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CTS Corporation (NYSE:CTS)
Q3 2021 Earnings Call
Oct 27, 2021, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the CTS Corporation Third Quarter 2021 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Kieran O'Sullivan, CEO. Please go ahead, sir.

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

Thank you, Tracy. Good morning, and welcome, everyone, to our third quarter 2021 earnings call. We reported solid financial results that were propelled by our ongoing diversification efforts. Sales in the third quarter were $122 million, up 8% compared to the same period in 2020. Customer demand remains robust, while supply challenges persist, especially for transportation products. Third quarter gross margin was 37.3%, up 490 basis points from 32.4% in the third quarter of 2020.

EBITDA margin of 21.7% was up 270 basis points from 19% in the same period last year. Third quarter adjusted earnings per share of $0.46 were up 35% from $0.34 in the third quarter of 2020. Later, Ashish Agrawal, our CFO, who is with me for today's call, will speak to the GAAP performance. Operating cash flow of $21 million was down from $26 million in the third quarter of 2020. New business awards of $179 million were solid and up from $127 million in the same period last year. Ashish will take us through the Safe Harbor statement, Ashish.

Ashish Agrawal -- Vice President & Chief Financial Officer

I would like to remind our listeners that this conference call contains forward-looking statements. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. Additional information regarding these risks and uncertainties is contained in the press release issued today and more information can be found in the company's SEC filings. To the extent that today's discussion refers to any non-GAAP measures under Regulation G, the required explanations and reconciliations are available in the Investors section of the CTS website. I will now turn the discussion back over to our CEO, Kieran O'Sullivan.

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

Thank you, Ashish. In the third quarter, our sales increased 8% to $122.4 million versus the prior period. Demand from customers remains strong, but not surprisingly, revenue has been dampened by persistent supply chain constraints reverberating throughout the global economy, especially for automotive products, where we saw sales decline in the third quarter. Excluding sales from the acquisition of Sensor Scientific, sales were up 6% organically. Importantly, the SSI acquisition continues to deliver solid growth, and we're pleased with the performance of our temperature acquisitions and the momentum we are building to scale this platform.

We are benefiting from the richness of our customer base, in particular, in transportation end market. As a result, we performed better than the overall market as our teams excelled in-sourcing initiatives globally, including the qualification of alternative sources. Gross margin for the third quarter was 37.3%, up 490 basis points from the 32.4% in the prior year. As we gain momentum from the advancement of our diversification strategy that I will talk about more in just a minute. EBITDA margin of 31.7% was up 270 basis points from 19% in the third quarter of 2020. We continue to be impacted by rising commodity prices as well as increased freight costs. That said, we've been working alongside our customers to offset or share these cost increases. While inflationary pressures negatively impacted our earnings for the third quarter, we remain confident in our ability to navigate this dynamic environment.

Third quarter adjusted earnings per share of $0.46 were up 35% from $0.34 in the same period last year. New business awards of $179 million were solid and up from $127 million in the same period last year. We added two new industrial customers in the quarter, one for an RF filter application and the other for a temperature-controlled crystal component applied in a GPS application. Our long-term strategy centers on diversifying our end market profile by expanding our range of technologies, products, customers and geographic reach. This diversification will also enhance the quality of our earnings. We made tremendous progress on this front with the non-transportation related revenue moving closer to 50% of total revenue during the third quarter of 2021. As a reminder, historically, our non-transportation related revenue was roughly 1/3 of sales, and our movement toward 50% of revenues is a meaningful shift that advanced our business across the board.

As we move forward, we will continue to strategically grow our transportation business, while at the same time continue to increase the growth rate of non-transportation revenues. We are well positioned in multiple end markets that offer attractive growth prospects. In the industrial space, we are seeing good traction in inkjet printing related to packaging and ceramic tile printing. We continue to expand our applications in cold and hot temperature sensing. In flow measurement, we have developed transducer applications in an area where we see good growth opportunities. In medical, we see strong mid to long-term growth driven by traditional ultrasound technologies.

