electrified platforms, such as high voltage electrical protection, advanced temperature sensing, highly sensitive electric motor position, and 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 in annual revenue. In addition, we benefit from the upgrading of certain systems in 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 package is upgraded and Sensata benefits. In the important area of braking, Sensata 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 leadership position in that market. We have 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 based on actual revenues and vehicle production. Our design wind activity within electrification has been growing rapidly. We saw an 80% rise in electrification winds 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're gaining and the products we are developing, we estimate that our battery electric vehicle content is on path to double that of an internal combustion engine vehicle on average within five years. On slide seven, we show how Sensata is expanding in 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 subsystems and full battery energy storage systems for customers in a multitude of end markets. Electrification is happening everywhere. not just in passenger vehicles. Manufacturers of 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 to provide electrified solutions to their customers. However, not all of these customers can design all aspects of the electrified solution in-house. Thanks to capabilities we have added via acquisition, Sensata can now provide either the subsystem of assembled components to manage battery charging in the form of a power distribution unit, or using technology from Lithium Balance and Spear Power, we can provide the full energy storage system, including battery management and a customized battery pack. By providing a full suite of offerings, our electrification and clean energy solutions, serviceable addressable market expands dramatically, reaching 15 billion by 2030. As an example of the solutions we offer, during the quarter, a large premier European heavy vehicle OEM awarded Sensada 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. This pivotal development means we can increase our content per heavy truck from the current 100 to 200 on average to more than 1,000 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 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 SPEAR, and we're 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 in 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 markets, and our go-to-market strategies in these key growth vectors for Sensata. We 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 in Sensata Insights. The Insights initiative addresses a fast and 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 shortage is constraining our Insights business, and we are unable to deliver on all of that expanding demand. You'll recall that these solutions are designed into customers' fleets. The revenue is sticky, and so our orders are 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 evidenced by the value-added nature of our solutions, we were recently awarded new business with telematics service providers and a large global shipping company, together worth more than $9 million in 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 comprise proprietary software and hardware purpose-built 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 and their surroundings to increase safety and lower insurance costs for fleets. Smart witness systems are logging 50 million miles of information every day. In sum, I'm 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 20.6% from the third quarter of 2020. Organic revenue increased 16.6%. The acquisition of Zergo increased revenue by 2.3%. And changes in foreign currency increased revenue by 1.7%. Adjusted operating income was $201 million, an increase of 29.8% compared to the third quarter of 2020, primarily due to higher revenues, partially offset by elevated costs related to the industry-wide supply chain shortages, higher spend to support megatrend growth initiatives, and higher incentive compensation aligned to improve financial performance. Adjusted net income was $138.6 million, an increase of 33.8% compared to the third quarter of 2020, largely due to the significant increase in operating income. Adjusted EPS was 87 cents in the third quarter, an increase of 31.8% compared to the prior year quarter. Now I want to 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 includes market growth of 470 basis points and outgrowth of 1,190 basis points, again demonstrating Sensata's ability to consistently outgrow its end markets. Our heavy vehicle off-road business posted an organic revenue increase of 58.9%, representing end market growth of 31.4%, and 2,400 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 NS6 emission regulations. And we are also benefiting from a wave of electrical, mechanical operator controls being installed in new off-road equipment. Our automotive business posted an organic revenue increase of 5.2%, representing end-market contraction of 21.6% and 1,150 basic points of market outgrowth. Our automotive business benefited from new product launches in powertrain emissions, safety, and electrification-related applications and systems. Recall, we saw an approximate $35 million inventory contraction a year ago as the 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 component delays. 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 continued 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 8.3% 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, an increase of 21.6% compared to the same quarter last year. Excluding the positive impact from foreign currency of 1.8% and the positive impact from the Zergo acquisition of 3.1%, 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 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 as 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 1.5%, Sensing 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 30.8%. The increase in segment operating income was primarily due to higher revenues. Sensing Solutions generated incremental margin of 46% in the third quarter on 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 and higher global incentive compensation costs aligned to our improving financial performance. Slide 15 shows Sensata's 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 and 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 the slide an adjusted operating income margin law from the third quarter of 2020 to the third quarter of 2021. As shown on slide 16, we generated $88 million in 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% of 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 to $155 million. Sensata's net debt to EBITDA ratio was 2.5 times at the end of September, the bottom end of our target operating net leverage range. Sensata's primary use of cash on hand is 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 shared purchase program within the fourth quarter, and as noted, we have $302 million available on our current purchase authorization. We are providing financial guidance for the fourth quarter of 2021, as shown on slide 17. Our expectations are based upon the end market outlook that I will discuss momentarily. We expect to generate revenues between $895 million and $925 million in the fourth quarter of 2021, representing a reported revenue change between a 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. To explain the impact of foreign currency and the Zergo acquisition, we expect an organic revenue change ranging from a 3% decline flat in the fourth quarter. Our current fill rate is 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 operating income margin is expected to be 20.3%, which includes 100 basis points of increased operating costs 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 and 31 million and adjusted EPS between 76 cents and 82 cents, which includes a two cent increase for foreign currency at the guidance midpoint. At the bottom of the slide, we have provided an adjusted operating income margin walk from the fourth quarter of 2020 to the fourth quarter of 2021. On slide 18, we provide our revised estimates 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. as we do not see production constraints from 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 abate considerably next year, a 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 Sensata's revenue growth in 2022 to align with the growth framework we have previously shared. Sensata's revenue by end market should grow consistent with each market's production growth, plus our target outgrowth of approximately 400 to 500 basis points across the whole company. In addition, We intend to continue our serial M&A approach to further expand our market position in our Megatron areas. We aim to have this activity at a material amount to revenue growth each year. Now let me turn the call back to Jeff for closing comments.

