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.

Yes, thank you, and congrats on a really strong quarter and guidance in this environment. Keith, I was wondering if you could clarify some of the moving pieces on transport margins. Your transport revenues were almost flat on a year-on-year basis, but you had big negative leverage. How much of that was the inventory issue that you were addressing earlier? And can you clarify... what the inventory levels are now and if there's going to be any residual impact to to margins in fiscal 1q and just as a point of clarification on the comment on reaching the high point of production in the december quarter i don't think you're suggesting that also implies peak eps in fiscal 1q but was just hoping you would clarify that as well thank you uh thanks wamsi and uh let me try to tackle those here yeah certainly uh that inventory reduction

more than two thirds of it or so from the total was in transportation. And that was really the driver of our transportation margins being close to the 13% level. So we would expect as we move forward, inventory is now in the right place in terms of what we need to see moving forward. And I would expect the Q1 numbers to tick up significantly at the transportation level. And as Terrence noted earlier, that'll flow through nicely to the overall performance for margins in our first quarter. In terms of the comments around The Q1, we're trying to highlight that the 21 million vehicle auto production number in Q1, we anticipate that 21 million to be the high point in the year. That does not mean that that's going to be necessarily the high point of TE's revenue or EPS for the year. Okay. And we've got other businesses in the portfolio and some do have some seasonality element to it. In addition to some of the medical recovery that we would anticipate more in the second half of our fiscal year. And obviously, you know, we're actively engaged in a lot of cost reductions. We've got pretty significant heavy lifting this year with some plants coming offline. The timing of those will be staggered throughout the year. But as you can imagine, as the year progresses, certainly we start to benefit more and more from exiting those costs. So hopefully that clarifies your question. That's great. Thank you. Thank you, Lanti. Can we have the next question, please?

Our next question comes from the line of Amit Adaryanani with Evercore.

Good morning, guys. Thanks for taking my question. You know, I was hoping... Hi. I was hoping, Terrence, maybe you could talk a little bit about content growth and how do you see that stacking up in fiscal 21, especially on the EV market, in a scenario where there are more tired of fuel efficiency and emission standard requirements, especially in the U.S. What could that do to that content growth number that you guys have in fiscal 21?

Certainly. I think 2020 clearly solidified where we sort of say 4% to 6%. There is an element of, you know, where does the consumer go to buy as well as the government programs help it. One of the things that's been very nice, and I mentioned in the comments, is you see EV production and car sales really increased last year, double-digit in what's a really tough economy. And it was more in Europe, and it actually was where it's been in Asia. And we still view that Asia and Europe will be the leading areas where you get adoptions. Like we've always said, you do typically mean where EVs are still less penetrated. You do need some government help to basically make sure as that scales. And the U.S. is still an area that is less penetrated than the others and has less regulation. So anything that helps EV penetration and increased penetration helps our growth. And, you know, a chunk of our content is driven by the EV growth this past year being in the double digits. And, you know, we're bullish on EV, and certainly we've been investing to make sure we help scale that architecture globally. And what's nice is it looks like the bigger adoption is going to be in Europe and Asia, which is, you know, our strongest market positions. Okay. Thank you, Ahmed.

Can we have the next question, please?

Your next question comes from the line of Mark Laney with Goldman Sachs.

Hello, Mark, are you on? All right, looks like we're having an issue. Could we go to the next question, please? We'll come back to Mark.

Your next question comes from the line of Craig Heitenbach with Morgan Stanley.

Yes, thanks. Question for Terrence. If I look at your December quarter, it looks a bit above typical seasonality. I know this is a very unusual year in terms of what's played out up to date, but just curious to get your context in terms of what you're seeing for December versus what you typically see and any puts and takes by the end markets there.

