TE Connectivity plc (TEL) Earnings Call Transcript & Summary

Okay. Great. Thanks, everybody, for joining us. My name is Mark Delaney, and I cover TE Connectivity for Goldman Sachs. As many of you know, TE is a leading connector and sensor company, with over $13 billion of annual revenue. With us today, I'm very pleased to have Heath Mitts, the CFO. Thanks for being here.

Thanks for having us, Mark.

I thought we could start discussing some of the orders trends that the company spoke to on its last earnings call. TE spoke about the view that the inventory correction that had been seen is approaching a bottom and some areas of sequential order improvement. Can you elaborate a bit on what TE has seen typically?

Sure. And for those of you who have followed us and our public statements, certainly going back to our earnings last summer and into the fall and then tied in with what our guidance was for fiscal '20, which we talked about at the end of October, we talked a fair amount about the portion of our business that goes through the distribution channel. So that's about 20% of TE in total, most pointedly at our data and devices business, our appliance business as well as our general industrial business within the industrial segment. And we have seen pretty significant inventory correction going on, really starting late spring through the summer. We're getting ready to anniversary that. And our guidance assumed that by the time we got largely to the end of our fiscal Q2, which is our March quarter here that we're in right now, that we would see those inventory levels come in line to parity in terms of the point-of-sale from the distributor relative to what they're buying from us. And we've got very good visibility to our distributor partners, the inventory levels for our parts. We know what their sales of our parts are out to their customers as well as in what they're buying from us. And we've seen about $100 million of inventory come off-line here in the quarter, and we would continue to expect that to come in, in line with what we saw guidance-wise. So what you saw in terms of the sequential order step-up, some of that was attributable to this. Some of it was attributable to that -- I'm talking sequentially, not year-over-year, and some of it was attributable to general improvement otherwise. But that part of the business, which is, again, about 20% of the total TE, the distribution channel part of the business, was on track. Now disruptions in China and all the things that I'm sure you'll ask about, we'll see how that has an impact going forward. But relative to our guidance, the assumptions were on track.

In terms of the distribution inventory, which the company monitors pretty closely, can you share any quantitative data about where distribution inventory of TE product is in terms of dollars or weeks that -- and how does that compare to normal levels?

Well, we don't disclose the external because it's a combination of inventories across a lot of different distributors, and I don't want to get into those levels. But I would say that by the time that we get to the end of Q2, they're more back towards levels that you would consider -- that they would consider the appropriate level from -- in terms of stocking for what they're seeing their demand is. And they generally -- the key with any type of distribution activity is if somebody doesn't have something on hand, somebody -- and the customer will go to one of their competitors. And certainly, our ongoing conversations with them bring us back to that they're comfortable with inventory levels that they would have seen a couple of years ago. We did see outsized growth. If you go back about 18 months, where they were buying more from us than they were actually selling because of some of the growth in certain areas, that contraction is now largely taking place.

Maybe we can pivot to the China situation and the unfortunate health crisis related to coronavirus. Can you talk about, from an operational and day-to-day business perspective, how TE is responding? And then from a business and revenue perspective, has the company seen any change in revenue trajectory because of the coronavirus situation?

Well, it's a fluid situation, which I'm sure you're hearing from a lot of people at this conference. We get daily updates from our team on the ground. In China, we operate in -- we have 18 manufacturing sites around China with nearly 20,000 employees. We're fortunate to be able to say that none of our employees have contracted the virus. We have a few that are under self-quarantine just because of their movement during the Lunar New Year holiday. But in general, we're in a pretty good place from our employees' safety perspective. Now we don't operate any manufacturing near the epicenter of the virus near Wuhan or the Hubei province. But it does impact in terms of our ability to support where our customers need things at certain times as our customers are reacting as well. So I'm certain there will be some element of impact to this. Now we've got factories that are dealing with their local provincial elements in terms of what they can manufacture now and at what levels, in terms of who can operate within that. But -- and the most important thing for us is to stay close to make sure our customers have what they need when they want it. And we're -- there will be supply chain impacts that it will be part of, I'm sure. But in general, I feel good about how the team has handled the crisis and on the ground, and we'll continue to monitor it. We're fortunate as well that China is roughly 20% of TE, and it's a very important piece, but we also have activities, obviously, in other parts of the world that we're able to withstand some of these pressures by overperforming or pulling levers in other places.

