Autoliv Inc Q3 FY2022 Earnings Call

Welcome to the Q3 2022 Autoliv, Inc. Earnings Group Conference Call. Throughout the call, all participants will be in listen-only mode. And afterwards, there will be a question-and-answer session. Today, I am pleased to present Anders Trapp, VP of Investor Relations; Mikael Bratt, CEO; and Fredrik Westin, Group CFO. I’ll now hand the floor to our speakers. Please begin your meeting.

Thank you, Mark. Welcome everyone to our third quarter 2022 earnings call. On this call, we have our President and CEO, Mikael Bratt; and our Chief Financial Officer, Fredrik Westin. During today's earnings call, Mikael and Fredrik will, among other things, provide an overview of the strong sales and margin recovery in the third quarter, give an update on the price negotiations, outline the expected sequential margin improvement in Q4, as well as provide an update on our general business and market conditions. We will then remain available to respond to your questions, and as usual, the slides are available on autoliv.com. Turning to the next slide, we have the Safe Harbor Statement, which is an integrated part of this presentation and includes the Q&A that follows. During this presentation, we will reference some non-U.S. GAAP measures. The reconciliation of historical U.S. GAAP to non-U.S. GAAP measures is disclosed in our quarterly press release available on autoliv.com and in the 10-Q that will be filed with the SEC. Lastly, I should mention that this call is intended to conclude at 03:00 PM Central European Time. So, please follow a limit of two questions per person. I now hand over to our CEO, Mikael Bratt.

Thank you, Anders. Looking at the next slide, I would like to recognize the entire team for delivering a strong quarter, which I believe reflects our strong execution culture. As the market leader, we are building resilience and strength in turbulent times. Our actions initiated earlier in the year are creating both short-term and long-term improvements and enable us to build an even more competitive position, despite the challenging micro environment. We continued to negotiate higher prices to compensate for inflationary pressure. We also achieved another strong outperformance versus LVP, despite a negative regional mix. Our sales in the quarter reached over $2.3 billion, the highest so far for the third quarter for our current business structure. This is despite recessionary light-vehicle sales volumes in Europe and an 8% currency headwind. We also achieved a strong profit recovery, increasing adjusted operating margin to 7.5%. Our strong performance in the third quarter is especially encouraging considering the market conditions continued to be challenging with almost 2 percentage points adverse currency effects, as well as significant inflationary pressure and high customer call-off volatility. We generated a strong operating cash flow. The leverage ratio improved to 1.6 times. In the quarter, we paid $0.64 per share in dividends and repurchased and canceled 260,000 shares. Our Q3 performance enables us to update our full-year indication for the adjusted operating margin to the upper end of the indication. We expect continued sequential margin improvement in Q4 through price increases, cost reduction activities, as well as higher LVP and engineering income. The Q3 performance and expected Q4 development strengthens our confidence in our mid-term targets. In addition, we expect that our balance sheet and positive cash flow trend will allow for higher shareholder returns. Looking now at an update of the inflation compensation negotiations on the next slide. To support a sustainable business model in an inflationary environment, we continue to work closely with customers to secure price increases to compensate for inflation, volatile light-vehicle production, and supply chain disruptions. We have reached agreements in more than 90% of the raw material-related price adjustment discussions that we initiated earlier. Price adjustment discussions with our customers for cost increases related to labor, logistics, and utilities are progressing. We are also implementing greater pricing flexibility into new and running contracts with our customers to account for changing raw material costs. Now about half of our contracts contain raw material losses. This is an increase from around 20% before we started the negotiations. The clauses should provide more stable and predictable earnings going forward as changes in costs will be more aligned with changes in price. Looking now at our cost control measures on the next slide. We continue with strict cost control measures, controlled hiring, and footprint effectiveness. As a result of these activities, headcount increased only by 9% year-over-year, whereas sales grew organically by 32% during the same period. The increase also reflects preparations for the expected strong sales growth in the fourth quarter. Also, we continue to execute on our capital efficiency program to improve trade working capital. Considering the uncertainty of the market development, keeping a high degree of flexibility and agility is essential and allows us to be an even stronger company long-term. Looking now at the financial overview on the next slide. Our consolidated net sales of $2.3 billion was 25% higher than in Q3 2021. Adjusted operating income excluding cost for capacity alignments increased from $103 million to $173 million. The adjusted operating margin was 7.5% in the quarter, around 2 percentage points higher than last year. The higher operating margin was mainly a result of higher prices, operational leverage on higher volumes, as well as cost-saving activities. Operating cash flow was $232 million, which was $43 million higher than the same period last year, mainly due to improved working capital and higher net income. Looking now at our sales growth more in detail on the next slide. Although currency translation effects had a negative impact of 8%, the third quarter consolidated net sales increased by more than $450 million to $2.3 billion. Retractable pricing contributed approximately $13 million and the price-volume mix contributed almost $600 million in the quarter. As a result, the organic sales grew by more than 32% in the third quarter compared to last year. Looking at the regional sales split, Asia accounted for 42% of sales in the quarter, North America for 34%, and Europe for 24%. Looking to our organic sales growth per region on the next slide. Our organic sales in the quarter came in as we expected in the beginning of the quarter, but with a different region mix with higher sales in China and Europe offsetting lower-than-expected sales in Japan and the Americas. According to S&P Global, light-vehicle production increased by 29% year-over-year in the quarter, which was almost 7 percentage points better than expected at the beginning of the quarter. All of the higher-than-expected volumes came in China and the rest of Asia, while volumes in higher content per vehicle markets North America, Europe, and Japan were lower than expected. Despite the negative regional light-vehicle production mix, we outperformed global light-vehicle production by around 4 percentage points. Based on the latest light-vehicle production numbers, we outperformed in Europe by 11 percentage points, in the Americas by 7 percentage points, and in Japan by 6 percentage points. Sales in China outperformed light-vehicle production, despite a negative mix with manufacturers of low-end vehicles benefiting from more than the latest tax incentives on EVs and cars with engine displacements of up to two liters. Supported by recent launches and a positive regional mix, as well as further price increases, we see sales outperforming light-vehicle production even more in Q4. On the next slide, we see some key model launches from the third quarter. In the quarter, we had a high number of launches, especially in Europe and China. The models shown on this slide have an Autoliv content per vehicle from approximately $95 to more than $400. The long-term trend to higher CPV is supported by the introduction of front-center airbags on five of these vehicles. I will now hand it over to our CFO, Fredrik Westin, who will talk about the financials on the next slide.