Yeah, let me spend a little time on it. And, you know, the first thing I would say is, and he talked about it, so that we're all aligned. You know, auto production typically in the December quarter is the strongest quarter of the year of global auto production. And that's really driven by China being the largest car-producing country on the planet. And, you know, as they've taken that position, the December quarter is typically the strongest in China. And, you know, that's why we believe the first quarter can be probably the strongest for the year. But as we look across the portfolio... You take areas like industrial transportation. There are areas that have been hit hard by COVID. We did see sequential improvement. We did benefit from China's strength, but our global position is also driving great content in places like India and Europe that we think can be a growth driver as we go into next year, even though China may have some market anniversary that becomes a little bit tougher. You know, in the industrial markets, Craig, you know, Comair, we do expect, you know, we are in the middle of a bottoming process there. We do think that'll be a little bit negative as we go into the early part of 21. But we do get excited that, you know, the medical business is going to be rebounding back here as elective procedures pick up. And in communications, we talk a lot about, you know, our performance this past year, And I think we're going to continue to benefit from as our global appliance position that you saw the benefit and revenue as we go into next year. And that recovers and certainly rebounds as well as where we've done things secularly in our D&D business, which has been a lot of hard work. We repositioned that. So I do think it's a little bit different than normal seasonality. You know, seasonality is tough to sort of think about in this environment when our customers are telling us visibility is short. But it's nice to see the recovery coming back a little bit faster than we thought in auto. And, you know, we're trying to stay close to our customers. How do we help them as we're all dealing with an environment where visibility is light?

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

Your next question comes from the line of Sean Harrison with Loop Capital.

Hi. Good morning, everyone, and my congrats on the strong finish to 2020. I wanted to just dig a little bit deeper into margins on a twofold aspect. Number one, do you expect transportation needed margins to be back to the year-ago level now adjusted for the inventory that came out? How do we think of kind of incremental margins either across transportation as well as industrial from here, knowing that we've had a couple of years of restructuring in hand?

Thanks, Sean. This is Heath. I think you can, you know, as we look into FY21, and obviously we're only guiding this first quarter, feel pretty confident in our ability to get back to prior levels in terms of margins for transportation, for sure. In terms of the incrementals, I think it's fair to say at the TE level that thinking about a 30% or 35% flow-through is a fair way to think about it, and that pretty much is consistent down through the segments. Now, we used to say kind of 25% to 30%, if you recall, and some of the activities that we've undertaken um are allowing us to step up some of that commentary a little bit um so i feel pretty good about that now keep in mind that you know some of the heavy lifting that we're doing on restructuring and these some of these plants if they were if these plants were easy to take offline we would have done it a long time ago so um they are you know in many cases from the time that we announce and take a charge it can take 12 or 15 months to completely get them offline and exit the costs from those. So, you know, we're active. We've seen plans come offline at FY20, and then in FY21, we'll see another surge of that. So we're really probably talking FY22 and so forth before you start to see the more significant step up incrementally from here. But certainly at the TS level, we expect margins to improve dramatically in our fiscal first quarter. Okay. Thank you, Sean. We have the next question, please. Luke, we have the next question, please.

I'm sorry. Your next question comes from the line of David Kelly with Jefferies.

Hi. Good morning, guys. I appreciate you taking my question. I just wanted to get a

morning. Just wanted to get a feel for some of the opportunities that are front of mind for TE into a new year with hopefully some continued ramp towards normalcy. So could you talk about some of the biggest strategies, opportunities out there that you see on the horizon, you know, things like whether it's ramping electrification and autos, you know, return to M&A or kind of broad electronification as a content driver? sure yeah thanks david and yeah let me take that you know first of all you know it is nice to see the world still in recovery mode you know certainly with the uncertainty that's around us due to covid but you know probably the first thing that we're excited about you know is not only how the portfolio is sort of playing out like we expected in a cycle because we will be impacted by auto cycles due to our great position there But I would also tell you that dealing with what we dealt with in 2020, that we do have a clean portfolio versus what we've had in other cycles, I think came true. And honestly, it allows us to play offense around where we make our investments organically, as well as if we do want to bring both home. And from that viewpoint, I think that's the number one thing that's nice going through the cycle versus others. think we gave you some examples about the content you know the number one content driver for te is around automotive it is around electrification it's also the element also around data in the car and you know that's why we get excited with the 600 basis points we showed last year about performance and we are confident with the wins we have that that type of level in our four to six percent that we've told you about above production as global production continues to heal And let's face it, we're so well off the 90-plus million units of cars produced a few years ago. The other thing that I would tell you is during this downturn, it's given us an opportunity in many ways to really make sure we get closer to our customers. They need to make sure they have the partners with them that are going to be there. long-term, and I do believe our manufacturing strategy that we've been investing in, which includes the cost actions that he talked about, has really been an element of how do we get and continue to move our global manufacturing to be local for local. And it's been a journey. We have a lot of work to do on that. It provides cost, but it also provides service elements. And it does come back to why we feel good that we didn't enter this flat-footed. we understand that we have margin opportunity in transportation and industrial. We've been talking about that. And, you know, how do we couple that with the content opportunities, not only in automotive but in medical, and also what we've done in cloud are things that we get really excited about. And, you know, we have the engineering lens that support that. So, you know, as we're all dealing with an uncertain environment, that we have to navigate through and adjust to, but we also have to accept the reality of the opportunities as well as where some markets like Comair, we have to adjust to the reality of that market won't be what it was. And they're the things that I think will drive both growth levers from here, but also margin levers and our capital structure and free cash flow generation allows us to make sure we can be focused on improving the business and growing the business.

