TE Connectivity Ltd

Ladies and gentlemen, thank you for standing by. Welcome to the TE Connectivity First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Instructions will be given at that time. If you should require assistance during the call, please press star then zero. As a reminder, this conference is being recorded. I would now like to turn the conference over to your 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 Mitz. During this call, we will be providing certain forward-looking information.

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. Note that all prepared remarks on today's call will reflect TE continuing

operations. We completed the sale of our

subcontractor business Q&A portion of today's call. We are asking everyone to limit themselves to one 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 first quarter results and our revised outlook for 2019. Before I get into the slides, I want to provide an overview of the key messages in today's call. Now first off, I am very pleased with our results in our first quarter. We delivered revenue near the midpoint of our guidance and adjusted earnings per share at the high end of our training in a market that continued to soften through the quarter. Our results reflected resiliency as well as the diversity of our portfolio with our industrial and communication segments offsetting lower than expected sales and transportation. And while our quarter one results demonstrated solid execution, softer market conditions are resulting in us having to reduce our outlook for the rest of our fiscal year. I want to stress that the change in our guidance versus our prior view is entirely due to market softness that we're experiencing. And if you look at this change by region, it is primarily driven by China, along with a slower global auto production environment than we anticipated 90 days ago. We continue to be focused on content growth to outperform these slower markets while we execute on other non-growth levers in our business model to drive improvements in profitability as we'll move through this year. And with this as a backdrop, let me tell you how we're thinking about financial success in 2019. As I just mentioned, we have a portfolio with content growth opportunities that will allow us to outgrow as well as partially buffer the weaker market conditions we're seeing. We remain committed to our long-term business model and we'll pull the non-growth levers to improve margin and EPS while ensuring we invest in long-term opportunities to drive future content growth. When we look at earnings power, we expect to demonstrate earnings per share performance in the second half of 2019, that is above our exit rate in fiscal 2018, while absorbing the FX headwinds we're experiencing and that we'll talk about in the call. And finally, we believe this year's success will position the company to be back to business model performance, which we demonstrated over the past two years when markets returned to growth. So with that as a backdrop, let me get into the slides and I'll get into more details and highlight the quarter on slide three. Sales during the first quarter were $3.35 billion, which was flat -over-year in a report basis and up 2% organically, driven by 5% growth in both our industrial and communication segments. In transportation, our sales were flat organically with a slight decline in auto revenue being offset by growth in commercial transportation and sensors. Global auto production was down 7% in the first quarter, well below our guidance expectations. In auto, our sales were down only 1% on an organic basis compared to that 7% decline in production and it demonstrates the resiliency of content growth in our auto business, even in a tough production environment. In the quarter, we delivered .9% adjusted operating margins. Our revenue was down over $160 million sequentially as expected and I'm pleased that we could maintain operating margins that were essentially flat from our 2018 exit rate on a much lower sales volume. Adjusted earnings per share was $1.29 in the quarter, which was at the high end of the guidance. From a free cash flow perspective, during the quarter, we generated $69 million, which was in line with our expectations and similar to quarter one of last year and we returned $645 million to shareholders through dividends and share repurchases in the quarter. Now let me turn from the first quarter and talk about our revised outlook. Back in October when we issued guidance for the year, we highlighted that we were entering a slower market environment. During the first quarter, our order trends were below our expectations to do weaker global auto production and lower order levels in China in our transportation and communication segments. Our overall orders in the first quarter were down 4% sequentially and on a year over year basis, total orders were down 6% with China orders declining over 20%. Based upon these trends, we now expect fiscal year sales at the midpoint of $13.65 billion versus our prior guidance of $14.1 billion. Versus our prior view, this is a change of $450 million at the midpoint in revenue. This reduction is primarily driven by China with some weakness in European auto as well. If you look at the change by segment, approximately two thirds of the reduction is in transportation with the remaining primarily in communications as both transportation and communications are being impacted by the weakness in China. In our transportation segment, we are now assuming that global auto production will decline 4% to 5% in our fiscal year compared to our prior outlook of flat production in our fiscal year. Our expectations for the industrial segment are consistent with our prior view with the ongoing strength that we're experiencing in the end markets, specifically commercial air, defense, as well as medical. With this revised sales outlook, we're adjusting our earnings per share. It's now expected to be $5.45 at the midpoint, and this is a reduction of 25 cents from our prior view. This change in our EPS guide is entirely driven by the market change, and the headwind on currency exchange effects that we highlighted last quarter remains essentially unchanged at $375 million in sales and 16 cents on EPS. So if you could please turn the slide floor, let's look at order trends. On this chart, you can find the details for each segment, but I wanna highlight what has changed over the past 90 days. As I mentioned earlier, orders were below our expectations. And when we guided 90 days ago, we were expecting that our orders in quarter one would be similar to our quarter four levels at $3.5 billion, but instead orders declined sequentially by 4%, and our book to bill in the quarter remained at .99. On a year over year basis, organic orders were down 4% driven by declines in China of 22%, as well as declines in Europe of 6%, partially offset by growth in North America of 7%. By segment, you can see on the slide, we continue to see strong industrial orders that continue to support our growth outlook that is consistent with our prior view. However, as you can see in transportation and communications, you can see the weakness we've experienced in orders, which relate primarily to China, and that's impacting our outlook. So let me get into things by segment, and if you could turn to slide five, I'll start with transportation. Transportation sales were flat organically year over year. Our auto sales were down 1% organically versus auto production declines of 7% in our first fiscal quarter, and this was well below our production assumption that we expected when we got it. We did see growth in the Americas, which was offset by lower sales in China and Europe. China auto production was especially weak, and it declined 15% year over year, much worse than we expected. Even in this weaker environment, the 7% decline in auto production over results reinforce the ability to outperform auto production.

