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Edited Transcript of TEL earnings conference call or presentation 24-Apr-19 12:30pm GMT

Q2 2019 TE Connectivity Ltd Earnings Call

SCHAFFHAUSEN Jun 7, 2019 (Thomson StreetEvents) -- Edited Transcript of TE Connectivity Ltd earnings conference call or presentation Wednesday, April 24, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Heath A. Mitts

TE Connectivity Ltd. - Executive VP & CFO

* Sujal Shah

TE Connectivity Ltd. - VP of IR

* Terrence R. Curtin

TE Connectivity Ltd. - CEO & Director

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Conference Call Participants

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* Christopher D. Glynn

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Craig Matthew Hettenbach

Morgan Stanley, Research Division - VP

* David Lee Kelley

Jefferies LLC, Research Division - Equity Analyst

* Deepa Bhargavi Narasimhapuram Raghavan

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Jim Suva

Citigroup Inc, Research Division - Director

* Joseph Craig Giordano

Cowen and Company, LLC, Research Division - MD and Senior Analyst

* Joseph D. Vruwink

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate

* Mark Trevor Delaney

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Matthew John Sheerin

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst

* Scott Reed Davis

Melius Research LLC - Founding Partner, Chairman, CEO & Research Analyst of Multi-Industry Research

* Shawn Matthew Harrison

Longbow Research LLC - Senior Research Analyst

* Steven Bryant Fox

Cross Research LLC - MD

* Wamsi Mohan

BofA Merrill Lynch, Research Division - Director

* William Stein

SunTrust Robinson Humphrey, Inc., Research Division - MD

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the TE Connectivity Second Quarter Earnings Call. (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.

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Sujal Shah, TE Connectivity Ltd. - VP of IR [2]

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Good morning and thank you for joining our conference call to discuss TE Connectivity's second 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.

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [3]

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Thank you, Sujal, and thank you, everyone, for joining us today to cover both our second quarter results and our increased outlook for 2019. And before I get into the slides let me provide a quick summary of the key messages in today's call and I want to start with the markets.

Overall, the market environment is largely unchanged from our last earnings announcement that we did back in January where we conveyed a weaker market environment in China as well as a slower global auto production environment. Based upon what we're seeing in our order patterns and customer discussions, we're maintaining a view of the second half of our fiscal year that is consistent with what we said back in January. Also, despite this weaker market backdrop in some of our key markets I'm pleased with how we are successfully executing on our strategy and outperforming the markets in key areas due to the multiple levers of our business model. And when you think about the gross side of it, I do believe we positioned TE to benefit from secular trends and we talked to you a lot about content growth. And as we go through our presentation today you're going to see that content growth is enabling us to partially buffer and outperform the weaker market environment, and you're going to see this in automotive, Commercial Transportation, Aerospace as well as our medical business.

The other key thing about our business model is we're also executing on non-growth levers that we've highlighted related to margin as well as capital usage, and this is very evident in our second quarter results.

Now this year, we do expect to keep adjusted earnings per share flat versus the prior year, even with $400 million of currency translation headwinds on sales and a declining auto production environment. As I talked about on our call 90 days ago, we're defining success in 2019 from a financial perspective as delivering adjusted earnings per share in the second half that is above our 2018 exit rate while absorbing the weaker market and currency headwinds that we're dealing with. And we believe our second quarter results demonstrate traction towards this goal and ensures we're well set up for the future.

And finally, I do want to stress we're also taking a long-term view towards creating value and expect to execute to the business model targets through the cycle. I think what's really good about TE is our strong cash flow generation model and that allows us to support sustainable organic growth at -- while enabling return to capital to shareholders while also looking at bolt-on acquisitions and these are all key levers in our value-creation model.

So with that as a quick summary let's get into the slides and I'll get into Slide 3 and I'll review the highlights in the second quarter.

First of all, I am pleased with our execution in the second quarter with revenue at the high-end of our guidance and adjusted earnings per share of $0.15 above the midpoint of our guidance. Our results continue to reflect improvement and the resiliency and the diversity of our portfolio. The outperformance in the quarter versus our guidance was driven by our Industrial and communication segments while our transportation segment was in line with our expectations.

Our sales were $3.4 billion, down 4% year-over-year on a reported basis and down 1% organically. Sales in the quarter included a headwind of approximately $150 million from currency translation. And by segment, in transportation, our sales were down 3% organically, which was in line with our guidance. And that was driven by global auto production declines of 8% in the quarter. Our industrial segment grew 5% organically, which was ahead of our guidance, driven by growth in commercial Aerospace, Defense as well as medical. And our communication segment declined by 2%, with weakness in Asia impacting both of our businesses in that segment, but our revenue was better than we expected.

Turning to earnings. In the second quarter we had operating margins of 17%, which is in line with our 2018 exit rate and up slightly sequentially. Our transportation margins were in line with our expectations and I do want to take a moment to reflect on the strong margin performance of our Industrial and Communications segment in the quarter.

Those of you who've been with us for a while, the reshaping that we've done in our portfolio, in our Communications segment over the past number of years, our focus was to get on higher-growth, higher-margin applications and we also had to do a lot of heavy lifting to drive improvements in our cost structure as well as our manufacturing footprint. When you look at the strong second quarter adjusted operating margins of 18% in the Communications segment, they are a direct result of our strategy and our team's execution. And to really put a fine point on this, back in [2019] this segment was a high-single-digit business and over the past couple of years we doubled the profitability of this segment based upon the strategic actions we took.

