Altra Industrial Motion Corp (AIMC) Q3 2021 Earnings Call Transcript

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Altra Industrial Motion Corp (AIMC)
Q3 2021 Earnings Call
Oct 22, 2021, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning. My name is Lisa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Altra Industrial Motion Q3 2021 Earnings Conference Call.

[Operator Instructions] Thank you. I would now like to turn the call over to Mr. David Calusdian from Sharon Merrill. Please go ahead, sir.

David Calusdian -- President

Thank you. Good morning, everyone, and welcome to the call. To help you follow management's discussion on this call, they'll be referencing slides that are posted to the altramotion.com website under Events & Presentations in the Investor Relations section. Please turn to Slide 3.

During the call, management will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are inherently uncertain, and investors must recognize that events could differ significantly from management's expectations. Please refer to the risks, uncertainties and other factors described in the company's quarterly reports on Form 10-Q and annual report on Form 10-K and in the company's other filings with the U.S. Securities and Exchange Commission. Except as required by applicable law, Altra Industrial Motion Corp. does not intend to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.

On today's call, management will refer to non-GAAP diluted earnings per share, non-GAAP income from operations, non-GAAP net income, non-GAAP adjusted EBITDA, non-GAAP operating income margin, non-GAAP adjusted EBITDA margin, non-GAAP organic sales, non-GAAP gross margin, non-GAAP operating working capital, non-GAAP net debt, non-GAAP free cash flow and non-GAAP adjusted free cash flow. These metrics exclude certain items discussed in our slide presentation and in our press release under the heading Discussion of Non-GAAP Financial Measures and any other items that management believes should be excluded when reviewing continuing operations. These reconciliations of Altra's non-GAAP measures to the comparable GAAP measures are available in the financial tables of the Q3 2020 financial results press release on Altra's website.

Please turn to Slide 4. With me today are Chief Executive Officer, Carl Christenson; Chief Financial Officer, Christian Storch; and Vice President of Finance, Corporate Controller and Treasurer, Todd Patriacca.

I'll now turn the call over to Carl.

Carl R. Christenson -- Chairman and Chief Executive Officer

Thank you, David, and thank you all for joining us today. I would like to start by saying that in spite of the challenges we face in the current environment, the Altra team delivered a great quarter. Like many companies in the industrial economy, Q3 was really a tale of two quarters. On one hand, we experienced exceptional broad-based demand due to our suite of innovative products and diversified growth markets as well as strong secular tailwinds. On the other hand, we faced supply chain and inflationary dynamics that tempered both top line growth and margin improvement.

The Altra team has done an exceptional job executing on the factors that we can control in face of the challenges impacting the global economy. As a result, we were able to grow sales 7% year-over-year to $469 million, which also outperformed the pre-COVID levels in the third quarter of 2019 by 6%.

GAAP EPS of $0.54 and non-GAAP EPS of $0.80 were lower than last year's $0.59 and $0.87, respectively. That said, our non-GAAP EPS of $0.80 was $0.11 higher than the Q3 2019 non-GAAP EPS of $0.69. The comparison with Q3 2019 is meaningful because Q3 2020 was favorably impacted by the pandemic-related cost reduction efforts and extremely strong shipments of motors and pumps for ventilators and respirators. In addition, we saw a significant reduction in the transportation market in China in Q3 when compared with the same quarter last year.

When compared with the pre-pandemic third quarter of 2019, our operating margin has increased 220 basis points to 13.2%, and gross margin has increased 80 basis points to 36.2%. Therefore, I feel really good about the operating performance of our business and the effectivity of the price increases we have been implementing to offset cost increases.

Finally, our incoming order rate has continued to be robust. Our book-to-bill ratio was 120%, and our backlog is very strong, approximately 150% of typical levels. In my opinion, there are several factors impacting our bookings rate. First, there are very strong underlying dynamics due to years of uncertainty and the resulting pent-up demand, pandemic-related investments and favorable secular trends. Second, extended lead times, price increases, unpredictable logistics and fear of shortages have caused customers to increase orders in an attempt to pre-empt the supply chain challenges or further price increases. The extremely strong demand has not let up. Our assumption is that we will eventually see a decrease in demand as the supply chain issues get resolved. But we believe the underlying economic strength will continue for at least the next several quarters, unless there is some external event or action that creates renewed disruption or uncertainty.

