TE Connectivity Ltd

Ladies and gentlemen, thank you for standing by and welcome to the TE Connectivity third 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 during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, 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, To Jill Shaw, please go ahead.

Good morning, and thank you for joining our conference call to discuss TE Connectivity's third quarter 22 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 I also want to thank everyone for joining us today to cover our results for the third quarter, along with our outlook for the fourth quarter of fiscal 2022. You know, as I normally do, and before Heath and I get into the details on a slide, I want to take a moment to discuss our performance within the backdrop of the current environment. We delivered strong performance again in the third quarter with record sales and this represents 11% organic growth year-over-year. We had growth in each of our three segments and organic growth across all nine of our business units. Adjusted operating margins were in the mid-18% range, and this is at levels similar to where we've been running through the year, despite incremental headwinds that we've been experiencing. And we also delivered record adjusted earnings per share that was above our guidance. I feel our performance is a result of how we strategically positioned our portfolio around secular growth trends, as well as the execution of our teams, both from a manufacturing perspective and in our ability to effectively manage pricing in this inflationary environment. I'm also proud of our teams as they continue to overcome broader macro challenges to effectively serve our customers and deliver the strong financial results we're going to talk about today. Now let me provide some color on the supply environment, key end demand trends, and the developments since our call 90 days ago. When we provided our guidance last quarter, we told you about an anticipated impact on our sales to the COVID lockdown in China. And even though these lockdowns extended further into the third quarter than our original expectation, our teams were able to recover. and the sales impact of the quarter was negligible. When you think about the global supply chain challenges and specifically around material availability, I would tell you they're about the same as they were 90 days ago, and inflationary pressures continue to linger. One element that I want to highlight that has changed since the last time we spoke is the strengthening of the U.S. dollar. This strengthening has significantly increased the headwind we're facing from foreign currency exchange rates, both year-over-year and sequentially, and Heath will talk about that a little bit more later. Turning to the markets, customer demand remains strong as evidenced by our order levels and our strong backlog position. And just to highlight, our backlog has grown over 20% versus the prior year. And we are seeing some consumer facing markets like appliance moderate, but we continue to see broad strength across our industrial segment. And we still have a number of markets that we serve that are not yet back to pre-COVID levels. And this includes automotive, commercial air, as well as medical devices. And we expect growth in these businesses as supply constraints are alleviated and those markets continue to recover. The other thing that I want to highlight and we've consistently talked about, and it has not changed, is the benefit we continue to see from the secular trends in our markets and the outperformance that we're generating from content growth and share gains. We are benefiting from our position as an industrial technology leader with growth from electric vehicles, smart factory applications including automation, renewable energy, and high-speed cloud and artificial intelligence applications. The other thing that I want to highlight as we continue to navigate through this noisy macro environment is that we remain committed to our business model and long-term value creation by driving further growth, margin expansion, and strong cash generation.

So with that as a backdrop, let me get into the slides and discuss additional highlights that are on slide three.

Our quarter three sales were a record at $4.1 billion, and this was up 7% on a reported basis and up 11% organically. As I mentioned, we saw growth across each of our segments and organic growth across all of our businesses, once again demonstrating the strength and positioning of the portfolio. We generated double-digit organic growth in the industrial and communication segments and 8% organic growth in transportation, despite an auto production environment that was essentially flat year over year.

Our orders were $4.2 billion in the quarter with a book to bill of 1.02.

And this shows that the demand environment continues to be strong. And I'll get into more details about order trends by segment when I get to the next slide. From an earnings perspective, our adjusted earnings per share was a record at $1.86 That's up 4% year-over-year, with adjusted operating margins of 18.6%. From a cash flow generation, our year-to-date pre-cash flow is approximately $1 billion, with approximately $1.6 billion returned to shareholders this year. And I will tell you, we've been aggressive with share buybacks as we're taking advantage of the recent market price dislocations with our stock.

As we look forward...

We are expecting quarter four sales to be approximately $4.2 billion and adjusted earnings per share to be around $1.85. Our guidance reflects the benefits of an extra week that we have in the fourth quarter, but also factors in the impact of an increased headwind from currency exchange rates. And if you look at the slide, we've provided the details of each of these items and how they impact our fourth quarter. Before I get into orders, one thing I do want to do is move away from the financials for a moment and highlight that I'm pleased that we issued our 12th corporate responsibility report last quarter, which reinforces our one connected world strategy. When you look at the report, it has many highlights, but one of the keys that I think is important was that we were successful in driving a 30% reduction in absolute greenhouse gas emissions in a single year in fiscal 2021. And this is a very large step towards our goal of achieving a 40% plus absolute reduction in our Scope 1 and Scope 2 greenhouse gas emissions by 2030. So with those being the highlights on Slide 3, let me turn to Slide 4, and I'll discuss order trends as well as what we're seeing in our markets.

For the third quarter, our orders were $4.2 billion, as we expected.

