TE Connectivity plc (TEL) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the TE Connectivity First quarter Earnings Call for Fiscal Year 2021. [Operator Instructions] As a reminder, today's call is being recorded. I would now like to turn the conference over to our host, Vice President of Investor Relations, Sujal Shah. Please go ahead.

Good morning, and thank you for joining our conference call to discuss TE Connectivity's first quarter 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 portion of our website at te.com. Due to the large number of participants on the Q&A portion of today's call, we're asking everyone to limit themselves to 1 question to make sure we can give everyone an opportunity to ask questions during the allotted time. We are willing to take follow-up questions but ask that you rejoin the queue if you have a second question. Now let me turn the call over to Terrence for opening comments.

Thanks, Sujal, and thank you, everyone, for joining us today to cover our results for our first fiscal quarter and also our expectations for our second fiscal quarter of 2021. Before I get into the slides, I would like to share some perspective on our first quarter. As you will see in the results, we are benefiting from our diverse portfolio and are continuing to execute on our margin expansion plans. While markets have been very dynamic over the past year, we are seeing improving conditions across the majority of them. Against this backdrop, we are demonstrating not only the resiliency of our operations, but also the ability to drive organic content growth ahead of our markets, while expanding operating margins and demonstrating strong free cash flow generation that is in line with our business model. We are positioned to continue to benefit from secular trends in growing markets while driving the margin expansion plans that we've highlighted to you, and you'll see the benefit of these efforts in our first quarter results as well as our guidance for the second quarter. With that as a quick backdrop, let me now frame out some of the key messages of today's call. First, I am very pleased with our execution in the first quarter, and I believe our teams delivered strong results. We delivered sales growth of 11% and adjusted earnings per share growth of 21% year-over-year, demonstrating the strength and diversity of the portfolio and the benefits from our operational improvements. Our sales were ahead of our expectations in each segment, but with the greatest outperformance in transportation, where we continue to generate strong content growth from electrification of the powertrain as well as increased data in the vehicle. Our adjusted operating margins expanded 190 basis points year-over-year to 17.7% with margin growth in both transportation and our communications segment and a slight decline in our industrial segment, where we maintained mid-teens margin performance despite a sales decline. We continue to demonstrate our strong cash generation model with our quarter 1 free cash flow being at a first quarter record of approximately $530 million. We continue to expect approximately 100% free cash flow conversion to adjusted net income for this fiscal year. And as we look to our second quarter, we are expecting our strong performance to continue. We expect sales and adjusted earnings per share, similar to the first quarter at approximately $3.5 billion of revenue and $1.47 in earnings per share. And like in the first quarter, we again expect double-digit sales and adjusted earnings per share growth year-over-year. Now I'd like to take a moment to discuss our performance relative to where our markets were in the pre-COVID time frame of our fiscal 2019, and we do hope this will provide a baseline for evaluating our performance and progress this year. At the overall company level, our revenue is approximately back to pre-COVID levels despite the majority of our markets being below 2019 levels. And I'd like to give you some color by the 3 different segments. In our communications segment, we have seen strong improvement in our end markets, and this has helped enable sales to recover above pre-COVID levels. And for example, in data and devices as well as in appliances, we're benefiting from continued data center build-outs and home investments, respectively. In our industrial segment, it is a very different environment. We have markets that continue to remain weak as a result of COVID impacts, commercial layer and medical markets and our sales are still well below pre-COVID levels. However, what we are seeing is it does look like order patterns are indicating that we could be touching along the bottom in both of these businesses, and we could see some improvements later in the year. And in our transportation segment, our auto and commercial transportation businesses are now generating revenue above the levels we saw prior to COVID, even though global auto and truck production is still forecasted to be below fiscal 2019 levels. Content growth and share gains have driven the outperformance, reflecting our leadership position in these markets. TE products and technology are designed in the next-generation of sustainable vehicles at every leading OEM worldwide. The real proof of the traction is our content per vehicle progression. In fiscal 2019, our content per vehicle in auto was in the low 60s, and it's now trending into the low 70s range. As consumer adoption increases for hybrid and electric vehicles, and we continue to bring more innovation to our customers, we expect our content per vehicle to expand into the 80s over time. What's nice is that consumer preference continues to drive the features and the technology, and we will continue to benefit as vehicles become more safe, green and connected, driving more content for connector and sensing solutions. While I am pleased with our results and the progress that we've made operationally, I'm even more excited about the sales growth and margin expansion opportunities that we still have ahead of us. We continue to execute on our margin expansion plans in transportation and industrial that we started prior to COVID and accelerated during the pandemic. I'm also very proud of the margin progression in communications, which has offset the volume-related pressure that we're seeing in industrial as a result of the market impacts due to COVID. So now if we could turn to the slides, and I'd ask you to turn to Slide 3 to provide some additional details for the first quarter and our expectations for the second quarter. Quarter 1 sales of $3.5 billion were better than our expectations, up 11% on a reported basis and 6% organically year-over-year. We had 12% organic growth in both transportation and in communications, with growth across all businesses in those 2 segments. Industrial segment sales were down 8% organically due to the COVID-related impacts I already talked about. During the quarter, we saw orders of $4 billion, and this was up 25% year-over-year, reflecting an improvement in the majority of the end markets we serve, and I'll come back to orders in a couple