all right thank you david can we have the next question please your next question your next question comes from the line of deepak brahavana with wells fargo securities hi good morning all um yeah congrats on the uh solid execution as well um i have a margin question too um q1 you're on your how do you think about industrial margins in Q1, I'm assuming we won't see the inventory impact repeat in Q1. So would that grow margins year on year in Q1? Also, your leverage in autos should be pretty nice in Q1, just given that auto production in peak volumes, 21 million. But what kind of margin levers do you have post Q1? And should we expect that margins in TS can grow rest of the year also. I mean, clearly you've under-earned because of COVID situation in 2021.

Well, thanks, Deepa. There's a lot packed into that question. So let me get at it. The industrial margins, I think the prudent viewpoint on that is that they'll kind of move, they'll be consistent in Q1 with what you saw in our fiscal fourth quarter that we just completed. albeit on lower revenue, which was expected. And there is some seasonality as we move generally through the year within industrials. So, I think we're holding our own there in terms of the journey within the industrial margin structure. But from Q4 to Q1, I think you should expect those to be roughly flat on lower revenue. Obviously, your question around auto and then more broadly TS, the impact that it has, you are correct. I mean, we do have some good leverage there, you know, in terms of our Q1 performance, I think we've talked about it a few different times here on the call in terms of seeing significant sequential improvement in that. And then, you know, as we move throughout the year, you know, the auto has obviously gained the benefit of the content, and we've seen that activity continue to be strong. But, you know, it kind of gets down a little bit to what you think auto production is going to do in the subsequent quarters. That's one element of it. And then, you know, obviously, as we layer in some of the restructuring activities, we have several plants that are becoming offline, but you'll see those more impacted late in FY21 and more pointedly in FY22. So there are some pieces there, but we feel very good about that. the actions we've taken to date and what that allows us to do on the incrementals moving forward. And again, we've kind of stepped up our dialogue there from, I'll say, pre-COVID activities in terms of what we think the incrementals could look like. Okay. Thank you, Deepa. Can we have the next question, please?

Your next question is from the line of Sameek Chatterjee with J.P. Morgan.

Hi. Thanks for taking my question. I just wanted to hit the EV content story in a different way and see if I can get some more color here, particularly when I'm iterating today the 4% to 6% content growth in automotive as well as the 20% margin outlook longer term. Why shouldn't I be thinking of as the EV content story kind of plays out, there being upside pressure on both of those long-term targets, be it creative to content outperformance or be it 20% margin outperformance if kind of what we're seeing in terms of roadmap acceleration on EVs does play out?

I think the key that you have is we do have to remember we're on every car today, and certainly when we think about 4% to 6%, EVs probably 200 to 300 basis point to that. So when you look at that, when we think about it, it's across our whole portfolio. So we continue to see very strong growth in EV and high-power products, but you also have to realize what percentages of global auto production. So I think you will have years and if EV goes quicker and an adoption, you would have us closer to the higher end of our four to six range, but certainly adoption will be important. The other thing I would just say to the margin element, Like anything, EV products are things we have to scale, and from that viewpoint, you know, how they scale and how we get volume leverage is going to be very important, whether there would be margin upside potential to our target margins.

Thank you. Thank you. Thank you, Samir. We have the next question, please.

Your next question comes from the line of Mark Delaney with Goldman Sachs.