Additionally, with intravascular ultrasound applications, we are in sample qualification phases with potential customers, expanding our offering of temperature sensors in the medical market is a priority for us. In aerospace and defense, our growth in undersea Sonar is expanding as we develop samples with new European customers where we expect future growth. More recently, we provided samples for testing in underwater unmanned vehicle applications. We are working on new material formulations, which we expect to provide solid tailwinds for next-generation products and new applications. In transportation, the move toward hybrid and electric vehicles as well as increased sensor content with passive safety and future E-brake applications presents a tremendous opportunity.

Importantly, except for the smart actuator, the rest of our portfolio is agnostic to the propulsion system, which allows us to be flexible to meet the needs of our customers. Overall, across all end markets, demand remains robust, in particular, in transportation, which we expect to continue given the historic low days on hand of vehicle inventories. As I highlighted last quarter, some automotive customers have confirmed demand through 2022. Order intake in the non-transportation end market was again strong in the third quarter. We remain cautious of potential inventory buildup in various end markets, but most likely will not see this as an issue in the first half of 2022.

As I mentioned earlier, non-transportation sales now account for nearly 50% of our revenue, supported by our efforts to diversify the business. With a very challenging supply chain environment, our teams worked creatively and diligently to secure parts and adapt with speed to support our customers. Whilst transportation sales are lower than the previous quarter, we performed better than the outlook we provided in the last quarterly update. We expected the third quarter to be the most challenging from a supply chain perspective. The supply challenges and some customer shutdowns will likely persist for the balance of this year. We expect an improving trend in 2022. We also expect demand for automotive products to be robust in the year ahead as supply chain constraints improve.

In the accelerator module product lines, we had large wins with two existing Japanese customers. We also had accelerator wins with customers in China and North America. For passive safety sensors, we secured a win with a North American OEM and were awarded a Chassis Right Height Sensor program with a Japanese OEM. Moving to Megatronics, a customer for actuator products, extended an existing platform for an additional year where products being supplied to all regions. two of the awards this quarter were electric vehicle wins, one with a European OEM, and one with a Japanese OEM. Bookings and sales for 2-wheeler applications were consistent with prior quarters.

Our non-transportation end market performed strongly in the third quarter. Sales in industrial advanced from robust demand for temperature products across pool and spa, where we had two large awards, and we received multiple awards for HVAC applications. Our focus on extending into the hot side applications is gaining momentum, and we will begin shipments to a new customer later this year. Also, in industrial with wins for an EMC product, measurement transducers and a frequency product. We renewed contracts with two customers for an application in musical instruments and end use market, which continued to gain sales growth throughout the pandemic environment as consumers shift to dedicating more of their time to leisure products. Momentum in our medical end market continues to improve in a more consistently positive direction.

We had several wins from aiding drug delivery to next-generation medical ultrasound applications. Also, for medical we secured temperature sensing awards with existing customers ranging from incubators to critical freezer and disposable applications. We are working with new customers sampling medical ultrasound and temperature sensing products. In defense, we had several undersea sonar wins and extended an RF filter program for a GPS anti-jamming application. As I mentioned earlier, we are testing samples with new customers and expanding new advanced material formulations for next-generation products. Turning to telecom. We had various smaller wins for RF and 10 applications and continue to develop frequency solutions to support millimeter wave technology for 5G applications.

Operationally, Ashish will provide more color on the savings we anticipate from our restructuring activities, we are tracking close to the target range. We are nearing the end of our ERP implementation journey and the rollout of the SAP system, though we will continue to optimize our learnings and capabilities from these important initiatives. Our balance sheet is strong, which is bolstered by strong solid cash flow generation, continues to be a competitive advantage as we advance our diversification strategy. In the third quarter of 2021, we delivered operating cash flow of $21 million. As we look to capital deployment, our emphasis remains firmly on supporting organic growth investments and using our financial strength to advance on M&A in alignment with our strategic priorities.

