TE Connectivity plc (TEL) — Q1 2016 Earnings Call Transcript

Good morning. And thank you for joining our conference call to discuss TE Connectivity’s first quarter results. With me today are Chairman and Chief Executive Officer, Tom Lynch; President, Terrence Curtin; 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 accompanying slide presentation that address the use of these items. Press release and related tables, along with the slide presentation, can be found on the Investor Relations portion of our website. Finally, for participants on the Q&A portion of today’s call, I’d 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 comments.

Thanks for joining us today. Here are the key takeaways from today’s call. We’ve begun fiscal 2016 with a quarter of solid execution, delivering $0.84 in adjusted EPS, $0.08 above the high end of guidance, with sales slightly above our midpoint. This was driven by strong performance in our transportation segment and SubCom business, in combination with tight cost management in light of the macro environment. Excluding the impact of currency exchange rates, Q1 adjusted EPS was flat year-over-year and adjusted operating margins of 15.7% were ahead of expectations. For the full year 2016, we are reiterating our adjusted EPS guidance of $4. This represents an 11% year-over-year growth and a 15% growth in constant currency. Relative to our view last quarter, the transportation segment is a little stronger, with global auto production expectations improving. In industrial, our direct business with OEMs developed as expected and appears to be stabilizing, but sales through our distribution channel were weaker than expected, and the recovery is taking longer than anticipated. The oil and gas market remains very weak, with derivative effects impacting some other industrial markets. The midpoint of our annual guidance assumes 2% global auto production growth in our fiscal year. We’re also assuming sequential improvements in industrial sales and orders in the second quarter and into the second half. For the full year in communications, we assume double-digit growth at SubCom, second half growth in appliances, and continued decline in data and devices. By region, we assume that the overall U.S. and European economies continue to grow slowly, and China returns to growth in our markets in the second half. We continue to take a balanced approach with our capital strategy, and over time expect to return approximately two-thirds of our free cash flow to shareholders through dividends and buybacks, with a third of free cash being used for acquisitions, and we will talk more about this later in the call. We are very pleased with the performance of the businesses we acquired last year and will continue to look for acquisition opportunities that broaden our ability to address harsh environment applications and provide integrated solutions to our customers. We believe that integration is another emerging secular trend for our business and we are well-positioned to capitalize with our broad portfolio of products. In sensors, our unmatched presence across virtually every industry, coupled with a broad technology and product portfolio, enables us to expand our design win pipeline across market verticals and provide integrated solutions in certain applications. In medical, we have increased our presence in the high growth minimally invasive market and are well-positioned to provide integrated solutions to our customers that incorporate our connectors, sensors, fine wire technology, and material science know-how. While we can’t control the macro environment and inevitable economic cycles, we have positioned TE around harsh environment applications and continue to benefit directly from the secular trends of electronic content growth. We believe TE is uniquely positioned to provide highly engineered solutions that integrate connectors, sensors, and other technologies to improve reliability, lower cost, and increase performance, making the Company an increasingly valued partner to our customers. We have secured several key integrated solution design wins, particularly with major auto OEMs over the last several months. Now, please turn to slide three for a summary of Q1 results. While we continue to have the backdrop of a challenging macro environment, we generated adjusted EPS above the high end of the guidance, with sales slightly above the midpoint of guidance. Sales of $2.8 billion were down 7% year-over-year, but down only 1% in constant currency. Adjusted EPS was down 6% year-over-year and flat in constant currency. Performance above guidance in the quarter was driven by strength in our transportation segment and higher sales in SubCom, as a key program moved to completion earlier than expected. This, coupled with tight cost control, more than offset industrial being a little weaker than expected in the quarter. We generated adjusted operating margins of 15.7% in Q1 which were ahead of expectations, and our adjusted EBITDA margins were 21%. During the quarter, we returned $1.4 billion to shareholders including $1.3 billion in share buybacks. The Board of Directors also approved the recommendation to raise our dividend by 12%, with an annual rate of $1.48 per share. We expect this to be approved by shareholders in March and be effective in June. We also paid $127 million in dividends in the quarter. In addition, we returned approximately $1.3 billion of cash to shareholders due to share buybacks. While down year-over-year due primarily to weakness in China, our transportation segment sales were above expectations with better than expected demand in China. So, China was weak, but it was not as weak as we thought. In the industrial segment, our direct business with OEMs performed about as expected, but we did see lower sales through the distribution channel. Overall, we continued to perform well in harsh environments in applications, last year’s acquisitions in sensors and medical gaining momentum. During the quarter, we announced the sale of our circuit protection business, which is on track to close later this quarter. Before we get into the segment update, I’d like to provide a brief insight into order patterns, which will help provide a baseline for our results and expectations. Please turn to slide four. Organic orders were down 3% from the prior year but were better than our expectations 90 days ago. Orders were up 3% sequentially excluding SubCom and our book-to-bill was 1.04. China orders were up 11% sequentially on an organic basis, and better than expected. These data points are positive indicators for our expectations of second half sales growth. One area that doesn’t remain weak is the distribution channel, where our expectation of sales and orders recovery has pushed out slightly versus our prior view. Distribution accounts for about 15% of our total sales. Transportation orders improved 7% sequentially, reflecting incremental growth in global auto production expectations. During the quarter, we saw our industrial orders stabilize and grow slightly sequentially, with direct orders improving in line with expectations and weakness in the channel that I previously mentioned. Communications orders, excluding SubCom, declined 9% sequentially, driven by previously announced product exits and weakness in the distribution channel. To provide a little additional color on China, while both orders and sales were down year-over-year in aggregating Q1, we are seeing improvement in auto production; we saw a year-over-year organic growth in orders in transportation. We continued to see China weakness in the industrial and communications segments but are expecting growth in the second half as inventories come more in balance. Excluding SubCom, our book-to-bill ratio was 1.04 in Q1, with all segments book-to-bill exceeding 1.0. With that backdrop, I’ll now turn it over to Terrence to cover each of our segments in more detail.

