TE Connectivity Ltd

Ladies and gentlemen, thank you for standing by and welcome to the TE Connectivity fourth 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, simply press star followed by one on your telephone keypad. As a reminder, today's call is being recorded. I would now like to turn the conference over to your host, Vice President of Investor Relations, Sue Jill Shaw. Please go ahead.

Good morning, and thank you for joining our conference call to discuss TE Connectivity's fourth quarter and full year 2022 results. With me today are Chief Executive Officer Terrence Curtin and Chief Financial Officer Keith 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. I also want to remind you that our Q4 results include an extra week, and we will be discussing some of our results on both a 14 week and 13 week basis during the call. Please see the appendix in the slide presentation for the impact of the extra week in our results, as well as the accompanying reconciliations. Finally, during the Q&A portion of today's call, we are asking everyone to limit themselves to one question, and you may rejoin the queue if you have a second question. Now let me turn the call over to Terence for opening comments.

Thank you, Suzhou, and we appreciate everyone joining us today. As I typically like to do at the beginning of these calls before we get into the slides, I'd like to spend some time discussing our performance along with some of the developments that we're seeing since our call just 90 days ago. While there are a number of external data points showing cross-currents from global economic uncertainty, we continue to perform well. And you'll see this both in our fourth quarter and fiscal year 2022 results. Our performance came in ahead of our guidance and continues to demonstrate the benefits of how we strategically positioned our portfolio around secular growth trends as we continue to outperform our markets. We also are demonstrating operational performance in serving our customers and delivering strong financial results despite the broader macro challenges. Our backlog remains near all-time high levels and our overall order levels imply solid demand across the majority of the markets we serve. Within this backdrop, we have some markets that are growing, some that are still in recovery mode back to pre-pandemic levels, and others that are showing signs of moderation. At the same time, we're being negatively impacted by a stronger dollar, which will continue to be a significant headwind into 2023. I also want to highlight that our teams continue to proactively implement price increases to keep up with ongoing inflationary pressures. I am confident in our ability to execute in the short term as we navigate these challenges, and I am excited about the long-term opportunities as we go forward. And Heath and I will go into more details on these moving pieces as we discuss our performance and outlook on the call. To summarize our financial performance, we delivered strong results again in the fourth quarter, with double-digit organic growth and double-digit adjusted earnings per share growth year over year. For the full year, our adjusted sales and adjusted EPS were records, with sales up 12% organically and adjusted earnings per share up 13% versus the prior year, despite headwinds from foreign currency exchange and inflationary pressures. With this quick backdrop, let me give you some details of what we're experiencing. First, on the orders front. We're seeing some puts and takes across the different end markets we serve, and this is reflected in our orders and our backlog. With the higher backlog levels that we have and the stability we're starting to see in our supply chain for the first time since COVID, it is reasonable to see our book bill below one in the quarter. Our backlog remains strong at $6 billion, which is almost two times higher than pre-COVID levels. If you click down on orders by segment, transportation and industrial are continuing to show positive order trends. In transportation, OEM auto production is still constrained by supply chain limitations, and end demand remains above current levels of production. so we continue to have a favorable outlook for this market long-term on both production as well as the content growth. In the industrial segment, we continue to expect growth in Comair and medical markets as reflected in our orders, along with the benefits from wind and solar applications in our energy business. Renewables now represent 20% of our energy sales, and the Comair market is still recovering to pre-COVID levels And both of these will be growth areas within the industrial segment in 2023. In our communication segment, we are seeing orders decline in the appliance market. Based upon recent developments, we have seen our orders to cloud customers moderate, reflecting lower capital spending, along with inventory adjustments in the data center supply chain. We also continue to experience inflationary pressures, And this is particularly true for resins that we use for molding, as well as higher energy costs that impact our manufacturing operations globally. We are continuing to implement additional price increases to offset these inflationary costs and expect to have a positive contribution of margin later in 23 from the price-cost dynamic. And the last thing I want to highlight before we turn to the slides, and I think we've consistently demonstrated, we will take actions to ensure our cost structure is in line with what we're seeing in the market environment, and Heath will provide additional details on this in his section. So now let's get into the slides, and I'd ask you to turn to slide three, and I'll cover some additional highlights for the fourth quarter and the full year, as well as get into our first quarter outlook. As Suzhou mentioned earlier, Our fourth quarter included an extra week. Our fourth quarter sales were $4.4 billion, which were up 14% on a reported basis. Our adjusted operating margins were 17.4%, and our adjusted earnings per share was $1.88, and this was up 11% year over year. If you include the extra week to get to a better apples-to-apples comparison, our fourth quarter sales were slightly over $4 billion, and this was up 12% organically year-over-year, and adjusted earnings per share were $1.75. A key thing to highlight in the fourth quarter is that we delivered record-free cash flow of $745 million in the quarter, which demonstrates