In commercial transportation,

we had been expecting growth to moderate from the strengths we've had in the prior years. During the quarter, we grew 2% organically versus markets that declined 7% driven by China. And our growth in this era also continues to be driven by content and share gains. In our sensors business, we grew 4% organically year over year with growth driven by industrial applications. And in auto sensors, we continue to increase our design win value across a broad spectrum of sensor technologies and applications. Adjusted operating margins for the segment were 17.9%. This was essentially flat sequentially as we expected. In 2018, as we discussed with you, we increased investment to support a strong pipeline and new design win, including those in electric vehicles and autonomous driving applications. With production slowing considerably, both in China as well as in Europe, we are continuing to balance near term margin performance with long term growth opportunities. And while we're running currently below our target margin levels in the segment, we expect the cost actions that we'll be taking to enable margins back to the target levels. Let me turn over to industrial solutions and that's on slide six. Industrial segment sales grew 5% organically year over year as expected with growth across aerospace, defense, as well as in our energy business. Our space defense and marine business delivered strong 13% organic growth with double digit growth across each of its businesses. In commercial aerospace, growth is driven by content expansion and share gains in the ramp of new platforms. And in defense, over the past year, we've seen nice growth here being driven by favorable market as well as some new product cycles. In industrial equipment, our sales were down 1% organically with strength and medical offset by the expected deceleration and factory automation. And lastly, our energy business grew 6% on our organic bases driven by growth in North America. Adjusted operating margins for the segments expanded 60 basis points to .9% and was in line with our expectation. Our plans continue to remain on track to optimize our factory footprint and the industrial segment to expand adjusted operating margins to the high teams over time. So please turn to slide seven and I'll get into our communication segment. Communications grew 5% organically as expected with strong growth in data and devices being partially offset by appliances. Data and devices grew 9% organically with growth being driven by high speed connectivity in data center applications. Our appliance business was down 2% organically due to weakness across Asia, partially offset by growth in North America. Adjusted operating margins for the segment was .4% in line with our expectations. Before I get into guidance in more detail, I'm gonna turn it over to Heath. That'll get into more details on the financials in the first quarter.

Thank you, Terrence, and good morning, everyone. Please turn to slide eight where I'll provide more details on the Q1 financials. Adjusted operating income was 565 million with an adjusted operating margin of 16.9%. Gap operating income was 484 million and included 75 million of restructuring and other charges and 6 million of acquisition charges. As a result of market weakness, we are broadening the scope of our cost initiatives across our business and accelerating cost reduction and factory footprint consolidation plans. You should expect us to aggressively pursue incremental restructuring to reduce our fixed cost structure while balancing the investment opportunities which enable future growth. And we're confident that with these initiatives, we expect to exit the year with a more nimble cost structure, which will enable future margin expansion and earnings growth. We're currently working through these restructuring options and we'll update our estimates as the year progresses. Adjusted EPS was $1.29 at the high end of our guidance range and included five cents of headwinds from currency and tax rates. Gap EPS was $1.11 for the quarter and included restructuring and other charges of 16 cents and acquisition related charges of one cent. The adjusted effective tax rate in Q1 was 18.1%. And looking ahead, we do expect a slight decline in our tax rate in Q2. For the year, we expect the full year adjusted effective tax rate to be in the 18 to 19% range. Now, if you turn to slide nine, sales of 3.35 billion were flat year over year on a reported basis and up 2% organically. Currency exchange rates negatively impacted sales by 73 million versus the prior year. We expect the full year impact of currency exchange rates to be 375 million, which is consistent with our prior view. Adjusted operating margins were flat sequentially as expected at .9% and as Terrence mentioned earlier, I'm pleased that we could hold operating margins flat in the fourth quarter with over 160 million of sequential revenue decline. We do expect Q2 margins to modestly drop from Q1 levels as we adjust our operations to the lower outlook. In the quarter, cash from continuing operations was 328 million, that's up 16% year over year. And free cash flow is nearly 70 million, which is in line with our typical seasonality, with 209 million of net cap X. Also, we returned 645 million to shareholders through dividends and share repurchases in the quarter. And of course, this includes the return of proceeds from the sale of our subcom business that we completed last quarter. As I have told you in the past, our balance sheet is healthy and we expect cash flow to be strong, which provides us the ability to provide organic growth investments to drive long-term sustainable growth while also allowing us to return capital to shareholders and still pursue full-time acquisitions. With that, I will turn the call back over to Terrence to cover guidance.