Turning to Slide 6. I would like to emphasize a few key takeaways from the quarter. First, the fundamentals of our business remained strong. The combination of a broad-based industrial demand strength and Altra's diverse portfolio of high-value market-leading solutions led to an all-time backlog for Altra and a book-to-bill ratio of 120%. Second, although we executed very well on the factors in our control, the global supply chain and labor shortages impacted our top and bottom line performance.

On the top line, we were not able to ship the amount we could have in a normal supply chain environment, and this is primarily responsible for the delta between our top line expectations and our results. On the bottom line, our pricing initiative benefits from earlier in the year began to flow through in Q3 as expected, and we were able to maintain good cost control, resulting in solid operating margin performance. We continue to believe that as we work through the open orders, we will see increased benefits from our pricing actions by the end of the year. We will continue to stay focused and execute on the factors that we can control in this unpredictable environment.

Third, we were excited to be able to accelerate Altra Business System activities. This was made possible by the return of limited business travel and in-person events during the quarter. One notable area where we have made excellent progress recently has been with cross-selling activities. We secured cross-selling orders for well over $1 million in the third quarter and are currently working on opportunities in diverse applications, such as meat packaging, defense-related antennas, material handling, construction robotics and surgical robotics.

Fourth, we have continued to make exceptional progress advancing our strategic priority to pay down debt and de-lever our balance sheet. We paid down an additional $70 million of debt in Q3 for a total of $120 million so far in 2021, which puts us well ahead of the plan on our full year goal of $150 million.

And finally, we continue to make excellent progress advancing our strategic initiatives across several fronts. This includes collaborating with our customers across our business to create innovative solutions, and this positions us very well as the strong demand environment continues in 2022. Additionally, we continue to diligently and patiently explore potential bolt-on M&A opportunities that will strengthen our market position and expand our exposure to attractive markets.

Before we take a look at the end market dynamics this quarter, I would like to note two announcements made this week. First, we're thrilled to have shared that La Vonda Williams has been appointed to the Board of Directors effective October 19, 2021. La Vonda brings tremendous financial acumen, deep equity market knowledge and a very strong technical background to our Board, and I'm looking forward to working closely with La Vonda.

And as announced this morning, on February 1, Christian will be retiring and Todd Patriacca, our VP of Finance, Corporate Controller and Treasurer, will be taking over as CFO. Since this will be Christian's last quarterly call, I'd like to offer a word of thanks to Christian for his many years of service to the company. He has been an extremely valuable partner and leader at Altra and has been instrumental in growing the business to where we are today. Altra is a much stronger company now than when Christian started 14 years ago. Please join me in wishing Christian all the best in his well-deserved retirement.

I know many of you already know Todd as he is also an Altra finance veteran. Todd has been with the company and has been a tremendous contributor essentially since we formed Altra. We have a robust succession planning process at Altra, and I have the utmost confidence that the transition will be virtually seamless and our finance organization will thrive under Todd's leadership. I'm very much looking forward to working closer with Todd.

Now turning to Slide 7, and a review of the markets in more detail. Starting with transportation, which represents approximately 15% of our business, on a last 12-month basis, was down double-digits as the deceleration we began to see in China Class 8 heavy-duty trucks last quarter continued in Q3.

The semiconductor chip shortage had a material impact as well and we expect that to continue to be a headwind. Longer term, as the world's leading engine braking supplier, we expect Altra's transportation business to benefit from new technology initiatives that support future global safety and emissions mandates.

Factory automation and specialty machinery, which represents about 12% of our business, was up over 25% as we continue to see strong demand in robotics, electronic assembly equipment, specialty machinery and general factory automation machinery. We remain bullish about this market given the strong long-term macro trends driving growth.

Turf and Garden, Ag and Construction, which combined, represents approximately 10% of our business, had another very strong quarter, up mid double-digits. We continue to see strength across all three segments. We expect a strong end of the year and remain very positive on our long-term growth prospects.

