TE Connectivity Q3 2022 Earnings Call Transcript

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Provided by Quartr
July 26, 2022

Key Takeaways

  • TE Connectivity delivered record Q3 sales of $4.1 billion, up 11% organically year-over-year, with growth in all three segments and across nine business units.
  • A strengthening U.S. dollar created a significant currency headwind, dragging on sales by $236 million in Q3 and expected to cost roughly $700 million for full-year FY22.
  • Order momentum remained strong with a book-to-bill of 1.02 and backlog growth of over 20% versus prior year, driven by robust demand in industrial and communications markets despite some moderation in appliances.
  • Adjusted operating margin held at a resilient 18.6% and adjusted EPS reached a record $1.86, reflecting effective pricing actions and operational execution amid inflation and supply challenges.
  • TE generated $423 million of free cash flow in Q3 (and roughly $1 billion YTD) and returned approximately $1.6 billion to shareholders in the first nine months, including $1.1 billion in share buybacks.
AI Generated. May Contain Errors.
Earnings Conference Call
TE Connectivity Q3 2022
00:00 / 00:00

There are 17 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the TE Connectivity Third Quarter 2022 Earnings Call. At this time, all lines are in a listen only mode. Later, we will conduct a question and answer session. As a reminder, today's call is being recorded. I would now like to turn the conference over to our host, Vice President of Investor Relations, Sujal Shah, please go ahead.

Speaker 1

Good morning, and thank you for joining our conference Call to discuss TE Connectivity's Q3 2022 results. With me today are Chief Executive Officer, Terrence Curtin And Chief Financial Officer, Heath Mitts. During this call, we will be providing certain forward looking information, and we ask you to review the forward looking cautionary statements Included in today's press release. In addition, we will use certain non GAAP measures in our discussion this morning, and we ask you to review the sections of our press release And the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation,

Speaker 2

Can be found on the Investor Relations portion of our

Speaker 1

website atte.com. Due to the large number of participants on the Q and A portion of today's call, We're asking everyone to limit themselves to one question. We are willing to take follow-up questions, but ask that you rejoin the queue if you have a second question. Now let me turn the call over to Terrence for opening comments.

Speaker 2

Thank you, Sujal. And I also want to thank everyone for joining us today to cover our results for the Q3 along with our outlook for the Q4 of fiscal 2022. As I normally do and before Heath and I get to the details on the slide, I want to take a moment to discuss our performance within the backdrop of the current environment. We delivered strong performance again in the 3rd quarter With record sales and this represents 11% organic growth year over year. We had growth in each of our 3 segments And organic growth across all nine of our business units.

Speaker 2

Adjusted operating margins were in the mid-eighteen percent range, And this is at levels similar to where we've been running through the year despite incremental headwinds that we've been experiencing. And we also delivered record adjusted earnings per share that was above our guidance. I feel our performance is a result of how we We've strategically positioned our portfolio around secular growth trends as well as the execution of our teams, both from a manufacturing perspective And in our ability to effectively manage pricing in this inflationary environment. I'm also proud of our teams as they continue to overcome broader macro challenges Now let me provide some color on the supply environment, key end demand trends and the development since our call 90 days ago. When we provided our guidance last quarter, we told you about an anticipated impact from the sales On our sales to the COVID lockdown in China.

Speaker 2

And even though these lockdowns extended further into the Q3 than our original expectation, Our teams were able to recover and the sales impact to the quarter was negligible. When you think about the global supply chain challenges and specifically around material availability, I would tell you they're about the same as they were 90 days ago And inflationary pressures continue to linger. One element that I want to highlight That has changed since the last time we spoke is the strengthening of the U. S. Dollar.

Speaker 2

This strengthening has significantly increased the headwind we're facing from foreign currency exchange rates, both year over year and sequentially, and Heath will talk about that a little bit more later. Turning to the markets. Customer demand remains strong as evidenced by our order levels and our strong backlog position. And just to highlight, our backlog has grown over 20% versus the prior year. And we are seeing some consumer facing markets like appliance moderate, but we continue to see broad strength across our Industrial segment, And we still have a number of markets that we serve that are not yet back to pre COVID levels, and this includes automotive, commercial air as well as medical devices.

Speaker 2

And we expect growth in these businesses as supply constraints are alleviated And those markets continue to recover.

Speaker 3

The other thing that

Speaker 2

I want to highlight and we've consistently talked about And it has not changed is the benefit we continue to see from the secular trends in our markets and the outperformance that we're generating from content growth and share gains. We are benefiting from our position as an industrial technology leader with growth from electric vehicles, Smart factory applications, including automation, renewable energy and high speed cloud and artificial intelligence applications. The other thing that I want to highlight that we as we continue to navigate through this noisy macro environment Is that we remain committed to our business model and long term value creation by driving further growth, margin expansion and strong cash generation. So with that as a background, let me get into the slides and discuss additional highlights that are on Slide 3. Our quarter 3 sales were

Operator

a record of

Speaker 2

$4,100,000,000 and this was up 7% on a reported basis And up 11% organically. As I mentioned, we saw growth across each of our segments and organic growth across all of our businesses, Once again demonstrating the strength and positioning of the portfolio, we generated double digit organic growth in the Industrial and Communication segments And 8% organic growth in transportation despite an auto production environment that was essentially flat year over year. Our orders were $4,200,000,000 in the quarter with a book to bill of 1.02, And this shows that the demand environment continues to be strong. And I'll get into more details about order trends by segment When I get to the next slide. From an earnings perspective, our adjusted earnings per share was a record of 1.86 That's up 4% year over year with adjusted operating margins of 18.6%.