of slides. From an earnings per share perspective, our adjusted earnings per share was $1.47. This was up 21% year-over-year due to the strong operational performance, where we showed adjusted operating income being up approximately 25% year-over-year. As we look forward, we expect our strong performance to continue into our second quarter, with sales and adjusted earnings per share being similar to first quarter levels despite lower sequential auto production. For the second quarter, we expect sales to be approximately $3.5 billion, and this is up approximately 10% year-over-year on a reported basis and mid-single digits organically. Similar to our first quarter, year-over-year growth will be driven by transportation and communications, partially offset by an organic decline in industrial. Adjusted earnings per share is expected to be approximately $1.47 in the second quarter, and this will be up 14% year-over-year with adjusted operating margin expansion included in our earnings performance. So if you could, let me turn to Slide 4, and I'll get into our order trends that we're seeing. For the first quarter, our orders were approximately $4 billion with a book-to-bill of 1.15. I would like to highlight that this level of orders reflects improvements in a number of our end markets as well as some supply chain replenishment. As we see markets improving, it is not surprising that our orders reflect the impact of supply chains being replenished after the shutdowns that occurred in the U.S. and Europe in the third quarter of last year. We are also seeing customers placing advanced orders in some cases due to product constraints and the broader electronic component categories like semiconductors and certain passive components. And the guidance that we give, does factor in the impact of these supply chain dynamics. And looking at orders by segment, on a year-over-year basis, transportation and communication orders both grew 36% with broad-based growth across all businesses. Industrial orders declined slightly year-over-year. But on a sequential basis, we did see orders growth in all businesses in each segment. So let me also add some color on what we're seeing in orders from a geographic perspective, and I'll provide this on an organic basis. In China, our orders were up 33% in the first quarter with growth driven by transportation and communications. We are benefiting from our strong position in auto, commercial transportation and appliances and continue to see strong improvement across those markets in China. We also saw 26% year-over-year growth in Europe with growth in all segments. This represents a second consecutive quarter of orders growth in Europe with some markets improving following the large drops from COVID back in the middle of last year. And in North America, our orders were flat, with growth in transportation and communications being offset by declines in industrial. Now what I'd like to do is touch upon our segment results briefly, and I'll cover those on Slide 5 through 7 of the slides we issued. Starting with transportation. Our sales were up 12% organically year-over-year with growth in each one of our businesses. In auto, sales were up 11% organically versus global auto production growth in the low single digits. The outperformance is driven by continued strong content growth and some benefits from the supply chain replenishing. We are seeing gains from our leadership position in next-generation products and technology and the value that we bring to our customers. As I mentioned earlier, we are seeing strong content growth from the move to an electric powertrain and increased data connectivity as well as the continued electronification of the vehicle. In our commercial transportation business, we saw 25% organic growth driven by electronification trends, which are helping content outperformance as well as ongoing share gains. We are also benefiting from higher emission standards and new increased operator adoption of Euro 5 and 6 in China and new emission standards in India. We saw growth in all regions as well as all market verticals that we serve in our commercial transportation business and continue to benefit from our strong position in China. We are also seeing increased program wins in the electric powertrain and commercial transportation that will provide future content growth. In sensors, we saw 29% growth on a reported basis, which included the revenue contribution from the First Sensor acquisition. On an organic basis, sales increased 3%, driven by growth in auto applications. And we continue to expand our design win pipeline in auto sensing and expect growth at these platforms continue to increase in volume. From an operating margin perspective, the segment expanded margins by 200 basis points to 19.4%, driven by strong operational performance. Now let me move over to the industrial segment, where, as I mentioned, our sales declined 8% organically year-over-year, and our adjusted operating margins were down slightly to 13.5% despite the 8% organic sales decline. I am very proud we were able to maintain our mid-teens adjusted operating margins due to the cost actions that we initiated over the past couple of years. During the quarter, the segment continued to be impacted by the decline in the commercial aerospace market, with our AD&M business declining 22% organically. As I mentioned earlier, we do believe we're touching along the bottom in this business and could see improvement in comm air later in this year. Our industrial equipment business was up 8% organically with growth in all regions and strength in factory automation applications. And we continue to see weakness in our medical business with ongoing delays in interventional elective procedures that have been caused by COVID. We anticipate this to be a short-term dynamic in medical that is consistent with what our customers are seeing and expect this market to return to growth as these procedures start to increase later in the year. And lastly, in our energy business, we saw a 4% organic decline driven by COVID impact on utility spending, but we did see growth in renewable energy applications in the wind and solar applications. Now let me turn to the communications segment, where our sales grew 12% organically year-over-year with growth in both data and devices as well as appliances. We do continue to benefit from the recovery in China and Asia more broadly, which represents over half of our sales in this segment. In data and devices, our sales grew 5% organically year-over-year due to the strong position we built in high-speed solution for cloud applications. And in appliances, we grew 21% organically year-over-year with growth across all regions and benefits from home investments and an improved housing market. I would have to say our communication team continues to perform very well, delivering 17.6% adjusted operating margins, which is up 550 basis points versus the prior year. Now with that segment overview, let me turn it over to Heath, who will get into more details on the financials and our expectations going forward.