Medical equipment, which is about 8% of our sales, was down double-digits year-over-year, due largely to a difficult comp with Q3 2020 when we shipped about half of all COVID-related respirator and ventilator sales for the entire year. This was partially offset by strong medical capital equipment and portable equipment sales, which we expect to continue. This remains a very exciting long-term growth market for us, supported by several secular tailwinds.

Material handling, which represents 7% of sales, was up double-digits due to strength across all key segments, including conveyors, forklifts and vertical lifting systems. We have yet to see any disruption from the supply chain in this market and remain excited about the market's long-term growth prospects, driven by trends such as e-commerce and warehousing efficiency improvements.

Turning now to Aerospace and Defense, which combined is about 6% of sales. On a very encouraging note, commercial aerospace was up double-digits for the quarter, resulting in the first positive year-to-date performance in quite some time. The positive commercial performance was offset by a single-digit decline on the defense side due to project timing resulting in A&D being down slightly overall in the low single digits. Despite this, our A&D business remains an important bottom-line contributor with a very attractive margin profile, strong competitive position and high barriers to entry.

And finally, renewable energy, which represents about 5% of sales, was down mid double-digits in the quarter due to the hangover from China's policy induced production surge last year as their version of the PTC expired in December 2020. In addition, many of our customers are experiencing logistics challenges as product has being held up at ports due to global shipping delays.

While bookings remain quite strong, we now expect 2021 to be down high single-digits unless we see a positive change in the shipping [Technical Issues] and supply chain issues. Longer term, renewables remains a very exciting growth play for Altra.

Our sales funnel continues to be strong, and we have had good success taking share in certain key areas. For example, during the quarter, we had a nice win for 4-megawatt onshore turbines with a South Korean customer.

Looking at our markets overall, although we face some pockets of headwinds, bookings remained strong across the board. As a result, our demand runway remains very strong, and we expect this strength to continue throughout 2022. This further affirms that the underlying fundamental of Altra's business remain intact with strong long-term growth prospects.

Now please turn to Slide 8. As we close out 2021, we're not only extraordinarily proud of the entire Altra team, but we are increasingly confident about Altra's ability to thrive as a premier industrial company over the long run. Before I turn the call to Christian, I would like to reiterate Altra's priorities and prospects going forward. Looking forward, our focus remains on advancing our strategic priorities to deliver sustainable value over the long term. These include leveraging our world-class Business System to create sustainable competitive advantages and enabled long-term success, delevering our balance sheet, driving margin improvements, positioning Altra to drive top line growth and advancing our ESG initiatives.

And with that, I'll turn the call over to Christian and Todd.

Christian Storch -- Executive Vice President, Chief Financial Officer

Thank you, Carl, and good morning, everyone. As Carl noted, with my planned retirement comes February, this will be my last quarterly earnings call as Altra's CFO. Although I know I will have the chance to meet with many of you in the coming months, I wanted to take this opportunity to say thank you to our shareholders, the analyst community and the Altra team for a very rewarding 14 years. I have absolute confidence in handing the CFO reins over to Todd, and I'm looking forward to working with him over the next few months to ensure a smooth and seamless transition.

Please turn to Slide 9. Our third quarter results were highlighted by continued strong demand trends that while we were navigating multiple macro challenges. Let's start with a review of our top line performance. Sales were up 7.2% compared with the prior year period. Excluding FX sales increased 5.8% organically. The significant contribution from price was 200 basis points. Foreign exchange rates had a positive effect of 140 basis points. Excluding the effects of foreign exchange, net sales for the PTT segment were up 16% due to strong performance across all OpCos.