Thanks, Tom, and good morning, everyone. If you could please turn to slide five and we will start with transportation solutions. Sales grew 1% organically in the quarter, above our guidance expectations due to China sales being stronger than we anticipated. Overall segment organic growth of 1% was driven by automotive and sensors. Our auto sales organic growth of 1% in the quarter was driven by Europe growing 6% and North America growth of 3% offsetting the expected reductions in China that Tom talked about. With the orders that we experienced along with production schedules, we expect China to return to growth in the second quarter, reflecting the positive demand impacts from the government tax incentives that are driving increased production levels. For fiscal 2016, we now expect global auto production to be up 2% to just under 88 million vehicles, with China production up 6% compared to 2015. This compares favorably to our view last quarter when we expected global auto production with China production growth of only 2%. We continue to be confident that our auto business can grow well ahead of production as it’s included in our annual guidance, and this is driven by electronic content growth and a rich pipeline of platform ramps from design wins generated over the past several years. As expected, our commercial transportation business was down year-over-year, driven by weak global construction and agriculture market and weakness in the North America heavy truck area. While our sales declined versus last year, our organic orders were up 10% sequentially as we’re seeing signs of this business stabilizing. We expect to be up to flat low single digits on an organic basis for the year. Turning to sensors, our business continued to show strong momentum in the quarter in both sales and design wins. Aligned with our acquisition rationale, we are using the existing TE go-to-market teams to take new products and system-level solutions to our customers. This results in new sensor program awards to cross multiple market verticals. TE is uniquely positioned with the world’s broadest portfolio of connector and sensor solutions, and we have recently been awarded design wins in the automotive space and integrated multiple components to provide a complete solution to our customers. In this segment, adjusted operating income was $280 million in the first quarter. This was down year-over-year due to currency, a change in product mix, and our continuous investment for growth in automotive and sensors businesses. Adjusted operating margins came in higher than we expected and we anticipate the second half margin to be at 20% or above. Please turn to page six to discuss our industrial solutions segment. Aligned with our expectation, revenue in the segment declined 6% organically year-over-year in the first quarter. As Tom mentioned, we are being impacted by weakness in the distribution channel which is almost 30% of the segment sales organically. Distribution sales were down 6% organically in the quarter, as we see broad-based supply chain corrections occurring that we highlighted last quarter. Our direct sales to OEMs are improving in line with our expectations and we saw our OEM orders improve sequentially by nearly 3%, while orders through the channel partners remained flat sequentially. We currently expect that our distribution partners will continue to work through the second quarter to get in line with OEM demand. In addition to the distribution channel, we continue to be impacted by the oil and gas market. You can see on the slide, we broke this out separately this quarter, and it shows the 44% organic reduction in sales year-over-year in this market and the impact that’s having on the segment. With the weakness in the oil and gas market, our business is now running at approximately $30 million per quarter, down from approximately $60 million per quarter a year ago. We have seen order rates stabilize around the $30 million level, and we expect a more favorable year-over-year comparison in the second half. I also want to highlight that low oil and gas prices are also having some derivative effect in other areas of the industrial segment, impacting sales in our industrial equipment business and areas like factory equipment and rail and also in helicopter demand, which affects our aerospace business. These derivative effects are reflected in our guidance and our results. In the commercial aerospace and defense business, our momentum remains strong, with the slight year-over-year decline driven by the defense business due to program timing. We remain very well-positioned with our program wins in the space and expect to benefit from growth in the commercial aerospace as the defense market continues to improve. Our energy business grew 4% organically with strength in Europe and the Americas more than offsetting softness in China. From an adjusted operating income perspective, it was $78 million in the first quarter, down year-over-year, as expected due to the impact of currency, declines in our higher margin oil and gas business, and 6% organic decline in the channel. If you exclude the oil and gas business and FX impacts, our operating margins remained constant year-over-year, reflecting the benefit of our TEOA program as well as cost management. If you could turn to slide seven, please, so I can talk about communications solutions. In the first quarter, the segment revenue of $617 million was down 6% and 3% organically as expected. Our SubCom business saw a strong year-over-year growth as we successfully completed the America, Europe connect program earlier than our original plan. We now expect SubCom to grow low-double-digits for the full year, which is slightly better than our expectations 90 days ago. Our data and devices, and appliance businesses were impacted by the slowing in China as well as the supply chain adjustments by our distribution partner, similar to that I talked about in industrial. We expect this to be largely behind us as we head into the second half of the year. And just to remind you, data and devices growth is also impacted by the product exits that we initiated late in 2015 as part of our repositioning effort. From a margin perspective, adjusted operating margins expanded 380 basis points year-over-year, which was above expectations, driven by the early completion of the program in SubCom that we highlighted. Now, let me turn it over to Bob who will cover the financials.