Thanks, Heath. And let me start with the second quarter on slide 10, build on some of the things Heath said. With the slower market conditions we're experiencing, we do expect quarter two revenues and adjusted earnings per share to be roughly flat with quarter one, certainly building on the orders chart I talked about earlier. Second quarter revenue is expected to be 3.3 to 3.4 billion dollars with adjusted earnings per share of $1.25 to $1.29 for the quarter. At the midpoint, this represents year on year revenue reported in organic sales declines of 6% and 2% respectively. Given the ongoing strength of the US dollar, we do expect year over year currency exchange headwinds of approximately $155 million on the top line and five cents to EPS in the second quarter. By segment, we expect transportation solutions to be down low single digits organically. Auto revenue is expected to be down mid single digits organically versus a global decline in auto production 9%, given by weakness in both China and Europe. Once again, our top line will outperform versus auto production as it shows the benefit we derive from content growth. Industrial solutions is expected to grow low single digits organically with growth in ADNM and medical applications being partially offset by softness and factory automation applications. And we expect communication segment to be down mid single digits organically driven by Asia. If you could, please turn to a slide 11 and I'll get into more details on the full year guide for fiscal 19. Building on my earlier comments around market and order trends, we expect full year revenue of $13.45 to $13.85 billion. This represents flat sales organically and a reported sales decline of 2%. Due to foreign currency exchange headwinds of $375 million. And as I said before, this headwind is consistent with our prior view. Adjusted earnings per share is expected to be in the range of $5.35 to $5.55 per share. This guide includes a 25 cent negative impact from both currency exchange rates, as well as tax. Excluding these headwinds, adjusted earnings per share would be growing low single digits at midpoint in a flat organic sales top line. Now let me get into some color on our segments for the full year. We expect our transportation solution segment to be flat organically. We also expect auto sales be flat organically with content growth enabling out-performance offset four to 5% decline in global auto production. When we look at global auto production be down four to 5%, we expect auto production in China to be down 10% in our fiscal year. Europe to be down mid single digits and North America to remain roughly flat. And when you think about this, this reflects our assumption that global production and units will remain around quarter one production levels, which was around 22 million vehicles per quarter throughout our fiscal year. We are also expecting continued growth in sensors in both industrial and auto applications driven by the ramp of the new auto design ones that we've talked to you about. In industrial solutions, our outlook is unchanged from our prior view. We expect sales to be up low single digit organically with growth driven by aerospace, defense, and medical applications. And clearly our 6% order growth in the first quarter supports this unchanged outlook. In communications, we expect to be down low single digits organically driven by Asia markets in both data and devices as well as in appliance. So before we go to questions, let me just summarize some of the key takeaways and I'll reiterate some of the things I said at the front end. Now in the first quarter you saw the positive impact of our diverse portfolio with revenue and EPS in line with guidance in quarter one, despite a soft-fifth marketing from our kind of environment. Our revised 2019 guidance is driven entirely by weaker markets. This is primarily driven by China with some weakness in European auto as well. And by segment, approximately two thirds of the reduction is in transportation with the remaining in communications. We also remain committed to our long-term business model and we're gonna be pulling the non-growth levers to respond to market conditions. When we have seen weaker markets in the past, we have taken advantage of the opportunity to aggressively go after cost reduction and consolidation activities. And we plan to follow the same approach and emerge with increased earning powers when markets return to growth. And as I stated up front, we expect to demonstrate earnings per share performance in our second half that is above our exit rate in fiscal 18, even with our revised sales outlook. We are focused on ensuring the company will be back to business model performance when markets return to growth. And lastly, before I close, I do wanna thank our employees across the world for their execution in the first quarter and also their continued commitment, not only to T, but also our customers and a future that is safer, sustainable, productive and connected.

So with that, Suzhou, let's open up for questions. All right, thank you, Terrence. Greg, could you please give the instructions for the Q&A session?

Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star then one on your touchtone phone. You will hear a tone indicating you have been placed in Q. You may remove yourself from Q at any time by pressing the pound key. If you're using a speakerphone, please pick up the handset before pressing the numbers. And as a reminder, in order to get through as many questions as possible today, please limit yourself to one question per turn. Once again, if you have a question, please press star one at this time. And one moment, please, for your first question. Your first question comes from the line of David Kelly from Jeffreys. Please go ahead.

Good morning, thanks for taking my questions. Just a quick one on transportation solutions and autos. I guess if we look at your global vehicle production assumption for the full year, as you said, down four to five, it seems like it's in line where I think both that's the most are expecting, given the recent downturn in China and maybe your September fiscal year end. How should we think about the regional cadence you're building into the back half of the year? And then I guess more importantly, has the softer macro in any way changed your customers' approach to electrification and connectivity and the related orders you're seeing there?