Net sales for the A&S segment were down 2.6% compared with the same quarter last year. The decline was driven by headwinds for Class 8 trucks in China as well as very challenging comps for the medical business due to record sales into the ventilator market in the prior year. Taking a closer look at organic sales performance by geography. Asia and the rest of the world was down 15.3%, mainly due to the Class 8 truck and wind energy markets in China, as Carl discussed. In Europe, sales were up 11.5%, driven by strong performance of our gearing and coupling businesses. And in North America, revenues were up 12.4%, with strengths across most end markets. Non-GAAP income from operations decreased $5.1 million or 6% due to difficult comps. Recall, the strong performance of Class 8 trucks in our medical business in the prior year quarter, it is also important to recognize that the prior year quarter reflects an exceptional level of cost saving actions due to COVID-19. Non-GAAP adjusted EBITDA was $97 million for the third quarter or 20.7% of net sales, down 260 basis points compared with last year.

Please turn to Slide 10, as I turn the call over to Todd for a closer look at our balance sheet improvements, cash flow and liquidity.

Todd B. Patriacca -- Vice President of Finance, Corporate Controller and Treasurer

Thanks, Christian. It's a real pleasure to be here today. Free cash flow for the quarter was very strong at $61.9 million despite heavy investment into working capital, and compares with $81.1 million a year ago. We have now generated $144 million in non-GAAP adjusted free cash flow year-to-date. Our free cash flow conversion for the year-to-date period was approximately 125% of net income. Capital expenditures during the quarter totaled $8.1 million, up about 16% from the prior year quarter. We plan to modestly increase our capital expenditure levels in the fourth quarter as we continue to invest in growth opportunities. We ended the quarter with $256.8 million of cash, and this reflects payments of $70 million on our term loan. This brings our total debt paydown year-to-date to $120 million, and we are ahead of our plan to achieve $150 million for the year.

Since completing the A&S merger, we have paid down $430 million in term loan debt. This has allowed us to decrease our net leverage to 2.68 times, which is well within our target range of less than 3 times net leverage. Our top capital allocation priorities continue to be to reduce our debt balance by at least $30 million in 2021, while we continue to manage leverage, preserve optionality for investing in future growth and continue to support our quarterly dividend. As we have shared before, now that we are within our target leverage range, we have grown increasingly open to potential bolt-on M&A opportunities that further align Altra with attractive secular trends.

With that, please turn to Slide 11, as I turn the call back to Christian to conclude with an update on our outlook for 2021.

Christian Storch -- Executive Vice President, Chief Financial Officer

Thanks, Todd. As we enter the final quarter of the year, we expect broad-based industrial demand and strong order rates to continue. At the same time, we do not anticipate that the supply chain challenges and material inflation dynamics playing out globally will abate during the fourth quarter. The updated guidance does not assume an improvement, nor a deterioration in the current challenging operating environment.

Our updated guidance for the full year '21 is as follows: annual sales in the range of $1.88 billion to $1.9 billion; GAAP diluted EPS in the range of $2.22 to $2.31; and non-GAAP diluted EPS in the range of $3.25 and $3.35; non-GAAP adjusted EBITDA in the range of $390 million to $400 million; depreciation and amortization in the range of $122 million to $124 million; capital expenditures are expected in the range of $40 million to $45 million; our normalized tax rate for the full year to be in the range of 20% to 22%; and adjusted non-GAAP free cash flow in the range of $200 million to $225 million.

With that, we will open the call up for questions.

Questions and Answers:

Operator

[Operator Instructions] Your first question comes from the line of Bryan Blair with Oppenheimer.

Bryan Blair -- Oppenheimer -- Analyst

Thanks. Good morning, guys.

Carl R. Christenson -- Chairman and Chief Executive Officer

Good morning, Bryan.

Bryan Blair -- Oppenheimer -- Analyst

Christian, congratulations on your retirement. Very well deserved.

Christian Storch -- Executive Vice President, Chief Financial Officer

Thank you.

Bryan Blair -- Oppenheimer -- Analyst

And Todd, congrats to you as well.

Todd B. Patriacca -- Vice President of Finance, Corporate Controller and Treasurer

Thanks.

Bryan Blair -- Oppenheimer -- Analyst

You'll now have a title that fits on your business card. Printed that out, Todd?

Todd B. Patriacca -- Vice President of Finance, Corporate Controller and Treasurer

That's right.

Bryan Blair -- Oppenheimer -- Analyst

To level set a little bit on the guidance provision, how should we think about the breakout between what took place in Q3 already realized and Q4 still anticipated in terms of P&L impacts relative to the prior framework?