And this reflects the continued strong demand environment from our customers, as well as we continue to see the impacts of ongoing supply chain volatility in the markets. Our backlog is up over 20% and increased double digits in each of our segments versus the prior year. It is also important to note that currency exchange headwinds are not only impacting our sales, but also when you look in the year-in-year compares, negatively impacts the value of our orders in the third quarter. And this impact, when you look at the year-in-year compare, orders would be $230 million higher this quarter if it wasn't for the strengthening of the U.S. dollar. In transportation, we had a book to bill of one in the third quarter, which is in line with where the segment has run historically. And keep in mind that we also have a strong backlog position. End demand for autos remains healthy and is significantly higher than what OEMs can currently produce, providing a potential setup for future auto production increases as supply chain bottlenecks begin to resolve and dealer inventories get back to more normal levels. In our industrial segment, we saw another quarter of strong orders with a book-to-bill of 1.16 and growth across all businesses year over year. We continue to see a favorable backdrop in capital expenditures for factory automation, manufacturing capacity, and renewable energy. And these trends benefit both our industrial equipment and our energy businesses. The other thing about our industrial segment orders are we're continuing to see improving order trends in the commercial aerospace, as well as medical markets, where we expect growth as those markets continue to recover. In our communications segment, orders reflect a double-digit increase in our backlog versus the prior year, along with expected moderation in the appliance market that we've been talking about all year. And one thing, when you look at the communications order trends, it is important to note that our backlog in our communications segment is approximately $1 billion. So with that as a backdrop on orders, let me get into the year-over-year segment results that you can see on slide five through seven, and each one of those slides has the details for each segment. So starting with transportation, our sales were up 8% organically year-over-year. Our auto business grew 9% organically versus auto production that was roughly flat versus the prior year. Global auto production was 18 million units, and this was slightly lower than our expectations due to the lockdowns in China. and we do expect some sequential increase in auto production into the fourth quarter. The trends around our content remain robust as we continue to benefit from increased electronification as well as higher production of electric vehicles. And we do expect electric vehicles to be up over 30% this year compared to a total auto production environment that is going to be flat. As we look forward, We do expect continued expansion in our content per vehicle, and you'll see that as we move from the first half to the second half of this year. In the commercial transportation market, we saw 10% organic growth driven by North America and Europe, with significant market outperformance in all regions, driven by strong content growth as well as share gains.

In our sensors business, we grew 2% organically,

And what was nice is that growth was driven by the focus we had on factory automation applications. When you look at earnings for the segment, adjusted operating margins were 17.3%. And you know, this was impacted by the inflationary pressures. As you know, there's a time lag from when we incur higher inflation until price increases become effective with our auto customers. So let's move to the industrial segment. And in our industrial segment, sales increased 13% organically year over year. Industrial equipment was up 19% organically, with double-digit growth in all regions and continued benefit from increased capital spending and factory automation. In our energy business, we saw 17% organic growth, driven by increased penetration and renewable applications. And in our aerospace defensive marine business, This is the first time we've seen year-over-year growth since the market was impacted by COVID, and we now expect continued growth as we go forward. Our medical sales in the segment were up 1% organically, with a modest increase in interventional procedures, as well as medical device market is continuing to work through supply chain challenges. From a segment margin perspective, our adjusted operating margins expanded year-over-year by 100 basis points to 16.8%, driven by higher volume and strong operational performance by our team. We have made significant progress in our margin progression over the past several years, and I'm pleased with how the team continues to drive towards its business model target of consistent high teens operating margin. So let's turn to the communications segment. And as you can just see looking at the slide, our team continues to execute while capitalizing on the growth trends in the markets they serve. Sales growth was 16% organically year-over-year for the segment, with growth in both businesses as highlighted on the slide. In our data and device business, we saw market outperformance driven by content growth in high-speed cloud, as well as share gains in artificial intelligence applications. And as we highlighted last quarter, these artificial intelligence applications do improve energy efficiency in the data center. It's just another example of how we enable lower carbon emissions with our customers through our engineering. In our appliance business, it didn't perform ahead of our expectations, despite the expected declines in the China market. We saw growth both in North America and Europe in our appliance business. and that is driven by continued share gains enabled by our global manufacturing strategy. From a margin perspective, the communications team continues to deliver outstanding performance. The adjusted operating margins were 26.2%, and this was up 270 basis points versus a strong quarter in the prior year, and our teams continue to deliver strong performance both on sales as well as proving margin resiliency. more details on the financials as well as our expectations going forward.

