TE Connectivity Ltd

Ladies and gentlemen, thank you for standing by and welcome to the TE Connectivity Third Quarter Earnings Call for Fiscal Year 2020. At this time, all lines are in a listen-only mode. Later, we will conduct a question and answer session. To ask a question during that time, you will need to press star 1 on your telephone keypad. As a reminder, today's call 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 third 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, Sheila, and also thank you everyone for joining us today to cover our third quarter results, as well as our expectations as we look forward. Before we get into the results of the quarter and the slides, I do want to take a moment to provide our perspective of what is the same and also what is different from the time we spoke just on our last earnings call 90 days ago. So let me first start off with what is the same. First, we do continue to be in a challenging market environment that is influenced by COVID, and we continue to prioritize the safety of our employees while also focusing on meeting the needs of our customers while they are also navigating this environment. I think the second key thing that is the same is that our balance sheet and liquidity were strong coming into the COVID downturn, and it remains strong. We have a strong cash generative business model with flexibility to use our cash for investing for growth opportunities and improving our cost structure while continuing to return capital to our owners. Another key point that is the same is that we continue to execute on our cost reduction and footprint consolidation plans. These plans will enable higher earnings leverage as we capitalize on content opportunities as the markets return to growth. And the last thing that we spoke about last call that is the same is that our manufacturing resilience was a differentiator last quarter, and you're seeing it again this quarter. It is enabling us to serve our customers through this volatile environment and our strong operations capability continues to set TE apart from other suppliers that we believe will enable share gain opportunities during this time. So with that being a backdrop of what's the same, now let me highlight some of the key differences versus 90 days ago that both Heath and I will cover during today's discussion. Last time when we spoke in April, orders were declining And during that time, our customers were shutting down manufacturing plants in Europe and North America due to COVID, with the biggest impact being in our market-leading automotive business. We have now seen China return to essentially pre-COVID levels, and we continue to see improving order trends in both North America and Europe after the April low point. Another key difference is that in our third quarter, we were looking at strong sequential sales declines and margin and EPS compression when we spoke. I'm happy to say that our quarter three results came in better than we expected. And in the fourth quarter, we are now expecting sequential sales growth as our auto customers are ramping production, along with not only sales increase, we're going to continue to see expansion of margins and earnings per share sequentially. And we do believe that our third quarter was the low point for our revenue and earnings. To continue to build on auto, another key difference is that auto production was declining to a low point of 12 million vehicles that were produced in our third fiscal quarter. We are now expecting a 40% increase in auto production sequentially into September. And we're pleased that dealer inventories remain at appropriate levels that support that production. And the last key difference I would say versus last quarter is, you know, while we're being impacted by market volatility in our transportation segment, our industrial and communication segments performed well in light of market conditions last quarter. And we expect sequential sales to be stable into our fourth quarter for those two segments on a combined basis. So I do hope that just starting off by sharing what's the same and what's different from 90 days ago, will help frame our discussion today. One final thing I'd like to cover before we get into the slides is also how our employees and teams have completely leaned in and aligned with TE's purpose of creating a safer, more sustainable, productive, and connected world during this crisis. Our teams have been focused on working with our customers to increase production of key elements like for respirators and ventilators where our products are key building blocks in their architecture. And another thing that I'm very proud of, and it was an employee-led effort, is that we've utilized our 3D printing and molding expertise to supply face shields for healthcare workers around the world. And I'm pleased to tell you that we now have produced and donated over 120,000 face shields for frontline healthcare workers in hospitals around the world. I would tell you these are just a few examples of what our teams have done, but it also gives me confidence in our focus as well as the opportunities of what we're capable of as we come out of this crisis. Overall, we are pleased with our performance considering this challenging and in many ways unprecedented environment. We are also expecting that the recovery will be gradual, more like an endurance race than a sprint. But I will tell you, we remain excited about our content and growth opportunities that we position TE around. So with that lead in, Let's jump into slides and if you jump to slide three, let me get into the numbers for quarter three as well as how we're thinking about quarter four. For the third quarter, sales of $2.5 billion were better than our expectations. They were down 20% sequentially and versus our expectations where we thought they would be down 25%. Excluding auto, Our sequential sales declined 4%, showing the performance of our industrial and communication segment, which delivered results in line with our expectations in a challenging market. Transportation sales were down 32% sequentially, better than we anticipated across each of our businesses in the segment. And really, the supply chain corrections we thought by our customers were less than we expected in the quarter. In the industrial segment, sales were down 10% sequentially, with much of the weakness driven by commercial aerospace. While in the communication segment, our sales were up 14% sequentially, driven by strength related to cloud applications. From an earnings perspective, adjusted operating margins were 9.4%. And I am pleased, even with a concentrated drop in our auto sales, in our transportation segment, we were able to manage the earnings fall down on sales and achieve the adjusted OI we reported. Adjusted earnings per share was 59 cents. This was ahead of our expectations due to the management of our operations on lower sales. In the third quarter, our free cash flow was $280 million, with approximately $240 million being returned to shareholders in the quarter. including approximately $160 million in dividends. Year to date, free cash flow was approximately $830 million, and we continue to expect to exceed $1 billion of free cash flow for 2020. As we look to the fourth quarter, we do expect fourth quarter sales to be up sequentially by approximately 10% from the third quarter, with sales growth driven by the transportation segment as our customers increase auto production. We expect our industrial and communication segments to be essentially flat sequentially in the fourth quarter on a combined basis. We also continue to expect to improve our earnings power by continuing to execute the footprint consolidation plans while we've also accelerated additional cost reductions considering the weaker demand environment that we're experiencing. Longer term, we remain committed to our margin expansion plans and the expectations that we've shared with you. As we look beyond the current environment, we are excited about how we positioned our portfolio to benefit from secular trends, and I'll highlight these as I go through the segment results. So if you could, I'd appreciate it if you could turn to slide four, and let's get into the order trends so