So let's take it, I'll start with the second piece because then I'll get into the regional, if that's okay, and thanks for your question, David. First off, when it comes to electrification and autonomy or connect vehicle, I would tell you nothing has changed. The amount of programs that we have, and it's one of the things we will balance through the softer environment is to make sure we capitalize on those trends. And you also see the benefit of those trends, even in our first quarter, where our sales were down in a much worse production environment. And I think you're gonna continue to see that content growth even in this week or period where we outperform production. Now, when you think about your first part of your question, so let me go back a little bit and talk about auto. Clearly, production is slower than we expected. When we started the year and we guided 90 days ago, we guided to what we thought was gonna be a flat environment. We thought relatively flat in Asia, relatively flat in North America and slightly down in Europe. Clearly, car sales in China were very weak in the first quarter, production adjusted, and we're also seeing production being adjusted here for the rest of the year. So when we look at it, we do expect China production to be down 10% this year, European auto to be slightly worse than our prior guide, going to more mid single digit down versus slightly down that we said before in North America, staying where it is. Actually, when you think about how we see that going throughout the year, we're actually seeing and expecting from what we hear from our customers, production is gonna be more constant throughout the year than you normally would see. So with this week first quarter around 22 million units, we do expect that production is gonna stay around 22 million units per quarter in our fiscal year, plus or minus a little bit. So one thing I do wanna stress, and you mentioned in your comment, anything we're talking about auto production is on our fiscal year basis, which is very different than how others talk about, which is more calendar basis.

Okay, thank you, David. Could we have the next question, please?

Your next question comes from the line of Wamsi Mohan from Merrill Lynch, please go ahead.

Yes, thank you, good morning. Good morning, Wamsi. Karen, it's really impressive that even in a 5% production decline environment, you're actually able to show auto revenues flat organically. Your fiscal 19 guide obviously implies a four to five point like content growth over here. So can you just talk about what you're seeing within the pipeline that suggests that customers might not be mixing down, or is this actually assuming that customers do mix down and that's why the content is four to five percent? And just to clarify, Heath, can you just talk about the magnitude of that restructuring charge that you're taking and maybe which areas of the segment that will impact? Because you were already doing some restructuring on industrial, and I'm assuming this is incremental to that. So if you could clarify that'd be helpful, thank you.

Sure, Wamsi, thanks for the question. And let me take the first half. Number one is let's go back to how we talk about content growth and how we've talked to you about and how do we think about it. And it has been in a four to six percent content range. And over the past couple years, we've had a constructive production environment. You saw us actually overachieve that four to six over the past couple of years. And that also, you'll see a little bit of supply chain effect, take that up in a growth environment. When we look at it, you're exactly right. We're towards the lower end of our content ranges here. There will be a little bit of supply chain effect as well as lower value vehicles. But that's included in our guide, and that's why you'll see us more towards the lower end of the content growth. I would say on a quarter by quarter basis, as supply chains adjust to a slow environment, you may see some separation that bounces around a little bit like we've always told you. But long term, the four to six, and what we see, the trends going on, I think all of us who purchase new vehicles, you see the content around autonomy. You see certainly the electric vehicle continues to pick up momentum. And it's also new product cycles and launches. And those launches typically happen later in our year. New product cycles don't typically hit early in our fiscal year, they typically hit later in the year. And they're assumed in our guidance as well. So with that, we're over to

Heath. Wamsi, it's a good question on restructuring. As you mentioned, we had already had some assumptions in with our prior guidance and consistent with what we had talked publicly about over the last year and a half or so, which is some of the footprint consolidation opportunities within our industrial segment. We are broadening that, as I mentioned in the opening comments, across portions of the rest of the other two segments. Part of that is volume driven, part of it is taking advantage in this weaker revenue environment, opportunities to get after some things that we may not have been able to do where capacity would have stood otherwise. So in addition to industrial, it has been broadening. And then the other thing to think about is we did sell a subcomp business and closed on that last quarter. And when you remove $700 million of revenue out of your P&L, which is roughly what subcom represented to the corporation, we do have some stranded costs in the middle of the P&L and operating expenses that you would expect us to tackle. And we are going after those as well. In terms of quantifying it, we're still in the process of several of these initiatives. We're not at a point now where I wanna go out with a number, but certainly as the quarter progresses and we get this call back together in about 90 days, we'll give you an update in terms of both the magnitude of a charge over and above what we guided and what you should expect from the savings profile from that.

Okay, thank you, Wamsi. Can we have the next question, please?

Your next question comes from the line of Christopher Glynn from Oppenheimer. Please go ahead.

Thank you, good morning. It's said a question about how much you think you've been able to ring fence or de-risk expectations here. Does it feel like kind of stable at a weaker run rate or markets still kind of searching for what the lower levels might look like?

No, Chris, I would tell you, order rates are staying right around this one book to build. So I would say other than China, which was meaningfully weaker in our first quarter, it does feel it's stable at a lower rate. And if you think about our guy change, we needed to step up and we sort of expected orders to stay around that 3.5 billion in our first quarter. And they were a little bit softer than that due to China. So when we're looking at our order rates, even in early January, it does feel stable at a lower rate. Certainly we're gonna continue to watch it. And we need to focus on clearly what we can control that he talked about. So, and it's very, it is mixed. You know, you see on the order chart, our industrial orders were up 6%. And we see very good strength in aerospace and the medical. We also continue to see broadly very strong growth in the United States. So, you know, it is, there are mixed views between different angles you look at it, but China was weak across the board. And, you know, the adjustment is primarily due to China that we're adjusting to.