Thank you Terrance and good morning everyone. Please turn to slide 8 where I will provide more details on the Q3 financials. Adjusted operating income was $761 million with an adjusted operating margin of 18.6%. GAAP operating income was $719 million and included $30 million of restructuring and other charges and $12 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 $1.86, and GAAP EPS was $1.83 for the quarter and included a tax-related benefit of $0.06, and additionally we had restructuring, acquisition, and other charges of approximately $0.09. The adjusted effective tax rate in Q3 was approximately 19%. For the fourth quarter, we expect our adjusted effective tax rate to be roughly 20%. So we continue to expect an adjusted effective tax rate around 19% for the full year. Importantly, we continue to expect our cash tax rate to stay well below our adjusted ETR for the full year. I'll turn to slide nine. Sales of $4.1 billion, a company record, were up 17% reported and up 11% on an organic basis year over year. When you think about our organic growth, approximately one-third was driven by price increases and the remaining two-thirds was driven by volume as a result of the strength of our portfolio. In the third quarter, currency exchange rates negatively impacted sales by $236 million and seven cents versus the prior year. As Terence mentioned, FX impacts have worsened significantly over the past 90 days. In Q4, we expect currency exchange rates to be a sequential headwind of approximately $70 million and a year-over-year headwind of approximately $275 million. For the full year, we now expect a negative impact from FX of roughly $700 million, which is significantly worse than our view 90 days ago. Adjusted EPS was a record at $1.86. Adjusted operating margins were 18.6%. And I am pleased with the performance of our team given the incremental inflationary and supply chain pressures we are seeing. We continue to pull pricing levers across the business to help partially offset these pressures. And as we talked about last quarter, while we are not able to offset these costs dollar for dollar, we continue to recover approximately two-thirds through price and the remaining through productivity initiatives. We continued taking pricing actions to offset these inflationary pressures. Turning to cash flow in the quarter, cash from operation, excuse me, from operating activities was $579 million. Free cash flow for the quarter was $423 million. As we mentioned in past calls, the year-over-year trend in free cash flow does reflect strategic inventory builds. However, we expect to work down inventory this quarter, with Q4 expected to be the highest quarter of free cash flow for the fiscal year. Through the first three quarters of the year, we have returned approximately $1.6 billion to shareholders with approximately $1.1 billion returned through share buybacks. We will continue to remain disciplined in our use of capital and near-term We have been aggressive in buying back our stock and taking advantage of investing in our own value creation opportunities. So we've made significant progress towards our business model over the past few years, and our teams are continuing to execute well in a volatile environment. The strategic positioning of the portfolio has enabled us to deliver sales growth, margin resiliency, and EPS expansion despite the challenges we are facing. We will continue to focus on what we can control to effectively serve our customers, drive strong financial performance, including strong cash generation. So now, let's open it up for questions.

Okay, thank you. Can you please give the instructions for the Q&A session?

At this time, I recommend 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 and If you would like to ask a follow-up question, please press star 1 to return to the queue. Our first question comes from Chris Snyder with UBS. Your line is open.

Thank you. I wanted to ask about expectations for global auto production over the next couple quarters. You know, obviously a big debate in the market. You know, consumers are pressured, but, you know, we've already had production near top levels for the last two years. So just what are you hearing from customers around expectations for production and in-term connectors over the visible time horizon? I would also be interested in any views on auto demand versus production debate.

Thank you. Sure, Chris. Thanks for the question. And, you know, let's just frame it a little bit. You know, auto production, I talked about it in my comments. You know, we think in our fiscal year, the September year, there's going to be 76 million vehicles made this year. And that's the same amount as it was made last year. And you look at demand, we would tell you we think demand's well above 80 million units. And also to give you another guidepost, back in 19 pre-COVID, there was 88 million cars made on the planet. So we still have a way to go to get back to pre-COVID production. And we can also see where inventory levels are in pretty much every region of the world, still very low. So we do think there is potential for production increases. Even if demand comes down a little bit, there's still a big disconnect between demand levels versus what our customers can deliver. And a lot of that is well documented from the OEMs around semiconductor supply and things like that. I think the other thing that I just want to say is we did see 18 million units made this quarter. Going into the next quarter, we do think, and I said it in my presentation, prepared remarks, 19 million units. And so there is, I think, upward momentum to production as we move into the next year if the supply chain continues to improve. I think that his point, though, you know, the other thing is what do we control? We control content. We don't control production. Certainly, TE does not make semiconductors. But I think the other element I just want to stress is, and I think it's shown up through this period, even in a tough production environment like we've been in the past couple years, how our content has expanded from what was in the 60s, consistently in the 80s, you'll see an increase in the second half, really shows where we position the portfolio, both around as electric vehicles continue to be built, continue to be a bigger pie, but also from the electronification. And as I told you in other calls, you look at that $20-plus delta per vehicle, About 60% of that's driven by electric vehicle growth. The other 40% is due to electronics on both combustion engines as well as on electric vehicles. So I do think while production has been frustrating, I do think we're still well below demand, and if we do get some breaks on semiconductor and other supply chain, there could be upside as we go next year, even with a cloudy macro environment.

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

The next question comes from . Your line is open.

Hey, good morning, Terrance and Heath, and thanks for taking my question. Maybe to follow up on the order summary page and specifically the transportation and communications orders, which pulled back a bit here. Can you talk about demand trends and maybe transportation kind of outside of automotive and also what you're seeing in communications? And maybe also if you could give us a sense of how orders are tracking for both in markets Q4 to date, that would be great. Thank you. Sure.

So let me take the last piece of your question first. So when you look at our orders in July at total TE levels, they're running very similar to what they were running at last quarter. So, you know, our orders overall have been pretty steady here. You know, what we saw last quarter as we go into this, you know, one month in. So from a July, they remain healthy. The other thing that I think is important is we do have to keep in perspective, and we talked about this a lot over the past year, two years, you know, A lot of customers were ordering ahead. Certainly we have an elevated backlog position. And even in some of the compares, like our communication segment, last year in this quarter, our orders were over $800 million. So it's very strong compares and tough compares. What we continue to look at in our orders is orders with backlog. And I mentioned on the call, communications, we have a billion dollars of backlog. And our communication customers were... did a good job of ordering out. You know, I do think they did a better job than our transportation customers when they were trying to make sure they were securing supply. And overall, that's what you're seeing in the trends. So as we look forward, and no different with our guide, we continue to see healthy demand trends. Certainly the industrial markets continue to look like they're accelerating, and we have two of our four markets in industrial, you know, We're a little bit later to the recovery party with medical and commercial aerospace. Industrial equipment stays strong. And the one market that we do see moderation in, which isn't a surprise that we talked about, has been the appliance market. We would have thought there'd be moderation even before now. We saw it in China. Certainly, that's tied to housing and property. And we would expect that we'll continue to moderate But when we say moderation, you're really talking about our orders sequentially going from our March quarter to our June quarter being down like 12%. I don't want it to be they're falling off a cliff. But they did moderate, and certainly the backlog also supports where we guided. So hopefully that gives you better color about how we think about and also confidence.

