TE Connectivity Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
July 27, 2021

There are 11 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to TA Connectivity Third Quarter Earnings Call for Fiscal Year 2021. Q and A session. As a reminder, today's call is being recorded. I I'd now like to turn the conference over to our host, Vice President of Investor Relations, Mr. Shudil Shah.

Operator

Sir, please go ahead.

Speaker 1

Good morning, and thank you for joining our conference call to discuss TE Connectivity's 3rd quarter results. With me today are Chief Executive Officer, Terrence Curtin Chief Financial Officer, Heath Mitts. During this call, we will be providing certain forward looking information, and we ask you to review the forward looking cautionary statements included in today's press release. In addition, we will use certain non GAAP measures in our discussion this morning, and we ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation, can be found on the Investor Relations portion of our website atte.com.

Speaker 1

Due to the large number of participants on the Q and A portion of today's call, second question. Let me now turn the call over to Terrence for opening comments.

Speaker 2

Thank you, Susan, and I also appreciate everyone joining us today to cover our results for the Q3 as well as our expectations for our 4th fiscal quarter. Before Heath and I get into the slides sales of the quarter. I want to frame our view of the environment that we're operating in as well as our performance. We are in an economy that is showing strong GDP growth globally, driven by the recovery from last year's COVID shutdowns with consumer spending that is robust as well as corporations around the world increasing investment to capitalize on this recovery. In addition to the recovery, It's also important to note that we strategically focus TE around select secular trends and these trends are accelerating in the key markets that we serve.

Speaker 2

You'll see this in our transportation segment with electric vehicle adoption accelerating, in our Communications segment around cloud investment and in our Industrial segment with capital spending accelerating globally around factory automation as well as digitization. While we have a recovery that is happening faster and The reality is that the world is dealing with supply chains trying to catch up to this faster recovery. This is causing volatility for our customers as well as everyone that's in our customer supply chains. In this backdrop, we are performing well in this environment. And our strong results for the quarter and our performance so far this year demonstrates the strength and diversity of our portfolio.

Speaker 2

You'll see this with contributions from each of our 3 segments. We are generating sales, adjusted operating margins and adjusted earnings per share better above pre COVID levels. And we remain excited about the additional growth and margin opportunities that will be beyond this year. With this backdrop, let me provide some key messages from today's call about our performance. First, I am pleased with our execution in the Q3 and the quarterly records that we achieved.

Speaker 2

These records include sales of over $3,800,000,000 adjusted earnings per share of 1.79 and adjusted operating margins of over 19%. Our results were ahead of our expectations driven by the continued recovery in most end markets that serve our broad leadership positions and strong operational performance by our teams. It's also important to note that while we are in a recovery, our growth also continues to be driven by the secular trends across our markets that are driving our market outperformance this year and will continue to drive outperformance going forward. Another key factor that you see is that We are continuing to demonstrate our strong free cash generation model and continue to expect free cash flow conversion to approximately 100% for this full fiscal year. And as we look forward, you'll see and we'll talk about our orders in quarter 3 remain consistent with our 2nd quarter.

Speaker 2

And we expect our quarter 4 sales to be roughly flat to our quarter 3 sales. And we expect that These revenue levers will translate into strong performance with $1.65 in adjusted earnings per share in the 4th quarter. As I mentioned, our results are demonstrating the strength and diversity of our portfolio with growth and margin contributions from each In communications, you see the growth opportunities in the cloud and the ongoing increase in capital expenditure trends by the cloud providers. In our Industrial segment, you see increased investments in capacity and higher levels of factory automation. And in transportation, you see content growth trends for electrification as well as further electronification of both autos and trucks.

Speaker 2

And in each of our segments, we are delivering strong operational performance, which are evident in the margins. Yes, when we look back to our discussion we had in October, we did indicate that our Q1 would be the peak of global quarterly auto production for our fiscal year, but not the peak of our earnings. This is playing out as we anticipated because of our diverse portfolio. For this fiscal year, we are expecting over 20% growth in sales, approximately 400 basis points of adjusted operating margin expansion and over 50% growth in adjusted earnings per share. I am very pleased with this level of progress towards our business model and our team's ability to execute, especially with some of the markets continuing to recover and the broader challenges we faced in the supply chain.

Speaker 2

So now let me turn and I want to take a moment to frame the current market environment and our business relative to where we were just 90 days ago when we last spoke. So starting with transportation. Consumer demand for autos remained robust, but ongoing challenges with semiconductor supply continue to impact our Customers' ability to produce. Global auto production came in slightly lower than expected in the 3rd quarter, and we're expecting auto production to be approximately 19,000,000 units in our 4th quarter. The trends around our content growth remain strong in the Transportation segment.

Speaker 2

Call. Our content per vehicle has accelerated from the low $60 range few years ago into the $70 range this year. We continue to benefit from increased electronification and higher production of electric vehicles, which will enable us In our industrial segment, we continue to see an industrial backdrop that is improving, which is benefiting our industrial equipment as well as our energy businesses. Also in our quarter, our orders in medical have begun to recover and we've returned to growth as interventional procedures have started to increase again. And the one area where we are not seeing acceleration is in our AD and M business.

Speaker 2

But I will highlight The business does feel stable at current revenue levels. From 90 days ago, let me talk about communications. The end market trends that we mentioned last quarter are continuing. Consumer demand continues to be robust in appliances And capital expenditure trends remain strong in cloud applications. And while that's a look at Where we were versus 90 days ago by our segments, I do want us all to remember that we are in a world that's still dealing with COVID And the uncertainties around variance.

