TE Connectivity Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
April 26, 2023

There are 13 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the TE Connectivity Second Quarter 2023 Earnings Call. At this time, all lines are in a listen only mode. Later, we will conduct a question and answer session. As a reminder, today's call is being recorded. I would now like to turn the conference over to our host, Vice President, Investor Relations, Sujil Shah, please go ahead.

Speaker 1

Good morning, and thank you for joining our conference call to discuss TE Connectivity's Q2 2023 results. With me today are Chief Executive Officer, Terrence Curtin and Chief Financial Officer, Heath Mitts. During this call, we will be providing certain forward looking information, and we ask you to review the forward looking cautionary statements included in today's press release. In addition, we will use certain non GAAP measures in our discussion this morning, and we ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation, can be found on the Investor Relations of our website atte.com.

Speaker 1

Finally, during the Q and A portion of today's call, we are asking everyone to limit themselves to one question, And you may rejoin the queue if you have a second question. Now let me turn the call over to Terrence for opening comments.

Speaker 2

Thanks, Sujal, and I do appreciate everyone joining us Today to cover our results for our 2nd fiscal quarter along with our outlook for our 3rd quarter. Through the details on the slides, I want to take a moment to discuss our performance this quarter within the backdrop of what remains a dynamic market environment, along with what we're seeing versus our last call 90 days ago. We continue to operate in a world with cyclicality in certain So the strategic positioning of our portfolio around key secular trends. These include global growth in electric vehicle adoption, Momentum in Renewable Energy Adoption, Growth in Interventional Medical Procedures And wins in the artificial intelligence space. Growth from these trends are enabling us to offset the impacts from We delivered 8% organic sales growth that was above our guidance and adjusted earnings per share that was ahead of our guidance as well.

Speaker 2

We remain on our journey to expand margins through a combination of growth, price increases and cost reduction actions. As we discussed back in the Q1, our plan was to drive margin improvement from the beginning of this year as we enter next year. We are executing to this plan and you see this in the sequential margin progression segment in the 2nd quarter and the sequential margin expansion at the company level that's implied in our 3rd quarter guidance. You all know that an important part of our business model is strong cash generation. With supply chain Driving our inventory levels down and along with our team's strong operational performance, Inventory reduction helped to drive free cash flow improvement of over 35% year over year in the first half And enabled us to continued strong return of capital back to our owners.

Speaker 2

So let me now provide some color on markets that we're seeing and other update With the macro environment we're experiencing, it is driving uneven impacts across our portfolio. We have some markets that are growing, Some that are remaining very stable and some that are cycling. And this is truly evident as we go through our Q2 results today, Where all our businesses in the Transportation and Industrial segments grew organically, while both of our business in the Communications segment Our view of the transportation end markets remain consistent with our prior view, And we continue to expect auto production to remain roughly flat at approximately 20,000,000 units per quarter as we move through the second half of our year. Our growth will continue to be driven by content outperformance and our leading electric vehicles. In our Industrial segment, when we spoke to you last quarter, all of our businesses were strong and our 2nd quarter sales results reflect this.

Speaker 2

We continue to see strength in 3 out of our 4 businesses. Our commercial air business continues to recover. Our Medical business had record quarterly sales and our Energy business had a record quarter of momentum in renewable applications. In our Communications segment, orders and sales remain weak due to both the market weakness and inventory corrections across our customers' supply chain. Last quarter, we talked about being in a $450,000,000 to $500,000,000 quarterly revenue range, And we now believe we will be at the lower end of this range for the next couple of quarters to get worked off by our customers.

Speaker 2

And finally, before I get in the slides, I do want to highlight the way we think about long term value creation And that has remained unchanged. It is built on the pillars of secular growth and increased content around the markets where we have positioned TE, Strong free cash flow generation, a disciplined approach And levers, which will enable margin expansion as we move through this year as well as longer term. So with that as a quick overview, Let me get into the slides and discuss additional highlights that are on Slide 3. Our sales in the 2nd quarter were $4,200,000,000 and it was ahead of our guidance driven by the transportation We saw organic growth of 12% in the Transportation segment and 15% in the Industrial Solutions segment, With organic growth in all businesses in these two segments. In our Communications segment, The decline was in line with our expectations.

Speaker 2

On a reported basis, sales were up 4% year over year and included approximately 100 In the quarter, our orders grew 10% sequentially to $4,000,000,000 And I will talk more about Order Trend Dynamics' I segment on the next slide. Adjusted earnings per share was ahead of our guidance at $1.65 and included a $0.17 of currency exchange and tax headwinds versus the prior Adjusted operating margins came in at 16%. Free cash flow for the first half of the year was very at approximately $850,000,000 with nearly $800,000,000 being returned back to our owners. And we do expect continued strong cash generation in the second half along with strong free cash flow conversion this year. We are expecting our 3rd fiscal quarter sales to be approximately $4,000,000,000 And adjusted earnings per share to be around $1.65 Our guidance represents a sequential decline in sales A flat earnings per share, which implies margin expansion from the 2nd to 3rd quarter.

Speaker 2

We continue to be confident in margin expansion as we move from the first half of twenty nineteen, largely driven by our Transportation segment. And just moving away from the financials for a second, we are pleased that We were named among Fortune World's Most Admired Companies. This is the 6th consecutive year that TE has received this recognition, which measures a number of criteria, including a company's investment value and product quality Your responsibility. So let's talk about orders and let's move to Slide 4, We'll talk about order trends as well as what we're seeing in the markets. The sequential growth of our orders to $4,000,000,000 reflects Increased stability in the supply chain as well as our team's ability to improve the service levels to our customers.