Speaker 2

From a cash flow generation, our year to date free cash flow was approximately $1,000,000,000 with approximately $1,600,000,000 return to shareholders this Sure. And I will tell you, we've been aggressive with share buybacks as we're taking advantage of the recent market price dislocations with our stock. As we look forward, we are expecting quarter 4 sales to be approximately $4,200,000,000 and adjusted earnings per share to be around 1.85 Our guidance reflects the benefits of an extra week that we have in the 4th quarter, but also factors in the impact of an increased headwind And if you look at the slide, we've provided the details of each of these items and how they impact our Q4. Before I get into orders, one thing I do want to do is move away from the financials for a moment And highlight that I'm pleased that we issued our 12th corporate responsibility report last quarter, which reinforces our 1 Connected World strategy. And when you look at the report, it has many highlights.

Speaker 2

But one of the keys that I think is important was that we were successful in driving a 30% reduction in absolute greenhouse gas emissions in a single year in fiscal 2021. And this is a very large step towards our goal of achieving a 40 percent plus absolute reduction in our Scope 1 and Scope 2 greenhouse gas emissions by 2,030. So with those being the highlights on Slide 3, let me turn to Slide 4, and I'll discuss order trends as well as what we're seeing in our markets. For the Q3, our orders were $4,200,000,000 as we expected, And this reflects the continued strong demand environment from our customers as well as we continue to see the impacts of ongoing supply chain volatility in the markets. Our backlog is up over 20% and increased double digits in each of our segments versus the prior year.

Speaker 2

It is also important to note that currency exchange headwinds are not only impacting our sales, but also when you look in the year on year compares negatively impacts valuable orders in the Q3. And this impact when you look at the year on year compare, our orders would be $230,000,000 higher This quarter, it wasn't for the strengthening of the U. S. Dollar. In transportation, We had a book to bill of 1 in the 3rd quarter, which is in line with where the segment has run historically.

Speaker 2

And keep in mind And we also have a strong backlog position. End demand for autos remains healthy and is significantly higher than what OEMs can currently produce, Providing a potential setup for future auto production increases as supply chain bottlenecks begin to resolve And dealer inventories get back to more normal levels. In our Industrial segment, we saw another quarter of strong orders with book to bill of 1.16 and growth across all businesses year over year. We continue to see a favorable backdrop in capital expenditures For factory automation, manufacturing capacity and renewable energy, and these trends benefit both our industrial equipment And our Energy businesses. The other thing about our Industrial segment orders are we're continuing to see improving order trends in the commercial aerospace As well as medical markets, where we expect growth as those markets continue to recover.

Speaker 2

In our Communications segment, orders reflect a double digit increase in our backlog versus the prior year, along with expected moderation in the appliance market that we've been talking about all year. And one thing, when you look at the communications order trends, it is important to note that our backlog in our Communications segment is approximately $1,000,000,000 So with that as a backdrop on orders, Let me get into the year over year segment results that you can see on Slide 5 through 7, and each one of those slides have the details for each segment. So starting with transportation, our sales were up 8% organically year over year. Our auto business grew 9% organically versus auto production that was roughly flat versus the prior year. Global auto production was 18,000,000 units, and this was slightly lower than our expectations due to the lockdowns in China.

Speaker 2

And we do expect some sequential increase in auto production into the Q4. The trends around our content remain robust As we continue to benefit from increased electronification as well as higher production of electric vehicles. And we do expect electric vehicles to be up over 30% this year compared to a total auto production environment that is going to be flat. As we look forward, we do expect continued expansion in our content per vehicle, and you'll see that as we move from the first half to the second half of this year. In the commercial transportation market, we saw 10% organic growth driven by North America and Europe With significant market outperformance in all regions, driven by strong content growth as well as share gains.

Speaker 2

In our sensors business, we grew 2% organically. And what was nice is that growth was driven by The focus we have on factory automation applications. When you look at earnings for the segment, Adjusted operating margins were 17.3%, and this was impacted by the inflationary pressures. As you know, there's a time lag from when we incur higher inflation until price increases become effective with our auto customers. So let's move to the Industrial segment.

Speaker 2

And in our Industrial segment, sales increased 13% organically year over year. Industrial Equipment was up 19% organically with double digit growth in all regions and continued benefit from increased capital spending In our energy business, we saw 17% organic growth, driven by increased penetration in renewable applications. And in our Aerospace, Defense and Marine business, this is the first time we've seen year over year growth since the market was impacted by COVID, And we now expect continued growth as we go forward. Our medical sales in the segment were up 1% organically With a modest increase in interventional procedures as well as medical device market is continuing to work through supply chain challenges. From a segment margin perspective, our adjusted operating margins expanded year over year by 100 basis points 16.8%, driven by higher volume and strong operational performance by our team.

Speaker 2

We have made significant progress on our margin progression over the past several years, and I'm pleased with how the team continues to drive towards its business model target of consistent High teens operating margin. So let's turn to the Communications segment. And as you can just see looking at the slide, our team continues to execute while capitalizing on the growth trends in the markets they serve. Sales growth was 16% organically year over year for the segment, with growth in both businesses as highlighted on the slide. In our data and device business, we saw market outperformance driven by content growth in high speed cloud As well as share gains in artificial intelligence applications.

Speaker 2

And as we highlighted last quarter, these Artificial intelligence applications do improve energy efficiency in the data center. It's just another example of how we enable Lower carbon emission with our customers through our engineering. In our appliance business, it didn't perform ahead of our Despite the expected declines in the China market, we saw growth both in North America and Europe in our appliance business, And that is driven by continued share gains enabled by our global manufacturing strategy. From a margin perspective, The communications team continues to deliver outstanding performance. The adjusted operating margins were 26.2%.