What's nice about it, you're also seeing it that we're applying some of that same heavy lifting in our Industrial segment that we teed up a couple of years ago when we mentioned to you that the segment was not earning what we thought it was entitled. And in the quarter the Industrial operating margins expanded to 15.8% reflecting revenue growth and benefits from the strategic actions that we're taking and certainly we're only partially way through that. And Heath will get into more details on that later.

Adjusted earnings per share of $1.42 exceeded the high end for guidance, and again, was driven by the strong operational execution I just mentioned in Industrial and Communications.

Our adjusted earnings per share includes a currency exchange headwind of $0.06 and adjusted EPS was flat year-over-year despite this currency headwind. Free cash flow was also a highlight of the quarter and it was $344 million. Year-to-date, our free cash flow was $413 million and is up approximately 45% versus the prior year due to the positive impact of working capital.

During the quarter we returned $338 million to shareholders through buybacks and dividends and this month we're pleased to announce that we signed a definitive agreement to acquire the Kissling Group, a provider of high-voltage and power management solutions. This bolt-on acquisition further expands our portfolio for hybrid electric commercial vehicle applications and we do expect that this deal will close before the end of our fiscal year.

Based upon our earnings momentum in quarter 2, we are raising the midpoint of our guidance by $0.15 to take the total year up at midpoint to $5.60. We are maintaining the midpoint of our sales guidance at $13.65 billion reflecting a second half that is consistent with our prior view.

So with that as an overview of the quarter, let's turn to Slide 4 and I'll get into our order trends.

For the second quarter, orders came in as we expected and support the second half guidance. Our book-to-bill was 1.01 and orders grew sequentially by 4% with growth across all segments versus prior quarter. And the one thing I want to highlight is while overall orders were as expected, there were some things we saw regionally that were different that we want to highlight. We did see an increase in orders sequentially in China by 9%, which we believe indicates stabilization in the markets we serve there, while in Europe our orders were down sequentially by 2% due to a softer end market across our business.

Turning to orders by segment. Transportation orders declined 4% year-over-year as expected and we saw the similar trends sequentially that I just mentioned with stabilization in China while having a slightly weaker euro. In the Industrial segment, orders grew 3% organically year-over-year, driven by Aerospace, Defense and medical. And in Communications, while orders were down year-over-year, they did grow 9% sequentially, driven by both our businesses in this segment in China, data & devices and Appliances.

So with that overview on orders, let's get into the segment details and I'll start with Slide 5 and we'll start with transportation. Overall for this segment, sales were down 3% organically year-over-year. Our auto sales were down 5% organically versus auto production declines of 8% in the quarter. Our outperformance versus auto production continues to be driven by constant growth from secular trends around electric vehicle and increased autonomous features. For the year, we continue to expect to outperform auto production by 4% to 6%, consistent with our content growth targets.

In commercial transportation, we grew 2% organically in the quarter versus global market declines of 3%, with outperformance versus the market fueled by ongoing content and share gains. We saw growth in North America and Europe and this was offset by declines in Asia. Our sensors business grew 1% organically year-over-year with growth driven by Industrial applications.

To highlight the design wins, we continue to increase our design win value across a broad spectrum of auto sensor technologies and applications and year-to-date we have $450 million in new design wins across transportation applications. For this segment, adjusted operating margins were 17.5% and this was in line with our expectations. As we mentioned last quarter, with the market pause we're seeing, we are accelerating cost actions in this segment which will result in margin expansion in the second half.

With that, let's turn over to Industrial and that starts on Slide 6. Overall, the segment sales grew 5% organically year-over-year. This was above expectations with growth being very strong in Aerospace, Defense and medical. In AD&M, the business delivered a strong quarter of 13% organic growth driven by program ramps in both commercial aerospace as well as a strengthening defense market.

In Industrial Equipment, sales were up 1% organically and it was really a tale of 2 cities. Our medical business grew 12% but this was offset by mid-single digit declines in the broader Industrial markets, certainly in factory automation. And lastly, our energy business grew 4% on an organic basis driven by growth in North America.

The Industrial segment adjusted operating margins expanded 190 basis points over the prior year to 15.8% driven by strong operational execution by our team. We believe this performance shows our continued traction improving the profitability of this segment as we've laid out for you. While we do expect margins to decline slightly from the first half to second half due to cost associated with factory consolidation efforts, we remain ahead of our original expectations and do expect margin expansion for the full year compared to last year. Additionally, our plans remain on track to expand, adjusted operating margins in the high teens for the segment over time.

So please turn to Slide 7 and I'll get into Communications Solutions. Communication sales declined 2% organically due to softness I mentioned earlier across Asia. It's important to remember that for this segment, over half of its segment sales are in Asia region. In data and devices, sales were flat organically with growth in data center application being offset by broad product weakness across Asia. And our appliance business was down 4% organically due to weakness in Europe and Asia partially offset by growth in North America. As I highlighted earlier, adjusted operating margins were an exceptional 18% in the quarter and expanded 260 basis points year-over-year from strong operational execution. Now this margin performance is above our target levels and is a result of our strategy to focus on higher-growth, higher-margin applications.

