Hello, and welcome to the Signify Third Quarter Results 2021. Throughout the call, all participants will be in listen-only mode, and afterwards there will be a question and answer session. Please note, this question and answer session is limited to one question plus one follow-up. Today, I am pleased to present Eric Rondolat, CEO, Javier van Engelen, CFO, and Thelke Gerdes, Head of IR. Please go ahead with your meeting.
Good morning, everyone, and welcome to Signify's earnings call for the third quarter 2021. With me are Eric Rondolat, CEO of Signify, and Javier van Engelen, CFO. During the call, Eric will touch on the key operational and financial takeaways for the third quarter of 2021. Javier will then follow with a review of the company's performance for the third quarter. To close, Eric will end today's presentation with the outlook for the remainder of the year and closing remarks. After that, we will be happy to take your questions. Our press release and presentation were published at 7:00 A.M. this morning. Both documents are available for download from our investor relations website. The transcript of this earnings call will be made available as soon as possible on our IR website. With that, I will now hand over to Eric.
Thank you, Thelke. Good morning, everyone, and thank you for joining us today. Let's start with some highlights of the third quarter on slide four. The demand for connected lighting and the performance of our growth platforms remained solid in what has been a very disrupted external environment this quarter. The strong demand pick up across most segments and geographies is evidenced by our healthy order book, which increased by 90% in comparison to the third quarter of last year. This economic recovery further aggravated the challenging supply environment which we had already discussed in the three previous quarters. These developments impaired our ability to meet the high demand and resulted in a negative top-line impact of more than EUR 100 million.
We have taken a comprehensive set of short-term and mid-term mitigating actions to reduce the impact on our customers, while simultaneously increasing our prices to offset structural inflation. These actions have enabled us to deliver a strong double-digit adjusted EBITA margin of 11.1%, driven by an acceleration of price mix and indirect cost savings. At the same time, we continue to invest in digital and marketing initiatives to further enhance our growth profile. Working capital remained structurally healthy in the third quarter, and our free cash flow generation remains on track, although delayed due to the current external challenges. I would like now to discuss our third quarter performance in more details, and I propose that we move to slide five.
We increased the installed base of connected light points from 86 million in Q2 to 92 million at the end of Q3, including 2 million connected light points from Telensa, the U.K.-based street lighting company we recently acquired at the start of the third quarter. LED-based sales now represent 83% of total sales. Sales came in at EUR 1.6 billion, representing a comparable sales decline of 4.8%. Adjusted indirect costs decreased by EUR 37 million to 29.4% of sales, driven by structural cost savings and one-off effects in the previous year, namely the provisions for the partial reimbursement of solidarity contributions to employees. Strategic investment in digitalization activities continued.
The strong double-digit adjusted EBITA margin of 11.1% reflects the positive price and mix actions, offsetting the structural part of inflation and under absorption of fixed costs. Net income increased by EUR 4 million to EUR 94 million. Finally, free cash flow was EUR 85 million as a result of a lower income from operations and an outflow from working capital. On the next two slides, I will give a bit more details on the demand, supply, and supply environment, as well as the pricing developments. Let's go to slide six. Our order book grew since Q3 2020, with order levels increasing sequentially over the last four quarters. Compared to last year, the order book value increased by 90% at the end of Q3.
This is due to a strengthening demand in component scarcity and logistic challenges. Indeed, we have been exposed to e-component shortages with a spike in the number of escalations in the second and third quarter. The Q3 lockdowns that had been taking place in Malaysia and other ASEAN countries lead to further e-component decommitments from our suppliers. We have also been exposed to global logistic challenges, including container shortages and port congestions, as 10% of the world shipping capacity was taken out during the quarter. During that same quarter, we experienced 5 cases where Chinese ports, which are important hubs within our supply chain, experienced a shutdown or congestion. As widely reported, we are continuing to see congestion at U.S. ports, such as L.A. and Long Beach, impacting our deliveries to the U.S.
Altogether, these disruptions negatively impacted our top line by more than EUR 100 million during the quarter, mainly affecting Digital Solutions and Digital Products divisions. This top line effect is to a large extent attributable to components around 75% and logistics around 25%. Let's now talk to price development. Moving to slide seven. This quarter, net price continued to improve and turn positive. More importantly, price and sales mix more than offset what we call the structural part of our COGS inflation. It is important to consider that sales mix is taken into account as it includes product replacements and new product launches that are mostly at higher gross margins. Overall, we see positive momentum on pricing and are planning regular and necessary price increases to compensate for the upcoming structural inflation.
Now, let's move on to the discussion on our divisions, starting with Digital Solutions on slide eight. Comparable sales decreased by 7.3% as the division was most exposed to the component shortages and logistics disruptions. Sales growth was still affected by lockdowns in some of our markets like ASEAN countries and Canada. Adjusted EBIT margin declined by 100 basis points versus last year to 10.5%. This was mostly due to lower fixed cost absorption, but also due to increased input and logistics costs that were only partly offset by pricing and indirect cost savings. On slide nine, you will find some of the business highlights from our Digital Solutions division.
The first one I would like to highlight shows our commitment to safety and security as we continue to support the emergence of smart cities around the globe through the acquisition of Telensa. Through this acquisition, we're adding a narrowband and TALQ compliance solution to our already feature-rich open and secured systems. With Telensa, we're able to make smart city infrastructure affordable to cities utilizing the unlicensed radio space. Telensa will continue to sell its systems under its own brand name. The second highlight shows our support to food availability where our existing customer Den Berk Délice in Belgium decided to go for a second hybrid lighting installation with LED top lighting.