Christian Storch -- Executive Vice President, Chief Financial Officer

So I'm not sure if -- you didn't come across [Speech Overlap] a little bit, Bryan. When we look at the fourth quarter and when we look at the guidance, I think as I said, we assume no improvement nor deterioration in the current operational environment. I think we're optimistic in regards to the fourth quarter in terms of our ability currently to -- I think, to maybe between the mid and high end-point of the EPS range is where we're looking at. And if things go well, and we do have a chance to get to that high-end of that range as we currently sit here. The white card is the supply chain, which is changing daily.

In terms of price cost, I think we've almost caught up. Remember last quarter, I said we were behind about 120 basis points. We now think we're almost caught up, maybe we're short 40 basis points. We will -- but we have increased confidence we would have fully caught up by the end of the fourth quarter. I'm not sure if that answered your question, but yes.

Bryan Blair -- Oppenheimer -- Analyst

Yes. Yes, at a high level, that's where I was going. And in terms of price cost, so if we went through the somewhat fullish exercise of assuming commodities and other cost flatlined, if I read into your commentary correctly that based on your recent pricing actions and the pending flow-through of those and your normalized pricing going into Q1 of next year that you would be price cost positive for 2022?

Christian Storch -- Executive Vice President, Chief Financial Officer

Yes. And I would include in that, by the end of the year, we will have caught up. And with January price increases are currently planned, I think we might -- we have a chance to be ahead of the price cost curve starting the first quarter.

Bryan Blair -- Oppenheimer -- Analyst

Okay. Very good. And looking at sales margin the last couple of quarters, that's been, in our view, the highlight of performance. Have there been significant structural cost savings that have flowed through in Q2 and Q3? Just trying to gauge whether this is a reset that we should look at as kind of jumping off point for further incremental drop-through and fine-tuning for the synergies that you've laid out before, or if there's anything one time-ish that has impacted Q2, Q3.

Christian Storch -- Executive Vice President, Chief Financial Officer

Yes. So when we -- as Carl did in his remarks, we like to compare '21 performance to '19, the pre-pandemic period. And when you look at the legacy segment, the PTT segment, I think we've seen a margin improvement in the neighborhood of 240, 250 basis points. And as partially reflected of the power of ABS, combined with synergies really starting to show up on that side as we had planned as part of the merger, that was partially offset by really a roller coaster on the Class 8 truck side of the business, particularly in China, very strong first quarter this year, and then just disastrous quarters, Q2, Q3, as China is still consuming all the China 5 trucks that have been produced. I think that should get better next year.

And then if I -- maybe last comment, if I take out that year-over-year headwind Class 8 trucks and medical that Carl referred to, the rest of the business grew 13% year-over-year in the third quarter. That's just a great, great number. We're very proud of that. And unfortunately, we get those headwinds with ventilators, pumps and the China Class 8 truck situation. But outside of that, the portfolio did extremely well, and that has contributed to that margin north of 20% EBITDA despite all these challenges.

Carl R. Christenson -- Chairman and Chief Executive Officer

The only thing I'd add is we still have not fully come back with the -- from the cost savings that we implemented during the -- we haven't gotten all the snapback costs back yet. But we've had tremendous costs related to expediting materials and logistics issues, and I can walk you through some of the things we've done to get parts in to get product out the door. And so we're going to see a nice savings as the logistics and supply chain improvements come through. And even as the snapback costs come back, the pre-pandemic or the pandemic savings that we had, I think we're going to see some really nice long-term improvements in the P&L and all those synergies that we've been talking about, we're going to start to see them come in.

Bryan Blair -- Oppenheimer -- Analyst

Okay. Thanks, again.

Operator

Your next question comes from the line of Jeff Hammond with KeyBanc Capital.

Jeffrey Hammond -- KeyBanc Capital -- Analyst

Hey, good morning, guys. Good luck, Christian. I can't believe we've been on these calls for 14 years here.

Christian Storch -- Executive Vice President, Chief Financial Officer

Yes.

