TE Connectivity plc (TEL) — Q3 2021 Earnings Call Transcript

Good morning and thank you for joining our conference call to discuss TE Connectivity's third quarter results. With me today are Chief Executive Officer, Terrence Curtin; and Chief Financial Officer, Heath Mitts. During this call, we will be providing certain forward-looking information and we ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning and we ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables along with the slide presentation can be found on the Investor Relations portion of our website at te.com. Due to the large number of participants on the Q&A portion of today's call, we're asking everyone to limit themselves to one question to make sure we can give everyone an opportunity to ask questions during the allotted time. We are willing to take follow-up questions but ask that you rejoin the queue if you have a second question. Now let me turn the call over to Terrence for opening comments.

Thank you, everyone, for joining us today as we discuss our third-quarter results and our expectations for the fourth fiscal quarter. Before we dive into the slides and details, I want to outline the current economic environment and our performance. We are witnessing strong global GDP growth, fueled by the recovery from last year's COVID shutdowns, with robust consumer spending and increased corporate investments. Our strategic focus on select trends is accelerating in our key markets, evident in transportation with growing electric vehicle adoption, cloud investment in communications, and ramping capital spending in industrial sectors for factory automation and digitization. While the recovery is faster and more robust than anticipated, supply chain challenges persist, causing volatility for our customers. Nevertheless, our strong results this quarter reflect the strength and diversity of our portfolio, with contributions from all three segments. We are generating sales, adjusted operating margins, and adjusted earnings per share that surpass pre-COVID levels, and we're optimistic about further growth and margin opportunities this year. I’m pleased with our execution in the third quarter, achieving records with sales exceeding $3.8 billion, adjusted earnings per share of $1.79, and adjusted operating margins over 19%. Our results exceeded expectations, supported by strong market recovery in most end markets, our leadership positions, and exceptional operational performance from our teams. Importantly, our growth is also propelled by the secular trends that will continue to support our market outperformance moving forward. We are on track to achieve approximately 100% free cash flow conversion for the full fiscal year and expect our orders in the third quarter to remain consistent with the second quarter. Our fourth-quarter sales are expected to be roughly flat compared to the third quarter, leading to projected adjusted earnings per share of $1.65. Each segment is driving growth and margin contributions, with increased cloud investment in communications, rising capacity and factory automation spending in industrial, and growing electrification trends in transportation. Looking at the automotive sector, consumer demand remains strong, but semiconductor supply issues are impacting production. We're anticipating global auto production to reach about 19 million units in the fourth quarter, with significant content growth per vehicle due to electrification trends. In industrial, we see ongoing improvement benefiting our equipment and energy businesses, while orders in medical are starting to recover. However, our aerospace and defense business remains stable at current revenue levels. In communications, consumer demand and capital expenditure trends in cloud applications are strong. Our global factories are operational, and we're focused on employee safety while helping customers benefit from economic improvements. In summary, our third-quarter sales of $3.8 billion reflected strong performance, up over 50% year-over-year, with consistent orders of $4.5 billion. We'll continue to balance returning capital to shareholders with strategic acquisitions, such as our recent agreement to acquire a European connector manufacturer. Looking ahead, we expect sales in the fourth quarter to grow in the high teens year-over-year, with adjusted earnings per share expected to increase by 40%. Now, I’ll turn it over to Heath for more financial details and our outlook moving forward.