our strong cash generation model, and we returned over $500 million to shareholders. I do want to highlight, and we discussed it with you previously, Earlier in the year, we did increase inventory levels to deal with supply chain volatility and ensure we can meet the needs of our customers. As we have begun to see our supply chain improving, we decided to get our inventory more in line and reduce our inventory by approximately $350 million in the quarter. And you'll see our days on hand were actually down year on year in the fourth quarter. We do believe this was prudent balance sheet management in the current environment, and this action improved our free cash flow in the quarter, but does pressure our margin in the short term. So now let me touch upon a few additional highlights for our full year results. Our fiscal 2022 results were a record at $16.3 billion, and this is up 9% year over year on a reported basis, despite currency exchange headwinds of approximately $760 million. Sales were up 12% organically, with industrial and communications up double digits and transportation up high single digits, demonstrating the strategic positioning of our portfolio. Adjusted earnings per share was a record at $7.33, which was up 13% year over year, and adjusted operating margins were 18.2%, with expansion in the industrial and communication segments versus the prior year. For the full year, we returned $2.1 billion to shareholders between share buybacks and dividends, as our focus was on organic investment in the business, as well as return of capital to our owners. Now, with that as a wrap-up of the financials for 2022, Let me touch upon our first quarter guidance. And I want to frame this out by incorporating some of the moving pieces I already highlighted for you. I do want to make sure we have the right baseline together for guidance. So when you look at this, the year-over-year comparison would be against $3.8 billion of sales in the first quarter of fiscal 22. And the sequential comparison would be against the 13-week sales in quarter four of $4 billion. So if we look at it going back to quarter one of 2022, I mean, sorry, 23, we do expect sales of approximately $3.75 billion. And this sales in the first quarter of 23 will be up 9% organically and down slightly on a reported basis year over year, despite approximately $400 million of FX headwinds. Adjusted earnings per share is expected to be approximately $1.50. which includes year-over-year headwinds of approximately 25 cents from currency exchange and a higher tax rate of 21%, which will be up from a year ago. When you look at our guidance sequentially versus the 13-week $4 billion, we are declining by $300 million in sales and 25 cents in EPS. Roughly half of our top-line sequential decline is from foreign currency, with the remaining balance split between typical seasonality and a decline in the communications volume due to end market moderation. The EPS decline is driven by foreign exchange and volume declines I just mentioned, as well as a temporary impact from the proactive inventory reductions we drove in the fourth quarter. While we have some near-term pressures that are non-structural, we have been making progress on what we can control with our teams driving price increases this past year to partially offset the increasing inflationary pressures. As we've mentioned in the past, in transportation, there is a lag between inflation and our ability to recover through price. We have implemented additional price increases, which should get transportation margins back up into the high team sometime in the second half of 23. While we are working through the crosscurrents we're experiencing, One thing that has not changed is the benefit we continue to see from the secular trends in our markets and the outperformance we're generating from content growth. We are benefiting from our position in electric vehicles, smart factory applications including automation, renewable energy, and high speed cloud and artificial intelligence applications. We remain committed to our business model and long term value creation through growth, margin expansion, as well as driving our strong cash generation model. So with that, wrapping up the highlight slide, let's turn to slide four, and I'll share some more details on orders. For the fourth quarter, our orders were $4.3 billion, and this reflects resiliency in both transportation and industrial, and also demonstrates moderation in our communications segments. Our backlog of $6 billion is up 11% year-over-year, and I want to emphasize that we're seeing very little impact from push-outs or cancellations from our customers. In transportation, we had a book-to-bill of 1.03, along with a strong backlog position. This reflects favorable demand patterns. And demand for autos continues to be higher than what OEMs can currently produce, providing a favorable backdrop for production increases as our customer supply chain bottlenecks begin to resolve and dealer inventories get back to historical levels. Our content growth remains strong, with content per vehicle expanding in fiscal 22 to over $80 per vehicle from the 60 range of pre-COVID. We do expect further content expansion due to our global leadership position and increased adoption of electric vehicles globally. In our industrial segment, we had a book-to-bill of 1.01. Year-over-year order growth was driven by both AD&M and our medical businesses as these businesses continue to recover from pre-pandemic levels. And in our communications segment, orders declined year-over-year and sequentially, reflecting expected decline in appliances and moderation in data and devices as the data center supply chain adjusts inventory levels for its cloud customers. Despite this market cyclicality, we expect to continue to outgrow the market in the data and devices business due to share gains and benefits from high-speed and AI implementations in the data center and cloud. Now, let me provide a little color of what we're seeing in orders geographically. On a 13-week organic basis by region, we saw year-over-year growth of 6% in China and Europe, while North America was essentially flat. On a sequential basis, we saw orders grow 18% in China, with single-digit declines in Europe as well as in North America. So with that as a backdrop of orders and backlog, let me turn it over to Heath, and he'll get into segment highlights as well as some information on the financials.