Speaker 2

I think the key Is that we're continuing to see stability in transportation, overall strength in the industrial market And continued weakness in communications. Looking at orders by segment, our transportation orders Businesses with continued momentum around renewable applications in our energy business, improving trends in commercial air And as well as our Medical business, where we continue to see recovery. One change that we've seen since last quarter Is that order patterns are indicating moderation in certain industrial equipment end markets? In segment, orders reflect the continued weakness in the data and devices that we've talked about for a few quarters now, as well as the expected moderation of the appliances market. So with that brief overview around orders, Let's get into the year on year segment results that are highlighted on slides 5 through 7 and you can see the details on each of these slides.

Speaker 2

Starting with Transportation. Sales growth was strong, up 12% organically year over year With organic growth across all businesses. Our auto business grew 14% organically versus auto production that was up low single digits versus the prior year. The outperformance was driven by our leading position in electric vehicles, electronification trends in the vehicle, Actions from pricing. As we previously discussed, we were lagging in the recovery of inflationary pressures, But we've implemented price increases, which help us enable margin expansion as we go forward.

Speaker 2

While overall auto production is to remain flat for this fiscal year. We continue to expect production of hybrid and electric vehicles to be approximately 25 In 2023. And as you know, we generate 2x to content in EV platforms versus ICE vehicles. So we expect our content per vehicle to continue to expand as we move through this year. In Commercial Transportation, We saw 7% organic growth driven by North America and Europe, partially offset by declines in China.

Speaker 2

We remain excited about our leading global position in electric vehicles for commercial transportation market. We continue to make significant progress with design wins at all the key truck, bus and specialty vehicle OEMs. We are providing a broad range of high voltage connectivity products, which are enabling our customers to solve fundamental challenges that they face in the EV space. These include 1,000 volts throughout the vehicle, increasing the speed of battery charging And withstanding the harsh environment that's expected in a heavy truck application. Turning to our Sensors business.

Speaker 2

We had 9% organic growth, which was driven by automotive applications Adjusted operating margins were 16.6 percent as expected. While the dynamics of price versus inflation caused year over year impacts to margin. We saw an 80 basis point sequential improvement in the quarter, reflecting the progress that I mentioned. We expect adjusted operating margins to improve sequentially again in the Q3 in the Transportation segment to get back into the high teens in the second half Now moving to the Industrial segment. Sales increased 15% organically year over year with Growth across all businesses.

Speaker 2

Our Medical business sales in the quarter was a record at $200,000,000 And it had 26% organic growth. The Interventional Medical market was depressed following COVID, but now Back up to pre pandemic levels, and it's nice to be talking about growth in Medical again. In our Energy business, we continue to see the growth momentum with 28% organic growth, and this is entirely driven by Renewable Applications. We continue to drive growth both from wind and solar applications, and the addressable market for TE and renewable applications has a double digit Catherine, we're helping enable utility scale solar and wind farm deployments around the world. When you get into these renewable applications, we provide switchgear and high voltage connectivity products.

Speaker 2

And just to give you a little bit perspective, When we talk about high voltage and energy, these are mentioned in kilowatts, not volts like we talk about in the car. And it's very important that the application knowledge we bring on these higher wattages are very important to enable these renewable applications. And through our broad product portfolio, we are helping our customers reduce installation and maintenance cost. And you can see our strong positioning playing out in the growth of the renewable applications. And now in our Energy business, It's going to represent nearly 25% of our total revenue.

Speaker 2

Turning to our Aerospace, Defense and Marine. Our sales were up 19% organically with ongoing improvement in the commercial air market. And finally, in the Industrial Equipment business, Our sales were up 3% organically with growth in Europe, partially offset by weakness in the Americas and China. Adjusted operating margins for the segment came in at 14.6%, and this reflects an impact from business mix as well as the impact from acquisitions and divestitures. We expect margins to expand sequentially into the 3rd quarter And continue to target high teens margin for our Industrial segment.

Speaker 2

Now let me turn to the Communications segment, Well, our sales were down as expected at 20% organically, but within the $450,000,000 to $500,000,000 range provided last quarter. The appliance market is down as we expected and declined across all regions. In Data and Devices, we were down due to market weakness and supply chain inventory digestion, as I discussed earlier. Communications adjusted operating margins were 16.3% as we expected. As I mentioned earlier, we expect quarterly segment sales to be at the low end of the range we gave and closer to the $450,000,000 And we think it's going to be there for the next couple of quarters.

Speaker 2

And we do think adjusted operating margins at this low volume will be able to maintain in the mid teens. As we look beyond the near term, I do want to highlight that our D and D business continues to have strong design win momentum in next generation platforms that's serving the When you get into the rising complexity in artificial intelligence, it drives low latency architectures Semiconductor and Cloud Companies. We have already generated over $1,000,000,000 of new design wins in AI and server applications and expect new programs to begin ramping up in fiscal 'twenty four. So with that as a backdrop of the segment performance, Let me turn it over to Heath, who will get into more details on the financials and our expectations going forward.