Speaker 2

While all our global factories are operational, we continue to watch developments in each of the regions we operate And our focus has been and will continue to be on keeping our employees safe, while also helping our customers capitalize on the improving economic conditions. So now let me get into the slides and please turn to Slide 3, so I can get into some additional details for the Q3 as well as our expectations for the Q4. In the Q3, sales of $3,800,000,000 were better than our expectations and were up over 50% year over year, demonstrating strong performance through the economic recovery with growth in all segments. Also on a sequential basis, sales were up 3% and our earnings per share was up 14% with sequential margin expansion in each segment. Compared to last quarter, Industrial segment sales were up 5%, driven by ongoing strength in Industrial Equipment and increases in Energy and Medical.

Speaker 2

And in the Communications segment, sales were up 16% with double digit growth in both end end devices and appliances on a sequential basis. And in our transportation segment, our sales were in line with our expectations. When you look at orders in the quarter, They remained strong at $4,500,000,000

Speaker 3

consistent with

Speaker 2

the levels we had in the 2nd quarter, and this reflects market improvement along with ongoing inventory replenishment by our customers. So if you think about the balance sheet, we continue to maintain capital strategy between making sure we're returning capital to shareholders as well as M and A. Earlier this month, we entered into an agreement to acquire Ernie, a European connector manufacturer that has a complementary product line and serving the industrial market. This acquisition has a purchase price of approximately $300,000,000 and is consistent with the bolt on strategy around acquisitions that we talked to you about. As we look forward, we expect our strong performance to continue into our 4th quarter.

Speaker 2

We expect sales to be up in the high teens over the year to approximately $3,800,000,000 Adjusted earnings per share is expected to be approximately $1.65 and this will be up 40% year over year. And as you can see on the slide, we've included our full year numbers and our performance relative to both fiscal 2020 2019, which I highlighted earlier. So let's turn to Slide 4, and I'll get into orders a little bit more. For the Q3, our orders remained strong at approximately $4,500,000,000 consistent with the 2nd quarter levels that I mentioned earlier. Order levels continue to reflect economic recovery and replenishment across a number of our end markets.

Speaker 2

Year over year, we saw orders growth in all businesses and in all regions. Transportation orders remained elevated due to the market recovery as well as the auto industry supply dynamics. In our Industrial segment, orders grew 8% sequentially with growth in Industrial Equipment, Energy and Medical and Flat Borders in AD and M, Which indicates the stabilization that I mentioned earlier. In communications, sequential order growth was driven by strength in data and devices. So let me also add some color on orders and what we're seeing from a geographic perspective on a sequential basis.

Speaker 2

We continue to see growth in Asia, where our China orders were up 6% sequentially. In Europe, Our orders were down 7% sequentially and in North America, orders were essentially flat versus last quarter. So with that as a backdrop around orders, let me get into our segment results that you'll see on Slides 5 through 7, and I'll cover this briefly. Starting with transportation, our sales were up approximately 70% organically year over year with growth in each of our businesses. Our auto business grew 90% organically, and we are benefiting from the market recovery and are demonstrating continued content outperformance due to our leading global position.

Speaker 2

We continue to benefit from increased production of electric vehicles as TE's technology and products are enabling high voltage and applications with every leading OEM on the planet. In commercial transportation, we saw 56% organic growth,

Speaker 4

driven by

Speaker 2

the market recovery, ongoing emission trends as well as content outperformance. We are continuing to benefit from stricter emission standards around the world and increased operator adoption of Euro 6, which reinforces our solid position in China. The other key point is that we continue to gain momentum with wins on electric powertrain platforms and trucks, which while this doesn't give revenue or orders today, it will provide future content growth for our leading position in commercial transportation. In sensors, we saw 20% organic growth, driven primarily by auto applications, and we also saw growth in the commercial transportation and industrial applications as well. For the segment, adjusted operating margins expanded sequentially to 19.4% on essentially flat sales.

Speaker 2

Well, let me turn to the Industrial segment. And in this segment, sales increased 13% organically year over year. In our Industrial Equipment business, Sales were up 36% organically with growth in all regions and benefiting from the momentum in factory automation applications where we continue to benefit from accelerating capital expenditures in areas like semiconductor and automotive manufacturing. Our AD and M business sales declined 7% organically, driven by the continued weakness in the commercial aerospace market. In In our energy business, we saw 9% organic growth driven by increases in renewables, especially global solar applications.

Speaker 2

And lastly, in our medical business, as I mentioned earlier, it returned to growth in the quarter and was up 10% organically year over year with the recovery in interventional procedures around the world. From a margin Adjusted operating margins for this segment expanded year over year by nearly 300 basis points to 15.8 percent despite the volume declines in our AD and M business, and this was driven by solid operational performance by the teams. Let me turn to the Communications segment, And our team continues to demonstrate strong operational execution, while capitalizing on the growth trends in the markets that we serve. Sales grew 31% in this segment organically year over year with robust growth in both data and devices and appliances. In data and devices, we grew 16% organically year over year due to the solid position we built in high speed solutions for cloud applications.

Speaker 2

We continue to see capital expenditures increasing by our customers, and our content growth is enabling us to grow cloud related sales at double the market rate Sure. In appliances, sales grew 57% organically versus the prior year, With growth in all regions driven by market improvement, our leading global market position and ongoing share gains. I do want to say that our communications team continues to deliver outstanding performance to complement the higher sales levels That they're executing to. And you see this with our adjusted operating margin in the segment 23.5%, which is up 760 basis points versus the prior year. Overall, across our segments, our teams are capitalizing on growth trends in their end markets, demonstrating the diversity of our portfolio, while delivering strong operational execution.

Speaker 2

And with that, let me turn it over to Heath, who will get into more details on the financials and our Expectations Going Forward.

