TE Connectivity Ltd

Ladies and gentlemen, thank you for standing by and welcome to the TE Connectivity second quarter 2022 earnings call. 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, please press the star key followed by the number one on your telephone keypad. If you would like to remove yourself from the queue, please press star one again. 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, Sujal Shah. Please go ahead.

Good morning, and thank you for joining our conference call to discuss TE Connectivity's second quarter 2022 results. With me today are Chief Executive Officer Terrence Curtin and Chief Financial Officer Heath Mitz. During this call, we will be providing certain forward-looking information and we ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning, and we ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation, can be found on the investor relations portion of our website at te.com. Due to the large number of participants on the Q&A portion of today's call, we are asking everyone to limit themselves to one question. 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, Sujal, and also I appreciate everyone joining us today to cover our second quarter results as well as our outlook for the third quarter of fiscal 22. Before Heath and I take you through the slides and details, I want to take a moment to discuss the current environment and frame our performance relative to some of the developments that we've been seeing. Since our last earnings call three months ago, we've seen some elements of the macro environment become more volatile. And specifically, we've seen the invasion of Ukraine, as well as COVID lockdowns in certain parts of China. While we've seen volatility increase, We continue to see strong end demand trends across the markets that we serve, and I'm very pleased that, despite the incremental pressures, our teams were able to deliver results in quarter two that were ahead of our expectations. Our continued strong performance is a result of how we strategically positioned our portfolio around secular growth trends. Also, the resilience of our global manufacturing strategy, where we have invested to produce in region and the commitment of the hard work of our employees across the world. I'm very proud of our teams as they continue to overcome broader challenges to effectively serve our customers to both manage the present while also ensuring we're winning programs that will drive future growth for TE. I'd like to put our performance into perspective a little bit. We've made significant progress towards our business model over the past couple of years. We've been driving top-line growth despite market headwinds, executing successfully on cost reduction and footprint consolidation plans, and driving margin and earnings per share growth despite the supply chain and inflationary pressures that we faced. And if you look at TE versus a pre-COVID timeframe of fiscal 2019, our auto sales have increased nearly 20% against auto production declines of approximately 10 million units, or 15%, And this really illustrates our global strengths in the automotive space, as well as the content gains we've been talking to you about. Our industrial equipment and data and device businesses have both grown approximately 50% over the same timeframe. And this is significantly above the markets that we serve, showing the benefit of where we strategically position these businesses, as well as a strong execution of our teams. I do think it's important to separate signal from noise as you look at TE from an investment perspective. While we are in a very noisy environment near term, the longer term growth signals across our portfolio remain positive. These signals are secular in nature, giving us confidence that we will continue to perform in line with our business model through cycle as an industrial technology leader. We have all three segments contributing to our performance. For example, in our transportation segment, we are the established global leader for EV connectivity solutions. Over the past year, the value of our design wind pipeline grew by over 50%, and we are designed into every major electric vehicle and hybrid platform with customers around the world. This position has been driving and will continue to fuel our content growth and enable consistent above-market performance in our transportation segment. If you turn to our industrial segment, we are in the heart of the industrial automation trend and have grown our sales at double the rate of capital expenditures as the market's recovered from COVID. We've been working with industry-leading customers to develop engineered solutions targeting higher-growth robotic and safety applications, and this is resulting in the robust growth pipeline that you're seeing. And in our communications segment, we are expanding content in high-speed cloud applications, and gaining share in artificial intelligence deployments as customers implement workload architectures to make data centers more efficient. And these are just a few of the secular trends that we have positioned the portfolio around, which will drive future growth. And we remain excited about the long-term growth and margin expansion opportunities we still have in front of us. So now let me highlight a few additional takeaways from today's call. Our second quarter results were a record in quarterly sales and adjusted earnings per share with strong results in each segment. On a year-over-year basis in the second quarter, we delivered organic sales growth of 8% and adjusted earnings per share growth of 15% along with adjusted operating margins of 18.4%. Margins expanded in each segment year-over-year as our teams are effectively managing pricing and cost in an inflationary environment to drive the margin performance across our businesses. The other key highlight is that the demand environment continues to be strong, and we'll talk about it, and it's evidenced in our orders, which were $4.5 billion in the quarter. Our book to bill was well above one for each segment, and it reflects the continued strength across our markets. The other highlight about our organic performance is that in the second quarter, it shows the strength in the positioning of the portfolio, with our industrial and communications segment growing over 10% and 20% respectively, and our transportation segment growing 5% despite auto production declines in the quarter. We continue to benefit from the ramp of new electric vehicle platforms, which will continue to drive content outperformance for our transportation segments. And the last highlight is that we are expecting our quarter three sales to be around $3.9 billion, and this does reflect continued strong performance. You know, we have a strong demand environment, but coupled with the broader volatility, I do want to stress our ability to produce will remain a key factor in our near-term sales performance. So let me turn now, and I'll provide some additional color on some key end demand trends, as well as talk about the supply environment. We are continuing to see broad-strength and global capital expenditures that relate to factory automation, cloud, and data center efficiency, as well as renewable energy sources. End demand for autos remain healthy and is significantly higher than what the OEMs can produce, and this provides a setup for future auto production increases as supply chain bottlenecks begin to resolve. While we see a demand environment that remains positive, The invasion of Ukraine and COVID lockdowns in China are new developments versus 90 days ago. And let's face it, the supply chain challenges and inflationary pressures continue to linger. On the supply chain, the challenges around material availability and flow, I would tell you are about the same as 90 days ago. But we have seen an uptick in inflationary pressures. I am pleased with how our teams are continuing to manage the supply constraints to meet our obligations to customers, and they're also working additional price increases to partially offset higher costs so that we can maintain margin performance in each segment. We believe that we are differentiated with our global manufacturing strategy and ability to produce in region, and this is