TE Connectivity plc (TEL) — Q2 2015 Earnings Call Transcript

Good morning and thank you for joining our conference call to discuss TE Connectivity’s second quarter results. With me today are Chairman and Chief Executive Officer, Tom Lynch and Chief Financial Officer, Bob Hau. During the course of this call, we will be providing certain forward-looking information. 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. We ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation, can be found on the Investor Relations portion of our website at te.com. To effectively set a baseline for today’s call, please keep in mind that we announced the sale of our broadband networks business last quarter and continue to expect the transaction to close by the end of the calendar year. BNS is reflected as discontinued operations and is not included in our Q2 results or guidance going forward. Note that all prepared remarks on today’s call will reflect TE continuing operations unless otherwise noted. We have provided additional slides number 13 through 17 in our earnings presentation to help reconcile the difference between previously reported results and guidance against assumptions for continuing operations. You will find this information to be helpful as we go through the call today. Finally, for participants on the Q&A portion of today’s call, I would like to remind everyone to limit themselves to one follow-up question to make sure we are able to cover all questions during the allotted time. Now, let me turn the call over to Tom for opening remarks.

Thanks and good morning everyone. Here are the key takeaways from today’s call. In Q2, we continued to deliver strong results with organic revenue growth of 6%, adjusted earnings per share of $0.02 above implied guidance for continued operations and adjusted operating margins of 16.4%. For the full year, our prior adjusted EPS guidance of $4.20 assumes $0.53 from BNS and $3.67 from continuing operations. We are holding our guidance at the $3.67 level as continued strong performance of our harsh businesses coupled with SubCom improvement is offsetting additional FX headwind. Our EPS guidance reflects 11%, adjusted EPS growth year-over-year. And as Sujal mentioned, there is a detailed reconciliation of guidance found on Page 16 of our earnings presentation. I would also like to mention a few other points: we are very well-positioned and continue to benefit from the secular trend of electronic content growth, with 80% of our revenue derived from products serving harsh environment applications. This is a theme you heard before and you will continue to hear throughout today’s call. And it’s a very important part of our strategy. Our recovering SubCom business continues to gain momentum, with over $1 billion of contracts now enforced and over $700 million of revenue expected this year. Our sensor business continues to build momentum as well with the growing design win pipeline across several market verticals. Overall, the integration of the acquisition is going well. Just a comment on market conditions: I would say they continue to be mixed compared to 90 days ago when we last spoke. Europe is up a little bit, of course off a low base; China has slowed a little bit; and the end markets in the U.S. are mixed although growth is continuing. Overall, we are seeing similar trends this last quarter. I would now like to provide some additional color on the performance of our business. As I mentioned, Q2 was another good quarter for the company operationally, and we made four important moves to strengthen the company strategically during the quarter. We announced the sale of our broadband networks business for $3 billion in January and continue to expect the transaction to close by the end of this calendar year. As a result of this transaction, 90% of our revenue is now focused on the attractive and growing connectivity and sensor markets. These markets have solid underlying growth trends due to the increasing demand for more electronics as the world becomes safer, greener, and more connected. With our unmatched portfolio of connectivity and sensors, TE is well-positioned in providing the key building blocks for the connected world. As I mentioned, 80% of our revenue is focused on providing solutions for harsh environment applications that demand the highest quality and reliability performance, which has long been our strong suit. This capability is not easily replicated and we believe that TE’s ability to provide solutions for harsh environments will remain a strong differentiator and growth driver as we move forward. In February, we announced the purchase of AdvancedCath, a company focused on applications serving the medical and healthcare markets. The combination of AdvancedCath and our broad range of sensor and connectivity technologies puts us in a very good position to capitalize on opportunities in the high growth, high margin interventional applications in this market. This acquisition is accretive to our industrial segment growth rate and operating margins. This is a good example of where having a broad range of connectivity in sensors, with fine wire capability, molding, and stamping manufacturing capability enables us to provide a broader set of solutions for our customers. In March, along with the planned divestiture of BNS, we organized into three segments: Transportation, Industrial, and Communications. The Transportation and Industrial segments remain exactly the same in terms of business composition and Communications are now made up of appliances, SubCom, and Data and Devices. Data and Devices reflects the combination of consumer devices and DataComm into a single business. This combination improves our ability to win in these dynamic markets. These markets are converging and combining the unique strengths of each business will strengthen our competitive position and profitability and potential for growth in these markets. In March, we also announced the appointment of Terrence Curtin to the newly created position of company President. Terrence has been an important leader in our transformation as CFO and most recently President of our Industrial Solutions segment. In his expanded role as President of TE, Terrence will focus on accelerating our performance across our harsh connectivity and sensor businesses by driving growth in TEOA across the business. Please turn to Slide 3 for a summary of Q2 results and our guidance. As I mentioned, we delivered strong results for Q2 with adjusted EPS of $0.91, $0.02 above the midpoint of guidance and sales of $3.1 billion, growing 4% year-over-year and up 6% organically. Currency translation rates impacted Q2 by $246 million in revenue and $0.09 in EPS year-over-year, negatively impacting Q2. The continued strong performance of our harsh environment business is coupled with improvements in SubCom more than offset the FX headwind compared to the prior year. Excluding the impact of currency exchange rates, adjusted EPS would have improved by 16%. During the quarter, we returned $261 million to shareholders. Total company orders were $3 billion flat year-over-year; excluding SubCom orders, orders were up 1%. The book-to-bill excluding SubCom was 1.03%. As I mentioned earlier, I am pleased with the momentum in our sensor business. We expect strong growth this year and are adding resources to support the significant increase in customer RFPs. We are seeing an increasing number of opportunities to integrate sensors with our other products and provide our customers with innovative, highly reliable, and cost-effective solutions. We intend to aggressively build this business with inorganic and organic investment and we believe our unmatched customer-facing and engineering resources are significant assets for TE. Our TEOA program continues to enhance margin and drive higher profitability. Adjusted gross margins were up 70 basis points year-over-year and adjusted operating margins expanded to 16.4%, up 50 basis points versus the prior year. Please turn to Slide 4. As I mentioned earlier, we continue to hold our full-year guidance despite increasing FX headwinds. Our full-year EPS outlook is unchanged from our prior guidance for continuing operations, with harsh environment business strength, contribution from strategic acquisitions, and a leading position in the recovering SubCom market offsetting additional FX headwinds versus our previous yield. We expect full-year sales of $12.5 billion, up 4% from the prior year and 6% organically. We expect adjusted operating margins to exceed 16%, with adjusted EPS in the range of $3.60 to $3.74, up 11% at the midpoint. With the cumulative move of the dollar versus world currencies during the last six months or so, 2015 FX headwinds are now approximately $1 billion in revenue and $0.38 in EPS versus last year. For our full year, where now for the impact of FX, we would be generating 13% revenue growth and 22% adjusted EPS growth year-over-year, a strong financial performance by any measure. Now, I will turn it over to Bob to cover segment results and then I will wrap it up in a little while.