Thanks, Paul. Let me wrap up with a few key messages as outlined on slide 19. Sensata 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 Sensata across all of our end markets. We are making excellent progress in electrified components, clean energy solutions, and Sensata 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 through strategically important value-creating acquisitions and or 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 Sensata's long-standing mission to help create a cleaner, safer, and more connected world. not just for our customers' products, but also through our own operations. We believe we are meaningfully contributing to a better world. We are incorporating ESG considerations into our strategy, 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'll turn the call back to Jacob. Thank you, Jeff. We'll now move to Q&A. Given the large number of listeners on the call, please limit yourself to one question each. Sarah, please go ahead and assemble the Q&A roster.

Thank you. To ask a question, you may press star then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily while we assemble our roster. Our first question comes from Wormzy Mullen with Bank of America. Please go ahead.

Yes, thank you. I was wondering if you could maybe just give us some more color on the channel-fill dynamics, how broad-based this is. If we use $30 to $40 of content per vehicle, we're talking about roughly a million units. But the production changes are quite large. And, Jeff, you noted that going into 2022, it seems that IHS maybe is a bit too optimistic. So, Is the guide sort of a 4Q encapsulating all the channel inventory dynamics, or do you think this persists into 2022? And if I could, could you also just maybe quickly talk about the China issues, both around power rationalization and resurgence of COVID, if you're seeing any impact from that? Thank you so much.

Sure. So let me touch on Q4. So IHS forecast automotive production at about 16.5, 16.6. We've called it lower than that, about 15 million. In addition, given that we know there has been some of our parts built up in inventory, we are expecting a little bit of depletion on that. I think that's a little bit of a conservative guy, but we're watching it closely. We want to make sure that we're not going above and beyond to deliver for customers so they could just have it sit in inventory. We'd rather address that as it occurs and serve other customers because the shortage is impacting all of our customers in all of the end markets. As it relates to 2022, a couple of dynamics there. Obviously, we're not providing guidance for 22, but we like to look ahead as everybody does. Specific as it relates to the automotive market, the call right now, traditionally, AIHS 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 commit 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, increased capacity comes online, we think there will be a mitigation from the fourth quarter level. So it'll start to taper a little bit. So we'll keep monitoring that and give a perspective on 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 are 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's a continued opportunity for growth in those markets as we go into Q4 and also into 2022. And I've lost the question on China, I think is just around what's happening there in terms of COVID and so forth. You know, 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 there's 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 answers your question, Wamsi. Thank you, Wamsi.

Our next question comes from Matt Sheeran with Siebel. Please go ahead.

Yes, thank you, and good morning. Jeff, I just wanted to ask regarding your comment about doubling the EV content into light vehicles in the next five years from the base of about, I guess, 20% incremental content today. You know, where in that product portfolio would you see that coming? Is that from existing products and technologies or are there other incremental, you know, products or areas that you're looking at?

