TE Connectivity plc (TEL) Earnings Call Transcript & Summary

Hello, everyone, and thank you so much for joining us here again at Citi's Global Technology Conference where this year, of course, it's held virtually due to COVID. We want to welcome everybody. A few housekeeping items. This session is with TE Connectivity, stock ticker, TEL. A few other items. We want to note that no media and no press are allowed. If you are media or press, please disconnect immediately. If you're an investor subject to MiFID II, please ensure you have the applicable agreements in place. There are disclosures associated with this from the Citigroup website and also available upon log-in. Contact your representative if you need it. We also do note that please go to the TE Connectivity website, in their Investor Relations website, has safe harbor, risks and forward-looking statements. I want to formally introduce the 2 speakers who are joining us here today from TE Connectivity. We have the Chief Financial Officer, Heath Mitts; and also Sujal Shah, the Vice President of Investor Relations. Thank you so much for joining us here, gentlemen.

And maybe to kick things off, can we start by talking about overall, the electronification of everything seems to be materializing, in fact, even, I would say, accelerating regardless of end market. It doesn't matter if it's automotive or aerospace or the solar panels on my house or what I'm driving or using in my pocket or my briefcase. Now while TE Connectivity has a very strong footprint in transportation and industrial markets, which end markets are you actually seeing the most incremental focus on and maybe that you feel that you can actually outperform? Just general trend that's helping out all the electronics.

Sure. And Jim, let me start off by thanking you for inviting us for this opportunity to present in this forum and meet with some of your clients. No, it's a great question. I appreciate [ teeing it all, teeing it up ]. We get a lot of questions about EV, and obviously, it's a very popular topic right now because of the growth in the hybrid and electric category of vehicle. We're obviously very excited about it. But within our overall TE world, there's a lot of things we get excited about. And if you think about within transportation, it's not just our -- the additional content per vehicle that we have with hybrid and electrics, which is significant, but it's also the -- within traditional combustion engine vehicles. There's a lot of things that we've seen. Our content increase there. There's heightened safety standards. There's things around emission standards, autonomy, the data connectivity within the infotainment of the vehicle. There's a lot of things that we get excited about regardless of whether it's a combustion engine or an EV. And as you've seen, our content per vehicle increased pretty dramatically over the past couple of years from kind of the low $60 per vehicle to the low $70 per vehicle. About half of that growth is coming from higher adoption and more quick adoption of EV vehicles, and about half of it is coming from additional content from combustion engine side of things. We also get excited within this for what's going to happen on the commercial transportation side. And they're a few years behind the automotive side of things when it comes to EV or alternative other methods, hydrogen and so forth. But there's a lot of excitement there, and we're very well positioned with our share. Within the industrial segment, also we're very well positioned. With everything going on right now with factory automation, robotics, that's a sweet spot for us. And we see our team taking advantage of those opportunities and winning design in and specs, and you've certainly seen that in the growth numbers. Within data and devices, within our -- I'm sorry, within our communications segment, the high-speed data for the hyperscale players and all their cloud activity, the reasons we can have meetings like this instead of being face-to-face, all off the backbone of the cloud. And we're really the hardware that enables that. We're very well positioned to take advantage. So there's a lot of places we could take you down into subsets within any of those, but it is very encouraging, both the current and the long-term trends of where the secular growth drivers are for us.

Well, one current trend, Heath, that we've seen a little bit is the semiconductor chip and component shortages. It's created some bottlenecks, whether mass production and end markets. Take, for example, automotive, which is your biggest end market in transportation. Is this impacting your company? How should we think about these bottlenecks? Typically, I think about the lead times for connectors not being as long as they connectors -- I'm sorry, as long as semiconductors that connectors are a lot shorter lead times. So are the shortages are actually of your products or more of the chips? And how should we think about this situation?

Well, it's a good question, and it's most acutely felt for us in the automotive sector where there's been a lot of well-publicized shutdowns of auto manufacturers for periods of time. You've seen something that are shutting out for 2 weeks or 3 weeks and -- or pulling things off because they can't get semiconductors to complete the automobile. It's also had an impact then of creating a lot of volatility to us. And we, although we don't buy semiconductors, we do provide -- we do sell into those same automobiles. And there's no doubt that we've also had our own supply chain challenges with availability of resins, the availability of metals and where we manufacture those things as we've had challenges in certain regions, some of it's disaster related in terms of the metals availability in Germany. It's coming out of the flood this summer. Still the resins problems we had in Texas earlier this spring with the shutdowns there. Certainly, that is taking a while to catch up and will continue to. So we've had our own challenges with delivery. And what's happened is where somebody would normally have a 4- to 6-week lead time on our parts, we've seen people place orders much further out. And you've seen that in our heightened order number over the past 3 quarters where we've been doing north of $4 billion in orders. And if you think about it, where we're going to end this year, right, we're going to end this year with about $15 billion of revenue and about $17 billion in orders. And as you know, Jim, you've been following us for a long time, that's not natural for us to have that type of 1.2-ish book-to-bill rate. Normally, we were on between 1, 1, 12, 1.05. So there's no doubt that people are placing orders further out. That does give us more visibility, but we're also conscientious of the fact that at some point, we'll see the order number come more in line with revenue. And what that'll allow us to do is to work down some of that backlog that's not necessarily natural for us. But there is -- the semicon piece I don't think is going to be resolved anytime soon. I think you'll see it kind of over in waves in the pockets of things as things improve over the coming quarters. And I'm sure that you've -- you can probably answer that question better than me in terms of the semicon availability, but it is impacting our customers.