Den Berk Délice, which is the largest tomato grower in Belgium, is the first customer to have installed our GreenPower LED toplighting force, which has a higher light output and is perfect for light-loving crops such as tomatoes. This results in higher output for farmers. All the lights are connected to the GrowWise Control System to provide our customer with the ability to dim light levels when necessary, improving the growth cycle and reducing energy use and costs. Let me now move to Digital Products on slide 10. During the quarter, division showed a resilient sales and adjusted EBITA performance. Comparable sales growth was 2.5% despite the impact of supply chain constraints. These had a particularly strong impact on connected home products.
The adjusted EBITA margin was broadly in line with the previous year at 13%, driven by a positive effect of sales mix and price increases, which were offset by higher COGS. Given the continued demand, we implemented our commercial pool plans through additional marketing spend. The next slide 11 shows a few business highlights from the Digital Products division, all illustrating our commitment to customer-driven innovation. Let me start with the latest addition to our Philips LED family, one that truly embodies how innovation and sustainability come together at Signify. In September, we launched in Europe our most energy efficient LED bulb to date, called the Philips LED A-class bulb. This is the first in the new Philips ultra-efficient LED range. This bulb is 60% more energy efficient in comparison with standard Philips LED bulbs.
Due to these energy efficiency gains, the product helps to save consumers money on their electricity bills, something that with the rising energy prices seems more important than ever. Furthermore, we also have enriched our product offering for our consumers, both for Philips Hue as well as WiZ, as you can see. More specifically, we announced the Philips Hue and Spotify partnership. Together we developed an algorithm that analyzes the metadata of each song in real time. This algorithm creates a more advanced light script that on top of matching the beat, matches mood, tempo, and more. This provides consumers who use the Hue app with the most immersive music experience ever.
Moving on to slide 12 and to talk about Conventional Products, which declined by 13.2% on a comparable basis, while adjusted EBITA margin increased by 90 basis points to 18.8%, once again showing the resilience of that division. Next, I would like to discuss the third quarter performance of our Brighter Lives, Better World 2025 program on slide 13. In the third quarter, we celebrated one year of carbon neutrality in our operations, and we continued to progress on our Brighter Lives, Better World 2025 sustainability program commitments. First, we achieved a cumulative carbon reduction across our value chain of 48 million tons of CO2 and we are on track.
This reduction was mainly achieved by an accelerated shift to energy efficient and connected LED lighting in the first three quarters of 2021, which have decreased Signify's carbon emissions in the use phase. Circular revenues increased to 24% compared with the 2019 baseline of 16%, and we are on track for the 2025 target of 32%. This is mainly driven by the strong portfolio of serviceable luminaires and the further expansion of both the home luminaire and modular businesses. Brighter Lives revenues were 26%, making good progress towards the 2025 target of 32%. This positive trend can be explained by a strong contribution of the well-being portfolio, including quality of light, eye comfort, Hue, and WiZ products.
Finally, the percentage of women in leadership position was 25%, stable compared to last quarter, but slightly below our 2021 interim goal to reach the 2025 target of 34%. Also, this quarter, we signed the United Nations Women's Empowerment Principles, which emphasizes our commitment to gender equality. Let me now hand over the presentation to Javier, who will discuss the third quarter financial performance.
Thank you, Eric, and hello to everyone. Moving to slide 15, where we visualize the adjusted EBITA bridge for Signify. Overall, adjusted EBITA margin remains strong as pricing and mix offset structural inflation, while indirect cost savings partially offset the negative impact of volume and transitory inflation. Compared to Q3 2020, the quarter in which we hit an all-time record Q3 profit margin of 11.5%, the adjusted EBITA margin decreased by 40 percentage points to 11.1%. Let me explain the main variances on the more detailed bridge. First, lower sales driven by the supply constraints led to a negative volume impact of EUR 38 million. Mix effect, now separated from volume as it includes a positive margin impact of new product launches, had a positive effect of EUR 30 million.
This mix, together with the EUR 12 million positive pricing impact, helped to more than offset what we call structural inflation in Q3, which was worth about EUR 35 million. Transitory inflation, including the occasional spot buys and higher logistic costs, had a EUR 22 million year-on-year impact. As we believe them to be more temporary of nature, we decided to not yet pass this cost on through further price increases. Indirect costs as a percentage of sales improved by 70 basis points or EUR 37 million. This was mainly driven by structural cost savings and one-time effects in the previous year, including provisions for the reimbursement of solidarity contribution to employees last year. Finally, FX had a small adverse impact of only EUR 4 million. On slide 16, I would now like to zoom in on our working capital performance during the quarter.
On an absolute basis, working capital decreased by EUR 127 million year-on-year to EUR 316 million. As a percentage of last twelve month sales, this is an improvement from 6.4% at the end of Q3 2020 to 4.7% at the end of this quarter. The lower year-on-year working capital was a result of higher payables, lower receivables, and lower other working capital items, which more than offset temporary increases of goods in transit due to shipment delays. On slide 17, you can see our net debt evolution. At the end of September, our net debt position remained at around EUR 1.4 billion, translating into a slight increase in net leverage ratio to 1.8 times. The slightly higher net debt and leverage was mainly due to our dividend tax payment, leases and M&A.