Speaker 2

This was up 2 70 basis points versus a strong quarter in the prior year, and our teams continue to deliver strong performance both on sales As well as proving margin resiliency. So with that as a backdrop of our segment results, let me turn it over to Heath, We'll get into more details on the financials as well as our expectations going forward.

Speaker 4

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 CAD 761,000,000 With an adjusted operating margin of 18.6 percent. GAAP operating income was $719,000,000 and included $30,000,000 of restructuring and $12,000,000 of acquisition related charges. We continue to expect restructuring charges of approximately $150,000,000 For the full year, as we continue to optimize our manufacturing footprint and improve the cost structure of the organization.

Speaker 4

Adjusted EPS was $1.86 and GAAP EPS was $1.83 for the quarter and included a tax related benefit of $0.06 And additionally, we had restructuring acquisition and other charges of approximately 0 point 19%. For the Q4, we expect our adjusted effective tax rate to be roughly 20%. So we continue to expect an adjusted effective tax rate around 19% for the full year. Importantly, we continue to expect our cash tax rate to stay well below our adjusted ETR for the full year. Now turn to Slide 9.

Speaker 4

Sales of $4,100,000,000 a company record were up 17% reported And up 11% on an organic basis year over year. When you think about our organic growth, approximately 1 third Was driven by price increases and the remaining 2 thirds was driven by volume as a result of the strength of our portfolio. In the Q3, currency exchange rates negatively impacted sales by 236,000,000 And $0.07 versus the prior year. As Terrence mentioned, FX impacts have worsened significantly over the past 90 days. In Q4, we expect currency exchange rates to be a sequential headwind of approximately 70,000,000 And a year over year headwind of approximately $275,000,000 For the full year, we now expect a negative impact from FX Roughly $700,000,000 which is significantly worse than our view 90 days ago.

Speaker 4

Adjusted EPS was a record at $1.86 Adjusted operating margins were 18.6 percent and I am pleased with the performance of our team given the incremental inflation And supply chain pressures we are seeing. We continue to pull pricing levers across the business to help partially offset these pressures. And as we talked about last quarter, while we are not able to offset these costs dollar for dollar, we continue to recover approximately 2 thirds Through price and the remaining through productivity initiatives. We continued taking pricing actions to offset these Inflationary pressures. Turning to cash flow in the quarter.

Speaker 4

Cash from operations excuse me, from Operating activities was $579,000,000 Free cash flow for the quarter was 423,000,000 As we mentioned in past calls, the year over year trend in free cash flow does reflect strategic inventory builds. However, we expect to work down inventory this quarter with Q4 expected to be the highest quarter of free cash flow for the fiscal year. Through the 1st three quarters of the year, we have returned approximately $1,600,000,000 to shareholders with approximately $1,100,000,000 return Through share buybacks, we will continue to remain disciplined in our use of capital. And near term, we have been aggressive in buying back our stock Taking advantage of investing in our own value creation opportunities. So we've made significant progress towards our business model over the past few years, Our teams are continuing to execute well in a volatile environment.

Speaker 4

The strategic positioning of the portfolio has enabled us to deliver sales growth, margin resiliency And EPS expansion despite the challenges we are facing, we will continue to focus on what we can control to effectively serve our customers And drive strong financial performance, including strong cash generation. So now let's open it up for questions.

Speaker 1

Thank you. Can you please give the instructions for the Q and A session?

Operator

Our first question comes from Chris Snyder with UBS. Your line is open.

Speaker 3

Thank you.

Speaker 2

I wanted to ask about expectations for global auto production over the next couple of quarters. Obviously, a big debate in the market. Consumers are pressured, but we've already had production near trough levels for the last 2 years. So just what are you hearing from customers around Expectations for production and in turn connectors over the visible time horizon? And would also be interested in any views on auto demand versus production debate?

Speaker 2

Thank you. Sure, Chris. Thanks for the question. And let's just frame it a little bit. Auto production, I talked about it in my comments.

Speaker 2

Yes. We think in our fiscal year, the September year, there's going to be 76,000,000 vehicles made this year. And that's the same amount as it was made last year. And you look at demand, we would tell you we think demand is well above 80,000,000 units. And also to give you another guide that goes back in 2019 pre COVID there was 88,000,000 Cars made on the planet.

Speaker 2

So we still have a way to go to get back to pre COVID production, And we can also see where inventory levels are in pretty much every region of the world still very low. So we do think there is potential for production increases. Even if demand comes down a little bit, there's still a big disconnect between demand levels versus what our customers can deliver and a lot of that is well documented from the OEMs around I think the other thing that I just want to say is we did see 18,000,000 units made this quarter. Going into next quarter, we do think, and I said in my prepared remarks, 19,000,000 units. And so there is, I think, upward Momentum to production as we move into next year, the supply chain continues to improve.

Speaker 2

I think to Heath's point though, The other thing is what we control. We control content. We don't control production. Certainly, TE does not make semiconductors. But I think the other element I just want to stress is, and I think it's shown up through this period, even in a tough production environment like we've been in the past couple of years, How our content has expanded from what was in the 60s, consistently in the 80s, you'll see an increase in the second half, Really shows where we position the portfolio both around as electric vehicles continue to be built, continue to be a bigger pie, But also from the electronification and as I told you on other calls, you look at that $20 plus delta per vehicle, About 60% of that's driven by electric vehicle growth.

Speaker 2

The other 40% is due to electronics on both combustion engines As well as on electric vehicles. So I do think while production has been frustrating, I do think we're still well below demand. And if we do get some breaks on semiconductor and other supply chain, there could be upside as we go next year even with A cloudy macro environment. Okay. Thank you, Chris.