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

Our next question comes from... Ron Finohan with Bank of America. Your line is open.

Yes, thank you. Terrence, can you talk about the various moving pieces and margins across the segments? Automotive was weaker, and I know you experienced a lot of headwinds in the quarter, but comms and industrials were quite strong. How should we think about the trajectory from here? And also, if you could address how the incremental margins should track, because that seemed to decelerate somewhat in the quarter. Thank you.

Hey, Wamsi, this is Heath, and I appreciate the question. Listen, I think, you know, if we just start with where we are TE in total, right, we're still tracking in that mid-18% level, which is really where we've been tracking most of the year. And there's no doubt, you know, some of the strength coming out of our communications segment and then, you know, some of the improvement we're seeing in industrial has helped offset some of the the pricing lag that we get in the automotive and overall transportation business, but we're pretty pleased with the diversity of the portfolio and the ability to be able to withstand these volatile environments. Part of the answer to your question, though, is the timing on when price increases go into effect. Within transportation specifically, you're dealing with a lot of automotive customers, and there's a lag between when we see the price increases go in relative to when we see the impact of inflation. And I think it's important for us all to remember that where we operate in the world, inflation looks very different. In some cases, it has worsened, including in Europe, where energy prices continue to be a pretty significant headwind. So, you know, we are offsetting about two-thirds of that inflationary pressure with price, which, as you know well, you know, us moving into positive prices was a big move, you know, coming out of COVID here. But it does still, because we can only cover about two-thirds of it, it still does require us to make up the difference through either productivity initiatives and then obviously what we've been undertaking with some of the longer-term restructuring activities. Within the quarter, I think it'd be fair to say transportation also felt a little bit of the impact from China, just the inefficiencies of not shipping much for two months and then catching it all up in the final month of the quarter. That did have an impact. And as we move forward, I think we'll continue to focus in on where we stand from our ability to be able to pass on price. But overall, we're feeling good in where we stand.

With that, hopefully that answers your questions. Thanks. Thank you, Wamsi. We have the next question, please.

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

Yes, good morning, and thank you for taking the question. So we need to better understand the FX impacts, and from a couple dimensions potentially. So first, you spoke to some of the translational impacts, but are you seeing any change in actual business conditions, and are any of the international companies potentially being more aggressive with quoting activity given some of the changes in currencies? And then specifically to the P&L, I was hoping you could maybe speak a little bit more specifically to the 4Q sequential EPS. Heath, I think you said it's $70 million on revenue quarter-on-quarter. Could you speak to the EPS impact? Thanks.

Sure. Mark, this is Heath. As I said on the call, when we sat here 90 days ago, I gave a number, a range for the full-year FX impact. I think I said between $400 million and $500 million, and that has stepped up by a couple, $250 million for our full year now to about $700 million. You know, about 75% of that has been in the second half of our fiscal year that we're in the middle of right now. So, you know, it does flow through when we give the translational impact. The overall EPS impact from all that is about 17 cents for the full year, FY22. So it is meaningful to us. In the fourth quarter, we expect that number to be year over year about $275 million, so incrementally worse than what we saw in the third quarter. And as we look into FY23, obviously we'll provide more guide here next quarter. But if we just snapped a line in the sand right now with where various currencies are, it would be about a $300 million headwind here. in FY23 for us, most of which would be in the first half of our fiscal year. So there are some numbers out at you just to try to, you know, frame up what we're seeing out there. Now your question on the competitive landscape is we really haven't seen a whole lot difference in that yet. We're keeping an eye on it, but For the most part, we haven't seen anything change considerably in terms of how, you know, competitors are treating each other or along those lines. And, you know, listen, we're not economists. We're not going to predict where the dollar is going to go relative to these other currencies that we do transact in. But we feel pretty good about our balance position globally. Okay. Thank you, Mark.

We have the next question, please.

Our next question comes from Joe Giordano with Toen and Company. Your line is open.

Hey, good morning. This is Robert Jameson in for Joe. Just wanted to pivot quickly and ask about the buyback activity. It looks like you guys are running about 2x what you did last year at this time. Just wondering if there's any changes to your capital allocation strategies.

Well, this is Heath. I'll take this question. Listen, you know, long term, our strategy is unchanged, right? You think about it over a cycle, we still think about two thirds of our free cash flow being returned to shareholders in the form of buyback and dividends and about one third being used for M&A. However, there's, you know, we've always, we've There will be times when we might deploy more into M&A. There will be times when we might deploy more through buybacks, and that kind of takes into consideration market dynamics, where we're trading, the value of acquisitions out there relative to our value, and weighing everything through a strategic lens as well. So we have the good fortune that we have a very strong balance sheet, and that has allowed us to play offense in the near term here. It's allowed us to play offense in the sense that we were able to make some strategic inventory builds and flex our working capital to make sure we were taking care of our customers. That's not letting ourselves off the hook. We will start working that back down now that we're seeing a little bit, in certain markets, a little bit more visibility allows us to plan in our factories better. But, you know, we've been able to flex with that. We've been able to flex, obviously, using our free cash flow for buybacks as well. But I would not consider this a permanent change, but more of an opportunity to create value for our shareholders. Okay.