So with that, I'm going to turn it over to Heath who'll get into the financials and I'll come back and talk about guidance.

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Heath A. Mitts, TE Connectivity Ltd. - Executive VP & CFO [4]

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Thank you, Terrence, and good morning everyone on the call. Please turn to Slide 8 where I will provide more details on the Q2 financials. Adjusted operating income was $581 million with an adjusted operating margin of 17%. GAAP operating income was $530 million and included $42 million of restructuring and other charges and $9 million of acquisition charges.

As we mentioned last quarter, we have broadened the scope of our cost initiatives across our business and are accelerating cost reduction and factory footprint consolidation plans. As a result, we are increasing our estimate of restructuring charges to $250 million for the full year.

With these initiatives, we expect to exit the year with a more nimble cost structure, which will help enable future margin expansion and earnings growth. Adjusted EPS was $1.42 exceeding the high end of our guidance range and included $0.06 of headwind from currency. We were able to maintain flat adjusted EPS year-over-year despite a reduction of revenue, which demonstrates our ability to execute on multiple levels to drive earnings performance.

GAAP EPS was $1.26 for the quarter and included restructuring and other charges of $0.09, tax-related charges of $0.04 and acquisition-related charges of $0.02. The adjusted effective tax rate in Q2 was 15.4%. For the full year we expect the adjusted effective tax rate to be in the range of 17.5% to 18% and versus the prior guide we have lowered our full year expectations due to the expected jurisdictional mix of global income. We continue to expect our cash tax rate to be lower than the effective tax rate for the year. As we continue to drive earnings growth in line with our business model, we are looking at all levers under our control. In Q2, interest expense decreased $13 million year-over-year and we've taken advantage of the global interest rates and increased percentage of our borrowings in foreign currencies. Looking ahead, we expect our quarterly interest expense to be in line with Q2 levels.

Now if I can get you to turn to Slide 9. Sales of $3.4 billion were down 4% year-over-year on a reported basis and down 1% organically. Currency translation negatively impacted sales by $154 million versus the prior year. Adjusted operating margins were 17% driven by strong operational performance and we expect margin expansion in the second half of the year as we see the benefit of accelerated cost actions.

And as Terrence noted, I'm pleased with the progress we are making to drive long-term improvements in our cost structure. This really sets us up for a more nimble structure as we move into 2020 and beyond.

In the quarter, cash from continuing operations was $555 million and up 53% year-on-year. Free cash flow was $344 million with $179 million of net capital expenditures. We've returned $338 million to our shareholders through dividends and share repurchase in the quarter. And the first half 2019 free cash flow was $413 million, an increase of 44% versus the first half of prior year. We expect that our free cash flow will exceed the prior year even with the increased level of restructuring investment related to our cost initiatives.

Our balance sheet is healthy and we expect cash flow to remain strong, which provides us the ability to support organic growth investments to drive long-term sustainable growth while also allowing us to return capital to shareholders and to continue to pursue bolt-on positions.

Now I'm going to turn back over to Terrence to cover guidance before Q&A.

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [5]

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Yes. Thank you, Heath. And as I get into guidance let's start with the third quarter on Slide 10. And a lot of this is going to build on the things we already highlighted. So based upon what we're seeing in the end markets and new order trends, third quarter revenue is expected to be $3.4 billion to $3.5 billion with adjusted earning per share of $1.41 to $1.45. And at the midpoint this on sales -- this is reporting organic sales declines of 4% and 1% respectively. And the difference that you have between the reported and organic is the ongoing strength of the U.S. dollar, which we expect to have a headwind year-over-year from -- which is about $120 million in sales and $0.06 in EPS in the third quarter.

Similar to the second quarter we expect to offset this headwind from an adjusted EPS perspective and our adjusted EPS at the midpoint is slightly up over the prior year. By segment, we expect Transportation Solutions to be flat organically and order revenue is expected to be flat to down slightly versus a mid-single-digit decline in global auto production that is still going to be driven by weakness in China and Europe. Our outperformance versus auto production again reinforces the positioning that we've done to benefit from content growth with the key secular trends in that market. In Industrial Solutions, we expect to grow low single digits organically with continued growth in Aerospace, Defense and Marine and medical applications and these are going to be offset partially by weaker factory automation market that we're seeing. And in communication, we expect to be down mid-single digits organically year-over-year. But I think the important thing to note is sequentially we're going to continue to see that segment revenue improve over the second quarter levels.

So let's turn to Slide 11 and I'll get into the full year guidance. As I mentioned earlier, we're reiterating the midpoint of our revenue guidance and the range that we're going out with is a range of $13.55 billion to $13.75 billion in revenue. This continues to represent flat sales organically and a reported sales decline of 2% due to the currency translation headwind that I mentioned earlier of $400 million.

Adjusted earnings per share is expected to be in the range of $5.55 per share to $5.65 per share, an increase of $0.15 at the midpoint from our prior view. I am very proud that we expect to keep adjusted earnings per share flat versus the prior year even with the $0.16 of currency translation headwinds and the declining auto production environment.