A little of both, but candidly, based upon my comments, I think the listeners probably can appreciate that we tend to be fairly digital in terms of what we've demonstrated. We got a lot of feedback that the 20% uplift was good, but not hugely exciting. We went back and realized that that is demonstrated capability that we're experiencing right now. We've seen a very dramatic uplift in the wins 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 NBOs. So when there isn't a new socket, but it's the same socket in the new application, that wouldn't count toward our NBO growth. And as we've said, there's a lot of content on vehicles that applies in battery electric vehicles as well as internal combustion engines. So we don't have to refill that pipeline. But a further evaluation of that trend, continued wins, more investment that we're making, 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 with number four. Please go ahead.

Yeah, thanks a lot, and thanks for taking my question. I guess my question really, Jeff, it's for you, but I think when you talk about the December quarter guide, you're sort of implying that, you know, Sensata's auto revenues will undergo auto production trends, as you mentioned, the depletion of your inventory that's sitting in the channel. Is that fair? Is there a way to think about how much extra inventory of Sensata is out in the channel and how long does it take to normalize? And if I could just ask Paul, could you just remind me how does free cash flow revert back to this 80% conversion? And does that happen in December, or is that more a calendar 22 narrative?

Yeah, so I'll hit the Q4, and then Paul can hit the other topic. So we've already stated we're 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 to deplete. So that's baked into the guide that we provided 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 for 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 of 24 days, just replenishing that back to a more normalized 50 or 60 would absorb a lot of that inventory 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 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 builds, 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 higher logistics costs and expedite fees to get customers' 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% conversion relates to 2021. It's lower than we originally anticipated when we started the year, and we made a conscious decision to build inventory, take our raw materials earlier to make sure that we were able to serve customers' needs. A conscious decision. For next year, I mean, we've been looking at a free cash conversion rate in the mid-80s, and that's what we're going to continue to target as good performance versus thought. Great. Thank you, Ahmed.

Our next question comes from Mark Delaney with Goldman Sachs. Please go ahead.

Yes, good morning, and thanks very much for taking the question. I was hoping you could 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 4Q and also into next year. What are some of the most difficult things as it relates to supply chain force and thought in any particular components that are most short for the company? If you could talk about the shortage you're seeing, not only for Sensata, but what you think is maybe impacting some of your customers as well, and any added color on that I think would be helpful.

Yeah, sure. So first, obviously, it's an industry issue. I think everybody understands that. It's not specific to Sensata. It's most acute in electronics at the foundry level. So capacity at the foundry level, I think these are sort of pretty well-known facts, and that capacity takes a while to get put in place. Now, over the last 18 months since that's been happening, Obviously, our suppliers have been moving their capacity around to serve needs. I think we've 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 experience it in our everyday. Everything's short today, right? Supply chain issues, not only capacity issues, demand question, but just logistics in general is very challenged in terms of finding labor to unload container trucks and so forth. So it continues to be a problem that everyone is experiencing. As we've talked about in the past, many of our electronics are customized. So we feel as though we've been impacted less as a result of that because in a lot of cases, Those are areas that our suppliers would focus on as opposed to more standard off-the-shelf electronics. Candidly, that's what's impacting our insights business a little more. The solution is differentiated and customized, but a lot of the electronics that go into it are more standard. So we're seeing a little bit more of a shortage and a crunch when 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 21, 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 Sensata shareholders are not the ones that – that take the hit. We want to be good partners. We want to deliver, but we need to share in the cost associated with making sure we can continue to deliver.

Thank you, Mark.

Our next question comes from Luke Young with Baird. Please go ahead.