Thanks, Tom. Good morning, everyone. Please turn to Slide 5 for Transportation Solutions. Our revenue grew 3% organically in the quarter in line with our expectations. Our automotive business grew 4% organically, while global vehicle production was up about 1%. We continue to outgrow auto production volumes due to content growth trends and share gains. Our Commercial Transportation business declined slightly in Q2 as expected, driven by slowing growth in the heavy truck market and continued weakness in the off-road equipment market. In sensors, we continue to gain momentum with an expanding design win funnel across transportation and other market verticals. We continue to expect strong growth in sensors due to our unique combination of technology, resources, and broad, deep customer engagements. Our total transportation adjusted operating income was $333 million in Q2, down 1% year-over-year as expected, the strong operational performance offset by FX. We continue to invest in sensors and support a growing pipeline of opportunities. In automotive and commercial transportation, adjusted operating margin expanded 60 basis points year-over-year in Q2 driven by additional volume and operational execution. Looking forward, we expect another good quarter in Q3, with actual sales growth in the low single-digits and organic growth in the mid single-digits. Please turn to Slide 6. Our Industrial Solutions segment performed well in Q2, growing 5% organically, representing the seventh consecutive quarter of year-over-year growth for this segment. Industrial equipment was up 6% organically, with strong growth in all regions. In our Aerospace, Defense, Oil, and Gas business, 6% organic growth was driven by continued strength in commercial aerospace, which more than offset declines in oil and gas. Going forward, we would expect continued strength in commercial aerospace to offset weakness in our oil and gas business. In our energy business, we saw 4% organic growth, with growth in Asia and North America partially offset by declines in Europe. We also completed the acquisition of AdvancedCath, increasing our opportunities in the high-growth medical interventional market. AdvancedCath is now part of our industrial equipment business. Adjusted operating income was $112 million in Q2, up 5% year-over-year, with the 50 basis points expansion in adjusted operating margins due to organic growth and TEOA initiatives. For Q3, we expect low single-digit organic growth with similar market trends as in Q2. Please turn to Slide 7. A newly created Communications Solutions segment grew 16% year-over-year on an organic basis, driven by our strong position in the recovering SubCom market and a continued strong performance in our market-leading appliances business. This more than offset the planned declines in our data and devices business, where we continue our strategy of exiting low-margin products in this business. Adjusted operating income was $61 million, up 126% year-over-year, and operating margin doubled to 9% from 4.5% a year ago. We expect to continue to drive further operating margin improvement in this segment. Heading into Q3, we expect the actual revenue to grow mid-teens and high-teens on an organic basis driven by a new SubCom program coming into force. The new AE Connect program, which is scheduled to be ready for service in December 2015, is the latest transatlantic subsea fiber optic cable system connecting North America to Europe.