So let me get into some color around our annual guidance for the segments. We expect Transportation Solutions to be flat organically. We expect auto sales to be roughly flat organically, with auto production now expected to be down 5% in our fiscal year, which is at the weaker end of the range we indicated last quarter. Content gains will continue to enable outperformance versus the production environment. We continue to assume that global production units will remain fairly consistent at approximately 22 million vehicles per quarter through our fiscal year. So we had that in the second quarter and we expect 22 million units to be made in the third quarter and fourth quarter.

And lastly, in Transportation, we're expecting continued growth in sensors in both Industrial and auto applications.

Turning to Industrial Solutions, we expect sales to be up low single-digit organically with growth driven by Aerospace, Defense and medical applications. We expect to be down low single-digits organically driven by the Asia market weakness that's affecting both of these businesses.

So before we turn it over to questions I just want to provide a quick summary of the call. First off, we remain committed to our long-term business model and you're continuing to see the positive impact of our diverse portfolio with our Industrial and Communications segment performing above expectations in the quarter with strong operating margins as well as earning contributions. Secondly, the market environment we laid out 90 days ago is largely unchanged with our order patterns indicating stability in China. And as I mentioned earlier, even with the weaker market backdrop we are successfully executing on the non-growth levers of our business model and have increased the midpoint of our earnings guidance. We are maintaining flat adjusted earnings per share growth even with FX and auto production headwinds.

And finally, as we indicated last quarter we anticipate to demonstrate earnings per share performance in the second half that is above our exit rate in fiscal '18. The leverage we are pulling this year are expected to enable increased earnings and business model performance when markets return to growth, as Heath mentioned.

So before I close, I do want to thank our employees across the world for their execution in the second quarter and also their continued commitment to our customers and a future that is safer, sustainable, productive and connected. So with that, Sujal, let's open it up for questions.

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Sujal Shah, TE Connectivity Ltd. - VP of IR [6]

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Okay. Thank you. Kayla, can you please give the instructions for the Q&A session?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Scott Davis with Melius Research.

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Scott Reed Davis, Melius Research LLC - Founding Partner, Chairman, CEO & Research Analyst of Multi-Industry Research [2]

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I wanted to just dig a little bit into the Industrial business because the margin performance there was well above what we had and I think -- back of the envelope, it looked like incremental margin is almost close to 70% here. And you used the word strong operational performance but that can mean a lot of different things. So can you help us understand -- I know the guide is for that not to necessarily continue at the same exact level, but can you help us understand at least what happened in the quarter that led to such big positive margin beat?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [3]

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Sure, Scott, and thanks for the question. And when you -- I'm going to take a step back a little bit. When we started our journey in Industrial a couple of years back, we certainly laid out a picture where we saw our margins getting into the high teens. And one of the things that we talked about was we had to look at our footprint and do a lot of heavy lifting on the footprint. When you look at the performance in the quarter it really is not around the footprint moves. It is around getting some growth in the segment as well as other cost actions we've been taking as we're tightening up the business. And I think one of the things that's nice is you're seeing the pull-through potential in these Industrial markets. We're also going to get, be able to get additional levers as some of the things that we're doing on the footprint over the next couple of quarters even that the margin in the segment may come back a little bit, but long term to make sure we get further margin expansion going forward. So during the quarter when you look at it, it was truly around getting some volume also sort of the non-footprint flow-through going on and it is nice that you're seeing nice growth both in Aerospace as well as medical, which are 2 of the markets that are key from a content perspective. And we did it even with an Industrial market that we do see in the factory automation side, Scott, certainly in Europe and Asia a softer environment there. So we also did in an environment where not every business unit was humming. So it truly was outside the footprint actions and I think it shows the potential and the traction we have to get it up when those footprint actions come into place as we execute them in the second half.

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Operator [4]

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Our next question comes from the line of Shawn Harrison with Longbow Research.

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Shawn Matthew Harrison, Longbow Research LLC - Senior Research Analyst [5]

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What are you seeing in terms of inventory either at your direct customers or through distribution in terms of where you want that inventory to be? And maybe how long it'll take to get to a normalized level?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [6]

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Shawn, while I appreciate that being one question, that's about 3 questions in 1 question. But when you look at inventory one of the things we talked about last quarter as we highlighted markets being a little bit slower with what we saw from our order trends and I mentioned it on the call, sequentially we saw orders increase about 4%. And what was nice about that was you started to see orders increase in China up about 9% sequentially, which is a pretty good indicator inventory has normalized in China. And I would also say if you look out to the end customers in car inventories for the automotive business itself they have come down closer to a normalized level, they were elevated.

So I would say in China it feels that process has worked through. Europe, I would say we do see probably inventories being a little bit ahead and certainly the order trends support that. And specifically [if we go to] auto, car inventories were a little bit elevated. So some of the softness we're seeing in Europe is not surprising. And from a distributor perspective, inventories are pretty much in line with where we would expect. So we aren't seeing distributors having excess inventory. I do think that has worked through. And I would also say our lead times are staying pretty steady as well. So there are typically attributes with the sequential orders and our lead times that keep inventory in check. So I would say we are in the later parts, maybe a little bit in Europe but overall feels inventory is at a decent spot.

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Operator [7]

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The next question comes from the line of Christopher Glynn with Oppenheimer.