Yeah, thanks, and good morning, Jeff. I was hoping you could comment further on the the view that bev content here is on a path to double isis in the next five years and was hoping if we could specifically talk about some of the key lovers and drivers that you're looking at in particular any products you see growing in importance versus and maybe the best ones to look at this would be directionally if we look at power related products versus traditional sensing products is there um something that leads here any additional color would be appreciated thank you

Sure. Yeah, 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 investment to make sure that we can serve our customers going forward. So that's the backdrop, right? We've always talked about the fact that although we have expertise in individual sensing parameters, pressure as an example, temperature, position, we have thousands of products that we bring to our customers. 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 of a contactor capability, we have the Gigavac capability, we have the Sherard capability with higher levitation. We have e-motor position that we've transformed from position sensors that we have. We have building capability around current sensing. A lot of our pressure and temperature apply in terms of the environment for an electric platform. So the goal is not to have one capability that we're relying on. It's to make sure that we're ubiquitous in terms of an EV platform. And the combination of the capabilities and product solutions that we have poured over, built on by the other applications like high voltage current 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'll continue to work at it, right? I mean, it's a very small portion of the fleet yet, but 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 as we're working with those customers to bring things to market very quickly. And that trend has created more confidence in our ability to see this being a real significant tailwind to us as a company. Thank you, Luke.

Our next question comes from Brian Johnson with Barclays. Please go ahead.

Thank you. You know, flesh out a little bit more the inventory question. I guess the first question is, you know, a lot of the pure auto suppliers have very severe decrementals due to the top start nature of production in the quarter. Is most of the work you do in automotive from a catalog and therefore not customized to an OEM? And does that allow you to have smoother decrementals when one model, one factory is up, one factory is down on your customer's end?

Yeah, definitely not every one of our products. We have 15,000 different products that we bring to customers. They're not drop-in. They are very much customized to the application, very frequently sole-sourced with them. I would just say that we've built inventory, and I think we've managed through this better. We're not the bottleneck with our customers, which is a nice place to be. We're in escalation with a lot of customers, but I'll tell you, I've talked with a lot of them and the feedback I get is we're not the biggest problem. That's good. I like not being the biggest problem and I'm okay with building a little bit of inventory to give a 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's going to come around, right? They're going to take that inventory out at some point and then we'll 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 our close eye on it. Thanks, Brian.

Our next question comes from Sumik Chamari with JP Morgan. Please go ahead.

Yes, hi, Samir Chatterjee. Hey, Josh. I guess when you outlined the content outperformance since 2018, and I think previously the narrative was about a 400 to 600 basis points outperformance, and you've consistently done better than that in both autos as well as heavy vehicles. So I'm just thinking with the roadmap that you have on electrification and battery electric vehicles, What are you thinking in terms of visibility, in terms of raising that outperformance guide, and are there any concerns about hitting an air pocket as the transition happens in the industry, or is it pretty much smooth sailing from here and that content outperformance should really start to continue to build from that level? Thank you.

Yeah, thanks, Amit. Historically, we reference outgrowth in automotive and HVOR, I think, to just make the story simpler. And by the way, we did that because of Mix and 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. We know markets will ebb and flow. That's the nature of the end markets that we serve. And that's why we've quoted the 570 basis points sent to 18 across the company. It's really driven by HVOR and auto, but we do see outgrowth in industrial and aerospace as well, just not as pronounced. The call for 400 to 500 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 has a lot to do with you're 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 we just want more time where we've demonstrated beating the target before we raise. We're going to share what we have a high level of confidence in. But certainly we've demonstrated the ability to do better than what we've said. We'll aim to keep doing that, but we feel really comfortable with the 400 to 500 across the company and then the other quotes of 400 to 600 in auto and 600 to 800 in HVOR going forward. So hopefully that helps. Thank you, Samick.

our next question comes from michael philip with barenberg please go ahead hi good morning guys thanks for the time um just on the doubling of the ev content not to be the dead horse there um just the margin profile of that extra content you're seeing on uh electric vehicles because maybe talk about how that'll impact sort of the business margin um and maybe where that margin profile is more attractive within the the actual electric vehicle content mix

Yeah. So we exclusively focus on really hard-to-do applications that will achieve differentiated margins. So we steer very clear of commoditized applications and use 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 capability. We always focus on them, right? And so we're not going to deviate. 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. You're getting the kinks worked out of automated manufacturing. You're gaining scale on your raw materials. You're utilizing your factory capabilities in terms of absorption. Your yields start to increase dramatically. But we're factoring that in. We don't see this transition as being hugely disruptive. The long-term margin profile of these products that we're engaging with our customers on will continue to have the differentiated margin profile that we have as an organization, as a company, and we'll 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 and make sure that we're competitive from a cost standpoint.

Thank you, Michael.