So -- and I think since you've been CFO, the company has guided a little bit more conservatively in general. So as investors, I mean, should we feel that if it's not too severe of a situation, that TE would still be able to meet its financial guidance for the quarter?

Well, I mean, more to come on that. We'll certainly update it as appropriate. But I do feel like the team is responding well. You have to understand that just last week, people came back from their extended Chinese New Year holiday. So the situation is still pretty fluid.

Okay. In terms of the -- as you said, you had 15 or 18 sites in China that...

18.

18. Can you give us a sense of how many of those have started to come back on, how many are still on extended holiday?

Almost all of them are back on some level of capacity. There's a couple of provinces that are asking companies to monitor who's been in the province and who's been out in terms of the employees and what they can do. But we're fortunate that most everybody is at some kind of -- some level of capacity going, almost all.

Maybe we can dig in more into the transportation segment and talk about automotive. Electronic content per car has been a very nice driver for TE historically and a big part of the potential growth for the company going forward. Maybe remind investors what are the most important applications for TE that's driving that content growth. And what's TE's view about how much its revenue can outgrow auto unit production?

Well, certainly, hybrid and electric vehicles, and we kind of put those all in one bucket, is a very powerful piece of our overall growth strategy. If you think about content per vehicle that we have today on average globally is around $65, $66 a vehicle, when you start getting into hybrids, and those are different types, there's true hybrids, there's plug-in hybrids and everything else, but it goes up by about 50% to somewhere in the $90 range. And when you start getting into EV, true EV, gets into about the $120 range of content per vehicle. So that's an important piece of our overall strategy and how we've capacitized the business and how we've aligned the amount of engineering that supports that, as far disproportionately is aligned to those types of platforms and applications around data, power, signal robustness, more so than if you were to look at, I'll say, traditional combustion-engine type of platforms. And so we're putting our money there because that's where our customers want us to make the platform investments as well. So as you think about the hybrid electric bucket of vehicles in our fiscal '19, which is, as a reminder, calendar September 30 year-end, we -- it was just under, globally, about 6 million vehicles stayed in the hybrid electric space. That number is going to grow to close to 9 million this year. And in an environment where total global production of auto is going to be -- is somewhere last year around 86 million, 87 million, it's going to drop down to about 84 million. So within that, you see the total come down but disproportionately going up. Now we've seen more growth there coming out of Europe than maybe I would have thought about 2 years ago, and China has been a little slower with that, given all the things that are going on in China, but not just with the current situation with the virus, but also just a slowing economy and where their subsidy structures are. But our investment is pretty balanced between those regions when you come to hybrid and electric because our thesis is that both China and Europe will adopt those more rapidly, what you will see in North America.

Can we dig in, in a bit more depth on that content per car in an electric vehicle? You talked about it being roughly double or $120 per car. What is the reason that the content is so much higher? Is it these are more sophisticated connectors that handle higher voltages and so you get a better price? Is it more connector units? Is it the fact that the car company is building an EV or smaller volumes, so they don't get purchasing scale? Maybe just help us think through some of those dynamics.

Well, I think you got to think about things where they are today and where they will be, right, when you talk about scale. I mean you got people -- you got places, like in China, where you might have 50 OEMs that are doing some level of auto production. Some are more focused on an EV type of platform and some just on smaller engine combustion-vehicle type of platforms. So there's different needs, and we're embedded in with all of those. And then we deal with the major customers in Japan, Korea, Germany, the U.S. It's a little bit different there. They've already kind of thought about scale in a little bit different way. Most of our thinking though and where we're winning opportunities with those OEMs is coming less so from who's at scale and who's not because it's not so much around pricing and it's much more around the robustness of the product. I suspect that as you move forward -- we're not in the harness business, but I suspect there will be fewer absolute connections that happened, wire-to-wire connections, but there will be more robustness in things where there are modules placed in the car. And where there are the brain power of the car and where the signals need to come into, whether that's things around data, whether that's things around power, whether it's overall signal, where those are going to come in from will be more modularized within the car, and that's where -- that really plays to a sweet spot of ours in terms of that. In terms of solutions, they can't fail. They can deal with the higher power requirements. The volatility, the harshness of what's going on in there in terms of vibration and temperatures and everything else that play into it, that really plays well into our strengths because that's really where you're engineering a solution for somebody, not just a passive connector.

So the -- so even if the number of engine control units gets reduced, and that limits at least the growth rate of new connectors, there's enough of an ASP uplift because of sophistication that the content per car still goes up in any of the...