This was partially offset by the third quarter free cash flow generation of EUR 85 million. Other includes cash use for new lease liabilities, acquisitions, purchase of treasury shares, derivatives, repayment of debt, and FX impact on cash. Overall, we remain well on track to deliver on our commitment to reduce our leverage ratio back to one time at the end of 2022. With this, I will now hand back to Eric for the outlook and some closing remarks.
Thank you, Javier. To wrap up, I would like to highlight again that we are encouraged by the continuously strong demand for our products as evidenced by our healthy order book. We are addressing the unprecedented, yet transitory supply chain challenges. Looking ahead, we expect that they will continue to have an impact over the coming months. We're also planning price increases to offset structural inflation and will maintain rigorous cost discipline. As a result, and with no further deterioration of the supply chain, we are expecting to end at the lower end of our 2021 guidance ranges of 3-6% comparable sales growth and adjusted EBITA margin of 11.5%-12.5% and a free cash flow exceeding 8% of sales.
The fundamentals of our business remain stronger than ever, driven by the ever-growing need for energy-efficient and digital lighting technologies. Well, with that, we would like to open the call for questions, which both Javier and myself will be happy to answer.
Thank you. If you do wish to ask a question, please press zero, one on your telephone keypad now. If you wish to withdraw your question, you may do so by pressing zero, two to cancel. Once again, if you have a question for the speakers, please press zero, one on your telephone keypad now. Our first question comes from the line of George Featherstone from Bank of America. Please go ahead. Your line is now open.
Hi, guys. Good morning, everyone. Thanks for taking my questions. Firstly, on the order book, thanks for the additional information here. I wondered if you could tell us the mix within this in terms of connected and non-connected and also by division. Could you give us a sense of the margin quality in the order book compared to current levels? Thank you.
Yes, good morning, George. Let me give an indication on the order book. Effectively, it increased quite substantially quarter-over-quarter. Now, you may recall that what we have said previously is that most of what we invoice during the quarter are orders that we take also during the quarter. You know, when we enter in a new quarter, we have, you know, an order book to be invoiced during the quarter, which is about slightly below 20% of the quarter. We are slightly above 50% entering Q4. This is a very important difference for us, you know, in the way we manage the business. Clearly the orders are there.
They are a bit more skewed towards Digital Solutions in terms of divisions and also projects for connected, because what needs to be explained is that if you have missing products, and especially missing connected products that are using a lot of e-components, then you cannot deliver a project. These projects are being delayed. We see you know quite a fair amount of those in our backlog at this point in time. 50% of what we should normally invoice is already in the order book. The most touched divisions and business in Digital Solutions and the connected businesses.
Thank you very much. Just to kind of follow up on the component shortages as well. You put the charts in there. I just wanted to know what the kind of number was, what's the order of magnitude of the components in Q3 that you'd had on an escalation list.
We effectively didn't give a number. It's in the hundreds. You know, we're not disclosing specifically that number, but you can see that the ramp-up has been dramatically high and slightly going down at the back end of Q3. We see also an improvement of the situation. I would say a gradual improvement, understanding that at this point in time, we're also taking commitments with our suppliers on the volume that we need for 2022 and in some cases in 2023. It's in the hundreds, so it's very substantial.
Okay. Thank you very much.
Our next question comes from the line of Lucie Carrier from Morgan Stanley. Please go ahead. Your line is now open.
Good morning, gentlemen. Thanks for taking my question. The first one is a follow-up on George's question regarding the backlog. If I understand well, when you're talking about 50% of the quarter is already visible to you in the order backlog, that means you have about six weeks visibility, kind of half of the quarter. But just on that backlog, what is your kind of visibility around the potential risk for double ordering? Because we've heard that from several distributor and, you know, the cancellation policy you have around the order, and I think you maybe didn't answer the question from George around the margin in the backlog. That would be my first follow-up on the backlog.
Yeah. Good morning, Lucie. You're right, I didn't answer the question on the margins. Let me take it after answering the first part of your question. You're right, on the visibility, that's the six weeks ahead. You know, on the backlog of orders that we have today, which is, of course, bigger than that because we have also orders in the backlog that we are going to be delivering in Q1 and also potentially in Q2, and they are in our overall backlog. We didn't have any cancellation of orders, you know, at this point in time. That backlog has been very stable. The way we are working, we are working on two sides.
We are working on the sides of our customer to make sure that the demand is genuine. We do not have customers that have ordered more today in order to make sure that they're getting something. We've been very precise. We went into the details in order to understand really the demand. We do not have, you know, customer as we understand it today that are ordering over the normal levels. I mean, we know also what the consumption is on a regular basis, especially for the make to stock item that go through distribution. We don't have that situation. Well, we see a margin that is gonna be pretty much in line with what we've seen so far.
Understanding also that the way we see the margin, it's, you know, it's a moving target because as, you know, costs are increasing on a regular basis, we need to increase price on a regular basis. We entering in a situation where it's not about, you know, there is an increase of the cost of commodities, and we need to make a price increase. I think we need to enter in a different setup where we have to make regular price increases when we see, new commodities, being, increased at the level of their cost in what we call, you know, we've been thinking a lot about that with Javier and the team. We talk about the structural part of the inflation, meaning the inflation that we believe is gonna stick in the long run.