Thanks, Terrence, and good morning, everyone. Please turn to slide eight where I’ll provide more details on earnings. Our adjusted operating income was $444 million, down 5% in constant currency due to investments in transportation, impacts of oil and gas weakness, and the distribution inventory corrections impacting our industrial segment that Terrence covered. Including $30 million of foreign currency headwinds, operating income was down 11% from the prior year. GAAP operating income was $398 million and included $6 million of acquisition-related charges as well as $40 million of restructuring and other charges related to data and devices product exits, elimination of corporate stranded costs from BNS divestiture, and general cost reductions. Our Adjusted EPS was $0.84 for the quarter, down $0.05 from the prior year, with reduced volume from higher margin products and negative impacts from foreign currency exchange rates, offsetting incremental benefits from the share buyback. Excluding the $0.05 impact from foreign currency, adjusted EPS was flat to the prior year. GAAP EPS was $0.83 for the quarter and included acquisition-related charges of $0.01, restructuring and other charges of $0.07, and $0.07 from tax-related income. I now expect approximately $85 million of restructuring charges for the full year of 2016, a $10 million increase from our prior guidance 90 days ago. Please turn to slide nine. While we remain in a challenging environment, the progress we’ve made with TEOA and productivity initiatives enabled the business to demonstrate resiliency, as reflected in our margins. Our adjusted gross margin in the quarter was 33.4%. While this was down from last year due to lower sales and higher margin products, it’s up 90 basis points sequentially from Q4. As Terrence discussed in the industrial section, we’re seeing softness in some higher margin businesses like oil and gas and lower sales to the distribution channel. Adjusted operating margins declined 70 basis points, driven by lower volume and product mix while benefiting from the early completion of the SubCom program in the quarter. Total operating expenses were $502 million in the quarter, down 8% from the prior year. We continue to tightly manage discretionary spending, but are also continuing to invest in our harsh businesses. In the quarter, cash from continuing operations was $367 million and our free cash flow was $237 million, up from prior year levels due to lower working capital and reduced revenue and timing of SubCom payments. We continue to have a balanced capital allocation strategy. In Q1, we returned $1.4 billion to shareholders including $1.3 billion in buybacks. In the quarter, we bought back nearly 21 million shares, executing against our commitment of returning the proceeds in the Broadband Network’s divestiture. We’re also introducing a chart on EBITDA margins, which better shows the profitability performance of our businesses, including acquisitions. EBITDA margins in Q1 were 21% and show our margin resiliency despite lower sales levels. We continue to be pleased with the operating performance of our business, especially in light of the challenging macro backdrop. Also, you may have seen in the 8-K filed yesterday that Tyco International, on behalf of TE Connectivity, has entered into an agreement with the IRS to resolve all disputes related to the previously disclosed intercompany debt issues. The resolution would result in a total cash payment to the IRS from TE Connectivity of between $147 million and $163 million, which includes all interest and penalties. We are pleased with the proposed settlement and look forward to having this behind us in the near future. Of course, we have also added a balance sheet and cash flow summary in the appendix for additional details. Now, I’ll turn it back to Tom.