Jeffrey Hammond -- KeyBanc Capital -- Analyst

So I guess, with the supply chain, I'm just wondering how broad it is across your businesses and end markets versus maybe more isolated within your comments around renewables and truck? And then kind of just as a follow-on, like how much revenue do you think is shifting from '21 to '22 because it just seems like more getting stuff out the door than anything else?

Carl R. Christenson -- Chairman and Chief Executive Officer

Well, I'll start, Jeff, and Christian can jump in. But I think the supply chain issues are pretty broad. I mean, we see it from laminations for electric motors to chips for our controllers to our customers having issues, getting chips and having to push out orders. So it's pretty broad-based. We've done -- I think the teams have done an outstanding job and have worked really, really hard. I mean the supply chain management people in our company have worked incredible hours in trying to make sure that we get things in. And we've done a lot of creative things. So products being shipped on a vessel will also initiate shipments in two or three airplanes at the same time, so we get some product flying over the boat to make sure that we can put stuff together and ship it. So it is pretty broad-based, but we're managing it very well.

When I look at the incoming order rate, the book-to-bill ratios and the backlog we're building, we've got -- we are set up really, really well for 2022. And we're shipping at 13%, Christian said, in the businesses once you take out those -- the tough comps on the ventilator and in the medical space and the Class 8 trucks. So we have ramped up production significantly, even in light of the supply chain issues. So even if things don't get better, we've still got some really, really good runway and potential for 2022 and beyond.

And then I look at the demand picture and our customers and some of the markets we serve, there just is not enough product there, and there is going to be some inventory builds back. And so that's going to push out the strength of this industrial economy for a while. And I know there's going to be a dip in the order book at some point and people are going to panic and say, "Oh my god, the order book is down". But I don't think that's anything to panic about. I think it's just as our lead times come in and supply chain gets better, people readjust their orders and say, "Okay, the supply is better than it was." But this is a really good economy for a while, I think. I don't know if that answers your question, but --

Christian Storch -- Executive Vice President, Chief Financial Officer

And Jeff, if I look at where the backlog is compared to normal historical levels, if I look at current bookings, weekly bookings, run rate, we're pushing in front of us about $200 million worth of revenues that we haven't been able to ship in excess of normal levels.

Jeffrey Hammond -- KeyBanc Capital -- Analyst

Yes, what would that number -- what was it relative to kind of guidance? Like is the revenue guidance change just a function of stuff that you had orders in hand and were scheduled to ship, and you either can't ship them or your customers are shutting down production?

Christian Storch -- Executive Vice President, Chief Financial Officer

So the shortfall, we had expected. The shortfall in the third quarter was with all Class 8 trucks in China. And that was -- everybody else outperformed our expectations at the beginning of the quarter. But China, the situation in China on the Class 8 trucks, if you look at this, revenues in China in the third quarter were down 85% year-over-year. That's about $10 million. The headwind on the medical side was about $11 million in terms of tough comps.

So between the two, compared to last year, we were down $21 million across those two. Everybody else in total was up 13%. We think that the China situation year-over-year, the comparison will get better in the fourth quarter and then continues to get better with easy comps next year. And that overall, again, this is about compared to normalized bookings levels and normalized backlogs. There's about $200 million of revenues that are shifting into next year.

Jeffrey Hammond -- KeyBanc Capital -- Analyst

Okay. And then just last one. You talked about, Carl, all these additional costs. And when those -- when the supply chain issues alleviate, those come out, is there a way to quantify how much of a headwind that is, whether it be in 3Q or on a full year basis that you anticipate when you get normal?

Carl R. Christenson -- Chairman and Chief Executive Officer

Yes, I don't have that number right now, but we will put that number together just because it is significant. And to be honest with you, people are spending all their waking hours trying to get product through, but we will put that number together over the next several weeks.

Jeffrey Hammond -- KeyBanc Capital -- Analyst

Okay. Perfect. Thanks, guys.

Operator

Your next question comes from the line of Mike Halloran with Baird.