Thank you, Mikael. This slide highlights our key figures for the third quarter of 2022 compared to the third quarter of 2021. Our net sales were $2.3 billion; this was 25% higher than Q3 ’21 and 11% higher than Q2 this year. Gross profit increased by 28% to $383 million, while the gross margin increased to 16.7%. The gross margin increase was primarily driven by higher prices, partly offset by cost inflation, currencies, and volatile light-vehicle production. In the quarter, we made $2 million in provisions for capacity alignment activities. The adjusted operating income increased from $103 million to $173 million, and the adjusted operating margin increased from 5.6% to 7.5%. The operating cash flow was $232 million, and I will provide further comments on our cash flow later in the presentation. Earnings per share diluted increased by $0.53, where the main driver was $0.59 from higher adjusted operating income, partly mitigated by $0.06 from financial items and non-operating items. Our adjusted return on capital employed increased to 18% and the adjusted return on equity to 17%, up from 11% and 10% respectively. We paid a dividend of $0.64 per share in the quarter, the same as in the previous quarter, and repurchased around 260,000 shares for $20 million under our stock repurchase program. Looking now at the adjusted operating income bridge on the next slide. In the third quarter of 2022, our adjusted operating income of $173 million was $70 million higher than the same quarter last year. The impact of raw material price changes was a negative $96 million in the quarter year-on-year. FX impacted the operating profit negatively by $41 million, or almost 2 percentage points. This was a result of translation effects due to the stronger U.S. dollar and transaction effects mainly relating to the strong U.S. dollar versus the Japanese yen, Korean won, and the Euro. SG&A and RD&E net combined were $13 million higher, due to higher costs for IT and application engineering, as well as the timing of engineering income. The profit increase was driven by improved pricing, high volumes, as well as our strategic initiatives, partly offset by the significant headwinds from raw materials, foreign exchange, call-off volatility, and general cost inflation. As a result, the leverage on the higher sales excluding currency effects was within the range of the normal interval of 20% to 30%, despite the substantial headwinds from raw materials. Looking now at the cash flow performance on to the next slide. For the third quarter of 2022, operating cash flow increased by $43 million to $232 million compared to last year, mainly due to strong performance in working capital and higher net income. During the quarter, trade working capital improved by $65 million, despite the steep ramp-up in sales. The improved trade working capital was a result of improved payables in part due to our capital efficiency program. In the quarter, the volatile light-vehicle production and logistics challenges continued and it drove inefficiencies in inventories. Inefficiency in inventory continued to be in excess of $100 million at the end of the quarter. Our ambition is to eliminate these inefficiencies as soon as possible, which does require further stabilization of the supply chain and call-off patterns from our customers. For the third quarter, capital expenditures net increased by 47% to $164 million. In relation to sales, it was 7.1% versus 6.0% a year earlier. The higher level to some extent reflects a temporary catch-up of investments that were delayed during the pandemic. It is also related to the ongoing footprint activities and capacity expansion for growth, especially in China. For the third quarter of 2022, free cash flow was $68 million, $9 million lower than a year earlier, driven by the higher capital expenditures. The cash conversion over the last 12-months was around 25%. In the quarter, we paid $56 million in dividends and again repurchased shares for $20 million. In the fourth quarter of 2022, the timing of payment of customer compensations and the seasonality of engineering income are expected to support positive cash flow development. Now looking at our shareholder returns on the next slide. Autoliv has shown in the past several years its ability to generate solid cash flow in a difficult market environment, with COVID lockdowns, the war in Ukraine, industry supply-chain challenges, and a substantial decline in light-vehicle production. We have historically used both dividend payments and share repurchases to create shareholder value. Historically, the dividend usually represented a yield of approximately 2% to 3% concerning the average share price. Since the beginning of 2019, we have reduced net debt significantly, as well as returned $700 million directly to shareholders. This includes stock buybacks of around $60 million as part of the stock repurchase program that we announced at our Capital Markets Day in 2021. We expect that our balance sheet and positive cash flow trend will allow for increasing shareholder returns. Now looking on to the next slide, the leverage ratio at the end of September 2022 was 1.6 times. This was a reduction from the 1.7 times in the previous quarter as our 12-month trailing adjusted EBITDA increased by $58 million and our net debt decreased by $36 million. Looking at the liquidity position, we go to the next slide. At the end of the quarter, we had a significant liquidity cushion of approximately $1.6 billion in cash and unutilized committed credit facilities. Our unutilized $1.1 billion revolving credit facility is with 11 major banks. This was refinanced in May of this year and matures in 2027 with an extension option to 2029. To minimize refinancing risks, we have diversified our long-term funding sources and we also have a maturity profile that is well spread over the coming years. None of the credit facilities are subject to financial covenants. Now looking at our energy usage on to the next slide, we are continuously monitoring the development of the energy markets and we have taken actions to secure supply and to lock-in prices. The energy issue is mainly a European challenge. The cost for the energy used in our facilities in 2021 for the company overall corresponded to approximately 1% of sales. Of our total energy use, 66% was purchased electricity and 27% came from natural gas. Autoliv does not generally use gas for its manufacturing processes; it is mainly used for heating at some of our facilities. Our main concern at this stage is the potential impact that a shortage of gas or electricity might have on the industry supply chain, especially in Europe. Currently, we do see a slight easing of prices in Europe, due to the steady inflow of gas, mainly LNG, and recent decisions to activate nuclear power plants again. For the remaining of 2022, energy prices are locked-in, and contract negotiations for 2023 are completed in all regions except for Europe. In Europe, we have locked-in most of the prices for the first half of 2023; several of them are new Green Energy contracts. We are still negotiating in a few countries for the second half of the year. I now hand it back to, Mikael.