we can share what's on the slide. and what we've seen as we've gone through the quarter, as well as what we've seen in July. For the third quarter, our orders were $2.4 billion, and that was in line with what we expected. We have seen continued monthly trends improve since the bottoming in April. In April, really, as our customers shut down, it was a very slow order month, and we talked about it in our last call. When we look at going into the fourth quarter, we are entering the fourth quarter with a stronger backlog position than we normally have. And our July book-to-bill ratio came in at 105. And this supports our view of a 10% sequential growth in the fourth quarter, which will be driven by our transportation segment. I also want to add some color on what we're seeing in order from a geographic perspective. We have seen improvement in China back to pre-COVID levels. And while our order is contracted in both North America and Europe across all segments during the quarter, we are encouraged that the monthly order trends have been improving in those regions since the low point in April. So I'd ask that you turn to slide five and let's get into our sales view for the fourth quarter and how we're thinking about it. We are expecting sales to increase by approximately 10% sequentially into our fourth quarter. primarily driven by a 40% sequential increase in auto production. We expect auto production to go from roughly 12 million vehicles produced globally in the quarter three to nearly 17 million vehicles produced in quarter four. When you factor in our content per vehicle, this will drive approximately $300 million of growth sequentially. While this is a sharp increase, I do want to highlight that auto production is still well below the 21 million vehicles per quarter that we were planning our business around being produced before COVID. Beyond automotive, we do have some puts and takes, both on the positive and the negative side. And we are expecting sequential growth in some of other businesses, but this is expected to be offset by residual impact of supply chain correction by our auto and other customers. When we think about this growth of 10% sequentially by segment, we are expecting approximately 20% sequential growth in transportation, while in industrial we'll have slight growth, which will be offset by a modest sequential decline in communications. On this increase for revenue sequentially, we expect roughly 35% incremental adjusted operating margins on the volume growth, Note that the incremental margins do reflect the impact of us working down inventory in the quarter as we continue to drive free cash flow. Now, with that as a backdrop at the total company level, let me briefly discuss year-on-year segment results in the quarter on slides 7 through 9, along with some key drivers in each of the segments that we expect will fuel future content and growth. So in the transportation segment, sales were down 37% organically year over year, with declines in each of our business as you can see on the slide. In auto, sales were down 43% organically, which was in line with global auto production declines. Even with the dynamic changes in the auto market due to COVID, our content growth expectations are unchanged as evidenced by the fact that year to date we are generating 600 basis points of content growth above production, which continues to enable our outperformance versus a weaker production environment. The other thing I want to highlight is that while the production of internal combustion vehicles will drop significantly this year, we do expect production of hybrid and electric vehicles to be up approximately 12% in fiscal 2020. That gives us confidence around where we've positioned ourselves around the electric powertrain and the investments we make. And just to bring this to life a little bit on the electric vehicle, we continue to innovate with our customers as they move to more sustainable vehicles by providing leading-edge technology and products to enable and improve performance of both hybrid and full electric platforms. In fact, we've generated approximately $6 billion in design wins for connectors and sensors in hybrid and electric vehicle platforms across every leading OEM. More importantly, our customers' plans remain intact for EV and hybrid electric vehicles. And there's even been some acceleration of roadmaps along these platforms as OEMs respond to increased demand and a more stringent regulatory environment in certain parts of the world. And what we also get excited about is while we talk to you a lot about what's going on in the electrical powertrain in cars, It's also important that we're taking this technology over to the commercial transportation space as well. And a key example of how we're doing that there is the applications in our work with Nikola. Nikola is using hydrogen electric technology in its next-generation trucks, and we have partnered with them to enable these designs as we work with them on their architecture. Our products are in various subsystems within the electrified powertrain of their trucks, as well as also the various infotainment and driver convenience systems that use high-speed data connectivity solutions. And what's really important about this as we look forward is all these things come together in delivering a Class 8 zero-emission truck with equal or better performance of a diesel truck and capable of a 750-mile range. And I think it just proves that, you know, In these markets, we've had leadership, and we're going to continue to have clear leadership as we help solve next-generation electrical powertrains. So with that on transportation, let me turn over to the industrial segment. In the industrial segment, our sales declined 13% organically year over year, and adjusted operating margins were approximately 13%, and certainly impacted by the lower volumes. It's important... that we feel good that we remain in track with our long-term margin expansion plans to drive adjusted operating margins into the higher teams in this segment. During the quarter, commercial airspace and industrial equipment perform as we expected. However, we did see some declines in our medical business due to the delays in elective procedures caused by COVID-19. We do believe this is a short-term dynamic in our medical business that is consistent with what our customers are seeing. And we expect this market to return to strong growth as elective procedures start to increase. And just to remind you, what we built in our medical space is a leading position around interventional procedures. And we will come back to strong growth because this is a market that we believe long-term has high single-digit growth. And we partner with the leading device makers globally by enabling minimally invasive treatments for heart valve replacement, stroke clot removal, brain aneurysm treatment, and other critical procedures. And to bring it to life, on average, 120 patients per minute are treated with medical devices that incorporate our innovation. And we've generated over a billion dollars of design wins in this business, which will enable strong growth over the long term. Let me turn to communications and give a recap of that segment in the quarter. In the segment, we grew 4% organically year-over-year, and adjusted operating margins expanded to approximately 16%. That was in line with the business model target of the mid-teens that we've been talking to you about. Data and devices grew 13% organically year-over-year due to our strong position in high-speed solutions and cloud applications. In this business, we continue to benefit from the increasing demand for bandwidth and higher speeds in the data center. Our products and technologies enable 800 gigabit per second performance, and with that, also the thermal properties that are required in next-generation data centers for the world's leading cloud providers. Similar to medical, in the past three years, we've generated over a billion dollars of new design wins in our cloud business, giving us confidence around future growth. So with that backdrop, both overall and with the segments, let me turn it over to Heath, who'll get into more details on the financials and our expectations going forth.