Speaker 1

Can we have the next question, please?

Operator

Next question comes from David Kelly with Jefferies. Your line is open.

Speaker 5

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

Speaker 2

Sure. So let me take The first the last piece of your question first. So when you look at our orders in July at total TE level, They're running very similar to what they were running at last quarter. So our orders overall have been pretty steady here. What we saw last quarter as we go into this, 1 month in, so from a July, they remain healthy.

Speaker 2

The other thing that I think is important is we do have to keep in perspective, and we talked about this a lot over the past year, 2 years. A lot of customers are ordering ahead. Certainly, we have an elevated backlog position. And even in some of the compares like our Communications segment, Last year in this quarter, our orders were over $800,000,000 So it's very strong compares and tough compares. What we continue to look at in our orders is orders with backlog.

Speaker 2

And I mentioned on the call, in communications, we have $1,000,000,000 of backlog. And our communication customers did a good job of ordering out. I do think they did a better job than our Transportation customers when they were trying to make sure they were securing supply. And overall, that's what you're seeing in the trends. So As we look forward and no different with our guide, we continue to see healthy demand trends.

Speaker 2

Certainly, the industrial markets Continue to look like they're accelerating, and we have 2 of our 4 markets in industrial. We're a little bit later to the recovery party with medical And commercial aerospace, industrial equipment stays strong. And the one market that we do see Moderation, which isn't a surprise that we talked about, has been the appliance market. We would have thought there'd be moderation even before now. We sold it in China.

Speaker 2

Certainly, that's tied to housing and property, and we would expect that will continue to moderate. But when we say moderation, you're really talking about our orders sequentially going from our March quarter to our June quarter being down like 12%. I don't want it to be they're falling off a cliff, but they did moderate. And certainly, the backlog also supports where we guided. So hopefully that gives you better color about how we think about and also confidence.

Speaker 1

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

Operator

Our next question comes from Ramsey Mohan with Bank of America. Your line is open.

Speaker 6

Yes. Thank you. Terrence, can you talk about the various moving pieces in margins across the segments? Automotive was Speaker, and I know you experienced a lot of headwinds in the quarter, but comms and industrials were quite strong. How should we think about the trajectory from here?

Speaker 6

And also if you could address how the incremental margin should track because That seemed to decelerate somewhat in the quarter. Thank you.

Speaker 4

Hey, Wamsi, this is Heath, and I appreciate the question. Listen, I think if we just start with where we are at TE in total, right, we're still tracking in that mid-eighteen percent level, which is really where We've been tracking most of the year and there's no doubt some of the strength coming out of our communications Segment and then some of the improvement we're seeing in industrial has helped offset some of the Pricing lag that we get in the automotive and overall transportation business, but we're pretty pleased with The diversity of the portfolio and the ability to be able to withstand these volatile environments. Part of the answer to your question though is the timing on when price increases go into effect. Within transportation specifically, you're dealing with a lot of automotive customers and there's a lag Between when we see the price increases go in relative to when we see the impact of inflation. And I think it's important for 1st, all to remember that where we operate in the world, inflation looks very different.

Speaker 4

In some cases, it has worsened, including in Europe, where energy prices So continue to be a pretty significant headwind. So we are offsetting about 2 thirds of that inflationary pressure with price, which as you know well, Moving into positive prices, it was a big move coming out of COVID here, but it does still We can only cover about 2 thirds of it. It still does require us to make up the difference through either productivity initiatives and then obviously what we've been undertaking With some of the longer term restructuring activities. Within the quarter, I think it'd be fair to say transportation also felt a little bit of the impact from China, Just the inefficiencies of not shipping much for 2 months and then catching it all up in the final month of the quarter, that did have an impact. And as we move forward, I think We'll continue to focus in on where we stand from our ability to be able to pass on price.

Speaker 4

But Overall, we're feeling good in where we stand. So with that, hopefully that answers Your questions. Thanks.

Speaker 1

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

Operator

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

Speaker 7

Yes. Good morning and thank you for taking the question. So we need to better understand the FX impacts and From a couple of dimensions, potentially. So first, you spoke to some of the translational impacts, but are you seeing any change in Actual business conditions and are any of the international companies potentially be more aggressive with quoting activity given Some of the changes in currencies. And then specifically to the P and L, I was hoping you could maybe speak a little bit more specifically to 4Q sequential EPS.

Speaker 7

Heath, I think you said $70,000,000 on revenue quarter on quarter. Could you speak to the EPS impact? Thanks.

Speaker 4

Sure. Mark, this is Heath. As I said on the call, it's we sat here 90 days ago, I gave a number or range For the full year FX impact, I think this is between $400,000,000 $500,000,000 and that has stepped up by a couple $250,000,000 for Full year now to about $700,000,000 and about 75% of that has been in the second half of our fiscal year that we're in the middle of right now. So, it does flow through when we give that's the translational impact. The overall EPS impact from all that's about $0.17 for the full year FY 22.

Speaker 4

So it is meaningful to us. In the Q4, we expect That number to be year over year about $275,000,000 so incrementally worse than what we saw in the Q3. And as we look into the first We look into FY 'twenty three. Obviously, we'll provide more guide here next quarter. But if we just snapped a line in the sand right now with where various currencies are, it would be about a $300,000,000 headwind In FY 'twenty three for us, most of which would be in the first half of our fiscal year.

Speaker 4

So there are some numbers out actually just to try to frame up What we're seeing out there now your question on the competitive landscape is we really haven't seen a whole lot difference In that yet, we're keeping an eye on it. But for the most part, we haven't seen anything change considerably in terms of how Competitors are treating each other or along those lines. And listen, we're not economists. We're not going to predict Where the dollar is going to go relative to these other currencies that we do transact in, but we feel pretty good about our balance position globally.

