TE Connectivity Ltd

Ladies and gentlemen, thank you for standing by and welcome to the ETE Connectivity second quarter earnings call for fiscal year 2020. At this time, all lines are in listen-only mode. Later, we'll conduct a question and answer session. To ask a question during that time, you'll need to press star 1 on your telephone. If you require any further assistance, please press star 0. As a reminder, today's call is being recorded. I would now like to turn the conference over to your host today, Vice President of Investor Relation, Sujil Shah. Please go ahead.

Good morning, and thank you for joining our conference call to discuss TE Connectivity's second quarter 2020 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're 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 our second quarter results, insights around what we're seeing in real time, and how this is expected to impact us as we look forward. We are all living through a challenging environment brought about by the global COVID-19 pandemic. When we had our last earnings call just 90 days ago and provided our outlook, it was before the initial onset of COVID in China, and we did not include any expected impacts in our quarter two guidance. I'm very pleased that despite the impacts, we were able to deliver the results in line with the expectations and meet the commitments we made to our customers as well as our shareholders during the quarter. Before I get into the results, I do want to thank our employees. As you all know, we are a global company with engineering and manufacturing operations around the world, and the safety of our employees has been a primary concern. I would like to express my gratitude and appreciation to our teams for their dedication as we navigate the COVID-19 crisis and continue to effectively serve our customers as they also were trying to figure out how to navigate this crisis. A few things that I think stand out in our response to this crisis. First, as a company, we were able to prioritize the safety of our employees while demonstrating strong execution with our customers. Our engineering, customer service, and other non-manufacturing teams adapted well to remote and online work to ensure innovation and service to our customers. I also believe we demonstrated operations resiliency. In China, we brought back our plants online relatively quickly, considering the environment, and steadily increased utilization levels to minimize the impact in the quarter. All of our factories are open and running in China, and Heath will highlight where we are in manufacturing in Europe and North America in his section a little bit later. And lastly, I believe we demonstrated agility, and it gives us confidence about our ability to continue to adapt to changing conditions. Our employees have been extraordinary in supporting our communities, customers, and each other. And what I've seen in the past few months gives me confidence in our position coming out of this crisis. We'll talk more about what we expect over the next few months, but I am proud of the performance, resilience, and flexibilities of our team in this quarter. So if you could, let me start talking about results, and they'll begin on slide three, and I'll frame out the key points of today's call. We delivered sales that were in line with our guidance and adjusted earnings per share that was above the high end of our guidance range with strong performance across all three of our segments. Adjusted operating margins were above 16% and reflect the diversity of our portfolio and the early execution of cost reduction actions, placing TE in a position of strength in a time of continued uncertainty. Another key point is that our balance sheet is strong and we have ample liquidity. A key part of our business model is a strong free cash flow engine that is resilient in periods like this. We expect to generate well in excess of $1 billion of free cash flow this year, and we also have $2.3 billion of liquidity available. Also, as we look forward, there is limited visibility of future demand. We do expect to see greater COVID-19-related impacts in our business in the second half, with particular market weakness in transportation as well as in the commercial aerospace market. As a result, we are estimating that our sales could be down approximately 25% sequentially into quarter three from our quarter two levels. And lastly, as we look beyond the crisis, we do remain excited about where we position TE strategically. I'm convinced we'll get through the crisis and there is no change to our margin expansion plans and the expectations we've shared with you. We expect to improve our earnings power by continuing to execute footprint consolidation plans while accelerating additional cost reductions in light of the weaker demand environment. When markets do stabilize and return to growth, we are well positioned to benefit from a recovery in China, which is about 20% of our business, as well as a broader recovery in the automotive and transportation markets. And the other thing that's great with our cash flow is that we will continue to invest in content growth opportunities to enable outperformance versus underlying end markets. And we will continue to benefit from the secular trends across the businesses and where we position TE. So if you could, I'd appreciate if you could turn the slide floor and at four, and I'll get in to review a few additional highlights from the second quarter. Sales of $3.2 billion were in line with our guidance and it was down 6% on a reported basis and 5% organically year over year. Our orders grew sequentially and we sold a book to bill of 1.05. And these orders reflect that our customers securing supply chain of components in an uncertain supply and demand environment. In fact, our orders in the quarter were higher than we expected when we started the quarter. But I think a key point is that late in the quarter, we did see a fall off in orders in certain businesses, which continued into April. And I'll discuss that and more when I talk to the next slide. From an earnings perspective, our adjusted operating margins were above 16%, and adjusted earnings per share of $1.29 exceeded the high end of our guidance, driven by the strong execution of our teams in all segments. And reinforcing my earlier comments on our cash-generative business model, year-to-date free cash flow was up 34% versus the prior year, and in the second quarter, free cash flow was approximately $310 million, with approximately $430 million being returned to shareholders during the quarter. Going forward, we remain committed to our dividend, but we'll continue to evaluate our share buyback plans in light of the uncertain market conditions. As we look forward, we are withdrawing our guidance for the full year, but we are providing a high level view of quarter three as compared to quarter two. For the third quarter, we believe that our sales