Thanks, Bob. Please turn to slide 10, and I will cover Q2 guidance at a high level, with additional details provided in the slide deck. We expect Q2 revenue of $2.88 billion to $3.08 billion, down 3% or 1% organically, and adjusted EPS of $0.84 to $0.92, down approximately 3% year-over-year at the midpoint but flat in constant currency. Versus our view last quarter, we expect transportation to be a bit stronger, industrial to be a bit weaker, and communications to be impacted by the early completion of the SubCom program we discussed earlier, and most of that was in Q2 when we guided last time. For the full year, we expect revenue of $12.3 billion at the midpoint, up 1% versus the prior year and reflecting 4% organic growth at midpoints. We are reducing the top line by about $100 million, reflecting the sale of our circuit protection business that we expect to complete this quarter. Our adjusted EPS guidance remains at $4 and represents year-over-year growth of 11% at midpoint. On a constant currency basis, revenue is expected to grow over 3% and adjusted EPS is expected to grow by 15% year-over-year. Versus our prior view, transportation is expected to have higher growth, industrial is a little weaker, and communications is weaker factoring the impact of the sale of the circuit protection business. I think you heard a constant theme that transportation is a little better, industrial is a little weaker, but overall, no big change from the prior guidance. Our full year outlook is based on the following market and regional assumptions. In transportation, we expect mid-single-digit actual and high single-digit organic growth. We are assuming that global auto production is up 2% year-over-year, which is an improvement from our prior view of flat production. We are anticipating China auto production to grow 6% year-over-year. We expect another year of strong growth in our sensors business. In industrial, we are assuming flat actual and low single-digit organic growth. We have seen orders stabilize in some industrial end markets, and we assume inventories come into balance by the end of Q2, ending the negative supply chain effect on our business. We continue to assume a weak oil and gas market, and will continue to see the signs of the negative impacts in other adjacent markets in the industrial space, which is also factored into our guidance. In communications, we assume high single-digit actual and low single-digit organic declines, but growth in SubCom and appliances being more than offset by product exits and the sale of the circuit protection business in data and devices. By region, we assume Europe and the U.S. to continue to improve with China markets rebounding in the second half. Outside of auto, China markets are as expected 90 days ago. Our guidance does assume a 53rd week in current currency exchange rates. As the year progresses, we have much less of a headwind from FX translation and an increase in earnings tailwind from our share repurchase program. We remain positive on our outlook and at several levels to drive growth in a very challenging macro environment. As a result of the transformation of our portfolio and increased focus on harsh applications, we are well-positioned with differentiated solutions for our customers. The secular trend of constant growth is increasingly apparent in our served markets and our ability to produce integrated solutions that solve system level challenges for our customers will enable TE to continue to become an even more valuable strategic partner for our customers in the future. These factors combined with our TEOA initiatives and capital strategy are expected to drive consistent double-digit earnings growth. Now Sujal, let’s open it up for questions.

Thank you, Tom. Cynthia, could you give the instructions for the Q&A session?

Thanks, good morning guys. So just to start with on the industrial segment, could you just talk about the margin ramp expectations as you go forward after the December quarter numbers, and are there any incremental cost-cutting initiatives that you guys are thinking about to help drive these margins potentially towards the mid-teens to corporate averages?

It is Bob. Good morning. We have some additional restructuring updates; our previous guidance included $75 million for restructuring, which I am now increasing to $85 million. In the first quarter, we incurred $35 million in costs. We executed our planned actions a bit sooner than anticipated. Therefore, we expect to see benefits in the latter part of the year from both this acceleration and the increased spending. This spending is not specifically targeted at the industrial sector; instead, it focuses more on data and devices where we are making product exits and on corporate expenditures that affect all our segments due to stranded costs from BNS. There will also be some added activity and benefits in oil and gas that will positively impact the industrial sector. Overall, as we anticipate a recovery in volume, particularly while addressing the final effects of distribution inventory channel recovery in the second half of the year, we expect margins to improve. In the current quarter, margins were at 11% despite a decrease in revenue. Specifically, oil and gas has a high margin in the distribution channel, and while we are facing negative impacts, we anticipate these will improve in the latter half of the year.

As a follow-up on the March quarter guidance, I apologize if I missed this, but you are expecting sales to be up sequentially, however, the EPS guidance implies a decline in operating margins. Is there a gross margin improvement expected sequentially or will operating expenses increase, and if so, could you discuss the reasons and the extent of that increase?

There are a number of moving pieces as you move from Q1 to Q2, probably the biggest one, and Tom and Terrence alluded to this a little bit and I made a brief comment on it in my opening remarks. Part of the benefit in Q1 was the timing of the completion of the SubCom program, which is a very high margin. As you wrap up a SubCom program, you typically record very good margins on that last guest spending. And that is pure timing that was completed earlier. So, we saw the benefit in Q1 that holds directly out of Q2 and to some extent Q3.

Question to Tom, the opportunity in auto seems intriguing in terms of you are talking about integrated products. So, just want to get some background there in terms of the technology pieces you have to offer, really as you interact with customers and suppliers, kind of how you see the market evolving there and how you can play into that?