Mike Halloran -- Baird -- Analyst

Hey, good morning, everyone. And I'll echo what the last two said. Congrats, Christian and congrats, Todd. I don't quite have Jeff's 14 years, but the 12 has been a really, really good time to interact with you, Christian. So I really appreciate all the time together. So thank you, and Todd, looking forward to you.

So I just want to combine a lot of the stuff that you guys were saying there, just to make sure I understand the demand picture that you're thinking about as we go into next year. It feels like you're talking about healthy underlying fundamentals for an extended period of time. And the comments you made in the opening remark about declining trends was more on the order book side, not necessarily the revenue side. My guess is you're trying to say that revenue should remain healthy for that period, but you'll get some fluctuations in the order book numbers simply as lead times start coming in, start normalizing and the environment normalizes. And so all in, expecting a healthy 2022, if not longer, from a revenue perspective, and that will be aided by the $200 million that I think Christian mentioned of tailwind from revenue going into next year. Is that a fair characterization, or did I miss something?

Carl R. Christenson -- Chairman and Chief Executive Officer

Yes, absolutely. That's exactly right. I think we get a lot of questions from people about, well, how much of the demand is just people trying to make sure they're getting stuff and they're in the queue and how much of it is the building inventory versus how much is the underlying industrial economy. So at some point, the order book is going to -- it is definitely part of both. And at some point, the order book will come back down to what is the underlying demand. And I think that is still really strong. So I'm just trying to emphasize that. And then -- and I think that's got some real legs to it, some runway to it.

Christian Storch -- Executive Vice President, Chief Financial Officer

And if we look at the backlog, it reflects to some -- to a large extent that customers don't want to be in the same position in 2022 that they were in 2021, that they want to get their stuff on time, they want to get the stuff that they ordered. And so they have doubled, tripled up on orders given the extended lead times. So that's, as Carl said, eventually, that will cause order rates to decline. But underlying all that is very healthy industrial demand.

Mike Halloran -- Baird -- Analyst

And to be clear, it doesn't sound like the double ordering has a ton of risk of cancellation. I'm sure there's a little bit of that here and there. But it's more people have extended out the lead times to accommodate the schedule as opposed to double ordering for risk of cancellation.

Carl R. Christenson -- Chairman and Chief Executive Officer

No -- exactly. And they're probably trying to build a little bit of inventory too. Just looking at some of the project work that's coming in and some of the things we're working on for customers, it's -- there are some really, really good activity out there. So --

Christian Storch -- Executive Vice President, Chief Financial Officer

And Mike, unlike other companies, we're not sitting on a large amount of half-finished products. We don't have parking lots full of stuff that has missing parts. Because of our assembly process, it goes so fast and overall that once we get the order and we get the material, we'll assemble and we'll ship.

Carl R. Christenson -- Chairman and Chief Executive Officer

But they are contractual commitments by our customers that they will stand behind. And so the cancellation should not be significant unless the world comes to an end, again, like the financial crisis or something.

Christian Storch -- Executive Vice President, Chief Financial Officer

Yes. The point is that on the half finished products, they are not -- there's no overhang of absorption in the future, where we already absorbed the factory and then we ship and we don't have the absorption. We don't have those challenges going into next year.

Mike Halloran -- Baird -- Analyst

Makes sense. And Todd, in the prepared remarks, certainly mentioned a little bit more -- eyes a little bit wider, just trying to see what kind of opportunity sets to bring in from an M&A perspective. Obviously, great to see you guys sub 3 times on the leverage side. How actionable would you look at that pipeline today from your perspective? And how wide does it look?

Todd B. Patriacca -- Vice President of Finance, Corporate Controller and Treasurer

Yes. I think we've said it a few times that there's -- that we're building out that pipeline. And I'm pretty excited about the end markets and some of the opportunities we hope will come available over the next few years. And that the one roadblock is just the valuations and multiples that people are putting on the businesses. I think, you've known us for a long time that we've been pretty disciplined about what we'll do. And so I just hope the environment gets a little bit better.

Mike Halloran -- Baird -- Analyst

Makes sense. Well, thanks gentlemen. Appreciate the time and congrats again, Christian and Todd.

Carl R. Christenson -- Chairman and Chief Executive Officer

Thanks.