We also remain committed to returning cash to shareholders. This past quarter, we repurchased approximately 148,000 shares for slightly less than $5 million as part of our previously announced stock buyback program. We continue to strengthen our M&A pipeline in an environment where activity is at record highs. From an M&A perspective, our strategy centers on enhancing our technology and product capabilities as well as our geographic reach across our end markets to enhance our diversification goals. At the same time, adding technology that will enhance our EV offering remains a priority. Our sweet spot continues to be acquisition targets in the range of up to $50 million a year in sales, but we remain open for the right larger opportunities that will advance our long-term strategy.

Looking ahead, the semiconductor shortage is now expected to reduce vehicle builds by nine million to 10 million units this year. Pressure from the semiconductor shortages and OEM shutdowns certainly deteriorated downwards in the third quarter. For the U.S. light vehicle transportation market, the SAAR dropped closer to $12 million in September, and we expect approximately 13 to 13.5 million unit range for this year. On hand days supply are now closer to 20 days, the lowest in recent history and down over 60% from the five-year average of 55 days. European production is forecasted in the 16 million to 17 million unit range. The Chinese market has fluctuated, which also reflects the chip related impact. China volumes are expected to be in the 23 million to 24 million unit range for this year.

The commercial vehicle market remains solid and likely to remain robust in 2022. The biggest challenge to that outlook is the supply of semiconductors and the subsequent rescheduling of some unit builds into next year. As I mentioned earlier, for transportation, the supply challenges will continue to impact our sales for the balance of this year. However, we continue to see improvements in the medical end market as well as solid growth in industrial and defense markets. In terms of our guidance for full year 2021, we are updating and narrowing our range. Our previous guidance was for sales in the range of $480 million to $500 million and adjusted earnings per share in the range of $1.70 to $1.90. We are now updating our guidance for sales to be in the range of $495 million to $505 million, and adjusted earnings are expected to be in the range of $1.85 to $1.95.

Our global team continues to demonstrate strong execution and a commitment to delivering operational excellence and achieving our long-term goals. Our investments in our business development program and front-end sales are providing us with opportunities to build on our existing accounts and cross-sell our technologies, as you will find at some of our new business wins. In our ongoing efforts to build our talent and culture, we came together in September as the global leadership team for the first time since the beginning of the pandemic. Our event proved to be engaging and energizing as we collaborated and worked diligently on our focus 2025 initiatives to support growth, focusing on our strategic path forward customer relationships, operating systems, leadership, talent and culture.

Along the same lines and as part of our ongoing efforts to bolster engagement in our communities, we launched CTS Cares, a new platform designed to help our employees across the globe, collaborate on community engagement and charitable giving programs and share best practices for doing so. This is our 125 anniversary, and we're very proud of our rich heritage and excited by what we can give back to our communities in the years ahead as we integrate the CTS Cares program into our culture. In conclusion, CTS is well positioned for the future. We have a strong team aligned around common goals that continue to advance the business for long-term value creation for our shareholders and other stakeholders. Now I'll turn it over to Ashish who will walk us through our third quarter financial results.

Ashish Agrawal -- Vice President & Chief Financial Officer

Thank you, Kieran. Third quarter sales were $122.4 million, up 8% compared to the third quarter of 2020 and down 6% sequentially from the second quarter. Sales to transportation customers declined by 5% compared to the third quarter of 2020 and 13% sequentially. Conversely, sales to our other end markets increased 24% year-over-year and 3% sequentially, as the industrial, aerospace and defense end markets exhibited consecutive year-over-year double-digit growth. As Kieran mentioned, this quarter, we have made significant advances in our diversification strategy as the sales to transportation end market represented 51% of our total revenue.