Speaker 3

Thank you, Terrence, and good morning, everyone. Please turn to Slide 8, where I will provide more details on the Q2 financials. Adjusted operating income was $664,000,000 with an adjusted operating margin of 16%. GAAP operating income was $537,000,000 and included $62,000,000 of restructuring charges, dollars 57,000,000 of other non cash charges related to divestiture activities and $8,000,000 of acquisition related charges. Year to date, we have taken 166 $1,000,000 of restructuring charges and would expect full year restructuring

Speaker 1

charges to

Speaker 3

now be approximately $250,000,000 as we continue to optimize our manufacturing footprint and improve the cost structure of the organization. Adjusted EPS was 1 point and GAAP EPS was $1.34 for the quarter and included restructuring, acquisition and other charges of $0.31 The adjusted effective tax rate was approximately 20% in Q2. For the Q3 and for the full year, we now expect Our adjusted effective tax rate to be approximately 20%. Importantly, as always, we continue to expect Our cash tax rate to stay well below our adjusted ETR for the full year. As I turn to Slide 9, Sales of nearly $4,200,000,000 were up 4% reported and up 8% on an organic basis year over year.

Speaker 3

Currency exchange rates negatively impacted sales by $155,000,000 and adjusted EPS by $0.15 versus the prior year. We expect FX to have a modest negative impact for both sales and EPS again in our Q3 on a year over year basis. Adjusted operating margins were 16% in the 2nd quarter. To provide some perspective, we saw about 200 basis points of headwind To our adjusted operating margins year over year as a result of lower volumes in our Communications segment combined with the impacts from currency exchange rates. As we go forward, we remain confident about margin expansion in the second half, And it's important to note that we are not dependent on higher volumes to drive margin expansion.

Speaker 3

We have successfully implemented Pricing actions to offset inflationary impacts in our Transportation segment, and this will drive margin expansion at the company level as we move through the second half of our fiscal year. We also expect that industrial margins will modestly expand in the second half from Q2 levels. Communications should remain in the mid teens at the expected volume levels that Terrence mentioned. It's a good story here. In the quarter, we once again demonstrated our cash generation model of our business With cash from operations of $634,000,000 Free cash flow for the quarter was approximately 445,000,000 Through the first half of our fiscal year, free cash flow was $845,000,000 up 37% year over year, With roughly $785,000,000 return to shareholders through share buybacks and dividends.

Speaker 3

As you may recall, a few quarters ago, That we would look to drive our inventory levels lower as we see performance improving in our supply chain. And as Terrence mentioned Earlier, we reduced inventory again this past quarter, which contributed to our free cash flow performance. We continue to remain disciplined in our use of capital and our long term strategy remains consistent, Which is to return 2 thirds of our free cash flow to shareholders and use 1 third for acquisitions over time. I want to stress that our capital structure remains very strong as evidenced by our robust credit profile, ample available liquidity and ease of access to the capital markets. We are maintaining a consistent financial policy and a strong balance sheet Before I turn

Operator

over to

Speaker 3

questions, let me provide a quick recap. The strategic positioning of our portfolio is enabling us to deliver strong results from secular growth trends despite cyclicality in certain end markets. From a market perspective, the Transportation and Industrial segments are consistent with our 90 days ago with ongoing cyclical weakness in our Communications segment as we expected. Our focus in the second half is to continue to generate strong free cash flow and expand our adjusted operating margins, driving to a higher margin rate as we enter Fiscal 'twenty four. We continue to demonstrate our strong cash generation model with a strong balance sheet that can support investments for growth.

Speaker 3

We remain excited about the opportunities we have ahead of us to drive long term growth, margin expansion and value creation for all of our stakeholders. So with that, let's open it up for questions.

Speaker 1

Thank you, Heath. Chris, can you please give the instructions

Speaker 3

for the Q and A session?

Operator

In order to have time for all questions, each participant is limited to one question. The first The first question is from Mark Delaney with Goldman Sachs. Your line is open.

Speaker 4

Yes. Good morning. Thanks for taking the question. Good morning. Could you comment in more detail on your end market expectations for the balance of the year and how that's been impacted by the various cyclical crosscurrents and content Drivers, and then on the topic of content, maybe elaborate if you could please on China in particular and how TE's content per vehicle and share compares between China domestic auto OEMs and then your content with the multinational OEMs.

Speaker 2

All right. Yes. Thanks, Mark. Let me start with the first part of that, Which is what we've seen in the various markets and some of this will be repetitive, but I'll add a little bit of color. Clearly, there is unevenness of what we're seeing.

Speaker 2

And I think with what we see in orders as well as the markets, it is most of the industrial space continues to be very strong. You have stability in transportation and you have communication markets where you do have inventory correction and some market weakness. So I think You have to keep it in the framing of those big buckets. I think if you click down and I think about transportation, Transportation is still and automotive is still well below the 90,000,000 plus or minus units it did back in 2019, and we've sort of been now for 3 years in a row around 80,000,000 units. So we're still off 11% or so On the production side, one of the things that you can see comes through and it's been built up over time is our automotive business is up About $1,500,000,000 over the same period while production is down.

Speaker 2

And it is the content trend we talk about every quarter. It is about And it's also about the chunk of that, the vast majority comes out of electric vehicles. And I think it shows Where we position the business and also we do expect this year in excess of $2,000,000,000 of our automotive revenue will be from electric vehicles. And that's something we're proud of and it also improves the content. And even with production staying Flat, as we've said.

Speaker 2

We're going to you're going to continue to see that content growth. Now the one thing we do have this year in our growth to content It's the benefit from the pricing that we put in to offset inflation. So that's about 300 basis points more on the growth than we would normally have. What I do feel with even the guide, we said where margin will be up next quarter implied in our guidance versus this quarter really reflects Those dynamics. I think when you get into the industrial businesses, we have 3 markets That's still remember, remains strong.