Thank you, Fredrik. Looking now at the LVP development on the next slide. Part of the auto industry continues to operate at or near recessionary levels impacted by supply chain challenges. For example, due to a lack of new vehicles, European registrations year-to-date are approximately 30% lower than for the same period in 2009, during the financial crisis. For the fourth quarter of 2022, global light-vehicle production is expected to grow by 3% compared to the same period in 2021 according to S&P Global. Sequentially, LVP is expected to improve by 4% compared to Q3 as the availability of automotive semiconductors is expected to improve, although not as much as previously anticipated. In North America and Europe, the near-term production forecast continues to be limited by automakers’ ability to produce, not by demand. In China, light-vehicle production is supported by robust EV sales and the effects from tax incentives on certain new vehicles. According to S&P Global, full-year global 2022 light-vehicle production is forecasted at 79 million units, representing year-over-year growth of 6.8%. Now looking at the Q4 business outlook on the next slide. As illustrated by this chart, we have been able to gradually improve the adjusted operating margin from 3.2% in the first quarter to 7.5% in the third quarter of 2022. This is despite continued headwinds from raw materials and other inflationary costs. The chart also shows the substantial year-over-year improvements in Q4 that are implied by our full-year indication. The main reasons for the sequential improvement are the price increases, higher volumes, as well as our strong focus on continuous improvements throughout the organization and our strategic roadmap initiatives. As implied by our full-year indication, we expect the sequential margin improvement trend to continue in Q4. In addition to higher prices, continued volume recovery, and cost-reduction initiatives, we expect positive seasonal effects from engineering income. Although uncertainties continue to affect the industry volumes, we expect to significantly outperform light-vehicle production in Q4. To put things in context, this year has been dramatic, especially in Europe. The year started with light-vehicle production expected to grow by 17% in Europe, while now nine months later, it is expected to decline by 2%. Additionally, we were globally affected by volatile light-vehicle production with late changes to call-offs, the war in Ukraine, and the challenging supply chain, which created disruptions and substantial cost increases. While we continue to challenge ourselves to further improve, I am pleased that our performance in such a dramatic environment enables us to guide towards the upper end of the adjusted operating margin range. Looking at the updated full-year 2022 indications on the next slide. Our full-year 2022 indications exclude costs and gains from capacity alignments, anti-trust-related matters, and other discrete items. We are adjusting our full-year indication for the adjusted operating margin to the upper-end of the indication range of 6% to 7%, reflecting our Q3 performance and the shorter time span remaining of the year. The updated indications assume that full-year 2022 global light-vehicle production will grow around 6% and that we achieve our targeted cost compensations plus some level of market stabilization. We expect sales to increase organically by around 15%, currency translation effects on sales are assumed to be around a negative 6%, and operating cash flow is expected to be around $700 million to $750 million. This concludes our formal comments for today's earnings call, and we would like to open the line for questions. I will now turn it back to Mark.