Thanks Bob. Please turn to Slide 10 and I will cover our outlook and then go through the outlook in more details in the following slides. We expect to deliver another solid quarter in Q3, with revenue of $3.13 billion to $3.23 billion, up 3% on an actual basis and 7% organically year-over-year at the midpoint. We expect adjusted EPS of $0.85 to $0.89, an increase of flat to 5% year-over-year. As Bob and I have been mentioning throughout this call, our Q3 outlook does include a significant headwind from currency exchange rates, which are negatively affecting our guidance by approximately $330 million in revenue and $0.13 per share in EPS versus the prior year. Just on a constant currency basis, it would be up about 18% in EPS year-over-year. Our third-quarter performance will continue to be driven by the strong performance of our harsh environment businesses and building momentum in SubCom, as well as contributions from our recent acquisitions in sensors and industrial. This is more than offsetting the FX headwind. Please turn to Slide 11. For the full year, we now expect revenue of $12.3 billion to $12.7 billion, up 4% versus the prior year and reflecting 6% organic growth. Our adjusted EPS guidance range is $3.60 to $3.74, representing year-over-year growth of 11% at midpoint. Note that the total impact of currency exchange rates is now approximately $1 billion versus the prior year and $0.38 in EPS. We have a number of catalysts for growth: strong secular trend of increasing electronic content, especially in harsh applications; our expansion into the high-growth sensor market; and the growing SubCom business. To provide a baseline for the performance of our business, adjusted EPS would be growing by 22% year-over-year were it not for the negative impact of the stronger dollar relative to other currencies. Now a few final comments before we open it up for Q&A. The company is performing well in a relatively still slow-growth world and we are extremely well positioned in a world of increasing connectivity, which demands more sensors and more connectors. Our harsh environment strategy is paying off. 80% of our revenues are derived from products designed for harsh environment applications. This requires innovation and the highest quality and reliability. These applications are sticky. This collection of business has generated margin above our current 16% adjusted operating margin run rate. We have now grown harsh environment revenue to 80% from about 50% of our portfolio over the last five years. Our inorganic and organic growth investments will continue to focus on harsh applications. Our sensor business is building momentum and we are adding resources to support the significant increase in customer RFPs. We see an increasing number of opportunities to integrate sensors with our other products and provide our customers with innovative, highly reliable, cost-effective solutions. We really feel our unmatched customer-facing and engineering resources are a significant asset for the company. We intend to aggressively build this business with inorganic and organic investments. The BNS divestiture is going well and we will return the majority of the proceeds to shareholders. Bob mentioned we have restructured our data and devices business to improve our focus on competitive position and reduce costs. I expect this business to be a contributor to EPS growth in fiscal 2016. Our SubCom business is continuing to build momentum. The market appears to be in the early stages of an up-cycle and we continue to win a majority of the key awards. We now have pretty good visibility through fiscal 2016 and expect SubCom to improve our performance at least this year and next. Our strong cash flow and balance sheet enables us to consistently return two-thirds of our free cash flow to shareholders in the form of dividends and share repurchases and pursue strategic acquisitions to strengthen our leadership position. TE has a strong portfolio of business; it’s probably the strongest we have ever had with strong secular growth drivers that should enable us to grow 6% plus organically and to 3% plus GDP world. We will continue to grow our adjusted operating margins building on the 16% level we will deliver this year and continue to generate free cash flow at the 10% of revenue level. In summary, we have a lot of leverage to grow profitability and cash flow, and I have never felt better about the company. Now let’s open it up for questions.

Good morning. Thank you for taking my question. So I think the prior EPS guidance midpoint was $4.20; the new guidance is $3.67. I think it’s clear the biggest driver of that reset is the BNS divestiture, but can you walk us through the components that are driving this change in the discontinued – or rather in the continuing operations EPS guidance?

Yes. Well, good morning. Thanks. This is Bob. So the prior guidance that we gave many days ago, $4.20, included the broadband networks business. As you recall, the morning of our earnings release, we closed that agreement to sell the business; the business is not yet – the transaction is not yet closed. But with that announcement, that business now moves into discontinued operations. At the end of March, that will be around March 23. We issued an 8-K to recast prior periods’ earnings and actually going back nine quarters. We went a little bit further than required to ensure to give the full color to our investor base. What you saw in that 8-K release was last year, 2014, on a full-year basis, broadband networks contributed about $0.48 to our earnings. So adjusting last year’s results previously reported would have been $3.79, backing up the $0.48 of broadband networks; the recasted 2014 actual is now $3.31. When you compare that to the $4.20, the prior guidance, BNS had $0.53 of earnings embedded as part of that $4.20. So you take the $4.20, you back out the $0.53, and you get the $3.67. The change in the number is completely BNS. Essentially, $3.67 is the new $4.20 and a similar sort of number on a continuing operations basis. That growth from $0.48 to $0.53 really is comprised of a couple of things. Number one, as you may recall, we did a number of restructuring actions last year to take costs out of the business. A good portion of that was directed at the broadband networks organization, and so we expected to see operating income, operating margin improve nicely in that business, 2014 and 2015. Additionally, we did have some modest organic growth on a year-over-year basis. So net-net, the BNS contribution was going about 10% on an EPS basis, roughly in line with what the total company was, and it’s going to be driven by low double-digits – I mean single-digits, modest organic growth as well as the benefits of restructuring and general productivity.

Okay. That helps. So we are now through this earnings reset; of course, we are expecting earnings to grow again on an all-in basis, contemplating the buyback that we would expect following the close of the BNS sale. I guess, despite the fact that you didn’t guide to it, I would have expected to see the buyback accelerated at least a little in the quarter, and I wonder if perhaps you are planning more acquisitions to replace the divested BNS or to replace part of it anyway. You have talked about looking both organically and inorganically in the sensor area. I am wondering how prominent this is in your plans from now till the end of the year and on an ongoing basis?