We remain committed to further diversifying the business. Changes in foreign exchange rate impacted our revenues favorably by approximately $1.3 million. Our gross margin was 37.3% in the third quarter, up 490 basis points compared to the third quarter of 2020 and up 50 basis points sequentially from the second quarter of 2021. Our global team's operational efficiencies as well as profitability in our industrial, medical, aerospace and defense end markets helped mitigate the price increases in raw materials and freight costs that we have seen during the year. We are also working closely with our customer base to find the best ways to manage the macroeconomic pricing pressures we currently face. In the third quarter, we achieved $0.03 in EPS in savings from our restructuring program.

We remain on track to achieve targeted annualized savings of $0.22 to $0.26 of EPS by the end of 2022. SG&A and R&D expenses were $26 million or 22% of sales in the third quarter of 2021 versus $23 million or 20% of sales in the third quarter of 2020. The higher expenses in 2021 were driven by higher incentive compensation, timing of certain projects and the full restoration of cost reduction initiatives implemented in 2020. In the third quarter, we recorded a noncash charge of $106 million before tax as part of the U.S. pension plan termination process. As a reminder, these are noncash charges as the U.S. pension plan was overfunded at settlement.

The third quarter tax rate was 28.9% as a result of the impact of the final pension settlement charge on our income statement. We anticipate our 2021 tax rate to be in the range of 19% to 21%, excluding the impact of the pension settlement and other discrete items. We are also closely monitoring the U.S. government initiatives on tax that may impact our business in the future. For the third quarter 2021, we reported a loss of $1.97 per share. Adjusted earnings for the third quarter were $0.46 per diluted share compared to $0.34 per diluted share in the same period last year. Our operating cash flow was $21 million for the third quarter of 2021 compared to $26 million in the same period last year. The primary driver of lower operating cash during Q3 was inventory increases in our plants as we work through the supply chain challenges and our customers pushing out shipments.

We continue to focus on working capital efficiency, but anticipate carrying some excess inventory considering the ongoing supply chain challenges. Our cash position is strong with a cash balance of $129 million as of September 30, 2021, up from $92 million on December 31, 2020. Our long-term debt balance is at $50 million, a slight decrease from the $55 million on December 31, 2020. Our debt to capitalization ratio was at 9.9% at the end of the third quarter compared to 11.4% at the end of 2020.

Given the strength of our balance sheet and cash flows, we continue to carefully consider M&A transactions that will further help our diversification efforts. We are near the end of our rollout of the SAP system. A majority of our sites are now running on SAP, and we expect to complete the rollout to the remaining sites in early 2022. As Kieran mentioned earlier, we see a sustained demand ahead of us. However, supply chain challenges are expected to persist for us and our customers on both material availability and cost through the rest of the year and into 2022. This concludes our prepared comments. We would like to open the line for questions at this time.

Questions and Answers:

Operator

Thank you sir. (Operator instruction]. We will now take our first question.

Justin Trennon Long -- Stephens Inc. -- Analyst

Thanks, and good morning. Wanted to follow-up on the last point you made about the supply chain headwinds. I know from the prior call you were expecting third quarter to be the most challenged of the year. But if I look at margins sequentially from both a gross margin perspective and adjusted EBITDA margins actually improved sequentially in the third quarter. So, could you comment on what drove that outperformance? And then as we think about these supply chain headwinds going forward, how do you anticipate things to trend in 4Q relative to 3Q?

Ashish Agrawal -- Vice President & Chief Financial Officer

So Justin, the gross margin outperformance let me address that, and then I'll pass it on to Kieran in terms of comments on what we expect as we look ahead. The gross margin in the third quarter is helped by several factors. Number one, we executed well, and our teams have been working hard to make sure that we can manage through all the supply chain challenges despite all the cost increases. We also were able to work with our customers on the price increases that we have been working on which helps offset some of the cost increases we were facing. And the big difference is also driven by the improvement in mix. Transportation was much closer to 50% of our total sales and the other end markets did better in the quarter which definitely has a positive impact on our gross margin.

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

Justin, as we look forward, on the transportation side, we see demand has been very robust. I think I mentioned in my prepared remarks that we have some customers booking through 2022. And obviously, we were impacted in the third quarter by several million here on the transportation side. We still will have some shutdowns and supply issues in the fourth quarter. But you can see from our guidance, we see us moving in a fairly good direction and continuing to improve into next year. I think the main theme that we're bringing out here is the diversification. And maybe just trying to expand them out a little bit.