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Christopher D. Glynn, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [8]

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I had a question about the debt restructuring if that's the right word. Looks like your weighted average cost of debt was approximately cut in half and probably done at the beginning of the second quarter. Can you just explain a little more the mechanics of how that goes?

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Heath A. Mitts, TE Connectivity Ltd. - Executive VP & CFO [9]

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Sure, Chris. This is Heath. As you know, a substantial part of our business is conducted outside the U.S. and we have a fair amount of exposure in Europe and in parts of Asia, particularly in Japan. And so as we've monitored the situation and the spread of the interest rates being what they are, we did take advantage of a series of cross-currency swaps to take advantage of where the interest rates lie today. And it does set us up in a better position. It doesn't change anything with our maturity ladder related to when we have debt and future refinancing, but it does take advantage of where those cash flows are generated in those regions and our ability to take advantage of that through a series of cross-currency swaps.

So as we look at it going forward the next few quarters, for sure, the interest expense should be very similar to the quarter we just reported and into the future and until we have to start refinancing into higher price debts. So it was a very opportunistic chance for us to take advantage of where the interest rates lie.

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Operator [10]

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The next question comes from the line of Joe Giordano with Cowen.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [11]

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So I wanted to ask about the auto restructuring that you guys announced here. So over the last couple of years you've had to spend a ton of money to bring that business up to -- to handle the demand ramp that you guys have seen and the content ramp that you guys have seen. So talk to me about how you ramp that down in an efficient way where you're not undoing the things that you just spent money to do.

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Heath A. Mitts, TE Connectivity Ltd. - Executive VP & CFO [12]

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Yes, sure. Joe, this is Heath. You have got to remember we're a global auto supplier, right? So we're producing in regions where our customer supply chains are. And the expansion that we've had to keep up with the demand particularly where we said and benefit from the content gains has been pretty tremendous. And those investments have been in parts of the world where -- that are growing the fastest mainly in parts of China and parts of Mexico and so forth where we've seen a lot of activity in terms of supply chain growth.

So the restructuring activity that is going to -- it is really what we're doing is we're taking advantage of a slower global auto production environment where we actually can take a pause for a moment in a couple of places that are less strategic to us in terms of proximity to supply chains, not impacting places where we've invested in heavily. So we're taking advantage of the opportunity because when things return to growth it gets more hectic and it's a little bit tougher to move back -- manufacturing activity around. And it's never a great time to do restructuring but we're going to take advantage of the lull in the demand. Having said that, some of these restructurings, particularly things outside the U.S., can get a little more expensive and the paybacks are a little bit more elongated. But we've elected to get those done over the next year or so. We're going to take some of those charges in our FY '19 and push through this activity over to the next year and change.

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Operator [13]

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The next question come from the line of Craig Hettenbach with Morgan Stanley.

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Craig Matthew Hettenbach, Morgan Stanley, Research Division - VP [14]

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Question for Terrence. Thanks for the details on the auto and sensor design wins year-to-date. Just looking as you build that book of business can you talk about why TEL is winning? How do you stack up relative to incumbents in the market and any synergies that you see in terms of having both kind of sensors and connectors as you go to win business?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [15]

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Well, thanks, Craig. And when you look at it as we've always mentioned to all of you, Measurement brought, when we did that acquisition and a couple of the bolt-ons we did afterwards, they brought with us technologies and I think when you think through synergy we have, it really is around our leading global automotive position and also our industrial transportation business, which is a leading business. And we have leading share and it gives us access to all global OEMs. It's one of the I think special things about our transportation business is our leadership position is balanced globally, and we are with essentially every major OEM.

So the synergy that we really get is our automotive customers look at us as an automotive company and how do we bring our processes, our quality and to scale things and that's what we're doing with these wins and it's great that the customer access that we have is the big synergy.

From a competition perspective, the sensor space is very fragmented. It's not just 1 company out there. And what's really nice is when we're coming with it, so number of sensors in a car continue to increase so it does have a very nice secular trend with it with all the things we're talking about whether it's electric vehicle as well as autonomous features and we play in that physical network sort of bumper-to-bumper in the car. But the other thing competitively is they're seeing us bring both technology as well as our scale and being a trusted supplier -- it's all coming together -- that is why we talk about, while today we might have about $2 of content per vehicle in sensors, with the pipeline of wins we're doing we're seeing that well doubling up to $5 to $6 share per car over the next 5 years. And I think it's with the fragmentation in the market, it's going to continue to be an opportunity area where we're going to continue to build on both organically and inorganically over time.

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Operator [16]

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The next question is from Wamsi Mohan with Bank Of America.

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Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [17]

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Terrence, if you look at the auto revenues versus production you still have a 3-point outperformance. Can we view this as a cross gap versus production given there was some inventory adjustment presumably in the quarter? And if production is flat from here for the next few quarters but Europe is weaker, why do you expect content outperformance to narrow that gap back to sort of mid-single digit levels?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [18]

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So a couple of things. Let me clarify, production being flat is really sequential production being flat, Wamsi. It wasn't year-over-year. We do expect in our third quarter, as I said, production is going to be down 5% mid-single digit and we also expect to be down 5% for the year. So when you look at it year-to-date, we basically have separation of about 500 basis points, which is right square in the middle of our 4% to 6% content growth target we've always said. So we are sort of right in the middle of it, and you will have inter-quarterly due to supply chain movement around it. So we always ask you to look at it over multiple quarters. And with what we're seeing with the program wins we've had in electric vehicle and as well as the future launches we have, we do expect in a flat environment our auto sales are going to go up sequentially from here even in a flat environment due to some of those program launches. So I feel very good about the 4% to 6%. I think you've seen it now for a number of years. You're seeing it in a negative production environment and I think it's been pretty evident in the numbers we've talked about.