helping us to enable the growth and share grains across our business during these volatile times. Now, with this as an overview, let me get into the slides and discuss a few additional highlights that are on slide three. Our quarter two sales of $4 billion were up 7% on a reported basis and 8% on an organic basis. And adjusted earnings per share was $1.81, which is up 15% year over year, with both being records, as I mentioned. From a free cash flow perspective, we generated approximately $615 million in the first half, and we returned approximately $670 million to shareholders in the second quarter, and we did increase the pace of our buybacks during the quarter. If I turn from financials for a minute, I'm also impressed that we continue to be recognized for our ESG initiatives, with TD being named among the world's most ethical companies by Ethisphere for the eighth consecutive year. I am pleased with our commitment and continued progress along our ESG initiatives And also, our employees are really leaning in and being engaged on these important initiatives across TE. So let me again touch upon our guidance for the third quarter. We do expect sales of approximately $3.9 billion, and this will be up 1% on a reported basis and 3% on an organic basis versus the prior year. This guidance does include approximately 300 basis points of year-over-year headwinds from the expected COVID related shutdowns in China that we expect in the quarter. And we do expect adjusted EPS to be approximately $1.75 in the third quarter. So if you could, I'd like you to turn to slide four and I'll get into the order trends and markets a little bit further. At an overall level, our second quarter orders were $4.5 billion with a book to bill of 1.13. and it highlights the strong demand that I've mentioned already. While TE is not typically a backlog business, we are in an environment where you need to look at both bookings and backlog to get a full picture of demand. Our backlog is up 40% year-over-year and is up significantly in every segment. Importantly, we continue to see stability in our backlog in each segment, and our customers continue to provide order visibility beyond the current quarter to ensure supply certainty in these ongoing volatile markets. In our transportation segment, we saw order levels increase sequentially, influenced by concerns around the recent developments in Ukraine and China. Global auto production was in line with our expectations in the second quarter at approximately 19 million units, and we expect auto production to decline slightly in the third quarter on a sequential basis. The trends around our content remain robust as we continue to benefit from increased electronification and higher production of electric vehicles. And we expect electric vehicles to be up approximately 30% this year in production. Given the volatility we're seeing in global auto production and the comparisons that can result as we move through the second half, it is important we look at content per vehicle as an additional long-term metric. Our content per vehicle has expanded from the low 60s range in pre-COVID times to roughly $80 in fiscal 2021. As we look forward, we expect continued expansion in our content per vehicle from the first half to the second half of this year. When you look beyond the near-term noise in the auto supply chain, we continue to see a favorable setup for a longer-term auto production growth with healthy end demand and dealer inventories that remain extremely low. Looking at our industrial segment orders, we saw another quarter of strong orders with a book-to-bill of 1.22. We continue to see an improving backdrop with increased capital expenditures for factory automation, manufacturing capacity, and renewable energy. And these trends benefit both our industrial equipment and energy businesses. We're also continuing to see improving order trends in the Comair, as well as favorable conditions in our medical business and we expect to see favorable year-over-year revenue comparisons in those businesses later in this fiscal year. And lastly, in communications, orders continue to reflect strong demand as well. We had a book to bill of 1.07. In data and devices, we're seeing a robust outlook for cloud capital expenditures, and we continue to gain share. As we mentioned last quarter, We continue to expect softening in our appliance business from the first half to the second half of this year. And just to add some color of what we're seeing geographically, and I'll do this on an organic basis sequentially. In North America, our orders were up 12%. In Europe, they were up 16%. And in China, our orders were down 4%. So with that overview about orders and markets and what we're seeing, Let me get into the segment results that you can see on slides five through seven, and I'll hit on some of the highlights in each of the segments. In our transportation segment, our sales were up 5% organically year over year. Our auto business grew 5% organically versus auto production declines in the mid-single digits. This continues to show the separation of our sales performance versus the market. which has been driven by our leading position in electric vehicles and their increased adoption. In commercial transportation, we saw 5% organic growth driven by North America and Europe. Even though the market in China is still going to be down this year, we continue to see significant outperformance in all regions driven by content growth and share gains. And in our sensors business, we were roughly flat organically, and we continue to see strong design wind momentum and transportation applications. If you look at earnings in the segment, adjusted operating margins were 18.2% as our teams continue to execute well and implement price increases to partially offset the inflationary pressures. So let me turn to the industrial segment where our sales increased 11% organically year over year. In the industrial equipment business, our sales were up 27% organically with double-digit growth in all regions and continued benefits from increased capital spending and factory automation. In energy, we saw 5% organic growth driven by increased penetration in renewable applications. And in our AD&M and medical business, our sales were both roughly flat. And as I said earlier, we expect improvement in both markets and more favorable comparisons as we go forward. At the segment level, adjusted operating margins expanded year-over-year by 280 basis points to 15.3%, driven by higher volume, price actions, and strong operational performance. So let me move to the communication segment. And as you'll see on the slide, our teams continue to execute well while capitalizing on the growth trends in the markets that we serve. Sales grew 23% organically year-over-year for the segment, with growth in each business, as you can see on the slide. In our data and devices business, we saw market outperformance driven by content growth in high-speed cloud and share gains in artificial intelligence applications, which are aimed at improving energy efficiency in data centers. This continues to illustrate how we are enabling a positive impact in carbon emissions across our portfolio through our products and our technologies. In our appliance business, we performed ahead of our expectations, and this is despite the expected declines we saw in the China market. We saw growth in North America and in Europe with continued share gains enabled by our manufacturing strategy to produce close to our customers. This resiliency has proven to be a differentiator as customers navigate the challenges in the macro environment. And from an earnings perspective, our communication teams continues to deliver outstanding performance with adjusted operating margins of 24 percent of 330 basis points versus a strong quarter in the prior year. Because of the heavy lifting we've done in the segment around cost reduction and footprint consolidation, we expect segment adjusted operating margins to remain above 20 percent through the second half, even as the appliance market moderates. So with that as an overview of the segments and the markets, let me turn it over to Heath to go into more details on the financials and our expectations going forward.