While we get some benefit from transportation been down in the current quarter, what we've been doing over the last number of years is taking that transportation portion down from closer to 70%, now closer to 50%. And that really helps the overall profile of the company and the quality of the earnings as we go forward and we want to make sure we continue to work on that while also growing our transportation business.

Justin Trennon Long -- Stephens Inc. -- Analyst

Okay. That makes sense. And when you just look at the monthly trends related to the supply chain headwinds, does it feel like things have bottomed? Maybe you could just give an update on how those trends progress sequentially over the course of the third quarter and maybe what you're seeing in October as well?

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

Yes. I think just probably giving you a snapshot on the transportation side. If you look back a week or two ago, the cuts globally were 115,000 up to 280,000. In the last week, the cuts now are more like 26,000 versus 84,000. So there's an improving trend there. But we got to say that with caution because it's been fluctuating. If I look at our Japanese customers, they've done much better than the American OEMS, what we've seen on the trend here is some of the North American OEMs being down over 30%. Japanese customers, which are a large percentage for us, being down about 24%. And we know Toyota has said, Hey, instead of one million units in November, we're going to be closer to 900,000. So it's a moving thing. But the trend is starting to stabilize in the cuts. I'd like to say it's stabilizing and moving in a good direction, but it's something to be watched carefully.

Justin Trennon Long -- Stephens Inc. -- Analyst

Understood. And last one for me. Ashish, you mentioned pricing, and I know FX has been a tailwind this year as well. Any way to help us think about the all-in tailwinds in 2021 from pricing and foreign exchange and how to think about those two items going into next year?

Ashish Agrawal -- Vice President & Chief Financial Officer

So just in the -- we have had some tailwinds on revenue from currency, not so much on the overall cost side. So, when we look at the operating earnings impact, we don't see significant tailwinds from currency. We actually see some headwinds in different parts of the world. Specifically, if you look at the Taiwanese dollar that has appreciated quite a bit. So that has created some headwinds for us. And the Mexican Peso is a little bit stronger than it was last year as well. So, there's puts and takes on the revenue side, we've fared favorably on the cost side, not quite so much. And on the price increases, it's more offsetting the cost increases we have seen. So I wouldn't say that they've had a positive impact on profitability. We've been able to offset some of the cost increases that we have dealt with during the year.

Justin Trennon Long -- Stephens Inc. -- Analyst

Okay, great. I'll leave it there, I appreciate the time.

Operator

Please take your name and company before posing a question. We will now take our next question.

John Franzreb -- Sidoti -- Analyst

Good morning. Its John Franzreb from Sidoti. Kieran, you mentioned in your prepared remarks, and you just kind of referenced a little bit that some customers have confirmed demand through 2022. Based on those orders, what does the build rate kind of look like? What are the customer signal build like kind of recovers to in 2022 versus '21?

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

They want to confirm demand because they're concerned about supply chain and making sure we have a good supply of components are showing a robust strength. They want to make sure they can fill the orders, that pent-up demand they have there. So that's probably the best way of describing it, John.

John Franzreb -- Sidoti -- Analyst

I mean, it looks like $17 million versus the $13.5 million it looks like you are going to finish this year? Or is that too big of a stretch number?

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

Well, I'll put it this way, John. The reason why I'm being a little cautious is as we come into this year, it was expected north of a $14 million start if I take the North American market, and it's probably tracking now toward 13%. But they're showing robust demand and what happens out there with the supply chain is the unknown at the moment.

Ashish Agrawal -- Vice President & Chief Financial Officer

Yes, John, I think the SAAR will be impacted pretty significantly because of supply chain. The demand environment expectation is that the demand looks OK.