Speaker 2

And like we talked about last quarter, our industrial equipment market showed some plateauing in some areas that we've Seeing a little bit more weakness in our orders in certain areas in the industrial equipment market. You're going to continue to see strong growth in our energy business due to renewable applications. If you take this quarter, we grew high 20%, but over since 2019, it's high single digit growth on a CAGR basis and That's really what we've done to position TE around Renewable and turn energy into a growth business. Medical, it's really nice that you see the record revenue. I also think That's where we positioned ourselves in interventional procedures.

Speaker 2

And I think that's something that as we get supply chain corrected And growth back there again can be higher single digits. And then Comair, we're still in a recovery mode. Our revenue is still below pre COVID levels. Isla is not back. So I still think there's upside there, as that entire space recovers and the supply chains get better.

Speaker 2

And then in communications, really what's happening there is well documented. Cloud spending pause, we have throughout everything corrections across the supply chain and inventory, whether it be the OEM, the ODMs, Any of the contract manufacturers that are there as well as distributors. And we do think that's going to be with us at least the next couple of quarters. But as I said on the call, I feel very good that the design wins we're getting on next generation artificial intelligence, which comes on the back of cloud, Well, our teams are going to get there with the highest speed interconnects that are required, really like where we're positioned there once that does that inventory does get worked off And we move forward. So clearly, some moving pieces, but I do think where we've talked to you about content is coming through It has come through during the cycle that we've been in.

Speaker 2

Now let me turn to China, your second question. And I think the first thing we all have to remember is China just printed its GDP report and that was up 4.5%. Clearly, as it comes out of recovery, it's been choppy. For TE, what we see in China is The things in the Communications segment were very similar to the overall segment, not only in China, but globally. So those markets are weak, a lot of supply chain correction.

Speaker 2

When you look at our Industrial segment, our bigger play in the Industrial segment in China is around our Industrial Equipment. That remains weak and we're looking to see if that does get some positive momentum. And then the automotive and transportation side, we grew last quarter. We expect to grow year over year this quarter. So we continue to see the growth from the momentum we have there.

Speaker 2

And I think what's important is when you think about it, China is the grower of electric vehicles globally. You see that in our growth. We have even share When you look at whether it's a multinational or local, our shares vary even. It's something our teams have worked very hard to make sure we get. And as EVs get adopted, whether it's in China or elsewhere in the world, it's going to be something that drives content growth and it's part of our 4% to 6%.

Speaker 2

We don't see any change in our content momentum related to any OEM change. And what's important for TAE is we're always agnostic To OEM. We're trying to win and scale what we do for to make sure that the auto industry Has further adoption of electric vehicles out to the consumer.

Speaker 1

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

Operator

The next question is from Chris Snyder with UBS. Your line is open. Thank you. So the auto business Was up 16% organically in the first half of the year, so about double digit outgrowth versus production, 2x the targeted levels. How should we expect this to trend into the back half of the year?

Operator

The company in the prior response, you just called out 300 basis points of price, I believe, for auto this year. Is the back half stronger than the first half as the recent price increases or implemented or is that roughly flat throughout the year? Thank you.

Speaker 2

Thanks for the question. And you know what I'm probably going to say first is, Please be careful looking at content in any quarter or short period of time because you do get into supply chain elements as you get in there. I do think to your comment around price, I do think 300 basis points are going to is going to be the benefit as we continue and as price rolls in. And that will continue to take for the year, drive us above the 4% to 6% range that we normally talk about. Price will be a part of that when we look at this year.

Speaker 2

I think the other thing, and I know it will be a little bit probably redundant with what I just said, We continue to expect that electric vehicles will be 25% of global production. So I do think you're going to continue to see that setup be very good. And I think overall content per vehicle and how it trends over time is the most important factor to look at. So we talked about this a lot on these calls 2 years ago, back in 2018, we were in the low 60s, we're in the low 80s today. That just proves it's due to electric vehicle content.

Speaker 2

And as global supply chains continue to improve and our service levels go up, you're going to have some of these inter quarter impacts at times, But net net, feel very good about where we're positioned on content growth.

Speaker 1

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

Operator

The next question is from Wamsi Mohan with Bank of America. Your line is open.

Speaker 5

Yes. Thank you. Good morning. I was hoping to get Some incremental color on the margins in Q2 where you made progress in transport, but industrials turned a bit lower. Also the decremental margins on a year on year basis was much higher than normal.

Speaker 5

What drove that? And how should we think about the overall Margin and conversion margin trajectory for the course of this year? Thank you.

Speaker 3

Hey, Wamsi, this is Heath. I'll take this one. Well, listen, I think the single biggest impact, if you look at the TE margins on a year over year basis is The pretty significant decline in the communications segment, but you have to remember, You go back a year ago, we kind of framed up the communications segment margins is a bit overheated And it kind of showed how much volume leverage you can get those types of volumes you're getting. And we have a business that goes from roughly A quarterly run rate of between $6,000,000 to $650,000,000 down to $450,000,000 to $500,000,000 that Gene is steep and you get brought back to reality pretty quickly. We expected this.

Speaker 3

We were certainly didn't expand our cost structure or anything when our revenue was higher knowing that it would cycle down. And then if you add in the impact of FX, those together are over 200 basis points of impact year over year to the company margins. And quite honestly, if you go back and look at our Q3, which is our June quarter That we're guiding to now and you look at that from last year, we're going to have similar kind of impact. And that impacts both whether you want to say the year over year margin, That's going to have that same impact. So that's implied in our guidance, as you can see.