Thank you, Terrence, and good morning, everyone. Please turn to slide eight, where I will provide more details on the Q2 financials. Adjusted operating income was $736 million with an adjusted operating margin of 18.4%. GAF operating income was $705 million and included $21 million of restructuring and other charges and $10 million of acquisition related charges. We continue to expect restructuring charges of approximately $150 million for the full year as we continue to optimize our manufacturing footprint and improve the cost structure of the organization. Adjusted EPS was $1.81, and GAAP EPS was $1.71 for the quarter and included tax-related items of two cents. Additionally, we had restructuring, acquisition, and other charges of approximately eight cents. The adjusted effective tax rate in Q2 was approximately 19%. For the third quarter, we expect our adjusted effective tax rate to be roughly 20%. And we continue to expect an adjusted effective tax rate around 20% for the full year. Importantly, we expect our cash tax rate to stay well above our adjusted ETR for the full year. So let's turn to slide nine. Our results that you see on the slide reflect the strong execution of our teams and how we have strategically positioned our portfolio. As Terrance mentioned, we delivered strong results in each segment. Sales of $4 billion, the company record, were up 7% reported and 8% on an organic basis year over year. And just to provide some color on our organic growth, approximately one-third of our organic growth was driven by the price increases. Also, currency exchange rates negatively impacted sales by $116 million versus the prior year. As we look forward into Q3, We expect currency exchange rates to be sequential headwind of approximately $50 million and a year-over-year headwind of approximately $150 million due to the strengthening U.S. dollar. As you may recall, last quarter we discussed the impacts of currency exchange rates for our fiscal year, and we now expect fiscal 22 impact between $400 and $500 billion headwind from FX. This is about 100 million worse than we were 90 days ago with the majority of that additional impact occurring in our second half of our fiscal year. Adjusted EPS of $1.81 was up 15% year over year and represents a company record as mentioned earlier. Adjusted operating margins were 18.4% and I am pleased with the performance of our team given the incremental inflationary pressures we are seeing. We are pulling price levers across the business to help partially offset these pressures. While we are not able to offset these costs dollar for dollar, we are able to recover approximately two-thirds through price and the remainder through productivity initiatives. As you would assume, we will continue to respond with pricing levers to mitigate the impacts in this environment. Turning to cash flow in the quarter, cash from operating activities was $413 million. Free cash for the quarter was $242 million. As we mentioned last quarter, the year-over-year trend in free cash flow reflects strategic inventory builds. We expect free cash flow to increase significantly in the second half of the year versus the first half and expect inventory levels to stabilize as we move through the year. We increase the pace of our share buyback in the quarter and return approximately $670 million to shareholders through share repurchases and dividends. Through the first half, we have returned over $1 billion to shareholders. We remain committed to our discipline use of capital, and over time, we still expect two-thirds of our free cash flow to be returned to shareholders and one-third to be used for bolt-on acquisitions. So before we go to questions, I want to reiterate some of the key points that we covered today. We are continuing to execute well in a volatile environment demonstrating sales growth, margin resiliency, and EPS expansion. We remain in a strong demand environment as evidenced by our orders and backlog, and the ability to produce will be a key factor of our near-term revenue performance. We have strategically positioned TE around well-recognized secular growth trends, and we continue to generate performance ahead of the markets we serve. Our teams continue to prove their ability to execute in this volatile environment, effectively serving our customers while managing price and cost dynamics and we continue to demonstrate resilience through our global manufacturing strategy. So with that, let's now open it up for questions.

Audra, can you please give the instructions for the Q&A session?

Thank you. At this time, I would like to remind everyone, in order to ask a question, press star 1 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. We'll take our first question from Chris Schneider at UBS.

Thank you. So my question is on order trends. When we see transportation orders up 18% sequentially, how should we think about the drivers here between improving demand but also likely longer duration ordering as supply chain fears are picking back up? From a higher level, the company talked a lot in the prepared remarks about the secular transformation of the business. So when we look at the $4.5 billion of orders, are there any metrics or color you could provide around how much of this is coming from the secular growth business lines, whether it be EVs, medical, automation, or data centers, just to help get more comfortable around the ability to drive continued growth in a macro slowdown? Thank you.