Thank you. Our first question comes from the line of Mattias Holmberg of DNB. Please go ahead, your line is open.

Hi, everyone. Thank you. Two questions from me. I really appreciate the details you provided on the new pricing agreements, and this might be a dumb question, but to make it very clear, let's say we have a scenario where steep prices fall or rise by X percent. Can you sort of walk us through the difference of how your selling prices would change in the contracts, where you have these raw-material costs versus the ones where you do not? And my second question is on net working capital, in relation to the inefficiencies in inventories exceeding $100 million, how does this relate to the $800 million, I think you mentioned in the capital efficiency program that you discussed at the Capital Markets Day last year and how far you've progressed here? Thank you.

Thank you for your question, sir. Let me start with the pricing question there. What we're stating here is that we have come through 90% of the contracts to be negotiated around the raw material. In those negotiations, we have increased what we call compensation clauses for the future year and connected that to the developments of raw materials, so we have a better balance. It's difficult, and I can't give you a very detailed breakdown on that because each agreement has its unique details, and what we are focusing on here is, of course, to make sure that we have a balance between our supplier base and our customer base and respective raw materials here. But we have a better position today than what we had at the beginning of the year in relation to that, but I can't afford to give you more details than that. And when it comes to the net working capital, I ask Fredrik to take that.