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

Your next question comes from Amit Gariani with Evercore. Your line is open.

Yes. Good morning, everyone. So I guess I have a question and a clarification. Karen, the question is for you. As we think about beyond the September quarter, I think there's a lot of concern around what 2023 could look like, given all the macro worries that are out there. Can you perhaps just maybe talk about the cross-codes that you see at TE as it relates to 2023 across the segments would be helpful, I think, to just level set things like content growth and how you see that stacking up next year? And then, Keith, if you could just clarify, I heard your discussion on margins. Maybe I don't appreciate this enough yet. Why are margins going down in September quarter, sequentially, when I think some of these headwinds you've talked about should start to alleviate? So, maybe just talk about the margins puts and takes as well for September. Thank you.

Thanks, Meek. Let me get into the first half of your question. As you know, we've been guiding a quarter out, so anything. We'll give you more about next year, but I'll give you some initial thoughts here, and then we'll tighten them up in 90 days. You know, the transportation, back to an earlier question I had, content feels very good about. And you can all see the OEM programs that are coming out on electric vehicles. You know, it isn't one or two OEMs in the world. It's every OEM in the world that's coming out with electric vehicles that, you know, the content momentum that we've had, we continue to see that. And, you know, probably being closer to the higher end of the range that we've talked about in the four to six. But that's not only in automotive. That's also in commercial transportation. And our commercial transportation team has been driving a lot of content, so I think you can have a good content there. And let's face it, this year in commercial transportation in 22, China was rough. China drove the entire global market to contract this year, but our team grew. And I do think, as you think about some of the stimulus China is doing around infrastructure, as well as what they're doing around auto stimulus as they're coming out of COVID, I do think there's upside opportunity versus the production environment in both of those markets that I said earlier. And, you know, certainly that China stimulus is important because it's one of the bigger markets in the U.S. as well as Europe. You know, in industrial, I would tell you, you know, feel good about the capex trends. I feel very good about the renewable positioning we've done in energy, and you saw our 17% growth here. This quarter in energy, I think you're going to continue to see that momentum because they were tied to good trends. And then Comair and medical, I know I spoke about they're growing again, but in Comair, we're still only at two-thirds of what we were pre-COVID. And while single aisle has improved, there's double aisle opportunity that's even more content for us than a single aisle aircraft. So the content's true there, and it's really about how does the large air framers continue to ramp production as it gets in there. When you look at our communication segment, I think it's going to be probably a tale of two cities. The appliance market we talked to you about, we expect that to moderate next year, but offsetting that will be cloud CapEx. And the question is, Where does Cloud CapEx go after it was up 20% this year? We do expect Cloud CapEx growth next year. We just have to see where our customers really put it at. I'm not sure it will be at 20%, but I still believe it will be growth. So there's a bunch of moving pieces out there, but I would tell you when we look at the order trends, we also look at the content growth that you've seen in our results plus the backdrop of where we play. It still feels very constructive as we go into 23. And as I said, when we get on our next quarter call, we'll add more color versus what we're seeing. So please, why don't you take the second piece of Ahmed's question.

Sure, Ahmed. Your question was relative to implied margins for Q4. As you know, we did not guide a margin number. So if you're backing into a margin number relative to the sales and the EPS, I think, you know, one, taking consideration the tax rate is going to be a point higher as we guided in the fourth quarter. So, you know, we're not seeing a dramatic fall off in margins. But, you know, if you're on the fringes, if you will, you know, keep in mind a couple of things. As we signaled, we do expect our communications segment to be a little bit lower revenue levels in the fourth quarter just because of some of the appliance pieces that Terrence just talked about. That has a little bit of a mixed impact. You know, there's no change in our assumptions around this inflation and price segment. go-get, you know, when we're only covering two-thirds. And then, you know, again, on the fringes, we're going to be working down some inventory in the quarter, and that's going to have a little bit of impact as we work through that count. But it's not something that we see falling materially at all, if any.

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

Your next question comes from William Stein with Truist Securities. Your line is open.

Great. Thanks for taking my question. Terrence, if we zoom out and don't really focus on any particular end market or segment, just look at the overall revenue performance and overall bookings. This sort of feels like the elusive soft landing. We're still seeing good revenue growth, but the orders are backing off these very elevated levels that we've experienced in recent quarters. Is that the way you all see it? And if that's the right characterization, How many more quarters of this sort of performance do you anticipate? Do you think that, you know, this is going to continue to play out and we'll continue to see perhaps a moderation of orders, but sort of a burning of the backlog and revenue growth still sort of at, you know, at good levels?