No, sure. Thanks, Chris. And, you know, there's two questions there. And so let's start with the first one. As I said on the comments right now, the demand environment remains strong. And you can look across all three segments. Certainly you saw transportation pick back up. I do think some of that was a reflection of people trying to make sure they had supply chain certainty with what was going on in Eastern Europe and Ukraine. which, you know, a number of our customers have operations in the Ukraine, if you're one customers, and people really working hard to make sure we get continuity of supply. The other thing that you certainly had was also with some of the China lockdowns, and the China lockdowns we've been dealing with since, you know, even in the second quarter, certainly in southern China, but what we're experiencing in Shanghai is obviously more widespread than what we've been dealing with today. And I think the other key thing when you look at these orders, in addition to what I said, is I want to go back to the point which I think is very important. The amount we can produce will be the driver of our revenue. And even when we look at our performance in the second quarter, it was more about our teams executing well to be able to get more out. And I would say it was more incremental demand. You know, we're still in a supply chain constrained environment. The other thing about your question on the that I mentioned in the pre-remarks, I do think it's important to also look at backlog. And I know that's not something we like to talk about a lot, but it is something as we continue to see customers try to get more certainty, also knowing what's going on around the world, we do see customers placing orders out to make sure they are securing supply certainty. And let's face it, over what we do, you don't want to be shutting down a line over what our content is in any application. So we continue to see customers place orders out. It is across all our businesses. And the other element that we always look for is are we seeing push-outs or cancellations in the backlog? And we are not seeing meaningful push-outs or cancellations anywhere. So it really is an indicator that the demand is strong. And we feel good that you see things are like the industrial businesses continue to improve from the industrial recovery we've been talking about. Places like appliance, we do see moderating. It started in China. We expect that to moderate through the remainder of the year. But net-net, it is a constructive demand environment. As you get down to your second part of your questions about orders in those secular trends, I think you see that in how we talk about our guidance and some of the things I mentioned. So, you know, the orders that we're seeing do reflect those secular trends. I don't have numbers here in front of me to tell you the orders by each one of them. But when we talk about our guide and our content outperformance, let me tell you, with the program plans as well as the orders as they're coming in, as these are typically newer custom programs, you know, it is things that are coming in and driving the orders as well.

Thank you, Chris. Can we have the next question, please?

Next, we'll go to David Kelly with Jefferies.

Good morning, Kim. I was hoping to dig into the auto content for vehicle drivers, and I believe you referenced an expected uptick from first half to second half. I think we have content tracking in the low 80s trailing 12 months versus you referenced that low 60s numbers in 2020. So can you walk us through the EB impact of content over the last two years and how we should think about EB momentum and contribution into the second half and then any color on expectations of broader mix and inventory dynamics first half to second half would be helpful as well. Okay.

Thanks for the question, David. And let me get into, I want to reiterate what I said in my prepared remarks. And when we talk about automotive content and what EV's done, one of the things that I always think is important in TE is we have content increase due to electronification, which happens on both combustion and electric vehicles. And then we also get the kicker versus 2019, while auto production is off 10 million units. And really, it really shows where we positioned our portfolio and the investments we've been making for a word of a decade. And the $60 I referenced on the comments, that's 2019. So in 2019, our content was around 60, low 60s. And in 2021, we were at 80, and we're running above that as we continue to grow content. And if you look over this period, certainly the number of ICE vehicles made on the planet and down, the number of EV vehicles are up significantly. And if you look at content going from 60 to 80, about 60% of that content increase is due to electric vehicles. Their increased adoption as well as their content, both of those items. But the other 40% is content growth on electronic applications. So we have content increase on both types of platforms over this period. Certainly you get the kicker that we've always talked to you about around if EVs grow faster, our content's bigger on us. And you're going to continue to see that because let's face it, EV adoption is up to about 12 million units this year from 9 million last year. And that's why we get so excited. The other thing I do want to highlight is Our products are really differentiated. We're in a business review, and right now we're up to about 1,000 patents that we've generated around EV technology globally. We don't typically talk patents a lot, but when you think about the innovation we bring, I talked about the number of programs and dollar value programs in the prepared comments. This is happening whether it's a charger inlet, the connectivity that happens close to the motor, what's happening on the cells, the connectivity you need there, as well as some of the power conversion that you need to occur between the battery and the motor. And there are things that we benefit from all of that, and then where we get sensor elements around current sensing also creates a kicker. So I really think you're going to continue to see, as EVs continue to get adopted, that is a concept, and our teams are scaling. And that's something that we also have to do, not only how do we innovate, how do we get the manufacturing done, And I think you're going to continue to see that content per vehicle grow. And I also believe there's a good setup as production gets better, that auto production to get into a growth mode again at some point in time, which will be an additional kicker.

Okay, thank you, David. We have the next question, please.

Next, we'll go to Mark Delaney with Goldman Sachs.

Yes, good morning, and thanks very much for taking the question, which is on margins. You mentioned cost is going up. You spoke about being able to recover about two-thirds with pricing and the remainder with productivity. Could you give more details in terms of the timing to fully execute on those mitigation measures, and is there going to be some period of time where margins are going to be temporarily depressed, and if so, by how much as you work through some of those offsets to the cost pressure. Thanks.