Yes. So – I will cover the buyback and then Tom can touch a little bit on the M&A plans. In terms of the buyback, again, 90 days ago when we announced the transaction, we indicated that we expect to receive $3 billion in proceeds from the transaction; the majority of that will be used to buy back shares. But we would not be doing that in advance of closing the transaction. So we have not accelerated share buyback in the current quarter, nor do we expect to until that transaction closes, which currently has been and remains expected to close by the end of the calendar year. Once we receive that cash, we will begin the buyback. As we indicated in the past, we continue to expect that share buyback will help to largely offset the $0.53 of dilution once that buyback is completed, and net-net the transaction will be neutral approximately one year after closing. That’s the benefit of the share buyback being fully implemented, as well as working through some shared costs. If you think about the TE business model, we have things like our IT procurement, HR finance-type organizations, working through a shared services model. Essentially, this organizes the organization around some of those functions, and those costs are shared across our business. With the BNS divestiture, we obviously see some de-scaling of those shared services. Once the deal closes, we do have a transition services agreement with CommScope, which will absorb some of the shared service and once those TSAs start to unwind, we will work to offset the costs and eliminate the impact one year after closing. Roughly in order of magnitude, that shared services type cost is about $0.07 of the $0.53. You get the benefit of reduced share count on the $3 billion of the share buyback and the benefit of working through those shared services costs post-TSA unwinding, and you can get to a net neutral position on the $0.53.

On the acquisition comment or question, while we are always – our strategy as you can see is around harsh environment connectivity and sensors. As we did in the last quarter, we had the AdvancedCath and another small technology acquisition. We have a robust pipeline. It has to fit within our strategy, and similar to the sensor logic, it has to be able to leverage our scale. So, we aim to continue to identify the best fits, and if we can get them at a price that works to make acquisitions.

If I can fit in one more, please. On the sensors side, you talked quite a bit about having success in that market. You report that business in transportation, but as I recall, measurement and the other – you did another sensor acquisition; they are not exclusively transportation as I recall. Maybe you could talk about where you are seeing success in terms of combining sensors and connectors from an end-market perspective. Where do you see the bigger opportunities?

Sure. Right now, they are all – there are a couple of design wins and a lot of customer activity to prove out the concept. The most important thing is the businesses that we bought are growing slightly ahead of our assumption in the acquisition plan. The core organic growth of those businesses has been very good, and the technology breadth and depth is even better than we thought. This is now what is the catalyst for being able to walk into customers. Medical would be a good example, on the same gauge wire that we provided to the customer, now putting a very small sensor on the end of it to dramatically improve the capability, and we can do it all. We can optimize the functionality. That’s a good example. In early discussions in the industrial industry, the appliance industry, and of course automotive and in the industrial transportation industry, the good challenge we have right now is there is a lot of opportunity and prioritizing them. It’s the kind of challenge we want to have, and that’s why I mentioned and Bob mentioned that we are going to continue to add organic resources into these businesses. So far the hypothesis for bringing sensors together with connectors is playing out. We know it’s still the early part of the game, but we are very optimistic and excited about the capabilities we have.

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

Thanks a lot. Good morning guys. I guess to start off, could you just talk about the transportation segment a little bit? I think the organic growth of 3% was a little below what you have seen the last few quarters. I am curious about what you are seeing in China and Asia that you talked about that’s leading to the softness. Do you think it’s a one-quarter phenomenon, or are those headwinds going to sustain for the next few quarters as well?

Yes, Amit. A couple of comments there. One was in pretty much in line with what we expected based on what the industry was projecting as vehicle production. Last year, vehicle production was just under 5. This year, we’ve been predicting anywhere from 2 to 3 depending on when the estimates are coming out. So, no surprise there. In our case, our auto business grew 4% on 1% vehicle production. Three or four years ago, on 1% vehicle production, we would have grown 2% to 2.5%. We have had a tremendous run of design wins over the last three to five years coming out of the downturn and including the downturn. So, no surprise there. Generally, I would say the auto business is still pretty healthy. China has continued to be strong for us. We have a tremendous position in China and continue to grow solid double-digits there. We expect that to slow down a little bit, but not dramatically. Overall, still feel in line with what we expected in automotive and the production rates, like I said, kind of in line, a little bit below the historical average, but they were above the historical average last year. Looking over time, they tend to balance out over two or three years, but we are generating a lot more revenue for $1 or 1% growth in production than we have in the past.

Got it. And if I just go back to the BNS divestiture impact, if I just get this right, $0.53 impact from discontinued ops; $0.07 of that is shared services that goes away once the deal closes, or do you have to do some restructuring to negate that? And then $0.45 will be offset through buybacks. Is that kind of the right way to characterize those two buckets?

Yes, that’s essentially correct, Amit. The $0.07, some of that will be absorbed by the transaction services agreement that will kick in once the deal closes. So, you will see some quick absorption of that. Over time, as we unwind those transaction services agreements, we will work the cost down so that once those are unwound, it’s a net neutral.

Yes, I guess could you just talk about how the buyback mechanism works once the deal closes? I mean, would you have to do an ASR or something fairly quick to ensure that the neutrality holds up from the divestiture, or would you elongate that over a 12-month process?

Yes, what we have indicated is it will be one year after closing. That will encompass some time to actually execute the share buyback over a period of time.

Perfect, thanks a lot for your time.

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

Hi, guys. Good morning. I had a question and a follow up. Tom, maybe I will focus on the industrial solutions segment. I think you are expecting full year growth of low single-digits. Just wanted to get a sense of when can we expect to see slightly better top line growth for this segment? And profitability seems to be doing better than expected; can you sustain it at the levels you just reported, so both the demand environment as well as profitability? Then I have a follow-up.