Christian Storch -- Executive Vice President, Chief Financial Officer

Thanks, Mike.

Operator

[Operator Instructions] Your next question comes from the line of John Franzreb with Sidoti & Company.

John Franzreb -- Sidoti & Company -- Analyst

Good morning, guys. And again, congratulations, Christian and Todd. Carl, in your prepared remarks, you, I think, alluded to the fact that the factory automation business has kind of avoided some of the pitfalls that are hitting everybody else as far as the supply chain issues. Why is that the case?

Carl R. Christenson -- Chairman and Chief Executive Officer

Well, I just think part of it, John, is that those markets were pretty -- they were down significantly. So we just have seen our customers there, be able to produce. We haven't seen them have the issues that some of the other customers have had. And I think part of it is just because they were probably a little bit slower for a little bit longer. We just have not seen the same the demand there. We haven't seen customers say, geez, we can't take the stuff because we can't get ships to put everything else together. So it's been -- we have not seen that kind of dynamic in that market. It's been really pretty stable. It's been good, it's been coming up nicely. And maybe that will be impacted, but we haven't seen it yet.

John Franzreb -- Sidoti & Company -- Analyst

I just agree with the chip issue, that would be some place that that'd be at risk. And in the transportation sector, it sounds like your original thoughts about the strength in Class 8 China is moving to the right from what you were thinking three months ago. Is that the case or not? And secondly, how does the North American Class 8 truck market look compared to three months ago?

Christian Storch -- Executive Vice President, Chief Financial Officer

Yes. So that's absolutely right in regards to China, the overhang on, they're calling red tagged trucks, which are trucks that have been partially finished, exists in the U.S. on the North American side. In China, it's just a sell-through of the -- and the prebuying of China 5 trucks ahead of the conversion to China 6. That should ease next year. In North America, when I look at U.S. overall, we think the market will be up for us about 23% in North America. We think there's going to be a slowing and going into the fourth quarter as a result of chip shortage that's affecting some of our customers. They have -- they're sitting on, I don't know, 25,000 half-finished trucks that are missing parts. So in that sense, our outlook in North America has also gotten a little worse compared to three months ago. I think three months ago, we would have expected in the U.S., revenues to be probably in the neighborhood of $5 million, $6 million higher.

John Franzreb -- Sidoti & Company -- Analyst

And just lastly, your inventory levels kind of ticked up a little bit in the September quarter. Are you building inventory for any particular customer base? Are you just making sure you have the necessary parts to that as the market firms up the game or you just keeping the guys busy?

Todd B. Patriacca -- Vice President of Finance, Corporate Controller and Treasurer

No, it's inventory that we need for the orders that we currently have. So that increase is all due to the underlying demand. I would expect it will continue to grow modestly over the fourth quarter as we continue to try to get in the missing parts that we need to meet our shipments.

John Franzreb -- Sidoti & Company -- Analyst

Great. Okay, guys. Thanks and congratulations again.

Carl R. Christenson -- Chairman and Chief Executive Officer

Thank you.

Christian Storch -- Executive Vice President, Chief Financial Officer

Thanks, John.

Operator

At this time, I would like to turn the call back over to management for closing remarks.

Carl R. Christenson -- Chairman and Chief Executive Officer

Thank you, and thank you all again for joining us today. We will once again be on the virtual road this quarter, including attending Baird's Global Industrials Conference on November 9 and Wolfe's Industrial Growth and Technology Conference on November 15. So we look forward to engaging with you, with many of you in the months ahead, and thank you again for your time.

Operator

[Operator Closing Remarks]

Duration: 44 minutes

Call participants:

David Calusdian -- President

Carl R. Christenson -- Chairman and Chief Executive Officer

Christian Storch -- Executive Vice President, Chief Financial Officer

Todd B. Patriacca -- Vice President of Finance, Corporate Controller and Treasurer

Bryan Blair -- Oppenheimer -- Analyst

Jeffrey Hammond -- KeyBanc Capital -- Analyst

Mike Halloran -- Baird -- Analyst

John Franzreb -- Sidoti & Company -- Analyst

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