Thank you, Terrence, and good morning, everyone. Please turn to Slide 8, where I will provide more details on the Q1 financials. Adjusted operating income was $624 million, up approximately 25% year-over-year with an adjusted operating margin of 17.7%. GAAP operating income was $448 million and included $167 million of restructuring and other charges and $9 million of acquisition-related charges. We plan for the restructuring to be front-end loaded this year and continue to expect total restructuring charges in the ballpark of $200 million for fiscal '21, as we continue to optimize our manufacturing footprint and improve the fixed cost structure of the organization. Adjusted EPS was $1.47, and GAAP EPS was $1.13 for the quarter and included a tax-related benefit of $0.09. We also had restructuring, acquisition and other charges of $0.43, the reconciliation is provided. The adjusted effective tax rate in Q1 was approximately 20%. For the second quarter, we expect our tax rate to be in the high teens and continue to expect an effective tax rate of around 19% for fiscal '21. Importantly, we expect our cash tax rate to stay well below our reported ETR for the full year. So if you'll turn to Slide 9. Sales of $3.5 billion were 11% -- were up 11% on a reported basis and up 6% on an organic basis year-over-year. Currency exchange rates positively impacted sales by $106 million versus the prior year. We are demonstrating our business model execution with adjusted EPS of $1.47, up 21% year-over-year. Adjusted operating margins were 17.7%, as I mentioned earlier, and that is an expansion of 190 basis points versus prior year. I am pleased with the progress we are making in driving improvements to our cost structure and our strong operational performance, and we continue to execute on our footprint consolidation and cost reduction plans in both transportation and industrial, and we are now benefiting from the heavy lifting that we've already completed in our communications segment. Transportation adjusted operating margin was 19.4%, which is nearing our business model target of 20%. Industrial adjusted operating margins remained in the mid-teens despite significant volume drops, which demonstrates the benefits of our cost actions that we have been discussing with you over the past few years. I'm also very pleased with the 17.6% adjusted operating margin in communication, which reflects our strong operational execution that I mentioned earlier. In the quarter, cash from continuing operations was $640 million, and we had very strong cash flow for the quarter of approximately $530 million, which represents a first quarter record, as Terrence mentioned, and we returned $286 million to shareholders through dividend and share repurchases. Our strong cash flow performance last year and into the first quarter of this year demonstrates the strength of our cash generation model, and we continue to expect free cash flow conversion to approximate 100% for the full year. We remain committed to our disciplined use of cash and over time, we expect 2/3 of our free cash flow to be returned to shareholders and about 1/3 to be used for acquisitions. Now before we go into questions, I want to reiterate that we remain excited about how we've positioned our portfolio. With leadership positions in the markets we serve, along with organic growth and margin expansion opportunities ahead of us. To summarize, we have discussed the benefits of secular trends across our portfolio. You are seeing content growth enabling sales performance above our markets in auto and commercial transportation, benefits from some market recovery in data and devices and appliances and some markets that have been impacted by COVID in the industrial segment that are now showing signs of stabilization. We initiated cost actions well ahead of the COVID downturn, and we're seeing strong margin expansion as a result of our efforts. We expect to continue to generate strong cash flow, maintain a disciplined and balanced capital strategy and drive to business model performance and our focus on value creation for our stakeholders going forward. So now let's open this up for questions, Sujal?