In our core connector business, we offer an extensive range of products that are integral to every aspect of the vehicle. This is backed by nearly 2000 engineers who engage directly with our customers. This presence allows us to provide a diverse selection of connectivity solutions. Additionally, we have expanded our offerings to include sensors and various sensor technologies, along with sealing and protection products and relays. We have been integrating on a small scale for years, but the inclusion of sensors in our product lineup enables us to tackle more complex applications. We can now combine multiple products that used to be supplied by different vendors into a single subsystem, simplifying the process for customers by providing one point of contact. While we have previously engaged in this type of integration, the addition of sensors has broadened our capabilities significantly. Recently, we secured some substantial design wins, although shipments for these projects won’t commence for about a year to two years. Our broad product range, coupled with our engineers' insights from direct collaboration with customers, allows us to understand their architectures almost as well as they do. We have a wealth of engineering expertise, and our customers share their objectives with us, rather than merely requesting specifications. This communication opens up opportunities for us to deliver tailored solutions.

And just as a follow-up, certainly we’ve seen a lot of volatility and pressure in the equity markets, I am just curious as you look at your M&A pipeline and on the private side, do you think there could opportunities, any thoughts on that for M&A?

Our strategy focuses on harsh environments, connectivity, and sensors, which has led to a strong pipeline aligned with our product strategy. The first part of your question relates to our acquisition approach. We aim for customer synergy in our acquisitions rather than just acquiring components. Last year, we completed acquisitions that added around $700 million in revenue. We intend to keep integrating technology and products into our offerings, enhancing our engineering, sales, and marketing capabilities in front of customers. This approach essentially equips us with more tools that customers desire, creating a powerful business model. We are selective in our acquisitions, ensuring they are a good fit, but our pipeline remains active. Terrence, would you like to add anything?

No. I think Tom, you handled it well. When you look at last year, we did do for last year, certainly the big one around measurements in the sensors, as Tom talked about. Also in the medical space that is another example of a harsh environment application, leveraging the capabilities, as Tom talked about your first question Craig. So I think you are going to continue to see things like that. When you think about the pipeline momentum we have, we feel very good about it. I don’t think there is anything that has meaningfully changed even with all the macro backdrop as we look at the pipeline to sort of answer one element of your question.

Your restructuring charges incrementally are going up 10 million over here. But is that enough given that the near-term weakness in data and devices is really pronounced; organic revenues were down close to $90 million, it’s the largest decline in share dollar amount relative to much larger segments. I’m curious, how you see this progressing, especially given that you’re also divesting the CPD business? And I have a follow-up.

Wamsi, the $85 million as I mentioned is a small increase. We did spend quite a bit of restructuring last year, particularly at data and devices proactively, got at some of the costs as we execute against those product exits that we initiated in the first part of 2015. We took a lot of restructuring charges and started actions. Then as we continued to execute against those exits and revenue declines, that’s what’s driving some of the incremental spend. So, we got out in front of it early on in 2015 as we announced those exits, and we continue to take out costs where appropriate.

And as my follow-up, so what’s the margin trajectory that we should assume ex-SubCom within data and devices? Should we be expecting some of these past actions to start to bear fruit from the margin front here through the next couple of quarters? I’m assuming most of the operating margin improvement in those segments came from better SubCom performance in this quarter.

Hi Wamsi, this is Tom. I would say you’ll see it next year. The market outlook is pretty weak, and we’re losing a lot of revenue; most of it is very low margin. However, by the time we finish this year’s restructuring and the product exits, we expect to build margin momentum. As we’ve mentioned before, about two-thirds of the business is solid; that consists of the core, highly engineered products we offer, so next year I wouldn’t expect much from this year.

Wamsi, just to remind you, we’ve got product exits or the divestiture of the circuit protection business that’s part of data and devices that will impact us in the second half of the year. We expect to complete that here in the current quarter.

I have a question regarding your comments about the distribution inventory correction, which seems to be extending into another quarter. Are you sensing that sellout in distribution has stabilized and is relatively normal, or is there just an inventory build that needs to be reduced? Alternatively, do you feel that sellout for distribution is still weak or possibly getting weaker?

I’m going to let Terrence handle that one; he was just with that group.

Hey Matt, good morning; a couple of insights. I think when you look at it, one of the things that was weaker, we actually saw the inventory come down as expected with our partner, but sell-through was a little weaker than we expected, which is why we see supply chain correction happening impacting our channel partner. The inventory bring down in the first quarter on what they had was there with the sell-through was weaker. But we look at it as also the direct order patterns that we see. What we see in the direct order patterns, on terms that Tom talked about, as well as what we’re seeing elsewhere, it does look like it’s going to be another quarter or so that we’re going to have our partners and expect that sell-through to improve. So, when you look at this quarter, we still expect it to be a weak sell-through quarter. I think when you take our segments like industrial, I think what we talk about, about this quarter, we will expect the same sort of next quarter from the channel element of it. So, they’re still being worked through, and sell-through was a little bit worse than we thought.