Okay, thank you, Chris. We have the next question, please.

Your next question comes from the line of Craig Hittenbach from Morgan Stanley. Please go ahead.

Yes, thank you. Taren, just a question on the broad-based weakness in China, which has been evident kind of through the supply chain, but just, you know, you have end markets which are clearly slowing, but there's also likely inventory management happening. So any additional color you can shed on that in terms of your discussions with customers and distributors as to how they're managing the -of-demand environment and where you think they are at this point from an inventory perspective?

Well, in China, you know, as I said on the call, orders were down 22%, and, you know, auto was weak due to the weaker decline. And where we play in the supply chain, you're always gonna have some supply chain adjustment that's happening as people relook at their production to their end customer, so whether that be a car buyer, an appliance buyer, anything else, that is happening. And so we are gonna work through as they do it, and that has a supply chain element to it. Typically, they last three to six months. So depending upon the market, I would say we're sort of in the early innings of that is what we're going through. I would say that is not consistent globally. You know, in places we have a healthy environment like in industrial, like in North America, I would say we see pretty healthy demand orders. We don't see contractions, but certainly in China, we are seeing some contraction as people. It's just normal behavior.

Okay, thank you, Craig. We have a

next question,

please. Your next question.

The

calendar year, it's kind of gone from rising high single digits to now down pretty heavily. And since the middle of last year, obviously there's been escalating trade tensions and China's underlying economy has slowed. Have you given some thought if we get maybe trade resolution or China explore is a more aggressive fiscal stimulus, not just monetary stimulus, how quickly your business in Asia could potentially come back?

You know, that's a question that's probably beyond me. So when we look at it, clearly there's a lot of moving parts in the world. We would like all the moving parts because we're global free traders. I think it would give everybody confidence. But when we look at it, we do not have stimulus in our guidance is the way that you should be thinking about it. And you know, we would like constructive resolution to those matters, but we got a plan to what's in front of us and the environment we're seeing. And that's what we're doing.

Okay, thank you, Joe. Okay, next question, please.

Your next question comes from the line of Sean Harrison from Longbow Research. Please go ahead.

Morning, a question, I guess, specifically for Heath on capital return and buyback. So buying back was greater than normal in the first quarter. I think that was mainly the subcom proceeds, but you guys are, you know, I could argue under levered right here. If this is going to be the bottom over the next couple of quarters for your business, do you get more aggressive with the buyback at the end of the year? And is there a number to think about? Is that in the guidance?

What's assumed in our guide, first of all, Sean, thanks for the question. You are correct. We returned 645 million in the quarter. Roughly 500 of that was the buyback. And disproportion amount of that 500 did come from the subcom proceeds, which was about 300 million. So we obviously put that to work in terms of getting that back to the shareholders as we had committed to when we announced that transaction. As you think about the year in terms of the buyback, we generally say about a third of our free cash flow goes towards the buyback. So let's assume that's about 600 million. You can layer in on top of that the subcom amount, and that gets you up to about the $900 million number. And I think that's probably a fair way to frame that out. Now, in terms of, you know, we are always looking at opportunities to intelligently deploy capital. That's not suggesting that we're gonna do anything in terms of additional leverage, but we will flex from time to time in terms of where our capital is deployed. And at times, when we look at the stock price relative to what we would deem an intrinsic value of our company based on our strong free cash flows, that dislocation does create opportunity from time to time, and we will flex a bit higher as it makes sense. So, you know, we'll keep you posted, but I'd say from a modeling perspective, you can use kind of the normal one third plus the subcom proceeds. Okay, thank you, Sean. Can we have the next question, please?

Your next question comes from the line of Mark Delaney from Goldman Sachs. Please go ahead.

Yes, good morning. Thanks for taking the question, which is on the data and devices segment, which I know did quite well this quarter and I think is benefiting from data center. So can you help us understand how much of data and devices is now tied to hyperscale data center? It seems like in the go-forward view of data and devices that there's maybe some weakness that's coming up in Asia for data and devices, if I read your slides correctly. So can you talk about what may be weighing on some of the incremental view on data and devices for the balance of the year? Thank you.

Yeah, hey, Mark. It's Terrence. Thanks for the question. First off, you're right. When we think about data and devices and a lot of the repositioning we've done of that unit, it was really around making sure that unit is pointed to high speed. Certainly the hyperscale, which is broadly, when you think about that entire high speed market, it is very levered to Asia. The whole supply chain, certainly somehow the ODM elements tie into it. When we look at hyperscale, we do expect hyperscale to continue to grow nicely. We do see their capital being down slightly, not down in dollars, but the growth rate declining a little bit over last year. And the other thing that we saw was later in the quarter, due to how much of that supply chains around Asia, we did see orders around that supply chain get conservative. So I do think the positioning of the business is very strong. Certainly we're experiencing the broader Asia weakness is touching that like our other businesses. And what I would say is it's more around what we're seeing in Asia, which is well above 70% of the revenue in that segment, well above 50%, sorry, the revenue in that segment is tied to Asia. So it is something that we're being caught up with some of the other weakness we're seeing in that region.