[ Sara ], could you please give the instructions for the Q&A session?

[Operator Instructions] Your first question comes from the line of Craig Hettenbach.

Yes. And Terrence, thanks for the color on the current supply chain dynamics. Maybe if you can just expand on that. I know there's plenty of news around kind of bottlenecks out there. And you mentioned semiconductors. Just kind of a gauge of how you would frame what you're seeing in your business versus the demand out there? And where we are in this kind of replenishment phase?

Thanks, Craig. And I would say, first off, I think, like many things COVID, the recovery is very uneven, and it's impacting different businesses differently. So the comments I made were very much around transportation. In markets that are soft, like industrial, I would tell you, we still have in places like medical and aerospace, inventory is still being burned. So I do think the factors I'm talking about the supply chain are very similar to how we painted the overall picture of the 3 segments. I think when you look at the supply chain and you go to transportation, though, I think we ought to keep in perspective where auto production went to and that automotive is a just-in-time supply chain. So back in the third quarter, 12 million units were made that we made 22 million units on the planet, I think was quicker than we all would have thought the recovery was. And there will be some areas where there will be bottlenecks as everybody recovers, and you heard that. And certainly, our customers have adjusted some of their production due to that, and that's reflected in our guidance. But what's nice is, on top of that, even though we're talking about supply chain is where consumer inventory levels are, are very healthy. So when I think about what we try to track for long-term or how many cars are being bought on the planet, it's nice to see inventory levels on the lots when you look at North America and China, probably being more towards middle-to-low end of normal ranges, Europe is probably right around the middle. And it's not surprising that the supply chain is being stressed a little bit due to the improving markets we're seeing. And some of our customers have adjusted their production, and that's in our guidance.

Our next question comes from the line of Amit Daryanani.

I will stick to 1 question, and turn on to say, congrats on some really good execution in the last 6 months with the way demand has recovered. I guess the question I would have is, when I look at the December quarter print and the March quarter guide, especially transportation up really strong and better than end unit production. I think the fewer folks will have is that a strong first half, fiscal first half for you folks could be over shipping versus end demand and OEMs are just building a lot more inventory than they need. And the risk would eventually be that in the back half of the year, your fiscal year back half, ends up being a lot softer as OEMs start to normalize inventory. Can you just perhaps talk about what are you seeing from your OEM level that gives you confidence that this isn't all building up inventory and there's a correction in the back half that we have to worry about?