Yeah, good morning, and thanks for taking the question, and apologies for the connection issues I was having before. I was hoping to speak more on the electric vehicle opportunity, and I think the content is about double in an EV for Tao compared to a traditional car. Now that you're seeing a number of EV startups come to market, are you seeing a similar type of content opportunity with some of those customers? And then maybe also just talk about any differences on margins and market share. I mean, you know, this is an evolving landscape. I mean, there would potentially be the opportunity to do more of a solution sale with newer entrants into the industry, but also perhaps they're also looking to bring in nontraditional suppliers. So any kind of comments around not only the content opportunity, but also margins and market share? Thank you.

Yeah, sure, Mark. And, you know, it's a question we get a lot, and I'll try to frame it here. In many ways, it comes into not only where we innovate with them, it comes into their strategy about how do they want to make the car. In some cases, we've shared examples where we have $500, $600 on an EV product. It's where they're looking to others to do the assembly and more of the manufacturing for them. We have ones that have $200, where we're playing much more like our traditional component players. So I think as that space evolves, I think that's why you see the wide variation. But even on the component side, the component side is where we get and we typically stick to the 2X, the opportunity. We also, when you come into margin, you have to say, where do we bring value and where do we bring our engineering? We are not a contract manufacturer. We do not view ourselves as a tier one. So, you know, that's not been part of our strategy. So it's why we typically tell you 2X. What I would tell you, the opportunity is not just with new startups. It's also the strategies of every one of the OEMs as they come up and figure out how they want to assemble the vehicles versus traditional. And in some cases, we do more in other places. We play our component role. And either way, it creates opportunity for us that drives the content. And what's really great is because we know the architecture so well, and there is existing architecture that goes into an electric vehicle, that we get content, not just the high-power products. That's why we get such content opportunity over the combustion engine, as well as the electrical powertrain. Okay, thank you, Mark. We have the next question, please.

Your next question comes from the line of Matt Sheeran with Stiefel.

Yes, thanks, and good morning. Terrence, another question on the auto market. You talked about Q1 being a peak largely because of China's seasonality. Do you have any thoughts on what the production number looks like for your FY21 and how you see North America and Europe playing out in terms of their catch-up on production and also sell-through there?

Hey, as we look at that, and I know I said it, you know, visibility is limited. And, you know, what I'd like to keep it to is probably the latter part of your question on sell-through. And, you know, we talked about it in other calls. The element is it's good to see production recovering, but the real proof in the pudding is more people buying cars. And what has been nice is If you go in Asia, and as that ramped, we had concerns of what was pent-up demand versus ongoing sell-through. And China, as you've seen from the figures, has stayed pretty consistent with the sell-through. And the inventory levels in China are at very normalized levels. In North America, certainly production is ramping. We also see that demand is nice and inventory levels are at a comfortable spot. The one area where I would say inventory is still elevated is Europe. Some of that we've also told you is relates to with the regulatory changes there between EV and combustion engines. I do think the consumer has been a little bit more cautious on vehicle purchases. So that's the one area that we continue to look at to say, hey, we'd like to see inventory work down. We like the structures and some of the incentive programs governments have put into place to really do cash for conquer type programs and incent EVs, but we still need to see inventories come down in Europe. Okay. Thank you, Matt. Can we have the next question, please?

Your next question comes from the line of Chris Schneider with UBS.

Thank you. So the company's capital intensity has picked up over the last couple of years, which I assume is largely driven by the scaling of EV capacity. But should capital intensity come down as we kind of look out the next couple of years, just as this build-out winds down? And then what does this level of investment mean for competitive positioning within the EV market? As it seems like smaller competitors will have trouble matching this level of investment. And then could that transition, you know, further add to the mode around the business?