John Franzreb -- Sidoti -- Analyst

Okay. And Ashish you mentioned some of the restructuring actions you'll exit the year on the target $0.22 to $0.26. What restructuring actions remain to be done or you just looking for the revenue to kind of build up so you could get that exit rate?

Ashish Agrawal -- Vice President & Chief Financial Officer

So John, in the prior quarters, we have talked about delays in some of the programs that we are working on because of demand. We have not been able to execute because the demand has been so strong. We want to complete the execution of those program to date since we announced the program in Q3 last year, we have achieved $0.16 out of the 22 to 26. So there are some remaining pieces that we are working on execution, and we are on target to complete those by the end of 2022.

John Franzreb -- Sidoti -- Analyst

Any specific programs that are meaningful that have to be done?

Ashish Agrawal -- Vice President & Chief Financial Officer

So I don't think there's anything that hasn't begun, but we haven't been able to complete the full scope of certain activities that we've already started John.

John Franzreb -- Sidoti -- Analyst

Okay. And you mentioned -- I guess, its Kieran actually mentioned something that smart actuators and how they are more sensitive to EV versus ICE. Could you just explain that comment to me?

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

Yes. John, before I do that, I just wanted to go back to your question really. I'm not going to lock in on a SAAR number for next year. But I want to emphasize on the demand side and on the supply side, we're not able to hit some of the demand we have this year because of supply chain constraints. And those customers that we've been working with have increased that demand, and we've actually been working to increase the supply chain. But we're sometimes at the mercy of other suppliers into those OEMs to see how they're doing as well. So that's why I'm being a little hesitant on that robust demand.

And then back to your question on smart actuators, what we -- John, what was clarifying there was, in the past, we've made statements on the light vehicle market that we are agnostic to the propulsion system. So, when it comes to EV, all the products transfer over. What we're seeing is on the smart actuator, that goes into heavy duty, mostly commercial vehicles, some midrange and trucks as well. But what we're saying there is that has -- while it helps the environment in reducing harmful emissions, it is on an application that is ICE related. So we're just spelling that out. We're not worried about demand for those products for the next decade.

John Franzreb -- Sidoti -- Analyst

All right. So, I guess we'll [Indecipherable] put you on the hot seat a little bit. For the last year or so, EPS has vested consensus by roughly 25%. Is it the revenue that's been the greatest surprise or the execution on your side? That's been a bit of surprise in your markets driven better results over the past year.

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

I'll let Ashish comment on this, too. But I would look at it from -- it's both sides of the equation. I think we've always been good on managing operating leverage and cost. I also think that the diversification rate has helped us across the board, as we said in the prepared comments. Ashish, do you want to add to that?

Ashish Agrawal -- Vice President & Chief Financial Officer

Yes. John, when we started the year, we were very concerned about how strong the markets will be and so from that standpoint, we have been able to deliver more on revenue. So that has definitely helped. And the strength in our non-transportation end markets, they've done better than we started the year in terms of expectations. And quite frankly, we've made good progress on some of the operating challenges we were dealing with as well. If you think about last year, we were talking about significant problems with our foundry operations. And we've made very good progress on improving the consistency, the efficiency of that operation. So that's also helping with the overall profitability.

John Franzreb -- Sidoti -- Analyst

Great guys, thanks. I'll get back to the queue.

Operator

[Operator Instructions]. We will take our next question.

Lanny -- Cowen & Co -- Analyst

This is Lanny on for Karl Ackerman from Cowen & Co. Congratulations on your performance. I have just a few questions. Could you discuss the tightness you are seeing in the automotive supply chain and your customers' procurement behavior in anticipation of ongoing supply constraints? And I have some follow ups.

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

The constraints are pretty tight. It's really around the semiconductor side. I think we said nine million to 10 million units taken out of production this year. And on the commercial vehicle side, some units because of semiconductor shortage even going into next year. So, it's tightly constrained out there. We're working all the time in terms of securing supply, working directly with our customers and our suppliers. We're constantly working and evaluating alternative sources so we can actually gain capability. But it's been tight, but we do expect it to begin improving, and we expect kind of more significant improvement in the second half of next year.