Well, thank you, Terrence, and good morning, everyone. Please turn to slide nine, where I'll provide more details on the Q3 financials. Adjusted operating income was $240 million with an adjusted operating margin of 9.4 percent. Adjusted EPS was 59 cents. GAAP operating income was $134 million and included $98 million of restructuring and other charges and $8 million of acquisition charges. We expect restructuring charges to be approximately $250 million for this fiscal year, similar to last year. GAAP EPS was a loss of 18 cents for the quarter and included a non-cash tax-related charge of 51 cents related to an increase of our valuation allowance for certain non-U.S. deferred tax assets. We also have restructuring and acquisition and other charges of 25 cents. The adjusted effective tax rate in Q3 was 15.9%. For Q4, we expect a tax rate of approximately 19.5%. Importantly, we expect our tax rate to continue to stay well below our reported ETR for the full year. Turning to slide 10, sales of $2.5 billion were down 25% year-over-year on both a reported and organic basis. Currency exchange rates negatively impacted sales by $35 million versus the prior year. Adjusted operating margins were 9.4%. And as Terrance mentioned, I am pleased with our overall performance, especially given the over 40% sales drop in our auto business in the quarter. We continue to execute on footprint consolidation plans and pursue additional opportunities to drive cost reduction. We remain committed to our margin expansion goals, and we expect volume growth combined with our restructuring plans to drive adjusted operating margins in transportation to 20%, industrial into the high teens, and communications consistently in the mid-teens. In the quarter, cash from continuing operations was $380 million. Free cash flow was $280 million for the quarter, and year-to-date free cash flow is $834 million. For this fiscal year, we expect free cash flow to be above $1 billion. In the quarter, we return $241 million to shareholders through dividends and share repurchases. And just as we noted last quarter, we will continue to thoughtfully evaluate the buyback program as we see market conditions evolve. And I want to give you an update from an operational perspective. We are currently operating all of our factories around the world. As Terrance mentioned, our manufacturing resiliency has enabled us to support our customers' demand through a volatile supply chain environment. Our inventory position increased in the quarter, which helped us meet customer commitments, but we do expect to reduce our inventory levels going forward, normalizing to the demand environment. Reinforcing our comments from last quarter, We are in a strong liquidity position with approximately $2 billion available and have a strong balance sheet. This allows us to maintain a balanced capital strategy, returning capital to shareholders while continuing to invest to support our growth opportunities. Now please turn to slide 11 to summarize how we were thinking about the fourth quarter based on everything we've discussed so far today. For Q4, we are expecting sales to grow approximately 10% from Q3 with sequential improvement driven by auto. As we mentioned earlier, we are expecting approximately 35% fall through to adjusted operating income on that sequential volume growth. In terms of market, we are expecting global auto production to increase from approximately 12 million vehicles in our fiscal Q3 to approximately 17 million in our fiscal Q4. We believe this is supported by the production ramps of our customers, along with the appropriate levels of dealer inventory in China and North America. As we discussed throughout the call, our portfolio is well-balanced to benefit from several secular trends across our business, including content growth. While this will be a gradual recovery, as Terrence noted earlier, we do expect revenue growth and margin and EPS expansion as demand returns. So while the demand environment continues to be dynamic, we are pleased with our operations resiliency as well as our ability to keep employees safe while continuing to serve our customers during this challenging time. We have a solid balance sheet, ample liquidity, and solid free cash flow which enables us to maintain a balanced capital strategy and we will continue to invest in growth opportunities across our business. I'm Also very confident that this will enable us to emerge stronger and more profitable when markets do return to growth. So with that, Suzhou, let's open it up for questions.