And has it -- the situation actually gotten worse or actually kind of stabilized with this lengthening of lead times?

I think it depends on which region you're in. And it feels like if you were in the trenches with our team, they would feel like they solved one problem and another problem comes up. And so while we're working our way through the resins issues in the Americas, we end up with metals issues in Europe, right? And our supply chains are very regional in nature and have been localized for a region -- for a reason because they give our teams a lot of flexibility and agility to react in a normal time. So what ends up happening for us is where can then -- where we have shortages somewhere we have trouble producing, we will produce in a different region and then end up moving things to satisfy our customer needs. And that has -- I think, last quarter, we talked about the shortage of our materials cost is about $100 million in revenue that got deferred that we couldn't ship. And the quarter that we're in right now, we also said it'd be about the same level. And I'll tell you with a couple of weeks to go in the quarter, it still feels like there's about $100 million of -- that we would have liked to have shipped had we had that availability. So I wouldn't say that it's just worsened, but it certainly hasn't gotten any better. And it's just in different pockets, and the challenges that come from that are -- and the cost, a lot of it is coming from expedited freight costs and higher freight inflation. And we move things at more expensive mechanisms than we traditionally would have. So we're hammering through it. The teams are doing a terrific job dealing with what they can control, but I would tell you that it's not without its challenges.

And I wanted to ask you a little bit about those raw material costs, like the minivan that my wife drives and I drive it, too, to pick up the kids. It's got DVD players, seat warmers. One child wants 68 degrees. The other one wants 72 degrees. My wife wants 71 degrees, and I want 69 degrees. All these things have -- I typically think about plastic resins, aluminum, copper, alloys, things like that. How should we think about raw material costs and maybe even shipping costs? There used to be the boat that was stuck in the channel sideways and slowing up the whole world. How should we think about raw material costs? And can you actually adjust raw materials? Or are they kind of long term in nature because you've contracted out hundreds of thousands of automobiles and parts for probably multiple years?

Well, there's about 3 questions embedded there. So let me see if I can peel it back a little bit. The biggest areas from an input cost perspective would be specialty resins and specialty metals, and those tend to be things that, again, we source locally. And we have seen inflationary pressures come on those as capacity has been -- has come off-line because of some of the things I mentioned earlier. And naturally, when you're trying to then procure things that are in a shortage, you're going to end up paying a higher price. And we will continue to have to pay that price until the capacity comes back into more normal alignment. The freight cost is it dwarfs the inflationary pressures that we see in metals and resins because we're moving things unnaturally where we would like to have things on a boat, well planned out, and it arrives in 6 weeks to where it's supposed to be. We find that in this volatile environment, we're shipping a lot more things via air. And particularly on international routes, that tends to get very expensive. So there's just been a lot of capacity taken off-line on those international routes, and we're feeling that. So then the question becomes, hey, we're still hammering through that. We're still putting good margins up on the board and enjoying all this volume leverage coming through our factories. But what are we doing on passing that through? And the answer is very different depending on which business it is within TE where we have parts that go through channel partners, distributors, that's about 20% of total TE revenue. We've done 2 pretty significant price increases this year to help cover some of those inflationary pressures. We did one in January. We did another one this past July. And those were in line with what we saw a lot of competitors do as well. So nobody wants to receive a price increase, but I think they were expecting it. And then where we have OEM contracts in place, some of those have natural riders in them with surcharges. When we get certain inflationary pressures, we can pass those back via surcharge, and we do take advantage of that mechanism where we can. And then a lot of it is just customer discussions and explaining to them what we're feeling and what we're doing and how do we recoup some of that. We won't recoup dollar for dollar all of the inflationary pressures, but we have put things in place where we'll start to see some relief on that, especially as we go into FY '22, from some of the actions that we've successfully navigated our way through here in the past couple of quarters. So those are not easy discussions, and sometimes they get into future volume commitments and certain pricing commitments going forward. But I think everyone understands the situation, and it's not unique to TE, but we're managing our way through it. And we're still putting very respectful margins on the board. So some of that restructuring activity that we had undertaken over the last several years and continue to really helped withstand some of the inflationary pressures we feel today.

Looking at end demand, Heath, say, versus 3 to 6 months ago, which markets have been better and maybe which is a little bit softer?