Mark, this is Heath. I'll take the question on margins. Well, certainly, you know, listen, we're holding our head in this environment. As you mentioned, this is a very heavy inflationary environment for us that impacts you know, metals and resins and freight and utility energy prices. So, you know, we feel pretty good about our ability to hold our head in the mid-18s range of operating margins. I would tell you, as you mentioned, you know, we recovered about two-thirds of that through price. That will be the story as we continue to work our way through the fiscal year as well. And you have to remember, and I know, Mark, you know as well, you know, in a normal – environment, our business model contemplates more of a negative price environment based on volume commitments. And so, you know, it's not uncommon for us kind of before we get, you know, outside this inflation environment to be down a point, point and a half of price a year. We've moved that up into positive territory. And as I mentioned on the call, it represented about one-third of our overall organic growth. So you can kind of frame up a little bit what that looks like from a price, and yet that's still only covered about two-thirds of the inflationary pressures, which are significant. So our business model contemplates certain things, and in this environment, we're happy we're able to pass on the amount of price that we can. Our footprint, we've done a lot of work on that over the last few years, as you know, and especially you see that come through on the communications footprint Where we have optimized that at these volume levels, we continue to print margins in the mid-20s in terms of operating margins. And we've been going through a similar type of activity, as you know, within transportation and industrial. Over the last few years, in some cases, we're getting close to where we need to be, and a regional footprint is important to be close to the supply chains of our customers, and I feel good about that impact that that's having for us to be able to hold our head here. In terms of going forward, I'd say we're kind of in that same range, and I don't anticipate calling out a temporary depressed margin relative to the timing as part of your question. We'll continue to pound through this and take advantage of the opportunities that we have and continue to optimize the cost structure.

Okay, thank you, Mark. We have the next question, please.

We'll go next to Wamsi Mohan at Bank of America.

Yes, thank you. Terrence, can you share some more color on the China lockdowns? I know you quantified the impact at about $100 million, but how much of that is supply versus demand? What is happening with the demand trajectory in China, and how much impact do you expect through the rest of the year? And then... On pricing, I know he said that there was about a third of the growth is benefiting from pricing. I was wondering if you could put a lens on what percent of your portfolio you've been able to change pricing on, and as it pertains to auto, is there more to come? Thank you.

Sure, Ramzi. Thanks for the question. So let me start with the China element first, and just to base everybody, China is an important market for us. It's about 20% of our sales. And we do not see what's going on in China as a demand issue. Our orders in China have been above $900 million for five to six quarters now. And even in the last quarter, our book to bill was 1.07. So from a demand perspective, we don't see there being a demand problem. But when you think about the lockdowns, and like I said earlier, we've been dealing with lockdowns because not all our factories are in the Shanghai area. We have factories in the north. Up in Qingdao, we have factories down in southern China, around Shenzhen, Guangzhou, Shanda. And really, what we're seeing here is you've got to break it into pieces. Where are the customers located? We have customers that are in shutdown. Where are some of our suppliers? And then also, how do we move things around China? Because our China business is really to serve the China manufacturing market. It is not an export business to the world. And really what we're dealing with is we have factories that are running. They aren't running full tilt. We have customers that are trying to get back up and running. And the number that we laid out here today is really what we know from a bottoms-up. If the lockdown would end, I would hope we would be able to recover up the amount that we're missing here in quarter three. But it is more of a logistics and a supply getting to the customer than it is actually our ability. or demand destruction in any way. So demand is strong, but certainly a very fluid situation and a very important market for us. On pricing, your second part of your question, when you look at pricing, we're getting pricing across all businesses and all segments. So when you talk about what element of the portfolio are we getting pricing on, it's all of it. It is different degrees. It depends upon the customer, certainly. You know, in areas like distribution, we'll be putting another price increase into effect here in July with the increased inflation. Certain in those with direct customers, we're having direct contractual discussions. You know, they started last year, and they're continuing. And I think it's proven, you know, between the pricing and the productivity that we've been able to drive. It shows up in the margin. That shows the breadth of it. So, certainly, you know, we have to get it because of the breadth of the inflation that that we've seen and we continue to experience.

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

And next, we'll just go to Amit Dharinani at Evercore.

Good morning. Thanks for taking my question. You know, I realize TE doesn't provide a formal folio guide, but, you know, Terrence, you spoke about sort of signal versus noise, and there really is a lot of noise out there. I'm hoping you stick your perspective on, you know, what are you seeing in the back end of the year? There are multiple cross-currents. in terms of how things will play out. So I'd love to just get a sense on what are the puts and takes with telecom and revenue and cost perspective for the back half of the year that you're contemplating. Yeah, and you're right.

So I'll give you some tidbits here, Amit, but certainly you're right. We're only gone for the third quarter. It is due to the volatility. But I think you have to start with demand is strong. And while we have a little bit of an impact here due to China, you know, Our second half revenue is going to be driven by what we can get out of our factories. We still believe that. And it's how do we get material, how do we get it produced, how do we get it shipped, because we do want to, you know, continue to make sure we help our customers with the supply situation. If you look at it by business, you know, we're going to continue to probably say you're going to see industrial improve. I've talked about, you know, Comair and medical improving, certainly industrial staying strong in energy. We will see our CS segment moderate due to appliances, and that's not new. That has nothing to do with the recent market. That's really what we've expected and we've talked to you about. And I think transportation is probably going to be moving sideways more due to auto production demand than content. We would have thought probably 90 days ago auto production would improve in the second half. With some of the things that are going on, we sort of expect it will probably be running around 19 million units a quarter. We do have, as he talked about, currency. I would ask you all to make sure you're picking up the currency impact. That's an incremental headline, about $100 million in our second half. And some of the wild card will be around China. If the lockdowns are able to get done, it will be how do we recover, the customers recover, that if demand stays where it's at. Could that be some recovery in the second half of this 300 basis points that we estimate today? But overall, it remains constructive, and we're going to continue to do the productivity and pricing actions that Heath and I have talked about. So net-net, I think you could see us getting back more to the quarter two level plus as we get to later in the year.