Sure. Thanks, Amitabh. I would say like a lot of these businesses, particularly industrial, you kind of have to disaggregate it to make it meaningful. Commercial air is growing very nicely; the market is solid with new aircraft builds and leasing over the last five to six years significantly increased our content. That’s a nice high single-digit growth story. Industrial equipment has been growing for the last six or seven quarters now, which is nice and you kind of mid – occasionally drifting a little bit above mid single-digits, which is a healthy growth rate for that business. Oil and gas is declining now. It’s about a little under 10% of that segment; so it’s not massive, but a couple of quarters ago, it was a nice growth for us. Of course, with energy – with oil prices where they are, that’s slowed the growth down in that business. The other big piece within there is our energy business, which has gone back to – kind of a low single-digit growth business, very steady, close to company average margins, good cash flow generator, but getting hit hard by the strong dollar because about 45% of our business is in Europe. When you disaggregate it, we expect normalized – let’s say oil and gas is flat where it is now, we would expect that business to grow in the 5% to 6% range for us, because there is a lot of content growth in aircraft, military starting to grow slightly again and that had been a negative for a while. There is also content growth on the factory floor with things like Industrial 4.0 really starting to pick up momentum.

Thanks, Tom. That was helpful. And then maybe just a quick follow-up either for you or Bob, at $700 million for your subsea business, can you maybe just update us on how we should be thinking about profitability for the segment? Also, what profitability was for subsea in the March quarter?

Yes, Amitabh, it’s Bob. Our current outlook for 2014 is about $720 million in revenue. We will do low double-digit operating margin at that level. As we have indicated in the past, as we approach $1 billion in volume or in revenue on an annual basis, we have to expect that to increase to the company average margins. Right now, part of it is we are still doing ramp-ups, restarting factories and hiring folks and getting our assets fully utilized. But this year at $720 million, we will do low double-digit operating margin.

And in the March quarter?

It’s about similar.

Okay, alright. Thank you both.

Thanks Amitabh. Can we have the next question please?

Thanks. Just a couple of quick follow-up questions regarding the transportation business. In the commercial area, you talked about weakness in heavy trucking, and related to oil and gas, do you see that bottoming in the next couple of quarters or so? In terms of how it impacts your margins, my understanding that margins in that business were perhaps better than your automotive margins, so does that impact things at all? If that does get worse, could you shift resources into your passenger vehicles side or are they separate operations?

Thanks, Matt. Yes, a couple of things there. I would say what we saw in the heavy truck market is the slowdown in the growth rate in the heavy truck market and continued weakness in the off-road market. As you know, mining and agriculture, those markets have been soft. As the growth rates slow down, what you typically see is supply chain slow down a little faster. We saw that tail end in the last quarter and this quarter. We are not seeing anything that says it’s going to get any worse. I think there are good drivers in there such as the emission standards in China; for example, while truck production is down, the content for trucks in China now that they are really adopting and enforcing Euro IV standards is up more than the truck volume is down. Overall, we would see this business stay for the next couple of quarters at about the level it is now. The margins are above company average; it’s a nice margin business. There is not enough change in the business to really be thinking about redeploying; it’s kind of staying at the level it’s been. We do share within the business, so we share factories. As Bob talked about, our shared costs infrastructure for support services, we optimize that. So we have, for example, if it’s slowed in – trucks slowed in one part of the world, cars picked up, we can take advantage of that with essentially the same facility for the most part.

Okay. That’s helpful. Regarding the subsea business, you guided to $700 million plus for the year and you are looking at, I think it’s called the growth year-over-year in communications overall. Should there be a step up this quarter in subsea revenue, in sort of the mid-teens sequentially?

On a sequential basis for SubCom, I would expect some modest improvement. The new AE Connect program ramps up; we are actually doing some juggling within our factories to manage that program. We will complete that program this calendar year and probably offset some other programs. It’s a net-net, not full increase of what it is growth from our prior guidance up to that $720 million level, about a $70 million increase from prior guidance. You will see some incremental into Q3 and Q4 from that new program.

Okay, alright. Thanks a lot.

Thank you. Can we have the next question please?

Hi, good morning. Thanks for providing a lot of these bridges. My first question is just on the operational performance line on Slide 4, the $65 million lower sales, and the $0.07 increased EPS. I know you had mentioned SubCom is up more than $50 million versus your expectation; can you just provide what was dragging or what was offsetting that, and on the lower sales how you are able to get to $0.07? Is that commodity deflation or operational improvement?

You are talking about full year, Mike? I think I am correct. Some of that is subsea; some of that is accelerated restructuring. For example, related to data and devices, as we told you last quarter, we are doing significant combination efforts there that are driving costs out and continuing to drive the productivity side. We get a little lift from metals being lower in the year as our hedges roll off versus last year, but we are going to see most of that next year. It’s a combination of things and just tightening up.

Mike, the revenue decline of about, I think on that page is $55 million operationally. We get the lift from SubCom, but we have, as we talked about, continuing to work through refocusing our data and device business as well as some of that weakness in ICT offsetting that.

Okay, great. And then just a question in terms of recent European Western vehicle registrations have been pretty strong; it seems like the industry and yourselves are still looking for auto production that seems to remain pretty tepid. I am just curious what you are expecting there from the cadence. I mean eventually does the – is there an offset to that strong Western European vehicle registrations in other European regions that you are seeing, or is this just a timing issue? Eventually the production will ramp back up?

Yes. I would say if you take Europe in total, it’s gradually improving. To put it in perspective, if it stays on its current track, which would be a little under 2% total production growth, it will get back to slightly above 2012 levels. So, yes, there are more new registrations, but in certain countries, you also have the impact of Russia’s uncertainty on Eastern European and the Russian market itself, not huge, but that’s down 50%. Net-net, I think the industry estimates now are that the Europe production growth, so that’s the way we think about it. All the production of the European OEMs is going to be up high, 1% and 1.5%, 1.6% range, which is a little better than it’s been. But still, we believe there is pent-up demand there. It’s better than it has been, but it’s not robust yet.