Yes, regarding the $800 million, we are aligning that with our mid-term targets set for 2024. On the payable side, we are making strong progress and may actually be ahead of our timeline. As for inventory, we have implemented the necessary initiatives; however, the outcomes are not meeting our expectations due to volatility from our suppliers and varying call-off patterns from customers. This situation limits our ability to fully utilize our inventory setups since we need to maintain higher safety stock levels. If the volatility decreases, we anticipate it will enable us to improve our efficiency levels. While our initiatives are on track, the results are somewhat delayed due to the current market conditions.

Great. Thank you, both.

Thank you.

Thank you. Our next question comes from the line of Colin Langan at Wells Fargo. Please go ahead, your line is open.

Oh, great, thanks for taking my questions. I just, as we're looking at Q4, and I think your guidance implies something close to 10% if sort of go to the mid-point in Q4. Is there anything, I think you highlighted some seasonality? Is there any retroactive pricing help there? And anything that would prevent us from taking that in any material way and not annualizing that as for our margin for 2023?

I mean, you saw already now in the third quarter that the retroactive part on the pricing negotiations was already smaller than in the second quarter, and I would expect that the fourth quarter would be even smaller than the third quarter. So it's not a matter of, say, high retroactivity or something that then increases the margin sequentially; it is the slightly higher volumes that we expect for the fourth quarter versus the third, and that's particularly in Europe and Japan. It is a further improvement of the price position, and then the seasonality on the higher engineering income, which is a typical pattern for our company, that are the main drivers for the fourth quarter.

And so as we're thinking about, let's say production is flat in 2023, what are the other sort of key pieces we should be thinking about of how your margins should trend? Because obviously, it's been on a pretty great trajectory so far sequentially, you have continued pricing helps, so there should be more help next year, it looks like in the walk the inflationary headwinds aren't what they were at the beginning of the year, so they actually become tailwinds next year in a restructuring production volatility. This seems like a lot of tailwinds, in any way to maybe frame some of those issues if the next year is sort of flat, but steady production?

I think when it comes to 2023, we will come back with more commentary around the progression there as we get to the Q4 presentation, as we usually do, so it's too early to comment on that. But I think what we're showing here in the quarter is really that we are focusing on, first of all, the price discussions, but our job internally here is really to continue to work with our cost base and drive the efficiencies here. We have talked on the bases here, which is that we will have strategic roadmaps to drive efficiency across the whole value chain and additional cost focus that we announced earlier in the spring. But of course, I mean, there is still a lot of uncertainty out there as we have alluded to here also in the Q3 presentation here. We don't have it behind us yet, and we have talked about the volatility, labor challenges, and component challenges, etc. So I think we will have to come back and give you more details when the time comes here in the beginning of next year.

Okay. All right, thanks for taking my questions.

Thank you. Our next question comes from the line of Chris McNally at Evercore. Please go ahead, your line is open.

Thanks so much, and I appreciate the team. Maybe if we can focus on FX headwinds, particularly it looks like you have in the short term a transactional headwind from the Japanese yen in terms of exporting inflators from the U.S. Typically, FX has kind of washed out for you, but obviously, extreme moves in the currencies. Could you just give us an idea, is this something that you can kind of work around from global supply, or should we sort of think this is going to be a headwind as long as sort of the FX is going against you in the short term?

Yes. I mean as we see, we have a total currency headwind of $42 million in the quarter. Roundabout $25 million of that is from transactional FX. And as you said, the main reasons are the Japanese yen, which has weakened around about 30% year-over-year against the dollar, but also as I mentioned, the won, the Korean won, and the Euro. We do have, especially in Asia, FX clauses with a number of customers, so that should compensate for some of these developments. But should the FX rates stay at their current levels, we would also expect a negative impact in the fourth quarter, and then we would look into more long-term solutions should the rates maintain at this level.

So that touched, so there are FX clauses for some of the Asian contracts, but like anything there's probably a delay and there's probably some gaps. So again, the issue in Q4 is a headwind, but there may be some recoveries that can if I think about 2023?

Yes, correct.