Okay. Thank you, Amit. Can we have the next question, please?

We'll go next to Samink Shatterjee at J.P. Morgan.

Hi. Good morning. Thanks for taking my question. I guess I just want to ask you on data and devices, we get often asked this by investors about how long can this sort of trend that you're seeing in data and devices continue? And maybe if you can flesh out, I know you spoke about sort of the higher speed cloud applications, but if you can flesh out the content growth story there between more number of connectors going into some of these applications over time versus where are you seeing sort of more appetite to So by higher feature or higher content connectors over time, how much of the content group is purely more volume versus higher feature or higher specification connectors?

Yes, Amik, thanks for the question. And I think when you look at our D&D business, the important metric you should be looking at is really what's happening in Cloud CapEx. Cloud CapEx is the important driver because as our cloud customers look at it, They're really trying to solve a couple of problems, certainly not only the consumer need and enterprise need for cloud infrastructure, but also they're trying to solve operating efficiency because one of the biggest drivers that they have is not only the need for speed and compute, but also how do they reduce their economic footprint. And, you know, Cloud CapEx continues to be strong. You know, it actually increased a little bit, and we continue to see that be strong. The other thing that's benefiting our content is not only just Cloud CapEx, and you see us growing ahead of Cloud CapEx, we are also winning not only in the speed sign, but how do we help our customers solve some of the energy efficiency operating cost issues they're trying to tackle because data centers use so much energy. And I know Aaron has shared some things around our thermal bridge product, but also as they move to AI, they're really trying to say how do they increase computational power with some of their workload architectures And that benefits us from a content perspective. And while we do have share gain happening, that content element is just as important across all facets of the compute and the store and move elements of cloud. So I think you're going to continue to see it based upon the Cloud CapEx trends. And that's the key driver to look on. And we can draw it out performance versus that Cloud CapEx due to really how our engineers are really tucked into our cloud customers.

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

We'll go next to Matt Sheeran at Stiefel.

Yes, thanks. Good morning. Terrence, I wanted to get your take on the inventory environment. Your inventory was up like your peers, but we're also seeing inventory climb within EMS, OEMs, and even the auto guys. So what is your sense of customer inventories, and did you see any pull-ins in your March quarter due to anticipation of lockdowns, et cetera?

I wouldn't say we saw a pull in that because in many cases, what we can produce, people are taking. So it comes back to what I've been saying throughout the call about, hey, what we can produce, our customers want. The one area where we always have the most visibility is in our distribution partnerships. And one of the things that we've been seeing with them is they're still light on a day's perspective versus pre-COVID and what they would normally target. So across our partner network, which is about 20% of our sales, they typically target about 180 days of inventory. They're still running in the 150, 160 overall. So that's something we look at because they can be a pretty concentrated proxy to say, is inventory good? you know, getting too flush out there. But I would tell you, you know, we did see orders increase due to some of the certainty people were trying to get with some of the increased volatility. We did not see pull-ins, and, you know, really how we produce will be the dictator of revenue. Okay. Thank you, Matt.

Can we have the next question, please?

Next, we'll go to Joe Giordano at Cowen.

Hey, guys. Good morning. Hey, John.

There was a comment that I believe GM made, and not to get specific about one customer or anything, but just more of an overarching theme, that on ICE vehicles, they're going to use one-third less of unique parts. I have no idea if they're talking about where in the car that's going, but I'm just curious if that's a risk going forward to legacy platforms where maybe products where you can have more pricing power and leverage because they're custom engineered become less and less prevalent.

Joe, could you repeat what GM said? I've missed you with what you said there on the one-third of what?

So they said that they're going to use one-third less unique parts in, like, ICE platforms going forward. Okay.

You know, if you look at that, certainly – you see the innovation around ICE platforms. You know, there has been less innovation put into it. You look at, you know, engine development has scaled back, so what you really are getting on the ICE vehicles, you really have the auto companies very much focusing their effort on, obviously, EV first. You also get into data and autonomy-type trends. And really, on the ICE vehicle, it has become a little bit more of a maintain. That being said, you do need to think about what TE does. And what we do, we also play into features, safety features. And that really drives, whether it's safety feature, infotainment features, emission features, those types of things really are where we get scale. And even getting more standardized, we have many ports that are standardized in a car that create tremendous scale for us. So going less unique in an ICE vehicle is not bad for us. It actually provides us for scale. And in some cases, we're seeing them look to us to be that partner to help get that standardization. And I would go back to what I said on the call. Our content growth in a nice vehicle is still strong, even though you have the innovation turning towards the next generation electric vehicles. So we do not see cannibalization in a move to EV. And we also continue to see that electronification trend And I would just ask you to think about your cars of what you feel from a feature, how features change. And each time you're doing that, you're typically getting into more data in the car, things that are going to want more processing to get to more fuel efficiency in a nice vehicle, could be safety features, and all of those create content for TE because you're into the electrical architecture of a vehicle, whether it's low voltage in an engine or you're high voltage in an electric vehicle.

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

We'll go next to William Stein at Trust Securities.

Great, thanks. I'd like to ask a question about capital allocation. Keith, you reminded us, I think about a third of cash flow would be targeted towards bolt-on acquisitions. I'm hoping you might just remind us about the end market focus that we should expect to see such transactions, and Your propensity today, given, you know, somewhat lower valuations, the stock market's pulling back, I wonder if that's influencing in any way the likely pace or ability to execute a deal. Thank you.