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Operator [19]

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The next question comes from the line of Steven Fox with Cross Research.

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Steven Bryant Fox, Cross Research LLC - MD [20]

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Just a question on Europe. Terrence, you mentioned some incremental weakness there. I was wondering what the chances are that we continue to see further weakness there? How you factor that in for the guidance and its implications maybe for some of the restructuring that you're doing over there?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [21]

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Yes, Steve, thanks for the question. We did bake in weakness. So the overall environment was, if you look at it macroly, the same as 90 days go but China got stronger, Europe got weaker. And so we do plan that Europe was incrementally weaker and actually why we're at the minus 5% in auto production versus the 4% to 5% last quarter is really due to Europe from a production getting a little weaker. So I think we have appropriately dialed it in. To Heath's comments earlier around the restructuring, we're going to be making sure our supply chain is balanced to where it needs to be and we're taking advantage of the pause and most of the actions we're looking at would be outside of North America. So I do think they're appropriately pointed to where we see the weakness.

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Operator [22]

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The next question comes from the line of Mark Delaney with Goldman Sachs.

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Mark Trevor Delaney, Goldman Sachs Group Inc., Research Division - Equity Analyst [23]

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Congratulations on the nice results. So if I could follow-up on the commentary about the China macro situation that was spoken to in the prepared remarks. Maybe you can help us better frame the -- I think you said 9% sequential increase in China orders. How does that compare to normal seasonality in China and then any other commentary in terms of what customers are saying or trends by end market that give you some confidence to talk about some improved macro trends in China more broadly?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [24]

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Well, I would just say, Mark, just maybe start with how do you normally sequentially see China? Normally, the December quarter in China for us is our strongest due to that's typically a very strong production environment. That being said, certainly we did not see that. So we're seeing more stability. And what we actually saw where we would typically see a December to March quarter have a decline in orders, it actually increased. And we saw increases in our transportation segment as well as our communication segments both in double-digit.

That being said, we also do see the inventory levels around cars improving. And the other thing that I think is pretty important around China as we talked about is electric vehicle. And while China's production is going to be down double-digit year-over-year the electric vehicle momentum in China really has not changed. And what's great and how we positioned ourselves is we think this year you're going to have about 50% growth in China electric vehicles between hybrid and full-electric vehicles going on in China approaching close to 2 million units versus being about 1.2 million last year. And really where we have invested to make sure we take advantage of that electric vehicle trend, we aren't seeing slowdown in that category of vehicle at all in China. So I think the way we're positioned -- certainly, where we pointed as well as the order trends and what we're hearing from our customers -- we do have a feel of stabilization and improvement in China.

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Operator [25]

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The next question comes from the line of William Stein with SunTrust.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [26]

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The acquisition that you mentioned, I'm hoping you can provide some details as to the applications, profitability, size, growth -- any characteristics, that would really help.

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [27]

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I think, first off, let's talk about it. It is the Kissling group. I said it during our pre-remarks. And what we're excited about with it and I'll get into some of it is this actually, this business plays very close to Industrial transportation applications. And what we look at -- coming into our Industrial transportation unit, you all know how strong position is there, provides good opportunity for synergy as we bring it into that unit. The other thing, if you were at our Investor Day, we did talk about some applications around where do we see electrification in commercial vehicles, which is really where this is primarily going to help us. And when you look at it, it really goes along our product technology that we already have through some of our relay and contactor technology that we bring to automotive electric vehicles. But in a commercial vehicle and certainly heavy truck where you bring it in, you have to get the voltage rates that are much higher than a traditional automotive electric engine. And what's really nice about what Kissling does, it gets us up to 1000-volt technology, which is important in those applications. And I feel very good it's going to tuck in and our team is going to do a nice job with it and you see what they're doing on the content already.

From the sizing, it is a bolt-on. It's about $50 million of revenue, good profitability and it really tucks in with our strategy of how we think about bolt-ons. And I think I said in the script we expect it's going to close later in our fiscal year and it'll be more something that will benefit 2020 and beyond than 2019.

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Operator [28]

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The next question comes from the line of David Kelley with Jefferies.