There's one part of the inflation that we believe is fundamentally structural. We're pricing up against that, and that's working. Now there's a less structural part of the inflation, and on that one, for also commercial reasons, we're not pressing it up. You know, we're buying components on the spot market, sometimes 20 times, 30 times, what is the normal cost. We believe that this is not a longer-term trend. You know the story on containers that, you know, have increased by, you know, four times the price that we could pay them for, you know, previously. If you go on the spot market for containers, it's probably 10 times where they used to be. I think that's not gonna last. It's not gonna stick. Now, we're doing also some adjustments that are gonna benefit the margin.
For instance, we're gonna put an add-on cost for transportation, so it will not be reflected on our pricing, but it will be an additional element for inflation linked directly to transportation. We're putting that in place, you know, in the coming days. It's gonna be a permanent adaptation, I believe, in the quarters to come, and we have to be ready for that, and we are ready for that.
Thank you very much for the details. I guess that brings me to my second question. I was hoping maybe you could give us some indication around the percentage of sales and procurement that you have coming from Asia and going into North America and Europe. When you think about your freight kind of contract or your logistics arrangement, can you maybe help us understand usually, you know, if you have kind of longer term contract or if they roll over after one year or if you usually have spot based type of contract?
Okay. Let me take that question in a broad way, and then I will come back and zoom a bit more on the specific points that you're asking. We don't have long-term contracts, you know, in many years, but we have contracts over a period that can be six months to a year, you know, depending on the freight forwarders that we're using. We have to understand that given the situation at this point in time, all this notion of longer-term has to a given extent vanished. There is a lot of adjustment that is being done, you know, on a daily basis.
On the side of the freight forwarders that have you know their own issues to find containers and make sure the overall supply chain is balanced. We nevertheless have contractual agreements, and the way it works is that we try to book a given capacity at a given price. If ever we need more, then we have to go on what we call the spot market, which is substantially higher in terms of cost, especially at this point in time. You know, there's no contractual terms over the very long term. Can be six months to a year. We block capacity at a given rate, and if we go above that, we have to go at higher spot rates.
What we also have done during the crisis, we've moved to more air freight, which we don't like to do, not only for a cost perspective, but also because of the fact that it's very much CO2 emitting, so we don't like to do that. I think delivering our customer was the absolute priority, so we had also to move to this. Very disruptive situation. You know, if I take a bit of distance, we realize that you know, managing a demand crisis probably much simpler than managing a supply crisis, which is what we're doing at this point in time. We've done a lot of action also on the side of freight forwarders to make sure that we could adapt to the situation.
You know, we were well inspired to do a lot of the action that we have done, otherwise the situation would have been even more critical. Now, it's true that our supply chain is very global, and it's internationalized. In a situation like that one where we need to move. I will tell you, it's several hundreds of containers on a weekly basis, from one part of the world to another one. In a situation like that one, we were particularly impacted. Now, moving forward, that doesn't tell anything about the positioning and the strategic positioning of the company, but you know, punctually from an operational standpoint, yeah, it impairs quite a bit our capacity to deliver.
Understood. Thank you very much.
Our next question comes from the line of Rajesh Singla of Societe Generale. Please go ahead. Your line is now open.
Yeah. Hi. Thanks for taking my question. First question would be on your comment earlier. You mentioned that because of significantly higher energy prices, we could see an increase in demand for LED. Are you seeing any early signs of pickup in or acceleration in demand for LED? I think your order book suggest the demand is likely to remain strong in the near term. The second question would be on supply chain. Are you seeing a gradual improvement? What kind of improvement we can expect in Q4 or maybe in the first half of next year? Are you seeing any kind of commitment level from your suppliers which can guarantee you timely supply of your components?
Now, thanks, Rajesh for the questions. Look, acceleration in demand, the major issue we have today is are we facing a crisis of supply. It's very complicated in a situation where you have a crisis of supply to be also able to measure, you know, an increase in demand because you have a difficulty just to simply deliver. What we believe is that the increase in energy prices, and I'm not talking about gas, I'm more talking about electricity, is favorable to us because, you know, we are bringing a very high level of energy efficiency with the solutions that we bring to the market with a very, very fast return on investment.
If the price of energy goes up, it will make our solution even more interesting from an ROI standpoint. You may have seen. I will just comment on that one because it's a very, very important one. We have released to the market, and we have launched what we call our ultra efficient LED bulb. You have to picture that LED bulb, which is going to retail, you know, around 9.99 euro/dollars, is a completely new design where we see basically a good illustration of innovation and sustainability coming together because that bulb will be saving 60% of the energy consumption of already available LED bulb.
In order to do that, there are five patterns and that we had to develop and file, you know, on the filament, on its structure, its positioning, the electronics that regulates current and voltage. It is an LED bulb that comes on the market with a very high level of, you know, added technology and innovation to it. To your direct question, do we see an accelerated demand at this point in time? It's very complicated to say. What I just can tell you is the focus that we have on connected lighting in consumer space and professional space, as well as our growth platforms, are really getting a strong traction. That was the case also before the crisis.
I think that the more we go, the more we find that the market is well-educated to understand what these technologies are bringing. Improvement in the supply chain. I strongly believe that we should see an improvement, but that's not the way we've even built our Q4. We built our Q4 on the basis of no further degradation. That's something very important to understand. You know, back in Q1, we didn't expect what would be happening in Q2. In Q2, we were also not expecting what really happened in Q3, where the crisis, you know, on the component and the logistics side clearly worsened.