Speaker 3

But if you take a broader Picture and say, what does it look like going forward from here, right? We're kind of running in this $4,000,000,000 $4,000,000,000 range of revenue, Plus or minus, I'm not guiding now beyond the quarter that we just gave, but let's just assume we're kind of in that range. $2,400,000,000 to $2,500,000,000 quarterly in our back half of our fiscal year, Industrial running between $1,100,000,000 $1,200,000,000 right. And then you get into the communications Business, which as Terrence said, is going to be closer to $450,000,000 quarterly run rate for the next few quarters. I think when you look at that and you say, okay, what's that going to do Margins.

Speaker 3

Within transportation, the price that we've discussed so far in this call and Terrence just walked Drew, in a prior question, the price that we were have been successful implementing that was a long time coming and was Negotiated contract by contract with OEM by OEM is largely in effect and we'll get the full benefit of that as we work our way through the second half And it gives us confidence in our margins, in addition to growth versus market that we get from content. So we feel more confident around the transportation margins as we look forward. The industrial side is a bit more challenged, Right. We've got a business in here that the industrial equipment business, which is feeling the pressure on the order front and certainly as it translates into the revenue side of Thanks. And that is our highest margin business within the segment.

Speaker 2

And you

Speaker 3

saw that as we move from our fiscal Q1 into our fiscal Q2 That while industrial equipment grew, albeit modestly 3%, the rest of the segment far outgrew it. And if you look at how that impacted The mix within the industrial equipment I'm sorry, within the industrial segment, it did have an impact and will have within Aerospace and Defense, Terrence also mentioned Medical and then obviously our Energy business, which we've highlighted on this call. Those, albeit they have structurally lower margins than the industrial equipment business, volumes do help. And our commercial transportation I'm sorry, our commercial air business is not back to pre pandemic levels yet. And so we are still catching up on the margin front.

Speaker 3

Thanks for turning it in the right directions. There's also some things cycling down with our industrial equipment business that is putting pressure on those margins. But we do expect from a modeling perspective, Wamsi, if you wanted to assume a modest improvement as we move from our Q2 levels through the rest of the year within the segment. And then communications is pretty straightforward. Listen, at this roughly $450,000,000 quarterly level, Mid teens is

Speaker 2

a good thing. So I

Speaker 3

think we've discussed that already. So hopefully that answers your question. Happy to take anything else.

Speaker 1

Thank you, Wamsi. We have the next question please.

Operator

The next question is from Amit Daryani with Evercore. Your line is open.

Speaker 6

Perfect. Thanks. I guess, I was hoping if you folks could spend a bit of time just talking about from a supply chain perspective, what are you seeing from a component availability and then The inflation side, and really on the inflation side, I'd love to understand if you think the price increases so far are adequately offsetting this? Or do you think more that needs We're done here. And then just secondly, if I could get the clarification, could you just remind me what are you estimating from an auto production perspective in the June quarter?

Speaker 6

I think IHS is at 21,500,000 units. So I'd love to get a sense of what are you kind of taking into the guide from the auto production side? Thank you.

Speaker 2

Yes. Sure, Amit. Let me do the last one first. All year, we've sort of said we're going to be around 20,000,000 units on of auto production to 80,000,000 in total. And it's just going to be a flat environment and that hasn't changed from the beginning of the year.

Speaker 2

So that's pretty much how we think about it. And I know there's some differences of heavy vehicles that are in the IHS number that we put in our commercial transportation, but we viewed flat. On your first question is about supply chain inflation and price. I want to give a little bit before I get into supply chain is service levels of how we're servicing our customers Because I do think whether it is supply chain, whether it is the orders that I talked about earlier is they're all interrelated. And it's why when we talk about some market being strong or stable, it does come into how we're servicing

Speaker 3

our customers.

Speaker 2

And what I would tell you at the overall TE level, our service levels are back to 2019 at the overall TE level. Some people are higher, some people were servicing better as supply chain has improved. There are markets like commercial air and medical, which were late in the recovery. I would tell you our service levels still need to improve. And the main reason the service levels need to improve is we're still seeing supply chain impacts.

Speaker 2

But at the big picture, what I would tell you is the availability across the global supply chain has improved. Our customers are feeling it from us, and I think that's a key element that also explains why we see some stabilization And backlog, and I think our orders going up sequentially is a positive factor. Now from an inflationary impact, what I would tell you is places like freight and logistics, we have seen deflationary impacts. I would tell you elsewhere, it's sort of just moving sideways. I wouldn't say it's getting worse.

Speaker 2

I wouldn't say it's getting better. And that's why when we feel with the things that we've done on pricing, especially in transportation where we're lagging, we do think we're really in a mode of recovering the that we've incurred over the past 2 years and that's why we feel good about the margin impact and we do expect that the pricing will stick.

Speaker 1

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

Operator

The next question is from Joe Giordano with Cowen. Your line is open.

Speaker 7

Hey, guys. Good morning.

Speaker 2

Hey, Jim.

Speaker 7

I want just a quick clarification and then a question on industrial and Some of your other markets here. Just in China on EV, do you have a big spread between like a high end Tesla type vehicle and a low end Kind of local manufacturer in terms of content. And then bigger picture, if I look at something like industrial equipment or IT, Obviously, those are moderating here. But even with moderations, they're still up a lot, even adjusted for inflation or M and A From like a pre COVID level. So like if those markets like how much of a real reset should we think is reasonable in like an economic Downturn for something like that, that's moderating now, but still up a lot over like a fairly short period?