Speaker 1

Thank you, Terrence, and good morning, everyone. Please turn to Slide 8, where I will provide more details on the Q3 financials. Adjusted operating income was $734,000,000 up $714,000,000 and included $11,000,000 of restructuring and other charges and $9,000,000 of acquisition related charges. We still expect total restructuring charges to approximate $200,000,000 for fiscal 2021 as we continue to optimize our manufacturing footprint and improve the structure of the organization. Adjusted EPS was $1.79 and GAAP EPS was $1.74 for the quarter, which included restructuring acquisition and other charges of approximately 0 point The effective tax rate in Q3 came in as we expected at approximately 18%, with our 4th quarter tax rate expected to be around 20%.

Speaker 1

We expect to continue our we continue to expect our adjusted effective tax rate for the full year to be around 19%. Importantly, we expect our cash tax rate to stay well below our reported for the full year. Now we turn to Slide 9. Our results and progress you see on the slide reflects the strength and diversity of our portfolio and business model execution. As Terrence mentioned, we delivered record performance in Q3 on sales, adjusted operating margins and adjusted EPS.

Speaker 1

We are not only showing progress versus the prior year, but we are also delivering higher sales margins and adjusted EPS versus fiscal 2019, which quarter. Sales of $3,800,000,000 were up over 50% versus the prior year and up 3% sequentially with solid performance in each of our segments. Currency exchange rates positively impacted sales by $138,000,000 versus the prior year. Adjusted EPS of $1.79 was up significantly year over year and up 14% sequentially, reflecting our strong operational performance. Adjusted operating margins were 19.1%, also up significantly versus the prior year.

Speaker 1

Year to date, our adjusted operating margins are running at around 18%, and our 4th quarter is expected to be a continuation of the strong performance. Turning to cash flow. In the quarter, cash from operating activities was $682,000,000 We had very strong free cash flows for the quarter of $539,000,000 and year to date free cash flow is approximately 1,500,000,000 In Q3, we returned approximately $445,000,000 to shareholders through dividends and share repurchases. Our Cash flow performance demonstrates the strength of our cash generation model, and we continue to expect free cash flow conversion to approximate 100% for the full year. We remain committed to our disciplined use of capital.

Speaker 1

And over time, we continue to expect 2 thirds of our free cash flow to be returned to shareholders And 1 third to be used for acquisitions. As Terrence noted, we entered into an agreement to acquire Ernie earlier this month and we expect to close by the end of this quarter. Earnings revenues were approximately $200,000,000 annually and will be reported as part of our industrial equipment business. Before we go to questions, I want to reiterate that we are performing well in this environment despite challenges in the broader supply chain. Our results for the quarter and our performance so far this year demonstrate the strength and diversity of our portfolio with contributions from each of our 3 segments.

Speaker 1

We delivered record performance in Q3. Our 4th quarter guidance represents a continuation of our strong performance. We are excited about growth and margin opportunities beyond this fiscal year, in line with our business model. Let's now open up for

Operator

Call. Our first question comes from the line of Mark Delaney of Goldman Sachs. Your line is open.

Speaker 4

Yes, good morning and thanks very much for taking the question. Terence, you mentioned several secular trends that the company is addressing and longer term that TE can grow revenue and margins.

Speaker 5

So I was hoping

Speaker 6

you could speak a bit more about what

Speaker 4

the company is seeing with respect to this industry backdrop and what that may mean for the company's fundamentals in the intermediate to longer term?

Speaker 2

Yes. Thanks, Mark. And I think when you sit there, you see the performance we put up, which we're very proud of. But in many ways, a lot of where the recovery is across our business is still pretty early. And I think The first thing to frame to your question is probably around where can't we meet demand a little bit.

Speaker 2

And I would still tell you one of the things is with this quarter with some of the supply chain elements that happened within TE, There is about $100,000,000 of revenue we estimate across our segments that due to our supply chain, we can't get out to customers. So we are still trying to get up to the level of demand that's out there. And certainly with the supply chain issues, We estimate it's about in quarter 3, dollars 100,000,000 we think it will be a similar amount in quarter 4. But and that's really where materials impact Around metals and resins, and we think that will be with us a little bit. But when you think through the markets and you think about where Auto production is at right now.

Speaker 2

Auto production this year with the 19,000,000 we expect in the 4th quarter is still significantly below 2019 levels. That 81,000,000 units issue will still be down from 88,000,000 in 2019. And certainly, we're being throttled a little bit by some of the semiconductor supply chain. So we think as you think through the cycle, Auto production can go up. As we go look forward, certainly content is going to help us.

Speaker 2

We also have in the industrial, as I mentioned in my comments, it Truly feels like it's just getting started. Our medical business is picking up. Our energy business that was pretty resilient continues to be strong and you're seeing Well, we started a couple of quarters ago around industrial equipment. We continue to see that picking up as you have CapEx. And then in communications, cloud CapEx was up 20% this year.

Speaker 2

It's expected to be up 10% next year. So we still see they're big drivers for us that will help us. And on the margin side, We still have margin improvement that we need to deliver in 2 or 3 segments and they're our largest segments. So certainly, we're working through the supply chain elements I think everybody in the plant is working through and we still see margin improvement back up to where we told you on our business model going forward. So the cycle is a recovery And one of the things we feel very good about is the consumer showing up, whether it be to buy cars, whether it be to buy appliances And companies now are showing up.

Speaker 2

So it would probably be lumpy, but I would tell you it feels very good from the drivers that we position TE around.

Speaker 3

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

Operator

Our next question comes

Speaker 7

I wanted to focus maybe on the 4th quarter earnings guidance implies

Speaker 1

I saw a mass sequentially lower margins relative to the Q3.

Speaker 7

It feels like we're seeing rising input costs and ongoing supply chain disruptions, But also improved pricing and clearly volume recovery. So with that in mind, could you talk about some of the dynamics at play here in context How you're thinking about the 4th quarter margin trajectory?