Okay, thank you, Mark. We have the next question, please.

Your next question comes from the line of Joe Giordano from Cohen. Please go ahead.

Hey guys, good morning. Hey, Joe. Quick one from me. So just first in terms of China auto, I'm just curious as to how like orderly that 15% decline has been. I know the landscape there very different than US and Europe with a lot of OEM. So are you seeing like some trying to be opportunistic and take share from others during this kind of environment? And then I guess the second part of the question kind of spreads more to communications too. But as we recover ultimately from some of these declines, do you think there's a fundamental change in the competitive position of non-Chinese companies in those markets? And as these markets start to grow again, will they gravitate more and more towards local producers of content that are Chinese owned?

Well, let me start with the automotive piece. Certainly when you take our position in automotive and the share we have in automotive, no different than we did in the last week period we had. We gained share and while we will adjust our cost base, one of the other things that's very important is that we're also very much focused on winning at the same time. And when you think about our coverage in China, where we cover the entire landscape of the 50 OEMs that are in China through broad technologies, we will focus on gaining shares. So I don't see some of the adjustments we're making impacting share there. Actually, we're very much discussions around how we gain share in these market environments when other competitors typically scale back. In the data and devices side, certainly there's an element which goes, supports China and then parts that support the globe. I don't think the competitive dynamic will change in what supports the globe. Certainly there's a piece that is very much around China OEMs. I think we just have to continue to watch that with some of the dynamics to the earlier question. But right now, when we think about the technologies we bring as well as our key competitors in that space, I think we have a significant advantage in the high speed area over local companies and we will continue to invest in that innovation to keep that competitive mode well entrenched going

forward. Okay, thank you. Thanks, Joe. Can we have the next question,

please? Your next question comes from the line of Stephen Fox from Cross Research. Please go ahead.

Thanks, good morning. My one question is on inventories. It looks like you guys built some inventories during the quarter, even in the face of some of these declines. Can you sort of talk about your strategy going forward for your own balance, how much it helped or hurt this recent quarter and then whether you're seeing any unusual inventory activity in the supply chain?

Thanks. Stephen, you know, given the severity of the slowdown, particularly in the areas we've already talked about on the call across China and parts of Europe in the back half of the quarter, certainly we did see some pressure on driving inventory up. Fortunately, that has, in our model, that comes out pretty quickly in terms of our ability to reduce inventory as we both correct our expectations, both from the cost structure side as well as our revenue expectations around what's needed. So in terms of anything that's systemic, there's nothing there and you should see inventory levels come down fairly significantly between now and the end of the year. There are a couple instances where we do have facility consolidations that we have talked pretty openly about within our industrial segment and a few other places and that does, as you're in the middle of any type of facility consolidation activity, that does tend to, over a short period of time, drive inventory a little bit higher in those cases where you're producing buffer in order to handle the transition into new locations. So we have a little bit of that going on as well and that will continue sporadically during the year. You'll see little bumps in terms of that, but otherwise, nothing other than just the slowdown that drove sort of that. Okay, thank you, Steve.

Can we have the next question, please?

Your next question comes from the line of Amit Daryani from RBC Capital Markets. Please go ahead.

Yep, thanks. Just a question on your operating margin guide or the implied guide, I guess. If my math's right, you guys are basically saying operating margins go up by 50 to 80 basis points in the back half, worse in the first half. Could you touch on what is gonna enable that? And again, you don't wanna quantify your cost reduction initiative, but historically, I think your cost reductions are taking 12 months or higher to pay back, so I'm assuming that's not a level for back half, but I'm just curious, what enables this margin expansion in H2 worse in the front half of the year?

Well, Amit, this is Steve. I think as we think about the first half to second half, you've got a couple of things going on. We do have a little bit of normal seasonality in terms of first half to second half revenue, and that has natural leverage that comes with it. That's not a huge number relative to maybe we've seen in prior years, but there's a little bit of seasonality embedded in our revenue guidance, and that does have an upward impact on the margins. But very pointedly, we've had restructuring activities going on, and some of the things that we do benefit from, particularly as we get towards the end of our fiscal year, are some of the activities that we've been undertaking in our industrial segment, as well as some of the things that we're going after -facility-wise, rather operating expenditures relative to some of the stranded costs for the subcomp divestiture. So there are some restructuring activities that certainly benefit us in the back half of the year. You are correct, some of the newer things that we're gonna now tackle, don't have the, you don't get as much near-term help on that, but that will certainly set us up very well for the next several years. Okay, thank you, Ahmed. We

have the next question, please.

Your next question comes from the line of Deepa Raghavan from Wells Fargo. Please go ahead.

Good morning. Follow-up on the margin question here. Especially margin protection on the downside. Looks like there will be more cost actions, which is good, but in the mean, does the guidance still assume auto margins will hit to 20% in second half, especially given that there was this mixed auto sensor participation in Q1, and just longer term, will the SG&A and industrial self-help margin ramp still be on track, or will that be pushed out a little bit? Thank you.