Well, thanks, William. I'll take the question. You know, longer term, which is kind of how we think about the two-thirds back to shareholders via share repurchase and dividends and then one-third back via M&A, you know, that is a long-term view over a cycle, right? So you're going to have periods of time, including the ones we're in right now, where we see dislocations in our stock price, and we see ourselves as a better opportunity to buy, and we are spending accordingly on that, and we haven't been seeing as many deals get done in the spaces that we're focusing in on. But there's still a fair amount of fragmentation out there for bolt-on activities across, I'd say, about two-thirds of our end markets. And there is a focus, you know, on the spaces that you've seen us do deals in, whether that's in industrial or certain things within medical and our high-speed data and some of the activities that we've undertaken more recently there. And it's pretty broad, the net that we cast to look at transactions. And at any given time, you can imagine we're looking at, you know, half a dozen or so and most of which don't get to the finish line for a variety of reasons, but we're very active in that front. I would say the pullback in the stock price, we have not seen a meaningful impact of that and impacted on valuations here in the near term. What that does over the long term, we'll see. Most of the things we do look at are not public companies, so there tends to still be a fairly decent appetite out there to deploy capital from us as well as others, so that has continued to inflate the multiple sum. So we have to be selective. We've got to be smart with what we do with our owners' money and make sure we're getting good financial returns and things that make strategic sense for us, but we're active out there.

Okay, thank you, Wolf. We have the next question, please.

We'll go next to Shreyas Patil at Wolf Research.

Hey, thanks so much for taking my question. I just had two clarifications. So it looks like auto outgrowth this year is going to be better than the six points. I mean, you're already doing about 10 in the first half. Is that mainly related to favorable pricing, and should we be thinking about the underlying content growth still in that six points level? And then the second one was on the Q3 guide in slide 12. It looks like the contribution margin on the $209 million of year-over-year operational performance was pretty low. It's only about $0.02 the EPS. So that's maybe like a 5% contribution margin. And I'm just curious how much of that is being driven by COVID lockdowns and the cost impact of those.

Yeah, let me take the first half, and I'll ask Heath to touch upon your guidance question. On the first half, You know, we are running well ahead. A lot of that relates to, you know, EV production is very strong this year. So you will have points where, depending upon where EV production is versus ICE production, can drive that outperformance. And like I said, we would anticipate, if you look at a content per vehicle, we'll continue to move up in the second half versus the first half. Heath, you want to take...

The Q3 contribution margin, I would steer you to really look at how we've been trending sequentially in the mid-18s, 18-ish, plus four operating margins. If you recall a year ago, we were pretty upfront that our fiscal Q3 a year ago, which was over 19%, was trending fairly hot. between the second and third quarter of last year, if you go back and look at those margin swings. So you kind of have to look at those together to get a fair view versus this year's Q2 and Q3, which is a little bit more consistent. But I would tell you that there's no doubt relative to the lockdowns. I mean, there is some pressure that's put on. Obviously, we quantified the top line of about 300 basis points to the total company relative to those China lockdowns. And that does come in a region where we make very good margins. And so it's something that does have a mixed impact as we think about the roll-up to a degree. But we're hammering through it, and I don't feel like it's something that's permanent. And I think as you get through and you look at our full year, the full year contribution margin, even including absorbing the earning acquisition still should be, you know, with a three-handle in front of a 30-30, we work our way through the full year. Thank you, Shreyas. Can we have the next question, please?

And next we'll go to Jim Suba, Citigroup.

Thank you. Can you just help us bridge the orders and the pricing? And what I mean by that is if everyone knows pricing is going up, isn't it logical that everybody puts in a lot of orders to beat those increased pricing? Or do you put in some type of escalators or variables? And just if you can kind of talk about those dynamics and how they're kind of at play.

Well, Jim, it's a little bit, you know, I don't want to be elusive to your question, but it is a little bit different. With our distribution partners, you know, we've also been repricing backlog. So, you know, even if they put orders in, we have been repricing backlog due to the broad escalations that we have. When you come into our large customers, You know, that's part of a contract negotiation. We have not been doing surcharges and adders like that. You know, it's been more ground price increases. And, you know, that's, you know, like we've said here today, it's about cost recovery. You know, so we're going to continue that, you know, certainly with the uptick that we've seen. You know, we have more discussions we need to have on pricing. And we're going to be further pricing increases into the channel here come in July.

Thank you, Jim.

Can we have the next question, please?

We'll go next to Chris Glenn at Oppenheimer.

Thanks. Good morning. I wanted to ask about factory automation and industrial, sort of similar to the question about measuring the longevity of the potential data devices cycle. There are capital cycles, of course, but you're talking about robotics, electrification, and safety, and I think people contemplate maybe some longer-term labor constraints. How would you view the sort of cyclical versus durable kind of secular components of what you're seeing in industrial growth these days?

A couple of things. You know, clearly you've got to start with where is the capital cycle at? And, you know, we will, similar to the D&D comments I made around cloud capex, I do think there will be an element that we will follow, you know, industrial capex. especially where we continue to position our industrial equipment business. And I think there's an element when I talk about that business, while I talk about some applications we focused on, it's also where we've done acquisitions to get deeper into. We did the Intercontact acquisition a number of years ago. We did Ernie. We did Entrelac. And these were things that were really about how do we get deeper into the trend. Because when you deal with factory automation, as well as the labor element, What are you trying to do? You're trying to get data off a machine. You're trying to get the machine to have more intelligence that actually can do things that, you know, humans can do in machine learning as well as preventative things. And that all starts with, you know, are you getting data off the machine? And that's with what we do, whether it's from a sensing or a connectivity perspective. So I do think the capital spending element is a positive construct, and I think what you're going to continue to see, similar to what we've seen with our data and device business is you're going to see content outperformance above that capital capex trend, and you've seen it already. So certainly it's a more fragmented world than what we have when we talk cloud, but it is something we like where we position ourselves, and I think you're going to continue to see us deploy capital to the bolt-ons that Heath talked about in those spaces to really make sure we strengthen our position.