Speaker 1

Sure, David. This is Steve. I'll take the questions. First First of all, I think what we effectively commented in my prepared statement was we're running at around 18% Year to date, in terms of margins and we see that more or less continuing as we work our way into To the Q4, if you get the particular quarter, you're going to have timing issues given the diverse How diverse we are, how we're set up globally, you're going to have timing issues in any one particular quarter. So I think you've got to be careful about just picking out quarter.

Speaker 1

I'm trying to compare it forward or backwards. Within our world, there is price cost differences between The different businesses, in some cases, we're able to pass along that price more quickly, particularly if it runs through our channel partners where we have distribution and some of our businesses We're heavier dependent upon that. And in places where we don't have that distribution partner or that mechanism to cash on price That quickly, it takes a little bit longer. So the realization of that is very mixed within our portfolio. The other thing to consider is we're still as We've talked about in the past.

Speaker 1

We're still on this restructuring journey with some of our footprint optimization. And as part of that, you're going to have timing issues of when you start to realize some of those savings versus The cost of getting some of those things done, and you spend a little bit ahead of before you take things offline. So there's all kinds of different Moving parts in a portfolio like ours. From an EPS perspective, sequentially, we will have from a Q3 or Q4, we will have a tax headwind. Our tax rate is going to step up a couple of 100 basis points and that's fairly normal in terms of timing for the Q4.

Speaker 1

So some of the EPS drops sequentially just It's tied to that tax rate.

Speaker 3

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

Operator

Our next question comes from the line of Amit Dayanani of Evercore. Your line is open.

Speaker 7

Good morning. Thanks for taking my question. I guess, Terrence, I wanted to maybe expand a bit more on the Supply chain dynamics you've talked about. I think there's been a fair bit of discussion around this by everyone, including your peers. So I'd love to get your What does really all of it mean for TEL?

Speaker 7

And maybe you can explain what are the supply chain pressures you're referring to? And then what impact is it happening to your operations in P and L broadly?

Speaker 2

Yes. Thanks for the question. And let me Supply chain, I guess, we're all using more than we would like to use on calls. So let me make sure what it means to TE. First of all, let's it all starts with end demand in our customers.

Speaker 2

So let me spend a little bit of what we're feeling from customers. Certainly customers are trying to make sure they recover. And in some cases, when you think about what we go into and even take a car, Car has 30,000 parts. If 1 or 2 or 3 parts they can't procure, they struggle making a car. And so what you have right now because of the recovery being faster, you have everybody scrambling and also you have a lot The data signals that are coming down from our customers are changing a lot as they're trying to make sure they meet customer demand.

Speaker 2

So the first thing I would say from a supply chain is Pretty severe volatility coming from our customers as they're trying to make sure they get up and running. And unfortunately, in some cases, you've seen Customers having to stop production because of things like semiconductor. So that creates volatility. Now when you look into our world, It is important that when you think about TE, we are a manufacturer. We start from very base materials.

Speaker 2

What we innovate, we make. And so from that viewpoint, the biggest things that we use are things that are plastic, certainly resins from commodity all the way up to very highly Engineered things that help with flame retardancy and temperature, as well as metals that are used for Conductivity. So when you sit there in those two key areas, we did have some areas where resin supply was impacted And certainly metal supply has been impacted. And what that has created for us is not only a supply impacted, We've had to do some things that aren't as natural for TE, which is we might have supply to our global supply chain in certain parts of the world, And we may be shipping things around the world. So not only the availability, it's also created some of those pressures, as you said it in your question, that we're managing because guess what, we're trying to really make sure we ramp, we help our customers.

Speaker 2

And the reality of it is This is going to be with us. We've been dealing with it in the recovery. I wouldn't say it's getting better, but I would say we're going to continue to be dealing with it through our fiscal And into early next year as we're trying to pick up to a world that's recovering. And this type Recovery, whether you see it in our orders or in the supply chain means there's a fast recovery that's happening out there as people are trying to catch up to So hopefully that gives some flavor and I think our teams have actually been managing it through the volume, the price and the productivity As you see, enough results.

Speaker 3

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

Operator

Our next question comes from the line Joseph Spak of RBC. Your line is open.

Speaker 7

Thanks. Good morning. Sharon, you talked about some of The BEV wins and how that doesn't really impact the numbers today, but it helps for future growth. I was wondering if you could help dimensionalize That for us at all, like maybe quantify the bookings in this quarter or the lifetime backlog and how fast are some

Speaker 1

of those factors growing? How should we think about

Speaker 2

So number 1 is from a momentum perspective, the momentum that we've talked about has not changed. And There's really two factors. We benefit from our global position. We also benefit from the technology that we bring as you move to high voltage Actually, whether that be in connecting, it be into sensors that are resolvers and current sensors when you get into the electric motors. And when you look at it to conceptualize a little bit, I'll go back to what I talked a little bit about last call or the call before, Which is what it means to our content.

Speaker 2

A few years back, we were in the low-60s dollar preferring content. We're in the 70s now. And when you think about that $10 increase in content, approximately half of that is due to high voltage. So that's about $5 of content at the total TE level across all production that has translated into revenue. And that's a key driver as we say our content can grow above 18%.

Speaker 2

So realize there's only 9 1,000,000 electric vehicles made this year. What's great is that, that adoption continues to accelerate. It didn't stop during COVID. And certainly as that accelerates, that's going to continue to drive content outperformance for us. And it Actually just continues to accelerate all around the world and it's nice to see the traction in places even like the United States, which has always been a slower The technology actually pick up as well as the models that are coming out from all our global customers are showing how this trend is picking up.

Speaker 3

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

Operator

Our next question comes from the line of Scott Davis at Williams Research. Your line is open.

Speaker 7

Good morning, guys.

Speaker 2

Hey, Scott.