Great. Thank you.

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

Good morning. Two questions: first to open the bridge, the increase in revenue guidance sequentially with EPS going down sequentially. On that typical type of volume increase, I would have expected that to mitigate the sequential FX headwinds. So if you can maybe help me out on why EPS is going down sequentially on higher revenues; it doesn’t look essentially like you are getting any volume leverage?

Yes. Shawn, it’s not unusual in this set of businesses in Q3, particularly our transportation business, for margin to drift down a little bit in Q3, and we aren’t expecting it to kick off. We are also seeing very low production in Q3 with a pick up because of a lot of new model launches in Q4, which means towards the end of Q3 and in Q4 we will be shipping higher content vehicles. So we have got a little bit of that. There is a more significant FX hit and that FX hit is on our European businesses. Those are – if you look at our energy, industrial equipment, and particularly our very strong European auto businesses, those are nice margin businesses. So you get a little bit of mix effect. You have the ICT business slowing down a bit. It’s more of a mix factor than anything else. Margins will stay in the ballpark, let’s say, within 50 basis points of Q2, but we are solidly in the 16% range for 16% plus for the year. So, $0.09 – $0.08 to $0.09 EPS impact in Q2, $0.13 in Q3, so it’s a variety of things depressing the earnings growth.

Got it. Thanks. I guess, to add, is there any tax rate dynamics? Because I know it ticked down a bit sequentially; do taxes rise?

Yes, the tax rate for the quarter was down nicely from first quarter. Overall, we still expect the full year to be above 23%. The first half of the year, if you put the two quarters together, was 22.5%. So net-net all are in line with about 23%. Largely the difference is the timing of the ability to release some reserves or statute limitations expiring that we have planned—just a matter of when those actually expire and when we are able to report those impacts.

Okay. And then as my follow-up, I understand, I guess, the concept of waiting until we have the $3 billion in hand for accelerating the buyback. At the same time, if everything goes as planned, your stock price should be higher exiting the year than it is now, and you have access to cheap capital if you want to borrow it. I think the euro debt issuance was at 1%. My question is on the rationale on why not accelerating the buyback if you could borrow some short-term money and do it now before the stock price rises if everything goes as planned?

Yes, I would say while we have been pretty consistent, we are not changing our answer on this because we don’t think that’s a good idea, obviously, or else we would be doing it. But fundamentally, until the deal is closed, I mean it’s on track. All government approvals are not received yet. We are getting through them; I am optimistic, but it’s not that far off. It’s really the answer.

Okay, that’s fair. Thanks, Tom.

Okay. Can we have the next question please?

Yes, thanks. On the DataComm side of the business, can you provide an update on the 25-gig product cycle in terms of what your visibility is there and then also as you start to see revenue, what are the implications for the margins in that business?

Sure, thanks Craig. I feel good about our win rate and frustrated about the actual rate of adoption. That’s been our sad story in a way for the last year. We have a nice product; customers seem to like it. They are selecting it; they are designing it in. I think the tremendous amount of change going on in that industry is just delaying the impact of new technology. We remain committed to the product line, and it’s not quite the drag it had been because for so long, heavy R&D, we are starting to see the light at the end of that tunnel. We expect next year to be shipping some of this product. But part of the nature of what’s going on in that industry is the convergence of customers, the white box effect, software-defined networks—all those things are continuing to squeeze the industry, which is why we combined the two businesses. We need to run it differently than we have in the past. I like our product line; it’s a much more focused product line and there is still more focusing to do, but our core connectivity product line is very good. We have been investing in high-speed and we think that’s going to pay off for us, but it’s taking longer for the market to adopt the higher speed solutions in any significant way than we thought.

Okay. Thanks for the color there. As a follow-up on the automotive side, particularly within sensors, understanding it’s a time process in terms of longer cycle business, the design in, but you did have an organic development underway. Now, you have some incremental technology from the MEAS side. Can you just talk about the engagements you are seeing in the automotive side and what that means mid- to longer-term in terms of the growth opportunity?

Yes. We are very pleased with the engagement. Of course, we are not generating any sales in our financials yet from measurement products that capitalize on our market presence, but there is a lot of customer engagement. It will be a couple of years before we can turn the engagements into revenue, but it’s happening. The number of engagements are happening faster than we expected. We just—it's a really, really good product line that Measurement Specialties had. We are the established customer supplier for connectivity and our own sensor base, so we have the credibility and the wherewithal to support the cost business. The auto customers have very, very strict requirements, and that was a key part of our hypothesis; our ability to capitalize on that and bring in products that otherwise might not get there is good. It’s activity right now; the activity level is high; we are excited about it. A couple of small victories that will turn into revenue, but on or ahead of track I would say. It’s a couple of years out before revenue synergies start to kick in. Importantly, the core organic revenue of the acquisitions is tracking slightly ahead of plan; so that’s also nice. Okay?

Got it. Thank you.

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

Hi, thanks. Just looking at your Transportation Solutions margins; they are starting to get near the sort of 21% level and they have been in the 21% level last year. How much more upside do you have to the Transportation Solutions margin and how much more do you think you can do with restructuring—not necessarily restructuring, but with better cost alignment?