Speaker 7

Thanks.

Speaker 2

Yes. Let me take both of those. So first off, when you think about content per vehicle, I think what you have to start with, especially with China, is anytime you move from an electric vehicle to from a combustion engine, That's a content growth element for us because we're on both multinationals and local. So I do think the bigger thing is to be thinking about Not comparing content between, it's really about it drives content growth because we have a good position on them. And depending upon class of car, you're always going to have, whether it's a combustion or electric vehicle, it's going to come into the features of what's in the vehicle.

Speaker 2

So I think the real thing is that I think China is over 20% of new cars sold are electric vehicles. All that is good for us. It's really Yes. A key driver to our growth and we've always said Asia overall is the growth driver of electric vehicles. So The 25% of the 80,000,000 units that we've always that we say we think it's going to be at this year, 70% of those units are going to be in Asia and certainly China.

Speaker 2

China is the largest. So it's only positive for us. On Industrial Equipment, I think the element that you Let me add a little bit of color to your question is, Industrial Equipment is a very broad space. There's factory automation, There's building automation, things that go into construction. There's process automation.

Speaker 2

There's a number of different buckets. And what I would tell you, In areas around factory automation that supports consumer electronics, that has got to be a little bit more difficult. So there will be some element of where that will downdraft. Areas around building automation, also we've seen weakening there where you get into the commercial construction side. So I don't expect it will be what we see in our Communications segment, but you will see it come down a little bit as some of those markets moderate.

Speaker 2

There's also the element of our service levels have improved across that market as well even though it's up. And we are seeing some of our OEM customers Pull out some buffer stock. So we do think there can be some moderation. Right now, you can probably think about it, the growth in the other three business Can offset some of that moderation, but we got to continue to watch it and make sure it stays contained in some of the submarkets in the industrial space.

Speaker 1

Okay. Thank you, Joe. Next question please.

Operator

The next question is from Scott Davis with Melius Research. Your line is open.

Speaker 8

Hey, good morning, guys. Hi, Scott.

Speaker 2

I want to switch gears

Speaker 8

a little bit. And you mentioned AI a couple of times in the Prepared remarks, but how material is this upgrade cycle? Is this kind of a nice to have or is this something that could be And about multi year, pretty powerful demand driver for you guys?

Speaker 2

No, super, Scott. So yes, Scott, we talked about it in there. We talked about some of the design wins It's really just the next extension of what you get into high speed. So one of the things that's nice is where we position ourselves in cloud. That will be a multiyear cycle as you get into those higher speeds and also the importance of, like I said, the low latency you need.

Speaker 2

So those design wins we're getting today will start in 2024 and I think it could be very similar to the cloud cycle that we saw Over the past 3 to 4 years. So I think as we work through the whole communications and the telecom and the cloud inventory work off, Once that settles, I think you're going to continue to see content growth that will be both from reinvigorated cloud investment plus the AI element that will really drive Our D and D business,

Speaker 3

as you get into 2024 and 2025

Speaker 2

and beyond.

Speaker 1

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

Operator

The next question is from Christopher Glynn with Oppenheimer. Your line is open.

Speaker 9

Yes, thanks. Good morning. Just wanted to Dig into transportation revenues a little bit more. It looks like it was well above your guidance Production may be in line with guidance, but there's always some timing around supply chain and maybe launches pull forward or More likely push out a little bit. So, it sounds like you expect consistent revenue in the back half.

Speaker 9

Just curious what really changed there with the volumes that came through versus expectations?

Speaker 2

Yes. So when you look at it, One of the things we saw is that a lot of our over performance in this past quarter was really out of Europe. And Europe was an area that coming into this year, and I don't think we were atypical of anybody else between what was going on from Utility perspective and energy costs as well as the war. And I would tell you, in our transportation business and our OEM customers, They've been building more aggressively than we would have thought when we came into it. China is a little bit slower, which sort of gets you to the flattish and really not a But what's really nice is we were able to service them when they wanted it here.

Speaker 2

And on the back half, the back half isn't that much different When you go first half, second half and when you think about we're going to be down sequentially a little in transportation, that's really just due to the choppiness I talked about in China.

Speaker 1

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

Operator

The next question is from Matt Sheerin with Stifel. Your line is open.

Speaker 7

Thanks and good morning everyone. Good

Speaker 2

morning. I had

Speaker 7

a question regarding your distribution channels. Terrence, I know that you've got the big concentration of distribution within your industrial markets. And I imagine you're seeing some Destocking at the industrial equipment market. Have you seen that play out anywhere else or expectations that the distributors are going to start to cut inventories, Particularly as lead times continue to come in?

Speaker 2

Sure. So a couple of things, Matt, just to frame everything. When you really look at where we Play in the distribution channel. Certainly, in our Communications segment, a big chunk goes through to our channel partners. And you're exactly right, a big chunk goes through in our Industrial business and our Aerospace business.

Speaker 2

Now what I would tell you is in our Aerospace business, As that continues to ramp, orders continue to grow, backlog builds and certainly, we need to continue to increase our output to service The backlog and get service levels where they were before the pandemic. So what you see is you sort of see trends in the distribution channel That do mirror what we talk about in our different business verticals. So we've been seeing already, and it started a few quarters back with our distribution Those that were around our communications segment units, order levels have come down. They have been trying to manage their inventory. It's probably at It's at the higher end of their range.

