TE Connectivity Ltd

Ladies and gentlemen, thank you for standing by and welcome to the TE Connectivity Fourth Quarter Earnings Conference 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. If you would like to ask a question at that time, please press star 1 on your touchtone phones. If you would like to withdraw your question, press the pound key. 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, Mr. Jules Shah. Please go ahead.

Jules Shah Good morning, and thank you for joining our conference call to discuss TE Connectivity's fourth quarter and four-year 2020 results. With me today are Chief Executive Officer Terence Curtin and Chief Financial Officer Heath Mitts. During this call, we will be providing certain forward-looking information and we ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning and we ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation, can be found on the investor relations portion of our website at te.com. Due to the large number of participants on the Q&A portion of today's call, we're asking everyone to limit themselves to one question to make sure we can give everyone an opportunity to ask questions during the allotted time. We're 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 results of the fourth quarter, as well as our expectations for our first quarter of fiscal 2021. Before I get into the slides, I do want to frame out some key points about today's call. First off, I am very pleased with our execution in the fourth quarter, where we delivered sequential sales growth of 28 percent, which was above our expectations, and adjusted earnings per share of $1.16. Our top line benefited from a better than expected recovery in automotive production, coupled with our leading position in this market. Adjusted operating margins expanded sequentially by over 500 basis points, while we also executed on our inventory reduction plans that we discussed with you last quarter. And while we're still in a market where we're being impacted by COVID-related weakness, and it has challenged our business model on margins and EPS, I also believe we successfully executed a number of the key elements of our business model, including strong free cash flow, as well as content growth that helped offer the weakness we had in key markets. And I'll come back to this in a moment and get into a little bit more detail into that. The other thing is that we are pleased to see a faster recovery in certain markets as evidenced in our orders. But I do want to highlight that the visibility on the shape and the slope of the longer term recovery still remains limited. And lastly, as we look into our first quarter, we are expecting sales to be roughly flat to the first quarter of fiscal 2019, but with adjusted operating margin and earnings per share expansion, both year over year, and on a sequential basis. And for the first quarter, which Heath and I will talk about, we are expecting sales and adjusted earnings per share of approximately $3.2 billion and $1.25, respectively. Now, while the challenges that we've experienced associated with COVID impacted the second half of our year, I am pleased that we demonstrated the key elements of our business model in fiscal 2020. We are benefiting from the active management of our portfolio over the years and the actions that we've taken to optimize our cost structure. And before we get into the slides again, I just want to give a few examples of what stood out to us during the year. First off, despite the market headwinds, we benefited from the secular trends across the business that we've positioned the company around. And this is evident in automotive. where we delivered six points of outgrowth versus the auto market in 2020, which reinforced our ability to generate content growth in both a growing and production or declining production environment. And it's also important to remember that China is the largest auto production market in the world, and we've benefited from increased volumes in our leading position in this region as it's recovered. Another highlight is our communication segment that remained resilient through the downturn and delivered strong growth both year-over-year and sequentially in the second half, driven by the build-out of data center capability. We also saw margin expansion with the segment delivering adjusted operating margins at its mid-teens target level for the year. And lastly, the foundation of our business model is the cash-generative nature of our businesses. We once again demonstrated this in fiscal 20 with $1.5 billion of free cash flow, and this represents 104 percent conversion in net income. You know, with this as a backdrop, I do want to take a moment to provide some perspective on our business and markets relative to our last earnings call 90 days ago. Last quarter, we said that the third quarter would be the low point of our downturn, of the downturn. This is now confirmed with 40% improvement in sequential orders in the fourth quarter, along with sequential revenue and EPS growth, both in the fourth quarter as well as what we expect into the first quarter. As we look into the first quarter, the business is returning to prior year levels with expansion of adjusted margin and earnings