Thank you, Terrence, and good morning, everyone. I will now briefly discuss year-over-year segment results in the quarter on slides 5 through 7. You can see the details on the slides, and I will talk about organic sales performance on a 13-week basis. Slide 5. Transportation sales were up 13% organically year over year. Our auto business grew 16% organically with growth across all regions. We continue to increase our content for vehicle through our global leadership in EV, electric vehicles, now account for nearly 20% of auto production, with further increases in production expected in 23. To provide context, EV and HEV production has grown 3x from 2019, with 14 million units produced in 2022. And importantly, for 2023, we expect our market outperformance to be well above our stated 4% to 6% range in automotive production. In commercial transportation, we saw 13% organic growth driven by North America and Europe with significant market outperformance in all regions driven by content growth and share gains this year. In sensors, we declined 3% organically with our focused growth areas offset by continued portfolio optimization activities. At the transportation segment level, adjusted operating margins were 16.6%, and the margins reflect a short-term impact from our planned inventory reduction, along with the timing of price actions to offset inflationary pressures, which Terrence mentioned earlier. Moving to the next slide, the industrial segment. Sales increased 16% organically year-over-year. Industrial equipment was up 20% organically, with double-digit growth in all regions and continued benefits from factory automation applications. Aerospace and defense was also up 20% organically, growth driven primarily by ongoing market improvement in calm air. In energy, we saw 16% organic growth driven by increased penetration in renewable applications. And our medical sales were up 3% organically with increases in interventional procedures as the medical device market continues to work through supply chain challenges. Adjusted operating margins for the segment expanded year over year to 16.5%. driven by higher volume, price actions, and implementation of previous cost actions. The next slide, communications. We had 3% organic growth year over year. In data and devices, we saw continued market outperformance driven by content growth in high speed cloud and share gains in artificial intelligence applications. Our appliance business declined 6% organic reflecting the expected moderation in this end market that will continue into fiscal 23. Communications adjusted operating margins were 21.7%, reflecting the lower sales in the appliance business. Happy to turn to slide 8, where I'll provide more details on the Q4 financials. As mentioned earlier, Q4 includes an extra week, and we have provided tables in the appendix that bridge sales, margins, and EPS for that extra week. Sales of $4.4 billion were up 14% on a reported basis year over year, and currency exchange rates negatively impacted sales by $348 million versus the prior year. Adjusted operating income was $757 million, with an adjusted operating margin of 17.4%. We are being impacted in the near term by non-structural pressures of foreign exchange, inflation, and the previously mentioned inventory reductions. While we can't influence currency exchange rates, we are continuing to be proactive on recovering inflationary pressures through price increases. Additional upcoming price increases will go into effect in transportation, helping to lift segment margins back to the high teens in the second half of fiscal 23. And while our Q4 inventory reduction has a near-term impact on margins, We do expect margin expansion as we move through this year with the back half closer to run rate company margins. And as you know, we ran in the 18% range for most of fiscal 22. GAAP operating income was $660 million and included $82 million of restructuring and other charges and $15 million of acquisition related charges. For the full year, restructuring charges were approximately $150 million, which were in line with expectations. We did ramp up our restructuring charges in Q4 to proactively react to the market environment. While I expect restructuring charges in fiscal 23 to be roughly consistent with fiscal 22, the charges will be more heavily weighted to the first half of the fiscal year, and we will continue to further evaluate cost actions as we move forward. Adjusted EPS was $1.88, and GAAP EPS was $2.21 for the quarter, and included a tax-related benefit of $0.57, related to discrete tax benefits during the quarter. Additionally, we had restructuring, acquisition, and other charges of $0.25. The adjusted effective tax rate was approximately 19% in both Q4 and fiscal 2022, And for Q1 and fiscal 23, we expect our adjusted tax rate to be roughly 21%. Importantly, we continue to expect our cash tax rate to stay well below our stated ETR for the full year. Turning to year-over-year comparisons on slide 9, fiscal 22 sales of $16.3 billion were a record and up 9% on a reported basis and 12% organically year-over-year. Currency exchange rates negatively impacted sales by approximately $760 million versus the prior year. Due to the further strengthening of the U.S. dollar against other currencies, we expect currency exchange rate headwinds to be approximately $1 billion for fiscal 23, with roughly 70% of this headwind to be felt in the first half of the fiscal year. This equates to approximately 600 basis points of headwinds to reported growth in fiscal 23. Adjusted EPS expanded 13% year-over-year to $7.33, and adjusted operating margins were 18 to 0.2% with year-over-year expansion in our industrial and communications segments. Turning to cash flow, free cash flow for the year was approximately $1.8 billion, with over $2 billion returned to shareholders through share buybacks and dividends. We continue to remain disciplined in our use of capital, and our long-term strategy remains consistent. which is to return approximately two thirds of our free cash flow to shareholders and use one third for acquisitions. Nearer term, we have been aggressive in buying back our stock and taking advantage of investing in our own organic value creation opportunities. And before we get into questions, let me wrap up. We delivered strong performance this past year. Our teams have continued to execute well in this volatile environment to effectively serve our customers. And while we have some near-term headwinds, I am excited about the opportunities we have ahead of us this fiscal year. Our positioning of the portfolio will drive content outperformance. We also have a trajectory for further margin expansion and EPS growth through actions we can control, including price increases to fully offset inflation, cost reduction initiatives, and a strong balance sheet that can support investments for growth while continuing to return capital to shareholders. So there's a lot to be excited about there.

Alex opened up for questions. Angela, can you please give the directions for the Q&A session?