Thanks, Chris. We did tick up our CapEx investments. If you go back a couple of years ago, we were up north of $900 million. I think you've seen that number certainly come down over the past couple of years. And I would say our viewpoint as we look at FY21 is consistent. You should probably think about somewhere around that 5% of revenue in terms of our CapEx intensity, certainly no more than that. One of the things we do benefit from is as we were increasing our capacity, and that's both to support the traditional combustion engine customers, but it was heavier weighted towards some of the EV fit-up. in our factories. Certainly, we're able to now utilize that. That was done under the assumption of significantly higher auto production than what we saw in FY20 and anticipate in FY21. But we are able to utilize some of that capacity as we bring some of these plants offline. We're talking to you about restructuring dollars to take some of these plants, primarily in Europe, offline. You don't hear us talking about incremental capex on the receiving end of where that activity is going to go because that's already in place. The second part of your question around does this differentiate us versus others, I certainly think it does. I can't speak on behalf of other companies and what their capital structures are in terms of some of the smaller players, but I can tell you that there is, particularly on the front end, a fair amount of capital investment, both on the CAPEX side as well as on the engineering front, to support these customers, particularly, as Terrence noted, as it's an evolving area in terms of what actually is going to be produced where and who's going to do what. And I think we're very well positioned. And as you know, to make money in this business, it's all about scale. And it's about having the ability to handle the customer's needs and be able to ramp production at full scale. And that's what we're good at. Heath is exactly right. I mean, it is important while there are startups, you still have to get the price points and where the consumer is there. And scale is a big advantage. It is something that when you think about scale, there's two elements of scale in our business model that, to your point, use your word mode, are very important. It is the element of how you deploy the engineering resources against where those designs are happening. And then there's a back-end scale. A part of it is how do you make sure that manufacturing, what you design, you bring scale in the automotive business where the customer wants the supply chain to be. You know, the automotive business is still a just-in-time business, and it's very important that the scale that you bring is where are they selling the vehicles. And in some cases, what starts as maybe they think they're going to penetrate one part of the world, they may take off in another part of the world, the platform. And how do you bring scale for continuity? Because it is still an industry that wants to make sure it's quality and, you know, that element. And they also want to make sure they can get the product to a cost point, their car, that somebody can afford. So it is the scale element as EV scales. I think it's the biggest opportunity we have and also one we've signed up for. How do we make sure that we bring scale to it? Okay, thank you, Chris. Can we have the next question, please?

Your next question is from the line of William Steen with Truist Securities.

Great. Thanks for taking my question. I'm wondering if you can remind us what the annual pricing negotiations in automotive look like, when they occur, how pricing typically trends through these negotiations, and maybe how the current market negotiations, let's say, compared to what you think they do in a typical year? As I recall, you know, during these times and dislocations, there can be sort of unusual discussions around that topic. Thank you. David Morgan Your pricing across the portfolio is slight deflation. And, you know, in auto, you know, auto is typically one that it's annual discussions that are based upon volume, as well as opportunities. And those discussions typically happen, you know, late in the calendar year, early in the following calendar year. So they'll be upon us. You know, certainly when you think about 2020, there's a lot of volume commitments that weren't made as well as, you know, how we're ramping a lot of things. So they are very strategic discussions we have with our customers also come into, you know, how are we doing on being sure where we invest engineering and, you know, with where the world is, I don't see them being more price deflationary than normal. I think it'll be real active discussions that we have as we get in those discussions with our customers. The reason I ask is I recalled the credit crisis. There was also an expectation that you'd see normal price reductions, even though the customers were not meeting volume commitments. So that's sort of where I was headed with that. Do you think we'll see normal deflation this year as we have in other years, even though the volumes might not have been met in the prior year? I think we'll have some deflation because of the automotive market. I'm not sure it'll be normal. and then we have to get through those discussions with our customers. Thank you. All right. Well, thanks, Will. Can we have the next question, please?

Your next question is from the line of Joe Giordano with Cowan.

Hey, good morning, everyone. One thing I just wanted to clarify first, Terrence, you mentioned inventory levels in Europe. Can you just clarify, are you seeing customer demand, like market demand satisfied out of customer inventory right now? And then my main question, a little bit more high level, you see something like GM coming out with a big new EV platform and plan to spend a lot of money. Can you just talk to me about how like that, relationship with a customer like that kind of evolves through their kind of planning phase and how early are you involved with something like that and how would that be similar or different to like a you know some of the startups that Mark mentioned earlier so so you have a couple questions there so let me take the first one you know what's been nice car registrations have improved in Europe