Deepa, I think your question's a good one. In terms of our transportation, we're running at about 18% here for the last couple of quarters, and certainly that's below our target margin for that segment, which has a disproportionate impact on the overall margins for the company, given its relative size. As you think about our transportation business, the way I would think about it is you'll see the margins begin to improve sequentially as we move through the year, and much of that is driven by some cost actions that you'll see that are underway right now, and as those prevail in terms of our end of year exit rate, you'll be closer back towards that 20% number that historically has been our target for that transportation segment. In terms of the industrial segment, that is really relatively unchanged. What we talked about 90 days ago on our call was that this year, we've seen significant step up in our industrial segment margins over the last two years, and as you work your way through these footprint consolidation activities, and these are fairly sizable, the things that are underway right now within that segment, you should expect that the margins are gonna stay relatively flat, maybe modestly higher, as we go through this year with an industrial, but you'll see another step function improvement as we go into the next several years as these facilities come offline. So not a lot has changed on the industrial side relative to margins in our expectations. Certainly we would see a recovery towards the end of the year within transportation.

Okay, thank you, Deepa. We have the next question,

please. Your next question comes from the line of William Stein from SunTrust. Please go ahead.

Great, thanks for taking my question. Hi, I believe the weakness in China generally, and automotive as well, is pretty well understood. I don't think surprising anyone. What wasn't a bit of a surprise was that the guidance for industrial, at least for the March quarter, looks a little bit better than what I was expecting, and I think you're reiterating for the full fiscal year. Can you dig into what's triggering that sort of guidance relative to the current environment? Is it all aerospace defense? Are these new programs, content wins, new technology, greater volumes? Any clarity would be helpful, thank you.

Yeah, sure, Will. A couple of things. First of all, let me just frame. Our industrial segment, while it does have a China position, it's not as weighted to China and Asia as our other businesses. It has a heavier weighting more to Europe and North America. So I do think that's part of it versus the other trends. Also, it is the mix that you sort of indicated, and I'll go back to, if you look at our orders on the earlier slide I mentioned, our book to middle and industrial was well above one. I think it's around one of seven. So it is having very good order trends, and it goes back to the markets you talked about. It does go back to, we're seeing a very strong commercial aerospace. We're also seeing a very strong defense market. It's down slightly, and to get a little slower because it was running well above trend line. So when we look at industrial, it really has not changed. And honestly, from an orders perspective, it was one segment in the first quarter where orders came in where we expected for the year, and we're continuing to see good order momentum in industrial around those key markets I talked about.

Okay, thank you, Will. Can we have the next question, please?

Your next question comes from the line of Jim Suva from Citi, please go ahead.

Thank you very much. And your prepared comments, one of you made the comment about as you exit the year, you expect to be stronger. Was that in reference to operating margins of each and every segment, the company in totality or earnings per share, or how should we think about what that was referring to?

Jim, I made that comment, and that is a total company comment. Certainly we have levers that are different by our segments. And when we make that comment, that was truly made out of the viewpoint of earnings per share and at a total company level. And certainly as he talked about, we do expect operating margin to improve. I think he did a good job highlighting the levers, but certainly our earnings power, we also view we're gonna continue to improve as we exit the second half versus when you compare year on year.

Okay, thank you, Jim. Can we have the next question, please?

Your next question comes from the line of Matt Sheeran from Stiefel, please go ahead.

Yes, thanks, and good morning, guys. Just another question regarding your auto guide. I know you're guiding Europe sort of in between North America and in Asia down modestly. We should though, I would think have some improving year over year comps as we get through the year, particularly given the WLTP testing that went on in Europe and slow things down. So what's your perspective on that market, relative to production, but also relative to the relationship between Europe and exporting into Asia?

Well, a couple of things. When you think about it, you're right. Some of our incremental decline is around, you know, WLTP has been lingering and we also have had certain shutdowns there. And just the overall tone around Europe, whether it's Brexit, whether it's WLTP, whether it's cars going from Europe to Asia, it is sort of reflected in our outlook. So, but what I would tell you is we are sort of seeing probably off the point we were in the fourth quarter, you'll see your sort of more normal Europe shape, which is typically auto production in our third fiscal quarter picks up and then sort of gets in a little bit slower in the fourth quarter due to just traditional production bill schedules. But we are still expecting Europe to be down mid single digits with the bulk of that happening in the first three quarters of our fiscal year.

Would you expect working capital to be a

source of cash this year?

Yeah, Chris, good questions. The, let's take CapEx first. So our CapEx as we guided last, you know, as we got in the last quarter was expected to be in that range of around 850 million for the year. We'll bring that down some as we've seen, you know, certain activities slow down. But you got to know that, you know, the vast majority of our CapEx fortunately is tied to customer programs. And when we went a customer program, and that's not just within auto or commercial transportation, that's really across the board. When we went a customer program, that generally commits us to some level of tooling and fit up in advance of production. So given the long-term horizon and the strength of that, we're still committed to because that spin, because that has the best return on capital just about any of their opportunities out that's out there. So you should expect it somewhere in that 800, 850 million. We'll prune as necessary. Your other point is exactly right on target though. Working capital will be a source of cash this year, particularly as I mentioned earlier on inventory, receivables will have a natural impact coming down with the sales and payables. We have a robust program to drive payables improvement. We're pretty good at that already, but you'll see inventory correct as well as part of the needs to bring that down. So we would expect that as we make our way through the next three quarters towards the end of our fiscal year, that that will continue to be a source of cash. Okay, thank you, Chris. We have the next question, please.