Speaker 7

Nice to see you surviving this mess that's out there and thriving. But I kind of just wanted to follow-up on that last question a little bit in the context of the Chevy Bolt recall and Perhaps the architecture that is being utilized there on the high voltage side. Is there are there learnings from that recall and That perhaps increases your content growth going forward and having more backup And safety systems around, particularly around high voltage. Is there anything to be gleaned there or nothing new?

Speaker 2

Scott, great question and good to hear from you. I think the thing that you look at, I wouldn't say when you think about does That learning out of that recall provide extra content. I wouldn't say it does, but I think it shows how fast the technology is moving As well as when you look at the architecture evolution, the pace of which is coming at. When you think about combustion engines and how long they took to develop as well as everybody getting their models out, you will have situations where There will be events that there will be learnings of what how do you need to harden the electrical architecture. I don't think that will create Incremental content opportunity, but what I would tell you for TV is when those issues occur, we're the type of company that they look to Because we're working on up to 1,000 volts, we play not only from the charger inlet, we play into where the motors go, the high voltage there.

Speaker 2

You also play on what's happening on the cell to cell or module to module connections as well as the sensing that occurs. So certainly, GM will really work hard to make sure those types of events don't occur in the future, but it actually also creates a bigger opportunity for stickiness for us. And certainly on the new truck platforms at GM, we have very strong content that's in line with that 2x content we've talked to you about.

Speaker 3

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

Operator

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

Speaker 7

Thank you. My question is

Speaker 6

around TE's high voltage differentiation. The company has invested Significantly in both in developing, but also scaling these solutions globally in recent years. And is this leading to high High voltage share gains relative to low voltage. It also seems like the OEMs would lean more heavily on top flyers, just given how important these initial EV rollouts are, and then particularly within high voltage, as it's a new But also extremely critical component for them.

Speaker 2

Yes. So Chris, when we look at it, I think Let me take a step back for just for a second. With what we do around our interconnect and sensing portfolio, Anywhere you have data, you have power, you have sensing and guess what, getting into smaller packages and then higher power and higher data, That's what our engineers do. And so when you deal with high voltage architecture in the car, certainly our customers, that's why We'd like the position we have and it's a global position, as I said, where we design all around the world with all the OEMs. So when you think about it, It is.

Speaker 2

One point I want to highlight is the low voltage architecture carries over for us because you're not putting in your low voltage applications Onto the battery and the motors. So our low voltage carries over. And where we really get into, and I mentioned it's a Scott's question, It starts at the charging inlet. It goes into how does you get the connections and the sensing occur around the high voltage connection that you need around the motors. It gets into the battery solutions.

Speaker 2

It gets into the contactors that we provide to switch the power over as you go from AC from DC to AC and back as well as the position in the current sensors. So it's Completely across. And I think the other thing that's unique for Hollys versus some others that might be a Tier 1, now we're Tier 2. Our customers really like that we're agnostic. We are there to solve their challenges that they're trying to get to, How are they trying to solve fast charging?

Speaker 2

What type of cells are they using in their battery pack? And that agnostic element is what they really like about our global position as they come into and we focus on the connection systems. We don't get Complicated about harnesses and other things. That's what the Tier 1s do. But it's really about the connection technology that we invest in as they think about platforms and how they have to evolve these platforms.

Speaker 2

And that's where you get the content increase that we mentioned and we shared examples, But it gives us a real content opportunity to double our content in electric vehicles. And like I said earlier, the content growth you're seeing In TE, about half of it over the past couple of years is due to high voltage wins.

Speaker 3

Okay. Thank you, Chris. Next question please.

Operator

Our next question comes from the line of Wamsi Mohan of Bank of America. Your line is open.

Speaker 8

Yes, thank you. Terrence, you had a pretty solid Fiscal third quarter, you're guiding so pretty strong exit for this fiscal year. Can you maybe share some early thoughts into next fiscal year? It feels like there should be some nice production growth and other end markets seem to be in recovery mode as well. So any bookends around dimensioning fiscal 'twenty two would be helpful.

Speaker 8

Thank you.

Speaker 2

Thanks, Wamsi. And I guess I'm going to have to give you the caveat that we only guide for the Q4 and we'll talk to you in 90 days about What we see going into 2022. But I just do want to reflect on what we say our business model is, maybe before I talk to It is about the content we've talked about even to your questions. It is about where our underlying production I'll go into various markets that we serve, and it is about also continuing to capitalize on some of the execution things that Heath talked about on restructuring. Yes.

Speaker 2

We're still not at the entitled margin in 2 of our 3 segments, and it's how do we use that capital to return it to you. So I do think it's important that's the way we think about TE and it's important that we keep in front of us. And some of this I talked about. In transportation, we do still see runway around production. Semiconductors had been a little bit of a governor this year.

Speaker 2

That probably will get fixed. I think people say in 2022 at some point, But also that the consumer demand and inventory being depleted on car lots really are something that you could see auto production going up. Certainly, our Tim will continue. In industrial, manufacturing CapEx is accelerating. I mentioned we're seeing it Semiconductor, we're benefiting from that.

Speaker 2

We're seeing it in the automation. We're benefiting from that. And what we're seeing in medical as well as energy Looks like very nice legs to it. The one spot that we don't sort of see any signs of acceleration is around aerospace and defense, And that's just something there's good consumer trends. We aren't seeing it yet in that supply chain.

Speaker 2

And then in communications, I would just say, Cloud, we expect to be strong. And when it comes to appliances, the consumer is showing up strong. That probably will normalize at some point.

Speaker 3

I don't know if that

Speaker 2

will be in 'twenty two or later, but certainly we're benefiting from a very strong appliance cycle here around the consumer. So really Like how the end markets could be teeing up for 'twenty two, and we'll share more with you in 90 days.

Speaker 3

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

Operator

Next question coming from the line of Joe Giordano of Cowen. Your line is open.

Speaker 7

Hey guys, good morning.

Speaker 2

Hey Joe.