per share. And while auto production has come back a little bit stronger than we expected, we are still well below 2019 production levels of 88 million units on an annual basis. And we still believe the shape of the recovery will continue to be gradual and dependent on the global consumer. Over 19 million vehicles were produced in the fourth quarter, and we expect sequential improvement in auto production in the first quarter to 21 million units. In our other two segments, the industrial and communication segments, we do expect them to be down sequentially with some pockets of weakest like we have in commercial aerospace. So with that, let me get into the slides. And if you could please turn to slide three, I'll provide some additional details for the fourth quarter and the full year, as well as our expectations for 2021 first quarter. Quarter 4 sales of $3.26 billion were better than our expectations and up 28% sequentially. Transportation sales were up approximately 50% sequentially, driven by the recovery in our auto sales, which were up 68%. Industrial sales were up 11% sequentially with growth across all businesses. And in our communication segments, sales were up slightly sequentially and up 12% year over year. During the quarter, we saw orders of approximately $3.35 billion and a book-to-bill ratio of 103, which I'll add more color on when I talk to that slide in a moment. Adjusted earnings per share was $1.16, and adjusted operating margins were at 500 basis points, sequentially to 14.5%. As we mentioned at the onset of COVID, we kept inventory levels relatively high to ensure we could meet commitments to our customers through a period of supply chain volatility. During the quarter, we drove a significant reduction in inventory in TE, primarily in the transportation segment, with some reduction in industrial as well. This helped our free cash flow, but did impact our margins negatively, both at the company level and in the transportation segment. In the fourth quarter, free cash flow was approximately $650 million, and we returned $1.1 billion to shareholders during the year, including approximately $625 million of dividends and $500 million of share buybacks. When we look to the full year of 2020, Sales were $12.2 billion and they were down 10% year over year on both a reported and organic basis due to the impacts of COVID on our markets. Adjusted operating margins were 14.2% with adjusted EPS of $4.26. While transportation and industrial were impacted by the market weakness, our communication segment grew 15% organically from the first half to the second half, demonstrating the diversity of our portfolio. I am also pleased that we didn't hit this downturn flat footed. Prior to the onset of COVID, we began executing on cost reduction and footprint consolidation plans in the transportation and industrial segments to get to the target margins we've been discussing with you. As we look forward, we do expect quarter one sales of $3.2 billion, which is up 1% year over year on a reported basis. and adjusted earnings per share of $1.25, up 3% year-over-year, which is an expansion in both adjusted operating margins and EPS in the first quarter. So if you could, I would appreciate if you'd turn to slide four and let me talk about orders across the businesses as well as geographically. For the fourth quarter, our orders were over $3.3 billion, and our book-to-bill improved to 1.03, as I mentioned earlier. On a year-over-year basis, transportation orders grew 12%, driven by auto. But we did also see growth in our commercial transportation and sensors orders as well. Industrial declines year-over-year were primarily driven by the ongoing weakness in commercial airspace. And in communications, our growth was 13%, driven by the appliances business unit, as that market recovers globally post-COVID. Our book to bill was above one in transportation and below one in our other segments, supporting our sequential revenue growth in quarter one in our transportation segment and the declines we expect sequentially in industrial and communications. So let me add some color on orders from a geographic perspective. For the second consecutive quarter, we saw an increase of orders in China. which were up nearly 25 percent year-over-year in the fourth quarter, with growth in each of our segments but particular strength in transportation. We saw approximately 8 percent year-over-year growth in our orders in Europe, and this was also primarily driven by transportation. And in North America, our orders declined 8 percent year-over-year, primarily driven by the industrial segment and weakness in the Comair market. So with that as a backdrop of orders, let me get into the segment results, and they'll be on slides five through seven, and I'll hit the high points that'll be on the slides as I go through the segments. So let me start with transportation. Transportation sales were down 6% organically year over year, with declines in each of our business, as you can see on the slide. In auto, sales were down 4% organically, driven by global auto production declines. Even with the dynamic changes in the auto market due to COVID in 2020, we generate six points of content growth for the full year. And that