Your next question comes from the line of Mark Delaney from Goldman Sachs. Please go ahead.

Yes, thanks for taking the follow-up question. It's about aerospace and defense, which I noted quite well this quarter, but given the US government shutdown, just curious if there's been any change in the overall operating environment in terms of ability to win new programs or order rates or things of that nature. Thank you.

No, good question, really. How we do design, and we're actually with the primes and so forth. So that's really not having an impact on us, just due to where we are and how we do our design work with the primes in that space.

Okay, thank you, Mark. We have the next question, please.

Your next question comes from the line of Amant Dariani from RBC Capital Markets. Please go ahead.

Yeah, thanks for the follow-up, guys. I was hoping you could talk a little bit more on the sensor side. Sort of what do you think the growth trends and growth trajectory looks like in fiscal 19? And then on the margin side, is there anything to think about what sort of headwind was the sensor business to transportation margins in fiscal 18, and how does that diminish, I guess, in 19?

Couple of things on the latter part. It's pretty small due to the weighting of the total segment on it, so I won't over-focus on that. On your point around the pipeline, what we really like about this year, the sensor business is, you sort of saw the growth rate go down a little bit. It is being impacted by the global macro, because there is a big piece of it that does go into industrial transportation, does go into industrial applications today. But as we go through the year, you're gonna see some of the auto winds that we've had as those launches happen later in the year help the growth rate sensor. So we aren't getting the benefit of those yet, as we told you. They were later in 19 events just due to how auto production hits, and those launches hit. So you'll continue to see more positives from the auto side and sensors as we go through the year than where we are today.

Okay, thank you, Elmet. Can we have the next question, please?

Your next question comes from the line of Deepa Raghavan from Wells Fargo. Please go ahead.

Hey, thanks for the follow-up. Two quick housekeeping question. What's the updated tax rate assumption? Looks like the lower headwind is more than just a Q1 event. And two, what's the embedded free cash flow conversion rate within the guidance? Thank you.

Deepa, as I noted in the prepared comments, the expected effective tax rate for the year is between 18 and 19%. So we did drop that modestly from our original guide, which was closer to the 19% level. As you would expect, given the complexity of our structure, you're gonna have some quarters that swing around, particularly when you have statute expirations that hit us at different points in the year. In terms of the cash conversion, I think you could still model it. It'll be up in that 80 to 90% range as we work through. We've increased our capex over the last two years, as you can see in the numbers. And there's still takes, there's a little bit of lag for the depreciation to catch up on that in terms of how that math works. But it'll be up in the higher end range would be our assumption for the year in terms of free cash flow. Okay, thanks, Deepa. Can we have the next question, please?

Your next question comes from the line of Stephen Fox from Cross Research. Please go ahead.

Hi, not really a question, just a quick clarification. Your new guidance, does it assume more cost savings relative to your prior plan or is that more like a fiscal 2020 help? Thanks.

Stephen, there is some incremental restructuring that we will benefit from in the back half of this year, certainly relative to our original guidance. And that's one of the reasons we're able to withstand on the lower revenue growth, a pretty low flow through down to our revised EPS is largely tied to our ability to get costs out of the business. Now, having said that, there will be, part of what Terrence and I have mentioned earlier this call, we are taking advantage of the solar environment to much more aggressively go after the fixed cost structure of the business. And that will enable us to have a step function improvement in terms of overall profitability in the out years. So, we're focused both on preserving income and cashflow for this year, as well as what it sets ourselves up for to drive profitable business going forward.

Okay, thank you, Steve. Cui, next question, please.

Your next question comes from the line of William Stein from SunTrust. Please go ahead.

Thanks for taking the follow up. You're welcome. Hi, you talked about customer uncertainty relative to, all the geopolitical risks that we're aware of. When you look at your customer orders or when you have discussions with customers, I'm sure it's different for many of them across the spectrum, but what would you estimate is their assumption as to the resolution of the current sort of trade negotiations going on? Or asked another way, if we see tariffs tick up from the 10% rate to 25, do you think that's already contemplated in your customer's outlook or is that an incremental hit to demand? Thank you. Well, you

know how many customers we have. It's basically well over a half a million. So, to synthesize that, it's very different depending upon where they are in the world as well as other opinions they have. So, I really can't answer that. I think everybody has been planning and working around a tariff environment and I do think that creates uncertainty for all of us. So, people go to the conservative side versus the aggressive side and that's really the only color I can give you from our customer discussions. Okay, thank you,

Will. It looks like there's no further questions. So, if you have additional questions, please contact Investor Relations at TE. Thank you for joining us this morning and have a nice day.

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