TE Connectivity plc (TEL) Earnings Call Transcript & Summary

Well, it's a complex discussion, and we could probably spend the next hours on this, but it gets into not just where you produce, but also where the intellectual property for those products reside to determine, I'll say, nationality and where the enforcement protocol comes from. I would say we're not super concentrated with any one customer. But there have been things, whether it's Huawei or ZTE and others, that we've had to work our way through because we were -- we did have exposure. But it gets even more complicated from that because those are very large companies and some of the companies that are on that list, it's not all of their products that are impacted. There might be products that are deemed to be closer to some national security and those types of things versus things that they would be buying from us that might be, I'll say, more run of the mill data servers or things like that, that we're providing a product that goes into, a back plane on a data server or something that is deemed to be not -- so not -- doesn't -- is not as applicable to some type of regulatory control. So it's a lot of work. Our team and our government affairs and our regulatory compliance team spend a lot of effort as these things come up with different customers, categorization of part numbers and so forth and going through processes to get our products cleared. Largely, Jim, we have found that we can get our products cleared. We don't do a lot of things that are, right, I'd say, are -- that support activities that are real sensitive from a regulatory perspective. But that doesn't necessarily mean that we're off the hook entirely because even if we get our products cleared, we're only one part on somebody's building materials. And if they can't get all the other products cleared, that causes them headaches in demand, and we've seen demand for that at times tick down. Since COVID, particularly, we haven't seen as much of that activity, but it's something we keep a close eye on and how much of it turns into, say, the rattling and banter versus real sanctions.

So, so far, we've talked a lot about the connect -- connector industry. Can we maybe shift over and talk a little bit about sensors. Not everyone may be familiar that you also do sensors. Maybe you can talk about, a little bit about the history, how much is your sensor business? Why it's important? And then we'll kind of go into the sensors a little bit more?

Sure. Well, our sensor business, the most meaningful part of our sensor business came in with the acquisition of Measurement Specialties in 2000s -- pretty -- before my time. It came in, in 2014 -- late 2014. And so it's been about 6 years since that was acquired. And Measurement in and of itself was a bit of a roll-up of a series of acquisitions. So as part of this, the thesis at the time and continues to be is that we could use our automotive expertise on the connector side and those relationships with the OEMs to bring some of the sensor business up. And we've grown that pretty considerably now. From almost 0, we've grown our automotive sensor business to about 25% of our total sensor business. Our sensor business last year did about $900 million. So -- and that's grown from very little to something much more meaningful and will double in the next few years because of the platforms that we've won. And our content per vehicle, while it's very large on the connector side, it's very small on the sensor side. And so that's something that we're excited about. And it's driven investment levels ahead of revenue. And we anticipate that revenue to continue to be meaningfully a growth driver within the sensor business. There was also a piece that came in on industrial -- on commercial transportation. So off-road or a 18-wheeler type of activity. That is a good -- very good franchise for us and continues to be very good, and we see common growth rates in that part of sensors as we see in our commercial transportation side on the connector side. So that aligns very well. And then you have about half of sensors that is kind of more general, lots of different applications, we call it our industrial portion of sensors. And that's one -- that's an area that we'll continue to prune certain things that we are less attractive and double down in certain areas that are more attractive. And so that's an area that I think you'll continue to see us invest in. And then most recently, we acquired First Sensor which was a German public company that we largely concluded the transaction over the past couple of quarters. And First Sensor brings -- it's a German-based business that brings in -- that touches markets right on top of ours, industrial, medical, auto, and most of its low-pressure capabilities that we didn't have in our portfolio. And so part of the opportunity there isn't just acquiring good business in and of itself, but they bring capabilities that as we operationally integrate, in some cases, we'll be moving out of our existing sensor business moving into theirs. In some of the cases, maybe moving out a couple of their facilities into ours. So on top of the fact that it fit really well market-by-market with what we do today in markets we understand well, it's also one that provides a lot of cost opportunities in terms of the synergy to ensure the return. So it's not without its challenges, sensors. And the technology can move fast at times. But we're continuing to fine-tune it and prune where we don't want to be and double down in places where we definitely.

And it sounds like you're doing a lot of integration with these and going to customers. But it also seems like, if I remember, didn't you recently do an impairment charge. Why would that be the case if sensors are doing so well?

Well, the numbers in sensors is -- COVID, there is no doubt that when COVID ticked in and drove auto production down, it throws up the commercial transportation market in a lot of regions. And then the general industrial side was hit hard. So that put a lot of pressure on the fact that our sensor business was, I'll say, in the scheme of our portfolio, more recently acquired and carried a fair amount of goodwill given the premium that was paid for sensors back in 2014. So it was a bit of the accounting math on how that projects. But it does reset a little bit in terms of we're a couple of years behind the original deal model. COVID certainly did not help that, but it did avail the opportunity for us to go ahead and take additional costs out, too. So...