um so when you sit there when i talked about inventory it's really think about that dealer lots you know it was heavy coming in you know certainly covet impacted it and we've talked about that so what i would say is it's really making sure that inventory looks down the more normalized level and sell through um and sell out get more in line um so that was really my comment around europe when you think about a program A program, and it isn't just one car, one plan. It really starts at the platform level. And those discussions happen as we're in the design element of the electrical architecture or the data architecture. And in some cases, what occurs is they're taking product off a traditional platform that they say is good enough. That could be an interconnect on a light. doesn't change really between a combustion engine and an electrical vehicle, and how they actually start working their platforms. And those can take years, depending upon where they get to the platform element. And once you're on the platform, that can spray how they evolve the platform. And certainly, I think when you talk about EV, when you have a startup, they're basically starting with a model. Larger companies really have platforms. And you are seeing some of our larger customers come out with platforms. You see much more advertisement around the world on it. In some cases, it's due to the regulations they have to meet. But it's also about where they see the market going. And I think it's pretty consistent with what we laid out. So is it different than how we innovate today? No. But what I would tell you is the urgency and the pace on those platforms have certainly kicked in much faster than the design cycles that you would have had on a traditional evolutionary combustion engine. You do see how they're focused very much on EV. You see how autonomy has taken a little bit of a step back during the downturn that our customers are very focused on the electric powertrain. And they're also seeing the opportunities of where they are in the world. So you see people very much want to be penetrating China, as well as the high-end areas, which some of the vehicles that we talk a lot about are very high-end vehicles. Okay. Thank you, Joe. We have the next question, please.

Your next question comes from the line of Stephen Fox with Fox Advisors. Thanks for taking my question.

Good morning.

Hi. You talked a lot about the EV side. I was wondering if you could just sort of focus on the legacy CO2 side of the business since it's still so big.

Where would you be getting the content growth from there? I assume there is still some content growth. And then just specifically with CO2, how do you manage it as your customers seem to be dramatically increasing their emphasis on the other side of the business? Thanks. Well, it's really two factors. You still have electrification that happens on a combustion engine. When you look at TE and you think about TE, other than on the engine, other than where you get into the ECU element, powertrain is not as big of a content element for us as other things. So like you have on an EV platform. So where we get content is continued comfort features. Certainly the data architecture that's being built into a car as you move up the levels, it's going to happen in both a CO2 engine as well as an electric vehicle. So that element that comes into the data architecture continues to evolve. Certainly the sensing you have around safety. and the features that we all rely on. So while the development of combustion engines aren't as strong as they used to be, because people are going to EV, the other features we're getting in the car that do provide, like we've talked about when we've done some of our analyst phase, you know, 200 or 300 basis points. of content above production in a core engine is still occurring. And those programs are as the data architecture puts in, comfort features get added, as well as just the whole ECU network evolves we typically see more contacts being added in a car than less. And the only other thing I would say on the combustion engine is, you know, we also see our customers leaning on us more on that legacy electrical architecture because they want their engineers working on figuring out the electrical platforms. Good. That's helpful. Thank you. Thanks, Steve. All right. Thanks, Steve. Can we have the next question, please?

Your next question comes from the line of Jim Suva with Citigroup.

Thank you. If we could take the opportunity maybe to clarify before there's any confusion about the peaking in the December quarter. My memory is that auto production typically generally always peaks in December, but people are going to be concerned that it's going to be your peak earnings per share. And I think Heath mentioned that that's not necessarily the case, but It sounds like there may be some hedging around that. I know you're not giving it for your guidance, but can you just kind of help us think about that? Because I can sense a lot of people are actually thinking that it's the peak of your earnings per share and the story on that. So if you could maybe walk us through that a little bit.

No, Jim, thanks. And, you know, you said it right. You know, 21 million units in the December quarter, I think for the past five years has been the peak production globally. So when we look at the 21 million we expect in the first quarter, we do expect that to be a high point. But that doesn't mean it's the high point for EPS, Jim. That's just our auto production estimate. And, you know, it's the high point as we look into 21. So like I said during the call, we still think a gradual recovery of our markets is the right way to look at this. Certainly, we'd like that the recovery in auto production is quicker than we expected, and I think like most people expected, but we do also have to realize that the first quarter is typically the high point of auto production in the year due to the effect of China and how China is the largest car-producing country on the planet. Okay, thank you. Thanks, Jim.