At this time, I would like to remind everyone in order to ask a question, press star followed by one on your telephone keypad. In order to have time for all questions, each participant is limited to one question. If you would like to ask a follow-up question, please press star one to return to the queue. Your first question comes from the line of David Kelly with Jefferies. Your line is open.

Hi, good morning team and thanks for taking my question. You know, number of moving parts in the quarter, the extra weeks, and inventory reduction, shifting in demand. So I was just hoping to dig into maybe the earnings trajectory into 2023. So could you walk us through or give us a sense of exit rate 2022 sales and margin levels?

Sure, David. This is Heath. I'll take it. You know, we just laid out a lot of moving parts for you, so I appreciate the opportunity to To clarify anything that may come across as confusing, as we exited the year, certainly we enjoyed good order volume, and we saw that reflected in our sales. And you saw that, and certainly we benefited from the flow through some of that. But we still are dealing with a lot of pressures. We have our inventory that we've elected to take down in the quarter. It was over 10% of our overall inventory balance. It was $350 million, and that does have a natural impact on margins and the flow through accordingly. But importantly, we did bring our days on hand of inventory metric more back in line with where we would see a healthy ending balance at this volume level. So we feel good about that, and obviously it had the benefit of the cash flow, which was a record in the quarter of nearly $750 million. So, you know, we're going to keep our foot on that in terms of making sure that that stays in check as we move forward. But it does have a negative near-term impact on the P&L. The other piece is we still are seeing a lot of heightened pressures, particularly in transportation around inflation. And where we buy resins and so forth that are oil-based driven cost structures is still hitting us. And so we do have planned costs. increases that have already been agreed upon and will go into effect in more or less the January timeframe and the other parts of Q2 that will have a nice uptick for us as we move from the first half to the second half of the year. And we are seeing our communication segment moderate as expected. We had expected appliances to moderate. We've been discussing that openly throughout the year, and we have started to see that both in our orders and our sales. And that does have a little bit of a dilutive impact on the segment margins there for communications. So there's a few things heading that direction. Now, on the flip side, as we think about EPS, FX and the strengthening dollar is heightened. If you recall back in July, when we snapped the line on what the currencies look like, I had given an early preview that Our FY23 exposure was going to be roughly $300 million, and now we're calling that a billion dollars, with about $700 million of it hitting us in the first half of the year. While that doesn't hit our margins quite as hard, that does have an impact on earnings per share, and we're certainly feeling that in the first quarter. We can't control that, but we are working. That's just the reality. We want to be transparent with the analysts and owners of the stock here. There's some moving parts there as we work our way through the year. At the same time, we're not sitting flat-footed. We mentioned some restructuring activity that will continue. That is about right-sizing some things in an anticipated softer macro environment. So I appreciate the question, and certainly if there's follow-on, let us know.

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

Your next question comes from the line of Wamsai Mohan with Bank of America. Your line is open.

Yes, thank you. Good morning. I was wondering if you can talk a little more about the order and backlog trends in Calm, if you could share some color on that, and maybe the magnitude of the inventory adjustment potentially that you're seeing at these ODMs, suppliers to hyperscalers. And if I could, I was also wondering if you could comment on how TE's performance was in outgrowth versus production in fiscal 22 for transport, and how much of that was inventory adjustments in 22 as well. Thank you so much.

Sure, Ramzi, I'll take that, and good morning. And let me talk about orders a little bit, because I know you talked about comms. I want to talk about what we're seeing in orders again across, and then I'll talk about content outperformance You know, first off, I just want to be honest that having a book to bill below one with where our bookings have been and building a backlog, that's not surprising to us. And, you know, as supply chains around the world improve, we would continue to expect to see book to bills dip below one. So I just really want to make sure as supply chains improve, including our own, we would expect our customers to work down our backlogs that we have, that they have with us. So I really want to make sure that people don't read into this, that demand is dropping off across our markets, because we're not seeing that. And as I said in the script, we aren't seeing cancellations or pushouts in any meaningful way. I think if you look by segment, you know, TS and IS, I think those backlogs are getting, and booked bills are getting more normalized. And I think it shows resiliency. In communications, I think what's important is We've had CapEx growth with our cloud customers that have been 20%, 30% cloud CapEx, and we've outperformed that. Clearly, you can see it in the growth rates. But as you see the cloud CapEx moderating well off those levels, the ODM supply chain does have excess inventory in it that's being worked off, and I think that could impact us for a couple of quarters. But it's probably to that magnitude that you'll see it in our D&D business. And then the other area that comes that we've always talked to you about is the appliance market was one that benefited from the trends during COVID. And we're seeing that moderation that we've always expected. So we're getting both of those in those order patterns. Now, let me turn to your second part of your question around content outperformance. I think what's very important is, as Sujolsa and I said earlier, was we aren't From how much our revenue has been impacted, any more from supply chain disruptions, it's only about $50 million of revenue that we haven't built. That used to be about $100 million. And content outperformance was at the high end of our range that we told you, four to six. When we look at the auto supply chain, I can't tell you what the impact of that growth is in there. We actually feel very good that it's at the high end of the range for 2022. And we expect for 2023, we'll be above the high end of the range. So we don't see any major inventory impacts in the auto supply chain from what we're seeing. Certainly, we've seen orders moderate and people getting more comfortable with where working off the backlog.