Sure. Jacqueline, could you please give the instructions for the Q&A session?

Certainly. At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. In order to have time for all questions, each participant is limited to one question. If you would like to ask a follow-up question, please press star 1 to return to the queue. Your first question comes from the line of Wamsi Mohan from Bank of America. Your line is open.

Yes, thank you. Good morning, Terrence. Really impressive performance on the trough operating margins this cycle. For my question, I was wondering if you could provide some additional color on the order cadence you're seeing and any early thoughts on how this recovery cadence compares to perhaps other auto downturns you've seen. Thank you.

No, thanks, Wamsi. So let me spend a little bit more time on orders, expand on what I said. So first off, one of the things that I think has been unique about this downturn has been production was shut off. even when there was still demand. And that's very different than any other downturn. And our orders in the quarter, and you can see on the order slide I went through, the $2.4 billion, and even our book to build was very light in the quarter because of the sharp decline in orders we saw in April in the Western world. And we saw Asia and China orders. In China, they bounced back. In other markets like Japan and Korea, They're still recovering, but didn't go down as deep as certainly Europe and North America did. So, you know, when you think about the shape that we've seen and what we're working with our customers on, especially in transportation, you saw as they were thinking about ramping improvement in May, improvement in June. And as we shared during the call, you had, you know, we had 105 books to build in July. And I think one of the keys when you think about a book to build, there's a numerator and there's a denominator. And the denominator is also strong. So it gives us the confidence around where we're telling you we think sales are going to be, even though we continue to be in a very volatile environment. I think when you think about, and let's keep it to transportation first, how is production ramping? We do see production getting back to 17 million units, which is pretty consistent with where production was in the second quarter. but it's still below the 21 million units. So it's nice to see our customers ramp. If you take places like North America and China, dealer inventories look in line because production was shut down so abruptly and demand continued, albeit at a lower level. So, you know, they're the things we're going to continue to be watching as we move forward. And what has been nice outside of transportation, while there's puts and takes, like we covered with Heath and I, While there's strength in some markets, it's also offset in some markets that are weak like Comair. And I think that demonstrates how we've improved the portfolio over, you know, our time since the last crisis. So we are encouraged by where the orders have been tracking to, but certainly it is a continually environment that's impacted by COVID that I think we do believe will continue to be a gradual recovery, as I said. Don't think it'll be bouncing back to 21 million vehicles immediately, but we have to see how the world heals and how the economy heals.

Okay. Thank you, Wamsi. We have the next question, please.

Your next question comes from Amit Daryanani from Evercore. Your line is open.

Perfect. Good morning, guys. Thanks for taking my question. I guess I had one question on the incremental margins, and it's super early on the West Coast. I'm probably doing my math wrong, but it looks like you did about 43% decremental margins in the June quarter, and the guide, I think, is implying about 35% incremental margins. I guess, Terrence or Heath, maybe it would be helpful to understand why aren't we seeing the same magnitude of margin recovery in the September quarter as we saw the downtick over here. Just some context on this would be really helpful. Thanks.

Thanks, Ahmed. This is Heath, and good morning. Your math is correct on the decrementals in terms of the magnitude of the sales drop in our fiscal third quarter was about $650 million. And clearly the guidance, if you will, here in terms of our directional sequential move up 10%, It implies something closer to $250 million or so on the way back up sequentially. So part of it is just the magnitude of the revenue drop versus the smaller initial rebound. The other thing is, and keep in mind, I mentioned in my prepared comments that we will be reducing inventory in the quarter, and that does have some effect as we think about the flow-through math on how that handles, works through our absorption. So thank you for the question. Thank you, Amit.

Can we have the next question, please?

The next question comes from Craig Hettenbach from Morgan Stanley. Your line is open.

Yes, thank you. Question for Terrence. Can you talk about the dollar content that you're seeing in designs for EVs versus combustion? And then just more broadly, Terrence, I know there's been a lot of supply chain disruptions, but what are you seeing from a new design outside of EVs, just an automotive? Are you seeing any stall programs or things kind of tracking as you'd expect from a new design perspective?

Thanks, Craig, for the question. So a couple of things. One of the things that is a real positive that we talked about in the prepared comments was where our content's holding in. And let's face it, the content's holding in very strong, and we have the separation, and it is due to the progress in EV. And, you know, we're getting the benefit of, while electric vehicles are up 12%, you're seeing that in the content, and you see that year-to-date. And, you know, I think the story around content is still the same for us. It's going to be 4% to 6% over time. We're proving it through the cycle, which I think is one of the things that I think we're going to prove to you through a down cycle here that that content story is real. And the other thing that I would share with you is how we thought about what that content opportunity is versus a combustion engine has not changed. So when you think about full electric, due to not only the normal features you have as you get the electrified powertrain and the other products we bring, And the architecture we bring, we still view that's 2X, our traditional combustion engine. That's around 60-some bucks. Hybrid electric is about one and a half times. So when you look there, that's intact. Now, to the second part of your question about what do we see from customers, you know, our customers, you know, continue full steam ahead on the electric programs, but they are making choices. And we do see Around some areas around autonomy, that is being pushed out. So as they're making their choices, as they're selling less cars, producing less cars, and they have the pressures of COVID, they're making choices. And where you see the choices being made prioritized are very much on the electric powertrain. And we have seen some slowdowns and some features and programs around autonomy. As you always know, electric vehicles are a bigger content play for us that we've shared with you than autonomy. Certainly, autonomy will continue to be a content opportunity. It's just going to be longer, and that's what we're seeing. And we did have some program slippage just due to how our customers have to work with COVID and had to delay some ramps, but that's just temporary. It's not impacting our content at all. So hopefully that helps. Okay. Thank you, Craig. Can we have the next question, please?