Speaker 1

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

Operator

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

Speaker 6

Hey, good morning. This is Robert Jamieson in for Joe. Just wanted to pivot quickly and ask about the buyback Tivity, it looks like you guys are running about 2x what you did last year

Speaker 8

at this time. Just wondering if there's any changes

Speaker 6

to your capital allocation strategy? Rob, this is Heath.

Speaker 4

I'll take this question. Listen, long term, our strategy is unchanged, Right. So you think about it over a cycle. We still think about 2 thirds of our free cash flow being returned to shareholders in the in the form of buyback and dividends and about 1 third being used for M and A. However, there's we've always qualified that With there'll be times when we might deploy more into M and A.

Speaker 4

There'll be times when we might deploy more through buybacks. And that kind of takes into consideration market dynamics, where we're trading, the value of acquisitions out there relative to our value And weighing everything through a strategic lens as well. So we have the good fortune that we have a very strong balance sheet And that has allowed us to play offense in the near term here. It's allowed us to play offense in the sense that we were able to make some strategic inventory builds And flex our working capital to make sure we are taking care of our customers. That's not letting ourselves off the hook.

Speaker 4

We will start working that back down Now that we're seeing a little bit in certain markets, a little bit more visibility allows us to plan in our factories. But we've been able to flex with that. We've been able to flex obviously using our free cash flow For buybacks as well, but I would not consider this a permanent change, but more of an opportunity to Create value for our shareholders.

Speaker 2

Okay. Thank you, Rob.

Speaker 1

We have the next question, please.

Operator

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

Speaker 3

Yes. Good morning, everyone. So I guess I have a question and a clarification.

Operator

Terrence, the question is

Speaker 3

for you. As we think about beyond the September quarter, I think there's a lot of concern around What 'twenty three could look like, given all the macro worries that are out there. Can you perhaps just maybe talk about the cross codes that you see at TE as it relates to 'twenty three Across the segments would be helpful, I think, to just level set things like content growth and how you see that stacking up next year. And then Heath, if you could just clarify, I hold your discussion On margins, maybe I don't appreciate this enough yet. Why are margins going down in September quarter sequentially, I think some of these headwinds you talked about should start to alleviate.

Speaker 3

So maybe just talk about the margin puts and takes as well for September. Thank you.

Speaker 2

Thanks, Mehta. Let me get into the first half of your question. And as you know, we've been guiding a quarter out. So anything We'll give you more about next year, but I'll give you some initial thoughts here and then we'll tighten them up in 90 days. The transportation back to an earlier question I had, content feel very good about.

Speaker 2

And You can all see the OEM programs that are coming out on electric vehicles. It isn't 1 or 2 OEMs in the world. It's every OEM in the world that's coming out with electric vehicles that the content momentum that we've had, we continue to see that And probably being closer to the higher end of the range that we've talked about in the 4% to 6%. But that's not only in automotive, that's also in commercial And our commercial transportation team has been driving a lot of content, so I think you can have a good content there. And let's face it, this year in commercial In 2022, China was rough.

Speaker 2

China drove the entire global market to contract this year, But our team grew. And I do think as you think about some of the stimulus China is doing around infrastructure As well as what they're doing around auto stimulus as they're coming out of COVID, I do think there's upside opportunity versus production environment in both of those markets that I said earlier. And certainly, that China stimulus is important because it's one of the most The bigger market in the U. S. As well as Europe.

Speaker 2

In Industrial, I would tell you, Feel good about the CapEx trends. Feel very good about the renewable positioning we've done in Energy, and you saw our 17% growth here. This quarter in energy, I think you're going to continue to see that momentum because they're tied to good trends. And then Comair and Medical, I know I Talk about it. They're growing again.

Speaker 2

But in Comair, we're still only at twothree of what we were pre COVID. And while single aisle has improved, There's double aisle opportunity. That's even more content for us in a single aisle aircraft. So the content is true there and it's really about How does the large airframers continue to ramp production as it gets in there? When you look at our communications segment, I think it's going to be probably a tale of 2 cities.

Speaker 2

The appliance market we talked to you about, we expect that to moderate next year, But offsetting that will be cloud CapEx. And the question, where does cloud CapEx go after it was up 20% this year, We do expect cloud CapEx growth next year. We just have to see where our customers really put it at. I'm not sure it will be a 20%, But I still believe it will be growth. So there's a bunch of moving pieces out there.

Speaker 2

But I would tell you, when we look at the order trends, We also look at the content growth that you've seen in our results, plus the backdrop of where we play. It still feels Very constructive as we go into 'twenty three. And as I said, when we get on our next quarter call, we'll add More color versus what we're seeing. So, Hamed, why don't you take

Speaker 4

the second piece of Amit's question? Sure. Amit, your question was relative to implied Margins for Q4, as you know, we did not guide a margin number. So if you're backing into a margin number relative to the sales and the EPS, I think we want to take into consideration the tax rate is going to be a point higher As we guided in the Q4. So we're not seeing a dramatic fall off in margins.

Speaker 4

But if you're on the fringes, if you will, keep in mind a couple of things as we signal. We do expect our Communications segment to be a little bit lower revenue levels in the 4th quarter just because Some of the appliance pieces that Terrence just talked about, that has a little bit of a mix impact. There's no

Speaker 2

change in our assumptions around this inflation and price.

Speaker 4

Go get, when we're around this inflation and price, go get when we're only covering 2 thirds. And then again, on the fringes, We're going to be working out some inventory in the quarter and that's going to have a little bit of impact as we work through that count. But it's not something that we see Fine, materially at all, if any.