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

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

Hi, good morning. I was just wondering, since you're not providing a full fiscal year guidance for the new fiscal year, if you could maybe walk through what you're thinking about in markets at this point in time. Thank you.

Yeah, thanks, Steve. And, you know, we guided for the first quarter, so, you know, there is volatility in the macro. I don't think that's a surprise. And, you know, the color I'm providing is on what we're seeing today. and you know how we're planning the business and certainly there can be changes here depending upon how the global macro moves but let me do it by segment first off in transportation you know the transportation environment's been a challenging environment for the past couple of years auto production has really been sort of stuck around 76 70 million 77 million units due to all the things that we talked about whether it's supply constraints The war in Europe, certainly extended lockdowns in China around COVID. And I still think where you get, and it's nice to see some of our customers talking about semi-supply improving, it's going to be really about how can they ramp production to still keep up with demand that is greater than what they can produce. So we still see end demand for auto being above the production environment. So we still see that as a nice setup as we go into next year. We do also expect, as I just said to Wamsi's question, that we're going to have outperformance versus market above the 4% to 6% this year. And this is really going to be driven by the global leadership position we have, where we position ourselves in electric vehicles, and certainly the penetration of electric vehicles continuing to increase as a percentage of total production. The other key market that's in transportation, which is commercial transportation, you know, it's a market that decreased double digits this year really around China and some of the emissions standards that were put in effect a year before. And, you know, we would expect that China could have an increased market situation there. And, you know, we've been driving out performance versus the market in commercial transportation, as you've seen all year through all the three regions. It's also something we've had a tough year this year from a market perspective in commercial transportation. Could have some upside next year. You know, in industrial, you look at that, and I still think it's a very strong setup. And you heard me when I talked about orders, you know, both on backlog and orders. And we see Comair and Medical are markets that are still recovering. And we expect further growth in these markets in 2023. And when you look at Comair, while single-aisle aircraft are back to pre-pandemic level from a build, double-aisle is still only at 50%. And what's nice is some of the air framers are talking about increasing production and increased demand on double-aisle aircraft. The other thing that I mentioned in the script is wind and solar remain strong. And our energy business, very strong double-digit growth this year. and 20% of our sales are energy from renewables. So we expect further growth in that this year. And the one market that's been really hot for us, which has been industrial equipment, and we had extremely strong performance the past two years, we see good trends there, but we're going to have tough comps. And as we're focused on higher growth applications and robotics and new programs around Ethernet connectivity, that'll help make sure we outperform the market, but I just want to remind everybody we'll have tough comms there. And in communication, you know, the appliance market is weakening as we expected, and you see the step down in our sales in the fourth quarter, and you're going to continue to see that this coming year. And in data devices, as I just talked about with Wamsi's question, you know, we do expect Cloud CapEx to step down from where it was and moderate. And then we also have to have the ODM supply chain that's going to impact us in the first part of this year as they adjust to the hyperscale company's demand. And I think it's reasonable to expect that our D&D business will be down this year based upon those two factors that we're dealing with. So I know you asked a simple question and I gave you a lot, but it's sort of how we're thinking about the macro as we're entering 23.

All right. Thank you, Steve. Can we have the next question, please?

Your next question comes from the line of Matt Sheeran with Stifel. Your line is open.

Yes, thanks. Good morning. I wanted to circle back to the gross margin and specifically the impact of that inventory reduction, that $350 million. How much, I mean, it looks like in Q4 you were down, what, 220 basis points in gross margin year over year. And it looks like you're guiding roughly 200 basis points down in Q1. So how much of that is related to that inventory reduction? And is that, you know, one quarter issue or does that carry through to Q2 of 23? Thanks.

Hey, Matt, it's Terrence. So, yeah, I'll take that. And You know, you're right. I want to be clear. This is our inventory that we took out. So I know we, I talked a little bit about, you know, D and D supply chain with cloud customers. This is our inventory. And as he sort of said, you know, our inventory is back in days on hand in the mid eighties, it was running in the nineties as we were working through supply chain. And, you know, we made the proactive action to bring inventory down. And as you have factories, that have cost of X. You have less units running through it. You have higher cost inventory you have to work off. We had a partial impact in our fourth quarter, and you'll have a bigger impact in our first quarter. That'll be about 100 basis points in the first quarter. And it'll be a little bit in the second quarter as it works off, but then that'll be a temporary issue. The other thing is, why did we do it? I do think it's important, the why. It is something we made choices to carry more inventory during the year, but as our supply chain got better and we saw more normal flow coming in, it was something we said, hey, let's make sure we get our inventory more back in line and we're serving our customers consistently, and it's just something we thought was prudent from a cash generation as well as the uncertainty in the macro. The only area we're seeing really supply chain impacts will be in some niche materials as well as those markets that are really still in recovery mode back to pre-pandemic medical, as well as commercial aerospace, which I don't think has surprised anybody. So it is something that it was, you know, get inventory back in line in TE. And, you know, that always is going to have a gross margin impact. That will be with us here early in 23. But, you know, that was a proactive action on our part.