At the end of the day, if there's no further COVID-related closure of factories, like, you know, the closure of factory in Malaysia that took for some of our key suppliers two to three weeks. If we do not have ports and harbors being congested or being shut down like it was the case for a few of the key hubs that we are using in China, if we do not have these COVID-related issues, we believe that we should see a sequential improvement in Q4, but probably even more so in Q1 is on the e-component side, on the foundry side, and probably on, you know, the next level of transformation of the semiconductor industry in Q2.
If you look at what some of the probably more knowledgeable analysts are saying at this point in time is that we should go back to a more normal situation in the second part of 2022. Look, this is where we are. If there is no further COVID-related issues affecting the supply chain, we see continuous improvement in Q4 and probably coming back to a situation that would be close to being normalized in the second half of next year. I would like to say more, but at this point in time, the situation is so fluid and so unpredictable, like it was the case in Q3. We never thought that what happened in Q3 would happen. Now, we need to adapt and that's what we're doing.
Just maybe a follow-up question on the LED penetration in the U.S. Can you share your information or insights into the percentage of LED penetration in the U.S. and Europe currently?
Well, I think we have an LED penetration that's complicated because it depends on the segments and so on, but it should be on 40% at this point in time. 40%-50% and connected is probably below 10%.
Thank you. Thank you very much.
Our next question comes from the line of Sven Weier from UBS. Please go ahead. Your line is now open.
Yeah, good morning, and thanks for taking my questions. They are both on the EBITA bridge, and the first one is on the pricing side of the bridge. I was just wondering which quarter should we see actually the full impact of your price increases? Because I would assume Q3 doesn't really show it yet. The same probably for the structural costs increase. Is that already showing the maximum here? Yeah, that's the first one.
Good morning, Sven. I'll take this one. Look, on the pricing, I go back to what Eric said before. The important thing is what we said. We see now a change really getting the pricing to the bottom line compared to previous quarters. If you go back a little bit longer, you see that the change is material from EUR 60 million-EUR 70 million erosion per quarter to now being positive. The important thing is that the product mix is compensating the increase in the bill of material and what you call the more structural cost increase. Now, specific to your question on where will it end, I go back to what Eric said. I don't think this has got a short-term ending point.
We will see quarter by quarter an increase in inflation, which means that what we are clearly doing at this point in time, we have regular price increases that we have been implementing since early this year and believe that will continue. I would expect that all from a cost point of view, we'll still see those kind of amounts that we have on this slide, probably to proportionally go up, always with the objective that we have of stabilizing gross margin, and that's how we balance the equation. Do I expect for Q4 a further impact on pricing? Yes, but same in Q1, Q2 next year as we continue pricing in an inflationary environment. I don't think this is gonna be a one quarter, two quarter phenomenon.
It's gonna go further and we are prepared for taking those pricing quarter by quarter as we see input costs coming up.
Okay, thanks, Javier. The second question I had was on the logistic costs. I was just wondering, I mean, how much of your logistic cost is shipping? That's maybe a more structural question. I mean, what are your plans? Because you talked about CO2 reduction. When do you plan to go to zero carbon shipping? I think we've seen an announcement from Amazon. They want to do it by 2040. Are you more ambitious than that? I guess that will probably take up the logistic cost structurally. So what are your plans on that side?
Yes, Sven, good morning on my side. I think the proportion of shipping and the repartition of the logistic cost, you can imagine in the past, a few weeks or few months has radically changed. It's very difficult to give an average today because this is moving on a daily basis. When we decide to go air freight or if, you know, we are above the reservation that we had in terms of capacity, we need to go to the spot market, which is, you know, far higher. It's very complicated today to have a clear average, and I don't think we should take that into account, you know, to modelize the business moving forward, because once again, this is very transitory.
Now, the question that you ask is a very important one because it's not only because we are in a crisis today, which is basically impacting the supply chains that are fairly globalized, which is the case of ours. I think that we should effectively try to limit more the shipments in general, especially across continents. We should have supply chain that are more continentally independent, and that's a decision that we had strategically decided to take. We're building the plans in order to make that happen. That's a decision that we had already taken. Now, what we need to understand is that the CO2 emission of shipments is not the most important one in the world.
I would say it's only a fragment of the emission of CO2. Nevertheless, I believe this is something that we need to do because it has other positive elements. I think if we are more continentally based, it will be probably more in line with the geopolitical tensions that we see at this point in time. It will help us at the level of our working capital, probably to alleviate some of the working capital that we have in some regions. You know, if we source more locally, we are much, much faster in terms of of delivery, which has a lot of added collateral benefits.
Sorry not to be more precise on shipping, but I tell you at this point in time, it's very complicated to say, and there's no number that could serve, you know, as an important number to model those costs because things are very fluid at this point in time.
I take it that you haven't made a decision yet whether you're going to join some of these alliances, like I said, on Amazon, committing to the zero carbon shipping that's still pending.
Yes. No, Sven, we've, Look, I do not know how to tell you the absolute truth, so I'm gonna ask Javier, you know, where we stand there. We've made commitments that I think are bigger than that. We carbon neutral Scope 1, Scope 2, and a bit of Scope 3 already since a year. You know, we've made the commitment on our new program and enlarging our scope to Scope 3, to the full Scope 3, that we will do the reductions that are the objective of the Paris Agreement. We would achieve these reductions in line with the Paris Agreement, not in 2030, but in 2025. We wanna go two times faster than the Paris Agreement on an enlarged scope, which is saving huge amounts of tons of CO2.