Thank you, Terrence and good morning everyone. Please turn to slide eight where I will provide more details on the Q3 financials. Adjusted operating income was $734 million, up significantly year-over-year with an adjusted operating margin of 19.1%. GAAP operating income was $714 million and included $11 million of restructuring and other charges and $9 million of acquisition-related charges. We still expect total restructuring charges to approximate $200 million for fiscal 2021 as we continue to optimize our manufacturing footprint and improve the cost structure of the organization. Adjusted EPS was $1.79 and GAAP EPS was $1.74 for the quarter, which included restructuring acquisition and other charges of approximately $0.05. The adjusted effective tax rate in Q3 came in as we expected at approximately 18% with our fourth quarter tax rate expected to be around 20%. We continue to expect our adjusted effective tax rate for the full year to be around 19%. Importantly, we expect our cash tax rate to stay well below our reported ETR for the full year. If we turn to slide nine, our results and progress you see on the slide reflects the strength and diversity of our portfolio and business model execution. As Terrence mentioned, we delivered record performance in Q3 on sales, adjusted operating margins, and adjusted EPS. We are not only showing progress versus the prior year, but we are also delivering higher sales margins and adjusted EPS versus fiscal 2019, which represents a pre-COVID baseline. Sales of $3.8 billion were up over 50% versus the prior year and up 3% sequentially with solid performance in each of our segments. Currency exchange rates positively impacted sales by $138 million versus the prior year. Adjusted EPS of $1.79 was up significantly year-over-year and up 14% sequentially reflecting our strong operational performance. Adjusted operating margins were 19.1%, also up significantly versus the prior year. Year-to-date our adjusted operating margins are running at around 18% and our fourth quarter is expected to be a continuation of this strong performance. Turning to cash flow, in the quarter cash from operating activities was $682 million. We had very strong free cash flow for the quarter of $539 million and year-to-date free cash flow is approximately $1.5 billion. In Q3, we returned approximately $445 million to shareholders through dividends and share repurchases. Our cash flow performance demonstrates the strength of our cash generation model. And we continue to expect free cash flow conversion to approximate 100% for the full year. We remain committed to our disciplined use of capital. And over time, we continue to expect two-thirds of our free cash flow to be returned to shareholders and one-third to be used for acquisitions. As Terrence noted, we entered into an agreement to acquire ERNI earlier this month. And we expect to close by the end of this quarter. ERNI has revenues of approximately $200 million annually, and will be reported as part of our industrial equipment business. Before we go to questions, I want to reiterate that we are performing well in this environment, despite challenges in the broader supply chain. Our results for the quarter and our performance so far this year demonstrate the strength and diversity of our portfolio with contributions from each of our three segments. We delivered record performance in Q3. Our fourth quarter guidance represents a continuation of our strong performance. And we are excited about growth and margin opportunities beyond this fiscal year in line with our business model. Let's now open up for questions. Sujal?

Okay. Ludy, could you please give the instructions for the Q&A session?

Yes. Good morning. And thanks very much for taking my questions. Terrence, you mentioned several secular trends that the company is addressing and longer term that TE can grow revenue and margins. So I was hoping you could speak a bit more about what the company is seeing with respect to this industry backdrop? And what that may mean for the company's fundamentals in the intermediate to longer term.

Thanks, Mark. We're very proud of the performance we've delivered. However, much of the recovery in our business is still in its early stages. To address your question, it's important to highlight where we can meet demand. This quarter, due to some supply chain challenges at TE, we estimate around $100 million in revenue across our segments that we were unable to deliver to customers. We are still working to meet the existing demand. We anticipate a similar revenue impact in the fourth quarter as a result of supply chain issues related to materials like metals and resins. When looking at the automotive sector, production this year, with the expected $19 million in the fourth quarter, remains significantly below 2019 levels, where we saw $88 million units. The semiconductor supply chain challenges continue to impact us. However, as we look ahead in this cycle, we expect auto production to increase, which will support our growth. In the industrial sector, which I mentioned earlier, things are just beginning to take off. Our medical business is gaining momentum, and our resilient energy sector remains strong. We are also seeing growth in industrial equipment as capital expenditures are on the rise. In the communications cloud sector, capital expenditures increased by 20% this year, with a forecasted 10% rise next year. We still have room for margin improvement in two or three of our largest segments, and we are addressing supply chain challenges that many in the industry are facing. We remain optimistic about margin recovery aligning with our business model going forward. The overall cycle indicates a recovery, and we are pleased to see consumer activity increasing, whether in automotive or appliances. Businesses are also starting to engage more. While the growth may be uneven, the indicators we have at TE are encouraging.