Got it. Heath, being Chief Financial Officer, you're in charge of capital and the deployment of it. Sujal -- and then want to use things for expansion or R&D or new ideas. And then you've got shareholders who are listening here who want you to pay a dividend and buy back stock. And then you have a CEO who wants to grow the business organically and then some -- maybe some acquisitions. Can you give us an update on your capital deployment strategy?

Yes, there has -- it's largely unchanged. I mean, you've covered the stock a long time, Jim, and I think a lot of the investors on this call know us well. It's largely unchanged. I mean we look at it, our free cash flow is good. And we kind of target over a cycle. Roughly 2/3 of that free cash flow goes back to our shareholders, about half through M&A and half through share repurchase. And about 1/3 is used towards M&A. Now M&A is slow right now. And candidly, probably it will be slow for a little while longer. So there will be times in there where you might be a little bit more than 2/3, 1/3 or maybe more towards acquisitions during times. But that's largely unchanged. The beauty of TE is that we can grow better than market because of where we play and the electronification, everything we touch. I've said that earlier in this discussion. We're not acquisition dependent to get things done. Acquisitions for us are an enhancement. They're an ability to maybe fill in product gaps or get us into a particular market that is easier to acquire our way into versus -- and more quickly than doing it organically. But having said that, our organic revenue growth continues to be fully funded, right? We go through these down cycles. We're largely not touching engineering staffs, right? We're going after and making sure that we're being smart with our CapEx, but we're fortunate to have a very strong balance sheet, and we can continue to make bets well ahead of revenue in terms of where we need to be. So that will continue to always be fully funded because our best return on invested capital is always organic revenue growth. And acquisitions, particularly in a very low interest rate environment, can get pretty pricey. And that for us is something we just always have to keep an eye on in terms of where -- what's the best use of that. But maybe versus some other companies out there, we do have somewhat secular market support in terms of our long term drivers. But I feel pretty good about our ability to not be fully dependent upon M&A, certainly not big platforms of M&A, but continue to enhance it with bolt-ons as it makes sense.

And some of other companies have changed their capital allocation, such as suspended dividends, suspended buybacks. Can you talk about your dividend and buyback and how we should think about those in the prioritization?

Listen, they both are -- we didn't suspend anything, we didn't reduce anything. We raised our dividend modestly earlier this year. We continue to be aggressive in share repurchase, particularly when we saw major dislocations in the stock price in the middle of COVID, we were very -- we were much more aggressive with our share repurchases at that point. But this is going to continue to be -- we've got a strong balance sheet. We're going to -- we have strong cash flows, like it's going to continue to be the case. And I feel good. We don't have underfunded pension plans or anything that come -- that has hung around us in terms of things we've got to go and fund outside the core business. So unchanged. People should expect to see the dividend where it is and grow with our earnings and cash flows, and our share repurchases being part of our deployment structure.

And whether it be Heath or Sujal, for modeling CapEx, this year, I would say with coronavirus, it's been a little bit odd with restructuring, just the way of doing business. How should we think about CapEx and maybe normal expenditures, whether it be dollar amount or percent of sales? How should we think about capital expenditures?

I think 5% is probably a good modeling number. There'll be times where it could spike up a little bit and there's times where it will be maybe below that. But they tend to be -- most of our CapEx is tied to new products. So it's generally tooling, generally tooling tied to a specific application. And that's the vast majority of our CapEx. So it's tied to when we see new products coming online. So if we see something that maybe because of COVID a product launch by an end customer has been pushed out a couple of quarters or whatever, you might see, okay, we're going to hold off on that. We don't have to buy that machine quite yet. But our CapEx is generally made up of a lot of things in that 2 -- $1 million to $5 million purchase price -- purchase range, not a lot of things in the $50 million or $100 million price range.

And Heath, earlier during the call, you had mentioned, given the government Entity List, that you've found ways to legally still ship things to your customers, especially since you're maybe not in the most sensitive areas of communications. But that being said, assuming if Huawei totally got the goose egg or the 0 from the U.S. government of shipping for everything to them, would that have a material impact to your company? I assume given automotive is such a large portion of your business, the answer is probably not. But can you quantify what that risk would be, if anything, if Huawei was totally not able to ship to them?

Well, it would not be material. It'd be meaningful for -- it would be meaningful for our data and device business because it would impact them. At the TE level, it would not be meaningful.

Got you. Great. I have a question for Sujal. Sujal, as Investor Relations, you field as many questions as I do about your company, if not even more. Are there a few things, Sujal, that you want to take the opportunity to really clear the air or maybe help right any misperceptions about the company or any questions that you get asked again and again, with this very large audience who are connected here, that you can help them educate the most appropriate answers or understanding?