Our next question comes from William Dean with Drew Security. Please go ahead.

Thanks for taking my question. We've spoken quite a bit about inventory levels, but I still have a question about it. I'm looking to hopefully distill all of it into one comment. So can you remind us to what degree the excess inventory at your customers that you cited last quarter do you believe was in raw form to them. In other words, they were holding your part versus in a car that was 99% complete, just waiting for one semiconductor to drop in. Can you also remind us of the dollar of inventory you believed was in excess last quarter, what that is This quarter, again, because I've heard a couple numbers, but 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 you? Is this part of the build planned? Sorry for the long-winded question. Thank you.

Well, I'll try to spill this down to something simple. So we believe that our customers built about 25 million of inventory Q2 in 35 this quarter. And so we're shipping to them above production. With that said, given the fact that we think we're a very good supplier and we're not the bottleneck, the assumption would be, and there's no facts to support this, that a lot of our parts are probably sitting in vehicles that are work in progress, that will get released to the market at some point. given the fact that we're shipping well, we're having lots of discussions to meet their order 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. Hard to say when it's gonna unwind, but to Jeff's point, there's a lot of inventory levels in the dealerships are very low. So likely that's something that will need to get rebuilt, and so that's positive. That's a positive tailwind to what's being seen right now. Don't think that's going to change much in the current supply chain constraints that we're seeing, but it's likely a longer-term mitigating factor to some of this imagery that's been built with channel today. Thanks for the question, Will.

Our next question comes from Nick Todorov with Longbow. Please go ahead.

Yeah, hi. Thanks. Good morning, everyone. Jeff, I think I heard you talk about implementing a differentiated or different commercial approach to addressing the rising costs. Maybe can you 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 inflation costs you've seen so far, you've been able to pass through to direct customers so far this year. And how should investors think about once we start a new calendar year in terms of passing through those? Thanks.

Sure. So in 2021, we've recovered about half of the cost that we've incurred. And given that we're expecting those costs to continue, we're going to aim to get all of that going forward. Certainly, we've been able to achieve that in Q3 and Q4. So I mentioned that the first half of the year, we sort of held off on that until we determined whether or not it was going to be persistent. And it's not one size fits all. Every customer is different, and the tradeoffs are unique. But it's very strategic in terms of how we're engaging with customers to optimize all of the levers that we have available. But we're committed to making sure that we serve our customers, but that we share in the cost associated with achieving that outcome. Thanks, Nick.

Our next question comes from Rod . Please go ahead. Okay, thanks.

This is on for Rod. So just I wanted to clarify a couple of points. So I think you mentioned earlier there was about 100 to 125 million of inventory bill that you've experienced so far this year. So should we be assuming that inventory basically unwinds 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 you're experiencing this year would likely moderate if you continue to receive those recoveries?

And so, Ms. Paul, a couple of things. When we talk, you know, there's an year-over-year impact that we have to take into consideration. Last year, inventories were contracting. This year, they're 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, 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 there was a contraction. So it's how you want to think about year-over-year versus sequential, but just think of Q4 as largely related to the production that's being estimated. We're estimating at 15 is what we're going to serve, 15 million cars, Ex-Lyota, and Ford Sport.

And the only other thing I'd mention is I think you commented about the outgrowth. We exclude inventory from the outgrowth that we quote. Right.

When it's material. Thanks, Rod. Of course you're right, I guess.

Our next question comes from Joseph Spack with RBC Capital Markets. Please go ahead.

Thanks so much. And not to beat a dead horse here, but I know you're sort of talking about your fourth quarter outlook below IHS, and I know we've got to make some adjustments there because you look at it on your mixed 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 unwinds. And I'm just trying to understand that, because going back, Paul, to your comments, it seems like the automakers might not really be in a position to have that happen in the near term, given the dealer inventory situation. So I just want to try to square those two sentiments.

Just trying to keep it really simple. I mean, our Q3 revenue, production was 14.4, but we benefited from inventory build, right? In Q4, production's 15 million, so it's up about 4%. We're not assuming that inventory build will continue. That's the difference. And our automotive business is slightly down, you're right, you know, 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.

Yeah, and that's auto, right? So on HBOR 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. Yeah, that's seasonal, right? But that has to be factored into the Q3, Q4 transition as well. Arrow is 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 mix, the guide makes sense, and it's just a lot of moving pieces.