Okay, fair enough. It looks like some of the semiconductor suppliers that have already announced earnings have talked about that inventory correction having played out. They tend to lead by a quarter or so. So, that may be encouraging. And just as my follow-up regarding the recent divestitures of BNS and then now the circuit protection business, are there other things that you’re looking at to divest or is that pretty much done, specifically in the data and devices area where it looks like you’re putting down and deselecting revenue, but are there other parts of that business that you could sell off?

No Matt, you expressed it well. It’s primarily about exiting certain product lines now. We believe the portfolio is very strong with 90% in sensors and connectors, and 80% in harsh environments. Even within the data and devices segment I mentioned earlier, the products there are excellent and quite profitable. Circuit protection was mostly a standalone business focused on the consumer market. So, while I’m cautious about making definitive statements since circumstances can change, we’ve completed the major challenges.

Hi guys, thanks. It’s Ryan filling in for Mike. I just had a question on the destocking that you guys are calling to and this next quarter. What are customers telling you guys that give you confidence that this is happening? And give a rough sense of how much destocking took up the overall orders, and particularly in the industrial segment?

A couple of things, what our customers are telling us, certainly we’ve seen, we have their orders with that increase. So as Tom highlighted, both in transportation and industrial, we saw sequential order increases and that was driven by direct activity. When it comes into the actual destocking amount, we did think that was around $20 million in the quarter, actually inventory but the sell-through was a little bit worse than we expected, which is why we think it’s going to work through in this quarter. As we try to look at our channel partners, they do have to get back to OEM demand that has come back to parity at some point.

What I would add to that Terrance is our actual orders from the channel partners were flat this quarter and they had been declining for three quarters. So, it’s one data point and as Terrance said earlier, we’ve got to see the sell-through pick up. We feel like when you look at the direct business still growing albeit low growth that over time the channel converges with that. Now we are projecting it will converge into low growth based on the trends we’re seeing.

And just a quick follow-up; is there any material end market differences or product differences that explain the trend differences between OEM and distribution, other than just destocking?

Distribution is pretty broad-based, so the trend that we have actually seen has been broad-based and that’s why you see both the impact in the industrial segment and the communications segment. When you look at the direct business, it varies by end market dynamics. So certainly, things like commercial aero are very strong, oil and gas weak, but on the channel side it’s pretty broad-based.

I wanted to talk about the auto sector for a moment. Your team has always taken a practical approach to production rates and market trends, and it appears that fiscal '16 may perform better than initially expected. My main question is whether we are entering a peak production phase. How long do you think this strength can continue, considering that content will always play a significant role? Are there any markets you are worried about potentially peaking in 2016?

I would suggest looking at this from a regional perspective. Europe hasn't fully recovered to the demand levels seen before the financial crisis. In the U.S., although 2015 was a record year, the average age of vehicles is still slightly above normal, and if that changes significantly, it could be a cause for concern. China is experiencing a natural slowdown but is still projected to grow at a reasonable rate of around 5% or 6% in the long term. The emerging markets are seeing more people moving into the middle class, which indicates they will have better living conditions and increased car purchases. These trends appear promising. Last year's auto production declined a bit compared to the previous year, and this year it's expected to grow around 2%. While it may feel quite active in the U.S., globally, production is a bit below historical growth rates for fiscal 2016. Additionally, regarding your other point, content growth remains steady across all vehicle types and is not showing signs of slowing down. The emphasis on green technology should continue, even with current low oil prices, as the content in hybrid and electric vehicles significantly exceeds that of traditional combustion engines. We believe that the positive factors outweigh the negatives. There will be fluctuations, but the past five years have been somewhat better than the previous five, which were below typical levels.

And then as the follow-up, I guess I’m struggling with the flat sales in industrial for the year because the first half of the year, understanding all the dynamics, are probably going to be down mid to high single digits year-over-year, implying you need similar type of growth into the second half. The direct sales within industrial I think you quote, it was up 3% here in the December quarter. So, there is an implication that we either see some restocking event or some acceleration of true underlying demand in the second half across the entire portfolio. I guess I’m trying to dig into whether you expect any restocking in the second half of the year or where you expect the demand to accelerate to even flat for the year?

A couple of things, Shawn, I do think we are a little bit high on an organic basis when you take currency out. When you look at it, there we do expect our overall direct business to be about plus 3%. We’ll get some of the anniversary effects. We do assume that our channel business will get back to parity where we ran last year in the latter half. There is a little bit of a restock that happens in quarter four due to quarter four being very weak that we talked about last fourth quarter. There are some of those effects that help you get closer to flat. We have program launches that are going to take place in medical, which gives us something that helps in that dynamic. We do expect in major industrial areas, we do expect again from commercial aerospace, and medical programs that drove certain upticks the second half is important and the challenges we face from distribution channels were going to become more like it was earlier in 2015.