Okay, thank you, Chris. We have the next question, please.

We'll move next to Joseph Spack at RBC.

Thanks. Eve, maybe just one quick clarification on your inventories, which have been higher as planned, as you've indicated. But is that the new normal, or do you think they go back down? And just with some of the disruptions in the industry, we've seen some of the auto capacity shift to other parts of the world, particularly out of Ukraine and others. Does that create any strain for TE?

Well, good. Thanks for the question. No, our inventory levels are a bit more inflated now than I would say that not a new norm, okay? So our days on hand are higher than we would normally run. So even at these volume levels, we're carrying a bit more than we would normally. This was intentional, and we've talked pretty openly about that as we work our way through the year in this volatile environment. where we've seen pretty aggressive swings, largely higher in terms of demand, the ability to be able to respond quickly to our customers, make sure that the customers' needs are met outweighed the pain of carrying more inventory. So we did do that. Now, as certain parts of our business have, you know, we've been able to get a little bit better insight into a few things and order patterns and so forth. We will begin to start working down modestly to this level through the rest of the fiscal year and you'll see that corresponding impact on our cash flows, but this is not the new norm and you know we'll continue to talk about where we should settle in particularly you know from the days on hand perspective from from that side of it in terms of the shift of production you know I think you're talking about we don't do any production in the Ukraine but certainly some of our customers do particularly on the automotive side and as some of those customers are have had to shift some of their capacity to other places. And we're really talking about the harness makers within automotive. You know, that has shifted around. It hasn't really impacted our inventory so much because, you know, it's already been sold to them. But as they shifted around, it's generally being shifted around within regions. So in this case, within EMEA. to other parts of either Eastern Europe or Morocco or otherwise. So, you know, we're able to respond to those new locations. And that doesn't specifically have a major working capital headwind towards us. So I hope I answered that question. Okay, thank you, Joe. We have the next question, please.

We'll go next.

Good morning. Thanks for taking the question. I wanted to ask a bigger picture question as we get deep into the call here. Specifically, hoping to get a feel Terrence, for the ascent of your data and devices franchise over the past couple of years, this is roughly a billion-dollar business in fiscal 19 pre-COVID that's now pushing a billion and a half on its TM basis. Obviously, I don't know why the market is growing here, but really the heart of my question is, to what extent has the overall positioning of the company changed competitively over that time frame, especially as it relates to impacts on future growth and profitability? Thank you.

You know, on it, it is something that I would tell you it goes back to, you know, some of the hard work we had to do in the D&D business that we've talked about. You know, and it was around we wanted to be focused on ultimate high speed. Certainly, we bring the innovation to it. We have pretty even share across all the cloud providers. And on top of it, you know, one thing that the cloud providers look for is also not only around technology, it's speed to ramp. And I think our teams have done an exceptional job on how they keep up with the pace that a cloud customer wants. And that's also created share opportunities on top of the innovation. So let's face it, part-time, we had calls about D&D where we would talk about the problems we had in D&D. And I really think the D&D story is one where we got focused, we repositioned the cost structure, we refocused the team, and the team has really executed very strongly on what has been a really good growth trend We've gained share, and we're also being a partner that you continue to see our confidence on these calls about the content that's growing. And I think there's still a lot of opportunity, especially while you get very customizable solutions that the cloud providers are getting around how do they get their operating costs down. It's not just a CapEx decision. It is an operating cost decision. And the innovation that we get to work with the cloud providers with to make that happen is just as unique as when we deal with the EV and the auto OEMs. So, you know, it's a position we really built there. We continue to be focused on it, and it's going to continue to grow, and, you know, cloud growth is projected to continue. So I appreciate the discussion, Lou. Thank you, Lou.

Can we have the next question, please?

We'll go to Nick Todorov at Longbow Research.

Thanks, Tim. Good morning. Another question on cloud and data center. Terrence, I think this is the first time you kind of highlight the AI architecture impact on TEs. And can you please talk about the content uplift there in AI architecture versus more traditional server architecture that TE benefits from?

Well, what you have is you obviously have much more complicated compute as you get through there. So You get speed. You also get increased thermal dimensions. And that comes into things that our team that really works well with. And they have to help our customers solve all of that. And some of the orders we saw in the first quarter were some new AI platforms that came in and are going to continue to benefit growth. On each application, the content does vary. It's not cookie cutter because the solutions that our cloud providers have are very customized around their chipsets. So it is something, and we'll try to get you a little bit more as we do some of our investor days to give you a little bit more framing, but it is very different by the cloud architecture that you go after.

Okay, thank you, Nick. I want to thank everyone for joining us this morning. If you have further questions, please contact Investor Relations at TE. Thank you, and have a nice morning.

Ladies and gentlemen, today's conference call will be available for replay beginning at 1130 a.m. Eastern Time today, April 27th, on this Investor Relations portion of TE Connectivity's website. That will conclude the conference for today.