I would say in doing so and in working on this, we're gonna save much more than what we can save on transportation. It doesn't mean that we should not look at it, but I think the stakes that we're looking at are far bigger for us.
Thank you, Eric. Our next question comes from the line of Andreas Willi from J.P. Morgan. Please go ahead. Your line is now open.
Good morning, Eric, Javier, and Thelke. I have a question on the ultra-efficient LEDs. If you look at the improvement in energy consumption, is this something you would expect to trigger a bit of a replacement wave now after maybe some of the first-generation LEDs being replaced again? Is there enough of an incentive both for consumer or professional users to do that from here, if you compare it maybe to the relatively straightforward payback calculations that were there to go to LEDs in the first instance?
Yeah, that's a very important point, Andreas, and we're looking at that strategically, and we believe so, because of the added energy efficiency that, you know, some customers are gonna go for. Maybe even more importantly, Europe has been a first mover revising, you know, what were the energy class definition. If you have the LED of the old times, which is classified, you know, A class in terms of energy efficiency. With the new classification, it will be F or G. The new ultra-efficient LED bulb that we are now bringing to the market will be A. We also, you know, matching the evolution of the standard and the higher requirement in terms of energy efficiency.
If at one stage, you know, in some instances, people want only wanna have A-class, then this type of technology will effectively replace existing one, and there could be an earlier replacement cycle on existing LED bulbs. Absolutely.
My follow-up question on the component shortages, maybe specifically talking about connected home lighting, is that a meaningful part of the EUR 100 million you called out? How should we assess end market demand there? Obviously, we're coming up also against some relatively tough comparables, but I guess it's gonna remain an issue of supply and not demand there for the coming quarters.
Yes. Here, once again, because of all the different things happening in opposite direction, it's sometimes complicated to have a clear view. Let me try to give highlights on the different elements. First of all, in brief, what happened in Q3 on e-components. We were supposed to receive a lot of components in July, and they were delayed, and they arrived at the back end of September. Even, you know, trying to manufacture, you know, very quickly, we could not be able to deliver on time. That's one thing. On the sales that we have not realized, you know, we're not giving the information.
I would not say that the majority of it is smart home lighting, but at the level of the smart home lighting business, it is clearly a few points of growth. That business continued to behave well during the quarter. Now to the second part of your question, we see also with, you know, consumers spending more money now going back to restaurants, going back to a different type of entertainment, traveling again, we see a demand which is going slightly down compared to what it used to be during the crisis. You know, this is a question that we had very often between you guys and us. We see that happening. We're also comparing the performance of that business against a higher base. You know, that business is growing. There's still demand.
Probably because of the higher base and the change of behavior, there's a bit more growth than what we have seen at the time. Nevertheless, what is gained is gained, which is the accelerated education of the consumer on connected offers and especially connected lighting. Also revitalized by the fact that we bring systematically new innovation to the market. You can imagine, and I'm talking about that one, it's not anecdotal, it's really a cool one. I'm using it myself at home. You connect your Spotify and your Hue app, and you get a very immersive experience on your music listening. So that's a reality. Yes, probably a demand which is going down slightly, but which is still growing and healthy.
Thank you very much, Eric.
Our next question comes from the line of Philippe Lauwerys from Goldman Sachs. Please go ahead. Your line is now open.
Good morning. Thanks for taking my question. My first one is on you're calling out UVC as having a high comparison base. But previously you mentioned this was going to be a multi-year structural opportunity. Could you just give some more color on that?
Yes, surely, Philippe. I think that becomes truer every day, you know, with the extension of the crisis also. What we have seen a complete change in what we sell in UVC from in 2020, you know, the burner, you know, the part which is emitting light, so the component, and to finished products, both on the consumer side, but also on the professional side. What we have seen very interesting wins in schools, for instance, where we have a device which is completely closed that we also use here, by the way, which is, you know, ensuring that the room is clean.
A lot of, you know, countries are looking at how they can have, you know, the pupils to go back and to stay at school, you know, in a safer environment. We get a fairly good traction there. Our profile in terms of growth and in terms of sales growth is really changing from the component back then to the finished product at this point in time. We're looking also at integrating UVC, you know, also with Honeywell in what we call healthier workplaces, and we have interesting wins. I think, you know, the level of education is still to be done. I myself am meeting many potential customers, and when I talk about this, a lot of them are surprised.
When I talk to them about what it does and how it works, I mean, they wanna go for it. I think, you know, it's a pending assignment on our side to educate the market more, but we see a good traction on that business. You know, despite all the situation that we've mentioned about supply chain, we see a good traction on that business, even with a different profile.
Got it. Thank you. Just secondly, you've obviously made very strong improvement in your working capital over the past year. Do you think that could be part of the reason why you're also having component shortages? Do you think actually maybe inventories could go higher again in the future to deal with that?
No, not really. You know, I think the working capital is well managed. What we've done, we structurally worked on it in the past five to six years, you know, to go from double-digit to low single-digit at this point in time. Not really. It's true that, you know, we didn't have plethora of inventory. You know, the people who are managing the inventory, maybe, you know, not as rigorously as we do, maybe would have benefited during the crisis, but only for a time. No, I don't think that the way we manage inventory and working capital is a consequence of what happens today.
Okay, thank you.
Our next question comes from the line of Andre Kukhnin from Credit Suisse. Please go ahead. Your line is now open.