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

Your next question comes from the line of Amit Dharanari with Evercore ISI. Your line is open.

Thanks a lot. Karen, I think there's going to be a lot of focus on operating margin trajectory in fiscal 23 beyond the mid-16% I think we're going to do in December. I was wondering if you could provide some clarity on how do you think margins stack up in 23 qualitatively across segments And really specifically on transport, you know, doing the back half, recovery looks better versus the first half. And then CIS, you think we end up dipping below 20 over there. Just any breakdown on margin trajectory going forward would be really helpful. Thank you.

Thanks. Steve, I appreciate the question. No, listen, I think it's certainly on point. As we think about transportation margins and some of the things we've already discussed this morning, you know, A couple of things that are pressuring transportation margins. One is we talked about the price cost differential and what we're looking forward to in terms of seeing higher prices go into effect that we've already got agreement on later in the first half of our fiscal year. That will have any benefit as we move into the second half on transportation margins. The other thing, Terrence just walked uh, map through was on the inventory side. As you can imagine, you know, we did take out 350 million of inventory as we burned through, uh, that the accounting element of that and the pressure it puts on margins, there is a disproportionate amount of that, that hits transportation. So again, as we just talked about, that will have a benefit, you know, as we think about our second half versus our first half. So transportation margins, definitely a second half, uh, improvement based on a couple of things we talked about. Industrial is honestly performing very well. And we've been pretty vocal and transparent with you about our journey on transportation and the restructuring journey in terms of rooftop consolidation that we've taken on. The business has done that well and has absorbed some acquisitions in the middle of this journey that are going to be very good returns for the company and for the shareholders. So we're looking forward to those. At any given time, there might be a quarter pressure here or there, but we are making strong progress towards our journey towards high-teens margins, even while absorbing some of the dilutive impact on acquisitions. So, you know, stay tuned on industrial, but we feel good about our trajectory there in 23. And then the last part of your question, Amit, was around transfer communications margins and being able to stay north of 20%. Listen, we've never advertised it as a high 20% business. We've enjoyed a couple of years, and we basically have said as a reminder that at those volume levels, it just shows what kind of margins that we can generate at those volumes. Now that we're seeing volumes come back down, Terrence mentioned earlier on a question that we do expect communications to be down modestly year over year on the top line. We would expect that the margins would moderate I still think they'll be a little above 20% for the full year, but there's some pieces there that in a given quarter that might dip below, but generally I feel like we'll be above 20% for the year there, which still shows the resiliency of that even at lower volume. All right. Thank you, Amit. Can we have the next question, please?

Your next question comes from the line of Chris Snyder with UBS. Your line is open.

Thank you. So, you know, I wanted to talk about more the margin outlook for transport solutions, but maybe more so focusing on price cost. You know, prior commentary from the company has said that you're recovering about two-thirds of cost inflation. And, you know, it translates to more than $200 million loss at the EBIT line, based on my math. Presumably, the high majority, if not all of that, is transport costs. So I guess as we look into the back half of next year and we see pricing going higher in cost, maybe flat to down, at least with metal, how should we think about that 200 plus kind of EBIT loss? Could that get to neutral? Is there any scope for that getting beyond neutral? Any color there would be helpful. Thank you.

Well, thanks, Chris. I'll take that. First of all, I think your math is pretty close, okay? So, again, I'll give you props for that because certainly that is not an easy way to back into it, but your math is pretty close. Listen, you know, our inflationary pressures really come from, you know, four main places. It's metals, right? It's resins, right, that we use for our molds. It's freight cost and it's just overall utility costs that we've seen spike, particularly in Europe, to run our factories. Some of those things we have started to see moderation on in terms of being able to, as capacity has come back online and so forth, we are still feeling inflationary pressures on resins and on utilities, which are both energy-driven prices. So we anticipate that to continue even as we have certain buckets that will begin to moderate and potentially lower year over year in terms of any incremental pressure. Throughout the year, as you mentioned, we have recovered on the TE basis about two-thirds of that inflationary pressure through price. So that still leaves us, as you mentioned, a couple hundred million dollar gap. When you break it into our segments, it's a little bit different. So while it may be two-thirds for the company, we're covering much more in FY22 in both industrial and in communications. And the nuance there is that we do, in both of those segments, we do more through our distribution channel partners. And it's simply easier to pass along you're going through distribution partners because you can go out with more regular increases and they're less about reopening contractual negotiations. So those have both been recovering more price, recovering more inflation through price as we work through both, not just last year, but the prior year. Transportation is where it gets tougher because you've got more direct OEM contracts and those contracts are tied to platforms and so forth. And so many times when you're recovering inflation, which everyone is trying to do, you are discussing things that won't go into effect for sometimes six or nine months out. And that's really what we're feeling in the transportation world now. Fortunately, we're coming up on those price increases later in the second half of this fiscal year. And I do feel that as we do that, we'll start to see that two-thirds of pricing coverage uh certainly will improve now as we get to the back half of our year where we go above the inflationary pressures i would say stay tuned uh but um you know we that that ratio will improve as we work our way from the first half to the second half for sure uh and that gives us more confidence as we move into as we move and make our plans for the rest of the fiscal year okay thank you chris we have the next question please

Your next question comes from the line of Joe Spack with RBC Capital Markets. Your line is open.