Yeah, well, thanks for the question. And I guess I know we spoke to many about it. You know, when we think about our business and the lead time for our product, let's put things into perspective about our lead times. For an average product, you might be 6 to 12 weeks. So I do want to frame, you know, when you look at TE and you think about an average lead time, you're 6 to 12 weeks. You know, it's not some of the lead times you hear from other product categories that you have. So there's an element here of when we were talking to you about what the bill is at 1.20, We always said there will come a time that, you know, as markets become more normalized, we would expect our book-to-bill to reflect more normal patterns than a 1.2 book-to-bill. So when I look at it and I think about transportation, you know, getting closer to a one, we expect it to get to. Certainly, as we work on backlog, you know, like you saw in communications, you know, we got a lot of backlog. We have over a billion dollars of backlog in communications. customers, you know, if they feel good with that backlog, they're not going to place more orders. They're going to want to work that off. And we look for pushes and cancellations. Are people pushing out orders? Are they canceling orders? We are not seeing any major trends in pushes and cancellations. So, with the indicators that we're looking at, you know, show that, hey, while we have some markets in transition like appliance that we've been highlighting to you, we also still have markets that are still trying to catch up like commercial aerospace. So, I do think it's an environment where not everything is going up and growing, and we just have to realize if a customer is concerned about the macro, they're probably going to get a little bit more conservative and say, hey, let me work off a little bit of backlog. So I think you're going to continue to see book-to-bills getting more normalized in an environment like we have, but certainly we have some markets where customers are concerned about supply chain volatility. And like we've talked about in the industrial segment, we're still at a 1.16 book to build, which is a very strong book to build, and that means we're still building backlog.

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

Your next question comes from Sumit Chatterjee with J.P. Morgan. Your line is open.

Hi, this is MP on for Sumit Chatterjee from J.P. Morgan. Thank you for taking my question. So I just wanted to ask regarding the order trends in industry, like we are seeing some of your peers, you know, downgrading their expectations for the growth in this particular sector. Additionally, the global PMIs are also down relatively compared to the starting of the year. What exactly is driving like strong order growth for you in this particular sector? And as you said, that day you see them accelerating as well.

Yeah, when I look at our, thank you for the question, when we look at our industrial business unit, it also comes into the backlog of our customers. If you look at our customers that are all the robot manufacturers of the world, certainly the factory automation, and you even go back to semi-capacity being put in, electric vehicle battery capacity being put in, other automation programs being put in, they're the drivers of it. So you have to look at the capital spending And the backlog of the projects continues to be very strong. And, you know, that's creating backlog for our customers of the world, whether they're in Asia, whether they're in Europe, whether they're here. And, you know, what's nice is we're very globally deployed in that business unit. And orders continue to be very strong as people are trying to make sure they can fulfill their backlog. And we've really positioned well in that space. And you've seen that outperformance consistently over the past year and a half.

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

Your next question comes from Matt Sheeran with Steve. Your line is open.

Yes, thanks. Good morning, everyone. Terrence, I was hoping to get your take on inventory picture at your customers. Obviously, with longer lead times, there is ordering and perhaps double ordering even of your products, which we don't typically see with interconnects. But are you getting a sense of any build, particularly in the industrial markets where you have a lot of distribution exposure? You know, we're seeing lots of inventory at EMS and the OEMs. And at some point, you know, that's all going to give and we're going to see a correction. And I'm just wondering, are you seeing that? Are you expecting that at some point?

Well, I think the thing is, first off being, you know, people have been trying to make sure you're not going to want to hold up. manufacturing of an end product for a connector. If you're waiting for a semiconductor, people will want to make sure they have the interconnects with certainly the semiconductor being the brain and we're a little bit more like the arms and the legs. But when you look at it and you take distribution to what you said, you know, distribution inventory is still not back to where we would expect it to be. It's still probably 15 days light on a term perspective of where it was pre-COVID. So we continue to monitor that inventory position. And that's an important thing to watch to make sure that the distribution channel does not get heavy from a day's perspective. So feel good that they're still in a good spot. When you get into where our product goes everywhere in the world, we're not going to know every little pocket of inventory. But it's something that if lead times continue to get better, And I wouldn't tell you they have gotten better yet. They're stable, but they're not better. You know, you would expect, you know, there might be a little bit of an air pocket, but we're not at that point yet.

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

Your next question comes from Christopher with Oppenheimer. Your line is open.

Thanks. Good morning, Terrence Heath. Good morning. I had a quick question. I had a question about how you're viewing market share in the electric vehicle space. Curious if you're able to, you know, kind of cite or see share gain there or if the market's still too formative.

No, when you look at that, and I think you have to start with, we have a very strong position already. And as we say, we're in essentially every car in the planet already. So I think our market share, our strong position we already have, that has been in combustion engine, as we bring the technology in, I know we've shared content elements of, hey, you look at an electric vehicle, it's about 2x what we have. But then you also carry over what we do on a low-voltage architecture that, when you add the high-voltage motors in it, basically is additive. So when you look at it from a market share perspective, I feel very good about the programs we're winning. What's great is it's as global as our current position. We want to sit there and make sure we're globally positioned, and it's pretty similar to what we have and what we had in our historical market share.

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

Your next question comes from Sheriaz Hatil with Wolf Research. Your line is open.

Hey, thanks so much. Just wanted to quickly understand how to think about the interplay between order activity and backlog. So, you know, for example, if you're seeing some segments like transportation nowadays in a more normal book to bill, but you also mentioned that the backlog is still growing in those segments. Is the right way to think about that, you know, potentially the order activity would moderate as those customers try to work down that backlog? I'm just trying to understand how we should be interpreting those going forward.