Speaker 7

Just curious on in auto on the customer inventory side of component parts, A lot of different commentary coming out so far in earnings season from what different companies are seeing. Just curious what you do internally to kind of Make sure you're understanding whether what percentage of orders that you're getting are for like actual production of cars right now and how much is for Your own customers building some stocks. So what's the internal procedure for kind of flushing that out?

Speaker 2

Well, a couple of things that we do, do. Yes. It's not unreasonable to assume that people will be trying to hold a little bit more buffer stock right now. But as I said, We're not even able to meet current full demand. And I said that was about $100,000,000 We do actually make sure as we check with our customers, actually in some cases, we visit their warehouses to make sure we don't see Forwarding occurring.

Speaker 2

And we also talk to our OEM customers because let's realize in some cases we ship into Tier 1s. And there's lots of discussions between the OEM, the Tier 1s to make sure flow continues to happen. So yes, I'm sure in some parts, there may be some people trying to build up a little bit extra buffer stock, especially in the supply chain environment. I would tell you, we're still trying to get to make sure we keep demand flowing to keep production going with the OEM lines.

Speaker 3

Okay. Thank you, Joe. We'll go to the next question, please.

Operator

Our next question coming from the line of Christopher Lane of Oppenheimer. Your line is open.

Speaker 9

Yes, thanks. Also wanted to double down a little bit on the relationship between orders and consumption. And As it pertains to revenue, I'm wondering if there's any mismatch relative to the actual production now with the transportation segment specifically that we might qualify our view of production advancement next year? And then as far as orders go, Would we anticipate a quarter or 2 where maybe you have the reciprocal of what we're seeing now and kind of mismatched the other way with the Continued outsized book to bills in the trailing periods?

Speaker 2

All right. You asked about 3 questions there. So, no. Let me start at the And if you take this quarter, we billed 3.8%. I think when you look at that gap, that gap is certainly larger than normal.

Speaker 2

There is about $100,000,000 of that gap. That is real demand that due to our supply chain, we could not fulfill. When you look at that remaining gap, I sort of think about it in a couple of buckets. And certainly, we look at it a lot. We study it by our different end markets.

Speaker 2

There's probably about half of that element which relates to our distribution partners. That is where people may not be able to get goods from us. They're looking to our channel partners to procure. And from that viewpoint, we have seen an increase, very strong increase over the past two quarters in our channel partner Orders,

Speaker 9

but

Speaker 2

what I would tell you, our channel partner inventory is at the same levels as last year. So their turn is up Very big. They're placing orders. Certainly, we're not able to meet them to the levels that they're ordering. The other portion would be from our direct OEM customers and it will be that they're trying to make sure TE's parts are not that 1, 2 or 3 parts that they can't make Something.

Speaker 2

So we have seen people go out an extra quarter in some of their ordering patterns due to the current environment. And I think as the supply chain continues to get better, what you would see in places like transportation, a Transportation book to bill is typically around 1. It's not typically 1.1, 1.2. And I think as the supply chain catches up, you will see things get more normal and get closer to where they should be As they normalize and the whole supply chain gets better. So I would expect at some time, orders will get closer to billings.

Speaker 2

Clearly, as the supply chain continues to improve and things come better.

Speaker 3

Question, please.

Operator

Our next question coming from the line of Samik Chatterjee of JPMorgan. Your line is open.

Speaker 5

Hi, good morning. I guess, Terence, just wanted to follow-up on your comment about order trends by geography and Seemed like Europe is kind of the outlier there where you're still seeing you're seeing some weakness in the quarter. So just if you can talk about what you're seeing In terms of the difference there in Europe and the recovery there and why probably kind of the order trends being kind of a bit off of an

Speaker 2

No. Honestly, when you look at that, I know it's down by about 7% sequentially. I would say when you look at that, that's more around some of the normal summer shutdowns and transportation. Then I would say it's a big deceleration. I would say we continue to see orders even as we're into July stay at elevated levels because the conditions we're in Hard changing.

Speaker 2

And I wouldn't say it's one barometer, negative or positive. It's just a little bit slower. And certainly, we would Normally see that as some of our customers do summer shutdowns in Europe in the automotive space and they are still doing those.

Speaker 3

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

Operator

Next question is from William Stein of Trubist. Your line is open.

Speaker 9

Thanks for taking my question. Terrence, you mentioned earlier this fact of manufacturing where Car has 30,000 parts or whatever it is and you need all of them to make the car, not just a subset, even if you're missing a couple, you have a problem. Certainly true in almost all products. In autos though, I'm sure you've acknowledged that there are cases where these companies can decide, well, There's a feature or 2 that we can isolate and perhaps be contented and get a car shipped. We're Picking this trend up pretty clearly from multiple sources that we're seeing the content and going on in order to get around the shortages.

Speaker 9

I'm wondering if TE is Seeing this, if so, to what degree? And in particular, does it take away from your growth In sort of the next couple of quarters in any way where perhaps a more content rich car would have Provided a better opportunity, but what the company is shipping is something of a smaller content opportunity or vice versa?

Speaker 2

Yes. Hey, Will. Great question. Number 1, let's face it. The auto manufacturers are being creative because there's consumer demand.

Speaker 2

And let's face it, they want to get the vehicles out and if there's a feature where they can't get a component, they certainly are taking some of those features out Near term. I would tell you on our revenue, while we do see that around certain OEMs, that is not having a meaningful effect. Yes, where we play in the core architecture in the electrical network as well as in the backbone in an EV, you may lose A couple of interconnects, but that is not that much from a big picture content. And even if you look at our content growth this year, overproduction, it's not evident in any way. So I would also say in this type of environment, while you have some of that decontending, they are also being able to add options to it, which we also benefit come.