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David Lee Kelley, Jefferies LLC, Research Division - Equity Analyst [29]

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Maybe a follow-up on the previous China electric vehicle discussion. If we start to see that overall auto market stabilize, do you think that is more concentrated in higher contented vehicles whether it be electric vehicles or active safety-enabled cars that require incremental sensor and connectivity content? And do you think that maybe drives a further improvement in your content outgrowth story in the near term?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [30]

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Couple of things. I mean I do want to frame, the China market is a big market overall and still you're probably looking at electric vehicle still being slightly below 10% of that market. Anytime you have that electric vehicle that does help us from a content perspective, so you're going to have that content trend. I don't think it's going to be concentrated near term in electric vehicles. I think you have to play in all technologies and I think it's where we positioned ourselves very well that we can make the bets as you have to support combustion engines, hybrids as well as full electric. And I think we're going to drive increased content from all of them. The other thing is certainly, as you said, autonomous features. Certainly there's a whole stepping stone you have to go through on autonomous features that need to get added before you even get near full autonomy and that's going to also continue to benefit us. But it's those 2 trends together that give us so much confidence when we say 4% to 6% above production. So if the market is flat, we view we're going to grow. 4% to 6% above market, would be mid-single-digit growth whether it's in China or anywhere in the world.

And so those 2 big secular trends that you mentioned are so important for us and that's why we've made the bets to make sure where we have a leading position we're going to capitalize on.

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Operator [31]

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The next question comes from the line of Jim Suva with Citi.

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Jim Suva, Citigroup Inc, Research Division - Director [32]

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You announced the additional restructuring, which appears from the press release to be focused on the transportation segment, yet that is one of your more profitable segments in the past. You've talked about how you're doing so well there. So what's changed or really different that causes you to do restructuring in this segment, which appears to be doing quite well when -- it looks like these different areas of pockets and strength you have footprints there. So we're just trying to figure out about what's really changed to have the need for incremental restructuring in automotives?

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Heath A. Mitts, TE Connectivity Ltd. - Executive VP & CFO [33]

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Well, Jim, this is Heath, thanks for the question. It really is the global footprint that we have. And as the supply chains for our customers have shifted over time we need to make sure that we're always staying close to them and there are a couple of locations outside the U.S. that are handful of locations that I would say we have the opportunity of the slower environment to continue to hone that model.

In terms of what's changed relative to the profile, obviously some of the margins there we're running currently at our transportation margin below our target margin there and with negative auto production that puts pressure in addition to some of the other cost activities that we're working through in this segment.

And so obviously in the time when we have the opportunity to deal with capacity that's not being taken up by the higher global auto production, it's the right time for us to dig into that and to further optimize that. And what it really does is it lowers our fixed cost structure within that business, which allows us when we return to more times of better organic growth, really allows us to see better incremental margins and flow-through.

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Operator [34]

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The next question comes from the line of David Leiker with Baird.

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Joseph D. Vruwink, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Associate [35]

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This is Joe Vruwink for David. It certainly hasn't been a consistent message from the electronic supply chain regarding things like distributor lead times or inventory levels. And so your comments stand out and are certainly on the stronger end of what we've been hearing. Do you think when you step back and look at your business relative to the industry we might be seeing bigger market share gains or maybe the fact that TE skews towards higher contented applications and maybe that's the reason for the outperformance relative to some of your peers?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [36]

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When I think about your question, I do think -- I don't know what peers you're looking at. Certainly, there are some categories in passives and so forth which are product categories we don't play that still have lead time challenges. And certainly there are semi elements that depending upon which semi category you are in, we don't compete against those, I don't view them as competitors. I view our business model that is why we talk about being Industrial tech. We get the benefit of content but we also do have different levers than some of those others that I would view are a little bit more cyclical than us even though we may have some of the inventory supply chain effects. So net-net I do believe we position ourselves around secular trends. And like I said, I do feel that the content we positioned ourselves around and the hard work we've done in our portfolio and where we're making our organic bets have allowed us to buffer some weaker market. And then also on the nongrowth leverage you're seeing what we doing to make sure we maintain earnings and what is, auto is a big business for us, it is a negative environment. So I can't compare to the peer you're comparing to. But I do think what you're seeing in this quarter and also our guide shows how we've improved this portfolio and also how we use our levers to make sure when it does get a little slower we can maintain earnings and also work on some of the margin areas that we've highlighted for you.

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Operator [37]

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The next question comes from the line of Deepa Raghavan with Wells Fargo.

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Deepa Bhargavi Narasimhapuram Raghavan, Wells Fargo Securities, LLC, Research Division - Associate Analyst [38]

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I had a margin question across your segment. So what's the transportation segment margin in Q2? Was that what you're expecting or was that below your plan? And if you can comment on just given the restructuring and stuff should we expect a pause to your 20% plus/minus target? Or how soon do we get there, back up there? Conversely how sustainable is this Industrial and commercial segment margin story?

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Heath A. Mitts, TE Connectivity Ltd. - Executive VP & CFO [39]

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Thanks, Deepa, and I appreciate the questions. Certainly I would say this as we went into the quarter the TS margin we ended up with was right in line with what we expected going into the quarter. We were a little bit -- the communication and the Industrial margins were a little better than what we expected and that's reflected in the 17% margin which was higher than what we had gone into the quarter expecting to come out of it.

If you break these margins down into pieces, right? Terrence talked in his prepared remarks about some of the activities that were going on in the CS relative to getting the footprint righted in that business. And it's -- we're very pleased with where the CS margins have ended up at this point in their journey. I would say it's being the smallest of the 3 segments that's going to have -- probably have a little bit more volatility and because it's a little bit of law smaller numbers and maybe 18% is on the high side of our expectations but certainly in the mid and at times high teens is a good place for our communication margin business and very high returns on that because it's not a terribly capital-intensive piece of our business.