Speaker 2

And that's something that when we talk about what we're going to be at a $450,000,000 in the Next couple of quarters, that includes OEMs bringing down inventory, ODMs bringing down inventory and certain our distribution partners getting To a better inventory level. I would tell you in the industrial space, we have seen some impacts, but I would also say part of it comes to service levels. So during COVID, when we could not meet service levels due to supply chain, certainly, our customers would go to our distribution partners To get product, which is part of the role they play. We have seen as our service levels improve, you've See buffer stocks taken out and we have seen order levels weaken in certain of those industrial markets. It's not even.

Speaker 2

It's not even across all of them like we see in communications. It's around the markets that we talked about that can be building automation and things like that. And we do see that the inventory levels are at the higher end of the range that our distribution partners Would want to be at. So that's why their inventory levels are a little bit down, but not to the extent that we see in the Communications segment.

Speaker 1

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

Operator

The next question is from Samik Chatterjee with JPMorgan. Your line is open.

Speaker 10

Yes. Hi. Thanks for taking my question. I guess, thanks for all the color about the individual end markets. I was just trying Think of it in more accurate terms when we take all your outlook for the different end markets, the Q4 of activity here.

Speaker 10

Are we comfortable that in relation to cycling pass a trough in relation to aggregate autos as you sort of Match all those outlooks up by the end markets. And maybe if you can touch on autos there, particularly I know you mentioned choppiness in China, but It just also has a pretty material step up in production in China all through the year. Is that what you sort of are Maintaining more caution around or are you seeing it in the orders yet?

Speaker 2

Yes. No, so a couple of things. As I said on our orders in Transportation, they were actually up 12%. And I think the other thing we have to realize, the China automotive market does a Big build in our December quarter. So typically, you do have a step down in China.

Speaker 2

And we sort of view China auto production for the rest Our fiscal year being pretty flat to where it was in the Q2. So we don't see an acceleration of build, but I do want to highlight that Typically, the December quarter, Chinese auto producers do do a big build to meet production targets. And as we look forward, it is choppy right now. We're watching it. Certainly, the price activity that certain OEMs are doing in China, I think, is creating a little bit of pause for consumers to say, hey, how does this settle out?

Speaker 2

The Chinese consumer is an intelligent consumer when it comes to price. So there are some things that are creating So near term choppiness, but we view it's going to be flat from here when we look at auto production in China For the rest of our fiscal year.

Speaker 1

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

Operator

The next question is from Steven Fox with Fox Advisors, your line is open.

Speaker 11

Good morning. I was just curious on the restructuring charges that you've taken Year to date and plan to date for the full year, how those are flowing through the income statement? When are you getting the benefits? What kind of return on it? It looks like More is going into Transportation and Other segments based on what I saw in the slides.

Speaker 11

Any color there would be helpful. Thanks.

Speaker 3

Sure. Thanks, Steve. Yes, we did as you recall, when we went out early part of the year, our initial View into 'twenty three, we said the restructuring will be somewhere around $150,000,000 which was flat from prior year. And then in the last call, 90 days ago, I said we were reevaluating that. And we did in the discussions with our business and obviously with our Board.

Speaker 3

We've increased that by about $100,000,000 to $250,000,000 Now you are right. There is a there is chunks. It is just in transportation. There is some incremental things we're doing to adjust some cost structure, as you can imagine, in this more accelerated downturn in both the communications and in the Industrial Equipment business that is driving some of that. In addition to accelerating some of the rooftop consolidations in other parts Of TE that had been planned that we want to go ahead and pull in and get done sooner, that we've determined we So that's part of it.

Speaker 3

Now a bigger chunk of this as it has been the trend over the past Couple of years has been a little bit more in Europe based. And the payback when you start getting into Europe based Restructuring activity is a little bit longer than what you would think of in other parts of the world. And it just has to do with the demographics that you're dealing with and Construction costs and statutory requirements. So if you're looking at it, I would say, historically, we've said that Payback on our restructuring, has been just inside of 2 years. That's been traditionally kind of how it's blended together.

Speaker 3

It's a little bit longer for that, especially for this Incremental piece, it's probably stretching out to 2.5%, maybe not quite 3 years on the payback of this. But it does give us Structural benefits in terms of fixed cost reductions and that's what we're really aiming for to lower the fixed cost side of the thing and give us more nimbleness to flex the business.

Speaker 1

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

Operator

The next question is William Stein with Truist Securities. Your line is open.

Speaker 11

Great. Thanks for taking my question. You all have done an excellent job of highlighting the content growth Tuned and EV and executing against it. At Tesla's recent Analyst Day, they showed how in the cyber truck And then also in the NextGen platform, they're transitioning the lower voltage part of the vehicle to a 40 volt architecture. And this looks like it consumes significantly excess content in terms of cabling and I suspect connectors as well.

Speaker 11

Can you talk about the degree to which this might have already become a trend at other OEMs or if it's brand new and still on the comm and what The impact, if any,

Speaker 2

you think this will have in your business? Thank you. Thanks, Will. So when you get into this, I think First thing is, even if you take a Model 3, which has a simplified harness versus the Model S, we have more content on it. So I appreciate harnesses being showed, but you really need to look at when you look at a harness, Not the wire.