could be down approximately 25% sequentially with a roughly 45% sequential fall through to adjusted operating income on the sequential revenue decline. This reflects the order trends we're seeing with market weakness driven primarily in the transportation and commercial aerospace markets, along with some inventory and supply chain corrections that I will discuss. While we can't influence the market environment or how COVID will impact our customers, we remain committed to execute on the leverage we can control to drive our cost reduction and footprint consolidation plans while continuing to invest in the long-term growth and content opportunities of TEE. So please turn to slide five and let me get into the order trends, not only in the quarter, but also what we've seen since quarter M. For the second quarter, orders were at $3.4 billion and stronger than expected as customers secured supply of components in an uncertain supply chain environment, particularly in China. While we were impacted by the COVID-related shutdowns in China early in February, I am pleased with how quickly we brought our 18 factories back online. Due to the high levels of automation, our revenue was minimally impacted in the quarter, and we were able to maintain production to meet our customer commitments, even with periods of labor shortages. I believe this demonstrates that our core manufacturing capability is a source of differentiation, both for TE as well as our customers. As you can see on the chart, We've laid out the sequential orders for quarter one and quarter two, so I'm not going to spend as much time on the actual numbers in quarter two, but I want to spend time on what we're seeing in late March through April to provide a more accurate picture of demand going forward as the Americas and Europe were being impacted by COVID. In transportation, we saw a drop off of orders that started both in auto and commercial transportation late in March and continued into April. As you know, our customers have closed factories starting late in March in Europe and North America. I'm also sure you've seen some of the announcements discussing the plant closures as well as the assumptions of when production can return. In industrial, we saw erosion of orders in commercial aerospace, but we had ongoing strength of orders in our defense business, our medical business, and our energy business and our energy business services, the power utilities of the world. In communications, we have seen stronger demand in data and devices for cloud-based applications as data centers build out further capacity to handle the increase in high-speed data traffic and storage, as well as China recovering. And in China, which represents about 20% of our sales, In March and into April, our orders have basically returned to pre-lunar New Year levels before the COVID outbreak occurred in China. So we are seeing a recovery in China across many of our businesses. So let me turn to slide six, and I can frame how these trends connect to our sales view of quarter three. And this is a new chart that we included for you. We are highlighting some of the major sequential drivers from quarter two to quarter three in our assumptions on this slide, but I do want to highlight we aren't capturing all the puts and takes of our different businesses in the quarter. Directionally, we are expecting sales to decline approximately 25% sequentially into quarter three, and we put these into four buckets. The first bucket is around auto production. We do expect auto production globally to decline by approximately one-third sequentially from the 18 million vehicles globally produced in the second quarter to approximately 12 million vehicles being produced in the third quarter, which is aligned with IHS's view. This production decline in auto will drive about half of our sequential decline of total company revenue. The second bucket... is an expected reduction in commercial aerospace market of approximately one-third due to lower production by the large airframe manufacturers. So these first two buckets are really market related. The third bucket is around the auto supply chain. And with our second quarter auto sales well ahead of production, and I'll talk about that, there was a component inventory build by our customers in the quarter. As a result, we expect approximately $200 million of inventory adjustments by our customers in the third quarter. And this should be a temporary effect as that inventory bleeds off. And then the fourth bucket covers supply chain impacts outside of auto. DE and our customers have a number of factories that are temporarily shut down due to COVID-19 as a result of government actions. We expect the resulting supply chain disruptions to impact a number of our other businesses, and this will cause a reduction of approximately $100 million in the quarter as we go through this quarter. I want to highlight, you know, this is the near-term impact that we're seeing due to the pandemic. But longer term, we expect to continue to benefit from broad secular trends across our businesses, you know, based upon the leading market positions that we've built. So let me now turn briefly to discuss segment results in the quarter. And, you know, we probably did it with the full details on slide seven through nine for your reference. I'm just going to touch it high-level verbally. In our transportation segment, sales were down 5% organically year over year with declines in each of our business. Auto sales were down 2% organically with global production declines being down 20%. Our relatively stronger performance was driven by our customer supply chain builds ahead of factory closures, as well as the continued benefit of content growth. While we are in a volatile demand environment, we continue to expect increased production of hybrid and electric vehicles and ongoing adoption of autonomous features, which will continue our market outperformance that we've had for quite some time now. In sensors, I want to highlight that we recently completed the acquisition of First Sensor, which will now be included in our financial results beginning in the third quarter. In the industrial segment, our sales declined 3% organically year over year as we expected. We saw declines in commercial aerospace and industrial equipment as a result of the market weakness. However, we are seeing stability in defense, medical, and energy due to positive underlying trends and expect those businesses to continue to be stable as we move through the rest of the year. In communications, sales and margins came in as we expected, and while data and devices declined in the second quarter, we are seeing growth in high-speed and cloud applications, and expect this to continue into our third quarter. So with that as a backdrop, let me turn it over to Heath, who will get into more details on the financials, and then I'll come back and cover our expectations for the third quarter.