Okay. Thank you, Mark. Next question please.

Hi, good morning, Terrence and thanks for taking my question. Wanted to focus maybe on the fourth quarter earnings guidance implies based on our math sequentially lower margins relative to the third quarter. It feels like we're seeing rising input costs some ongoing supply chain disruptions but also improved pricing and clearly volume recovery. So with that out of mind, could you talk about some of the dynamics that play here in context of how you're thinking about the fourth quarter margin trajectory?

Sure, David. This is Heath. I'll take the questions. Listen, I mean, first of all I think what we effectively had commented in my prepared statement was we're running at around 18% year-to-date in terms of margins. And we see that more or less continuing as we work our way into the fourth quarter. If you pick a particular quarter you're going to have timing issues given the – how diverse we are, how we're set up globally. You're going to have timing issues in any one particular quarter. So I think you've got to be careful about just picking out a quarter and trying to compare it forward or backwards. Within our world there is price-cost differences between the different businesses. In some cases we're able to pass along that price more quickly, particularly if it runs through our channel partners where we have distribution in some of our businesses. Some are heavier dependent upon that. And in places where we don't have that distribution partner and that mechanism to pass along price that quickly it takes a little bit longer. So the realization of that is very mixed within our portfolio. The other thing to consider is we're still as we've talked about in the past we're still on this restructuring journey with some of our footprint optimization. And as part of that, you're going to have timing issues of when you start to realize some of those savings versus the cost of getting some of those things done and you spend a little bit ahead before you take things offline. So there's all kinds of different moving parts in a portfolio like ours. From an EPS perspective sequentially, we will have from a third quarter to fourth quarter we will have a tax headwind. Our tax rate is going to step up a couple of hundred basis points and that's fairly normal in terms of timing for the fourth quarter. So some of the EPS drop sequentially is tied to that tax rate.

Okay. Thank you, David. Next question please.

Good morning. Thanks for taking my question. I guess Terrence, I wondered if you could maybe expand a bit more on the supply chain dynamics you've talked about. There's been a fair bit of discussion around this by everyone including your peers. So I'd love to get your perspective on what does really all of it mean for TEL. And maybe you can explain what are the supply chain pressures you're referring to? And then what impact does it have with your operations and P&L broadly? Thank you.

Yes, thank you for the question. Regarding our supply chain, we're currently using more coal than we would prefer. It all begins with the demand from our customers, so let me elaborate on that. Customers are focused on recovery, and for instance, think about a car that consists of 30,000 parts. If they cannot procure a few essential parts, it severely hampers their ability to manufacture vehicles. Right now, due to the rapid recovery, there's a lot of scrambling among suppliers, and the data signals from our customers are changing frequently as they try to meet demand. The supply chain is experiencing significant volatility due to these factors, with some customers even halting production because of shortages, like with semiconductors, which adds to the instability. From TE's perspective as a manufacturer, we start with basic materials for our innovations. The primary materials we utilize include various plastics, ranging from commodities to highly engineered resins for flame retardancy and temperature, as well as metals for conductivity. We've faced disruptions in resin and metal availability, which is not typical for us, and as a result, we’ve had to adapt by managing worldwide supply chain logistics. The pressures we’re facing are related to supply constraints and global shipping challenges. Our goal is to ramp up and support our customers through this period. While we have been navigating these challenges during the recovery, I wouldn’t say the situation is improving. Instead, we anticipate dealing with these issues throughout our fiscal year and into the beginning of next year as we adjust to a recovering market. This quick recovery is evident in both our orders and supply chain dynamics as everyone strives to catch up. I hope this provides some insight, and I believe our teams have been effectively managing these challenges related to volume, pricing, and productivity as reflected in our results.

Okay. Thank you, Amit. We have the next question please.