Speaker 2

But that isn't meaningful and a big number either. So it would probably impact others more than us. But with our breadth that we have across where we play in the architecture, while they're doing it, it's not having a meaningful impact on TE.

Speaker 3

Okay. Thank you. Will, can we answer your question

Operator

please? Your next question from Matt Sheerin of Stifel. Your line is open.

Speaker 7

Yes. Good morning. Tony, I wanted to ask about the strength that you're seeing in the communications segment and specifically The cloud business and the margins there, it looks like record margin. So the question is how sustainable is that? And then within the cloud on demand side.

Speaker 7

How diversified are you? I know obviously there's just a handful of really big Hyperscale players, but in terms of the diversification and the lumpiness of that business, if you could provide more color.

Speaker 2

Sure, Matt, and thanks. So a couple of things. Let me talk about the cloud element, and then I'll talk about segment margins. On the cloud element, What's really been nice is and those of you that follow us, we very much our B and D business years ago, we basically made a strategic So we could focus on just high speed. And I remember when we had less than $100,000,000 with our cloud It's well over $300,000,000 today.

Speaker 2

And our market share at one point in time was with 1 of the cloud providers. Our market Pretty even across all the cloud providers, not only the U. S. Cloud provider, but also globally. So The breadth and the strengthening of it as well as the share gain, it's both the growth of the CapEx and their investment, but also how our teams executed on share gain as well and bringing Important technology to it.

Speaker 2

And it has been a strong cloud environment. I think I mentioned already close 20% CapEx growth in cloud. What's nice is next year we still see double digit again. And as you not only get that underlying growth, Goes back to the secular trend around content is content to next generation as new chips come out on those servers, we also benefit from our next generation products from what the content is. So feel very good with where we're positioned there.

Speaker 2

When you look at Segment margin, the performance by the team has been very strong. It's benefited not only by what we've done in cloud, I would also say our clients business in that global leading position. That growth there in that business has also very much contributed To the margin in that segment. So we still think that's a high teens business through cycle. So with having both segments being very strong, it's benefiting the margin there.

Speaker 2

And it's something that as How the appliance normalizes, we could have some pressure, but net net that that segment is above target margins is something we're proud of.

Speaker 3

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

Operator

Next question from Steven Fox. Your line is open.

Speaker 3

Hi, good morning everyone.

Speaker 2

Terence and Heath, I was just curious if you

Speaker 3

could talk about when you start considering some of these supply chain pressures and inflation pressures to be sort of a New normal and how you might change managing your supply chain, how you might change hedging, how your customers might change? And within that context, can you just Sort of give us a baseline for what you're doing on hedging inflation at once? Thanks.

Speaker 1

Sure, Steven. This is Heath. I'll take that. Our biggest Input pressures that we have when we talk about things that are impacting our P and L would be around resins and being around certain metals, right, that we use in our products. In many cases, For the metals, we do have a hedging program that generally hedges out about 18 months of our anticipated usage or purchase and then subsequent usage.

Speaker 1

So when we see inflation or deflation relative to the metals, that tends to kind of layer in more quietly into our Results both directions. So that is unchanged and we'll continue to do that. The bigger issue that we are seeing when we are looking at Some of these when we throw them into the broader supply chain bucket is we do have local sourcing, which is really good. It enables a lot of nimbleness and Agility for our businesses, whether that's in Asia, Europe or in the Americas to be able to procure product locally versus shipping things around the world. That also has the challenges of when we do have supply chain disruption in a Particular location or particular region, whether that's driven by natural causes like floods or otherwise, Again, the situation down in Texas earlier this year where a lot of the chemical companies came offline and

Speaker 2

put a lot of pressure

Speaker 1

through the resins and so forth in the Americas. Those types of things when they happen are floods in Germany. So when those things happen, We still have to be responsive to our customers. So sometimes that means we are then moving some of our supply around the world and that Very expensive. So the freight costs, it's a long winded way of saying some of the freight costs layer into some of the supply chain pressures as well from us because of some of Our structure.

Speaker 1

For us, we're going to continue to take advantage of those local supply chains. And we just need to make sure that we have that flexibility going forward. In terms of our ability to manage it and when do we first see it being part of the new norm, I don't know. I mean the help in the semicon doesn't impact us directly, but it impacts our customers. So you're probably better equipped to come up with Thanks, Rich.

Speaker 1

The way the semiconductor shortage is dissipate. In terms of some of the other things relative directly to us, I would say we're working through those and feel pretty good about how we're ready to jump into FY 2020 2.

Speaker 3

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

Operator

Next question coming from the line of Jinhua of Citigroup. Your line is open.

Speaker 7

Thank you. And my one question It's actually a follow on to your response sheet that you just gave. And not talking about the Semiconductor shortages, but the resins input costs and all that, you talked about hedging and such. I'm wondering as shipping costs have been around for call. A while now, an extended amount of time all through COVID and these additional raw material costs.

Speaker 7

I'm wondering, is it come time to start like re Pricing some of your contracts with customers or put in indexing for raw materials or all your answers so far talk more about Hedging and dealing with your supply and stuff. I'm just wondering, does it come time to go back to talk

Speaker 2

to the customer? Or are

Speaker 7

we just not there yet?

Speaker 2

No, Jim, it's Terrence. Two folds. We've been there, quite frankly. So To sort of go where we are on it, across our channel partners, we did a price increase. This is 20% of our business in January.

Speaker 2

We just implemented another price increase and we're going to continue to look in this environment. In our direct customers, we are having those discussions right now. We do have metal riders And many of our agreements are sort of like collars, if you bust out of an area on metal, we have ability to recapture. And then when you deal with resins and freight, which are newer, we are having those discussions with our customers. It's very different by industry.

Speaker 2

And that's what has been going on and that they will layer in at different times, but I feel we are having those discussions Real time.

Speaker 3

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

Operator

Next question comes from the line of Luke Zhang of Baird. Your line is open.