Your next question comes from Joe Giordano from Cowan. Your line is open.

Hey, guys. Good morning. Hey, Joe. Hey, just curious for that. The content discussion here, as you talk about a 40% increase in market production in the next quarter, how do you guys expect to compare to that? And some of your competitors, when they're talking about the market over the next three and six months, have been pretty conservative versus third-party estimates. And talking about summer shutdowns and some restocking in China over the last months, a few months that haven't been like directly related to production. So just curious how you think through that.

Yeah, sure, Joe. So let me maybe share a little bit about the production environment, then we'll get into, because we do believe there is some supply chain work off by our customers. So, you know, we did say that we think there's going to be 17 million vehicles made in the fourth quarter. And China is running, you know, about 400 Four and a half million units. So it's come back. It's production solid there. We still expect that in North America and Western Europe, you're off a very deep trough. And I think the other key element to realize is, you know, being a global leader, we're strong in every market, which also includes Japan and Korea, not just North America, Europe and China. And, you know, while the effect has not been as deep in Japan and Korea, auto production is still off pre-COVID levels in Japan and Korea. So we see that being a gradual recovery back up. So that's the production environment that we see, and that's really from talking to our customers and the insights we have. When we think about sequential revenue, we do expect an increase aligned with our content to the production. But as I mentioned, there is about $100 million that we think needs to work off by our customers. They ramp down hard, and they're ramping up hard. And from a supply chain, that is a lot to happen perfectly. So as we think about our guide, and as I said, from our expectations, there is about $100 million that is primarily an automotive that we think needs to be worked off at this point in time and does normalization. So hopefully that answers your question. Okay, thank you, Joe. Can we have the next question, please?

Our next question comes from Sean Harrison from Loop Capital. Your line is open.

Hi, morning everybody. Terrence, you touched on kind of, you know, EV acceleration, but maybe you could speak on kind of, you know, what you're seeing coming out of this, maybe an acceleration of programs and other end markets or businesses or things that just, you know, you've seen during COVID that have you excited and also just the other side of that kind of, you know, incremental margins on the upside as you get through this restructuring, are they going to be better than kind of what we've seen or at least anticipating better than what we've seen over the past couple of years as well? Yeah.

Thanks, Sean. And I think when you say, what do I get excited about post-COVID, the first thing will be that we're post-COVID. So certainly it's been a challenging environment that we're all living in. The first one that I would say, and it's a little bit different than where we position TE and also the cost actions that you highlight in your question, is one of the things that we are very excited about in this time is opportunity for just core share gains. You know, during this time, our customers are making choices. They have to make choices as, you know, they're dealing with the same reality we are. And, you know, during the last down term, we picked up here in some key markets, and I also believe this market is an opportunity for that. And I think some of the things we talked about up front, not only how we innovate, how we're proving them through manufacturing, we're going to be there for them no matter what market environment we're in, and also the stability of TEA. from our capital structure that was pre-COVID. So that's one thing we do get excited about. The other thing I would tell you that we're excited about, and it goes into some of your cost elements and incremental margins, is we're excited we didn't hit this downturn being flat-footed. We talked to you about the work we had to do in transportation as we were planning around an 84 million global vehicle environment. that we had cross-actions that were starting. That'll come in as we go forward. And let's face it, we'll have to do further adjustments to whatever global auto production comes out to. And also in industrial, where we were marching up. Certainly, we have to make some adjustments in some of the areas around commercial aerospace due to that market. But I do feel that we didn't hit it flat-footed, and our teams are embracing the reality of where markets have been impacted You know, we're making those adjustments that we have to make to really make sure we serve our customers and also our owners well. The other thing I would say that we do get excited about, and you see it in the results, which it is very different, where we position TE, we have a leading automotive business that we aren't going to apologize for. The content opportunities, both around EV as well as the returns we get in that business, You know, we're very strong, and they have not changed the return profile. The other thing I would tell you is you see the benefits of how this portfolio has changed. You see us talking about cloud. You see CS being at target margins. And the other opportunities that I highlighted in the script, I feel very good about. So where this portfolio is positioned, yeah, we're being impacted by COVID in our leading business, but we don't feel we should apologize for it because it's a global business with a leading position that our customers are going to need us more now, and we see opportunity in this time as we come out of it, and we're going to be there for them. So I do appreciate you asking that question, Sean, to maybe get away from the current a little bit, but I do appreciate the question. All right. Thank you, Sean. Can we have the next question, please?