I think the thing that you look at is certainly we have orders that are accelerating to the improving market. Supply chain does need to get to a normalized level where production is. I think when you look at auto production going from quarter 1 to quarter 2, we do expect it to be down to about 20 million units in our second quarter versus 22 in the first quarter. So that should also allow the supply chain to help normalize since there will be a little bit less production. And when we look at it is, what's really nice is our growth is due more to content and production than it is due to the supply chain replenishment. As we've always told you in an individual quarter, you can get supply chain movements one way or the other. But when I think about content per vehicle, as I said on the call, and really think about the $10 or so that our content increased over the past couple of years, really about half of that is driven due to traditional electronification of the car being more electronics in it. The other half is being driven by the benefit of the wins we have in HEMs as well as -- I'm sorry, electric mobility as well as what we've guided in content on the car having more data. So when we look at that, that's real content growth. Certainly, inter quarter, there may be a little bit of movement as supply chain goes, but the bigger driver of our growth is content. And it's what's really allowed our transportation segment to get back to pre-COVID levels on what we all know will be production this year based upon the external estimates, that will be less than pre-COVID.

Your next question comes from the line of David Kelley.

Maybe just following up on that point, and just to be clear, when you're talking about the buckets and the drivers of that content per vehicle ramp. Was that in regard to the shift you've seen, the low 60s to the low 70s? And just as a follow-up as we start thinking about the go-forward drivers to that low $80 target. Just curious what percentage of that or the mix shift driver you expect from the electrification and EV trends specifically?

No. I think what you're going to see is balance as we go up into the 80s, similarly. Because I think one of the things that's important is what's nice about what we've seen over the past year is the electric vehicle seems to have stand the test of COVID. We talked about it last year about -- you had electric vehicle growth last year. This year, we believe electric vehicles on the planet are going to be up about 50% versus last year, continued strong adoption in Europe. Certainly, the adoption that Asia has already had and it's going to break through 10% of global production. So content will continue to be benefited by our position in electric vehicle. But we also have to realize there's still content opportunity in traditional architecture, too. And those products also go into electric vehicles. So what's nice about what we talked about going to 60 to 70, it's going to be a similar picture as we go forward because where we play in the architecture is on every vehicle. It's not just electric, it's also our legacy position and how globally strong we are with that position. So as we look forward, growth components, whether it be electric vehicle powertrain movement, whether it be features and electronification of any vehicle as well as you get more data and all of those are drivers to our content. And just in the past 2 years, you can see the reality of it. And that's what we get excited about, and I think it's what we get excited about as we look to forward growth.

Your next question comes from the line of Matt Sheerin.

Terrence, I wanted to ask, outside of transportation, the commentary on industrial, particularly of areas that you're seeing strength. How much of that is relative to supply chain inventory adjustments versus true demand? And I know there's a decent amount of distribution exposure there. Are you seeing signs of good POS or sell-through and any inventory build there?

So a couple of things, Matt. Thanks for your question. And when you think about distribution, distribution touches both our CS and IS segments, industrial and communications segments, more than transportation. Our sales into the channel in the quarter, we're on par with our total company sales growth. So that 6%, pretty much how our sales to our channel partners were. Sell-out is -- their sell-out accelerated with some of these supply chain dynamics. They have a role to play. That's why they hold inventory. We have seen some of their orders increase, but I would say we're not over shipping into our distributors. Actually, their inventory levels on sort of a churn are actually lower than normal. So that's some of the balancing that will be occurring here as the world normalizes, hopefully. And net-net, in industrial, what I would tell you, while we may have some areas like in our industrial equipment, that showed shrink, I'll go back to, our medical customers are still burning some inventory, and so is aerospace and defense. So net-net, I would not say there is supply chain replenishment in industrial that we're benefiting from.

Your next question comes from the line of Christopher Glynn.

Just the kind of CPV the last couple of years. I know there may be some rounding, but it looks like maybe you're trending a little bit above your long-term range. I think we saw that for a couple of years in the '17 to '19 period, too. Is that range hedged or anything? Or are your commercial teams just executing better in wins? Or is it fleet mix that consumers are buying?

Well, on CPV, the range we've always said is 4% to 6%, and I believe that range is still appropriate long term. There are assumptions in there, where does electric vehicle adoption goes, certainly, feature sets and so forth. But we feel very good about that range. And certainly, that range is not -- we do not limit our commercial teams to that range. So it does come back to. There's always consumer preference there. It is nice that the consumer preference has been picking up the features that we're benefiting from. And we feel very good about that 4% to 6% range about the auto production going forward. So I don't think that range changes. And hopefully, we stay towards the high end of it.