Thanks so much. Heath, you mentioned some higher restructuring. I was wondering if you could give a little bit more details on that stepped-up level in the fourth quarter. It looks like it was really in the transportation business and And I think on your guidance, it looks like restructuring is still going to be a healthier level in the first quarter. So maybe just a little bit more on those actions, what you're looking for in terms of the payback, and when can restructuring return to more normalized levels?

Joe, thanks for the question. Listen, as we noted in the prepared comments, we did do a little more than 80. Of the 150 and change that we took charges for in FY22, A little over 80 of that was in the fourth quarter. And a lot of it was geared towards transportation. Now, we have been working our way through restructuring programs, which has been very focused on factory footprint consolidations. I think we've been pretty clear that we had some European footprint in Western Europe that we've been in the process of taking offline. Most of that is in transportation and to a lesser extent in our industrial segment. Those are either finished, on track, or certainly underway versus when those charges were taken, and the payback for those continues to be in line with what you would expect for us when we start talking about European footprint consolidations or somewhere in that two- to three-year payback period. The charges that we took in the fourth quarter and that I anticipate taking in the first quarter certainly are more geared towards you know, a bit more of a somber view of the macroeconomic view, and we want to make sure that we are getting ahead of that. Now, you know, we're not going to do anything to pinch capacity to a point that we can't deal with a rebound in certain markets, and it won't be universally applied across TE, but it will be disproportionate in our transportation segment, both in auto and then a couple of other selected places. you know, this will be more focused on cost reduction. We want those costs to come out. We want them to come out of our structural costs. And I think importantly, lowering our fixed cost structure, you know, as we move forward here to maintain some nimbleness on the margin front.

Okay.

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

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

Yes, good morning. Thank you very much for taking the question. I want to better understand what's making the company take the view that 2023 content growth will be higher than the 4% to 6% target, and do you think there will be any inventory reductions that your customers could be making that perhaps could offset some of the underlying content growth this coming year? Thank you.

Hey, Mark. Thanks for the question. And, you know, really when you look at it, I think it just has to do with when we look at the setup of electric vehicle, penetration. And you see, and I know Heath talked about where electric vehicles have grown from and to, and the broad global acceptance of them, which is exciting to us. It's very exciting to us that, you know, we still continue to see that being a big driver of our content growth. And with the mix that we would expect, we do expect that we would be above the high end of the four to six range. You know, that also has a view, you know, when we make that comment, and as I sort of said, that, you know, production, you know, is stable. And we do view we'll drive that off of stable production. We don't assume major supply chain excesses in the supply chain when we say that. You know, and it's what we're seeing, especially as you look at our orders and where our book to bill has gotten to in auto. It's more back to more traditional levels. So, net-net, we actually feel pretty good. If production was to change meaningfully, maybe that could create a little bit of supply chain, but right now we're not expecting that.

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

Your next question comes from the line of Sameek Chatterjee with JPMorgan. Your line is open.

Hi, this is MP for Sameek Chatterjee. Thanks for taking my question. I just wanted to ask on transportation relative to the underlying market, like what are your expectations for auto production growth for 2023? Like IHS is currently forecasting for a 4% growth, like amounting to nearly 85 million vehicles produced. What's your take on that?

No, thank you for the question. And I think what's important, and I know at times we don't include light vehicles, so it might be a little bit different to how we talk numbers and how you talk You talk, you know, we saw about 20 million units made in the fourth quarter of, you know, 2022. And we also expect 20 million units to be made in the first quarter. And, you know, there'll be seasonality in it. And we think production can be a little up. But net-net, we don't see it's going to be a rocket ship of production increases. We sort of view it'll be up low single digits, which I don't think is far off of what you say. So, net-net, I think that's how we see production right now is the OEMs try to make sure they fulfill the demand that's in excess of production.

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

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

Thank you. Heath and Terrence, at this time of year, you typically give a little bit more on the 2023 or the next year outlook. I know I think I heard Terrence talk a little bit about the end markets, but then with the moving parts of inventory, digestion, book to build, all that, and restructuring, I was thinking on the company totality level, any preliminary thoughts on either sales or margins or cost structure or cash flow for kind of the full years as we look out because there are a lot of moving parts.