Sure. Transportation margins are very healthy at above 20%. Our primary focus is to drive higher revenue, and that’s what’s starting to happen. As I mentioned earlier, if you look at our auto sale rate versus production rate, the sensor business is growing in the 8% to 10% rate. That’s our big opportunity. I would say within the portfolio, sensors—as we mentioned when we acquired the business—significant opportunities to move the margin up with our scale. It won’t happen overnight, but we expect the margins to move up steadily towards the core automotive connectivity margins. So, you might see it look like our total margin is moving a little bit, but within that holding the margins we have and growing the sensor margins. At 3%, 3.5% production, I would expect to deliver 30 to 50 basis points of margin improvement, everything else being equal. We have been consistently moving the margins up, but again, our focus is to drive revenue growth, and to continue to drive above mid-single-digit revenue growth into the high single-digit revenue growth in this business.

And then just following up on the growth rates, I think in the past you have talked about a 6% to 8% growth rate for this business. Is that number higher with the sensor acquisition that you have done in the sensor business, or is it still sort of 6% to 8%?

We are in that range, but I think it starts to move towards the higher end of the range. Now, sensors right now is still a little more than 10% of the business, so it doesn’t have that much leverage. But that’s going to change. Our goal is to continue to change it.

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

Thanks. Good morning. Just a few clarifications on Measurement Specialties first: are you providing sort of the EPS accretion you are getting from it in the most recent quarter and how it looks for the rest of the year? Secondly, I think what I heard, Tom, is that you are saying that you are seeing a pickup in wins around sensors, but it’s more longer-term, mainly related to auto still. Is that the right characterization? Then I had a quick follow-up. Thanks.

Yes, what my point really on the second part of the question—and I will turn it to Bob for the first part—is that designing process takes a while. You guys have the design-in where you convinced the customer to let you bid on a quote, and we are having a lot of that activity. If you win, you have got to get designed in. For these applications, even in things like appliances and on the industrial floor, it’s a couple of years typically before between design-in and revenue. It’s shorter in the consumer space, of course, but we are really very targeted in that space with our sensor business. Most of our sensor business—even the way it’s spread today—is in harsh environments. That’s what I mean; it’s kind of the three elements. There is the organic growth that’s kind of the normal MEAS and AST growth that they would have had whether we acquired them or not, we probably helped that a little bit. That’s growing at a little better rate than we thought and we bought the assumption. Then there are the sensors and leveraging our channel strength for standard products. We expect to start to see that next year. Then new design wins that we enable because we are sitting with a customer that MEAS or AST would not have had access to—that’s a couple of years out. So that’s the way I think about it.

In terms of the impact of Measurement, on a full-year basis, we expect about $0.10 in terms of EPS in the current quarter, call it $0.02 to $0.03 was what we saw in the second fiscal quarter. One important point to note between your questions and Sherri’s previously, around the operating margin: overall, our automotive and ICT margins actually grew year-over-year. We talked about that in our opening comments. With the acquisition of Measurement, that’s slightly less of the sensors business; it’s up nicely on a year-over-year basis on a pro forma basis. So seeing operating performance is actually taking the overall transportation margins down slightly. Some of that is acquisition accounting; some of that is on the beginning of sensors adding into our business. Overall, we are seeing nice margin benefits in auto and ICT.

That’s really helpful. And then just really quickly on the book-to-bill, the 1.03 ex-SubCom, that seems like a pretty positive number despite all the mix trends you pointed to. Can you just isolate what the drivers are? I guess that’s part of why the fourth quarter should be so strong?

It’s in the harsh businesses. Those businesses continue to perform well, both from I think the markets are holding up and we are performing well. Our design-ins continue to get a little bit bigger each year. So it’s really across those businesses; we had a pretty good order— a very good order month, for example, in automotive in Q2. That’s starting to line up for the model that we will start shipping into in Q4 to your point.

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

Hey guys. Sorry, just a quick follow-up on my end. Bob, I apologize if you touched on this, but can you help us understand how we go from the $0.87 to the implied $1 for fiscal Q4—the Q3 to Q4 jump on essentially flattish sales?

Yes. There are a couple of things driving that. Number 1, we are seeing some growth in our aerospace business, so we are getting some additional leverage in that. Obviously, FX continues to be a headwind. So there is some organic growth. Productivity, the benefits of restructuring in particular. In the opening comments, I talked about the restructuring charges that we will be taking actually in Q3, but also in the first half of the year. We have taken about $64 million worth of charges. We expect the full year to be around $75 million of charges. The majority of those charges are associated with data and devices and oil and gas. Particularly in the data and devices business that’s OpEx, so you get very quick payback, and we will start seeing the benefits of that in the fourth quarter. That helps to bring some nice leverage on the organic growth with lower OpEx spending.

Okay.

The other thing, Amitabh, just if you look at our auto business, because of the changeover when we start shipping into the new models, our production is actually going to be higher in Q4 than it was last year. We are going to get the benefit as a lower cost per unit. So we are getting a little bit of that, and there are a lot of new models being launched that we will be— they will actually come on the market calendar Q4, but we will be shipping for them to be built in our late Q3, but mostly through our fiscal Q4, which ends in September, and we have more content on that. That helps our margin as well.

Which is contrary to normal seasonality, right, because typically I thought...

It’s not that super seasonal anymore because China has become such a bigger part of the auto story. Now it used to be more pronounced, and they are introducing more cars quicker. That thing is starting to get tamped down. In this quarter, you have got new models for all the German OEMs launching a bunch of new cars, so there is a little bit of an unusual impact because we wouldn’t typically see that Q3 to Q4.