just proves our continued outperformance versus the weaker market. I would ask you to keep in mind that content growth can vary quarter by quarter, but we continue to expect four to six percent content growth in auto over the long term. And when you look at 2020, The production of internal combustion vehicles dropped nearly 20% this year, but we did benefit from the increase in hybrid and electric vehicle production that was up 13% in our fiscal year. You know, when you look at hybrid and electric vehicle production, and that represents 10% of total global auto production, and we expect that EV and HEV production to reach approximately 20 million units in the next five years. Our customers' plans remain on tack for full battery electric and hybrid electric vehicles, and there's even been some acceleration of roadmaps as OEMs respond to increased demand and a more stringent regulatory environment in certain parts of the world. We are a leading provider of technology and products to our customers as they move to more sustainable hybrid and electric platforms. In sensors, we saw 10% growth year-on-year due to the revenue contribution from the first sensor acquisition. And on an organic basis, sales increased 9% sequentially as we expected, with our year-over-year performance being impacted by the market volatility. We continue to grow our design wind pipeline and auto applications and expect growth as these platforms increase in volume. Adjusted operating margins for the transportation segment declined year over year as a result of the planned inventory work down in the quarter that I mentioned earlier. We expect significant sequential adjusted margin expansion in the transportation segment in the first quarter, which will be the driver of the company's margin expansion both sequentially and year over year in the first quarter. Let me turn to the industrial segment. In this segment, Sales declined 6% organically year-over-year, and our adjusted operating margins were approximately 14% and impacted by the lower volumes, as well as some of the inventory work down. We remain on track with our long-term margin expansion plans in this segment, and we remain focused on driving adjusted operating margins into the high teens. During the quarter, the segment continued to be impacted by the decline in the commercial aerospace market. with our airspace defense and marine business declining 13% organically. We do expect the common air weakness to continue into early 2021 as the market is still in the process of bottoming. In our industrial equipment business, our revenue was down 2% organically and better than we expected, with declines in Europe being partially offset by growth in Asia. We continue to see weakness in our medical business with ongoing delays in elective procedures caused by COVID. We believe this is a short-term dynamic in our medical business as consistent with what our customers are seeing, and we expect this market to return to strong growth as elective procedures start to increase. Turning now to communications, our sales grew 11% organically year-over-year with growth in both data and devices, as well as appliances. We continue to benefit from the recovery in China and Asia more broadly, which represents over half of our sales in this segment. Data and devices grew 7 percent organically year-over-year due to our strong position that we've built in high-speed solutions and cloud applications. Appliances grew 18 percent organically year-over-year, with growth across all regions and benefits from an improved housing market, as well as supply chain replenishment. Our communications team performed very well, and adjusted operating margins grew to over 21% in the fourth quarter. This strong performance is a result of the multi-year transformation of our portfolio and reduction in our cost structure and manufacturing footprint. Adjusted operating margins for the segment for the full year were 16%, which is in line with our target, and we continue to expect mid-teens operating margins long-term in this segment. So with this overview of segment performance, if we turn it over to Keith, he'll get into more details on the financials as well as our quarter one expectations. Thank you, Terrence, and good morning, everyone. Please turn to slide eight, where I will provide more details on the Q4 financials. Adjusted operating income was $473 million with an adjusted operating margin of 14.5%. GAAP operating income was $347 million and included $113 million of restructuring and other charges and $13 million of acquisition-related charges. For the full year, restructuring charges were $257 million, and I expect restructuring charges of approximately $200 million in fiscal 21 as we continue to optimize our manufacturing footprint and improve the cost structure of the organization. Adjusted EPS was $1.16, and GAAP EPS was 69 cents for the quarter and included a non-cash tax-related charge of 17 cents related to an increase of the valuation allowance for certain deferred tax assets. We also had restructuring, acquisition, and other charges of 31 cents. The adjusted effective tax rate in Q4 and the full year was approximately 17%. And for FY21, we expect an adjusted effective tax rate