Speaker 1

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

Operator

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

Speaker 9

Great. Thanks for taking my question. Terence, if we zoom out and don't really focus on any particular end market or segment, just look at the overall revenue performance and overall bookings, this Sort of feels like the elusive soft landing. We're still seeing good revenue growth, but the orders are Backing off these very elevated levels that we've experienced in recent quarters. Is that the way you all see it?

Speaker 9

And If that's the right characterization, how many more quarters of this sort

Speaker 8

of performance do you anticipate?

Speaker 9

Do you think that This is going to continue to play out and we'll continue to see perhaps a moderation of orders, but sort of a burning of the backlog and revenue growth still Sort of at good levels?

Speaker 2

Yes. Well, thanks for the question. And I guess, I know we spoke to many about it. Yes. When we think about our business and the lead time for our product, let's put things into perspective about our lead times.

Speaker 2

For an average product, you might be 6 to 12 weeks. So I do want to frame, when you look at TE and you think about an average Lead time, you're 6 to 12 weeks. It's not some of the lead times you hear from other product categories that you have. So there's an element here of when we were talking about book to bill of 1.20, We always said there will come a time that as markets become more normalized, we would expect our book to bill to reflect more Normal patterns, then a 1.2 book to bill. So when I look at it and I think about transportation, Getting closer to a one, we expected to get to certainly as we work on backlog, like you saw in communications, We got a lot of backlog.

Speaker 2

We have over $1,000,000,000 of backlog in communications. Customers, if they feel good with that backlog, they're not Place more orders, you're going to want to work that off. And we look for pushes and cancellations. Are people pushing out orders? Are they canceling orders?

Speaker 2

We are not seeing any major trends and pushes and cancellations. So with the indicators that we're looking at, So that, hey, while we have some markets in transition like appliance that we've been highlighting to you, We also still have markets that are still trying to catch up like commercial aerospace. So I do think it's an environment where not everything is going up to the And growing. And we just have to realize, if a customer is concerned about the macro, they're probably going to get a little bit more conservative and say, hey, let me work off a little bit of So I think you're going to continue to see book to bills be getting more normalized in an environment like we have. But certainly, we have some markets where customers are concerned about supply chain volatility.

Speaker 2

And like we talked about in the Industrial We're still at a 1.16 book to bill, which is a very strong book to bill, and that means we're still building backlog.

Speaker 1

Okay. Thank you, Will. We have next question, please.

Operator

Your next question comes from Samik Chatterjee with JPMorgan. Your line is open.

Speaker 10

Hi, this is MP on for Samik Chatterjee from JPMorgan. Thank you for taking my question. So I just wanted to ask regarding the order trends in industrial like you are seeing some of your peers downgrading their expectations for the growth In this particular sector, additionally, the global PMIs are also down relatively compared to the starting of the year. What exactly is driving like Strong order growth for you in this particular sector and as you said that you see them accelerating as well.

Speaker 2

Yes. When I look at our Thank you for the question. When we look at our Industrial Business Unit, it also comes into the backlog of our customers. If you look at our customers that are all The robot manufacturers of the world, certainly the factory automation, and you even go back to semi capacity be put in, Electric vehicle battery capacity being put in, other automation programs being put in, they're the drivers of it. So you have to look at the capital spending and the backlog of the projects continues to be very strong.

Speaker 2

And that's creating backlog for our customers of the world, whether they're in Asia, whether they're in Europe, whether they're here. And what's nice is we're very globally Lloyd in that business unit and orders continue to be very strong as people are trying to make sure they can fulfill their backlog. And we've really positioned well in that space, and you've seen that outperformance consistently over the past year and a half.

Speaker 1

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

Operator

Your next question comes from Matt Sheerin with Stifel. Your line is open.

Speaker 11

Yes. Thanks. Good morning, everyone. Hi. Terry, I was hoping to get your take on inventory Picture at your customers.

Speaker 11

Obviously, with longer lead times, there is ordering and perhaps Double ordering even of your products, which we don't typically see with interconnects. But are you getting a sense of any build, Particularly in the industrial markets where you have a lot of distribution exposure, we're seeing lots of inventory at EMS and the OEMs and at some point that's all going to give And we're going to see a correction. And I'm just wondering, are you seeing that? Are you expecting that at some point?

Speaker 2

Well, I think the thing is, First off, being people have been trying to make sure you're not going to, want to hold up manufacturing of an end product for a connector. If you're waiting for a semiconductor, people will want to make sure they have the interconnects, but certainly the semiconductor being the brain and we're a little bit more like the arms and the legs. But when you look at it and you take distribution to what you said, distribution inventory is still Not back to where we would expect it to be. It's still probably 15 days light on a term perspective of Where it was pre COVID, so we continue to monitor that inventory position. And that's an important thing to watch to make sure that the distribution channel does not get heavy from a day's perspective.

Speaker 2

So feel good that they're still in a good spot. When you get into where our product goes everywhere in the world, We're not going to know every little pocket of inventory, but it's something that if lead times Continue to get better, and I wouldn't tell you they have gotten better yet. They're stable, but they're not better. You would expect There might be a little bit of an air pocket, but we're not at that point yet.

Speaker 1

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

Operator

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

Speaker 12

Thanks. Good morning, Terrence, Heath, Sujal.

Speaker 2

Hey, good morning.

Speaker 12

I had a question about how you're viewing market share in the electric Vehicle space, curious if you're able to kind of sight or see share gain there or if the market is still too formative?