Lanny -- Cowen & Co -- Analyst

Great thank you. And last quarter on the call, you had mentioned that you didn't see any inventory buildup through your customers or your distribution channels just yet. Have you seen any changes for those two segments?

Ashish Agrawal -- Vice President & Chief Financial Officer

So what I would say is, obviously, on the transportation side, we're not seeing any lack of demand because the inventory days are 20 days or less when it should be up closer to 55 days of supply. On the other end markets, we haven't seen any buildup in inventories in industrial, medical, defense. The small piece that goes into the consumer side, we've seen a little bit of change there, but it's minimal in our business. So we would be more concerned about end of the second quarter of next year into the second half of next year, what we're seeing at that point in time.

Lanny -- Cowen & Co -- Analyst

Great. And just one more question. Could you discuss the pricing environment currently? And what leverage you can pull to offset inflation? We've heard a lot of comments from other companies and competitors that freight continues to be getting worse. So, any color you could provide on passing along pricing to customers from here? Thank you.

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

Yes. Just as Ashish said earlier, we're really focused on the cost increases and sharing those cost increases with our customers, whether it comes to freight or part prices, and that's what we've been doing. And we concur with the freight increases, they're hugely up, and we don't expect them to drop-off in the next quarter even. So again, it's a partnership with our customers, our long-term relationships to share that cost as we move forward.

Operator

We will now take our next question. Please state your name and company before posing your questions.

Hendi Susanto -- Gabelli Funds -- Analyst

Hendi Susanto, Gabelli Funds. Ashish and Kieran your full year guidance implies about year-over-year growth between minus 7% and 1.5% in Q4. So at the top end of that guidance it represents like small sequential sales increase from Q3. You indicated that Q3 is the most challenging quarter in terms of supply chain challenges. So how should we think about like Q4 directionally, do you expect sales to transform patient market to decline, stay flat or grow sequentially into Q4?

Ashish Agrawal -- Vice President & Chief Financial Officer

So Hendi, the fourth quarter guidance, we're just being cautious because there's still a lot of uncertainty in the supply chain. We saw in the third quarter, our customers push out shipments, which was much more in the third quarter than in the prior two quarters. And we're just remaining cautious there because we're coming up on year-end where things could slow down in the automotive end market or the transportation end market. So, it's just a reflection of taking a cautious view on how the quarter might evolve.

Hendi Susanto -- Gabelli Funds -- Analyst

Thank you Ashish, and Ashish how should we think about potential benefit of ERP in 2022?

Ashish Agrawal -- Vice President & Chief Financial Officer

So a big portion of the cost-saving programs that we implemented as part of the restructuring we started last year was related to shared service implementation. We have done a good portion of that already. And as Kieran mentioned, we are getting smarter on how to utilize the better data that we have coming out of the ERP system now. So, I'd be looking to use that information to drive further operational efficiency improvement, working capital improvements. But we haven't specifically called out improvements that you might see in the coming years. It will be a process of learning and getting smarter with how we are using the information that is available to us now.

Hendi Susanto -- Gabelli Funds -- Analyst

Understood. And then one last question. So Kieran, you mentioned about working on and evaluating alternate sources. Any potential benefit or impact from sorting alternatives? And then how fast can you implement alternate sources?

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

So the primary focus there, obviously, is to support our customers and have -- when there's a shortage in supply like in chips that we can qualify other sources of chip suppliers. Obviously, Hendi, the second part of that is, we usually have a dual sourcing strategy anyway, but it's more than dual sourcing these days, just trying to get three or four suppliers, so you have got more options. But as you have more sources, it gives you more leverage on the supply base.

Hendi Susanto -- Gabelli Funds -- Analyst

Thank you Ashish, thank you Kieran.

Operator

We will now take our next question.