Your next question comes from Stephen Fox from Fox Advisors. Your line is open. Thanks. Good morning.

I was wondering if you could just maybe following up on that last question, talk a little bit more about your footprint from two aspects. One is your advantages versus say the other large sensor like Molex, Amphenol, Hirose, et cetera, since you highlighted that. And then secondly, Terrence and Keith, just getting a sense for the endpoint on the industrial business or rather the manufacturing footprint. How do we think about that given your prior comments? Do we, relative to when auto production comes back to prior levels and your content gains, how much more would there be to go? Thank you. Sure.

So let me take the first part, and then I'll ask Heath to take the second part, Steve, and thanks for the question. One of the things when you think about the footprint and one of the things that's a fragmented space, and you mentioned a couple customers, it is very important, especially as people are trying to think about where supply chain need to be post-COVID, certainly post other things going on in the world, and how we've continued over the past decade to make sure we are global while also making sure we're supporting regional supply chains, you all know we've done a lot of work. And it's actually served us extremely well in this time. So as our customers are really working through where do their supply chains need to be post-COVID and certainly to their strategies, we continue to see our global deployment, which is balanced to our revenue, and also how we continue to make shifts to be something that is a differentiator. So, you know, in some cases we compete against companies that are very regional, might be in only a single country, and where we're able to flex, it is very important. And I think we prove that during the tariff time. And certainly, you know, we're continuing to prove it during COVID. And I think you saw that in both last quarter and this quarter's results. As we go forward, we still view that that's the right strategy, that we're going to continue to make sure we engineer where innovation is happening in the world. And where innovation occurs and where manufacturing occurs is not always completely aligned based upon our customer strategy. So it is very important in our business model that the innovation and our engineering nodes are where innovation happens in the world. We have not seen where the innovation happens in the world change. Certainly, there's been more discussion around how does the supply chain work. And, you know, we're going to continue to evolve to make sure we service our customers as they see where they want to innovate and make. And that will continually evolve. Supply chains don't change in a day. And I really like how we're positioned and how we service our customers, especially in this dynamic time. So that's the first half. Keith, do you want to take the second half around the industrial?

Yeah, and Steve, I appreciate the question. The industrial footprint, you know, we talked about really going back to a couple, three years ago in terms of that journey that we're on. And the number of facilities, where they are and everything, that is unchanged. We are executing along that plan. I will say that, you know, we're still a couple years away, and partly is because of some of the COVID-driven changes slowdown, particularly in the commercial aerospace, where we're not expecting a recovery anytime soon. And that does, you know, allow us opportunity to, to, you know, continue to streamline that footprint. So we're still a couple years away, but you'll see incremental improvements along the way, like I believe you already have. So You know, I think the next couple of years are going to continue to be very busy, both on the transportation side and on the industrial side, with some of the activity that's underway.

Thank you.

That's helpful. Thanks, Steve. Thanks, Steve. Can we have the next question, please?

The next question comes from Mark Delaney from Goldman Sachs. Your line is open.

Yes, good morning. Thanks very much for taking the question. Hey, Mark, better under... Good morning. I was hoping to better understand the thought process about reducing the company's inventory this current quarter. And maybe you can frame it relative to the bookings that are improving and also with the footprint consolidation concept. I think the company would need to carry some extra inventory to enable the footprint consolidation. So if you can balance some of those facts with the decision to reduce inventory and provide some more clarity on that, it would be helpful. Thanks.

Sure. Mark, and I'll take that question. You know, we made a conscious decision in certain parts of the business when things really started getting, I'll say, choppier dynamic here back in the spring and that our customers, which are always front and center in our inventory discussions, they were still working through exactly what their production plans look like. Some were thinking a shorter-term shutdown, which then evolved to a longer-term shutdown. Some were moving production in different places. It was obviously an opportunity for us to make sure we were there with them And we made the conscious decision to hold a bit more inventory in different parts of the world and different end markets to make sure we were there. Now as we see a little bit more stability in the order pattern and a little bit more consistency week to week, it does avail an opportunity for us to, I'll say, more normalize. Now, you're absolutely right. You know, there are some buffer builds associated with factory moves. But some of that was underway here, you know, not just starting here in those past quarters. Some of that's been underway for a while. So that's already built into our assumption set. And, you know, we'll continue to manage it, you know, along the lines of what we see out there with demand patterns. But I see an opportunity in the quarter to reduce it. And we'll execute on that. But if we need to make decisions otherwise, as the quarter progresses, we will. But it's all tied to how we think about the customer's order pattern and the confidence that we can have coming from their moves. Okay. Thank you, Mark. We have the next question, please.

Your next question comes from David Kelly from Jefferies. Your line is open.

Hey, good morning. Hey, David. Just hoping you could remind us of your typical sequential flow through in a growth macro. And maybe given your cost actions over the last three years, how are you thinking about potential leverage post-inventory work down? And we were curious, particularly if we see a gradual market recovery through 21, how you're thinking about sequential flow through here.