Speaker 2

No. When you look at that, and I think you have to start with we have a very strong position already. And as we say, we're on essentially every car in the planet already. So I think our market share, our strong position we already have That has been a combustion engine. As we bring the technology and I know we shared content elements of how you look at an electric vehicle, it's about 2x what we have.

Speaker 2

But then you also carry over what we do on a low voltage architecture that when you add the high voltage motors in it, Basically, it's additive. So when you look at it from a market share, I feel very good about the programs we're running. What's great is It's as global as our current position. We want to sit there and make sure we're globally positioned. And it's pretty similar To what we have and what we had in our historical market share.

Speaker 1

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

Operator

Your next question comes from Haraj Patel with Wolfe Research. Your line is open.

Speaker 13

Hey, thanks so much. Just wanted to quickly understand, how to think about the interplay between order activity and backlog. For example, if you're seeing some segments like transportation now in

Speaker 8

a more normal book to bill, but you also mentioned that the backlog is still growing In those segments, is the right way to think about that potentially the order activity would moderate as those customers try to work down That backlog, I'm just trying to understand how we should be interpreting those going forward.

Speaker 2

So when you look at it, book to bill of 1 basically means you're not building So I think the one thing when we look at book to bills, please remember there's 2 numbers in a book to bill equation, The order number and then obviously the revenue number and you have to realize we have brought up our output By the growth that we talked about. So the bill has also gone up. But when you look at it, similar to what we talked about in communications, If the backlog is so strong, you can have a book bill below 1 because the customers feel they are scheduled out Over a couple of quarters, could be up to 3 quarters in our case, where they say, hey, guess what, I feel good where I'm primed in the system, And you could run below 1 a little bit. So they're just key factors of how it works. And I think you have to keep in the mindset, I'll go back to what I said today.

Speaker 2

When we have an average lead time of 6 to 12 weeks, let's say, we aren't somebody that has backlog that goes out years. That is not our business. Our backlog typically is within the next 9 months.

Speaker 1

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

Operator

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

Speaker 8

Thank you. I know it's just kind of an accounting thing with the extra week, but I know that there's also a year end thing, whether it be Stock vesting, merit increases, but also in your fiscal Q4, a lot of the OEMs do Production change over years and kind of close for annual vacation and switch over model years and such. So I know you gave some commentary in your slides on the Q4 impact. But I'm just wondering, is it more complicated than just Adding 1 extra week of sales and EPS due to some of the things I mentioned. And importantly though, for setting up expectations for Q1, I know it's early, but do we just remove that exact same amount in Q1?

Speaker 8

Or is it kind of nonlinear? And I expected it's a lot more It's complicated than what people just may initially think, but I think it's important so people level set and don't get ahead of themselves For extrapolating that going forward, so any additional clarity around that on revenues and EPS would be great for the extra week.

Speaker 2

Thanks, Jim. And good to hear from you. I'll let Heath

Speaker 4

Thanks, Terrence. Jim, I'm sure you remember that we went through this in the fall of 2016 as well, right, which is the last time we had the extra week. And so this is a convention that does happen every 5 to 6 years based on When we the true up of our fiscal calendar, where we end up with an extra week. So if you think about it, it's from a fiscal year perspective, operationally, nothing changes, right? So there's nothing changes relative To a cut over into our October, which will be the 1st month of FY2023, Nothing changes with employee schedules and everything else.

Speaker 4

It really is basically a mechanism that trues up the calendar Every 5 to 6 years. It does provide as we did here, we gave our best guesstimate of what that extra week will Provide which is about $250,000,000 in revenue and about $0.10 of EPS. What will happen and when we get our 4th quarter results and our Q1 guide Here in about 90 days, we will tighten up that estimate. So we'll give you what it what we can calculate it more Appropriately and more accurately at that time. And then obviously, as we move into the Q1, Q1, we'll be back to Having 13 weeks and we'll move forward with that way.

Speaker 4

So from a Q4 to Q1 compare, there is an extra week in Q4 versus Q1. We're estimating that to be about $250,000,000 and about $0.10 of EPS. But we'll tighten all that up and be very transparent As we close the books here in about 90 days. So I hope that answers your question, but It's some fun stuff we work through every 5 to 6 years with this fiscal calendar.

Speaker 1

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

Operator

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

Speaker 6

Good morning. Hey, good morning. Hey, good morning. Hey. I heard all the comments on margins this morning.

Speaker 6

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

Speaker 4

Thanks, Steve. This is Heath. Listen, I know the question in our stated business model, Right. We've said this segment, should be in the high teens operating margins, and I'm acutely aware that we've been running significantly higher than that, Particularly over the past couple of years. I think what's important here is to step back a little bit and say, This was a journey in this segment to get it to where it is today, right?

Speaker 4

There was a lot of if you go back several years, There was about $1,000,000,000 of consumer related products that we walked away from and There was a tremendous amount of restructuring to get this business where it is today. And what that shows is when you get that operating footprint right And then you get these levels of volume that we're seeing out of both appliances as well as data and devices. We can kick out these kinds of margins. There's nothing artificial in these margins. We have been aggressive on price as you would expect.

Speaker 4

And in some cases, we are able to pass through price In both industrial and in communications, a bit more efficiently because a bigger chunk of those businesses go through channel partners. And those price increases can go on a little bit more rapidly and take effect more quickly versus transportation that is a renegotiation OEM by OEM. So there is some price piece. There's no doubt about that. And we'll continue to keep our foot pressed Down on those elements to help cover.

Speaker 4

We're not we're just trying to cover where we stand from an inflationary pressure environment. But when we do see appliance moderate, right, we've been running about $1,000,000,000 annual run rate in appliances. And if that moderates down Some element some amount, we do expect that to have a little bit of pressure on the margin front. That doesn't mean we see it collapsing. And we'll give more color as we're more comfortable with that here in this fall.