We have the next question, please.

Your next question comes from the line of Joseph Spank with RBC Capital Markets.

Thanks. Good morning. This is actually Derek Clump on for Joe. Thanks for fitting me in. I guess just continue on the electrification, maybe shifting gears to commercial transportation. I mean, I think historically you've talked about, you know, commercial transportation, CPV growth being a little bit below the four to six you kind of experienced in Target and Auto. But maybe just update us on kind of where we're on that journey in terms of maybe commercial transportation, outgrowth getting closer to the four to six and auto, you know, what the prospects are for next year, even we're seeing more kind of electric commercial transportation programs come to market, and then kind of what your conversations with customers have been recently around, you know, broader electrification within commercial transportation.

Yeah, when you look at commercial transportation, it is a very broad market. So you're dealing with agriculture, you're dealing with construction vehicles, certainly you're dealing with truck and bus. And when you look at electrification, you do see it much more on the short haul delivery. Certainly you see people on some longer haul experimentation. But at the overall market, when you deal with electrification, the impact won't be as broad as you have in the auto space market. That being said, you know, we do see a lot of content as both electrification as well as data autonomy because the features you have in the truck and bus space does have more data uses because you get into fleet management, how they think about their business models. And what's been nice over the years is what our ICT business, which historically would have been probably moving much more with underlying production, We have, due to EV as well as data, have created content separation. And, you know, I think you've seen that this year. We also expect, you know, as you get some of the things that are happening globally, you know, China, we do expect to be a little bit of a headwind, but we do expect other parts of the world to be able to make up for that part of the league, plus our content is really going to be due to the content opportunity in ICT. We still do believe it's below the 4% to 6% in the car, but it is something that's going to be a big content driver for that business. Okay, thank you. We have the next question, please.

Our next question comes from the line of Luke Junk with Baird.

Thanks for taking the question. Just hoping you could comment on medically related puts and takes as we go through, you know, the rising COVID cases. What factors need to align to get this business back on a growth trajectory as you've outlined?

When you look at it, realize where we've pointed our business has been very much around interventional procedures. And if you look at our customers, they've been impacted around it, and they also are working off inventory. So when we look there, we still see the procedures that we're very much around being down. We have seen recovery. We would probably say the recovery plus as they work off inventory, you're probably looking more at the latter half. of R21 based upon what we know today, but that could be impacted based upon COVID or any other market developments. But, you know, I think we're probably in the middle of it as we speak.

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

Your last question comes from the line of Nick Tadevor with Longbow Research.

Thank you for the question. You guys talked about the December quarter auto production peaking at 21 million. I know visibility is limited, but I'm guessing How are you thinking about the low point of auto production into the next fiscal year? Could we get down to 17, 18 million vehicles a quarter? I'm just trying to understand how you're thinking about probabilities. And then can you give us just a breakdown of production and growth year over year into the December quarter by geography? Thanks.

well we aren't guiding for the year and i i guess on the first point i'd ask you to look at third-party resources um on your first part of your question when we when we look at the first quarter though where we are guiding you know there is element that even in the first quarter you know at the 21 million units that will still be down year on year versus around 22 million units last year we see you know every geography still being down year on year, but certainly at a lower rate than we've been experiencing. So as you look through the geographies, even though China continues to go up to its first quarter, we do expect China production to be down year over year. And we also expect the other regions of the world I do think it's important to realize, you know, we like this recovery, but we still, you know, some of the reasons we highlight where we're at is we're still below where we were at in 2019. And what we're very focused on is how do we make sure we adjust to the world, not only in Ottawa and elsewhere, but the world that's close to COVID that we're still trying to figure out. So, you know, still, it's nice to see the sequential recovery up to the 21 million units versus where we were two quarters ago at 12 million. and we'll continue to keep you updated as we go through the year, and we still expect a gradual recovery. Okay, thank you. It looks like there's no further questions, so I want to thank everybody for joining us on the call this morning. If you have additional questions, please contact Investor Relations at TE. Thank you, and have a nice morning.

Ladies and gentlemen, your contact will be unavailable for replay beginning at 1130 a.m. Eastern Time today. October 28, 2020, on the investor relations portion of TE Connectivity's website. That will conclude your conference call for today.