For sure, for sure. Honestly, we don't think about it so much as an ASP because it's not a like-for-like product, right? It's just it's more in the overall solution that you're providing that solves maybe something that used to have 30 or 50 pins that -- in different places are all aggregated into one connector or one module.

Okay. As the types of products that TE is selling are changing and as we shift into this electrified world, are you seeing the competitive landscape change at all?

Well, I mean, our competitors, our competitors that you know well, they're -- and whether that's in the connector or in the sensor side, right, I mean, this is an attractive space. So they're all responding as you would think they would be. We haven't seen a lot of new entrants into the space because it is hard to do, hard to do at scale. It's hard to replicate that level of engineering, and I would say that, probably, most of our competitors that you would think about, and whether that's in the connector space, the auto-focus connectors in that space or in the sensor side, are certainly feeling the same thing, where they're -- that we're all trying to go after and win our respective component of the space. It is very -- this is not something that -- in all cases, this is not where a standard has been created. So we're working with the OEMs to help create those -- answer those questions and build a solution for them. As you do that, there's a level of engineering and kind of that's hard to replicate, especially as you're ramping up into something that's -- that largely has not happened before.

And I want to talk about the broader pricing environment in your automotive business. Just we're in a downturn. I think OEM -- the car OEMs look for better pricing always, where that's not unusual in any business, but especially in the downturn, that pressure can intensify. It's something I've been asked about by investors. Has TE seen any change in the pricing landscape?

No, not really. I mean most of our pricing in the automotive space, specifically, is tied to volume. So you'll see us when there's been times. If you go back a couple of years, where auto is growing, our respective auto business was growing high single digits, right, you would have seen more price pressure then because as people get to certain levels of volume, they know that we're going through our productivity. And our productivity is soaring because people then pass your fixed cost, and part of that, what we call price, is really sharing some of that productivity back. We may see times where auto production has come down, we don't see nearly as much price -- us giving price because it's just in the formula of that. Now those are ongoing discussions with the OEMs and feeling that. But they also want us to be in a position to be able to invest in the new platforms, that they need us, therefore, too. So there's a lot of joint discussions that factor into a lot of different things.

I would like to talk a little bit more about sensors, if we could. TE did the Measurement Specialties acquisition a few years back. Part of the value proposition was taking the products, Measurement Specialties had, that were used on trucks and taking it into the light vehicle market, which -- that takes time, given the design cycles in automotive. Can you give us an update about how much sensor revenue TE has today per car? Today, there's $60 or so of connector content on average. I mean what's the equivalent number in sensors?

Well, it's much smaller, right? So -- and Mark, as you pointed out, when Measurement Specialties was acquired in late 2014, there was really -- they had a very strong franchise within commercial transportation, heavy truck. Now that continues to be the case. But what we've added and brought with that is about -- now about 1/4 of our total sensors revenue, about 1/4 of it, so it's about $900 million of revenue, is automotive, and that really was organically built from next to nothing. As that's happened, we've continued to win more and more platforms going out. We've won over $2 billion worth of platforms since 2016, many of which -- in this market, you get specked in, you win the business. There's some volume assumption that's going to take place with that particular model vehicle, but you may not see revenue from that until they start production 2 or 3 years out. So when we talk about this $2 billion, it could be out over the next 5 to 7 years. And we're starting to enjoy some of that. You'll certainly -- volume productions aside for -- our production volume to the side for a second, the things that we've won would suggest that, that 1/4 of our total sensors will double in the next 3 or 4 years. And it's a very powerful place to be, and those are applications that we've already been specked into. And we're going through different levels of qualification and ramp-up, and we've got to get the right tooling and molding and all the other things in place to support that. So that's been a good piece of what we like about sensors. So if you think about our total sensors, you got about 1/4 of it. That's still this heavy truck, nice business, but has a volatility to it. You've got about 1/4 now that's automotive. And then you still have about half that is a pretty broad set of applications and end markets from medical to automation and robotics, to, you name it.

And just to make sure I understood the point you're making. That doubling of automotive sensor revenue, that's on a dollars basis. So $900 million, it could become $1.8 billion in 3, 4 years.

That was just the auto piece of that. So the total sensors business is about $900 million. So 1/4 of that, call it, $250 million, going towards $500 million, certainly.

Okay. Got it. Got it. And on the sensor industry, the company has the proposed acquisition of First Sensor. And talk a little bit about what capabilities that brings, and then -- and can we talk about some of the financial implications, too?