When you look at it, book to bill of one basically means you're not building backlog. So I think the one thing when we look at book to bills, please remember there's two numbers in a book to bill equation. The order number and then obviously the revenue number. And you have to realize we have brought up our output by the growth that we talked about. So the bill has also gone up. But when you look at it, similar to what we talked about in communications, if the backlog is so strong, you can have a bill below one because the customers feel they are scheduled out over a couple quarters, could be up to three quarters in our case, where they say, hey, guess what? I feel good where I'm primed in the system. And you could run below one a little bit. They're just key factors of how it works, and I think you have to keep in the mindset. I'll go back to what I said today. When we have an average lead time of six to 12 weeks, let's say, you know, we aren't somebody that has backlog that goes out years. That is not our business. You know, our backlog typically is within the next, you know, nine months.

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

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

Thank you. I know it's just kind of an accounting thing with the extra weeks, but I know that there's also a year-end thing, whether it be stock vesting, merit increases, but also in your fiscal Q4, a lot of the OEMs do production change over years and kind of close for annual vacation and switch over model years and such. So I know you gave some commentary in your slides on the Q4 impact, but I'm just wondering, is it more complicated than just adding one extra week of sales and EPS to some of the things I mentioned? And importantly, though, for setting up expectations for Q1, I know it's early, but do we just remove that exact same amount in Q1, or is it kind of nonlinear? And I expect that it's a lot more complicated. you know, complicated than what people just may initially think. But I think it's important so people level set and don't get ahead of themselves for extrapolating that, you know, going forward. So any additional clarity around that on revenues and ETF would be great for the next two weeks. Thanks, Jim.

And good to hear from you. I'll let Heath handle that.

Thanks, Terrence. Jim, you know, I'm sure you remember that we went through this in the fall of 2016 as well, right, which was the last time we had the extra week. And so this is a convention that does happen every five to six years based on when we, you know, the true up of our fiscal calendar. where we end up with that extra week. So if you think about it, from a fiscal year perspective, operationally, nothing changes, right? So nothing changes relative to a cutover into our October, which will be the first month of FY23. Nothing changes with employee schedules and everything else. It really is basically a mechanism that trues up the calendar every five to six years. It does provide, as we did here, we gave our best guesstimate of what that extra week will provide, which is about $250 million in revenue and about $0.10 of EPS. What will happen and when we deal with our fourth quarter results and our Q1 guide here in about 90 days, we will tighten up that estimate. So we'll give you what we can calculate it more appropriately and more accurately at that time. And then obviously as we move into the first quarter, we'll be back to having 13 weeks and we'll move forward with that way. So from a Q4 to Q1 compare, there is an extra week in Q4 versus Q1. We're estimating that to be about $250 million and about 10 cents of EPS. But we'll tighten all that up and be very transparent as we close the books here in about 90 days. So I hope that answers your question, but it's some fun stuff we work through every five to six years with this fiscal calendar.

All right. Thank you, Jim. We have the next question, please.

Your next question comes from Stephen Fox with Fox Advisors. Your line is open.

Thanks. Good morning. I heard all the comments on margins this morning. I was just wondering if you could dig a little deeper into the communications margins. I think You keep telling us not to expect these mid-20 margins to repeat themselves, but they keep repeating. So there must be something going on in terms of products or pricing or execution since you put up 26% and you're talking about pressure on appliance markets. So any color there would be helpful. Thanks.

Thanks, Stephen. This is Heath. You know, listen, I know the question in our stated business model, right, we've said this segment before. uh should be in the high teens operating margins and i'm i'm acutely aware that we've been running significantly higher than that particularly over the past couple of years i think what's important here is is is to step back a little bit and say you know this was a journey in this segment to get it to where it is today right there was a lot of if you go back several years you know there was about a billion dollars of of consumer related product that we walked away from and then there was a tremendous amount of restructuring to get this business where it is today and what that shows is when you get that operating footprint right and then you get these levels of volume that we're seeing out of both appliances as well as data and devices we can kick out these kinds of margins so there's nothing artificial in these margins we have been aggressive on price as you would expect and in some cases we are able to pass through price in both industrial and in communications a bit more efficiently because a bigger chunk of those businesses go through channel partners. And those price increases can go on a little bit more rapidly and take effect more quickly versus transportation that is a renegotiation OEM by OEM. So there is some price piece. There's no doubt about that. And we'll continue to keep our foot pressed down on those on those elements to help cover. We're not, you know, we're just trying to cover where we stand from an inflationary pressure environment. But when we do see appliance moderate, right, we've been running about a billion dollars annual run rate appliances. And, you know, if that moderates down some element, some amount, you know, we do expect that to have a little bit of pressure on the margin front. That doesn't mean we see it collapsing, and we'll get more color as we're more comfortable with that here this fall. But, you know, right now at these volume levels, this would be the margin you would expect. Okay.

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

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

Thanks so much. Can you give us some color on what your customers are thinking in Europe in light of the energy issues there? Ironically, one of the things we've heard is in transportation industrial, some of those players may try to produce as much as possible this quarter to get ahead of what they think might be potential larger issues later in the winter, I guess, as long as the supply chain allows them to do so. Are you seeing any evidence of that? And then related, I do think you have some facilities in Germany. So how directly impacted would you be by gas shortages?