Thanks. Good morning. Terrence, you talked about some of the BEV wins and how that doesn't really impact the numbers today, but it helps for future growth. I was wondering, if you could help dimensionalize that for us at all. Like, maybe quantify the bookings in this quarter or the lifetime backlog? And how fast are some of those factors going? How should we think about that?

So, number one is from a momentum perspective, the momentum that we've talked about has not changed. And there's really two factors. We benefit from our global position. We also benefit from the technology that we bring as you move to high-voltage architecture, whether that being connecting, it being to sensors that are resolvers and current sensors when you get into electric motors. And when you look at it to conceptualize a little bit, I'll go back to what I talked a little bit about last call or the call before which is what it means to our content. A few years back, we were in the low $60s before in content. We're in the 70s now. And when you think about that $10 increase in content, approximately half of that is due to high voltage. So that's about $5 of content at the total TE level across all production that has translated into revenue. And that's a key driver as we say for our content can grow above $80. So realize there's only 9 million electric vehicles made this year. What's great is that that adoption continues to accelerate. It didn't stop during COVID. And certainly, as that accelerates, that's going to continue to drive content outperformance for us. And it actually just continues to accelerate all around the world and it's nice to see the traction in places even like the United States which has always been a slower adopter of the technology actually pick up as well as the models that are coming out from all our global customers are showing how this trend is picking up.

Okay. Thank you, Joe. Can we have the next question please?

Good morning guys.

Hey, Scott.

It's great to see you navigating through these challenging times and succeeding. I wanted to touch on the previous question regarding the Chevy Bolt recall, particularly concerning the architecture used in the high voltage system. Are there lessons from that recall that could enhance your content growth moving forward, especially in terms of adding more backup and safety systems related to high voltage? Is there any insight to be gained from this situation, or is it just the same as before?

Scott, that's a great question, and it's good to hear from you. Regarding whether the learning from that recall leads to additional content, I wouldn't say it does. However, it does highlight the rapid advancement of technology, especially in terms of architectural evolution. Consider how long the development of combustion engines took and how manufacturers rolled out their models. There will be instances that provide insights into how to strengthen the electrical architecture. I don't foresee this creating new content opportunities. However, for us at TE, when these issues arise, we are the type of company they turn to. We operate with voltages up to 1000 volts, contributing from the charger inlet to the motors and high-voltage systems, as well as in cell-to-cell and module-to-module connections and sensing capabilities. GM will certainly work hard to prevent such events in the future, but it also presents a larger opportunity for us to enhance our partnerships. On GM's new truck platforms, we have substantial content that aligns with the 2X content we've discussed.

Okay. Thank you, Scott. Can we have the next question please?

Thank you. My question is around TE's high voltage differentiation. The company has invested significantly in both developing and scaling these solutions globally in recent years. And is this leading to high-voltage share gains relative to low voltage? It also seems like the OEMs would lean more heavily on top suppliers, just given how important these initial EV rollouts are? And then particularly, within high voltage as it's a new, but also extremely critical component for them?

Yeah. So Chris, when we look at it I think – let me take a step back just for a second. With what we do around our interconnect and sensing portfolio, anywhere you have data, you have power, you have sensing and guess what getting into smaller packages and then higher power and higher data that's what our engineers do. And so when you deal with high-voltage architecture in a car, certainly, our customers that's why they like the position we have and it's a global position as I said where we design all around the world with all the OEMs. So when you think about it, it is – one point, I want to highlight is the low voltage architecture carries over for us, because you're not putting in your low voltage applications onto the battery and the motors. So our low voltage carries over. And where we really get into – and I mentioned it to Scott's question it starts at the charging inlet. It goes into how does – you get the connections and the sensing occur, around the high-voltage connection that you need around the motors. It gets into the battery solutions. It gets into the contactors that we provide to switch the power over as you go from DC to AC and back, as well as the position in the current sensors. So it's completely across, and I think the other thing that's unique for us versus some others that might be a Tier 1 – now we're Tier 2. Our customers really like that we're agnostic. We are there to solve their challenges that they're trying to get to. How are they trying to solve fast charging? What type of cells are they using in their battery pack? And that agnostic element is what they really like about our global position as they come into and we focus on the connection systems. We don't get complicated about harnesses and other things. That's what the Tier 1's do. But it's really about the connection technology that we invest in as they think about the platforms and how they have to evolve these platforms. And that's where you get the content increase that we mentioned and we shared examples. But it gives us a real content opportunity to double our content in electric vehicles. And like I said earlier, the content growth you're seeing in TE about half of it over the past couple of years is due to high voltage wins.