So very pleased with where we are in CS. And for the most part, most of the restructuring activity is behind us. As we think about Industrial, right, we've pretty been forthright in terms of our journey on the Industrial margins to increase from just a couple of years ago north of 300 basis points moving forward. And we're certainly well on that journey. We're up a couple of hundred basis points from where we were just a few years ago and that is part of the activity that you'll continue to see as we step forward from '19 to '20 and from '20 to '21 and those activities are well underway as that journey for getting Industrial to consistently be at mid to high margins. And we're a little bit ahead of pace on that relative to what our original FY '19 expectations are.

For TS. Listen, TS has grown so quickly over the last few years that we have put some money into the business to help it grow. I would say that some of that has had an impact on the margins. And as we've seen auto production moving to recessionary conditions that it is in today globally, that obviously puts additional pressure on our production environment and allows us an opportunity to take advantage of this lull and put some restructuring activity to work as I've mentioned on some of the prior questions.

In terms of what the margin is going to be going forward, we'll exit the year on a much higher rate than we're at now. I don't anticipate us being at the 20% number but I do anticipate the journey back towards that 20% is well underway.

The second half margins for transportation will be higher than we've run in the first half of the year and some of that is due to some of the restructuring that we've already completed.

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Operator [40]

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The next question comes from the line of Matt Sheerin with Stifel.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [41]

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Just a quick question, Terrence, on the commercial transportation segment within transportation. You had obviously very strong growth the last couple of years. It's been soft but seems to be holding up better than the automotive segment. So could you just talk about puts and takes in that business? What is your outlook there? I know there is a big content story, there is also an EV story there, but could you just talk about that?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [42]

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Yes, certainly. And thanks, Matt, for asking about it. When we look at ICT, what we call ICT, Industrial and commercial transportation, that's construction, that's ag, that's Class A trucks. And certainly almost everything that has 4 wheels that isn't a car. And one of the things I think that's been very nice, we capitalized on strong markets the past couple of years and those strong markets were really driven by China. This year we have seen China decline and we think it's probably declined about 6%. But North America we do expect the markets, they're up slightly. And what's really good is that we're growing and you're seeing the separation and I would say 5 years ago we would not have expected separation, it's really by the content momentum our team has done. Certainly, we've gotten into deeper penetration into China with our technologies. Electric vehicles and heavy trucks are certainly earlier, I mean later in the process than cars. But it's also around the autonomy that happens and a commercial vehicle also drives a lot more content than a commercial vehicle. So we're getting it drive,n, in the Powertrain, certainly as you have fuel emissions as always in the space. But then also as you're getting the autonomous features, cameras being added to trucks, agricultural equipment, that's creating data flow on the commercial vehicle that's driving content and our team's doing a really nice job globally.

So net-net, the content growth separation is similar to what we see in automotive in that 4% to 6%. And I'm proud of what the team has accomplished. It will be great as we bring Kissling into what the team's been doing in that market.

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Operator [43]

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The next question comes from the line of William Stein with SunTrust.

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William Stein, SunTrust Robinson Humphrey, Inc., Research Division - MD [44]

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I wanted to take a minute to talk about the medical end market. It's not one we hear about too often. You did a couple of acquisitions a few years ago that were a little bit surprising but from a market position and perhaps even pricing perspective but they are doing well now. Can you remind us what the exposure is? I think you have catheters even and can you just remind us a little bit about what that business is, how big it is and what the growth looks like today?

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Terrence R. Curtin, TE Connectivity Ltd. - CEO & Director [45]

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Yes, certainly. It's in our Industrial segment, Bill, and it is part of our Industrial business unit and market that we disclosed. And it is about $700 million, roughly, annually, what we do in Industrial. And when you look at that $700 million about $500 million of our medical business is completely focused around interventional applications, so that can be things around the heart, catheters going to the heart, also some that also go into the brain and it really leverages our capabilities around what we do from a fine wire, also the very special things that we do around packaging and mechanical applications that isn't throughout TE. And what you saw on the quarter you saw when we went into that business it was an element to diversify our growth based upon capabilities we had. We did do Creganna and we've done some small bolt-ons after that. But it is something when you look at those minimally invasive procedures, they are helping the outcomes getting to more cost-effective outcomes than traditional procedures and the 12% growth shows how we penetrated the major OEMs and our global position is very strong. So we always say we do expect that business to grow high single-digit and certainly we were above it this quarter with the program momentum we have. And I think similar to sensors there's still a lot more opportunity as we continue to increase our penetration in the applications we're in today as well as other applications where we can bring our capabilities and drive synergy.

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Sujal Shah, TE Connectivity Ltd. - VP of IR [46]

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Okay. Thank you. It looks like we have no further questions. I appreciate all of you joining us on our call this morning. And if you have further questions, please contact Investor Relations at TE. Thank you, and have a great day.

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Operator [47]

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Ladies and gentlemen, this conference will be available for replay after 10:30 a.m. today through Wednesday, May 1, 2019. You may access the AT&T teleconference replay system at any time by dialing 1 (800) 475-6701 and entering the access code 464389. International participants may dial (320) 365-3844. Those numbers, again, are 1 (800) 475-6701 and (320) 365-3844 with the access code 464389. That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.