First, I would like to dig a little bit into the sensors business, in particular in automotive. It sounds like these are integrating functions that might have already existed in the car. Is that a fair way to look at what’s happening, and the dynamic in this part of your business may be more of a share gain versus a competitor standalone sensor competitor in that area, or is this more sort of new content?

It’s a combination. Currently, we see the most opportunity in the power train as customers develop their power train and the ability to integrate various components such as subsystems, sensors, connectors, rounding, sealing, and more. This is where some of our most exciting opportunities have emerged. We believe that larger, more complex content will present the biggest opportunities.

And maybe you can help me also think about your share and your opportunity in that market. I think you have a very substantial share of automotive connectors and very small share in automotive sensors. Are you seeing any initial effects in sales, not just design wins but actual sales in that market today? And what do you think the pace of your share gains over the next several years?

I think it moves slowly. It’s not in our sales yet. We are selling at a high single-digit growth rate products we have in sensors. So that’s playing out very nicely according to plan. I would say the design rate in some of the applications that we’re penetrating is playing out ahead of plan; some of them are more complex applications in the auto space. But it will take some time; you are right, significant connector share. We feel the opportunity continues gaining as we have been with the new applications we are bringing, and we’re getting design-ins across all of those in the auto space, industrial transportation space.

If I can squeeze in one clarification, is the circuit protection revenue included in the March quarter guide or is that excluded from the full year; how’s that working? We expect that transaction to complete in the latter part of Q2, so in part of Q2, it is out for the second half for the year essentially driving the reduced guidance on a full year basis.

Just a couple of questions on margins; just looking at the base of gross margins you just reported, the 33.4%, you mentioned a bunch of different mix issues going forward: distribution, SubCom, appliance, etc. How does the gross margin get affected as we go through the rest of the fiscal year by all these mix changes coming and going? And then I had a follow-up.

Steve, there are always mixed issues, both positive and negative. In the current quarter, we are experiencing a negative mix in the oil and gas sector within the distribution channel, particularly alongside the positive performance in SubCom. The benefit from SubCom in the first quarter is mainly a timing issue, largely related to the second and third quarters. We anticipate the oil and gas segment to continue facing challenges until the end of the second quarter, when we will start to see easier year-over-year comparisons. As Terrance mentioned, we have one more quarter of inventory correction and lower point of sale to navigate in the distribution channel. This situation should improve in the second half of the year. Additionally, we expect to see reduced foreign exchange impacts, as the dollar's strength began in the second quarter of last year and that year-over-year effect will lessen. Moreover, we will benefit from additional restructuring savings and lower metal costs in the second half of the year, which will help boost overall gross margins going forward.

So, it sounds like, if you add all those up, that’s probably a lot of math to do right now, but that you have more tailwinds around gross margin than headwinds as you get into the second half of the year, even excluding the volume pick-up?

Yes.

And then just a quick follow-up question on the SubCom business. I understand timing had an issue to play here in terms of the margin impact, but if you smooth out this quarter and last quarter in terms of volumes, and then look to this double-digit growth you’re talking about for the full year, where are the margins improving to in SubCom; how much increases coming through and where are they at versus maybe prior peak levels? Thanks.

Yes. What we said on SubCom is at the $750 million, $800 million range we are at, we get into the double-digit range. As we see additional volume, if new programs were to come into the force, if that volume were to ramp up say to $1 billion, which is really where we peaked in prior years, you start getting up into the Company average of 15% to 16% operating margins.

Hi, thanks. I just wanted to confirm my understanding of the operating margin dynamics across the different segments. From what I gathered, the transportation margins are expected to improve to 20% or higher in the second half, the industrial margins are also projected to improve in the latter half of the year, while the communication segment's margins are anticipated to deteriorate in the second and third quarters. However, it seems that they are expected to recover in the fourth quarter, and I would like to ensure that I have grasped these dynamics correctly.

You’re exactly right Sherri on transportation and industrial, very consistent with what we were trying to describe earlier in the call. From a communications solutions segment, I think the way to think about it is if you just take out the timing benefit of the completion of the SubCom program, we still see improvement on a year-over-year basis we’re in double digits, just north of 10% operating margin. We’ll see that kind of negative impact into Q2, but then more in that 10% range in the second half of the year.

And that’s ex-SubCom?

That’s including SubCom.

Including SubCom, okay, perfect. And then I was hoping to get some comments, Tom, in terms of the macro environment from you. I think you said China is about as you had expected 90 days ago, but it sounds like most metrics are suggesting China is weaker. So I was hoping you could maybe provide a little more detail and maybe some detail on what you’re seeing in emerging markets.