That's a good question. I'd say if you go back a couple of quarters or 6 months ago, the resiliency of our appliance business has been very, very strong. We would never have pegged our appliance business where we have a very large market share, but we've never pegged this to be at the kind of growth rates that we've been enjoying. And one thing was coming in through COVID and seeing the recovery and people investing in their homes and office buildings and so forth. We saw a bump there, but that has continued to be quite strong and much higher than what we would have expected, and we're still keeping a close eye as we go through the next 4 quarters or so to see where that demand goes. But that's been quite strong as people have diverted where they're spending money. I'd say in terms of things that have been softer, maybe even past 6 months ago, the medical business that we have, we're the leader in the delivery systems for interventional medicine, particularly around the heart. And that was one that even if you go back compared to last year, we would have thought that would have been a little bit more resilient through the COVID time period, right? People are going to put off some of these procedures that they need to have done in terms of stents and valves. And we really did see a lot of that -- those procedures get deferred, people avoiding surgical centers and hospitals otherwise. And over the past couple of quarters, we're finally starting to see that come back a little bit, and we're starting to see bookings and orders for those devices that support those procedures. So that's been encouraging, but that's been one that's been a little bit slower on the uptick than what we would have assumed and longer time period, probably about 5 quarters of more depressed revenue there than what we would have expected going in. Fortunately, we're seeing the uptick. And then commercial air, listen, I think we have a very sober view of commercial air. We're very well placed. We've got a great franchise there. But our view of commercial air is that still that we're still a couple of years out from any kind of meaningful recovery there as we've seen well-publicized pressures on the OEM and the aircraft builds. So -- and we got a whole variety of things in our portfolio. And some things, like you said, keep you surprised on the uptick and others, we kind of scratch our heads a little bit at times, but we feel like we're well positioned.

Well, hopefully, if COVID gets behind us a little bit, then some of those elective or even what I'd consider non-elective procedures get back to a little bit more normal. It's been tough for the health care industry.

For sure.

Let's talk about profitability, growth and operating margins. You've really seen some strong improvement. Have that been mostly through like factory closures or exiting like cell phone business or low profitable business? Or what's been the true cause for your increase in profitability?

Well, I mean, as you know, we've been on a multiyear journey here to get the footprint right. It started back before my time period where there was about a -- within our communications segment, there was about a $1 billion business that supported consumer devices, whether it's PCs or phones and tablets and so forth. And it just wasn't something that strategically made sense for TE to be involved with. And you were covering the company back then, Jim, so you're acutely aware that, that segment was single-digit profitability in terms of margins. And that was a very painful exit. There were a lot of site closures and a lot of consolidation of factories. And that footprint work that happened 7 or 8 years ago is part of the success we're having today where now we're really focused on high-speed data and focused on appliances, and we're hyper-focused on that. And as you see those that come across, what happens is that the types of volumes you get today, now you have a business that's been running north of 20%. Now I would not tell you to model that. We've been pretty careful to not get too far over our skis in terms of that, but consistently a high-teens margin business. Longer term, I think is fair, and it's a massive step from where it was 7 or 8 years ago. So that's been a nice help. Within the industrial segment, over the past 4 years, we've been focused in on factory consolidation. This is a business that's been -- a segment that's been the beneficiary of a lot of acquisitions over the years, and it has a very fragmented footprint. So whether it's industrial, aerospace, medical or energy, there were things we needed to clean up within that. We undertook a pretty significant footprint reduction, near 20 locations over that time horizon, and we're about 2/3 of the way through that. And what we've been able to do within this is to hold that business at roughly a mid-teens operating segment -- operating margin for the segment even while we're dealing with a significant commercial error downtick within the segment. That commercial air piece is very profitable for us, and we withstood a pretty significant downtick and still be able to hold those margins in the mid-teens. When we do get comm air back, plus some incremental restructuring that we still have underway, I'm confident that we'll meet our commitment to that being a high-teens operating margin segment. And then you get into transportation. We talked about all the near-term pressures that we're dealing with there. We're still -- we announced last year even in the middle of all this going on that we were taking 3 factories in Europe off-line, in Western Europe, and moving that capacity to places we already have existing capacity to generally more automated facilities like in Eastern Europe, parts of Asia. Those are continuing underway, and those will continue to have nice returns for us. And I feel good about our target to get to 20% consistently of operating margins within that segment. We won't get there this year or next, but I'll tell you, you're going to continue to see progress towards that at that segment level. So I still think we've got a lot of room. We're probably overheated in communications right now from being candid. And we've got room to grow in industrial and in transportation and feel good about when you add those up in aggregate, what it means for the company. So very bullish on that front, and it's something that we're hyper-focused on.

Well, maybe to let you get a drink of water, I'll ask a question to Sujal about sensors.

I like that, I like that idea a lot.

Sujal, can you talk a little bit about sensors? Many people may not be aware that TE Connectivity also makes sensors. Maybe how big of your sales are sensors? And are they actually integrated into like one package? Or is it a salesperson that's selling a sensor different from a connector?