Speaker 10

Yes, thank you. Probably a question for Heath this morning. I was hoping you could walk us through the sequential margin walk in industrial margins given the step up that we saw versus first half levels and also looking forward here maybe just in the Q4 if you could give us any help What that margin outlook might look like in industrial specifically?

Speaker 1

Sure. Well, I think first of all, thanks for the question. We We've been pretty public with the journey that we're on within the Industrial segment margins, right? And we started This in the low teens and with the multiyear trajectory of through a lot of rooftop consolidations of getting this business into the high We're kind of we're in that journey. We made a lot of improvement here in the quarter.

Speaker 1

Certainly a couple of the things Industrial benefits from 1, the restructuring activity that has been underway continues. That comes in chunks at times As operations get taken offline and so you might have some cost in 1 quarter before something comes offline and that tends to create quarter to quarter lumpiness, But when you smooth it out over a year or longer, you can kind of see that result. The other thing is, and Terrence Just hit on this, the industrial segment does benefit from the opportunity on the price side because more of the industrial business goes through Distribution. And so fairly large chunks of our industrial segments did have the opportunity to not only do price increases back at the beginning of the calendar year, but in July implemented additional price increases and that does have More of a near term benefit for the segment versus some of the other segments where it's more of a direct OEM relationship and it takes a little bit longer to work that way through. So those are a couple of the pieces as we look forward into the 4th quarter.

Speaker 1

Listen, timing on things, you're always going to have that with the businesses as big and complex as we are. And our Industrial segment being a $4,000,000,000 has a lot of moving pieces, but I feel very good about the trajectory as we move from the first half to second half or Yes. 3rd quarter to 4th quarter, but I think even more importantly, as we work our way into 2022 and beyond, There is still margin upside for this segment and the team is hyper focused on that. So more to come.

Speaker 3

Thanks for the question. Thank you, Luke. Can we have the next question please?

Operator

Next question from Nick Tazeurab of Longbow Research. Your line is open.

Speaker 7

Yes, thanks. Good morning. I think the near term dynamics on supply chain are well publicized. But My question is, Terence, do you see any impact on the longer term dynamics like design by your customers specifically in automotive? Do you see any changes in the way they operate or think about design in the current environment?

Speaker 7

And if you do, what impact that should have from these changes on your business?

Speaker 2

Please? No, twofold. From a design perspective, when I think about the velocity and even coming through COVID, The velocity did not change during COVID. So if anything, especially in transportation, Specifically, MDBs. You see the launches that are happening.

Speaker 2

You see the innovation that's happening real time. What typically happens with customers, I think with all of You're seeing the pace continues to accelerate because the consumer expects it. So and that I think not only is in transportation everywhere, but it's also It goes through their supply chain and also some of the benefits we get in our industrial business over people's investments, including our own Around how their factories have to be more flexible and digitized. When it comes to the question about supply chain design, Clearly, customers will reflect going through this period of what needs to be different and the more JIT you are, They'll probably pick some spots of what do they have to do differently. I would say we're not seeing anything near term.

Speaker 2

We don't see people thinking about vertically integrating interconnects versus maybe some other areas, especially in the transition to EV. Well, what's good is we're very close to our customers and hopefully we can take advantage of it for opportunity for TE versus risk as they work through it. Because once again, being with every OEM, we have a pretty good purview, especially in automotive as we go forward.

Speaker 3

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

Operator

And our last question coming from the line of Rob Lachey of Wolfe Research. Your line is open.

Speaker 7

Hey, this is Shreyes Patel on for Rod. Just two quick ones. One, could you help quantify the supply chain impact As you saw in the quarter, I believe last quarter you mentioned it was a $50,000,000 headwind. And then second, just looking at the year over year Comparison. I know it's a bit challenging given the base effect, but it looks like your incremental margin Ex currency was maybe closer to 40%.

Speaker 7

And I think in the past, you've talked about 30% to 35% incremental mortgage. Maybe just how we should think about that going forward? Sure.

Speaker 1

This is Heath. I'll take the question. I think in the quarter, and Terrence mentioned this earlier, we quantify the supply chain impact To us and define more or less as our availability to or in 2K's inability to get the input materials that we need that that impact to us was about $100,000,000 And I would Say that probably 2 thirds of that would have been the transportation. So our inability to ship was about $100,000,000 that I would quantify on the top line for the supply chain impact. And obviously, the teams are scrambling day by day to recover that and keep customers happy.

Speaker 1

In terms of the flow through, listen, the year over year flow through, I would we're proud of it. We're proud of it when we look at it and not just in the 3rd quarter And anticipated flow through the Q4, but also on a year to date and full year basis, and we are proud of it. I think I would caution you Last year our compares last year were so far off relative to the severe downtick and that had a disproportionate impact To our margins as well last year. So when we look at that on the downtick versus the recovery a year later, You're going to see some out in a quarter in a given quarter, you're going to see some outsized numbers. I don't I would not want to guide you to Reset your expectation that 40% is the new norm for our flow through.

Speaker 1

We are still confident in that 30% to 35% number, which was up Which we took up earlier this year due to some of the restructuring activities that have been underway. And I think it normalizes into that range. But you're going to have quarter noise from time to time, particularly in a year over year basis that we had in the Q3. Okay. Thanks for the question, Trayus.

Speaker 1

And I

Speaker 4

want to thank everybody for joining

Speaker 1

us this morning. If you have more questions, please contact Investor Relations at TE. Thank you, and have a good morning.

Operator

Thank you. Ladies and gentlemen, your conference will be made available for replay beginning at 11:30 am Eastern Time today, July 28, 2021, on the Investor Relations portion of TE Connectivity's website. That concludes your conference for today. You may now disconnect.

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Earnings Conference Call
TE Connectivity Q3 2021
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