Your next question comes from the line of Scott Davis.

Anyways, I wanted to just ask you for a little bit of an update on First Sensor. What is kind of your early read on it? What you're getting out of it? Any details you can provide there would be great.

Sure. Thanks, Scott. This is Heath, and appreciate the question. Sure. First Sensor, we own a little over 70% of it still. There's a -- given the German public company takeover dynamics, there's still a bit of a tail in terms of us acquiring the remaining 25 to 30 percentage points of the business with owners. But within that, First Sensor is behaving as we would expect it to, where we have market overlap, which is pretty considerable, whether that's in auto, general industrial, medical applications. It's trending right, as we would expect, as we see in other parts of both our sensor and our connector business. So everything is on track there. Now it's given us about $50 million or so a quarter or $40 million, $50 million a quarter of revenue. And I would say that some of the work that we needed to do relative to some of the operational synergies, footprint consolidation things, not just on their end, but things that will eventually move into their facilities from our existing sensors business is still ongoing. So we're not expecting a lot of bottom line support this particular year, but trajectory still looks good as we move forward.

Your next question comes from the line of Wamsi Mohan.

This is [ Danielle ] asking on behalf of Wamsi. Can you just talk about kind of your position in the broader electric vehicle market and kind of key differentiators for TE?

Yes. So first off, I -- thanks for that. I think the first differentiator we have is our global position and where do we bring the innovation. And it starts with those design centers that are everywhere where current vehicles are designed in next-generation vehicles and that's pretty special. And that's where we've leveraged our traditional position there. The other thing is when you get into the architecture of a car, our knowledge is there are parts of traditional architecture that do go over into an electric vehicle. So certainly, there's a lot of discussion around the powertrain, how does that involve the batteries, but also realize that architecture does come together as you bring low voltage and high voltage together and certainly come into the infotainment and data element of it that could go into autonomy. So we play across all those elements. I think it's a very unique position that TE has that also comes into the content opportunity. The other thing that is, and these are investments that we started to make 10 years ago, is when we look at electric vehicle, like I said earlier, we think there's going to be about 9 million made this year, 5 million of those will be in Asia. Europe continues to accelerate. And one of the things we probably get more excited about is not only the vehicle technology but where do you see support coming to make sure that electric vehicle penetration gets stronger. There's 2 big factors that come in, not only just -- not only consumer adoption, but you come into the 2 big things outside the car that relate to infrastructure as well as battery technology. And you continue to see developments in that space that with where EVs are going, we think will create continued momentum on EV adoption as well as support of the infrastructure and certainly, the battery technologies that are so important to it. And that's happening globally. So early on, we were very much bullish on Asia. Certainly, Europe with some of their regulations and certainly, you continue to see, at a lesser pace, momentum here. But where TE comes in on that architecture, where how that architecture comes together, the electric, the data, the signal, that is our specialty. And it's really great how these trends we're going to benefit from and show them in our content numbers.

Your next question comes from the line of Samik Chatterjee.

I did want to go back to the content growth story again in autos. And just -- but focus a bit more on the sensor side of the business there. You kind of outlined $10 of content increase you've had over the kind of -- moving to $17 range, low 70s. Can I just clarify if -- and that includes sensors at all? Or is it de minimis at this point? And more kind of looking forward, how should we think about the opportunity in terms of sensors that you can address today on a vehicle and what the aspirations are of what that content per vehicle for the sensors portfolio can look like?

No, thank you, Samik. And actually, those figures, I said earlier, did not include sensors. That was our traditional interconnect solutions that we provide. And when you think about sensors and you think about sensors back in '19, you're talking about -- that's about $2 of content. We see that going up to about $5 of content there. So that would be additive to those figures I gave you. We're getting benefits of the launch. That's actually -- the auto launch actually drove the organic growth. Our sensory business still has a big industrial piece to it that impacted those figures, but sensors is a part that would be additive to those figures I said earlier.