Sure. I mean China is our big emerging market by far. We do have business in Latin America and India, but China is the big one. China was down as we said year-over-year in revenue. It was up sequentially, flat in orders, up sequentially in orders, which is a good sign. It came back faster than we thought. Now, it’s one data point. We have to see that continue. But we have the first sequential improvement in orders in a year, so that feels like a pretty good sign. We expected that to happen in the second quarter, and happening in the first quarter is encouraging. So that was a little better. If you go around the rest of the world, I think the U.S. in a way was a little worse because of the industrial and the channel, and oil and gas continues to be down, and as Terrence talked quite in detail about the channel. Europe continues to be steady; I think it’s 6 or 7 quarters of growth in a row now in Europe. We don’t see any signs of that backing off yet. Versus 90 days ago, the outlook feels slightly better because of the industrial OEM orders increasing sequentially and China orders increasing sequentially. Of course this is a key quarter for that to continue and to set up. We will get normal seasonal growth in the second half. We’ve been seeing our orders trend naturally the way they always do seasonally, as we get towards the second half of the year. But we expect them to pick up from the run rate because of the correction, primarily in the channel and secondarily, if China continues where it was in Q1, orders would be in good shape for China for the balance of the year, even if it doesn’t raise from there, stayed at that level. Terrence, do you want to add?

Sherri, just one thing I would like to add and highlight is when you look at China, China is over $2 billion of revenue for us and 50% of that is around our automotive business. When we talk about our China trends, I know it was a little bit better in our transportation area like Tom talked about, and certainly we see production increasing in China; I would say in the greater industrial and other spaces, it’s moving as we expected. It is a little bit more sideways. Orders are improving, but when you look at it overall, orders increased almost 10% from our fourth quarter to our first quarter, which is a significant step that we didn’t see, as Tom talked about, as our orders were stepping down quarter-over-quarter last year.

Thank you, Sherri. Could we have the next question, please?

Thank you and congratulations to you and your team there. A quick clarification question and my follow-up kind of back to back on the clarification, you mentioned a second half improvement in industrial. I understand the inventory and distribution issues, but what if oil stays at $30; I’m not smart enough to know if it’s going to go higher or lower but if it stayed at $30, is that supportive of your second half recovery view; does that pose a risk or does that impact it at all? And then my follow up is on the timing of the stock buyback given the BNS sale. Can you help us understand the cadence that we should expect about that? I mean on one hand, you’ve been very diligent and always bring back stock each quarter; on the other hand, one would say, well why not do a big accelerated program, so you get a bigger EPS benefit sooner, especially given the recent stock price volatility? Thank you very much.

Let me take the industrial question on oil and gas and Bob will take the share repo question. On oil and gas, one of the things that we have seen, certainly the program elements of the oil and gas market, we’ve seen in our step down of revenue. Like I said last year early in the year, we would run about out of $60 million per quarter. Our business as it’s come down and oil has been impacted, we’re seeing a lot of those large projects obviously not happening, and there is not being a lot of large projects being bid. The $30 million per quarter level that we have right now is sort of a maintenance type revenue level for us; it’s not a big project build. So whether it’s $25, $35, $40, I do actually think that’s a floor that we’re going to be pretty close to plus or minus a little bit. I do think that element that we have in our forecast reflects current oil prices.

Jim, regarding the share repurchases, our intention remains to complete the return of proceeds from the BNS transaction in the third quarter. We have considered various methods to return that cash during the period from announcement to actual closure and concluded that an open market transaction is the best option. There are several reasons why an accelerated share buyback isn’t feasible for us; primarily, as a Swiss company, we face different regulations despite being listed on the New York Stock Exchange, which complicates the accelerated process.

Can we have the next question, please?

The first question is on the automotive business. I understand the long-term content opportunity, but in 2016, given that you are seeing China stimulus targeted towards low-end cars, are you seeing any short-term mix effects that are headwinds for content in the near-term that you thought about?

Mark, hi; it’s Terrence, clearly size of engine does impact; it’s just not that meaningful. I think when we take the penetration that we’ve done in China, both with the local OEMs and the multinational OEMs, the mix effect isn’t what it used to be and it is reflected in our guidance. Certainly, it’s focused at 1.6-liter engines and below, the stimulus. What’s good is we cover every OEM there and we have content on it. It is in our guidance, but it’s pretty minor.

And then follow-up question for Bob on the potential tax settlement, if that does get finalized with the IRS, how should we think about both other income and the tax rate going forward?

As you might guess Mark, that gets really convoluted really quickly. I think the most straightforward answer to give you is the settlement is not yet final; it’s proposed; the two sides are largely agreed. We’re working through a lot of nuances within the IRS to get that finalized. At this point, anything I would give you would be speculation and hypothesis. We are very comfortable, and as stated in the 8-K, we are very comfortable that we are adequately reserved. So there won’t be an additional charge, and going forward, once the settlement is actually finalized, we will give some detailed guidance on the implication of other income and the go forward effect of the tax rate.

Thank you, Mark. It looks like we have no further questions. We thank you for joining us today. If you do have further questions, please contact Investor Relations at TE. We hope you all have a great day.