Okay. Thank you, Chris. Could we have the next question please?

Yes. Thank you. Terrence, you had a pretty solid fiscal third quarter. You're guiding to a pretty strong exit for this fiscal year. Can you maybe share some early thoughts into next fiscal year? It feels like there should be some nice production growth since other end markets seem to be in recovery mode as well. So, any bookends around dimensioning fiscal 2022 will be helpful? Thank you.

Thank you, Wamsi. I want to emphasize that we are only providing guidance for the fourth quarter, and we will give you more insight in 90 days regarding our outlook for 2022. Before discussing the markets, I’d like to highlight our business model. It's centered around our content and the various markets we serve, as well as leveraging the improvements Heath mentioned regarding restructuring. We are not yet at our target margin in two of our three segments, and we're focused on using our capital to provide returns to you. In transportation, we see continued opportunities for growth in production. Semiconductors have been a challenge this year, but we anticipate improvements in 2022. Additionally, consumer demand and reduced inventory at car dealerships suggest that auto production may increase, which will benefit our content. In industrial manufacturing, capital expenditures are rising, particularly in semiconductors and automation, which we are taking advantage of. The medical and energy sectors also show promising growth. However, we do not see any signs of progress in aerospace and defense; while consumer trends are good, the supply chain is lagging. In communications, we expect cloud services to remain strong, particularly regarding appliances. Consumer engagement is robust, but there may be a normalization phase ahead, possibly in 2022 or later. Overall, I am optimistic about how the end markets are aligning for 2022, and we will provide more details in 90 days.

Okay. Thank you, Wamsi. Could we have next question please?

Hey, guys. Good morning.

Hey, Joe.

I'm curious about the customer inventory situation regarding component parts in the auto sector. There's been a lot of varied commentary from different companies during this earnings season. Can you explain how you ensure you understand what percentage of the orders you're receiving are for actual car production versus stock building by your customers? What is your internal process for clarifying this?

Well, a couple of things that we do. So, it's not unreasonable to assume that people will be trying to hold a little bit more buffer stock right now. But as I said, we're not even able to make current full demand and I said that was about $100 million. We do actually make sure as we check with our customers. Actually in some cases, we visit their warehouses to make sure we don't see hoarding occurring. And we also talk to our OEM customers. Because let's realize in some cases we ship into Tier 1s. And there's lots of discussions between the OEM, the Tier 1s to make sure flow continues to happen. So, I'm sure in some parts, there may be some people trying to build up a little bit extra buffer stock, especially in the supply chain environment. I would tell you we're still trying to get to make sure we keep demand flowing to keep production going with the OEM lines.

Okay. Thank you, Joe. Could we have the next question please?

Yes. Thanks. Also wanted to double down a little bit on the relationship between orders and consumption, and as pertains to revenue. I'm wondering if there's any mismatch relative to the actual production now with the transportation segment specifically that we might qualify our view of production advancement next year? And then, as far as orders go, would we anticipate a quarter or two where maybe you have the reciprocal of what we're seeing now and kind of mismatched the other way with the continued outsized book-to-bills for the trailing periods?