Speaker 2

You need to look at the functionality. And in some cases, what certainly they're trying to achieve is Do they approve assembly, assembly quality as well as they do over the top updates? But when you're bringing data, power and signal together, It's coming together and what may look like it's a simplified harness. The interconnects on that harness are a lot more complicated, Higher pin count and a higher pin count means an individual contact or connection point. So what you get into while the harness And yes, if we make cable or we were a harness maker, it would probably be bad for us.

Speaker 2

What occurs is you move to a lot more Complicated interface, which typically have data, power and signal running through them, which create a whole bunch of other daemons in the architecture That engineers need to solve for and what we get excited about that actually while it may lower the amount of interconnects themselves, The more complex interconnects in there are higher content, more highly engineered and really what you get rid of is some of the commodity interconnects That are out there. So and the same goes through if you jump from not only a simplified harness, you get to zonal architecture, all of that Plays into part of the content increase we talk about when we talk about electronification. So the trend for us, we like it. It does get into what we do and what we do well. And we've dealt with this for decades, And it's going to continue to evolve.

Speaker 2

And I think certainly when you get to an electric vehicle, it allows you to look at the architecture with a clean sheet versus a nice vehicle, And that's what we'd like to do. So net net, it's a positive for us. Appreciate you bringing up the question.

Speaker 1

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

Operator

The next question is from Luke Junk with Baird. Your line is open.

Speaker 12

Hi, good morning. Thanks for taking the question. A question for Heath this morning. Heath, as you saw the change in mix developed during the quarter in Industrial, I'm wondering How the margins within the sub segments performed or levered versus your expectations in the areas that are exciting right now? So Differently, should we view address mix as being more mechanical or are there levers you can pull to get to that better volume leverage Out of those higher growth areas that you're envisioning in the back half and maybe if you could put a finer point on what you think margins might look like in industrial in

Speaker 1

the back half, that'd be great too. Thank you.

Speaker 3

Sure, Luke. Listen, I mean, the thing we're coming off of is a pretty significant What we're worried about in terms of our worry beads is a mix of that of obviously less of the industrial equipment business, which You know, Cameron, anywhere from 500 basis points to 800 basis points more profitable than the combination of the other businesses in that segment, If you combine those all up. Now, the challenge then is, obviously, we've enjoyed a nice part of the cycle and the margins that that has Drive for the segment overall is to minimize that impact on the way down and some of the restructuring undertaking that I just mentioned is going to help with that. The other side is getting more volume leverage out of the pieces, as you mentioned, that we're growing through. And

Speaker 2

There's a lot of

Speaker 3

moving parts in that. And I won't want to air in terms of how we've layered in acquisitions and the impact from those acquisitions is also some of the rooftop Consolidations and things that don't get captured restructuring, but drive near term margin pressures. But I do feel confident as I think about our Aerospace Defense business To continue, we've seen it. Although we don't share those margins at the business unit level externally, we have seen that And to improve as commercial air has come off of a pretty steep decline and is starting to work its way back, but still not back to pre pandemic levels. Our medical business is not nearly as profitable, but as we've seen the volume get back to pre pandemic levels, We've started to see volume leverage there.

Speaker 3

And then the other piece is our energy business, which is more of a steady state margin business. So there is some We have as we look at it on the near term. As I look at it and look at where the growth is coming from and how that mix impact goes, I could see it if I was to frame it up, the industrial equipment business could run another, Let's say 50 to 100 basis points higher as we work our way through into the second half. But the ultimate goal here and if Team was here to show it. I mean, the ultimate margins within this segment.

Speaker 3

And we know that we do a lot of acquisitions in this segment. Sometimes They're small for TE, but they're meaningful for the segment. That resets it down some, but the goal is still to get operating footprint in the right place Where it needs to be as well as getting the overall cost structure where it needs to be. So I feel good about where we'll This mix impact in the near term is a bit of a pinch point for us.

Speaker 1

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

Operator

The next question is from Shreyas Patel with Wolfe Research. Your line is open.

Speaker 7

Hey, thanks so much. In the past, you've talked about typical price downs that you pay customers. I normally it's in the 1% to 2% range, especially within your automotive business. You have been taking price Over the last couple of years through recoveries, but with the supply chains broadly stabilizing, I'm wondering if you expect That you will have to start those price downs with customers again? And if so, are you able to extract productivity from your own supply base Or drive restructuring savings to kind of help mitigate that?

Speaker 2

I do think there's an element there that and where does price really occur, like you sort of say, it's typically in our automotive And our D and D business is where you really see those types of impacts like you stated. I don't think we're close to that yet. And with where inflation is at for TE, still we're in a recovery mode, that's the discussions that we're having with our customers. I think there was things like deflation, real deflation and things like that, we may get back to those Traditional patterns, because it does come into how do we drive productivity that helps our customer if they hit the volumes in places like auto. But that's not going to be something we're seeing in the second half.

Speaker 2

But as cost comes down around the world, that is something we could get back into in outer years.

Speaker 1

Okay. Thank you, Shreyas. Before we wrap up, we have heard from some of you that we had patchiness of audio cutting in and out. So we are going to publish our earnings script on the Investor Relations portion of the website and that should be up shortly. Thank you, everyone, for joining us today.

Speaker 1

And if you have any questions, please contact Investor Relations at TE. Have a nice morning. Thank you.

Operator

Ladies and gentlemen, today's conference call will be available for replay beginning at 11:30 am Eastern Time today, April 26, 2023, on the Investor Relations portion of TE Connectivity's website. That will conclude today's conference for

Remove Ads
Powered by Quartr
Earnings Conference Call
TE Connectivity Q2 2023
00:00 / 00:00
Remove Ads