TE Connectivity Ltd

Ladies and gentlemen, thank you for standing by, and welcome to the TE Connectivity second quarter earnings call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If you should require assistance during today's call, please press star, then zero. 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, Sujel Shah. Please go ahead.

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 Mitz. 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 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. Thank you, Shijal, 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 about 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. You know, also, despite this weaker market backdrop in some of our key markets, I'm pleased with how we're 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 growth side of it, I do believe we position T to benefit from secular trends, and we talk 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 CE is our strong cash flow generation model. And that allows us to support sustainable organic growth while enabling return to capital shareholders, while also looking at bulk on acquisitions. And these are all key levers in our value creation model. So with that as a quick summary, let's get into slides and I'll get into slide three 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 15 cents above the midpoint of our guidance. Our results continue to reflect improvement in 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 communications 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. You know, those of you who have been with us a while, you know the reshaping that we've done in our portfolio and our communications segment over the past number of years. You know, 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 communication segment, they're 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 margin business. And over the past couple of years, we doubled the profitability of this segment based upon the strategic actions we took. You know, 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 years ago when we mentioned to you that the segment was not earning where 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 of our 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 flattened 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 is $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 Kisling 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 earning momentum in quarter two, we are raising the midpoint of our guidance by 15 cents to take the total year up a 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 review. So with that as an overview of the quarter, let's turn to slide four, 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, orders were down sequentially by 2%. due to a softer end market across our business. Turning the orders by segment, transportation orders declined 4% year-over-year as expected. And we saw the similar trend sequentially that I just mentioned with stabilization in China while having a slightly weaker Europe. 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, given by both our businesses in this segment and China, data devices and appliances. So with that overview on orders, let's get into the segment details, and I'll start with slide five, 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 content 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% without performance 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 wind value across a broad spectrum of auto sensor technologies and applications. And year-to-date, we have $450 million in new design winds across transportation applications. For the 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 the segment. which will result in margin expansion in the second half. With that, let's turn over to industrial, and that starts on slide six. Overall, the segment sales grew 5% organically year over year. This was above expectations, with growth being very strong in aerospace, defense, medical. In AD&M, the business delivered a strong quarter of 13% organic growth, driven by program ramps in both commercial airspace as well as a strengthening defense market. In industrial equipment, sales were up 1% organically, and it was really a tale of two 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 costs 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 to just operating margins at the high team for this segment over time. So please turn to slide seven and I'll get into communication 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 the Asia region. In data and devices, sales were flat organically, with growth in data center applications 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. I'll get in the financials and I'll come back and talk about guidance.

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. We have 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 impacts sales by $154 million versus the prior year. Adjusted operating margins were 17%, driven by strong operational performance. 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. Pre-cash flow was $344 million with $179 million of net capital expenditures. We returned $338 million to our shareholders through dividends and share repurchases in the quarter. In the first half of 2019, free cash flow was $413 million, an increase of 44% versus the first half of the prior year. We expect that our free cash flow will exceed the prior year, even with the increased level of restructure 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 acquisitions. I'm now going to turn back over to Terrence to cover guides before Q&A.