Perfect. I wanted to check in on your medium-term margin target of 12%, which still seems achievable once production normalizes, potentially at around $89 million. You've done well managing raw material prices, which is encouraging. While foreign exchange might present some challenges, I wanted to confirm that the 12% target remains on track as we work towards normalizing production again.

Yes. As I think we stated here in the Q3 report, this quarter is an important stepping stone towards our mid-term targets here and the framework around the 12% that we have announced at least $85 million vehicle production level and that we have a net effect of raw material prices at 2021 levels is still valid, yes, absolutely.

Okay. Great, thank you so much.

Thank you.

Thank you.

Thank you. Our next question comes from the line of Joseph Spak at RBC Capital Markets. Please go ahead, your line is open.

Thanks, everyone. So I totally appreciate that you sort of want to punt on ‘23 until we get to next quarter, because there are still some moving pieces; but as I sort of mentioned earlier, right? The implied sort of fourth quarter margins are close to 10%. Fourth quarter, I know typically has that like 100 basis point, 150 basis point from the RD&E income. So if we factor that in and all the other actions you've taken, is something around 9% the right base we should think about? And then we need to sort of consider all those other uncertainties on pricing, volume, commodities, FX, et cetera; is that how we should start thinking about it?

I'm sorry, I think my answer has to be the same here as before here. We can't really give you any comments around ‘23 until we get there. But of course, as you said yourself here, it's a lot of moving pieces here in the external environment that also makes it difficult here now to draw conclusions. But what I can say is that I feel comfortable with what we can control, that our team is doing well and that we are moving forward in the right direction here, and as I said, Q3 is an important stepping stone on that directional movement there, and we will come back with more detail later.

Maybe to simplify the question and like is, is that right that the fourth quarter has about 100 basis points, 150 basis points RD&E benefit?

Yes, it sounds about right, yes.

Okay. For your second question, you mentioned the 5 percentage point impact from raw materials in 2022. Considering the way the new contracts are structured, what do you believe that impact would have been in 2022?

I don't understand the question.

So you're expecting a 5 percentage point hit from raw materials in ’22, right? But you've formed new contracts that can compensate you for raw materials, so if those had been in place starting on January 1, what do you think that margin hit would have been for the year?

Let me try to answer it this way. I mean we have, as we said here achieved more than 90 or settled more than 90% of the negotiations related to raw materials, and we have done that at a level that is satisfactory for us to offset the raw material headwinds that we have experienced. So with that, we are where we think we should be when it comes to the raw material compensation, yes, at the moment.

Perfect, thank you. I have two questions, and I will ask them one by one. So, Mikael and Fredrik, you said that the main reason for the margin improvement in Q3 was the price increases and higher volumes; yet when I look at the margin development in the quarter sequentially or year-on-year, I come to the conclusion that much of this improvement was driven by OpEx costs such as R&D and SG&A and not that much by the improvement in gross margin? I would appreciate your comment on that and what we should expect going forward?

Yes, absolutely. To start, we have established a balance regarding raw materials. However, we have not made as much progress in negotiations concerning other inflationary pressures like labor, logistics, freight, and utilities. This is why you don't see the full impact of the price negotiations reflected in the gross margin, as there is still work to be done on those three areas. Regarding foreign exchange, it has a more significant impact on the gross profit line than on costs below it, actually benefiting costs below gross profit. It's essential to consider this to better understand the operational performance. Lastly, there remains considerable inefficiency in our setup due to call-off volatility. Although the situation is improving, it is not yet at the levels we experienced pre-COVID. For example, premium freight continues to be a cost burden; it has improved since the first and second quarters, but it still poses challenges that affect gross margin.

Okay, perfect, to your point. And then my last question is about your referring to the 90% of the negotiated contracts being now concluded, the contracts that you negotiate, are they all contracts that you have? Or is it just the proportion of the outstanding contracts?

Hi, can you clarify? I don't understand.

You can say like that might be, so you have, say, total contracts with your customers, are you addressing all the contracts that you have with the price negotiations or just choosing some of the contracts to address?

No, no, it is by customer, so we typically have an agreement by customer; it might be sometimes by customer and region, but the 90% indicates that it covers all customers and all contracts that we have.