Justin Trennon Long -- Stephens Inc. -- Analyst

Hi guys, just a follow-up maybe to Hendis question and rephrase it possibly. Embedded in your outlook for the balance of the year. Is it safe to assume that transportation is a greater part of revenue in the fourth quarter than the 51% that you registered in the third quarter?

Ashish Agrawal -- Vice President & Chief Financial Officer

It's quite possibly going to trend that way, John, unless we see further disruptions in the supply chain.

Justin Trennon Long -- Stephens Inc. -- Analyst

But based on the current environment, you would expect it to be higher. And assuming that, is it safe to assume that the gross margin will be lower or the remaining cost savings actions, would that be sufficient to offset the mix change in the fourth quarter?

Ashish Agrawal -- Vice President & Chief Financial Officer

So I would expect gross margin to be similar to where we are at in Q3 or maybe slightly worse because of the mix shift. I'm not expecting a significant movement, John. And part of it could be interpreted as the unfavorable mix impact being offset with some improvements in the operational efficiency.

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

John, just to add to that, if we do well on the supply chain side in transportation, revenue could be up a few million, as Ashish said. I just want to emphasize, though, this diversification trend we're on and the goals we set for ourselves. And over the medium to long term, that's going to bring more sustained benefit to the margin profile of the company.

Justin Trennon Long -- Stephens Inc. -- Analyst

Agreed. I guess I'll just extend that thought with this question. A year from now, given the demand you indicated on the transportation side of the business, is the mix going to come closer to 60% or 55% this time next year? Or is it going to -- or do you have enough orders in non-transportation related programs that you can sustain something closer to 55%.

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

So John, but I've given you any strong guidance on this, I would say that we would expect the transportation percentage of our portfolio to be in the low to mid-50s by the end of next year, but we would have set more aggressive goals for ourselves if we can do some things that we want to get done as well.

Justin Trennon Long -- Stephens Inc. -- Analyst

Okay. And one other question, I guess, Kieran, you had said earlier in your prepared comments, and correct me if I'm wrong here that regarding M&A, you're actually looking at maybe some potential products in the EV market. Did you say that? And if so, can you just give us some kind of examples or you'd be looking to add in that market?

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

So John, just to frame it, we said we will grow in our transportation market and do acquisitions that would strengthen our EV play. On the flip side, I also said, we'll grow at a faster rate in our other end markets, which corresponds to what I just said about the diversification goals we set ourselves. So, we would look for particular plays may be that would complement the products we have today.

Justin Trennon Long -- Stephens Inc. -- Analyst

Okay. Is there anything like you could give me an example? I just can't kind of -- I can't visualize it, I guess, is what I'm saying. What will you be looking forward in EV?

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

Well, I suppose put it this way, John. Organically, we've been very clear that we're excited about E-brake and what we're doing in that space, and we see that as a tremendous opportunity. We would look at other sensors and capabilities around the vehicle.

Justin Trennon Long -- Stephens Inc. -- Analyst

Sorry to put that little stress on you Kieran. Thanks for taking my question guys, great quarter.

Operator

There has been no further questions. I'd like to turn the conference back to the host for any additional or closing remarks.

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

Okay. Thank you, Tracy, and thank you again for joining us today. I'm proud of the strong execution and operational efficiency exhibited by our global teams, driving measurable results for the business. Together as an organization, we're not only focused on advancing our business, but also improving and enhancing the communities we live and work in. In closing, as we enter the fourth quarter of 2021, I'm confident that our diversification strategy and expansive reach of geographic locations will position us for profitable growth and mitigate the supply chain challenges impacting industries worldwide. Thank you for joining us today, and this concludes our call.

Operator

[Operator Closing Remarks]

Duration: 46 minutes

Call participants:

Kieran O'Sullivan -- Chairman, President & Chief Executive Officer

Ashish Agrawal -- Vice President & Chief Financial Officer

Justin Trennon Long -- Stephens Inc. -- Analyst

John Franzreb -- Sidoti -- Analyst

Lanny -- Cowen & Co -- Analyst

Hendi Susanto -- Gabelli Funds -- Analyst

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