Yes, sure. Thank you, Jim. And I think we covered a lot of ground with your questions in the businesses. I think kicking it up one level. I think given the COVID environment, I'm asked at times whether that has changed anything with respect to the business model or if it's changed anything with respect to our segment margin targets or if we've seen any change to the secular dynamics that we have been benefiting from as a company. And the short answer is, no, our views have not changed. We continue to target about 4% to 6% organic growth over a cycle. The secular dynamics that have been in place pre-COVID, they remain in place. So we continue to benefit from trends such as the electrification of the powertrain in auto, increased production of hybrid and electric vehicles, which Heath covered earlier. We benefit from growth in our medical business, where we focus on interventional medical applications. And in Communications, we're seeing benefit from increased hyperscale CapEx. So the Googles and Amazons, Facebooks of the world, as they're increasing spending and building out their data centers, we're benefiting from those secular trends. And on the segment margin side, we're targeting 20% adjusted operating margins in Transportation. That is unchanged. From this point forward, it's going to be a combination of volume growth plus execution of restructuring actions that Heath talked about earlier. In Industrial, we're targeting high teens in terms of operating margins. We've expanded those margins from the low teens to the mid-teens, pre-COVID. About 2/3 of that expansion is based on what we control and the fact that we've had restructuring plans that we were executing on already as we entered the COVID downturn. So we're certainly not flat-footed. And we still have a couple of years to go until we're consistently running in the high teens. And the Communications segment is already running at target margins in the mid-teens, even in the COVID environment. So I'd say we get those questions, and I think the -- that's the response, that nothing has changed with respect to the business model or the trends that we benefit from, and our operating margin targets remain the same.

Great. As we kind of wrap things up here in the next 5 or 6 minutes, Heath, can we think about you as Chief Financial Officer, you've been through a lot of this pandemic. What gets you so excited to be CFO of TE Connectivity. And maybe a few bullet points about why you think investors on this conference call should be buying and owning TE Connectivity stock?

Well, sure. And I appreciate the opportunity, Jim. I mean, listen, this is -- like everybody on this call, we've weathered through the last 6 months of remote work environment and all the things that have caused lifestyle and professional style changes, right, and all of us in terms of personal and professional environment. One of the things that I would say, we use the term resiliency a lot around the company, is that the company's resiliency through this environment, particularly on the operating front. Our ability to stay in business, really a couple of days of shutdown in China in February and keep our European factories running when they went through and our North American factories working through the dynamics, Mexico was coming on and off-line, different by states and different by industry, all of those things, our teams powered through that. And we didn't miss -- disrupt anything in the supply chain. Our on-time delivery was fantastic through this period. And so not only am I proud of how we operated in this environment. And then our employees who are not in the manufacturing environment to continue to operate remotely, even gets me more excited for the future of where this is going because we weren't caught flat-footed in this, right? And those of you who have followed us, we were in the process of taking some of these more expensive cost structures offline going into this. So COVID did avail the opportunity to accelerate some of those moves, and we have done so. There are some things that we're going to continue to do into next year. And I feel very good that when we get by 2000 -- into '21, '22, we're going to have a cost structure that's different than what we had going into this. And that was always in the plans for things like Industrial segment. And Sujal mentioned the target margins there that were trending towards this. Transportation, we were starting to look at some of these plans that, again, if they were easy to do, we would have done a long time ago. So we weren't caught flat-footed. It wasn't like we had to draw team -- pull team together and say what we got to do, we simply were able to accelerate some of the things on the cost side. And then more importantly, on the growth side, as I mentioned earlier, I don't lose sleep about the balance sheet. We're in a very good place. Our cash flows are very strong. They continue to be very strong. I'm excited about our ability to grow coming out of this. We talked a lot about auto, we talked about sensors today. We talked about data and devices. We have a lot of pieces of this business that helped cushion us on the downtick because of the diversity of our portfolio, and it will benefit us on the uptick. So I feel very good the next several years are going to be great for TE. I feel good about that. The team has shown we can execute in rough environments and better environments coming forward, I feel. And I think as customers value us and with whatever metric they use, I tend to focus on cash flows the most, that's one that I think they're going to be impressed by. So again, I appreciate you having us on today, Jim, and look forward at some point being able to see live soon.

Correct. Ladies and gentlemen, we thank you so much for joining us here today with the Chief Financial Officer, Heath Mitts; and Head of Investor Relations, Sujal Shah. This is Jim Suva signing off, wishing everybody safe and happiness. And we certainly hope next year, we can do this live and in person. Thank you so much.