You raised three questions, so let me start with the overall company perspective. We received $4.5 billion in orders in the last quarter and this quarter, and in this quarter, we fulfilled $3.8 billion. The difference is larger than usual, with about $100 million of that being genuine demand that we couldn't meet due to our supply chain issues. The rest of the gap can be categorized in a couple of ways, and we analyze it across our various end markets. Approximately half of that shortfall relates to our distribution partners. They are finding it difficult to source goods from us and are turning to our channel partners for procurement. Over the past two quarters, we’ve noticed a significant increase in orders from these channel partners. However, their inventory levels remain similar to last year, indicating that their turnover rate has improved, but we still cannot fulfill their orders to the extent they are placing them. The other portion comes from our direct OEM customers, who are cautious about ensuring that TE parts are not the bottleneck in their production. Some have adjusted their ordering patterns by planning further ahead due to the current situation. As the supply chain improves, particularly in transportation, we expect the order-to-billing ratio to stabilize. Typically, the transportation book-to-bill rate is around one, not above that. As conditions improve, we anticipate that orders will align more closely with billings.

Okay. Thank you Chris. Operator, next question please.

Hi. Good morning. Thanks for taking my question. Terrence, I wanted to follow up on your comments about order trends by geography. It seems like Europe is somewhat of an outlier, where you are experiencing some weakness in orders. Can you elaborate on what you are observing in Europe regarding the differences and the recovery, and why the order trends are distinct from the other regions?

No. Honestly, when you look at that, I know it's down by about 7% sequentially. I would say, when you look at that that's more around some of the normal summer shutdowns in transportation. Then I would say, it's a big deceleration. I would say, we continue to see orders even as we're into July stay at elevated levels, because the conditions we're in aren't changing. And I wouldn't say, it's one barometer negative or positive. It's just a little bit slower. And certainly we would normally see that as some of our customers do summer shutdowns in Europe in the automotive space and they are still doing those.

Okay. Thank you Samik. Operator, next question please.

Great. Thanks for taking my question. Terrence, you mentioned earlier this fact of manufacturing where a car has 30,000 parts or whatever it is and you need all of them to make the car, not just a subset. Even if you're missing a couple you have a problem. It's certainly true in almost all products. In autos though, I'm sure you'd acknowledge that there are cases where these companies can decide, well, there's a feature or two that we can isolate and perhaps decontent it and get a car shipped. We're picking this trend up pretty clearly from multiple sources that we're seeing decontenting going on in order to get around the shortages. I'm wondering if TE is seeing this. If so to what degree? And in particular does it take away from your growth in sort of the next couple of quarters in any way where perhaps a more content-rich car would have provided a better opportunity. But what the company is shipping is something of a smaller content opportunity or vice versa?

Hey, Will, great question. Number one, let's face it. The auto manufacturers are being creative because there's consumer demand. And let's face it, they want to get the vehicles out. And if there's a feature where they can't get a component, they certainly are taking some of those features out near-term. I would tell you on our revenue, while we do see that around certain OEMs, that is not having a meaningful effect. Where we play in the core architecture and the electrical network as well as in the backbone in an EV, you may lose a couple of interconnects, but that is not that much from a big-picture content. And even if you look at our content growth this year over production, it's not evident in any way. So I would also say in this type of environment while you have some of that decontenting, they are also being able to add options to it, which we also benefit from. But that isn't meaningful and a big number either. So it would probably impact others more than us. But with our breadth that we have across where we play in the architecture, while they're doing it, it's not having a meaningful impact on TE.

Okay. Thank you Will. Next question please.

Yes, good morning. Terrence, I wanted to just ask about the strength that you're seeing in the communications segment and specifically the cloud business and the margins there. It looked like record margins. So the question is how sustainable is that? And then within the cloud demand side, how diversified are you? I know obviously there's just a handful of really big hyperscale players, but in terms of the diversification and the lumpiness of that business if you could provide more color?