Hey, Jim, this is Heath. Well, certainly we've got to be careful in terms of what we say because we have not provided FY23 guidance other than a few buckets like where foreign currency currently stands as well as what we're anticipating for restructuring. Those were full year numbers. You know, I think as we sum up a lot of things here, you know, we've talked a little bit today about the first half versus second half, and hopefully that provides a little bit of color for you in our expectations that margins will improve and you can kind of cascade that way down through the P&L. From a cash flow perspective, you know, listen, we finished very strong and had record-free cash flow in the quarter, and that was largely attributable to our inventory reduction. We do expect to have a strong cashier in FY23. You know, we will fund all the organic opportunities that are in front of us because we still are in a lot of markets and applications where we can outgrow our markets. That should give you some confidence that we feel pretty good about the revenue line. And in general, I feel good about that cash opportunity, not just return money back to shareholders, but to fund the CapEx and the investments we need and still deliver a very strong cash flow year above where we are in FY22. So I know that's probably more vague than you wanted, but that's about all I can give you at this point.

All right, thank you, Jim. Can we have the next question, please?

Your next question comes from the line of Shreya Patil with Wolf Research. Your line is open.

Hey, thanks so much. I was just maybe on automotive. You talked about content outgrowth this year. It sounds like it was around six points. And I'm just curious what that would be if you stripped out some of the price recoveries just to kind of get a sense of the underlying content growth. And then I think as we look ahead, how are you thinking about the ability to sustain that six points of growth over market or potentially even do better than that. And, you know, as you look at your position amongst some of the big OEMs that are poised to be the largest players in EV, you know, what gives you confidence that you're seeing content expansion, especially with those OEMs? Yeah, sure. So a couple of things.

And I missed it on my answer earlier, so I apologize to the earlier question. One of the things as we get into being above the 6% this year is not only content, but we will have price benefit for the costs that we've talked about. So I missed that on the 23 element as we get in there. And, you know, those numbers were framed out earlier. You know, when we look at the program wins and, you know, this year alone, our electric vehicle revenue of our automotive industry and transportation segment is a billion dollars. So if you take what we have today in our revenue, it's a billion dollars today. And when we look at the momentum that we have, which are by platform wins, guess what? That's how we build capacity. We know those wins. And really, the bigger wild part is what cars get made, how the what consumers, the cars, the consumers, the cars consumers want. Sorry, I said that backwards. And really, that's the bigger variable. So net-net, when we look at the programs that we've won, we feel very good about the content momentum, as well as where we're positioned globally. And let's face it, it's not only the OEMs we know here in the U.S. You take places like China, which is about a third of the global electric vehicle cars made in the world. So the 14 million that Heath talked about, four to five million of them are made in China. And that position is very important, as well as elsewhere with our European customers, our Japanese customers, and our Korean customer. So we feel very good about the content. It shows a demonstration of our global position, as well as I think the billion dollars of revenue we have already in 2022 really shows how deep our penetration is already. And EV, that's EV revenue.

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

Your next question comes from the line of Luke Junk with Baird. Your line is open.

Great. Thanks for taking the question. Terrance, regarding the outlook for communications normalization, clearly there's been a lot of data center capacity put into places since COVID hit in 2020, and that's, of course, benefited data and devices. What I'm wondering is, as you look forward, do you think there are opportunities to go back and strengthen the system after what at times has seemed like a very frantic pace of investment in the past three years? Any near-term changes in channel inventory side, of course? Thanks.

Yeah. So, you know, hey, Luke, one of the things is I think there were elements that were certainly around COVID from an investment, but I also think it really supports their core business models. It could be around gaming elements and so forth where people want to have service. It's not just about COVID, but it's also about how the network that we've all used has had to get strengthened. And I also think there's a big element about refresh that you're always going to have around the energy efficiency of the cloud infrastructure and the data centers that go into it. So when we look out, there will always be steps around how the technology improves to make them more efficient. Certainly the speeds in the data center are always very important. And some of that will come in as chipsets come out for the data center. You will continue to see a refresh element of the cycle. I'm not sure you're going to have the 20%, 30% growth we've had from the past couple of years. So when we talk about it, we really view it as a moderation off of two very strong CapEx years by the cloud customers. But I think when you think about efficiency, AI, how they continue to improve the compute, the move in the store element of everything that a data center and a cloud needs to do, that all plays into content growth for us. So we're very excited about that trend long term. Certainly we think as we're starting 23, we have a little bit of moderation on the CapEx side, as well as the supply chain getting in line, like you said, from a channel perspective.

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

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

Hey, guys. Good morning. This is Tristan in for Joe. Thanks for squeezing me in here. Just wanted to double-click on your industrial orders, which I believe went down sequentially despite that extra week. Any reason for that? Anything you can highlight?

No. As I said on the call a little bit, in industrial equipment, we have seen a moderation a little bit, but off a very high level. And I wouldn't use the word moderation like we've been talking about in communications. Our industrial equipment business has had very strong growth. It does look like the orders are moving more a little bit sideways and actually coming down. And that's what you're really reflecting in our orders. And also realize orders do also represent, they do have currency effects in them as well. So you'll also see that sequentially have an impact. So what Heath and I talked about from a sales element also does affect our orders.

Okay, thank you, Tristan. And I'd like to thank everybody for joining us on the call this morning. If you have any more questions, please contact Investor Relations at TE. Thank you and have a nice morning.

Ladies and gentlemen, today's conference will be available for replay beginning at 11.30 a.m. Eastern Time. Today, November 2nd, on the Investor Relations portion of TE Connectivity's website. That will conclude the conference for today.