Good morning. Thank you very much for taking my question. Can I just start with a follow-up on what you said? I think you're looking to introduce logistics related surcharges that won't be the core pricing, but will be specifically directed at higher logistics costs. Could you share with us any order of magnitude or maybe more simply, would you expect these to offset all or a part of that headwind component on profit bridge of EUR 22 million in Q3?
I just simply don't know Andre, so I don't have the number, you know, the absolute value. The only thing that I can tell you, yes, it is there to offset, you know, part of what we have experienced in logistics cost increase. What also needs to be understood, we do that in order not to have an increase of our final tariff price. We should see that situation as very much evolving because the logistics costs have changed, you know, all the way through. Now we have an increase of the energy costs, which are going to impact once again those costs.
We can imagine that, you know, whatever we charge for can also evolve in the future, you know, up or down, depending on what we see coming. The most complicated thing to do at this point in time is to try to forecast where things are going. You have a permanent catch-up game, you know, where, you know, we increase prices when we understand where things are going and, but things are not stable, so they're moving again, and we need to adapt permanently. That's what we have developed in the company, especially in Q3. More than ever adaptation is part of the game.
We've seen that, you know, during the quarter, because our situation in Q3 has also evolved positively from a gross margin standpoint, if we look at where we were at the beginning of the quarter in July versus where we were at the end of the quarter in September. It's really a game of permanently adapting and adjusting in order to adapt to what we see coming and also, you know, I would not say it's not only remaining competitive. Of course, we have to remain competitive. But we also have engagement with our customers for the long run, and we wanna be as transparent as we can with them to make sure that they understand what we are transmitting in terms of price and for the longer-term relationships that we are building.
There are also some activities where, for instance, we didn't increase price, not only talking about logistics. If you take a range like the Hue range, it's not only because people may believe that it's priced high, but given its growth and the capacity that that business has to generate more gross margin with the growth that it provides, we didn't feel the need to increase prices. It's really dictated by businesses and it's really dictated by market. The main idea, Andre, behind all that is that it's very fluid and it's a matter of adapting.
Thank you. That's helpful. The main question I had really on mix, given the substantial contribution, is this all about the new ultra-efficient A-class LED bulb or are there other products that are contributing to this? Maybe you could give us some details so we can track them a bit closer.
Well, the new bulb has no impact on the numbers in Q3. I would tell you, I think, Javier, if we look at the mix in Q3, we didn't have a mix effect coming from the divisions.
No. The mix impact is more. The reason why we separated it out is because you have new product introductions that indeed come, as we know, pricing more clearly come at higher price and higher margin. The biggest mix impact was, I think on the Digital Products category, where also with new introductions, especially also in the home lighting, you have new things coming in at higher margin. It's not between the divisions, it's really the new product introductions that we are pricing up already for the inflation. The LED will be an example for the future, obviously. That will also have an impact with the pricing and the margin it has. It's those introductions within the categories that we look at.
When we look at pricing, and that's a bit theoretical, what we qualify in our overview as pricing, and that's why we broke it out in more detail this time. Pricing is purely SKUs, which are 100% comparable with last year. With the rotation of the portfolio, when we introduce new products at higher prices, higher margin, that's an important part of our story. With innovation, we drive margin back to the original levels. That's why we kind of this time we're more specific on breaking out pricing mix and then transitory and structural inflation.
Very helpful. Thank you very much for your time.
Thank you.
Our next question comes from the line of Peter Olofsen from Kepler Cheuvreux. Please go ahead. Your line is now open.
Yes, good morning. My question is actually a clarification question on the amount of more than EUR 100 million that you mentioned. I recall that at the half year stage you mentioned a number of EUR 85 million. The more than EUR 100 million that you mentioned for Q3, is that a net figure? Because I assume that some of the revenues that you missed in the first half were actually booked in Q3. Whether or not have you accounted for that in that number of EUR 100 million?
Yes, Peter. Look, let me take a bit of distance and explain something additional. What we realized in Q3 is that we had to take another element into consideration, which is about the orders that we could not confirm. So what is our problem? You know, it's still a bit the case in Q4. You know, today, at the end of the first month, I don't have a complete visibility on some of the components I'm expecting for Q4. So the problem is that it's difficult for us to confirm an order to a customer when we don't have a confirmation of the components. And these orders would be genuinely normally taken during the quarter and invoiced during the quarter. So we added that dimension that was small in Q2, but started to be bigger in Q3.
If you were trying now to make a comparison between, you know, the EUR 55 million or the EUR 85 million that we mentioned in Q1 and Q2, what you need to know is that the degradation quarter-over-quarter is around EUR 71 million between the end of Q2 and the end of Q3. It's an additional degradation which is around EUR 71 million. Now, we're not starting from the same base because in the 85 we didn't have the unconfirmed orders. If we were adding the unconfirmed orders that we had at the end of Q2, like we did at the end of Q3, the difference and the increase is EUR 71 million, you know, which is quite substantial.
Thank you. Thank you.
Our next question comes from the line of Marc Hesselink from ING. Please go ahead. Your line is now open.
Yes. Thank you. Good morning. I would like to come back on the order book to better understand what that exactly is, that increase in 90%. How much of that is the EUR 100 million of lost revenue? And maybe also to get the larger picture, how much of your normal revenue is order book business? And the second question is on a follow-up on the consumer connected lighting. Given that the fourth quarter is so key for this business, how many inventory do you have? And do you still need some of those key components like you just explained, the one that went from July to September?