Sure Matt and thanks. Let me discuss the cloud aspect first, followed by the segment margins. The cloud element has been impressive. For those who follow us, we made a strategic decision years ago to prioritize our D&D business towards consumer high speed. I recall when our cloud customer revenue was under $100 million, and now it exceeds $300 million. Our market share, which was once limited to one cloud provider, is now well-distributed across all major cloud providers both in the U.S. and internationally. This expansion, along with gaining market share, stems from increased CapEx investments and our team’s effective execution in enhancing share, while also introducing significant technology. The cloud environment remains robust, with close to 20% CapEx growth noted, and we anticipate double-digit growth next year as well. This growth is influenced by the ongoing shift toward next-generation content and the introduction of new chips in servers, which benefitted from our next-generation offerings. We feel very confident about our positioning in this area. Furthermore, the segment margin performance has been strong, bolstered by our cloud initiatives and our prominent appliance business, which has significantly contributed to that segment's margin. We believe this business can maintain high teen margins going forward. With both segments performing well, they are positively impacting overall margins. While there may be some pressure as the appliance segment normalizes, we remain proud that this segment is exceeding target margins.

Okay. Thank you, Matt. Can we have the next question, please?

Hi. Good morning, everyone. Terrence and Heath, I was just curious if you could talk about when you start considering some of these supply chain pressures and inflation pressures to be sort of a new normal and how you might change managing your supply chain? How you might change hedging? How your customers might change? And within that context can you just, sort of, give us a baseline for what you're doing on hedging inflation? Thanks.

Sure, this is Heath. I'll address that. Our main input pressures that affect our profit and loss relate to resins and certain specialty metals used in our products. We generally have a hedging program for the metals, which covers about 18 months of our expected usage and purchases. When there's inflation or deflation regarding the metals, it gradually affects our results in both directions. This remains consistent, and we will continue with this approach. A larger issue we face falls under the broader supply chain category. Local sourcing is beneficial as it allows for much greater agility and responsiveness in our operations across Asia, Europe, and the Americas, enabling us to procure products locally instead of shipping them globally. However, supply chain disruptions in specific locations can arise from natural events like floods, or incidents like the situation in Texas earlier this year where many chemical companies went offline, which put pressure on resins and other materials in the Americas. Events such as these require us to adapt to our customers' needs, which sometimes involves relocating our supplies globally, and that can increase costs significantly. In essence, freight costs contribute to some of these supply chain pressures due to our structure. We will continue to leverage local supply chains while ensuring we maintain flexibility going forward. Regarding our ability to manage these pressures and when we might consider them the new norm, I cannot say for certain. While the semiconductor issues do not directly affect us, they do impact our customers, and you may have better insights on when those shortages will lessen. Concerning other factors relevant to us, we are addressing them and feel confident about our readiness for fiscal year 2022.

Okay. Thank you, Steve. Can we have the next question please?

Thank you. And my one question is actually a follow-on to your response Heath that you just gave. And not talking about the semiconductor shortages, but the resins input costs and all that. You talked about hedging and such. I'm wondering as shipping costs have been around for a while now, the same amount of time all through COVID and these additional raw material costs. I'm wondering is there come time to start like repricing some of your contracts with customers or put in indexing for raw materials. Or all your answers so far talk more about hedging and dealing with your supply and stuff. So, I'm just wondering is it time to go back to talk to the customer or are we just not there yet.

No Jim. It's Terrence. Twofold. We've been there quite frankly. So, to sort of go where we are on it across our channel partners, we did a price increase. And this is 20% of our business in January. We just implemented another price increase and we're going to continue to look in this environment. And our direct customers, we are having those discussions right now. We do have metal riders in many of our agreements that are sort of like towers. If you bust out of an area on metal, we have ability to recapture. And then when you deal with resins and freight which are newer, we are having those discussions with our customers. It's very different by industry. And that's what has been going on and that they will layer in at different times. But I feel we are having those discussions real time.

Okay. Thank you, Jim. Next question please?

Thank you. I have a question for Heath this morning. Could you explain the sequential margin changes in industrial margins, especially considering the increase we observed compared to the first half levels? Additionally, could you provide any insights on the expected margin outlook for industrial in the fourth quarter?