around 19%. But it's important to note here that our cash tax rate will still be well below that in the mid-teens. Turning to slide 9, sales of $3.3 billion were down 1% on a reported basis and down 4% on an organic basis year over year. Currency exchange rates positively impacted sales by 39 million versus the prior year. And at current levels, currency will be up 55 million tailwind in Q1. Adjusted operating margins were 14.5% and expanded 510 basis points sequentially, as mentioned earlier. While we anticipated pressure to our operating margin performance due to the planned inventory reduction we highlighted last quarter, I am pleased that we reduced inventory by nearly $300 million in the quarter. Just as a point of reference, our inventory overall came down 12% from the June quarter to the September quarter. And as you can imagine, that had a couple hundred basis points of pressure to our margins as we got the inventory right-sized. But I feel good about the impact it had on our cash flows. The inventory reduction, primarily impacted the transportation segment, but we also had some impact in the industrial segment. We continue to execute on our footprint consolidation plans and pursue additional opportunities to drive cost reduction. We remain committed to our business model margin expansion goals, and we expect volume growth combined with our restructuring plans over time to drive adjusted operating margins in transportation to 20%, industrial to the high teens, and communications consistently in the mid-teens. For the quarter, cash from continuing operating activities was $719 million. Free cash flow was approximately $650 million for the quarter. For the full year, free cash flow was approximately $1.5 billion, which represents 104% cash conversion. For fiscal 21, we expect free cash flow conversion to again be strong at approximately 100%. Looking back on our performance in fiscal 20 and the extreme volatility we saw in our in markets, our cash flow and capital structure performed in line with our expectations. We maintained a strong liquidity position and generated strong free cash flow in each quarter of this year. We maintained a balanced capital strategy, returning capital shareholders and remaining active in M&A with the acquisition of First Sensor. During the year, we spent $505 million on share repurchases, buying back 6.5 million shares. At the same time, we continued to invest for future growth through R&D and capital spending initiatives and were able to gain share with key customers through our robustness we showed in our manufacturing operations. Going forward, we remain committed to our balanced capital deployment strategy and expect to return two-thirds of free cash flow to shareholders while supporting our inorganic growth initiatives. Please turn to slide 10 to discuss our expectations going forward. For Q1, we are expecting sales of approximately $3.2 billion, up 1% on a reported basis and down 2% organically on a year-over-year basis. Sequentially, we are expecting organic growth in transportation to be offset by modest declines in both industrial and communications. On a year-on-year basis, for the first quarter, we expect transportation to be essentially flat organically, communications to grow mid-single digits, and industrial to be down mid to high single digits. Adjusted EPS is expected to be approximately $1.25, up 3% year-over-year. And for the first quarter, we are expecting significant growth in adjusted operating margins from the fourth quarter levels. As Terrence mentioned, we are still dealing with low visibility, and it is difficult to predict the shape and slope of the recovery in different end markets and geographies as the world continues to deal with COVID. We do want to share some of our key market assumptions as we plan the business. We expect global auto production to be approximately 21 million units in the first quarter, up sequentially from Q4, but still below prior year levels. Due to the December quarter being the strongest production level of the year in China, we are expecting Q1 to be the high point of global auto production for our fiscal year. We continue to expect strong content growth of 4% to 6%, enabling us to continue outperforming the auto market. In industrial, we continue to expect commercial aerospace market to stay weak, declining over 20% for the second consecutive year. And we do expect our medical business to improve as we move through the year. In communications, we expect continued increases in cloud provider spending, driven by the growth in online activities and our data and device business plays directly into this favorable trend. So I've already summarized some of our financial assumptions for the fiscal year on this slide. They are there for easy reference for you. Now let's open it up for questions.

If you would like to ask a question, please press star 1 on your touchtone phone. In order to have all questions for each participant answered, There is a limited, we are limited to one question per participant. If you would like to ask a follow-up question, please press star one to get Bob to answer it. One moment for your first question. Your first question is coming from Ramzi Mahan with Bank of America.