All contracts, okay, perfect. And then maybe a short follow-up on that so when we look at Q3, how much of your sales was based on the negotiated prices, was it already 90% or was it a smaller proportion?

Yes. It was less because they were contracts that were adjusted during the quarter and not all of those had retroactivity in them.

Yes. Hey, guys, thanks for taking my question. My first question is just coming back to the raw materials; you're guiding for around 5% for this year. If I look at it year-to-date, we are running at around 5%, and it was around 4% in the third quarter. Is it fair to say that this is maybe a bit of a conservative assumption that probably given that Q4 should also see a bit of an improvement sequentially? And when do you see your potential rollover? I think in the first quarter of this year, you had a majority of your steel contracts that you renegotiated; would these be renegotiated again in the first quarter of next year? That's my first question.

Yes, we're observing up to a 5 percentage point change. This is due to the decrease in prices for steel and other non-ferrous metals, which should positively impact the fourth quarter. However, this is counterbalanced by developments in costs related to Jon and Westin. As we have mentioned several times, there is a six to nine month delay between changes in spot prices and their reflection in our profit and loss statement, and that still applies. We need to monitor how cost indices evolve moving forward and what that means for the next year. It's also crucial to note that despite the decline in raw material costs, they remain significantly higher than pre-COVID levels.

Thank you. And my second question is just connected to the pricing on that; you moved up to 50% from 20% on the raw materials. Does that then also include the six to nine months' time lag in line with how it hits your P&L? Or is it really pretty different across contracts?

There is a range on the contracts as well. What we're striving for is to have a good balance between how the top line is impacted and how our cost base is impacted. As Mikael mentioned before, the structures are rather complex when you consider how the different contracts are set up by customer and also the adjustment cycles involved. Our goal is to achieve a better balance between both cost and top line development.

Yes, thank you very much. So it's good to see that you're having productive negotiations around price recoveries for energy, freight, and labor. When would you expect the timing of these negotiations to conclude? And would the benefit be seen this year? Or is this something that would be incremental for 2023?

I think it's gradually coming on here as we move forward with negotiations. And of course, I mean, it's as long as we live in an inflationary environment here and we see continued cost pressure, it's of course, an ongoing dialogue and discussion with our customer and how to pass this on. So I wouldn't say that we will be finished at a certain point; it all is connected to how the cost development will be when it comes to these external factors, but gradually we are seeing the effects from that.

Understood. And then, I guess, separately, you mentioned, I guess, in the implied fourth quarter margin outlook, you mentioned some typical seasonality and sort of timing benefit in there. Would you be more comfortable thinking about your second half 2022 margin as a good run rate to start thinking about building expectations for next year? Is that a cleaner number in terms of where you think your business is operating on an underlying basis?

Yes. I think first of all, I mean the good thing here is that we are moving in the right direction here and building momentum as we manage through this difficult external landscape. And I think when we talk about run rates here, I think what we're showing here is that we have a good improvement on the underlying run rate here. But we still have a lot of external factors heading in the wrong direction. I mean, it's still a headwind for us and will probably continue to be so, and we have mentioned them earlier here around overall inflationary pressure. We have the currency situation volatility, we still see far from normalized there, and we have the component and labor shortages in general for the industry here. So I think with too many moving pieces on the outside, I think it's difficult to be too firm here. But despite all this, I think we are showing here that our own activities are really producing results here. And I’m happy to see that, and I'm feeling that we are well set up to continue to deal with the external environment here.

Hello, can you hear me?

Yes, we hear you.

Hello, okay. I wanted to ask about the new contract. So if you do see direct material declines from here or commodity declines from here, can you maybe just give us a little bit of color on how much of that gets retained? So I believe that 40% of your material exposure is steel, which is obviously down a lot, but now you have index agreements on some of your contracts? And then secondly, just regarding the non-raw material negotiations. So labor, logistics, and utilities; could you give us a sense of what the value at stake is or what you are targeting in terms of recovery in that category?