Thank you for the questions. We have been transparent about our journey in improving margins within the industrial segment. We started in the low teens and aim to reach the high teens through a multi-year effort involving various rooftop consolidations. We're making progress, and we saw significant improvements this quarter. One factor benefiting the industrial segment is our ongoing restructuring efforts, which occur in phases as operations are temporarily shut down. This can lead to varying costs from quarter to quarter, but over time, we see this smoothing out. Additionally, as Terrence mentioned, the industrial segment has had opportunities for price adjustments since much of our business goes through distribution. We implemented price increases at the start of the calendar year and additional ones in July, which have provided immediate benefits for this segment compared to others that deal more directly with OEMs, where price changes may take longer to implement. Looking ahead to the fourth quarter, timing will always play a role in our large and complex business. Our Industrial segment, valued at $4 billion, has many moving parts. However, I am optimistic about the direction we are headed as we progress from the first half to the second half of the year. More importantly, as we look into 2022 and beyond, there is still potential for margin improvement, and the team is focused on achieving that. Thank you for your question.

Thank you, Luke. Can we have the next question, please?

Yes. Thanks. Good morning. I think the near-term dynamics on supply chain are well publicized. But my question is, Terrence, do you see any impact on the longer-term dynamics like design by your customers, specifically in automotive? Do you see any changes in the way they operate or think about design in the current environment? And if you do, what's the impact that you have from these changes on your business? Thanks.

From a design perspective, the pace of innovation and launches, particularly in transportation and EVs, remained steady during COVID. Customers are witnessing an accelerating pace due to consumer expectations. This trend is not limited to transportation; it extends throughout supply chains. The industrial sector is also benefiting from investments aimed at making factories more flexible and digitized. Regarding supply chain design, customers are reflecting on necessary changes, particularly in just-in-time practices. Currently, we’re not observing any immediate shifts, such as a move toward vertical integration of interconnects, especially as it relates to the transition to EVs. However, we maintain strong relationships with our customers, which could allow us to leverage opportunities instead of risks as they navigate these changes. Our close ties with original equipment manufacturers provide us with valuable insights as we look ahead in the automotive sector.

Okay. Thank you, Nik. Can we have the next question, please?

Hey. This is Shreyas Patil on for Rod. Just two quick ones. One, could you help quantify the supply chain impact that you saw in the quarter? I believe last quarter you mentioned it was a $50 million headwind. And then, second, just looking at the year-over-year comparison, I know, it's a bit challenging given the base effect. But it looked like your incremental margin, ex currency, was maybe closer to 40%. And I think in the past you've talked about 30% to 35% incremental margins. So, maybe, just how we should think about that, going forward?

Sure. This is Heath. I'll take the question. In the quarter, we quantified the supply chain impact as our ability, or in some cases, inability to obtain the input materials we needed. The financial impact to us was about $100 million, with approximately two-thirds of that related to transportation. Our inability to ship resulted in about $100 million in topline impact due to the supply chain issues. The teams are actively working every day to recover that and keep our customers satisfied. Regarding the flow-through, we're proud of our year-over-year flow-through. This pride extends not only to the third quarter and anticipated fourth-quarter flow-through but also on a year-to-date and full-year basis. I would caution, however, as last year's comparisons were quite different due to a severe downtick that significantly affected our margins. As we look at the contrast between the downturn and the recovery a year later, you're likely to notice some outsize numbers in certain quarters. I don't want to suggest that 40% should be the new standard for our flow-through. We remain confident in the 30% to 35% range, which we increased earlier this year due to ongoing restructuring efforts. It is likely to normalize around that range, but expect some quarter-to-quarter fluctuations, especially on a year-over-year basis like we experienced in the third quarter.

Okay. Thanks for the question Shreyas. And I want to thank everybody for joining us this morning. If you have more questions please contact Investor Relations at TE. Thank you and have a good morning.