Good question, and I would say this is real-time, and we're staying close with our customers, so I would not say there is one-size-fits-all as they deal with it. So the key element for us is we've got to stay close to our customers on it. We do have a team that's working at real-time, and this is a real-time issue to say, hey, if output of our customers were impacted, and we do have some factories in Europe primarily supporting the automotive industry, we would have... impacts as well. So it's a real-time situation, but I would not assume it's one-size-fits-all across Europe.

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

Your next question comes from Luke Jones with Barrett. Your line is open.

Good morning. He's just hoping you can help us unpack the margin in industrial this quarter. It's a new high-water mark. we look bigger picture and there was a nice step up sequentially as well. Last time we saw this kind of step up was in the third quarter of last year. And that margin upside proved to be pretty sticky on a go forward basis. So just hoping you could expand on what's going on under the surface in that business this quarter, especially as it pertains to the path of industrial margins from here. Thank you.

Sure. Thanks, Luke. Listen, I, you know, we've been very public going back almost five years now on this March in towards, uh, margin improvement in this segment right and it involved a lot of restructuring activity we talked about at the time this is going back you know when we started this journey of taking over 20 facilities offline and consolidating those into lower lower cost locations where we already had capabilities and capacity and you know i would say we're two-thirds the way through that at this point Certainly, you know, we did not anticipate COVID and some of the other in the bounce back and so forth that we've had to adjust the playbook a little bit on timing. But the overall strategy is unchanged, and a lot of it is around rooftop consolidations and so forth. And we've been more aggressive in this segment with acquisitions, which also give opportunity to us to, you know, further right-size and realize synergies by acquisitions. integrating those into existing facilities that we already have. So most recently, the earning acquisition came in, and we see a real margin opportunity there within that business, which is in our industrial equipment portion of the overall segment. Having said all that, there's still pieces of the segment that are underperforming from a margin perspective, and largely that's due to volume. Right. Terrence talked about medical and our commercial air business, which is inside our aerospace and defense business unit. You know, those are far from getting back to normalized volume levels. And both of those opportunities avail opportunities for us to continue to see margin expansion in addition to some of the restructuring activities. So, you know, hey, we're pleased with the results this quarter. In any one quarter, there can be noise that swings your margins a point or so either direction, but we're pleased with the results. We're pleased with the trajectory of where the cost structure is in this business. Obviously, as I mentioned in the previous question, we're able to get more pricing in this segment than we have in transportation. So there's a lot of good things going here, and with the recovery of medical and commercial air, we feel like there's still legs to go. Okay, thank you, Luke.

Can we have the next question, please?

Your next question comes from Nikolay Todorov with Longbow Research. Your line is open.

Yeah, thanks, and good morning. Two qualification questions for me. One is, in auto, you posted 9% outgrowth versus production, but I just wonder, was there any inventory build in the June quarter last year that would suggest that your outgrowth was even stronger? And then the second question, a clarification, I think it was asked, but what is the FX EPS impact sequentially? I think I heard revenue impact 70 to 75 million sequentially, but what is the FX, the EPS impact sequentially? Thank you.

So I'm going to let Heath take the second part, and I'll talk about the first part.

Yeah, Nicolay, I apologize if we didn't provide that. The sequential impact, we are on FX, we are estimating to be it's around $70 million revenue and about $0.05 of EPS sequentially.

And then on the outperformance, you know, quarter on quarter, I'm always going to caution you, be careful on trying to come up with inventory bills in a quarter, especially with the volatility we have. So when you look at it, you know, I don't think there was a meaningful impact that you should take that outperformance and add or subtract to it.

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

Your next question comes from William Stein with Druid Security. Your line is open.

Oh, great. Thanks for getting me back in. I apologize if this might have already been asked, but specifically in the transportation end market, you have a target of 20% EBIT margins. And I understand that right now we're going through this well-documented and well-discussed on this call. inflationary effects that there's a timing effect of passing that on. Do you all have an expectation as to when you might approach that 20% level again? Is that like something we should think of in the next year or two, or is that now feeling longer out in time?

Oh, and, uh, you know, thanks for the question. Um, You know, I'm not going to go back through, like you said, we've discussed a lot of things on the call here relative to the current situation with our ability to get price relative to inflationary pressures and the pressures that that's putting on the business. So, you know, as that equation morphs over the next year or so, you know, we'll see how that plays out. The other thing was, if you recall, a couple of years ago, you know, we did start particularly in our Western European footprint. for transportation of restructuring a couple of locations, and that's well underway. In some cases, we'll see support coming out of those actions here as we get into next year. But the other thing to remember is we've talked about in our business model that 20% target for transportation. That never contemplated auto production being down in the 76, 77 million units. So if we start to see some support there, we're getting closer to 21 plus million units a quarter. I think that is a better opportunity for us to capitalize on not just our content growth, but also absolute volume production that we're set up to support. So I think that would have the bigger impact versus most of the other variables.

Okay, thank you, Will. I want to thank everybody for joining our call today. If you have further questions, please contact Investor Relations at TE. Thank you, and have a nice day.

Ladies and gentlemen, today's conference call will be available for replay beginning at 11.30 a.m. Eastern Time today, July 27th, on the Investor Relations portion of TE Connectivity's website. That will conclude the conference for today.