Well, I mean, our sequential flow through, if you go back over time, right, in a, I'll say, more normalized environment, which we're certainly, you know, view those days a bit more favorably, but we would kind of say our flow through would be consistently around 25% year over year on that kind of math. Sequential flow through, though, can be a bit more dynamic because your cost structure every 90 days doesn't move as much as it might year over year. Now we have taken a lot of costs out. We have a lot more costs that are going to continue to come out. That has the benefit for us of simply reducing our fixed cost base as we consolidate plants and so forth. And so, you know, coming out of this, I would hope that our flow through would obviously improve versus maybe normalized times if you go back over the last couple of years. At the same time, we're continuing to make some investments to grow with our customers as they recover. But right now, I feel like the moves that we're making will have a significant impact on our fixed cost structure, particularly in our industrial and in our transportation businesses. And we've taken charges over the last two years of about $500 million to enable that. Now, some of that's because many of these plants were outside the U.S. and tend to have more expensive um you know restructuring costs to do so but the long-term strategies is uh is worth the the cost to us so it will improve versus that 25 i can't tell you exactly when because some that's going to be dependent upon a lot of we depend upon where the revenue comes back to okay thank you david we have the next question please

Your next question comes from Deepa Righevan from Wells Fargo. Your line is open.

Hi, good morning. Can you talk through how European automotive vertical is responding to the green stimulus and other incentives provided by countries there? Also, how would you generally rate the sales recovery trends in Europe automotive? Thank you.

Hey, Deep, it's Terrence. You know, one of the things, you know, on your question is, you know, the EU had put in in Europe, you know, carbon regulations that have been impacting our customers that we talked a lot about pre-COVID and certainly how those regulations have come in. I think when you really look at what we've seen, and certainly COVID has made it confusing while those regulations are in, I think the real bright spot that we see, and the growth this year in electric vehicles, that 12% we talk about is almost entirely driven out of Europe. And if we went back two, three years ago, we would have sat down with you and said, China and Asia will be the driver of hybrid and electric vehicles. Then Europe and North America, certainly there isn't regulatory support for it. North America would always be... the slowest adoption rate. And with the regulations that we have, European EV and HEV sales are up about 90% year on year. So it actually gives us confidence that some of those regulations are gaining traction in the car sales and also in the production levels. And as you all know, Europe is one of our higher content regions. and also higher share regions. So it serves very well, and we've been investing very much in electric vehicles all over the world, but certainly in Europe and Asia it's been very important. So, you know, those trends are helping us, and we think that certainly they're going to continue to help us as we go forward. So thanks for the question.

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

Your next question comes from Jim Suva from Citigroup Investments. Your line is open.

Thank you. Um, Terrence, I believe if I heard correctly on your prepared comments, you mentioned the guidance for transportation to be up around 20%, if I heard that right. Um, yeah. And if, if so, then auto production, you know, I think people are expecting kind of say from 12 million to 17 million, which is like a 40% or a much bigger increase. What's, what's the, reason or rationale to bridge that gap? Is that inventory digestion or timing? And if so, does that kind of get in equilibrium after this quarter?

Sure. No, good question, Jim. And really, there's two factors. When we talk about our transportation segment, no different than our quarter we just ended, auto production was down 40. You know, the segment was down 30. So there are other things outside of auto. That's industrial transportation, certainly sensors. So there is an element that won't always correlate. But the other big part is the part that you articulated. We do, and as I said in my prepared comments, we still think there's about $100 million of supply chain to work off as our customers have been trying to get their component supply chains lined up. And that's a headwind as we go sequentially. And a lot of that's in automotive. If you look at it, it is 40% in production increase from the 12 to the 17. You also get the $100 million of supply chain work off, and then just realize we have two other units in that segment that aren't fully auto. So that's really how you should think about it. Okay, thank you, Jim. Thanks, Jim. We have the next question, please.

Your next question comes from Matt Sheeran from Stiefel. Your line is open.

Yes, thank you. Terrence, I'm hoping you can give us your read on the commercial transportation business. We've been in a cyclical downturn for the last few quarters here. So what's your outlook there? Has that market bottomed as the passenger vehicle market has, or is there still some downside there? And then related to that, the content opportunity, I think, in that market probably is as beneficial as it is in the passenger vehicle market.