If I start with the raw material aspect, there are now different arrangements with various customers, each following distinct indices and renewal cycles. Our aim is to achieve a balance between our costs and customer pricing that will not significantly impact our margins in the future, ensuring that we maintain a good equilibrium between price and cost. It's also important to note that we have secured material agreements for about half of our portfolio, while the other half is still under negotiation and does not adhere to any specific indexation or closure setup. Regarding non-raw materials, this constitutes a much smaller portion that has impacted our cost structure to date. For utilities, for instance, this accounts for around 1% of our cost base. We anticipate a potential increase of about 10 basis points in utility costs this year, but we are facing stronger headwinds from freight and labor. Our priority now is to engage in data-driven discussions with our customers to secure compensations for these cost increases.

No, I think we have held on to what we call the strategic road maps where digitalization and optimization is a part of. I think that's very important to do that even though we have a lot of challenges short-term here in the market. We are progressing according to plan there; and that, of course, is also what's helping us gradually each quarter. We will continue with that.

Thank you very much. I just wanted to hear you guys on the deal activity in Europe; I had some conversations with other sub-suppliers to the auto industry saying that we've been cancellations from OEMs and part of that could be that they are now seeing better component availability, which means that they're slightly normalizing their inventory levels. What's your view on that, and your experience similar in your daily business? That's my only question. Thanks.

I think as we said before, I mean, we have seen improvements when it comes to the volatility. But I would say it's still an issue and far from normalized, so that's ongoing. And of course, the volumes also have stabilized and improved on an absolute level here, compared to the previous quarters. So we're moving in the right direction, but it's still from normalized year. And it's clearly so that, I mean, yes, the semiconductor availability has improved, but we still see differences between the different customers here; some are, you could say, almost gone. It's not a topic while others still are facing some challenges there. So I guess it depends on the OEM here still.

Yes. Hi, everyone. I want to revisit the topic of pricing. I'm curious about your price adjustments. Are you using 2019 or 2020 as a base for some of these increases, or are they more related to current pricing levels? If prices begin to decline, how might that affect your future pricing? Could you clarify the starting point versus the base pricing you are using?

Yes, that's a valid point. If you don't have a specific setup and need to switch to the index, it’s essential to ensure you receive appropriate price compensation. Our primary focus has been on achieving the right adjustments to account for the costs we had to manage for a while. With over 90% of these agreements finalized, we believe we've successfully reached the expected adjustment levels; otherwise, we wouldn't have been able to close them.

Got it. And so then as you look at ‘23, given that pricing might come down, but still they could be fairly elevated. You would expect still that to be a fairly good tailwind into ‘23 as well, right?

It's too early to tell. However, the current state of the industries suggests that costs may decrease, which could lead to adjustments in pricing or the other way around. Our goal is to achieve a better balance between cost and pricing development, ensuring this balance is reflected in a reasonable timeframe to reduce our risk profile as a company. That has been our main objective. Actually, the main problem for us at the moment is more on the raw material side, so more on the incoming inventory levels, and that's where we have larger problems due to still rather distressed supply chains and then also longer lead times. So that has been the larger issue for us. Then, of course, also the call of volatility causes inefficiencies on the finished goods side, but that is not a large problem year-over-year. I mean that was actually even worse last year than this year.

Actually, the main problem for us at the moment is more on the raw material side, specifically the incoming inventory levels, where we are facing larger challenges due to distressed supply chains and longer lead times. This has been the bigger issue for us. Additionally, the volatility in the market leads to some inefficiencies in finished goods, but that is not a significant problem when compared year-over-year. In fact, it was even worse last year than this year.

I think we're out of time here, sorry. I think we should close the call maybe.

Of course. I'll hand back to you for the closing comments.

Okay. Thank you, Mark. Before we end today's call, I would like to say that we are continuing to build resilience and strength in turbulent times, relying on our strong company culture. Our actions are creating both short-term and long-term improvements, and we believe these actions will enable us to build an even stronger position, despite the challenging macro environment. We remain agile and prepared for more adverse market developments should that be necessary. Autoliv continues to focus on our vision of saving more lives, which is our most important direct contribution to a sustainable society. Our fourth quarter earnings call is scheduled for Friday, January 27, 2023. Thank you, everyone, for participating in today's call. We sincerely appreciate your continued interest in Autoliv. Until next time, stay safe.