And the fill is at 95%, a little bit less than last quarter, but last quarter we were expecting more orders to drop out given some of the shutdowns. We're expecting a little less of that, so that's why the fill being a little lower we think is appropriate given where we're forecasting the revenue to be at the midpoint of the guide. So it's largely consistent with what we saw in Q3. Thanks, Joe.

Our next question comes from David Kelly with Jeffrey. Please go ahead.

Hey, good morning, guys, and thanks for taking my question. Maybe just a question on the fourth quarter margin guidance and the sequential view, the step down from Q3. I'm 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's anything mix-related we should be thinking through and modeling?

You got it right. The difference from Q3 to Q4, the drop, we're dropping about $40 million-ish. and revenue in about 16th coming out on the bottom line. So a lot of it is just volume conversion and leverage that we lose. There is a little bit of an expectation of higher logistics costs as logistics rates continue to eke up, just given the constraints are in global logistics channels. Those would be the two main drivers sequentially.

Our next question comes from Chris Snyder with UBS. Please go ahead.

Thanks for squeezing in. Also, just kind of want to follow up on the commentary on the EV content per vehicle, you know, can be double ICE within five years, because this is, you know, a really significant change from the recent plus 20% run rate. So, this... you know kind of unpack this more um i think it's not super clear to me uh what is driving that you know kind of like 80 delta relative to expectations just three to six months ago um is it that the market opportunity is stronger than than previously thought um are share gains accelerating you know kind of based on what you're seeing on orders and i just want to confirm this does not include incremental m a yeah it does not include incremental m a um

So, again, the 20% is a demonstrated capability. If you take, you know, in 2020 and 2021, total revenue from electric vehicles divided by electric vehicles produced, it's a 20% uplift from the balance of the automotive business, right? So it's demonstrated. There's a lot that needs to happen in terms of seeing how those vehicle platforms roll out But a lot of the business is, one, we have 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 pour 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. You know, no one knows that the final answer is to how many electric vehicles, but if you use a 25, 30% total electric vehicle park in, you know, five years, market's going to grow, content's 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 even more accentuated in some of the stationary equipment in every 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 and reference points so that you can monitor our progress. Thanks, Chris.

Our next question comes from Joe Giordano with Cohen. Please go ahead.

Hey, guys. I think we got to most of the things at this point, but just curious, you know, when you scale your content, things like that, like what does that contemplate in terms of megatrends then associated with that? And particularly as you do all these kind of bulk on it, does that megatrend number ramp with that? How do you kind of see that going over the next couple of years?

I think for next year, our current planning model is to, staying at $50 million, $55 million range per megatrend spend, the composition of that spend may change. It may end up pivoting more towards where we think the greatest 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 target is about keeping it at that $55 million level. Thanks, Joe.

Our next question comes from Jim Duva with Citi. Please go ahead.

Thank you for all the details thus far. A question on the logistics and the supply chain issues. Are you having to or starting to consider putting to your contracts like additional riders or, I guess, indexing to raw materials or shipping or things like that? Because I'm just wondering if these things are prolonged so it could potentially, you know, protect your profitability some more. I'm just kind of wondering how it's going because I know you have very long-term relationships with your customers and a long sight of visibility into the designs. Thank you.

Yeah, so it's a great question, Jim. Typical contracts, it was not unusual to have rate of exchange riders or metal commodity riders 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 today. That's the legal side of it. The reality 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'll get to the right answer with them in terms of navigating through this challenge. Again, it's never an easy conversation to have this type of discussion with customers, but they understand the world we're living in. They understand the world that everybody's living in, and, you know, for the most part, we feel good. But we will drive more into the contractual element, but it's a dialogue with them around how we partner. Thank you. Thanks, Jim. Thanks, Jim.

This concludes our question and answer session. I would like to turn the conference back over to Jacob Thayer for any closing remarks.

I'd like to thank everyone for joining us this morning and for hanging in there through all those questions. Sensato will be participating in upcoming investor conferences this quarter, including Bayer's industrial conference and Amelia's industrial conference in New York during the quarter. As Jeff mentioned, we also expect to offer a webinar on our electrification components and clean 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 Sensata. Operator, you may now end the call.

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