Speaker 4

But right now at these volume levels, This would be the margin you would expect.

Speaker 1

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

Operator

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

Speaker 14

Thanks so much. Can you give us some color on what your customers are thinking in Europe in light of the energy issues there? Like ironically, one of the things we've heard is In Transportation Industrial, some of those players may try to produce as much as possible this quarter to get ahead of what they think might be potential larger issues Later in the winter, I guess, as long as supply chain allows them to do so. Are you seeing any evidence of that? And then related, I do think you have some facilities in Germany.

Speaker 14

So how directly impacted would you be by gas shortages?

Speaker 2

Yes. Good question. And I would say this is real time. And we're staying close with our So I would not say there is one size fits all as they deal with it. So the key element for us is we got to stay close to our customers on it.

Speaker 2

We do have a team that's working at real time. And this is a real time issue to say, hey, if output of our customers were impacted And we do have some factories in Europe primarily supporting the automotive industry. We would have impacts as well. So It's a real time situation, and but I would not assume it's one size fits all across Europe. Okay.

Speaker 1

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

Operator

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

Speaker 15

Good morning. Heath, just hoping you could help us unpack the margin in Industrial this quarter. It's a new high watermark. If we look Bigger picture and there was a nice step up sequentially as well. Last time

Operator

we saw this kind of

Speaker 15

step up was in the Q3 of last year and that margin upside proved to be Pretty sticky on a go forward basis. So just hoping you could expand on what's going on under the surface in that business this quarter, especially as it pertains

Speaker 4

Sure. Thanks, Luke. Listen, we've been very public going back almost 5 years now on this march Towards margin improvement in this segment, right? And it involved a lot of restructuring activity. We talked about at the time, this is going back when we started this journey of taking over 20 facilities offline, Consolidating those into lower cost locations where we already had capabilities and capacity.

Speaker 4

And I would say we're 2 thirds the way through that at this point. Certainly, we did not anticipate COVID and some of the other and the bounce back and so forth That we've had to adjust the playbook a little bit on timing, but the overall strategy is unchanged and a lot of it is around Rooftop consolidations and so forth. And we've been more aggressive in this segment with acquisitions, which also Give opportunity to us to further right size and realize synergies by Integrating those into existing facilities that we already have. So in most recently, the Ernie acquisition Came in and we see a real margin opportunity there within that business, which is in our Industrial Equipment A portion of the overall segment. Having said all that, there's still pieces Of the segment that are underperforming from a margin perspective and maybe and largely that's due to volume, right?

Speaker 4

Terrence talked about medical and Our commercial air business, which is inside our Aerospace and Defense business unit, those are far from getting back To normalize the volume levels and both of those opportunities avail opportunities for us to continue to see margin expansion In addition to some of the restructuring activity. So, hey, we're pleased with the results this quarter. In any one quarter, there can be noise That just swings your margins a point or so either direction, but we're pleased with the results. We're pleased with the trajectory Of where the cost structure is in this business. Obviously, as I mentioned in the previous question, we're able to get more pricing in this segment than we have And transportation, so there's a lot of good things going here.

Speaker 4

And with the recovery of medical and commercial air, We feel like there's still legs to go.

Speaker 1

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

Operator

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

Speaker 16

Yes, thanks and good morning. Two clarification questions from me. One is, in auto, you posted 9% outgrowth versus production. But I just wonder, was there Any inventory build in the June quarter last year that would suggest that your outgrowth was even stronger? And then the second question, a clarification, I think it was asked, But what is the FX EPS impact sequentially?

Speaker 16

I think I heard revenue impact $70,000,000 to $75,000,000 sequentially, but what is the FX The EPS impact sequentially. Thank you.

Speaker 2

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

Speaker 4

Yes. Nikolay, I apologize If we didn't provide that, the sequential impact we are on FX, we are estimating to be it's about $70,000,000 revenue and about $0.05 of EPS sequentially.

Speaker 2

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

Speaker 1

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

Operator

Your next question comes from William Stein with Brewer Securities, your line is open.

Speaker 9

Great. Thanks for getting me back in. I apologize if this might have already been asked, but Specifically in the transportation end market, you have a target of 20% EBIT margins. And I Understand that right now we're going through this well documented and well discussed on this call, inflationary effects that There's a timing effect of passing that on. Do you all have an expectation as to when you might approach that 20% Level again, is that like something we should think of in the next year or 2 or is that now feeling longer out in time?

Speaker 4

Thanks for the question. I'm not going to go back through. Like you said, we've discussed a lot of On the call here relative to the current situation with our ability to get price relative to inflationary pressures and the pressures that that's putting on the business. So as that equation morphs over the next year or so, we'll see how that plays out. The other thing was, if you recall, a couple of years ago, we did start particularly in our Western European footprint For transportation of taking of restructuring a couple of locations and that's well underway.

Speaker 4

In some cases, We'll see support coming out of those actions here as we get into next year. But the other thing to remember is we've talked about in our business model, right, that 20% target for transportation, that never contemplated Auto production being down in the 76,000,000, 77,000,000 units. So if you start to we start See some support there. We're getting closer to 21 +1000000 units a quarter. I think That is better opportunity for us to capitalize on not just our content growth, but also absolute volume production that we're set up to support.

Speaker 4

So I think that would have the bigger impact versus most of the other variables.

Speaker 1

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

Operator

Ladies and gentlemen, today's conference call will be available for replay beginning at 11:30 am Eastern Time today, July 27, on the Investor Relations portion of TE Connectivity's website. That will conclude the conference for

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