Is there a sort of shipment that you still need coming in for the fourth quarter? Thank you.
Yes. Good morning, Marc. The EUR 100 million that we could not invoice in Q3 are part of the order book and that we have at the beginning of Q4. I have said that in normal business situation, we have, at the beginning of the quarter, a visibility on less than 20% in terms of orders of what needs to be invoiced during the quarter. Today, for Q4, it is more than 50%. That's just to summarize the numbers in a succinct way. Q4 is key for the consumer part of the business, and especially on the consumer side. Yes, we working very hard to be able to get the components. We have also to allocate components when we receive them to what we believe are the priority businesses and customers.
Now, I have to also admit that at this point in time, we cannot, for that business, fulfill all our customer needs. We have shortages on some parts of the business, but we're building inventory on the other hand. We still believe that we can do a good Q4, but we're gonna do probably a Q4 that is gonna be a bit limited compared to what we would have been able to do normally. That's taken into account, you know, in the indication we have given at the level of the guidance. Yes, we prepared. We're gonna do a good Q4, but it's gonna be probably a bit impaired compared to what we would have been able to do if we had received all the components.
Okay, clear. Wait for the order book to be 100% clear, that what you just explained in the previous question, that orders that you could not confirm, those are not in there yet?
The orders, over EUR 100 million, that we could not invoice in Q3 will be invoiced in Q4, and they are part of the order book that we have at the beginning of Q4.
Okay, thanks.
Thank you.
Our last question comes from the line of Joseph Zhou from Redburn. Please go ahead. Your line is now open.
Yes. Thank you for taking my questions. I'll go one at a time. Firstly, on your lower end of the guidance, that implies a Q4 organic sales growth of 1%. That sounds fairly ambitious to me, given the existing run rate. What gives you the confidence to achieve that? I know you talk about now you have visibility on more than 50% of the Q4 sales, but then the rest is still a big proportion. Yeah, I just wonder where does that come from? Maybe some arrangement with your suppliers, et cetera, et cetera, that gives you the confidence.
Good morning, Joseph. What gives us the confidence is that we have spent a huge amount of time with the teams reviewing the backlog of orders, reviewing the status of the inventories, reviewing goods in transit. Look, we're not starting Q4 as a normal quarter. You know, once again, starting Q4, we have a much higher visibility on orders than ever before. We're taking that into account and we're matching the orders with the inventory we have already and with the inventory which is coming, whether it is finished goods or industrial inventory. We've done that in a very, very detailed way. I would say that even at this point in time, we have made a forecast with the team which is constrained.
With all these measures taken into account, we believe that we can achieve the lower end of the guidance. You know, I don't think it's ambitious, frankly speaking, with what I see today. I think it's something which is completely at reach. There's just one caveat. If we have new harbor closures, if we have new plant closures, it's a different game. If the this situation doesn't deteriorate compared to what it is now, I think we have more than the capability to do what we have said we could do, because our forecast is even constrained.
Yes. Thank you. That is very clear. Then my next and final question is about the supply chain situation. Do you think we will be at the worst point of the supply chain challenges or in terms of financial impact in Q4, including shipping and component shortage? Maybe to look at numbers, you already obviously had EUR 100 million, more than EUR 100 million supply impact, but also you had EUR 22 million of gross transitory impact. It looks like this could go up in Q4 and in proportion with the high sales lighting season as well. Do you think Q4 will basically be the worst point and it gets better from there, you know, so there's numbers?
What impacts us more, Joseph, is not the cost and the pricing. I mean, cost and pricing is something that we manage and we adapt. The major issue we have is the uncertainty in the supply chain. Let me give you an example, which is a very concrete example. You have a factory supposed to receive components on Wednesday, components are not coming. You have on top of the added cost of logistics, what do you do with the factory? I mean, you have fixed costs and you have variable costs, so you need to dedicate them to another task, but it's not always possible.
At the end of the day, it generates a lot of underleverage, and specifically in the Digital Solutions division, because this is a division where you're doing, you know, a lot of different products, so you need a lot of different components. Those components and those products are made to order. Basically it you know, the situation that we have today breaks the flexibility that we normally have. That is for me, the most complicated part of the equation, not so much the cost. I mean, the cost, we adapt to it, we price up. We have, you know, a policy, and we have the processes that are put in place to price up, you know, in the logic that we have described previously. I think that the most and the worst part was Q3.
Provided there are no additional deterioration of plants closing because of COVID, or I've said that many times, harbors reducing their capacity also because of COVID. If we don't have that, I think the supply chain will go in an improvement trend from now on. We think that we could go back to normal, as I've said before, in the second half of 2022. I see a much more positive Q4 from a supply chain standpoint than Q3, which was very disrupted. I tell you, I've worked for many, many years. I've never seen anything like it, and we've gone through crisis. A crisis of that magnitude on supply side, like what we have seen in Q3, completely not anticipated, that was very, very tough to face.
I think that Q4 will be better and the upcoming quarters even better.
Thank you. We unfortunately have no more time for any questions. I'll hand back to the speakers for any further remarks.
Ladies and gentlemen, thank you very much for attending today's earnings call and for taking part in the discussion about our results. If you have any additional questions, please do not hesitate to contact Philip or myself. We're happy to answer your questions then. Again, thank you very much and enjoy the rest of your day.