Got it. Thank you.

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

Thanks very much. Two questions: first one for me is actually following up on the implied outlook for the fiscal fourth quarter into September; if I am doing my math right, you get to the $1 of EPS in Q4 on that flattish revenue. I mean, it seems to me like the EBIT margin is to be something in the mid-17% range, and that your OpEx has to be stepping down pretty materially in the September quarter. I guess the question is around is my math right? The OpEx is coming down that much in the fiscal fourth quarter; what does that imply for the OpEx trends into fiscal ’16? Are you getting the full restructuring benefits, and can you hold those levels, or are there going to be changes as we think about fiscal '16 OpEx?

Mark, your numbers are certainly in the ballpark. We have indicated we expect to close the full year out well north of 16%, which implies a nice uptick into the fourth quarter. Some of that is certainly the OpEx spending; it’s the data and devices restructuring, as well as the restructuring that we are doing in the oil and gas business to a much smaller level than what we are seeing in the data and devices. Plus the refocusing of that data and devices business by exiting some unprofitable product lines. You see we are actually reducing revenue, but not only raising operating margin but also raising operating income dollars. That gives you a nice lift. So it’s not all OpEx; it’s some gross margin lift also, but definitely a nice lift into the fourth quarter.

I mean, do you have the year-over-year transportation business up more than usual because of what I said and the SubCom relative to last year especially? So you have the three big levers, but Bob talked about costs, the margin effect of transportation and SubCom.

Okay. And then for a follow-up question on the industrial segment, I understand you are seeing some weakness in the oil and gas end markets specifically. Some of the bigger industrial companies have seen weakness outside of oil and gas and just traditional industrial and appliance type end markets. I missed the 1Q numbers; have you guys seen anything in your recent order patterns or just the conversations with your customers that would indicate any broader weakness in industrial outside of oil and gas?

I wouldn’t say broad, and I think just all the shocks to the system—between oil prices, the dollar strengthening, and Russia’s lingering situation—as people kind of are concerned. If you look at the core pieces of our industrial business, we are not seeing it in aerospace and defense; we are seeing it in oil and gas to your point. We are seeing it in industrial equipment; we are keeping an eye on China. What happened in our quarter is that China softened and Europe was strong in industrial equipment in the second quarter from both the sales and order rates. It’s kind of a mixed bag for sure. There is not a lot of momentum in the growth rate, is the way I would say it. I thought 90 days ago there would be more momentum in the world from a growth point of view, and it’s kind of going just sideways. There are pockets of industries like auto that overall are continuing to have a very positive outlook and doing well, particularly auto in a couple parts of the world. But it's a real mixed bag; it’s not a circumstance that has been one comfortable, I would say.

Thank you very much.

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

Thanks for taking my question. Tom, you've mentioned that in the data and devices segment, you're exiting some low-margin products. Could you clarify how much of that remains and what kind of margin improvement we can expect from it?

Sure. We are getting through it. It's on the other side I would say. Most of the heavy exits are a little bit left to do. The way we think about that business with the combination of a more focused product line and the cross actions we are taking is that it should contribute to EPS growth next year. As you start going out to the next year, we expect that business to start closing in on double-digit margins.

Thanks. Can we have the next question please?

Thanks very much. And the bridge to the financials was greatly appreciated. I have a question regarding Slide 5. So if you take a look at Slide 5 on the transportation side, I see that you show auto up 4% and then you have a little note on 1% unit growth. So if I do the math correctly, that shows about 3% content growth net of ASP erosion. So I am just kind of scratching my head here—are there content growth supposed to be about net 4% to 6% driven by about 6% to 8% content growth plus ASP erosion of 2% long-term? So was pricing more aggressive or content a little bit less, or was this more of a rounding error, or is my memory and math wrong? Because I thought kind of the general rule of thumb was global auto’s long-term 1% to 3%, which is 1% this quarter, which is fine. And then you have got 6% to 8% content less ASP erosion of 2%, so kind of a long-term growth rate of adding 4% to 6%. So, if you could just kind of help me out a little bit about what’s going on there; maybe it’s just a rounding error?

The model we always refer to is production is what it is. This quarter was 1% content; it’s 4% to 6% and price is 2%. We don’t net price in that scenario against content. Four to 6%, so it’s not 6% to 8%. If we netted price, it would be 2% to 4%.

Got it. Okay, great. Regarding content growth for cars, is it being relatively stable growth, acceleration, or with oil prices going down, has there been a deceleration, or can you talk a little bit about the content growth of what you are seeing?

It’s pretty stable. I mean, it really hasn’t changed that much. What we see is in every part of the world, content growth is going up. Some parts of the world, the European cars have the highest content, but everybody continues to move up. The biggest—the three big drivers, right, safe, green, and connected—there is just more safety, everything from more airbags to better breaking systems, stability control, things like that. You have the connectivity, which is really increasing; then you have emissions or green, which is driving a lot more electronics around the engine and the powertrain in general, which requires operating margin connectivity and more sensing to optimize the performance of the engine so that you can hit the emission target. Generally, we have not seen any significant shift in the trends.

Great, okay. Thanks so much guys.

Alright, thank you Jim. I think we have no further questions, so if you do have further questions please contact Investor Relations at TE. Thank you for joining us this morning and have a great day.

Thanks everyone.