Thanks, Matt. You asked about one of our more complex markets, and, you know, when you look there, it has been in a downturn, and we talked about it. And, you know, when we think about 2020, the year we're in, you know, globally you have, you know, construction's been weak. The truck and bus part has been weak, and certainly agriculture has been weak. So if you really take the bigger markets there, they've all been weak. And there's different inflection points when you look at that geographically. You know, emissions play a very big part into this market, not only what goes on with COVID. And it's one of the things that I think when you go to, as we see there, in certain regions it does look like it's bottoming. In other areas, you know, due to emission benefits we've gotten, it may get weaker. So it's a tale of multiple cities. The more important thing, you know, is where we've improved our content opportunity here. And, you know, one of the things that I think we've done an exceptional job on, you know, not only in where we were traditionally strong in the U.S. and North America and Europe, but also in China, I mean, China this year will be our largest region in our industrial transportation market, and that's very different than when we did the Deutsche acquisition. Historically, you would have had probably China would have been maybe 10% share, and now it's our largest region really due to how we've really penetrated that market, taken advantage of the infrastructure spending there and also the emissions evolution. And that is truly not only a market story but a content story. And then, you know, even the example I gave during the script today where you see some of the progress of where does a sustainable powertrain go in a Class A truck. You know, in ICT on total, we can range on average $300 to $400 a content per vehicle. You get really like a 3X in an electrified vehicle. large vehicle. And they're the things that our engineers are working on with our customers. And as that becomes more of a reality, we'll drive content growth. So it's not only what we see in the auto, but also some of those features that are trying to be taken over into the truck and bus and the commercial transportation markets are also benefiting us. And we have the leading position in that market, similar to automotive business. So It's really about how do we continue to help our customers as they want to take to the next generation's architectures. Okay, thank you, Matt. Can we have the next question, please?

Your next question comes from Sameek Chidurji from J.P. Morgan. Your line is open.

Hi, good morning. Thanks for taking my question. I just had one longer-term question on automotive. You've talked today extensively about the leverage you have to electrification as a theme. Just curious kind of how to think about the portfolio, automotive portfolio, and leverage to autonomous vehicles as a kind of team overall, even though we're seeing some push-outs here. And you mentioned kind of the landscape is good for share gains overall in this kind of right now the environment we are in, but how are you thinking about M&A in this landscape? Thanks.

Well, a couple of things. First off, we are exposed both. One of the things I think is unique to us is You know, we benefit from both of those trends, and many companies benefit from one or the other. Autonomy, though, has been one. When you think about architecture in the car, it has always been a lower content opportunity versus EV. And we've shared those content charts with you about how much do we get on a content of our $65, which it breaks down between safety applications, impotent and data stack, as well as production, I mean, power train stack. And clearly the powertrain stack is always the biggest content for us, and that's why we do benefit as the architecture moves more electric. Autonomy is going to be something that drives content. It's part of our four to six, but clearly not the largest piece of it. Powertrain has always been the largest piece, and we play in all the applications in the car, just not specific ones. As you look at M&A, I think as we've gone over time, we're going to look where we can add value both to the acquisition as well as helps us solve our customers' problems. And we continue to look at M&A. You see first sensor, we finally closed after we announced that last year. That's going to help us from the sensor suite, and we'll continue to look at M&A across all our businesses as we move forward to say how does it strengthen us and continue to improve our portfolio and get return for our ownership. Okay, thank you, Sumit. Can we have the next question, please?

Your next question comes from Joseph Spack from RBC Capital Markets. Your line is open.

Thanks very much. Terrence, maybe you could just be a little bit more explicit about your assumption for North America production on a year-over-year basis in this coming quarter because indications are that July is even flat to up year-over-year. So I just want to understand some of your conservatism there. And then maybe also if you could just clarify, I thought I heard you say 4.5 million units in China, which seems well below trend. I don't know if I misheard there, but if you could clarify that. Thanks.

Now, a couple of things. Your 4, 4.5 million for China is right per quarter. So that's a per quarter number, not an annual number. So that is where we view China production was in quarter three, and we expect it to be similar in quarter four. So that is right for China. And when you get to North America, honestly, we think North America production is going to be around 3.5 million units, which is pretty consistent with where it was in quarter one and quarter two of this year. I do want to, you know, I made the comment earlier, you know, at TE we serve every piece of the world, and North America is our lowest piece of our revenue. So, you know, Just remember, there is other countries out there that we have very large positions in, like Japan, like Korea, in addition to North America. So North America, we expect production to be about 3.5 million units in the fourth quarter. Okay. Thank you, Joe. Can we have the next question, please?

Thank you. Your last question comes from Nick Todorov from Longbow. Your line is open.

Yeah, guys, thanks. Good morning. I think, you know, giving us those production numbers, I think you and your competitors differ from the third-party estimates. So I was wondering if you can give us any sense of what is your initial thought on calendar year 21 production? I know we're way too far and visibility is very low, but how are you thinking about that recovery? I think you mentioned you're expecting a gradual one. Do you see in a scenario where when calendar year 21 production goes back to similar levels to 2019 or you think that's going to take a little bit longer to get there?

I think the one thing you have to think about and it's the hard thing that we all have to deal with is how does COVID continue to impact? It is the thing that's the same and how does that go forward? So we can't comment on 2021. I think the key is you look right now and We are encouraged that production is getting back to 17 million units. We have to see that the consumer demand to pull through on those cars produced. We like where inventory levels are right now. But as this is all ramping, I think the first step we have to get there to is how does our customers ramp up to 17 million after being at 12 and where the consumer demand goes in the next year. And I think the baseline you would start with is where quarter four production is at as you go into next year and you can do scenarios. I think point estimates are very dangerous in an environment like this. You've got to be thinking scenarios. Okay, thank you, Nick. It looks like there's no further questions. So if you do have further questions, please contact Investor Relations at TE, and we thank you for joining us this morning. Have a great day.

This concludes today's conference call. You may now disconnect.